Premier Explosives Ltd Management Discussions.

1. Macroeconomic review

The novel corona virus (Covid-19) pandemic and related containment measures have resulted in steep decline in economic activity in an already-weak global economy.

As per Jun20 estimates by World Trade Organization (WTO), volume of merchandise trade shrank by 3% YoY in Q4FY2020. And, it dropped rapidly by 18.5% in Q1FY2021. This has been brought about by social distancing measures and restrictions adopted in most countries throughout April and May.

Likewise, the World Bank (WB) forecasts a 5.2 percent contraction in global GDP in calendar year 2020, which is the deepest global recession in decades.

On the positive side, however, recent commentaries by WTO and WB indicate that there are tentative signs of recovery and the worst of the global pandemic might be over, with lockdowns gradually being eased around the world. Moreover, progress on vaccine development and medical treatments are likely to elevate confidence, which ultimately helps higher economic activity going forward.

India, which has been subjected to national lock-down on March 23, 2020, has recorded a growth of just 3.1% in January - March 2020 quarter, compared to 5.7% in that quarter of the previous year. Annual growth also has declined from 6.1% in 2018-19 to 4.2% in 2019-20, which is the slowest rate recorded in the last eight years.

However, the Indian economy has begun to recoup from the lows experienced in April 2020, when the lockdown measures were at their firmest, with many sectors adapting to the new business normal. Nevertheless, in view of growing Corona virus cases and localised lockdowns, rating agencies continue to project an adverse GDP outlook for the ongoing fiscal. Factors like migrant worker dislocations are a major concern for domestic manufacturing and trade activities.

Relevant to our business, the May 2020 report for eight core domestic sectors reported a cumulative YTD decline of 14.7% in Coal and 54% in Cement production.

In early May 2020, government announced "Aatma Nirbhar Bharat Abhiyan" programme, a special economic package of Rs. 20 lakh crores, equivalent to 10% of Indias GDP. This programme is aimed at ramping up policy imperatives to make India a selfreliant economy and to help parts of the economy that have been adversely affected by Covid-19. Given these stimulus measures, the long-term outlook for India remains stable as per major rating agencies, reflecting that Indias economy will recover following the containment of the Covid-19 pandemic.

Suspected role in global spread of Covid-19 virus, attempts to dominate South Sea China waters and undesirable aggression at India border have been resulting in polarisation of China on one side and India, US, Japan, Australia, European Union, etc on the other. Trade restrictions by major countries on imports from China may see profound changes in international trade

and countries like India may see opportunities knocking their doors to set up manufacturing the goods that were hitherto manufactured by China.

2. Operating environment

Need for defending the borders, higher investments in advanced technologies and ambitious export targets in the defence sector - all lend to a positive outlook for the defence sector.

Structural reforms in the coal sector, new mineral policy of 2019 and aiming for reduction in coal imports - all lend to a positive outlook for the coal and mining sector.

Together these initiatives provide hope and opportunities for your company, which primarily operates in defence explosives and mining explosives.

A. Developments in Defence sector

a) "Aatma Nirbhar" initiatives and revision of Defence Procurement Procedure

India is the second largest armed forces and the fifth largest defence budget in the world.

Aiming to achieve self-reliance in defence production, recently the government has increased the FDI limit in defence manufacturing under automatic route from 49% to 74%.

Supporting the "Make in India" initiative, in April 20, the Ministry of Defence has revised Defence Procurement Procedure mainly to facilitate greater participation of Indian Industry and develop robust defence industrial base.

Though defence expenditure has been increasing during the last 10 years, most of the increased expenditure has been in the Personnel & administration costs (49% of total spend in 201112 to 61% in 2020-21 estimated).

Inversely, actual expenditure on Acquisitions, stores and R&D has been decreasing (41% in 201112 to 29% in 2020-21).

Thus, a bigger push is required from the government in terms of allocation of defence spend in improved technologies to strengthen the countrys military position. (Source: Bang for Buck: Indias Defence expenditure in wider perspective, Manohar Parrikar Institute for Defence Studies and Analyses)

b) India bans import of 101 defence items to boost self-reliance

In August 2020, government of India has banned import of 101 defence items. Expected to boost up domestic defence industry, the ban-list includes missiles, ammunition and other items for which your company has built up competence and capacities.

c) Separate budget for procuring only Indian made defence items

In May 2020, Finance Minister announced that emphasis will be on procuring locally made products and said separate budgetary provisions for procuring only Indian made defence items.

d) Unstable developments along the border and the need for Defence preparedness

In a significant deterioration of border relations, India and China were locked in a face-off in early Jun20, with China claiming sovereignty over the Galwan Valley. Though the process of disengagement at several places is underway after diplomatic talks, this is the first major confrontation between the two countries since 1967 and marks an environment of increased tension that will require vital defence preparedness to meet any untoward incident at the border in future.

e) Growing ranks of India as defence exporter globally

At the inauguration of DefExpo, Lucknow, on February 5, 2020 Prime Minister Modi said, "In 2014, the export of defence equipment from India was about Rs. 2,000 crore. In the last two years, it has gone up to Rs 17,000 crore. In the next five years, our target is to increase exports to $5 billion, which is about Rs 35,000 crore."

It is estimated that an export target of $5 billion in the next five years is not only achievable but can even match the national current capital outlay for defence of $15 billion in a decade.

Anecdotally, US is one of the largest importers of Propellant Powders with imports of USD 280 million in 2019. While US imports from China formed close to 7% of the total imports in 2018, the growing trade tensions between the two countries has resulted in this share to decline to less than 1% in 2019. Such continued realignment of global procurement supply chains presents an export opportunity for India.

Recently India has begun exploring export of missiles like Brahmos and Akash to Philippines, Indonesia & Vietnam and MoU has been signed with Phillippines. Already exporting personal protective gear and armour plating for military vehicles to Phillippines, now missiles are expected to widen the export product mix.

In a significant development, your company received SCOMET license from DGFT for export of "Propellant filled rocket motor" to Israel Aerospace Industries, Israel. Designed and developed by your company, this is Indias first ever export of such product, marking a small but strong beginning of your companys contribution to Indias defence exports.

f) DRDOs push for new technologies

In January 2020, DRDO opened 5 new labs in India, to focus on each of the futuristic technologies: Artificial Intelligence, Quantum technologies, Cognitive technologies, Asymmetric technologies and smart materials. This is paving way for putting India on the world map of technological warfare.

Your company has been partnering with DRDO in high energy materials and can be part of such new programmes in coming years.

g) Update on your companys contribution to Indias missile programmes

Your company has been working with various defence entities towards indigenisation of national missile programs. Following table gives details of missiles for which PEL has been supplying solid propellants.

Missile Type Stage Order from End user Remarks
Akash Tactical, Surface to Air Production Bharat Dynamics Limited (BDL) Indian Air Force and Indian Army Supplied 2000+ booster grains and 450+ sustainer grains
LRSAM Tactical, Surface to Air Development cum Production DRDL Indian Navy Sole supplier of solid propellants
MRSAM Tactical, Surface to Air Production from 2019 BDL Indian Air Force and Indian Army Sole supplier of solid propellants
QRSAM Tactical, Surface to Air Development DRDL Army Sole supplier of Solid Propellant
NGARM Tactical, Air to Surface Anti Radiation Development DRDL IAF Sole supplier of Solid Propellant
Astra Tactical, Air to Air Development and Production DRDL/BDL Indian Air Force Sole supplier of solid propellants
Astra - 2 Tactical, Air to Air Development DRDL Indian Air Force Sole supplier of solid propellants
Missile Type Stage Order from End user Remarks
Casting of motor as a service
Agni IV Ballistic Production Advanced Systems Laboratory Strategic Forces Command Supplier of Pyrogen igniter
Brahmos Cruise Anti-ship, Land attack Production HEMRL Indian Air Force, Indian Navy and Indian Army Transfer of technology is under induction at Katepally plant
Pralay Tactical, Ballistic short range surface to surface Development RCI Indian Army Transfer of technology is under induction at Katepally plant

h) Update on PELs other defence and space products

In addition to missile area, PEL has been working with defence and space entities in the national indigenisation effort with the following products:

Product Type Order from Remarks
Strap on motor for satellite launcher Solid propellant ISRO Trial runs are going on at Katepally plant
Air Target Imitator Dummy Rockets with IR Flares for Practice Firing Large Igniters for Initiation of Army First such product to be designed, developed and manufactured in India Sole supplier of Pyrogen Igniters
Pyrogen Igniters Strategic Missiles propellant stages Munition device that detonates DRDO Supplied Igniters for various Strategic missiles like Agni and Submarine launched missiles
Mines by way of pressure when a target steps on it or drives over it DRDO / Indian Army Qualified in user / DGQA trials and evaluation
Chaff Counter measure Indian Air Force First indigenous supplier of the product Entered into Memorandum of Agreement with Indian Air Force for development and manufacture under Make in India
IR flare Counter measure Indian Air Force First indigenous supplier of the product
Smoke flare Signalling device Indian Navy, Para Military Force Supplies going on
Multispectral flare Advanced counter-measure Indian Air Force, Indian Navy, Indian Army Under offer for user trials
Pyro cartridges Initiators for missiles and other projectiles ISROBharat Dynamics Limited Supplies going on
Water cannon disruptor Neutralising IEDs Para Military Force Supplies going on
Mob control device Tear gas grenades and shells Para Military Force, State Police Supplies going on
Fuze (filling and assembling) Device that detonates a munitions explosive material Ministry of Defence Under user trials

B. Commercial explosives - key drivers

a) Pan-India production of explosives

Product UoM 2017-18 2018-19* Growth
SMS explosives tons 8,37,593.47 8,57,266.69 2%
Cartridge explosives tons 4,75,957.17 5,38,652.52 13%
Boostex and PETN tons 9,207.04 10,203.33 11%
Safety fuse mn mtr 58.95 53.10 -10%
Detonating fuse mn mtr 674.98 696.40 3%
Detonators mn no 983.96 1,034.13 5%

*2019-20 details yet to be available

Except Cartridge explosives and Boostex / PETN all other products show muted or negative growth. It is in this backdrop that your company has been focussing more on defence explosives which offer better prospects in the coming years.

b) Production of coal in India

All India Production of coal during 2019-20 was 729.10 MT, almost on par with 728.72 MT in 2018-19.

Coal India Limited (CIL) and its subsidiaries production also remained stagnant at 602.15 MT of coal in 2019-20 compared to 606.89 MT in 2018-19.

India imported 247.1 million tonnes (MT) of coal in 201920, about 5 per cent higher than 235.35 MT in 2018-19.

Several initiatives are being taken by Ministry of Coal for supply of domestic coal to reduce import dependency.

In May 2020, the central government decided to bring the import of coal for blending purpose by domestic coal-based power plants to zero in FY 2020-21.

This is expected to ramp up production by Indian coal miners and to generate demand for explosives.

c) Auction of coal mines for commercial extraction by the private sector

On June 18, 2020, the Government launched auction of 41coal mines for commercial mining with the theme "Unleashing Coal: New Hopes for Atmanirbhar Bharat", for Indias self-reliance in coal mining through structural reforms in the coal sector.

Salient features of the auction include:

• In all 41 mines total geological coal reserves amounts to 17 billion tonne of coal
• Peak rated capacities (PRC) of all mines is 225 mtpa
• The mines on offer are largely fully explored ones - could be brought to production immediately.
• 100 per cent FDI through automatic route allowed
• Floor price of coal mines has been set competitively at 4 per cent of revenue share
• Complete freedom to to use coal production for sale, captive consumption, sale to affiliates, coal gassification and exports

The coal mines auctions are expected to lay strong foundation for energy security, large scale employment generation and huge opportunities for investment in coal sector.

These initiatives provide increased opportunities for supply of explosives.

d) Volume restrictions on electric detonators

With a view to enhance safety in mining operations, restrictions have been imposed on volumes of electric detonators to phase them out over a period of time. Nonelectric detonators would replace the electric detonators and your company is taking steps to increase production of shock tube and other parts for non-electric detonators.

3. Outlook

Your company has been focussing on defence explosives business and continues to accept mining explosives opportunities wherever the margins are profitable.

In October 2019, your company has withdrawn from Coal India tender below certain price and consequently there had been lower top line and 2019-20 and it would continue to affect the top line for 2020-21 also. However, a new order from Jaiprakash Ventures would compensate the turnover to some extent.

Your company has been working to ramp up few of the defence products like Chaff so as to come back to positive net earnings.

Trial runs at Greenfield project at Katepally are under way:

- Propellant casting for ISRO satellite launcher has been going on
- Prototypes of propellants for Brahmos missiles are under development with transfer of technology from DRDO
- Recently transfer of technology has been initiated with DRDO for Pralay missile propellant and trial runs are about to start
- After receiving all necessary licenses, trial runs have been going on for manufacture of RDX/HMX

4. Segment-wise performance

The companys primary business is manufacture of high energy materials as a single business segment.

5. Financial analysis

Generally accepted accounting principles:

The financial statements are prepared under the historical cost convention on an accrual basis.

Performance:

Current years net operating revenue has been Rs. 15,650.80 lakhs compared to Rs. 24,093.35lakhs during 2018-19. During the year the company has incurred a loss before tax of Rs. 1,450.94 lakhs compared to a profit of Rs. 1,631.65 lakhs last year. Loss after tax stood at Rs.958.24 lakhs against profit after tax at Rs. 1,172.55 lakhs.

During the year, macro economic factors like low demand for detonators, longer monsoon, generally weak economic activity, together with specific factors like withdrawing from major tender for supply of explosives at lower prices, postponement of certain defence deliveries in the wake of Covid-19 at year- end, affected Companys top line. Consequently, fixed costs could not be covered from lower turnover and profitability of the company has been impacted significantly.

Financial position:

During the year, the company incurred a total capital expenditure of Rs. 3,125.87 lakhs including capital work in progress and intangible assets. Major capex is towards Katepally Greenfield project. After receiving all necessary manufacturing licenses, currently trial runs are going on and the company expects to capitalise the project in second quarter of the financial year 2020-21.

Key financial ratios:

2019-20 2018-19
Debtors turnover 3.33 3.71
Inventory turnover 3.72 7.52
Current ratio 1.27 2.11
Long term Debt equity ratio 0.03 0.04

6. Risk management

Your company recognizes Risk Management as a very important part of business and has kept in place necessary policies, procedures and mechanisms. The company proactively identifies monitors and takes precautionary and mitigation measures in respect of various risks that threaten the operations and resources of the company, which include the following:

Risk Description Mitigation
COVID-19 risk First identified in December 2019 in Wuhan, China, it is an infectious disease and has resulted in an ongoing pandemic affecting almost all the countries. In financial terms, market demand and supply chains have been affected causing global economic recession. The company has been following the lock-down / relaxation guidelines prescribed by the government. Plants and offices have been taking precautions such as sanitisation, social distancing, etc. Delivery schedules and payment terms are being renegotiated with customers and suppliers to mitigate contract obligation risks.
Project risk The company has been executing various projects for enhancement of capacity as well as establishment of manufacturing facilities for new products. These capital projects may be exposed to time and cost overruns. To mitigate these risks, the technocrat management developed in-house design of equipment to the extent possible. The management also closely follows up the execution of projects to meet the deadlines.
Market and Competition risk Commercial explosives business is linked to mining and infrastructure activity which have not been faring well in recent times. Further, there has been intensive competition in the industry with entry of new units. To mitigate this risk, the company is exploring new markets including export markets. The company is also focusing on defence products which are expected to grow into a reasonably large stream of revenues to add diversity to the product portfolio.
Safety risks Both raw materials and finished goods are high risk items during production and handling. Apart from strict adherence to mandatory safety measures, the company has developed an alternative chemical compound as primary explosive in production of detonators. This alternative chemical is less sensitive to friction and hence is safer than its traditional counterpart.
The company which is already an ISO 9000 compliant for commercial products is now implementing AS 9100 C for defence / aero products.
The company gives utmost priority for the safety of its employees as well as the manufacturing assets.
These measures are expected to make the systems function in accordance with safety standards.
Raw material price risks Ammonium nitrate and fuel oil form major part of raw materials in manufacture of explosives and those raw material prices are influenced by international dynamics. This risk is mitigated by price escalation clauses in supply contracts whereby selling prices are periodically adjusted for the changes in prices of main raw materials. The company also uses a mix of domestic and imported ammonium nitrate taking into account the landed cost of the materials in both the options. As such risk absorption clauses are not available in supply of other products, the company takes all efforts to control the overall cost of manufacture, including backward integration.

7. Internal financial controls and their adequacy

Your company has established necessary internal financial controls and have got them assessed by professionals in the field during the year.

Your company has been utilising an ERP system for recording all financial transactions with built in checks and balances. This has been helping in preparation of financial statements and other reports accurately, reliably and timely.

Management reviews the operations on a regular basis.

Independent auditors, internal auditors, cost auditors and secretarial auditors verify financial and other information from their respective angles on intervals as are required.

Board and its committees review the quarterly and annual financial statements in conjunction with the financial policies, assurances through auditors observations and management responses and certifications.

Based on the above measures your company is confident that internal controls are in place, they are adequate and are reasonably working.

8. Material developments in human resources / industrial relations including number of employees

Your company has 1,103 employees as on March 31,2020 (1,075 a year ago). Relations between the management and employees have been cordial. Employees have been imparted training in their respective areas for better performance. The management acknowledges the contributions made by each and every employee and records its appreciation for the cooperation extended by them at all levels.

Secunderabad Dr. A.N. Gupta
11.09.2020 Chairman & Managing Director