Item 1. Business
Our Company
Nova LifeStyle, Inc. (“Nova LifeStyle” or the “Company”) is a U.S.-based innovative designer and marketer of contemporary styled residential and commercial furniture. The Company’s products are marketed through wholesale and retail channels as well as various online platforms worldwide.
Nova LifeStyle’s family of brands includes Diamond Sofa (www.diamondsofa.com), Colorful World, Giorgio Mobili, and Bright Swallow.
Our business strength lies in our abilities to quickly adapt to changing marker demand and stay ahead of the latest trends in modern furniture designs. Our customers principally consist of designers, distributors and retailers who cater to mid-level and high end private label home furnishings that have little product overlap within our specific furnishings products or product lines. Nova LifeStyle is constantly seeking to integrate new sources of distribution and manufacturing that are aligned with our growth strategies, allowing us to continually focus on growing our customer base as well as driving the expansion of our overall distribution and manufacturing relationships worldwide, providing our customers with trendy furnishing solutions.
We generate the majority of our sales as a branding and marketing company with vertically integrated third-party manufacturing capabilities for global furniture distributors and large national retailers. We have established long term relationships with our worldwide customers by providing them with high quality, large scale and cost-effective sourcing solutions. Our worldwide logistics and delivery capabilities provide our customers with the flexibility to select from our extensive furniture collections tailored for their respective shipments. Our decades of experience accumulated from marketing products to international customers have enabled us to fully integrate the supply scale, product delivery logistics, marketing efficiency and design expertise to address customer demand from established markets in the U.S., Canada, Europe, Australia and the Middle East.
Our History
We are a U.S. holding company that operates through several wholly-owned subsidiaries. We design and market residential and commercial furniture products worldwide. Our subsidiaries include Nova Furniture Limited in the British Virgin Islands (“Nova Furniture”), Nova Furniture Limited in Samoa (“Nova Samoa”), Nova Furniture Macao Commercial Offshore Limited (“Nova Macao”), Bright Swallow International Group Limited (“Bright Swallow”), Diamond Bar Outdoors, Inc. (“Diamond Bar”), and i Design Blockchain Technology, Inc (“i Design”). Nova Macao was organized under the laws of Macao on May 20, 2006. Nova Macao is a wholly owned subsidiary of Nova Furniture. Diamond Bar, doing business as Diamond Sofa, 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 which was fully paid at the closing of the acquisition.
On October 24, 2013, Nova Furniture (Dongguan) Co., Ltd. (“Nova Dongguan”) incorporated Dongguan Ding Nuo Household Products Co., Ltd. (“Ding Nuo”) under the laws of the People’s Republic of China (the “PRC”) and contributed capital of RMB 1 million ($162,994). Nova Dongguan made an additional capital contribution of RMB 0.1 million ($16,305) on November 27, 2013 through one of Nova Dongguan’s officers, Mr. Gu Xing Chang, who acted as the nominee shareholder of Ding Nuo.
On September 23, 2016, Nova Furniture, a wholly-owned subsidiary of the Company (the “Seller”), entered into a Share Transfer Agreement (the “Agreement”) with Kuka Design Limited, an unrelated company incorporated in British Virgin Islands (“Kuka Design BVI” or “Buyer”). Pursuant to the terms of the Agreement, the Seller sold all of the outstanding equity interests in Nova Dongguan, a wholly owned subsidiary of the Seller, to the Buyer for a total of $8,500,000 (the “Transaction”), which such value was primarily derived from Nova Dongguan and Nova Dongguan’s wholly owned subsidiary, Nova Museum, and 90.97% owned subsidiary, Ding Nuo. Upon consummation of the Transaction on October 25, 2016, the Buyer became the sole owner of Nova Dongguan.
On November 10, 2016, Nova Furniture entered into a Trademark Assignment Agreement with Kuka Design BVI (“Assignee”). Pursuant to the terms of the Trademark Assignment Agreement, Nova Furniture agreed to assign to the Assignee its full right to, and title in, the NOVA trademark in China for $6,000,000 (the “Assignment Fee”). Assignee was to pay the Assignment Fee in two installments: $1,000,000 on or before November 30, 2016, and $5,000,000 on or before December 31, 2016. As of December 31, 2017, the full balance had been received.
As a result, the operations of Nova Dongguan, Nova Museum and Ding Nuo are now accounted for as discontinued operations in the accompanying consolidated financial statements for all periods presented.
On December 7, 2017, Nova LifeStyle, Inc. incorporated i Design under the laws of the State of California, USA. The purpose of i Design is to build our own blockchain technology team. This new company will focus on application of blockchain technology in the furniture industry, including encouraging and facilitating interactions among designers and customers, and building blockchain-powered platform that enables designers to showcase their products including current and future furniture designs. This company is in a planning stage and has had minimum operations to date.
Our organizational structure is set forth in the following diagram:
Our Products
We design and market modern residential and commercial furniture in diverse markets worldwide. Our products feature urban and contemporary styles, combining comfort and functionality in matching furniture collections and upscale luxury pieces appealing to lifestyle-conscious middle and upper middle-income consumers. Many of our products are segments of multi-component furniture collections in distinctive design styles, attractively priced in the medium and upper-medium ranges. Our product lines feature upholstered, wood and metal-based furniture pieces. We classify our residential products by room; designation or series, such as living room, dining room, bedroom and home office series, and by category or product types such as sofas, chairs, dining tables, beds, entertainment consoles, cabinets and cupboards. Our largest selling product categories for the year ended December 31, 2017 were sofas, TV cabinets and beds, which respectively accounted for approximately 54%, 16% and 10% of 2017 sales, respectively. For the year ended December 31, 2016, our largest selling product categories were sofas, beds and dining tables, which accounted for approximately 61%, 11% and 7% of sales in 2016, respectively. Our products are manufactured primarily from medium-density fiberboard, or MDF board, and particleboard covered with veneers or lacquers and combined with other materials, including steel, glass, marble, leather and fabrics.
Our product offerings consist of a mix of furnishings designed by us, and sourced from third party manufacturers that are supervised under our rigorous quality control processes. Through market research, customer feedback, and ongoing design development, we identify the latest trends and customer needs in target markets to develop new products, collections and brands. Our product collections are designed to appeal to consumer preferences in specific markets. We develop both individual furniture pieces and complete furniture collections that equip an entire home which feature matching furniture suites, providing convenient home furnishing options for lifestyle-conscious consumers.
We generally introduce new collections and launch new design styles at international furniture exhibitions or trade fairs. Our products are displayed in our showrooms. We further support our new product launches with product brochures and online marketing campaigns. Our staff collects customer feedback and collaborates with customers worldwide to design store and showroom layouts. In marketing materials, we highlight matching furniture collections by displaying complete and fully accessorized whole-room settings instead of individual furniture pieces. We believe that such in-store presentations provide convenient, one-stop solutions to customers, and thus incentivize clients to purchase an entire room of furniture from us instead of shopping for individual pieces offered by different brands or manufacturers. Our products are designed by our own designers. Customer orders are filled by third party manufacturers under our direct quality control. We believe that our products feature superior materials, attractive appearances, superb functionalities and satisfying price points generally desired by today’s middle to upper middle-income consumers worldwide.
International Markets
We sell products to the U.S., Canadian, Chinese, Australian, European and Middle Eastern markets under the Diamond Sofa brand. We believe that discretionary purchases of furniture by middle to upper middle-income consumers will continue to increase in the furniture markets worldwide. We also believe that furniture products that feature contemporary design styles such as ours will continue to attract significant customer demand.
In 2017, our products were sold in over 14 countries worldwide, with North America and Australia our principal international markets. Sales to North America accounted for 46.7% and 62.8% of sales in 2017 and 2016, respectively. Sales to Europe accounted for 3.3% and 13.5% of sales in 2017 and 2016, respectively. Sales in this region decreased as expected as we have gradually dropped low-margin products. We changed our marketing strategy by shifting revenue focus to high- margin products. Sales to Australia accounted for 24.3% and 5.3% of sales in 2017 and 2016, respectively. We also expanded sales to other regions, and sales to those regions, primarily in China and other Asian countries, accounted for 25.7% and 18.4% of our total sales in 2017 and 2016, respectively. As we continue to broaden our distribution network, increase direct sales and grow in the emerging markets, we believe that we are well positioned to respond to changing market conditions that will allow us to take advantage of any upturns in the global and local economies of the markets that we serve.
Our global logistics and delivery capabilities provide our customers with the flexibility to select from our extensive furniture collections to address their respective needs. We design and supply our products under our own brands. We also design and ship products for other major brands as their OEM designer or supplier. Our OEM design customers include Actona Company (Denmark), Dormitienda (Spain) and El Dorado Furniture (United States) and others. We offer a wide selection of stand-alone furniture pieces across a variety of product categories and approximately 20 collections developed exclusively for the international markets. We also sell products under the Diamond Sofa brand to distributors and retailers in North America and South America and to end-user U.S. consumers through third-party shopping portals. Reflecting market demand, our research and development team works closely with customers to timely modify our existing product designs. We also offer custom-designed styles for specific market segments. We believe that we can continue to increase sales both in the U.S. and internationally as we further expand the Diamond Sofa brand. In 2018, we plan to grow both online and offline sales.
Sales and Marketing
Our sales and marketing strategies target middle class, urban consumers, including: (1) direct sales to the U.S. and international customers; (2) internet sales and online marketing campaigns; and (3) participation in exhibitions and trade shows.
We diversify our customer base by increasing direct sales to a broad range of retailers and chain stores across the U.S. and international markets. In August 2011, we acquired Diamond Bar, a California importer and marketer of modern home furniture with market presence in North and South America. In the U.S., Diamond Bar markets its products under the “Diamond Sofa” brand to wholesale distributors and retailers. Through Diamond Bar’s longstanding customer relationships and distribution capabilities, we plan to continue to solidify the “Diamond Sofa” brand in the U.S., Mexico and South America markets. Through our relationship with St. Joyal, a California-based corporation specializing in business development, management and organizational planning and an investor in us, we plan to continue to expand our direct sales and marketing efforts in North America, and in particular the U.S., which historically is the largest market worldwide for imported furniture. St. Joyal has extensive business contacts with U.S. domestic furniture wholesalers and retailers, through which we have been introduced to some of our current customers in the U.S. We intend to expand the “Diamond Sofa” brand and introduce new brands for direct sales in the U.S. and international markets while continuing to offer custom-made products under private label.
Diamond Bar also currently sells products under the Diamond Sofa brand in the U.S. through third party shopping portals, shipping orders received online directly to the end customer. We believe that our planned direct-to-consumer online sales and marketing strategies will increase our sales in the U.S. by building our brand awareness and acting as an effective advertising vehicle. We also support new product collections and brand launches with print and online advertising campaigns, participation in furniture exhibitions and by offering product brochures and samples. We provide samples and brochures of new products for international markets to distributors and buyers, as is common in the furniture industry.
We have also historically expanded our market presence through strategic acquisitions. In April 2013, we acquired Bright Swallow International Group Limited (“Bright Swallow”), an established furniture company with a global client base. Bright Swallow has since become an integral part of the Nova LifeStyle family brands. Bright Swallow generated revenues of over $7.0 and $6.90 million for fiscal years 2017 and 2016, respectively, and its complementary product lines as well as broad geographical reach have offered Nova LifeStyle an ideal opportunity to grow its global footprint. One of Bright Swallow’s clients, Canada-based The Brick Limited (www.TheBrick.com) has over 200 store locations.
We gain new customers by attending many international furniture trade shows throughout the year. During these events, we introduce new product offerings and launch new design collections. We believe this marketing process helps us to develop and detect the latest-trends in the marketplace, allowing us to better understand the challenges and opportunities facing distributors and buyers with whom we have long-standing customer relationships. Each year, we present new products at the International Famous Furniture Fair (3F) in Dongguan, China and the China International Furniture Exhibition in Shanghai, China. We also exhibit products under the “Diamond Sofa” brand during the Las Vegas Market (U.S.) and the High Point Market (U.S.) trade shows. Internationally, we participate in trade fairs in collaboration with our customers such as the Actona Company at IMM Cologne (Germany) show and Yeh Brothers during the Interiors Birmingham (United Kingdom) furniture show. We plan to expand our business in the Middle East by attending several furniture exhibitions in those markets. To highlight our latest design collections, we maintain year-round showrooms at Diamond Bar’s headquarters in California as well as the High Point Market and Las Vegas Market.
Suppliers and Manufacturers
We source finished goods from third-party manufacturers to fulfill orders placed by customers through Nova Macao and Diamond Bar for the U.S. and international markets. Our principal suppliers of finished goods in 2017 were Shen Bang Trading Development Ltd., Zhejiang Luxury Trading Company Limited, Chinese Top Holdings Ltd. and Yin Tong Furniture Limited accounting for approximately 17.4%, 24.0%, 12.9%, and 10.4% of our total purchases in 2017, respectively. By maintaining relationships with multiple suppliers, we benefit from a more stable supply chain and better pricing. If a change of suppliers is necessary, we believe that we can quickly fulfill our requirements from other suppliers without interruptions in order fulfillment. We monitor our suppliers’ ability to meet our product needs and we participate in quality assurance activities to reinforce our high-quality standards. Our third-party manufacturing contracts are generally of annual or shorter durations. We issue production orders to manufacturers based on individual purchase orders. Our manufacturing relationships are non-exclusive, and we are permitted to procure products from other sources at our discretion. None of our manufacturing contracts include production volume or purchase commitments on the part of either party. Our third-party manufacturers are responsible for sourcing raw materials, agreeing to produce parts and finished products to our specifications. We hold our suppliers to high quality standards and delivery deadlines. Our quality control procedures may extend to stringent requirements for raw material suppliers.
Customers
Our target end customer is the middle and upper middle-income consumer of residential furniture. In the U.S. and international markets, our sales principally are to furniture distributors and retailers who in turn offer our products under their own brands or under our Diamond Sofa brand. Our largest customers in 2017 were Merlino Lewis LLP, Shanxi Wanqing Senior Care Service, Group and Home Centre LLC, which accounted for 24.3%, 13.7% and 11.5% of our total sales in 2017, respectively. Our two largest customers in 2016 were Shanxi Wanqing Senior Care Service, Group and Actona Company A/S, a global furniture distributor, which accounted for 10.8% and 9.7% of our total sales in 2016, respectively. No other individual customer accounted for greater than 10% of our sales in 2017 or 2016. We plan to increase direct sales to retailers and chain stores worldwide as we continue to diversify our customer base from global furniture distributors.
We are focusing on establishing and growing long-term relationships with our customers. We believe that the majority of our customers view us as a strategic long-term supplier and value the quality of our products, our timely delivery and design capabilities. We generally negotiate renewable supplier agreements with firm pricing on our products, typically for a term of one year, as is customary in the furniture industry, with individual orders made on standard purchase orders. In 2017, we sold products into approximately 14 countries worldwide, with North America and Australia as our principal international markets, while we expanded our sales in other regions. Sales to North America accounted for 47% and 63% of sales in 2017 and 2016, respectively. Sales to Australia accounted for 24% and 5% of sales in 2017 and 2016, respectively. The change was attributed principally to our changing sales and marketing strategy to diversify international sales. Sales to other regions, primarily in Europe, China and Asia, accounted for 29% and 32% of our total sales in 2017 and 2016, respectively. We expect that a majority of our revenues will continue to come from our sales to the U.S. and international markets. We acquired Diamond Bar in August 2011, which has driven expansion of our sales to the U.S., Mexico, and South America through Diamond Bar’s longstanding customer relationships and distribution capabilities. Diamond Bar accounted for 51.2% and 53.7% of Nova Lifestyle’s total sales in 2017 and 2016, respectively, and Nova Macao’s revenues accounted for 42.3% and 38.8% of Nova Lifestyle’s total sales in 2017 and 2016, respectively. In addition, we anticipate increasing internet sales under the Diamond Sofa brand through third-party shopping portals. We believe that as we expand our broad network of distributors and increase direct sales, our exposure to regional recessions will be reduced and allow us to better capitalize on emerging market trends.
We typically experience stronger third and fourth calendar quarters as our product sales are subject to the seasonality and fluctuations typical of the furniture industry. This industry-based seasonality is generally caused by shipping lead-times to international markets combined with the real estate market slowdown and decrease in furniture consumption commonly experienced during the summer months in the Northern Hemisphere markets in which the majority of our customers are located and our products sell at retail. In addition, we believe that consumer demand for furniture generally reflects sensitivity to overall economic conditions, including, but not limited to, unemployment rates, housing market conditions and consumer confidence.
Competition
The residential furniture industry is large and highly competitive. The industry consists of many manufacturers, distributors and retailers, none of which dominates the fragmented and diverse market. Our products principally compete in the U.S., China, Europe and Australia. The primary competitive factors in these markets for our product price points and target consumers are price, quality, style, marketing, functionality and availability.
In the U.S. and international markets, we compete against other furniture distributors and wholesalers which are mostly located in China and other Southeast Asian countries. We also compete against traditional distributors in North America and Europe. We believe that we have significant competitive advantages over North American and European distributors due to our superb customer service and a history of prompt delivery of high quality products. We offer a broad range of approximately 30 distinct product collections at competitive prices. Our contemporary product designs have styles and functionality that are better than, at least comparable to, those offered by our higher-priced competitors. Our design team closely coordinates with our sales and marketing staff to include customer feedback as part of their ongoing R&D improvement process, thus allows the Company to develop and timely modify products to meet the changing stylistic and functional demands from our worldwide customers. We believe that our decades of product experience and proven performance record offer competitive edges over many other suppliers. In addition to our design and logistical capabilities, we believe that our experience from sourcing custom-made products for distributors presents significant benefits to our customers. We expanded our presence in the North American market through the acquisitions of Diamond Bar in August 2011 and Bright Swallow in 2013. We have since expanded their customer base and integrated their sales channels into our growing marketing network.
Environmental and Regulatory Matters
Our operations are subject to various laws and regulations both domestically and abroad. In the U.S., federal, state and local regulations impose standards on our workplace and our relationship with the environment. For example, the U.S. Environmental Protection Agency, Occupational Safety and Health Administration and other federal agencies have the authority to promulgate regulations that may impact our operations. In particular, we are subject to legislation placing restrictions on our generation, emission, treatment, storage and disposal of materials, substances and wastes. Such legislation includes: the Toxic Substances Control Act; the Resource Conservation and Recovery Act; the Clean Air Act; the Clean Water Act; the Safe Drinking Water Act; and the Comprehensive Environmental Response and the Compensation and Liability Act (also known as Superfund). We are also subject to the requirements of the Consumer Product Safety Commission and the Federal Trade Commission, in addition to regulations concerning employee health and safety matters. We believe the Company has complied with the relevant federal, state, local and international requirements for environmental protection.
Intellectual Property
We rely on the patent and trademark protection laws in the U.S. to protect our intellectual property and maintain our competitive position in the marketplace. The Company and our subsidiaries currently hold two trademarks registered in the U.S. related to the “Diamond Sofa” brand. We acquired all rights, title and interest in the two registered U.S. trademarks from St. Joyal at a price of $200,000 (which was paid in full at closing) pursuant to a trademark purchase and assignment agreement dated August 31, 2011. In addition, we have registered and maintained numerous internet domain names related to our business, including “novalifestyle.com” and “diamondsofa.com.”
Research and Development
We believe that new product designs are important to our continued success. We actively seek to protect our product designs and brand names under the patent and trademark protection laws in the U.S. and China, but the copying of a product’s appearance is a common and ongoing issue in the furniture industry as manufacturers seek to capitalize on popular designs and features by copying those of their competitors and making subtle changes to avoid infringement claims. To remain competitive, we believe that we must constantly innovate to stay ahead of competitors. We have developed a design process that enables us to better manage the short product life cycles for furniture designs by anticipating and responding quickly to changing consumer preferences. We attend furniture exhibitions worldwide, conduct market research and solicit customer feedback to help us identify new trends and customer needs in our target markets. We then incorporate customer feedback into new product designs. We introduce new product collections annually for the U.S. and international markets. We anticipate introducing new products under the “Diamond Sofa” brand on a quarterly basis for the U.S. market. At least annually, we assess the marketing results for new designs in order to decide whether to continue with a particular line.
We use in-house designers and computer-aided modeling systems to generate design and related development work. We have used independent designers in the past for product design, from which we built prototype furniture pieces for refinement and testing. In 2017 and 2016, we invested $373,935 and $95,877, respectively, on research and development expense. We may increase future investments in R&D based on our growth strategies.
Furniture Industry Regulations and Standards
We and our products are subject to PRC, U.S. and international regulations related to the furniture industry.
China has a series of national standards, or the GB and QB standards, that govern certain technical, safety and quality requirements for furniture manufactured in and exported from China. The Standardization Administration of the PRC, or SAC, and the China Chamber of Commerce for Import and Export of Light Industrial Products and Art-Crafts, or the CCCLA, develop and revise these national standards relating to the structure, material, size and quality requirements for the many varied categories and classifications of upholstered, wood and metal-based furniture. Many of these standards are not compulsory, but manufacturers typically follow all applicable recommended standards.
Our products are also subject to the mandatory and voluntary furniture test standards of the U.S. and international markets in which our products are distributed to end consumers, including those developed by the American National Standards Institute, or ANSI, Business and Institutional Furniture Manufacturer’s Association, or BIFMA, ASTM International, California Air Resources Board, or CARB, Furniture Industry Research Association, or FIRA, and the International Organization for Standardization, or ISO. These environmental, ecological and formaldehyde emission standards and source of origin labeling requirements are national or international, with the U.S. and European Union typically having the strictest standards for their markets. We manufacture all products to customer specifications and we believe that our products meet all currently applicable national and international furniture test standards.
Export Laws and Regulations
We may be subject from time to time to various PRC governmental regulations related to exportation, including the Customs Law of the PRC and the Regulation of the PRC on the Administration of the Import and Export of Goods. These laws and regulations set out standards and requirements for various aspects of the export and import of goods, customs registration, sanitary registration and inspection. Failure to comply with these laws and regulations may result in the confiscation of our products for export and proceeds from the sales of non-compliant products, orders for correction, fines, revocation of licenses and, in extreme cases, criminal liabilities. We believe we are in material compliance with all applicable PRC laws and regulations related to the exports of our products.
Foreign Currency Regulations
The principal regulations governing foreign currency exchange in China are the Foreign Exchange Administration Regulations promulgated by the State Council, as amended on August 5, 2008, or the Foreign Exchange Regulations. Under the Foreign Exchange Regulations, the RMB, the national currency of the PRC, is freely convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities outside of China, unless the prior approval of the State Administration of Foreign Exchange, or the SAFE, is obtained and prior registration with the SAFE is made.
On July 4, 2014, the SAFE issued Circular 37, the Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, which became effective as of July 4, 2014. Please refer to “Risk Factors - Risks Related to Business in China - PRC regulations relating to the registration requirements for PRC resident shareholders owning shares in offshore companies may subject our PRC resident shareholders to personal liability and adversely affect our business” for a discussion of Circular 37.
On August 29, 2008, the SAFE promulgated Circular 142, the Notice on Perfecting Practices Concerning Foreign Exchange Settlement Regarding the Capital Contribution by Foreign-invested Enterprises, regulating the conversion by a foreign-invested company of foreign currency into RMB by restricting how the converted RMB may be used.
Taxation
We are subject to transfer pricing regulations in the U.S. because we are subject to income taxes in the U.S. and conduct operations worldwide through our current subsidiaries. We assess our potential transfer pricing-related liabilities arising from transactions with Nova Macao on a quarterly basis, and we have taken an additional income tax expense for 2017 as a reserve based on management’s reasonable analysis for estimated tax principal, interest and penalties under U.S. transfer pricing regulations because of the recently enacted Tax Cuts and Jobs Act in December 2017 in the United States.
Employees
As of December 31, 2017, we had 33 full time employees worldwide. Our U.S. corporate office and operations employed 30 full-time employees and our locations in Macau and Hong Kong employed a total of 3 full-time employees. We believe that relations with our employees are satisfactory. We have no collective bargaining agreements with our employees.
Item 1A.
Item 1A. Risk Factors
Our business and an investment in our securities are subject to a variety of risks. The following risk factors describe the most significant events, facts or circumstances that could have a material adverse effect upon our business, financial condition, results of operations, ability to implement our business plan and the market price for our securities. Additional risks and uncertainties that presently are not considered material or are not known to us, and therefore are not mentioned herein, may impair our business operations. Many of these events are outside of our control. If any of these risks actually occurs, our business, financial condition or results of operations may be materially adversely affected. In such case, the trading price of our common stock could decline and investors in our common stock could lose all or part of their investment.
Risks Related to Our Business
Changes in economic conditions in the industries and markets served by our customers could adversely affect demand for our products.
The furniture industry is subject to cyclical variations in the global economy and to uncertainty regarding future economic prospects. Our business is affected by the number of orders we are able to secure from our customers, which is determined by the level of our customers’ business activity. Our customers’ level of business activity is in turn determined by the level of consumer spending in the markets our customers serve. Economic downturns could affect discretionary consumer spending habits by decreasing the overall demand for home furnishings. Any significant or prolonged decline of the economy in China, the U.S. or other international markets in which our products are sold will affect disposable income and spending by consumers in these markets, and may lead to a decrease in demand for consumer products. To the extent that such decrease in demand for consumer products translates into a decline in the demand for home furnishings, our sales and financial performance could be adversely affected. Any economic downturn also could negatively impact our primary customers, furniture wholesalers, distributors and retailers, possibly resulting in a decrease in our sales or earnings. Changes in interest rates, consumer confidence, new housing starts, existing home sales, the availability of consumer credit and geopolitical factors could have particularly significant effects on our consolidated financial condition, results of operations and cash flows. Any decline in economic activity and conditions in the industries and markets served by our customers and in which we operate may reduce demand for our products and could adversely affect our financial condition and results of operations.
We historically have derived a substantial part of our sales from a limited number of customers. If we lose any of these customers, or any of these customers reduce the amount of business they do with us, our sales may be adversely affected.
Historically, a substantial part of our sales was attributed to a limited number of customers. Sales to our largest customer constituted 24.3% and 10.8% of our total sales in 2017 and 2016, respectively. If the demand for our products decreases in one or more of the markets supplied by our largest customers, or if there are any material social or regulatory changes in these markets, our sales could decline and we could lose market share, any of which could materially harm our business. We do not foresee relying on these same customers for sales generation as we expand our business to increase our internet sales and direct sales to the U.S. and other international markets. We cannot assure you, however, that we will be able to successfully implement these plans.
If we lose our key personnel, or are unable to attract and retain additional qualified personnel, the quality of our services may decline and our business may be adversely affected.
We rely heavily on the expertise, experience and continued services of our senior management, including our Chief Executive Officer, President, Director and Chairperson, Ms. Lam, and our Chief Financial Officer, Mr. Chuang. Loss of their services could adversely affect our ability to achieve our business objectives. Ms. Lam and Mr. Chuang are key factors in our success at establishing relationships within the furniture industry in the U.S. and international market because of their extensive industry experience and reputation. The continued development of our business depends upon their continued employment. We have entered into employment agreements with Ms. Lam and Mr. Chuang that include provisions for non-competition and confidentiality.
We believe our future success will depend upon our ability to retain key employees and our ability to attract and retain other skilled personnel. We cannot guarantee that any employee will remain employed by us for any period of time or that we will be able to attract, train or retain qualified personnel in the future. Such loss of personnel could have a material adverse effect on our business and company. Furthermore, we will need to employ additional personnel to expand our business. Qualified employees are in great demand and may be unavailable in the time frame required to satisfy our customers’ requirements. There is no assurance we will be able to attract and retain sufficient numbers of highly skilled employees in the future. The loss of personnel or our inability to hire or retain sufficient personnel at competitive rates could impair the growth of our business.
We may not be able to keep pace with competition in our industry, which could adversely affect our market share and result in a decrease in our future sales and earnings.
The furniture industries in the U.S. and international markets are very competitive and fragmented. Our business is subject to risks associated with competition from new or existing industry participants who may have more resources and better access to capital. Many of our competitors and potential competitors may have substantially greater financial and government support, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in the industry than we do. Among other things, these industry participants compete with us based upon price, quality, style, functionality and availability. We cannot be sure we will have the resources or expertise to compete successfully in the future. Some of our competitors may also be able to provide customers with additional benefits at lower overall costs to increase market share. We cannot be sure we will be able to match cost reductions by our competitors or that we will be able to succeed in the face of current or future competition. Also, due to the large number of competitors and their wide range of product offerings, we may not be able to continue to differentiate our products through value, styling or functionality from those of our competitors. In addition, some of our customers are also performing more manufacturing services themselves. We may face competition from our customers as they seek to become more vertically integrated. As a result, we are continually subject to the risk of losing market share, which may lower our sales and earnings.
We will face different market dynamics and competition as we develop new products to expand our presence in our target markets. In some markets, our future competitors may have greater brand recognition and broader distribution than we currently enjoy. We may not be as successful as our competitors in generating revenues in those markets due to the lack of recognition of our brands, lack of customer acceptance, lack of product quality history and other factors. As a result, any new expansion efforts could be more costly and less profitable than our efforts in our existing markets. If we are not as successful as our competitors are in our target markets, our sales could decline, our margins could be impacted negatively and we could lose market share, any of which could materially harm our business.
We may lose U.S. market share due to competition and our dependence on production facilities located outside the U.S., which would result in a decrease in our future sales and earnings.
We compete in the U.S. market principally through our sales under the Diamond Sofa brand, which we acquired on August 31, 2011. The furniture industry in the U.S. is very competitive and fragmented. We compete with many domestic U.S. and international residential furniture sources, including national department stores, regional or independent specialty stores, dedicated franchises of furniture manufacturers and retailers marketing products through catalogs and over the internet. There are few barriers to entry in the U.S. furniture market, and new competitors may enter this market at any time. Some of our competitors have greater financial resources than we have and often offer extensively advertised and well-recognized branded products. We may not be able to meet price competition or otherwise respond to competitive pressures in the U.S. market. We also may not be able to continue to differentiate our products from those of our competitors in the U.S. through value, styling and functionality because of the large number of competitors and their wide range of product offerings. In addition, our operations in the U.S. also depend primarily on our sourcing of products through Nova Macao, which is subject to increased risks of delays in shipments to the U.S. not typically encountered for domestically sourced furniture, such as shipment delays caused by customs, export and tariff issues, decreased availability of shipping containers and the inability to secure space aboard shipping vessels to transport our products. Our failure to fill customer orders in a timely manner during an extended business interruption for Nova Macao, or due to transportation issues, could negatively impact our existing customer relationships in the U.S. market and result in decreased sales and earnings. Furthermore, some large furniture retailers in the U.S. are sourcing products directly from furniture manufacturers located in China and other Southeast Asian countries instead of through distributors like us. Over time, this practice may expand to smaller retailers in the U.S. Accordingly; we are continually subject to the risk of losing U.S. market share, which may decrease our future sales and earnings.
Failure to anticipate or timely respond to changes in fashion and consumer preferences could adversely impact our business.
Furniture is a styled product and is subject to rapidly changing fashion trends and consumer preferences, as well as to increasingly shorter product life cycles. We believe our past performance has been based on, and our future success will depend, in part, upon our ability to continue to improve our existing products through product innovation and to develop, market and produce new products. We cannot assure you that we will be successful in introducing, marketing and producing any new products or product innovations, or that we will develop and introduce in a timely manner innovations in our existing products that satisfy customer needs or achieve market acceptance. Our success also depends upon our ability to anticipate and respond in a timely manner to fashion trends related to residential furniture. If we fail to identify and respond to these changes, our sales could decline and we could lose market share, any of which could materially harm our business.
If we are unable to manage our growth, we may not continue to be profitable.
Our continued success depends, in part, upon our ability to manage and expand our operations and facilities in the face of continued growth. This planned growth includes the expansion of our internet sales and diversifying our international sales by expanding our broad network of distributors, increasing direct sales in the U.S., Europe and other international markets and entering emerging growth markets. The growth in our operations has placed, and may continue to place, significant demands on our management, operational and financial infrastructure. If we do not manage our growth effectively, the quality of our products and services could suffer, which could negatively affect our operating results. To manage this growth effectively, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. We cannot assure you that we will be able to fulfill our staffing requirements for our business, successfully train and assimilate new employees, or expand our management base and enhance our operating and financial systems. Failure to achieve any of these goals will prevent us from managing our growth in an effective manner and could have a material adverse effect on our business, financial condition or results of operations.
We may need additional capital to execute our business plan and fund operations and may not be able to obtain such capital on acceptable terms or at all.
In connection with the development and expansion of our business, we may incur significant capital and operational expenses. We believe that we can increase our sales and net income by implementing a growth strategy that focuses on (i) increasing online sales and (ii) diversifying our international sales. We plan to increase and diversify our sales to the U.S., Europe and international markets by further integrating the Bright Swallow brand family and establishing new brands for the international markets and to increase our online sales presence.
Management anticipates that our existing capital resources, cash flows from operations, collection of our accounts receivable, and loan facilities, any proceeds from any possible equity financings related to the shelf registration statement on Form S-3 we filed in July 2017, as amended, which became effective on October 12, 2017, will satisfy the liquidity requirements of our business for the next 12 months. However, if available funds are not sufficient to meet our plans for expansion, our plans include pursuing alternative financing arrangements, including additional bank loans based on our good credit rating or funds raised through additional offerings of our equity or debt, if and when we determine such offerings are required. Our ability to obtain additional capital on acceptable terms or at all is subject to a variety of uncertainties, including:
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Investors’ perceptions of, and demand for, companies in our industry;
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Investors’ perceptions of, and demand for, companies operating in China;
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Conditions of the U.S. and other capital markets in which we may seek to raise funds;
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Our future results of operations, financial condition and cash flows;
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Governmental regulation of foreign investment in companies in particular countries;
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Economic, political and other conditions in the U.S., China, and other countries; and
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Governmental policies relating to foreign currency borrowings.
There is no assurance we will be successful in locating a suitable financing transaction in a timely fashion or at all. In addition, there is no assurance we will obtain the capital we require by any other means. Future financings through equity investments are likely to be dilutive to our existing shareholders. Also, the terms of securities we may issue in future capital transactions may be more favorable for our new investors. Newly-issued securities may include preferences or superior voting rights, be combined with the issuance of warrants or other derivative securities, or be the issuances of incentive awards under equity employee incentive plans, which may have additional dilutive effects. Furthermore, we may incur substantial costs in pursuing future capital and financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which will adversely impact our financial condition. If we cannot raise additional funds on favorable terms or at all, we may not be able to carry out all or parts of our strategy to maintain our growth and competitiveness.
Our accounts receivable remain outstanding for a significant period of time, which has a negative impact on our cash flow and liquidity.
Our standard payment term for accounts receivable is 30 - 120 days. We give an extended payment term to certain of our major customers of up to 180 days. Our sales to customers in the U.S. and international markets typically are made through letters of credit. We remain subject to negative impacts on our cash flow and liquidity due to the significant period of time our accounts receivable remain outstanding with respect to sales made under the longer payment terms. In 2016, we had accounts receivable turnover of 2.10 on an annualized basis, with sales outstanding of 174 days. In 2017, we had accounts receivable turnover of 2.14 on an annualized basis, with sales outstanding of 170 days. As of December 31, 2017, we had gross accounts receivable of $54,225,489, of which $21,651,964 was not yet past due, $12,766,284 was less than 90 days past due, $19,807,241 was over 90 days but within 180 days past due and $0 over 180 days past due. We had an allowance for bad debt of $ 218,976 for accounts receivables. The increase in gross accounts receivable was due to, among other things, a 14.9% increase in sales in the year ended December 31, 2017 to $106.49 million, compared to $92.65 million in 2016. Additionally, we have been more lenient towards the collection of accounts receivable from certain major customers to maintain good relationships and to attract new major accounts. While historically our collections have been reasonably assured, delays in collections and the significant period of time our accounts receivable remain outstanding may result in pressure on our cash flow and liquidity. We recognized a loss of $305,519 and $2,603,745 from bad debts from continuing operations during the years ended December 31, 2017 and 2016. The loss in 2016 primarily resulted from the inability to collect accounts receivable from Nova Macao’s customers on time.
We may experience material disruptions to our ability to acquire sufficient inventory from third-party suppliers that could result in material delays, quality control issues, increased costs and loss of business opportunities, which may negatively impact our sales and financial results.
We rely upon our third-party suppliers to produce our products and maintain sufficient inventory to meet customer demand. A material disruption at our suppliers’ manufacturing facilities could prevent us from meeting customer demand, reduce our sales and negatively impact our financial results. We may also experience quality control issues as we seek out new suppliers or are forced to contract with new suppliers to meet increased customer demand. Any such material disruption may prevent us from shipping our products on a timely basis, reduce our sales and market share and negatively impact our financial results. Our third-party supplier contracts are generally of annual or shorter duration, or manufactured products are sourced on the basis of individual purchase orders. There is no assurance that we will be able to maintain our current relationships with these parties or, if necessary, establish future arrangements with other third-party suppliers on commercially reasonable terms. Further, while we maintain an active quality control program, we cannot assure that their manufacturing and quality control processes will be maintained at a level sufficient to meet our inventory needs or prevent the inadvertent sale of substandard products. While we believe that products manufactured by our current third-party suppliers could generally be procured from alternative sources, temporary or permanent loss of services from a significant manufacturer could cause disruption in our supply chain and operations.
Our dependence on foreign suppliers and our increased global operations subject us to a variety of risks and uncertainties that could impact our operations and financial results.
In 2017, the majority of our products were purchased from foreign suppliers and manufacturers, predominantly in Asia. Our dependence on foreign suppliers means that we may be affected by changes in the value of the U.S. dollar relative to other foreign currencies. For example, any upward valuation in the Chinese yuan, the euro, or any other foreign currency against the U.S. dollar may result in higher costs to us for those goods. Declines in foreign currencies and currency exchange rates might negatively affect the profitability and business prospects of one or more of our foreign suppliers. This, in turn, might cause such foreign vendors to demand higher prices for products in their effort to offset any lost profits associated with any currency devaluation, delay product shipments to us, or discontinue selling to us, any of which could ultimately reduce our sales or increase our costs.
We, and our foreign suppliers, are also subject to other risks and uncertainties associated with changing economic and political conditions worldwide. These risks and uncertainties include import duties and quotas, compliance with anti-dumping regulations, work stoppages, economic uncertainties and adverse economic conditions (including inflation and recession), government regulations, employment and labor matters, wars and fears of war, political unrest, natural disasters, public health issues, regulations to address climate change and other trade restrictions. We cannot predict whether any of the countries from which our raw materials or products are sourced, or in which our products are currently manufactured or may be manufactured in the future, will be subject to trade restrictions imposed by the U.S. or foreign governments or the likelihood, type or effect of any such restrictions. Any event causing a disruption or delay of imports from foreign suppliers, including labor disputes resulting in work disruption, the imposition of additional import restrictions, restrictions on the transfer of funds and/or increased tariffs or quotas, or both, could increase the cost, reduce the supply of merchandise available to us, or result in excess inventory if merchandise is received after the planned or appropriate selling season, all of which could adversely affect our business, financial condition and operating results.
A delay in getting non-U.S.-sourced products through port operations and customs in a timely manner could result in reduced sales, canceled sales orders and unanticipated inventory accumulation.
Our business depends on our ability to source and distribute products in a timely manner. As a result, we rely on the free flow of goods through open and operational ports worldwide. Labor disputes or other disruptions at ports create significant risks for our business, particularly if work slowdowns, lockouts, strikes or other disruptions occur during our peak importing seasons. Any of these factors could result in reduced sales, canceled sales orders and unanticipated inventory accumulation and have a material adverse effect on our operating results, financial position and cash flows.
Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations.
We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws that apply to our business could reduce our after-tax income from such jurisdiction and could adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, the United States and many of the other countries in which our products are distributed or sold, including countries in which we have significant operations, have recently made or are actively considering changes to existing tax laws. For example, the Tax Cuts and Jobs Act (the “TCJ Act”) was recently signed into law in the United States. The changes in the TCJ Act are broad and complex and we are continuing to examine the impact the TCJ Act may have on our business and financial results. In accordance with applicable SEC guidance, we recorded a provisional net tax expense in the fourth quarter of 2017 resulting from the enactment of the TCJ Act. This provisional expense is subject to change, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in Internal Revenue Service (IRS) interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not yet adopted state-level laws similar to the TCJ Act.
Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, could adversely affect our business, financial condition or results of operations.
We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation could differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. In addition, in connection with the Organization for Economic Co-operation and Development Base Erosion and Profit Shifting project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries.
We are subject to warranty claims for our products, which could result in unexpected expense.
Many of our products carry warranties for defects in quality and workmanship. Historically, the amount for return of products, the discount provided to the customers due to defects and cost for the replacement parts has been immaterial. However, we may experience significant expense as the result of future product quality issues, product recalls or product liability claims which may have a material adverse effect on our business. The actual costs of servicing future warranty claims may exceed our expectations and have a material adverse effect on our results of operations, financial condition and cash flows.
We may not be able to protect our product designs and other proprietary rights adequately, which could adversely affect our competitive position and reduce the value of our products and brands, and litigation to protect our intellectual property rights may be costly.
We attempt to strengthen and differentiate our product portfolio by developing new and innovative brands and product designs and functionality. As a result, our patents, trademarks and other intellectual property rights are important assets to our business. Our success will depend in part on our ability to obtain and protect our products, methods, processes and other technologies, to preserve our trade secrets, and to operate without infringing on the proprietary rights of third parties in China, the U.S. and other international markets. Despite our efforts, any of the following may reduce the value of our owned and used intellectual property:
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Issued patents and trademarks that we own or have the right to use may not provide us with any competitive advantages;
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Our efforts to protect our proprietary rights may not be effective in preventing misappropriation of our intellectual property or that of those from whom we license our rights to use;
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Our efforts may not prevent the development and design by others of products or technologies similar to or competitive with, or superior to those we use or develop; or
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Another party may obtain a blocking patent and we or our licensors would need to either obtain a license or design around the patent in order to continue to offer the contested feature or service in our products.
Effective protection of intellectual property rights may be unavailable or limited in China or certain other countries. Policing the unauthorized use of our proprietary technology can be difficult and expensive. Litigation might be necessary to protect our intellectual property rights, which may be costly and may divert our management’s attention away from our core business. Furthermore, there is no guarantee that litigation would result in an outcome favorable to us. If we are unable to protect our proprietary rights adequately, it would have a negative impact on our operations.
We, or the owners of the intellectual property rights licensed to us, may be subject to claims that we or such licensors have infringed the proprietary rights of others, which could require us and our licensors to obtain a license or change designs.
Although we do not believe any of our products infringe upon the proprietary rights of others, there is no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against us or those from whom we have licenses or that any such assertions or prosecutions will not have a material adverse effect on our business. Regardless of whether any such claims are valid or can be asserted successfully, defending against such claims could cause us to incur significant costs and could divert resources away from our other activities. In addition, assertion of infringement claims could result in injunctions that prevent us from distributing our products. If any claims or actions are asserted against us or those from whom we have licenses, we may seek to obtain a license to the intellectual property rights that are in dispute. Such a license may not be available on reasonable terms, or at all, which could force us to change our designs.
We incur significant costs as a result of our operating as a public company and our management is required to devote substantial time to compliance with the regulatory requirements placed on a public company.
As a public company with substantial operations, we incur significant legal, accounting and other expenses. The costs of preparing and filing annual, quarterly and current reports, proxy statements and other information with the SEC and furnishing audited reports to shareholders is time-consuming and costly.
It has also been time-consuming, difficult and costly for us to develop and implement the internal controls and reporting procedures required by the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and this remains an ongoing process. Certain members of our management have limited or no experience operating a company whose securities are listed on a national securities exchange or with the rules and reporting practices required by the federal securities laws as applied to a publicly traded company. We have needed to recruit, hire, train and retain additional financial reporting, internal control and other personnel in order to develop and implement appropriate internal controls and reporting procedures. If we are unable to comply with the internal controls requirements of the Sarbanes-Oxley Act, we may not be able to obtain the independent accountant certifications required by the Sarbanes-Oxley Act.
If we fail to establish and maintain an effective system of internal controls, we may not be able to report our financial results accurately. Any inability to report and file our financial results accurately and timely could harm our business and adversely affect the trading price of our common stock.
We are required to establish and maintain internal controls over financial reporting and disclosure controls and procedures and to comply with other requirements of the Sarbanes-Oxley Act and the rules promulgated by the SEC. Our management has concluded that our internal control over financial reporting was effective as of December 31, 2017. See “Item 9A. Controls and Procedures.” However, our management, including our Chief Executive Officer and Chief Financial Officer, cannot guarantee that our internal controls and disclosure controls and procedures will prevent all possible errors. Because of the inherent limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the possibility that judgments in decision-making can be faulty and subject to simple error or mistake. Furthermore, controls can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, measures of control may become inadequate because of changes in conditions or the degree of compliance with policies or procedures may deteriorate. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
We are a holding company that depends on cash flow from our wholly owned subsidiaries to meet our obligations, and any inability of our subsidiaries to pay us dividends or make other payments to us when needed could disrupt or have a negative impact on our business.
We are a holding company with no material assets other than the stock of our wholly owned subsidiaries, Bright Swallow, Diamond Bar, Nova Furniture and Nova Samoa. We rely on dividends paid by our subsidiaries for our cash needs, including the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. If our subsidiaries are unable to pay us dividends and make other payments to us when needed because of regulatory restrictions or otherwise, we may be materially and adversely limited in our ability to make investments or acquisitions that could be beneficial to our business, pay dividends or otherwise fund and conduct our business.
We may not be able to attract the attention of major brokerage firms because we became public by means of a share exchange, which could limit our ability to obtain future capital and financing.
There may be risks associated with our becoming public by means of a share exchange, or reverse merger with a public shell company that had no revenues, operations or material assets prior to the time of the share exchange. Analysts of major brokerage firms may not provide coverage for our company because there is no incentive for brokerage firms to recommend the purchase of our common stock. Furthermore, we can give no assurance that brokerage firms will, in the future, want to conduct any secondary offerings on our behalf, which could limit our ability to obtain future capital and financing.
Risks Related to Business in China
If relations between the U.S. and China worsen, our business could be adversely affected and investors may be unwilling to hold or buy our stock and our stock price may decrease.
At various times during recent years, the U.S. and China have had significant disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversies between the U.S. and China, whether or not directly related to our business, could reduce the price of our common stock. These controversies also could make it more difficult for us to provide our products to our customers in the U.S. The international trade policies of China and the U.S. could adversely affect our business, and the imposition of trade sanctions relating to imports, taxes, import duties and other charges on imports from China, including those applied specifically to furniture products, or the imposition of taxes, import duties or other charges on exports to the U.S. could increase our costs and decrease our earnings.
The nature and application of many laws of China create an uncertain environment for business operations and they could have a negative effect on us.
The legal system in China is a civil law system. Unlike the common law system, the civil law system is based on written statutes in which decided legal cases have little value as precedents. In 1979, China began to promulgate a comprehensive system of laws and has since introduced many laws and regulations to provide general guidance on economic and business practices in China and to regulate foreign investment. Progress has been made in the promulgation of laws and regulations dealing with economic and commercial matters, but these recently enacted laws and regulations may not cover all aspects of business activities in China sufficiently. In particular, because these laws and regulations are relatively new, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, there may be certain instances when we may not be aware of our violation of these policies and rules until sometime after such violation.
The PRC government has enacted some laws and regulations dealing with matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. Our ability to enforce commercial claims or to resolve commercial disputes under these laws and regulations is unpredictable, however, because the implementation, interpretation and enforcement of these laws and regulations is limited and, given their relative newness, involve uncertainties. For example, contracts governed by PRC law tend to contain less detail than those under U.S. law and generally are not as comprehensive in defining the rights and obligations of the contracting parties. Consequently, contracts in China are more vulnerable to disputes and legal challenges than those in the U.S. In addition, contract interpretation and enforcement in China is not as developed as in the U.S., and the result of any contract dispute is subject to significant uncertainties. We currently are not subject to any contract dispute, but we cannot assure you that we will not be subject to future contract disputes with our suppliers and other customers under contracts governed by PRC law, and if such disputes arise, we cannot assure you that we will prevail.
Furthermore, the political, governmental and judicial systems in China are impacted sometimes by corruption. There is no assurance we will be able to obtain recourse in any legal disputes with the suppliers, customers or other parties with whom we conduct business, if desired, through China’s developing and sometimes corrupt judicial systems. Any rights we may have under PRC law to specific performance or to seek an injunction are severely limited, and without a means of recourse by virtue of the PRC legal system, we may be unable to prevent these situations from occurring. The occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.
PRC regulations relating to the registration requirements for PRC resident shareholders owning shares in offshore companies may subject our PRC resident shareholders to personal liability and limit our ability to acquire companies in China or to inject capital into our operating subsidiaries in China, limit our subsidiaries’ ability to distribute profits to us or otherwise materially and adversely affect our business.
SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment through Special Purpose Vehicles, or SAFE Circular 37, on July 4, 2014, which replaced the former circular commonly known as “SAFE Circular 75” promulgated by SAFE on October 21, 2005. SAFE Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, for the purpose of overseas investment and financing, with such PRC residents’ legally owned assets or equity interests in domestic enterprises or offshore assets or interests, referred to in SAFE Circular 37 as a “special purpose vehicle.” SAFE Circular 37 further requires amendment to the registration in the event of any significant changes with respect to the special purpose vehicle, such as an increase or decrease of capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. In the event that a PRC shareholder holding interests in a special purpose vehicle fails to fulfill the required SAFE registration, the PRC subsidiaries of that special purpose vehicle may be prohibited from making profit distributions to the offshore parent and from carrying out subsequent cross-border foreign exchange activities, and the special purpose vehicle may be restricted in its ability to contribute additional capital into its PRC subsidiary. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC law for evasion of foreign exchange controls. We cannot predict fully how Circular 37 will affect our business operations or future strategies because of ongoing uncertainty over how Circular 37 is interpreted and implemented, and how or whether SAFE will apply it to us.
We have requested our PRC resident beneficial owners to make the necessary applications, filings and amendments as required under SAFE regulations in connection with their equity interests in us. We attempt to ensure that our subsidiaries in China comply, and that our PRC resident beneficial owners subject to these rules comply, with the relevant SAFE regulations. We cannot provide any assurances that all of our present or prospective direct or indirect PRC resident beneficial owners will comply fully with all applicable registrations or required approvals. The failure or inability of our PRC resident beneficial owners to comply with the applicable SAFE registration requirements may subject these beneficial owners or us to fines, legal sanctions and restrictions described above.
Dividends distributed by us to our non-PRC resident shareholders may be subject to PRC withholding taxes.
Before the EIT Law came into effect on January 1, 2008, dividends paid to foreign investors by FIEs, such as dividends paid to us by our subsidiaries in China, were exempt from PRC withholding tax. We are a Nevada holding company and substantially all of our income is derived from dividends we receive from our subsidiaries, including those in China. Pursuant to the EIT Law, dividends generated after January 1, 2008, and distributed to us by our subsidiaries in China are subject to withholding tax at a rate of 10%, provided that we are determined by the relevant PRC tax authorities to be a “non-resident enterprise” under the EIT Law and hold at least 25% of the equity interest of our subsidiaries. If we are determined to be a “resident enterprise,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as “resident enterprises” for PRC enterprise income tax purposes. In addition, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC shareholders and with respect to gains derived by our non-PRC shareholders from transferring our shares.
The SAT promulgated “Notice on How to Understand and Determine the Beneficial Owners in Tax Agreement” on October 27, 2009, or SAT Circular 601, which provides guidance for determining whether a resident of a contracting state is the “beneficial owner” of an item of income under China’s tax treaties and tax arrangements. According to SAT Circular 601, a beneficial owner generally must be engaged in substantive business activities. An agent or conduit company will not be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits. The agent or conduit company normally refers to a company that is registered in a jurisdiction other than China and merely meets the minimum legal requirements on organizational form and is not engaged in substantive operational activities for manufacturing, distribution or management. It is still unclear how SAT Circular 601 is implemented by SAT or its local counterparts in practice and whether we could be recognized as a “beneficial owner.” If we are deemed a non-resident enterprise but not qualified as a beneficial owner, we will not be entitled to a reduced 5% withholding tax and the 10% withholding tax would be imposed on our dividend income received from our subsidiaries. As a result, our net income would be reduced and our operating results would be adversely affected.
Our compliance with the Foreign Corrupt Practices Act may put us at a competitive disadvantage, while our failure to comply with the Foreign Corrupt Practices Act may result in substantial penalties.
We are required to comply with the United States Foreign Corrupt Practices Act, or the FCPA, which prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Although we inform our personnel that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties. Non-U.S. companies, including some of our competitors, are not subject to the provisions of the FCPA. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time to time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage.
Risks Related to Our Securities
The market price for our common stock may be volatile, which could make it more difficult or impossible for an investor to sell our common stock for a positive return on their investment.
The trading price of our common stock may fluctuate widely in response to various factors, some of which are beyond our control. These factors include, but are not limited to, our quarterly operating results or the operating results of other companies in our industry, announcements by us or our competitors of acquisitions, new products, product improvements, commercial relationships, intellectual property, legal, regulatory or other business developments and changes in financial estimates or recommendations by stock market analysts regarding us or our competitors. In addition, the stock market in general, and the market for companies with substantial operations based in China or that became public by means of a reverse acquisition with a public shell company in particular, has experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated or disproportionate to their operating performance. These broad market fluctuations may materially affect our stock price, regardless of our operating results. Furthermore, the market for our common stock historically has been limited and we cannot assure you that a larger market will ever be developed or maintained. Market fluctuations and volatility, as well as general economic, market and political conditions, could reduce our market price. As a result, these factors may make it more difficult or impossible for you to sell our common stock for a positive return on your investment.
Shares of our common stock lack a significant trading market, which could make it more difficult for an investor to sell our common stock.
Our common stock began trading on The NASDAQ Stock Market LLC on January 17, 2014; however, there is no assurance that an active trading market in our common stock will develop, or if such a market develops, that it will be sustained. As a result, an investor may find it more difficult to dispose of our common stock.
Future sales of shares of our common stock by our shareholders could cause our stock price to decline.
Future sales of shares of our common stock could adversely affect the prevailing market price of our stock. As of March 23, 2018, Steven Qiang Liu, our largest shareholder and vice president of our subsidiary, Diamond Bar Outdoors, Inc., owned approximately 36% of our outstanding shares of common stock. If Mr. Liu sells a large number of shares, or if we issue a large number of shares, the market price of our stock could decline. Moreover, the perception in the public market that significant shareholders might sell shares of our stock could depress the market for our shares. If such shareholders sell substantial amounts of our common stock in the public market, such sales could create a circumstance commonly referred to as an “overhang,” in anticipation of which the market price of our common stock could fall. The existence of an overhang, whether or not sales have occurred or are occurring, also could make it more difficult for us to raise additional financing through the sale of equity or equity-related securities in the future at a time and price we deem reasonable or appropriate.
We may issue additional shares of our common stock or debt securities to raise capital or complete acquisitions, which would reduce the equity interest of our shareholders.
Our Articles of Incorporation, as amended, authorize the issuance of up to 75,000,000 shares of common stock, par value $0.001 per share. As of December 31, 2017, there were 46,808,073, authorized and unissued shares of our common stock available for future issuance among which 858,334 shares are issuable upon exercise of outstanding warrants, based on 28,191,927 shares of our common stock outstanding. Although we have no commitments as of the date of this report to issue our securities, we may issue a substantial number of additional shares of our common stock or debt securities to complete a business combination or to raise capital. On July 13, 2017, we filed a shelf registration statement on Form S-3 under which we 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.
On May 28, 2015, we entered into a Securities Purchase Agreement (the “2015 Purchase Agreement”) with certain purchasers (the “Purchasers”) pursuant to which we 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. 2,000,001 shares of our common stock were sold to the Purchasers at a negotiated purchase price of $2.00 per share, for aggregate gross proceeds to us of $4,000,002, before deducting fees to the placement agent and other estimated offering expenses payable by us. In accordance with the terms of the 2015 Purchase Agreement, the outstanding Series A Warrants described above and issued in connection with the transactions contemplated by the 2014 Purchase Agreement were exchanged for 660,030 shares of our Common Stock, and the outstanding Series C Warrants described above and issued in connection with the transactions contemplated by the 2014 Purchase Agreement were exchanged for 310,478 Shares of our Common Stock.
As contemplated under the 2015 Purchase Agreement and pursuant to a concurrent private placement, we also sold to the Purchasers a warrant to purchase one share of our Common Stock for each share purchased for cash in the offering, pursuant to that certain Common Stock Purchase Warrant, by and between us and each Purchaser (the “2015 Warrants”). The 2015 Warrants are 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 our Common Stock under the 2015 Warrants is equal to the exercise price.
The issuance of additional shares of our common stock may significantly reduce the equity interest of our existing shareholders and adversely affect prevailing market prices for our common stock.
We do not expect to pay dividends in the foreseeable future. Any return on investment may be limited to the value of our common stock.
We do not anticipate paying cash dividends on our common stock in the foreseeable future. The payment of dividends on our common stock will depend on earnings, financial condition and other business and economic factors affecting it at such time as the Board of Directors may consider relevant. Furthermore, China has currency and capital transfer regulations that require us to comply with complex regulations for the movement of capital and restrict the amount of capital available for distribution as dividends from our subsidiaries in China. See “Risks Related to Our Business - We are a holding company that depends on cash flow from our wholly owned subsidiaries to meet our obligations, and any inability of our subsidiaries to pay us dividends or make other payments to us when needed could disrupt or have a negative impact on our business.” Although our management believes we are in compliance with these regulations, should these regulations or their interpretation by PRC courts or regulatory agencies change, we may not be able to pay dividends to our shareholders outside of China. Our management intends to follow a policy of retaining all of our earnings to finance the development and execution of our strategy and the expansion of our business. If we do not pay dividends, our common stock may be less valuable because a return on your investment will occur only if our stock price appreciates.
Our principal shareholders have the ability to exert significant control in matters requiring a shareholder vote and could delay, deter or prevent a change of control in our company.
As of March 23, 2018, Steven Qing Liu, our largest shareholder, owned approximately 36% of our outstanding shares of common stock. Mr. Liu may exert significant influence over us, giving him the ability, among other things, to exercise significant control over the election of all or a majority of the Board of Directors and to approve significant corporate transactions. Such share ownership and control may also have the effect of delaying or preventing a future change in control, impeding a merger, consolidation, takeover or other business combination, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company. Without the consent of Mr. Liu, we could be prevented from entering into potentially beneficial transactions if such transactions conflict with our principal shareholder’s interests. The interests of Mr. Liu may differ from the interests of our other shareholders.
Provisions in the Nevada Revised Statutes and our Amended and Restated Bylaws could make it very difficult for an investor to bring any legal actions against our directors or officers for violations of their fiduciary duties or could require us to pay any amounts incurred by our directors or officers in any such actions.
Members of our Board of Directors and our officers will have no liability for breaches of their fiduciary duty of care as a director or officer, except in limited circumstances, pursuant to provisions in the Nevada Revised Statutes and our Amended and Restated Bylaws as authorized by the Nevada Revised Statutes. Specifically, Section 78.138 of the Nevada Revised Statutes provides that a director or officer is not individually liable to the company or its shareholders or creditors for any damages as a result of any act or failure to act in his or her capacity as a director or officer unless it is proven that (1) the director’s or officer’s act or failure to act constituted a breach of his or her fiduciary duties as a director or officer and (2) his or her breach of those duties involved intentional misconduct, fraud or a knowing violation of law. This provision is intended to afford directors and officers protection against and to limit their potential liability for monetary damages resulting from suits alleging a breach of the duty of care by a director or officer. Accordingly, you may be unable to prevail in a legal action against our directors or officers even if they have breached their fiduciary duty of care. In addition, our Amended and Restated Bylaws allow us to indemnify our directors and officers from and against any and all costs, charges and expenses resulting from their acting in such capacities with us. This means that if you were able to enforce an action against our directors or officers, in all likelihood, we would be required to pay any expenses they incurred in defending the lawsuit and any judgment or settlement they otherwise would be required to pay. Accordingly, our indemnification obligations could divert needed financial resources and may adversely affect our business, financial condition, results of operations and cash flows, and adversely affect prevailing market prices for our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
Our principal executive offices and those of Diamond Bar are in leased office space with showroom, distribution and warehouse space in Commerce, California. Diamond Bar also maintains showrooms in leased space at Las Vegas Market in Nevada and High Point Market in North Carolina. Nova Macao leases office space in Macao. Bright Swallow leases office space in Hong Kong.
We believe that our existing office and distribution facilities are adequate for current and presently foreseeable operations. In general, our properties are well maintained, considered adequate and being utilized for their intended purposes. See Note 14 to our consolidated financial statements contained herein, which disclose lease agreements.
Item 3.
Item 3. Legal Proceedings
We may 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 may arise from time to time that may have an adverse effect on our business, financial conditions 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 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Since January 17, 2014, our common stock has been quoted on The NASDAQ Stock Market under the symbol “NVFY.”
The following table sets forth the range of the high and low bid prices per share of our common stock for each quarter (or portion thereof) as reported on The NASDAQ Stock Market during 2016 and 2017.
Holders of Record
On March 23, 2018, there were approximately 45 record holders of record based on information provided by our transfer agent. Many of our shares of common stock are held in street or nominee name by brokers and other institutions on behalf of shareholders and we are unable to estimate the total number of shareholders represented by these record holders.
Dividend Policy
Dividends may be declared and paid out of legally available funds at the discretion of our Board of Directors. We do not anticipate or contemplate paying dividends on our common stock in the foreseeable future. The timing, amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors. We currently intend to utilize all available funds to develop our business.
Shelf Registration
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.
Item 6.
Item 6. Selected Financial Data
Not required.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Safe Harbor Declaration
The following discussion and analysis of the consolidated financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from the results described in or implied by these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly under the heading “Risk Factors.”
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; the purchase price was $6.5 million in cash and was fully paid at the closing of the acquisition.
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.
Discontinued Operations
On September 23, 2016, Nova Furniture, a wholly-owned subsidiary of the Company (the “Seller”), entered into a Share Transfer Agreement (the “Agreement”) with Kuka Design Limited, an unrelated company incorporated in British Virgin Islands (“Kuka Design BVI” or “Buyer”). Pursuant to the terms of the Agreement, the Seller sold all of the outstanding equity interests in Nova Dongguan, a wholly owned subsidiary of the Seller, to the Buyer for a total of $8,500,000 (the “Transaction”), which such value was primarily derived from Nova Dongguan and Nova Dongguan’s wholly owned subsidiary, Nova Museum, and 90.97% owned subsidiary, Ding Nuo. Upon consummation of the Transaction on October 25, 2016, the Buyer became the sole owner of Nova Dongguan. The purchase price of $8,500,000 was fully paid on October 6, 2016.
On November 10, 2016, Nova Furniture (“Assignor”) entered into a Trademark Assignment Agreement with Kuka Design BVI (“Assignee”). Pursuant to the terms of the Trademark Assignment Agreement, Assignor agreed to assign to the Assignee its full right to, and title in, the NOVA trademark in China for $6,000,000 (the “Assignment Fee”). Assignee was to pay the Assignment Fee in two installments: $1,000,000 on or before November 30, 2016, and $5,000,000 on or before December 31, 2016. As of December 31, 2016, $4,750,000 had been received, and the remaining balance of $1,250,000 was fully paid in January 2017.
As a result, the operations of Nova Dongguan, Nova Museum and Ding Nuo are now accounted for as discontinued operations in the accompanying consolidated financial statements for all periods presented.
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, 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
While our significant accounting policies are described more fully in Note 2 to our accompanying consolidated financial statements, we believe the following accounting policies are the most critical to aid you in fully understanding and evaluating this Management Discussion and Analysis.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for Nova LifeStyle and its subsidiaries, Diamond Bar, Bright Swallow, Nova Macao, Nova Furniture and Nova Samoa, and its former subsidiaries, Nova Dongguan, Nova Museum and Ding Nuo.
Use of Estimates
In preparing consolidated financial statements in conformity with U.S. GAAP, we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made by us, include, but are not limited to, the allowance for bad debt, valuation of inventories, unrecognized tax benefits, valuation allowance for deferred tax assets, assumptions used in assessing impairment of long-lived assets and goodwill and fair value of warrant derivative liability. Actual results could differ from those estimates.
Accounts Receivable
Our policy is to maintain an allowance for potential credit losses on accounts receivable. We review the composition of accounts receivable and analyze historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. We maintained an allowance for bad debt of $218,976 and $3,019,931 as of December 31, 2017 and 2016, respectively. During the years ended December 31, 2017 and 2016, bad debts from continuing operations were $305,519 and $2,603,745, respectively. As of December 31, 2017, we had gross receivable of $54,225,489, of which $19,807,241 was over 90 days but within 180 days past due and $0 over 180 days past due. As of December 31, 2016, we had gross receivable of $45,122,692, of which $7,250,188 was over 90 days but within 180 days past due and $6,301,315 over 180 days past due. The long overdue balances as of December 31, 2016 were mainly related to Nova Macao’s customers in the U.S. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing trade accounts receivable. We determine the allowance based on historical bad debt experience, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns.
During the year ended December 31, 2016, bad debts from discontinued operations were $512,978.
Advances to Suppliers
Advances to suppliers are reported net of allowance when we determine that amounts outstanding are not likely to be collected in cash or utilized against purchase of inventories. Based on our historical record and actual practice, we 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 us. Any provisions for allowance for advance to suppliers, if deemed necessary, will be included in general and administrative expenses in the consolidated statements of comprehensive income.
Income Taxes
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.
We follow 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 and Diamond Bar are subject to U.S. federal and state corporate income taxes on their taxable income at a rate of up to 21% for taxable years beginning after December 31, 2017 and U.S. corporate income tax on their taxable income of up to 35% for prior tax years. 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 us 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. Taxpayers may elect to pay the one-time transition tax over eight years, or in a single lump-sum payment.
To the extent that portions of our U.S. taxable income, such as Subpart F income or GILTI, are determined to be from sources outside of the U.S., subject to certain limitations, we may be able to claim foreign tax credits to offset our U.S. income tax liabilities. Any remaining liabilities are accrued in our consolidated statements of comprehensive income and estimated tax payments are made when required by U.S. law.
Revenue Recognition
Our revenue recognition policies are in compliance with ASC Topic 605, “Revenue Recognition.” Sales revenue is recognized when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of ours exist and collectability is reasonably assured. No revenue is recognized if there are significant uncertainties regarding the recovery of the consideration due, or the possible return of the goods. Payments received before all of the relevant criteria for revenue recognition are recorded as unearned revenue.
Sales revenue represents the invoiced value of goods, net of value-added taxes, or VAT. All of our products sold in China are subject to VAT of 17% of the gross sales price. This VAT may be offset by VAT paid by us on raw materials and other materials purchased in China and included in the cost of producing the finished product. We record VAT payable and VAT receivable net of payments in the consolidated financial statements. The VAT tax return is filed offsetting the payables against the receivables. Sales and purchases are recorded net of VAT collected and paid when we act as an agent for the PRC government.
Our sales policy allows for the return of product within the warranty period if the product is defective and the defects are our fault. As alternatives for the product return option, the customers have options of asking a discount from us for the products with quality issues or receiving replacement parts from us at no cost. The amount for return of products, the discount provided to the customers and cost for the replacement parts were immaterial for the years ended December 31, 2017 and 2016.
Foreign Currency Translation and Transactions
The accompanying consolidated financial statements are presented in USD. The functional currency of Nova LifeStyle, Nova Samoa, Nova Furniture, Nova Macao, Bright Swallow and Diamond Bar is the United States Dollar (“$” or “USD”). The functional currency of our former PRC subsidiaries, Nova Dongguan, Nova Museum and Ding Nuo, is RMB. The functional currencies of our foreign operations are translated into USD for balance sheet accounts using the current exchange rates in effect as of the balance sheet date, except for equity account using the historical exchange rate, and for revenue and expense accounts using the weighted-average exchange rate during the fiscal year. The translation adjustments are recorded in the consolidated statements of income and comprehensive income, captioned “Accumulated other comprehensive income.” Gains and losses resulting from transactions denominated in foreign currencies are included in “Other income (expenses)” in the consolidated statements of income and comprehensive income. There have been no significant fluctuations in the exchange rate for the conversion of RMB to USD after the balance sheet date.
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.
We determined that our operations constitute a single reportable segment in accordance with ASC 280. We operate exclusively in one business and industry segment: the design and sale of furniture.
We concluded that we 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. Each of our subsidiaries is operated under the same senior management of our company, and we view the operations of Diamond Bar, Bright Swallow and Nova Macao as a whole for making business decisions.
Prior to the disposal of Nova Dongguan, our furniture products sold through Nova Dongguan, Nova Macao, and Ding Nuo were created with similar production processes, in the same facilities, under the same regulatory environment and sold to customers using similar distribution systems. Although Nova Museum was principally engaged in the dissemination of the culture and history of furniture in China, it also served a function of promoting and marketing our image and products by providing a platform and channel for consumers to be exposed to us and our products, it was operated under the same management with the same resources and in the same location as Nova Dongguan, and it was an additive and supplemental unit to our main operations, the design and sale of furniture.
Until the disposal of Nova Dongguan and its subsidiaries, all of our long-lived assets for production were located at our facilities in Dongguan, Guangdong Province, China, and operated within the same environmental, safety and quality regulations governing furniture manufacturers. After the disposal of Nova Dongguan and its subsidiaries, our 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 our customers. For example, if the products are delivered to a customer in the U.S., 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 Accounting Standards Update (“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. We are in the process of evaluating the impact of adoption of this ASU on the consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB approved a one-year deferral of the effective date of the new revenue recognition standard. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 31, 2016, including interim reporting periods within that reporting period. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue versus Net). In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing. In May 2016, the FASB issued ASU 2016-11, Revenue from Contracts with Customers (Topic 606) and Derivatives and Hedging (Topic 815) - Rescission of SEC Guidance Because of ASU 2014-09 and 2014-16, and ASU 2016-12, Revenue from Contracts with Customers (Topic 606) - Narrow Scope Improvements and Practical Expedients. These ASUs clarify the implementation guidance on a few narrow areas and adds some practical expedients to the guidance Topic 606. In the fourth quarter of 2017, we completed the evaluation of our adoption of ASU 2014-09 (including those subsequently issued updates that clarify ASU 2014-09’s provisions) and finalized our determination of the impact of the guidance on revenue recognition. We do not expect the new revenue standard to have a material impact on our consolidated financial statements.
On March 30, 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which includes amendments to accounting for income taxes at settlement, forfeitures, and net settlements to cover withholding taxes. The amendments in ASU 2016-09 are effective for public companies for fiscal years beginning after December 31, 2016, and interim periods within those annual periods. We adopted ASU 2016-09 on January 1, 2017. Upon adoption, we recorded a reduction in deferred tax asset of $0.4 million for previously unrecognized excess tax benefits from stock-based compensation, resulting in a reduction to opening retained earnings. In addition and as provided for under this guidance, we made an accounting policy election to recognize forfeitures as they occur. The adoption of this aspect of the guidance did not have a material impact on our consolidated financial statements and related disclosures.
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. We are currently evaluating the impact that the standard will have on our 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. This ASU is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted. We do not expect the standard to have a material impact on us.
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. We do not anticipate that the adoption of this ASU will have a significant impact on our 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. Early adoption is permitted, including adoption in an interim period. The standard should be applied using a retrospective transition method to each period presented. We do not anticipate that the adoption of this ASU will have a significant impact on our consolidated financial statements.
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. Early adoption is permitted. The standard should be applied prospectively on or after the effective date. We 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. We are currently evaluating the impact of adopting this standard on our consolidated financial statements.
Results of Operations
Comparison of Years Ended December 31, 2017 and 2016
The following table sets forth the results of our operations for the years ended December 31, 2017 and 2016. Certain columns may not add due to rounding.
Net Sales
Net sales for the year ended December 31, 2017 were $106.49 million, an increase of 15% from $92.65 million in the same period of 2016. This increase in net sales resulted primarily from a 71% increase in average selling price, which was partially offset by a 33% decrease in sales volume. Our largest selling product categories in the year ended December 31, 2017 were sofas, television cabinets and beds, which accounted for approximately 54%, 16% and 10% of sales, respectively. In the year ended December 31, 2016, the largest three selling categories were sofas, beds and dining tables, which accounted for 61%, 11% and 7% of sales, respectively.
The $13.85 million increase in net sales in the year ended December 31, 2017, compared to the same period of 2016, was mainly due to increased sales to Australia, China and Asia. North American sales decreased by 14.5% to $49.77 million in the year ended December 31, 2017, compared to $58.20 million in 2016. Europe sales decreased by 72.3% to $3.46 million in the year ended December 31, 2017, compared to $12.49 million in the same period of 2016. Hong Kong sales decreased by 81.2% to $0.47 million in the year ended December 31, 2017, compared to $2.50 million in the same period of 2016. Sales in these regions decreased as we gradually stopped selling low margin, low quality products after the sale of our factory in China in connection with our discontinued operations. We aggressively changed our product mix and our sales and marketing strategies targeted at high-end products and customers. We will continue to maintain our marketing efforts in those regions. Sales to Australia increased 431.8% to $25.90 million in the year ended December 31, 2017, compared to $4.87 million in the same period of 2016, primarily as a result of increased sales orders from one of our customers in Australia who was involved in projects in many hotels and apartments during 2017. We do not anticipate that such significant sales orders will continue in the near future from that customer. Sales to China were $14.60 million in the year ended December 31, 2017, an increase of 46.0% from $10.00 million in the same period of 2016, primarily due to increasing sales order from a Chinese customer who is building a senior care facility in China. Sales to Asia, excluding China and Hong Kong, increased by 182.3% to $12.28 million in the year ended December 31, 2017, compared to $4.35 million in the same period of 2016, primarily due to the increases of sales orders from one of our customers who expanded its business in Asia.
Cost of Sales
Cost of sales consists primarily of finished goods purchased from other manufacturers. Total cost of sales increased by 9% to $86.07 million in the year ended December 31, 2017, compared to $79.12 million in the same period of 2016. Cost of sales as a percentage of sales decreased to 81% in the year ended December 31, 2017, compared to 85% in the same period of 2016. The increase in cost of sales in dollar terms resulted primarily from increased costs of higher quality products purchased from third party manufacturers. However, due to our marketing efforts, we were able to secure more high-end customers who are willing to pay such higher prices. As a result, cost of sales as a percentage of sales decreased in 2017.
Gross Profit
Gross profit increased by 51% to $20.42 million in the year ended December 31, 2017, compared to $13.52 million in the same period of 2016. Our gross profit margin increased to 19% in the year ended December 31, 2017, compared to 15% in the same period of 2016. 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 to secure more high-end customers who are willing to pay higher prices for our products.
Operating Expenses
Operating expenses consist of selling, general and administrative expenses and research and development expenses. Operating expenses were $13.62 million in the year ended December 31, 2017, compared to $14.29 million in the same period of 2016. Selling expenses decreased by 22% or $1.19 million to $4.13 million in the year ended December 31, 2017, from $5.32 million in the same period of 2016, due primarily to decreased sales and marketing expenses since we decreased advertising on shows and television in the U.S. General and administrative expense increased by 6% or $0.52 million to $9.49 million in the year ended December 31, 2017, from $8.97 million in the same period of 2016, primarily due to increase in amortization expense of approximately $0.92 million on our intangible assets (see note 6 to our consolidated financial statements), increase in consulting fees and entertaining and travelling expenses of approximately $0.65 million and $0.25 million, respectively, and a one-time termination cost on Academic E-commerce platform of approximately $0.80 million (see note 7 to our consolidated financial statements), offset by a reduction of bad debt expenses of approximately $2.30 million.
Other Expenses, Net
Other expenses, net, was $279,446 in the year ended December 31, 2017, compared with other expense, net, of $362,564 in the same period of 2016, representing a decrease in other expense of $0.08 million. The decrease in other expense was due primarily to the decreased interest expense on our lines of credit to $174,316 in the year ended December 31, 2017 from $283,795 in the same period of 2016.
Income Tax Benefit (Expense)
Income tax expense was $2,759,813 in the year ended December 31, 2017, compared with $836,620 of income tax benefit in the same period of 2016. The income tax expense in 2017 was mainly due to a one-time transition tax expense of $3.27 million, which was recognized in the fourth quarter of 2017 and 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 in accordance with recent changes in U.S. tax laws and regulations. We may elect to pay the one-time transition tax over eight years commencing in April 2018, or in a single lump-sum payment. The income tax benefit in 2016 was mainly due to the deferred tax on our NOL carryforwards in the U.S. and a reversal of our tax liability reserves due to a statute of limitations expiration, partially offset by accruing interest on prior year ASC 740-10 (FIN 48) reserves.
Loss from Discontinued Operations
The subsidiaries that were sold on October 25, 2016, Nova Dongguan, Nova Museum, and Ding Nuo, are reported as discontinued operations in our consolidated financial statements. Loss from discontinued operations, net of tax, was approximately $0.83 million for the year ended December 31, 2016.
Net Income (Loss)
As a result of the foregoing, our net income was $3.76 million in the year ended December 31, 2017, as compared with $1.12 million of net loss for the same period of 2016.
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. During 2016, we raised approximately $3.09 million from exercise of warrants.
We had net working capital of $72,236,890 at December 31, 2017, an increase of $13.83 million from net working capital of $58,407,707 at December 31, 2016. The ratio of current assets to current liabilities was 27.95-to-1 at December 31, 2017.
The following is a summary of cash provided by or used in each of the indicated types of activities during the years ended December 31, 2017 and 2016:
Net cash used in operating activities was $1.31 million in the year ended December 31, 2017, a reduction of cash outflow of $5.11 million from $6.42 million of cash used in operating activities in 2016. The reduction of cash outflow was attributable primarily to (i) an increased cash inflow of $5.09 million from advances to suppliers in 2017, compared with $5.73 million outflow in 2016, due in part to the fact that product orders prepaid to a mattress supplier in 2016 were delivered in 2017; and (ii) a reduction in cash outflow for accounts payable, from $3.86 million in fiscal 2016 to $0.73 million in fiscal 2017. The reduction in cash outflow was partially offset by (i) an increased cash outflow from inventories of $3.59 million in the year ended December 31, 2017, compared to $0.27 million of cash outflow in 2016; and (ii) an increased cash outflow from accounts receivable of $12.2 million during the year ended December 31, 2017, compared to $2.02 million of cash outflow in 2016. This increase was mainly a result of providing longer payment terms to our long-term relationship customers. Net operating cash inflow from our discontinued operations was $1.71 million in the year ended December 31, 2016.
Net cash provided by investing activities was $8.22 million in the year ended December 31, 2017, an increase of cash inflow of $2.12 million from $6.10 million inflow in the same period of 2016. In the year ended December 31, 2017, we received a cash inflow of $15.84 million from repayment from unrelated parties, an inflow of $1.25 million on collection of an assignment fee, which were partially offset by a cash outflow from advances to unrelated parties of $8.84 million, and a cash outflow of $26,818 from purchase of property and equipment. In the year ended December 31, 2016, we received $13.21 million from the disposal of subsidiaries, which was partially offset by a cash outflow from advances to unrelated parties of $7.00 million, and paid $13,494 for purchasing property and equipment. Net investing cash outflow from our discontinued operations was $94,231 in the year ended December 31, 2016.
Net cash used in financing activities was $3.78 million in the year ended December 31, 2017, an increase of cash outflow of $5.70 million from cash inflow of $1.93 million in the same period of 2016. In the year ended December 31, 2017, we repaid $52.45 million on bank loans, and borrowed $48.67 million from bank loans. In the year ended December 31, 2016, we repaid $43.93 million for bank loans, borrowed $44.41 million from bank loans, and had $3.10 million cash received from warrant exercises. Net financing cash outflow from discontinued operations was $1.64 million in the year ended December 31, 2016.
As of December 31, 2017, we had gross accounts receivable of $54,225,489, of which $21,651,964 was not yet past due, $12,766,284 was less than 90 days past due, $19,807,241 was over 90 days but within 180 days past due and $0 over 180 days past due. We had an allowance for bad debt of $218,976 for accounts receivable. As of March 19, 2018, $15,740,026 accounts receivable outstanding at December 31, 2017 had been collected.
As of March 19, 2018, $45,122,692, or 100%, of accounts receivable outstanding at December 31, 2016 had been collected.
As of December 31, 2017 and 2016, we had advances to suppliers of $8,580,609 and $13,669,752, 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 decreased by $5.09 million due in part to the fact that product orders prepaid to a mattress supplier in 2016 were delivered in 2017. We made prepayment to our suppliers in order to secure our purchasing power over new materials and priority position of our production lines with our suppliers, especially when we are introducing eight new product lines in 2017. Also, the decision for such advances is to establish long term relationship with our suppliers.
With the tightening regulations and enforcement on environmental issues in recent years in China, where our suppliers are located, many factories have been affected 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 December 31, 2017 and December 31, 2016, 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 March 19, 2018, $8,193,051, or 95%, of our advance to suppliers outstanding at December 31, 2017 had been delivered to us in the form of inventory purchase.
The balance of $8,580,609 advance to suppliers outstanding at December 31, 2017 is expected to be delivered to us in the form of inventory purchase through the second quarter in 2018.
Private Placements
On April 14, 2014, we entered into a Securities Purchase Agreement (the “2014 Purchase Agreement”) with certain purchasers (the “Buyers”) pursuant to which we sold to the Buyers, in a registered direct offering, an aggregate of 1,320,059 shares of common stock, par value $0.001 per share, at a negotiated purchase price of $6.78 per share, for aggregate gross proceeds to us of $8.95 million, before deducting fees to the placement agent of $716,000 and other estimated offering expenses of $20,000 payable by us.
As part of the transaction, the Buyers also received (i) Series A warrants to purchase up to 660,030 shares of common stock in the aggregate at an exercise price of $8.48 per share (the “Series A Warrants”); (ii) Series B warrants to purchase up to 633,628 shares of common stock in the aggregate at an exercise price of $6.82 per share (the “Series B Warrants”); and (iii) Series C warrants to purchase up to 310,478 shares of common stock in the aggregate at an exercise price of $8.53 per share (the “Series C Warrants” and together with the Series A Warrants and the Series B Warrants, the “Warrants”). The Series A Warrants had a term of four years and were exercisable by the holders at any time after the date of issuance. The Series B Warrants had a term of six months and were exercisable by the holders at any time after the date of issuance. The Series C Warrants had a term of four years and were exercisable by the holders at any time after the date of issuance. After the six month anniversary of the issuance date of the Series C Warrants, to the extent that a holder of Series C Warrant had exercised less than 70% of such holder’s Series B Warrants and the closing sale price of the common stock was equal to or greater than $9.81 for a period of ten consecutive trading days, then we were entitled to purchase the entire then-remaining portion of such holder’s Series C Warrants for $1,000. The shares and warrants were registered on a takedown of our shelf registration statement described below. The Series B Warrants expired on October 14, 2014, and none of the Series B Warrants were exercised prior to such expiration.
On May 28, 2015, we entered into a Securities Purchase Agreement (the “2015 Purchase Agreement”) with certain purchasers (the “Purchasers”) pursuant to which we 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 shares, 2,000,001 shares were sold to the Purchasers at a negotiated purchase price of $2.00 per share, for aggregate gross proceeds to us of $4,000,002, before deducting fees to the placement agent and other estimated offering expenses payable by us. In accordance with the terms of the 2015 Purchase Agreement, the outstanding Series A Warrants described above and issued in connection with the transactions contemplated by the 2014 Purchase Agreement were exchanged for 660,030 shares of our common stock, and the outstanding Series C Warrants described above and issued in connection with the transactions contemplated by the 2014 Purchase Agreement were exchanged for 310,478 Shares of our common stock.
As contemplated under the 2015 Purchase Agreement and pursuant to a concurrent private placement, we also sold to the Purchasers a warrant to purchase one share of our common stock for each share purchased for cash in the offering, pursuant to that certain common stock Purchase Warrant, by and between us and each Purchaser (the “2015 Warrants”). The 2015 Warrants are 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 our common stock under the 2015 Warrants is equal to the exercise price.
Lines of Credit
Diamond Bar entered into an agreement with a bank in California for a line of credit of up to $5,000,000 with annual interest of 4.25% 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 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 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 was 4.5% as of December 31, 2017. The line of credit is secured by all of the assets of Diamond Bar and is guaranteed by Nova LifeStyle. As of December 31, 2017 and 2016, Diamond Bar had $4,202,118 and $6,129,841 outstanding on the line of credit, respectively. During the years ended December 31, 2017 and 2016, the Company recorded interest expense of $187,097 and $213,967, respectively. As of December 31, 2017, Diamond Bar had $3,797,882 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 1.0% of total revenue quarterly; and (iv) maintain a current ratio in excess of 1.25 to 1.00. As of December 31, 2017, 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 December 31, 2017 and 2016, Nova Macao had $0 and $1,848,000 outstanding on the line of credit, respectively. During the years ended December 31, 2017 and 2016, Nova Macao paid interest of $0 and $69,830, respectively.
On April 25, 2012, Nova Dongguan entered into an agreement with a commercial bank in Dongguan for a line of credit of up to $3,016,045 (RMB 20 million) with maturity on April 24, 2015. On November 20, 2014, the Company paid off the line of credit and entered into a new agreement with a reduced line of credit of up to $1,508,023 (RMB 10 million) with a maturity on May 19, 2015. On May 5, 2015, Nova Dongguan extended the line of credit of $527,808 (RMB 3.5 million) and $980,215 (RMB 6.5 million) with maturities on September 6, 2015 and October 18, 2015, respectively. On September 21, 2015, Nova Dongguan paid off the lines of credit and entered into a new agreement with an increased line of credit of up to $3,016,045 (RMB 20 million) for a period up to September 20, 2018. As of October 31, 2016 and 2015, Nova Dongguan had $1,049,659 (RMB 7.10 million) and $2,756,560 (RMB 17.9 million) outstanding, respectively. The loan of $1,931,773 (RMB 12.9 million) currently bears monthly interest of 0.51458% and requires monthly payment of the interest. The loan is due for repayment on September 24, 2016. On September 23, 2016, this line of credit was extended to October 24, 2016. On October 24, 2016, Nova Dongguan paid off this loan. On November 10, 2015, Nova Dongguan borrowed an additional $748,750 (RMB 5.0 million), which bears monthly interest of 0.47125% and requires monthly payment of the interest with maturity date on November 9, 2016.
On January 26, 2016, Nova Dongguan borrowed an additional $314,475 (RMB 2.1 million), which bears monthly interest of 0.47125% and requires monthly payment of the interest with maturity date on January 25, 2017. The loans are secured by the buildings of Nova Dongguan and guaranteed by the Company’s former CEO. During the year ended December 31, 2016, the Company recorded interest expense of $145,645 for discontinued operations related to the applicable line of credit agreements. This line of credit was disposed of on the date of sales of subsidiaries (See Note 3 - Discontinued Operations).
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 December 31, 2017, we recorded long-term taxes payable of $4.53 million, consisting of an income tax payable of $2.50 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 U.S. Tax Reform, and a $2.03 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 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not required.
Item 8.
Item 8. Financial Statements and Supplementary Data
Our financial statements, together with the report thereon, appear in a separate section of this Annual Report beginning on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. 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 annual 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 December 31, 2017, our disclosure controls and procedures were effective.
Internal Control over Financial Reporting
Our management, with oversight from our audit committee effective as of June 4, 2013, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting includes those policies and procedures that: (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. In designing and evaluating internal controls, management recognizes that any internal controls, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of control systems must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Our management, including our Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2017, including the remediation of the material weakness disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016, based upon the updated framework in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in 1992 and updated in May 2013. Based on this assessment, our management concluded that, as of December 31, 2017, our internal control over financial reporting was effective.
Changes in Internal Control over Financial Reporting
As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016, our management identified a material weakness in our internal control over financial reporting as of December 31, 2016, specifically owing to the fact that we lacked sufficient accounting personnel with the appropriate level of knowledge, experience and training in U.S. GAAP and SEC reporting requirements.
This material weakness has been remediated since Jeffery Chuang has joined Nova as our CFO since August 22, 2017. Mr. Chuang received his Bachelor of Science in Finance from California State University, Northridge in 1997 and his Master of Science in Taxation from Golden Gate University in 2006. Mr. Chuang is a Certified Public Accountant and is a member of California Society of Certified Public Accountants.
Except as set forth above with respect to remediating the previously reported material weakness, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the year ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information relating to nominees for director of Nova LifeStyle, compliance with Section 16(a) of the Securities Exchange Act of 1934, and the Company’s code of ethics is set forth under the captions “Proposal 1-Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance,” and “Code of Ethics,” respectively, in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 25, 2018. Such information is incorporated herein by reference. The definitive Proxy Statement will be filed with the Securities and Exchange Commission no later than 120 days after December 31, 2017.
Item 11.
Item 11. Executive Compensation
Information required by this Item 11 relating to executive compensation and other matters is set forth under the captions “Executive Compensation,” “Non-Employee Director Compensation,” and “Corporate Governance” in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information related to ownership of common stock of Nova LifeStyle by certain persons is set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information relating to existing or proposed relationships or transactions between Nova LifeStyle and any affiliate of Nova LifeStyle, as well as matters related to director independence, is set forth under the caption “Certain Relationships and Related Transactions” in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
Information relating to Nova LifeStyle’s principal accountant’s fees and services is set forth under the caption “Principal Accountant Fees and Services” in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
The following documents are filed as part of or are included in this Annual Report:
1.
Financial statements listed in the Index to Financial Statements, filed as part of this Annual Report beginning on page; and
2.
Exhibits
Exhibit No.
Description
2.1
Agreement and Plan of Merger by and between Stevens Resources, Inc. and Nova LifeStyle, Inc., dated June 14, 2011 (Incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
2.2
Share Exchange Agreement and Plan of Reorganization by and between Nova Furniture Limited and Nova LifeStyle, Inc., dated June 30, 2011 (Incorporated herein by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
2.3
Return to Treasury Agreement by and between Nova LifeStyle, Inc. and Alex Li, dated June 30, 2011 (Incorporated herein by reference to Exhibit 2.3 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.1
Articles of Incorporation (Incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (File No. 333-163019) filed on November 10, 2009)
3.2
Amended and Restated Bylaws (Incorporated herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.3
Certificate of Amendment to Articles of Incorporation filed with the Secretary of the State of Nevada on December 15, 2009, and effective as of September 9, 2009 (Incorporated herein by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.4
Articles of Merger between Stevens Resources, Inc. and Nova LifeStyle, Inc. amending the Articles of Incorporation filed with the Secretary of State of the State of Nevada on June 14, 2011, and effective as of June 27, 2011 (Incorporated herein by reference to Exhibit 3.4 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.5
Articles of Exchange of Nova Furniture Limited and Nova LifeStyle, Inc. filed with the Secretary of State of the State of Nevada on June 30, 2011 (Incorporated herein by reference to Exhibit 3.5 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
4.1
Specimen Stock Certificate (Incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
4.2
Form of Regulation S Subscription Agreement (Incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.3
Form of Regulation D Subscription Agreement (Incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.4
Form of Regulation S Warrant (Incorporated herein by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.5
Form of Regulation D Warrant (Incorporated herein by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.6
Form of Regulation S Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.7
Form of Regulation D Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.7 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.8
Form of Regulation S Subscription Agreement (Incorporated herein by reference to Exhibit 4.8 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.9
Form of Regulation D Subscription Agreement (Incorporated herein by reference to Exhibit 4.9 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.10
Form of Regulation S Warrant (Incorporated herein by reference to Exhibit 4.10 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.11
Form of Regulation D Warrant (Incorporated herein by reference to Exhibit 4.11 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.12
Form of Regulation S Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.12 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.13
Form of Regulation D Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.13 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
10.1
Shareholder Agreement by and between Nova Furniture Limited and St. Joyal, dated January 1, 2011 (Incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
10.2#
Amended and Restated Employment Agreement between Nova LifeStyle, Inc. and Thanh H. Lam, dated May 3, 2013 (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on May 9, 2013)
10.3#
Form of Director Agreement (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 3, 2013)
10.4#
Stock Award Agreement between Thanh H. Lam and Nova Lifestyle, Inc., effective May 3, 2013 (Incorporated herein by reference to Exhibit 10.26 to the Company’s Annual Report on Form 10-K (File No. 333-163019) filed on March 31, 2014)
10.5#
Nova LifeStyle, Inc. 2014 Omnibus Long-Term Incentive Plan (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K/A (File No. 333-163019) filed on July 10, 2014)
10.6#
Nova LifeStyle, Inc. Form of Restricted Stock Award Agreement (Incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K/A (File No. 333-163019) filed on July 10, 2014)
10.7#
Employment Agreement between Nova LifeStyle, Inc. and Jeffery Chuang, dated August 22, 2017 (Incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2017)
10.8#†
Employment Agreement between Nova LifeStyle, Inc. and Min Su, dated February 27, 2018 and effective as of November 14, 2017
10.9
Share Transfer Agreement between Nova Furniture Limited and Kuka Design Limited, dated September 23, 2016 (Incorporated herein by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K filed on April 14, 2017)
10.10
Trademark Assignment Agreement between Nova Furniture Limited and Kuka Design Limited, dated November 10, 2016 (Incorporated herein by reference to Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed on April 14, 2017)
10.11#
Amendment to Amended and Restated Employment Agreement between Thanh H. Lam and Nova LifeStyle, Inc., dated July 24, 2017 (Incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on July 27, 2017)
14.1
Code of Business Conduct and Ethics of Nova Lifestyle, Inc. (Incorporated herein by reference to Exhibit 14.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 10, 2013)
21.1†
Subsidiaries of the Registrant
23.1†
Consent of Centurion ZD CPA Limited
24.1†
Power of Attorney (Included on the Signature Page of this Annual Report on Form 10-K)
31.1†
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2†
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1‡
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS†
XBRL Instance Document
101.SCH†
XBRL Taxonomy Extension Schema Document
101.CAL†
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF†
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB†
XBRL Taxonomy Extension Label Linkbase Document
101.PRE†
XBRL Taxonomy Extension Presentation Linkbase Document
# Indicates management contract or compensatory plan, contract or arrangement.
† Filed herewith.
‡ Furnished herewith.
NOVA LIFESTYLE, INC.
Consolidated Financial Statements
Years Ended December 31, 2017 and 2016
Page
Report of Independent Registered Public Accounting Firm
Financial Statements
Consolidated Balance Sheets as of December 31, 2017 and 2016
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2017 and 2016
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2017 and 2016
Consolidated Statements of Cash Flows for the years ended December 31, 2017 and 2016
Notes to Consolidated Financial Statements for the years ended December 31, 2017 and 2016
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
Nova LifeStyle, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Nova LifeStyle, Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of comprehensive income (loss), changes in stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Centurion ZD CPA Limited
Centurion ZD CPA Limited
We have served as the Company’s auditor since 2016.
Hong Kong, China
March 29, 2018
NOVA LIFESTYLE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2017 AND 2016
NOVA LIFESTYLE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
DECEMBER 31, 2017 AND 2016
The accompanying notes are an integral part of these consolidated financial statements.
NOVA LIFESTYLE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
The accompanying notes are an integral part of these consolidated financial statements.
NOVA LIFESTYLE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
The accompanying notes are an integral part of these consolidated financial statements.
NOVA LIFESTYLE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
The accompanying notes are an integral part of these consolidated financial statements.
NOVA LIFESTYLE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
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, and as a result, they are now accounted for as discontinued operations in the accompanying consolidated financial statements for all periods presented. Accordingly, assets and liabilities, revenues and expenses, and cash flows related to the business of these subsidiaries have been appropriately reclassified in the accompanying consolidated financial statements as discontinued operations for all periods presented. Additional information with respect to the sale of these subsidiaries is presented at Note 3.
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, USA. The purpose of i Design is to build our own blockchain technology team. This new company will focus on application of blockchain technology in the furniture industry, including encouraging and facilitating interactions among designers and customers, and building blockchain-powered platform that enables designers to showcase their products including current and future furniture designs. This company is in a planning stage and has had minimum 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. The “Company” may also from time to time in these Notes include the Company’s former subsidiaries, Nova Furniture BVI, Nova Dongguan, Nova Museum and Ding Nuo.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation
The 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.
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, 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 December 31, 2017 and 2016, 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 all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Accounts Receivable
The Company’s policy is to maintain an allowance for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. An analysis of the allowance for doubtful accounts is as follows:
During the years ended December 31, 2017 and 2016, bad debts from continuing operations were $305,519 and $2,603,745, respectively. During the year ended December 31, 2016, bad debts from discontinued operations were $512,978.
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 advance to suppliers, if deemed necessary, will be included in general and administrative expenses in the consolidated statements of comprehensive income.
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 December 31, 2017 and 2016.
In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330) - Simplifying the Measurement of Inventory,” which requires that inventory within the scope of the guidance be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted ASU 2015-11 effective January 1, 2017 and it did not have a material effect on the Company’s consolidated financial statements.
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:
Building and workshops
20 years
Computer and office equipment
5 years
Decoration and renovation
10 years
Machinery
10 years
Autos
5 years
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 December 31, 2017 and 2016, there was no significant 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 from continuing operations were $373,935 and $95,877 for the years ended December 31, 2017 and 2016, respectively. Research and development expense from the Company’s discontinued operations was $628,627 for the year ended December 31, 2016.
Income Taxes
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 and Diamond Bar are subject to U.S. corporate income taxes on their taxable income at a rate of up to 21% for taxable years beginning after December 31, 2017 and U.S. corporate income tax on its taxable income of up to 35% for prior tax years. 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. Taxpayers may elect to pay the one-time transition tax over eight years, or in a single lump-sum payment. See Note 10.
To the extent that portions of its U.S. taxable income, such as Subpart F income or GILTI, are determined to be from sources outside of the U.S., subject to certain limitations, the Company may be able to claim foreign tax credits to offset its U.S. income tax liabilities. Any remaining liabilities are accrued in the Company’s consolidated statements of comprehensive income and estimated tax payments are made when required by U.S. law.
Nova Furniture Limited and Bright Swallow are incorporated in the BVI. Nova Macao is incorporated in Macao. Nova Samoa is incorporated in Oceania. There is no income tax for companies domiciled in the BVI, Oceania or Macao. Accordingly, the Company’s consolidated financial statements do not present any income tax provision related to the BVI and Macao tax jurisdiction where Nova Furniture BVI, BSI and Nova Macao are domiciled. Nova Macao is an income tax-exempt entity incorporated and domiciled in Macao.
A reconciliation of the January 1, 2016 through December 31, 2017, amount of unrecognized tax benefits excluding interest and penalties (“Gross UTB”) is as follows:
At December 31, 2017 and 2016, the Company had cumulatively accrued approximately $599,000 and $494,000 for estimated interest and penalties related to unrecognized tax benefits related to the Company’s continuing operations. For the years ended December 31, 2017 and 2016, the Company recorded interest and penalties related to unrecognized tax benefits as a component of income tax expense, which totaled approximately $38,000 and $139,000 related to the Company’s continuing operations, respectively. The Company does not anticipate any significant changes to its unrecognized tax benefits within the next 12 months.
For the year ended December 31, 2016, the Company did not record unrecognized tax benefits related to transfer pricing adjustments between Nova Dongguan and Nova Macau since the intercompany sales between the two entities appears to comply with reasonable arm’s length principles.
Nova Lifestyle and Diamond Bar are subject to U.S. federal and state income taxes and tax years 2011-2016 remain open to examination by tax authorities in the U.S.
Revenue Recognition
The Company’s revenue recognition policies are in compliance with ASC Topic 605, “Revenue Recognition.” Sales revenue is recognized when a formal arrangement exists, the price is fixed or determinable, the delivery is completed and no other significant obligations of the Company exist and collectability is reasonably assured. No revenue is recognized if there are significant uncertainties regarding the recovery of the consideration due, or the possible return of the goods. Payments received before all of the relevant criteria for revenue recognition are recorded as unearned revenue.
Sales revenue represents the invoiced value of goods, net of value-added taxes (“VAT”). All of the Company’s products sold in China are subject to the PRC VAT of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials purchased in China and included in the cost of producing the finished product. The Company records VAT payable and VAT receivable net of payments in the consolidated financial statements. The VAT tax return is filed offsetting the payables against the receivables. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government.
The Company’s sales policy allows for the return of product within the warranty period if the product is defective and the defects are the Company’s fault. As alternatives for the product return option, the customers have options of asking a discount from the Company for the products with quality issues or receiving replacement parts from the Company at no cost. The amount for return of products, the discount provided to the Company’s customers and the costs for replacement parts were immaterial for the years ended December 31, 2017 and 2016.
Franchise Arrangements
In 2010, the Company’s former subsidiaries in China began entering into area product franchise agreements with franchisees who operated specialty furniture stores carrying only Nova-branded products. The product franchise agreement provided for the franchisee to retail Nova-brand furniture products for a period of one year from the date of the agreement. The franchisee was required to pay a deposit of RMB 30,000 at the signing of the agreement, which is used as payment for future purchases and is deferred on the Company’s balance sheet as a customer deposit. The franchisee was required to guarantee a minimum purchase amount from the Company during the contract period. The Company had the right to terminate the agreement should the franchisee fail to meet the minimum purchase amount. The Company previously provided the franchisee with store images and designs, signage, floor plan product information and training. In addition, the Company would rebate a per square meter subsidy to the franchisee for the store build-out within 12 months from the agreement date. Under the program, the Company established standard renovation amounts (the “Renovation Subsidy”) for various cities in China. The franchisee was able to obtain, in the form of credits against purchase orders, percentages of the Renovation Subsidy applicable in the city in which the franchisee is located, as follows: 0% to 30% of the Renovation Subsidy applied to the first purchase order and 5% of each purchase order thereafter until the aggregate of all credits equals 100% of the Renovation Subsidy, or 12 months from the date of the franchise agreement, whichever occurs first. In accordance with ASC 605-50, as the Company does not receive an identifiable benefit from these rebates, the rebates are recorded as a reduction of revenue on sales to the franchisees. All of the franchise agreements relating to the Company’s operations were divested in connection with its discontinued operations (see Note 3 - Discontinued Operations).
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 years ended December 31, 2017 and 2016, shipping and handling costs from continuing operations were $3,319 and $724, respectively. During the year ended December 31, 2016, shipping and handling costs from discontinued operations was $417,563.
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 $1,321,606 and $2,580,728 for the years ended December 31, 2017 and 2016, respectively. Advertising expense from discontinued operations was $62,218 for the year ended December 31, 2016.
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 years ended December 31, 2017 and 2016:
* Including 777,518 and 616,451 shares that were granted and vested but not yet issued for the years ended December 31, 2017 and 2016, respectively.
For the years ended December 31, 2017 and 2016, 858,334 shares purchasable under warrants were excluded from EPS, respectively, as their effects were anti-dilutive. For the year ended December 31, 2016, the unvested restricted stock 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.
Three major customers accounted for 50% (24%, 14% and 12% each) of the Company’s sales for the year ended December 31, 2017. Two major customers accounted for 21% (11% and 10% each) of the company’s sales for the year ended December 31, 2016. Accounts receivable from these customers were $42,882,694 and $9,992,022 as of December 31, 2017 and December 31, 2016, respectively.
The Company purchased its products from four and five major vendors during the years ended December 31, 2017 and 2016, accounting for a total of 64% (24%, 17%, 13% and 10% for each) and 80% (22%, 19%, 16%, 12%, and 11% for each) of the Company’s purchases, respectively.
Advances made to these vendors were $8,236,941 and $13,463,715 as of December 31, 2017 and 2016, respectively. Accounts payable to these vendors were $345,144 and $446,428 as of December 31, 2017 and 2016, respectively.
Prior to its divestment of its PRC subsidiaries, the operations of the Company were located principally in China and the U.S. Accordingly, the Company’s Chinese subsidiaries’ business, financial condition and results of operations were, from time to time, influenced by the political, economic and legal environments in China, as well as by the general state of the PRC economy.
The Company’s operations in the PRC were subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These included risks associated with, among others, the political, economic and legal environments in China and foreign currency exchange. The Company’s results may be adversely affected by changes in PRC government policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
The Company’s sales, purchase and expense transactions in China are denominated in Chinese Yuan Renminbi (“RMB”), and all of the assets and liabilities of the Company’s former subsidiaries in China are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current law. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies other than RMB may require certain supporting documentation in order to affect the remittance.
Statement of Cash Flows
In accordance with FASB ASC Topic 230, “Statement of Cash Flows,” cash flows from the Company’s operations is calculated based upon local currencies. As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.
Fair Value of Financial Instruments
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:
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Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
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Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
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Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The carrying value of cash, accounts receivable, advance 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.
The functional currency of Nova Dongguan, Nova Museum and Ding Nuo is RMB. The functional currencies of the Company’s foreign operations are translated into USD for balance sheet accounts using the current exchange rates in effect as of the balance sheet date, except for the equity account using the historical exchange rate, and for revenue and expense accounts using the weighted-average exchange rate during the fiscal year. The translation adjustments are recorded in the consolidated statements of income and comprehensive income, captioned “Accumulated other comprehensive income.” Gains and losses resulting from transactions denominated in foreign currencies are included in “Other income (expenses)” in the consolidated statements of income and comprehensive income.
The RMB to USD exchange rates in effect as of October 25, 2016, was RMB6.7641 = USD$1.00. The weighted-average RMB to USD exchange rates in effect for the period from January 1, 2016 to October 25, 2016 (date of disposal of subsidiaries) was RMB6.5904 = USD$1.00. The exchange rates used in translation from RMB to USD were published by the People’s Bank of the People’s Republic of China.
Comprehensive Income
The Company follows FASB ASC 220 “Reporting Comprehensive Income.” Comprehensive income is comprised of net income and all changes to the consolidated statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. Comprehensive income for the year ended December 31, 2016 included net income and foreign currency translation adjustments.
Segment Reporting
ASC Topic 280, “Segment Reporting,” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s 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
Prior to the disposal of Nova Dongguan, the Company’s furniture products sold through Nova Dongguan, Nova Macao, and Ding Nuo were created with similar production processes, in the same facilities, under the same regulatory environment and sold to customers using similar distribution systems. Although Nova Museum was principally engaged in the dissemination of the culture and history of furniture in China, it also served a function of promoting and marketing the Company’s image and products by providing a platform and channel for consumers to be exposed to the Company and its products, it was operated under the same management with the same resources and in the same location as Nova Dongguan, and it was an additive and supplemental unit to the Company’s main operations, the design and sale of furniture.
Until the disposal of Nova Dongguan and its subsidiaries, all of the Company’s long-lived assets for production were located at its facilities in Dongguan, Guangdong Province, China, and operated within the same environmental, safety and quality regulations governing furniture manufacturers. 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 May 2014, the FASB issued No. 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB approved a one-year deferral of the effective date of the new revenue recognition standard. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 31, 2016, including interim reporting periods within that reporting period. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue versus Net). In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing. In May 2016, the FASB issued ASU 2016-11, Revenue from Contracts with Customers (Topic 606) and Derivatives and Hedging (Topic 815) - Rescission of SEC Guidance Because of ASU 2014-09 and 2014-16, and ASU 2016-12, Revenue from Contracts with Customers (Topic 606) - Narrow Scope Improvements and Practical Expedients. These ASUs clarify the implementation guidance on a few narrow areas and adds some practical expedients to the guidance Topic 606. In the fourth quarter of 2017, the Company completed the evaluation of its adoption of ASU 2014-09 (including those subsequently issued updates that clarify ASU 2014-09’s provisions) and finalized its determination of the impact of the guidance on revenue recognition. The Company does not expect the new revenue standard to have a material impact on the consolidated financial statements
On March 30, 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which includes amendments to accounting for income taxes at settlement, forfeitures, and net settlements to cover withholding taxes. The amendments in ASU 2016-09 are effective for public companies for fiscal years beginning after December 31, 2016, and interim periods within those annual periods. The Company adopted ASU 2016-09 on January 1, 2017. Upon adoption, the Company recorded a reduction in deferred tax asset of $0.4 million for previously unrecognized excess tax benefits from stock-based compensation, resulting in a reduction to opening retained earnings. In addition and as provided for under this guidance, the Company made an accounting policy election to recognize forfeitures as they occur. The adoption of this aspect of the guidance did not have a material impact on the consolidated financial statements and related disclosures.
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. This ASU is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted. The Company does not expect the standard to have a material impact on its consolidated financial statements.
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 Company does not anticipate that the adoption of this ASU will have a significant impact on its 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. Early adoption is permitted, including adoption in an interim period. The standard should be applied using a retrospective transition method to each period presented. The Company does not anticipate that the adoption of this ASU will have a significant impact on its consolidated financial statements.
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. Early adoption is permitted. The standard should be applied prospectively on or after the effective date. 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 - Discontinued Operations
On September 23, 2016, Nova Furniture, a wholly-owned subsidiary of the Company (the “Seller”), entered into a Share Transfer Agreement (the “Agreement”) with Kuka Design Limited, an unrelated company incorporated in British Virgin Islands (“Kuka Design BVI” or “Buyer”). Pursuant to the terms of the Agreement, the Seller sold all of the outstanding equity interests in Nova Dongguan, a wholly owned subsidiary of the Seller, to the Buyer for a total of $8,500,000 (the “Transaction”), which such value was primarily derived from Nova Dongguan and Nova Dongguan’s wholly owned subsidiary, Nova Museum, and 90.97% owned subsidiary, Ding Nuo. Upon consummation of the Transaction on October 25, 2016, the Buyer became the sole owner of Nova Dongguan. The purchase price of $8,500,000 was fully paid on October 6, 2016.
On November 10, 2016, Nova Furniture entered into a Trademark Assignment Agreement with Kuka Design BVI. Pursuant to the terms of the Trademark Assignment Agreement, Nova Furniture agreed to assign to Kuka Design BVI its full right to, and title in, the NOVA trademark in China for $6,000,000 (the “Assignment Fee”). Kuka Design BVI was to pay the Assignment Fee in two installments: $1,000,000 on or before November 30, 2016, and $5,000,000 on or before December 31, 2016. As the result of the assignment of NOVA trademark in China, Nova Furniture and its affiliated companies, including Nova Macao, have ceased to use the NOVA trademark and brand in their business in China. A portion of the Assignment Fee in the amount of $4,750,000 was received in 2016, and the remaining balance of $1,250,000 was fully paid in January 2017.
The following table summarizes the net assets of Nova Dongguan, Nova Museum and Nova Ding Nuo at the date of disposal (October 25, 2016):
As a result, the operations of Nova Dongguan, Nova Museum and Ding Nuo are now accounted for as discontinued operations in the accompanying consolidated financial statements for all periods presented. The following table presents the components of discontinued operations reported in the consolidated statements of operations:
Note 4 - Inventories
The inventories as of December 31, 2017 and 2016 totaled $6,374,560 and $2,781,123, respectively, and were all finished goods.
Note 5 - Plant, Property and Equipment, Net
As of December 31, 2017 and 2016, plant, property and equipment consisted of the following:
Depreciation expense from continuing operations was $40,848 and $42,297 for the years ended December 31, 2017 and 2016, respectively; Depreciation expense from discontinued operations was $1,120,559 for the year ended December 31, 2016.
Note 6 - 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 is 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 December 31, 2017 and 2016:
Amortization of intangible assets from continuing operations was $1,484,015 and $560,858 for the years ended December 31, 2017 and 2016, respectively; Amortization of intangible assets from discontinued operations was $31,247 for the year ended December 31, 2016.
Estimated amortization expense relating to the existing intangible assets with finite lives for each of the next five years is as follows:
Note 7 - 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, 2017 and 2016, the Company prepaid $0 and $7,000,000 to the unrelated party, respectively.
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 does 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. The Company collected a total of approximately $13 million, which was prepaid previously, as of December 31, 2017, and no further balance was owed by the unrelated party.
(b) Prepaid Expenses and Other Receivables consisted of the following at December 31, 2017 and 2016:
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. During the year ended December 31, 2017, the Company collected full payment of the principal and interest of $26,575 from the unrelated party.
Note 8 - Accrued Liabilities and Other Payables
Accrued liabilities and other payables consisted of the following as of December 31, 2017 and 2016:
As of December 31, 2017 and 2016, other accrued expenses mainly included legal and professional fees, transportation expenses and utilities. Other payables represented other tax payable and meal expenses.
Note 9 - Lines of Credit
Diamond Bar entered into an agreement with a bank in California for a line of credit of up to $5,000,000 with annual interest of 4.25% 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 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 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 was 4.5% as of December 31, 2017. The line of credit is secured by all of the assets of Diamond Bar and is guaranteed by Nova LifeStyle. As of December 31, 2017 and 2016, Diamond Bar had $4,202,118 and $6,129,841 outstanding on the line of credit, respectively. During the years ended December 31, 2017 and 2016, the Company recorded interest expense of $187,097 and $213,967, respectively. As of December 31, 2017, Diamond Bar had $3,797,882 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 December 31, 2017, 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 December 31, 2017 and 2016, Nova Macao had $0 and $1,848,000 outstanding on the line of credit, respectively. During the years ended December 31, 2017 and 2016, Nova Macao paid interest of $0 and $69,830, respectively.
On April 25, 2012, Nova Dongguan entered into an agreement with a commercial bank in Dongguan for a line of credit of up to $3,016,045 (RMB 20 million) with maturity on April 24, 2015. On November 20, 2014, the Company paid off the line of credit and entered into a new agreement with a reduced line of credit of up to $1,508,023 (RMB 10 million) with a maturity on May 19, 2015. On May 5, 2015, Nova Dongguan extended the line of credit of $527,808 (RMB 3.5 million) and $980,215 (RMB 6.5 million) with maturities on September 6, 2015 and October 18, 2015, respectively. On September 21, 2015, Nova Dongguan paid off the lines of credit and entered into a new agreement with an increased line of credit of up to $3,016,045 (RMB 20 million) for a period up to September 20, 2018. As of the date of disposal of Nova Dongguan and December 31, 2015, Nova Dongguan had $1,049,659 (RMB 7.10 million) and $2,756,560 (RMB 17.9 million) outstanding, respectively. The loan of $1,931,773 (RMB 12.9 million) bears monthly interest of 0.51458% and requires monthly payment of the interest. The loan is due for repayment on September 24, 2016. On September 23, 2016, this line of credit was extended to October 24, 2016. On October 24, 2016, Nova Dongguan paid off this loan. On November 10, 2015, Nova Dongguan borrowed an additional $748,750 (RMB 5.0 million), which bears monthly interest of 0.47125% and requires monthly payment of the interest with maturity date on November 9, 2016.
On January 26, 2016, Nova Dongguan borrowed an additional $314,475 (RMB 2.1 million), which bears monthly interest of 0.47125% and requires monthly payment of the interest with maturity date on January 25, 2017. The loans are secured by the buildings of Nova Dongguan and are guaranteed by the Company’s former CEO. During the year ended December 31, 2016, the Company recorded interest expense of $145,645 for discontinued operations related to the applicable line of credit agreements. This line of credit had been disposed as a result of disposal of subsidiaries (See Note 3 - Discontinued Operations).
Note 10 - Income Taxes
Taxes payable consisted of the following at December 31, 2017 and 2016:
As of December 31, 2017 and 2016, noncurrent tax payable were $4.53 million and $2.14 million, respectively, consisting of an income tax payable of $2.50 million (2016: nil), primarily arising from a one-time transition tax recognized in the fourth quarter of 2017 on post-1986 foreign unremitted earnings (see below), and a $2.03 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 (see Note 2).
The components of income (loss) before income taxes from continuing operations consisted of the following for the years ended December 31, 2017 and 2016:
The provision (benefit) for income taxes on income (loss) from continuing operations consisted of the following:
The following is a reconciliation of the difference between the actual provision for income taxes and the provision computed by applying the federal statutory rate on income (loss) before income taxes from continuing operations:
The following presents the aggregate dollar and per share effects of the Company’s tax exemption:
The aggregate dollar effect of tax holiday
Deferred Tax Assets and Liabilities
Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred taxes are comprised of the following:
Nova LifeStyle, Inc. and Diamond Bar are subject to U.S. federal and state income taxes. Nova Furniture BVI was incorporated in the BVI. There is no income tax for a company domiciled in the BVI. Accordingly, the Company’s consolidated financial statements do not present any income tax provision related to the BVI tax jurisdiction where Nova Furniture BVI is domiciled. On April 24, 2013, the Company acquired all outstanding shares of Bright Swallow. Generally, there is no income tax for a company domiciled in the BVI.
For U.S. Federal income tax purpose, the Company has net operating loss, or NOL carryforwards, of approximately $0 million and $2.39 million, at December 31, 2017 and 2016, respectively.
For U.S. California income tax purpose, the Company has net operating loss, or NOL carryforwards, of approximately $1.86 million and $1.7 million, at December 31, 2017 and 2016, respectively.
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.
To the extent that portions of its U.S. taxable income, such as Subpart F income or GILTI, are determined to be from sources outside of the U.S., subject to certain limitations, the Company may be able to claim foreign tax credits to offset its U.S. income tax liabilities. Any remaining liabilities are accrued in the Company’s consolidated statements of comprehensive income and estimated tax payments are made when required by U.S. law.
At 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 Statement of Comprehensive Income 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. The Company may make an election to pay the one-time transition tax over eight years commencing in April 2018, or pay in a single lump sum. The actual impact of the U.S. Tax Reform on the Company may differ from management’s estimates, and management may update its judgments based on future regulations or guidance issued by the U.S. Department of the Treasury, and specific actions the Company may take in the future.
The Company continues to examine the impact of certain provisions of the Tax Act that will become applicable in calendar year 2018 related to Base Erosion and Anti Abuse Tax (“BEAT”), GILTI, deduction for FDII, and other provisions that could affect its effective tax rate in the future. The Company will record the income tax effects of GILTI and other provisions of the Tax Act as incurred beginning in calendar year 2018. Also, because there may be additional state income tax implications, the Company will continue to monitor changes in state and local tax laws to determine if state and local taxing authorities intend to conform or deviate from changes to U.S. federal tax legislation as a result of the Tax Act. 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 calendar year 2018.
On September 19, 2013, Bright Swallow moved the office from Macau to Hong Kong, which is subject to a 16.5% corporate income tax. Nova Museum is subject to a 25% corporate income tax in the first year and allowed to apply for tax-exempt status in the second year following its incorporation. Nova Macao is an income tax-exempt entity incorporated and domiciled in Macao.
Undistributed earnings of the Company’s foreign subsidiaries amounted to approximately $21 million as of December 31, 2017, of which all was subject to the one-time transition tax on foreign unremitted earnings required by the Tax Act or has otherwise been previously subject to U.S. tax. Those earnings are considered to be permanently reinvested and accordingly, no deferred tax expense is recorded for U.S. federal and state income tax or applicable withholding taxes.
On January 1, 2017, we adopted Accounting Standards Update No. 2016-09 (“ASU 2016-09”) and as a result, we recorded a debit of $0.38 million, tax-effected, to retained earnings due to the realization of unrealized excess tax benefits.
Note 11 - 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, 2017, the Company renewed the lease for an additional one year term. The lease was $32,916 for one year and only for use during two furniture exhibitions to be held between April 1, 2017 and March 31, 2018. During each of the years ended December 31, 2017 and 2016, the Company paid rental amounts of $32,916 that are included in selling expenses from continuing operations.
Note 12 - Stockholders’ Equity
Share repurchase program
On December 12, 2017, the Company issued a press release announcing the Company has adopted 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 December 31, 2017 and as of the approval date of the 2017 annual report, no shares have been repurchased under the program.
Warrants
Following is a summary of the warrant activity for the years ended December 31, 2017 and 2016:
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 will be 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 will be amortized over the service term. During the years ended December 31, 2017 and 2016, the Company amortized $68,567 and $74,800 as consulting expenses, respectively.
On March 1, 2015, the Company entered into a marketing agreement with a consultant for marketing and product promotion services effective on March 1, 2015. The Company agreed to grant the consultant $100,000 worth of shares of the Company’s common stock for 12 months of consulting services starting on March 1, 2015. The shares vested immediately on March 1, 2015. The share price was calculated as the average closing price per share for ten trading days immediately prior to the execution of the agreement and was amortized over the service term. On March 9, 2015, the Company issued 38,745 shares at an average price of $2.581 per share to the consultant. During the years ended December 31, 2017 and 2016, the Company amortized $0 and $16,667 as consulting expenses, respectively.
On September 14, 2015, the Company entered into a business marketing advisory agreement with a consultant for marketing and general consulting services effective on August 15, 2015. The Company agreed to pay the consultant a monthly fee of $5,000 and also granted 18,348 shares of the Company’s common stock to the consultant for 12 months of services starting on August 15, 2015. Twenty-five percent (25%) of those shares vested on November 15, 2015, 25% on February 15, 2016, 25% on May 15, 2016 and the remaining 25% vested on August 15, 2016. The fair value of the 18,348 shares was $45,870, which was calculated based on the stock price of $2.50 per share on August 15, 2015 and will be amortized over the service term. During the years ended December 31, 2017 and 2016, the Company amortized $0 and $28,669 as consulting expenses, 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 will be amortized over the service term. During the year ended December 31, 2017 and 2016, the Company amortized $54,400 and $149,600 as consulting expenses, respectively.
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 or will vest 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 will be amortized over the service term. During the years ended December 31, 2017 and 2016, the Company amortized $163,200 and $149,600 as consulting expenses, respectively.
On February 1, 2016, the Company entered into a consulting agreement with a consultant for planning, coordinating and strategy implementation services for a term of 6 months. The Company agreed to grant the consultant $10,000 worth of shares of the Company’s common stock per month. During the years ended December 31, 2017 and 2016, 83,386 shares vested, based on the stock prices as of the end of each month commencing February 2016 and concluding September 2016. During the years ended December 31, 2017 and 2016, the Company amortized $0 and $60,000 as consulting expense, 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 would be 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% will vest 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 will be amortized over the service term. During the years ended December 31, 2017 and 2016, the Company amortized $256,142 and $37,858 as consulting expenses, 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 would be 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 years ended December 31, 2017 and 2016, the Company amortized $257,250 and $36,750 as consulting expense, 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 would be issued pursuant to the Plan. During the years ended December 31, 2017 and 2016, the Company amortized $182,500 and $17,500 as consulting expense, respectively.
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 would be issued pursuant to the Plan. During the year ended December 31, 2017, the Company amortized $65,000 as consulting expense.
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 2, 2018, 25% on May 15, 2018, 25% 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 year ended December 31, 2017, the Company amortized $21,803 as consulting expense.
On December 10, 2017, the Company entered into a consulting agreement with a consultant for business advisory service on 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 year ended December 31, 2017, the Company amortized $3,750 as consulting expense.
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 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 Securities Purchase Agreement entered on April 14, 2014, the outstanding 2014 Series A Warrants were exchanged for 660,030 shares of common stock, and the outstanding 2014 Series C Warrants were exchanged 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
In March 2015, the Company entered into restricted stock award agreements under the 2014 Omnibus Long-Term Incentive Plan with three independent directors of the Board. The Company agreed to grant 12,195 shares of the Company’s common stock to each of these independent directors with a grant date of March 24, 2015. The restricted period lapses as to 25% of the restricted stock on September 30, 2015, December 31, 2015, March 31, 2016 and September 30, 2016, subject to the director remaining in the continuous service of the Company or its affiliates on each applicable vesting date. The fair value of these shares was $119,999, which was calculated based on the stock price of $3.28 per share on March 24, 2015. During the years ended December 31, 2017 and 2016, the Company amortized $0 and $26,959 as directors’ stock compensation expenses, respectively.
In May 2015, the Company entered into a restricted stock award agreement under the 2014 Omnibus Long-Term Incentive Plan with a new independent director. The Company agreed to grant 12,195 shares of the Company’s common stock to the new independent director with a grant date of May 19, 2015. The restricted period lapsed as to 25% of the restricted stock on September 30, 2015, December 31, 2015, March 31, 2016 and September 30, 2016, subject to the director remaining in the continuous service of the Company or its affiliates on each applicable vesting date. The fair value of these shares was $38,292, which was calculated based on the stock price of $3.14 per share on May 19, 2015. During the years ended December 31, 2017 and 2016, the Company amortized $0 and $14,478 as directors’ stock compensation expenses, respectively.
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 years ended December 31, 2017 and 2016, the Company amortized $96,438 and $63,562 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 year ended December 31, 2017, the Company amortized $18,740 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 vest on the September 30, 2017, 25% on December 31, 2017, 25% on March 31, 2018, and the remaining 25% will vest on June 30, 2018, subject to the director remaining in the continuous service of the Company or its affiliates on each applicable vesting 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”). 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 year ended December 31, 2017, the Company recorded $162,454 as directors’ stock compensation expenses.
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 or will vest 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 will be amortized over the service term. During the years ended December 31, 2017 and 2016, the Company amortized $194,400 and $121,433 as stock compensation expenses, respectively.
On May 20, 2016, the Company entered into restricted stock award agreements under the 2014 Omnibus Long-Term Incentive Plan with the Company’s non-director employees for their hard work and dedication over the past years. The Company’s agreed to grant an aggregate 600,000 shares of the Company’s common stock to the Company’s employees on May 20, 2016. The shares were fully vested as of the grant date. The fair value of these shares was $366,000, which was calculated based on the stock price of $0.61 per share on May 20, 2016. During the year ended December 31, 2016, the Company recorded $366,000 as stock compensation expenses.
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% vest on September 30, 2017. During the years ended December 31, 2017 and 2016, the Company amortized $79,988 and $12,112 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 will be amortized over the service term. Twenty-five percent (25%) of those shares vested on February 15, 2017, 25% on May 15, 2017, 25% will vest on August 15, 2017 and the remaining 25% will vest on November 15, 2017. During the years ended December 31, 2017 and 2016, the Company amortized $257,250 and $36,750 as stock compensation.
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% will vest 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 year ended December 31, 2017, the Company recorded $321,591 as stock compensation.
As of December 31, 2017, unrecognized share-based compensation expense related to options was $484,044.
(1)
The intrinsic value of the stock options at December 31, 2017 is the amount by which the market value of the Company’s common stock of $2.59 as of December 31, 2017 exceeds the exercise price of the option.
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 PRC laws and regulations described below that require such annual appropriations of 10% of after-tax income to be set aside prior to payment of dividends as a general statutory reserve fund, Nova Macao is restricted in its ability to transfer a portion of its net assets to the Company as a dividend.
Surplus Reserve Fund
Prior to the Company’s divestment of Nova Dongguan and Ding Nuo, such subsidiaries were required to transfer 10% of net income, as determined under PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the subsidiary’s registered capital. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholdings or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issuance is not less than 25% of the registered capital.
At December 31, 2017 and 2016, 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 13 - Geographical Sales
Geographical distribution of sales consisted of the following for the years ended December 31, 2017 and 2016:
* excluding China and Hong Kong
Note 14 - 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. 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, 2017. On October 24, 2017, the Company renewed the sublease agreement with this customer for another one-year term commencing on November 1, 2017 and expiring on October 31, 2018. The sublease income of $5,400 per month was recorded against the rental expense. During the years ended December 31, 2017 and 2016, the Company recorded $67,500 and $73,902 sublease income, 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 from continuing operations for the years ended December 31, 2017 and 2016 was $805,404 and $675,717, 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 were 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. During the years ended December 31, 2017 and 2016, the Company recorded $0 and $64,626, as stock-based compensation to Ms. Lam, respectively. 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 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 years ended December 31, 2017 and 2016, the Company recorded reversal ($30,000) and $360,000, 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 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 was described in the Note 12 - Stockholders’ equity.
Note 15 - Subsequent Events
The Company has evaluated all events that have occurred subsequent to December 31, 2017 through the issuance of the consolidated financial statements and the following subsequent event has been identified.
On February 27, 2018, the Company renewed an employment agreement with the Company’s Corporate Secretary 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 $68,400, which was calculated based on the stock price of $2.28 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% vest on September 30, 2018.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NOVA LIFESTYLE, INC.
(Registrant)
Date: March 29, 2018
By:
/s/ Thanh H. Lam
Thanh H. Lam
Chairperson and Chief Executive Officer
(Principal Executive Officer)
Power of Attorney
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Thanh H. Lam and Jeffery Chuang, jointly and severally, his or her attorneys-in-fact, with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Thanh H. Lam
Chief Executive Officer, President, Director and Chairperson
March 29, 2018
Thanh H. Lam
(Principal Executive Officer)
/s/ Jeffery Chuang
Chief Financial Officer
March 29, 2018
Jeffery Chuang
(Principal Financial and Accounting Officer)
/s/ Min Su
Director
March 29, 2018
Min Su
/s/ Bin Liu
Director
March 29, 2018
Bin Liu
/s/ Umesh Patel
Director
March 29, 2018
Umesh Patel
/s/ Huy P. La
Director
March 29, 2018
Huy P. La
EXHIBIT INDEX
Exhibit No.
Description
2.1
Agreement and Plan of Merger by and between Stevens Resources, Inc. and Nova LifeStyle, Inc., dated June 14, 2011 (Incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
2.2
Share Exchange Agreement and Plan of Reorganization by and between Nova Furniture Limited and Nova LifeStyle, Inc., dated June 30, 2011 (Incorporated herein by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
2.3
Return to Treasury Agreement by and between Nova LifeStyle, Inc. and Alex Li, dated June 30, 2011 (Incorporated herein by reference to Exhibit 2.3 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.1
Articles of Incorporation (Incorporated herein by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (File No. 333-163019) filed on November 10, 2009)
3.2
Amended and Restated Bylaws (Incorporated herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.3
Certificate of Amendment to Articles of Incorporation filed with the Secretary of the State of Nevada on December 15, 2009, and effective as of September 9, 2009 (Incorporated herein by reference to Exhibit 3.3 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.4
Articles of Merger between Stevens Resources, Inc. and Nova LifeStyle, Inc. amending the Articles of Incorporation filed with the Secretary of State of the State of Nevada on June 14, 2011, and effective as of June 27, 2011 (Incorporated herein by reference to Exhibit 3.4 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
3.5
Articles of Exchange of Nova Furniture Limited and Nova LifeStyle, Inc. filed with the Secretary of State of the State of Nevada on June 30, 2011 (Incorporated herein by reference to Exhibit 3.5 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
4.1
Specimen Stock Certificate (Incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
4.2
Form of Regulation S Subscription Agreement (Incorporated herein by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.3
Form of Regulation D Subscription Agreement (Incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.4
Form of Regulation S Warrant (Incorporated herein by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.5
Form of Regulation D Warrant (Incorporated herein by reference to Exhibit 4.5 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.6
Form of Regulation S Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.6 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.7
Form of Regulation D Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.7 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on August 22, 2011)
4.8
Form of Regulation S Subscription Agreement (Incorporated herein by reference to Exhibit 4.8 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.9
Form of Regulation D Subscription Agreement (Incorporated herein by reference to Exhibit 4.9 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.10
Form of Regulation S Warrant (Incorporated herein by reference to Exhibit 4.10 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.11
Form of Regulation D Warrant (Incorporated herein by reference to Exhibit 4.11 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.12
Form of Regulation S Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.12 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
4.13
Form of Regulation D Registration Rights Agreement (Incorporated herein by reference to Exhibit 4.13 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on January 18, 2012)
10.1
Shareholder Agreement by and between Nova Furniture Limited and St. Joyal, dated January 1, 2011 (Incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 30, 2011)
10.2#
Amended and Restated Employment Agreement between Nova LifeStyle, Inc. and Thanh H. Lam, dated May 3, 2013 (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on May 9, 2013)
10.3#
Form of Director Agreement (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 3, 2013)
10.4#
Stock Award Agreement between Thanh H. Lam and Nova Lifestyle, Inc., effective May 3, 2013 (Incorporated herein by reference to Exhibit 10.26 to the Company’s Annual Report on Form 10-K (File No. 333-163019) filed on March 31, 2014)
10.5#
Nova LifeStyle, Inc. 2014 Omnibus Long-Term Incentive Plan (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K/A (File No. 333-163019) filed on July 10, 2014)
10.6#
Nova LifeStyle, Inc. Form of Restricted Stock Award Agreement (Incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K/A (File No. 333-163019) filed on July 10, 2014)
10.7#
Employment Agreement between Nova LifeStyle, Inc. and Jeffery Chuang, dated August 22, 2017 (Incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 13, 2017)
10.8#†
Employment Agreement between Nova LifeStyle, Inc. and Min Su, dated February 27, 2018 and effective as of November 14, 2017
10.9
Share Transfer Agreement between Nova Furniture Limited and Kuka Design Limited, dated September 23, 2016 (Incorporated herein by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K filed on April 14, 2017)
10.10
Trademark Assignment Agreement between Nova Furniture Limited and Kuka Design Limited, dated November 10, 2016 (Incorporated herein by reference to Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed on April 14, 2017)
10.11#
Amendment to Amended and Restated Employment Agreement between Thanh H. Lam and Nova LifeStyle, Inc., dated July 24, 2017 (Incorporated herein by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on July 27, 2017)
14.1
Code of Business Conduct and Ethics of Nova Lifestyle, Inc. (Incorporated herein by reference to Exhibit 14.1 to the Company’s Current Report on Form 8-K (File No. 333-163019) filed on June 10, 2013)
21.1†
Subsidiaries of the Registrant
23.1†
Consent of Centurion ZD CPA Limited
24.1†
Power of Attorney (Included on the Signature Page of this Annual Report on Form 10-K)
31.1†
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2†
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1‡
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS†
XBRL Instance Document
101.SCH†
XBRL Taxonomy Extension Schema Document
101.CAL†
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF†
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB†
XBRL Taxonomy Extension Label Linkbase Document
101.PRE†
XBRL Taxonomy Extension Presentation Linkbase Document
# Indicates management contract or compensatory plan, contract or arrangement.
† Filed herewith.
‡ Furnished herewith.