Shoppers Drug Mart Corporation announces first quarter results
TORONTO, April 28 /CNW/ - Shoppers Drug Mart Corporation (TSX: SC) today announced its financial results for the first quarter ended March 27, 2010.
First Quarter Results (12 Weeks)
First quarter sales increased 5.7% to $2.321 billion, with the Company continuing to experience sales growth in all regions of the country, led by gains in Québec and Western Canada. On a same-store basis, sales increased 3.1% during the quarter.
Prescription sales increased 6.3% in the first quarter to $1.155 billion, accounting for 49.8% of the Company's sales mix compared to 49.5% in the same period last year. On a same-store basis, prescription sales increased 4.1%. Prescription sales growth continues to be driven primarily by strong growth in the number of prescriptions filled, while increased generic utilization continues to have a deflationary impact on sales growth in the category. In the first quarter of 2010, generic molecules represented 54.2% of prescriptions dispensed compared to 52.8% of prescriptions dispensed in the first quarter of 2009.
Front store sales increased 5.1% in the first quarter to $1.166 billion, with the Company continuing to experience sales gains in its core categories. On a same-store basis, front store sales increased 2.1%.
First quarter net earnings increased 8.2% to $116 million or 53 cents per share (diluted) from $107 million or 49 cents per share (diluted) a year ago. This result was driven by top line growth, improved purchasing synergies and a continued emphasis on cost reduction, productivity and efficiency, the benefits of which were partially offset by higher operating expenses at store-level associated with the Company's network growth and expansion initiatives, including increased amortization, and continued investments in pricing and promotional activities. Net earnings growth was also aided by lower interest expense and by a reduction in the Company's effective income tax rate.
Commenting on the quarter, Jürgen Schreiber, President and CEO stated, "We are pleased with our first quarter results, especially in light of the fact that we experienced a weaker cough, cold and flu season compared to a year ago. In these challenging times for community pharmacy, particularly in the Province of Ontario, I am extremely proud of our Associate-owners and their teams as they work through this difficult period without ever losing sight of what matters most - the health and well-being of our valued patients and customers."
Store Network Development
During the first quarter, 27 drug stores were opened or acquired, 11 of which were relocations, and one smaller drug store was closed. At quarter-end, there were 1,303 stores in the system, comprised of 1,234 drug stores (1,183 Shoppers Drug Mart/Pharmaprix stores and 51 Shoppers Simply Pharmacy/Pharmaprix Simplement Santé stores), 63 Shoppers Home Health Care stores and six Murale stores. Retail selling space was approximately 12.2 million square feet at the end of the first quarter, an increase of 9.0% compared to a year ago.
Dividend
The Company also announced today that its Board of Directors has declared a dividend of 22.5 cents per common share, payable July 15, 2010 to shareholders of record as of the close of business on June 30, 2010.
Update on Fiscal 2010 Outlook
On April 7, 2010, the Ontario Ministry of Health and Long-Term Care (the "Ministry") announced its plans with respect to further drug reform in the province. The proposed reforms announced by the Ministry included lowering the cost of generic prescription drug products for patients under the Ontario Drug Benefit Program from the current level of 50% of the equivalent brand name price for multi-source generic prescription drug products to 25% of the equivalent brand name price, and extending these same benefits to private payors over a multi-year period. The proposed reforms also include a phasing out of professional allowances, which the Ministry indicated would be eliminated by 2014, and increases in the dispensing fees, including support for access to pharmacy services in rural communities and under-serviced areas. As part of the proposed reforms, the Ministry also announced that it would pay pharmacy operators for additional services that pharmacists provide to patients.
On April 8, 2010, the Ministry published Notice of Proposed Regulations to Amend Regulation 935 under the Drug Interchangeability and Dispensing Fee Act and Ontario Regulation 201/96 under the Ontario Drug Benefit Act (collectively, the "Proposed Regulations") for comment. The Proposed Regulations outline the regulatory changes that the Ministry proposes to enact in order to implement the reforms announced on April 7, 2010. For a more fulsome discussion of the Proposed Regulations, please refer to the discussion on "Ontario Drug Reform" under "Industry and Regulatory Developments" under "Risks and Risk Management" in the attached Management's Discussion and Analysis which forms an integral part of this news release.
In its fourth quarter 2009 earnings release dated February 11, 2010, the Company stated that it anticipated comparable prescription sales growth of between 4.0% and 5.0% for fiscal 2010. At that time, the Company specifically cautioned that its prescription sales growth estimates were based on what it believed to be a reasonable set of assumptions with respect to matters such as the cost of prescription drugs, drug pricing and pharmacy reimbursement regulation and programs, among others, and stated that potential changes to the Ontario drug system may differ materially from its assumptions. The proposed reforms differ materially from the Company's assumptions in respect of the extent of the reduction in generic drug pricing, the extension of the Ontario Drug Benefit Program price to the private sector, the small increase in the dispensing fee for most pharmacy operators and the decrease in the permitted mark-up under the Ontario Drug Benefit Program for pharmacies not purchasing at least 75% of the products it supplies under the Ontario Drug Benefit Program from a comprehensive wholesaler.
While the Company is in the process of reviewing these proposed changes to assess their impact on its sales and profitability, it is anticipated that, prior to giving effect to the implementation of any mitigating actions on the part of the Company, the net effect of the proposed reforms will have a material adverse impact on its operations and financial performance. Part of the Company's continuing review of these announced changes includes the further development and subsequent implementation of contingency plans for its own business and service model in order to ensure that it can, in the long-term, continue to generate a fair and adequate return and fulfill its obligations to all stakeholders. As a result of these announced changes to the Ontario drug system, the Company will also be undertaking a review of its longer-term strategic priorities and initiatives. With respect to its previously issued expectations for comparable prescription sales growth of between 4.0% and 5.0% in fiscal 2010, the Company is revising its expected rate of comparable prescription sales growth to between 2.0% and 3.0%. The Company is also implementing measures to cut the amount of its fiscal 2010 capital expenditures by approximately $100 million, reducing the program size to approximately $460 million, in an effort to maintain its strong balance sheet, financial position and investment grade credit ratings. A component of this reduction in capital expenditures includes the cancellation or deferral of certain retail development projects. Accordingly, the Company now expects that the selling space of its retail store network will increase by approximately 7% in fiscal 2010, down from its earlier estimate of between 8% and 9%.
Other Information
The Company will hold an analyst call at 3:00 p.m. (Eastern Daylight Time) today to discuss its first quarter results. The call may be accessed by dialing 416-340-2216 from within the Toronto area, or 1-866-226-1792 outside of Toronto. The call will also be simulcast on the Company's website for all interested parties. The webcast can be accessed via the Investor Relations section of the Shoppers Drug Mart website at www.shoppersdrugmart.ca. The conference call will be archived in the Investor Relations section of the Shoppers Drug Mart website until the Company's next analyst call. A playback of the call will also be available by telephone until 11:59 p.m. (Eastern Daylight Time) on May 12, 2010. The call playback can be accessed after 5:00 p.m. (Eastern Daylight Time) on Tuesday, April 28, 2010 by dialing 416-695-5800 from within the Toronto area, or 1-800-408-3053 outside of Toronto. The seven-digit passcode number is 5087440.
About Shoppers Drug Mart Corporation
Shoppers Drug Mart Corporation is one of the most recognized and trusted names in Canadian retailing. The Company is the licensor of full-service retail drug stores operating under the name Shoppers Drug Mart (Pharmaprix in Québec). With more than 1,183 Shoppers Drug Mart and Pharmaprix stores operating in prime locations in each province and two territories, the Company is one of the most convenient retailers in Canada. The Company also licenses or owns more than 51 medical clinic pharmacies operating under the name Shoppers Simply Pharmacy (Pharmaprix Simplement Santé in Québec) and six luxury beauty destinations operating as Murale. As well, the Company also owns and operates 63 Shoppers Home Health Care stores, making it the largest Canadian retailer of home health care products and services. In addition to its retail store network, the Company owns Shoppers Drug Mart Specialty Health Network Inc., a provider of specialty drug distribution, pharmacy and comprehensive patient support services, and MediSystem Technologies Inc., a provider of pharmaceutical products and services to long-term care facilities in Ontario and Alberta.
For more information, visit www.shoppersdrugmart.ca.
Forward-looking Information and Statements
This news release, including the Management's Discussion and Analysis, (collectively, the "News Release"), contains forward-looking information and statements which constitute "forward-looking information" under Canadian securities law and which may be material, regarding, among other things, the Company's beliefs, plans, objectives, estimates, intentions and expectations. Forward-looking information and statements are typically identified by words such as "anticipate", "believe", "expect", "estimate", "forecast", "goal", "intend", "plan", "will", "may", "should", "could" and similar expressions. Specific forward-looking information in this news release includes, but is not limited to, statements with respect to the Company's future operating and financial results, its capital expenditure plans, the ability to execute on its future operating, investing and financing strategies and the impact on the Company's financial results of the announced changes to the Ontario drug system.
The forward-looking information and statements contained herein are based on certain factors and assumptions, certain of which appear proximate to the applicable forward-looking information and statements contained herein. Inherent in the forward-looking information and statements are known and unknown risks, uncertainties and other factors beyond the Company's ability to control or predict, which give rise to the possibility that the Company's predictions, forecasts, expectations or conclusions will not prove to be accurate, that its assumptions may not be correct and that the Company's plans, objectives and statements will not be achieved. Actual results or developments may differ materially from those contemplated by the forward-looking information and statements.
The material risk factors that could cause actual results to differ materially from the forward-looking information and statements contained herein include, without limitation: the risk of adverse changes to laws and regulations relating to prescription drugs and their sale, including pharmacy reimbursement programs and the availability of manufacturer allowances, or changes to such laws and regulations that increase compliance costs; the risk that the Company will be unable to implement successful strategies to manage the impact of Ontario's proposed drug reforms; the risk of adverse changes in economic and financial conditions in Canada and globally; the risk of increased competition from other retailers; the risk of an inability of the Company to manage growth and maintain its profitability; the risk of exposure to fluctuations in interest rates; the risk of material adverse changes in foreign currency exchange rates; the risk of an inability to attract and retain pharmacists and key employees; the risk of an inability of the Company's information technology systems to support the requirements of the Company's business; the risk of changes to estimated contributions of the Company in respect of its pension plans or post-employment benefit plans which may adversely impact the Company's financial performance; the risk of changes to the relationships of the Company with third-party service providers; the risk that the Company will not be able to lease or obtain suitable store locations on economically favourable terms; the risk of adverse changes to the Company's results of operations due to seasonal fluctuations; risks associated with alternative arrangements for sourcing generic drug products, including intellectual property and product liability risks; the risk that new, or changes to current, federal and provincial laws, rules and regulations, including environmental and privacy laws, rules and regulations, may adversely impact the Company's business and operations; the risk that violations of law, breaches of Company policies or unethical behaviour may adversely impact the Company's financial performance; property and casualty risks; the risk of injuries at the workplace or health issues; the risk that changes in tax law, or changes in the way that tax law is expected to be interpreted, may adversely impact the Company's business and operations; the risk that new, or changes to existing, accounting pronouncements may adversely impact the Company; the risks associated with the performance of the Associate-owned store network; and the risk of damage to the reputation of brands promoted by the Company, or to the reputation of any supplier or manufacturer of these brands.
This is not an exhaustive list of the factors that may affect any of the Company's forward-looking information and statements. Investors and others should carefully consider these and other risk factors and not place undue reliance on the forward-looking information and statements. Further information regarding these and other risk factors is included in the Company's public filings with provincial securities regulatory authorities including, without limitation, the sections entitled "Risks and Risk Management" and "Risks Associated with Financial Instruments" in the Company's Management's Discussion and Analysis for the 52 week period ended January 2, 2010. The forward-looking information and statements contained in this news release represent the Company's views only as of the date of this release. Forward-looking information and statements contained in this news release about prospective results of operations, financial position or cash flows that are based upon assumptions about future economic conditions and courses of action are presented for the purpose of assisting the Company's shareholders in understanding management's current views regarding those future outcomes and may not be appropriate for other purposes. While the Company anticipates that subsequent events and developments may cause the Company's views to change, the Company does not undertake to update any forward-looking information and statements, except to the extent required by applicable securities laws.
Additional information about the Company, including the Annual Information Form, can be found at www.sedar.com.
SHOPPERS DRUG MART CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
As at April 22, 2010
The following is a discussion of the consolidated financial condition and results of operations of Shoppers Drug Mart Corporation (the "Company") for the periods indicated and of certain factors that the Company believes may affect its prospective financial condition, cash flows and results of operations. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements of the Company and the notes thereto for the 12 week period ended March 27, 2010. The Company's unaudited interim period financial statements and the notes thereto have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are reported in Canadian dollars. These financial statements do not contain all disclosures required by Canadian GAAP for annual financial statements and, accordingly, should be read in conjunction with the most recently prepared annual consolidated financial statements for the 52 week period ended January 2, 2010.
FORWARD-LOOKING INFORMATION AND STATEMENTS
This discussion of the consolidated financial condition and results of operations of the Company contains forward-looking information and statements which constitute "forward-looking information" under Canadian securities law and which may be material regarding, among other things, the Company's beliefs, plans, objectives, estimates, intentions and expectations. Forward-looking information and statements are typically identified by words such as "anticipate", "believe", "expect", "estimate", "forecast", "goal", "intend", "plan", "will", "may", "should", "could" and similar expressions. Specific forward-looking information in this document includes, but is not limited to, statements with respect to the Company's future operating and financial results, its capital expenditure plans, the ability to execute on its future operating, investing and financial strategies and the impact on the Company's financial results of the announced changes to the Ontario drug system.
The forward-looking information and statements contained herein are based on certain factors and assumptions, certain of which appear proximate to the applicable forward-looking information and statements contained herein. Inherent in the forward-looking information and statements are known and unknown risks, uncertainties and other factors beyond the Company's ability to control or predict, which give rise to the possibility that the Company's predictions, forecasts, expectations or conclusions will not prove to be accurate, that its assumptions may not be correct and that the Company's plans, objectives and statements will not be achieved. Actual results or developments may differ materially from those contemplated by the forward-looking information and statements.
The material risk factors that could cause actual results to differ materially from the forward-looking information and statements contained herein include, without limitation: the risk of adverse changes to laws and regulations relating to prescription drugs and their sale, including pharmacy reimbursement programs and the availability of manufacturer allowances, or changes to such laws and regulations that increase compliance costs; the risk that the Company will be unable to implement successful strategies to manage the impact of Ontario's proposed drug reforms; the risk of adverse changes in economic and financial conditions in Canada and globally; the risk of increased competition from other retailers; the risk of an inability of the Company to manage growth and maintain its profitability; the risk of exposure to fluctuations in interest rates; the risk of material adverse changes in foreign currency exchange rates; the risk of an inability to attract and retain pharmacists and key employees; the risk of an inability of the Company's information technology systems to support the requirements of the Company's business; the risk of changes to the estimated contributions of the Company in respect of its pension plans or post-employment benefit plans which may adversely impact the Company's financial performance; the risk of changes to the relationships of the Company with third-party service providers; the risk that the Company will not be able to lease or obtain suitable store locations on economically favourable terms; the risk of adverse changes to the Company's results of operations due to seasonal fluctuations; risks associated with alternative arrangements for sourcing generic drug products, including intellectual property and product liability risks; the risk that new, or changes to current, federal and provincial laws, rules and regulations, including environmental and privacy laws, rules and regulations, may adversely impact the Company's business and operations; the risk that violations of law, breaches of Company policies or unethical behaviour may adversely impact the Company's financial performance; property and casualty risks; the risk of injuries at the workplace or health issues; the risk that changes in tax law, or changes in the way that tax law is expected to be interpreted, may adversely impact the Company's business and operations; the risk that new, or changes to existing, accounting pronouncements may adversely impact the Company; the risks associated with the performance of the Associate-owned store network; and the risk of damage to the reputation of brands promoted by the Company, or to the reputation of any supplier or manufacturer of these brands.
This is not an exhaustive list of the factors that may affect any of the Company's forward-looking information and statements. Investors and others should carefully consider these and other factors and not place undue reliance on the forward-looking information and statements. Further information regarding these and other risk factors is included in the Company's public filings with provincial securities regulatory authorities including, without limitation, the sections entitled "Risks and Risk Management" and "Risks Associated with Financial Instruments" in the Company's Management's Discussion and Analysis for the 52 week period ended January 2, 2010. The forward-looking information and statements contained in this discussion of the consolidated financial condition and results of operations of the Company represent the Company's views only as of the date hereof. Forward-looking information and statements contained in this Management's Discussion and Analysis about prospective results of operations, financial position or cash flows that are based upon assumptions about future economic conditions and courses of action are presented for the purpose of assisting the Company's shareholders in understanding management's current views regarding those future outcomes and may not be appropriate for other purposes. While the Company anticipates that subsequent events and developments may cause the Company's views to change, the Company does not undertake to update any forward-looking information and statements, except to the extent required by applicable securities laws.
Additional information about the Company, including the Annual Information Form, can be found at www.sedar.com.
OVERVIEW
The Company is the licensor of full-service retail drug stores operating under the name Shoppers Drug Mart(R) (Pharmaprix(R) in Québec). As at March 27, 2010, there were 1,183 Shoppers Drug Mart/Pharmaprix retail drug stores owned and operated by the Company's licensees ("Associates"). An Associate is a pharmacist-owner of a corporation that is licensed to operate a retail drug store at a specific location using the Company's trademarks. The Company's licensed stores are located in prime locations in each province and two territories, making Shoppers Drug Mart/Pharmaprix stores among the most convenient retail outlets in Canada. The Company also licenses or owns 51 medical clinic pharmacies operating under the name Shoppers Simply Pharmacy(R) (Pharmaprix Simplement Santé(R) in Québec) and six luxury beauty destinations operating as Murale(TM).
The Company has successfully leveraged its leadership position in pharmacy and its convenient store locations to capture a significant share of the market in front store merchandise. Front store merchandise categories include over-the-counter medications health and beauty aids, cosmetics and fragrances (including prestige brands), everyday household needs and seasonal products. The Company also offers a broad range of high-quality private label products marketed under the trademarks Life Brand(R), Quo(R), Balea(R), Everyday Market(R), Bio-Life(R), Nativa(R) and Easypix(R), among others, and value-added services such as the HealthWATCH(R) program, which offers patient counselling and advice on medications, disease management and health and wellness, and the Shoppers Optimum(R) program, one of the largest retail loyalty card programs in Canada. In fiscal 2009, the Company recorded consolidated sales of approximately $10.0 billion.
Under the licensing arrangements with Associates, the Company provides the capital and financial support to enable Associates to operate Shoppers Drug Mart(R), Pharmaprix(R), Shoppers Simply Pharmacy(R) and Pharmaprix Simplement Santé(R) stores without any initial investment. The Company also provides a package of services to facilitate the growth and profitability of each Associate's business. These services include the use of trademarks, operational support, marketing and advertising, purchasing and distribution, information technology and accounting. In return for being provided these and other services, Associates pay fees to the Company. Fixtures, leasehold improvements and equipment are purchased by the Company and leased to Associates over periods ranging from two to 15 years, with title retained by the Company. The Company also provides its Associates with assistance in meeting their working capital and long-term financing requirements through the provision of loans and loan guarantees.
Under the licensing arrangements, the Company receives a substantial share of Associate store profits. The Company's share of Associate store profits is reflective of its investment in, and commitment to, the operations of the Associates' stores.
The Company operates in Québec primarily under the Pharmaprix(R) and Pharmaprix Simplement Santé(R) trade names. Under Québec law, profits generated from the prescription area or dispensary may only be earned by a pharmacist or a corporation controlled by a pharmacist. As a result of these restrictions, the licence agreement used for Québec Associates differs from the Associate agreement used in other provinces. Pharmaprix(R) and Pharmaprix Simplement Santé(R) stores and their Associates benefit from the same infrastructure and support provided to all other Shoppers Drug Mart(R) and Shoppers Simply Pharmacy(R) stores and Associates.
The Company has determined that the individual Associate-owned stores that comprise its store network are deemed to be variable interest entities and that the Company is the primary beneficiary in accordance with the Canadian Institute of Chartered Accountants Accounting Guideline 15, "Consolidation of Variable Interest Entities" ("AcG-15"). As such, the Associate-owned stores are subject to consolidation by the Company. However, as the Associate-owned stores remain separate legal entities from the Company, consolidation of these stores has no impact on the underlying risks facing the Company. (See note 1 to the accompanying unaudited consolidated financial statements of the Company.)
The Company also owns and operates 63 Shoppers Home Health Care(R) stores. These retail stores are engaged in the sale and service of assisted-living devices, medical equipment, home-care products and durable mobility equipment to institutional and retail customers.
In addition to its retail store network, the Company owns Shoppers Drug Mart Specialty Health Network Inc., a provider of specialty drug distribution, pharmacy and comprehensive patient support services, and MediSystem Technologies Inc., a provider of pharmaceutical products and services to long-term care facilities in Ontario and Alberta.
OVERALL FINANCIAL PERFORMANCE
Key Operating, Investing and Financial Metrics
The following provides an overview of the Company's operating performance for the 12 week period ended March 27, 2010 compared to the 12 week period ended March 28, 2009, as well as certain other metrics with respect to investing activities for the 12 week period ended March 27, 2010 and financial position as at that same date.
- Sales of $2.321 billion, an increase of 5.7%.
- Comparable store total sales growth of 3.1%.
- Comparable store prescription sales growth of 4.1%.
- Comparable store front store sales growth of 2.1%.
- EBITDA(1) of $242 million, an increase of 8.0%.
- EBITDA margin(2) of 10.42%, an increase of 22 basis points.
- Net earnings of $116 million or $0.53 per share (diluted), an
increase of 8.2%.
- Capital expenditure program of $99 million compared to $111 million
in the prior year.
- Opened or acquired 27 new drug stores, 11 of which were
relocations.
- Year-over-year increase in retail selling square footage of 9.0%.
- Maintained desired capital structure and financial position.
- Net debt to equity ratio of 0.36:1 at March 27, 2010 compared to
0.42:1 a year ago.
- Net debt to total capitalization ratio of 0.26:1 at March 27, 2010
compared to 0.30:1 a year ago.
(1) Earnings before interest, taxes, depreciation and amortization. (See
reconciliation to the most directly comparable GAAP measure under
"Results of Operations" in this Management's Discussion and
Analysis.)
(2) EBITDA divided by sales.
Results of Operations
The following table presents a summary of certain selected consolidated financial information for the Company for the periods indicated.
12 Weeks Ended
--------------------------
March 27, March 28,
($000s, except per share data) 2010 2009
-------------------------------------------------------------------------
(unaudited) (unaudited)
Sales $ 2,321,099 $ 2,195,260
Cost of goods sold and other operating expenses 2,079,327 1,971,422
--------------------------
EBITDA(1) 241,772 223,838
Amortization 64,292 55,603
--------------------------
Operating income 177,480 168,235
Interest expense 12,878 14,506
--------------------------
Earnings before income taxes 164,602 153,729
Income taxes 48,969 46,887
--------------------------
Net earnings $ 115,633 $ 106,842
--------------------------
--------------------------
Per common share
- Basic net earnings $ 0.53 $ 0.49
- Diluted net earnings $ 0.53 $ 0.49
(1) Earnings before interest, taxes, depreciation and amortization.
Sales
Sales represent the combination of sales of the retail drug stores owned by the Associates, sales at Murale(TM) and sales of the home health care business, Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc.
Sales in the first quarter were $2.321 billion compared to $2.195 billion in the same period last year, an increase of $126 million or 5.7%, with the Company continuing to experience sales growth in all regions of the country, led by gains in Québec and Western Canada. The Company's capital investment and store development program, which resulted in a 9.0% increase in retail selling space compared to a year ago, continues to have a positive impact on sales growth. Effective marketing campaigns, combined with investments in pricing and promotions utilizing the Shoppers Optimum(R) loyalty card program, also contributed to top-line growth. On a same-store basis, sales increased 3.1% during the first quarter of 2010.
Prescription sales were $1.155 billion in the first quarter compared to $1.086 billion in the first quarter of 2009, an increase of $69 million or 6.3%. During the first quarter of 2010, prescription sales accounted for 49.8% of the Company's sales mix compared to 49.5% in the same period last year. On a same-store basis, prescription sales increased 4.1% during the first quarter of 2010, driven primarily by strong growth in the number of prescriptions filled, while increased generic utilization continues to have a deflationary impact on sales growth in the category. In the first quarter of 2010, generic molecules represented 54.2% of prescriptions dispensed compared to 52.8% of prescriptions dispensed in the first quarter of 2009.
Front store sales were $1.166 billion in first quarter compared to $1.109 billion in the first quarter of 2009, an increase of $57 million or 5.1%, with the Company continuing to experience sales gains in all core categories. On a same-store basis, front store sales increased 2.1% during the first quarter of 2010.
Cost of Goods Sold and Other Operating Expenses
Cost of goods sold is comprised of the cost of goods sold at the retail drug stores owned by the Associates, the cost of goods sold at Murale(TM) and the cost of goods sold at the home health care business, Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc. Other operating expenses include corporate selling, general and administrative expenses, operating expenses at the retail drug stores owned by the Associates, including Associates' earnings, operating expenses at Murale(TM) and operating expenses at the home health care business, Shoppers Drug Mart Specialty Health Network Inc. and MediSystem Technologies Inc.
Total cost of goods sold and other operating expenses were $2.079 billion in the first quarter compared to $1.971 billion in the same period last year, an increase of $108 million or 5.5%. Expressed as a percentage of sales, cost of goods sold declined by 93 basis points in the first quarter of 2010 versus the comparative prior year period, reflecting the benefits of improved purchasing synergies, offset somewhat by stepped-up investments in promotional pricing and Shoppers Optimum(R) events in order to drive sales growth in the front of the store. Other operating expenses, expressed as a percentage of sales, increased by 71 basis points in the first quarter of 2010 versus the comparative prior year period. Other operating expenses were higher due in large part to increased store-level expenses, primarily occupancy, wages and benefits associated with the expansion of the store network, partially offset by productivity and efficiency gains resulting from the successful rollout and implementation of the Company's Project Infinity initiative which is now in place at 794 stores compared to 214 stores at the end of the first quarter of last year.
Amortization
Amortization of capital assets and other intangible assets was $64 million in the first quarter compared to $56 million in the same period last year, an increase of $8 million or 15.6%. Expressed as a percentage of sales, amortization increased by 24 basis points in the first quarter of 2010 versus the comparative prior year period, an increase which can be attributed to the Company's capital investment and store development program.
Operating Income
Operating income was $177 million in the first quarter of 2010 compared to $168 million in the same period last year, an increase of $9 million or 5.5%. As described above, this increase was driven by top-line growth, improved purchasing synergies and productivity and efficiency gains, partially offset by higher operating costs and increased amortization tied to the Company's strategic growth and store network expansion initiatives, along with increased investments in pricing and promotional activities. First quarter 2010 operating margin (operating income divided by sales) was 7.65%, essentially flat compared to the operating margin of 7.66% in first quarter of last year. The Company's EBITDA margin (EBITDA divided by sales) was 10.42% in the first quarter of 2010, a 22 basis point improvement over the EBITDA margin of 10.20% posted in the same period last year.
Interest Expense
Interest expense is comprised of interest expense arising from borrowings at the Associate-owned stores and from debt obligations of the Company.
Interest expense was $13 million in the first quarter of 2010 compared to $15 million in the same period last year, a decrease of $2 million or 11.2%. This decrease can be primarily attributed to a market-driven decrease in short-term interest rates on the Company's floating rate debt obligations. (See note 5 to the accompanying unaudited consolidated financial statements of the Company.)
Income Taxes
The Company's effective income tax rate in the first quarter of 2010 was 29.7% compared to a rate of 30.5% in the same period last year. This decrease in the effective income tax rate can be attributed to a reduction in statutory rates.
Net Earnings
First quarter net earnings were $116 million compared to $107 million in the same period last year, an increase of $9 million or 8.2%. On a diluted basis, earnings per share were $0.53 in the first quarter of 2010 compared to $0.49 in the same period last year.
Capitalization and Financial Position
The following table provides a summary of certain information with respect to the Company's capitalization and consolidated financial position at the end of the periods indicated.
March 27, January 2,
($000s) 2010 2010
-------------------------------------------------------------------------
Cash $ (41,700) $ (44,391)
Bank indebtedness 250,441 270,332
Commercial paper 247,488 260,386
Long-term debt 945,226 946,098
--------------------------
Net debt 1,401,455 1,432,425
Shareholders' equity 3,893,059 3,826,110
--------------------------
Total capitalization $ 5,294,514 $ 5,258,535
--------------------------
--------------------------
Net debt:Shareholders' equity 0.36:1 0.37:1
Net debt:Total capitalization 0.26:1 0.27:1
Net debt:EBITDA(1) 1.21:1 1.25:1
EBITDA:Cash interest expense (1)(2) 20.33:1 19.59:1
(1) For purposes of calculating the ratios, EBITDA is comprised of EBITDA
for each of the 52 week periods then ended.
(2) Cash interest expense is comprised of interest expense for each of
the 52 week periods then ended and excludes the amortization of
deferred financing costs, but includes capitalized interest.
Financial Ratios and Credit Ratings
The following table provides a summary of the Company's credit ratings at March 27, 2010.
Standard DBRS
& Poor's Limited
--------------------------
Corporate credit rating BBB+ -
Senior unsecured debt BBB+ A (low)
Commercial paper - R-1 (low)
Subsequent to the end of the first quarter, on April 8, 2010, DBRS Limited placed the short and long-term ratings of the Company under review with negative implications. The rating action was in response to the Ontario Ministry of Health and Long-Term Care's April 7, 2010 announcement with respect to further drug reform in the province. (See discussion on "Ontario Drug Reform" under "Industry and Regulatory Developments" under "Risks and Risk Management" in this Management's Discussion and Analysis.)
Outstanding Share Capital
The Company's outstanding share capital is comprised of common shares. An unlimited number of common shares is authorized and the Company had 217,432,898 common shares outstanding at April 22, 2010. As at this same date, the Company had issued options to acquire 1,168,662 of its common shares pursuant to its stock-based compensation plans, of which 746,542 were exercisable.
Liquidity and Capital Resources
Sources of Liquidity
The Company has the following sources of liquidity: (i) cash provided by operating activities; (ii) cash available from a committed $800 million revolving bank credit facility maturing June 6, 2011, less what is currently drawn and/or being utilized to support commercial paper issued and outstanding; and (iii) up to $500 million in availability under its commercial paper program, less what is currently issued. The Company's commercial paper program is rated R-1 (low) by DBRS Limited. In the event that the Company's commercial paper program is unable to maintain this rating, the program is supported by the Company's $800 million revolving bank credit facility. At March 27, 2010, $8 million of the Company's $800 million revolving bank credit facility was utilized, all of which was in respect of outstanding letters of credit. At January 2, 2010, $10 million of this facility was utilized, including $9 million in respect of outstanding letters of credit. At March 27, 2010, the Company had $248 million of commercial paper issued and outstanding under its commercial paper program compared to $261 million at the end of 2009.
The Company has also arranged for its Associates to obtain financing to facilitate their purchase of inventory and fund their working capital requirements by providing guarantees to various Canadian chartered banks that support Associate loans. At the end of the first quarter of 2010, the Company's maximum obligation in respect of such guarantees was $520 million, unchanged from the end of the prior year. At March 27, 2010, an aggregate amount of $435 million in available lines of credit had been allocated to the Associates by the various banks compared to $431 million at the end of the prior year. At March 27, 2010, Associates had drawn an aggregate amount of $261 million against these available lines of credit compared to $254 million at the end of the prior year. Any amounts drawn by the Associates are included in bank indebtedness on the Company's consolidated balance sheets. As recourse in the event that any payments are made under the guarantees, the Company holds a first-ranking security interest on all assets of Associate-owned stores, subject to certain prior-ranking statutory claims. As the Company is involved in allocating the available lines of credit to its Associates, it estimates that the net proceeds from secured assets would exceed the amount of any payments required in respect of the guarantees.
The Company has obtained additional long-term financing from the issuance of $450 million of five-year medium-term notes maturing June 3, 2013, which bear interest at a fixed rate of 4.99% per annum (the "Series 2 Notes"), $250 million of three-year medium-term notes maturing January 20, 2012, which bear interest at a fixed rate of 4.80% per annum (the "Series 3 Notes") and $250 million of five-year medium-term notes maturing January 20, 2014, which bear interest at a fixed rate of 5.19% per annum (the "Series 4 Notes"). The Series 2 Notes were issued pursuant to a final short form base shelf prospectus dated May 22, 2008 (the "Prospectus"), as supplemented by a pricing supplement dated May 28, 2008, and filed by the Company with Canadian securities regulators in all of the provinces in Canada. The Series 3 Notes and Series 4 Notes were issued pursuant to the Prospectus, as supplemented by pricing supplements dated January 14, 2009, and filed by the Company with Canadian securities regulators in all of the provinces of Canada. At the time of issuance, the Series 2 Notes, Series 3 Notes and Series 4 Notes were assigned ratings of A (low) from DBRS Limited and BBB+ from Standard & Poor's.
On June 22, 2009, the Company filed, with the securities regulators in all of the provinces of Canada, an amendment (the "Amendment") to the Prospectus (as amended, the "Amended Prospectus"), increasing the aggregate principal amount of medium-term notes that can be issued from time to time pursuant to the Amended Prospectus to $1.5 billion from $1.0 billion. To date, the Company has issued an aggregate principal amount of $950 million of medium-term notes pursuant to the Amended Prospectus.
Cash Flows From Operating Activities
Cash flows from operating activities were $148 million in the first quarter of 2010 compared to $71 million in the same period last year. This increase can be primarily attributed to growth in net earnings adjusted for non-cash items, principally amortization and future income taxes, combined with a reduction in the amount invested in non-cash working capital balances when compared to the prior year period. The reduction in the amount invested in non-cash working capital balances was driven largely out of an increase in accounts payable and accrued liabilities, offset somewhat by the timing of accounts receivable and income tax payments.
Cash Flows Used in Investing Activities
Cash flows used in investing activities were $63 million in the first quarter of 2010 compared to $105 million in the same period last year. Of these totals, purchases of property and equipment, net of proceeds from any dispositions, amounted to $41 million in the first quarter of 2010 compared to $76 million in the same period last year, reflecting further investments by the Company in its store network and related infrastructure projects in information technology and distribution. Included in the net purchases of property and equipment in the first quarter of 2010 was $36 million of proceeds resulting from dispositions, $35 million of which related to the sale/leaseback of 13 retail locations (See note 4 to the accompanying unaudited consolidated financial statements of the Company.) The Company invested an additional $11 million in business acquisitions and a combined $11 million in the purchase and development of intangible and other assets during the first quarter of 2010 compared to $27 million and $2 million, respectively, in the same period last year. These investments relate primarily to acquisitions of drug stores and prescription files, as the Company continues to pursue attractive opportunities in the marketplace, albeit at a somewhat slower pace. During the first quarter of 2010, the balance of funds deposited and held in escrow in respect of outstanding offers to purchase drug stores and land decreased by $1 million, essentially unchanged from the same period last year.
During the first quarter of 2010, the Company opened or acquired 27 new drug stores, 11 of which were relocations, closed one smaller drug store, and completed eight major drug store expansions. At the end of the first quarter of 2010 there were 1,303 retail stores in the Company's network, comprised of 1,234 drug stores (1,183 Shoppers Drug Mart(R)/Pharmaprix(R) stores and 51 Shoppers Simply Pharmacy(R)/Pharmaprix Simplement Santé(R) stores), 63 Shoppers Home Health Care(R) stores and six Murale(TM) stores.
Cash Flows Used in Financing Activities
Cash flows used in financing activities were $88 million in the first quarter of 2010. Cash outflows were comprised of a $20 million decrease in bank indebtedness, a $13 million decrease in the amount of commercial paper issued and outstanding by the Company under its commercial paper program, a $1 million reduction in prime borrowings under the Company's $800 million revolving bank credit facility, a $7 million reduction in the amount of Associate investment and $47 million for the payment of dividends.
In the first quarter of 2010, the net result of the Company's operating, investing and financing activities was an decrease in cash balances of $3 million.
Future Liquidity
The Company believes that its current credit facilities, commercial paper program and financing programs available to its Associates, together with cash generated from operating activities, will be sufficient to fund its operations, including the operations of its Associate-owned store network, investing activities and commitments for the foreseeable future. Historically, the Company has not experienced any major difficulty in obtaining additional short or long-term financing given its investment grade credit ratings. While the Company is committed to maintaining its investment grade credit ratings, credit ratings may be revised or withdrawn at any time by the rating agencies if, in their judgment, circumstances warrant.
NEW ACCOUNTING PRONOUNCEMENTS
Transition to International Financial Reporting Standards
In January 2006, the Accounting Standards Board (the "AcSB") announced its decision to require all publicly accountable enterprises to report under International Financial Reporting Standards ("IFRS") for years beginning on or after January 1, 2011. As a result, financial reporting by Canadian publicly accountable enterprises will change significantly from current Canadian generally accepted accounting principles ("Canadian GAAP") to IFRS.
In February 2008, the AcSB confirmed that publicly accountable enterprises will be required to use IFRS, as issued by the International Accounting Standards Board ("IASB"), unless modifications or additions to the requirements of IFRS are issued by the AcSB. IFRS must be adopted for interim and annual financial statements related to fiscal years beginning on or after January 1, 2011.
The Company launched its IFRS transition project in 2008 with a high-level assessment of the key areas where conversion to IFRS may have a significant impact, or present a significant challenge. The Company has engaged an external advisor, established a working team and developed documentation and status reporting protocols. The Company has delivered its initial training program and is ensuring that the working team has an in-depth understanding of relevant IFRS as well as new developments in IFRS.
The Company's working team has substantially completed a detailed assessment of IFRS focused on the identification of differences between the Company's current policies and those under IFRS. In this regard, a topic- specific issues list was developed, identifying the activities required for resolution and timelines for completion, including potential impacts on taxation, information technology and data systems. The Company has developed a timeline for its 2010 deliverables under its transition plan. The Company will use this timeline to monitor progress against its transition plan and meet future quarters' disclosure requirements. Activities that the Company expects to undertake in 2010 include finalization of positions on accounting issues, confirmation of changes to accounting policies, the development of the opening balance sheet, performance of the impairment test on the opening balance sheet under IFRS, conversion of 2010 interim results and development of draft 2011 financial statement and Management's Discussion and Analysis disclosures. The Company will refine existing processes or develop any new processes for accumulating information to meet new disclosure requirements, including identifying any required information system changes. Current developments and changes to IFRS will continue to be monitored throughout 2010 and the Company's transition plan and timelines will be adjusted as necessary to respond to these developments.
The Company is focusing its primary efforts on the following standards:
IAS 27, Consolidated and Separate Financial Statements
Under Canadian GAAP, subsidiaries are consolidated based first on the variable interest model under Accounting Guideline 15, "Consolidation of Variable Interest Entities", and then based on the voting interest model under CICA Handbook Section 1590, "Subsidiaries".
Under Canadian GAAP, the Company concluded that the individual Associate-owned stores that comprise the Company's store network were deemed to be variable interest entities and, therefore, were subject to consolidation by the Company. Under IFRS, there is no variable interest concept and consolidation is based on the concept of control as described in IAS 27, "Consolidated and Separate Financial Statements" ("IAS 27").
Based on its assessment, the Company has made the preliminary determination that consolidation of the Associate-owned store network is still appropriate under IFRS. The IASB issued an exposure draft in December 2008 that will revise IAS 27. The exposure draft provides additional guidance regarding the definition and assessment of control. The exposure draft could however change prior to finalization and the Company is continuing to monitor the IASB's project on this standard. The IASB is expecting to issue the revised standard in the fourth quarter of 2010.
IFRS 3, Business Combinations
The primary impacts of adopting IFRS 3, "Business Combinations" ("IFRS 3"), compared to the current requirements are:
a) the inability to capitalize acquisition costs which are currently
considered part of the purchase price;
b) any adjustments to the purchase price within the twelve month period
subsequent to an acquisition will require retroactive application and
a restatement of prior periods;
c) additional limitations exist for establishing restructuring
provisions, thereby reducing the number or amount of provisions
recognized on acquisition; and
d) intangible assets (liabilities) arising from favourable
(unfavourable) operating leases are recognized as a component of the
leased asset (under current Canadian GAAP, these are recognized as
separate intangible assets or liabilities).
In addition to these accounting differences, there are incremental disclosures under IFRS. The Company expects that the only area of impact will be the inability to capitalize certain acquisition costs.
IFRS 1, "First-time Adoption of IFRS" ("IFRS 1"), states that a first-time adopter may elect not to apply IFRS 3 retrospectively to business combinations that occurred before the date of transition to IFRS. It is the Company's current intention to make this election and, therefore, only apply IFRS 3 to business combinations prospectively (i.e., to those that occur on or after January 3, 2010). This may result in the reversal of certain acquisition costs that are capitalized in conjunction with 2010 acquisitions.
IFRIC 13, Customer Loyalty Programmes
IFRIC 13, "Customer Loyalty Programmes" ("IFRIC 13"), addresses how companies should account for the obligation to provide free or discounted goods or services under customer loyalty programs.
IFRIC 13 is based on a view that customers are implicitly paying for the points they receive when they buy goods or services and, therefore, a portion of the revenue should be deferred at the time that points are issued. IFRIC 13 requires companies to estimate the value of the points to the customer and defer this amount of revenue as a liability until they have fulfilled their obligations to supply awards. IFRIC 13 will impact the measurement and recognition of the Company's Shoppers Optimum(R) loyalty card program (the "Program"). Currently, when points are earned by Program members, the Company records an expense and establishes a liability for future redemptions by multiplying the number of points issued by the estimated cost per point. The actual cost of Program redemptions is charged against the liability account.
The Company believes that under IFRS the fair value per point should represent the retail value of the award received by the customer upon redemption, whereas under the Company's current liability measurement, the cost per point represents the cost to the Company of providing the reward on redemption. The determination of fair value and cost per point are impacted by many factors, including the historical behaviour of Program members and expected future redemption patterns. The Company is currently quantifying this measurement difference.
IAS 16, Property, Plant and Equipment
The objective of IAS 16, "Property, Plant and Equipment" ("IAS 16"), is to prescribe the accounting treatment for property, plant, and equipment. The principal issues are the recognition of assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognized in relation to them. The Company has investigated each class of its assets and has come to the preliminary determination that IAS 16 will not significantly impact the classification or carrying amounts of its property, plant and equipment.
It is recognized that first-time adopters of IFRS may have difficulty reconstructing historical information relating to property, plant and equipment in sufficient detail to retrospectively comply in full with IAS 16. IFRS 1 offers the option for entities to use fair value as deemed cost for the opening balance of items of property, plant and equipment. As the Company does not believe any additional componentization of its assets is required, the Company believes the current carrying value of its assets is consistent with IFRS.
IAS 17, Leases
IAS 17, "Leases" ("IAS 17"), retains the concepts of capital (finance) leases versus operating leases. IAS 17 differs in the use of qualitative versus quantitative thresholds as exist under Canadian GAAP. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. A finance lease is defined as a lease that transfers substantially all of the risks and rewards incidental to ownership of the leased asset from the lessor to the lessee. Title to the asset may or may not transfer under such a lease. An operating lease is a lease other than a finance lease.
The Company is currently assessing the impact of IAS 17 on its existing leases.
The IASB is undertaking a long-term lease project. In March 2009, the IASB issued a discussion paper on leases. The primary objective of the project is to develop a new model for the recognition of assets and liabilities arising under lease contracts, with the expectation that all leases will be reflected on the balance sheet. Comments on the discussion paper were requested by July 2009. This standard is not expected to be in effect prior to the adoption of IFRS in 2011.
IAS 39, Financial Instruments: Recognition and Measurement
The Company intends to continue to apply hedge accounting under IFRS to its interest rate derivative agreement and cash-settled equity forward agreements. The Company has formally identified, designated and documented all relationships between its hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Company has assessed the effectiveness of the hedges as at January 3, 2010 under IFRS and has concluded that the derivatives used in hedging transactions are highly effective in offsetting future changes in cash flows and market values of the hedged items.
IAS 36, Impairment of Assets
The objective of IAS 36, "Impairment of Assets" ("IAS 36") is to ensure that assets are carried at no more than their recoverable amount, through use or sale. An asset carried at more than its recoverable amount through use or sale is considered impaired and an impairment loss must be recognized immediately in income. A previously recognized impairment loss on an asset, other than goodwill, is reversed if there has been a change in the factors used to determine the asset's recoverable amount since the last impairment loss was recognized. An impairment loss for goodwill is not reversed.
Assets are assessed at the end of each reporting period to determine whether there is any indication of an impairment. If any such indication exists, the recoverable amount of the asset must be determined. Goodwill and intangible assets not subject to amortization must be tested at least annually for impairment, or more frequently if an indication of impairment exists.
If there is any indication that an asset may be impaired, a recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, the recoverable amount is determined for the cash-generating unit to which the asset belongs. An asset's cash-generating unit is the smallest group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Identification of an asset's cash-generating unit involves judgement.
The requirements of IAS 36 are similar to those that exist under Canadian GAAP however, there are differences in identification of cash-generating units, reversals in previously recognized impairment losses and the methodology for calculating the recoverable amount. The Company is currently assessing its cash-generating units.
Other Standards
In addition to the above standards, the Company is also focusing on IAS 12, "Income Taxes", and is in the process of finalizing its preliminary determinations on this standard. This list should not be regarded as a complete list of the IFRS standards that may have an impact on the Company's results of operations, financial position and disclosures. The list is intended to highlight areas the Company believes to be the most significant. Final conclusions could change as the Company progresses through its assessments. At this point, the Company is not able to reasonably quantify the expected impacts of the changes.
Further options under IFRS 1, beyond those that have been identified above, are being analyzed as the Company progresses through its detailed assessment of the individual standards.
The impact of the transition to IFRS on other business activities, disclosure controls and procedures and internal controls over financial reporting will be assessed once the impacts of the standards as a whole are identified.
The IASB has significant ongoing projects, which management is monitoring, that could affect the ultimate differences between Canadian GAAP and IFRS and the impact those differences have on the Company's results of operations, financial position and disclosures.
SELECTED QUARTERLY INFORMATION
Reporting Cycle
The annual reporting cycle of the Company is divided into four quarters of 12 weeks each, except for the third quarter which is 16 weeks in duration. The fiscal year of the Company consists of a 52 or 53 week period ending on the Saturday closest to December 31. When a fiscal year consists of 53 weeks, the fourth quarter is 13 weeks in duration.
Summary of Quarterly Results
The following table provides a summary of certain selected consolidated financial information for the Company for each of the eight most recently completed fiscal quarters. This information has been prepared in accordance with Canadian generally accepted accounting principles.
First Quarter Fourth Quarter
($000s, except per ------------------------- -------------------------
share data - 2010 2009 2009 2008
unaudited) (12 Weeks) (12 Weeks) (12 Weeks) (13 Weeks)
-------------------------------------------------------------------------
Sales $ 2,321,099 $ 2,195,260 $ 2,488,544 $ 2,496,799
Net earnings $ 115,633 $ 106,842 $ 171,060 $ 166,536
Per common share
- Basic net earnings $ 0.53 $ 0.49 $ 0.79 $ 0.77
- Diluted net
earnings $ 0.53 $ 0.49 $ 0.79 $ 0.77
Third Quarter Second Quarter
($000s, except per ------------------------- -------------------------
share data - 2009 2008 2009 2008
unaudited) (16 Weeks) (16 Weeks) (12 Weeks) (12 Weeks)
-------------------------------------------------------------------------
Sales $ 3,013,007 $ 2,793,005 $ 2,288,789 $ 2,109,308
Net earnings $ 170,894 $ 160,276 $ 136,112 $ 126,593
Per common share
- Basic net earnings $ 0.79 $ 0.74 $ 0.63 $ 0.58
- Diluted net
earnings $ 0.79 $ 0.74 $ 0.63 $ 0.58
Excluding the benefit of the extra week in the fourth quarter of 2008, which accounted for $174 million of additional sales, the Company experienced growth in sales and net earnings in each of the four most recent quarters when compared to the same quarter of the prior year. The Company has invested capital in expanded and relocated stores and in new store development, which has allowed the Company to increase the selling square footage of its store network, resulting in increased sales and profitability.
The Company's core prescription drug operations are not typically subject to seasonal fluctuations. The Company's front store operations include seasonal promotions which may have an impact on comparative quarterly results, particularly when a season, notably Easter, does not fall in the same quarter each year. Also, as the Company continues to expand its front store product and service offerings, including seasonal promotions, its results of operations may become subject to more seasonal fluctuations.
RISKS AND RISK MANAGEMENT
Industry and Regulatory Developments
Ontario Drug Reform
On July 10, 2009, the Ontario Ministry of Health and Long-Term Care (the "Ministry") announced that the Ministry was considering proposals to change Ontario's drug system. The stated objective of any proposed reforms was to ensure that Ontario received value for money in all aspects of the provincial drug plan while maintaining or improving patient care. According to statements made by the Ministry at that time, among the range of proposals being considered were reductions in generic prescription drug pricing, reduction or elimination of professional allowance funding and implementation of competitive agreements for generic prescription drug products. Following the July 2009 announcement, the Ministry engaged in a series of consultations with stakeholder working groups, including community pharmacy.
On March 25, 2010, the Government of Ontario introduced, Bill 16 Creating Foundation for Jobs and Growth Act, 2010 (the "Act") for first reading. The Act included proposed changes to the Ontario drug system to eliminate professional allowances and to include ordinary commercial terms as a new exception to the prohibition on rebates. Under Ontario's current drug system, a manufacturer is prohibited from providing a rebate to other parties in the downstream distribution chain for any interchangeable prescription drug product or prescription drug product listed on the Ontario public drug formulary. However, professional allowances, generally funding provided by the manufacturer for the purposes of direct patient care for certain legislatively prescribed activities, are an exception to the rebate prohibition.
As part of the comprehensive drug system reform initiative, on April 7, 2010, the Ministry announced that the Government of Ontario planned to further reform the prescription drug system to provide patients with better access to lower-cost generic drugs. The proposed reforms announced by the Ministry include:
- lowering the cost of generic drugs by at least 50 percent, to
25 percent of the cost of the original brand name drug for Ontario's
public drug system and private payors;
- eliminating professional allowances;
- increasing dispensing fees and paying for additional services for
patients; and
- supporting access to pharmacy services in rural communities and
under-serviced areas.
On April 8, 2010, the Ministry published the proposed amendments to Ontario Regulation 201/96 under the Ontario Drug Benefit Act ("ODBA") (the "Proposed ODBA Regulations") and Regulation 935 under the Drug Interchangeability and Dispensing Fee Act ("DIDFA") (the "Proposed DIDFA Regulations") (collectively, the "Proposed Regulations") for comment. The Proposed Regulations outline the regulatory changes that the Ministry proposes to enact in order to implement the reforms announced on April 7, 2010 and are discussed in more detail below.
Lowering the cost of generic drugs by at least 50 percent, to 25 percent of the cost of the original brand name drug for Ontario's public drug system and private payors
Pursuant to the Proposed ODBA Regulations, which are currently anticipated to come into effect on May 15, 2010, the price for most generic prescription drug products reimbursed under the Ontario Drug Benefit Program will be reduced by 50 percent, to 25 percent.
Pursuant to the Proposed DIDFA Regulations, the price to be paid by private payors for most generic prescription drugs will be reduced by more than 50 percent, to 25 percent of the price of the original brand name prescription drug over the next three years, resulting in parity with the price under the Ontario Drug Benefit Program. The Proposed DIDFA Regulations provide that the price of most generic prescription drugs for private payors will be reduced to 50 percent upon implementation of the Proposed DIDFA Regulations and that further reductions from 50 percent to 35 percent and from 35 percent to 25 percent will come into effect on April 1, 2011 and April 1, 2012, respectively.
Proposed elimination of professional allowances
The Proposed ODBA Regulations reduce the cap on professional allowance funding for the public sector from the current permitted level of 20 percent to 5 percent. However, as the Ministry has indicated that all professional allowance funding will be eliminated by 2014, it is anticipated that the reduction of the cap from 20 percent to 5 percent is an interim measure and that further changes to the Ontario drug system under the Act eliminating professional allowances in the public sector will come into force prior to or during 2014.
The Proposed DIDFA Regulations introduce a declining cap on professional allowance funding for the private sector. The proposed schedule for reduction of the cap on professional allowances is as follows: upon implementation of the Proposed DIDFA Regulations, the professional allowance cap imposed in the private sector would be 50 percent of sales of interchangeable prescription drug products that are not reimbursed under the Ontario Drug Benefit Program; the professional allowance cap on the private sector would be reduced to 35 percent on April 1, 2011; and further reduced to 25 percent on April 1, 2012. As the Ministry has indicated that professional allowance funding will be eliminated by 2014, it is anticipated that changes to the Ontario drug system under the Act eliminating professional allowances in the private sector will come into force prior to or during 2014.
Changes to the permitted mark-up under the public drug plan
The pharmacy operators' permitted mark-up on the price of the prescription drug product dispensed under the public drug plan for rural pharmacies and pharmacies in under-serviced areas would increase from the current level of 8 percent to 10 percent, provided that the pharmacy purchases at least 75 percent of the products it supplies under the Ontario Drug Benefit Program from a comprehensive wholesaler. For pharmacies other than rural pharmacies and pharmacies in under-serviced areas, the permitted mark-up on the price of the prescription drug product would remain at the current level of 8 percent provided that the pharmacy purchased at least 75 percent of the products it supplies under the Ontario Drug Benefit Program from a comprehensive wholesaler. For pharmacy operators not purchasing at least 75 percent of the products it supplies under the Ontario Drug Benefit Program from a comprehensive wholesaler, the permitted mark-up on the price of the prescription drug product dispensed is reduced from the current level of 8 percent to 5 percent. Also, a cap of $125 on the permitted mark-up for all prescription drug products dispensed under the Ontario Drug Benefit Program has been introduced.
The Proposed ODBA Regulations define a comprehensive wholesaler as a wholesaler that, (a) has as its principal business the business of distributing pharmaceutical and other consumer products; (b) carries in stock and has available for sale to an operator of a pharmacy at least 80 percent of the listed drug products and listed substances in the formulary; (c) is prepared to supply products to any operator of a pharmacy in Ontario that regularly orders from the wholesaler and pays the wholesaler; and (d) has an arms-length relationship with all manufacturers, operators of pharmacies and companies that own, operate or franchise pharmacies.
Increasing dispensing fees and paying for additional services for patients, and supporting access to pharmacy services in rural communities and under-serviced areas
Immediately upon implementation of the Proposed ODBA Regulations, dispensing fees paid under the public drug plan by most pharmacies would increase from the current level of $7.00 to $8.00, and the dispensing fee for certain rural pharmacies in under-serviced areas would increase to between $9.00 and $11.00. Additionally, the dispensing fees for the public drug plan would increase annually, ultimately reaching $8.83 for most pharmacies and up to $12.14 for certain rural pharmacies in under-serviced areas by April 1, 2014.
The Ministry has indicated that at least $150 million would be allocated to compensate pharmacy owners for certain professional services pharmacists provide to Ontarians. Within this funding, money would be dedicated to rural pharmacy services and long-term care pharmacy services. There are no changes in the Proposed Regulations that commit the Ministry to any additional funding or payment for additional services.
Introduction of ordinary commercial terms
Under the Proposed Regulations, a rebate will not include the value of a benefit provided by a manufacturer which is provided in accordance with ordinary commercial terms that meet all of the following conditions:
- the benefit is provided in the ordinary course of business in the
supply chain system of interchangeable products between any of a
manufacturer, a wholesaler, an operator of a pharmacy or a company
that owns, operates or franchises pharmacies;
- the value of the benefit is set out in a written agreement between
any of a manufacturer, a wholesaler, an operator of a pharmacy and a
company that owns, operates or franchises pharmacies; and
- the benefit relates to an ordinary commercial relationship that is
any of the following:
(i) a prompt payment discount,
(ii) a volume discount, or
(iii) a service fee.
Prohibition on private label products
Under the Proposed Regulations, a drug product that falls under the definition of a "private label product" will not be designated as an interchangeable drug product or as a listed drug product for the Ontario Drug Benefit Program. Designation as an interchangeable drug product is generally necessary for market adoption of generic prescription drug products and designation as a listed drug product for the Ontario Drug Benefit Program is necessary for public reimbursement.
Impact on operations and financial results
Based on the negotiations that took place between community pharmacy and the Ministry after July of 2009, when the reforms were first announced, it was the Company's belief that any reforms to the Ontario drug system would balance the needs of all stakeholders, including community pharmacy, drug manufacturers, pharmacists and patients. However, the depth and extent of the reforms to the Ontario drug system contained in the Proposed Regulations does not balance these needs, but rather makes cuts to community pharmacy that go far beyond anything that was anticipated.
The Company is actively monitoring regulatory developments in each of the jurisdictions in which it operates and will continue to seek opportunities to engage in discussion with government authorities across the country, in co-operation with other participants in the pharmacy industry. In Québec, legislation provides that the selling price for prescription drug products for the provincial drug insurance program must not be higher than any selling price granted by the manufacturer for the same drug under other provincial drug insurance programs. In Newfoundland, the government has previously announced a decision to reduce the maximum allowable cost for a prescription drug product to the Ontario public drug program price. A date for implementation in Newfoundland is not known at this time.
In its fourth quarter 2009 earnings release dated February 11, 2010, the Company stated that it anticipated comparable prescription sales growth of between 4.0% and 5.0% for fiscal 2010. At that time, the Company specifically cautioned that its prescription sales growth estimates were based on what it believed to be a reasonable set of assumptions with respect to matters such as the cost of prescription drugs, drug pricing and pharmacy reimbursement regulation and programs, among others, and stated that potential changes to the Ontario drug system may differ materially from its assumptions. The proposed reforms differ materially from the Company's assumptions in respect of the extent of the reduction in generic drug pricing, the extension of the Ontario Drug Benefit program price to the private sector, the small increase in the dispensing fee for most pharmacy operators and the decrease in the permitted mark-up under the Ontario Drug Benefit Program for pharmacies not purchasing at least 75% of the products it supplies under the Ontario Drug Benefit program from a comprehensive wholesaler.
While the Company is in the process of reviewing these proposed changes to assess their impact on its sales and profitability, it is anticipated that, prior to giving effect to the implementation of any mitigating actions on the part of the Company, the net effect of the proposed reforms will have a material adverse impact on its operations and financial performance. Part of the Company's continuing review of these announced changes includes the further development and subsequent implementation of contingency plans for its own business and service model in order to ensure that it can, in the long-term, continue to generate a fair and adequate return and fulfill its obligations to all stakeholders. As a result of these announced changes to the Ontario drug system, the Company will also be undertaking a review of its longer-term strategic priorities and initiatives. With respect to its previously issued expectations for comparable prescription sales growth of between 4.0% and 5.0% in fiscal 2010, the Company is revising its expected rate of comparable prescription sales growth to between 2.0% and 3.0%. The Company is also implementing measures to cut the amount of its fiscal 2010 capital expenditures by approximately $100 million, reducing the program size to approximately $460 million, in an effort to maintain its strong balance sheet, financial position and investment grade credit ratings. A component of this reduction in capital expenditures includes the cancellation or deferral of certain retail development projects. Accordingly, the Company now expects that the selling space of its retail store network will increase by approximately 7% in fiscal 2010, down from its earlier estimate of between 8% and 9%.
RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS
The Company is exposed to a number of risks associated with financial instruments that have the potential to affect its operating and financial performance. The Company's primary financial instrument risk exposures are interest rate risk and liquidity risk. The Company's exposures to foreign currency risk, credit risk and other price risk are not considered to be material. The Company may use derivative financial instruments to manage certain of these risks but it does not use derivative financial instruments for trading or speculative purposes.
Exposure to Interest Rate Fluctuations
The Company, including its Associate-owned store network, is exposed to fluctuations in interest rates by virtue of its borrowings under its bank credit facilities, commercial paper program and financing programs available to its Associates. Increases or decreases in interest rates will positively or negatively impact the financial performance of the Company.
The Company monitors market conditions and the impact of interest rate fluctuations on its fixed and floating rate debt instruments on an ongoing basis and may use interest rate derivatives to manage this exposure. The Company is party to an interest rate derivative agreement converting an aggregate notional principal amount of $50 million (2009 - $100 million) of floating rate debt into fixed rate debt. The fixed rate payable by the Company under this agreement is 4.18% (2009 - two agreements with a range between 4.11% and 4.18%). This agreement contains reset terms of one month and matures in December 2010.
Furthermore, the Company may be exposed to losses should any counterparty to its derivative agreements fail to fulfill its obligations. The Company has sought to minimize counterparty risk by transacting with counterparties that are large financial institutions. There is no unrecognized exposure as at March 27, 2010, as the interest rate derivative agreement is in a liability position, unchanged from the end of the prior year.
As at March 27, 2010, the Company had $459 million (2009 - $472 million) of unhedged floating rate debt. During the 12 weeks ended March 27, 2010, the Company's average outstanding unhedged floating rate debt was $618 million (2009 - $671 million). Had interest rates been higher or lower by 50 basis points during the period, net earnings would have decreased or increased, respectively, by approximately $0.5 million (2009 - $0.5 million) as a result of the Company's exposure to interest rate fluctuations on its unhedged floating rate debt.
Foreign Currency Exchange Risk
The Company conducts the vast majority of its business in Canadian dollars. The Company's foreign currency exchange risk principally relates to purchases made in U.S. dollars and this risk is tied to fluctuations in the exchange rate of the Canadian dollar vis à vis the U.S. dollar. The Company monitors its foreign currency purchases in order to monitor and manage its foreign currency exchange risk. The Company does not consider its exposure to foreign currency exchange rate risk to be material.
Credit Risk
Accounts receivable arise primarily in respect of prescription sales billed to governments and third-party drug plans and, as a result, collection risk is low. There is no concentration of balances with debtors in the remaining accounts receivable. The Company does not consider its exposure to credit risk to be material.
Other Price Risk
The Company uses cash-settled equity forward agreements to limit its exposure to future changes in the market price of its common shares by virtue of its obligations under its Long-Term Incentive Plan ("LTIP") and Restricted Share Unit Plan ("RSUP"). The income or expense arising from the use of these instruments is included in cost of goods sold and other operating expenses.
Based on market values of the equity forward agreements in place at March 27, 2010, the Company recognized a liability of $2.1 million, of which $1.4 million is presented in accounts payable and accrued liabilities and $0.7 million is presented in other long-term liabilities. Based on market values of the equity forward agreements in place at March 28, 2009, the Company recognized a liability of $2.3 million, of which $1.1 million was presented in accounts payable and accrued liabilities and $1.2 million was presented in other long-term liabilities. During the 12 week periods ended March 27, 2010 and March 28, 2009, respectively, the Company assessed that the percentages of the equity forward agreements in place related to unearned units under the LTIP and the RSUP were effective hedges for the exposure to future changes in the market price of its common shares in respect of the unearned units. Market values were determined based on information received from the Company's counterparty to these equity forward agreements.
Capital Management and Liquidity Risk
The Company's primary objectives when managing its capital are to profitably grow its business while maintaining adequate financing flexibility to fund attractive new investment opportunities and other unanticipated requirements or opportunities that may arise. Profitable growth is defined as earnings growth commensurate with the additional capital being invested in the business in order that the Company earns an attractive rate of return on that capital. The primary investments undertaken by the Company to drive profitable growth include additions to the selling square footage of its store network via the construction of new, relocated and expanded stores, including related leasehold improvements and fixtures, the acquisition of sites as part of a land bank program, as well as through the acquisition of independent drug stores or their prescription files. In addition, the Company makes capital investments in information technology and its distribution capabilities to support an expanding store network. The Company also provides working capital to its Associates via loans and/or loan guarantees. The Company largely relies on its cash flow from operations to fund its capital investment program and dividend distributions to its shareholders. This cash flow is supplemented, when necessary, through the borrowing of additional debt. No changes were made to these objectives during the period.
The Company considers its total capitalization to be bank indebtedness, commercial paper, short-term debt, long-term debt (including the current portion thereof) and shareholders' equity, net of cash. The Company also gives consideration to its obligations under operating leases when assessing its total capitalization. The Company manages its capital structure with a view to maintaining investment grade credit ratings from two credit rating agencies. In order to maintain its desired capital structure, the Company may adjust the level of dividends paid to shareholders, issue additional equity, repurchase shares for cancellation or issue or repay indebtedness. The Company has certain debt covenants and is in compliance with those covenants.
The Company monitors its capital structure principally through measuring its net debt to shareholders' equity ratio and net debt to total capitalization ratio, and ensures its ability to service its debt and meet other fixed obligations by tracking its interest and other fixed charges coverage ratios. (See discussion under "Capitalization and Financial Position" in this Management's Discussion and Analysis.)
Liquidity risk is the risk that the Company will be unable to meet its obligations relating to its financial liabilities. The Company prepares cash flow budgets and forecasts to ensure that it has sufficient funds through operations, access to bank credit facilities and access to debt and capital markets to meet its financial obligations, capital investment program and fund new investment opportunities or other unanticipated requirements as they arise. The Company manages its liquidity risk as it relates to financial liabilities by monitoring its cash flow from operating activities to meet its short-term financial liability obligations and planning for the repayment of its long-term financial liability obligations through cash flow from operating activities and/or the issuance of new debt.
For a complete description of the Company's sources of liquidity, see the discussions under "Sources of Liquidity" and "Future Liquidity" under "Liquidity and Capital Resources" in this Management's Discussion and Analysis.
INTERNAL CONTROLS OVER FINANCIAL REPORTING
The Chief Executive Officer and the Chief Financial Officer have designed, or caused to be designed under their supervision, internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting, its compliance with Canadian GAAP and the preparation of financial statements for external purposes. Internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be designed effectively can provide only reasonable assurance with respect to financial reporting and financial statement preparation.
There were no changes in internal control over financial reporting that occurred during the Company's most recent interim period that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
NON-GAAP FINANCIAL MEASURES
The Company reports its financial results in accordance with Canadian GAAP. However, the foregoing contains references to non-GAAP financial measures, such as operating margin, EBITDA (earnings before interest, taxes, depreciation and amortization), EBITDA margin and cash interest expense. Non-GAAP financial measures do not have standardized meanings prescribed by GAAP and, therefore, may not be comparable to similar measures presented by other reporting issuers.
These non-GAAP financial measures have been included in this Management's Discussion and Analysis as they are measures which management uses to assist in evaluating the Company's operating performance against its expectations and against other companies in the retail drug store industry. Management believes that non-GAAP financial measures assist in identifying underlying operating trends.
These non-GAAP financial measures, particularly EBITDA and EBITDA margin, are also common measures used by investors, financial analysts and rating agencies. These groups may use EBITDA and other non-GAAP financial measures to value the Company and assess the Company's ability to service its debt.
SHOPPERS DRUG MART CORPORATION
Consolidated Statements of Earnings
(unaudited)
(in thousands of dollars except per share amounts)
-------------------------------------------------------------------------
12 Weeks Ended
--------------------------
March 27, March 28,
2010 2009
-------------------------------------------------------------------------
Sales $ 2,321,099 $ 2,195,260
Operating expenses
Cost of goods sold and other operating
expenses (Note 2) 2,079,327 1,971,422
Amortization 64,292 55,603
-------------------------------------------------------------------------
Operating income 177,480 168,235
Interest expense (Note 5) 12,878 14,506
-------------------------------------------------------------------------
Earnings before income taxes 164,602 153,729
-------------------------------------------------------------------------
Income taxes
Current 55,448 46,724
Future (6,479) 163
-------------------------------------------------------------------------
48,969 46,887
-------------------------------------------------------------------------
Net earnings $ 115,633 $ 106,842
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Net earnings per common share:
Basic $ 0.53 $ 0.49
Diluted $ 0.53 $ 0.49
Weighted average common shares outstanding
- Basic (millions) 217.4 217.3
- Diluted (millions) 217.5 217.4
Actual common shares outstanding (millions) 217.4 217.3
SHOPPERS DRUG MART CORPORATION
Consolidated Statements of Retained Earnings
(unaudited)
(in thousands of dollars)
-------------------------------------------------------------------------
12 Weeks Ended
--------------------------
March 27, March 28,
2010 2009
-------------------------------------------------------------------------
Retained earnings, beginning of period $ 2,297,091 $ 1,899,139
Net earnings 115,633 106,842
Dividends (48,922) (46,727)
-------------------------------------------------------------------------
Retained earnings, end of period $ 2,363,802 $ 1,959,254
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Consolidated Statements of Comprehensive Income and Accumulated Other
Comprehensive Loss
(unaudited)
(in thousands of dollars)
-------------------------------------------------------------------------
12 Weeks Ended
--------------------------
March 27, March 28,
2010 2009
-------------------------------------------------------------------------
Net earnings $ 115,633 $ 106,842
-------------------------------------------------------------------------
Other comprehensive (loss) income, net of tax
Change in unrealized loss on interest rate
derivatives (net of tax of $132 (2009 - $121)) 282 257
Change in unrealized loss on equity forward
derivatives (net of tax of $215 (2009 - $2)) (473) 9
Amount of previously unrealized loss recognized
in earnings during the period (net of tax of
$4 (2009 - $23)) 9 91
-------------------------------------------------------------------------
Other comprehensive (loss) income (182) 357
-------------------------------------------------------------------------
Comprehensive income $ 115,451 $ 107,199
-------------------------------------------------------------------------
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Accumulated other comprehensive loss, beginning
of period $ (1,125) $ (3,442)
Other comprehensive (loss) income (182) 357
-------------------------------------------------------------------------
Accumulated other comprehensive loss, end of
period $ (1,307) $ (3,085)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
SHOPPERS DRUG MART CORPORATION
Consolidated Balance Sheets
(unaudited)
(in thousands of dollars)
-------------------------------------------------------------------------
March 27, March 28, January 2,
2010 2009 2010
-------------------------------------------------------------------------
Assets
Current
Cash $ 41,700 $ 26,190 $ 44,391
Accounts receivable 478,206 411,293 471,029
Inventory (Note 2) 1,830,078 1,716,123 1,852,441
Income taxes recoverable 3,477 9,371 -
Future income taxes 87,665 82,285 86,161
Prepaid expenses and deposits 54,365 53,511 75,573
-------------------------------------------------------------------------
2,495,491 2,298,773 2,529,595
Property and equipment (Note 4) 1,567,580 1,363,472 1,566,024
Goodwill (Note 3) 2,492,034 2,446,832 2,481,353
Intangible assets (Note 3) 260,128 216,512 258,766
Other assets 17,411 11,872 16,716
-------------------------------------------------------------------------
Total assets $ 6,832,644 $ 6,337,461 $ 6,852,454
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Liabilities
Current
Bank indebtedness (Note 6) $ 250,441 $ 265,058 $ 270,332
Commercial paper 247,488 293,045 260,386
Accounts payable and accrued
liabilities 910,997 845,846 964,736
Income taxes payable - - 17,046
Dividends payable 48,922 46,727 46,748
-------------------------------------------------------------------------
1,457,848 1,450,676 1,559,248
Long-term debt (Note 9) 945,226 943,384 946,098
Other long-term liabilities (Note 4) 375,421 317,219 347,951
Future income taxes 37,835 31,565 42,858
-------------------------------------------------------------------------
2,816,330 2,742,844 2,896,155
-------------------------------------------------------------------------
Associate interest 123,255 111,381 130,189
Shareholders' equity
Share capital 1,519,903 1,516,359 1,519,870
Contributed surplus 10,661 10,708 10,274
Accumulated other comprehensive
loss (1,307) (3,085) (1,125)
Retained earnings 2,363,802 1,959,254 2,297,091
-------------------------------------------------------------------------
2,362,495 1,956,169 2,295,966
-------------------------------------------------------------------------
3,893,059 3,483,236 3,826,110
-------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 6,832,644 $ 6,337,461 $ 6,852,454
-------------------------------------------------------------------------
-------------------------------------------------------------------------
SHOPPERS DRUG MART CORPORATION
Consolidated Statements of Cash Flows
(unaudited)
(in thousands of dollars)
-------------------------------------------------------------------------
12 Weeks Ended
--------------------------
March 27, March 28,
2010 2009
-------------------------------------------------------------------------
Operating activities
Net earnings $ 115,633 $ 106,842
Items not affecting cash
Amortization 63,912 54,217
Future income taxes (6,479) 163
Loss on disposal of property and equipment 1,142 1,865
Stock-based compensation 387 180
-------------------------------------------------------------------------
174,595 163,267
Net change in non-cash working capital
balances (38,564) (101,530)
Increase in other long-term liabilities 12,056 9,623
-------------------------------------------------------------------------
Cash flows from operating activities 148,087 71,360
-------------------------------------------------------------------------
Investing activities
Purchase of property and equipment (77,402) (81,207)
Proceeds from disposition of property and
equipment (Note 4) 35,964 5,204
Business acquisitions (Note 3) (11,358) (27,280)
Deposits 1,202 555
Purchase and development of intangible assets (10,364) (2,426)
Other assets (982) 242
-------------------------------------------------------------------------
Cash flows used in investing activities (62,940) (104,912)
-------------------------------------------------------------------------
Financing activities
Bank indebtedness, net (Note 6) (19,891) 24,214
Commercial paper, net (13,000) (47,000)
Repayment of short-term debt (Note 9) - (200,000)
Issuance of Series 3 notes (Note 9) - 250,000
Issuance of Series 4 notes (Note 9) - 250,000
Revolving term debt, net (1,298) (200,000)
Financing costs incurred - (2,088)
Associate interest (6,934) (7,297)
Proceeds from shares issued for stock options
exercised - 1,945
Repayment of share purchase loans 33 110
Dividends paid (46,748) (46,709)
-------------------------------------------------------------------------
Cash flows (used in) from financing activities (87,838) 23,175
-------------------------------------------------------------------------
Decrease in cash (2,691) (10,377)
Cash, beginning of period 44,391 36,567
-------------------------------------------------------------------------
Cash, end of period $ 41,700 $ 26,190
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Supplemental cash flow information
Interest paid $ 14,950 $ 4,880
Income taxes paid $ 76,343 $ 48,276
SHOPPERS DRUG MART CORPORATION
Notes to the Consolidated Financial Statements
(unaudited)
(in thousands of dollars except per share amounts)
-------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The unaudited interim consolidated financial statements have been
prepared in accordance with Canadian generally accepted accounting
principles ("GAAP") and follow the same accounting policies and methods
of application with those used in the preparation of the audited annual
consolidated financial statements for the 52 week period ended January 2,
2010. These financial statements do not contain all disclosures required
by Canadian GAAP for annual financial statements and, accordingly, should
be read in conjunction with the most recently prepared annual
consolidated financial statements and the accompanying notes included in
the Company's 2009 Annual Report.
Under the Canadian Institute of Chartered Accountants ("CICA") Accounting
Guideline 15, "Consolidation of Variable Interest Entities", the Company
consolidates the Associate-owned stores. The individual Associate-owned
stores that comprise the Company's store network are variable interest
entities ("VIE") and the Company is the primary beneficiary. The
Associate-owned stores remain separate legal entities and consolidation
of the Associate-owned stores has no impact on the underlying risks
facing the Company.
The consolidated financial statements of the Company include the accounts
of Shoppers Drug Mart Corporation, its subsidiaries and the Associate-
owned stores that comprise the majority of the Company's store network.
All intercompany balances and transactions are eliminated on
consolidation.
2. INVENTORY
During the 12 weeks ended March 27, 2010, the Company recognized cost of
inventory of $1,443,516 (2009 - $1,384,322) as an expense. This expense
is included in cost of goods sold and other operating expenses in the
consolidated statements of earnings for the period.
During the 12 weeks ended March 27, 2010 and March 28, 2009, there were
no significant write-downs of inventory as a result of net realizable
value being lower than cost and no inventory write-downs recognized in
previous periods were reversed.
3. ACQUISITIONS
In the normal course of business, the Company acquires the assets or
shares of pharmacies. The total cost of acquisitions during the 12 weeks
ended March 27, 2010 of $11,358 (2009 - $27,280), including costs
incurred in connection with the acquisitions, is allocated primarily to
goodwill and intangible assets based on their fair values. Purchase price
allocations are preliminary when initially recognized and may change
pending finalization of the valuations of the assets acquired. The
operations of the acquired pharmacies have been included in the Company's
results of operations from the date of acquisition.
4. SALE-LEASEBACK TRANSACTIONS
During the 12 weeks ended March 27, 2010, the Company sold certain real
estate properties for net proceeds of $35,470 (2009 - $4,869) and entered
into leaseback agreements for the area used by the Associate-owned
stores. The leases have been accounted for as operating leases. The
Company realized a gain on disposal of $12,358 (2009 - $2,195). The gain
has been deferred and is being amortized over the lease terms of 10 to 15
years (2009 - 20 years). The deferred gain is presented in other long-
term liabilities.
5. INTEREST EXPENSE
The components of the Company's interest expense are as follows:
12 Weeks Ended
--------------------------
March 27, March 28,
2010 2009
-------------------------------------------------------------------------
Interest on bank indebtedness $ 1,147 $ 1,534
Interest on commercial paper 850 2,000
Interest on short-term debt - 504
Interest on long-term debt 11,896 11,060
-------------------------------------------------------------------------
13,893 15,098
Less: interest capitalized 1,015 592
-------------------------------------------------------------------------
$ 12,878 $ 14,506
-------------------------------------------------------------------------
-------------------------------------------------------------------------
6. BANK INDEBTEDNESS
The Associate-owned stores borrow under their bank line of credit
agreements, which are guaranteed by the Company. The Company has entered
into agreements with banks to guarantee a total of $520,000 (2009 -
$425,000) of lines of credit. As at March 27, 2010, the Associate-owned
stores have utilized $261,311 (2009 - $278,444) of the available lines of
credit.
7. EMPLOYEE FUTURE BENEFITS
The net benefit expense included in the results for the 12 weeks ended
March 27, 2010 for benefits provided under pension plans was $1,540
(2009 - $1,082) and for benefits provided under other benefit plans was
$23 (2009 - $23).
8. STOCK-BASED COMPENSATION
Long-term Incentive Compensation Awards
The Company maintains a Long-Term Incentive Plan ("LTIP") pursuant to
which certain employees are eligible to receive an award of share units
equivalent in value to common shares of the Company ("Share Units").
Awards of Share Units under the LTIP are made in February of the fiscal
year immediately following the year in respect of which the award is
earned. For a description of the awards, see Note 14 to the consolidated
financial statements in the Company's 2009 Annual Report. For long-term
incentive awards in respect of the 2009 fiscal year, the Company, in
February 2010, made grants of restricted share units ("RSUs") under the
Company's Restricted Share Unit Plan (the "RSU Plan") and for certain
senior management, grants of RSUs, combined with grants of stock options
under the Company's Share Incentive Plan (the "Share Plan"). There were
no awards made under the LTIP in respect of the 2009 fiscal year.
During the 12 weeks ended March 27, 2010, the Company awarded 341,685
RSUs at a grant-date fair value of $44.09, which vest 100% after three
years. Full vesting of RSUs will be phased in for employees who received
an award under the LTIP in respect of a fiscal year prior to the 2009
fiscal year. During the 12 weeks ended March 27, 2010, the Company
recognized compensation expense of $2,125 associated with RSUs.
During the 12 weeks ended March 27, 2010, the Company awarded 282,120
stock options under the Share Plan at a grant-date fair value of $6.94,
which vest one-third each year. The exercise price of the stock options
granted was $44.09 and upon vesting, the stock options may be exercised
over a period not exceeding seven years. During the 12 weeks ended
March 27, 2010, the Company recognized compensation expense of
$276, measured at fair value on the date of the grant using the Black-
Scholes option-pricing model.
9. DEBT REFINANCING
On January 20, 2009, the Company issued $250,000 of three-year medium-
term notes maturing January 20, 2012, which bear interest at a fixed
rate of 4.80% (the "Series 3 notes") and $250,000 of five-year medium-
term notes maturing January 20, 2014, which bear interest at a fixed rate
of 5.19% (the "Series 4 notes"). The Series 3 notes and the Series 4
notes were issued pursuant to the Company's shelf prospectus, as
supplemented by pricing supplements dated January 14, 2009.
The net proceeds from the issuance of the Series 3 notes and the
Series 4 notes were used to refinance existing indebtedness, including
repayment of all amounts outstanding under the Company's senior unsecured
364-day bank credit facility ("short-term debt"). The Company's senior
unsecured 364-day bank credit facility was terminated on January 20,
2009.
On June 22, 2009, the Company filed with the securities regulators in
all of the provinces of Canada an amendment to its short form base shelf
prospectus dated May 22, 2008 (the "Amended Prospectus") to increase the
aggregate principal amount of medium-term notes to be issued from
$1,000,000 to $1,500,000. Subject to the requirements of applicable law,
the Company may issue medium-term notes under the Amended Prospectus for
up to 25 months from May 22, 2008.
As at March 27, 2010, the Company can issue an additional $550,000 of
medium-term notes under its Amended Prospectus.
10. FINANCIAL RISK MANAGEMENT OBJECTIVES AND POLICIES RELATED TO
FINANCIAL INSTRUMENTS
In the normal course of business, the Company is exposed to financial
risks that have the potential to negatively impact its financial
performance but it may use derivative financial instruments to manage
certain of these risks. The Company does not use derivative financial
instruments for trading or speculative purposes. These risks are
discussed in more detail below:
Interest Rate Risk
Interest rate risk is the risk that fair value or future cash flows
associated with the Company's financial assets or liabilities will
fluctuate due to changes in market interest rates.
The Company, including its Associate-owned store network, is exposed to
fluctuations in interest rates by virtue of its borrowings under its bank
credit facilities, commercial paper program and financing programs
available to its Associates. Increases or decreases in interest rates
will negatively or positively impact the financial performance of the
Company.
The Company uses interest rate derivatives to manage this exposure and
monitors market conditions and the impact of interest rate fluctuations
on its fixed and floating rate debt instruments on an ongoing basis. The
Company is party to an interest rate derivative agreement converting an
aggregate notional principal amount of $50,000 (2009 - $100,000) of
floating rate commercial paper debt into fixed rate debt. See Note 11 for
further discussion of the derivative agreement.
As at March 27, 2010, the Company had $459,311 (2009 - $472,444) of
unhedged floating rate debt. During the 12 weeks ended March 27, 2010,
the Company's average outstanding unhedged floating rate debt was
$617,993 (2009 - $670,969). Had interest rates been higher or lower by
50 basis points during the 12 weeks ended March 27, 2010, net earnings
would have decreased or increased, respectively, by approximately $500
(2009 - $537) as a result of the Company's exposure to interest rate
fluctuations on its unhedged floating rate debt.
Furthermore, the Company may be exposed to losses should any counterparty
to its derivative agreements fail to fulfill its obligations. The Company
has sought to minimize counterparty risk by transacting with
counterparties that are large financial institutions. As at March 27,
2010 and March 28, 2009, there were no net exposures, as the interest
rate derivative agreements were in a liability position.
Credit Risk
Credit risk is the risk that the Company's counterparties will fail to
meet their financial obligations to the Company, causing a financial
loss.
Accounts receivable arise primarily in respect of prescription sales
billed to governments and third-party drug plans and, as a result,
collection risk is low. There is no concentration of balances with
debtors in the remaining accounts receivable. The Company does not
consider its exposure to credit risk to be material.
Liquidity Risk
Liquidity risk is the risk that the Company will be unable to meet its
obligations relating to its financial liabilities.
The Company prepares cash flow budgets and forecasts to ensure that it
has sufficient funds through operations, access to bank facilities and
access to debt and capital markets to meet its financial obligations,
capital investment program and fund new investment opportunities or other
unanticipated requirements as they arise. The Company manages its
liquidity risk as it relates to financial liabilities by monitoring its
cash flow from operating activities to meet its short-term financial
liability obligations and planning for the repayment of its long-term
financial liability obligations through cash flow from operating
activities and/or the issuance of new debt.
The contractual maturities of the Company's financial liabilities as at
March 27, 2010, are as follows:
Payments
due Payments
between due
Payments 90 days between 1
due in and less year and Payments
the next than a less than due after
90 days year 2 years 2 years Total
-------------------------------------------------------------------------
Bank indebted-
ness $ 250,441 $ - $ - $ - $ 250,441
Commercial
paper 248,000 - - - 248,000
Accounts
payable 860,207 34,836 - - 895,043
Dividends
payable 48,922 - - - 48,922
Medium-term
notes - - - 950,000 950,000
Other
long-term
liabilities - - 10,008 15,988 25,996
-------------------------------------------------------------------------
Total $ 1,407,570 $ 34,836 $ 10,008 $ 965,988 $ 2,418,402
-------------------------------------------------------------------------
There is no difference between the carrying value of bank indebtedness
and the amount the Company is required to pay. The accounts payable and
other long-term liabilities amounts exclude certain liabilities that are
not considered financial liabilities.
11. FINANCIAL INSTRUMENTS
Interest Rate Derivative
As at March 27, 2010, the Company is party to an interest rate derivative
agreement converting an aggregate notional principal amount of $50,000 of
floating rate commercial paper debt into fixed rate debt. The agreement
has a fixed rate payable of 4.18% and matures on December 16, 2010, with
reset terms of one month.
Based on market values of the interest rate derivative agreement in place
at March 27, 2010, the Company recognized a liability of $1,230 (2009 -
$4,268), all of which was presented in accounts payable and accrued
liabilities (2009 - $1,318 was presented in accounts payable and accrued
liabilities and $2,950 was presented in other long-term liabilities).
During the 12 weeks ended March 27, 2010 and March 28, 2009, the Company
assessed that the interest rate derivatives were effective hedges for the
floating interest rates on the associated commercial paper debt. Market
values were determined based on information received from the Company's
counterparties to these agreements.
Equity Forward Derivatives
The Company uses cash-settled equity forward agreements to limit its
exposure to future price changes in the Company's share price for share
unit awards under the Company's LTIP and RSU Plan. The income or expense
arising from the use of these instruments is included in cost of goods
sold and other operating expenses for the period.
Based on market values of the equity forward agreements in place at
March 27, 2010, the Company recognized a liability of $2,124 (2009 -
$2,334), of which $1,422 (2009 - $1,145) is presented in accounts payable
and accrued liabilities and $702 (2009 - $1,189) is presented in other
long-term liabilities. During the 12 weeks ended March 27, 2010 and March
28, 2009, the Company assessed that the percentages of the equity forward
derivatives in place related to unearned units under the LTIP and RSU
Plan were effective hedges for its exposure to future changes in the
market price of its common shares in respect of the unearned units.
Market values were determined based on information received from the
Company's counterparty to these equity forward agreements.
During the 12 weeks ended March 27, 2010, amounts previously recorded in
accumulated other comprehensive loss of $9 (2009 - $91) were recognized
as income in earnings.
Fair Value of Financial Instruments
The fair value of a financial instrument is the estimated amount that the
Company would receive or pay to settle the financial assets and financial
liabilities as at the reporting date.
The fair values of cash, accounts receivable, deposits, bank
indebtedness, commercial paper, short-term debt, accounts payable and
dividends payable approximate their carrying values at March 27, 2010 and
March 28, 2009 due to their short-term maturities. The fair values of
long-term receivables, revolving term facility and other long-term
liabilities approximate their carrying values at March 27, 2010 and
March 28, 2009 due to the current market rates associated with these
instruments; and the fair value of the medium-term notes at March 27,
2010 is approximately $1,005,698 compared to a carrying value of $950,000
(excluding transaction costs) due to decreases in market interest rates
for similar instruments (2009 - the fair value of long-term debt
approximated its carrying value).
The interest rate and equity forward derivatives are recognized at fair
value, which is determined based on current market rates and on
information received from the Company's counterparties to these
agreements. The interest rate derivative is valued using the one-month
Reuters Canadian Dealer Offered Rate Index. The primary valuation input
for the equity forward derivatives is the Company's common share price.
12. CAPITAL MANAGEMENT
The Company's primary objectives when managing capital are to profitably
grow its business while maintaining adequate financing flexibility to
fund attractive new investment opportunities and other unanticipated
requirements or opportunities that may arise. Profitable growth is
defined as earnings growth commensurate with the additional capital being
invested in the business in order that the Company earns an attractive
rate of return on that capital. The primary investments undertaken by the
Company to drive profitable growth include additions to the selling
square footage of its store network via the construction of new,
relocated and expanded stores, including related leasehold improvements
and fixtures, the acquisition of sites as part of a land bank program, as
well as through the acquisition of independent drug stores or their
prescription files. In addition, the Company makes capital investments in
information technology and its distribution capabilities to support an
expanding store network. The Company also provides working capital to its
Associates via loans and/or loan guarantees. The Company largely relies
on its cash flow from operations to fund its capital investment program
and dividend distributions to its shareholders. This cash flow is
supplemented, when necessary, through the borrowing of additional debt.
No changes were made to these objectives during the period.
The Company considers its total capitalization to be bank indebtedness,
commercial paper, short-term debt, long-term debt (including the current
portion thereof) and shareholders' equity, net of cash. The Company also
gives consideration to its obligations under operating leases when
assessing its total capitalization. The Company manages its capital
structure with a view to maintaining investment grade credit ratings from
two credit rating agencies. In order to maintain its desired capital
structure, the Company may adjust the level of dividends paid to
shareholders, issue additional equity, repurchase shares for cancellation
or issue or repay indebtedness. The Company has certain debt covenants
and was in compliance with those covenants as at March 27, 2010 and
March 28, 2009.
The Company monitors its capital structure principally through measuring
its net debt to shareholders' equity and net debt to total capitalization
ratios, and ensures its ability to service its debt and meet other fixed
obligations by tracking its interest and other fixed charges coverage
ratios.
The following table provides a summary of certain information with
respect to the Company's capital structure and financial position as at
the dates indicated.
March 27, March 28, January 2,
2010 2009 2010
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Cash $ (41,700) $ (26,190) $ (44,391)
Bank indebtedness 250,441 265,058 270,332
Commercial paper 247,488 293,045 260,386
Long-term debt 945,226 943,384 946,098
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Net debt 1,401,455 1,475,297 1,432,425
Shareholders' equity 3,893,059 3,483,236 3,826,110
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Total capitalization $ 5,294,514 $ 4,958,533 $ 5,258,535
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Net debt:Shareholders' equity 0.36:1 0.42:1 0.37:1
Net debt:Total capitalization 0.26:1 0.30:1 0.27:1
EBITDA:Cash interest expense(1)(2) 20.33:1 17.39:1 19.59:1
(1) For purposes of calculating the ratios, EBITDA (earnings before
interest, taxes, depreciation and amortization) is comprised of
EBITDA for the 52 week and 53 week periods then ended, as
appropriate. EBITDA is a non-GAAP financial measure. Non-GAAP
financial measures do not have standardized meanings prescribed by
GAAP and therefore may not be comparable to similar measures
presented by other reporting issuers.
(2) Cash interest expense is also a non-GAAP measure and is comprised of
interest expense for the 52 week and 53 week periods then ended, as
appropriate. It excludes the amortization of deferred financing costs
and includes capitalized interest.
As measured by the ratios set out above, the Company maintained its
desired capital structure and financial position during the period.
The following table provides a summary of the Company's credit ratings at
March 27, 2010:
Standard DBRS
& Poor's Limited
--------------------------
Corporate credit rating BBB+ -
Senior unsecured debt BBB+ A (low)
Commercial paper - R-1 (low)
There were no changes to the Company's credit ratings during the 12 weeks
ended March 27, 2010.
On April 8, 2010, DBRS Limited placed the short and long-term ratings of
the Company under review with negative implications. The rating action
was in response to the Ontario Ministry of Health and Long-Term Care's
(the "Ministry") April 7, 2010 announcement with respect to further drug
reform in the province. See Note 13 for further discussion on the
Ministry's announcement.
13. SUBSEQUENT EVENTS
On April 7, 2010, the Ministry announced its plans with respect to
further drug reform in the province. The proposed reforms announced by
the Ministry included lowering the cost of generic prescription drug
products for patients under the Ontario Drug Benefit Program from the
current level of 50% of the equivalent brand name price for multi-source
generic prescription drug products to 25% of the equivalent brand name
price, and extending these same benefits to private payors over a multi-
year period. The proposed reforms also included measures to eliminate
professional allowances, increase dispensing fees and pay for additional
pharmacy services, including support for access to pharmacy services in
rural communities and under-serviced areas.
On April 8, 2010, the Ministry published Notice of Proposed Regulations
to Amend Regulation 935 under the Drug Interchangeability and Dispensing
Fee Act and Ontario Regulation 201/96 under the Ontario Drug Benefit Act
(collectively, the "Proposed Regulations") for comment. The Proposed
Regulations outline the regulatory changes that the Ministry proposes to
enact in order to implement the reforms announced on April 7, 2010.
While the Company is in the process of reviewing these proposed changes
to assess their impact on its sales and profitability, it is anticipated
that, prior to giving effect to the implementation of any mitigating
actions on the part of the Company, the net effect of the proposed
reforms will have a material adverse impact on its operations and
financial performance. An estimate of this impact cannot be made at this
time.
SHOPPERS DRUG MART CORPORATION
Exhibit to the Consolidated Financial Statements
(unaudited)
Earnings Coverage Exhibit to the Consolidated Financial Statements
52 Weeks Ended March 27, 2010
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Earnings coverage on long-term debt obligations 19.03 times
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The earnings coverage ratio on long-term debt (including any current
portion) is equal to earnings (before interest and income taxes) divided
by interest expense on long-term debt (including any current portion).
Interest expense excludes any amounts in respect of amortization and
includes amounts capitalized to property and equipment that were included
in and excluded from, respectively, interest expense as shown in the
consolidated statement of earnings of the Company for the period.
%SEDAR: 00016987EF
For further information: Media Contact: Tammy Smitham, Director, Communications & Corporate Affairs, (416) 490-2892, or [email protected], (416) 493-1220, ext. 5500; Investor Relations: (416) 493-1220, ext. 5678, [email protected]
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