Dr. Reddy's Laboratories' CEO Discusses Q1 2012 Results - Earnings Call Transcript

| About: Dr. Reddy's (RDY)

Dr. Reddy's Laboratories (NYSE:RDY)

Q1 2012 Earnings Call

July 20, 2011 9:00 am ET

Executives

Kallam Reddy - Managing Director, Chief Operating Officer, Executive Director, Member of the Management Council, Chairman of Management Committee, Member of Shareholders Grievance Committee, Member of Investment Committee and Member of Strategy Committee

Umang Vohra - Chief Financial Officer, Chief Compliance Officer, Senior Vice President and Member of the Management Council

Kedar Upadhye - Director

G. Prasad - Executive Vice Chairman, Chief Executive Officer, Member of Management Council, Chairman of Investment Committee, Member of Strategy Committee, Member of Shareholders Grievance Committee and Member of Management Committee

Analysts

Surajit Pal - Elara Securities (India) Private Limited

Bino Pathiparampil - IIFL Research

Sonal Gupta - UBS Investment Bank

Nitin Agarwal - IDFC Securities Ltd.

Ranjit Kapadia

Chirag Talati

Sameer Baisiwala - Morgan Stanley

Prakash Agarwal - RBS Research

Bhagwan Chowdhry

Saion Mukherjee - Nomura Securities Co. Ltd.

Girish Bakhru - HSBC

Anubhav Aggarwal - Crédit Suisse AG

Hitesh Mahida - Marwadi Shares

Nimish Mehta

Ravi Agrawal - Standard Chartered plc

Abhay Shanbhag - Deutsche Bank AG

Unknown Analyst -

Operator

Ladies and gentlemen, good day, and welcome to the Dr. Reddy's Laboratories Ltd. Q1 FY '12 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. At this time, I would like to turn the conference over to Mr. Kedar Upadhye from Dr. Reddy's. Thank you, and over to you, sir.

Kedar Upadhye

Thank you, Melissa. Good morning and good evening to all the participants. Welcome to Dr. Reddy’s earnings conference call for the quarter ended June 30, 2011, which is the fourth quarter of fiscal 2012. Earlier during the day, we have released our results and the same are also posted on our website. We are conducting a live webcast of this call, and the transcript shall be available on our website soon. The discussion and analysis in this call will be based on IFRS consolidated financials.

To discuss the business performance and outlook, we have today G. V. Prasad, our Chief Executive Officer; Satish Reddy, our Chief Operating Officer; and Umang Vohra, our Chief Financial Officer. Please note that today's call is copyrighted material of Dr. Reddy’s and cannot be rebroadcast or attributed in press or media outlet without the company's expressed written consent.

Before we proceed with the call, I would like to remind everyone that the Safe Harbor language contained in today's press release also pertains to this conference call and webcast. After the end of the call, in case any additional clarification you'd require, please feel free to get in touch with Rajan, Milan or myself.

I would now like to turn the call over to Umang Vohra.

Umang Vohra

Thanks, Kedar. Good morning and good evening to everyone. I welcome you all on this call today. I will discuss the key financial highlights. For this section, all the figures are translated to U.S. dollars at a convenience rate of 44.59 per U.S. dollar.

Our consolidated revenues in this quarter grew by 18% on a year-on-year basis to $444 million. Global Generics recorded revenues of $323 million, a strong growth of 21%. Pharmaceutical Services and Active Ingredients, which we will call PSAI in this call, grew revenues by 7% to $108 million. Our gross profit margin for this quarter is at 53%, and the margins remained roughly the same both at the segment and the overall level when compared to the previous year.

SG&A expenses, including amortization for the quarter, are $852 million (sic) [$151 million], an increase of 23% over the previous years. This increase is attributable to the following factors: annual inflationary increase in manpower costs across business; the setup -- the step-up in the OTC-related selling and marketing costs in Russia in line with our strategic intent to expand the OTC portfolio; and the general overhead in the U.S. due to the recently acquired Bristol penicillin in facility. R&D costs, at $27 million for the quarter, show a planned increase of 21% over the previous year.

Included in our financials this time are interest on bonus debentures of approximately $3 million, which we believe is an indirect form of dividend to the shareholders; a one-time charge of $3 million on account of the voluntary retirement scheme sponsored by the company. And adjusting for both of these factors are adjusted EBITDA at $97 million represents 22% of sales and has registered a growth of 27% over the same period previous year.

In this quarter, we made required shipments to the U.S. from India in anticipation of our launches. This has triggered a tax benefit in line with the IFRS-mandated treatment for unrealized profits on these stocks. The tax charge at the India entities rate of 32% was more than offset by the tax credit of the U.S. entities rate of 38%, resulting in a net credit of 40 [ph] inventory shipped out of India. Hence, the reported effective tax rate for the quarter is 4%. Adjusted for this benefit, it would have been 16%. On a full year basis, we expect the annualized effective tax rate to be around 21%, driven largely by olanzapine-related exclusivities in quarter 3 and quarter 4. Adjusted profit after tax for the quarter, non-lining for the 16% tax rate is $56 million and is at 13% of sales.

Key balance sheet highlights are as follows. Our operating working capital has increased marginally by $20 million from the previous year. The increase in inventories in anticipation of new launches was partially offset by the release in receivables. Capital expenditure for the quarter is at $41 million. Foreign currency cash flow hedges in the form of derivatives and offsetting loans are at $410 million as of date, hedged largely in the range of INR 45 to INR 47 a dollar. In addition to these, we have approximately $236 million of balance sheet hedges of net receivables. Our current net debt is at $440 million and the net-debt-to-equity is at 0.38.

With this, I now request Satish to take us through the business highlights.

Kallam Reddy

Thank you, Umang. Yes, so I think it was somewhat of a mixed quarter for us. While North America and Russia, CIS markets demonstrated strong growth, India formulations was below expectations, and the PSAI segment growth of 7% was in line with expectations. I'll now cover the business highlights for each of our key markets. Performance analysis is based on respective local currencies.

Starting with North America Generics. We recorded an impressive year-on-year growth of 51%, recording revenues of $129 million. We're quite delighted with the continuing progress in our North America Generics business. Our key limited-competition products, Tacrolimus and Anzicazole [ph], acquired a strong performance and sequential market share improvements. In this quarter, we have a benefit from the initial launch of -- initial launch revenues of fexofenadine OTC. We now have 5 customers for this product, and the uptick is quite encouraging. Other key products in the portfolio such as omeprazole prescription and Omeprazole Mg OTC have also acquired an impressive increase in their market shares over last one year.

We have also begun working from the newly acquired Bristol penicillin facility with 4 SKU launches this quarter. We expect this business to scale up after the fourth quarter with launches some of the larger SKUs

During the quarter we also launched 5 new products in our regular prescription portfolio. We have now gotten approval for OTC [indiscernible] for Fexo-Pseudo combination products and launch preparations are underway.

During the quarter we have filed 3 ANDAs, and cumulatively we now have 76 ANDAs pending approval with the U.S. FDA, of which 36 are Para IVs and 11 are first-to-files.

Moving on to India. Revenues for the quarter are at INR 2,936 million or $66 million, which delivered a year-on-year growth of 6%. The performance in this quarter was below our expectations largely due to some pressures on our top brands. While we can seem to get impacted by the price impression, as I think, from competitors' activities, it's less than what have seen of before -- of the previous year. In the last 1.5 years, we also expanded and reorganized our field force deployment, which we have yet to see the desired results. While we have slide with the start to the year, we hope to recover the lost ground in the second half of the year.

During the quarter we have also launched 12 new products. Our recent launches of biosimilars are doing well, and our oral biosimilars portfolio, which is now 7% of India sales, has grown at an impressive rate of 69% over the previous year.

Russia business continues steady growth with revenues of $56 million for the quarter and year-on-year growth of 23%. Our secondary sales growth of 17% for the Moving Annual Total of May 2011 is much higher than the industry growth rate -- much higher than the industry growth of 6.5%. Our rank in Russia currently stands at #13.

This growth was largely driven by volume growth in our OTC products and key prescription products. The OTC segment still represents almost 40% of the Russian market, and that's part of our strategic intent to increase our presence. We have been investing in brand promotional activities in the space. As a result of this, our OTC portfolio is now at 30% of the sales from about 25% about a year back.

Talking about Europe Generics. Revenues are at EUR 28 million, which is a decline of 11% over previous year. Revenues from Germany for the quarter are at EUR 19 million, which is a decline of 17% and which is due to the continuing tender-based pricing compressions. In June we have commenced our supplies towards the recently awarded AOK tender. Despite winning a few high-volume products, we expect the margins to remain subdued due to a low pricing. Revenues from Rest of Europe grew marginally on the back of outlets and products.

Moving now on to the PSAI business. Revenues for the quarter are at $108 million, showing a year-on-year growth of 8%. The Active Ingredients business grew very well on the back of new launches, but revenues from the Pharmaceutical Services declined sharply due to the center extension of sales and our mix complexity, mostly import alert.

A lot of you expect to review more supplies as are not from major product, which is Naproxen API, is exempt from this import alert. In our Active Ingredients segment, we are seeing good pipeline lock-ins around certain large molecules, and the business is expected to show higher growth. However, in the Pharmaceuticals Services segment, the outcomes are dependent on the progression of unapproved partner's trials, which we may see by the year end. However, the business environment for these segments to remains challenging. During this quarter, we have filed 9 DMFs globally including 2 in North America, 1 in Europe and the rest in other markets. With this, the cumulative filings stand at 495 globally.

I now hand it over to Prasad for his discussion.

G. Prasad

Thank you, Satish. Satish explained this was a mixed quarter for us. And we will continue to work on strengthening our market positions. I am however extremely happy with the progress in our North American Generics business. Apart from the impressive growth, we've also seen a number of positive developments recently, culminating in the accrual of Fondaparinux, which is being launched now after its long-awaited approval. The product will have a trade launch into the pipeline -- into the customer pipeline over the coming quarters. As you are aware, the development process for this product was quite complex, and we would like to acknowledge the contribution of the entire development team and our technology partner Alchemia in this regard.

Similar to this product, our existing generics R&D effort is increasingly focused on complex molecules. In the north sea, a trend of high number of filings as earlier where the complexity and market potential are expected to be much higher. As a result, our R&D cost are likely to go up in the coming years not only on account of the booked complex generics portfolio but also increased investments in proprietary products and biosimilars.

We also plan to launch another limited-competition product, Fexofenadine Pseudoephedrine higher strength, in the OTC segment in the second quarter. We expect the second half of this year to have a higher growth in profits relative to the first half. This will be driven by Olanzapine 20 mg under exclusivity and new SKU launches from our Bristol penicillin facility in the Augmentin and Amoxil range, ramp-up in the market shares of Fondaparinux and the OTC launch of Fexofenadine Pseudoephedrine higher strength. While we desire the benefits of these positive developments, we also need to focus on some immediate challenges.

Apart from sluggish growth in our India formulation business, another immediate priority for us is for us to resolve issues raised in the warning letter by the USFDA on our Mexico facility. As indicated in the -- in both alerts, Naproxen, which is our key product from this site, have been exempted. And we have sent our responses to the warning letter in end June and are working closely with the FDA to seek clarifications and resolve the issues so that the import alert may be lifted.

With this, I would now like to open the call for question and answers.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from the line of Saion Mukherjee from Nomura.

Saion Mukherjee - Nomura Securities Co. Ltd.

I have a question on the domestic market because towards the middle for last quarter, you were expecting that the growth will derive after anew that Q4. But that hasn't happened. So can you throw some more light as to why the growth has been sluggish in India? What steps are we taking? And how do you see growth reviving from a 1- to 2-year perspective?

Kallam Reddy

Okay the growth has been disappointing, yes. We indicate that nothing should improve from this year -- this financial year onwards, but quarter 1 results have not certainly reflected that, all right? So we do expect a sense of disappointment toward that. So if you -- looking to the some of the reasons why and what do we expect going forward -- so we will simply look at some initiative we have undertaken about, say, 2 years back. One was field force expansion. We also wanted to redeploy some of the peoples of Albany. But I think the deployment after the expansion have not yielded that sales increases that we expected it would, right, so that's one issue which need to be still tackled. And we're still working on it, right, so that's one. After that initiative goal, the expansion to rural markets while the [indiscernible] there was a good scale-up in the previous year. There's been some issues with that in terms of field source, attrition and things like that, which was somewhat beyond our control, right, but that's something we also had to anticipate. So I mean, while these are 2 primary reasons in terms of where we have seen -- first quarter was also hit with somewhat lower growth in some of the top brands, so that's another issue. So these are broadly what I see as the issues for the first quarter compared to, say, what we anticipated in the previous quarter. Now while we -- while it's work in progress in terms of trying to sort of the execution issues, I would expect that things to start looking up in the second quarter -- sorry, in the second half of the year, right, so this will be based on some of the interventions, which we have started plugging in early enough this quarter. But again, I would still like to see the performance of the second quarter. Once that improves, I would be able to comment more on that. I will be able to say with much more confidence on what happens in the second half, which I'm sure will definitely start recovering.

Saion Mukherjee - Nomura Securities Co. Ltd.

Okay. And just one more question, have you seen an authorized generic in Fonda yet?

Kallam Reddy

Not yet, but we heard of possible brand generic asking.

Operator

The next question is from the line of Ben Anani [ph] from Edelweiss.

Unknown Analyst -

Just to take time question for the -- like have you seen any pricing placement in the domestic market? Because for one of your [indiscernible], Pfizer has come out with almost little like 50% of your pricing. So do you see that MNC is coming out even with a very impressive pricing and it's affecting the overall pricing [indiscernible] as in the Indian market?

Kallam Reddy

It's not just MNCs, I think, even among the Indian companies and all that exist in the industry itself are big intense pricing that are just happening to various products. So obviously, it does take the market share, and that's something we want to see, yes.

Unknown Analyst -

And have you also taken some like price corrections in omeprazole labels in balance?

Kallam Reddy

It is one of the leading products of the industry.

Unknown Analyst -

Okay. And what could be the adverse impact because of the demo slide? Because there was some concern in the market and, well, it might have impacted growth in the market.

Kallam Reddy

The [indiscernible], I think, see -- from the time the EMEA had open complex issues in the past, especially the issues on the PDX [ph] suspension, which we had begun quite some time back. I think the recent TMA report also has clarified in terms of the benefits of Nimesulide, except for chronic usage of that, which is something which we are already implemented quite some time in the past. But I think the whole activity, especially by competition, by also putting in false propaganda, which we also, in one case, actually successfully gone to court to restrain them, right? So this is something which has also seen the growth in this molecule compared or to the past. That's something we have definitely seen in this molecule.

Unknown Analyst -

Okay. And the second thing I just wanted to understand, like what could be their depreciation and amortization impact because of the slope has taken the U.S. for this quarter?

Kallam Reddy

It'd be about $1 million, $1 million to $1.5 million.

Operator

The next question is from the line of Ranjit Kapadia from Centrum Broking.

Ranjit Kapadia

My question relates to the domestic market. If you can throw some light on the sales force? And how much of sales force was EBITDA in the last year? And anything in the guidance for the FY '12?

Kallam Reddy

So far we have not guided for FY '12, right?

Ranjit Kapadia

Sorry, FY '13. FY '13 of $2.7 billion for guidance, whether there is chance that you are revising...

Kallam Reddy

That still remains. There's no change because of what you have seen, just because of Indian market growth in the fourth quarter. I mean, that's no indication of any revision nor any change. We still stick to the guidance, what we have indicated. In terms of the field force that you are asking, I think, last year, we added quite significantly fair to the field force, and it was about 500. Yes, 500 field force is what we have added.

Ranjit Kapadia

And what is a current trend now?

Kallam Reddy

Total will be about 3,800.

Ranjit Kapadia

3,800, and then can you feel that the full potential of this 500 people will be available to us?

Kallam Reddy

I think it's difficult to just to comment, saying that not just because the added field force, that all streams will be increased. That's not what I was intending to say, right. So it is about field force which are added in different marketing divisions and also the field force strategies that they employ and the execution that happens after that. So it's a combination of various things, which I said that, on execution, we have not performed up to expectations.

Ranjit Kapadia

And what is the attrition rate in the field force currently?

Kedar Upadhye

It's about 25%, Ranjit. I could also do [indiscernible] but overall, it's about 25%.

Operator

The next question is from the line of Hitesh Mahida from Marwadi Shares & Finance.

Hitesh Mahida - Marwadi Shares

First thing is, what will be sales contribution? And how much will it cost from the new GSK facility, penicillin facility?

Umang Vohra

The sales is about $2 million, and the cost of the facility, because we haven't yet scaled up, is about $5 million.

Hitesh Mahida - Marwadi Shares

$5 million. And how much sort of do you still, are you expecting from this?

Umang Vohra

This will peak in quarter 3, and I think it could go both at an average run rate of almost about $8 million to $10 million. At quarter 3, right? But this is a seasonal product so you will begin to see the variations between quarter 1 and quarter 3 at an full year average, and a good rate would be about $5-million-odd per month.

Hitesh Mahida - Marwadi Shares

Okay. What's your view on the German pharma market? You are not, say, you have started here okay at play. Do you expect sales growth this year?

Kallam Reddy

This will definitely not grow because I -- we have already indicated in the last earning call that the price decline will continue for this year, right? So what you're seeing in the first quarter is generally the trend even for the rest of the year because the view on the market is the AOK tender will also work good products with increasing volumes as an outcome of that. Because of the pricing pressures, that's why you see the decline.

Hitesh Mahida - Marwadi Shares

Okay. And what would be your market share in Lansoprazole, Tacrolimus, fexofenadine and omeprazole?

Kedar Upadhye

Satish will share these numbers offline with you.

Operator

Next question is from the line of Fushan Zalmia [ph] from Bank [indiscernible].

Unknown Analyst -

Just one question in terms of how -- the housekeeping. So this, I suppose, the $3 million of the VRS is thin in the SG&A costs. And in terms of bonus, debentures have flobbed [ph] the financial expenses. That would be right, then?

Umang Vohra

Yes. I just clarify: The VRS, it's flipped 70% in the manufacturings cost and 30% in the SG&A, right? And the debt interest is in the interest line, the bonus debenture interest in the [indiscernible] financing committee, yes.

Operator

The next question is from the line of Bino Pathiparampil from IIFL.

Bino Pathiparampil - IIFL Research

When you said the Fonda will be launched in a phased manner over the quarters, can we go a little deeper into that? Why is it phased? And what is the time period in which you expect to achieve the best market share?

G. Prasad

So part of the reason this is going to be a slow phasing is because of the complexity of manufacturing this product. So it's in all 60 -- nearly 60 steps of manufacturing, and hence, when we launch the product, I think we'll be able to fully exploit the market share of the product in like 3 months from now.

Bino Pathiparampil - IIFL Research

Okay, great. Just today, there was in FD a lead that you got an approval for Palonosetron Hydrochloride...

G. Prasad

It's tentative approval.

Kallam Reddy

It's a tentative one.

Bino Pathiparampil - IIFL Research

It's a tentative one. Okay, great. A little date before, did I hear that you said you already got the approval?

Kallam Reddy

Yes, we have received the approval. We should be -- we are hoping to launch.

Bino Pathiparampil - IIFL Research

Okay, great, great. And finally, housekeeping which is in recognition from the previous question. In the calculation of EBITDA, you have added back interest of about INR 32 crores in your press release, whereas the interest in your P&L is only about INR 4 crores or INR 5 crores. So what is the disconnect there?

Umang Vohra

So, Bino, the interest in the P&L is actually the net finance expense so that includes ForEx gain also. You can see the last page of the press release, it will give you all the components adding up to -- if you move the united -- 16 below ForEx gain this quarter.

Bino Pathiparampil - IIFL Research

Right. So with that number you had, you will now be glued to ForEx?

Umang Vohra

That's right.

Operator

The next question is from the line of Sonal Gupta from UBS.

Sonal Gupta - UBS Investment Bank

Just wanted to get a sense on have you seen a weak trend in terms of growth in Other CIS markets other than Russia and also in the ROW market? I think you're seeing a sort of weak or even -- over the last couple of quarters. So I just wanted to get a sense on what's happening there.

Kallam Reddy

Couple of markets are under devaluation, right, so Venezuela was one and also Belarus, which was -- I mean, we are talking about steep devaluation of the currency. So that's, well, one impact of what has happened, and that's what the issue was. Other than that, I don't think there's too much that we are concerned about right now.

Operator

The next question is from the line of Girish Bakhru from HSBC.

Girish Bakhru - HSBC

Just on Fonda, but an off-side one, to understand if there is any difference in the -- basically if there are different channels where Fonda has probably more taken churn like it's probably based -- hospital-based channel, which probably be for the product more. Just a little more color on that?

Kallam Reddy

Yes, yes. So Fonda is split about 60% hospital and 40% retail and wholesale.

Girish Bakhru - HSBC

Okay, 60% is hospital?

Kallam Reddy

That's right.

Girish Bakhru - HSBC

Okay. And I know of course, U.S. launch is pretty much priority right now, but any update on the new filing? Where does that stand right now?

Kedar Upadhye

Yes, I'm still writing an update on that as yet. Well, the data is soon to be runs until next year, Girish...

Girish Bakhru - HSBC

Yes, I understand the exclusivity 'til 2012, but I mean, filing would, of course, be in preparation, right?

Kedar Upadhye

Yes. So we are not commenting on that right now but it is our plan to try to monetize Fondaparinux as much as we can across-the-board.

Girish Bakhru - HSBC

Okay, okay. And I just wanted some more color on the U.S. sale. U.S. sale has been, of course, has been pretty strong, and of course, OTC launch, it's been there. But how have been the launches, say, in higher strength and also to the other launches, which were pretty recent. How have been the markets share there? And what is the color on where the base sales might actually go to, say, by end of the year? I mean, excluding -- it's only excluded launches that's maybe coming in the later half of the year.

G. Prasad

So these products are highly competitive because of very large number of players' launching a product. So I don't think they're fond of significant amount [ph] of profit.

Operator

The next question is from the line of Abhay Shanbhag from Deutsche Bank.

Abhay Shanbhag - Deutsche Bank AG

Picking a question forward on Fondaparinux. You said 60% in hospitals, 40% is also retail. Right now in the press review, we are indicating that you will be targeting wholesale, retail. So is that what you'll start off right now, targeting 40% of the market?

Umang Vohra

Yes, that's right.

Abhay Shanbhag - Deutsche Bank AG

And what do you say the increased months time you will then target the balance of the market? Yes, in terms of hospital situation, because of the field that I know you don't really have the main injectables in place, so what sort of tie-up, marketing tie-up you would have to take this product forward?

Kallam Reddy

So this one is a little different from the rest of the products that sell in the hospital, so it doesn't require that kind of a special GPO-type of an organization.

Abhay Shanbhag - Deutsche Bank AG

And what sort of market share can we presume, say, about March, April next year? Can we assume a 20%, 30% market share build up for April, May, June next year? Or will it take longer to reach market share like that?

Kallam Reddy

Abhay, we're not commenting on that as yet.

Abhay Shanbhag - Deutsche Bank AG

The last one was on Russia. You indicated 30% is OTC now. How much is hospitals as a percentage of your Russian revenues?

Umang Vohra

Less than 5% would be hospital. And we have plans to see what products we could pick and choose to increase that portfolio and prepare it for the biosimilar and then the other oncology products that we'll be launching in the near future.

Abhay Shanbhag - Deutsche Bank AG

Okay. Any outlook on the Russian pricing? Is there any transition? Is there any expectation of any price changes or structural changes from the Russian market?

Umang Vohra

We haven't heard anything in this quarter, which is significantly the same from the previous quarters. However, we will continue to maintain the standard. We don't see anything drastic happening in Russia, except that the long-term trend of that market will be to probably correct a bit in terms of pricing.

Operator

The next question is from the line of Bhagwan Chowdhry from Indiana Based Securities.

Bhagwan Chowdhry

All my questions is answered.

Operator

The next question is from the line of Ravi Agrawal from Standard Chartered.

Ravi Agrawal - Standard Chartered plc

Yes. Just a question on the GSK penicillin facility. If you got non-recognition $5 million on a monthly basis, that's a regular trend, right?

Umang Vohra

That's quarterly, that's quarterly. $5 million -- sorry, there are 2 things that I indicated. $5 million was the cost that we had in this quarter, and the average sales that I mentioned on the subsequent question was $5 million per month.

Ravi Agrawal - Standard Chartered plc

So tablet seemed almost steady [indiscernible] $5 million a month.

Umang Vohra

Can be $5 million, but it will spread between $2 million and $8 million depending on the season.

Ravi Agrawal - Standard Chartered plc

Depending on the seasons, yes.

Kallam Reddy

But the cost is $5 million roughly per quarter. So what we've shown in this quarter is $5 million costs.

Ravi Agrawal - Standard Chartered plc

Okay. Just going on in the question on the penicillin facility. I do believe one of the reasons for acquiring the facility was also to take part in the tender businesses which come up in the U.S. and, I assume, to share the growth whether you could actually see some upside in terms of revenues, some tenders in that facility for this year?

G. Prasad

As of now, I think we should go with this $50 million on an annualized basis [indiscernible].

Ravi Agrawal - Standard Chartered plc

Okay. The second question is on the ROW markets and the growth of around 6%. When do we actually see the benefits on the GSK lines so emerging markets actually begin to flow in terms of some of the numbers other than the markets? I mean, you've had some sales coming from some markets last year.

G. Prasad

Meaningful numbers towards 2014.

Operator

The next question is from the line of Anubhav Aggarwal from Crédit Suisse.

Anubhav Aggarwal - Crédit Suisse AG

I just want to understand the SG&A slightly better. Many say for the business facility, the cost is $5 million. Is that all the fixed costs which is included in SG&A?

Umang Vohra

No, SG&A has about $2 million.

Anubhav Aggarwal - Crédit Suisse AG

Okay. So if we'll just look at SG&A sequentially, excluding the amortization part, it just increases roughly around $10 million. So $2 million for the Bristol facility. So when do you ramp up? Let's say for the full year sales of $50 million from the Bristol facility, what could be SG&A component look like?

Umang Vohra

I don't think SG&A will change as much.

Anubhav Aggarwal - Crédit Suisse AG

It's fully factored in there. So tell me, should we consider this as the base -- the 2 base to go forward for the SG&A part? Or is there some more costs other than this could be added -- other than factoring the normal increase in personnel cost every year.

Umang Vohra

This could be considered as base except the quarters where we might have to spend on OTC in Russia and other one-time expenses.

Anubhav Aggarwal - Crédit Suisse AG

So that incremental spend on OTC in Russia would be for these future products. But for the current product that you have in the market, the expense is very much there in the numbers. Would that be...

Umang Vohra

Even for the existing products, the timing of various compounds might be spread across various quarters.

Anubhav Aggarwal - Crédit Suisse AG

Okay, just to understand this slightly better than -- is first quarter on a higher side or a much lower side in terms of OTC expense? And what portion are you -- I mean, for example, if I look at the SG&A numbers, for example, the 631 growth for this quarter excluding SG&A and the impact on the others. What is the OTC expenditures part of this? I'm just trying to understand this part slightly better.

Umang Vohra

We aren't guiding to that level of granularity. But if you were to look at maybe our quarter 3 or quarter 4 and our quarter 1, right? Quarter 3 of last year, quarter 4 of this -- of last year and quarter 1 of this year, you will come to a rough average around the level that you're talking about.

Anubhav Aggarwal - Crédit Suisse AG

Okay, that's helpful. And this next question was just on the India business. Just -- you did mention about several products. But on therapy business, can you just give this therapy value facing the mix and pricing pressure? Is it like more in the acute side? And even the acute side is like being impacted SG&A. Has that kind of affect the outlook?

Umang Vohra

It's more on the acute than the cardio side.

Anubhav Aggarwal - Crédit Suisse AG

Okay. And not much of pressure in effective SG&A on both?

Umang Vohra

[indiscernible] doesn't really affect us too much because we don't have to bigger portfolio on that.

Anubhav Aggarwal - Crédit Suisse AG

Okay. And just one more question. On the gross margin on the PSAI segment, like, sequentially they were down from, like, some 27% to 24% level. Why is it only being imported? Because imported potentially for you guys came in at second of the quarter like -- so what was the essential reason? Was it just the problem with the service business?

Kallam Reddy

It was a service business problem, and it was slightly higher input costs, which have, after accrued is corrected a bit, have did not -- have begun to even out.

Anubhav Aggarwal - Crédit Suisse AG

Okay. And just a last question here on the tax rate. For this -- the true tax rate for this quarter, something like 17.5%?

Umang Vohra

Yes, that's right. 16% is the true tax rate for this quarter.

Anubhav Aggarwal - Crédit Suisse AG

Okay. And that's for the base business venue, so you could -- for the purpose of value to 21%, but for the base business, is 16% a more definitive number or is something higher is more representative?

Umang Vohra

16% is the more representative of this case.

Operator

The next question is from the line of from Sameer Baisiwala from Morgan Stanley.

Sameer Baisiwala - Morgan Stanley

Can you update us on the 2 industrial accidents that had happened in December and then one after that, in which we had 2 deaths each? Specifically, have regulators visited your Bollaram facility after that? And could this culminate into something more serious like a warning letter in Portalet or something like that?

G. Prasad

The accidents took place in a [indiscernible] facility. One was a fire accident, and one was nitrogen caused an asphyxiation in a confined space. Both teams [ph] have been investigated. In one case we've applied a short card notice, another one the proceedings are going on. We expect some investigation and some regulatory action on both, but nothing which should stop manufacturing or other financial impact as such, but there could be some action by the department.

Sameer Baisiwala - Morgan Stanley

Which department you're referring to? Is it a local authority or is it your...

G. Prasad

Yes, it's a state authority, local -- maybe state authority. Nitro factions which comes from the Ministry of Labor.

Sameer Baisiwala - Morgan Stanley

Okay. But ever since then, do you have regulators from foreign countries visiting in?

G. Prasad

No, this has more indication on Bolloram regulators. They had no sort of jurisdiction on this.

Sameer Baisiwala - Morgan Stanley

Would FDA now, at some point in time come over here and do inspection?

G. Prasad

Nothing to do with the quality of the product. Both were industrial accidents, involving people equipment. So there is no product involvement.

Sameer Baisiwala - Morgan Stanley

Okay. And just a bit of some of this useful strategy ramp-up that you've mentioned on a previous call. Has that started? Or when should we expect that?

G. Prasad

So part of the ramp-up -- part of the shift of manufacturing from here to there has slowed down because we've got additional business in Shreveport. That includes more customers. Some of the products, that they used already when we purchased the facility. And so hence the shift from there has been slowing down. So the facility is fully utilized now, and we're actually expanding the facility.

Umang Vohra

So in quarter 2, we should see some revenues on account of that.

Sameer Baisiwala - Morgan Stanley

Okay. And I guess that you've had a good flex of clean OTC launch. Has this been good enough to make up for what you had lost on exiting on a value basis?

Kallam Reddy

Yes, it could be something. On a full year basis, it could be.

Sameer Baisiwala - Morgan Stanley

And just one final question on Fonda pricing. Is this something that is more or less in line with what happens with the one-player market dynamics that's also generated this 20%, 30% generation? Or is it something different than that?

G. Prasad

We hope it could be that.

Operator

The next question is from the line of Nitin Agarwal from IDFC Securities.

Nitin Agarwal - IDFC Securities Ltd.

A couple of them, one is on the balance sheet loss around when the -- within the annual report, we've stressed quite a bit upon our capability in biosimilars and that being a medium-term growth driver. So beyond the launching that you've done in India, how do you see the biosimilar route mapping out for us over the next 2 to 3 years?

G. Prasad

So we had started with this single product in markets, which will allow us to register products on basis of the clinical trials they've done in India and some marginal additional trials. So that revenue, I think, will become significant by 2014 or so. But the real value or nothing will happen when the products have launched in the U.S., European and European markets. So for these we have to do much bigger plans. And our plan is to partner with somebody who has the expertise to do large-scale clinical trials and then detail and market the product in these geographies. So we are, in the meanwhile, we have progress in the product lined on the TMA and with new EMEA meetings. We have requested for a meeting with the USFDA, and the process of registering and doing the clinical trials will continue. We will not wait for a partner, but we believe that the full potential of the first few biosimilars funded up to register will be unlocked given a strong partner. But these patients have to expire there to do the trials or to file. So they are a little bit away, 2016, '15, '16 onwards.

Nitin Agarwal - IDFC Securities Ltd.

But how material could the Rest of the World actually be for you for some of these products?

G. Prasad

I hate to put numbers, but they'll be significant.

Nitin Agarwal - IDFC Securities Ltd.

Okay. And so in terms of India, how many new products in this biosimilars strategy could you launch over the next -- so you've already launched 4, so how do you see that playing out in India per se?

G. Prasad

I think we should launch another product in the next 12 months and repeat that every 12 months.

Nitin Agarwal - IDFC Securities Ltd.

Okay. And on the USDs side, you have recorded $129 million sales for the current quarter. So barring the launch that will come incrementally for the existing budget product, is that like a base that's pretty much [indiscernible].

G. Prasad

Yes, pretty much to assume the business.

Nitin Agarwal - IDFC Securities Ltd.

And in terms of the pace of market, the market share addition, which is there on land, to impact you. I mean, is it instant significant upside left in terms of more market share gains? Or are we kind of maxing out on market share gains that you can have on these products?

G. Prasad

Some products there is room -- headroom there, but not all.

Nitin Agarwal - IDFC Securities Ltd.

Okay. And as lastly, how many products have you think you launched out more during the year, going forward?

G. Prasad

Something like 10 to 12 products.

Kallam Reddy

There are about 10 in the U.S.

Nitin Agarwal - IDFC Securities Ltd.

And barring the 2 or 3 that you've talked about in terms of the niche opportunity risk of them, all of them are going to be examined now? Or there are going to be some dressing up, some interesting launch and even in the one that we have during -- that you specifically mentioned?

G. Prasad

I wish I could comment with a bit of accuracy in the call. Sometimes you are flipping through the [indiscernible] of a big win, and sometimes [indiscernible]. But I do think there are significant possibility.

Operator

The next question is a follow-up from the line of from Saion Mukherjee from Nomura.

Saion Mukherjee - Nomura Securities Co. Ltd.

Just one question on the Mexico facility and the impact of import alert. [indiscernible] we've announced to market Naproxen. What is the overall yearly impact that you see because of the import alert?

Kallam Reddy

Free from the Mexico facility, we have a sale of, on an average, about $60 million a year, right. So you come in with Naproxen, which is half of that, and you have then some of the products. Also that's the extent of if you should take [indiscernible].

Saion Mukherjee - Nomura Securities Co. Ltd.

Around $30 million.

Umang Vohra

For this full year...

Kallam Reddy

Full year, by the way, so...

Saion Mukherjee - Nomura Securities Co. Ltd.

Okay. I mean, on an annualized basis, it will be around $30 million?

Kallam Reddy

.

Yes.

Saion Mukherjee - Nomura Securities Co. Ltd.

Okay. On the R&D cost, you mentioned about increased or a step-up in R&D spend because of complex filing biosimilars and proprietary products. I mean, what is the level of R&D spend that you could expect? What is the level of step-up that you are kind of thinking that in absolute level?

Kallam Reddy

Yes. So I think, in the past, we used to be at around 6% of the sales. Even the first quarter we have roughly around that. I think what we have generally guided is that, well, we should be above 7%, 7.5% of sales. That's what we expect it to be, which is quite significant of a step-up because when you think of sales increasing and then you think of percentage of possible in half increase on top of that.

Saion Mukherjee - Nomura Securities Co. Ltd.

Yes, so basically, if we're talking about $2.7 million in Slide 14, so we could expect around 7% of that to be the R&D spend?

Kallam Reddy

That's right. 7% to 7.5% assign on some of the biosimilar drivers there.

Operator

The next question is from the line of Surajit Pal from Elara.

Surajit Pal - Elara Securities (India) Private Limited

I was just -- as you say, that you will be targeting 40% of Fonda market in U.S., which has been the tail end of sales, and 60% are special and injectable product. So I was thinking that, since there isn't talk about AD [ph] and if AD [ph] is given to any established hospital, generic guys like, without mentioning any names, like those already have delivered in U.S. Do you think that will have a dent on the potential revenue Fonda -- for your product?

Kallam Reddy

We don't think so, for several reasons. Because like I mentioned before, this is not a complete GPO type of a product. And we -- we are vertical on this product, and we have the best cost solution on it.

Surajit Pal - Elara Securities (India) Private Limited

Okay. So do you believe any established guy in top 3 hospital issued in U.S., if they got the AD [ph], will not impact your potential revenue? Even in hospitals, I think.

Kallam Reddy

So see, any AD [ph] would impact our potential revenue, but we are quite confident of retaining the relatively large market share over time.

Surajit Pal - Elara Securities (India) Private Limited

Okay. Another one is that, as you were saying, is that you were also putting money on proprietary technology through rerouting expenditure and winning by that kind of a niche product, as Fonda has. Are you planning or do you have in your pipeline of similar carbohydrate sensitive they've started, which is pretty complex in nature? And your team has done a fantastic job in scaling up of successful drinks. So do you have any product in pipeline? Or any expect patenting in the next 2 years time?

Kallam Reddy

We have products in our pipeline, which are very complicated and require characterization, like Fonda required. And we've got to find some of the pipeline off that.

Operator

Next question is from the line of Prakash Agarwal from RBS.

Prakash Agarwal - RBS Research

So just one question on the gross margin side. If you look at 1Q '12 and 1Q '11, not much improvement in spite of few large high-value, higher-margin products being there for last 3 quarters, 2 to 3 quarters. So any particular reason? Or is because of the lower domestic business growth, which is again, a higher-margin product for you?

Kallam Reddy

Prakash, there is -- it's a function of variety of factors, partly because of the new factor in U.S. That portion has come in the cost of books sold, that is one factor. Technically, what you rightly mentioned is the proportion of India is a bit lower this quarter. It's a result of a number of several factors like this.

Prakash Agarwal - RBS Research

Okay. And just going to Russia, I mean, we're all aware of this Pharma 2020, which is spread across 3 to 4 step functions especially talking about 2013 to '17 where it aims to replace 50% of imported generic drugs with locally produced products. Is there a strategy which we have in terms of buying out of local body or setting up own facilities? Because what I understand we are currently a marketing company in Russia.

Kallam Reddy

We still, I mean, still have to wait to see how it's actually plays out, right, so it is not as simple as just stating that this is what the company wants to do and then you could just have a [indiscernible]. So there is a lead time. By the time it will happen -- and then I think each company will come up with some strategy. So currently, we don't have any immediate plans to acquire anything local or interesting. There's several options to it. We're still evaluating. As things get progress, and we will take a stance on that, but there is no telling hurry to get into any one on these.

Prakash Agarwal - RBS Research

Okay. And on the tax rate, I think I missed something. What Umang said was 15% on a annualized basis, 21% given olanzapine being on the second half.

Kallam Reddy

Yes. So let's say, without olanzapine, we're at 16%, or with olanzapine we are at 21%.

Prakash Agarwal - RBS Research

On a full year basis?

Kallam Reddy

That's right. And that's why this quarter is what we have normalized to 16%.

Prakash Agarwal - RBS Research

Okay, so going forward we would see a much higher tax rate than the annualized 16%.

Kallam Reddy

You would see the higher-than-the-16% in the quarters where we have the exclusivity and around 16% in the quarters that we don't have.

Prakash Agarwal - RBS Research

Okay. And any more color you could give on Lipitor? I mean, last week you had [indiscernible] stay around May or something. Can you throw us some more light there?

Kallam Reddy

We cannot comment on that right now, so we choose not to comment on that, please.

Prakash Agarwal - RBS Research

But we are definitely there in the product, that's what I wanted to understand.

Kallam Reddy

Yes, we are on that product, but I can't comment on the exact dynamics of it right now.

Operator

The next question is from Nimish Mehta from MP Advisors.

Nimish Mehta

A lot of my questions have been answered. Can you hear me?

Operator

Our line has disconnected. We are trying to reconnect you.

[Technical Difficulty]

Nimish Mehta

Just one question. I actually missed the number that you mentioned from the Bristol rather penicillin facility. How much sales have you booked from this quarter? If you can just repeat that.

Kallam Reddy

We have booked $4 million.

Nimish Mehta

$4 million of sales from [indiscernible]. Okay, fine.

Operator

The next question is from the line of Ashman Aldervesin Algash Ganga in Westmont's [ph].

Unknown Analyst -

I have a Gentile [ph] question. Indian companies would very, very high in quality, but do you still see many Indian companies in Gentile [ph] getting FDA warnings? Perhaps FDA regulations have become much more stringent?

Kallam Reddy

I would just say it's in that term. FDA [indiscernible] really have increased for the past, say, couple of years, which was the stated intent. I don't think it's far different than [indiscernible] country generally, also for all the companies because it happens. So you are seeing national companies, you've seen larger America international companies. [indiscernible].

Unknown Analyst -

One more observation I have seen, that time gap between a warning letter and an import alert has reduced significantly. Any reason that they don't want companies to fill the pipeline in the U.S., which you can market? Or what has been the reason?

Kallam Reddy

I mean, I don't know exactly why you'd ask [indiscernible]. So I can't comment on it. It's something that we're not at liberty to answer.

Operator

The next question is from the line of Chirag Talati from Espirito Santo.

Chirag Talati

My questions, I have 2 questions. So the first, if we look at your annual report, your EPB [ph] and your net credits have wound up materially this year as a percentage of sales. How should we look at that going forward? I mean, could that decline? Do scries [ph] have an impact on your margin for [indiscernible] to under FY '13?

Kallam Reddy

I'm sorry, could you repeat your question? We didn't get the last half of it. Could you just repeat it, please?

Chirag Talati

Yes. So I mean, if we look at your annual report for FY '11, then the EPB [ph] credits and other related credits have gone up materially as a percentage of sales, almost double -- more than double, how should we look at it going forward? I mean, if that goes down, could we see it's halting the margins for, say, FY '12 and FY '13? How should we look at it?

Kallam Reddy

Not materially. It should not impact the margins materially because I think the government will also announce a separate scheme or extend the BBJ [ph] scheme at possibly in higher rates. So we don't expect too much of an impact on margins. However, the numbers that you're seeing in our annual report also announce what we sold in terms of Fexo-Pseudo into the market, so for the jump that you're seeing includes that.

Chirag Talati

Okay. And one question, could you update us on how do you see -- how you -- how the business evolve for Thomas Pharma as a whole? And how do

see that going forward? And some update on your terbinafine product for visual [indiscernible] and whole?

Kallam Reddy

Well, the terbinafine's trials are ongoing. We do not have an early read. We have not gotten early read kind of a methodology for that trial. And we hope to receive data from that over the next one year. On proprietary products, our business is approximately $20 million in size. And we are hoping to add more from our pipeline to take that higher as we go along.

Chirag Talati

How -- I mean, you acquired Cloderm, so how should we see the potential of like product in terms of peak sales, going forward?

Kallam Reddy

We aren't guiding to that as yet, Chirag, so we'll have to -- we're not guiding by each product sale, but the rationale for that acquisition was to have -- to enable us to be a little bit more critically sized on the Promius space.

Operator

Ladies and gentlemen, due to time constraints, we will take one last question from the line of Vishal Bakshi [ph] from IDBI Mutual Funds.

Unknown Analyst -

Just on the margin trend. You said from June 1, midyear, actually started supplying for the AOK tenders. What -- I mean, how much of an erosion you're going -- seeing going forward? Or is this the margins, I mean, made this time, sustainable? What's your take on it, sir?

Umang Vohra

Vishal, we've gone over comment on specific margins, specific to the AOK tender. But what we said is for the overall Germany business, that's just from the year-on-year price compression, we could see some margin step. Although like overall consolidated financials, we don't feel there will be any noticeable impact.

Unknown Analyst -

Okay. And also on the annual average figure, you said around $5 million for the GSK penicillin facility. Does that include the ones you told you launched from quarter 3? Does that include the $60 million or annual figure includes that?

Umang Vohra

Yes. So it might be phased in that respective quarter in which the launch happens. So what we said, the monthly range could vary. And on an average basis, it could settle down to about $5 million or so but, yes, this is a forward-looking statement so, yes.

Unknown Analyst -

Okay. And on the R&D focus, if you could just reemphasize on the focus that a P&L you are looking at going forward? Because you said your filings are going to come down, and it will be more than a complex product-based filing. So if you could reemphasize value focus right now?

Umang Vohra

Yes, it can be -- from the U.S. side, it will be more dictated by the patent expiries. And as of now, we don't have any therapy bias in the portfolio. But from a complexity perspective, we would like to increase the proportion of characterization-led products because that's where our strengths lie.

Unknown Analyst -

Okay, okay. And also on the devaluation of currency, which happened in some of your markets you mentioned, are you actually changing the strategy towards your hedging policy or you'll view -- I mean, will this impact flow through other quarters also? How would that play out?

Umang Vohra

Yes. So the specific markets in which we create this devaluation challenge were Venezuela and Belarus. And we don't believe a cost-effective hedging solution is available for these markets. And development has already happened. Obviously, the effect will flow through in the coming quarters.

Operator

Ladies and gentlemen, that was the last question. I would now like to hand the floor back to the management for closing comments. Please go ahead, sir.

Kedar Upadhye

We thank all for joining Dr. Reddy’s senior management for the earnings conference call for quarter 1 FY '12. In case you need any additional clarifications, please feel free to get in touch with Rajan, Milan or myself. Thank you, and good evening to all of you.

Operator

Thank you, gentlemen of the management. Ladies and gentlemen, on behalf of Dr. Reddy’s, that concludes this conference call. Thank you for joining us, and you may now disconnect your lines.

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