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

Good morning, ladies and gentlemen, and welcome to the Adcock Ingram year-end results. [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, sir.

Thank you, Denai. Good morning, ladies and gentlemen. Welcome to our webcast for our 30 June 2022 annual results. I'm going to take you through an overview of the financial performance, which we consider to be very strong. These results can be attributed to a healthy growth in turnover. We had a favorable exchange rate supporting the margin during the year and obviously, on the top line, underpinned by a huge sales, marketing and operational effort from our people. And once I'm done, I'll hand over to Dorette and she will talk through the detailed financials for you. For the year under review, turnover increased by 12%, which was driven by volume growth of 6%. What we saw there was really good demand for our OTC and consumer products. We had a mix benefit of 5% either through partnerships, innovation or new products. We did see some price deflation in both the renal segment of the hospital business as well as the ARV segment in the prescription business. And when combined back into the overall group, that resulted in overall price realization of just 1.5%. We saw an improvement in the margin. Gross margin to 35.1% effectively due to the favorable sales mix and the improved exchange rate. Our operating expenditure was up by 10%. This was predominantly a result of higher variable selling and distribution expenses on the back of the higher turnover. And then we had increased investment in marketing of our flagship brands compared to the prior year. Trading profit increased by an excellent 22%. Just looking at the regulatory environment. As you know, we operate in a highly regulated environment, including price controls. The single exit price adjustment for 2022 was 3.5%, and that was on the back of 3.7% in the previous year. The Pharmaceutical Task Group has engaged with the pricing committee on the single exit pricing for next year, and we've submitted a consolidated submission to the department in that regard. As you know, the quantum of the SEP adjustment that's awarded by Department of Health ultimately determines the extent to which our margins remain under pressure with the rising cost of raw materials and packaging and at the moment transport as well as utilities and wages. Another regulatory matter that is receiving attention at the moment in July, SAHPRA requested supporting clinical data to substantiate the safety and efficacy of coding in the population younger than 12 years, and we are busy with our submissions in that regard. They had already received industry-wide submissions for the general population, and those were reviewed sometime this year. Just looking quickly at our business units, our Consumer division, which competes in the health care, personal care and home care segments of the market, in its portfolio, it has analgesia, energy, dermatology, vitamins, minerals and supplements, shoe care and home cleaning products. This business delivered an outstanding performance during the year, reporting an increase in turnover of 23%. This included a sterling performance from Panado, which reached a landmark annual sales value in excess of ZAR 500 million. Other core brands such as Epi-max, Compral, Plush and ProbiFlora also all showed excellent growth. The division's innovation and marketing performance was exceptional and trading profit ended 49% ahead of the prior year. In terms of the growth and expansion, newly acquired brands from Peppina on 1 December 2021, and which are effectively personal care and health care brands collectively added sales of ZAR 15 million; and then innovation within the existing portfolio added approximately another ZAR 20 million. In this regard, on innovation, the team launched sugar-free variants in its Gummy Vites range. Epi-max launched 4 variants of Emolian washes. GynaGuard has expanded its range and now includes larger pack sizes on the washers and also introduced a teen range. And plus right at the end of the year, launched a bleach range. In June, the division concluded a commercial agreement with Karo Pharma, which has been a long-standing prescription division partner of ours, and that agreement is for the sales, marketing and distribution rights to E45 in South Africa, a very well-known dermatological brand. We expect to be selling that product in the new calendar year. Our over-the-counter division holds market leadership positions in pain, cough, colds and flu, digestive and allergy therapeutic categories. These products moving mainly through the pharmacy channel in South Africa. In Schedule 1 and 2 in pharmacy, this business has a 20% market share and about 30% by volume. It's basket of winter products, which were most negatively impacted by the COVID-19 pandemic have shown a good recovery post the pandemic due to the increased prevalence of colds and flu and both corporate and independent pharmacy have responded well to this team's commercial strategies. So we saw an increase in turnover here of 19% with Citro-soda, Allergex, Corenza or Alcophyllex and Dilinct, all posting double-digit ex factory growth. The gross margin was lower than the prior year, partly due to the rate of acceleration in the cost of raw materials, utilities and wages. And we are also absorbing the full depreciation on the new ophthalmic plant at the moment into this division as their facility is now operating commercially. As a result, trading profit in this division increased by 9% to ZAR 318 million. The very well-established sponsors of Brave campaign continues to recognize health care professionals who are doing exceptional work within their communities and community pharmacy has been recognized as playing a pivotal role in the delivery of primary health care and of course, that being a key customer to this division. Our prescription division markets a portfolio of branded and generic medicines. They also have specialized ophthalmology equipment and surgical products and promote brands on behalf of multinational partners. The turnover in the prescription division improved by 7%, which is effectively 10.5% on a like-for-like basis. You will recall, we transferred Epi-max out of this division in the middle of the prior year. The performance of the business has been aided by the increase in elective surgeries and health care practitioner visits consequent to the reduction in lockdown restrictions. The largest non-OTC brands in this division are Synaleve and Adco-Zolpidem and they both performed well in the fiscal year, showing double-digit sales growth. With effect from 1 March 2022, the division entered into a sales, marketing and distribution agreement with Novartis, again, another long-standing partner of ours on a well-known range of 19 ophthalmic products and these were generating revenue in excess of ZAR 200 million per annum. In the final quarter of the financial year, the team launched DEXILANT, a new chemical entity on behalf of Takeda, one of our multinational partners. It's a proton pump inhibitor, giving patients 24-hour relief of heartburn symptoms. In its first full year of sales, since its launch in the prior financial year, [ Blitcima, ] which was the first rituximab biosimilar launched in South Africa has exceeded ZAR 50 million in sales whilst at the same time, significantly reducing the cost of these biosimilar treatments to patients. All in all, this division grew trading profit by an exceptional 24% even after the transfer of Epi-max to the Consumer division. Our Hospital division is the leading manufacturer and supplier of critical care and hospital products in South Africa. Turnover year increased by 6%, assisted by the onboarding of a portfolio of renal products from Roche specialized pharmaceuticals. We've seen improved demand for a number of products due to the increased number of hospital admissions and elective surgeries. And also, we saw good sales from the Abbott Diagnostics rapid testing COVID kits during the year. However, the very welcomed but significant decline in COVID-19-related hospitalizations resulted in far less demand for acute renal dialysis products in this division. Trading profit here improved by 2%. Just looking at our manufacturing facilities in Clayville, the high-volume liquids, effervescence and powders facility delivered a decent performance during the year with improved throughput. And now this was achieved despite regular interruptions in the municipal water supply in that part of Ha Tinh. The production of the first commercial batches of Allergex eye drops has been completed and we're currently awaiting approval from SAHPRA to release that product into the market. At Wadeville, the liquid screens and ointment section of that plant has shown good improvement in throughput and we intend to increase those production levels in the new financial year as we transfer products from a contract manufacturing into that facility. The low allocation by the National Department of Health in the latest ARV tender requires that the oral solid dosage part of that facility be reconfigured. And effectively, we will be doing shorter and more flexible runs of tablets and capsules in that part of the factory. The Aeroton-based critical care facility is at satisfactory throughput through the year and is still undergoing a number of regulatory improvements and infrastructure upgrades to maintain its regulatory compliance with SAHPRA and continue to meet Baxter's quality standards. Our distribution department operates in partnership with RTT, which is our outbound logistics service provider. Our focus area in distribution still remains service levels, regulatory compliance and cost containment, especially in the current environment of ongoing fuel price hikes. We've renewed the leases of 3 of our coastal distribution centers in KZN, the Eastern Cape and the Western Cape. So those have been signed up for another 5 years. In our ESG journey, our ongoing efforts to move towards the use of renewable energy. We've installed solar panels at our head office, which is also where our main distribution center is located in Midrand. Our distribution centers in Cape Town and Durbin will also be using solar energy before the end of this calendar year. And all of these initiatives were done in partnership with our respective landlords at those 3 sites. Solar power at our Clayville manufacturing plant is expected to be commissioned by the end of this month. And that should provide that plant with about 30% of its daytime energy usage. Our other environmental initiatives are focused on waste management and reducing the waste that we currently send to landfill. Transformation remains a key focus for the group. We achieved a Level 2 rating in November last year. The group continues to invest in the development and up-skilling of our employees. We expanded our enterprise and supply development program this year, and we also invested more in corporate social responsibility projects then a year ago. This included providing relief to the flood victims in KZN and making a donation to the Independent Community Pharmacy Association Emergency Fund following the looting that took place there in the middle of 2021. That completes my overview for the year. I'll hand over now to Dorette for the financials.

Thank you, Andy. Before I get into the details of the financial results, I would just like to mention that the results were clear as well as the annual financial statements are also available on our website. So looking at the income statement, starting with turnover, which increased by ZAR 929 million to ZAR 8.7 billion following the increased demand for over-the-counter and consumer health care products. Organic volume growth of 5.8% was achieved and mix accounted for 4.6%. Price increases in line with inflation were realized in OTC and consumer. However, when this was combined with the price deflation we've seen in the renal segment of the Hospital division and the ARV segment in the prescription division, overall price realization was just 1.5%. Gross profit of just over ZAR 3 billion is 14% above the prior year with some leverage achieved from the growth seen in sales and the gross margin improving from 34.5% to 35.1%. This was a result of a more favorable sales mix and improved currency and both of those could offset the increases we've experienced in the production costs. Speaking of the currency, during the year, the following material foreign currencies were bought EUR 46.5 million at an average rate of ZAR 17.51 which represents a strengthening of 7.5% compared to the prior year, which was at ZAR 18.92. And we bought USD 77.5 million at an average rate of ZAR 15.22, representing a 6.3% strengthening compared to the prior year which was at ZAR 16.25. With approximately 60% of our FECs in U.S. dollar and 40% in euro, the weighted cost of our basket of all currencies decreased by approximately 6.9% compared to the prior year. At the end of the financial year, we were carrying the following open FECs: EUR 21.5 million at ZAR 17.38 and USD 26.2 million at ZAR 15.83, which already represent a 4% weakening over the rate we achieved during the previous year. Moving on to the operating expenses of ZAR 1.9 billion, which ended 10% higher than the prior year. The overall increase of 10% in units distributed, the higher car costs following several fuel price increases during the year, as well as the increased investment in marketing of our core brands contributed to the increase, as Andy also mentioned earlier. Trading profit of ZAR 1.1 billion ended almost ZAR 200 million or 21.6% above the prior year, a first for the company. Non-trading expenses of almost ZAR 60 million consists mainly of share-based expenses of ZAR 40 million and intangible asset impairment of ZAR 11.5 million, a fair value adjustment on the long-term receivable of ZAR 4 million and corporate activity costs of ZAR 3 million. Operating profit of just over ZAR 1 billion is 24% above the prior year. Net finance costs of ZAR 41 million include IFRS 16 lease finance costs of ZAR 28 million. Moving to the equity accounted earnings, which are from the joint ventures during the year. The joint ventures, as you know, are the one with Netcare, National Renal Care, as well as the one in India, the JV with Medreich. The combined contribution is ZAR 10 million, below that of the prior year as the NRC results decreased by 1.6% and the results from the Indian JV dropped by 15%, the latter due to the increase in the cost of paracetamol experienced across the globe as well as the discontinuance of a government export incentive in that country. The effective tax rate adjusted for equity-accounted earnings is 29.7% with nondeductible expenditure causing the increase over the statutory rate. Headline earnings from operations for the year increased by 21% to ZAR 812 million. This translates into headline earnings per share of ZAR 0.502, an improvement of 24%. If we turn to the balance sheet, and I'll start at the top with the noncurrent assets. Under property plant and equipment, the depreciation charges for the year amounted to ZAR 183 million, marginally below that of the prior year, and it includes depreciation charges of ZAR 41 million on the separately disclosed right-of-use assets. Intangible assets, including goodwill, have a carrying value of ZAR 1.2 billion and comprised of generic, consumer and OTC trademarks and licensing agreements and include the addition of another tranche of brands from Aspen ZAR 465 million, a range of products bought for ZAR 38 million from Peppina as well as the trademark for ADCO Hygiene. Amortization in the year amounted to ZAR 9 million. Other financial assets of ZAR 22 million are primarily the capital contribution made to the Tiger Brands Black Managers' Trust, which has reduced following the fair value adjustment and as a result of options exercised during the year. And turning to current assets. Inventory of ZAR 2.2 billion is stated at the level of cost and net realizable value. The days in inventory at the end of the year are 133 days higher than the 123 days we reported in June 2021. Inventories increased due to the higher safety inventory help to address global supply constraints and to service the increased demand for OTC and consumer health care products as well as the onboarding of the Novartis ophthalmic brands and the newly launched products. Trade accounts receivable of ZAR 1.6 billion are shown net of provisions of ZAR 54 million and days were at 58 days at the end of the year, an improvement over the 60 days reported in June of the prior year. Government debt makes up 16% of the trade receivables and 54% of this customer's total outstanding amount is due within 60 days or less. Cash and cash equivalents ended on a very healthy ZAR 345 million at the end of the year. Looking at the bottom of the balance sheet, the ZAR 76 million movement in the non-distributable reserves since June 2021 relates mainly to an increase in the cash flow hedge accounting reserve of ZAR 17 million, an increase in the foreign currency translation reserve and an increase in the share-based payment reserves. The group has shareholders' funds of ZAR 5.2 billion at June. The only interest-bearing liabilities relates to leases and that amounts to just short of ZAR 340 million. Turning to the cash flow, where cash generated from operations was exceptional at almost ZAR 1.2 billion. We pay dividends of ZAR 350 million during the year and tax to the amount of ZAR 252 million. Investing activities of ZAR 323 million are mainly made up of an investment of ZAR 120 million into property, plant and equipment and ZAR 210 million for the intangible assets we acquired. Financing activities of ZAR 37 million relate to the repayment of lease liabilities and the settlement of equity options. The result of the aforementioned is an increase of just short of ZAR 300 million in the cash balances. Turning to the segmental information and starting with Consumer. Sales of ZAR 1.6 billion improved by 23.3% compared to the prior year, partly to the inclusion of Epi-max for the full year compared to the 6 months in the prior year. On a like-for-like basis, sales still improved 14.3%. Volumes improved by 7% with all material brands posting growth and most notably, Panado, who benefited from the COVID-19 vaccination campaign. And as only mentioned, reaching a landmark performance of -- in excess of ZAR 500 million in sales. The division achieved an average price increase of 4.7%, with mix, excluding the impact of Epi-max, contributing 2.6% and following the acquisition of a range of brands from Peppina, which was effective the first of December last year. A gross margin improvement was realized driven by the improvement in the exchange rate as well as a favorable sales mix. Operating expenditure ended 14.7% above the comparative year on the back of marketing investments behind the big brands and the distribution of higher volumes. As a result, training profit ended on an impressive ZAR 351 million, almost 50% ahead of the prior year of ZAR 235 million and 28.7% ahead on a like-for-like basis. Moving to the OTC business. Results was ZAR 2.1 billion, improving by ZAR 324 million compared to the prior year. This was mainly driven by the improved volumes of 14.3% following the relaxation in the COVID-19 restrictions which resulted in a higher demand across the division's cough and cold basket. The business benefited from an average price increase of 5.7% and while mix declined by 1.2% due to the repatriation of Abbott's brand. The gross margin was lower than the prior year, mainly due to the rate of acceleration in the cost of raw materials and utilities and wages. In addition, the factory has suffered from regular water supply interruptions during the year, which impacted the recoveries. Subsequent to year-end, we have constructed water storage tanks at this site to provide us with a 5-day buffer. Operating expenses ended 20% above the prior year as marketing investments, including TV advertising was released to support the big brands. As a result, trading profit of ZAR 318 million ended 8.8% above the prior year. Looking at prescription, the sale was ZAR 3.2 billion and ended 6.8% ahead of the prior year. On a like-for-like basis, excluding the Epi-max transfer, sales improved by 10.1%, aided by the lower levels of lockdown and a steady increase in elective surgeries. Volumes increased by 3.3% but price deflation in the ARV segment resulted in an overall price increase of less than 1%. Mix, excluding the removal of Epi-max contributed 6% to the increase and it includes the onboarding of the certain ophthalmology products from Novartis effective 1 March 2022. The gross margin ended in line with the prior year, even with the removal of Epi-max. Trading profit increased by 23.5% to ZAR 276 million. Lastly, the Hospital division. Hospital turnover improved by 5.9% to ZAR 1.9 billion driven by a change in mix, which contributed 9.5%, including the onboarding of the Roche renal portfolio as well as a rapid diagnostic test kits on behalf of Abbott Diagnostics and an infant nutrition range for the public sector from Similac. Selling prices were decreased in the renal business following the strengthening of the rand as agreed with customers when prices have been increased during the previous financial year when the rand deteriorated. This resulted in an overall price deflation of 3.8% in this part of the business or in this division. Organic volumes increased by only 0.2% as all modalities of the renal dialysis treatments declined. The gross margin ended in line with the comparative year and trading profit improved by 1.8% to ZAR 164 million. That's all from my side. Thank you, and I will hand back to Denai and we shall deal with any questions you might have.

[Operator Instructions] Now at this stage, we have no questions on the conference call. Are there questions from the webcast?

Thank you, Denai. I will read the questions. So we have a question on if we could provide more detail as to why Panado and the other core brands did so well this year, asking if the consumers use Panado to overcome some of the symptoms of the COVID vaccine. Andy?

I think if we look, first of all, at our marketing investment this year, you'll see it's quite a bit higher than it was in the prior year. So as we came out of COVID lockdown restrictions, we made sure that we put marketing spend behind the big brands and we've effectively increased that number by 16%. So one would expect the brands to react. In addition to that, we had much better footfall in retail and in pharmacy than we had a year ago. So if our products are well merchandised and visible to the consumer, that tends to help us. And then on the Panado side, your analysis is correct. We launched a campaign around COVID-19 vaccines. Because as you know, when people get these vaccines, sometimes they get symptoms, including headache and fever and the like. And that campaign effectively paid off in pushing those sales of Panado to record levels. So it was really a combination of those 3 things.

Then the next question is from Grant Morris asking for clarity on a few things on the ARV contract. Firstly, one thing to know when the existing contract is ending. How much revenue in rand, how much in rand value inventory we are typically holding? And does the IRV stop generally turn more slowly than the group average?

Grant, on that ARV contract, that contract already ended at the end of 1 June 2022. So it effectively runs for 3 years from the first of July this year. We were doing about ZAR 400 million per annum on the previous tender. Our business on the tender, we effectively have all of the single molecule products or most of them, I should never say all. That will reduce our revenue there to about ZAR 100 million per annum on the ARV tender. The stock does turn a little bit slower in the ARV business. and it's mainly because a lot of the stock is related to active ingredients that's purchased from the East that we have to keep here to be able to respond to any orders that we receive from government. So it does turn a bit slower. And at the end of the year, we were holding around about ZAR 100 million in ARV inventory across the business.

Then we had a question from Luyanda from Nedbank. Also relating to the tender, wanting to know the impact on revenue and EBITDA. I think Andy pretty much just answered the impact on the revenue numbers. And we mentioned repurposing of Wadeville, how much CapEx will be allocated and over what time frame this will be done? Sorry, I'm just trying to go through -- also asking if we have EBITDA margin targets for divisions. So Andy.

Yes. So on the ARV tender, as I said, the reduction in revenue, we anticipate around about ZAR 300 million per annum, maybe just higher than that, Luyanda. The EBITDA -- the ARV margin on the tenders is thin. It's in the single digits. So the profitability impact is not severe to us. although we still obviously need to make sure that we recover in the factory, the production that's been lost there. So that's effectively what we're looking at from a financial perspective. The repurposing of the Wadeville factory is not an expensive exercise because that factory were -- the oral solid dosage portion of that factory was well configured for long runs of ARVs. And now effectively, we're just moving to shorter runs. So it makes the factory a little bit more flexible. There is some equipment that we'll need to purchase, but it's not material. And I can't see the CapEx for this project running at more than about ZAR 50 million over the 6-month period that we are in now. Look, we don't have a target EBITDA margin on the Consumer division. Our divisions here are measured on trading profit and return on funds employed in the main. And that's effectively how our top management in those divisions are incentivized. And then hedging, yes, as Dorette had mentioned, look, we hedge all our foreign denominated purchases. So as soon as we have a firm order, whether it's in dollars or euro and we have some other very small currencies, we take out an FEC at that stage that matches effectively the anticipated delivery date. Cost of raw materials, what we're currently seeing on active ingredient pricing, it's stable in hard currency terms at the moment. And in fact, we've just seen paracetamol prices come down a little bit, which was a nice surprise. But where we are experiencing pressure at the moment is on packaging, particularly cans, plastics, cardboard related packaging and some of the chemicals that go into our home care business also seeing quite significant price increases there.

Thanks, Andy. And then, Jared, from All Weather had a few questions. I'm going to deal with them pretty much one by one. The first 1 was asking about the impairments we've taken. And I'll answer it. If you look at the financials we published, we've taken an impairment on the Vita-thion brand as the sales, the future sales just doesn't support the value that we had on the balance sheet. And this is because this is really a niche kind of brand at a price point that is at the higher [indiscernible] level. And we've also seen the market following the car with pandemic that the vitamins, minerals and supplements overall coming down. So we felt it's necessary to take an impairment there. The next 3 questions from Jared, I'll hand over to Andy asking for detail on the Aspen brands that we acquired strategy to replace the ARV volume and why we haven't done a buyback in the current period, given our cash position.

Jared, look, on the Aspen brands acquired, Aspen identified a portfolio of generic products. So these are generally prescription products, but a handful of them are also over-the-counter products. that they identified as non-core for their operation in South Africa. And I suspect it might have something to do with Aspen's manufacturing strategy because these are not huge brands for them. So potentially, they do create options in their supply chain. But I'd much prefer Stephen or somebody there to answer that question for you. What it does for us is it effectively broadens our portfolio of generic products in our prescription division and then it adds some brands in our OTC business that allow us to operate at different price points to what we're currently operating with particularly in digestive products, yes, in the meal and digestive products. Replacing the ARV volumes, not a simple answer, but the Wadeville factory, it's effectively 2 facilities. You've got a liquid creams and ointments facility. And what we're doing there is we are bringing liquids that are made by a contract manufacturer in-house. So that will push up the volumes in the liquids part of the facility. And then in the tablet and capsule part of the facility, which is the other half. What we're doing is we obviously select to continue making the single molecules of ARVs, the capsules there. And then we are going to use Wadeville as a backup site for the Bangalore facility. So, for instance, products like Napamol and Panado are made in the main, the tablets in Bangalore. We're going to run batches of those products in South Africa as a backup to Bangalore, the reason being that we saw during COVID that when global supply chain problems hit and we have difficulties getting product out of the East, having a backup facility for those products would be useful in South Africa. So I don't think we'll replace those ARV volumes in total in aggregate. I think that would be optimistic. But certainly, I think we can get a long way to recovering to getting those recoveries back.

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