Adcock Ingram Holdings Limited (AIP) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Adcock Ingram interim results for the 6 months in the December 2019 presentation. [Operator Instructions] Please note, more detailed announcement is available on the Adcock Ingram website as well as on the [ sent ] link. [Operator Instructions] Please note that this call is being recorded. I would now like to turn the conference over to Andy Hall. Please go ahead.

Thanks, Irene. Good morning, ladies and gentlemen. Welcome to our telecon for the 6 months that ended in December. We appreciate you taking the time to show some interest in the company. We will follow our usual format. I'll give you an overview of the results and talk a little bit about the regulatory environment. And then I'll hand over to Dorette Neethling, Adcock Ingram's CFO, who will take you through some detail on the financials. [Foreign Language] if we look at the overall business performance, we are satisfied for the results for the half year. In a nutshell, the regulatory businesses, the OTC business and the prescription business struggled somewhat. Sorry, I'm just checking that we're back online. I'm just going to start again. So looking at the overall business performance, we are satisfied for the results for the 6 months. In a nutshell, the regulatory businesses, being the OTC business and the prescription business, you can see, struggled a little bit. Whereas our less-regulated businesses, being in hospital as well as the consumer environment, they performed relatively well. So the result of that was that turnover in total was up by 1% compared to the previous reporting period. We had an average price increase in there of 3.7% and that was mainly realized in the consumer business, where we have the branded products like Panado and Bioplus and Compral and the like. We had a mix benefit of 3.7%. We added -- included in that were some products that we added in from Leo Pharma some dermatology brands. And then we launched a new ARV in the year, which added about ZAR 15 million. Thus Leo Pharma rands were about ZAR 90 million. Offsetting those 2 benefits, we had a volume decline of about 6.3%. There were a couple of issues there. And the 1 was we suspended the sales of BronCleer roundabout May, June 2019, it was a voluntary suspension of sales that impacted the volumes in the OTC business. We have had reduced demand for our ARVs in the private sector relative to the corresponding period. And then we had some stock supply issues on some of our big generic brands, where we receive product from partners overseas. Just looking quickly at the regulatory environment because there is quite a bit happening there. You've all seen the single exit price increase of 4.53% for 2020, a little bit higher than what we got in 2019 when it was 3.78%. So while the 4.53% is very much in line with CPI, it certainly doesn't balance the scales for us. When you take into consideration the rate of production of inflation, particularly in wages and utilities, which have gone up, respectively, by 7% and 11%. And then of course, the deterioration in the rand doesn't help the imported products or imported active ingredients. That was about an additional 6% in -- relative to the prior year. On the South African Health Products Regulatory Authority side, we -- you've all seen that we had correspondence to the industry from January indicating that SAHPRA was in the process of reviewing the scheduling status of codeine and codeine-containing medication. They've asked for ways in which the Codeine Care Initiative could be improved. And they've also asked for the industry to comment or make proposals on alternatives to up-scheduling. And of course, we're busy with that at the moment. And with other industry players as well as on our own, we will be making a submission to SAHPRA software before the end of the month. Certainly, we are in support of SAHPRA's intention to explore further ways of further promoting responsible dispensing and use of codeine medicines and we agree that improving controls at every level of the supply chain would be a good thing. We're not in favor though of up-scheduling of codeine products in South Africa. Affordability and lack of access are already a significant issue with -- in our health care system. And certainly up-scheduling these products is just going to compound those problems. At the same time, it's letting the industry know about codeine. SAHPRA also asked for a sales data of pro -- Meprobamate-containing medicines from manufacturers and obviously, we will be submitting that data and seeing what the process is intended to be on Meprobamate. On the National Health Insurance, the PTG, or the Pharmaceutical Task Group, which represents about 90% of the pharma industry in South Africa did submit a written submission on the Board towards the end of 2019. As an industry, we indicated that we are in support of the provision of universal health care. We included comments, particularly related to the industry on issues such as procurement and supply mechanisms for medicine that would facilitate long-term viability of the pharmaceutical industry under an NHI. We were quite vocal on the maintenance of quality and the level of care within the system. And then also that -- we did feel that NHI, if there was a milestone approach in terms of implementation rather than a big-bang approach and good governance around the structure, was certainly workable. At Adcock Ingram, we remain supportive of NHI. We do think there are some benefits for our business, and we think our portfolio gives us relatively good protection against NHI. So we're happy to play a role, provided that we have certainty on the funding model and it's rolled out in a phased and sustainable manner. Just getting back to the numbers, and talking a little bit about the underlying divisions. The over the -- our over-the-counter business, which is about a 90% private sector and 10% public sector business, does a little bit of exports into the rest of Africa. This business competes in the self-medication category, mainly through the pharmacy channel and is the leader in OTC products in pharmacy. We've seen a turnover decrease there of 7% compared to the prior reporting period. That 7% attributable mainly to the temporary voluntary sales suspension of BronCleer that I mentioned earlier. That was about a ZAR 70 million swing. And then we did have some stock supply challenges out of our Clayville factory, where we experienced some water supply challenges in the period, but those have since been rectified. Despite the difficulties in the division, a number of its top brands, such as Allergex, Alcophyllex and Napamol actually showed very good growth. And I guess, that might be an indication of people down-trading or looking for more affordable products because those are on the more affordable spectrum of products that are available in allergy, coughs and pain. On the prescription side, very challenging first half for that business. The prescription medicine environment is evolving rapidly in South Africa. We've got significant pricing pressure in generics and ARVs, that's more a landscape problem. And then within our own business, we are struggling with some tight margins in the multinational portfolio. Nonetheless, the business did produce revenue growth of 4%. That's with the bio-dermatology portfolio included. And that has made Adcock Ingram, the leader in dermatology in prescription medicine in South Africa. A couple of new developments that are at least making sure that this business is sustainable. We had a successful launch of Fucidin as the topical product to OTC or Schedule 2 in 2019, and that product is growing well. On our multinational side, in the central nervous system portfolio, Roche has agreed to extend its marketing agreement that we market Rivotril for them. And another multinational, Biocodex, has agreed that we continue to sell, market and distribute STRESAM, a product that's showing very good growth in the market of about 20%. We've also with Sandoz, extended our 5-year licensing agreement for women's health products, being Estalis, Estradot and Aclasta. Where we have struggled in this division, the ARV portfolio is operating in an environment of intense competition, and there's a lot of price deflation on those products in the private sector. And from a tender perspective, unfortunately, the uptake of the new triple combination product has been very disappointing. Our sales in the 6-month period for that product amounted to just ZAR 15 million, 1-5. The generic portfolio, that's about 20% of this division's business, impacted by some supply challenges, as I've mentioned, on a couple of the flagship brands that come out of Europe, particularly, Simvastatin and Zolpidem, but that has been remedied before the start of January 2020. So I think we're over that hump. And in this portfolio, Gen-Payne performing particularly well, that business -- that product, since it's been down-scheduled, growing in double digits. The division has received regulatory approval for its first biosimilar. So we think that's a good step for us, certainly a step in the right direction and takes us into a new category. We've received approval for a biosimilar of infliximab. Sorry, I'm just checking the system. We've received approval for a biosimilar called infliximab towards the end of calendar 2019. That product is indicated for a number of conditions, including ulcerative colitis, rheumatoid arthritis and psoriasis effectively. We plan to launch that later in the 2020 year, maybe before the end of the fiscal. But certainly, if not, before the end of the calendar. In the consumer business, we've seen a healthy performance, there turnover increased by 7%. Two of the big brands, Bioplus and Compral have shown double-digit ex-factory growth and Panado, also very good growth in that market, not into the double digits, but coming off a big base, still growth that we are particularly happy with. We've seen lot of good marketing activity in that division, supporting the analgesic range and the energy range and good packaging revamps for our Shape portfolio as well as our Island Tribe sunscreen range. Some of you might have seen that earlier this month, that division launched a product called ADCOCBD, which is our cannabidiol range. We brought 2 variants to the market, and they're available effectively at the moment in Dis-Chem and Independent Pharmacy, and we intend to get that product as to at Clicks as well. On the hospital business or what we call our critical care division, which is the leading manufacturer and supplier of critical care and hospital products in the country, we saw an excellent turnover increase there of 8%, good volume growth of just over 3%. And we also managed to get some price there of just under 3%, which in that environment is not common. So we're very happy with that. We've seen really good performances from the medicine delivery and renal segments there, in particular. In January, that business has expanded into the sports medicine and rehabilitation environment, we are marketing directly to physiotherapists and sports medicine practices, quite an innovative concept that I've certainly never seen in the pharmaceutical industry before. We have branded vans going after these practices with stock on hand and sales are literally made and delivered as these reps call on the physio. So we're quite excited about where that could go. It's not a huge space in South Africa. But it's certainly incremental and also again, not being regulated, helps us a little bit on the pricing side. We've got 6 principles that we signed up there, all overseas principles, and they've given us exclusive rights for 5 years. Just looking at the factories at Clayville, our factory that does the high-volume liquids as well as the powders and effervescence. I mentioned we had some water supply challenges that had negatively impacted production, but those have largely -- not largely, those are through the system now. So I think we're okay. The construction of the ophthalmic facility at Clayville is complete. We're busy with our validations at the moment. And once we get a SAHPRA inspection and if that inspection allows us to get transfer of products into that facility, we are hoping to commence production late in this calendar year. At Wadeville, our liquids, creams and ointments facility is operating at reasonable levels. So we're seeing good throughput there and relatively happy with that part of the factory. The oral solid dosage facility, though, continues to operate at suboptimal levels. We're just not getting the right throughput there. We've made some people changes, getting a new head of that facility in at the beginning of April. But we've had under-recoveries at that factory, which really have been punitive on the prescription business. So we do need to start looking at making dramatic improvements there. We've also in the last couple of months, looked at our long-term options for that facility. So we're in the process of figuring out where to take the Wadeville factory over time. At Aeroton, you saw that -- you'll see that they've had a good margin improvement at the gross level there, and that was really supported by an excellent throughput at that factory. They've met the demand -- increased demand in both the private and the public sectors. And overall, we're very satisfied with that factory's performance. On the distribution front, our focus there remains on maintaining regulatory compliance, keeping costs down and obviously, improving service delivery. In November 2019, the Competition Commission approved the application for an outsourcing arrangement between ourselves and RTT. And effectively, that now means that all of our transport and distribution requirements from the outbound warehouse stores onwards, are going to be transferred to RTT. They're also taking over our entire fleet and all the staff that were involved in distribution. We will retain responsibility for our own warehousing there. So we'll be doing warehousing, orders, customer service and inventory management in-house. Lastly, on the transformation side, late last year, we -- our BE scheme unwound. In fact, that unwound in the middle of the year. That did reduce our Black ownership to a small extent, but we had some compensatory effects through Bidvest's increased stake in Adcock Ingram. And in addition, we fulfilled all the requirements for the YES program, which was really a resounding success. Throughout our business, we've absorbed a lot of those young people. And that supported the other elements of the scorecard, which collectively moved us from what was a level 3 to a level 1. So an achievement that we're really proud of. I'll hand over now to Dorette to talk about the financials, and I'll come back to you just as we enter into questions.

Thank you, Andy. Before I get into the detailed results, I thought to explain to you the impact on the group following the adoption of the new standard for leases, the IFRS 16 standard. It has also been disclosed in note 1.2 on Page 8, for those of you who have downloaded the booklet from the website or the sent link. As you know, the group adopted this standard on the 1st of July, which requires that all material operating leases with a term longer than 1 year should be capitalized as a right-of-use asset and at the same time, we should recognize a lease liability. So the impact on the balance sheet on the 1st of July was that we have recorded an increase in lease liabilities of ZAR 329 million, which represented the present value at that time of the future lease payments. We also recorded an increase in property, plant and equipment of ZAR 300 million to account for the right-of-use assets after the balance of ZAR 29 million relating to the previous straight lining of leases was offset against this asset. And at the end of December, these assets had a carrying value of ZAR 282 million. The impact on the income statement for the 6 months between the previous and the new standard was as follows: Under the old standard an operating lease charge of ZAR 33 million would have been recognized in profit or loss in the current period if we had to apply that standard. By now applying IFRS 16, it's replaced by a depreciation charge of ZAR 18 million, 1-8 following the recognition of the asset as well as the recognition of finance costs of ZAR 14 million due to the accounting of the lease liability's finance costs. So overall, between the 2 standards, see -- you will note there's not a material difference to profit before tax should we have applied either of them. However, the difference between the actual charge in the comparable period of ZAR 22 million and the current year's charge of ZAR 32 million resulted in an on-cost to the business negatively impacting profits by ZAR 10 million. Of this amount, we've seen a reduced cost of ZAR 4 million, which is reflected in trading profit and an on-cost of ZAR 14 million in finance costs. The overall on-cost to the business is as a result of the renewal of the Midrand lease on basically the same terms as before which was effective on the 1st of July and the addition of a new warehouse in halfway house. And now in a closer look at the income statement, and if you turn to Page 3 on the booklet. Turnover of ZAR 3.6 billion ended in line with the comparative period, supported by an average price increase of 3.8% mainly realized in the consumer segment as well as a big -- mix benefit of 3.5%, mostly from the new Bayer portfolio, which Andy mentioned earlier. But this was, to a large extent, offset by a 6% decline in volumes from the reduction in the sales of BronCleer as well as reduced sales of our ARV product, Trivenz, into the private market. Gross profit of ZAR 1.4 billion ended just ahead of the comparative period. The margin of 38.4% is slightly lower than the prior period, which was at 38.7%. This was impacted by the lower factory recoveries in Clayville and Wadeville, the inclusion of the Bayer portfolio at a lower margin as well as a 6.1% increase on the basket of imported goods. Good factory throughput at Aeroton and excellent management of supply increases in the consumer business compensated to a certain extent. Operating expenses ended in line with the prior year with disciplined control of discretionary spend, especially seen in the light of the slow sales performance. As a result, trading profit of ZAR 490 million is 1% ahead of the prior period. Nontrading expenses, which is detailed in note 2 of ZAR 28 million includes share-based expenses of ZAR 20 million and ex-gratia payment of ZAR 10 million made to the group's BEE shareholder, Ad-izinyosi, as well as a ZAR 2 million profit on the disposal of that investment, consequent to the termination of the BEE scheme in the end of July. Consequently, operating profit of ZAR 462 million ended 1% above the comparative period. The net finance cost for the period was ZAR 12.5 million, compared to ZAR 8.6 million in the prior period. Excluding the IFRS 16 finance costs of ZAR 14.3 million, finance income from cash balances was ZAR 1.9 million. The income from investments is the dividend that we received from the Tiger Brands Black Managers' Trust of ZAR 2.3 million, and it's a function of dividends declared by Adcock and Tiger Brands into that scheme. Equity accounted earnings from our joint ventures for the 6-month period from National Renal Care, our JV with Netcare as well as our JV in India of ZAR 62 million, a very pleasing 32% above the comparative period of ZAR 47 million. The Indian JV represents around 64% of those earnings with the balance contributed by NRC. Profit before tax for the period is ZAR 514 million, up 3%. The effective tax rate adjusted for equity accounted earnings is 50.2% with nondeductible expenditure causing the increase over the statutory right. Minorities at Novartis Ophthalmics and Menarini amount to ZAR 3 million. Headline earnings for the 6-month period from continuing operations amounted to ZAR 373 million, a 3% improvement on the comparative period of ZAR 361 million. This translates into headline earnings per share of ZAR 2.185 from the continuing operations, an improvement of 1% over last year. If one were to exclude the payment of ZAR 10 million, which was made to the BEE consortium as well as the impact on treasury shares following the unwinding of that scheme, headline earnings per share would have increased by 6%. So if we turn to the segment information, which is on Page 9 and 10 of the booklet. I'll start with the OTC business. OTC turnover ended almost ZAR 80 million lower than the comparative period, as Andy mentioned, as a result of volumes declining by 10.3%, mainly relating to the temporary voluntary suspension of sales of BronCleer, coupled with some inconsistent inventory supply on certain oral subs. Excluding BronCleer, 8 of the top 10 brands showed good growth. The volume declines were partly mitigated by an average price increase of 2.6%. The gross margin is lower than the comparative period, impacted by weaker currency and lower factory recoveries at Clayville. Operating expenses have been very well controlled in this business and ended ZAR 29 million lower than the comparative period. As a result, trading profit of just short of ZAR 200 million ended ZAR 19 million lower than the comparative period. If we move on to prescription. Turnover of ZAR 1.4 billion ended ZAR 60 million higher than the comparative period. Due to the branded segment benefiting from the inclusion of the Leo Bio products like Advantan, Scheriproct, Travocort and Skinoren, and -- as well as good growth from Synaleve, which compensated for the poor sales in generics and ARV, both of which were impacted by pricing pressures. The Genop portfolio is performing well, with growth of 9% on the sales line. The gross margin in this division is lower than the comparative period once again impacted by the weaker currency and inventory vitals as well as the poor factory recoveries as well as the inclusion of the Bayer products, which were at lower margins. Operating expenses were well-controlled and ended below the prior period. As a result, the trading profit of ZAR 142 million is ZAR 8 million lower than the comparative period. In looking at the hospital division, turnover for the 6-month period of ZAR 826 million reflects excellent growth of 8% over the comparative period, contributed by an average price increase of 2.6%, volume growth of 3.1%, which emanated from medicine delivery and renal products and a mix benefit of 2.3% related to the new product launches. The gross margin in this business ended higher than the comparative period, benefiting from an improved sales mix and excellent throughput in the factory, which offset the impact of the weaker currency. Operating expenditure ended higher than the comparative period, mainly as a consequence of the higher sales and marketing investments. Trading profit of ZAR 72 million ended at a very impressive 40% ahead of the comparative period. Lastly, if we look at the consumer division, turnover for the 6 months of ZAR 422 million ended 7.3% above the comparative period, mainly realized through price increases. The gross margin improved through the realization of price increases as well as the containment of supply cost increases. The operating expenses ended higher due to the increased marketing investments behind brands like Panado, Compral and Island Tribe and this resulted in trading profit of ZAR 73 million, ending ZAR 8 million higher than the comparative period. In looking at some of our foreign exchange details for the rest of you that ran models. During the 6-month period, the following material foreign currencies were bought by the South African businesses. EUR 25 million at an average rate of ZAR 16.67 which was a 3.4% weakening in the local currency compared to the prior period, which was at ZAR 16.12. And we bought USD 35 million at an average rate of ZAR 14.79 representing an 8.3% rand weakening compared to the prior period, which was at ZAR 13.66. With approximately 54% of the FEC is in dollars and 44% in euro, the weighted cost of the group's basket of all currencies increased by 6.1% compared to the first half of the 2019 financial year. As at December 31, the business was carrying the following open FECs: EUR 20 million at ZAR 16.74 compared to the current spot of around ZAR 16.20 and USD 27 million at ZAR 14.86 compared to the current spot of around ZAR 15. In looking at the foreign operations, which now only comprise Kenya, the turnover of ZAR 30 million remained flat in comparison to the same prior period. Whilst trading profit share, the pleasing improvement from ZAR 1.6 million in the comparative period to ZAR 2.6 million in the current period. So if we turn to Page 6, on the balance sheet. And specifically, looking at the noncurrent exits, depreciation charges to the property, plant and equipment including depreciation of the ZAR 18 million relating to the right-of-use assets, which I explained at the start of the call, amounted to ZAR 92 million compared to the ZAR 79 million in the comparative period. Intangible assets, including goodwill, have a carrying value of ZAR 604 million comprised of generic, consumer and OTC trademarks and license agreements as well as intangibles and goodwill recognized on the acquisition of Genop. Amortization of ZAR 5 million was recorded in the 6 months, and this charge is in line with that of the previous period. Other financial assets of ZAR 29 million were primarily the capital contribution made to the Tiger Brands Black Managers' Trust, which has reduced slightly as options were exercised during the 6 months. In looking at the current assets, inventory of ZAR 1.6 billion represents inventory days of 124 days compared to 108 days recorded in June 2019. This increase mainly arrived from an investment in active pharmaceutical ingredients related to the ARV tender, the onboarding of the Leo Pharmaceuticals' dermatology brands as well as a stock build ahead of an extended factory shutdown period of December and January. Trade accounts receivable of ZAR 1.6 billion are shown net of provisions of around ZAR 80 million. Days in receivables of 66 days, slightly up from the 64 days reported at the end of June 2019. But this book really remains well controlled as 92% of all receivables are due within 60 days or less, which is the general terms of the business. Government bit now represents 17% of the total growth status book, but around 84% of this customer's total outstanding amount is due within 60 days or less. And the state is in most part, complying with the agreed payment plan, which allowed for the settlement of arrears over 2 years with the final payment expected in May of this year. The group remains in a net cash position with cash of ZAR 363 million and is comfortably able to service its obligations in the short term, and have access to working capital facilities of ZAR 860 million. I'll now hand back to Andy to close the session.

Thanks very much, Dorette. I guess, just looking forward a bit, in light of the current economic climate, the high unemployment rate and a sort of job cut information that seems to be hitting the market regularly. In addition to the load shedding problem, we don't foresee that consumer spending and behavior is going to improve in the short term. And then our ACP increase, as I mentioned, just places pressure on us to focus as much as we have then in the last period on cost containment, improve that productivity in our facilities and then importantly, continue to seek opportunities to grow our portfolio of unregulated or less regulated product. So with that, I'll hand back to Irene, the operator, and we'll be happy to take any questions.

[Operator Instructions] Our first question is from Catherine Cunningham of JPMorgan.

Just 1 question for me. Your release mentioned that there has been an extremely low rollout of the DLT combination drug. Could you perhaps just give us a little bit more color on what exactly is driving the bottleneck for this drug specifically?

Yes, Catherine. So we can't say exactly what the obstacles have been to rolling out the combination. I think that's more a question for the department. But we can give you the sort of stats that are -- that we've got in our business. So the ARV tender that we won should be giving us -- on an average run rate basis should be giving us about ZAR 690 million with a revenue per annum. We only realized ZAR 103 million of revenue in the last 6 months on that tender. And the triple combination that you referred to was only ZAR 15 million, 1-5, of that number. We have been in touch with the department I think last week. We had information and I can't confirm this, so this was what was told to us informally, we have information that the DLT rollout has been as low as 10%, the uptake in Hà Tinh Province and as high as 50% in KZN. So I guess, the average is probably somewhere between the 2. And then also remember that they've put out a supplementary tender for TEE, which was the old combination drug, and we're waiting for that to be adjudicated. And our information is that that's likely to be adjudicated in the first week of March. And we had put in a bid for that product. So we'll know a little bit more, I think, early next month.

Our next question is from Itumeleng Seanego of Benguela Global Fund Managers.

Just can you give us a bit of more color on why did you guys suspend BronCleer? Were there stuff that you -- effects that you found in the product? Just a bit of color on that. And what is the plans on reinstating that product back into the market?

Yes, with pleasure, Itumeleng. And so I think you might have noticed last year sort of in the -- roundabout April, May...

Sorry, the line is a bit bad. I can't hear you. Hello? Hello?

Can you hear me now?

No, it's breaking, probably let's give...

Well, Mr. Itumeleng, that's from your side. Then will you -- can you just redial, please? Because the line is very clear on the main speaker's side.

Okay, I can hear you properly now. Let's try maybe one -- like one more time?

Okay, Itumeleng, have you got me?

Yes, yes. I can hear you properly now.

Okay. Sort of roundabout April, May last year, it might have even been roundabout March. There was a lot of adverse publicity around abuse of BronCleer in the market. And we are a company that supports responsible use of our medicines. No matter what active ingredients are inside them. And we just weren't comfortable with the level of publicity we were seeing and we made a decision. We spoke to the regulator about it and made a voluntary decision to effectively stop selling BronCleer in May, so that we could see where the problem areas might be and effectively to try and wash the market out of the product. And we resumed those sales again in consultation with the regulator in late November 2019. So that came back into the market effectively at the end of the year. There were certainly no product defects or any quality issues with BronCleer at all.

Okay. And just in terms of -- just as a follow-through, in terms of your African business, I mean it was a nice strong up-trading profit there. I mean can you give us a bit of color what drove that? Were -- is it through cost containment or what? Because, obviously, revenue was split, but trading profit was quite strong up.

Yes. Look, we are not a big player in Africa. So I think about 3% of our revenue comes from outside of Africa and probably about 0.5% of our profit. Our model in Africa is to not put down any fixed infrastructure in terms of facilities and the like. And we prefer to operate through distributors and agents. And our plan in Kenya over the last 6 months has really been to look at the cost base there to see how we can reduce it. And in fact, we are still busy with that process of potentially outsourcing all our work to an agent or a distributor there and not doing anything in-house. And we actually prefer that model for everything outside of Southern Africa.