Viyash Scientific Limited (512529) Earnings Call Transcript

Ladies and gentlemen, good day, and welcome to the Q2 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.

Thanks, Richa. A very good morning, and thank you for joining us today for SeQuent Scientific's Earnings Conference Call for the second quarter and half year 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 that have been uploaded on our website as well as the 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 Relations team. I now hand over the call to Manish to make the opening comments.

Thank you, Abhishek, and good morning, everyone. I welcome you all to our Q2 earnings conference call. Joining me on this call are Sharat Narasapur, our Joint Managing Director; as well as Tushar Mistry, our CFO. Before I come to the business and the earnings aspect, health and safety of our employees were core to our values, and I'm happy to share that over 99% of our workforce is now fully vaccinated, with the rest 1% to be vaccinated during the month as they become eligible for the second dose. On the business front, while the numbers were muted compared to the corresponding quarter, it is heartening to note or see that we recovered well in comparison to the last quarter or Q1 of this year with a 10% growth. This was aided by a healthy 21% growth in our API business in comparison to the Q1, while our formulation business continues to deliver consistent growth across geographies. Even though the industry at large is facing challenges due to rising input and logistics costs, we have undertaken several steps across the business to mitigate the impact, and we expect these to start reflecting in our margins in the coming quarter with the full benefit from Q4 onwards. We faced multiple challenges on the business front due to cost pressures and the recent energy crisis in China. Our businesses in Brazil and Spain which have a greater dependence on antibiotic APIs from China faced significant margin pressures due to sharp increase in the input cost. While we have initiated steps to pass on the incremental cost, we all agree that there is a lag, and we expect sequential improvement in margins and expect to achieve normalcy from Q4 onwards. There was some decline in the API margin as well, partly on account of cost increases and balance on account of product mix. We are also looking at our costs aggressively and have initiated significant programs on both process and yield fronts. Now let me discuss the performance of each business segment in detail. On the API business, as you can see from the numbers, challenges on the demand side are gradually reversing as we witnessed a sequential growth. We expect the growth to accelerate in the coming quarters. We are seeing muted sales of one of our larger products, albendazole, for last couple of quarters. This is largely due to slower uptake from WHO, who is a major consumer of this drug for deworming amongst school children in Africa. With schools now reopening, the WHO demand is slowly coming back. The rest of the portfolio grew over 25% in the quarter. We continue to track well with a steady high single-digit growth on the formulation side. We did reasonably well across most geographies, with Lat Am and Turkey leading and Europe back on track with about a 10% growth. India's growth was subdued at 4%, but this was largely on account of the base effect as we had commercialized Zoetis portfolio last year in the same quarter, and it was a dry, clean kind of launch. In the sense, there were 3 to 6 months lag before we relaunched that portfolio. So there was a lot of pent-up demand in that case. Emerging markets were slow, and we continue to maintain a safe approach in these geographies, more so in the current heightened volatility scenario. Strategically, we are adding new growth engines with several new initiatives to expand our offerings to include vaccines in India and Turkey as well as the recently concluded long-term agreement with the top 10 animal health company. All of these shall contribute to our revenues from FY '23 onwards. As mentioned in the last call, we are pleased to welcome Alexis Goux in our organization as Vice President, Commercial, to spearhead our formulations business. Alexis joined us on 1st September and brings in over 20 years of experience with leading companies like [ Robek ] and Ceva and had led businesses in multiple geographies, including Europe, Lat Am and Southeast Asia. Alexis has hit the ground running and is currently driving our strategic initiatives around U.K. and Germany, both of which should see commercialization in the coming year. We continue to make progress in our inorganic initiatives and expect some new growth engines to be added in the second half of the current year. To conclude, despite the challenging first half of the year, we look at the second half of FY '22 with increasing confidence as we start reaping benefits of our recent actions and delivered a near double-digit growth despite a flat API business for the year because there has been a decline. We expect a recovery in our API business, but even then we expected overall flat API business for the year. This will be led by a sharp recovery in our order book, which we already see building up for the second half. Business should be back on strong growth track from FY '22, supported by some of the initiatives, just as I mentioned a little earlier. I would now like to hand over the floor to Tushar to discuss the financials in detail. Over to you, Tushar.

Thank you, Manish, and good morning, everyone. Let me give you some insights into the financials for the quarter, and let me start with the P&L. During Q2 FY '22, while our revenues were slightly above similar quarter last year, the business saw some pressure on the gross margins. This was mainly on account of product mix in our API business has also cost pressures and business mix in our Spanish operations. While operating expenses are in line with expectations, it will be important to note that last year, due to COVID restrictions, there was lower sales and marketing expenses like travel and marketing spends. As things normalize, we see these expenses normalizing again. However, concerns remain on logistics cost due to timely availability of containers and vessels. The overhang of the cost continues to be there, even though it is a noncash expense. As mentioned in our Q4 call, the charge will take off slowly with addition matters facing the male. We would also recollect that last year, our effective tax rate was higher as a percent in some geographies were delayed due to COVID. During the quarter, we saw the closure of the [ spend ] resulting in reversal of provisions made for prior year. Let me now give you some insights into the balance sheet position. We saw an increase in the inventory as we prepare for improved demand in the second half of the year, resulting in higher working capital as well as our net debt position. We are in process of closing the consolidation of the minority stake in Brazil and expect to complete the same during the quarter. We do not expect any significant impact on the liabilities accounted as of 30th September on this account. Certainly, I wish you all a very happy Diwali and prosperous new year. Thank you.

So we can now open the floor for questions.

[Operator Instructions] The first question is from the line of Manish Gupta from Solidarity.

I have 2 questions. The first one is how much of the -- you said the API business will roughly be flat for the year. How much of this would you attribute just to inventory normalization in the supply chain? And what percentage of this would you attribute to more competitive intensity from China? That's my first question. The second question is that given what's happening in Turkey, how are our long-term growth plans for using Turkey as a sourcing base for other geographies affected by any risk that if the Turkish President starts acting tougher on diplomats, how much of our growth plans would be impacted by Turkey as a supply base?

Sorry to interrupt, but we cannot hear the management.

Sorry, we were on mute. Thanks, Manish. Very, very interesting questions, and I think you have hit nail on the head. Now coming to your first question, the API business, all our -- the entire dynamics that is playing out in our API business is purely coming out of the supplies. I mean we are not facing any competitive pressures either from China or any other player. And that, I think, is one of the strengths of our business model. The only challenge we have is on account of 2 things. One, there was a buildup potentially of some of the APIs undertaken by our customers last year. And so therefore, there is a base effect. And also they are kind of now aligning their inventory. And second is, which I mentioned, there has been a slowdown in the albendazole sale, which is one of our larger products, simply because WHO, who is a major consumer of this formulation as they distribute this product across school students for deworming in Africa, with schools being closed for almost a year, this demand was subdued. And therefore, this led to a shortfall in demand for the albendazole product. Both these aspects are now reversing. And therefore, we are seeing a continued buildup in our API business, Q2 has been better than Q1, and looking at the order book that we have currently. So in spite of having a 10% or a little over 10% decline in first half, we are guiding to a flattish API business because clearly, H2 will see a growth vis-a-vis last year, as also growth vis-a-vis H1 this year. So we are very confident of a strong rebound in our API business, more so in FY '23 because there we will benefit from a normalized sales through the year plus also some of the new initiatives, which I mentioned, especially the new multiyear contract that we have signed with another top 10 company that should come in very quickly. And FY '20 -- FY '23 should see a significant spike coming from that contract. That is as far as API business is concerned. Now coming to Turkey. Let's see, for us, Turkey is a Made in Turkey for Turkey business model. While we have been exploring emerging markets and even Europe exports from that market, actually, this recent currency depreciation makes it even better and more competitive for us. Turkey makes it -- becomes even more competitive in that aspect. The only risk or challenge is on the diplomatic relations side of Turkey, on which we have no control. Having said that, Turkey business has been an outperforming business for us. We continue to benefit from our close to leadership position in the local market and we are very confident of maintaining more than double-digit growth in the local markets by itself. So I will not be -- while yes, we will be continuously watching the entire political game, but I will not be unduly worried about it as far as our Turkey business is concerned.

Manish, if I may ask a follow-up. Given the weird economic policies that the President is proposing, that is you have to reduce interest rates to manage inflation. Is there a risk that we are putting -- and I'm not talking about the local business of Turkey. I'm really talking about using Turkey as the base for your global foray. Do you think that Turkey may not be the right location geopolitically to use as a supply base?

So if you -- and you have been tracking us long enough, we have been always cautious in using Turkey as a global base for our supplies on manufacturing. So fundamentally, it does not change any of our plans. And you would also notice that we have been investing more in Germany to convert that to our global base especially for injectables. So I will be -- honestly, it does not impact our business plan at all. At best, there would be a couple of percentage change in the outlook for just Turkish business, that too from the emerging markets. Otherwise, I'm not at all worried strategically because we never looked at Turkey from a global sourcing angle.

[Operator Instructions] The next question is from the line of [ Somia Rajanshi Navidesh ] from [ HCCI ].

Yes. So I also want to focus on the Turkey business, which is [indiscernible]. You mentioned emerging markets, we are having a cautious look, so can you elaborate on that one?

I'm sorry, I could not hear your question well enough. Can you -- do you mind repeating it?

Yes, sure. Actually, I saw in your results that you are having a cautious approach towards emerging markets. Can you elaborate on that front, what you said?

Yes. So the emerging markets, what we categorize is largely markets of Africa, and to some extent, Middle East. Middle East is a very small component of that. A larger part is Africa. Selling in these markets is never a problem, collections is. So therefore, especially when there is a heightened volatility, the currencies in these countries and currencies are also -- availability is also controlled by the central bank in these geographies. So therefore, we continue to be cautious as far as these geographies are concerned because we do not want to take any payment risk and only do business on more or less either advanced payment or LC basis. That's why you will continue to see volatility in our emerging markets business. And we -- that is by design because we do not want to push and take higher risk in that part of the market. Does that answer your question?

Yes, yes. Another follow-up, if I may ask is like we are seeing like the profit and loss statement is not that good from the last couple of quarters. So how long it will be continuing the same? How likely are we like going to see the reversal?

Yes. Again, a very valuable question and certainly very important for any investor. Clearly, I would say this quarter was a perfect storm because there were pressures on the cost side, not only on the logistics cost, but also material costs. Demand was slightly subdued. There were enormous volatility across currencies, especially in Turkey and Brazil. And -- all in all, that led to a significant reduction in our margins with flattish sales, you would have seen that our gross margins dropped by about 5% and our operating costs went up by about 10%, even we did reasonably well as far as our operating costs are concerned, leading to the overall reduction in gross margins for the business. Qualitatively, I can assure you that there is no deterioration in business. In fact, we continue to be uniquely positioned in all the markets where we are, especially in our API business. Some of the actions that we are taking and have taken both on increasing the prices and also aggressively tackling the cost will start showing results from Q3 and full benefit will start accruing from Q4. So as of now, I have reasons to believe that Q4 onwards, we should be back on our growth track as far as margins are concerned.

The next question is from the line of [ Aditya Khemka ] from [ InCred Asset Management ].

Manish, sir, 3 questions. Firstly, you mentioned in your remarks that Turkey currency depreciation actually makes you more competitive. Yet in this quarter, despite the depreciation, we have seen actually an adverse impact. So is it the -- completely the Brazilian currency that has made you loose so much gross margin?

Yes. Do you want to complete all the 3 questions? Or should I take one-by-one?

Let's go one-by-one, Manish.

Okay. No, so the gross margins have come -- impact on gross margins has nothing to do with Turkey. It has more to do with 2 matters. One is pressure on margins in Spain and Brazil, which is coming from API cost increases because most of these APIs that are consumed in these markets come from China, given that these are oral antibiotic markets. The other part is the business mix. So you would notice that the share of API business in the overall business mix is down and within API also the product mix. All of these have led to -- so there is no singular reason for this drop. It has come from all the areas of business. But largely, it has come from the 3 specific buckets. Spain and Brazil is the largest impact and some impact coming from the API business.

Okay. And just wanted to understand a question related to the fabric combination of our business. So like in human pharma, we have chronic drugs and acute drugs. Is the case similar in animal pharma? Do we also have chronic and acute?

Fortunately or unfortunately, no. Animal health is a very basic market in that sense because 60% of the market for the world is commercial business. It is driven by meat and milk and rest, 40%, is the companion animal business, which is obviously more emotional or emotive in nature. So largely, it's more an acute market. There's negligible or 0 -- close to 0 component of chronic diseases. Though I must admit that this is now coming up especially in the pet animal segment. So the real way of looking at this market is segregation between companion animal and the production animals rather than chronic and acute.

Understood. But at the same time, given that majority of the market is acute, let's say, 90%, 95% is acute because these are products given to different animals once they are processed at a certain stage. Then in that case, in COVID, we saw acute consumption of drugs falling for humans because people were not stepping out of their homes. For animal health care, I don't know how this would play. So just wanted to understand were the volumes last year lower than what they were supposed to be because of COVID? Or was there any impact of covering the volumes last year because of the impact of COVID this year. I mean if you could give us some sense on how COVID impacted volumes in the business.

No. So fortunately, as I said, a major part of the market is driven by commercial animals and people do eat whether they are in-house or outside the house. So there was no demand as far as protein -- no change in demand as far as protein requirement was concerned. And therefore, there was no impact on the animal health market. Of course, there was a benefit on the companion animal side of the market simply because as people were stuck at home, there was an increase in the people adopting more pets at their homes. So that part definitely benefited as far as structure of the market is concerned, but there was no adverse impact on the production animal side of the business. Does that answer, [ Aditya ]?

It does, Manish. Just one last question I have. When you're selling API to your customers, right? So last year, when you were selling them to your API and this year as you continue to sell to your customers, is it possible for you to know why you are saying that this is an overorder, and therefore, this is the customer trying to build up a [ venti ]? Or do you only come to know post-facto when in the next quarter, the customer doesn't place enough order?

So this is unfortunately one of the problems of our industry because in absence of any database or information, we are only relying on customer information. We do not have any historical trends accepting our own internal trends. So see, unlike in human pharma, wherein there is a kind of a complete transparency because of IQVIA information. There's nothing in animal health, and therefore, we it's both a challenge and an opportunity because a lot of information is not only true for us, but it is also true for our competitors. So in that sense, I must admit that it is only a de facto analysis and not something which we can gauge beforehand.

Understood. So the way you are gauging the fact that there is inventory destocking happening at the customer end today, is that a customer would have placed order for 100 units last quarter is placing order for 30 units this quarter and you went back to him and asked him why you're replacing 30 units today, whereas you placed 100 units last quarter. And he has informed you that he has 60-50 units of inventory already lying with him. Is that a reasonable understanding of what's happening?

Yes. Largely reasonable, but obviously, they never tell you this clearly. They will only -- typically, we get an annual forecast with quarterly firm orders. From all our business is regulated market, driven by long-term arrangements, okay? -- almost 75%, 80% of our API business is like that. So we get fairly detailed forecast from our customer for 1 year with a firm commitment for 1 quarter. So what they typically do is they will shift demand by 1 quarter and then when you engage, they'll give you some color around it. But they'll never be so open about it that I built up this inventory, and I'm carrying so much stock -- all that kind of information, obviously, is very commercially sensitive and nobody would like to give.

Sure. So at any given point in time, do you have visibility or it's not visible? Do you have an understanding of what your next 6, 9 or 12 months of order book looks like, given that your customer gives you indicative budget of what he wants from you over the next 6 to 12 months. Is that a fair statement?

Yes, that's correct. That is true for about 80% of our revenues, as I mentioned, which are driven by regulated market and long term because we are part of their filings technically.

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

I have 2 questions. The first one is in the presentation, you talked about the first success with the supply arrangement. Could you just talk about more about this contract, whether this arrangement is a longer-term arrangement. Is it a new API that you are looking to supply to them? And what made them choose you over the other peers in the market? I mean is it purely on price that you offer that is forward reason in that sense? So that's question number one. The second question is, you did talk about API growth being flat for the entire year. Is that confidence coming from albendazole demand recovery or a bit more from [indiscernible], the other product market which you're looking at strong recovery.

So let me respond to the extent I can because I cannot disclose too much sensitive information or commercially sensitive information about the new arrangement that we have made. But it's one of the newer products in our portfolio, which has been validated and commercialized a year or 2 back. This demand is largely -- the customer demand is largely for the U.S. market. And in the second year of commercialization, it should contribute over $10 million of revenues for us. Now coming to why they are shifting to us. Obviously, it is their prerogative, but we believe we are very well placed on this molecule. That was the reason we developed it. Other than one competitor or 2 competitors in Europe who were historically there in this molecule, there is no other competitor. So we clearly have a long-term strategic and competitive advantage as far as this molecule is concerned. Even if others were to come, it'll take them at least a year or 2 before they can come where we are today. Having said that, the reason we have gotten is not on price. In fact, we are same price or even higher than the current suppliers, but it's more around supply chain security. So we are significantly backward integrated on this molecule, and we have done a lot of -- this engagement has been almost for a year before conclusion. So you must understand the diligence that the customer would have done or not in terms of supply chain security for them to move such a large volume of a fairly expensive API to us. So that is, I think, broadly the answer to your first question. What was the second one?

On API -- API growth projection of flat growth for the year, is it more from albendazole sale recovery is it from [indiscernible] that you're expect out? Or has the organization demand haven't been recovered? what will be the confidence for the flatter growth or flat or 10% decline in 6 months?

Yes. So it comes from 3 facts. One is, obviously, we are seeing recovery in albendazole, may not come back to the full normalcy, but there is a recovery. Already, we are seeing a building up as WHO is releasing more and more orders to the formulators. So that is one aspect. Second is our rest of our portfolio continues to do extremely well and has grown 25% in the first half, and we expect the growth rates to be maintained in the second half as well, coming from the order book that we already have. And the third aspect is overall that inventorization that had occurred, the stock buildup that also is moderating, and we are already seeing customers coming back with demand for us. So all these 3 factors collectively give us the confidence of API showing a positive outcome in second half, making up the shortfall for the first half, that's why leading to a flattish overall revenue for the year. And as I mentioned a little while back, to be back on reasonably strong growth track for FY '23.

The next question is from the line of Rushabh Sharedalal from Pravin Ratilal Share and Stock Brokers.

I just have a request, if you can patch in [ Mr. Aditya Khemka ] in my opportunity. I think it will be good because his questions were good. If you can just patch him in my chance.

He's already [indiscernible].

He's already asked the questions. Can we have the next question, please, Richa?

We'll move to the next question, which is from the line of Manish Gupta from Solidarity.

Manish, one more question, please, but in your APIs of interest, what share of wallet do you estimate you have of the customer's total purchase as of now?

Manish, this is a very, very difficult question for me to answer. It's not for the reason that I want to avoid it but simply because such an information is more or less impossible to get in the animal health business, but let me give you -- or make some attempt, okay? There are products in our portfolio wherein we are currently the sole VMF holder for U.S. market, okay? So what it means is the innovator may have his own source, but all generic companies are dependent on us at this point of time. And even innovator may be looking to move to us because we are certainly more competitive than his own manufacturing at this point of time. So there are a couple of products in that bucket. A larger bucket will be the second bucket, wherein there is very limited competition [ and there's ] one more API manufacturer other than the innovator. And then there is a third bucket wherein we will have 1 or 2 products which are more competitive. So that's a large composition. The reason we always talk with confidence about our API business is not because we are taking competitive position and taking up a share of others. We are actually working with the so-called innovators and gaining their wallet share, okay? So our is not a -- I mean it shouldn't -- our business model should not be seen in line with the other API companies. It's a very different model simply because we are in animal health space and simply because there are no facilities approved by U.S. FDA in the states that we are in. So we have taken a fairly good positioning, as far as this business is concerned. The negative side of this is that each of our product opportunities is nowhere comparable to the larger-size opportunities that human API companies [ play with ].

Yes, very clear, Manish. The last question is that, given that the primary concern of your customers really seems to be to ensure supply chain security, and I think we are the only U.S. FDA-approved API plant in India at least as of now, how do you see the margin of this business, say, 5 years [ out hence ]?

Yes. [ If for ] these 2 quarters' performance, which you obviously saw a dip in our margins, the regions we -- the reason I have been so confident about projecting our growth in margins was largely stemming from the -- from our API business. It's a amazing business model that we have created. I think it'll take time for anybody to catch up to where we are. So certainly I stay extremely confident around the margins of our API business, excepting for the short-term pressures which we saw. You would also appreciate that, when you are in regulated markets, you tend to have price increase in your contract only once a year. And you need to honor or respect your customers to that extent. So yes, short term, there are margin pressures in the API business but which we'll correct certainly from Q4, and we'll be back on strong growth track thereafter.

But 5 years out, Manish, could this be a 25% margin business given the fact that supply chain security is more important than costs?

Manish, you are trying to [ extract ]...

Okay, no, no, no. That's not fair. No, no, Manish. That's not fair on my side. I don't want to put you under any difficult [ over here ]. Manish, the easy questions [indiscernible]. It's the hard questions we have to ask you.

[ Yes ]...

[indiscernible].