Elgi Equipments Ltd Management Discussions.

The year, 2020-21 was unique in many ways and the financials reported for the year do not truly reflect the challenges that the business faced. Starting a financial year with a complete lockdown of the economy in the two key markets for the Company, India and Italy, and recording a near-zero revenue in the first month (April, 2020) in some of the key markets, set a challenging tone for the year.

During this unprecedented period, there were three key areas that we focused on. The highest priority was for ensuring employees’ wellbeing and protecting their jobs. Next, was to support customers’ needs amidst the challenging environment. The third was for ensuring the health of the business and the interest of the stakeholders. The Company moved very quickly to address all of the above.

In the interest of employees, the Company shut down its facilities even before the Government of India announced a countrywide lockdown. We reopened the facility for manufacturing operations after ensuring that all the infrastructure was in place to ensure the health and safety of all employees who reported to work. All employees, except those in manufacturing and technology functions, were asked to work remotely and continued to do so through the year.

The sales, marketing, and product management teams increased customer engagement efforts and embraced new ways of reaching out to customers proactively, to understand and address their needs, while the backend team in the Company geared up for the safe and timely delivery of products and services.

The Company’s leadership teams at various levels across the geographies increased the frequency of their meetings, using all the technologies available, to remain strongly connected and engage with all stakeholders. Everyone in the Company pitched in to drive costs down and conserve cash, to address our commitment to protect employment and stakeholders’ interests even while ensuring that we emerged strong to leverage future opportunities. The Company also spent significant time in the second part of the year in creating a robust strategic business plan for the mid-term.

The result of the short-term focused efforts can be seen in the increased profits and reduced net debt position as at the end of the year. The benefits of long-term focused efforts will be visible as we are poised to deliver consistent top-line and profitable growth in the next 5 years. https://www.elgi.com/in-wp-content/uploads/2020/7/ ELGi-Annual-Report-2019-2020.pdf In the MD&A of 2019-20, we had stated that we would present a financial direction for the future while presenting the Q1 results for 2020-21. We could not do this either at that time or during the subsequent quarters. We had to go back to the drawing board and collectively as a team review the context, our position and distill out directions so that we can confidently achieve the intended milestones within the time lines promised. We have developed a Strategic Business Plan (SBP), which embeds a financial plan focused on setting goals on revenue, profitability (measured by EBITDA) and returns (measured by ROCE). The Annual Business Plan (ABP) will be a subset of the SBP. In addition to sales EBITDA and ROCE are two additional goals we are setting for the medium term. Broad targets for the SBP to be achieved by 2025-26 are:

z Revenue - $ 400Mn

z EBITDA - 16%

z ROCE - 30%

The SBP is focused on:

z India, North America, Europe, SEA and Australia

z Backward integration in manufacturing

z New products and technology

z Focus on growing the aftermarket revenue

z Talent development and management

z Digital strategy

While each business region and global function are identifying the strategic initiatives required to achieve their respective SBP goals, at a corporate level, the key drivers are:

z Aggressive working capital management and cash generation

z Judicious investments in organic and inorganic opportunities

z Strategic divestiture of non-core portfolios and real estate

Detailed discussion on performance in the year 2020-21:

While 2018-19 was a strong year, slowdown was seen in 2019-20 starting from July 2019. There were some signs of an uptick in December 2019 which continued till the time the first wave of the pandemic hit market sentiments in March 2020. During the previous year 2019-20, the Company acquired Michigan Air Solutions, LLC, an independent compressor distributor in the USA and the Company’s European expansion plan gained full traction.

The year 2020-21 started amidst the raging pandemic and consequent lockdowns in many key markets. While the lockdown in India lasted for over 6 weeks during the year, other markets did not have such long lockdowns. However, there was a huge uncertainty around the business outlook for the year. The right thing to do was to conserve cash and contain costs. The Company spent significant time and efforts to build mitigation plans for a worst-case scenario while employee health and safety remained the primary focus.

We closed the first quarter of the year on a low note registering a drop in top-line and profits. We started witnessing the business bouncing back from the second quarter. While the initial belief was that it could be driven by some pent-up demand, the sales continued to grow with steady order inflow across most markets. The sales growth, our prudent cost measures, and governmental support for Covid in certain markets like the USA and Australia helped register good results for the second quarter. During the third quarter, while the sales continued to grow, the entire industry started facing severe cost pressures driven by volatile commodity prices. This definitely became a dampener as it was difficult to pass on the price increase impact to the market which had just started coming back to normal levels. The unexpected increase in material cost had a negative impact on our contribution margins. However, the Company’s continued efforts to keep other overheads in check helped offset loss of contribution margins to a certain extent. The buoyancy in the market continued well into the fourth quarter which helped us register some impressive sales growth. However, the volatility in commodity prices continued unabated. Even though we tried to roll out a price increase for our finished products and services, it was not commensurate with the cost increase. Overall for the full year, we have registered a small sales growth despite a very subdued first quarter. Our strong focus on containing people cost and overheads coupled with government subsidies in two countries helped us deliver an improved, strong bottom-line for the year.

Our focus on cash conservation continued through the year. We realized significant cash from the working capital management and improved profitability during the year. Our net-debt position reduced significantly in 2020-21. While the opening net debt was 2599mn, we closed the year with a net debt of 925 mn.

International markets: Our key markets of focus continue to be the USA, Europe, and Australia.

USA: The impact of the pandemic was significant at the beginning of the year negatively impacting our served markets but we did experience recovery with increased demand for our products and services during the second half of the year. The region increased revenue by over 10% with the addition of Michigan Air Solutions, LLC to its portfolio of businesses and going direct to the market with the portable compressor products. Improvement in contribution was accomplished by price realization and product mix. Disciplined cost control measures further helped increase the overall profitability.

On the business development front, the region made further progress by entering into key strategic Distributor Served Areas. Besides expanding our independent distributor base, we also launched three new joint ventures with local partners as part of our Go-To-Market program. The implementation of this strategy is progressing to the expectations and we are experiencing favorable impact in these target markets. Furthermore, we gained traction in Oil-Free product installations in several key market segments positioning us for future growth in this attractive product category. Also, our initiative to develop new channels and penetrate target market segments with the portable compressor portfolio is creating new opportunities for this business. As we continue to develop new channel partners and expand our market coverage, we will make consistent progress towards achieving our growth aspirations.

Europe: The year began with the region continuing its efforts in hiring additional resources as per plan to enhance its presence and competitiveness in Europe. Italy - the key market for the Region was in lockdown as a consequence of the pandemic resulting in the closure of their Rotair facilities, postponement of hiring, and a total travel ban. While Italy slowly began to reopen in May 2020, Europe as a whole was impacted similarly, but at varying degrees of infection wave intensity and timing throughout the year. During the crisis, Europe’s team prioritized the safety of employees while focusing on securing and developing new channel partners – oftentimes via video conferencing. As a prudent response to the emerging situation, the Region initiated measures to substantially reduce costs. The benefits of these efforts were realized during the second half of the year as the market began to reopen The team was well-positioned to serve their customers resulting in the profitable growth of 80% in the industrial business segment. This was made possible by the expansion of the Region’s market presence through the addition of 100 new channel partners in 26 countries. The team also created important reference installations within key customer segments and successfully introduced ELGi’s oil-free AB series screw technology throughout Europe thereby helping their customers realize dramatic reductions in the total cost of ownership, improved reliability, and a reduction of their environmental impact.

Australia: Our strategic acquisition of F.R.Pulford & Son Pty Ltd, an independent distributor, to gain customer access in key markets, has served us very well. In a tough and challenging year, under pandemic conditions, the team at Pulford delivered a commendable performance. Overall we registered more than 20% sales growth in Australia, including sales to various distributors. The growth in sales, coupled with cost-saving measures helped us deliver improved profit for the year. During the year, we increased our presence in target segments and secured key wins that would serve as good reference installations.

Domestic market - India: In the last quarter of the year, we had kick-started the second phase of the go-to-market initiative focused on enhancing our reach and market share. The year began with a countrywide lockdown and sales dropped significantly in the first quarter. On the back of a business revival post the lockdown, the order flow kept improving through the year. The business grew quarter on quarter for the next three quarters and we finished the year on a good note recording sales just above the previous year’s level despite two months of near-zero business. The team, besides quickly adapting to the new way of doing the business, ensured strong customer engagement leading to the continued flow of orders.

The Oil-free - Disrupted, AB series product has been gaining significant acceptance across different segments in the market. The customers are realizing the benefits of significant efficiency and lower life cycle cost which has helped us win many break-through orders during the year. The portable products registered good growth over last year due to increased construction and mining activity The Rail segment faced challenges in the first half of the year due to lower running of trains but picked up gradually during the year.

ATS ELGI Limited: The Indian Automotive market was already facing headwinds and had slowed down during 2019-20. The year 2020-21 started on this backdrop and the industry suffered the most with the advent of pandemic and the consequential impact on the economy. The first half of the year was tough for this business and there was a moderate recovery in the second half.

The ATS ELGi team quickly looked for growth opportunities inside and beyond the passenger vehicles market and realized revenues that helped us close the year 10% below our previous year’s sales. Further, the business focused on better price realization to respond to the extraordinary escalation in domestic steel prices and took strong cost-savings measures which helped us close the year with an increase in profit over the previous year. The team also took this opportunity to optimize its working capital by reducing the receivables and inventory significantly which helped them generate good cash flow during the year.

ELGI Sauer Compressors Ltd: Established in the year 2008, ELGI Sauer Compressors Ltd is a joint venture between Elgi Equipments and J.P. Sauer & Sohn, Kiel, Germany. The joint venture manufactures high-pressure air and gas compressors for the Navy, Shipping Industry, and Petro/offshore segment. The Joint venture has created a strong brand identity in India and neighboring countries, such as Sri Lanka, Nepal, Bhutan, and Maldives.

This Company is focused on projects business and has been providing standards and customized end to end solutions; from design, engineering, manufacturing to the installation of the compressor units at sites. The business is largely dependent on government budget allocation and capital budget investment by the non-govt segment. The sales grew by 12% during the year. The order book position continues to be healthy and has grown significantly over the previous year. The outlook for the business during 2021-22 is expected to be strong as the Government allocation to this sector is increasing. While the active enquiry level is encouraging, the pandemic situation has slowed down the order finalization as there is a focus on cash conservation across segments.

During the year, ELGi Sauer’s Engineering Support Team Coimbatore (ESTC) was established to provide exclusive engineering support to the parent Company, Sauer-Germany, and its global subsidiaries. It is fully operational now. The ESTC provides complete engineering support comprising of 3D modeling, FEA analysis, and shock calculation. ELGi Sauer has also commenced construction of a new factory in the outskirts of Coimbatore.

Product Management and Marketing: This key global function that connects the customers and the Company did a phenomenal job in converting some of the challenges into opportunities, working closely with the businesses and the technology function. Managing the planned launch of products in the pandemic situation has not been easy. The marketing function quickly embraced new technologies and platforms to engage with the customers and helped the sales organization to be effective in knowing and meeting market needs. They also utilized the lean periods to enhance awareness and educate end customers on compressor technology, products, energy conservation, etc.

Technology: As another key global function, the technology function adjusted to the new work norms quickly. The team adopted a judicious mix of working remotely and working from the office to keep all the product development and innovation projects progressing on schedule during this tough period. Product upgrades and new product roll-outs that were planned and executed helped us significantly in an otherwise challenging year.

Operations: The operations team seamlessly moved to the changing work environment and timings, including working in shifts. Significant productivity improvements were made and the team also ensured there was only minimal interruption to the supply chain, resulting in the consistent supply of raw materials to the factories. While focusing on the health, safety, and social distancing norms, the team ensured continuous delivery of products to meet market demands. The operations team also delivered record production across various product lines during the year.

Human Resources: Providing and ensuring health, safety, and environment for all became an imperative and required significant commitment more than ever before under the new pandemic situation. The other critical need was to maintain employee engagement at very high levels in a tough environment. The Human Resources function demonstrated its commitment to employee wellbeing by being sensitive to employees’ changing needs and the challenges they faced. From creating awareness to extending all support to employees across functions and businesses remained the priority through the year. Employees were sensitized on COVID-19 protocols to be followed, both at factories and offices. The organization has enforced these protocols strictly with the co-operation of the employees.

Finance: The year began with lots of uncertainties across all the Geographies and the finance team started working right away with the CEO and the business leaders to create contingency business plans and upfront measures to mitigate the potential impact on the financials of the Company. During the year, the finance function was focused on efficiently managing working capital and implementing cost control measures. The finance team continued to extend support to the business and ensured on-time completion of financial reporting and auditing. It is commendable that the team completed their immense responsibilities by operating from remote locations for the most part of the year. The quick adoption of technology and the unflinching commitment of the team made this possible.

Overall summary: While the uncertainties around Covid continue to be a dampener, the Company is focused on staying the course while committing to the strategic initiatives to deliver the mid-term goals of the Company. In the short-term, the challenges are volatile commodity prices, high freight costs, delays in shipment, and disruption of production and movement of goods due to pandemic. Our technology function, with its continuous focus on cost reduction will help the Company mitigate some of the cost-related issues and alternate sourcing opportunities to minimize dependence on concentration and movement of goods.

The short-term opportunities are seen in the growing demand for our products in certain segments like pharma and medical equipment. The Company is continuing to improve its internal controls and mitigate risks through continuous improvements and investments in systems and processes. Upgrading various IT platforms, moving to cloud storage in a phased manner, and investing in technologies to protect the IT system are given enhanced priority in the current situation. Besides implementing sufficient protection and control systems, the Company regularly conducts vulnerability assessment and penetration testing (VAPT) audits to identify threats and mitigate issues if any.

The year under review has been abnormal due to the external environment. While sales did not grow as expected, the Company has managed to improve the profits and Return on Capital Employed (ROCE).

Compressor

Automotive

Consolidated

INR Mn 2019-20 2020-21 2019-20 2020-21 2019-20 2020-21
Sales 16494 17624 1800 1616 18294 19241
Growth %

(1%)

7%

(9%)

(10%)

(2%)

5%

Contribution 6815 7311 562 501 7377 7812
Contribution %

41.3%

41.5%

31.2%

31.0%

40.3%

40.6%

People cost 3759 3849 287 268 4046 4117
Growth %

21%

2%

(2%)

(6%)

19%

2%

Other Fixed Cost 1841 1453 131 85 1972 1538
Growth %

0%

(21%)

(13%)

(35%)

(1%)

(22%)

EBITDA 1215 2008 145 148 1359 2157
EBITDA %

7%

11%

8%

9%

7%

11%

PAT %

2%

5%

5%

6%

2%

5%

Average Capital employed 9173 9632 402 324 9574 9957
Growth %

12%

5%

(13%)

(19%)

11%

4%

ROCE 8% 16% 31% 42% 9% 17%

A sales growth of 7% in the compressor segment, in spite of a very poor first quarter, was accomplished with the support of international business growth and a strong second half performance in domestic market.

The Company managed to contain the impact of volatile commodity prices through timely internal and external measures further supported by business mix. The increase in employee cost to support Europe and North America expansions were partially off-set by Covid related Government subsidies that we received in geographies such as North America and Australia. The Company kept very tight control on other expenses through the year. While lower levels of activity drove some costs down, there were deliberate efforts to reduce certain costs and such reduced levels can be sustained even during "business as usual" times.

EBITDA for the period grew by 65% on a sales growth of 7% aided by significant reduction in expenses.

The Return on Capital Employed grew by 100% this year.

The automotive business segment sales was impacted by the pandemic. However the business managed to retain EBITDA at the same level as previous year.

The Company’s working capital improved significantly during the year driven by focused efforts to reduce inventory and trade receivables. The improved cash flow helped the Company to reduce its net debt significantly as indicated earlier.

In summary, we have gained further traction and market share in many of the key markets in a difficult year. Tight working capital management and prudent cost measures that are getting institutionalized would help the Company improve profits and cash flow in the next year. These, along with the increased focus on talent management, continuous improvement and other strategic initiatives, will enable the Company to meet its mid-term goal and long-term aspirations.

Comments on Financial Ratios

During the year there was a significant improvement in the profitability ratio – (Operating profit margin and Net profit margin). This was primarily due to cost saving measures that were initiated and further aided by lower activity levels due to the pandemic situation that prevailed.

The company also witnessed an improvement in Debt Equity ratio as the international entities made repayment of their long term loan instalments which reduced the debt besides increase in equity from the profits for the year.

Ratios Analysis of performance table 2020-21 2019-20 % of change
1 Debtors turnover Trade Receivables turnover ratio (DTR) 5.12 5.09 0.67%
2 Inventory turnover 5.58 5.87 (5.09%)
3 Interest coverage ratio Interest component ratio (%) 0.70 0.86 (17.64%)
4 Current ratio Current Ratio 1.51 1.42 6.40%
5 Debt equity ratio Long Term Debt Equity Ratio 0.09 0.13 (30.16%)
6 Operating profit margin % Gross Profit Margin (%) 12.28 8.10 51.58%
7 Net Profit margin % Net Profit Margin (%) 5.26 2.31 127.53%
8 Change in return on net worth RONW (%) 12.51 5.53 126.22%