Sigma Healthcare Limited (SIG) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. My name is Brian Jamieson, and as Chairman of the Board of Sigma Healthcare Limited, I would like to welcome you to today's meeting, which is being held online-only in what are very unusual circumstances. As it is past the appointed time, I formally declare the 2020 Annual General Meeting of Sigma open. All presentations and a recording of today's event will be available on our website for later viewing. When I commenced as a director back in Sigma in 2003, I could not have envisaged my last AGM in 2020 would be a virtual meeting with no shareholders in attendance. However, the world is a different place, and we find new ways to adapt and deal with challenges and create opportunities from crisis. Before we proceed, I would like to introduce the members of the Sigma Board and Management who are present today with us: David Manuel, who is a member of our People and Remuneration committee, and he's online from Perth; Kate Spargo, who is a member of the Risk Management and Audit Committee; David Bayes, who is the current Chairman of the People and Remuneration Committee and a member of the Risk Management and Audit Committee and is up for reelection today; Christine Bartlett, who is a member of our People and Remuneration Committee and is online from Sydney; Ray Gunston, who is the current Chairman of the Risk Management and Audit Committee and a member of the People and Remuneration Committee and is up for reelection today; Michael Sammells, the newest addition to the Sigma Board having joined in February this year and is up for election today. We're also joined online today by Mark Hooper, our Managing Director and Chief Executive Officer; Wayne Johnston, our Interim Chief Financial Officer; Sam Lawson, our General Manager and Company Secretary; as well as representatives from the company's auditors, Deloitte, and our share registrars, Link Market Services. Turning to the order of business. We have 5 items of business today, as outlined in our Notice of Meeting, being the Chairman and CEO addresses, the financial statements and reports, a remuneration report, the reelection of directors and the renewal of the proportional takeover provisions. There is a chat facility provided on your screen where you can type in questions relevant to each item of business, and we will endeavor to respond as appropriate. The first item of the business is effectively an overview of the past 12 months and general business update. I will now give my insights and then hand over to Mark for more detail. Well, what a 12 months we've just had. In an ordinary year, our business transformation program of the scale we embarked on, designed to achieve over $100 million in efficiency gains, would have been enough to stretch management and the business, but this has not been an ordinary year. Over and above this, we have successfully defended a takeover offer, commenced operations at 3 new distribution centers, kicked off an SAP implementation program, launched the Salesforce customer relationship management platform, facilitated the smooth end of the Chemist Warehouse supply agreement before we successfully won back a large proportion of that business. We extended our pharmacy network, continued to grow our hospitality -- pharmacy cost base, have dealt with logistical challenges to support the community through the devastating bushfires and now have been dealing with responding to the challenges of COVID-19. I will leave the detail on that to Mark, but let me first say, I'm incredibly proud of the way that Sigma's management team and all team members have embraced everything that has been thrown at them this year. Through all of this, we have just got on with making Sigma a better business for the long-term benefit of shareholders. With that context, the financial results for the year were always going to be difficult and complicated to follow. Revenue for the year was $3.2 billion, which is down from $3.9 billion last year. This reflects the supply to Chemist Warehouse for 5 months, largely ending at 30th of June, and then some phased supply recommencing from December 2019 under the new agreement for FMCG products only. The fact that a new agreement was entered into so soon is a testament to the way our team have managed the overall process and the service levels Sigma provides. What is perhaps overshadowed in this number is that our retail pharmacy brands, Amcal, Guardian, Discount Drug Stores, PharmaSave, Chemist King and WholeLife Pharmacy have achieved like-for-like sales growth during the year of 11.7%, significantly above market. Around 20% of the consumer spend in pharmacy is in one of those brands. This flowed onto -- into our ongoing sales -- wholesale sales revenue being up 8.5%. And in addition, our sales to hospital pharmacy were up 26% for the year, as we continue to extend our reach into this market. So I am confident that the underlying operating business is in good shape. Reported EBITDA for the year was $24.2 million impacted by a number of one-off costs incurred whilst we undertook the transformation program. Adjusting for that, underlying EBITDA was $46.7 million. Net debt for the year ended at $146 million. The Board unfortunately had to take the decision to suspend our final dividend for this year. Whilst we are not alone this year, our decision was influenced by having insufficient franking credits. We continue to have confidence in the business, our path through the COVID-19 challenges and our cash generation. We will review our position as the year progresses. Turning to our capital investment. We have maintained an accelerated concentrated capital investment program these past 4 years which will include -- conclude over the next 18 months. This has seen over $220 million invested in generational change that will deliver an industry-leading distribution center network that significantly improves our operational capacity and efficiency. This investment cycle has seen Sigma acquire land, construct purpose-built distribution centers and fit them out with the latest automation. This has been completed at Berrinba in Queensland, Canning Vale in Western Australia, Pooraka in South Australia and Kemps Creek in New South Wales. More importantly, the decision to own and manage the construction of these distribution centers has not only ensured that we have the facilities we need. Operationally, it has also seen the creation of significant shareholder value, which is not currently recognized in our accounts. We have flagged our intention to review a potential sale and leaseback of these facilities to realize that value, and I will leave that to Mark to provide an update shortly. Our investment cycle will conclude with the implementation of a new ERP or enterprise resource planning system, which will be deployed during FY '21. Significant planning and analysis work went into managing the process and ultimately selecting SAP S/4HANA and SAP next-generation product suite. Whilst the COVID pandemic did impose some early challenges, good progress has been made to a point of validating the proposed operational framework. We have partnered with Accenture and Infosys, both experienced partners in SAP implementation programs, and we are confident we will achieve the desired outcomes from the program. I would also like to make reference to the proposed merger put forward by API, which played out during the year. Just to recap, API acquired 12.95% of Sigma as at December 2018. Having considered their proposal and established a clear road map for the medium- to long-term future of Sigma as a stand-alone business, we rejected their proposal. And API sold their holding and exited our share register in December 2019. We remain absolutely confident this was the right decision and still the right decision for shareholders. At the time of rejecting the proposal, we announced that over $100 million of efficiency gains will be achieved over the next 2 years through Project Pivot. As at the 31st of January, action had been taken on achieving $62 million of that with progress continuing. As I've just outlined, our capital investment program is nearing completion and is already delivering an outstanding result for customers and their shareholders. Before I hand over to Mark, I would like to mention the work we do on corporate social responsibility. We have continued our efforts to improve our environmental footprint through reducing energy, efficient routing of logistics services, adopting environmentally friendly packaging and effective waste management. Our new DCs were constructed with an eye on minimizing our environmental footprint, which they have done. They have also proven their worth through standing up to the challenges society faced recently with the bushfires and COVID-19. During bushfires, Sigma made financial and product donations to the community in need. Above that, I want to recognize our team members who went to extraordinary efforts, partnering with the essential services and local pharmacies to support the isolated communities to receive essential medicines and provide the support they needed. During the year, we also continue to provide direct support to customers, charities and communities in need, including Vinnies and the Summer Foundation. Just finally, as I address the meeting for my last time as Chairman, I thank all shareholders for your support over many years as we have faced and overcome many challenges and taken the opportunities available to us. In particular, I would like to thank my fellow directors for their support, the executive team for their passion and drive in the business, and especially, Mark, for his unwavering work ethic, drive and commitment in always seeking the best outcome for Sigma and our shareholders. Thank you. I will now hand over to Mark.

Thanks, Brian. And I -- can I extend my thanks to shareholders for joining us online today. This is a new experience for everyone as we adapt to the challenges of COVID-19. Brian has already provided a high-level review of this year's financial results, so I'm not going to address that further today. Long-term financial performance is important, and we have made significant progress over the past few years towards building a stronger future for the business. Today, I want to briefly outline the key business drivers that I'm confident will lead single back to a position to sustainable growth. First, the Project Pivot. To refresh people's memory, it was just over a year ago in February 2019 that we announced this major business transformation program. Following detailed analysis of our business, supported by Accenture and EY, we identified in excess of $100 million in efficiency gains that could be extracted over 2 years. This is a challenging and ambitious program to fundamentally reengineer our business and to become a more efficient and effective version of ourselves. Our full year results announcement in March this year, we reported great progress on Project Pivot with actions taken to release over $62 million in annualized efficiencies to the end of January 2020. While the bushfires and COVID-19 pandemic has seen a delay in timing, it has not derailed our program, and we remain on track to realize the full $100 million of targeted benefits. We will provide a further update at our half year results announcement in September. One pleasing complication to the program was the FMCG supply contract with Chemist Warehouse. As we announced in November, we reached agreement to recommence the supply of FMCG products on commercially acceptable terms to both parties. At full run rate, this will see approximately $700 million to $800 million in revenue. This has resulted in our team effectively reinvesting some of the earlier gains under Project Pivot, which is obviously more than offset by the margins we earn. Pleasingly, the progress has been well managed with 80% of the work complete to date, and we expect to be operating at full rate -- full run rate under this agreement by 30 June this year. On the investment front, as Brian stated, the past 4 years has seen Sigma undertake the most significant capital investment program in our long and proud history, operationalizing 4 new distribution centers and decommissioning old, less efficient DCs. We have installed the latest automation capabilities to provide an efficient and effective platform to continue to improve our service standards for existing and new customers and provide operational and physical capacity for growth. This was clearly demonstrated with our DCs very -- with our DCs very effectively absorbing the recent spike in demand from COVID-19. The decision for Sigma to initially own fund the land and buildings has also created significant incremental financial value for shareholders that is not currently recognized by the market. As flagged at our results announcement in March, we're investigating a potential sale and leaseback of the DCs to realize the uplift in value created through the process and then create balance sheet flexibility to pursue further growth options. An information memorandum was released in April, and we received 13 expressions of interest from which we have selected a short list to assess and progress discussions. We will provide a further update once the transaction is finalized, which we anticipate being in the third quarter of this year. Turning to industry regulation. The regulated part of our remuneration is determined by the terms of the Community Pharmacy Agreement or CPA, and the Community Service Obligation or CSO. These are typically 5-year agreements with the current agreements running until June 2020. Currently, negotiations are ongoing and engagement with the Health Minister and the Department of Health has been positive. While I can't comment specifically due to confidentiality constraints, I'm encouraged by the fact that there's a broad understanding that after 5 years of declining returns, investment in this critical sector is needed to ensure that it can continue to service the community needs for equitable access to medicines. And whilst the bushfire crisis and COVID-19 are tragic in every sense of the world, they have highlighted the important work that we do in ensuring medicines reach every corner of Australia when needed and the critical role played by the infrastructure that we have built to make that happen. The COVID-19 pandemic has presented unique challenges, and I am incredibly proud of the way that our team members have adapted. The support they have shown each other and the way they have ensured that we continue to deliver the essential medicines the community rely on. From a Sigma perspective, we moved quickly to implement practices across the business to help protect the health and safety of our teams, including social distancing, enhanced cleaning practices, working from home and rostering. We've put in place a resource hub to support the physical and mental well-being of our teams, both now and in preparation for coming out of the isolation period. We also increased our support and communication for our retail pharmacy partners, undertaking new initiatives to help them better support Australian patients. From an operational perspective, at its peak in March, volume, excluding Chemist Warehouse, was up an average of 70% for the month over last year and 80% in some weeks. We brought in additional labor to deal with the demand to ensure we could not only fulfill customer orders, but could also replenish with new stock as it became available. We work closely with the government, the TGO, TGA, the CSO agency and various industry bodies to ensure the effectiveness of managing the supply chain. This period has provided an unprecedented test of our team members and our new DC infrastructure and both have absorbed everything that was thrown at them. Finally, I'll now make some closing comments on the outlook for Sigma. As you'll know, we ended FY '21 with great momentum. Wholesale sales has had an extraordinary start to the year, accelerated by the COVID-19 volume growth. Excluding the Chemist Warehouse transition in each year, underlying volume for the first 3 months of the year is up over 30% and revenue is also up by around 30%. This is likely a combination of new revenue and revenue that's being pulled forward and where the balance sits on that will play out over the remainder of the year. Our retail pharmacy brand delivered 11.7% growth in FY '20 and appear on track to deliver above-market growth again for the current year. The strength of our pipeline for potential new customers is also pleasing. Full credit to our retail and sales team, who continue to support the network, especially through this challenging period. Our hospital pharmacy services business achieved growth of 26% in FY '20 and again shows much signs of maintaining that growth into the current year. We have recently signed 2-year extensions on some existing service agreements and are actively participating in tenders for new business. A lower profile business within our group is Medical Industries Australia or MIA. MIA provides medical consumables and devices to hospitals, aged care facilities, medical clinics and pharmacies. It is operating in a sweet spot right now. We have previously flagged our intentions to diversify into this space, and MIA is our vehicle for doing that. While coming off a low base, it is seeing significant uplift in volumes and revenue, and we continue to seek avenues for this business to accelerate its growth through FY '21 and beyond. We're experiencing strong growth and momentum in the year-to-date, Consistent with most companies, we are not providing FY '21 earnings guidance. What I can say is the combination of the actions we have taken, such as the efficiencies from Project Pivot, our DC investments, and our various sales programs and expanding our 3PL and Medical Consumables business has already produced a strong platform for earnings growth. The return of some of the Chemist Warehouse contract and the opportunities created as we emerge from the COVID-19 pandemic will further enhance this. Finally, I extend my thanks to all the frontline health care workers across the country who are working tirelessly to keep us all safe and healthy, and to all our team at Sigma, who are also working hard to support the community. I would also like to personally acknowledge and thank Brian for his support, leadership and guidance over the past 10 years as Chairman. Thank you for your online attendance today, and I'll now hand it back to Brian.

Thank you, Mark, for that update. Before we move on to the remaining items of business, I thank those shareholders who took the time to send in questions in advance of today's meeting. I will now address a couple of the more common questions received. A chat function is also available on the right of the screen, and we will respond to questions where possible. First question. Why has Sigma held its AGM via webcast only? Given the COVID-19 social distancing requirements, face-to-face meetings was not possible, and we did consider various options for holding the AGM. On balance, we were not convinced that a live video webcast offered a materially better experience for shareholders given the broadband issues into households and the significantly higher cost of this option. We have provided the ability for shareholders to lodge questions in advance of the meeting and to enter questions live in the chat function that we can respond to. Next question. How has Sigma responded to the risk of COVID-19 pandemic? We identified COVID-19 as a business risk, and some of the early steps we took to manage this risk were outlined on Page 29 of our annual report. We implemented a whole of business COVID-19 working group, which reviewed our risks and assessed our business continuity and response plans. This process helped to ensure we were prepared for various scenarios and could adapt our ways of working under the social distancing requirements. We are in a position to respond and manage any of those risks to ensure business continuity. We also identified areas of opportunity for Sigma longer-term once we come out of the other side of COVID-19 restrictions. There were also several other questions received on the remuneration report, which we'll address when we reach that item of business. We'll now move to the next 4 items of business, which are the financial statements and reports; the remuneration report; the reelection of 3 directors, being Michael Sammells, David Bayes and Ray Gunston; and the renewal of the proportional takeover provisions. All resolutions will be put to a poll with all eligible proxies required to have been received by 11:00 a.m. on Monday, the 11th of May 2020. If there are any questions during the course of business, please enter the details in the chat function provided on your screen, and we will endeavor to respond where appropriate. I will be voting any undirected proxies appointing the Chairman as proxy as in favor of all resolutions. Item 2 in the Notice of Meeting is consideration of Sigma's financial report, director's report, auditor's report for the financial year ended 31st of January 2020, which I will take as received and read. This matter does not require a resolution. So I will now pause to allow time for any questions to be entered in the chat function. The company auditors partner, Andrew Reid, from Deloitte is online to take any questions on the auditor's report and on the conduct of the audit.

Mr. Chairman, I have a question from Mr. Mike Robey from the Australian Shareholders Association. The question is, "The ASA is pleased to see that you comply with the new ASX diversity reporting requirements. It is a little disappointing that 2 senior female executives were lost, moving the gender diversity from 50% to 20%. Was there less concern with the retention or loss of these 2 senior female executives?"

Thank you, Mr. Robey, for your question. Sigma is committed to workplace diversity, not just gender-based. As reported in our workplace gender equality report, 58% of our workforce are female and 42% male. Whilst it's disappointing to lose 2 senior female executives during the year, these permanent positions remain open to the recruitment of the best available candidate, whether they be male or female executives. Regarding the retention incentive, this was available to both these executives. However, both left Sigma and therefore, forfeited the retention. This highlights the very real challenges we, as a business, were facing at the time of putting a retention in place.

Okay. Mr. Chairman, we have another question from Mr. Mike Robey from the Australian Shareholders Association, which reads, "Whilst we applaud the 5-year FMCG deal with Chemist Warehouse to better utilize the newly minted warehouse capacity, what makes us confident that we will not get similar issues with the new contract, given they only completed a single year of their contract with DHL?"

Thank you, again, Mr. Robey. We can't speak for the DHL arrangement, other than to say that we understand there were supply issues that they -- could not be resolved. The terms of the agreement are confidential, but we have both entered into in good faith, with the new contract structured it differently to provide some safeguards for both parties. Thank you. That concludes our consideration of the financial statements and report.

We now come to Item #3 on the Notice of Meeting to adopt the company's remuneration report for the year ended 31st of January 2020. The Corporations Act requires an advisory nonbinding resolution to be put to shareholders for the adoption of the remuneration report. The remuneration report provides the detail. However, the key objective of our remuneration strategy, as outlined on this slide, is to attract, retain, motivate and reward employees in return for achieving high performance and creating sustained shareholder value. Alignment with shareholder value is driven by our executive remuneration structure that comprises a fixed salary component and had risk component made up of short-term and long-term incentives. What I do want to highlight from this year's remuneration report are the following points. Our STI plan effectively has 2 steps, an initial gateway test to determine whether there is a potential for an SDI to be awarded at all. If that is achieved, as it was this year, then we assess the specific financial and nonfinancial outcome against predetermined performance hurdles. This year, STI was awarded for reaching the nonfinancial hurdles, but the hurdle was not reached for the financial performance. So no STI was awarded in respect to financial performance. Looking back at 2018 and 2019, no STI, other than safety, was awarded at all. This indicates an alignment of shareholder value with the company's gateway being consistently set at the same level of budgeted net profit after tax for almost 10 years. The other component of our remuneration structure is the long-term incentive plan. LTIs are issued each year but if performance criteria are not met, they expire and are forfeited. With the exception of 2019, Sigma has operated a loan-funded share plan. Meaning that if the performance criteria is met, the employee is eligible to pay off the balance of the loan to acquire the shares or to forfeit the shares if they are valued below that loan amount. By way of background, a proportion of the 2015 LTI's vested, however, some have been forfeited and the 2017 LTIs did not vest and were forfeited. For 2016, 50% of the LTI is vested and the executives have until the 31st of January 2021 to either pay off the loan, to acquire the shares or forfeit them. In 2018, the LTI remains subject to performance hurdles until January '21. For the 2019 grant, we switched to performance rights to -- in response to the unique circumstances we faced during the year, including the potential takeover, subject to the same performance conditions as in the previous years. With many of the challenges now behind us, we have now reverted back to the loan-funded share plan for 2020. All of this points to a strong alignment between shareholder value and executive remuneration. This year, we faced extraordinary circumstances with a potential takeover and a significant business transformation program. Individually, these were significant events. Combined, they were enormous. Given the critical nature of Project Pivot in transforming the Sigma business, specific incentives were put in place for key personnel charged with the responsibility to execute the project and deliver $100 million-plus in efficiency gains. I will say here that when we announce the extent of the program to the market, there was considerable skepticism about our ability to execute such an ambitious program. This incentive was measured over a 2-year period based on achieving performance targets. The targets were met for year 1, resulting in 100% of the rights attributable to Tranche 1 fully vesting on 31st of January 2020. Tranche 2 remains subject to achieving performance targets, which will be tested in January '21. Finally, our retention incentive was provided to keep certain key personnel. This decision was taken in recognition that Sigma was subject to a takeover offer and was at the most vulnerable to losing key people during this period of challenges and uncertainty. Such loss would have resulted in significant difficulty and cost to replace them in this environment. In fact, 17% of the people on the program did leave, forfeiting their right. This would have been much worse without it. I am very firm in my commitment that implementing this retention, which was tested with external advisers, was critical to the ongoing success of Sigma. In my opinion, to do nothing increased the risk that key executives would leave, which would not be a commercially responsible option nor in the best interest of shareholders. With that short background, I now move to the remuneration report for the year ended 31st of January 2020 be adopted. I would now like to pause to allow time for questions on this resolution to be raised through the chat function.