Attached files
file | filename |
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EX-5.1 - QKL Stores Inc. | v211115_ex5-1.htm |
EX-23.3 - QKL Stores Inc. | v211115_ex23-3.htm |
EX-23.2 - QKL Stores Inc. | v211115_ex23-2.htm |
As
filed with the Securities and Exchange Commission on February 17,
2011
Registration
No. 333-167087
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
S-1/A
(Amendment
No. 3)
REGISTRATION
STATEMENT UNDER THE SECURITIES ACT OF 1933
QKL
STORES INC.
(Exact
name of registrant as specified in its charter)
Delaware
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445110
|
75-2180652
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||
(State
or other jurisdiction of
|
(Primary
Standard Industrial
|
(I.R.S.
Employer Identification Number)
|
||
incorporation
or organization)
|
Classification
Code Number)
|
1
Nanreyuan Street
Dongfeng
Road
Sartu
District
163300
Daqing, P.R. China
+86-459-460-7626
(Address,
including zip code, and telephone number including area code, of registrant’s
principal executive offices)
National
Corporate Research, Ltd.
615
South DuPont Highway, County of Kent
Dover,
DE 19901
800-483-1140
(Name,
address, including zip code, and telephone number,
including
area code, of agent for service)
Copies
to:
Mitchell
S. Nussbaum, Esq.
Loeb
& Loeb LLP
345
Park Avenue
New
York, New York 10154
Tel.
No.: 212-407-4159 Fax No.: 212-407-4990
Approximate date of commencement of
proposed sale to the public: From time to time after this Registration
Statement becomes effective.
If any of
the securities being registered on this Form are to be offered on a delayed or
continuous basis pursuant to Rule 415 under the Securities Act of 1933, check
the following box. x
If this
Form is filed to register additional securities for an offering pursuant to Rule
462(b) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. ¨
If this
Form is a post-effective amendment filed pursuant to Rule 462(c) under the
Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement for the same
offering. ¨
If this
Form is a post-effective amendment filed pursuant to Rule 462(d) under the
Securities Act, check the following box and list the Securities Act registration
statement number of the earlier effective registration statement for the same
offering. ¨
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
definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
Accelerated Filer ¨
Accelerated Filer ¨
Non-Accelerated Filer ¨ Smaller
Reporting Company x
CALCULATION
OF REGISTRATION FEE
Title of each class of securities to be
registered
|
Amount to be
registered(1)
|
Proposed
maximum
offering price
per share (2)
|
Proposed
maximum
aggregate
offering price (2)
|
Amount of
registration
fee (3)
|
||||||||||||
Common
stock, par value $.001 per share (3)
|
798,875 | $ | 3.24 | $ | 2,588,355 | $ | 301 | |||||||||
Common
stock, par value $.001 per share, underlying Series A Preferred Stock
(4)
|
1,129,430 | $ | 3.24 | $ | 3,659,353 | $ | 425 | |||||||||
Common
stock, par value $.001 per share, underlying Series A Warrants
(5)
|
3,201,025 | $ | 3.24 | $ | 10,371,321 | $ | 1,204 | |||||||||
Common
stock, par value $.001 per share, underlying Series B Warrants
(6)
|
796,372 | $ | 3.24 | $ | 2,580,245 | $ | 300 | |||||||||
Total
|
5,925,702 | $ | 19,199,274 | $ | 2,230 | (7) |
(1)
|
Pursuant to Rule 416 promulgated
under the Securities Act of 1933, as amended, there are also registered
hereunder such indeterminate number of additional shares as may be issued
to the selling stockholders to prevent dilution resulting from stock
splits, stock dividends or similar
transactions.
|
|
|
(2)
|
Estimated solely for purposes
of calculating the registration fee. The registration fee is calculated
pursuant to Rule 457(c). Our common stock is quoted under the symbol
“QKLS” on the NASDAQ Capital Market (“NASDAQ”). On February 10, 2011,
the highest price reported was $3.28 per share and the lowest reported
price was $3.20 per share. The average of the highest and lowest reported
prices as of such date was $3.24 per share. Accordingly, the registration
fee is $2,230 based on $3.24 per
share.
|
(3)
|
Consists of 798,875 shares of
our common stock (for a more detailed description, see “Selling
Stockholders”).
|
|
|
(4)
|
Consists of 1,129,430 shares of
common stock issuable to the selling stockholders upon conversion of the
Series A Preferred Stock (for a more detailed description, see “Selling
Stockholders”).
|
|
|
(5)
|
Consists of 3,201,025 shares
of common stock issuable to the selling stockholders upon exercise of the
Series A Warrants (for a more detailed description, see “Selling
Stockholders”).
|
|
|
(6)
|
Consists of 796,372 shares of
common stock issuable to the selling stockholders upon exercise of Series
B Warrants (for a more detailed description, see “Selling
Stockholders”).
|
(7)
|
$6,020 was previously
paid.
|
Pursuant
to Rule 429 under the Securities Act of 1933, the prospectus included in this
registration statement is a combined prospectus relating to registration
statement no. 333-150800 previously filed by the registrant on Form S-1 and
declared effective August 11, 2009, under which sales ceased on April 1, 2010.
This registration statement, which is a new registration statement, also
constitutes post-effective amendment no. 3 to registration statement no.
333-150800, and such post-effective amendment shall hereafter become effective
concurrently with the effectiveness of this registration statement and in
accordance with Section 8(c) of the Securities Act of 1933. This
registration statement excludes an aggregate of 958,882 shares of common
stock that were included on registration statement no. 333-150800, including
shares of common stock underlying the Series A Preferred Stock, Series A
Warrants and Series B Warrants that have been sold under registration statement
no. 333-150800, pursuant to Rule 144 of the Securities Act of 1933, as amended
(the “Act”), or otherwise disposed of pursuant to an available exemption from
the Act.
The
registrant amends this registration statement on such date or dates as may be
necessary to delay its effective date until the registrant shall file a further
amendment which specifically states that this registration statement shall
hereafter become effective in accordance with Section 8(a) of the Securities Act
of 1933, or until the registration statement shall become effective on such date
as the Commission, acting pursuant to Section 8(a), may
determine.
PROSPECTUS
QKL
STORES INC.
5,925,702 Shares
of Common Stock
Offered
by Selling Stockholders
This
prospectus relates to the sale by the selling stockholders identified in this
prospectus of up to 5,925,702 shares of our common stock
comprising:
§
|
798,875 shares of common
stock held by selling
stockholders;
|
|
|
§
|
1,129,430 shares of common
stock that the selling stockholders may acquire on conversion of Series A
Preferred Stock;
|
|
|
§
|
3,201,025 shares of common
stock issuable to certain selling stockholders upon exercise of Series A
Warrants; and
|
|
|
§
|
796,372 shares of common stock
issuable to certain selling stockholders upon exercise of Series B
Warrants.
|
Of
the 798,875 shares of currently outstanding common stock being
registered, 392,616 were acquired by the selling stockholders prior to
completion of the private placement and the reverse merger described in this
prospectus, 6,000 were issued upon the exercise of Series A Warrants and Series
B Warrants that were issued to one of our consultants for services rendered in
connection with the private placement, 57,656 were issued upon exercise of
Series A Warrants and Series B Warrants issued to the placement agent for
services rendered in connection with the private placement, and 342,603 were
issued upon conversion of Series A Preferred Stock acquired in the private
placement. The Series A Preferred Stock was purchased by the selling
stockholders in a private placement completed on March 28, 2008. We
are required by the terms of a registration rights agreement and a separate
agreement to register the shares listed above. The Series A Preferred
Stock is convertible into common stock at the rate (subject to adjustment) of
one share of common stock for each share of Series A Preferred Stock. The
Series A Warrants are exercisable for one share of common stock at an exercise
price of $3.40 per share (subject to adjustment) and expire on March 27,
2013. The Series B Warrants are exercisable for one share of common stock
at an exercise price of $4.25 per share (subject to adjustment) and expire on
March 27, 2013.
Our
common stock is listed on the Nasdaq Capital Market (“NASDAQ”) under the symbol
“QKLS.” On February 15, 2011, the last reported sale price of our
common stock quoted on NASDAQ was $3.26 per share.
The
selling stockholders may sell all or any portion of their shares of common stock
in one or more transactions on NASDAQ or in private negotiated
transactions. Each selling stockholder will determine the prices at which
it sells its shares. Although we will incur expenses in connection with
the registration of the common stock (estimated to be approximately $55,230), we
will not receive any of the proceeds from the sale of the shares of common stock
by the selling stockholders. To the extent the warrants are exercised for cash,
if at all, we will receive the exercise price for those warrants. Under
the terms of the warrants, cashless exercise is permitted after September 28,
2009 but only if the resale of the warrant shares by the holder is not covered
by an effective registration statement. We cannot assure you that the
warrants will be exercised for cash or at all.
Investing
in our common stock involves a high degree of risk. See “Risk Factors” beginning
on page 6 for a discussion of certain risk factors that you should consider. You should read the entire
prospectus before making an investment decision.
Neither
the Securities and Exchange Commission nor any state securities commission has
approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
The
date of this prospectus is ,
2011
TABLE
OF CONTENTS
PROSPECTUS
SUMMARY
|
1
|
THE OFFERING | 5 |
RISK
FACTORS
|
6
|
ABOUT
THIS PROSPECTUS
|
21
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CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS AND OTHER INFORMATION CONTAINED
IN THIS PROSPECTUS
|
22
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OTHER
REFERENCES
|
23
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EXPLANATORY
NOTE
|
23
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SELLING
STOCKHOLDERS
|
24
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PLAN
OF DISTRIBUTION
|
30
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USE
OF PROCEEDS
|
31
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
32
|
BUSINESS
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44
|
PROPERTIES
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56
|
LEGAL
PROCEEDINGS
|
60
|
OUR
HISTORY AND CORPORATE STRUCTURE
|
61
|
MARKET PRICE OF COMMON EQUITY AND RELATED STOCKHOLDER MATTERS | 69 |
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
|
71
|
DIRECTORS
AND EXECUTIVE OFFICERS
|
72
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EXECUTIVE
COMPENSATION
|
75
|
CERTAIN
RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
|
78
|
DESCRIPTION
OF SECURITIES TO BE REGISTERED
|
81
|
LEGAL
MATTERS
|
82
|
EXPERTS
|
82
|
INTERESTS
OF NAMED EXPERTS AND COUNSEL
|
83
|
SERVICE
OF PROCESS AND ENFORCEMENT OF JUDGMENTS
|
83
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS
|
83
|
WHERE
YOU CAN FIND MORE INFORMATION
|
84
|
DISCLOSURE
OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES
|
84
|
INDEX TO FINANCIAL STATEMENTS | 85 |
i
PROSPECTUS
SUMMARY
References
to “QKL-China” are to Daqing Qing Ke Long Chain Commerce & Trade Co., Ltd.,
a People’s Republic of China retail company that we control through a series of
contractual arrangements described in the section entitled “Our History and
Corporate Structure.” Unless otherwise specified or required by context,
references to “we,” “our,” “us” and the “Company” refer collectively to (i) QKL
Stores Inc. (formerly known as Forme Capital, Inc.), (ii) the subsidiaries of
QKL Stores Inc., which are Speedy Brilliant Group Limited, a British Virgin
Islands company (“Speedy Brilliant (BVI)”), which is wholly owned by QKL Stores
Inc., and Speedy Brilliant Commercial Consultancy Co., Ltd. (“Speedy Brilliant
(Daqing)”), which is wholly owned by Speedy Brilliant (BVI), (iii) QKL-China,
and (iv) Daqing Qinglongxin Commerce & Trade Co., Ltd. (“QC&T”), a
wholly owned subsidiary of QKL-China. For convenience, certain amounts in
Chinese Renminbi (“RMB”) have been converted to United States dollars at an
exchange rate of $1 = RMB 6.8282, the exchange rate on December 31, 2009.
References to “IGA” are to the Independent Grocers Alliance, an international
trade group and network of supermarkets that offers its members access to
industry information, bargaining advantages with suppliers, and other benefits
of affiliation with a large trade group. IGA reports that its member companies
operate in 40 countries worldwide and have total revenues of $21 billion per
year. Its website is www.IGA.com. References in this prospectus to the “PRC” or
“China” are to the People’s Republic of China.
In
keeping with standard practice and the practice of the National Bureau of
Statistics of China, references to “northeastern China” are to the three
northeastern provinces of Heilongjiang, Jilin and Liaoning. A map showing these
provinces is included in the section of this report entitled “Other
References.”
References
to QKL-China’s “registered capital” are to the equity of QKL-China, which under
PRC law is measured not in terms of shares owned but in terms of the amount of
capital that has been or will be contributed to a company by a particular
shareholder or all shareholders. The portion of a limited liability company’s
total capital contributed by a particular shareholder represents that
shareholder’s ownership of the company and the total amount of capital
contributed by all shareholders is the company’s total equity. Capital
contributions are made to a company by deposits into a dedicated account in the
company’s name, which the company may access in order to meet its financial
needs. When a company’s accountant certifies to PRC authorities that a capital
contribution has been made and the company has received the necessary government
permission to increase its contributed capital, the capital contribution is
registered with regulatory authorities and becomes a part of the company’s
“registered capital.”
Summary
We are
a regional supermarket chain that currently operates 45 supermarkets and 3
department stores in northeastern China and Inner Mongolia. Our supermarkets
sell a broad selection of merchandise including groceries, fresh food and
non-food items. We currently have 2 distribution centers servicing our
supermarkets, one for fresh food and another for grocery and non-food
merchandise.
We are
the first supermarket chain in northeastern China and Inner Mongolia that is a
licensee of the Independent Grocers Alliance, or IGA, a United States-based
global grocery network with aggregate retail sales of more than $21.0 billion
per year. As a licensee of IGA, we are able to engage in group bargaining with
suppliers and have access to more than 2,000 private IGA brands, including many
that are exclusive IGA brands.
Our total
revenues for the year ended December 31, 2009 was approximately $247.6 million,
an increase of $87.5 million, or 54.7%, compared to total revenues of $160.1
million for the year ended December 31, 2008. Our net income excluding changes
in fair value of warrants for the year ended December 31, 2009 was approximately
$10.8 million, an increase of $1.8 million, or 20.0%, from approximately $9.0
million for the year ended December 31, 2008.
1
Our
Industry
We
operate in the supermarket industry in China, which is a part of the country’s
retail trade sector. We believe the retail market has benefited from compelling
industry fundamentals such as rapid economic growth, urbanization and increasing
disposable income.
China’s
economy has been experiencing consistent growth with nominal GDP growing from
approximately $1.9 trillion in 2004 to approximately $4.9 trillion in 2009. As a
result of China’s rapid economic growth, the urban population has increased
dramatically as people in rural and less developed areas migrate to cities in
search of better jobs and higher living standards. During the period between
2004 and 2009, the total urban population in China increased by approximately
79.0 million, or approximately 14.6%. This growth has been accompanied by rising
income levels of urban households where annual per capita disposable income
increased from $1,379 in 2004 to $2514 in 2009 a compound growth rate of 12.8%.
A growing middle class combined with an increasing affluence and purchasing
power has driven the rapid development of the retail sector and in turn driven a
large increase in consumer spending. Consumer spending has grown from $789
billion in 2004 to approximately $1.8 trillion in 2009, a compound growth rate
of approximately 18.4%.
Northeast
China has a population of 133 million, or approximately 9% of China’s
population. In December 2007, a major economic-development plan for northeastern
China, the “Plan for Revitalizing Northeast China,” was announced by an office
of the PRC’s State Counsel. We believe that the plan indicates a commitment by
the PRC government to make economic development of northeastern China a high
priority. We also believe that this development is likely to contribute to our
growth.
Company
History
On March
28, 2008, QKL Stores Inc. (formerly known as Forme Capital, Inc.) acquired
control of QKL-China through a “reverse merger” transaction. Upon completion of
the reverse merger transaction, QKL Stores Inc. ceased to be a shell company (as
that term is defined in Rule 12b-2 under the Securities Exchange Act of 1934
(the “Exchange Act”)).
2
Shares
Issued To The Selling Stockholders
Placement
Agent Warrants
On March
9, 2007, QKL entered into an engagement agreement with Kuhns Brothers, Inc.
(“Kuhns Agreement”) for the provision of investment banking and other services
as in contemplation of a reverse merger of the company or a company affiliated
with the company with a publicly traded shell company and simultaneous $15.5
million financing transaction. On January 22, 2008, QKL terminated the
engagement agreement and the parties executed a settlement agreement. Under the
terms of the settlement agreement, Kuhns Brothers, Inc. was paid a cash fee
equal to 8.5% of the gross proceeds invested in the financing by investors
introduced to the Company by Kuhns Brothers, Inc. and was issued Series A
Warrants to purchase 191,250 shares of our common stock and Series B Warrants to
purchase 153,000 shares of our common stock. We believe that the designees to
whom Kuhns Brothers, Inc. transferred the securities it received pursuant to the
settlement agreement were employees or otherwise affiliated with Kuhns Brothers,
Inc. and received their shares as consideration for their services to Kuhns
Brothers, Inc.
Mass
Harmony Consulting Agreement
Yang
Miao, Ying Zhang and Fang Chen are principals of Mass Harmony Asset Management
(“Mass Harmony”). On March 13, 2007, QKL-China entered into a Financial
Consulting Agreement (the “Mass Harmony Agreement”) with Mass Harmony under
which Mass Harmony agreed to perform certain financial services for QKL-China.
QKL-China paid Mass Harmony an aggregate of RMB 500,000 (approximately $70,000)
and Mass Harmony also received 299,999 shares of common stock, Series A Warrants
to purchase 91,176 shares of common stock, and Series B Warrants to purchase
72,941 shares of common stock. 6,000 shares of common stock, 30,392 shares of
common stock underlying Series A Warrants and 24,314 shares of common stock
underlying Series B Warrants that have not previously been disposed of are being
registered in this prospectus. On March 30, 2010, Ying Zhang assigned her Series
A Warrant to purchase 30,392 shares of common stock and her Series B Warrant to
purchase 24,314 shares of common stock to Roth Capital Partners, a registered
broker-dealer. The remaining shares transferred to Yang Miao, Ying Zhang and
Fang Chen by Mass Harmony have been disposed of pursuant to our registration
statement on Form S-1 (file no. 333-150800) or pursuant to Rule 144 promulgated
under the Securities Act of 1933, as amended. Yang Miao and Fang Chen are
selling stockholders. Roth Capital Partners is not a selling
stockholder.
Other
Issuances in 2007
Robert
Scherne, a selling stockholder, served as a director and Chief Financial Officer
of Forme Capital from September 19, 2007 until March 28, 2008. In December 2007,
Mr. Scherne received 21,000 shares of common stock as compensation for his
services, of which he currently holds 17,000 shares of common stock that are
being registered on this prospectus.
In
December 2007, we issued 37,211 shares of our common stock to Menlo Venture
Partners, LLC, as repayment of a working capital advance in the amount of
$25,000.
Reverse
Merger and Private Placement Transaction
On March
28, 2008, we acquired control of QKL-China through a “reverse merger”
transaction. Through the reverse merger we ceased to be a shell company as that
term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”) and then became in the business of operating
supermarkets in northeastern China.
At the
same time as the closing of the reverse merger transaction, we closed a private
placement of securities, in which we sold to certain accredited investors listed
under “Investors In Private Placement” in the Selling Stockholders table
included in the section of this prospectus entitled “Investors in Private
Placement,” for gross proceeds to us of $15.5 million, 9,117,647 units at a
purchase price of $1.70 per unit, each unit consisting of one share of Series A
Preferred Stock (each of which is convertible into one share of our common
stock), a 0.625 interest in a Series A Warrant and a 0.625 interest in a Series
B Warrant. The Series A Warrants have an exercise price of $3.40 per share
(subject to adjustment), the Series B Warrants have an exercise price of $4.25
per share (subject to adjustment). We received $13,523,530 as net proceeds from
this financing. The closing of the private placement was conditioned on the
closing of the reverse merger transaction.
On March
28, 2008, as part of a $15.5 million private placement, we entered into a
registration rights agreement (as amended on May 8, 2008) with certain
investors, pursuant to which we agreed to register for resale up to an aggregate
of 20,514,705 shares of common stock, including shares of common stock
underlying Series A Preferred Stock, Series A Warrants and Series B Warrants.
The registration rights agreement provided that if the initial registration
statement required to be filed thereunder was not declared effective by
September 24, 2008, we would be required to pay certain liquidated damages to
the investors. On March 9, 2009, the investors party to the registration rights
agreement waived their right to such liquidated damages and on August 11, 2009,
the initial registration statement covering 2,070,836 shares of the total shares
registrable pursuant to the registration rights agreement was declared
effective. We were not able to register the balance of the shares required to be
registered pursuant to the registration rights agreement due to limits imposed
by the Securities Exchange Commission’s interpretation of Rule 415 of Regulation
C promulgated under the Securities Act of 1933, as amended (the “ Securities Act
”).
There are
additional deadlines we are required to meet if the private placement investors
request that we file one or more registration statements covering the remaining
shares that we are obligated to register pursuant to the registration rights
agreement. In the event that we are required to file an additional registration
statements to cover securities that we have previously been unable to register,
we will be required to file any such additional registration statement within 30
days of receipt of demand notice from certain of our stockholders. We will
further be required to have any such additional registration statement declared
effective within 150 days of its initial filing date, or 180 days from its
initial filing date in the event that the registration statement is given a full
review by the Securities and Exchange Commission. If we fail to meet one or more
of those deadlines, we would, in the absence of an additional waiver, be
required to pay the investors up to a maximum of $1,550,000 in liquidated
damages. Payment of a significant amount of liquidated damages would harm our
profitability and we may not have sufficient cash to pay them.
Other
Issuances
Castle
Bison, Inc., a selling stockholder, is a California corporation owned and
controlled by Raul Silvestre. Mr. Silvestre was counsel to the Company from
September 17, 2007 to March 28, 2008. On September 17, 2007, Castle Bison
acquired its shares of our common stock from Synergy Business Consulting
pursuant to a stock purchase agreement (“2007 Private Placement”) by and among
the Company, Synergy Business Consulting and Lomond International, Inc., as
agent for several buyers. Prior to March 28, 2008, Castle Bison owned
approximately 9.19% of our outstanding common stock, or 137,790 shares.
Therefore, Castle Bison could be deemed to have been our affiliate at that
time.
Windermere
Insurance Company, a selling stockholder, is a British Virgin Islands business
development company. John Scardino has sole voting and dispositive power over
the shares held by Windermere. Windermere acquired its shares of our common
stock in the 2007 Private Placement. Prior to March 28, 2008, Windermere owned
approximately 7.75% of our outstanding common stock, or 116,234 shares.
Therefore, Windermere could be deemed to have been our affiliate at that
time.
Each
of Benjamin Hill, Fink Family Trust, Brandon Hill, Mark Bell M.D. Inc Retirement
Trust, Larry Chimerine, Irv Edwards M.D. Inc. Employee Retirement Trust, and
Marie Tillman acquired its shares of our common stock in the 2007 Private
Placement.
In
December 2007, we issued 37,211 shares of our common stock to Menlo Venture
Partners, LLC, as repayment of a working capital advance in the amount of
$25,000.
In
December 2007, Robert Scherne, our former chief financial officer and director,
acquired his shares of our common stock as compensation for his
services.
Pursuant
to a Warrant Purchase Agreement by and between Warberg Opportunistic Trading
Fund, LP (“Warberg”) and Straus-GEPT Partners, L.P. dated June 14, 2010, Warberg
acquired 147,059 Series B Warrants to purchase 147,059 shares of common
stock.
For
additional information regarding the Private Placement Transaction, please see
the section of this prospectus entitled “Our History and Corporate
Structure”.
3
The
following table compares:
A. the
number of shares of common stock issued and outstanding prior to our March 2008
private placement transaction, which were held by persons other than the selling
shareholders, affiliates of the company, and affiliates of the selling
shareholders;
B. the
number of shares registered for resale by the selling shareholders or affiliates
of the selling shareholders in our registration statement No. 333-150800
previously filed with the SEC and declared effective on August 11, 2009 (the
“2009 Registration Statement”);
C. the
number of shares registered for resale in the 2009 Registration Statement by the
selling shareholders or affiliates of the selling shareholders that continue to
be held by the selling shareholders or affiliates of the selling
shareholders;
D. the
number of shares registered for resale in the 2009 Registration Statement that
have been sold in resale transactions by the selling shareholders or affiliates
of the selling shareholders; and
E. the
number of shares registered for resale on behalf of the selling shareholders or
affiliates of selling Shareholders pursuant to this Registration
Statement.
A
|
B
|
C
|
D
|
E
|
||||||||||||
99,044
|
2,070,836
|
1,111,954
|
958,882
|
5,925,702
|
Public
Offering
In
November 2009, we raised an aggregate of $39.7 million in a public offering of
6,900,000 shares of our common stock at a price of $5.75 per share.
Name
Change
On June
18, 2008, we changed our name from Forme Capital, Inc. to QKL Stores Inc. On the
same date, our name change was reflected on the Over-the-Counter Bulletin Board
(“OTCBB”) and our common stock began trading under the stock symbol QKLS.OB. On
October 21, 2009, our common stock was listed on NASDAQ under the symbol
“QKLS.”
Executive
Office
Our
executive offices are located at 1 Nanreyuan Street, Dongfeng Road, Sartu
District, Daqing, 163300 P.R.C. and our telephone number is (011)
86-459-4607987. Our corporate website is www.qklstoresinc.com.
Information contained on, or accessed through our website is not intended to
constitute and shall not be deemed to constitute part of this
report.
4
The
Offering
Offering
by Selling Stockholders
This
prospectus relates to the sale by the selling stockholders identified in this
prospectus of up to 5,925,702 shares of our common stock
comprising:
§
|
798,875 shares of common stock
held by selling
stockholders;
|
§
|
1,129,430 shares of common stock
that the selling stockholders may acquire on conversion of Series A
Preferred Stock; and
|
§
|
3,201,025 shares of common
stock issuable to certain selling stockholders upon exercise of Series A
Warrants
|
§
|
796,372 shares of common stock
issuable to certain selling stockholders upon exercise of Series B
Warrants.
|
The
shares being registered may be offered for sale by the selling stockholders from
time to time. No shares are being offered for sale by the Company.
Common
stock outstanding prior to Offering
|
29,769,590
as of February 16, 2011
|
|
Common
stock offered by the Company
|
0
|
|
Total
shares of common stock offered by selling stockholders
|
5,925,702
|
|
Common
stock to be outstanding after the offering (assuming conversion of all of
the Series A Preferred Stock being offered, exercise of all of the Series
A and exercise of all the Series B Warrants being offered Warrants being
offered )
|
48,490,903
|
|
Total
dollar value of common stock being registered
|
Our
common stock is listed on the Nasdaq Capital Market (“NASDAQ”) under the
symbol “QKLS.” On February 15, 2011, the last reported sale price of our
common stock quoted on NASDAQ was $3.26 per share. Using this value the
dollar value of the 5,925,702 shares of common stock (including the shares
underlying the Series A Preferred Stock, Series A Warrants and Series B
Warrants) being registered was $19,317,789.
|
|
Use
of Proceeds
|
We
will not receive any of the proceeds from the sales of the shares by the
selling stockholders. To the extent the warrants are exercised for cash we
will receive the exercise price for those warrants. Under the terms of the
warrants, cashless exercise is permitted after September 28, 2009 but only
if the underlying shares have not been registered. We intend to use any
cash proceeds received from the exercise of the warrants for working
capital and other general corporate purposes. We cannot assure you that
any of those warrants will ever be exercised for cash or at
all.
|
|
Our
NASDAQ
Trading
Symbol
|
QKLS
|
|
Risk
Factors
|
See
“Risk Factors” beginning on page 6 and other information included in this
prospectus for a discussion of factors you should consider before deciding
to invest in shares of our common
stock.
|
5
RISK
FACTORS
An
investment in our common stock involves a high degree of risk. You should
carefully consider the risks described below and the other information contained
in this report before deciding to invest in our common stock.
If
we do not receive prompt delivery of the goods we order, in good condition, and
at the prices we expect, our ability to generate profits could be
harmed.
As a
retail company, our ability to keep our shelves stocked with a wide variety of
merchandise is essential to our success and is dependent on the prompt delivery
of the goods we order, in good condition, and at the prices we expect.
Disruptions to our supply chain could cause us to reduce the variety or overall
amount of goods we sell; to seek alternative sources for affected supplies; or
to increase our prices, decrease our profit margins, or both. Any of these
consequences could lead to our customers buying less, shopping elsewhere or
criticizing our reputation. If this occurred, our income, profitability,
reputation and competitive position would all suffer.
Our
supply chain and costs could be disrupted by a wide variety of events. The most
significant of these are described below:
|
§
|
Problems with
transportation infrastructure in and around northeastern China and Inner
Mongolia
|
Delivery
of our supplies depends on the smooth passage of commercial cargo through the
railways, highways and waterways in and around northeastern China and Inner
Mongolia. Transportation infrastructure in and around northeastern China and
Inner Mongolia may suffer more breakdowns and offer fewer alternative routes
than systems in many western countries.
|
§
|
Bad harvests
and severe weather could harm the agricultural production on which we
depend, prevent customers from reaching our stores and disrupt our power
supply
|
Severe
storms could also reduce supplies of fresh foods by destroying crops and
livestock and, in extreme cases, could reduce supplies of processed foods by
reducing overall availability of the agricultural raw materials from which they
are made, and cause shortages of, and price increases for, the affected
supplies.
Poor
yields of crops and livestock, whether due to bad weather, disease, errors in
agricultural planning or other causes, could reduce the market supplies of fresh
foods as well as processed foods that depend on agricultural products as raw
materials. Such reductions could raise the cost of our supplies and cause the
supply shortages.
|
§
|
Quality
control problems and operational difficulties among a small number of
suppliers
|
We rely
on suppliers to provide sufficient amounts of merchandise that meet our quality
standards and government health and consumer-protection standards. A significant
portion of our supplies (approximately 14.7% in 2008 and 9.1% in 2007) come from
our top 10 suppliers, which are primarily large wholesalers and meat processors.
We usually secure a primary vendor and a secondary vendor for each category of
merchandise by entering into standard contracts with them, which typically have
a term of one year and provide for payment at market prices. In case there are
merchandise shortages, we utilize the secondary vendor. If one or more of these
suppliers experiences quality control failures or is unable to secure its own
supply of merchandise, whether self-produced or purchased from others, the
merchandise that it delivers to us could fail to meet our or the government’s
quality standards or arrive in insufficient amounts to meet our needs. If such
risks do materialize, there is no guarantee we would succeed in securing
replacement supplies meeting our and the government’s standards from other
suppliers quickly and at reasonable prices, or at all, and we could suffer the
consequences of supply chain disruption described above.
Under our
supply contracts, our suppliers are responsible for damage that occurs during
shipping and, under the PRC’s consumer protection laws, our suppliers must
reimburse us for the cost of spoiled goods returned to us by customers for a
refund. Nevertheless, significant spoilage could reduce the amount of fresh food
we are able to offer, which could reduce our income.
6
|
§
|
Economic
conditions
|
Economic
conditions, in northeastern China in particular, affect the price and
availability of our supplies. Inflation in prices of agricultural products and
in general is a significant concern in China. If inflation develops and becomes
a significant problem, many retailers in China, including us, will have to
choose between increasing the prices we charge our customers and reducing the
profit margins on our sales. In either case, our competitive position and
operating results could be harmed, and the value of any investment in our common
stock could be reduced.
In
addition, the geographic concentration of our operations exposes us to the risks
of the local economy. We operate in northeastern China and Inner Mongolia, and
our near-term plans call for expansion only within the three provinces of
northeastern China and the eastern region of Inner Mongolia. Our headquarters,
warehouses and distribution facilities and all of our stores are located within
a relatively limited geographic area. As a result, our business is more
susceptible to regional conditions, including conditions affecting
infrastructure, agriculture, inflation and employment, than our more
geographically diversified competitors.
The
supermarket industry in the PRC is becoming increasingly competitive and, unless
we are able to compete effectively with domestic and foreign retailers, and
restaurants and fast food chains, our profits could suffer.
The
supermarket industry in the PRC is highly and increasingly competitive. Giant
international retailers such as Wal-Mart and Carrefour have entered the market,
national retailers such as Bailian and Lianhua have expanded, and local and
regional competition has grown. Some of these companies have substantially
greater financial, marketing, personnel and other resources than we
do.
Our
competitors could adapt more quickly than we do to evolving consumer preferences
or market trends, have more success than we do in their marketing efforts,
control supply costs and operating expenses more effectively than we do, or do a
better job than we do in formulating and executing expansion plans. Increased
competition may also lead to price wars, counterfeit products or negative brand
advertising, all of which may adversely affect our market share and profit
margins. Expansion of large retailers into new locations may limit the locations
into which we may profitably expand. To the extent that our competitors are able
to take advantage of any of these factors, our competitive position and
operating results may suffer.
We also
face heightened competition from restaurants and fast food chains, which are
capturing an increasing portion of household food expenditures in the
PRC.
Because
we face intense competition, we must anticipate and quickly respond to changing
consumer demands more effectively than our competitors. In order to succeed in
implementing our business plan, we must achieve and maintain favorable
recognition of our private label brands, effectively market our products to
consumers, competitively price our products, and maintain and enhance a
perception of value for consumers. We must also source and distribute our
merchandise efficiently. Failure to accomplish these objectives could impair our
ability to compete successfully and adversely affect our growth and
profitability.
Our
limited operating history makes it difficult to evaluate our future prospects
and results of operations; our business could fail, and you could lose some or
all of your investment.
We have a
limited operating history and the PRC supermarket industry is young and
continually growing. Accordingly, you should consider our future prospects in
light of the risks and uncertainties experienced by early-stage companies in
evolving markets. Some of these risks and uncertainties relate to our ability
to:
§
|
Offer new products to attract and
retain a larger customer
base;
|
|
|
§
|
Respond to competitive and
changing market conditions;
|
|
|
§
|
Maintain effective control of our
costs and expenses;
|
7
§
|
Attract additional customers and
increase spending per
customer;
|
§
|
Increase awareness of our brand
and continue to develop customer
loyalty;
|
§
|
Attract, retain and motivate
qualified personnel;
|
§
|
Raise sufficient capital to
sustain and execute our expansion
plan;
|
§
|
Respond to changes in our
regulatory environment;
|
§
|
Manage risks associated with
intellectual property rights;
and
|
§
|
Foresee and understand long-term
trends.
|
Because
we are a relatively new company, we may not be experienced enough to address all
the risks in our business or in our expansion plan. If we are unsuccessful in
addressing any of these risks and uncertainties, our business may
fail.
Our
internal control over financial reporting and our disclosure controls and
procedures have been ineffective, and failure to improve them could lead to
future errors in our financial statements that could require a restatement or
untimely filings, which could cause investors to lose confidence in our reported
financial information, and a decline in our stock price.
In
connection with the preparation and audit of our 2009 financial statements and
notes, we were informed by our auditor, BDO China Li Xin Da Hua CPA Co. Ltd.
(“BDO”) of certain deficiencies in our internal controls that BDO considered to
be material weaknesses. These deficiencies related to our financial closing
procedures and errors in classification of warrants. After discussions between
management, our audit committee and BDO, we concluded that the Company had
improperly classified warrants pursuant to FASB ASC Topic 815 “Derivatives and
Hedging”) (“ASC 815”). As a result of the reclassification, the Company
recognized a $35.5 million loss for the year ended December 31,
2009.
In
addition, as a result of the reclassification, on March 31, 2009 our audit
committee met with BDO and made a determination that the Company’s financial
statements in each of its quarterly reports filed in 2009 could not be relied on
that it will restate the Company’s financial statement for each of the quarterly
reports it filed in 2009. The Company filed a current Report on Form 8-K
disclosing these determinations under Item 4.02 of Form 8-K concurrent with the
filing of its Annual Report on Form 10-K for the fiscal year ended December 31,
2009 (“Annual Report”) and filed amended 10-Qs on May 17, 2010.
As
required by Rule 13a-15 promulgated under the Exchange Act, in connection with
the filing of our Annual Report, 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) promulgated under the Exchange Act) as of December 31,
2009 and determined that our disclosure controls and procedures were not
effective as of such date. This conclusion was based on the fact that on
December 30, 2009, we entered into an agreement to acquire a building for use as
our new headquarters. Pursuant to Item 1.01 of Form 8-K under the Exchange Act,
we should have filed a current report on Form 8-K disclosing the agreement by
January 6, 2010, but we did not file such current report until January 25,
2010.
As a
result of the material weakness in our internal controls and the ineffectiveness
of our disclosure controls and procedures described above, current and potential
stockholders could lose confidence in our financial reporting, which would harm
our business and the trading price of our stock.
Economic
conditions that affect consumer spending could limit our sales and increase our
costs.
Our
results of operations are sensitive to changes in overall economic conditions
that affect consumer spending, including discretionary spending. Inflation and
adverse changes to employment levels, business conditions, interest rates,
energy and fuel costs and tax rates can, in addition to causing the supply chain
cost challenges described above, reduce consumer spending and change consumer
purchasing habits.
8
As of
the date of this prospectus, we have not been significantly negatively impacted
by the economic downturn in the PRC. The recession in the PRC to date has mainly
impacted the export sector based in southeastern China. Northeastern China and
Inner Mongolia, where our stores are located, have not been affected to the same
extent. Should the economic downturn worsen and spread to northeastern China and
Inner Mongolia, where we are based, a general reduction in the level of consumer
spending in the region would likely result, which would reduce our sales
revenues and profits.
Much
of our income comes from sales of perishable merchandise, which can lose its
value quickly; such losses could harm our operating results.
We could
suffer spoilage if supply chain disruptions occur, if our refrigerators and
freezers malfunction or if we suffer lapses of quality control inspection and
supervision. If our inspections fail to discover spoilage in a shipment of fresh
food or if we fail to routinely inspect perishable merchandise on our shelves,
we could inadvertently offer spoiled food for sale, which could harm our
reputation, competitive position and operating results. Moreover, if we fail to
accurately predict future customer demand for perishable food, we would be
forced to discard unsold perishable food once it spoils, which would also
negatively affect our operating results.
Consumer
concerns regarding the safety and quality of food products or health concerns
could adversely affect sales of our high-margin products, which would negatively
impact our profits.
Our sales
results could be harmed if consumers lose confidence in the safety and quality
of our fresh food products. Consumers in the PRC are becoming increasingly
conscious of food safety and nutrition. Consumer concerns about, for example,
the safety of meat, fish, or dairy products, or about the safety of food
additives used in processed food products, could discourage them from buying
these relatively high-margin products and cause our profit margins to fall and
our results of operations to suffer.
We
rely on the performance of our individual stores, individual store managers,
three regional managers and our operating director for our sales, and should any
or all of them perform poorly for any reason, our sales results, reputation and
competitive position would suffer.
We sell
all of our products through our individual stores. Each supermarket is managed
by a store manager who reports directly to one of our three regional managers.
Each regional manager manages around 10 stores and reports to our operating
director, who reports to our COO, Mr. Alan Stewart. Regional managers spend
their time in stores to work together with each individual store manager. Each
region holds teleconferences every week. Although all purchasing decisions as to
vendors and costs are made by company management and not store managers, the
store manager makes the decision as to order quantities and is responsible for
the daily operation of the store. If factors either in or out of a store
manager’s control reduce a store’s business — for example, disruption of
customer traffic by nearby construction or customer dissatisfaction with store
employees — the individual store’s income could fall, which would negatively
impact our sales. Also, if our managers and operating director fail to
adequately manage store employees and day-to-day operations in a manner that
pleases our customers, our reputation and competitive position will
suffer.
We
may fail to identify or anticipate trends in consumer preferences, which could
result in decreased demand for our merchandise, and lower revenues and
profits.
Our
continued success in the retail market depends on our ability to anticipate the
changing tastes, dietary habits and lifestyle preferences of customers. If we
are not able to anticipate and identify new consumer trends and stock our
shelves accordingly, our sales may decline and our operating results may be
adversely affected. For example, we believe meat and dairy products have strong
growth potential in northeastern China and Inner Mongolia. Accordingly, we have
increased our focus on sales of these products, which tend to have higher profit
margins than our other products. If the market for these products in the PRC
does not grow as we expect, our income may not grow as we expect and our
operating results may suffer.
9
Our
profit margins could narrow and as a result the value of any investment in our
common stock could be reduced.
Profit
margins in the grocery retail industry are narrow. In order to increase or
maintain our profit margins, we are developing strategies to reduce costs by
attempting to increase efficiencies and increase sales of higher-margin items
such as private label merchandise, prepared-in-store foods, and meat and dairy
products, but we can offer no assurance that such strategies, or our execution
of such strategies, will be successful. We also implement promotional price
reductions as part of our competitive strategy that may further affect our
profit margin. Thus, there is no guarantee that our current profit margin will
not decline, which would negatively impact our profitability.
We
rely heavily on information technology systems, which could fail, causing damage
to our operations.
We have a
large and complex information technology system that we rely on to keep track of
inventory and sales, determine our ordering of supplies, and communicate among
stores, our distribution center and our corporate headquarters. Like any
electronic data management system, ours is subject to malfunction. In such a
case, our operations could be significantly disrupted as we work to fix the
problem, upgrade our system or adopt a new system.
In
addition, despite our efforts to secure our computer network, the security of
our network could be compromised, confidential information could be
misappropriated and other system disruptions could occur. This could lead to
loss of sales and diversion of corporate resources from operations and
planning.
If
we have difficulties finding and leasing new retail space for new stores or
retaining existing retail space, our operations could be disrupted and we will
be unable to grow as planned, which would negatively affect our stock
price.
We
currently lease the majority of our store locations. Typically our supermarket
leases have initial 10- to 20-year lease terms and may include renewal options
for up to an additional 10 or 20 years. Our revenues and profitability would be
negatively impacted if we are unable to renew these leases at reasonable
rates.
Under our
expansion plan, in 2009 we opened seven new stores that have, in the aggregate,
approximately 32,000 square meters of space and, in 2008, we opened 10 new
stores that have, in the aggregate, approximately 42,000 square meters of space.
Our success in executing our expansion plan depends on our ability to open or
acquire new stores in existing and new retail areas and to operate these stores
successfully. We may also choose to continue to expand through acquisitions. We
must find suitable locations for those stores and reach reasonable terms with
building owners and other interested parties, which could be difficult as we
face intense competition from other retailers for such sites. If we cannot find
suitable locations at a reasonable cost, our ability to grow will be
compromised, which would negatively affect our stock price.
Our
insurance coverage may be inadequate and, if any of the products we sell causes
personal injury or illness, we could be exposed to significant losses resulting
from negative publicity and harm to our reputation. This exposure could harm our
business.
The sale
of food products for human consumption involves an inherent risk of injury to
consumers. Such injuries may result from tampering by unauthorized third
parties, contamination, including by bacteria, insecticides, fertilizers and
other substances, spoilage and mislabeling. Although we and our suppliers are
subject to governmental inspections and regulations, consumption of our products
could still cause a health-related illness in the future and we could be subject
to claims or lawsuits relating to such events. Under certain circumstances, we
could be required to recall products. Unlike most supermarket companies in the
United States, but in line with industry practice in the PRC, we do not maintain
product liability insurance, and we cannot predict the extent of liability we
could face if such events were to occur.
10
Although
the standard contracts we sign with our suppliers include a provision that
shifts liability to our suppliers if a consumer is injured by a supplier’s
product, the negative publicity surrounding any assertions that merchandise we
carry caused personal injury or illness could adversely affect our reputation
and competitive position. In addition, our property and equipment insurance does
not cover the full value of our property and equipment, which leaves us with
exposure in the event of loss or damage to our properties. Except for property,
accident and automobile insurance, we do not have other insurance such as
business liability or disruption insurance coverage for our operations in the
PRC.
We do not
maintain a reserve fund for potential warranty or defective products claims. If
we experience an increase in warranty claims or if our repair and replacement
costs associated with warranty claims increase significantly, our results of
operations and financial condition would suffer.
Our
company name and private label merchandise may be subject to counterfeiting or
imitation, which could damage our reputation and brand image, and lead to higher
administrative costs.
We regard
brand positioning as an important element of our competitive strategy, and
intend to position our private label brands to be associated with low prices,
high quality, convenience and a positive shopping experience. There have been
frequent occurrences of counterfeiting and imitation of products in the PRC in
the past. Imitation of our company name or logo could occur in the future and
there is no guarantee that we will be able to detect it and deal with it
effectively. Any occurrence of counterfeiting or imitation could damage our
corporate and brand image.
If
we do not effectively manage our growth, our expansion efforts could fail, which
would negatively affect our stock price.
There is
no guarantee that our expansion plan will be successfully implemented. In order
to fully implement these plans, we will have to hire a large number of
additional employees, secure new retail locations, and integrate new stores and
distribution routes into our existing business. There is no guarantee that we
will meet all or any of these needs and therefore no guarantee that we will
succeed in our efforts to expand.
Moreover,
our future expansion will depend both on the profitability of our business and
our ability to raise capital from outside sources. We intend to finance our
expansion plan, which includes the opening of three additional stores during the
remainder of 2009, from funds generated from operations, bank loans, and
proceeds from this offering.
If our
business and markets grow and develop, it will be necessary for us to finance
and manage expansion in an orderly fashion. We may not have the requisite
experience to manage and operate a larger network of stores and distribution
centers. In addition, we may face challenges in integrating acquired businesses
with our own. These events would increase demands on our existing management,
workforce and facilities. Failure to satisfy these increased demands could
interrupt or adversely affect our operations and cause production backlogs,
longer product development time frames and administrative
inefficiencies.
If our
expansion plans are not fulfilled, our stock price will decline.
We
may not be able to hire and retain qualified personnel to support our growth and
if we are unable to retain or hire such personnel in the future, our ability to
implement our business objectives could be limited. Difficulties with hiring,
employee training and other labor issues could disrupt our
operations.
Our
operations depend on the work of nearly 3,900 employees. We may not be able to
retain those employees, successfully hire and train new employees or integrate
new employees into the programs and policies of the Company. Any such
difficulties would reduce our operating efficiency and increase our costs of
operations, and could harm our overall financial condition.
If one or
more of our senior executives or other key personnel are unable or unwilling to
continue in their present positions, we may not be able to replace them within a
reasonable time, and our business may be disrupted and our financial condition
and results of operations may be materially and adversely affected. Competition
for senior management and personnel is intense, the pool of qualified candidates
is very limited, and we may not be able to retain the services of our senior
executives or senior personnel, or attract and retain high-quality senior
executives or senior personnel in the future. This failure could limit our
future growth and reduce the value of our common stock.
11
We
may have difficulty establishing adequate management, legal and financial
controls in the PRC, which may result in a material misstatement of our annual
or interim consolidated financial statements.
Companies
in the PRC have not historically adopted a western style of management and
financial reporting concepts and practices, or a modern western style of
banking, computer and other control systems. We may have difficulty in hiring
and retaining a sufficient number of employees qualified in these areas to work
for our operating company in the PRC. As a result of these factors, we may
experience difficulty in establishing management, legal and financial controls,
collecting financial data, preparing financial statements, books of account and
corporate records, and instituting business practices relating to our PRC
operations that meet western standards. Any such difficulty could result in a
material misstatement of our annual or interim consolidated financial
statements.
We
could be required to pay liquidated damages to our investors under the
registration rights agreement entered into with our investors and such payment
could harm our financial condition.
On March
28, 2008, as part of a $15.5 million private placement, we entered into a
registration rights agreement (as amended on May 8, 2008) with certain
investors, pursuant to which we agreed to register for resale up to an aggregate
of 41,495,261 shares of common stock, including shares of common stock
underlying Series A Preferred Stock, Series A Warrants and Series B Warrants.
The registration rights agreement provided that if the initial registration
statement required to be filed thereunder was not declared effective by
September 24, 2008, we would be required to pay certain liquidated damages to
the investors. On March 9, 2009, the investors party to the registration rights
agreement waived their right to such liquidated damages and on August 11, 2009,
the initial registration statement covering 2,070,836 shares of the total shares
registrable pursuant to the registration rights agreement was declared
effective. We were not able to register all of the 41,495,261 shares in the
initial registration statement due to limits imposed by the Securities Exchange
Commission’s interpretation of Rule 415 of Regulation C promulgated under the
Securities Act of 1933, as amended (the “ Securities Act ”
).
There are
additional deadlines we are required to meet if the private placement investors
request that we file one or more registration statements covering the remaining
shares that we are obligated to register pursuant to the registration rights
agreement. In the event that we are required to file an additional registration
statement to cover securities that we have previously been unable to register,
we will be required to file any such additional registration statement within 30
days of receipt of demand notice from certain of our stockholders. We will
further be required to have any such additional registration statement declared
effective within 150 days of its initial filing date, or 180 days from its
initial filing date in the event that the registration statement is given a full
review by the Securities and Exchange Commission. If we fail to meet one or more
of those deadlines, we would, in the absence of an additional waiver, be
required to pay the investors up to a maximum of $1,550,000 in liquidated
damages. Payment of a significant amount of liquidated damages would harm our
profitability and we may not have sufficient cash to pay them.
If
our lease agreements for certain stores are nullified due to title deficiencies
of our landlords, our business may be adversely affected.
The PRC
real property laws and regulations require landlord to be the legal owner of the
relevant leased properties, otherwise the lease agreement may be nullified. We
have not received or confirmed documentation evidencing our landlord’s legal
ownership for 14 of our stores. If any of these landlords do not legally own the
leased properties, the actual legal owners could force the affected stores to
relocate and operation of the stores concerned may be temporarily terminated
until such stores are relocated.
In
addition, the PRC real property laws and regulations require landlords to obtain
prior consent from the legal owner of the relevant leased properties before the
execution of any sublease agreements; otherwise the sublease agreement may be
nullified if the legal owner refuses to rectify his consent. We have not
independently confirmed whether consents authorizing our subleases for our
supermarkets and distribution centers have been obtained. If the legal owners of
the stores claim that the subleases were invalid, operation of the supermarkets
or distribution centers concerned may be terminated until the supermarkets or
distribution centers are relocated.
12
Some
of our stores may not be in full compliance with legal requirement on their
sector approvals and business licenses and may therefore be subject to
punishment imposed by the relevant PRC authorities.
The PRC
laws and regulations require that store operators obtain a Public Site Hygiene
License and, if applicable, a Food Hygiene License if there are edible products
being processed or distributed in the store. Store operators are also required
to indicate “store operation” on the Public Site Hygiene License and to specify
each category of edible product (i.e., vegetables, fresh seafood, etc.)
distributed. Failure to do so may expose the store to administrative punishments
imposed by the relevant government authorities. Punishments include
administrative penalty up to RMB20,000 (approximately US$3,000), confiscation of
income generated from the excluded business items and, in extreme cases,
revocation of the business license of the violating store.
Several
of our stores have either not obtained the Public Site Hygiene License or are
distributing edible products without specifying the product category on their
Food Hygiene License. Such stores may be subject to sanction as discussed above,
which may be imposed at the sole discretion of PRC authorities.
In
addition, several of our stores are distributing products salt, alcohol,
audio-video products and tobacco which are not permitted on their business
license. While such stores have not been sanctioned for such discrepancy, we
cannot guaranty that the relevant PRC authority will not impose administrative
penalties on such stores in the future, which penalties could be up to
RMB100,000 (approximately US$15,000) per store.
We
are not current in our payment of social insurance and housing accumulation fund
for our employees and such shortfall may expose us to relevant administrative
penalties.
The PRC
laws and regulations require all the employers in China to fully contribute
their own portion of the social insurance premium and housing accumulation fund
for their employees within a certain period of time. Failure to do so may expose
the employers to make rectification for the accrued premium and fund by the
relevant labour authority. Also, an administrative fine may be imposed on the
employers as well as the key management members. Speedy Brilliant (Daqing),
QKL-China and QT&C have failed to fully contribute the social insurance
premium and housing accumulation fund. Therefore, they may be subject to the
administrative punishment as mentioned above.
Risks
Related to Our Corporate Structure
We
control QKL-China through a series of contractual arrangements, which may not be
as effective in providing control over the entity as direct ownership and may be
difficult to enforce.
We
operate our business in the PRC through our variable interest entity, QKL-China.
QKL-China holds the licenses, approvals and assets necessary to operate our
business in the PRC. We have no equity ownership interest in QKL-China and rely
on contractual arrangements with QKL-China and its shareholders that allow us to
substantially control and operate QKL-China. These contractual arrangements may
not be as effective as direct ownership in providing control over QKL-China
because QKL-China or its shareholders could breach the
arrangements.
Our
contractual arrangements with QKL-China are governed by PRC law and provide for
the resolution of disputes through arbitration in the PRC. Accordingly, these
contracts would be interpreted in accordance with PRC law and any disputes would
be resolved in accordance with PRC legal procedures. If QKL-China or its
shareholders fail to perform their respective obligations under these
contractual arrangements, we may have to
§
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incur substantial costs to
enforce such arrangements,
and
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rely on legal remedies under PRC
law, including seeking specific performance or injunctive relief, and
claiming damages.
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The legal
environment in the PRC is not as developed as in the United States and
uncertainties in the Chinese legal system could limit our ability to enforce
these contractual arrangements. In the event that we are unable to enforce these
contractual arrangements, our business, financial condition and results of
operations could be materially and adversely affected.
13
If
the PRC government determines that the contractual arrangements through which we
control QKL-China do not comply with applicable regulations, our business could
be adversely affected.
Although
we believe our contractual relationships through which we control QKL-China
comply with current licensing, registration and regulatory requirements of the
PRC, we cannot assure you that the PRC government would agree, or that new and
burdensome regulations will not be adopted in the future. If the PRC government
determines that our structure or operating arrangements do not comply with
applicable law, it could revoke our business and operating licenses, require us
to discontinue or restrict our operations, restrict our right to collect
revenues, require us to restructure our operations, impose additional conditions
or requirements with which we may not be able to comply, impose restrictions on
our business operations or on our customers, or take other regulatory or
enforcement actions against us that could be harmful to our
business.
The
controlling shareholders of QKL-China have potential conflicts of interest with
us, which may adversely affect our business.
The
controlling shareholders of QKL-China are also beneficial holders of our common
shares. They are also directors of both QKL-China and us. These shareholders
hold a larger interest in QKL-China when compared to their beneficial ownership
in our shares. Conflicts of interest between their dual roles as shareholders
and directors of both QKL-China and us may arise. We cannot assure you that when
conflicts of interest arise, any or all of these individuals will act in the
best interests of the Company or that conflicts of interest will be resolved in
our favor. In addition, these individuals may breach or cause QKL-China to
breach or refuse to renew the existing contractual arrangements that allow us to
receive economic benefits from QKL-China. Currently, we do not have existing
arrangements to address potential conflicts of interest between these
individuals and our company. We rely on these individuals to abide by the laws
of the State of Delaware, which provide that directors owe a fiduciary duty to
the Company, and which require them to act in good faith and in the best
interests of the Company, and not use their positions for personal gain. If we
cannot resolve any conflicts of interest or disputes between us and the
shareholders of QKL-China, we would have to rely on legal proceedings, which
could result in disruption of our business and substantial uncertainty as to the
outcome of any such legal proceedings.
Risks
Related to Doing Business in the People’s Republic of China
Our
business operations are conducted entirely in the PRC. Because China’s economy
and its laws, regulations and policies are different from those typically found
in western countries and are continually changing, we will face risks including
those summarized below.
The
PRC is a developing nation governed by a one-party government and may be more
susceptible to political, economic, and social upheaval than other nations; any
such upheaval could cause us to temporarily or permanently cease
operations.
China is
a developing country governed by a one-party government that imposes
restrictions on individual liberties that are significantly stricter than those
typically found in western nations. China has an extremely large population,
significant levels of poverty, widening income gaps between rich and poor and
between urban and rural residents, large minority ethnic and religious
populations, and growing access to information about the different social,
economic, and political systems to be found in other countries. China has also
experienced rapid economic growth over the last decade, and its legal and
regulatory systems have changed rapidly to accommodate this growth. These
conditions make China unique and may make it susceptible to major structural
changes. Such changes could include a reversal of China’s movement to encourage
private economic activity, labor disruptions or other organized protests,
nationalization of private businesses, internal conflicts between the police or
military and the citizenry, and international political or military conflict. If
any of these events were to occur, it could damage China’s economy and impair
our business.
14
We
are subject to comprehensive regulation by the PRC legal system, which is
uncertain. As a result, it may limit the legal protections available to you and
us and we may not now be, or remain in the future, in compliance with PRC laws
and regulations.
QKL-China,
our operating company, is incorporated under and is governed by the laws of the
PRC; all of our operations are conducted in the PRC; and our suppliers and the
agricultural producers on whom they depend are all located in the PRC. The PRC
government exercises substantial control over virtually every sector of the PRC
economy, including the production, distribution and sale of our merchandise. In
particular, we are subject to regulation by local and national branches of the
Ministries of Agriculture, Commerce and Health, as well as the General
Administration of Quality Supervision, the State Administration of Foreign
Exchange, and other regulatory bodies. In order to operate under PRC law, we
require valid licenses, certificates and permits, which must be renewed from
time to time. If we were to fail to obtain the necessary renewals for any
reason, including sudden or unexplained changes in local regulatory practice, we
could be required to shut down all or part of our operations temporarily or
permanently.
QKL-China
is subject to PRC accounting laws, which require that an annual audit be
performed in accordance with PRC accounting standards. The PRC foreign-invested
enterprise laws require that our subsidiary, Speedy Brilliant (Daqing), submit
periodic fiscal reports and statements to financial and tax authorities and
maintain its books of account in accordance with Chinese accounting laws. If PRC
authorities were to determine that we were in violation of these requirements,
we could lose our business license and be unable to continue operations
temporarily or permanently.
The legal
and judicial systems in the PRC are still rudimentary. The laws governing our
business operations are sometimes vague and uncertain and enforcement of
existing laws is inconsistent. Thus, we can offer no assurance that we are, or
will remain, in compliance with PRC laws and regulations.
PRC
regulations also involve complex procedures for acquisitions conducted by
foreign investors that could make it more difficult for us to grow through
acquisitions.
The New
M&A Rules also established additional procedures and requirements that are
expected to make merger and acquisition activities in China by foreign investors
more time-consuming and complex, including requirements in some instances that
the MOFCOM be notified in advance of any change-of-control transaction in which
a foreign investor takes control of a PRC domestic enterprise, or that the
approval from the MOFCOM be obtained in circumstances where overseas companies
established or controlled by PRC enterprises or residents acquire affiliated
domestic companies and special anti-monopoly submissions for parties meeting
certain reporting thresholds. We may grow our business in part by acquiring
other retail companies. Complying with the requirements of the new regulations
to complete such transactions could be time-consuming, and any required approval
processes, including approval from MOFCOM, may delay or inhibit our ability to
complete such transactions, which could affect our ability to expand our
business or maintain our market share.
The new
regulations also established additional procedures and requirements that are
expected to make merger and acquisition activities in China by foreign investors
more time-consuming and complex, including requirements in some instances that
the MOFCOM be notified in advance of any change-of-control transaction in which
a foreign investor takes control of a PRC domestic enterprise, or that the
approval from the MOFCOM be obtained in circumstances where overseas companies
established or controlled by PRC enterprises or residents acquire affiliated
domestic companies. We may grow our business in part by acquiring other retail
companies. Complying with the requirements of the new regulations to complete
such transactions could be time-consuming, and any required approval processes,
including approval from MOFCOM, may delay or inhibit our ability to complete
such transactions, which could affect our ability to expand our business or
maintain our market share.
In
addition, on February 2, 2010, our Chief Executive Officer, Mr. Wang, acquired
all of the shares of Winning State (BVI), which currently owns 19,082,299 shares
(approximately 64.4%) of our common stock, through a call option. While it is
the case that our PRC counsel Deheng Law Firm believes that this arrangement was
lawful under PRC laws and regulations, there are substantial uncertainties
regarding the interpretation and application of the current or future PRC laws
and regulations, including regulations governing the validity and legality of
such call options. Accordingly, we cannot assure you that PRC government
authorities will not ultimately take a view contrary to the opinion of our PRC
legal counsel.
15
PRC
laws and regulations governing our businesses and the validity of certain of our
contractual arrangements are uncertain. If we are found to be in violation, we
could be subject to sanctions. In addition, changes in such PRC laws and
regulations may materially and adversely affect our business.
We do not
currently have any equity interest in QKL-China or its subsidiary, but instead
enjoy economic benefits and control over these entities substantially similar to
equity ownership through contractual arrangements among our wholly-owned
subsidiary in China, Speedy Brilliant (Daqing), QKL-China and their respective
shareholders. Consistent with the provisions of Financial Accounting Standard
Board “FASB” Interpretation No. 46 (revised), “Consolidation of Variable
Interest Entities — an Interpretation of ARB No. 51”, we consolidated QKL-China
from its inception.
There are
substantial uncertainties regarding the interpretation and application of the
current or future PRC laws and regulations, including regulations governing the
validity and enforcement of such contractual arrangements. Accordingly, we
cannot assure you that PRC government authorities will not ultimately take a
view contrary to the opinion of our PRC legal counsel and Albert Wong & Co.
that we have properly consolidated QKL-China from its inception.
The PRC
government has broad discretion in dealing with violations of laws and
regulations, including levying fines, revoking business and other licenses,
proscribing remittance of profits offshore and requiring actions necessary for
compliance. In particular, licenses and permits issued or granted to us by
relevant governmental bodies may be revoked at a later time by higher regulatory
bodies. We cannot predict the effect of the interpretation of existing or new
PRC laws or regulations on our businesses. We cannot assure you that our current
ownership and operating structure would not be found to be in violation of any
current or future PRC laws or regulations. As a result, we may be subject to
sanctions, including fines, and could be required to restructure our operations
or cease to provide certain services. Any of these or similar actions could
significantly disrupt our business operations or restrict us from conducting a
substantial portion of our business operations, which could materially and
adversely affect our business, financial condition and results of
operations.
Anti-inflation
measures could harm the economy generally and could harm our
business.
The PRC
government exercises significant control over the PRC economy. In recent years,
the PRC government has instituted measures to curb the risk of inflation. These
measures have included devaluations of the RMB, restrictions on the availability
of domestic credit, and limited re-centralization of the approval process for
some international transactions. These measures may not succeed in controlling
inflation, or they may slow the economy below a healthy growth rate and lead to
economic stagnation or recession; in the worst-case scenario, the measures could
slow the economy without curbing inflation, causing “stagflation.” The PRC
government could adopt additional measures to further combat inflation,
including the establishment of price freezes or moratoriums on certain projects
or transactions. Such measures could harm the economy generally and hurt our
business by limiting the income of our customers available to purchase our
merchandise, by forcing us to lower our profit margins, and by limiting our
ability to obtain credit or other financing to pursue our expansion plan or
maintain our business.
Governmental
control of currency conversions could prevent us from paying
dividends.
All of
our revenue is earned in RMB and current and future restrictions on currency
conversions may limit our ability to use revenue generated in RMB to make
dividend or other payments in United States dollars. Although the PRC government
introduced regulations in 1996 to allow greater convertibility of the RMB for
current account transactions, significant restrictions still remain, including
the restriction that foreign-invested enterprises like us may buy, sell or remit
foreign currencies only after providing valid commercial documents at a PRC
banks specifically authorized to conduct foreign-exchange
business.
16
In
addition, conversion of RMB for capital account items, including direct
investment and loans, is subject to governmental approval in the PRC, and
companies are required to open and maintain separate foreign-exchange accounts
for capital account items. There is no guarantee that PRC regulatory authorities
will not impose additional restrictions on the convertibility of the RMB. These
restrictions could prevent us from distributing dividends and thereby reduce the
value of our stock.
Fluctuation
in the exchange rate of the RMB against the United States dollar could result in
foreign currency exchange losses.
In 2005,
the PRC government changed its decade-old policy of pegging the value of the RMB
to the United States dollar. Under the new policy, the RMB is permitted to
fluctuate within a narrow and managed band against a basket of certain foreign
currencies. This change in policy has resulted in an appreciation of the RMB
against the United States dollar of approximately 17.5% from July 1, 2005
through September 1, 2009. There remains significant international pressure on
the PRC government to adopt an even more flexible currency policy, which could
result in a further and more significant appreciation of the RMB against the
United States dollar.
The value
of our common stock will be affected by the foreign exchange rate between United
States dollars and RMB. For example, to the extent that we need to convert
United States dollars we receive from an offering of our securities into RMB,
appreciation of the RMB against the United States dollar could reduce the value
in RMB of our proceeds. Conversely, if we decide to convert our RMB into United
States dollars for the purpose of declaring dividends on our common stock or for
other business purposes, and the United States dollar appreciates against the
RMB, the United States dollar equivalent of our earnings from our business would
be reduced. In addition, the depreciation of significant United States
dollar-denominated assets could result in a charge to our income statement and a
reduction in the value of these assets.
The
RMB is not a freely convertible currency, which could limit our ability to
obtain sufficient foreign currency to support our business operations in the
future.
We
receive all of our revenues in RMB. The PRC government imposes controls on the
convertibility of RMB into foreign currencies and, in certain cases, the
remittance of currency out of the PRC. Shortages in the availability of foreign
currency may restrict our ability to remit sufficient foreign currency to pay
dividends, or otherwise satisfy foreign currency denominated obligations. Under
existing PRC foreign exchange regulations, payments of current account items,
including profit distributions, interest payments and expenditures from the
transaction, can be made in foreign currencies without prior approval from SAFE
by complying with certain procedural requirements. However, approval from
appropriate governmental authorities is required where RMB are to be converted
into foreign currency and remitted out of the PRC to pay capital expenses, such
as the repayment of bank loans denominated in foreign currencies.
The PRC
government could restrict access in the future to foreign currencies for current
account transactions. If the foreign exchange control system prevents us from
obtaining sufficient foreign currency to satisfy our currency demands, we may
not be able to pay certain expenses as they come due.
Our
PRC stockholders are required to register with SAFE; their failure to do so
could cause us to lose our ability to remit profits out of the PRC as
dividends.
SAFE has
promulgated several regulations, including Circular No. 75 (“Circular 75”),
which became effective in November 2005, requiring PRC residents, including both
PRC legal person residents and PRC natural person residents, to register with
the competent local SAFE branch before establishing or controlling any company
outside of the PRC for the purpose of equity financing with assets or equities
of PRC companies, referred to in the Circular 75 as an “offshore special purpose
company.” PRC residents that have established or controlled an offshore special
purpose company, which has finished a round-trip investment before the
implementation of Circular 75, are required to register their ownership
interests or control in such “special purpose vehicles” with the local offices
of SAFE. Under Circular 75, the term “PRC legal person residents” as used in
Circular 75 refers to those entities with legal person status or other economic
organizations established within the territory of the PRC. The term “PRC natural
person residents” as used in Circular 75 includes all PRC citizens and all other
natural persons, including foreigners, who habitually reside in the PRC for
economic benefit. The term “special purpose vehicle” refers to an offshore
entity established or controlled, directly or indirectly, by PRC residents or
PRC entities for the purpose of seeking offshore equity financing using assets
or interests owned by such PRC residents or PRC entities in onshore companies,
and the term “round-trip investment” refers to the direct investment in PRC by
PRC residents through “special purpose vehicles,” including without limitation,
establishing foreign invested enterprises and using such foreign invested
enterprises to purchase or control (by way of contractual arrangements) onshore
assets.
17
In
addition, any PRC resident that is the shareholder of an offshore special
purpose company is required to amend his/her/its SAFE registration with the
local SAFE branch upon (i) injection of equity interests or assets of an onshore
enterprise to the offshore entity, or (ii) subsequent overseas equity financing
by such offshore entity. PRC residents are also required to complete amended
registrations or filing with the local SAFE branch within 30 days of any
material change in the shareholding or capital of the offshore entity not
involving a round-trip investment, such as changes in share capital, share
transfers and long-term equity or debt investments or, already organized or
gained control of offshore entities that have made onshore investments in the
PRC before Circular 75 was promulgated must register with their shareholdings in
the offshore entities with the local SAFE branch on or before March 31,
2006.
Under
Circular 75, PRC residents are further required to repatriate into the PRC all
of their dividends, profits or capital gains obtained from their shareholdings
in the offshore entity within 180 days of their receipt of such dividends,
profits or capital gains. The registration and filing procedures under the
Circular 75 are prerequisites for other approval and registration procedures
necessary for capital inflow from the offshore entity, such as inbound
investments or shareholders loans, or capital outflow to the offshore entity,
such as the payment of profits or dividends, liquidating distributions, equity
sale proceeds, or the return of funds upon a capital reduction.
To
further clarify the implementation of Circular 75, SAFE issued Circular No. 106
(“Circular 106”) on May 9, 2007, which is a guidance that SAFE issued to its
local branches with respect to the operational process for SAFE registration
that standardizing mores specific and stringent supervision on the registration
relating to the Circular 75. Under Circular 106, PRC subsidiaries of an offshore
special purpose company are required to coordinate and supervise the filing of
SAFE registrations by the offshore holding company’s shareholders who are PRC
residents in a timely manner. If these shareholders and/or beneficial owners
fail to comply, the PRC subsidiaries are required to report such failure to the
local SAFE authorities and, if the PRC subsidiaries do report the failure, the
PRC subsidiaries may be exempted from any potential liability to them related to
the stockholders’ failure to comply. The failure of these shareholders and/or
beneficial owners to timely amend their SAFE registrations pursuant to the
Circular 75 and Circular 106 or the failure of future shareholders and/or
beneficial owners of our company who are PRC residents to comply with the
registration procedures set forth in the Circular 75 and Circular 106 may
subject such shareholders, beneficial owners and/or our PRC subsidiaries to
fines and legal sanctions and may also limit our ability to contribute
additional capital into our PRC subsidiaries, limit our PRC subsidiaries ability
to distribute dividends to our company or otherwise adversely affect our
business.
These
regulations apply to our stockholders who are PRC residents. In the event that
our PRC-resident stockholders do not follow the procedures required by SAFE, we
could (i) be exposed to fines and legal sanctions, (ii) lose the ability to
contribute additional capital into our PRC subsidiaries or distribute dividends
to our company, (iii) face liability for evasion of foreign-exchange
regulations, and/or (iv) lose the ability to consolidate the financial
statements of our PRC subsidiaries and of QKL-China under applicable accounting
principals.
Mr. Wang,
our Chief Executive Officer, was required to register with the competent SAFE
branch prior to exercise of his call option, and he completed such registration
on October 10, 2009. Mr. Wang has exercised his call option and all of the
shares of Winning State (BVI) were transferred from Mr. Yap to Mr. Wang on
February 2, 2010.
Enforcement
against us or our directors and officers may be difficult and you could be
unable to collect amounts due to you in the event that we or any officer or
director violates applicable law.
Our
operating company, QKL-China, is located in the PRC and substantially all of our
assets are located in the PRC. Most of our current officers and directors are
residents of the PRC, and most of their assets are located in the PRC. As a
result, it could be difficult for investors to effect service of process on us
or those persons in the United States, or to enforce a judgment obtained in the
United States against us or any of these persons.
18
Health
problems in the PRC could negatively affect our operations.
A renewed
outbreak of severe acute respiratory syndrome, or SARS, or another widespread
public health problem in the PRC, such as bird flu, could have an adverse effect
on our ability to receive and distribute merchandise, the ability of our
employees and customers to reach our stores, and other aspects of our
operations. Public-safety measures such as quarantines or closures of some
stores could disrupt our operations. Any of the foregoing events or other
unforeseen consequences of public health problems could adversely affect our
business.
Risks
Related to an Investment in Our Common Stock
Our
Chief Executive Officer beneficially owns a significant portion of our common
stock and will be able to exert significant influence over us through his
position and stock ownership; his interests may differ from yours, and he could
cause us to take actions that are contrary to your interests and that could
reduce the value of your stock.
Our Chief
Executive Officer, Mr. Wang, owns all of the shares of Winning State (BVI),
which currently owns 19,082,299 shares (approximately 64.4%) of our common
stock. Even assuming conversion of all of the outstanding Series A Preferred
Stock and the exercise of all of the Series A Warrants and Series B Warrants,
Mr. Wang will own a significant portion of our outstanding common stock. As a
result, Mr. Wang will be able to influence the outcome of stockholder votes on
various matters, including the election of directors and extraordinary corporate
transactions such as business combinations. In any such stockholder vote, Mr.
Wang’s interests may differ from that of other stockholders, and he could cause
us to take actions that are contrary to your interests and that could reduce the
value of your stock.
We
do not intend to pay cash dividends in the foreseeable future; this may affect
the price of our stock.
We
currently intend to retain all future earnings for use in the operation and
expansion of our business. We do not intend to pay any cash dividends in the
foreseeable future but will review this policy as circumstances dictate. Should
we decide in the future to do so, as a holding company, our ability to pay
dividends and meet other obligations depends upon the receipt of dividends or
other payments from Speedy Brilliant (Daqing). Speedy Brilliant (Daqing) may,
from time to time, be subject to restrictions on its ability to make
distributions to us, including as a result of restrictions on the conversion of
local currency into United States dollars or other hard currency and other
regulatory restrictions. (See “Risks related to doing business in the People’s
Republic of China” above.) In addition, under the terms of the securities
purchase agreement relating to the private placement, as long as any Series A
Preferred Stock remains outstanding, the Company cannot pay any dividends on the
common stock unless such dividends are also paid to the holders of the Series A
Preferred Stock.
Our
common stock is illiquid and subject to price volatility unrelated to our
operations and could lose some or all of its value even if our business is
strong.
The
market price of our common stock could fluctuate substantially in the future due
to a variety of factors, including the market perception of our ability to
achieve our planned growth, quarterly operating results of other companies in
the same industry, trading volume in our common stock, changes in general
conditions in the economy and the financial markets or other developments
affecting our competitors or us. The failure to establish and maintain an active
trading market for our common stock may adversely affect our shareholders’
ability to sell our common stock in short periods of time, or at all. Trading of
our common stock has been sporadic and our common stock has experienced, and may
experience in the future, significant price and volume fluctuations. Future
sales of substantial amounts of our common stock in the trading market could
adversely affect market prices.
19
The
resale in the public market of the shares underlying the Series A Preferred
Stock and Series A Warrants and Series B Warrants issued in the March 2008
private placement and of the shares acquired prior to the private placement may
cause the market value of our common stock to fall.
In
August 2009, we registered for resale 2,070,836 shares of our common stock by
certain selling stockholders. As of February 16, 2011, there were issued and
outstanding (i) 29,769,590 shares of common stock, (ii) 7,269,549 shares of
Series A Preferred Stock (convertible into 7,269,549 shares of common stock);
(iii) Series A Warrants to purchase 5,728,921 shares of common stock; and (iv)
Series B Warrants to purchase 5,722,843 shares of common stock. Assuming
conversion of all of the Series A Preferred Stock and exercise of all of the
Series A Warrants and Series B Warrants, there will be 48,490,903 shares of
common stock outstanding. Many of our shares, including all of the shares
underlying the Series A Preferred Stock, are currently eligible for resale under
Rule 144. As of the date of this prospectus the shares underlying the Series A
and Series B Warrants were eligible for resale under Rule 144.
Also, as
a result of our public offering of 6,900,000 shares of common stock, there is a
significant number of new shares of common stock in the market. Sales of
substantial amounts of common stock, or the perception that such sales could
occur under Rule 144 or otherwise, and the existence of warrants to purchase
shares of common stock at prices that may be below the then current market price
of the common stock, could reduce the market price of our common stock and could
impair our ability to raise capital through the sale of our equity
securities.
20
ABOUT
THIS PROSPECTUS
You
should rely only on the information contained in this prospectus. We have not
authorized anyone to provide you with any information or to make any
representations about us, the selling stockholders, the securities or any matter
discussed in this prospectus, other than the information and representations
contained in this prospectus. If any other information or representation is
given or made, such information or representation may not be relied upon as
having been authorized by us or any selling stockholder.
The
selling stockholders are offering to sell and seeking offers to buy shares of
our common stock including shares they may acquire on conversion of their Series
A Preferred Stock and exercise of their warrants, only in jurisdictions where
offers and sales are permitted. This prospectus does not constitute an offer to
sell or a solicitation of an offer to buy the securities in any circumstances
under which the offer or solicitation is unlawful.
The
information contained in this prospectus is accurate only as of the date of this
prospectus, regardless of the time of delivery of this prospectus or of any sale
of our common stock. Neither the delivery of this prospectus nor any
distribution of securities in accordance with this prospectus shall, under any
circumstances, imply that there has been no change in our affairs since the date
of this prospectus. The prospectus will be updated and updated prospectuses made
available for delivery to the extent required by the federal securities
laws.
21
CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS AND OTHER INFORMATION CONTAINED IN
THIS PROSPECTUS
This
prospectus contains some forward-looking statements. Forward-looking statements
give our current expectations or forecasts of future events. You can identify
these statements by the fact that they do not relate strictly to historical or
current facts. Forward-looking statements involve risks and uncertainties.
Forward-looking statements include statements regarding, among other things, (a)
our projected sales, profitability and cash flows, (b) our growth strategies,
(c) anticipated trends in our industries, (d) our future financing plans and (e)
our anticipated needs for working capital. They are generally identifiable by
use of the words “may,” “will,” “should,” “anticipate,” “estimate,” “plan,”
“potential,” “projects,” “continuing,” “ongoing,” “expects,” “management
believes,” “we believe,” “we intend” or the negative of these words or other
variations on these words or comparable terminology. These statements may be
found under “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and “Business,” as well as in this prospectus generally.
In particular, these include statements relating to future actions, future
performance, sales efforts, expenses, the outcome of contingencies such as legal
proceedings, and financial results.
Any or
all of our forward-looking statements in this prospectus may turn out to be
inaccurate. They can be affected by inaccurate assumptions we might make or by
known or unknown risks or uncertainties. Consequently, no forward-looking
statement can be guaranteed. Actual future results may vary materially as a
result of various factors, including, without limitation, the risks outlined
under “Risk Factors” and matters described in this prospectus generally. In
light of these risks and uncertainties, there can be no assurance that the
forward-looking statements contained in this filing will in fact occur and you
should not place undue reliance on these forward-looking
statements.
22
OTHER
REFERENCES
In
keeping with standard practice and the practice of the National Bureau of
Statistics of China, references to “northeastern China” are to the three
northeastern provinces of Heilongjiang, Jilin and Liaoning.
Source:
Society for Anglo-Chinese Understanding,
http://www.sacu.org/provmap.html
EXPLANATORY
NOTE
The
registration statement on Form S-1 of which this prospectus forms a part is
being filed by QKL Stores Inc., formerly known as Forme Capital, Inc., in order
to register shares of our common stock so that they may be sold to the public by
(i) investors who purchased them (or Series A Preferred Stock convertible into,
or Series A Warrants exercisable for, such shares) from us in connection with a
private placement transaction completed on March 28, 2008 and (ii) stockholders
who acquired their shares prior to the private placement. In the private
placement we sold to certain accredited investors, for gross proceeds to us of
$15.5 million, 9,117,647 units at a purchase price of $1.70 per unit, each unit
consisting of one share of Series A Preferred Stock (each of which is
convertible (subject to adjustment) into one share of our common stock), a 0.625
interest in a Series A Warrant and a 0.625 interest in a Series B Warrant. The
Series A Warrants have an exercise price of $3.40 per share (subject to
adjustment) and the Series B Warrants have an exercise price of $4.25 per share
(subject to adjustment). We received $13,523,530 as net proceeds from this
financing. In order to induce the investors in the private placement to purchase
our securities, we agreed to register their stock for resale with the SEC. We
have filed the registration statement of which this prospectus forms a part with
the SEC in order to meet our obligations under that agreement. At the same time
as the private placement transaction closed, we completed a separate
transaction, or set of transactions, through which we acquired control of an
operating company in China. We refer to this separate set of transactions as the
“reverse merger.” The closing of the private placement transaction was
conditioned on the closing of the reverse merger. Through the reverse merger, we
ceased to be a shell company as that term is defined in Rule 12b-2 under the
Securities Exchange Act of 1934 (the “Exchange Act”) and are now in the business
of operating supermarkets in northeastern China.
23
SELLING
STOCKHOLDERS
This
prospectus relates to the offer and sale of our common stock by the selling
stockholders identified in the table below.
As of
February 16, 2011, there were 29,769,590 shares of our common stock issued and
outstanding, of which 10,687,591 shares of our common stock comprise our public
float, which is the number of shares of common stock held by our non-affiliates.
Vision Opportunity China LP is offering to sell an aggregate of 2,303,110 shares
of our common stock pursuant to this prospectus, which constitutes 21.55% of our
public float. Hua-Mei 21Century Partners, LP is offering to sell an aggregate of
593,884 shares of our common stock pursuant to this prospectus, which
constitutes 5.56% of our public float. Guerrilla Partners, LP, an affiliate of
Hua-Mei, is offering to sell an aggregate of 248,658 shares of our common stock
pursuant to this prospectus, which constitutes 2.33% of our public float. All
together, Vision, Hua-Mei and Guerrilla are offering to sell an aggregate of
3,145,652 shares of our common stock, which constitutes 29.43% of our public
float.
Except
for John Kuhns and Mary Fellows, none of the selling stockholders is a broker
dealer or an affiliate of a broker dealer. John Kuhns and Mary Fellows received
the shares they are offering for resale as compensation. None of the Selling
Stockholders had any agreement or understanding, directly or indirectly, to
distribute any of the shares being registered at the time of
purchase.
Except as
set forth below, none of the selling stockholders has been an officer, director
or affiliate of the Company or any of its predecessors or affiliates within the
last three years, nor has any selling stockholder had a material relationship
with the Company. None of the selling stockholders is currently an officer,
director or affiliate of the Company.
§
|
Castle Bison, Inc., a selling
stockholder, is a California corporation owned and controlled by Raul
Silvestre. Mr. Silvestre was counsel to the Company from September 17,
2007 to March 28, 2008. On September 17, 2007, Castle Bison acquired its
shares of our common stock from Synergy Business Consulting pursuant to a
stock purchase agreement (“2007 Private Placement”) by and among the
Company, Synergy Business Consulting and Lomond International, Inc., as
agent for several buyers. Prior to March 28, 2008, Castle Bison owned
approximately 9.19% of our outstanding common stock, or 137,790 shares.
Therefore, Castle Bison could be deemed to have been our affiliate at that
time.
|
|
|
§
|
Windermere Insurance Company, a
selling stockholder, is a British Virgin Islands business development
company. John Scardino has sole voting and dispositive power over the
shares held by Windermere. Windermere acquired its shares of our common
stock in the 2007 Private Placement. Prior to March 28, 2008, Windermere
owned approximately 7.75% of our outstanding common stock, or 116,234
shares. Therefore, Windermere could be deemed to have been our affiliate
at that time.
|
|
|
§
|
Each of Benjamin Hill, Fink
Family Trust, Brandon Hill, Mark Bell M.D. Inc Retirement Trust, Larry
Chimerine, Irv Edwards M.D. Inc. Employee Retirement Trust, and Marie
Tillman acquired its shares of our common stock in the 2007 Private
Placement.
|
§
|
In December 2007, we issued
37,211 shares of our common stock to Menlo Venture Partners, LLC, as
repayment of a working capital advance in the amount of
$25,000.
|
§
|
In December 2007, Robert Scherne,
our former chief financial officer and director, acquired his shares of
our common stock as compensation for his
services.
|
|
|
§
|
Vision Opportunity China, LP, a
selling stockholder, purchased 600,000 shares of our common stock from
Stallion Ventures, Castle Bison and other affiliates on February 7, 2008,
becoming the holder of approximately 42% of Forme Capital’s then
outstanding stock. Therefore, Vision could be deemed to have been our
affiliate at that time. The 2,303,110 shares of common stock held by
Vision that are being registered in the registration statement of which
this prospectus forms a part were acquired in a private placement
completed on March 28, 2008.
|
|
|
§
|
The three selling stockholders
named above, namely Vision, Castle Bison, and Windermere, collectively
held approximately 85.2% of our common stock, or 1,204,024 shares, prior
to March 28, 2008, the date of the reverse merger
transaction.
|
|
|
§
|
Kuhns Brothers, Inc. entered into
a placement agent agreement with the QKL-China dated January 17, 2007.
QKL-China decided to terminate the placement agent agreement with Kuhns
Brothers, Inc. and entered into a settlement agreement dated January 22,
2008 with Kuhns Brothers to settle any and all claims Kuhns Brothers may
have under the placement agent agreement. Under the terms of the
settlement agreement, Kuhns Brothers received a placement agent fee of
$1,300,500 at the closing of the private placement transaction and also
received Series A Warrants to purchase 191,250 shares of common stock and
Series B Warrants to purchase 153,000 shares of common stock. Kuhns
Brothers transferred fifty percent of those warrants to Sam Shoen, Paul
Kuhns, John Kuhns, Mary Fellows, Jeff Triana and Jennifer Vuong, which
warrants were subsequently exercised in full for shares of common stock.
John Kuhns and Mary Fellows still own shares of common stock that are
included in the below table. Kuhns Brothers, Inc. is a licensed broker
dealer and John Kuhns and Mary Fellows are therefore affiliates of a
broker-dealer.
|
24
§
|
Yang Miao, Ying Zhang and Fang
Chen are the principals of Mass Harmony Asset Management (“Mass Harmony”).
On March 13, 2007, QKL-China entered into a Financial Consulting Agreement
(the “Mass Harmony Agreement”) with Mass Harmony under which Mass Harmony
agreed to perform certain financial services for QKL-China. QKL-China paid
Mass Harmony an aggregate of RMB 500,000 (approximately $70,000) and Mass
Harmony also received 299,999 shares of common stock, Series A Warrants to
purchase 91,176 shares of common stock, and Series B Warrants to purchase
72,941 shares of common stock. 6,000 shares of common stock, 30,392 shares
of common stock underlying Series A Warrants and 24,314 shares of common
stock underlying Series B Warrants that have not previously been disposed
of are being registered in this prospectus. On March 30, 2010, Ying Zhang
assigned her Series A Warrant to purchase 30,392 shares of common stock
and her Series B Warrant to purchase 24,314 shares of common stock to Roth
Capital Partners, a registered broker-dealer. Yang Miao and Fang Chen are
selling stockholders. Roth Capital Partners is not a selling
stockholder.
|
|
|
§
|
Pursuant to a Warrant Purchase
Agreement by and between Warberg Opportunistic Trading Fund, LP
(“Warberg”) and Straus-GEPT Partners, L.P. dated June 14, 2010, Warberg
acquired 147,059 Series B Warrants to purchase 147,059 shares of common
stock.
|
Each
selling stockholder may offer for sale all or part of its shares included in
this prospectus from time to time. The table below assumes that the selling
stockholders will sell all of the shares offered for sale. A selling stockholder
is under no obligation, however, to sell any shares pursuant to this
prospectus.
Other
than as described in this prospectus, we have not in the past three years
engaged in any securities transaction with any of the selling stockholders, any
affiliates of the selling stockholders or, after due inquiry and investigation,
to the knowledge of the management of the Company, any person with whom any
selling stockholder has a contractual relationship regarding the transaction (or
any predecessors of those persons).
Other
than as described in this Selling Stockholders section or in “Our History and
Corporate Structure”, we do not have any agreement or arrangement with any
selling stockholder with respect to the performance of any current or future
obligations.
25
Names of Selling
Stockholders
|
Number of
Shares of
Common
Stock, and
number of
shares of
Common Stock
underlying
Series A
Preferred
Stock, Series A
Warrants and
Series B
Warrants
owned
prior to
the
offering
|
Number (and
percent) of
shares of
Common
Stock, and number
of shares of
Common Stock
underlying
Series A
Preferred
Stock, Series A
Warrants and
Series B Warrants
beneficially
owned prior to the
offering (1)(2)
|
Maximum
number of
shares of
Common
Stock to be
sold in
offering
|
Number (and
percent) of
shares of
Common
Stock, and number
of shares of
Common Stock
underlying
Series A
Preferred
Stock, Series A
Warrants and
Series B Warrants
beneficially
owned after the
offering (1)(2)
|
||||||||||||
Stockholders
who Acquired their shares prior to Reverse Merger and Private
Placement
|
||||||||||||||||
Castle
Bison, Inc. (3)
|
137,790 | 137,790 | (*) | 137,790 | 0 | (*) | ||||||||||
Windermere
Insurance Company Ltd. (4)
|
115,234 | 115,234 | (*) | 115,234 | 0 | (*) | ||||||||||
Benjamin
Hill
|
12,915 | 12,915 | (*) | 12,915 | 0 | (*) | ||||||||||
Fink
Family Trust (5)
|
18,222 | 18,222 | (*) | 18,222 | 0 | (*) | ||||||||||
Brandon
Hill
|
7,749 | 7,749 | (*) | 7,749 | 0 | (*) | ||||||||||
Mark
Bell M.D. Inc. Retirement Trust (6)
|
9,687 | 9,687 | (*) | 9,687 | 0 | (*) | ||||||||||
Larry
Chimerine
|
19,372 | 19,372 | (*) | 19,372 | 0 | (*) | ||||||||||
Irv
Edwards M.D., Inc. Employee Retirement Trust (7)
|
9,687 | 9,687 | (*) | 9,687 | 0 | (*) | ||||||||||
Marie
Tillman
|
7,749 | 7,749 | (*) | 7,749 | 0 | (*) | ||||||||||
Robert
Scherne
|
17,000 | 17,000 | (*) | 17,000 | 0 | (*) | ||||||||||
Menlo
Venture Partners, LLC (8)
|
37,211 | 37,211 | (*) | 37,211 | 0 | (*) | ||||||||||
Investors
in Private Placement
|
||||||||||||||||
Vision
Opportunity China LP (9)
|
12,903,928 | 2,125,243 | (4.99)% | 2,303,110 | 2,125,243 | (4.99)% | ||||||||||
Guerrilla
Partners, LP (10)
|
1,335,329 | 1,335,329 | (4.29)% | 248,658 | 1,086,671 | (3.52)% | ||||||||||
Hua-Mei
21st
Century Partners, LP (10)
|
2,669,514 | 1,621,954 | (4.99)% | 593,884 | 1,621,954 | (4.99)% | ||||||||||
Straus
Partners, L.P. (11)
|
776,097 | 776,097 | (2.57)% | 776,097 | 0 | (*) | ||||||||||
GB
Global Private Balanced Fund I (12)
|
661,764 | 661,764 | (2.17)% | 661,764 | 0 | (*) | ||||||||||
China
Private Equity Partners Co., Limited (12)
|
529,412 | 529,412 | (1.75)% | 529,412 | 0 | (*) | ||||||||||
James
Fuld, Jr. (13)
|
154,740 | 154,740 | (*) | 154,740 | 0 | (*) | ||||||||||
Placement
Agent’s designees
|
||||||||||||||||
John
Kuhns (14) (15)
|
28,828 | 28,828 | (*) | 28,828 | 0 | (*) | ||||||||||
Mary
Fellows (14) (15)
|
28,828 | 28,828 | (*) | 28,828 | 0 | (*) | ||||||||||
Consultants
and transferees
|
||||||||||||||||
Yang
Miao (16)
|
6,000 | 6,000 | (*) | 6,000 | 0 | (*) | ||||||||||
Fang
Chen (16)
|
54,706 | 54,706 | (*) | 54,706 | 0 | (*) | ||||||||||
Other
Investors
|
||||||||||||||||
Warberg
Opportunistic Trading Fund, LP (17)
|
147,059 | 147,059 | (*) | 147,059 | 0 | (*) | ||||||||||
Total
|
19,688,821 | 7,862,576 | 5,925,702 | 4,833,868 |
* Less
than 1%.
(1)
|
Under applicable SEC rules, a
person is deemed to beneficially own securities which the person as the
right to acquire within 60 days through the exercise of any option or
warrant or through the conversion of a convertible security. Also under
applicable SEC rules, a person is deemed to be the “beneficial owner” of a
security with regard to which the person directly or indirectly, has or
shares (a) voting power, which includes the power to vote or direct the
voting of the security, or (b) investment power, which includes the power
to dispose, or direct the disposition, of the security, in each case,
irrespective of the person’s economic interest in the security. Each
listed selling stockholder has the sole investment and voting power with
respect to all shares of common stock shown as beneficially owned by such
selling stockholder, except as otherwise indicated in the footnotes to the
table.
|
26
(2)
|
As of February 16, 2011 there
were 29,769,590 shares of our common stock issued and outstanding. In
determining the percent of common stock beneficially owned by a selling
stockholder on February 16, 2011 (a) the numerator is the number of shares
of common stock beneficially owned by such selling stockholder (including
shares that he has the right to acquire within 60 days of February 16,
2011), and (b) the denominator is the sum of (i) the 29,769,590 shares
outstanding on February 16, 2011 and (ii) the number of shares of common
stock which such selling stockholder has the right to acquire within 60
days of February 16,
2011.
|
|
|
(3)
|
Raul Silvestre, the President of
Castle Bison, Inc. has sole voting and dispositive power over the
shares.
|
|
|
(4)
|
John Scardino has sole voting and
dispositive power over the shares held by
Windermere.
|
|
|
(5)
|
Marvin Fink has sole voting and
dispositive power over the shares held by the Fink Family
Trust.
|
|
|
(6)
|
Mark Bell has sole voting and
dispositive power over the shares held by the Mark Bell M.D. Inc.
Retirement Trust.
|
|
|
(7)
|
Irv Edwards has sole voting and
dispositive power over the shares held by the Irv Edwards M.D., Inc.
Employee Retirement Trust.
|
|
|
(8)
|
Mr. Ariel Coro has sole voting
and dispositive power of the
shares.
|
|
|
(9)
|
The securities to be offered
by Vision consist of 458,544 shares of common stock issuable upon the
conversion of Series A Preferred Stock that were previously included on
our registration statement on Form S-1 (file no. 333-150800) and 1,844,566
shares of common stock issuable upon the exercise of 1,844,566 Series A
Warrants. Vision acquired 600,000 shares of our common stock in February
2008 in a private sale of stock by its prior holders, of which it still
holds 34,620 shares, and 500,000 shares of our common stock upon
conversion of 500,000 shares of Series A Preferred Stock, of which it
still holds 134,013 shares. In addition Vision acquired in the March 28,
2008 private placement (i) 5,882,353 shares of Series A Preferred Stock,
of which Vision still holds 5,382,353 shares as of February 16, 2011 that
are convertible into 5,382,353 shares of common stock, (ii) Series A
Warrants which as of February 16, 2011 are exercisable for 3,676,471
shares of common stock and (iii) Series B Warrants which as of February
16, 2011 are exercisable for 3,676,471 shares of common stock. Under the
securities purchase agreement at no time may a purchaser of Series A
Preferred Stock convert such purchaser’s shares into shares of our common
stock if the conversion would result in such purchaser beneficially owning
(as determined in accordance with Section 13(d) of the Exchange Act and
the rules thereunder) more than 4.99% of our then issued and outstanding
shares of common stock; provided, however, that upon a purchaser providing
us with sixty-one days’ notice that such purchaser wishes to waive the
cap, then the cap will be of no force or effect with regard to all or a
portion of the preferred shares referenced in the waiver notice. Similarly
under the terms of the Series A Warrants and the Series B Warrants, at no
time may a holder exercise a warrant if the exercise would result in such
holder beneficially owning (as determined in accordance with Section 13(d)
of the Exchange Act and the rules thereunder) more than 4.99% of our then
issued and outstanding shares of common stock; provided, however, that
upon a purchaser providing us with sixty-one days’ notice that such
purchaser wishes to waive the cap, then the cap will be of no force or
effect with regard to all or a portion of the shares referenced in the
waiver notice. In the absence of the 4.99% beneficial ownership limitation
Vision would be the beneficial owner of 12,903,928 shares of common stock,
or 30.36%. The 4.99% beneficial ownership limitation does not prevent a
stockholder from selling some of its holdings and then receiving
additional shares. Accordingly, Vision could exercise and sell more than
4.99% of our common stock without ever at any one time holding more than
this limit. Adam Benowitz has sole voting power and sole dispositive power
over the shares.
|
27
(10)
|
The securities to be offered
by Guerrilla consist of 45,771 shares of common stock issuable upon the
conversion of Series A Preferred Stock that were previously included on
our registration statement on Form S-1 (file no. 333-150800) and 202,887
shares of common stock issuable upon the exercise of 202,887 Series A
Warrants. The securities to be offered by Hua-Mei consist of 95,703 shares
of common stock issuable upon the conversion of Series A Preferred Stock
that were previously included on our registration statement on Form S-1
(file no. 333-150800) and 498,181 shares of common stock issuable upon the
exercise of 498,181 Series A Warrants. Guerrilla acquired in the March 28,
2008 private placement (i) 647,059 shares of Series A Preferred Stock, of
which Guerrilla still holds 526,505 shares as of February 16, 2011 that
are convertible into 526,505 shares of common stock, (ii) Series A
Warrants which as of February 16, 2011 are exercisable for 404,412 shares
of common stock and (iii) Series B Warrants which as of February 16, 2011
are exercisable for 404,412 shares of common stock. Hua-Mei, Guerrilla’s
affiliate, acquired in the March 28, 2008 private placement; (i) 1,352,941
shares of Series A Preferred Stock, of which Hua-Mei still holds 831,279
shares as of February 16, 2011 that are convertible into 831,279 shares of
common stock, (ii) Series A Warrants which as of February 16, 2011 are
exercisable for 992,647 shares of common stock and (iii) Series B Warrants
which as of February 16, 2011 are exercisable for 845,588 shares of common
stock. Pursuant to a Warrant Purchase Agreement by and between Hua-Mei and
Straus-GEPT Partners, L.P. dated June 30, 2010, Hua-Mei acquired 147,059
Series A Warrants to purchase 147,059 shares of common stock. Under the
securities purchase agreement executed in connection with the March 28,
2008 private placement, at no time may a purchaser of Series A Preferred
Stock convert such purchaser’s shares into shares of our common stock if
the conversion would result in such purchaser beneficially owning (as
determined in accordance with Section 13(d) of the Exchange Act and the
rules thereunder) more than 4.99% of our then issued and outstanding
shares of common stock; provided, however, that upon a purchaser providing
us with sixty-one days’ notice that such purchaser wishes to waive the
cap, then the cap will be of no force or effect with regard to all or a
portion of the preferred shares referenced in the waiver notice. Similarly
under the terms of the Series A Warrants and the Series B Warrants, at no
time may a holder exercise a warrant if the exercise would result in such
holder beneficially owning (as determined in accordance with Section 13(d)
of the Exchange Act and the rules thereunder) more than 4.99% of our then
issued and outstanding shares of common stock; provided, however, that
upon a purchaser providing us with sixty-one days’ notice that such
purchaser wishes to waive the cap, then the cap will be of no force or
effect with regard to all or a portion of the shares referenced in the
waiver notice. Guerrilla would be the beneficial owner of 1,335,329 shares
of our common stock, or 4.29% computed in accordance with Section 13(d) of
the Exchange Act and the rules thereunder. In the absence of the 4.99%
beneficial ownership limitation Hua-Mei would be deemed to the beneficial
owner of 2,669,514 shares of our common stock, or 8.23% computed in
accordance with Section 13(d) of the Exchange Act and the rules
thereunder. The 4.99% beneficial ownership limitation does not prevent a
stockholder from selling some of its holdings and then receiving
additional shares. Accordingly, each stockholder could exercise and sell
more than 4.99% of our common stock without ever at any one time holding
more than this limit. Peter Siris and Leigh S. Curry have shared voting
power and dispositive power with respect to the shares held by Guerrilla
and Hua-Mei.
|
|
|
(11)
|
The securities to be offered
consist of securities acquired by Straus Partners L.P. (“Straus”) in the
March 28, 2008 private placement (i) Series A Preferred Stock which as of
February 16, 2011 had been converted into 352,941 shares of common stock,
of which Straus still holds 334,921 shares, (ii) Series A Warrants which
as of February 16, 2011 are exercisable for 220,588 shares of common stock
and (iii) Series B Warrants which as of February 16, 2011 are exercisable
for 220,588 shares of common stock. Melville Straus, the principal of
Straus Partners LP, has the sole voting and dispositive power over the
shares beneficially owned by Straus Partners
LP.
|
|
|
(12)
|
The securities to be offered
consist of securities acquired by GB Global Private Balanced Fund I in the
March 28, 2008 private placement (i) Series A Preferred Stock which as of
February 16, 2011 are convertible into 294,118 shares of common stock,
(ii) Series A Warrants which as of February 16, 2011 are exercisable for
183,823 shares of common stock and (iii) Series B Warrants which as of
February 16, 2011 are exercisable for 183,823 shares of common stock.
China Private Equity Partners, Co., Limited, its affiliate, acquired in
the March 28, 2008 private placement (i) Series A Preferred Stock which as
of February 16, 2011 are convertible into 235,294 shares of common stock,
(ii) Series A Warrants which as of February 16, 2011 are exercisable for
147,059 shares of common stock and (iii) Series B Warrants which as of
February 16, 2011 are exercisable for 147,059 shares of common stock.
Edward James Hahn has the sole voting and dispositive power over the
shares beneficially owned by each of these
funds.
|
|
|
(13)
|
The securities to be offered
consist of securities acquired by James Fuld, Jr. in the March 28, 2008
private placement (i) 117,647 shares of Series A Preferred Stock which as
of February 16, 2011 had been converted into 117,647 shares of common
stock, of which Mr. Fuld still holds 7,682 shares of common stock, (ii)
Series A Warrants which as of February 16, 2011 are exercisable for 73,529
shares of common stock, and (iii) Series B Warrants which as of February
16, 2011 are exercisable for 73,529 shares of common
stock.
|
|
|
(14)
|
Kuhns Brothers, Inc. is a
licensed broker dealer. John Kuhns has sole voting and dispositive power
over the shares held by John Kuhns and Mary Fellows who are affiliated
with Kuhns Brothers.
|
|
|
(15)
|
Kuhns Brothers, Inc., an
affiliate of a selling stockholder and a corporation controlled by John
Kuhns, a selling stockholder, entered into a placement agent agreement
with the Company dated January 17, 2007 and a settlement agreement with
QKL-China dated January 22, 2008. Under the terms of the placement
agreement and settlement agreement Kuhns Brothers received a placement
agent fee of $1,300,500 at the closing of the private placement
transaction and Series A Warrants to purchase 191,250 shares of common
stock and Series B Warrants to purchase 153,000 shares of common stock.
Kuhns Brothers transferred fifty percent of those warrants to Sam Shoen,
Paul Kuhns, John Kuhns, Mary Fellows, Jeff Triana and Jennifer Vuong,
which warrants were subsequently exercised in full for shares of common
stock. John Kuhns and Mary Fellows still own shares of common stock that
are included in the above
table.
|
28
(16)
|
Yang Miao, Ying Zhang and Fang
Chen are the principals of Mass Harmony Asset Management (“Mass Harmony”).
On March 13, 2007, QKL-China entered into a Financial Consulting Agreement
(the “Mass Harmony Agreement”) with Mass Harmony under which Mass Harmony
agreed to perform certain financial services to QKL-China. QKL-China paid
Mass Harmony an aggregate of RMB 500,000 (approximately $70,000) and Mass
Harmony also received 299,999 shares of common stock, Series A Warrants to
purchase 91,176 shares of common stock, and Series B Warrants to purchase
72,941 shares of common stock. Each of Yang Miao and Fang Chen received
100,000 shares of common stock, Series A Warrants to purchase 30,392
shares of common stock and Series B Warrants to purchase 24,314 shares of
common stock. Ying Zhang received 99,999 shares of common stock, Series A
Warrants to purchase 30,392 shares of common stock and Series B Warrants
to purchase 24,314 shares of common stock. Yang Miao exercised his
warrants in full on a cashless basis, for which he received 14,808 shares
of common stock. Yang Miao disposed of 99,998 shares of common stock, and
currently holds 6,000 shares of common stock. 6,018 of the shares disposed
of by Yang Miao were sold pursuant to our registration statement on Form
S-1 (file no. 333-150800). 102,792 of the shares disposed of by Yang Miao
were sold pursuant to Rule 144 promulgated under the Securities Act of
1933, as amended. On March 30, 2010, Ying Zhang assigned her Series A
Warrant to purchase 30,392 shares of common stock and her Series B Warrant
to purchase 24,314 shares of common stock to Roth Capital Partners, a
registered broker-dealer. Roth Capital is not a selling stockholder. Ying
Zhang sold the shares of common stock she acquired in connection with the
Financial Consulting Agreement pursuant to our registration statement on
Form S-1 (file no. 333-150800). Fang Chen sold all of the shares of common
stock he acquired in connection with the Financial Consulting Agreement
pursuant to our registration statement on Form S-1 (file no. 333-150800),
but still holds the Series A Warrants and Series B Warrants. Yang Miao and
Fang Chen are selling
stockholders.
|
(17)
|
Pursuant to a Warrant Purchase
Agreement by and between Warberg Opportunistic Trading Fund, LP
(“Warberg”) and Straus-GEPT Partners, L.P. dated June 14, 2010, Warberg
acquired 147,059 Series B Warrants to purchase 147,059 shares of common
stock. Warberg Asset Management LLC (“WAM”) is the general partner of
Warberg. The managers of WAM are Daniel Warsh and Jonathan Blumberg. Each
of WAM and its manager(s) disclaims beneficial ownership of the
securities, other than to the extent, if any, of its or his pecuniary
interest therein.
|
29
PLAN
OF DISTRIBUTION
The
selling security holders and any of their pledgees, donees, assignees and
successors-in-interest may, from time to time, sell any or all of their shares
of common stock being offered under this prospectus on any stock exchange,
market or trading facility on which shares of our common stock are traded or in
private transactions. These sales may be at fixed or negotiated prices. The
selling security holders may use any one or more of the following methods when
disposing of shares:
§
|
ordinary brokerage transactions
and transactions in which the broker-dealer solicits
purchasers;
|
|
|
§
|
block trades in which the
broker-dealer will attempt to sell the shares as agent but may position
and resell a portion of the block as principal to facilitate the
transaction;
|
|
|
§
|
purchases by a broker-dealer as
principal and resales by the broker-dealer for its
account;
|
|
|
§
|
an exchange distribution in
accordance with the rules of the applicable
exchange;
|
|
|
§
|
privately negotiated
transactions;
|
|
|
§
|
to cover short sales made after
the date that the registration statement of which this prospectus is a
part is declared effective by the
Commission;
|
|
|
§
|
broker-dealers may agree with the
selling security holders to sell a specified number of such shares at a
stipulated price per share;
|
|
|
§
|
a combination of any of these
methods of sale; and
|
|
|
§
|
any other method permitted
pursuant to applicable law.
|
The
shares may also be sold under Rule 144 under the Securities Act of 1933, if
available, rather than under this prospectus. The selling security holders have
the sole and absolute discretion not to accept any purchase offer or make any
sale of shares if they deem the purchase price to be unsatisfactory at any
particular time.
The
selling security holders may pledge their shares to their brokers under the
margin provisions of customer agreements. If a selling security holder defaults
on a margin loan, the broker may, from time to time, offer and sell the pledged
shares.
Broker-dealers
engaged by the selling security holders may arrange for other broker-dealers to
participate in sales. Broker-dealers may receive commissions or discounts from
the selling security holders (or, if any broker-dealer acts as agent for the
purchaser of shares, from the purchaser) in amounts to be negotiated, which
commissions as to a particular broker or dealer may be in excess of customary
commissions to the extent permitted by applicable law.
If sales
of shares offered under this prospectus are made to broker-dealers as
principals, we would be required to file a post-effective amendment to the
registration statement of which this prospectus is a part. In the post-effective
amendment, we would be required to disclose the names of any participating
broker-dealers and the compensation arrangements relating to such
sales.
The
selling security holders and any broker-dealers or agents that are involved in
selling the shares offered under this prospectus may be deemed to be
“underwriters” within the meaning of the Securities Act in connection with these
sales. Commissions received by these broker-dealers or agents and any profit on
the resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act. Any broker-dealers or agents
that are deemed to be underwriters may not sell shares offered under this
prospectus unless and until we set forth the names of the underwriters and the
material details of their underwriting arrangements in a supplement to this
prospectus or, if required, in a replacement prospectus included in a
post-effective amendment to the registration statement of which this prospectus
is a part.
Except
for John Kuhns and Mary Fellows, none of the selling stockholders is a broker
dealer or an affiliate of a broker dealer. John Kuhns and Mary Fellows received
the shares they are offering for resale as compensation.
30
The
selling security holders and any other persons participating in the sale or
distribution of the shares offered under this prospectus will be subject to
applicable provisions of the Exchange Act, and the rules and regulations under
that act, including Regulation M. These provisions may restrict activities of,
and limit the timing of purchases and sales of any of the shares by, the selling
security holders or any other person. Furthermore, under Regulation M, persons
engaged in a distribution of securities are prohibited from simultaneously
engaging in market making and other activities with respect to those securities
for a specified period of time prior to the commencement of such distributions,
subject to specified exceptions or exemptions. All of these limitations may
affect the marketability of the shares.
If any of
the shares of common stock offered for sale pursuant to this prospectus are
transferred other than pursuant to a sale under this prospectus, then subsequent
holders could not use this prospectus until a post-effective amendment or
prospectus supplement is filed, naming such holders. We offer no assurance as to
whether any of the selling security holders will sell all or any portion of the
shares offered under this prospectus.
We
have agreed to pay all fees and expenses we incur incident to the registration
of the shares being offered under this prospectus (estimated to be approximately
$55,230). However, each selling security holder and purchaser is responsible for
paying any discounts, commissions and similar selling expenses they
incur.
We and
the selling security holders have agreed to indemnify one another against
certain losses, damages and liabilities arising in connection with this
prospectus, including liabilities under the Securities Act.
USE
OF PROCEEDS
We will
not receive any of the proceeds from any sale of shares by the selling
stockholders. To the extent the warrants are exercised for cash, we will receive
the exercise price for those warrants. Under the terms of the warrants, cashless
exercise is permitted, but only after September 28, 2009 and then only if the
underlying shares have not been registered. We intend to use any cash proceeds
received from the exercise of the warrants for working capital and other general
corporate purposes. We cannot assure you that any of the warrants will ever be
exercised for cash or at all.
31
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Throughout
this section, our fiscal years ended December 31, 2009 and December 31, 2008 are
referred to as fiscal 2009 and 2008, respectively. The following management’s
discussion and analysis should be read in conjunction with our financial
statements and the notes thereto and the other financial information appearing
elsewhere in this report. In addition to historical information, the following
discussion contains certain forward-looking information. See “Special Note
Regarding Forward Looking Statements” above for certain information concerning
those forward looking statements.
Overview
We are
a regional supermarket chain that currently operates 45 supermarkets and 3
department stores in northeastern China and Inner Mongolia. Our supermarkets
sell a broad selection of merchandise including groceries, fresh food and
non-food items. We have 2 distribution centers servicing our supermarkets, one
for fresh food and another for grocery and non-food
merchandise.
We
believe that we are the first supermarket chain in northeastern China and Inner
Mongolia that is a licensee of the Independent Grocers Alliance, or IGA, a
United States-based global grocery network with aggregate retail sales of more
than $21.0 billion per year. As a licensee of IGA, we are able to engage in
group bargaining with suppliers and have access to more than 2,000 private IGA
brands, including many that are exclusive IGA brands.
Our
expansion strategy emphasizes growth through geographic expansion in
northeastern China and Inner Mongolia, where we believe local populations can
support profitable supermarket operations, and where we believe competition from
large foreign and national supermarket chains, which generally have resources
far greater than ours, is limited. Our strategies for profitable operations
include buy-side initiatives to reduce supply costs; focusing on merchandise
with higher margins, such as foods we prepare ourselves and private label
merchandise; and increasing reliance on the benefits of membership in the
international trade group IGA.
We
completed the initial steps in the execution of our expansion plan in March
2008, when we raised financing through the combination of our reverse merger and
private placement. Under that plan, we opened 7 new stores in 2009 that have, in
the aggregate, approximately 32,000 square meters of space and 10 new stores in
2008 that have, in the aggregate, approximately 42,000 square meters of space. 6
stores opened in 2008 were opened by us and 4 of the new stores were opened
through the acquisition of existing businesses by us. We opened 4 new stores in
the first nine months of 2010 that have, in the aggregate, approximately 34,600
square meters of space, and closed 2 stores due to the expiration of lease
contract in the second quarter and the third quarter respectively. Since our
distribution center in Harbin that has approximately 19,600 square meters of
space was put into operation in the second quarter of 2010, we closed one
distribution center in Daqing City which had been servicing our stores with
groceries and non-food merchandise over the last few years. In the last quarter
of 2010, we plan to open additional hypermarkets, supermarkets and department
stores having, in the aggregate, approximately 50,000 square meters of space. We
are also making improvements to our logistics and information systems to support
our supermarkets. We expect to finance our expansion plan from funds generated
from operations, bank loans and proceeds from our fourth quarter 2009 public
offering. Our long-term target is to open more than 200 stores over the next
four to five years, including hypermarkets, supermarkets and department
stores.
Our
Operations in China
Our
headquarters and all of our stores are located in the provinces of northeastern
China and Inner Mongolia. The economy of this area has grown rapidly over the
last four to five years and we believe that the national government is committed
to enhancing economic growth in the region. In December 2003, a major
economic-development plan for northeastern China, the “Plan for Revitalizing
Northeast China,” was announced by an office of the national government’s State
Council.
32
Based on
our own research, we believe there are approximately 200 to 300 small and
medium-sized cities in northeast China without modern supermarket chains. 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 as the
region continues to experience urbanization.
Our
Strategy for Growth and Profitability
Our
strategic plan includes the following principal components: expanding by opening
stores in new strategic locations, improving profitability by decreasing the
cost through origin sourcing, setting up distribution centers and increasing the
percentage of our sales attributable to private label merchandise, membership
sales and gift card sales.
Expanded
Operations
As of
September 30, 2010, we operated 35 supermarkets, 3 department stores, 2
distribution centers, one for non-fresh merchandise and another for fresh food.
Under our expansion plan, we opened 3 supermarkets and 1 department store in the
first nine months of 2010 that have, in the aggregate, approximately 34,600
square meters of space, and closed 2 stores due to the expiration of lease
contracts, one in the second quarter and one in the third quarter. Since our
distribution center in Harbin that has approximately 19,600 square meters of
space was put into operation in the second quarter of 2010, we closed one
distribution center in Daqing City which had been servicing our stores with
groceries and non-food merchandise over the last few years. In the last quarter
of 2010, we plan to open 6 hypermarkets and 1 department store having, in the
aggregate, approximately 50,000 square meters of retail space. These stores will
be opened or acquired by us. We are also making improvements to our logistics
and information systems to support our supermarkets. We expect to finance our
expansion plan from funds generated from operations, bank loans and proceeds
from our public offering which closed in November 2009. Based on our previous
experience, we believe it takes three to six months for a new store to achieve
profitability.
Private
Label Merchandise
Some of
the merchandise we sell is made to our specifications by manufacturers using the
QKL brand name. We refer to such merchandise as “private label” merchandise.
With private label merchandise, we entrust the manufacturer to make the product
and to select the name and design. Under our agreements with the private label
manufacturer, the private label manufacturer cannot sell the private label
merchandise to any other party. Sales of private label merchandise accounted for
approximately 5% of our total revenues for the nine months ended September 30,
2010 and 2009. In June 2008, we established a specialized department for
designing and purchasing private label merchandise, in which 8 full-time
employees currently work. Our goal is to increase private label sales to 20% of
our total revenues in the near future.
Principal
Factors Affecting Our Results
The
following factors have had, and we expect they will continue to have, a
significant effect on our business, financial condition and results of
operations.
Seasonality
– Our business is subject to seasonality, with increased sales in the first
quarter and fourth quarter, due to increases in shopping and consumer activity
as a result of the holidays such as New Year (January 1), Chinese Lunar New Year
(January or February), the Dragon Festival (February 2), Women’s Day (March 8),
the Back to School Day (March 1), National Day (October 1), Mid-Autumn Festival
(September or October) and Christmas (December 25).
33
Timing of New
Store Openings – Growth through new store openings is a fundamental part
of our strategy. Our new stores typically operate at a loss for approximately
three months due to start-up inventory and other costs, promotional discounts
and other marketing costs and strategies associated with new store openings,
rental expenses and costs related to hiring and training new employees. Our
operating results, and in particular our gross margin, have and will continue to
vary based in part on the pace of our new store openings.
Locations for New
Stores – Good commercial space that meets our standards, in locations
that meet our needs, may be scarce in some of the cities we wish to enter. One
option for entering certain target markets within our intended timeframe may be
to begin operations in a location that is not optimal and wait for an
opportunity to move to a better location. Alternatively, we may seek to enter
into a target market through acquisitions. As such, the timing and costs
associated with entry into new markets can be difficult to predict. Identifying
and pursuing opportunities will be a resource-intensive challenge, and if we do
not perform or if actual costs of entering new markets exceed our expectations,
our total revenues, cash flows, and liquidity could suffer.
Logistics of
Geographic Expansion – Opening additional stores in cities further from
our headquarters in Daqing will mean that the transportation of our supplies and
personnel among our stores will become more difficult and subject to disruption.
To alleviate this, we expanded our distribution capabilities by opening a new
distribution center in Harbin in the 2nd quarter of 2010. We have been using our
regional purchasing systems since 2008. All fresh food is ordered by individual
stores based on their needs from local vendors designated by our headquarters or
regional purchasing department and is delivered directly by the local vendors to
individual stores. A portion of our non-perishable food and non-food items are
distributed from our distribution center to our different stores, and the
remaining portion 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 in the winter as the roads can be covered with
snow. As we expand in territories further from our existing or planned
distribution facilities, the costs of delivering food and merchandise may become
less predictable and more volatile.
Hiring –
In our experience, it takes approximately three months to train new employees to
operate a new store. Training and supervision is organized by experienced
teachers in our training school. The management team for a new store is hired
first and is trained in our training school, where they learn 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 the employees and
management team members 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.
Shortages of
Trained Staff in Our New Locations – Opening stores in locations with
little or no competition from other large supermarkets is a major part of our
strategy. However, there are disadvantages to this approach, which relate to
hiring. Where competitors operate supermarkets nearby, their trained staff is a
potential source for our own hiring 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 our headquarters or other stores to new stores to provide assistance. This
increases our cost of operating and decreases our gross margin.
Critical
Accounting Policies and Estimates
Our
critical accounting estimates are included in our significant accounting
policies as described in Note 2 of the consolidated financial statements
included in this prospectus. Those consolidated financial statements were
prepared in accordance with GAAP. Critical accounting estimates are those that
we believe are most important to the portrayal of our financial condition and
results of operations. The preparation of our consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenue and expense. Our estimates are evaluated on an
ongoing basis and drawn from historical experience, current trends and other
factors that management believes to be relevant at the time our consolidated
financial statements are prepared. Actual results may differ from our estimates.
Management believes that the following accounting estimates reflect the more
significant judgments and estimates we use in preparing our consolidated
financial statements.
Revenue
Recognition
We earn
revenue by selling merchandise primarily through our retail stores. Revenue is
recognized when merchandise is purchased by and delivered to the customer and is
shown net of estimated returns during the relevant period. The allowance for
sales returns is estimated based upon historical experience.
Cash
received from the sale of cash card (aka “gift card”) is recorded as a
liability, and revenue is recognized upon the redemption of the cash card or
when it is determined that the likelihood of redemption is remote (“cash card
breakage”) and no liability to relevant jurisdictions exists. We determine the
cash card breakage rate based upon historical redemption patterns and recognizes
cash card breakage on a straight-line basis over the estimated cash card
redemption period.
34
We record
sales tax collected from our customers on a net basis, and therefore excludes it
from revenue as defined in ASC 605, Revenue Recognition.
Included
in revenue are sales of returned merchandise to vendors specializing in the
resale of defective or used products, which accounted for less than 0.5% of net
sales in each of the periods reported.
Inventories
Inventories
primarily consist of merchandise inventories and are stated at lower of cost or
market and net realizable value. Cost of inventories is calculated on the
weighted average basis which approximates cost.
Management
regularly reviews inventories and records valuation reserves for damaged and
defective returns, inventories with slow-moving or obsolescence exposure and
inventories with carrying value that exceeds market value. Because of its
product mix, we have not historically experienced significant occurrences of
obsolescence.
Inventory
shrinkage is accrued as a percentage of revenues based on historical inventory
shrinkage trends. The Company performs physical inventory counts of its stores
once per quarter and cycle counts inventories at its distribution center once
per quarter. The reserve for inventory shrinkage represents an estimate for
inventory shrinkage for each store since the last physical inventory date
through the reporting date.
These
reserves are estimates, which could vary significantly, either favorably or
unfavorably, from actual results if future economic conditions, consumer demand
and competitive environments differ from expectations.
Long-lived
Assets
We review
long-lived assets for impairment annually or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable.
Long-lived
assets are reviewed for recoverability at the lowest level in which there are
identifiable cash flows, usually at the store level. The carrying amount of a
long-lived asset is not considered recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use of the asset. If the
asset is determined not to be recoverable, it is considered to be impaired and
the impairment to be recognized is the amount by which the carrying amount of
the asset exceeds the fair value of the asset, determined using discounted cash
flow valuation techniques, as defined in ASC 360, Property, Plant, and
Equipment.
We
determined the sum of the undiscounted cash flows expected to result from the
use of the asset by projecting future revenue and operating expense for each
store under consideration for impairment. The estimates of future cash flows
involve management judgment and are based upon assumptions about expected future
operating performance. The actual cash flows could differ from management’s
estimates due to changes in business conditions, operating performance and
economic conditions.
Recently
Issued Accounting Guidance
See Note
2 to consolidated financial statements included elsewhere in this
report.
Results
of Operations
Nine
months ended September 30, 2010 compared with Nine months ended September 30,
2009
The
following table sets forth selected items from our condensed consolidated
statements of income by dollar and as a percentage of our net sales for the
periods indicated:
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Nine Months Ended
|
Nine Months Ended
|
|||||||||||||||
September 30, 2010
|
September 30, 2009
|
|||||||||||||||
Amount
|
% of
Net Sales
|
Amount
|
% of
Net Sales
|
|||||||||||||
Net
sales
|
$ | 212,575,456 | 100.0 | % | $ | 174,410,057 | 100.0 | % | ||||||||
Cost
of sales
|
175,160,430 | 82.4 | 143,823,125 | 82.5 | ||||||||||||
Gross
profit
|
37,415,026 | 17.6 | 30,586,932 | 17.5 | ||||||||||||
Selling
expenses
|
21,801,656 | 10.3 | 16,255,898 | 9.3 | ||||||||||||
General
and administrative expenses
|
6,022,119 | 2.8 | 3,217,258 | 1.8 | ||||||||||||
Operating
income
|
9,591,251 | 4.5 | 11,113,776 | 6.4 | ||||||||||||
Other
expenses
|
- | - | - | - | ||||||||||||
Changes
in fair value of warrants
|
7,801,649 | 3.7 | (45,050,638 | ) | (25.8 | ) | ||||||||||
Interest
income
|
510,215 | 0.2 | 188,448 | 0.1 | ||||||||||||
Interest
expense
|
10,416 | - | 20,800 | - | ||||||||||||
Income
(loss) before income taxes
|
17,892,699 | 8.4 | (33,769,214 | ) | (19.4 | ) | ||||||||||
Income
taxes
|
2,865,614 | 1.3 | 2,986,599 | 1.7 | ||||||||||||
Net
income (loss)
|
$ | 15,027,085 | 7.1 | % | $ | (36,755,813 | ) | (21.1 | )% |
Net Sales
– Net sales increased by $38.2 million, or 21.9%, to $212.6 million for the nine
months ended September 30, 2010 from $174.4 million for the nine months ended
September 30, 2009. The change in net sales was primarily attributable to the
following:
|
●
|
Same store sales represents sales
from stores that were opened for at least one year before the beginning of
the comparison period, or by January 1, 2009. Same store (30 stores) sales
generated approximately $189.6 million sales in the first nine months of
2010, an increase of $15.2 million, or 8.7% compared with $174.4 million
net sales in the first nine months of
2009.
|
35
|
●
|
New store sales increased,
reflecting the opening of 8 new stores since July 1, 2009. These 8 stores
generated approximately $23.0 million sales in the first nine months of
2010 compared to $42,923 in the first nine months of
2009.
|
|
●
|
The number of stores including
supermarket/hypermarket and department stores at September 30, 2010 was 38
versus 33 at September 30,
2009.
|
Cost of Sales
– Our cost of sales for the nine months ended September 30, 2010 was
approximately $175.2 million, representing an increase of $31.3 million, or
21.8%, from approximately $143.8 million for the same period in 2009. The
increase was due to the increase in volume of sales. Our cost of sales primarily
consists of the cost for our merchandise; it also includes costs related to
packaging and shipping and the distribution center costs.
Gross
Profit – Gross profit, or total revenue minus cost of sales, increased by
$6.8 million, or 22.3%, to $37.4 million, or 17.6% of net sales, in the first
nine months of 2010 from $30.6 million, or 17.5% of net sales, in the first nine
months of 2009. The change in gross profit was primarily attributable to net
sales that increased by $38.2 million in the first nine months of 2010 compared
to the first nine months of 2009.
Selling
Expenses – Selling expenses increased by $5.5 million, or 34.1%, to $21.8
million, or 10.3% of net sales, in the first nine months of 2010 from $16.3
million or 9.3% of net sales in the first nine months of 2009. The change in
selling expense was mainly due to increase in labor costs, depreciation, rent
expense, and utilities and other operating costs in the nine months ended
September 30, 2010 compared to same period in 2009 primarily due to support of
an increase in store count. In specific, labor costs increased by $2.1 million
or 39.1%, to $7.4 million in the first nine months of 2010 from $5.3 million in
the first nine months of 2009. Depreciation increased by $1.0 million, or 58.5%,
to $2.7 million in the first nine months of 2010 from $1.7 million in the first
nine months of 2009. Rent expenses increased by $0.8 million, or 138.9%, to $1.3
million in the first nine months of 2010 from $0.5 million in the first nine
months of 2009. Utilities increased by $0.7 million, or 25.9%, to $3.2 million
in the first nine months of 2010 from $2.5 million in the first nine months of
2009.
General and
Administrative Expense – General and administrative expenses increased by
$2.8 million, or 87.2%, to $6.0 million, or 2.8% of net sales, in the first nine
months of 2010 from $3.2 million, or 1.8% of net sales, in the first nine months
of 2009. The increase was mainly due to the fact that we continued to strengthen
our work force by hiring new employees, training and providing higher
compensation to managerial staff. Moreover, after we upgraded to Nasdaq in
October 2009, professional fee expenses increased due to additional compliance
standards. In specific, staff costs increased by $0.3 million or 18.7%, to $1.9
million in the first nine months of 2010 from $1.6 million in the first nine
months of 2009. Depreciation increased by $0.8 million, or 692.8%, to $0.9
million in the first nine months of 2010 from $0.1 million in the first nine
months of 2009. Professional fee expenses increased by $0.3 million, or 81.0%,
to $0.7 million in the first nine months of 2010 from $0.4 million in the first
nine months of 2009. Besides that, in the first three quarters of 2010, we
recognized a non-cash expense of $823,540, relating to the warrant agreement we
entered into on January 22, 2010 and the option agreements we entered into with
our independent directors on September 14, 2009, and our Chief Operating
Officer, Alan Stewart and 20 employees on June 26, 2010.
Changes in fair
value of warrants – In the first nine months of 2010, we recognized a
non-cash income of $7.8 million unrelated to the company’s operations, which
resulted from the change in fair value of warrants issued to investors in
conjunction with the Company’s issuance of warrants in March 2008 pursuant to
provisions of FAB ASC Topic 815, “Derivative and Hedging” (“ASC 815”). The
accounting treatment of the warrants resulted from a provision providing
anti-dilution protection to the warrant holders. The warrant holders have
permanently waived the “down-round” protection from the warrants as of March 24,
2010. Therefore, the non-cash charges affecting net income will not be applied
after that day, for details, please see Note 6.
36
Income
Taxes – The provision for income taxes was $2.9 million for first nine
months of 2010 compared with $3.0 million for first nine months of 2009.
Excluding the effect of changes in fair value of warrants, our effective tax
rate was 26.3% for first nine months of 2010, compared with 26.5% for first nine
months of 2009. This decrease was primarily due to lower taxable income resulted
from higher expenses relating to new stores opening and overseas expenditure
compared to same period during 2009.
Net Income
– For the nine months ended September 30, 2010, net income was approximately
$15.0 million, compared with net loss of $36.8 million for the nine months ended
September 30, 2009. Excluding changes in the fair value of warrants, adjusted
net income for the first nine months of 2010 decreased 12.9% to $7.2 million, or
$0.18 per diluted share, from $8.3 million, or $0.28 per diluted share, in the
prior year period. The number of shares used in the computation of diluted EPS
(excluding changes in the fair value of the warrants) increased 32.7% to 39.8
million shares from 30.0 million shares for the same period during
2009.
Three
months ended September 30, 2010 compared with three months ended September 30,
2009
The
following table sets forth selected items from our condensed consolidated
statements of income by dollar and as a percentage of our net sales for the
periods indicated:
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Three Months Ended
|
Three Months Ended
|
|||||||||||||||
September 30, 2010
|
September 30, 2009
|
|||||||||||||||
Amount
|
% of
Net Sales
|
Amount
|
% of
Net Sales
|
|||||||||||||
Net
sales
|
$ | 64,869,749 | 100.0 | % | $ | 56,567,838 | 100.0 | % | ||||||||
Cost
of sales
|
53,575,513 | 82.6 | 46,820,423 | 82.8 | ||||||||||||
Gross
profit
|
11,294,236 | 17.4 | 9,747,415 | 17.2 | ||||||||||||
Selling
expenses
|
7,817,663 | 12.1 | 5,624,479 | 9.9 | ||||||||||||
General
and administrative expenses
|
2,123,248 | 3.3 | 1,051,608 | 1.9 | ||||||||||||
Operating
income
|
1,353,325 | 2.1 | 3,071,328 | 5.4 | ||||||||||||
Changes
in fair value of warrants
|
- | - | (31,612,218 | ) | (55.9 | ) | ||||||||||
Interest
income
|
165,287 | 0.3 | 35,342 | 0.1 | ||||||||||||
Interest
expense
|
35 | - | 4 | - | ||||||||||||
Income
(loss) before income taxes
|
1,518,577 | 2.3 | (28,505,552 | ) | (50.4 | ) | ||||||||||
Income
taxes
|
486,712 | 0.8 | 829,840 | 1.5 | ||||||||||||
Net
income (loss)
|
$ | 1,031,865 | 1.6 | % | $ | (29,335,392 | ) | (51.9 | )% |
37
Net Sales
– Net sales increased by $8.3 million, or 14.7%, to $64.9 million for the three
months ended September 30, 2010 from $56.6 million for the three months ended
September 30, 2009. The change in net sales was primarily attributable to the
following:
|
●
|
Same store sales represents sales
from stores that were opened for at least one year before the beginning of
the comparison period, or by July 1, 2009. Same store (30 stores) sales
generated approximately $57.1 million sales in the third quarter of 2010,
an increase of $0.5 million, or 1.0% compared with $56.6 million net sales
in the third quarter of
2009.
|
|
|
|
●
|
New store sales increased,
reflecting the opening of 8 new stores since July 1, 2009. These 8 stores
generated approximately $7.8 million sales in the third quarter of 2010
compared to $42,923 in the third quarter of
2009.
|
|
|
|
●
|
The number of stores including
supermarket/hypermarket and department stores at September 30, 2010 was 38
versus 33 at September 30,
2009.
|
Cost of Sales
– Our cost of sales for the three months ended September 30, 2010 was
approximately $53.6 million, representing an increase of $6.8 million, or 14.4%,
from approximately $46.8 million for the same period in 2009. The increase was
due to the increase in volume of sales. Our cost of sales primarily consists of
the cost for our merchandise; it also includes costs related to packaging and
shipping and the distribution center costs.
Gross
Profit – Gross profit, or total revenue minus cost of sales, increased by
$1.5 million, or 15.9%, to $11.3 million, or 17.4% of net sales, in the third
quarter of 2010 from $9.7 million, or 17.2% of net sales, in the third quarter
of 2009. The change in gross profit was primarily attributable to net sales
increased by $8.3 million in the third quarter of 2010 compared to the third
quarter of 2009.
Selling
Expenses – Selling expenses increased by $2.2 million, or 39.0%, to $7.8
million, or 12.1% of net sales, in the third quarter of 2010 from $5.6 million,
or 9.9% of net sales in the third quarter of 2009. The change in selling expense
was mainly due to increase in labor costs, depreciation, rent expense, and
utilities and other operating costs in the three months ended September 30, 2010
compared to same period in 2009 primarily due to support of an increase in store
count. In particular, labor costs increased by $1.0 million or 56.3%, to $2.9
million in the third quarter of 2010 from $1.9 million in the third quarter of
2009. Depreciation increased by $0.3 million, or 50.2%, to $1.0 million in the
third quarter of 2010 from $0.7 million in the third quarter of 2009. Rent
expenses increased by $0.4 million, or 417.8%, to $0.5 million in the third
quarter of 2010 from $0.1 million in the third quarter of 2009. Utilities
increased by $0.2 million, or 25.8%, to $1.1 million in the third quarter of
2010 from $0.9 million in the third quarter of 2009.
General and
Administrative Expense – General and administrative expenses increased by
$1.0 million, or 101.9%, to $2.1 million, or 3.3% of net sales, in the third
quarter of 2010 from $1.1 million or 1.9% of net sales, in the third quarter of
2009. The increase was mainly due to the fact that we continued to strengthen
our work force by hiring new employees, training and providing higher
compensation to managerial staff. Moreover, after our common stock was listed on
Nasdaq in October 2009, professional fee expenses increased due to additional
compliance requirements. In particular, staff costs increased by $0.1 million or
27.7%, to $0.6 million in the third quarter of 2010 from $0.5 million in the
third quarter of 2009. Depreciation increased by $0.3 million, or 687.0%, to
$0.3 million in the third quarter of 2010 from $42,899 in the third quarter of
2009 . Professional fee expenses increased by $0.1 million, or 23.0%, to $0.2
million in the third quarter of 2010 from $0.1 million in the third quarter of
2009. In the third quarter of 2010, we recognize a non-cash expense of $231,726
relating to the option agreements we entered into with our independent directors
on September 14, 2009, and our Chief Operating Officer, Alan Stewart and 20
employees on June 26, 2010.
38
Income
Taxes – The provision for income taxes was $0.5 million for the third
quarter of 2010 compared with $0.8 million for the third quarter of 2009.
Excluding non-cash expenses related to warrants and options, our effective tax
rate was 27.8% for third quarter of 2010, compared with 26.7% for the third
quarter of 2009. This increase was primarily due to higher non-deductible
expenses relating to overseas expenditure in the three months ended September
30, 2010 compared to same period during 2009.
Net Income
– For the three months ended September 30, 2010, net income was approximately
$1.0 million, compared with net loss of $29.3 million for the three months ended
September 30, 2009. Excluding changes in the fair value of warrants, adjusted
net income for the three months ended September 30, 2010 decreased 54.7% to $1.0
million, or $0.03 per diluted share, from $2.3 million, or $0.08 per diluted
share, in the period prior year. The number of shares used in the computation of
diluted EPS (excluding changes in the fair value of the warrants) increased
28.4% to 38.5 million shares from 30.0 million shares for the same period during
2009.
The
accounting treatment of the warrants resulted from a provision providing
anti-dilution protection to the warrant holders, which was permanently waived by
the warrant holders effective March 24, 2010. As such, there will be no non-cash
charges related to changes in fair value of warrants from the 2nd quarter
of 2010.
Fiscal
2009 Compared to Fiscal 2008
The
following table sets forth selected items from our consolidated statements of
operations by dollar and as a percentage of our net sales for the periods
indicated:
Year Ended
December 31, 2009
|
Year Ended
December 31, 2008
|
|||||||||||||||
Amount
|
% of Net
Sales
|
Amount
|
% of Net
Sales
|
|||||||||||||
Net
sales
|
$ | 247,594,272 | 100.0 | % | $ | 160,129,600 | 100.0 | % | ||||||||
Cost
of sales (1)
|
206,639,561 | 83.4 | 129,739,748 | 81.0 | ||||||||||||
Gross
profit
|
40,954,711 | 16.6 | 30,389,852 | 19.0 | ||||||||||||
Selling
expenses (2)
|
21,680,096 | 8.8 | 12,639,565 | 7.9 | ||||||||||||
General
and administrative expenses
|
4,802,262 | 1.9 | 3,249,506 | 2.0 | ||||||||||||
Operating
income
|
14,472,353 | 5.8 | 14,500,781 | 9.1 | ||||||||||||
Other
expenses
|
14,253 | 0.0 | 1,979,460 | 1.2 | ||||||||||||
Changes
in fair value of warrants
|
35,492,017 | 14.3 | - | 0.0 | ||||||||||||
Interest
income
|
(222,007 | ) | (0.1 | ) | (272,551 | ) | 0.2 | |||||||||
Interest
expenses
|
23,734 | - | 240,330 | 0.2 | ||||||||||||
Income
(loss) before income taxes
|
(20,835,644 | ) | (8.47 | ) | 12,553,542 | 7.8 | ||||||||||
Income
taxes
|
3,807,794 | 1.5 | 3,556,474 | 2.2 | ||||||||||||
Net
income (loss)
|
$ | (24,643,438 | ) | (10.0 | )% | $ | 8,997,068 | 5.6 | % |
Net Sales
– Net sales increased by $87.5 million, or 54.6%, to $247.6 million for 2009
from $160.1 million for 2008. The change in net sales was primarily attributable
to the following:
|
§
|
Comparable stores are stores that
were opened for at least one year before the beginning of the comparison
period, or by January 1, 2008. Those 18 stores generated approximately
$134.5 million sales in 2009, an increase of $7.5 million, or 5.9%
compared with $127.0 million sales in
2008.
|
|
|
|
§
|
New store sales increased,
reflecting the net opening of 16 new stores since January 1,
2008.
|
39
|
§
|
Store including
supermarket/hypermarket and department store at the end of 2009 was 36
versus 30 at the end of fiscal 2008, there were two department stores at
the end of 2009 and 2008. We opened 6 new stores in fiscal 2009, and
opened 10 new stores, net of closures and relocations, in fiscal 2009 and
2008. Our fiscal 2009 store growth was slowed substantially in response to
management strategy of building distribution center, setting up logistic
systems and training systems to get ready for opening more new stores in
the future. We anticipate opening total area of 100,000 square meters of
new stores in year 2010.
|
Cost of
Sales – Our cost
of sales for 2009 was approximately $206.6 million, representing an increase of
$76.9 million, or 59.3%, from approximately $129.7 million for 2008. The
increase was due to increase in volume of sales. Our cost of sales primarily of
the cost for our merchandises, it also includes related costs of packaging and
shipping costs and the distribution center cost.
We
anticipate that our cost of sales will continue to increase along with our
expansion in the coming quarters.
Gross
Profit – Gross profit, or total revenue minus cost of sales, was
decreased by $10.6 million, or 34.8%, to $41.0 million, or 16.5% of net sales,
in 2009 from $30.4 million, or 19.0% of net sales, in fiscal 2008. The change in
gross profit was primarily attributable to the following:
|
§
|
Net sales increased by $ 87.5
million in 2009 compared to
2008.
|
|
|
|
§
|
We reclassified: 1) distribution
cost from selling expenses to cost of sales; 2) rental income from renting
spaces in our supermarkets from revenue to directly offsetting rental
income with rental expense; 3) marketing income from revenue to directly
offsetting it with promoting expenses. The consolidated financial
statements and the relevant notes for the prior years have been changed in
conformity with the current year presentation of the consolidated
financial statements and the corresponding notes. For comparative
purposes, the Company reclassified the following: 1) Approximately $1.4
million of revenue to general and administrative expenses in the
statements of income in year 2008. These selling revenue were primarily
related to sub-lease rental income; 2). Approximately $2.6 million of
selling expenses to cost of sales in the statements of income in year
2008. These selling expenses consisted of distribution costs. We believes
that such reclassification represents better presentation to its retail
industry standard.
|
All of
the reasons above attributed to the gross margin changes. We believe that our
gross margin is likely to be between 17.0% and 19.0%, over the next few business
quarters. New stores 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 low prices in order to increase our market share and long-term
sales volume.
Selling
Expenses – Selling expenses increased by $9.0 million, or 71.5%, to $21.7
million, or 8.8% of net sales, in fiscal 2009 from $12.6 million, or 7.9% of net
sales, in fiscal 2008. The change in selling expense was primarily attributable
to the increase of labor cost by 5.1million, or 177.1% compared with fiscal 2008
the increase of labor cost was mainly due to new store openings and more staff
being recruited to meet our growing business in 2009. Depreciation, rent expense
and utilities and other operating costs for fiscal 2009 increased primarily as a
result to support the increase in store count.
General
and
Administrative Expense – General and administrative expenses increased by
$1.6 million to $4.8 million, or 1.9% of net sales, in fiscal 2009 from $3.2
million, or 2.0% of net sales, in fiscal 2008. The change in general and
administrative expenses was primarily attributable to the increase of labor cost
by $2.1million, or 280%.The increase of labor cost was mainly due to more staff
being recruited in our headquarter to meet our growing business in 2009 and the
employee benefits incurred.
Changes in fair
value of warrants – In 2009, we incurred a non-cash charge of $35.5
million unrelated to the company’s operations, which resulted from the change in
fair value of warrants issued to investors in conjunction with the Company’s
issuance of warrants in March 2008 pursuant to provisions of FAB ASC Topic 815,
“Derivative and Hedging” (“ASC 815”). The accounting treatment of the warrants
resulted from a provision providing anti-dilution protection to the warrant
holders. The warrant holders have permanently waived the “down-round” protection
from the warrants as of March 24, 2010. Therefore, we believe that the non-cash
charges affecting net income will not be applied after March 31,
2010.
40
Income
Taxes – The provision for income taxes was $3.8 million for fiscal 2009
compared with $ 3.6 million for fiscal 2008. This increase was primarily due to
higher pre-tax income (excluding changes in fair value of warrants) in fiscal
2009 compared to the prior year. Our effective tax rate was negative 18.3% for
fiscal 2009 compared with 28.3% for fiscal 2008.
Net
Income
In 2009
we had a net loss of $24.6 million, compared to net income of $9.0 million in
2008. In 2009 our net loss was impacted by a non-cash charge of $35.5 million
unrelated to the company’s operations. Excluding this $35.5 million non-cash
charge, the Company’s net income from operations for the full year 2009 would
have been $10.8 million, representing a year over year net income growth of
20.6%.
Liquidity
and Capital Resources
Our
principal liquidity requirements are for working capital, capital expenditures
and cash dividends. We fund our liquidity requirements primarily through cash on
hand, cash flow from operations and borrowings from our revolving credit
facility. We believe our cash on hand, future funds from operations and
borrowings from our revolving credit facility will be sufficient to fund our
cash requirements for at least the next twelve months. There is no assurance,
however, that we will be able to generate sufficient cash flow or that we will
be able to maintain our ability to borrow under our revolving credit
facility.
At
September 30, 2010 we had $48.4 million of cash on hand compared to $26.7
million at September 30, 2009. The following table sets forth a summary of our
cash flows for the periods indicated:
(Unaudited)
Nine Months Ended
September 30,
|
Years Ended December 31,
|
|||||||||||||||
|
2010
|
2009
|
2009
|
2008
|
||||||||||||
Net
cash provided by operating activities
|
$ | 7,332,951 | $ | 15,239,968 | $ | 10,866,330 | $ | 18,661,267 | ||||||||
Net
cash used in investing activities
|
(6,014,706 | ) | (4,113,932 | ) | (19,455,014 | ) | (24,528,810 | ) | ||||||||
Net
cash provided by financing activities
|
- | (2,192,178 | ) | 35,210,517 | 12,627,365 | |||||||||||
Effect
of foreign currency translation
|
1,141,629 | (1,529,702 | ) | 5,944 | 1,783,135 | |||||||||||
Net
change in cash
|
$ | 2,459,874 | $ | 7,404,156 | $ | 26,627,777 | $ | 8,542,957 |
The
seasonality of our business historically provides greater cash flow from
operations during the holiday and winter selling season, with the fourth fiscal
quarter net sales traditionally generating the strongest profits of our fiscal
year. Typically, we use operating cash flow and borrowings under our revolving
credit facility to fund inventory increases in anticipation of the holidays and
our inventory levels are at their highest in the months leading up to Chinese
Spring Festival. As holiday sales significantly reduce inventory levels, this
reduction, combined with net income, historically provides us with strong cash
flow from operations at the end of our fiscal year.
Our
improved earnings contributed to higher cash flow from operations for fiscal
2009 compared to fiscal 2008, which enabled us to continue to increase our work
in capital and to decrease our bank loans. In 2009 we purchased larger
quantities of inventory earlier in the year to insure adequate product
availability for the holiday and winter selling season. The higher inventory
levels and timing of purchases combined with lower than anticipated sales in the
fourth quarter of fiscal 2009 resulted in reduced operating cash flow for the
year.
41
Operating
Activities – Net cash provided by operating activities for the first nine
months of 2010 and 2009 was $7.3 million and $15.2 million, respectively. The
decrease in cash provided by operating activities for the nine months ended
September 30, 2010 compared to the same period in 2009 primarily reflects net
cash outflow caused by the decrease of accounts payable, the decrease of
customer deposit received and the increase of prepaid expense. The decrease of
accounts payable and the increase of prepaid expense is largely attributable to
the fact that we accelerated our repayment and advance payment to suppliers in
order to maintain stable and good relationships with our suppliers. The cash
inflow from inventories and consumables for the nine months ended September 30,
2010 was $1.6 million compared to net cash outflow of $1.0 million for the same
period in 2009. The changes reflected our continuous effort on inventories
management. The new distribution center also contributed significant improvement
on our logistic system.
Net cash
provided by operating activities for fiscal 2009 and 2008 was $10.9 million and
$18.7 million, respectively. The decrease in cash provided by operating
activities for fiscal 2009 compared to fiscal 2008 primarily reflects net loss
offset by change in fair value of warrants for the year, higher other
receivables resulted from lending money to vendors in the amount $7.3 million to
help insure adequate levels of merchandise during the peak Chinese new year
season and increases in accrued expenses and higher inventory
levels.
Investing
Activities – Net cash used in investing activities for the first nine
months of 2010 and 2009 was $6.0 million and $4.1 million, respectively. Capital
expenditures represented substantially all of the net cash used in investing
activities for each period. Our capital spending is primarily for new store
openings, store-related remodeling and distribution center and corporate
headquarters. Capital expenditures were higher in the first nine months of 2010
mostly due to the acquisitions of three new operating rights for new store
business. Moreover, we terminated a property buying/selling agreement (“Purchase
Agreement”), and approximately $11.0 million was refunded to us. The building
which we have determined to lease instead was intended to accommodate future
growth of the Company's administrative and operations personnel as we implement
our supermarket expansion plan.
Net cash
used in investing activities for fiscal 2009 and 2008 was $19.5 million and
$24.5 million, respectively. Capital expenditures represented substantially all
of the net cash used in investing activities for each period. Capital
expenditures were lower in fiscal 2009 due to substantially fewer new store
openings.
Financing
Activities – Net cash used for financing activities for the first nine
months of 2010 and 2009 was nil and $2.2 million, respectively. Cash provided by
financing activities was used to open new stores, and a distribution center,
store renovations and relocations.
Net cash
proceeds from financing activities for fiscal 2009 and 2008 was $35.2 million
and $12.6 million, respectively. In the fourth quarter of 2009 we raised an
aggregate of $39.7 million in a public offering of 6,900,000 shares of our
common stock at a price of $5.75. For fiscal 2009 and 2008, cash provided by
financing activities was used to open new stores, and a distribution center,
store renovations and relocations.
42
Financing
Agreement – On June 18, 2009, we entered into a financing agreement with
Daqing City Commercial Bank, under this agreement, the Company had a credit line
up to RMB27.6 million (amount to $4.0 million) from June 18, 2009 to June 18,
2011. The loan under this financing agreement is be secured by buildings with
net work book value of RMB37.4million (amount to approximately $5.5million). As
of March 31, 2010, we did not have any outstanding revolving credit
line.
Future Capital
Requirements – We had cash on hand of $48.4 million as of September 30,
2010. We expect capital expenditures for the remainder of 2010 primarily to fund
the opening of new stores, store-related remodeling and relocation, distribution
center equipment and computer hardware and software purchases. We anticipate
opening a total of 11 new stores with an aggregate of 90,000 square meters of
space in 2010.
We
believe we will be able to fund our cash requirements, for at least the next
twelve months, from cash on hand, operating cash flows and borrowings from our
revolving credit facility. However, our ability to satisfy our cash requirements
depends upon our future performance, which in turn is subject to general
economic conditions and regional risks, and to financial, business and other
factors affecting our operations, including factors beyond our control. There is
no assurance that we will be able to generate sufficient cash flow or that we
will be able to maintain our ability to borrow under our revolving credit
facility.
If we are
unable to generate sufficient cash flow from operations to meet our obligations
and commitments, or if we are unable to maintain our ability to borrow
sufficient amounts under our existing revolving credit facility, or successfully
negotiate and enter into a new revolving credit facility to replace our current
facility, which has an initial termination date of June 18, 2011, we will be
required to refinance or restructure our indebtedness or raise additional debt
or equity capital. Additionally, we may be required to sell material assets or
operations, suspend or further reduce dividend payments or delay or forego
expansion opportunities. We might not be able to implement successful
alternative strategies on satisfactory terms, if at all.
Off-Balance Sheet
Arrangements and Contractual Obligations – Our material off-balance sheet
arrangements are operating lease obligations. We excluded these items from the
balance sheet in accordance with generally accepted accounting principles in the
United States of America (“GAAP”). Information regarding our operating leases is
available under the section entitled Properties and Note 12, Lease Commitments, of the
notes to consolidated financial statements included elsewhere in this
prospectus. Operating lease commitments consist principally of leases for our
retail store facilities and distribution center. These leases frequently include
options which permit us to extend the terms beyond the initial fixed lease term.
With respect to most of those leases, we intend to renegotiate those leases as
they expire.
In the
ordinary course of business, we enter into arrangements with vendors to purchase
merchandise in advance of expected delivery. Because most of these purchase
orders do not contain any termination payments or other penalties if cancelled,
they are not included as outstanding contractual obligations.
43
BUSINESS
Overview
We are
a regional supermarket chain that currently operates 45 supermarkets and 3
department stores in the northeastern three provinces and Inner Mongolia. Our
supermarkets sell a broad selection of merchandise including groceries, fresh
food and non-food items. We currently have 2 distribution centers servicing our
supermarkets, one for fresh food and another for grocery and non-food
merchandise.
We are
the first supermarket chain in northeastern China and Inner Mongolia that is a
licensee of the Independent Grocers Alliance, or IGA, a United States-based
global grocery network with aggregate retail sales of more than $21.0 billion
per year. As a licensee of IGA, we are able to engage in group bargaining with
suppliers and have access to more than 2,000 private IGA brands, including many
that are exclusive IGA brands.
Our
expansion strategy emphasizes growth through geographic expansion in
northeastern China and Inner Mongolia, where we believe local populations can
support profitable supermarket operations, and where we believe competition from
large foreign and national supermarket chains, which generally have resources
far greater than ours, is limited. Our strategies for profitable operations
include buy-side initiatives to reduce supply costs; focusing on merchandise
with higher margins, such as non-food items, foods we prepare ourselves and
private label merchandise; and increasing reliance on the benefits of membership
in the international trade group IGA.
We
completed the initial steps in the execution of our expansion plan in March
2008, when we raised financing through the combination of our reverse merger and
private placement. Under our expansion plan, we opened seven new stores in 2009
that have, in the aggregate, approximately 32,000 square meters of space and ten
new stores in 2008 that have, in the aggregate, approximately 42,000 square
meters of space. Six of the stores opened in 2008 were opened by us and four of
the stores were opened through the acquisition of existing businesses by us. In
2010, we plan to open hypermarkets and additional supermarkets department stores
having, in the aggregate, approximately 100,000 square meters of space and one
additional distribution center in the second quarter of 2010 that will have
approximately 19,600 square meters of space. We are also making improvements to
our logistics and information systems to support our supermarkets. We expect to
finance our expansion plan from funds generated from operations, bank loans and
proceeds from our fourth quarter 2009 public offering, and our long-term target
is to open 200 stores over the next five years, including hypermarkets,
supermarkets and department stores.
Our
Competitive Advantages
We
believe that our competitive advantages include our low prices, the quality of
our meat and produce, our breadth of products, and the location of our
stores.
The
location of our stores is also essential to our competitiveness, and our current
competition strategy focuses on locating our stores within the three provinces
of northeastern China and the eastern region of Inner Mongolia. Within those
areas, we try to locate our stores in small- and medium-sized cities/counties
where we expect to face limited competition from large foreign or national
supermarket chains.
In
addition to the competitive advantages described above, we believe we have
specific and distinct advantages over our domestic and foreign
competitors.
Compared
with local supermarkets, we believe we have the following
advantages:
|
§
|
Strong relationships with local
suppliers;
|
|
|
|
§
|
Membership in the international
trade group IGA, which provides access to purchasing discounts for
packaged goods and access to IGA’s exclusive
brands;
|
|
|
|
§
|
Superior management, especially
in inventory management, information management systems, and sales and
marketing programs;
|
|
|
|
§
|
A focus on human-resource
management, including formal employee training programs;
and
|
44
|
|
|
§
|
A management team with global
experiences in the supermarket
industry.
|
Compared
with large foreign supermarkets, we believe we have the following
advantages:
|
§
|
A familiarity with Chinese and
local circumstances and culture, religion and customs, and a corresponding
understanding of local customer needs and consumption patterns, which we
believe are especially helpful in the areas of raw food and meat
sales;
|
|
|
|
§
|
Our supermarkets are positioned
within their respective markets as stores that provide goods and services
at low prices in a manner that is convenient to our communities. By
contrast, we believe that Wal-Mart and other foreign retailers are
perceived in Daqing and other medium-sized cities in northeastern China as
places for higher priced and more extravagant
purchases;
|
|
|
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§
|
Strong relationships with local
suppliers; and
|
|
|
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§
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Certain advantages under Chinese
law, such as the right to sell cigarettes, a right foreign competitors do
not enjoy.
|
Business
Strategy
Our
strategy is to expand our current market share and to benefit from the
anticipated growth in China’s retail industry. Our operating strategy consists
of the following key elements:
|
§
|
Emphasizing growth through
geographic expansion in the three northeastern provinces and Inner
Mongolia where there is an emerging market for our retail operations and
where competition is
limited.
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|
|
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§
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Reducing cost of goods sold by
(i) acquiring more merchandise directly from manufacturers, cutting out
middlemen and distributors, and otherwise reducing supply costs, and (ii)
building a larger distribution center to enable us to purchase larger
orders from vendors at lower prices, and (iii) taking advantage of the
purchasing power of collective ordering of supplies through
IGA.
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§
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Increasing our profit margins by
(i) offering and selling more self-prepared foods, which have higher
profit margins, including baked goods made in our bakery, and cooked meats
such as fried chicken legs and roast chicken, (ii) offering and selling
more private label goods, which also have higher profit margins, and (iii)
increasing non-food section in newly opened stores to increase gross
margin.
|
In 2009
and 2008, we acquired approximately 12% and 10.0%, respectively, of our
merchandise directly from manufacturers (not including private label
merchandise). We estimate that approximately 6% of our total revenue in 2009 was
due to sales of self-prepared foods compared to approximately 5.5% of our total
revenue in 2008.
Our
strategy is to increase our sales of these cost-saving and higher-margin
categories of merchandise — direct-from-manufacturer, self-prepared food,
private label and IGA-related merchandises. In addition to emphasizing sales of
these categories, we also emphasize sales of other higher-margin items, such as
fashionable clothing and cosmetics, and seasonal items like gloves, coats,
sun-block and swimsuits, etc.
Our
Stores and Merchandise
Our
stores are spread throughout northeastern China and Inner Mongolia with a
concentration in Heilongjiang Province. The map below shows the location within
Heilongjiang province of all of our current locations. The right side of the map
depicts Heilongjiang Province; the left side depicts our stores and its
surrounding areas. The retail locations are indicated by a “QKL” mark; our
distribution center is indicated by a red truck icon.
45
Map
of locations — Heilongjiang Province and Municipality of Daqing
Our
Supermarkets
Our
supermarkets generated approximately 98.8% of our revenues in 2009 and 98.6% of
our revenue in 2008. Our current supermarkets have a total area of approximately
133,410 gross square meters, which includes all rental space as opposed to
85,688 square meters of retail space. All supermarkets share the same general
format and sell from the same inventory, however the larger stores carry a
greater variety of items than the smaller stores.
Our
supermarkets are designed to provide our customers with quality merchandise at a
low price and carry a broad selection of grocery, meat, produce, liquor and
tobacco, clothing, household items, small electronics, jewelry and general
merchandise.
Our
supermarkets carry merchandise divided into three major categories: grocery,
fresh food, and non-food items.
The table
below sets forth our total revenues for our sales of grocery, fresh food and
non-food items for the years ended December 31, 2008 and 2009
Percentage of Store sales for the Year
Ended December 31,
|
||||||||
2008
|
2009
|
|||||||
Grocery
|
32.3 | % | 33.6 | % | ||||
Fresh
food
|
50.5 | % | 47.5 | % | ||||
Non-food
items
|
17.2 | % | 18.9 | % |
Grocery items
include:
|
§
|
Prepared or packaged foods,
including instant foods, canned foods, packaged rice and wheat powder, and
crackers and chips;
|
|
|
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§
|
Bulk (unpackaged) grains
including rice and ground
wheat;
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|
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§
|
Bottled water and
beverages;
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|
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§
|
Cigarettes;
and
|
|
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§
|
Certain non-food items such as
cleaning products, cosmetics, and disposable
razors.
|
Fresh-food items
include:
|
§
|
Fresh raw meat, which we cut and
package;
|
|
|
|
§
|
Cooked
meats;
|
46
|
§
|
Fresh
seafood;
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|
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§
|
Fresh bakery items, including
breads, buns, dumplings, and other self-prepared
foods;
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§
|
Fresh noodles and
pastas;
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§
|
Fresh milk, yogurt, and eggs
(supplied fresh every day);
and
|
|
|
|
§
|
Packaged dumplings (supplied
fresh every day).
|
Non-food items include all
non-food items, except cleaning and cosmetic items included in grocery;
specifically:
|
§
|
Clothing and
shoes;
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|
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§
|
Books and
stationery;
|
|
|
|
§
|
Bedding and home
furnishings;
|
|
|
|
§
|
Small electronics and household
use items like irons, electric shavers, hair dryers, massage machines;
and
|
|
|
|
§
|
Office supplies, toys, sporting
goods and other items.
|
Our
target rate for loss due to spoilage and breakage of perishable and breakable
items is 0.4% of total revenue. This was also our approximate rate of loss for
spoilage and breakage in both 2008 and 2009.
Private
Label
Some of
the merchandise we sell in our supermarkets is made to our specifications by
manufacturers, using our QKL brand name. We refer to such merchandise as
“private label” merchandise. With private label merchandise, we entrust the
manufacturer to make the product and to select the name and design. Under our
agreements with the private label manufacturers, the private label manufacturers
cannot sell the product to any other company. Average profit margins from
private label products are typically 20%-30%, with certain products having a
profit margin of 30-50%, and are generally higher than profit margins for other
grocery items which are typically 12-13%.
Sales of
private label merchandise represented approximately 5.5 % and 5.0% of our total
sales revenue for 2009 and 2008, respectively. In June 2008, we established a
specialized department for designing and purchasing private label merchandise.
Six 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 increase private label sales to 20% of our total revenues in the
near future.
Our
Department Stores
As of the
date of this report, we operate three department stores through QKL-China’s
subsidiary, Daqing Qinglongxin Commerce & Trade Co., Ltd. (“QC&T”). Our
department stores generated 0.95% and 1.2% of our total revenues in 2009 and
2008, respectively. Our department stores are located in the same buildings as
our supermarkets and are licensed to sell all of the non-food products sold by
our supermarkets. Our department stores sell brand-name and luxury clothing and
accessories, cosmetics, small electronics, jewelry, books, home furnishings, and
bedding, and contain a movie theater and a traditional beauty
salon.
Our first
department store opened in September 2006 and is located in Ranghulu District of
Daqing. It has a total area of 12,000 square meters, including approximately
3,000 square meters occupied by our supermarket on the ground floor of the
building.
On
September 28, 2008, we opened a new supermarket store and a department store in
Taikang, a county in Heilongjiang Province located approximately 30 kilometers
from Daqing. It is the Company’s second unit comprised of a supermarket and
department store. It occupies roughly 10,000 square meters of leased space (the
supermarket is approximately 2,800 square meters and the department store is
nearly 7,200 square feet) in the commercial center of the city.
The
Company’s Jian Department Store, situated in Ji’an County, Jilin Province, was
opened on September 29, 2010. Ji’an County is the fourth largest port city in
China and is an important goods distribution center in Northeast China’s
Changbai Mountain region. The store is located in the center of the business
district in Ji’an county serving over 50,000 customers within the business
community. The department store occupies the first six stories of the building
and has an area of approximately 19,000 square meters. One of our supermarkets
occupies the basement of the building.
47
Our
department store business model is different from our supermarket business
model. The department stores operate on a concession and rent basis, with the
selling space occupied by retail partners who either sublet their space from, or
pay concession fees for use of the space to, QC&T. We do not own the
merchandise sold in the department stores, yet we do receive the proceeds of the
sales of merchandise in the department stores. The merchandise is owned by our
retail partners, we render the revenue we collected to them by deducting our
percentage of fees. In 2009 and 2008, approximately 67.9% and 66.2%,
respectively, of our department store revenue came from concession fees and
approximately 32.1% and 33.8%, respectively, came from rent.
Our
department store business model also differs from our supermarket business
model, in that our retail partners conduct their own purchasing operations (in
consultation with QC&T employees) and do not use our purchasing department.
Our retail partners receive their merchandise by delivery from distributors and
do not use our distribution center, delivery vehicles or logistics resources.
Each of the three above-ground floors in each of the department stores (but not
the ground floor, which houses a QKL-China supermarket) is occupied by a number
of stores, each operated by a retail partner. Each floor has one floor manager
who is employed by QC&T and who oversees the workings of that floor. The
employees charged with the logistical operation of the stores are employees of
our retail partners. Compared to our supermarket operations, our department
store operations are simpler and are less demanding of our resources, including
time, labor and purchasing effort.
Our
Distribution Centers
We
currently distribute grocery products to our supermarkets from our two
distribution centers located in Daqing, one for fresh food and one for grocery
and non-food merchandise. Approximately 45.0% of the merchandise sold in our
supermarkets are distributed through these facilities, which are located 1.5
kilometers and 5 kilometers from our headquarters. We plan to open a new
distribution center in the second quarter of 2010 located in Harbin, a city in
Heilongjiang Province, which will have approximately 19,600 square meters of
space and is approximately 180 kilometers from our headquarters in
Daqing.
Size
of Our Supermarkets
The table
below sets forth the size of our stores in net square meters, which includes
retail space as opposed to all rental space, and the average monthly sales per
square meter of each of our supermarkets which were open during 2008 and
2009.
Store
Number
|
Store Name
|
Date Opened
|
Retail
Space
Square
Meters
|
Average
Monthly Sales
(In RMB) per
Square Meter,
2008
|
Average
Monthly Sales
(In RMB) per
Square Meter,
2009
|
|||||||||||
1
|
Xincun
Store
|
01/23/99
|
4,408 | 1,371 | 2,369 | |||||||||||
2
|
Longfeng
Store
|
06/18/00
|
1,499 | 2,920 | 3,222 | |||||||||||
3
|
Chengfeng
Store
|
05/12/01
|
2,706 | 1,644 | 1,523 | |||||||||||
4
|
Hengmao
Store
|
11/16/02
|
1,906 | 3,141 | 3,556 | |||||||||||
5
|
Yixi
Store
|
01/18/03
|
1,557 | 2,796 | 2,988 | |||||||||||
6
|
Wanbao
Store
|
04/26/03
|
1,290 | 1,453 | 1,764 | |||||||||||
7
|
Xizhai
Store (1)
|
06/28/03
|
3,118 | 2,295 | 2,065 | |||||||||||
8
|
Zhaoyuan
Store
|
03/29/08
|
2,246 | 479 | 1,723 | |||||||||||
9
|
Zhaodong
Store
|
12/07/03
|
1,669 | 3,151 | 2,995 | |||||||||||
10
|
Wanli
Store
|
04/18/04
|
1,541 | 1,468 | 1,884 | |||||||||||
11
|
Hubin
Store
|
12/25/04
|
1,163 | 1,049 | 1,931 | |||||||||||
12
|
Donghu
Store
|
09/24/05
|
2,315 | 1,855 | 2,589 | |||||||||||
13
|
Yichun
Store
|
01/23/06
|
3,160 | 1,522 | 1,345 | |||||||||||
14
|
Jixi
Store
|
09/17/06
|
2,500 | 1,939 | 1,954 | |||||||||||
15
|
Acheng
Store
|
05/20/06
|
4,035 | 2,436 | 1,887 | |||||||||||
16
|
Lusejiayuan
Store
|
04/30/06
|
760 | 1,108 | 2,341 | |||||||||||
17
|
Jixi
Store 2
|
03/29/07
|
1,720 | 1,955 | 1,639 | |||||||||||
18
|
Yixi
Store 2
|
09/09/06
|
866 | 664 | 2,180 |
48
Store
Number
|
Store Name
|
Date Opened
|
Retail
Space
Square
Meters
|
Average
Monthly Sales
(In RMB) per
Square Meter,
2008
|
Average
Monthly Sales
(In RMB) per
Square Meter,
2009
|
|||||||||||
19
|
Harbin
Store
|
12/27/06
|
2,370 | 1,245 | 1,719 | |||||||||||
20
|
Central
Street Store
|
09/27/08
|
4,968 | 2,781 | 2,222 | |||||||||||
21
|
Suihua
Store
|
07/12/08
|
1,883 | 1,223 | 2,392 | |||||||||||
22
|
Taikang
Store
|
09/14/08
|
1,560 | 3,313 | 2,501 | |||||||||||
23
|
Zhaodong
Dashijie
|
05/27/09
|
2,587 | — | 2,599 | |||||||||||
24
|
Lindian
|
04/01/09
|
2,196 | — | 2,358 | |||||||||||
25
|
Boli
Store
|
12/21/08
|
4,045 | 433 | 1,107 | |||||||||||
26
|
Xinguangtiandi
Store
|
04/28/09
|
2,066 | — | 1,921 | |||||||||||
27
|
Hailaer
Store
|
12/28/08
|
4,606 | 3,113 | 1,377 | |||||||||||
28
|
Anda
Store
|
11/22/08
|
1,595 | 2,962 | 2,877 | |||||||||||
29
|
Fuyu
Store
|
11/29/08
|
1,630 | 3,303 | 2,227 | |||||||||||
30
|
Nehe
Store
|
11/11/08
|
1,774 | 2,801 | 2,308 | |||||||||||
31
|
Shidai
Lijing Store
|
06/21/03
|
101 | 616 | 701 | |||||||||||
33
|
Zhalaiteqi
Store
|
12/13/09
|
1,727 | — | 2,766 | |||||||||||
34
|
Tongjiang
Store
|
9/30/09
|
2,115 | — | 1,958 | |||||||||||
35
|
Datong
Store
|
11/07/09
|
2,590 | — | 1,820 | |||||||||||
36
|
Nongan
Store
|
12/20/09
|
4,987 | — | 2,715 | |||||||||||
Average
|
2,240 | 1,835 | 2,158 |
(1)
|
This store has been temporarily
closed for refurbishment and is expected to re-open in 2011.
|
Recent
Developments
Supermarket
Store Openings
Tongjiang
Store
On
September 30, 2009, we opened one new supermarket in Tongjiang, a border city
next to Russia in Heilongjiang province, approximately 800 kilometers from
Daqing. The new store occupies approximately 4,000 square meters in a large
shopping center in the commercial area in Tongjiang. More than 40,000 people in
the rural area plus additional people from surrounding suburban areas may shop
in our new store. The store carries more than 13,000 products in fresh food,
groceries and nonfood items. Since the store only open for one day during the
third quarter, meaningful sales data is not available yet.
Lindian
Store
On April
1, 2009, we opened a new supermarket store in Lindian, a city in Heilongjiang
Province, approximately 140 kilometers from Daqing. The new store occupies
approximately 5,000 square meters in the commercial center of
Lindian.
The
county of Lindian has a population of approximately 80,000. Based on our own
independent research, we believe there are no other large supermarket stores in
Lindian.
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. The new store occupies
approximately 6,000 square meters in the commercial center of Zhaodong. It is
the second store the Company opened in Zhaodong city.
The city
of Zhaodong has a population of approximately 230,000.
49
Datong
Store
On
November 7, 2009, we opened a new supermarket store in Datong, Heilongjiang
Province. Datong District is rich in oil and natural gas and is surrounded by
farmlands with abundant agriculture. With no competing stores in the area, the
Company’s modern supermarket will address the population of approximately 85,000
people. The Datong store occupies an area of 4,340 square meters and carries a
wide variety of grocery, fresh food and non-food products.
Zhalaiteqi
Store
On
December 13, 2009, the company opened a new supermarket store in the city of
Zhalaiteqi, Inner Mongolia, which has a population of approximately 40,000. As
the first modern supermarket in Zhalaiteqi, the store occupies an area of 2,880
square meters and carries items across all three of the Company’s core
categories.
Nong’an
Store
On
December 20, 2009, we opened a new supermarket in Nong’an County, Jilin, a city
with a population of approximately one million residents. Nong’an County is one
of the largest counties in China in terms grain production. The Nong’an store
occupies an area of 7,485 square meters and carries a wide variety of grocery,
food and non-food items.
Acquisitions
of Existing Businesses
Jian
On August
1, 2010, the Company purchased the operating rights of Jian County Great Wall
Operating Management Co., Ltd (“Jian Co”) in Jian County of Jilin Province.
After the closing of the acquisition the operating rights, Jian Co ceased its
operations of a retail store. The purchase price was $4,647,080 (RMB 31,500,000)
in cash. On September 29, 2010 we opened a new supermarket in Ji’an County,
Jilin Province. Ji’an County is the fourth largest port city in China and is an
important goods distribution center in Northeast China’s Changbai Mountain
region. The store is located in the center of the business district in Ji’an
county serving over 50,000 customers within the business community. The
supermarket is located in the basement below our Jian department store and has
an area of approximately 4,600 square meters.
Taian
Store
On July
1, 2010, the Company purchased the operating rights of Taian County Jiahemei
Commercial Co., Ltd (“Taian Co”) in Taian County of Liaoning province. After the
acquisition of the operating rights by the Company, Taian Co ceased its
operations of a retail store. The purchase price was $4,121,714 (RMB 28,000,000)
in cash. On October 20, 2010, we opened a new supermarket in Tai’an County,
Liaoning Province. Tai’an County, known as the breadbasket of the Liaohe Plain
for its fishery and timber resources, enjoys the distinction of being in the
East Asia and the Bohai economic zones. The new store is located in the center
of the business district in Tai’an county serving over 100,000 customers within
the community. The two-floor hypermarket store occupies approximately 11,200
square meters.
Xinguangtiandi
Store
On
September 30, 2008, we entered into an agreement with Daqing Xinguangtiandi
Shopping Center Co., Ltd. to acquire the business and all of the 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
Xinguangtiandi store occupies approximately 3,700 square meters in a commercial
shopping center in Daqing. The purchase price of RMB 13.8 million (approximately
$2.0 million) was paid in two installments: a deposit of RMB 100,000
(approximately $14,590) 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 government registration procedures
regarding the change of the ownership.
We
reopened the Xinguangtiandi Store on April 30, 2009.
Manzhouli
store
On July
1, 2010, the Company purchased the operating rights of Mangou Shopping Mall, a
branch of Inner Mongolia Fada Property Development Group Co., Ltd (“Inner
Mongolia Co”) in Manzhouli City of Inner Mongolia Autonomous Region. After the
acquisition of the operating rights, Inner Mongolia Co ceased operating the
retail store, and the Company was licensed to operate in this location. The
Company is currently refurbishing the supermarket and intends to reopen the
supermarket before the end of 2010. The purchase price was $2,705,611 (RMB
18,380,000) in cash. Manzhouli is China’s biggest inland trade port with Russia,
and Manzhouli Port is located in the Asia-Europe Continental Bridge. The
supermarket is located in the center of the business district, serving over
100,000 customers both Chinese and Russian within the business community. This
hypermarket occupies approximately 9,000 square meters which will be the largest
modern grocery store in the city.
Renovations
Xizhai
Store
We
temporarily closed our Xizhai store in Daqing on June 1, 2009 due to a
renovation of the building by the landlord. After the renovation the size of the
store will be increased to 7,000 square meters. We anticipate that the store
will be reopened before the end of 2011.
Our
Equipment
The
equipment we use in operating our business includes standard equipment for our
industry, such as display cases, freezers and ovens, delivery trucks, and the
computer hardware and software used in our electronic information, inventory and
logistics system. All of our equipment is owned outright by us and was acquired
by cash purchase.
50
Advertising
and Publicity
We
advertise in many ways, including direct-marketing circulars (bi-weekly, weekly
and 3 days on weekends), local newspaper advertisements and coupons, membership
cards and member promotions, and general promotions such as discounts and prize
lotteries.
Our
marketing and advertising activities are conducted by our marketing department,
which has ten employees. The department’s responsibility covers a wide range of
issues, including our brand strategy and brand promotion, sales promotion,
design of advertising materials, design of décor of stores, and management of
our club membership. They are also engaged in market and price investigation. We
base our advertising on our analysis and observations of the market and our
competitors. The head of the marketing department works closely with the
purchasing department in determining purchasing and sales patterns.
Under
contracts we have with our suppliers, our suppliers are responsible for the
costs of most of the discounts and promotions
Customers
and Pricing
Our
pricing strategy is to offer merchandise of a quality comparable to that of our
competitors and at a competitive price.
In
general, all customers pay the same price for our merchandise. However, the
following discounts are available to some customers as part of our promotional
marketing strategy.
|
§
|
We have a program where bulk
buyers may receive discounts by negotiation, which currently has over
650,000 members. These discounts are typically up to 2.0% of our retail
price, depending on what our annual gross margin targets allow. Sales to
these customers represented less than 2% of our total revenues for 2009
and less than 2.0% of our total revenues for
2008.
|
|
|
|
§
|
Membership card holders may
receive discounts on select products during promotional periods. Sales to
these customers represented 36.8% of our total revenues in 2009 and 25.9%
of our total revenues for
2008.
|
The rest
of our customers, including large customers such as school cafeterias, pay our
standard price.
Payment
methods for customers include cash, bank cards, and two kinds of store cards:
cash cards, which can be charged in advance and used as cash, and membership
cards, which can deposit money in, accumulate points and provide discounts for
membership products.
In recent
years, the pricing of our merchandise has changed as the price of our supplies
has changed. For example, in 2007, the price of pork rose significantly and
store prices rose correspondingly, until they were partially offset by
government subsidies. The price of imported products, primarily including wine,
beer and liquor, has changed as the RMB exchange rate has changed. We do not
believe any price changes have had a significant effect on our business to
date.
Suppliers
Our 10
largest suppliers of merchandise in 2009 were, from largest to
smallest:
|
§
|
Fengyou Wang (Vegetable
Vendor);
|
|
|
|
§
|
Fan Huang (Fruit
Vendor);
|
|
|
|
§
|
Daqing Huayao Economic and Trade
Company;
|
|
|
|
§
|
Heilongjiang Longjiangfu food and
oil Ltd.;
|
|
|
|
§
|
Lianxiang Li (Meat
Vendor);
|
51
|
§
|
Daqing Hongtaiyuan Economic and
Trade Ltd.;
|
|
|
|
§
|
Harbin Pepsi Cola Co.,
Ltd.;
|
|
|
|
§
|
Daqing Tianyi Food,
Ltd.;
|
|
|
|
§
|
Heilongjiang Cigarettes Company,
Daqing Branch; and
|
|
|
|
§
|
Harbin Hongyang Economic and
Trade, Ltd.
|
Customers
have the right under PRC law to return defective or spoiled products to us for a
full refund. Pursuant to the same law, our suppliers are required to fully
reimburse us for these returns.
Choosing
Suppliers
We
typically have two or more suppliers for each product we sell. Even for special
brands, including western beverages, we have several distributors from whom we
can order. We choose among competing suppliers on the basis of price and the
strategic needs of our business.
Shipping
from Suppliers
We
receive most of our merchandise from suppliers, which are often large
distribution companies, which deliver goods by their own trucks sent either to
our distribution center (in the case of grocery and non-food items) or directly
to our stores (in the case of fresh food items).
We
receive some merchandise direct from agricultural producers or manufacturers,
which arrive by train or truck and ships to a convenient location where we
transfer it to our delivery trucks. Our Daqing distribution centers also receive
train shipments directly through train tracks on the premises.
Distribution
to Our Supermarkets and Department Stores
For
distribution from our distribution centers to our supermarkets, we use our own
trucks to deliver merchandise in the Daqing area. We hire third-party shipping
companies to deliver goods to stores more distant from Daqing. We follow a
delivery schedule determined by our electronic information, inventory and
logistics system.
Distribution
to our department stores is arranged by our retail partners, as described under
“Our Department Stores” above.
Pricing
and Terms of Payment to Suppliers
We have
three kinds of payment arrangements with our suppliers: cash payment,
pre-payment and payment in arrears. The terms of these arrangements are
negotiated individually with each supplier and formalized in written
contracts.
Employees
As of
December 31, 2009, we had approximately 3,877 employees, all of whom are
full-time employees. Approximately 3,516 of our employees work in operations and
approximately 361 work in management. We have signed standard labor employment
contracts with all our employees, including our executive officers, with a
standard term of two to five years, and we have an employee manual that sets
forth relevant policies. We also hire temporary employees, typically for a term
of three months.
Under
each of our employment contracts, we are required to comply with applicable
labor laws and are obligated to:
|
§
|
Provide a safe and sanitary
working environment;
|
52
|
§
|
Provide regular breaks for
employees;
|
|
|
|
§
|
Comply with mandated limits on
each employee’s weekly working
hours;
|
|
|
|
§
|
Obey applicable minimum wage
standards;
|
|
|
|
§
|
Provide necessary training for
technical or specialized
tasks;
|
|
|
|
§
|
Make required payments to
retirement, unemployment and medical insurance
plans;
|
|
|
|
§
|
Provide 30 days’ notice of
termination to an employee, except in special circumstances;
and
|
|
|
|
§
|
Terminate an employee’s
employment only for certain reasons, specifically, if the
employee:
|
|
|
|
§
|
Proves unsuitable for employment
during a probation period;
|
|
|
|
§
|
Seriously neglects employment
duties, causing harm to our
interests;
|
|
|
|
§
|
Forces us to terminate or amend a
labor contract against our will by means of deception, coercion or taking
advantage of difficulties experienced by
us;
|
|
|
|
§
|
Simultaneously enters an
employment relationship with another employer that seriously affects the
employee’s ability to complete the tasks of the Company, or refuses to
remedy the situation after we point out the
problem;
|
|
|
|
§
|
Seriously violates our
disciplinary policy; or
|
|
|
|
§
|
Is guilty of criminal acts and/or
is subject to criminal
prosecution.
|
Employee
benefits include five state-mandated insurance plans:
|
§
|
Retirement
insurance: We
withhold a portion of each employee’s monthly salary, which is determined
by the provincial government, and is generally 8.0%, and contribute to a
pooled fund an additional amount determined by law, up to approximately
20.0% of the employee’s monthly
salary.
|
|
|
|
§
|
Medical
insurance: We
withhold approximately 2.0% of each employee’s salary and contribute to a
pooled fund an additional amount totaling approximately 8.0% of total
payroll expense.
|
|
|
|
§
|
Unemployment
insurance: We
withhold approximately 1.0% of each employee’s salary and contribute to a
pooled fund an additional amount totaling approximately 2.0% of total
payroll expense.
|
|
|
|
§
|
Worker’s
comp. insurance: We
pay 5% of base amount salary of RMB 1,140 for each employee and contribute
to a pooled fund. We do not withhold employees’ salary to pay for such
insurance.
|
|
|
|
§
|
Maternity
insurance: We pay
0.7% of base amount of RMB 1,140 for each employee and contribute to a
pooled fund. We do not withhold employees’ salary to pay for such
insurance.
|
In 2009
our average compensation per employee per month was RMB 1,372 (approximately
$201) compared to RMB 1,084 (approximately $156) in 2008. We also pay benefits
in the form of social security insurance fees for each of our
employees.
We have a
system of human resource performance review and incentive policies that allow
personnel reviews to be carried out monthly, quarterly or annually.
Training
We have a
business school and training center at our headquarters in Daqing, which
includes a lecture hall where we provide professional advancement and management
courses, training in company policies and compliance with regulations, and
lectures by outside members of the business community.
There are
also monthly meetings with all the store managers, led by our CEO or COO. There
are regional training conferences once per week, which provide opportunities for
sharing experiences and improving our business performance, as well as for
developing the skills and judgment of our store managers.
53
Intellectual
Property
We have
registered the name “Qingkelong” as a trademark in the PRC, details of which are
set forth below:
Trademark
|
Certificate No.
|
Category
|
Owner
|
Valid Term
|
||||
Qingkelong
|
No.
1995020
|
No.
35: “sales promotion (for others)”
|
Qingkelong
|
4/7/03
– 4/6/13
|
Insurance
Vehicle
Insurance
We have a
standard commercial vehicle insurance policy in place for all of our delivery
trucks.
Comprehensive
(“All-Risk”) Property Insurance
A number
of comprehensive property insurance policies are held by us covering losses to
our retail stores and distribution center. Our “all-risk” policies range in
coverage amounts from RMB 270,000 (approximately $39,455) to RMB 51.6 million
(approximately $7.5 million) at related premiums that range between RMB 51,639
(approximately $7,546) to RMB 270 (approximately $39), respectively, for the
one-year periods they cover.
Public
Liability Insurance
Each of
our stores carries a public liability insurance policy, covering losses relating
to claims of loss or damage due to injuries occurring on our premises. Our
public liability policies typically have a coverage amount of RMB 2 million
(approximately $292,261) and a premium of RMB 3,000 (approximately $438), with
the exception of our Acheng store, which has a coverage amount of RMB 7.2
million (approximately $1.1 million) and a premium of RMB 7,212 (approximately
$1,054), for the one-year periods they cover.
Research
and Development Activities
We are
not presently engaged in any research and development activities. However, for
self-prepared products (e.g. baked goods), our fresh foods department and bakery
department perform continuing market investigations in order to determine how
other companies are making prepared foods and whether we can improve on those
methods. Our cooking personnel and head chef work with the purchasing department
to develop formulas for use in our stores.
Government
Regulation of Our Operations
Our
operations are subject to a wide range of regulations covering every aspect of
our business. The most significant of these regulations are set forth below. In
each case, we have passed the most recent required inspections and have received
appropriate and up-to-date licenses, certificates and authorizations, as set
forth in the next subsection of this prospectus.
§
|
Circular of State Administration
of Industry and Commerce Concerning the Relevant Issues for the
Administration of Registration of Chain Stores in effect on May 30, 1997,
which sets forth the conditions for the establishment for chain stores and
branches, and the procedures for applying for a business
license.
|
§
|
Circular Concerning the Relevant
Issues on the Management of Specific Goods by Chain Stores (collectively
promulgated by PRC State Economic and Trade Commission, Ministry of
Domestic Trade, Ministry of Culture, Ministry of Posts and
Telecommunication, General Administration of Press and Publication, State
Administration for Industry and Commerce and State Tobacco Monopoly
Bureau) in effect on June 25, 1997, which provides that chain stores must
obtain a license from relevant government authorities for the management
of specific goods, such as tobacco, pharmaceutical products, food products
and audio-video
products.
|
54
§
|
Relevant Opinions on the
Promotion for the Development of Chain Stores, promulgated by PRC State
Commission for Economic Restructuring and State Economic and Trade
Commission, in effect on September 27, 2002, which provides relevant
opinions on the promotion for the development of chain stores, such as
simplifying the administrative approval
procedures.
|
Approvals,
Licenses and Certificates
We
require a number of approvals, licenses and certificates in order to operate our
business. We believe we are in compliance in all material respects with all laws
relevant to the operation of our business.
Competition
Competitive
Environment
The
supermarket industry in China is intensely competitive, with many companies,
both local and foreign, competing as retailers of food, groceries and other
merchandise, using a variety of business strategies.
Our main
competitors are local, regional and national chain supermarkets, and national
and foreign chain retailers operating “big box” or hypermarket stores of the
kind made famous by Wal-Mart and Carrefour.. We also face competition from
traditional street markets and markets where customers can purchase live poultry
and fish, convenience stores, tobacco and liquor retailers, restaurants,
specialty retailers and large drugstore chains.
We do not
believe we currently face significant direct competition from China’s large
national supermarket chains as we have decided not to compete in the areas in
which they focus their operations, which are China’s biggest cities and
surrounding suburbs-Shanghai, Shenzhen, Guangzhou, Beijing, and Chongqing-all
areas outside of northeastern China and Inner Mongolia. Instead, we have decided
to focus on China’s less-populated “second tier” and “third tier” cities and
surrounding areas in northeastern China and Inner Mongolia, which we believe
provide ample opportunity for expansion.
Among the
large foreign supermarket chains currently doing business in China, we believe
that Wal-Mart is currently the only significant direct competitor to one of our
stores. This is also primarily due to our choice of store locations. Although
Carrefour, Metro, Tesco and other foreign companies also operate in China and
compete with local supermarkets in their locations, they do not have a
significant number of stores in northeastern China or Inner Mongolia, where our
stores are located. In addition, our expansion plan targets small and
medium-sized cities and counties, which we believe are not being targeted by
these large international retailers. We believe that these plans will allow us
to avoid intense competition from these retailers.
Our
Competitors — Domestic Supermarkets
We
believe that the two supermarket companies listed below are our most significant
direct domestic competitors based in China:
|
§
|
Dashang
Supermarkets is a
national supermarket/department store chain consisting of approximately 70
supermarkets/department stores located in 30 cities across China. Its
headquarters are located in Dalian City, Liaoning Province. The chain is
managed by Dashang Group Co., Ltd., one of China’s largest retailers,
which operates more than 60 medium- to large-sized retail outlets,
including department stores, shopping malls and specialty stores. We
believe that, as of the date of this prospectus, approximately nine of our
stores compete directly with one Dashang supermarket/department store,
which is about 20 kilometers away from our headquarter in
Daqing.
|
|
|
|
§
|
Huachen
Supermarkets is a
local supermarket chain consisting of approximately 10 supermarkets. Its
headquarters are located in Suihua City, Heilognijiang Province. Five of
its stores are in the same city or county as ours competing directly with
our stores.
|
55
Our
Competitors — Foreign Supermarkets
Wal-Mart
is the world’s largest retailer and has more than 200 stores and 70,000
employees in China. Of its China stores, nearly 100 are in its supermarket or
hypermarket format, three are in its Sam’s Club format, two are in its
neighborhood market format, and approximately 100 are operated under the name of
its partially-owned PRC affiliate, Trust-Mart. We believe that approximately six
of our stores compete directly with one Wal-Mart store, which is about 200
meters from one of our Xincun Store.
National
and foreign retailers have greater resources and a greater geographic range than
we do, and their stores are often bigger (hypermarkets often have an area of
14,000 square meters of retail space, compared to the average 2,240 square
meters of retail space of our stores), which may enable them to offer a greater
variety of products. This may give them advantages in terms of pricing, ability
to expand, advertising budgets, efficiencies in distribution, bargaining power,
and other areas.
PROPERTIES
All land
in the PRC is owned by the government and cannot be sold to any individual or
entity. Instead, the government grants or allocates landholders a “land use
right,” which we sometimes refer to informally as land ownership. There are four
ways of acquiring land use rights in the PRC:
|
§
|
Grant of the right to use
land;
|
|
|
|
§
|
Assignment of the right to use
land;
|
|
|
|
§
|
Lease of the right to use land;
and
|
|
|
|
§
|
Allocation of the right to use
land.
|
Granted
land use rights are provided by the government in exchange for a grant fee, and
carry the rights to pledge, mortgage, lease and transfer the land within the
term of the grant. Land is granted for a fixed term, generally 70 years for
residential use, 50 years for industrial use, and 40 years for commercial and
other use. The term is renewable in theory. Unlike in western nations, granted
land must be used for the specific purpose for which it was
granted.
Allocated
land use rights are generally provided by the government for an indefinite
period (usually to state-owned entities) and cannot be pledged, mortgaged,
leased, or transferred by the user unless otherwise approved by the competent
government authorities. Allocated land can be reclaimed by the government at any
time. Allocated land use rights may be converted into granted land use rights
upon the payment of a grant fee to the government.
We have
land use rights to our headquarters and two other stores; we lease our 31 other
retail locations and our distribution center. Most of our lease agreements have
a typical term of 8 to 15 years, and most of our leased properties have a fixed
rent based on a price per square meter, which cannot be raised during the term
of the lease.
Our land
use rights are set forth below:
Land
Use Rights Acquired through Grants from Land Management Authority
Land No.
|
No. 1
|
No.2
|
||
Land
Use Right Certificate No.
|
Daqing
Guo Yong (2006)
No.
001485
|
Daqing
Guo Yong (2006)
No.
001488
|
||
User
of the Land
|
Qingkelong
|
Qingkelong
|
||
Location
|
North
Building 3-23,
East
Jing Qi Street,
Dongfeng
Xincun Village
|
Building
3-36A
East
Jing Qi Street,
Dongfeng
Xincun Village,
Sartu
District
|
||
Usage
|
Commercial
Use
|
Commercial
Use
|
||
Area
(square meters)
|
3193.70
|
34.30
|
||
Form
of Acquisition
|
From
related land authority
|
From
related land authority
|
||
Expiration
Date
|
2044-6-27
|
2044-6-27
|
||
Encumbrances
|
None
|
None
|
56
Land
Use Rights Acquired by Transfer
Land No.
|
No. 1
|
No.2
|
No.3
|
|||
Land
Use Right
Certificate
No.
|
Daqing
Guo Yong (2008) No.
02-31415
|
Daqing
Guo Yong (2008) No.
02-31383
|
Daqing
Guo Yong
(2008)
No. 02-31396
|
|||
User
of the Land
|
Qingkelong
|
Qingkelong
|
Qingkelong
|
|||
Location
|
No.
44 of Jingqi Street,
Dongfeng
Xincun,
Sartu
District
|
No.
44 of Jingqi Street,
Dongfeng
Xincun,
Sartu
District
|
Shangfu
No. 4 Building 7,
Wanbao
No. 2
Community
Sartu District
|
|||
Usage
|
Commercial
Use
|
Commercial
Use
|
Commercial
Use
|
|||
Area
(square meters)
|
68.5
|
503.6
|
1,242.58
|
|||
Form
of Acquisition
|
Transferred
Land
|
Transferred
Land
|
Transferred
Land
|
|||
Expiration
Date
|
2043-6-19
|
2043-6-19
|
2048-3-10
|
|||
Encumbrances
|
None
|
None
|
None
|
* There
are mortgages on this land, which encumber the land use rights.
Owned
Premises
1
|
2
|
3
|
4
|
|||||
Certificate
No.
|
Qing
Fang Quan
Zheng
Sartu District
Zi
No.
NA337278
|
Qing
Fang Quan
Zheng
Sartu District
Zi
No.
NA337270
|
Qing
Fang Quan
Zheng
Sartu District
Zi
No.
NA229912
|
Qing
Fang Quan
Zheng
Sartu
District
Zi
No.
NA221332
|
||||
Owner
|
Qingkelong
|
Qingkelong
|
Qingkelong
|
Qingkelong
|
||||
Location
|
Shangfu
No. 4,
Building
7, Wanbao
No.
2 Community,
Sartu
District
|
No.
44 of
Jing
Qi Street,
Dongfeng
Xincun,
Sartu
District
|
No.
44 of
Jing
Qi Street, Sartu
District
|
No.
5, 6, 7,
Ground
Floor, 3-36A,
Dongfeng
Xincun,
Sartu
District
|
||||
Category
|
Owned
by Joint Stock
Company
|
Owned
by Joint Stock
Company
|
Owned
by joint stock
company
|
Private
|
||||
Area
(square meters)
|
1,872.62
|
1,500
|
6,674.43
|
137.57
|
||||
Encumbrances
|
Mortgaged
to Daqing
Commercial
Bank
with
the guaranty
value
of RMB
4,369,010
from
December
12, 2008 to
November
20, 2010
|
Mortgaged
to Daqing
Commercial
Bank
with
the guaranty
value
of RMB
4,549,545
from
December
12, 2008 to
November
20, 2010
|
Mortgaged
to Daqing
Commercial
Bank
with
the guaranty
value
of RMB
27,600,000
from June
18,
2009 to June 18,
2011
|
Mortgaged
to Daqing
Commercial
Bank
with
the guaranty
value
of RMB
481,445
from
December
12, 2008 to
November
20,
2010
|
57
Leased
Premises
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year
(Yuan)
|
||||
1
|
Daqing
Longfeng Shopping Center Company Limited
|
First
Floor of Longfeng Shopping Center
|
5-1-2000
to
5-1-2010
|
200,000
|
||||
*2
|
Daqing
Hongyun Shopping Center
|
Department
Store of Chengxin En Cum Second Community of Chengxin, Ranghu
Road
|
2-1-2009
to
1-31-2012
|
400,000
|
||||
3
|
Nonggongshang
Branch of Transportation Company
|
Xizhai
Market of Longnan Qiushi Road (2,650m2,
additional 137 m2
)
|
2003-2-15
to
2011-2-15
|
700,000
for years 1-2;
750,000
for years 3-6;
800,000
for years 7-8.
|
||||
4
|
Hengmao
Company of Daqing Oilfield
|
Cheng
Bei Qi Street, Rang District, Daqing
|
2002-12-15
to
2010-12-15
|
350,000
|
||||
5
|
Yixi
Huayou Store
|
Operation
Area, warehouse, three rooms for Office, West of Huayou Road, Yixi Xinghua
Street, Longfeng District
|
2003-1-1
to
2013-1-1
|
270,000
|
||||
*6
|
Petro
China Daqing Petro Chemical Company
|
Second
and third Floor of Yixi Huayou Shopping Center (1,620 m2)
|
2008-1-1
to
2018-1-1
|
300,000
|
||||
7
|
Yigeng
Property Management Company of Daqing Development Zone
|
Shidai
Lijing Building 107# (135 m2
)
|
2003-4-20
to
2011-4-20
|
Free
for first 2 years,
30,000
for last 6 years
|
||||
8
|
Zhaodong
Yibai Company Limited
|
South
of Xinjian Yibai Building, Nanerdao Street, East of Zhengyang Street,
Zhaodong
|
2004-1-1
to
2014-1-1
|
300,000
|
||||
9
|
Haibo
Zhao
|
Room
201, 2nd
Floor, Building 1, Hubin Community, Sartu District
|
2005-1-1
to
2015-1-1
|
20,000
|
||||
10
|
Hui
Hu
|
Room
326, 2nd
Floor, Building 1, Hubin Community, Sartu District
|
2005-1-1
to
2015-1-1
|
10,000
|
||||
11
|
Yajuan
Wu
|
No.
15 (first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
12
|
Yajuan
Wu
|
No.
14 (first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
13
|
Yingtian
Li
|
No.
9 (first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
14
|
Shuzhi
Liang
|
No.
13 (first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
15
|
Runzhi
Chen
|
No.
10 (first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
16
|
Xiaoguang
Qin
|
No.
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
||||
17
|
Qing
Xiao & Hong Xiao
|
No.
(first and second floor), Building 1, Hubin Community, Sartu
District
|
2005-1-1
to
2015-1-1
|
80,000
|
58
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year
(Yuan)
|
||||
*18
|
Logistics
Company of Daqing Oilfield
|
No.
7 Qinfen East Road, Sartu District, Daqing
|
2006-1-1
to
2010-12-31
|
252,000/year,
(total fee: 1,260,000)
|
||||
19
|
Daqing
Beichen Real Estate Development Company Limited
|
First
Floor of Lüse Jiayuan Guild Hall, Xuewei Road, Daqing (1,450.22 m2
)
|
2005-12-1
to
2015-12-1
|
Free
for first to third years and 114,300 for fourth to tenth
years
|
||||
20
|
Yichun
Mengke Shopping Center
|
First
Floor of Basement, Mengke Shopping Center No. 62, Tonghe Road,
Yichun
|
2006-3-5
to
2021-3-5
|
Free
for first year, 200,000 for second year, 300,000 for third to fifth years,
400,000 for sixth to tenth years and 500,000 for eleventh to fifteenth
years
|
||||
21
|
Jixi
Green Sea Consuming Goods Market
|
Ground
Floor, Jixi Green Sea Square
|
2006-6-11
to
2016-6-11
|
700,000
|
||||
22
|
Mengke
Real Estate Development Company Limited
|
Buildings
and facilities at Jiyuan Culture Square, Yanchuan South Street,
ACheng
|
2006-8-20
to
2021-8-20
|
350,000
for first to fifth years, and 400,000 for sixth to tenth years, and
2,100,000 for the remaining years
|
||||
23
|
Guifen
Zhao
|
Basement
1 of Dongfeng Garden 3, Donfeng Road, Jiguan District, Jixi (2,700 m2
)
|
2007-1-1
to
2017-1-1
|
600,000
|
||||
24
|
Daqing
Factory for SINOFECT
|
Zone
8, Xinhua Village, Longfeng District (2,800 m2
)
|
2006-12-14
to
2010-12-13
|
260,000
|
||||
25
|
Heilongjiang
Beidahuang Food and Oil Wholesale Company Limited
|
No.
41 Xiangdian Street, Xiangfang District, Harbin (2,950 m2
)
|
2006-10-15
to
2016-10-14
|
720,000
for years 1-3, 735,000 for years 4-6, and 750,000 for years
7-10
|
||||
26
|
Qiquan
Zhou
|
Songjiang
Mingzhu Shopping Center, West of Zhongyang St. Zhaoyuan County, Heilong
jiang
|
2008-4-10
to
2018-4-09
|
84,000
for 1st
to 3rd
years; 89,375 for 4th
to 6th
years; and 94,750 for 7th
to 10th
years
|
||||
27
|
Suihua
Fudu Construction and Installation Ltd.
|
Zhongxing
East Road, Suihua No. 79-81 Zhongyang Blvd. Ranghu District, Daqing,
China
|
2008-7-1
to
2018-6-30
|
800,000
for 1st
to 3rd
years, 850,000 for 4th
to 6th
years, and 900,000 for 7th
to 10th
years
|
||||
28
|
Beiya
Construction and Development Ltd. Of Qitaihe
|
Kanghua
St. Boli County, Heilongjiang, China
|
2008-10-30
to
2023-10-30
|
1,100,000
for 1st
to 5th
years, 1,200,000for 6th
to 15th
years.
|
||||
29
|
Mo
Xu
|
No.
78 Zhongyang Blvd.
Ranghulu
District, Daqing
|
5-20-2008
to
6-20-2016
|
530,000
for 1st
to 3rd
years,
560,000
for 4th
to 8th
years,
|
||||
30.
|
Shujun
Wang
|
No.
78 Zhongyang Blvd. Ranghulu District, Daqing
|
5-20-2008
to
6-20-2016
|
530,000
for 1st
to 3rd
years, and
560,000
for 4th
to 8th
years
|
59
No.
|
Lessor
|
Location
of Building
|
Term
|
Rent
per Year
(Yuan)
|
||||
31.
|
Lexi
Xu
|
No.
78 Zhongyang Blvd. Ranghulu District, Daqing
|
6-20-2008
to
6-20-2016
|
540,000
for 1st
to 3rd
years, and
580,000
for 4th
to 8th
years
|
||||
32.
|
Yusheng
Cheng
|
No.
78 Zhongyang Blvd. Ranghulu District, Daqing
|
5-20-2008
to
6-20-2016
|
74,000
per year
|
||||
33.
|
Alateng
Shopping Center Co. Ltd.
|
Alateng
Shopping Center
|
9-1-2008
to
8-31-2023
|
700,000
|
||||
34.
|
Zhaodong
Huafu Pharmaceutical Co. Ltd.
|
South
of the Crossing between No. 9 Street and Zhengyang Street,
Zhaodong
|
11-01-2008
to
10-31-2018
|
1,800,000
for 1st
to 2nd
years, and
900,000
since 3rd
year
|
||||
35.
|
Lin
Dian Lianyi Commerce Co. Ltd.
|
The
crossing between Hexiang Road and Daqi Street, Lidian
County
|
1-1-2009
to
12-31-2024
|
using
area x 0.4/m2 x
365 for 1st
to 5th
year using area x 0.45/m2 x
365 for 6th
to 10th
years using area x 0.5/m2 x
365 for 11th
to 15th
years
|
||||
36.
|
Daqing
Wanbao Property Management Co. Ltd.
|
Third
Community of Wanbao Zone, Sartu District, Daqing
|
4-10-2003
to
10-4-2013
|
90,000
for 1st
year
110,000
for 2nd
year
120,000
for 3rd
year
150,000
for 4th
to 10th
years
|
LEGAL
PROCEEDINGS
Neither
we nor any of our subsidiaries is a party to any pending legal
proceedings.
60
OUR
HISTORY AND CORPORATE STRUCTURE
Organizational
History of QKL Stores Inc.
Prior to
June 18, 2008, QKL Stores Inc. was known as Forme Capital, Inc.
Forme
Capital, Inc. (“Forme”) was incorporated in Delaware on December 2, 1986. Prior
to 1989, Forme’s only activity was the creation and spinning off to its
stockholders of nine blind pool companies, or companies with no specified
business plan. From 1989 to 1998, Forme was a real estate company. From 1999 to
2000, Forme invested in fine art. From 2000 to 2007, Forme had no operations or
substantial assets. Accordingly, Forme was deemed to be a “blank check” or shell
company, that is, a development-stage company that has no significant non-cash
assets and either has no specific business plan or purpose or has indicated that
its business plan is to engage in a merger or other acquisition with an
unidentified company.
On
November 13, 2007, Forme filed an Amended and Restated Certificate of
Incorporation to change the number of shares of stock that it was authorized to
issue to 100,000,000 shares of common stock, par value $0.001 per share, and
100,000,000 shares of preferred stock, par value $0.01 per share. The change
became effective on December 5, 2007.
We have
no operations or substantial assets other than those of QKL-China, over which we
acquired control in the reverse merger transaction discussed below. Prior to the
reverse merger transaction, our business plan was to seek out and obtain
candidates with which we could merge or whose operations or assets could be
acquired through the issuance of common stock and possibly debt.
The
Reverse Merger Transaction
On March
28, 2008, we completed a number of related transactions through which we
acquired control of QKL-China: (i) a restructuring transaction which granted
control of QKL-China to another PRC entity, Speedy Brilliant (Daqing), and (ii)
a share exchange transaction, which transferred ownership and control of Speedy
Brilliant (Daqing) to us.
We refer
to the restructuring transaction and the share exchange transaction together as
the “reverse merger transaction.” The purpose of the reverse merger was to
acquire control of QKL-China. We did not acquire QKL-China directly by either
issuing stock or paying cash for QKL-China (or for Speedy Brilliant (Daqing))
because under PRC law it is uncertain whether a share exchange would be legal,
and the terms of a cash purchase would not have been favorable. Speedy Brilliant
(Daqing) did not acquire QKL-China directly, by either issuing its own stock or
paying cash for QKL-China, because under PRC law it is uncertain whether such a
share exchange would be legal, and the terms of a cash purchase would not have
been favorable to Speedy Brilliant (Daqing).
We
instead chose to acquire control of QKL-China through the contractual
arrangements described below because alternative methods of acquisition -
specifically, the acquisition of QKL-China outright either by share exchange or
by cash payment - was not available or advisable as described above. Acquisition
of QKL-China by share exchange was not available to Speedy Brilliant (Daqing)
because (i) Speedy Brilliant (Daqing) is wholly owned by Speedy Brilliant (BVI),
a British Virgin Islands company, and is therefore a wholly foreign-owned entity
under PRC law, (ii) wholly foreign-owned entities are, under PRC law, treated as
foreign entities for relevant regulatory purposes, and (iii) under PRC laws that
became effective on September 8, 2006, it is uncertain both what procedures must
be used in order for a foreign entity to acquire a PRC entity by share exchange
and whether such an acquisition would have binding legal effect in the PRC.
Acquisition of QKL-China for cash was not advisable for Speedy Brilliant
(Daqing) because the terms of such a cash acquisition, including (i) a purchase
price for QKL-China determined under PRC law and (ii) the terms of a financing
transaction in which we would raise the funds to pay the purchase price, would
not have been favorable to Speedy Brilliant (Daqing).
61
PRC
Restructuring Agreements
The PRC
restructuring transaction was effected by the execution of five agreements
between Speedy Brilliant (Daqing), on the one hand, and QKL-China (and in some
cases the shareholders of QKL-China), on the other hand. Those five agreements
and their consequences are described below.
Consigned
Management Agreement
The
Consigned Management Agreement among Speedy Brilliant (Daqing), QKL-China and
all of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing)
will provide financial, business management and human resources management
services to QKL-China that will enable Speedy Brilliant (Daqing) to control
QKL-China’s operations, assets and cash flow, and in exchange, QKL-China will
pay a management fee to Speedy Brilliant (Daqing) equal to 4.5% of QKL-China’s
annual revenue. The management fee for each year is due by January 31 of the
following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
Technology
Service Agreement
The
Technology Service Agreement among Speedy Brilliant (Daqing), QKL-China and all
of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing) will
provide technology services, including the selection and maintenance of
QKL-China’s computer hardware and software systems and training of QKL-China
employees in the use of those systems, and in exchange QKL-China will pay a
technology service fee to Speedy Brilliant (Daqing) equal to 1.5% of QKL-China’s
annual revenue. The technology service fee for each year is due by January 31 of
the following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
Loan
Agreement
The Loan
Agreement among Speedy Brilliant (Daqing) and all of the shareholders of
QKL-China, provides that Speedy Brilliant (Daqing) will make a loan in the
aggregate principal amount of RMB 77 million (approximately $11.2 million) to
the shareholders of QKL-China, each shareholder receiving a share of the loan
proceeds proportional to its shareholding in QKL-China, and in exchange each
shareholder agreed (i) to contribute all of its proceeds from the loan to the
registered capital of QKL-China in order to increase the registered capital of
QKL-China, (ii) to cause QKL-China to complete the process of registering the
increase in its registered capital with PRC regulatory authorities within 30
days after receiving the loan, and (iii) to pledge their equity to Speedy
Brilliant (Daqing) under the Equity Pledge Agreement described
below.
The loan
is repayable by the shareholders at the option of Speedy Brilliant
(Daqing) either by the transfer of QKL-China’s equity to Speedy Brilliant
(Daqing) or through proceeds indirectly from the transfer of QKL-China assets to
Speedy Brilliant (Daqing). The loan does not bear interest, except that if (x)
Speedy Brilliant (Daqing) is able to purchase the equity or assets of QKL-China,
and (y) the lowest allowable purchase price for that equity or those assets
under PRC law is greater than the principal amount of the loan, then, insofar as
it is allowable under PRC law, interest will be deemed to have accrued on the
loan in an amount equal to the difference between the lowest allowable purchase
price for QKL-China and the principal amount of the loan. The effect of this
interest provision is that, if and when permitted under PRC law, Speedy
Brilliant (Daqing) may acquire all of the equity or assets of QKL-China by
forgiving the loan, without making any further payment. If the principal amount
of the loan is greater than the lowest allowable purchase price for the equity
or assets of QKL-China under PRC law, then Speedy Brilliant (Daqing) would
exempt the shareholders from paying the difference between the two amounts. The
effect of this provision is that (insofar as allowable under PRC law) the
shareholders of QKL-China may satisfy their repayment obligations under the loan
by transferring all of QKL-China’s equity or assets to Speedy Brilliant
(Daqing), without making any further payment.
62
The Loan
Agreement also contains promises from the shareholders of QKL-China that during
the term of the agreement they will elect as directors of QKL-China only
candidates nominated by Speedy Brilliant (Daqing), and they will use their best
efforts to ensure that QKL-China does not take certain actions without the prior
written consent of Speedy Brilliant (Daqing), including (i) supplementing or
amending the articles of association or rules of QKL-China, or of any subsidiary
controlled or wholly owned by it, (ii) increasing or decreasing its registered
capital or shareholding structure, (iii) transferring, mortgaging or disposing
of any interests in its assets or income, or encumbering its assets or income in
a way that would affect Speedy Brilliant (Daqing)’s security interest unless
required for QKL-China’s normal business operations, (iv) incurring or
succeeding to any debts and liabilities, (v) entering into any material contract
(exceeding RMB 5.0 million, or approximately $0.7 million, in value); (vi)
providing any loan or guarantee to any third party; (vii) acquiring or
consolidating with any third party, or investing in any third party; and (viii)
distributing any dividends to the shareholders in any manner. In addition, the
Loan Agreement provides that at Speedy Brilliant (Daqing)’s request, QKL-China
will promptly distribute all distributable dividends to its
shareholders.
The funds
that Speedy Brilliant (Daqing) used to make the loan came from the proceeds
received by us, its indirect parent company, in the private placement
transaction completed in March 2008.
Exclusive
Purchase Option Agreement
The
Exclusive Purchase Option Agreement, among Speedy Brilliant (Daqing), QKL-China,
and all of the shareholders of QKL-China, provides that QKL-China will grant
Speedy Brilliant (Daqing) or its designated third party an irrevocable and
exclusive right to purchase all or part of QKL-China’s assets, and the
shareholders of QKL-China will grant Speedy Brilliant (Daqing) or its designated
third party an irrevocable and exclusive right to purchase all or part of their
equity interests in QKL-China. Either right may be exercised by Speedy Brilliant
(Daqing) in its sole discretion at any time that the exercise would be
permissible under PRC law, and the purchase price for Speedy Brilliant
(Daqing)’s acquisition of equity or assets will be the lowest price permissible
under PRC law. QKL-China and its shareholders are required to execute purchase
agreements and related documentation within 30 days of receiving notice from
Speedy Brilliant (Daqing) that it intends to exercise its right to
purchase.
The
Exclusive Purchase Option Agreement contains promises from QKL-China and its
shareholders that they will refrain from taking actions, such as voting to
dissolve or declaring dividends, that could impair Speedy Brilliant (Daqing)’s
security interest in the equity of QKL-China or reduce its value. These promises
are substantially the same as those contained in the Loan Agreement described
above.
The
agreement will remain effective until Speedy Brilliant (Daqing) or its designees
have acquired 100% of the equity interests of QKL-China or substantially all of
the assets of QKL-China. The exclusive purchase options were granted under the
agreement on the closing date.
Equity
Pledge Agreement
The
Equity Pledge Agreement, among Speedy Brilliant (Daqing), QKL-China, and all of
the shareholders of QKL-China, provides that the shareholders of QKL-China will
pledge all of their equity interests in QKL-China to Speedy Brilliant (Daqing)
as a guarantee of the performance of the shareholders’ obligations and
QKL-China’s obligations under each of the other PRC Restructuring Agreements.
Under the Equity Pledge Agreement, the shareholders of QKL-China have also
agreed (i) to cause QKL-China to have the pledge recorded at the appropriate
office of the PRC Bureau of Industry and Commerce, (ii) to deliver any dividends
received from QKL-China during the term of the agreement into an escrow account
under the supervision of Speedy Brilliant (Daqing), and (iii) to deliver
QKL-China’s official shareholder registry and certificate of equity contribution
to Speedy Brilliant (Daqing).
The
Equity Pledge Agreement contains promises from QKL-China and its shareholders
that they will refrain from taking actions, such as voting to dissolve or
declaring dividends, that could impair Speedy Brilliant (Daqing)’s security
interest in the equity of QKL-China or reduce its value. These promises are
substantially the same as those contained in the Loan Agreement described
above.
63
Completion
of the PRC Restructuring
The PRC
restructuring transaction closed on March 28, 2008 and after the closing date,
Speedy Brilliant (Daqing) completed all required post-closing steps, including
the payment and verification of all the installments of Speedy Brilliant
(Daqing)’s registered capital.
The
remaining portion of Speedy Brilliant (Daqing)’s registered capital was
contributed and verified by August 1, 2009, two years after the issuance of its
business license.
Share
Exchange Transaction
In the
share exchange transaction, Forme acquired control of Speedy Brilliant (BVI), a
British Virgin Islands holding company and the parent company of Speedy
Brilliant (Daqing), by issuing to the stockholders of Speedy Brilliant (BVI)
shares of common stock in exchange for all of the outstanding capital stock of
Speedy Brilliant (BVI). The stockholders of Speedy Brilliant (BVI) with whom we
completed the share exchange were (i) the majority holder, Winning State
International Limited, a British Virgin Islands holding company (“Winning State
(BVI)”) all of whose stock may be acquired in the future by our Chief Executive
Officer, Mr. Zhuangyi Wang, pursuant to a currently exercisable call option held
by Mr. Wang and (ii) three minority stockholders, Ms. Fang Chen, Mr. Yang Miao,
and Ms. Ying Zhang. Mr. Wang has exercised his call option and all of the shares
of Winning State (BVI) were transferred from Mr. Yap to Mr. Wang on February 2,
2010.
Share
Exchange Agreement
On March
28, 2008, Forme entered into a share exchange agreement with (i) Speedy
Brilliant (BVI); (ii) Speedy Brilliant (Daqing); (iii) the owners of all of the
outstanding voting stock of Speedy Brilliant (BVI), namely (a) Winning State
(BVI) (a company that is wholly owned and controlled by Mr. Chin Yoke Yap (all
of whose stock was acquired by our CEO, Mr. Zhuangyi Wang, pursuant to a call
option held by Mr. Wang that he exercised on February 2, 2010)), which owned
approximately 98.5% of the Speedy Brilliant (BVI) stock, and (b) three
individuals, Ms. Fang Chen, Ms. Yang Miao and Ms. Ying Zhang, who collectively
owned approximately 1.5% of the Speedy Brilliant (BVI) stock; and (iv) Forme’s
then controlling stockholders, Vision Opportunity China LP, Stallion Ventures,
LLC, and Castle Bison, Inc. Under the terms of the share exchange agreement, the
Speedy Brilliant (BVI) stockholders exchanged all of the outstanding shares of
Speedy Brilliant (BVI) for a total of 19,382,298 newly issued shares of Forme
common stock. As a result of the share exchange, Forme acquired Speedy Brilliant
(BVI) as a wholly owned subsidiary, and the Speedy Brilliant (BVI) stockholders
became holders of 92.8% of our common stock on a non-diluted basis (64.6% of our
common stock assuming conversion of our newly-issued Series A Preferred Stock
and 46.3% of our common stock assuming conversion of our newly-issued Series A
Preferred Stock and exercise of all of the Series A Warrants and Series B
Warrants).
In the
PRC restructuring transaction described above, Speedy Brilliant (BVI) gained
control of our operating company, QKL-China. Therefore, when we acquired control
of Speedy Brilliant (BVI) in the share exchange, we acquired indirect control of
QKL-China. As a result, at the time of the share exchange, (i) we ceased to be a
shell company as that term is defined in Rule 12b-2 under the Exchange Act, (ii)
Speedy Brilliant (BVI) became our wholly owned subsidiary, and (iii) through our
newly-acquired indirect subsidiary Speedy Brilliant (Daqing) we now control,
through the contractual arrangements described above.
64
Our
current structure, after completion of the reverse merger transaction, is set
forth in the diagram below:
Private
Placement Transaction
The
other transaction we completed on March 28, 2008 was a private placement in
which we raised funds through a private sale of securities that was exempt from
the registration requirements under Section 4(2) of the Securities Act as a
result of our compliance with Rule 506 of Regulation D promulgated under the
Securities Act. In the private placement we sold to certain accredited
investors, for gross proceeds to us of $15.5 million, 9,117,647 units, each unit
consisting of one share of Series A Preferred Stock (each of which is
convertible into one share of our common stock), a 0.625 interest in a Series A
Warrant and a 0.625 interest in a Series B Warrant.
The
agreements through which the private placement were carried out are described in
detail below, all of which were entered into on March 28, 2008 unless otherwise
indicated.
Securities
Purchase Agreement
The
securities purchase agreement among Vision Opportunity Master Fund Ltd. (“Vision
Master”), Vision Opportunity China Fund Limited (together with Vision Master,
“Vision”) and certain other investors listed in Exhibit A thereto involved the
sale of an aggregate of 9,117,647 units, each unit consisting of one share of
Series A Preferred Stock, a 0.625 interest in a Series A Warrant and a 0.625
interest in a Series B Warrant. The closing of the private placement transaction
and the securities purchase agreement was contingent upon and dependent on the
closing of the reverse merger transaction. Each share of Series A Preferred
Stock is convertible into one share of common stock subject to adjustment as
described below. Each warrant is exercisable for one of common stock or an
aggregate of up to 11,397,058 shares of common stock. The Series A Warrants are
exercisable for up to 5,698,529 shares of common stock and have an exercise
price of $3.40 per share, subject to adjustment. The Series B Warrants are
exercisable for up to 5,698,529 shares of common stock and have an exercise
price of $4.25 per share, subject to adjustment. The warrants expire on March
28, 2013, which is five years from the date of issuance.
The terms
of our Series A Preferred Stock are set forth in a Certificate of Designations,
which we filed with the Secretary of State of the State of Delaware on March 13,
2008. For more information regarding the material terms of Series A Preferred
Stock, see the section of this report entitled “Description of our Securities”
under the subheadings “Preferred Stock” and “Terms of Series A Preferred
Stock.”
65
Securities
Escrow Agreement
The
securities escrow agreement among Vision, as representative of the purchasers
under the securities purchase agreement, Winning State (BVI), and Loeb &
Loeb LLP, as escrow agent, was entered into as an inducement to the purchasers
to enter into the securities purchase agreement. Winning State (BVI) agreed to
deliver 18,235,294 shares of our common stock owned by Winning State (BVI) as
escrow shares (the “Escrow Shares”) to the escrow agent for the benefit of the
purchasers, and to deliver some or all of those shares to the purchasers in the
event the Company fails to achieve certain financial performance thresholds for
the 12-month periods ending December 31, 2008 and December 31,
2009.
The
financial performance thresholds for 2008 required that the Company achieve (i)
both net income and cash from operations greater than $9.4 million and (ii)
fully diluted earnings per share equal to or greater than $0.23. Under the terms
of the agreement these thresholds were met if the Company achieved at least 95%
thereof. The Company reported net income of $9.0 million, cash from operations
of $18.7 million and diluted earnings per share of $0.29 for 2008, and therefore
the thresholds for 2008 were met by the Company. Accordingly, all of the Escrow
Shares remain in escrow, pending the performance of the 2009 performance
thresholds described below.
The
financial performance thresholds for 2009 will be satisfied if the Company
achieves (i) both net income and cash from operations of greater than $11.15
million and (ii) fully diluted earnings per share of $0.27. On April 1, 2010 the
securities escrow agreement was amended to exclude amounts recorded as
liabilities under ASC815. At December 31, 2009, excluding amounts recorded as
liabilities under ASC815, the Company had net income of $10.9 million, cash from
operations of $10.9 million and fully diluted earnings per share of
$0.34.
Because
we achieved at least 95% of each of the 2009 performance thresholds, all of the
2009 escrow shares have been returned to Winning State (BVI).
For
purposes of determining the performance thresholds described above, fully
diluted earnings per share was calculated by (x) dividing the lesser of net
income and cash from operations, as reported in our 2009 financial statements
plus any amounts that may have been recorded as charges or liabilities on the
2009 financial statements due to the application of Emerging Issues Task Force
Issue No. 00-19 that are associated with (1) any outstanding warrants issued in
connection with the Securities Purchase Agreement or (2) any liabilities created
as a result of the escrow shares being released to any of our officers or
directors by (y) the aggregate number of shares of our then outstanding common
stock on a fully-diluted basis which number includes, without limitation, the
number of shares of common stock issuable upon conversion of the then
outstanding shares of Series A Preferred Stock and the number of shares of
common stock issuable upon the exercise of any then outstanding preferred stock,
warrants or options of the Company.
Investor
and Public Relations Escrow Agreement
We also
entered into an investor and public relations agreement with Vision Opportunity
China LP, as representative of the purchasers under the securities purchase
agreement, and Loeb & Loeb LLP, as escrow agent. Under the agreement,
$300,000 of the proceeds of the private placement was deposited into an escrow
account with Loeb & Loeb LLP for use in investor and public
relations.
Settlement
Agreement
On
January 22, 2008, QKL terminated its engagement agreement with Kuhns Brothers to
provide QKL with investment banking services, on an exclusive basis, with
respect to the private placement transaction and the share exchange transaction,
and the parties executed a settlement agreement. Under the terms of the
settlement agreement, we were required to pay Khuns Brothers (i) a cash fee
equal to 8.5% of the gross proceeds invested in the financing by investors
introduced to the Company by Kuhns Brothers, Inc. (“Introduced Investors”), and
(ii) warrants to purchase up to a number of shares of common stock of the
Company equal to 8.5% of the dollar amount of the shares purchased by the
Introduced Investors divided by the per-share purchase price of the common stock
or preferred stock in the financing. The warrants have the same terms as
warrants received by the Introduced Investors. Accordingly, Kuhns Brothers
received from us a cash fee of $1,300,500, Series A Warrants to
purchase 191,250 shares of our common stock and Series B Warrants to purchase
153,000 shares of our common stock.
66
Lock-Up
Agreement
In
connection with the private placement we also entered into an agreement with
Winning State (BVI) under which, in order to induce Forme to enter into the
share exchange agreement, certain stockholders including Mr. Zhuangyi Wang, our
CEO and Mr. Xudong Wang, our former CFO, agreed that (i) they would not sell or
transfer any shares of our common stock until at least 12 months after the
effective date of a registration statement filed with the SEC registering for
resale the shares of common stock underlying the Series A Preferred Stock issued
in the private placement transaction and (ii) for an additional 24 months after
the end of that 12 month period, would not sell or transfer more than
one-twelfth of its total shares of that common stock during any one
month.
Agreements
Executed in Connection with Our Public Offering
Waiver
to Registration Rights Agreement
On
October 16, 2009, Vision Opportunity China LP, as representative of the
purchasers listed on Schedule I to the Registration Rights Agreement dated as of
March 28, 2008, agreed to waive the notice and piggyback registration rights
provided by the Registration Rights Agreement solely with respect to our
November 2009 public offering of 6,900,000 shares of our common stock at a price
of $5.75 per share that raised aggregate net proceeds of $39.7
million.
Waiver
to Securities Purchase Agreement
On
October 16, 2009, Vision Opportunity China LP, as representative of the
purchasers listed on Schedule A to the Securities Purchase Agreement dated as of
March 28, 2008, agreed to waive the notice and preemption rights provided by the
Securities Purchase Agreement, solely with respect to our November 2009 public
offering of 6,900,000 shares of our common stock at a price of $5.75 per share
that raised aggregate net proceeds of $39.7 million.
Amendment
to Securities Escrow Agreement
On
October 15, 2009, we entered into an Amendment to Securities Escrow Agreement,
amending the Securities Escrow Agreement dated March 28, 2008, by and among the
Company, Vision Opportunity China LP as representative of the Purchasers,
Winning State Investment Limited and Loeb & Loeb LLP, as escrow agent, to
revise the definition of “Net income” and “Cash from Operations” for the fiscal
year ended December 31, 2009 to exclude the one time non-recurring cash expenses
incurred by us in connection with this offering and the transactions
contemplated by this offering that were not contemplated by the Securities
Escrow Agreement.
Lock-Up
Letters
On
October 15, 2009, in connection with the offering and in order to induce Roth
Capital Partners, LLC to act as our underwriter, each of our directors and
executive officers, and Winning State (BVI) agreed that, without the prior
written consent of Roth Capital Partners, LLC, they would not, during the period
commencing on October 15, 2009 and ending 180 days after the date of the final
prospectus relating to our public offering (i) either directly or indirectly
sell, pledge, lend or transfer any shares of our common stock or any securities
convertible into or exercisable or exchangeable for our common stock, subject to
certain exclusions, or (ii) make any demand for or exercise any right with
respect to the registration of any shares of common stock or any security
convertible into or exercisable or exchangeable for shares of common
stock.
Anti-dilution
Agreements
On March
24, 2010, we entered into a Warrant Amendment (“Series A Warrant Amendment”) to
the Series A Warrant to Purchase Shares of Common Stock of the Company (“Series
A Warrant”) with Vision Opportunity China LP, pursuant to which certain
anti-dilution provisions of the Series A Warrants were removed on behalf of the
Series A Warrant holders. Pursuant to the Series A Warrant Amendment, we
agreed not to issue any additional shares of common stock or common stock
equivalents, except as otherwise contemplated by the Series A Warrant, at a per
share price less than the exercise price then in effect, without the prior
written consent of holders of a majority of the Series A Warrants at such
time.
67
On March
24, 2010, we entered into a Warrant Amendment (“Series B Warrant Amendment”) to
the Series B Warrant to Purchase Shares of Common Stock of the Company (“Series
B Warrant”) with Vision Opportunity China LP, pursuant to which certain
anti-dilution provisions of the Series A Warrants were removed on behalf of the
Series A Warrant holders. Pursuant to the Series B Warrant Amendment, we
agreed not to issue any additional shares of common stock or common stock
equivalents, except as otherwise contemplated by the Series B Warrant, at a per
share price less than the exercise price then in effect, without the prior
written consent of holders of a majority of the Series B Warrants at such
time.
On March
25, 2010, we entered into a Waiver (“Waiver”) to the Certificate of
Designations, Preferences and Rights of Series A Convertible Preferred Stock
(“Certificate”) with the holders of our Series A Convertible Preferred Stock,
pursuant to which certain anti-dilution protections of the Certificate were
waived. We plan to amend the Certificate to state that we will not issue
any additional shares of common stock or common stock equivalents, except as
otherwise contemplated by the Certificate, at a conversion price less than the
conversion price then in effect for the Series A Preferred Stock, without the
prior written consent of holders of a majority of the Series A Warrants at such
time.
68
MARKET
PRICE OF COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market
Information
On
October 21, 2009, our common stock was listed on NASDAQ under the symbol
“QKLS.” Prior to that date our common stock was traded on the
OTCBB.
The
following table sets forth the high and low bid prices, on the OTCBB, as
reported and summarized by the OTCBB, or NASDAQ, as applicable, for each fiscal
quarter during the fiscal years ended December 31, 2010 and 2009 and for the
first (through February 15th) quarter of 2011.
Quarter Ended
|
High
|
Low
|
||||||
2011:
|
||||||||
First
Quarter (through February 15th)
|
$
|
3.82
|
$
|
3.13
|
||||
2010:
|
||||||||
First
Quarter
|
$
|
7.09
|
$
|
4.68
|
||||
Second
Quarter
|
6.67
|
4.08
|
||||||
Third
Quarter
|
5.50
|
3.82
|
||||||
Fourth Quarter
|
6.36
|
3.12
|
||||||
2009:
|
||||||||
First
Quarter
|
$
|
2.50
|
$
|
2.50
|
||||
Second
Quarter
|
5.50
|
2.50
|
||||||
Third
Quarter
|
8.75
|
3.50
|
||||||
Fourth
Quarter
|
7.64
|
5.00
|
As
of February 15, 2011, the last reported sale price of our common stock was
$3.26 per share.
As
of February 16, 2011, there were 29,769,590 shares of our common stock and
7,269,549 shares of our Series A Preferred Stock issued and outstanding and we
had approximately 675 shareholders of record of our common stock and five
holders of record of our Series A Preferred Stock. This does not reflect the
number of persons or entities who hold stock in nominee or “street” name through
various brokerage firms.
Dividends
We have
never declared or paid any cash dividends on our common stock and are restricted
from paying dividends by virtue of the fact that we are a holding company. We
currently intend to retain all earnings, if any, for use in business operations
and we do not anticipate declaring any dividends in the near
future.
The
payment of dividends is contingent on the ability of our PRC based operating
subsidiary QKL-China to obtain approval to send monies out of the PRC. The PRC’s
national currency, the Yuan or renminbi, is not a freely convertible currency.
The PRC government imposes controls on the convertibility of renminbi into
foreign currencies and, in certain cases, the remittance of currency out of the
PRC. Shortages in the availability of foreign currency may restrict our ability
to remit sufficient foreign currency to pay dividends.
In
addition, under the terms of Series A Preferred Stock set forth in a Certificate
of Designation which was filed in the office of Secretary of State for the State
of Delaware on March 13, 2008, if we pay dividends on the common stock the
holders of Series A Preferred are entitled to receive dividends on an “as
converted” basis.
69
Securities
authorized for issuance under equity compensation plans
On
September 14, 2009, we adopted the 2009 Omnibus Securities and Incentive Plan
(the “Plan”). The Plan provides for the grant of incentive stock options and
restricted stock awards (the “Awards”). The Plan has not been approved by our
stockholders.
The total
number of shares of common stock that may be issued under the Plan may not
exceed 3,750,000. The total number of shares may be increased annually based
upon the total number of shares of common stock outstanding in subsequent years.
In connection with the private placement we completed in March 2008, we agreed
to limit the number of awards we grant under any stock option, restricted or
other equity incentive plans to no more than 12.5% of the sum of the number of
shares of common stock issued and outstanding and the number of shares of common
stock into which the issued and outstanding shares of Series A Preferred Stock
are convertible at any time.
On
September 14, 2009, the Company issued non-transferable options to three newly
appointed independent directors to purchase an aggregate of 60,000 shares of
common stock at an exercise price of $7.50 per share. The options vest and
become exercisable in three equal amounts on the three subsequent anniversary
dates of the grant. The board of directors approved such grants.
Issuer
Purchases of Equity Securities
None.
Use
of Proceeds from Registered Offering
On
November 27, 2009, we consummated a public offering of 6,000,000 shares of
common stock at a public offering price of $5.75 per share. On December 4,
2009, we consummated a public offering of an additional 900,000 shares of common
stock as a result of the exercise of the over-allotment option. Aggregate gross
proceeds were $39,675,000 and we received net proceeds of approximately $37.4
million from the offering, after deducting underwriting discounts and estimated
offering expenses of $2,275,000.
We
offered the shares sold in the offering pursuant to our registration statement
on Form S-1 (File No. 333-162150), which was declared effective by the SEC on
November 19, 2009. We used approximately $12.8 million of the net proceeds from
the offering to open a new distribution center and new stores, store renovations
and relocations, and the remaining $24.6 million will be used for working
capital and other general corporate purposes, which may include, among other
things, the expansion of our existing capacity and potential
acquisitions.
The
offering was underwritten by Roth Capital Partners, LLC.
70
OWNERS
AND MANAGEMENT
The
following table sets forth certain information with respect to the beneficial
ownership of our voting securities by (i) any person or group owning more than
5% of each class of voting securities, (ii) each director, (iii) each executive
officers and (iv) all executive officers and directors as a group, as
of February 16, 2011.
Name and Address of Beneficial Owner
|
Amount and
Nature of
Beneficial
Ownership (1)
Common
Stock
|
Percentage
of Class (1)(2)
Common Stock
|
||||||
Owners
of More than 5% of Class
|
||||||||
Winning
State International Ltd Road Town, Tortola VG1110 British Virgin Islands
(3)
|
19,082,299
|
64.1
|
%
|
|||||
H.
Philip J. Hempleman (4)
|
1,599,500
|
5.4
|
%
|
|||||
Directors
and Executive Officers (5)
|
||||||||
Mr.
Zhuangyi Wang (Director and CEO) (3)
|
19,082,299
|
64.1
|
%
|
|||||
Mr.
Alan Stewart (Director and COO) (6)
|
20,000
|
*
|
||||||
Mr.
Tsz-Kit Chan (CFO) (7)
|
20,000
|
*
|
||||||
Mr.
Gary Crook (Independent Director)
|
0
|
0
|
||||||
Mr.
Zhiguo Jin (Independent Director)
|
0
|
0
|
||||||
Mr.
Chaoying Li (Independent Director)
|
0
|
0
|
||||||
All
Directors and Executive Officers (6 persons)
|
19,122,299
|
64.2
|
%
|
*
|
Less than
1%.
|
(1)
|
As of February 16, 2011
there were 29,769,590 shares of our common stock issued and outstanding.
In determining beneficial ownership of our common stock as of that date,
the number of shares shown includes shares of our common stock which may
be acquired within 60 days of that date on exercise of warrants or options
or conversion of convertible securities. Unless otherwise stated, each
beneficial owner has sole power to vote and dispose of its shares. None of
the persons named in the table own any shares of preferred stock or
warrants.
|
(2)
|
In determining the percent of
our common stock owned by a person or entity on February 16, 2011 (a) the
numerator is the number of shares of the class beneficially owned by such
person or entity, including shares which may be acquired within 60 days on
exercise of outstanding warrants and conversion of convertible securities,
and (b) the denominator is the sum of (i) the total shares of our common
stock outstanding on that date (29,769,590), plus (ii) the total number of
shares that the beneficial owner may acquire on conversion of preferred
stock and on exercise of warrants and
options.
|
(3)
|
On March 28, 2008, the Company
acquired Speedy Brilliant (BVI) in a share exchange transaction with
Winning State (BVI) and the other stockholders of Speedy Brilliant (BVI).
In the share exchange, we received the Speedy Brilliant BVI shares from
Winning State (BVI) and the other stockholders of Speedy Brilliant (BVI)
and in exchange we issued and delivered to them 19,382,298 of our newly
issued shares of our common stock. Wining State (BVI) received 19,082,299
of those shares. Winning State (BVI) is wholly owned by Mr. Zhuangyi
Wang, our CEO. Accordingly, the 19,082,299 shares of our common stock
issued to Winning State (BVI) as a result of the consummation of the share
exchange are beneficially owned by Mr.
Wang.
|
(4)
|
Based solely on the information
filed with the SEC on Schedule 13G on April 16, 2010 (the “13G”), which
statement was filed by Ardsley Partners Fund II, L.P., a Delaware limited
partnership ("AP II"), with respect to the 680,000 shares of Common Stock,
par value $0.001 per share ("Common Stock") directly owned by it; Ardsley
Partners Institutional Fund, L.P., a Delaware limited partnership
("Ardsley Institutional"), with respect to the 551,200 shares of Common
Stock directly owned by it; Ardsley Partners Renewable Energy Fund, L.P.,
a Delaware limited partnership ("Ardsley Energy"), with respect to the
64,400 shares of Common Stock directly owned by it; Ardsley Offshore Fund,
Ltd., a British Virgin Islands corporation ("Ardsley Offshore"), with
respect to the 119,600 shares of Common Stock directly owned by it;
Ardsley Renewable Energy Offshore Fund, Ltd., a British Virgin Islands
Corporation ("Ardsley Energy Offshore"), with respect to the 27,600 shares
of Common Stock directly owned by it; Ardsley Advisory Partners, a New
York general partnership ("Ardsley") which serves as Investment Manager of
Ardsley Offshore and Ardsley Energy Offshore and as Investment Adviser of
AP II, Ardsley Institutional, Ardsley Energy and a certain managed
account, with respect to the shares of Common Stock directly owned by
Ardsley Offshore, Ardsley Energy Offshore, AP II, Ardsley Institutional,
Ardsley Energy and the managed account; Ardsley Partners I, a New York
general partnership ("Ardsley Partners") which serves as General Partner
of AP II, Ardsley Institutional and Ardsley Energy; and Philip J.
Hempleman ("Mr. Hempleman"), the Managing Partner of Ardsley and Ardsley
Partners, with respect to the shares of Common Stock owned by AP II,
Ardsley Institutional, Ardsley Energy, Ardsley Offshore, Ardsley Energy
Offshore and the managed account and with respect to the shares of Common
Stock owned by certain managed accounts managed by him directly. The
foregoing persons are hereinafter sometimes collectively referred to as
the "Reporting Persons." The address of the business office of each of the
Reporting Persons, with the exception of Ardsley Offshore and Ardsley
Energy Offshore, is 262 Harbor Drive, Stamford, Connecticut 06902. The
address of the registered office of Ardsley Offshore and Ardsley Energy
Offshore is Romasco Place, Wickhams Cay 1, Roadtown Tortola, British
Virgin Islands. Mr. Hempleman has voting and investment control over the
shares of Common Stock held by AP Fund II, LP, Ardsley Institutional,
Ardsley Energy, Ardsley Offshore, and Ardsley Energy Offshore. Mr.
Hempleman is the Managing Partner of Ardsley and Ardsley Partners and in
that capacity directs their operations and therefore may be deemed to be
the indirect "beneficial owner" of the shares of Common Stock owned by
Ardsley Offshore, Ardsley Energy Offshore, AP II, Ardsley Institutional,
Ardsley Energy and the managed accounts. Mr. Hempleman disclaims
beneficial ownership of all of the shares of Common Stock reported in the
13G.
|
(5)
|
The address of each of the
officers and directors named in the table is 1 Nanreyuan Street, Dongfeng
Road, Sartu District, Daqing, 163300 P.R.
China.
|
(6)
|
Represents an option to purchase
20,000 shares of common stock at an exercise price of $4.40 per
share.
|
(7)
|
Represents an option to purchase
20,000 shares of common stock at an exercise price of $3.42 per
share.
|
71
DIRECTORS
AND EXECUTIVE OFFICERS
Our
current executive officers and directors as of the date of this report are as
follows:
Name
|
Age
|
Other positions with Company; other
directorships held in last five years (1)
|
Has served as Company
director/officer since
|
|||
Zhuangyi
Wang
|
50
|
Chief
Executive Officer, Director
|
1998
|
|||
Alan
D. Stewart
|
67
|
Chief
Operating Officer, Director
|
2010
|
|||
Tsz-Kit
Chan
|
34
|
Chief
Financial Officer
|
2010
|
|||
Gary
B. Crook
|
57
|
Director
|
2009
|
|||
Zhiguo
Jin
|
53
|
Director
|
2009
|
|||
Chaoying
Li
|
39
|
Director
|
2009
|
(1) The
biography of each of the nominees below contains information regarding the
business experience of such nominee.
Mr. Zhuangyi
Wang is the founder of QKL-China and since its inception in 1998 has been
its Chief Executive Officer and Chairman of its Board of Directors. From 1998 to
the present, Mr. Wang has also worked as the store manager of one of our
supermarket stores. Mr. Wang received his bachelors degree from Heilongjiang
Radio & TV University in 1984. As our founder and CEO, we believe that Mr.
Wang’s extensive experience in the supermarket industry provides him with
significant insights into our business which make him qualified to be the
Chairman of our Board of Directors.
Mr. Alan D.
Stewart joined the company as Chief Operating Officer in July
of 2008. His professional career includes General Manager – Hypermarket
Division for N.T.U.C. – Fairprice of Singapore (2006-2008); CEO
– Supermarket Division Director of Hypermarket for PT Matahari Putra
Prima of Indonesia (2001-2006); General Manager – Alazizia/ Panda United, Inc.
Saudi Arabia and 32 years with American Stores Inc. of Salt Lake City, Utah in
various positions including President and COO. A graduate of the Advanced
Management Program from Harvard University. We believe that Mr. Stewart’s
extensive experience in supermarket industry in a number of countries provides
him with significant insights into our business which are needed by our Board of
Directors.
Mr. Chan
was appointed as our Chief Financial Officer on October 18, 2010. Mr. Chan is
currently an independent, non-executive Director of New Smart Energy Group
Limited, a Hong Kong main board-listed company, serving as the chairman and a
member of the Audit Committee. Mr. Chan was a partner in a Hong Kong CPA firm,
Albert Wong & Co, from 2007 to 2010, and was a manager at that firm from
2005 to 2007. Mr. Chan graduated from the Hong Kong Polytechnic
University with a bachelor degree in Accountancy in 1998 and also obtained an
MBA from the Chinese University of Hong Kong in 2001. Mr. Chan is a member of
the Association of Chartered Certified Accountants (ACCA) and a fellow member of
the Hong Kong Institute of Certified Public Accountants (HKICPA), and has the
Practising Certificate of Hong Kong SAR. Mr. Chan is also a member of the
American Institute of Certified Public Accountants (AICPA), and holds an active
license in the Colorado State Board of Accountancy.
Mr. Gary
B. Crook was appointed chairman of audit committee of the Company in
September of 2009. Mr. Crook has been a financial consultant since 2005.
Previous engagements included various financial projects for private companies
as well as roles as acting CFO at a publicly traded alternative energy company
and a privately held professional sports and broadcasting firm. Prior to these
roles, he was Senior Vice President of Operations with the INTEQ Group, Inc.
from 2000 to 2005 and Senior Vice President and Chief Financial Officer of SOS
Staffing Services, Inc. from 1995 to 2000. Mr. Crook served as Vice President
and Controller at Food 4 Less Supermarkets in La Habra, California, was the VP
and Controller of Alpha Beta Company from 1986 to 1991, and served in various
positions in American Stores Company in Salt Lake City in Utah from 1979 to
1986. He also served as an independent director and chairman of the audit
committee at Q Comm International, Inc., a technology company traded on the
American Stock Exchange, from 2004 until the company was sold in 2007. Mr. Crook
has a Bachelor’s degree in Business Economics and MBA from the University of
Utah. We believe that Mr. Crook’s experience as CFO of one public and two
private companies and as an independent director of a U.S. public company
provides him with a unique and valuable perspective from which he helps advise
the Board of Directors.
Mr. Zhiguo
Jin was appointed as a director of the Company in September of 2009. Mr.
Jin has been the Chairman of Tsingtao Brewery Company Limited since June 2008.
He joined Tsingtao Beer in 1975. He became the Vice-chairman and President of
Tsingtao Brewery in July 2001. Mr. Jin was profiled as one of the top 10
prominent figures in business by CCTV in 2007. Mr. Jin has spent his entire
career with Tsingtao Beer Group, Ltd. He received a PhD in Natural Science from
Qingdao University and an EMBA from the China Europe International Business
School (CEIBS). We believe that Mr. Jin’s significant experience in beverage
industry in the PRC and familiarity with working in PRC provides him with a
unique and valuable perspective from which he helps advise the Board of
Directors.
72
Mr. Chaoying
Li was appointed as a director of the Company in September of 2009. Mr.
Li is a founding partner of the Han Kun Law Offices, where he has worked since
January 2005. Mr. Li specializes in foreign direct investment, mergers and
acquisitions, public and private financings (equity and debt), incorporation and
corporate restructuring, as well as intellectual property protection. From
August 2001 to December 2004, he was a partner at T&C Law Offices in
Beijing. Prior to that, he was a founder and general counsel of Bookoo, Inc., a
pioneer in the e-book marketplace and one of the first Internet companies in
Greater China to emphasize the management of intellectual property rights.
Before founding Bookoo, Mr. Li spent over four years working for Cha & Cha,
an international law firm. Mr. Li received a Bachelor of Science in Mathematics
in 1995, a Bachelor of Laws in 1996 and a Master of Laws from Peking University.
In 2003, he also obtained a Master of Laws from University of Ottowa. Mr. Li has
written numerous academic and professional articles that have been widely
published internationally and in Mainland China, Taiwan and Hong Kong. We
believe that Mr. Li’s significant experience as a PRC lawyer advising Chinese
companies listing on the stock market in the United States provides him with a
unique and valuable perspective from which he helps advise the Board of
Directors.
All of
our directors will hold their positions on the board until our next annual
meeting of the stockholders and until their respective successors have been
elected or appointed. Officers serve at the discretion of the board of
directors.
There are
no family relationships among our directors and executive officers. There is no
arrangement or understanding between or among our executive officers and
directors pursuant to which any director or officer was or is to be selected as
a director or officer, and there is no arrangement, plan or understanding as to
whether non-management shareholders will exercise their voting rights to
continue to elect the current board of directors.
Our
directors and executive officers have not, during the past ten
years:
|
§
|
had any bankruptcy petition filed
by or against any business of which was a general partner or executive
officer, either at the time of the bankruptcy or within two years prior to
that time;
|
|
§
|
been convicted in a criminal
proceeding and is not subject to a pending criminal
proceeding;
|
|
§
|
been involved in any judicial or
administrative proceeding (not subsequently reversed) in which the person
was found to have committed mail or wire
fraud;
|
|
§
|
been involved in any judicial or
administrative proceeding (not subsequently reversed) in which the person
was found to have violated any law respecting financial institutions or
insurance companies or any settlement of such a proceeding (other than a
settlement between private
litigants);
|
|
§
|
been subject to any disciplinary
sanction or order by a securities or commodities self-regulatory
organization;
|
|
§
|
been subject to any order,
judgment or decree, not subsequently reversed, suspended or vacated, of
any court of competent jurisdiction, permanently or temporarily enjoining,
barring, suspending or otherwise limiting his involvement in any type of
business, securities, futures, commodities or banking activities; or been
found by a court of competent jurisdiction (in a civil action), the
Securities Exchange Commission or the Commodity Futures Trading Commission
to have violated a federal or state securities or commodities law, and the
judgment has not been reversed, suspended or
vacated.
|
The Board
of Directors has determined that Messrs. Crook, Jin and Li are independent under
Rule 5605(a)(2) of the NASDAQ Listing Rules.
Corporate
Governance
Board
of Directors
We have
five members serving on our Board of Directors, a majority of which are
considered “independent directors” as defined under NASDAQ Marketplace Rules.
All actions of the Board of Directors require the approval of either a majority
of the directors in attendance at a meeting, duly called and noticed, at which a
quorum is present or the unanimous written consent of all of the members of the
Board of Directors. From March 2008 until September 14, 2009, the Board
consisted solely of Mr. Wang and his wife, Ms. Limin Zheng. In 2008, our Board
of Directors met in person one time and acted by written consent three
times.
73
Board
Committees
The Board
of Directors has an audit committee, a nominating and corporate governance
committee and a compensation committee, each of which was formed on September
14, 2009.
Audit
Committee
Our audit
committee consists of Messrs. Crook, Jin and Li, each of whom is considered
“independent” under Rule 5605(a)(2) of the NASDAQ Marketplace Rules as
determined by our Board of Directors. The audit committee recommends to the
Board of Directors the annual engagement of a firm of independent accountants
and reviews with the independent accountants the scope and results of audits,
our internal accounting controls and audit practices and professional services
rendered to us by our independent accountants. The audit committee operates
under a written charter. Mr. Crook is the Chairman of our audit
committee.
The Board
of Directors determined that Mr. Crook possesses accounting or related financial
management experience that qualifies him as financially sophisticated within the
meaning of Rule 4350(d)(2)(A) of the Nasdaq Marketplace Rules and Section 803 of
the NYSE Amex Company Guide and that he is an “audit committee financial expert”
as defined by the rules and regulations of the SEC.
Nominating
and Corporate Governance Committee
The
purpose of the nominating and corporate governance committee is to assist the
Board of Directors in identifying qualified individuals to become members of our
Board of Directors, in determining the composition of the Board of Directors and
in monitoring the process to assess Board effectiveness. Each of Messrs. Crook,
Jin and Li are members of the Nominating and Corporate Governance Committee. The
Nominating and Corporate Governance Committee operates under a written charter.
Mr. Jin is the Chairman of Nominating and Corporate Governance
Committee.
Compensation
Committee
The
compensation committee is responsible for (a) reviewing and providing
recommendations to the Board of Directors on matters relating to employee
compensation and benefit plans, and (b) assisting the Board in determining the
compensation of the chief executive officer and making recommendations to the
Board with respect to the compensation of the chief financial officer, other
executive officers of the Company and independent directors. Each of Messrs.
Crook, Jin and Li are members of the Compensation Committee. The Compensation
Committee operates under a written charter. Mr. Li is the Chairman of
Compensation Committee.
Code
of Ethics
We
adopted a Code of Business Conduct and Ethics on February 6, 2009. The Code of
Ethics, in accordance with Section 406 of the Sarbanes-Oxley Act of 2002 and
Item 406 of Regulation S-K, constitutes our Code of Ethics for our principal
executive officer, our principal financial and accounting officer and our other
senior financial officers. The Code of Ethics is intended to promote honest and
ethical conduct, full and accurate reporting, and compliance with laws as well
as other matters. A printed copy of the Code of Ethics may be obtained free of
charge by writing to us at QKL Stores Inc., 1 Nanreyuan Street, Dongfeng Road,
Sartu District 163300 Daqing, P.R. China.
74
EXECUTIVE
COMPENSATION
The
following is a summary of the compensation we paid to persons who served as our
chief executive officer and chief financial officer during the years ended
December 31, 2010 and December 31, 2009. Except as listed below, no executive
officer received compensation in excess of $100,000 for any of the two years
listed below.
Summary
Compensation Table
Name
and
Principal
Position
|
Year
|
Salary
($)
(1)
|
Bonus
($)
|
Stock
Awards
($)
|
Option
Awards
($)
|
Non-Equity
Incentive
Plan
Compensation
($)
|
Nonqualified
Deferred
Compensation
Earnings
($)
|
All
Other
Compensation
($)
|
Total
($)
|
||||||||||||||||||||||||||
Zhuangyi
Wang,
CEO (2)
|
2010
|
79,646 | -0- | -0- | -0- | -0- | -0- | -0- | 79,646 | ||||||||||||||||||||||||||
2009
|
70,140 | -0- | -0- | -0- | -0- | -0- | -0- | 70,140 | |||||||||||||||||||||||||||
Alan D. Stewart, COO
(3)
|
2010
|
191,352 | -0- | -0- |
168,420
|
-0- | -0- | -0- | 359,772 | ||||||||||||||||||||||||||
2009
|
191,352 | -0- | -0- | -0- | -0- | -0- | -0- | 191,352 | |||||||||||||||||||||||||||
Crystal Chen, CFO
(4)
|
2010
|
140,118 | -0- | -0- | -0- | -0- | -0- | -0- | 140,118 | ||||||||||||||||||||||||||
2009
|
158,000 | -0- | -0- | -0- | -0- | -0- | -0- | 158,000 | |||||||||||||||||||||||||||
Tsz-Kit Chan, CFO
(4)
|
2010
|
17,607 | -0- | -0- | 111,360 | -0- | -0- | -0- | 128,967 | ||||||||||||||||||||||||||
2009
|
-0- | -0- | -0- | -0- | -0- | -0- | -0- | -0- |
|
(1)
|
The
amounts reflect compensation provided by our named executive officers in
their capacities as officers of
QKL-China.
|
|
(2)
|
Zhuangyi
Wang was appointed as our CEO effective March 28,
2008.
|
|
(3)
|
Alan
D. Stewart was appointed as our COO in July
2008.
|
Outstanding
Equity Awards at 2010 Fiscal Year End
On
September 14, 2009, the Company entered into stock option agreements with its
three independent directors, Gary Crook, Chaoying Li and Zhiguo Jin, granting
each director options to purchase 20,000 shares of the Company’s common stock at
an exercise price of $8.00 per share. The options vest in approximately
equal amounts on the three subsequent anniversary dates of the grant and expire
on the fifth anniversary of the date of agreement of or the date the option is
fully exercised. On January 30, 2010, the Company entered into amendment
agreements with its three directors to correct the exercise price to $7.50,
which was the fair market value on the date of the grant.
There
were no other outstanding options, no outstanding stock awards (vested or
unvested) and no other equity plan awards as of December 31, 2009.
On
June 26, 2010, the Company entered into a stock option agreement with its chief
operating officer, Alan Stewart, granting Mr. Stewart options to purchase
100,000 shares of the Company’s common stock at an exercise price of $4.40 per
share. The options vest in equal amounts on the grant date and on the following
four anniversary dates of the grant date and expire on June 26, 2018 or the date
on which the option is fully exercised.
On
December 2, 2010, the Company entered into a stock option agreement with its
chief financial officer, Tsz-Kit Chan, granting Mr. Chan options to purchase
100,000 shares of the Company’s common stock at an exercise price of $3.42 per
share. The options vest in equal amounts on the grant date and on the following
four anniversary dates of the grant date and expire on December 2, 2018 or the
date on which the option is fully exercised.
Option
Exercises and Stock Vesting during 2010
None.
Employment
Agreements
We have
signed standard Chinese employment agreements as required by PRC Labor Contract
Law with all of our employees, including executive officers, which have a term
of two to five years.
75
Mr.
Zhuangyi Wang entered into a two-year agreement on October 1, 1998 with
QKL-China, which was renewed every two years until October 1, 2008. The current
contract was signed in 2008 for five-year term and a salary of RMB 40,000
($5,845) per month.
Mr. Alan
Stewart entered into a three-year agreement on July 1, 2010 with QKL-China for a
salary of US$15,946 per month.
Mr.
Tsz-Kit Chan entered into an employment contract for a term of two years that
will expire on October 17, 2012. The term will automatically extend for two-year
periods unless either party provides thirty days’ written notice of termination
of the employment contract prior to the end of the initial term or any extension
thereof. Pursuant to the employment contract, Mr. Chan will receive an after-tax
monthly salary of RMB 50,000 (approximately US$ 7,460) per month Mr. Chan will
be granted stock options on an annual basis based on his work performance and
the performance of the Company in accordance with the Company’s employee stock
option plan. According to the employment contract, the Company may
terminate the employment with Mr. Chan for causes defined in the employment
contract with thirty days’ advance written notice, in which event Mr. Chan will
be entitled to receive compensation in accordance with relevant laws and
regulations. Under certain circumstances provided in the employment contract,
the Company may elect to pay an additional month’s salary to replace its written
notice advancement obligation. Mr. Chan may terminate the employment with the
Company by giving a thirty-day advance written notice to the
Company. Both the Company and Mr. Chan may terminate the employment
for causes provided in the employment contract without advance written notice.
The employment contract also contains covenants regarding non-competition and
confidentiality.
Additional
Narrative Disclosure
We have
no plan that provide for the payment of retirement benefits or benefits that
will be paid primarily following retirement, including, but not limited to, tax
qualified defined benefit plans, supplemental executive retirement plans, tax
qualified defined contribution plans and non-qualified defined contribution
plans.
There are
no contact, agreement, plan or arrangement, whether written or oral, that
provide for payment to a named executive officer at, following, or in connection
with the resignation, retirement or other termination of a named executive
officer or a change in control of the Company or a change in the executive
officers responsibilities following a change in control, with respect to each
named executive officer.
76
Compensation
of Directors
The
following table sets forth information regarding compensation of each director
for fiscal 2010 .
DIRECTOR
COMPENSATION
Name
|
Fees
Earned
or
Paid in
Cash
($)
|
Stock
Awards
($)
|
Option
Awards
($)
|
Non-Equity
Incentive
Plan
Compensation
($)
|
Nonqualified
Deferred
Compensation
Earnings
($)
|
All
Other
Compensation
($)
|
Total
($)
|
||||||||||||||||||||||
Gary
B. Crook
|
17,500 | -0- | -0- | -0- | -0- | -0- | 17,500 | ||||||||||||||||||||||
Zhiguo
Jin
|
15,000 | -0- | -0- | -0- | -0- | -0- | 15,000 | ||||||||||||||||||||||
Chaoying
Li
|
15,000 | -0- | -0- | -0- | -0- | -0- | 15,000 | ||||||||||||||||||||||
Zhuangyi
Wang
|
-0- | -0- | -0- | -0- | -0- | -0- | -0- | ||||||||||||||||||||||
Alan
Stewart
|
-0- | -0- | -0- | -0- | -0- | -0- |
-0-
|
On
September 14, 2009, we entered into agreements with each of our three
independent directors. The agreements provide for annual cash compensation of
$15,000. In addition, on September 14, 2009 we granted stock purchase options to
each of the three newly appointed independent directors to purchase 20,000
shares of common stock at an exercise price of $7.50 per share (the stock price
at the date of the grant). The options vest and become exercisable in three
approximately equal amounts on the three subsequent anniversary dates of the
grant. The board of directors approved such grants.
77
CERTAIN
RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Since
January 1, 2008, we have engaged in the following transactions with our
directors, executive officers, holders of more than five percent of our voting
securities, and affiliates of our directors, executive officers and five-percent
stockholders.
Transactions
With Vision
The
largest investor in the private placement transaction that closed in March 2008
was Vision Opportunity China LP (“Vision”), a party related to us as described
below. For more information about the transaction and the agreements governing
the transaction, see the section of this prospectus entitled “Reverse Merger and
Private Placement” above.
§
|
Vision
was a related party because immediately prior to the private placement
transaction, Vision owned approximately 40% of our outstanding common
stock, which it had acquired in February
2008.
|
§
|
Vision’s
interest in the private placement transaction was as
follows:
|
§
|
Under the securities purchase
agreement, Vision received shares of Series A Preferred Stock convertible
into approximately 5.9 million shares of our common stock at a purchase
price of $1.70 per share, for a total purchase price of approximately $10
million.
|
§
|
Also under the securities
purchase agreement, Vision received warrants to purchase approximately 7.4
million shares of our common stock in the future, half at an exercise
price of $3.40 per share and half at an exercise price of $4.25 per share.
Vision did not pay additional consideration for the
warrants.
|
|
§
|
Under the registration rights
agreement executed in connection with the private placement (“Registration
Rights Agreement”), Vision received rights to have the common stock that
is issuable to it upon conversion of its Series A Preferred Stock and upon
exercise of its warrants registered under an effective registration
statement filed by the Company with the SEC. Pursuant to a Waiver and
Release dated as of March 9, 2009, the investors party to the Registration
Rights Agreement 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.
|
|
§
|
Under the securities escrow
agreement entered into in connection with the private placement, Vision
received rights to take ownership of up to a total of approximately 11.8
million shares of our common stock owned by Winning State (BVI) if we do
not meet certain financial performance thresholds in 2008 and 2009. The
financial performance thresholds for 2008 were met. For a comprehensive
description of the financial performance thresholds and the Securities
Escrow Agreement, see “Securities Escrow Agreement” under the section of
this prospectus entitled “Reverse Merger and Private Placement”
above.
|
|
§
|
Also under the securities escrow
agreement, Vision received rights to take ownership of up to approximately
645,000 shares of our common stock owned by Winning State (BVI) if we fail
to list our common stock on the NASDAQ Capital Market, NASDAQ Global
Select Market, NASDAQ Global Market, or New York Stock Exchange prior to
March 28, 2010. On October 21, 2009, our common stock was listed on the
NASDAQ Capital Market.
|
§
|
Each right and benefit received
by Vision as purchaser in the transaction represented Vision’s pro-rated
share of the rights and benefits received by all purchasers in the
transaction. Specifically, Vision received approximately 64.5% of the
securities issued, and rights to receive approximately 64.5% of any
additional securities delivered, to the purchasers in the transaction
because Vision paid approximately 64.5% of the purchase price in the
transaction.
|
§
|
The approximate dollar value of
the total amount involved in the private placement transaction as measured
by its cash value to us was $15.5 million, the amount of gross proceeds of
the transaction. The approximate dollar value to Vision of the amount
involved in the private placement transaction, as measured by its cash
value to us, was $10
million.
|
78
§
|
The approximate dollar value of
the total amount involved in the transaction, as measured by the value of
the common stock that the investors may receive upon conversion or
exercise of preferred stock and warrants, and upon our failure to meet
certain financial performance thresholds under the securities escrow
agreement, calculated using the OTCBB closing market price on October 13,
2009, of $7.50 per share, was approximately $290.6 million. This figure is
the sum of the approximately $68.3 million value, so calculated, of the
9,117,647 shares of common stock issuable upon conversion of preferred
stock issued in the private placement, the approximately $85.4 million
value, so calculated, of the 11,397,058 shares of common stock issuable
upon exercise of warrants issued in the private placement, and the
approximately $136.7 million value, so calculated, of the 18,235,294
shares of common stock that the private placement investors would receive
from Winning State (BVI) under the Securities Escrow Agreement if we
failed to meet all of our financial performance thresholds for
2009.
|
§
|
The approximate dollar value to
Vision of the private placement was 64.5% of the total dollar value,
because Vision purchased approximately 64.5% of the securities sold.
Therefore, (i) the approximate dollar value to Vision of the transaction,
as measured by the cash value of the transaction to us, was $10 million,
and (ii) the approximate dollar value to Vision of the transaction, as
measured by the value of the common stock that Vision may receive upon
conversion or exercise of preferred stock and warrants, and upon our
failure to meet certain performance thresholds, calculated using the OTCBB
closing market price on October 13, 2009 of $7.50 per share, was
approximately $187.4
million.
|
Securities
Escrow Agreement
As
mentioned under “Transactions with Vision” above, Vision Opportunity China LP, a
party related to us by virtue of owning approximately 40% of our common stock
prior to the private placement transaction on March 28, 2008. Vision was a party
to the securities escrow agreement that we entered into in connection with the
private placement transaction. In that agreement, Vision represented itself and
all of the other purchasers under the securities purchase agreement. The other
parties to the securities escrow agreement were Winning State (BVI), Loeb &
Loeb LLP, as escrow agent, and us. Other than Vision, no party to the securities
escrow agreement was a party related to us. More specifically, other than
Vision, no party to the to the securities escrow agreement, and no purchaser
under the securities purchase agreement, was a director, executive officer, or
holder of more than 5% of our voting securities, or an affiliate of any
director, executive officer, or five-percent stockholder, from January 1, 2006
until the agreement was executed.
Under the
securities escrow agreement, if we fail to list our common stock on the NASDAQ
Capital Market, NASDAQ Global Select Market, NASDAQ Global Market, or New York
Stock Exchange prior to March 28, 2010, the purchasers in the private placement
will have the right to receive one million shares of common stock owned by
Winning State (BVI) on a pro rata basis. Accordingly, in the event we fail to
have our common stock so listed, Vision could receive up to approximately
645,000 additional shares (representing Vision’s pro rata share of the one
million shares). On October 21, 2009, our common stock was listed on the NASDAQ
Capital Market.
Other
than these interests, Vision has no interests in the securities escrow
agreement, and no other related party has any interests in the securities escrow
agreement. For more information about the securities escrow agreement, please
see “Securities Escrow Agreement” in the section of this prospectus entitled
“The Two Transactions: The Reverse Merger Transaction and the Private Placement
Transaction” above.
Other
Transactions
The
building that houses our headquarters and flagship store, which has net book
value of $562,516, is held in trust by Mr. Zhuangyi Wang, our Chief Executive
Officer. We have transferred title to the building to QKL-China. We have not
paid and will not pay any fee or other consideration to any related party for
the use of the building, transfer of title, or any related matter. There have
been and continue to be no leases or other contracts between us and any related
party relating to the use of the building, transfer of title, or any related
matter.
In
addition, two of our store buildings, which have a net book value of $473,337,
are held in trust by Mr. Wang Jiafan, the father of Mr. Zhuangyi Wang. We have
transferred title to these buildings to QKL-China. We have not paid and will not
pay any fee or other consideration to any related party for the use of the
buildings, transfer of title, or any related matter. There have been and
continue to be no leases or other contracts between us and any related party
relating to the use of the buildings, transfer of title, or any related
matter.
79
Director
and Executive Compensation
Please
see “Executive Compensation” for a discussion of information regarding the
compensation of our directors and our executive officers.
Procedures
for Approval of Related Party Transactions
Our board
of directors is charged with reviewing and approving all potential related party
transactions. All such related party transactions must then be reported under
applicable SEC rules. We have not adopted other procedures for review, or
standards for approval, of such transactions, but instead review them on a
case-by-case basis.
80
DESCRIPTION
OF SECURITIES TO BE REGISTERED
The
following is a summary description of our capital stock and certain provisions
of our certificate of incorporation and by-laws, copies of which have been filed
as exhibits to this prospectus. The following discussion is qualified in its
entirety by reference to such exhibits.
General
We are
authorized to issue 100,000,000 shares of common stock, par value $0.001 per
share, and 100,000,000 shares of preferred stock, par value $0.01 per
share.
As of
February 16, 2011, we have 29,769,590 shares of common stock issued and
outstanding. We have designated 10,000,000 shares of our preferred stock as
Series A Convertible Preferred Stock, of which 7,269,549 were issued and
outstanding as of February 16, 2011.
The
following is a summary of the material terms of our capital stock.
Common
Stock
Voting: The
holders of common stock are entitled to one vote per share on all matters to be
voted on by the stockholders and are not entitled to cumulate their votes in the
election of directors.
Dividends:
Holders of common stock are entitled to any dividends that may be
declared from time to time by the Board of Directors in its discretion out of
funds legally available therefore subject to the prior rights, if any, of
holders of any outstanding shares of preferred stock.
The
payment of dividends is contingent on the ability of our PRC based operating
subsidiary QKL-China to obtain approval to send monies out of the PRC. The PRC’s
national currency, the yuan or RMB, is not a freely convertible currency. The
PRC government imposes controls on the convertibility of RMB into foreign
currencies and, in certain cases, the remittance of currency out of the PRC.
Shortages in the availability of foreign currency may restrict our ability to
remit sufficient foreign currency to pay dividends.
Liquidation: In
the event of our liquidation or dissolution, holders of common stock are
entitled to share ratably in all assets remaining after payment of liabilities
and the liquidation preferences of any outstanding shares of preferred
stock.
No Preemptive Rights:
Holders of common stock have no preemptive or other subscription
rights and no right to convert their common stock into any other
securities.
Preferred
Stock
We are
authorized to issue 100,000,000 shares of preferred stock. As of February 16,
2011 there were 7,269,549 shares of Series A Preferred Stock issued and
outstanding. Additional shares of our preferred stock may be issued from time to
time in one or more classes or series, each of which class or series shall have
such distinctive designation or title as shall be fixed by the board of
directors prior to the issuance any shares thereof. The issuance of shares of
preferred stock, or the issuance of rights to purchase such shares, could be
used to discourage an unsolicited acquisition proposal. For instance, the
issuance of a series of preferred stock might impede a business combination by
including class voting rights that would enable the holder to block such a
transaction or facilitate a business combination by including voting rights that
would provide a required percentage vote of the stockholders. In addition, under
certain circumstances, the issuance of preferred stock could adversely affect
the voting power of the holders of the common stock. Although the board of
directors is required to make any determination to issue such stock based on its
judgment as to the best interests of our stockholders, the board of directors
could act in a manner that would discourage an acquisition attempt or other
transaction that some, or a majority, of the stockholders might believe to be in
their best interests or in which stockholders might receive a premium for their
stock over the then market price of such stock. The board of directors does not
at present intend to seek stockholder approval prior to any issuance of
currently authorized preferred stock, unless otherwise required by
law.
81
Terms
of Series A Preferred Stock
The terms
of our Series A Preferred Stock are set forth in a Certificate of Designations,
which we filed with the Secretary of State of the State of Delaware on March 13,
2008. Set for below are the material terms of our Series A Preferred
Stock:
Conversion and Anti-Dilution:
Each share of Series A Preferred Stock is convertible at any time
into one share of our common stock. A holder of Series A Preferred Stock may not
convert those shares if as a result of the conversion, that holder would
beneficially own more than 4.99% of our common stock outstanding at that time. A
holder may, however, waive this provision by providing the Company with 61 days’
notice that such holder wishes to waive this restriction with regard to any or
all shares of common stock issuable upon conversion of such holder’s Series A
Preferred Stock.
Voting: Holders
of the Series A Preferred Stock vote on an “as converted” basis together with
the common stock, as a single class, in connection with any proposal submitted
to stockholders to: (i) increase the number of authorized shares, (ii) approve
the sale of any capital stock of the Company, (iii) adopt an employee stock
option plan, and (iv) effect any merger, consolidation, sale of all or
substantially all of the assets of the Company, or related consolidation or
combination transaction. Holders of the Series A Preferred Stock have a separate
class vote on all matters that impact the rights, value, or ranking of the
Series A Preferred Stock.
Liquidation Preference:
In the event of a liquidation, dissolution or winding up, voluntary
or involuntary, of the Company, the holders of Series A Preferred Stock then
outstanding will be entitled to receive, out of our assets available for
distribution to our stockholders, an amount equal to $1.70 per share before any
payment is made or any assets distributed to the holders of the common stock or
any other stock that ranks junior to the Series A Preferred Stock. The holders
rank (a) senior to the common stock and to any other class or series of stock
issued by the Company not designated as ranking senior to or pari passu with the Series A
Preferred Stock in respect of the right to participate in distributions or
payments on a liquidation event and (b) pari passu with any other
class or series of stock of the Company, the terms of which specifically provide
that such class or series will rank pari passu with the Series A
Preferred Stock in respect of the right to participate in distributions or
payments on a liquidation event.
Dividends : The
shares of Series A Preferred Stock are not entitled to dividends unless the
Company pays dividends, in cash or other property, to holders of outstanding
shares of common stock. If the Company does pay dividends, each outstanding
share of Series A Preferred Stock will entitle its holder to receive dividends
out of available funds equal to the dividends to which the common stock into
which such share was convertible on the record date would have been entitled,
had such common stock been issued.
LEGAL
MATTERS
Our
counsel, Loeb & Loeb LLP, located at 345 Park Avenue, New York, New York
10154, is passing upon the validity of the issuance of the common stock that the
selling stockholders are offering under this prospectus.
With
respect to certain matters involving the enforcement of foreign judgments in the
PRC and the bringing of original actions in the PRC predicated solely on the
federal securities laws of the United States, Deheng Law Firm of Beijing, PRC,
has given us certain advice.
EXPERTS
Albert
Wong & Co., independent registered public accountants, located in Hong Kong,
and BDO China Li Xin Da Hua CPA Co., Ltd., independent registered public
accountants located in Shenzhen, PRC have audited our financial statements for
fiscal 2008 and 2009, respectively, included in this registration statement to
the extent and for the periods set forth in their respective reports. We have
relied on such reports given upon the authority of such firms as experts in
accounting and auditing.
82
INTERESTS
OF NAMED EXPERTS AND COUNSEL
No
“expert” or “counsel” as defined by Item 509 of Regulation S-K promulgated under
the Securities Act, whose services were used in the preparation of this Form
S-1, was hired on a contingent basis or will receive a direct or indirect
interest in us or our parents or subsidiaries, nor was any of them a promoter,
underwriter, voting trustee, director, officer or employee of the
Company.
SERVICE
OF PROCESS AND ENFORCEMENT OF JUDGMENTS
Some of
our directors and officers reside in the PRC and substantially all of our assets
are located in the PRC. In addition, certain “experts” named in this prospectus
are located in the PRC. As a result, it may be difficult or impossible for you
to effect service of process on our officers and directors or those experts
within the U.S.
Deheng,
our counsel as to PRC law, has advised us that there is uncertainty as to
whether the courts of the PRC would (1) recognize or enforce judgments of
U.S. courts obtained against our officers or directors or the experts named in
this prospectus based on the civil liability provisions of the securities laws
of the U.S. or any state in the U.S., or (2) entertain original actions
brought in the PRC against our officers or directors or the experts named in
this prospectus based on the securities laws of the U.S. or any state in the
U.S.
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS
On
October 15, 2009, we dismissed Albert Wong & Co. (“Albert Wong”), as our
independent registered public accounting firm. The reports of Albert Wong on our
financial statements for each of the past two fiscal years contained no adverse
opinion or a disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles. The decision to change
independent accountants was approved by our Audit Committee on October 14,
2009.
During
our two most recent fiscal years and through October 16, 2009, the date of
filing our Current Report on Form 8-K announcing the dismissal of Albert Wong,
we have had no disagreements with Albert Wong on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of Albert
Wong, would have caused it to make reference to the subject matter of such
disagreements in its report on our financial statements for such
periods.
During
our two most recent fiscal years there have been no reportable events as defined
under Item 304(a)(1)(v) of Regulation S-K adopted by the SEC.
Albert
Wong has provided us with a letter addressed to the SEC stating that it agreed
with the above statements. This letter was filed as an exhibit to our Current
Report on Form 8-K, which was filed with the SEC on October 16,
2009.
On
October 16, 2009, we appointed BDO China Li Xin Da Hua CPA Co., Ltd. (formerly
known as BDO Guangdong Dahua Delu CPAs, LLP) (“BDO”) as our new independent
registered accounting firm. The appointment of BDO was approved by our Audit
Committee on October 14, 2009.
FINANCIAL
STATEMENTS
Our
consolidated unaudited financial statements for the three months ended March 31,
2009 and 2010 and our audited consolidated financial statements for the fiscal
year ended December 31, 2009 and 2008 are presented beginning at page
F-1.
83
WHERE
YOU CAN FIND MORE INFORMATION
We have
filed with the U.S. Securities and Exchange Commission, 100 F. Street,
N.E., Washington, D.C. 20549, a registration statement on Form S-1 under the
Securities Act for the common stock offered by this prospectus. We have not
included in this prospectus all the information contained in the registration
statement and you should refer to the registration statement and its exhibits
for further information.
The
registration statement and other information may be read and copied at the SEC’s
Public Reference Room at 100 F. Street N.E., Washington, D.C. 20549. The
public may obtain information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. The SEC maintains a web site
(http://www.sec.gov) that contains the registration statements, reports, proxy
and information statements and other information regarding registrants that file
electronically with the SEC such as us.
You may
also read and copy any reports, statements or other information that we have
filed with the SEC at the addresses indicated above and you may also access them
electronically at the web site set forth above. These SEC filings are also
available to the public from commercial document retrieval
services.
DISCLOSURE
OF COMMISSION POSITION ON INDEMNIFICATION
FOR
SECURITIES ACT LIABILITIES
Our
bylaws provide that we will indemnify our directors and officers from all
liabilities incurred by them in connection with any action, suit or proceeding
in which they are involved by reason of their acting as our directors and
officers.
Insofar
as indemnification for liabilities arising under the Securities Act may be
permitted to our directors, officers and controlling persons, we have been
informed that in the opinion of the SEC such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by us of expenses incurred or paid by a director, officer or
controlling person in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in connection with
the securities being registered, we will, unless in the opinion of our counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by us is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
84
QKL STORES
INC.
INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS
CONTENTS
|
PAGES
|
|
CONSOLIDATED
BALANCE SHEETS AS OF SEPTEMBER 30, 2010 AND DECEMBER 31,
2009
|
Q-1
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND
2009
|
Q-2
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND
2009
|
Q-3
|
|
NOTES
TO UNAUTIDTED CONSOLIDATED FINANCIAL STATEMENTS
|
Q-4
– Q-14
|
|
REPORTS
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|
F-1
– F-2
|
|
CONSOLIDATED
BALANCE SHEETS AS AT DECEMBER 31, 2009 AND 2008
|
F-3
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2009 AND
2008
|
F-4
|
|
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2009
AND 2008
|
F-5
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2009 AND
2008
|
F-6
|
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
F-7
– F-29
|
|
CONSOLIDATED
FINANCIAL STATEMENT SCHEDULE:
|
||
VALUATION
AND QUALIFYING ACCOUNTS
|
II-A
|
85
Item
1. Condensed Consolidated Financial Statements
QKL
STORES INC. AND SUBSIDIARIES
Condensed
Consolidated Balance Sheets
September 30,
2010
|
December 31,
2009
|
|||||||
(Unaudited)
|
||||||||
ASSETS
|
||||||||
Cash
|
$
|
48,372,672
|
$
|
45,912,798
|
||||
Restricted
cash
|
98,161
|
181,836
|
||||||
Accounts
receivable
|
712,606
|
283,929
|
||||||
Inventories
|
23,499,640
|
24,691,156
|
||||||
Other
receivables
|
14,992,551
|
13,980,572
|
||||||
Prepaid
expenses
|
4,265,965
|
2,993,191
|
||||||
Advances
to suppliers
|
4,657,114
|
2,965,139
|
||||||
Deferred
income tax assets
|
859,736
|
417,788
|
||||||
Total
current assets
|
97,458,445
|
91,426,409
|
||||||
Property,
plant and equipment, net
|
20,961,609
|
29,402,630
|
||||||
Land
use rights, net
|
755,807
|
753,226
|
||||||
Goodwill
|
31,250,657
|
19,280,509
|
||||||
Other
assets
|
394,380
|
408,391
|
||||||
Total
assets
|
$
|
150,820,898
|
$
|
141,271,165
|
||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Accounts
payable
|
$
|
29,403,630
|
$
|
29,244,923
|
||||
Cash
card and coupon liabilities
|
9,837,627
|
7,721,630
|
||||||
Customer
deposits received
|
982,005
|
3,862,890
|
||||||
Accrued
expenses and other payables
|
7,094,505
|
6,656,089
|
||||||
Income
taxes payable
|
1,079,544
|
1,154,229
|
||||||
Total
current liabilities
|
48,397,311
|
48,639,761
|
||||||
Warrant
liabilities
|
-
|
44,304,034
|
||||||
Total
liabilities
|
48,397,311
|
92,943,795
|
||||||
Commitments
and contingencies
|
-
|
-
|
||||||
Stockholders’
equity
|
||||||||
Common
stock, $.001 par value per share, authorized 100,000,000 shares, issued
and outstanding29,717,441 and 29,475,983 shares at September 30, 2010 and
December 31, 2009, respectively
|
29,717
|
29,476
|
||||||
Series
A convertible preferred stock, par value $0.01, authorized 10,000,000
shares, issued and outstanding 7,321,698 and 7,548,346 at September 30,
2010 and December 31, 2009, respectively
|
73,217
|
75,483
|
||||||
Additional
paid-in capital
|
90,519,167
|
53,191,217
|
||||||
Retained
earnings – appropriated
|
4,913,072
|
4,913,072
|
||||||
Retained
earnings (Accumulated deficit)
|
790,974
|
(14,236,111
|
)
|
|||||
Accumulated
other comprehensive income
|
6,097,440
|
4,354,233
|
||||||
Total
stockholders’ equity
|
102,423,587
|
48,327,370
|
||||||
Total
liabilities and stockholders’ equity
|
$
|
150,820,898
|
$
|
141,271,165
|
See
notes to unaudited condensed consolidated financial statements.
Q-1
QKL
STORES INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Income
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Nine Months Ended September
30,
|
Three Months Ended
September 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
sales
|
$
|
212,575,456
|
$
|
174,410,057
|
$
|
64,869,749
|
$
|
56,567,838
|
||||||||
Cost
of sales
|
175,160,430
|
143,823,125
|
53,575,513
|
46,820,423
|
||||||||||||
Gross
profit
|
37,415,026
|
30,586,932
|
11,294,236
|
9,747,415
|
||||||||||||
Operating
expenses:
|
||||||||||||||||
Selling
expenses
|
21,801,656
|
16,255,898
|
7,817,663
|
5,624,479
|
||||||||||||
General
and administrative expenses
|
6,022,119
|
3,217,258
|
2,123,248
|
1,051,608
|
||||||||||||
Total
operating expenses
|
27,823,775
|
19,473,156
|
9,940,911
|
6,676,087
|
||||||||||||
Income
from operations
|
9,591,251
|
11,113,776
|
1,353,325
|
3,071,328
|
||||||||||||
Non-operating
income (expense):
|
||||||||||||||||
Increase
(decrease) in fair value of warrants
|
7,801,649
|
(45,050,638
|
)
|
(31,612,218
|
)
|
|||||||||||
Interest
income
|
510,215
|
188,448
|
165,287
|
35,342
|
||||||||||||
Interest
expense
|
(10,416
|
)
|
(20,800
|
)
|
(35
|
)
|
(4
|
)
|
||||||||
Total
non-operating income (loss)
|
8,301,448
|
(44,882,990
|
)
|
165,252
|
(31,576,880
|
)
|
||||||||||
Income
(loss) before income taxes
|
17,892,699
|
(33,769,214
|
)
|
1,518,577
|
(28,505,552
|
)
|
||||||||||
Income
taxes
|
2,865,614
|
2,986,599
|
486,712
|
829,840
|
||||||||||||
Net
income (loss)
|
$
|
15,027,085
|
$
|
(36,755,813
|
)
|
$
|
1,031,865
|
$
|
(29,335,392
|
)
|
||||||
Comprehensive
income statement:
|
||||||||||||||||
Net
income (loss)
|
$
|
15,027,085
|
$
|
(36,755,813
|
)
|
$
|
1,031,865
|
$
|
(29,335,392
|
)
|
||||||
Foreign
currency translation adjustment
|
1,743,207
|
(1,427,032
|
)
|
1,697,722
|
(1,782,839
|
)
|
||||||||||
Comprehensive
income (loss)
|
$
|
16,770,292
|
$
|
(38,182,845
|
)
|
$
|
2,729,587
|
$
|
(31,118,231
|
)
|
||||||
Weighted
average number of shares outstanding:
|
||||||||||||||||
Basic
|
29,647,487
|
20,882,353
|
29,714,017
|
20,882,353
|
||||||||||||
Diluted
|
39,800,488
|
20,882,353
|
38,529,272
|
20,882,353
|
||||||||||||
Earnings
per share:
|
||||||||||||||||
Basic
|
$
|
0.51
|
$
|
(1.76
|
)
|
$
|
0.03
|
$
|
(1.40
|
)
|
||||||
Diluted
|
$
|
0.38
|
$
|
(1.76
|
)
|
$
|
0.03
|
$
|
(1.40
|
)
|
See
notes to unaudited condensed consolidated financial statements.
Q-2
QKL STORES INC. AND SUBSIDIARIES
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
||||||||
Nine Months Ended September 30,
|
||||||||
2010
|
2009
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income
|
$
|
15,027,085
|
$
|
(36,755,813
|
)
|
|||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Depreciation
– property, plant and equipment
|
3,776,394
|
1,920,162
|
||||||
Amortization
|
30,920
|
20,359
|
||||||
Share-based
compensation
|
823,540
|
-
|
||||||
Deferred
income tax
|
(434,518
|
)
|
-
|
|||||
Change
in fair value of warrants
|
(7,801,649
|
)
|
45,050,638
|
|||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Accounts
receivable
|
(423,628
|
)
|
342,666
|
|||||
Inventories
|
1,630,666
|
(1,034,325
|
)
|
|||||
Other
receivables
|
(763,314
|
)
|
309,164
|
|||||
Prepaid
expenses
|
(1,198,263
|
)
|
(614,555
|
)
|
||||
Advances
to suppliers
|
(938,109
|
)
|
311,285
|
|||||
Accounts
payable
|
(361,435
|
)
|
2,225,442
|
|||||
Cash
card and coupon liabilities
|
1,978,662
|
2,387,021
|
||||||
Customer
deposits received
|
(2,949,589
|
)
|
(317,626
|
)
|
||||
Accrued
expenses and other payables
|
(968,598
|
)
|
1,889,190
|
|||||
Income
taxes payable
|
(95,213
|
)
|
(493,640
|
)
|
||||
Net
cash provided by operating activities
|
7,332,951
|
15,239,968
|
||||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||
Purchases
of property, plant and equipment
|
(5,486,632
|
)
|
(4,225,388
|
)
|
||||
Acquisition
of operating rights
|
(11,627,230
|
)
|
-
|
|||||
Refund
of office building purchase payment
|
11,015,480
|
-
|
||||||
Decrease
of restricted cash
|
83,676
|
111,456
|
||||||
Net
cash used in investing activities
|
(6,014,706
|
)
|
(4,113,932
|
)
|
||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Repayment
of bank loan
|
-
|
(2,192,178
|
)
|
|||||
Net
cash used in financing activities
|
-
|
(2,192,178
|
)
|
|||||
Effect
of foreign currency translation
|
1,141,629
|
(1,529,702
|
)
|
|||||
Net
increase in cash
|
2,459,874
|
7,404,156
|
||||||
Cash
– beginning of period
|
45,912,798
|
19,285,021
|
||||||
Cash
– end of period
|
$
|
48,372,672
|
$
|
26,689,177
|
||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
received
|
510,215
|
188,448
|
||||||
Interest
paid
|
$
|
10,600
|
$
|
20,800
|
||||
Income
taxes paid
|
$
|
3,528,790
|
$
|
2,504,587
|
See
notes to unaudited condensed consolidated financial statements.
Q-3
Notes
to Unaudited Condensed Consolidated Financial Statements
NOTE
1 – ORGANIZATION AND BUSINESS OPERATIONS
QKL
Stores Inc. (“Store”) was incorporated under the laws of the State of Delaware
on December 2, 1986. Store currently operates through a wholly owned subsidiary
in the British Virgin Islands: Speedy Brilliant Group Ltd. (“Speedy Brilliant
(BVI)”), wholly owned subsidiary of Speedy Brilliant (BVI) located in Mainland
China: Speedy Brilliant (Daqing) Ltd. (“Speedy Brilliant (Daqing)” or “WFOE”),
operating company located in Mainland China: Daqing Qingkelong Chain Commerce
& Trade Co., Ltd. (“Qingkelong Chain”), which Store controls, through
contractual arrangements between WFOE and Qingkelong Chain, as if Qingkelong
Chain were a wholly owned subsidiary of Store, and wholly owned operating
subsidiary of Qingkelong Chain located in Mainland China: Daqing
Qinglongxin Commerce & Trade Co., Ltd (“Qinglongxin Commerce”).
The Store
and its subsidiaries (hereinafter, collectively referred to as the “Company”)
are engaged in the operation of retail chain stores in the PRC.
The
Company is a regional supermarket chain that currently operates 35 supermarkets
and 3 department stores in northeastern China and Inner Mongolia. The Company’s
supermarkets and hypermarkets sell a broad selection of merchandise including
groceries, fresh food and non-food items. A supermarket offers various daily
necessities on a self-service basis and averages 2,500 square meters in sales
area. A hypermarket is similar to a supermarket but has a larger operating
scale, and is typically over 4,500 square meters in sales area. The Company
currently has two distribution centers servicing its
supermarkets. The Company is the first supermarket chain in
northeastern China and Inner Mongolia that is a licensee of the International
Grocers Alliance, or IGA, a United States-based global grocery network. As a
licensee of IGA, the Company is able to engage in group bargaining with
suppliers and have access to more than 2,000 private IGA brands, including many
that are exclusive IGA brands.
Principles of Consolidation
and Presentation
The
condensed consolidated financial statements have been prepared in accordance
with U.S. generally accepted accounting principles (“U.S. GAAP”). The
condensed consolidated financial statements include the financial statements of
QKL Stores Inc., and its wholly owned subsidiaries. All intercompany
accounts, transactions, and profits have been eliminated upon
consolidation.
The
accompanying interim unaudited condensed consolidated financial statements
(“Interim Financial Statements”) of the Company and its wholly owned
subsidiaries have been prepared in accordance with accounting principles
generally accepted in the United States of America (“GAAP”) for interim
financial information and are presented in accordance with the requirements of
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these Interim Financial
Statements do not include all of the information and notes required by GAAP for
complete financial statements. These Interim Financial Statements should be read
in conjunction with the consolidated financial statements and notes thereto for
the fiscal year ended December 31, 2009 included in the Company’s Form 10-K. In
the opinion of management, the Interim Financial Statements included herein
contain all adjustments, including normal recurring adjustments, considered
necessary to present fairly the Company’s financial position, the results of
operations and cash flows for the periods presented. The operating
results and cash flows of the interim periods presented herein are not
necessarily indicative of the results to be expected for any other interim
period or the full year.
Q-4
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted 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 period. Actual results could materially differ from those
estimates.
Reclassification
The
presentation of certain line items presented on the consolidated financial
statements and the relevant notes for the prior years have been changed in
conformity with the current year presentation of the condensed consolidated
financial statements and the corresponding notes. For comparative
purposes, in the financial statements for the nine months ended September 30,
2009, the Company reclassified the following:
|
·
|
$810,340 of net sales related to
sub-lease rental income for its stores was reclassified to offset selling
expenses and $174,112 of net sales related to advertising and promotion
was reclassified to offset selling
expense.
|
|
·
|
$391,387 of net sales related to
vendor rebates received from vendors was reclassified to offset cost of
sales, and $66,156 of net sales related to DC revenue was reclassified to
offset cost of sales in the statements of income in the first nine months
of 2009.
|
|
·
|
$1,184,081 of selling expenses
related to distribution center costs was reclassified to cost of sales in
the statements of income in the first nine months of
2009.
|
For
comparative purposes, in the financial statements for the three months ended
September 30, 2009, the Company reclassified the following:
|
·
|
$282,140 of net sales related to
sub-lease rental income for its stores was reclassified to offset selling
expenses and $60,658 of net sales related to advertising and promotion was
reclassified to offset selling
expense.
|
|
·
|
$102,080 of net sales related to
vendor rebates received from vendors was reclassified to offset cost of
sales, and $66,156 of net sales related to DC revenue was reclassified to
offset cost of sales
|
|
·
|
$380,752 of selling expenses
related to distribution center costs was reclassified to cost of
sales.
|
The
Company believes that such reclassification represents better presentation to
its retail industry standard. The reclassification had no effect on the
Company’s previously reported condensed consolidated statements of income,
condensed consolidated statements of stockholders’ equity or condensed
consolidated statements of cash flows, and is not considered material to any
previously reported condensed consolidated financial statements.
Q-5
Segment
Reporting
The
Company operates in one industry segment, operating retail chain
stores. ASC 280, Segment Reporting, establishes standards for
reporting information about operating segments. Given the economic
characteristics of the similar nature of the products sold, the type of customer
and the method of distribution, the Company operates as one reportable segment
as defined by ASC 280, Segment Reporting.
Revenue
Recognition
The
Company earns revenue by selling merchandise primarily through its retail
stores. Revenue is recognized when merchandise is purchased by and delivered to
the customer and is shown net of estimated returns during the relevant period.
The allowance for sales returns is estimated based upon historical
experience.
Cash
received from the sale of cash card (aka “gift card”) is recorded as a
liability, and revenue is recognized upon the redemption of the cash card or
when it is determined that the likelihood of redemption is remote (“cash card
breakage”) and no liability to relevant jurisdictions exists. The Company
determines the cash card breakage rate based upon historical redemption patterns
and recognizes cash card breakage on a straight-line basis over the estimated
cash card redemption period. The Company recognized approximately nil
in cash card breakage revenue for the nine months ended September 30, 2010 and
2009.
Included
in revenue are sales of returned merchandise to vendors specializing in the
resale of defective or used products, which accounted for less than 0.5% of net
sales in each of the periods reported.
Cost of
Sales
Cost of
sales includes the cost of merchandise, related cost of packaging and shipping
cost, and the distribution center costs.
Selling
Expenses
Selling
expenses include store-related expenses, other than store occupancy costs
expenses, as well as advertising expenses, depreciation and amortization
expenses, and certain expenses associated with operating the Company’s corporate
headquarters.
Advertising
Costs
Advertising
costs are expensed as incurred. Advertising expense, net of reimbursement from
suppliers, amounted to $126,192 and $53,816 for the nine months ended
September 30, 2010 and 2009, and amounted to $35,790 and $8,211 for the three
months ended September 30, 2010 and 2009, respectively. Advertising expense is
included in selling expenses in the accompanying condensed consolidated
statements of income. The Company receives co-operative advertising allowances
from vendors in order to subsidize qualifying advertising and similar
promotional expenditures made relating to vendors’ products. These
advertising allowances are recognized as a reduction to selling expenses when
the Company incurs the advertising cost eligible for the credit. Co-operative
advertising allowances recognized as a reduction to selling expenses amounted to
nil for the nine months ended September 30, 2010 and 2009.
Q-6
Vendor
Allowances
The
Company receives allowances for co-operative advertising and volume purchase
rebates earned through programs with certain vendors. The Company records a
receivable for these allowances which are earned but not yet received when it is
determined the amounts are probable and reasonably estimable, in accordance with
ASC 605. Amounts relating to the purchase of merchandise are treated as a
reduction of inventory cost and reduce cost of goods sold as the merchandise is
sold. Amounts that represent a reimbursement of costs incurred, such as
advertising, are recorded as a reduction in selling expenses. The Company
performs detailed analyses to determine the appropriate amount of vendor
allowances to be applied as a reduction of merchandise cost and selling
expenses.
Inventories
Inventories
primarily consist of merchandise inventories and are stated at lower of cost or
market and net realizable value. Cost of inventories is calculated on the
weighted average basis which approximates cost. Management regularly
reviews inventories and records valuation reserves for damaged and defective
returns, inventories with slow-moving or obsolescence exposure and inventories
with carrying value that exceeds market value. Because of its product mix, the
Company has not historically experienced significant occurrences of
obsolescence.
Inventory
shrinkage is accrued as a percentage of revenues based on historical inventory
shrinkage trends. The Company performs physical inventory count of its stores
once per quarter and cycle counts inventories at its distribution centers once
per quarter throughout the year. The reserve for inventory shrinkage represents
an estimate for inventory shrinkage for each store since the last physical
inventory date through the reporting date.
Fair Value
Measurements
The
carrying value of cash, accounts receivable, other current liabilities, accounts
payable, accrued expenses and other current liabilities approximate the fair
values of these instruments due to their short-term nature.
Income
Taxes
The
Company adopted ASC 740-10-25 on January 1, 2007, which provides criteria for
the recognition, measurement, presentation and disclosure of uncertain tax
position. The Company must recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position.
The tax
benefits recognized in the financial statements from such a position are
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon ultimate resolution. The Company did not recognize any
additional liabilities for uncertain tax positions as a result of the
implementation of ASC 740-10-25.
Recently Issued Accounting
Guidance
Adoption
of FASB ASU 2010-13
In April
2010, the FASB issued an Accounting Standard
Update (“ASU”) No.2010-13,”Compensation-Stock
Compensation” (Topic 718): Effect of Denominating the Exercise Price of a
Share-Based Payment Award in the Currency of the Market in Which the Underlying
Equity Security Trades,” which address the classification of a share-based
payment award with an exercise price denominated in the currency of a market in
which the underlying equity security trades. Topic 718 is amended to clarify
that a share-based payment award with an exercise price denominated in the
currency of a market in which a substantial portion of the entity’s equity
securities trades shall not be considered to contain a market, performance, or
service condition. Therefore, such an award is not to be classified as a
liability if it otherwise qualifies as equity classification. The amendments in
this update should be applied by recording a cumulative-effect adjustment to the
opening balance of retained earnings. The cumulative-effect adjustment should be
calculated for all awards outstanding as of the beginning of the fiscal year in
which the amendments are initially applied, as if the amendments had been
applied consistently since the inception of the award. ASU 2010-13 is
effective for interim and annual periods beginning on or after December
15, 2010 and is not expected to have a material impact on the Company’s
consolidated financial position or results of the operations.
Adoption
of FASB ASU 2010-17
In April
2010, the FASB issued an Accounting Standard Update (“ASU”) No. 2010-17,
“Revenue Recognition – Milestone Method (Topic 605), which provides guidance on
defining milestones under Topic 605 and determining when it may be appropriate
to apply the milestone method of revenue recognition for research and
development deliverables in an arrangement in which one or more payments are
contingent upon achieving uncertain future events or circumstances. ASU 2010-17
is effective for the fiscal years beginning on or after June 15, 2010 and is not
expected to have a material impact on the Company’s consolidated financial
position or results of operation.
The
Company has considered all new accounting pronouncements and has concluded that
there are no new pronouncements that may have a material impact on results of
operations, financial condition, or cash flows, based on current
information.
Q-8
NOTE
3 – OTHER RECEIVABLES
Other
receivables consisted of the following:
September 30,
2010
(Unaudited)
|
December 31,
2009
|
|||||||
Deposits
|
$
|
2,493,098
|
$
|
1,486,336
|
||||
Purchase
deposits
|
1,252,441
|
701,225
|
||||||
Input
value added tax receivables
|
465,630
|
1,164,315
|
||||||
Loans
to suppliers
|
8,695,655
|
8,531,986
|
||||||
Rebates
receivables
|
1,415,311
|
1,109,903
|
||||||
Rent
deposits
|
595,203
|
499,032
|
||||||
Others
|
75,213
|
487,775
|
||||||
Total
|
$
|
14,992,551
|
$
|
13,980,572
|
NOTE
4 – ACCURED EXPENSES AND OTHER PAYABLES
Accrued
expenses and other payables consisted of the following:
September 30,
2010
(Unaudited)
|
December 31,
2009
|
|||||||
Accrued
expenses
|
$
|
2,411,630
|
$
|
1,688,890
|
||||
VAT
and other PRC tax payable
|
70,467
|
202,873
|
||||||
Repair,
maintenance, and purchase of equipment payable
|
3,385,002
|
3,471,555
|
||||||
Employee
promoters bond deposit
|
1,227,406
|
1,292,771
|
||||||
Total
other payables
|
$
|
7,094,505
|
$
|
6,656,089
|
Q-9
NOTE
5 – EARNINGS PER SHARE
The
Company calculates earnings per share in accordance with ASC 260, Earnings Per
Share, which requires a dual presentation of basic and diluted earnings per
share. Basic earnings per share are computed using the weighted average number
of shares outstanding during the fiscal year. Potentially dilutive common shares
consist of convertible preferred stock (using the if-converted method) and
exercisable warrants and stock options outstanding (using the treasury
method). The following table sets forth the computation of basic and
diluted net income per common share:
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Nine Months Ended September 30,
|
Three Months Ended September 30,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
income
|
$ | 15,027,085 | $ | (36,755,813 | ) | $ | 1,031,865 | $ | (29,335,392 | ) | ||||||
Weighted-average
shares of common stock outstanding
|
||||||||||||||||
Basic
|
29,647,487 | 20,882,353 | 29,714,017 | 20,882,353 | ||||||||||||
Dilutive
shares:
|
||||||||||||||||
Conversion
of Series A Convertible Preferred Stock
|
7,372,789 | - | 7,325,122 | - | ||||||||||||
Dilutive
effect of stock warrants and options
|
2,780,212 | - | 1,490,133 | - | ||||||||||||
Diluted
|
39,800,488 | 20,882,353 | 38,529,272 | 20,882,383 | ||||||||||||
Basic
earnings per share
|
$ | 0.51 | $ | (1.76 | ) | $ | 0.03 | $ | (1.40 | ) | ||||||
Diluted
earnings per share
|
$ | 0.38 | $ | (1.76 | ) | $ | 0.03 | $ | (1.40 | ) |
NOTE
6 – STOCK WARRANTS
Series
A and Series B Stock Warrants
As a
result of a completed sale of 9,117,647 units for cash proceeds of $15,500,000
on March 28, 2008, the Company issued Series A stock warrants of 5,822,655 and
Series B stock warrants of 5,800,911 which can be converted to 1:1 common
shares. The stock 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. These stock warrants will expire on March 28, 2013 pursuant to
the warrant agreements.
The
Company used the Black-Scholes option pricing model to determine the fair value
of the Series A and B stock warrants on March 28, 2008 (assumptions used –
expected life of 5 years, volatility of 89%, risk free interest rate of 2.51%,
and expected dividend yield of 0%).
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, “Determining
Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own
Stock”). As a result of adopting ASC 815, warrants to purchase 11,623,566 of the
Company’s common stock previously treated as equity pursuant to the derivative
treatment exemption were no longer afforded equity treatment as there was a
down-round protection (full-ratchet down round protection). As
a result, the warrants were not considered indexed to the Company’s own stock,
and as such, all future changes in the fair value of these warrants were
recognized in earnings until such time as the warrants are exercised or
expire. The Company reclassified the fair value of these warrants
from equity to liability, as if these warrants were treated as a derivative
liability. On January 1, 2009, the Company recorded as a cumulative effect
adjustment of decreasing additional paid-in capital of $6,020,000 and beginning
retained earnings of $2,792,017 and $8,812,017 to warrant liabilities to
recognize the fair value of such warrants. The fair value of the warrants was
$44,304,034 on December 31, 2009. The Company recognized a $35,492,017 loss from
the change in fair value of warrants for the year ended December 31,
2009.
Q-10
The
Company amended Series A and Series B stock warrant agreements deleting the
down-round protection (full-ratchet down round protection) provision on March
24, 2010. As a result of this amendment, the Company is no longer required to
treat Series A and Series B warrants as a liability and was reclassified to
equity as of March 24, 2010 (assumption used – expected life of 3 years,
volatility of 57%, and risk free interest rate of 1.67%, and expected dividend
yield of 0%). Based on the revaluation, the Company recognized
$7,801,649 of income related to this transaction and reclassified $36,502,385 to
equity.
Warrant
C
On
January 22, 2010, the Company entered into a warrant agreement with a
non-related individual, granting the individual stock warrants of 200,000 shares
(“Warrant C”) which can be converted to 200,000 shares of the Company’s common
stock at an exercise price of $5.00 per share, in exchange for consulting
service relating to operational and managerial experience. These stock warrants
have a five year life and can be exercised after 180 days from the date of this
warrant.
The
Company recognized share-based compensation cost based on the grant-date fair
value estimated in accordance with ASC 505-50 “equity based payments to
non-employees”. The fair value of these stock warrants on the date of
grant was estimated using the Black-Scholes method (assumption used – expected
life of 2.75 years, volatility of 54%, and risk free interest rate of 1.25%, and
expected dividend yield of 0%). The Company recognized $558,180 of
compensation expense related to this transaction.
A summary
of the Company’s stock warrant activities are as follows:
Shares
|
Weighted
Average
Exercise Price
|
Weighted
Average
Remaining
Contractual
Term
|
||||||||||
Balance
– December 31, 2009
|
11,623,566
|
$
|
3.82
|
2.49
|
||||||||
Granted
– Warrant C
|
200,000
|
5.00
|
4.31
|
|||||||||
Exercised-Warrants
A
|
(30,392
|
)
|
3.40
|
2.49
|
||||||||
Exercised-Warrants
B
|
(24,314
|
)
|
4.25
|
2.49
|
||||||||
Cancelled
|
-
|
-
|
-
|
|||||||||
Balance
– September 30, 2010
|
11,768,860
|
$
|
3.84
|
2.52
|
NOTE
7 – SHARED BASED COMPENSATION
Under
the 2009 Omnibus Securities and Incentive Plan, on September 14, 2009, the
Company entered into stock option agreements with its three independent
directors, granting each director options to purchase 20,000 shares of the
Company’s common stock at an exercise price of $8.00 per share. The
options vest in approximately equal amounts on the three subsequent anniversary
dates of the grant and expire on the fifth anniversary of the date of agreement
of or the date the option is fully exercised. On January 30, 2010, the Company
entered into amendment agreements with its three directors to correct the
exercise price to $7.50, which was the fair market value on the date of the
grant. The correction of this error was not considered
material.
Q-11
Under the
2009 Omnibus Securities and Incentive Plan, on June 26, 2010, the Company
granted the its Chief Operating Officer, Alan Stewart and 20 employees options
to acquire 2,070,000 shares of the Company's common stock at an exercise price
of $4.40 per share. The options vest in approximately equal amounts
on the four subsequent anniversary dates of the grant and expire on the eighth
anniversary of the date of agreement of or the date the option is fully
exercised.
The
Company accounts for its share-based compensation in accordance with ASC 718 and
recognizes compensation expense using the fair-value method on a straight-line
basis over the requisite service period for share option awards and non-vested
share awards granted which vested during the period. The fair value
for these awards was estimated using the Black-Scholes option pricing model on
the date of grant with the following assumptions:
September 14,
2009
|
June 26,
2010
|
|||||||
Expected
life (years)
|
3.5
|
3.25
|
||||||
Expected
volatility
|
41.2
|
%
|
53
|
%
|
||||
Risk-free
interest rate
|
1.69
|
%
|
1.49
|
%
|
||||
Dividend
yield
|
-
|
-
|
The
expected volatilities are based on the historical volatility of the Company’s
common stock. The observation is made on a weekly
basis. The observation period covered is consistent with the expected
life of the options. The expected life of stock options is based on
the minimum vesting period required. The risk-free rate is consistent
with the expected terms of the stock options and is based on the United States
Treasury yield curve in effect at the time of grant.
Stock-based
compensation expenses recognized was $231,726 and $265,360 for the three months
and nine months ended September 30, 2010, respectively.
A summary
of the Company’s stock options activities under the 2009 Omnibus Securities and
Incentive Plan are as follows:
Shares
|
Weighted
Average
Exercise Price
|
Weighted
Average
Remaining
Contractual
Term
|
||||||||||
Balance
– December 31, 2009
|
60,000
|
$
|
7.5
|
1.96
|
||||||||
Granted
|
2,070,000
|
$
|
4.4
|
3.74
|
||||||||
Exercised
|
-
|
-
|
-
|
|||||||||
Cancelled
|
-
|
-
|
-
|
|||||||||
Balance
– September 30, 2010
|
2,130,000
|
$
|
4.49
|
3.69
|
The
weighted average grant date fair value of options granted during year of 2009
and the nine months ended September 30, 2010 was $144,498 and $3,486,294,
respectively.
As of
September 30, 2010, there was $3,351,180 of total unrecognized compensation cost
related to non-vested share option awards granted. Such cost is
expected to be recognized over a weighted-average period of 3-4
years.
NOTE
8 – ACQUISITIONS
During
the third quarter of 2010, the Company acquired three stores from three
independent third parties:: (1) Taian County Jiahemei Commercial Co., Ltd
(“Taian”); (2) Jian County Great Wall Operating Management Co., Ltd ( “Jian”) ;
and (3) Inner Mongolia Fada Property Development Group Co.,
Ltd (“Inner Mongolia”).According to ASC 805 “business combinations”, the
acquisition of these three stores should be treated as acquisition of business.
The details for the acquisition of three stores are as follows:
On July
1, 2010, the Company purchased the operating rights of Taian County Jiahemei
Commercial Co., Ltd (“Taian Co”) in Taian County of Liaoning province. After the
acquisition of the operating rights by the Company,, Taian Co ceased its
operations of a retail store with approximately 11,200 square meters of gross
area, and the Company was licensed to operate in this location. The Company
opened a hypermarket store on October 20, 2010 with its trade name QKL that
sells grocery, food and non-food products. The operating results of this
business have been included in the consolidated financial statements since July
1, 2010. The purchase price was $4,121,714 (RMB 28,000,000) in cash. The
purchase price was accounted for as follows :
July 1, 2010
|
||||
Assets
|
$
|
-
|
||
Goodwill
|
$
|
4,121,714
|
||
Total
purchase price
|
$
|
4,121,714
|
On July
1, 2010, the Company purchased the operating rights of Mangou Shopping Mall, a
branch of Inner Mongolia Fada Property Development Group Co., Ltd (“Inner
Mongolia Co”) in Manzhouli City of Inner Mongolia Autonomous Region. After the
acquisition of the operating rights, Inner Mongolia Co ceased its operations of
a retail store with approximately 9,000 square meters of gross area, and the
Company was licensed to operate in this location. The Company plans
to open a hypermarket store in December of 2010 with our trade name QKL that
sells grocery, food and non-food products. The operation results of this
business have been included in the consolidated financial statements since July
1, 2010. The purchase price was $2,705,611 (RMB 18,380,000) in cash. The
purchase price was as follows:
July 1, 2010
|
||||
Assets
|
$
|
-
|
||
Goodwill
|
$
|
2,705,611
|
||
Total
purchase price
|
$
|
2,705,611
|
Q-12
On August
1, 2010, the Company purchased the operating rights of Jian County Great Wall
Operating Management Co., Ltd (“Jian Co”) in Jian County of Jilin Province.
After the closing of the acquisition the operating rights, Jian Co ceased its
operations of a retail store with approximately 23 600 square meters of gross
area, and the Company was licensed to operate in this location. The
Company opened a department store and a supermarket on September 29, 2010 that
sells grocery, food and non-food products. The operation results of this
business have been included in the consolidated financial statements since
August 1, 2010.The purchase price was $4,647,080 (RMB 31,500,000) in
cash. The purchase price was as follows:
August 1, 2010
|
||||
Assets
|
$
|
-
|
||
Goodwill
|
$
|
4,647,080
|
||
Total
purchase price
|
$
|
4,647,080
|
No
supplemental pro forma information is presented for the acquisitions due to the
immaterial effect of the acquisition on the Company’s results of
operations.
NOTE
9 - COMMITMENTS AND CONTINGENCIES
Operating
Leases
Certain
of our real properties and equipment are operated under lease agreements. Rental
expense under operating leases was as follows:
(Unaudited)
|
(Unaudited)
|
|||||||||||||||
Nine Months Ended
September 30
|
Three Months Ended
September 30
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Rent
expense
|
$
|
2,876,279
|
$
|
1,411,310
|
$
|
1,390,262
|
$
|
382,064
|
||||||||
Less:
Sublease income
|
840,696
|
810,340
|
332,545
|
282,140
|
||||||||||||
Total
rent expense, net
|
$
|
2,035,583
|
$
|
600,970
|
$
|
1,057,717
|
$
|
99,924
|
Annual
minimum payments under operating leases are as follows:
As of September 30,
|
Minimum
Lease
Payment
|
Sublease
Income
|
Net Minimum
Lease
Payment
|
|||||||||
2011
|
$
|
5,816,356
|
$
|
879,828
|
$
|
4,936,528
|
||||||
2012
|
5,808,578
|
101,587
|
5,706,991
|
|||||||||
2013
|
5,647,132
|
37,573
|
5,609,559
|
|||||||||
2014
|
5,529,866
|
5,529,866
|
||||||||||
2015
|
5,448,872
|
5,448,872
|
||||||||||
Thereafter
|
47,534,442
|
47,534,442
|
||||||||||
Total
|
$
|
75,785,246
|
$
|
1,018,988
|
$
|
74,766,258
|
Q-13
NOTE
10 – SUBSEQUENT EVENTS
The
Company has evaluated subsequent events through the date the financial
statements were issued, or November 15, 2010 in accordance with ASC 855
“Subsequent events”. Management does not believe any subsequent events have
occurred that would require further disclosure or adjustment to the financial
statements.
Q-14
Report of
Independent Registered Public Accounting Firm
To the
Shareholders and Board of Directors of
QKL
Stores Inc. and Subsidiary:
We have
audited the accompanying consolidated balance sheet of QKL Stores Inc. and
Subsidiary (the “Company”) as of December 31, 2009 and the related consolidated
statements of operations, shareholders’ equity, and cash flows for the year
ended December 31, 2009. In connection with our audit of the financial
statements, we have also audited the financial statement schedule listed in the
accompanying index as of and for the year ended December 31, 2009. These
financial statements and schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The financial statements of QKL Stores Inc.
and Subsidiary as of December 31, 2008 and for year ended December 31, 2008 were
audited by other auditors whose report dated March 23, 2009, expressed an
unqualified opinion on those statements.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company at December 31,
2009, and the results of its operations and its cash flows for the year ended
December 31, 2008, in conformity with accounting principles generally accepted
in the United States of America.
As
discussed in Note 10 to the financial statements, the Company adopted ASC Topic
815-40, “Derivatives and Hedging: Contracts in Entity ‘ s Own Equity” (effective
January 1, 2009) as it related to the Company’s warrants.
Also, in
our opinion, the financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly, in
all material respects, the information set forth therein.
BDO China
Li Xin Da Hua CPA Co., Ltd.
Shenzhen,
People’s Republic of China
April 1,
2010
ALBERT
WONG & CO.
CERTIFIED
PUBLIC ACCOUNTANTS
7th
Floor, Nan Dao Commercial Building
359-361
Queen’s Road Central
Hong
Kong
Tel :
2851 7954
Fax: 2545
4086
ALBERT
WONG
B.Soc.,
Sc., ACA., LL.B.,
CPA(Practising)
To:
|
The
board of directors and stockholders of
|
QKL
Stores Inc. (“the Company”)
|
Report of Independent
Registered Public Accounting Firm
We have
audited the accompanying consolidated balance sheet of QKL Stores Inc. and
subsidiaries as of December 31, 2008 and the related consolidated statements of
income, stockholders’ equity and cash flow for the year then ended. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We
conducted our audit in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of QKL Stores Inc.
as of December 31, 2008 and the results of its operations and its cash flow for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.
Hong
Kong, China
|
Albert
Wong & Co.
|
March
23, 2009
|
Certified
Public Accountants
|
F-2
PART
1. FINANCIAL INFORMATION
|
|
Item
1. Consolidated Financial Statements
|
QKL
STORES INC AND SUBSIDIARIES
|
Consolidated
Balance Sheets
December 31,
2009
|
December 31,
2008
|
|||||||
ASSETS
|
||||||||
Cash
|
$
|
45,912,798
|
$
|
19,285,021
|
||||
Pledged
deposits
|
181,836
|
293,149
|
||||||
Accounts
receivable, net of allowance for doubtful accounts of nil and nil,
respectively
|
283,929
|
793,352
|
||||||
Inventories
|
24,691,156
|
14,544,341
|
||||||
Other
receivables
|
13,980,572
|
4,189,140
|
||||||
Prepaid
expenses
|
2,993,191
|
1,862,591
|
||||||
Advances
to suppliers
|
2,965,139
|
3,342,756
|
||||||
Deferred
income tax assets
|
417,788
|
-
|
||||||
Total
current assets
|
91,426,409
|
44,310,350
|
||||||
Property,
plant equipment, net
|
29,402,630
|
12,960,303
|
||||||
Land
use rights, net
|
753,226
|
776,259
|
||||||
Goodwill
|
19,280,509
|
18,878,823
|
||||||
Other
assets
|
408,391
|
787,741
|
||||||
Total
assets
|
$
|
141,271,165
|
$
|
77,713,476
|
||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Short-term
bank loans
|
$
|
-
|
$
|
2,188,439
|
||||
Accounts
payable
|
29,244,923
|
21,283,818
|
||||||
Cash
card and coupon liabilities
|
7,721,630
|
3,858,514
|
||||||
Customer
deposits received
|
3,862,890
|
2,901,205
|
||||||
Accrued
expenses and other payables
|
6,656,089
|
2,362,077
|
||||||
Income
taxes payable
|
1,154,229
|
1,252,336
|
||||||
Total
current liabilities
|
48,639,761
|
33,846,389
|
||||||
Warrant
liabilities
|
44,304,034
|
-
|
||||||
Total
liabilities
|
92,943,795
|
33,846,389
|
||||||
Commitments
and contingencies
|
-
|
-
|
||||||
Stockholders’
equity
|
||||||||
Common
stock, $.001 par value per share, authorized 100,000,000, shares, issued
and outstanding 29,475,983 and 20,882,353 at December 31, 2009 and
December 31, 2008, respectively
|
29,476
|
20,882
|
||||||
Series
A convertible preferred stock, par value $0.01, 10,000,000 shares
authorized, 7,548,346 and 9,117,647 shares outstanding at
December 31, 2009 and 2008, respectively
|
75,483
|
91,176
|
||||||
Additional
paid-in capital
|
53,191,217
|
21,783,477
|
||||||
Retained
earnings – appropriated
|
4,913,072
|
3,908,247
|
||||||
Retained
earnings (accumulated deficit)
|
(14,236,111
|
)
|
14,204,169
|
|||||
Accumulated
other comprehensive income
|
4,354,233
|
3,859,136
|
||||||
Total
stockholders’ equity
|
48,327,370
|
43,867,087
|
||||||
Total
liabilities and stockholders’ equity
|
$
|
141,271,165
|
$
|
77,713,476
|
See
notes to audited consolidated financial statements.
F-3
Consolidated
Statements of Operations
Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Net
sales
|
$
|
247,594,272
|
$
|
160,129,600
|
||||
Cost
of sales
|
206,639,561
|
129,739,748
|
||||||
Gross
profit
|
40,954,711
|
30,389,852
|
||||||
Selling
expenses
|
21,680,096
|
12,639,565
|
||||||
General
and administrative expenses
|
4,802,262
|
3,249,506
|
||||||
Income
from operations
|
14,472,353
|
14,500,781
|
||||||
Other
expenses
|
14,253
|
1,979,460
|
||||||
Changes
in fair value of warrants
|
35,492,017
|
-
|
||||||
Interest
income
|
(222,007
|
)
|
(272,551
|
)
|
||||
Interest
expense
|
23,734
|
240,330
|
||||||
Income
(loss) before income tax
|
(20,835,644
|
)
|
12,553,542
|
|||||
Income
tax expense
|
3,807,794
|
3,556,474
|
||||||
Net
income (loss)
|
$
|
(24,643,438
|
)
|
$
|
8,997,068
|
|||
Weighted
average number of shares outstanding
|
||||||||
Basic
|
21,885,423
|
20,882,353
|
||||||
Diluted
|
31,922,995
|
31,137,642
|
||||||
Earnings
(loss) per share
|
||||||||
Basic
|
$
|
(1.13
|
)
|
$
|
0.43
|
|||
Diluted
|
$
|
(0.77
|
)
|
$
|
0.29
|
See
notes to audited consolidated financial statements.
F-4
Consolidated
Statements of Shareholders’ Equity
Common stock
|
Series A convertible
preferred stock
|
Additional
paid-in
capital
|
Retained
Earnings -
Appropriated
|
Accumulated
deficit
Retained earnings
|
Accumulated
other
comprehensive
income
|
Total
|
||||||||||||||||||||||||||||||
Share
|
Amount
|
Share
|
Amount
|
|||||||||||||||||||||||||||||||||
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 | |||||||||||||||||||||||||||
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 | ||||||||||||||||||||
Net
loss
|
- | - | - | - | - | - | (24,643,438 | ) | - | (24,643,438 | ) | |||||||||||||||||||||||||
Reclassification
of warrants from equity to derivative liabilities
|
(6,020,000 | ) | (2,792,017 | ) | (8,812,017 | ) | ||||||||||||||||||||||||||||||
Compensation
expense for stock option granted
|
- | - | - | - | 14,252 | - | - | - | 14,252 | |||||||||||||||||||||||||||
Warrants
exercised (cashless)
|
124,329 | 124 | (124 | ) | - | - | ||||||||||||||||||||||||||||||
Preferred
stock convert to common stock
|
1,569,301 | 1,570 | (1,569,301 | ) | (15,693 | ) | 14,123 | - | - | - | - | |||||||||||||||||||||||||
common
shares offering
|
6,900,000 | 6,900 | 37,399,489 | 37,406,389 | ||||||||||||||||||||||||||||||||
Appropriation
to statutory reserves
|
- | - | - | - | - | 1,004,825 | (1,004,825 | ) | - | - | ||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
- | - | - | - | - | - | - | 495,097 | 495,097 | |||||||||||||||||||||||||||
December 31,
2009
|
29,475,983 | $ | 29,476 | 7,548,346 | $ | 75,483 | $ | 53,191,217 | $ | 4,913,072 | $ | (14,236,111 | ) | $ | 4,354,233 | $ | 48,327,370 |
See
notes to audited consolidated financial statements .
Consolidated
Statements of Cash Flows
Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||
Net
income (loss)
|
$
|
(24,643,438
|
)
|
$
|
8,997,068
|
|||
Depreciation
|
2,721,636
|
1,727,668
|
||||||
Amortization
|
27,967
|
26,679
|
||||||
Deferred
income tax
|
(416,944
|
)
|
—
|
|||||
Loss
on disposal of property, plant and equipment
|
36,938
|
—
|
||||||
Change
in fair value of warrants
|
35,492,017
|
—
|
||||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Accounts
receivable
|
512,692
|
(781,040
|
)
|
|||||
Inventories
|
(10,047,537
|
)
|
(5,265,816
|
)
|
||||
Other
receivables
|
(9,749,527
|
)
|
(771,775
|
)
|
||||
Prepaid
expenses
|
(327,811
|
)
|
(874,300
|
)
|
||||
Advances
to suppliers
|
1,686,988
|
(2,234,224
|
)
|
|||||
Accounts
payable
|
7,829,738
|
12,699,697
|
||||||
Cash
card and coupon liabilities
|
3,834,412
|
1,892,717
|
||||||
Customer
deposits received
|
944,028
|
1,938,371
|
||||||
Accrued
expenses and other payables
|
3,069,863
|
467,163
|
||||||
Income
taxes payable
|
(104,692
|
)
|
839,059
|
|||||
Net
cash provided by operating activities
|
10,866,330
|
18,661,267
|
||||||
CASH
FLOWS USED IN INVESTING ACTIVITIES:
|
||||||||
Purchases
of property, plant and equipment
|
(19,566,327
|
)
|
(4,595,461
|
)
|
||||
Acquisition
of business, net
|
—
|
(19,640,200
|
)
|
|||||
Decrease
(Increase) of pledged deposits
|
111,313
|
(293,149
|
)
|
|||||
Net
cash used in investing activities
|
(19,455,014
|
)
|
(24,528,810
|
)
|
||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||
Proceeds
from issuance of Common stock
|
37,406,389
|
—
|
||||||
Proceeds
from issuance of Series A convertible preferred stock
|
15,500,000
|
|||||||
Repayment
of bank loan
|
(2,195,872
|
)
|
(2,872,635
|
)
|
||||
Net
cash provided by financing activities
|
35,210,517
|
12,627,365
|
||||||
Net
increase in cash
|
26,621,833
|
6,759,822
|
||||||
Effect
of foreign currency translation
|
5,944
|
1,783,135
|
||||||
Cash
at beginning of period
|
19,285,021
|
10,742,064
|
||||||
Cash
at end of period
|
$
|
45,912,798
|
19,285,021
|
|||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
paid
|
23,734
|
240,330
|
||||||
Income
taxes paid
|
$
|
4,120,045
|
2,472,229
|
See
notes to audited consolidated financial statements .
F-6
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE
1 – ORGANIZATION AND BUSINESS OPERATIONS
QKL
Stores, Inc. (“Store”) (formerly known as Forme Capital, Inc.) was incorporated
under the laws of the State of Delaware on December 2, 1986. From 1989 to 2000,
Store 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, Store was a shell company with no substantial operations or assets. Store
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 Store controls, through contractual arrangements between WFOE and
Qingkelong Chain, as if Qingkelong Chain were a wholly-owned subsidiary of
Store, and (5) one wholly-owned operating subsidiary of Qingkelong Chain located
in Mainland China: Daqing Qinglongxin Commerce & Trade Co., Ltd
(“Qinglongxin 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 Store
and its subsidiaries (hereinafter, collectively referred to as “the Company”)
are engaged in the operation of retail chain stores in the PRC.
The
Company is a regional supermarket chain that currently operates 34
supermarkets and 2 department stores in northeastern China and Inner Mongolia.
The Company’s supermarkets sell a broad selection of merchandise including
groceries, fresh food and non-food items. The Company currently has one
distribution center servicing its supermarkets.
Management
believes that the Company is the only supermarket chain in northeastern China
and Inner Mongolia that is a licensee of the International Grocers Alliance, or
IGA, a United States-based global grocery network with aggregate retail sales of
more than $21.0 billion per year. As a licensee of IGA, the Company is able to
engage in group bargaining with suppliers and have access to more than 2,000
private IGA brands, including many that are exclusive IGA brands.
The
Company completed the initial steps in the execution of its expansion plan
in March 2008, when the Company raised financing through the combination of a
reverse merger and private placement. Under that plan, the Company opened seven
new stores in 2009 that have, in the aggregate, approximately 32,000 square
meters of space and ten new stores in 2008 that have, in the aggregate,
approximately 42,000 square meters of space. Six stores opened in 2008 were
opened by the Company and four of the new stores were opened through the
acquisition of existing businesses by the Company. Seven stores opened in 2009
were opened by the Company. In 2010, the Company plans to open additional
hypermarkets, supermarkets and department stores having, in the aggregate,
approximately 100,000 square meters of space. The Company is also making
improvements to its logistics and information systems to support its
supermarkets. The Company expects to finance its expansion plan from funds
generated from operations, bank loans and proceeds from private or public
financing, to the extent available.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRC
Restructuring Agreements
The PRC
restructuring transaction was effected by the execution of five agreements
between Speedy Brilliant (Daqing), on the one hand, and QKL-China (and in some
cases the shareholders of QKL-China), on the other hand. Those five agreements
and their consequences are described below.
F-7
§ Consigned
Management Agreement
The
Consigned Management Agreement among Speedy Brilliant (Daqing), QKL-China and
all of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing)
will provide financial, business management and human resources management
services to QKL-China that will enable Speedy Brilliant (Daqing) to control
QKL-China’s operations, assets and cash flow, and in exchange, QKL-China will
pay a management fee to Speedy Brilliant (Daqing) equal to 4.5% of QKL-China’s
annual revenue. The management fee for each year is due by January 31 of the
following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
§ Technology
Service Agreement
The
Technology Service Agreement among Speedy Brilliant (Daqing), QKL-China and all
of the shareholders of QKL-China, provides that Speedy Brilliant (Daqing) will
provide technology services, including the selection and maintenance of
QKL-China’s computer hardware and software systems and training of QKL-China
employees in the use of those systems, and in exchange QKL-China will pay a
technology service fee to Speedy Brilliant (Daqing) equal to 1.5% of QKL-China’s
annual revenue. The technology service fee for each year is due by January 31 of
the following year. The agreement will remain effective until Speedy Brilliant
(Daqing) or its designees have acquired 100% of the equity interests of
QKL-China or substantially all of the assets of QKL-China.
§ Loan
Agreement
The Loan
Agreement among Speedy Brilliant (Daqing) and all of the shareholders of
QKL-China, provides that Speedy Brilliant (Daqing) will make a loan in the
aggregate principal amount of RMB 77 million (approximately $11.2 million) to
the shareholders of QKL-China, each shareholder receiving a share of the loan
proceeds proportional to its shareholding in QKL-China, and in exchange each
shareholder agreed (i) to contribute all of its proceeds from the loan to the
registered capital of QKL-China in order to increase the registered capital of
QKL-China, (ii) to cause QKL-China to complete the process of registering the
increase in its registered capital with PRC regulatory authorities within 30
days after receiving the loan, and (iii) to pledge their equity to Speedy
Brilliant (Daqing) under the Equity Pledge Agreement described
below.
The loan
is repayable by the shareholders at the option of Speedy Brilliant
(Daqing) either by the transfer of QKL-China’s equity to Speedy Brilliant
(Daqing) or through proceeds indirectly from the transfer of QKL-China assets to
Speedy Brilliant (Daqing). The loan does not bear interest, except that if (x)
Speedy Brilliant (Daqing) is able to purchase the equity or assets of QKL-China,
and (y) the lowest allowable purchase price for that equity or those assets
under PRC law is greater than the principal amount of the loan, then, insofar as
it is allowable under PRC law, interest will be deemed to have accrued on the
loan in an amount equal to the difference between the lowest allowable purchase
price for QKL-China and the principal amount of the loan. The effect of this
interest provision is that, if and when permitted under PRC law, Speedy
Brilliant (Daqing) may acquire all of the equity or assets of QKL-China by
forgiving the loan, without making any further payment. If the principal amount
of the loan is greater than the lowest allowable purchase price for the equity
or assets of QKL-China under PRC law, then Speedy Brilliant (Daqing) would
exempt the shareholders from paying the difference between the two amounts. The
effect of this provision is that (insofar as allowable under PRC law) the
shareholders of QKL-China may satisfy their repayment obligations under the loan
by transferring all of QKL-China’s equity or assets to Speedy Brilliant
(Daqing), without making any further payment.
The Loan
Agreement also contains promises from the shareholders of QKL-China that during
the term of the agreement they will elect as directors of QKL-China only
candidates nominated by Speedy Brilliant (Daqing), and they will use their best
efforts to ensure that QKL-China does not take certain actions without the prior
written consent of Speedy Brilliant (Daqing), including (i) supplementing or
amending the articles of association or rules of QKL-China, or of any subsidiary
controlled or wholly owned by it, (ii) increasing or decreasing its registered
capital or shareholding structure, (iii) transferring, mortgaging or disposing
of any interests in its assets or income, or encumbering its assets or income in
a way that would affect Speedy Brilliant (Daqing)’s security interest unless
required for QKL-China’s normal business operations, (iv) incurring or
succeeding to any debts and liabilities, (v) entering into any material contract
(exceeding RMB 5.0 million, or approximately $0.7 million, in value); (vi)
providing any loan or guarantee to any third party; (vii) acquiring or
consolidating with any third party, or investing in any third party; and (viii)
distributing any dividends to the shareholders in any manner. In addition, the
Loan Agreement provides that at Speedy Brilliant (Daqing)’s request, QKL-China
will promptly distribute all distributable dividends to its
shareholders.
The funds
that Speedy Brilliant (Daqing) used to make the loan came from the proceeds
received by the Company, its indirect parent company, in the private placement
transaction completed in March 2008.
§ Exclusive
Purchase Option Agreement
The
Exclusive Purchase Option Agreement, among Speedy Brilliant (Daqing), QKL-China,
and all of the shareholders of QKL-China, provides that QKL-China will grant
Speedy Brilliant (Daqing) or its designated third party an irrevocable and
exclusive right to purchase all or part of QKL-China’s assets, and the
shareholders of QKL-China will grant Speedy Brilliant (Daqing) or its designated
third party an irrevocable and exclusive right to purchase all or part of their
equity interests in QKL-China. Either right may be exercised by Speedy Brilliant
(Daqing) in its sole discretion at any time that the exercise would be
permissible under PRC law, and the purchase price for Speedy Brilliant
(Daqing)’s acquisition of equity or assets will be the lowest price permissible
under PRC law. QKL-China and its shareholders are required to execute purchase
agreements and related documentation within 30 days of receiving notice from
Speedy Brilliant (Daqing) that it intends to exercise its right to
purchase.
The
Exclusive Purchase Option Agreement contains promises from QKL-China and its
shareholders that they will refrain from taking actions, such as voting to
dissolve or declaring dividends, that could impair Speedy Brilliant (Daqing)’s
security interest in the equity of QKL-China or reduce its value. These promises
are substantially the same as those contained in the Loan Agreement described
above.
The
agreement will remain effective until Speedy Brilliant (Daqing) or its designees
have acquired 100% of the equity interests of QKL-China or substantially all of
the assets of QKL-China. The exclusive purchase options were granted under the
agreement on the closing date.
§ Equity
Pledge Agreement
The
Equity Pledge Agreement, among Speedy Brilliant (Daqing), QKL-China, and all of
the shareholders of QKL-China, provides that the shareholders of QKL-China will
pledge all of their equity interests in QKL-China to Speedy Brilliant (Daqing)
as a guarantee of the performance of the shareholders’ obligations and
QKL-China’s obligations under each of the other PRC Restructuring Agreements.
Under the Equity Pledge Agreement, the shareholders of QKL-China have also
agreed (i) to cause QKL-China to have the pledge recorded at the appropriate
office of the PRC Bureau of Industry and Commerce, (ii) to deliver any dividends
received from QKL-China during the term of the agreement into an escrow account
under the supervision of Speedy Brilliant (Daqing), and (iii) to deliver
QKL-China’s official shareholder registry and certificate of equity contribution
to Speedy Brilliant (Daqing).
The
Equity Pledge Agreement contains promises from QKL-China and its shareholders
that they will refrain from taking actions, such as voting to dissolve or
declaring dividends, that could impair Speedy Brilliant (Daqing)’s security
interest in the equity of QKL-China or reduce its value. These promises are
substantially the same as those contained in the Loan Agreement described
above.
Completion
of the PRC Restructuring
The PRC
restructuring transaction closed on March 28, 2008 and after the closing date,
Speedy Brilliant (Daqing) completed all required post-closing steps, including
the payment and verification of all the installments of Speedy Brilliant
(Daqing)’s registered capital.
The
remaining portion of Speedy Brilliant (Daqing)’s registered capital was
contributed and verified by August 1, 2009, two years after the issuance of its
business license.
F-9
Share
Exchange Transaction
In the
share exchange transaction, Forme acquired control of Speedy Brilliant (BVI), a
British Virgin Islands holding company and the parent company of Speedy
Brilliant (Daqing), by issuing to the stockholders of Speedy Brilliant (BVI)
shares of common stock in exchange for all of the outstanding capital stock
of
Speedy
Brilliant (BVI). The stockholders of Speedy Brilliant (BVI) with whom the
Company completed the share exchange were (i) the majority holder, Winning State
International Limited, a British Virgin Islands holding company (“Winning State
(BVI)”) all of whose stock was acquired by the Company’s Chief Executive
Officer, Mr. Zhuangyi Wang, pursuant to a call option held by Mr. Wang that he
exercised on February 2, 2010,and (ii) three minority stockholders, Ms. Fang
Chen, Mr. Yang Miao, and Ms. Ying Zhang.
Share
Exchange Agreement
On March
28, 2008, Forme entered into a share exchange agreement with (i) Speedy
Brilliant (BVI); (ii) Speedy Brilliant (Daqing); (iii) the owners of all of the
outstanding voting stock of Speedy Brilliant (BVI), namely (a) Winning State
(BVI) (a company that is wholly owned and controlled by Mr. Chin Yoke Yap (all
of whose stock may be acquired by the Company’s CEO, Mr. Zhuangyi Wang, pursuant
to a currently exercisable call option held by Mr. Wang)), which owned
approximately 98.5% of the Speedy Brilliant (BVI) stock, and (b) three
individuals, Ms. Fang Chen, Ms. Yang Miao and Ms. Ying Zhang, who collectively
owned approximately 1.5% of the Speedy Brilliant (BVI) stock; and (iv) Forme’s
then controlling stockholders, Vision Opportunity China LP, Stallion Ventures,
LLC, and Castle Bison, Inc. Under the terms of the share exchange agreement, the
Speedy Brilliant (BVI) stockholders exchanged all of the outstanding shares of
Speedy Brilliant (BVI) for a total of 19,382,298 newly issued shares of Forme
common stock. As a result of the share exchange, Forme acquired Speedy Brilliant
(BVI) as a wholly owned subsidiary, and the Speedy Brilliant (BVI) stockholders
became holders of 92.8% of the Company’s common stock on a non-diluted basis
(64.6% of the Company’s common stock assuming conversion of the Company’s
newly-issued Series A Preferred Stock and 46.3% of the Company’s common stock
assuming conversion of the Company’s newly-issued Series A Preferred Stock and
exercise of all of the Series A Warrants and Series B Warrants).
In the
PRC restructuring transaction described above, Speedy Brilliant (BVI) gained
control of the Company’s operating company, QKL-China. Therefore, when the
Company acquired control of Speedy Brilliant (BVI) in the share exchange, the
Company acquired indirect control of QKL-China. As a result, at the time of the
share exchange, (i) the Company ceased to be a shell company as that term is
defined in Rule 12b-2 under the Exchange Act, (ii) Speedy Brilliant (BVI) became
the Company’s wholly owned subsidiary, and (iii) through the Company’s
newly-acquired indirect subsidiary Speedy Brilliant (Daqing) we now control,
through the contractual arrangements described above.
F-10
The
Company’s current structure, after completion of the reverse merger transaction,
is set forth in the diagram below:
Principles of Consolidation
and Presentation
The
consolidated financial statements have been prepared in accordance with U.S.
generally accepted accounting principles (“U.S. GAAP”). The consolidated
financial statements include the financial statements of QKL Stores Inc, and its
wholly-owned subsidiaries (collectively referred to herein as the
“Company”). All intercompany accounts, transactions, and profits have been
eliminated upon consolidation.
Use of
Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted 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 period. Actual results could materially differ from those
estimates.
Reclassification
The
presentation of certain line items presented on the consolidated financial
statements and the relevant notes for the prior years have been changed in
conformity with the current year presentation of the consolidated financial
statements and the corresponding notes. For comparative purposes, the
Company reclassified the following:
§
|
Approximately $1,351,753 of
revenues was reclassified to general and administrative expenses in the
statements of income in fiscal 2008. These revenues were primarily
related to sub-lease rental
income.
|
§
|
Approximately $2,567,502 of
selling expenses was reclassified to cost of sales in the statements of
income in fiscal 2008. These selling expenses consisted of DC
costs. The Company believes that such reclassification represents
better presentation to its retail industry
standard.
|
These
reclassification had no effect on the Company’s previously reported consolidated
statements of operations, consolidated statements of stockholders’ equity or
consolidated statements of cash flows, and is not considered material to any
previously reported consolidated financial statements.
Foreign Currency
Translation
The
Company’s financial statements are presented in the U.S. dollar ($), which is
the Company’s reporting currency, while its functional currency is Chinese
Renminbi (RMB). Transactions in foreign currencies are initially recorded at the
functional currency rate ruling at the date of transaction. Any differences
between the initially recorded amount and the settlement amount are recorded as
a gain or loss on foreign currency transaction in the consolidated statements of
income. Monetary assets and liabilities denominated in foreign currency are
translated at the functional currency rate of exchange ruling at the balance
sheet date. Any differences are taken to profit or loss as a gain or loss on
foreign currency translation in the statements of income.
In
accordance with ASC 830, Foreign Currency Matters, the Company translates the
assets and liabilities into RMB using the rate of exchange prevailing at the
applicable balance sheet date and the statements of income and cash flows are
translated at an average rate during the reporting period. Adjustments
resulting from the translation are recorded in shareholders’ equity as part of
accumulated other comprehensive income.
Below is
a table with foreign exchange rates used for translation:
(Average Rate)
|
||||||||
Years Ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Chinese
Renminbi (RMB)
|
RMB
|
6.8310
|
RMB
|
6.9623
|
||||
United
States dollar ($)
|
$
|
1.0000
|
$
|
1.0000
|
As
of December 31,
|
2009
|
2008
|
||||||
Chinese
Renminbi
(RMB)
|
RMB
|
6.8172
|
RMB
|
6.8542
|
||||
United
States dollar ($)
|
$
|
1.0000
|
$
|
1.0000
|
Segment
Reporting
The
Company operates in one industry segment, operating retail chain stores.
ASC 280, Segment Reporting, establishes standards for reporting information
about operating segments. Given the economic characteristics of the similar
nature of the products sold, the type of customer and the method of
distribution, the Company operates as one reportable segment as defined by ASC
280, Segment Reporting.
Revenue
Recognition
The
Company earns revenue by selling merchandise primarily through its retail
stores. Revenue is recognized when merchandise is purchased by and delivered to
the customer and is shown net of estimated returns during the relevant period.
The allowance for sales returns is estimated based upon historical
experience.
Cash
received from the sale of cash card (aka “gift card”) is recorded as a
liability, and revenue is recognized upon the redemption of the cash card or
when it is determined that the likelihood of redemption is remote (“cash card
breakage”) and no liability to relevant jurisdictions exists. The Company
determines the cash card breakage rate based upon historical redemption patterns
and recognizes cash card breakage on a straight-line basis over the estimated
cash card redemption period. The Company recognized approximately nil in
cash card breakage revenue for fiscal 2009 and 2008,
respectively.
F-12
The
Company records sales tax collected from its customers on a net basis, and
therefore excludes it from revenue as defined in ASC 605, Revenue
Recognition.
Included
in revenue are sales of returned merchandise to vendors specializing in the
resale of defective or used products, which accounted for less than 0.5% of net
sales in each of the periods reported.
Cost of
Sales
Cost of
sales includes the cost of merchandise, related cost of packaging and shipping
cost and the distribution center costs.
Selling
Expenses
Selling
expenses include store-related expense, other than store occupancy costs, as
well as advertising, depreciation and amortization, and certain expenses
associated with operating the Company’s corporate headquarters.
Advertising
Costs
Advertising
costs are expensed as incurred. Advertising expense, net of reimbursement from
suppliers, amounted to $471,694 and nil for fiscal 2009 and 2008, respectively.
Advertising expense is included in selling expense in the accompanying
consolidated statements of income. The Company receives co-operative advertising
allowances from product vendors in order to subsidize qualifying advertising and
similar promotional expenditures made relating to vendors’ products. These
advertising allowances are recognized as a reduction to selling expense when the
Company incurs the advertising cost eligible for the credit. Co-operative
advertising allowances recognized as a reduction to selling and administrative
expense amounted to nil for fiscal 2009 and 2008 respectively.
Vendor
Allowances
The
Company receives allowances for co-operative advertising and volume purchase
rebates earned through programs with certain vendors. The Company records a
receivable for these allowances which are earned but not yet received when it is
determined the amounts are probable and reasonably estimable, in accordance with
ASC 605. Amounts relating to the purchase of merchandise are treated as a
reduction of inventory cost and reduce cost of goods sold as the merchandise is
sold. Amounts that represent a reimbursement of costs incurred, such as
advertising, are recorded as a reduction in selling and administrative expense.
The Company performs detailed analyses to determine the appropriate amount of
vendor allowances to be applied as a reduction of merchandise cost and selling
expenses.
Leases
The
Company accounts for its leases under the provisions of ASC 840, Leases. Certain
of the Company’s operating leases provide for minimum annual payments that
change over the life of the lease. The aggregate minimum annual payments are
expensed on the straight-line basis over the minimum lease term. The Company
recognizes a deferred rent liability for minimum step rents when the amount of
rent expense exceeds the actual lease payments and it reduces the deferred rent
liability when the actual lease payments exceeds the amount of straight-line
rent expense. Rent holidays and tenant improvement allowances for store remodels
are amortized on the straight-line basis over the initial term of the lease and
any option period that is reasonably assured of being exercised.
Restricted
Cash
Restricted
cash are cash deposited in a trust account maintained in the United States for
the purpose of investor and public relation affairs.
F-13
Accounts
Receivable
Accounts
receivable consist primarily of third party purchasing card receivables, amounts
due from inventory vendors for returned products or co-operative advertising and
amounts due from lessors for tenant improvement allowances. Accounts receivable
have not historically resulted in any material credit losses. An allowance for
doubtful accounts is provided when accounts are determined to be
uncollectible.
Inventories
Inventories
primarily consist of merchandise inventories and are stated at lower of cost or
market and net realizable value. Cost of inventories is calculated on the
weighted average basis which approximates cost.
Management
regularly reviews inventories and records valuation reserves for damaged and
defective returns, inventories with slow-moving or obsolescence exposure and
inventories with carrying value that exceeds market value. Because of its
product mix, the Company has not historically experienced significant
occurrences of obsolescence.
Inventory
shrinkage is accrued as a percentage of revenues based on historical inventory
shrinkage trends. The Company performs physical inventory count of its stores
once per quarter and cycle counts inventories at its distribution centers once
per quarter throughout the year. The reserve for inventory shrinkage represents
an estimate for inventory shrinkage for each store since the last physical
inventory date through the reporting date.
These
reserves are estimates, which could vary significantly, either favorably or
unfavorably, from actual results if future economic conditions, consumer demand
and competitive environments differ from expectations.
Property, Plant and
Equipment
Property,
plant and equipment are recorded at cost. Significant additions or improvements
extending useful lives of assets are capitalized. Maintenance and repairs are
charged to expense as incurred. Depreciation is computed using the straight-line
method over the estimated useful lives as follows:
Buildings
|
30
to 40 years
|
Shop
equipment
|
6
years
|
Office
equipment
|
5
years
|
Motor
vehicles
|
8
years
|
Car
park
|
43
years
|
Leasehold
improvements
|
Shorter
of estimated useful life or term of
lease
|
Land Use
Rights
According
to the laws of the PRC, the government owns all the land in the PRC.
Companies or individuals are authorized to possess and use the land only through
the land use rights granted by the government. The land use rights represent
cost of the rights to use the land in respect of properties located in the PRC.
Land use rights are carried at cost and amortized on a straight-line basis over
the period of rights of 30 to 40 years.
Goodwill
Goodwill
represents the excess of purchase price over fair value of net assets acquired.
Under ASC 350, Intangibles—Goodwill and Other, goodwill is not amortized but
evaluated for impairment annually or whenever events or changes in circumstances
indicate that the value may not be recoverable.
The
Company performed an annual impairment test as of the end of fiscal 2009 and
2008, and determined that goodwill was not impaired.
F-14
Long-lived
Assets
The
Company reviews long-lived assets for impairment annually or whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable.
Long-lived
assets are reviewed for recoverability at the lowest level in which there are
identifiable cash flows, usually at the store level. The carrying amount of a
long-lived asset is not considered recoverable if it exceeds the sum of the
undiscounted cash flows expected to result from the use of the asset. If the
asset is determined not to be recoverable, then it is considered to be impaired
and the impairment to be recognized is the amount by which the carrying amount
of the asset exceeds the fair value of the asset, determined using discounted
cash flow valuation techniques, as defined in ASC 360, Property, Plant, and
Equipment.
The
Company determined the sum of the undiscounted cash flows expected to result
from the use of the asset by projecting future revenue and operating expense for
each store under consideration for impairment. The estimates of future cash
flows involve management judgment and are based upon assumptions about expected
future operating performance. The actual cash flows could differ from
management’s estimates due to changes in business conditions, operating
performance and economic conditions.
The
Company’s evaluation resulted in no long-lived asset impairment charges during
fiscal 2009 and 2008.
Concentration of Credit
Risk
The
Company maintains cash in bank deposit accounts in PRC, except one restricted
cash deposit account in the U.S. for the sole purpose of disbursements of
investor relations expenses. The account in the U.S. is uninsured by the
Federal Deposit Insurance Corporation (“FDIC”) up to $81,693. The Company
performs ongoing evaluations of this institution to limit its concentration risk
exposure.
The
Company operates retail stores located principally in the Northeast of China.
Because of this, the Company is subject to regional risks, such as the economy,
regional financial conditions and unemployment, weather conditions, power
outages, and other natural disasters specific to the region in which the Company
operates.
The
Company relies on two distribution centers located in Daqing, China, which
service its stores. Any natural disaster or other serious disruption to the
distribution center due to fire, earthquake or any other cause could damage a
significant portion of inventory and could materially impair the Company’s
ability to adequately stock its stores.
Retirement Benefit
Plans
Full time
employees of the Company in the PRC participate in a government mandated defined
contribution plan, pursuant to which certain pension benefits, medical care,
employee housing fund and other welfare benefits are provided to employees.
Chinese labor regulations require the Company to make contributions to the
government for these benefits based on certain percentages of the employees’
salaries. The Company accounts the mandated defined contribution plan under the
vested benefit obligations approach based on the guidance of ASC 715,
Compensation—Retirement Benefits.
The total
amounts for such employee benefits which were expensed were $2,087,718 and
$911,831 for the years ended December 31, 2009 and 2008,
respectively.
Retained Earnings -
Appropriated
The
income of the Company’s PRC subsidiaries is distributable to their shareholder
after transfer to reserves as required by relevant PRC laws and regulations and
the subsidiary’s Articles of Association. As stipulated by the relevant
laws and regulations in the PRC, these PRC subsidiaries are required to maintain
reserves which are non-distributable to shareholders. Appropriations to the
reserves are approved by the respective boards of directors.
F-15
Reserves
include statutory surplus reserves and discretionary reserves. Statutory
surplus reserves can be used to make good previous years’ losses, if any, and
may be converted into capital in proportion to the existing equity interests of
shareholders, provided that the balance after such conversion is not less than
25% of the registered capital. The appropriation to the statutory surplus
reserves must not be less than 10% of net profit after taxation. Such
appropriation may cease to apply if the balance of the fund is equal to 50% of
the entity’s registered capital. The annual appropriations of reserves of
Qingkelong Chain and Qinglongxin Commerce are 10% and nil for the years ended
December 31, 2009 and 2008, respectively.
Income
Taxes
The
Company follows ASC 740, Income Taxes, which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Under
this method, deferred income taxes are recognized for the tax consequences in
future years of differences between the tax bases of assets and liabilities and
their financial reporting amounts at each period end based on enacted tax laws
and statutory tax rates, applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized.
The
Company adopted ASC 740-10-25 on January 1, 2007, which provides criteria for
the recognition, measurement, presentation and disclosure of uncertain tax
position. The Company must recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical
merits of the position. The tax benefits recognized in the financial statements
from such a position are measured based on the largest benefit that has a
greater than 50% likelihood of being realized upon ultimate resolution. The
Company did not recognize any additional liabilities for uncertain tax positions
as a result of the implementation of ASC 740-10-25.
Fair Value
Measurements
ASC
820 defines fair value as the price that would be received from selling an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. When determining the fair value
measurements for assets and liabilities required or permitted to be recorded at
fair value, the Company considers the principal or most advantageous market in
which it would transact and it considers assumptions that market participants
would use when pricing the asset or liability. ASC 820 establishes a fair value
hierarchy that requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. A financial
instrument’s categorization within the fair value hierarchy is based upon the
lowest level of input that is significant to the fair value measurement.
ASC 820 establishes three levels of inputs that may be used to measure fair
value:
§
|
Level 1 – Valuations based on
unadjusted quoted prices in active markets for identical assets or
liabilities that the Company holds. An active market for the asset or
liability is a market in which transactions for the asset or liability
occur with sufficient frequency and volume to provide pricing information
on an ongoing basis.
|
§
|
Level 2 – Valuation based on
quoted prices in markets that are not active for which all significant
inputs are observable, either directly or
indirectly.
|
§
|
Level 3 – Valuations based on
inputs that are unobservable and significant to the overall fair value
measurement.
|
The
Company adopted ASC 820, Fair Value Measurements and Disclosures, on January 1,
2008 for all financial assets and liabilities and nonfinancial assets and
liabilities that are recognized or disclosed at fair value in the consolidated
financial statements on a recurring basis (at least annually). ASC 820 defines
fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. The Company has also adopted ASC 820,
on January 1, 2009 for non financial assets and non financial liabilities, as
these items are not recognized at fair value on a recurring basis. The adoption
of ASC 820 for all financial assets and liabilities and non-financial assets and
non-financial liabilities did not have any impact on the Company’s consolidated
financial statements.
F-16
Financial
instruments include cash, accounts receivable, prepayments and other
receivables, short-term borrowings from banks, accounts payable and accrued
expenses and other payables. The carrying amounts of cash, accounts receivable,
prepayments and other receivables, short-term loans, accounts payable and
accrued expenses approximate their fair value due to the short term maturities
of these instruments. See footnote 10 regarding the fair value of the Company ‘
s warrants, which are classified as Level 3 liabilities in the fair value
hierarchy.
Recently Issued Accounting
Guidance
In
December 2007, the FASB issued ASC 810-10-65(formerly SFAS 160, “Noncontrolling
Interests in Consolidated Financial Statements — an amendment of ARB No. 51”),
Consolidation, which applies to all companies that prepare consolidated
financial statements, except not-for-profit organizations, but will affect only
those entities that have an outstanding non-controlling interest in one or more
subsidiaries or that deconsolidate a subsidiary. ASC 810-10-65 requires
that ownership interests in subsidiaries held by parties other than the parent,
and the amount of consolidated net income, be clearly identified, labeled and
presented in the consolidated financial statements. It also requires that once a
subsidiary is deconsolidated, any retained non-controlling equity investment in
the former subsidiary be initially measured at fair value. Sufficient
disclosures are required to clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. It is
effective for fiscal years beginning after December 15, 2008, and requires
retroactive adoption of the presentation and disclosure requirements for
existing minority interests. All other requirements are applied prospectively.
The Company adopted ASC 810-10-65 on January 1, 2009 and the Company’s
consolidated financial statements reflect the required changes.
Effective
January 1, 2009, the Company adopted FASB ASC 805-10, (formerly SFAS 141R,
“Business Combinations”), which establishes principles and requirements for how
an acquirer recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, any noncontrolling interest in an
acquiree and the goodwill acquired. In addition, the provisions in this
ASC require that any additional reversal of deferred tax asset valuation
allowance established in connection with our fresh start reporting on January 7,
1998 be recorded as a component of income tax expense rather than as a reduction
to the goodwill established in connection with the fresh start reporting. The
adoption did not have a material impact on the Company’s consolidated financial
statements.
Effective
January 1, 2009, the Company adopted FASB ASC 805-20 (formerly FSP FAS 141R-1,
“Accounting for Assets Acquired and Liabilities Assumed in a Business
Combination That Arise from Contingencies”), which amends ASC 805-10 to require
that an acquirer recognize at fair value, at the acquisition date, an asset
acquired or a liability assumed in a business combination that arises from a
contingency if the acquisition-date fair value of that asset or liability can be
determined during the measurement period. If the acquisition-date fair value of
such an asset acquired or liability assumed cannot be determined, the acquirer
should apply the provisions of ASC Topic 450, Contingences, to determine whether
the contingency should be recognized at the acquisition date or after such date.
The adoption of ASC 805-20 did not have a material impact on the Company’s
consolidated financial statements.
Effective
January 1, 2009, the Company adopted ASC 350-30 and ASC 275-10-50 (formerly 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 SFAS No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” The
adoption of these revised provisions had no impact on the Company’s consolidated
financial statements.
In June
2009, the FASB issued ASC 810-10-30, Variable Interest Entities (formerly FASB
167), regarding when and how to determine, or re-determine, whether an entity is
a variable interest entity. In addition, FASB No. 167 replaces FIN 46R’s
quantitative approach for determining who has a controlling financial interest
in a variable interest entity with a qualitative approach. Furthermore, ASC
810-10-30 requires ongoing assessments of whether an entity is the primary
beneficiary of a variable interest entity. ASC 810-10-30 is effective beginning
January 1, 2010 and the adoption is not expected to have a material impact on
the Company’s consolidated financial statements.
F-17
In June
2009, the Financial Accounting Standards Board (“FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles — a replacement of FASB Statement No. 162. SFAS No. 168
established the FASB Accounting Standards Codification (“ASC”) as the single
source of authoritative generally accepted accounting principles in the United
States of America (“GAAP”) to be applied by nongovernmental entities in the
preparation of financial statements. Rules and interpretive releases of the
Securities and Exchange Commission (“SEC”) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. All guidance in
the ASC carries an equal level of authority. The ASC supersedes all previously
existing non-SEC accounting and reporting standards. The ASC simplifies user
access to all authoritative GAAP by reorganizing previously issued GAAP
pronouncements into approximately 90 accounting topics within a consistent
structure, without creating new accounting and reporting guidance. The ASC
became effective for financial statements issued for interim and annual periods
ending after September 15, 2009; accordingly, the Company adopted the ASC in the
third quarter of fiscal 2009. Following SFAS No. 168, the FASB will not issue
new standards in the form of Statements, FASB Staff Positions, or Emerging
Issues Task Force Abstracts; instead, it will issue Accounting Standards
Updates. The FASB will not consider Accounting Standards Updates as
authoritative in their own right; these updates will serve only to update the
ASC, provide background information about the guidance, and provide the bases
for conclusions on the change(s) in the ASC. In the discussion that follows, the
Company will refer to ASC citations that relate to ASC Topics and their
descriptive titles, as appropriate, and will no longer refer to citations that
relate to accounting pronouncements superseded by the ASC. The adoption of the
ASC had no impact on the Company’s consolidated financial
statements.
In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets – an amendment of FASB Statement No. 140,” (not yet reflected in FASB
ASC). SFAS No. 166 limits the circumstances in which a financial asset should be
derecognized when the transferor has not transferred the entire financial asset
by taking into consideration the transferor’s continuing involvement. The
standard requires that a transferor recognize and initially measure at fair
value all assets obtained (including a transferor’s beneficial interest) and
liabilities incurred as a result of a transfer of financial assets accounted for
as a sale. The concept of a qualifying special-purpose entity is removed from
SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities,” along with the exception from applying FIN
46(R), “Consolidation of Variable Interest Entities.” The standard is effective
for the first annual reporting period that begins after November 15, 2009 (i.e.
the Company’s fiscal year beginning January 1, 2010), for interim periods within
the first annual reporting period, and for interim and annual reporting periods
thereafter. Earlier application is prohibited. It is expected the adoption of
this Statement will have no material effect on the Company’s consolidated
financial statements.
In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R),” (not yet reflected in FASB ASC). The standard amends FIN No. 46(R) to
require a company to analyze whether its interest in a variable interest entity
(“VIE”) gives it a controlling financial interest. A company must assess whether
it has an implicit financial responsibility to ensure that the VIE operates as
designed when determining whether it has the power to direct the activities of
the VIE that significantly impact its economic performance. Ongoing
reassessments of whether a company is the primary beneficiary are also required
by the standard. SFAS No. 167 amends the criteria to qualify as a primary
beneficiary as well as how to determine the existence of a VIE. The standard
also eliminates certain exceptions that were available under FIN No. 46(R). This
Statement will be effective as of the beginning of each reporting entity’s first
annual reporting period that begins after November 15, 2009 (i.e. the
Company’s fiscal year beginning January 1, 2010), for interim periods within
that first annual reporting period, and for interim and annual reporting periods
thereafter. Earlier application is prohibited. Comparative disclosures will be
required for periods after the effective date. As such, the Company will adopt
this Statement for interim and annual periods ending after January 1,
2010. It is expected the adoption of this Statement will have no material
effect on the Company’s consolidated financial statements.
In
September 2009, the accounting standard regarding multiple deliverable
arrangements was updated to require the use of the relative selling price method
when allocating revenue in these types of arrangements. This method allows a
vendor to use its best estimate of selling price if neither vendor specific
objective evidence nor third party evidence of selling price exists when
evaluating multiple deliverable arrangements. This standard update is effective
January 1, 2011 and may be adopted prospectively for revenue arrangements
entered into or materially modified after the date of adoption or
retrospectively for all revenue arrangements for all periods presented. The
Company is currently evaluating the impact that this standard update will have
on its consolidated financial statements.
In
October 2009, the FASB concurrently issued the following ASC
Updates:
F-18
§
|
ASU No. 2009-14 - Software (Topic
985): Certain Revenue Arrangements That Include Software Elements
(formerly EITF Issue No. 09-3). This standard removes tangible products
from the scope of software revenue recognition guidance and also provides
guidance on determining whether software deliverables in an arrangement
that includes a tangible product, such as embedded software, are within
the scope of the software revenue
guidance.
|
§
|
ASU No. 2009-13 - Revenue
Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements
(formerly EITF Issue No. 08-1). This standard modifies the revenue
recognition guidance for arrangements that involve the delivery of
multiple elements, such as product, software, services or support, to a
customer at different times as part of a single revenue generating
transaction. This standard provides principles and application
guidance to determine whether multiple deliverables exist, how the
individual deliverables should be separated and how to allocate the
revenue in the arrangement among those separate deliverables. The standard
also expands the disclosure requirements for multiple deliverable revenue
arrangements.
|
These
Accounting Standards Updates should be applied on a prospective basis for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010, with earlier application permitted.
Alternatively, an entity can elect to adopt these standards on a retrospective
basis, but both these standards must be adopted in the same period using the
same transition method. The Company expects to apply this standard on a
prospective basis for revenue arrangements entered into or materially modified
beginning January 1, 2011. The Company is currently evaluating the
potential impact these standards may have on its financial position and results
of operations.
In
January 2010, the FASB issued the following ASC Updates:
§
|
ASU No. 2010-01—Equity (Topic
505): Accounting for Distributions to Shareholders with Components of
Stock and Cash. This Update clarifies that the stock portion of a
distribution to shareholders that allows them to elect to receive cash or
stock with a potential limitation on the total amount of cash that all
shareholders can elect to receive in the aggregate is considered a share
issuance that is reflected in EPS prospectively and is not a stock
dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this Update are effective for interim and
annual periods ending on or after December 15, 2009 with retrospective
application.
|
§
|
ASU No. 2010-02—Consolidation
(Topic 810): Accounting and Reporting for Decreases in Ownership of a
Subsidiary. This Update amends Subtopic 810-10 and related guidance to
clarify that the scope of the decrease in ownership provisions of the
Subtopic and related guidance applies to (i) a subsidiary or group of
assets that is a business or nonprofit activity; (ii) a subsidiary that is
a business or nonprofit activity that is transferred to an equity method
investee or joint venture; and (iii) an exchange of a group of assets that
constitutes a business or nonprofit activity for a noncontrolling interest
in an entity, but does not apply to: (i) sales of in substance real
estate; and (ii) conveyances of oil and gas mineral rights. The amendments
in this Update are effective beginning in the period that an entity adopts
FAS 160 (now included in Subtopic
810-10).
|
§
|
ASU No. 2010-06—Fair Value
Measurements and Disclosures (Topic 820): Improving Disclosures about Fair
Value Measurements. This Update amends Subtopic 820-10 that require
new disclosures about transfers in and out of Levels 1 and 2 and activity
in Level 3 fair value measurements. This Update also amends Subtopic
820-10 to clarify certain existing disclosures. The new disclosures and
clarifications of existing disclosures are effective for interim and
annual reporting periods beginning after December 15, 2009, except for the
disclosures about purchases, sales, issuances, and settlements in the roll
forward of activity in Level 3 fair value measurements, which are
effective for fiscal years beginning after December 15,
2010.
|
The
Company expects that the adoption of the above Updates issued in January 2010
will not have any significant impact on its financial position and results of
operations.
F-19
NOTE
3 – OTHER RECEIVABLES
Other
receivables consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Deposits
to employee for purchases and disbursements (1)
|
$
|
1,486,336
|
$
|
1,889,291
|
||||
Coupon
sales receivables
|
1,688,032
|
719,317
|
||||||
Input
value added tax receivables (2)
|
1,164,315
|
196,207
|
||||||
Loans
to suppliers (3)
|
8,531,986
|
893,435
|
||||||
Prepaid
rent
|
-
|
490,890
|
||||||
Rebates
receivables (4)
|
1,109,903
|
-
|
||||||
Total
|
$
|
13,980,572
|
$
|
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.
|
(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 vendors are
used to secure the merchandise needed during the peak season at the end of
the year. Except the loans amount to $7,334,388(RMB50million) was
unsecured bearing an interest rate of 6.237% per annum, the other
loans are unsecured, interest free and repayable on
demand.
|
(4)
|
Rebates receivables represent
promotional allowances provided by vendors for promotions incurred by the
Company.
|
NOTE
4 – PROPERTY, PLANT AND EQUIPMENT, NET
Property,
plant and equipment consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Buildings
|
$
|
6,275,438
|
$
|
6,241,563
|
||||
Shop
equipment
|
11,515,649
|
8,498,599
|
||||||
Office
equipment
|
1,199,554
|
834,563
|
||||||
Motor
vehicles
|
751,430
|
562,876
|
||||||
Car
park
|
18,893
|
18,791
|
||||||
Leasehold
improvements
|
7,611,421
|
3,736,509
|
||||||
Construction
in progress
|
11,001,584
|
-
|
||||||
Total
property, plant and equipment
|
38,373,969
|
19,892,901
|
||||||
Less: accumulated
depreciation and amortization
|
(8,971,339
|
)
|
(6,932,598
|
)
|
||||
Total
property, plant and equipment, net
|
$
|
29,402,630
|
$
|
12,960,303
|
NOTE
5 – LAND USE RIGHTS
Land use
rights consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Land
use rights
|
$
|
862,527
|
$
|
857,097
|
||||
Less
– accumulated amortization
|
(109,301
|
)
|
(80,838
|
)
|
||||
Total
intangible assets, net
|
$
|
753,226
|
$
|
776,259
|
F-20
Future
amortization of land use rights is as follows:
Years
Ending December 31,
|
Amount
|
|||
2010
|
$
|
27,967
|
||
2011
|
27,967
|
|||
2012
|
27,967
|
|||
2013
|
27,967
|
|||
2014
|
27,967
|
|||
Thereafter
|
613,391
|
|||
Total
|
$
|
753,226
|
NOTE
6 – GOODWILL
During
the year 2008, the Company acquired a number of businesses in Northeast 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.
Goodwill
for impairment has been tested annually, or whenever events or circumstances
indicate that it is more likely than not that the fair value of a reporting unit
is below its carrying amount. The test to evaluate for impairment is a two-step
process. In the first step, we compare the fair value of each of our reporting
units to its carrying value. If the fair value of any reporting unit is less
than its carrying value, we perform a second step to determine the implied fair
value of goodwill associated with that reporting unit. If the carrying value of
goodwill exceeds the implied fair value of goodwill, such excess represents
the amount of goodwill impairment. There is no impairment occurred for the year
ended December 31, 2009.
In order
to expand, the Company had 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.
No
supplemental pro forma information is presented for the acquisitions due to the
immaterial effect of the acquisition on the Company’s results of
operations.
On
September 30, 2008, the Company purchased the operating rights and certain
assets of Daqing Xinguangtiandi Shopping Center Co., Ltd, a supermarket store
that selling grocery, food and non-food products in Daqing of Heilongjiang, for
a purchase price of $1,982,118 (RMB 13,800,000) paid in cash. The operating
results of Daqing Xinguangtiandi Shopping Center Co. Ltd. have been included in
the consolidated financial statements since that date. The purchase price has
been allocated based on estimated fair values as of the acquisition date. The
purchase price has been allocated based on estimated fair values as of the
acquisition date. The purchase price was allocated as follows:
September
30,
|
2008
|
|||
Current
assets
|
$
|
71,816
|
||
Property,
plant and equipment, net
|
54,580
|
|||
Goodwill
|
1,855,722
|
|||
Total
purchase price
|
$
|
1,982,118
|
On
October 31, 2008, the Company purchased the operating rights and certain assets
of Hulunbeier Huahui Department Store Co., Ltd, a supermarket store that selling
grocery, food and non-food products in Hulunbeier City of Inner Mongolia
Autonomous Region. The operation results of Hulunbeier Huahui
Department Store Co., Ltd have been included in the consolidated financial
statements since that date. The purchase price was $9,479,694 (RMB 66,000,000)
of cash. The purchase price has been allocated based on estimated fair
values as of the acquisition date. The purchase price was allocated as
follows:
F-21
October
31,
|
2008
|
|||
Current
assets
|
$
|
150,813
|
||
Property,
plant & equipment, net
|
76,125
|
|||
Goodwill
|
9,252,756
|
|||
Total
purchase price
|
$
|
9,479,694
|
On August
31, 2008, the Company purchased the operating rights and certain assets of
Heilongjiang Longmei Commerce Co., Ltd, a supermarket store that selling
grocery, food and non-food products in Suihua City of Heilongjiang.
The operation results of Heilongjiang Longmei Commerce Co., Ltd have been
included in the consolidated financial statements since that date. The purchase
price was $3,266,185 (RMB22,740,400) of cash. The purchase price has been
allocated based on estimated fair values as of the acquisition date. The
purchase price was allocated as follows:
August
31,
|
2008
|
|||
Current
assets
|
$
|
52,770
|
||
Property,
plant & equipment, net
|
86,610
|
|||
Goodwill
|
3,126,805
|
|||
Total
purchase price
|
$
|
3,266,185
|
On
October 31, 2008, the Company purchased the operating rights and certain assets
of Fuyu Xinshuguang Real Estate Development Co., Ltd, a supermarket store that
selling grocery, food and non-food products in Qiqihar City of Heilongjiang.
The operation results of Fuyu Xinshuguang Real Estate Development Co., Ltd
have been included in the consolidated financial statements since that date. The
purchase price was $2,499,186 (RMB17,402,000) of cash. The purchase price
has been allocated based on estimated fair values as of the acquisition
date. The purchase price was allocated as follows:
October
31,
|
2008
|
|||
Current
assets
|
$
|
58,458
|
||
Property,
plant & equipment, net
|
91,206
|
|||
Goodwill
|
2,349,522
|
|||
Total
purchase price
|
$
|
2,499,186
|
On
September 30, 2008, the Company purchased the operating rights and certain
assets of Nehe Wanlong Commercial Building Co., Ltd, a supermarket store that
selling grocery, food and non-food products in Qiqihaer City of
Heilongjiang. The operation results of Nehe Wanlong Commercial Building
Co., Ltd. have been included in the consolidated financial statements since that
date. The purchase price was $2,413,017 (RMB16,800,000) of cash. The purchase
price has been allocated based on estimated fair values as of the acquisition
date. The purchase price was allocated as follows:
September
30,
|
2008
|
|||
Current
assets
|
$
|
56,232
|
||
Property,
plant & equipment, net
|
62,767
|
|||
Goodwill
|
2,294,018
|
|||
Total
purchase price
|
$
|
2,413,017
|
F-22
NOTE
7 – SHORT-TERM BANK LOANS
The
Company had two short-term bank loans from a financial institution bearing an
interest rate of 7.425% and 5.94% per annum, due on May 22, 2009 and December
23, 2009, respectively. The Company had amount of nil and $2,188,439
outstanding as of December 31, 2009 and December 31, 2008,respectively.
Interest expense was $23,734 and $240,330 for the years ended December 31, 2009
and 2008, respectively.
NOTE
8 – ACCURED EXPENSES AND OTHER PAYABLES
Other
payables consisted of the following:
December
31,
|
2009
|
2008
|
||||||
Accrued
expenses
|
$
|
1,688,890
|
$
|
681,969
|
||||
VAT
and other PRC tax payable
|
202,873
|
203,443
|
||||||
Repair,
maintenance, and purchase of equipment payable
|
3,471,555
|
1,034,993
|
||||||
Employee
promoters bond deposit
|
1,292,771
|
441,672
|
||||||
Total
other payables
|
$
|
6,656,089
|
$
|
2,362,077
|
NOTE
9 – EARNINGS PER SHARE
The
Company calculates earnings per share in accordance with ASC 260, Earnings Per
Share, which requires a dual presentation of basic and diluted earnings per
share. Basic earnings per share are computed using the weighted average number
of shares outstanding during the fiscal year. Diluted earnings per share
represents basic earnings per share adjusted to include the potentially dilutive
effect of outstanding stock options. Potentially dilutive common shares
consist of convertible preferred stock (using the if-converted method) and
exercisable warrants outstanding.
The
following table sets forth the computation of basic and diluted net income per
common share:
Years Ended December 31,
|
2009
|
2008
|
||||||
Net
income (loss)
|
$
|
(24,643,438
|
)
|
$
|
8,997,068
|
|||
Weighted-average
shares of common stock outstanding
|
||||||||
Basic
|
21,885,423
|
20,882,353
|
||||||
Dilutive
shares:
|
||||||||
Conversion
of Series A Convertible Preferred Stock
|
8,816,289
|
9,117,647
|
||||||
Dilutive
effect of stock warrants
|
1,221,283
|
753,466
|
||||||
Diluted
|
31,922,995
|
30,753,466
|
||||||
Basic
earnings (loss) per share
|
$
|
(1.13
|
)
|
$
|
0.43
|
|||
Diluted
earnings (loss) per share
|
$
|
(0.77
|
)
|
$
|
0.29
|
NOTE
10 – PREFERRED STOCK AND STOCK 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, a 0.625 interest in a Series A warrant and a 0.625 interest in
a 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 exercisable for one share 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.
F-23
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.
The
registration statement has 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, there
has been no accrual of any contingent liability recorded for this
issue in the financial statements as of December 31, 2009 and December 31,
2008.
During
2009, an aggregate of 1,569,301 shares of the Company’s Series A convertible
preferred stock were converted into corresponding shares of common stock.
For cash flow purposes, these transactions were non-cash
transactions.
During
2009, Series A Warrants to purchase 158,300 shares of common stock were
exercised for 78,565 shares of common stock and Series B Warrants to purchase
123,560 shares of common stock were exercised for 45,764 common stock on a
cashless basis. In connection with these transactions, the Company issued an
aggregate of 124,329 shares of common stock and received no cash proceeds from
such issuances. For cash flow purposes, these transactions were non-cash
transactions.
A summary
of the status of the Company’s stock warrants as of and for the year
ended December 31, 2008 is presented below:
Number of
Shares
|
||||
Balance
– December 31, 2007
|
-
|
|||
Granted-
Warrants A
|
5,980,955
|
|||
Granted-Warrants
B
|
5,924,471
|
|||
Exercised
|
-
|
|||
Cancelled
|
-
|
|||
Balance
– December 31, 2008
|
11,905,426
|
|||
Granted
|
-
|
|||
Exercised-Warrants
A
|
(158,300
|
)
|
||
Exercised-Warrants
B
|
(123,560
|
)
|
||
Cancelled
|
-
|
|||
Balance
– December 31, 2009
|
11,623,566
|
F-24
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, “Determining
Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own
Stock”). As a result of adopting ASC 815, warrants to purchase 11,905,426
of the Company’s common stock previously treated as equity pursuant to the
derivative treatment exemption were no longer afforded equity treatment as there
was a down-round protection (full-ratchet down round protection). As
a result, the warrants are not considered indexed to the Company’s own
stock, and as such, all future changes in the fair value of these warrants will
be recognized currently in earnings until such time as the warrants are
exercised or expire.
As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants were treated as a
derivative liability since their issuance in March 2008. On January 1,
2009, the Company recorded as a cumulative effect adjustment of decreasing
additional paid-in capital of $6,020,000 and beginning retained earnings of
$2,792,017 and $8,812,017 to warrant liabilities to recognize the fair value of
such warrants. The fair value of the warrants was $44,304,034 on December 31,
2009. The Company recognized a $35,492,017 loss from the change in fair value of
warrants for the year ended December 31, 2009.
The fair
value was calculated using the Black-Scholes option pricing model. The
assumptions that were used to calculate fair value as of December 31, 2009 and
December 31, 2008 were as follows:
Investor Warrants:
|
12/31/2009
|
12/31/2008
|
||||||
Expected
volatility
|
54 | % | 51 | % | ||||
Risk
free rate
|
1.82 | % | 1.34 | % | ||||
Expected
terms
|
3.24 | 4.24 | ||||||
Expected
dividend yield
|
- | - |
Expected
volatility is based on average peer group volatility with comparable size and
operations. The Company did not have enough historical share trade period
and was thinly traded. The Company believes this method produces an
estimate that is representative of the Company’s expectations of future
volatility over the expected term of these warrants. The Company has no reason
to believe future volatility over the expected remaining life of these
warrants is likely to differ materially from historical volatility. The expected
life is based on the remaining term of the warrants. The risk-free interest
rate is based on U.S. Treasury securities according to the remaining term of the
warrants.
NOTE
11 – SHARED BASED COMPENSATION
On
September 14, 2009, the Company entered into stock option agreements with its
three independent directors, Gary Crook, Chaoying Li and Zhiguo Jin, granting
each director options to purchase 20,000 shares of the Company’s common stock at
an exercise price of $8.00 per share. The options vest in approximately
equal amounts on the three subsequent anniversary dates of the grant and expire
on the fifth anniversary of the date of agreement of or the date the option is
fully exercised. On January 30, 2010, the Company entered into amendment
agreements with its three directors to correct the exercise price to $7.50,
which was the fair market value on the date of the grant.
The
Company adopted the fair value recognition which requires the measurement and
recognition of compensation expense for all stock-based payment awards made to
the Company’s employees and directors, including stock options and employee
stock purchases. Stock-based compensation expense for stock options was
based on the grant-date fair value. During the process of estimating the
fair value of the stock options granted and recognizing share-based
compensation, the following assumptions were adopted.
The fair
value for these awards was estimated using the Black-Scholes option pricing
model with the following weighted average assumptions, assuming no expected
dividends:
Years Ended December 31,
|
2009
|
2008
|
||||||
Expected
life (years)
|
3.5
|
-
|
||||||
Expected
volatility
|
41.2
|
%
|
-
|
F-25
Years Ended December 31,
|
2009
|
2008
|
||||||
Risk-free
interest rate
|
1.69
|
%
|
-
|
|||||
Dividend
yield
|
-
|
-
|
The
expected volatilities are based on the historical volatility of the Company’s
common stock. The observation is made on a weekly basis. The
observation period covered is consistent with the expected life of the
options. The expected life of stock options is based on the minimum
vesting period required. The risk-free rate is consistent with the
expected terms of the stock options and is based on the United States Treasury
yield curve in effect at the time of grant.
At
December 31, 2009, the Company had stock-based compensation expenses in the
aggregate amount of $.14,252. A summary of stock option activities during the
two-year period ended December 31, 2009 is as follows:
Number
of option
|
Weighted
Average
Exercise
Price Per
Share
|
Remaining
Contractual
life (months)
|
Aggregate
intrinsic
|
|||||||||||||
Balance
– December 31, 2007
|
-
|
$
|
-
|
-
|
$
|
-
|
||||||||||
Granted
|
-
|
-
|
-
|
|||||||||||||
Granted
|
-
|
-
|
-
|
-
|
||||||||||||
Exercised
|
-
|
-
|
-
|
|||||||||||||
Cancelled
|
-
|
-
|
-
|
|||||||||||||
Balance
– December 31, 2008
|
-
|
-
|
-
|
-
|
||||||||||||
Granted
|
60,000
|
7.5
|
4.65
|
-
|
||||||||||||
Exercised
|
-
|
-
|
-
|
|||||||||||||
Exercised
|
-
|
-
|
-
|
|||||||||||||
Cancelled
|
-
|
-
|
-
|
|||||||||||||
Balance
– December 31, 2009
|
60,000
|
$
|
-
|
4.65
|
$
|
-
|
The
weighted-average grant-date fair value of stock options granted during the years
2009 and 2008 was$144,498 and nil respectively. The total intrinsic value of
options exercised during the years ended December 31, 2009 and2008 was
approximately nil, respectively.
NOTE
12 – INCOME TAXES
The
income tax provision consisted of the following:
Years
Ended December 31,
|
2009
|
2008
|
2007
|
|||||||||
Current:
|
||||||||||||
Foreign
|
$
|
4,224,737
|
$
|
3,556,474
|
$
|
2,997,615
|
||||||
Federal
|
-
|
-
|
-
|
|||||||||
State
|
-
|
-
|
-
|
|||||||||
Deferred
|
||||||||||||
Foreign
|
(416,943
|
)
|
-
|
-
|
||||||||
Federal
|
-
|
-
|
-
|
|||||||||
State
|
-
|
-
|
-
|
|||||||||
Provision
for income taxes
|
$
|
3,807,794
|
$
|
3,556,474
|
$
|
2,997,615
|
F-26
Deferred
tax assets and liabilities reflect the net tax effects of temporary differences
between carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
that give rise to deferred tax assets and liabilities as of December 31,
2009 were as follows:
December
31,
|
2009
|
2008
|
||||||
Current:
|
||||||||
Accrued
liabilities
|
$
|
239,229
|
$
|
-
|
||||
Non-current:
|
-
|
-
|
||||||
Depreciation
on property, plant and equipment
|
50,299
|
-
|
||||||
Net
operating loss carry-forward
|
154,476
|
|
||||||
Total
deferred income taxes
|
444,004
|
|||||||
Less:
valuation allowance
|
(27,061
|
)
|
-
|
|||||
Net
deferred income taxes
|
$
|
416,943
|
$
|
-
|
As of
December 31, 2009, two new open stores, one department store and Speedy
Brilliant (Daqing) have accumulated operating losses totally of $617,906 for
Chinese income tax purposes, which can be carried forward for 5 years.
Management estimates that it is more likely than not that the potential economic
benefits of the net operating loss of Speedy Brilliant (Daqing) will not be
realized in the near future. As a result, the full amount of the valuation
allowance was provided against the potential tax benefits.
The
difference between the effective income tax rate and the expected federal
statutory rate was as follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Statutory
rate
|
34.0 | % | 34.0 | % | ||||
Income
tax rate reduction
|
(9.0 | )% | (9.0 | )% | ||||
Permanent
differences
|
0.6 | % | - | |||||
Valuation
allowance
|
0.2 | % | - | |||||
Warrant
Liability
|
(44.3 | )% | - | |||||
Other
|
0.2 | % | 3.3 | % | ||||
Effective
income tax rate
|
(18.3 | ) % | 28.3 | % |
The
permanent differences were related to the non-deductible expenses under China
taxation law.
NOTE
13 – 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
years ended December 31, 2009 and 2008, the Group’s net revenues from external
customers for products and services are as follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Sale
of general merchandise
|
$
|
244,566,173
|
$
|
157,841,011
|
||||
Department
store income
|
2,348,033
|
1,857,340
|
||||||
Other
income
|
680,066
|
431,249
|
||||||
Total
|
$
|
247,594,272
|
$
|
160,129,600
|
F-27
For the
years ended December 31, 2009 and 2008, the Group’s net revenues from external
customers for sale of general merchandise by categories of product are as
follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Grocery
|
$
|
82,219,402
|
$
|
51,013,639
|
||||
Fresh
food
|
116,136,695
|
79,739,451
|
||||||
Non-food
|
46,210,076
|
27,087,921
|
||||||
Total
|
$
|
244,566,173
|
$
|
157,841,011
|
NOTE
14 –COMPREHENSIVE INCOME
Total
comprehensive income includes, in addition to net income, changes in equity that
are excluded from the consolidated statements of income and are recorded
directly into a separate section of shareholders’ equity on the consolidated
balance sheets. Comprehensive income and its components consist of the
following:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Net
income
|
$
|
(24,643,438
|
)
|
$
|
8,997,068
|
|||
Foreign
currency translation adjustment
|
495,097
|
2,434,364
|
||||||
Comprehensive
income
|
$
|
(24,148,341
|
)
|
$
|
11,431,432
|
NOTE
15 - COMMITMENTS AND CONTINGENCIES
Operating
Leases
Certain
of our real properties and equipment are operated under lease agreements. Rental
expense under operating leases was as follows:
Years
Ended December 31,
|
2009
|
2008
|
||||||
Rent
expense
|
$
|
2,150,986
|
$
|
1,312,720
|
||||
Less:
Sublease income
|
737,370
|
800,344
|
||||||
Total
rent expense, net
|
$
|
1,413,616
|
$
|
512,376
|
Annual
minimum payments under operating leases are as follows:
Years Ended December 31,
|
Minimum
Lease
Payment
|
Sublease
Income
|
Net
Minimum
Lease
Payment
|
|||||||||
2010
|
$
|
2,532,719
|
$
|
519,494
|
$
|
2,013,225
|
||||||
2011
|
2,169,206
|
76,412
|
2,092,795
|
|||||||||
2012
|
2,092,083
|
14,073
|
2,078,008
|
|||||||||
2013
|
1,991,294
|
-
|
1,991,294
|
|||||||||
2014
|
1,436,842
|
-
|
1,436,842
|
F-28
Years Ended December 31,
|
Minimum
Lease
Payment
|
Sublease
Income
|
Net
Minimum
Lease
Payment
|
|||||||||
Thereafter
|
11,696,317
|
-
|
11,696,317
|
|||||||||
Total
|
$
|
21,918,461
|
$
|
609,979
|
$
|
21,308,481
|
As of
December 31, 2009 and 2008, buildings with net book value of nil and $4,538,407
respectively of the Company were pledged as collateral under loan
arrangements.
As of
December 31, 2009 and 2008, land use rights with net book value of nil and
$621,191 respectively of the Company were pledged as collateral for the above
loan arrangements. These loans were primarily obtained for general working
capital.
Litigation
The
Company is not involved in legal proceedings and claims.
NOTE
16 – SUBSEQUENT EVENTS
In May
2009, the FASB issued new guidance on subsequent events. The standard provides
guidance on management’s assessment of subsequent events and incorporates this
guidance into accounting literature. The standard is effective prospectively for
interim and annual periods ending after June 15, 2009. The implementation
of this standard did not have a material impact on the Company’s
consolidated financial position and results of operations.
The
Company amended Series A and Series B warrant agreements deleting or amending
the down-round protection (full-ratchet down round protection) provision on
March 24, 2010. As a result of this amendment, the Company will no
longer be required to treat Series A and Series B warrants as a liability and
will be reclassified to equity subsequently.
Effective
January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815,
“Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, “Determining
Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own
Stock”). As of and for the quarter ended March 31, 2009, June 30, 2009,
and September 30, 2009, the Company erroneously did not account its Series A and
Series B warrants of 11,905,426 as a derivative accounting as there was a
down-round protection (full-ratchet down round protection) and the
warrants are not considered indexed to the Company’s own stock. The
Company expects to restate those quarters as soon as it is practical to do
so.
F-29
PART
1. FINANCIAL INFORMATION
|
|
Item
1. Consolidated Financial Statements
|
QKL
STORES INC AND SUBSIDIARIES
|
SCHEDULE
II – VALUATION AND QUALIFYING ACCOUNTS
Balance at
|
||||||||||||||||
Beginning
of
|
Charged to
Costs and
|
Balance at
End of
|
||||||||||||||
Period
|
Expenses
|
Deductions
|
Period
|
|||||||||||||
December
31, 2009
|
||||||||||||||||
Allowance
for doubtful receivables
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-.
|
||||||||
Allowance
for sales returns
|
—
|
1,142,016
|
1,132,018
|
9,998
|
||||||||||||
Inventory
reserves
|
82,228
|
230,685
|
250,358
|
62,555
|
||||||||||||
December 31,
2008
|
||||||||||||||||
Allowance
for doubtful receivables
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
-
|
||||||||
Allowance
for sales returns
|
-
|
775,265-
|
775,265
|
-
|
||||||||||||
Inventory
reserves
|
100,095
|
173,794
|
191,661
|
82,228
|
II-A
PART
II:
INFORMATION
NOT REQUIRED IN PROSPECTUS
Item
13. Other Expenses of Issuance and Distribution.
Although
we will not receive any of the proceeds from the sale of the shares being
registered in this registration statement, we have agreed to bear the costs and
expenses of the registration of those shares. Our expenses in connection with
the issuance and distribution of the securities being registered, other than the
underwriting discount, are as follows:
SEC
Registration Fee
|
$
|
2,230
|
*
|
|
Professional
Fees and Expenses**
|
$
|
45,000
|
||
Printing
and Engraving Expenses **
|
$
|
5,000
|
||
Transfer
Agent’s Fees**
|
$
|
0
|
||
Miscellaneous
Expenses**
|
$
|
3,000
|
||
Total
|
$
|
55,230
|
* $6,020
was previously paid.
**
Estimates
Item
14. Indemnification of Directors and Officers.
Under our
By-Laws, we may indemnify any person who was or is a party or is threatened to
be made a party to any threatened, pending or completed action or proceeding,
whether civil, criminal, administrative or investigative (other than an action
by or in the right of the Company) by reason of the fact that such person is or
was a director, officer, employee or agent of the Company, or is or was serving
at the request of the Company as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise,
against expenses (including attorneys’ fees), judgments, fines, settlements, and
other amounts actually and reasonably incurred in connection with such action or
proceeding if such person acted in good faith and in a manner such person
reasonably believed to be in the best interests of the Company and, in the case
of a criminal action or proceeding, had no reasonable cause to believe the
conduct of such person was unlawful.
Item
15. Recent Sales of Unregistered Securities
Following
are all issuances of securities by the registrant during the past three years
which were not registered under the Securities Act of 1933, as amended (the
“Securities Act”). In each of these issuances the recipient represented that he
or it was acquiring the shares for investment purposes only, and not with a view
towards distribution or resale except in compliance with applicable securities
laws. No general solicitation or advertising was used in connection with any
transaction, and the certificate evidencing the securities that were issued
contained a legend restricting their transferability absent registration under
the Securities Act or the availability of an applicable exemption therefrom.
Unless specifically set forth below, no underwriter participated in the
transaction and no commissions were paid in connection with the
transactions.
2008
March
2008 Private Placement Transaction
On
March 28, 2008, we entered into a private placement transaction in which we sold
to certain accredited investors, for gross proceeds to us of $15.5 million,
9,117,647 units at a purchase price of $1.70 per unit, each unit consisting of
one share of our Series A Preferred Stock (each of which is convertible into one
share of our common stock), a 0.625 interest in a Series A Warrant and a 0.625
interest in a Series B Warrant. The Series A Warrants have an exercise price of
$3.40 per share (subject to adjustment), the Series B Warrants have an exercise
price of $4.25 per share (subject to adjustment). We received $13,523,530 as net
proceeds from this financing.
II-1
March
2008 Share Exchange Transaction
On March
28, 2008, we entered into and consummated a share exchange agreement with (i)
Speedy Brilliant (BVI); (ii) Speedy Brilliant (Daqing); (iii) the owners of all
of the outstanding voting stock of Speedy Brilliant (BVI), namely (a) Winning
State International Limited (“Winning State (BVI)”), a company that is wholly
owned and controlled by Mr. Chin Yoke Yap and all of the stock of which may be
acquired in the future by our CEO, Mr. Zhuangyi Wang, pursuant to a call option
held by Mr. Wang, which owned approximately 98.5% of the Speedy Brilliant (BVI)
stock, and (b) three individuals, Ms. Fang Chen, Mr. Yang Miao and Ms. Ying
Zhang, who collectively owned approximately 1.5% of the Speedy Brilliant (BVI)
stock; and (iv) our controlling stockholders, specifically Vision Opportunity
China LP, Stallion Ventures, LLC, and Castle Bison, Inc.
Under the
terms of the share exchange agreement, the Speedy Brilliant (BVI) stockholders
delivered all of the outstanding shares of Speedy Brilliant (BVI) to us, and in
exchange, we issued and delivered a total of 19,382,298 shares of our common
stock to them. As a result of the share exchange, we acquired Speedy Brilliant
(BVI) as a wholly owned subsidiary, and the Speedy Brilliant (BVI) stockholders
became holders of the majority of our outstanding common stock.
Placement
Agent Warrants
On March
9, 2007, QKL entered into an engagement agreement with Kuhns Brothers, Inc.
(“Kuhns Agreement”) for the provision of investment banking and other services
as in contemplation of a reverse merger of the company or a company affiliated
with the company with a publicly traded shell company and simultaneous $15.5
million financing transaction. On January 22, 2008, QKL terminated the
engagement agreement and the parties executed a settlement agreement. Under the
terms of the settlement agreement Kuhns Brothers, Inc. was paid a cash fee equal
to 8.5% of the gross proceeds invested in the financing by investors introduced
to the Company by Kuhns Brothers, Inc. and was issued Series A Warrants to
purchase 191,250 shares of our common stock and Series B Warrants to purchase
153,000 shares of our common stock.
Mass
Harmony Consulting Agreement
Yang
Miao, Ying Zhang and Fang Chen are principals of Mass Harmony Asset Management
(“Mass Harmony”). On March 13, 2007, QKL-China entered into a Financial
Consulting Agreement (the “Mass Harmony Agreement”) with Mass Harmony under
which Mass Harmony agreed to perform certain financial services for QKL-China.
QKL-China paid Mass Harmony an aggregate of RMB 500,000 (approximately $70,000)
and Mass Harmony also received 299,999 shares of common stock, Series A Warrants
to purchase 91,176 shares of common stock, and Series B Warrants to purchase
72,941 shares of common stock. 6,000 shares of common stock, 30,392 shares of
common stock underlying Series A Warrants and 24,314 shares of common stock
underlying Series B Warrants that have not previously been disposed of are being
registered in this prospectus. On March 30, 2010, Ying Zhang assigned her Series
A Warrant to purchase 30,392 shares of common stock and her Series B Warrant to
purchase 24,314 shares of common stock to Roth Capital Partners, a registered
broker-dealer. The remaining shares transferred to Yang Miao, Ying Zhang and
Fang Chen by Mass Harmony have been disposed of pursuant to our registration
statement on Form S-1 (file no. 333-150800), or pursuant to Rule 144 promulgated
under the Securities Act of 1933, as amended. Yang Miao and Fang Chen are
selling stockholders. Roth Capital Partners is not a selling
stockholder.
Sichenzia
Ross Friedman & Ference LLP was special counsel to Forme Capital prior to
the reverse merger and the private placement and received 15,000 shares for
services rendered to Forme Capital.
2007
Vincent
Finnegan served as a director of Forme Capital from September 19, 2007 until
March 28, 2008. In December 2007, Mr. Finnegan received 7,000 shares of common
stock as compensation for his services.
John
Vogel served as our CEO and a director of Forme Capital from September 19, 2007
until March 28, 2008. In December 2007, Mr.
Vogel received 7,000 shares of common stock as compensation for his
services.
II-2
Robert
Scherne, a selling stockholder, served as a director and Chief Financial Officer
of Forme Capital from September 19, 2007 until March 28, 2008. In December 2007,
Mr. Scherne received 21,000 shares of common stock as compensation for his
services, of which he currently holds 17,000 shares of common stock that are
being registered on this registration statement.
In
December 2007, we issued 37,211 shares of our common stock to Menlo Venture
Partners, LLC, a selling stockholder, as repayment of a working capital advance
in the amount of $25,000.
Other
than the securities mentioned above, we have not issued or sold any securities
without registration for the past three years from the date of this registration
statement.
Exemptions
All of
the above issuances were deemed to be exempt under Regulation D and Section 4(2)
of the Securities Act. No advertising or general solicitation was employed in
offering the securities. The offerings and sales were made to a limited number
of persons, all of whom were accredited investors, business associates of ours
or our executive officers, and transfer was restricted by us in accordance with
the requirements of the Securities Act.
Item
16. Exhibits and Financial Statement Schedules
3.1
|
Certificate
of Incorporation (2)
|
|
3.2
|
Bylaws
(2)
|
|
3.3
|
Certificate
of Amendment of Certificate of Incorporation (7)
|
|
4.1
|
Specimen
of Common Stock certificate (1)
|
|
4.2
|
Certificate
of Designations authorizing the Series A Preferred Stock
(1)
|
|
4.3
|
Form
of Series A Warrant (1)
|
|
4.4
|
Form
of Series B Warrant (1)
|
|
4.5
|
Warrant
Amendment to the Series A Warrant to Purchase Shares of Common Stock of
the Company, dated as of March 24, 2010, by and among the Company and
Vision Opportunity China LP (9)
|
|
4.6
|
Warrant
Amendment to the Series B Warrant to Purchase Shares of Common Stock of
the Company, dated as of March 24, 2010, by and among the Company and
Vision Opportunity China LP (9)
|
|
5.1
|
Opinion
of Loeb & Loeb LLP*
|
|
10.1
|
Series
A Convertible Preferred Stock Purchase Agreement, dated as of March 28,
2008 between the Company and the Purchasers (1)
|
|
10.2
|
Registration
Rights Agreement dated March 28, 2008, by and among the Company and the
Purchasers (1)
|
|
10.3
|
Lock-Up
Agreement, dated as of March 28, 2008, by and among the Company, the sole
stockholder of Winning State (BVI) and certain of our stockholders
(7)
|
|
10.4
|
Securities
Escrow Agreement, dated March 28, 2008, by and between the Company, Vision
Opportunity China LP as representative of the Purchasers, Winning State
(BVI) and Loeb & Loeb LLP, as escrow agent (1)
|
|
10.5
|
Investor
and Public Relations Escrow Agreement dated March 28, 2008 between the
Company and Vision Opportunity China LP as representative of the
Purchasers and Loeb & Loeb, as escrow agent (1)
|
|
10.6
|
Share
Exchange Agreement, dated as of March 28, 2008 between the Company, the
controlling stockholder of the Company, Winning State (BVI), Fang Chen,
Yang Miao and Ying Zhang (1)
|
|
10.7
|
Consigned
Management Agreement, dated as of March 28, 2008 (1)
|
|
10.8
|
Technology
Service Agreement dated as of March 28, 2008 (1)
|
|
10.9
|
Loan
Agreement, dated as of March 28, 2008 (1)
|
|
10.10
|
Exclusive
Purchase Option Agreement, dated as of March 28, 2008
(1)
|
|
10.11
|
The
Equity Pledge Agreement, dated as of March 28, 2008 (1)
|
|
10.12
|
Engagement
Letter Agreement, dated March 9, 2007, by and between QKL and Kuhns
Brothers, Inc. (2)
|
|
10.13
|
Settlement
Agreement, dated January 22, 2008, by and between QKL and Kuhns Brothers,
Inc. (2)
|
|
10.14
|
Financial
Consulting Agreement, dated March 13, 2007 between QKL and Mass Harmony
Asset Management Limited (3)
|
|
10.15
|
Amendment
dated May 8, 2008 to Registration Rights Agreement dated March 28, 2007,
by and among the Company and the Purchasers (3)
|
|
10.16
|
Form
of employment agreement (7)
|
|
10.17
|
Waiver
and Release dated as of March 9, 2009. (5)
|
|
10.18
|
Agreement
dated October 31, 2008 between Daqing Qingkelong
Chain Commerce & Trade Co., Ltd. and Fuyu Count Xinshuguang
Real Estate Development Co., Ltd
(6)
|
II-3
10.19
|
Agreement
dated October 31, 2008 between Daqing Qingkelong Chain Commerce &
Trade Co., Ltd. and Hulunbeier Huahui Co., Ltd
(6)
|
|
10.20
|
Agreement
dated August 31, 2008 between Daqing Qingkelong Chain Commerce & Trade
Co., Ltd. and Heilongjiang Longmei Commerce Co., Ltd
(6)
|
|
10.21
|
Agreement
dated September 30, 2008 between Daqing Qingkelong
Chain Commerce & Trade Co., Ltd. and Nehe City
Wanlong Co., Ltd. (6)
|
|
10.22
|
Agreement
dated September 30, 2008 between Daqing Qingkelong
Chain Commerce & Trade Co., Ltd. and Daqing Xinguangtiandi
Shopping Center Co., Ltd. Incorporated by reference to our Registration
Statement of Form S-1/A (Reg. No. 333-150800) filed with the SEC on March
11, 2009. (6)
|
|
10.23
|
Waiver
dated October 15, 2009 to the Registration Rights Agreement dated March
28, 2008, by and between the Company and Vision Opportunity China LP, as
representative of the Purchasers (7)
|
|
10.24
|
Waiver
dated October 15, 2009 to the Securities Purchase Agreement dated March
28, 2008, by and between the Company and Vision Opportunity China LP, as
representative of the Preferred Shareholders (7)
|
|
10.25
|
Amendment
to Securities Escrow Agreement dated October 15, 2009 to the Securities
Escrow Agreement dated March 28, 2008, by and among the Company Vision
Opportunity China LP, as representative of the Purchasers, Winning State
Investment Limited, and Loeb & Loeb LLP, as escrow agent
(7)
|
|
10.26
|
Lock-up
Letter dated October 15, 2009, by and among Roth Capital Partners, LLC,
the Company, our directors, executive officers and Winning State
International Limited (7)
|
|
10.27
|
2009
Omnibus Securities and Incentive Plan (7)
|
|
10.28
|
Form
of Independent Director Agreement (7)
|
|
10.29
|
Form
of Waiver to Certificate of Designations, Preferences and Rights of Series
A Convertible Preferred Stock, dated as of March 25, 2010, by and among
the Company and the holders of Series A Convertible Preferred Stock
(9)
|
|
10.30
|
Property
Buying/Selling Contract, dated December 30, 2009 (8)
|
|
10.31
|
Amendment
No. 2 to Securities Escrow Agreement dated April 1, 2010
(9)
|
|
10.32
|
Lease
Agreement dated June 28, 2010 between the Company and Xiangdong Zhang.
(10)
|
|
10.33
|
Termination
Agreement dated June 28, 2010 between the Company and Xiangdong Zhang.
(10)
|
|
10.34
|
Employment
Agreement of Tsz-Kit Chan, dated October 18, 2010
(11)
|
|
16.1
|
Letter
from the Company to Comiskey and Company, P.C. (2)
|
|
16.2
|
Letter
from Comiskey and Company, P.C. to the SEC (2)
|
|
16.3
|
Letter
from Albert Wong & Co. to the SEC (7)
|
|
21.1
|
List
of Subsidiaries (3)
|
|
23.1
|
Consent
of Loeb & Loeb LLP to the use of the opinion annexed as Exhibit 5.1
(contained in the opinion annexed as Exhibit 5.1)
|
|
23.2
|
Consent
of Albert Wong & Co., Certified Public Accountants, for use of their
audit report relating to the financial statements of QKL Stores
Inc.*
|
|
23.3
|
Consent
of BDO China Li Xin Da Hua CPA Co., Ltd., Certified Public Accountants,
for use of their audit report relating to the financial statements of QKL
Stores Inc.*
|
(1)
|
Incorporated
by reference to our current report on Form 8-K filed with the SEC on
April 3, 2008.
|
|
(2)
|
Incorporated
by reference to our current report on Form 8-K/A filed with the SEC
on April 14, 2008.
|
|
(3)
|
Incorporated
by reference to our Registration Statement of Form S-1 (Reg. No.
333-150800) filed with the SEC on May 9, 2008.
|
|
(4)
|
Incorporated
by reference to our Registration Statement of Form S-1/A (Reg. No.
333-150800) filed with the SEC on August 7, 2008.
|
|
(5)
|
Incorporated
by reference to our Registration Statement of Form S-1/A (Reg. No.
333-150800) filed with the SEC on March 11, 2009.
|
|
(6)
|
Incorporated
by reference to our Form 10-K filed with the SEC on April 14,
2009.
|
|
(7)
|
Incorporated
by reference to our Registration Statement of Form S-1/A (Reg. No.
333-162150) filed with the SEC on October 19, 2009.
|
|
(8)
|
Incorporated
by reference to our current report on Form 8-K filed with the SEC on
January 25, 2010.
|
|
(9)
|
Incorporated
by reference to our Form 10-K filed with the SEC on April 1,
2010.
|
|
(10)
|
Incorporated
by reference to our current report on Form 8-K filed with the SEC on
July 1, 2010.
|
|
(11)
|
Incorporated
by reference to our current report on Form 8-K filed with the SEC on
October 21, 2010.
|
|
*
|
Filed
herewith.
|
II-4
Item 17. Undertakings
Undertakings
required by Item 512 of Regulation S-K.
(a) The
undersigned registrant hereby undertakes:
(1) To
file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i)
To include any prospectus required by Section 10(a)(3)
of the Securities Act;
(ii) To
reflect in the prospectus any facts or events arising after the effective date
of this registration statement (or the most recent post-effective amendment
thereof) which, individually or in the aggregate, represent a fundamental change
in the information in the registration statement. Notwithstanding the foregoing,
any increase or decrease in volume of securities offered (if the total dollar
value of securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range may
be reflected in the form of prospectus filed with the Commission pursuant to
Rule 424(b) if, in the aggregate, the changes in volume and price represent no
more than a 20% change in the maximum aggregate offering price set forth in the
“Calculation of Registration Fee” table in the effective registration statement;
and
(iii) To
include any material information on the plan of distribution not previously
disclosed in the registration statement or any material change to such
information in the registration statement.
(2) For
determining liability under the Securities Act, each post-effective amendment
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of the securities at that time to be the
initial bona fide offering.
(3) If
the registrant is subject to Rule 430C, each prospectus filed pursuant to Rule
424(b) as part of a registration statement relating to an offering, other than
registration statements relying on Rule 430B or other than prospectuses filed in
reliance on Rule 430A, shall be deemed to be part of and included in the
registration statement as of the date it is first used after
effectiveness. Provided, however, that no statement made in a registration
statement or prospectus that is part of the registration statement or made in a
document incorporated or deemed incorporated by reference into the registration
statement or prospectus that is part of the registration statement will, as to a
purchaser with a time of contract of sale prior to such first use, supersede or
modify any statement that was made in the registration statement or prospectus
that was part of the registration statement or made in any such document
immediately prior to such date of first use.
(4) To
remove from a registration statement by means of a post-effective amendment to
remove from registration any of the securities being registered that remain
unsold at the end of the offering.
(b) For
determining liability of the registrant under the Securities Act to any
purchaser in the initial distribution of the securities, the registrant
undertakes that in a primary offering of securities of the registrant pursuant
to this registration statement, regardless of the underwriting method used to
sell the securities to the purchaser, if the securities are offered or sold to
such purchaser by means of any of the following communications, the registrant
will be a seller to the purchaser and will be considered to offer or sell such
securities to such purchaser:
(i)
Any preliminary prospectus or prospectus of the registrant
relating to the offering required to be filed pursuant to Rule 424;
(ii) Any
free writing prospectus relating to the offering prepared by or on behalf of the
registrant or used or referred to by the registrant;
(iii) The
portion of any other free writing prospectus relating to the offering containing
material information about the registrant or its securities provided by or on
behalf of the registrant; and
II-5
(iv) Any
other communication that is an offer in the offering made by the registrant to
the purchaser.
(c)
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(d) That,
for the purpose of determining liability under the Securities Act of 1933 to any
purchaser:
(i)
Each prospectus filed by the registrant pursuant to 424(b)(3) shall be deemed to
be part of the registration statement as of the date the filed prospectus was
deemed part of and included in the registration statement; and
(ii)
Each prospectus required to be filed pursuant to Rule 424(b)(2), (b)(5), or
(b)(7) as part of a registration statement in reliance on Rule 430B relating to
an offering made pursuant to Rule 415(a)(1)(i), (vii), or (x) for the purpose of
providing the information required by section 10(a) of the Securities Act of
1933 shall be deemed to be part of and included in the registration statement as
of the earlier of the date such form of prospectus is first used after
effectiveness or the date of the first contract of sale of securities in the
offering described in the prospectus. As provided in Rule 430B, for liability
purposes of the issuer and any person that is at that date an underwriter, such
date shall be deemed to be a new effective date of the registration statement
relating to the securities in the registration statement to which that
prospectus relates, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof. Provided, however, that no
statement made in a registration statement or prospectus that is part of the
registration statement or made in a document incorporated or deemed incorporated
by reference into the registration statement or prospectus that is part of the
registration statement will, as to a purchaser with a time of contract of sale
prior to such effective date, supersede or modify any statement that was made in
the registration statement or prospectus that was part of the registration
statement or made in any such document immediately prior to such effective
date.
II-6
SIGNATURES
In
accordance with the requirements of the Securities Act of 1933, the registrant
has duly caused this Amendment No. 3 to Registration Statement on Form S-1 to be
signed on its behalf by the undersigned thereunto duly authorized in Daqing,
PRC, on February 17, 2011.
QKL
STORES INC.
|
/s/ Zhuangyi Wang
|
By:
Zhuangyi Wang
|
Title:
Chief Executive Officer and Director
(principal
executive officer)
|
In
accordance with the requirements of the Securities Exchange Act of 1934, this
Amended Report was signed by the following persons in the capacities and on the
dates indicated.
Name and Title
|
Date
|
|
/s/ Zhuangyi Wang
|
February
17, 2011
|
|
Zhuangyi
Wang
|
||
Chief
Executive Officer and Director
|
||
(principal
executive officer)
|
||
/s/ Tsz-Kit Chan
|
February
17, 2011
|
|
Tsz-Kit
Chan
|
||
Chief
Financial Officer
|
||
(principal
financial officer and accounting officer)
|
||
*
|
February
17, 2011
|
|
Alan
Stewart
|
||
Director
|
||
*
|
February
17, 2011
|
|
Gary
Crook
|
||
Director
|
||
*
|
February
17, 2011
|
|
Zhiguo
Jin
|
||
Director
|
*
|
February
17, 2011
|
||
Chaoying
Li
|
|||
Director
|
|||
/s/ Zhuangyi Wang
|
February
17, 2011
|
||
*
|
Zhuangyi
Wang, Attorney-in-Fact
|
II-7