China Sky third quarter total revenue decreases 16.3% to $36.2 million

Nov 8 2010

China Sky One Medical, Inc. ("China Sky One" or "the Company") (Nasdaq: CSKI), a leading fully integrated pharmaceutical company producing over-the-counter drugs in the People's Republic of China ("PRC"), today announced financial results for the third quarter of 2010.

Third Quarter 2010 Financial Highlights

• Total revenues decreased 16.3% year-over-year to $36.2 million
• The Company marketed 115 products, compared with 89 products in the quarter ended September 30, 2009
• Gross profit fell 18.4% to $26.4 million
• Operating income declined 41.0% to $9.5 million
• GAAP net income, including a non-cash gain from change in the fair value of derivative warrant liability, decreased 31.7% year-over-year to $8.6 million, or $0.51 per diluted share
• Excluding the non-cash gain, non-GAAP adjusted net income declined 45.7% to $6.8 million, or $0.40 per diluted share

"Our third quarter revenue declined by 16% year-over-year, reflecting one of the more challenging periods in China Sky One's history. As previously announced, two distributor relationships were discontinued during the quarter, negatively impacting our top-line performance, and higher raw material pricing for our TCM portfolio reduced overall gross margin. To address these external issues, during the quarter we stepped up our efforts to establish relationships with new distributors and have been evaluating ways to minimize our exposure to raw material price fluctuations," said Mr. Yan-Qing Liu, Chairman and CEO of China One Medical, Inc. "Despite this quarter's challenges, we intend to reestablish robust revenue and earnings growth at China Sky One Medical by continuing to invest in R&D, building new distributor relationships and identifying uses for our extremely strong balance sheet and cash flow."

Third Quarter 2010 Results

In the third quarter of 2010, China Sky One's total revenues decreased 16.3% to $36.2 million from $43.2 million in the same quarter last year, largely reflecting the impact of terminated business relationships with Harbin Shiji Baolong, a domestic distributor, and Hangzhou Jiupin, an overseas sales agent, during the third quarter of 2010, which negatively impacted the sales of the Company's Patches, Ointments, Sprays and Diagnostic Kits categories. These two distributors accounted for 0% and 22% of the Company's overall revenue in the third quarter of 2010 and third quarter of 2009, respectively.

By product category, lower sales from Patches, Sprays and Diagnostic Kits contributed to the Company's overall year-over-year revenue decline, offset somewhat by top-line growth in the Ointments, Drops and Others categories.  

Sales of patch products declined 44.6% year-over-year to $6.5 million in the third quarter of 2010. Slim Patch sales fell 48.2% to $3.8 million, as compared to $7.3 million in the comparable period of 2009, due to weaker domestic sales after Chinese government restrictions on television advertising for weight loss products and due to weaker overseas sales by the agent who terminated its business relationship. Excluding the Slim Patch, sales of other patch products, including Pain Relief Patch, Asthma Patch and Hypertension Patch, declined 38.7% to $2.8 million in the third quarter of 2010, as compared to $4.5 million in the year ago quarter. Sales of Pain Relief Patch products decreased by $1.4 million, or 70.5%, compared to third quarter 2009, primarily due to the terminated business relationship with the domestic distributor.  

Sales of spray products decreased by $3.1 million, or 46.2%, to $3.6 million in the third quarter of 2010, primarily due to decreased sales of Stomatitis Spray, FuShuang Spray, JiaoShuang Spray, and JieYin Spray after the termination of certain domestic distributor relationships.

Revenue generated from Diagnostic Kits decreased by $2.0 million, or 74.8%, to $0.7 million in the third quarter of 2010, primarily due to lower revenues from Cardiac Arrest Early Examination Kit, which had been promoted by a distributor that ended its relationship with the Company. Excluding sales of Cardiac Arrest Examination Kit, core Diagnostic Kits sales were roughly flat at $0.5 million.  

Revenues from the Ointments category grew by 7.2% year-over-year to $11.6 million in third quarter 2010, primarily reflecting $0.7 million of incremental revenue from 7 new Ointment products launched after third quarter 2009 and $0.7 million of higher sales from the Compound Camphor Cream.  

Revenue from the Company's Drops products increased by $0.8 million, or 26.1%, to $3.9 million, primarily due to $0.5 million of incremental revenue from 6 new Drops products that were introduced after the third quarter of 2009.

Sales of Other Products grew 21.2% year-over-year this quarter to $9.9 million. Higher revenues from Other Products were mainly driven by $0.4 million of higher sales of Metronidazole and Chlorhexidine Washing Fluid and $1.5 million of incremental sales from 14 new products introduced after third quarter 2009. The revenue generated from the Metronidazole and Chlorhexidine Washing Fluid increased by $425,000, compared to the same period of 2009, primarily due to a new distributor from the second quarter of 2010.  

Gross profit declined 18.4% to $26.4 million in the third quarter of 2010. Gross margin in the quarter was 72.9%, as compared to 74.8% in the 2009 quarter. Regional flooding and droughts in 2010 have led to higher pricing of herbal raw materials, including Honey Suckle Flower and Notoginseng, used by the Company to produce traditional Chinese medicine (TCM) products.    

Operating expenses increased 3.9% year-over-year to $16.9 million in the third quarter of 2010. The increase was principally due to $0.7 million higher R&D expenses and $0.4 million higher depreciation and amortization expenses associated with two proprietary technologies acquired in the fourth quarter of 2009. Third quarter 2010 operating income was $9.5 million, representing an operating margin of 26.1%, as compared to $16.0 million and 37.1% in the same period a year ago.

Total other income was $1.9 million in the third quarter of 2010, as compared to $0.2 million in the prior year quarter. The increase reflected a non-cash gain related to the change in the fair value of our derivative warrant liability related to the private placement in January 2008.

Provision for income taxes was $2.7 million in the third quarter of 2010, as compared to $3.6 million in the same period last year.  

GAAP net income for the third quarter of 2010 was $8.6 million, as compared to $12.6 million in the third quarter of 2009. Excluding the non-cash $1.8 million gain related to the change in fair value of derivative warrant liability, the Company's non-GAAP adjusted net income declined 45.7% to $6.8 million, or $0.40 per diluted share, as compared to $12.5 million, or $0.74 per diluted share, in the prior year period.

Financial Condition

As of September 30, 2010, China Sky One had $72.0 million in cash and equivalents, with a current ratio of 8.8. Working capital was approximately $88.0 million, up from $56.9 million at December 31, 2009. Stockholders' equity at September 30, 2010, was $158.4 million, 31.0% higher than the $120.9 million recorded at December 31, 2009.

Accounts receivable turnover days increased to 55.7 for the nine months ended September 30, 2010, as compared to 45.2 days in the same period of 2009. Inventory turnover days increased to 35.7 for the nine months of 2010 from 17.3 days in the year ago quarter. This increase primarily reflected management's decision to increase the inventory levels toward the second half of 2009 due to the forecast of certain cost increases of raw materials in 2010.

The Company generated $25.6 million in net cash flow from operating activities in the first nine months of 2010, compared to $25.9 million in the year ago comparable period. Management believes current working capital and borrowing capabilities are sufficient to cover their operating and capital requirements in the near future.

Business Outlook

The Company reiterates guidance for 2010 of revenue from $128 million to $136 million and adjusted net income, excluding the impact of the derivative warrant liability, from $26 million to $31 million.  The Company currently is in the process of evaluating its outlook for 2011 and will provide guidance for next year once its forecast has been finalized.

"We believe that our strong and efficient sales network, combined with new relationships with national and provincial distributors, provides a solid base from which we can rekindle growth heading into 2011. Furthermore, our healthy cash position provides us with flexibility to pursue value creating acquisitions and to enter into beneficial strategic relationships. We are very excited about our recently announced joint application with Heilongjiang Traditional Chinese Medical University ("HTCMU") for production licenses of 15 new medical products.  We look forward to revenue and earnings contribution in 2011 from these products as well as from another 3 to 5 products that we hope will obtain SFDA approval by the end of 2010.  We will continue our efforts in research and development of high margin branded products, while focusing on increasing sales and promotion of our current products, including our promising portfolio of diagnostic kits," concluded Mr. Liu.