Denel Annual Report and Financial Statements 2010/11

NCOP Public Enterprises and Communication

01 May 2012
Chairperson: Ms M Themba (ANC, Mpumalanga)
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Meeting Summary

The main thrust of discussion following Denel’s presentation revolved around the organisation’s ability to generate sufficient income to guarantee its future sustainability.

The Committee heard that Denel had 13 business entities, with 6 400 employees, which were responsible for the supply of defence products and services, 56% of which were purchased locally and the balance overseas. 

Denel had continued to show progress towards self-sustainability, and had achieved a profit of R111m. However, the organisation’s debt of R1,5bn, in relation to its equity of R650m, meant that recapitalisation was required, and its current bank facilities of R5bn needed to be doubled to support growth.  It was critical to secure local and export orders to ensure its sustainability.

Denel drew attention to its wide-ranging training and skills development programmes, which were focussed on the engineering, science and technical fields.  It had also shown improvement in the area of transformation, which was regarded as a management priority.
Members expressed concern about Denel’s need for continual government funding, as well as the possible loss of skilled personnel while orders were still in the pipeline.  Denel responded by saying its future marketing strategy would focus on emerging markets in the Far East, Middle East and Latin America, where defence spending was on the increase.

Denel provided an update on its legal battle with the Indian government.  Denel had been blacklisted from India on the assumption that some wrong doing had taken place, but so far no formal document had been put forward to Denel laying out very clearly what charges had been levelled. Denel was currently engaging in a formal process and both countries had agreed that the matter needed to be resolved, as it was affecting cooperation at a defence level.

The Committee was also briefed on the status of two Denel employees who had been arrested in Sudan while working on a United Nations contract to clear landmines and other unexploded ammunition and explosives in order to make it safe for civilians and the government to use roads and other infrastructure.

Denel had just submitted a new three-year corporate plan.  It was hoped that by the end of the three year period, Denel would be back in a positive financial situation and would have addressed the revenue streams and all the interventions being made on the marketing and profitability side.

Meeting report

Mr Riaz Saloojee, Group Chief Executive Officer of Denel, introduced an overview of Denel’s performance in relation to the shareholder’s compact, and its turnaround progress.
Denel’s key role was to supply strategic defence capabilities and technology to the South African National Defence Force (SANDF) on a commercially viable basis, to act as a catalyst for advanced manufacturing in the broader economy, and to export products to improve revenue.  Denel’s products and services, offered to the SANDF and the United Nations - and promoted in over 50 countries - were humanitarian de-mining services and products, maintenance repair and overhaul (MRO), technical training, munitions and sub components, mine protected vehicles, missiles, command and control, and land based systems ( artillery, infantry and armour systems). Other services included engineering services
, Aerostructures and unmanned aerial vehicles (UAVs). 
These products and services were manufactured by 13 business entities, 6 400 direct employees and over 30 000 indirect employees through a multiplier effect, with ten offices outside South Africa.  The Denel group consisted of four industrial clusters:
•Defence:  Denel Integrated Systems Solutions, Denel Aviation & DPS, Denel Land Systems, Turbomeca Africa, PMP, Denel Dynamics Missiles and Rheinmetall Denel Munition.
•Security:  Mechem,  Denel Dynamics UAVs and Carl Zeiss Optronics.
•Certification and Training: Denel Technical Academy and OTR.
•Aero-structures:  Denel Aerostructures.

Mr Fikile Mhlontlo, Group Finance Director; Denel, presented the group’s financial highlights, business development status and major programmes.
Denel had achieved its strategic intent in most key performance areas, except for profitability management, reducing debt and gearing, productivity improvement and optimising operating expenditure. (Please refer to the presentation for key performance areas successfully achieved - slide nine).
Denel had continued to show progress towards self-sustainability.  It had achieved a profit of R111m.  The defence, security and certification clusters had generated positive earnings before interest and taxes (EBIT), but losses for Aerostructures had contributed to Denel’s problems. Denel’s actual sales for 2010/11 (including associated companies) had included 56% sales locally, 19% to the Middle East, 13% to Europe, 6% to North America, 3% to Asia Pacific, 2% to Africa and 1% to South America.
Denel’s debt and equity levels had continued to be a source of concern, as debt stood at about R1,5 billion, while equity was at R 650 million.  Denel had consistently achieved clean internal and external audit reports.

There was an urgent need to strengthen the balance sheet to fund growth.   Denel had been recapitalised in the past to enable repayment of debt, legacy issues and investments, but there had been continued losses at Aerostructures (FY11: -R237m; FY10: – R328m; FY09:  -R453m). The debt / equity ratio was of concern, with R1.85bn of debt at March 2011. Debt levels had been high, requiring recapitalisation.   Denel had experienced low funding levels in the short term, and had used overdraft facilities as it was a high working capital investment company, and required on-going funding and support.  There had been pressure on bank facilities related to additional borrowings, and issues of bank guarantees. The current bank facilities of R5bn needed to be increased to R10bn to support growth.  It was critical to secure the following multi-year orders, which formed part of the future revenue plan, as this would significantly reduce revenue risk:
• Local orders with SANDF - Hoefyster (Infantry Fighting Vehicle Programme), GBADS Phase II (Ground Based Air Defence Programme), A-Darter Missile Programme and Small Medium Calibre Orders.
•Export orders - A-Darter programme-linked order and Umbani programme finalisation. The year 2012 showed adequate order coverage, although future years had order gaps.

Mr Mike Ngidi, Group Executive Human Resource Manager: Denel, covered human resource and transformation issues.
Denel’s skills development initiatives included courses and seminars, the Engineering Academy of Learning, employee study assistance, group succession plans and a Leadership and Management Development Programme. Youth development programmes included bursaries, the Denel Youth Foundation Training Programme, South African Women in Engineering, the Schools Outreach Programme, learnerships and artisan training. To address the challenge of skills shortages, Denel had focused its social investment resources and efforts to the development of mathematics and science, rooted firmly on working with learners to either encourage them to take mathematics and science at high school or to provide bursaries to study engineering and science.  
Denel’s flagship programme was its artisan training academy, within the Denel Training Academy (DTA), which enrolled learners for different aviation and general apprenticeships.  Approximately 300 apprentices were enrolled per annum, but with additional funding, the DTA could enrol a greater number. The Denel Youth Foundation Training Programme (DYFTP) was a Matric bridging facility, pro-actively responding to the challenge of a lack of skills, especially in the engineering, science and technical fields. Learners were sourced from all nine provinces and were provided with accommodation.  Some learners had achieved distinctions as a result of the programme.

Other youth development programmes included the schools outreach programme, where learners from grade 8 to 12 were offered tuition at weekends, in some cases by Denel engineers. The programme was currently running in the Gauteng and North-West Provinces, and was currently fully funded by Denel at a direct cost of R1,2m per year.  Denel also partnered with the South African Women in Engineering, spearheaded by a group of young female engineers with a passion for encouraging female learners to enter the field of engineering, science and technology.  Denel funded this programme along with other organizations.
There had also been collaborations with tertiary institutions, and Denel Dynamics was rated number three by the Graduate Recruiters Association (SAGRA). Initiatives had been developed which included visits to universities to improve Denel’s ranking as a group, and participation in engineering career fairs at various universities.  Bursaries were also used as a primary tool for bringing young engineers and scientists into the group to counter the ageing workforce profile.  Bursars were taken into the programme annually and were individually mentored and supported and provided with vacation work and mentors. Over 90% of the bursars who completed their university studies had been employed in the group.

Denel believed in genuine transformation that was sustainable and added value. Transformation committees were chaired by the business entity’s CEO or general manager.  Human resources and transformation received a 20% weighting in the CEO’s or general manager’s performance contract each year.  Denel had improved in all aspects of  Broad-Based Black Economic Empowerment (BBBEE) with an overall improvement score of 76%, compared to 69% in 2010.  This score made Denel a 110% BBBEE contributor and added value to its suppliers.  The group’s target was to maintain a Level Three BBBEE score.

Mr Saloojee described Denel’s “value-add” to South Africa and critical strategic matters, which included national security and peacekeeping through internal security and border control, de-mining and post-conflict support.  Value was also added through a contribution to industrial strategy, the Industrial Policy Action Plan 2 (IPAP2), the National Growth Plan (NGP), the creation of intellectual property and cross-leveraging to other industries, and procurement from local industry through supply chain interventions. Additional value was added through employment and skills development and the group’s contribution to a better environment.
Denel priorities included strengthening its balance sheet, continuation of its turnaround strategy to achieve sustainability of Aerostructures, and smart partnerships between Denel and key state agencies, requiring well coordinated political support for exports.

Mr Saloojee concluded the presentation by stating that Denel was addressing three key elements. One was the external environment, which comprised the external stakeholders and markets, and how Denel would increase the revenue coming from these streams. The second was the internal environment, where Denel was now looking at the financial positioning of the company and what it was doing to empower its employees.  It was implementing programmes and processes to ensure that transformation was meaningful and could be quantified.  Finally, Denel was looking at a strategy that would give effect to the strategic objectives which had been set.  
Denel was confident that given the new objectives and share holders’ compact and the corporate plan submitted to the Department of Public Enterprise, there was a definite growth path which looked at a sustainable Denel in the future.

Discussion
Mr H Groenewald (DA, North West) stated that the financial position of Denel was worrying.  It should not rely on government support but should be self-sustaining and become profitable.

Mr Saloojee replied that profitability was a key issue, and that was what was being addressed.  Denel could not continuously rely on the Treasury, which had to cope with pressures to meet social development needs.  A business model was required that would allow it to provide technology, products and services to the Department of Defence on a medium to long term basis. Profitability and sustainability was a key part of the new repositioning strategy.

Mr Groenewald asked which were the biggest countries supporting Denel and what kind of support they required.

Mr Saloojee replied Denel had realised that South Africa, as a developing country from an industrial perspective within the defence environment, could not see the developed world such as the USA and Europe as key markets.  Denel’s new marketing strategy was fundamentally focussing on emerging markets such as the Far East, Middle East and Latin America, and was not only focussing on supplying products, but also on smart partnerships and joint investment.  In the Middle East, Denel was involved in the United Arab Emirates (UAE) with technology transfers and joint ventures, and was active in countries such as Oman and Saudi-Arabia.  In Latin America, it had just sold a number of aircraft to Ecuador.  Denel was looking to market itself as an integrated unit.

Mr Groenewald stated that Denel was producing 20 engineers a year, and asked what plans were in place to retain the skills.

Mr Saloojee replied that a huge part of the overhead cost structure of Denel was salaries. The revenue stream coming in did not justify sustaining the number of people in the organisation.  Denel was in agreement that people should not be retrenched and was going to make sure it kept as many people as possible.  The only way that it could do this was by investing more money in the organisation.
Mr Ngidi added that retention was critical, and currently Denel was not having alarming levels of staff turn over, as it was running at about 6.4% for the past year.  Training programmes had been run for senior managers and a strategy to create projects where young engineers could be deployed had been put in place.  Denel was also looking at creating a work environment that was conducive for young people. The entity also identified its top performers and paid them accordingly.

Mr Groenewald stated that when the Committee had visited Denel, most of the machines had not been working. What was the current position?

Mr Mhlontlo replied that the Committee had visited Denel Aerostructures, and at the time there was a contract that was being negotiated that was worth about R10 billion. The contract was placed by SANDF and phase one had been completed, but phase two was still in progress. At the time of the visit the machines may have not been operational because the signing of the contract had been delayed.

Mr Groenewald asked where the reported work force of 6 394 had been at the time the Committee had visited Denel, as just a few people had been standing around. 

Mr Mhlontlo replied that the Committee had visited Kempton Park, but there were four other sites where Denel was active. The employees were at all these sites.  The Kempton Park site housed the Denel Aerostructures operation, which largely supported the A4100M programme, and which at the time was delayed, so not a lot was happening.

Mr M Sibande (ANC, Mpumalanga) asked what Denel’s plans were for the R700 million allocated to them by government.

Mr Mhlontlo replied that the R700 million was earmarked specifically for working capital. This was part of the preparation to produce on a large scale with the A4100M programme, which would also allow South Africa as a country to play an active role in the aerospace and defence industry.

Mr Sibande stated that Denel kept on borrowing but no one was buying its products.

Mr Mhlontlo replied that as Denel geared itself for big orders, banks wanted a certain guarantee to be in place in support of those contracts. This did not necessarily mean that Denel was going to borrow more, but rather that certain guarantees were required to be put in place.

Mr M Jacobs (ANC, Free State) stated that in the presentation there was mention that Denel was repositioning itself. The problem with state-owned enterprises was that when new management came in, it came with new plans and changed existing plans. This was a challenge.

Mr Saloojee replied that if the impression had been given that there was a new management team and new brooms were attempting to sweep clean, that had not been the intention of the presentation. From the interventions made in the last twelve months, it was clear that the fundamentals were in place. However, it could not be ignored that there were real problems within the organisation. The problems related to the financial performance of some of the operations and inability to access financial streams that could make the business sustainable. This was what the team at Denel was attempting to address.  The fact was that Denel was a loss-making organisation and government had had to bail it out on a number of occasions. There were many positive things within the organisation which were being built on in terms of the new interventions that were in place, including the human capital, the level of skills and level of technology

Mr Jacobs asked what Denel’s marketing strategy was.

Mr Saloojee replied that the new marking strategy was fundamentally aimed at the Latin American region and Middle East, where defence spending was on the increase.

Mr Jacobs asked what the update was on the legal battle with the Indian government.

Mr Saloojee replied that the issue had been going on since 2006. There were two processes in progress. One was a civil litigation case against Denel and the other was a criminal investigation against Denel.  Denel had briefed the Minister of Public Enterprises on Monday on the matter, as the President of India had been in South Africa on an official visit. There had been numerous attempts to resolve this issue both at the political and official level through bureaucratic channels, but progress had not been made. There was now a concerted effort between Denel and the Department of Public Enterprises (DPE) to address the matter both within the legal framework and also from a bilateral perspective.  Denel was blacklisted from India on the assumption that some wrong doing had taken place, but so far no formal document had been put forward to Denel laying out very clearly what charges had been levelled against Denel.  Denel was currently engaging in a formal process and both countries agreed that the matter needed to be resolved, as it was affecting cooperation at a defence level.

Mr Jacobs said it had been reported that two of Denel’s workers had been arrested in Sudan. What was the position?

Mr Saloojee replied that Denel had a company called Mechem which was involved in the civil security environment in post-conflict resolution.  The company was contracted primarily by the United Nations (UN) to clear landmines and other unexploded ammunition and explosives in order to make it safe for civilians and the government to use roads and other infrastructure.  A huge amount of work had been done in Mozambique, Libya, Iraq, Somalia and Sudan, particularly after the independence of South Sudan.  Mechem had been working with the UN on a UN contract, and had been granted immunity by the UN.  It was protected by the protocols of the UN and Mechem’s vehicles were registered as UN vehicles.  The information received was that the two employees of Dene l- one was a South African and the other a South Sudanese national – had been in a vehicle led by a person from the UN who was in charge of that particular operation, and who had insisted on taking a shorter route which was not protected by the South Sudanese authorities. They had been abducted in what Denel had been told was South Sudanese territory, and flown to Khartoum. As there was a British national and Norwegian national that worked for the UN, the UN, British, Norwegian and South African governments, together with the Ambassador, defence attaché and Department of International Cooperation, were busy with negotiations in order to secure the release of the two individuals. 

Mr Jacobs asked where the Saturday maths and physics classes conducted by Denel to assist learners, were held.

Mr Ngidi replied that there was one conducted in the North West Province, three in Pretoria and there were plans to start one in the Eastern Cape.

The Chairperson asked what criteria were used when sourcing learners form all nine provinces. Could Denel produce the list and criteria used?

Mr Ngidi replied that Denel would get back to the Committee and provide the list and criteria.

Mr Sibande asked about the timeframe for the turn-around strategy.

Mr Saloojee replied that Denel had just submitted a new three-year corporate plan. It was hoped that by the end of the three year period Denel would be back in a positive financial situation and would have addressed the revenue streams and all the interventions being made on the marketing and profitability side.
Mr Sibande asked how many people were employed by Denel outside the country.

Mr Mhlontlo replied that there were not many people placed overseas, but a comprehensive response would be made available in writing to the Committee.

Mr Jacobs asked if the weapons being sold could not end up being a threat to the country. Was there a counter strategy in place?

Mr Saloojee replied that that there were due processes and Secrecy Acts, which mitigated against that situation arising. There had not been any fundamental problems, as the law was very strict.

The meeting was adjourned.

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