Viyash Scientific Limited (512529) Earnings Call Transcript

Ladies and gentlemen, good day, and welcome to the Q1 FY '22 Earnings Conference Call of SeQuent Scientific Limited. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Abhishek Singhal. Thank you, and over to you, sir.

A very good morning, and thank you for joining us today for SeQuent Scientific's earnings conference call for the first quarter ended financial year 2022. Today, we have with us Manish, SeQuent's Managing Director; Sharat, Joint Managing Director; and Tushar, CFO, to share the highlights of the business and financials for the quarter. I hope you've gone through our results release and the quarterly investor presentation, which have been uploaded on our website as well as stock exchange website. The transcript for this call will be available in a week's time on the company's website. Please note that today's discussion may be forward-looking in nature and must be viewed in relation to the risks pertaining to our business. After the end of this call, in case you have any further questions, please feel free to reach out with the Investor Relation team. I now hand over the call to Manish to make the opening comments.

Thank you, Abhishek. Good morning, friends. A very warm welcome to all of you who have joined us for this Q1 call. Joining me on this call, as usual, are Sharat Narasapur, our Joint Managing Director; as well as Tushar Mistry, our CFO. We are meeting in quick succession this time as we had just met about 40 days back. So my address will be short and focus on some key highlights for the quarter and also the strategy [ or way ahead ]. Q1 has been one of the most difficult and challenging operating quarters as we saw multiple challenges right from muted demand, inflated cost structures across businesses as well as significant execution challenges. Overall, in that context, the performance in this quarter was a bit of a mixed bag for us. While formulations business grew about 15% on constant currency basis, there was a decline in API business after many years of consistent growth. We closed the quarter with a revenue of INR 3,200 million or INR 320 crores, which broadly translated in a growth of 9% in constant currency terms. This is slightly lower than where we would have liked to be at this stage. The overhang of costs all around also impacted our profitability with EBITDA pre-ESOP charges being about 20% lower at INR 356 million or about INR 36 crores. Tushar will cover the financials in greater details in his remarks. Coming to the respective business segment. The growth of 15% in formulations was primarily led by continuing outperformance in India as also in Latin American markets, primarily Brazil. Our India business continues to do well on the back of strong outperformance in the cattle business as well as recovery in the poultry side of business. Brazil also recorded a strong growth driven by recent launches. While Turkey performed ahead of the market, the depreciation in Turkish lira took away all of that growth. Our performance in Spain dragged our European performance even as Sweden and Benelux did well. We expect recovery in Spain starting this quarter, which is Q2, which should put our largest region back on growth track. API, as I mentioned, was muted this quarter. This was primarily due to the low offtake by some customers as well as operational challenges at both our end as well as our supply chain partners. As I had mentioned in the last call, we had more COVID cases this time in April and May as compared to the entire 12-month period prior to that. An equal number of employees actually had to be quarantined due to COVID in their families. We also suffered 2 unfortunate casualties. However, the situation has been in control since June, and we also draw comfort from the fact that more or less, our entire eligible workforce is now vaccinated with at least one dose. Notwithstanding the numbers, we continue to move in the right strategic direction in terms of quality of business with ever increasing contribution of our regulated market business, which now stands at 72% as against 66% in the corresponding quarter last fiscal. We commissioned the pilot bank as well as additional clean room at Vizag, leading to about a 20% increase in capacity during the quarter. We expect a strong recovery in our API business in the second half of the current year. There have been some significant strategic developments on the formulations front in line with our blueprint for SeQuent 2.0. I'm pleased to announce that we have now launched the pet division in India initially with [ 8 ] headquarters. I'm also pleased to welcome Alexis Goux in the organization as Vice President, Commercial to spearhead our formulations business. Alexis brings in over 20 years of experience with leading companies like Virbac and Ceva, having led businesses in multiple geographies, including Europe, Latin America as well as Southeast Asia. His last role -- or his most recent role was with Virbac where he was responsible for global marketing department on food-producing animals. Based in Barcelona, Alexis will drive our business in our key markets of Europe, Turkey and Latin America, including global marketing especially for our value-added R&D portfolio under development as well as entry into key new markets of U.K., Germany and Southeast Asia. Overall, while we had a slow start to the year than our expectations, we stay confident and on track of achieving our financial and strategic objectives for the year. I would now like to close here and hand it over to Tushar for his comments.

Thank you, Manish, and good morning all. While Manish has given insights on the operational performance, let me discuss the financial performance for the quarter. Our revenue for the quarter has grown by 8.4% year-on-year on a constant currency basis to INR 3.2 billion. Formulations business continues to drive the growth with strong 15% growth year-on-year supported by [ stelar growth ] momentum in India, Lat Am and Brazil. Europe business continues to remain muted due to subdued performance in Spain, whereas Turkey business was affected due to adverse currency movements. Overall, we also saw price pressures on both input prices across both API and formulations business and also the [ strict ] operating costs like for [indiscernible] as well as logistics costs. EBITDA, excluding ESOP cost, stood at [ INR 36 million ], while the reported EBITDA came in at [ INR 400 million ] after considering the ESOP cost of [ INR 156 million ]. This ESOP cost, as has been explained earlier, is a noncash cost to account for the recent grant of ESOPs to key employees with almost 50% of the impact coming in the first 12 months. Further, the EBITDA is also after considering additional cost of INR 58 million incurred during the quarter as spelled out in Slide 13 of the investor deck. What we also missed this quarter was other operating income, which was almost INR 29 million last year, as RoDTEP rates are yet to be announced by the authorities. On the balance sheet side, we witnessed a slight increase in working capital as we build strategic stocks of some of our key products in line with our business plan. We have also consolidated our minority interest partners in Turkey, Belgium and the Netherlands during the last fiscal year and should be completing minority stake buyout in Brazil in the current quarter. I would like to conclude my remarks by stating that this quarter has been challenging. We're extremely focused on execution on both business and cost trends even as we continue to invest in and pursue the strategic objectives around SeQuent 2.0. Thank you, and we can now open the floor for Q&A.

[indiscernible] can we take the Q&A, please?

[Operator Instructions] The first question is from the line of [indiscernible].

So there was a note in the audited financial statements that there was some revenue recognition which was overstated in the last quarter. So could you throw some light on it? Because like it was of a decent size of around INR 50 crores of profitability.

INR 50 crores of profitability. I don't know where you're getting that number. But if you recollect, in the last call, I had mentioned that we had detected certain instances where revenues in respect of certain sales transactions were recognized on dates earlier than those allowed by group revenue recognition policy. It is in light of those that this has been the revenue and the P&L has been restated. So these were timing issues pertaining to the API shipment in terms of where the revenue should be recognized. So there were certain gaps in the documentation. And on account of that, after a complete review, we have undertaken a correction of the entire process of recognition as also the impact of the same on the P&L. Tushar, if you want to add anything?

No, that's right. Yes.

And most of it would have been done, right, so there would be no such thing like in the further quarters? That is what I'm assuming.

So if you look at, again, the notes of last financial year, we had spelled out the complete implication for the -- each of the quarters of the previous year. There's no continuing implication because all of it was corrected within the year, but they were within the year corrections between the quarters. So Q1 sales went into Q2 in a way. Therefore, if you look at the disclosure or the notes of the last financials, all aspects have been detailed out in that.

Perfect. Perfect. That was helpful. All the best for the business.

There is no continuing impact. Everything has been resolved within the previous year.

[Operator Instructions] The next question is from the line of Jolyon Loo from [ Sixteenth Street Capital ].

Can you hear me?

Yes, please.

I have 2 questions. I think, first, is more on our observation and [indiscernible] in terms of certain animal majors selling off their captive plants and declare very aggressive restructuring targets. I think it might be the cause of our supply chain rationalization. Maybe you can give us more colors around this, and maybe what gives us the confidence that demand should return in the second half of the year for the API? That's the first question.

I'm not sure whether we could understand the question properly, but I'm assuming you're referring to the impact of COVID on operations? Or is it something else?

No, I'm thinking more in terms of the supply chain rationalization that was alluded to so called API weakness. So maybe just more details or colors around that.

Yes. Understood. Understood. So it is -- see, last year, around March and April is when the first wave of COVID had struck, and there was, I believe, enormous uncertainty in the marketplace. What we believe happened at that time is many companies, including such as us, overbought certain inventories to secure plant operations. And on account of that, once things have stabilized, the purchase has come down, which is what we believe has happened on the API side of our business. So there must have been some inventory buildup undertaken by our customers in Q1 and Q2 last year given the uncertainty. That rationalization is occurring at this point of time, leading to a slowdown in procurement. I believe that demand will be back to normal probably in the second half, if not earlier. Does that answer?

Sure. Sure. Okay. Okay. And I guess in terms of the ESOP, what's the nature of it? And it seems like it's treated as a one-off. Maybe you can give more details around that, please?

Yes. So this is -- as part of the change of control that occurred in the company last year, the new promoters had rolled out a new ESOP scheme. It underwent a process of approval through the shareholders. Consequently, from the time they rolled out to the time of approval, there was a significant change in the stock price. And therefore, while the vesting price of these ESOPs were in line with the entry price of [ Carlyle ], but by the time the final shareholder approval had come, there was a price difference in that period. Using, what, Black-Scholes model, these ESOPs are valued, the fair market value [ is arrived at ], and the difference of fair market value versus the vesting price. Those charges have to be booked into the P&L. These are noncash charges. And the way the model works is almost 50 -- given that these ESOPs vest over 5 years, almost 50% of the cost gets booked in the first year or the first 12 months. So that's the implication of the ESOP costs that we have booked during the current quarter. It started from March of -- March 2021. So one month cost was booked in previous quarter. The current quarter reflects the peak cost, which is 3 months of cost, and it will continue until February of next year. And thereafter, it will start coming down unless new ESOPs are also granted to new employees.

The next question is from the line of Vishal Manchanda from Nirmal Bang Institutional Equities.

With respect to the API business, can we expect on a full year basis, would you grow over your FY '21 base? Or would that be difficult to achieve?

Look, certainly, there will be a growth over FY '21. But right now, guiding to what kind of growth is slightly difficult. But we are hoping that it should not be very different from the past.

Okay. So kind of -- so we have been growing around, say, 20%, 25%. So can we look at that kind of a growth number?

No. I think even if you look at our last year, it was a mid-teens growth in the API side of business, and we certainly are working towards achieving that. I'm not committing that we should achieve that, but we certainly have clear plans on how do we go back to that level of growth. I do believe that the quarter is more anomaly and not a trend.

Got it, sir. Yes. And one more on the Turkey business. So it was -- it has sharply corrected. So as you pointed out, there are supply challenges and customers -- and challenges on the customer front, too. But anything kind of other product-level disruptions, demand disruptions? Or -- so how is it? So can we see kind of higher demand in subsequent quarters should make up for what we have lost in first quarter?

This is pertaining to formulation. Is that right?

Yes. Yes, formulation business.

Yes. Look, formulation, I don't think we have really lost too much, excepting in Turkey wherein we had operating challenges. Our order book is full, and order book is already in line with the business plan for the year. So we have no issues in terms of achieving what we have envisaged in Turkey. It's all about what we missed out in the previous quarter will be covered up in the rest of the year because the order books are already in place.

Great. And the new facility, tablet facility that has come up in Turkey, would that also contribute during the year?

For within Turkey, yes, it is going to contribute. But what we have highlighted is now we have EU GMP approval for that tablet facility. So we will be initiating filings for EU from that facility, which is what is going to be more valuable. But it will still take some time to certify in terms of commercial numbers.

Right. But in Turkey, this can start contributing in the current year?

Absolutely.

Any color on what kind of peak revenues we can look to generate maybe 4 years or 5 years down the line from this facility?

Look, so it is not a new facility. It is an additional line per se. See, we have been growing at 20% plus in Turkey, and we continue to maintain the same growth rate in terms of our expectations. What we are adding in Turkey is export business, which is over and above the Turkish growth rates, and that is something that will get facilitated by the approvals that we are getting. Difficult to put in a number, but clearly, it is a part of a broader strategy to make Turkey as a manufacturing hub for all markets other than U.S. Vishal, you would also kind of appreciate that we have a multi capability in Turkey in terms of manufacturing and almost 8 or 9 manufacturing lines, most of which are sterile manufacturing. So that makes us a very -- it makes it a very strong manufacturing hub for us.

The next question is from the line of Bharat Sheth from Quest Investment.

Manish, can you give some more color -- in your opening remarks, you said that we have [indiscernible] some formulation strategy has already been in place. So how that will drive? That is one. Second, our injectable business, if you can give some color -- detail what stage we are Germany plant and when do really we'll start supplying to U.S.? And third on the Vizag facility supplying to regulated market, particularly U.S.A. and the FDA [ inspection stage ].

Yes. So let me first start with our formulation strategy or SeQuent 2.0. As we had spelled out last time, fundamentally, it's a focused strategy. Sterile would be our core focus area of domain in terms of product development and manufacturing area. And to that extent, we will -- we are looking to expand both our Germany facility, primarily for U.S., as also our Turkish facility for rest of the world including EU. You would also recollect that we had spelled out very clearly the markets that we have chosen to expand, which obviously included U.S., U.K. and Germany for front-ending in Europe and also select Southeast Asian markets, Indonesia and Vietnam to be specific, for footprint expansion. We also had decided to dive deeper in the 3 key strategic markets that we have, including Brazil, Turkey and in India, including foray into pet animal segment in these markets, okay? So that was a very clearly articulated strategy. It was a very sharp and focused strategy for SeQuent 2.0. To that extent, what we have already kind of initiated in this quarter is we have launched a pet division in India. We have started work in Germany for the project expansion for U.S. FDA standards, not only for U.S. FDA standards, but more about capacity built up because volumes in U.S. are very, very different and the pet sizes in U.S. are very, very different from the rest of the world. Everything in U.S. is much bigger as we are all aware of. So our work in German facility has been already started. We have also initiated or expanded our entire R&D framework for formulations, including value-added generics. I won't be able to give more details on that for strategic reasons. In that context, we also kind of fast track new GMP approval for Turkey, including the renewals because, clearly, we are building Turkey now as global hub of manufacturing for all other markets other than U.S. And finally, I think your last question was towards the API side of business and the Vizag plant. Vizag is already U.S. FDA approved since 2016, and it has been also reinspected and reapproved in 2018. So our entire API strategy has been built around that. We continue to stay approved and stay the only U.S. FDA-approved veterinary API facility from India. What has slightly slowed down is validation at the customer end because of COVID. Because as API [ supplier ], finally, customer also has to validate our APIs in their formulations before they can start using. Last 12 months, as you would understand, that every company has suffered on execution, so have our customers. So to some extent, both on account of rationalization of their supply chain and some delays in validation at customer end, you could see a muted API demand in the current quarter, and we are very confident that the API business will bounce back fairly strongly in the second half of the year.

Okay. So if you can give a little -- when do we expect the U.S. -- I mean, from the German [ supplier of ] these injectable or sterile business to start delivering? [ Any some ] time frame?

I believe it will be FY '24 before the first commercialization occurs in U.S. because while we have already made our first filing for U.S., in the current scenario, you would expect that FDA may not visit for next 12 to 18 months. So therefore...

Because of this U.S. FDA not visiting or it is '24 also because of the validation and getting approval for the whatever we have filed the project up?

No, this is predominantly for the U.S. FDA not visiting. See, right now, FDA is not traveling. Animal health will obviously not have that higher priority vis-à-vis the other plants that they have to audit once they start visiting. So on account of that, we believe that it will -- we will be slightly later in the queue in terms of their priority.

Okay. And is that fair assumption that with the API, say, bouncing back strongly and formulation we have already grown 15%, of course, you said it's in constant currency, despite there was a growth in Turkey in constant currency, there is a decline. So how in rupee value overall company growth we can look forward?

Yes. So Bharat, if you see our -- you won't see much difference between our constant currency growth and the reported growth as well. So while formulations grew 15.3% on constant currency, even the reported currency growth is 14.7%, okay? So it is not very different. Collective growth is about 9% for the organization. That is because of the slight decline on the API side of business. But as API business recovers, we believe that the overall growth will not be very different from the growth that we delivered in the last few years for the overall business.

Okay. Great. And on -- any color on the EBITDA side?

Sorry to interrupt you, Mr. Sheth. [Operator Instructions] The next question is from the line of V.P. Rajesh from Banyan Capital.

Just, Manish, trying to understand the API a little bit better. Was it a supply chain issue? Or was it a demand issue? Or was it a logistics issue this quarter? If you could just give more color on that?

So it is a bit of both, and I will have my colleague Sharat to explain the supply side challenges that we had. But there was a subdued demand, as I mentioned, a bit coming from rationalization of supply chain at the customer level. And there were also execution issues because whatever demand we had also, we could not service the demand for our own execution challenges, and Sharat can explain a little more about the execution challenges given the quarter that we had. Sharat, [ please explain ].

So on the -- basically, on the supply side, the situation which we faced was faced across the industry, I mean, predominantly driven by uncertainties during COVID lockdowns. So we also depend on several of our CMOs for supply of input late-stage [ intermediates ] for making API. They also did undergo the same challenges. Therefore, that was a muted supply there. Plus, also there was pressure on, as Tushar mentioned, on the cost side, so availability as well as cost. So both of them played a role in playing sort of spoilsport in execution.

I see. [ Second ] question on the option side. Is it typical that you would be able to write off 50% of the ESOPs in the first 12 months itself? I would think they would have gone over the period after vesting schedule.

Tushar?

Yes, Rajesh, actually, it goes as per of the vesting period for each year. So the way it works is, first year, you have the experts sitting for the first vesting that is happening, plus all the other 4 vesting that is happening. Second year, it will only hit for the 4 vestings. So here, it will only hit us for the 3 vestings that are happening. That way, the maximum impact is in the first year, and then it keeps on going down over a period of time over the vesting period.

And Rajesh, if I explain it a little more. See, since it vests over 5 years and 20% is in the first year -- at the end of first year, so the entire cost of first vesting will hit in the first year itself. The second year vesting, 50% of the cost will hit in the first year and 50% in the second year. The third year of vesting, 1/3 of the cost will hit in the first year itself. So effectively, it becomes 100% of year 1 vesting, plus 50% of year 2 vesting, plus 33% of year 3 vesting, plus 20% of -- so that way, if you add up the first year impact, it is the maximum.

Understood. But the total dilution is same as what you had indicated previously, right, at the shareholding base? There is no change beyond that, like in terms of number of issuance of shares.

Absolutely.

The next question is from the line of Raghav Soni from Deloitte.

Sir, just want to get clarity on Note #7, although you have discussed it. But was it a onetime event? Or it's going to take the hit in subsequent events also, subsequent quarters? That is the first question. And sir, can you give the guidance on margin? Even after taking -- even before the ESOP hit, it was very low. It was close to 11.8%. Can you give the guidance on the margin? That's it from my end, sir.

Yes. So I think I clearly spelled this out. Whatever was the impact was limited to last year and within the quarters of last year. There was no impact even in Q4 of last year. But within the quarter, there was a kind of a readjustment of P&L, all of which was disclosed in the annual filing. So does that answer your first part of the question?

Yes, sir. It answers the first part. And second part on the guidance, sir?

Our second part on the guidance, I will split this into 2 parts of business: one is the operating part and second is the buildup for SeQuent 2.0. On the first part of business, we stay very confident of delivering if not the same, better -- if not better, but at least similar margins as last year from the operations front. There may be some mismatch within the quarter simply because there is a lag between cost. And by the time, you can start recovering or pass on to the customers. There's always some lag. There is a second part of that, which is the cost built up for the future for Sequent 2.0. Now that is something which is still work in progress. They may be incremental costs coming on R&D front, on employees front and as we build up the organization, that is something, for me, it is difficult to guide you at this point of time. And therefore, what you would have seen is we have brought in the Slide 13 equivalent in our investor deck, which will -- which we will keep disclosing. We will not address the margins or we will -- we are not calling the exceptionals or whatever, they are part of our strategy. But we will certainly spell it out for you to take a view on those additional costs that we would have built up during the quarter or the year.

Perfect. Just want to clarify. These questions are asked in my personal capacity as a retail investor.

The next question is from the line of Hardick Bora from Union Mutual Fund.

Actually, my question is in line with what the earlier participant asked. So this margin guidance that you gave, that we would come back to at least the last year's level, this guidance is by -- I mean, by when will we touch that level?

What I'm saying, while it is very difficult to guide for the -- from a -- on a quarter-to-quarter basis, I think at the operational level, our EBITDA margins will not be any inferior to what we showed last year by the end of the year. Certainly, a lot of this growth or improvement will be back-ended because you would understand or appreciate that the incremental contribution of [ API business ] in margins is much superior given that there are no sales and marketing costs related to a B2B business. So certainly, the catch-up will be more back-ended, not front-ended. But at the end of the year, I do believe and I have fair confidence to say that our EBITDA margin from operations will not be very different from where we ended last year.

Okay. Okay. So now if I remove the one-off costs that you highlighted in the Slide 13 and even the ESOP cost, it seems that our costs are -- total costs seem to be growing at the pace of between 12% to 15%. And our revenues historically have grown at that line, I mean, the consistent growth rate, you've just seen this one blip now coming. So the question is before this ESOP plan was announced and before we were -- we had a conversation, you have guided that there's a 2x revenue growth potential in 5 years from FY '20 as the base. So I'm just trying to figure -- guess that, that still holds, right? That kind of 20% EBITDA margin potential in 5 years, this is a short-term pressure that we are seeing in the profitability. Otherwise, going forward, that actually is not changing.

You're absolutely right. In fact, obviously, as I said, in SeQuent 2.0, our aim would be to better that and not be satisfied with that.

Right. And Manish, sir, I'm sorry, I actually missed the beginning part of the call. So these costs that are highlighted in Slide #13, while one of them is clearly indicated, I do not understand the nature of the rest of them, on the new initiative and the one-off exceptions. So if you could just highlight what they are of?

I mean there are multiple new initiatives currently happening in the organization, both on strategy front, product selection front, R&D front as also on the processes and the systems of the organization, because we are obviously scaling up and preparing for a much larger organization. So all the new initiative costs are pertaining to that. There are obviously also inorganic initiatives that the company keeps looking at, and there are costs that come on account of that. The one-offs and exceptionals are on the other side, which are -- sometimes these are past expenses and all that. So that is coming as one-off. Tushar, do you have better color on the one-offs and the exceptionals?

Yes. So for costs, which -- some of these costs pertain to last year, which has come in the current year because the way we -- like in case of one of the service providers, these charges for the entire year in the current -- for the past costs. Also, in some of the geographies, we have taken certain provisions for certain inventories and all, which are coming here as one-off. So all that is built up into this one-off and exceptionals.

Understood. So of these, the nonrecurring ones are the INR 7 million and the [ INR 20 million ]. INR 28.5 million as such would maybe recur for some time before they start getting absorbed in the incremental business.

Yes. But we do believe those will start dipping, as we would have seen that they are already lower than Q4.

Okay. So the [ absolute ] will dip going forward.

That's correct.

Okay. One final, if I can squeeze in. The CapEx plan, has that changed over the last 2 quarters? Anything changes on that front?