China Nepstar Chain Drugstore third quarter revenue increases 7.3% to RMB597 million

Nov 17 2010

China Nepstar Chain Drugstore Ltd. (NYSE: NPD) ("Nepstar" or "the Company"), the largest retail drugstore chain in China based on the number of directly operated stores, today announced its unaudited financial results for the quarter ended September 30, 2010.

Financial Highlights for the Quarter Ended September 30, 2010:

• Revenue was RMB597 million (US$89 million), reflecting a 7.3% increase compared to revenue of RMB556 million in the third quarter of 2009
• Gross margin was 49.8%, compared to 49.6% in the third quarter of 2009
• Income from operation was RMB14 million (US$2 million), compared to a loss of RMB13 million in the second quarter of 2010 and a loss of RMB4 million in the first quarter of 2010
• Net cash flow from operations was RMB38 million (US$6 million)

Mr. Jason Wu, Acting Chief Executive Officer of Nepstar, commented, "We are encouraged by the improvement in same store sales growth over the course of the third quarter, as we continue our transformation into a hybrid of pharmacy and convenience store. We believe this shift in strategy will be key to offsetting pressure on pharmacy revenues due to ongoing government reform initiatives and the imposition of price caps on drug manufacturers and retailers. This product driven strategy is also expected to compensate for increases in labor and rental costs across the regions in which we operate. Since the beginning of the year 2010, we have added nearly 370 new SKUs (Stock Keeping Unit) and these newly introduced high turnover convenience products accounted for approximately 10% of the revenue we generated for the nine-month period ended September 30, 2010. We are focused on optimizing our product mix to drive new customer acquisition, increasing sales among our existing loyal customer base, and maximizing operating efficiencies."

Third Quarter Results and Operating Highlights

During the third quarter of 2010, the Company opened 32 new stores and closed 37 stores.  As of September 30, 2010, Nepstar had a total of 2,577 stores in operation.

Revenue for the quarter ended September 30, 2010 increased 7.3% to RMB597 million (US$89 million), compared to revenue of RMB556 million for the same period in 2009. The increased sales of newly introduced high turnover convenience products offset the negative impact from Chinese government's price control policy on prescription and over-the-counter ("OTC") drug sales.

Third quarter revenue contribution from prescription drugs was 21.6%, OTC drugs was 35.5%, nutritional supplements was 20.1%, traditional Chinese herbal products was 3.2% and other products was 19.6%. Since the beginning of the year, the Company has added nearly 370 new SKUs and these newly introduced high turnover convenience products accounted for approximately 10% of the revenue we generated for the nine-month period ended September 30, 2010.

Same store sales (for 2,139 stores opened before December 31, 2008) for the third quarter of 2010 increased by 1.6% compared to the same period in 2009. Monthly same store sales growth year over year for July, August and September was 0.8%, 1.3% and 2.8%, respectively. These increases were mainly attributable to effective marketing campaigns and the introduction of high turnover convenience merchandise. Cash receipts from Nepstar Shopper's Card, a prepaid card introduced in the second quarter of 2010, reached RMB56 million in the third quarter, compared to RMB14 million in the second quarter. The unutilized balance of these prepaid cards was approximately RMB 24 million by end of the third quarter.

Nepstar's portfolio of private label products included 1,709 products as of September 30, 2010. Sales of private label products represented approximately 31.4% of revenue and 42.5% of gross profit for the third quarter of 2010.

Third quarter gross profit was RMB297 million (US$44 million), compared to RMB276 million in the same period of 2009. Gross margin in the third quarter of 2010 was 49.8%, compared to 49.6% in the same period of 2009 and 50.1% in the second quarter of 2010. The gross margin decline from the second quarter to the third quarter of 2010 was mainly due to the introduction of a large number of high turnover convenience products with competitive prices in September 2010. However, due to the Company's active efforts to promote private label products and selected high turnover convenience products, private label products' contribution in the convenience category also reached 30.5%, which effectively helps maintain the convenience category at a reasonable gross margin level.

Sales, marketing and other operating expenses as a percentage of revenue in the third quarter of 2010 increased to 41.9%, compared to 38.4% in the same period of 2009. This increase was primarily due to the higher labor cost associated with the upward minimum wage adjustments in literally all of the regions in which Nepstar operates. Increased rental expenses and logistics cost associated with the shift in the Company's product mix to high turnover convenience products also contributed to higher operating expenses.

General and administrative expenses as a percentage of revenue in the third quarter of 2010 were 5.5%, compared to 5.1% in the same period of 2009.

Primarily as a result of the factors discussed above, income from operation in the third quarter of 2010 was RMB14 million (US$2 million), compared to RMB34 million in the same period of 2009 and loss from operation of RMB13 million with a one-time non-recurring penalty in the second quarter of 2010. Operating margin was 2.4% in this quarter, compared to 6.1% in the same quarter of 2009.

Interest income for the third quarter of 2010 was RMB5.5 million (US$8 million), compared to RMB17 million in the same period of 2009. Equity in income of an equity method investee was RMB2 million (US$0.3 million), compared to that of RMB0.8 million in the same quarter of 2009. The decrease in interest income was mainly due to (i) the maturity of all held-to-maturity investment securities which earned higher interest income (ii) a general decrease of interest rates for short-term bank deposits; and (iii) lower cash balances as a result of the dividend payments in 2009 and 2010.

Nepstar's effective tax rate was 53.2% for the third quarter, compared to 28.4% for the same period in 2009. The increase in effective tax rate was primarily due to the varying profitability among subsidiary companies for the third quarter of 2010, an increase in the deferred tax asset valuation allowance for tax loss carry forwards, and an increase in transitional tax rate from 20% in 2009 to 22% in 2010 for subsidiaries in Shenzhen.

Net income in the third quarter of 2010 was RMB10 million (US$1.6 million), which represented RMB0.10 (US$0.01) basic earnings per American depositary share ("ADS"), and RMB0.10 (US$0.01) diluted earnings per ADS. This compares to net income of RMB37 million, which represented RMB0.36 basic earnings per ADS and RMB0.35 diluted earnings per ADS in the same period of 2009. The total number of outstanding ordinary shares of the Company as of September 30, 2010 was 207 million. The weighted average number of ordinary shares in the third quarter of 2010 was 211 million. Each ADS represents two ordinary shares of the Company.

On August 13, 2010, the Company announced a share repurchase program of up to US$20 million over 12 months. The repurchases shall be made on the open market at prevailing market prices or in block trades and subject to restrictions relating to volume, price and timing under the applicable laws, including Rule 10b-18 under the U.S. Securities Exchange Act of 1934, as amended. By the end of third quarter of 2010, approximately 1.9 million shares of ADS have been repurchased at an average price of USD2.8 per ADS.

As of September 30, 2010, Nepstar's total cash, cash equivalents and current bank deposits were RMB1,147 million (US$171 million) and its shareholders' equity was RMB1,551 million (US$232 million).

In the third quarter of 2010, net cash flow from operations was RMB38 million (US$6 million).

Business Outlook

"We remain cautiously optimistic as we continue to implement our strategic transition," commented Mr. Wu. "As we expand our product range by adding more high turnover convenience products, we are also upgrading logistics support, improving store space management and adopting a more proactive marketing approach to attract new customers. In Northern China, we have seen improvement in same store sales, but need to enhance margins. In Southern China, sales and margins are both experiencing steady growth. In Eastern and Central China, we achieved solid margin expansion, but still need to improve same store sales. We believe that the entire transformation process will continue to involve tremendous planning, testing and execution in the near term, but will be rewarding in the long run. We continue to leverage our established store footprint, proven central procurement program, and advanced IT systems to execute our strategy. We believe that the strong foundation we have built over the past decade will make our transition successful."