Sigma Healthcare Ltd (SIG) Q4 2021 Earnings Call Transcript

Sigma Healthcare Ltd  ( ?????? : SIG) Q4 2021 earnings call dated Mar. 28, 2022

Corporate Participants:

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Presentation:

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

Good morning and welcome to the results presentation for the 12 months ended January 2022. I’m Vikesh Ramsunder, the new CEO of Sigma Healthcare, and I’m joined here today by Jeff Sells, our Interim CFO; and Gary Woodford, our Corporate Affairs Manager. Jeff and I will take you through the presentation and you’re welcome to submit your questions during the webcast by the tab at the right-hand corner of the screen.

This is my first presentation as part of the Sigma Healthcare Group, and I’m very pleased to have joined the organization. I joined Sigma after spending 28 years at the Clicks Group in South Africa, the last three of which was as Group CEO.

This is the overview of the presentation. I will take you to the review of the year. Jeff will then take you through more detail on the financial performance. I will end with the business performance and outlook for the year ahead. Gary will then read out your questions for Jeff and I to answer.

Starting with the review of the year. Sigma experienced a difficult trading period for the year, predominantly impacted by the implementation of our company-wide ERP system as well as challenges experienced in managing an environment impacted by COVID-19. Sales for the full year was up 1.3%. However, all the growth was delivered in the first half, which was up 5.7%. Second half sales was down 2.5%.

The first half of the year featured solid momentum from our core operations, which grew above market growth rate. In contrast, unfortunately, our operating performance in the second half was significantly impacted by issues relating to our new system implementation and our move from the Rowville DC to Truganina DC in Victoria.

On the upside, the increase in demand for rapid antigen tests in the last month of the year softened the negative impact in H2 and continues to support the growth of the business in the current fiscal year.

The poor service delivered to our customers from the ERP implementation was very disappointing and our teams are keenly focused on improving this on a daily basis. I will provide you with more feedback on the ERP implementation later in the presentation.

Operational performance was obviously, significantly impacted with both stock availability and service level targets not being achieved. Significant challenges with the shortage of specialists labor was experienced in January whilst transitioning our Victorian operations from Rowville to Truganina.

Despite all these disruptions, the scale of Sigma is reflected in the 220 million units of product that we managed to pick, pack and deliver for the year. We have almost finalized investment cycle that has consumed the business for the past four years, with only the expansion of Truganina and the completion of a new Tasmanian facility to conclude this year. Whilst this has been a long process, Sigma now has world-class DC network, providing the business with capacity for growth and the opportunity to improve operating efficiencies.

The challenges experienced in the year as well as the introduction of the SaaS accounting standards has resulted in a net loss after-tax of $7.2 million.

As we complete our investment program, the Board remains optimistic on our growth prospects moving forward and has declared a fully franked final dividend of $0.01 per share.

I will now hand over to Jeff, to take you through the financial performance of the business.

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

Thanks Vikesh and welcome, everyone. I’ll now run through the financial results and key variances year-on-year. And I’ll also discuss our capital management performance and capital expenditure activity.

Firstly, as we stated in our recent market update, we will referring to the reported statutory numbers in this presentation and not reference underlying results moving forward.

We clearly communicate the items that have benefitted or impacted our reported statutory numbers. The results presented today, I should note, are in line with the updated guidance we released on the 3rd of March.

As already mentioned, we had a net loss for the year of $7.2 million, which is not where we want to be. This was impacted by the cost and the operating disruption from our ERP implementation in the second half of the year. Revenue was up 1.3% to $3.4 billion, reflecting the strong pipeline of pharmacy sales growth in the first half from a combination of new wholesale customer wins, including the Chemist Warehouse over-the-counter volume, plus like-for-like sales growth of 8.7% in our own brands during the first half. Unfortunately, the ERP implementation had a profound impact on our customer service, negatively impacting our revenue in the second half.

Sales momentum was lost and the pipeline of growth we had seen in the first half was stored. This impact was somewhat cushioned by the results of rapid antigen test sales that we experienced in the last month of the financial year.

Despite the sales growth, gross profit was 5.1% down on last year. This reflects the impact of higher margin PPA in FY21 compared to only one month of sales of rapid antigen tests this year, plus the negative impact on cost of goods sold due to stock adjustments in the second half as a result of our ERP implementation.

On a more positive note, whilst total other revenue was down for the year, this movement reflects the $29 million profit on sale of 2 DCs in the prior year. Excluding this, we saw a rebound in commissions, supplier and promotional revenue during the year.

Our operating costs were marginally higher than the prior year. This reflects a number of factors year-on-year, which I’ll now turn to in the next slide.

At a headline level, operating costs were relatively flat for the year, up only 0.2%. However, this is not where we want to be given average investments and is a key focus area for Sigma. Warehouse and delivery expenses were up 5.3% for the year. This was impacted by higher labor costs in our DC operations as we dealt with the challenges of transitioning our operating processes into the new ERP environment and dual operating one-off closure costs and lower productivity as we transitioned our Victorian operations from Rowville to Truganina.

Sales and marketing expenses were down 8.5% for the year to $61.7 million. This was a reflection of cost benefits from streamlining our organizational structures and spending over the last two years, but was partially offset by higher doubtful debt provision of $0.6 million in the year.

Administration costs for the year were down 1.5% to $93 million. This includes a higher Software-as-a-Service charge of $31.8 million in FY22 compared to the restated amount of $25.6 million in the prior year, as well as higher IT licensing and people costs from the ERP implementation. These higher costs were offset by savings achieved in people and consulting costs over the prior year. In total, an additional $10.4 million in one-off costs were incurred relating to the ERP disruption.

In terms of cash management, net debt at year-end finished at $149 million, up $50 million on the prior year and $82 million reported at the half year. The increased net debt position from the first half reflects a number of factors. Profit was impacted by additional costs associated with the ERP implementation and customer service disruption. There were the restructuring and redundancy costs as we closed our Rowville DC in Victoria. We had an additional prepayment on the balance sheet at year-end for rapid antigen tests and we finalized the ERP implementation and Truganina builds in the second half.

Net interest for the year was $10.6 million, down $0.8 million on the prior year, reflecting lower average debt over the year compared to FY21.

Cash conversion cycle was up from 31 days last year to 33 days in FY22 this will be an area for improvement moving forward. The primary reason for the increase was due to higher days sales outstanding resulting from the rapid antigen test sales in January and the spread of supplier funding we picked up between our days payable versus days inventory was lower. It was lower at year-end. This funding spread will be a key area of focus into the new financial year as we return to more normalized operations and improve the velocity of our working capital cycle.

Finally, now turning to capex. We are in the final stages of concluding what has been a sustained four-year investment program. Whilst the system changes have been disruptive to the business, it has delivered Sigma a world-class DC network that we will now seek to leverage for the benefit of our customers and our shareholders. The final stages of the program will see around $40 million to $45 million to be invested in FY23.

We have commenced construction to double the size of our owned DC in Truganina, to match the size of our Kemp’s Creek DC in New South Wales, which is expected to be completed by year-end. We will also fit out a new leased Hobart DC as a result of outgrowing our current facility. This will be operational in October this year.

Lastly, we will include us incur some SaaS expenditure in the current year as we close out our ERP and system projects. This will bring an end to the investment cycle. As we return to a more normalized capex program of $5 million to $10 million, our focus is already on leveraging our existing assets to drive improved customer service and shareholder returns.

Given the investment and the impact of the ERP implementation on sales, we are now at the low point of the cycle on return on invested capital. We are reporting ROIC on an unadjusted basis and we will now drive to optimize our returns to shareholders.

I’ll now hand back to Vikesh, who will review our operational performance and outlook.

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

Thank you, Jeff. I will now take you through the performance of the business. Starting with our ERP implementation. The implementation of the new SAP system was in the preparation and planning phase for over 18 months. Unfortunately, several issues surfaced in the live environment. These impacted stock ordering, stock warehousing, customer ordering and deliveries, which ultimately impacted our service levels, operating costs and sales.

Initially we experienced technical challenges associated with the system implementation. The challenges were further exacerbated by having to train people and adopt new processes within a highly restrictive COVID-19 environment. This made change management significantly more difficult. People were being trained remotely due to travel restrictions, which was not an ideal environment for learning and development.

Additional labor costs as well as specialist consulting costs have been incurred and continues to be incurred to ensure operational effectiveness. Many of the system issues have been identified and rectified, and we continue to refine the configuration through weekly assessments.

We have now entered an accelerated change management program to improve the way we use the system and ensure high levels of service is reinstated to our customers. This is expected to be finalized by the end of April.

The next phase of work, which is expected to last until the end of the fiscal year, is process and system optimization. This will help to progressively remove the inefficiencies introduced during the implementation.

I am fully aware that we need to rebuild customer confidence and trust, and our teams have my full support to take the requisite actions to achieve this and return Sigma to a position where we are providing industry leading customer service.

Turning now to our sales performance, starting with wholesale. Wholesaling is the core activity for Sigma and is the bulk of our revenue. During the year, Sigma delivered over 220 million units to customers across Australia, despite the difficulties of COVID-19 restrictions and significant environmental challenges.

Our core wholesale operations effectively service four channels: Community Pharmacy, our own branded pharmacy network, hospitals and other, which includes Allied Health and government channels. Sales across our core Community Pharmacy channel, which is our largest channel, increased by 6%, supported by growth in the OTC category. However, sales in our on-franchise members were down 2% due to the challenges previously described.

Hospital sales grew by 6% for the year, well above market growth rates despite the price impact of some high-cost drugs coming off patent. This growth for the year was supported by some contract renewals and we will continue to actively chase new opportunities in the year ahead.

The other channel declined by 17% for the year. Sales growth in this channel was affected by larger sales of PPE in the previous year. The impact of our operational disruption in the second half, resulted in our total pharmacy wholesale market share declining by 1% to just under 20%.

We recognize that this is not a healthy outcome and our primary focus is on turning the situation around to stabilizing our operations at Truganina and bidding down our ERP implementation.

Sigma has a long history of supporting Community Pharmacy and has trusted pharmacy brands with positive consumer attraction. We have over 530 pharmacies operating under one of our brands, accounting for around 17% of consumer spend. Sigma’s wholesale sales to our pharmacy brands were down 2% for the full year after being up 1.9% in the first half. The reduction is a clear reflection of the disruption that has occurred in H2.

Our pharmacists have continued to play a critical role in providing ongoing care to the communities through the COVID-19 challenges. Since June last year, our franchise members have administered almost 650,000 COVID-19 vaccinations across Australia.

Sigma currently offers a private label and exclusive range of over 500 products across 27 categories. This gives us the opportunity to differentiate ourselves against our competitors. We are currently underpenetrated in the segment, and I see tremendous opportunity for growth in this area moving forward.

Having come from a retail background, I will work closely with our retail team to help improve our consumer value proposition whilst fully supporting the independent Community Pharmacy model that operates in Australia.

Moving to Contract Logistics. Contract Logistics remains a key growth factor for Sigma, having achieved 16% sales growth over the last 12 months. We are currently managing 30,000 pallets of medicines on behalf of 11 clients with sufficient capacity for growth at the Kemp’s Creek facility in Sydney.

As I mentioned earlier, we’ve also commenced the expansion of Truganina, which will provide us with an additional 20,000 pallet positions to expand the Contract Logistics business. We will continue to actively participate in several upcoming tenders in the year ahead.

MPS is our dose administration provider. MPS has a regulatory advantage in the market due to its TGA registered packaging facilities. It also has a tactical advantage by offering aged care facilities, a true integrated end-to-end medication management solution.

Sales in MPS grew by 3% for the year. This is a reasonable result in the context of an aged care markets that was heavily impacted by COVID-19 during the year. MPS is a clear market leader in its field with 20% market share of packaging services provided to residential aged care facility.

MPS also delivered market leading accuracy in medication management with a published error rate of one in 800,000. Importantly, the opportunity for this business is to increase its reach and broaden our market penetration, which is supported by the technology investments undertaken during the year. Particularly in the current environment, there is considerable focus on improving electronic records and patient safety within aged care settings. MPS is at the forefront in supporting these.

We have just launched market-leading integrated software, allowing the team to target in excess of 2,700 aged care facilities that were previously inaccessible. In addition to growth, MPS will focus on site consolidation and extracting efficiencies in the coming year.

I will now take you through the outlook for the remainder of the year. As we enter the final stages of our investment cycle and progressively optimize our operations, we will not be providing FY23 guidance. However, we do expect to return to profit this year.

The immediate focus for everyone at Sigma is to urgently overcome our system, change management and operational challenges. We expect to stabilize our ERP implementation by April and focus on optimizing our processes for the balance of the year. The operational performance of Truganina is significantly below expectations and is a further drag on sales in this first half. Resolving this is our number one priority.

I have set three key objectives for this financial year. Firstly, we have to get the basics right across the organization and we have to put the customers’ needs at the center of everything we do. Secondly, we need to simplify the corporate and people structures to ensure accountability and enable excellence of execution. Thirdly, to produce clear and transparent reporting to enhance business decision making.

As we come to the end of a period of significant investments and organizational change, our teams are ready to move the business forward. They have worked exceptionally hard through very demanding circumstances and I thank them all involved for their commitment to the business.

We now have world-class physical infrastructure and IT systems that I will focus on leveraging to enable a competitive advantage that can deliver long-term sustainable growth.

Finally, my experience in both wholesale and retail are largely to provide valuable inputs in the direction of Sigma moving forward. I’m currently working with my executive team and the Board to clearly define the strategy and direction for the business. I look forward to sharing this with the market at our next results presentation.

Thank you for listening and we are now happy to take your questions.

Questions and Answers:

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Okay. Thanks, Vikesh. We have a couple of questions here from Ross Curran and Mathieu Chevrier [Phonetic]. The Group had FY23 target of underlying EBITDA of at least $100 million. Is this still relevant or has the ERP issues mean we need to step that back?

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

I would certainly say that, firstly, we’ve moved to a new reporting — a way of reporting, right, which is reported NPAT. So that makes it very clear for our analysts to understand where the business is currently.

I would say that the current challenges with our ERP implementation has certainly become a drag for us in the current year and we’ll provide further guidance as we get to the half-year results.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Follow-up question. So what impact will SaaS have on EBITDA and NPAT in FY23 and ’24?

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

So we’re still working that through. It’s likely that the SaaS impact will be significantly less than it was in FY22, so currently we are budgeting for a number that’s well less than $20 million probably under $15 million is what we’re looking at. It depends on the timing of the actual implementation of projects, but it’d be significantly less than it was in the prior year.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Okay. A follow-up question from Mathieu. So could you provide interest expense and D&A guidance for FY23?

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

Interest expense will be, if we think about it, effectively a function of debt. We would expect our debt figures to come down over the coming year. As I indicated in my presentation, I think there is improvements that we can make in our working capital velocity. That will be the biggest impact on the debt figure. Still some capital expenditure to be made as we’ve already highlighted. So I’d expect our interest expense to be marginally lower than it was in the current year. Obviously, interest rates are quite low.

The other part of that question was –?

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

D&A.

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

Depreciation will be, I think, in line with what it was in FY22, won’t be significantly different.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Okay. Another question from Mathieu. So capex number of $40 million to $45 million is different than times given about six months ago. Is there any particular reason?

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

I don’t think it’s significantly — it shouldn’t be too different. I mean, the main issue will be — the main decision that was taken in the second half of the year will have been the decision to expand the Truganina DC. That’s about $20 million. So that would be probably the main difference in terms of guidance that we might have given in early in the second half of last year.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Okay. A question from Greg Jenner [Phonetic]. Can you quantify the loss of sales from ERP disruption? How much market share was lost? How do you expect to reclaim market share?

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

It’s actually very difficult to truly estimate, you know, how much of sales has been lost. Certainly, we disappointed our customers over this period. And as I mentioned in my presentation, we’ve lost about 1% of market share and it’s too early to predict how we grow that back.

As I mentioned, we’ve got to stabilize the ERP system and we’ve got to get our performance in Truganina improved. So before I can commit to anything to the market, the one thing I can show the market that actually our performance is improving on a daily basis. So that’s very encouraging for the business.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Question from David Stanton [Phonetic]. You mentioned that extra FY22 ERP expenses was 10 million. What will it be for FY23?

Jeff Sells — BBus (Acc), CA, MAICD, Harvard Business School – Advanced Management program, Executive General Mana

It’s difficult to estimate. I guess the number that we quoted in the presentation was direct costs. So most of the direct expenditure we’ve worked our way through. So I guess the biggest issue we have in the current financial year is the negative drag that we have on the underlying business. So I guess it’s difficult for us to be able to estimate that at this point in time.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Question from John Deakin Bell. Can you talk about the impact on the customers? Have the non-aligned customers loss total confidence in the ERP system? And has the product ordering reverted to second line suppliers where you cannot supply?

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

So it’s interesting coming into Sigma and having joined in February 1, I have to say that there is no doubt, right, we disrupted our customers with service and there’s no doubt we disappointed our customers. But what has been amazing to me to be honest, is the loyalty of our customers to the Sigma brand. In relative terms, of course, you’ve lost some customers, but it actually hasn’t been as material as one would have expected with the disruption of this nature.

So I do remain quite confident that there is a portion of these customers that we can get back to Sigma once we are operating at an optimum level, because I mean having — I say this very respectfully right, only lost a share, 1% of share over the year. It could have been significantly worse. So it talks really around the stickiness of Sigma with the current customer base.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

Question from Phil Pepe. Have you made any immediate changes to the way Sigma is run based on initial impressions?

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

Yes. So it’s not really so much about changes. It’s about priorities and focus. So as I said in the presentation, it’s really about making sure we get the basics right. Because as you know, errors cost money and they disrupt your service levels to consumers. So it’s really about getting that right across the organization.

I do feel the business is complex. So simplifying that and driving greater accountability will improve execution. And of course, having reports that assist managers to make informed decisions, particularly when you change to a new system. Generally what tends to happen, right, the first spectrum is your reporting structure. So there is no doubt, getting the reports back into place, accurate reporting, tier reporting will assist managers in making more informed decisions. That would certainly be the priority for me, in the current period.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

A question from Jackson Tucker. Could you please provide an update on the performance of the Chemist Warehouse contract?

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

Well, I would say to you we. I mean, I wouldn’t declare that openly in the market space. Of course, I wouldn’t. But we certainly aren’t providing the relevant service levels, particularly in the Victoria area that we should. We are engaging with Chemist Warehouse. It’s our biggest customer around this and we’re working with them to ensure that we revert back to high levels of service in the coming month.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

And then a more broader question from Dan Haren [Phonetic]. What is company expectation for industry growth in FY23? And has that has been used in that prediction of profitability.

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

It’s very tough to predict, right? But you have to believe that it was coming out of COVID lockdowns should grow certainly some level of 2 different infections can be expected in the months ahead. So there is no doubt. I would expect to kind of higher market growth. Our job is to service the customers, so we can reap the benefits of that increasing market growth.

What’s factored potentially in our forecast of profitability for the year is stabilizing our operations and the system and reverting back to providing excellent customer service.

Gary Woodford — Corporate Affairs Manager Sigma Healthcare Limited

There is no more questions in the queue. So I think what to turn back to Vikesh for closing remarks.

Vikesh Ramsunder — Chief Executive Officer and Managing Director, B.Com (Logistics), MBL (Corporate Strategy)

So I really just want to thank you all for tuning in today and listening to us and we’re really happy to take your questions in the future. So thank you very much from Jeff, Gary and myself.