Denel 2018/19 Annual Report

Meeting report

The Chairperson opened the meeting and read out the apologies for three absent Members.
 
He indicated that the Minister and Deputy Minister were also unavailable as they were attending the investor conference in Johannesburg.
 
He noted that it was the third time the Committee would interact with Denel.
 
He asked the Chairperson of Denel to introduce the delegation after the Committee had introduced themselves.
 
The Committee members introduced themselves.
 
The delegation from Denel introduced themselves.

The Chairperson said there would be 45 mins for the presentation and another hour for engagement thereafter.
 
Briefing by Denel on 2018/19 Annual Report and Financial Statements
 
Background
 
Mr Danie du Toit, Group CEO, Denel, said the Board of Denel was confident that it had the core technological products, basic systems, skills and capabilities which formed the key base required for effective business turnaround in the international defence industry arena.
 
The key challenges that had been faced since the board’s appointment in April 2018 included investigating the nature, extent and underlying causes of the liquidity constraints faced by Denel which had resulted in: i) unprofitable sales, loss-making and onerous contracts. Denel had taken measures to exit these contracts, in some cases paying back advanced payments to international customers, ii) higher costs with declining revenues, iii) poor cash and inventory management, iv) high dependency on large and complex contracts which had not proceeded as planned, v) a lack of basic fiscal discipline and internal controls. Denel did not have an integrated enterprise resource planning tool, integrated HR tools, or an integrated financial system. This had meant it was difficult to consolidate Denel’s numbers, vi) poor governance, vii) mismanagement, viii) overzealous and expensive acquisitions. All acquisitions made in the last year were being reviewed, and ix) general corruption in line with the State Capture emerging at the Zondo Commission of Enquiry regarding Denel Asia and the VR Laser Group in Denel’s case.
 
Since the new Board’s appointment in May 2018, there had been a focus on improving governance with an executable and viable turnaround strategy formulated by the Board. The plan had been continuing at a steady pace. The findings of investigations were being expedited. A number of senior executives had been suspended subject to investigation and one had been dismissed. A number of the staff were going through disciplinary hearings.
 
Interim measures had been implemented with the appointment of an Interim Group CFO to deal with the governance and integrity of numbers.
 
Since January 2019, a full executive committee consisting of the Group CEO, COO, and Human Resources Officer had been completed.
 
As a result of the recapitalisation received from the shareholder, compilation and execution of a liquidity management strategy, together with one to deal with the liquidity challenges faced had been implemented.
 
Denel was tax compliant in terms of all its operations.
 
Denel at a Glance
 
In economic terms, Denel’s revenue was R3.8 billion compared to R5.8 billion in 2017/18. Its cash was R575 million compared to R1.3 billion in 2017/18. Its borrowings were R3.4 billion compared to R3.3 billion in 2017/18. The net profit/loss was R1749 million compared to R1053 million in 2017/18. Its debt: equity ratio was -2.05:1 compared to 7.39:1 in 2017/18. Research and Development (R&D) was R108 million compared to R769 million in 2017/18. The debt-equity ratio had improved since the recapitalisation of the business.
 
In social terms, Denel had spent R32 million on skills development compared to R52 million in 2017/18. Corporate and social investment had amounted to R593 000 compared to R9.4 billion in 2017/18. Employee numbers amounted to 3968 compared to 4629 in 2017/18. Its black-owned spend amounted to R417 million compared to R614 million in 2017/18.
 
In transformation terms, Denel had retained a Level Six Broad-Based Black Economic Empowerment (B-BBEE) rating. Denel was targeting moving to a level four rating by 2020. Female appointments amounted to 58 percent compared to 44 percent in 2017/18. African, Coloured and Indian (ACI) appointments had remained at 83 percent.
 
Governance
 
Improving corporate governance and oversight was a core pillar of the turnaround plan. A comprehensive governance framework and turnaround plan was being implemented with i) the GCEO, Danie du Toit, being appointed in January 2019, ii) the GCOO, William Hlakoane, and the GHR Executive, Mercia Ngema, both appointed in July 2019, iii) the GCFO, Carmen le Grange was appointed in September 2019, iv) the outsourcing of the internal audit to Ernst and Young (EY) in September 2019, v) a determined effort by the new management team and the Board had been undertaken to address the performance culture and consequence management at Denel following the filling of all Executive Committee positions, and vi) there had been a new delegation of authority to enable effective management and accountability at Denel. Cooperation with the State Capture Inquiry and the Special Investigative Unit (SIU) was being undertaken with i) the addressing of irregular, and fruitless and wasteful expenditure through investigations, as well as criminal and civil litigation in order to recoup and claw back financial losses emanating from corruption at Denel, and ii) the supply chain policy at Denel was being reviewed in order to ensure relevance and a balance between business execution and the PFMA. It would report to the GCFO.
 
Turnaround Plan
 
Progress on the Turnaround Plan included i) an order intake of R7.8 billion in 2019/20 compared to R509 million in 2018/19, ii) a winnable order pipeline of R30 billion within a 24 month window, iii) a solid order backlog of R17.4 billion which would cover roughly four years of sales revenue, iv) the receipt of Denel’s largest export contract of R6.3 billion, v) there being excellent potential in target markets – the Denel brand was well-respected and its products were highly sought after, vi) there being solid support from local customers, shown by continued order intake, vii) Denel having exited onerous contracts of around R250 million annually, with Airbus in particular, viii) Denel having mitigated the parent company guarantee of risk amounting to R1.6 billion, ix) Denel having reduced operating costs by R500 million, x) Denel having reduced Head Office costs by R15 million, xi) Denel having a solid skills base of 620 development engineers and technicians with an average of 15 years of experience, and xii) there being 1740 technicians and operators in Manufacturing and Support Operations. With the reduction of head counts at the head office, there was the question of whether Denel had the capability to expedite the orders for the domestic and international markets. The exodus of people had been stopped and the situation was becoming more positive. With the recapitalisation, Denel was able to restart operations and begin performing and delivering to customers.
 
There was also potential to generate cash from divesting non-core assets of R1.56 billion which had been agreed in February 2019. It was a combination of exiting non-core business as well as loss-making business. The first result of this would be seen in a three-six-month window. There was potential to generate cash from SEP activities amounting to R2 billion. There was a further operating cost reduction potential of R500 million relating to the supply chain. There had been around 40 expressions of interest to enter partnerships with Denel businesses and/or the acquisition of Denel businesses. There was excellent return on investment and cash generation potential on recapitalisation. There was a high probability to unlock the Hoefyster Programme (contingent on political will and support). There was good potential to improve the programme delivery precision under the new GCOO. There was good potential to improve human capital and capability under the new HR executive. There was a plan to improve financial function effectiveness and build a strategic finance function under an experienced GCEO. There was a motivated and capable management team led by a GCEO with a strong military, defence industry and international background.
 
2018/19 Financial Results
 
Ms Carmen le Grange, Group CFO, Denel, said she was eager to help Denel achieve financial sustainability.
 
She reported that there had been a significant drop in revenue by 38 percent to R3.8 billion as a result of low production activity.
 
There had been a GP loss of R614 million as opposed to R438 million from the previous year. This was a result of labour under-recoveries.
 
The net loss situation was R1.75 billion due to high interest expenses, the exit of loss-making divisions and the onerous contracts. There were also costs of divesting.
 
Poor financial performance was mainly due to the liquidity challenges. Denel was grateful to receive the R1.8 billion recapitalisation on 31 August 2019.
 
Solvency issues had seen a deterioration in reserves from R2.3 billion to negative R1.69 billion. The recapitalisation had improved equity, but it was still a long way to re-strengthen.
 
Denel had its lowest cash levels ever.
 
That being said, Denel was grateful to the shareholders for the recapitalisation. It was mindful of the conditions of the recapitalisation needing to be met. These included the disposal of non-core assets, the property portfolio, the provision of monthly progress reports and tax compliance.
 
The root causes for the audit disclaimers regarding revenue was the application of a new accounting standard. If revenue was accounted for incorrectly, it impacted operating costs and the cost of sales number, the inventory number, and the contract liabilities. When receiving an advanced payment guarantee, it could either be recognised correctly as a liability or it could be recognised as revenue. The significant revenue reduction was a result of correctly accounting for revenue.
 
The second problem on property, plant and equipment audit disclaimer was on the basis that assets had been undervalued due to not having applied the new standard IA16 which required the recalculation of assets at the end of a financial year based on the future use. Re-evaluation would probably make the balance sheets slightly stronger.
 
The other issues were consequences of incorrect classification.
 
The root causes for the disclaimer was really around the issue of repeated audit findings. These included property, plant and equipment, corresponding disclosures, vacancies throughout Denel and instability of key management positions, inadequate skills and knowledge of accounting standards, and the lack of accountability in the internal control environment. As a result, the internal audit had been outsourced to EY. There was a lack of consequence management.
 
Given what was emerging at the Zondo Commission, some of which was based on the outcomes of Denel’s internal forensic investigations, the impact of state capture was falling through and would result in increased debt in the next two to three years. It had also had an impact on the supply chain environment. This required improving delegation of authority by overhauling the supply chain.
 
Denel was seeking to move from disclaimer to qualified and then to an unqualified audit opinion over the next two years. Denel was targeting steady improvement in the financial reporting environment. The liquidity plan for the next five years involved looking at monthly cash flows, examining how to restructure balance sheets, as Denel was technically insolvent.
 
There was the need to build a credible finance function and consequence management to improve performance culture. Denel needed finance people with the right qualifications and experience. These people needed the ability to report in at the right levels by being given the capability, the processes that enabled them, and the systems that supported them. Denel was also looking to do closer work with the Auditor General (AG) vis a vis interpretation of financial standards.
 
2018/19 External Audit Opinion and Corrective Action Plan
 
The basis of the disclaimer external audit opinion of 31 March 2019 included issues with i) revenue being measured using the incorrect IFRS application (IAS 11 and IFRS 15) and the translation of prepayments, ii) property, plant and equipment assets’ understatement being valued at zero, inadequate evidence for properties, and impairment of assets, iii) trade and other receivables using the incorrect application of IFRS 9 Financial Instruments, iv) the recording of accruals due to cut off year-end controls for trade and other payables and financial liabilities, v) investment into subsidiaries through fair value acquisition of Turbomeca and the impairment valuation of DVS, vi) non-current assets being held for sale as the sale of Hensoldt had not been adequately disclosed, vii) the service costs and net interest of retirement benefit obligation had not been adequately disclosed, viii) operating expenditure and contingent liabilities had received inappropriate supporting evidence for expenditure, ix) there having been inadequate disclosure for changes in accounting policies, prior periods, related parties, statement of cash flows, financial risk management and related parties, x) there were deferred tax and income tax implications due to the prior year period errors that could not be quantified at the conclusion of the audit, xi) additional irregular, and fruitless and wasteful expenditure had been identified by the AG.
 
The AG had identified the root causes contributing to both years’ disclaimers as being i) repeat audit findings regarding revenue and related accounts, property, plant and equipment, and disclosures, ii) vacancies and instability at key management positions, iii) inadequate skills/knowledge of accounting standards, iv) a lack of accountability and commitment towards improving the internal control environment, v) a lack of consequence management, vi) a lack of sufficient review by senior management, vii) the slow pace of addressing the root causes of the findings that had been raised.
 
In light of what was emerging at the Zondo Commission and based on the outcomes of Denel’s internal forensic investigations, Denel was not only seeing the impact of state capture reflected in poor financial results, but also the impacts on the control and supply chain environments, with management having to focus on re-energising and motivating the workforce.
 
The key outcomes for Denel finance going forward included i) addressing the audit findings of previous years to move Denel from a disclaimer to qualified, and subsequently unqualified audit opinion over the next two-three years, ii) a liquidity plan for the next five years which included monthly cash flows and simultaneously restructuring the balance sheet, iii) building a credible finance function in order to enable consequence management through IFRS training and building skills, capacity and capability, iv) improving the integrity of the numbers by working with the AG to document position papers on the IFRS standards, getting sign-off on interpretation of standards so that implementation was achieved, documenting business processes and controls, and adequately preparing for interim and final audits, v) improving internal controls and the control environment by working with the internal audit.
 
The high-level plan to address the disclaimer included improving the credibility of financial reporting through the re-configuration of SAP and Bridge. This would involve the development of SAP Security Management Policies and Procedures and the configuration of SAP and Bridge system maps in order to meet business needs and improve controls and reporting. It would also involve the setting up of an internal audit function to assist with overseeing and auditing the financial information as well as performing interim audits of information before it was submitted for the year-end audit to the AG. It also required building a strategic finance function effectiveness that added value to the business and its stakeholders in respect of the quality of its people, the operating model and a finance architecture that enabled a fit-for-future organisation. ICT and supply chain would be audited as part of the final audit. The internal audit would assist with General Computer Control Reviews. The ICT Consolidation Project would continue to identify cost-savings and efficiencies. The supply chain policy and processes were under review to ensure a clear understanding of the PFMA in respect of irregular, and fruitless and wasteful expenditure with relevance to Denel as a commercial business competing in global markets. It would be mandatory for all finance teams to keep abreast of technical accounting developments that impacted the preparation of key accounts and accounting records through assessment of IFRS training and the appointment of an IFRS specialist to improve adherence to the standards. Denel would develop documented business processes that were readily available and regularly updated. These would be supported by key internal controls, needed to be adequately designed, and operated effectively. The business transformation process needed to include communication, monitoring, performance, and consequence management. There would be quarterly walkthroughs by each division of accounts through the presentation of key account reconciliations and accounted prepared to date with management in order to test the implementation of standards timeously. The would be a recurring monthly review of key accounts and programme reviews performed by management so as to review, standardise, and supervise work performed by the various finance staff members.
 
Irregular Expenditure
 
The previous year’s irregular expenditure identified in the current year amounted to an additional R1.389 million compared to the previously reported amount of R510 million as a result of investigations on transactions from the 2016 to 2018 financial years.
 
Matters handed over for forensic investigations included: VR Laser Holdings, ENNE 7, the Chad government contract, EML Engineers and Construction, and the Landward Mobility Technologies (LMT) loan.
 
Additional investigations were being conducted by the Special Investigations Unit (SIU).
 
Denel had reviewed all procurement transactions since the 2015/16 financial years. There had been a restatement of the disclosure for irregular, fruitless and wasteful expenditure. The policy and processes had been reviewed and updated to prevent and detect transactions leading to irregular expenditure, including: i) in instance involving OEMs and sole suppliers, prior approval had to be obtained from the Group SC Manager prior to the placement of an order, and ii) the Group SC manager worked closely with National Treasury to ensure compliance regarding Industrialised and Client Prescribed Suppliers.
 
Conclusion
 
Ms le Grange said Denel was focusing on strengthening governance under a capable executive team and strong guiding board. There had been improvement in the control environment and Denel had reduced costs base (with concomitant exit costs when such actions impacted other suppliers who then sued Denel). There had also been the disposal of non-core business. 
 
Closing
 
Ms Monhla Hlahla, Board Chairperson, Denel, said that without guidance of the Committee, Denel would not have arrived at that point. As Denel continued to check whether its financial statements followed correct IFRS standards, there may be additional issues that emerge from the period under investigation 2015-2019. Board was listening to executives working on those details. It was a three to five-year process.
 
The Chairperson said the Committee had received the input from Denel and move to the discussion.
 
Mr Gumede said the questions asked from the last meeting had not been addressed. He did not want to leave the questions unattended – he understood there would be a response.
 
Ms Hlahla said Mr du Toit would deal with the follow up questions.
 
Response to Questions from 4 September 2019 meeting
 
Mr du Toit said the question from the EFF regarding executive remuneration could be answered with the audited remuneration numbers for 2018/19 for amounts paid or accrued to the executives. These amounted to 0.8 percent of total labour costs in 2018/19.
 
Key areas of concern for supply chain were governance weaknesses, weak controls that had enabled state capture-related events to occur, and ineffective and inefficient processes in place for a commercial business to compete in the global market. These stemmed from the appointment of single source suppliers.
 
Improvements for supply chain were investment in capable leadership, capacity building, training and development, ii) implementation of processes that would address proper demand setting, planning for procurement and stock control, and iii) a review of the policy was underway to improve governance, meet the constitutional requirements of accountability, transparency, effectiveness, efficiency, competitiveness, equitability, integrity, uniformity and risk avoidance, and enable the efficient execution of contracts for the local and international markets.
 
Denel had learnt lessons regarding strategic challenges faced by poor governance practices and financial management which included the undermining of the Denel executive committee in decision-making, inappropriate investment decisions and weak supply chain. This had been improved by the appointment a credible and independent board, an experienced executive management and the reinstatement of the executive committee, and the implementation of a governance framework.
 
Lessons had been learnt relating to poor programme execution where there had been poor risk management, a lack of consequence management and low productivity. Improvements had been made by the new GCOO and divisional CEOs focussing on improving performance. This included programme management to identify technical risks, cost overruns, resource allocations and availability, risk management and scheduled performance and programme management controls.
 
Lessons had been learnt about Denel’s limited market access and declining order book with certain markets such as NATO having barriers to entry. Improvements had been made by the re-focusing of the marketing strategy and intelligence resulting in improved order intake and the largest ever export order being secured.
 
Denel’s unsustainable cost base had been improved by the R500 million cost reduction over the past 12 months.
 
Denel’s severely constrained liquidity had seen an improved working capital management, including ring-fencing cash for major contracts.
 
Denel’s high debt would be improved upon receipt of the additional R1 billion recapitalisation to normalise the capital structure. There had been the disposal of non-core assets, the securing of SEPs(?) and the expectation of improving Denel’s solvency position. The increase of funding to R&D was required to maintain core capabilities.
 
The unfocused and fragmented operational structure leading to fragmented overhead costs had been improved by the new operational structure being finalised and implemented, leading to cost reductions and skills optimisation at Denel. Operations structures were being reviewed in line with corporate strategy.
 
Weak supply chain management leading to weak controls, inefficient procurement, irregular and fruitless and wasteful expenditure, and non-adherence to legislation had been improved by the strengthening of supply chain leadership and the updating of policy and processes for improved governance and efficiency.
 
The misaligned stakeholder environment between the DoD, the Department of Public Enterprises, National Treasury and others had been improved through better alignment through regular consultation and communication with stakeholders.
 
Public-Private Growth Initiative (PPGI) project collaboration in private sector partnerships in core business areas that were to be grown included Infantry Systems, Artillery Systems, missiles, Integrated Systems Solutions (ISS), and cyber. Private sector partnerships in core business areas that were to be maintained were Test and Evaluation (OTR) and Large Munitions (RDM).
 
Private sector partnerships to be evaluated / repositioned as SEP/JV. Candidates included Military Aircraft/Engine: MRO, armoured vehicles, unmanned aerial vehicles (UAVs), the Rooivalk MKII, small and medium calibre munitions, infantry weapons, optronics, mechatronics, and maritime maintenance and repair (MRO).
 
Private sector partnerships in non-core business areas to be exited / divested following the PFMA S54 requirements included properties, satellites, foundry, aerostructures manufacturing, gear ratio manufacturing, demining and canine, and Denesecure.
 
Key core / non-core business criteria included the achievement of financial sustainability in the short term, the support by a competitive coherent internal or accessible capability system, having acceptable market access or having secured long-term strategic funding, and the consideration being given to the meeting of sovereign/strategic capability requirements.
 
The partnership value criteria included the rationale for seeking potential investors according to market penetration, technology injection, the raising of capital, the retention of indigenous capability, and job retention and growth.
 
The cost to run non-core business areas was R375 million annualised.
 
The objective of gaining capital through private sector partnerships was qualified by the interested party’s ability to invest in equity at a value based on Denel’s offering of intellectual property rights, products, facilities and existing markets.
 
The objective of accessing markets through private sector partnerships was qualified by access to additional markets and/or the growth of Denel’s existing markets.
 
The objective of gaining expertise/technology through private sector partnerships was qualified by a track record and specific expertise and/or technology together with leadership to support and/or expand Denel’s portfolio.
 
The objective of creating jobs through private sector partnerships was qualified by the protection of existing jobs, as well as growth through application of strategic / core capabilities in Denel and the South African Aerospace and Defence industry in general.
 
The objective of ensuring indigenous capability through private sector partnerships was qualified by the positive impacts, constraints and benefits related to the sustainability and supportability of capabilities, technologies and products that were considered strategic or required sovereign control.
 
Discussion
 
The Chairperson said that had covered Mr Gumede’s point. He opened for questions from the Committee.
 
Mr E Marais (DA) said the presentation had been positive overall. Denel had a full executive committee which was critical to state-owned enterprises (SOEs).
 
He congratulated Denel on securing the major contract. This showed Denel was getting out of the lull of not generating income.
 
The CEO had stated that middle management had been implemented which was a favourable situation. Confidence had been gained from local business, being the defence force of South Africa. Because how could Denel be competitive on the international scale if it was not able to do so at the local level?
 
In terms of supply chain management and the reappointments in executive and middle management, this was one of the problems that had been highlighted in the Eskom enquiry. This urgently needed to be addressed. It needed to be done by everybody in the organisation. This could be seen by what was emerging at the Zondo Commission, where supply chain was the weakest point of any organisation.
 
In terms of business units, how was the sustainability of smaller business units envisaged? How were they adding to broader profitability and value of Denel? In terms of future profitability, was it sustainable?
 
What was happening at the Denel maritime business unit?
 
The guidelines had mentioned the engineering academy. Was Denel satisfied with the prospects of long-run training of youth for relevant positions and requirements at Denel. Were these learnerships going to produce a sustainable workforce aligned with Denel? The needs could be satisfied within South Africa.
 
The financial statements had been submitted two months late. He asked the CFO if it would happen again? Was Denel now structured to be on time?
 
In terms of financing, he had learnt a lot from the Zondo Commission. Denel would continue to struggle for another two to three years of recovery. There had been positive signs with the securing of the large contract and the turnaround strategy. He was positive that the turnaround could work, though not as positive after the 11 turnarounds at SAA.
 
Ms J Mkhwanazi (ANC) congratulated the board and the executive on the work done during oversight period.
 
In terms of being a positive money-making company and the total loss in 2015-17, what had the new board identified as the main causes of that drop? What did the new board have in place to ensure the same mistakes were not repeated and Denel was moving back towards positive money making?
 
She appreciated the filling of vacancies at Denel.
 
On page 10 of the presentation and the reduction of jobs, she commented that Denel needed to not lose focus on the main mandate of SOEs which was economic development, growth and job creation. Denel was losing jobs. What was the plan to tie this with the turnaround strategy and reducing costs? In 2017/2018 46 jobs had been created; in 2018/2019 it was 39 and currently it stood at 36. Was there a plan to improve on that job creation?
 
What was the progress to date on the potential to generate cash from non-core assets? What was the progress on the Denel model from 2017, was it being closed down? What would be the effects of this on job losses?
 
On financial results, she was excited to see female representation.
 
In terms of financial results, page 13 of the report mentioned operations on standstill because Denel could not pay specialised suppliers. What was happening in this regard?
 
In terms of skills and the national skills fund, could there be an update on engineering academy of learning.
 
Regarding the R1.8 billion recapitalisation, Denel had requested R2.8 billion. What was the plan to cover the shortfall?
 
Was the board comfortable in saying it was in agreement with the Minister of Finance who had said during the budget delivery that the recapitalisation would be loans? Looking at Denel in three-four years; would it be able to repay the recapitalisation if it became a loan? Were the board positive about the future of the company to deliver its mandate in a profitable manner?
 
There was an issue of numbers. In the annual report, the numbers were not tying in with the shareholders compact.
 
Mr S Gumede (ANC) congratulated the team for the presentation. He had kept on deleting questions he had wanted to ask in his head as the presentation continued as it had addressed most of his concerns.
 
The stories the Committee was hearing were stories that had been heard when joining Parliament already. Much of the presentation had been heard before in various contexts, the question was how to convert it into a programme of action. Because the Committee had not been presented with the time frame, it would be left open ended, therefore retaining shortcomings in addressing the issues that were mentioned. There needed to be audit trajectory aims and the criticality of a revised policy on supply chain needed to be included. “Very soon” did not have a time frame, the Committee needed specific dates and deadlines. 

On the issue of the degradation of authority, the VR Laser decision should have necessitated instant dismissal of those responsible. By instituting investigations into the matter, Denel was undertaking internal workings of things the Committee was not informed about. It was easier said than done. 

Presentations required practicality in the form of concrete turnaround programmes with specific deadlines.
 
In terms of contracts in the pipeline; the Committee needed to be convinced that concrete evidence/proof was being implemented. This required converting the presentation into programmes.
 
What was the take on when the Minister had announced that the Minister of Finance would be giving loans? What were the implications for the accumulation of debts at Denel as more loans accumulated? It was an accounting purpose in fact. Denel had been at “5.8” and was now at “3.8”. The mission was to improve the situation. The mission was to improve the situation but why was it going worse? What corrective measures were being taken?
 
In terms of offering of employee severance packages and their non-acceptance, there appeared to be encouragement of people not to exit at the same time. What were the demographics of those who exited?
 
Regarding the 23 performance indicators and achievement of seven of these -  reasons cited for these had been liquidity constraints. Had liquidity constraints been corrected for the current financial year or were they heading for a similar scenario of not meeting key performance indicators (KPIs)?
 
Denel was 60 % international business. When was this being turned around to be more local than international? When things were dry, you always went home.
 
Ms D Dlamini (ANC) said at the next meeting the information of what had been achieved would need to be presented to Committee. The Committee needed to be shown achievements not just presentations by the board of Denel.
 
Could it be explained to the Committee what the impacts of the R1.8 billion recapitalisation meant for the balance sheet and business operations at Denel?
 
What were the key fundamentals of the Denel corporate turnaround plan?
 
Regarding the budget for the financial year, would Denel manage until the next budget? If not, what was the plan?
 
Ms C Phiri (ANC) welcomed the report and applauded the board and management in allowing the Committee and Denel to be “seeing the light”. It brought hope. There was a good track record in the year of work that had been done.
 
Slide 17 of the report had presented root causes for the disclaimer as being inadequate skills and knowledge of accounting standards. There was already a problem with retrenchment of employees; would this not be reappearing? How would it be dealt with?
 
At the Committee’s oversight visit, there were no young people. Transferring of skills was the root cause of the disclaimer audit. What would have happened if the “old man” who had demonstrated at the shooting range died? Was Denel in position to employ additional staff?
 
What hindrances were there in terms of policy hindrances for Denel? The Committee and the board were in it together. What partnerships were there that were hindered by policy issues and restrictions? What were they and how could the Committee assist to recommend to parliament?
 
At the oversight visit, the Committee  had seen sensitive and specific products where the market was not in South Africa. In terms of internal buyers, what obstacles were emerging where Parliament could help in changing the relationships. Were the South African Police Service (SAPS) and the South African National Defence Force (SANDF) using same products?
 
With the movement of Denel to be ready without bailouts and movements to loan forms of recapitalisation; how would Denel sustain operations?
 
In terms of investor securement of R6 billion, how successful could Denel be securing investor attraction / attachment? South Africans were watching Denel and wanted it to bring back pride.
 
Could the Committee be briefed about Denel Asia which had seen delays?
 
The Chairperson appreciated the comprehensive information briefing. It was still positive compared to the first meeting with Denel. He had been ignorant about Denel’s work. The oversight visit had seen exposure to the importance of the entity and the need to improve it to be profitable.
 
He asked about the validity of WhatsApp information trending on social media regarding the composition of Denel. The new board of Denel was not necessarily contaminated with the previous shenanigans.

He was also mindful off the appointment of a new executive which was appreciated. He sought clarity on whether the new executive was representative of the country. He knew that the people who had written the WhatsApp were associated with the ‘fightback’ campaign and state capture, but it should not be ignored despite them exploiting situations to deflect from themselves.
 
In terms of capitalisation conditions, he had no problems with the loan issue. Was Denel capable to absorb the nature of such conditions? The nature of conditions entailed the doing away with other operations. To what extent would the conditions affect the Denel workers and community?
 
He had received a complaint from the Speaker’s Office about Mr Selvin. He had forwarded it to Denel in September. Could the Committee receive feedback about it? Parliament was pressured to respond. The Committee was not the Commission for Conciliation, Mediation and Arbitration (CCMA) but did not ignore complaints. What was really happening there?
 
The oversight visits to Denel had spoken to the vetting of financial results from the eight percent decline in revenue. People were not doing work at Denel; plants were not operational. Some were state capture related. It was based on the fact that the SANDF was no longer procuring Denel bullets. He directed a question to the retired generals on the board; what was reason for this? The SANDF needed bullets for training exercises.
 
In terms of diversification, there were skills at Denel that he never knew existed in South Africa. South Africa was not a fighting nation; it had had a negotiated settlement. Even uMkhonto weSizwe (MK) soldiers had not been about directly attacking the South African army; they were a peace-loving people. Denel could not only be focused on killing/destruction material; diversification was needed. The country needed cars produced by South Africans for example with these skills to improve the quality of life for South Africans. They were guilty as charged in helping the nation out of this quagmire. Denel and Transnet were holding back the transformation of the country, whether this was because they had reduced the country to being captured by business.
 
Ms Hlahla addressed the broader issues. On the movement from notional R8 billion revenue reducing to “R3.5”. The board had been comforted that the AG being present had meant they had to go back and review every assumption made to get to the R8 billion. They were attempting to get to the correct base of what Denel made. The AG had made every contract be re-examined about what revenue could be realised. Reading the huge numbers was unfortunately from the year one, the AG and the new finance team were reviewing all assumptions that had been made in contracts. The IFRS rules and new accounting principles should have already been followed. It was a historical issue of not accounting properly on revenue and would move to a correct base and new revenues would be accounted for correctly. A new executive, internal audit team and the AG had been brought in to account for everything correctly. It was like saying you made R8 billion but then looking in the bank and it was not there. They had had to go back and figure out where it had gone. The AG and the board were trying to clean up the correct base. This would be reinforced by the new sales that would be made in the next year. When they had more time with the Committee they would continue to update.
 
She was unaware of the complaint referred to by the Chairperson; management would have to deal with it.
 
On diversification, it was definitely necessary. The board at Denel and most non executives were comprised of people who had raised their hands to assist government to turn around the institutions they believed in. She was honoured with the time the board was putting into ideas. Denel’s top-class ambulances had the potential to serve civilians. It would help to be given to Parliament to pressure other Committees for collaboration. In terms of other vehicles, Denel had the capacity to support the state, including the private sector in various areas. Important to the partnerships and strategic equity partners were largely about keeping intellectual property within South Africa and retaining jobs.
 
On the social media matter, Denel had tried to get people to look at its website and see who their executives were. They were proud of the top leadership. The CFO was a coloured female, the executive of human resources was an African woman, the COO was an African male. The CEO was the only white male in the group. The information that had been published on social media was focused on targeting Indian sections of Denel’s executive. There were other fantastic members in the Denel executive committee that had not been shown in the social media campaign as they did not fit the target. She added that she would have liked to send the full executive structure and their demographics to the Committee for clarity through a comprehensive set of information.

The policy natured questions on what would be done now that the formidable and brilliant Minister of Finance had said loans would be the way going forward - there would be workshops with the Departments of Public Enterprises and Defence to deal with the future operating conditions to form a thought-through response to it as a Denel team.
 
Ms le Grange said the reduction of revenue by 38 percent was due to the R3.8 billion decline from the R8 billion in  2014/2015 which was explained by long term contracts with advance payment guarantees. There had been no achievement of milestones yet. Instead of the payment guarantee being shown as a contract liability as should be the case as it was a credit instrument, it should not have gone to a credit of revenue. These were the things that had happened, and the AG had done 100 percent sampling of every contract in order to account for it. This meant a significant reclassification of revenue due to the credit issues and advance payment guarantee interpretations. This was ongoing. When the revenue became normalised, it was expected to reach around R7 billion. They hoped this could increase as Denel divested some of the businesses and looked into diversification. For the next three years it was expected to slowly improve on the R3.8 billion. There would need to be examination of the corporate plan to see in more detail how it was planned to increase this number.
 

At a high level, Denel did not plan to fail the audit. There was a fixed plan for financing going forward and ensuring Denel was on the same page regarding interpretation of issues of accounting through negotiating with the auditor. Accounting had become complicated in recent years.
 
There had been introduction of an interim audit into the audit fixed plan so the AG would not have to do 100 percent of the sample sizing. The audit committee chairperson had agreed with the plan. Denel was working hard towards getting good results in terms of at least getting things in on time and getting audited properly.
 
There were 189 positions in finance across Denel. There were 29 vacancies that were in the process of being filled to be able to achieve the management fixed plan for audit and providing the company with the credible financial information by filing these positions with the best people.
 
There was a supply chain discussion with National Treasury ongoing in the third week of November 2019. Proposals had been submitted regarding single source suppliers, industrialised suppliers and compliance with the Public Finance Management Act (PFMA) to aid in a globally competitive market.
 
In terms of liquidity plans and challenges, there was a short-term plan that would get Denel to June 2020. In terms of alternative funding mechanisms being looked into, the company was working with banks for support, financing big projects, bringing in trade finance, as well as getting long term projects and breaking up projects to finance outside of the traditional banking system. This also involved giving banks an understanding of how Denel financed itself and sold its products. There were issues around the National Conventional Arms Control Committee (NCACC), but Denel was providing the banks with information about how it sold its products into the markets and where Denel’s mandates came from. For most projects Denel presented a defence solution.
 
Mr du Toit gave additional responses and indicated that written responses will also be provided.
 
In terms of supply chain policy, Denel was in full agreement that it was a key focus area for them that needed to be improved upon. Assuming Denel achieved R4 billion revenue, supply of material could amount to R2 billion of the cost base. This meant there was no question that this was an opportunity to optimise to make Denel more profitable.
 
Similarly, there was opportunity for mismanagement and corruption as well. Active steps were being taken to improve it so that no single individual could approve and pay a supplier. There had been discussions with National Treasury surrounding the content of applicable regulations to Denel. Denel was looking at pre-qualified panels of specialists for different domains, for example in legal. This would improve speed of execution.
 
As a result, there had been a draft of the supply chain policy reviewed in the executive committee. Crucial to completion of this was input from National Treasury.
 
Regarding the request of an action plan and a programme of activities, Denel had this internally. It had a register of all its strategic initiatives. This was actively monitored and reviewed at executive committee meetings and board meetings. It had been included in Denel’s monthly and quarterly reports to the Department of Public Enterprises. If the Committee was interested in that level of detail, all those actions were well defined. For example, the delegation of authority had been approved by the internal subcommittee on the board and would go to the board meeting on 25 November 2019 for approval. There were detailed plans of action and Denel knew all the dependencies.
 
In terms of the sustainability of operations in business. The main parts of the business included: primary product (PMP) (small calibre ammunition) which had become commoditised. This meant Denel faced profitability pressure as it was a high-volume business and there were many players in the market. Prices had been affected and profitability was under pressure. This was the area of the business with the most staff, around 800 people. The factory was old, as the Committee had seen. Denel had made attempts to manage the full value chain, by doing the full cycle from making the basic cups, cartridges etc. Denel planned to make attempts to take smaller parts of the value chain that it did well and do so in an economically viable manner. One of the consequences of this would be to modernise the factories. It would be difficult to break even in the current form in the next few years. something drastic was needed.
 
In terms of declining local demand, there had been significant decline in both the Department of Defence and SAPS spending, as well as the security cluster in general. Denel had been blamed in the media by SAPS for not delivering ammunition, but they did not have the orders; stock had been produced. He had met with the Commissioner of Police and Denel was trying to expedite orders for nine millimetre and 556-millimetre ammunition. This was an attempt to improve demand and compete where opportunities were. There remained a sustainability challenge in the current form. Reformation and improvement were needed.
 
Denel Dynamics was the next business operation. It was the missile business and Denel was very proud of it. Only five to seven countries could produce missiles; there was the opportunity to invest. There was a significant order backlog. There were significant opportunities and capabilities to deliver the products. There was little concern about sustainability for Dynamics. They intended to focus on this business. In terms of the diversification objective, there were opportunities for production of UAVs. They had also been approached by other SOEs to provide asset monitoring and protection services. There was significant potential to diversify into adjacent businesses.
 
The next core business was Aeronautics. This was what remained after the aerostructure exit. This was intended to go through by April 2020. Denel still intended to go on to do prototyping of parts and infrastructure. In keeping some of this capability, the aeronautics part would be related to maintenance repair operations (MRO). As Denel was the original equipment manufacturer for the main South African operators, it could take responsibility for servicing and midlife upgrades after certain numbers of flight hours. This was a business of around R1 billion a year. When South Africa implemented maritime patrol aircraft programmes, Denel could address the new platforms.
 
Denel also did a lot of African work such as in Kenya.
 
Another opportunity was to do that type of work for South African Airways (SAA) and SA Express. The aircraft fleet in South Africa was attractive. The MRO space in South Africa could be valued at around R5 billion.
 
The next core business was land vehicles, armoured cars and artillery. It was internationally recognised. Denel had a number of international export contracts. This business could be sustainable. Denel was consolidating the operations of vehicles systems and land systems to ensure they were optimised and regroup the operations to be more sustainable.
 
The final one was the Overberg test range at Arniston. It was a smaller operation. It amounted to around R80 million of turnover. While small, it was something to be proud of. Many international customers used it to test / qualify their missiles as the tracking equipment was very sophisticated to track the profile, height and movement of missiles. It was a sustainable business. There were challenges in PMP and land services but in the other main parts Denel was confident that if it focussed on doing the right things and invested, the sectors could be sustainable in the long term.
 
In terms of diversification, Denel needed to look at new revenue streams. Most of the successful defence companies in the world had undergone a migration from hardware to homeland security based on software. There would be a workshop later in November on the 4th Industrial Revolution and what it meant for Denel, particularly relating to cybersecurity. This could relate to the police and drone detection and destruction.
 
In terms of current capabilities, Denel’s canine units could be used for border protection and scanning vehicles.
 
Denel wanted to work with other state-owned entities. Denel produced critical chemicals for Sasol and the mining business within PMP. These were explosives for mining applications.
 
There was a concept design and elements of a prototype for an African light aircraft. It was aimed as a 20-seater passenger vehicle but had various configurations such as a cargo craft. Denel was thinking about the future and diversification.
 
Denel Maritime was actively being looked into, but Denel was cautious. It needed to look at the potential/business case for expansion. There was opportunity/space for dry docks capability. This was similar to the air business for maintenance repair operations. In terms of viability, they had to be sure they had the capability in Denel.
 
The Denel training academy at Kempton Park was part of aerospace operations. It had a long and successful track record, in terms of international and local students, primarily as qualified aerospace technicians. There were numerous courses. The leadership was actively discussing diversification of the facility to have broader subjects. It was currently not a profitable facility. It cost around R40 million with a loss of R16 million. There was opportunity to not make the facility only applicable to the aerospace environment.
 
Denel had received the Mr Selvin complaint some weeks ago. An independent investigator had been used to investigate the matter. He had received the report two weeks before and had provided feedback to the Department of Public Enterprises. Unfortunately, there was a history with the individual, who had been employed at four companies where he had disputes with management and negotiated exit packages. Denel had reviewed and found that Denel and associate companies were not guilty of wrongdoing. The Committee could receive report through the Department of Public Enterprises.
 
Ms Hlahla added the governance process was to engage, receive, and provide feedback.
 
On the question of losing license permits and how to ensure that permits were not lost she handed back to Mr du Toit.
 
Mr du Toit said that Denel needed local and international certification to service aircraft. There was the Civil Aviation Authority (CAA) certification in South Africa and the IHASA (Europe) certificate which had been lost. Denel was working with IHASA to get it reinstated. Denel was confident of re-certification. It was high on the agenda.
 
Mr du Toit explained that voluntary severance was not accepted as it was the management prerogative to approve them or not. Denel had wanted some people to apply to reduce costs but some people with critical expertise had applied for VSPs which was not feasible.
 
Mr du Toit addressed the question about “old persons” and said it reflected skills transfer issues. Around 11 percent of the workforce was due to leave within five to seven years. However, this provided opportunities to fill the gaps when they left. Denel had good technical young talent in their 30s. Denel was planning for skills transfers. Denel had to be the employer of choice and grow the business.
 
Ms Hlahla said that in South Africa, many young people were entering jobs and the few experienced people were leaving jobs. There needed to be ways of retraining.
 
On demand generally for the defence industry, she transferred this to her colleague. On the question of VR Laser – she left this to the chairperson of the audit committee. She felt after that they would have broadly answered all the questions of the Committee but that there still needed to be a follow up with a written response and another workshop with Denel for specificity. 
 
Retired General Themba Matanzima, Board Member, Denel, said he was delighted to be member of the board, which was a combined experience.
 
He said Denel was aware that the defence budget was declining, therefore buying capacity was also decreasing. Denel wanted to support the internal agencies. But it was not surprising that Denel was taking external orders. Regarding the orders from outside, there was engagement with internal stakeholders. Denel understood the situation. It was possible for the committee to speak to colleagues in defence and Treasury to address the concerns.
 
He was delighted to get the chairperson’s commitment for commitment to speak to colleagues in Defence and National Treasury to address concerns voiced by Denel. It was not always possible to be very open when media was present due to the privacy of Denel’s clients being jeopardised. This would enable Denel’s competitors. He wanted Denel and the Committee to go together and win together like the Springboks. The new team was committed to making it work. He was happy with the Chairperson’s commitments to engage.
 
Denel could not be just producing weapons; it needed to be helping people. Like the defence force, they needed to be helping South Africans. Denel operated within the parameters of the country and the laws and regulatory frameworks. They needed Denel for the future despite the lack of war. This was when defence capabilities needed to be pre-emptively built. If Denel was properly supported, it would help the nation. They were ready to deliver.
 
Mr Talib Sadik, Chairperson: Audit Committee, Denel, referred to the Denel Asia question, and stated that the Hong Kong courts had granted provisional liquidation. As the company did not trade, it was not expected to be a problem and the 2020 conclusion was in sight. The creation of Denel Asia had affected revenue and confused international markets. There had also been a drop-in revenue due to poor programme management. This was seen in the sale of Casspirs to the government of Chad. Investigations on the contract were being completed. Denel intended on lodging civil actions by end of 2019.
 
On VR Laser, Denel was concluding transactions based on unlawful agreements from 2014/15. They had signed statements with SAPS and had the Special Investigative Unit (SIU) and State Capture Enquiry engagement.
 
On job creation, Ms Hlahla replied that the reality is that revenue was way lower than costs based on past operations. The situation was unsustainable. The collective wisdom would look at how to address this.
 
The Department of Public Enterprises said the report on Mr Selvin was prepared and would be communicated.

On the social media controversy, the Department stated that the information had been presented selectively. The Department had collected information about the executive management teams. 69 percent were African, 15 percent coloured, 16 percent white, and 38 percent were female. The Department had compiled a full report on the demographics.
 
The Chairperson said the WhatsApp issue had ignored the overall executive makeup of every entity. The intention was to reverse gains and to focus on issues that were not really issues.

 
Minutes
 
The Committee considered and approved outstanding minutes dated 30 October 2019 with no amendments.

Closing remarks
 
The meeting was adjourned.