Neuland Laboratories Ltd

NSE:NEULANDLAB

Earnings Call Transcript 2023-Q3

[Operator]

Ladies and gentlemen, good day, and welcome to Neuland Laboratories Limited Q3 FY '23 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded.

I now hand the conference over to Mr. Ravi Udeshi from Ernst & Young. Thank you and over to you.

[Ravi Udeshi]

Thank you, Yashasvi. Good evening, friends. We welcome you to the Q3 FY '23 earnings call of Neuland Laboratories Limited. To take us through the results and to answer your questions, we have with us the top management from Neuland, represented by Mr. Sucheth Davuluri, Vice Chairman and CEO; Mr. Saharsh Davuluri, Vice Chairman and Managing Director; Mr. Abhijit Majumdar, CFO; and Mr. Sajeev Emmanuel Medikonda, Head, Corporate Planning and Strategy.

We will start the call with a brief overview of the financials by Abhijit Majumdar, and then Saharsh will give you a broad highlight of the business trends and what he is observing in the market. And post this, we will open it up for the Q&A session. As usual, the standard safe harbor clause applies as we start the call.

With that said, I now hand over the floor to Abhijit. Over to you, Abhijit.

[Abhijit Majumdar, executive]

Thank you very much, Ravi, and a very good evening to all, friends, and a warm welcome to you all for joining our Q3 FY '23 earnings call. I think you must have seen the presentation, which Ravi mentioned, and it is put up on our website and has been uploaded on the BSE and NSE websites. As always, any comment on the content of this presentation which we have sent will be highly appreciated, and we'll do our best to give out additional data points, which will help you to understand our business better.

I will briefly talk about financials now. The total income for this quarter is INR 270-odd crores against INR 238.4 crores in Q3 FY '22. This was largely driven by our growth in our GDS business. Our EBITDA for the quarter stands at INR 54.9 crores with an EBITDA margin of 20.3%, an increase of 6% or 600 basis points over the previous year. The increase in EBITDA margin has been led by a revenue shift margin towards high-margin products.

While we have continued to witness volatility in input prices however in line with Q2 FY '23, we continue to experience some easing on a related basis. Our focus on execution excellence and cost has enabled us to minimize the cost impact from raw material increases facing our industry.

At the same time, we have seen a sequential drop in revenue by 8% when compared to Q2 FY '23 and an EBITDA margin drop of 30 bps due to a slight change in business mix as well as lower revenues impacting our operating leverage. I would request you to measure our performance over a 1-year time horizon as our EBITDA margins will fluctuate on a quarter-on-quarter basis.

Coming to specifics. Our gross margin was 55.2% in Q3 compared to 49.2% in Q3 FY '22 and 56.2% in Q2 FY '23. Profit after tax was at INR 30.4 crores as compared to INR 12.7 crores last year. This quarter's EPS is at INR 23.7 per share.

On a 9-month basis, the total income is INR 785.8 crores, an increase of 12.3% over the prior period of last year. The EBITDA increased by 46.1% to INR 153.3 crores as against INR 104.9 crores in the 9 months FY '22. The EBITDA margins come -- has come in at 19.5% compared to 15% for 9 months FY '22 on account of our stated shift to higher-margin products.

We generated a free cash flow of INR 161 crores in the 9 months of FY '23. Our net debt position stands reduced to INR 72 crores versus INR 212 crores as at the end of March '22. We continue to invest in updating our facilities and have invested INR 50.9 crores in CapEx during this period. Our net gearing ratio stands at 0.1x as of December 2023.

With that, I would like to hand over the call to Saharsh for his remarks. And once again, thank you very much.

[Davuluri Rao, executive]

Hi. Good evening, everyone. Thank you, Abhijit. I think in terms of the quarter itself, I'll add a few comments on top of what Abhijit has already said, and then we can open it up for Q&A.

The quarter, in many ways, is a fairly decent representation of the direction that we have in steering our business. While there is uncertainty surrounding raw material prices, we are starting to see some stability. In my opinion, this quarter continues to indicate that our strategy of focusing on the GDS specialty and the CMS business is shaping up well. The growth driven by both the specialty and the commercial products in the CMS business has meant that we have healthy gross margins flowing through to the rest of the P&L.

In the specialty segment, products like Apixaban and Ezetimibe have contributed significantly, and we are excited about these products. With regards to the CMS business, I would like to highlight the significant jump in revenues from commercial products. You may recall that over the past few years, we have stressed that our molecules will gradually transition from development to commercial, and this quarter marks such a transition. We expect further commercialization to happen over the medium to long term.

The contribution of the CMS business has been a significant driver of the improved EBITDA margins that we have witnessed in the last few quarters. We continue to see some early-stage projects get added to the business this quarter. And we are continuing to see an increased traction from new customers as our ability to execute complex late-stage projects that distinguishes us and makes us a highly regarded CDMO.

In terms of the overall business, we are witnessing a shift towards high-margin business, which has been our stated goal, but we continue to remain slightly cautious about how the business or even product mix. Raw material prices or ForEx could negatively impact these margins in the future. I think that this is something that we would like investors, analysts and all stakeholders to be mindful of.

I'd further like to mention that our Unit 3 operations continue to ramp up, which has contributed to growth that you have recently witnessed. Some of our late-stage products have been scaled up here. Hence, we foresee Unit 3 utilization continuing to move up.

As I had alluded earlier, we have a good visibility on the CMS business flow in terms of higher-value projects over the short to medium term. And we expect these factors will contribute to our margin increase in the future as well. In order to keep up with the requirements of our customers, we will add new production blocks in Unit 3 and invest in R&D infrastructure to facilitate their goals over time.

As always, I'd like to state that the very nature of Neuland's business in terms of working on high-quality complex molecules is such that revenues and margins could be lumpy on a quarter-to-quarter basis. But as Abhijit just now emphasized, on an annual basis, they are steadily moving upwards, and you could expect the same going forward.

We think that the recent momentum is sustainable over long term, and therefore, we continue to remain excited about the future of the business. So maybe I think I'll pause here and open it up for Q&A.

[Operator]

[Operator Instructions]

We have our first question from the line of P Suresh from Baram Financials.

[Unknown Analyst]

Sir, Neuland last time properties onetime sale. That amount is not taken the balance sheet.

[Davuluri Rao, executive]

Sorry, we are not able to follow the question. Maybe you can jump back in the queue again...

[Operator]

Mr. Suresh, please check your net. Can you redial, please?

We'll take the next question from the line of Sajal Kapoor, an independent investor.

[Unknown Attendee]

I have a small acknowledgment to start with. So I've been tracking Neuland Labs for almost 2 decades now. And I must say that our balance sheet and cash flow has never been stronger than what we have today. So well done, team, and a warm welcome to our new CFO, Mr. Abhijit Majumdar.

I have 2 questions. So let's assume a hypothetical scenario where you know your competitor is a privately held and unlisted entity operating in the area of innovator synthesis and NCE scale up as a service model. I guess, they will have much more freedom to plan strategic objectives and execute them as there will be a limited number of shareholders in a privately held business. And these shareholders are also much more educated and much more aware of the business economics in terms of upfront capital deployment, long gestation window, lumpiness in cash flows, et cetera, compared to being a listed entity like Neuland Labs where analysts and other shareholders are usually very impatient and short-term-oriented and look 1 quarter at a time in a business that is fundamentally has very long cycle times, like 7, 8 or even 10 years with upfront capital deployment in infrastructure, R&D, scientific talent, et cetera. So which of these 2 companies is better placed in your view, the listed one or the unlisted one? That's my first question.

[Davuluri Rao, executive]

Yes. I think it's -- actually sharing an observation. I think from the way we look at our business, while there is challenges in the quarter-on-quarter smoothness of the business, I think as CDMOs reach a certain size and I think for Neuland, our CMS business has been fairly small compared to our overall revenues. Rating now is closer to 35%, 40% of our total revenues.

But I think as we keep scaling up the business, we think that some of these volatilities can be managed. And I think that going forward also, as the business keeps growing, we should be able to provide a certain run rate of growth and performance. But it will be very difficult to demonstrate that on a quarter-to-quarter basis. And I think, ultimately, investors will have to decide whether this is the kind of business that they would be interested in.

But I think that -- I do believe that as a listed company, you can have lumpiness in your business model. And as long as the business is profitable and has sustainably grown, I think being a listed company does not really create any kind of challenges in the CDMO business.

[Sucheth Davuluri, executive]

Yes. No, I agree completely with what Saharsh said. It all depends on the specific organization rather than whether they're listed or unlisted. And therefore, as a company, if you noticed our investor calls over the last several quarters, we've always said that we do not expect consistency on a quarter-to-quarter basis because that's not how our business operates -- that a business life cycle operate.

However, we stated what our expectations from the business are in terms of product mix as well as margins over the long term. So I think as long as the company is transparent, I think from shareholders and people like yourself, we'll always be unlisted and given that little bit.

[Unknown Attendee]

That's helpful, Sucheth. So second question is on the private equity money that has been chasing API and generic CMO assets in India in recent years, whether it is Carlyle Group or any other PE for that matter. They all are sitting on losses after almost 3 years, and these guys typically invest for about 5 years, right?

So question really is on the economics of the generic pharma stroke API businesses. I mean, is this not an investment-worthy sector and private equity has got it wrong? Or you think they overestimated the growth runway and the cyclicality, which is inherent in any generic business with pricing pressure on one end and raw material challenges on the supply side, both availability and the pricing of raw material and the pricing pressure, of course, on the product side?

So how would you read it as an industry participant, this obsession of private equity running after API assets and not being able to make any decent gains? I mean all of them, as far as I know, are sitting on losses. So what do you think it means for the industry, and more importantly, for Neuland Labs?

[Davuluri Rao, executive]

Yes. Thanks for the question, Sajal. I think we're quite well aware of the private equity activity in the API space. And I think, obviously, while we are aware of what's going on, it's hard for us to comment on what their specific strategy, financial goals or exit plans are.

I think what you understand about the business is that every API company is having a different strategy. Some of -- some companies are going after plans of big pharma, some companies are going after biotech companies, some companies are more focused on generic APIs. And every business has its own dynamics in terms of margin profile, growth challenges, et cetera.

So I think the way we are looking at it from Neuland's perspective is the kind of businesses that we are focusing on, which is the specialty APIs as well as the CMS business, I think these require a very high level of attention to the customer needs in terms of what needs to be done for their drug, whether it is phase-appropriate development, setting up the right kind of infrastructure and providing them a partnership for a 5- to 10-year runway. And that's an area where we feel that we are very well elaborated as I think both companies organizationally need to do that.

And in that space, when we are going through the journey, we don't necessarily see competitors around us, I think because it's a very large space, right? It's a $50 billion, $60 billion space, the CDMO space, that we operate in.

It's true we have 2 small players -- or no one is big enough to really elbow the other out. And therefore, I think while we keenly observe what's happening, we would find it very difficult to comment on what the rationale is. But I think as far as our business is concerned, we're not really seeing any direct threat or concerns coming out from these private equity-backed organizations.

[Operator]

Mr. Rajat?

[Unknown Analyst]

Can you hear me?

[Operator]

Yes.

[Unknown Analyst]

Congrats on the great set of numbers. I just have 2 questions. My first question is that if I were to compare your gross margins to any of the other API players right now, even if I compare it to DV -- like right now, you're sitting at the highest gross margins within the API space, in India at least or at least on the listed space.

I just want to understand like what are you doing so differently like because I think you have a large portion of your business coming from generic APIs also. While if I see DV, they have roughly 50% of their revenues coming from custom synthesis. But still, your gross margins are higher than that. Could you just give some color on that for my benefit? I also want to understand, are there any particular products where you are really enjoying high realizations at the moment and you feel that going forward, they might not be sustainable? That's my first question.

[Davuluri Rao, executive]

Yes. I think -- Rajat, I think what we've shared in terms of our remarks about the quarter, I think it's a general representation of the trend going forward. I think, yes, we also did see some challenges on raw materials. But as I had mentioned in my remarks, it has softened a little bit, it's not as severe as it was, say, 3 or 4 quarters ago. I think some of these raw materials like these lithium, metal-based prices are still high, but solvent and all that softened.

But again, I think the gross margins are also a direct factor of the business mix and the product mix that we have. And maybe because of the mix that we have, we have this kind of margin. But again, we are very clear that it's not a onetime exceptionally high gross margins. We think that this is a reasonable margin that we think is sustainable, provided there's no major shift in terms of raw material supply situations or foreign exchange fluctuations and things like that.

But yes, I would not really know why the other players' margins have maybe -- again, because the businesses are so diverse within the API space, it's just maybe the challenges that they are facing for their specific product.

I think also another point to note is Prime has been relatively smaller compared to how big it used to be for us in the past. And Prime is definitely a segment where we have some pricing challenges and maybe a few issues on raw materials. But I think we don't see any other challenges other than what we had mentioned.

[Unknown Analyst]

Sure. Saharsh, could you also tell me like what -- how much backward-integrated are you at the moment? Like what percentage of your raw material is imported from China? Could you give some color there?

[Davuluri Rao, executive]

So your question is about how backward-integrated are we?

[Sucheth Davuluri, executive]

Yes. So it's a very product-specific strategy, Rajat. So we don't have an overall umbrella strategy that for every product we have to be backward-integrated because it doesn't make sense. So we do a product-by-product evaluation. And for some products, we are fully backward-integrated.

For some products, given the supply situation, they're not backward-integrated. Therefore, we could not give you an overall percentage number. Today, our procurement from China, I would say, is in the range of about 25% or so, though our dependence on China is far less than that. But those are the rough numbers.

[Unknown Analyst]

Got it. And would it also be possible for you to break down this 24% growth, which you have reported in the GDS segment in terms of price and volumes? Would that be possible?

[Davuluri Rao, executive]

We would prefer keep the growth numbers to what we have shared. We'll not be able to provide further.

[Operator]

We have a next question from the line of Ankush Mahajan from Axis Securities.

[Unknown Analyst]

Congrats for a good set of numbers. Sir, my question is that in the API segment, at this time, the whole industry is talking about the low or less export and prices are falling for the APIs. Even the peers are -- they are also saying the same things on the con call. So would you throw some light, sir, how do you see our company in regarding to it that what about the price realizations for the APIs? That's the first part. Second, sir, what about the capacity utilization of the new plants? And how do you see the capacity utilization in the current quarter, that's a Q4?

[Sucheth Davuluri, executive]

So Ankush, on the pricing side, we've mentioned this in previous calls. But over the last decade or so, we've consistently derisked our procurement positions from China to other suppliers. So we've made the supply chain much closer to home. And therefore, as far as our solvents or raw materials are concerned, we are seeing volatility, but it is not extreme volatility as you see reflected in our performance numbers as well.

Coming to your second part, I think our Unit 1 and Unit 2, the capacity utilization tends to range between 80% to 85% given that specific quarter and the product mix. Our Unit 3 is about 65% based on the installed capacity to date. But given that, our Unit 3 is growing and we continue to add capacity. That number will keep evolving.

[Unknown Analyst]

So sir, Unit 1, Unit 2, 85% and Unit 3 is 65%, currently?

[Sucheth Davuluri, executive]

Correct. I said 80%, plus/minus.

[Unknown Analyst]

Okay. Okay, okay. Sir, would you throw some more light on the CMS business? How the commercial and development stage they could do in upcoming quarters?

[Sucheth Davuluri, executive]

I think as I had indicated earlier, there has been good progress in terms of commercialization of certain CMS molecules. I think the increase in the commercial revenue this quarter is an indication of that. Going forward, we expect over the several quarters, in the next couple of years maybe, that more molecules will get commercialized. And we are actually very excited about the potential of these molecules. And as these molecules get commercialized and the ones that just recently got commercialized also scale up, we think that will be a key driver for the CMS business.

I think if you go back to our con calls 2 years ago, we had indicated that we have a pipeline of several molecules which are either completing Phase III, early part of commercialization. These molecules are all kind of still around. And maybe 2 have become commercial since then. I think if you look at our tables that will disclose, that number is evident. And I think in maybe next 1 to 2 years, we expect maybe a couple more to get commercial.

The number may be really small, but these are high-potential molecules. So I think we are excited about that. The only caveat I would add is because these are new drugs, there's always a risk that the drug may not get approved or there is also a risk that the drug may not be successful. So therefore, we are still very cautious. But I think if you look at the last several quarters' trend, it should give you some indication that things are looking positive from our CMS commercialization revenues. So I think that's what we can share at this point.

[Unknown Analyst]

And even, sir, we see in the CMS business that from the last 2 quarters doing very well. So some kind of a growth, sir, any growth number that we can put on the CMS side?

[Davuluri Rao, executive]

Yes. We won't be able to give any sort of guidance. But I think all we have been confident to say that whatever numbers we are seeing and whatever kind of strategy we're seeing is a sustainable one. So there's nothing like an exceptional quarter that has happened and we will go back to how we were, like say, 3, 4 quarters ago. But I think beyond that, it's very difficult for us to give any guidance.

[Operator]

[Operator Instructions]

We have a next question from the line of Nikhil from SiMPL.

[Nikhil Upadhyay, analyst]

Am I audible?

[Operator]

Yes.

[Nikhil Upadhyay, analyst]

Congratulations on great set of numbers. And I think I'll add to previous participants' point that we've never seen the balance sheet of Neuland being so strong in terms of debt and cash flows. So great work and the efforts which the management has been making, I think now results are clearly visible.

Just 2 questions. One is, Saharsh, if I look at our product mix breakup between Prime and specialty and compare it year-on-year, so last year, it was around 56%, which is now 61%, Prime and specialty both. While if we look at the industry across most API commentary, people have been complaining about high inventory levels. And as a result, there is a major inventory destocking which is happening, and the demand has been hit and also the pricing has been hit.

But our numbers seem to be very different from what the industry -- across players, what we are looking at. So if you can just help us understand what's different is happening in our set of products because the Prime and specialty mix has only improved, where there should have been more inventory issues, which the industry is talking about, but our numbers belie that thing. So just help us understand on these 2 segments.

[Davuluri Rao, executive]

So Nikhil, I think there are 2 elements. When it comes to our specialty business, I think that we both have driven by...

[Operator]

Sorry, sir, you're sounding muffled.

[Davuluri Rao, executive]

Yes. Can you hear me better now?

[Operator]

Yes. Yes, please go ahead.

[Davuluri Rao, executive]

Yes. When it comes to our specialty business, I think the growth is being driven and the numbers are a reflection of some of the molecules which are in the pipeline where our customers are taking quantities for launch. And as we have mentioned molecules like Apixaban and Paliperidone have driven some of the revenues and the growth there.

And also, we have had other specialty molecules like Donepezil, Ezetimibe too which have contributed. And I think even as you see that there's a industry trend, I think for these specific [indiscernible] part of the cycle where I think there is a continuous growth and also customers are looking at launch, which is why you have seen that reflection in numbers.

And when it comes to Prime, I think, again, it is products like Mirtazapine and a few others which are contributing consistently to their revenues. And it is, in our case, we have a lot of molecules which are, say, around 100 to 200 ton medium in terms of the molecule size when it comes to tonnage, where there are -- there haven't been unfortunately so many inventory issues because the buildup is likely to be lower in the medium-sized kind of volume products. So that is the reason why we have seen a certain consistency in the last 2 quarters from these segments.

[Nikhil Upadhyay, analyst]

Okay. Just one last question on the CMS side. Now if you go to Slide #15, what we see is that the commercial launch has scaled up. So for last 4 quarters, we were averaging around between INR 40 crores to INR 50 crores. In this quarter, we moved to almost INR 75 crores. So, which means there is a big commercial launch, either which has happened or we've participated.

So do you see, because what we understand in the patented molecules buyers, pick up large volumes and then it pays for some time, and then it reduces to a normal level till the time the next amount is -- next quantum is required for a larger launch or based on the demand. So this INR 74 crore, INR 75 crore is sustainable? Or do you think we'll come back to that INR 40 crore, INR 50 crore kind of a run rate? So is it supported by a launch of a molecule, which has driven this?

[Davuluri Rao, executive]

The short answer is that it's sustainable because I think what you are alluding to is typically how a launch happens. But every case is very different. Sometimes you get to -- you are commercializing a drug that is already in the market as a second source. In which case, you will probably start supplying continuously from the beginning.

In some cases, there could be a situation where you will make maybe 3, 4 months or 3, 4 quarters of lunch quantities, and then you'll go into maybe hibernation for a year or so. So I think it's possible, different scenarios are possible. But I think the question that I'm guessing you want to know is, is this a onetime thing or is it sustainable. I think the short answer to that is it is sustainable.

[Operator]

We have a next question from the line of Sanjaya Satapathy from Ampersand.

[Sanjaya Satapathy, analyst]

I just wanted to ask a couple of questions that your specialty business contribution declined in this quarter, if you can just explain that. And secondly, you -- though you have already warned that your numbers will be volatile because of the nature of business, but your commentary nowadays is far more confident than what you used to do in previous years. So what has really changed? If you can just explain us.

[Operator]

Sir, we are unable to hear you.

[Sucheth Davuluri, executive]

Yes. So if we are to look at the specialty segment, I think we -- again, because the molecules themselves are small volume in terms of their nature. So there is likelihood to be more lumpiness because even customers, campaigns and all are not done on a regular basis but are done more only made-to-stock or -- not want to made-to-stock but on the made-to-order and in certain markets based on how the demand phases out over a period of time. So therefore, there's likely to be a certain lumpiness.

But if you have to look at it over an annual period, we can see that there has been a significant growth even in the specialty business and which is very clear both in the percentage from the specialty business and even it is reflected even in our margins, too. So it is just -- there is likely to be a certain lumpiness because of the nature of the molecules. But overall, we are seeing an upward trend.

[Sanjaya Satapathy, analyst]

If you can just tell us about that will your numbers be less volatile and kind of a secular -- relatively secular compared to what the turbulence that you saw in the previous years? I mean, have you kind of reached a state where you can be a lot more sure about your prospects primarily because your new molecules are in a more better commercial state?

[Davuluri Rao, executive]

Are you referring to the specialty business in particular or the over...

[Sanjaya Satapathy, analyst]

No, I'm talking about the CMS business now.

[Davuluri Rao, executive]

The CMS business. I think, yes, as we had indicated a couple of times in this call, the CMS business, the shift to commercialization is giving us more confidence that the business is sustainable and it's more sticky. And I think you should see continued performance going forward.

I think depending on the order mix [indiscernible] there could be variation in terms of margins and numbers, et cetera. But I think overall, what we are emphasizing is if it's commercial revenue, you can see that it will be sustainable, maybe with a little bit of lumpiness, but it will be sustainable for sure.

[Sanjaya Satapathy, analyst]

Understood. And lastly, on Unit 3, can you just tell us like what kind of utilization now and what kind of utilization we're looking forward in like couple of years?

[Abhijit Majumdar, executive]

Yes. So if you look at I think Sucheth has mentioned that Unit 3 utilization in FY '23 estimate is around 65 -- 62% to 65%. As we move forward into FY '24 with the product mix change, we would be closer to 68%, 69%. And so kind of tells you there's a window of growth that would come from, I think, [ 2, 3 years] or next 2 years.

[Operator]

We have our next question from the line of Gautam Bahal from Mauryan Capital.

[Gautam Bahal, analyst]

Just a quick one on Unit 3. Has the U.S. FDA approval come through there? Or if not, what is the update there, please?

[Sucheth Davuluri, executive]

Yes. So we have products that we are shipping into the U.S. from Unit 3. So we've had virtual audits by the FDA. We haven't had critical inspection yet. But the site is listed in the FDA database as an inspected site for the U.S. market.

[Gautam Bahal, analyst]

Is there any sort of clarification of when that physical inspection will happen? Like it's been triggered already, right?

[Sucheth Davuluri, executive]

See, right now, the FDA determines when the physical inspection happens. Right now as far as they're concerned, we do not -- we haven't seen any approvals from Unit 3 being held up because of a lack of a physical inspection. Therefore, it's a complete prerogative of agency to schedule an inspection.

[Gautam Bahal, analyst]

Okay. Okay. But I mean, correct me if I'm wrong, at the moment, you are not making any novel -- sort of novel stuff from Unit 3, right? It's mostly the generic that is being manufactured there? You're waiting for the...

[Davuluri Rao, executive]

We are making NCEs from Unit 3 along with generics. And I think what Sucheth said applies to both because the way the FDA has been functioning, especially post COVID, is if they are not seeing any broad-based challenges with an organization, they are approving specific filings with online inspections. They are not necessarily holding back approvals for physical inspection. So therefore, our product is getting consumed or will get consumed in the U.S. market without any physical inspections both for NCEs and generics.

[Sucheth Davuluri, executive]

Yes. And that's the current state of it, but as you know, nothing keep changing in the dynamic...

[Davuluri Rao, executive]

Yes. They may come for a physical inspection, which we are ready and welcome at anytime.

[Gautam Bahal, analyst]

Okay. But Unit 3 at the moment is still running at a breakeven or loss? Or any update there?

[Davuluri Rao, executive]

I think we did not disclose unit-wise numbers, Gautam. But I think we can indicate that I think by this upcoming quarters, we would have turned the corner when it would be profitable,yes..

[Operator]

We have a next question from the line of Keshav Kumar from RakSan Investors.

[Keshav Kumar, analyst]

Sir, with a debt-to-equity of 0.13, it looks like you've released a substantial amount of debt this quarter. And one of your peers have seen challenges in receivables. So I guess the inflation and cost of debt is leading to some pain over there due to clients deferring payments. So are we seeing or anticipating some impact in the near term? Or as of now, it's business as usual for us?

[Abhijit Majumdar, executive]

So if you look at how we have reduced debt in this quarter, it kind of gives -- tells you the resilience of the underlying business. Working capital remains as it is as we gear up ourselves for Q4. So the short answer is we are not facing the challenges that others maybe facing.

[Keshav Kumar, analyst]

Sure, sir. And sir, lastly, on a medium to long term. So there's quite a bit, which has happened in biopharma in the last 20 years. And the last 5 years, you've seen AI impacting in a big way. So there is a lot of progress in proteomics. Databases are being populated at an ever increasing pace, ability to figure protein structure, finding potential new targets and so forth. So this should come as a beneficiary to both small molecules and peptides.

But when we see the CDMO supply, we have traditionally been in short supply and with lead times of 18 to 24 months. And the capacity can't be scaled exponentially to match the pace of drug discovery advances. So just pure empirically, we should see a much larger share of inquiry because we are a recently established player and also have the capability to do both peptide and small molecules. So is it too soon to sort of have any feelers yet or are we seeing the intensity of early-phase inquiries going up?

[Davuluri Rao, executive]

I think, generally speaking, we have -- I think as we have been executing more projects successfully in the CMS space, because it's a B2B space and a lot of recognition, brand recognition happens through professional networks, et cetera, I think we are seeing increase -- steady increase in terms of inquiries.

And I think beyond that, I think it's hard to correlate with the comments you had made about the general drug discovery landscape and what's happening over there. But I think we have been kind of seeing a healthy increase in terms of inquiries. And we've been -- we've become a little bit more selective in terms of the kind of projects we want to work on.

Sajeev, anything you want to add?

[Sajeev Emmanuel Medikonda, executive]

Yes. So again, Keshav, the point that you make about the discovery, the time line and all of that is valid. But I think if you seen over the past, our focus has been more in terms of molecules, in terms of our BD efforts is more around molecules in Phase II onwards. And there, even as we are seeing more traction, I think it will take some more time for us the impact from flowing through from preclinical to Phase II to happen for it to show up in our purview. So I think to answer your broader question, that's where we are right now.

[Operator]

We have our next question from the line of Sachin Jain, an individual investor.

[Unknown Attendee]

Congratulations on good set of numbers. My question is, as now business mix improving at desired level and probably the margin trajectory, you're sounding more confident. What is a sustainable ROE you guys building in?

[Abhijit Majumdar, executive]

So we are targeting an ROC in the broad range of 17% to 20%. And that, I think so is what we would kind of want to sustain at in that broad range.

[Unknown Attendee]

Sure. Am I audible?

[Operator]

Yes.

[Unknown Attendee]

Yes. And my second question is, basically, if you have to see the CMS business for next 3 to 5 years, can you give some color how you guys are seeing the scalability from here basically?

[Davuluri Rao, executive]

I think it's definitely looking very exciting for us because the quality of the pipeline in the recent periods have been significantly better compared to what we used to have earlier. And I think in terms of the annual revenue per molecule or the margin profile for the molecule or the likelihood of the drug success, the therapeutic area, I think all the important parameters that you would assess [ see ] I think the pipeline has been better.

And I think these molecules have also now started commercialization. So therefore, I think in many ways, there's a lot of scope for growth and obviously a lot of excitement about the CMS pipeline. The revenue growth that will come, I think, will be evident in the coming couple of years. And it's hard to paint a picture around it because seeing a percentage number, I think, could be misleading because it could be either way.

But I think we started to see commercialization. And again, as I've mentioned, 2 molecules have already commercialized in the last 1 year. And we expect maybe another couple to commercialize. And each of these by themselves are fairly attractive. And cumulatively, it should be good.

And the most important thing I would like to underscore is that our pursuit of new projects continues. Our goal is to keep having such opportunities to our pipeline. And not every opportunity will be a successful commercial contract. But I think we are continuing to add these, and we are creating capacities to support that.

So I think overall, it's very exciting. I think next 3 to 5 years, we should see a good healthy growth and profitability from the CMS business. And I think it complements very nicely with our GDS business. So I think we have a good package or not. But I'm not really able to quantify things, unfortunately.

[Operator]

We have a next question from the line of Kunal from Carnelian Asset Management.

[Kunal Shah, analyst]

I have just one question. What are the CapEx planned for the next year, if at all any?

[Abhijit Majumdar, executive]

So broadly, if you look at trending, we spend around -- we've been spending around INR 100 crores to capability in our plant and that could be taken as a trending that would continue. Having said that, large capital investments we have to do to grow our business. As and when it happens and we get Board approval, we will surely inform you in our quarterly earnings call.

[Kunal Shah, analyst]

So basically INR 100 crores would be maintenance kind of a CapEx, not capacity financing CapEx, if I understand correctly?

[Abhijit Majumdar, executive]

Yes. So it's a combination of maintenance as well as upgrades, which kind of enables us to meet the capacities of a particular molecule which suddenly grew. So it's a combination of both. So you could take that as a broad indicator.

[Davuluri Rao, executive]

And maybe what I will add to Abhijit's comment is, I think a lot of the business growth may also require capital expenditure, which I think will happen in tandem with the business contract or some certainty of business. So in some ways, I think beyond what Abhijit said, if we do invest more, it will be perhaps because we see more growth in terms of some other scale-up opportunities. But I think what we have shared is currently what's on the radar.

[Kunal Shah, analyst]

Okay. It will be fair to assume it will be more on the CMS business side, if at all, anything lined up?

[Davuluri Rao, executive]

Yes. I think typically, we -- our strategy has been to add capital expenditure on the back of the CMS molecules. And since the capacity is fungible between GDS and CMS, we are also able to use the same capacities for the GDS business. But I think over the last few years, I don't think we have created capacity exclusively for our GDS business.

[Abhijit Majumdar, executive]

Unit 3, we have.

[Davuluri Rao, executive]

I think in Unit 3 -- to initiate Unit 3 operations, I think the initial capacity created was also GDS. But I think the capacity that we are creating now is we are creating new capacity, it may be to accommodate the growth from these new CMS molecules. But irrespective, the capacity is fungible between GDS and CMS. And what we typically do is we look 2 years ahead and make sure that we have capacities in place.

[Kunal Shah, analyst]

Okay. Okay. Fair enough. Just one question as [indiscernible]. I just wanted to understand as our gross margin is bearing because of the products mix change and because of the variances that we have in the CMS specialty businesses. So how did one look at the margin basically for these 3 businesses? I mean the ranking has gone bright. But still, what would be the kind of deferrals in the gross margins between those 3 segments? So as an investor to go out as to how much gross margin can vary between the 3 business verticals depending on the quantity?

[Davuluri Rao, executive]

I think they can be -- see, I think at a high level, the gross margins of the Prime -- sorry, the specialty and the CMS may be similar, Kunal. But I think what's very important for you to understand is that at product level, there is a variation in gross margin product to product. In CMS or in specialty, we have products which have 80% gross margins. We also have products which have maybe 30%, 35% gross margins. And how we do in a particular quarter is also a factor of how much of a particular product we have shipped.

So I think it's hard to give you more granularity on how the gross margins will figure out. But I think what we are seeing is a good blend right now. And unless there's a crazy surge in raw materials or maybe a big fluctuation in products, these margins are a reasonable baseline for now to take.

But we don't really want to give you spell-out margins of Prime, specialty and CMS separately because that may also not be very accurate because then if we ship certain products in CMS, then that margin will change. And then you will wonder why is the margins of CMS different. So I think we'd rather keep the margin at aggregate level and just help you understand that these are broadly the reasonable margins to assume.

[Kunal Shah, analyst]

Okay. Okay. Fair enough. So the only reason for asking is, if I look at the last 8 quarters, the margin, the gross margin specifically had a wide variance. So just wanted to have color. But fair enough. I understand what you're trying to say.

[Operator]

We have a next question from the line of Sajal Kapoor, an individual investor.

[Unknown Attendee]

Quick question now on R&D infrastructure. So in terms of our R&D investment, is the current R&D setup in terms of campus size and capability as well as the scientific talent mix? Is it good enough for next 2 years? Or do you think we need a bigger R&D campus or we need to significantly scale up from our current base of around 300 scientists?

[Davuluri Rao, executive]

I think today, we are operating at about 360, 370 scientists, Sajal, but as you indicate, it is fairly tight because we do have -- we do use a lot of scientists for troubleshooting in the plant. We use them for life cycle management. We also have active GDS programs, and then we have the CMS business. So we are making some increases in R&D capacity in the upcoming financial year. And we think tactically that should surprise for the upcoming financial year.

But maybe from a 2- to 3-year perspective, it may not be enough. So we're also looking at slightly medium-term plan, which might involve some expansion of R&D. But at the same time, we're also looking at ways in which we can improve the effectiveness of R&D. That could be in terms of maybe putting certain systems in place, trying to also be better in selecting the kind of projects we want to take up in the organization, maybe also trying to do more computer-aided experimentation to reduce the load on the bench.

So I think there are a lot of important initiatives that have been taken up right now. I think studying pilot batches carefully, using good modern techniques, using chemical engineering expertise is also a way to reduce your load on R&D labs.

So I think it's an important question. I think we are in the midst of doing proper evaluation on what's good for doing process R&D. I think decisions to expand will be based on what we figure out in the next 6 months or so. But I think definitely, as a growing company, we will have to make sure that R&D resources do not limit our ability to scale up more and more projects.

[Operator]

Ladies and gentlemen, that was the last question for today. I now hand the conference over to management for closing comments.

Over to you, sir.

[Abhijit Majumdar, executive]

Yes. I'd like to thank everyone for the engaging questions on the business. While we make every effort to answer your questions with the available clarity to us at this point of time, your questions also act as stimulants for our internal conversations. Even as we are excited about our business, it is important for us that our investors share that, and your participation today reflects that. And for that, we would like to thank you. Wish you all a good evening and look forward to talk to you again.

[Operator]

Thank you. On behalf of Neuland...

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