During the three months ended June 30, 2012, Chinese herb farming accounted for less than 10% of revenues, while contributing more than 44.6% to the overall gross margin during the three months ended June 30, 2012.


First Quarter Fiscal 2013 Results
Three months ended June 30,
2012   2011
Amount   Percentage

of total

Amount     Percentage

of total

Revenue $ 32,847,330   100.0 % $ 21,427,859   100.0 %
Gross profit $ 5,144,777 15.7 % $ 6,869,323 32.1 %
Selling expenses $ 1,858,225 5.7 % $ 1,378,300 6.4 %
General and administrative expenses $ 2,846,578 8.7 % $ 1,074,783 5.0 %
Income from operations $ 439,974 1.3 % $ 4,416,240 20.6 %
Other income (expense), net $ 98,698 0.3 % $ 19,420 0.1 %
Change in fair value of purchase option derivative liability $ (158 ) (0.0 )% $ 62,632 0.3 %
Income tax expense $ 3,882 0.0 % $ 1,255,563 5.9 %
Net income attributable to controlling interest $ 534,887 1.6 % $ 3,242,729 15.1 %
Net loss attributable to noncontrolling interest $ (255 ) (0.0 )% $ - 0.0 %

Revenue. We had three revenue streams for the three months ended June 30, 2012: (i) store and online retail sales of pharmaceutical and other healthcare products, (ii) wholesale distribution of pharmaceutical and other healthcare products, and (iii) our self-cultivated TCM herbs, that were sold primarily to third-party pharmaceutical trading companies. Included in our wholesale revenue are: (i) wholesales of pharmaceutical and healthcare products that we purchased from third-party manufacturers or suppliers, and (ii) direct group sales or sales to non-distributors. In contrast, store retail sales provided all of our revenue for the three months ended June 30, 2011.

Our revenue increased by $11,419,471 or 53.3% period over period, primarily due to the expansion of our wholesale business and Chinese herb farming business, offset by a decrease in our retail business:
(1)   We started our wholesale business after acquiring Jiuxin Medicine in August 2011, through which we have been distributing third-party pharmaceutical and healthcare products to pharmaceutical trading companies and other group customers. Our wholesale business increased rapidly during fiscal 2012 because we introduced very competitive pricing to customers to stimulate sales. Sales from the wholesale business accounted for $21,368,783 or approximately 65.0% of our total revenue for the three months ended June 30, 2012.
(2)   In the fourth quarter of fiscal 2012, we also began distributing TCM herbs such as Peucedanum that we have been cultivating, to third-party pharmaceutical trading companies. Although we hired several specialists to oversee our farming business, we mainly relied on the local village government to manage the cultivation process. For example, the local government organized local farmers to sow seeds, fertilize and harvest. In turn, we paid for the expenses incurred by the local farmers based on agreements. Sales from the farming business accounted for $2,524,091 or approximately 7.7% of our total revenue for the three months ended June 30, 2012.
(3)   Our retail sales decreased by $12,473,403 or 58.2% to $8,954,456 for the three months ended June 30, 2012 from $21,427,859 for the three months ended June 30, 2011. Although our retail store count increased to 65 as of June 30, 2012, from 57 stores a year ago, our retail store sales decreased as a result of stricter government policies, a competitive retail market, and a shift of our group sales from our retail stores to our wholesale business. Retail sales accounted for approximately 27.3% of our total revenue for the three months ended June 30, 2012. Same-store sales decreased by approximately $13,421,318 or 62.0%, while our new stores contributed approximately $462,365. We expect same-store sales will continue to decline as the frequency of government-mandated price controls and the number of drugs subject to price controls continue to rise and, to a lesser extent, with the shift of our group sales to our wholesale business.

Quarterly Revenue by Segment.  The following table breaks down the revenue for our three business segments for the three months ended June 30, 2012 and 2011:
  Three months ended June 30,    
2012   2011
Amount     % of total revenue Amount     % of total revenue Variance by amount % of change
Revenue from retail business
Revenue from drugstores $ 8,393,098   25.6 % $ 21,350,669   99.6 % $ (12,957,571 )   (60.7) %
Revenue from online sales   561,358   1.7 %   77,190   0.4 %   484,168     627.2 %
Sub-total of retail revenue 8,954,456 27.3 % 21,427,859 100 % (12,473,403 ) (58.2) %
Revenue from wholesale business 21,368,783 65.0 % - 0 % 21,368,783 100.0 %
Revenue from farming business   2,524,091   7.7 %   -   0 %   2,524,091     100.0 %
Total revenue $ 32,847,330   100 % $ 21,427,859   100 % $ 11,419,471     53.3 %

The revenue fluctuation period over period reflected the following combined factors:

Revenue from "Jiuzhou Grand Pharmacy” stores decreased by approximately $13.0 million or 60.7% quarter over quarter, mainly due to two reasons. During the three month ended June 30, 2011, we implemented a variety of promotional activities such as giving out gifts and discounts to our customers. Since the second quarter of fiscal 2012, the Hangzhou government has been gradually restricting retail drugstores within the city from organizing large-scale marketing promotions on the streets in which further rebates or discounts are given to customers making purchases with government-sponsored medical insurance cards. Our promotional activities were curtailed accordingly, which, in turn, impacted our retail sales revenue, especially from sales of certain prescription drugs covered by the medical insurance cards. In addition, the government subjected more drugs to price controls in October 2011, which caused us to reduce prices for some of the affected drugs and stop carrying others at our pharmacies.

Another factor for the decreased retail revenue is the shift of group sales from Jiuzhou Pharmacy’s retail business to Jiuxin Medicine’s wholesales business. We originally recorded group sales under Jiuzhou Pharmacy’s retail system in the prior year. But starting in August 2011, such sales have been recorded under Jiuxin Medicine’s wholesale system because we believe group sales are essentially wholesale in nature. Accordingly, $7.4 million in group sales that would have otherwise been recorded under Jiuzhou Pharmacy have now been recorded under Jiuxin Medicine. Such internal re-allocation of sales revenue between our retail and wholesale businesses affected the comparison of our retail sales for the three months ended June 30, 2012 versus the three months ended June 30, 2011, but has no impact on our unaudited condensed consolidated financial statements.
(3)   Our online pharmacy sales increased by $484,168 or 627.2% quarter over quarter. As we started business cooperation with local business-to-consumer online vendors during the second half of 2011, our online pharmacy has become more and more widely exposed to potential customers. As a result, we have seen a steady growth in online sales.

Gross Profit. Our gross profit decreased by $1,724,546 or 25.1% period over period primarily as a result of decreased retail sales. Our gross margin decreased period over period from 32.1% to 15.7% as a result of decline in our retail sale profit margin as well as a lower profit margin from our wholesale business. The average gross margin of our retail, wholesale businesses and farming business for the three months ended June 30, 2012 were as follows:
  Three months ended

March 31,
2012   2011
Average gross margin for retail business   26.0 %   32.1 %
Average gross margin for wholesale business 2.5 % N/A
Average gross margin for farming business 90.9 % N/A

Our retail gross margin decreased to 26.0% in the three months ended June 30, 2012 from 32.1% in the three months ended June 30, 2011. Beginning in August 2011, the Chinese government included more and more prescription and OTC drugs on the price control list. Some of our products’ prices were higher than the prices set by the Chinese government. Hence, we had to adjust these products’ prices. As a result, the profit margin for these products declined. In addition, due to the economic slowdown, stringent government policies relating to insurance reimbursements and the expansion of Essential Drug List (EDL), the retail drugstore business became much more challenging. For example, drugs listed in the EDL were being sold at a price equal to its cost at local community hospitals that, in turn, receive government subsidies. In order to stay competitive, we lowered certain drug prices resulting in an overall decrease in our retail gross profit margin.

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