DENEL on financial & legal challenges relating to outstanding employee salaries, with Deputy Minister

Meeting report

The Chairperson opened the virtual meeting, welcoming all the Members.

Deputy Minister’s Opening Remarks
Mr Phumulo Masualle, Deputy Minister of Public Enterprises, introduced the Department and Denel pfficials and thanked the Select Committee in advance for its engagements. He handed over to the Department to deliver the presentation.

Briefing by Denel
Mr Talib Sadik, Interim Group Chief Executive, Denel, reported that Denel is structurally and operationally inefficient, requiring reforms to address revenue generation, programme management, cash management and cost reduction. There is a high probability of the entity not meeting its contractual performance obligations and a delayed contractual performance due to poor working capital. Despite the turnaround strategies, Denel remains rooted in a liquidity crisis with an order book that is significantly exposed to risk.

Local defence budget continues to the shrinkage; this impacts Denel and the rest of the Southern African Development Institute (SADI). The Denel Balance Sheet reflects short-term debt of R3.2 billion in less than 12 months and negative equity of R2.3 billion.

Denel has been impacted severely by COVID-19, including its operations. Due to significant decline in productivity, Denel was unable to pay full salaries including third party statutory obligations. Employees were paid a cash portion of their salaries on sliding scale, with the lowest earning employee receiving the highest percentage compared to the highest earning employees.

On 04 August 2020, the Labour Court ruled in favour UASA and Solidarity (Applicant Unions) ordering Denel to pay members of the Applicant Unions outstanding cash portion of their salaries and payment of all deductions made in their salaries for third-party payments. Denel was ordered to make payments within seven days. Denel failed to honour the Labour Court order and the Applicant Unions launched an ex-parte application for Denel and its Board of Directors to be held in contempt of court. The Labour Court gave Denel a return date of 03 December to show cause why it and its Board of Directors should not be held in contempt of court for the failure to comply with the court order of 04 August 2020.

In December 2020, medical aid arrear contributions for April to September 2020 were settled with the medical aid service providers. The final settlement payment will be made to Discovery by March 2021. Employee risk benefits were maintained throughout the period and continue to remain in place.

Discussion
Ms L Bebee (ANC, KZN) asked how many Denel skills personnel or critical staff members have left the company. How has this affected Denel’s productive capacity? Has Denel identified any of its properties as non-core assets and earmarked them for disposal? Has it sought new equity partners?

Mr A Arnolds (EFF, Western Cape) asked Denel how it plans to restore its reputation, as the financial and legal challenges have affected its reputation. How will it improve employee moral considering that employees are not being paid in full? What is the turnaround strategy to retain core skills and capabilities? What are the outcomes of on-going and concluded disciplinary hearings? He requested Denel to explain its plan to get out of debt.

Mr M Nhanha (DA, Eastern Cape) stated that Denel was one of the best performing state-owned enterprises; thus the situation it is in is shameful. The Committee and Department need to get to the bottom of how Denel found itself in this situation. According to the presentation, there has been slow progress in disposing of loss-making entities or divisions within the company. Which entities or divisions does this refer to? Why is the progress slow? The turnaround strategies mentioned needed key performance indicators (KPIs) that will indicate whether Denel is on the right track. How often does the Department refer to the new turnaround strategy? How many of the KPIs have been achieved? Does the Department think the turnaround strategy will be successful? New turnaround strategies are usually the result of new boards but not necessarily because the Department anticipates that it will succeed.

Do senior executives at Denel take a salary knock and do they receive their bonuses? Do members of the board receive board fees when the board sits? Denel’s Hoefyster Project is the land systems biggest project; the presentation suggestions that there are prospects of poor performance of this project. What are the reasons for such prospects? What is the plan to mitigate poor performance? Denel’s board has reportedly said to the Portfolio Committee on Public Enterprises that the Hoefyster Project has posed financial difficulties for Denel. How can this be so if the client paid Denel upfront?

Ms W Ngwenya (ANC, Gauteng) asked what the current status of the turnaround strategy was. What has worked and what has failed in the implementation of this strategy? What divisions of Denel have managed to restart since COVID-19? Which divisions have not been able to restart? Is Denel’s legal representation outsourced? Can Denel compensate its legal team? Has there been feedback from National Treasury on its support to Denel?

Ms T Modise (ANC, North West) asked if Denel has systems in place that will help them get out of the challenges faced. What is the status of Denel’s case regarding law enforcement? Has the Department vetted the Board Members that were appointed in 2019?

The Chairperson asked if the turnaround strategy is appealing to Denel’s customers. Has the strategy been aligned to the skills acquired by Denel or are skills restructuring needed? What salary sacrifices have senior officials and directors made, as workers should not bare all the brunt? If high-tech skills are being lost, as presented, is Denel’s intellectual property still safe? What level of support does Denel receive from other Departments within the Security Cluster?

Responses
Ms Monhla Hlahla, Chairperson of Denel Board, stated that from 2014 to the present, the issues Denel faced were dealt with slowly and thus compounded, leading to the situation it is in now. Some of the causes of the liquidity compounding were that Denel has been dependent on the Department of Defence as its primary client for many years. The Department of Defence has had a declining budget; over time Denel should have noted that the demand for work by the Department of Defence was dwindling. It tried to respond to this by becoming more export lead. However, there could have been shortcomings in dealing with this.

Since 2012, the Hoefyster Project was delayed due to redesigns, restructuring and other reasons; this meant that Denel had to catch up on the costs and funding that was taken upfront. This becomes a burden unless the funding was ring-fenced and managed appropriately. Denel bought BAE Land Systems, which is now DVS, which was purchased for R855 million. DVS became a cost larger than what Denel could afford. Thus, due to the decline in the Department of Defence’s budgets, Hoefyster Project and the acquisition of DVS started to drag. Denel also took resources from core businesses to fund its liabilities. This happened for a number of years and has caught up with Denel.

The fear that the market has about Denel is the potential for Denel to use funding from client’s projects to support Denel’s corporate challenges. The Board has removed all the loopholes that had previously allowed Denel to do this. Divisions taking charge of projects, project income, growth and ability to support its salaries have been empowering for the divisions. Most divisions have been able to meet the gap in salaries that was created by COVID-19.

The Department of Public Enterprises and the Department of Defence both have suggestions for where Denel can acquire strategic equity partners. The Department of Defence has warned Denel about what it may consider as core and non-core business. A core principle needs to be developed to deal with strategic equity partners. This has created a delay within Denel’s programmes. However, it has created an engagement between both departments that will result in an aligned view.

The highest knocks in salaries have been at the most senior levels. The board is receiving a limited flat rate and the normal rate of board fees is no longer available for Denel. This has been a case for months. This is unfortunate but is a part of trying to turnaround Denel’s situation.

Mr Sadik stated that from 01 April 2020 to present, the staff turnover has been about 16%. In the Dynamics, Missiles and Unmanned Aerial Vehicle (UAV) businesses, the staff turnover was around 34%, which is above the norm as about 5-10% is more reasonable. This has had an impact on Denel’s operations. The year-to-date revenue is a lot lower and the ability to rehire is constrained. Denel is not an attractive employer as it has been unable to pay salaries.

The turnaround strategies that the Board had implemented in 2019 had ten items, which included:
- The business value of the core business areas,
- Strategic partnerships,
- Non-core business areas that need to be exited,
- Improve governance,
- Cost reduction,
- Optimise property portfolio,
- Secure funding,
- Ensure skills and capability management,
- Order intake and restore brand and
- Improve brand and employee morale.

Mr Sadik reflected on these previous strategies and stated that Denel has been unable to achieve these goals that were set. It has made progress in exiting non-core businesses. Denel is in the final stage of exiting aero-structures and LMT, which were businesses that were placed under business rescue. There are other activities underway in exiting other non-core businesses.

Denel’s order intake and pipeline are low due to its current challenges. A number of Denel’s properties are classified as national key points; the entity is engaging with the Department of Defence to potentially sell some land to the Department of Defence. It is considering relocating businesses that are not within national key points in order to sell those properties. The current economic climate, however, is a challenge in selling property. There has been progress in improving Denel’s governance but the entity has received a disclaimer audit opinion from the Auditor-General for three consecutive years.

Other than Denel being unable to pay employees, employees have left Denel due not being offered career path guidance. The declining Defence Budget has affected Denel’s capabilities, especially in research and development. Poor management has been an issue for Denel, State Capture and poor acquisitions for corporate actions; inefficient capital application has contributed to the state that Denel is in.

Denel is engaging with the Special Investigation Unit (SIU), the Commission on State Capture, the Hawks and the South African Police Services with regards to fraud and corruption. The loss of Hoefyster Project will have a major impact on Denel as it has received over R2 billion in advance payments. Denel has invested in inventory close to R1 billion; this stock will need to be written off. Hoefyster Project has enabled Denel to secure the largest export order for Denel in Malaysia. The Department is pleased with the progress it is making with regards to the exports to Malaysia.

Denel has an internal legal team as well as a group of legal firms that are on the panel that has been selected according to a stipulated criterion. The panel is utilised in a transparent process.

There are Divisional Executive Council meetings that occur on a monthly basis where the performance of each company is tracked. The meetings look at revenue, business development and order pipeline. Denel is finalising performance management contracts to start in the New Year. During the year, improved performance management contracts for employees were put in place and will improve further on. The Denel next strategy has put together eight work streams each of which are led by Members of the Executive of Denel.

Unfortunately, Denel still has not paid salaries; they are overdue and payable. Denel is negotiating with organised labour and the employees to see if it can be taken as a salary sacrifice. To the extent possible, Denel will not have to catch up the amount. The trade union and Solidarity took Denel to court, as the entity was unable to pay workers full salaries.

Ms Carmen Le Grange, Group Chief Financial Officer, Denel, stated that Denel received funding from Government in 2007, 2013, 2020 and 2021, which totals to R2.37 billion. It is difficult for banks to lend Denel money and Denel has thus funded its programmes through guarantees from banks. It has funded operations through debt rather than equity and this has resulted in interest that needs to be paid. From 2015 to present, R1.7 billion has been paid in interest to banks with the projection of R242 million in 2021. This money could have been out back into state coffers but are instead being paid to private banks.

Denel has tried to ring-fence funds, which it believes will be cash generative for Denel. These funds may have long-term multiplier effects. The entity has considered which international and local programmes can be saved. The programmes stipulated in the Aerospace and Defence Master plan are Denel’s possible way out of its situation, if Denel can receive support from other players in the industry in delivering on programmes stipulated by the master plan. The entity is evoking private-public partnership solutions, negotiating with suppliers, as previously it accepted fixed cost CVOs and did not negotiate concomitant costs with design changes. Negotiating holidays for penalties from Armscor will help Denel become more cash generative. There is value in Denel’s Intellectual Property (IP) and thus, seeking strategic partnerships in this regard will be beneficial.

The non-core assets strategy has been in place to reduce the cost structure, to find strategic equity partners and negotiate the Hoefyster Project to at least part in a break-even way. To strengthen the balance sheet, the amount of interest and debt burden Denel experiences is unsustainable. Partners and stakeholders need to give Denel some kind of relief in terms of the structure of the debt. The board has been assessing the implementation of the strategy. However, some implementation items require finance support and voluntary packages.

Mr Sadik stated that there have been hotline reports regarding IP security infringements that are being investigated. The Defence Intelligence and Armscor Intelligence are assisting in this regard. Many employees that leave Denel are highly expert and knowledgeable. These employees are leaving South Africa. Going forward, there is a need for recapitalisation for stability and strengthening its balance sheet. Denel needs to be globally competitive and more efficient.

Deputy Minister Remarks
The Deputy Minister stated that the board members were vetted as it is Department standard to appoint members of the board that are in good standing and in high repute. The necessary checks were done, and the integrity of the Board Members is beyond question. All management, even at the highest level and board member level, have taken salary cuts due to the challenges that Denel faces.

Follow-up Discussion
Mr Nhanha suggested that Denel should be invited back to the Select Committee to brief in greater detail on their turnaround strategy. He stated that his question regarding the prospect of poor performance has not been adequately answered as the Department failed to explain its specific plan to mitigate this. This explanation would give the Select Committee comfort and enable better oversight.

Mr Arnolds requested Denel to submit the status and outcomes for disciplinary hearing cases in writing.

The Chairperson stated that Mr Nhanha’s proposal is well received as it is in the interest of the Committee.

Deputy Minister Closing Remarks
The Deputy Minister agreed that it would be beneficial for the Department to return to the Select Committee so that both parties can be on the same page. He stated that it is urgent that Denel’s plan improves its challenges. A form of recapitalisation is necessary to give life to that vision. The Department has tried to remain in the paradigm where the Department provides for in-house needs such as being of service to the defence force and looking after the sovereign capabilities. However, a company must exist beyond these confines and be competitive in terms of the market on the continent and beyond the continent. Future markets also need to be considered and ensure it is facilitated by the capacity of management level to take it in that direction.

The Chairperson thanked the Department and Denel officials for their engagement. The Department was dismissed.

Consideration and adoption of minutes
The Committee considered meeting minutes from the following dates:
- 25 November 2020
- 03 February 2021
- 10 February 2021

All three minutes were adopted without amendments.

The Chairperson thanked the Members and Committee support staff for attending the virtual meeting.

The meeting was adjourned.