MANAGEMENT DISCUSSION AND ANALYSIS

INDUSTRY STRUCTURE & DEVELOPMENTS

Pharmaceutical Industry - Global & Indian

The global pharmaceutical market is expected to reach $ 1.3 trillion by 2018, due to increased global spending driven by population growth, an aging population and improved access in pharmerging markets. CAGR of pharmerging market will be 8 to 11% by 2018. Due to globalization, pharmerging countries have increased from 5 to 21 and healthcare improvement will continue to be their priority. Many of these countries are implementing healthcare reforms to ensure universal coverage. The developed market -led by the United States, the major five European markets and Japan had been the primary drivers of increased growth, while the 21 pharmerging countries are expected to increase their contribution to growth over next five years and account for nearly 50% of absolute growth by 2018.

The Indian pharmaceutical market is the third largest in terms of volume and thirteen largest in terms of value. Its revenue is estimated to grow at 15 per cent per annum between 2015 and 2020, thus outperforming the global pharmaceutical industry. India is the largest provider of generic drugs globally with the Indian generics accounting for 20 per cent of global exports in terms of volume. By 2020, India is likely to be among the top three pharmaceutical markets by incremental growth and sixth largest market globally in absolute size. Indian pharmaceutical industry has many advantages in terms of efficient cost of production, good R&D technical work force for process improvements, lower healthcare costs, diversified array of products viz., over 60,000 generics brands across 60 therapeutic categories comprising of more than 500 different APIs. Economic prosperity, increased drugs affordability and increasing penetration of health insurance along with government initiatives like 'Pharma Vision 2020' will propel India to become a global leader as an end-to-end drug manufacturer. The Government of India is committed to setting up robust healthcare and delivery mechanisms.

BUSINESS STRATEGY

Domestic Market and Trends:

The domestic formulation market has witnessed a healthy growth in demand during the past five years. Going forward, this trend is expected to continue broadly based on growing population, increasing health awareness and an increasing per capita income leading to a large overall healthcare spend. The market is expected to grow with a CAGR of 15.92% to reach a size of US $ 55 billion by 2020. Indian bulk drug industry has grown as a direct offset of formulation growth worldwide.

Aarti Drugs Limited (ADL) has a strong regulatory framework and CGMP level documentation, which is now a standard requirement of most of the big Indian Pharmaceutical Companies. High process efficiency and high standard for quality has created good brand name for the Company in the space of Antibiotic, Anti-diabetic, Antifungal, Antidiarrheal, Anti-inflammatory and Cardioprotectant therapeutic segments. Indian pharmaceutical market is growing fast due to penetration of health services in rural areas of the country. There is also a shift in demand from drugs treating hygiene related diseases to drugs treating lifestyle related diseases in the urban sector. ADL has recently constructed new facilities for three antibiotic products (Fluoroquinolones) and its intermediates and doubling the capacity of one of its major Antidiarrheal product. Both these projects are commercially operational and will drive the growth of domestic sales in coming years.

Export Market and Trends:

Indian bulk drug companies have filed 49% of the overall drug master filings (DMFs) made in the US in 2013, which will help Indian pharmaceutical companies to capitalize further on export opportunities in regulated and semi-regulated markets.

The Ministry of Commerce targets to export $ 25 billion worth of pharmaceuticals in 2016. India supplies 20 per cent of global generic medicines market exports in terms of volume, making the country the largest provider of generic medicines globally and expected to expand even further in coming years. America accounted for around 34% of Indian pharma exports in FY 2013, followed by Europe 26% and Asia 20%. Exports to Africa increased at a CAGR of 21% from 2009 to 2013. The global generics market has grown at a phenomenal pace in past few years and is expected to grow over the next five years.

Significant portion of bulk drugs manufactured in India is exported as compared to developed countries, where bulk drugs are primarily manufactured for captive consumption. Recent Anti-diabetic facility, which started its commercial operations last year is now WHO-GMP approved. Same facility was also inspected by other international regulatory authorities last year and also expected to get further regulatory approvals for European markets as well.

The Company continues to further enhance the IT infrastructure of its USFDA facility to address data integrity issue. USA based consultants have conducted a third party audit, based on which further remediation measures are being implemented. The Company is committed to comply and get USFDA Import Alert for Tarapur facility withdrawn at the earliest possible. However, other facilities of ADL continue to maintain CGMP certifications like COFEPRIS, ANVISA, TGA, WHO GMP and ISO resulting in competitive advantage. Due to macroeconomic conditions across the globe like sudden crash of currencies, oil price collapse, tightening of government budgets resulted in subdued demand in global markets. However, due to new product launches and additional regulatory approvals, Company expects to grow in exports in spite of these conditions.

OPPORTUNITIES & THREATS

SWOT ANALYSIS

Strengths & Opportunities:

The Company has been continuously striving to keep its costs to minimum possible to aggressively compete with Chinese competitors. Moreover, slowly India is getting competitive with respect to Chinese manufacturers, as Chinese environmental rules are becoming stringent like that of India. Moreover, global players brfer Indian manufacturers to Chinese due to better documentation and quality. Furthermore, currently the Company has customer audited and CGMP facilities, which give us an edge over competition throughout the world.

The Company continues to enjoy economies of scale due to its large production capacities in Anti Diarrhea, Anti Inflammatory, Anti Fungal, and Anti Biotic segments. Bigger market share automatically helps us to be competitive in market due to sbrad of overheads and better bargaining power. The Company has always been vertically integrated company, manufacturing most of its intermediates for captive consumption. Till date the Company has exported over 100 countries worldwide indicating its strong marketing network, logistics capability and geographic sbrad of the ADL brand. Customer diversification is also one of key strengths of the Company reducing its dependence on any single customer.

The Company is operating State-of-the Art R&D Center, at Tarapur, which is recognized by Department of Science and Industry Research, Government of India. Our scientists are constantly working for developing technology, non-infringing route of synthesis, scale up and its transfer to manufacturing location for commercialization. They actively work not only on bulk drugs in various therapeutic categories but also on specialty chemicals for non-API related applications. The Company has 30 years of manufacturing experience and has developed expertise in various reactions for bigger volumes of production, also building the long-term customer relationships, which is a key strength in API manufacturing industry.

The Company has also taken few forward-integration steps to include a small formulation manufacturing plant for toll manufacturing of formulations and also registering few finished products for exports market.

RISK AND CONCERNS

Weaknesses, Risks and Concerns:

Variation in crude oil prices would always be area of concern. The Company has already installed greener technologies like briquette fired boilers, economizers etc. to save power and fuel costs, which reflects in the financial result of the Company. The Company was able to cope up with these brssures due to strong operational efficiency and increased market share of its products.

Extreme volatility of exchange rate of rupee against US dollar can have significant impact on the Company's operations because approximately 36% of its total revenues consist of exports. However, natural hedge mitigate the risk to large extent due to the imports. The Company has a strict FOREX policy of hedging all of its foreign currency loans to mitigate the risk of volatility of exchange rate.

Macro economic conditions like sudden currency variations, sharp fall in crude, US dollar remittance issues in African countries etc. do affect the export demand. However, pharmaceutical being a defensive sector, backed by the strong domestic demand, such risks are mitigated to some extent.

INTERNAL CONTROL SYSTEM & ADEQUACY

The Company has sound and adequate internal control systems commensurate with its size and nature of business. We constantly upgrade our systems for incremental improvements, because we firmly believe that 'change is the only permanent thing'.

The Audit Committee of the Board periodically reviews these systems. These systems ensure protection of assets and proper recording of transactions and timely reporting. Internal audit is being carried out by an independent firm of chartered accountants on a quarterly basis.

The Audit Committee also regularly reviews the periodic reports of the Internal Auditors. Issues raised by Internal Auditors and Statutory Auditors are discussed and addressed by the Audit Committee. Audit Committee constantly tries to add value by evaluating existing systems. Since August 1, 2014, the Company completely stopped its legacy systems and is online on Microsoft Dynamics Navision ERP systems. This has already enhanced the reporting and internal control systems.

FINANCIAL & OPERATIONAL PERFORMANCE

During the year under review the Company has achieved consolidated top line of Rs. 1228.31 crore, achieving a y-o-y growth of 4.13%, correspondingly EBIDTA worked out to Rs. 175.69 crore as against Rs. 169.67 crore in the brvious year recording a growth of 3.55%. Net profit after tax was Rs. 68.72 crore as against Rs. 77.25 crore in the brvious year recording decline of 11.04%.

Keeping long term view in mind, the Company has carried out various expansion programs in last three years. Many of the expansion projects went live in the year under review leading to higher debrciation and expensing of interest costs. However due to increasingly stricter regulatory norms and approvals from government regulatory authorities, the overall gestation period for Active Pharmaceutical Ingredient projects has gone up considerably. In addition, macroeconomic conditions like sudden devaluation of currencies across globe, sharp fall in crude prices, US dollar remittance issues in some regions posed challenges for global trade.

Due to underutilization of the expanded capacities across the company, there was under absorption of overheads which led to increase in costs and reduction in the profitability. However, the company is confident to reap the benefit of utilization of expanded capacities, to increase the operating leverage thus resulting in better profitability. With reference to USFDA import alert, the company is actively upgrading its USFDA facility with the help of remediation plan, based on recent audit conducted by USA based consultant

SEGMENT-WISE PERFORMANCE

For the year 2015-16, around 94% of the total sales of the standalone company came from API and its allied intermediate segment and approximately 3% from the speciality chemicals. Within the API segment, Antibiotic therapeutic category contributes to around 50%, Anti-diarhoeals around 20%, Anti-inflammatory around 12%, followed by Anti-fungal, Anti-diabetic and Cardioprotectant therapeutic categories. On a consolidated basis, formulation sales is around 10% of the total revenues.

MATERIAL DEVELOPMENTS IN HUMAN RESOURCES/INDUSTRIAL RELATIONS FRONT INCLUDING NUMBER OF PEOPLE EMPLOYED

Human Resource

Human capital has always been the most important and valuable asset to the Company. The Company has approximately 1072 permanent employees as on 31st March, 2016 at factory and office level. HRD center had conducted number of training programs during the year 2015-16 as well on the various topics related to Technological Development, Quality System Management, Behavioral Change Modules, Individual and Operational Safety, Personality Development, Computerization of Systems etc. Apart from these internal training programs, employees are also sent for training/ seminars at prominent training institutes on regular basis for upgrading their knowledge and skill level.

CORPORATE SOCIAL RESPONSIBILITY

As a contribution towards Community Development to fulfill Company's obligations towards the Society, Company organizes many activities on regular basis including Blood donation, Eye and Health check up camps and Career guidance workshops for young students in areas surrounding its units. Company also worked closely with Institute of Chemical Technology for the cleaning of Rankala Lake in Kolhapur, Maharashtra. The Company has also constructed public toilets in the area near Sarigam, Gujarat. The Company has also made donations to hospitals. Contributions are made to primary schools of surrounding villages for painting of school buildings, purchase of benches & furniture, sports equipment, records storage facilities etc. We continue to provide maintenance services to the Palghar-Dahanu Taluka Sport Association. The Company has taken up a big forestation project across an area of 100 hectares in the nearby area along with the forest department.

ENVIRONMENT HEALTH & SAFETY

All our plants are designed with appropriate Waste Management Systems and operate in harmony with the surrounding ecosystem. Safe disposal of waste, treating effluents to manufacture an eco-friendly by-product, generating steam through a waste heat recovery plant and In-house R&D team ensuring pollution control & energy conservation are some of the ways adopted by ADL to operate in an eco-friendly manner.

Continuously, the Company has innovated many more techniques to reduce the effluent generation in the process, utility and domestic areas across units to reduce the entire effluent stream. Environmental requirements are incorporated into the plant design right from the brliminary stage of a process. Air scrubbers, dust filters, fire protection systems and Effluent Treatment Plants are in place & well maintained.

In the current year, the Company has conducted various trainings and decampment programmes with the help of faculty of Civil Defence (Tarapur), Bombay Productivity Council & safety consultancy from Ex. Deputy Director, Department of Industrial Safety and Health on various aspects like Fire fighting & Rescue operation, '5S & Kaizan', Importance of PPE's, safety awareness and behavior related safety. Dedicated corporate safety team along with individual unit-wise teams consistently monitor plants for notifying unsafe conditions. Regular safety drills ensure that readiness for safety gets top priority. We will strive to further improve ourselves to create safer working conditions for our workers.

OUTLOOK

The Company's R&D programs are currently focused on new products development related to lifestyle related diseases like diabetics, cardiovascular, anticoagulant, cholesterol etc. These products would be developed along with their DMFs in a time-horizon of 2-4 years. This falls in line with the vision of expanding the Company's brsence in the regulated markets. Company will continue to do R&D on APIs that are off patents and will work on non-infringing route of synthesis. The Company has also tied up with European distributor on profit sharing basis of finished dosage sale. Already 2 finished dosage dossiers are filed with UK MHRA and 2 are under developmental stage. Strategy would be to engage in our own APIs.

The Company has started commercial operations of intermediate plant, first in India, for three of its Anti-biotic products. Majority market share and economies of scale with strong technological backup will continue to remain key strengths of the Company. Few of its expansion projects were commercialized last year, which will give good impetus to growth initially targeting domestic markets and eventually the global markets post getting necessary regulatory approvals. Macroeconomic conditions and higher gestation period due to newer regulatory processes had caused a subdued growth in last year, however company is in advance stage to get such approvals for the last years' expansions.

Cautionary Statement

Statement in the Management Discussion and Analysis describing the Company's objectives, projections, expectations and estimates regarding future performance may be "forward looking statements" and are based on currently available information. The management believes these to be true to the best of its knowledge at the time of brparation of this report. However, these statements are subject to certain future events and uncertainties, which could cause actual results to differ materially from those, which may be indicated in such statements.