IL&FS Engineering & Construction Co Ltd Management Discussions.

(A) INTRODUCTION:

IL&FS Engineering and Construction Company Ltd (IECCL) has more than three decades of experience in the engineering and construction business with capabilities in providing integrated Engineering, Procurement and Construction (EPC) services. With engineering experience, trained and qualified manpower, IECCL is primarily executing infrastructure projects across India.

IECCL has been delivering projects in the sectors of Power, Oil and Gas, Roads, Railways and Metros, Water and Irrigation, and Buildings & Structures.

(B) ECONOMIC OVERVIEW

(1) Indian Economy

India continues to remain the fastest growing major economy in the world in 2018-19, despite a slight moderation in its GDP growth from 7.2 per cent in 2017-18 to 6.8 per cent in 2018-19. On the other hand, the world output growth declined from 3.8 per cent in 2017 to 3.6 per cent in 2018.

Indias growth of real GDP has been high with average growth of 7.5 per cent in the last 5 years (2014-15 onwards). The Indian economy grew at 6.8 per cent in 2018-19, thereby experiencing some moderation in growth when compared to the previous year. This moderation in growth momentum is mainly on account of lower growth in ‘Agriculture & allied, ‘Trade, hotel, transport, storage, communication and services related to broadcasting and ‘Public administration & Defence sectors. On the demand side, lower growth of GDP in 2018-19 was accounted for, by a decline in growth of government final consumption.

The Government of India projected GDP growth for FY 2020 at 7% on the back of anticipated pickup in the growth of investment and acceleration in the growth of consumption. UN Report also says that India to remain fastest-growing economy in 2019 and 2020. Notwithstanding growing global turmoil arising out of rising oil prices, trade wars between US and China, India shined based on better demand conditions, settled GST implementation, growing investments in infrastructure, continuing positive effect of reform policies and improved credit off take especially in Service sector.

India has secured 77th position out of 190 countries in World Banks Ease of Doing Business Report 2019 which is 23 place up since the last report.

(2) Indian Infrastructure Sector

Being a key driver of the economy, Infrastructure and Construction sector is significantly responsible for propelling Indias overall development and enjoy intense focus from Government for initiating policies that would ensure time-bound creation of world class infrastructure in the country. Infrastructure sector includes power, bridges, dams, roads, railways, housing and urban infrastructure development

The Ministry of Road Transport & Highways (MoRTH) declared the financial year 2018-19 as the "Year of Construction". In FY 2020 also, Infrastructure sector continues to be key driver for Indian Economy and play pivotal role in achieving the Governments vision of making India a USD 5 Trillion Economy by 2024. The Government of India started several initiatives such as industrial corridors for stimulating industrial development in different regions, Dedicated Freight Corridors (dedicated rail route for freight trains movement), Bharatmala Pariyojana (a centrally-sponsored and funded Road and Highways project), Sagarmala (A scheme for reducing logistics cost for EXIM and Domestic trade unlocking the potential of waterways and the coastline) and UDAN-RCS schemes (‘Ude Desh ka Aam Naagarik - Regional Connectivity Scheme - the scheme for development of regional airports with the objective of letting the common citizen of the country fly, aimed at making air travel affordable and widespread), House for All, Smart Cities, Bullet Train etc.

The Government of India has proposed several schemes and reforms for improvement of infrastructure in India. Major initiatives are announcement of investment of Rs.100,000 Crore in infrastructure segment in the next five years, an investment of Rs.50,00,000 Crore to improve railway infrastructure between 2018-30, upgrade of roads of 1,25,000 KM length in the next five years, 1 crore houses to be built under PMAY, 50 lakh more houses to attain the motto of ‘House for All by 2022, target to build 100 smart cities.

Apart from the budgetary support, the Government of India is also encouraging foreign portfolio investors to invest in infrastructure debt funds, introduce credit default swaps for the infrastructure sector, deepen the corporate bond market and encourage equity investment by non-resident Indians.

(C) Performance during the year :

Business Performance :

As in the past, your company is executing various EPC and Item Rate projects with both Government and Private clients in the sectors of Power, Oil & Gas, Railways & Metros, Water & Irrigation, Buildings & Structures and Roads situated pan India.

The Sector wise Order Book of the Company is as follows:

(Rs. In Crores)
Sector On hand as on 31-3-2019 On hand as on 31-3-2018
Roads 593 2666
Railways & Metros 214 1,180
Buildings 48 939
Irrigation 223 2,762
Power 390 1,745
Oil & Gas 148 636
Ports - 212
Total *1615 10,140

*executable order book

Developments at IL&FS and its adverse impact on IECCL:

While IECCL was progressing satisfactorily in its projects execution, certain entities of the IL&FS Group began to default on their debt obligations during the second quarter of FY 2019. Considering the impact IL&FS defaults were having on the financial system in India, the Government of India (GoI) petitioned the National Company Law Tribunal (NCLT) to replace the IL&FS Board of Directors. In its order on October 1, 2018, NCLT superseded the Board of IL&FS with a new Board, with members nominated by Government of India. Further, the Government of India also initiated an investigation into the affairs of IL&FS through the Serious Fraud Investigation Office (SFIO) and Enforcement Directorate (ED).

The developments in the IL&FS Group has had an adverse impact on IECCL The immediate and direct impact was stopping payments to financial creditors till NCLT order is released. Payments against liabilities to operational creditors prior to 1st October 2018 are also deferred till NCLT order is issued. IL&FS Group support to IECCL in the form of Corporate Guarantees/ Bank Guarantees has been stopped. Because of all these deferment of Payments / support, subcontractors and suppliers stopped supply of their services / materials which affected the projects progress and projects came to stand still for three months. Evidencing no progress in the Projects and news about IL&FS group defaults, several clients issued termination noitces and a few clients terminated few projects.

The new Board of Directors appointed a new Chief Executive Officer (CEO) for streamlining the business of the Company by coordinating with clients, lenders, subcontractors, suppliers, government bodies and employees.

Discussion on Financial Performance:

The adverse developments in the IL&FS Group have significant direct impact on IECCLs business plans for revenue and profit growth. The company could not achieve its projected revenue targets due to termination of IECCLs projects at Kolkata Metro, Nagpur Metro, Jharkhand based six Rural Electrification works. This has significant impact on its present revenue and future order book

In order to contain the adverse impact, IECCL has effected stringent cost rationalization measures. These measures included manpower rationalization and salary cuts for the senior management, shifting of Head Officeto lesser area office premises thereby reducing rent outgo. IECCL has also initiated special efforts for early realization of long pending claims and receivables.

Overall Financial Performance:

2018-19 2017-18 Explanation for significant changes (i.e 25% or more as compared to immediately previous financial year)
Revenue 1239.14 1868.76 Change in Revenue numbers due to change in budget numbers of some projects.
EBITDA ((58.67)) 443.78 Same as Above
PAT (2036.45) 6.92 Includes exceptional items of Rs 1640.42
EPS (155.31) 0.53 Same as Above
Share Capital 170.87 170.87
Debt 2692.05 2512.77
Net Worth (1900.18) 135.13 Major Change due to exceptional items
Fixed Assets 531.11 567.69
Inventory 89.79 1018.13 Reclassification of Unbilled Revenue from Inventory to contract Asset under Other Asset
Debt Equity Ratio 29.73 30.30
Current Ratio 0.37 0.64
Return on Equity 7.25 10.94
Interest Coverage Ratio (0.33) 1.01

(D) Outlook on the performance of FY 2020: Risks and Concerns:

There are ample opportunities for infrastructure and construction business in the coming years. The Government of India(GOI) has initiated several schemes and gave higher budget allocation for creation of world class infrastructure pan India. The Governments pro-industry policies such as lowering corporate tax, setting up of Real Estate Investment Trust (REIT)s and Infrastructure Investment Trusts would drive new investments in Infrastructure sector. IECCL is seeing the good opportunities in the sectors of Power, Oil & Gas, Metros, Roads and Housing.

As regards IECCL, the adverse developments at IL&FS Group have significantly impinged on IECCLs business plans for revenue growth. The newly constituted Board has been working on a resolution plan for IL&FS Group. This plan calls for selling identified assets of IL&FS Group. The outcome of the sale process is uncertain as the same by IL&FS is, at the onset, contingent on approval of investors.

Given the above developments, it is imperative to realign and rebuild the Companies business model. In the near term, this would require the Company to focus on the sectors where it has core competency of timely execution with profits. Working capital requirements and execution cost will be optimized by associating with competitive subcontractors

In the event IECCL is able to successful embark on these initiatives, the same would enable the Company to ride over the current challenging external and internal environment which it faces and, over time, rebuild the Company

The period of business realignment is expected to take 12 – 18 months, during which period the Company would have to deal with a large degree of uncertainties. However, IECCL has the ability to undergo this metamorphosis.

It has been a challenging year, and more challenges lies ahead. The aforementioned strengths are expected to stand IECCL in good stead as it endeavors to overcome the setbacks and once again rebuild its business.

(E) Risk Management:

IECCL has an integrated Enterprise Risk Management (ERM) framework in place for identification, assessment, mitigation and reporting of risks. Risk Management Committee / the Audit Committee/ the Board of Directors oversees the function by periodically reviewing the Critical Risks of the Business and its mitigation plans.

The critical enterprise level risks of the Company and the mitigation measures being taken are submitted below:

Liquidity Position:

The current level of debt is not commensurate with the size of its operations and there has been severe stress in terms of cash flows. Your company is in discussion with its bank consortium and the promoter group for debt restructuring to support revival of business. Your Company is also in discussion with Vendors for extending credit period support in execution of current projects.

Order Book Risk:

IECCL has not won any new works for the last two years. The Company cannot bid for new projects at present due to inadequate fund and non-fund support from Banks pending finalization and implementation of a viable Resolution Plan for your Company. Your Company is also in discussion with other financially sound contracting agencies to form Joint Ventures for bidding for new works in the meantime.

Reputation and Brand Risk:

The overburdened debt of IL&FS group, its default in debt servicing and discussion of its corporate governance practices in public have impacted its group companies including IECCL. This negative publicity will affect IECCL in winning new EPC Projects, in getting new borrowings at lower interest rate and in getting project services from vendors with credit facility in the near to medium term.

Operational Risks:

In order to mitigate operational risks in Project execution, due care is exercised in the preparation of design and drawings, selection of sub-contractors, selection of suppliers, recruitment of technical and non-technical staff, utilization of resources, insurance coverage etc. The Company has documented and implemented Standard Operating Procedures for all important operations of the Company, Delegation of Authority, periodical business monitoring mechanism and risk identification and mitigation mechanism

Political Risk:

Your Company is operating in multiple Indian States with different political mileus and consequently subject to Political risks. Appropriate and adequate mitigation strategies are in place to mitigate these risks. The Company is spreading its operations in all major sectors of Infrastructure and in various States avoiding business concentration in same region

Contractual Risks:

The Company is exposed to several contractual risks with clients, subcontractors, suppliers and lenders in its day to day operations. In order to mitigate these risks, the Company has an exclusive Contracts and Claims Department to oversee contract documentation, major claims and arbitrations.

Subcontractors Risk and Joint Venture Risks:

The Company associated with several subcontractors and joint ventures for executive of their projects. Their non-performance may affect the revenue and profitability of the Company. The Company has a robust system for selection of back-to-back subcontractors and Joint Venture Partners and monitor their performance regularly

(F) Internal Control System and their Adequacy:

The Companys internal financial control framework, established in accordance with the COSO framework, is commensurate with the size and operations of the business and is in line with requirements of the Act. The effectiveness of the internal controls is continuously monitored by Internal Audit. Internal Audits main objective is to provide to the Audit Committee, an independent, objective and reasonable assurance of the Companys risk management, control and governance processes.

Internal Audit continuously assesses opportunities for improvement in all business processes, systems and controls and provides recommendations which add value to the Company. It also follows up on the implementation of corrective actions and improvements after the review by the Audit Committee. The internal audit scope covers inter alia, all projects and corporate functions, as per the annual plan reviewed and approved by the Audit Committee at the beginning of every year.

The Company has institutionalized internal control in the form of standard operating procedures with an objective of orderly and efficient conduct of its business, safeguarding the Companys assets, prevention and detection of frauds, accuracy and completeness of accounting records and compliance with applicable statutory requirements. The Company is having Oracle e-Business Suite as Enterprise Resource Planning (ERP) System for recording transactions in an integrated way with complete audit trail.

The Company has also deployed an external firm of Chartered Accountants and the combined Internal Audit team consists of technical auditors (Engineers), Chartered Accountants and Cost Accountants.

(G) Human Resources & Industrial Relations:

IECCL considers its employees as a valuable asset. Human Resource (HR) is entrusted with the responsibility for nurturing its talent pool. In 2018 IL&FS did Employee Satisfaction Survey and IECCL fared well and remained in top 5 among all Group Companies on all parameters. We have well written down transparent policies like Performance Management System (PMS), Whistle Blower, Sexual Harassment, etc. All employees are appraised about policies repeatedly through email and trainings. HR has online HR Helpdesk which addresses all queries/grievances of employees within maximum 4 working days. Job rotation is the key to talent growth of IECCL.

IECCL continues to maintain harmonious relations with its employees across all its Project sites and offices in India and as on March 31, 2019, the Company had 473 permanent employees

(H) Cautionary Statement:

Statements in this Annual Report, describing the Companys outlook, projections, estimates, expectations or predictions may be "Forward Looking Statements" within the meaning of applicable laws or regulations. Actual results could differ materially from those expressed or implied. Several other factors could make significant difference to the Companys operations which includes economic conditions affecting demand and supply, Government Regulations, taxation, natural calamities and so on, over which the Company does not have any control.