China Nepstar Chain Drugstore's (NPD) CEO Fuxiang Zhang on Q1 2014 Results - Earnings Call Transcript

May.29.14 | About: China Nepstar (NPD)

China Nepstar Chain Drugstore Ltd. (NYSE:NPD)

Q1 2014 Earnings Conference Call

May 29, 2014 08:00 ET

Executives

Dixon Chen - Investor Relations, Grayling

Fuxiang Zhang - Chief Executive Officer

Zixin Shao - Chief Financial Officer

Analysts

Isabella Zhao - Morgan Stanley

Ryan Roberts - China Stock Research

Operator

Greetings and welcome to the China Nepstar First Quarter 2014 Earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Dixon Chen with Grayling. Thank you, Mr. Chen. You may begin.

Dixon Chen - Investor Relations, Grayling

Thank you. If you have not received a copy of Nepstar’s first quarter 2014 earnings press release, it is currently available on the company’s website at www.nepstar.cn. A presentation to accompany today’s call and live webcast is also available on the website under the Investor Relations section.

Before we start, I would like to remind you that certain statements that are not historical facts made during the course of this conference call about future events and financial results constitute forward-looking statements that are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. You should note that the company’s actual results may differ materially from those projected in these statements due to variety of factors affecting the business. Forward-looking statements are subject to risks and uncertainties. Discussions of factors that may affect future results are contained in our filings with the Securities and Exchange Commission. We undertake no obligation to correct or update any forward-looking statements provided as a result of new information, future events, or even changes in expectations.

Joining us on today’s call are Mr. Fuxiang Zhang, Chief Executive Officer and Mr. Zixin Shao, Chief Financial Officer. I will be your translator during the question-and-answer session. We will be translating question and answers and ask for your patience at that time.

With that, I would like to turn the call over to Mr. Shao, our CFO. Mr. Shao, please go ahead.

Zixin Shao - Chief Financial Officer

Thank you. Good morning and good evening to all of you. We are pleased to report continuing growth in same-store sales in the first quarter of 2014. Our focus on non-prescription pharmaceutical and nutritional products and proactive promotions continued to drive the average value per transaction, which was increased by 9.3% as compared with the same period in 2013. We are still challenged by the lower gross profits and increasing operating expenses. However, our product optimization strategy has helped stimulate top line growth enabling us to focus on profit improvement through cost controls and inventory management.

During the first quarter of 2014, we opened 15 new stores and closed 24 stores. As of March 31, 2014, we had 2,057 directly operated stores in total.

Revenue for the first quarter of 2014 increased by 8.1% to RMB678.3 million or $109.1 million from RMB627.4 million for the same period in 2013. Same-store sales for the 1,924 stores opened before December 31, 2012 and which were still operating. For the first quarter increase of 7.9% compared with the same period in 2013. The increase in same store sales was primarily due to in-store promotional initiatives and marketing of pharmaceutical products and nutritional supplements.

First quarter revenue contribution by product category was 23.3% from prescription drugs compared with 22.1% for the same period of 2013, 40.3% from OTC drugs compared with 40.0% for the same period of 2013, 14.8% from nutritional supplements compared with 14.9% for the same period of 2013; 4.5% from herbal products compared with 4.1% for the same period of 2013; and 17.1% from convenience and other products compared with 18.9% for the same period of 2013.

First quarter gross profit was RMB278.4 million or $44.8 million compared with RMB290.9 million in the same period of 2013. Gross margin in the first quarter was 41%, compared with 46.4% in the same period of 2013. The year-over-year decrease in gross margin was mainly the result of proactive promotional activity such as more discounts on certain pharmaceutical and nutritional products.

Our portfolio of private label products expanded to 2,120 types of products as of March 31, 2014. Sales of private label products represented approximately 20.8% of revenues and 29.9% of gross profit for the first quarter.

Sales, marketing and other operating expenses as a percentage of revenue decreased to 39.9% for the first quarter from 40.2% in the same period of 2013. General and administrative expenses as a percentage of revenue were 5.4% for the first quarter compared with 4.4% for the same period of 2013. This increase was mainly due to higher staff costs from the various functional departments, as well as a penalty of RMB3.2 million or $0.5 million imposed by Nanjing Social Insurance Administration Centre on Jiangsu Nepstar for non-compliance with the policy of allowing customers to use the balances on their medical insurance cards for purchase of merchandises not included on the Essential Drug and Reimbursement Lists.

Loss from operations in the first quarter was RMB28.8 million or $4.6 million compared with income from operations of RMB11.3 million in the same period of 2013. This loss was mainly due to lower gross profit and the fact that increases in operating expenses outpaced revenue growth. Interest income for the first quarter was RMB2.5 million or $0.4 million, compared with RMB4.1 million in the same period of 2013. This decrease was primarily due to withdrawal of our bank deposits for the 2013 dividend payment.

We had tax credit of RMB3.1 million in the first quarter of 2014. This credit was primarily due to the following reasons. First, a tax credit of RMB4.3 million attributable to deferred tax assets mainly derived from tax losses recognized by certain subsidiaries. And second, a RMB2.2 million reversal of deferred tax liabilities derived from withholding tax due to loss from operations in the first quarter of 2014. The tax credit is partially offset by the income tax expense of RMB3.4 million attributable to current tax charges of profitable subsidiaries.

Net loss for the first quarter was RMB18.2 million or $2.9 million, or RMB0.18 or $0.03 basic and diluted losses per ADS compared with net income of RMB7.1 million or RMB0.07 basic and diluted earnings per ADS for the first quarter of 2013. As of March 31, 2014, we had 197.4 million outstanding ordinary shares. Each ADS represents two ordinary shares of the company.

Net cash outflow from operating activities for the first quarter was RMB22.6 million or $3.6 million, compared with the RMB6.9 million cash inflow for the same period in 2013. This cash outflow is primarily due to the operating loss incurred in the first quarter of 2014.

As of March 31, 2014, our total cash, cash equivalents, short-term and long-term bank deposits and restricted cash were RMB399.4 million or $64.2 million compared with the RMB622.8 million as of December 31, 2013. Shareholders’ equity was RMB827.2 million or $133.1 million compared with RMB845.5 million as of December 31, 2013. On November 26, 2013, we announced a cash dividend of $0.32 per ADS. Approximately, $31.6 million was subsequently paid to shareholders in January 2014.

As we look forward to the remainder of the year, there are some encouraging signs of improvement in our market environment. The National Development and Reform Commission of the People’s Republic of China recently announced cancellation of the price ceiling on certain low-cost drugs and initiated the process of re-pricing. The implementation of this new policy may take a few quarters, but we believe these are favorable developments that could restore differentiated pricing for a considerable number of the drugs that we sell and ultimately improve both top and bottom line performance for our pharmaceutical products. In the meantime, we plan to start adjusting pricing on certain nutritional products in an effort to improve gross margins.

With that, Mr. Zhang and I will address your questions. Operator, please begin Q&A. thank you.

Question-and-Answer Session

Operator

Thank you, sir. At this time we will be conducting question-and-answer session. (Operator Instructions) Our first question today is coming from Isabella Zhao from Morgan Stanley. Please proceed with your question.

Isabella Zhao - Morgan Stanley

Thank you for taking my question. I have three questions. The first question is regarding what kind of strategy initiatives the company will take in order to better control operating costs. And the second question is could Mr. Zhang give us more color about the low cost drug list and what percentage of drugs on our current product portfolio belongs on this list and what kind of impact in quantity or in revenue that we are going to see if the product is really implemented. And the third question is about recently the China’s FDA announced possible policy to allow the Rx drugs to be sold online. And I want to hear Mr. Zhang’s comments, what kind of impact with this policy for – on the retail sales for the Rx drugs? Thank you.

Fuxiang Zhang

Thank you for the questions. Let me answer your – let me address your first question. We agree the first quarter we have seen some of the healthy growth in the same-store sales level. However, we believe there is still room for growth. We are – we continue to aim double-digit growth in the same-store sales category for our goal. In terms of cost control, a big part of that is the rent and labor and we believe we will have lot of room to compress on that. However, we would make our best effort to optimize our G&A segment. So, we are going to do some of the downsizing in the back office management. So, that can help us to reduce the G&A expenses. So, that should address your first question.

Maybe it will be helpful to take you back to the background and how the EDL, essential drug list came to play and why government wanted to – want to loosen up in the price ceiling. It’s mainly due to the government, Chinese government overly focused on pricing control to tackle some of the inflationary discussions, which in turn cause lot of low price drugs falling to the essential drug list. We see a shortage of those drugs, because some of the factories, the OEMs, they stopped producing these, because they are just not profitable. And now with our government’s new initiative and we believe overall is a positive development and we believe it’s a favorable policy. And however, we are talking about most of those drugs are in the low price category. And their contribution to our gross profit is not a lot. So, it’s overall we think it’s a good thing. It’s just not a lot to our gross profit. And however, we think with this new policy, it’s going to help us to regain some of the store traffic. And in terms of our products, we have about 1,700 products in that low price of EDL drug list and so I hope that answer your second question.

Okay, to your last question, it’s a long answer let me try to summarize it. The background of this discussion actually started in early April. Mr. Yin Li, the Vice Minister of China Food and Drug Administration, CFDA. He and his team visited us and our ecommerce center. And they are also invited to Guangdong province based retail drug chain, who are also doing some of the ecommerce, selling products online. This panel or the sort of seminar discussion is mainly focusing on and better understand the ecommerce trends, the internet retail trade and then – and how that can integrate with our existing retail network to better service the mass audience or customers.

So during that discussion, we happy learned the government is actually looking more into a way to encourage the existing drug store chains to develop online presence. And as you know, we are one of the largest drugstore chain in China. Our footprint is all over in different provinces and we have one of the best – we have one of the best distribution platforms in China. And however, if you look at the prescription drugs, we cannot sell them online. And we do sell other product online. So, during the visit with the CFDA officials, we talked about how we can – how that policy can help us if government decides to give us that policy. And the prescription drug sales, is one of the main advantages for traditional drug retailers like us. We believe this is one of the most important favorable policy if government can rollout and that will give us a clear advantage over some of the other players doing online, because where most professional will specialize in prescription drugs fulfillment. I hope with that, I answered your last question.

Isabella Zhao - Morgan Stanley

Thank you for answering my question.

Operator

Thank you. (Operator Instructions) Our next question is coming from Ryan Roberts from China Stock Research. Please proceed with your question.

Ryan Roberts - China Stock Research

Good evening and thanks for taking my questions. I just wanted to settle back and ask about the discounting that you mentioned earlier and kind of how that’s affecting the top line? And I just wanted to ask specifically kind of what’s – what you are looking at coming from how much longer is that going to be going on? And also what kind of results that we see, I think we mentioned store traffic, excuse me, average spend, I am just wondering if there is any of the – are there any of the metrics or any of the benefits that we are seeing from that?

Fuxiang Zhang

So, we look at it for us to a part of our pricing strategy is by looking into each region and municipality what type of drugs it’s more popular in that area. And we are also looking to local the medical reimbursement program list where a couple of drug will fall into that list. And lastly we look at the product by tracking some of our customer behavior to see what kind of product is more price sensitive to them. And based on those research and we then go out replenish or increase our product offerings.

And then – and along with that we should reset our pricing strategy and so that’s our general approach. With that kind of approach we see some of the positive development in our business as you saw our revenue has increased and our traffic, store traffic on a year-over-year basis has been relatively flat for this quarter. However, and the general trend is looking strong. And our membership basis has been growing there well. And lastly, our per customer per visit consumption has increased and just first quarter alone we booked 9.3% year-over-year on the per customer consumption and so we are pretty happy with that.

Ryan Roberts - China Stock Research

Okay. So if I can just kind of follow-up in terms of the, I think you mentioned earlier that there is still some discounting and store promotions and basically spending like that and I am just wondering what – how much longer that’s going to continue?

Fuxiang Zhang

Okay, we will continue to apply those tools such as discounting and promotion. We do see some of the positive results already in some of our markets. For instance we saw some of the competitors adjacent to our store are closing shops due to our strategy and they can continue to compete with us. And in the near-term we will continue to focusing on growing market share. If we can get the market share and at some point I think we can come back to improve the other matters. So right now top priority is market share, we will continue to it and to do some of the discounting and promotions to grow our top line.

Ryan Roberts - China Stock Research

Okay. If I can just ask just one quick I guess related question on I guess the pricing and margin a little bit, can you discuss a little bit in the I guess the margin trends versus the private label are good?

Fuxiang Zhang

In terms of private label products, in general, it’s a higher margin category for us. We believe it’s continuing to stay in a very high margin area. However, we did compare some of the private label products with a generic product and adjust our price points accordingly. And so in the near term, there are some effects on the margin for our private label products. And however, we believe normal run as we mentioned earlier, if we can’t gain market share, it’s going to be worked out eventually.

If you look at our gross margin, we believe we remain confident. We are still probably weren’t highest in the industry. And however, that’s not the only goal we want to achieve. We want to leverage our gross high margin advantage to attack the market to eventually grow our bottom line to increase the efficiency of our stores. We believe we have some emanation there to use. So, that’s why we are using those things to help us to achieve our long-term goals.

Ryan Roberts - China Stock Research

Got it. Thank you. It’s very helpful.

Dixon Chen

Thank you.

Operator

Thank you. With no further questions at this time, I would like to turn the floor back over to management for any further or closing comments.

Fuxiang Zhang - Chief Executive Officer

Thank you again for our analysts, friends and investors for ongoing support. We will continue to focusing on building our platform and expanding our market share. And we will carefully manage the gross margin and also continue to control cost and expenses. In the near term, due to some of the ongoing initiatives what we talked about earlier, there are – there maybe some near-term pressure on the profitability. And however, with our collective effort in all aspects, we believe we are going to have a strong comeback to report to our shareholders. With that, that concludes our first quarter 2014 China Nepstar’s earnings conference call. Thank you.

Operator

Thank you. That does conclude today’s teleconference. Thank you for your participation today. You may disconnect your lines at this time.

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China Nepstar Chain Drugstore (NPD): Q1 EPS of -$0.03 misses by $0.03. Revenue of $109.1M (+8.1% Y/Y).