Varroc Engineering Ltd Management Discussions

Outlook

With the worlds transition to green energy, the automotive industry is expected to play a critical role in this shift. The Indian domestic electric vehicle (EV) market is projected to have a compound annual growth rate (CAGR) of 49% between 2022 and 2030 , with estimated annual sales of one crore units by 2030⁵. India ranks fifth in the global EV industry and is expected to climb to the third place by 2030, creating 5 crore direct and indirect employment opportunities. Currently, Indias automotive industry is valued at approximately $222 Bn, and the EV market is expected to grow to $2 Bn by 2023 and $7.09 Bn by 2025. The automotive industry accounts for 8% of all national exports and 40% of the total global research and development spend.

2.3. Global Auto-Component Industry⁶

In recent years, the automotive industry has experienced significant changes due to technological advancements and shifting consumer preferences. Two major trends that are guiding the growth of the industry are the rising implementation of stringent vehicle emission regulations and the growing introduction of environmentally sustainable automobile products. Despite these challenges, the market is expected to witness healthy growth in the forecast period of 2023-2028. This growth is driven by factors such as the rising production and sale of vehicles, the digitisation of distribution systems, and technological advancements and innovations. The global auto parts manufacturing market reached a value of nearly USD 2265.9 billion in 2022, and is expected to grow at a CAGR of 3.2% during the forecast period of 2023-2028. The industry is projected to reach about USD 2737.28 billion by 2028, with a projected CAGR of 3.2% between 2023 and 2028.

2.4. Indian Auto component industry

The Indian auto component industry has witnessed significant growth in recent years, with the sector recording its highest-ever turnover of $6.5 billion in FY 2021-22, a 23% increase from the previous year. This growth can be attributed to the increasing presence of global automobile Original Equipment Manufacturers (OEMs) in India, which has led to a significant increase in the localization of components in the country. The Indian automotive industry has attracted substantial foreign direct investment (FDI) over the years, with a total inflow of $34.1 billion during the period between April 2000 and December 2022. The industry is also expected to grow significantly, with the $46 billion auto components industry projected to reach $200 billion by 2026.

The export market for Indian auto components is also expected to grow significantly, with exports currently valued at $13.3 billion in FY21 and anticipated to reach $80 billion by 2026. The top export destinations for

Indian auto components include the USA, Germany, UK, Thailand, and Italy.

The aftermarket segment, which includes tire, battery, and brake parts, is also expected to grow significantly, with the segment projected to reach $32 billion by 2026, up from $9.8 billion in FY20. In H1 FY23, the Indian auto components industry grew by 34.8% to H2.65 lakh crore.

This growth is expected to continue, with the sector set to become the third-largest globally by 2025.

To further boost domestic manufacturing and attract investment in the automotive manufacturing value chain, the Union Cabinet announced the Production-Linked Incentive (PLI) Scheme in the Automobile and Auto Components sectors. The scheme proposes financial incentives of up to 18% for the manufacturing of advanced automotive technology products in India, and 95 applicants have been approved under this scheme.

Key Growth Drivers

• At least 90 of the top 100 auto-component suppliers have a presence in India, indicating the countrys potential as a global sourcing hub.

• India has reduced its dependence on imports through localised production, making it an attractive option for companies looking to tap into the Indian market.

• Indias cost advantage, with costs 10-25% lower than Europe and Latin America, further contributes to its growth.

Role in the Global Value Chain

• India allows 100% FDI through the automatic route, making it easy for foreign players to invest in the country.

• The presence of auto design centres, automotive training institutes, special auto parks, and virtual SEZs for auto components gives India an edge in the global value chain.

Geographic Proximity

• The geographic proximity of key automotive manufacturing countries, including ASEAN countries and South Korea, creates significant opportunities for Indian auto ancillary players.

• Asia is emerging as a growing market due to its cost competitiveness, rising incomes, rapid urbanisation, improved infrastructure, and scope for greater vehicle penetration.

Trade Policy

Trade policy in India is favourable, with nominal restrictions on import-export, making it an attractive destination for businesses.

The Indian Foreign Trade Policy 2023 proposes a number of new programmes, including a one-time amnesty programme for exporters to finish up any outstanding authorizations and begin again. The Status Holder Scheme and the Towns of Export Excellence Scheme both promote the recognition of new towns and exporters, respectively.

3. Company Overview

Varroc is a global Tier-1 automotive component company that has been operating since 1990, when it started with its Polymer business in India. Over the years, the Company has expanded its offerings to design, manufacture, and supply a wide range of products, including electrical electronics component, plastic & polymer components, precision metallic components, exterior lighting systems and advanced safety solutions. Its customer base spans across various segments, including passenger cars, commercial vehicles, two-wheelers, three-wheelers, and off-highway vehicles. One of the Companys strengths is its R&D capabilities and technological partnerships, which have helped the Company develop products that align with the emerging mega trends of safer, greener, smarter, and connected vehicles in the automotive industry. With over 3 decades of relentless commitment to excellence and performance, it has become the most preferred partner for all leading OEMs in the automotive segment worldwide.

It is a leading global auto technology company with a diverse product portfolio covering electrical, electronics, lighting, polymer, metallic, aftermarket, and advanced safety solutions. The Company has a strong presence in India, where it generates 81.7% of its business value, while the rest comes from its global operations. Varroc has a vast network of 36 operating manufacturing facilities, 7 technical centers, and over 6,500 employees spread across 7 countries.

The Companys vision is to create safe, smart, and sustainable future mobility solutions for everyone. To achieve this vision, the company has set a mission to be the trendsetter in delivering the highest value for money mobility solutions, extend its India market leader position in 2W mobility, lighting, and driver assistance to the world, double its profitable growth by 2030 through business excellence, be the partner of choice for its valued customers through superior customer experience, and empower and enable all teams committed to speed, excellence, and its values to achieve exceptional success. Varroc is committed to being a trusted Indian family-owned enterprise focused on societal and environmental sustainability. Its core values include sincerity, humility, integrity, passion, and self-discipline.

The Companys capabilities span across product development, manufacturing, and delivery. It has end-to-end capabilities across design, engineering, testing/ validation, tooling, manufacturing, and delivery.

It is also investing in technology such as safety, connectivity and digitization, personalization, electrification and efficiency, and sustainability, to meet the evolving needs of its customers. Overall, Varrocs commitment to excellence, innovation, and sustainability has helped it become a leading player in the global automotive industry.

Technology

As the demand for efficient and eco-friendly vehicles increases, the Company has implemented cutting-edge technology to stay ahead in the game. From electric scooters to high-performance electric motorcycles, the industry is experiencing a significant shift towards sustainable and efficient modes of transportation.

On the other hand, in the realm of four wheelers, technology is being used to enhance performance and safety. Advanced driver assistance systems (ADAS) such as lane departure warning and adaptive cruise control are becoming increasingly common, while features like automatic emergency braking and blind spot monitoring are becoming standard in many vehicles. In terms of propulsion, hybrid and electric drivetrains are gaining popularity, offering reduced emissions and improved fuel economy.

Overall, technology is playing a critical role in transforming the automobile manufacturing industry. From two to four wheelers, companies are investing in new and innovative solutions to make transportation more sustainable, efficient, and safer for everyone.

Technology for Two Wheelers

The current industrial megatrends are driving the development of two-wheeler technology, which aims to allow safer, smarter, connected, and sustainable mobility.

LED headlights and mirrors are among the safety features being adopted for two-wheelers, while connection and digitalization include linked displays, TFT and sensor interfaces, and FOTA in telematics. Additionally, trademark lighting and foam in place seats are customization elements, while electrification and efficiency include traction motor and controller, power assist ISG, and e-Drivetrain energy management system. Finally, electronic fuel injection for ICE cars and BS6 catalytic converters are being deployed for sustainability.

Technology for Four Wheelers

The newest megatrends in four-wheeler technology are safety, personalisation, connection, and digitalization. Advanced driver-assistance systems (ADAS), driver monitoring systems, surround view systems, LED headlights and LCUs, and adaptive front lighting system mirrors are examples of safety features. Signature lighting, interior systems, in-cabin sensors, interior mood lighting, and centre consoles are examples of four-wheeler customization elements. FOTA in telematics, video telematics, AI-powered sensor interfaces, and AUTOSAR compliant modules are also part of connection and digitalization.

Product Portfolio Enhancement

Product portfolio augmentation encompasses a number of subcategories aimed at improving the present product offering. These subcategories include proprietary goods with a continuing focus on creative, cost-competitive designs, R&D and product development, new technological tie-ups to suit market demands, and GoIs DSIR accredited R&D facilities.

In the automobile business, the development of technologies for safer, smarter, more connected, sustainable, and lightweight cars is critical. The incorporation of these elements into automobiles provides increased safety and connection, as well as sustainability and light weighing.

Our 2W and 3W EV Capabilities

The companys 2W and 3W EV capabilities include locally designed, developed, and manufactured products like traction motors, traction controllers, DC-DC convertor, chargers, BMS, telematics etc. Furthermore, the firm has complete vertical integration for electrical production as well as a motor dyno testing facility for 2W and 3W EV testing. The machines are also IOT enabled for mapping the capacity utilisation.

Business Review

Our business are mainly in India and have operations also in Europe and Asia continent.

Indian Operation

The Indian operation is the dominant contributor to the Companys total revenue i.e. over 85%. The Indian operations is divided into four segments.

Polymer & Plastics Segment (PBU) :- PBU has 13 facilities across India and has technical center set up in Pune as well as in Aurangabad. They offer wide range of products and over period has evolved from just component maker for 2W to high end system solution for passenger and commercial vehicle. The product range includes painted & molded body parts, seats, air filters, mirrors, roof rails, console, door trims etc. The company is known for making the vehicles lighter so that fuel efficiency improves. In this segment the company is working on advanced technology for sustainable usage of material like using natural fiber composites ( Rice husk, bamboo fiber, coffee schaaf etc). Going ahead the company is looking to develop functional decorative surfaces for the vehicles.

Electrical Electronics (including lighting) (EBU):- EBU has 10 facilities across India and has technical center in Pune where more than 400+ engineers work. The product range is very wide and have developed products required in ICE to EV vehicles. The product includes digital Instrumental cluster, motors & magneto, engine control unit, switches, catalytic convertor, telematics, lighting for 2W, 3W and 4W, EV products (traction motors, traction controllers, DC-DC convertors, battery chargers, BMS, etc. The capability has evolved over a period due to strong R&D team and through various collaborations. The Company has joint venture with Dellorto for fuel injection system, technical collaboration with Candrea for HMI technology and acquired CAR IQ for telematics solutions.

Metallic (Transmission & Valves) (MBU):- MBU has 5 facilities in India all located in Aurangabad. The product range includes transmission assembly, crank pin, crank shaft, gear, connecting rods and engine valves. The Company has proven its mettle in the metallic business with impeccable design, development, manufacturing and supply of high performance and cost effective components using environment friendly practices such as Zero Liquid Discharge (ZLD) in our plants. The products are not only supplied to leading OEMs and tier-1 suppliers in India but also exported to Europe, North America and Asia.

Aftermarket division (AMD):- The growth in AMD business over years have been better than the remaining business for the company. This is helping the company to reduce the dependency on the OEM sales and also helping the improvement in the profitability of the Company. The product range in aftermarket includes both the product produced by the company inhouse and contract manufacturing. The company has over 700+ distributors in 260 cities in India and also exports to more than 28+ countries its 2000+ SKUs. it has state of the art warehouse of 120 thousand sq ft in Aurangabad. Product portfolio and channel expansion in newer geographies is being looked for continuing the profitable growth of AMD.

European Operation (Including Vietnam in Asia)

The European operation growing business and serves well-known brands such as Aprilia, KTM, Piaggio, Vespa, Yamaha, Honda, Moto Guzzi, Ducati, Zero Motors, Kawasaki, Husqvama, and McLaren. The

European operation is divided into three segments - global lighting, electronics, and metallic (IMES). With three manufacturing facilities, the global lighting segment is a leading supplier of exterior lighting systems for Two-Wheeler OEMs and Super Luxury PV. The electronics segment, focuses on ADAS, Lighting Electronics (Light Engines & Light Control Units), and Electronics Manufacturing Services (EMS). We also have 2 manufacturing facilities for the metallic (IMES) segment, manufacturing hot steel forged parts for the construction and oil & gas industries.

China Market (JV)

China is responsible for supplying exterior lighting systems for PV and Aftermarket. This is facilitated through two manufacturing facilities in China.

3.1. SWOT Analysis

Strengths – The automotive industry is continuously evolving with innovation and technological advancements, offering exciting opportunities for growth. Varrocs continuous emphasis on R&D puts us in a unique position to capitalise on megatrends and cater to evolving market demand. Additionally, our strong relationship with leading companies such as Bajaj, Honda, Royal Enfield, Yamaha, and Skoda enable us to remain competitive and focus on cost optimisation, free cash flow and debt reduction. Weakness - Varroc faced challenges in generating commensurate ROE from its operations in line with Industry. However, the Company has divested loss making segment to concentrate on its growing and profitable business to position itself for future opportunities.

Opportunities - The auto component market is growing due to premiumization, regulatory changes and next-gen features in the vehicle. The strong team of more than 500+ people in R&D across 7 technical centers are helping us to grab this opportunity.Varroc will focus to strengthen its competitiveness in India and globally by developing world class products and services. Varroc will enhance and leverage its global footprint as its a global company with strong roots in India.

Threat - Varroc faces threats from rising input costs due to supply chain pressures resulting from the Russia-Ukraine war and it could affect the bottom line. Fuel price hikes could also hurt the automobile segment. Additionally, supply side issues can prevails and disrupts global auto supply chains, it might act as a bottleneck for our operations.

Outlook

We are poised to take advantage of growth opportunities driven by megatrends in our business environment, including the increasing adoption of electric vehicles, the focus on safety, and compliance with BS-VI regulations. Specifically, we are well-positioned to capitalise on growth opportunities in our electrical-electronics and polymer business units in India as well as our electronics business in Romania and our global 2W lighting business in Italy, Romania, and Vietnam. In Europe, we aim to partner with global OEMs who are gradually embracing electrification. Additionally, our facilities in Romania are focusing on developing capabilities to provide high-tech and cost-effective solutions in the ADAS space. Finally, our Indian businesses, such as the polymer and metallic business unit, are expected to benefit from the thriving Indian market.

4. Financial Overview

Revenue from Operations

The Companys consolidated revenue from continuing operations increased to H68,631 million in FY2023 up

17.4% from H58,442 million in FY2022. The company witnessed growth in both India as well as overseas operations. Commercialisation of new products which were developed and growth in aftermarket helped the company to outperform the Industry growth.

Raw Material

Raw material cost (cost of material consumed + changes in inventories of work in progress and finished goods) for continuing operations increased by 15.1% to H44,305 million in FY 2023 from H38,494 million as Revenue from operations were higher but raw material cost as percentage reduced in FY 2023 as compare to FY 2022 due to business mix and softening of commodity prices.

Employee Cost

In FY 2023 , the employee benefit expense was H7,173 million as compare to H6,193 million in FY 2022. This is up by 15.8%. Post the divestment of our loss making 4W lighting overseas business in Europe and America, the employee expenses related to overseas continuing operations has increased as we are integrating the process which we have in Indian operations.

Finance Cost

Finance cost has increased by 60.8% as to H1,903 million in FY 2023 as compare to H1,184 million in FY

2022 as most of the debt in FY 2023 was in India where the cost of funding is higher, interest rate has also raising interest rate to curb inflation and more over the absolute average outstanding gross debt in continuing operations were higher in FY 2023 as compare to FY 2022.

Depreciation & Amortisation (D&A)

The increase in depreciation & amortisation was 10.6% in FY 2023 as compare to FY 2022. The absolute depreciation & amortisation was H3,367 million in FY 2023 as compare to H3,045 million in FY 2022. This year D&A were higher because of certain accelerated depreciation in our books.

Other Expenses

The other expense has increased from H11,468 million in FY 2023 to H10,080 million in FY 2022. There has been an increase of 13.8% YoY.

Other expenses does not include foreign exchange loss of H217.54 million for FY 2023 and H82.19 million for FY 2022.

Profit/ (loss) before tax before share of joint venture

The Company reported profit of H775 million before tax and share of joint venture in FY 2023 as against loss of H296 million in previous year.

Profit/ (loss) before tax for continuing operations (PBT)

The PBT was also positive in FY 2023 of H829 million as against loss reported in FY 2022 of H301 million.

Tax Expense

The tax expense in FY 2023 was lower in FY 2023 of H441 million as compare to H482 million reported in FY 2022.

Profit/ (loss) after tax for continuing operations (PAT)

In FY 2023, the Company reported profit after tax of H388 million as business operation across improved as compare to loss reported in FY 2022 of H783 million.

Profit/ (loss) from discontinued operations

Loss from discontinued operations were H8,559 million in FY 2023 as compare to H10,284 million in FY 2022.

The discontinued operations was sold in the month of Oct22.

Profit/ (loss) of the year

The reported loss for the company was H8,171 million in

FY 2023 as compare to loss of H11,067 million in FY 2022 due to losses mainly in discontinued operations.

Net worth

Net worth of the Company in FY 2023 was H10,042 million as compare to H20,140 million in FY 2022. The difference in net worth has ben mainly due to losses incurred in the discontinued operations.

5. Research & Development

Innovation is key to creating a better future, and our company prioritises the importance of Research & Development to diversify its product portfolio. As a leading player in the automotive industry, we have developed in-house research and development (R&D) capabilities in India, China, Italy, Romania, and Poland. Seven (7) technical centers and 90+ patents granted globally, we are constantly discovering new ways to enable mobility.

In order to capture future growth trends, we remain focused on enhancing engineering and software development capabilities to introduce cost-efficient products in major automotive markets. Our core competencies in designing, developing, and manufacturing automotive components for leading OEMs enable us to prioritise the needs of end-users. We are the preferred early development partner for OEMs, providing end-to-end solutions for design, development, testing and validation, manufacturing, and supply chain management.

6. Human Resource

We consider our Human Resource (HR) as the cornerstone of our success and remain committed to fostering a work environment that prioritises the safety and well-being of employees. To ensure employee engagement and create a conducive workplace for employees to thrive and prosper, we recently conducted a Gallup survey to identify areas of improvement.

We place a strong emphasis on encouraging internal movements, allowing employees to explore diverse career opportunities and contributing to the development of a robust talent pipeline. Our culture lies in values such as Collaboration, Passion to Excel, High Standards, and Psychological Safety, fostering an environment where innovation thrives and individuals are empowered to achieve their best.

Our leadership development initiatives prioritize the nurturing of effective people managers and the identification of potential successors, ensuring a steady influx of capable leaders to guide our future endeavors. Organization effectiveness is paramount, aligning goals, optimizing teams, and providing rewarding experiences to foster growth at every level. We offer an unparalleled employee experience, characterized by best-in-class practices that address the holistic well-being of its workforce.

7. Internal Control system and adequacy

Ouroperationsaresupportedbyrobustinternalcontrols and systems that are tailored to match our size, scale, and complexity. The Internal Audit function takes a proactive approach in identifying key concern areas for review, resulting in increased operational efficiency and optimal use of our resources. Our processes are evaluated and assessed for compliance with relevant laws and regulations. The Audit Committee approves audit plans, giving the Internal Audit function flexibility to provide timely support through management audits. Every function and plant receives adequate and appropriate coverage, with close monitoring of audit observations and prompt reporting of status updates to management. The Audit Committee of the

Board is presented with significant audit observations and corrective actions, along with updates on their status of closure.

8. Cautionary statement

The document contains statements about expected future events and financial and operating results of Varroc Engineering Limited and may be construed as forward-looking. By their nature, forward-looking statements require the Company to make assumptions and are subject to inherent risks and uncertainties. There is a significant risk that the assumptions, predictions, and other forward-looking statements will not prove to be accurate. Readers are cautioned not to place undue reliance on forward-looking statements as several factors could cause assumptions, actual future results, and events to differ materially from those expressed in the forward-looking statements. Accordingly, this document is subject to the disclaimer and qualified in its entirety by the assumptions, qualifications and risk factors referred to in the managements discussion and analysis of Varroc Engineering Limiteds Annual Report of FY 2023.