"SP Apparels Limited Q3 FY2019 Earnings Conference Call"

February 15, 2019

ANALYST: MR. ANKIT GOR – SYSTEMATIX SHARES & STOCKS LIMITED

MANAGEMENT: MR. P. SUNDARARAJAN – CHAIRMAN & MANAGING DIRECTOR – S.P. APPARELS LIMITED MRS. S. LATHA – EXECUTIVE DIRECTOR – S.P. APPARELS LIMITED MR. S. CHENDURAN – DIRECTOR OPERATIONS - S.P. APPARELS LIMITED MRS. P.V. JEEVA – CHIEF EXECUTIVE OFFICER - S.P. APPARELS LIMITED MR. V. BALAJI – CHIEF FINANCIAL OFFICER - S.P. APPARELS LIMITED

• Ankit Gor: Thank you Raymond. I welcome all on our Q3 FY2019 earnings call of S.P. Apparels. From management side, we have Mr. P. Sundararajan, CMD, Mrs. S. Latha, Executive Director, Mr. S. Chenduran, Director Operations, Mrs. P. V. Jeeva, CEO, and Mr. V. Balaji, CFO of the company. I would like to hand over call over to the management.
• P. Sundararajan: Thank you Ankit. Good evening one and all. At the outset, I am glad to inform you all that this quarter has been a wonderful quarter in terms of performance of all the three divisions. Financial performance of the company; the company has achieved total revenue of Rs.224 Crores this quarter, which is all time high in the history of S. P. Apparels. The revenue grew at a growth rate of 37.5% on year-on-year basis and a growth of 17.08% on quarter-on-quarter basis. EBITDA has grown by 37.45% on a year-on-year basis and 25.4% on a QoQ basis. PAT has grown by 94.4% on a year-on-year basis and 79.58% on quarter-on-quarter basis. Company's EPS grew by 90.49% on a year-on-year basis and 79.66% on a quarter-on-quarter basis.

Let me give you a brief on each division. About the garmenting division, I would just like to give a small brief on the global apparel market. After the trade war between US and China, now much of the retailers from the US are diverting their orders from China to other countries and preferably to India. Also, the EU retailers are diverting their orders out of China due to an increase in the cost of manufacturing in China. Furthermore, the global recession will affect the apparel industries, but the chances of negative impacts on the business due to the recession is very low. Moreover, we are in the niche segment of children and babies, so the global recession will not affect our business. Now, all major retailers are constantly consolidating their vendor base in order to be more efficient in sourcing and we are one of their preferred vendors, which will bring an additional order inflow due to further consolidation.

Regarding Brexit, we are not able to comment on its impact, but we have already overcome the effects of Brexit during few quarters last year. Even if Brexit happens, we do not foresee any major impact in the business. However, any changes in currency may affect margins to some extent.

Regarding customers, we have already consolidated with the customer base of 10 customers. We have also diluted the geographical concentration of our customers. Currently, our country wise contribution is US 20%, other European countries 30% and UK is 50%. Whereas, UK were closely about 85% of our exposure around three years ago.

Now, we have diluted the geographical concentration of our customers. Currently, the order book is Rs.345 Crores up to the month of July. With regard to capacity, we have added three factories that were mentioned during the last concall, and they will be up and running by the end of this

quarter. There has been an addition of 300 machines during this quarter, in our existing factories and new factories. Our capacity utilisation is around 72%. Our factory in Kovilpatti has now reached the capacity utilisation level of 40% machines over a period of eight months, and is expected to reach full utilisation by March 2020. We are in the process of adding more capacities during this quarter, and will reach 5000 machines in total by end of March 2019.

As for financial performances, the garment division revenue grew by 37% on a year-on-year basis, EBITDA stood at 18.1% for this quarter, and stood at 18.1% for nine months period. The margins changed very little due to the underutilisation of spinning units and the processing units because of ongoing projects.

Now, coming to the retail division, regarding the number of stores we have 30 COCO stores and 15 FOFO stores as on December 2018. We have 257 large format stores as on December 2018 and expansion plans in place for FY2019-2020. We intend to focus more on EBOs, that is both COCO and FOFO, in addition to the increase in large format stores.

Sales for this quarter stood at Rs.24 Crores as against a sale of Rs.21 Crores year-on-year, which is at a growth of 13%. We have achieved sales worth Rs.61 Crores up to December 2018, which is Rs.7 Crores over and above the whole year performance of Rs.54 Crores. Margins during this quarter were stressed due to deep discounts during the month of November and December.

As for the financial performance of our UK operations, the nine months ended revenue stood at £4.2 million, which is at par with the revenue of full year performance of last year. Our margins also improved from 4% to 7% now.

Regarding the outlook of UK operations, this business model is very promising and successful as retailers are looking to increase the sourcing through full service vendors, which are importers, in order to source efficiently by having the proper mix of direct sourcing and delivery based sourcing. We are planning to increase the customer base year-on-year by sourcing from various countries.

And other details with regards to the spinning expansion: spinning mills saw utilisation levels of 60% due to the modernisation process of existing frames, and expansion of the blow room capacity. The spinning expansion project is almost over and should be put into operation by March end. We can expect a better financial performance of the spinning plants in the next financial year.

Talking about the expansion of the processing division, the biological treatment plant of ETP is 75% completed and we are expecting this to be fully operational by April end. Thanks for your continuous support and thanks for the trust you have in the company. We expect to keep performing in the same manner in quarters to come. Now our CFO will brief you on the financial performance of the company and each division. I will hand it over to Mr. Balaji. Thank you.

V. Balaji: Good evening everybody. I will just run through the financial performance of the company and each division. For Q3 we have made revenue of Rs.218.4 Crores as against Rs.162.9 Crores of revenue at a growth rate of 34% on a consolidated basis. Our EBITDA margin stood at Rs.34 Crores as against Rs.26 Crores last year, which was a growth rate of 31%. Our PBT grew at 90.8%, which stood at Rs.38 Crores. Our PAT grew at 94.4%, which stood at Rs.26.8 Crores comparing last year performance of Rs.13.7 Crores.

For nine months end, our revenue stood at Rs.595.8 Crores with a growth rate of 21.8% and our adjusted EBITDA stood at Rs.95.9 Crores as against Rs.86.5 Crores of last year, which was 10.9% increase. PBT of Rs.79.5 Crores as against Rs.52.2 Crores of last year, which grew by 52.5%. PAT of Rs.54.3 Crores as against Rs.34.5 Crores of PAT compared to last year.

The garment division grew by 37% on a quarter-on-quarter basis. The UK office grew by 29% on a quarter-on-quarter basis. The retail division grew by 16% on a quarter-on-quarter basis. Here, if you compare the retail division, the revenue of 21 Crores for the last year's year-on-year number is now is Rs.25 Crores, where last year we were on a primary selling basis and this year it is a secondary sale basis. So even though retail shows a growth rate of 16%, the difference in the standard growth rate should be closely around 40%. Our EBITDA margins for the garment division stood at 18.1% as against 17.3% last year. As CMD spoke about some strain in the EBITDA margin, this year it was due to the projects running in our processing and spinning divisions, which was utilised 60% and 75% accordingly.

For the nine months end, the garment division stood at 18.1% and SP UK stood at 7.2% — I am talking about the adjusted EBITDA margins. Retail stood at 5.8% on the margin front. On the revenue front, the total revenue from garment increased from Rs.409.9 Crores to Rs.495.5 Crores, which is 21% growth. SP UK grew from Rs.25.1 Crores to Rs.39.2 Crores, which is a 56% increased growth rate. Retail grew to Rs.61 Crores as against Rs.54 Crores, which is again a growth rate of 13%. In terms of the debt, current gross debt is Rs.167 Crores and net debt is closely around Rs.140 Crores. On the inventory level we have Rs.244 Crores of inventory and receivables of Rs.120 Crores and a payable of Rs.105 Crores, which is Rs.259 Crores of working capital as of December 2018, which was Rs.262 Crores last quarter. Other things are covered in the presentation and any queries can be raised now. Thank you.

Moderator: Sure. Thank you very much. We will now begin the question and answer session. Ladies and gentlemen, we will wait for a moment while the question queue assembles. The first question is from the line of Kashyap Jhaveri from Emkay Global. Please go ahead.

Kashyap Jhaveri: If I recollect in the previous quarter that number was about 3% to 4%?

V. Balaji: Yes.

Kashyap Jhaveri: I missed that number you said 7%, right?

V. Balaji: You are talking about new customers, because Garan is contributing from last year onwards.

Kashyap Jhaveri: Whatever we added in the last 12 months.

V. Balaji: Carter's and H&M is closely around 7%.

P. Sundararajan: 7%, which was 3% last time.

Kashyap Jhaveri: Now if I look at your adjusted margins and this will be on slide 10 in the presentation, they have actually come down from about 16.2% to about 15.9% for the quarter and from 17.7% to about 16.1% in the nine months, Sir what would you attribute this to the gross margins on constant

currency basis. This has happened because of the cotton prices or if there is anything on our foreign currency realisations, which have come down?

• V. Balaji: We are looking on the gross margin level, so gross margin has got various impacts. One when you compare our first quarter, we had a hit in the gross margin because of the product mix. So, if you recollect the conference call, we had explained that there was a hit in the product mix and the margin got hit at that point of time. In Q2 and Q3, we are maintaining it more than 18% and because of the spinning underutilisation where we are only using 60% utilisation for the Q3 and Q4 and the processing division where the utilisation level has come down from 75% because of the projects that are ongoing. So there is a hit in the margin because of these impacts. Also, regarding retail in the opening remarks, our CMD spoke about deep discounts that have been given and the margins have been impacted there.
• Kashyap Jhaveri: Sir second question is on the retail front, despite gross margins as well as EBITDA margins going down because of deep discounts; we have seen the growth on YoY from Rs.21.5 Crores to just about Rs.24 Crores to Rs.25 Crores, so any plans to increase this growth on this still very low base?
• V. Balaji: The strategy in the retail is to first penetrate in all areas. Now we have started penetrating in the large format stores and after we achieve a pan India presence, we will start looking at improving on the margin front. If you recollect, two years before, we spoke about most of our concentration being given to the large format stores. If you compare the opening remarks given by CMD, he said that next year 2019-2020 we are looking at opening stores COCO and FOFO. So now the preference is to have a balance between the large format stores — where we give deep discounts — and COCO and FOFO — where our preference also increases. So by next year our margin should definitely improve.
• Kashyap Jhaveri: Have we realised the full impact of the currency in terms of our realisation let us say US Dollar at Rs.72 or GBP at 91 plus, hedges are still in place and the full potential will be realised only now?
• V. Balaji: I am not in a position to understand your question but let me tell you how the hedges functions. So I have taken a hedge against the order and whenever it is getting realised I use the hedge. So there is no open position here at all.

Kashyap Jhaveri: Sir my question is that in terms of our hedges now, would all hedges be at the current exchange rate or would we still have some old hedges, which are at less than 70 also let us say in terms of GBP less than probably 88 or 87?

V. Balaji: 10% or below 10% on the old rates.

P. Sundararajan: At the time of booking the orders, we do the costing on the prevailing currency exchange rate and based on that we do the hedging - keeping about 10% to 20% open, so if the rupee depreciates then benefit will be only to that extent of 20%.

Kashyap Jhaveri: Right and last question what is the gross debt number as of December?

V. Balaji: Rs.167 Crores.

• Moderator: Thank you. The next question is from Ankit Gupta from Bamboo Capital. Please go ahead.
• Ankit Gupta: Sir how much can be the contribution from top five customers in this quarter?

all terms. The large suppliers who are in line with their requirements in terms of quality, price,

compliances, and deliveries have been working for many years, and as they are consolidating they feel better, so the business will increase with the existing customers.

• Ankit Gupta: In terms of new customers that you are getting are they changing their vendors or what is happening like as you think that vendor consolidation is happening, it might be impacting the new customers as well, so like why are they switching to us?
• P. Sundararajan: Correct. The process is like this. Each retailer will struggle to settle down with the proper vendors. When somebody is weak in sourcing they try all the corners and find out so many factories and get the experience with each factories and drop many and gradually settle down with few factories and then consolidate them. This is a process vendor sourcing process. So those customers who are coming to us now are in the process of replacing some of the vendors with a better one, or one with the capability of what we have in the baby's fashion, which they may not get from other factories. This would make them prefer to ship the business here, so both the process will happen continuously.

Ankit Gupta: Sure and in terms of designing I think the customers control the design, we also offer them designing services?

• P. Sundararajan: It is mutual, both do the design and they send us the development packs and we develop them, it is a joint exercise.
• Ankit Gupta: Thank you.
• Moderator: Thank you very much. We will take that as the last question. I would now like to hand the conference back to the management team for closing comments.
• P. Sundararajan: Thanks for participating and thanks for various questions and I hope that we have been able to answer all the questions. In case if anyone is not clear, please do not hesitate to talk to us and call us on phone. Thanks for participating. Thank you.
• Moderator: Thank you very much. On behalf of Systematic Shares and Stocks Limited that concludes the conference. Thank you for joining us ladies and gentlemen. You may now disconnect your lines.