Denel implementation of turnaround strategy; with Deputy Minister

Meeting report

Denel implementation of turnaround strategy

Mr Obed Bapela, Deputy Minister of Public Enterprises (DPE), briefly welcomed the state-owned entity (SOE), Denel SOC Ltd, to present on the progress of its turnaround strategy. He gave an assurance that support would be given to the entity by the Department when needed.

Ms Gloria Serobe, Interim Group Chairperson, Denel, encountered network problems due to load-shedding, and was therefore unable to make any opening statements.

Mr Mike Kgobe, Interim Chief Executive Officer, Denel, presented the delegates that were present from Denel – Ms Thandeka Sabela, interim group Chief Financial Officer, Ms Maryna Gie, Group Company Secretary, Mr Gawie van Zyl, Group Company Treasurer and another executive member.

Mr Kgobe assigned different parts of the presentation to respective delegates.

He highlighted the entity’s status and relevance, with specific attention given to the 2015 Defence Review’s section 15, paragraph 95, which stated that Denel was a national security asset, with the primary purpose of designing, developing, manufacturing and supporting defence matériel. In addition, thereto, Denel was charged with:

• The custodianship of assigned sovereign or strategic defence capabilities, technologies and abilities, inclusive of those that may be at risk, the loss of which would threaten South Africa’s required defence capability.
• The design, development, manufacture and support of important capabilities which may not be commercially viable.

From a geopolitical perspective, the SANDF was dependent on a significant “level of effort” and capability from Denel to support their preparation and readiness for deployment both internally, such as during the July 2021 unrest and the recent KwaZulu-Natal (KZN) floods, and externally, such as in the Democratic Republic of Congo (DRC) and Mozambique.

Denel was an integral component of the South African National Defence Force (SANDF).

Mr Kgobe went on to analyse the presented graphs, explaining that there had been a decrease in the company’s order book, sitting at R8.7 billion. There had also been a decrease in the revenue generated, decreasing from R8.2 billion in 2016, to R1.4 billion at the close of the 2022/23 financial year in March 2023. These need to be increased to maintain the company’s sustainability.

There had also been a decrease in the company headcount, with an employee headcount of 4 952 in 2016 declining to just 1 670 in 2023. The biggest contributing factor to this was the exit of employees.

Mr Kgobe explained that the stabilisation of the organisation and its human resources was underway, and that a restructuring of the human resources within the organisation would be aligned with the skill requirement for the advancement of the company.

Ms Sabela presented a graph on the company’s solvency, stating that it was relative to the revenue generated over the years, and the reduction in the order books.

The company had been solvent at R2.3 billion in 2016, but it had seen a sharp decline in the following years, till it reached insolvency between 2019 and 2022. This was due to factors such as liabilities being higher than assets, and having no equity to combat this.

The government had helped in the entity’s attempt to resolve insolvency by providing funding to pay off debts, which was what led to the improvement in 2022. Government gave more funding to Denel in the 2022/23 financial year, which led to an improved 2023.

Structural changes were necessary to maintain the sustainability and improvement of the organisation. The turnaround strategy aimed to address this. The company’s client relations were to be re-evaluated to ensure that Denel appealed to the suitable target market, especially when expanding beyond the SANDF client base. Processes were also being reviewed to ensure accurate and timeous service delivery to clients.

Mr Kgobe presented the implementation status of the turnaround strategy. The strategy framework dealt with six major outlines:

• Reduction of costs and increased revenue. This was already on the way to being achieved, and much attention had been given to export revenue, as Denel was now pursuing other revenue contributors outside of SANDF, which had decreased its number of orders over the years.
• Engaging staff who were performance orientated. It was important that a performance culture be promoted within the organisation, and that employee engagement in company activity was ensured.
• An increased customer base. There was a need to diversify Denel’s customer base, outside of just the SANDF.
• Effective supply chain. There was a need for improved procurement processes and contract management whilst driving optimal stock levels.
• Optimised planning and production. There was a need to streamline the planning and production processes to support the effective execution of maintenance.
• National and global partnerships and joint ventures are needed for Denel’s increased access to finance, technology, and broader markets.

Mr Kgobe further explained Denel’s strategic approach, which was approved in July 2022, and its progress. There was a new model combining the company’s divisions -- human resources, financial services, legal services, risk/safety, health, environment and quality (SHEQ)/configuration, business development, supply chain, communications and information communication technology (ICT) services -- in an attempt to cut down on costs. He briefly touched on sustainability and growth strategies before being cut off due to connectivity issues.

Mr Kgobe resumed with the presentation, outlining the new operational model to be adopted in the coming year. The model focused on four main capability areas:

• Guided weapons, with the following key products - missiles and precision-guided munitions' (PGM’s) supply and support;
• Land, with the following key products - infantry artillery, armoured vehicles, mechatronics and infantry weapons products' supply and support. Small weapons ammunition and medium calibre munitions supply;
• Air, with the following key products - military aircraft and engine maintenance, repair and overhaul (MRO), aircraft systems integration and upgrades, Rooivalk helicopter, unmanned aerial vehicles, aerospace test and evaluation, and other aerospace products and support.
• Integrated Systems, with the following key products - complex integrated systems, such as ground-based air defence systems (GBADS), commercial off-the-shelf (COTS) security systems and cyber solutions, with supply and support

Mr Kgobe indicated Denel’s associates and subsidiaries, along with Denel’s shareholding. These were:

• Rheinmetall Denel Munitions (RDM) (Large), where Denel owned 49% of the shares.
• Barij Dynamics in the United Arab Emirates (UAE) -- precision-guided munition (PGM), where Denel owned 49% of shares.
• Hensoldt Optronics in South Africa, where Denel owned 30% of the shares. This company would be divested out of, and the shares sold.

The restructuring would involve space optimisation. The three sites focused on were Kempton Park, Lyttelton, and Irene. The movement of the Benoni site to Lyttelton was underway, and would be completed by 30 September. This would help with saving at least R18 million per annum. As part of its footprint reduction, Denel would put some of the properties up for rental, and where deemed non-strategic, it would sell its properties to generate income for the company.

Mr Kgobe proceeded to address the status of the sale of non-core assets. The sale of Hensoldt was awaiting Public Finance Management Act (PFMA) approval, and for Denel Gear Ratio, the buyer had not met all the contractual obligations, therefore the company had gone back to the market. The Denel Medical Trust sale had been concluded and had assisted in stabilising the company by paying off the salaries of employees, amongst other things. The sale of RDM and Hendsoldt properties would be concluded by October.

He provided insight into the proceedings of increasing Denel’s customer base, nationally and internationally, to attend to their prospective and existing global and national customers.

• Denel management had supported and accompanied the Deputy Minister as part of his delegation to Brazil from 1 to 8 July.
• On 5 July, the South African Air Force (SAAF) Command Council visited Denel for a presentation, discussion and demonstration on the KAMAS status and execution plan, and the missile capability sustainability approach.
• On 6 July, there had been a meeting with the Chief of Defence Intelligence to align and move forward with operationalising the Seeker 400s at Waterkloof, and discuss the support Denel required to jointly demonstrate the capability at the Denel capability demo in August.

These were among some of the progressive steps that had been undertaken.

Concerning the Seeker 400 unmanned aerial vehicle, Denel had been able to fly the system – notably at its mid-August Alkantpan demonstration – and in July, they had met with the Chief of SANDF Defence Intelligence to align and move forward with operationalising the Defence Intelligence Seeker 400s at the Waterkloof air force base.

Regarding artillery systems, Mr Kgobe highlighted a successful trial of the T5-52 self-propelled howitzer at Alkantpan last month, where nearly a dozen international participants had come to witness the demonstration. He said there were big requirements around the world for such guns due to changing geopolitics. He said the successful Alkantpan trial, which saw 155mm rounds fired over 60 km, “sparked a lot of interest internationally.”

Regarding partnerships and joint ventures, Denel was restoring productive relationships with existing associates in South Africa, such as RDM and Hensoldt. It was also normalising its relationship with the EDGE Group of military contractors through its partnership with Barij Dynamics. The board had been re-constituted, and new technology opportunities were being explored. New partnerships were being developed in Türkiye, with Aselsan and Turkish Aerospace Industries (TAI) for access to technology and markets, amongst other developments.

Mr Kgobe briefly presented Denel’s human resources scorecard, outlining the company's demographic makeup. As of 30 June, it had a total headcount of 1 659 employees.

The human resources (HR) strategy strongly focused on reframing Denel on the correct skills sets. To achieve this, there was both a requirement to gain external skills and to maximise skills internally. An integrated talent management strategy had been developed to illustrate how various key elements would flow into each other. This was inclusive of the national imperatives, and other macro influences on internal processes. The Denel Technical Academy was being reorganised to be able to fulfil many of the learning initiatives identified.

(There were multiple connectivity disturbances as a result of load-shedding).

The Chairperson asked that the Committee grant Denel some grace, seeing that the connectivity issues were not their fault.

Financial Sustainability

Ms Sabela presented the financial sustainability aspect of the presentation.

There was slow progress on revenue, mainly due to the lack of maintenance in some entities. There was also a delay in orders in the order book, hence the decline. There had been a 2021/22 financial year financial statements submission to the Auditor General (AG), and the auditing was underway. The 2022/23 financial statements had been submitted on time, and the audit would be finalised by November.

The order book for the 2023/24 financial year stood at R1.9 billion, and approximately half of this figure had been secured by the end of June 2023. The entity hoped to achieve its target by the end of the year.

In terms of revenue, Denel’s budget was R292 million, but as of June, only R173 million had been achieved. There needed to be an improvement in the second half of the year to achieve the planned R1.9 billion revenue.

The earnings before interest and taxes (EBIT) budget was R139 million. However, the actual was R172 million due to delays in sales against budget.

Besides the R3.4 billion allocated as part of the October 2022 medium-term budget policy statement (MTBPS) adjustments to Denel to implement its turnaround, it had received roughly R1.8 billion in the financial year ending in March 2020 for critical creditors, suppliers, taxes and debt, and a further R3.8 billion over the next three years for settling of long term debt and interest, and R1 billion from the exit of non-core business used to restart operations.

Ms Sabela briefly explained the cash review aspect on slides 24-25.

Priority actions and way forward

Mr Kgobe went through the priority actions and way forward slide, which indicated:

• Denel was to conclude the restructuring in terms of the Labour Relations Act (LRA) Section 189A and stabilise the leadership of the organisation with the appointment of a Group Chief Executive Officer, a Group Chief Financial Officer, a Chief Audit Executive and the rest of the group executive leadership;
• With the appointment of the Chief Audit Executive, it would finalise capacitation of the internal audit function;
• The sale of non-core assets would be expedited to realise the cash injection to be ploughed back into the business as part of the turnaround plan;
• There would be continued board oversight on the utilisation of the recapitalisation funds, with support from the monthly monitoring committee including representatives from the DPE, National Treasury (NT), the Department of Defence (DoD) and Armscor;
• The rebuilding of Denel capabilities would be expedited by focusing on employee value propositions, by making the company attractive -- new work, improved working conditions, etc.
• The drive to realise the opportunity pipeline of around R30 billion -- local and export -- would continue;
• Funding would be secured to invest in research and development through collaboration with customers.
• The CAPEX plan would be funded through recapitalisation funds and own funds from operations, and investment in infrastructure and preventative maintenance actions would be prioritised;
• As part of operational excellence, there would be improved collections from sales and reinvestment in the business.

See attached for full presentation

Discussion

Mr S Gumede (ANC) expressed his appreciation for the clear and promising presentation, and said that the targets presented would be attainable if everyone did their job. He expressed worry, however, about the execution and financial management of Denel, given the entity’s past and its reputation. Denel was known for its promising presentations, and not for delivery or coherent communication.

He commented that it would have been better to have had the previous years’ financial statements presented to the Committee prior to the current meeting.

Denel was notorious for not attending meetings, despite the importance of consolidation between the entity and the Portfolio Committee for effective resolution.

He said that Denel had to go back to the drawing board to change its external loss-oriented approach. National Treasury’s cash injection to Denel had been beneficial in helping the entity achieve its targets and resolve existing issues.

He asked for regular updates on the programme promised to be concluded by July 2024. He was concerned about the timeframe, considering the elections, and asked for updates before the close of the fourth quarter, at the end of February 2024, and lastly, at the end of May 2024. Oversight visits would accompany these consistent reports to ensure that whatever was presented matched reality.

Mr Gumede asked about the sale of non-core assets – as Denel was in the process of growth, would it not need the assets it was currently putting up for sale?

He lastly asked for information regarding the entity’s skill acquisition strategies.

Mr G Cachalia (DA) asked about the entity's solvency. Was it improving, since performance and skills were declining?

He questioned Denel’s ambition, given its current problems that were nowhere near resolution, and its declining revenue.

He asked for its detailed funding requirements and information on its possible funding sources, especially on the vehicle systems plans.

He lastly commented on strategic relationships, stating that they were not new in nature, were not known to aid with funding, and were not their duty.

Ms N Mhlongo (EFF) asked about the employee demographic complement, questioning why more than 72% of male employees were male while female employees accounted for the minority? How many of the employees were youths? Were there internships and learnerships in place to combat the unemployment problem in South Africa? Why was the employee headcount sharply declining over the years? When implementing the severance strategy in 202, what had been done to retain skilled employees?

She asked about the operating budget and the implications of the R24 million deficit on the company’s overall production.

What was Denel’s strategy on skill acquisition, especially after the directive from National Treasury instructing departments and entities to freeze any new employee intake as from 15 September? How many employees would lose their jobs in the restructuring process? Would any of them be skilled personnel? What was Denel’s desired employee headcount?

She said that 3 September marked five years since a fatal blast in Somerset West which had claimed eight lives. An investigation had been launched by the Department of Employment and Labour (DEL) in May 2021, where the site of the incident was found to be defective and in contravention of prescribed safety measures. What was Denel doing to ensure fatal accidents like this one never occurred again?

She asked for progress on moving the Benoni site to Lyttelton,  and what process was involved. Was it not more economically sound to lease out immovable state-owned assets instead of selling them to the private sector? Was there no need for Gear Ratio, since it was also up for sale? Who would then service the equipment it currently services?

Ms Mhlongo’s last question was on employee remuneration. Since there had been issues of payment backlogs to employees, had the board members received their salaries? How was this decided on?

Ms C Phiri (ANC) asked whether Denel’s technical academy would be reopened as part of the restructured model. Would it assist other entities concerning it? Were courses advertised, and was a prospectus made available to interested prospective students?

What were the conditions of the restructuring and exit strategies that Denel had to meet prior to it achieving the second tranche of the restructuring recapitalisation? When did Denel envisage the attainment of these conditions?  

Regarding Denel’s exit strategy, how else did it aim to attain its desired headcount, apart from severance or natural causes?

Mr N Dlamini (ANC) asked about the measures in place to prevent the theft of intellectual property (IP), as there had been a previous incident of IP theft by a company in the UAE, under the guise of a partnership with South Africa.

What was the progress of the Denel vehicle systems investigation handled by the Special Investigating Unit (SIU)? Would anyone be prosecuted?

Mr Dlamini’s last question was whether a supply development programme was in place.

Mr F Essack (DA) asked whether due diligence had been applied to the determination of property sale values and current returns. Although the market was in a tough condition, it was important to dispose of assets at suitable prices.

He commented that there had been a major lack of productivity within Denel.

He concluded by asking if the R1.8 billion in funding given by National Treasury had been used to ensure the settlement of creditors.

Ms J Mkhwanazi (ANC) asked whether there was a plan in place to monitor the implementation and the timeline compliance of the turnaround strategy. She also asked about the shift from stabilisation to sustainability delays indicated in Slide 9 (see presentation).

The Chairperson approved the report, highlighting the importance of a working relationship between Denel and the SANDF. Denel provided for the needs of the Force -- there was no need to seek out external suppliers when a state-owned entity (SOE) like Denel existed.

He questioned Denel’s willingness to diversify their production catalogue, seeing that they had assisted with manufacturing ventilators during Covid-19. Surely they could manufacture other goods beneficial to South African citizens, such as police vans and ambulances?

It would be ironic for Denel to collapse when such a large market for its services existed nationally and had the suitable infrastructure.

Responses

Mr Kgobe said that Denel was available to make constant presentations, as per Mr Gumede’s request.

Ms Sabela repeated that the annual financial statements (AFS) would be made available to the Committee upon audit finalisation by the AG, hopefully by November.

Mr Kgobe said he would welcome oversight visits by the Committee to indicate the implementation of the actions mentioned in the presentation.

He said the properties put up for sale had not been utilised by Denel for a significant number of years, and they would not be needed in the future. These properties had been in use by either RDM or Hensoldt, of which Denel was a shareholder. There was sufficient space in Lyttelton and Pretoria West to accommodate the moving of the Benoni site.

The income backlog of employees had been settled, and only the pension contributions were outstanding. A payment plan had been devised, whereby these contributions would be paid back to employees over time, with interest.

The order book reduction was largely due to multi-year orders executed over time. It was important for Denel to diversify its portfolio to explore other revenue streams outside of the Department of Defence. The African continent was a fertile market, so there was a need to capitalise on regional relationships.

Ms Sabela explained the improvement in solvency, stating that it resulted from the funding from National Treasury, which had increased the company’s equity, combating the problem of liabilities being higher than assets.

Mr Kgobe explained that right-sizing was necessary to balance the entity's skills, especially after losing technical engineering skills. Skills acquisition had to match current revenue.

He was confident to assert that there was an opportunity pipeline of R30 billion, as this figure had been derived from market research.

New staff demographic targets to rectify the current situation were underway. The reflection of the youth would be presented later in writing. Rigorous processes had been put in place during the assessment of voluntary severance applications to avoid the loss of skilled employees. To adhere to the directive of National Treasury, Denel would acquire fixed-term contracted employment when in need of duty execution, to justify the on-boarding of new employees. The restructuring process began in September 2022, and 184 employees have exited since then, while 159 voluntary severance applications have been approved. They were nearing the targeted employee headcount. The current headcount was inclusive of contracted employees, meaning that upon the end of their contracts, the targeted 1 400 headcount could be achieved.

To prevent recurrence, the prevention of explosions like the one that occurred in Somerset West had been tabled during committee proceedings with RDM, the Department of Labour and the Department of Public Enterprises.

Discussions for entity collaboration were underway, with the repositioning of the technical academy, involving collaboration with the Ekurhuleni technical and vocational education and training (TVET) college, in progress.

Mr Kgobe asked that the query regarding progress on the senior vacancy issue, be attended to later.

Supplier development programmes were under initiation, and stricter oversight conduct had been adopted in partnerships to avoid past mistakes. Denel was also working closely with Armscor.

Denel would reach out to the SIU entity and request a progress report on its investigation to present to the Committee.

Transaction advisors had been appointed to determine the value of the non-core assets to be sold. Progress had been made with repaying legacy creditors, but there were still outstanding balances, and a payment plan was underway.

There was a monthly monitoring process of the turnaround strategy, chaired by the DPE.

There were attempts by Denel to diversify its product catalogue, such as entering the civil security sphere, and consideration of manufacturing specialised vehicles, despite oversaturation of the commercial vehicle space.

Deputy Minister Bapela said that the Department was in constant contact with Denel, and was available to assist when needed. Engagements on expanding the product catalogue were underway, and he was optimistic.

The Chairperson permitted Denel’s exit from the meeting.

Adoption of minutes

The minutes from previous meetings were flighted, and Mr Dlamini moved their adoption after amendment. He was seconded by Ms Mkhwanazi.

The meeting was adjourned.