Granules India Limited (532482) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Q2 and H1 FY '22 Earnings Conference Call of Granules India Limited. This conference call may contain forward-looking statements about the company, which are based on the beliefs opinions and expectations of the company as on date of this call. The statements are not the guarantees of future performance and involve risks and uncertainties that are difficult to predict. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Dr. Krishna Prasad Chigurupati, Chairman and Managing Director of Granules India Limited. Thank you, and over to you, sir.

Thank you very much. So a very good morning, ladies and gentlemen. Thank you very much for attending our Q2 earnings call, especially on the weekend. I'm glad that we are meeting this time under better conditions related to COVID, and I sincerely hope that the work is over and good times are ahead of us. Though the COVID situation has improved, we are now facing the after wrath of COVID on the economic front, especially in relation to pharmaceuticals, chemicals and logistics. Though we are able to overcome the actual crisis, the after effects continue to negatively affect all of us for some more time. I'm sure all of you are fully aware of the disruptions in supply chain of various chemicals, intermediates and energy that are happening across the world, especially in China. These disruptions have led to huge price increase in various chemicals, leading to increased cost of production for our products. The PAP situation that you are all aware of have led to 164% price increase and global acetic acid shortage led to a price increase of 120% in the cost of acetic anhydride. Both these products are ASMs for paracetamol, which is one of our main products. While our costs have increased drastically, we were not able to pass through our cost to most of our customers in the last quarter. This has been the most challenging quarter in the recent past. But despite the challenges, we have taken various measures to improve cost efficiency to come up with a reasonable performance for Q2. One of the measures was the voluntary reduction in managerial compensation of the promoters by 40%. Though the performance for Q2 may look subdued, I am personally satisfied with the outcome, keeping in mind the extraordinary headwinds we are all facing. Though the challenges will continue for quite some time, I feel the worst is over and that we will see a substantial improvement in our performance in the coming quarters. We are continuously interacting with our customers, and we were able to get price increases with most of the B2B customers for Q3. We are making positive progress with the distributors in the U.S. and we see a willingness in them to accept the price increases, and we hope to start implementing them shortly. On the logistics front, too, though we do not see any freight rate reduction as yet, we see a better availability of containers, which will help us reduce inventories and increase revenues. The availability of PAP is improving as we had qualified one Indian source and another non-Chinese source, though the prices have not decreased, we at least have enough product to keep our plant occupied and generate increased revenues. As we continue to face many challenges in the short term, we will not be able to comply to our guidance for the year. Due to the continuing uncertainties, we cannot offer any new guidance either. However, as mentioned earlier, performance [ of H2 ] is substantially better than H1. All our initiatives for growth are on track. The new MUPS block [ construct ] qualifications in December and validation in the new API capacity built at Unit V, Vizag have started. Our ANDA, EU dossiers, U.S. DMFs and CEP filings are also on schedule. Based on the current scenario, we are reworking our plans for the proposed greenfield formulation facility to reduce the capacity and also the cost. We plan to spend the savings on setting up facilities for most of our KSMs and reduce our dependency on imports, especially from China. There will be a reallocation of CapEx towards backward integration, but definitely no increase. We are confident of reducing our dependency significantly, a dependency on China significantly by the end of 2024. I would like to end my speech on a confident note that we see exciting times and a great future ahead. I now request our CFO, Sandip Neogi, to take you through some of the important financials before we start our Q&A.

Thank you, sir, and good morning to all of you. Let me now move on to the financials for the Q2 of FY '22. We are happy with our performance despite the challenges caused by various business scenarios in the backdrop of COVID and logistic disruptions resulting in shortage of raw material and lower utilization of capacities, especially paracetamol, which has been explained in our CMD speech. Coming to the revenue. The second quarter revenue was INR 888 crores as compared to INR 858 crores in Q2 of FY '21. Our increased sales from existing products and new launches, especially in the finished dosage vertical has resulted in the increased top line. Revenue share from other molecules has increased to 19% and revenue share of finished dosage has increased to 57%, consistent with our strategy. The sales breakup as per the business verticals and regions are presented in our investors presentation, which is available on the website. Coming to the gross margin. For the quarter, the gross margin contracted from 57.9% in Q2 of April '21 to 50.9% in Q2 of FY '22, mainly due to reduction in margins on almost all products especially paracetamol due to increase in raw material prices and freight costs, and our short-term inability to pass on the improved price increases to the customers. Going forward, we'll be able to pass on substantial portion of these increases to the customers. And therefore, it is likely that the gross margin percentage will increase. EBITDA and EBITDA margin percentage. EBITDA for the quarter was INR 151 crores when compared to INR 256 crores in Q2 of FY '21. Apart from the gross margin drop, we have also seen increase in freight cost by INR 20 crores, and increase in R&D cost by INR 25 crores when compared to Q2 of FY '21. We expect that the freight cost should come back to normal around Q4 of FY '22. And for Q3 of FY '22, we are talking to our customers to recover some of these increased costs, which will reflect in our added top line in Q3. Our R&D spend for the quarter stood at INR 47 crores compared to INR 22 crores in the previous year. We are in track with respect to our R&D goals. We are judiciously spending on R&D based on select products and are also among the most efficient companies in terms of R&D cost per project. We will spend more in R&D in line with our expansion plan, and we'll continue to strike a balance between R&D spend in U.S.A. and India. Net debt. Our net debt increased by INR 82 crores on account of increase in our short-term borrowing due to significant increase in our inventories because of increased business requirements both on the raw materials and finished goods front. On the raw materials front, we stocked up due to potential COVID disruption and supply issues. And nonavailability of containers has also increased the finished dosage inventory. Cash to cash cycle. Our cash to cash cycle increased by 25 days from 117 days in March '21 to 142 days, mainly on account of planned increase in the inventory holding days, which is up by 25 days. Core creditors and debtors are same -- are in the same range. Planned increase in the inventory as I mentioned, is on account of nonavailability of containers and raw material requirement that has been stocked up. Other ratios as referred in the earnings presentation is also showing a drop in the current quarter. As we are confident that our performance will be substantially better in H2, we expect the ratios to turn better by the end of the year. In order to combat China supply issues, the company needs to build up inventories of significant raw materials and key starting materials. Operating cash flow. Operational cash flow for the quarter stood at INR 101 crores compared to INR 112 crores in Q2 of FY '21. This was mainly on account of lower operational profit. We had a free cash of INR 32 crores, while it was INR 52 crores in Q2 of FY '21, after spending INR 68 crores of CapEx for this quarter. Cumulative CapEx spend for H1 of FY '22 stood at INR 231 crores. With this, I would like to open the floor for questions.

[Operator Instructions] The first question is from the line of Madhusudan Kela with MK Ventures.

First of all, congratulations to all of you for keeping up the momentum of performance even though the numbers look subdued. I would like to ask 2 questions, sir. One, when you say that these disruptions are likely to continue for a long time, what do you mean by a long time? And when do you think things will get back to normal? And the second part of my question is while we all understand the short-term implications of logistics, freight cost and some key raw material price increase. How has it changed the medium-term outlook for the company? Basically, I'm talking of 3 to 5 years. Is there -- are there any positives in this crisis from the management perspective?

First of all, Madhu, good morning to you. The first question is how long will this last? This is a question which is up in the air for anybody, and I would not dare give a straight answer to this. But however, in my opinion, maybe it should start improving a bit from next fiscal year, and over the quarters, it should improve drastically. And a new normal would be set in terms of pricing. Pricing of raw materials will definitely not go back to old levels, and the normal will be set for finished product pricings, too. The world has to accept that the costs have gone up and they will have to pay more. So we see this positivity in customers today. Customers who have refused to accept prices in the Q2 have started seeing reality because they are starting seeing shortages. People who had excess inventories, companies, especially in the U.S. were trying to get rid of their inventories, and there was no pressure. But right now, I see that there is willingness. So while the shortages of raw materials may continue, I think the performance of companies may not be in the same line, they would be better as better prices can be realized. And coming back to the question of medium term, 3 to 5 years, we are on track. This year it looks like a blip. But under the new normal, I think everything will go on as planned. And our MUPS block, I have mentioned in my speech, is getting ready with our commercial operations Q4, and also the APIs that we are going to use for all the MUPS products are also being validated in our API plant at Vizag, and that will also give us a lot of comfort. In addition, I have also mentioned in my speech that -- opening remarks that our FD increasing venture, we are going to slow down our capacity because we had some recent capacity from the MUPS block. The MUPS block not only makes MUPS product, it's also makes other solid oral products. And the focus, while we build the greenfield venture it will be possibly half the capacity. We have earmarked about INR 300 crores plus for that. We may end up spending only INR 150 crores and INR 150 crores savings plus the other amount we earmarked for APIs will all go into APIs, and also backward integration. We are working on various, I would say -- I would not like to expand too much, but we -- I see that by the year '24, we will not be forget importing. We will not even be buying intermediates or KSMs. I see that we will be making products, everything ourselves in-house. And also we are working on differentiated technologies where we may not need these KSMs. So we've already made one -- I have an example of one of the products where the only supplier of 1 intermediate -- not intermediate, 1 chemical used in the process is China. We were able to remove that chemical and come up with a process where we don't need that. So there's a lot of work going on. A lot of work has gone on in the last 8 years on this front. We were absorbing all the technologies, building various technology platforms, but the time has now come to implement all this and the next few years, we'll see this. And definitely, the medium-term outlook is going to be quite bright.

Okay. We'd be fully backward integrated by 2024, while I don't want a specific number, how will our margin trajectory change, sir? When we are fully backward integrated is it safe to assume that the margins will improve at least by 200, 300 basis points?

Yes, Madhu. The basic thing here is when we are backward integrating, we are not integrating in the traditional process, what we have developed over the last 3 years or 8 years in green technology with the -- the highest atom efficiency and least carbon footprint. I think I mentioned this briefly in some of the previous calls. And any -- as you increase atom efficiency and reduce wastage as carbon footprint goes down, automatically, the costs come down. The usage of materials come down. There will be a very decent improvement in costs. I cannot say at what percentage today. But as we commercialize some of these operations, we will start seeing them. And yes like I said, the future looks exciting. A slight change in our approach, reducing a little bit focus on finished dosages, but strengthening ourselves by integrating all the way backwards doesn't mean that not importing from China we buy something from India, or we make something from India and intermediate. But the raw material for the intermediate again comes from China. So that doesn't mean anything. So we are totally going backwards all the way to raw materials starting from basic building blocks and from there, we are going to work on coming out with final products. It's not only our core products we are working on also new products, everything will be based on the new technologies and the new approach.

The next question is from the line of Ashwini Agarwal from Ashmore Investment Management.

Congratulations for a reasonable set of numbers in a very, very difficult operating environment. And continuing from the question asked by Madhu, I just wanted to get a sense that there are 2 aspects to the question. One is what happens near term and what happens long term? What I gather is that in the near term, what you're suggesting is that the September quarter was probably the bottom in terms of operating performance, operating margins because going ahead, you should start -- we should start to see some pricing escalations coming through to compensate for higher raw material prices and higher freight costs? So that's the medium-term question. And I -- while I understand you don't want to give a guidance, but if you could at least help us understand the trajectory. And second is that the flavor of CapEx going ahead has changed with greater focus on backward integration, efficiency and carbon footprint versus new product development, finished dosages and so on. Because from what I understand, you're going to keep the CapEx outlay the same in order to minimize the drag on your cash flows or keep within the cash flows that are being generated by the company. If you could just comment on these 2 aspects.

Okay. Again, good morning, Ashwini, near term I think you have it right, the improvement is not going to come from reduction in prices of raw materials, which could be a positive thing if it happens. But mostly, it's going to come from our customers accepting reality. And though we do not see an immediate great benefit in this quarter but going month-on-month, as everybody is facing the same problem, there's no way anybody can supply at these old prices. So there will be an improvement. As we see B2B customers today, most of them have accepted, but B2C customers, especially in U.S., is a challenge. But the good news is that they also have started accepting reality. And also the stocks that people had are getting used up. And definitely, this quarter, we'll see some improvement in the next quarter, we'll see some more improvement from our U.S. distributors. Coming to the CapEx and the outlay. Definitely, the outlay continues to be the same. We actually had enough money like even if we were only saving about INR 150 crores from the Greenfield facility. But other than that, we have earmarked about INR 300-plus crores for APIs in the past. So we'll be having about INR 450 crores to spend on APIs and backward integration. And as I repeatedly say, and one of my favorite things is this carbon footprint. A lot of work is going on and one small block actually for one small product is actually being built right now. And we'll be going in with more and more of these products. I'm not sure I've answered all your questions maybe if it's not clear you can again ask me Ashwini.

Yes. No, no, no. That provides me the -- what I was looking for. One follow-up question I had, while raw material prices, shipping costs were kind of challenges during the quarter under review. Was there also a destocking at the end of your customers, especially in the U.S. that hurt revenue? Because that's the commentary we are hearing from some other peers in the pharmaceutical industry. So just want to get a sense of what you are seeing?

I think Priyanka is on the line anything on the U.S., I think it's best that she answers. Let's hear it from the horse's mouth. Priyanka?

Ashwini, yes. I think, could you just explain what you mean by destocking?

So what we heard is that there were several customers who -- and distributors who had bought a lot of inventory over the last 6 months, anticipating potential disruptions in supply chain, anticipating shortages, anticipating greater demand for base products like paracetamol, ibuprofen, in particular, given the pandemic. And now as things are returning to normal, the inventory in the system is being run down as a result primary sales from producers like yourself are getting impacted a little bit. Are you seeing that at all?

Yes, Ashwini, there's actually a mix of what you mentioned in terms of overstocking by the -- our customers as well as overstocking by suppliers. But that said, like you actually said, things are getting back to normal in terms of normal -- having normal levels of inventory, but that will still take some time. We are still not there at that critical point yet. Over the next quarter or 2, we'll start to see that -- a significant impact on the inventory levels where we should be able to pass on some of our price increases.

The next question is from the line of Rahul Veera from Abakkus.

Sir, just a quick question from my end. Sir, some of the ultimate sources to China. For example, if we have empaneled Valiant or probably Sadhana Nitro Chem whose plants of PAP are about to come in a quarter or so. Sir, does it require for us to leave -- send the revalidation batches in terms of change of sources of raw material from the client side? Is there any process required?

Again let me ask you this -- ask you for detail. You said in view of other sources going to manufacture PAP in India like Sadhana and possibly Kutch. Is there any change in your strategy? What was the question?

So do we -- if we are sourcing it from Sadhana from here on, once the plant starts, does it require any validation batches or approval from a customer end?

Yes. Yes, you're right. Yes. Definitely. So first of all, let me answer this question, then I'll add something else. Any new -- this is a KSM, any new KSM, actually, we will also have to file to reverse FDA. But then in view of the current circumstances, it could be a quick acceptance. Customers and FDA also have to accept and the product we make out of the KSM has to be again validated at our end and the finished product uses also have to validate it themselves. But for our own tablet manufacturing, it becomes easier compared to other customers. And coming Sadhana Nitro Chem, I don't know what's happening with them. They say they're coming online, God only knows, but the other good news is Kutch has started manufacturing. They're having a few tethering issues, but they should be -- and we are also helping them streamline their processes and they should stabilize pretty quickly.

Sure. And sir, Sadhana, I believe is coming through an alternate route like 90% of the path is produced by 1 route and Sadhana is opting for another alternate route. So how do we see the stability of our molecules, given the process of Sadhana is a little bit different than the normal PAP production?

The process that Sadhana is going to use is the best process available in the world. And there's only 1 company which makes it today, that is Mallinckrodt in the U.S. and nobody else was able to succeed so far. And I'm not sure a few other companies in India, I don't want to name them, have tried this, but they have not succeeded. So I don't know what's happening with Sadhana then I wish them all the best if they do that, that's going to be great. But I would like to add here, we have worked in the last 8 years on this technology, and we had a pilot plant running for 1 year producing this day and day out. And we have been very successful in producing right from basic material benzene like people, the current people use and PNCB, and PNCB again, you need to buy nitric acid, you need to buy chlorine. You need to buy benzene, acetic acid to acetic chlorobenzene, so many issues. But here, it's a clean thing starting from benzene, no byproducts they go straight into PAP. We have the process ready. And if other people are not able to stabilize their production, it's in our plans to quickly set up a plant. We also have the designs ready they may be able to set up a plant quickly if the others fail, but I wish others success and we don't have to put our CapEx into that.

[Operator Instructions] The next question is from the line of Cyndrella Thomas from Centrum Broking Limited.

Sir, if you could help us understand in terms of our top 3 products, Paracetamol, Ibu and Metformin. How are we seeing the disruption at this level from your raw materials side, especially on the PAP side? And what is the status? What improvements we have seen? And then on the demand side on these top 3 products, if you could comment and help us understand what is the scenario presently. How is it -- how has it improved? I mean, if you could just help us give some color on these?

Cyndrella. So let me start with PAP, Paracetamol. We just discussed that PAP availability has improved, though the cost has not decreased. Actually, the cost is going on going up a little bit month-on-month. And acetic anhydride again, which is made from acetic acid and acetic acid made from methanol. There's a global shortage of methanol today. It's not just China. And that has impacted acetic anhydride prices, so which has gone up more than 120%, 150% these projects. But looks like they're becoming stable now, not any more price increases and acetic acid sees a slight downward trend. So again, like I said, prices will not go back to normal. The only way is for us to get some price increases, and we are glad that people are accepting this. That's with regard to paracetamol. The good news is we have material to utilize the capacity. Then coming back to Metformin, we have increased our metformin capacities drastically, and we are also trying to improve our share in the world market. There is a challenge in supply of DCDA one of the key raw materials for Metformin are the products are not too bad, other raw materials are not too bad DCDA is challenged, but Granules have reversed itself a little bit by buying from the only non-Chinese source in Europe at a much, much higher price long before the disruption in China happened. We were very proactive, and we said we'll pay a higher price today take a hit rather than suffer a shortage. So that also we have covered though at a higher price but we have supplies. And other products Ibuprofen, there seems to be a surplus capacity in the world today, and that's not at a problem. We get whatever we need for our formulations. That's going well. And there are disruptions in other products, Epichlorohydrin for guaifenesin prices have gone through the roof and some of the product. One more raw material from China has gone through the roof. Like I mentioned a little earlier, the raw material that has gone through the roof and the cheap and short supply from China, we were able to avoid that and quickly validate our process. So we are working on various fronts. And as of today, I see we are good on all our 5 products and also products -- some of the products that we are validating also, we appear to be quite good.

This is helpful, sir. So just on the industry-wide, if the supply is normalized, then the prices also should normalize going forward, right? Is that a correct understanding specifically on the raw material side?

Raw material side, again, it's not just a question of supplier, supplier also has his own inputs, his own raw materials, and with the energy situation in China and also -- for I mean, let's say, methanol, there's going to be a big time lag before more capacity has come up. And again, in my humble opinion, the world has not really looked at increasing capacities of most of the key materials, key chemicals. So that's changing now. It's going to take a while. And meanwhile, I feel the prices of raw materials will be continuing to be high. And energy, the disruption in China in terms of energy Again, that's a little black box. We don't know what exactly is going to happen, especially with the winter olympics is coming up in the short term. But even in the long term, we just have to see what's going to happen.

Absolutely. Sir, just 1 more thing. I mean, if we have to look at the overall scenario on the supply side, when we are looking at the demand side, what is giving us confidence to call it out that gradually, at least we should start seeing a better performance. If -- and I heard your commentary where you also mentioned that people are ready to accept a higher pricing or we are able to pass on a bit. So in terms of our contracts, how are we placed, where do we see we can forward these pricing? And is it led by demand revival? Or how should we look at it?

Okay. First of all, let me separate this on the B2B side, customers who were trying to get away from contracts in the past, and most of them have got away because there is a surplus of raw materials are now coming back to us and asking us for long-term contracts, and we are negotiating with them based on raw material prices. So we see B2B customers accepting these contracts. But when it comes to the distributors in the U.S. for finished formulations it is a different ball game. It doesn't work like that. Fixed contracts don't work in that system they give you an award. But once they award you the business, if somebody goes lower, they have the right to cancel our award and again go for a fresh quotation, a fresh offer. So if you need more details on that, I think Priyanka can explain, but I think in short, this is the whole gist. But it's all supply and demand. Everybody has a similar price increase, every manufacturer. There's no way 1 manufacturer can give it a lower price. It's like, I again, keep saying it's a new normal that's going to happen.

Next question is from the line of Tushar Bohra from MK Ventures.

We appreciate the detailed situation that the management has explained on the business side and also the performance in light of the issues. Sir, a couple of points. There is 1 positive read-through on the other molecules where we've seen on a higher revenue this quarter, other molecules have increased their share, I understand there are quite a few initiatives you are looking at beyond the core molecules. If you can just detail out some of these initiatives and the outlook on other molecules. Also, how are you seeing the things on a specific products? Any positives that you can highlight?

Yes, we are really trying to get a good leadership position in some of the molecules, mainly in the present segments and in the APIs. And of course, there are products like in the formulation side, products like KCL and dexmethylphenidate which we make in the US, these are some of the products we think we can keep getting better market share as we go by. But on the APIs side again coming back, one of the products that we see good potential today is losartan. Losartan, I'm sure you -- most of you know, there have been these azido impurities, which may result in some recalls going forward. And everybody has stopped purchases of Losartan and they're looking for Losartan with no azido impurities. So we have a process. Our process does not create this azido impurities. So we have given undertakings to all our customer -- most of the new customers that our product does not have these impurities, and we have given them samples. We have given them a route of synthesis also evaluated all patents that we are not infringing any patents on these things. And looks like Losartan is really going to take off for us. We have also integrated backwards in Losartan. So our dependency on China for losartan used to be there. It doesn't have to be there anymore today. So losartan is 1 product that appears quite good in the coming few quarters short term. And many other products we are working on, on improving those technologies and capabilities, I mean products like Fexofenadine and all. There's a lot of work going on and these products also will continue to grow.

And sir, just on the same question, if you can highlight how many new launches we have done this quarter over the last couple of quarters and how the traction is picking up in some of these molecules? Any guidance?

APIs, we have not done any new launches, but FDs, Priyanka, you want to say in the U.S., what launches we have made?

Sure. In the last quarter, Tushar, we did about 4 launches. We have a decent market share for all the products that we have launched, barring maybe 1 or 2 smaller products. But the bigger products, it's a matter of timing, like we've multiply -- we've said multiple times. We don't want to crash prices in the market. So we wait for a little bit like some of our biggest products they are very close to the target market share that we wanted within the first year. So without getting into product specifics yes, most of the products that we have, we've been able to hit decent market shares. Overall, today, we have 19 products in the U.S. market.

Great. My second question is just trying to get a sense on the -- how much of the current performance can be taken as a short term on a transient thing. So we have historically, over the last 3 quarters, we were stabilizing at 57%, 58% kind of gross margins. This quarter, we're down good 600, 700 bps. Is it fair to say without seeking of guidance, is it fair to say that once things normalize, our gross margins should incept back to at least what was the normal earlier, if not higher. And also the revenue trajectory should continue to move up?

It should Tushar. We should definitely see improvement in gross margins, definitely, no doubt about that. But what level will it go to? It depends on many other factors. I mean Q2 of last year was a very good year in terms of gross margin whether we'll go back to that level, may not. But if you want to we can, but the choice we have is to get a bigger market share with a little lesser gross margin or lesser market share with a bigger gross margin. So that's a trade-off. So we will take the call based on product by product. And definitely, gross margins will improve, but we cannot say to what level.

Sir, if I may just stick on this and just try to get this clarified slightly better. See, we had last quarter on a Y-o-Y basis, I think we had also an MEIS impact. And if I take the impact from paracetamol, which hopefully is clearly a one-off for a couple of quarters. If I were to look at the revenue we did this quarter, and hopefully, we are able to build a growth on this in subsequent quarters. It would be fair to say that the run rate and profitability that we had achieved on a Y-o-Y basis, adjusting for MEIS, we should be able to achieve that level of profitability again in the next year?

Sandip, do you want to answer that? Or shall I?

So definitely, we should be able to do that as long as things don't go again, out of control. Yes, I see visibility on that.

The next question is from the line of Harshal Patil from Sharekhan.

Most of my questions have been answered, but just need 1 clarification. I think I missed on that comment from your side. So sir, in the U.S. market, we've seen some bit of higher inventory and stocking across channels. And we -- simultaneously the second point would be more towards gross margins where we're seeing that some bit of price increase needs to be taken. So sir, would that be a fair assumption to make till the time the stocks -- or the destocking exercises won't really complete the gross margins would be at similar levels to what we've seen right now in Q2?

Could be. Priyanka, you want to answer that it is mainly because of the U.S. markets?

Yes. So I think -- yes, you're right. I do see that happening. The gross margins will continue to remain at the existing levels until we start passing on the prices.

The next question is from the line of Surya Patra from PhillipCapital.

Yes. Sir, just on the azido impurities issues so which could come off for the losartan. Same is the situation even for the metformin, I believe sir, so would that maybe have a kind of a -- or would that be a kind of a concern as well? And whether any indication or whether any kind of guidances that we have received about it to immune our supply capability of those products going ahead with some regulator side?

I'm sorry, I didn't understand the full question, but let me just start with the first part and you can ask me again.

Yes.

So on the metformin, I mean, we have been quite good. And we have, I think, I mean talked with most of the suppliers of metformin we were one of the few that did not have any issues on Nitroso impurities, except 1 product which is 750 mg extended release Metformin tablet, which was a very small product. So we were very good on that, and we continue to be good on Metformin absolutely no issue. Losartan, the azido impurity is a new issue that has come up. And for us, because we believe in the highest quality we were already clear of azido impurity, and we think that is going to give us a great advantage in the market today. We don't have to do anything to remove that impurity. So that's with regard to these 2 products, and maybe I missed the next part, if you can ask me again.

Sir, that was a related question only on that impurities. Sir, but my second question is about how is the gross margin and the overall margin for the company. So see what I assume that okay if we consider last year was a high base in terms of revenue and all that. So we have, to some extent, we have -- it is in the similar lines only, the side of the challenges. And the product mix or the market mix or the category of the product mix, all that we have considered it has either remained same or improved. So let's say that there is a kind of course correction in the gross margin. So is it because...

Go ahead.

Is it because of the higher volume of material supply at a elevated cost means the spreads which -- that was witnessed that is one, along with the revenue what we are seeing maintained revenue, it is on a -- driven by higher volumes at an elevated cost level that is why the situation that we are witnessing?

Your question somehow left its trail, I'm not able to really understand, but at least the first I mean we are happy -- go ahead.

Yes. We believe that in more than -- from the Q2 onwards, the revenue also will increase, and there will be definitely some improvement in the gross margin. And so if we are able to kind of -- we will be able to be consistent with our expenditure run rate also. So therefore, we believe that there will be improvement in our performance, both in terms of top line and bottom line. Gross margin also will be improved.

But let me just add to that and also to, again -- because on the previous participant was asking the question. It was not very clear to me. Gross margins for this year will definitely not go back to old levels. They can only improve from last quarter. quarter-on-quarter, we see an improvement. So when I say we'll do substantially better, substantially better compared to Q2. But overall, like I said, the year will not be in line with our guidance. But definitely, there will be an improvement quarter-on-quarter. And next year, we see that things may sort of get back to normal growth part.

Okay. And sir, is it a large part of the issue is just the cost elevation or it is also on the revenue front, there is issues in terms of realization for the -- on the broader basis? I'm not asking about U.S. specific pricing pressure or something like that. But whether on your realization front for your portfolio also you are seeing some correction?

No, the cost is the main issue cost has gone up. And due to that, revenues -- people are not buying as much as they would like to. It's always a wait and watch. It's shifting inventories for them also. So hence, our actually quantities have come down a bit. But because of price escalations, the revenues seem to be the same level of going up. But as the demand and as the pickup improves, the revenues will definitely go up a lot. But again, though the EBITDA absolute number may come to a decent level, the margins may be slightly less made up by higher volumes.

[Operator Instructions] The next question is from the line of Rashmi from Incred Capital.

Yes. Just want to understand out of your total raw material cost, how much currently we are importing and especially from China?

From China, the imports are roughly about 35%, Rashmi. And from the rest of the world, from the Europe and other places, it is going to be another 10%, maybe about 43% as such total imports and 35% from China. And out of 35% from China, 27% is only from PAP that's the past. So now with PAP, if we can get half of our PAP from India itself, and that will just bring it down by 13% straight away.

Okay. And like out of 35% is 27% is from PAP. The rest is for the DCDA we are dependent?

DCDA like I said, we are not totally dependent on China, we also have another source, but we are dependent -- we do put on China.

Okay. And...

And brand wise, we don't have too many products from China. We have substituted most of those other products, with domestic vendors or making in-house as well. 2 important products are only PAP and DCDA. So PAP, I see as one of the -- in a year or so, PAP can be totally derisked. DCDA will continue to be a little bit of a problem, but that also we are working on some plans.

Okay. Sir, what I want to understand is basically this path on acetic anhydride, as we said that you will be starting sourcing from the Indian source, so that's going to start from third quarter itself or it will take a little time?

No, PAP we have already started buying from 1 source in India and one non-Chinese source elsewhere. And the Indian source is still stabilizing their production. And quarter-on-quarter, they will definitely be able to supply more and I see that shortly, more than 50% of our requirement would be coming from the Indians source itself. And on acetic anhydride we always work with an Indian source, a very small percentage from a Gulf source, otherwise, mostly it was India source. But again, Rashmi is a very complicated world. When I say we are buying from Indian source a manufacturer of acetic anhydride, imports acetic anhydride from Gulf or some other place. So that's how it works, luckily you are not from [ Chennai ].

Okay. And second question is related to backward integration, which you mentioned that for all your core molecules you are -- at least you will plan for getting into the manufacturing of the KSMs and all. So this could include DCDA also because that would require a huge capital outlay like manufacturing that molecule in our country would require a bigger land parcel clearance from pollution board is also challenging. So is it that you would fit that particular product and go for the other molecules? Another thing related to that is that for all these molecules would you go through PLI scheme and all? And what would be the capital outlay total, like earlier we planned for INR 400 crores this year INR 300 in FY '23, and then coursed back INR 200 crores, would the CapEx remain same that would include the backward integration or we would require more CapEx?

No. We have enough funds there, Rashmi, we provided more than INR 300 crores for APIs in our CapEx plan of INR 1,000 crores over 3 years. And now we are trying to save INR 150 crores from our greenfield formulation plant. So we still will have INR 450 crores to spend over the next 2.5 years to -- on just the KSMs and APIs. So that should be definitely enough.

Okay. And sir, regarding the backward integration of the core molecule product, especially -- yes.

Actually DCDA slipped my mind. DCDA you have created all the head I mean it's a highly polluting process and it's a process that as it looks today, may not be feasible to be Made in India. PLI scheme may be there. But definitely, it's not an easy enough to crack. But for us derisking on DCDA is increasing our the market share from our non-Chinese source. And we have a very good relationship. We, as a company, take them a lot of -- at much higher price compared to China, I'm not looking at short-term. So the relationship is strong. And maybe we can get a maximum requirement from this source and Chinese dependency will be minimal.

Okay. And my last question is on your B2B and B2C, what share of your revenues -- total revenues that comes from B2B and what revenues comes from B2C segment?

DCDA, sorry, can you repeat again?

No, not DCDA, I'm asking about your total revenue share that comes from B2B customers and from B2C segment.

Okay. I think B2C today is about 35%, 40% and 60% is from B2B.

60%?

60% was from B2B.

The next question is from the line of Anirudh Gangahar from Avendus Wealth Management.

Two questions from my side. One, could you help us with the status of the U.S. FDA inspections of the products which have been due. Have they started anything, and updated on the status? And secondly, just a housekeeping question on the other OpEx, which we see this quarter. It's about 25% from the June quarter. Is there -- is that largely due to the straight forward costs? Or is there any other elements which would probably be on the line?

What was the second question? Can you please? First 1 was, that you said regard to FDA inspections, I'll come to that. But what was the second question?

The second question, sir, is that if I am looking at other operating expenses of [ INR 208 crores ]...

Other operating expenses?

In the September quarter was INR 164 crores.

Okay. So Sandip will answer that. But on FDA inspections, what I understand from your question is are they inspecting, are they likely to inspect shortly? If that is the question, yes, FDA has started physical inspect they were doing paper inspections, online inspections for some time. And actually, we went through one of those for our Vizag facility and we went through quite well. But of late, they have been doing physical inspections and many plants in India have started getting inspected. And in the U.S., of course, we had some online inspections, 2 online inspections and 1 physical inspection so far after COVID.

So sir, has physical inspections of our facilities started in India as well?

Our facility, only 1 facility was inspected online, but we are ever ready. We have -- one of our I mean I would say key strengths is the FDA compliance, and we always are very happy to say we will never have any data integrity issues. We may have some other problem but never data integrated issues and all our plants are in good share. And operating income, I think Sandip kindly respond.

Regarding the operating expenses increase from the last year's similar quarter. The main contributors are R&D expenses have gone up by INR 25 crores. Freight increase is around INR 20 crores. And there is a onetime consultancy expenses, which is incurred in this year is almost INR 6 crores.

So that fiscal year business shows last year-on-year, I was stressing more on quarter-on-quarter.

This is June quarter was INR 160 crores.

Between June quarter and this quarter, R&D expenses have gone up by INR 20 crores. And then freight has gone up by INR 9.5 crores. And there are other manufacturing costs, some of the doubtful debt elements and then ForEx loss, conversion charges, repairs and maintenance, small pieces. So these are like some of the things which had to be incurred in this quarter. And if you see the overall kind of a run rate from the last year to the current year, if you exclude all the onetimes and exceptions, it is likely that the run rate will be going up by 10% to 12%.

The next question is from the line of Abdulkader Puranwala from Elara Capital.

Sir, just 1 question on debt considering that in the first half, we have faced certain challenges with regards to squeezing of margins and the working capital is also going high. And as you mentioned earlier on the call, we are spending close to INR 300 crores to INR 400 crores this year and similar amount next year. So sir, how do we see the debt position of the company? I mean do we still remain confident that much of this CapEx would be driven by internal accruals or we will have to raise debt in the near term?

Yes. So internal accruals will be the source for funding our CapEx for this year and future. There is no doubt about it. The other thing is that since our long-term debt is coming down because of continuous repayment which is happening, even if there's a little bit of increase in the working capital requirement based on the increased demand or kind of a strategic decision about making bigger inventory buildup at a net level, the debt position should not change a big time. It should be enough.

The next question is from the line of Praful Bohra from Systematix.

Sir, you highlighted the possibility of price hikes on the B2B segment. Can you also throw some light on the B2C segment?

So B2C already we have explained, it's -- they've just started looking at price increases. And B2C is all in the U.S. today for us. So again, Priyanka you want to expand on that?

Sure. Thinking is right now, like somebody earlier mentioned, there is a lot of stocking in the U.S. So as the -- so today, those people are just about starting to see the impact or starting to understand what the impact would be over the next few months or quarters. So based on that, they are looking at strategic customers, especially for our products and based on the history we have had, they do think of us as a strategic customer with the market share that we have. So we are looking at discussing the cost increases that could translate into price increases with the customers, but there will be a lag. So even if we do pass on the prices today, it will still take us a few months to be able to see that physically affect our numbers.

Okay. Got it. And secondly, sir, the spike in the R&D spend this quarter. Is it more of a timing issue? Or this is going to be the new normal now?

Are you talking about the target R&D spend?

Yes.

Yes, the INR 47 crores number.

I mean, the spend is in line with our plan. So it's not that there is any brought forward from the earlier quarter. This was the planning. And as we kind of progress, this will be our run rate for the rest of the year.

Ladies and gentlemen, this was the last question for today. I would now like to hand the conference over to Dr. Krishna Prasad Chigurupati for closing comments.

So once again, ladies and gentlemen, I sincerely thank you for being with us on the weekend and spending your time away from the families. And again, I would like to end this conference on a very positive note that we will be seeing improvement quarter-on-quarter. And though this year is going to be a blip, we see the future to be quite exciting and encouraging. Thank you very much once again.

Thank you. On behalf of... [Audio Gap]