Dr. Reddy's Laboratories Limited (RDY) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and a very warm welcome to the Dr. Reddy's Laboratories' Limited First Quarter Earnings Conference Call. As a reminder, all participant lines will be in the listen-only-mode. There will be an opportunity for you to ask questions after the presentation concludes. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Saunak Savla. Thank you and over to you sir.

Yeah, a very good morning and good evening to all of you, and thank you for joining us today for the Dr. Reddy's Earnings Conference call for the first quarter ended 30 June, 2017. 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 the IFRS consolidated financial statement. To discuss the business performance and outlook, we have the leadership team of Dr. Reddy, comprising Mr. G.V. Prasad, our CEO; Mr. Abhijit Mukherjee, our COO; Mr. Saumen Chakraborty, our CFO; Mr. Anil Namboodiripad, who is the Head of our Proprietary Products Business and the Investor Relations team. Please note that today's call is a copyrighted material of Dr. Reddy and cannot be rebroadcasted or attributed in press or media outlets without the company's expressed written consent. Before we proceed on to the call, I would like to remind everyone that the Safe Harbor language contained in today's press release also pertains to the conference call and the webcast. Now I would like to turn the call over to Mr. Saumen Chakraborty, our CFO.

Thank you, Saunak. Greetings to everyone. Let me begin with key financial highlights. For this section, all the amounts are translated into U.S. dollars at the convenient translation rate of 64.62, which is the rate as of June 30, 2017. Consolidated revenues for the quarter of INR 3,316 crores or $513 million, grew 3% year-on-year but declined 7% sequential. Sequential decline is primarily attributable to the lower sales in our domestic formulation business, due to channel destocking during GST transition and quarterly fluctuates in our PSAI business. Revenues from Global Generic segment at $425 million, and PSAI segment is $72 million. Consolidated gross profit margin for the quarter is at 51.6%. This quarter we had some very good launches in North America generic business. However, considering that most are follow-on launches their contribution in this quarter is low. There were few key external or market dynamics responsible for pulling down the margin, against our more recent benchmarks. These are: One, incremental price erosion in the base business in US, in addition to increased competitive intensity in some of the key molecules, enhanced customer consolidation, lead erosion, played out beyond our earlier estimate. Two, GST transition impact. This transition was characterized by significant deduction in the channel offtake and also higher return. In order to ensure adequate product availability in the marketplace, we have to make certain one-time interventions in the form of selective incentivisation, public compensation for any loss incurred by them, with respect to the channel inventory. These channel interventions have grossly impacted the margin. Three, adverse impact of manufacturing overhead deleverage. During the quarter we had lower reported sales, partly as a consequence of GST implementation and partly on account of quarter getting [indiscernible]. These factors should get normalized going forward. And four, adverse movement in currency rates. During the quarter the U.S. dollar net delivered rate depreciated against the rupee. The USD rate is now stabilized around 64 to 64.5 range. SG&A spend, including amortization for the quarter is INR1,176 crores, or $182 million, a decrease of 4% year-on-year due to reduction in spend on limitation-related [ph] expenses. We continue to explore revenue to optimize the spending. R&D expense for the quarter are at INR 507 crores or $79 million, representing 15.3% to revenues. This spend is in line with the ongoing set of development activities as planned. EBITDA for the quarter stands at INR 336 crores, which is $52 million, and is around 10% of revenue. Out net debt-to-equity ratio stands at $0.29 as on 30 June, 2017. The effective tax rate is around 23.5% for the quarter. And we anticipate it to be in the range of 23% to 25% for the full year. Key balance sheet highlights are as follows: Our operating working capital increased by INR 283 crores or $44 million during this quarter, primarily due to increase in receivables in North America generic business. We remained focused on optimizing the working capital cycle. Capital expenditure for the quarter were INR 272 crores or $42 million. Foreign currency cash flow ranges for the next nine months in the form of derivatives for U.S. dollar are approximately $240 million, largely hedged around the range of INR 66.3 to INR 68.7 to the dollar. In the recent we have balance sheet hedged of $374 million. We also have foreign currency cash flow hedges of 900 million ruble at the rate of rupees 1.135 to the ruble, maturing over next nine months. With this I now request Abhijit to take through the key business highlights.

Thank you, Saumen. Greetings to everybody, and I extend a warm welcome to you on this earnings conference call. Let me take you through some of the business highlights for each of our key markets. Please note that in this section, all references to numbers are in respective local currencies. Our North America revenues for the quarter are at $230 million, on Q-on-Q basis we have managed to sustain the overall business and in fact grew marginally despite multiple challenges. Our base business witnessed pricing pressures driven by enhanced channel consolidation and increased competitive intensity on a couple of key assets; Ezetimibe and Bivalirudin [ph]. With further consolidation among buyers consortium we expect the adverse pricing environment to persist going forward. We had a fairly reasonable quarter in terms of new product with four launches, G-Vytorin has been a successful launch with strong contracted market share. We also had doxorubicin liposomal injection, our first complex injectable. We are ramping up market share and since most of these are follow on launches we expect to peak in terms of value contribution over next couple of quarters. With respect to the pipeline we continue to work with agency on the approval of our assets and remain optimistic on 2 to 3 launches per quarter. However quality overhang at our injectable facility may impact approval time range for few of our key assets. Continuing on pure generics, our Europe business is fairly stable now and well poised to deliver a profitable growth on the back of new product launches and traction in the new markets. Our emerging markets business is on track to gradual recovery. Russia business grew 31% y-o-y in local currency. During the quarter we had our first shipment of Rituximab with a secure share under the national tender. Ex-rituximab the growth is in line with expectations. We continue to focus on improving productivity and on maintaining the pipeline. Ex-Russia the performance of the other markets were also in line with our expectations. We are well on track to expand our presence leveraging our institutional business portfolio and biosimilars. Commercialization of biosimilars across emerging markets has started to gain meaningful traction. We remain optimistic of building on this momentum further. India business revenues are at INR469 crores and declined 10% Y-o-Y, 18% Q-o-Q. The nation implemented one of the largest and significant transitions to a progressive taxation regime in this quarter. We are witnessing a lot of transition challenges and we are working towards those. There was an evident disruption in the normal flow of activities and we had our share of impact. As discussed earlier, the decline in domestic businesses is resulting from channel destocking due to transition to the GST regime, which obviously had sizable impact on our quarterly performance, there are some teething issues still being resolved and it will take some time for all the industry to return to normalcy. Subject to this we continue to focus on productivity improvement and portfolio augmentation. The API business posted revenues of $72 million. Our efforts are directed towards building a healthy order book. Our proprietary product business we continue to execute our strategy of expanding Zembrace and Sernivo. Over the past quarters we had several successful initiative to accelerate volume growth. Effective this quarter we have started focusing on more on improving the net realization through optimal payor coverage. On R&D front, the pipeline is continuing to grow. Overall progress in R&D program milestones are on track. This concludes my part. Now I will handover to Prasad for his comments.

Thank you Abhijit, thank you Sauman. From the preceding discussions on the PPT discussions you have an idea of the challenge that we face ahead. Delays in approvals, additional competition, regulatory actions have all combined to put significant pressure on our performance. Given these circumstances we have -- we the management of Dr. Reddy’s have done a strategic review of the various businesses and initiatives and have developed three high priorities for our team. The first one is of course strengthening our manufacturing and quality system. Our first priority to ensure that our manufacturing systems meet the highest level of quality and compliance. We will need to modernize some of our infrastructure, systematically implement our new quality management system and automate some of the critical manufacturing and quality related processes. To accomplish this, a number of initiatives have been taken up across all locations and this would take us a few more quarters to complete. The second priority is to revitalize growth. Our efforts to deliver a healthy pipeline of products, enabling sustainable high performance are on, and we’re focused on accelerating the development of our complex generics portfolio and also making efforts to ensure that the approvals come in time through appropriate risk management and proactive measures to deal with possible deficiencies. We’re also registering our assets in several countries beyond the U.S., in emerging markets to drive growth. This is our second priority. The third priority is really to look at our cost structure and optimize that. Over the years our fixed cost structures have outpaced our growth in revenue and we feel this must be corrected now to enable us to compete effectively in the market place. We’ve embarked on a systematic exercise to transition to a linear and flexible cost structure, focus on areas such as network rationalization, improving plant operating efficiency, R&D site optimization and productivity as well as portfolio rationalization has the potential to deliver significant savings. And we’ve already made a firm start and we expect to see some results starting this year onwards. So this concludes my commentary I’ll hand it back to you Saunak.

Hello, so we can have the Q&A session now.

Sure sir. Thank you. Ladies and gentlemen we will now begin the question-and-answer session. [Operator Instructions] We’ll take the first question from the line of Prakash Aggarwal from Axis Capital. Please go ahead.

Yeah, thanks for the opportunity. Just trying to understand the gross margin, you did mention about the India GST impact. Just trying to understand without that impact what would have been the gross margin, given the fact that we have started to see limited competition products in the U.S.?

Yeah I basically spoke about four points, which had overall contributed on a year-on-year basis, about 450 to 500 basis points deduction in gross margin. So if you see relatively the maximum impact comes from the North America Generics price erosion. And then second comes from the GST. This is specific quarter impact that we see. And of course the third one is that manufacturing overhead deleverage which is directly attributable to a level of sales, as the sales increase, definitely that we have normalized. And the fourth which is much lesser impact is due to the currency rate.

Yeah, if we exclude the GST impact sir, what could have been the normalized, because that’s something which is really one-off?

That as well as the manufacturing overhead deleverage, both would be really a quarter specific kind of thing. So we will not able to exactly give what will be the -- what would have been the thing but it will be grossly in the range of around 53 to 54, in that percentage.

Okay, and we would assume -- or is it fair to assume that this is the base case now given the fact that the approvals and launches have begun during the quarter. So you’ll have full quarter impact going forward. So this should ideally improve going forward?

Yeah assuming no further erosions takes place.

And the erosion is in line with what you have guided in the past. I mean what you have seen in the past?

If it's more than what we would have expected and in annual report we mentioned that we feel -- we said, based on last year the huge erosion which has happened, which was much higher than the previous year. So we felt that this year it would be more calibrated. But it is more than our expectation, our estimate. Erosion has been more both because of the intensity of competition as well as the customer consolidation between the three players having 82%, 85% of the market and this is the quarter when most of the RFPs happen from different customer. So that impact is felt. We could not have felt it, say in April and May, mostly it happens in June. So then we understand that our initial estimates were lesser than what has actually happened in actual.

So any broad range or -- I mean 12% plus minus or?

Yes, it is double in double digits. Two major assets I mentioned itself account for about a dozen [ph] million Q impact, [indiscernible].

Perfect, thanks. I’ve more questions, and I’ll join back the queue.

Thank you. We’ll take the next question from line of Kumar Saurabh from Motilal Oswal Securities. Please go ahead.

Yeah, hi, thanks for taking my question. So sir as you mentioned just a follow-up, I believe that only in the month of June we could realize the impact of re-negotiation of RFPs but does that mean that the full quarter impact we will be seeing in the second quarter?

No some of them had a retrospective effect as well as from 1st of April.

Okay. So, going forward if no further pressure comes from here onwards, ideally the margin should improve, ex of GST, I am talking about, US business only?

You cannot take it for granted. Normally, it is a practice of annual RFP. But one cannot take it for granted

Yes, no, no. I’m assuming that because we have good product approvals, which have come and which are expected to come in coming quarters, so taking that into account, we should see some kind of respite.

Yeah, hopefully.

And sir India business, in the current quarter are we seeing -- how confident are we that we will be able to recouped the impact which we witnessed in 1Q?

We are seeing some recovery. Confidence level is there that whatever GST impact one has seen it is -- should be limited to Q1.

And we should see that full recovery coming in quarter two?

I can't comment on full recovery. There will be recovery?

Yes, overall I think couple of quarters, I think it's -- the current run rate is very good. It is temporary hit unlike the headwinds of pricing in North America. So I think shouldn’t be that big a concern.

Sure, sure. So sir, as you mentioned that there were couple of one offs and the US business price erosion was there, so how should we look at what is the normalized margins going forward, we should look at, from second half FY '18 onwards?

I wouldn't comment on that, these are difficult to sort out to predict, I think the key issue is getting the approval and launches. That would be the probably way the most impacting factor. The headwinds which are beyond our control, we can’t do much and there isn't too much of a point trying to predict that. Overall what we’re saying is, it has been a little more intense than what we thought. Yes, I do agreed that the -- some of the juicy assets have already weed out. But hopefully let’s see whether it stabilizes a little or not .

And in terms of growth strategy, the high priority which we talked about revitalizing growth and cost control. Is there any change in strategy in terms of focus area, in terms of geographic focus? So U.S. has been our key focus area and given the challenges which we are seeing, is it fair to assume that the focus should be more in other geographies as well, or in terms of geographic focus we still continue to focus on US and India as our core markets.

The core markets are beyond US and India. US, Russia, some select large emerging markets and India. The focus on US continues. The -- most of the assets that we are developing are targeted towards the U.S., but we will leverage them in Europe as well as in all other parts of the world. We have increased our globalization of select high value assets, including biosimilars. So to that extent we are seeing more activity in the emerging markets in the medium term. So but that's not going to be a head against the U.S. The U.S. is such a large market that any other market or even a collection of markets cannot replace the growth we hope to see in the U.S.

Kumar I'm sorry to interrupt, but I would request you to come back in queue for any follow-up questions. [Operator Instructions]. We have the next question from the line of Neha Manpuria from JPMorgan. Please go ahead.

Thanks so much for taking my questions. My first question is on the other expenses SG&A expense excluding depreciation and amortization. The base seems pretty high for the quarter. Is there some incentive payments et cetera in the quarter, or is this the new base new normal for SG&A?

If you see year-on-year there has been a decline in the SG&A. Quarter-on-quarter, in the last quarter if you remember, we have talked about certain specific long-term incentives and others which were earlier accounted for but was reversed because we didn't pay due to non-performance. So that with the previous quarter manpower cost would have been lower than normal. Now what you see this quarter is a fair indication after all the increment cost that has been built in to manpower cost, but our endeavor internally is to continue to improve on these and reduce further.

So for all purposes this is the new base for our cost going forward, for the time being?

We will say this will be something for which we need to improve further quarter-on-quarter.

And sir, when you mentioned our efforts to sort of improve our cost structure to make it more lean and therefore you're expecting certain synergies. Is there a number for the synergy or sorry, for this savings that can be expected from a cost control over the medium term probably not for FY18 but how much do you think we can improve our costs by.

So we are working on this project right now. It's going to be quite substantial. I don't have an exact number but it's 100 crores kind of possibility to take cost away. Multiple hundreds of crores.

Okay. And my second question is on the proprietary business, the license -- the out licensing agreement that we announced yesterday for DFA 02. I mean is there a change in the way we are looking at the proprietary business in terms of commercializing these assets ourselves?

Well, is Anil on the call. Could Anil answer this.

Yeah, I'm on the call. Prasad you want comment first or you want me to take --.

Broadly I'm saying that we are looking at more differentiated assets and assets more aligned with our sales force. And the head line message but I leave it to you to give it more color Anil. Anil, go ahead.

Yeah, so specifically this particular asset that we licensed is a high value asset, but it was within a therapeutic area that we are not focusing on at this point in time. It's for the acute care hospital markets. So we felt that it is best developed at the hands of somebody else. And we believe the CHD Biosciences is a capable partner to develop this particular asset. The value of this asset is tremendously high, but we made a conscious decision to focus on two areas neurology and dermatology, hence this divestiture.

Okay. Are there any other such assets that we're looking at in the near term on the proprietary side or now most of the launches would be commercialized by Dr. Reddy's?

There are couple of other assets that we believe are high value and do not fall within the preview of our strategic focus. And there are discussions ongoing about partnering those as well. But we cannot disclose at this time.

Thank you. We'll take the next question from the line of Anubhav Aggarwal from Credit Suisse. please go ahead.

Yeah thank you. One question is Srikakulam plant. Just wanted to understand that once this plant comes back -- once it gets a EIR, how much of PSI sales is impacted because this plant has a warning letter right now which can get, or which gets recovered Second, how much is the unabsorbed fixed cost which is impacting our cost right now. So just trying to understand how much benefit we get once the plant comes back?

So the warning letter never prevented us from marketing the product which were there already. So what it will have is some of the assets for the future approval. Some we have tech transfer and not relevant anymore, but for the future approvals it will have an impact. As far as unused or overheads, which are unutilized, I wouldn't make a very material impact. I think for sure the injectable plant, which I mentioned is more important in terms of the launches and it's extremely important to work towards getting it back.

Yeah, which is I was thinking more in terms of whether it had any impact on the PSAI business not just this quarter, but in general because…

Yeah. So it’ll be -- some impact will be there. The flow will improve of products, and we’ve been heavily focused on remediation. We’re trying to now focus on efficiencies on floor. So there will be some impact but it won’t be very huge.

Okay. That’s helpful. Second question on the PSAI business itself, and the composition of the business this quarter was very different from the trend that we’ve seen so far, where sales in Europe has significantly and sales in India has significantly picked up. On both counts, if you can explain that. And secondly, if this trend were to, let’s say remain, if when you sell a PSAI sales in India verses Europe, are the margins very different in the two categories or similar.

No, this is a B2B business and I wouldn’t recommend -- I wouldn’t suggest that we read too much into regional sales from PSAI. These are depending on customers who pick what when. What is more is important is the last point we have mentioned that we were very focused on lot of remediation activities which sort of certainly had some disruptive effect on manufacturing and supplies. I think we would – we can focus much more now on supply chain – managing the supply chain better. So to that extent, I think it’ll be certainly beneficial and move upwards from here I guess.

Okay. Just last question on the US business. You quantified the price erosion year-on-year, Abhijit can you just give an idea sequentially as well the impact of price erosion in the US business. A – Abhijit Mukherjee: Sequentially, is not right way to look at. But if you -- I’ll give you a broad study, which we did in terms of top eight or nine generic companies, if you add there erosion and you can get it from the IMS, and add it up and then take an average that will give you the industry. Because certain quarter we could be very high. Other companies will be low and could be vice-versa in subsequent quarters. So overall, the trend for the last eight quarters we studied, and it has been eing fairly steady a forward moving percentage. Two years back it was probably 5-6. It is trending between 10 to 20 right now. Now having said that look whether this whole consolidation also has broadly -- I think we've more or less seen seeing the end of it come going further between three players 85% of the market share. So whether it will plateau out a bit, time will tell.

Thank you. We’ll take the next question from the line of Nimish Mehta, from Research Delta Advisors. Please go ahead.

Yeah. Thanks for taking my question. On the India’s business and specifically on the impact of GST, I just wanted to have a few clarifications. One obviously we got impacted because of the lower stage because of new [ph] stocking. But you also mentioned about we giving some compensation to the distributor for the kind of losses? So is there and first obviously whether my understanding is correct and if yes, what was that amount or can you quantify that?

Specifically not, I don’t think so, but there was certainly enough confusion -- in the transition, some amount, is it very significant, no. But there was some efforts to sort of keep the stocks moving. We didn’t want also the retail sales to run dry and that would’ve been apart from anything else, which would have meant secondary sales loss, which was not correct to sort of in this confusion. So I wouldn’t be very much, but yes there were some.

Okay. Understood. But that's not material, right that is what I understood?

Not really significant, no.

Okay. And second on the U.S. business you mentioned about two to three launches per quarter here, any guidance about how many high values launches specifically, launches like Copaxam [ph] will be appreciated.

Difficult to say, two to three in numbers would happen and I think you're very right. I mean what is the quality of two to three would decide everything, there are few assets and there are also few concerns after injectable sites delay, but the numbers are there and there are fewer assets without getting into specific. If things go okay then we may see a few good launches.

Quantify that, by how many (inaudible) two-three, three-four.

We just can't, because the uncertainty is because of intellectual property are fixed to faith[ph] and FDA’s approval timelines are not in our control.

Okay. Great. If I may squeeze in one, just wanted to know the fate of our biosimilars strategy now that Merck is opting out of the JV. So any thoughts that could be?

Well Fresenius who is the new owner of this business is very motivated to continue and we've had our meetings and it is going quite well. So they’ve acquired this business from Merck, they paid a lot of money. So we believe that they're very committed to building this business going forward.

Thank you very much.

Thank you. We'll take the next question from the line of Sameer Baisiwala from Morgan Stanley. Please go ahead.

Thanks. Good evening everyone. Abhijit, can you update us on the progress when with 13 observations, what's the way forward and would it require a second re-inspection?

This would require a secondary inspection, Sameer, so our position to have significant, we responded. But it will require another inspection. We are working towards it and normally one of the growth site is observation profound. There is secondary inspection and we would -- can't say exactly when we would sort of invite FDA back again, but we're working towards it. Yes.

Okay. Is it say to say that Copaxone filing is being done from here? And so -- and that's what you have said few times on the call that because some of the injectables will get delayed? And second are you looking to site switch it?

Copaxone is not from Duvvada, `there are others good at it, which are in the process of site switching. But site switching has some timeline delays. So let's see which comes through earlier and we'll take.

But optimistically, we expect to have FDA coming by the year-end, December.

Okay. And just one last question. In the context of complex generics, can you update us the progress with the patches, how many you're working on and what's a sort of filing targets?

Not very significant, Sameer, I mean, there are -- there was one which we are little delayed, there is one still alive which we have settled and maybe Q2 next year, but these wouldn't really move revenues much, I think we are still banking a lot on injectable products filed both from our side and the partner sides.

Okay. Thank you very much.

Thank you. We'll take the next question from the line of Saion Mukherjee from Nomura Securities. Please go ahead.

Yeah. Thanks for taking my question. On this cost cut and restructuring, is it possible to share like which business areas this would really come from and which line items are you talking about R&D employee cost, any color you can give on this?

It's little too early to share such details but it is, when we will consider global R&D fights, R&D [indiscernible], manufacturing network, portfolio where we don’t have enough margin from rationalization of portfolio, number of different of activities. So at this point it's too preliminary to share so that level of detail.

But you think it should come through next year or if you’ll take longer for realizing these savings?

We should start seeing impact from next year onwards and some impact in this year also.

Okay, okay, thank you. I’ll return back in the queue.

Thank you. We’ll take the question from the line of Chirag Talati from Kotak Securities. Please go ahead.

Yes, hi, thanks for taking my question. Firstly, is it fair to say that this quarter has not seen any impact from price erosion diffida being [ph] from the new competitor?

Yes, some, yes.

That would be marginal in overall context of things.

To an extent, yes.

Secondly, if you can help us for understand on your some books on product, is there any pending CRL, and if you have there and it there is so what are the timeline of refilling?

We submitted the response on the complete response later. Now we are awaiting the judgment maybe four to eight weeks as you know it’s in litigation. The outcome is important for this asset. Of course, either way this can be, if the general experience in a way to overcome challenge and vice versa. But that’s the next important milestone. On the development front, I think, we feel very good about it.

Second, just kind of fast that the follow up query, was the last response submitted to the FDA?

Yes, when? June, I guess, yes, June.

Okay, thank you.

Yes, just similar question on NuvaRin, has the CRL been responded on that?

Yes, around the same time and this is cleaner on the category front. We have had this on board Copaxone and NuvaRin in around on Q4 of the financial year. So we’ll see where it goes.

On the litigation front, there is appeals case going on if I understand, although that’s on the activist in diem [ph] , but you don’t see that shouldn’t be I mean delaying it anyway beyond April 2018, right?

You’re talking of NuvaRin is it?

Yes.

The [indiscernible] expires in April of next year in any case.

Right, Abhijit any color on, I mean how soon you’ll see competition in this product, would it be like three year, no competition?

Those are difficult questions to answer. This was a certainly difficult question to answer. I wouldn’t know there is another asset we heard that it's in development. But these are complex to assess, I mean in terms of development FDA may ask questions and ask us well although, we feel good about our development but we will see. Difficult to say about others.

Okay, idea I know on Copaxone again, when are we ready to re-file 40mg?

Very soon, in couple of weeks.

And just your follow-up on that if the decision on …

You are talking of the response to the CRL, right? I mean the updation of this thing. Yeah, couple of weeks.

Yes, so if I understand the tat on 20mg is close and if you get positive response, approval on that, would it make you confident on 40mg as well or do you these two are separately linked.

So, firstly we have a tat but these are extremely complex assets. So naturally they would be -- they may not be [indiscernible] but they would be certainly questioned, and could the CRs as well. I don't know, I mean although we have done -- we think we have done a reasonably good job. But so to assume that everything is done is certainly optimistic but let's see. If the questions are not significantly I agree than that gives certainly a directional signal towards the whole asset. Because there's not much in the formulation side, it's actually the DMS which is the same and the view of that is more critical.

All right, thanks so much.

Thank you. We will take the next question from the line of Kartik Mehta from Deutsche Bank. Please go ahead.

Just if we have to look the gross margin, which is there for the last two-three years, it has come up from about 60% to now around between 50% to 53%. Is that a reason where there is a structural issue, where we believe that since we are using third-parties to manufacture or there is higher competition, is it fair to assume that this now remains here or is there any scope for improvement? I just wanted to your thought on this.

Yeah, there's certainly room for improvement. The primary reason it has come down is also because of the price competition. And as we launch newer assets with higher margins the gross margin can go up. Our cost initiative should also help us and if you look at the current quarter there is some one time stuff also happening there. So I think gross margin should go up. Your question about manufacturing third-party would that erode, I don’t think this is a very significantly factor, while it is a [indiscernible] cost. It's not a cost which can really change the economics of our business model.

Sure, and if we have to look at the cost saving which you spoke about, would that -- and you entering into other markets, would M&A be a part of it because we have pretty low on debt and if we have to make entry an into any of the larger emerging markets with the pipeline that you have, would that be something that you consider?

Largely we are looking at not inorganic entry because we are looking at institutional sales as the vehicle for entry into emerging markets. We don’t require large sales forces or establishments. So I don’t think we really need to do inorganic growth to expand our footprint in the markets that we are considering today. But if there is a good opportunity we will not be shy of that.

No, I meant in the markets where you are not there now, maybe some other markets in Europe.

Well, in Europe we've already entered big five markets. We have two markets where we are selling products for a long time and we have established our presence in three other markets. So we don’t really need to do anything inorganic.

Yeah, and on Doxil, just this one. So how do we record here the revenue and the profit given that we have a partner and so that would just help us in terms of the margins that could flow in the next quarters? Thanks.

So it is a significant asset, it is certainly without giving a specific number, specifically we can address it and we are the dominant partner in the partnership. So based on that you'll have to sort of work in…

Yeah, so I just actually wanted to know that do we record the revenue upfront and then there is a profit share, or I mean some how is it recorded, I don’t want to --

Full revenue, we book full revenue on…

Okay. Thank you.

Thank you. We will take the next question from the line of Aditya Khemka from DSP Black Rock. Please go ahead.

Yeah, hi thanks for the opportunity. Sir what would be the product concentration now in the U.S. business for us, I mean would the top five products account for 30%, 40%, 50% of our sales, just a ballpark number?

It has reduced over the years. Right now I think -- if you take comparative figure we are lower than quite a few peers group companies, if you take the first two three year's type of a thing. But the figure which I have is available is top two assets is…

Top five would be around 25%.

Yeah.

Okay that’s helpful and sir just wanted to verify one number, Saunak mentioned that Q-on-Q because of [indiscernible] and one more asset he mentioned for these two products the price erosion has been about $11 million Q-on-Q?

I don't know.

Yes.

So between [indiscernible].

Okay and that was a sequential number right?

That was a Q-on-Q.

Okay, yeah, just wanted to check that, thank you. And just one last question on your take on the Bachupally Form 483, have you seen any product approvals since the Form 483 have been issued from Bachupally? And if not then would you -- is it fair to say that it is an OAI status with the FDA?

The only one which is pending we mentioned I think last time is Atomoxetine and I think immature to conclude anything. I think we have responded adequately and there was just one follow up question out of many observations, which we have also responded. So we’ll see where it goes.

Sir, timeline discussed with the FDA on Bachupally or is there something that you have to wait for and see what the FDA does?

Timelines, we have responded. So as I said response was sent, there was one clarification on one specific point. We have responded that as well so….

When was this response sir?

Last one was about a month back, I guess roughly our take. We’ll come back to you, month back, maybe about 15 days back or something, 15 days or a month back.

Okay, fine. I’ll get back in the queue. Thanks.

Thank you. We’ll take the next question from the line of Nitin Agarwal from IDFC Securities. Please go ahead.

Hi, thanks for taking my question. So you alluded a couple of times about this emerging market strategy. Can you just help us understand a bit in terms of potential of maybe if there are some illustrative examples of what is the kind of potential some of these assets have, relevant U.S. assets have, will you sort of take them on a pan Global footprint of sorts?

It’s significant, I think I would maintain what I said in the earlier call. I think we are getting on the institutional strategy and leveraging our assets globally. We’re getting to Brazil as we speak into Q2 and we have three approvals, three products also getting launched, Q3 may see a couple of more approvals. These are big markets, smaller markets like Colombia and ASEAN markets, biosimilars taking or gaining more momentum. So overall it’s not something which will be quick, one quarter type of thing but we’re doing it systematically, leveraging these assets globally in these markets, putting the footprint just what is needed because it is not -- while it’s B2B but it is needing our contact with the clinics and all that. So we will be deep into these markets understanding how exactly each of these clinics sort of operate on this area. And hence it is significant involvement focus which will be a result, I guess in next two to three years.

Okay, so you think it is going to be tough couple of years before it starts to show meaningfully in numbers?

Well yeah true but we will start seeing something even this year itself. Meaningful meaning what is meaningful, for us even 5 million to 10 million is meaningful, we can get going.

Okay, and secondly on the distribution angle -- distribution consolidation, which is angle, was your experience, I mean sense on that part of the business, obviously the price erosion and the business combination of the asset or erosion because of competition. But if you were to see -- if there’s a way to sort of dissect that, so what is the distribution consolidation driven price erosion which is probably a little more sustainable normal going forward or any assessment?

Not sure I understood your question. You are aware of the consolidation there are three players, right.

Right.

Clarus, Redoc [ph] and [indiscernible] combination. So what's the specific question?

Sir I'm saying, we have had erosion in the business on account of compression in our key assets as well as pressure which is brought about by the consolidation, the distribution consolidation. So is there a way to sort of segregate the two in terms of the erosion which has been brought about by the consolidation process, or what and how do you see that playing forward?

It's very difficult to answer your question in terms of numbers, because it's very asset specific. It depends on the number of competitors for the given asset and so on and so forth. But it feels very difficult to give a general answer. But it's a fact that price erosion is higher than what it used to be because of the high yields concentration of market shares among these three players. So somebody -- anybody who has his market shares will hang on to it for a long time and to dislodge that you need a bigger discount and that is where this price erosion is coming from.

Yeah.

Got it. Thank you very much.

Thank you. We'll take the next question from the line of Shyam Srinivasan from Goldman Sachs. Please go ahead.

Hi, yeah, thank you for taking my question. The first is on Aloxi, is there any update on the launch of this product?

The 505(b)(2), I think we have challenged the lower court decision. So that's one aspect, but the more happening one today is the [indiscernible] we achieve one which is being fought by one company and few of us -- couple of ourselves watching that closely. There I think the innovators have asked for hearing and the generic company is responding to it. So in summary, I think the verdict on that we would see in give-or-take, eight weeks -- within eight weeks, or around eight weeks from now, positive then it moves ahead negative then goes into a hearing which is a little long term, maybe another seven, eight months.

So and your settlement with the innovator lets you launch with the generic company with Teva perhaps, if all goes well?

You make your own -- you are tracking it closely, so I couldn't -- have your guess.

Okay. Sure thank you. My second question is on the new FDA commissioner, not new anymore, Dr. Scott Gottlieb. He's talking about more generics being on the market and priority reviews for the first generic on the market. So there has been a lot of talk but have you seen any walking the talk kind of a thing. So do you foresee more complex generic approvals or limited competition approvals in the next six to 12 months?

Look I think firstly, it's difficult to sort of expect rapid action, we are very excited about his comments and think very, very forward looking in the right direction and I think we will come there a lot. And so he's talking about few really sort of apt and relevant issues and so let see one, the positive change which has come in as in terms of prioritized expedited review. Earlier was just one generic -- it's been increased till three generics are approved. So quite a few SSR coming into expedited which is a good move. And then the rest we'll see as it unfolds actually, but overall comments are in absolutely right direction.

Okay. Thank you. And my last question is on your R&D, what levels should we be assuming for the rest of the year, 15% first quarter and where is the incremental kind of R&D going into, is it going into mechanical trails, if you can get any color that will be useful? Thank you.

Instead of taking as a percentage because the sales [indiscernible] there is a wide fluctuate in the percentage changes tremendously, I think we should take R&D will be in the vicinity of 500 crores per quarter, take 10, 20 crores plus/minus.

Thank you. We'll take the next question from the line Alok Dalal from CLSA. Please go ahead.

Hi good evening guys. Just one question. Mr. Prasad, how do you measure R&D productivity in the company, and how has it progressed over the last few years, has it declined, has it gone up? Thank you.

We look at the NPV of assets. We look at the money we spend and NPV of pipeline that we deliver. There has been some fluctuation in the last two three years. It can’t be a very smooth year-on-year growth, last years has been a good year, we hope to continue that this year too. So the number themselves, number of filings while we are not as high as some of our competitors we believe the kind of assets we have justify the productivity of the assets. So we have complex assets and then we have simple assets, we have the blend for - difficult to have a number beyond our NPV number that we calculate internally.

Yes, this is helpful. So when do you expect the R&D to get monetized, because the problem is that the R&D spend is hitting your P&L but the assets have not yet come maybe for multiple reasons. So when do you think whatever you spent on R&D so far is the two three year cycle or is it beyond that.

I think in the next two three years we should see significant growth in the company that I am not the R&D investments that we made.

So, just going back in time, you had a vision of $3 billion by FY 2013 do you think you will realize that in the next three years.

We hope so.

We may even more.

Okay, thank you sir.

Thank you. Due to time constraints, we will take the last question from the line of Anmol Ganjoo from JM Financial. Please go ahead.

Hi, thanks for taking my question. my first question is to Mr. Prasad, Mr. Prasad you spoke about this initiatives around costs. I know it's too early to get into details, but as you embark on your initiative to perch costs what are the strategic areas, what are the areas which you think are non-focus non-strategic and what will come under your cross - first as you move to perch costs?

So we are not looking at divesting or cutting any businesses. So the businesses won’t get impacted, that there is significant amount of inefficiencies due to the way this grown over the years and we have never test back and looked at our network where we are spending what we are getting out of them and we didn’t have exercise frequently and we found significant scope for tightening everywhere without impacting outcomes. And we believe that we can achieve that in next two to three years a very significant saving over our operating base.

Okay, thanks, that’s helpful. My second question is that you spoke about whatever approvals you have gotten this quarter, they peak only in subsequent couple of quarters. If you look at this quarter the impact of the scale up of the market shares thus far how far would be with respect to just these three assets from our peaks this quarter contains an impact to what 40% of peak, 50% of peak, if you can just help us understand that that will be helpful.

You are talking about new launches.

Yes, yes, so you said --

New launches is small ocean I mean first quarter it doesn’t make very big impact I mean it's not zero but it's not that significant number.

No that’s not what I meant, what I mean was that in terms of the peak sales potential of these three launches, how far we are 40%?

So in Q2 let’s not talk of Q1 Q2 I think these are two major assets I think we would almost get there like what - still those Q3 slightly, still to Q3 but by Q2 these assets will the run rates we should get.

Okay.

Almost there like - being an traditional assets and sometimes its channel loading so they takes a little bit time but our market share of these asset is very good and so I think it will scale up by certainly by end Q2 to early Q3.

Expected…

And my last question is if I may that you sounded optimistic that we will be restocking fairly soon and as far as India is concerned if we look at a full year basis I know it’s early but what’s your assessment that on a full year basis what is the prognosis of Indian market this year, is the lost sales for this quarter going to be compensated in subsequent quarters and to that extent do you think GST is a neutral event from an India grow of trajectory standpoint or what are your thoughts that…

Okay let me try and answer this little early at the moment but right now as we have seen the momentum coming back in July and I think we are reasonably satisfied so given that I'm not sure this would be a very significant behavior I mean in terms of India business let’s see how they come in force and are still possible for growth to be in reasonable range and all, high single-digit, low double-digit that’s to think.

Okay thank you. That was my last question thank you.

Thank you ladies and gentlemen due to time constraints that was the last question. I now hand the conference over to Mr. Saunak Savla for closing comments.

Thank you all for joining the call and in case if you have any additional clarifications please feel free to get in touch with me in Investor Relations. Thank you.

Thank you. On behalf of Dr. Reddy's Laboratories Limited, that concludes this conference call for today. Thank you for joining us and you may now disconnect your lines.