Dr.Datsons Labs Ltd Management Discussions

THE PHARMACEUTICAL INDUSTRY

The pharmaceutical value chain can be widely broken down into 3 distinct parts: Intermediates Active Pharmaceutical Ingredients also known as Bulk Drugs Formulations Active Pharmaceutical Ingredient ("API") or Bulk Drug means any substance that is represented for use in a drug and that, when used in the manufacturing, processing, or packaging of a drug, becomes an active ingredient of the drug e.g. Paracetamol in Crocin, Ibuprofen in Combiflam. The starting or intermediate raw material for an API is a raw material called "Intermediate". Intermediate is a chemical substance that is produced during API processing that undergoes further molecular change or purification before it becomes the API. Formulations are the final medicinal product that includes an API and excipients which is made available for consumption.

ORGANIZATION TYPES

The pharmaceutical industry is a complex matrix of various organizations specializing in different sections of the Pharmaceutical Value Chain, namely Intermediates or APIs or Formulations. There are companies that undertake a mix of all these activities and are typically known as "integrated" pharmaceutical companies. Pharmaceutical companies can be classified into two broad types:

a) Innovators – involved in drug discovery, development, manufacturing and marketing of branded (patented) drugs usually found in developed countries like USA and Europe, and

b) Generic Companies – involved in manufacturing and marketing of off-patent drugs (branded as well as unbranded) The outsourcing phenomenon has given rise to a host of companies that undertake research and development and manufacturing services on a contract basis. These are typically known as CRAMS companies.

GLOBAL PHARMACEUTICAL INDUSTRY

According to IMS Health Incorporated ("IMS Health"), a leading industry body, the global pharmaceutical market is expected to grow at a compound annual growth rate ("CAGR") of 5-8% through 2015 to reach market size of USD1.1 trillion. This is backed by robust growth expected in 17 emerging markets led by China with increasing government support in these countries to make more medical facilities available to their citizens. This growth will, despite significant worldwide patent losses and fewer blockbuster drugs reaching the markets coupled with lower growth expected in the United States, be the largest pharmaceutical market.

INDIAN PHARMA INDUSTRY

The Indian Pharmaceutical industry is highly fragmented with about 24,000 players (around 330 in the organised sector). The top ten companies make up for more than a third of the market. The Indian pharma industry (IPM) grew by 16% year-on-year in 2012 to Rs.629 bn. It accounts for about 1.4% of the world’s pharma industry in value terms and 10% in volume terms.

The demand for pharmaceutical products in India is significant and is driven by low drug penetration, rising middle-class and disposable income, increased government and private spending on healthcare infrastructure, increasing medical insurance penetration etc. Besides the domestic market, Indian pharma companies also have a large chunk of their revenues coming from exports. While some are focusing on the generics market in the USA, Europe and semi-regulated markets, others are focusing on custom manufacturing for innovator companies. Biopharmaceuticals is also increasingly becoming an area of interest given the complexity in manufacture and limited competition.

The Indian pharmaceutical industry is growing at about 8 to 9 percent annually according to "A Brief Report Pharmaceutical Industry in India," published in January 2011. The Pharmaceutical industry in India meets around 70% of the country’s demand for bulk drugs, drug intermediates, pharmaceutical formulations, chemicals, tablets, capsules, orals and injectables. There are approximately 250 large units and about 8000 small scale units, which form the core of the pharmaceutical industry in India (including 5 Central Public Sector Units).

CURRENT SCENARIO

Globally, India ranks third in terms of manufacturing pharma products by volume. According to McKinsey, the pharmaceutical market is ranked 14th in the world. By 2015 it is expected to reach top 10 in the world beating Brazil, Mexico, South Korea and Turkey. More importantly, the incremental market growth of US$14billion over the next decade is likely to be the third largest among all markets. The USA and China are expected to add US$200bn and US$23bn respectively. McKinsey & Company’s report, "India Pharma 2020: Propelling access and acceptance, realizing true potential," predicted that the Indian pharmaceuticals market will grow to US$55 billion in 2020; and if aggressive growth strategies are implemented, it has further potential to reach US$70 billion by 2020. Market Research firm Cygnus’ report forecasts that the Indian bulk drug industry will expand at an annual growth rate of 21 percent to reach $16.91 billion by 2014. The report also noted that India ranks third in terms of volume among the top 15 drug manufacturing countries. Further, McKinsey reports Healthcare grew from 4 per cent of average household income in 1995 to 7 per cent in 2005 and is expected to grow to 13 per cent by 2025.

INDIAN GENERICS MARKET

In the part five years, the Indian pharmaceutical industry hasemerged among the world’s key markets. Generics have played a key role in this evolution. India – with a contribution of ~22 per cent in terms of value towards the global generic drug market, also is the leading exporter of generic medicines in the world, valued around US$ 11 Billion. Indian firms manufacture about 60,000 generic brands across 60 therapeutic categories. The branded generics market will continue to dominate the Indian pharmaceutical industry. 61 drugs worth US$80 Billion will go off patent at the US Patent and Trademark Office between 2011 and 2013. Indian pharmaceutical industry is all set to gain from the patent expiry of some blockbuster drugs by producing their generic equivalents. The Indian generic drug market is expected to grow at a CAGR of around 17 per cent between 2010-11 and 2012-13India tops the world in exporting generic medicines worth US$ 11 billion. The Indian generic drug market is to grow at a CAGR of around 17 per cent between 2010-11 and 2012-13. Over the next few years, it is expected that the patent laws will provide impetus to the launch of patent-protected products. Such products have the potential to capture upto a 10 per cent share of the market by 2015, implying the market size of US$2 bn. Both the US and Europe together account for 53 per cent of the global pharmaceutical market, but the US is the more coveted territory for many reasons. It has a favourable regulatory environment compared to the stringent price control norms in key European markets. A depreciating rupee versus the dollar has also helped. Moreover, generic drugs are now a core part of how the US health system cuts its costs today. According to the Generic Pharmaceutical Association, during 1999-2008, generic drugs saved the American healthcare system more than US$ 734 bn (Rs 41,80,192.49 crore). Expenditure on prescription medicines is one of the fastest-growing components of healthcare costs, and hence, is a prime target for cost reduction .According to industry estimates, Indian companies are filling an average of 1,000 abbreviated new drug application (ANDAs) every year in the US to tap the opportunity. The bulk drug filings from Indian companies in US have also increased significantly. Of the total bulk drug filings in US, India accounted for 45 per cent in 2009 and 49 per cent in 2010, which further increased to 51 per cent last year.

APIs

In terms of global ranking, India is now the third largest API producers of the world just after China and Italy and by end 2011 was expected to be the second largest producer after China. However, in Drug Master File (DMF) filings India is currently ahead of China. In addition, India scores over China in ‘documentation’ and ‘Environment, Health and Safety (EHS) compliance. All these have contributed to India having around 175 USFDA approved world class manufacturing facilities, which is considered the largest outside the US. India is likely to be the fastest growing API supplier during the next five years. Japan is the largest market for APIs in the Asia-Pacific region contributing 42.8 per cent of the region’s total API market revenues. China is the second largest and the fastest growing API market in Asia-Pacific. China currently holds a share of 20.8 per cent in the region’s total API market revenues. India accounts for 10.3 per cent, while South Korea holds an 8.1 per cent share of the market. The top three markets for APIs are the US, Europe and Asia Pacific in which Asia-Pacific is the fastest growing. The region is the third largest regional market for APIs by revenue in the world after North America and Europe.

CRAMS

According to industry estimates, India’s CRAMS sector is likely to touch US$ 7.6 bn by 2015 end from US$ 3.5 bn in 2012.According to industry sources, outsourcing market is of ~US$80 bn in 2014 and increasing at 15 per cent CAGR. Of this, 35 per cent is R&D outsourcing and remaining is for manufacturing. Considering competitive labor cost (skilled labor in emerging countries cost is as low as 20 per cent of manufacturing cost in US market), many MNCs are shifting their manufacturing and R&D work to emerging countries including India.Approximately 64 per cent of the estimated US$ 67 bn global CRAMS market in 2014 is dominated by contract manufacturing, which includes manufacturing of intermediates for new chemical entities (NCEs) or manufacturing of APIs. Contract Research predominantly consists of drug discovery, preclinical and clinical research and represent US$ 25 bn opportunity globally It is estimated that currently only ~20 per cent of global Pharma R&D spend is being outsourced. This represents a huge opportunity for the Indian Companies.

Advantage India

Between 2010 and 2015 patent drugs worth US$ 171 bn are estimated to go off-patent leading to a huge surge in generic products.

High margin pharma export business is expected to grow at a higher rate than domestic market given increased in outsourcing activities.

Increased M&A activities is set to consolidate the market which widens geographic reach, strengthens distribution network and venture into new Goographies Indian companies files the highest number of ANDAs with USFDA leading to greater chances of approvals and thereby increasing export to regulated markets especially the US.

There are currently approximately 175 USFDA and nearly 90 UK-MHRA approved pharma-manufacturing plants in India, which can supply high quality pharma products globally. Growth from rural markets will outstrip overall pharma market growth, albeit at lower margins, given lower penetration of 18-19 per cent coupled with rising income level and awareness. Biopharmaceuticals is another potential high growth segment for Indian pharma growing at double digit driven by the vaccines market and other therapeutic segments

THE COMPANY’S PERSPECTIVE

Dr.Datsons has a strong presence across the pharmaceutical chain, manufacturing and marketing active pharma ingredients (also known as APIs/bulk actives/bulk drugs) and generics (also known as formulations). Both these market segments demonstrate growth trends every year with rising volume & value.

Dr.Datsons has robust product portfolio spread over major product areas encompassing CVS, CNS, anti-retroviral, antibiotics, gastroenterologicals, anti-diabetics and anti-allergic with approved manufacturing facilities by WHO GMP and having ISO certifications for both APIs & formulations and has global presence with own infrastructure, strategic alliances, and subsidiaries Among the emerging vertically integrated pharmaceutical companies in India, the product portfolio includes over 300 finished dosage formulations and 50 APIs with diversified product portfolio in life-style disease, anti-AIDS, anti-invective’s and pain management with paediatric products and technologies.

After creating a name for itself in the manufacture of bulk actives and ensuring a firm foundation of cost effective production capabilities together with a clutch of loyal customers, the Company has entered the high margin specialty generic formulations segment, with a global marketing network. The business is systematically organized with an identified accountability structure, and a focused team for each key international market. Dr.Datsons business strategy includes gaining volume and market share in every business/segment it enters.

Dr.Datsons has invested significant resources in building a mega infrastructure for APIs and formulation manufacture to emerge as a vertically-integrated pharmaceutical company. Dr. Datsons units (APIs and formulations) are being designed to address the regulated markets.

Over the years, the Dr Datsons has evolved into a knowledge driven company. It is R&D focused, has a multi-product portfolio with multi-country manufacturing facilities, and is becoming a marketing conglomerate across the semi regulated markets Dr Datsons R&D strengths lie in developing intellectual property in non-infringing processes and resolving complex chemistry challenges. In the process, Dr Datsons develops new drug delivery systems, dosage formulations and applies new technology for better processes.

The medium-term strategy of the Company is to globalize its intellectual property assets. The Company continues to enhance cost-efficient quality leadership in chosen segments (newer anti-infectives and lifestyle disease drugs). It is the endeavour of the Company to achieve this by resolving complex chemistry challenges, improving process efficiencies, adopting global scale manufacturing and using cost-effective market networks.

Dr.Datsons aims to repeat its success and emerge as a major player in regulated markets. In line with this stated objective, the long-term growth strategies include:

* Develop a broad portfolio of DMFs through non-infringing processes and intellectual properties and become a significant player in the generics market (especially semi-regulated);

* Manage cost-efficiently in a mega-manufacturing environment approved by WHO and other regulatory authorities; enhance the attractiveness as a partner of repute;

* Resolve complex chemical challenges and offer advanced drugs to the global markets;

* Globalize and penetrate through joint ventures/ subsidiaries/ organic means into China, Brazil and other Latin American countries; and,

* Emerge as a leading player in global high quality innovative specialty generic formulations and domestic brand segments.

The Company’s competitive advantage is in capturing a large portfolio of approvals, backed up by a global standard R&D effort that offers several patented non-infringing processes, intellectual properties and a cost-efficient mega manufacturing environment complying with various regulatory authorities.

Threats and challenges

Dr. Datsons is present in a competitive market with challenges from manufacturers (India, Chinese and European) with similar production facilities. Indian manufacturers in general and Dr.Datson’s in particular, have made a global impact.

Price sensitivities get tested in a crowded market where prices sag for volume-based businesses. Competing pharmaceutical companies possess several similar bio-equivalent products in the same market manufactured at facilities approved by the highest regulatory authorities. All of them stay focused on the same markets with the result that price elasticity is tested and margins eroded.

This threat, however, does not affect Dr. Datsons because of its control over raw material sourcing. The Company is a dominant player in the active ingredients business that has been able to control quality, save timelines, manage costs and deliver at a short notice. Dr Datson’s enjoys a pricing power (ability to price lower and yet manage to get higher returns on sales than competitors).

The key strengths of the Company include its manufacturing infrastructure, the knowledge base at research centers and the ability to deal successfully with complex process chemistries strengths. All strengths have been tested from the perspective plan to manufacturing plant to market place. There is a powerful marketing infrastructure backed by state-of-the-art manufacturing systems driving the business.

Dr. Datsons has been timing launches to take advantage of products going off-patent and opportunities available in a first-mover market. This strategy is built around the in-house R&D capabilities, technology strength in manufacturing facilities and the marketing infrastructure. The Company has worked on its speed-to-market abilities and is quick to convert product approvals into invoices. Besides, the Company possesses unmatched strengths like its experienced competencies with the ability to anticipate market needs, plan for product launches with supportive documentation, create products that meet regulatory norms, and execute plans within tight cost and time budgets.

Internal controls

The Company is in process of implementing ERP which not only adds to the controls, but to lead to faster information, analysis and improved decision making.

Dr.Datsons has a well-defined internal control system which is adequately monitored. Checks and balances and control systems have been established to ensure that assets are safe guarded, utilized with proper authorization and recorded in the books of account. There is a proper definition of roles and responsibilities across the organization to ensure information flow and monitoring.

These are supplemented by internal audit carried out by a firm of Chartered Accountants. The Company has an Audit Committee consisting of three Directors, all of whom are independent directors. This Committee reviews the internal audit reports, statutory audit reports, the quarterly and annual financial statements and discusses all significant audit observations and follow up actions arising from them.

Outlook

Dr. Datsons has set ambitious goals for the years through to 2015 in expectation of a moderate upward trend in the global economy.

The Company has world-class manufacturing facilities and an enviable basket of approved markets and relationships built with some of the best names in the pharma industry. The management team has set in motion a set of strategic initiatives to enhance revenues and profitability.

The focus will be on expanding markets; portfolio profitability will be analysed on a continuous basis. By implementing these strategies, Dr.Datsons aims to increase revenues and margins higher than the industry average. The Company is targeting to emerge as cash flow-positive, eliminate leverage and enhance shareholder returns.