Item 1. Interim Financial Statements
QKL STORES INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
|
|
June 30,
2014
|
|
|
December 31,
2013
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
47,167,228
|
|
|
$
|
9,245,212
|
|
Restricted cash
|
|
|
8,607,363
|
|
|
|
8,668,882
|
|
Accounts receivable
|
|
|
331,294
|
|
|
|
557,745
|
|
Inventories
|
|
|
47,439,533
|
|
|
|
64,724,923
|
|
Other receivables
|
|
|
22,232,748
|
|
|
|
21,979,152
|
|
Prepaid expenses
|
|
|
4,813,266
|
|
|
|
9,915,479
|
|
Advances to suppliers
|
|
|
4,926,266
|
|
|
|
7,822,660
|
|
Income taxes receivables
|
|
|
1,760,382
|
|
|
|
1,739,773
|
|
Deferred income tax assets – current portion
|
|
|
2,768,651
|
|
|
|
2,788,918
|
|
Total current assets
|
|
|
140,046,731
|
|
|
|
127,442,744
|
|
Property, plant and equipment, net
|
|
|
38,289,047
|
|
|
|
40,247,576
|
|
Land use rights, net
|
|
|
698,564
|
|
|
|
718,337
|
|
Deferred income tax assets – non-current portion
|
|
|
66,956
|
|
|
|
66,956
|
|
Other assets
|
|
|
17,276
|
|
|
|
17,276
|
|
Total assets
|
|
$
|
179,118,574
|
|
|
$
|
168,492,889
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Short-term loans
|
|
$
|
60,087,370
|
|
|
$
|
40,889,761
|
|
Accounts payable
|
|
|
34,221,996
|
|
|
|
35,840,964
|
|
Cash card and coupon liabilities
|
|
|
18,040,939
|
|
|
|
18,465,030
|
|
Customer deposits received
|
|
|
1,050,325
|
|
|
|
984,308
|
|
Accrued expenses and other payables
|
|
|
19,580,082
|
|
|
|
18,827,472
|
|
Total current liabilities
|
|
|
132,980,712
|
|
|
|
115,007,535
|
|
Total liabilities
|
|
|
132,980,712
|
|
|
|
115,007,535
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value per share, authorized 100,000,000 shares, issued and outstanding 1,522,326 shares at June 30, 2014 and December 31, 2013
|
|
|
1,522
|
|
|
|
1,522
|
|
Series A convertible preferred stock, par value $0.01, authorized 10,000,000 shares, issued and outstanding 529,412 shares at June 30, 2014 and December 31, 2013
|
|
|
5,294
|
|
|
|
5,294
|
|
Additional paid-in capital
|
|
|
93,541,985
|
|
|
|
93,337,957
|
|
Retained earnings – appropriated
|
|
|
8,329,586
|
|
|
|
8,329,586
|
|
Retained earnings
|
|
|
(68,965,143
|
)
|
|
|
(62,145,794
|
)
|
Accumulated other comprehensive income
|
|
|
13,224,618
|
|
|
|
13,956,789
|
|
Total shareholders’ equity
|
|
|
46,137,862
|
|
|
|
53,485,354
|
|
Total liabilities and shareholders’ equity
|
|
$
|
179,118,574
|
|
|
$
|
168,492,889
|
|
See notes to unaudited condensed consolidated
financial statements.
QKL STORES INC. AND SUBSIDIARIES
Condensed Consolidated Statements of
Income
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
Three Months
Ended June 30,
|
|
|
Six Months
Ended June 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
Net sales
|
|
$
|
51,655,611
|
|
|
$
|
58,995,918
|
|
|
$
|
137,688,287
|
|
|
$
|
156,053,109
|
|
Cost of sales
|
|
|
42,968,964
|
|
|
|
48,862,015
|
|
|
|
114,269,481
|
|
|
|
129,279,758
|
|
Gross profit
|
|
|
8,686,647
|
|
|
|
10,133,903
|
|
|
|
23,418,806
|
|
|
|
26,773,351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling expenses
|
|
|
9,456,970
|
|
|
|
9,879,874
|
|
|
|
22,737,153
|
|
|
|
23,204,087
|
|
General and administrative expenses
|
|
|
1,963,838
|
|
|
|
2,080,136
|
|
|
|
5,197,248
|
|
|
|
4,598,472
|
|
Total operating expenses
|
|
|
11,420,808
|
|
|
|
11,960,010
|
|
|
|
27,934,401
|
|
|
|
27,802,559
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
(2,734,161
|
)
|
|
|
(1,826,107
|
)
|
|
|
(4,515,595
|
)
|
|
|
(1,029,208
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-operating income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
254,517
|
|
|
|
261,991
|
|
|
|
484,616
|
|
|
|
455,564
|
|
Interest expense
|
|
|
(1,279,388
|
)
|
|
|
(226,280
|
)
|
|
|
(2,778,631
|
)
|
|
|
(523,888
|
)
|
Total non-operating income (expense)
|
|
|
(1,024,871
|
)
|
|
|
35,711
|
|
|
|
(2,294,015
|
)
|
|
|
(68,324
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(3,759,032
|
)
|
|
|
(1,790,396
|
)
|
|
|
(6,809,610
|
)
|
|
|
(1,097,532
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
|
3,867
|
|
|
|
(336,185
|
)
|
|
|
9,739
|
|
|
|
(46,591
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,762,899
|
)
|
|
$
|
(1,454,211
|
)
|
|
$
|
(6,819,349
|
)
|
|
$
|
(1,050,941
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income statement:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(3,762,899
|
)
|
|
$
|
(1,454,211
|
)
|
|
$
|
(6,819,349
|
)
|
|
$
|
(1,050,941
|
)
|
Foreign currency translation adjustment
|
|
|
21,002
|
|
|
|
447,273
|
|
|
|
(732,171
|
)
|
|
|
1,633,053
|
|
Comprehensive (loss) income
|
|
$
|
(3,741,897
|
)
|
|
$
|
(1,006,938
|
)
|
|
$
|
(7,551,520
|
)
|
|
$
|
582,112
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,516,140
|
|
Diluted
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,516,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(2.47
|
)
|
|
$
|
(0.96
|
)
|
|
$
|
(4.48
|
)
|
|
$
|
(0.69
|
)
|
Diluted
|
|
$
|
(2.47
|
)
|
|
$
|
(0.96
|
)
|
|
$
|
(4.48
|
)
|
|
$
|
(0.69
|
)
|
See notes to unaudited condensed consolidated
financial statements.
QKL STORES INC. AND SUBSIDIARIES
Condensed Consolidated Statements of
Cash Flows
|
|
(Unaudited)
|
|
|
|
Six Months Ended June 30,
|
|
|
|
2014
|
|
|
2013
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(6,819,349
|
)
|
|
$
|
(1,050,941
|
)
|
Depreciation
|
|
|
3,279,750
|
|
|
|
3,280,567
|
|
Amortization
|
|
|
14,708
|
|
|
|
16,172
|
|
Share-based compensation
|
|
|
204,029
|
|
|
|
408,234
|
|
Deferred income tax
|
|
|
-
|
|
|
|
390,291
|
|
Loss on disposal of fixed assets
|
|
|
-
|
|
|
|
25,646
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
222,985
|
|
|
|
40,727
|
|
Inventories
|
|
|
16,863,267
|
|
|
|
21,299,200
|
|
Other receivables
|
|
|
(314,995
|
)
|
|
|
1,669,983
|
|
Prepaid expenses
|
|
|
5,042,852
|
|
|
|
2,861,272
|
|
Advances to suppliers
|
|
|
2,847,162
|
|
|
|
7,603,073
|
|
Accounts payable
|
|
|
(1,367,629
|
)
|
|
|
(4,713,502
|
)
|
Cash card and coupon liabilities
|
|
|
(293,696
|
)
|
|
|
501,696
|
|
Customer deposits received
|
|
|
73,164
|
|
|
|
(117,765
|
)
|
Accrued expenses and other payables
|
|
|
447,597
|
|
|
|
(2,776,056
|
)
|
Income taxes payable
|
|
|
(33,029
|
)
|
|
|
20,322
|
|
Net cash provided by operating activities
|
|
|
20,166,816
|
|
|
|
29,458,919
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment
|
|
|
(1,603,149
|
)
|
|
|
(538,595
|
)
|
Net cash used in investing activities
|
|
|
(1,603,149
|
)
|
|
|
(538,595
|
)
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Bank loan borrowing
|
|
|
35,806,650
|
|
|
|
-
|
|
Bank loan repayment
|
|
|
(16,275,750
|
)
|
|
|
(16,005,275
|
)
|
Net cash provided by (used in) financing activities
|
|
|
19,530,900
|
|
|
|
(16,005,275
|
)
|
|
|
|
|
|
|
|
|
|
Effect of foreign currency translation
|
|
|
(172,551
|
)
|
|
|
295,196
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash
|
|
|
38,094,567
|
|
|
|
12,915,049
|
|
Cash – beginning of period
|
|
|
9,245,212
|
|
|
|
8,479,413
|
|
Cash – end of period
|
|
$
|
47,167,228
|
|
|
$
|
21,689,658
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
2,789,480
|
|
|
$
|
523,888
|
|
Income taxes paid
|
|
$
|
23,252
|
|
|
$
|
205,035
|
|
See notes to unaudited condensed consolidated
financial statements.
QKL STORES INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated
Financial Statements
NOTE 1 – ORGANIZATION AND BUSINESS OPERATIONS
QKL Stores Inc. (“Store”) was incorporated under
the laws of the State of Delaware on December 2, 1986. Store currently operates through a wholly owned subsidiary in the British
Virgin Islands: Speedy Brilliant Group Ltd. (“Speedy Brilliant (BVI)”), wholly owned subsidiary of Speedy Brilliant
(BVI) located in Mainland China: Speedy Brilliant (Daqing) Ltd. (“Speedy Brilliant (Daqing)” or “WFOE”),
operating company located in Mainland China: Daqing Qingkelong Chain Commerce & Trade Co., Ltd. (“Qingkelong Chain”),
which Store controls, through contractual arrangements between WFOE and Qingkelong Chain, as if Qingkelong Chain were a wholly
owned subsidiary of Store, wholly owned operating subsidiary of Qingkelong Chain located in Mainland China: Daqing Qinglongxin
Commerce & Trade Co., Ltd (“Qinglongxin Commerce”) and wholly owned operating company located in Mainland China:
Daqing Longqing Microcredit Co., Ltd. (“QKL-LQ”), which Qingkelong Chain controls, through arrangement that absorbs
operations risk, as if QKL-LQ were a wholly-owned subsidiary of Qingkelong Chain.
Store and its subsidiaries (hereinafter, collectively referred
to as the “Company”) are engaged in the operation of retail chain stores in the PRC. The principal business activity
of QKL-LQ is money lending.
The Company is a regional supermarket chain that currently operates
26 supermarkets, 16 hypermarkets and 4 department stores in northeastern China and Inner Mongolia. The Company’s supermarkets
and hypermarkets sell a broad selection of merchandise including groceries, fresh food and non-food items. A supermarket offers
various daily necessities on a self-service basis and averages 2,500 square meters in sales area. A hypermarket is similar to a
supermarket but has a larger operating scale, and is typically over 4,500 square meters in sales area. The Company currently has
two distribution centers servicing its supermarkets.
The Company is the first supermarket chain in northeastern China
and Inner Mongolia that is a licensee of the Independent Grocers Alliance, or IGA, a United States-based global grocery network.
As a licensee of IGA, the Company is able to engage in group bargaining with suppliers and have access to more than 2,000 private
IGA brands, including many that are exclusive IGA brands.
Principles of Consolidation and Presentation
The condensed consolidated financial statements have been prepared
in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). The condensed consolidated
financial statements include the financial statements of QKL Stores Inc., and its wholly owned subsidiaries. All intercompany
accounts, transactions, and profits have been eliminated upon consolidation.
The accompanying interim unaudited condensed consolidated financial
statements (“Interim Financial Statements”) of the Company and its wholly owned subsidiaries have been prepared in
accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial
information and are presented in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these
Interim Financial Statements do not include all of the information and notes required by GAAP for complete financial statements.
These Interim Financial Statements should be read in conjunction with the consolidated financial statements and notes thereto for
the fiscal year ended December 31, 2013 included in the Company’s Form 10-K. In the opinion of management, the Interim Financial
Statements included herein contain all adjustments, including normal recurring adjustments, considered necessary, in management’s
opinion, to present fairly the Company’s financial position, the results of operations and cash flows for the interim periods
presented. The operating results and cash flows of the interim periods presented herein are not necessarily indicative
of the results to be expected for any other interim period or the full year.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ
from those estimates.
Segment Reporting
The Company operates in one industry segment, operating retail
chain stores. ASC 280, Segment Reporting, establishes standards for reporting information about operating segments.
Given the economic characteristics of the similar nature of the products sold, the type of customer and the method of distribution,
the Company operates as one reportable segment as defined by ASC 280, Segment Reporting.
Revenue Recognition
The Company earns revenue by selling merchandise primarily through
its retail stores. Revenue is recognized when merchandise is purchased by and delivered to the customer and is shown net of estimated
returns during the relevant period. The allowance for sales returns is estimated based upon historical experience.
Cash received from the sale of cash cards (aka “gift cards”)
is recorded as a liability, and revenue is recognized upon the redemption of the cash card or when it is determined that the likelihood
of redemption is remote (“cash card breakage”) and no liability to relevant jurisdictions exists. The Company determines
the cash card breakage rate based upon historical redemption patterns and recognizes cash card breakage on a straight-line basis
over the estimated cash card redemption period. The Company recognized approximately nil in cash card breakage revenue
for the six months and three months ended June 30, 2014 and 2013.
The Company records sales tax collected from its customers on
a net basis, and therefore excludes it from revenue as defined in ASC 605, Revenue Recognition.
Included in revenue are sales of returned merchandise to vendors
specializing in the resale of defective or used products, which accounted for less than 0.5% of net sales in each of the periods
reported.
Cost of Sales
Cost of sales includes the cost of merchandise, related cost
of packaging and shipping cost, and the distribution center costs.
Selling Expenses
Selling expenses include store-related expense, other than store
occupancy costs, as well as advertising, depreciation and amortization, utilities, labour costs, preliminary expenses and certain
expenses associated with operating the Company’s corporate headquarters.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense,
net of reimbursement from suppliers, amounted to $60,574 and $173,069 respectively for the six months ended June 30, 2014 and 2013,
and amounted to $26,996 and $75,897 respectively for the three months ended June 30, 2014 and 2013, respectively. Advertising expense
is included in selling expenses in the accompanying condensed consolidated statements of income. The Company receives co-operative
advertising allowances from vendors in order to subsidize qualifying advertising and similar promotional expenditures made relating
to vendors’ products. These advertising allowances are recognized as a reduction to selling expenses when the Company incurs
the advertising cost eligible for the credit. Co-operative advertising allowances recognized as a reduction to selling expenses
amounted to nil for the six months and three months ended June 30, 2014 and 2013.
Vendor Allowances
The Company receives allowances for co-operative advertising
and volume purchase rebates earned through programs with certain vendors. The Company records a receivable for these allowances
which are earned but not yet received when it is determined the amounts are probable and reasonably estimable, in accordance with
ASC 605. Amounts relating to the purchase of merchandise are treated as a reduction of inventory cost and reduce cost of goods
sold as the merchandise is sold. Amounts that represent a reimbursement of costs incurred, such as advertising, are recorded as
a reduction in selling and administrative expense. The Company performs detailed analyses to determine the appropriate amount of
vendor allowances to be applied as a reduction of merchandise cost and selling expenses.
Inventories
Inventories primarily consist of merchandise inventories and
are stated at lower of cost or market and net realizable value. Cost of inventories is calculated on the weighted average basis
which approximates cost.
Management regularly reviews inventories and records valuation
reserves for damaged and defective returns, inventories with slow-moving or obsolescence exposure and inventories with carrying
value that exceeds market value. Because of its product mix, the Company has not historically experienced significant occurrences
of obsolescence.
Inventory shrinkage is accrued as a percentage of revenues based
on historical inventory shrinkage trends. The Company performs physical inventory count of its stores once per quarter and cycle
counts inventories at its distribution centers once per quarter throughout the year. The reserve for inventory shrinkage represents
an estimate for inventory shrinkage for each store since the last physical inventory date through the reporting date.
These reserves are estimates, which could vary significantly,
either favorably or unfavorably, from actual results if future economic conditions, consumer demand and competitive environments
differ from expectations.
Income Taxes
The Company follows ASC 740, Income Taxes, which requires the
recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based
on enacted tax laws and statutory tax rates, applicable to the periods in which the differences are expected to affect taxable
income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.
The Company adopted ASC 740-10-25 on January 1, 2007, which
provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax position. The Company
must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized
in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood
of being realized upon ultimate resolution. The Company did not recognize any additional liabilities for uncertain tax positions
as a result of the implementation of ASC 740-10-25.
Fair Value Measurements
ASC 820 defines fair value as the price that would be received
from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value,
the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market
participants would use when pricing the asset or liability.
ASC 820 establishes a fair value hierarchy that requires an
entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial
instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to
the fair value measurement. ASC 820 establishes three levels of inputs that may be used to measure fair value:
|
·
|
Level 1 – Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company holds. An active market for the asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
|
|
·
|
Level 2 – Valuation based on quoted prices in markets that are not active for which all significant inputs are observable, either directly or indirectly.
|
|
·
|
Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
|
The Company adopted ASC 820, Fair Value Measurements and Disclosures,
on January 1, 2008 for all financial assets and liabilities and non-financial assets and liabilities that are recognized or
disclosed at fair value in the consolidated financial statements on a recurring basis (at least annually). ASC 820 defines fair
value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The Company has
also adopted ASC 820, on January 1, 2009 for non financial assets and non financial liabilities, as these items are not recognized
at fair value on a recurring basis. The adoption of ASC 820 for all financial assets and liabilities and non-financial assets and
non-financial liabilities did not have any impact on the Company’s consolidated financial statements.
Financial instruments include cash, accounts receivable, prepayments
and other receivables, short-term borrowings from banks, accounts payable and accrued expenses and other payables. The carrying
amounts of cash, accounts receivable, prepayments and other receivables, short-term loans, accounts payable and accrued expenses
approximate their fair value due to the short-term maturities of these instruments. See footnote 7 regarding the fair value of
the Company’s warrants, which are classified as Level 3 liabilities in the fair value hierarchy.
Recently Issued Accounting Guidance
The FASB has issued Accounting Standards
Update (ASU) No. 2014-06, Technical Corrections and Improvements Related to Glossary Terms. The amendments in this ASU relate to
glossary terms and cover a wide range of Topics in the FASB’s Accounting Standards Codification™ (Codification). These
amendments are presented in four sections:
1. Deletion of Master Glossary Terms (Section
A) arising because of terms that were carried forward from source literature (e.g., FASB Statements, EITF Issues, and so forth)
to the Codification but were not utilized in the Codification.
2. Addition of Master Glossary Term Links
(Section B) arising from Master Glossary terms whose links did not carry forward to the Codification.
3. Duplicate Master Glossary Terms (Section
C) arising from Master Glossary terms that appear multiple times in the Master Glossary with similar, but not identical, definitions.
4. Other Technical Corrections Related
to Glossary Terms (Section D) arising from miscellaneous changes to update Master Glossary terms.
The amendments do not have transition guidance and are effective upon issuance for both public entities and nonpublic entities.
The FASB has issued Accounting Standards Update (ASU) No. 2014-08,
Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations
and Disclosures of Disposals of Components of an Entity. The amendments in the ASU change the criteria for reporting discontinued
operations while enhancing disclosures in this area. It also addresses sources of confusion and inconsistent application related
to financial reporting of discontinued operations guidance in U.S. GAAP.
Under the new guidance, only disposals representing a strategic
shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s
operations and financial results. Examples include a disposal of a major geographic area, a major line of business, or a major
equity method investment.
In addition, the new guidance requires expanded disclosures
about discontinued operations that will provide financial statement users with more information about the assets, liabilities,
income, and expenses of discontinued operations.
The new guidance also requires disclosure of the pre-tax income
attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting.
This disclosure will provide users with information about the ongoing trends in a reporting organization’s results from continuing
operations.
The amendments in this ASU enhance convergence between U.S. GAAP and International Financial Reporting Standards (IFRS). Part of
the new definition of discontinued operation is based on elements of the definition of discontinued operations in IFRS 5, Non-Current
Assets Held for Sale and Discontinued Operations.
The amendments in the ASU are effective in the first quarter
of 2015 for public organizations with calendar year ends. For most nonpublic organizations, it is effective for annual financial
statements with fiscal years beginning on or after December 15, 2014. Early adoption is permitted.
The Company has considered all new accounting pronouncements
and has concluded that there are no new pronouncements that may have a material impact on results of operations, financial condition,
or cash flows, based on current information.
NOTE 3 – OTHER RECEIVABLES
Other receivables consisted of the following:
|
|
June 30,
2014
(Unaudited)
|
|
|
December 31,
2013
|
|
Deposits
|
|
$
|
5,282,764
|
|
|
$
|
5,281,030
|
|
Purchase deposits
|
|
|
8,780
|
|
|
|
8,777
|
|
Input value added tax receivables
|
|
|
4,821,559
|
|
|
|
4,819,976
|
|
Rebates receivables
|
|
|
4,123,901
|
|
|
|
4,122,547
|
|
Loans to customers
|
|
|
7,795,521
|
|
|
|
7,546,665
|
|
Others
|
|
|
200,223
|
|
|
|
200,157
|
|
|
|
|
|
|
|
|
|
|
Total other receivables
|
|
$
|
22,232,748
|
|
|
$
|
21,979,152
|
|
NOTE 4 – PROPERTY, PLANT
AND EQUIPMENT, NET
Property, plant and equipment consisted of the following:
|
|
June 30, 2014
(Unaudited)
|
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
Buildings
|
|
$
|
7,131,822
|
|
|
$
|
6,997,206
|
|
Shop equipment
|
|
|
19,935,770
|
|
|
|
19,559,473
|
|
Office equipment
|
|
|
4,332,012
|
|
|
|
4,250,243
|
|
Motor vehicles
|
|
|
1,408,530
|
|
|
|
1,381,943
|
|
Car park
|
|
|
21,471
|
|
|
|
21,066
|
|
Leasehold improvements
|
|
|
27,146,707
|
|
|
|
26,634,300
|
|
Construction in progress
|
|
|
10,020,427
|
|
|
|
9,831,287
|
|
|
|
|
69,996,739
|
|
|
|
|
|
Total property, plant and equipment
|
|
|
|
|
|
|
68,675,518
|
|
Less: accumulated depreciation and amortization
|
|
|
(31,707,692
|
)
|
|
|
(28,427,942
|
)
|
|
|
|
|
|
|
|
|
|
Total property, plant and equipment, net
|
|
$
|
38,289,047
|
|
|
$
|
40,247,576
|
|
The depreciation expenses for the six months period ended June
30, 2014 and 2013 were $3,279,750 and $3,280,567, respectively.
NOTE 5 – ACCRUED EXPENSES AND OTHER PAYABLES
Accrued expenses and other payables consisted of the following:
|
|
June 30,
2014
(Unaudited)
|
|
|
December 31,
2013
|
|
Accrued expenses
|
|
$
|
16,124,052
|
|
|
$
|
15,504,283
|
|
VAT and other PRC tax payable
|
|
|
345,367
|
|
|
|
332,092
|
|
Shop equipment and leasehold improvements payables
|
|
|
324,699
|
|
|
|
312,218
|
|
Deposit from vendors and employees
|
|
|
2,785,964
|
|
|
|
2,678,879
|
|
|
|
|
|
|
|
|
|
|
Total accrued expenses and other payables
|
|
$
|
19,580,082
|
|
|
$
|
18,827,472
|
|
NOTE 6 – EARNINGS PER SHARE
The Company calculates earnings per share in accordance with
ASC 260, Earnings Per Share, which requires a dual presentation of basic and diluted earnings per share. Basic earnings per share
are computed using the weighted average number of shares outstanding during the fiscal year. Potentially dilutive common shares
consist of convertible preferred stock (using the if-converted method) and exercisable warrants and stock options outstanding (using
the treasury method). Holder of Series A convertible preferred stock participate in dividends of the Company on the same basis
as holders of the Company’s common stock and is therefore included in the calculation of basic earnings per share using the
two class method.
The following table sets forth the computation of basic and
diluted earnings per common stock:
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
Three Months
Ended June 30,
|
|
|
Six Months
Ended June 30,
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
Net loss to QKL Stores, Inc. for computing basic net income per share
|
|
$
|
(3,762,899
|
)
|
|
$
|
(1,454,211
|
)
|
|
$
|
(6,819,349
|
)
|
|
$
|
(1,050,941
|
)
|
Undistributed earnings allocated to Series A Convertible Preferred Stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Net loss attributable to ordinary shareholders for computing basic net loss per ordinary share
|
|
$
|
(3,762,899
|
)
|
|
$
|
(1,454,211
|
)
|
|
$
|
(6,819,349
|
)
|
|
$
|
(1,050,941
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares of common stock outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,516,140
|
|
Dilutive shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of series A convertible preferred stock
|
|
|
22,059
|
|
|
|
22,059
|
|
|
|
22,059
|
|
|
|
28,043
|
|
Dilutive effect of stock warrants and options
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Anti-dilutive effect of preferred stock
|
|
|
(22,059
|
)
|
|
|
(22,059
|
)
|
|
|
(22,059
|
)
|
|
|
(28,043
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,522,326
|
|
|
|
1,516,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
(2.47
|
)
|
|
$
|
(0.955
|
)
|
|
$
|
(4.48
|
)
|
|
$
|
(0.693
|
)
|
Diluted earnings per share
|
|
$
|
(2.47
|
)
|
|
$
|
(0.955
|
)
|
|
$
|
(4.48
|
)
|
|
$
|
(0.693
|
)
|
The 84,708 options were not included in the computation of diluted
net earnings per share as their effects would have been anti-dilutive since the average share price for the three months and six
months ended June 30, 2014 and 2013 were lower than the options and warrants exercise price.
NOTE 7 – STOCK WARRANTS
Series A and Series B Stock Warrants
As a result of a completed sale of 9,117,647 units for cash
proceeds of $15,500,000 on March 28, 2008, the Company issued Series A stock warrants of 242,611 and Series B stock warrants of
241,705 which can be converted on a one-for-one basis into shares of the Company’s common stock. The stock warrants have
a five year life and the Series A warrants are exercisable at an equivalent price of $81.60 per share and the Series B are exercisable
at an equivalent price of $102.00 per share. These stock warrants expired on March 28, 2014 pursuant to the warrant agreements.
The Company used the Black-Scholes option pricing model to determine
the fair value of the Series A and B stock warrants on March 28, 2008 (assumptions used – expected life of 5 years, volatility
of 89%, risk free interest rate of 2.51%, and expected dividend yield of 0%).
Effective January 1, 2009, the Company adopted the provisions
of FASB ASC Topic 815, “Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, “Determining
Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock”). As a result of adopting ASC 815,
warrants to purchase 484,315 of the Company’s common stock previously treated as equity pursuant to the derivative treatment
exemption were no longer afforded equity treatment as there was a down-round protection (full-ratchet down round protection). As
a result, the warrants were not considered indexed to the Company’s own stock, and as such, all future changes in the fair
value of these warrants were recognized in earnings until such time as the warrants are exercised or expire. The Company
reclassified the fair value of these warrants from equity to liability, as if these warrants were treated as a derivative liability.
On January 1, 2009, the Company recorded as a cumulative effect adjustment of decreasing additional paid-in capital of $6,020,000
and beginning retained earnings of $2,792,017 and $8,812,017 to warrant liabilities to recognize the fair value of such warrants.
The fair value of the warrants was $44,304,034 on December 31, 2009. The Company recognized $35,492,017 loss from the change in
fair value of warrants for the year ended December 31, 2009.
The Company amended Series A and Series B stock warrant agreements
deleting the down-round protection (full-ratchet down round protection) provision on March 24, 2010. As a result of this amendment,
the Company is no longer required to treat Series A and Series B warrants as a liability and was reclassified to equity as of March
24, 2010 (assumption used – expected life of 3 years, volatility of 57%, and risk free interest rate of 1.67%, and expected
dividend yield of 0%). Based on the revaluation, the Company recognized $7,801,649 of income related to this transaction
and reclassified $36,502,385 to equity for the year ended December 31, 2010.
Warrant C
On January 22, 2010, the Company issued a warrant (“Warrant
C”) to a non-related individual in exchange for consulting services relating to operational and managerial experience. Warrant
C can be converted into 8,333 shares of the Company’s common stock at an exercise price of $120 per share. Warrants C has
a five year term and became exercisable 180 days from the date of issuance of Warrant C.
The Company recognized share-based compensation cost based on
the grant-date fair value estimated in accordance with ASC 505-50 “equity based payments to non-employees”. The fair
value of these stock warrants on the date of grant was estimated using the Black-Scholes method (assumption used – expected
life of 2.75 years, volatility of 54%, and risk free interest rate of 1.25%, and expected dividend yield of 0%). The Company recognized
$558,180 of compensation expense related to this transaction.
A summary of the Company’s stock warrant activities are
as follows:
|
|
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual
Term
|
|
Balance – December 31, 2013
|
|
|
490,369
|
|
|
$
|
92.24
|
|
|
$
|
0.00
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance – June 30, 2014
|
|
|
490,369
|
|
|
$
|
92.24
|
|
|
$
|
0.00
|
|
NOTE 8 – SHARED BASED COMPENSATION
Under the 2009 Omnibus Securities and Incentive Plan, on September
14, 2009, the Company entered into stock option agreements with its three independent directors, granting each director options
to purchase 833 shares of the Company’s common stock at an exercise price of $192.00 per share. The options vest in approximately
equal amounts on the three subsequent anniversary dates of the grant and expire on the fifth anniversary of the date of agreement
of or the date the option is fully exercised. On January 30, 2010, the Company entered into amendment agreements with its three
directors to correct the exercise price to $180.00, which was the fair market value on the date of the grant. The correction of
this error was considered immaterial.
Under the 2009 Omnibus Securities and Incentive Plan, on June
26, 2010, the Company granted its Chief Operating Officer, Alan Stewart and 20 employees options to acquire 86,250 shares of the
Company's common stock at an exercise price of $105.60 per share. The options vest in approximately equal amounts on the four subsequent
anniversary dates of the grant and expire on the eighth anniversary of the date of agreement of or the date the option is fully
exercised. On June 17, 2011, Mr. Alan Stewart resigned from his position as Chief Operating Officer of QKL Stores Inc. This has
no material impact on the Company’s consolidated financial statements.
Under the 2009 Omnibus Securities and Incentive Plan, on December
2, 2010, the Company granted its Chief Financial Officer, Tsz-Kit Chan options to acquire 4,167 shares of the Company's common
stock at an exercise price of $82.08 per share. The options vest in approximately equal amounts on the four subsequent anniversary
dates of the grant and expire on the eighth anniversary of the date of agreement of or the date the option is fully exercised.
The Company accounts for its share-based compensation in accordance
with ASC 718 and recognizes compensation expense using the fair-value method on a straight-line basis over the requisite service
period for share option awards and non-vested share awards granted which vested during the period. The fair value for
these awards was estimated using the Black-Scholes option pricing model on the date of grant with the following assumptions:
|
|
September 14,
2009
|
|
|
June 26,
2010
|
|
|
December 2,
2010
|
|
Expected life (years)
|
|
|
3.5
|
|
|
|
3.25
|
|
|
|
3.25
|
|
Expected volatility
|
|
|
41.2
|
%
|
|
|
53
|
%
|
|
|
44.9
|
%
|
Risk-free interest rate
|
|
|
1.69
|
%
|
|
|
1.49
|
%
|
|
|
0.96
|
%
|
Dividend yield
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
The expected volatilities are based on the historical volatility
of the Company’s common stock. The observation is made on a weekly basis. The observation period covered
is consistent with the expected life of the options. The expected life of stock options is based on the minimum vesting
period required. The risk-free rate is consistent with the expected terms of the stock options and is based on the United
States Treasury yield curve in effect at the time of grant.
Stock-based compensation expenses recognized was $ 102,014 for
the three months ended June 30, 2014. A summary of the Company’s stock options activities under the 2009 Omnibus Securities
and Incentive Plan are as follows:
|
|
Shares
|
|
|
Weighted Average
Exercise Price
|
|
|
Weighted Average
Remaining Contractual
Term(Years)
|
|
|
Intrinsic Value
|
|
Outstanding – December 31, 2013
|
|
|
84,708
|
|
|
$
|
106.64
|
|
|
|
0.49
|
|
|
$
|
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding– June 30, 2014
|
|
|
84,708
|
|
|
$
|
106.64
|
|
|
|
0.00
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable – June 30, 2014
|
|
|
51,825
|
|
|
$
|
102.02
|
|
|
|
0.04
|
|
|
$
|
-
|
|
As of June 30, 2014, there was $ $203,929 of total unrecognized
compensation cost related to non-vested share option awards granted. Such cost is expected to be recognized over a weighted-average
period of 0-1 year.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Operating Leases
Certain of our real properties and equipment are operated under
lease agreements. Rental expense under operating leases was as follows:
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
Three Months Ended
June 30
|
|
|
Six Months Ended
June 30
|
|
|
|
2014
|
|
|
2013
|
|
|
2014
|
|
|
2013
|
|
Rent expense
|
|
$
|
2,148,114
|
|
|
$
|
2,119,348
|
|
|
$
|
4,291,564
|
|
|
$
|
4,167,722
|
|
Less: Sublease income
|
|
|
(246,087
|
)
|
|
|
(498,763
|
)
|
|
|
(491,640
|
)
|
|
|
(995,536
|
)
|
Total rent expense, net
|
|
$
|
1,902,027
|
|
|
$
|
1,620,585
|
|
|
$
|
3,799,924
|
|
|
$
|
3,172,186
|
|
Annual minimum payments under operating leases are as follows:
As of June 30,
|
|
Minimum Lease
Payment
|
|
|
Sublease
Income
|
|
|
Net Minimum
Lease Payment
|
|
2015
|
|
$
|
10,728,910
|
|
|
|
1,229,099
|
|
|
|
9,499,811
|
|
2016
|
|
|
10,634,396
|
|
|
|
139,821
|
|
|
|
10,494,575
|
|
2017
|
|
|
10,424,492
|
|
|
|
137,901
|
|
|
|
10,286,591
|
|
2018
|
|
|
9,802,343
|
|
|
|
123,133
|
|
|
|
9,679,210
|
|
2019
|
|
|
9,436,824
|
|
|
|
21,499
|
|
|
|
9,415,325
|
|
Thereafter
|
|
|
81,854,218
|
|
|
|
-
|
|
|
|
81,854,218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
132,881,183
|
|
|
|
1,651,453
|
|
|
|
131,229,730
|
|
Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion and analysis of the QKL Stores Inc.
and subsidiaries (“we”, “our”, “us”) financial condition and results of operations includes
information with respect to our plans and strategies for our business and should be read in conjunction with our interim unaudited
condensed consolidated financial statements and related notes (“Interim Financial Statements”) included herein and
our consolidated financial statements and related notes, and Management’s Discussion and Analysis of Financial Condition
and Results of Operations contained in our Form 10-K for the fiscal year ended December 31, 2013.
Overview
We are a regional supermarket chain that currently operates
26 supermarkets, 16 hypermarkets and 4 department stores in northeastern China and Inner Mongolia. Our supermarkets and hypermarkets
sell a broad selection of merchandise including groceries, fresh food and non-food items. A supermarket offers various daily necessities
on a self-service basis and averages 2,500 square meters in sales area. A hypermarket is similar to a supermarket but has a larger
operating scale, and is typically over 4,500 square meters in sales area. We currently have two distribution centers servicing our
supermarkets.
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. 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 and also raised
additional financing in our public offering in the fourth quarter of 2009. Under our expansion plan, we opened:
|
·
|
ten new stores in 2008 that have in the aggregate approximately 42,000 square meters of space
|
|
·
|
seven new stores in 2009 that have, in the aggregate, approximately 32,000 square meters of space
|
|
·
|
nine new stores in 2010 that have in the aggregate approximately 74,189 square meters of space
|
|
·
|
fourteen new stores in the 2011 that have in the aggregate approximately 101,000 square meters of space
|
|
·
|
one new store in 2012 that has approximately 5,700 square meters of space
|
|
·
|
two new stores in first six months of 2014 that have approximately 18,700 square meters of space
|
We are making improvements to our logistics and information
systems to support our supermarkets. We expect to finance our expansion plan from funds generated from operations and bank loans.
On March 28, 2012, QKL-China formed QKL-LQ for money lending
business. Currently, the business activity of QKL-LQ is immaterial.
On June 11, 2012, we completed a 1-for-3 reverse stock split
of our common stock (the “2012 Stock Split”), such that for each three shares outstanding prior to the 2012 Stock Split
there was one share outstanding after the 2012 Stock Split.
On February 4, 2013, we completed a 1-for-8 reverse stock split
of our common stock (the “2013 Stock Split”), such that for each eight shares outstanding prior to the 2013 Stock Split
there was one share outstanding after the 2013 Stock Split.
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.
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, and improving profitability by decreasing the cost through resource purchase, 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 June 30, 2014, we operated 26 supermarkets, 16 hypermarkets,
4 department stores, and 2 distribution centers, one in Daqing, and one in Harbin. We are making improvements to our logistics
and information systems to support our supermarkets. We expect to finance our expansion plan from funds generated from operations
and bank loans.
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 manufacturers cannot sell the product to any other party.
Sales of private label merchandise accounted for approximately 6.0% of our total revenues for the first three months ended June
30, 2014 and 2013. In June 2008, we established a specialized department for designing and purchasing private label merchandise,
in which 7 full-time employees currently work. Our goal is to increase private label sales to 20% of our total revenues.
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).
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 Store
– 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. We started using our regional purchasing systems in 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.
Human Resources
– 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 human resources. Where competitors operate supermarkets nearby,
their trained staff is a potential source for our own human resources needs, especially if we offer a superior compensation package.
Cities that have no large supermarkets also have no sources of trained employees. Although we believe we have a good training school,
from time to time we have to send experienced management team members from our headquarters or other stores to new stores to provide
assistance. This increases our cost of operating and decreases our gross margin.
Critical Accounting Estimates
As discussed in Part II, Item 7, Management’s Discussion
and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended December
31, 2013, we consider our estimates on revenue recognition, vendor allowances, and inventory valuation to be the most critical
in understanding the judgments that are involved in preparing our consolidated financial statements. There have been no significant
changes to these estimates in the three months ended June 30, 2014.
Recently Issued Accounting Guidance
See Note 2 to condensed consolidated financial statements included
in Item 1, Interim Financial Statements, of this Quarterly Report on Form 10-Q.
Results of Operations
Three months ended June 30, 2014 compared with three months
ended June 30, 2013
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
|
|
|
|
June 30, 2014
|
|
|
June 30, 2013
|
|
|
|
Amount
|
|
|
% of
Net Sales
|
|
|
Amount
|
|
|
% of
Net Sales
|
|
Net sales
|
|
$
|
51,655,611
|
|
|
|
100.0
|
%
|
|
$
|
58,995,918
|
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
42,968,964
|
|
|
|
83.2
|
|
|
|
48,862,015
|
|
|
|
82.8
|
|
Gross profit
|
|
|
8,686,647
|
|
|
|
16.8
|
|
|
|
10,133,903
|
|
|
|
17.2
|
|
Selling expenses
|
|
|
9,456,970
|
|
|
|
18.3
|
|
|
|
9,879,874
|
|
|
|
16.7
|
|
General and administrative expenses
|
|
|
1,963,838
|
|
|
|
3.8
|
|
|
|
2,080,136
|
|
|
|
3.5
|
|
Operating loss
|
|
|
(2,734,161
|
)
|
|
|
(5.3
|
)
|
|
|
(1,826,107
|
)
|
|
|
(3.1
|
)
|
Interest income
|
|
|
254,517
|
|
|
|
0.5
|
|
|
|
261,991
|
|
|
|
0.4
|
|
Interest expense
|
|
|
1,279,388
|
|
|
|
2.5
|
|
|
|
226,280
|
|
|
|
0.4
|
|
Loss before income taxes
|
|
|
(3,759,032
|
)
|
|
|
(7.3
|
)
|
|
|
(1,790,396
|
)
|
|
|
(3.0
|
)
|
Income taxes
|
|
|
3,867
|
|
|
|
0.0
|
|
|
|
(336,185
|
)
|
|
|
(0.6
|
)
|
Net loss
|
|
$
|
(3,762,899
|
)
|
|
|
(7.3
|
)%
|
|
$
|
(1,454,211
|
)
|
|
|
(2.5
|
)%
|
Net Sales
– Net sales decreased by $7.3
million, or 12.4%, to $51.7 million for the three months ended June 30, 2014 from $59.0 million for the three months ended June
30, 2013. 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, 2013. Same store (44 stores) sales generated approximately $49.6 million in sales in the second quarter of 2014, a decrease of $3.8 million, or 7.1% compared with $53.4 million in net sales in the second quarter of 2013.
|
|
·
|
New store sales increased, reflecting the opening of two new stores since January 1, 2013. These stores generated approximately $2.1 million in sales in the second quarter of 2014.
|
|
·
|
The number of stores including supermarkets/hypermarkets and department stores at June 30, 2014 was 46 versus 45 at June 30, 2013.
|
Cost of Sales –
Our cost of sales for the
three months ended June 30, 2014 was approximately $43.0 million, representing a decrease of $5.9 million, or 12.1%, from approximately
$48.9 million for the same period in 2013. The decrease was due to the decrease 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, decreased by $1.4 million, or 14.3%, to $8.7 million, or 16.8% of net sales, in the second quarter of 2014
from $10.1 million, or 17.2% of net sales, in the second quarter of 2013. The change in gross profit was primarily attributable
to a decrease in net sales of $7.3 million and a decrease in cost of sales of $5.9 million in the second quarter of 2014 compared
to the second quarter of 2013.
We believe that our gross margin is likely to be between 16.8%
and 17.3%, 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 decreased
by $0.4 million, or 4.3%, to $9.5 million, or 18.3% of net sales, in the second quarter of 2014, and $9.9 million, or 16.7% of
net sales, in the second quarter of 2013. The increase in selling expenses relative to net sales was due to the significant decrease
in net sales in the three months ended June 30, 2014 compared to the same period in 2013.
General and Administrative Expense
–General
and administrative expenses decreased by $0.1 million, or 5.6%, to $2.0 million, or 3.8% of net sales, in the second quarter of
2014 from $2.1 million, or 3.5% of net sales, in the second quarter of 2013. There is no significant change to our general and
administrative expense.
Interest Expense
–Interest expenses increased
by $1.1 million to $1.3 million in the second quarter of 2014 from $0.2 million in the second quarter of 2013. The increase in
interest expenses was due to the increase in our short term bank loans.
Income Taxes
–The provision for income taxes
was $3,867 for the second quarter of 2014 compared with $0.3 million of tax credit for the second quarter of 2013.
Net Loss
– Our net loss for the second
quarter of 2014 was $3.8 million, or $2.47 per diluted share, from net loss of $1.5 million, or $0.96 per diluted share in the
prior year period. The number of shares used in the computation of diluted EPS was 1,522,326 for the second quarter of 2014 and
2013.
Six months ended June 30, 2014 compared
with six months ended June 30, 2013
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)
Six Months Ended
June 30, 2014
|
|
|
(Unaudited)
Six Months Ended
June 30, 2013
|
|
|
|
Amount
|
|
|
% of
Net Sales
|
|
|
Amount
|
|
|
% of
Net Sales
|
|
Net sales
|
|
$
|
137,688,287
|
|
|
|
100.0
|
%
|
|
$
|
156,053,109
|
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
114,269,481
|
|
|
|
83.0
|
|
|
|
129,279,758
|
|
|
|
82.8
|
|
Gross profit
|
|
|
23,418,806
|
|
|
|
17.0
|
|
|
|
26,773,351
|
|
|
|
17.2
|
|
Selling expenses
|
|
|
22,737,153
|
|
|
|
16.5
|
|
|
|
23,204,087
|
|
|
|
14.9
|
|
General and administrative expenses
|
|
|
5,197,248
|
|
|
|
3.8
|
|
|
|
4,598,472
|
|
|
|
2.9
|
|
Operating loss
|
|
|
(4,515,595
|
)
|
|
|
(3.3
|
)
|
|
|
(1,029,208
|
)
|
|
|
(0.7
|
)
|
Interest income
|
|
|
484,616
|
|
|
|
0.4
|
|
|
|
455,564
|
|
|
|
0.3
|
|
Interest expense
|
|
|
2,778,631
|
|
|
|
2.0
|
|
|
|
523,888
|
|
|
|
(0.3
|
)
|
Income loss before income taxes
|
|
|
(6,809,610
|
)
|
|
|
(4.9
|
)
|
|
|
(1,097,532
|
)
|
|
|
0.7
|
|
Income taxes
|
|
|
9,739
|
|
|
|
0.0
|
|
|
|
(46,591
|
)
|
|
|
(0.0
|
)
|
Net loss
|
|
$
|
(6,819,349
|
)
|
|
|
(5.0
|
)%
|
|
$
|
(1,050,941
|
)
|
|
|
(0.7
|
)%
|
Net Sales
– Net sales decreased by $18.4
million, or 11.8%, to $137.7 million for the six months ended June 30, 2014 from $156.1 million for the six months ended June 30,
2013. The change in net sales was primarily attributable to the following:
|
·
|
Same store sales represent sales from stores that were opened for at least one year before the beginning of the comparison period, or by January 1, 2013. Same store (44 stores) sales generated approximately $131.6 million sales in the first half of 2014, a decrease of $17.4 million, or 11.7% compared with $149.0 million net sales in the first half of 2013.
|
|
·
|
New store sales increased, reflecting the opening of two new stores since January 1, 2013. These stores generated approximately $4.6 million sales in the first half of 2014.
|
|
·
|
The number of stores including supermarket/hypermarket and department stores at June 30, 2014 was 46 versus 45 at June 30, 2013.
|
Cost of Sales –
Our cost of sales for the
six months ended June 30, 2014 was approximately $114.3 million, representing a decrease of $15.0 million, or 11.6%, from approximately
$129.3 million for the same period in 2013. The decrease was due to the decrease 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, decreased by $3.4 million, or 12.5%, to $23.4 million, or 17.0% of net sales, in the first half of 2014 from
$26.8 million, or 17.2% of net sales, in the first half of 2013. The change in gross profit was primarily attributable to net sales
decreased by $18.4 million and a decrease in cost of sales of $15.0 million in the first half of 2014 compared to the first half
of 2013.
We believe that our gross margin is likely to be between 16.8%
and 17.3%, 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 decreased
by $0.5 million, or 2.0%, to $22.7 million, or 16.5% of net sales, in the first half of 2014 from $23.2 million, or 14.9% of net
sales in the first half of 2013. The increase in selling expenses relative to net sales was due to the significant decrease in
net sales in the six months ended June 30, 2014 compared to the same period in 2013.
General
and Administrative Expense
–General and administrative expenses increased by $0.6 million, or 13.0%, to $5.2 million,
or 3.8% of net sales, in the first half of 2014 from $4.6 million, or 2.9% of net sales, in the first half of 2013.
We
have expanded our resources buying team in the first quarter and the related expenses were $0.5 million.
Interest Expense
–Interest expenses increased
by $1.1 million to $1.3 million in the first half of 2014 from $0.2 million in the first half of 2013. The increase in interest
expenses was due to the increase in short term bank loans.
Income Taxes
–The provision for income taxes
was $9,739 for the first half of 2014 compared with $46,591 of tax credit for the first half of 2013.
Net Income
– Net loss for the first
half of 2014 was $6.8 million, or $4.48 per diluted share compared with net loss of $1.1 million, or $0.69 per diluted share, in
the prior year period. The number of shares used in the computation of diluted EPS was 1,522,326 and 1,516,140 for the first half
of 2014 and 2013, respectively.
Liquidity and Capital Resources
Our principal liquidity requirements are for working capital
and capital expenditures. 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 June 30, 2014, we had $47.2 million of cash compared to $21.7
million at June 30, 2013. The following table sets forth a summary of our cash flows for the periods indicated:
|
|
(Unaudited)
|
|
|
|
Six Months Ended June 30,
|
|
|
|
2014
|
|
|
2013
|
|
Net cash provided by operating activities
|
|
$
|
20,166,816
|
|
|
$
|
29,458,919
|
|
Net cash used in investing activities
|
|
|
(1,603,149
|
)
|
|
|
(538,595
|
)
|
Net cash provided by (used in) financing activities
|
|
|
19,530,900
|
|
|
|
(16,005,275
|
)
|
Effect of foreign currency translation
|
|
|
(172,551
|
)
|
|
|
295,196
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash
|
|
$
|
37,922,016
|
|
|
$
|
13,210,245
|
|
Seasonality
The seasonality of our business historically provides greater
cash flow from operations during the holiday and winter selling season, with the fourth quarter net sales traditionally generating
the strongest profits of each 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 each year.
Operating Activities
–Net cash provided
by operating activities for the six months ended June 30, 2014 and 2013 were $20.2 million and $29.5 million, respectively. The
decrease in cash provided by operating activities for the six months ended June 30, 2014 compared to the same period in 2013 primarily
reflects the decrease in net sales for the six months ended June 30, 2014.
Investing Activities
– Net cash used in
investing activities for the first six months of 2014 and 2013 were $1.6 million and $0.5 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 and store-related remodeling.
Financing Activities
– Net cash provided
by (used in) financing activities for the first six months of 2014 and 2013 was $19.5 million and ($16.0) million, respectively.
Cash provided by (used in) financing activities was sourced from and repayment to short-term bank loans.
Loan Facility
– On July 6, 2011, Qingkelong
Chain entered into a working capital agreement with Longjiang Commercial Bank. Under this agreement, Qingkelong Chain has a credit
line up to approximately $7.7 million (RMB50.0 million). The term of any loan under the agreement is one year after the date the
loan is issued, with the current annual interest rate of 7.2%%. The loan under this financing agreement is secured by buildings
with appraisal value of approximately $11.9 million (RMB 77.0 million).
On September 30, 2013, Qingkelong Chain entered into a working
capital agreement with China CITIC Bank. Under this agreement, Qingkelong Chain borrowed $3.3 million (RMB20 million). The loan
is repayable on September 29, 2014 with the current interest rate of 6.6%. The loan is secured by personal guarantee of Zhuangyi
Wang.
On October 22, 2013, Qingkelong Chain entered into a working
capital agreement with China CITIC Bank. Under this agreement, Qingkelong Chain borrowed $4.9 million (RMB30 million). The loan
is repayable on October 23, 2014 with the current interest rate of 6.6%. The loan is secured by personal guarantee of Zhuangyi
Wang.
On October 23, 2013, Qingkelong Chain entered into a working
capital agreement with China CITIC Bank. Under this agreement, Qingkelong Chain borrowed $8.2 million (RMB50 million). The loan
is repayable on October 22, 2014 with the current interest rate of 6.6%. The loan is secured by pledged deposit of $8.7million.
On December 4, 2013, Qingkelong Chain entered into a working
capital agreement with Industrial and Commercial Bank of China Limited. Under this agreement, Qingkelong Chain borrowed $16.4million
(RMB100 million). The loan is repayable on December 2, 2014 with the current interest rate of 7.2%.
On February 19, 2014, Qingkelong Chain entered into a working
capital agreement with China CITIC Bank. Under this agreement, Qingkelong Chain borrowed $11.4 million (RMB70 million). The loan
is repayable on February 18, 2015 with the current interest rate of 7.2%.
On March 19, 2014, Qingkelong Chain entered into a working capital
agreement with China CITIC Bank. Under this agreement, Qingkelong Chain borrowed $8.1 million (RMB50 million). The loan is repayable
on March 18, 2015 with the current interest rate of 6.6%.
On April 1, 2014, Qingkelong Chain entered into a working capital
agreement with Industrial and Commercial Bank of China Limited. Under this agreement, Qingkelong Chain borrowed $16.3million (RMB100
million). The loan is repayable on March 31, 2015 with the current interest rate of 7.2%.
Future Capital Requirements
– We had cash
on hand of $47.2 million as of June 30, 2014. We expect capital expenditures for the remainder of 2014 primarily to fund the opening
of new stores, store-related remodeling and relocation.
We believe we will be able to fund our cash requirements, for
at least the next 12 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 credit facility.
If we are unable to generate sufficient cash flow from operations
to meet our obligations and commitments, 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”). 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.