South African State-owned defence industrial group Denel released its 2019/20 annual report on February 1. The period covered by the report did not include the very difficult months for the group that followed the commencement of the 2020/21 financial year at the start of last April. From last May, Denel had failed to pay its employees their full salaries, nor the other statutory payments it was required to make.

During 2019/20, group revenues fell by 20% to R2.72-billion, compared with the R3.40-billion achieved in 2018/2019. (Revenues during 2017/18 had come to just over R6.02-billion.) The group blamed this fall on limited liquidity.

The group suffered an operating loss of R1.5-billion and a net loss of R1.96-billion, as against a net loss of R1.47-billion in the previous year (although the net loss for 2017/2018 had been R2.01-billion). According to Denel, the deeper net loss in 2019/20 was mainly the result of the fall in revenues, an “increase in labour under-recoveries as operational activities declined during the year”, and an increase in financing costs.

Its net financing costs amounted to R576-million, lower than the R618-million for 2018/19, but still “high”, as the report said. “Denel continues to rely on debt to finance its operational costs.”

Assets decreased by about R200-million to R8.5-billion from R8.7-billion in 2018/19, because of decreases in both inventory and contract assets, as a result of deliveries to customers and to corrections to errors made in previous reporting periods. Total liabilities also decreased, by R616-million, to R10.8-billion from R11.4-billion.

“Denel’s loans and borrowings are fully guaranteed by the government of South Africa, [which] bears the risk of default in the repayment of this debt,” observed the report. “As at 31 March 2019/20, Denel was insolvent by R2.3-b[illio]n. This was driven by the losses incurred since 2017/18. On 31 August 2019, the Shareholder approved and paid to Denel R1.8-b[illio]n in recapitalisation funds to re-stabilise the business and improve the solvency position. “This funding injection was utilised to restart operations, pay overdue taxes and debt financing costs, and implement strategic actions in the turnaround plan.”

The group admitted to having suffered from problems regarding its accountancy procedures and financial reporting. As a consequence, the Auditor-General had issued a disclaimer audit opinion regarding it. “[A]t year-end, due to the significant number of prior-period errors that required correction to each monthly reporting period, the consolidated financial reporting tool [used by Denel] became unstable and, although mitigating steps were taken to prepare the annual financial statements, these were inadequate to completely deal with the full impact on the group’s consolidation,” it reported.

In his statement within the annual report, interim CEO Talib Sadik addressed the failure of the company to fully pay the salaries of its employees last year, even though this fell within the 2020/21 financial year. He blamed the group’s lack of liquidity and the Covid-19 pandemic. “The most important risk that has been threatening the sustainability of the organisation over recent years is the liquidity challenge it is experiencing,” he highlighted.

Although the pandemic hit South Africa after the end of the 2019/20 reporting period, he addressed its effects, pointing out that government put the country into a hard lockdown on March 27 last year and kept it in force until April 30. This lockdown effectively shut down the country (except for essential services) and sought to isolate the country from the wider world.

“This had a severe impact on the economy, and also further exacerbated Denel’s liquidity situation,” he stressed. “This impacted on production and also on the payment of salaries for the months of April to July 2020, with net salaries for the months of May to July not being fully paid to employees, and the payroll third-party statutory payments not being paid from April to July 2020.”