Unichem Laboratories Ltd Management Discussions.

ECONOMY

More than a year into the deadliest global pandemic for a century, the way we live has changed dramatically, most likely forever. For all of us, there will a pre-and post-COVID-19 world.

The economic devastation brought by the pandemic was unmatched creating an environment of uncertainty. The world was ill-prepared for its scale, magnitude, and duration which has now entered its second year. The key challenge is that infections still need to be controlled, and we are seeing new variants and mutations affecting large populations that pose a significant challenge in terms of recovery and world economic growth.

Global economics is optimistic that recovery is starting to accelerate in the developing countries particularly in the USA, a key market for your Company where a large part of the population is vaccinated. Further, the fiscal stimulus package being given in these countries is expected to mend its economy. But this may be insufficient to lift the rest of the worlds economies as the outlook for the countries in South Asia, Sub-Saharan Africa, Latin America, and the Caribbean remains fragile, uncertain, and the inadequate availability of vaccines in many countries threaten its recovery.

Most of us are still optimistic about the global economic recovery but there are uncertainties especially on the coverage of vaccination that needs to happen in the next few months to achieve the growth rate that is being forecasted. The Covid-19 pandemic has resulted in a paradigmatic shift in preference from physical interface to virtual interaction with health and medical professionals. This has come as a boon in disguise to the Indian Pharmaceutical sector, although part of its business was affected by disruption in the supply chain and restrictions in the import of Active Pharmaceutical Ingredients (APIs). Covid-19 is expected to boost the pharmaceutical sector as globally, countries are expected to invest more in the health sector.

GLOBAL PHARMA MARKET

The Indian pharma industry is the third-largest in the world by volume and 14th largest in terms of value. It contributes 3.50% of total drugs and medicines exported globally. India produces affordable drugs in the world. 95% of the drug produced in India are generics. It manufactures 60% of the worlds vaccines and is also the biggest player in the global generic drugs market with a 20% market share, its pharma products being exported to every single country with earnings of $16.28 billion in 2019-2020.

The global pharmaceutical market size was valued at USD 324.42 billion in 2019 and is expected to grow at a Compound Annual Growth Rate (CAGR) of 13.74% from 2020 to 2027. One of the reasons for higher growth is increased health spending globally which should also accelerate Indian pharmaceutical exports.

Your Company performed well during this pandemic and could achieve 27% growth in net sales as compared to the previous year. Our success is a story of timely planning, proactive actions, commitment to quality, efficiency, and value creation.

GENERICS AND GENERIC FORMULATIONS

The products manufactured by the Company are exported to many developed as well as developing countries. Over the last 58 years, the Company has been at the forefront in supplying affordable medicines for patients and it offers a wide array of medicines for therapeutic areas such as gastroenterology, cardiology, diabetology, psychiatry, neurology, anti-bacterial, anti-infectives, and pain management.

North America dominated the market for pharmaceutical manufacturing with a revenue share of around 40% and should continue to weigh for 43% of the global pharma market in value and is expected to contribute around 44% to worldwide market growth over the 2019 2024 period. For Unichem, USA stands as the major revenue driver by contributing 57% of the total revenue. We are optimistic to grow our business in this region which is witnessed by the number of filings as detailed in the R&D section.

The Pharmaceutical Market in the European Union (EU) is positioned as the second biggest pharmaceutical market in the world, with Germany, France, Italy, United Kingdom, and Spain as the top 5 countries. The size of the market in EU-5 is set to grow by double-digit between 2017-2022 with a CAGR of 4.5% over this period. Unichem has performed significantly well in this region and going forward we are hopeful to add more products in this market.

In the Asia Pacific, the market for pharmaceutical manufacturing is expected to witness the fastest growth due to a huge customer base, an increase in healthcare expenditure, disease incidence, and the presence of supportive regulatory systems. New regions will emerge as leaders in the low-cost generic market. Unichem also demonstrated the growth trajectory in emerging markets which is called the ACASIA division. With such an immense portfolio of products, we expect to grow considerably in the years to come.

In recent years, key drug manufacturers have shifted their focus towards external service providers for R&D and manufacturing services. The growth in the demand for customized products, the need for enhanced productivity and efficiency across the value chain, and continuous pressure from regulatory bodies on drug pricing have compelled the pharmaceutical companies to rely more on outsourcing mode of drug development which opens the avenue of contract research and manufacturing.

GLOBAL API MARKET

The global API market size is expected to reach over USD 200 billion in 2021. With the expected CAGR of 6.6% from 2021 to 2028, the market size has the potential to reach USD over 310 billion by 2028. The API market is undergoing immense changes due to supply chain disruption by Covid-19. Countries such as India are being preferred over China for the export of APIs owing to geopolitical situations as entities are attempting to mitigate the risk of dependency on a single territory for such products.

The strategic investments in two entities, namely Optimus Drugs Private Limited and Optrix Laboratories Private Limited both engaged in the business of APIs and intermediates continue to provide the Company with additional capacity to meet its immediate requirements and fulfill its export orders. The management of these Companies had decided to merge Optrix Laboratories with Optimus Drugs to combine the activities and operations in a single Company to build strong capability to effectively meet future challenges in a competitive business environment which would benefit your Company.

Unichem today is the partner of choice for global generics companies directly or through its Wholly-Owned Subsidiaries. Looking at the product pipeline and market opportunities, we are confident that it will contribute further to our continual growth.

MANUFACTURING OPERATIONS

We express our heartfelt gratitude towards the government, frontline workers, and our employees for their grit, determination, and perseverance in these unprecedented times. We are humbled to be a part of this industry that came together in solidarity to fight this pandemic. Our employees at the manufacturing locations have demonstrated significant drive and commitment during these testing times to ensure continued production and an uninterrupted supply of medicines.

All our plants continue to deliver as per strategic intent and have focused on a safer and healthier working environment. Further, each one of the facilities has robust quality systems to ensure high standards for product quality. The manufacturing operations are heavily regulated by governmental health authorities around the world, including the US Food and Drug Administration (USFDA), Medicines and Healthcare products Regulatory Agency (MHRA), Ministry of Health of the Russian Federation, European Medicines Agency (EMA), Health Canada, etc which endorse the quality and safety of the product. The Company is incorporating various digital capabilities for data integrity through automation of manufacturing processes and systems.

Unichem has been successfully maintaining high-quality standards as per the CGMP (Current Good Manufacturing Practice) guidelines issued by USFDA, EU, and other global regulators. During the year under review, Unichem successfully underwent the EU audit of Baddi and the Ukraine audit of Ghaziabad plant.

It is expected that the current phase of the epidemic would be less severe on manufacturing as the focus has been on ‘micro containment zones to deal with the second wave of infections as opposed to a nationwide lockdown. Yet, the lockdown, even if localized and partial, will impact the economy as supply chains and production will get disrupted. Your Company is focused to meet these challenges and has completed its expansion plan at Ghaziabad plant to keep up the uninterrupted supply. The expansions at Goa plant is expected to be completed during the financial year and at the Pithampur plant in the next financial year.

OPPORTUNITIES AND THREATS

Covid-19 has been a painful disruption, but it is believed that for the pharmaceutical industry it will create long-term opportunities. Growth will be driven by improved access to healthcare, new product launches, and burgeoning hospital infrastructure.

Most of the advanced countries which have recovered from the pandemic surge are expected to see a sharp economic bounce back particularly in the second half of the year, although concerns are expressed that the growth is more likely to be delayed due to the continued pandemic situation. The second wave of the virus outbreak in several countries is getting controlled with stricter measures of lockdown. The global race to develop effective treatments and vaccines which is in an advanced stage coupled with monetary and fiscal stimulus packages, should provide cushion, and pave the road to recovery.

In our view, the combination of shutting of borders and rising global tariffs amid in Covid-19 had threatened global supply chains. The business of forecasting has been more challenging as manpower in the supply chain gets infected, with more areas moving into macro containment as well as restricted lockdown impacting operations.

While the pharmaceutical industry continues to face other challenges like higher prices of APIs and intermediates resulting in margin pressures, the pandemic has once again realized that health needs to be given higher priority by the policymakers. The expansion of capacity of providing health services as part of overall infrastructure expansion should be taken up on an urgent basis to improve the threat in dealing with the pandemic. This will lead to opportunities that should act as a catalyst in the near term.

The Indian government has approved a 15000 crore Production-Linked Incentive (PLI) scheme for the pharmaceutical sector in a bid to boost domestic manufacturing. This PLI will address the missing link in addition to our excellence in generic drugs where we are a pharmacy to the world. It is a good move to strengthen the pharma industry which is of strategic importance to India.

We remain committed to investing in building new capabilities and capacities across locations including R&D, manufacturing, and quality, as well as strengthen our product portfolio. We are confident that focus on our strategic

Annexure A

priorities and execution excellence will ensure that we will

continue to deliver long-term sustainable growth.

RESEARCH AND DEVELOPMENT

R&D is the core that will power Unichems future growth through a dual strategy of development of patent non-infringing processes for APIs and development of Novel Drug Delivery Systems (NDDS). The Centre of Excellence in Goa, fuelled by over 300 scientists including over 30 PhDs, is the place where the potential of Unichem is brought to life. Offering the most conducive environment for value-added research, the R&D has to date developed novel, innovative and efficient processes for 77+ new generation molecules and 72+ ANDAs across markets and therapeutic categories. The R&D Centre boasts of a strong synthesis and analytical team with the latest facilities at their disposal. The Formulations R&D has State-of-the-Art facilities to undertake formulation development of tablets, capsules, liquid orals, creams, ointments and, a separate facility for injectable and pre-formulation laboratories to carry out drug-excipient compatibility studies and physical characterisation of API.

The R&D Centre undertakes formulation services on contract research and development projects for several leading global pharmaceutical companies. It is also responsible for formulation development and ANDA filings following the Quality by Design (QbD) protocol as laid down by the USFDA and has a Bio-Tech facility that engages in developing novel or biosimilar products using Recombinant DNA platform technology.

Your Companys R&D efforts have borne fruit with a ramp-up of the output from R&D resulting in an increased number of DMF, Dossier, and ANDA filings in regulated markets. We believe that our investment in R&D will open the door to growth, including out-licensing opportunities in generics and biologics.

In the year under review, Unichem filed 5 ANDAs (Abbreviated New Drug Applications) (including one Para 4), 2 USDMFs (US Drug Master Files), and 1 CEP (Certification of Suitability of European Pharmacopoeia), and other regulatory submissions to various health authorities. This financial year the R&D efforts were strategically focused on reverse engineering, launch planning, and cost rationalization efforts. The sustained efforts of R&D over the years resulted in 9 ANDA approvals this year highest so far and 8 launches in the largest generic market of the USA and 2 launches in Brazil. We expect an increase in the number of filings and approvals in time to come.

RISKS AND CONCERNS

The economic recovery appeared well on track until recently when the second wave of Covid-19 hit again posing a serious risk to its early expected recovery. As a result, our economic prospects this year have begun to again look dimmer.

The Pharma sector is highly regulated, maintaining and complying with the regulatory changes will always remain a challenge. The prices of APIs and intermediates fluctuate based on the market demand and supply conditions. The Company may not be able to pass on any sharp increases in the prices of raw material to the consumers, resulting in margin contraction. Any adverse changes in policies concerning drug pricing or trade margins for the Companys products may impact its performance. The price pressure in the pharma market and competition particularly in the primary USA market, the major export region for the Company will continue to pose further challenges in growth and margins.

Like any sectorial entity, your Company is also exposed to risks of cybersecurity, tax, currency fluctuation, and litigations, etc.

Your Company is also taking several initiatives, including cost improvement measures and a digitization drive, to optimise its systems and processes and drive efficiencies. These initiatives are expected to improve our cost structure which will, in turn, enable us to be more competitive in the future.

APIs, the building block of medicines, are largely sourced from overseas and the Indian government is realizing that specific steps need to be taken to help the Indian industry make them competitive. Overcoming dependence on API imports, will not be easy, given that APIs are made from intermediates, which in turn come from chemicals, which our country does not manufacture enough. The efforts are being taken in this direction by the government and it is expected that with renewed focus, things will become more conducive going forward.

Unichem management team identifies, measures, monitors, and minimizes these risks to ensure safe, sound, and efficient operations. These are internally supervised and monitored through the Core Team Management (CTM). The CTM collaborates with various departments of the organization to identify and mitigate these risks. The Company has strong monitoring systems, access restrictions, firewalls, and backups to protect its data privacy. Since Unichem is fully into the international business it continuously evaluates political and economic scenarios across the globe in terms of its business operations and investments. During the year, a risk assessment for the organization was presented to the Board.

OUTLOOK

The current pandemic has given the biggest jolt to strategy, and it has jeopardised forecasting due to the uncertainty of this situation. Even after a year, we are unsure of the further magnitude and duration of this crisis. However, it has accelerated the digital adoption and organisation to embrace analytical concepts to address physical distancing which has been a new norm in tackling it.

Countries across the globe had witnessed crisis in dealing with medical infrastructure for their citizens. The health sector is being looked as the next biggest driver of growth and employment, as it has multiplied impact on the growth of the economy. It is expected that the world will allocate more in its policies with emphasis on primary healthcare.

The pharma sector is also realising the need to unlock the full value of the huge data by using artificial intelligence and machine learning. Medical technology is the future of healthcare and will see a whole new world of job opportunities in the health sector and inpatient care. Artificial Intelligence, machine learning, nanotech, the Internet of Things (IoT), robotics, 3D printing are just a few examples of technologies that are going to play an important role in healthcare. The wider the adaptation to technology, the lower will be the cost of specialized treatment.

It is also expected that a rise in drug approvals by the regulatory bodies is expected to fuel pharmaceutical manufacturing activities. We believe that Unichem is well-positioned to grow its business globally on the back of robust business fundamentals, successful international accreditations at its plants, and an increased number of regulatory filings.

FINANCIAL PERFORMANCE

Consolidated Operations:

During the financial year ended 2020-2021, the Company registered Revenue from Operations of Rs 1,23,513.53 lakhs as against Rs 1,10,371.28 lakhs in the previous year, representing a growth of 12%.

Profit before tax of Rs 5,147.94 lakhs was achieved during the year against the loss before tax in the previous year amounting to Rs (4,821.02) lakhs, representing a growth of 207% for the financial year ended 2020-2021.

The Profit after tax for the year was Rs 3,432.48 lakhs against a loss of Rs (6,018.25) lakhs, representing a growth of 157% for the year ended 2020-2021.

The gross profit margin for the year increased by 4.4% over the

previous year. The increase was driven by a better product mix.

Standalone Operations:

During the year ended 2020-2021, the Company registered

Revenue from Operations of Rs 1,12,397.28 lakhs as against

Rs 90,444.07 lakhs in the previous year, representing a growth of 24%.

Revenue from the international formulation business contributed 82% of Net Revenue from Operations, which increased from Rs 72,498.24 lakhs in the financial year 2019-2020 to Rs 92,559.80 lakhs in the financial year 2020-2021, representing a growth of 28%.

Profit before tax of Rs 6,564.55 lakhs was achieved during the year under review against the loss before tax in the previous year amounting to Rs (6,381.18) lakhs, representing a growth of 203% for the financial year ended 2020-2021.

The Profit after tax for the year was Rs 5,408.23 lakhs against a loss of Rs (5,631.62) lakhs, representing a growth of 196% for the year ended 2020-2021.

Capital expenditure for the financial year 2020-2021 was

Rs 33,489.11 lakhs.

The year was benefited by new launches, a better product mix in the international formulation business, and increased leverage from manufacturing overheads and logistics costs. The gross profit margin for the year increased by 3.8% over the previous year. This was partly offset by lower export incentives. We are pleased that we were able to ensure the continuity of our business operations and serve patients and partners in these challenging times.

We are confident that our strong business fundamentals with global reach will see us expanding to patients globally.

Details of significant changes (i.e. change of 25% or more as compared to the immediately previous financial year) in key financial ratios, along with detailed explanations thereof are provided below in Table 1.

HUMAN RESOURCES

With the world facing an unprecedented challenge in the financial year 2020-2021, new work norms had to be established to enable us to navigate through unchartered territories. During this time, the Human Resource function across industries put on creative hats to deal with the new challenges, especially those involving employee health, safety, and security. Balancing these along with business continuity became a priority. Digitalisation and Automation and the consequent scaling up of infrastructure and training employees thus became the focus areas for HR as a function.

Table 1: Details of significant changes in key financial ratios, along with detailed explanations thereof

Ratio Standalone Consolidated Remarks
FY FY Variance FY FY Variance (In case variance is +/- 25%)
20-21 19-20 (%) 20-21 19-20 (%)
(i) Debtors Turnover 3.29 2.76 19 3.86 2.67 44 Consolidated - improved compared to the previous year
(ii) Inventory Turnover 1.23 1.30 (5) 0.81 1.05 (23) -
(iii) Interest Coverage Ratio 51.47 (48.78) (206) 11.06 (5.14) (315) Standalone and Consolidated - Better profitability as compared to the previous
year
(iv) Current Ratio 3.51 4.32 (19) 2.72 2.98 (8) -
(v) Debt Equity Ratio - 0.01 (100) 0.04 0.07 (46) Consolidated - Increased profitability of overseas subsidiaries
(vi) Operating Profit Margin (%) 13 1 1243 11 4 205 Standalone - Improvement in financial performance
(vii) Net Profit Margin (%) 5 (6) (177) 3 (5) (151) Consolidated - Increased profitability of overseas subsidiaries
(viii) Return on Net Worth (%) 3 (2) (240) 2 (2) (189)

The concept of work from home surfaced for certain functions which led to the Human Resources professionals to wear pioneering lenses and equip employees to adopt new communication medium to deliver on business objectives. Remote working required that very vital personal touch and employee engagement. Employees working from home were provided tools and regular guidance to adapt to the technology required and that too at a fast pace.

Unichem, a manufacturing Company with 3,090 employees, has around 95% of the workforce operating from its factories. To ensure safety of the employees, the Company ensured that all the guidelines as laid down by the Central/State governments and WHO were complied with. With Covid-19 becoming rampant and a global crisis looming, the leadership team constituted a special COVID Taskforce which implemented strict protocols and procedures to tackle the pandemic. Employee awareness, training, and monitoring of these initiatives were carried out with great integrity and spirit.

Employees at manufacturing sites were provided with safety gear/PPE kits. Sanitisation of the premises and other COVID appropriate behaviour became a way of life. SOPs were framed and monitored. Masks were in place; canteens became silent zone and social distancing was ensured. Fever screening machines were installed to ensure compliance and daily health monitoring by a medical team have become a norm. The very important aspect of employee motivation, counselling, and education has become a regular feature since the onset of the pandemic. Monitoring the physical and mental health of the employees and providing support to them and their families was undertaken.

Numerous health programmes and activities were planned for employees both at the manufacturing sites and virtually, for others, all the while adhering to Covid-19 protocol. Live yoga classes, awareness on COVID and how to deal with it, group plasma donations, and online entertainment were among the initiatives undertaken.

Training for contract employees was also integral and

diligently followed during these tough times.

Since we are in the essential services sector, digitalization and automation were the most important resources at our disposal to ensure that the organizations business goals were met. Even before the pandemic, Unichem had begun its journey in these areas by introducing new technological mediums for the human resource function. A step in this direction was taken some years ago with the introduction of an online performance evaluation system, which continues to gain in upholding the ethos of accountability in assessing employee performance. Online Learning Management System is one such technological intervention that will bring an advanced mode of training delivery and management while reducing manual intervention. The software is in the final stages of implementation across the organisation.

We introduced a new cloud-based HRMS Uniconnect, which brought HR processes and technology to the fingertips of our employees. It was important to make HR processes for employees online and accessible anywhere, anytime, with minimum physical intervention which was made possible through the Uniconnect mobile app. Uniconnect integrated several erstwhile systems into one application while reducing manual intervention in the HR processes.

The year 2020-2021 demanded a new approach towards digitalization. Virtual communication became the best means for collaboration to ensure social distancing. All cross-functional teams adopted these means with open arms and honed their skills in no time.

Our core values of INTEGRITY, COLLABORATION, and EXECUTION EXCELLENCE (ICE) became a pillar of strength in the face of adversity. This was also celebrated by awarding the employees who showcased these values through the UNICHEM Stars awards program.

Unichem continues to have cordial relations with its union.

In the coming year, the HR team will continue to strive for excellence in the areas of HR technology, employee health, safety, and compliance.

INTERNAL CONTROL SYSTEMS

Your Company has an adequate internal control system commensurate with the nature and size of its business operations. These systems provide reasonable assurance that (i) the transactions are authorized, recorded, and reported diligently, (ii) the internal policies and procedures are adhered to, (iii) it safeguards the resources and assets of the Company, (iv) it maintains accuracy and completeness of accounting records, and (v) it mitigates operational and business risks.

Your Company views internal audit as a vital part of its management control system that keeps management informed about the working and processes of the organisation. The internal audit function independently tests the design, adequacy, and operating effectiveness of the internal control systems and this provides a credible assurance to the Audit Committee regarding its adequacy and effectiveness.

The Audit plan is made at the beginning of the year after it is duly approved by the Audit Committee. The internal audit plan and its reports are shared with the statutory auditors. These plans are executed by the internal audit team with the support of external audit professionals wherever required. The management duly considers and takes appropriate and timely actions on the recommendations made by the audit committee, statutory auditor, cost auditor, and internal auditor.

Dr. Prakash A. Mody
Mumbai Chairman & Managing Director
29th May, 2021 (DIN: 00001285)