China Nepstar Chain Drugstore announces third-quarter financial results

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, 2009.

Financial Highlights

In January 2009, Nepstar terminated a voting rights assignment agreement, which assigned 30% of the total voting rights of Yunnan JianZhiJia Chain Drugstore Co. Ltd. ("JZJ") to Nepstar. As of December 31, 2008, JZJ had 355 drugstore outlets, all located in the Yunnan province. As a result, Nepstar no longer consolidated JZJ's financials beginning in the first quarter of 2009, and the financial results of JZJ were accounted for under the equity method.

To facilitate comparability of figures between periods presented, pro forma financial information is presented to show the accounting impact of the termination of the voting rights assignment agreement as if that had taken place in the beginning of the relevant period.

For the quarter ended September 30, 2009: -- Revenue increased 8.0% to RMB556 million (US$81 million) compared to RMB515 million in the third quarter of 2008 on a pro forma basis -- Operating income rose 92.1% to RMB34 million (US$5 million) compared to RMB18 million in the third quarter of 2008 on a pro forma basis -- Net income was RMB37 million (US$5 million) -- Net cash flow from operations was RMB93 million (US$14 million)

"Our continuous efforts to improve store merchandise offerings and grow foot traffic have started to show encouraging results," commented Mr. Ian Wade, Chief Executive Officer of Nepstar. "As the Chinese economy continues to recover, we are encouraged by rising consumer spending in the healthcare sector. The value of our combination of quality products, reliable service and maximum convenience is becoming more and more recognized by community residents."

Third Quarter Results

During the third quarter of 2009, the Company opened 47 new stores and closed 22 stores. As of September 30, 2009, Nepstar had a total of 2,337 stores in operation.

Revenue for the third quarter of 2009 was RMB556 million (US$81 million), compared to RMB613 million for the same period in 2008, and RMB515 million for same period in 2008 on a pro forma basis.

For the third quarter of 2009 revenue contribution from prescription drugs was 22.0%, from over-the-counter ("OTC") drugs was 36.7%, from nutritional

supplements was 21.6%, from traditional Chinese herbal products was 3.4% and from other products was 16.3%.

Same store sales (for the 1,589 stores opened before December 31, 2007) for the third quarter of 2009 increased by 3.8% from the same period in 2008. The increase was mainly due to streamlining of operations and further optimization of product mix and recovery of the overall Chinese economy.

Nepstar's portfolio of private label products included 1,499 products as of September 30, 2009. Sales of private label products represented approximately 30.1% of revenue and 44.4% of gross profit for the third quarter of 2009.

For the third quarter of 2009, gross profit was RMB276 million (US$40 million), compared to RMB298 million for the same period in 2008 and RMB267 million for the same period in 2008 on a pro forma basis. Gross margin for the third quarter of 2009 was 49.6% compared to 48.6% for the same period in 2008 and 51.8% for the same period in 2008 on a pro forma basis. The decrease in gross margin for the third quarter of 2009 compared with the same period in 2008 on a pro forma basis was mainly due to expansion of the breadth of product offerings and price ranges to maintain competitiveness and address evolving consumer consumption patterns.

Sales, marketing and other operating expenses as a percentage of revenue for the third quarter of 2009 decreased to 38.4% compared to 41.1% for the same period in 2008 and 43.4% for the same period in 2008 on a pro forma basis. This decrease was primarily due to implementation of effective cost control measures, which resulted in a reduction in headcount and a reduction in rental expenses. The decrease was also due to the closing of non-performing stores.

General and administrative expenses as a percentage of revenue for the third quarter of 2009 were 5.1% compared to 4.4% for the same period in 2008 and 5.0% for the same period in 2008 on a pro forma basis. This increase compared to the same period in 2008 on a pro forma basis was primarily due to increased labor costs associated with the recruitment of additional middle and senior management.

As a result of previously mentioned factors, operating income for the third quarter of 2009 increased to RMB34 million (US$5 million) compared to RMB19 million for the same period in 2008 and RMB18 million for the same period in 2008 on a pro forma basis. Operating margin improved to 6.1% for the third quarter of 2009, from 3.4% for the third quarter of 2008 on pro forma basis, and subsequently improved from 4.1% for the second quarter of 2009.

Interest income for the third quarter of 2009 was RMB17 million (US$2 million) compared to RMB30 million for the same period in 2008 on a pro forma basis. The decrease in interest income was primarily due to (i) the maturity of a majority of the held-to-maturity investment securities of which the proceeds were placed in bank deposits; (ii) a general decrease of interest rates for bank deposits; and (iii) lower cash balances as a result of the dividend payment of approximately RMB248 million in May 2009.

Nepstar's effective tax rate was 28.4% for third quarter of 2009, compared to 26.7% for the same period in 2008 on pro forma basis. The increase in effective tax rate was primarily due to relatively higher portion of Nepstar's taxable profits being generated by subsidiaries subject to the PRC statutory tax rate, rather than the preferential rate.

Net income for the third quarter of 2009 was RMB37 million (US$5 million), which represented RMB0.18 (US$0.03) basic and diluted earnings per ordinary share and RMB0.35 (US$0.05) basic and diluted earnings per American depositary share ("ADS"). This compares to net income of RMB36 million, which represented RMB0.17 basic and RMB0.16 diluted earnings per ordinary share and RMB0.34 basic and RMB0.32 diluted earnings per ADS for the same period in 2008. The total number of outstanding ordinary shares of the Company as of September 30, 2009 was 210 million. The weighted average number of ADSs for the third quarter of 2009 was 105 million. Each ADS represents two ordinary shares of the Company.

As of September 30, 2009, Nepstar's total cash, cash equivalents and current bank deposits were RMB1,807 million (US$265 million), long-term bank deposits were RMB200 million (US$29 million), held-to-maturity investment securities were RMB400 million (US$59 million) and total shareholders' equity was RMB1,735 million (US$254 million).

Mr. William Dai, the Chief Financial Officer of Nepstar, stated, "We continue to exercise financial discipline on cost control and cash flow management. Our ability to consistently generate strong free cash flow demonstrates that our financial health strengthened throughout the economic recovery, and paves the way for the further expansion of our store network in 2010."

On August 24, 2009, Nepstar declared a special dividend of US$1.50 per ADS, or approximately US$156 million. Around December 1, 2009, the special cash dividend was paid out to shareholders of record as of the close of business on September 25, 2009.

Latest Developments and Business Outlook

In July 2009, Nepstar entered into a definitive agreement with Beijing Ze Run Tang Drugstore, to acquire its five drugstores in Beijing. This acquisition represents Nepstar's first retail presence in Beijing. The five stores have an average store size of 170 square meters, and are located in densely populated residential areas in Beijing. The acquisition was completed and the stores have been transferred to Nepstar by end of November and are serviced by the Company's regional logistics center in Tianjin, where Nepstar has over 100 stores.

In October 2009, Nepstar entered into a definitive agreement with Wenzhou Ren Ren Hao Chain Drugstore Ltd. ("Ren Ren Hao") to acquire the operations of all of its eight drugstores in Wenzhou City. This acquisition represents China Nepstar's first retail presence in Wenzhou, one of the most affluent markets in Zhejiang province in terms of consumption power. The eight Ren Ren Hao drugstores have an average store size of 250 square meters and are located in the city center or in prime locations in nearby major townships. The transaction is expected to be completed by the end of 2009.

In November 2009, Nepstar entered into a strategic cooperation agreement with ATMU (China) Technology Co., Ltd., a subsidiary of ATMU Inc., one of the largest ATM operators in China, to install ATMs in Nepstar stores. This cooperation is not only designed to provide convenience to customers and generate rental revenue for Nepstar, but will also help increase store traffic and accelerate the development of electronic payment services at Nepstar stores. ATMU plans to complete the initial 1,000 ATM installations in Nepstar's existing stores by end of 2010.

Mr. Wade commented, "Our strategy to increase overall revenues includes opening additional stores in selective areas of China, where economic trends are more favorable; establishing presence in lucrative markets through acquisitions; improving product mix; and increasing marketing and co-marketing programs to grow foot traffic. We are delighted to see our efforts to strengthen our product selection and broaden our price range result in positive same store sales growth and increased store traffic, which has continued into October and November."

Mr. Wade continued, "In general, we remain cautiously optimistic about the economic recovery and are pleased to see some positive elements coming together. The Chinese government's implementation of the Essential Drug List has had an adverse effect on many smaller drugstore chains. However, we at Nepstar view healthcare reform as a strategic opportunity to leverage our large retail network. We are also more optimistic on the outlook for acquisitions, as we expect more smaller-sized competitors may look to exit the sector due to increasing margin erosion on Essential Drug List products which may lead to their worsened financial conditions."