Laurus Labs Limited (LAURUSLABS) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to Laurus Labs Q3 FY '20 Earnings Conference Call hosted by Kotak Securities Ltd. [Operator Instructions] I'll now hand the conference over to Sir Chirag Talati from Kotak Securities Ltd. 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'll 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 9 months FY '20. Our Q3 revenues stood at INR 530 crores, showcasing a robust growth of over 38% year-on-year. To begin with, I'd like to share key updates on our formulation business. We are happy to share that our Unit 2, which underwent successfully USFDA the inspection in November 2019 has received 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 9 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 9 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 the maximum utilization levels of our formulation business. And with a healthy outlook and order book, we continue to invest further in the business, as we have invested also in the development. The growth potential from formulation business remains centered within LMIC antiretroviral market, funded by Global Fund, PEPFAR and other in-country tenders. We continue to have good visibility for FY '21 as well. We also expect 2 new major approvals in the next couple of months for TLE400 and TLE600. The sales growth, also as we have in our U.S. as well as in EU. But in EU, our sales was 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 8 approvals, 5 filed approvals and 3 tentative approvals from USFDA. Going forward, we expect 2 more approvals and launch a few more products. Maybe 2 in this financial year and a few more in the African demand. In Canada, we also have 5 products approved, and we are launching 2, and we are preparing to launch 2 more shortly. As far as new market is concerned, we are happy to share that our contract manufacturing partner from [indiscernible] formulation have done actually really well. And we have a very good order book for FY '21 as well. Besides this, we are also launching 2 products in European market under our own label. So far, we have 5 products approvals from Europe, and we already launched 1, and we are planning to launch 2 more. As we always say, our FDF R&D is geared up to both develop and evaluate between 8 and 10 products per year, and we continue to believe we will meet that number. So far, we have filed 24 ANDAs in U.S., 6 dossiers in Europe, 9 in Canada and 8 with WHO Geneva and 2 in South Africa and also 2 dossiers in India. And we also filed several dossiers in various other countries where we aim to reach and deliver our products. Of the 24 ANDAs filed, we believe that there are 2 P IV and 7 FTF opportunities with target middle market as far as $1 billion. As we always speak, our approach remains product-specific and not market-specific. That 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 sped up growth, we had a setback in our ARV APIs where there was a significant de-growth. And rest of the division performed as per our expectations. Synthesis did 14% more than the corresponding quarter. And the ingredients did exceedingly well, about 70% more than the corresponding quarter. Whereas generic API as a total, we did de-grow that segment by almost 20% quarter-on-quarter. And when it comes to ARV, our de-growth mainly came from lack of clarity on the awards of supplemented 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 filing of our second-line ARV APIs, and will probably then be formulated. And we expect to do some formulation development of the other second-line APIs as well. When it comes to onco, revenues were as expected. We did about INR 5 crores to INR 7 crores in Q3 and about more than INR 150 crores in 9 months. The revenue growth is as we expected. There is no significant growth, but it is as we expected. In the past years, we were unable to ramp up a portion of one of the key onco API because of backward integration we didn't complete on time. But now we -- since last quarter, we were able to ramp up intermediate manufacturing for the VAR and onco APIs, 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 the APIs to other generic companies. We also have very good visibility for FY -- Q4 and FY '21 for android manufacturing of the APIs for the partners. When it comes to synthesis business, we are doing exceedingly good. In Q4, we did INR 62 crores. And so far in the 9 months, we did INR 180 crores, and we have a very good sales plan for Q4. When it comes to ingredients, we did INR 18 crores in Q4 and INR 64 crores so far from -- in 9 months. We also launched 1 key product to a customer in U.S., and we expect that will do very well in the near future as well. With that, I would like to hand it over to Ravi to share financial highlights.

Thank you, Dr. Satya, and very warm welcome to everyone on our call for the update on 9 months FY '20. Total income from operations for the quarter is INR 730 crores against INR 530 crores in the corresponding quarter last year, growing a robust growth of 38%. And for 9 months, total income from operations came at INR 1,993 crores against INR 1,657 crores with a growth of 30%. 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 price factors. Our EBITDA margin at 41%, and the growth in EBITDA was mainly because of improved operating leverage from the business of the formulation and other APIs. Our diluted EPS for the quarter at INR 6.9 and INR 13.6 on an annualized basis with growth of 183%. On the CapEx front, we invested around INR 130 crores for 9 months. And we will have a normalized CapEx of around INR 250 crores in the current year. For the next year, we're still working on this and new demand we expect to slightly higher than INR 250 crores, but we will come back. And probably in the next quarter, I'll report [indiscernible] guidance for FY '21 CapEx. With the improved contribution from our high-margin business 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 '20 and looking forward, of course, to free cash flow in FY '21 and beyond. With this, I would request moderator to open the lines for Q&A. Thanks.

[Operator Instructions] We have a first question from the line of Hari Belawat from Techfin Consultants.

Congratulations for such nice results, which have come during this quarter. It's really very good. Sir, this is regarding USFDA inspection. Unit 2, yes, you were EIR. But 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 3 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. And in the November, we had another inspection for a product-specific Pre-Approval Inspection, PAI. And we had 3 minor observations, and we responded to those. And we expect EIR soon from the inspection there as well.

Okay. That means it will be cleared very soon, whatever observations are there.

Yes. You're right.

Yes. Another thing, you said this is regarding the investment in total usage, but till March, it's some INR 250 crores, and in FY 2021, also INR 250 crores. What will go for -- 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 APIs will be equal.

Okay. And because of the de-growth in API, are you looking for lower investment in API segment? Or any such view is being taken?

Actually, if you look at -- formulation business is also driven by renewals APIs. So API production was -- never came down. So our API division is giving APIs to formulation division. So...

Okay. That means both will continue to run that way.

Yes. Yes, you're right.

Just one small query. Just again, China problems are there and so many APIs are being imported. Will it affect this -- our company also in this regard?

We are very well backward integrated through starting materials. So we don't import any APIs or advanced materials from China. So we don't expect any disruption in supply chain because of this.

We have next question from the line of Sudarshan Padmanabhan from Sundaram Mutual Fund.

Sir, my question is on the formulation side. I mean this quarter has been phenomenal with almost INR 300 crores of sales. And you did talk about capacity is more or less reaching the top of block over there. I mean given that we have invested in the 9 months close to INR 130 crores, INR 140-odd crores, I mean, should the -- given that we are seeing a fair amount of growth and 2 more products coming in, in the fourth quarter, should we be having capacities to kind of drive incremental growth as we move towards FY '21?

We are getting some initial capacity between April and June FY '21. So after that, we also plan to construct a new building, which we expect will come operational between April to June 2021. So we have some capacity augmentation coming in next quarter, that is Q1 FY '21. And again, significant capacity expansion will be available in the Q1 FY '22.

Sure. And on the ARV segment, I mean, 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 the -- what we are seeing is that the older molecules, specifically the Efavirenz and [indiscernible], we're seeing some kind -- or Efavirenz specifically seeing some kind of a slower growth, whereas the expected is towards -- more towards lamivudine and dolutegravir. So 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 the segment?

So if you look at ARV APIs in Q3 contributed only 27% of our revenue, whereas formulation contributed 40% of our revenue. If you look at 9 months' number, 39% of revenue is contributed by ARV APIs, whereas formulation contributed 28% of our revenue. So the decline in sales of ARV APIs is a combination of many products, not only attributable to Efavirenz growth. See, if we get clarity on South African supplement tender, we supply Efavirenz, Tenofovir and Emtricitabine, 3 APIs. So decline came from a bunch of APIs, not alone Efavirenz. And there is also a shift in regimen. So other than South Africa, majority of triple combination is dolutegravir based rather than Efavirenz based. That has also contributed some decline in our API sales because we are not selling as much as -- dolutegravir as we used to sell Efavirenz.

Sure, sir. And how about the oncology, sir? I mean you did give some color about the third party, I mean, dependence coming down with primarily some internal capacities coming in. And 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, I mean, in terms of growth, run rate, et cetera, sir?

So the onco segment will give around INR 250 crores, but yes -- so that's a good number. We don't expect significant growth coming from onco APIs. See, our onco APIs, as you're aware, we -- the volume is so low. And we are -- despite of we having very large capacity and good market share, that is the nature of onco business. Interestingly, the onco business, what happens, our gross margin is going up in onco business when compared to the previous year.

Yes. Sure. Sir, one final question from my side is if we are looking at the run rate that we are seeing in the formulation side, almost from 100 to 150 to 300 now, I mean 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, INR 800 crores this year going by the run rate. And definitely next year, we should be able to see, even if you are looking at the similar kind of a run rate, over INR 1,000 crores, INR 1,100 crores of formulations happening. And probably with additional capacities coming in, it should also further improve from here on. So 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?

We are not giving any guidance, but you are on the right track. So you can annualize our INR 290 crores, INR 300 crores. That's -- we are geared up to deliver that kind of capacities to the market.

We have next question from the line of Tushar from Motilal Oswal. We lost the line of Mr. Tushar. We have the next question from the line of [ Ram Dorshee ] from [indiscernible].

Congratulations on a very terrific result. I have a couple of questions. One is that we have a significant leadership in antiretroviral, if I am correct, globally. So have you seen the demand bump up related to the coronavirus outbreak in China?

No.

There's no demand bump up yet?

There is no demand -- there were small demands, small queries came, but that is not going to be significant for us or anybody. So the volume will be still low.

Okay. And 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 a plan to reduce the pledge over a period of time.

We have next question from the line of [ Costa Bhuntnar ] from [ Rare Enterprises ].

Yes. So this is -- 40% of revenues that's coming from FDF in quarter 3 FY '20 and 28%, coming from FDF in 9 months FY '20, how much of it would be the tender business? And could you first answer that?

About 75 -- between 75% and 80% of the business is coming from tender-driven ARV business and remaining is coming from North America and Europe.

Okay. So 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 like 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?

See, there are 3 parts of this business: Global Fund-driven, PEPFAR-driven and in-country tenders. So in-country tenders is winner takes all, there is no preference. You have to quote based on that particular tender rate. Whereas in the PEPFAR and Global Fund, Global Fund especially, there will be fiscal allocation percentage-wise. Whatever they buy, we will get from fiscal allocation, which we cannot reveal how much we will get. But that is a bit more certain, and they will place orders over 3 or 4 -- several quarters. We have good visibility from Global Fund. We have reasonable visibility from PEPFAR. And in-country tenders, we can't commit right now because it is a tender to tender quotes, and then winner takes -- generally, winner takes all. Whereas in the case of PEPFAR and Global Fund, there is a fiscal allocation, and they make sure that business is sustainable enough. We are being -- 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. And what is the margin profile of this full tender of business versus the rest of your business?

It's comparable with the overall [indiscernible].

See, if you look at our gross margins improved 1 year out of 2, maybe 3 to integrate it. So the FDF business is certainly helping us to increase our gross margins because we are getting more gross margin in FDF for sure in formulation business.

And working capital cycle?

Pardon?

And working capital cycle for this tender business versus regular business.

[indiscernible] intermediate to formulation, it's slightly higher than API.

No, no. Sir, I'm specifically talking about the tender business of formulation, not the U.S. and Europe business.

The tender business of formulations, the payment cycles are very, very good, and we never had any problem of receivables. So...

How many months would it be, the receivable days for the tender business?

No. We can't.

It's less than 90 days.

We have next question from the line of Nitin Agarwal from IDFC Securities.

Sir, on the API other segment, which is there, I mean, given the upsurge, which is there, in general API business momentum, I mean, 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 the segment?

The API segment, our growth will be primarily driven by getting more clarity on the South African tenders, and 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 several quarters from now. The majority of the growth is coming from, actually, worldwide rather than from new APIs that we are working. So people are trying to move business around regulatory uncertainty manufacturing facilities to more sustainable regulatory companies. So we have seen some traction. But this business is -- even if somebody wants to move their API to a new vendor, it takes anywhere between 12 to 24 months. So we are in that cycle. So we expect good traction coming from non-ARV APIs in the coming 12 to 18 months.

Sir, overall, even if you split the business into formulations, APIs and synthesis, I mean, so on API, overall, I mean, what kind of -- so if you take a 3-year view, what kind of growth the overall API segment can deliver given the challenges that are there in the oncology business and the hep C as well as the ARV API segment?

Yes. I think based on our current guesstimate, maybe we can expect around 10% growth in API business, whereas formulation and synthesis will drive our majority growth.

And the synthesis, our growth is going to be driven by existing products, contracts? Or you envisage your ramp-up coming through some newer sort of contracts and pipelines?

Majority of synthesis growth will come from our existing customers and existing products going into the next clinical development and some commercial companies as well. While we'll grow from existing clients and products, but there is also possibility that we will add new clients and new products, which is also -- we added 2 industrial clients last year.

And sir, last one on the formulation side. Sir, on this -- on ARV formulations, what is the peak size that we can potentially do on this business whenever -- sir, what is the peak potential opportunities which is there in this market for us, sir?

It's difficult to predict. See, there are 25 million patients on treatment and about 22 million on first line. So whether we get 10% market share, 50% market share, it all depends on -- but today, we are geared up around 10% market share, or our capacities are created to get 10% market share.

10% of $1 billion market, sir?

Yes.

$1 billion.

That's just top of head, here. So we have gained up to 10% of the $1 billion right now.

We have next question from the line of Arun Subrahmanyam from Ampersand Capital.

So just two questions. When you were saying that your API will grow at about 10%, is your -- and formulations will grow a lot faster, so can you give us a sense of what is the overall growth of the company over the next 2 to 3 years? And considering that you are dealing with these [indiscernible] at this INR 250 crores kind of CapEx, which will continue, so what will be the overall growth over 3 years?

See, if you look at our 9 months, we did grow 20% despite of significant drop in ARV APIs. So we expect that trend will continue. At least we will have 20% growth this year, next year as well. So we don't -- we can't tell you beyond that. We don't have visibility.

And your lack of visibility, of which you're talking about, considering that you are putting up capacity and you have just got 10% market share, the lack of visibility is because of, what? That you cannot get substantially higher market share? Or I mean considering your cost structure and your cost advantages, I thought that you'll be in a far better position.

No. It's not absolutely lack of visibility. We are not giving any guidance, you see. But generally, we can say we are investing in capacities and we will grow, but we are not giving any guidance how much we'll grow. But I'm giving you a trend what happens. See, in 9 months, we grew by 20%, so it is reasonable to estimate that we'll also grow in Q4 by 20% and FY '21 also by 20%. If you're asking FY '22 how much we'll grow, we haven't run our numbers right now.

Understood. And sir, last thing that I wanted to understand from you is that when you were seeing this drop in API and the significant expansion in formulations, but formulations is far more tender business. Is the tender business a lot more like in terms of bunched up, in the sense that it will be like not a smooth, forecastable number? Or I mean what I'm saying is that is the tender business like a normal production, manufacturing and sales business or not? Or you -- these tender orders, 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 is this tender is.

These tenders are long-term tenders. These are not -- you will get tender for 0.5 million kind. So you get tender and with committed delivery times. So for example, we have visibility for Q4 and Q1 next year as well. So that is the kind of visibility we usually have.

Okay. And sir, the final question, like earlier, when we're interacting with you, you -- in your calls, you were saying that you were winning more and more tenders. Is that something which is a status now? Or you were like because you're fully already utilized, so you will just continue at current level of operation?

For Q4, we'll run at the current level of operations, but Q1 FY '21, we are adding more capacity. So we have scope to grow our formulation business in Q1 FY '21.

We have next question from the line of C. Srihari from PCS Securities.

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 have moved up by just 100-odd basis points. So could you please explain that? And secondly, on the formulation front, if you could please give the U.S. sales breakup for Q2 and Q3, that would be great. And I would also like to know whether there's any exception here in terms of, let's say, profit share or a milestone receipt. And finally, on the ARV front, you have indicated that you are going to be looking out to an ARV. Now was this as per schedule? Or you're trying to accelerate the process for some developments?

Maybe I'll answer the questions in reverse order. So locally, retail we have a goal date already. So I wouldn't expect the FDA going through faster approval because of current awareness. That is one. And second, there is no one-off in Q3. That is what I wanted to clarify. So then the third one is our formulation business, as we explained, little more than 2/3, 3/4 is coming from ARV, and the rest is coming from North America and Europe. We can't give you the -- how much we are selling in North America and Europe, but that trend will continue. But part of revenue come from North America and Europe and 3/4 is coming from LMIC.

Could you at least give an indication, directionally, U.S. sales, has it increased sequentially?

If you look at U.S. sales, when we have increased our revenue from INR 150 crores to INR 290 crores in Q3, our U.S. revenues also went above $7 million, our Canada revenue went up, and Europe revenue went up, yes.

Finally, I mean, basically, based on the guidelines that you have given regarding asset turnover, if I go by that number, then INR 290 crores seems way beyond what you had indicated as your optimal revenue for the formulations division. So can you please explain that?

Can you repeat your question, Srihari? I didn't get it exactly.

Yes. So for the formulations division, you had indicated earlier that the asset turnover should be around 1.7x or maybe, at the most, I guess, 2x, whereas where we are right now is, I presume it will be close to 3x, if you annualize the quarterly number.

Here, you have to consider the API CapEx. See, this is a backward-integrated project for us. So the entire API is what we're using in formulations coming from our own facilities. So where we are not taking any revenue of the APIs in the API division. So when it comes to the asset partner ratio, you have to think about API CapEx as well as the FDF CapEx. So it's not 3x. It's not 3x, yes, as you're saying. INR 300 crores into 4, INR 1,200 crores divided INR 400 crores CapEx is not 3x the asset ratio. It will be -- you have to allocate certain amount of CapEx we have done for API as well here.

Okay. I'm still not clear about that. But your existing capacity is at 5 billion tablets, right?

Here, you're right. These are not at capacity, but yes, at least we're doing it with the combination. So 1 tablet is equivalent to more or less equivalent to 3 dispensings, 3 dilutions and up. So its compression and packing is one, so significant capacities will be used for triple combination. And we are doing capsules. We are doing tablets for other markets. I would say, if you convert our triple combination as 3, we are running around maybe 300 million, 400 million units per month.

So I mean at optimal capacity for the quarter, you would be at around 1.25 billion tablets. Is that the...

Yes. You're right. You're right, yes.

Production was around 1.25 billion tablets within the quarter.

Yes. But you have -- there, you have to consider triple as your 3x because the ARV, we are doing a combination of 3 drugs into 1 tablet.

Srihari, we are talking about 200 with 2x. So when we are talking on what is the plausible revenue from formulation, we have been talking about 2x plus we can do it. What's the earlier case, so you're talking about up to INR 800 crores revenue. Someone I feel like -- when the companies are saying that INR 800 crores, that's -- we can do it, we have done more than that. So this is a peak. It is possible with the existing capacity to answer your question straight.

Okay. So what is the kind of CapEx you're planning on that provision expense?

Another INR 50 crores we are planning immediately. And then with further expansion, we have not crystallized the CapEx amount.

I mean in terms of capacity. Will that be 5 billion tablets?

So I think let's not talk on the tablet because it can confuse us, right? So it is a triple combination and all. But -- or if you have any further things, we will take it off-line now, Srihari.

We have next question from the line of Aditya Khemka from DSP Mutual Funds.

And sorry, I also have similar questions as the previous participant. So just to understand what you're saying, so currently, you're at -- running at a 5 billion tablet capacity, counting triple combination as one, right, because that's how the industry deals with it. So 5 billion tablet capacity, and you're doing 300 million to 400 million, as Chava has indicated in his comment, per month. So you are doing 3.6 billion to 4.8 billion tablets already, so pretty much 100% utilized, right? So going from -- by what you previously mentioned that you have visibility, that you'll be able to sell these 300 million to 400 million tablets a month for the next 3 to 6 months, right? That's the order book you already have, correct?

You are right, Aditya. And also, we also mentioned, we are going to debottleneck and add liquid 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. So now if you were to quantify the debottlenecking potential capacity to add to these 300 million to 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.

Okay. About 20% it can add. And the cost of this bottlenecking was INR 50 crores revenue.

Yes. INR 60 crores is actually a bit more. Close to INR 60 crores, right?

INR 60 crores. Okay. So that CapEx that Ravi was alluding to is this debottlenecking CapEx, right?

Yes. Yes.

Yes. So now is the next question. So 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. So your total CapEx would be for INR 60 crores on the formulation side. Now my question is that now that -- given that you have been able to sell so well on the formulation side, you have 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, that is only the amount of market share that you're able to get in the end market or it could be that you don't want to spend as much in that particular segment and you see better opportunities in other segments.

I think that here -- in the -- when we have 1 existing building where we did division investment and added another investment and we are debottlenecking and some additions but in the existing building. So with this, our additional INR 60 crores CapEx would not have any space in the existing building. We have to do a new building, which is under planning right now. And probably we'll do -- have a groundbreaking in the next few weeks. There, we usually need 12 months to finish that building and bring that into operation. So that is the reason I had mentioned some additional capacity will come between April and June this year, and again, in April and June next year. So that will be a very big capacity. We are doing a building, and we'll know through those numbers how many billions we'll do. But that building can take another 5 billion capacity.

Fair enough. Fairly understood, sir. So that's good. Now on the gross margin side, I think one participant asked you this question. So on the ended second quarter of FY '20, you had a gross margin of 49.5%. This quarter, you had reported 50.6% despite a significant jump in your formulation revenues. So the question, I think, everybody is trying to understand is from a margin profile perspective, how different -- so as I understand it, your ARV segment is -- ARV API is probably the lowest gross margin segment, which is where you significantly declined this quarter. And your formulation should be, ideally, your highest gross margin segment where you have significantly grown this quarter. So I believe the delta in your gross margin in the third quarter versus the second quarter should have been much higher than what has been reported. So this is what we're trying to understand as to whether this incremental volume in formulation segment from INR 150 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. So there is no -- ARV APIs are a lower gross margin. It's like -- it may be slightly lower, not very lower. And basically, it depends on the product mix. The formulations are in higher gross margin than in API. But because of the product mix, this change will come.

Understood. So is it fair to say that formulations are not like 20 percentage point higher gross margin than API. It's more like 5% or 10% higher margin than API? Is that a fair statement to make?

It all depends. Like it maybe could be from 5% to 20%, that kind of a range.

Depending on the product that you are selling.

Depending on the product. .

So LMIC would be a lower gross margin in -- within formulations, and U.S. and Europe will be higher gross margin?

Yes. When compared to U.S. and Europe, it's just lower than the North America and Europe, actually.

But the volume will be higher.

And volume will be higher. Absolutely, yes. No, so that explains a lot, sir. That explains a lot to me. And on the cost side now, so on our other expenses, the growth in the cost has been phenomenal. Now as I understand it, the capacity that we have already had in the formulation and API, so in this quarter or in the last 2, 3 quarters, we haven't added any material capacity. We already had this capacity from a very long time, right? And the sales actually went up this quarter because you got the tender and we were able to supply. So let's say I'm comparing second quarter to the third quarter, so in second quarter, our other expenses were INR 88 crores, which was a growth of 11% year-over-year. But in this quarter, we have other expenses of INR 92 crores, which is actually a growth of something like 17% year-over-year. So one is the base effect because your second quarter FY '19 other expense were INR 80 crores, and then the third quarter FY '19 other expense was only INR 54 crores, and this is excluding your R&D spend. So if you add your R&D spend, the numbers become slightly different. But I'm just taking out the entire R&D spend from other expenses and then stating the numbers. So what I'm 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 have -- not have gone up the way they have gone up this quarter. So 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?

Okay. So long question. But I can make -- I can take a sense on the question that you're asking, why the other expenses are higher in the fourth -- third quarter. The answer is there is a one-off expenditure, like we have a CPSI expenditure that is booked as a cash expenses through this year. So probably, next year onwards, we are going to move on an accrual basis, I think one. And second, because of the formulation expenses, the selling costs also will increase. These are the 2 reasons for the higher other expenses in the third quarter.

Fair enough. So can you care to quantify the CPSI expenses this quarter?

Maybe INR 4.5 crores or INR 5 crores.

About INR 5 crores. Yes, that explains a lot on that front. And in your formulation business, you are incurring more selling expenses because in the LMIC -- but LMIC is a tender business, right? So what is the reason for incurring more selling expenses in an LMIC kind of business?

Carriage of more than [ 5 million ] commission this year.

We have next question from the line of Aditya Agrawal from Indgrowth Capital.

I had a couple of questions. You had mentioned that we don't buy any APIs or intermediates from China. What -- would we also be buying any KSMs from China?

We buy significant quantities of KSMs from China.

Okay. And in case there is a disruption there, what would that -- how would that affect us?

Actually, it's difficult to predict. If there is disruption, there is no ship coming out of China, not only us, everybody is -- there is a factorial challenge, not only pharma, but in many other sectors. So -- but looking at some more feedback what we're getting from vendors, they are starting their operations here come next week.

Okay. So our KSM dependency on China is going to hopefully reduce over a period of time.

No. It's not going to reduce. Our vendors are, let's say, asking us to then pass to others, but when you look at the one in coronavirus, I don't know it seems that well. Most of the China is on vacations. So they were supposed to come back on 3rd of February, now they are starting their operations on 10th of February. So there's a big delay. But this delay in supplies is not going to disrupt supplies, for sure.

Okay. My next question is, roughly, what would be our market share in dolutegravir till now? Would we have -- roughly, what would that number be?

About 10%. I'll confidently say, about 10%.

Okay. And are we expecting our market share in that to increase over a period of time? Or how are we...

We are creating capacities to get instant market share, but we can't say right now what percentage is that. But we are adding capacities to garner more market share.

And my third question is, roughly, what would be our market share in the tender business, which is PEPFAR, Global Fund, et cetera? Is that increasing over the last few quarters? And are we projecting it to continue increasing?

Increased from Q2 to Q3, but we expect that it should go up in Q1 FY '21.

[Operator Instructions] We have a next question from the line of Dipan Mehta from Elixir Equities.

Sir, my question is...

Sir, I'm sorry to interrupt, kindly use the handset.

Okay. Is that clear?

Yes, it is, sir.

So my question is that of the INR 700 crores of sales which are there, how much would be completely tender-driven? What percent?

20%?

25%, yes.

Only 25% is tender-driven, whether it's ARV or generic FDF or whatever. All put together.

Yes. Generic FDF. Yes, generic FDF, yes.

They are usually tender driven?

Yes. Yes.

No, sir. I understand that there is tender business in ARV and generic FDF. So those...

We have the APIs, but we don't participate in any tenders, our customers participate and we supply APIs to them. Whereas generic FDF, we directly participate in tenders.

Okay. And 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 percent?

I would say fairly stable. Fairly stable.

Okay. So that means -- and the second question is generic FDF, what would be the percentage of sales to U.S.?

As we mentioned in the 9-month time frame, 3/4 is coming from ARVs and 1/4 coming from North America and Europe, that is the North America and Europe is purely non-ARV driven business.

So sir, in generic FDF, also you sell to U.S. market, right?

That's not what I'm saying. U.S. market -- U.S. and Europe formulation business, 25% of our revenues came from North America and Europe. Why we're using North America is because we're also selling in Canada apart from U.S. So that segment is about 25% of the FDF revenues.

We have next question from the line of Anuj Momaya from Valuequest Investments.

Congratulations on a good set of numbers. On the ARV business, have you seen any prices correction in the Efavirenz API or prices have remained stable?

Efavirenz is a fairly matured product, so prices are stable.

So whatever the loss of business is volume loss is what you're saying?

Volume loss, yes. There's no value loss.

There is no value loss.

Yes. Correct.

Okay. And do you think this will be coming back in the next couple of quarters? Or now this INR 200 crores or INR 250 crores for the quarterly is the new run rate for the ARV business?

So we expect this is the normal but expectations should go up.

Go up and just become -- coming back to INR 1,000 crores kind of an annual...

Yes. We expect that.

Okay. And what is the current gross debt on our books, gross and net?

Gross is roughly about...

INR 2,600 crores.

INR 2,600 crores in the gross debt.

Debt. I'm asking about debt.

Debt?

Debt is around INR 1,100 crores.

We have next question from the line of Prakash Agarwal from Axis Capital.

Congrats on a good set of numbers. Sir, just one clarification of what you mentioned that we are vertically integrated. So I understand from a formulation side, you have a strong API distinct. But from the API side, I think one of the participants also asked that most of the industry is dependent on KSM from China. So you mentioned that it's a week postponement, I heard that. But 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, 1, 2 months I'd say there wouldn't be any issue. But if you are aware that China was shut for last 15 days because of the new year holiday, but now they are extending. They were supposed to start their operation, but they extending their leave. We have to wait and watch. Probably during March, if they continue to shut for another month, probably then the trouble may come. So let's wait and watch for the next 1 week and then probably we can find our...

I just want 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. Like so you don't get KSM, you were not able to supply, so are there -- what really happens from a business point of view?

We will exhaust most of the inventory. And we have inventory in raw materials, we have inventory in the [indiscernible] inventory in book, inventory of intermediates, inventory of API, then there is not an issue for a quarter. So then maybe we'll have to import by sea, you will cut down our largest peak time by 3, 4 weeks because everything has to be imported by air. Some -- so that situation is -- we have to plan as things go by. It is difficult to plan right now.

So for the temporary purpose, the worst case could be some costs could increase. But what I was trying to understand, could the supply be restricted? And not only costs, but could there be damages in terms of not able to supply? Or the industry world understands that, okay, there is a serious problem and the penalties are not levied?

Yes, that is a bit difficult for us to answer right now.

Right now, it is very hypothetical. We need to wait and watch how it is going to move. So there will be -- as Dr. Satya said, it will be -- the pipeline will be dried up. So we have to create the pipeline through -- in air to -- probably sea through air and some other measures. So I think we have to wait and watch.

We have next question from the line of Tarang Agrawal from Old Bridge Capital.

Am I audible?

Yes, sir, you are.

So as I see the trend in your ARV business and whatever commentary that I've gathered on your generic APIs, 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, and consequently, getting better margins.

It's not true. See, whatever capacities are earmarked for FDF consumption, we have created that capacity plus what we are selling APIs to other customers.

Okay. And -- so other than FDA capacities will be used to cater to your generics API business, is it?

Yes, yes, yes. So if there is more demand in generic API, we have the APIs, we are geared up to service. So we are not diverting third-party API sales to formulations.

We have next question from the line of Tushar Bohra from MK Ventures.

Congratulations on an excellent set of numbers. So just to understand, we've -- there's been a discussion on gross margins earlier on in the conversation. Would it be fair to assume that over the next 2 years, as formulations revenue from U.S. picks up -- and I would assume North America today would probably be more Canada than U.S., please correct me if I'm wrong.

You're right. Yes.

Okay. So as U.S. picks up over the next 2 years and maybe your European formulation business picks up, within formulation, your mix is changing. So again, your gross margins overall, is there a scope for this to move up, say, by 300, 350 bps 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 is chance of improvement. In the worst case scenario, probably it's going to be maintained.

Okay. So we should be at or above the current levels.

Yes. Yes. That's a good estimate, yes.

Okay. Second, sir, just -- so 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 '20. It'd be fair to assume that we are seeing 20% revenue growth in FY '21. With some operating leverage, the profitability should be higher and it should be on a INR 300 crores base? Would that be a fair assumption?

We don't want to comment again on the number.

Okay. Just generally, the base for profit calculation for next year should be the exit run rate for FY '20. Would that be fair to assume?

Gross -- we can say that gross margins and EBITDA will maintain at least the current level. We are not commenting how much it will grow, but it will maintain its current level, at least.

On the overall China situation, again, a lot has been asked earlier by earlier participants. But just to take a scenario where this scales up into a bigger issue and we see -- 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? And second, is there any opportunity also from a supply perspective for us in turn for any of the APIs intermediate? Could that be an opportunistic business for Indian companies?

There is opportunity, but 1 API manufacturing won't give full results. We get 19, we don't get 1, and that means we don't get any API, as simple as that. So it is difficult, obviously. But we are taking this risk to like extreme extent, but we don't feel that is going to happen. The reality is supplies will resume very quickly, yes.

But just -- sorry to persist. Just to understand, intermediate and KSM is relatively easier to source in India, as in you can still set up supplies in India, right, if you plan ahead compared to API?

No. Actually, it's relatively easy to get intermediates in India rather than [ packing them there ]. The intermediates [indiscernible] also buys 30 million from China.

Okay. So there could be an issue overall if the KSM supply is disrupted.

We have next question from the line of Cyndrella Carvalho from Centrum Broking.

Congratulations on good set of numbers. Sir, just wanted to understand more on the synthesis side. So the Aspen contract, whatever we have said or did, how do we see it going ahead? And you have also mentioned that there are 2 commercialized products right now with us. So how many are there with us in total in terms of number of contracts, if you could help us understand? And how many of them would be in the late stages? If you could provide some color on that, it would be really helpful.

Yes. Our Aspen business will peak out next year because most of the products went commercial. And then when it comes to the end feed, we have 2 products commercial. We've built an API, and 1 intermediate commercial. I think there are 2 more in Phase III right now and several in the earlier phases. In total, we have maybe between 30 to 40 active projects right now at various stages.

Okay. And 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.

We have next question from the line of Charulata Gaidhani from Dalal & Broacha.

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 percent?

See, the current year, we expect to do about 600 million units to the partner. And the FY '21, maybe we'll do 1 billion units per month. So that's the level of increase we expect.

Okay. And this is entirely formulation?

We do API as well, and we convert that API into formulations and give it in bulk to our partner in Europe.

Okay. So what proportion would be formulations from this?

So the potential is 1 billion units in formulations. So that means we are using roughly 20% of our formulation capacity to contract manufacturing through the U.S. partner where we make API also for our formulations.

Okay. And my second question pertains to Efavirenz. The inventory, has it been sold off?

There is no inventory right now.

It was there in the last quarter, right?

We don't have any inventory charges in Efavirenz

Yes. Okay. And 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. And Metformin?

Metformin, we have a very small market share.

Okay. And yes, my question was in terms of the ARV treatment, is the Indian market also seeing some scope for opening up?

So far in ARV, India tenders, we all participated, yes. But the opportunity is big. So far, we all participated.

Okay. But 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 new year in India involving tenders.

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. And some of your questions were very interesting and very forward looking. Thanks for the participation. And thanks, Chirag, from Kotak. We hand back over to you.

Thank you.

Thank you. Ladies and gentlemen, on behalf of Kotak Securities, that concludes today's conference call. Thank you for joining with us. You may now disconnect your lines.