Commentary

Highlights

Turnover up 11% to R4,4 billion
Gross profit improved 15% to R2,3 billion
Normalised(*) headline earnings up 15,5% to R900 million
Cash on hand R1,4 billion
Final dividend up 27,5% to 102 cents per share
* Refer to note 7.

FINANCIAL REVIEW

Headline earnings
Adcock Ingram is pleased to have achieved normalised headline earnings for the year ended 30 September 2010 of R900,2 million (518,2 cents per share). This represents a 15,5% increase over the comparable figure for 2009 of R779,3 million and translates into an improvement of 15,2% in normalised headline earnings per share and 14,8% improvement in normalised earnings per share.

Turnover
The impact of our acquisitions of Unique Formulations, Ayrton Drug Manufacturing Limited and Indigenous Systems, as well as the conclusion of co-promotion agreements, supported turnover growth of almost 11% to R4,4 billion (2009: R4,0 billion). The above mentioned acquisitions and new multi-national partnerships contributed R187,2 million to revenue.

Price decreases averaged 1% across the business. Government granted a 7,4% Single Exit Price (SEP) increase in June 2010. In the Prescription segment the SEP increase was implemented where market conditions allowed. The Pharmaceutical division experienced price decreases in a significant portion of its generics portfolio, the greatest impact being on Adco Simvastatin and Adco Efavirenz.

Continued volume growth in prescription generics, including anti-retrovirals (ARVs) and the Hospital Products division was dampened by declining volumes in the over-the-counter (OTC) segment as a result of continued consumer down-trading.

Profits
Gross profit for the 12 months increased by 14,6% to R2,3 billion (2009: R2,0 billion) with overall margins improving from 50,9% to 52,6% (March 2010: 51,8%).

The gross margin percentages in Prescription and OTC improved to 58,2% (2009: 53,9%) and 58,5% (2009: 58,1%) respectively, while in the Hospital Products division it reduced slightly to 39,3% (2009: 39,8%). Gross margins across all businesses benefited from the strong Rand, which favourably affected imports of raw materials and finished products, but this was partially offset by a higher proportion of lower margin ARVs in the sales mix and continued pricing pressure in the rest of the generic portfolio. In the Hospital Products division the benefit of the strong Rand was outweighed by additional overheads and overtime costs, consequent to the factory upgrade and a higher proportion of tender sales compared to the prior year.

Factory upgrades at Clayville and Aeroton adversely affected production with periods of significant downtime to ensure product quality and safety, and overtime costs to make up production levels. In addition, implementation of new processes and hiring of additional human resources to implement new regulatory and quality standards has caused some on-cost to the business. The costs of these disruptions totalled R49 million in the year under review.

Operating profit improved by 14,9% to R1,2 billion (2009: R1,0 billion) with the percentage on sales improving from 26,1% to 27,0%. Operating expenses increased by 14,4% to R1,1 billion (2009: R992 million), the primary drivers being increased distribution and staff costs at the additional sortation facility in Midrand, higher marketing spend and operating expenditure of R42,6 million in newly acquired businesses which is not in the base 2009 figure. IFRS2 expenses increased from R32,7 million in the comparable period to R45,8 million in the current year. This excludes the IFRS2 expense of R269 million relating to the issue of shares to the strategic partners in the BEE transaction which is reflected as an abnormal item.

After net finance income and dividends received, profit before tax and abnormal items grew 18,6% to R1,2 billion (2009: R1,0 billion). The effective tax rate for the year was 33,1% (2009: 23,8%).

Cash flows and financial position
Cash generated from operations was a healthy R1,4 billion (2009: R1,1 billion). This is reflective of sound working capital management in the period under review, with overall levels of working capital reducing by R115 million.

Trade and other accounts receivable increased by just R113 million from September 2009 with trade debtors’ days at the end of the period at approximately 58 days, an improvement over the 62 days reported in September 2009.

Inventory increased by R135 million in the twelve-month period, now representing 120 days of cost of sales compared with 105 days at September 2009. This increase resulted from the large stock holding for the distribution and co-promotion agreements entered into with MSD, Lilly and Novartis.

After net finance income, dividends and taxation, cash generated was R862 million (2009: R754 million). This improvement was achieved despite dividend payments having increased by R154 million compared with the previous financial year.

The group paid R140 million to acquire businesses in support of its growth strategy and total capital expenditure across the various sites during the twelve months was R333 million. Of the R800 million secured facilities for the factory upgrades programme, R430 million was drawn down to fund the extensive regulatory upgrade at the Aeroton operation and the construction of the high-volume liquids facility at Clayville.

During the year, cash equivalents increased by R740 million, leaving the business with a gross cash position of R1,4 billion (2009: R693 million) and net cash of R850 million (2009: R381 million).

Dividends
In recognition of the strong cash position, we are pleased to announce a final cash dividend of 102 cents per share (September 2009: 80 cents) representing an increase of 27,5%. This results in the total dividend for the year being 2,5 times covered by normalised headline earnings.

BUSINESS OVERVIEW

Pharmaceutical Division
The Pharmaceutical Division has regained its position as number 1 measured against 44 OTC/self medication companies in the Campbell Bellman confidence survey, assessing level of performance on a number of defined attributes. In addition, the company has maintained the number 1 confidence ranking with General Practitioners amongst local and generic companies.

For the year under review, as measured by IMS, Adcock Ingram increased share in the private market, in both volume and value terms. This was driven by a strong volume performance by generics and continued growth from its bigger branded prescription products, particularly Synap Forte.

Important strategic developments during the year were the conclusion of the acquisition of Ayrton Drug Manufacturing Limited in Ghana and the collaboration agreement with MSD – the 2nd largest global pharmaceutical company. Attractive marketing synergies for both parties are anticipated from this agreement for the distribution and co-promotion of several MSD products.

Upgrades to the Wadeville factory have been completed during the year while the construction of the high-volume liquid plant in Clayville is on track to meet the target completion date in 2012. Supply from the Midrand distribution centre improved significantly with 96% of stock delivered on time to customers.

Sales during the period rose by 12,3% to R3,1 billion with anti-retrovirals performing well via the South African government tender. Overall, the continued financial pressure on consumers was evident in a shift to economy brands from premium brands. Operating profits grew by 15,0% to R948 million assisted by the strong Rand during the year which had a positive impact on input costs.

Adcock Ingram’s Kenyan operation is showing good growth, particularly from its strong pharmaceutical brands. Dawanol sales are increasing in Kenya and the product is now available in Uganda and other East African markets via local distribution partners. Good growth is expected in the new financial year as new Prescription and OTC products are registered and new distribution agreements begin to bear fruit.

Hospital Products Division
This division is comprised of Adcock Ingram Critical Care and The Scientific Group.

Adcock Ingram Critical Care (AICC)
The financial performance for the twelve months ended 30 September 2010 reflects a pleasing 11% volume growth and significant public sector wins. Long term partnerships were secured in the renal and blood arenas, with National Renal Care and South African National Blood Services (SANBS). AICC has actively endorsed various drives undertaken by the SANBS and has successfully secured a three year agreement with that organisation effected from 1 April 2010.

The 9,5% increase in turnover was achieved despite the late start to the RT299 fluids public sector tender and registration delays for new plasma expanders and the oncology range.

The period under review saw major public sector tender wins for AICC. AICC was awarded in excess of 80% of the tender for intravenous fluids and over 95% of the tender for renal products. These tenders are set to run for 24 months, and commenced on 1 March 2010.

At year end, the R290 million factory upgrade was 65% complete and proceeding according to schedule.

Shortly after the year end, the option agreement under which Baxter could procure a controlling share in AICC was cancelled by mutual agreement. AICC will continue to benefit from the existing 15-year licence, distribution and raw materials supply agreements with Baxter.

The Scientific Group (TSG)
Turnover increased by 2,7% but improved margins and well controlled expenses have resulted in strong operating profit growth over the comparative period. The disappointing increase in revenue was a result of reduced sales in the biosciences and export divisions, delayed funding for local research projects and reduced donor funding into sub-Saharan Africa. The strengthening of the Rand saw price decreases passed on to customers. On the positive side, medical equipment sales into hospitals showed double digit growth. TSG’s market presence improved with the successful acquisition and integration of Indigenous Systems during the second half of the financial year, bringing to the business a reputable product portfolio and a team with strong relationships within private hospital groups.

Growing demand for improved and cost effective healthcare to large populations within sub-Saharan Africa provides good growth opportunities. TSG has directly employed its own staff in Zambia and Mozambique. In other territories, where the business is still building critical mass, it will continue to utilise local distributors.

REGULATORY ENVIRONMENT

The Department of Health’s SEP increase of 7,4% on scheduled pharmaceutical products was implemented in June 2010.

The South African government reiterated its commitment to implementing National Health Insurance (NHI), with National Treasury working on understanding the full cost implications of such a scheme, which seeks to provide free or low cost health cover for all South Africans. It is premature to speculate on the impact of the proposed NHI on the business of Adcock Ingram. The group is monitoring developments and will engage where necessary.

TRANSFORMATION

In support of the Broad-Based Black Economic Empowerment (BEE) Codes of Good Practice, Adcock Ingram entered into a BEE equity transaction on 9 April 2010. The total value of the transaction was R1,3 billion, based on the VWAP of R50,91 per ordinary share on the JSE at the close of trade on Thursday, 19 November 2009, the date when the Memorandum of Understanding was signed. The total economic cost of implementing the transaction has been calculated at approximately R370 million, with reference to the requirements of IFRS2 and including transaction costs as well as the grant to the Mpho ea Bophelo Trust. The cost of R269 million recognised in the current year is related to the shareholding of the strategic partners in the transaction. No expense was recognised for share allocations to employees as they will take place in the next financial year.

PROSPECTS

With the mutually agreed cancellation of the Baxter option agreement, AICC will be wholly integrated into the Adcock Ingram group to streamline the business, improve efficiencies and reduce costs.

Adcock Ingram will continue to seek opportunities and new multinational collaborations to service sub-Saharan Africa after the successful acquisition of Ayrton in Ghana, which gives it a platform to grow sales in that country and in other West African markets. Several new launches and line extensions are planned for 2011.

Acquisition opportunities in the personal care and well-being categories have been identified. Also, investment will continue in brands, people and customers from our existing platform. However, the slow pace of the economic recovery is likely to affect organic growth in this category.

Price increases in the SEP portion of the portfolio are unlikely to be granted in 2011, and given low inflation, we also expect challenges in being allowed price increases in the non-SEP product portfolio.

Adcock Ingram remains committed to supporting the South African government in its rollout of ARVs and has tendered with a range of new generation ARV-molecules and combination ARVs in the next government tender. Whilst volumes in the new tender are higher than in previous years, tough competition on pricing is expected to drive margins significantly lower.

The recent pipeline innovations obtained through partnerships with multi-national partners including MSD, Celltrion, Lilly, Novartis, Roche and Norgine are already bearing fruit and have greater revenue potential in the coming year. Volume growth in AICC, driven in part by the national tender business, is set to continue.

The manufacturing facility upgrades, which enabled international accreditation of facilities, as well as improvements in the distribution network, are yielding positive results in efficiencies and customer service levels and attracting further multinational partnerships.

Adcock Ingram continues to seek opportunities to enter adjacent categories in the South African market and to seek acquisitions in other emerging markets to leverage the current Adcock Ingram pipeline.

For and on behalf of the board

KDK Mokhele JJ Louw
Chairman Chief Executive Officer