Jean Coutu Group's (JCOUF) CEO Francois Coutu on Q1 2018 Results - Earnings Call Transcript

The Jean Coutu Group (OTCPK:JCOUF) Q1 2018 Results Earnings Conference Call July 11, 2017 8:30 AM ET

Executives

Hélène Bisson - VP, Communications

Francois Coutu - President and CEO

Andre Belzile - SVP, Finance and Corporate Affairs

Analysts

James Durran - Barclays

Irene Nattel - RBC Capital Markets

Michael Van Aelst - TD Securities

Keith Howlett - Desjardins Securities

Jennifer Panes - BMO Capital Markets

Operator

Good morning, ladies and gentlemen. Welcome to the Jean Coutu Group’s Financial Results for the First Quarter of Fiscal Year 2018 Conference Call. Please be advised that this call is being recorded.

I would now like to turn the meeting over to Ms. Hélène Bisson. Please go ahead.

Hélène Bisson

Good morning, everyone. Welcome to our first quarter conference call. Sorry for this little delay this morning. The Q1 earnings release was put on the wire earlier this morning and was then posted on the Jean Coutu Group’s corporate website. The quarterly press release is accompanied by additional financial information, and we will refer to the quarterly results slide presentation and MD&A during this call. The press release and MD&A are also available on SEDAR.

Here with me today are Francois Coutu, President and CEO; and Andre Belzile, Senior VP, Finance and Corporate Affairs. Mr. Coutu will discuss Company’s results and key operating highlights, and Mr. Belzile will then cover few financial details. This will be followed by a question-and-answer period for analysts only. I would ask you to limit yourselves to only one question at a time to allow us time to address as many different analysts’ questions as possible. Media are invited to contact me for comments or interview purposes. We would like to remind listeners that the Company’s forward-looking statement disclaimer applies to all our communications.

Now, Mr. Coutu will begin our presentation.

Francois Coutu

Thank you, Hélène. Good morning, everyone. On this busy summer day, we’re going to start by looking at the details of the results.

So, during the first quarter, network sales increased by 7% to $1,154.3 million, while Jean Coutu Group’s consolidated sales were up by 2.7% to $671.3 million. Note that following the announcement of an agreement between the association of Quebec pharmacist-owners and the Quebec Health Minister for the cancellation of the periodical withdrawals in April, the retail sales in our network have benefited from a onetime adjustment to account for the reversal of accrued and unpaid withdrawals of that date.

As shown on the first table, network pharmacy sales increased by 10% while distribution center pharmacy sales were up by 4.6%. The introduction of new generic drugs reduced retail pharmacy sales growth by 0.6% in the last quarter and price reductions of generic drugs reduced it by another 0.5%.

Also, the onetime reversal of liabilities following the abolition of the periodical withdrawals increased the growth of those sales by 5.7%. Without these factors, network pharmacy sales growth would have been 5.4% in the last quarter. The generics penetration rate increased by 0.9% year-over-year to reach 71.6% in the last quarter, thus impacting pharmacy sales.

Network front-end sales showed an increase of 1.9% while distribution center front-end sales were up by 4.9%.

If we look at the other slide, we see that operating income before depreciation and amortization decreased by 7.1% this quarter to $71.5 million. The decrease of $15.1 million in the contribution of Pro Doc to the consolidated OIBA following the removal of the ceiling on professional allowance authorized to a pharmacist has been compensated partly by the increase in royalties and higher volume for the distribution centers in both pharmacy and front-end.

Net profit amounted to $45.5 million or $0.25 per share during the quarter ended June 3, 2017 compared with $49 million or $0.27 per share last year. This decrease is mainly due to the decrease of Pro Doc’s contribution to the net profit.

The following slide shows the quarterly same-store sales growth for the PJC network. On a same-store basis, network pharmacy sales increased by 10.1% during the first quarter of fiscal 2018 over the comparable quarter while prescriptions count grew by 3% year-over-year.

Once again, keep in mind that despite 71.6% generics penetration rate, introduction of new generic drugs and price decreases, the one-time reversal of liabilities following the abolition of the periodical withdrawals increased the growth of pharmacy retail sales. Also on a same-store basis, front-end sales increased by 1.4% year-over-year. Overall, network sales increased by 6.8% during the past quarter on the same basis.

During the first quarter, we have put forward many different marketing initiatives such as special weekly flyers as well as TV and radio campaign. We also launched various promotions and popular contests. In May, we introduced the prestige brand Clinique in our network. 50 stores now will offer the Clinique products this year and over a 125 stores by the end of 2018.

On the real estate front, we opened three new stores including two relocations. You see on the slide, the stores located in Cap‐Pelé and St. John, both in New Brunswick and one in St‐Canut, Quebec, near Mirabel airport. On slide eight, you can see the pictures of these new drug stores.

Furthermore, 12 renovation projects were completed in the quarter and there are 35 other projects underway. Indeed, our chain is quite in good health when you look at the image that we project to our clientele.

Again, this year, we were the official presenter of the popular parents and kids fair held in Montreal and Quebec City in May promoting our various services and exclusive products. During the first quarter, we proposed various health related initiatives to our customers such as prevention against shingles.

That completes my presentation. Let’s look at the financial details and Andre Belzile will tell you about it.

Andre Belzile

Thank you, Francois, and good morning everyone. First, I just want to apologize, I realize that the analyst slide show has not been posted on our website as of yet, it should be there in the next few minutes. We just had small technical issues with it. You should get it in the next few minutes, again.

Having said that, the tables that we show on the slide 11, you will get in few minutes, reconciles operating income before depreciation and amortization to net profit. The income taxes amounted to $16.8 million in the first quarter of fiscal 2018, compared with $18.4 million in the comparable quarter of fiscal 2017. Earnings are subject this year to 26.78 tax rate in our 2018 fiscal year, and there was no significant item impacting the effective tax rate in the quarter. Depreciation and amortization charges amounted to $10 million during the first quarter of fiscal 2018 compared to $10.1 million for the comparable quarter of fiscal 2017. As explained earlier by Francois, the first quarter fiscal 2018 OIBA decreased to $71.5 million compared to $77 million in the comparable quarter of fiscal 2017.

You also have summary of our statement of financial position on the slide show. There was no bank debt, again used at the end of the quarter, and we had $189.3 million of cash on hands. We have sufficient liquidity with availability of $250 million under our revolving credit facility with an optional accordion of another $500 million. The book value of total liquidity amounted $1,233.8 million compared to $1,210.1 million at the end of the previous fiscal year.

On slide 13, you can see that the cash flow related to operating activities amounted to $39 million during the first quarter of fiscal 2018. Cash flow used in investing activities was $6.6 million during the last quarter, including $3.8 million used for the purchase of property and equipment and $1.3 million invested in intangible assets. Total selling square footage was 3,301,000 square feet at the end of the last quarter, compared to 3,253,000 square feet at the end of the same quarter in the previous fiscal year.

On the last page of that slide show, you will get the contribution from our generic drugs manufacturing subsidiary in our consolidated results. Sales decreased slightly to $50.1 million while OIBA margin decreased significantly to 12.4% following further prices decline and increased professional allowances since the removal of the ceiling in January, that’s compared to 41.4% for the same period of the previous fiscal year. The last April agreement between the government and the AQPP stipulates that the ceiling on professional allowances will be restored to 15% at a future date to be determined.

That concludes our presentation on the first quarter of fiscal 2018 results. I would now ask the operator to open the question period. Thank you.

Question-and-Answer Session

Operator

Thank you. We will now take questions from the telephone lines. [Operator Instructions] The first question is from James Durran from Barclays. Please go ahead, your line is now open.

James Durran

Good morning. There is a lot of moving parts obviously this quarter because all the changes and the reversal of the charges, but I notice that your royalty rate was up about 43 basis points year-over-year. Is that just an aberration based on the flow changes or is there a conscious move to increase your royalty rate?

Francois Coutu

Yes. As explained, James, in previous quarters, since the professional allowance cap has been eliminated, there was no need to provide as much support programs to our pharmacists as we did in past. So, yes, it’s a deliberate increase in the royalty rate that has been restated. And there is only a onetime adjustment on the non-recurring reversal of provision for periodical withdrawals we mentioned in the release. Obviously royalties are applied to those sales, retail sales and the total impact of that number is slightly more than $1 million. So, there is an increase of roughly about $7 million of the royalties in the quarter of which about $1 million is non-recurring.

James Durran

So, I know this is frustrating for you and for all of us but at this juncture we have no idea when that cap is going to be removed, right -- sorry, reinstated on rebates?

Francois Coutu

I wish I could tell you. No. As you know, the discussions between the Minister of Health and the association of Canadian generic manufacturer are still ongoing, and we are confident that all the parties will agree on a negotiated agreement, which is in the best interest of all parties with less risk for both the citizens of this country and for the government. Having said that, we suspect that the professional allowance cap of 15% will reinstate at some point in conjuncture with a deal occurring.

James Durran

And would you feel that at that juncture from a royalty rate standpoint you feel a need to step back in and help out some of the pharmacists in terms of profitability or do you think the royalty rate increase is going to stick?

Francois Coutu

Well, they’re going through good times at this time. And so, they are -- those who is having financial support and all of this, I think most of them will be reduced, alleviated and probably will be in better shape going forward.

James Durran

Okay. I just had one last question, the Clinique announcement. Can you just give us an understanding, like is this sort of the beginning of a stronger push on prestige cosmetics for the Jean Coutu network?

Francois Coutu

It is, Jim. I think we were left out of probably a very important prestige line that were only available in department stores and in some of our competitors’ throughout Canada. I think the company Estee Lauder realized that to have a strong presence in the province of Quebec they need to be with Jean Coutu. And they are extremely impressed by the way our cosmeticians are keen and sharp in a sense that they will take this challenge and make sure that the introduction of Clinique and Estee Lauder eventually in our pharmacies will be a success.

Operator

Thank you. The next question is from Irene Nattel, RBC Capital Markets. Please go ahead.

Irene Nattel

Thanks and good morning. Just continuing discussion around the whole issue of the conversations with industry stakeholders. Is it in your view that the pharmacists understand that to some extent everybody is going to have to take haircut here, because the government wants to reduce its generic…

Francois Coutu

I’m sorry, Irene. We don’t hear you well. I don’t know if your phone is…

Irene Nattel

Okay, is this better? All right, is that better?

Francois Coutu

Yes. Go ahead. Can you rephrase it?

Irene Nattel

Yes. My question is this. Clearly, the government has an agenda and that agenda is to reduce the expenditures on generic drugs. Do you feel that at this point or is that your view that at this point, industry stakeholders all kind of understand that there is going to be financial pain and it’s going to have to be shared around a little bit?

Andre Belzile

Yes. That’s for sure. There is clearly a trend and we all realize generic drug prices are not going to go up; they will go down, that’s for sure. In which form and to what magnitude is still open for discussion; they are in negotiation, as we were saying. And we are confident they settle an agreement that will be in the best interest of all parties. But having said that, yes, sure, this is going to be hurting our numbers, as you saw in Pro Doc by the way in this quarter, and that both the franchisor and the franchisees will have to realize that each has to share the pain, as you see.

Francois Coutu

But the good part, I think if I want to speak for the industry is that they saw in the last 10 years especially a growth and a tremendous growth in prescription for generic drugs. So, I think it’s quite normal that governments throughout Canada, provincials and federal, look at ways to maybe reduce the costs associated with prescription drugs and generics are really a target at this time, because they don’t have patents and they could rely on just share volume that they do in this country. So, hopefully, this will come, not with the tendering process but an agreement with all the provinces in Canada.

Irene Nattel

That’s very helpful. Here in Canada, there is a formula, right, for how branded pricing is established. I mean are you hearing any rumblings about any potential changes to that approach?

Francois Coutu

No, not really. We’re not [on the table] [ph] at all.

Irene Nattel

Okay. That’s great. And then, just I’m sorry to belabor this whole point, but obviously a key one. The uncertainty that creates for you is certainly significant. I would think if independent, small pharmacists, this all create -- I mean they have to be extremely worrisome. Are you seeing more openness to the idea of M&A?

Francois Coutu

Well, you’re right to point that this is creating uncertainties and lot of independents are saying, what will I be doing. But, Irene, I think everyone is waiting, independents and so on, see what will be the next move from the Minister. And then after that, it should settle, the dust should settle I think.

Irene Nattel

Absolutely, absolutely. And then, just turning back to the quarter, if may for a minute. Can you just talk a little bit about category performance in pharma store?

Francois Coutu

Yes. It’s pretty good. Last quarter, it’s been -- they were up in all departments that we have in the store, except unfortunately May was not the tremendous month as far as seasonal products. I don’t know if it’s the same in if you were in Toronto or in Montreal or -- I mean the summer has been extremely late coming and it’s too bad. We don’t have the sales that we wanted to have especially in the sunscreen, lotions and so on. But at the same time, I think we’re very satisfied with customer traffic in our stores, even though we can’t blame nature too much.

Operator

Thank you. The next question is from Michael Van Aelst from TD Securities. Please go ahead. Your line is now open.

Michael Van Aelst

Just a quick question to start off. Can you tell us what the stock-based compensation was in the quarter?

Andre Belzile

Sorry. could you repeat your question?

Michael Van Aelst

Could you tell us, what the stock-based compensation was in the quarter?

Andre Belzile

The stock-based compensation, actually the variation with last year was for the same quarter, was unfavorable variation of $900,000. So, the reduction in the EBITDA in this quarter as compared to last year is actually on the comparable basis excluding the impact of the stock-compensation is less by that number.

Michael Van Aelst

I think it was 0.1 contribution negative stock-based comp last year, so it’s 0.8 expense?

Andre Belzile

Let me check the right numbers. Yes, exactly. That’s the number.

Michael Van Aelst

All right. So, on the DC. Can you give us an update whether you have this now running at the expected efficiencies? How did it perform during the quarter and what kind of improvements can we expect in the coming quarter?

Francois Coutu

Yes. It’s not at 100% efficiency, obviously. There are still things that almost done. We need to transfer a few more things from our Longueuil DC, I think only have Pro Doc products left over there. And we’re improving every day service to our franchisees. I would say percentage of service is high but obviously there is some fine tuning to be done, again. It’s a big move that we made. We’re still looking forward obviously to see the ripening fruits coming from this investment. But it will take another few months before we see, we realize the full efficiency of that move.

Michael Van Aelst

Okay. So, when do you expect the Pro Doc products to be transferred over?

Francois Coutu

It should be within the next couple of weeks.

Michael Van Aelst

And just finally, given the earnings outlook for the pharmacy industry, what’s your longer term square footage growth expectations?

Francois Coutu

Depend on the opportunities that we have. We have a few in the pipeline, new stores and some acquisitions, independents that are pending. So still an ongoing process for us.

Michael Van Aelst

So, should we be assuming it slows into 2% to 3% growth rate or…?

Francois Coutu

Yes. That’s probably what you should expect, around 2% or less. Again, there is larger opportunities that arise or let’s say a wave or a movement from independent pharmacists willing to retire at some point following the latest and newest regulatory changes, we’ll see.

Operator

The next question is from Keith Howlett from Desjardins Securities. Please go ahead. Your line is now open.

Keith Howlett

Yes. I was just wondering where the transition costs to the new DC are running, if they’re still at around 3 million a quarter?

Francois Coutu

Yes. If you remember last quarter, they were roughly, slightly more than 3 million, 3.5 to be specific; this quarter, they were at the 2.4 million. So about 1 million less than last quarter, and it should decline to zero pretty quickly as we move forward.

Keith Howlett

Do you anticipate sort of by the end of 2Q or 3Q more like?

Francois Coutu

At the end of second quarter, yes.

Keith Howlett

2Q?

Francois Coutu

Yes.

Keith Howlett

And then just on the -- and then in terms of the upside to the new distribution center, will that take sort of another 12 to 18 months to realize or…?

Francois Coutu

Yes. To realize fully, again, it’s a question of productivity and efficiencies and those things are being learned step-by-step gradually. It’s a lot of work, but it’s going well actually. We already see some results in terms of productivity. And we are still in cementing new initiatives and the things are going better and better. So, you should -- yes, by, let’s say next fall -- this fall, we should see significant difference. But overall, to get to the overall goal, we will need about what -- as you say 12 to18 months.

Keith Howlett

Thank you. And then, just on the issue of professional allowances, do you think the independent pharmacists that are less -- have less volume or presence in the market, do they get the same rough professional allowance percentage as sort of a top tier store in your network?

Francois Coutu

Phrase that again. I am sorry.

Keith Howlett

I was just wondering, if an independent pharmacist in Quebec would receive the same rough percentage, professional allowance as does a member of a high volume chain like your own?

Francois Coutu

This is left entirely to the pharmacist owners. Some of them are -- they could squeeze a little bit more than others. We haven’t been involved in this process, we -- our franchisees I think are probably better businessmen than most and they are probably negotiating better rates than some others. But it’s entirely out there and I can’t speculate on that too much.

Keith Howlett

And one last, could you -- I am sorry I missed it, was the adjusted same store sales in pharmacy without the reversal on the government payments, was it 5.4%?

Francois Coutu

Actually, it’s 4.3, if you exclude the onetime reversal, 10 less 5.7% impact from that onetime element. But, if you add back the negative impact from price reductions and production of new generics, overall of 0.9%, then you get to that number. Yes.

Operator

Thank you. We have a follow-up question from James Durran from Barclays. Please go ahead. Your line is now open.

James Durran

Thank you. I just wanted to go back, some adjustments in the quarter. So, the other goods and services line that was down line 6.7%, was there any shift there or what’s that related to?

Andre Belzile

Which line are you referring to?

James Durran

Other goods and services in the income statement, it’s like 29…

Andre Belzile

This line has made up of lot of small items, I can’t recall from the top of my head what it is. You see in the cost of -- in the operating cost, other…

James Durran

Yes, after operating leases and expenses that’s 29.1 million in the quarter down 6.7% versus the prior year. I just wasn’t sure what was it…

Andre Belzile

Yes, but this is not necessarily all variables. If you look at last year, it was 31.2. So, it’s not much different than last year.

James Durran

Yes, okay, just wanted to check on this.

Operator

Thank you. The next question is from Jennifer Panes BMO Capital Markets. Please go ahead. Your line is now open.

Jennifer Panes

Hi. This is Jennifer. I’m filling in for Peter Sklar.

Francois Coutu

Hi, Jennifer. Good morning.

Jennifer Panes

Hi. Good morning. I was just wondering if you have any update on where the government is in the tender process with Bill 81.

Andre Belzile

I think the things are that they are negotiating. The government, the minister has said that he would go ahead with the tendering process; he said that 10 days ago. Last week, he said well, I’m going to give a chance to negotiate with the industry, the association and so on. So, we’re still waiting, we’re still waiting on that; can’t speculate as well on my side.

Francois Coutu

Yes. As we have mentioned, you may have missed the beginning of this call. As we have mentioned earlier, we believe that it’s in the best of interest of all parties to negotiate a deal among the industry and the government that it will be less risky for the citizen of this country. The tender is clearly more risky and is not the best solution. And we believe that all parties will end up concluding that.

Jennifer Panes

Yes. That makes sense. But, if it was to go ahead with the tender process, what proportion of the total drug volumes applied by Pro Doc would be included in that tender process?

Francois Coutu

As we’ve mentioned, sorry to come back with the same answer, but we don’t expect the tender to move forward. We are considering, they we will succeed to have an agreement.

Jennifer Panes

Okay. And then, lastly, can you just speak qualitatively to the impact from the cap on the professional allowances? How has that trended since the last quarter?

Francois Coutu

If you look at the margins, it’s quite clear that on top of price reductions, the removal of a cap on professional allowances hurt the margin quite substantially moving from over 40% to something like 12%. But, if you do the reverse math by yourself, you will probably realize what is the current level of professional allowance being paid. Having said that, again, the Minister announced that he will reinstate a cap of 15% at future date that is not determined as we speak. But we suspect that the combination of that 15% cap and the combination of price reductions in new agreement will continue to hurt the margins of Pro Doc going forward. But in the more easiest way to forecast, let’s say our cash flows in the future and would still sufficient margin to maintain the business alive which is a good news for us.

Operator

Thank you. We have a follow-up question from Keith Howlett from Desjardin Securities. Please go ahead. Your line is now open.

Keith Howlett

Yes. I was wondering about the deal in the market now that McKesson may takeover Uniprix. I was just wondering if you know how the competition bureau looks at sort of transaction where two franchise networks are going to be sort of under the same ownership?

Andre Belzile

Yes. It’s not a franchise type of -- but it’s Proxim and well I give the Proxim and Uniprix. I think McKesson did it for -- to preserve this distribution. But I can’t speculate as far as you know for the competition bureau...

Francois Coutu

Yes. We’re not involved in that…

Andre Belzile

We’re not involved obviously, as you know. And obviously this is a comparison -- so we’re better not to comment too much about it.

Operator

Thank you. The next question is from Vishal Shreedhar [ph] from National Bank. Please go ahead. Your line is now open.

Unidentified Analyst

Hi. Thanks for taking my questions. Just on the negotiated settlement with the government for the tenders. Do you know if the government is going to also help the pharmacy industry or maybe redistribute cost by giving the pharmacy industry more professional services in conjunction with reducing generic prices or is the conversation only about taking cost out from generics?

Francois Coutu

The AQPP has struck a deal with the Minister until March or April 2018. I think they will have a year or two once the dust is settled, as I said, to negotiate other things than just price of prescription drugs and fees and rebates and so on professional fees. I think looking forward, they have to be looking at some other services that pharmacists can render to help the Minister in this public health issues.

Unidentified Analyst

Okay. So, the professional services that your franchisees pharmacists offer, is it correct to think that revenue predominantly goes to the franchisee and PJC participates from the royalty? Is that the right way to think about it?

Francois Coutu

Right.

Unidentified Analyst

Okay. Just switching gears on another topic that’s seemingly becoming more invoked. Just on e-commerce, I want to get your thoughts on what the appetite is from the consumer for e-commerce from your type of offer and what management’s thoughts are over there?

Francois Coutu

Yes. It’s a good question, because every year, every quarter, it seems like there is new moves that we’re seeing in the market. We are actually pretty well prepared for this. We have an offer under web. But I think the main goal for us at Jean Coutu here is to use the internet and the web to promote what we have in the store, because we are conveniently located. We are accessible to our clientele. So, if they want to go via the net, fine, we’ll give them the service. But at the same time, I believe with the store that we have, the business hours that we have and the pharmacists on premises that we have and all the other stuff, I think we correspond to what people want to have of a retail store. And so, we’ll see. Obviously this is a constant lookout for us what our future consumers will be doing. And do don’t worry about that. We’ll be wise enough to follow what our customer wants.

Unidentified Analyst

Related to investments for e-com, how does PJC split that investment with the franchisees, mainly PJC corporate expense or does the franchisee have to help out with those infrastructure costs?

Francois Coutu

No, I think it’s the role of the franchisor organization to put the leadership forward. And they will - they understand that we work as a team.

Unidentified Analyst

Okay. Would a click and collect type offer make sense for PJC to increase convenience?

Francois Coutu

Could be an opportunity, yes.

Operator

Thank you. There are no further questions registered at this time. I would like to turn back the meeting over to Ms. Bisson.

Hélène Bisson

Thank you everyone for your interest in the Jean Coutu Group and your participation in today’s conference call. If you have any further questions, please feel free to contact us. Our contact information is contained in the Company communications. We look forward to report on our second quarter results of fiscal 2018 on October 12, 2017. Thank you very much and have a greater summer.

Francois Coutu

Have a good summer everyone.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.