Nepstar second quarter revenue increases 7.3% to US$93.8 million

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 second quarter ended June 30, 2011.

Financial Highlights

For the quarter ended June 30, 2011:

• Revenue increased by 7.3% to RMB606.6 million (US$93.8 million), compared to revenue of RMB565.2 million in the second quarter of 2010.
• Same store sales increased by 9.8% over the same period in 2010.
• Gross margin was 47.8%.
• Net income was RMB6.5 million (US$1.0 million).
• Net cash flow from operations was RMB42.6 million (US$6.6 million).

Mr. Simin Zhang, Chairman of the Board of Nepstar, commented, "Our merchandise diversification efforts continue to help mitigate the negative impact of price cuts imposed by government on pharmaceutical products. During the quarter, we achieved a 9.8% increase in same store sales compared to that in the second quarter of 2010. While we are expanding our revenues, we remain focused on optimizing our product mix, both in pharmaceutical categories and in non-pharmaceutical categories, to protect gross margins."

"Driving revenue growth and remaining competitive with an optimal product mix remain the central themes of our strategy at this stage," continued Mr. Zhang. "We are encouraged that our existing customers are attracted to the new product categories we have introduced so far and we are utilizing this opportunity to highlight service quality and the overall shopping experience in an effort to improve average spending per customer visit and same store productivity."

Second Quarter Results

During the second quarter of 2011, the Company opened 18 new stores and closed 40 stores. As of June 30, 2011, Nepstar had a total of 2,511 stores in operation.

Revenue for the quarter increased by 7.3% to RMB606.6 million (US$93.8 million), compared to revenue of RMB565.2 million for the same period in 2010. Increase in sales of non-pharmaceutical products continued to reduce the negative impact on drug sales from ongoing healthcare reform that has led to price cuts and the diversion of patients from drugstores.

Second quarter revenue contribution from prescription drugs was 19.1%, OTC drugs was 35.2%, nutritional supplements was 19.1%, traditional Chinese herbal products was 3.8% and convenience and other products was 22.8%.

Same store sales (for 2,239 stores opened before December 31, 2009) for the second quarter of 2011 increased by 9.8% compared to the same period in 2010. This growth was mainly attributable to increased sales of non-pharmaceutical products.  

Nepstar's portfolio of private label products included 1,818 products as of June 30, 2011. Sales of private label products represented approximately 31.3% of revenue and 42.3% of gross profit for the second quarter of 2011. The Company continued to make efforts to provide high-quality yet reasonably-priced private label products in the convenience products category. In the second quarter, private label products' contribution to sales of the convenience products category reached 27.2%, helping maintain a reasonably favorable gross profit margin level on sales of convenience products.

Second quarter gross profit was RMB289.9 million (US$44.9 million), compared to RMB283.2 million in the same period of 2010. Gross margin in the second quarter of 2011 was 47.8%, compared to 50.1% in the second quarter of 2010 and 47.7% in the first quarter of 2011. The decrease in gross margin year over year was mainly due to mandatory price cuts on pharmaceuticals and changes in revenue mix as the Company introduced more convenience products with a lower gross margin.

Sales, marketing and other operating expenses as a percentage of revenue in the second quarter of 2011 decreased to 41.8% compared to 42.7% in the second quarter of 2010. This decrease was primarily due to higher sales revenue generated from the merchandise diversification strategy and rigorous cost control efforts.

General and administrative expenses as a percentage of revenue in the second quarter of 2011 were 4.6%, remaining stable compared to the second quarter of 2010.

As the result of the factors discussed above, income from operations in the second quarter of 2011 was RMB8.2 million (US$1.3 million) compared to a loss of RMB12.6 million in the second quarter of 2010. The loss in the second quarter of 2010 was due to a one-time non-recurring penalty charge in the amount of RMB26 million (US$3.8 million) imposed by State Administration of Foreign Exchange of the People's Republic of China (the "SAFE penalty").

Interest income for the second quarter was RMB5.6 million (US$0.9 million), compared to RMB5.3 million in the second quarter of 2010. The increase in interest income was mainly due to an increase in interest rates set by the Chinese government in the first half of the year. Dividend income from cost method investments was RMB0.9 million (US$0.14 million) for the second quarter of 2011, compared to RMB0.03 million in the second quarter of 2010. Equity in income of an equity method investee was a loss of RMB0.4 million (US$0.06 million), compared to an income of RMB1.5 million in the second quarter of 2010.

Nepstar's effective tax rate was 55.1% for the second quarter of 2011, compared to -130.2% for the same period in 2010. The negative effective tax rate for the second quarter of 2010 was primarily a result of the non-deductible SAFE penalty recorded in the second quarter of 2010.

Net income for the second quarter of 2011 was RMB6.5 million (US$1.0 million), which represented RMB0.06 (US$0.01) basic and diluted earnings per American depositary share ("ADS"). This compares to a net loss of RMB13.4 million, which represented RMB0.12 basic and diluted loss per ADS in the same period in 2010. The total number of outstanding ordinary shares of the Company as of June 30, 2011 was 207.7 million. The weighted average number of ordinary shares in the second quarter of 2011 was 207.8 million. Each ADS represents two ordinary shares of the Company.

As of June 30, 2011, Nepstar's total cash, cash equivalents and bank deposits were RMB1.003 billion (US$155.2 million) and its shareholders' equity was RMB1.377 billion (US$213.0 million).

In the second quarter of 2011, net cash flow from operations was RMB42.6 million (US$6.6 million).

Business Outlook

"Entering into the second half of 2011, we typically enjoy some seasonal benefit from higher sales of cold and flu remedies as well as nutritional supplements, heading into the fall and winter. However, government policy remains a challenge. The recently announced price cut by the National Development and Reform Commission over certain pharmaceuticals will become effective on September 1st, affecting a total of 295 medicines including 290 prescription drugs and five OTC drugs Nepstar currently carries in our stores.

"We do believe that the Chinese healthcare sector reform will ultimately reset the competitive landscape of the entire drug supply chain in China. In the meantime, we are doing our best to strategize on ways to optimize our product offerings and sustain the momentum we have achieved to date," concluded Mr. Zhang.