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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
 
445110
 
75-2180652
(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
   
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS AND OTHER INFORMATION CONTAINED IN THIS PROSPECTUS
22
   
OTHER REFERENCES
23
   
EXPLANATORY NOTE
23
   
SELLING STOCKHOLDERS
24
   
PLAN OF DISTRIBUTION
30
   
USE OF PROCEEDS
31
   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
32
   
BUSINESS
44
   
PROPERTIES
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
   
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.
 
 
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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.

 
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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:
 
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Offer new products to attract and retain a larger customer base;
 
 
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Respond to competitive and changing market conditions;
 
 
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Maintain effective control of our costs and expenses;
 
 
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Attract additional customers and increase spending per customer;

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Increase awareness of our brand and continue to develop customer loyalty;

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Attract, retain and motivate qualified personnel;

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Raise sufficient capital to sustain and execute our expansion plan;

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Respond to changes in our regulatory environment;

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Manage risks associated with intellectual property rights; and

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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.

 
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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.

 
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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.

 
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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.

 
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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.

 
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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.

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.

 
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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.

 
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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.

 
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(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 )%
 
 
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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.

 
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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;
 
 
 
§
Strong relationships with local suppliers; and
 
 
 
§
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.
 
 
 
§
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.
 
 
 
§
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;
 
 
 
§
Bulk (unpackaged) grains including rice and ground wheat;
 
 
 
§
Bottled water and beverages;
 
 
 
§
Cigarettes; and
 
 
 
§
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;
 
 
 
§
Fresh bakery items, including breads, buns, dumplings, and other self-prepared foods;
 
 
 
§
Fresh noodles and pastas;
 
 
 
§
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;
 
 
 
§
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:
 
 
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Provide a safe and sanitary working environment;

 
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Provide regular breaks for employees;
 
 
 
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Comply with mandated limits on each employee’s weekly working hours;
 
 
 
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Obey applicable minimum wage standards;
 
 
 
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Provide necessary trai