Nova Lifestyle, Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Commission file number: 011-36259

NOVA LIFESTYLE, INC.

(Exact name of registrant as specified in its charter)

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  ☒    NO  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).

YES  ☒    NO  ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

YES  ☐   NO  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 27,652,836 shares of common stock outstanding as of November 6, 2018. 

Nova LifeStyle, Inc.

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVA LIFESTYLE, INC. AND SUBSIDIARIES 

CONDENSED CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2018 (UNAUDITED) AND DECEMBER 31, 2017

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

NOVA LIFESTYLE, INC. AND SUBSIDIARIES 

CONDENSED CONSOLIDATED BALANCE SHEETS (CONT’D)

SEPTEMBER 30, 2018 (UNAUDITED) AND DECEMBER 31, 2017

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

NOVA LIFESTYLE, INC. AND SUBSIDIARIES 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)

FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

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

NOVA LIFESTYLE, INC. AND SUBSIDIARIES 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

NOVA LIFESTYLE, INC. AND SUBSIDIARIES 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

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

NOVA LIFESTYLE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (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 and sell furniture worldwide: Nova Furniture Limited in the British Virgin Islands (“Nova Furniture”), Nova Furniture Ltd. in Samoa (“Nova Samoa”), Bright Swallow International Group Limited (“Bright Swallow” or “BSI”), Nova Furniture Macao Commercial Offshore Limited (“Nova Macao”), and Diamond Bar Outdoors, Inc. (“Diamond Bar”).

Nova Macao was organized under the laws of Macao on May 20, 2006, and is a wholly owned subsidiary of Nova Furniture.  Diamond Bar, doing business as Diamond Sofa, was incorporated in California on June 15, 2000.  Nova Macao is a trading company, importing, marketing and selling products designed and manufactured by Nova Furniture (Dongguan) Co., Ltd. (“Nova Dongguan”) and third-party manufacturers for the U.S. and international markets. Diamond Bar markets and sells products manufactured by third-party manufacturers under the Diamond Sofa brand to distributors and retailers principally in the U.S. market.  On April 24, 2013, the Company completed the acquisition of Bright Swallow, an established furniture company with a global client base.  

The sale of three of the Company’s former subsidiaries, Nova Dongguan, Nova Dongguan Chinese Style Furniture Museum (“Nova Museum”), and Dongguan Ding Nuo Household Products Co., Ltd. (“Ding Nuo”), was consummated on October 25, 2016.

Before its divestment, Nova Dongguan was a wholly foreign-owned enterprise, or WFOE, and was incorporated under the laws of the PRC on June 6, 2003. 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. Nova Dongguan markets and sells products in China to stores in our former franchise network and to wholesalers and agents for domestic retailers and exporters. At the time of sale, Nova Dongguan also provided design expertise and facilities to manufacture branded products and products for international markets under original design manufacturer and original equipment manufacturer agreements, or ODM and OEM agreements. On October 24, 2013, Nova Dongguan incorporated Ding Nuo under the laws of the PRC.

On December 7, 2017, Nova LifeStyle, Inc. incorporated i Design Blockchain Technology, Inc. (“i Design”) under the laws of the State of California. The purpose of i Design is to build our own blockchain technology team. This new company will focus on the application of blockchain technology in the furniture industry, including encouraging and facilitating interactions among designers and customers, and building a blockchain-powered platform that enables designers to showcase their products, including current and future furniture designs. This company is in the planning stage and has had minimal operations to date.

The “Company” and “Nova” collectively refer to Nova LifeStyle, the U.S. parent, and its subsidiaries, Nova Furniture, Nova Samoa, Nova Macao, Diamond Bar, i Design and BSI. 

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 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, 2018 and for the nine and three month periods ended September 30, 2018 and 2017 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, 2017, previously filed with the SEC on March 29, 2018.

In the opinion of management, all adjustments (which include all significant normal and recurring adjustments) necessary to present a fair statement of the Company’s interim condensed consolidated financial position as of September 30, 2018, its interim condensed consolidated results of operations and cash flows for the nine and three month periods ended September 30, 2018 and 2017, 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.

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 as of the dates of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made by management include, but are not limited to, revenue recognition, the allowance for bad debt, valuation of inventories, the valuation of stock-based compensation, income taxes and unrecognized tax benefits, valuation allowance for deferred tax assets, assumptions used in assessing impairment of long-lived assets and goodwill. 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 more frequently 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 two-step goodwill impairment test is required to be performed. Otherwise, no further testing is required. 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 two-step goodwill impairment test for Diamond Bar reporting unit.  Accordingly, as of September 30, 2018 and December 31, 2017, the Company concluded there was no impairment of goodwill of Diamond Bar.

Cash and Cash Equivalents

For purposes of the statement of cash flows, the Company considers cash, money market funds, investments in interest bearing demand deposit accounts, time deposits and all highly liquid investments with an original maturity of three months or less to be cash equivalents. 

Advances to Suppliers

Advances to suppliers are reported net of allowance when the Company determines that amounts outstanding are not likely to be collected in cash or utilized against purchase of inventories. Based on its historical record and actual practice, the Company always received goods within 5 to 9 months from the date the advance payment is made. As such, no reserve on supplier prepayments had been made or recorded by the Company. Any provisions for allowance for advances to suppliers, if deemed necessary, will be included in general and administrative expenses in the consolidated statements of comprehensive income. During the nine and three months ended September 30, 2018 and 2017, no provision was made on advances to suppliers.

Inventories

Inventories are stated at the lower of cost and net realizable value with cost determined on a weighted-average basis. 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 write-downs of inventory at September 30, 2018 and December 31, 2017.

Plant, Property and Equipment

Plant, property and equipment are stated at cost, net of accumulated depreciation and impairment losses, if any. Expenditures for maintenance and repairs are expensed as incurred; while 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:

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

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, 2018 and December 31, 2017, there was no impairment of its long-lived assets.

Research and Development

Research and development costs are related primarily to the Company designing and testing its new products during the development stage. Research and development costs are recognized in general and administrative expenses and expensed as incurred. Research and development expense were $86,790 and $364,105 for the nine months ended September 30, 2018 and 2017, respectively. Research and development expense were $7,985 and $0 for the three months ended September 30, 2018 and 2017, 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 for the nine months ended September 30, 2018 is (24.99%) and the income tax benefit for the nine and three months ended September 30, 2018 are $505,074 and $942,267, respectively. The income tax benefit for the nine and three months ended September 30, 2017 are $750,037 and $262,034, respectively, The income tax benefits for these periods are primarily caused by the reversal of the Company’s prior year ASC740-10 reserves due to the expiration of the statute of limitation and year to date losses generated from U.S. operations.

Income taxes are accounted for using an asset and liability method. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The Company follows ASC Topic 740, which prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods, and income tax disclosures.

Under the provisions of ASC Topic 740, when tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

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, Nova Samoa was incorporated in Samoa and Nova Macau was incorporated in Macau. There is no income tax for companies domiciled in the BVI, Samoa and Macau. Accordingly, the Company’s consolidated financial statements do not present any income tax provision related to the BVI, Samoa and Macau tax jurisdiction where Nova Furniture BVI and BSI, Nova Samoa and Nova Macau are domiciled.

On December 22, 2017, the Tax Cut and Jobs Act (“Tax Act”) was signed into law. The Tax Act introduced a broad range of tax reform measures that significantly change the federal income tax laws. The provisions of the Tax Act that may have significant impact on the Company include the permanent reduction of the corporate income tax rate from 35% to 21% effective for tax years including or commencing on January 1, 2018, one-time transition tax on post-1986 foreign unremitted earnings, provision for Global Intangible Low Tax Income ("GILTI"), deduction for Foreign Derived Intangible Income ("FDII"), repeal of corporate alternative minimum tax, limitation of various business deductions, and modification of the maximum deduction of net operating loss with no carryback but indefinite carryforward provision. Many provisions in the Tax Act are generally effective in tax years beginning after December 31, 2017.

As of December 31, 2017, the Company reflected the provisional income tax effects of the Tax Act under Accounting Standards Codification Topic 740, Income Taxes. The Company has recorded a provisional tax expense in the year ended December 31, 2017 of approximately $3.37 million, comprised of approximately $3.27 million tax expense from recording the estimated one-time transition tax on post-1986 foreign unremitted earnings and $0.09 million of tax expense from remeasurement of U.S. deferred taxes using the relevant tax rate at which the Company expects them to reverse in the future.

As of September 30, 2018, unrecognized tax benefits were approximately $1.3 million.  The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $1.3 million as of September 30, 2018.

A reconciliation of the January 1, 2018 through September 30, 2018, amount of unrecognized tax benefits excluding interest and penalties (“Gross UTB”) is as follows:

At September 30, 2018, the Company had cumulatively accrued approximately $594,000 for estimated interest and penalties related to unrecognized tax benefits. At December 31, 2017, the Company had cumulatively accrued approximately $599,000 for estimated interest and penalties related to unrecognized tax benefits. The Company recorded interest and penalties (reversal) related to unrecognized tax benefits as a component of income tax expense, which totaled approximately $(4,949) and $73,000 for the nine months ended September 30, 2018, and 2017, respectively; and $(67,949) and $7,000 for the three months ended September 30, 2018 and 2017, respectively. The Company does not anticipate any significant changes to its unrecognized tax benefits within the next 12 months.

The prospects of supplemental legislation or regulatory processes to address questions that arise because of the Tax Act, or evolving technical interpretations of the tax law, may cause the final impact from the Tax Act to differ from the provisionally recorded amounts. The Company expects to complete its analysis within the measurement period allowed by Staff Accounting Bulletin (“SAB”) No.118, no later than the fourth quarter of 2018.

As of September 30, 2018 and December 31, 2017, a total of $1.3 million and $2.0 million, respectively, of unrecognized tax benefit was recorded as long-term taxes payable, as ASC 740 specifies that tax positions for which the timing of the ultimate resolution is uncertain should be recognized as long-term liabilities. Other long-term taxes payable as of September 30, 2018 and December 31, 2017 also consisted of an income tax payable of $2.3 million and $2.5 million, respectively, primarily arising from a one-time transition tax recognized in the fourth quarter of 2017 that represented management’s estimate of the amount of U.S. corporate income tax based on the deemed repatriation to the United States of its share of previously deferred earnings of our non-U.S. subsidiaries of mandated by the Tax Cuts and Jobs Act of 2017. The Company elected to pay the one-time transition tax over eight years commencing in April 2018.

Revenue Recognition

In May 2014 the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes all existing revenue recognition requirements, including most industry specific guidance. This new standard requires a company to recognize revenues when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. The FASB subsequently issued the following amendments to ASU No. 2014-09 that have the same effective date and transition date: ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations; ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing; ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients; and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. The Company adopted these amendments with ASU 2014-09 (collectively, the new revenue standards).

The new revenue standards became effective for the Company on January 1, 2018, and were adopted using the modified retrospective method. The adoption of the new revenue standards as of January 1, 2018 did not change the Company’s revenue recognition as the majority of its revenues continue to be recognized when the customer takes control of its product. As the Company did not identify any accounting changes that impacted the amount of reported revenues with respect to its product revenues, no adjustment to retained earnings was required upon adoption.

Under the new revenue standards, the Company recognizes revenues when its customer obtains control of promised goods or services, in an amount that reflects the consideration which it expects to receive in exchange for those goods. The Company recognizes revenues following the five step model prescribed under ASU No. 2014-09: (i) identify contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenues when (or as) we satisfy the performance obligation.

Revenues from product sales are recognized when the customer obtains control of the Company’s product, which occurs at a point in time, typically upon delivery to the customer. The Company expenses incremental costs of obtaining a contract as and when incurred if the expected amortization period of the asset that it would have recognized is one year or less or the amount is immaterial.

Revenues from product sales are recorded net of reserves established for applicable discounts and allowances that are offered within contracts with the Company’s customers.

Product revenue reserves, which are classified as a reduction in product revenues, are generally characterized in the following categories: discounts, returns and rebates. These reserves are based on estimates of the amounts earned or to be claimed on the related sales and are classified as reductions of accounts receivable as the amount is payable to the Company’s customer.

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 Company’s customers and the costs for replacement parts were immaterial for the nine months ended September 30, 2018 and 2017.

Accounts Receivable

The Company’s accounts receivable arise from product sales. The Company does not adjust its receivables for the effects of a significant financing component at contract inception if it expects to collect the receivables in one year or less from the time of sale. The Company does not expect to collect receivables greater than one year from the time of sale.

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. Amounts determined to be uncollectible are charged or written-off against the reserve. An analysis of the allowance for doubtful accounts is as follows:

During the nine months ended September 30, 2018 and 2017, bad debts expense were $2,298,488 and $203,905, respectively. During the three months ended September 30, 2018 and 2017, bad debts (reversal) expense were $2,128,579 and $(300,419), respectively.

The adoption of the new revenue standards did not change the Company’s historical accounting methods for its accounts receivable.

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-downs 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, 2018 and 2017, shipping and handling (income) costs were $(6,624) and $1,576, respectively; and $(347) and $623 for the three months ended September 30, 2018 and 2017.

Advertising 

Advertising expenses consist primarily of costs of promotion and marketing for the Company’s image and products, and costs of direct advertising, and are included in selling expenses. The Company expenses all advertising costs as incurred. Advertising expense was $554,070 and $847,177 for the nine months ended September 30, 2018 and 2017, respectively; and $9,754 and $186,381 for the three months ended September 30, 2018 and 2017, respectively.

Share-based compensation

The Company accounts for share-based compensation awards to employees in accordance with FASB ASC Topic 718, “Compensation – Stock Compensation”, which requires that share-based payment transactions with employees be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period.

The Company accounts for share-based compensation awards to non-employees in accordance with FASB ASC Topic 718 and FASB ASC Subtopic 505-50, “Equity-Based Payments to Non-employees”. Share-based compensation associated with the issuance of equity instruments to non-employees is measured at the fair value of the equity instrument issued or committed to be issued, as this is more reliable than the fair value of the services received. The fair value is measured at the date that the commitment for performance by the counterparty has been reached or the counterparty’s performance is complete.

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 pertaining to warrants, stock options, and similar instruments 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 unvested restricted stock, 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 (loss) per share for the nine and three months ended September 30, 2018 and 2017: 

* Including 836,534 and 571,533 shares that were granted and vested but not yet issued for the nine months ended September 30, 2018 and 2017, respectively.

For the nine and three months ended September 30, 2018 and 2017, 858,334 shares purchasable under warrants were excluded from EPS, respectively, as their effects were anti-dilutive. For the three months ended September 30, 2018, 35,000 options 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.

Two customers accounted for 36% (18% and 18% each) of the Company’s sales for the nine months ended September 30, 2018 and one customer accounted for 35% of the Company’s sales for the same period of 2017. A customer accounted for 17% of the Company’s sales for the three months ended September 30, 2018 and one customer accounted for 54% of the Company’s sales for the same period of 2017. Gross accounts receivable from these customers were $44,212,605 and $21,812,355 as of September 30, 2018 and 2017, respectively.

The Company purchased its products from three major vendors during the nine months ended September 30, 2018 and five major vendors during the same period of 2017, accounting for a total of 84% (33%, 30% and 21% for each) and 82% (26%, 19%, 15%, 12% and 10% for each) of the Company’s purchases, respectively. The Company purchased its products from three and four major vendors during the three months ended September 30, 2018 and 2017, accounting for a total of 74% (39%, 24% and 11% for each) and 59% (20%, 15%, 12% and 12% for each) of the Company’s purchases, respectively. Advances made to these vendors were $18,651,339 and $13,237,351 as of September 30, 2018 and 2017, respectively. Accounts payable to these vendors were $3,043,782 and $0 as of September 30, 2018 and 2017, respectively.

Fair Value of Financial Instruments

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:

The carrying value of cash, accounts receivable, advances to suppliers, other receivables, accounts payable, short-term line of credit, advance from customers, other payables and accrued liabilities approximate estimated fair values because of their short maturities.  The estimated fair value of the long-term lines of credit approximated the carrying amount as the interest rates are considered as approximate to the current rate for comparable loans at the respective balance sheet dates.

Foreign Currency Translation and Transactions

The consolidated financial statements are presented in United States Dollar (“$” or “USD”), which is also the functional currency of Nova LifeStyle, Nova Furniture, Nova Samoa, Nova Macao, Bright Swallow, Diamond Bar and i Design.

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 chief operating decision maker organizes segments within the company for making operating decisions assessing performance and allocating resources. 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 and sale of furniture.

Management concluded that the Company had one reportable segment under ASC 280 because Diamond Bar is a furniture distributor based in California focusing on customers in the US, Bright Swallow is a furniture distributor based in Hong Kong focusing on customers in Canada, and Nova Macao is a furniture distributor based in Macao focusing on international customers. They are all operated under the same senior management of the Company, and management views the operations of Diamond Bar, Bright Swallow and Nova Macao as a whole for making business decisions.

After the disposal of Nova Dongguan and its subsidiaries, all of the Company’s long-lived assets are mainly property, plant and equipment located in the United States for administrative purposes.

Net sales to customers by geographic area are determined by reference to the physical locations of the Company’s customers. For example, if the products are delivered to a customer in the US, the sales are recorded as generated in the U.S.; if the customer directs us to ship its products to China, the sales are recorded as sold in China.

New Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of adoption of this ASU on the consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact that the standard will have on its consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 clarifies the presentation and classification of certain cash receipts and cash payments in the statement of cash flows. The amendments are an improvement to U.S. GAAP because they provide guidance for each of the eight issues, thereby reducing the current and potential future diversity in practice. This ASU is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company has adopted the guidance retrospectively to each period presented. The adoption does not have any material effect on the presentation of its unaudited consolidated statements of cash flows.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU improves the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. For public business entities, the amendments in this update are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. Early adoption is permitted. The adoption of this ASU did not have a significant impact on the Company’s consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, and interim period within those fiscal years. The Company has adopted the guidance retrospectively to each period presented. The adoption does not have any material effect on the presentation of its unaudited consolidated statements of cash flows.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company has adopted the guidance effective January 1, 2018. The Company will evaluate the impact of adopting this standard prospectively upon any transactions of acquisitions or disposals of assets or businesses.

In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The guidance should be adopted on a prospective basis for the annual or any interim goodwill impairment tests beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements.

Note 3 - Inventories

The inventories as of September 30, 2018 and December 31, 2017 totaled $5,787,459 and $6,374,560, respectively, and were all finished goods.

Note 4 - Plant, Property and Equipment, Net

As of September 30, 2018 and December 31, 2017, plant, property and equipment consisted of the following:

Depreciation expense was $28,488 and $30,307 for the nine months ended September 30, 2018 and 2017, respectively; and $9,098 and $10,164 for the three months ended September 30, 2018 and 2017, respectively.

Note 5 - Intangible Assets

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 said customer relationship and the trademarks 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 said customer relationship is provided using the straight-line method and estimated life was 15 years. 

The Company’s eCommerce platform is a website through which customers are able to browse and place orders online for the Company’s products. For the downloadable mobile application, customers are able to download the application onto their own mobile devices to browse the Company’s product offerings. The Nova sales kit application is used on mobile devices to enable the Company’s sales representatives to display the Company’s products and inventory to customers. The total cost associated with the development, programming, design and roll-out of the Company’s eCommerce platform, downloadable mobile application, and Nova sales kit application was approximately $1.20 million. The Company’s eCommerce platform, downloadable mobile application, and Nova sales-kit application were completed and put into operation in 2015. These intangible assets are amortized using the straight-line method with an original estimated life of 10 years for each and are revised to 1 year in the quarter ended March 31, 2017.  The effect of the change in estimate is accounted for on a prospective basis.  

Intangible assets consisted of the following as of September 30, 2018 and December 31, 2017:

Amortization of intangible assets was $305,028 and $1,113,011 for the nine months ended September 30, 2018 and 2017, respectively; and $101,676 and $371,004 for the three months ended September 30, 2018 and 2017, respectively.

Estimated amortization expense relating to the existing intangible assets with finite lives for each of the next five years is as follows:

Note 6 - Receivables from an Unrelated Party, Prepaid Expenses and Other Receivables

(a)       On September 22, 2016, in order to promote the Company’s image and extend its customer reach, the Company entered into a memorandum of understating with an unrelated party (“MOU”) whereby the Company agreed to pay a total fee of $16,000,000 for a period of twelve months, commencing on December 31, 2016, to finance the establishment and promotion of the unrelated party’s Academic E-commerce platform and integrated training center in Hong Kong (the “Platform”). As of December 31, 2016, the Company prepaid $7 million to the unrelated party.

After December 31, 2016, the Company further prepaid $6,835,000 to the unrelated party. However, having considered the recent market situation and the status of the establishment and promotion of the Platform, the Company did not wish to continue to finance the promotion of the Platform. On March 20, 2017, the Company and the unrelated party terminated the MOU and released both parties from all the obligations and liabilities under the MOU. The Company agreed to bear the costs of $800,000 incurred by the unrelated party on the Platform, which were charged as expenses in the first quarter of fiscal year 2017. In fiscal 2017, the Company collected a total of approximately $13 million, which was prepaid previously, and as of December 31, 2017 and September 30, 2018, no further balance was owed by the unrelated party.

(b)       Prepaid Expenses and Other Receivables consisted of the following at September 30, 2018 and December 31, 2017: 

On March 23, 2017, the Company made a short-term advance of $2,000,000 to an unrelated party. The advance is unsecured and bears interest of 5% per annum. The unrelated party agreed to pay the whole amount of $2,000,000 back to the Company by May 31, 2017. After March 31, 2017, the Company collected full payment of the principal from the unrelated party.

Note 7 - Accrued Liabilities and Other Payables

Accrued liabilities and other payables consisted of the following as of September 30, 2018 and December 31, 2017:

As of September 30, 2018 and December 31, 2017, other accrued expenses mainly included legal and professional fees, transportation expenses and utilities. Other payables represented other tax payable and meal expenses.

Note 8 - 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 rate of 4.25% and maturity on June 1, 2015. On June 8, 2015, the bank extended and modified the terms of the loan agreement to extend the line of credit up to a maximum of $6,000,000 until July 31, 2015 and $5,000,000 thereafter with an annual interest rate of 4.25% and maturity on September 1, 2015 (the term of which the bank allowed to extend until the renewal described in the following sentence while the bank conducted its own audit associated therewith). On September 28, 2015, Diamond Bar extended the line of credit up to a maximum of $6,000,000 with annual interest rate of 3.75% (4% from December 17, 2015) and maturity on June 1, 2017. On January 20, 2016, Diamond Bar increased the line of credit up to a maximum of $8,000,000 with annual interest rate of 4%.  On June 22, 2017, Diamond Bar extended the line of credit to maturity on September 1, 2017. On September 19, 2017, Diamond Bar extended the line of credit to maturity on June 1, 2019. The annual interest rate was 5.25% as of September 30, 2018. The line of credit is secured by all of the assets of Diamond Bar and is guaranteed by Nova LifeStyle. As of September 30, 2018 and December 31, 2017, Diamond Bar had $4,851,825 and $4,202,118 outstanding on the line of credit, respectively.  During the nine months ended September 30, 2018 and 2017, the Company recorded interest expense of $92,524 and $145,857, respectively; and $36,696 and $40,932 for the three months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, Diamond Bar had $3,148,175 available for borrowing without violating any covenants.

The Diamond Bar loan has the following covenants: (i) maintain a minimum tangible net worth of not less than $20 million; (ii) maintain a ratio of debt to tangible net worth not in excess of 2.5 to 1.0; (iii) the pre-tax income must be not less than 1% of total revenue quarterly; and (iv) maintain a current ratio in excess of 1.25 to 1.00. As of September 30, 2018, Diamond Bar was in compliance with the stated covenants.  

On January 22, 2015, Nova Macao renewed a line of credit, with an annual interest rate of 4.25% and principal of up to $6,500,000, with a commercial bank in Hong Kong to extend the maturity date to January 29, 2016. On February 16, 2016, Nova Macao extended the maturity date of line of credit to January 31, 2017, with an annual interest rate of 4% and principal of up to $6,500,000. The loan requires monthly payment of interest and that the interest rate will be adjusted annually. The loan was secured by assignment of Sinosure (China Export and Credit Insurance Company) credit insurance and was guaranteed by Nova LifeStyle and Diamond Bar. The Company did not extend the line of credit and paid it off in February 2017. As of September 30, 2018 and December 31, 2017, Nova Macao had $0 outstanding on the line of credit, respectively. During the nine months ended September 30, 2018 and 2017, Nova Macao paid interest of $0 and $13,828, respectively; and $0 for the three months ended September 30, 2018 and 2017.

Note 9 - Related Party Transactions

On September 30, 2011, Diamond Bar leased a showroom in High Point, North Carolina from the Company’s president who is currently also our Chief Executive Officer and Chairman of the Board. The lease is to be renewed and has been renewed each year since 2011. On March 16, 2018, the Company renewed the lease for an additional one year term. The lease was for the amount of $34,561, with a term of one year and only for use during two furniture exhibitions to be held between April 1, 2018 and March 31, 2019. During the nine months ended September 30, 2018 and 2017, the Company paid rental amounts of $34,561 and $32,916 that are included in selling expenses, respectively; and $17,281 and $16,458 for the three months ended September 30, 2018 and 2017, respectively.

Note 10 - Stockholders’ Equity

Share repurchase program

On December 12, 2017, the Company issued a press release announcing that the Board of Directors of the Company had approved a 10b-18 share repurchase program to repurchase up to $5 million of its outstanding common stock. Under the repurchase program, shares of the Company’s common stock may be repurchased from time to time over the next 12 months. As of September 30, 2018 and as of the approval date of this quarterly report, no shares have been repurchased under the program.

Warrants

Following is a summary of the warrant activity for the nine months ended September 30, 2018: 

 Shares Issued to Consultants 

On December 1, 2014, the Company entered into a consulting agreement with a consulting firm for management consulting services effective on December 1, 2014. The Company agreed to issue 60,000 shares of the Company’s common stock to the firm for three years of consulting services. The shares were issued according to the following vesting schedule set forth as follows: The initial 10,000 shares were required to be issued within 30 days upon signing of the agreement; for the remaining 50,000 shares, the Company issued to the consultant 10,000 shares of common stock on or before each of June 1, 2015, December 1, 2015, June 1, 2016, December 1, 2016 and June 1, 2017. The Company or the consultant may terminate the agreement at any time by 90 days’ written notice to the other party. The fair value of the 60,000 shares was $224,400, which was calculated based on the stock price of $3.74 per share on December 1, 2014 and was amortized over the service term. During the nine months ended September 30, 2018 and 2017, the Company amortized $0 and $56,100 as consulting expenses, respectively; and $0 and $18,700 for the three months ended September 30, 2018 and 2017, respectively. 

On February 1, 2016, the Company entered into a marketing agreement with a consultant for marketing development strategies and consulting services for 15 months. The Company agreed to grant the consultant 10,000 unregistered restricted shares of the Company’s common stock per month, for a total commitment of 150,000 shares of common stock. The fair value of the 150,000 shares was $204,000, which was calculated based on the stock price of $1.36 per share on February 1, 2016, the date the agreement was executed, and was amortized over the service term. During the nine months ended September 30, 2018 and 2017, the Company amortized $0 and $54,000 as consulting expenses, respectively; and $0 for the three months ended September 30, 2018 and 2017.

On February 1, 2016, the Company entered into an agreement with a consultant for E-Commerce consulting service with a term of 24 months. The Company agreed to grant the consultant 10,000 shares of the Company’s common stock per month, for a total commitment of 240,000 shares. Twelve and half percent (12.5%) of those shares vested on April 30, 2016, 12.5% on July 30, 2016, 12.5% on October 31, 2016, 12.5% on January 31, 2017, 12.5% on April 30, 2017, 12.5% on July 30, 2017, 12.5% on October 31, 2017, and the remaining 12.5% on January 31, 2018. The fair value of the 240,000 shares was $326,400, which was calculated based on the stock price of $1.36 per share on February 1, 2016, the date the agreement was executed, and was amortized over the service term. During the nine months ended September 30, 2018 and 2017, the Company amortized $13,600 and $122,400 as consulting expenses, respectively; and $0 and $40,800 for the three months ended September 30, 2018 and 2017, respectively.

On November 15, 2016, the Company entered into a consulting and strategy service agreement with a consultant for marketing and general consulting services effective on November 14, 2016. The Company agreed to grant 100,000 shares of the Company’s common stock to the consultant for 12 months of services starting on November 14, 2016. The shares were issued pursuant to Nova LifeStyle, Inc. 2014 Omnibus Long-Term Incentive Plan (the “Plan”) approved by the Board of Directors (“Board”) of the Company on May 13, 2014 and ratified at the annual shareholder meeting on June 30, 2014. The Plan was registered under Form S-8 on July 30, 2014. Twenty-five percent (25%) of those shares vested on December 15, 2016, 25% on February 15, 2017, 25% on May 15, 2017, and the remaining 25% vested on August 15, 2017. The fair value of the 100,000 shares was $294,000, which was calculated based on the stock price of $2.94 per share on November 15, 2016 and was amortized over the service term. During the nine months ended September 30, 2018 and 2017, the Company amortized $0 and $219,896 as consulting expenses, respectively; and $0 and $74,104 for the three months ended September 30, 2018 and 2017, respectively.

On November 15, 2016, the Company entered into a consulting agreement with a consultant for business development and financial advisory service for a term of 12 months. The Company agreed to grant the consultant 100,000 shares of the Company’s common stock. The shares were issued pursuant to the Plan. The fair value of the 100,000 shares was $294,000, which was calculated based on the stock price of $2.94 per share on November 15, 2016 and will amortized over the service term. During the nine months ended September 30, 2018 and 2017, the Company amortized $0 and $220,500 as consulting expense, respectively; and $0 and $73,500 for the three months ended September 30, 2018 and 2017, respectively.

On November 15, 2016, the Company entered into a consulting agreement with a consultant for business advisory service for a term of 12 months. The Company agreed to compensate the consultant a one-time amount of $20,000 worth of shares of the Company’s common stock based on the price per share on November 15, 2016. The Company also granted the consultant $15,000 worth of shares of the Company’s common stock per month starting from December 1, 2016 for 12 months. The shares were issued pursuant to the Plan. During the nine months ended September 30, 2018 and 2017, the Company amortized $0 and $150,000 as consulting expense, respectively; and $0 and $50,000 for the three months ended September 30, 2018 and 2017.

On June 30, 2017, the Company entered into a consulting agreement with a consultant for business advisory service for a term of 12 months. The Company agreed to compensate the consultant a one-time amount of $10,000 worth of shares of the Company’s common stock based on the price per share on June 30, 2017. The Company also granted the consultant $10,000 worth of shares of the Company’s common stock per month starting from July 1, 2017 for a period of 12 months. The shares were issued pursuant to the Plan. On June 12, 2018, the Company renewed the agreement with the consultant for an additional year and agreed to compensate the consultant $10,000 worth of shares of shares of the Company’s common stock per month starting from July 1, 2018 for a period of 12 months. The shares will be issued pursuant to the Plan. During the nine and three months ended September 30, 2018, the Company amortized $95,000 and $30,000 as consulting expense, respectively; and $32,500 for the nine and three months ended September 30, 2017.

On November 16, 2017, the Company entered into a consulting agreement with a consultant for consulting and strategy services effective on November 16, 2017 for one year. The Company agreed to grant the consultant 100,000 shares of the Company’s common stock. Twenty-five percent (25%) of those shares vested on February 15, 2018 and 25% on May 15, 2018, and 25% will vest on August 15, 2018 and the remaining 25% will vest on November 15, 2018. The fair value of 100,000 shares was $173,000, which was calculated based on the stock price of $1.73 per share on November 16, 2017 and will be amortized over the service term. The shares would be issued pursuant to the Plan. During the nine and three months ended September 30, 2018, the Company amortized $129,395 and $43,605 as consulting expense, respectively.

On December 10, 2017, the Company entered into a consulting agreement with a consultant for business advisory services effective as of January 1, 2018 and ending on December 31, 2018. The Company agreed to compensate the consultant a one-time amount of $15,000 worth of shares of the Company’s common stock based on the price per share on December 15, 2016. The Company also granted the consultant $15,000 worth of shares of the Company’s common stock per month starting from January 1, 2018 for 12 months. The shares would be issued pursuant to the Plan. During the nine and three months ended September 30, 2018, the Company amortized $146,250 and $48,750 as consulting expense, respectively.

Shares and Warrants Issued through Private Placement

Private Placement on May 28, 2015

On May 28, 2015, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with certain purchasers (the “Purchasers”) pursuant to which the Company offered to the Purchasers, in a registered direct offering, an aggregate of 2,970,509 shares of common stock, par value $0.001 per share. Of these, 2,000,001 shares were sold to the Purchasers at a negotiated purchase price of $2.00 per share, for aggregate gross proceeds to the Company of $4,000,002, before deducting fees to the placement agent and other estimated offering expenses payable by the Company. In accordance with the terms of the Purchase Agreement, the Company exchanged outstanding 2014 Series A Warrants with their holders for 660,030 shares of common stock, and exchanged the outstanding 2014 Series C Warrants with their holders for 310,478 shares of common stock.

In a concurrent private placement, the Company also sold to the Purchasers a warrant to purchase one share of the Company’s common stock for each share purchased for cash in the offering, pursuant to that certain Common Stock Purchase Warrant, by and between the Company and each Purchaser (the “2015 Warrants”). The 2015 Warrants became exercisable beginning on the six month anniversary of the date of issuance (the “Initial Exercise Date”) at an exercise price of $2.71 per share and will expire on the five year anniversary of the Initial Exercise Date. The purchase price of one share of the Company’s common stock under the 2015 Warrants is equal to the exercise price. 

The warrants issued in the private placement described above are exercisable for a fixed number of shares, and are classified as equity instruments under ASC 815-40-25-10. The Company accounted for the warrants issued in the 2015 private placement 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 5 years, volatility of 107%, risk-free interest rate of 1.55% and dividend yield of 0%. No estimate of forfeitures was made as the Company has a short history of granting options and warrants. The fair value of the warrants issued to investors at grant date was $3,147,530.

Shares and Options Issued to Independent Directors

On August 9, 2016, the Board approved a restricted stock award agreement under the 2014 Omnibus Long-Term Incentive Plan with four independent directors. The Company agreed to grant $40,000 worth of stocks to each of its four independent directors. The restricted period lapses as to 25% of the restricted stock granted vested on September 30, 2016 based on the closing price of common stock on Nasdaq as of August 9, 2016, 25% of the restricted stock granted vested on December 31, 2016 based on the closing price of common stock on Nasdaq as of September 30, 2016, 25% of the restricted stock granted vested on March 31, 2017 based on the closing price of common stock on Nasdaq as of December 31, 2016, and 25% of the restricted stock granted vested on June 30, 2017 based on the closing price of common stock on Nasdaq as of March 31, 2017. During the nine and three months ended September 30, 2017, the Company amortized $96,438 and $17,096 as directors’ stock compensation expenses, respectively.

On April 10, 2017, the Company entered into restricted stock award agreements under 2014 Omnibus Long-Term Incentive Plan with a new independent director of the Board. The Company agreed to grant $20,000 worth of stock to the independent director with a grant date on April 10, 2017. The restricted period lapses as of 50% of the restricted stock granted vested on April 10, 2017 based on the closing price of common stock on Nasdaq as of April 10, 2017, and 50% of the restricted stock granted vested on June 30, 2017 based on the closing price of common stock on Nasdaq as of June 30, 2017. During the nine months ended September 30, 2018 and 2017, the Company amortized $1,260 and $13,699 as directors’ stock compensation expenses, respectively. During the three months ended September 30, 2018 and 2017, the Company amortized $0 and $5,041 as directors’ stock compensation expenses.

On September 26, 2017 (the “Grant Date”), the Company entered into stock option agreements under the 2014 Omnibus Long-Term Incentive Plan with the three independent members of the board of directors. The Company agreed to grant the Company’s three independent directors options to purchase an aggregate of 300,000 shares of the Company’s common stock at an exercise price of $1.65 per shares, with a term of 5 years. Twenty-five percent (25%) of those stock options vested on September 30, 2017, 25% on December 31, 2017, 25% on March 31, 2018, and the remaining 25% vested on June 30, 2018.

The fair value of the stock option granted is estimated on the date of the grant using the Black-Scholes option pricing model (“BSOPM”). The BSOPM has assumptions for risk free interest rates, dividends, stock volatility and expected life of an option grant. The risk-free interest rate is based upon market yields for United States Treasury debt securities at a maturity near the term remaining on the option. Dividend rates are based on the Company’s dividend history. The stock volatility factor is based on the historical volatility of the Company’s stock price. The expected life of an option grant is based on management’s estimate as no options have been exercised in the Plan to date. The fair value of the option granted to of the independent directors is recognized as director fee over the vesting period of the stock option award. The fair value of the options was calculated using the following assumptions, estimated life of five years, volatility of 84%, risk free interest rate of 1.87%, and dividend yield of 0%. The fair value of 300,000 stock options was $324,907 at the grant date. During the nine and three months ended September 30, 2018, the Company recorded $162,454 and $0 as directors’ stock compensation expenses, respectively; and $81,227 for the nine and three months ended September 30, 2017.

Shares Issued to Employees and Service Providers

On May 18, 2016, the Company entered into agreements with three designers for product design services for a term of 24 months. The Company agreed to grant each designer 240,000 shares of the Company’s common stock. Twenty five percent (25%) of those shares vested on May 31, 2016, 25% on December 18, 2016, 25% on June 18, 2017 and the remaining 25% on December 18, 2017. The fair value of these shares was $388,800, which was calculated based on the stock price of $0.54 per share on May 18, 2016, the date the agreement was executed, and was amortized over the service term. During the nine months ended September 30, 2018 and 2017, the Company amortized $72,967 and $145,401 as stock compensation expenses, respectively; and $0 and $48,999 for the three months ended September 30, 2018 and 2017, respectively.

On November 14, 2016, the Company entered into an employment agreement with an executive for one year. The Company agreed to grant an award of 30,000 restricted Stock Units to the executive pursuant to the Company’s 2014 Omnibus Long-Term Incentive Plan. The fair value of these shares was $92,100, which was calculated based on the stock price of $3.07 per share on November 11, 2016, the date the awards were determined by the Compensation Committee of the Board. Twenty-five percent (25%) of those shares vested on December 30, 2016, 25% on March 31, 2017, 25% on June 30, 2017 and the remaining 25% vested on September 30, 2017. During the nine and three months ended September 30, 2017, the Company amortized $68,886 and $23,214 as stock compensation, respectively.

On November 15, 2016, the Company entered into an agreement with a designer for furniture design services effective on November 15, 2016 for 1 year. The Company agreed to grant the designer 100,000 shares of the Company’s common stock. The fair value of the 100,000 shares was $294,000, which was calculated based on the stock price of $2.94 per share on November 15, 2016 and was amortized over the service term. Twenty-five percent (25%) of those shares vested on February 15, 2017, 25% on May 15, 2017, 25% vested on August 15, 2017 and the remaining 25% vested on November 15, 2017. During the nine and three months ended September 30, 2017, the Company amortized $220,500 and $73,500 as stock compensation, respectively.

On February 27, 2018, the Company renewed an employment agreement with the Company’s Corporate Secretary and director for a term of one year. The Company agreed to grant an award of 30,000 restricted Stock Units to the officer pursuant to the Company’s 2014 Omnibus Long-Term Incentive Plan. The fair value of these shares was $68,100, which was calculated based on the stock price of $2.27 per share on February 27, 2018, the date the awards were determined by the Compensation Committee of the Board. Twenty-five percent (25%) of those shares vested on February 27, 2018, 25% on March 31, 2018, 25% on June 30, 2018 and the remaining 25% vested on September 30, 2018. During the nine and three months ended September 30, 2018, the Company amortized $40,114 and $16,978 as stock compensation, respectively.

Options Issued to Employees

On August 29, 2017 (the “Grant Date”), the Board approved option grants to the Company’s employees to purchase an aggregate of 780,000 shares of the Company’s common stock (including options to purchase 100,000 shares and 35,000 shares to the Company’s CEO and CFO, respectively) at an exercise price of $1.26 per shares, with a term of 5 years, pursuant to the Company’s 2014 Omnibus Long-Term Incentive Plan. Fifty percent (50%) of those stock options vested immediately, and the remaining 50% vested on the six-month anniversary of the Grant Date.

The fair value of the stock option granted is estimated on the date of the grant using the Black-Scholes option pricing model (“BSOPM”) as described in options to independent directors above. The fair value of the option granted to employees is recognized as compensation expense over the vesting period of the stock option award. The fair value of the options was calculated using the following assumptions, estimated life of ten years, volatility of 84%, risk free interest rate of 1.70%, and dividend yield of 0%. The fair value of 780,000 stock options was $643,182 at the grant date. During the nine months ended September 30, 2018 and 2017, the Company recorded $321,591 as stock compensation. During the three months ended September 30, 2018 and 2017, the Company recorded $0 and $321,591 as stock compensation.

On August 24, 2018 (the “Grant Date”), the Board approved option grants to the Company’s CFO to purchase an aggregate of 35,000 shares of the Company’s common stock at an exercise price of $1.85 per shares, with a term of 5 years, pursuant to the Company’s 2014 Omnibus Long-Term Incentive Plan. Fifty percent (50%) of those stock options vested immediately, and the remaining 50% vested on the six-month anniversary of the Grant Date.

The fair value of the option granted to CFO in 2018 is recognized as compensation expense over the vesting period of the stock option award. The fair value of the options was calculated using the following assumptions, estimated life of ten years, volatility of 84%, risk free interest rate of 2.72%, and dividend yield of 0%. The fair value of 35,000 stock options was $43,680 at the grant date. During the nine and three months ended September 30, 2018, the Company recorded $21,840 as stock compensation.

As of September 30, 2018, unrecognized share-based compensation expense related to options was $21,840.

Stock option activity under the Company’s stock-based compensation plans is shown below:

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 subsidiary, 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 Nova Macao. Pursuant to the corporate laws of the PRC and Macao, including the PRC Regulations on Enterprises with Foreign Investment, Nova Macao is required to maintain a 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 Macau laws and regulations that require annual appropriations of 10% of after-tax income to be set aside prior to payment of dividends as a general statutory reserve fund until such reserve balance reaches 50% of the subsidiary’s registered capital. Nova Macao is restricted in its ability to transfer a portion of its net assets to the Company as a dividend.

Surplus Reserve Fund

At September 30, 2018 and December 31, 2017, Nova Macao had surplus reserves of $6,241, representing 50% of its registered capital.

Common Welfare Fund

The common welfare fund is a voluntary fund to which Nova Macao can 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 Macao does not participate in this voluntary fund.

Note 11 - Geographical Sales

Geographical distribution of sales consisted of the following for the nine and three months ended September 30, 2018 and 2017:

 * excluding Hong Kong

Note 12 - Commitments and Contingencies

Lease Commitments

On June 17, 2013, the Company entered into a lease agreement for office, warehouse, storage, and distribution space with a five year term, commencing on November 1, 2013 and expiring on October 31, 2018. The lease agreement also provides an option to extend the term for an additional six years. On April 23, 2018, the Company extended the lease for another 36 months with an expiration date of October 31, 2021. The monthly rental payment is $42,000 with an annual 3% increase.  The rent is recorded on a straight-line basis over the term of the lease. 

On January 7, 2014, the Company entered into a sublease agreement with Diamond Bar for warehouse space with a five-year term commencing on November 1, 2013 and expiring on October 31, 2018. The Company subleased a portion of its warehouse space to one of its customers with a one-year term commencing on December 1, 2013 and expiring on November 30, 2014, which has been renewed every year with the current term expiring on October 31, 2018.  The sublease was not renewed. The sublease income of $6,000 per month was recorded against the rental expense. During the nine months ended September 30, 2018 and 2017, the Company recorded $47,330 and $48,600 sublease income, respectively; and $11,330 and $16,200 for the three months ended September 30, 2018 and 2017, respectively.

On September 19, 2013, Bright Swallow entered into a lease agreement for office space in Hong Kong with a two year term, commencing on October 1, 2013 and expiring on September 30, 2015.  On September 15, 2015, Bright Swallow renewed the lease for another two year term, commencing on October 1, 2015 and expiring on September 30, 2017. On September 13, 2017, Bright Swallow renewed the lease for another two year term, commencing on October 1, 2017 and expiring on September 30, 2019. The monthly rental payment is 20,000 Hong Kong Dollars ($2,560). 

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 on monthly or annual terms. Total rental expense for the nine months ended September 30, 2018 and 2017 was $638,398 and $597,103, respectively; and $241,004 and $224,349 for the three months ended September 30, 2018 and 2017, respectively. The rental expense is recorded on a straight-line basis over the term of the lease.

The total minimum future lease payments are as follows: 

Employment Agreements

On May 3, 2013, the Company entered into an amended and restated employment agreement with Thanh H. Lam to serve as the Company’s president for a five-year term. The agreement provides for an annual salary of $80,000, a grant of 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 vested immediately, and the remaining shares vest at 50,000 shares per year for three years on each anniversary of the effective date of the stock award agreement. The fair value of the shares was based on the stock price of $3.82 per share on May 3, 2013. On July 24, 2017, the Company and Thanh H. Lam entered into an amendment (the “Amendment”) to her amended and restated employment agreement, pursuant to which she serves as the Company’s Chief Executive Officer and President.  The Amendment increased the annual salary of Ms. Lam from $80,000 to $100,000. On May 8, 2018, the Company entered into an employment agreement with Ms. Lam for a new term of five years. The employment agreement provides for an annual salary of $100,000 to the CEO and annual bonuses at the sole discretion of the Board of Directors.

On March 21, 2016, the Company granted Restricted Stock Units to Ya Ming (Jeffrey) Wong (the Company’s former CEO), Yuen Ching (Sammy) Ho, the Company’s former CFO, and Thanh H. Lam, the Company’s President. Each of them will receive a grant of 100,000 Restricted Stock Units (“RSU”). The fair value of the 300,000 shares of RSU was $360,000, which was calculated based on the stock price of $1.20 per share on March 21, 2016. The RSU grants, to the extent not forfeited, have fully vested. During the nine months ended September 30, 2017, the Company recorded reversal ($30,000), as stock-based compensation to the officers, respectively. 

On March 25, 2016, the Company entered into one-year employment agreements, effective as of November 11, 2015, with Mr. Ya Ming (Jeffrey) Wong and Mr. Yuen Ching (Sammy) Ho to serve as the Company’s CEO and CFO, respectively. These agreements were in substantially the same form as the previous one-year employment agreements entered into on March 25, 2015 (which expired by their terms), and provide for annual salaries of $100,000 for Mr. Wong and $80,000 for Mr. Ho, and annual bonuses at the sole discretion of the Board of Directors. The employment agreements also reflect the RSU grants described in the immediately preceding paragraph. On October 3, 2016, Mr. Wong resigned his position as CEO, terminated his employment agreement, and forfeited 25,000 RSUs granted to him under such agreement. On August 15, 2017, Mr. Ho resigned his position as CFO and terminated his employment agreement.

On August 22, 2017, the Company entered into a one-year employment agreement, effective as of August 22, 2017, with Jeffery Chuang, the Company’s new CFO. The employment agreement provided for an annual salary of $50,000 to the CFO and annual bonuses at the sole discretion of the Board of Directors. The employment agreement also provides for a grant of options to purchase 35,000 shares of the Company’s common stock, which is described further in the Note 10 – Stockholders’ Equity. Upon the expiration of this employment agreement, the Company entered into a new one-year employment agreement, effective as of August 22, 2018, with Mr. Chuang to continue serving as the Company’s CFO. The agreement was in substantially the same form as the previous one-year employment agreements entered into on August 22, 2017 (which expired by its terms), and provides for annual salary of $50,000 for Mr. Chuang and annual bonuses at the sole discretion of the Board of Directors. The employment agreement also provides for a grant of options to purchase 35,000 shares of the Company’s common stock, which is described further in the Note 10 – Stockholders’ Equity.

Note 13 - Subsequent Events

The Company has evaluated all events that have occurred subsequent to September 30, 2018 through the date that the consolidated financial statements were issued and the following subsequent event has been identified.

On November 7, 2018 (the “Grant Date”), the Company entered into stock option agreements under the 2014 Omnibus Long-Term Incentive Plan with the three independent members of the board of directors. The Company agreed to grant the Company’s three independent directors options to purchase an aggregate of 300,000 shares of the Company’s common stock at an exercise price of $1.18 per shares, with a term of 5 years. Twenty-five percent (25%) of those stock options vested on November 30, 2018, 25% on will vest on February 28, 2019, 25% on May 31, 2019, and the remaining 25% will vest on August 31, 2019. The fair value of the stock options granted is estimated on the date of the grant using the Black-Scholes option pricing model (“BSOPM”) as described above. The fair value of the options was calculated using the following assumptions: estimated life of ten years, volatility of 84%, risk free interest rate of 3.07%, and dividend yield of 0%. The fair value of 300,000 stock options was $240,105 at the grant date.

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. Words such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” the negatives of such terms and other terms of similar meaning typically identify forward-looking statements. 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 2017 Form 10-K (as defined below). The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report and in our 2017 Form 10-K. 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

Safe Harbor Declaration

The following discussion and analysis is based upon our financial statements as of the dates and for the periods presented in this section. You should read this discussion and analysis in conjunction with the financial statements and notes thereto found in Part I, Item 1 of this Form 10-Q and our consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 31, 2017 (the “2017 Form 10-K”). All references to the third quarter and first nine months of 2018 and 2017 mean the three and nine month periods ended September 30, 2018 and 2017.  In addition to historical information, the following discussion and other parts of this report contain certain forward-looking information. When used in this discussion, the words, “believes,” “anticipates,” “expects” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from projected results, due to a number of risks, uncertainties and factors beyond our control. We do not undertake to publicly update or revise any of these forward-looking statements, even if experience or future changes show that the indicated results or events will not be realized. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Readers also are urged to carefully review and consider our discussions regarding the various factors that affect the company’s business, which are described in this section and elsewhere in this report. For more information, see our discussion of risk factors located at Part I, Item 1A of our 2017 Form 10-K.

Overview

Nova LifeStyle, Inc. is a broad based distributor and retailer 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 LifeStyle’s brand family currently includes Diamond Sofa (www.diamondsofa.com), Colorful World, Giorgio Mobili, and Bright Swallow.

Our customers principally consist of distributors and retailers having specific geographic coverages 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 manufacturing 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.

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 and sell residential furniture worldwide: Nova Macao, Bright Swallow, and Diamond Bar. Nova Macao was organized under the laws of Macao on May 20, 2006. Nova Macao is a wholly owned subsidiary of Nova Lifestyle.  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.  On December 7, 2017, we incorporated i Design Blockchain Technology, Inc. (“i Design”) under the laws of the State of California. The purpose of i Design is to build our own blockchain technology team. This company is in the planning stage and has had minimal operations to date.

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., Canadian, European, Australian, Asian and Middle Eastern markets. 

Principal Factors Affecting Our Financial Performance

Significant factors that we believe could affect our operating results are the (i) prices of our products to our international retailer and wholesaler customers and their markups to end consumers; (ii) consumer acceptance of our new brands and product collections; and (iii) general economic conditions in the U.S., Chinese, Canadian, European and other international markets. We believe most of our customers are willing to pay 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 acquiring the Diamond Sofa brand in the U.S. market and developing higher-margin products for the U.S. and international markets, and acquiring Bright Swallow for the Canadian market. 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 (excluding the United States), and particularly in Europe, remain challenging because such markets are experiencing a slower than anticipated recovery since the international financial crisis. 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 the recovery of housing markets. Furthermore, we believe that our expansion of direct sales in 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.  

Critical Accounting Policies

Our condensed consolidated financial information has been prepared in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect (1) the reported amounts of our assets and liabilities, (2) the disclosure of our contingent assets and liabilities at the end of each fiscal period and (3) the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and reasonable assumptions, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

For a description of our critical accounting policies and estimates, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and Note 2 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. For Revenue Recognition refer to Note 2 to the unaudited consolidated financial statements contained herein.

Changes in Accounting Standards

Please refer to Note 2 to our condensed consolidated financial statements, “Summary of Significant Accounting Policies – New Accounting Pronouncements,” for a discussion of relevant pronouncements.

Results of Operations

Comparison of Three Months Ended September 30, 2018 and 2017

The following table sets forth the results of our operations for the three months ended September 30, 2018 and 2017. Certain columns may not add due to rounding.

Net Sales

Net sales for the three months ended September 30, 2018 were $16.75 million, a decrease of 49.59% from $33.22 million in the same period of 2017. This decrease in net sales resulted primarily from a 44.48% decrease in sales volume and 8.09% decrease in average sales price. Our largest selling product categories in the three months ended September 30, 2018 were sofas, cabinets and beds, which accounted for approximately 64%, 10% and 9% of sales, respectively. In the three months ended September 30, 2017, the largest three selling categories were television cabinets, sofas and dining tables, which accounted for 48%, 32% and 6% of sales, respectively.

The $16.47 million decrease in net sales in the three months ended September 30, 2018, compared to the same period of 2017, was mainly due to decreased sales to Australia and Asia. Australia sales decreased by 96.65% to $0.55 million in the three months ended September 30, 2018, compared to $17.99 million in 2017, primarily as a result of decreased sales orders from one of our customers who was involved in projects in many hotels and apartments since the third quarter of 2017. We anticipate that we will gradually receive fewer sales orders from that customer in the near future. Sales to Asia, excluding China and Hong Kong, decreased by 15.41% to $2.82 million in the three months ended September 30, 2018, compared to $3.33 million in the same period of 2017, primarily due to the decreases of sales orders from one of our customers who expanded its business in Middle East. North America sales increased by 11.23% to $13.24 million in the three months ended September 30, 2018, compared to $11.90 million in 2017, primarily as a result of increasing demand for our existing products and introducing new products to our customers. Sales to other countries also increased to $0.15 million in the three months ended September 30, 2018, compared to $0 sales in 2017. We had no sales to Europe and Hong Kong in the three months ended September 30, 2018 and 2017, primarily due to the fact that we stopped selling low margin products to customers and ceased our marketing efforts in those regions. We aggressively changed our sales strategy to aim for sales of high margin products and their customers.

Cost of Sales

Cost of sales consists primarily of finished goods purchased from other manufacturers. Total cost of sales decreased by 50% to $13.5 million in the three months ended September 30, 2018, compared to $27.3 million in the same period of 2017. Cost of sales as a percentage of sales decreased to 81% in the three months ended September 30, 2018, compared to 82% in the same period of 2017. The decrease in cost of sales in dollar terms resulted primarily from decreased volume and cost of high quality products purchased from third-party manufacturers.

Gross Profit

Gross profit decreased by 45% to $3.22 million in the three months ended September 30, 2018, compared to $5.9 million in the same period of 2017. Our gross profit margin increased to 19% in the three months ended September 30, 2018, compared to 18% in the same period of 2017. The increase in gross profit margin resulted primarily from decreased cost of sales as a percentage of net sales, which was mainly due to a decreased cost of high quality products purchased from third parties.

Operating Expenses 

Operating expenses consist of selling, general and administrative expenses and research and development expenses. Operating expenses were $4.58 million in the three months ended September 30, 2018, compared to $3.13 million in the same period of 2017. Selling expenses decreased by 15%, or $0.15 million, to $0.85 million in the three months ended September 30, 2018, from $1.00 million in the same period of 2017, due primarily to decreased marketing advertising expenses and show expenses. General and administrative expense increased by 75%, or $1.60 million, to $3.72 million in the three months ended September 30, 2018, from $2.12 million in the same period of 2017, primarily due to increases in bad debt expense by approximately $2.43 million, which was partially offset by a decrease in amortization expense by approximately $0.27 million on our intangible assets (see Note 5 to our condensed consolidated financial statements) and stock-based compensation to our employees and consultants by approximately $0.6 million.

Other Expenses, Net

Other expenses, net, was $77,497 in the three months ended September 30, 2018, compared with other expense, net, of $75,534 in the same period of 2017, representing an increase in other expense of $1,963. The increase in other expense was due primarily to the increase non-operating expense to $3,486 in the three months ended September 30, 2018 from $0 in the same period of 2017 and increase in financial expense to $37,392 in the three months ended September 30, 2018 from $34,508 in the same period of 2017, which was partially offset by a decrease in interest expense on our line of credit of $4,302 to $36,630 in the three month ended September 30, 2018 from $40,932 in the same period of 2017.

Income Tax Benefit

Income tax benefit was $942,267 in the three months ended September 30, 2018, compared with $262,034 of income tax benefit in the same period of 2017.  The increase in income tax benefit for the three months ended September 30, 2018 was mainly due to a larger reversal of our tax liability reserves due to a statute of limitations expiration in 2018.

Net Income (Loss)

As a result of the foregoing, our net loss was $0.49 million in the three months ended September 30, 2018, as compared with $2.96 million of net income for the same period of 2017.

Comparison of Nine Months Ended September 30, 2018 and 2017

The following table sets forth the results of our operations for the nine months ended September 30, 2018 and 2017. Certain columns may not add due to rounding.

Net Sales

Net sales for the nine months ended September 30, 2018, were $63.16 million, a decrease of 11% from $70.81 million in the same period of 2017; this decrease in net sales resulted primarily from a 16.07% decrease in sales volume and 6.38% increase in average selling price. Our largest selling product categories in the nine months ended September 30, 2018 were sofas, TV cabinets and beds, which accounted for approximately 59%, 8% and 7% of sales, respectively. In the nine months ended September 30, 2017, the largest three selling categories were sofas, television cabinets and beds, which accounted for approximately 56%, 22% and 9% of sales, respectively.

The $7.65 million decrease in net sales in the nine months ended September 30, 2018, compared to the same period of 2017, includes a $13.62 million decrease in sales in Australia, $3.46 million decrease in sales in Europe and a $0.46 million decrease in sales in Hong Kong, partially offset by a $3.06 million increase in sales in North America, $6.66 million increase in sales in Asian and $0.16 million increase in sales in other countries. North American sales increased by 8.25% to $40.22 million in the nine months ended September 30, 2018, compared to $37.16 million in 2017. Europe sales were $0 in the nine months ended September 30, 2018, compared to $3.46 million in the same period of 2017. Sales in Europe decreased as we gradually stopped selling low margin, low quality products after the sale of our factory in China and ceased our marketing efforts in that region. We aggressively changed our product mix and our sales and marketing strategies to target high-end products and their customers. Sales to Australia decreased 55.14% to $11.08 million in the nine months ended September 30, 2018, compared to $24.69 million in the same period of 2017, primarily as a result of decreased sales orders from one of our customers in Australia who has been involved in projects in many hotels and apartments since the third quarter of 2017. We anticipate that we will gradually receive fewer sales orders from that customer in the near future. Sales to Asia, excluding China and Hong Kong, increased by 132.59% to $11.68 million in the nine months ended September 30, 2018, compared to $5.02 million in the same period of 2017, primarily due to the increases of sales orders from one of our customers who expanded its business in Middle East.

Cost of Sales 

Cost of sales consists primarily of finished goods purchased from other manufacturers. Total cost of sales decreased by 13% to $50.8 million in the nine months ended September 30, 2018, compared to $58.7 million in the same period of 2017. The decrease of cost of sales is primarily due to the decreased volume and cost of high quality products purchased from third-party manufacturers.

Gross Profit

Gross profit increased 2% to $12.33 million in the nine months ended September 30, 2018, compared to $12.07 million in the same period of 2017. Our gross profit margin increased to 20% in the nine months ended September 30, 2018, compared to 17% in the same period of 2017. The increase in gross profit margin resulted primarily from decreased cost of sales as a percentage of net sales, which was due primarily to our marketing efforts targeted at more customers of high-end products who are willing to pay such higher prices.

Operating Expenses

Operating expenses consist of selling, general and administrative expenses and research and development expenses. Operating expenses were $10.11 million in the nine months ended September 30, 2018, compared to $10.30 million in the same period of 2017. Selling expenses decreased by 5.8% to $2.53 million in the nine months ended September 30, 2018, from $2.69 million in the same period of 2017, due primarily to decreased sales and marketing expense since we decreased costly advertising on shows and television in the U.S. in the first half of 2018 in favor of increased internet-based marketing. General and administrative expense decreased by 0.49% to $7.57 million in the nine months ended September 30, 2018, from $7.61 million in the same period of 2017, primarily due to decreases in amortization expense by approximately $0.81 million on our intangible assets (see Note 5 to our condensed consolidated financial statements), consulting expense by approximately $0.64 million, and termination cost on Academic E-commerce platform by approximately $800,000, (see Note 6 to our condensed consolidated financial statements), which was partially offset by an increase in bad debt expense by approximately $2.09 million.

Other Expenses, Net

Other expenses, net was $199,139 in the nine months ended September 30, 2018, compared with other expense, net, of $218,955 in the same period of 2017, representing a decrease in other expense of $0.02 million. The decrease in other expense was due primarily to the decreased interest expense, net, on our lines of credit to $92,416 in the nine months ended September 30, 2018, from $133,093 in the same period of 2017, which was partially offset by an increase in financial expense of $20,554 to $106,889 in the nine month ended September 30, 2018 from $86,335 in the same period of 2017.

Income Tax Benefit 

Income tax benefit was $505,074 in the nine months ended September 30, 2018, compared with $750,037 of income tax benefit in the same period of 2017. Despite a higher reversal of our tax liability reserves due to a statute of limitations expiration, we recorded a higher taxable income in 2018, causing a decrease in income tax benefit for the nine months ended September 30, 2018.

Net Income

As a result of the foregoing, our net income was $2.53 million in the nine months ended September 30, 2018, as compared with $2.3 million of net income for the same period of 2017.

Liquidity and Capital Resources

Our principal demands for liquidity related to our efforts to increase sales, to purchase inventory, and for expenditures related to sales distribution and general corporate purposes. We intend to meet our liquidity requirements, including capital expenditures related to purchase of inventories and the expansion of our business, primarily through cash flow provided by operations and collections of accounts receivable, and credit facilities from banks.

As we continue to execute our growth strategy focused on aggressively expanding sales, particularly in the U.S., we remain focused on improving net margins and bottom line growth.  As noted above, following the divestment of certain subsidiaries, we have in recent periods found it necessary to rely on third-party providers in order to meet demand for the products required by our customers. We also believe that 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 rely 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.

We had net working capital of $70,908,186 at September 30, 2018, a decrease of $1.33 million from net working capital of $72,236,890 at December 31, 2017. The ratio of current assets to current liabilities was 8.75-to-1 at September 30, 2018. 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, 2018 and 2017: 

Net cash used in operating activities was $5.51 million in the nine months ended September 30, 2018, an increase of cash outflow of $0.14 million from $5.36 million of cash used in operating activities in the same period of 2017. The increase of cash outflow was attributable primarily to (i) an increased cash outflow of $6.97 million from accounts receivable to $2.01 million cash outflow in the nine months ended September 30, 2018, compared to $4.96 million cash inflow in the same period of 2017, such increase being primarily due to providing longer payment terms to our long-term relationship customers; and (ii) an increased cash outflow of $2.86 million from advances to suppliers to $11.14 million cash outflow in the nine months ended September 30, 2018, compared to $8.28 million cash outflow in the same period of 2017, such increase being mainly a result of placing more deposits to our suppliers in China in preparation of sales in the latter part of 2018, which have become more necessary to ensure adequate product supply as compared with the same period of 2017. The increase in cash outflow was partially offset by (i) the increase in cash inflow for accounts payable of $4.02 million to $1.81 million cash inflow in the nine months ended September 30, 2018, compared to $2.21 million cash outflow in the same period of 2017, such increase being mainly due to a slowdown of payments to suppliers; (ii) increase in cash inflow for inventories of $4.53 million to $0.59 million in the nine months ended September 30, 2018, compared to $3.4 million of cash outflow in the same period of 2017, such increase being primarily due to fewer inventory purchases because of a decrease in net sales, and (iii) an increased cash inflow of net income, before non-cash depreciation and amortization, stock compensation expense and bad debt allowance, of $0.73 million from $5.43 million in the nine months ended September 30, 2017 to net income of $6.16 million in the nine months ended September 30, 2018, such increase being mainly a result of higher profit margins and lesser amount of cash expenses.

Net cash used in investing activities was $0.01 million in the nine months ended September 30, 2018, an increase of cash outflow of $8.25 million from $8.23 million inflow in the same period of 2017. In the nine months ended September 30, 2018, we incurred cash outflow of $12,960 from purchases of property and equipment. In the nine months ended September 30, 2017, we received net repayment of advances from unrelated parties of $7.00 million and a receipt of $1.25 million from a trademark assignment fee in connection with the divestment of our former Chinese subsidiaries, which were partially offset by a cash outflow of $17,443 from purchase of property and equipment. 

Net cash provided by financing activities was $0.68 million in the nine months ended September 30, 2018, an increase of cash inflow of $5.34 million from cash outflow of $4.66 million in the same period of 2017. In the nine months ended September 30, 2018, we repaid $55.41 million on bank loans and borrowed $56.06 million from bank loans, while cash received from the exercise of outstanding options for common stock was $31,500.  In the nine months ended September 30, 2017, we repaid $41.54 million for bank loans, and borrowed $36.88 million from bank loans.

As of September 30, 2018, we had gross accounts receivable of $56,236,204, of which $14,037,216 was not yet past due, $10,248,726 was less than 90 days past due, $7,866,950 was over 90 days but within 180 days past due and $24,083,312 over 180 days past due. We had an allowance for bad debt of $2,517,464. As of November 2, 2018, $2,702,716 accounts receivable outstanding at September 30, 2018 had been collected.

As of November 2, 2018, $32,782,219, or 60%, of accounts receivable outstanding at December 31, 2017 had been collected.

As of September 30, 2018 and December 31, 2017, we had advances to suppliers of $19,721,445 and $8,580,609, respectively. The nature of these supplier prepayments is that the payment is made for goods before we actually receive them. The balances of advances to suppliers have increased by $11.14 million due in part to the fact that we prepaid product orders to suppliers for regular customer orders and a special project from orders of a Senior Care Center in Shaanxi, and we anticipate that the products will be delivered to our customers in the fourth quarter of 2018. We made prepayment to our suppliers in order to secure our purchasing power over new materials required by our suppliers and priority position of the production lines with our suppliers, especially when we introduced eight new product lines in 2017 and continue to introduce new product lines in 2018.

Additionally, we hope to establish long-term relationships with our suppliers due, in part, to making such advances. With the tightening of regulations and increased enforcement actions related environmental issues in recent years in China, where our suppliers are located, many factories have been affected and are operating with limited production hours. These advances can ensure that our products are treated as priorities and lock in raw material prices with our suppliers. We do not foresee additional risk with the increase of the advances as we have contracts with the suppliers and our QC team is on site to monitor daily production of our suppliers. Based on our past experience, all products and projects have been delivered as promised by our existing suppliers.

For a brand new product, the normal lead time from new product R&D, prototype, mass production to delivery of goods from our suppliers to us is approximately six to nine months after we make advance payments to our suppliers. For other products, the typical time is five months after our advance payment. We will consider the need for a reserve when any suppliers fail to fulfill the orders within the time frame as stipulated in the purchase contracts. As of September 30, 2018 and December 31, 2017, no reserve on supplier prepayments had been made or recorded by us.

In addition, we have noticed increasing demand for antique home furnishing and within the decorating market for products such as reclaimed wood flooring and one-of-a-kind antique furniture. Due to the nature of antique furnishing business, funds are required up front in order for suppliers to source and secure these products whenever they are available in the market.

As of November 2, 2018, $5,866,042, or 30%, of our advances to suppliers outstanding at September 30, 2018 had been delivered to us in the form of inventory purchase.

Most of the remaining balance of $13,855,403 advances to suppliers outstanding at September 30, 2018 is expected to be delivered to us in the form of inventory purchase through the fourth quarter in 2018.

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 rate of 4.25% and maturity on June 1, 2015. On June 8, 2015, the bank extended and modified the terms of the loan agreement to extend the line of credit up to a maximum of $6,000,000 until July 31, 2015 and $5,000,000 thereafter with an annual interest rate of 4.25% and maturity on September 1, 2015 (the term of which the bank allowed to extend until the renewal described in the following sentence while the bank conducted its own audit associated therewith). On September 28, 2015, Diamond Bar extended the line of credit up to a maximum of $6,000,000 with annual interest rate of 3.75% (4% from December 17, 2015) and maturity on June 1, 2017. On January 20, 2016, Diamond Bar increased the line of credit up to a maximum of $8,000,000 with annual interest rate of 4%. On June 22, 2017, Diamond Bar extended the line of credit to maturity on September 1, 2017. On September 19, 2017, Diamond Bar extended the line of credit to maturity on June 1, 2019. The annual interest rate was 5.25% as of September 30, 2018. The line of credit is secured by all of the assets of Diamond Bar and is guaranteed by Nova LifeStyle. As of September 30, 2018, and December 31, 2017, Diamond Bar had $4,851,825 and $4,202,118 outstanding on the line of credit, respectively. During the nine months ended September 30, 2018 and 2017, the Company recorded interest expense of $92,524 and $145,857, respectively; and $36,696 and $40,932 for the three months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, Diamond Bar had $3,148,175 available for borrowing without violating any covenants.

The Diamond Bar loan has the following covenants: (i) maintain a minimum tangible net worth of not less than $20 million; (ii) maintain a ratio of debt to tangible net worth not in excess of 2.5 to 1.0; (iii) the pre-tax income must be not less than 1% of total revenue quarterly; and (iv) maintain a current ratio in excess of 1.25 to 1.00. As of September 30, 2018, Diamond Bar was in compliance with the stated covenants.

On January 22, 2015, Nova Macao renewed a line of credit, with an annual interest rate of 4.25% and principal of up to $6,500,000, with a commercial bank in Hong Kong to extend the maturity date to January 29, 2016. On February 16, 2016, Nova Macao extended the maturity date of line of credit to January 31, 2017, with an annual interest rate of 4% and principal of up to $6,500,000. The loan requires monthly payment of interest and that the interest rate will be adjusted annually. The loan was secured by assignment of Sinosure (China Export and Credit Insurance Company) credit insurance and was guaranteed by Nova LifeStyle and Diamond Bar. The Company did not extend the line of credit and paid it off in February 2017. As of September 30, 2018 and December 31, 2017, Nova Macao had $0 outstanding on the line of credit, respectively. During the nine months ended September 30, 2018 and 2017, Nova Macao paid interest of $0 and $13,828, respectively; and $0 for the three months ended September 30, 2018 and 2017. 

Shelf Registration; Resale Registration Statement

On July 13, 2017, 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 October 12, 2017.

Other Long-Term Liabilities

As of September 30, 2018, we recorded long-term taxes payable of $3.6 million, consisting of an income tax payable of $2.3 million, primarily arising from a one-time transition tax recognized in the fourth quarter of 2017 that represented management’s estimate of the amount of U.S. corporate income tax based on the deemed repatriation to the United States of our share of previously deferred earnings of our non-U.S. subsidiaries of mandated by the Tax Cuts and Jobs Act of 2017, and a $1.3 million unrecognized tax benefit, as ASC 740 specifies that tax positions for which the timing of the ultimate resolution is uncertain should be recognized as long-term liabilities.

At this time, we are unable to make a reasonably reliable estimate of the timing of payments or realization of deferred tax liabilities in individual years beyond 12 months due to uncertainties in the timing of the tax impact of the transactions.

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.

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, 2018, our disclosure controls and procedures were effective.

During the period covered by this quarterly report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We 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.

EXHIBIT INDEX

† Filed herewith

‡ Furnished herewith

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.