DR REDDYS LABORATORIES LTD annual report, Q4 FY2020

Dr. Reddy’s Laboratories Limited — Form 20-F Summary

Business context and reporting period

This is an annual report on Form 20-F for the fiscal year ended March 31, 2020, prepared under IFRS as issued by the IASB. The requested period metadata states “2019 Q4,” but the filing is not a quarterly report and presents full-year fiscal 2020 results, with comparisons to fiscal 2019 and fiscal 2018.

Dr. Reddy’s is an India-based global pharmaceutical company with four reportable segments: Global Generics, Pharmaceutical Services and Active Ingredients, Proprietary Products, and Others. Key markets include the United States, India, Russia and Europe.

Financial performance and liquidity

Metric	FY2020	FY2019	Change
Revenue	Rs.174,600 million	Rs.153,851 million	+13.5%
Gross profit	Rs.94,009 million	Rs.83,430 million	+12.7%
Gross margin	53.8%	54.2%	Down 0.4 percentage points
Operating profit	Rs.15,993 million	Rs.20,888 million	-23.4%
Profit before tax	Rs.18,032 million	Rs.22,443 million	-19.7%
Profit for the year	Rs.19,498 million	Rs.18,795 million	+3.7%
Basic EPS	Rs.117.63	Rs.113.28	+3.8%
Operating cash flow	Rs.29,841 million	Rs.28,704 million	+4.0%

Reported profit benefited from a net tax benefit of Rs.1,466 million, compared with a tax expense of Rs.3,648 million in fiscal 2019. The effective tax rate was negative 8%, primarily due to deferred tax asset recognition, including MAT credits and impairment-related tax benefits.

Cash and cash equivalents were Rs.2,053 million at March 31, 2020, while other investments totaled Rs.24,015 million. Working capital was Rs.57,556 million, and the Company reported Rs.39,374 million of available uncommitted bank credit lines.

Total borrowings, including current and non-current portions but excluding certain presentation distinctions, were approximately Rs.22,011 million at March 31, 2020. Principal debt obligations excluding leases totaled Rs.20,224 million, all contractually due within one year. The Company stated that it was in compliance with its financial covenants.

Segment and operating developments

Global Generics: Revenue increased 12% to Rs.138,123 million, representing 79% of consolidated revenue. Growth reflected higher existing-product volumes and new launches, partly offset by approximately 9% price erosion. Segment gross margin declined to 56.8% from 58.5%.
Pharmaceutical Services and Active Ingredients: Revenue increased 7% to Rs.25,747 million, while gross margin decreased to 24.0% from 25.4%, primarily because of product mix.
Proprietary Products: Revenue increased 67% to Rs.7,949 million, including Rs.7,486 million from the sale of U.S. and selected-territory rights for ZEMBRACE SYMTOUCH and TOSYMRA to Upsher-Smith. This transaction was a significant unusual item.
Research and development: Expense decreased 1.3% to Rs.15,410 million, or 8.8% of revenue versus 10.1% in fiscal 2019.
U.S. pipeline: The Company had 285 cumulative U.S. filings, including 281 ANDAs and four 505(b)(2) NDAs. At March 31, 2020, 99 filings were pending approval, including 54 Paragraph IV ANDAs.
Capital expenditure: Net capital expenditures were Rs.5,725 million, with additional capital commitments of Rs.4,888 million. Capital work-in-progress was Rs.4,521 million.

Material changes versus the prior comparable period

Revenue growth was strong, but operating profit declined because of a Rs.16,767 million impairment charge, compared with Rs.210 million in fiscal 2019.
The impairment charge primarily included Rs.11,137 million related to the generic NuvaRing product, following competitor launches, and Rs.5,620 million related to other product intangibles.
Net profit increased only modestly despite revenue growth because of impairment charges and lower gross margins; the improvement was substantially supported by the tax benefit.
Operating cash flow increased, but days sales outstanding rose to 100 days from 90 days, reflecting a higher proportion of U.S. receivables with longer credit periods.
Financing cash outflows increased to Rs.25,159 million, primarily due to net repayment of borrowings of Rs.18,683 million and dividends and related taxes of Rs.3,916 million.
The Company adopted IFRS 16 on April 1, 2019, recognizing Rs.1,335 million of lease liabilities and Rs.1,153 million of right-of-use assets. Prior periods were not restated.
The U.S. FDA completed the re-audit of the Srikakulam API facility in January 2020; the facility was classified as Voluntary Action Indicated in May 2020. The filing states that all facilities subject to the 2015 warning letter were then classified as VAI.

Guidance, outlook, risks and unusual items

The filing does not provide a quantified fiscal 2021 earnings or revenue forecast. Management expects continued growth opportunities in PSAI from newer technologies, partnerships and global customer expansion, but emphasizes uncertainty around COVID-19, regulatory approvals, pricing pressure and market competition.

COVID-19 created risks to manufacturing, raw-material sourcing, logistics, clinical-trial recruitment, customer liquidity, sales activity and regulatory timelines. The Company stated that its operations continued during lockdown with safety measures and that, based on information available at approval, it expected to recover the carrying amounts of receivables, goodwill, intangibles, investments and other assets.
Ranitidine products were voluntarily recalled in the United States because of NDMA contamination concerns. The Company recorded Rs.373 of inventory write-downs and Rs.239 of refund liabilities. Related litigation remained unresolved, and no provision was recorded because the potential liability was considered unascertainable.
Major risks include generic price erosion, customer and distributor concentration, regulatory and manufacturing compliance, patent litigation, product liability, supply-chain interruptions, foreign-exchange movements, interest-rate exposure, cybersecurity, tax disputes and environmental matters.
The ten largest customers accounted for approximately 80% of North America Global Generics revenue, highlighting customer concentration.
The Company faced ongoing U.S. antitrust and pricing-related litigation and investigations, including multidistrict litigation involving alleged generic-drug price fixing and market allocation. The Company denied wrongdoing and recorded no provision for claims considered unascertainable.
In February 2020, the Company signed an agreement to acquire selected Wockhardt branded-generics assets for up to Rs.18,500 million. The transaction closed on June 10, 2020 and was not accounted for in fiscal 2020. The revised consideration included Rs.14,830 million paid at closing, Rs.670 million in escrow and a potential Rs.3,000 million holdback.
The Board proposed a dividend of Rs.25 per share, totaling Rs.4,154 million, subject to shareholder approval. The Company had paid Rs.20 per share for each of fiscal 2018, 2019 and 2020.

Most important facts for an investor to verify

Whether fiscal 2020 operating performance can improve without the exceptional tax benefit and despite continued generic price erosion.
The recoverability and remaining commercial value of the Rs.27,659 million intangible-asset balance and the assumptions supporting impairment testing.
The financial impact and potential exposure from ranitidine litigation, U.S. generic-pricing antitrust proceedings, patent disputes and regulatory investigations.
Execution, integration costs and post-closing revenue performance of the Wockhardt acquisition, including the contingent holdback.
COVID-19 effects on demand, manufacturing capacity, supply chains, customer collections and regulatory approvals after March 31, 2020.
Debt refinancing and liquidity needs given that reported principal debt obligations excluding leases were due within one year, notwithstanding available credit lines and investment balances.
Progress in resolving U.S. FDA observations and maintaining VAI or NAI classifications across manufacturing sites.
Customer concentration, receivables aging and the increase in days sales outstanding to 100 days.