Nova Lifestyle, Inc. - Quarter Report: 2014 September (Form 10-Q)

novalifestyle10q093014.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2014
OR
¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 011-36259

NOVA LIFESTYLE, INC.

(Exact name of registrant as specified in its charter)

Nevada		90-0746568
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

6565 E. Washington Blvd. Commerce, CA		90040
(Address of principal executive offices)		(Zip Code)

(323) 888-9999

(Registrant’s telephone number, including area code)

Indicate by checkmark 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 last 90 days.

YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES x NO ¨

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

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Smaller reporting company x
(do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨ NO x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 20,787,316 shares of common stock outstanding as of November 10, 2014.

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Nova Lifestyle, Inc.

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		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013	1
	Condensed Consolidated Statements of Income and Comprehensive Income for the nine and three months ended September 30, 2014 and 2013 (unaudited)	3
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited)	4
	Notes to Condensed Consolidated Financial Statements for the nine months ended September 30, 2014 and 2013	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	34
Item 4.	Controls and Procedures	34

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	(Removed and Reserved)
Item 5.	Other Information
Item 6.	Exhibits	35

	Signatures	36

	Exhibit Index	37

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVA LIFESTYLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2014 (UNAUDITED) AND DECEMBER 31, 2013

	September 30,		December 31,
	2014		2013
	(Unaudited)
Assets

Current Assets
Cash and cash equivalents	$	1,867,461	$	2,323,338
Accounts receivable, net		37,730,838		27,967,831
Advance to suppliers		6,368,879		3,535,100
Inventories		6,095,466		3,353,634
Prepaid expenses and other receivables		1,018,799		648,620
Income tax receivable		--		38,654
Deferred tax asset		242,403		243,682

Total Current Assets		53,323,846		38,110,859

Noncurrent Assets
Heritage and cultural assets		131,791		132,993
Plant, property and equipment, net		14,517,939		13,146,638
Construction in progress		613,367		1,024,645
Lease deposit		92,550		103,122
Deposits		795,490		-
Goodwill		218,606		1,027,124
Intangible assets, net		6,608,218		6,976,991
Deferred tax asset, net		--		44,334

Total Noncurrent Assets		22,977,961		22,455,847

Total Assets	$	76,301,807	$	60,566,706

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NOVA LIFESTYLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2014 (UNAUDITED) AND DECEMBER 31, 2013

	September 30,		December 31,
	2014		2013

Liabilities and Stockholders' Equity

Current Liabilities
Accounts payable	$	8,353,551	$	6,895,254
Line of credit		7,167,715		820,089
Advance from customers		102,055		43,077
Accrued liabilities and other payables		1,426,931		1,458,157
Warrant derivative liability		2,818,689		--
Taxes payable		87,140		-

Total Current Liabilities		19,956,081		9,216,577

Noncurrent Liabilities
Line of credit		-		6,602,258
Deferred rent payable		79,685		74,152
Deferred tax liability		10,978		--
Income tax payable		6,458,094		5,944,424

Total Noncurrent Liabilities		6,548,757		12,620,834

Total Liabilities		26,504,838		21,837,411

Contingencies and Commitments

Stockholders' Equity
Common stock, $0.001 par value; 75,000,000 shares authorized, 20,787,316 and 19,206,024 shares issued and outstanding as of September 30, 2014 and December 31, 2013		20,787		19,206
Additional paid-in capital		24,183,997		20,977,058
Subscription receivable		--		(750,000	)
Shares to be issued		462,000		--
Statutory reserves		6,241		6,241
Accumulated other comprehensive income		2,473,274		2,603,010
Retained earnings		22,650,670		15,873,780

Total Stockholders' Equity		49,796,969		38,729,295

Total Liabilities and Stockholders' Equity	$	76,301,807	$	60,566,706

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NOVA LIFESTYLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED)

	Nine Months Ended September 30,						Three Months Ended September 30,
	2014			2013			2014			2013
	(Unaudited)						(Unaudited)

Net Sales	$	69,708,982		$	56,471,241		$	25,892,872		$	22,310,842

Cost of Sales		55,592,993			44,973,299			20,001,433			17,911,859

Gross Profit		14,115,989			11,497,942			5,891,439			4,398,983

Operating Expenses
Selling expenses		2,798,329			2,386,646			1,174,658			812,574
General and administrative expenses		5,799,195			4,381,147			2,128,469			1,880,448
Goodwill impairment		808,518			--			--			--
Loss on disposal fixed assets		28,963			--			6,437			--
											.
Total Operating Expenses		9,435,005			6,767,793			3,309,564			2,693,022

Income From Operations		4,680,984			4,730,149			2,581,875			1,705,961

Other Income (Expenses)
Non-operating income (expenses), net		164,280			(46,497	)		(2,721	)		(9,571	)
Change in fair value of warrant liability		2,841,177			--			630,264			--
Interest income (expense)		(100,917	)		(218,815	)		38,548			(76,349	)
Financial expense		(56,323	)		(106,229	)		(49,458	)		(39,883	)

Total Other Income (Expenses), Net		2,848,217			(371,541	)		616,633			(125,803	)

Income Before Income Tax		7,529,201			4,358,608			3,198,508			1,580,158

Income Tax Expense		752,311			772,135			77,825			359,232

Net Income		6,776,890			3,586,473			3,120,683			1,220,926

Other Comprehensive Income
Foreign currency translation		(129,736	)		313,811			(1,359	)		69,909

Comprehensive Income	$	6,647,154		$	3,900,284		$	3,119,324		$	1,290,835

Basic weighted average shares outstanding		20,133,976			18,778,902			20,861,990			19,026,934
Diluted weighted average shares outstanding		20,274,325			19,038,815			20,943,076			19,276,153

Basic net earnings per share	$	0.34		$	0.19		$	0.15		$	0.06
Diluted net earnings per share	$	0.33		$	0.19		$	0.15		$	0.06

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NOVA LIFESTYLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED)

	Nine Months Ended September 30,
	2014			2013
	(Unaudited)

Cash Flows From Operating Activities
Net Income	$	6,776,890		$	3,586,473
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		1,244,376			923,347
Deferred tax expense (benefit)		55,317			(17,179	)
Stock compensation expense		462,895			449,490
Warrants expense		76,629			48,747
Change in fair value of warrant liability		(2,841,177	)		--
Changes in bad debt allowance		76,438			22,947
Goodwill impairment		808,518			--
Loss on disposal of fixed assets		28,963			--
Changes in operating assets and liabilities:
Accounts receivable		(9,886,758	)		(1,594,509	)
Advance to suppliers		(2,839,808	)		1,083,200
Inventories		(2,761,204	)		31,344
Other current assets		(127,273	)		(434,290	)
Accounts payable		1,486,895			(2,034,541	)
Advance from customers		59,882			(209,094	)
Accrued expenses and other payables		(64,664	)		(37,491	)
Deferred rent payable		6,211			6,142
Taxes payable		678,640			413,876

Net Cash (Used in) Provided By Operating Activities		(6,759,230	)		2,238,462

Cash Flows From Investing Activities
Deposit on acquisition of Bright Swallow Int'l Group Ltd.		--			(3,500,000	)
Cash acquired from acquisition of Bright Swallow		--			342,029
Deposits on plant construction		(786,378	)		--
Purchase of property and equipment		(1,371,816	)		(467,964	)
Cash received from disposition of fixed assets		11,998			--
Construction in progress		(640,501	)		(319,309	)

Net Cash Used in Investing Activities		(2,786,697	)		(3,945,244	)

Cash Flows From Financing Activities
Repayment to related parties		--			(1,987	)
Proceeds from line of credit and bank loan		21,417,000			12,081,000
Repayment to line of credit and bank loan		(21,664,221	)		(12,762,396	)
Proceeds from subscription receivable		750,000			--
Cash received from warrants exercised		448,841			795,848
Proceeds from equity financing, net of expenses of $831,000		8,139,000			--

Net Cash Provided by Financing Activities	$	9,090,620		$	112,465

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NOVA LIFESTYLE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

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

	Nine Months Ended September 30,
	2014			2013

Effect of Exchange Rate Changes on Cash and Cash Equivalents	$	(570	)	$	24,221

Net decrease in cash and cash equivalents		(455,877	)		(1,570,096	)

Cash and cash equivalents, beginning of period		2,323,338			3,150,492

Cash and cash equivalents, ending of period	$	1,867,461		$	1,580,396

Supplemental Disclosure of Cash Flow Information

Cash paid during the year for:
Income tax payments	$	21,485		$	358,957
Interest expense	$	227,285		$	210,303

Supplemental Disclosure of Non-Cash Financing Activities

Construction in progress transfer to fixed assets	$	1,044,015		$	4,747,359

The accompanying notes are an integral part of these condensed consolidated financial statements.

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NOVA LIFESTYLE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED)

Note 1 - Organization and Description of Business

Nova LifeStyle, Inc. (“Nova LifeStyle” or the “Company”), formerly known as Stevens Resources, Inc., was incorporated in the State of Nevada on September 9, 2009.

The Company is a U.S. holding company with no material assets other than the ownership interests of our subsidiaries through which we market, design, manufacture and sell furniture worldwide: Nova Furniture Limited (“Nova Furniture”), Bright Swallow, Nova Furniture (Dongguan) Co., Ltd. (“Nova Dongguan”), Nova Furniture Macao Commercial Offshore Limited (“Nova Macao”), Nova Dongguan Chinese Style Furniture Museum (“Nova Museum”), Diamond Bar Outdoors, Inc. (“Diamond Bar”), and Dongguan Ding Nuo Household Products Co., Ltd. (“Ding Nuo”).

Nova Dongguan is a wholly foreign-owned enterprise, or WFOE, and was incorporated under the laws of the PRC on June 6, 2003. Nova Macao was organized under the laws of Macao on May 20, 2006. Nova Dongguan and Nova Macao are wholly owned subsidiaries of Nova Furniture, a wholly owned subsidiary of the Company organized under the laws of the British Virgin Islands, or the BVI. Nova Dongguan organized Nova Museum on March 17, 2011 as a non-profit organization under the laws of the PRC engaged in the promotion of the culture and history of furniture in China. Diamond Bar, doing business as Diamond Sofa, was incorporated in California on June 15, 2000. Nova Dongguan markets and sells our products in China to stores in our franchise network and to wholesalers and agents for domestic retailers and exporters. Nova Dongguan also provides the design expertise and facilities to manufacture our branded products and products for international markets under original design manufacturer and original equipment manufacturer agreements, or ODM and OEM agreements. Nova Macao is a trading company, importing, marketing and selling products designed and manufactured by Nova Dongguan and third party manufacturers for the U.S. and international markets. Diamond Bar markets and sells products manufactured by us and third party manufacturers under the Diamond Sofa brand to distributors and retailers principally in the U.S. market. On April 24, 2013, we completed our acquisition of Bright Swallow, an established furniture company with a global client base. Bright Swallow’s current client, Canadian based The Brick Limited (www.TheBrick.com) has over 200 locations and provides an excellent example of this exceptional integration opportunity. On October 21, 2013, Nova Dongguan incorporated Dongguan Ding Nuo Household Products Co., Ltd. (“Ding Nuo”) under the laws of the PRC and contributed capital of RMB 1 million ($162,994). Nova Dongguan made an additional capital contribution of RMB 0.1 million ($16,305) on November 27, 2013 through one of Nova Dongguan’s officer who acts as the nominee shareholder of Ding Nuo. All of the nominee shareholder’s shares were put in escrow and trust with Nova Dongguan and all profits and loss of Ding Nuo will be distributed to Nova Dongguan; accordingly, Nova Dongguan effectively controls 100% of Ding Nuo. Ding Nuo was established mainly for engaging in business with IKEA.

The “Company” and “Nova” collectively refer to Nova LifeStyle, the U.S. parent, and its subsidiaries, Nova Furniture, Nova Dongguan, Nova Macao, Nova Museum, Diamond Bar, BSI and Ding Nuo.

Note 2 - Summary of Significant Accounting Policies

Basis of Presentation

The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The condensed consolidated financial statements include the financial statements of the Company and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.

The interim condensed consolidated financial information as of September 30, 2014 and for the nine and three month periods ended September 30, 2014 and 2013 have been prepared without audit, pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures, which are normally included in consolidated financial statements prepared in accordance with U.S. GAAP have not been included. The interim condensed consolidated financial information should be read in conjunction with the Financial Statements and the notes thereto, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, previously filed with the SEC on March 31, 2014.

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company’s interim condensed consolidated financial position as of September 30, 2014, its interim condensed consolidated results of operations and cash flows for the nine and three month periods ended September 30, 2014 and 2013, as applicable, have been made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.

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Use of Estimates

In preparing consolidated financial statements in conformity with U.S. GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates, required by management, include the allowance for bad debt, valuation of inventories and recoverability of long-lived assets, goodwill and warrant derivative liability. Actual results could differ from those estimates.

Business Combination

For a business combination, the assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree are recognized at the acquisition date, measured at their fair values as of that date. In a business combination achieved in stages, the identifiable assets and liabilities, as well as the noncontrolling interest in the acquiree, are recognized at the full amounts of their fair values. In a bargain purchase in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree that excess in earnings is recognized as a gain attributable to the acquirer.

Deferred tax liability and asset are recognized for the deferred tax consequences of differences between the tax bases and the recognized values of assets acquired and liabilities assumed in a business combination in accordance with Accounting Standards Codification (“ASC”) Topic 740-10.

Goodwill

Goodwill is the excess of purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. In accordance with ASC Topic 350, “Intangibles-Goodwill and Other,” goodwill is not amortized but is tested for impairment, annually or when circumstances indicate a possible impairment may exist. Impairment testing is performed at a reporting unit level. An impairment loss generally would be recognized when the carrying amount of the reporting unit exceeds its fair value, with the fair value of the reporting unit determined using discounted cash flow (“DCF”) analysis. A number of significant assumptions and estimates are involved in the application of the DCF analysis to forecast operating cash flows, including the discount rate, the internal rate of return and projections of realizations and costs to produce. Management considers historical experience and all available information at the time the fair values of its reporting units are estimated.

ASC Topic 350 also permits an entity to first assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first step of the two-step goodwill impairment test is required to be performed. Performing the qualitative assessment involved identifying the relevant drivers of fair value, evaluating the significance of all identified relevant events and circumstances, and weighing the factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. After evaluating and weighing all these relevant events and circumstances, it was concluded that a positive assertion can be made from the qualitative assessment that it is more likely than not that the fair value of Diamond Bar is greater than its carrying amount. As such, it is not necessary to perform the first step of the two-step goodwill impairment test for Diamond Bar reporting unit. Accordingly, as of September 30, 2014 and December 31, 2013, the Company concluded there was no impairment of goodwill of Diamond Bar.

On April 24, 2013, Nova LifeStyle completed the acquisition of Bright Swallow. Under the acquisition method of accounting, the total purchase is allocated to tangible assets and intangible assets acquired and liabilities assumed based on their fair values with the excess charged to goodwill. Nova Lifestyle recognized $808,518 goodwill from the acquisition. As of December 31, 2013, the Company first assessed qualitative factors and determined it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. The Company then performed the first step of the two-step goodwill impairment test. The Company completed the step one analysis using discounted cash flow. The DCF method uses revenue and expense projections and risk-adjusted discount rates. The process of determining fair value is subjective and requires management to exercise a significant amount of judgment in determining future growth rates, discount and tax rates and other factors. The results of the step one analysis indicated there was no impairment of goodwill of Bright Swallow at December 31, 2013. In June 2014, the Company performed an interim goodwill impairment assessment for Bright Swallow based on Bright Swallow’s actual performance for the 1st six-months of 2014 and updated revenue and expense projections. Based on this analysis, the Company concluded that the goodwill of $0.81 million for Bright Swallow was impaired as of June 30, 2014. The goodwill impairment charge is non-cash. The goodwill impairment charge is not deductible for income tax purposes and, therefore, the Company has not recorded a corresponding tax benefit in 2014.

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Cash and Cash Equivalents

For purposes of the statement of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Accounts Receivable

The Company’s policy is to maintain an allowance for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Based on historical collection activity, the Company recorded $355,960 and $280,055 as allowance for bad debts as of September 30, 2014 and December 31, 2013, respectively.

Inventories

Inventories are stated at the lower of cost or market value with cost determined on a weighted-average basis, which approximates the first-in first-out method. Management compares the cost of inventories with the net realizable value and an allowance is made for writing down their inventories to market value, if lower. The Company did not record any provision for write-downs of inventory at September 30, 2014 and December 31, 2013.

Plant, Property and Equipment and Construction in Progress

Plant, property and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred; additions, renewals and improvements are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation is removed from the respective accounts, and any gain or loss is included in operations. Depreciation of property and equipment is provided using the straight-line method for substantially all assets with 10% salvage value and estimated lives as follows:

Building and workshops	20 years
Computer and office equipment	5 years
Museum decoration and renovation	10 years
Machinery	10 years
Autos	5 years

Depreciation of property, plant and equipment attributable to manufacturing activities is capitalized as part of inventories, and expensed to cost of goods sold when inventories are sold.

Construction in progress represents capital expenditure in respect of direct costs of construction or acquisition and design fees incurred. Capitalization of these costs ceases and the construction in progress is transferred to the appropriate category of property, plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. Construction in progress is not depreciated.

Impairment of Long-Lived Assets

Long-lived assets, which include property, plant and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.

Recoverability of long-lived assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. Based on its review, the Company believes that, as of September 30, 2014 and December 31, 2013, there were no significant impairments of its long-lived assets except the disposal of autos, damaged equipment, furniture and fixtures for which the Company recognized a loss from disposal of $28,963 and $6,437 during the nine and three months ended September 30, 2014, respectively.

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Research and Development

Research and development costs are related primarily to the Company designing and testing its new products in development stage. Research and development costs are recognized in general and administrative expenses and expensed as incurred. Research and development expense was $903,798 and $301,837 for the nine months ended September 30, 2014 and 2013, respectively; $338,924 and $112,710 for the three months ended September 30, 2014 and 2013, respectively.

Income Taxes

In its interim financial statements, the Company follows the guidance in ASC 270 “Interim Reporting” and ASC 740 “Income Taxes” whereby the Company utilizes the expected annual effective rate in determining its income tax provision. The actual effective tax rate of 10.00% for the period ended September 30, 2014 differs from the U.S. federal statutory tax rate primarily as a result of a tax benefit from the tax-exemption status of Nova Macao and non-taxable income from change in fair value of warrant liability from Nova Lifestyle offset by tax liability reserves from uncertain tax positions.

Nova LifeStyle, Inc. and Diamond Bar Outdoors, Inc. (“Diamond Bar”) are subject to U.S. federal and state income taxes. Nova Furniture BVI and Bright Swallow International Group Limited (“BSI”) were incorporated in the BVI. There is no income tax for a company domiciled in the BVI. Accordingly, the Company’s consolidated financial statements do not present any income tax provision related to the BVI tax jurisdiction where Nova Furniture BVI and BSI are domiciled.

Nova Museum, and Ding Nuo are governed by the Enterprise Income Tax Law of the People’s Republic of China (the “PRC”) which is subject to a 25% corporate income tax. Nova Dongguan is qualified as High-Tech Enterprise status in China, which is entitled to the 15% preferential tax rate until December 31st, 2015. Nova Macao is an income tax-exempt entity incorporated and domiciled in Macao.

During the nine months ended September 30, 2014 and 2013, the Company recorded income tax expense of approximately $752,000 and $772,000 respectively. During the three months ended September 30, 2014 and 2013, the Company recorded income tax expense of approximately $78,000 and $359,000 respectively.

As of September 30, 2014, unrecognized tax benefits were approximately $5.2 million. The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $5.2 million as of September 30, 2014. As of September 30, 2013, unrecognized tax benefits were approximately $4.6 million. The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $4.6 million as of September 30, 2013.

A reconciliation of the January 1, 2014, through September 30, 2014, amount of unrecognized tax benefits excluding interest and penalties ("Gross UTB") is as follows:

	Gross UTB

Beginning Balance – January 1, 2014		4,927,431
Increase in unrecorded tax benefits taken in the nine months ending September 30, 2014		279,785
Exchange rate adjustment – 2014		(19,260	)
Ending Balance – September 30, 2014	$	5,187,956

At September 30, 2014, the Company had cumulatively accrued approximately $1,344,000 for estimated interest and penalties related to unrecognized tax benefits. At December 31, 2013, the Company had cumulatively accrued approximately $1,017,000 for estimated interest and penalties related to unrecognized tax benefits. The Company recorded interest and penalties related to unrecognized tax benefits as a component of income tax expense, which totaled approximately $327,000 and $366,000 for the nine months ended September 30, 2014, and 2013, respectively; and totaled approximately $113,000 and $152,000 for the three months ended September 30, 2014, and 2013, respectively. The Company does not anticipate any significant changes to its unrecognized tax benefits within the next 12 months.

For the nine months ended September 30, 2014, the Company has recorded $82,000 of unrecognized tax benefit related to transfer pricing adjustment between Nova Dongguan and Macau in the statement of operations and in long term income taxes payable.

Nova Dongguan and Ding Nuo are subject to taxation in the PRC. Nova Dongguan’s PRC income tax returns are generally not subject to examination by the tax authorities for tax years before 2009. With a few exceptions, the tax years 2009-2013 remain open to examination by tax authorities in the PRC; the tax years 2011-2013 for US entities remain open to examination by tax authorities in the US.

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Revenue Recognition

The Company’s revenue recognition policies are in compliance with ASC Topic 605, “Revenue Recognition.” Sales revenue is recognized when a formal arrangement exists, the price is fixed or determinable, the delivery is completed and no other significant obligations of the Company exist and collectability is reasonably assured. No revenue is recognized if there are significant uncertainties regarding the recovery of the consideration due, or the possible return of the goods. Payments received before all of the relevant criteria for revenue recognition are recorded as unearned revenue.

Sales revenue represents the invoiced value of goods, net of value-added taxes (“VAT”). All of the Company’s products sold in China are subject to the PRC VAT of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials purchased in China and included in the cost of producing the finished product. The Company records VAT payable and VAT receivable net of payments in the consolidated financial statements. The VAT tax return is filed offsetting the payables against the receivables. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government.

The Company’s sales policy allows for the return of product within the warranty period if the product is defective and the defects are the Company’s fault. As alternatives for the product return option, the customers have options of asking a discount from the Company for the products with quality issues or receiving replacement parts from the Company at no cost. The amount for return of products, the discount provided to the customers and cost for the replacement parts were immaterial in the nine and three months ended September 30, 2014 and 2013.

Franchise Arrangements

In 2010, the Company began entering into area product franchise agreements with franchisees who operate specialty furniture stores carrying only Nova-branded products. The product franchise agreement provides for the franchisee to retail Nova-brand furniture products for a period of one year from the date of the agreement. The franchisee is required to pay a deposit of RMB 30,000 at the signing of the agreement, which is used as payment for future purchases and is deferred on the Company’s balance sheet as a customer deposit. The franchisee is required to guarantee a minimum purchase amount from the Company during the contract period. The Company has the right to terminate the agreement should the franchisee fail to meet the minimum purchase amounts. The Company provides the franchisee with store images and designs, signage, floor plan product information and training. In addition, the Company will rebate a per square meter subsidy to the franchisee for the store build-out within six months from the agreement date. The franchisee earns 30% of the rebate on its initial purchase from the Company and then at a rate of 5% of each subsequent purchase until fully refunded of its deposit or six months from the agreement date, whichever is earlier. At September 30, 2014 and December 31, 2013, the Company had franchising subsidy payable of $148,314 and $149,667, respectively, and was included in other payables. In accordance with ASC 605-50, as the Company does not receive an identifiable benefit from these rebates, the rebates are recorded as a reduction of revenue on sales to the franchisees.

Cost of Sales

Cost of sales consists primarily of finished goods purchased from other manufacturers, material costs, labor costs and related overhead that are directly attributable to the production of the products. Write-down of inventory to the lower of cost or net realizable value is also recorded in the cost of sales.

Shipping and Handling Costs

Shipping and handling costs related to delivery of finished goods are included in selling expenses. During the nine months ended September 30, 2014 and 2013, shipping and handling costs were $441,234 and $386,659, respectively; during the three months ended September 30, 2014 and 2013, shipping and handling costs were $139,494 and 128,229, respectively.

Advertising

Advertising expenses consist primarily of costs of promotion and marketing for the Company’s image and products, and costs of direct advertising. The Company expenses all advertising costs as incurred. Advertising expense was $423,516 and $243,683 for the nine months ended September 30, 2014 and 2013, respectively; and $300,568 and 128,367 for the three months ended September 30, 2014 and 2013, respectively.

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Earnings per Share (EPS)

Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is computed similar to basic net income per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if all the potential common shares, warrants and stock options had been issued and if the additional common shares were dilutive. Diluted earnings per share are based on the assumption that all dilutive convertible shares and stock options and warrants were converted or exercised. Dilution is computed by applying the treasury stock method for the outstanding options and warrants, and the if-converted method for the outstanding convertible instruments. Under the treasury stock method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later) and as if funds obtained thereby were used to purchase common stock at the average market price during the period. Under the if-converted method, outstanding convertible instruments are assumed to be converted into common stock at the beginning of the period (or at the time of issuance, if later).

The following table presents a reconciliation of basic and diluted earnings per share for the nine and three months ended September 30, 2014 and 2013:

	Nine Months Ended September 30,				Three Months Ended September 30,
	2014		2013		2014		2013

Net income	$	6,776,890	$	3,586,473		3,120,683		1,220,926

Weighted average shares outstanding – basic		20,133,976		18,778,902		20,861,990		19,026,934
Effect of dilutive securities:
Unexercised warrants		140,349		259,913		81,086		249,219

Weighted average shares outstanding – diluted		20,274,325		19,038,815		20,943,076		19,276,153

Earnings per share – basic	$	0.34	$	0.19		0.15		0.06
Earnings per share – diluted	$	0.33	$	0.19		0.15		0.06

At September 30, 2014 and December 31, 2013, the Company had no options to purchase shares of common stock outstanding and warrants to purchase 1,875,090 and 522,473 shares of common stock were outstanding and exercisable, respectively. For the nine months ended September 30, 2014 and 2013, 1,696,540 and 155,100 shares purchasable under the warrants were excluded from EPS as their effects were anti-dilutive. For the three months ended September 30, 2014 and 2013, 1,825,090 and 155,100 shares purchasable under the warrants were excluded from EPS as their effects were anti-dilutive.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to credit risk consist primarily of accounts and other receivables. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of the financial condition and payment practices of its customers to minimize collection risk on accounts receivable.

No major customer accounted for over 10% of the Company’s sales for the nine months ended September 30, 2014, and two major customers accounted for 28% (16% and 12% for each) of the Company’s sales for the nine months ended September 30, 2013. No major customer accounted for over 10% of the Company’s sales for the three months ended September 30, 2014, and three major customers accounted for 37% (14%, 12% and 11% for each) of the Company’s sales for the three months ended September 30, 2013.

The Company purchased its products from four major vendors during the nine months ended September 30, 2014, and from one major vendor during the nine months ended September 30, 2013, accounting for 68% (20%, 19%, 15% and 14% for each) and 14% of the purchases, respectively. Three vendors accounted for 63% of the purchases during the three months ended September 30, 2014 (27%, 25% and 11%, respectively) and two major vendors accounted for 27% (15% and 12% for each) of the purchases during the three months ended September 30, 2013. Accounts payable to these vendors were $3,297,741 and $1,032,592 as of September 30, 2014 and December 31, 2013, respectively.

The operations of the Company are located principally in China and the US. Accordingly, the Company’s Chinese subsidiaries' business, financial condition and results of operations may be influenced by the political, economic and legal environments in China, as well as by the general state of the PRC economy.

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The Company’s operations in the PRC are subject to specific 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 environments in China and foreign currency exchange. The Company’s results may be adversely affected by changes in PRC government policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

The Company’s sales, purchase and expense transactions in China are denominated in Chinese Yuan Renminbi (“RMB”), and all of the assets and liabilities of the Company’s subsidiaries in China are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current law. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies other than RMB may require certain supporting documentation in order to affect the remittance.

Statement of Cash Flows

In accordance with FASB ASC Topic 230, “Statement of Cash Flows,” cash flows from the Company’s operations is calculated based upon local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.

Fair Value of Financial Instruments

Some of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, other receivables, accounts payable, accrued liabilities and short-term debt, have carrying amounts that approximate their fair values due to their short maturities. ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value of financial instruments held by the Company. ASC Topic 825, “Financial Instruments,” defines fair value and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. The three levels of valuation hierarchy are defined as follows:

·	Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

·	Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

·	Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The Company analyzes all financial instruments with features of both liabilities and equity under ASC Topic 480, “Distinguishing Liabilities from Equity,” and ASC Topic 815, “Derivatives and Hedging.”

The carrying value of cash, accounts receivable, advance to suppliers, other receivables, accounts payable, other payables and accrued expenses approximate estimated fair values because of their short maturities.

The carrying value of the warrant liability is determined using the Binomial Lattice option pricing model as described in Note 15. Certain assumptions used in the calculation of the warrant liability represent level-3 unobservable inputs. The Company did not have any assets or liabilities categorized as Level 1 or 2 as of September 30, 2014.

The following table summarizes the activity of Level 3 inputs measured on a recurring basis:

Fair Value Measurements of Common Stock Warrants Using Significant Unobservable Inputs (Level 3)

	Nine Months Ended
	September 30, 2014

Issuance of Series A, B and C Warrants and Placement Agent Warrants on April 14 and April 17, 2014, respectively.	$	5,659,866
Adjustment resulting from change in value recognized in earnings (a)		(2,841,177	)
Reclassification to equity upon exercise
Balance at September 30, 2014,	$	2,818,689

(a) Adjustment resulting from change in fair value is the amount of total gains or losses for the period attributable to the change in unrealized gains or losses relating to liabilities held at the reporting date. The unrealized gain or loss is recorded in change in fair value of warrant liability in the accompanying consolidated statements of operations.

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Foreign Currency Translation and Transactions

The consolidated financial statements are presented in USD. The functional currency of Nova LifeStyle, Nova Furniture, Nova Macao, Bright Swallow and Diamond Bar is the United States Dollar (“$” or “USD”). The functional currency of Nova Dongguan, Nova Museum and Ding Nuo is RMB. The functional currencies of the Company’s foreign operations are translated into USD for balance sheet accounts using the current exchange rates in effect as of the balance sheet date, except for equity account using the historical exchange rate, and for revenue and expense accounts using the weighted-average exchange rate during the fiscal year. The translation adjustments are recorded as a separate component of stockholders’ equity, captioned “Accumulated other comprehensive income.” Gains and losses resulting from transactions denominated in foreign currencies are included in “Other income (expenses)” in the consolidated statements of income and comprehensive income. There have been no significant fluctuations in the exchange rate for the conversion of RMB to USD after the balance sheet date.

The RMB to USD exchange rates in effect as of September 30, 2014 and December 31, 2013, were RMB6.1525 = USD$1.00 and RMB6.0969 = USD$1.00, respectively. The weighted-average RMB to USD exchange rates in effect for the nine months ended September 30, 2014 and 2013, were RMB6.1454 = USD$1.00 and RMB6.2146 = USD$1.00, respectively. The exchange rates used in translation from RMB to USD were published by the People’s Bank of the People’s Republic of China.

Comprehensive Income

The Company follows FASB ASC 220 “Reporting Comprehensive Income.” Comprehensive income is comprised of net income and all changes to the consolidated statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. Comprehensive income for the nine and three months ended September 30, 2014 and 2013 included net income and foreign currency translation adjustments.

Segment Reporting

ASC Topic 280, “Segment Reporting,” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.

Management determined that the Company’s operations constitute a single reportable segment in accordance with ASC 280. The Company operates exclusively in one business and industry segment: the design, manufacture and sale of furniture. All of the Company’s long-lived assets for production are located at its facilities in Dongguan, Guangdong Province, China, and operate within the same environmental, safety and quality regulations governing furniture manufacturers. The Company established Nova Macao and Ding Nuo, and acquired Diamond Bar and Bright Swallow for the purpose of marketing and selling the Company’s products. As a result, management views the business and operations of Nova Dongguan, Nova Macao, Diamond Bar, Bright Swallow and Ding Nuo as a blended gross margin when determining future growth, return on investment and cash flows. Nova Museum, a non-profit organization engaged principally in the promotion and dissemination of the culture and history of furniture in China, has no operations or substantial assets other than its decorations and renovation, and its heritage and cultural assets are for the purpose of exhibition only.

Accordingly, management concluded that the Company had one reportable segment under ASC 280 because: (i) the Company’s products sold through Nova Dongguan, Nova Macao, and Ding Nuo are created with similar production processes, in the same facilities, under the same regulatory environment and sold to customers using similar distribution systems; (ii) Diamond Bar is a furniture distributor based in California focusing customers in US, and Bright Swallow is a furniture distributor based in Hong Kong focusing customers in Canada, they both are operated under the same senior management of Nova Dongguan and Nova Macao, and management views the operations of Nova Dongguan, Nova Macao, Diamond Bar, Bright Swallow and Ding Nuo as a whole for making business decisions; and (iii) although Nova Museum is principally engaged in the dissemination of the culture and history of furniture in China, it also serves a function of promoting and marketing the Company’s image and products by providing a platform and channel for consumers to be exposed to the Company and its products, it is operated under the same management with the same resources and in the same location as Nova Dongguan, and it is an additive and supplemental unit to the Company’s main operations, the manufacture and sale of furniture.

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New Accounting Pronouncements

In July 2013, the FASB issued Accounting Standards Update (“ASU”) 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists.” The amendments in this ASU are to improve the current U.S. GAAP because they are expected to reduce diversity in practice by providing guidance on the presentation of unrecognized tax benefits and will better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carry-forwards, similar tax losses, or tax credit carry-forwards exist. Current U.S. GAAP does not include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward exists. This Update applies to all entities that have unrecognized tax benefits when a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward exists at the reporting date. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted.

As of September 30, 2014, the adoption of ASU 2013-11 did not have an impact on our statement of operations but did impact our balance sheet classification, with a decrease in long-term deferred tax assets and a corresponding decrease in long term income tax payable by approximately $55,000.

The FASB has issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU is effective on January 1, 2017 and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. The adoption of this standard is not expected to have a material impact on the Company's condensed consolidated financial position and results of operations.

The Financial Accounting Standards Board ("FASB") has issued Accounting Standards Update ("ASU") No. 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's condensed consolidated financial position and results of operations.

Note 3 - Inventories

As of September 30, 2014 and December 31, 2013, inventories consisted of the following:

	September 30,		December 31,
	2014		2013

Raw material	$	223,032	$	250,914
Work in progress		1,744,843		964,587
Finished goods		4,127,591		2,138,133

	$	6,095,466	$	3,353,634

Note 4 – Advance to suppliers

As of September 30, 2014 and December 31, 2013, the Company had advance to suppliers of $6,368,879 and $3,535,100, respectively. During the nine months ended September 30, 2014, the Company made certain advance payments to one of its suppliers totaling $5,000,000 to secure a favorable pricing structure on purchase orders submitted. As a result of production delays, on July 1, 2014, the Company entered into an agreement with this supplier to charge interest on these advances at an annual rate of 4.75% with maturity on March 31, 2015. Interest is to be paid monthly. Shipments received from the supplier will be credited against the advance payments. The supplier has the option to repay the short-term advances for any product that it will not be able to deliver at any time. Initial shipments against these purchase orders were received by the Company in July 2014. As of September 30, 2014, the outstanding balance of advance payments to this supplier was $1,981,611. During the nine and three months ended September 30, 2014, the supplier paid interest of $109,548 to the Company.

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Note 5 - Heritage and Cultural Assets

As of September 30, 2014 and December 31, 2013, Nova Museum had heritage and cultural assets of $131,791 and $132,993, consisting principally of collectibles and antiques for exhibition. Depreciation is not required to be provided on heritage assets that have indefinite lives and no reduction in their value with the passage of time; however, the carrying amount of the heritage and cultural assets will be reviewed when there is evidence of impairment in accordance with ASC 360-10.

Note 6 - Plant, Property and Equipment, Net

As of September 30, 2014 and December 31, 2013, plant, property and equipment consisted of the following:

	September 30,			December 31,
	2014			2013

Building and workshops	$	10,846,340		$	10,945,252
Office equipment		674,126			659,947
Autos		1,055,439			318,759
Machinery		6,206,577			4,921,867
Decoration and renovation		938,258			775,874
Less: accumulated depreciation		(5,202,801	)		(4,475,061	)

	$	14,517,939		$	13,146,638

Depreciation expense was $884,749 and $672,812 for the nine months ended September 30, 2014 and 2013, respectively; and $295,196 and $270,357 for the three months ended September 30, 2014 and 2013, respectively.

Note 7 - Construction in Progress

At September 30, 2014, the construction in progress was mainly for the Company’s eCommerce platform and mobile apps, and Nova sales kit apps design. Total cost of design is approximately $1.30 million, the Company expects to complete all the design in the fourth quarter of 2014. As of September 30, 2014, the Company had approved all the layout designs for the eCommerce platform and is working with the designer for finalizing the layout for mobile apps, and had launched initial use of the Nova sales-kit. At December 31, 2013, the construction in progress was $1,024,645, for equipment and machinery to be installed in a new manufacturing plant at Nova Dongguan, the factory construction was completed and the manufacturing machines and equipment were installed, and put into the operation during the second quarter of 2014.

Note 8 – Deposits

At September 30, 2014, the deposits mainly consisted of $795,490 for the deposit payment for construction for a new plant at Nova Dongguan.

Note 9 - Intangible Assets

Intangible assets consisted of land use right, trademark and customer relationship. All land in the PRC is government-owned and the ownership cannot be sold to any individual or company. However, the government grants the user a right to use the land (“land use right”). The Company acquired the right to use land in Dongguan, Guangdong Province, China, in 2004 for 50 years and is amortizing such rights on a straight-line basis for 50 years.

At February 28, 2012, the Company acquired another land use right for $536,193 (RMB3.4 million) with useful life of 50 years and is amortizing such right on a straight-line basis for 50 years. As of December 31, 2012, the Company paid in full for this land use right. In addition, the Company is required to pay an annual fee at $240 per MU (total 17.97 MU for the land) from the second year after commencement of the land filling for 60 years for a total of approximately $333,000 (RMB 2.1 million). The payment will be made annually with a 5% increase every 5 years. The Company records such fees on a straight-line basis.

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The Company acquired a customer relationship with a fair value of $50,000 on August 31, 2011, as part of its acquisition of Diamond Bar. Concurrently with its acquisition of Diamond Bar, the Company entered into a trademark purchase and assignment agreement for all rights, title and interest in two trademarks (Diamond Sofa and Diamond Furniture) for $200,000 paid in full at the closing. Amortization of customer relationship and trademark is provided using the straight-line method and estimated lives were 5 years for each.

The Company acquired a customer relationship with a fair value of $6,100,559 on April 24, 2013, as part of its acquisition of Bright Swallow. Amortization of customer relationship is provided using the straight-line method and estimated life was 15 years.

Intangible assets consisted of the following at September 30, 2014 and December 31, 2013:

	September 30,			December 31,
	2014			2013

Land use right	$	1,138,625		$	1,149,009
Customer relationship		6,150,559			6,150,559
Trademark		200,000			200,000
Less: accumulated amortization		(880,966	)		(522,577	)

	$	6,608,218		$	6,976,991

Amortization of intangible assets was $359,627 and $250,535 for the nine months ended September 30, 2014 and 2013, respectively, and $119,824 and $95,383 for the three months ended September 30, 2014 and 2013, respectively. Annual amortization expense is expected to be approximately $472,800 for 2015, $469,300 for 2016, $432,600 for 2017, $431,800 for 2018, and $427,600 for 2019.

Note 10 - Prepaid Expenses and Other Receivables

Other current assets consisted of the following at September 30, 2014 and December 31, 2013:

	September30,		December 31,
	2014		2013

Prepaid expenses	$	903,253	$	546,364
Other receivables		115,546		102,256
Total	$	1,018,799	$	648,620

Other receivables represented cash advances to employees, security deposit and exhibition deposits. At September 30, 2014, prepaid expenses included prepayments for marketing of approximately $60,000, website server hosting fee of approximately $112,700, consulting fee of approximately $36,700, shipping and freight cost of approximately $17,500, IR expense of approximately $346,500, insurance of approximately $246,400, and other prepaid expenses of approximately $83,200. At December 31, 2013, prepaid expenses included prepayments for consulting of approximately $100,000, designing fee for show rooms of approximately $245,040, insurance of approximately $115,600, and IR expense of approximately $80,200.

Note 11 - Accrued Liabilities and Other Payables

Accrued liabilities and other payables consisted of the following at September 30, 2014 and December 31, 2013:

	September 30,		December 31,
	2014		2013

Other payables	$	41,069	$	119,481
Salary payable		546,845		500,057
Financed insurance premiums		118,909		61,147
Accrued consulting fees		135,845		174,710
Franchising subsidy		148,314		149,667
Accrued rents		155,954		164,982
Accrued expenses, others		279,995		288,113

Total	$	1,426,931	$	1,458,157

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At September 30, 2014 and December 31, 2013, other accrued expenses mainly included designer fee, legal and utilities. Other payables represented payables to landlord, contractors and vendors other than for purchase of materials. Franchising subsidy represented the accrued amount the Company will pay to its franchisees as a rebate to support their franchise store decoration expense.

Note 12 - Lines of Credit

Diamond Bar entered into an agreement with a bank in California for a line of credit of up to $5,000,000 with annual interest of 4.5% and maturity on June 1, 2015. The line of credit is secured by all of assets of Diamond Bar Outdoors, Inc., a subsidiary of Nova Lifestyle and guaranteed by Nova Lifestyle. As of September 30, 2014 and December 31, 2013, Diamond Bar had $4,507,037 and $4,754,258 outstanding on the line of credit, respectively. During the nine months ended September 30, 2014 and 2013, the Company recorded interest expense of $125,258 and $117,352, respectively. During the three months ended September 30, 2014 and 2013, the Company recorded interest expense of $46,325 and $42,867, respectively.

In June 2013, the loan was modified for the following covenants: (i) maintain a minimum tangible net worth of not less than $5 million; (ii) maintain a current ratio in excess of 1.25 to 1.00; and (iii) maintain a ratio of debt to tangible net worth not in excess of 2.500 to 1.000; (iv) the pre-tax income must be not less than 1.000% of total revenue quarterly. As of September 30, 2014, Diamond Bar was in compliance with all the covenants. In addition, the loan agreement provided a cross default provision whereby an event of default on this loan will cause the Nova Macao loan, which is described below, to also be in default, as both loans are from the same lender.

On April 25, 2012, Nova Dongguan entered into an agreement with a commercial bank in Dongguan for a line of credit of up to $3,280,356 (RMB 20 million) with maturity on April 24, 2015. As of September 30, 2014 and December 31, 2013, Nova Dongguan had $812,678 (RMB 5.00 million) with maturity on November 20, 2014 and $820,089 (RMB 5.00 million) outstanding on the line of credit, respectively. The loan currently bears monthly interest of 0.55% and requires monthly payment on the interest; the interest rate will be adjusted annually. The loan was secured by the building of Nova Dongguan and guaranteed by Nova Dongguan and the Company’s CEO. During the nine months ended September 30, 2014 and 2013, the Company recorded interest expense of $40,722 and $42,656, respectively. During the three months ended September 30, 2014 and 2013, the Company recorded interest expense of $13,603 and $13,630, respectively.

On August 24, 2012, Nova Macao entered into an agreement with a commercial bank in Hong Kong for a line of credit of up to $8,000,000 with maturity on August 23, 2013. On August 23, 2013, the Company renewed the line of credit with annual interest rate of 4.25% and maturity on November 21, 2013. On December 17, 2013, the Company renewed the line of credit of up to $6,500,000 with maturity on January 30, 2015. The loan requires monthly payment on the interest and the interest rate will be adjusted annually. The loan was secured by assignment of Sinosure (China Export and Credit Insurance Company) credit insurance. As of September 30, 2014 and December 31, 2013, Nova Macao had $1,848,000 outstanding on the line of credit. During the nine months ended September 30, 2014 and 2013, the Company paid interest of $61,305 and $58,811, respectively. During the three months ended September 30, 2014 and 2013, the Company paid interest of $20,072 and $19,854, respectively.

The loan has the following covenants: (i) total outstanding under working capital advance shall not exceed the lesser of (a) the credit commitment of $6,500,000, (b) insurance claim limits and (c) borrowing base allowed of 80% advance rate against certain eligible accounts receivable; (ii) eligible account receivables are insured buyers by Sinosure assigned to the bank and within established insurance limit; (iii) the bank has an absolute right to exclude any portion of the accounts receivable from the aging report for computation of the borrowing base as it deems fit; (iv) in case the aggregate outstanding amount of credit facilities exceeds the available amount of facilities conferred by the aforesaid computation of borrowing base, the excess amount should be settled with 7 days by Nova Furniture Macao Commercial Offshore Limited; and. (v) the Company maintains a debt to tangible net worth ratio of not in excess of 3.0x throughout the whole term of the loan. As of September 30, 2014, Nova Macao was in compliance with all the covenants.

Note 13 - Related Party Transactions

Diamond Bar leased a warehouse and office in Commerce, California, U.S., from an entity owned by the spouse of the Company’s president. The lease expired upon the sale of the property by the landlord in June 2013 and the Company continued to lease the space on monthly basis until October 31, 2013 with the written permission from the buyer. The monthly rent under this lease was $41,500.

On September 30, 2011, Diamond Bar leased a showroom in High Point, North Carolina from the Company’s president. On March 16, 2014, the Company renewed the lease for one year. The lease was for $31,650 and only for use during two furniture exhibitions held in April 1, 2014 to March 31, 2015.

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Note 14 - Deferred Rent Payable

Deferred rent payable represented supplemental payments the Company must pay to the residents who originally lived on the land in Dongguan, Guangdong Province, China, to which the Company acquired land use rights for commercial use. The Company was required to pay an annual amount at RMB 800 per mu (or 666.67 square meters) for a total of 60 mu (or 40,000 square meters) starting from 2003 for 60 years. The payment increases 10% every 5 years. The Company recorded such expense on a straight-line basis. During the nine months ended September 30, 2014 and 2013, the Company recorded expense of $14,802 and $10,323, respectively. During the three months ended September 30, 2014 and 2013, the Company recorded expense of $7,811 and $3,471, respectively. As of September 30, 2014 and December 31, 2013, the Company had $79,685 and $74,152 of deferred rent payable, respectively.

Note 15 - Stockholders’ Equity

Warrants

Following is a summary of the warrant activity for the nine months ended September 30, 2014:

	Number of Warrants		Average Exercise Price		Weighted Average Remaining Contractual Term in Years

Outstanding at January 1, 2014		522,473	$	2.93		0.93
Exercisable at January 1, 2014		522,473		2.93		0.93
Granted		1,696,540		7.87		2.69
Exercised		201,233		2.33		-
Expired		142,690		2.00

Outstanding at September 30, 2014		1,875,090		7.54		2.09
Exercisable at September 30, 2014		1,875,090	$	7.54		2.09

Shares issued to IR firm

On August 3, 2012, the Company entered into a contract with an investor relations firm. The Company agreed to issue 100,000 shares of common stock to the firm for 24 months of investor relation services. On August 15, 2012, the Company issued the first 50,000 of such 100,000 shares to the investor relations firm, at $2.75 per share, which was the stock price on the date of contract. The remaining 50,000 common stock shares were to be issued to the investor relations firm within 180 business days of the contract signing date and the Company issued the remaining 50,000 common stock shares on April 30, 2013. During the nine months ended September 30, 2014 and 2013, the Company amortized $80,208 and $103,125 as IR expense, respectively. During the three months ended September 30, 2014 and 2013, the Company amortized $11,458 and $34,375 as IR expense, respectively.

On July 1, 2014, the Company entered into a contract with an investor relations firm. The Company agreed to issue 100,000 shares of common stock to the firm for 12 months of investor relation services. The fair value of the 100,000 shares of common stock was $462,000 and was recorded as shares to be issued at September 30, 2014; the fair value was calculated based on the stock price of $4.62 per share on July 1, 2014, and will be amortized over the service term. During the nine and three months ended September 30, 2014, the company amortized $115,500 as IR expenses.

Shares issued to consultant

On April 30, 2013, the Company entered a consulting service agreement extension addendum to the original agreement dated on January 16, 2013 with a consultant for continuously providing the Company general business related consulting services and corporate support related to the Company’s IR and up-listing efforts. In the original agreement, the Company agreed to pay $1,250 per month on or about the 15th of each month for the services to be performed in January, February, March and April of 2013, and issue 4,000 shares of the Company’s common stock. In the extension addendum, the Company agreed to pay $1,250 per month on or about the 15th of each month for the services to be performed in May, June, July and August of 2013, the Company also agreed to issue an additional 4,650 shares of common stock to the consultant. The board approved the issuance and delivery of 8,650 common stock shares to the consultant on July 19, 2013 and those shares were issued on August 6, 2013. The Company recorded $26,349 stock compensation expense for 8,650 shares issued to the consultant.

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On July 1, 2013, the Company entered into a consulting agreement with a consulting firm in China for providing management M&A, business strategy and financing consultation services effective July 15, 2013. The Company agreed to issue 50,000 shares of common stock to the firm for 12 months of consulting services starting on July 15, 2013. The Company also agreed to issue three-year warrants for the firm to purchase 50,000 shares of the Company’s common stock with an exercise price of $4 per share. Both the common stock and warrants shall be issued to Consultant or its designees within 7 business days upon execution of the Agreement. The fair value of the 50,000 shares of common stock was $200,000 at July 1, 2013, and will be amortized over the service term. During the nine and three months ended September 30, 2014, the company amortized $100,000 and $50,000 as consulting expenses. During the three months ended September 30, 2013, the company recorded $50,000 as stock-based compensation.

The warrants issued to the consulting firm are exercisable for a fixed number of shares, and classified as equity instruments. The Company accounted for the warrants issued based on the fair value method under ASC Topic 505, and the fair value of the warrants was calculated using the Black-Scholes model under the following assumptions: estimated life of 3 years, volatility of 353%, risk-free interest rate of 0.66% and dividend yield of 0%. No estimate of forfeitures was made as the Company has a short history of granting options and warrants. Because these equity-classified warrants are vested immediately and are non-forfeitable; based on ASC 505-50, performance commitment has been reached at the grant date, and accordingly, the measurement date is the grant date. The fair value of the warrants issued to the consulting firm at grant date was $194,989, and will be amortized over the service term. During the nine and three months ended September 30, 2014, the company recorded $76,629 and $38,314 as warrants expense, respectively. During the nine and three months ended September 30, 2013, the company recorded $48,747 as warrants expense.

On August 15, 2014, the Company entered into a consulting agreement with a consulting firm for general business advisory, marketing and administration, and business strategy consulting services effective on September 1, 2014. The Company agreed to issue 10,000 shares of common stock to the firm for 12 months of consulting services starting on September 1, 2014. The fair value of the 10,000 shares of common stock was $42,000, which was calculated based on the stock price of $4.20 per share on September 1, 2014, and will be amortized over the service term. During the nine and three months ended September 30, 2014, the company amortized $5,250 as consulting expenses.

Shares and Warrants issued through private placement

On April 14, 2014, the Company entered into a Securities Purchase Agreement with certain purchasers pursuant to which the Company sold to the Buyers, in a registered direct offering, an aggregate of 1,320,059 shares of common stock, par value $0.001 per share, at a negotiated purchase price of $6.78 per share, for aggregate gross proceeds to the Company of $8.95 million, before deducting fees to the placement agent of $716,000 and other estimated offering expenses of $20,000 payable by the Company.

The Series A Warrants have a term of four years and are exercisable by the holders at any time after the date of issuance. The value of warrants as of April 14, 2014 was determined by using the Binomial option pricing model with the following assumptions: risk-free interest rate – 0.82%; dividend yield – 0%; expected volatility – 121%. As of September 30, 2014, the fair value of the Series A Warrants was $1,750,729 with the assumptions of risk-free interest rate – 1.07%; dividend yield – 0%; expected volatility – 114%. The Company recorded $1,245,905 and $316,866 as income from change in fair value of the warrants for the nine and three months ended September 30, 2014, respectively. The Series B Warrants have a term of six months and are exercisable by the holders at any time after the date of issuance. The value of warrants as of April 14, 2014 was determined by using the Binomial option pricing model with the following assumptions: risk-free interest rate – 0.06%; dividend yield – 0%; expected volatility – 99%. As of September 30, 2014, the fair value of the Series B Warrants was $0 with the assumptions of risk-free interest rate – 0.02%; dividend yield – 0%; expected volatility – 39%. The Company recorded $922,105 and $120,447 as income from change in fair value of the warrants for the nine and three months ended September 30, 2014, respectively. On October 14, 2014, the series B Warrants have expired and none of series B warrants have been excised. The Series C Warrants have a term of four years and are exercisable by the holders at any time after the date of issuance. After the six month anniversary of the issuance date of the Series C Warrants, to the extent that a holder of Series C Warrant exercises less than 70% of such holder’s Series B Warrants and the closing sale price of the Common Stock is equal to or greater than $9.81 for a period of ten consecutive trading days, then the Company may purchase the entire then-remaining portion of such holder’s Series C Warrants for $1,000. On October 14, 2014, the Company’s closing sale price of the Common Stock was not equal to or greater than $9.81 for a period of ten consecutive trading days, accordingly, the Company cannot purchase the entire then-remaining portion of such holder’s Series C Warrants for $1,000. The value of warrants as of April 14, 2014 was determined by using the Binomial option pricing model with the following assumptions: risk-free interest rate – 0.82%; dividend yield – 0%; expected volatility – 121%. As of September 30, 2014, the fair value of the Series C Warrants was $822,509 with the assumptions of risk-free interest rate 1.07%; dividend yield – 0%; expected volatility – 114%. The Company recorded $585,756 and $148,578 as income from change in fair value of the warrants for the nine and three months ended September 30, 2014, respectively.

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In addition, the Company granted Placement Agent or its designees at the Closing warrants to purchase that number of shares of common stock of the Company equal to seven percent (7%) of the aggregate number of Shares placed in the Placement. The Placement Agent Warrants shall have the same terms, including exercise price, anti-dilution and registration rights, as the warrants issued to the Investors in the Placement. The placement agent and its designees received Series PA warrants to purchase up to 92,404 shares of common stock at the closing. The value of Placement Agent Series PA warrants as of April 17, 2014 was determined by using the Binomial option pricing model with the following assumptions: risk-free interest rate – 0.91%; dividend yield – 0%; expected volatility – 122%. As of September 30, 2014, the fair value of the PA Warrants was $245,451 with the assumptions of risk-free interest rate - 1.07%; dividend yield – 0%; expected volatility – 114%. The Company recorded $87,411 and $44,373 as income from change in fair value of the warrants for the nine and three months ended September 30, 2014, respectively.

Shares issued to Independent board of directors

In July 2014, the Company entered into restricted stock award agreements (under 2014 Omnibus Long-Term Incentive Plan) with four independent directors of the Board. The company agreed to grant 5,000 shares to one and 4,000 shares to each of three of its independent directors with a grant date on July 9, 2014, respectively. The restricted period lapses as to twenty-five percent (25%) of the restricted stock on each of the three-month, six-month, nine-month and twelve-month anniversaries of the grant date. The fair value of these shares was $81,090, which was calculated based on the stock price of $4.77 per share on July 9, 2014. During the nine and three months ended September 30, 2014, the company amortized $18,662 as directors’ stock compensation expenses with corresponding amount of shares to be issued at September 30, 2014.

Note 16 - Statutory Reserves

As a U.S. holding company, the Company’s ability to pay dividends is primarily dependent on the Company receiving distributions of funds from its subsidiaries. Relevant PRC statutory laws and regulations permit payments of dividends by the Company’s PRC subsidiaries, Nova Dongguan and Nova Macao, only out of the subsidiary’s retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. The results of operations reflected in the financial statements prepared in accordance with U.S. GAAP differ from those reflected in the statutory financial statements of the Company’s PRC subsidiaries. Pursuant to the corporate laws of the PRC and Macao, including the PRC Regulations on Enterprises with Foreign Investment, Nova Dongguan and Nova Macao are only required to maintain one statutory reserve by appropriating from after-tax profit before declaration or payment of dividends. The statutory reserve represents restricted retained earnings. As a result of the PRC laws and regulations described below that require such annual appropriations of 10% of after-tax income to be set aside prior to payment of dividends as a general statutory reserve fund, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of their net assets to the Company as a dividend.

Surplus Reserve Fund

Nova Dongguan and Nova Macao are required to transfer 10% of net income, as determined under PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the subsidiary’s registered capital. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholdings or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issuance is not less than 25% of the registered capital.

At September 30, 2014 and December 31, 2013, Nova Macao had surplus reserves of $6,241, representing 50% of its registered capital. Nova Dongguan did not make any transfer to surplus reserves due to its accumulated deficit.

Common Welfare Fund

The common welfare fund is a voluntary fund to which Nova Dongguan and Nova Macao can each elect to transfer 5% to 10% of its net income. This fund can only be utilized on capital items for the collective benefit of the subsidiary’s employees, such as construction of dormitories, cafeteria facilities, and other staff welfare facilities. This fund is non-distributable other than upon liquidation. Nova Dongguan and Nova Macao do not participate in this voluntary fund.

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Note 17 - Geographical Sales

Geographical distribution of sales consisted of the following for the nine and three months ended September 30, 2014 and 2013:

	For nine months ended September 30,				For three months ended September 30,
Geographical Areas	2014		2013		2014		2013

China*	$	12,156,477	$	11,789,781		4,418,156		4,389,640
North America		44,248,448		30,774,215		18,332,753		12,637,264
Asia**		4,050,094		1,728,902		818,534		716,003
Europe		8,160,461		11,119,659		1,943,704		4,118,378
Australia		292,909		543,241		130,677		197,085
Hong Kong		693,590		483,426		214,747		236,722
Other countries		107,003		32,017		34,301		15,750
	$	69,708,982	$	56,471,241		25,892,872		22,310,842

* excluding Hong Kong

** excluding China

Note 18 - Commitments and Contingencies

Lease Commitment

On June 17, 2013, Diamond Bar entered into a lease agreement for office, warehouse, and storage and distribution space with five years term from November 1, 2013 to October 31, 2018. The lease agreement also provides an option to extend for an additional six-year term. The monthly rental payment is $42,000 with 3% increase annually. The rent will be recorded on a straight-line basis over the term of the lease.

On September 19, 2013, Bright Swallow entered into a lease agreement for office space with two years term from October 1, 2013, to September 30, 2015. The monthly rental payment is 20,000 Hong Kong Dollars ($2,580 at September 30, 2014).

The Company has entered into several lease agreements for office and warehouse space in Commerce, California and showroom space in Las Vegas, Nevada and High Point, North Carolina with month-to-month or annual terms.

Diamond Bar subleased portion of its warehouse to one of its customers. The sublease income was recorded against the rental expense. Total rental expense for the nine months ended September 30, 2014 and 2013 was $389,081 and $377,131, respectively, $168,860 and $121,960 for the three months ended September 30, 2014 and 2013, respectively. The rental expense is recorded on a straight-line basis over the term of the lease. Minimum future lease payments are as follows:

Year	Amount
September 30, 2015	$	548,796
September 30, 2016		533,396
September 30, 2017		549,398
September 30, 2018		565,880
September 30, 2019		47,271
Thereafter		-
Total	$	2,244,741

Capital Contribution

Nova Dongguan’s total registered capital is $20 million. As of September 30, 2014 and December 31, 2013, Nova Dongguan had received $20.00 million and $14.60 million in cumulative capital contributions, respectively.

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Employment Agreements

On November 7, 2013, the Company entered into one-year employment agreements with Mr. Ya Ming (Jeffrey) Wong and Mr. Yuen Ching (Sammy) Ho to serve as the Company’s Chief Executive Officer and Chief Financial Officer, respectively. The agreements provide for annual salaries of $100,000 and $80,000, respectively and annual bonuses at the sole discretion of the Board of Directors.

On May 3, 2013, the Company entered an amended and restated employment agreement with Thanh H. Lam to serve as the Company’s president for five years. The agreement provides for an annual salary of $80,000, 200,000 shares of the Company’s common stock and an annual bonus at the sole discretion of the Board. The 200,000 shares to be issued to Ms. Lam are subject to the terms of a stock award agreement. The first 50,000 shares of common stock shall be vested immediately, and the remaining shares shall be vested at 50,000 shares per year for three years on each anniversary of the effective date of the stock award agreement. During the nine months ended September 30, 2014 and 2013, the Company recorded $143,250 and $270,016 as stock-based compensation to Thanh H Lam, respectively. During the three months ended September 30, 2014 and 2013, the Company recorded $47,725 and $79,016 as stock-based compensation to Thanh H Lam, respectively.

Note 19 - Subsequent Events

The company has evaluated subsequent events through the issuance of the consolidated financial statements and the following subsequent event has been identified that requires disclosure in this section.

On November 10, 2014, the Company’s Board of Directors ratified the 2015 annual compensation of the Company’s CEO, CFO and President as approved by the Company’s Compensation Committee, and, upon the recommendation of the Company’s Compensation Committee, approved the grant of Restricted Stock Units to the Company’s CEO, CFO and President. The cash compensation for such officers will remain the same as in 2014 ($100,000 for CEO. $80,000 for CFO and $80,000 for the President). In addition, all three of them will receive a grant of 46,403 Restricted Stock Units (“RSU”). The fair value of the 46,403 shares of RSU was $200,000, which was calculated based on the stock price of $4.31 per share on October 27, 2014, the date the awards were determined by the Compensation Committee. The RSU grants will be vested 25% on March 30, 2015, 25% on June 30, 2015, 25% on September 30, 2015 and 25% on December 31, 2015.

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CAUTIONARY STATEMENT FOR FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or the negative of such terms or other similar expressions. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those listed under the heading “Risk Factors” and those listed in our other Securities and Exchange Commission filings. The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report. Unless the context otherwise requires, references in this report to “we,” “us,” “Nova,” “Nova Lifestyle” or the “Company” refer to Nova Lifestyle, Inc. and its subsidiaries.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Nova LifeStyle Inc. is a broad based manufacturer of contemporary styled residential furniture incorporated into a dynamic marketing and sales platform offering retail as well as online selection and purchase fulfillment globally. We monitor popular trending and work to create design elements that are then integrated into our product lines that can be used as both stand-alone or whole-room and home furnishing solutions. Through our global network, Nova LifeStyle also sells (through an exclusive third party manufacturing partner) a managed variety of high quality bedding foundation components.

Nova's LifeStyle brand family currently includes Diamond Sofa (www.diamondsofa.com), Colorful World, Giorgio Mobili, and, starting from April 2013, includes Bright Swallow International Group Limited (Bright Swallow).

Our customers principally consist of distributors and retailers having a specific geographic coverage that deploy middle to high end private label home furnishings having very little competitive overlap within our specific furnishings products or product lines. Nova LifeStyle is constantly seeking to integrate new sources of distribution and manufacturer that are properly aligned with our growth strategy thus allowing us to continually focus on building both same store sales growth as well as drive the expansion of our overall distribution and manufacturing relationships through a deployment of popular, as well as trend-based, furnishing solutions worldwide.

Our acquisition of Bright Swallow International Group Limited, an established furniture company with a Canadian client base was finalized on April 24, 2013, and all issued and outstanding shares of Bright Swallow have been transferred to Nova by Bright Swallow's previous sole owner Mr. Zhu Wei, as that purchase has become an integral part of the Nova LifeStyle brand family. The purchase price for the acquisition was $6.5 million in cash and was fully paid at the closing of the acquisition. Bright Swallow’s complementary product line and geographical reach will offer Nova LifeStyle an ideal opportunity to expand its overall global market presence. Bright Swallow’s current client, Canadian based The Brick Limited (www.TheBrick.com) has over 200 locations and provides an excellent example of this exceptional integration opportunity. This new brand also provides Nova LifeStyle with an excellent opportunity to market to existing Bright Swallow partners and increase its sales accordingly. Bright Swallow is a British Virgin Island company with its principal offices in Hong Kong.

On October 21, 2013, Nova Dongguan incorporated Dongguan Ding Nuo Household Products Co., Ltd. (“Ding Nuo”) under the laws of the PRC and contributed capital of RMB 1 million ($162,994). Nova Dongguan made an additional capital contribution of RMB 0.1 million ($16,305) on November 27, 2013 through one of Nova Dongguan’s officers who acts as the nominee shareholder of Ding Nuo. All of the nominee shareholder’s shares were put in escrow and trust with Nova Dongguan and all profits and losses of Ding Nuo will be distributed to Nova Dongguan; accordingly, Nova Dongguan effectively controls 100% of Ding Nuo. Ding Nuo was established mainly for engaging in business with IKEA.

IKEA has strict standards and processes to choose and qualify its vendors and suppliers. In order to be qualified as an IKEA supplier, a company must go through a review, inspection and approval process according to IKEA standards which include the supplier’s operating history, manufacturing facility and equipment, production capacity, raw materials, employee benefits and work safety, environmental protection and compliance with laws and regulations, among other things. Nova began the discussions with IKEA to become a supplier in 2012. In order to expedite the qualification process with IKEA, the Company decided to incorporate a new company and construct a new facility/workshop in full compliance with IKEA's special requirements. Therefore, the Company incorporated Ding Nuo, built a manufacturing facility/workshop and leased it to Ding Nuo specifically for engaging in business with IKEA. In early September 2014, Ding Nuo completed an initial purchase from IKEA. The purchase was made under a Contract Review Trading Area – Supplier. IKEA finished installing a Purchase Agreement (the “PUA”) system into Nova’s computer system in early October, so that IKEA is able to place future orders through the system for Nova to execute. IKEA will place formal orders (every 2-3 weeks) through the system for the following 3 months. If DingNuo can successfully fulfill these orders (in terms of timing, product quality, delivery and other requirements) for the 3 months orders, then beginning in 2015, IKEA will provide the Company a yearly order plan.

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Our experience developing and marketing products for international markets has enabled us to develop the scale, logistics, marketing, manufacturing efficiencies and design expertise that serve as the foundation for us to expand aggressively into the highly attractive U.S., Canada and China markets.

We are a U.S. holding company with no material assets other than the ownership interests of our wholly owned subsidiaries through which we market, design, manufacture and sell residential furniture worldwide: Nova Dongguan, Nova Macao, Nova Museum, Nova Furniture, Bright Swallow, Diamond Bar and Ding Nuo, with each of Nova Museum and Ding Nuo a wholly owned subsidiary of Nova Dongguan. Nova Furniture (Dongguan) Co., Ltd. (“Nova Dongguan”) is a wholly foreign owned enterprise (“WFOE”) and was incorporated under the laws of the PRC on June 6, 2003. Nova Furniture Macao Commercial Offshore Limited (“Nova Macao”),was organized under the laws of Macao on May 20, 2006. Nova Dongguan organized Nova Dongguan Chinese Style Furniture Museum (“Nova Museum”), on March 17, 2011, as a non-profit organization under the laws of the PRC engaged in the promotion of the culture and history of furniture in China. Nova Dongguan and Nova Macao are wholly owned subsidiaries of Nova Furniture Limited (“Nova Furniture”), a wholly owned subsidiary of the Company, organized under the laws of the BVI on April 29, 2003. We acquired Nova Furniture pursuant to the Share Exchange Agreement on June 30, 2011. Diamond Bar Outdoors, Inc. (“Diamond Bar”), is a California corporation organized on June 15, 2000, which we acquired pursuant to a stock purchase agreement on August 31, 2011. On April 24, 2013, we acquired all of the outstanding stock of Bright Swallow; the purchase price was $6.5 million in cash and was fully paid at the closing of the acquisition. In 2013, we formed Ding Nuo as a new subsidiary, which is held 90.91% by Nova Furniture and 9.09% by Mr. Gu XingChang, as described above.

Nova Dongguan markets and sells our products in China to stores in our franchise network and to wholesalers and agents for domestic retailers and exporters. Nova Dongguan also provides the design expertise and facilities to manufacture our branded products and products for international markets under Original Design Manufacturer (“ODM”) and Original Equipment Manufacturer (“OEM”) agreements. Nova Macao is a trading company, importing, marketing and selling products designed and manufactured by Nova Dongguan and third party manufacturers for the U.S. and international markets. Nova Macao manages all aspects of Nova Dongguan’s export market. Diamond Bar markets and sells products manufactured by us and third party manufacturers under the Diamond Sofa brand to distributors and retailers principally in the U.S. market. Bright Swallow sells products manufactured by third party manufacturers through The Brick Limited which is principally in the Canadian market. Ding Nuo is primarily engaged in conducting business with IKEA. We added a factory in 2011 and completed construction of a new plant at our Nova Dongguan facilities in the second quarter of 2013. The manufacturing capacity provided by these new plants will help Nova Dongguan maintain current and anticipated levels of production on pace with our anticipated expansion and increase in sales to China. We intend to meet our liquidity requirements, including capital expenditures related to the expansion of our manufacturing facilities at Nova Dongguan, purchase of raw materials and the expansion of our business, through cash flow provided by operations, our existing credit facilities, and any possible equity financing.

Principal Factors Affecting Our Financial Performance

Significant factors that we believe could affect our operating results are the (i) cost of raw materials; (ii) prices of our products to our international retailer and wholesaler customers and their markup to end consumers; (iii) consumer acceptance of our new brands and product collections; and (iv) general economic conditions in the U.S., Canada, China, Europe and other international markets. We have experienced and anticipate continued fluctuation in raw material costs as a result of world economic conditions, such as the price of stainless and carbon steel. We can normally pass the raw material cost increase to our customers, but there may be a time lag as we renegotiate pricing with our customers on existing products and introduce new product collections. We attempt to mitigate short-term risks of raw material price swings in between customer price negotiations by purchasing some raw materials in advance based on forecasted production needs. In addition, we are less susceptible to these short-term raw material pricing risks in the China retail market because we reserve the right under our product franchise agreements to adjust our wholesale and retail product pricing based on raw material price fluctuations, providing franchisees with at least one month’s notice prior to price adjustment. We believe most of our customers are willing to pay us higher prices for our high quality and stylish products, timely delivery and strong production capacity, which we expect will allow us to maintain high gross profit margins for our products. We have diversified our products by introducing brands and product collections exclusively for China, acquiring the Diamond Sofa brand in the U.S. market and developing higher-margin products for the U.S. and international markets, acquiring Bright Swallow for the Canadian market and establishing Ding Nuo for doing business with IKEA. Consumer preference trends favoring high quality and stylish products and lifestyle-based furniture suites also should allow us to maintain our high gross profit margins. The markets in North America and Europe remain challenging because they are experiencing a slower than anticipated recovery from the recent international financial crisis and the Euro-area crisis in particular. However, we believe that discretionary purchases of furniture by middle to upper middle-income consumers, our target global consumer market, will increase along with expected growth in the worldwide furniture trade and recovery of housing markets. Furthermore, we believe that our expansion of direct sales in China and the U.S. will have a positive impact on our net sales and net income, while helping to diversify our customer base and end consumer markets.

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Critical Accounting Policies

While our significant accounting policies are described more fully in Note 2 to our accompanying consolidated financial statements, we believe the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for Nova LifeStyle and its subsidiaries, Diamond Bar, Bright Swallow, Nova Furniture, Nova Dongguan, Nova Macao, Nova Museum and Ding Nuo.

Use of Estimates

In preparing financial statements in conformity with U.S. GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include the allowance for bad debts, valuation of inventories and recoverability of long-lived assets, goodwill and warrant derivative liability. Actual results could differ from those estimates.

Accounts Receivable

Our policy is to maintain an allowance for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. In 2012, the company elected to establish a bad debt allowance in consideration of (1) the many collections-based variables associated with a fast growing global operation and (2) being subject to possible defaults that cannot be reasonably anticipated. The Company maintained an allowance for bad debt of $355,960 and $280,055 as of September 30, 2014 and December 31, 2013, respectively.

Revenue Recognition

Our revenue recognition policies are in compliance with ASC Topic 605, “Revenue Recognition.” Sales revenue is recognized when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of ours exist and collectability is reasonably assured. No revenue is recognized if there are significant uncertainties regarding the recovery of the consideration due, or the possible return of the goods. Payments received before all of the relevant criteria for revenue recognition are recorded as unearned revenue.

Sales revenue represents the invoiced value of goods, net of value-added taxes, or VAT. All of our products sold in China are subject to VAT of 17% of the gross sales price. This VAT may be offset by VAT paid by us on raw materials and other materials purchased in China and included in the cost of producing the finished product. We recorded VAT payable and VAT receivable net of payments in the financial statements. The VAT tax return is filed offsetting the payables against the receivables. Sales and purchases are recorded net of VAT collected and paid when we act as an agent for the PRC government.

Our sales policy allows for the return of product within the warranty period if the product is defective and the defects are the Company’s fault. As alternatives for the product return option, the customers have options of asking a discount from the Company for the products with quality issues or receiving replacement parts from the Company at no cost. The amount for return of products, the discount provided to the customers and cost for the replacement parts were immaterial in the nine and three months ended September 30, 2014 and 2013.

Foreign Currency Translation and Transactions

The accompanying consolidated financial statements are presented in USD. The functional currency of Nova Lifestyle, Nova Furniture, Nova Macao and Diamond Bar is the US Dollar. The functional currency of our PRC subsidiaries, Nova Dongguan, Nova Museum and Ding Nuo, is RMB. The functional currencies of our foreign operations are translated into USD for balance sheet accounts using the current exchange rates in effect as of the balance sheet date and for revenue and expense accounts using the weighted-average exchange rate during the fiscal year. The translation adjustments are recorded as a separate component of stockholders’ equity, captioned “Accumulated other comprehensive income.” Gains and losses resulting from transactions denominated in foreign currencies are included in “Other income (expenses)” in the consolidated statements of income and comprehensive income. There have been no significant fluctuations in the exchange rate for the conversion of RMB to USD after the balance sheet date.

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Segment Reporting

Accordingly, management concluded that the Company had one reportable segment under ASC 280 because: (i) the Company’s products sold through Nova Dongguan, Nova Macao, and Ding Nuo are created with similar production processes, in the same facilities, under the same regulatory environment and sold to customers using similar distribution systems; (ii) Diamond Bar is a furniture distributor based in California focusing on customers in US, and Bright Swallow is a furniture distributor based in Hong Kong focusing on customers in Canada, they both are operated under the same senior management of Nova Dongguan and Nova Macao, and management views the operations of Nova Dongguan, Nova Macao, Diamond Bar, Bright Swallow and Ding Nuo as a whole for making business decisions; and (iii) although Nova Museum is principally engaged in the dissemination of the culture and history of furniture in China, it also serves a function of promoting and marketing the Company’s image and products by providing a platform and channel for consumers to be exposed to the Company and its products, it is operated under the same management with the same resources and in the same location as Nova Dongguan, and it is an additive and supplemental unit to the Company’s main operations, the manufacture and sale of furniture.

New Accounting Pronouncements

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Results of Operations

Comparison of three months Ended September 30, 2014 and 2013

The following table sets forth the results of our operations for the three months ended September 30, 2014 and 2013. Certain columns may not add due to rounding.

	Three Months ended September 30,
	2014					2013
	$		% of Sales			$			% of Sales
Net sales		25,892,872					22,310,842
Cost of sales		20,001,433		77	%		17,911,859			80	%
Gross profit		5,891,439		23	%		4,398,983			20	%
Operating expenses		3,309,564		13	%		2,693,022			12	%
Income from operations		2,581,875		10	%		1,705,961			8	%
Other income (expenses), net		616,633		2	%		(125,803	)		(1	)%
Income tax expense		77,825		0	%		359,232			2	%
Net income		3,120,683		12	%		1,220,926			5	%

Net Sales

Net sales for the three months ended September 30, 2014, were $25.89 million, an increase of 16% from $22.31 million in the same period of 2013; this increase in net sales resulted primarily from a 6% increase in sales volume and 9% increase in average selling price. Our overall average selling price increased approximately 9% in the three months ended September 30, 2014 compared to 2013, resulting primarily from ceasing sales of an extremely low priced product of Nova Dongguan. Our largest selling product categories in the three months ended September 30, 2014 and 2013 were sofas, cabinets and dining tables, which accounted for approximately 37%, 16% and 15% of sales, respectively, for the three months ended September 30, 2014, and 37%, 15% and 16% of sales, respectively, for the three months ended September 30, 2013.

Of the $3.58 million increase in net sales in the three months ended September 30, 2014, compared to the same period of 2013, $3.55 million was attributable to sales in markets other than China, principally as a result of increased sales in North America and Asia, including Hong Kong and other countries. North American sales increased 45% to $18.33 million in the three months ended September 30, 2014 compared to $12.64 million in the same period of 2013 as we aggressively expanded sales to the U.S. and Canadian markets and integrated the operations of Bright Swallow. As part of our gradual change in sales and marketing strategy starting in 2012, we increased marketing efforts in the U.S. markets while maintaining our marketing efforts and existing customer base in Europe. Sales to Europe were $1.94 million in the three months ended September 30, 2014, a decrease of 52.8% from $4.12 million in the same period of 2013, as a result of the slow European economy. We anticipate increasing sales and marketing to the European market as the region’s economic outlook improves. Sales to Asia, including Hong Kong, and other countries, increased 2.81% to $1.20 million in the three months ended September 30, 2014 compared to $1.17 million in the same period of 2013.

Sales to China, which included sales to franchisees in addition to wholesalers and agents to domestic retail stores and distributors for the export market, accounted for 6% of sales in the three months ended September 30, 2014, compared to 8% of sales in the same period of 2013. Sales to franchisees selling our branded products in China contributed approximately $0.67 million or 15% of our total China sales in the three months ended September 30, 2014, compared to $0.74 million or 17% in the same period of 2013. The Company is currently adopting new image standards as well as product lines for its franchise operations that will take time to develop. First, through our production line, we intend to produce some products made from marble material. Second, we intend to import a range of additional products from the U.S. or Europe. We also intend to enrich our product lines to include a bedroom series, which would include beds, bed side tables, mattresses (which could be imported or purchased in China) and bedding sets including bed sheets, pillowcases, quilt covers, and other items (which can be purchased within China). Despite decreased sales to franchisees stores, our overall sales to China increased 1% to $4.42 million in the three months ended September 30, 2014, compared to $4.39 million in the same period of 2013 as a result of $0.57 million sales from our newly incorporated company, Ding Nuo.

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Cost of Sales

Cost of sales consists primarily of finished goods purchased from other manufacturers, material costs, labor costs and related overhead directly attributable to the production of our products. Total cost of sales increased 12% to $20.00 million in the three months ended September 30, 2014, compared to $17.91 million in the same period of 2013 due primarily to an increase in sales and production. Cost of sales for products that we manufactured was $4.94 million in the three months ended September 30, 2014, a 1% decrease from $5.01 million in the same period of 2013. Material costs, labor costs and related overhead accounted for 69%, 22% and 9% of cost of sales for such products in the three months ended September 30, 2014, compared to 72%, 19% and 9% in the same period of 2013, respectively. The cost of products purchased from third party manufacturers increased 17% to $15.06 million in the three months ended September 30, 2014, from $12.90 million in the same period of 2013. The increase of products purchased from third party manufacturers is primarily due to increased sales orders, which exceeded the company’s current manufacturing capacity. Cost of sales as a percentage of net sales was 77% in the three months ended September 30, 2014, compared to 80% in the same period of 2013. The decrease in cost of sales as a percentage of net sales from the three months ended September 30, 2014 to 2013 resulted primarily from increased sales while the cost of sales remained constant compared with the same period of last year.

Gross Profit

Gross profit increased 34% to $5.89 million in the three months ended September 30, 2014, compared to $4.40 million in the same period of 2013. Our gross profit margin increased to 23% in the three months ended September 30, 2014, compared to 20% in the same period of 2013. The increase in gross profit margin resulted primarily from decreased cost of sales as a percentage of net sales, which was due primarily to increased sales and decreased cost of direct materials for self-produced products; in addition, we attracted more sales orders from certain large trading company customers by conducting trade shows in United States.

Operating Expenses

Operating expenses consisted of selling, general and administrative expenses, goodwill impairment and loss on disposal of fixed assets. Operating expenses increased 23% to $3.31 million in the three months ended September 30, 2014, from $2.69 million in the same period of 2013. Selling expense increased 45% to $1.17 million in the three months ended September 30, 2014, from $0.81 million in the same period of 2013 due primarily to increased sales. General and administrative expense increased by 13% to $2.13 million in the three months ended September 30, 2014, from $1.88 million in the same period of 2013 due primarily to an increase of research and development expenses by $229,000, and salary by $77,300, public relations by $121,600, but offset with a decrease in attorney fee of $199,600.

Other Income (Expense)

Other income was $616,633 in the three months ended September 30, 2014, compared with other expenses of $125,803 in the same period of 2013, an increase of $742,436. The increase in other income was due primarily to change in fair value of warrant liability of $630,264 and the interest income of $109,548 paid by one of the Company’s suppliers in the three months ended September 30, 2014, as further discussed in Note 4 to our accompanying consolidated financial statements.

Income Tax Expense

Income tax expense was $77,825 in the three months ended September 30, 2014, compared with $359,232 in the same period of 2013. The decrease in income tax expense is mainly due to increased nontaxable income of $630,264 from the change in fair value of warrant liability in the three months ended September 30, 2014.

Net Income

Net income was $3.12 million in the three months ended September 30, 2014, an increase of 156% from $1.22 million for the same period of 2013. Our net profit margin was 12% in the three months ended September 30, 2014, an increase of 7% from 5% for 2013, due to the reasons explained above. The increase in profit margin resulted primarily from income from the change in fair value of warrant liability, which is a non-cash and non-taxable income.

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Comparison of nine months Ended September 30, 2014 and 2013

The following table sets forth the results of our operations for the nine months ended September 30, 2014 and 2013. Certain columns may not add due to rounding.

	Nine Months ended September 30,
	2014					2013
	$		% of Sales			$			% of Sales
Net sales		69,708,982					56,471,241
Cost of sales		55,592,993		80	%		44,973,299			80	%
Gross profit		14,115,989		20	%		11,497,942			20	%
Operating expenses		9,435,005		14	%		6,767,793			12	%
Income from operations		4,680,984		7	%		4,730,149			8	%
Other income (expenses), net		2,848,217		4	%		(371,541	)		(1	)%
Income tax expense		752,311		1	%		772,135			1	%
Net income		6,776,890		10	%		3,586,473			6	%

Net Sales

Net sales for the nine months ended September 30, 2014, were $69.71 million, an increase of 23% from $56.47 million in the same period of 2013; this increase in net sales resulted primarily from a 34% increase in sales volume due to a 9% decrease in average selling price. Our subsidiary Bright Swallow, which was acquired in April 2013, contributed $6.33 million to sales for the nine months ended September 30, 2014 while it only brought us $3.76 million for the same period of 2013. Our overall average selling price decreased approximately 9% in the nine months ended September 30, 2014, compared to 2013, resulting primarily from increased sales volume of low price products in both the China domestic market and worldwide. Our largest selling product categories in the nine months ended September 30, 2014 and 2013 were sofas, cabinets and dining tables, which accounted for approximately 37%, 17% and 15% of sales, respectively, for the nine months ended September 30, 2014, and 36%, 17% and 17% of sales, respectively, for the nine months ended September 30, 2013.

Of the $13.24 million increase in net sales in the nine months ended September 30, 2014, compared to the same period of 2013, $12.87 million was attributable to sales in markets other than China, principally as a result of increased sales in North America and Asia, including Hong Kong and other countries. North American sales increased 44% to $44.25 million in the nine months ended September 30, 2014, compared to $30.77 million in the same period of 2013 as we aggressively expanded sales to the U.S. and Canadian markets and integrated the operations of Bright Swallow. As part of our gradual change in sales and marketing strategy starting in 2012, we increased marketing efforts in the U.S. markets while maintaining our marketing efforts and existing customer base in Europe. Sales to Europe were $8.16 million in the nine months ended September 30, 2014, a decrease of 26.61% from $11.12 million in the same period of 2013 as a result of the slow European economy. We anticipate increasing sales and marketing to the European market as the region’s economic outlook improves. Sales to Asia, including Hong Kong, and other countries, increased 84% to $5.14 million in the nine months ended September 30, 2014, compared to $2.79 million in the same period of 2013, primarily due to the increase of sales orders from our major customers in Asia.

Sales to China, which included sales to franchisees in addition to wholesalers and agents to domestic retail stores and distributors for the export market, accounted for 17% of sales in the nine months ended September 30, 2014, compared to 21% of sales in the same period of 2013. Sales to franchisees selling our branded products in China contributed approximately $1.79 million or 15% of our total China sales in the nine months ended September 30, 2014, compared to $1.94 million or 16% in the same period of 2013. The Company is currently adopting new image standards as well as product lines for its franchise operations that will take time to develop. First, through our production line, we intend to produce some products made from marble material. Second, we intend to import a range of additional products from the U.S. or Europe. We also intend to enrich our product lines to include a bedroom series, which would include beds, bed side tables, mattresses (which could be imported or purchased in China) and bedding sets including bed sheets, pillowcases, quilt covers, and other items (which can be purchased within China). Overall sales to China increased 3% to $12.16 million in the nine months ended September 30, 2014 compared to $11.79 million in the same period of 2013 as a result of $0.66 million sales from our newly incorporated company, Ding Nuo.

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Cost of Sales

Cost of sales consists primarily of finished goods purchased from other manufacturers, material costs, labor costs and related overhead directly attributable to the production of our products. Total cost of sales increased 24% to $55.59 million in the nine months ended September 30, 2014, compared to $44.97 million in the same period of 2013 due primarily to an increase in sales and production. Cost of sales for products that we manufactured was $13.23 million in the nine months ended September 30, 2014, a 10% increase from $12.00 million in the same period of 2013. Material costs, labor costs and related overhead accounted for 66%, 22% and 12% of cost of sales for such products in the nine months ended September 30, 2014, compared to 70%, 21% and 9% in the same period of 2013, respectively. The cost of products purchased from third party manufacturers increased 28% to $42.36 million in the nine months ended September 30, 2014, from $32.97 million in the same period of 2013. The increase of products purchased from third party manufacturers is primarily due to increased sales orders, which exceeded the company’s current manufacturing capacity, and the purchase and continued integration of Bright Swallow, which is a furniture wholesale company. Cost of sales as a percentage of net sales stayed the same at 80% in the nine months ended September 30, 2014, compared with the same period of 2013.

Gross Profit

Gross profit increased 22.77% to $14.11 million in the nine months ended September 30, 2014, compared to $11.50 million in the same period of 2013. The increase in gross profit resulted primarily from increase of net sales. Our gross profit margin stayed the same at 20% in the nine months ended September 30, 2014, compared with the same period of 2013.

Operating Expenses

Operating expenses consisted of selling, general and administrative expenses, goodwill impairment and loss on disposal of fixed assets. Operating expenses increased 39% to $9.44 million in the nine months ended September 30, 2014, from $6.77 million in the same period of 2013. Selling expense increased 17% to $2.80 million in the nine months ended September 30, 2014, from $2.39 million in the same period of 2013 due primarily to increased sales. General and administrative expense increased by 32% to $5.80 million in the nine months ended September 30, 2014, from $4.38 million in the same period of 2013 due primarily to an increase of salary by $181,500, amortization of Bright Swallow’s customer relationship by $116,400, research and development expenses by $601,900, rent by $140,000, public relations by $146,500, and license fees related to listing of the Company’s stock on Nasdaq by $169,800. In addition, during the nine months ended September 30, 2014, the Company performed goodwill impairment tests, and concluded that goodwill of $0.81 million for Bright Swallow was impaired.

Other Income (Expense)

Other income was $2,848,217 in the nine months ended September 30, 2014, compared with other expenses of $371,541 in the same period of 2013, an increase of $3,219,758. The increase in other income was due primarily to change in fair value of warrant liability of $2,841,177, the interest income of $109,548 paid by one of the Company’s suppliers, as further discussed in Note 4 to our accompanying consolidated financial statements, the subsidy income of $50,500 from Chinese government for encouraging and supporting of the Company’s business expansion, and the insurance compensation of $136,600 for machinery which was damaged during shipping in the nine months ended September 30, 2014.

Income Tax Expense

Income tax expense was $752,311 in the nine months ended September 30, 2014, compared with $772,135 in the same period of 2013.

Net Income

Net income was $6.78 million in the nine months ended September 30, 2014, an increase of 89% from $3.59 million for the same period of 2013. Our net profit margin was 10% in the nine months ended September 30, 2014, an increase of 4% from 6% for 2013, due to the reasons explained above. The increase in profit margin resulted primarily from income from the change in fair value of warrant liability, which is a non-cash and non-taxable income.

Liquidity and Capital Resources

Our principal demands for liquidity are to increase sales in the U.S. and China, to purchase inventory, and for sales distribution and general corporate purposes. We intend to meet our liquidity requirements, including capital expenditures related to the expansion of our manufacturing facilities and production capacity, purchase of raw materials and the expansion of our business, primarily through cash flow provided by operations and collections of accounts receivable, and credit facilities from the bank.

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As we continue to execute our growth strategy focused on aggressively expanding sales, particularly in the U.S. and China, we remain focused on improving net margins and bottom line growth. As noted above, a particular focus in this regard is on reducing reliance on lower margin third party manufacturing and expansion of our own higher margin production facilities. We also believe there is elasticity in pricing our higher end products and an ongoing opportunity to improve our product mix which should help us to stay in step with cost increases. We further believe that increased direct sales in China, including the start-up of an internet sales platform for us to take internet orders in China, will positively impact profitability.

The Company relies primarily on internally generated cash flow and proceeds under our existing credit facilities to support growth. We may seek additional financing in the form of bank loans or other credit facilities or funds raised through future offerings of our equity or debt, if and when we determine such offerings are required. On April 14, 2014, the Company raised approximately $8.14 million after deducting fees to the placement agent of $716,000 and other estimated offering expenses of $115,000 by entering into a Securities Purchase Agreement with certain purchasers in a registered direct offering.

We had net working capital of $33,367,765 at September 30, 2014, an increase of $4,473,483 from net working capital of $28,894,282 at December 31, 2013. The ratio of current assets to current liabilities was 2.67-to-1 at September 30, 2014.

The following is a summary of cash provided by or used in each of the indicated types of activities during the nine months ended September 30, 2014 and 2013:

	2014			2013
Cash (used in) provided by:
Operating activities	$	(6,759,230	)	$	2,238,462
Investing activities		(2,786,697	)		(3,945,244	)
Financing activities		9,090,620			112,465

Net cash used in operating activities was $6.76 million in the nine months ended September 30, 2014, an increase of cash outflow of $9.00 million from $2.24 million of cash provided by operating activities in 2013. The increase in cash outflow was attributable primarily to advance payments to suppliers of $2.84 million including $1.98 million to one of our suppliers in exchange for the purchase of finished goods inventory at a favorable price in the nine months ended September 30, 2014, an increase in inventory by stocking more fast-selling products in order to avoid shipment delays for $2.76 million outflow, and the provision of longer sales terms on accounts receivable for the Company’s new product lines for $9.89 million outflow in the nine months ended September 30, 2014, despite an increase in cash inflow from accounts payable for $1.49 million inflow in the nine months ended September 30, 2014.

Net cash used in investing activities was $2.79 million in the nine months ended September 30, 2014, a decrease of $1.16 million from $3.94 million in the same period of 2013. In the nine months ended September 30, 2014, we paid $1.37 million for the acquisition of property and equipment, $0.79 million for deposits on new plant construction, and $0.64 million for construction in progress for website and mobile application design. In the same period of 2013, we paid $3.50 million as a deposit for the acquisition of Bright Swallow, $0.47 million for the acquisition of property and equipment, and $0.32 million for construction in progress for Dongguan new plant construction, offset by $0.34 million of cash received from the acquisition of Bright Swallow.

Net cash provided by financing activities was $9.09 million in the nine months ended September 30, 2014, an increase of $8.98 million from cash inflow of $0.11 million in the same period of 2013. In the nine months ended September 30, 2014, we repaid $21.66 million for bank loans, but borrowed $21.42 million from bank loans, and received $0.75 from outstanding subscription receivable, $0.45 million from warrants exercised and $8.14 million from equity financing. In the same period of 2013, we received $12.08 million proceeds from bank loans, but repaid $12.76 million in bank loans, and received $0.80 from warrants exercised.

As of September 30, 2014, we had gross accounts receivable of $38,086,798, of which $27,568,532 was with aging within 90 days, and $10,518,266 was with aging over 90 days; we had an allowance for bad debt of $355,960 for accounts receivables. The increase in accounts receivable was primarily due to increase of sales during the nine months ended September 30, 2014.

As of September 30, 2014, the annualized accounts receivable turnover rate was 2.83 compared with 3.11 as of December 31, 2013. The decrease of accounts receivable turnover rate was due to promoting new product lines by extending sales terms on accounts receivable during nine months ended September 30, 2014. Accordingly, the day sales outstanding (annualized) was 129.00 days at September 30, 2014, compared with 117.28 at December 31, 2013.

The annualized inventory turnover rate was 15.69 at September 30, 2014, compared with 19.10 at December 31, 2013. The decrease of inventory turnover rate was due to stocking of more fast-selling products in order to avoid shipment delays.

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To attract franchisees to our new franchise network in 2010, we granted new store operators a payment term of 90 days. We have a short history of collections with franchisees, but based on subsequent collections, we fully expect payment. Our management assesses the financial position, credit quality, credit history and other factors such as current market conditions before entering into product franchise agreements with new store operators to help ensure each franchisee’s ability to make payment in a timely manner. We retain the right to review and assess the performance of franchisees annually under the product franchise agreement, enabling our termination of franchises that fail to meet certain performance targets or make payments on product orders. We have since started phasing out the preferential payment terms we used in 2011, and our current product franchise agreement requires payment in full before delivery for most franchise customers, but provides 60 – 90 day credit terms to certain major and long-term customers.

Sales to international markets typically are made through letters of credit, but for some long-term, high volume customers, we accept telegraphic transfer, or T/T, with a payment term of 15-30 days upon receipt of the products. Historically, we have not experienced bad debts from our sales to international markets. Our accounts receivable related to sales to international markets, including the Canadian market through Bright Swallow’s sales, typically are less than three months, depending on customer shipment schedules. We expect the balance of accounts receivable to decrease as our new sales strategy and shortened payment terms to our major customers in the international markets take effect along with our new payment terms for franchisees.

Diamond Bar gives 30-60 day payment terms to customers who are approved for Account Receivable coverage by our credit insurance company. In most cases, Diamond Bar provides 30 day payment terms to most of the customers and 60 day payment terms for certain big customers with outstanding payment histories. Diamond Bar requires prepayment or COD for customers who are not approved by our credit insurance company. As a result of this policy, management expects accounts receivable outstanding from sales in the US and China to decrease correspondingly going forward.

Private Placement

As part of the transaction, the Buyers also received (i) Series A warrants to purchase up to 660,030 shares of Common Stock in the aggregate at an exercise price of $8.48 per share (the “Series A Warrants”); (ii) Series B warrants to purchase up to 633,628 shares of Common Stock in the aggregate at an exercise price of $6.82 per share (the “Series B Warrants”); and (iii) Series C warrants to purchase up to 310,478 shares of Common Stock in the aggregate at an exercise price of $8.53 per share (the “Series C Warrants” and together with the Series A Warrants and the Series B Warrants, the “Warrants”). The Series A Warrants have a term of four years and are exercisable by the holders at any time after the date of issuance. The Series B Warrants have a term of six months and are exercisable by the holders at any time after the date of issuance. The Series C Warrants have a term of four years and are exercisable by the holders at any time after the date of issuance. After the six month anniversary of the issuance date of the Series C Warrants, to the extent that a holder of a Series C Warrant exercises less than 70% of such holder’s Series B Warrants and the closing sale price of the Common Stock is equal to or greater than $9.81 for a period of ten consecutive trading days, then the Company may purchase the entire then-remaining portion of such holder’s Series C Warrants for $1,000. The shares and warrants were registered on a takedown of our shelf registration statement described below. The series B Warrants expired on October 14, 2014, and none of the Series B warrants were excised prior to such expiration.

Lines of Credit

Diamond Bar entered into an agreement with a bank in California for a line of credit of up to $5,000,000 with annual interest of 4.5% and maturity on June 1, 2015. The line of credit is secured by all of the assets of Diamond Bar Outdoors, Inc., a subsidiary of Nova Lifestyle and is guaranteed by Nova Lifestyle. As of September 30, 2014 and December 31, 2013, Diamond Bar had $4,507,037 and $4,754,258 outstanding on the line of credit, respectively. During the nine months ended September 30, 2014 and 2013, the Company recorded interest expense of $125,258 and $117,352, respectively; during the three months ended September 30, 2014 and 2013, the Company recorded interest expense of $46,325 and $42,867, respectively, related to this agreement. As of September 30, 2014, the Company had $492,963 available for borrowing.

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On August 24, 2012, Nova Macao entered into an agreement with a commercial bank in Hong Kong for a line of credit of up to $8,000,000 with maturity on August 23, 2013. On August 23, 2013, the Company renewed the line of credit with annual interest rate of 4.25% and maturity on November 21, 2013. On December 17, 2013, the Company renewed the line of credit of up to $6,500,000 with maturity on January 30, 2015. The loan requires monthly payment of the interest and the interest rate will be adjusted annually. The loan was secured by assignment of Sinosure (China Export and Credit Insurance Company) credit insurance. As of September 30, 2014 and December 31, 2013, Nova Macao had $1,848,000 outstanding on the line of credit. During the nine months ended September 30, 2014 and 2013, the Company record interest of $61,305 and $58,811, respectively; during the three months ended September 30, 2014 and 2013, the Company recorded interest of $20,072 and $19,854, respectively, related to this agreement. As of September 30, 2014, the Company had $4,652,000 available for borrowing.

The loan has the following covenants: (i) total outstanding under working capital advance shall not exceed the lesser of (a) the credit commitment of $6,500,000, (b) insurance claim limits and (c) borrowing base allowed of 80% advance rate against certain eligible accounts receivable; (ii) eligible account receivables are insured buyers by Sinosure assigned to the bank and within established insurance limit; (iii) the bank has an absolute right to exclude any portion of the accounts receivable from the aging report for computation of the borrowing base as it deems fit; (iv) in case the aggregate outstanding amount of credit facilities exceeds the available amount of facilities conferred by the aforesaid computation of borrowing base, the excess amount should be settled within 7 days by Nova Furniture Macao Commercial Offshore Limited; and. (v) the Company maintains a debt to tangible net worth ratio of not in excess of 3.0x throughout the whole term of the loan. As of September 30, 2014, Nova Macao was in compliance with all the covenants.

On April 25, 2012, Nova Dongguan entered into an agreement with a commercial bank in Dongguan for a line of credit of up to $3,280,356 (RMB 20 million) with maturity on April 24, 2015. As of September 30, 2014 and December 31, 2013, Nova Dongguan had $812,678 (RMB 5.00 million) with maturity on November 20, 2014 and $820,089 (RMB 5.00 million) outstanding on the line of credit, respectively. The loan currently bears monthly interest of 0.55% and requires monthly payment on the interest; the interest rate will be adjusted annually. The loan was secured by the building of Nova Dongguan and is guaranteed by Nova Dongguan and the Company’s CEO. During the nine months ended September 30, 2014 and 2013, the Company recorded interest expense of $40,722 and $42,656, respectively; during the three months ended September 30, 2014 and 2013, the Company recorded interest expense of $13,603 and $13,630, respectively, related to this agreement. As of September 30, 2014, the Company had $ 2,438,033 (RMB 15 million) available for borrowing.

Shelf Registration

On February 20, 2014, the Company filed a shelf registration statement on Form S-3 under which the Company may, from time to time, sell securities in one or more offerings up to a total dollar amount of $60,000,000. The shelf registration statement was declared effective as of March 7, 2014 and expires on March 6, 2017. As noted above, the shares and warrants issued by the Company on April 14, 2014, were registered on a takedown under the shelf registration.

Off-Balance Sheet Arrangements

There are no off-balance sheet arrangements between us and any other entity 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 is material to shareholders.

We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not required.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, our principal executive officer and principal financial officer, respectively, evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2014, our disclosure controls and procedures were not effective as of such date as identified in our internal control over financial reporting below.

Notwithstanding this material weakness, our management has concluded that, based upon the interim remediation of internal control described below under “Changes in Internal Control over Financial Reporting”, our consolidated financial statements for the periods covered by and included in this report are prepared in accordance with U.S. GAAP and fairly present, in all material respects, our financial position, results of operations and cash flows for each of the periods presented herein.

Changes in Internal Control over Financial Reporting

As of September 30, 2014, we have identified certain matters that constituted a material weakness in our internal control over financial reporting. Specifically, we lack sufficient accounting personnel with the appropriate level of knowledge, experience and training in U.S. GAAP and SEC reporting requirements.

We have taken, and are taking, certain actions to remediate the material weakness related to our lack of U.S. GAAP experience. We plan to hire additional credentialed professional staff and consulting professionals with greater knowledge and experience of U.S. GAAP and related regulatory requirements to oversee our financial reporting process in order to ensure our compliance with U.S. GAAP and other relevant securities laws. In addition, we plan to provide additional training to our accounting personnel on U.S. GAAP, and other regulatory requirements regarding the preparation of financial statements. Until such time as we hire qualified accounting personnel with the requisite U.S. GAAP knowledge and experience and train our current accounting personnel, we have engaged an outside CPA with U.S. GAAP knowledge and experience to supplement our current internal accounting personnel and assist us in the preparation of our financial statements to ensure that our financial statements are prepared in accordance with U.S. GAAP.

We believe the measures described above will facilitate remediation of the material weaknesses identified above and will continue to strengthen and have a material impact on our internal control over financial reporting. However, because this remediation process is still in its initial stages, we can give no assurance as to when it will be completed. As we continue to evaluate and work to improve our internal control over financial reporting, we may determine that additional measures are necessary to address control deficiencies.

Other than as described above, there were no changes in our internal control over financial reporting during the quarter ended September 30, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We may occasionally become involved in various lawsuits and legal proceedings arising in the ordinary course of business. Litigation is subject to inherent uncertainties and an adverse result in these or other matters that may arise from time to time could have an adverse effect on our business, financial condition or operating results. We are currently not aware of any such legal proceedings or claims that will have, individually or in the aggregate, a material adverse effect on our business, financial condition or operating results.

Item 6. Exhibits

See the Exhibit Index following the signature page to this Quarterly Report on Form 10-Q for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		NOVA LIFESTYLE, INC.
		(Registrant)
Date: November 12, 2014	By:	/s/ Ya Ming Wong
		Ya Ming Wong Chief Executive Officer (Principal Executive Officer)

Date: November 12, 2014		/s/ Yuen Ching Ho
		Yuen Ching Ho Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.		Document Description
31.1 †		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 †		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 ‡		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as signed by the Chief Executive Officer
32.2 ‡		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as signed by the Chief Financial Officer
101.INS†		XBRL Instance Document
101.SCH†		XBRL Schema Document
101.CAL†		XBRL Calculation Linkbase Document
101.DEF†		XBRL Definition Linkbase Document
101.LAB†		XBRL Label Linkbase Document
101.PRE†		XBRL Presentation Linkbase Document

† Filed herewith

‡ Furnished herewith