Sigma Healthcare Limited (SIG) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Sigma Healthcare Full Year Results Briefing Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Vikesh Ramsunder, CEO and Managing Director. Please go ahead.

Good morning, and welcome to our results presentation for the year ending January 2023. I'm Vikesh Ramsunder, the Chief Executive of Sigma Healthcare. Before I begin, I wish to acknowledge the Wurundjeri people, the Kulin Nation and acknowledge them as the traditional custodians of the land on which we meet today. I pay my respects to the elders past, present and emerging. I am joined here today by Nigel Simonsz, our Chief Financial Officer; and Gary Woodford, our Head of Corporate Affairs. Together, we will take you through today's presentation. You are welcome to submit questions during the webcast using the tab at the right corner of the screen. Gary will then read out your questions at the end of the presentation for Nigel and myself to answer. In terms of today's presentation, I will start with a review of the year. Nigel will provide more detail on our financial performance. I will then provide an update on business performance, strategy and finish with the outlook for the year. Starting with some key highlights. Removing complexity within Sigma has been high on my agenda, and pleasingly, we have made good progress in simplifying the business through organizational design, divestment of noncore assets, a strong focus on operational delivery and process improvements. A key enabler for the year has been the stabilization of our ERP system, which is now performing as designed. This was the single most disruptive issue for our business and our customers. With system stability achieved, it's enabled operational performance to consistently improve and provides a platform to win back trust and confidence of our customers. Our logistics operations have taken great strides this year. The team have been able to clear the backlog of issues that were a roadblock to our service levels and growth. Pleasingly, service levels are above where they were prior to our ERP challenges. Our delivery of full metric, which is a critical measure for customers is now worth 98% and delivery on time, close to 100%. In terms of our DC infrastructure, we opened our new Hobart distribution center, and we doubled the size to about Truganina distribution center. Both these projects improve our ability to better service our customers and increases our available capacity to absorb volume growth. That now concludes our DC renewal program. In September, we announced plans to consolidate data from 5 franchise brands, down to 2 brands, Amcal and Discount Drug Stores. Pleasingly this program is progressing well. Conversations with our guardian members have been positive, and the conversion pipeline of identified members is on schedule. Of course, brand consolidation comes with some risk, but the longer-term benefits of providing better and more targeted support for fewer brands will help drive customer engagement, foot traffic and ultimately, long-term growth. This year has also seen a major reset for our team. We have renewed our executive team and have recently announced changes at Board level, increasing Board expertise in the areas of logistics and finance. The new executive leadership team are currently focused on recruiting talented individuals to execute the strategy that we outlined at the half year. Turning now to our financial performance. I commented at our previous full year results announcement that we would return to profitability and pleasingly this has been achieved. Earnings before interest and tax were up over 700% for the year. Reported NPAT is $1.8 million. This is up from a loss of $7.2 million in the prior year. Momentum was skewed towards the second half as we began to rebound from the disruption of our ERP challenges and embed new ways of working under new leadership. Nigel will provide you with more detail on our financial performance shortly. A key highlight of these results is the reduction in net debt from $149 million at the end of FY '22 to $67 million at the end of FY '23. A major contributor was our focus on working capital management, which resulted in the cash conversion cycle producing to 22 days. Considering the improvement made in business performance, the Board has declared a fully franked final dividend of $0.005. This brings the total dividend paid in respect of this year to $0.01 per share. Guiding future decisions concerning dividend payouts, the Board has approved a dividend policy, which I will go through later in the presentation. With that overview, I will now hand over to Nigel to present the financial performance in more detail.

Thank you, Vikesh, and can I also say welcome and thanks for joining us today. I will now take you through our financial performance in some more detail. Sales revenue for the year was up 6.2% to $3.7 billion, largely driven by growth in sales to key customers and strong sales of rapid antigen tests in the early part of the year. Gross profit for the year was up 6.9%. There were 2 major one-off items impacting GP. The sale of high-margin RATs contributed around $52 million, which was $29 million on the prior year. Also impacting gross profit with $23 million of unfavorable stock adjustments versus the prior year. The stock adjustments largely reflect a provision for slow-moving inventory, including RATs and provisions arising out of ERP implementation and DC transition issues. Operating costs have improved by $4.7 million. However, this is the net result of various movements in both ongoing and one-off costs. Employment and freight costs were up partly due to higher volumes, and also in regards to freight, higher fuel prices. Marketing spend was also lower across the year, whilst IT costs, as we referred to at the half year, have increased year-on-year in an SAP environment. Total SAP and IT-related support costs have increased in the business by approximately $10 million per annum from the pre-SAP environment and will be ongoing. And in one-off costs, as we advised at the half year, we have taken impairment and write-off costs relating to Cura and also to recognize the sale of our interest in WholeLife in the second half. These are part of our ongoing program to simplify the business and streamline operations. There are a lot of moving parts noted on this slide, and I don't propose to go through each number in detail. However, importantly, the profit contribution from RATs sale has been an enabler for us to make significant progress during the year in executing against the foundational part of our strategy. It has supported our ability to cover the one-off costs associated with simplifying our business through the disposal of noncore assets, to better account for inventory using SAP and to make other necessary structural changes that will benefit the company and shareholders in the longer term. And positively, with all of these impacts, we have managed to deliver an EBITDA of $49.6 million, which is a 65% improvement on the prior year. And also for noting, the following key financial metrics have also improved. EBIT was $19.3 million versus $2.3 million in the prior year. And reported NPAT was $1.8 million as compared against the $7.2 million loss in the prior year. We have also made good progress in strengthening our balance sheet. We canceled our Tranche C debt facility during the year and closing net debt was down from $149 million to $67 million, which I will expand on shortly. And a couple of key points to note: Prepayments were down by around $43 million, which largely reflected the timing of purchases of RATs last year. Intangibles also decreased by $10 million, which is an outcome of the disposal of noncore assets already discussed. The reduction of net debt, as referred to earlier, is also a key positive highlight and is critically important as we continue to operate in a cycle of increasing interest rates. The most significant contribution came from an improvement in working capital, which was a real focus throughout the year. We also benefited from an improved EBITDA performance and the reduction in the prepayment for RATs inventory, as just discussed. Capital expenditure was $29 million, reflecting the finalization of the Truganina expansion and the move to our new Hobart DC in Tasmania. And turning to cash flow, improving working capital management has been a real focus for us. You can see the benefit in this graph with the cash conversion cycle, reducing significantly to 22 days, down from 33 days at the end of FY '22. This has freed up cash to pay down the Tranche C debt facility of $70 million and improve our overall net debt levels. Pleasingly, these have contributed to net cash flow from operating activities, increasing to $143 million, which is up significantly on the prior year. And finally, to our capital investment cycle. It has been an extended period of investment with close to $400 million spent in upgrading our distribution network and IT systems. This phase is now complete and CapEx should return to a normal cycle of between $5 million to $10 million per annum. This CapEx program has provided us with latent capacity to actively pursue growth opportunities. Our strategy now turns to leveraging these assets by growing profitable market share to grow shareholder returns. And with that, I'll now hand back to Vikesh.

Thank you, Nigel. I will now provide more detail on our business performance for the year. Starting with an update on our ERP implementation. Sigma committed to a total renewal of its ERP system in 2019, which went live in August 2021. Whilst this was disruptive for all our stakeholders during implementation, it now provides the business with world-class IT infrastructure and data intelligence to support growth. Over the first half of this year, we focused on stabilizing the system. This objective was achieved but required additional resources and costs. We also introduced a number of reporting tools and dashboards to support our teams in making better decisions and improving our operational performance. The second half of the year, our attention turn to optimizing the system and improving processes and practices across the organization. We also took the opportunity to enhance our cybersecurity measures, shifted our data center to the cloud and upgraded our customer ordering platform. This is all part of our overarching strategy of simplifying our business, and making Sigma easier to do business with. In January, we completed the upgrade of our inventory planning system, and early indications are encouraging as we have started to see an improvement in the availability of stock. The work ahead in the current year is to unwind system design elements that did not align to best-in-class business processes. Wholesale is the core of the Sigma business and an important part of our strategy. Pharmacy sales for the year was up 2.2%, benefiting from the strong sales of rapid antigen tests in the first half and sales of COVID antivirals in the second half, but were also significantly impacted by the operational challenges experienced during the year. These disruptions also meant that we lost over 2.5% in pharmacy market share for the year. Hospitals achieved 11% growth, and I will talk more about hospitals shortly. Over the last 5 years, Sigma had invested close to $400 million in new distribution centers and system upgrades. This has been a very disruptive period to navigate, and I am now firmly focused on growing scale to extract the return on this investment. During the year, we delivered 230 million units to pharmacy customers. Pleasingly, we made significant progress in improving our operational performance. You can see from this chart, delivery in full, which is a critical measure for customer satisfaction, has improved from 75% at the start of the financial year to over 99% in January 2023. These enhanced levels of performance have remained consistent since July '22. Stock availability has also continued to improve during the year. We also took the opportunity to renew our operational team by bringing in strong logistics leadership across the network. This is making a real difference to operational performance. The stabilization of the ERP system has also enabled an improvement in governance practices, which in turn has strengthened our stock management processes and reduced stock write-offs in the second half. In January, we upgraded our customer ordering platform to make it quicker and easier for customers to do business with Sigma, with average system response time increasing by 40%. Turning to our retail franchise brands, sales was up 4.2% across our franchise network. In September, we announced our strategy to focus on supporting 2 brands, Amcal and Discount Drug Stores. The first step in this strategy was to merge Guardian with the Amcal brand. In this process, we have been mindful of the impact for members who have a genuine connection with the Guardian brand. Importantly, the Amcal and Guardian brands have been run jointly for several years now, so the values are very much aligned. Their consolidation also allows the requisite scale required to drive a margin-enhancing private label strategy. Pleasingly, 50% of our identified Guardian members have already committed, and we are on track to achieve our convergence and targets. At the same time, we are renewing the brand value proposition of DDS and in new leadership. DDS has a strong market position and a dedicated member base, something we are keen to accelerate. There has been much focus this year on rebuilding the internal capability within our merchandise and franchise teams to ensure we have the required skills to implement our strategy. All these changes add risk in the short term, but are essential to uplifting our retail spending capability and will ensure sustainable brand member support and growth into the future. Our third-party logistics business has performed steadily throughout the year, providing warehousing and logistics services across the pharmaceutical medical consumable and fast-moving consumer goods sectors. Importantly, for suppliers, we offer secure temperature-controlled DCs, providing a high standard of care to help maintain the efficacy of the product. We currently have around 30,000 pallets of inventory under management for suppliers. With the completion of our Truganina DC in Victoria, we now have an additional 20,000 pallet capacity. Pleasingly, we have recently signed an extension of a major supply contract and are in active discussions to win new business to increase utilization. With our recent announcement regarding the disposal of our hospital business, more focus we shifted to growth opportunities in our third-party logistics business. Turning now to MPS Connect. This year has been one of steady and consistent improvement for MPS with 18% growth impact patient numbers. We have installed new technology and developed a strategic pathway towards growth, which has been particularly strong in the corporate aged care business, where we have achieved 45% growth in the last 12 months and now serves over 260 facilities. Importantly, growth has been achieved whilst maintaining best-in-class accuracy rates to deliver quality care and safety for our customers. An important initiative delivered during the year was the successful launch of MediSphere, our medication management software solution. Since the launch in February '22, subscriber numbers have grown from 5 to almost 350 and over 127,000 prescriptions generated through the platform. The quality of the MediSphere solution was recently recognized and was awarded silver at the Australian Good Design Awards in 2023. As I outlined at our half year results, an important part of our strategy is to simplify the business and to dispose of what we consider noncore assets. During the year, this resulted in the sale of Cura assets. Cura was a small component within the MPS operation, which is labor-intensive and loss-making. We also sold our interest in the WholeLife pharmacy brand. Whilst WholeLife provides a new product offering, it did not fit within our focused brand management strategy. As part of the divestment, we concluded a long-term wholesale agreement with the WholeLife owners. This month, we announced the signing of an agreement to dispose of our CHS hospital operation effective from 31 March, subject to regulatory approval. The value of the transaction is approximately $44 million, consisting of $35 million for inventory and $9 million for other assets. Whilst hospital is an adjacent operation to the core pharmacy wholesale business and continues to grow, it operates on unsustainable margins and are dilutive to earnings. To achieve profitability, the hospital business would have to grow to significant scale. Hospital market share has remained stable with no excess margin to price penetrate. In addition, this business is run separately and not part of the new automated distribution infrastructure and ERP platform. A significant investment would need to be made to conclude the integration. What the sale does for Sigma is the following: Firstly, it simplifies our operations; secondly, it negates the need to further invest in system integration; thirdly, it frees up between $35 million to $40 million of cash; and finally, it marginally accretes earnings. I will now provide an update on our strategy execution. Having invested significant capital on our new distribution center infrastructure and IT systems, we need to grow our market share. Our teams are highly motivated and actively engaging with pharmacy customers to land new business. As per my previous slide, the divestment of our noncore assets have begun with others expected to be concluded in the current financial year. This will continue to simplify our business as in a low margin, high-volume operating environment, complexity at friction and friction at cost. We now have a very clear brand strategy that is centered around strong retail management principles with the consumer being at the heart of the business. We will look to strengthen our product offering, enhance differentiation through increased penetration of private label and exclusive brands, as well as ramp up our marketing efforts to mention just a few. And finally, whilst diversification of income streams is an important strategic driver and evaluation work has commenced, this is a longer-term and more complex strategy to execute with meaningful implementation only expected to occur in financial year 2025. Turning now to our outlook for FY '24. Good progress has been made over the last 12 months to improve our operational performance, and I am confident that this will continue. [indiscernible] that the ERP disruptions have impacted customers' trust and confidence in Sigma, and this remains one of our biggest challenges. The pace at which we can turn this around is not possible to predict, but the core enablers to achieve success have now been put into place. As I have spoken about in the presentation, executing our brand strategy will be a very important focus area for the year ahead. The balance sheet has been strengthened and improving working capital management will remain an ongoing [ focus ]. Importantly, we also recognize the value of consistent and sustainable dividends for shareholders. As a result, the Board has approved a dividend policy, which will return between 50% to 60% of reported NPAT to shareholders and comes into effect in the current financial year. The dividend declaration will be assessed biannually and will remain subject to Board approval. Finally, we have made pleasing progress in improving our operational and financial performance. We are, however, only halfway through our turnaround objectives. There are still significant opportunity available to optimize our ways of working and pace of execution. We remain committed to a medium-term EBIT target of 1.5% to 2.5%. There will still be some disruption in FY '24 as we implement our brand strategy and continue our business simplification. In line with this, we anticipate EBIT to be between $25 million to $30 million in the year ahead. In closing, I would also like to take this opportunity to thank our people for their commitment and resilience in what has been a challenging but progressive year. Thank you for listening, and I will now hand over to Gary to read out your questions.

Thanks, Vikesh. Okay, first question is from Dave Stanton at Jefferies. Does the FY '24 estimate include or exclude the divestment of the hospitals business?

Because it hasn't achieved regulatory approval as yet, it excludes that.

Probably for Nigel. Should we see a significantly decreased interest expense in FY '24 compared to FY '23?

No, we still expect, with the backdrop of rising interest rates, we're still working through average net debt working levels. They'll continue to improve, but in a rising interest rate environment. We don't expect a reduction at this stage in interest rates.

Staying with Nigel and staying with the expansion, should we see an increased depreciation expense in FY '24 than FY '23?