Denel releases annual results: 31 March 2009

19 August 2009, Centurion. Group CEO of Denel, Talib Sadik , released the Group's annual results for 2009 today. While the organisation posted a normalised loss of R242m (2008: R307m), when viewed in context, its restructuring strategy clearly indicates viability, progress and improvement for the benefit of the South African defence and aerospace industry, the South African National Defence Force (SANDF) and the local economy. Its turnaround achievements further strengthen Denel's positioning as a leading technology company committed to developing South Africa's industrial and advanced manufacturing skills base through the creation of proprietary intellectual property and technical skills and, importantly, enhancing the country's defence capabilities, contributing towards the SANDF being equipped with world-class equipment and services.

Denel achieved key milestones during 2009 despite global financial turmoil. Strategic equity partnerships have enabled Denel to access global supply chains and become an internationally recognised, competitive defence supplier. At home, Denel continues to invest in skills development, and remains a key technology enabler as well as skills incubator in South Africa .

Key achievements of the past financial year include:

• Completion of the industrial recapitalisation programme at Denel's Aerostructures business, in partnership with SAAB, totalling R400m; and the establishment of advanced large-structure composites manufacturing processes and certified support processes. The company gained accreditation as a supplier of key dynamic assemblies for helicopters and manufacturer of sub-assemblies;
• Achievement of developmental milestones associated with Airbus's A400m programme, the Badger infantry combat vehicle, and the fifth generation air-to-air A-Darter missile programme in partnership with the Brazilian Government. In total, the group spent R1.2bn in research and development, representing in excess of 20% of total revenue;
• Turnaround of nine of its 11 entities, with total contracted orders amounting to R17.8bn including R3.4bn from the associates. Revenue per employee increased from R353 000 in 2006 to R774 000 in 2009;
• Direct employment of approximately 3 500 technically skilled employees including in excess of 400 specialist engineers and scientists, sustaining over 30 000 technical jobs in South Africa . Denel also provided work packages to a number of specialised locally based SMME engineering companies, as well as technical exposure / training opportunities to over 5 500 South African school learners and university students;
• Continued improvement in Denel's programme management, governance, national and global legislative compliance, and risk management processes; and
• Visible improvement in Denel's transformation goals with the organisation's culture index now at 50%. In striving towards being recognised as a respected South African company, all Denel entities and associate companies are in the process of obtaining verified BBBEE ratings, with the group aiming to achieve a collective Level Five contributor rating. By year-end, Denel's Aviation business achieved a verified rating of four.

The group's overall net loss of R544m (2008: R347m) is after accounting for certain once-off restructuring related items and an impairment charge of R172m in its Aerostructures business. The net loss of R347m in 2008 was positively impacted by the sale and leaseback of land to ACSA where a profit of R135m was generated.

Prior to accounting for the losses in its Aerostructures and Missiles businesses, and the interest expense, Denel posted a profit of R33m which compares very favourably with the previous year's comparable loss of R201m. This clearly demonstrates the viability of most entities and progress made in the execution of Denel's restructuring strategy.

Relating to Denel's Missiles business, Denel has a highly attractive turnaround plan, the implementation of which is subject to government approval and successful conclusion of equity partnership negotiations. As evidenced by audits performed by internationally recognised consultants, the sustainability of this world-class business is dependent on securing a reputable strategic equity partner to provide market access, specifically serial production orders. This business is not sustainable due to the lack of multi-year production-related orders that are required to underpin the substantial non-scaleable development-orientated, fixed costs associated with having the world-class full missile capability required by our Department of Defence (DoD). In their findings, the consultants confirmed that efficiency levels in the business approach world-class standards (in terms of its industrial capabilities and product portfolio), and, in some respects, is even best in class. In their collective view, Denel's missiles revenue challenge can only be solved by improving and stabilising its multi-year order book through increased global market access. These issues are being addressed and expected to bring the required revenue stream to secure this business domain well into the future.

Relating to Denel's Aerostructures investment, the impairment of R172m in Denel's 80% owned Aerostructures business is due to material slippages in its overly ambitious business plan which had under-estimated the impact of the R400m industrial recapitalisation programme, and the uncontrollable delay in the Airbus A400m programme. An aggressive turnaround plan has been implemented since February 2009, which is showing significant operational improvement.  Through mutual agreement with SAAB, the board and internal management were strengthened. The level of industrialisation through the recapitalisation has also been improved, including the adoption of new technologies, systems and processes. The company is well positioned for growth. The key challenge ahead relates to growing the revenue pipeline through a multi-year order book.

Denel's interest expense on borrowings increased to R86m in 2009 (2008: R67m) due to non-recapitalisation by the shareholder. At present the group is funded mainly by interest-bearing borrowings amounting to R1.1bn, backed by government guarantees, as opposed to share capital.

Without these three figures, Denel would have posted its first profit in almost a decade. If a similar adjustment is made regarding these areas with respect to the previous year, one can see that the business as a whole has effectively moved from a loss of R201m to a profit of R33m.

Overall, Denel has improved its performance significantly over the past five years from a loss of R1.6bn in 2006. This has been driven by the successful execution of its restructuring strategy. The structural reforms undertaken by the shareholder since 2006 in light of the significantly reduced local defence spend (which currently stands at 1.2% of GDP), was a definite contributor to the improved performance. For instance, at the time of concluding the optronics equity partnership with Germany based, Carl Zeiss, this division made a loss of R120m. In 2009, the recently formed Carl Zeiss Optronics is expecting to generate a healthy gross profit and positive net margin. The significant improvement in programme management through the adoption of world-class systems and processes has also contributed to Denel's improved performance. In 2006, Denel provided R554m for contract loss provisions whilst for the past year, the amount reduced to R57m.

The group's total order book is currently standing at R17.8bn compared to R3.8bn in 2006, while its total revenue (including that of the associates) increased to R5.1bn, comprising R2bn of export sales. Denel's share of revenue increased by 4% to R4.1bn from the previous year and from R2.8bn in 2006.

Revenue per employee has more than doubled from R353 000 in 2006 to R774 000 in 2009, while associates showed an average revenue per employee of R1m, with Turbomeca Africa (49% held by Denel) showing a revenue per employee of R1.3m. This can be ascribed to improved serial production, market access, focused technical recapitalisation, and adoption of world-class industrial practices and procedures. As such, it provides clear evidence of the value being added by SEPs in not only retaining, but in fact growing the broader South African defence industry to not only serve our greater security needs, as well as providing direct employment and skills development to some 2100 employees. There are less than 10 foreign employees bolstering the overwhelmingly local skills base. These companies additionally generate significant export orders through accessing the SEP's global supply chain and established global customer track record. Denel's ability to leverage the technical capacity that exists in the SEPs will ensure that our entities remain at the cutting edge of technology development. In the recently concluded Rheinmetall Denel Munitions equity transaction, a gross margin of 35% is targeted as a result of the above initiatives. The broader South African industry is directly benefiting from the successes of these entities - as seen in one instance, where the order intake by a local engineering company has more than doubled in the past six month period.

Concurrent to the marked achievements reported in SEP-supported associate companies, positive productivity improvements have also been witnessed across all other Denel entities. While loss-making legacy contracts are still in the process of being completed, there was a marked improvement of margins on a number of projects and a reduction in contract loss provisions, resulting in Denel's gross profit growing from a negative 6% in 2006 to a positive 16% in 2009.

Identified by the Departments of Public Enterprises, Defence, Science and Technology, and Trade and Industry to be a "strategic asset", Denel's value as a technology incubator and enabler is clearly demonstrated by the group's total research and development (R&D) spend growing to R1,2bn in 2009 (including client funded R&D), representing more than 20% of total revenue. R&D related funding benefited systems engineering, applied systems integration, advanced aerodynamic modelling and simulation, MEMS technology applications, advanced materials technology, certified surface and heat treatment, advanced forging technologies, state-of-the-art photonics capabilities and associated product/component design, while also supporting the retention of appropriate wind tunnel and mathematical modelling capabilities.

Denel also plays a leading role in developing an expanded local engineering and manufacturing supply chain, with an average workforce multiplier factor of six across the group. The group has participated in a number of DST and dTI led initiatives to further develop and industrialise these capabilities, and to explore civilian and/or industrial applications, contributing to South Africa 's drive to:

• become a knowledge-based economy;
• improve levels of industrialisation and global competitiveness;
• drive environmental management, safety and security; and
• contribute towards achievement of the aims of ASGISA and JIPSA.

Denel's contribution towards sustainable skills development additionally extends beyond that of its employees to partnerships with various tertiary institutions. Through bursary programmes as well as the provision of industry-accredited courses at its Denel Centre for Learning and Development (DCLD), the group is working to build a viable pool of future industry resources, spanning engineering to artisan skills. In the past year the DCLD enrolled 289 apprentices, as compared to 250 in the previous year, to enhance technical and artisan skills for Denel and the defence and aerospace industries.

When the current loss is viewed in context, one can therefore see how implementation of the strategy has positively affected Denel's turnaround. To ensure continued improvement and simultaneously address global economic uncertainty, the group recently launched its strategic drivers to position Denel for growth.

As the global economic challenges continue, Denel remains cautious in its outlook for 2009/10, with initial indications showing increased risk as governments worldwide including that of South Africa , seek to re-align their defence expenditure in light of revenue shortfalls and unplanned cash injections into economies. As a result of this, competition in Denel's traditional markets is likely to increase as major players search for alternative regions for their products and services. To mitigate and guard against the impact thereof, Denel has assessed the possible effects of the economic crisis on its activities and financial results in the forthcoming year, and will remain vigilant and proactively put measures in place wherever possible.

Key challenges for the group in the year ahead include:

• Successful turnaround of its Aerostructures business, including improving the revenue pipeline and achieving clarity relating to the production rollout of the A400m;
• Successful achievement of development milestones associated with its next-generation unmanned aerial vehicle (UAV) system: the Seeker 400; the A-Darter; and Badger ICV;
• Strengthening the balance sheet through reducing working capital requirements and debt through higher levels of stable serial production, improved industrialisation, supply chain management, contracting and continuing its recapitalisation discussions;
• Commencing a targeted R300m industrial recapitalisation programme at the recently established Rheinmetall Denel Munitions business over a period of five years;
• Effective rollout of Denel's new growth strategy namely: improve access to sustainable markets, deepening Denel's relationship with the DoD and other state agencies; operational excellence; strengthening governance and financial management; and positioning towards a respected South African company.

Denel's management is committed to ensuring the successful turnaround of the group into a self-sustainable entity for the benefit of all South Africans. As such, we will continue to drive this process, catalysing growth through the implementation of our revised strategic drivers and moving towards becoming a respected local company. In this way we will add strategic value to the country on an ongoing basis - developing advanced manufacturing and industrial skills and capacity, driving new technology, boosting the economy and importantly, partnering with the SANDF to enhance and maintain South Africa 's world-class defence capabilities well into the future. Denel will continue to play a critical role in supporting the SANDF's mandated operations, including peacekeeping missions in the rest of Africa through the provision of certified equipment and services, as well as technology support.

Statement issued by Denel, August 19 2009

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