December 4, 2021

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Edited Transcript of SHK.NSE earnings conference call or presentation 27-May-20 5:30am GMT

MUMBAI Jun 3, 2020 (Thomson StreetEvents) — Edited Transcript of S H Kelkar And Company Ltd earnings conference call or presentation Wednesday, May 27, 2020 at 5:30:00am GMT

Motilal Oswal Securities Limited, Research Division – Equity Research Analyst of Institutional Equities

* V.P. Rajesh

Citigate Dewe Rogerson Ltd. – Client Manager

Ladies and gentlemen, good day, and welcome to S H Kelkar and Company Limited’s Earnings Conference Call. (Operator Instructions) Please note that this conference is being recorded. I now hand the conference over to Mr. Anoop Poojari from CDR India. Thank you. And over to you, sir.

Anoop Poojari, Citigate Dewe Rogerson Ltd. – Client Manager [2]

Thank you. Good morning, everyone, and thank you for joining us on S H Kelkar and Company Limited’s Q4 and FY ’20 Earnings Conference Call. We have with us Mr. Kedar Vaze, Whole-Time Director and CEO; Mr. B. Ramakrishnan, Head Strategy; and Mr. Shrikant Mate, VP and Group CFO of the company.

We would like to begin the call with opening remarks from the management following which we have the forum open for a question-and-answer session. Before we start, I would like to point out that some statements made in today’s call may be forward-looking in nature and a disclaimer to this effect has been included in the earnings presentation shared with you earlier.

I would now like to invite Mr. Kedar Vaze to make his opening remarks.

Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [3]

Thank you, Anoop. Good morning, everyone, and thank you for joining us on our earnings conference call to discuss the operating and financial results for the fourth quarter and full year ended March 31, 2020. I will be covering the quarterly business highlights and financial performance for the quarter, post which we will open the forum for your questions and suggestions.

We began the fourth quarter on an encouraging note, witnessing increased demand and improved traction in all our business segments in terms of inquiries, leads, especially from the mid- and large-sized FMCG companies. This led to a solid pickup in the business momentum in the months of January and February. However, a countrywide lockdown and restrictions in the last 10 days of March changed our operating trajectory and moderated sales during the quarter.

On a consolidated basis, our revenue from operations stood steady at INR 269.8 crores in quarter 4 FY ’20 and for the year FY ’20, it was INR 1,105 crores, higher by 6% year-on-year.

The company saw several operational challenges due to COVID led lockdown in March and April. While we did not witness any significant impact on existing order backlog from the customers, our execution during the period was severely impacted due to plant closures and logistic issues. As per our assessment, the revenue impact owing to the lockdown, last 10 days of March roughly translates to around INR 30 crores of revenue. Adjusted for the same, we believe we would have been largely on track to deliver our performance as per our internal expectations for the quarter.

Despite the challenging environment, gross margins during the quarter improved to around 44%, and for the full year to 43%. While the reported PAT during the quarter stood at INR 12 crores, adjusted for the impact of COVID, our revenue and EBITDA would have registered around a PAT of INR 22 crores as per our assessment. Cash profit for the year stood at strong INR 122.7 crores and would have been roughly INR 10 crores higher without the COVID disruption.

In the Fragrance division, we are currently witnessing good demand and healthy buildup of order pipeline for categories such as household products, detergents, sanitizers, soap and personal wash are higher than the average of the previous year.

Our latest category addition, industrial fragrance is also tracking a healthy progress. We reported increased contribution from industrial fragrance in quarter 4 and full year ’20.

The new products we have introduced in the market have been well received, and we expect to deliver improving contribution from this division in the years to come. Our Flavor business also reported steady performance during quarter 4 and full year ’20, after taking into account the impact of the COVID-19 on this segment.

I would also like to update you on the encouraging performance reported by CFF, our Italian joint venture, despite a challenging operating environment in Europe. During the January-March quarter, revenues from the core Fragrance segment improved by 13.5% year-on-year. Gross margins in this segment stood stronger at 54.7%, higher by 580 bps year-on-year, driven by lower raw material prices. I’m also happy to share that despite the lockdown in Italy, CFF witnessed steady sales in the month of April and also in March. Going forward, we expect to deliver a healthy performance from CFF in the quarters ahead.

Let me now discuss the COVID-19 pandemic and its impact on our company’s operations. From January 2020, the outbreak of this pandemic has been disrupting global economies and markets. As discussed in our previous earnings call, we did not see any major impact on our raw material basket owing to supply chains in China. However, the nationwide lockdown in domestic market from March 22 to May 17 significantly affected our business activities. Our priority during this challenging operating environment was to maintain and secure our operations while also ensuring safety and wellbeing of our employees and business partners. Further, we were focused on serving all our customers, especially since we form an important part of the FMCG supply chain.

On the operational front, we took all recommended precautionary measures across our business operations and temporarily closed operations at our corporate office in Mumbai and implemented work from home. In line with the government directives, we had also temporarily suspended manufacturing operations across all our manufacturing facilities in India at Vashivali, Mulund, Vapi and Mahad for roughly 35-odd days. While the company faced supply chain disruption and labor management issues during the lockdown in March and April, the situation on the ground is certainly improving now. Pursuant to the requisite government approvals, we have resumed our operations from the facilities from 27th April onwards.

While the units are operating at low utilization levels, we are undertaking all precautionary measures and ensuring highest safety standards across all manufacturing sites. As I mentioned earlier, prior to the lockdown, we are seeing increased business wins and engagement with existing and new FMCG customers.

I’m happy to share that our contribution from business wins, both from existing and new customers, stood at around 5% during the FY ’20. Though it may seem optically low to you, we are enthused by such figures as it provides a multiyear growth visibility to our business.

Typically, such business wins from existing and new customers account for a small revenue contribution in the first year of operations. But as our customers’ end products mature in the market, the revenue contribution for these products keeps increasing. This is generally over a period of 2, 3 years of fast-growth before the business — product stabilizes.

So while we are seeing a healthy uptick in business wins, positive impact on our business performance is expected on a longer-term basis. Furthermore, we are also encouraged that our company has been winning in 1 to — 4 to 5 client wins over the years. And as the macro situation normalizes, we anticipate this trend to continue going forward.

Fundamentally, the company’s operations continue to be strong and stable. We are also seeing an increased contribution from our mid- and large-sized FMCG customers. The contribution from smaller customers post-GST and demonetization has reduced and currently contributes less than 10% of our total revenues. I would, however, like to state here that in SHK’s core DNA that we would work with all customers, small and big.

While the small customers have been impacted over the years owing to various issues, we do anticipate many of them coming back in some form and modifying their product mix in the next 3 to 5 years. In addition, we are also seeing the growing influence of e-commerce platforms and how they have been challenging the traditional brick-and-mortar stores.

This growing e-commerce platforms are being increasingly and successfully leveraged by a smaller consumer segment entrepreneurs to provide customized products across the domestic market. We believe this presents another set of opportunity for us to build engagement and service these small entrepreneurs.

On the financial position as an organization, we’re realizing our cost optimization strategies and deploying working capital measures to conserve cash flow and ensure steady profitability during this extraordinary situation. I’m happy to share that we reported healthy cash flows of operations during the year of INR 205 crores, owing to improvements in total working capital cycle.

This enabled us to reduce our net debt position on 31st March 2020 to less than INR 300 crore, INR 299 crores, as compared to INR 400 crores in the end of September 30, 2019. This notable reduction in debt was achieved after accomplishing a buyback and interim dividend.

I would also like to share here that our net debt position as on 22nd May is below the 31st March 2020 level, which further strengthens the company as we go into the COVID situation. Furthermore, we hold negligible term loans and most of the company debt is towards working capital.

Even for the 2020 year, we do not foresee major CapEx outflow, except for the CFF acquisition. We expect maintenance CapEx during the year to be less than INR 20 crores and anticipate this outflow to remain amidst this range on a sustainable basis going forward. On the whole, we have a strong balance sheet, fairly robust liquidity and cash flow position that will help us tide over these disorderly times. Our long-term focus remains toward making — marking a sustainable improvement in our return ratios as we go along.

As we look ahead, the fragrance and flavor industry remains a critical part of the FMCG industry. We are confident of the industry’s resilience and its growth prospects and it would be our endeavor to sustainably outperform the industry growth on the back of our leadership position, comprehensive product portfolio, diverse customer base and repeat business in many existing and new customers.

We are presenting ourselves as a reliable partner to all customers and continue to work with them to ensure smooth deliveries and supplies in this challenging operating environment. We are further encouraged that we hold adequate inventories to allow us to service customers in the months ahead. There is limited visibility on when the situation will normalize. We remain confident of our growth prospects and believe that in a normalized operating environment, we should be able to deliver healthy performance as things improve.

With this, I would now request the moderator to open the forum for any questions or suggestions that you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from the line of (inaudible) from Bharti AXA Life.

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Unidentified Analyst, [2]

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I’m attending the company call for the first time. Can you please explain me in detail how the raw material sourcing takes place for your company?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [3]

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Raw material procurement?

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Unidentified Analyst, [4]

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Yes. How does the raw material procurement work? What are your main raw materials? And what are the countries that we used to procure them?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [5]

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So we buy raw materials from over 200 different vendors in over 60 different countries. There is a raw material coming from — about 50% of our raw material is domestically sourced. 50% is imported. And our feedstocks are very varied from petroleum chemicals to turpentine, which is actually a derivative of wood or paper industry. And then citrus terpenes which come from orange juice as a byproduct. So our feedstocks are largely varied from different parts of the world. And then 25% of our volume, 40% roughly of our value is specific herbs, spices and flowers, fruits extracts, which are made across the world.

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Unidentified Analyst, [6]

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Okay. Sir, can you tell me what is the organized and unorganized market in the flavor and fragrance chemical industry?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [7]

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I do not have the latest numbers. But 2 years ago, our estimate was that there would be approximately 30% in the unorganized market in the flavor and fragrance and maybe 35% in flavor and 25% in fragrance.

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Unidentified Analyst, [8]

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Okay. And what would be your market share in the total industry as a percent of organized and as percent of total (technical difficulty) numbers?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [9]

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So as a percentage of the total industry segments on flavor, we would be around 13% of the market share.

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Unidentified Analyst, [10]

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13% of the market share.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [11]

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And around 20% market share on the fragrance.

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Unidentified Analyst, [12]

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20% in the fragrance side?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [13]

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Yes.

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Operator [14]

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(Operator Instructions) The next question is from the line of [S N Joachim] as an inventor.

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Unidentified Participant, [15]

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I just have a couple of questions. One is, can you tell me about your operations in China, of your acquisition which you did last year? And #2, which segment you see maximum growth going forward, for example, hand sanitizer is something which is like booming in geometric progression. So is there a chance for something like (technical difficulty). Are there opportunities because of the COVID in terms of new segments being created? And third is, if you — I mean, I know you may not like to answer, but in terms of your supplies to FMCG companies like Reckitt or HUL, et cetera, are we in the segment? I mean, for example, Love & Care of Hindustan Lever, which is the latest nice smelling detergent, I mean, are we there in that segment at all?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [16]

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So I think I will answer the second question first. We have been continuously working with the global MNC on various products, although our market share in their portfolio is quite small. We are approved vendors with many of them. The COVID has also given us a unique opportunity because many of the global MNCs are also looking for more local or reliable suppliers in addition to their global vendors. So this is an opportunity for us in the COVID environment to also look at businesses from the larger global MNC FMCG players.

To answer your first question, we do not see any new segments as such coming or emerging out of COVID. There is a whole host of new product launches within the existing personal wash, sanitizers and beauty care products. So there are definitely a huge number of products and greater sales.

If you look at the general trend of what has been in the Italian market through our CFF subsidiary, Italy was earlier in the COVID transition or COVID pandemic, we see that the typical products, hand sanitizers and cleaning and cleaning — multipurpose cleaners, all of these products have grown dramatically, almost jump was 50% in March and early part of April, and it will end up with a 10% to 12% increase in these product ranges in — for the full year.

We see a similar thing happening in the Indian context. Our market share in Fragrances on the personal wash, fabric, detergent and cleaning products in general will go up, as a percentage of our total sale and also as the market share of the total business.

Some of the higher premium products in terms of fine fragrance, air care, these markets will be muted for the time being. And as and when the general markets open all over the country and in the different parts of the world, this business will resume to, I think, normal level. So on the overall basis, I think there would be a 10% to 12% increase in the personal wash, sanitizer, cleaning products in general. And the remaining sectors will remain at the same levels as last year.

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Unidentified Participant, [17]

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And about China, please?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [18]

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So China, we have a factory in China, which has been operating throughout this pandemic with no disruption. We don’t see anything specifically negative or positive out of China. I think our view is that there might be some disturbances or some additional costs based on duties or logistics from China. So we are taking adequate stocks in domestic warehouses for products coming out of China for us in the near future.

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Operator [19]

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The next question is from the line of V.P. Rajesh from Banyan Capital.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [20]

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My first question was regarding our business that is coming out of India. So what percentage of the total revenue is from the clients based in India?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [21]

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Roughly 50% of our total revenue is based on clients’ consumption in India. We also have revenues overseas for clients which are based in India, but the consumption of clients in India is roughly 50% of our business.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [22]

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Okay. And then out of that 50%, how much is coming from MNCs here versus the domestic FMCG companies or some of the smaller FMCG companies that you alluded to earlier?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [23]

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So our market share in the global MNCs is very small. It will be a small digit 1%, 2% of our total sale.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [24]

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So 1% or 2% of our total sale of INR 1,105 crore is from the MNC based in India, is it?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [25]

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That’s correct.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [26]

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Okay. And what percentage of our revenue would be from these smaller FMCG companies, however, you may define them, meaning perhaps they are less than INR 100 crore or INR 200 crore of revenues? So if you could just give some more color on that, sir?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [27]

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No, I would just say more broadly — broad picture is that we have — like we are very strong in the middle segment. We have very limited market share owing to global vendor policies with the global MNC FMCGs like Unilever or others that you mentioned. We are very strong with the domestic FMCG companies across the board, which contribute roughly 40% of our sales in the Fragrance side. And maybe around 30% to 40% of our sales in the Flavors side as well. So we are very strong in the mid-sized or the domestic FMCG players, the large and small like everybody that you would know, Godrej, Emami, Marico, Dabur, and so on and so forth, all the well-known FMCG players within the country are large clients for us, and we continue to support their growth and their business through the years. We also have a large diverse client base of roughly 2,000 plus clients across the country and across the various geographies where we operate in 60 countries, where we are a supplier to the midsized and smaller FMCG companies for various products.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [28]

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So in India, if you were to just give a little bit more color, what percentage of our revenue is coming from these smaller FMCG companies? And how do you define the small — in the way you segment the market?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [29]

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So I mean it’s difficult. There is no like — it’s a continuum. So there is no like specific slab or band. We typically look at our potential sales of roughly INR 10 lakhs to INR 20 lakhs annualized basis as the starting point. It also little bit depends on which segment. So there are some segments which are smaller, some segments which are bigger. So in a personal wash soap, we would look at a slightly higher number as a large client and small client. So category by category, it defers. But on an average, customers below potential buying fragrance or flavor INR 10 lakh we define as the small customers, anywhere between INR 10 lakh to around INR 1 crore are the midsize customers and companies which are buying more than INR 1 crore per annum of fragrance or flavor would typically be the large brand companies.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [30]

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I see. And how — what percentage of revenue that would come from, let’s say, your top 10 clients across both categories as well as across India and the globe?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [31]

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Come again.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [32]

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What would be the percentage revenue from your top 10 customers out of revenue of 100 — sorry, INR 1,105 crores, what would be the revenue contribution from top 10 customers?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [33]

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Roughly 20% or 25% of our total revenue.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [34]

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Okay. Okay. And then…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [35]

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And that’s a very widely distributed, diversified portfolio of customers and products.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [36]

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Correct. Correct. And then just 1 more question on the customer side. What has been the challenge in penetrating the domestic MNCs? Or what I mean is the MNCs which are based here, for example, your HULs or your Nestlés and all those sorts of companies?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [37]

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So no challenge. We are working with them. We are continuously working on their briefs and potential business. It’s a matter of time before we get business from them as well.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [38]

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Okay. And for the CFF, you were planning to buy back the remaining portion. So what’s the plan on that side?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [39]

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At the moment, I mean, you can see the results even through the COVID have been very good. So they are operating a strong company, and we are very much inclined to complete the remaining balance 49% acquisition as soon as possible. With the COVID challenges, I think we’ll work out the time lines how to execute the transactions and put in the paper work. But we are keen — we would have — we had indicated that in second half of this financial, we would be closing the transaction. We admit in terms of the COVID situation in the Italy around February, we ended up with postponing that to a later date. But we are keen to go ahead and integrate that business with our business as soon as possible. In addition, it gives us a BCP, a business risk management tool for many of our customers in the Middle East and Africa. And we could supply from Italy in case of production stoppage in India as we have witnessed in April. So we are keen to have a site outside India to be able to face any emergency supply situation.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [40]

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Okay. And just a couple of numbers related questions. Your other income dropped quite dramatically, both for this quarter as well as for the year. So if you can just provide some commentary around that?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [41]

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Shrikant, do you want to answer that?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [42]

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Hello.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [43]

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Yes, Shrikant.

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [44]

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Am I audible? Yes. Yes. So I assume you are comparing with last year. And last year, there were write-backs of expense provision which were no longer required which is why last year number was higher. As we go along, we now continue to have normal composition, which is the export incentives, some scrap revenue and the ForEx gain, et cetera.

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V.P. Rajesh, Banayan Capital Advisors Llp – Managing Partner & Portfolio Manager [45]

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Okay. And last year, you had written-off, I think, INR 23 crores of intangibles. Is there an equivalent number this year corresponding to that? And was it in the depreciation amortization line last year?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [46]

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Kedar, do you want me to take it or you want to answer it?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [47]

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Yes, yes, Shrikant, answer it.

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [48]

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So this year also, there is approximately the same value of the amortization. This is the R&D, which is capitalized. And then it is written off following the systematic review of those projects resulting into revenues. These are categorized into other expenses following the accounting regulation.

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Operator [49]

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We’ll move on to the next question that is from the line of Manish Gupta from Solidarity Investment.

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Manish Gupta, [50]

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I have 2 questions. The first one is, can you please describe your competitive set? And what differentiates different players from each other in this industry? And the second one is, could you explain the strategic rationale of the overseas acquisitions that you have done?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [51]

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So let me start with the first question. We have been in this business for well over 90 years. I am personally in the same family of the founding family, and we have been — technically, the people who have been building fragrances and flavors for well over 90 years. The business of fragrance and flavors like many other businesses, which are related to people consumption, follows trends and follows liking and consumer liking and preferences. So the longer you are in the business, the more data you have, the more experience you have, the more prototypes you have developed, you have a better understanding of the consumer tastes and consumer trends, and you are better placed to make the products for the future. So this is why we have been around. We have been working in these markets over long periods of time. We have a strong library of product development. We have a continual R&D spend of well over 3% many years in a row. So we have the basis to compete with our knowledge, with our R&D, which has been continual R&D. So this is sort of — there is R&D where you need to spend money and there is R&D where you need to spend the time. So this peculiar characteristic of our industry, where as you have data or more periods of time, more prototypes and more trends, you can better select the products and trends for the future. So this is our strength, understanding of the consumer. We are also one of the fragrance companies that talks or even the same principle applies on the flavors, which works with the small and large customers alike. So from a sort of taking a bit from the HSBC tagline of The World’s Local Bank, we are the local developer of fragrance and flavors. So we understand local consumption. We understand local consumer tastes better than the large global companies. And we have global size and scale from our operations and quality control and service levels. So we combine the best of global service standards with local consumer understandings. This is our USP.

In your discussion on the global acquisition, so we have done 2 — 3 global acquisitions. The first acquisition was done 10, 12 years ago when we acquired a company called PFW which was manufacturer of aroma ingredient, and they had a strong pipeline of R&D for new molecules, which is the starting science behind the fragrance and flavors. We have acquired that 10 years ago. Last 1.5 years back, we have set up the tranche in Mahad. We have acquired a company in China, Anhui, which is also in the similar manufacturing base, and closed the Netherlands operating base. So these product lines were basically manufactured in Europe but sold on a global basis, including in India and China. And we thought it is beneficial to operate the manufacturing in an area of lower cost than continue to operate in the Netherlands. So that acquisition was largely in terms of our global ingredient supply chain and the research around the basic ingredients. Both the Netherlands acquisition and our recent acquisition last year on — in China were to support and strengthen our supply chain of the raw material position. We have now acquired CFF in Italy.

So if you look at our fragrance or flavor growth and investment method, we normally look at a market we have R&D exposure. We send market studies on the market, and then we invest to manufacture and produce in those markets. So we have done that for Southeast Asia, Middle East, and we have been operating in these markets for well over 40 years. And recently, after that, we — when we were moving the Netherlands factory out, we already have R&D people and management team in the Netherlands, plus I believe that overall, in the longer run, European business and particularly south of Europe businesses are where the new trends in the global fragrance markets are beginning. So we are now are well placed to operate in the south of France with the Italian acquisition and keep abreast of what is the global trends in fragrance in particular. So it helps us to sell and compete in the European markets and to keep updated on the latest trends in the global fragrance industry.

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Operator [52]

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The next question is from the line of Saravanan Viswanathan from Unfi Capital.

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Saravanan Viswanathan, [53]

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A couple of questions. So you had mentioned that the fixed assets — the investment required in fixed assets this year would be to the tune of INR 21 crores. And so given that, I want to understand what is the current level of capacity utilization? So if we were to see your last 5 years, fixed assets additions have almost doubled, but the revenue — in revenue terms and even operating profit terms, it has more behaved like sidewards. So can you just take us through the current level of capacity utilization? And how long before that we need to create more capacity?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [54]

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So in terms of capacity, with our large investments in the Netherlands and in the Mahad factory and relocating the Netherlands operations, we have primarily completed our cycle of investments for that phase of growth. We don’t foresee any real Mahad CapEx required for the continuation of our current business. We will look at small CapEx, if additional capacity enhancement is required. But by and large, our capacities are in place. At none of the plants — so all of the business segments, our current capacity is around the 50% to 60% level on demand — what is the current demand. So we have enough headroom across the divisions and factories to continue to increase our revenue without any large CapEx requirement.

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Saravanan Viswanathan, [55]

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Okay. So I mean — so the CFF Italian capacities and the Indian capacities, are they for similar products or they are…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [56]

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No, CFF capacity is in fragrance formulations and that is specific to the European market. We are not depending on that capacity for the Asia, Africa, Southeast Asia markets. We have 2 similar plants in India catering to these demands in Middle East, Africa, Indian subcontinent and Southeast Asia. So CFF is the next step to cover European market as a geography. We have the Chinese operations as well, which we have. So right now, our span of operations is between kind of Middle East, Indian subcontinent and Southeast Asia is our established market where we have market presence, and we are continuing for the last 25-plus years. Europe and China are additional markets where we will start to develop some marketing and sales.

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Saravanan Viswanathan, [57]

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Okay. So even in — from a European market perspective, the CFF Italian capacities are sufficient for a few more years?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [58]

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Yes, we have, last year, invested in additional production capacities in CFF as well in anticipation of the integration. So we have enough capacity. All the plants in terms of business segments are not exceeding 55%, 60% of their capacity at a maximum. For the fragrance domestic market and flavor domestic market, we are even at a lower utilization level because we see — we have invested heavily in kind of large capacity early in the cycle.

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Saravanan Viswanathan, [59]

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And the R&D expenditure that you’d hinted, is it all charged through the P&L account? Or some of it is capitalized?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [60]

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So since 2015 in the new accounting standard, we have been charging some — capitalizing some of the longer-term projects and charging off the immediate projects to expenses. As we speak, it’s pretty much a steady state. So we are by and last the same — so if I look at my cash expenses or I look at my expenses in the P&L, they are more or less the same. Because there is a net effect of some being capitalized and some being written-off from the earlier years, which did not materialize or were started to kind of amortization. So net result of the 2 is pretty neutral. So there is no additional things being charged off to the balance sheet in a year-on-year basis.

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Saravanan Viswanathan, [61]

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Okay. Understood. And one more — just one more question. What would be our financial outgo if we are to buy this 49% stake — remaining stake in PFF Italy?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [62]

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So we are negotiating with them. But as of the last discussion, we had roughly EUR 16 million of outlay planned.

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Operator [63]

——————————————————————————–

The next question is from the line of Alpesh Thacker from Motilal Oswal Financial.

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Alpesh Thacker, Motilal Oswal Securities Limited, Research Division – Equity Research Analyst of Institutional Equities [64]

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Sir, my first question is on the CFF mainly. So in terms of revenue and EBITDA margin, how was the performance for FY ’20? And how is the cross-selling opportunity doing there so far? So the CFF is good at fine fragrances and fabric care. So are there any opportunities that we are looking to cross-sell in other geographies from that? And second question would be that on a steady-state basis, what could be the optimal asset turn which would be expected from a business like SHK, sir?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [65]

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Shrikant, you want to take both these questions?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [66]

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So CFF, in spite of this COVID pandemic in Italy, has a fairly encouraging — in fact, they posted the revenue growth. Their core fragrance business is pretty much same like S H Kelkar’s fragrance business, clocking 18%, 20% EBITDA margin.

Coming back to cross-selling opportunities, I would request Kedar to take those in terms of specific plans or specific time-wise, but sure there are synergies, but I would request Kedar to take that.

Coming to the asset terms, we really are done with all our CapEx in last couple of years. We also had to invest fair amount to relocate our plant from Netherlands. So I would assume that with CapEx done and we looking to drive the growth going forward, from the current flows, we expect our asset turn to reach close to 2, but it will be over the next couple of years.

I would request Kedar to comment on the specific…

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Alpesh Thacker, Motilal Oswal Securities Limited, Research Division – Equity Research Analyst of Institutional Equities [67]

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Just additional, what was the revenue for the CFF this time in FY ’20?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [68]

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So when you say FY ’20, if you are referring to quarter 1 because they follow calendar year.

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Alpesh Thacker, Motilal Oswal Securities Limited, Research Division – Equity Research Analyst of Institutional Equities [69]

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Yes, right. True.

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [70]

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In Q1, it was roughly EUR 8.5 million. Kedar, over to you please.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [71]

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Yes. Just on the cross-selling, I have already alluded to that earlier, we have various products, some products which we have ready-from-fabric technologies and air care technologies, which they have, which we are cross-selling into Asia. So yes, there are opportunities for cross-selling. At this time, we are in the midst of the COVID crisis, and we are actually exploring cross operations opportunities as well where certain customers of ours could be serviced out of Italy. As you all know that Italy had a very bad impact of the pandemic, but it is also ahead of the curve and they have started seeing steep declines in the number of cases and so on and so forth and returning to more normal operations. And we could use Italian plant to offset some of our production challenges at this time. So right now, we are not looking to maximize on new product sales. There is a huge potential of cross-selling products in both the countries, both the regions. But at this moment, we are also excited about the opportunities on the operational addition to our portfolio that we have an alternative production site to service, particularly in the Middle East and Africa, where the logistic time is about the same as from India.

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Alpesh Thacker, Motilal Oswal Securities Limited, Research Division – Equity Research Analyst of Institutional Equities [72]

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Okay. Then, sir, 1 more question, sir. On the growth guidance for FY ’21 for both the fragrances and flavors business, and on the raw material price volatility side, given that the whole world is impacted by this pandemic, so do you see, again, some kind of raw material pricing which could impact the gross margin going ahead? Because in the last couple of quarters this has started improving. So just wanted to know on that front. So one is the growth side rate…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [73]

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I think the gross margin sort of historically, we had around 45% gross margin level. We had lost some of that in the hyperinflation post the force majeure and closing of plants in China and so on and so forth in 2018. I believe that we are now on the other side of the pendulum where things in terms of supply will get relieved and we will end up with normal buying pattern, normal prices in the rest of the year and going forward.

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Alpesh Thacker, Motilal Oswal Securities Limited, Research Division – Equity Research Analyst of Institutional Equities [74]

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Okay. And on the growth side of both the businesses on a company level basis, sir, any rough ballpark whether that you have like internal measures for the growth guidance for the year?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [75]

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For this year, I think the opportunities are very high. I think I wouldn’t want to commit what will be the eventual growth rate because we still have a very uncertain climate over the production over how the things will turn out in the next 2, 3 months. Once we have a normal operations, maybe it will be a better time we can give some guidance on the demand and our run rate going forward. So I would not want to commit any growth rate today in this market and this scenario.

We have strong demand. So there is no problem on the demand side. Our customers, FMCG companies are operating. We have good orders coming in. It is a question of how we are able to service the orders with the people movement, logistics difficulties at the moment. I would just add that within the country, we are amongst the — maybe the only or one of the few people who have a high automation level in the manufacturing in the fragrance side — particularly in the fragrance side. And this would enable us to operate at a much faster clip once things resume.

So there is, I would expect post the opening of the market, peak demand. Some of the smaller players and smaller customers who have not been buying would start to buy, and we have enough or more capacities within our plants to allow us to expand our production capability to meet this peak surge.

So I believe that we are very well pleased both from material capacity of production and financial strength of the company to take any opportunities that come our way. But I wouldn’t guess what will be the quantum of volume uptake or the value increase, excepting that we are well placed to take the opportunities as they come.

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Operator [76]

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The next question is from the line of Chirag Dagli from HDFC Mutual Funds.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [77]

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Sir, can you just comment on FY ’20 volume value split for overall sales? And also, in general, the pricing trend for both your ingredient business and the formulation business?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [78]

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Again, I will answer the second question first. The general trend for the pricing, the ingredient pricing has come down. The corresponding gross margin of Fragrances has gone up. So net to net, for us, we will still be in the 43%, 44% gross margin for the coming year. So there is no real impact of the entire gross margin change. We would see some impact on the global sales of certain products with the demand of fine fragrances being less. So we would have some impact of that. In terms of last year volume and value, I think, maybe, Shrikant, you’ll have the exact numbers. Unfortunately, with the work from home, I don’t have that data with me, but we can send it out to you.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [79]

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Yes. Okay, sir. And sir, there was a view that post shifting to — shifting the Netherlands facility to India, there will be OpEx savings. There was a number you had indicated, some INR 10 crores or INR 12 crores. How much of that has been realized or is in the base in FY ’20?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [80]

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So it has been realized over the last 2 years. We have already brought down our operating costs and employee cost to the corresponding levels, roughly INR 12 crores order reduction from the levels of 2 years — 3 years ago when we were operating our Netherlands plant. You can already see some impact of that through the employee cost reduction, and we will keep seeing that in the way forward. I mean, we have not specific working on the Netherlands movement to Mahad. We can make that and send it to you. The — but we have — just to say that we have completed our objective in line, in budget, and we have been able to produce with the full capacity of the plant in the past couple of quarters. And the costs are very much in line with what we had planned. So I think we would have realized the entire EUR 2 million savings across this plant shifting. But it would not hit you in 1 year because the plant closure was happening in phases and the plant restart was happening in phases. But if you look at, let’s say, a 2017 number to a 2021 number, you will see that operating difference of EUR 2 million savings.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [81]

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So in FY ’20, full potential of the INR 12 crores has not been realized is what you’re indicating here?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [82]

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No. It has been realized. It is not year-on-year realization. So on ’18 also, 2018, we have — ’19 we have realized something, ’20 we have realized something. The entire EUR 20 million is — EUR 2 million is not in FY ’20.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [83]

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Okay. So some bit of that will still spill over in FY ’20?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [84]

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Yes, some bit of that has come in ’20, some bit of that has come in ’19 and some bit of that will come in ’21 because we are phasing out and closing. So it’s not like it has stopped in one day and started on second day. So there has been a phased closure, there has been a phased manufacturing increase. So all — that entire EUR 2 million is spread over these 3 financial years in terms of the savings.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [85]

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Understood. And can you quantify the R&D spend in full year of FY ’20 and FY ’19?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [86]

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Shrikant?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [87]

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Yes. So R&D spend, in our context, so we spent roughly INR 50 crores, INR 55 crores this year versus last year, it had — it’s more or less comparable, although this year, a little bit more. But growing forward, it will stabilize.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [88]

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So INR 50 crores, INR 55 crores, and like you indicated that between amortization and capitalization, broadly, the cash flow element is also similar to the P&L element?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [89]

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So last year, this year, we had around INR 55 crores. And there is not really much difference. If you look at capitalized or actual cash expense, it’s around the INR 55 crores level itself. We have further reduced our expenditure on basic research in the Netherlands in the third quarter last year post closure of the full plant there. So that will bring down further the cost of the R&D for this year. We are also plans some of which are partly implemented, where we bring down the R&D cost further by INR 5 crores to INR 7 crores for this year. Many of our longer term projects, given the current pandemic, we will not be funding those in this year. So we anticipate INR 5 crore to INR 10 crore additional reduction in the R&D expenditure in this year.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [90]

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Understood. And Kedar you indicated that the demand environment seems reasonable, while there are some — there may be some COVID-related supply issues. But when you think of the business, do you think, in the past, you’ve commented about INR 100 crore kind of cash flow — free cash flow from the business. That number is something that FY ’21 can reach?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [91]

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It is anybody’s guess how the — because major part of our cash flow coming from operations in India. So by the time — if we assume that we have a normal scenario of operations and demand and logistics, I think reaching INR 100 crore cash flow is quite within the budget that we have. But I wouldn’t want to comment and speculate anything for this year till we have some level of normal operations.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [92]

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Understood. And just the last question, if I can. You said Jan and Feb were good months for you, but March seems to be having some impact. In the past you said…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [93]

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For last 10 days of March, we had no impact on demand. It was a strong month as every year, the last quarter is a strong quarter. We were seeing very good demand. We had more than INR 35 crores, INR 40 crores of open orders at the time the lockdown was announced. So we have lost — roughly, we anticipate or estimate roughly INR 30-odd crores for the end of March, and we would have closed on a INR 305-odd crore or INR 303-odd crore revenue for the fourth quarter.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [94]

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We are already through 2 months, April and May. How have the past 2 months been?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [95]

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So I think April has been — we were close, like I mentioned earlier till almost the first part of — or 23rd of April, almost all the plants were operating marginally. We started to operate some of the plants in end of April, some of the plants in end or beginning of May. Only on the 17th of May, we have started all our plants in some level of operations, I would say, 40%, 50% in total. So we are able to generate revenue only after the 15th of — 14th of May. And as we speak, we have covered, I think, roughly INR 50 crores of revenue for these 2 months. But that’s basically 15 days of operations in invariably.

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Chirag Dagli, HDFC Asset Management Company Limited – Senior Equity Analyst [96]

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Cumulatively, you are saying INR 50 crores that has been…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [97]

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Yes, around the INR 50 crores till the 22nd of May. So the last 3, 4 days, again, there would have been some sales. But till the 22nd of May, we have cumulatively roughly INR 50 crores of sales. Some of the — I mean, this is basically almost like 15 days of production, which is where we are rather. We have enough orders in hand. After we have started supplying, the order pipeline is strong, and we will catch up and it’s very fluid situation. So it can change on day-to-day, week-to-week but I think we are progressively increasing our production output, and it should be a fairly normal output by end of June.

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Operator [98]

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The next question is from the line of Vikram Kotak from Lansdowne.

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Vikram Kotak, [99]

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I have 2 questions. One is the — your net debt level, if I’m correct, you mentioned is INR 280 crores, right, on 31st March 2020. Is that a correct sum?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [100]

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I think INR 299 crores.

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Vikram Kotak, [101]

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Okay, INR 300 crores. So what’s the target in next 2, 3 years? Because since you have a strong cash flow and you reduced debt this year as well, how do you see maybe in a couple of years time, where do you see your debt level going to be?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [102]

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Again, we would continue to reduce the debt level with the cash flow approximately, I mean, in a normal year, INR 100 crores and INR 120 crores of free cash flow is what we are generating. We will look at the second part of the acquisition of the Italian — its subsidiary now. And after that, we will — hopefully, our target is to maintain the debt level INR 300 crore or below and continue to operate like this.

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Vikram Kotak, [103]

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Okay. And second question, life post-COVID for you as an organization in terms of business processes or in terms of employee in terms of research, is any major change for you post-COVID opportunity wise or even the processes wise? Anything you think so by learning or maybe what you’re trying to kind of improve upon? Or just want your feedback on that.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [104]

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Principally, nothing much will change for us. We will look at, obviously, we have been doing some work from home at this period, and we will assess if some of the operations or some of the things can be done from home or break up the entire teams into sub teams and work from different locations. That’s the kind of thing which will happen. But on the product side, on the operations side because we have to actually work with the product, smell and taste the product, there is no alternative but to run in the current way.

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Vikram Kotak, [105]

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Right, right. And geography wise also no change? You will maintain the same geographic distribution of your sales, more or less?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [106]

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Yes. See, geography-wise, we will continue in Southeast Asia, India, Africa, and now with the European acquisition, we will enter into South Europe.

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Operator [107]

——————————————————————————–

The next question is from the line of Lakshmi Narayan from ICICI Prudential.

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Lakshmi Narayan, [108]

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A couple of questions. First is if you look at your Indian business, approximately, if you look at your fragrance business, and when we look at India, it’s close to around INR 670 crores, right? And you used to categorize into multiple segments in terms of the regional players and the retail as well as national players, right? What is the kind of broad cut for FY ’20?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [109]

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So FY ’20 basically, the quarter, it was the same, the top large customers are roughly 40% of the domestic sale. The next one is 30%. 10% are the midsized or regional ones and 10% has been our retail. So that’s kind of the cut. I would say that in terms of the final revenue in March, the cut was a little different because some of the bigger orders could not go in time. But if I look at the actual demand point of view, we have roughly 45%, 46% from the large customers, 35% from the mid and the smaller ones have reduced from 10% to maybe 7% for the year.

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Lakshmi Narayan, [110]

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Got it. Okay. And in the domestic thing, which is around 45%, right, which has the large FMCG firms, what has been your market share? Has it been growing with them in the last couple of years?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [111]

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So yes, we have multiple — so all our large clients, we have done in excess of 15% growth in the last 2 years. We have — correspondingly, last year, we had de-growth on the smaller clients. This year, the base of the smaller clients has already existed. So if you see that we have continued to grow. Had it not been for the COVID, we would have registered a double-digit growth for the year.

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Lakshmi Narayan, [112]

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And if I look at the Fragrance business over the last 5 years, looking from FY ’16 to say, FY ’20, right, the point-to-point increase in the Fragrance business has been around 3%, and whereas, the operating margin has actually grown 1% over a 5-year period, right? So what it would take for us to go back to the FY ’15/’16 times where, Kedar, (inaudible) are upper single digits or even a double-digit growth, right? Because it’s been something I’m sure you will not see happening.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [113]

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The scenario on the entire basis, if we look at the churn, the repositioning of the products in the exports and the effect of the GST, demonetization, force majeure in the last 2, 3 years, I think we’re now faced with COVID, of course, but the underlying demand and the areas where we are operating and our research has been giving us a strong pipeline of new wins with the large customer, mid-size customer, all of them. We have had the specific challenges in the last 2, 3 years because we continued also to invest heavily in the research. With the scenario around COVID now, we will undertake to cut down our longer-term research programs and focus more on the next 1 or 2 years of business. So I think you will see a very quick improvement in the pass-through from the revenue and gross margin to the PAT, PBT line in terms of our spend on the research coming down and our overall operating margins kind of improving as we have a higher volume base on the same cost of operations.

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Lakshmi Narayan, [114]

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And then my last question is that if I just — let’s suppose our domestic fragrance numbers which are in the Indian FMCG industry in terms of volume terms, right, or in terms of revenue terms, we seem to be growing lower than the industry, right? But you’re saying that we are actually increasing wallet share in the larger clients. So what explains that difference?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [115]

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I think the typical FMCG that you look at the organized data and you compare with the organized data, there is a — I estimated earlier, around 30% or 25% in Fragrance of unorganized market, which typically does not get tracked in the FMCG reports or investors discussion because they are all very small companies across the country. With the GST and demonetization part of those have degrown, so if you look at the — I mean, if you look at any of the comparable FMCG companies’ volume growth and our growth with them, excepting a few companies like Unilever, where our presence in their portfolio is small, I think everywhere else, our portfolio of products has grown at the same rate or faster than their overall reported growth rate. We have grown with their customers. Our products have grown faster in their portfolio of products. The reality has been that some of the growth has come at the expense of some of our smaller brands and regional brands across the country. So we have seen 3% to 4% growth last year and roughly double-digit growth this year, largely because we have done still the 15% of the larger customers, but we have looked at a degrowth situation last year. And this year, we have no degrowth of the smaller clients.

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Lakshmi Narayan, [116]

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And what is the — you give a blended operating margin of the Fragrance business, right? So if you actually look at Indian and the non-Indian, what would be the mix of — what would be the operating margin difference?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [117]

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Shrikant, do you want to answer that, operating margin of domestic and operating margin of export fragrance?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [118]

——————————————————————————–

So there is not a large difference, Mr. Lakshmi Narayan. Of course, there are some changing patterns because of the FX rate movements. But broadly, they are comparable margin.

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Lakshmi Narayan, [119]

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So you have reported around 12% on an operating margin, and you say that, that would be broadly same between India and international?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [120]

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Yes. If you’re referring to the segment operating margin slides, yes.

——————————————————————————–

Lakshmi Narayan, [121]

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On a rough basis, I’m just doing INR 119 crores divided by INR 998 crores.

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [122]

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Yes.

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Lakshmi Narayan, [123]

——————————————————————————–

And if you go back to FY ’17 and ’18, it was around 15%, and which has actually come down to 12%, is it — I mean, how much you attribute this to raw materials? There is a 300 basis points difference from FY ’17/’18 to now, right? And how much you would attribute to something else?

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Shrikant Mate, S H Kelkar and Company Limited – Executive VP & Group CFO [124]

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I would attribute, of this 300 basis points erosion, roughly 200 basis points to raw material cost deterioration because it’s only now that we are able to have stable RM prices and therefore, more stable gross margin. So of that remaining 100 basis points out of the 300 would be for other expenses, and we have also been working on cost optimization. So that’s the broad split (technical difficulty).

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [125]

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There have been some one-offs in this year as well as we have taken some redundancies and plant closures. So there have been some one-off expenses in that as well.

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Operator [126]

——————————————————————————–

The next question is from the line of Anshul Saigal from Kotak PMS.

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Anshul Saigal, [127]

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I just want to know, carrying on from the previous question, where the margins have contracted in the stand-alone business meaningfully over the last 5, 6 years. I think they’ve contracted from as much as 20% to now about 11%. What is that on account of? And you referred to R&D as a proportion of sales actually contracting. How much was it then? And how much is it now as a proportion of sales? And so if it contracts, where can we see margins, say, in the next 2, 3 years? That’s one.

And the second is that I noticed that our revenue growth has been somewhere in the region of, say, 5% to 10% compounded over the last 5, 6 years. And you referred to the strength that the company has, being in business 95 years and having a portfolio of products, et cetera. Now why is it that, that strength is not getting translated into better growth? Is it because of industry growing at slower pace? Or some other aspects which we don’t understand? I’ll appreciate if you can address these.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [128]

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Okay. So I remember the last 2 questions, which I will answer. The first one, if you would be kind to repeat, I will take it up later. On the R&D, we have roughly INR 55 crores of expenses last year, the similar level of expense this year. And we’ve already taken certain amount of redundancy, certain amount of R&D closures in the Netherlands. We are also looking at further optimizing the R&D spend across the company for the — looking at the current demand and operating environment. So I think that’s a lever which is within our control to decrease or increase on a longer-term basis. We have always been maintaining 3% to 4% of the sales as our target R&D and trying to grow at 12% to 14%. I think the market environment, particularly in India in the last 2, 3 years, has been much poorer industry growth. I suspect that the last 3 years, the industry growth would have been in 3% to 4%, majority of which has been taken by the larger players where we also seen growth for us. Our churn of products in terms of export was — where we had due to the force majeure, certain products which we exited, there the margins were lower, particularly on the flavors as well. And — so we have planned and exited roughly INR 50-odd crore of revenue in the last 2, 3 years. So if you look at our 5% to 6% growth, we have also churned the growth to better margin products. And the scenario with the raw material and scenario with the overall picture, the gross margin could have been much worse. So we have adjusted our business to have lower growth, less credit risk and better margin, which is a sustainable longer term business, than trying to grow at 10% with longer credit terms and much poorer or worsening quality of business. So yes, it has been challenging. But our focus has been to ensure that we have a good focus on the correct kind of quality business that gives us year-on-year growth.

The first question you had asked, I did not…

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Anshul Saigal, [129]

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Yes. My question was that you — previously in the call, you mentioned that being in business 95 years, you have a whole array of products and also an understanding of local markets, et cetera. Now if that is the case, why is it that our growth has been, on a compounded basis, 5% to 10%. And then, of course, there has been that kicker of acquisitions. But why has organic growth been 5% to 10%? Is it because of industry growing slower or some other aspect?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [130]

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Yes. So the industry as a whole was growing much slower in the last 3, 4 years in the domestic market. When you look at the larger players and the reported numbers of FMCG and so on and so forth, I think the data and we monitor this data on a regular basis through AC Nielsen and Euromonitor and others. We typically cover only 80% of the market. There is a 20% to 25% market below this 80% which is tracked by any kind of data tracking. So there’s a lot of small players in parts of — different parts of the country. And those are really not tracked as a consumption or FMCG. Post the GST, particularly, I think a lot of these players had very big competition, and we’ve seen 2 or 3 quarters of large growth for companies like Unilever even has reported quarter-on-quarter 11% volume growth, which means that a lot of that is market share, which has gone from our customers to the likes of Unilever and Godrej and Emami and other large players. So there has been a churn for us. Particularly, we have lost market share as our presence in the global MNC brands was much lower. We haven’t grown at the same pace as what otherwise we would have.

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Anshul Saigal, [131]

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If I may just squeeze in 1 small question, again. If that is the case, are these MNC players procuring from international competition? I mean, do they have tie-ups internationally? Or are there local competitors who are — what…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [132]

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No, they are buying from the international players, which they have global tie-ups.

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Anshul Saigal, [133]

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And what is the hindrance for us to gain market share there?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [134]

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Nothing, just a matter of time.

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Anshul Saigal, [135]

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Okay. (technical difficulty) a bit cheaper than this competition and in quality similar?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [136]

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So I wouldn’t comment that as a broad-based better and worse. I think we have our strengths, they have their strengths. In certain segments, we are better. In certain types of products, they are better. So each company has its unique strengths and weaknesses. So by and large, we are in the same bracket to compete. I don’t see anything that we cannot offer a decision. Yes, we don’t have the breadth of global presence or the kind of manufacturing in various locations and so on and so forth. But we are supplementing that with a better understanding of local trends.

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Operator [137]

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The next question is from the line of Anupam Agarwal from Lucky Investments.

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Anupam Agarwal, [138]

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My first question is basically, you mentioned about your overall utilization in plants right now at about 50%. So sir, question is what was this percentage pre-COVID? And what is the peak optimum utilization for our kind of industry?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [139]

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So generally, our industry does not measure output on the basis of capacity constraint because there is not a lot of capacity constraint as a driver. They are not normally fully automated plants where you have a defined capacity. So typically, there is a big leeway on what is the capacity utilization and what is the final revenue based on the type of product, per kilo cost of the product and the size of the bag and so on and so forth.

For our product mix, what we are offering, we are typically operating all our plants at basically around the 50% average, and on the formulations plant around the 40%, 45% average for the manufacturing. We had a capacity and have a capacity with additional shifts with additional bases to quickly double the output in a short span of time.

I think at this moment, with the COVID scenario, we are half of our normal operating. So we would say 25% or 30% of the full capacity of the plant, 50% of the normal operating capacity of the plant.

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Anupam Agarwal, [140]

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Right. So on peak, we would be able to do 80%, 90%?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [141]

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In terms of what we call surge demand, if we have demand in excess of the normal average, we can pick up the production for a period of time and even double or triple the output for a couple of months in a normal basis, so without too much explanation about the CapEx or anything.

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Anupam Agarwal, [142]

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My question was coming from the slide that you mentioned about your asset turns being 2x. So at what level of utilization is this 2x target that you are alluding?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [143]

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Okay. So I understand the question. The thing is that the capacity utilization is not linear in terms of revenue. And so we typically see 15%, 18% extra capacity gives us double the revenue because of value addition over a period of time, the average selling price and the kind of product, premium products are more. So it’s not directly linear to the capacity utilization. But it is to say that we have enough capacity that if the revenue started to be — we have — double the revenue and double the production capacity we are required, we don’t need to invest anything for taking that business.

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Anupam Agarwal, [144]

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Right. And sir, secondly, so this is just a clarification. You talked about INR 50 crores of revenue is what you’ve done in the quarter 1, right, till today?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [145]

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That’s right.

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Anupam Agarwal, [146]

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Right. And you also mentioned about INR 30 crores of sales which did not happen in the last 15 days of March. So are those INR 30 crores sales lost? Or are they deferred?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [147]

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So most of the sales are deferred because they are not seasonal products. Maybe INR 2 crores, INR 3 crore of that will be lost for this year. They will come back in the later part of the year, maybe fourth quarter. So maybe INR 2 crores of the INR 30 crores is lost. INR 28 crores to INR 30 crores — I mean, almost all of that is deferred. As such customers come back, we will require those products.

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Anupam Agarwal, [148]

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So is that INR 27 crores included in the INR 50 crores? Or is it separate to INR 50 crores? INR 50 crores is plus this?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [149]

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No, it’s not included in the INR 50 crores. Maybe some of that has already moved. I don’t have a split, but my guesstimate is around INR 10 crore to INR 12 crore of the INR 30 crore has moved. INR 17 crores, INR 18 crores of the INR 30 crores has not yet moved, as those customers are not yet operating in any meaningful way.

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Anupam Agarwal, [150]

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Right, right, right. And sir, just on the order book visibility, if you can give some color in terms of how is this looking or how is it shaping up for the second half of this year or till December, that would be great, sir? I mean in — from the demand side, what is — how…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [151]

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So I think the demand side for us will increase more than the last year. I think that overall, across the board, there will be 8% to 10% additional demand. Given that some of our competitors are also unable to service their clients, some of the, even the larger competitors, we are seeing demand coming back to us or moving to us. So I think the demand is not only the total demand. I think we will be in a good position this year to also take some market share from the competition.

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Anupam Agarwal, [152]

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Right. So this 10% demand…

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [153]

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Also roughly INR 50 crores of new wins clock for this year, so which have annualized potential to be INR 70 crores, INR 80 crores of new revenue for the coming year. I will just put a caveat of subject to COVID because we don’t know how many — how much of that business we can regularly service. But we have a strong pipeline of new wins of INR 50-plus crores as we get into the 2021 year.

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Operator [154]

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The next question is from the line of Susmit Patodia from Motilal Oswal.

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Susmit Patodia, [155]

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I want to check if you could tell us — hello?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [156]

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Yes.

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Susmit Patodia, [157]

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Can you hear me?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [158]

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Yes, we can hear you. Go ahead.

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Susmit Patodia, [159]

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What contribution of fragrance comes from skin care and cosmetics, that segment?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [160]

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So skin care and cosmetics is a small part of the fragrance business in general and it sort of look at 3% to 4% of the total revenue. The category is very large in value terms, but volume terms, we do have certainly small levels of fragrance usage in that category when you talk about skin care. Now products that are skin cleaning like hand wash, body wash, these we typically add into personal wash. So when we say skin care or lotion cream…

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Susmit Patodia, [161]

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Lotions, yes, perfect, perfect.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [162]

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This is our small products.

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Susmit Patodia, [163]

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Got it. And the other thing I wanted to ask, if possible, which is if I could take you back to Jan, Feb and what would be your 3-, 5-year plan? And how would it look like? If you could just give us a peek into that?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [164]

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I think these are the times when we are focusing our attention on making sure we are back to normal operations. So much of the attention and mind space is focused on making sure we get out of this crisis strong and able to run. The market scenario post-COVID will be quite different from the pre-COVID situation, both from the kind of demand, type of demand and the competitive landscape. I believe that there will be further consolidation and further scenario where these small companies through the COVID may not be efficiently able to operate. So we see that the competitive space across the world in Southeast Asia, Middle East, India, Europe, the ones who have survived through the COVID in terms of properly able to service or better able to service, will get a big jump in the market share. We have helped to list in that with the capacities, inventories and the strong financial position. We have the product pipeline from the R&D already in place. So we don’t have to design products for the future. There, almost all of them are ready, at least in the prototype stage. So we — I think post-COVID, we are well placed to take up the opportunities as they come, and we may see a pace of growth which is restoring us back to the normal double-digit plus growth that we should be tracking.

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Susmit Patodia, [165]

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Right. And Kedar, I wanted to also check, we closed March with about 110 days of inventory. So when the manufacturing facilities were shut, could you liquidate this inventory, some part of it?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [166]

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No, we did not liquidate the inventory because also there was nobody operating. So it was not that somebody else needed the inventory. It was just like a pause button. Everybody was staying where they were.

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Susmit Patodia, [167]

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Okay. And just last question. The company has about INR 320 crores of non-RM cost as of FY ’20. How much of that can be optimized in a year like this?

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [168]

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So we are looking at the various cost elements in detail, and we are planning for a 20%, 30% decline and plus looking at each element from a cost principle, what do we need, what is the nature of the cost expense and focusing on what is required and essential for next 2, 3 years. So all the long-term projects, long-term proposals that we have been running as a product development or prototyping and so on and so forth, we will reduce in this year.

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Operator [169]

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

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [170]

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So the — I go ahead with the closing comments, Anoop?

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Anoop Poojari, Citigate Dewe Rogerson Ltd. – Client Manager [171]

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Yes, Mr. Kedar. Please go ahead.

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Kedar Ramesh Vaze, S H Kelkar and Company Limited – Group CEO & Whole-Time Director [172]

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Thank you. I hope I was able to answer all your questions satisfactorily. Should you need any further clarifications or would like to know more about the company, please feel free to contact our team or CDR India. Thank you, once again. All of you stay safe. And till we speak again, thank you very much.

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Operator [173]

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Thank you very much. Ladies and gentlemen, on behalf of S H Kelkar and Company Limited, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.

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