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Edited Transcript of SIP.AX earnings conference call or presentation 5-Sep-19 12:00am GMT

Half Year 2020 Sigma Healthcare Ltd Earnings Presentation

South Croydon Sep 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Sigma Healthcare Ltd earnings conference call or presentation Thursday, September 5, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Iona MacPherson

Sigma Healthcare Limited - CFO

* Mark Hooper

Sigma Healthcare Limited - CEO, MD & Executive Director

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Conference Call Participants

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* Gretel Janu

Crédit Suisse AG, Research Division - Research Analyst

* John Deakin-Bell

Citigroup Inc, Research Division - Director & Head of Healthcare in Australia and New Zealand

* Megan J. Kirby-Lewis

Morgan Stanley, Research Division - Research Associate

* Philip Pepe

Blue Ocean Equities Pty Ltd, Research Division - Senior Industrials Analyst

* Thomas Godfrey

UBS Investment Bank, Research Division - Analyst

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Presentation

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [1]

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Good morning, everyone. Welcome to the Sigma Healthcare results presentation for the half year ending July 2019. With me this morning to present is Iona MacPherson, our Group CFO.

So if I could just make some opening comments before I get into the detail of the presentation, as we often say inside Sigma, it's never a dull day. In the last 6 months, it has certainly been no different. We've seen the exit of the Chemist -- we've largely seen the exit of the Chemist Warehouse business, and we're now well into the execution phase of our business transformation program, Project Pivot.

The same time, we've continued to invest in the business from both an infrastructure and systems perspective which gives us a really strong platform for the future. As I've said in previous presentations, I think it is one of the really strong features of the Sigma business over this last 12 to 18 months, we have maintained that ongoing investment focus all the way through.

While we'll go through the actual results for the past half year, given that include 5 months of sales to Chem Warehouse, they're not necessarily as relevant for the go-forward business. So you'll see quite a bit in the presentation material where we've tried to give you some guidance on what to expect in terms of cost and revenues going forward. There are, however, some very positive underlying trends, and I'll talk to you those in more detail in a moment.

So before I hand you over to Iona, I just want to spend a few moments on the key highlights which picks up some of the underlying themes that I just mentioned. From a financial performance perspective, the result is as we would have expected, but the really pleasing point, from our point of view, the non-Chemist Warehouse sales grew by about 6.9% during the half even after the impact of PBS reforms. So the underlying sales base is actually slightly stronger. And we would expect this trend to continue into the second half. The sales team has done a really great job in building momentum inside the business, and that's obviously become more critical as we've gradually exited the Chemist Warehouse part of the business.

Just as importantly, the growth within our pharmacy brand has actually even been stronger with like-for-like sales up by 7.8%. I guess the only other market comparison we have is what Priceline announced in April, their like-for-like sales were up by 0.3%. So the strength of the growth inside the brands is really pleasing for the whole group.

Our business transformation program remains absolutely on track, delivering $100 million of benefits. And we've already undertaken actions to deliver annualized benefits of $33 million that's already been put in place. Now I guess to contextualize that, the larger part of the Chemist Warehouse business only exited in July, so the fact that we've acted so quickly to actually make those change, I think, again testament to the business, it's readiness to actually deliver on that -- I'll talk about that in more detail later in the presentation.

As we'd expect to see a similar manner of annualized savings delivered in the last part of this year. So when we talk to you in March, we said that around 60% of the benefits out of Pivot would be delivered by the end of this financial year, and that's absolutely on track in terms of what we've been doing over the past few months.

Just as critically, we've been making sure that we maintain a strong focus on ensuring our customers are well supported throughout this process. We've had a Voice of Customer program in place in the business for the past 12 to 18 months. And really pleasingly, over the last 6 to 12 months, in particular, we've seen a significant uplift in both Net Promoter Score and Net Easy Score, which given all the other challenge we have, I think, just again, a testament to the way the business is managed their way through this.

We've continued to invest in new warehouse infrastructure. All of those warehouses have been delivered on time and under budget. And gives just a fantastic platform to continue the growth that we've seen in retail pharmacy, the strong growth we've seen in hospitals and also our ambitions around 3PL and 4PL.

As expected, the wind down of the working capital supporting Chemist Warehouse has benefited our ongoing working capital but also our net debt positions. That will continue into the second half, and Iona will talk to you more about that in a little more detail on that in just a moment.

And last but not least, the team member engagement has remained very positive throughout this entire process. The culture has already been talking point, I guess, in corporate Australia at the moment. One of the things we're very conscious off is that we're implementing pivotal change in the business, but I have to say the enthusiasm with which the Sigma team has embraced the changes and the culture that we've built over the last 6 to 12 months has been really positive.

So I've got some more data on that later in the presentation. But what it means is we've got a great physical infrastructure and I've got an energized team that's absolutely out for the challenge and the growth that we see coming in the business moving forward.

So with that introduction, I'll hand you over to Iona.

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Iona MacPherson, Sigma Healthcare Limited - CFO [2]

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Thanks, Mark. I think it's fair to say that the financials for FY '20 are not going to be reflective of the ongoing Sigma business, and I say that when you take a kind of the impacts of the Chemist Warehouse exit, the Project Pivot business transformation program and the ongoing rollout of the network optimization program. So therefore, I'll only spend a couple of minutes on this year's half year results slide before I give you some insights into what you can expect in the key revenue and expense lines into the future.

So this group financial performance slides sets out both our statutory reported result that you see in our financial statements and the underlying result for the half year. The underlying results excludes 2 things. Firstly, the net one-off cost incurred during the first half. And secondly, the impacts of the new accounting standard on leases, AASB 16, and this accounting standard applies for the first time in this accounting period.

So firstly, on the net one-off costs. The half year result was impacted by a significant number of these nonoperating items, and these included $7.7 million of logistics team redundancies relating to both the unwind of the Chemist Warehouse contract and our network optimization program, where we're putting in place new distribution centers which are automated, and therefore, require a lower head count to run them; $4.8 million of cost associated with Project Pivot, and this includes a consultancy cost for both Accenture and EY, both of whom have been supporting us with several of the Project Pivot work streams; $3.4 million of one-off retention scheme costs linked to 2 things. The -- our retention rate arrangement following the API merger proposal and further retention scheme linked clearly to the deliverables of Project Pivot. With $1.3 million of dual operating costs associated with the new DCs, so these ones mainly related to our new automated Canning Vale distribution center which was opened in WA in February this year.

The remaining $1.8 million balance relates to corporate office redundancies, preflight costs for our upcoming ERP project and due diligence, legal and integration costs for our recent small acquisition and the dose administration aid space. These costs were offset by a one-off benefit from the settlement of a long-running legal disputes. So collectively, these items resulted in a net one-off costs for the half year of $12.4 million.

Secondly, the introduction of the new lease accounting standard, AASB 16, and I'm sure you're all as excited about this as I am. Now the detailed impact of this new standard are set out in note 10 and in our half year financial reports, so there's 2 pages of detail there. But in summary, the impacts on our P&L for the half year are, firstly, the removal of an operating lease expense of $5.8 million. So it's no longer recorded in our P&L, and that results in an increase in our EBITDA. So instead, we now have depreciation and amortization, which increased by $4.7 million, representing the D&A for the lease assets that's now recorded on our balance sheet. And we have a net finance expense, which has increased by $1.1 million because of the standard, which reflects the amortization of the lease liability that's now recorded on our balance sheet. So after tax, the net impact on Sigma's net profit after tax is a whopping $12,000.

So if I get into the revenue and cost lines. So sales revenue for the 6 months was $1.88 billion, which is down 4.1%, and that's impacted by only having 5 months of sales to Chemist Warehouse and the ongoing impact of PBS reform. Pleasingly, excluding Chemist Warehouse for the period, sales from our ongoing business were up 6.9%, reflecting good growth in hospitals, retail pharmacy, export sales and our Department of Defense contracts, where there was great growth in our supply of medical consumables. And gross profit, when we exclude the impacts of Hep-C, has declined by $8.8 million year-on-year. And again, this reflects the continued impact of PBS price reform, but the strong growth in our lower margin hospitals business, and there's also a major supplier in the market who's been significantly discounting their products.

So other revenue of $46.4 million was down $1.5 million, or 5.2% compared to the same period last year. So there are several minor items contributing to this, but the predominant impact is the reduced rebates we're receiving from suppliers, and that's aligning to the reduced stock purchases associated with the transition of Chemist Warehouse.

Just as a reminder, the other revenues in these categories include pharmacy brand member fees, dose administration services, promotional and marketing income and data analytics services. So underlying operating costs, including warehousing and delivery, sales and marketing and administration, reduced by $1.5 million. So that's against a backdrop of a decrease in overall net outbound units this year due to the commencement of the transition of Chem Warehouse, partially offset by higher hospital and retail banners sales volumes.

We've had an increase in labor efficiencies. We have a full half year period from the Berrinba distribution center in Queensland, and it's offset by higher payroll cost in accordance with our EBA requirements.

It's an important point to note that the scheduled drugs component of the Chemist Warehouse contract exited at the start of July, but the associated labor cost wasn't removed until a month later once we were sure the volumes have had permanently reduced.

Underlying sales and marketing cost increased slightly reflecting additional investment to expand -- sorry, [additional] investment to expand the size of the branded network and the implementation of additional programs to assist pharmacists improve the profitability of their pharmacies.

Underlying admin expenses decreased slightly. So underlying depreciation has increased largely as a result of the new Canning Vale DC in WA whose depreciation commenced in February. And the underlying increase in financing expense reflects the higher average monthly debt balance during the half, as we continued with our capital investment program.

So on to the next slide. Given the noise in this first half results, it's important to look at what we can expect in terms of the main sales and cost lines over the coming 18 months.

So firstly, sales revenue. In the second half of FY '20, total sales revenue will only have limited Chemist Warehouse revenue. We're expecting the remaining FMCG product lines to transition out by the end of October, meaning the second half result with only 3 months of revenue from these remaining FMCG lines.

In terms of our ongoing business, we expect sales to continue to grow at the same rate as in the first half, which was 6.9%. And looking forward to FY '21, we're not expecting any material level of sales to Chemist Warehouse, and we expect our ongoing sales growth to continue to grow at around the same level as in FY '20.

On to other revenue. In line with what we've experienced in the first half, we expect other revenue in the second half of this year to be impacted by declining wholesale rebates related to lower purchasing volumes because of the Chemist Warehouse transition. But we do expect this downside will be offset by improvements in our 3PL/4PL and dose administration aid growth businesses. Looking forward to next year, we expect that these 3PL/4PL and DAA revenue streams will continue to grow and be accompanied by sales growth from other business development opportunities.

So on to warehouse and delivery. The second half, we'll see a full 6 months benefit from the network optimization and Project Pivot cost savings that were delivered incrementally through the first half. And as we progress into FY '21, we'll see a full year of cost efficiencies in line with the Project Pivot estimates. And on top of that, we'll also further efficiencies being delivered from the new distribution centers, in particular, we'll have close to a full period of benefits from opening the Kemps Creek distribution center in the first quarter of 2020.

For sales and marketing, the second half of this year, we'll see the organizational changes from Project Pivot being rolled out. FY '21 is when you'll see a full periods of benefits from these changes. Whilst administration cost won't change significantly in the second half of this year, we'll see Project Pivot benefits coming through in FY '21.

So working capital management. The unwind to the Chemist Warehouse working capital commenced during the half, and about $150 million of the expected $300 million has been unwind by the end of July. The remaining balance is expected to flow into the second half of this financial year.

The cash conversion cycle days, excluding Hep-C, has reduced from the year-end by 11 days and sits at 29 days at the end of July. The cash conversion cycle reduction from January 2019 has been favorably impacted by the Chemist Warehouse transition across sales -- cost of sales and working capital. As the Chemist Warehouse transition completes, we expect the cash conversion cycle will normalize at a slightly higher level in the current 29 days.

Whilst we continue with our ongoing investment in the distribution centers and our IT systems, ROIC always remains a focus, and underlying ROIC at the end of July sitting at 12.2%.

In this cash flow waterfall, we said that each of the elements that contributed to the decrease in our net debt balance from $243 million at the FY '19 year-end to $193 million at the end of the FY '20 half year. So it's split into 3 main sections: operations and working capital, rewarding shareholders and investing activities.

So operations and working capital are the green bars. Underlying EBITDA and the return of working capital from Chemist Warehouse reduced net debt, but these were partly offset by the net $12.4 million of one-off costs I spoke about earlier and a small tax payment.

In terms of rewarding our shareholders, which is represented by the purple bars, a final dividend of $0.02 relating to FY '19 was paid during the half year, and that equated to a cash outflow of $20.2 million. Investing activities are represented by orange bars, display the cost from our ongoing capital investment program, then ranging at the waterfall, we have our net interest payment on our deck represented by the red bar. So as previously flagged, the ongoing unwind of the Chemist Warehouse working capital will continue to reduce our net debt balance in the second half of the year.

Finally, on the CapEx and debt profile. So looking forward, our accelerated capital expenditure program that's already well underway is expected to be completed during FY '22. And once complete, the Sigma group will return to more business-as-usual capital expenditure program that we wouldn't expect to exceed $10 million to $15 million in any 1 year. So whilst the net debt was $243 million at the end of the last financial year, it peaked at $294 million in June as we continue to invest, before reducing to $192 million at the end of July. And as I've said, that will continue to reduce as we unwind the Chemist Warehouse working capital.

So when we take account of our current financial forecast, the unwind of the Chemist Warehouse working capital, the upcoming investment profile, the one-off transformation cost and the declared and forecast dividends, management expects net debt at the end of FY '20 to be somewhere between $120 million and $130 million.

Looking to the future, outside the network optimization program, the major capital spend in FY '21 and FY '22 is our ERP replacement project.

So I'll hand you back to Mark who'll take you through the business transformation and investment program.

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [3]

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Thanks, Iona. I just wanted to build on some of the comments I made earlier in regards to some of the activities we've got ongoing from a business transformation and investment program perspective.

First of all, just starting with the ongoing investment in new warehouse infrastructure, which has been underway now for the past couple of years. Both our Berrinba DC in Queensland and Canning Vale DC in Western Australia are now both fully operational. And as I noted earlier, both were on time and below budget. Fantastic effort by the guys there. Our new Pooraka DC in South Australia will commence operations in October this year, again on time and under budget.

As a reminder for people, we own the land and buildings at Berrinba and Canning Vale. We've leased the site at Pooraka. I guess the principle we've undertaken here is where we've invested significant peaking technology we've chosen to own the building and the site. That doesn't reduce our flexibility to do something from a financing perspective later on if we want to, but we just feel like that was just a prudent thing to do both from a risk management point of view and to help get our balance sheet into long-term assets.

The previous DCs we have in each of the states were all owned. We've sold the Queensland property in Mansfield which was in last year's results. We just concluded the sale of our South Australian property, and we're looking to sell our WA property over the balance of this year. So we've got a little bit of cash back in from each of those over the next 6 months.

Turning to Kemps Creek, which is our -- which is the most significant investments we've made in DC infrastructure which is our new warehouse in New South Wales. The cost of this project is expected to be just above $100 million, which is well below the original budget that we have. We expect this to be fully operational in early 2020, although we have actually shifted some 3PL work in there already. Again, this is a wholly owned site. We build extra capacity in here to take on 3PL/4PL work. We've actually left half of this 40,000-square-meter warehouse available to do 3PL/4PL work, but it also gives us the flexibility to subdivide the warehouse if, for some reason, down the track, we don't know the capacity, there's actually dual access into this site. So we've got quite a bit of flexibility with what we do with this. But we are very confident about what we're doing in the 3PL/4PL space, so I think the more likely outcome is we'll end up filling it.

So if you think about that, it means we've completely reinvigorated the bulk of our network. We'll ultimately have to make a decision on Victoria when that lease runs out. That's got a few years left to run here.

If I just turn to some of the other investments we've made over the past few years, I guess, these are all stand-alone opportunities, but there are also areas where we're looking to connect our existing relationships through the health care supply chain. I guess the most recent ones that we've taken on are the doctors -- Doctors on Demand and BTC Health. Now while at this point, we haven't invested significant dollars, we believe both provides Sigma with additional optionality around new growth areas.

While tele-health is in its infancy in Australia, it's a widely used service overseas, and it's especially relevant from rural and remote locations in Australia. We know it's also a focus for the current Health Minister Greg Hunt who has made public comments about looking for MBS funding for tele-health consultations, and we believe it's a logical service for pharmacy to be able to provide to patients and particularly, as I say, in rural and remote and out-of-hours locations.

Likewise, BTC focus on specialty medicines which is a rapidly growing area of the health care space. We took a small equity placement in that just prior to the last set of results we put out. The partnership with Sigma provides benefits to both parties. It gives BTC a much broader and efficient distribution platform to support its growth, but it also means for us, we pick up the wholesaling, and it gives access to a range of new hospitals in particular, that previously we wouldn't have.

So they're just examples here of, as I say, partnerships that we're trying to build. Quite often, we don't like to take significant equity interest in those things because we don't want to crimp their entrepreneurial spirit that sort of drives these organizations. But it is a great example of us looking for opportunities just to sort of provide different ways of linking through the health care supply chain.

Now turning to Project Pivot. As I said in my opening comments, Project Pivot remains on target, both in terms of actions and activity, other than a slight slippage in the Chemist Warehouse exit, which is just reflecting the delay in some of the FMCG product moving over the DHL.

So this slide here gives you some more detail in the progress that we've made progress that we've made. As I said, it's on track to deliver $100 million plus of efficiency gains over the next 12 to 18 months. You'll noticed there's been a slight change between the 3 programs in terms of where the benefits are realized. We have refined the work that we've been doing over the past 6 months, so we're expecting a little bit more out of the operating efficiencies and probably a little less out of the smart spend piece.

As I mentioned in my opening comments, the actions that we've taken to date have already locked in around $33 million of annualized efficiency gains, and we'd expect that to double by year-end which will be consistent with our earlier guidance that around 60% of the annualized benefits will be delivered in terms of actions taken by the end of this financial year.

Given most of this comes from the exit of the Chemist Warehouse business, which mostly took place late in the first half of this year, there's not a lot of Pivot benefits actually in the underlying result that we've reported this time around. The scheduled medicines business was obviously the most significant part of that, as Iona mentioned, that only exited on 1st of July. And we left the labor in place until we were sure the volume had disappeared. So there's not a lot of significant benefits in the first half. But as you commented in terms of the cost outlook, we expect to see all of those benefits that we've actually delivered in the second half.

Just delving into a bit more detail on the Chemist Warehouse transition process because it does seem to be the focus for everyone on what's happening. It is the lion's share of the benefits. As I mentioned, the scheduled medicines portion transferred to EBA on July 1. The FMCG business has been gradually transitioning to DHL since about March this year. There's about 40% of that business still to transition to DHL over the balance of this year.

From a Sigma perspective, I guess our core focus has been to make sure that we provide an efficient transition for our Chemist Warehouse, but we also make sure that we don't interrupt service to that -- the remaining part of our customer base. And then from a cost perspective, we've had a very, very structured program that's been focused on removing all of the costs associated with servicing Chemist Warehouse, which is mostly about labor and freight, but it's also about managing inventory risks.

So you can see from the slide, around 75% of the roles that were identified has been associated with supporting Chemist Warehouse. They've already been removed. We've also shut down 3 regional warehouses which literally happened last week. So Shepparton, Launceston and Newcastle have all been closed. So you can see we haven't waited to sort of take the actions that are required here. We've been sort of planning this for quite some time, and we've moved quite swiftly to make the changes when we think we can.

We've also got this -- we've also got a quite a structured process for managing the inventory risk because you can imagine when Chemist Warehouse is sort of 35% to 40% of our sales, they made up quite a bit of demand for key products. So we've got to be careful we don't end up in a position where we ended up with any significant inventory write-offs. So the team's done a fantastic job supported by EY. EY has been really good at supporting the team through this process to make sure that we've been generating all of the reports and information we need to do, to manage that process. So having exited all of the scheduled medicines and 60% of the FMCG piece.

At this point, we wouldn't expect any significant issues in terms of stock write-offs. We think we've managed that pretty well. I have to say with good support from both Chemist Warehouse and suppliers. The process had been well managed all the way through. And as I said, we feel like we stripped the cost out. We're managing the inventory well. So the end result is the original savings we targeted to remove from the business from Chemist Warehouse going, we're very confident that will be realized and subject to them exiting over the next couple of months, we'd expect those to be realized inside the current year.

Just touching on the one-off costs associated with business transformation. When we did the full year announcement, we gave guidance around $30 million to $35 million of cost associated with Project Pivot. I think they're going to end up being slightly higher than that. I think that's no more complicated than the actual cost of redundancies, which is obviously just an estimate when we talk to you at the full year, is about $5 million higher than what we thought. So it's probably now more like $35 million to $40 million of one-off cost will have in association with Pivot. And that might still move around a bit, but I guess given we've made a lot of the redundancies already, hopefully, that's reasonably firm.

As Iona touched on, about $17 million of Pivot-related costs were incurred in the first half year, and we probably got a similar amount coming in the second half of this year. We've also got some one-off cost in relation to the establishment of the new DCs, but we talked about that in previous presentations as well. So this is really just to give you some visibility on where we are in that particular journey, but suffice to say, the fact that we've had slightly higher redundancy cost, per se, again, we're feeling pretty comfortable that we've got a good handle on that and where that's likely to land.

As I said in my opening comments, one of the things that I see -- I've been quite concerned about is to make sure that we maintain good customer experience, generally, but also at a time of significant change for the Sigma business when the worst thing that can happen when you're going through the sorts of challenges is that, for some reason, service to the remainder of your customer base falls away. So around 18 months ago, we implemented a formal Voice of Customer program inside Sigma. So this is where we formally track customer experience across a whole range of areas. So it includes hospitals and retail pharmacy, ease of ordering. So there's a reasonably significant investments we've made to track the customer experience. And just as importantly, we've invested in making sure that when we get feedback from our customers, we use a cross-functional approach to actually resolve any concerns that are raised.

So you can see here from the chart on the slide, the Net Promoter Score has gone up 15 points in 2019 than what we've had in 2018. And the Net Easy Score, which is just a measure on how easy Sigma is to do business with has gone up by 10 points. So the team, as I said earlier, has done a really good job of making sure that not only we're addressing ongoing concerns that might have been there in the business anyway, but at the time of significant change. What our customers are seeing is a better level of service from Sigma. So that's a fabulous platform for us to be able to build from. And I think it's partly reflected in what you're seeing in the sales growth for the non-Chemist Warehouse proportion of the Sigma business.

Just as critically is the employee engagement piece. I mean you are putting the business through quite a bit of stress when you make these changes. We do regular pulse checks inside the Sigma business to make sure that the team remains engaged. And specifically, as we've been implementing Project Pivot and we bought in specific change resources. And it's just -- it's fantastic to see how the business has embraced the changes that's required.

The whole principle behind Program Pivot was around a program of transformation. So yes, there's an efficiency gain from, but it's a program of transformation that set the Sigma business up to be the most efficient version of itself as if we've never had the Chemist Warehouse business and to give us a platform for growth. And I have to say the engagement now of the team has been fantastic. But we need to make sure that we're investing in change resources to support them as they go through that. As I say, we do regular pulse checks of how the team is feeling about that. And whilst it certainly has its challenges, there is an energy inside the Sigma business at the moment that I don't think we've seen for quite some time. So it gives me a great deal of confidence that if we get our physical platform right, we get our systems platform right, we efficiently manage the exit of the Chemist Warehouse, the business is well placed moving forward.

Just on capital management, Iona has already talked about this a little. The Board is very focused on the fact that we've previously said, we'll focus on a high-dividend payout ratio. We would expect that to continue going forward. This half year results got around a 95% of underlying NPAT payout ratio. It's about [10 million percent] of reported NPAT, but that's less relevant, I think, for, as I say, the business moving forward.

Given the sort of heavy capital commitment that we've got, there's no real activity on the share buyback front. We have sort of have to make sure that it's kept alive, and we'll keep it under review. But if you think about the capital program that Iona talked about earlier, that's probably our core focus just for the moment. But that remains under review as we go forward.

So just a few comments to finish on the outlook. If you haven't gathered already, I'm pretty positive about where the business sits at the moment. We've made some really good progress here. I think about it in terms of key metrics. I've got strong growing sales. I've got a Pivot program that's progressing in line with what we thought it would. We've got a return of capital out of Chemist Warehouse, and the investments we're making in the business are starting to give us the returns we expected.

So sales momentum is strong. We expect that to continue in the second half. There's plenty of growth opportunities, both from a retail pharmacy perspective, but also hospitals which we didn't spend a lot of time on today but revenue in hospitals grew by 23%, excluding Hep-C, over the past 6 months. 3PL/4PL presence, again, we think, is a great opportunity. We think there's a market there that's not well serviced at the moment, and we've got a brand-new set of infrastructure that can support that pretty efficiently.

I think, as I said, Project Pivot is on track. We'll get about 60% of benefits by the end of this year. The only slight negative, I think, is because of the delay of the Chemist Warehouse business shifting. We would have it originally expected at all to be gone now. It's meant we haven't been able to get all the cost out as quickly as we would have liked, so we're probably towards the lower end of the previous guidance that we gave to the market. We guided towards $55 million to $60 million of EBITDA. I think it will probably be towards the lower end of that, but that's a timing difference that will sort of rectify itself as we head into 2021.

I guess the really important thing is in terms of what we talk to you about full year, which is underlying growth in EBITDA of 10% for the next 3 years remains intact, and we look forward to reporting to you on that journey in future presentations results.

So that concludes the formal part of the presentation. I'm happy to take any questions either from the room or online. We'll go to the room first. There's quite a few people here who've got questions.

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Questions and Answers

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Gretel Janu, Crédit Suisse AG, Research Division - Research Analyst [1]

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It's Gretel Janu, Credit Suisse. Firstly, just looking at the sales. Just can you just give us a bit of commentary just on the outlook for picking up additional volumes in the wholesaling business, in the next 12 to 18 months? Are there any significant contracts coming up for renewal? You mentioned some of your competitors going pretty heavily on the price discounting. What's happening in that?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [2]

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So look, yes, there are always larger pharmacy groups coming out for tender. I mean we've tendered for quite a few over the last sort of 6 months. But the growth that we're getting is just from winning small groups and ongoing ones and twos. And I think one of the pleasing thing is we've got a really strong pipeline, as we head into the second half. So the first half, non-Chemist Warehouse sales, I guess, is the more relevant metric grew by 6.9%. We'd expect to see around that level or higher in the second half. And we'd expect to see the growth continue into '21 as well. So we feel like we've had a stronger pipeline of new businesses we've had for quite some time.

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Gretel Janu, Crédit Suisse AG, Research Division - Research Analyst [3]

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And then just in terms of your competitors and what they're doing in terms of pricing. And do you have to respond to that?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [4]

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Well, it is a very, very competitive market. I mean you do have to respond to it, but I guess we'd like to think that we've maintained a discipline around return all the way through. I mean we have always focused on return on invested capital. So I've got no doubt we have missed out on business because we're not prepared to compromise that. It has always been a very competitive space, Gretel. That's never stopped driving -- and it does sort of make me shake my head sometimes when I say what's out there, but I think we've remained pretty true to those principles around return.

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Gretel Janu, Crédit Suisse AG, Research Division - Research Analyst [5]

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And then what was the impact of PBS reforms in this half? And are we cycling pretty much most of that now, so that it reduced?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [6]

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Look, at the -- this year wasn't as big as previous years. I mean last year was a really big year in terms of PBS reforms because they had those June adjustments. So we had the normal April and October. We had the June adjustment. So I think for the products that have been listed on the PBS for 10 and 15 years that hadn't already had a price cut. I think this year's ones have been a bit smaller. But on the numbers, we were at probably knocked about 2% to 2.5% of sales growth. So pre-Pivot, it's one of the challenges that we have right? You start every year and you sell exactly the same products, you probably -- your revenue goes backwards by 2% to 3% minimum. So as I say, the 6.9% growth after that is fantastic.

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Gretel Janu, Crédit Suisse AG, Research Division - Research Analyst [7]

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And then just finally, just on the warehouse capacity, so how much spare capacity will you have once all of the DCs are up and running?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [8]

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Plenty. So we obviously -- obviously, the questions come up previously about, do we regret having built any of these DCs and not having the Chemist Warehouse volume. We quite clearly consider that when we made each of these decisions. And as I said on Sydney, which is our biggest, we can literally cover it in half if we have to. We have built the warehouses so that we've got capacity both in terms of extra shifts we can put on, but also extra automation that we can put into the warehouse. So we have got plenty of capacity in those. Being serious about it for a moment, but that -- the attitude of driving the businesses is one of a growth mindset. It's a build it and they will come, right? And as strange as it sounds, particularly when we look at 3PL/4PL opportunities and significant customer groups. Sometimes, you've got to have the capacity to take them on. So the team, again, feels quite energized about the fact that they've got to get out there and fill the DCs basically, but capacity won't be the issue, I guess, is the short answer to your original question.

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Gretel Janu, Crédit Suisse AG, Research Division - Research Analyst [9]

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And then just in terms of when you think they could likely be filled, are we talking 2-, 3-year horizon?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [10]

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Look, if I give you the example of Pooraka, right, which is our new DC in South Australia, so there's an example. We've lost the Chemist Warehouse volumes, so it's probably running at about sort of 30% or 40% of what it set up to do because we have allowed for some growth. So I can double volume tomorrow and still be okay. I could then put on another shift, right, so I might be running dayshift there at the month. That will double capacity again. And then inside the warehouse, we left additional capacity to put a new automation if we need to. So I would double capacity again. So I can literally take on 4x the volume that I have, but I haven't invested a lot of capital other than the size of the building to sort of facilitate that.

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Unidentified Company Representative, [11]

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We got questions online?

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Operator [12]

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Your first question from the phone today comes from the line of Tom Godfrey from UBS.

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Thomas Godfrey, UBS Investment Bank, Research Division - Analyst [13]

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Can you hear me okay?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [14]

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Yes.

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Thomas Godfrey, UBS Investment Bank, Research Division - Analyst [15]

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Right. If I could just start with the longer-term guidance. I think in March, you've said that FY '23 EBITDA will be back in line with FY '19. I think today the commentaries around 10% underlying EBITDA growth over the next 3 years. I think you need to sort of 18% CAGR to get back to the $90 million. I'm just wondering whether the $90 million still holds? Or if you could just give us a bit more color on that.

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [16]

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Yes. So we weren't looking to walk away from the $90 million, right? But if I'm being honest, I don't want to provide running 3-year guidance, right? That's a recipe for disaster. So the ambitions that we still have, as we did in March, is to get back to that level of those earnings, and we've done the work so we think we can deliver that. And so I guess we're just reinforcing the 10% comment, which, if you recall, was what we included in the March presentation. But we're not walking away from that statement about getting ourselves back to those sort of levels by the end of '23.

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Thomas Godfrey, UBS Investment Bank, Research Division - Analyst [17]

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Got it. Very clear. Can I just ask secondly on the Chemist Warehouse working capital release. I think you said that it would be largely done by October '19, so just wondering, have you got a clear line of sight on that sort of remaining $150 million being in the door by that point or will it take longer?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [18]

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We've got about another $80 million or $90 million in August because you obviously had the scheduled medicines. So I think it's -- so we've got -- I'm looking at only -- probably about $220 million of the $300 million already back. The exact timing of the last piece will depend on how quickly they transition that FMC -- that last bit of the FMCG piece to DHL. So when we presented to you in March, we would have assumed that it would have all transitioned to DHL. And we would have the money back. Now there's obviously been a few challenges there, so we've been supporting Chemist Warehouse while they worked through that. And we'll get the money back at the end of that process. So it goes as it's currently scheduled, then by the time we're talking to you in January, we'll have it all back. The only exception to that would be is we've kept any small amount of ongoing business with Chemist Warehouse. We've obviously had some working capital tied up. But at the moment, we'd expect all of that back by the end of January, and the timing is driven by them fully exiting the FMCG, not us.

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Thomas Godfrey, UBS Investment Bank, Research Division - Analyst [19]

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Got it. And then maybe if I could just have one more, maybe for Iona. Obviously, the net debt balance has been pretty volatile through this year. So if you can give us any sort of give us an FY '20 interest cost guidance, and potentially depreciation?

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Iona MacPherson, Sigma Healthcare Limited - CFO [20]

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Yes. So when -- our average cost of debt in the first half when you take account of everything, including all of the line fees and the interest, runs at about 5%. Obviously, we're seeing that debt balance reduce over time despite the continuing investments. So we expect our interest expense to be lower into second half. And as we said by the end of FY '20, we're expecting the net debt to be in a range of about $120 million to $130 million. If we do anything in the acquisition space, it would be higher. That excludes acquisitions, but that what's we're aiming for at the moment. I think a slight difference on that to the former guidance is the fact that we did do a small dose administration aid company acquisitions during the year, and our one-off costs were slightly higher.

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Thomas Godfrey, UBS Investment Bank, Research Division - Analyst [21]

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Okay. Great. And would you expect appreciation to kick up again in the second half just in terms of the new DCs coming online? Or is that sort of the new run rate?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [22]

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Yes, yes -- no, yes, we would. We would.

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Operator [23]

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Your next question from the phone today comes from the line of Philip Pepe from Blue Ocean Equities.

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Philip Pepe, Blue Ocean Equities Pty Ltd, Research Division - Senior Industrials Analyst [24]

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Just a couple of quick ones, please? Just with Chemist Warehouse today, I'd see the it's their problem, not your problem, but it's costing you sort of $3 million to $5 million EBITDA and maybe $80 million working capital release. Why not just show them the door or charge them a late fee? I mean why do you need to wear that $3 million to $5 million EBITDA instead of them?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [25]

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Well, that's an interesting customer philosophy there, Phil. Look...

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Philip Pepe, Blue Ocean Equities Pty Ltd, Research Division - Senior Industrials Analyst [26]

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Former customer. Former customer.

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [27]

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Well, I guess when we win customers or we lose customers, I always like to make sure we provide a level of professional support all the way through. We have, as I say, we've worked pretty well with the Chemist Warehouse guys like -- because we need their support to make sure that we can clear the stock efficiently on the way out, right, because of the challenges I've talked about earlier where they have significant demand in some SKUs. So it's deferring the timing on when we can realize some cost savings, yes. But the return we're getting from it is sort of washing its face. It just means we don't get the permanent reduction in cost base as quickly as we would have liked. So I'm not going to just going to kick them out the door. We will work with them in an orderly fashion to sort of make sure that the business has exited in a way that provides them with a reasonable level of support on the way through.

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Philip Pepe, Blue Ocean Equities Pty Ltd, Research Division - Senior Industrials Analyst [28]

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Fair enough. The 3PL/4PL opportunity sounds interesting. Can you elaborate a little bit on that? Or give us some examples of what you've achieved in the half?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [29]

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So we've had a couple of small wins during the half. So nothing significant. I've actually set up a completely separate team inside the business. So we actually inherited a little bit of 3PL/4PL work when we bought the CHS business a few years ago. It's also where we picked up the hospitals business. But we haven't had anyone actually fully dedicated to it. So I think I mentioned in the previous presentations, we brought in our next Total Health guy to help run that business. I put on additional couple of QA resources because we're chasing 3PL/4PL work being ISO accredited and potentially having GMP accreditation in some of your DCs. So as you take on high-level pharma work, is sort of a requirement. So we've invested a little bit extra head count, and we've also invested in some separate systems to support the sort of 3PL/4PL work. The guys have actually got a reasonably strong pipeline of opportunities at the moment. I know your next question will be how much could that be, so I wouldn't want to give you that at the moment, because I mean they are still at a relatively early stage. But we've had a couple of small wins over the last 6 months, and it's reasonably efficient business for us because it's 3PL work at its most basic is just pallet storage. I've got plenty of space in the DCs. It's a very efficient for us to be able to provide that sort of support. Now I do think there's an opportunity to support pharma companies, in particular, who maybe don't feel as well looked after by the larger players. And we think we can provide a bit more of a bespoke service as well. So we think that's a really interesting opportunity for us.

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Operator [30]

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Your next question comes from the line of Megan Kirby-Lewis from Morgan Stanley.

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Megan J. Kirby-Lewis, Morgan Stanley, Research Division - Research Associate [31]

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My first question is just on the hospital market. Just what is the strategy to grow that 8% market share, and where could that potentially go? And then my second question is just on the upcoming community pharmacy agreement. Just sort of what are your expectations there, I guess, in the context of the sort of extra media attention over the last week on relapsing the relocation rules?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [32]

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Yes. So what's the first question? I forgot. I had my brain fried.

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Megan J. Kirby-Lewis, Morgan Stanley, Research Division - Research Associate [33]

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Just on the hospital market.

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [34]

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Yes, hospital market. Sorry. The hospital market, when we first bought it -- when we first bought CHS, it was probably doing about $60 million or $70 million of revenues. So we've grown quite strongly. It's probably doing around $250 million to $300 million of annualized revenues at the moment. So we've done that over the last 3 or 4 years.

Okay. Our ambition here would be to be at least the second biggest player in that market that would put it up around sort of $600 million, $700 million, $800 million of revenue. It's really dependent on our ability to win a few large tenders on the way through. I mean I think we're very confident of our ability to grow that business at a double-digit rate of growth moving forward. But to really sort of catapult ourselves into that second market position, we probably need to win a few of the bigger tenders that are around the place. So we keep sort of participating in that. But at the very least, I think we're very comfortable about our ability to grow that in strong double-digit terms moving forward, which we've done over the last few years.

The thing to remember about hospitals is it is lower margin than pharmacy. So it does sort of -- doesn't quite give you the same kick in terms of earnings. But we also see that as a strong growth area as well.

In terms of the Seventh CPA, I mean, first of all, deal with it from just the straight wholesaling perspective. I think one of the things that's very clear for all of the CSO wholesalers is that we need an independent voice in that discussion. Traditionally, the Seventh CPA or the CPA arrangements to cover all of the remuneration arrangements in pharmacy, including dispensing fees for pharmacies, distribution fees for wholesalers and the CSO. We haven't been a direct part of that previously. We're not saying we necessarily need to be a signatory to that process, but we do need a direct voice in the arrangements that impact us, so we've been talking to the guild about that. The guild understands that, and we've also been talking to the Department of Health about that. So I think everyone understands it from a wholesaler perspective. This time around, we want our own voice in the process rather than waiting for someone else to tell us what the outcome is.

I think in terms of the noise over the last week or so, to be absolutely honest, I don't pay any attention to it. Why? Because I think if you look at the motors for -- the position of each of the parties that involved in that debate, there are other issues, I think, potentially at work. I think, whilst I know there are challenges with some of the issues in pharmacy, I can't really see that the governments likely to change the ownership or location rules quickly. There is, I think, a logic to the location rules that means you got a dispersion of pharmacies that does have some validity. So I -- there'll be typical of every CPI process is going to be a lot of noise. If you go back to previous CPIs, it was all that Coles and Woolies wanting to own pharmacies. I don't think there's any difference to that. But I don't know that I would necessarily expect to see any material change at the back of it.

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Operator [35]

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Your next question today comes from the line of John Deakin-Bell from Citigroup.

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John Deakin-Bell, Citigroup Inc, Research Division - Director & Head of Healthcare in Australia and New Zealand [36]

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Mine is slightly simpler I think. Just with the new warehouses all having come on stream, I think from -- by January, a lot of noise, but all things being equal, I think your EBITDA margin kind of ranged historically 2% to 2.5%. What type of margin uplift, all things being equal, would you expect from the automation, given that all of the warehouses ex the Victoria would've been upgraded, EBITDA margin uplift?

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [37]

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I don't have that answer off the top of my head, John. We might come back to you on that. I mean the broad economics of each of the DCS that we've built were that the automation would pay for itself within 5 years in terms of labor and other savings. And so even with the loss of the Chemist Warehouse volume, those metrics largely hold through. So in very rough terms, whatever the dollar spend on automation divided by 5 is the kick that you get coming through in the margin. But turning it into the percentage, I don't know that we have that off the top of my head. So we'll do a little bit of work and I'll come back to you.

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John Deakin-Bell, Citigroup Inc, Research Division - Director & Head of Healthcare in Australia and New Zealand [38]

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Okay. Maybe just to clarify then, if the growth came from hospital and 3PL/4PL, I'm assuming that's going to be lower margin. So it's kind of unlikely that you get back to the same margin as when all the business was really drug distribution. Is that...

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [39]

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No, 3PL/4PL will be higher margin, because it's lower touch, right? You're dealing with pallets on shelves, right? So that's higher margin. Hospitals will be lower margin.

So I guess the general statement that you make is depending on the mix of growth you've got that could knock around what you're seeing. Look, in our sort of forward-looking comments, we've not -- just to be clear, we've not assumed any material wins from our hospitals or 3PL/4PL perspective. I think we made a comment when we came out of the full year and gave the longer-term guidance. It was -- we were simply rolling out the benefits of the Pivot Program and the new DCs and a slightly above-market growth in our retail pharmacies sales are at over a 3- or 4-year period. So to the extent, we have success in the 3PL or hospital space moving forward, that will be over and above what we've already talked about.

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John Deakin-Bell, Citigroup Inc, Research Division - Director & Head of Healthcare in Australia and New Zealand [40]

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Got it. And just one quick one and just to come back to that. I couldn't see in the accounts the number of shares you used to get to your EPS numbers. Is that -- maybe you can let me know that later, but just for the modeling.

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [41]

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All right. We'll dig that. We haven't done it. We haven't done any -- we haven't done anything from an equity perspective there -- so that -- buyback or anything. That should be -- I think something around the weighted average. We'll come back to you, John.

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Operator [42]

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There are no further questions at this time. I would like to hand the conference back Mr. Mark Hooper. Please continue.

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Mark Hooper, Sigma Healthcare Limited - CEO, MD & Executive Director [43]

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Thanks, everyone, for your time. We look forward to catching up with a number of you over the next few days. Thanks.