Update on Denel’s performance, financial sustainability and challenges; with Deputy Minister

Meeting report

The Chairperson welcomed Denel and the Committee Members to the meeting. He noted apologies for Ms Mamorobela (ANC, Limpopo), Ms C Visser (DA, North West), Mr I Ntsube (ANC, Free State) and Mr M de Bruyn (FF+, Free State). He welcomed Mr Obed Bapela, Deputy Minister of Public Enterprises (DPE), and thanked him for taking the time to attend this meeting. Denel would be presenting how the entity had performed, the challenges they had faced, and the opportunities that had been presented to turn this around.

DM Bapela said that Denel was on a recovery path and was turning a corner. The future looked brighter as the Board guided the entity to stabilisation and growth. The challenges such as corruption that nearly collapsed the company, ought to be noted by the Members. This was documented in the Zondo Commission. Many skilled workers had left Denel after the corruption that took place, because it had been unable to pay salaries. The money that was granted to Denel to assist in its’ stabilisation was received only in March and was only now flowing into the entity’s system. This would allow it to pay the salaries of the workers.

Denel’s successful turnaround plan

Ms Gloria Serobe, Chairperson of the Denel Board, said Denel was in a better position now than it had been previously. She appreciated the support from DPE, the shareholder Department, and this Committee. Even when Denel received reprimands, they took it as constructive criticism. The Board was stable and steering the ship by supporting the entity's management.

Denel was a prestigious company to work for. Now that liquidity was no longer a problem, hopefully, all the skills that had been lost would be regained. Skills had been lost specifically because of Denel’s inability to pay the employees' salaries.

Mr Michael Kgobe, Acting Chief Executive Officer (CEO) of Denel, said it was a state-owned commercially driven company and strategic partner for innovative defence, security and related technology solutions. Its primary purpose was to design, develop, manufacture and support defence material that remained critical for the South African National Defence Force. It derived its mandate from the Defence Review Policy of 2015, which made it responsible for ensuring security supply to the Defence Force and ensuring the Defence Force remained independent of international suppliers.

Denel was active in the different battle spaces within the army. It provided maintenance support to the systems provided to the military. It was also actively involved in the maintenance and upkeep of the South African Air Force's equipment and the South African Navy. However, it supported only the missiles and cannons within the Navy.

As the turnaround plan was developed, it became important to ensure alignment with the key stakeholders, such as the Military Command Council. Denel had experienced a lot of engagement in the process of socialising the turnaround plan, with various engagements taking place since November 2022 up until recently. The DPE had been extensively involved with these engagements. There was a monthly monitoring committee that had been established to monitor Denel’s progress.

The turnaround plan had been based on the entity’s introspection and the external environment, specifically how the entity responded to the external environment. Mr Kgobe noted that strong leadership had been a requirement for this to be achieved. The funding of this turnaround plan was a two-pronged strategy, sourcing internal funding within Denel, and recapitalisation. Progress had been made in the past year, where Denel had been able to unlock funding from internal sources, such as the medical trusts. This assisted with paying salaries, suppliers who wanted to liquidate the entity, and tax affairs with the SA Revenue Service (SARS). The workforce was stabilised in September last year, which encouraged many workers to return to work. All the outstanding salaries had been settled, as well as the salaries of third parties.

This turnaround plan was currently being implemented with six operating divisions. These divisions had support functions like human resources (HR) and information communication technology (ICT). The aim was to rationalise the cost structure and make it fit into the framework that Denel was currently executing. Through this, the entity could reduce the footprint that it currently left with the six divisions. The Denel head office had set up a shared service model, and the six divisions were then rationalised to the four seen in the presentation.

It was important that Denel’s service models were customer-centric. Some of the key structural initiatives included the relocation of the Denel Vehicle Systems (DVS) capability to the under-utilised Lyttleton Denel Land Systems (DLS) facilities, to capitalise on the significant shortage of skills in the DVS capability and avoid the urgent backlog investment in infrastructure and facility refurbishment required in Benoni. The relocation of the Unmanned Aerial Vehicle (UAV) capability to the Kempton Park-based air facilities was to capitalise on the significant overlap in airborne platform capabilities between aeronautics and dynamics (UAVs), to solve skills shortages in the UAV programme capability, and consolidate it on one site, thereby also freeing up the Irene footprint for the property optimisation initiative.

Mr Kgobe gave a brief overview of Denel’s operating model that had been approved in July 2022. Core skills had been allocated to the structure to maintain a critical mass for all key capabilities to execute programmes, to partner with industry, and ramp up as operational requirements dictate. The model was built on a foundation of standardised governance, delegation of authority (DoA), policies, practices, standards and business management systems.

After extensive engagements with National Treasury, the conditions for its recapitalisation had been met, so R3.4 billion was released to Denel. The monthly monitoring committee was still monitoring the balance of the account. It was putting operations in place to generate income in order not to rely on the recapitalisation solely for the entity’s funding. A new structure for the model needed to be released in accordance with the Labour Relations Act, and through a Commission for Conciliation, Mediation and Arbitration (CCMA) conference, there had been various engagements with the union and non-unionised employees to familiarise them with the realisation process. So far, 90% of this process has been achieved.   An opportunity pipeline had been identified, based on Denel's capabilities. It was believed to amount to about R30 billion, and in terms of the turnaround that had been developed, there had been extensive positive feedback. This was very good for executing the growth model.

As for the divisional update on Denel’s guided weapons, the primary activities were design, development, production of guided weapons (missiles and precision-guided munitions) for both the local and export markets. So far, there has been an upgrade of the Surface to Air Missile (SAM) system for an export client, as well as support for the local SA National Defence Force (SANDF) on an on-demand basis. This programme was on track and was planned for completion in March 2024. Maintenance and repair of the STM sight system for an export client for the next two years were also in progress.

Mr Kgobe presented the human resources scorecard, detailing specific information relating to the gender composition of Denel’s workforce and the percentage of permanently employed employees, students and contractors. It obtained a Level 5 on the broad-based black economic empowerment (BBEEE) metric, with the goal to eventually obtain a Level 6. As for female leadership, 18.2% of top management positions were held by women, 30.8% were in senior management, 13.6% in middle management and 24.3% in junior management. Over 70% of Denel’s workforce was made up of men, and 27.1% was made up of women. The HR strategy strongly focused on reframing Denel with the correct skills sets, and there was a requirement to gain both external skills and maximising skills internally. It would be necessary to bring in contracted workers on fixed terms, who would come in to execute a specific contract. This was the model that would be implemented going forward.

Ms Thandeka Sabela, Interim Group Chief Financial Officer (CFO), Denel, said that the entity had experienced a reduction in operations over the last three to five years, which had led to revenues declining by 46%. It had reported a preliminary result of R390 million in earnings before interest and taxes as a result of the Denel Medical Benefit Trust. Denel had remained insolvent since the 2020 fiscal year, but had received funds of up to R3.03 billion between 2021 and 2023 for the repayment of bonds against the guarantees issued by the government. She said that while this had improved the insolvency position, it had not addressed the operational challenges it faced until the sourcing of the medical benefit and the recapitalisation received in 2023. However, it allowed Denel to successfully defend supplier liquidation applications and asset attachments by unions and employees.

The recapitalisation required for the turnaround plan amounted to R5.2 billion, through recapitalisation of R3.4 billion and the sale of non-core assets of R1.8 billion. Denel had received R992 million in August 2022 through the unbundling of the Denel Medical Benefit Trust, which was used for working capital to restart the operations and normalise labour relations. The stabilisation phase was completed and implemented with the recapitalisation funding (R3.4 billion) received in March this year. Approximately R605 million of this had been spent to date on operations, restructuring, and towards legacy obligations, which had allowed significant progress to be made on implementing the sustainability phase of the turnaround plan. The balance of the funds would be spent largely to clear legacy obligations and support the growth phase of the turnaround plan.

Denel had experienced an aggressive increase in export orders over the last three years, with a 100% revenue growth predicted for the 2025/2026 fiscal year. The entity also expects a gross profit margin between 20% and 25% in the third year of the turnaround plan. It also hoped to achieve the operational target of 8% in the third year of this plan. The debt-to-equity ratio had also improved to acceptable industry levels, at 0.5.

Ms Sabela said that the order cover at Guided Weapons was significantly low, with it taking between six to 12 months to translate an order into revenue. The Landward capability plan included an amount of the Hoefyster project's Phase 2. Air capability had a concentration of local market demand, and assumed improved pricing to ensure sustainment of sovereign and strategic capabilities. The Information Security System (ISS) business was expecting exponential growth based on increased business in the civil security sector and the Defence Force's export revenue. Furthermore, all entities, except for Guided Weapons, expect to return to operating profitably in the first year of the turnaround plan. Guided Weapons retained a critical mass headcount to maintain strategic and core capabilities, and Denel expected it to return to profitability in the third year of the turnaround plan.

As for the status of outstanding annual reports, Ms Sabela said that timeous submission of these statements in the 2021 and 2022 financial years had been a challenge due to Denel’s high personnel turnover, which was attributed to the non-payment of salaries. The Auditor General (AG) had been unable to commence with the audits until some payment was made, as it was owed fees from the previous years, which also contributed to the delay in the submission of the financial statements. The statement for the 2020/21 financial year was submitted on 20 November 2022, the 2021/22 financial statement was submitted on 31 January 2023, and the 2022/23 statement was submitted in May 2023. The AG commenced the audit of all three years after receiving payment in March. The date of completion for these audits would be made available at the end of June, whereafter, the expected tabling of all three annual reports would be expected.

Addressing the entity's irregular expenditure, Ms Sabela said that the key challenges that Denel faced before 2018 were the misinterpretation of the procurement regulations, misalignment of the supply chain policy regulations, inadequate procedures with respect to deviations from single source and sole suppliers, and inadequate skilled personnel, particularly in the supply chain. As of this financial year, irregular expenditure amounted to R3.28 billion. This stemmed mainly from deviations in competitive bidding, expansions and variations of orders. However, the annually incurred irregular expenditure has decreased impressively by 98% since April 2018. In the 2019 fiscal year, an investigation was commissioned on the irregular expenditure incurred prior to 2018, which could not be included due to liquidity constraints. The investigations currently underway would be completed by the end of the 2023/2024 fiscal year. She pointed out that consequence management and the processes for reviewing all potential irregular expenditure would require significant improvement.

The irregular expenditure in the 2023 financial year amounted to R20.193 million. The two main categories contributing to this had been the deviation from competitive bidding process, amounting to R9.6 million, and the tax clearance certificate not being obtained, amounting to R10.17 million. No fraud, corruption or other criminal activities related to these transgressions were reported in this financial year.

Denel was re-establishing its loss control committee to initiate the determination and assessment principles as per the irregular expenditure framework, to adequately deal with the irregular expenditure portfolio.

Mr Kgobe said that the appointment of the chief audit executive would finalise the capacitation of the internal audit function. With support from the monthly monitoring committee, there would be continued board oversight on utilising the recapitalisation funds. The entity hoped to secure funding to invest in research and development (R&D) through collaborations. The Department of Defence played a key role in this. Denel needed to be able to fund its own R&D as well. There has been a maintenance backlog over the years, especially in terms of investing in capital expenditure (CAPEX). Part of the recapitalisation funds would be used to keep up to date with technology. As part of its operational excellence, Denel aimed to improve collections from sales and its investments in the business.

Discussion

Ms M Mokause (EFF, Northern Cape) said it was not possible for Denel to have had so many “senseless” assets that had now been sold to put it in a stable position. Referring to companies as “state-owned” hinted at the privatisation of these companies, particularly when the company’s assets were being sold, reducing the capacity that would later benefit Denel, and preventing it from fulfilling its primary function. She asked if there had been engagements between the Minister of Public Enterprise and Denel to privatise the entity. She also asked how many of the skills that had been lost had not yet been regained.

Ms L Bebee (ANC, KZN) referred to the loss of critical skills in the last few years, and asked how critical this loss was to Denel's turnaround plan. How did it plan to retrench staff while also retaining critical skills personnel?

Ms T Modise (ANC, North West) asked how many employees had been investigated and found to be involved in state capture. Had any money lost to the state capture been recovered to date, and if so, how much had been recovered? What was being done with the people involved with the corruption activities after the recovery of funds?

Mr M Mgwala (EFF, Western Cape) asked how far Denel was with settling the outstanding debtors? He asked what percentage of debtors have been settled already, and when the Committee could expect the rest to be resolved. In terms of the turnaround plan, was there a secondary strategy in the event that this one does not work? He also asked if Denel would still require more bailouts from National Treasury.

Ms W Ngwenya (ANC, Gauteng) asked how many standing committees the Board had, and what the names of these committees were. Why was there only a 27% representation of women at Denel? Women constituted the majority of the population in this country, and thus needed to be represented appropriately in the workplace. What plans have been put in place to avoid a high staff turnover in the future? Lastly, how would Denel deal with the loss of its intellectual property?

The Chairperson expressed his appreciation for the presentation. Denel was one of this nation’s assets, and it was a concern when they were informed it was veering off track. This presentation also gave the Committee hope that the entity was on the right trajectory. He asked if Denel still had a partnership with the UAE-based organisation that had caused real injury to Denel’s financial position, and almost liquidated the entity. Did Denel have any other military clients besides the Department of Defence in the country?

Given that South Africa was a member of the Brazil-Russia-India-China- SA (BRICS) bloc, this provided an opportune market. He wanted to know if Denel provided services to these countries, because this was a large market with solid economies. Did Denel have any intention to have private strategic partners?

Denel's response

DM Bapela clarified that no entities were for sale, nor was Denel itself for sale. It would remain a 100% state-owned entity (SOE). Denel had faced several misfortunes while operating in a competitive sphere. To combat this, they acquired strategic partners, but these partners did not obtain any percentage of their profits. Denel nearly went into business rescue, but it was thanks to this Board that it did not go in that direction.

In response to the BRICS and Middle Eastern engagement, he referred the Members to the National Conventional Arms Control Committee, which specifies where Denel could sell arms. Due to this, Denel was prohibited from selling to certain countries, specifically countries that were in conflict with another. This pertained specifically to Russia and Ukraine’s current state of affairs. BRICS nations that were not in conflict with others could be pursued regarding business arrangements. He acknowledged this was an advantage, as it would expand the market.

Ms Serobe confirmed what the Deputy Minister had said, pointing out that even if Denel wanted to privatise now, they did not have the finances to do so. Denel had partnerships with certain organisations for specific programmes, and in these partnerships, Denel always remained the main partner. It was competing with five countries in the world, and its equipment was the best in some cases. Denel aimed to retain their critical skills when competing with France on missiles because they needed to be the best.

She said it was unlikely that Denel would require bailouts from Treasury, as the recapitalisation had provided the entity with breathing room now. After all the support Denel had received, they had to do right by those who supported them now. Currently, eight members have been given permission by the Department to source two new skills in engineering management.

The Special Investigating Unit (SIU) was conducting an operation to retrieve and re-establish Denel’s intellectual property. The UAE partnership still exists, as the reason that it was formed still remains. The challenge was to deal with this partnership on a fine line. The SIU was assisting Denel with this partnership. The risks that came with this partnership were eased when Denel placed its strongest Board members on the committee to manage this partnership. South Africa's relationship with the UAE was very strong, and Denel had to work hard to ensure this lapse in dealings did not affect government’s relationship with the UAE.

Denel was currently dealing with Brazil and India, so countries in the BRICS bloc were being engaged.

As for Denel’s sale of assets, the Committee must remember that those sold were non-core assets. She acknowledged that the sale of non-core assets was debated frequently, but there was no mandate currently to privatise Denel.

Mr Kgobe said that Denel’s vehicle manufacturing facility had delivered, particularly in the mining industry, for transporting minerals like diamonds and gold. This was an area of diversification that Denel continued to pursue. Fire trucks were not necessarily in its portfolio, as Denel typically manufactured vehicles that could withstand explosions.

As for the loss of skills, Denel dealt with high-end engineers and during the phase of instability, it had lost many of these skilled workers. This activity would pick up again with the turnaround plan, as the business was stabilised, and so the retention of high-end skilled workers would come in time. Skills were very important to the business, and with the organisation's restructuring, new skills were being contracted to solve strategic incapabilities. There was a skills mix currently taking place, because Denel had more administrative skilled workers and fewer skilled workers in the engineering and science fields, where they were most needed. The business restructuring would support the efficient mix of skilled workers in all fields. The loss of some jobs may be attributed to this.

Denel was currently reviewing and finalising the forced retrenchments in the workforce, and hoped to reduce the number of jobs that would be lost. This would be finalised by the end of this month.

As for the money recovered from the illegal activities, approximately half a million rand had been recovered from the R2 billion that was lost during the corruption. The Board would provide the Committee with a detailed written review of this.

He added that the SIU was assisting the entity with strengthening the framework around intellectual property (IP). Any other questions would be responded to in written submissions.

The Chairperson thanked Mr Kgobe for his responses, noting that the follow up responses would be submitted later. He advised that the details pertaining to the numbers and statistics should be in the submitted letter.

Regarding the critical posts that needed to be filled -- the CFO, the CEO and the Chief Audit Officer -- when could the Committee expect these to be filled?

The Chairperson commented that while the non-core assets may not be core assets to the entity, they remained assets to the country, and he suggested that they should not be sold to foreigners but rather remain in the ownership of Africans and the local communities.

Ms Serobe said the Board planned to fill those positions by October 2023; the sooner, the better. The leaders like the CEO and the CFO should drive the turnaround plan. The Board process would drive these appointments, so this date should be met, and any challenges along the way would be communicated. Many people did not want to apply for these positions because of the fear that Denel would not be able to pay their salaries, but hopefully, this image would change with the turnaround plan.

An example of a non-core asset would be a property owned by Rheinmetall Denel Munition (RDM), which was partly owned by Denel and partly owned by Rheinmetall. Ideally, this property was probably best owned by RDM, because it was not critical to Denel’s business ventures. She pointed out that while it may be best to keep the sale of non-core assets local, if a local buyer offered significantly less for the asset than a Brazilian business offered for the same asset, for example, then it would make sense to sell the asset for the most profit. Either way, many people would have different opinions about this. The first prize was to allow these assets to remain in the hands of South Africans, and Denel remained mindful of that.

The Chairperson thanked the Deputy Minister, Denel and the Board Members for providing their detailed presentation and answers. He appreciated the turnaround they were currently undergoing.

Committee matters

The Chairperson presented the draft minutes for the meeting dated 7 June 2023. The minutes were adopted.

He thanked the Committee for the questions they had put to Denel, because this meeting was critical to the progress and growth this entity intended to make as one of the most important state-owned companies in the country. He expressed his faith and trust that Ms Serobe would be able to steer this ship in the right direction.

The meeting was adjourned.