Sigma Pharmaceuticals (SIP) 2014 Voting Intentions

Company/ASX Code : Sigma Healthcare Limited (SIG)
Registry : Link Market Services
Poll/Show of Hands : Poll on remuneration report
Webcast : Yes
Venue :
Melbourne, Victoria
Monitor : Mr Geoffrey Bowd
AGM Details / NoM : Wednesday 7th May, 2014
ASA Position
Not Applicable
Item 1: Approval of accounts

Sigma reported a Net Profit After Tax (NPAT) of $53.5 million compared to $18.7 million last year. A reduction in litigation expenses and a gain from a property sale are extraordinary items which have been major contributors to this result. While the profitability from business activity has been below expectation the chairman considered that a solid return has been maintained. Sales revenue increased slightly more than 1% and the cost of goods sold increased slightly less than 1%. Gross Profit is a narrow 7.2% of sales revenue and reflects the challenging competitive environment and the higher than expected impact of the Federal Government’s Pharmaceutical Benefits Scheme (PBS) i.e. price disclosure reforms.

Freedom from any debt, an improved Return On Investment Capital (ROIC), inventory control, a reduction in working capital and positive cash flow are positive factors in the Sigma financial profile. There has been increased investment in marketing and distribution efficiency which has generated significant improvements in customer relationships.

The PBS disclosure reforms remain a pertinent factor for earnings by major pharmaceutical wholesalers but it is not anticipated that there will be more severe impacts in continued implementation nor is it likely that pharmacies will be allowed in supermarkets.

The acquisition of Central Health Care (CHC) will broaden Sigma’s presence in retail and hospital pharmaceuticals and improved earnings are anticipated. The purchase cost of CHC was offset by the gain from the recent property sale.

The Sigma share price has fluctuated over the past 12 months and is currently at approx 72 cents compared to 75 cents last years. The dividend has been maintained and although a continuation at this rate with an 84% payout ratio is expected, a fully franked interim dividend for 2015 is unlikely. Sigma have progressed a share buy-back and since October 2013 5.6% of issued capital as been bought back. Commitment is expressed to consider further buy-back and other capital management to reward shareholders.

ASA Position
Item 3: Remuneration Report

While ASA encourage brevity in a Remuneration Report the Sigma report lacks adequate explanation of certain important factors which to meet ‘an easy to understand’ criterion require questioning and discussion.

Non Executive Directors fees were increased by 4% during the year and, although not stated in the report, appear to be at a high percentile of the market for a company of this size. 25% of post tax fees are committed to the purchase of Sigma shares on market and must be held for at least 3 years. This is in positive alignment with ASA policy and shareholders’ interest.

The short term incentive plan (STI) enables the CEO to receive a maximum incentive equivalent to 100% of his fixed remuneration and other executives 50% of fixed remuneration. ASA considers that the CEO should have a reduced percentage of short term incentive and a higher percentage of long term incentive and the Chairman acknowledged this concern. 40% of earned STI’s are awarded in equity and subject to one and two year deferral periods before vesting. This is in positive alignment with ASA policy and shareholders’ interest.

A gateway for STI awards, except those with safety targets, is budgeted NPAT. For this financial year the only STI awards were for achievement of safety targets as financial performance was below expectation. 92.5% of the possible STI for the CEO was forfeited and an average of 96.25% of possible STIs for other executives was forfeited. ASA notes this as evidence of strict STI discipline i.e. set performance targets must be achieved.

The Long Term Incentive (LTI) for the CEO is 57% of Fixed Remuneration and 29% for other executives. ASA would prefer a higher percentage and reduction in STI. The award is in equity and is funded by a limited non-recourse loan which must be repaid in full before any receipt of shares subsequent to achievement of Total Shareholder Return (TSR) and Return On Investment Capital (ROIC) targets. Such a loan structure is not ASA preferred policy but in view of taxation treatment of Options it is a cost effective alternative. The measurement period is 3 years; while not the ASA preferred 4 years 72% of ASX 200 companies in 2013 had a 3 year term and this, arguably, is relatively long term for retailing and similar business.

The 2011 tranche of LTIs exceeded the TSR hurdle of 50% with 131% achievement and ROIC exceeded the 11% hurdle achieving 13.5%.

In summary ASA seeks significant improvement in the explanations of the Remuneration Report for it to be clear to all shareholders. We voted FOR the remuneration resolution last year but requested an improvement in the clarity of the report. There is no improvement this year and we have concern about aspects of SIGMA remuneration policy when aligned to the recently launched ASA policy. However we recognise the positive aspects of alignment as noted above. We will express our concerns at the AGM and determine whether to vote FOR or AGAINST having heard all that is said.

ASA Position
Item 4.1: Re-elect Ray Gunston

Ray Gunston has been a director since July 2010 and has experience in corporate and financial services in the public and private sector. He is a former Chief Financial Officer of Tatts Group Ltd. and is a non executive director of the relatively small ASX listed company Hotel Property Investments Limited (HPI). He has attended all Board and Committee meetings, as has each Sigma director in 2013-2014.

ASA Position
Re-elect Brian Jamieson

Brian Jamieson has been a non-executive director of Sigma since 2003 and chairman since June 2010. ASA has a high regard for the qualifications, experience and competence of Brian Jamieson as a director and as a chairman. However ASA has a firm policy guideline for director workload, setting a total of 5 where 1 is for director and 2 for chairman. Brian Jamieson is also the chairman of Mesoblast (MSB), a director of Oz Minerals (OZL, Tatts Group (TTS) and Tigers Realm Coal TIG) i.e. a total of 7. This is a heavy work load with 5 companies, each of who are experiencing particularly challenging situations. Brian Jamieson does not accept justification of this ASA governance policy. Mr Jamieson has also been on the Sigma board for 11 years and ASA no longer classifies directors as independent after 12 years of service. The company has had a a mixed run for shareholders over that period.

ASA Position
Item 5.1: Remuneration arrangements for CEO

ASX rules require shareholder approval for acquisition of equities in a remuneration package This resolution relates to the proposed issue of securities to the CEO, i.e. performance rights, as part of the Short Term Incentive Plan (STIP) in the CEO remuneration. Although not favouring a large total STI component ASA supports an equity component. The Sigma STI plan has 60% payable in cash and 40% in equity with vesting after one and two years. Passing this resolution enables the consideration of the equity component.

ASA Position
Item 5.1: Remuneration arrangements for CEO

Under the Corporations Act, on ceasing employment after a minimum 3 years a termination payment must not be in excess of that person’s average annual base salary over that period unless approved by shareholders. This resolution is to enable the Sigma Board to consider the equity component in the STI plan which may have been earned but not vested and could be compromised in an event such as a merger or takeover.

The AGM Notice clearly states that approval of the resolution does not give the Board authority to pay ex-gratia handshakes or obviate meeting performance hurdles. It is confined to the equity component of earned awards.

ASA Position
Item 6: renewal of proportional takeover provisions

The Corporations Act permits a company’s constitution to include a provision to refuse to register shares acquired under a proportional takeover bid unless shareholders approve the bid. This resolution is to renew i.e. continue that provision. The major advantage, amongst others, for shareholders is that, with this provision, they will have a say in whether an offer under a proportional takeover bid should proceed. ASA supports the resolution.

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