Shoppers Drug Mart Earnings Call Nuggets: Operations Underlying Trends, Drug Reimbursement Reform

On Thursday, Shoppers Drug Mart (OTC:SHDMF.PK) reported its first quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Operations Underlying Trends

Patricia Baker – Scotia Bank: I guess this question is for Brad. If we could just get a little bit more information on the underlying trends in the operations in the first quarter, if we look at the EBITDA, it is pretty much flat at C$247.9 million, with the dollar level that we saw in the first quarter of 2011, but you saw a very nice positive impact there on the gross margin which was up 58 basis points. So, if you could share with us a little bit of the background on the gross margin trends with respect to what’s happening both in the front of the store and the pharmacy? Secondly, related to that there was an offset there on the expense side, with your SG&A excluding D&A actually up C$31 million or 4.8% on a dollar basis and maybe it would be nice to share with us a little bit more color on the contributors to that increase and perhaps the relative importance of various factors?

Bradley Lukow – EVP and CFO: First off with the gross margin improvement in Q1 more than a 100% of the basis points improvement was attributed to the front store performance as pharmacy continues to be a drag on gross margin as a result of previous reform that was announced, that continues to get phased in and will continue this year. So, in terms of the front store there were a couple of items, certainly, we have seen as a follow-on to Q4 last year, very strong performance in cosmetics, continued market share gains in a very important category for us, and also, we’ve previously about our promo effectiveness program, which is really kicking in, really looking at the effectiveness of our various offers and really trying to maximize both the gross margin dollars and sales on those promos. So, together, those two items really drove solid performance in gross margin in the front of the store. Turning to the SG&A, a couple of factors, first of all, in the 4.8% SG&A one of the things that we have to keep in mind which drives that 74 basis point decline year-over-year and we’ll continue to face this all year along is the deflationary impact in the top line as a result of increased generic penetration as well as ongoing drug reform. So, of that minus 74 basis points performance in Q1, about half of it is due to the deflationary impact on the top line. Also, we had a couple of items that I had point out, that were unique in the first quarter as compared to that of the prior year. Last year’s Q1 had about a $4 million expense reversal that came back into income associated with the departure of the former CEO in terms of stock options and RSUs that were not yet vested, but previously expensed, so that back into earnings in Q1 last year. Also, we are negatively impacted in the current quarter with regards to an additional labor cost in the stores in connection with the staff holiday of New Year’s that fell into the first quarter of this year. So, if you adjust for those two items, the SG&A was up 4% in the first quarter of 2012.

Drug Reimbursement Reform

Perry Caicco – CIBC World Markets: Domenic, drug reimbursement reform seems to become rampant and maybe a little too frequent and surprising. So, I’m wondering, how you are viewing it right now, do you think it ever ends and what shoppers and pharmacy can do about it?

Domenic Pilla – President and CEO: I don’t have a crystal ball in terms of, if you think it will ever end. I think what the reality is that the government is under a lot of pressure to try to balance their budget and their single biggest point of expenditure is healthcare and the growth and demand for services in health care is growing faster than their capacity to raise fund. So, I think that’s a reality and it’s a reality that we have to face as Canadians. What Shoppers is doing about it and lot of work we are doing with government as well as ourselves is to try to advocate for and move in the direction of providing additional services that in fact address the problem. We’ve recognized the problem and so the kinds of things we’re talking about is the expanded scope of doctor’s programs around adherence, programs around disease management and trying to get a handle on our chronic disease management cost. Importantly for us, things like therapeutics substitution. I do believe that we’re making headway in working with governments and having them understand the benefit of those programs which in fact increase revenue for pharmacy or margin for pharmacy and reduce cost for governments and improve patient outcome. I think it’s all the right things. So, that’s what we’re working on from a pharmacy standpoint. In terms of the rest of our business as we’re seeing very encouraging as the rest of our business, we’re doing two things, having to grow the important categories like cosmetics, we’re continuing to have penetration in our food offering and we’re continuing to improve our performance inside our store. We’re continuing to add other categories like financial services and we also believe that we are an opportunity or we have the opportunity to consolidate the market both in the front of the store and the dispensary. So, that’s what we’re doing about it, Perry and I think the question is can we accelerate those things and can we continue to advocate government. We’re seeing some encouraging signs in some jurisdiction and we’re having good discussion with the Ontario Government. I think that Donald Drummond report was a reinforcement of everything I just told you and we’re going to continue to advocate for those things.

Perry Caicco – CIBC World Markets: On the consolidation front, I mean you obviously passed on the large Zellers’ file base, what was your thinking behind that and are there other ways to grab those particular customers and I’m just kind of wondering what that tells us about how you are going to approach this topic going forward?

Domenic Pilla – President and CEO: In terms of the Zellers’ files, we didn’t think it was worth the value that they were looking for. In terms of other files, we do have a fairly active pipeline and we are quite encouraged by that in terms of activity in the market. In terms of specifically growing our market share organically, I mean we have addressed and are looking very actively at increasing our participation in a very important segment, which is the Seniors. And that segment is very important to us and we are continuing to launch marketing programs addressing that segment and improving the assortment and the services offered in our stores to address the needs of that segment and we are quite encouraged by that. We believe that the Zellers’ files were over indexed in that segment significantly and we believe that our marketing program will be a very successful tool in getting a large portion of those patients to come and shop in our stores.

Perry Caicco – CIBC World Markets: The $2 co-pay reduction I guess will be part of that?

Domenic Pilla – President and CEO: That will be part of it, it’s an important part, but it is not the only part. Our stores – first of all, there was an impediment for many seniors to shop our pharmacy, they were already in a large numbers shopping our store and appreciate some of the value and offers that happen in our stores both in terms of pricing, assortment, and promotion events and so on. But we weren’t happy with how they were and the frequency at which they were shopping our pharmacy. One of the impediments to that was the $2 co-pay that they had to bear, so by removing that barrier we think they will access some services, but it’s not just about that. It is about doing additional med checks, and again increase the number of med checks we did in the first quarter compared to prior quarters. It’s about OTC counseling, it’s about interaction with their physician and we’ve created a tool for our pharmacists to have better interaction with the physician. It’s about adapting to store, to their reality in terms of assortment merchandising and what we are promoting. It’s about working with our manufacturing and launching products that cater to that segment and merchandising them and promoting them in a way that resonates with that segment. It’s about doing additional days, seniors days, as well as other senior events. So, it’s a very broad range of activity to attract that segment and to build the basket and number of trips with that segment, but clearly one of the impediments was the co-pay and we’ve tried to remove that impediment.