Profarma Distribuidora de Produtos Farmaceuticos SA

BOVESPA:PFRM3

Earnings Call Transcript

[Operator]

So good morning, ladies and gentlemen, and welcome to the Profarma Distribuidora de Produtos Farmacêuticos S.A. conference call, where we will discuss the fourth quarter 2017 earnings results. [Operator Instructions] This call is being simultaneously translated into English. [Operator Instructions] As a reminder, this conference is being recorded and the audio will be available at the company's website in up to 24 hours. Should you not have a copy of the earnings release published yesterday, March 22, after the closure of the BM&FBOVESPA trading session, you may also access it at the company's website at www.profarma.com.br/ri.

This conference call, as well as the presentation, is being simultaneously broadcast over the Internet and can be accessed at www.profarma.com.br/ri.

Before proceeding, we'd also like to mention that the forward-looking statements that may be made during this conference call related to the company's business, prospects and forecasts as well as operating and financial targets related to its potential growth, are based on management's expectations about the future of Profarma. These expectations are highly dependent on domestic market conditions, the general economic performance of the country, and international markets, and therefore, are subject to change.

With us today are Mr. Sammy Birmarcker, CEO; and Mr. Max Fischer, CFO and IRO.

Now I will turn the conference over to Mr. Birmarcker. Mr. Birmarcker, you may begin.

[Sammy Birmarcker, executive]

Good morning, everyone. I would like to start the 4Q '17 earnings results conference by thanking you all for your interest in our performance. 2017 was a very important year to consolidate the strategy we have been implementing for 6 years in Profarma based on big changes in capital allocation, combining the Pharmaceutical Distribution and Retail divisions. Through this model, known as mix model, we tried to capture the advantages of an integrated work and improved operating margins and returns on the capital invested in the company as a whole. Such advantages would not be possible if we decided to work only on the Retail or the Distribution business, and they are underpinned by major value-creation factors, such as supply agility, increased relevance with suppliers, and an effective presence in the drugstore market, which gives us better margins and sales mix.

Not to mention improved synergy in general and administrative expenses. In addition to overcoming our operating challenges, Profarma also strived to better balance its capital structure with a view to minimizing the impacts of financial expenses directly related to the substantial investments we made to implement the integrated model which amounted to around BRL 380 million from 2013 to 2017.

The approval of the capital increase and the consequential injection of roughly BRL 380 million, including BRL 50 million invested by AmerisourceBergen in the Specialties division, and more importantly, the agreement by 90% of our stockholders, prove that our investors are committed to our strategy of capturing the value of the integrated model.

On Slide 5, you can see the increase of invested capital, broken down by segments in the company's potential consolidated ROIC. Looking at the progress made from 2010 to 2017, you can clearly see the strategic capital allocation we adopted, with Retail growing in importance within the group with a potential ROIC of around 15% in 2017.

In 2017, we implemented a number of products in the Pharmaceutical and Retail divisions to maximize the benefits of the integrated model. In the Pharmaceutical Division, after investing a total of BRL 35 million in 3 years of development, we opened our new distribution center in Rio de Janeiro, which happened in September, 2017. The new DC is expected to save approximately BRL 10 million per year from the second quarter of 2018 onwards.

In the Retail division, we renovated and expanded 14 stores and executed projects to increase productivity which significantly contributed to the reduction of expenses in stores and corporate departments resulting in an increase by 2.2 percentage points in the Retail contribution margin growing from 5.1% in the first half of 2017 to 7.3% in the second half.

On Slide 6, you can see the progress of some important indicators in the Rosário chain. The biggest challenge in Rosário was to turn around the negative results from 2016 before acquisition, in a sustainable and consistent way.

The fourth quarter '17 results bear witness to the success of the initiatives we adopted. After improving our performance quarter-after-quarter, on the fourth quarter, we had the best quarterly results since the acquisition. We expect that by continuing to advance Rosário operationally and implementing the actions planned for the year of 2018, we will fulfill the commercial potential of the chain throughout the year.

In early 2017, we had a new and relevant Retail operation. However, due to its former management in the previous quarters, it had a negative EBITDA of BRL 70 million, a 50% service level in stores, and major working capital deficit. To start our turnaround, in the first quarter of 2017, we received a private capital increase of BRL 100 million used to pay the second installment of the purchase of Tamoio BRL 50 million, and adjust Rosário's working capital, BRL 70 million.

It should be noted that the adjustment will cause a reduction of BRL 30 million to BRL 40 million in the amount of the installment to be paid in December 2019, since it exceeded the amounts provided in the acquisition agreement. 2017 was certainly a very challenging year for the company. The integration of Rosário, which doubled the size of our Retail platform as well as its turnaround, the opening of the new DC in October, and a balanced capital structure in an adverse economic scenario had a strong impact on our operating results.

On the other hand, in 2018, especially in the second quarter, the results of the capital increase will be fully achieved, the new DC will generate savings and around 40 Rosário stores will have been renovated. And we are certain that we will be ready for positive results in a sustainable organic growth.

I will now turn the conference over to Max Fischer, our Finance and Investor Relations VP, who will comment on the company's Q4 '17 performance. Thank you.

[Maximiliano Fischer, executive]

Thank you, Sammy, good morning. On Slides 8 and 9, you can see the main figures and progress of every division of Profarma, which we accomplished by focusing on the results we expected from them.

Looking at the consolidated numbers, sales in the Retail division grew by 47.5%, driven by the rise in the Rosário sales, which started to be included in the consolidated figures in December 2016. The Retail division accounts for approximately 53% of the company's 2017 consolidated gross profit compared to 41% in 2016.

In the Pharmaceutical Distribution business, as Sammy mentioned before, we opened the new DC in Rio de Janeiro after a total investment of around BRL 35 million and an estimated decrease in expenses of roughly BRL 10 million per year from 2018 onwards.

The new DC takes our largest platform to a new level in terms of scale and efficiency to better serve the second biggest market in the country and our greatest Retail platform, the d1000 retail pharma Rio de Janeiro.

In 2017, the division's revenue from independent customers grew by 8.4%. This segment provides better operating margins and had a total growth rate of 71% since the company broke into the Retail market in 2013.

In the Specialties division, some factors contributed to the rise in sales such as the significant growth of 18.8% in the vaccine segment and adjustments in our supplier and customer mix in the Specialties Pharmacy segment. Its integrated position is now consolidated within the industry, and this has brought good results in 4Q '17 with a growth by 18% year-on-year.

In 2017, net earnings increased by BRL 5 million year-on-year, but it is still negative by BRL 6 million. In the Retail division, we should look at the performance of d1000 retail pharma Rio de Janeiro, bearing in mind that the financial situation in the State of Rio de Janeiro is too feeble and the performance of the Pharmaceutical business there was roughly 50% lower than that of the country as a whole.

One of the highlights is the increase of the contribution margin to 6%, 3.2% higher year-on-year and the reduction of 5.7 days in cash cycle bringing it to 24.3 days. Another highlight was the average sales per store per month in the d1000 retail pharma Rio de Janeiro, totaling BRL 568,700, 6.8% more than ABRAFARMA’s average. As a result of the actions targeted at increasing productivity and reducing expenses in its structure, the contribution margins of stores grew by 1.3% from the first to the second half of 2017 and reached 9.2%.

When it comes to Rosário, we should take into account the stores that we shut down in the period to complement the optimization process of the platform.

Analyzing the performance in 4Q '17, we can see the Rosário's results have never been better since this acquisition. We virtually achieved EBITDA breakeven with minus BRL 500,000. This is a result of the increase in stores contribution from -18% in November 2016 to 3.7% in 4Q '17, in addition to a reduction in corporate operating expenses by 40% or BRL 3 million in comparison with 1Q '17.

I will now comment on the main lines of our consolidated results starting with gross revenue on Slide 10. In 2017, consolidated gross revenue amounted to BRL 4.8 billion, up by 1.7% year-on-year. This improvement is mainly related to the Retail division, which grew by 47.5% as a result of the acquisition of Rosário and the inclusion of its sales that is now consolidated in the figures since December 2016.

On Slides 11 and 12, you can see the increase in EBITDA, which amounted to BRL 49.2 million with a margin of 1.4%. There was BRL 64.7 million reduction year-on-year caused by a decrease of BRL 48.8 million in the Pharmaceutical Distribution EBITDA, which fell by 80%. This drop is related to the 2017 price increase which was 70% lower year-on-year.

Slide 13 shows CapEx in 2017, which totaled BRL 50.1 million. It is mainly due to the new DC in Rio de Janeiro. Our debts amounted to BRL 424.4 million, BRL 35.4 million more year-on-year. It should be noted that in 2017, we invested BRL 117 million. This amount includes, besides the new DC in Rio de Janeiro, BRL 13 million in store renovations and expansions and BRL 51 million to pay the second installment of the Tamoio acquisition.

Thus, Profarma's net debt-to-EBITDA ratio was 6.1 at the end of December 2017. This increase was mainly due to a drop by BRL 64.7 million in consolidated EBITDA, as mentioned earlier, which was 80% lower due to a smaller price increase in 2017. It should be noted that the private capital increase of BRL 333 million completed in March 2018 significantly reduced the company's debt level.

Lastly, on Slides 14 and 15, we can see the company's 2017 net earnings. We had an adjusted net loss of BRL 7.6 million, BRL 23.7 million lower than the BRL 16.1 million adjusted net profit in 2016. The results of both years presented here have been adjusted by 3 main events: Nonrecurring expenses; Rosário's losses; and financial expenses related to investments in Retail, including the correction of the debt balance of the 2 acquisitions.

The Pharmaceutical Distribution and Retail divisions, excluding Rosário, were the main causes of the drop in adjusted net profit, respectively accounting for BRL 20.5 million and BRL 4.1 million. This was offset by the increase in the Specialties results by BRL 2.4 million.

It is important to mention, when it comes to total debt that in the financial statements, BRL 220 million were previously accounted for as long-term liabilities. They have been reclassified to short-term liabilities to comply with Item 74 of Rule 26 of the Accounting Statements Committee, although the company have attained waivers in periods prior to the year ended December 31, 2017. The waiver request processes that we adopted last year were the same that we used in previous years and quarters. The company formally submitted its request to financial institutions indicating the numbers and the reasons for such request. This concludes my presentation. We can now begin the question-and-answer session.

[Operator]

[Operator Instructions] The first question comes from Guilherme Assis with Brasil Plural.

[Guilherme Assis, analyst]

I would like to ask you about 2 things. First, about Distribution. We can see that the market is very tough right now because we still have many players in the business, but you have the strategy of focusing on the smaller customers. And you have been improving your results in sales for independent customers. So I would like to understand what you are going to do from now on. Are you going to be able to offset this situation, increasing the sales in independent customers? And how much do you expect to grow? Still regarding Distribution, you ended the operations in the State of Ceará in the Northeast, if I'm not mistaken, and now you opened -- actually, you shut down the DC in State of Espírito Santo. So I would like to know if you are going to continue to decrease your presence across the country in the distribution business. Now I have another question, and this one is related to Retail. We can see the initiatives that you have implemented closing down stores. So I would like to understand a little bit more about your strategy when it comes to Rosário. Do you think that you have a good number of stores open? Or do you intend to shut down other stores? Is that in your plans? If not, what do you think about the competition for Rosário? I believe that you have grown a lot in gross sales per store and do you expect to see more increases in those numbers? And what is your goal? Can you reach the same level as the Profarma? And how long would that take?

[Sammy Birmarcker, executive]

Guilherme, thank you very much for your questions, and good morning. About Distribution, I believe that it is now clear that the company has been striving to strike a balance. In 2013 and '14, after the merger of the major chains, we also had a transition. Distribution lost part of its sales because some chains bought directly from our Distribution business. And this year, the same thing happened. We have major customers, but if you look at our background, our history, you can see that we have been growing in independent customers for 5 years now. All of the variables that we have in our market, for example, decreasing the participation of a major customer, you need to build results quarter-after-quarter. It's hard to bring sales up overnight just because you lost a customer to another major chain. But if you do that constantly, then, yes, you can recover the results and go back to the same high level that you have before and, of course, Retail is very important in that strategy. And we started focusing more on independent customers. We had lower results due to the new DC that we opened. So I believe those results are outliers. In January and February, we saw better service levels and the operating departments went back to the level that we expected. And we can see progress is related to the expenses, as we said in the presentation. And I believe that we are going to go back to the same levels of growth that we had in 2014, for example, we grew by 20%. And if you think about the transition of the customer mix within that growth rate, it is very significant. We are no longer dependent on major chains. Now we don't depend that more on them, and we were able to do that by focusing on smaller clients and focusing on expanding our own chains. I believe that the first quarters are always weaker due to the season, especially for distribution, but I believe that we have all the right foundations to start growing, again. We cannot do that overnight. In our case, we started doing that very early on. So I believe that we have a solid foundation, a solid structure now. With the new DC in Rio, I believe that we are going to go back on track and grow in line with the market. Now when it comes to the closure of DCs and stores, we have been committed to allocate capital in a profitable way. The integrated model is an integral part of our strategy. Now we have been focusing on maximizing results by combining operations, always evaluating our capital allocation, obviously, to give more contributions to the Distribution centers than stores, if that's the case. And that's the mindset that we have in the company. We need to bear in mind that our company has an integrated model. We are always going to combine all of the divisions. We are not going to focus on one to the detriment of the other. Now when it comes to Retail, you are right. We saw major transformations in our operations and the results bear witness to that. We were able to revert a situation in which we had minus BRL 70 million in EBITDA. Now we have almost a breakeven in our EBITDA, and you saw everything that we did throughout the year. We closed over 50 stores. I believe that we always have to evaluate the situation of stores to see if we have to shut some down or not. We are going to renovate over 40 stores this year. We have already renovated 8, and we can see that this activity, this strategy, will bring a new -- a second wave that is going to give us more energy to work on improving sales. Of course, when you change the level of operations in such a relevant chain such as Rosário, of course, the competition is going to react. No market will just see and watch the competition -- and the competition, a company that has such a strong background, they are not just going to watch what we're doing and do nothing. No, they are going to react to this. We have our own actions planned for 2018. We are going to renovate some stores, and we are going to bring some stores that have a more low income profile to lower-income regions. And of course, the renovations are not going to cause the stores to be closed for a period, no. The renovations will allow stores to continue to operate. Of course, we may have some drop in sales, but this is not going to be the case as we had in Drogasmil in the past. In Drogasmil, we had to close stores for 45 days, for example. These renovations that we are conducting this year are lighter in terms of CapEx. This is not going to be even 20% of the CapEx that we invested in Drogasmil. We are going to capture the margins and the margins in stores are very high. Additional expenses are very small. Renovation CapEx is relatively small. And upside is very high because we are leveraging 30%, 40% margins with very low investment. We should also remember, and this is a very important point in terms of Rosário because sometimes we don't think about the working capital that we invested in Rosário. I'm going to put it in simple terms. With sales stores with products, to reverse the service level, which was below 50% and now stores are ready to sell 450,000 -- 500,000. And now they are selling 200,000. So we have working capital. We have made major investments last year and at the end of December of 2017. So this is the benefit that we have by conducting these renovations. We can also optimize our product mix in the stores and all of the actions that are going to complement the renovations. Renovations are not enough to drive better sales. This is not that simple. There are many other actions that have to come together with renovations. Our intention is to continue to implement our strategy with Rosário because results have been improving quarter-after-quarter and Rosário chain is 100% consolidated in our results. We were able to decrease the number of stores, shutting down the stores that did not contribute at all to our results to bring better results gradually, and that is going to continue throughout 2018. This is our expectation when it comes to Rosário. Okay?

[Guilherme Assis, analyst]

So if I could just talk about the Retail operation in Rio de Janeiro d1000, can you talk a little bit about how you see that? I understand the crisis in Rio and there's still a little bit of turnaround of the operation that can -- I'd like to understand the perspective because the sales are still weak when you look into a mature store, numbers are still negative. So how do you see? I mean, do you see any improvement after the renovations? Do you think we can reverse those numbers and make them positive at least for mature stores growth over on the first half of this year? What's your perspective about that?

[Sammy Birmarcker, executive]

Well, Rio de Janeiro is a state that is very competitive and unfortunately undergoing one of the most serious crisis ever. What we have prepared for 2018 for Rio is that part of this chain that has a more affordable profile, we also have renovations and increases forecasted for this year. And when you talk about mature store, maybe we only have actual mature stores that we can consider, as I can really restart that store either by investing on renovation or opening a new one which I consider not starting from scratch, but I have several stores, both that I cannot consider as mature stores, although they are by definition because I haven't worked on them the way or at least like I did at d1000 Drogasmil last year, they were growing 10% a month. Why is that? Because it was the chain where we invested the most in '13, '14, '15. Tamoio late last year in the second half of last year, just like Rosaria, we had some actions over Tamoio. And we believe that we're going to be able to have something more comprehensive in terms of mature stores, that's to a [ little math ] by stores that are mature in time, but are not mature in terms of operation. And being mature in terms of operation is that after my intervention 2 years later, it becomes mature, 1.5 years later it's mature. So we still have a little bit of that to onboard, and we are very optimistic about Drogasmil and Tamoio for 2018.

[Operator]

The next question is from Adeodato Netto with Eleven Financial.

[Adeodato Netto, analyst]

Max, I don't know if you already answered that, I was trying to connect through my phone, and I missed a little bit of the session. I would like to understand a little what are the perspectives in your point of view of participation of Amerisource in a strategic way? That's my first question in terms of their involvement and adding value in the execution. And the second question is when we talk about negotiating with banks for credit lines and structuring, do you understand that the size of the participation and their effective arrival, do you think that changes for the best, of course, the way banks see the company?

[Maximiliano Fischer, executive]

Well, thank you for the question. That's a very important question for us again. When we think a little bit of the history of ABC, a lot of the company -- we -- this participation level has been increased. We do have perspectives that they can participate even more of our management, of course, and they always said that Brazil is for Brazilians, but we have a long story of almost 4 years with them, and have this joint venture and we believe that with this, they are going to be able to add much value to Profarma's operation, always putting to perspective that they also work -- operate the integrated model exactly. So it's relevant for the biggest world player in Retail and Distribution. So it is a very positive scenario for the company. As for banking, you touched on a subject that I don't think it's primary or secondary. But in fact, there are 2 things that really changed the perspective of the relationship we have with the banks. One, most certainly is more participation of Amerisource. There are no doubts. We saw that happening at JV during the -- when it was a 50% joint venture in our everyday operations. And the other perspective is to reduce debt. When I look at my net debt for December 2017, putting the BRL 230 million that I just raised, if I get the average EBITDA in the last 3 years, my debt is about 2, 2.5 without putting to perspective the average of the last 2 years, Retail had a participation of pretty much 0 in the consolidated EBITDA and, as I was talking to Guilherme, you have a lot of it. The positive perspectives we have both in Rio and Brazil, which is something that we were able to show in this last 1.5 year in Retail. We know that by this leverage, that changes completely the perspective for costs, structure, bank relationship. We, in fact, are almost sure that this is going to happen considering that the company, although it's been through a transition period, we have investments, we always counted on the support of financial institutions. They are key for us to be where we are, and we have a Profarma before and after the investment, and now we can see with this new scenario for 2018 and onwards, we will go back to be in the scenario where Profarma never had any losses and grew sustainably where you could keep a long-term relationship in a very safe and comfortable way.

[Adeodato Netto, analyst]

My question about the banks, of course, involves the deleveraging, but what I see positively and I like to share with you and Sammy, is that for this capital increase, that's exactly the growth of Amerisource's relevance because a lot of what was debit in terms of future projection in the company was the capacity or the willingness, better than capacity, but the willingness of the controller, of Sammy and family, to keep doing successive increases by themselves pretty much. So I think it changes not only the indicator of leverage. And my question comes from there. Do you feel that depending less on Sammy and being a company that looks more like a corporation, if that is already giving any sign that in terms of credit offer or capital cost or collateral or the company structure? So if that came along this year and the next year, if this could have some effects. And the first question -- the first part of my question is connected to the more Amerisource is engaged and to participate and the more involved they are in the process, the higher the chance that this is not only a perception connected to shareholder participation, but also the reality of the business?

[Maximiliano Fischer, executive]

I believe you are right on both things. We, in fact, have the perspective that they would have more involvement from now on. We are a public-traded company, that's an important pillar in our perspective for the future. As you said, the family that's founded the company does have an important share, a relevant share of the company. Actually, since we decided to go public, the vision of being a corporation, I can say as a witness that it was one of the definitions that we had on going public in a pioneer fashion at that time consider that at some time the company would really be a corporation, and an opportunity of this segment is pretty big. So we ended up leading this way in a sustainable fashion. So with Specialty, Retail, distribution, the company today works in the pharmaceutical area in a much broader way and being publicly traded makes a big difference today, and it's really focused on the businesses, operations that provide more return as long as you can reach them. And that's where being a publicly traded company having a strong partner like Amerisource, that is participative, that understands the model, which is an important thing because they also operate this model, of course, there is -- through a different scale with different gains that may be in a different scale. We're going to look into that as well. Today, we have some that they never had the chance to have because when they joined us, they were already so big and we here have the chance to surf the wave of the Retail consolidation. So I believe you are right. Maybe in 2018, it is still a short-term point of view with the structured prices and interest rates, but as that turns into results and that's kind of the direction that we give, we want to grow profitable and that's going to put us more in line in terms of return for those who followed us and supported us with the capital in the last 3 years. Our shareholders were there for us. So it's time to give that return in a sustainable way because deep down in these 4, 5 years, we prepared the company for that.

[Operator]

[Operator Instructions] If there are no more questions, I would like to turn the floor over to Mr. Max for the final remarks.

[Maximiliano Fischer, executive]

Well, our focus remains on organically -- on growing organically and capturing value drivers in the new Profarma Distribution and Retail integrated model. This will drive profitability and higher returns on investments and will lead us towards an even more solid long-lasting operation. Feel free to contact us. See you on our next call.

[Operator]

That concludes Profarma's conference call for today. Thank you very much for your participation. Have a great day. Thank you.