China Nepstar Chain Drugstore third quarter revenue increases 1.9% to RMB608.6 million

Nov 28 2011

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 third quarter ended September 30, 2011.

Financial Highlights

For the quarter ended September 30, 2011:

• Revenue increased 1.9% to RMB608.6 million (US$95.4 million), compared to revenue of RMB597.0 million in the third quarter of 2010
• Gross margin was 47.5%, compared to 49.8% in the third quarter of 2010
• Same store sales increased by 6.5% over the prior year's period
• Net income was RMB1.2 million (US$0.2 million), compared to RMB10.4 million in the third quarter of 2010
• Net cash flow from operations was RMB34.1 million (US$5.4 million), compared to RMB 38.4 million in the third quarter of 2010

Mr. Fuxiang Zhang, Chief Executive Officer of Nepstar, commented, "Our strategy of positioning Nepstar as a neighborhood store for one-stop pharmacy and convenience shopping is executed in the midst of highly publicized Chinese healthcare reform, which presents new dynamics of both challenges and opportunities. On the one hand, our gross margin has been facing significant downward pressure due to the price cap policies covering increasing number of pharmaceuticals in the market. On the other hand, we observe that the reform is also exerting pressure on pharmaceutical manufacturers. We see this as an opportunity to reinforce our pharmacy business, as we believe more pharmaceutical manufacturers are looking to retail channels to leverage their production capacity.

"At Nepstar, we continue to work on introducing new products in both pharmaceutical and non-pharmaceutical categories, streamlining our operations and growing same store sales to stand the headwind of the general operational environment. During the quarter, we have established a stringent model to track and evaluate store productivity. While we have increased same store sales, we also scaled back non-performing stores, as operating costs have been steadily rising."

Third Quarter Results

During the third quarter of 2011, the Company opened 10 new stores and closed 63 stores. As of September 30, 2011, Nepstar had a total of 2,458 stores in operation.

Revenue for the quarter increased 1.9% to RMB608.6 million (US$95.4 million), compared to revenue of RMB597.0 million for the same period in 2010. Increased sales of newly introduced convenience products continued to offset the negative impact on drug sales from ongoing healthcare reform that has led to price cuts and the diversion of patients from drugstores.

Third quarter revenue contribution from prescription drugs was 20.7%, OTC drugs was 34.9%, nutritional supplements was 18.2%, traditional Chinese herbal products was 3.9% and convenience and other products was 22.3%. During the third quarter of 2011, the Company introduced 45 new stock keeping units (SKUs) within the convenience products category.

Same store sales (for 2,179 stores opened before December 31, 2009) for the third quarter of 2011 increased by 6.5% compared to the same period in 2010. This growth was mainly attributable to increased sales of convenience products and other new non-pharmaceutical products introduced since the second half of 2010.

Nepstar's portfolio of private label products included 1,856 products as of September 30, 2011. Sales of private label products represented approximately 30.9% of revenue and 43.2% of gross profit for the third quarter of 2011.

Third quarter gross profit was RMB289.3 million (US$45.4 million), compared to RMB297.4 million in the same period of 2010. Gross profit margin in the third quarter of 2011 was 47.5%, compared to 49.8% in the same period of 2010 and 47.8% in the second quarter of 2011. The decline in gross profit margin was mainly due to price reductions on essential drugs and changes in revenue mix as the Company introduced more convenience products with lower gross profit margin. The Company continued to make efforts to provide quality private label products at reasonable prices in convenience products category. In the third quarter, private label products' contribution to the convenience products category reached 28.0%, which helped maintain a reasonably favorable gross profit margin level on sales of convenience products.

Sales, marketing and other operating expenses as a percentage of revenue in the third quarter of 2011 increased to 42.6% compared to 41.9% in the same period of 2010. The increase was primarily due to higher rental and labor costs owing to a general inflationary economic environment.

General and administrative expenses as a percentage of revenue in the third quarter of 2011 were 4.2%, compared to 5.5% in the same period of 2010. The lower G&A expenses were mainly due to rigorous cost control measures and reduced share based expenditures, etc.

As a result of the factors discussed above, income from operations in the third quarter of 2011 was RMB3.0 million (US$0.5 million), compared to RMB14.5 million in the same period of 2010.

Interest income for the third quarter of 2011 was RMB6.1 million (US$1.0 million), compared to RMB5.5 million in the same period of 2010. The increase in interest income was mainly due to an increase in interest rates by the Chinese government. Dividend income from cost method investments was RMB0.7 million (US$0.1 million) for the third quarter of 2011, compared to zero in the same quarter of 2010. Equity income of an equity method investee was a loss of RMB0.6 million (US$0.1 million), compared to a gain of RMB2.3 million in the same quarter of 2010.

Nepstar's effective tax rate was 87.0% for the third quarter of 2011, compared to 53.2% for the same period in 2010. Other than the impact from non-deductible expenses, the high effective tax rate in the third quarter of 2011 was partially due to the valuation allowance made on deferred tax assets arising from the tax loss carryforwards of the loss-making subsidiaries. It is also due to the decreased profitability of the profitable subsidiaries, which resulted in lower consolidated income before income tax.

Net income for the third quarter of 2011 was RMB1.2 million (US$0.2 million), which represented RMB0.01 (US$0.002) basic and diluted earnings per American Depositary Share ("ADS"). This compares to a net income of RMB10.4 million, which represented RMB0.10 basic and diluted earnings per ADS in the same period of 2010. The total number of outstanding ordinary shares of the Company as of September 30, 2011 was 204.4 million. The weighted average number of ordinary shares in the third quarter of 2011 was 206.1 million. Each ADS represents two ordinary shares of the Company.

As of September 30, 2011, Nepstar's total cash, cash equivalents and bank deposits were RMB975.6 million (US$153.0 million) and its shareholders' equity was RMB1.35 billion (US$211.6million).

In the third quarter of 2011, net cash flow from operations was RMB34.1 million (US$5.4 million).

Business Outlook

"We are committed to further broadening our product mix in both pharmaceutical and non-pharmaceutical categories as we are encouraged by the same store sales growth contributed by new products we added since the second half of last year. The ongoing healthcare reform brought new dynamics to our strategy. We look forward to taking advantage of the policy-driven pricing pressure to drug manufacturers and increasing our own prescription and OTC drugs coverage. In the fourth quarter, we are also reinforcing training to our floor staff to improve store productivity. Overall, we remain confident in the long-term prospects of the Company and the consumer healthcare market in China," Mr. Zhang concluded.