Commentary

Salient features

Turnover increased 5% to R2,25 billion
EBITDA decreased 15% to R490 million
HEPS decreased 10% to 198,7 cents
Dividend per share increased 6,2% to 86 cents
Cash on hand: R568 million

FINANCIAL REVIEW

The six-month period under review saw Adcock Ingram facing several challenges, both internal and external, that tested the Company’s business model and strategy. Although the financial results achieved were disappointing, the Company continues to invest in its supply chain, products and people, all of which give confidence for improved future performance.

Headline earnings

The Company achieved headline earnings for the six months ended 31 March 2012 of R335,8 million. This represents a 12% decrease from the comparable figure for 2011 of R381,7 million. This translates into a decrease of 10,2% at the headline earnings per share (HEPS) level and 10,4% at the earnings per share (EPS) level.

Turnover

The acquisition of NutriLida and the conclusion of new co-promotion and distribution agreements with multinational (MNC) partners supported turnover growth of 5% to R2,251 million (2011: R2,152 million). This was achieved notwithstanding the loss of sales of DPP-containing products and the reduced Anti-Retroviral (ARV) tender award. Price reductions averaged 2% for the half-year.

In the Prescription division, no Single Exit Price (SEP) increase was granted during the period under review and revenue declined by 8%. Over-the-counter (OTC) turnover growth of 18% benefited from the inclusion of NutriLida, with volumes increasing by 8%. However, price deflation of 3% was experienced in this segment, reflecting increased competition. Hospital revenue grew by 4% as full production resumed post the factory upgrade, but the business segment continued to experience price deflation.

Profits

Gross profit for the six months decreased by 0,8% to R1 050 million (2011: R1 059 million) with margins declining from 49,2% to 46,7% (September 2011: 48,7%). Gross margin as a percentage of sales was adversely impacted by the inclusion of MNC revenue at lower than average gross margins, production inflation and by the weaker Rand, which affected imported raw materials and finished products. The average exchange rates for procurement were R7,57 (2011: R7,06) and R10,48 (2011: R9,64) for US Dollar and Euro imports, respectively, with total contracts settled during the period amounting to R366,1 million (2011: R330,8 million).

Operating profit declined by 17% to R435 million (2011: R526 million) with the percentage on sales reducing from 24,5% to 19,3% (September 2011: 24,0%). Operating expenses increased by 15,5% to R615 million (2011: R533 million), with new businesses, including amortisation of the acquired trademarks, not in the base contributing R24 million to the increase and M&A-related project costs increasing by R22 million. Excluding these, base costs were up by 7%.

After net finance costs and dividends received, profit before tax declined 19% to R450 million (2011: R554 million). The effective tax rate for the period was 24,0% (2011: 29,9%), as the Company utilises the remaining portion of its Strategic Industrial Project allowance of R308 million. As a result, the profit after tax from continuing operations declined 12% to R342 million (2011: R388 million).

Cash flows and financial position

Cash generated from operations was R181 million (2011: R264 million) after working capital increased by R316 million.

Trade accounts and other receivables increased by R117 million with trade accounts receivable days at the end of the period being 62 days, an improvement from the 65 days reported at September 2011.

Inventory decreased by R40 million with inventory days improving from 134 days at September 2011 to 123 days. Trade and other accounts payable decreased by R239 million.

After net finance income, dividends and taxation, the cash inflow was R65 million. The upgrade at the Aeroton facility has been completed and the construction of the high-volume liquids facility at Clayville is progressing well, with total capital expenditure amounting to R274 million (2011: R217 million).

A further R25 million of treasury share purchases were made by the special purpose vehicles party to the Broad-Based Black Economic Empowerment (BBBEE) transaction concluded in April 2010. Subsequent to September 2011, an amount of R100 million was repaid on the capex loan facility. The remaining loans of R254 million for the upgrade at the Aeroton plant and of R446 million for the high-volume liquids plant are being repaid in quarterly instalments from March 2012, with the final instalment due in the last quarter of the 2013 calendar year. Cash equivalents decreased by R535 million during the six months, leaving a healthy gross cash position of R568 million (September 2011: R1,1 billion).

Interim dividend

The Board has declared a gross interim dividend out of income reserves of 86 cents per share for the six months ended 31 March 2012, an increase of 6% over the comparable distribution in 2011. The dividend will be subject to Dividend Tax of 15% which will result in a net dividend to those shareholders who are not exempt from paying dividend tax of 73,1 cents per share. No Secondary Tax on Companies (STC) credits have been utilised. As at the declaration date, Adcock Ingram has 174 697 484 ordinary shares in issue, including 5 736 163 treasury shares. There are also 25 944 261 “A” and “B” ordinary shares in issue, all held as treasury shares, which are entitled to a dividend.

BUSINESS OVERVIEW

COMMERCIAL

Southern Africa

The segment encompasses all of the businesses in the Southern African region namely, OTC, Prescription and Hospital. The most significant impact on the period has been the withdrawal of DPP-containing products and the disappointing ARV tender award at the last adjudication in December 2010. The negative net sales impact in the half-year under review was R55 million for DPP-containing products and R100 million for ARV’s. The NutriLida acquisition has offset this effect by R98 million for the period. The region overall posted a sales increase of 4,4% in a tough economic climate that has seen pressure on the consumer as well as aggressive competition.

Overall the business, as measured in IMS, has performed well in the private market with a value growth of 10,1% (excluding DPP) in pharmacy and market share has increased in a declining FMCG market.

OTC sales increased by 18% to R875 million (2011: R741 million), assisted by the acquisition of NutriLida in the last quarter of 2011. Adcock Ingram is now number 1 in the Wellbeing category in FMCG(1) and number 2 in Pharmacy(2). Dependence on SEP products has reduced from 66% to 62%. Contribution after marketing expenses decreased by 2,6% to R319 million (2011: R327 million). This business has experienced the impact of the poor economic climate as consumers have continued to be under pressure. Adcock has however managed to increase market share in this highly competitive environment.

Excluding the DPP and ARV tender impact, the Prescription business has performed well due to new multi-national collaborations, sound performance of Adcock Ingramís core brands and continued progress in the generics business. Overall turnover has declined by 7,8% (14,7% increase excluding DPP and ARV tenders) to R752 million (2011: R816 million).

Hospital turnover increased by 4% over the comparable period to R535 million (2011: R514 million), as volumes increased by almost 5%.

The Renal division continues to grow market share in the public and private sectors with growth reflected in all portfolios. In the generic market, the division continued to invest in injectable analgesics, antibiotics and speciality drugs. The Transfusion Therapy division was impacted by lower blood donor numbers which increased only 2% compared to the 2011 comparable period.

The relationship with Baxter remains collaborative, with Baxter having performed an audit of the upgraded facility in February 2012. No additional product has been imported from Baxter during the period under review, as the Aeroton factory is now able to meet market demand.

Rest of Africa and India

It has been a challenging six months for the business, but revenue growth of 14,7% over the same period last year was still achieved. There was good growth in the first quarter of the year, driven mainly by aggressive media advertising and promotions in Ghana as well as strong growth of the core pharmaceutical export business. In the second quarter, results were adversely affected by product recalls in Kenya and the temporary shutdown of the liquids plant in Ghana.

(1) Source: Nielsen

(2) Source: IMS

In Kenya, sales of our flagship OTC analgesic, Dawanol, fell due to the introduction of counterfeit Dawanol in the market which required a recall of stock in the trade. The recall is complete and the business has obtained authority to distribute new stock with hologram security measures. In addition, two key products were withdrawn from the Kenyan market by their regulator after a third party manufacturing site failed a regulatory inspection in January 2012. A new manufacturing site has been approved and the relaunch of one of the products is planned for June 2012.

In Ghana, poor quality water supply at the liquids factory led to the temporary shutdown of the facility in February. A rapid but significant upgrade of the plant to the required standards was initiated and 70% of manufacturing capacity was restored by the end of April 2012.

SUPPLY CHAIN

The upgrade at the Wadeville facility is now complete. The plant underwent a US Food and Drug Administration (FDA) audit in the first quarter of the financial year. The outcome of the audit was satisfactory and the final report is awaited. Oracle manufacturing software was implemented at the plant in January 2012, which temporarily disrupted production.

The Clayville effervescent plant is performing well and the high-volume liquids plant is progressing, albeit with some time extensions. The plant will be ready for validation batches in July 2012 and inspection by the South African Medicines Control Council (MCC) in August 2012.

The completion of the construction of the Aeroton facility was achieved in late January 2012 and validations are expected to be performed until December 2012. The finalisation of this project will result in the facility attaining compliance with the international Pharmaceutical Inspection Convention and Pharmaceutical Co-operation Scheme Ė jointly referred to as PIC/s Ė standards adopted by the MCC.

LOGISTICS

Distribution volumes on a unit basis have increased 23% compared to the same period last year, and warehouse capacity remains a focus. Distribution expenses, as a cost per unit, have decreased year-on-year, and further transport and costsaving opportunities have been identified and remedial action to realise the savings has been instituted. Further costsavings initiatives are being explored by rationalising the different distribution networks in the Group.

TRANSFORMATION

Adcock Ingramís BBBEE transformation scorecard was certified by an accredited verification agency in February 2012, maintaining a level 4 BBBEE status, but importantly benefitted from the Black Employee Share Scheme which was finalised in March 2011.

The Owner Driver Scheme is progressing well and is expected to be fully implemented by September 2012. This should increase the Enterprise Development score and support an improvement to level 3 BBBEE status.

REGULATORY ENVIRONMENT

The Department of Health announced an SEP increase of 2,14% in March 2012. An announcement on the regulation of logistics fees is still awaited.

PROSPECTS

The upgrades to the Critical Care and Wadeville manufacturing plants have been completed and these will operate at full capacity for the second half of the year. The expansion to the Midrand distribution centre remains on course to be finished by the end of the financial year. The completion and commissioning of the high-volume liquids plant at Clayville, also scheduled for this year, will conclude the Groupís investment in its supply chain. Internationallyaccredited manufacturing plants and direct to customer distribution capability will strengthen the Groupís competitiveness.

The multi-national partner of choice strategy continues to deliver value with the recent addition of co-operation agreements with Novo Nordisk and Lundbeck. Additional collaborations are being explored to continue the path of revenue stream diversification and decrease the dependence on mature products. Supply chain collaborations will address the challenge in extending multi-national collaboration partnerships into sub-Saharan Africa.

Whilst registration delays at the MCC continue to impede the ability of the Group to bring new products to market, new product launches are planned for early in the third quarter in the Feminine Health and OTC segments.

The Group continues to search for acquisition opportunities in high growth emerging markets, particularly Africa and India. The successful registration and resourcing of its wholly-owned Indian subsidiary represents important capacity in support of this objective.

The effect of the current economic climate on consumer spending is concerning. Margins will continue to be impacted by cost pressures, particularly labour, transport and utilities, and by active ingredient prices which are directly linked to currency fluctuations.

CHANGES TO DIRECTORS

Mr Mpho Makwana was appointed as an independent non-executive director with effect from 1 February 2012.

DIVIDEND

The Board has declared a gross interim dividend out of income reserves of 86 cents per share, for the six months ended 31 March 2012.

The salient dates for the dividend are as follows:

Last date to trade: Friday, 15 June 20
Shares trade “ex” dividend: Monday, 18 June 2012
Record date: Friday, 22 June 2012
Payment date: Monday, 25 June 2012

Share certificates may not be dematerialised or rematerialised between Monday, 18 June 2012 and Friday, 22 June 2012, both dates inclusive

By order of the Board

NE Simelane
Company secretary

Johannesburg
28 May 2012

Comprehensive additional information is available on our website: www.adcock.com