10-Q/A 1 v155131_10qa.htm Unassociated Document
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A

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

For the quarterly period ended March 31, 2009
or

o
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. 033-10893

QKL STORES INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
75-2180652
(State or other jurisdiction of incorporation)
 
I.R.S. Employer Identification Number

Jing Qi Street
Dongfeng Xincun
Sa’er Tu District
163311 Daqing, P.R. China
(Address of principal executive offices)

(011) 86-459-460-7825
(Registrant's telephone number, including area code)



(Former name, former address and former fiscal year, if changed since last report)

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. x Yes    o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer 
o
 
Accelerated filer
o
Non-accelerated filer
o
 (Do not check if a smaller reporting company) 
Smaller reporting company 
x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes       No

The number of shares of the issuer’s common stock, $.001 per share, outstanding at July 13, 2009 was 20,882,353.

 

 

QKL STORES INC.

TABLE OF CONTENTS

     
Page
       
PART I
FINANCIAL INFORMATION
 
1
       
Item 1.
Financial Statements
 
1
       
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
30
       
Item 4.
Controls and Procedures
 
43
       
PART II
OTHER INFORMATION
 
44
       
Item 6.
Exhibits
 
44
       
Signatures
 
45
       
Exhibits/Certifications
   

 

 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
 
QKL STORES INC.
 
CONSOLIDATED BALANCE SHEETS
AS AT MARCH 31, 2009 AND DECEMBER 31, 2008
(Stated in US Dollars)

  
 
Notes
   
March 31,
2009
   
December
31, 2008
 
  
       
(Unaudited)
   
(Audited)
 
ASSETS
                 
Current assets
                 
Cash and cash equivalents
       
$
22,626,709
   
$
19,285,021
 
Pledged deposits
   
3
     
230,350
     
293,149
 
Trade receivables
           
-
     
793,352
 
Other receivables
   
4
     
3,827,883
     
4,189,140
 
Prepaid expenses
           
2,042,966
     
1,862,591
 
Advances to suppliers
           
2,894,422
     
3,342,756
 
Inventories and consumables
   
5
     
13,028,787
     
14,544,341
 
                         
Total current assets
         
$
44,651,117
   
$
44,310,350
 
Property, plant and equipment, net
   
6
     
14,019,536
     
12,960,303
 
Intangible assets, net
   
7
     
770,451
     
776,259
 
Goodwill
   
7
     
19,200,521
     
18,878,823
 
Long term prepayment
   
8
     
768,766
     
787,741
 
                         
TOTAL ASSETS
         
$
79,410,391
   
$
77,713,476
 
                         
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
Current liabilities
                       
Short-term bank loans
   
9
   
$
-
   
$
2,188,439
 
Accounts payable
           
21,928,761
     
21,283,818
 
Cash card and coupon liabilities
           
4,358,166
     
3,858,514
 
Deposits received
           
1,445,411
     
2,901,205
 
Accruals
           
718,565
     
681,969
 
Other PRC taxes payable
           
322,123
     
203,443
 
Other payables
   
10
     
1,274,422
     
1,476,665
 
Income taxes payable
           
1,469,150
     
1,252,336
 
                         
Total current liabilities
         
$
31,516,598
   
$
33,846,389
 
                         
TOTAL LIABILITIES
         
$
31,516,598
   
$
33,846,389
 
                         
Commitments and contingencies
   
15
   
$
-
   
$
-
 

See accompanying notes to consolidated financial statements

 
1

 

QKL STORES INC.
 
CONSOLIDATED BALANCE SHEETS (Continued)
AS AT MARCH 31, 2009 AND DECEMBER 31, 2008
(Stated in US Dollars)
 
   
Note
   
March 31,
2009
   
December
31, 2008
 
         
(Unaudited)
   
(Audited)
 
STOCKHOLDERS’ EQUITY
                 
Common stock, par value $0.001, 100,000,000 shares authorized, 20,882,353 shares issued and outstanding at March 31, 2009 and December 31, 2008
        $ 20,882     $ 20,882  
                       
Series A convertible preferred stock, par value $0.01, 10,000,000 shares authorized, 9,117,647 shares issued and outstanding at March 31, 2009 and December 31, 2008
    16       91,176       91,176  
Additional paid-in capital
            21,783,477       21,783,477  
Statutory reserves
            3,908,247       3,908,247  
Retained earnings
            17,878,687       14,204,169  
Accumulated other comprehensive
                       
Income
            4,211,324       3,859,136  
                         
            $ 47,893,793     $ 43,867,087  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
          $ 79,410,391     $ 77,713,476  
 
See accompanying notes to consolidated financial statements


 
2

 

QKL STORES INC.
 
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
(Stated in US Dollars)(Unaudited)

  
       
Three months ended March
31,
 
   
Notes
   
2009
   
2008
 
Net revenues
                 
    Direct sales
       
$
66,105,519
   
$
32,352,709
 
    Other operating income
   
12
     
1,121,885
     
1,536,790
 
                         
           
$
67,227,404
   
$
33,889,499
 
Cost of inventories sold
           
(54,836,837
) 
   
(26,382,060
)
                         
Gross profit
         
$
12,390,567
   
$
7,507,439
 
                         
Selling expenses
           
(5,810,144
)
   
(2,962,974
)
General and administrative expenses
           
(1,479,598
)
   
(485,642
)
                         
Income from operation
         
$
5,100,825
   
$
4,058,823
 
Other expenses
           
-
     
(5,751
)
Interest income
           
63,670
     
24,707
 
Interest expenses
           
(20,786
)
   
(72,759
)
                         
Income before income taxes
         
$
5,143,709
   
$
4,005,020
 
                         
Income taxes
   
13
     
(1,469,191
)
   
(1,025,825
)
                         
Net income
         
$
3,674,518
   
$
2,979,195
 
                         
Basic earnings per share
   
11
   
$
0.18
   
$
0.14
 
                         
Diluted earnings per share
   
11
   
$
0.12
   
$
0.12
 
                         
Basic weighted average share outstanding
   
11
     
20,882,353
     
20,882,353
 
                         
Diluted weighted average share outstanding
   
11
     
30,000,000
     
25,441,177
 

See accompanying notes to consolidated financial statements

 
3

 


QKL STORES INC.
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND
ACCUMULATED OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED DECEMBER 31, 2008 AND THREE MONTHS ENDED
MARCH 31, 2009
(Stated in US Dollars)(Unaudited)
 
               
Series A convertible
                     
Accumulated
       
   
Common stock
   
preferred stock
   
Additional
               
other
       
   
No. of
         
No. of
         
paid-in
   
Statutory
   
Retained
   
comprehensive
       
   
share
   
Amount
   
share
   
Amount
   
capital
   
reserves
   
earnings
   
income
   
Total
 
Balance, January 1, 2008
    19,082,299     $ 19,082       -     $ -     $ 4,457,653     $ 2,703,742     $ 9,179,694     $ 1,424,772     $ 17,784,943  
Net income
    -       -       -       -       -       -       8,997,068       -       8,997,068  
Reverse acquisition
    1,500,055       1,500       -       -       -       -       (851,088 )     -       (849,588 )
Appropriations to statutory reserves
    -       -       -       -       -       1,204,505       (1,204,505 )     -       -  
Shares issued for services
    299,999       300       -       -       -       -       -       -       300  
Issuance of Series A convertible preferred stock
    -       -       9,117,647       91,176       17,325,824       -       (1,917,000 )     -       15,500,000  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       2,434,364       2,434,364  
Balance, December 31, 2008
    20,882,353     $ 20,882       9,117,647     $ 91,176     $ 21,783,477     $ 3,908,247     $ 14,204,169     $ 3,859,136     $ 43,867,087  
                                                                         
Balance, January 1, 2009
    20,882,353     $ 20,882       9,117,647     $ 91,176     $ 21,783,477     $ 3,908,247     $ 14,204,169     $ 3,859,136     $ 43,867,087  
Net income
    -       -       -       -       -       -       3,674,518       -       3,674,518  
Foreign currency translation adjustment
    -       -       -       -       -       -       -       352,188       352,188  
Balance, March 31, 2009
    20,882,353     $ 20,882       9,117,647     $ 91,176     $ 21,783,477     $ 3,908,247     $ 17,878,687     $ 4,211,324     $ 47,893,793  

See accompanying notes to consolidated financial statements

 
4

 

QKL STORES INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
(Stated in US Dollars)(Unaudited)

   
Three months ended March
31,
 
   
2009
   
2008
 
Cash flows from operating activities
           
   Net income
 
$
3,674,518
   
$
2,979,195
 
      Depreciation
   
569,605
     
425,317
 
      Amortization
   
6,782
     
1,580
 
      Loss on disposal of plant and equipment
   
     
5,751
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Other receivables
   
1,160,701
     
(99,190
)
Inventories and consumables
   
1,533,604
     
(848,870
)
Advances to suppliers
   
452,468
     
56,803
 
Prepaid expenses
   
(158,048
)
   
250,818
 
Accounts payable
   
618,116
     
2,399,996
 
Cash card and coupon liabilities
   
494,734
     
664,566
 
Deposits received
   
(1,459,228
)
   
(870,719
)
Accruals
   
35,802
     
45,230
 
Other PRC taxes payable
   
118,406
     
51,351
 
Other payables
   
(251,723
)
   
(175,196
)
Income taxes payable
   
215,210
     
643,697
 
                 
   Net cash provided by operating activities
 
$
7,010,947
   
$
5,530,329
 
                 
Cash flows from investing activities
               
   Purchase of plant and equipment
 
$
(1,612,406
)
 
$
(353,422
)
   Payment of lease prepayments
   
-
     
(10,949
)
                 
   Decrease in pledged deposits
   
62,799
     
-
 
                 
Net cash used in investing activities
 
$
(1,549,607
)
 
$
(364,371
)

See accompanying notes to consolidated financial statements

 
5

 

QKL STORES INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
(Stated in US Dollars)(Unaudited)

  
 
Three months ended March
31,
 
   
2009
   
2008
 
Cash flows from financing activities
           
  Issuance of Series A convertible preferred stock
 
$
-
   
$
13,539,921
 
  Bank loan repayments
   
(2,190,872
)
   
(1,393,596
)
                 
Net cash (used in)/provided by financing activities
 
$
(2,190,872
)
 
$
12,146,325
 
                 
Net cash and cash equivalents sourced
 
$
3,270,468
   
$
17,312,283
 
Effect of foreign currency translation on cash and cash equivalents
   
71,220
     
528,977
 
                 
Cash and cash equivalents–beginning of year
   
19,285,021
     
10,742,064
 
                 
Cash and cash equivalents–end of year
 
$
22,626,709
   
$
28,583,324
 
             
Supplementary cash flow information:
           
      Interest paid
 
$
20,786
   
$
72,759
 
      Tax paid
   
1,220,800
     
382,127
 

See accompanying notes to consolidated financial statements

 
6

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

1. ORGANIZATION AND PRINCIPAL ACTIVITIES

QKL Stores, Inc. (the “Company”) (formerly known as Forme Capital, Inc.) was incorporated under the laws of the State of Delaware on December 2, 1986. From 1989 to 2000, the Company created and spun off to its stockholders nine blind pool companies for two years, then operated as a real estate company for eight years, then sold substantially all of its assets and ceased operations.  From 2000 until March 28, 2008, the Company was a shell company with no substantial operations or assets.  The Company currently operates through (1) itself, (2) one directly wholly-owned subsidiary in the British Virgin Islands: Speedy Brilliant Group  Ltd. (“Speedy Brilliant (BVI)”), (3) one directly wholly-owned subsidiary of Speedy Brilliant (BVI) located in Mainland China:  Speedy Brilliant (Daqing) Ltd. (“Speedy Brilliant (Daqing)” or “WFOE”), (4) one operating company located in Mainland China:  Daqing Qingkelong Chain Commerce & Trade Co., Ltd. (“Qingkelong Chain”), which the Company controls, through contractual arrangements between WFOE and Qingkelong Chain, as if Qingkelong Chain were a wholly-owned subsidiary of the Company, and (5) one wholly-owned operating subsidiary of Qingkelong Chain located in Mainland China:  Daqing Qinglongxin Commerce & Trade Co., Ltd (“Qingkelong Commerce”).

Speedy Brilliant (BVI) was established in the British Virgin Islands as a BVI business company on February 23, 2007.

Speedy Brilliant (Daqing) was established in the Heilongjiang Province of the People’s Republic of China (the PRC) as a limited company on August 1, 2007.

Qingkelong Chain was established in the Heilongjiang Province of the PRC as a limited company on November 2, 1998.

Qinglongxin Commerce was established in the Heilongjiang Province of the PRC as a limited company on July 10, 2006.

The Company and its subsidiaries (hereinafter, collectively referred to as “the Group”) are engaged in the operation of retail chain stores in the PRC.

On March 28, 2008, pursuant to the share exchange agreement between Forme Capital, Inc. the shareholders of Speedy Brilliant (BVI), and the other parties named therein, Forme Capital, Inc. issued 19,382,298 shares of its common stock to the shareholders of Speedy Brilliant (BVI), in exchange for 100% of the common stock of Speedy Brilliant (BVI). As a result of the share exchange, Speedy Brilliant (BVI) became a wholly-owned subsidiary of Forme Capital, Inc.

 
7

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)

The share exchange transaction was accounted for as a reverse acquisition in accordance with Statements of Financial Accounting Standards (“SFAS”) No. 141. “Business Combinations”. For financial reporting purposes, this transaction is classified as a recapitalization of the Company and the historical financial statements of Speedy Brilliant (BVI). The accompanying audited consolidated financial statements were retroactively adjusted to reflect the effects of the recapitalization. In specific, the 1,500,055 shares of Forme Capital, Inc. outstanding prior to the stock exchange transaction were accounted for at the net book value at the time of the transaction, which was a deficit of $851,088. Speedy Brilliant (BVI) is deemed to be the acquirer (accounting acquirer) and QKL Stores Inc. (formerly the “Forme Capital, Inc.”) is deemed to be the accounting acquiree.  The consequence of the reverse acquisition is that the legal and accounting treatments diverged, with the legal acquiree being the acquirer for financial reporting purposes.  The historical financial statements prior to the acquisition are restated to be those of the accounting acquirer.  The historical financial statements are a continuation of the financial statements of the accounting acquirer not the accounting target. Historical stockholders' equity of the accounting acquirer prior to the merger is retroactively restated (a recapitalization) for the equivalent number of shares received in the merger after giving effect to any difference in par value of the acquiree's and acquirer's stock with an offset to paid-in capital. Retained earnings (deficiency) of the accounting acquirer are carried forward after the acquisition. Operations prior to the reverse acquisition are those of the accounting acquirer. Earnings per share for periods prior to the reverse acquisition are restated to reflect the number of equivalent shares received by the acquiring company's shareholders. Accordingly, the consolidated statements of income include the results of operations of Qingkelong Chain from the acquisition date through December 31, 2008, and 2007.

Also on March 28, 2008, WFOE entered into a series of agreements with Qingkelong Chain, as a result of which WFOE gained control of all of Qingkelong Chain’s business and management as if Qingkelong Chain were a wholly-owned subsidiary of WFOE.  Those agreements were a consigned management agreement, a loan agreement, an exclusive purchase option agreement, a technology service agreement, and an equity pledge agreement.

Pursuant to those agreements, Speedy Brilliant (Daqing) made a loan of RMB77 million (approximately $11 million) to the shareholders of Qingkelong Chain and obtained the management control and an exclusive right to acquire all of the equity of Qingkelong Chain.

The loan of $11 million to the stockholders of Qingkelong Chain is considered as an indirect investment from the Company to Qingkelong Chain through a series of contractual arrangements by way of a shareholders’ loan. The loan was recognized as an amount due from the shareholders of Qingkelong Chain to the Company in the individual company stage. The registered capital of Qingkelong Chain was increased by $11 million after the indirect investment. Both amounts were eliminated as inter-company investment in the consolidation of the Company with Qingkelong Chain. The loan remains outstanding as at December 31, 2008.

 
8

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
(a)  
Method of accounting

The Company maintains its general ledger and journals with the accrual method accounting for financial reporting purposes.  The financial statements and notes are representations of management.  Accounting policies adopted by the Company conform to generally accepted accounting principles in the United States of America and have been consistently applied in the presentation of financial statements.

The interim results of operations are not necessarily indicative of the results to be expected for the fiscal period ending March 31, 2009. The Company’s consolidation balance sheet as of December 31, 2008 has been taken from the Company’s consolidation balance sheet as of the date. All other financial statements contained herein are unaudited and, in the opinion of management, contain all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of financial position, results of operations and cash flows for the period presented.

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. This basis of accounting differs in certain material respects from that used for the preparation of the books of account of the Company’s principal subsidiaries, which are prepared in accordance with the accounting principles and the relevant financial regulations applicable to enterprises with limited liabilities established in the PRC and Hong Kong, the accounting standards used in the places of their domicile. The accompanying condensed interim consolidated financial statements reflect necessary adjustments not recorded in the books of account of the Company's subsidiaries to present them in conformity with US GAAP.

(b)  
Principles of consolidation

The Company consolidates the subsidiaries and the entities it controls through a majority voting interest or otherwise, including entities that are variable interest entities (“VIE’s”) for which the Company is the primary beneficiary pursuant to FASB Interpretation No. 46(R) (revised December 2003), “Consolidation of Variable Interest Entities, Interpretation of ARB 51” (“FIN 46(R)”).  The provisions of FIN 46(R) have been applied respectively to all periods presented in the consolidated financial statements.

 
9

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
(b)  
Principles of consolidation (Continued)

Subsidiaries

The Company consolidates its two wholly owned subsidiaries, Speedy Brilliant (BVI) and Speedy Brilliant (Daqing), because it controls those entities through its 100% voting interest in them.  The following sets forth information about the wholly owned subsidiaries:

Name of Subsidiary
 
Place & date of
Incorporation
 
Equity
Interest
Attributable
to the
Company
(%)
   
Registered
Capital
($)
   
Registered Capital
(RMB)
 
Speedy Brilliant Group  Ltd.
(“Speedy Brilliant (BVI)”)
 
BVI/February 23, 2007
    100     $ 50,000       -  
                             
Speedy Brilliant (Daqing) Ltd.
“Speedy Brilliant (Daqing)” or “WFOE”
 
PRC/August 1, 2007
    100     $ 13,000,000     RMB  101,453,542  

Variable Interests Entities

The Company has variable interests in two entities for which it is the primary beneficiary and accordingly consolidates the statements of financial position, results of operations and cash flows for these entities pursuant to FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest Entities - an interpretation of ARB No. 51 (FIN 46R). These variable interests typically consist of a combination of voting rights arrangement, management control, loans and option to acquire all equity that grant the Company to right to acquire all equity from the equity owners, subject to prior governmental approvals to purchase their ownership interest if and when certain events occur.  The Company has no significant variable interests for which it is not deemed to be the primary beneficiary.

 
10

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
(b)  
Principles of consolidation (Continued)

Daqing Qingkelong Chain Commerce & Trade Co., Ltd

On March 28, 2008, WFOE entered into a series of agreements with Qingkelong Chain, as a result of which WFOE gained control of all of Qingkelong Chain’s business and management as if Qingkelong Chain were a wholly-owned subsidiary of WFOE.  Those agreements were a consigned management agreement, a loan agreement, an exclusive purchase option agreement, a technology service agreement, and an equity pledge agreement.  Pursuant to those agreements, the WFOE made a loan of RMB77 million (approximately $11 million) to the shareholders of Qingkelong Chain. In consideration for the loan all the equity of Qingkelong Chain was pledged to WFOE, WFOE obtained control over the management and obtained the exclusive right to acquire all of the equity of Qingkelong Chain.

Daqing Qinglongxin Commerce & Trade Co., Ltd

By virtue of the agreements above, the Qingkelong Commerce being the wholly subsidiary of Qingkelong Chain is regarded as a VIE by the Company.

The table below sets forth information about the two VIE’s of which the Company is the primary beneficiary:

Name of Variable Interest Entity
 
Place & date of
incorporation
 
Equity
interest
attributable
to the
Company
(%)
   
Registered
capital ($)
   
Registered capital
(RMB)
 
Daqing Qingkelong Chain
Commerce & Trade Co., Ltd
 
PRC/November 2, 1998
    100     $ 15,363,774     RMB  113,800,000  
                             
Daqing Qinglongxin
Commerce & Trade Co., Ltd.
 
PRC/July 10, 2006
    100     $ 62,642     RMB  500,000  

The consolidated financial statements are presented in US Dollars.  All significant inter-company balances and transactions are eliminated in consolidation.

 
11

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(c)  
Use of estimates

The preparation of the financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.

(d)  
Economic and political risks

The Group’s operations are conducted in the PRC. Accordingly, the Group’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.

The Group’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Group’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.

(e)  
Inventories and consumables

Inventories comprise merchandise purchased for resale and are stated at lower of cost and net realizable value.  Cost of merchandise, representing the purchase cost, is calculated on the weighted average basis.  Net realizable value is the estimated selling price in the ordinary course of business less any applicable selling expenses.

Consumables comprise (i) the packaging materials and (ii) the stationery for own consumption. Consumables are stated at cost, which is determined by using the weighted average method. The costs of packaging materials are expensed into the costs of inventories sold.  The costs of consumables for our own consumption are expensed into selling expenses and general & administrative expenses, depending on which department consumed.

 
12

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(f)  
Property, plant and equipment

Plant and equipment are carried at cost less accumulated depreciation.  Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of the plant and equipment are as follows:

Buildings
30-40 years
Motor vehicles
8 years
Shop equipment
6 years
Car park
43 years
Office equipment
5 years
Leasehold improvements
5 years

The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income.

(g)  
Maintenance and repairs

The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.

(h)  
Lease prepayments

 Lease prepayments represent the cost of PRC land use rights which are carried at cost and amortized on a straight-line basis over the period of rights of 30 to 40 years.

(i)  
Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net acquired identifiable assets at the date of acquisition. Goodwill is included in intangible assets and no amortization is provided.

Goodwill is tested for impairment annually on December 31. During the periods, no impairment is made.

 
13

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(j)  
Accounting for the impairment of long-lived assets

The Group periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets subject to amortization, when events and circumstances warrant such a review, pursuant to the guidelines established in SFAS No. 144. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognised based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose.

During the reporting periods, there was no impairment loss.

(k)  
 Foreign currency translation

The accompanying financial statements are presented in United States dollars. The functional currency of the Group is the Renminbi (RMB).  The financial statements are translated into United States dollars from RMB at year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.

The exchange rates used to translate amounts in RMB into USD for the purposes of   preparing the consolidated financial statements were as follows:

  
 
March 31,
2009
   
December
31, 2008
   
March 31,
2008
 
Twelve months ended
                 
RMB : USD exchange rate
   
-
     
6.8542
     
-
 
Three months ended
                       
RMB : USD exchange rate
   
6.8456
     
-
     
7.0222
 
Average three months ended
                       
RMB : USD exchange rate
   
6.8466
     
-
     
7.1757
 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through authorized institutions.  No representation is made that the RMB amounts could have been, or could be, converted into USD at the rates used in translation.  In addition, the current foreign exchange control policies applicable in PRC also restrict the transfer of assets or dividends outside the PRC.

 
14

 
 
QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(l)  
Cash card and coupon liabilities

Cash cards and coupon liabilities are recorded as liabilities at face value or selling value to the customers when coupons or cash cards are sold.

Coupons surrendered in exchange for products and/or debit in cash cards during the year are recognized as sales less discount and transferred the net sales to the income statements.

Cash cards have no expiration dates.  Therefore, cash cards cannot expire unredeemed.  Unredeemed cash cards are not recognized as income.  Unredeemed cash cards are accounted for as cash card and coupon liabilities, which is deferred revenue in current assets. Management recognizes income when there is evidence that the revenue is earned.

Coupons have expiration dates. If coupons with expiration dates remain unredeemed at the expiration date, they are recognized as other operating income.

Outstanding cash card and coupon liabilities are classified as current liabilities at the end of the periods.

(m)  
Cash and cash equivalents

The Group considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. The Group maintains bank accounts only in the PRC. The Group does not maintain any bank accounts in the United States of America.   The cash located outside the United States is not restricted as to usage.

(n)  
Revenue recognition

Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, and the seller’s price to the buyer is fixed or determinable, and collection is reasonably assured. The Company recognises sales revenue net of sales taxes and estimated sales returns at the time it sells merchandise to the customers.

Direct sales are sales to customers at stores and are recognized at the point of sale on gross basis and net of sales taxes and estimated returns when products are delivered and title has passed to the end users. The products generally could be returned by the customers within 30 days after purchased. Estimated sales returns are based on past experience and that are immaterial. Customer purchases of cash cards are not recognized as revenue until the card is redeemed and the customer purchases merchandise by using the cash cards.

 
15

 
 
QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(m)  
Revenue recognition (Continued)

Administration and management fee, products entrance fee, promotion income, sponsorship income and transportation income are recognized on an accrual basis when the right to receive has been established or as services are provided according to contract terms.

Rental income under operating leases is recognized in the consolidated income statements in equal installments over the accounting periods covered by the lease term.

(n)  
Suppliers and consignees

Generally, we have 30 days credit period from our suppliers and consignees.  Income from suppliers and consignees includes fees paid in connection with product promotions, general sponsorships, and savings relating to transportation and early settlement of our accounts.  Consistent with EITF 02-16, product promotions and general sponsorships are classified as a reduction in the cost of inventory. Other income from supplies and consignees, such as savings relating to transportation and early settlement of our accounts have been included as other operating income in our net revenues.  Rebates from suppliers and consignees have been included as a reduction in the cost of inventory as earned and recognized as a reduction in cost of sales when the product is sold.

In connection with our sponsorships, we incur expenses for our posters and promotional flyers.  The sponsorship amounts we disclose are net of those expenses.

(o)  
Leases

The Group did not have lease which met the criteria of capital lease. Leases which do not qualify as capital lease are classified as operating lease. Operating lease rental payment included in selling expenses were $462,693 and $252,494 for the three months ended March 31, 2009 and 2008 respectively, also included in the general and administrative expenses for three months ended March 31, 2009 and 2008 were $104,412 and $938 respectively.

(p)  
Advertising

The Group expensed all advertising costs as incurred.  Advertising expenses included in the selling expenses for the three months ended March 31, 2009 and 2008 were $25,372 and $23,282 respectively, also included in the general and administrative expenses for three months ended March 31, 2009 and 2008 were $6,102 and $2,017 respectively.

 
16

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(q)  
Income taxes

The Group accounts for income taxes using an asset and liability approach and allows for recognition of deferred tax benefits in future years.  Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Group is able to realize their benefits, or that future realization is uncertain.

The Group is operating in the PRC, and in accordance with the relevant tax laws and regulations of PRC, the enterprise income tax rate is 25% for the three months ended March 31, 2009 and 2008.

(r)  
Retirement benefit plans

 
The employees of the Group are members of a state-managed retirement benefit plan operated by the government of the PRC.  The Group is required to contribute a specified percentage of payroll costs to the retirement benefit scheme to fund the benefits.  The only funding obligation of the Group with respect to the retirement benefit plan is to make the specified contributions.

Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the statements of income as incurred. The retirement benefit funding included in the selling expenses for the three months ended March 31, 2009 and 2008 were $432,567 and $177,057  respectively, and included in the general and administrative expenses for the three months ended March 31, 2009 and 2008 were $45,082 and $29,615  respectively.

(s)  
Cash and concentration of risk

Cash includes cash on hand and demand deposits in accounts maintained within PRC and Hong Kong.  Total cash in these banks at March 31, 2009 and December 31, 2008 amounted to $20,048,730 and $18,412,721 respectively, of which no deposits are covered by Federal Depository Insured Commission.  The Group has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.

 
17

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(t)  
Statutory reserves

As stipulated by the Company Law of the People’s Republic of China (PRC) as applicable to Chinese companies with foreign ownership, net income after taxation can only be distributed as dividends after appropriation has been made for the following:

(i)  
Making up cumulative prior years’ losses, if any;
   
(ii)  
Allocations to the “Statutory surplus reserve” of at least 10% of income after tax, as determined under PRC accounting rules and regulations, until the fund amounts to 50% of the Company's registered capital, which is restricted for set off against losses, expansion of production and operation or increase in registered capital; and

(iii)  
Allocations to the discretionary surplus reserve, if approved in the shareholders’ general meeting.

These reserves from the PRC subsidiaries are not distributable in the form of cash dividends to the Company.

(u)  
Segment

The Company operates in one business segment of operating retail chain stores in the PRC.

(v)  
Comprehensive income

Comprehensive income is defined to include all changes in equity except those resulting from investments by owners and distributions to owners.  Among other disclosures, all items that are required to be recognized under current accounting standards as components of comprehensive income are required to be reported in a financial statement that is presented with the same prominence as other financial statements.  The Group’s current component of other comprehensive income is the foreign currency translation adjustment.

 
18

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(w)  
Recent accounting pronouncements

In March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 161 “Disclosures about Derivative Instruments and Hedging Activities”. SFAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact of SFAS 161 on its consolidated financial statements but does not expect it to have a material effect.

In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. This Staff Position is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. Application of this FSP is not currently applicable to the Company as the Company’s intangible assets consist of land used rights which has a fixed useful life of 30 - 40 years.

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS 162 directs the GAAP hierarchy to the entity, not the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to remove the GAAP hierarchy from the auditing standards. SFAS 162 is not expected to have a material impact on the Company’s financial statements.

In May 2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee Insurance Contracts, an interpretation of FASB Statement No. 60 (SFAS 163).  This statement clarifies accounting for financial guarantee insurance contracts by insurance enterprises under FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises.  SFAS 163 is effective for fiscal years and interim periods within those years, beginning after December 15, 2008.  Because the Company does not issue financial guarantee insurance contracts, it does not expect the adoption of this standard to have an effect on its financial position or results of operations.

 
19

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

3. PLEDGED DEPOSITS

Pledged deposits are restricted cash kept in a trust account maintained in the United States for the purpose of investor and public relation affairs.

4. OTHER RECEIVABLES

Details of other receivables are as follows:
  
 
March 31,
2009
   
December
31,
2008
 
Deposits to employee for purchases and disbursements (1)
 
$
923,390
   
$
1,889,291
 
Coupon sales receivables
   
586,471
     
719,317
 
Input VAT receivables (2)
   
391,257
     
196,207
 
Loans to unrelated companies (3)
   
643,617
     
893,435
 
Prepaid rent
   
407,436
     
490,890
 
Rebate receivables
   
875,712
     
-
 
                 
   
$
3,827,883
   
$
4,189,140
 

(1)  
Deposits to employees for purchases and disbursements are cash held by employees in different retail shops in various cities and provinces in the PRC. They are held for local purchases of merchandise, and held by salespersons in shops for day to day operations. Normally, these deposits will be recognized as costs and expenses within 3 months after the deposits are paid.

(2)  
Input VAT arises when the Group purchases products from suppliers and the input VAT can be deducted from output VAT on sales.

(3)  
Loans to unrelated companies are unsecured, interest free and repayable on demand.

5. INVENTORIES AND CONSUMABLES

Details of inventories and consumables are as follows:
 
  
 
March 31,
2009
   
December
31,
2008
 
Merchandise for resale
 
$
12,503,166
   
$
14,036,699
 
Production supplies
   
514,759
     
440,459
 
Low value consumables
   
10,862
     
67,183
 
   
$
13,028,787
   
$
14,544,341
 

 
20

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

5. INVENTORIES AND CONSUMABLES (Continued)

At March 31, 2009 and December 31, 2008, the net book value of inventories that are carried at net realizable value amounted to $13,715 and $20,090 respectively.

Obsolete inventories written-off for the three months ended March 31, 2009 and December 31, 2008 were $4,634 and $2,691 respectively.

6. PROPERTY, PLANT AND EQUIPMENT, NET

Details of property, plant and equipment, net are as follows:

  
 
March 31,
2009
   
December
31,
2008
 
At cost
           
Buildings
 
$
6,249,404
   
$
6,241,563
 
Shop equipment
   
9,781,305
     
8,498,599
 
Office equipment
   
881,783
     
834,563
 
Motor vehicles
   
940,037
     
562,876
 
Car park
   
18,815
     
18,791
 
Leasehold improvements
   
3,589,484
     
3,736,509
 
                 
   
$
21,460,828
   
$
19,892,901
 
Less: accumulated depreciation
   
(7,441,292
)
   
(6,932,598
)
                 
   
$
14,019,536
   
$
12,960,303
 

Depreciation expense included in the selling expenses for the three months ended March 31, 2009 and 2008 were $536,768 and $405,781 respectively, also included in the general and administrative expenses for the three months ended March 31, 2009 and 2008 were $32,837 and $19,536 respectively.

As of March 31, 2009 and December 31, 2008, buildings with net book value of nil and $4,538,407 respectively of the Group were pledged as collateral under certain loan arrangements.

 
21

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

7. INTANGIBLE ASSETS, NET

Details of intangible assets, net are as follows:
 
  
 
March 31,
2009
   
December
31,
2008
 
Intangible assets, gross
           
    Goodwill
 
$
19,200,521
   
$
18,878,823
 
    Lease prepayments
   
858,174
     
857,097
 
                 
   
$
20,058,695
   
$
19,735,920
 
Accumulated amortization
   
(87,723
)
   
(80,838
)
                 
   
$
19,970,972
   
$
19,655,082
 

During the year 2008, the Company acquired a number of business in sundry locations of China through the purchases of assets and the operating rights from unrelated parties. Goodwill represents the excess of the cost of the purchases over the fair value of the net acquired identifiable assets at the date of acquisition.

Lease prepayments represent the prepaid land use rights.  The land on which the Group’s retail stores, distribution centres and office are located is owned by the PRC government.

Amortization expenses for the above lease prepayments were approximately $6,782 and $1,580 for the three months ended March 31, 2009 and 2008 respectively. Estimated amortization expense for the next five years is approximately $27,133 each year.

As of March 31, 2009 and December 31, 2008, lease prepayments with net book value of nil and $621,191 respectively of the Group were pledged as collateral under certain loan arrangements.

8. LONG TERM PREPAYMENT

      Long term prepayment represents the rental expenses paid in advance.

 
22

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

9. SHORT-TERM BANK LOANS

Details of short-term bank loans are as follows:
 
  
 
March 31,
2009
   
December
31,
2008
 
Loans from Daqing City Commercial
Bank, interest rate at 7.425% per
annum, due on May 22, 2009
 
$
-
   
$
2,188,439
 
                 
   
$
-
   
$
2,188,439
 

As of March 31, 2009 and December 31, 2008, buildings with net book value of nil and $4,538,407 respectively and lease prepayments with net book value of nil and $621,191 respectively of the Group were pledged as collateral for the above loan arrangements.  These loans were primarily obtained for general working capital.

Interest expenses for the loans were $20,786 and $72,759 respectively for the three months ended March 31, 2009 and 2008.

10.  OTHER PAYABLES

Details of other payables are as follows:

  
 
March 31,
2009
   
December
31,
2008
 
Repair, maintenance, and purchase of equipment payables
 
$
835,992
   
$
1,034,993
 
Staff and promoters bond deposits
   
438,430
     
441,672
 
                 
   
$
1,274,422
   
$
1,476,665
 

 
23

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

11. EARNINGS PER SHARE

The calculation of the basic and diluted earnings per share attributable to the common stock holders is based on the following data:

   
For the three months ended
March 31,
 
   
2009
   
2008
 
Earnings:
           
             
Earnings for the purpose of basic earnings per share
 
$
3,674,518
   
$
2,979,195
 
Effect of dilutive potential common stock
   
-
     
-
 
                 
Earnings for the purpose of dilutive earnings per share
 
$
3,674,518
   
$
2,979,195
 
             
Number of shares:
           
             
Weighted average number of common stock for the purpose of basic earnings per share
   
20,882,353
     
20,882,353
 
                 
Effect of dilutive potential common stock
               
 – conversion of Series A
               
    convertible preferred stock
   
9,117,647
     
4,558,824
 
                 
Weighted average number of common stock for the purpose of dilutive earnings per share
   
30,000,000
     
25,441,177
 


 
24

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

12. OTHER OPERATING INCOME

Details of other operating income are as follows:
   
For the three months ended
March 31,
 
   
2009
   
2008
 
Rental income from leasing of shop premises
 
$
801,230
   
$
500,754
 
Income from suppliers and consigners
               
- Administration and management fee
   
39,685
     
8,307
 
- Promotion
   
-
     
78,464
 
- Sponsorship
   
7,011
     
796,406
 
- Transportation
   
157,141
     
84,529
 
Gain on sales of consumables to third parties
   
45,870
     
24,070
 
Training income
   
7,138
     
-
 
Equipment rental income
   
26,559
     
-
 
Rebate
   
5,042
     
-
 
Others
   
32,209
     
44,260
 
                 
   
$
1,121,885
   
$
1,536,790
 

13. INCOME TAXES

(a)  
The Company, being registered in the State of Delaware and which conducts all of its business through its subsidiaries incorporated in PRC, is not subject to any income tax. The subsidiaries are Speedy Brilliant (BVI), Speedy Brilliant (Daqing), Qingkelong Chain, Qingkelong Commerce. (see note 1).

Speedy Brilliant (Daqing), Qingkelong Chain, and Qingkelong Commerce, being registered in the PRC, are subject to PRC’s Enterprise Income Tax. Under applicable income tax laws and regulations, an enterprise located in PRC, including the district where our operations are located, is subject to a 25% Enterprise Income Tax (“EIT”).

 
25

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

13.  INCOME TAXES (Continued)

A reconciliation between the income taxes computed at the U.S. statutory rate and the rate of Group’s provision for income taxes is as follows:

   
For the three months
ended
March 31,
 
   
2009
   
2008
 
U.S. statutory rate
    34 %     34 %
Foreign income not recognized in the U.S.
    (34 )%     (34 )%
PRC EIT
    25 %     25 %
                 
Provision for income taxes
    25 %     25 %

(b)  
The PRC EIT rate was 25% for the years ended March 31, 2009 and 2008, respectively.

Income before income taxes of $5,143,709 and $4,005,020 for the three months ended March 31, 2009 and 2008, respectively, was attributed to subsidiaries with operations in China. Income taxes related to China income for the three months ended March 31, 2009 and 2008 are $1,469,191 and $1,025,825 respectively.

(c)  
No deferred tax has been provided as there are no material temporary differences arising during the three months ended March 31, 2009 and 2008.

14. FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties.  The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, other receivables, accounts payable, and other payables, approximate their fair values because of the short maturity of these instruments and market rates of interest.

 
26

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

15. COMMITMENTS AND CONTINGENCIES

We may be in violation of Section 5 of the Securities Act and consequently certain investors may have rescission rights as to securities acquired.  The Staff of the Division of Corporation Finance of the Securities and Exchange Commission has advised us that in their opinion the filing by us on October 24, 2008 of a Current Report on Form 8-K disclosing a power point presentation made at a number of investor conferences in October constitutes a violation of Section 5 of the Securities Act of 1933.  The power point presentation contained certain statements about our company in addition to those contained in the registration statement currently on file with the Commission and did not disclose many of the related risks and uncertainties described in the registration  statement relating to an investment in our company.   If such action was held by a court or other governmental body to be a violation of the Securities Act, we could be required to repurchase any shares purchased by investors as a result of the power point presentation, plus statutory interest. As no investors purchased any shares from us as a result of the power point presentation we have determined that notwithstanding the possible violation by us of Section 5 there is no contingent liability for any damages or other remedy under Section 12(a) (1) of the Securities Act.
The Group has entered into several tenancy agreements for retail stores expiring through 2021. Total rental expenses for three months ended amounted to $567,105 and $253,432 respectively.

As at March 31, 2009, the Group’s commitments for minimum lease payments under these leases for the next five years and thereafter are as follows:
       
Three months ended March 31,
     
2010
 
$
1,827,158
 
2011
   
1,717,416
 
2012
   
1,668,150
 
2013
   
1,521,645
 
2014 and thereafter
   
8,837,548
 
         
   
$
15,571,917
 

 
27

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

16. PREFERRED STOCK AND WARRANTS

On March 28, 2008 the company completed the sale of 9,117,647 units for approximately $15,500,000. Each unit consisted of one share of our Series A preferred stock and one Series A warrant and one Series B warrant. Each share of Series A preferred stock is convertible into one share of common stock, subject to certain anti-dilution provisions. Each warrant is convertible into 0.625 shares of common stock or a total of 11,397,058 shares of common stock. The warrants have a five year life and the Series A warrants are exercisable at an equivalent price of $3.40 per share and the Series B are exercisable at an equivalent price of $4.25 per share.

The proceeds from the transaction were allocated to the warrants and preferred stock based on the relative fair value of the securities.  The value of the Series A shares was determined by reference to the market price of the common shares into which it converts and the gross value of the warrants was calculated using the Black–Scholes model. (Assumption used life of 5 years, volatility of 89%, and risk free interest rate of 2.51%).  The proceeds were allocated $91,176 to the par value of the Series A preferred, $9,388,824 to additional paid in capital – preferred series A and $6,020,000 to the warrants.  This allocation resulted in the holders of the Preferred Series A shares receiving a beneficial conversion feature totaling $1,917,000. This beneficial conversion feature as been accounted for as a dividend to the holders and has been charged to retained earnings.

In connection with the sale of the units the Company paid fees totaling approximately $1,591,000 in the form of cash of $1,371,500 and Series A and Series B warrants to purchase 191,250 and 153,000 shares of common stock respectively. The warrants were valued using the Black-Scholes model using the same assumptions as used for the warrants contained in the units.

Under Section 8(e) of the Registration Rights Agreement dated as of March 28, 2008 by and among the Company and certain purchasers listed on a schedule attached thereto the Company agreed to have a registration statement registering certain of the securities of those purchasers declared effective with the Securities and Exchange Commission on or prior to September 24, 2008 or pay liquidated damages.

Although the registration statement has not yet been declared effective, pursuant to a Waiver and Release dated as of March 9 2009, the investors have waived their right to liquidated damages for the Company’s failure to have the registration statement declared effective on or prior to September 24, 2008.  Accordingly, as there is no contingent liability we have not accrued and recorded any amount for this in the financial statements as of March 31, 2009.

 
28

 

QKL STORES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND 2008
 (Stated in US Dollars)(Unaudited)

17. SEGMENT INFORMATION

The Group is principally engaged in the operation of retail chain store in the PRC. Nearly all identifiable assets of the Group are located in the PRC. All revenues are derived from customers in the PRC. Accordingly, no analysis of the Group’s sales and assets by geographical market is presented.

For the three months ended March 31, 2009 and 2008, the Group’s net revenues from external customers for products and services are as follows:

  
 
For the three months
ended
March 31,
 
   
2009
   
2008
 
Sale of general merchandise
 
$
66,105,519
   
$
32,352,709
 
Rental income
   
801,230
     
500,754
 
Other income
   
320,655
     
1,036,036
 
                 
Total
 
$
67,227,404
   
$
33,889,499
 

For the three months ended March 31, 2009 and 2008, the Group’s net revenues from external customers for sale of general merchandise by categories of product are as follows:

  
 
For the three months
ended
March 31,
 
   
2009
   
2008
 
Grocery
 
$
23,426,472
   
$
11,655,995
 
Fresh food
   
31,417,802
     
16,106,765
 
Non-food
   
11,261,245
     
4,589,949
 
                 
Total
 
$
66,105,519
   
$
32,352,709
 

 
29

 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Disclaimer Regarding Forward-Looking Statements

Some statements in this discussion and elsewhere in this report are “forward-looking statements,” which are basically statements about the future. These statements involve risk and uncertainty insofar as future events cannot be reliably predicted. Words such as “plans,” “intends,” “will,” “hopes,” “seeks,” “believes,” “anticipates,” “expects,” and the like often identify such forward-looking statements, but are not the only indication that a statement is a forward-looking statement. Forward-looking statements in this report include statements about our plans and objectives with respect to our present and future operations, and statements which express or imply that such present and future operations will or may produce revenues, income or profits. Many factors, including future events that cannot be predicted, could cause us to change these plans and objectives or fail to successfully implement such plans or achieve such objectives, and many factors could cause our present and future operations to fail to produce revenues, income or profits. Therefore, the reader is advised that the following discussion should be considered in light of the discussion of risks and other factors contained in our other filings with the Securities and Exchange Commission. No statements contained in the following discussion should be construed as a guarantee or assurance of future performance or future results.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and accompanying notes and the other financial information appearing in Part I and elsewhere in this report.

Overview

This section discusses and analyses our results of operations and financial condition, including the results and condition of our operating company, QKL-China, which have been consolidated with our own results for all periods presented. The discussion compares our results for the three months ended March 31, 2009 with results for the three months ended March 31, 2008.   QKL-China’s operations are our only operations.

This discussion is intended to help you understand our financial results and the current facts and trends that may cause them to change, so that you may make informed judgments about our likely financial results in the future and, insofar as those results may affect our stock price and informed investment decisions. Unless otherwise specified, references to quarters are to three-month periods (for example, “the first quarter of 2009” refers to the three-month period ended March 31, 2009).

Economic and Industry-wide Factors

Northeastern China: Our headquarters and all of our stores are located in the province of Heilongjiang and Inner Mongolia in northeastern China. We believe that the economy of northeastern China has grown rapidly over the last three to four years, that the national government is committed to enhancing economic growth in the region over the next several years, and that rapid economic grown in the Northeast is likely to continue over the next several years.

We believe there are approximately 200 to 300 small and medium-sized cities in northeastern China without modern supermarkets. We believe the number of supermarket customers and the demand for supermarkets in these cities are likely to grow significantly over the next several years.

Inflation:   Through the first quarter of 2009  food prices in China increased by 21%.  The increasing food prices were passed on to consumers and did not significantly affect our gross margins. We do not expect inflation to affect the prices we pay for supplies and the rents we will pay for future leases over the next several business quarters, and we have not taken any extraordinary measures to protect ourselves from severe inflation. Should inflation continue or worsen, we believe that it would not significantly reduce our profitability and cash flows, because we would pass it though from our vendors to our consumers, as most of the retailers in the PRC do.

 
30

 
 
Seasonality: Our business is subject to some seasonality, with increases in sales during the first quarter and fourth quarter due to increases in shopping and consuming activity, and decreases in sales during the summer months due to decreases in such activity. Due to the seasonality of our sales, our quarterly results will fluctuate, perhaps significantly.

Our Expansion Plan

As of the date of this report we have 30 supermarkets and two department stores.     

During the first three months of 2009 we opened no new stores.  We opened two new stores in April 2009 and one store in May 2009 that have a total area of approximately 16,000square. Two of these stores was opened by us and the other one was acquired through acquisition.  

Lindian store

On April 1, 2009, we opened a new supermarket store in Lindian, a city in Heilongjiang Province approximately 140 kilometers from Daqing, where our headquarters are located. The new store occupies approximately 5,000 square meters in the commercial center of Lindian.

The city of Lindian has a population of approximately 80,000. Based on our own independent research, there are no other large supermarket stores in Lindian.

Because the store was just opened recently, meaningful financial data are not available for it, and we have omitted it from the discussions of our business in this report except where otherwise specified.
 
Xingguangtiandi Store

On September 30, 2008, we entered into an agreement with Daqing Xingguangtiandi Shopping Center Co., Ltd to acquire from them all of the business and assets of a supermarket store located in the Xingguangtiandi shopping center in Daqing.   The assets included the lease, the inventory and all licenses held.  The transfer was completed on December 12, 3008. The Xingguangtiandi store occupies approximately 3,700 square meters in a commercial shopping center in Daqing. The purchase price of RMB 13.80 million (approximately $2.0 million) was paid in two installments: a deposit of RMB 100,000 (approximately $14,635) was paid prior to October 15, 2008 and the remaining balance was paid on December 2, 2008, the date of the completion of the transfer of the seller’s assets and the relevant registration procedures regarding the change of the ownership with the Bureau of Industry and Commerce.

This store was opened on April 30, 2009.

Zhaodong Dashijie Store

On May 27, 2009, we opened a new supermarket store in Zhaodong, a city in Heilongjiang Province approximately 115 kilometers from Daqing, where our headquarters are located. The new store occupies approximately 6,049 square meters in the commercial center of Zhaodong. It is the 2nd store the Company opened in Zhaodong city.

The city of Zhaodong has a population of approximately 230,000.

Because the store was just opened recently, meaningful financial data are not available for it, and we have omitted it from the discussions of our business in this report except where otherwise specified.

Because the store was only recently opened, meaningful financial data are not yet available, we have omitted it from the discussions of our business in this report except where otherwise specified.

In 2008 we opened 10 new stores (9 supermarkets and 1 department store) which have approximately 50,000 square meters of retail space.   Six of these stores were opened by us and four of these stores we acquired through four separate acquisitions.      

Under our expansion plan, in 2009 we opened 3 new stores  which have approximately 16,000 square meters of space and in 2008 we opened 10 new stores which have approximately 50,000 square meters of retail space. Six of these stores opened in 2008 were opened by us and four of the new stores were opened through the acquisition of existing businesses by us. We plan to open additional supermarkets in 2009 which will have  additional space of approximately 28,000 square meters and one additional distribution center which will have approximately  20,000 square meters.  Some of these stores will be opened by us and some will be opened through acquisitions.  We are also making improvements to our logistics and information systems to support our supermarkets.  We are financing this from funds generated from operations which we believe will be sufficient  to fund this expansion.   In addition, we intend to seek additional financing to finance the opening of even more stores during the remainder of 2009.  However, due to the global financial crisis we cannot assure you that our efforts to obtain additional financing will be successful.

 
31

 

In view of the global financial crisis it is becoming increasingly difficult to obtain additional financing and we  cannot assure you that our efforts to obtain additional financing will be successful.   If we are unable to obtain financing, as and when needed on acceptable terms, we may not be able to fully implement our expansion plans beyond 2009, and our ability to expand would be entirely dependent on funds generated for operations and our financial position, competitive condition, growth and profitability may be adversely affected.

Based on our previous experience, we believe it takes approximately three months for a new store to achieve the break-even point. The opening of new stores involves a number of uncertainties including those set forth below and the performance is difficult to predict:

 
·
performance of a new store is dependent on its location;
 
 
·
there are some existing supermarkets and traditional stores in some of the cities we are planning to enter;
 
 
·
some residents are used to shopping at traditional/farmer markets and may be reluctant to shop in supermarket such as ours; and
 
 
·
we need approximately 3 months to train new staff for our new stores.
   
Private-Label Merchandise

Sales of private-label merchandise accounted for approximately 5% of our total sales for the first quarter or 2009 (compared to nil for the first quarter of 2008).  In June 2008, we established a specialized department for designing and purchasing private label merchandise. Eight full-time employees currently work in this department. We plan to increase the proportion of private label merchandise sold over the next several quarters. Our goal is to eventually increase private-label sales to 20% of total sales in the next couple of years.

Risks and Uncertainties

We face significant risks and challenges, which you should keep in mind when evaluating our recent financial results and making judgments about our likely future financial results. We believe you should pay close attention to the following:

 
·
Locations for new stores. Good commercial space that meets our standards, in locations that meet our needs, may become less available in some of the cities we wish to enter.  Our only option for entering some target markets within our intended timeframe may be to begin operations in a location that we are not very satisfied with, including by taking over operations of existing supermarket stores, and then waiting for an opportunity to move to a better location. Alternatively we may seek to enter into a target market through acquisitions.  Keeping track of and taking advantage of all the available opportunities will be a resource-intensive challenge, and if we do not perform well our revenues, cash flows, and liquidity will all suffer.
 
 
·
Logistics of geographic expansion. Opening more stores in more cities further from our headquarters in Daqing will mean that transportation of our supplies and our personnel among our stores will become more difficult and subject to breakdown.  To alleviate this we plan to open a second distribution center during 2009.  We intend to keep using our current distribution center.  We started using our regional purchasing systems in 2008.  All fresh food is ordered by individual stores from vendors designated by our headquarters or regional purchasing department in our system and is delivered directly from vendors to individual stores as ordered based on their needs. Part of our food and non-food items are distributed from our distribution center to our different stores, the other part is purchased by our regional purchasing department or headquarters and delivered directly to individual stores. Long-distance transportation for both food and non-food items from our distribution center to our stores can be  challenging for several days in the winter as the roads can be covered with snow. If we do not plan ahead of time and perform well in response to these challenges, our operating costs will rise and our margins will fall.

 
32

 

 
·
Human resources. In our experience, we require approximately three months to train new employees to operate a new store. Training and supervision is organized by teachers in our training school within our company.   The management team for a new store is hired first and are trained in our training school regarding our culture and operations. Employees are hired afterwards, and are trained by both our teachers and the management team.  In addition, the management team and the employees are sent to existing stores to get practical training from employees and management team in those stores.  Eventually, local employees must learn to perform the training and supervisory roles themselves. If we do not perform well in response to these challenges, our operating costs will rise and our margins will fall.
 
 
·
Disadvantages of lack of competition. Opening stores in locations with little or no competition from other large supermarkets is a major part of our strategy because of the advantages we believe it brings, but there are also disadvantages to this approach, which relate to human resources. Where competitors operate supermarkets nearby, their trained staff is a potential source for our own human resources needs, especially if we offer a superior compensation package. Cities that have no large supermarkets also have no sources of trained employees. Although we believe we have a good training school, from time to time we have to send experienced management team members from headquarters or other stores to new stores to help from time to time. This increases our cost of operating, and decreases our margin at the beginning of the store opening.
 
 
·
Financing. As of the date of this report, we believe the U.S. capital markets are facing many difficulties. Potential sources of additional financing for us may be unwilling or unable to provide us with the additional financing we need to fully carry out our expansion plans. Finding additional financing could be a major challenge. If we are unable to obtain additional financing, we will have to rely solely on available funds from operations to fund our expansion and may not be able to carry out fully our expansion plans and will not benefit from the increased revenue that growth is intended to bring.
 
Results of Operations
 
The table below sets forth our operating results for the three month periods ended March 31, 2009 and 2008.

   
Three months ended
March 31,
  
     
2009
    
2008
 
Net revenues
           
Direct sales
 
$
66,105,519
   
$
32,352,709
 
Other operating income
   
1,121,885
     
1,536,790
 
                 
   
$
67,227,404
   
$
33,889,499
 
Cost of inventories sold
   
(54,836,837
   
(26,382,060
)
                 
Gross profit
 
$
12,390,567
   
$
7,507,439
 
                 
Selling expenses
   
(5,810,144
   
(2,962,974
)
General and Administrative expenses
   
(1,479,598
   
(485,642
)
                 
Operating income
   
5,100,825
     
4,058,823
 
Other expenses
   
-
     
(5,751) 
 
                 
Interest income
   
63,670
     
24,707
 
Interest expenses
   
(20,786
   
(72,759
)
                 
Income before income taxes
 
$
5,143,709
   
$
4,005,020
 
                 
Income taxes
   
(1,469,191
   
(1,025,825
)
                 
Net income
 
$
3,674,518
   
$
2,979,195
 

 
33

 

 
As of  March 31, 2009 we had 28 supermarkets and two department stores compared to 19 supermarkets and one department store as of March 31, 2008.

Number of supermarkets stores open and operating as of  January 1, 2009
   
28
 
Number of supermarkets stores open and operating as of  March 31, 2009
   
28
 
Number of  supermarkets opened during three months period ended March 31,  2009
   
0
 

Number of department stores open as of  January 1, 2009
   
2
 
Number of department stores open as of  March 31, 2009
   
2
 
Number of  department stores opened during three months period ended March 31,  2009
   
0
 
 
Three months ended March 31, 2009 compared with three months ended March 31, 2008

Net Revenue

Net revenue for the three months ended March 31, 2009 was approximately $67.2 million, representing an increase of approximately $33.3 million, or 98.4%, compared with net revenue of approximately $33.9 million for the three months ended March 31, 2008.  The increase in retail sales revenue is due primarily to an increase in sales volume due to sales growth in our existing stores that have  been in existence for more than one year.  The stores that have been operating for more than one year attracted more customers. They generated more revenue in 2009 than in 2008 because they benefited from more than 12 months’ operating experience and becoming better established in their communities over time.  Net revenue consists primarily (98.3% in the first quarter of 2009; 95.5% in the first quarter of 2008) of retail sales revenue, but also includes other operating income The relatively small remaining amount of net revenue (1.7% in the first quarter of  2009 and 4.5% in the first quarter of 2008) comes from other operating income, which is primarily rental income from leasing spaces in our supermarkets (Approximately $801,231 in the first quarter of 2009 and $500,754 in the first quarter of 2008)

Retail sales revenue.   Retail sales revenue for the three months ended March 31, 2009 was approximately $66.1 million, representing an increase of $33.7 million, or 104%, from approximately $32.4 million for the three months ended March 31, 2008.  Approximately $11.3 million, or 33.7% of that increase, was attributable to an increase in comparable store sales.  Comparable stores are stores that were open for at least one year before the beginning of the comparison period, or by January 1, 2008  The  19 comparable stores generated approximately $43.8 million in the first quarter of 2009, an increase of $ 11.3 million, or 34.6%, compared with the approximately $32.6 of revenue the first quarter of 2008.   $22.1 million, or 66.3% of the $33.4 million increase in retail sales revenue was generated by the 9 new stores opened after January 1 of 2008.

 
34

 
 
Other operating income.   The portion of our net revenue that is not retail sales revenue (1.7%  in the first quarter of 2009 compared to  4.5% in the first quarter of 2008) is other operating income. Other operating income for the first quarter of 2009 was $1.1 million, representing a decrease of $0.4 million , or 26.7%, compared with $1.5 million for the first quarter of 2008.

The main components of other operating income are the following:

 
·
Income from renters.  This income was approximately $801,230 in the first quarter of 2009, representing an increase of $300,476, or 60%, from $500,754 in the first quarter of 2008. The increase is due primarily to the additional rental space we have in the stores we opened during 2008. Our renters operate small shops in space in our supermarkets located between the front doors and the cash registers.

 
·
Income from suppliers and concessionaires.  This income was approximately $320,655 for the first quarter of 2009, representing a decrease of $715,381 or 69.0%, from approximately $ 1,036,036 for the first quarter of 2008.  The decrease accounts for approximately 45.8% of the total decrease in other operating income. Our suppliers are the vendors that sell us the goods we sell in our stores. Our concessionaires are sellers who sell their own merchandise, usually cooked foods, in space we provide within the main selling area of our supermarkets. Our concessionaires pay us a percentage of their sales as a concession fee and pay us separate amounts for advertising and promotional services.
 
Income from suppliers came from the following sources:

 
·
Fees paid to us in connection with merchandise administration and management services we provide to vendors (approximately $39,685 in the first quarter of 2009 and $8,307 in the first quarter of 2008). This increase was due to our increase in volume of sales, and did not have significant effects on our financial results. These fees include primarily fees for merchandise administration and related management activity.
     
 
·
Savings relating to transportation were approximately $157,141 in the first quarter of 2009 and $84,529 in the first quarter of 2008. Savings relating to transportation include amounts that our suppliers pay to us when our own transportation team handles the transportation of supplies for which the suppliers are responsible. We record transportation income when it is received.
   
We anticipate that our total net revenue will continue to increase if we are successful in implementing our expansion plan, opening new stores and increasing the volume of merchandise we sell, over the next several business quarters.

Cost of Sales

Our cost of sales for the first quarter of 2009 was approximately $54.8 million, representing an increase of $28.5 million, or 108.4%, from approximately $26.3 million for the first quarter of 2008.  The increase was due to increased volume of sales.  Our cost of sales consists almost entirely of the cost to us of the merchandise we sell, and also includes a small amount, generally less than 1%, relating to costs of packaging and shipping our merchandise to our stores. Packaging and shipping costs do not account for a greater portion of our cost of sales because they are generally borne by our suppliers.
 
We anticipate that our cost of sales will continue to increase if we are successful in implementing our expansion plans, opening new stores and increasing the volume of merchandise we sell, over the next few months.

 
35

 

Gross Profit

Gross profit, or total net revenue minus cost of sales, was approximately $12.4 million for the first quarter of 2009, representing an increase of $4.9 million, or 65.5%, from approximately $7.5 million for the first quarter of 2008. This increase was due primarily to our greater sales volume and therefore greater profits in the first quarter of 2009.
  
Our gross profit as a percentage of total net revenue, or “gross margin,” decreased from approximately 22.1% for the first quarter of 2008 to 18.4% for the first quarter of 2009. This decrease was due to a higher  relative percentage increase in the cost of sales than the increase in sales revenue. .  Although we increased the efficiency of our operations, and sold  a greater volume of merchandise with relatively high profit margins,  we believe that our gross margin is likely to be between 17% and 20% over the next few business quarters.  The main reason for the expected decline is that our expansion plans call for us to open a many new stores, which tend to be less profitable during their early months of operation.  In addition, China’s retail industry in general, and its supermarket industry in particular, are becoming more competitive every year. In this competitive marketplace, it is likely that we will focus on providing our customers with lower prices, in order to increase our market share and long-term sales volume, more than we focus on achieving high profit margins.

Selling Expenses 
 
Selling expenses, which principally include promotional, marketing and advertising expenses, and also include rental payments, were approximately $5.8 million for the first quarter of 2009, representing an increase of $2.8 million, or 93.3%, from approximately $3 million for the first quarter of 2008. This increase was due primarily to marketing expenses relating to our promotional and marketing events during the first quarter of 2009. We anticipate that marketing expense will continue to increase if we are successful in implementing  our expansion plans, opening new stores, increasing our sales volumes and increasing our advertising activities, over the next several years.
   
Selling expenses as a percentage of net revenue decreased slightly to 8.64% for the first quarter of 2009, compared with 8.74% for the first quarter of 2008.  The decrease basically represents a slight decrease in the amount of advertising expense we used to generate each dollar of revenue during this period. We believe the decrease was the result of decreased promotional activity in all of our stores,  Over the next few years we will pursue aggressive expansion plans and expect our industry to continue to become more competitive, accordingly, we are expecting that our selling expenses as a percentage of net sales to rise during that time.

General and Administrative Expenses 
   
General and administrative expenses, which include salaries, rents and general overhead, were approximately $1,479,598 for the first quarter of 2009, representing an increase of $993,956, or 204.6%, from approximately $485,642 million for the first quarter of 2008. The increase was due primarily to salaries we paid to the new employees we recruited to staff our new stores and manage our growing business in the first quarter of 2009.

As a percentage of net revenue, however, general and administrative expenses increased to 2.2% for the first quarter of 2009 from 1.4% for the first quarter of 2008. The increase basically indicates that we spent more on the salaries, rents and overhead we used to generate each dollar of revenue in the first quarter of 2009.
 
We anticipate that our general and administrative expenses, measured in terms of dollars and as a percentage of net sales, will grow significantly over the next few business quarters if we are successful in implementing our expansion plans and open new stores, restructure our management to meet the requirements of an expanding enterprise, and make considerable investments in assessing, improving and modifying our reporting, compliance, internal-control and corporate-governance systems as appropriate for a U.S. public company.

 
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Operating Income

Operating income, which is calculated as gross profit minus both selling expenses and general and administrative expenses, was approximately $5.1 million for the first quarter of 2009, an increase of $1.1 million, or 27.5%, from approximately $4.0 million for the first quarter of 2008. This increase was primarily due to the increase in gross profit described above.

Operating income as a percentage of net revenue, or “operating margin,” was approximately 7.6% for the first quarter of 2009, compared to 11.9% for the first quarter of 2008. The decrease in operating margin is due to the decrease in our gross margin described above, which outweighed the decrease in selling expenses and the increase in general and administrative expenses during the same period. Because over the next several business quarters we will pursue aggressive expansion plans and we expect our selling and general and administrative expenses to rise and our industry to continue to become more competitive, we believe that our operating margin could continue to fall during that time.

Transaction Costs of Reverse Merger
 
On March 28, 2008, we expensed all of the transaction costs of $1,976,470 in relation to our reverse merger and recapitalization transactions.  These transaction costs include legal and investment banking fees, and stock issuance fees.  The accounting treatment is in line with the SEC Staff View on Reverse Acquisitions that an operating company’s reverse acquisition with a non-operating company having some cash has been viewed as the issuance of equity by the accounting acquirer for the cash of the shell company, and therefore transaction costs may be charged directly to equity only to the extent of the cash received, while all costs in excess of cash received should be charged to expenses.   The amount of cash held by Forme Capital, Inc. at the time the reverse merger was consummated was immaterial.

Interest Expense

Interest income for the first quarter of 2009 was $63,670,  representing an increase of $38,963 from interest income for the first quarter of 2008. The increase is due to the interest we charged for the loans to several vendors.  Interest expense for the first quarter of 2009 was $20,786, representing a decrease of $51,973 from the interest expense of $72,759 for the first quarter of 2008.  The decrease of interest expense was primarily due to the decrease in our short-term bank borrowings which we used to meet the increased demands for working capital in connection with our operations in 2008. As a percentage of net sales, interest expense decreased from 0.2% for the first quarter of 2008 to 0.03% for the first quarter of 2008, due to less short-term borrowing.  We intend  to maintain the line of credit in effect and draw on it as needed..

We believe that our interest expenses are likely to grow over the next several years because increased bank borrowing may be necessary to fully implement our aggressive expansion plans.

Income tax   
  
Provision for income taxes was approximately $1,469,191 for the first quarter of 2009, compared to $1,025,825 for the first quarter of 2008.   The small size of the increase, in spite of our more significant increase in income during the same periods, was due entirely to a reduction in our income tax rate, from 33% of pre-tax net income (also called “income before taxes”) to 25% of pre-tax net income, which took effect on January 1, 2008, due to changes in PRC tax laws. We do not expect further reductions in tax rates after 2008.  If our tax rate had not been reduced, our income taxes for the first quarter of 2009 would have been approximately $1.9 million.
 
Net Income

Net income for the first quarter of 2009 was approximately $3.7 million, representing an increase of approximately $0.7 million, or 23.3%, from approximately $3 million for the first quarter of 2008. The increase is primarily due to the increase in revenue from our increased sales and to the reduction in our tax rate described above   If our tax rate had not been reduced, our net income for the first quarter of 2009 would have been approximately $3.2 million, representing an increase of $0.2 million, or 7.5%, from net income for the first quarter of 2008.   Because we expect our total net revenue to grow over the next several quarters as we increase the number of stores we operate, we expect our net income to grow as well during that time, in spite of the increasing costs of expansion.  We also expect the reduction in our tax rate to continue to increase our net income throughout 2009, as compared with periods in 2008; we do not expect those relative increases to continue after 2009.


 
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Net income as a percentage of total net revenue, or “net profit margin” was approximately 5.5% for the first quarter of 2009, compared with 8.8% in the first quarter of 2008.  This decrease is primarily attributable to the decrease in gross profit described above. We believe that our net profit margins could decline to 4%-5% over the next several business quarters, because the selling, general and administrative expenses associated with our expansion in the increasingly competitive PRC retail market may grow faster than our net revenue grows.
 
The variability of our net income over the last five years is presented in the table below, which shows that our net profit margin increased significantly in 2005, increased less significantly in 2006, and decreased in 2007 and decreased in 2008 and increased during the first quarter of 2009.
 
     
Q1 09
   
2008
   
2007
   
2006
   
2005
 
Net income ($)
    3,674,518       8,997,068       5,782,391       4,984,603       3,391,529  
Total net revenue ($)
    67,227,404       161,481,353       92,372,812       74,666,336       53,724,865  
Net profit margin
    5.46 %     5.57 %     6.26 %     6.68 %     6.31 %
 
Liquidity and Capital Resources

We generally finance our business with cash flows from operations and short-term bank loans and we use shareholders’ equity investment and retained earnings to fund capital expenditures. The large-scale capital expenditures relating to our current expansion plan  are funded partly by outside financing such as the private placement that closed March 28, 2008 as well as from funds for operations.

Our working capital consists mainly of inventory, salaries, operating overhead (including auxiliary materials and utilities) and finance expenses.  Inventory accounts for the majority of our working capital. Our working capital requirements may be influenced by many factors, including cash flow, competition, our relationships with suppliers, and the availability of credit facilities and financing alternatives, none of which can be predicted with certainty.  Since 2005, we have had a revolving credit facility of 50 million RMB (approximately $7.1 million) with Daqing City Commercial Bank, and we have the highest credit rating from that bank.

Our expansion activities in 2009 will depend on the availability of funds from operations as well as outside financing.  Our 2008 expansion activities were financed primarily by the $13.5 million of net proceeds we received from the private placement that closed March 28, 2008 and partly by funds for operations.    In the first quarter of 2009, three additional stores were under construction.  This was funded entirely with funds from net proceeds we received from the private placement as well as from funds from operations. We plan to open more supermarkets in 2009 which will have  additional space of approximately 44,000 square meters and one additional distribution center which will have approximately 20,000 square meters.  We are also making improvements to our logistics and information systems to support our supermarkets and department stores.  We intend to  finance this further expansion from funds generated from operations which we believe will be sufficient.   In addition, we are seeking additional financing to finance the opening of even more stores during the remainder of 2009.   However, due to the global financial crisis we cannot assure you that our efforts to obtain additional financing will be successful.  If successful, such a financing activity would provide us with significant cash resources.   This cash would be allocated for expansion activities and would not be available for working capital and general corporate purposes.


 
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Cash from Operating Activities

First quarter of 2009 compared with first quarter of 2008

Net cash generated from operating activities for the first quarter of 2009 was approximately $7.0 million, representing an increase of $1.5 million, from approximately $5.5 million generated from operating activities for the first quarter of 2008.  The increase was due primarily to the decrease in inventory and increase in accounts payable in the first quarter of 2009.

Analysis and expectations

Our net cash from operating activities fluctuates significantly due to changes in our inventories and other receivables such as those described just above.  Other factors that may vary significantly include the amounts of our accounts payable, advances to suppliers and prepayments of general expenses and our income taxes. The table below provides figures for the past 4 years and also for the three months ended March 31, 2009 and shows that net cash flow from operating activities increased very significantly in 2006, decreased in 2007 and increased significantly in 2008 and decreased during the first three months ended on March 31, 2009.

   
2009 1Q
   
2008
   
2007
   
2006
   
2005
 
Net cash from operating activities ($)
   
7,010,947
     
18,661,267
     
5,417,099
     
7,436,834
     
2,762,282
 

Looking forward, as we implement our expansion plan over the next several quarters we expect the net cash we generate from operating activities to continue to fluctuate as our inventories, other receivables, and the other factors described above change with the opening and operating of new stores. These fluctuations could cause net cash from operating activities to fall even if, as we expect, our net income grows as we expand. Although we expect that net cash from operating activities will rise over the long term, we cannot predict how these fluctuations will affect our cash flows in any particular quarter.

Under our expansion plan, in 2009 we opened 3 new stores which have approximately 16,000 square meters of space and in 2008 we opened 10 new stores which have approximately 50,000 square meters of retail space. We plan to open additional supermarkets in 2009 which will have additional space of approximately  28,000 square meters and one additional distribution center which will have approximately  20,000 square meters.  We also plan to make improvements to our logistics and information systems to support our supermarkets and department stores.  We will finance this from funds generated from operations which we believe will be sufficient  to fund this expansion.   In addition, we intend to seek additional financing to finance the opening of even more stores during the remainder of 2009.  However, due to the global financial crisis we cannot assure you that our efforts to obtain additional financing will be successful.

Cash in Investing Activities
 
First quarter of 2009 compared with First quarter of 2008

Net cash used in investing activities for the first quarter of 2009 was approximately $1.5 million, an increase of $1.2 million from approximately $364,371 for the first quarter of 2008.  Nearly all of this cash was used for plant and equipment expenses.

 Analysis and Expectations

Our net cash used in investing activities can fluctuate significantly due to changes in our plant and equipment expenses for new stores and the amounts of our lease prepayments. The table below provides figures for the last four years and shows that the amount of net cash we used in investing activities increased significantly in 2006, decreased very significantly in 2007, and increased significantly in the three months ended on March 31, 2009.


 
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2009 1Q
   
2008
   
2007
   
2006
   
2005
 
Net cash used in investing activities ($)
   
1,549,607
     
24,528,810
     
1,427,839
     
6,982,556
     
238,047
 

Our investing activities are likely to consume greater amounts of our cash over the next several periods as our opening of new stores (whether through acquisitions or organically) causes our plant and equipment expenses to increase.  This consumption of cash will be offset by our efforts, to the extent we are successful, to obtain additional financing.

Cash in Financing Activities

First quarter of 2009 compared with first quarter of 2008

Net cash used by financing activities was approximately $2.2 million for the first quarter of 2009.  We repaid our entire bank loan, and did not have financing activities in this quarter.  In the first quarter of 2008, net cash provided by financing activities was approximately $12.6 million, the result of our raising net proceeds of $13.5 million from the private placement transaction on March 28, 2008.

Loans. The balance of our outstanding short-term bank loans on March 31, 2009 was nil, compared with $1.4 million as of March 31, 2008.  We were obligated to repay this bank debt on May 22, 2009. We chose to repay it earlier because we temporarily have enough funds in operating and opening new stores. As we expand over the next several quarters, we anticipate that our working capital needs will increase, and we may need to increase our short-term bank borrowing.

As of March 31, 2009, we had (and as of the date of this report we have) a credit line of up to RMB 9.7 million, or approximately $1.4 million using a current exchange rate of $1 to 6.8456 RMB, based on our credit rating of AAA granted by Daqing City Commercial Bank. We believe that this credit line is sufficient for our working capital needs over the next several quarters.
 
Future Cash Commitments

Under our expansion plan, in 2009 we opened 3 new stores which have approximately 16,000 square meters of space and in 2008 we opened 10 new stores which have approximately 50,000 square meters of retail space. Six of these stores opened in 2008 were opened by us and four of the new stores were opened through the acquisition of existing businesses by us.  We plan to open additional supermarkets in 2009 which will have additional space of approximately 28,000 square meters and one additional distribution center which will have approximately 20,000 square meters.  We also plan to make improvements to our logistics and information systems to support our supermarkets.  We will finance this from funds generated from operations which we believe will be sufficient  to fund this expansion.   In addition, we intend to seek additional financing to finance the opening of even more stores during the remainder of 2009 and thereafter.

In view of the global financial crisis it is becoming increasingly difficult to obtain additional financing and we  cannot assure you that our efforts to obtain additional financing will be successful   If we are unable to obtain financing, as needed, on a timely basis and on acceptable terms, we will not be able to fully implement our expansion plans and or ability to expand would be entirely dependent or funds generated for operations and our financial position, competitive condition, growth and profitability may be adversely affected.

As of March 31, 2009, we had cash and cash equivalents equal to approximately $22.6 million, a decrease of $6.0 million or 21.0%, compared to $28.6  million as of March 31, 2008.  The main reason is because we received  net proceeds from our private placement transaction of  approximately $12.1 million in the first quarter of 2008, while we didn’t complete any financing in the first quarter of 2009, offset by a $8.5 million increase in cash and cash equivalents at the beginning of the first quarter of 2009 ($19.3 million) than at the beginning of first quarter of 2008 ($10.7 million), the greater net cash provided by operating activities in the three months ended March 31, 2009 than in the three months ended on March 31, 2008 (a difference of $1.4 million),  offset to some extent of the decrease in the total cash flow.

 
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Off-balance sheet arrangements

We have no off-balance sheet arrangements, and there are no such arrangements that have or are likely to have a current or future effect on our financial condition.

Critical Accounting Policies and Estimates

Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See Note 1 to our consolidated financial statements, “Summary of Significant Accounting Policies.” We believe that the following paragraphs reflect the more critical accounting policies that currently affect our financial condition and results of operations:
  
Method of Accounting

We maintain our general ledger and journals with the accrual method accounting for financial reporting purposes. Accounting policies adopted by us conform to generally accepted accounting principles in the United States and have been consistently applied in the presentation of financial statements.

Use of estimates

The preparation of the financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.
 
Economic and political risks

Our operations are conducted in the PRC. Accordingly, our business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.
 
Our operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. Our results may be adversely affected by changes in political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.

Revenue recognition

Revenue represents the purchase price of goods sold, recognized upon the delivery of goods to customers at the point of sale, generally at the checkout counter. We generally recognize revenue at the time of sale, when goods are delivered to the customer and cash is received and recorded by our employees. In addition to cash payments, we receive payments by bank debit card, for which we also recognize revenue at the time of sale. We also receive payments by a pre-paid Company cash card, which represents a cash account that the customer has funded prior to the sale. Revenue from cash cards is recognized at the time the customer funds the card account. We do not accept any other method of payment and we do not deliver goods on credit.

 
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Customers have a general right to return spoiled or defective products. Under PRC law, the suppliers of these goods are required to reimburse the Company for the purchase price that we have refunded to the customer. Management has not made allowance for estimated sales returns because they are considered immaterial based on the Company’s experience.

In recognizing revenue, we assume that the currency we receive from customers is valid legal tender in the PRC, that our cash card accounts have been properly funded and our electronic record-keeping system has not been tampered with or malfunctioned, that we will not inadvertently sell significant amounts of defective or spoiled goods, and that our suppliers will comply with their obligations under PRC law to reimburse us for the purchase price that we have refunded to customers for defective or spoiled goods. If any of these assumptions were to prove incorrect, we could have to restate our revenue. In our operating history as of the date of this prospectus, none of these assumptions has been incorrect.
 
Land use rights

Under PRC law, all land in the PRC is owned by the government and cannot be sold to an individual or company. The government grants individuals and companies the right to use parcels of land for specified periods of time. These land use rights are sometimes referred to informally as “ownership.” Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives, using the straight-line method. Estimated useful lives typically range from 30 to 40 years, and are determined to be the term of the land use right.

Property, plant and equipment

Plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of plant and equipment are as follows:
  
Buildings
30-40 years
Shop equipment
6 years
Office equipment
5 years
Motor vehicles
8 years
Car Park
43 years
Leasehold Improvements
5 years
 
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.

Goodwill represents the excess of the cost of an acquisition over the fair value of the net acquired identifiable assets at the date of acquisition. Goodwill is included in intangible assets and no amortization is provided.   Goodwill is tested for impairment annually on December 31.  No impairment was made in the first quarter of 2009 or 2008.

Accounting for the Impairment of Long-Lived Assets

The long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the asset. Our principal long-lived assets are our property, plant and equipment assets.

 
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If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

The Company did not recognize any impairment loss in 2007 or 2008, or the three month period ended March 31, 2009. Competitive pricing pressure and changes in interest rates, could materially and adversely affect our estimates of future net cash flows to be generated by our long-lived assets.

Inventories

Inventories consisting of finished goods, materials on hand, packaging materials and raw materials are stated at the lower of cost or market value. Finished goods are comprised of direct materials, direct labor and an appropriate proportion of overhead.

Management regularly evaluates the composition of its inventory to identify slow-moving and obsolete goods to determine if write-downs are required. Obsolete goods include inventory lost due to employee theft, shoplifting, administrative error and vendor fraud, or “inventory shrink.”

Changes in sales volumes due to unexpected economic or competitive conditions could materially affect the adequacy of these write-downs. We have never had to retroactively amend or restate our inventory figures.

Cash and cash equivalents

We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. We maintain bank accounts only in the PRC. We do not maintain any bank account in the United States.
 
Item 4. Controls and Procedures.
 
Disclosure Controls and Procedures
 
As required by Rule 13a-15 under the Exchange Act, in connection with the filing of this Quarterly Report on Form 10-Q, our management, including our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2009 and based upon that evaluation, our chief executive officer and chief financial officer concluded that the Company's disclosure controls and procedures were not effective.  Management arrived at that conclusion based on the fact  that as March 31, 2009 the Company had not filed a Current Report on Form 8-K  disclosing the closing of  the acquisition of the Hulunbeier Huahui Department Store Co., Ltd on December 5, 2008 (which was required within four business days of the closing) nor had the Company filed an 8-K containing audited financial statements of Hulunbeier Huahui Department Store Co., Ltd as well as pro-forma financials statements (which filing was required to have been made within 71 days and four business days of the closing).  On June 23, 2009, the Company filed the 8-K disclosing the closing of the acquisition and containing audited financial statements of Hulunbeier Huahui Department Store Co., Ltd. as well as pro forma financial information.

The background to this material weakness is set forth below.

The Company made five acquisitions during 2008 consisting of the purchase of the operating rights and certain assets of (1) Daqing Xinguangtiandi Shopping Center Co., Ltd; (2) Hulunbeier Huahui Department Store Co., Ltd; (3) Heilongjiang Longmei Commerce Co., Ltd; (4) Fuyu Xinshuguang Real Estate Development Co., Ltd and (5) Nehe Wanlong Commercial Building Co., Ltd.

 
·
On September 30, 2008 we entered into an agreement with Daqing Xinguangtiandi Shopping Center Co., Ltd. to  acquire from them all of the business and assets of a supermarket store located in the Xinguangtiandi shopping center in Daqing.  The assets included the lease, the inventory and all licenses held.  The transfer was completed on December 12, 2008.  The Xinguangtiandi store occupies approximately 3,700 square meters in a commercial shopping center in Daqing.  The purchase price of RMB 13.80 million (approximately U.S. $2.0196 million) was paid in two installments: a deposit of RMB 100,000 (approximately U.S. $14,635) was paid prior to October 15, 2008 and the remaining balance was paid on December 2, 2008, the date of the completion of the transfer of the Seller’s assets and the relevant registration procedures regarding the change of the ownership with the Bureau of Industry and Commerce.

 
·
On October 31, 2008 we entered into an agreement with Hulunbeier Huahui Department Store Co., Ltd. to  acquire from them all of the business and assets of a supermarket store located in Hailar.  The assets included the lease, the inventory and all licenses held.  The transfer was completed on October 31, 2008.  The Hailar store occupies approximately 7,600 square meters in the commercial center in Hailar.  The purchase price of  RMB 66 million (approximately U.S. $9.659 million) was paid in two installments: a deposit of RMB 300,000 (approximately U.S. $43,904) was paid prior to November 15, 2008 and the remaining balance was paid on December 5, 2008, the date of the completion of the transfer of the Seller’s assets and the relevant registration procedures regarding the change of the ownership with the Bureau of Industry and Commerce.

 
·
On August 31, 2008 we entered into an agreement with Heilongjiang Longmei Commerce Co., Ltd. to acquire from them all of the business and assets of a supermarket store located in Anda. The assets included the lease, the inventory and all licenses held. The transfer of the assets occurred on August 31, 2008.  The Anda store occupies approximately 2,490 square meters in the largest commercial center in Anda.  The purchase price of RMB 22.74 million (approximately U.S. $3.33 million), was paid in two installments: a deposit of RMB 100,000 (approximately U.S. $14,635) was paid prior to September 15, 2008 and the remaining balance was paid on October 8, 2008 the date of the completion of the transfer of the Seller’s assets and the relevant registration procedures regarding the change of the ownership with the Bureau of Industry and Commerce.

 
·
On October 31, 2008 we entered into an agreement with Fuyu County Xinshuguang Real Estate Development Co., Ltd. to acquire from them all of the business and assets of a supermarket store located in Fuyu.  The assets included the lease, the inventory and all licenses held.  The transfer occurred on October 31, 2008.  The Fuyu store occupies approximately 2,700 square meters in the commercial center in Fuyu. The purchase price of RMB 17.40 million (approximately U.S. $2.546 million) was paid in two installments: a deposit of RMB 300,000 (approximately U.S. $43,904) was paid on October 31, 2008 and the remaining balance was paid on November 13, 2008 the date of the completion of the transfer of the Seller’s assets and the relevant registration procedures regarding the change of the ownership with the Bureau of Industry and Commerce.

 
·
On September 30, 2008 we entered into an agreement with Nehe City Wanlong Commercial Building Co., Ltd,  to acquire from them all of the business and assets of a supermarket store located in Nehe.  The tranfer of the assets occurred on September 30, 2008.  The assets included the lease, the inventory and all licenses held.  The Nehe store occupies approximately 2,800 square meters of leased space in the commercial center in Nehe.  The purchase price of RMB 16.80 million (approximately U.S. $2.4587 million) was paid in two installments: a deposit of RMB 100,000 (approximately U.S. $14,635) was paid prior to October 15, 2008 and the remaining balance was paid on December 15, 2008 the date of the completion of the transfer of the seller’s assets and the relevant registration procedures regarding the change of the ownership with the Bureau of Industry and Commerce.

At the end of March 2009, in connection with the audit of the Company’s December 2008 financial statements, the auditor advised the Company the acquisition of the operating rights and certain assets of Hulunbeier Huahui Department Store Co., Ltd (the “Hailar Store”) for a purchase price of approximately $9.65 million was a significant acquisition as the purchase price exceeded ten (10%) percent of the Company’s assets as of the end of its last fiscal year.   (The Company had total assets of $34,646,839 as of December 31, 2007.)    Accordingly, the closing of the acquisition of the Hailar Store on December 5, 2008 required the Company to file a Current Report on Form 8-K (within four business days of the closing) and a further 8-K  (with 71 days and four business days of the closing) containing audited financial statements of Hulunbeier Huahui Department Store Co., Ltd as well as pro-forma financials statements. 

Each of these five agreements was disclosed in the Company’s Annual Report on Form 10-K for the fiscal year  ended  December 31, 2008 filed on April 15, 2009 and copies of each such agreement was filed as an exhibit thereto.

On June 23, 2009 the Company filed a Current Report on Form 8-K containing the audited financial statements of Hulunbeier Huahui Department Store Co., Ltd. as well as pro forma financial information.
 
In April 2009, the Company implemented procedures to ensure that all required disclosures are made, and that they are made in a timely manner, including education of management on all relevant disclosure requirements and adoption of formal disclosure controls and procedures.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the first quarter of  2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 
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PART II. OTHER INFORMATION

Item 6. Exhibits

(a) Exhibits

31.1 - Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 - Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 - Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 
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SIGNATURES

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

 
QKL STORES INC.
   
   
   
Date: July  21 2009
By:  
/s/ Zhuangyi Wang
   
Zhuangyi Wang
   
Chief Executive Officer
(principal executive officer)
     
 Date: July 21, 2009
By:  
/s/ Crystal Chen
   
Crystal Chen
   
Chief Financial Officer
(principal financial officer and accounting officer)

 
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