Denel still bleeding, but auditors say it's a going concern

The reputational damage state arms manufacturer Denel suffered following revelations of state capture had a "draining impact" on its financial position, says CEO Danie du Toit.

According to Denel's annual report, tabled by Public Enterprises minister Pravin Gordhan in Parliament last week, the company's losses grew by two-thirds to R1.7bn for the 2018/19 financial year ended March 31.

This was mainly attributed to a decline in revenue, which was down 36% to R3.76bn, as the company faced a "slowdown" in operational activity, Du Toit said in his address on the annual report.

How bad are things at Denel? Let's just say the R1.8bn from government it received in August is the state arms manufacturer's saving grace. By the 2018/19 financial year-end, Denel had been insolvent by R1.7bn, mainly driven by its losses.

The company had to rely on financial institutions to provide bridging finance to pay salaries during its liquidity crunch, Du Toit said.

Denel's balance sheet is overindebted to the value of R3.4bn. Government has agreed to extend guarantee to the company to five years and introduced an additional R1bn in guarantees in April 2019, Du Toit said.

Bailout a 'vote of confidence'

The R1.8bn it received from government was needed to "restabilise" the business and improve its solvency position, said Du Toit. It also shows government's vote of confidence in the company, he added.

The capital injection, along with other "mitigating steps" taken, is why the Auditor General of South Africa now believes the company will continue as a going concern for the foreseeable future. 

The AG did, however, give Denel a disclaimed opinion – which means no opinion could be given on the annual reports as the AG was not given enough audit evidence to provide a basis for assessment.

The AG also indicated that the company did not have adequate internal controls to account for expenditure. As a result, the amounts for irregular expenditure (R2.1bn) and fruitless and wasteful expenditure (R136m) are understated.

Denel, in its annual report, says that the AG's concerns were subsequently addressed.

Du Toit added that figures for the previous two years – 2018 and 2017 – had been restated due to errors.

Financial restructuring

Denel has taken a few steps to free up cash and improve its financial position. The company intends to generate cash by selling off non-core assets to the value of R1.56bn. A further R2bn is expected to be generated through strategic partnership activities, said Du Toit.

The company also exited "onerous" contracts to the value of R250m, as part of a financial restricting process. It reduced operating costs by R500m and reduced head office costs by R15m. Improving supply chain processes, could see a further reduction in operating costs in the next financial year, Du Toit added.

The arms manufacturer has secured an order of R18bn, which will cover four years of sales revenue, Du Toit said.

It is also pursuing several orders to the value of R30bn over the next 24 months. If these contracts are realised it would help support the company’s new corporate plan, he said.

Turning the ship around

In terms of governance, Du Toit emphasised that the new board and management is working to turn around the organisation so that it can once again be well respected in the global defence and technology industries.

"There can, however, be little doubt that the reputation of the company was badly affected by the revelations regarding state capture and the evidence regarding corruption, mismanagement and poor corporate governance that have emerged in recent months," Du Toit said.

Denel has committed to supporting official investigations – including the Zondo commission of inquiry into state capture – and to take action against transgressors and recover misappropriated state funds.

"We have initiated several forensic investigations into alleged fraud and misappropriation of funds that occurred under the watch of the previous board and management," he said.

Several reports concerning improper transactions, irregular appointments and potential fraud have been submitted to independent legal firms to review the evidence and advise Denel on implementing recommendations, he added.

President Cyril Ramaphosa has also signed off a proclamation for the Special Investigating Unit to conduct probes into alleged maladministration and unlawful expenditure, Du Toit said.

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