10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2011.

or

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                   to                   .

Commission File Number

QKL STORES INC.

(Exact name of registrant as specified in its charter)

Delaware	75-2180652
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

Jingqi Street, Dongfeng Xincun

Sartu District

Daqing, P.R. China 163311

(Address of Principal Executive Offices including zip code)

011-86-459-4607626

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every, Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company

Large Accelerated Filer  o Accelerated Filer  o Non-Accelerated Filer o (Do not check if a smaller reporting company) Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).

Yes o No o

The Registrant had 29,667,631 shares of common stock outstanding on May 13, 2011

QKL STORES, INC.

TABLE OF CONTENTS

PART I:  FINANCIAL INFORMATION	2
Item 1 – Financial Statements	2
Condensed Consolidated Balance Sheets	2
Condensed Consolidated Statements of Income	3
Condensed Consolidated Statements of Cash Flows	4
Notes to Unaudited Condensed Consolidated Financial Statements	5
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3 – Quantitative and Qualitative Disclosures about Market Risk	22
Item 4T – Controls and Procedures	22
PART II:  OTHER INFORMATION	24
Item 1 – Legal Proceedings	24
Item 1A – Risk Factors	24
Item 2 – Unregistered Sales of Equity Securities and Use Of Proceeds	24
Item 3 – Defaults Upon Senior Securities	24
Item 4 – Reserved and Removed	24
Item 5 – Other Information	24
Item 6 – Exhibits	24
Signatures	25

i

PART 1. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

QKL STORES INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

	March 31,  2011		December 31, 2010
	(Unaudited)
ASSETS
Cash	$	41,097,024	$	17,460,034
Restricted cash		56,231		77,205
Accounts receivable		725,633		167,509
Inventories		36,352,254		44,467,265
Other receivables		16,940,826		28,236,397
Prepaid expenses		6,593,806		5,088,825
Advances to suppliers		2,241,538		3,740,327
Deferred income tax assets		604,887		508,617
Total current assets		104,612,199		99,746,179
Property, plant and equipment, net		28,021,579		24,792,149
Land use rights, net		756,495		748,533
Goodwill		44,142,196		43,863,929
Other assets		459,508		467,927
Total assets	$	177,991,977	$	169,618,717
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable	$	38,966,162	$	38,944,917
Cash card and coupon liabilities		13,530,112		10,814,546
Customer deposits received		1,048,743		1,495,059
Accrued expenses and other payables		12,550,831		9,883,282
Income taxes payable		2,400,231		2,365,931
Total current liabilities		68,496,079		63,503,735
Total liabilities		68,496,079		63,503,735
Shareholders’ equity
Common stock, $.001 par value per share, authorized 100,000,000 shares, issued and outstanding 29,769,590 and 29,743,811 shares at March 31, 2011 and December 31, 2010, respectively		29,770		29,744
Series A convertible preferred stock, par value $0.01, authorized 10,000,000 shares, issued and outstanding 7,269,549 and 7,295,328 at March 31,2011 and December 31, 2010, respectively		72,695		72,953
Additional paid-in capital		90,927,009		90,710,619
Retained earnings – appropriated		6,012,675		6,012,675
Retained earnings		4,681,978		2,094,850
Accumulated other comprehensive income		7,771,771		7,194,141
Total shareholders’ equity		109,495,898		106,114,982
Total liabilities and shareholders’ equity	$	177,991,977	$	169,618,717

See notes to unaudited condensed consolidated financial statements.

2

QKL STORES INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income

	(Unaudited)
	Three Months Ended March 31,
	2011			2010
Net sales	$	101,311,096		$	81,606,113
Cost of sales		83,215,616			67,079,999
Gross profit		18,095,480			14,526,114
Operating expenses:
Selling expenses		12,537,203			6,866,038
General and administrative expenses		2,203,617			2,167,258
Total operating expenses		14,740,820			9,033,296
Income from operations		3,354,660			5,492,818
Non-operating income (expense):
(Increase) decrease in fair value of warrants		-			7,801,649
Interest income		289,622			146,938
Interest expense		(31,100	)		-
Total non-operating income		258,522			7,948,587
Income before income taxes		3,613,182			13,441,405
Income taxes		1,026,054			1,558,554
Net income	$	2,587,128		$	11,882,851
Comprehensive income statement:
Net income	$	2,587,128		$	11,882,851
Foreign currency translation adjustment		577,630			(128,127	)
Comprehensive income statement	$	3,164,758		$	11,754,724
Weighted average number of shares outstanding:
Basic		29,768,444			29,558,976
Diluted		37,039,139			40,356,404
Earnings per share:
Basic	$	0.09		$	0.40
Diluted	$	0.07		$	0.29

See notes to unaudited condensed consolidated financial statements.

3

QKL STORES INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

	(Unaudited)
	Three Months Ended March 31,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,587,128		$	11,882,851
Depreciation – property, plant and equipment		1,299,885			1,182,186
Amortization		7,433			6,793
Share-based compensation		216,158			570,222
Deferred income tax		(93,043	)		(106,549	)
Change in fair value of warrants		-			(7,801,649	)
Adjustments to reconcile net income to net cash provided by operating activities:
Accounts receivable		(557,061)			106,019
Inventories		8,397,106			6,813,119
Other receivables		11,474,705			(6,000,627	)
Prepaid expenses		(1,472,177	)		524,309
Advances to suppliers		(281,833)			330,749
Accounts payable		(225,817	)		(4,047,174	)
Cash card and coupon liabilities		2,646,960			715,600
Customer deposits received		(455,801	)		(3,074,499	)
Accrued expenses and other payables		1,980,840			(413,901	)
Income taxes payable		19,291			781,347
Net cash provided by operating activities		25,543,774			1,468,796
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(1,942,180	)		(888,146	)
Decrease of restricted cash		20,974			34,874
Net cash used in investing activities		(1,921,206	)		(853,272	)
Effect of foreign currency translation		14,422			800
Net increase in cash		23,636,990			616,324
Cash – beginning of period		17,460,034			45,912,798
Cash – end of period	$	41,097,024		$	46,529,122
Supplemental disclosures of cash flow information:
Interest received		157,048			146,936
Interest paid	$	(31,100	)	$	-
Income taxes paid		991,754			964,883

See notes to unaudited condensed consolidated financial statements.

4

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, and wholly owned operating subsidiary of Qingkelong Chain located in Mainland China:  Daqing Qinglongxin Commerce & Trade Co., Ltd (“Qinglongxin Commerce”).

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

The Company is a regional supermarket chain that currently operates 33 supermarkets, 13 hypermarkets and 3 department stores in northeastern China and Inner Mongolia. The Company’s supermarkets and hypermarkets sell a broad selection of merchandise including groceries, fresh food and non-food items. A supermarket offers various daily necessities on a self-service basis and averages 2,500 square meters in sales area. A hypermarket is similar to a supermarket but has a larger operating scale, and is typically over 4,500 square meters in sales area. The Company currently has two distribution centers servicing its supermarkets. 

 The Company is the first supermarket chain in northeastern China and Inner Mongolia that is a licensee of the 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, 2010 included in the Company’s Form 10-K. In the opinion of management, the Interim Financial Statements included herein contain all adjustments, including normal recurring adjustments, considered necessary to present fairly the Company’s financial position, the results of operations and cash flows for the periods presented.  The operating results and cash flows of the interim periods presented herein are not necessarily indicative of the results to be expected for any other interim period or the full year.

5

QKL STORES INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

Reclassification

The presentation of certain line items presented on the consolidated financial statements and the relevant notes for the prior years have been changed in conformity with the current year presentation of the condensed consolidated financial statements and the corresponding notes.  For comparative purposes, the Company reclassified the following:

§ $673,174 of net sales related to vendor allowance for the three months ended March 31, 2010 was reclassified to offset cost of sales.

The Company believes that such reclassification represents better presentation to its retail industry standard. The reclassification had no effect on the Company’s previously reported condensed consolidated statements of income, condensed consolidated statements of stockholders’ equity or condensed consolidated statements of cash flows, and is not considered material to any previously reported condensed consolidated financial statements.

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 three months ended March 31, 2011 and 2010.

6

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 $54,569 and $37,505 for the three months ended March 31, 2011 and 2010, 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 three months ended March 31, 2011 and 2010.

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.

7

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.

8

Financial instruments include cash, accounts receivable, prepayments and other receivables, short-term borrowings from banks, accounts payable and accrued expenses and other payables. The carrying amounts of cash, accounts receivable, prepayments and other receivables, short-term loans, accounts payable and accrued expenses approximate their fair value due to the short term maturities of these instruments. See footnote 10 regarding the fair value of the Company’s warrants, which are classified as Level 3 liabilities in the fair value hierarchy.

Recently Issued Accounting Guidance

In January 2010, the FASB issued the following ASC Updates:

 ASU No. 2010-01—Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash. This Update clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings Per Share). The amendments in this Update are effective for interim and annual periods ending on or after December 15, 2009 with retrospective application. The adoption had no impact on the Company’s consolidated financial statements.

 ASU No. 2010-02—Consolidation (Topic 810): Accounting and Reporting for Decreases in Ownership of a Subsidiary. This Update amends Subtopic 810-10 and related guidance to clarify that the scope of the decrease in ownership provisions of the Subtopic and related guidance applies to (i) a subsidiary or group of assets that is a business or nonprofit activity; (ii) a subsidiary that is a business or nonprofit activity that is transferred to an equity method investee or joint venture; and (iii) an exchange of a group of assets that constitutes a business or nonprofit activity for a noncontrolling interest in an entity, but does not apply to: (i) sales of in substance real estate; and (ii) conveyances of oil and gas mineral rights. The amendments in this Update are effective beginning in the period that an entity adopts FAS 160 (now included in Subtopic 810-10). The adoption had no impact on the Company’s consolidated financial statements.

 ASU No. 2010-06—Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.  This Update amends Subtopic 820-10 that require new disclosures about transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. This Update also amends Subtopic 820-10 to clarify certain existing disclosures. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010. The adoption of this Statement had no impact on the Company’s consolidated financial statements.

9

 ASU 2010-20 provides greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables by providing additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. The updated guidance is effective for public entities with interim and annual reporting periods beginning on or after December 15, 2010 for activities that occur during the reporting period. The Company does not expect the adoption of this guidance had no impact on its consolidated financial statements.

In April 2010, the FASB issued an Accounting Standard Update (“ASU”) No.2010-13,” Compensation-Stock Compensation” (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” which address the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. ASU 2010-13 is effective for interim and annual periods beginning on or after December 15, 2010 and do not have a material impact on the Company’s consolidated financial position or results of the operations.

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:

	March 31, 2011  (Unaudited)		December 31, 2010
Deposits	$	159,988	$	2,202,590
Purchase deposits		1,001,772		1,276,255
Input value added tax receivables		3,282,687		1,973,079
Loans to suppliers		8,581,408		18,119,405
Rebates receivables		1,761,983		1,725,963
Rent deposits		877,879		1,994,467
Others		1,275,109		944,638
Total	$	16,940,826	$	28,236,397

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NOTE 4 – ACCURED EXPENSES AND OTHER PAYABLES

Accrued expenses and other payables consisted of the following:

	March 31, 2011 (Unaudited)		December 31, 2010
Accrued expenses	$	5,759,213	$	3,652,235
VAT and other PRC tax payable		1,029,501		946,704
Repair, maintenance, and purchase of equipment payable		3,346,928		3,227,292
Employee promoters bond deposit		2,415,189		2,057,051
Total other payables	$	12,550,831	$	9,883,282

NOTE 5 – EARNINGS PER SHARE

The Company calculates earnings per share in accordance with ASC 260, Earnings Per Share, which requires a dual presentation of basic and diluted earnings per share. Basic earnings per share are computed using the weighted average number of shares outstanding during the fiscal year. Potentially dilutive common shares consist of convertible preferred stock (using the if-converted method) and exercisable warrants and stock options outstanding (using the treasury method).  The following table sets forth the computation of basic and diluted net income per common share:

The following table sets forth the computation of basic and diluted net income per common share:

	(Unaudited)
	Three Months Ended March 31,
	2011		2010
Net income	$	2,587,128	$	11,882,851
Weighted-average shares of common stock outstanding
Basic		29,768,444		29,558,976
Dilutive shares:
Conversion of Series A Convertible Preferred Stock		7,270,695		7,465,353
Dilutive effect of stock warrants and options		-		3,332,075
Diluted		37,039,139		40,356,404
Basic earnings per share	$	0.09	$	0.40
Diluted earnings per share	$	0.07	$	0.29

The 11,768,860 shares of stock warrants and 2,033,000 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 ended March 31, 2011 were lower than the options and warrants exercise price.

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NOTE 6 – STOCK WARRANTS

Series A and Series B Stock Warrants

As a result of a completed sale of 9,117,647 units for cash proceeds of $15,500,000 on March 28, 2008, the Company issued Series A stock warrants of 5,822,655 and Series B stock warrants of 5,800,911 which can be converted 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 $3.40 per share and the Series B are exercisable at an equivalent price of $4.25 per share.  These stock warrants will expire on March 28, 2013 pursuant to the warrant agreements.

The Company used the Black-Scholes option pricing model to determine the fair value of the Series A and B stock warrants on March 28, 2008 (assumptions used – expected life of 5 years, volatility of 89%, risk free interest rate of 2.51%, and expected dividend yield of 0%).

Effective January 1, 2009, the Company adopted the provisions of FASB ASC Topic 815, “Derivatives and Hedging” (“ASC 815”) (previously EITF 07-5, “Determining Whether an Instrument (or an Embedded Feature) is Indexed to an Entity’s Own Stock”). As a result of adopting ASC 815, warrants to purchase 11,623,566 of the Company’s common stock previously treated as equity pursuant to the derivative treatment exemption were no longer afforded equity treatment as there was a down-round protection (full-ratchet down round protection).   As a result, the warrants were not considered indexed to the Company’s own stock, and as such, all future changes in the fair value of these warrants were recognized in earnings until such time as the warrants are exercised or expire.  The Company reclassified the fair value of these warrants from equity to liability, as if these warrants were treated as a derivative liability. On January 1, 2009, the Company recorded as a cumulative effect adjustment of decreasing additional paid-in capital of $6,020,000 and beginning retained earnings of $2,792,017 and $8,812,017 to warrant liabilities to recognize the fair value of such warrants. The fair value of the warrants was $44,304,034 on December 31, 2009. The Company recognized $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 200,000 shares of the Company’s common stock at an exercise price of $5.00 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 in the first quarter of 2010.

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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, 2010		11,768,860	$	3.84		2.27
Exercised		-		-		-
Cancelled		-		-		-
Balance – March 31, 2011		11,768,860	$	3.84		2.02

NOTE 7 – SHARED BASED COMPENSATION

Under the 2009 Omnibus Securities and Incentive Plan, on September 14, 2009, the Company entered into stock option agreements with its three independent directors, granting each director options to purchase 20,000 shares of the Company’s common stock at an exercise price of $8.00 per share.  The options vest in approximately equal amounts on the three subsequent anniversary dates of the grant and expire on the fifth anniversary of the date of agreement of or the date the option is fully exercised. On January 30, 2010, the Company entered into amendment agreements with its three directors to correct the exercise price to $7.50, which was the fair market value on the date of the grant. The correction of this error was considered immaterial.

Under the 2009 Omnibus Securities and Incentive Plan, on June 26, 2010, the Company granted the its Chief Operating Officer, Alan Stewart and 20 employees options to acquire 2,070,000 shares of the Company's common stock at an exercise price of $4.40 per share.  The options vest in approximately equal amounts on the four subsequent anniversary dates of the grant and expire on the eighth anniversary of the date of agreement of or the date the option is fully exercised.

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 100,000 shares of the Company's common stock at an exercise price of $3.42 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		-			-			-

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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 $216,158 for the three months ended March 31, 2011. 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, 2010		2,033,000	$	4.44		3.45	$	13,000
Granted		-		-		-		-
Exercised		-		-		-		-
Forfeited		-	$	-		-		-
		-		-		-		-
Outstanding– March 31, 2011		2,033,000	$	4.44		3.27	$	-
Exercisable - March 31, 2011		414,601	$	4.35		3.27	$	-

As of March 31, 2011, there was $2,723,280 of total unrecognized compensation cost related to non-vested share option awards granted.  Such cost is expected to be recognized over a weighted-average period of 3-4 years.

NOTE 8 - 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)
	Three Months Ended March 31
	2011			2010
Rent expense	$	2,202,850		$	700,737
Less: Sublease income		(600,064	)		(247,921	)
Total rent expense, net	$	1,602,786		$	452,816

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Annual minimum payments under operating leases are as follows:

As of March 31,	Minimum Lease Payment		Sublease Income		Net Minimum Lease Payment
2012	$	8,688,161	$	399,410	$	8,288,751
2013		8,665,145		102,176		8,562,969
2014		8,468,845		19,279		8,449,566
2015		8,399,782		-		8,399,782
2016		8,326,633		-		8,326,633
Thereafter		80,776,610		-		80,776,610
Total	$	123,325,176	$	520,865	$	122,804,311

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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, 2010.

Overview

We are a regional supermarket chain that currently operates 33 supermarkets, 13 hypermarkets and 3 department stores in northeastern China and Inner Mongolia. The Company’s supermarkets and hypermarkets sell a broad selection of merchandise including groceries, fresh food and non-food items. A supermarket offers various daily necessities on a self-service basis and averages 2,500 square meters in sales area. A hypermarket is similar to a supermarket but has a larger operating scale, and is typically over 4,500 square meters in sales area. 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, 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.

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
	six new stores in the first quarter of 2011 that have in the aggregate approximately 35,000 square meters of space

We opened 6 new stores in the first three months of 2011 that have, in the aggregate, approximately 35,000 square meters of space. In the next 3 quarters of 2011, we plan to open 6 additional hypermarkets, supermarkets and department stores having, in the aggregate, approximately 35,000 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.

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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 buying card sales.

Expanded Operations

As of March 31, 2011, we operated 33 supermarkets, 13 hypermarkets, 3 department stores, and 2 distribution centers, one in Daqing and one in Harbin. Under our expansion plan, we opened 6 new stores in the first quarter of 2011 that have, in the aggregate, approximately 35,000 square meters of space.  In 2011, we plan to open 12 hypermarkets, supermarkets and department stores having, in the aggregate, approximately 70,000 square meters of retail space. Most of the stores will be opened 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 and bank loans. Based on our previous experience, we believe it takes six to nine 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 manufacturers cannot sell the product to any other party. Sales of private label merchandise accounted for approximately 5.5% and 5% of our total revenues for the three months ended March 31, 2011 and 2010, respectively. 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).

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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. To alleviate this, we plan to expand our distribution capabilities by opening a new distribution center in Harbin in the 2nd quarter of 2010. 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.

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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, 2010, 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 March 31, 2011.

Recently Issued Accounting Guidance

See Note 2 to condensed consolidated financial statements included in Item 1, Financial Information, of this Quarterly Report on Form 10-Q.

Results of Operations

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
	March 31, 2011					March 31, 2010
	Amount		% of Net Sales			Amount		% of Net Sales
Net sales	$	101,311,096		100.0	%	$	81,606,113		100.0	%
Cost of sales		83,215,616		82.1			67,079,999		82.2
Gross profit		18,095,480		17.9			14,526,114		17.8
Selling expenses		12,537,203		12.4			6,866,038		8.4
General and administrative expenses		2,203,617		2.2			2,167,258		2.7
Operating income		3,354,660		3.3			5,492,818		6.7
Changes in fair value of warrants		-		-			7,801,649		9.6
Interest income		289,622		0.3			146,938		0.2
Interest expense		(31,100)		-			-		-
Income before income taxes		3,613,182		3.6			13,441,405		16.5
Income taxes		1,026,054		1.0			1,558,554		1.9
Net income	$	2,587,128		2.6	%	$	11,882,851		14.6	%

Net Sales – Net sales increased by $ 19.7 million, or 24.1%, to $101.3 million for the three months ended March 31, 2011 from $81.6 million for the three months ended March 31, 2010. 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, 2010. Same store (34 stores) sales generated approximately $84.1 million sales in the first quarter of 2011, an increase of $6.6 million, or 8.5% compared with $77.5 million net sales in the first quarter of 2010.

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 New store sales increased, reflecting the opening of 15 new stores since January 1, 2010. These 15 stores generated approximately $17.2 million sales in the first quarter of 2011, and 2 stores opened in the first quarter of 2010 generated $0.3 million during the same period.

 The number of stores including supermarkets/hypermarkets and department stores at March 31, 2011 was 49 versus 38 at March 31, 2010.

Cost of Sales – Our cost of sales for the three months ended March 31, 2011 was approximately $83.2 million, representing an increase of $16.1 million, or 24.1%, from approximately $67.1 million for the same period in 2010. 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 $3.6 million, or 24.6%, to $18.1 million, or 17.9% of net sales, in the first quarter of 2010 from $14.5 million, or 17.8% of net sales, in the first quarter of 2010. The change in gross profit was primarily attributable to net sales increased by $19.7 million in the first quarter of 2011 compared to the first quarter of 2010.

Selling Expenses –Selling expenses increased by $5.6 million, or 82.6%, to $12.5 million, or 12.4% of net sales, in the first quarter of 2011 from $6.9 million, or 8.4% of net sales, in the first quarter of 2010. The change in selling expense was mainly due to increase in labor costs due to increase in the number of store employees and pay rise, depreciation, rent expense, and utilities and other operating costs in the three months ended March 31, 2011 compared to same period in 2010 primarily due to support of an increase in store count. In specific, labor costs increased by $1.8 million or 80.0%, to $4.0 million in the first three months of 2011 from $2.2 million in the first three months of 2010. Depreciation increased by $0.3 million, or 34.1%, to $1.2 million in the first three months of 2011 from $0.9 million in the first three months of 2010. Rent expenses increased by $0.3 million, or 63.2%, to $0.8 million in the first three months of 2011 from 0.5 million in the first three months of 2010. Utilities increased by $0.6 million, or 60.6%, to $1.6 million in the first three months of 2011 from $1.0 million in the first three months of 2010. Preliminary expenses related to new stores increased by $2.0 million to $2.2 million in the first three months of 2011 from $0.2 million in the first three months of 2010.

General and Administrative Expense –General and administrative expenses increased by $0.03 million, or 1.7%, to $2.20 million, or 2.2% of net sales, in the first three months of 2011 from $2.17 million, or 2.7% of net sales, in the first three months of 2010. There was no significant change in our general and administrative expenses.

Changes in fair value of warrants – In the first quarter 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.

Income Taxes –The provision for income taxes was $1.0 million for first quarter of 2011 compared with $1.6 million for first quarter of 2010. Excluding the effect of changes in fair value of warrants, our effective tax rate was 28.4% and 27.6% for first three months of 2011 and 2010.  This increase was primarily due to higher non-deductible expenses relating to option expenese and overseas expenditure such as legal fees and listing related fees in the three months ended March 31, 2011 compared to same period during 2010.

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Net Income – For the three months ended March 31, 2011, net income was approximately $2.6 million, compared with $11.9 million for the three months ended March 31, 2010.   Excluding changes in the fair value of warrants for the 2010 first quarter period, adjusted net income for the first quarter of 2011, decreased 35.9% to $2.6 million, or $0.07 per diluted share, from $4.1 million, or $0.10 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) decreased 8.2% to 37.0 million shares from 40.4 million shares for the same period during 2010. This decrease was due to higher selling expenses related to new stores opening and higher staff costs in the first quarter of 2011.

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 March 31, 2011 we had $41.1 million of cash compared to $46.5 million at March 31, 2010. The following table sets forth a summary of our cash flows for the periods indicated:

	(Unaudited)
	Three Months Ended March 31,
	2011			2010
Net cash provided by operating activities	$	25,543,774		$	1,468,796
Net cash used in investing activities		(1,921,206	)		(853,272	)
Net cash provided by financing activities		-			-
Effect of foreign currency translation		14,422			800
Net increase in cash	$	23,636,990		$	616,324

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 three month ended March 31, 2011 and 2010 was $25.5 million and $1.5 million, respectively. The increase in cash provided by operating activities for the three months ended March 31, 2011 compared to the same period in 2010 primarily reflects net cash inflow caused by the decrease of inventories, decrease of other receivables and decrease of advances to suppliers. The decrease of inventories was caused by reducing the inventory on hand after the peak Chinese New Year season. The decrease of other receivables is largely attributable to the repayment of money from vendors. The decrease of advances to suppliers is due to the decrease of advance payment of shop equipment and leasehold improvements for new stores opening.

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Investing Activities – Net cash used in investing activities for the first quarter of 2011 and 2010 was $1.9 million and $0.9 million, respectively. Capital expenditures represented substantially all of the net cash used in investing activities for each period. Capital expenditures were higher in the first quarter of 2011 due to substantially more new store openings. Our capital spending is primarily for new store openings, store-related remodeling and distribution center and corporate headquarters.

Financing Activities – Net cash used for financing activities for the first quarter of 2011 and 2010 was nil, respectively. Cash provided by financing activities was used to open new stores, and a distribution center, store renovations and relocations.

Financing Agreement – On June 18, 2009, we entered into a financing agreement with Longjiang Commercial Bank. Under this agreement, the Company had a credit line up to approximately $4.2 million (RMB27.6 million) expiring June 18, 2011. The loan under this financing agreement is secured by buildings with net worth book value of approximately $7.4 million (RMB 48.7 million).  As of March 31, 2011, we did not have any outstanding revolving line of credit.

Future Capital Requirements – We had cash on hand of $41.1 million as of March 31, 2011. We expect capital expenditures for the remainder of 2011 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 12 new stores with an aggregate of 70,000 square meters of space in 2011.

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 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”). 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.

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Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1).

Item 4T.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures –We conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a15(e) and 15d15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report. Based on such evaluation, our CEO and CFO have concluded that, as of the end of such period, our disclosure controls and procedures are not effective, at a reasonable assurance level, in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are not effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. The conclusion that our internal control over financial reporting was not effective was based on material weaknesses we identified in relation to our financial closing process.

Remediation Measures for Material Weaknesses – We have begun to take steps to remediate the material weaknesses described above in “Evaluation of Disclosure Controls and Procedures” and plan to implement the new measures described below in our ongoing efforts to address the internal control deficiencies described above. We plan to further develop policies and procedures governing the hiring and training of personnel to better ensure sufficient personnel with the requisite knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting and U.S. GAAP requirements. We plan to utilize qualified internal control consultants and supervisors to ensure that our staff has adequate professional knowledge and to monitor the need for additional or better qualified staff. In addition, we plan to utilize appropriate training programs on accounting principles and procedures to better ensure the adequacy of our accounting and finance personnel. We plan to continue to develop our corporate culture toward emphasizing the importance of internal controls and to ensure that all personnel involved in maintaining proper internal controls recognize the importance of strictly adhering to accounting principles accepted in the United States of America. We plan to continue to provide additional training to the Company’s internal auditor on appropriate controls and procedures necessary to document and evaluate our internal control procedures.

Changes in Internal Control over Financial Reporting – During the fiscal quarter ended March 31, 2011, no changes occurred with respect to our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

None.

ITEM 1A.  RISK FACTORS

As a smaller reporting company, the Company is not required to make disclosures under this Item 1A.

ITEM 2:  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.  RESERVED AND REMOVED

None.

ITEM 5.  OTHER INFORMATION

None.

ITEM 6:  EXHIBITS

(a) Exhibits

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

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

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

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	QKL STORES INC.
Dated: May 16, 2011	By:	/s/ Zhuangyi Wang
		Zhuangyi Wang
		Chief Executive Officer
		(Principal Executive Officer)
	By:	/s/ Tsz-Kit Chan
		Tsz-Kit Chan
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

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EX-31.1

Certification of Chief Executive Officer

Pursuant to Rule 13A-14(A)/15D-14(A)

of the Securities Exchange Act of 1934

I, Zhuangyi Wang, Chief Executive Officer (Principal Executive Officer), certify that:

1.  I have reviewed this Quarterly Report on Form 10-Q for the period ended March 31, 2011 of QKL Stores Inc.;

2.  Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.  Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.  The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. evaluated the effectiveness of registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.  The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Dated: May 16, 2011	By:	/s/ Zhuangyi Wang
		Zhuangyi Wang
		Chief Executive Officer

EX-31.2

Certification of Chief Financial Officer

Pursuant to Rule 13A-14(A)/15D-14(A)

of the Securities Exchange Act of 1934

I, Tsz-Kit Chan, Chief Financial Officer (Principal Financial and Accounting Officer), certify that:

1.  I have reviewed this Quarterly Report on Form 10-Q for the period ended March 31, 2011 of QKL Stores Inc.;

2.  Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.  Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.  The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. evaluated the effectiveness of registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.  The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Dated: May 16, 2011	By:	/s/ Tsz-Kit Chan
		Tsz-Kit Chan
		Chief Financial Officer (Principal Financial and Accounting Officer)

EX-32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350 AND EXCHANGE ACT RULES 13a-14(b) AND 15d-14(b)

(Section 906 of the Sarbanes-Oxley Act of 2002)

In connection with the Quarterly Report of QKL Stores Inc. on Form 10-Q for the period ended March 31, 2011, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of the operations of the Company.

Dated: May 16, 2011	By:	/s/ Zhuangyi Wang
		Zhuangyi Wang
		Chief Executive Officer

Dated: May 16, 2011	By:	/s/ Tsz-Kit Chan
		Tsz-Kit Chan
		Chief Financial Officer