Ladies and gentlemen, good day and welcome to Laurus Labs' Q3 FY 2020 earnings conference call hosted by Kotak Securities Limited. As a reminder, all participant lines will be in listen-only mode, and there will be an opportunity for you to ask questions after the presentation concludes. Should you need assistance during the conference call, please signal an operator by pressing star and then zero on your touch-tone phone. I now hand the conference over to Mr. Chirag Talati from Kotak Securities Limited. Thank you, and over to you, sir.
Good morning, everyone. On behalf of Kotak, I thank Laurus management for giving us opportunity to host this call. From Laurus, we have with us today Dr. Satyanarayana Chava, CEO, Mr. Ravi Kumar, CFO, and Monish Shah from the investor relations team. I now hand over the call to the management for opening remarks. Over to you, sir.
Thank you, everyone, and a very warm welcome to our results conference call on the Q3 and nine months FY 2020. Our Q3 revenues stood at INR 740 crores, showcasing a robust growth of over 38% year-over-year. To begin with, I would like to share key updates on our formulation business. We are happy to share that our Unit 2, which underwent a successful U.S. FDA inspection in November 2019, has received the EIR. Moving to the performance of formulation business, the division reported its highest-ever quarterly revenue of over INR 292 crores, and in the cumulative nine months, we did INR 558 crores. The overall contributions from FDF segment have improved to about 40% in the quarter and about 30% for the nine months in the financial year. From low single digits in the corresponding year, this was a significant shift.
This shift is in our business model and also underscores our philosophy of investing in manufacturing and research ahead of time. During the quarter, we have reached maximum utilization levels of our formulations unit, and with a healthy outlook and order book, we continue to invest further in our FDF infrastructure and also in the development. The growth driver for the formulation business remains tender-driven LMIC antiretroviral market funded by The Global Fund, PEPFAR, and other in-country tenders. We continue to have good visibility for FY 2021 as well. We also expect two new major approvals in the next couple of months for TLE 400 and TLE 600. The sales growth also we have in U.S. as well as in EU. In EU, our sales were primarily driven by pregabalin sales by our partner, Rising, and we have more than 10% market share right now.
As of today, we have received total eight approvals, five final approvals, three tentative approvals from U.S. FDA. Going forward, we expect two more approvals and launch a few more products, maybe two in this financial year and a few more in the FY 2021. In Canada, we also have five product approvals, and we have launched two, and we are preparing to launch two more shortly. As far as EU market is concerned, we are happy to share that our contract manufacturing partners for non-ARV formulations have done exceedingly well, and we have a very good order book for FY 2021 as well. Besides this, we are also launching two products in European market under our own label. So far we have five products approval from Europe, and we have already launched one, and we are planning to launch two more.
As we always said, our FDF R&D is geared up to develop and validate between eight and 10 products per year, and we continue to believe we will meet this number. Far, we have filed 24 ANDAs in U.S., six dossiers in Europe, nine in Canada, and eight with WHO Geneva, and two with SAHPRA, South Africa, and also two dossiers in India. We also filed several dossiers in various African countries for our antiretroviral products. Of the 24 ANDAs filed, we believe that there are two Para IV and seven first-to-file opportunities with addressable market of $several billion. As we always state, our approach remains product-specific and not market-specific. Is the reason we are filing our dossiers in various geographies across the globe.
Moving into the business segment, although we had great success in formulations, which fueled our growth, we had a setback in our ARV API, where there was significant degrowth. Rest of the divisions performed as per our expectations. Synthesis did 14% more than the corresponding quarter, and Ingredients did exceedingly well, about 20% more than the corresponding quarter. Generic API, as a total, we degrew that segment by almost 20% quarter-on-quarter. When it comes to ARV, our degrowth mainly came from lack of clarity on the awards of supplemental tender in South Africa, where our key customers are not building up inventory. Once the tender results are clear, we expect we will be able to improve our ARV sales in the coming quarters. We have completed the filing of our second line API, lopinavir and ritonavir.
We expect to do some formulation development of other second-line APIs as well. When it comes to Onco, our revenues were as expected. We did about INR 47 crores in Q3 and about more than INR 150 crores in nine months. The revenue growth is as we expect, there is no significant growth. The sales is as we expected. In the first year, we were unable to ramp up a portion of one of our key Onco API because of backward integration didn't complete on time. Now, since last quarter, we were able to ramp up intermediate manufacturing for key Onco API, and we expect Q4 will be very good for us. In the other API segment, we did exceedingly well, primarily driven by contract manufacturing of APIs to other generic companies.
We also have very good visibility for FY Q4 and FY 2021 for the contract manufacturing of APIs for our partners. It comes to synthesis business, we are doing exceedingly good. In Q4, we did INR 62 crores. So far, nine months we did INR 180 crores. We have a very good sales plan for Q4. It comes to ingredients, we did INR 18 crores in Q4 and INR 64 crores so far in nine months. We also launched one key product to a customer in U.S. We expect that will do very well in the near future as well. With that, I would like to hand over to Ravi to share financial highlights.
Thank you, Dr. Satya. Very warm welcome to everyone on our call for Q3 and nine months FY 2020. Total income from operations for the quarter is INR 730 crores against INR 530 crores in the corresponding quarter last year, showing a robust growth of 38%. For nine months, total income from operations came at INR 1,993 crores against INR 1,667 crores, with a growth of 20%. Our gross margin continued to show an improvement both sequentially and over the corresponding quarter at 51%. Improvement in gross margin was mainly led by favorable product mix and higher contribution from operations group. Our EBITDA margin at 31%. The growth in EBITDA was mainly because of improved operating leverage from the business of formulation and other APIs. Our diluted EPS for the quarter at INR 6.9 and INR 13.6 on annual basis, with a growth of 306% and 183%.
On the CapEx front, we invested around INR 130 crores for nine months. We will have a normalized CapEx of around INR 250 crores in the current year. For the next year, we are still working on based on the new demand, we expect to slightly higher than INR 250 crores, but we will come back and probably in the next quarter call what will be our guidance for FY 2021 CapEx. With the improved contribution from our high-margin business of FDF and other APIs, we remain confident of improving our return ratios. We are very optimistic about the improvement of our return ratios in FY 2020 and looking forward to positive free cash flow in FY 2021 and beyond. With this, I would request moderator to open the lines for Q&A. Thank you.
Thank you very much, sir. Ladies and gentlemen, we will now begin the question and answer session. Anyone who wishes to ask a question may press star and one on your touch-tone telephone. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use handsets while asking a question. Ladies and gentlemen, we will wait for a moment while the question queue assembles. To ask a question, please press star and one on your touch-tone phone now. We have our first question from the line of Hari Belawat from Techfin Consultants. Please go ahead.
Good morning, sir. Congratulations for such nice results, which has come during this quarter. It's really very good. This is regarding U.S. FDA inspection. Unit 2, yes, you got EIR. For unit 1 and 3, in the month of June, inspection was done and EIR was given. Again, in the month of November, the inspection was done, and again, some three observations were raised. How, sir, these inspections have come so quickly? One. Second thing is, why the observations have come in the second inspection?
The unit 1 and 3 underwent FDA inspection in June 2019, was a routine GMP inspection, and for which we have received EIR. In the November, we had another inspection for a product-specific pre-approved inspection, PAI. We had three minor observations, and we responded to those, and we expect EIR soon for the same day as well.
Okay. That means it will be cleared very soon, whatever observations are there.
Yes, you're right.
Yes. Another thing is, sir, this is regarding investment in total you said, but till March some INR 250 crore, in FY 2021 also INR 250 crore. How much will go in formulations and how much will go in API manufacturing?
We are still finalizing the numbers, but next year, probably the formulation and API will be equal.
Okay. Because of the degrowth in API, are you looking for lower investment in API segment or any such view is being taken?
Actually, if you look at our Formulation business is also driven by APIs. API production was never scaled down. Our API division is giving APIs to Formulation division.
Okay. That means both will continue to run that way.
Yes. You're right.
Just one small query. This again, China problems are there and so many APIs are being imported. Will it affect our company also in this regard?
We are very well backward integrated to starting material. We don't import any APIs or advanced intermediates from China. We don't expect any disruption in supply chain because of this.
Okay, good. Good, sir. Wish you all the best. Thank you.
Thank you.
Thank you, sir. We have next question from the line of Sudarshan Padmanabhan from Sundaram Mutual Fund. Please go ahead.
Good morning. Thank you for taking my question. Sir, my question is on the formulation side. This quarter has been phenomenal with almost INR 300 crores of sales, and you did talk about capacities more or less reaching in the chock-a-block over there. Given that we have invested in the nine months close to about INR 130-140 odd crores, given that we are seeing fair amount of growth and two more products coming in the fourth quarter, should we be having capacities to kind of drive incremental growth as we move towards FY 2021?
We are getting some additional capacity between April and June FY 2021. After that, we also have planned to construct a new building, which we expect will become operational between April to June 2021. We have some capacity augmentation coming in next quarter. That is Q1 FY 2021. Again, significant capacity expansion will be available in the Q1 FY 2022.
Sure. Yes, sir. On the ARVs segment, one, I think you had talked about APIs being used internally for formulations, which is a good thing. The second is, if you can give a bit more color about what we are seeing is that the older molecules, specifically in efavirenz and tenofovir, or efavirenz specifically, seeing some kind of a slower growth, whereas the expected is more towards lamivudine and dolutegravir. If you can give some color about whether we are seeing that shift happening, is it getting delayed? When can we see some kind of better margins, better mix as well as better growth in this segment?
ARV APIs in Q3 contributed only 27% of the revenue, whereas formulation contributed 40% of the revenue. Nine-month number, 39% of revenue contributed by ARV APIs, whereas formulation contributed 28% of revenue. The decline in sales of ARV APIs is a combination of many products, not only attributable to efavirenz degrowth. If we get clarity on South African supplement tender, we supply efavirenz, tenofovir and emtricitabine, three APIs. Decline came from a bunch of APIs, not alone efavirenz. There is also shift in regimen. Other than South Africa, majority of triple combination is dolutegravir based rather than efavirenz based. That has also contributed some decline in our API sale. We are not selling as much as dolutegravir as we used to sell efavirenz.
Sure, sir. How about the Oncology, sir? You did give some color about the third party, dependence coming down with primarily some internal capacities coming in. Definitely, I think compared to 1Q, you were expecting some kind of volume ramp up as well as value ramp up to happen. How do we see the trajectory over here in terms of growth, run rate, et cetera, sir?
The Oncology segment will give around INR 250 crore per year. That's a good number. We don't expect significant growth coming from Oncology APIs. See, our Oncology APIs as it is, the volume is so low and despite of we having very large capacity and good market share, that is the nature of Oncology business. Interestingly, Oncology business apart, our gross margin is going up in Oncology business when compared to the previous year.
Yes, sir. One final question from my side is, if we're looking at the run rate that we are seeing in the formulation side, almost from INR 100 to INR 150 to INR 300 now. Would it be a right assumption that at the beginning of the year, we had probably looking at about INR 500 crores this year, and we are probably running at around INR 750 crores or INR 800 crores this year going by the run rate. Definitely next year we should be able to see, even if you're looking at the similar kind of a run rate, over INR 1,000 crores, INR 1,000-INR 1,100 crores of formulations happening. Probably with additional capacities coming in, it should also further improve from here on. What is the kind of internal targets that you have for the formulation side, and how do you see it in the next couple of years, sir?
We are not giving any guidance, but you are on the right track. You can annualize our INR 290 crore-INR 300 crore. That we are geared up to deliver that kind of capacities to the market.
Sure. Sir, thanks a lot, sir. I'll join back with you.
Thanks. Thanks a lot.
Thank you, sir. We have next question from the line of Kishore from Motilal Oswal. Please go ahead. Oh, we lost the line of Mr. Kishore. We have the next question from the line of Prem Doshi from ACE Equities. Please go ahead.
Hello. Hi, sir. Good morning. Congratulations on a great set of results. I have a couple of questions.
Please.
One is that we have a significant leadership in antiretrovirals, if I am correct, globally. Have you seen a demand bump up related to the coronavirus outbreak in China?
No.
No, there's no demand bump up yet.
There's no demand. There's a small demand, small queries came. That is not going to be significant for us or anybody. The volume will be so low.
Okay. Another question is, are you looking to bring down the promoter pledge that is on the shareholding as of now?
Not right now, but we have plans to reduce the pledge over a period of time.
Okay. All right, sir. Thank you so much.
Thank you.
Thank you, sir. We have next question from the line of Kaustubh Bubna from Rare Enterprises. Please go ahead.
Yeah, sir. Out of this 40% revenue that's coming from FDF in quarter three FY 2020 and 28% coming from FDF in nine months FY 2020, how much of it would be the tender business? Could you first answer that?
About between 75% and 80% of the business is coming from channel-driven ARV business, remaining is coming from North America and Europe.
Okay, that's helpful. Now, on the 75%-80% that's coming from the tender business, could you explain exactly how sustainable this is? How does the tender process work? How much clarity do you have for the next few years in terms of where is this growth coming from? How much will it grow year-on-year? What's the clarity on ground like? Could you explain that situation?
There are three parts of this business, Global Fund driven, PEPFAR driven, and in-country tenders. In-country tenders is winner takes all. There is no preference. You have to quote based on that particular tender date. Whereas in the PEPFAR and Global Fund, Global Fund especially, there will be fixed allocation percentage-wise. Whatever they buy, we will get some fixed allocation, which we cannot reveal how much we will get. That is more certain, and they will place order over a period of several quarters. We have good visibility from Global Fund. We have reasonable visibility from PEPFAR. In-country tenders, we can't commit right now because it is a tender to tender quotes, and then generally winner takes all. Whereas in the case of PEPFAR and Global Fund, there is a fixed allocation, and they make sure the business is sustainable or not.
Actually, we have done so far, majority of our business came from Global Fund and PEPFAR, but some business also came from in-country tenders.
Okay, what is the margin profile of this whole tender business versus the rest of your business?
It's comparable with the overall formulation business.
If you look at our gross margins improved when we were a pure API play to integrated. The FDF business certainly helping us to increase our gross margins because we are getting more gross margin than API for sure in formulation business.
Working capital cycle?
Pardon.
Working capital cycle for this tender business versus the rest of your business?
From an intermediate to formulation, it's slightly higher than API.
No, sir, I'm specifically talking about the tender business of formulation, not the U.S. and Europe business.
Tender business of formulations, the payment cycles are very good, and we never had any problem of receivables.
How many months would it be, the receivable days for the tender business?
No, we can't-
Days are less than 90 days.
Okay. Thank you.
Thanks.
Thank you, sir.
Thank you, sir. We have next question from the line of Nitin Agarwal from IDFC Securities. Please go ahead.
Thanks for taking the question, sir. Sir, on the API other segment which is there, given the upsurge which is there in general API business momentum, how do you see the segment really playing out for us? Are there any specific new molecules where we see opportunities, or how should we look at growth in this segment?
The API segment, our growth will be primarily driven by getting more clarity on the South African tenders that will fuel our growth in ARV API. In our API segment, we are doing significant contract manufacturing, and we have great visibility for Q4 as well as in several quarters from now. The majority of the growth is coming from actually old molecules rather than from new APIs which are working. People are trying to move business from regulatory uncertainty manufacturing facilities to more sustainable regulatory companies. We have seen some traction, but this business is, even somebody wants to move their API to a new vendor, it takes anywhere between 12 to 24 months. We are in that cycle. We expect good traction coming from non-ARV APIs in the coming 12 to 18 months.
Sir, overall, if you split the business into formulations, APIs, and synthesis. On API overall, if you take a three-year view, what kind of growth the overall API segment can deliver given the challenges that are there in the oncology business, in the Hep C, as well as the ARV API segment?
I think, based on our current guesstimates, maybe we can expect 10% growth in API business, where formulation and synthesis will drive our majority growth.
The synthesis growth is going to be driven by existing products, contracts, or you envisage a ramp-up coming through some newer sort of contract and pipelines?
Majority of synthesis growth will come from the existing customers and existing products going into the next clinical development, and some commercial supplies as well. While we grow from existing clients and products, there is also possibility that we will have new clients and new products. We added two interesting clients last year.
Okay. Sir, last one on the formulation side. Sir, on ARV formulations, what is the peak size that we can potentially do on this business? What is the peak potential opportunity which is there in this market for us, sir?
It's difficult to predict. You see, there are 25 million patients on treatment and about 22 on the first-line. Whether we get 10% market share, 50% market share, it all depends. Today, we are geared up around 10% market share. Our capacities are created to get 10% market share.
10% of a billion-dollar market, sir?
Yeah.
Billion dollar. Okay, sir.
Actually, it's not of INR 1 billion. We are geared up to get 10% of that INR 1 billion right now.
Okay, sir.
Thank you, sir. We have next question from the line of Arun Subrahmanyam from Ampersand Capital. Please go ahead.
Just two questions. When you were saying that your API will grow at about 10% CAGR and formulations will grow a lot faster. Can you give us a sense of what is the overall growth of the company over next three year? Considering that you are doing this INR 250 crore kind of CapEx, which will continue. What will be the overall growth over three years?
See, if you look at our nine months, we did grow 20% despite a significant drop in ARV API. We expect that trend will continue. At least we will have 20% growth this year, next year as well. We can't tell you beyond that. We don't have visibility.
Your lack of visibility, which you're talking about, considering that you are putting up the capacity and you have just got 10% market share. The lack of visibility is because of what? That you cannot get substantially higher market shares? Considering your cost structure and your cost advantages, I thought that you would be in a far better position.
No. It's not absolutely lack of visibility. We are not giving any guidance. Generally we can say we are investing in capacities and we will grow, but we are not giving any guidance how much we will grow. I'm giving the trend what happened. See, in nine months, we grew by 20%. It is reasonable to estimate that we'll also grow in Q4 by 20% and FY 2021 also by 20%. If you are asking FY 2020 how much we'll grow, we haven't run our numbers right now.
Understood. Sir, last thing that I wanted to understand from you is that, when you are seeing this drop in API, and the significant expansion in formulations, but formulation is far more tender business. Is the tender business lot more like there's a bunch of things which is not a smooth forecast-able number? What I'm saying is that, is the tender business like a normal production, manufacturing, and sales business or not?
It's a-
You place tender orders on a very big quantity, and then you are not sure when the next tender will be open. I'm just trying to get a sense of how smooth.
This tender is a long-term tender. You will get tender for half a million times. You get tender and with committed delivery times. For example, we have visibility for Q4 and Q1 next year as well. That is the kind of visibility people will have.
Okay. Sir, final question, earlier when we were interacting with you, in your calls, basically you were saying that you are winning more and more tenders. Is that something which is the status now? Because you are fully already utilized, so you will just continue at current level of operation?
For Q4, we run at the current level of operations. For Q1 FY 2021, we are adding more capacity, we have scope to grow our formulations business in Q1 FY 2021.
Thanks a lot, sir.
Thanks.
Thank you, sir. We have next question from the line of C. Srihari from PCS Securities. Please go ahead, sir.
Yeah, thanks for the opportunity. Firstly, congratulations on a good set of numbers. I have a few questions. Firstly, if I look at the product mix, it has improved dramatically sequentially, but the gross margins are modest by just 100 basis points. Could you please explain that? Secondly, on the formulation front, if you could please give the U.S. sales breakup for Q2 and Q3, that would be great. I would also like to know whether there's any exceptional out here in terms of, let's say, profit share or a milestone receipt. Finally, on the ARV front, you have indicated that you're going to file for lopinavir and ritonavir. Was this as per schedule or you are trying to accelerate the process for some developments? Thank you.
Maybe I'll answer questions in reverse order. lopinavir, ritonavir, we have a goal date already. I wouldn't expect FDA going to faster approval because of coronavirus. That is one. Second, there is no one-off in Q3. That is, I wanted to clarify. The third one is our formulations business, as we explained, little more than three-fourths is coming from ARV, and rest is coming from North America and Europe. We can't give you how much we are selling in North America and Europe, but that trend will continue. About a quarter of revenue coming from North America and Europe, and three-fourths coming from LMIC.
Could you at least give an indication directionally, U.S. sales has it increased sequentially?
It is growing. See, when we have increased our revenue from INR 150 crore to INR 290 crore in Q3, our U.S. revenue also went up. Okay. North America, Canada revenue went up, and Europe revenue went up. Yeah.
Okay. Finally, basically based on the guidelines that you had given regarding asset turnover, if I go by that number, then INR 290 seems way beyond what you had indicated as your optimal revenue for the Formulations Division. Can you please explain that?
Can you repeat the question, Srihari? I didn't get it exactly.
Yeah. See, for the formulations division, you had indicated earlier that the asset turnover should be around 1.7 or maybe at the most, I guess, 2x. Where we are right now is, I presume it will be close to 3x, if you analyze the quarterly number.
See, here you have to consider the API CapEx. This is a captive backward-integrated project for us. Entire API is what we are using in formulation coming from our own facilities. We are not taking any revenue of API from API division. When it comes to the asset turnover ratio, we have to think at API CapEx as well as the FDF CapEx. It's not three. As you're saying, 300 into 1,200 divided by INR 400 crore CapEx is not three asset turnover ratio. You have to allocate certain amount of CapEx we have done for API as well here.
Yes. Okay. I'm still not clear about that. Your existing capacity is at 5 billion tablets, right?
You are right. It's a notional capacity. ARVs, we are doing a triple combination. One tablet is equivalent to more or less equivalent to three dispensing, three granulations kind of stuff. Whereas compression and packing is one, so significant capacities will be used for triple combination. We are doing capsules, we are doing tablets for other markets. Per se, if you convert our triple combination as three, we are running around maybe 300 million-400 million units per month.
At optimal capacity for the quarter, you would be at around 1.25 billion tablets. Is that the?
Yes. You're right.
Production was around 1.25 billion tablets during the quarter.
Yes. There we have to consider triple as 3x. See, at the ARV, we are doing a combination of three drugs into one tablet.
Right.
Harish, you are talking about 200, the 2x. When we are talking on what is the possible revenue from formulation, we have been talking about two times plus we can do it. That was an earlier case when you're talking about up to INR 800 crore revenue, some of you, when you are saying that INR 800 crore plus we can do it, we have done more than that.
This is the peak it is possible with the existing capacity. To answer your question briefly.
Okay. What is the kind of CapEx you're planning on the 2020 front?
Another INR 50 crores we are planning immediately, and then the further expansion, we have not crystallized the CapEx amount.
I mean, in terms of capacity, is it a 5 billion tablets?
I think let's not talk on the tablet because it kind of confuses. It is a triple combination and all. If you have any further things, we'll take it offline, Harish.
Sure. Thank you.
Thank you.
Thank you, sir. We have next question from the line of Aditya Khemka from DSP Mutual Fund. Please go ahead.
Yeah. Hi, thanks for the opportunity, and sorry, I also have similar questions as the previous participant. Just to understand what you're saying, currently you are running at a 5 billion tablet capacity, counting triple combination as one. Right? Because that's how the industry deals with it. 5 billion tablet capacity, and you're doing 300 million-400 million as [Chava Sir] had indicated in his comment, per month. You are doing 3.6 billion-4.8 billion tablets already. Pretty much 100% utilized, right? Going from by what you previously mentioned, that you have visibility that you'll be able to sell this 300 million-400 million tablets a month for the next 3-6 months, right? That's the order book you already have, correct?
You are right, Aditya. We also mentioned we are going to debottleneck and add little capacity, which will come into operation between April and June this year.
Between April and June this year. Perfect. I got your comments clear. Yes. Now, if you were to quantify the debottlenecking potential capacity to add to this 300-400 million tablets per month, how much debottlenecking can help? Can it add 50 million tablets? Can it add 100 million, 20 million?
About 20% capacity it can add. Yeah.
Okay. About 20% it can add. The cost of this bottlenecking is the INR 50 crores Ravi was alluding to in his comments.
Yeah, INR 60 crores actually. Close to INR 60 crores right now.
60 crores. Okay, the CapEx Ravi was alluding to is this debottlenecking CapEx, right?
Yeah.
Yeah. Now is the next question. We have already incurred Capex of INR 400 crores on the formulation side alone. I understand you're using API capacity as well, but on the formulation side only, you have done Capex of INR 400 crores. This INR 60 crores is only formulation Capex, correct?
Only formulation CapEx.
Right. Your total CapEx will be INR 460 crores on the formulation side. My question is that now that given that you have been able to sell so well on the formulation side, you have been able to get a very decent sized order book, why are we limiting our CapEx on the formulation side to INR 60 crores only? There can be a few reasons for that. One can be that is only the amount of market share that you're able to get in the end market. It could be that you don't want to spend as much in that particular segment, and you see better opportunity in other segments.
Aditya, we have one existing building where we did initial investment and added another investment, and we are doing debottlenecking and some new line addition, that's in existing building.
Yeah
With this additional INR 60 crore CapEx, we don't have any space in the existing building. We have to do a new building. Which is under planning right now, and probably we'll have a groundbreaking in the next few weeks. There, we will need 12 months to finish that building and bring that into operation. That is the reason I mentioned some additional capacity will come between April and June this year, and again in April and June next year. That will be a very big capacity. We are doing a building, and we haven't frozen our numbers, how many billions we'll do. That building can take another INR 5 billion capacity.
Fair enough. Fully understood, sir. That's good. Now, on the gross margin side, I think one participant asked you this question. In that second quarter of FY 2020, you had a gross margin of 49.5%. This quarter you have reported 50.6%, despite a significant jump in your formulation revenues. The question I think everybody's trying to understand is from a margin profile perspective, how different. As I understand it, your ARV API is probably the lowest gross margin segment, which is where you have significantly declined this quarter. And your formulation should be ideally your highest gross margin segment, where you have significantly grown this quarter. Ideally, the delta in your gross margin in the third quarter versus the second quarter should have been much higher than what has been reported.
This is what we're trying to understand as to whether this incremental volume in formulation segment from INR 150 crores to INR 300 crores, whether that came at a significantly lower margin versus what we were doing earlier in the INR 150 crores.
Aditya, Ravi here. There is no ARV APIs are a lower gross margin. It may be slightly lower, not in the very lower.
Okay.
Secondly, it actually depends on the product mix. It's like the formulations are in higher gross margin than an API. No doubt on that. Because of the product mix, this change will come.
Understood. Is it fair to say that formulations are not like 20 percentage point higher gross margin than API? It's more like five or 10% higher margin than API. Is that a fair statement to make?
It all depends, like maybe could be from 5%-20%. That kind of a range.
Depending on the product that you're selling.
Depending on the product.
LMIC would be a lower gross margin within formulations than U.S. and Europe will be higher gross margin?
Yes. When compared to U.S. and Europe, it is lower than in North America and Europe, for sure.
The volume is more.
The volume is higher. Absolutely.
Yeah.
That explains a lot, sir. That explains a lot to me. Thank you. On the cost side now. On our other expenses, the growth in the cost has been phenomenal. As I understand it, the capacity that we have already had in the formulation and API, in this quarter or in the last two, three quarters, we haven't added any material capacity. We already had this capacity from a very long time. Right? The sales actually went up this quarter because we got the tenders, and we were able to supply. Let's say I'm comparing second quarter to the third quarter. In second quarter, our other expenses were INR 88 crores, which was a growth of 11% year-over-year. In this quarter, we have other expenses of INR 92 crores, which is actually a growth of something like 70% year-over-year.
One is the base effect because the second quarter FY 2019 other expenses were INR 80 crore. The third quarter FY 2019 other expenses were only INR 54 crore. This is excluding your R&D spend. If you add your R&D spend, the numbers become slightly different. I am just taking out the entire R&D spend from other expenses and then stating the numbers. What I am trying to understand is that ideally, again, with such a huge amount of jump in your formulation sales, I would have expected that your other expenses would not have gone up the way they have gone up this quarter. Anything that you can point us out to whether this run rate of other expenses is what we should sustain, or can there be further growth in these other expenses?
Long question, huh? I can take a sense from the question that you're asking why the other expenses are higher in the third quarter. The answer is, there is a one-off expenditure. We have a CPhI expenditure that is booked as a cash expense till this year. Probably next year onward, we are going to move it on an accrual basis. That is one. Second, because of the formulation expenses, the selling cost also will increase. These are the two reasons for the higher other expenses in the third quarter.
Fair enough, sir. Can you care to quantify the CPhI expenses this quarter?
Maybe INR 4.5 crores or INR 5 crores.
About INR 5 crores. Yeah, that explains a lot on that front. In your formulation business, you are incurring more selling expenses because in the LMIC. LMIC is a tender business, right? What is the reason for incurring more selling expenses in an LMIC kind of business?
Carriage outward and freight will make commission will be there.
Basically carriage. Okay.
Yeah.
I got you, Ravi, sir. Thank you so much, and all the best.
Thank you.
Thank you. We have next question from the line of Aditya Agrawal from Indgrowth Capital. Please go ahead.
I have a couple of questions.
Please excuse me. I'll come to you.
You had mentioned that we don't buy any APIs or intermediates from China. Would we also be buying any KSMs from China?
No. We buy significant quantities of KSM from China.
Okay. In case there is a disruption there, how would that affect us?
It's difficult to predict. If there is a disruption, there is no ship coming out of China, that is a sectorial challenge. Not only pharma, many other sectors. Looking at some feedback, what we're getting from vendors, they are starting their operations from next week.
Okay, our KSM dependency on China is going to hopefully reduce over a period of time.
No. It's not going to reduce. See, our vendors are, after the Spring Festival, we look at one is coronavirus, the other one is Spring Festival. Most of China is on vacation. They were supposed to come back on 3rd of February. Now they are starting their operations on 10th of February. There's a week delay, but week delay in supplies is not going to disrupt supplies, for sure.
Okay. Thank you. My next question is, roughly what would be our market share in dolutegravir till now? Roughly, what would that number be?
About 10%. I'll calculate it here, but 10%. Yeah.
Okay. Are we expecting our market share in that to increase over a period of time? Or how are we
We are creating capacity to get a certain market share, but we can't say right now what percentage we get. We are adding capacity to garner more market share.
Thank you. My third question is our market share in the tender business, which is TLE, Global Fund, et cetera, is that increasing over the last few quarters? Are we projecting it to continue increasing?
Increase from Q2 to Q3, we expect it should go up in Q1 FY 2021.
Okay, fine. That is all that I have. Thanks.
Thank you.
Thank you. Ladies and gentlemen, in the interest of time and fairness to all participants, kindly restrict questions to two per participant. We have our next question from the line of Dipan Mehta from Elixir Equities. Please go ahead.
Yes, sir. My question is.
Sir, I'm sorry to interrupt. I think you lose handset.
Okay. Is that clear?
Yes, it is. Please go ahead.
Okay. My question is that of the INR 700 crores odd sales which are there, how much would be completely tender-driven? What %?
20%. 25%, yeah.
Only 25% is tender-driven.
Yeah.
Whether it's ARV or generic FDF or whatever, all put together.
Generic FDF. Yeah.
ARV is also tender-driven.
Yeah.
No, sir. I understand that there is tender business in ARV and generic FDF.
ARV APIs, we don't participate in any tenders. Our customers participate, and we supply API to them. Whereas generic FDF, we directly participate in tenders.
Okay. Next question is, how have you seen the prices in the tenders over the past few months, quarters? If you can give us some idea of the direction of pricing. Has it been stable or declined, and if so, by what %? Thank you.
I would say fairly stable, sir. Fairly stable.
Okay. Second question is, generic FDF, what would be the percentage of sales to U.S.?
As we mentioned in the nine months timeframe, three-fourths coming from ARVs and one-fourth coming from North America and Europe. That is, North America and Europe is purely non-ARV driven business.
No. Sir, in generic FDF also you sell to U.S. market, right?
That's what I'm saying. U.S. market, U.S. and Europe formulation business, 20% of our revenues came from North America and Europe. Why I'm using North America, we are also selling in Canada apart from U.S. That segment is about 20% of FDF revenues.
Okay, sir. Thank you and all the best.
Thank you.
Thank you, sir. We have next question from the line of Anuj Momaya from Value Quest Investments. Please go ahead.
Yeah. Congratulations, sir, on the good set of numbers. On the ARV business, have you seen any prices correction in the efavirenz API or price have remained stable?
efavirenz is fairly mature product, so prices are stable. Sir.
Whatever the loss of business is volume loss, is what you're saying?
Volume loss, yeah. There's no value loss. Yeah.
There is no value loss.
Yeah.
Okay. Do you think this will be coming back in the next couple of quarters, or now this is INR 200 crores or INR 250 crores for the quarterly is the new run rate for the ARV business?
See, we expect this is the bottom. I think we expect it should go up. Yeah.
Go up and this coming back to INR 1,000 crore kind of annual.
Yeah. We accept that.
Okay. What is the current gross debt on our books? Gross and net.
Gross is about-
two 600.
INR 2,600 crores is the gross.
Gross. Debt I'm asking about.
Debt.
Debt around INR 1,100 crores.
1,100. Okay.
Thank you, sir. We have next question from the line of Prakash Agarwal from Axis Capital. Please go ahead.
Yeah. Thanks for the opportunity and congrats on good set of numbers. Just one clarification of what you mentioned that we are vertically integrated. I understand from a formulation side you have a strong API, this thing. From the API side, I think one of the participant also asked that most of the industry is dependent on KSM from China. You mentioned that it's a week postponement, I heard that. What I'm trying to understand here is, what is the kind of inventory levels we normally keep, so that even if there is a delay, we are able to keep the supply momentum on?
Normally, one to two months actually there won't be any issue. You are aware that China was shut for last 15 days because of the New Year holiday. Now they're extending. They're supposed to start their operation, but they're extending the week. We have to wait and watch. Probably around March, if they continue to shut for another month, probably then the trouble may come.
Let's wait and watch for the next one week and then probably we can find our way.
I'm just trying to understand actually the worst case, like when you say trouble and suppose it opens by March and there's a month delay, what really can go for a pharma company is what I'm trying to understand. You don't get KSM, you would not able to supply. What really happens from a business point of view?
See, you will exhaust most of the inventory then. You have inventory in raw materials, you have inventory in warehouse, inventory in port, inventory of intermediates, inventory of API. There will not be an issue for a quarter. Maybe one has to import instead of by sea, you will cut down your logistics time by three, four weeks. If everything has to import by air. That situation, we have to plan as things go by. It is difficult to plan right now.
For the temporary purpose, the worst case could be some cost could increase.
Yeah.
What I was trying to understand, could the supply be restricted and not only cost, but could there be damages in terms of not able to supply or the industry world understands that, okay, there is a severe problem and the penalties are not levied?
That's a difficult question to answer right now.
Right now, it is very hypothetical. We need to wait and watch how it is going to move. There will be, as Dr. Satya said, the pipeline will be dried up. We have to fill in the pipeline through C2A and some other measures. I think we have to wait and watch.
Okay, understood. Thank you, sir, and all the best.
Thank you. Sir, we have next question from the line of Tarang Agarwal from Old Bridge Capital. Please go ahead.
Hello, sir. Good afternoon, sir.
Sir, please use your handset. We're not able to hear you. Thank you.
Hello, am I audible?
Yes, sir, you are.
Hi. Good afternoon. As I see the trend in your ARV business and whatever commentary that I've gathered on your generics API, my sense is, going forward, we should see a decline in your ARV API, which essentially would be because you would be utilizing those APIs to manufacture your APIs, correct? Consequently, getting better margins.
It's not true. See, whatever capacities are earmarked for in-house API consumption, we have created that capacity apart from what we are selling APIs to other customers.
Okay. Other than FDA capacities will be used to cater to your generics API business, is it?
Yes. If there is more demand in generic API, ARV APIs, we are geared up to serve it. We are not diverting third-party API sales to our formulations.
Okay. Thank you.
Yeah, thank you.
Thank you, sir. We have next question from the line of Tushar Bohra from MK Ventures. Please go ahead.
Good morning. Thanks for the opportunity. Congratulations, sir, for an excellent set of numbers. Just to understand, there's been a discussion on gross margins earlier on in the conversation. Would it be fair to assume that over the next two years as formulations revenue from U.S. picks up? I would assume North America today would probably be more Canada than U.S. Please correct me if I'm wrong.
You are right. Yeah.
Okay. As U.S. picks up over the next 2 years and maybe your European formulations business picks up, within formulations, your mix is changing. Again, your gross margins overall, is there a scope for this to move up, say, by 300, 350 basis points over, say, next 3 years? Would that be an overestimate or is it a possibility?
No, we don't want to give a quantitative guidance here on the percentage, but there are chances of improvement. In the worst-case scenario, probably it's going to be maintained.
Okay. We should be at or above the current levels. Fair.
Yes. That will be a good estimate, yeah.
Right. Second, sir, just again sticking to numbers, we did about INR 74 crores profit in this quarter. Assuming that we maintain more or less these levels, just for the sake of assumption, we're effectively saying about INR 300 crores is the run rate we established at end of FY 2020. It would be fair to assume that we are seeing 20% revenue growth in FY 2021. With some operating leverage, the profitability should be higher and it should be on an INR 300 crore base. Would that be a fair assumption?
We don't want to comment again on the number.
Okay. Just generally, the base for profit calculations for next year should be the exit run rate for FY 2020. Would that be fair to assume?
We can say the gross margins and our EBITDA will be maintained at least the current level. We are not commenting how much we'll grow, we'll maintain them at the current level, at least.
Thanks, sir. That helps. On the overall China situation, again, a lot has been asked earlier by earlier participants. Just to take a scenario where this scales up into a bigger issue and we say, worst case, we don't have supply from China coming in, maybe a 20%, 25%, 30% supply cut or even something more drastic. What are the alternatives we have from a sourcing perspective and how costly could those alternatives be? Second, is there any opportunity also from a supply perspective for us in turn, for any of the APIs, intermediates? Could that be an opportunistic business for Indian companies?
There is an opportunity, but when API manufacturing, you need say 20 chemicals. You get 19, you don't get one. That means you don't make any API. As simple as that.
Okay.
It is a difficult pill. See, we are taking this risk to extreme extent, but we don't see that is going to happen. The reality is supplies will resume very quickly. Yeah.
Just, sorry to persist, just to understand, intermediates and KSM is relatively easier to source in India. As in, you can still set up supplies in India, right? If you plan ahead as compared to APIs.
No. Actually, it is relatively easy to get intermediates in India rather than starting materials. The intermediate manufacturer in India also buys starting materials from China.
Okay. There could be an issue overall if the KSM supplies are affected. Fair enough, sir.
Thank you so much for the opportunity.
Thank you.
We have next question from the line of Cyndrella Carvalho from Centrum Broking. Please go ahead.
Hi. Thanks for the question, and congratulations on good set of numbers. Sir, I just wanted to understand more on synthesis side. The Aspen contract, whatever we have said earlier, how do we see it going ahead? You have also mentioned that there are two commercialized products right now with us. How many are there with us in total in terms of number of projects, if you could help us understand? How many of them would be in the late stages? If you could provide some color on that, would be very helpful.
Yeah. Our Aspen business will peak out next year because most of the products went commercial. When it comes to the NCE products, we have 2 products commercial. Those are API, and 1 intermediate is commercial. I think there are 2 more in phase III right now and several in earlier stages. Total, we have maybe between 30-40 active projects right now at various stages.
Okay. Sir, just to get some more clarity, the margin profile of this business should be better than our average margin. Is a good understanding?
Absolutely. This is the highest margin business we are doing right now.
Yeah. That's very helpful, sir. Thank you, and all the best.
Thank you.
Thank you. We have next question from the line of Charulata Gaidhani from Dalal & Broacha. Please go ahead.
Hi. Congrats on the good set of numbers. Can you give some clarity on the EU partner? You said that non-ARV business will grow by what %?
See, the current year, we expect to do about 600 million units to the partner. The FY 2021, maybe we'll do 1 billion units per annum. That's the level of increase we expect.
Okay. This is entirely formulations?
We do API as well, and we convert that API into formulations and give it in bulk to our partner in Europe.
Okay. What proportion would be formulations from this?
No. That entire 1 billion units is formulations. That means we are using roughly 20% of our formulation capacity to contract manufacturing to the U.S. partner, where we make API also for our formulations.
Okay. My second question pertains to efavirenz. The inventory, has it been sold off?
There's no inventory right now.
No, it was there in the last quarter, right?
We don't have any inventory challenges in efavirenz. Yeah.
Okay. In terms of how are your products doing in the U.S. market? pregabalin.
pregabalin is doing good. We have about 10, 12% market share right now.
Okay. metformin?
metformin, we have a very small market share right now.
Okay. Yeah, my question was in terms of ARV treatments. Is the Indian market also seeing some scope for opening up?
So far in ARV, India tenders, we haven't participated.
Okay.
The opportunity is big. Far, we haven't participated.
Okay. Do you think it can, with more focus on health in the Indian market?
Probably, yes, but not in the near future. We are not intending to participate in the NACO India government tenders.
Okay. Thank you. All the best.
Thank you.
Thank you, ma'am. Ladies and gentlemen, that was the last question. I now hand the conference over to the management for closing comments. Sir, over to you.
Thanks, everyone, for supporting us in the last several years. Some of your questions are very encouraging and very thought-provoking. Thanks for participation. Thanks to Chirag and Kotak for hosting this.
Thank you. Thank you very much, sir.
Yeah.
Thank you. Ladies and gentlemen, on behalf of Kotak Securities, that concludes this conference call. Thank you for joining with us. You may now disconnect your lines.