Attached files

file filename
EX-31.2 - NIVS IntelliMedia Technology Group, Inc.v178256_ex31-2.htm
EX-32.1 - NIVS IntelliMedia Technology Group, Inc.v178256_ex32-1.htm
EX-31.1 - NIVS IntelliMedia Technology Group, Inc.v178256_ex31-1.htm
EX-23.1 - NIVS IntelliMedia Technology Group, Inc.v178256_ex23-1.htm
EX-23.2 - NIVS IntelliMedia Technology Group, Inc.v178256_ex23-2.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K
 
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______ TO ___________
 
COMMISSION FILE NO. 000-52933
 
NIVS IntelliMedia Technology Group, Inc.
(Exact Name Of Registrant As Specified In Its Charter)

Delaware
 
20-8057809
(State or other jurisdiction of
 incorporation or organization)
 
(I.R.S. Employer
 Identification No.)
     
NIVS Industry Park
No. 29-31, Shuikou Road, Huizhou, Guangdong
People’s Republic of China 516006
 
N/A
(Address of principal executive offices)
 
(Zip Code)

Registrants telephone number, including area code:  (86) 752-3125862

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $0.0001 par value
 
NYSE Amex
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨ No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. 
Yes ¨ No x
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       Yes  x  No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       Yes ¨ No  ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.         x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 Large accelerated filer ¨
Accelerated filer  ¨
Non-accelerated filer   x
(Do not check if a smaller reporting company)
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes ¨ No x
 
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on June 30, 2009 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $67.4 million based on the closing price of the registrant’s common stock on The NYSE Amex of $2.96 per share.
 
There were 40,675,347 shares of common stock outstanding as of March 23, 2010.
 
DOCUMENTS INCORPORATED BY REFERENCE:   The information required by Part III of Form 10-K is incorporated by reference from the registrant's definitive proxy statement on Schedule 14A that will be filed no later than the end of the 120-day period following the registrant's fiscal year end, or, if the registrant's definitive proxy statement is not filed within that time, the information will be filed as part of an amendment to this annual report on Form 10-K/A, not later than the end of the 120-day period.
 

 
TABLE OF CONTENTS

NIVS INTELLIMEDIA TECHNOLOGY GROUP, INC.
TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2009
 
PART I
     
ITEM 1.
BUSINESS
 
1
ITEM 1A:
RISK FACTORS
 
14
ITEM 1B.
UNRESOLVED STAFF COMMENTS
 
33
ITEM 2.
PROPERTIES
 
33
ITEM 3.
LEGAL PROCEEDINGS
 
33
ITEM 4.
(REMOVED AND RESERVED)
 
33
       
PART II
     
       
ITEM 5.
MARKET FOR REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
34
ITEM 6.
SELECTED CONSOLIDATED FINANCIAL DATA
 
36
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS
 
37
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
50
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
51
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
51
ITEM 9A.
CONTROLS AND PROCEDURES
 
51
ITEM 9B.
OTHER INFORMATION
 
53
       
PART III
     
       
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
   
ITEM 11.
EXECUTIVE COMPENSATION
 
53
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
53
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
54
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
 
54
       
PART IV
     
       
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
54
SIGNATURES
 
55
 
 
 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
The information contained in this Form 10-K, includes some statements that are not purely historical and that are “forward-looking statements.” Such forward-looking statements include, but are not limited to, statements regarding our company’s and our management’s expectations, hopes, beliefs, intentions or strategies regarding the future, including our financial condition, and results of operations. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,” “should,” “will,” “would” and similar expressions, or the negatives of such terms, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.

The forward-looking statements contained in this Form 10-K are based on current expectations and beliefs concerning future developments and the potential effects on the Company. There can be no assurance that future developments actually affecting us will be those anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond the parties’ control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements, including the following:

 
·
Our reliance on our major customers for a large portion of our net sales;
 
 
·
Our ability to develop and market new products;
 
 
·
Our ability to continue to borrow and raise additional capital to fund our operations;
 
 
·
Our expansion into the competitive mobile phone industry;
 
 
·
Our ability to collect aging trade receivables, which represent a substantial portion of our assets;
 
 
·
Our ability to effectively integrate the operations of Dongri, which we acquired in January 2010;
 
 
·
Our ability to accurately forecast amounts of supplies needed to meet customer demand;
 
 
·
Our ability to obtain extension to our significant outstanding short-term borrowings when they mature;
 
 
·
The market acceptance of our products;
 
 
·
Exposure to product liability and defect claims;
 
 
·
Fluctuations in the availability of raw materials and components needed for our products;
 
 
·
Protection of our intellectual property rights;
 
 
·
Changes in the laws of the PRC that affect our operations;
 
 
·
Inflation and fluctuations in foreign currency exchange rates;
 
 
·
Our ability to obtain all necessary government certifications, approvals, and/or licenses to conduct our business;
 
 
·
Development of a public trading market for our securities;
 
 
·
The cost of complying with current and future governmental regulations and the impact of any changes in the regulations on our operations; and
 
 
·
The other factors referenced in this prospectus, including, without limitation, under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business.”
 
These risks and uncertainties, along with others, are also described above under the heading “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of the Company’s assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and we cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward looking statements. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. 

 
 

 

PART I
 
ITEM 1.                      BUSINESS

With respect to this discussion, the terms, “we,” “us,” “our” or “the Company” refer to NIVS IntelliMedia Technology Group, Inc., and our 100%-owned subsidiary NIVS Holding Company Limited, a British Virgin Islands corporation (“NIVS BVI”) and its subsidiaries, including NIVS (Huizhou) Audio & Video Tech. Co., Ltd., a company organized under the laws of the People’s Republic of China (“NIVS PRC”), which is 97.5% owned by NIVS BVI and 2.5% owned by Tianfu Li, our Chief Executive Officer and Chairman of the Board.

Overview

We are engaged in the design, manufacture, marketing and sale of consumer electronic products. Our products primarily consist of audio and video products, including digital audio systems, televisions, digital video broadcasting (“DVB”) set-top boxes, DVD players, as well as audio/video peripheral and accessory products.  We have invested substantial resources in the research and development of our intelligent audio and video consumer products, most of which utilize our Chinese speech interactive technology to permit users to control our products through their spoken commands.  We recently added mobile phones and other 3G communication devices to our product portfolio.  In January 2010, we acquired Dongri, a mobile phone product manufacturer, for a purchase price of up to $23 million.  Our products are distributed worldwide, including markets in Europe, Southeast Asia and North America.

Industry

We compete within certain categories in the wholesale consumer electronics industry.  Our current focus is on standard and intelligent home audio and video products, in addition to mobile phones.

Standard audio and video equipment

Our products that compete in the standard audio and video equipment category include mid and high-end home audio products, including premium home theater systems, speakers, shelf-stereo systems, televisions, DVD players, DVB set-top boxes, portable digital players, and related products. Growth of this market segment has been driven primarily due to the increase in consumer demand for flat screen digital televisions and for audio and visual products that complement flat screen televisions to create a home theater experience. Price pressure remains a key challenge for manufacturers of consumer electronics as the retail industry continues to evolve, with the major emerging markets like China, Russia, and India maintaining their strong growth, and retailers driving their expansion into new geographies as well as into the online sector.

Intelligent audio and video equipment

The market for intelligent audio and video products consists of traditional video and audio products combined with speech-based interface. Our products that compete in the intelligent audio and video equipment category are based on the Chinese language and include many of the types of products that we offer in our line of standard audio and video products, except these products are equipped with our speech interactive technology. The market for intelligent audio and video products is less developed than the market for standard audio and video equipment, and the market for products in this market based on Chinese language is less developed than products based on Western languages.

The intelligent audio and video electronics market has experienced growth in part due to consumer demand for simple, convenient interfaces. Commensurate with the increase in the scope and complexity of functions in consumer electronic products has been the unforeseen consequence that many audio/visual products have become cumbersome and difficult to use. Products now commonly utilize complex menu structures and difficult to navigate user interfaces that can limit a user’s ability to fully enjoy the functionality and convenience offered by these products. As compared to standard equipment, intelligent audio and video products powered by voice commands possess unique capabilities, superior convenience, and an increased ease-of-use. Also, improvements in speech-based technologies have enabled companies to implement these features in a broader array of products.

 Mobile phone products

The mobile phone market in China has experienced rapid growth over the past several years, driven in part by the country’s strong overall economic development.   China maintains a relatively low mobile phone penetration rate, which we believe may lead to additional substantial growth in the sector.

The Chinese government has adopted 3G standards, and in May 2008, it announced a restructuring plan to increase competition in the telecommunications market by permitting two additional wireless carriers, China Telecom and China Unicom, to enter the market that was previously dominated by China Mobile.   We believe that the increase in competition in the market will result in increased demand for 3G mobile phones and accessories in China.

 
1

 

China

China is world’s second largest electronic product consumer, after only the United States. China’s market for home consumer electronics has been growing, due in part to the country’s rapid economic growth. Economic growth in China has led to greater levels of personal disposable income and increased spending among China’s expanding middle-class consumer base. Notwithstanding China’s economic growth, with a population of 1.3 billion people, China’s economic output and consumption rates are still small on a per capita basis compared to developed countries. As China’s economy develops, we believe that disposable income and consumer spending levels will continue to become closer to that of developed countries like the United States.

China’s market share of manufacture of consumer electronic devices is expected to increase. China has a number of benefits in the manufacture of home consumer electronics, which are expected to drive this growth:

Low costs. China continues to have a relatively low cost of labor as well as easy access to raw materials and land.

Proximity to electronics supply chain. Electronics manufacturing in general continues to shift to China, giving China-based manufacturers a further cost and cycle time advantage.

Proximity to end-markets. China has focused in recent years on building its research, development and engineering skill base in all aspects of higher end manufacturing.

The market for speech-controlled consumer products for Western languages is more developed than the market for speech-controlled consumer products for Chinese languages because, compared with Western languages, there are extra challenges related to large vocabulary and continuous speech recognition systems for the Chinese language. These challenges are primarily due to the more complicated characteristics of Chinese language as compared to Western languages. We expect to see the market for Chinese speech-controlled products grow as technologies improve.

Competitive Strengths

We believe the following strengths contribute to our competitive advantages and differentiate us from our competitors:

Market position

Since the inception of NIVS PRC, we have traditionally focused on the research, development and manufacture of standard and intelligent audio and video products, and have more recently expanded into the mobile phone industry.  We have developed significant expertise in the key technologies and large-scale manufacturing that enables us to improve the quality of our products, reduce costs, and keep pace with current standards of the rapidly evolving consumer electronics industry, in addition to leveraging this expertise into positioning ourselves in the mobile phone industry.  We are able to bring to the market well-differentiated products that perform well against competitive offerings based on price, style, and brand recognition.  Our specific Mandarin-speech interaction technology has broad application to consumer products and has allowed us to distinguish our products from those of our competitors.

Design and manufacturing capabilities

We employ a rigorous and systematic approach to product design and manufacturing. We employ a senior design team with members educated by top colleges in China, with an average of 13 to 15 years of experience. Our design team develops and tracks new concepts and ideas from a variety of sources, including direct customer feedback, trade shows, and industry conferences.  We have, through NIVS PRC, a 2.7 million square foot factory, which includes a large-scale, 1.1 million square-foot production area, and more than 1,886 full-time employees, including approximately 1,469 employees in production. Our modernized production lines include automated processing equipment and procedures that we can rapidly modify to accommodate new customer requests, designs and specifications.  Our use of manual labor during the production process benefits from the availability of relatively low-cost, skilled labor in China. NIVS PRC has received several accreditations, including The International Organization for Standardization (ISO) 9001: 2000, ISO 14000, and RoHS certification, attesting to our quality management requirements, manufacturing safety, controls, procedures and environmental performance.  With our acquisition Dongri and its mobile phone manufacturer capabilities in January 2010, we have established significant manufacturing capabilities for mobile phones.
  
Experienced management team

Our senior management team has extensive business and industry experience, including an understanding of changing market trends, consumer needs, technologies and our ability to capitalize on the opportunities resulting from these market changes. The founder of NIVS PRC and our principal stockholder and current CEO and Chairman, Tianfu Li, has over 18 years of experience in the consumer electronics industry, which has been a key factor in establishing long-lasting and valuable business relationships. Other members of our senior management team also have significant experience with respect to key aspects of our operations, including research and development, product design, manufacturing, and sales and marketing.

 
2

 

Well-established distribution channels

We sell our products through a well-established network of distributors and resellers allowing us to penetrate customer markets worldwide. Our products are sold domestically in China at over 8,000 points of sale and internationally through numerous channels, including independent specialty retailers, international and regional chains, mass merchants, and distributors. We have also built strong relationships with many large national and regional electronics retailers, and we have well-established relationships with thousands of independent retailers.

Customer service expertise

We work closely with our major customers in order to ensure high levels of customer satisfaction. We constantly evaluate and identify our strongest customers in each distribution channel and focus our sales efforts towards the largest and fastest growing distributors and resellers. To provide superior service and foster customer trust and loyalty, we offer flexible delivery methods and product feedback opportunities to our customers. For Original Equipment Manufacturer, or OEM, customers, we provide a complete range of services, allowing us to take customer products from initial design through production to testing, distribution and after market support. In addition, our sales representatives and marketing personnel undergo extensive training, providing them with the skills necessary to answer product and service-related questions, proactively educate potential customers about our products, and promptly resolve customer inquiries.

Brand awareness

Our consumer electronic products marketed under the NIVS brand, have become a recognized brand name in China, which we expect will assist us in growing our business over the course of the next few years. Our audio products have a solid reputation and established a brand name in the PRC, particularly in Guangdong.   In September 2009, we were granted a license by the China Ministry of Industry and Information Technology to manufacture and market mobile phones under our NIVS brand, and we believe that our established brand in the audio/video consumer electronics industry will launch our product in the mobile phone industry.

Strategy

Our goal is to become a global leader in the development and manufacture of consumer electronic products.  We intend to achieve this goal by implementing the following strategies:

Expand offering of mobile phone and speech-controlled products

We plan to continue to leverage our expertise in product design and development, our intellectual property platform, and our diverse distribution network by continuing to develop and introduce mobile phones.  We have recently made significant investments to enter into the growing mobile phone industry, and in September 2009, we were granted a license to manufacture mobile phones by the Ministry of Industry and Information Technology.  We have positioned ourselves to take advantage of the market’s expansion with our new Third Generation (“3G”) standard mobile phone and communication devices, which resulted in a $28.8 million order to manufacture mobile phones for China Telecom Corp. Ltd. for 3G mobile phones.

We also plan to strengthen the performance of our Chinese speech technology to provide users with an easy-to-use, speech-enabled interaction with consumer audio/visual products.  Our goal is to continue to enhance the functionality of our core speech interactive technology by adding new features and making our products simpler to use.  We intend to invest additional resources in our research and development and speech-controlled technology, applications and intellectual property to promote innovation and maintain customer preference for our products.

Build partnerships with new and existing clients

We intend to strengthen relationships with our existing clients and explore opportunities for product expansion with new and existing customers.  Our strategy is to establish partnerships with our current clients whereby we develop and manufacture new products based on client needs.  For example, we were recognized as one of the approved vendors for e-Surfing, the mobile-communication service brand for FMC services by China Telecommunications Corporation (China Telecom, 0728.hk), a mobile-communication services provider in China.  According to China Telecom's 2010 purchasing plan, eight suppliers have been selected as the approved vendors as its e-surfing 3G GSM/WCDMA duo system phone suppliers: Samsung, Motorola, Sony Ericsson, LG, Huawei, ZTE, Coolpad and NIVS.  In addition, Korea HYUNDAI named NIVS PRC as its sole brand promoter for its digital MP3/MP4 players and television products in China. As sole brand promoter, NIVS PRC provides to the public a uniform product image for HYUNDAI. NIVS PRC attempts to strengthen the HYUNDAI brand as a high-end, quality brand.

 
3

 

We also seek to leverage our Mandarin-speech interactive technology to develop relationships and strategic alliances with third-party developers, vendors, and manufacturers of mobile phones, entertainment devices, and GPS navigation devices for use in their products.  We believe OEMs of consumer electronics devices and products, wireless operators, system integrators and value-added resellers (“VARs”) can simplify the use and increase the functionality of their electronic products and services by integrating our speech interactivity technologies, resulting in broader market opportunities and significant competitive advantages. For example, we believe that our technology can provide users a more convenient way to enter SMS messages, mobile instant messages, and mobile email into mobile wireless devices, significantly faster than with the traditional keypad.  We believe our technology can also be used in navigation systems to enable voice-activated dialing, voice destination entry, and vehicle command and control for in-vehicle entertainment systems.

Expand global presence

A growing percentage of our products are exported to countries outside of China, primarily to Europe, Southeast Asia, and North America. We intend to further expand our international resources to better serve our global customers and business associates and to leverage opportunities in markets such as Hong Kong, the Middle East, India, Great Britain, Germany, the United States, and Argentina. We hope to continue to add regional sales representatives and distributors in different geographic regions to better address demand for our products.

Expand sales network and distribution channels

We intend to expand our sales network in China and develop relationships with a broader set of wholesalers, distributors and resellers, all in order to expand the market availability of our products in China. We feel the Chinese markets are underserved and there exists vast opportunities to expand market presence. We hope that these relationships will allow us to diversify our customer base and significantly increase the availability and exposure of our products.

Augment marketing and promotion efforts to increase brand awareness

We continue to devote our efforts towards brand development and utilize marketing concepts in an attempt to strengthen the marketability of our products. During the past several years, we have carried out a brand development strategy based on product innovation, quality, and design excellence. We have also participated and intend to continue to participate in various exhibitions and similar promotional events to promote our products and brand, including Consumer Electronics Show (CES) in the United States, the IFA Electronics Fair, and the Hong Kong Electronics Fair.

Products

We have traditionally offered two primary lines of home audio and video products—standard audio and video equipment (including DVD players and DVB set-top boxes) and intelligent audio and video equipment—and we have recently began offer mobile phone products.

Audio and video products

As of December 31, 2009, our standard audio and video products include approximately 500 different products and our intelligent audio and video products include approximately 150 products. As of December 31, 2009, our standard audio and video products include approximately 500 different products and our intelligent audio and video products include approximately 150 products. We generate over 50% of our revenues from our sales of speech-controlled acoustics and televisions and we hope to continue to increase this portion of revenue going forward. The sale of standard audio equipment is the second largest, followed by sales of DVB boxes, DVD players, and televisions. A growing portion of our revenues is generated from our sales of speech-controlled acoustics and televisions and we hope to continue to increase this trend going forward.

Our line of standard audio and video equipment consists of mid- and high-end products, including:

·
packaged home theater systems,
  
·
a wide range of tower, stand-alone and on-wall speaker systems,
 
·
powered subwoofers used in a complete range of products for traditional stereo and home theater applications,
 
·
smaller speakers designed for specific home theater and stereo applications,
 
·
personal shelf-stereo systems,

·
KTV, Villa, and electronic tube speakers,
 
·
LCD televisions in sizes ranging from 17 to 52 inches,

·
LED televisions, portable televisions,
 
·
DVD players, including portable DVD players, DVD recorders and combination DVD/audio players,
 
 
4

 

·
DVB set-top boxes, DVB satellite receivers,
 
·
hi-fi multi-media speakers,

·
in-car Bluetooth speakerphones, all-in-one PC/TV, and
 
·
related peripheral and accessory products.
 
Our speech-controlled products are designed to improve people’s interaction with our products, making their experience more enjoyable, convenient, and safe and satisfying. Our intelligent video and audio products utilize our Mandarin-speech interactive technology to receive, recognize, and respond to spoken commands, permitting users to activate and control products solely through spoken-word. We believe our technology’s recognition and command functionality is highly accurate, particularly at home where there is less noise and interference. Our speech interactive technology is speaker independent, meaning that no voice training is involved. We believe our speech-controlled audio systems, speech-controlled television sets, and intelligent set-top boxes provide users with unique capabilities, superior convenience, and ease of use.

Our line of intelligent audio and video products consist of the types of our standard products with our integrated speech-controlled interface technology, including speech-controlled home theater systems, televisions, DVD players, set-top boxes, and shelf stereo systems. Our intelligent consumer products can be controlled by users’ oral commands to control all functions, including power, channel selection, volume control, and other setting controls. We also offer speech-controlled professional stage acoustics for use in gymnasiums, and other plazas and performance venues.

We also manufacture and distribute other peripheral and accessory consumer electronic products, such as remote controls, headphones, and lighting solutions. We have a universal speech-activated remote controller and module that works with most televisions, set-top box products, DVD players, and other audio/visual products.

Mobile phone products

In September 2009, we were granted a license to manufacture mobile phones by the Ministry of Industry and Information Technology. With our new license, we are authorized to operate mobile phone manufacturing business in mainland China under the “NIVS” brand name.   We have capabilities and intellectual property rights to manufacture 3G mobile phones and have already introduced a dual-mode EVDO/GSM 3G handset to the market.

Our mobile phones are equipped with many advanced features such as e-mail and multimedia messaging, touchscreen and PDA functionality, large CSTN (Color Super Twisted Nematic) and TFT (Thin Film Transistor) dual-color displays, MP3/MP4 audio and video recording and playing, and high resolution photography.

We also intend to offer other 3G communication products, such as 3G netbooks, 3G web surfing cards, 3G routers, 3G webcams. We expect to offer 3G surveillance camera, which we expect to be available for sale by mid-February 2010.  We believe that the potential applications for our new 3G surveillance camera include security in a commercial or industrial environment or in a home setting for baby or child monitoring, as an example. The camera can be accessed via a mobile phone in addition to computer access.

Net sales for each of our product categories as a percentage of net sales are set forth below:

  
 
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
Standard Audio and Video Equipment
   
49
%
   
80
%
   
92
%
Intelligent Audio and Video Equipment
   
45
%
   
13
%
   
6
%
Other Audio and Video Equipment
   
6
%
   
7
%
   
2
%

Supply of Raw Materials

The cost of the raw materials used to produce our products is a key factor in the pricing of our products. We currently work with over 100 supply manufacturers in attempt to establish a rapid and stable supply of high quality raw materials. Raw materials used in the manufacture of our products include integrated circuits, plastic-rubber materials, hardware materials, LCD/TFT/plasma display screens, LED, capacitors, resistors, switches, electrical outlets, wood board materials, packaging materials, and other electrical components. We attempt to purchase materials in volume which allows us the ability to negotiate better pricing with our suppliers. Our purchasing department locates eligible suppliers of raw materials and strives to use only those suppliers who have previously demonstrated quality control and reliability.

We procure materials to meet forecasted customer requirements. Special products and large orders are quoted for delivery after receipt of orders at specific lead times. We maintain minimum levels of finished goods based on market demand in addition to inventories of raw materials, work in process, and sub-assemblies and components. We reserve for inventory items determined to be either excess or obsolete.

 
5

 

Pricing and availability of raw materials can be volatile, attributable to numerous factors beyond our control, including general economic conditions, currency exchange rates, industry cycles, production levels or a supplier’s limited supply. To the extent that we experience cost increases we may seek to pass such cost increases on to our customers, but cannot provide any assurance that we will be able to do so successfully or that our business, results of operations and financial condition would not be adversely affected by increased volatility of the cost and availability of raw materials.

Our primary suppliers of raw materials are located in Japan, South Korea, Taiwan, United States, and China. Our top three suppliers accounted for an aggregate total of approximately 21.3%, 17.0%, and 18.8% of our raw material purchases for the years ended December 31, 2009, 2008 and 2007.  Other than these suppliers, no other supplier accounted for more than 5% of our total purchases in these periods.  The increase in our use of certain suppliers during fiscal 2009 as compared to fiscal 2008 is primarily attributable to adjustments in our purchasing strategy.  Due to an increasing price of raw materials, and because most of our production material is imported from other countries, we arranged for a fewer number of import companies to act as our import agents to save time and costs.  Our shift to a few import companies resulted in our top three suppliers accounting for a higher percentage of our raw material purchases during fiscal 2009.  In addition, the sales volume of our televisions and DVB set-top boxes increased significantly in fiscal 2009 as compared to fiscal 2008.  Most of the material for these two product categories are new model materials and are imported through our top three suppliers, which increased the total percentage of raw materials purchased through these suppliers. In addition, we acquired Dongri and its mobile phone manufacturer capabilities in January 2010 to strengthen our manufacturing capabilities for mobile phones in an attempt to reduce our reliance on third-party supplier for mobile phones components.

Presently, our relationships with our suppliers are good and we expect that our suppliers will be able to meet the anticipated demand for our products in the future.  However, due to our dependence on a few suppliers for certain raw materials, we could experience delays in development and/or the ability to meet our customer demand for new products.  In addition, we have a number of longstanding business relationships with certain suppliers, and we believe that alternative suppliers are available. Although we have not been subject to shortages for any of our components, we may be subject to cutbacks and price increases which we may not be able to pass on to our customers in the event that the demand for components generally exceeds the capacity of our suppliers.  We believe our manufacturing facility and design center in Huizhou, China, due to its location, provides us with flexibility in our supply chain, to better manage inventories and to reduce delays and long-term costs for our products.

Manufacturing

The manufacture of consumer electronics requires coordinated use of machinery and raw materials at various stages of manufacturing. Our manufacturing operations are conducted in Huizhou, Guangdong, in our modern, 2.7 million square-foot factory, which houses a large-scale, 1.1 million square-foot production area. We use automated machinery to process key aspects of the manufacturing process to ensure high uniformity and precision, while leaving the other aspects of the manufacturing process to manual labor. Our production facilities utilize modern machinery such as molding injectors, mounting machinery, cutting machines, sorting devices, soldering modules, wire cutting equipment, and other assembly machinery. We intend to further streamline our production process and continue investing in our manufacturing infrastructure to further increase our manufacturing capacity, helping us to control the per unit cost of our products.

We have historically outsourced manufacturing and customization of our mobile phone products.  In an effort to reduce our reliance on third-party manufacturers, we acquired Huizhou Dongri Digital Co., Ltd., ("Dongri"), a mobile phone product manufacturer, in January 2010.  The aggregate purchase price that we agreed to pay is up to $23 million, with $13 million being paid within one month of closing and up to an additional $10 million that may become payable at future dates if Dongri meets certain quarterly after-tax income targets during 2010.  With the acquisition of Dongri, we strengthen our manufacturing capabilities for mobile phones by increasing production capacity for mobile phones up to one million units per month.

Quality Control

We consider quality control an important element of our business practices. We have stringent quality control systems that are implemented by approximately 55 company-trained staff members to ensure quality control over each phase of the production process, from the purchase of raw materials through each step in the manufacturing process. Supported by advanced equipment, we utilize a scientific management system and precision inspection measurement, capable of ensuring our products are of high quality.

Our quality control department executes the following functions:

·
setting internal controls and regulations for semi-finished and finished products;
 
·
testing samples of raw materials from suppliers;

 
6

 
 
·
implementing sampling systems and sample files;
 
·
maintaining quality of equipment and instruments; and
 
·
articulating the responsibilities of quality control staff.
 
NIVS PRC has obtained certifications and accreditations that we believe exhibit our ability to efficiently manufacture quality products. NIVS PRC first obtained ISO9001:2000 quality system accreditation in July 2001 and ISO14000 environmental management system accreditation in October 2006. The International Organization for Standardization (ISO) defines the ISO 9000 quality management system as one of international references for quality management requirements in business-to-business dealings. ISO 14000 is an environmental management system in which the organization being accredited has to (i) minimize harmful effects on the environment caused by its activities, and (ii) achieve continual improvement of its environmental performance. In December 2005, NIVS PRC obtained certification for compliance with the Directive on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment, which is commonly referred to as the Restriction of Hazardous Substances Directive, or RoHS. RoHS restricts the use of various hazardous materials in the manufacture of electronic and electrical equipment.

Sales and Marketing

We have a sales network of more than 8,000 points of sale in China, in addition to distributors throughout more than 80 countries and regions around the world. Our sales network spans across all major provincial-level cities and a majority of municipal and county-level cities in China.   Our distribution network includes exclusive provincial and regional distributors, resellers, independent vendors, value-added resellers, and hardware vendors in addition to other marketplace points of sales.

We have established a standard of sales procedures covering before-sales consultation, preliminary design, final design, mold preparation, sample confirmation, production, product testing, sales, and after-sales services and technical support.  We have approximately 300 service stations throughout China, in addition to a 24-hour/7 days-a-week telephone hotline.  We have also set up 23 regional service centers in Europe, Southeast Asia, and North America to better serve our international clients.  The regional service centers offer updated product information, repair service and technical consultations for customers.

Most of our revenues are derived from sales to OEMs, or Original Equipment Manufacturers, followed by sales of our NIVS branded products.  OEMs contract with us to build their products or to obtain services related to product development and prototyping, volume manufacturing or aftermarket support.  Our services include engineering, design, materials, management, assembly, testing, distribution, and after-market services.  We believe that we are able to provide quality OEM services that meet unique requirements within customer timeframes, unique styling, product simplicity, price targets, and consistent quality with low defect rates.  As a result of efficiently managing costs and assets, we believe we are able to offer our customers an outsourcing solution that represents a lower total cost of acquisition than that typically provided by the OEM's own manufacturing operation. OEM sales accounted for 55%, 60%, and 77% of our revenues for the years ended December 31, 2009, 2008 and 2007, respectively, and sales of products with our own brand accounted for 45%, 40%, and 23% of our revenues for the same periods, respectively.

In addition, some of our OEM cooperation arrangements are with well-known manufacturers, including Samsung, Hyundai, Haier, and TCL. From February to June 2005, NIVS PRC commenced business relationships with each of Wal-Mart, Carrefour Group, and METRO pursuant to which these large distribution companies agreed to distribute our products. In January 2005, NIVS PRC began a business relationship with Samsung pursuant to which it is the exclusive authorized OEM manufacturer of Samsung’s multi-media speakers in China.

The table below shows our revenue categorized by geographic locations, which is based on the geographic areas in which our customers are located.

   
Year Ended December 31,
 
   
2009
   
2008
   
2007
 
China and Hong Kong
   
43.6
%
   
77.1
%
   
58.2
%
Other Asian Countries
   
28.5
     
16.3
     
24.0
 
Europe
   
16.1
     
3.1
     
11.9
 
South America
   
2.2
     
2.2
     
2.6
 
North America
   
1.4
     
1.1
     
3.3
 
Other countries
   
8.2
     
0.2
     
-
 
Total
   
100
%
   
100
%
   
100
%

In December 2009, our Chairman of the Board and Chief Executive Officer, Tianfu Li, was honored with a "Brand China People of the Year 2009" award from the Brand China Industry Union.  Each year, ten award winners are selected from both private and public domestic Chinese companies. Nominees and winners are chosen through a competitive combination of public voting and a selection committee that evaluates individuals based on their contribution to the promotion of the development of Chinese brands and the influence of those brands both domestically and internationally in 2009.

 
7

 

NIVS PRC has also received various governmental awards with respect to our brand. Beginning in 2005, NIVS PRC’s brand received the “Most Popular Brand” award in the acoustics industry for three successive years. NIVS PRC also received the “Famous Brand in Guangdong” award in 2007. In June 2003, NIVS PRC was honored by the Science and Technology Bureau of Guangdong Province as a “Private High-tech Enterprise” and “High-tech Enterprise,” which is an honor reserved for private enterprises developing new high-technology.

A small number of customers account for a very significant percentage of our revenue. The table below illustrates the number of customers that accounted for 5% or more of our sales for the periods presented.

 
Year Ended December 31,
 
 
2009
 
2008
 
2007
 
Number of customers accounting for 5% or more
   
4
     
4
     
5
 
Percentage of largest customer
   
15.9
%
   
12.7
%
   
13
%
                         
Total percentage of sales attributable to customers with 5% or more
   
34.9
%
   
33.4
%
   
38
%

The loss of any of these customers could have a material adverse effect upon our revenue and net income.

In addition, one customer represents substantially all of our mobile phone product sales. We entered into a purchase agreement with Kuanda (Xiamen) Communications Co., Ltd and China PTAC Communications Services, on behalf of China Telecom, for the purchase by China Telecom of our two 3G mobile phone products.  The purchase agreement is contingent on delivery of the 3G mobile phones representing the aggregate order by March 31, 2010.  The value of the order is approximately $28.8 million; the dollar value of any additional orders further to this relationship depends on the final number of delivered products.  If we fail to meet the requirements of the order or otherwise lose China PTAC as a customer could result in a material adverse effect upon our revenue and net income.

Research and Development

To enhance our product quality, reduce cost, and keep pace with technological advances and evolving market trends, we have established an advanced research and development center. Our research and development center is focused on enhancing our Chinese speech interactive technology by improving the performance of our current products and developing new products, in addition to developing related and alternative technologies. We have made investments in capital and time to develop technology engines, intellectual property and industry expertise in Chinese speech technologies that we believe provide us with a competitive advantage in the markets where we compete. Our technologies are based on complex formulas which require extensive amounts of linguistic data, acoustic models and recognition techniques. We continue to invest in technologies to maintain our market position and to develop new applications and products.

We conduct substantially all of our research and development with an in-house staff. After establishing its modernized speech technology lab in 2002, NIVS PRC has been able to more effectively recruit qualified speech technology researchers. We have approximately six senior technology researchers, many holding doctorate degrees, and 15 core researchers. The duties of our core researchers are to improve research and development management and market analysis, in addition to establishing and regulating the large-scale production projects. In addition, our research and development center is currently staffed with over 100 experienced research and development technicians who oversee our techniques department, product development department, material analysis lab, and performance testing lab. These departments work together to research new material and techniques, test product performance, inspect products and to test performance of machines used in the manufacturing process.
  
NIVS PRC has worked with Institute of Automation, Chinese Academy of Sciences, or IACAS, since October 2006 to better understand and develop Mandarin speech interaction technology. IACAS is an organization that specializes in the research and development of smart robot and speech interactive technology. We have focused our efforts to resolve issues caused by speaker-independent speech, the large number of words, and continuous speech identification. We have and continue to develop key technologies, including combined modeling for intonation and vowel variation, large speech database management, and system searching.

We continue to research and develop speech performance engines and databases. The various types of speech interactive engines include multi-language identification engines, compositing engine, and speech evaluation engine. Multi-language identification engines are products that can identify multiple languages. Compositing engines can speak as humans. Speech evaluation engines can make judgments of yes or no. In addition, our intelligent audio and video products require input from a speech database that we have assembled. We have generated numerous databases, including professional speech identification, speech synthesis, speech teaching and speech entertainment databases.

 
8

 

In December 2009, we entered into a strategic partnership arrangement with China Potevio pursuant to which we would collaborate with Potevio for the development of a 3G mobile phone, as well as the application of China Potevio's TD-SCDMA wireless products and solutions. We will also work with China Potevio’s research team to develop and apply the new technologies to our NIVS branded mobile phone, distributed in the mainland Chinese domestic market.  China Potevio is a state-owned equipment manufacturer and service provider in China’s telecommunications industry.

For the years ended December 31, 2009, 2008 and 2007, we expended approximately $5.3 million, $1.7 million, and $0.4 million, respectively, in research and development.

In addition to the advancement of our speech interactive and mobile phone technologies, we believe that the future success of our business depends upon our ability to enhance our existing products, to develop compelling new products, to develop cost effective products, to qualify these products with our customers, to effectively introduce these products to existing and new markets on a timely basis, and to commence and sustain volume production to meet customer demands. To avoid product obsolescence, we will continue to monitor technological changes, as well as users' demands for new technologies. Failure to keep pace with future technological changes could adversely affect our revenues and operating results in the future. Although we have attempted to determine the specific needs of the entertainment, mobile, computer, and residential user markets, there can be no assurance that the markets will, in fact, materialize or that our existing and future products designed for these markets will gain market acceptance.

Backlog
 
Our backlog of unfilled orders was $0.86 million as of December 31, 2009, compared to $1.32 million at December 31, 2008. We include all purchase orders scheduled for delivery over the next 12 months in backlog. As part of our commitment to customer service, our goal has been to ship products to meet the customers' requested shipment dates. Our backlog is occasionally subject to cancellation or rescheduling by the customer on short notice with little or no penalty. Because of the uncertainty of order cancellations or rescheduling, we do not believe our backlog as of any particular date is indicative of actual sales for any future period and, therefore, should not be used as a measure of future revenue.

Warranties and Return Policy

We offer limited warranties for our consumer electronics, comparable to those offered to consumers by our competitors in China. Such warranties typically consist of a 90-day period for our audio products, under which we will pay for labor and parts, or offer a new or similar unit in exchange for a non-performing unit. Our customers may return products to us for a variety of reasons, such as damage to goods in transit, cosmetic imperfections and mechanical failures, if within the warranty period. We offer a one-year guarantee for all of our products.

Product Liability and Insurance

We do not have product liability insurance. Because of the nature of the products sold by us, we may be periodically subject to product liability claims resulting from personal injuries. We may become involved in various lawsuits incidental to our business. To date, we have not been subject to products liability litigation. Product liability insurance is expensive, restrictive and difficult to obtain. Accordingly, there can be no assurance that we will have capital sufficient to cover any successful product liability claims made against us in the future, which could have a material adverse effect on our financial condition and results of operations.
  
Competition

We face competition from many other consumer electronics manufacturers, most of which have significantly greater name recognition and financial, technical, manufacturing, personnel, marketing, and other resources than we have. The major geographic markets in which we compete are China and Hong Kong, Southeast Asia and North America. The consumer electronics market is subject to rapid technology changes, highly fragmented, and cyclical. The industry is characterized by the short life cycle of products, requiring continuous design and development efforts, which necessitates large capital and time investments. Our competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products than we do.

We compete primarily on the basis of quality, price, design, reliability, brand recognition, and quality service and support to our customers. We believe that our standard audio and video consumer products are comparable in quality and performance with competitors in our market category. Many of our competitors in the standard audio and video consumer products market have a stronger competitive position than we do in that they have more technical and research and development resources, greater brand recognition and longer-standing customer relationships. Companies that offer products similar to our standard audio and video consumer products include SAMSUNG Electronics, Bose Corporation, LG Electronics, Matsushita Electric Industrial Co., Ltd., and Toshiba Corporation.

 
9

 

We believe that our intelligent audio and video products are comparable in quality and performance with competitors in our market category. Many of our competitors in the intelligent audio and video products market have a stronger competitive position than we do in that they have more technical and research and development resources, greater brand recognition and longer-standing customer relationships and began developing English intelligent speech technology earlier than we did. We believe have a strong competitive position in our domestic market for Mandarin-speech interactive technology as we have significant technical and research and development resources on Mandarin-speech technology. Companies that offer products similar to our intelligent audio and video products include Nuance Communications, Inc., Fonix Corporation, International Business Machines Corporation, Microsoft Corporation, Koninklijke Philips Electronics N.V., Haier Electronics Group Co., Ltd., Anhui USTC iFLYTEK Co., Ltd., and Shenzhen SinoVoice Digital Technology Co., Ltd.

We began to compete in the mobile phone industry in 2009 and therefore have no experience and brand awareness in the mobile phone industry.  The mobile phone market is particularly characterized by changing consumer demands for cellular telephone functions and applications, rapid product obsolescence and price erosion, intense competition, evolving industry standards, and wide fluctuations in product supply and demand. These factors require us to continuously develop new products and enhance our existing products to stay competitive.  For example, the market has recently experience rapid transitions from widespread market adoption of 2G, 2.5G, 2.75G and 3G technologies.  Changes in mobile phone industry standards and technologies, customer preferences and government regulation are rapid, more so than that of audio and video equipment, and this rapid change could limit our ability to sell our mobile phone products.  Our competitors have more experience in the industry and may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements.  Our mobile phone products face intense competition from multi-national mobile phone manufacturers such as Nokia, Samsung, and Motorola, in addition to competition from the domestic mobile phone producers such as Tianyu, Lenovo, and Gionee.

Intellectual Property

We rely on a combination of patent, trademark and trade secret protection and other unpatented proprietary information to protect our intellectual property rights and to maintain and enhance our competitiveness in the consumer electronics industry.  The founder of NIVS PRC and our principal shareholder and current Chief Executive Officer, Tianfu Li, has legal ownership of the approximately 48 patents in China, in addition to 19 patent applications, that we use in our business operations.  These patents include design, utility, and invention patents that relate to our products.  In July 2008, NIVS PRC entered into an assignment and transfer agreement with Mr. Li for the transfer and assignment of these patents and patent applications to NIVS PRC, in addition to other intellectual property related to our business operations.  We and Mr. Li intend to file appropriate transfer certificates with the Bureau of Intellectual Property in the PRC, which, after approved by the Bureau, would result in the legal transfer of the patents and patent applications to us.

We also rely on unpatented technologies to protect the proprietary nature of our product and manufacturing processes. We require that our management team and key employees enter into confidentiality agreements that require the employees to assign the rights to any inventions developed by them during the course of their employment with us. All of the confidentiality agreements include non-competition and non-solicitation provisions that remain effective during the course of employment and for periods following termination of employment, which vary depending on position and location of the employee.

We have four registered trademarks in China, with expiration dates between April 2011 and November 2016, and seven registered trademark applications.

Our success will depend in part on our ability to obtain patents and preserve other intellectual property rights covering the design and operation of our products. We intend to continue to seek patents on our inventions when we deem it commercially appropriate. The process of seeking patent protection can be lengthy and expensive, and there can be no assurance that patents will be issued for currently pending or future applications or that our existing patents or any new patents issued will be of sufficient scope or strength or provide meaningful protection or any commercial advantage to us. We may be subject to, or may initiate, litigation or patent office interference proceedings, which may require significant financial and management resources. The failure to obtain necessary licenses or other rights or the advent of litigation arising out of any such intellectual property claims could have a material adverse effect on our operations.
 
Employees

As of December 31, 2009, we had approximately 1,886 full-time employees, including approximately 1,469 employees in production and approximately 79 employees in sales and marketing. All of our employees are based inside China. Our employees are not represented by any labor union and are not organized under a collective bargaining agreement, and we have never experienced a work stoppage. We believe that our relationships with our employees are generally good.

NIVS PRC is required to contribute a portion of its employees’ total salaries to the Chinese government’s social insurance funds, including pension insurance, medical insurance, unemployment insurance, and job injuries insurance, and maternity insurance, in accordance with relevant regulations. Total contributions to the funds are approximately $213,650, $217,882, and $232,655 for the years ended December 31, 2009, 2008 and 2007, respectively. We expect that the amount of NIVS PRC’s contribution to the government’s social insurance funds will increase in the future as we expand our workforce and operations.

 
10

 

We also provide housing facilities for our employees. At present, approximately 80% of our employees live in company-provided housing facilities. Under PRC laws, we may be required to make contributions to a housing assistance fund for employees based in Huizhou, China.  We expect that the costs and expenses of conducting our business operations will increase, which could have a negative effect on our results of operations.

According to the relevant PRC regulations on housing provident funds, PRC enterprises are required to contribute housing provident funds for their employees. The monthly contributions must beat least 5% of each employee’s average monthly income in the previous year. NIVS PRC has not paid such funds for its employees since its establishment and the accumulated unpaid amount is approximately $870,000. For additional information, see “Risk Factors—We may be exposed to monetary fines by the local housing authority and claims from our employees in connection with NIVS PRC Light’s non-compliance with regulations with respect to contribution of housing provident funds for employees.”

PRC Government Regulations

Business license

Any company that conducts business in the PRC must have a business license that covers a particular type of work. Our business license covers our present business of to design, produce, and sell consumer electronic products, including digital camcorders, digital video recorders, digital audio recorders, digital audio and video coding and decoding equipments, digital audio radio equipments; produce and sell digital products for education and entertainment (MP3, MP4 and game box), PC equipment, and televisions, among other products.  Prior to expanding our business beyond that of our business license, we are required to apply and receive approval from the PRC government.  In September 2009, we were granted a license to manufacture mobile phones by the Ministry of Industry and Information Technology. With our new license, we are authorized to operate mobile phone manufacturing business in mainland China under the “NIVS” brand name.

Sino-Foreign Equity Joint Venture Laws

NIVS PRC, as a Sino-Foreign Equity Joint Venture, is governed by the Law of the People's Republic of China on Sino-Foreign Equity Joint Ventures, and its Implementation Regulations and other related rules, regulations and administrative orders.  An equity joint venture in the PRC is an independent entity having the form of a limited liability company, similar to a regular corporation with limited liability organized under state laws in the United States of America.  It is a "legal person" under PRC laws and has the right to own, use and dispose of property rights. The parties to the equity joint venture agree to share profits, risks and losses in the same proportion as their respective capital contributions to the equity joint venture.

The operations of equity joint ventures are subject to an extensive body of laws and regulations governing such matters as registration, capital contribution, profit distribution, board of directors, accounting, taxation, foreign exchange and labor management.  The PRC joint venture law stipulates that certain matters such as amendment to the articles of association, termination and dissolution of the equity joint venture, increase and transfer of the registered capital, and merger, must have the unanimous approval of the directors.  The PRC joint venture law also provides that after payment of taxes, an equity joint venture must allocate to three funds, namely, a reserve fund, an expansion fund and a fund for employee welfare and bonuses, before profits may be distributed to the joint venture parties. Under current law, the board of directors of the joint venture is entitled to determine the percentage of net income that the joint venture will allocate to these three funds. The board of directors has elected to allocate 10% of the net income of the joint venture to each of these three funds each year. If the Chinese government elects in the future to require that the joint venture allocate more of the annual net income of the joint venture to these three funds, or if the Chinese government enacts other legislation that restricts the ability of the joint venture either to use its net income for business operations or to distribute dividends to us, our business could be adversely affected.
 
Employment laws

We are subject to laws and regulations governing our relationship with our employees, including: wage and hour requirements, working and safety conditions, citizenship requirements, work permits, social insurance, non-completion obligations and travel restrictions. These include local labor laws and regulations, which may require substantial resources for compliance.

Environmental regulations

We are subject to various federal, state, local and foreign environmental laws and regulations, including those governing the use, discharge and disposal of hazardous substances in the ordinary course of our manufacturing process. The major environmental regulations applicable to us include the PRC Environmental Protection Law, the PRC Law on the Prevention and Control of Water Pollution and its Implementation Rules, the PRC Law on the Prevention and Control of Air Pollution and its Implementation Rules, the PRC Law on the Prevention and Control of Solid Waste Pollution, and the PRC Law on the Prevention and Control of Noise Pollution. In addition, we have complied with European Union Directives on Restrictions on certain Hazardous Substances on electrical and electronic equipment (“RoHS”).  We believe that our current manufacturing operations comply in all material respects with applicable environmental laws and regulations. Although we believe that our current manufacturing operations comply in all material respects with applicable environmental laws and regulations, it is possible that future environmental legislation may be enacted or current environmental legislation may be interpreted to create environmental liability with respect to our other facilities, operations, or products.

 
11

 

NIVS PRC constructed its manufacturing facilities with the PRC’s environmental laws and requirements in mind. We currently outsource the disposal of solid waste to a third party-contractor. We currently hold an environmental permit and Guangdong Province Pollution Charge Certificate issued by the Huizhou Environmental Protection Bureau covering our manufacturing operations. If we fail to comply with the provisions of the permit and environmental laws, we could be subject to fines, criminal charges or other sanctions by regulators, including the suspension or termination of our manufacturing operations.

Patent protection in China

The PRC’s intellectual property protection regime is consistent with those of other modern industrialized countries. The PRC has domestic laws for the protection of rights in copyrights, patents, trademarks and trade secrets.

The PRC is also a signatory to most of the world’s major intellectual property conventions, including:

·
Convention establishing the World Intellectual Property Organization (WIPO Convention) (June 4, 1980);
 
·
Paris Convention for the Protection of Industrial Property (March 19, 1985);
 
·
Patent Cooperation Treaty (January 1, 1994); and
 
·
The Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) (November 11, 2001).
 
Patents in the PRC are governed by the China Patent Law and its Implementing Regulations, each of which went into effect in 1985. Amended versions of the China Patent Law and its Implementing Regulations came into effect in 2001 and 2003, respectively.

The PRC is signatory to the Paris Convention for the Protection of Industrial Property, in accordance with which any person who has duly filed an application for a patent in one signatory country shall enjoy, for the purposes of filing in the other countries, a right of priority during the period fixed in the convention (12 months for inventions and utility models, and 6 months for industrial designs).

The Patent Law covers three kinds of patents—patents for inventions, utility models and designs. The Chinese patent system adopts the principle of first to file; therefore, where more than one person files a patent application for the same invention, a patent can only be granted to the person who first filed the application. Consistent with international practice, the PRC only allows the patenting of inventions or utility models that possess the characteristics of novelty, inventiveness and practical applicability. For a design to be patentable, it cannot be identical with or similar to any design which, before the date of filing, has been publicly disclosed in publications in the country or abroad or has been publicly used in the country, and should not be in conflict with any prior right of another.

PRC law provides that anyone wishing to exploit the patent of another must conclude a written licensing contract with the patent holder and pay the patent holder a fee. One broad exception to this rule, however, is that, where a party possesses the means to exploit a patent but cannot obtain a license from the patent holder on reasonable terms and in reasonable period of time, the PRC State Intellectual Property Office, or SIPO, is authorized to grant a compulsory license. A compulsory license can also be granted where a national emergency or any extraordinary state of affairs occurs or where the public interest so requires. SIPO, however, has not granted any compulsory license to date. The patent holder may appeal such decision within three months from receiving notification by filing a suit in a people’s court.

PRC law defines patent infringement as the exploitation of a patent without the authorization of the patent holder. Patent holders who believe their patent is being infringed may file a civil suit or file a complaint with a PRC local Intellectual Property Administrative Authority, which may order the infringer to stop the infringing acts. Preliminary injunction may be issued by the People’s Court upon the patentee’s or the interested parties’ request before instituting any legal proceedings or during the proceedings. Damages in the case of patent infringement is calculated as either the loss suffered by the patent holder arising from the infringement or the benefit gained by the infringer from the infringement. If it is difficult to ascertain damages in this manner, damages may be reasonably determined in an amount ranging from one to more times of the license fee under a contractual license. The infringing party may be also fined by Administration of Patent Management in an amount of up to three times the unlawful income earned by such infringing party. If there is no unlawful income so earned, the infringing party may be fined in an amount of up to RMB500,000, or approximately $73,200.

Tax

Pursuant to the Provisional Regulation of China on Value Added Tax and their implementing rules, all entities and individuals that are engaged in the sale of goods, the provision of repairs and replacement services and the importation of goods in China are generally required to pay VAT at a rate of 17.0% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayer. Further, when exporting goods, the exporter is entitled to a portion of or all the refund of VAT that it has already paid or borne. Our imported raw materials that are used for manufacturing export products and are deposited in bonded warehouses are exempt from import VAT.

 
12

 

Foreign currency exchange

Under the PRC foreign currency exchange regulations applicable to us, the Renminbi is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of the PRC State Administration of Foreign Exchange, or SAFE. Foreign-invested enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from the SAFE. Capital investments by foreign-invested enterprises outside of China are also subject to limitations, which include approvals by the Ministry of Commerce, the SAFE and the State Reform and Development Commission.  We currently do not hedge our exposure to fluctuations in currency exchange rates.

Dividend distributions

Under applicable PRC regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a foreign-invested enterprise in China are required to set aside at least 10.0% of their after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reach 50.0% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.

 
13

 

ITEM 1A:                      RISK FACTORS

Any investment in our common stock involves a high degree of risk. Potential investors should carefully consider the material risks described below and all of the information contained in this Form 10-K before deciding whether to purchase any of our securities. Our business, financial condition or results of operations could be materially adversely affected by these risks if any of them actually occur. The trading price could decline due to any of these risks, and an investor may lose all or part of his investment.  Some of these factors have affected our financial condition and operating results in the past or are currently affecting us. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced described below and elsewhere in this Form 10-K.
 
RISKS RELATED TO OUR OPERATIONS
 
We depend on a small number of customers for the vast majority of our sales. A reduction in business from any of these customers could cause a significant decline in our sales and profitability.

The vast majority of our sales are generated from a small number of customers. For the year ended December 31, 2009, we had four customers that each accounted for at least 5% of the revenues that we generated, with one customer accounting for 15.9% of our revenue. These four customers accounted for a total of approximately 34.9% of our revenue for that period. During the years ended December 31, 2008 and 2007, we had four and five customers that generated revenues of at least 5% of our revenues, with one customer accounting for 12.7% and 13.5% of our revenue, respectively. These customers accounted for a total of approximately 33.4% and 38.4% of our revenue for the years ended December 31, 2008 and 2007, respectively.  The loss of any of these customers could have a material adverse effect upon our revenue and net income.

In addition, we believe that one customer will represent substantially all of our mobile phone product sales in the foreseeable. We entered into a purchase agreement with Kuanda (Xiamen) Communications Co., Ltd and China PTAC Communications Services, on behalf of China Telecom, for the purchase by China Telecom of our two 3G mobile phone products.  PRC law currently permits only three wireless carriers in the China telecommunications market, China Mobile, China Telecom and China Unicom.   The purchase agreement that we have with China Telecom is contingent on delivery of the 3G mobile phones representing the aggregate order by March 31, 2010.  The value of the order is approximately $28.8 million; the dollar value of any additional orders further to this relationship depends on the final number of delivered products.  If we fail to meet the requirements of the order or otherwise lose China PTAC as a customer could result in a material adverse effect upon our revenue and net income.

Our lack of long-term purchase orders and commitments could lead to a rapid decline in our sales and profitability.

All of our significant customers issue purchase orders solely in their own discretion, often only two to four weeks before the requested date of shipment. Our customers are generally able to cancel orders or delay the delivery of products on relatively short notice. In addition, our customers may decide not to purchase products from us for any reason. Accordingly, we cannot assure you that any of our current customers will continue to purchase our products in the future. As a result, our sales volume and profitability could decline rapidly with little or no warning whatsoever.

We cannot rely on long-term purchase orders or commitments to protect us from the negative financial effects of a decline in demand for our products. The limited certainty of product orders can make it difficult for us to forecast our sales and allocate our resources in a manner consistent with our actual sales. Moreover, our expense levels are based in part on our expectations of future sales and, if our expectations regarding future sales are inaccurate, we may be unable to reduce costs in a timely manner to adjust for sales shortfalls. Furthermore, because we depend on a small number of customers for the vast majority of our sales, the magnitude of the ramifications of these risks is greater than if our sales were less concentrated with a small number of customers. As a result of our lack of long-term purchase orders and purchase commitments we may experience a rapid decline in our sales and profitability.

Historically, a substantial portion of our assets has been comprised of accounts receivable representing amounts owed by a small number of customers. If any of these customers fails to timely pay us amounts owed, we could suffer a significant decline in cash flow and liquidity which, in turn, could cause us to be unable pay our liabilities and purchase an adequate amount of inventory to sustain or expand our sales volume.

Our accounts receivable represented approximately 52.6% and 45.3% of our total current assets as of December 31, 2009 and 2008, respectively. As of December 31, 2009, 51.3% of our accounts receivable represented amounts owed by four customers, each of which represented over 5% of the total amount of our accounts receivable. As a result of the substantial amount and concentration of our accounts receivable, if any of our major customers fails to timely pay us amounts owed, we could suffer a significant decline in cash flow and liquidity which could adversely affect our ability to borrow funds to pay our liabilities and to purchase inventory to sustain or expand our current sales volume.

 
14

 

In addition, our business is characterized by long periods for collection from our customers and short periods for payment to our suppliers, the combination of which may cause us to have liquidity problems. We experience an average accounts settlement period ranging from one month to as high as four months from the time we sell our products to the time we receive payment from our customers. In contrast, we typically need to place certain deposits and advances with our suppliers on a portion of the purchase price in advance and for some suppliers we must maintain a deposit for future orders. Because our payment cycle is considerably shorter than our receivable cycle, we may experience working capital shortages. Working capital management, including prompt and diligent billing and collection, is an important factor in our results of operations and liquidity. We cannot assure you that system problems, industry trends or other issues will not extend our collection period, adversely impact our working capital.
  
The growth of aging receivables and a deterioration in the collectability of these accounts could adversely affect our results of operations.

We provide for bad debts principally based upon the aging of accounts receivable, in addition to collectability of specific customer accounts, our history of bad debts, and the general condition of the industry. Our doubtful account allowance at December 31, 2009 was $0.6 million, compared to $3.4 million at December 31, 2008 and $0.7 million at December 31, 2007. During 2008 and earlier portions of 2009, we have experienced increases in doubtful account reserves in the past due to an increase in the aging of our accounts receivable, the growth of the outstanding balance of receivables, the general decline in the domestic and global economy, and other factors. Our general and administrative expenses for the year ended December 31, 2009 include a bad debt reversal of approximately $(2.7) million as compared to $2.5 million bad debt expense for the prior year.  We believe that the reversal of bad debt allowance was justified due to an improvement in the Chinese economy in late 2009, stable collection of accounts receivable in 2009 and our efforts to collect outstanding old accounts receivables in 2009. Due to the difficulty in assessing future trends, we could be required to further increase our provisions for doubtful accounts.  As our accounts receivable age and become uncollectible our cash flow and results of operations are negatively impacted.

Our history of negative working capital could adversely affect our ability to raise additional capital to fund our operations and limit our ability to react to changes in the economy or our industry.

We had working capital of approximately $3.3 million and negative working capital of approximately, $18.6 million and $34 million as of December 31, 2009, 2008 and 2007, respectively. The negative working capital was largely caused by the substantial increase in financing from bank loans and notes.  Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under the Notes and Credit Facility. Our high degree of leverage could have important consequences for you, including:

·
increasing our vulnerability to adverse economic, industry or competitive developments;

·
requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

·
exposing us to the risk of increased interest rates;

·
making it more difficult for us to satisfy our obligations with respect to our indebtedness and any failure to comply with the obligations of any of our debt instruments that we may have or obtain, including restrictive covenants and borrowing conditions, could result in an event of default the agreements governing such other indebtedness;

·
restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;

·
limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes; and

·
limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting.

Our acquisition of Dongri in January 2010 may not result in the benefits and revenue growth we expect.
 
In January 2010, our wholly-owned subsidiary, NIVS Holding Company Limited, acquired 100% of the equity interest in Huizhou Dongri Digital Co., Ltd., a company organized under the laws of the People’s Republic of China (“Dongri”) for a purchase price of up $23 million. Our acquisition of Dongri and its manufacturing facility could expose us to potential liabilities, some of which may not be disclosed by the seller, and there are no assurances that our acquisition of Dongri will enhance our future financial condition. We may continue to acquire additional businesses in the future. This acquisition and future acquisitions involve substantial risks, including: 

 
15

 

·
integration and management of the operations;
 
·
retention of key personnel;
 
·
integration of information systems, internal procedures, accounts receivable and management, financial and operational controls;
 
·
diversion of management’s attention from other ongoing business concerns; and exposure to unanticipated liabilities of acquired companies;
 
·
uncertainty as to whether PRC governmental authorities will question the structure of the acquisition and require approval of PRC authorities that would have the ability to seek to void the transaction;
 
·
unforeseen tax liability in connection with our possession and operation of the Dongri; and

·
failure to realize anticipated financial results or benefits.
 
These and other factors could harm our ability to achieve anticipated levels of profitability or realize other anticipated benefits of an acquisition and could adversely affect our business and operating results.
 
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.

The capital and credit markets have been experiencing extreme volatility and disruption for more than twelve months. In recent weeks, the volatility and disruption have reached unprecedented levels. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. We have historically relied on credit to fund our business and we need liquidity to pay our operating expenses. Without sufficient liquidity, we will be forced to curtail our operations, and our business will suffer. Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our business. Such market conditions may limit our ability to replace, in a timely manner, maturing liabilities and access the capital necessary to operate and grow our business. As such, we may be forced to delay raising capital or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Our results of operations, financial condition, cash flows and capital position could be materially adversely affected by disruptions in the financial markets.

We have significant outstanding short-term borrowings, and we may not be able to obtain extensions when they mature.
 
Our notes payable to banks for short-term borrowings for the years ended December 31, 2009 and 2008 were approximately $51.7 million and $54.7 million, respectively. Generally, these short-term bank loans mature in one year or less and contain no specific renewal terms. However, in China it is customary practice for banks and borrowers to negotiate roll-overs or renewals of short-term borrowings on an on-going basis shortly before they mature. Although we have renewed our short-term borrowings in the past, we cannot assure you that we will be able to renew these loans in the future as they mature. In January 2010, the Chinese government took steps to tighten the availability of credit including ordering banks to increase the amount of reserves they hold and to reduce or limit their lending. If we are unable to obtain renewals of these loans or sufficient alternative funding on reasonable terms from banks or other parties, we will have to repay these borrowings with the cash on our balance sheet or cash generated by our future operations, if any. We cannot assure you that our business will generate sufficient cash flow from operations to repay these borrowings.

We may need additional capital to implement our current business strategy, which may not be available to us, and if we raise additional capital, it may dilute your ownership in us.

We currently depend on bank loans and net revenues to meet our short-term cash requirements. In order to grow revenues and sustain profitability, we will need additional capital. We intend to conduct a public offering of approximately $20 million in shares of common stock in 2010. In addition, we completed a public offering of shares of common stock in March 2009, and we may conduct additional financing transactions in the future. Obtaining additional financing will be subject to a number of factors, including market conditions, our operating performance and investor sentiment. These factors may make the timing, amount, terms and conditions of additional financing unattractive to us. We cannot assure you that we will be able to obtain any additional financing. If we are unable to obtain the financing needed to implement our business strategy, our ability to increase revenues will be impaired and we may not be able to sustain profitability.

 
16

 

Consumer electronics products, mobile phones in particular, are subject to rapid technological changes. If we fail to accurately anticipate and adapt to these changes, the products we sell will become obsolete, causing a decline in our sales and profitability.

Consumer electronics products are subject to rapid technological changes which often cause product obsolescence. Companies within the consumer electronics industry are continuously developing new products with heightened performance and functionality. This puts pricing pressure on existing products and constantly threatens to make them, or causes them to be, obsolete. Our typical product's life cycle is extremely short, generating lower average selling prices as the cycle matures. If we fail to accurately anticipate the introduction of new technologies, we may possess significant amounts of obsolete inventory that can only be sold at substantially lower prices and profit margins than we anticipated. In addition, if we fail to accurately anticipate the introduction of new technologies, we may be unable to compete effectively due to our failure to offer products most demanded by the marketplace. If any of these failures occur, our sales, profit margins and profitability will be adversely affected.

Moreover, changes in mobile phone industry standards and technologies, customer preferences and government regulation could limit our ability to sell our mobile phone products. The mobile phone market is particularly characterized by changing consumer demands for cellular telephone functions and applications, rapid product obsolescence and price erosion, intense competition, evolving industry standards, and wide fluctuations in product supply and demand. These factors require us to continuously develop new products and enhance our existing products to stay competitive. The market has recently experience rapid transitions from widespread market adoption of 2G, 2.5G, 2.75G and 3G technologies, and continued changes in industry standards may make our existing products obsolete or negate the cost advantages we believe we have in our products.

Mobile communications, information technology, media and consumer electronics industries are also converging in some areas into one broader industry leading to the creation of new mobile devices, services and ways to use mobile devices. As a result, new market segments within the mobile communications industry have begun to emerge and we have made significant investments in new business opportunities in certain of these market segments, such as our acquisition of Dongri, a mobile phone manufacturer. However, a number of the new market segments in the mobile communications industry are still in early stages of their development, and it may be difficult for us to accurately predict which new market segments are the most advantageous for us to focus on. As a result, if the segments on which we have chosen to focus grow less than expected, we may not receive a return on our investment as soon as we expect, or at all. We may also forego growth opportunities in new market segments of the mobile communications industry on which we do not focus.

In addition, we form alliances or business relationships with, and make strategic partnerships with, other companies to introduce new technologies. This is particularly important to the development and enhancement of our Chinese interactive speech technology. In some cases, such relationships are crucial to our goal of introducing new products and services, but we may not be able to successfully collaborate or achieve expected synergies with our partners. We do not, however, control these partners, who may make decisions regarding their business undertakings with us that may be contrary to our interests. In addition, if these partners change their business strategies, we may fail to maintain these relationships.

Our expansion into the mobile phone industry will depend on the continued growth of the mobile communications industry, and if the mobile communications industry does not grow as we expect, our sales and profitability may be adversely affected.

We have recently made significant investments to enter into the mobile phone industry, and sales of our mobile phone products depend on continued growth in mobile communications in terms of the number of existing mobile subscribers who upgrade or simply replace their existing mobile devices, the number of new subscribers and increased usage. As well, our sales and profitability are affected by the extent to which there is increasing demand for, and development of, value-added services, leading to opportunities for us to successfully market mobile devices that feature these services. These developments are outside of our control. For example, we are dependent on operators in highly penetrated markets to successfully introduce services that cause a substantial increase in usage of voice and data. If operators are not successful in their attempts to increase subscriber numbers, stimulate increased usage or drive replacement sales, our business and results of operations could be materially adversely affected.

We do not carry any business interruption insurance, products liability insurance or any other insurance policy except for a limited property insurance policy. As a result, we may incur uninsured losses, increasing the possibility that you would lose your entire investment in our company.

We could be exposed to liabilities or other claims for which we would have no insurance protection. We do not currently maintain any business interruption insurance, products liability insurance, or any other comprehensive insurance policy except for property insurance policies with limited coverage. As a result, we may incur uninsured liabilities and losses as a result of the conduct of our business. There can be no guarantee that we will be able to obtain additional insurance coverage in the future, and even if we are able to obtain additional coverage, we may not carry sufficient insurance coverage to satisfy potential claims. Should uninsured losses occur, any purchasers of our common stock could lose their entire investment.

Because we do not carry products liability insurance, a failure of any of the products marketed by us may subject us to the risk of product liability claims and litigation arising from injuries allegedly caused by the improper functioning or design of our products. We cannot assure that we will have enough funds to defend or pay for liabilities arising out of a products liability claim. To the extent we incur any product liability or other litigation losses, our expenses could materially increase substantially. There can be no assurance that we will have sufficient funds to pay for such expenses, which could end our operations and you would lose your entire investment.

 
17

 

We may be exposed to monetary fines by the local housing authority and claims from our employees in connection with NIVS PRC Light’s non-compliance with regulations with respect to contribution of housing provident funds for employees.

According to the relevant PRC regulations on housing provident funds, PRC enterprises are required to contribute housing provident funds for their employees. The monthly contributions must beat least 5% of each employee’s average monthly income in the previous year. NIVS PRC has not paid such funds for its employees since its establishment and the accumulated unpaid amount is approximately $870,000. Under local regulations on collection of housing provident funds in Huizhou City where NIVS PRC is located, the local housing authority may require NIVS PRC to rectify its non-compliance by setting up bank accounts and making payment and relevant filings for the unpaid housing funds for its employees within a specified time period. If NIVS PRC fails to do so within the specified time period, the local housing authority may impose a monetary fine on it and may also apply to the local people’s court for enforcement. NIVS PRC employees may also be entitled to claim payment of such funds individually. We accrued the entire $870,000 amount in our financial statements as of December 31, 2009. If we receive any notice from the local housing authority or any claim from our current and former employees regarding our non-compliance with the regulations, we will be required respond to the notice and pay all amounts due to the government, including any administrative penalties imposed, which would require us to divert our financial resources and/or impact our cash reserves, if any, to make such payments. Additionally, any administrative costs in excess of the payments, if material, may impact our operating results.

We could be liable for damages for defects in our products pursuant to the Tort Liability Law and Product Liability Law of the PRC.
 
The Tort Liability Law of the People’s Republic of China, which was passed during the 12th Session of the Standing Committee of the 11th National People’s Congress on December 26, 2009, states that manufacturers are liable for damages caused by defects in their products and sellers are liable for damages attributable to their fault. If the defects are caused by the fault of third parties such as the transporter or storekeeper, manufacturers and sellers are entitled to claim for compensation from these third parties after paying the compensation amount.

We may incur design and development expenses and purchase inventory in anticipation of orders which are not placed.

In order to transact business, we assess the integrity and creditworthiness of our customers and suppliers and we may, based on this assessment, incur design and development costs that we expect to recoup over a number of orders produced for the customer. Such assessments are not always accurate and expose us to potential costs, including the write off of costs incurred and inventory obsolescence if the orders anticipated do not materialize. We may also occasionally place orders with suppliers based on a customer’s forecast or in anticipation of an order that is not realized. Additionally, from time to time, we may purchase quantities of supplies and materials greater than required by customer orders to secure more favorable pricing, delivery or credit terms. These purchases can expose us to losses from cancellation costs, inventory carrying costs or inventory obsolescence, and hence adversely affect our business and operating results.

Allegations of health risks from the electromagnetic fields generated by mobile devices, and the lawsuits and publicity relating to them, regardless of merit, could affect our operations negatively by leading consumers to reduce their use of mobile devices or by causing us to allocate monetary and personnel resources to these issues.

There has been public speculation about possible health risks to individuals from exposure to electromagnetic fields from the use of mobile devices such as mobile phones, which we manufacture and sell. While a substantial amount of scientific research conducted to date by various independent research bodies has indicated that these radio signals, at levels within the limits prescribed by public health authority safety standards and recommendations, present no adverse effect to human health, we cannot be  certain that future studies, irrespective of their scientific basis, will not suggest a link between electromagnetic fields and adverse health effects that would adversely affect our sales and share price. Research into these issues is ongoing by government agencies, international health organizations and other scientific bodies in order to develop a better scientific and public understanding of these issues.

Although our products and solutions are designed to meet all relevant safety standards and recommendations globally, no more than a perceived risk of adverse health effects of mobile communications devices could adversely affect us through a reduction in sales of mobile devices or increased difficulty in obtaining sites for base stations, and could have a negative effect on our reputation and brand value as well as harm our share price.

We are subject to market risk through our sales to international markets.

A growing percentage of our sales are being derived from international markets. These international sales are primarily focused in Europe, Southeast Asia, and North America. These operations are subject to risks that are inherent in operating in foreign countries, including the following:

 
18

 

·
foreign countries could change regulations or impose currency restrictions and other restraints;

·
changes in foreign currency exchange rates and hyperinflation or deflation in the foreign countries in which we operate;

·
exchange controls;

·
some countries impose burdensome tariffs and quotas;

·
political changes and economic crises may lead to changes in the business environment in which we operate;

·
international conflict, including terrorist acts, could significantly impact our financial condition and results of operations; and

·
economic downturns, political instability and war or civil disturbances may disrupt distribution logistics or limit sales in individual markets.

In addition, we utilize third-party distributors to act as our representative for the geographic region that they have been assigned. Sales through distributors represent approximately 70% of total revenue. Significant terms and conditions of distributor agreements include FOB source, net 30 days payment terms, with no return or exchange rights, and no price protection. Since the product transfers title to the distributor at the time of shipment by us, the products are not considered inventory on consignment. Our success is dependent on these distributors finding new customers and receiving new orders from existing customers.

If our third party sales representatives and distributors fail to adequately promote, market and sell our products, our revenues could significantly decrease.

A significant portion of our product sales are made through third party sales representative organizations, whose members are not our employees. Our level of sales depends on the effectiveness of these organizations, as well as the effectiveness of our own employees. Some of these third party representatives may sell (and do sell), with our permission, competitive products of third parties as well as our products. During our fiscal years ended December 31, 2009, 2008 and 2007, these organizations were responsible for approximately 15%, 17% and 18%, respectively, of our domestic net revenues during such periods. If any of the third party sales representative organizations engaged by us fails to adequately promote, market and sell our products, our revenues could be significantly decreased until a replacement organization or distributor can be retained by us. Finding replacement organizations and distributors can be a time consuming process during which our revenues could be negatively impacted.

Our speech-controlled products may not achieve widespread acceptance or may have bugs, which could result in delayed or lost revenue, expensive correction, liability to our customers or claims against us.

We have invested and expect to continue to invest heavily in the research, development and marketing of our Mandarin-speech technology consumer products. The market for these products are is relatively new and rapidly evolving. Our ability to increase revenue in the future depends largely on acceptance of speech-controlled consumer electronic products in general and our products in particular. The continued development of the market for our current and future speech solutions will also depend on:

·
consumer and business demand for speech-enabled products and applications;

·
continuous improvement in speech interactive technology; and

·
development by third-party vendors and manufacturers of applications using speech technologies.

Sales of our speech-controlled products would be harmed if the market for such products does not continue to develop or develops more slowly than we expect, and, consequently, our business would be harmed and we may not recover the costs associated with our investment in our speech interactive technologies.

In addition, complex software applications, such as our Chinese speech interactive technology, often contain errors, defects or bugs. Defects in the solutions or products that we develop and sell to our customers could require expensive corrections and result in delayed or lost revenue, adverse customer reaction and negative publicity about us or our products and services. Customers who are not satisfied with any of our products may also bring claims against us for damages, which, even if unsuccessful, would likely be time-consuming to defend, and could result in costly litigation and payment of damages. Such claims could harm our reputation, financial results and competitive position.

 
19

 

We are subject to intense competition in the industry in which we operate, which could cause material reductions in the selling price of our products or losses of our market share.

The consumer electronics industry is highly competitive, especially with respect to pricing and the introduction of new products and features. Our products compete in the medium- to high- priced sector of the consumer electronics market and compete primarily on the basis of reliability, brand recognition, quality, price, design, consumer acceptance of our trademark, and quality service and support to retailers and our customers.

In recent years, we and many of our competitors, have regularly lowered prices, and we expect these pricing pressures to continue. If these pricing pressures are not mitigated by increases in volume, cost reductions from our supplier or changes in product mix, our revenues and profits could be substantially reduced. As compared to us, many of our competitors have:

·
significantly longer operating histories;

·
significantly greater managerial, financial, marketing, technical and other competitive resources; and

·
greater brand recognition.

As a result, our competitors may be able to:

·
adapt more quickly to new or emerging technologies and changes in customer requirements;

·
devote greater resources to the promotion and sale of their products and services; and

·
respond more effectively to pricing pressures.

These factors could materially adversely affect our operations and financial condition. In addition, competition could increase if:

·
new companies enter the market;

·
existing competitors expand their product mix; or

·
we expand into new markets.

An increase in competition could result in material price reductions or loss of our market share.

The consumer electronics industry is subject to significant fluctuations in the availability of raw materials and components. If we do not properly anticipate the need for critical raw materials and components, we may be unable to meet the demands of our customers and end-users, which could reduce our competitiveness, cause a decline in our market share and have a material adverse effect on our results of operations.

As the availability of raw materials and components decreases, the cost of acquiring those raw materials and components ordinarily increases. If we fail to procure adequate supplies of raw materials and components in anticipation of our customers' orders or end-users’ demand, our gross margins may be negatively impacted due to higher prices that we are required to pay for raw materials and components in short supply. High growth product categories have experienced chronic shortages of raw materials and components during periods of exceptionally high demand. If we do not properly anticipate the need for critical raw materials and components, we may pay higher prices for the raw materials and components, we may not be unable to meet the demands of our customers and end-users, which could reduce our competitiveness, cause a decline in our market share and have a material adverse effect on our results of operations.

Unanticipated disruptions in our operations or slowdowns by our suppliers and shipping companies could adversely affect our ability to deliver our products and service our customers which could materially and adversely affect our revenues and our relationships with our customers.

Our ability to provide high quality customer service, process and fulfill orders and manage inventory depends on:

·
the efficient and uninterrupted operation of our distribution centers; and

·
the timely and uninterrupted performance of third party suppliers, shipping companies, and dock workers.

Any material disruption or slowdown in the operation of our distribution centers, manufacturing facilities or management information systems, or comparable disruptions or slowdowns suffered by our principal manufacturers, suppliers and shippers could cause delays in our ability to receive, process and fulfill customer orders and may cause orders to be canceled, lost or delivered late, goods to be returned or receipt of goods to be refused. As a result, our revenues and operating results could be materially and adversely affected.

 
20

 

We rely heavily on the founder of NIVS PRC and our current Chief Executive Officer, Tianfu Li. The loss of his services could adversely affect our ability to source products from our key suppliers and our ability to sell our products to our customers.

Our success depends, to a significant extent, upon the continued services of Tianfu Li, who is the founder of NIVS PRC and our current Chairman of the Board and Chief Executive Officer. Mr. Li has, among other things, developed key personal relationships with our suppliers and customers. We greatly rely on these relationships in the conduct of our operations and the execution of our business strategies. The loss of Mr. Li could, therefore, result in the loss of favorable relationships with one or more of our suppliers and/or customers. We do not maintain "key person" life insurance covering Mr. Li or any other executive officer. The loss of Mr. Li could significantly delay or prevent the achievement of our business objectives and adversely affect our business, financial condition and results of operations.

We may not be able to effectively recruit and retain skilled employees, particularly scientific, technical and management professionals.

Our ability to compete effectively depends largely on our ability to attract and retain certain key personnel, including scientific, technical and management professionals. We anticipate that we will need to hire additional skilled personnel in all areas of our business. Industry demand for such employees, however, exceeds the number of personnel available, and the competition for attracting and retaining these employees is intense. Because of this intense competition for skilled employees, we may be unable to retain our existing personnel or attract additional qualified employees to keep up with future business needs. If this should happen, our business, operating results and financial condition could be adversely affected.

Our labor costs are likely to increase as a result of changes in Chinese labor laws.
We expect to experience an increase in our cost of labor due to recent changes in Chinese labor laws which are likely to increase costs further and impose restrictions on our relationship with our employees. In June 2007, the National People’s Congress of the PRC enacted new labor law legislation called the Labor Contract Law and more strictly enforced existing labor laws. The new law, which became effective on January 1, 2008, amended and formalized workers’ rights concerning overtime hours, pensions, layoffs, employment contracts and the role of trade unions. As a result of the new law, we have had to increase the salaries of our employees, provide additional benefits to our employees, and revise certain other of our labor practices. The increase in labor costs has increased our operating costs, which increase we have not always been able to pass through to our customers. In addition, under the new law, employees who either have worked for us for 10 years or more or who have had two consecutive fixed-term contracts must be given an “open-ended employment contract” that, in effect, constitutes a lifetime, permanent contract, which is terminable only in the event the employee materially breaches our rules and regulations or is in serious dereliction of his or her duties. Such non-cancelable employment contracts will substantially increase our employment related risks and limit our ability to downsize our workforce in the event of an economic downturn. No assurance can be given that we will not in the future be subject to labor strikes or that we will not have to make other payments to resolve future labor issues caused by the new laws. Furthermore, there can be no assurance that the labor laws will not change further or that their interpretation and implementation will vary, which may have a negative effect upon our business and results of operations.

Our business could be materially adversely affected if we cannot protect our intellectual property rights or if we infringe on the intellectual property rights of others.

Our ability to compete effectively will depend on our ability to maintain and protect our proprietary rights. We own a trademark related to the sale of our products, which is materially important to our business, as well as our licenses, other trademarks and proprietary rights that are used for certain of our home entertainment and consumer electronics products. Our trademarks are registered in China. However, third parties may seek to challenge, invalidate, circumvent or render unenforceable any proprietary rights owned by or licensed to us. In addition, in the event third party licensees fail to protect the integrity of our trademarks, the value of these marks could be materially adversely affected.

Our inability to protect our proprietary rights could materially adversely affect the license of our trade names and trademarks to third parties as well as our ability to sell our products. Litigation may be necessary to:

·
enforce our intellectual property rights;

·
protect our trade secrets; and

·
determine the scope and validity of such intellectual property rights.

Any such litigation, whether or not successful, could result in substantial costs and diversion of resources and management’s attention from the operation of our business.
 
21


We may receive notice of claims of infringement of other parties’ proprietary rights. Such actions could result in litigation and we could incur significant costs and diversion of resources in defending such claims. The party making such claims could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief. Such relief could effectively block our ability to make, use, sell, distribute or market our products and services in such jurisdiction. We may also be required to seek licenses to such intellectual property. We cannot predict, however, whether such licenses would be available or, if available, that such licenses could be obtained on terms that are commercially reasonable and acceptable to us. The failure to obtain the necessary licenses or other rights could delay or preclude the sale, manufacture or distribution of our products and could result in increased costs to us.
  
Our failure to effectively manage growth could harm our business.
 
We have rapidly and significantly expanded the number and types of products we sell, and we will endeavor to further expand our product portfolio. We must continually introduce new products and technologies, enhance existing products in order to remain competitive, and effectively stimulate customer demand for new products and upgraded versions of our existing products.

This expansion of our products places a significant strain on our management, operations and engineering resources. Specifically, the areas that are strained most by our growth include the following:
 
 
·
New Product Launch: With the growth of our product portfolio, we experience increased complexity in coordinating product development, manufacturing, and shipping. As this complexity increases, it places a strain on our ability to accurately coordinate the commercial launch of our products with adequate supply to meet anticipated customer demand and effective marketing to stimulate demand and market acceptance. If we are unable to scale and improve our product launch coordination, we could frustrate our customers and lose retail shelf space and product sales;

 
·
Forecasting, Planning and Supply Chain Logistics: With the growth of our product portfolio, we also experience increased complexity in forecasting customer demand and in planning for production, and transportation and logistics management. If we are unable to scale and improve our forecasting, planning and logistics management, we could frustrate our customers, lose product sales or accumulate excess inventory; and

 
·
Support Processes: To manage the growth of our operations, we will need to continue to improve our transaction processing, operational and financial systems, and procedures and controls to effectively manage the increased complexity. If we are unable to scale and improve these areas, the consequences could include: delays in shipment of product, degradation in levels of customer support, lost sales, decreased cash flows, and increased inventory. These difficulties could harm or limit our ability to expand.
 
Our facilities and information systems could be damaged as a result of disasters or unpredictable events, which could have an adverse effect on our business operations.
 
Our headquarters and major facilities including manufacturing plants, sales offices and research and development centers are located in China. We also operate procurement, logistics, sales and marketing facilities in other parts of the world. If major disasters such as earthquakes, fires, floods, wars, terrorist attacks, computer viruses, transportation disasters or other events occur, or our information system or communications network breaks down or operates improperly as a result of such events, our facilities may be seriously damaged, and we may have to stop or delay production and shipment. We may incur expenses relating to such damages.

Our quarterly results may fluctuate because of many factors and, as a result, investors should not rely on quarterly operating results as indicative of future results.

Fluctuations in operating results or the failure of operating results to meet the expectations of public market analysts and investors may negatively impact the value of our securities. Quarterly operating results may fluctuate in the future due to a variety of factors that could affect revenues or expenses in any particular quarter. Fluctuations in quarterly operating results could cause the value of our securities to decline. Investors should not rely on quarter-to-quarter comparisons of results of operations as an indication of future performance. As a result of the factors listed below, it is possible that in future periods results of operations may be below the expectations of public market analysts and investors. This could cause the market price of our securities to decline.

Factors that may affect our quarterly results include:

 
·
vulnerability of our business to a general economic downturn in China and globally;

 
·
fluctuation and unpredictability of costs related to raw materials used to manufacture our products;
 
 
22

 

 
·
seasonality of our business;

 
·
changes in the laws of the PRC that affect our operations;

 
·
our recent entry into the mobile phone market;

 
·
competition;

 
·
compensation related expenses;

 
·
application of accounting standards;

 
·
our ability to obtain and maintain all necessary government certifications and/or licenses to conduct our business; and

 
·
development of a public trading market for our securities.

RISKS RELATED TO DOING BUSINESS IN CHINA
 
Substantially all of our assets are located in the PRC and substantially all of our revenues are derived from our operations in China, and changes in the political and economic policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and accordingly on the results of our operations and financial condition.
 
Our business operations may be adversely affected by the current and future political environment in the PRC. The Chinese government exerts substantial influence and control over the manner in which we must conduct our business activities. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations, including those relating to taxation, import and export tariffs, raw materials, environmental regulations, land use rights, property and other matters. Under the current government leadership, the government of the PRC has been pursuing economic reform policies that encourage private economic activity and greater economic decentralization. There is no assurance, however, that the government of the PRC will continue to pursue these policies, or that it will not significantly alter these policies from time to time without notice.
 
Our operations are subject to PRC laws and regulations that are sometimes vague and uncertain. Any changes in such PRC laws and regulations, or the interpretations thereof, may have a material and adverse effect on our business.
 
The PRC’s legal system is a civil law system based on written statutes. Unlike the common law system prevalent in the United States, decided legal cases have little value as precedent in China. There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including but not limited to, governmental approvals required for conducting business and investments, laws and regulations governing the consumer electronics business and electric product safety, national security-related laws and regulations and export/import laws and regulations, as well as commercial, antitrust, patent, product liability, environmental laws and regulations, consumer protection, labor, and financial and business taxation laws and regulations.
 
The Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and judicial interpretation and their lack of force as precedents, interpretation and enforcement of these laws and regulations involve significant uncertainties. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
 
Our principal operating subsidiary, Huizhou NIVS Audio & Video Technology Company Limited, (“NIVS PRC”), is considered a foreign invested enterprise under PRC laws, and as a result is required to comply with PRC laws and regulations, including laws and regulations specifically governing the activities and conduct of foreign invested enterprises. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our businesses. If the relevant authorities find us in violation of PRC laws or regulations, they would have broad discretion in dealing with such a violation, including, without limitation

 
·
levying fines;
 
 
 
·
revoking our business license, other licenses or authorities;
 
 
 
·
requiring that we restructure our ownership or operations; and
 
 
 
·
requiring that we discontinue any portion or all of our business.
 
 
23

 

Investors may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based upon U.S. laws, including the federal securities laws or other foreign laws against us or our management.
 
Most of our current operations, including the manufacturing and distribution of our products, are conducted in China. Moreover, all of our directors and officers are nationals and residents of China or Hong Kong. All or substantially all of the assets of these persons are located outside the United States and in the PRC. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon these persons. In addition, uncertainty exists as to whether the courts of China would recognize or enforce judgments of U.S. courts obtained against us or such officers and/or directors predicated upon the civil liability provisions of the securities laws of the United States or any state thereof, or be competent to hear original actions brought in China against us or such persons predicated upon the securities laws of the United States or any state thereof.
 
The scope of our business license in China is limited, and we may not expand or continue our business without government approval and renewal, respectively.
 
Our principal operating subsidiary, NIVS PRC, is a Sino-foreign Equity Joint Venture, which can only conduct business within its approved business scope, which ultimately appears on its business license. Any amendment to the scope of our business requires further application and government approval. In order for us to expand our business beyond the scope of our business license, it will be required to file an application with the authorities for the approval to expand the scope of our business and have our business license re-issued to incorporate such expanded business scope. We cannot assure investors that NIVS PRC will be able to obtain the necessary government approval for any change or expansion of its business.
 
We are subject to a variety of environmental laws and regulations related to our manufacturing operations, and we may become subject to forthcoming environmental regulations enacted in response to climate change. Our failure to comply with environmental laws and regulations may have a material adverse effect on our business and results of operations.
 
We are subject to various environmental laws and regulations that require us to obtain environmental permits for our electronics manufacturing operations. Our environmental permit from the Huizhou Environmental Protection Bureau covering our manufacturing operations will expire in December 2010. The permit only covers of the existing premises at our manufacturing facility, and if we expand our operations, we will have to obtain further certification from the Bureau. In addition, we are required to renew some of our environmental certificates each year. If we do not receive the renewed permit or we fail to comply with the provisions of the renewed permit, we could be subject to fines, criminal charges or other sanctions by regulators, including the suspension or termination of our manufacturing operations.
 
We cannot assure you that at all times we will be in compliance with environmental laws and regulations or our environmental permits or that we will not be required to expend significant funds to comply with, or discharge liabilities arising under, environmental laws, regulations and permits.
 
In addition, future environmental regulations that are enacted in response to global and regional climate change could place additional burdens on our manufacturing operations. Public attention has focused on the environmental impact of electronics manufacturing and the risk to neighbors of chemical releases from such operations and to the materials contained in electronic products. Complying with existing and possible future environmental laws and regulations, including laws and regulations relating to climate change, may impose upon us the need for additional capital equipment or other process requirements, restrict our ability to expand our operations, disrupt our operations, increase costs, subject us to liability or cause us to curtail our operations.
 
Recent PRC regulations relating to acquisitions of PRC companies by foreign entities may create regulatory uncertainties that could restrict or limit our ability to operate. Our failure to obtain the prior approval of the China Securities Regulatory Commission, or the CSRC, for the listing and trading of our common stock could have a material adverse effect on our business, operating results, reputation and trading price of our common stock, and may also create uncertainties in the future.
 
The PRC State Administration of Foreign Exchange, or “SAFE,” issued a public notice in November 2005, known as Circular 75, concerning the use of offshore holding companies in mergers and acquisitions in China. The public notice provides that if an offshore company controlled by PRC residents intends to acquire a PRC company, such acquisition will be subject to registration with the relevant foreign exchange authorities. The public notice also suggests that registration with the relevant foreign exchange authorities is required for any sale or transfer by the PRC residents of shares in an offshore holding company that owns an onshore company. The PRC residents must each submit a registration form to the local SAFE branch with respect to their ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transactions or use of assets in China to guarantee offshore obligations. On May 29, 2007, SAFE released implementation rules for Circular 75, known as Circular 106. Under Circular 106, the acquired PRC company may be prohibited from distributing dividends to its offshore acquirer if the PRC residents fail to register with SAFE in accordance with the requirement under Circular 75.
 
 
24

 

On August 8, 2006, the PRC Ministry of Commerce (“MOFCOM”), joined by the State-owned Assets Supervision and Administration Commission of the State Council, the State Administration of Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission and SAFE, released a substantially amended version of the Provisions for Foreign Investors to Merge with or Acquire Domestic Enterprises (the “Revised M&A Regulations”), which took effect on September 8, 2006 and was further amended on June 22, 2009. These new rules significantly revised China’s regulatory framework governing onshore-to-offshore restructurings and foreign acquisitions of domestic enterprises. These new rules signify greater PRC government attention to cross-border merger, acquisition and other investment activities, by confirming MOFCOM as a key regulator for issues related to mergers and acquisitions in China and requiring MOFCOM approval of a broad range of merger, acquisition and investment transactions. Further, the new rules establish reporting requirements for acquisition of control by foreigners of companies in key industries, and reinforce the ability of the Chinese government to monitor and prohibit foreign control transactions in key industries.
 
Among other things, the revised M&A Regulations include new provisions that purport to require that an offshore special purpose vehicle, or SPV, formed for listing purposes and controlled directly or indirectly by PRC companies or individuals must obtain the approval of the CSRC prior to the listing and trading of such SPV’s securities on an overseas stock exchange. On September 21, 2006, the CSRC published on its official website procedures specifying documents and materials required to be submitted to it by SPVs seeking CSRC approval of their overseas listings. However, the application of this PRC regulation remains unclear with no consensus currently existing among the leading PRC law firms regarding the scope and applicability of the CSRC approval requirement. Our PRC counsel, Guangdong Laowei Law Firm, has advised us that because we completed our onshore-to-offshore restructuring before September 8, 2006, the effective date of the Revised M&A Regulations, it is not necessary for us to submit the application to the CSRC for its approval, and the listing and trading of our common stock does not require CSRC approval.
 
If the CSRC or another PRC regulatory agency subsequently determines that CSRC approval was required for our restructuring, we may face regulatory actions or other sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in the PRC, limit our operating privileges in the PRC, or take other actions that could have a material adverse effect on our business, financial condition, results of operations, reputation and prospects, as well as the trading price of our Common Stock.
 
Also, if later the CSRC requires that we obtain its approval, we may be unable to obtain a waiver of the CSRC approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding this CSRC approval requirement could have a material adverse effect on the trading price of our common stock. Furthermore, published news reports in China recently indicated that the CSRC may have curtailed or suspended overseas listings for Chinese private companies.
 
It is uncertain how our business operations or future strategy will be affected by the interpretations and implementation of Circular 75 and the Revised M&A Regulations. It is anticipated that application of the new rules will be subject to significant administrative interpretation, and we will need to closely monitor how MOFCOM, SAFE, CSRC and other ministries apply the rules to ensure that our domestic and offshore activities continue to comply with PRC law. Given the uncertainties regarding interpretation and application of the new rules, we may need to expend significant time and resources to maintain compliance.
 
If our land use rights are revoked, we would have no operational capabilities.
 
Under Chinese law land is owned by the state or rural collective economic organizations. The state issues to the land users the land use right certificate. Land use rights can be revoked and the land users forced to vacate at any time when redevelopment of the land is in the public interest. The public interest rationale is interpreted quite broadly and the process of land appropriation may be less than transparent. Each of our facilities relies on these land use rights as the cornerstone of their operations, and the loss of such rights would have a material adverse effect on our company.
 
The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to foreign exchange control regulations of China.
 
The ability of our Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balance of the Chinese operating subsidiaries. Because substantially all of our operations are conducted in China and a substantial majority of our revenues are generated in China, a majority of our revenue being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in China, and, as a result, we may be unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars. Accordingly, we may not be able to access NIVS PRC’s funds which may not be readily available to us to satisfy obligations which have been incurred outside the PRC, which could adversely affect our business and prospects or our ability to meet our cash obligations.
 
 
25

 

We will not be able to complete an acquisition of prospective acquisition targets in the PRC unless their financial statements can be reconciled to U.S. generally accepted accounting principles in a timely manner.
 
Companies based in the PRC may not have properly kept financial books and records that may be reconciled with U.S. generally accepted accounting principles. If we attempt to acquire a significant PRC target company and/or its assets, we would be required to obtain or prepare financial statements of the target that are prepared in accordance with and reconciled to U.S. generally accepted accounting principles. Federal securities laws require that a business combination meeting certain financial significance tests require the public acquirer to prepare and file historical and/or pro forma financial statement disclosure with the SEC. These financial statements must be prepared in accordance with, or be reconciled to U.S. generally accepted accounting principles and the historical financial statements must be audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), or PCAOB. If a proposed acquisition target does not have financial statements that have been prepared in accordance with, or that can be reconciled to, U.S. generally accepted accounting principles and audited in accordance with the standards of the PCAOB, we will not be able to acquire that proposed acquisition target. These financial statement requirements may limit the pool of potential acquisition targets with which we may acquire and hinder our ability to expand our retail operations. Furthermore, if we consummate an acquisition and are unable to timely file audited financial statements and/or pro forma financial information required by the Exchange Act, such as Item 9.01 of Form 8-K, we will be ineligible to use the SEC’s short-form registration statement on Form S-3 to raise capital, if we are otherwise eligible to use a Form S-3. If we are ineligible to use a Form S-3, the process of raising capital may be more expensive and time consuming and the terms of any offering transaction may not be as favorable as they would have been if we were eligible to use Form S-3.
 
We face risks related to natural disasters, terrorist attacks or other events in China that may affect usage of public transportation, which could have a material adverse effect on our business and results of operations.
 
Our business could be materially and adversely affected by natural disasters, terrorist attacks or other events in China. For example, in early 2008, parts of China suffered a wave of strong snow storms that severely impacted public transportation systems. In May 2008, Sichuan Province in China suffered a strong earthquake measuring approximately 8.0 on the Richter scale that caused widespread damage and casualties. The May 2008 Sichuan earthquake has had a material adverse effect on the general economic conditions in the areas affected by the earthquake. Any future natural disasters, terrorist attacks or other events in China could cause a reduction in usage of or other severe disruptions to, public transportation systems and could have a material adverse effect on our business and results of operations.
 
We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises' Share Transfer (“Circular 698”) that was released in December 2009 with retroactive effect from January 1, 2008.
 
The Chinese State Administration of Taxation (SAT) released a circular (Guoshuihan No. 698 – Circular 698) on December 15, 2009 that addresses the transfer of shares by nonresident companies. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes.
 
There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
 
The foreign currency exchange rate between U.S. Dollars and Renminbi could adversely affect our financial condition.
 
To the extent that we need to convert U.S. Dollars into Renminbi for our operational needs, our financial position and the price of our common stock may be adversely affected should the Renminbi appreciate against the U.S. Dollar at that time. Conversely, if we decide to convert our Renminbi into U.S. Dollars for the operational needs or paying dividends on our common stock, the dollar equivalent of our earnings from our subsidiaries in China would be reduced should the dollar appreciate against the Renminbi. We currently do not hedge our exposure to fluctuations in currency exchange rates.
 
 
26

 

Until 1994, the Renminbi experienced a gradual but significant devaluation against most major currencies, including dollars, and there was a significant devaluation of the Renminbi on January 1, 1994 in connection with the replacement of the dual exchange rate system with a unified managed floating rate foreign exchange system. Since 1994, the value of the Renminbi relative to the U.S. Dollar has remained stable and has appreciated slightly against the U.S. Dollar. Countries, including the United States, have argued that the Renminbi is artificially undervalued due to China’s current monetary policies and have pressured China to allow the Renminbi to float freely in world markets. In July 2005, the PRC government changed its policy of pegging the value of the Renminbi to the dollar. Under the new policy the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of designated foreign currencies. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in further and more significant appreciation of the Renminbi against the dollar.
 
Inflation in the PRC could negatively affect our profitability and growth.
 
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. According to the National Bureau of Statistics of China, the change in China’s Consumer Price Index increased to 8.5% in April 2008. If prices for our products and services rise at a rate that is insufficient to compensate for the rise in the costs of supplies such as raw materials, it may have an adverse effect on our profitability.
 
Furthermore, in order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. In January 2010, the Chinese government took steps to tighten the availability of credit including ordering banks to increase the amount of reserves they hold and to reduce or limit their lending. The implementation of such policies may impede economic growth. In October 2004, the People’s Bank of China, the PRC’s central bank, raised interest rates for the first time in nearly a decade and indicated in a statement that the measure was prompted by inflationary concerns in the Chinese economy. In April 2006, the People’s Bank of China raised the interest rate again. Repeated rises in interest rates by the central bank, in addition to tighter credit and lending restrictions on banks, would likely slow economic activity in China which could, in turn, materially increase our costs and also reduce demand for our products and services.
 
Because our funds are held in banks which do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.
 
Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. A significant portion of our assets are in the form of cash deposited with banks in the PRC, and in the event of a bank failure, we may not have access to our funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
 
Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
 
As our ultimate holding company is a Delaware corporation, we are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices may occur from time-to-time in the PRC. We can make no assurance, however, 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 and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
 
If we make equity compensation grants to persons who are PRC citizens, they may be required to register with the State Administration of Foreign Exchange of the PRC, or SAFE. We may also face regulatory uncertainties that could restrict our ability to adopt an equity compensation plan for our directors and employees and other parties under PRC law.
 
On April 6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic Individuals Participating in the Employee Stock Ownership Plan or Stock Option Plan of An Overseas Listed Company, also know as “Circular 78.” It is not clear whether Circular 78 covers all forms of equity compensation plans or only those which provide for the granting of stock options. For any plans which are so covered and are adopted by a non-PRC listed company after April 6, 2007, Circular 78 requires all participants who are PRC citizens to register with and obtain approvals from SAFE prior to their participation in the plan. In addition, Circular 78 also requires PRC citizens to register with SAFE and make the necessary applications and filings if they participated in an overseas listed company’s covered equity compensation plan prior to April 6, 2007. We have adopted an equity compensation plan in the future and intend to make securities grants to our officers and directors, most of who are PRC citizens. Circular 78 may require our officers and directors who receive option grants and are PRC citizens to register with SAFE. We believe that the registration and approval requirements contemplated in Circular 78 will be burdensome and time consuming. If it is determined that any of our equity compensation plans are subject to Circular 78, failure to comply with such provisions may subject us and participants of our equity incentive plan who are PRC citizens to fines and legal sanctions and prevent us from being able to grant equity compensation to our PRC employees. In that case, our ability to compensate our employees and directors through equity compensation would be hindered and our business operations may be adversely affected.

 
27

 

NIVS PRC has enjoyed certain preferential tax concessions and the loss of these preferential tax concessions may cause our tax liabilities to increase and our profitability to decline.
 
Under the tax laws of the PRC, NIVS PRC has had tax advantages granted by local government for enterprise income taxes commencing April 6, 2004. NIVS PRC has been entitled to have a full tax exemption for the first two profitable years, followed by a 50% reduction on normal tax rate of 24% for the following three consecutive years. On March 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law (“New EIT Law”), under which foreign invested enterprises and domestic companies will be subject to enterprise income tax at a uniform rate of 25%. The new law became effective on January 1, 2008. During the transition period for enterprises established before March 16, 2007 the tax rate will be gradually increased starting in 2008 and be equal to the new tax rate in 2012. The expiration of the preferential tax treatment will increase our tax liabilities and reduce our profitability.
 
Under the New EIT Law, we and NIVS BVI may be classified as “resident enterprises” of China for tax purpose, which may subject us and NIVS BVI to PRC income tax on taxable global income.
 
Under the new PRC Enterprise Income Tax Law (the “New EIT Law”) and its implementing rules, both of which became effective on January 1, 2008. Under the New EIT Law, enterprises are classified as resident enterprises and non-resident enterprises. An enterprise established outside of China with its “de facto management bodies” located within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese domestic enterprise for enterprise income tax purposes. The implementing rules of the New EIT Law define de facto management body as a managing body that in practice exercises “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise. Due to the short history of the New EIT law and lack of applicable legal precedents, it remains unclear how the PRC tax authorities will determine the PRC tax resident treatment of a foreign company such as us and NIVS BVI. Both us and NIVS BVI have all members of management team located in China. If the PRC tax authorities determine that we or NIVS BVI is a “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Second, the New EIT Law provides that dividend paid between “qualified resident enterprises” is exempted from enterprise income tax. A recent circular issued by the State Administration of Taxation regarding the standards used to classify certain Chinese-invested enterprises controlled by Chinese enterprises or Chinese group enterprises and established outside of China as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC source income, subject to PRC withholding tax, currently at a rate of 10%, when recognized by non-PRC shareholders. It is unclear whether the dividends that we or NIVS BVI receives from NIVS PRC will constitute dividends between “qualified resident enterprises” and would therefore qualify for tax exemption, because the definition of qualified resident enterprises is unclear and the relevant PRC government authorities 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. We are actively monitoring the possibility of “resident enterprise” treatment for the applicable tax years and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible. As a result of the New EIT Law, our historical operating results will not be indicative of our operating results for future periods and the value of our common stock may be adversely affected.
 
Dividends payable by us to our foreign investors and any gain on the sale of our shares may be subject to taxes under PRC tax laws.
 
If dividends payable to our shareholders are treated as income derived from sources within China, then the dividends that shareholders receive from us, and any gain on the sale or transfer of our shares, may be subject to taxes under PRC tax laws.
 
Under the New EIT Law and its implementing rules, PRC enterprise income tax at the rate of 10% is applicable to dividends payable by us to our investors that are non-resident enterprises so long as such non-resident enterprise investors do not have an establishment or place of business in China or, despite the existence of such establishment of place of business in China, the relevant income is not effectively connected with such establishment or place of business in China, to the extent that such dividends have their sources within the PRC. Similarly, any gain realized on the transfer of our shares by such investors is also subject to a 10% PRC income tax if such gain is regarded as income derived from sources within China and we are considered as a resident enterprise which is domiciled in China for tax purpose. Additionally, there is a possibility that the relevant PRC tax authorities may take the view that the purpose of us and NIVS BVI is holding NIVS PRC, and the capital gain derived by our overseas shareholders or investors from the share transfer is deemed China-sourced income, in which case such capital gain may be subject to a PRC withholding tax at the rate of up to 10%. If we are required under the New EIT Law to withhold PRC income tax on our dividends payable to our foreign shareholders or investors who are non-resident enterprises, or if you are required to pay PRC income tax on the transfer or our shares under the circumstances mentioned above, the value of your investment in our shares may be materially and adversely affected.
 
 
28

 

In January 2009, the State Administration of Taxation promulgated the Provisional Measures for the Administration of Withholding of Enterprise Income Tax for Non-resident Enterprises (“Measures”), pursuant to which, the entities which have the direct obligation to make the following payment to a non-resident enterprise shall be the relevant tax withholders for such non-resident enterprise, and such payment includes: incomes from equity investment (including dividends and other return on investment), interests, rents, royalties, and incomes from assignment of property as well as other incomes subject to enterprise income tax received by non-resident enterprises in China. Further, the Measures provides that in case of equity transfer between two non-resident enterprises which occurs outside China, the non-resident enterprise which receives the equity transfer payment shall, by itself or engage an agent to, file tax declaration with the PRC tax authority located at place of the PRC company whose equity has been transferred, and the PRC company whose equity has been transferred shall assist the tax authorities to collect taxes from the relevant non-resident enterprise. However, it is unclear whether the Measures refer to the equity transfer by a non-resident enterprise which is a direct or an indirect shareholder of the said PRC company. Given these Measures, there is a possibility that we may have an obligation to withhold income tax in respect of the dividends paid to non-resident enterprise investors.
 
Any recurrence of Severe Acute Respiratory Syndrome (SARS), Avian Flu, or another widespread public health problem, in the PRC could adversely affect our operations.
 
A renewed outbreak of SARS, Avian Flu, or another widespread public health problem in China, where all of our manufacturing facilities are located and where the substantial portion of our sales occur, could have a negative effect on our operations. Our business is dependent upon its ability to continue to manufacture products. Such an outbreak could have an impact on our operations as a result of:

 
·
quarantines or closures of some of our manufacturing facilities, which would severely disrupt our operations,
 
 
 
·
the sickness or death of our key officers and employees, and
 
 
 
·
a general slowdown in the Chinese economy.
 
Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect our operations.
 
A downturn in the economy of the PRC may slow our growth and profitability.
 
A significant portion of our revenues are generated from sales in China. The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any downturn will not have a negative effect on our business, especially if it results in either a decreased use of our products or in pressure on us to lower our prices.
 
Because our business is located in the PRC, we may have difficulty establishing adequate management, legal and financial controls, which we are required to do in order to comply with U.S. securities laws.
 
PRC companies have historically not adopted a Western style of management and financial reporting concepts and practices, which includes strong corporate governance, internal controls and, computer, financial and other control systems. Most of our middle and top management staff are not educated and trained in the Western system, and we may have difficulty hiring new employees in the PRC with such training. In addition, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in the PRC. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards. Therefore, we may, in turn, experience difficulties in implementing and maintaining adequate internal controls as required under Section 404 of the Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or material weaknesses in our internal controls which could impact the reliability of our financial statements and prevent us from complying with SEC rules and regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such deficiencies, weaknesses or lack of compliance could have a materially adverse effect on our business.
 
RISKS RELATED TO OUR CAPITAL STRUCTURE
 
Our stock price is volatile and you might not be able to resell your securities at or above the price you have paid.
 
Prior to the listing of our Common Stock on the NYSE Amex in March 2009, there was no public market for our securities. Since our listing, the price at which our Common Stock has traded has been highly volatile. From our date of listing on NYSE Amex until March 22, 2010, the low and high sale prices of our common stock on the NYSE Amex ranged from $2.03 to $5.50 per share. Accordingly, we cannot assure you that an active trading market will develop or be sustained or that the market price of our common stock will not decline. You might not be able to sell the shares of our common stock at or above the price you have paid. The stock market has experienced extreme volatility that often has been unrelated to the performance of its listed companies. Moreover, only a limited number of our shares are traded each day, which could increase the volatility of the price of our stock. These market fluctuations might cause our stock price to fall regardless of our performance. The market price of our common stock might fluctuate significantly in response to many factors, some of which are beyond our control, including the following:
 
 
29

 

 
·
actual or anticipated fluctuations in our annual and quarterly results of operations;
 
 
 
·
changes in securities analysts’ expectations;
 
 
 
·
variations in our operating results, which could cause us to fail to meet analysts’ or investors’ expectations;

 
·
announcements by our competitors or us of significant new products, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; 

 
·
conditions and trends in our industry;
 
 
 
·
general market, economic, industry and political conditions;
 
 
 
·
changes in market values of comparable companies;
 
 
 
·
additions or departures of key personnel;
 
 
 
·
stock market price and volume fluctuations attributable to inconsistent trading volume levels; and
 
 
 
·
future sales of equity or debt securities, including sales which dilute existing investors.
 
Holders of our common stock may be diluted in the future.
 
We are authorized to issue up to 100,000,000 shares of common stock and 10,000,000 shares of preferred stock. Our Board of Directors will have the ability, without seeking stockholder approval, to issue additional shares of common stock and/or preferred stock in the future for such consideration as our Board of Directors may consider sufficient. The issuance of additional common stock and/or preferred stock in the future will reduce the proportionate ownership and voting power of our common stock held by existing stockholders. At March 23, 2010 there were 40,675,347 shares of common stock outstanding and warrants to purchase 55,000 shares of common stock. In addition, we have an authorized reserve of 4,000,000 shares of common stock that we may grant as stock options or other equity awards pursuant to our stock option plan. We also intend to issue approximately $20 million worth of shares of common stock in a public offering that we intend to conduct in the near future. The public offering and any other issuances of our common stock would similarly dilute the relative ownership interest of our current stockholders, and could also cause the trading price of our common stock to decline.
 
Shares eligible for future sale may adversely affect the market price of our common stock, as the future sale of a substantial amount of outstanding stock in the public marketplace could reduce the price of our common stock.
 
The market price of our Common Stock could decline as a result of sales of a large number of shares of our Common Stock in the market or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
 
As of March 23, 2010, we had approximately 40.7 million shares of Common Stock outstanding. In March 2009, we conducted a registered public offering of 550,000 shares of common stock and registered for additional 7.6 million shares of common stock for resale by selling shareholders. All of these shares are now freely tradable, except for approximately 2.2 million shares that remain subject to lock up restrictions. We also intend to issue approximately $20 million worth of shares of common stock in a public offering that we intend to conduct in the near future, and all of these shares will be freely tradeable.
 
Additionally, in connection with our public offering in March 2009, the former stockholders of NIVS BVI and their designees, which collectively hold 27,546,667 shares of our common stock, entered into a lock-up agreement pursuant to which they agreed not to sell or transfer any of their shares until March 2011, subject to release from the underwriter, after which the shares may be sold subject to Rule 144. Under Rule 144, an affiliate stockholder who has satisfied a the required holding period may, under certain circumstances, sell within any three-month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. As of March 23, 2010, 1% of our issued and outstanding shares of common stock was approximately 406,753 shares. Non-affiliate stockholders are not subject to volume limitations. Any substantial sale of common stock pursuant to any resale prospectus or Rule 144 may have an adverse effect on the market price of our common stock by creating an excessive supply.
 
 
30

 

The interests of the existing minority shareholder in NIVS PRC may diverge from our own interests and this may adversely affect our ability to manage NIVS PRC.
 
NIVS PRC, our principal operating subsidiary, is an equity joint venture in which we, through NIVS BVI, directly own a 97.5% interest and the founder of NIVS PRC and our current Chief Executive Office and Chairman of the Board, Tianfu Li, owns the remaining 2.5% interest. Mr. Li’s interest may not be aligned with our interest at all times. If our interests diverge, Mr. Li may exercise his rights, as dictated under PRC laws, to protect his own interest, which may be adverse to us and our investors. For example, should we wish to transfer our equity interest in NIVS PRC, in whole or in part, to a third-party, Mr. Li, if he dissents to such a transfer, will have a right to have his interests purchased under general company regulations. If Mr. Li exercises his rights, any proposed sale and transfer of our interests in NIVS PRC may be delayed and our financial condition and results of operations may suffer.
 
The former principal shareholders of NIVS BVI and their designees have significant influence over us.
 
The former shareholders of NIVS BVI and their designees beneficially own or control approximately 75% of our outstanding shares. If these shareholders were to act as a group, they would have a controlling influence in determining the outcome of any corporate transaction or other matters submitted to our stockholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, election of directors, and other significant corporate actions. Such shareholders may also have the power to prevent or cause a change in control. In addition, without the consent of the former NIVS BVI shareholders and their designees, we could be prevented from entering into transactions that could be beneficial to us. The interests of the former NIVS BVI shareholders and their designees may differ from the interests of our other stockholders.
 
If we fail to maintain effective internal controls over financial reporting, the price of our common stock may be adversely affected.
 
We are required to establish and maintain appropriate internal controls over financial reporting. Failure to establish those controls, or any failure of those controls once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations. Any failure of these controls could also prevent us from maintaining accurate accounting records and discovering accounting errors and financial frauds. Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting, and attestation of this assessment by our independent registered public accountants. The annual assessment of our internal controls requirement first applied to our annual report for the 2008 fiscal year and the attestation requirement of management’s assessment by our independent registered public accountants will first apply to our annual report for the 2010 fiscal year.
 
The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. In October 2008, our independent registered public accounting firm Kempisty & Company Certified Public Accountants, P.C. (“Kempisty”), informed us that our financial statements for the years ended 2007, 2006, and 2005 and the quarter ended June 30, 2008 and 2007 contained an error in the accounting treatment of imputed interest on due to shareholders loan, resulting in an understatement of our expenses for those periods. Furthermore, in November 2008, our management identified a material weakness in our controls and procedures regarding our failure to timely disclose and prevent loan transactions made to entities owned and controlled by our CEO and related parties in violation of Section 402 of the Sarbanes-Oxley Act of 2002. In February 2010, we conducted a restatement related to an accounting error that resulted in an overstatement of selling expenses in the amount of approximately $618,000 for the three months ended September 30, 2009 and approximately $870,000 of unrecorded liabilities related to the Company’s non-payment of contributions to PRC housing provident funds for its employees as required under PRC regulations. We may encounter additional problems or delays in completing activities necessary to improve our internal control over financial reporting. In addition, the attestation process by our independent registered public accountants is new and we may encounter problems or delays in completing the implementation of any requested improvements and receiving an attestation of our assessment by our independent registered public accountants. If we cannot assess our internal control over financial reporting as effective, or our independent registered public accountants are unable to provide an unqualified attestation report on such assessment for fiscal year 2010, investor confidence and share value may be negatively impacted.
 
In addition, management’s assessment of internal controls over financial reporting may identify weaknesses and conditions that need to be addressed in our internal controls over financial reporting or other matters that may raise concerns for investors. Any actual or perceived weaknesses and conditions that need to be addressed in our internal control over financial reporting, disclosure of management’s assessment of our internal controls over financial reporting, or disclosure of our public accounting firm’s attestation to our report on management’s assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.
 
 
31

 

We provided loans to certain entities owned and controlled by our chief executive officer in violation of Section 402 of the Sarbanes-Oxley Act of 2002 and we and/or our chief executive officer could become subject to criminal, civil or administrative sanctions, penalties, or investigations and may also face potential private securities litigation.
 
Section 402 of the Sarbanes-Oxley Act of 2002 (“Section 402”) prohibits us from directly or indirectly, including through any subsidiary, extending or maintaining credit, arranging for the extension of credit, or renewing an extension of credit, in the form of a personal loan to or for any of our directors or executive officers. Prior to the Share Exchange, our subsidiaries entered into loan transactions with NIVS PRC’s founder and our principal shareholder and current Chief Executive Officer and Chairman of the Board, Tianfu Li. In these transactions, our subsidiaries would borrow funds from Mr. Li. In addition, our subsidiaries would lend funds to entities that were owned and controlled by Mr. Li. These entities are NIVS Investment (SZ) Co., Ltd.; Zhongkena Technology Development; Xentsan Technology (SZ) Co., Ltd.; Korea Hyundai Light & Electric (Int’l) Holding; NIVS Information & Technology (HZ) Co., Ltd.; and Hyundai Light & Electric (HZ) Co., Ltd. (collectively, the “Related Companies”). The loans, which were unsecured with no fixed repayment date, were for temporary funding of each of the Related Companies’ business.
 
It was intended that all loans from the Company to the entities owned by our CEO and related parties be repaid prior to the closing of the Share Exchange, and no further loans would be made after the closing of the Share Exchange. In November 2008, it was discovered that the loans to entities owned by our CEO and related parties continued after the closing of the Share Exchange, as more fully described in the notes to the financial statements contained in this Annual Report on Form 10-K. Although we have attempted to take remedial steps to address the violation of Section 402 by requiring immediate and full repayment of all outstanding loan balances, the violation of Section 402 may cause governmental authorities, such as the United States Securities and Exchange Commission, to subject us to criminal, civil, or administrative sanctions, penalties, or investigations, which may not be resolved favorably and will require significant management time and attention, and we could incur costs which could materially and negatively affect our business, results of operations and cash flows. There are no assurances that an investigation or litigation will not commence, and if commenced, that such investigation or litigation will result in a favorable outcome for us. Similarly, private parties may also initiate civil litigation against us for such violations.
 
We may not be able to achieve the benefits we expect to result from the Share Exchange.
 
On July 25, 2008, the Share Exchange closed and NIVS BVI became our 100%-owned subsidiary, and our sole business operations became that of NIVS BVI. We also appointed a new Board of Directors and management consisting of persons from NIVS BVI and changed our corporate name from SRKP 19, Inc. to NIVS IntelliMedia Technology Group, Inc.
 
We may not realize the benefits that we hoped to receive as a result of the Share Exchange, which include:

 
·
access to the capital markets of the United States;

 
·
the increased market liquidity expected to result from exchanging stock in a private company for securities of a public company that may eventually be traded;

 
·
the ability to use registered securities to make acquisition of assets or businesses;

 
·
increased visibility in the financial community;

 
·
enhanced access to the capital markets;

 
·
improved transparency of operations; and

 
·
perceived credibility and enhanced corporate image of being a publicly traded company.

There can be no assurance that any of the anticipated benefits of the Share Exchange will be realized with respect to our new business operations. In addition, the attention and effort devoted to achieving the benefits of the Share Exchange and attending to the obligations of being a public company, such as reporting requirements and securities regulations, could significantly divert management’s attention from other important issues, which could materially and adversely affect our operating results or stock price in the future.
 
Compliance with changing regulation of corporate governance and public disclosure will result in additional expenses.
 
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and related SEC regulations, have created uncertainty for public companies and significantly increased the costs and risks associated with accessing the public markets and public reporting. For example, on January 30, 2009, the SEC adopted rules requiring companies to provide their financial statements in interactive data format using the eXtensible Business Reporting Language, or XBRL. We will have to comply with these rules by June 15th, 2011. NIVS’ management team will need to invest significant management time and financial resources to comply with both existing and evolving standards for public companies, which will lead to increased general and administrative expenses and a diversion of management time and attention from revenue generating activities to compliance activities.
 
 
32

 

Our common stock may be considered a “penny stock,” and thereby be subject to additional sale and trading regulations that may make it more difficult to sell.
 
Our common stock may be considered to be a “penny stock” if it does not qualify for one of the exemptions from the definition of “penny stock” under Section 3a51-1 of the Securities Exchange Act for 1934, as amended (the “Exchange Act”). Our common stock may be a “penny stock” if it meets one or more of the following conditions (i) the stock trades at a price less than $5.00 per share; (ii) it is NOT traded on a “recognized” national exchange; (iii) it is NOT quoted on the Nasdaq Capital Market, or even if so, has a price less than $5.00 per share; or (iv) is issued by a company that has been in business less than three years with net tangible assets less than $5 million.
 
The principal result or effect of being designated a “penny stock” is that securities broker-dealers participating in sales of our common stock will be subject to the “penny stock” regulations set forth in Rules 15-2 through 15g-9 promulgated under the Exchange Act. For example, Rule 15g-2 requires broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document at least two business days before effecting any transaction in a penny stock for the investor’s account. Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult and time consuming for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.
 
We do not foresee paying cash dividends in the foreseeable future and, as a result, our investors’ sole source of gain, if any, will depend on capital appreciation, if any.
 
We do not plan to declare or pay any cash dividends on our shares of common stock in the foreseeable future and currently intend to retain any future earnings for funding growth. As a result, investors should not rely on an investment in our securities if they require the investment to produce dividend income. Capital appreciation, if any, of our shares may be investors’ sole source of gain for the foreseeable future. Moreover, investors may not be able to resell their shares at or above the price they paid for them.
 
ITEM 1B. UNRESOLVED STAFF COMMENTS
 
Not applicable.

In China, only the PRC government and peasant collectives may own land.  In 2005, NIVS PRC acquired a total of approximately 2 million square feet of land equity in Lianhelingwei Village, Shuikou Town, in Huizhou City, Guangdong, China for approximately RMB18.8 million (equivalent to approximately USD$2.7million) under land use right granted from the Huizhou State-Owned Land Resource Bureau.  We have the right to use the land until June 2052.  In the event we wish to continue to use the land after this expiration date, we must apply for an extension at least one year prior to the granted land use right’s expiration.

NIVS PRC built a modernized factory on this land property consisting of approximately 2.7 million square feet of total space, including of manufacturing plants, dormitories, research and development, warehouse space, and office facilities.  Its production area covers approximately 1.1 million square feet and its dormitories cover approximately 215,000 square feet.  The production area primary consists of full-product and semi-finished products assembly workshops, in addition to offices, showrooms, and warehouse space.

Our registered principal corporate offices are located in the PRC at NIVS Industry Park, No. 29-31, Shuikou Road, Huizhou, Guangdong, People’s Republic of China 516006.

ITEM 3.  LEGAL PROCEEDINGS

We are not involved in any material legal proceedings outside of the ordinary course of our business.
 
ITEM 4.  (REMOVED AND RESERVED)
 
 
33

 

 
ITEM 5.  MARKET FOR REGISTRANTS COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

 Prior to March 13, 2009, our shares of common stock were not listed or quoted for trading on any national securities exchange or national quotation system. On March 13, 2009, we completed the initial public offering and our common stock began trading on the NYSE Amex under the symbol “NIV.”
 
The following table summarizes the high and low sales price of our common stock as reported by the NYSE Amex for each quarter in the year ended December 31, 2009.   As of March 22, 2010, we had approximately 212 stockholders of record.

   
2009
 
   
High
   
Low
 
Fourth Quarter
 
$
3.00
   
$
2.17
 
Third Quarter
 
$
3.26
   
$
2.03
 
Second Quarter
 
$
4.58
   
$
2.14
 
First Quarter (from March 13, 2009)
 
$
5.50
   
$
3.24
 

Performance Stock Graph

March 13, 2009, the date of our initial listing on a national securities exchange, to the cumulative return over such period of The NYSE Amex Composite Index, and the Russell 2000 Index. We do not use a published industry or line-of-business basis, and do not believe we could reasonably identify a different peer group. The graph assumes that $100 was invested on the date on which we completed the public offering of our common stock conducted with our initial listing on March 13, 2009 and in each of the comparative indices on the same date. The graph further assumes that such amount was initially invested in the common stock of our company at the price to which such stock was first offered to the public by our company on the date of our public offering price of $3.50 per share that was conducted in connection with our initial listing. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG NIVS INTELLIMEDIA TECHNOLOGY GROUP, INC.,
THE NYSE AMEX COMPOSITE INDEX
AND THE RUSSELL 2000 INDEX


Dividends

We did not pay any dividends during the years ended December 31, 2009, 2008 and 2007.
 
 
34

 

We do not expect to declare or pay any cash dividends on our common stock in the foreseeable future, and we currently intend to retain future earnings, if any, to finance the expansion of our business. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in its discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant.
 
Under applicable PRC regulations, foreign-invested enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a foreign-invested enterprise in China is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reaches 50.0% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a foreign-invested enterprise has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.
 
Furthermore, the ability of our Chinese operating subsidiaries to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balance of the Chinese operating subsidiaries. Because substantially all of our operations are conducted in the PRC and a substantial majority of our revenues are generated in the PRC, a majority of our revenue being earned and currency received are denominated in Renminbi (RMB). RMB is subject to the exchange control regulation in the PRC, and, as a result, we may unable to distribute any dividends outside of the PRC due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.
 
Our inability to receive dividends or other payments from our Chinese operating subsidiary could adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends, or otherwise fund and conduct our business. NIVS PRC’s funds may not be readily available to us to satisfy obligations which have been incurred outside the PRC, which could adversely affect our business and prospects or our ability to meet our cash obligations. Accordingly, if we do not receive dividends from our Chinese operating subsidiary, our liquidity, financial condition and ability to make dividend distributions to our stockholders will be materially and adversely affected.
 
Transfer Agent
 
The transfer agent and registrar for our common stock is Corporate Stock Transfer, Inc.
 
Securities Authorized for Issuance Under Equity Compensation Plan
 
Our equity compensation plan information is provided as set forth in Part III, Item 11.
 
Additional Information
 
Copies of our annual reports, quarterly reports, current reports, and any amendments to those reports, are available free of charge on the Internet at www.sec.gov. All statements made in any of our filings, including all forward-looking statements, are made as of the date of the document in which the statement is included, and we do not assume or undertake any obligation to update any of those statements or documents unless we are required to do so by law.
 
 
35

 

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated statement of operations data for the years ended December 31, 2009, 2008, 2007, 2006 and 2005 and the balance sheet data as of December 31, 2009, 2008, 2007, 2006 and 2005 are derived from the Company’s audited consolidated financial statements. The following data is qualified in its entirety by the consolidated financial statements and the notes to the consolidated financial statements starting on page F-1 and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Form 10-K.
 
   
Years Ended December 31,
 
    
2009
   
2008
   
2007
   
2006
   
2005
 
    
(all amounts are in thousands except share and per share amounts)
 
Revenue
  $ 185,198     $ 143,631     $ 77,627     $ 37,735     $ 21,966  
Other Sales
    282       415       516       53       -  
Cost of Goods Sold
    (142,416 )     (109,763 )     (58,864 )     (28,072 )     (17,300 )
Gross Profit
    43,064       34,283       19,279       9,716       4,666  
                                         
Selling Expenses
    6,761       5,376       3,270       1,792       837  
                                         
General and administrative
                                       
Amortization
    79       69       62       59       137  
Depreciation
    331       337       328       300       198  
Bad debts (recovery)
    (2,745 )     2,531       473       133       81  
Merger cost
    -       1,786       -       -       -  
Stock-based compensation
    -       765       -       -       -  
Other G&A expense
    4,850       3,172       2,548       1,126       832  
Total General and administrative
    2,515       8,660       3,411       1,618       1,248  
Research and development
    5,315       1,737       373       417       230  
Total operating expenses
    14,591       15,773       7,054       3,827       2,315  
Income from operations
    28,473       18,510       12,225       5,889       2,351  
                                         
Other income (expenses)
                                       
Government grant
    576       32       28       -       160  
Write-down of inventory
    -       (132 )     (105 )     -       (5 )
Gain on disposal of assets
    -       -       -       1,226       -  
Interest income
    -       -       235       19       11  
Interest expense
    (1,567 )     (2,208 )     (1,792 )     (863 )     (319 )
Imputed interest
    -       (656 )     (527 )     (125 )     (97 )
Sundry income (expense), net
    11       (52 )     (111 )     (56 )     (7 )
Total other income (expenses)
    (980 )     (3,016 )     (2,272 )     201       (257 )
                                         
Income before Noncontrolling interest and income taxes
    27,493       15,494       9,953       6,090       2,094  
Income taxes
    (3,406 )     (2,031 )     (1,269 )     (753 )     -  
Noncontrolling interest
    (630 )     (430 )     (217 )     (135 )     (56 )
                                         
Net Income
  $ 23,457     $ 13,033     $ 8,467     $ 5,202     $ 2,038  
                                         
Basic and Diluted Earnings Per Share
  $ 0.59     $ 0.41     $ 0.31     $ 0.19     $ 0.07  
                                         
Basic Weighted-Average Shares Outstanding
    39,858,756       31,553,197       27,546,667       27,546,667       27,546,667  
Diluted Weighted-Average Shares Outstanding
    39,858,756       31,967,040       27,546,667       27,546,667       27,546,667  

Consolidated Balance Sheets
 
As of December 31,
 
  
 
2009
   
2008
   
2007
   
2006
   
2005
 
  
 
(in thousands)
 
Total Current Assets
  $ 63,122     $ 44,963     $ 25,309     $ 16,768     $ 12,287  
Total Assets
    140,477       118,924       88,554       37,015       34,860  
Total Current Liabilities
    59,786       63,592       59,528       28,715       19,415  
Total Liabilities
    59,786       71,435       70,537       34,808       29,469  
Total Stockholders’ Equity
    80,691       47,489       18,017       2,207       5,391  
 
 
36

 


Forward-Looking Statements

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes, and the other financial information included in this report.

This report contains forward-looking statements. The words “anticipated,” “believe,” “expect, “plan,” “intend,” “seek,” “estimate,” “project,” “could,” “may,” and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management’s current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, general economic and business conditions, changes in foreign, political, social, and economic conditions, regulatory initiatives and compliance with governmental regulations, the ability to achieve further market penetration and additional customers, and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements and there can be no assurance of the actual results or developments.

Overview

Through NIVS PRC, we engage in the development, production and sales of consumer electronic products.  Our products primarily consist of audio and video products, including digital audio systems, televisions, digital video broadcasting (“DVB”) set-top boxes, DVD players, as well as audio/video peripheral and accessory products.  We have invested substantial resources in the research and development of our intelligent audio and video consumer products, most of which utilize our Chinese speech interactive technology to permit users to control our products through their spoken commands.  We recently added mobile phones and other 3G communication devices to our product portfolio.  In January 2010, we acquired Dongri, a mobile phone product manufacturer, for a purchase price of up to $23 million.

Through wholesalers and distributors of electronic products, our products are distributed worldwide, including markets in Europe, Southeast Asia and North America.  For export sales and OEM production, we produce based on customer demand and orders. For products with our own brand names, customers generally do not provide us with any long-term commitments. As a result it is necessary for us to estimate, based in part on non-binding estimates by our customers and potential customers, the requirements for our products. In addition, in some instances, we develop products based on anticipated customer demand with no assurance that we will receive the anticipated orders. To the extent that we do not receive the anticipated orders or that our customers require products in greater quantities than anticipated, our revenue and margins will be affected.

A small number of customers account for a very significant percentage of our revenue. For the year ended December 31, 2009, we had four customers that each accounted for at least 5% of the revenues that we generated. These four customers accounted for a total of approximately 34.9% of our revenue for that period.  During the year ended December 31, 2009, we had one customer—Shenzhen Zhanhui (15.9%)—that accounted for more than 10% of our sales. During the year ended December 31, 2008, we had four customers that generated revenues of at least 5% of our revenues. These four customers accounted for a total of approximately 33.3% of our revenue for the year ended December 31, 2008. For the same period, we had one customer—Shenzhen Zhanhui (12.7%)—that accounted for more than 10% of our sales. During the year ended December 31, 2007, we had five customers that generated revenues of at least 5% of our revenues. These five customers accounted for a total of approximately 38.4% of our revenue for the year ended December 31, 2007. For the same period, we had one customer—HongKong Huian (13.5%)—that accounted for more than 10% of our sales. Unless we replace a customer, the loss of any of these customers could have a material adverse effect upon our revenue and net income.   

We have longstanding business relationships with certain suppliers with stable supply sources, and we believe this practice helps us reduce our risk on shortage of raw material supply.  We also enter into one-year agreements with some of our suppliers that provide our forecast of the quantity that we believe that we will need for the upcoming year.  These agreements typically result in obtaining a discount on our purchases from our suppliers during the year as we submit purchase orders further to the agreements.  Notwithstanding our practices to reduce the cost of our materials, price fluctuations of materials will still affect our production cost and gross margin.

Various factors may impact our company’s performance in different ways. Our ability to compete effectively in light of the short life cycle of many of our products is related to the amount of resources we invest in research and development and how quickly we are able to produce new product models to replace products with older functionality.  By upgrading our products, adding functionality, and improving technological specifications, we can increase the value of such products and the resulting product price, which can help compensate for losses associated with the short life cycle of many of our products and can help increase our revenue.  For example, the average selling price for certain of our existing speaker and CRT TV has been declining.  By adding functionality and developing new design to our speaker to form new intelligent audio and video equipment and shift CRT TV to LCDTV production, we believe we increased the value of such products and the resulting product price.
 
 
37

 

In addition, we have shifted our focus from one product to another product that we believe would increase our profitability. During 2009, our sales revenue for new intelligent audio and video equipment was approximately $83.9 million, which represented an increase of approximately 363.5% compared to revenue of $18.1 million from the sale of intelligent audio and video equipment in 2008. The increase in revenue for new intelligent audio and video equipment resulted from an increase in sales volume. In 2009, our sales volume for home theater increased approximately 15.5% as compared to sales volume in 2008. We believe the increase in sales revenue and volume is a result of our investment of resources into the research and development of new products and design, our focus on the promotion of our brand, and expansion of our sales channels. In year ended December 31, 2009, our sales revenue for LCDTV decreased approximately 5.9%, respectively, compared to our sales revenue for the year ended December 31, 2008.
 
Furthermore, we have recently entered into the mobile phone and communication device market. In January 2010, we agreed to pay up to $23 million in our acquisition of Huizhou Dongri Digital Co., Ltd., a mobile phone product manufacturer. We intend to devote additional management time and resources to penetrating the mobile phone and communication device market. We expect that Dongri will replace a significant portion of outsourced manufacturing services as it relates to mobile phone products that we previously utilized. Because we have our own factory and capabilities to produce a large number of the important components needed for our mobile phone products, we believe that the acquisition will ultimately be the most cost-effective manner to provide mobile phones to the market. We expect that the margins on our mobile phone products will be lower than our audio and video equipment; however, with the acquisition of Dongri, we believe that we will be able to increase the sales volume of our mobile phone products, which will increase our revenues.
 
In the past, we have relied more heavily on sales to original equipment manufacturers (OEMs) for a significant portion of our revenues; however, we have increased our focus on and investment of resources in sales of our own brand, which we believe will permit us to decrease our reliance on OEM sales. OEM sales accounted for approximately 55% of our revenues for the year ended December 31, 2009, as compared to 60% for the year ended December 31, 2008, and 77% for the year ended December 31, 2007, and sales of products with our own brand accounted for approximately 45% of our revenues for the year ended December 31, 2009, as compared to 40% for the year ended December 31, 2008, and 23% for the year ended December 31, 2007.
 
Corporate History
 
We were incorporated in the State of Delaware on December 7, 2006 as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly held corporation. On June 27, 2008, we entered into a share exchange agreement with Niveous Holding Company Limited, a British Virgin Islands company (“NIVS BVI”) and all of the shareholders of NIVS BVI. Pursuant to the exchange agreement, as it was amended on July 25, 2008, we agreed to issue an aggregate of 27,546,667 shares of our common stock in exchange for all of the issued and outstanding securities of NIVS BVI. The share exchange closed on July 25, 2008 and we (i) closed a share exchange transaction pursuant to which we became the 100% parent of NIVS BVI (ii) assumed the operations of NIVS BVI and its subsidiaries, and (iii) changed or name from SRKP 19, Inc. to NIVS IntelliMedia Technology Group, Inc. After the closing of the share exchange and private placement, as described below, we had 36,855,714 outstanding shares of common stock, no shares of preferred stock, no options, and warrants to purchase 946,667 shares of common stock.
 
The transactions contemplated by the Exchange Agreement, as amended, were intended to be a “tax-free” contribution and/or reorganization pursuant to the provisions of Sections 351 and/or 368(a) of the Internal Revenue Code of 1986, as amended. Because the shares issued that we issued in share exchange represented a controlling interest, the transaction has been accounted for as a recapitalization or reverse merger with NIVS BVI being considered the acquirer. The accompanying consolidated financial statements have been restated on a retroactive basis to present the capital structure of NIVS BVI as though it were the reporting entity.
 
Recent Events
 
January 2010 Acquisition of Dongri
 
In January 2010, we, through NIVS BVI, acquired 100% of the equity interest of Huizhou Dongri Digital Co., Ltd., ("Dongri"), a mobile phone product manufacturer located in the Huizhou Zhongkai Hi-tech Zone area. The aggregate purchase price that we agreed to pay is up to $23 million, with $13 million being paid within one month of closing and up to an additional $10 million that may become payable at future dates if Dongri meets after-tax income targets, as more fully described below. With the acquisition of Dongri, we augmented our manufacturing capabilities for mobile phones.
 
If Dongri's after-tax income for the first half of 2010 exceeds approximately $1.91 million, then an additional $3 million will be paid to the former shareholder of Dongri. If Dongri's after-tax income is between $955,000 and $1.91 million, then a pro-rata amount will be payable, and no percentage of the $3 million will be paid if the after-tax income is less than approximately $955,000. For the third quarter of 2010, if Dongri's after-tax income exceeds approximately $1.03 million, then an additional $3 million will be paid to the former Dongri shareholder. If Dongri's after-tax income is between approximately $514,000 and $1.03 million, then a pro-rata amount will be paid, and no amount will be paid if the after-tax income is less than $514,000. Similarly, for the fourth quarter of 2010, we will pay Dongri an additional $4 million if its after-tax income exceeds $1.18 million, and a pro rata portion if it falls between approximately $590,000 and $1.18 million. No amount will be paid for the fourth quarter if Dongri's after-tax income is less than $590,000.
 
 
38

 

All after-tax income amounts will be calculated by us in accordance with U.S. GAAP, as confirmed by our independent auditors. We will make additional payments owed to Dongri, if any, no later than the 30 days after the filing of our quarterly or annual report, as applicable, with the SEC for the respective period.
 
September 2009 Entry into Mobile Phone Market
 
In September 2009, we were granted a license to manufacture mobile phones by the Ministry of Industry and Information Technology. With our new license, we are authorized to operate mobile phone manufacturing business in mainland China under the “NIVS” brand name. We have capabilities and intellectual property rights to manufacture 3G mobile phones and have already introduced a dual-mode EVDO/GSM 3G handset to the market. Also in 2009, we reached an agreement to manufacture mobile phones for China Telecom Corp. Ltd. to be used with China Telecom’s 3G network, e-Surfing. We currently manufacture two CDMA 3G mobile phone models, the NE16 and NE20.
 
March 2009 Public Offering
 
In March 2009, we completed a public offering consisting of 550,000 shares of our common stock. WestPark Capital, Inc. acted as underwriter in the public offering. Our shares of common stock were sold to the public at a price of $3.50 per share, for gross proceeds of approximately $1.9 million. In April 2009, WestPark Capital exercised its over-allotment option to purchase an additional of 82,500 shares of common stock. The shares were sold at a price of $3.50 per share for a gross proceed of $288,750.
 
December 2008 Agreement to Convert Debt to Shares
 
On December 24, 2008, we and three of our subsidiaries (NIVS BVI, NIVS HK, and NIVS PRC) entered into an agreement with Mr. Li pursuant to which the outstanding debt that we owed to Mr. Li would be converted into shares of our common stock. According to the agreement, the shares would be issued upon the closing of our public offering. The public offering closed on March 18, 2009 and we issued 2,240,493 shares of common stock to Mr. Li, which is equal to the debt amount of approximately $7.8 million divided by the offering price of our public offering, which was $3.50 per share. As a result of the conversion of the debt into equity, the debt is no longer outstanding, and we do not have any outstanding debt owed to Mr. Li.
 
November 2008 Debt Repayment and Set-Off Agreement
 
From June 2005 to November 2008, our subsidiaries entered into hundreds of loan transactions with NIVS PRC’s founder and our principal shareholder and current Chief Executive Officer and Chairman of the Board, Tianfu Li. In these loan transactions, we would borrow funds from Mr. Li. In addition, our subsidiaries, primarily through NIVS PRC and NIVS International (H.K.) Limited (“NIVS HK”), would lend funds to the entities that were owned and controlled by Mr. Li. These entities owned and controlled by Mr. Li are NIVS Investment (SZ) Co., Ltd.; Zhongkena Technology Development; Xentsan Technology (SZ) Co., Ltd.; Korea Hyundai Light & Electric (Int'l) Holding; NIVS Information & Technology (HZ) Co., Ltd.; and Hyundai Light & Electric (HZ) Co., Ltd. (collectively, the “Related Companies”). Our loans to related parties also include a loan to a supplier of Hyundai Light and Electric (HZ) Co. Ltd. in the amount of 38,474,900RMB, which is equal to approximately U.S. $5.5 million. The note carried an interest rate of 1.5% per month and was guaranteed by Hyundai Light and Electric (HZ) Co Ltd.
 
The loans to the Related Companies were for temporary funding of each of the Related Companies’ business, and the amount of the loans made by our subsidiaries to the Related Companies ranged in amount. The aggregate amount loaned from our subsidiaries to the Related Companies was approximately $13 million and $10 million during the years ended December 31, 2008 and 2007, respectively. The loan amounts owed to our subsidiaries by the Related Companies as of December 31, 2008 and 2007 were $0 and $2.2 million, respectively. As of December 31, 2008, our subsidiaries had an aggregate outstanding loan balance due to Mr. Li of $7.8 million, which was converted into equity upon the closing of our public offering in March 2009. All of the loans to and from our subsidiaries were unsecured with no fixed repayment date. The loans were borrowed and repaid frequently. Normally, it was agreed that the loan amounts were to be paid back to our subsidiaries within three to six months from the date of the loan transaction.
 
Upon the closing of the Share Exchange, we, a public reporting company under U.S. securities laws, gained ownership of the subsidiaries. As a result, our subsidiaries became subject to the Sarbanes-Oxley Act of 2002, including Section 402’s prohibition against personal loans to directors and executive officers, either directly or indirectly. Because the loans did not have a purpose directly related to the business operations of our company or our subsidiaries, we believe that the loans made and outstanding after the closing of the Share Exchange may violate Section 402 of Sarbanes-Oxley, which would subject us and our chief executive officer to possible criminal, civil or administrative sanctions, penalties, or investigations, in addition to potential private securities litigation. It was intended that all loans from our subsidiaries to our officers and directors, whether directly or indirectly, be repaid in full prior to the closing of the Share Exchange, and no further loans were to be made to such related parties after the closing of the Share Exchange, which occurred on July 25, 2008. In November 2008, it was discovered that the loans to the entities owned by Mr. Li continued after the closing of the Share Exchange, as more fully described in the notes to the financial statements contained in this report. We made a total of 47 loans, with a total loan amount of $3,221,915, to the Related Companies after the closing of the Share Exchange.
 
 
39

 

On November 28, 2008, we and our subsidiaries entered into a Debt Repayment and Set-Off Agreement (the “Agreement”) with Mr. Li and the Related Companies. Pursuant to the Agreement, as it was amended on December 22, 2008, each of the Related Companies agreed to completely and immediately repay all outstanding loan amounts that it owed to us and our subsidiaries and we and our subsidiaries agreed to repay approximately $1.0 million of the debt that we and our subsidiaries owed to Mr. Li. As inducement for the Related Companies for entering into the Agreement, we and our subsidiaries agreed to, among other things, permit the amounts owed to us by the Related Companies to be off-set by amounts that we owed to Mr. Li and acknowledge that the Related Companies no longer owed any loan amounts to us or our subsidiaries.
 
Immediately prior to the repayments under the Agreement, our subsidiaries had an aggregate outstanding loan amount of approximately $8.8 million owed to Mr. Li (the “Li Debt”). On the same date, Mr. Li, through the Related Companies, had an aggregate outstanding loan amount of approximately $1.0 million owed to our subsidiaries (the “Related Companies’ Debt”), which consisted of approximately $1.0 million owed by Korea Hyundai Light & Electric (Int'l) Holding. Pursuant to the Agreement, the Related Companies’ Debt of approximately $1.0 million was repaid by set off against the Li Debt of approximately $8.8 million. As a result of the transactions contemplated by the Agreement, the Related Companies’ Debt was no longer outstanding and neither Mr. Li nor any of the Related Companies owed us or our subsidiaries any loan amount. Moreover, after the repayments under the Agreement, our subsidiaries’ remaining debt owed to Mr. Li was approximately $7.8 million. The parties to the Repayment Agreement also acknowledged that there were no remaining debt obligations owed to the us or our subsidiaries, either directly or indirectly, by Mr. Li, any other executive officer or director, or any related family member, of our company or subsidiaries, or any entity owned or controlled by such persons, including the Related Companies, and that no loans or similar arrangements will be made by us or our subsidiaries to such persons or entities in the future.
 
Critical Accounting Policies, Estimates and Assumptions
 
The SEC defines critical accounting policies as those that are, in management's view, most important to the portrayal of our financial condition and results of operations and those that require significant judgments and estimates.
 
The discussion and analysis of our financial condition and results of operations is based upon our financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities. On an on-going basis, we evaluate our estimates including the allowance for doubtful accounts, the salability and recoverability of inventory, income taxes and contingencies. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we deem it necessary.
 
Revenue recognition. We recognize revenue from the sales of products. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectivity is reasonably assured. Sales revenue is presented net of value added tax (VAT), sales rebates and returns. No return allowance is made as product returns are insignificant based on historical experience.
 
Allowance for doubtful accounts. In estimating the collectability of accounts receivable we analyze historical write-offs, changes in our internal credit policies and customer concentrations when evaluating the adequacy of our allowance for doubtful accounts. Differences may result in the amount and timing of expenses for any period if we make different judgments or use different estimates. Our accounts receivable represent a significant portion of our current assets and total assets. Our realization on accounts receivable, expressed in terms of United States dollars may be affected by fluctuations in currency rates since the customer’s currency is frequently a currency other than United States dollars.
 
Inventories. Inventories comprise raw materials and finished goods are stated at the lower of cost or market. Substantially all inventory costs are determined using the weighted average basis. Costs of finished goods include direct labor, direct materials, and production overhead before the goods are ready for sale. Inventory costs do not exceed net realizable value.
 
Taxation. Under the tax laws of PRC, NIVS PRC has had tax advantages granted by local government for corporate income taxes and sales taxes commencing April 6, 2004. NIVS PRC has been entitled to have a full tax exemption for the first two profitable years, followed by a 50% reduction on normal tax rate of 24% for the following three consecutive years. On March 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law, under which foreign invested enterprises and domestic companies will be subject to enterprise income tax at a uniform rate of 25%, except for High Tech companies that pay a reduced rate of 15%. The new law became effective on January 1, 2008. During the transition period for enterprises established before March 16, 2007 the tax rate will be gradually increased starting in 2008 and be equal to the new tax rate in 2012. We believe that our profitability will be negatively affected in the near future as a result of the new EIT Law.
 
 
40

 

Recently Issued Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board (FASB) issued a standard that established the FASB Accounting Standards Codification (ASC) and amended the hierarchy of generally accepted accounting principles (ASC) and amended the hierarchy of generally accepted accounting principles (GAAP) such that the ASC became the single source of authoritative nongovernmental U.S. GAAP. The ASC did not change current U.S. GAAP, but was intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All previously existing accounting standard documents were superseded and all other accounting literature not included in the ASC is considered non-authoritative. New accounting standards issued subsequent to June 30, 2009 are communicated by the FASB through Accounting Standards Updates (ASUs). The Company adopted the ASC on July 1, 2009. This standard did not have an impact on the Company’s consolidated results of operations or financial condition. However, throughout the notes to the consolidated financial statements references that were previously made to various former authoritative U.S. GAAP pronouncements have been changed to coincide with the appropriate section of the ASC.

In December 2007, the FASB issued a new standard which established the accounting for and reporting of noncontrolling interests (NCIs) in partially owned consolidated subsidiaries and the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs (previously referred to as minority interests) be treated as a separate component of equity, not as a liability (as was previously the case); that increases and decreases in the parent’s ownership interest that leave control intact be treated as equity transactions, rather than as step acquisitions or dilution gains or losses; and that losses of a partially owned consolidated subsidiary be allocated to the NCI even when such allocation might result in a deficit balance. This standard also required changes to certain presentation and disclosure requirements. The Company adopted the standard beginning January 1, 2009. The provisions of the standard were applied to all NCIs prospectively, except for the presentation and disclosure requirements, which were applied retrospectively to all periods presented. As a result, upon adoption, the Company retroactively reclassified the “Minority interest in subsidiaries” balance previously included in the “Other liabilities” section of the consolidated balance sheet to a new component of equity with respect to NCIs in consolidated subsidiaries. The adoption also impacted certain captions previously used on the consolidated statement of income, largely identifying net income including NCI and net income attributable to the Company.  The adoption of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

In June 2009, the FASB issued a new standard regarding the accounting for transfers of financial assets amending the existing guidance on transfers of financial assets to, among other things, eliminate the qualifying special-purpose entity concept, include a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, clarify and change the derecognition criteria for a transfer to be accounted for as a sale, and require significant additional disclosure. The standard is effective for new transfers of financial assets beginning January 1, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated results of operations or financial condition.

In June 2009, the FASB issued an accounting standard that revised the consolidation guidance for variable-interest entities. The modifications include the elimination of the exemption for qualifying special purpose entities, a new approach for determining who should consolidate a variable-interest entity, and changes to when it is necessary to reassess who should consolidate a variable-interest entity. The standard is effective January 1, 2010. The adoption of this standard did not have a material impact on the Company’s consolidated results of operations or financial condition.

In August 2009, the FASB issued ASU No. 2009-05, Measuring Liabilities at Fair Value, which provides additional guidance on how companies should measure liabilities at fair value under ASC 820. The ASU clarifies that the quoted price for an identical liability should be used. However, if such information is not available, a entity may use, the quoted price of an identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities traded as assets, or another valuation technique (such as the market or income approach). The ASU also indicates that the fair value of a liability is not adjusted to reflect the impact of contractual restrictions that prevent its transfer and indicates circumstances in which quoted prices for an identical liability or quoted price for an identical liability traded as an asset may be considered level 1 fair value measurements.  The ASU is effective October 1, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated results of operations or financial condition.

In September 2009, the FASB issued ASU No. 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), that amends ASC 820 to provide guidance on measuring the fair value of certain alternative investments such as hedge funds, private equity funds and venture capital funds. The ASU indicates that, under certain circumstance, the fair value of such investments may be determined using net asset value (NAV) as a practical expedient, unless it is probable the investment will be sold at something other than NAV. In those situations, the practical expedient cannot be used and disclosure of the remaining actions necessary to complete the sale is required. The ASU also requires additional disclosures of the attributes of all investments within the scope of the new guidance, regardless of whether an entity used the practical expedient to measure the fair value of any of its investments. This ASU is effective October 1, 2009. The adoption of this standard did not have a material impact on the Company’s consolidated results of operations or financial condition.
 
 
41

 

In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force, that provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. As a result of these amendments, multiple-deliverable revenue arrangements will be separated in more circumstances than under existing U.S. GAAP. The ASU does this by establishing a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. A vendor will be required to determine its best estimate of selling price in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis. This ASU also eliminates the residual method of allocation and will require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method, which allocates any discount in the overall arrangement proportionally to each deliverable based on its relative selling price. Expanded disclosures of qualitative and quantitative information regarding application of the multiple-deliverable revenue arrangement guidance are also required under the ASU. The ASU does not apply to arrangements for which industry specific allocation and measurement guidance exists, such as long-term construction contracts and software transactions. The ASU is effective beginning January 1, 2011. The Company is currently evaluating the impact of this standard on the Company’s consolidated results of operations and financial condition.
 
In October 2009, the FASB issued ASU No. 2009-14, Certain Revenue Arrangements That Include Software Elements—a consensus of the FASB Emerging Issues Task Force, that reduces the types of transactions that fall within the current scope of software revenue recognition guidance. Existing software revenue recognition guidance requires that its provisions be applied to an entire arrangement when the sale of any products or services containing or utilizing software when the software is considered more than incidental to the product or service. As a result of the amendments included in ASU No. 2009-14, many tangible products and services that rely on software will be accounted for under the multiple-element arrangements revenue recognition guidance rather than under the software revenue recognition guidance. Under the ASU, the following components would be excluded from the scope of software revenue recognition guidance: the tangible element of the product, software products bundled with tangible products where the software components and non-software components function together to deliver the product’s essential functionality, and undelivered components that relate to software that is essential to the tangible product’s functionality. The ASU also provides guidance on how to allocate transaction consideration when an arrangement contains both deliverables within the scope of software revenue guidance (software deliverables) and deliverables not within the scope of that guidance (non-software deliverables). The ASU is effective beginning January 1, 2011. The Company is currently evaluating the impact of this standard on the Company’s consolidated results of operations and financial condition.
 
In January 2010, the FASB issued ASU No. 2010-6, Improving Disclosures About Fair Value Measurements, that amends existing disclosure requirements under ASC 820 by adding required disclosures about items transferring into and out of levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchase, sales, issuances, and settlements relative to level 3 measurements; and clarifying, among other things, the existing fair value disclosures about the level of disaggregation. This ASU is effective for the first quarter of 2010, except for the requirement to provide level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which is effective beginning the first quarter of 2011. Since this standard impacts disclosure requirements only, its adoption will not have a material impact on the Company's consolidated results of operations or financial condition.
 
 
42

 

Results of Operations

The following table sets forth information from our statements of income for the years ended December 31, 2009, 2008, and 2007 in dollars and as a percentage of revenue:

   
Years Ended December 31,
 
    
2009
         
2008
         
2007
       
    
(in thousands)
 
Revenue
  $ 185,198       99.8 %   $ 143,631       99.7 %   $ 77,627       99.3 %
Other Sales
    282       0.2 %     415       0.3 %     516       0.7 %
Cost of Goods Sold
    (142,416 )     -76.8 %     (109,763 )     -76.2 %     (58,864 )     -75.3 %
Gross Profit
    43,064       23.2 %     34,283       23.8 %     19,279       24.7 %
                                                 
Selling Expenses
    6,761       3.6 %     5,376       3.7 %     3,270       4.2 %
                                                 
General and administrative
                                               
Amortization
    79       0.0 %     69       0.0 %     62       0.1 %
Depreciation
    331       0.2 %     337       0.2 %     328       0.4 %
Bad debts (recovery)
    (2,745 )     -1.5 %     2,531       1.8 %     473       0.6 %
Merger cost
    -       0.0 %     1,786       1.2 %     -       0.0 %
Stock-based compensation
    -       0.0 %     765       0.5 %     -       0.0 %
Other G&A expense
    4,850       2.6 %     3,172       2.2 %     2,548       3.3 %
Total General and administrative
    2,515       1.3 %     8,660       5.9 %     3,411       4.4 %
Research and development
    5,315       2.9 %     1,737       1.2 %     373       0.5 %
Total operating expenses
    14,591       7.8 %     15,773       10.8 %     7,054       9.1 %
Income from operations
    28,473       15.4 %     18,510       13.0 %     12,225       15.6 %
                                                 
Other income (expenses)
                                               
Government grant
    576       0.3 %     32       0.0 %     28       0.0 %
Write-down of inventory
    -       0.0 %     (132 )     -0.1 %     (105 )     -0.1 %
Gain on disposal of assets
    -       0.0 %     -       0.0 %     -       0.0 %
Interest income
    -       0.0 %     -       0.0 %     235       0.3 %
Interest expense
    (1,567 )     -0.8 %     (2,208 )     -1.5 %     (1,792 )     -2.3 %
Imputed interest
    -       0.0 %     (656 )     -0.5 %     (527 )     -0.7 %
Sundry income (expense), net
    11       0.0 %     (52 )     0.0 %     (111 )     -0.1 %
Total other income (expenses)
    (980 )     -0.5 %     (3,016 )     -2.1 %     (2,272 )     -2.9 %
                                                 
Income before Noncontrolling interest and income taxes
    27,493       14.9 %     15,494       10.9 %     9,953       12.7 %
Income taxes
    (3,406 )     -1.8 %     (2,031 )     -1.4 %     (1,269 )     -1.6 %
Noncontrolling interest
    (630 )     -0.3 %     (430 )     -0.2 %     (217 )     -0.3 %
                                                 
Net Income
  $ 23,457       12.8 %   $ 13,033       9.3 %   $ 8,467       10.8 %

Years ended December 31, 2009 and 2008

Revenues, which consist of sales of our products, were $185.2 million for the year ended December 31, 2009, an increase of $41.6 million, or 29.0%, compared to $143.6 million for the year ended December 31, 2008. The increase in revenue was attributed mainly to the increased demand for and sales of intelligent audio and video products, which we believe is a result of our market expansion efforts. The increase of revenue was also due to the sales of digital equipment and other products, as well as price increases of some of our audio system products. Sales revenue for our intelligent audio and video equipment increased to $83.9 million for the year ended December 31, 2009, an increase of 363.5% as compared to $18.1 million for the year ended December 31, 2008.  For the year ended December 31, 2009, our sales revenue for standard audio equipment decreased to $90.5 million, a decrease of 21.6 % compared to $115.5 million for the same period in 2008. Sales revenue for televisions decreased to $19.4 million, a decrease of 6.3% compared to $20.7 million for the same period in 2008.  For the year ended December 31, 2009, our sales volume for standard audio equipment decreased by 25.3% to 3.48 million pieces as compared to 4.66 million pieces for 2008.  For the year ended December 31, 2009, our sales volume for televisions increased by 5.6% to 0.19 million pieces as compared to 0.18 million pieces for the same period in 2008.  Our sales volume for intelligent audio and video equipment increased by 66.7% to 0.85 million pieces as compared to 0.51 million pieces for the same period in 2008. We believe the increases in sales revenue and volume of intelligent audio and video products are a result of our investment of resources into the research and development of new products and design to meet the requirements of the market, our focus on the promotion of our brand, and expansion of our sales channels.
 
 
43

 

Cost of sales, which include raw material, labor and manufacturing overhead, were $142.4 million for the year ended December 31, 2009, an increase of $32.6 million, or 29.7%, compared to $109.8 million for the year ended December 31, 2008. The increase was primarily a result of the increase in sales and was relatively consistent with the increase in our net revenue. As a percentage of net revenue, cost of sales for the years ended December 31, 2009 and 2008 were 76.8% and 76.2%, respectively.
 
Gross profit for the year ended December 31, 2009 was $ 43.1 million, or 23.3 % of revenues, compared to $34.3 million, or 23.9% of revenues, for the year ended December 31, 2008. Gross profit margins are a factor of cost of sales, product mix and product demand. For the year ended December 31, 2009, the price of standard audio equipments which are large percentage of our sales decreased and some of the costs involved in production increased; however, its effect is partially offset by increase in the new intelligent products. These factors caused the small decrease in gross margin.
 
Selling expenses, which mainly include marketing, shipping, insurance, wage and other expenses, were $6.8 million for the year ended December 31, 2009, an increase of $1.4 million, or 25.9%, compared to $5.4 million for the year ended December 31, 2008. The increase was primarily due to an increase in television advertising (on CCTV), internet advertising, and marketing activities.
 
Research and development expenses were approximately $5.3 million for the year ended December 31, 2009, an increase of approximately $3.6 million, or 211.8% compared to approximately $1.7 million for the year ended December 31, 2008. We believe that our focus on research and development contributed to the increase in our total sales. In the future, we expect to continue to increase our research and development efforts and to enable us to manufacture wider lines of products, such as mobile phones and other 3G communication products.
 
General and administrative expenses were $2.5 million for the year ended December 31, 2009, a decrease of $6.2 million, or 71.3%, compared to $8.7 million for the year ended December 31, 2008. General and administrative expenses include amortization, depreciation, bad debt(recovery), merger costs, professional fees, office expenses, salary and wages, utilities, employee housing fund and other expenses. The substantial portion of the decrease for the year ended December 31, 2009 was due to the $2.7 million reversal of bad debt allowance in 2009 and the $2.5 million bad debt expense recorded in 2008, and we had merger cost in 2008. We expect our general and administrative expenses to increase as a result of professional fees incurred as a result of being a public reporting company in the United States, in addition to the increased general administrative expense that will be involved with the operation of Dongri.
 
Interest expenses were $1.6 million and $2.2 million for the years ended December 31, 2009 and 2008, respectively. The decrease was due to the decrease in the interest rate during the year ended December 31, 2009.
 
Income tax provisions for years ended December 31, 2009 and 2008 were approximately $3.4 million and $2.0 million, respectively. The increase is mainly due to an increase in the taxable income for the year ended December 31, 2009. NIVS PRC is registered in PRC and has had tax advantages granted by local government for corporate income taxes and sales taxes commencing April 6, 2004. NIVS PRC has been entitled to have a full tax exemption for the first two profitable years, followed by a 50% reduction on normal tax rate of 24% for the following three consecutive years. Our effective income tax rates for the years ended December 31, 2009 and 2008 were 12.4% and 13.1%, respectively. On March 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law, under which foreign invested enterprises and domestic companies will be subject to enterprise income tax at a uniform rate of 25%. The new law became effective on January 1, 2008. During the transition period for enterprises established before March 16, the tax rate will be gradually increased starting in 2008 and be equal to the new tax rate in 2012. We believe that our profitability will be negatively affected as a result of the new EIT Law.
 
Net income was $23.5 million for the year ended December 31, 2009, an increase of $10.5 million, or 80.8%, compared to $13.0 million for the year ended December 31, 2008.
 
 
44

 

Years ended December 31, 2008 and 2007
 
Revenues, which consist of sales of our products, were $143.6 million for the year ended December 31, 2008, an increase of $66.0 million, or 85.1%, compared to $77.6 million for the year ended December 31, 2007. The increase in revenue was attributed mainly to the increased demand for our products, which we believe is a result of our market expansion efforts. The increase of revenue was also due to the new sales of digital equipment and LCD products, as well as price increases of some of our audio system products. For the year ended December 31, 2008, our sales revenue for standard audio equipment increased to $52 million, an increase of 2% compared to $51 million for the same period in 2007. Sales revenue for televisions increased to $15.18 million, an increase of 299.5% compared to $3.8 million for the same period in 2007. Sales revenue for our intelligent audio and video equipment increased to $25.31 million for the year ended December 31, 2008, an increase of 481.8% as compared to $4.35 million for the year ended December 31, 2007. For the year ended December 31, 2008, our sales volume for standard audio equipment increased by 17.1% to 4.66 million pieces as compared to 3.98 million pieces for 2007. The increase was due to product upgrades as we upgraded most of our standard audio equipment to intelligent audio equipment. For the year ended December 31, 2008, our sales volume for televisions increased by 380.6% to 76.32 million pieces as compared to 0.2 million pieces for the same period in 2007. Our sales volume for intelligent audio and video equipment increased by 755% to 0.513 million pieces as compared to 0.06 million pieces for the same period in 2007. We believe the increases in sales revenue and volume are a result of our investment of resources into the research and development of new products and design to meet the requirements of the market, our focus on the promotion of our brand, and expansion of our sales channels.
 
Cost of sales, which include raw material, labor and manufacturing overhead, were $109.8 million for the year ended December 31, 2008, an increase of $50.9 million, or 86.4%, compared to $58.9 million for the year ended December 31, 2007. The increase was primarily a result of the increase in sales and was consistent with the increase in our net revenue. As a percentage of net revenue, cost of sales for the years ended December 31, 2008 and 2007 were 76.2% and 75.3%, respectively.
 
Gross profit for the year ended December 31, 2008 was $34.3 million, or 23.8% of revenues, compared to $19.3 million, or 24.7% of revenues, for the year ended December 31, 2007. The increase in our gross profit margin for the year ended December 31, 2008 was primarily due to the increase of sales price of our audio system products. Management considers gross profit to be a key performance indicator in managing our business. Gross profit margins are a factor of cost of sales, product mix and product demand.
 
Selling expenses, which mainly include marketing, shipping, insurance, wage and other expenses, were $5.4 million for the year ended December 31, 2008, an increase of $2.1, million, or 63.6%, compared to $3.3 million for the year ended December 31, 2007. The increase in selling expenses was primarily attributable to the increase in advertising and marketing activities.
 
Research and development expenses were approximately $1.7 million for the year ended December 31, 2008, a increase of approximately $1.3 million, or 325.0% compared to approximately $0.4 million for the year ended December 31, 2007. The increase was caused by increased new product research and development and the upgrading of old products to meet the market need. We believe that our focus on research and development contributed to the increase in our total sales. In the future, we expect to continue to increase our research and development efforts and to enable us to manufacture wider lines of products, such as mobile phones and other 3G communication products.
 
General and administrative expenses, which include wage, benefit, bad debts, utility, consulting, professional fee, various taxes and levies and other expenses, were $8.7 million for the year ended December 31, 2008, an increase of $5.3 million, or 155.9%, compared to $3.4 million for the year ended December 31, 2007. The increase was primarily a result of the cost of merger. We expect our general and administrative expenses to increase as a result of professional fees incurred as a result of being a public reporting company in the United States, in addition to the increased general administrative expense that will be involved with the operation of Dongri.

Interest expenses were $2.2 million and $1.8 million for the years ended December 31, 2008 and 2007, respectively. The increase was due to new short-term and long-term bank loans during the year ended December 31, 2008.

Income tax provisions for years ended December 31, 2008 and 2007 were approximately $2.0 million and $1.3 million, respectively. The increase is mainly due to an increase in the taxable income for the year ended December 31, 2008. NIVS PRC is registered in PRC and has had tax advantages granted by local government for corporate income taxes and sales taxes commencing April 6, 2004. NIVS PRC has been entitled to have a full tax exemption for the first two profitable years, followed by a 50% reduction on normal tax rate of 24% for the following three consecutive years.  Our effective income tax rates for the years ended December 31, 2008 and 2007 were 13.1% and 12.7%, respectively. On March 16, 2007, the National People’s Congress of China enacted a new PRC Enterprise Income Tax Law, under which foreign invested enterprises and domestic companies will be subject to enterprise income tax at a uniform rate of 25%. The new law became effective on January 1, 2008. During the transition period for enterprises established before March 16, 2007, the tax rate will be gradually increased starting in 2008 and be equal to the new tax rate in 2012. We believe that our profitability will be negatively affected in the near future as a result of the new EIT Law.

Net income was $13.0 million for the year ended December 31, 2008, an increase of $4.5 million, or 52.9%, compared to $8.5 million for the year ended December 31, 2007.

Liquidity and Capital Resources

We had an unrestricted cash balance of approximately $5.9 million as of December 31, 2009, as compared to $0.5 million as of December 31, 2008. In addition, we also had approximately $4.8 million in restricted cash as of December 31, 2009, as compared to $11.7 million as of December 31, 2008. Our restricted cash is held as a security deposit for our recurring, short-term bank notes and short-term loans. Our funds are kept in financial institutions located in China, and banks and other financial institutions in the PRC do not provide insurance for funds held on deposit, and in the event of a bank failure, we may not have access to our funds on deposit.  In addition, we are subject to the regulations of the PRC, which restrict the transfer of cash from China, except under certain specific circumstances. Accordingly, such funds may not be readily available to us to satisfy obligations that have been incurred outside the PRC.
 
 
45

 

We had working capital of approximately $3.3 million and negative working capital of $18.6 million as of December 31, 2009 and 2008, respectively. The decrease of negative working capital was largely caused by public offering fund raising.
 
Our accounts receivable has been an increasingly significant portion of our current assets, representing $33.2 million and $20.4 million, or 52.6% and 45.3% of current assets, as of December 31, 2009 and 2008, respectively. If customers responsible for a significant amount of accounts receivable were to become insolvent or otherwise unable to pay for our products, or to make payments in a timely manner, our liquidity and results of operations could be materially adversely affected. An economic or industry downturn could materially adversely affect the servicing of these accounts receivable, which could result in longer payment cycles, increased collections costs and defaults in excess of management’s expectations. A significant deterioration in our ability to collect on accounts receivable could affect our cash flow and working capital position and could also impact the cost or availability of financing available to us.
 
We provide our major customers with payment terms ranging from 30 to 90 days. Additionally, our production lead time is approximately three weeks, from the inspection of incoming materials, to production, testing and packaging. We need to keep a large supply of raw materials and finished goods inventory on hand to ensure timely delivery of our products to our customers. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Allowance for doubtful accounts is based on our assessment of the aging of accounts receivable, the collectability of specific customer accounts, our history of bad debts, and the general condition of the industry.
 
Our aging of accounts receivables could result in our inability to collect receivables requiring us to increase our doubtful accounts reserve, which would decrease our net income and working capital. We experienced no bad debt expense during the year ended December 31, 2009 compared to $2.5 million for the same period in 2008. As of December 31, 2009, we believed it was appropriate not to recognize bad debt expense primarily due to the subsequent collections made on our receivable balance and our historical ability to collect our accounts receivable. Bad debt expense was $2.5 million for the year ended December 31, 2008, compared to $0.5 million for the year ended December 31, 2007. The increase was primarily due to an increase in the aging of our accounts caused by the financial crisis. Due to the difficulty in assessing future trends, we could be required to further increase our provisions for doubtful accounts. As our trade receivables age and become uncollectible our cash flow and results of operations are negatively impacted.
 
As of December 31, 2009, inventories amounted to $9.6 million, compared to $11.3 million as of December 31, 2008. We have experienced increased sales volume annually and, also, we launched promotion campaign in domestic market in the first quarter of 2009; as a result, we need to maintain certain amounts of finished goods to meet the customers’ demand when launching nationwide promotion campaign. We expect to experience increase in our inventory levels going forward, including both of raw material and finished goods. We maintain certain reserve amounts of raw materials in our inventories and engage in long-term arrangements with suppliers in an attempt to protect against any rising prices and shortages of raw materials used to manufacture our products.
 
NIVS PRC has entered into various revolving bank loans and bank notes to finance our operation. Most of the loans are one year renewable. NIVS PRC had bank loans of approximately $51.7 million and $54.7 million as of December 31, 2009 and 2008, respectively. These loans carry annual interest rates of approximately 3.3% to 7.2% with maturity dates ranging from 30 days to one year. These loans are either unsecured or secured by the Company’s buildings, equipment, receivables and land use rights. In China it is customary practice for banks and borrowers to negotiate roll-overs or renewals of short-term borrowings on an on-going basis shortly before they mature. Although we have renewed our short-term borrowings in the past, we cannot assure you that we will be able to renew these loans in the future as they mature. In January 2010, the Chinese government took steps to tighten the availability of credit including ordering banks to increase the amount of reserves they hold and to reduce or limit their lending. If we are unable to obtain renewals of these loans or sufficient alternative funding on reasonable terms from banks or other parties, we will have to repay these borrowings with the cash on our balance sheet or cash generated by our future operations, if any.
 
From June 2005 to November 2008, our subsidiaries entered into hundreds of loan transactions with NIVS PRC’s founder and our principal shareholder and current Chief Executive Officer and Chairman of the Board, Tianfu Li. In these loan transactions, we would borrow funds from Mr. Li. As of September 30, 2008, our subsidiaries had an aggregate outstanding loan balance due to Mr. Li of $9.1 million and $568,063 owed to NIVS Investment (SZ) Co., Ltd. In addition, our subsidiaries, primarily through NIVS PRC and NIVS International (H.K.) Limited (“NIVS HK”), would lend funds to the entities that were owned and controlled by Mr. Li. These entities controlled by Mr. Li are NIVS Investment (SZ) Co., Ltd.; Zhongkena Technology Development; Xentsan Technology (SZ) Co., Ltd.; Korea Hyundai Light & Electric (Int'l) Holding; NIVS Information & Technology (HZ) Co., Ltd.; and Hyundai Light & Electric (HZ) Co., Ltd. (collectively, the “Related Companies”). Our loans to related parties also include a loan to a supplier of Hyundai Light and Electric (HZ) Co. Ltd. in the amount of 38,474,900 RMB, which is equal to approximately U.S. $5.5 million. The note carried an interest rate of 1.5% per month and was guaranteed by Hyundai Light and Electric (HZ) Co Ltd. This loan has been paid in full as of November 28, 2008. The amount of the loans made by our subsidiaries to the Related Companies ranged in amount. The aggregate amount loaned from our subsidiaries to the Related Companies was approximately $0 and $13 million during the years ended December 31, 2009 and 2008, respectively.
 
 
46

 

As presented in our statements of cash flows in our financial statements, the cash payments directly to and from our largest shareholder, Mr. Li, are reflected as “Due to Shareholder” and are classified as financing activities pursuant to the standards within ASC 230, which provides that “financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; borrowing money and repaying amounts borrowed.”  The loan transactions with the related parties are classified as investing activity in accordance with the standards within ASC 230 as the related parties are not “owners” of our company as described in the standards within ASC 230 since the entities do not own equity in our company.  In addition, Mr. Li, from July 2008, has not owned any part of Hyundai Light & Electric (Int’l) Holding Limited, and Mr. Li has never had any ownership interest of the supplier of Hyundai Light & Electric (Int’l) Holding Limited that was the holder of the note.  The loans to the related parties were not a borrowing of funds by us, nor a repayment of funds borrowed by an owner.

Upon the closing of the Share Exchange, we, a publicly reporting company under U.S. securities laws, gained ownership of the subsidiaries. As a result, our subsidiaries became subject to the Sarbanes-Oxley Act of 2002, including Section 402’s prohibition against personal loans to directors and executive officers, either directly or indirectly. Because the loans did not have a purpose directly related to the business operations of our company or our subsidiaries, we believe that the loans made and outstanding after the closing of the Share Exchange may violate Section 402 of Sarbanes-Oxley, which would subject us and our chief executive officer to possible criminal, civil or administrative sanctions, penalties, or investigations, in addition to potential private securities litigation. It was intended that all loans from our subsidiaries to our officers and directors, whether directly or indirectly, be repaid in full prior to the closing of the Share Exchange, and no further loans were to be made to such related parties after the closing of the Share Exchange, which occurred on July 25, 2008. In November 2008, it was discovered that the loans to the entities owned by Mr. Li continued after the closing of the Share Exchange, as more fully described in the notes to the financial statements contained in this report. We made a total of 47 loans, with a total loan amount of $3,221,915, to the Related Companies after the closing of the Share Exchange.

On November 28, 2008, we and our subsidiaries entered into a Debt Repayment and Set-Off Agreement (the “Agreement”) with Mr. Li and the Related Companies.  Pursuant to the Agreement, as it was amended on December 22, 2008, each of the Related Companies agreed to completely and immediately repay all outstanding loan amounts that it owed to us and our subsidiaries and we and our subsidiaries agreed to repay approximately $1.0 million of the debt that we and our subsidiaries owed to Mr. Li.  As inducement for the Related Companies for entering into the Agreement, we and our subsidiaries agreed to, among other things, permit the amounts owed to us by the Related Companies to be off-set by amounts that we owed to Mr. Li and acknowledge that the Related Companies no longer owed any loan amounts to us or our subsidiaries.

Immediately prior to the repayments under the Agreement, our subsidiaries had an aggregate outstanding loan amount of approximately $8.8 million owed to Mr. Li (the “Li Debt”).  On the same date, Mr. Li, through the Related Companies, had an aggregate outstanding loan amount of approximately $1.0 million owed to our subsidiaries (the “Related Companies’ Debt”), which consisted of approximately $1.0 million owed by Korea Hyundai Light & Electric (Int'l) Holding. Pursuant to the Agreement, the Related Companies’ Debt of approximately $1.0 million was repaid by set off against the Li Debt of approximately $8.8 million.  As a result of the transactions contemplated by the Agreement, the Related Companies’ Debt is no longer outstanding and neither Mr. Li nor any of the Related Companies owed us or our subsidiaries any loan amount.  Moreover, after the repayments under the Agreement, our subsidiaries’ remaining debt owed to Mr. Li was approximately $7.8 million.  The parties to the Repayment Agreement also acknowledged that there were no remaining debt obligations owed to the us or our subsidiaries, either directly or indirectly, by Mr. Li, any other executive officer or director, or any related family member, of our company or subsidiaries, or any entity owned or controlled by such persons, including the Related Companies, and that no loans or similar arrangements will be made by us or our subsidiaries to such persons or entities in the future.

On July 25, 2008, concurrently with the close of the Share Exchange, we conducted an initial closing of a private placement transaction pursuant to which we sold an aggregate of 5,239,460 shares of common stock at $1.80 per share, for gross proceeds of approximately $9.4 million. On August 12, 2008, we conducted a second and final closing of the private placement pursuant to which we sold an additional 1,304,587 shares of common stock at $1.80 per share for gross proceeds of approximately $2.3 million. Accordingly, we sold a total of 6,544,047 shares of common stock in the private placement for aggregate gross proceeds of approximately $11.8 million (the “Private Placement”). WestPark Capital, Inc., the placement agent for the Private Placement, was paid a commission equal to 6.5% of the gross proceeds from the financing, in addition to a $130,000 success fee for the Share Exchange, for an aggregate fee of approximately $896,000.  We used the proceeds from the Private Placement to provide working capital for speech-controlled TV and product promotion, speech-controlled audio acoustics, DVD, and DVB production capacity expansion, technology and product research and development, basic research and application product development, brand building and publicity and strengthening channel building and brand promotion in China and to increase reserve funds as well as new production lines for LCD TV for the expansion of business.

 
47

 

On December 24, 2008, we and three of our subsidiaries (NIVS BVI, NIVS HK, and NIVS PRC) entered into an agreement with Mr. Li pursuant to which the outstanding debt of $7.8 million that we owed to Mr. Li would be converted into shares of our common stock based on the closing price of our public offering that we conducted in March 2009.  According to the agreement, we issued 2,240,493 shares of our common stock to Mr. Li in March 2009 upon the closing of our public offering.  As a result of the conversion, the debt amount of $7.8 million was converted into shares of common stock at $3.50 per share, and the debt is no longer outstanding.

In March 2009, we completed a public offering consisting of 550,000 shares of our common stock. WestPark Capital, Inc. acted as underwriter in the public offering.  Our shares of common stock were sold to the public at a price of $3.50 per share, for gross proceeds of approximately $1.9 million.  Compensation for WestPark Capital’s services included discounts and commissions of $192,500, a $57,750 non-accountable expense allowance, roadshow expenses of approximately of $10,000, and legal counsel fees (excluding blue sky fees) of $40,000.  WestPark Capital also received a warrant to purchase 55,000 shares of our common stock at an exercise price of $4.20 per share.  The warrant, which has a term of five years, is not exercisable until at least one-year from the date of issuance.  The warrant also carries registration rights.  In April 2009, the underwriters exercised their over-allotment option in full for the offer and sale of 82,500 additional shares of common stock at $3.50 per share, for gross proceeds of $288,750.

In April 2009, WestPark Capital exercised its over-allotment option to purchase an additional of 82,500 shares of common stock. The shares were sold a price of $3.50 per share for a gross proceed of $288,750. Compensation incurred in the public offering included discounts and commissions of $28,875, an $8,663 non-accountable expense allowance, other expenses of $4,821, and legal counsel fees of $42,500.

We are required to contribute a portion of our employees’ total salaries to the Chinese government’s social insurance funds, including pension insurance, medical insurance, unemployment insurance, and job injuries insurance, and maternity insurance, in accordance with relevant regulations. Total contributions to the funds are approximately $213,650, $217,882, and $232,655 for the years ended December 31, 2009, 2008, and 2007, respectively. We expect that the amount of our contribution to the government’s social insurance funds will increase in the future as we expand our workforce and operations and commence contributions to an employee housing fund.

According to the relevant PRC regulations on housing provident funds, PRC enterprises are required to contribute housing provident funds for their employees. The monthly contributions for Huizhou City must be at least 5% of each employee’s average monthly income in the previous year. The Company has not paid such funds for its employees since its establishment and the accumulated unpaid amount is approximately $870,000. Under local regulations on collection of housing provident funds in Huizhou City where the Company’s subsidiary, NIVS PRC, is located, the local housing authority may require the Company to rectify its non-compliance by setting up bank accounts and making payment and relevant filings for the unpaid housing funds for its employees within a specified time period. If the Company fails to do so within the specified time period, the local housing authority may impose a monetary fine on it and may also apply to the local people’s court for enforcement. The Company’s employees may also be entitled to claim payment of such funds individually. If the Company receives any notice from the local housing authority or any claim from our current and former employees regarding the Company’s non-compliance with the regulations, the Company will be required respond to the notice and pay all amounts due to the government, including any administrative penalties imposed, which would require the Company to divert its financial resources and/or impact its cash reserves, if any, to make such payments. Additionally, any administrative costs in excess of the payments, if material, may impact the Company's operating results. As of December 31, 2009, the Company has not received any notice from the local housing authority or any claim from our current and former employees

In October 2009, we commenced construction on Phase II of our factory in Huizhou (Phase II), which will include a new manufacturing facility and dormitory. Phase II's manufacturing facility, adjacent to Phase I, will span approximately 36,000 square meters and will be dedicated to designing and making super thin LEDTVs, HD LCDTVs and 3G cell phones under the NIVS brand name and intended for distribution in China's domestic market. The expected production capacity will be 2 million TV sets and 1.5 million phones per year. Construction is scheduled to be completed during the second quarter of 2010, and the manufacturing facility is expected to be operational later that same quarter.  The estimate completion date is April 30, 2010 for the manufacturing facility and June 30, 2010 for the dormitory. Total budget of the construction is RMB 53,500,000 ($7,847,380).

In January 2010, we acquired Dongri, a mobile phone product manufacturer, for a purchase price of up to $23 million, with $13 million being paid within one month of closing and up to an additional $10 million that may become payable at future dates if Dongri meets after-tax income targets for the first half of 2010, the third quarter of 2010, and the fourth quarter of 2010.  We are required to make additional payments owed to Dongri, if the targets are met, no later than the 30 days after the filing of our quarterly or annual report, as applicable, with the SEC for the respective period.

In January 2010, we entered into a purchase agreement with Kuanda (Xiamen) Communications Co., Ltd and China PTAC Communications Services, on behalf of China Telecom, for the purchase by China Telecom of our two 3G mobile phone products.  The purchase agreement is contingent on delivery of the 3G mobile phones representing the aggregate order by March 31, 2010. The value of the order is approximately $28.8 million, and the dollar value of any additional orders further to this relationship depends on the final number of delivered products.  We expect that we will expend approximately $14 million in the first quarter of 2010 to produce and deliver the mobile phone products pursuant to the purchase order.

 
48

 

The ability of NIVS PRC to pay dividends may be restricted due to the foreign exchange control policies and availability of cash balance of the Chinese operating subsidiaries. A majority of our revenue being earned and currency received are denominated in RMB, which is subject to the exchange control regulation in China, and, as a result, we may unable to distribute any dividends outside of China due to PRC exchange control regulations that restrict our ability to convert RMB into US Dollars.  Accordingly, NIVS PRC’s funds may not be readily available to us to satisfy obligations which have been incurred outside the PRC, which could adversely affect our business and prospects or our ability to meet our cash obligations.

Cash Flow Information

Net cash provided by operating activities was $18.6 million for the year ended December 31, 2009, compared to net cash used in operating activities of $0.8 million for the year ended December 31, 2008. The increase in net cash provided in operating activities was primarily due to an increase in collection of trade receivables and an increase in inventory turnaround. Our increase in net cash provided in operating activities for the year ended December 31, 2009 was partially offset by an increase in cash used in accounts receivable in response to demand of our products. Net cash used in operating activities was $0.8 million for the year ended December 31, 2008, compared to net cash used in operating activities of $9.7 million for the year ended December 31, 2007. The decrease in net cash used in operating activities was primarily due to a decrease in cash used in inventories, raw material purchases and advance to suppliers for purchases. Our decrease in net cash used in operating activities for the year ended December 31, 2008 was partially offset by a decrease in accounts payable and accrued liabilities and an increase in accounts receivable, which primarily resulted from an increase in our sales from $77.6 million in 2007 to $143.6 million in 2008.

Investing activity during the years ended December 31, 2009 and 2008 included the purchasing of property and equipment, intangible assets, and equity investment, which resulted in net cash used in investing activities of $11.4 million for the year ended December 31, 2009, compared to net cash used in investing activities of $ 24.3 million for the year ended December 31, 2008. The decrease in net cash used in investing activities was primarily due to the decrease in the restricted cash and the completion of our new plant renovation in 2008. In June 2008, we entered into an agreement for the purchase of production equipment and a new plant renovation at a contracted price of RMB 36,117,340 (USD $5,283,997). The plant renovation and the equipment installation were completed in the end of 2008. The remainder balance of RMB 24,210 (USD$3,542) was paid in January, 2009. As of December 31, 2009, we had paid $ 9.6 million for the purchase of production equipment and construction on Phase II of the factory. Investing activity during the years ended December 31, 2008 and 2007 included the purchasing of property and equipment and intangible assets, which resulted in net cash used in investing activities of $24.3 million for the year ended December 31, 2008, compared to net cash used in investing activities of $10.8 million for the year ended December 31, 2007. The increase in net cash used in investing activities was primarily due to the increase of restricted cash related to bank notes issued.

Net cash used in financing activities amounted to $1.8 million for the year ended December 31, 2009, compared to net cash provided by financing activities of 23.3 million for the year ended December 31, 2008. The change in cash used in/provided by financing activities was primarily a decrease in various notes payable financing, partially offset by an increase in cash flow provided by bank loans and our public offering closing in March 2009. Net cash provided by financing activities amounted to $23.3 million for the year ended December 31, 2008, compared to net cash provided by financing activities of $20.7 million for the year ended December 31, 2007. The increase of cash provided was primarily a result of the private placement closing in July 2008 and various notes payable financing.

Based upon our present plans, we believe that cash on hand, cash flow from operations and funds available to us through a public offering that we intend to conduct in 2010 will be sufficient to fund our current capital needs. We expect that our primary sources of funding for our operations for this year will result from our continued use of bank loans and bank notes and cash flow from operations to fund our operations during this year. However, our ability to maintain sufficient liquidity depends partially on our ability to achieve anticipated levels of revenue, while continuing to control costs. If we did not have sufficient available cash, we would have to seek additional debt or equity financing through other external sources, which may not be available on acceptable terms, or at all. Failure to maintain financing arrangements on acceptable terms would have a material adverse effect on our business, results of operations and financial condition.

Contractual obligations

The following table describes our contractual commitments and obligations as of December 31, 2009, in thousands:
 
   
Payments due by period
 
   
Total
   
Less than 1
year
   
1-3 years
   
3-5 years
   
More than 5
years
 
Short term bank loans and bank notes payable
 
$
51,700
   
$
51,700
   
$
-
   
$
-
   
$
-
 
Total
 
$
51,700
   
$
51,700
   
$
-
   
$
-
   
$
-
 

 
49

 

Seasonality

The first quarter is traditionally our low season due to the long Chinese New Year Holiday, with sales gradually increasing in the second quarter. Sales are usually highest in the fourth quarter as most of the factories in China will ship out their stock to prepare for the Chinese New Year Holiday.

Quarterly Information

The table below presents selected results of operations for the quarters indicated.  All amounts are in thousands, except share and per share amounts.  
  
 
Quarter Ended
       
  
 
December, 31 2009
   
September 30, 2009
   
June 30, 2009
   
March 31, 2009
   
Total
 
Revenues
    62,697     $ 52,384     $ 40,860     $ 29,257     $ 185,198  
Operating Income