Ajanta Pharma Management Q&A: July, 2012

Management Q&A

1. AJANTA PHARMA HAS HAD A GREAT RUN OVER THE LAST FEW YEARS. SALES HAVE DOUBLED IN LAST 5 YEARS TO OVER 600 CR WHILE NET PROFITS HAVE GONE UP MORE THAN 3 TIMES TO OVER 66 CR

Kindly take us through the journey and key success factors. Kindly explain Ajanta Pharma’s business model segments. Kindly explain how the company decided to concentrate on “Prescription-Sales” led business model.

Although we started operations way back in 1973, what you are seeing today – the seeds for this was really sown in the conscious choice we started exercising almost a decade back in 2002-03 – when we decided to concentrate on the Generics Formulations business with a 3 pronged focus – 1. Branded 2. Specialty 3. Innovative

We decided we will play in the branded generics space. We will not go for everything – we will have different basket for different markets -specialty segments. We will focus on country specific disease profiles. And we will bring innovative first-time products to the market.

The Innovative plank focuses on 2 aspects of delivery for the patient 1. Convenience 2. Compliance. For e.g we were the first to introduce  Met-XL  – a single dose BP drug. Similarly we have introduced several opthalmology products for the first time as eye-drops (which hitherto could only be taken orally with attendant acidity and gastric side effects). The convenience aspect encourages both doctors and patients to ensure better “compliance” to prescribed medicines.

How long did this process take? What were the main challenges on the way and how did the company manage these?

As mentioned before, this has taken us almost 10 years to reach where we are today. It has been a slow, careful and calibrated approach. In 2002-3 we were slightly negative on P&L or just break even. We could write-off accumulated losses only in 2005 (we were in a position to do it earlier also) since RBI permissions for the same were received only in that year.

We made a conscious decision to move away from low-margin tender-based sales. We invested in R&D and gradually built up the direct sales force.  In the last 3 years Direct Sales force has climbed up from 600-1300-2000.

Is it true that currently Tender based Sales constitute less than 20% of Sales?

For the last 3 years Tender-based sales contribution has been zero. We do have some institutional sales but those are based on rate contracts and for our Branded Generics products.

What is the current direct sales force size? And the distribution network?

We rely on a country-wide C&F Agents network, with our 2000+ direct sales force.

2. PRODUCT SEGMENTS

Kindly explain major product segments and their contribution to Revenues.

Cardiology, Dermatology  and Ophthalmology are our existing specialty segments. Orthopedics, ENT and Gastro Intestinal (GI) are the new Specialty segments that we have entered. As per IMS 2011, we are ranked No. 7 in Indian Opthalmology Industry valued at ~800 Cr. In Dermatology we are ranked 18th (Industry ~2600 Cr), and in Cardiology segment we are ranked 31st (Industry ~5300 Cr).

75% of Domestic Revenues come from our top 3 segments of Ophthalmology, Dermatology and Cardiac. Balance 25% come from new segments like Orthopedics, Gastro Intestinal and the Institutional segment

How has the company managed to produce Top 5 Generic brands in the Derma, Opthalmalogy and Cardiac segments?

Ajanta Pharma has leadership in many sub-therapeutic segments across specialties. We have been able to consistently move up the IMS rankings. This year we have been ranked 50th overall in terms of Sales in Indian market. This is because of our strategic focus, innovative product portfolio and leadership in many sub-therapeutic segments. We introduced many first to market products providing patient convenience & compliance.

In Opthalmology the company has totally 30 brands. 9 are leading brands with top 5 IMS ranking. Of these more than 16 products were first-time launch in India. Similarly in Dermatology we have some 34 brands. Leading brands are 4, with more than 10 First-time launch products in India. In Cardiology total brands are 51. leading brands are 3 with more than 6 first-time launch products in India.

Apart from the R&D skills, what does it take on the Marketing PUSH side?

New specialty segments, new product launches, brand building exercises and consistent investment in expanding quality direct sales force. In the last 3 years the sales force has gone up form 600 to 1300 to 2000. That is the main investment on the Marketing side.

Kindly take us through how your R&D spends and Marketing Overheads spend have looked over the years – as you made the transition majorly to the Prescription-Sales model?

We have one of the highest R&D spends among pharma companies of similar size. we spend 6.5% of Sales on R&D. We have invested in over 200 skilled personell with a 35000 sq feet dedicated facility.
Marketing spends will also be in a similar range.

How do you go about maintaining/augmenting market share of the top generic brands in domestic markets?

We have dedicated divisions responsible for each segment. They are responsible for chalking out individual programs in a very dynamic environment.

3. ROW EXPORT SALES. EXPORT SALES CONTRIBUTE MORE THAN 60% OF SALES.

Kindly explain the business model adopted in your ROW markets.

We are present in around 25 countries in Africa, South East Asia, Middle East, Central Asia and Latin America. Each country is treated as a different market. We have 1 distributor we go with for each country. With around 1300+ brand registrations across countries filed, we also have another 1300 or so brands under approval to ensure future growth.

The company has a policy of targeting select geographies for export of select products? How do you go about identifying such target markets? What are the criteria used?

We study the country specific disease profile, dissect what’s missing – again from the convenience & compliance angles. As explained above, this is a result of a detailed formalised market study.

What’s the revenue mix there between prescription-sales and tender-based sales there?

No Tender based sales.

How many employees in ROW markets? And in your experience is this better than the distributor-led model? Why?

We have a distributor in each country. We have some 300 direct sales force in RoW markets.

What’s the company’s hedging policy? How does it plan to manage the volatility ion Forex?

We do not hedge except for the natural hedging available by way of Foreign Currency loans.

4. USFDA AND ANDA APPROVALS. THIS IS A BIG SHIFT IN STRATEGY FOR THE COMPANY. TILL NOW THE COMPANY’S SUCCESS WAS ATTRIBUTABLE MAJORLY TO SUCCESS IN DOMESTIC AND ROW EXPORTS.

2 ANDA Approvals in 16 months. And 7 more filed in 2012. Kindly explain the segments these 2 products are launched for. What is the annual market size? How many companies with the same approvals?

Please understand the US market foray for what it is. We have deliberately not gone after blockbuster drugs. The market sizes for these products are small. You should see this as another means for us to diversify our geographical reach and open up additional revenue streams from new markets . We have had good success in RoW markets, and we do have some product advantages, but competition is not far behind!

While this is no doubt a very big achievement for the company, how long will this segment take before significant contributions come in? What kind of revenues can be expected from this segment in FY13?

Revenue contributions will not be significant, any time soon. You see today RoW markets contribute ~US$ 70 Mn. Even if we take a product basket of 10 approved ANDAs with a $4 Mn annual average business, it will add upto some $40 Mn. That itself will take some doing.

Kindly explain the Distribution/Sales model adopted by the company in US. What kind of partnerships have you struck? How does the company plan to ramp up sales in US market? What will it take for significant business to be derived – and by when?

The US is just another market for us. We have appointed 1 local distributor who will take care of Sales & Marketing efforts. We will not looking to have our own set up there.

What are the costs involved per ANDA filing? There are reports that additionally GDUFA fess are going to be levied which will make it very costly ($30,000 -$150,000) ? Kindly explain the impact of these and at what levels are these fees envisaged for FY13?

Yes, there are significant costs and may have a big impact on future plans. You see whatever has already been filed has been processed under existing fee structures. For any future filings, we will need to take account the new fee structures and its impact. We will have to assess fresh if it makes sense!

Why is the company focusing on developed markets? Isn’t the Indian and ROW markets large and lucrative enough? Why not push new products through well-established distribution channels in India/RoW, rather than push new products through new sales channels in US/Europe?

As explained before, RoW and Domestic markets will continue to be focus areas. Alongside we will always be looking to open up new markets and additional revenue streams for the company.

5. R&D SPEND. R&D SPENDS HAVE BEEN RAMPED UP OVER THE LAST FEW YEARS. FY13 SPEND AT 37 CR IS ~56% OF NET PROFITS.

Kindly explain your company’s R&D Philosophy and the sustainability of spends at such levels.

R%D spends at some 6-7% of Sales is something that we will continue to invest in. Regulations are becoming more and more stringent. The Approval/Registration process is getting extended. Our Focus is to remain ahead – in our specialty segments.

Many of your products are first-time launch in India. Kindly explain to us the philosophy of the company behind this strategy? What percentage is first-time products vs overall product launches in a year? Do all your first time products enjoy a 6-month or more kind of window before other competitors catch up?

The ‘Convenience” & “Compliance” focus as explained before is the mainstay of our specialty or innovative products business. The many first-to-market innovative products are based on a mix of Release profile, convenient dosages, combinations and/or new off-patented molecules.

Yes our first-time products do enjoy atleast a 6month first-mover window of opportunity to consolidate our branding. In many cases this goes upto almost a year.

Would you say this first-time product focus is an USP for Ajanta Pharma that differentiates it from other similar size branded generics manufacturers?

Yes Specialty Products is our USP and our strength. We will continue to build on our strengths. In keeping with the philosophy, the next 2 years Product Pipeline is ready, today. This rich new product pipeline should propel future growth.

6. PRODUCTION CAPACITY. CAPEX. THE COMPANY RECENTLY ANNOUNCED 400 CR CAPEX FUNDING REQUIREMENT IN NEXT 2 YEARS.THIS IS A BIG 4X KIND OF JUMP IN ANNUAL CAPEX FIGURES.

Isn’t this a very aggressive move? What are the current capacity utilisation levels? What are the underlying business/market assumptions that would require such a jump in Capex? Is there any link with the US market Foray?

We have 5 manufacturing facilities. 3 are formulation facilities in Aurangabad and 1 formulation facility in Mauritius for African countries. And 1 API facility in Aurangabad. Our Paithan formulation facility is one of the best in the country and approved by USFDA, MHRA, WHO Geneva and MOH of many other countries.

Yes, you are right about the jump from our normal Capex levels. There are good reasons for the move now. You see currently some 30% of our production is outsourced. At the rate we are growing, within 2 years it would have meant 50% of our production being outsourced.

We thought about it and decided we cannot take that risk – for the kind of specialty/innovative products we are in. We need a certain degree of control over Timing, Launch readiness, Quality. Besides that 50% of outsourced manufacturing when brought in-house will allow us greater operational efficiencies.

Also it will help us streamline product segmentation. Today we have only 1 plant that is USFDA/MHRA/WHO approved, and that already is working at 75% capacity utilisation levels as it caters to other markets as well. We are looking to dedicate this 1 plant exclusively for developed markets. Approvals for a separate new plant usually takes 24 months.

This will mean is we can switch other production in this plant, plus the outsourced portion, to the new plant/or other plants.

Does this mean you will stop outsourcing altogether?

Well, some 20% to 30% outsourcing may continue.

Is funding secured with the $55 Mn ECB and Internal accruals? What will be the order of Maintenance Capex needed over FY13 and FY14?

Yes, this ECB Loan comes with a 2 year moratorium and 4 year repayment period terms. Maintenance Capex will vary from 20-30 Cr and can go-upto 50 Cr depending on the specifics/de-bottlenecking, etc.

Post ECB, the company will have US$ receivables and payables in US$ as well, how much of a natural hedge will this bring in? Will there be major changes to existing hedging policy?

Yes, we probably have to re-look at our Hedging Policy.

7. WORKING CAPITAL. WORKING CAPITAL HAS GONE UP SIGNIFICANTLY TO OVER 25% OF SALES COMPARED TO EARLIER 20%. DEBTORS AND INVENTORY HAVE BOTH GONE UP BY OVER 25%.

What is the outlook for the next 2-3 years? As the company operates at a larger scale, will this keep going up? What are the company’s targets on this front?

Inventory levels went up this year due to some specific Raw Material situation. We should be able to revert to our normal 20% levels as Inventory Days. Debtor Days will probably remain at 25% levels.

8. MARGINS & PROFITABILITY. MARGINS AND PROFITABILITY HAVE MADE BIG UPWARD STRIDES IN THE LAST FEW YEARS. FROM ABOUT 6% LEVELS IN FY08, NET MARGINS HAVE CROSSED 11% IN FY12. OPERATING MARGINS HAVE TOUCHED ~21%

What are the key success factors? Where do you see margins stabilising? What is a sustainable level for the next 2-3 years? Why?

Yes in terms of EBITDA improvements that we have seen over the last few years, we have probably peaked. That pace will slow down, we may register small 100 bps kind of improvements. We certainly hope to be able to sustain at these levels.

9. WHERE DO WE GO FROM HERE? WHAT IS THE NEXT LEVEL FOR THE COMPANY?

Post completion of planned Capex (400 Cr) what is target revenue mix and target margins from different geographies (FY14-FY17)?  Where do you see the company in the next 5 years? What are the major milestones on that road and what are the major challenges?

We have our internal targets, for sure. We are here today because of what we started doing say 3 years back. We will be in a different (better) position 3 years into the future. The idea is to focus on our strengths, keep persevering in our goals, ensure that we make progress and not slip back or fall down from where we are – in spite of all the dynamic changes in the environment.

We want to be CONSISTENT, keep growing at a steady pace. We want to keep growing above industry average with improved profitability.

In 5 years time, what % of revenue will come from the US and ROW Exports, and what % from domestic?

Domestic will continue to be ~37-40% contribution levels. US contribution will be bigger.

10. LONG TERM VISION

Kindly elaborate on the long term vision and the strategic directions the company will be setting goals for itself.

You see 4 years back we were ranked 163 among Pharma companies in India as per the IMS MAT Survey. In 2012, we have made it to the 50th.

We will continue to focus on our main Segments. In Optha we are number 7 currently, our aim is to reach No. 2 position there. Similarly in Derma we are at No 14, we can considerably improve on that.

Which among dermatology, cardiology, ophthamology or other segment are the thrust/focus areas for the company? Where does the company see maximum potential for growth?

In India, the Basket approach works better. Doctors give priority or preference to a company with a larger basket of products in their segment. A cardiologist for example, will prefer an MNC company with say 5-10 products than say an Ajanta Pharma with say only 2 products.

Dermatology, Ophthalmology and Cardiac are focus areas for the company. In Ophthalmology the Industry has grown at a 5yr CAGR of 17%, and we have managed to grow at 23% CAGR over last 5 years. Similarly Cardiology Industry segment has grown at a 5yr CAGR of 17% and we have grown at a 24% CAGR. Dermatology Industry has grown at a 5 yr CAGR of 18%, while we have managed to grow at a much healthier 32% CAGR.

There is enough growth potential in all the 3 segments and we are constantly working to increase our product basket in these segments. The new sub segments like Orthopedics, Gastro, etc also have good potential.

Is the company thinking of partnering any bigger MNC company to scale up?

The segments that we operate in are niche segments. Small market size. Some of the new segments are even smaller. Bigger MNCs are not really interested in segments of these sizes, because even a 10% share of that market is pretty small for them.

Is the company looking for collaboration/partnerships for US market? How do you plan to cater to competition from larger Indian peers in US (5-10 years span, strategy)

This is still too far away to comment anything at this stage. we will see as things develop and our penetration increases.

Given the increased generic penetration levels in next 5 years, where do you see margins stabilising in 5 years time from now?

Fortunately we are not in the mass market volume segments like the Anti-Infectives/antibiotics (we were a late entrant) where it has become ultra-competitive fragmented – just too many players.

Can’t really say what will happen 5 years from now. If Rupee goes to 80 or 30 to the US$! Or other dynamic shifts in the environment. Having said that, in the face of normal competitive activity we should be able to hold our own and sustain at these levels – given that we operate in Specialty niche segments.

11. RISKS. GOING FORWARD, WHAT ARE THE MAJOR CHALLENGES & RISKS FOR THE COMPANY?

There are many sectors coming under the Competition Commission lenses. Any chances of Pharma sector coming under its purview?

Regulatory RISK is the possibly the biggest risk the industry/company faces. Regulation and compliance norms are getting stricter and tougher. There are many forces at work. The industry on its part has been trying to engage and work with the Government – to come out with a comprehensive National Drug Policy, now for a number of years.

What are the other challenges before the company?

Forex Management is another one. Volatility in either direction is a concern and is a dynamic challenge that we have to gear up to face.

Changing consumer patterns is also a bigger challenge for companies like us. There is much more awareness and access to information on the part of consumers. We need to be able to understand and harness these shifts in consumer patterns.

12. CONSISTENT PROMOTER BUYING. THERE HAS BEEN CONSISTENT BUYING BY PROMOTERS FROM OPEN MARKET FROM OCT 2011. PROMOTER STAKE HAS CONSEQUENTLY GONE UP TO ~70% IN Q4FY12 FORM ~66% IN Q2FY12. THE BUYING HAS BEEN SUSTAINED IN Q1FY13 TOO!

Would you like to make any comment on this? There seems to be a hurry to race to 75% stake by Promoters. Do you find the company undervalued at current levels? Are there any major events unfolding in near future??

There are no external factors at play. This is part of a natural scheme of things.The Promoters believe in the prospects of the company. And yes, they find it undervalued. They have been enhancing stake in the company from time to time.

Also pledged shares have again gone up. From 200,000 shares pledged in Q2FY12 to 550,000 in Q3FY12. Please comment.

That is only by way of financing the additional share purchases.

Disclosure(s)

Atul Sethi: No Holdings in the Company; ;
Ayush Mittal: No Holdings in the Company; ;
Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months;
: ; ;

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