Drake & Scull (DSI) released its financials which show negative equity of 4.7 billion UAE dirhams ($-1.3 billion).

Multiple audit disclaimers

The newly-appointed auditors, EY, stated that they “…have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on the consolidated financial statements.” But that the financial statements “…have been prepared on a going concern basis, based on a restructuring plan developed by management […] The Group's going concern assumption is highly dependent on the successful execution of such a plan[…]”.

Inability to obtain appropriate evidence was previously highlighted by DSI’s previous auditor, PWC, in its 2017 audit.

EY further states that DSI’s “…current liabilities exceeded its current assets by 4,741 million dirhams. These conditions indicate the existence of a material uncertainty which may cast significant doubt about the Group's ability to continue as a going concern…”.

It is not clear if DSI could not or simply did not provide audit evidence to its auditors but in either scenario such a situation makes it hard to understand how effective DSI would be in developing, let alone executing, a restructuring plan that would allow DSI to remain a going concern.

EY states that it was not able to obtain bank confirmations to verify, amongst other things, bank balances. DSI’s inability to provide something as simple as a bank confirmation to its auditors points to a major challenge for DSI to restructure. Indeed, not being able to produce bank confirmations might explain why DSI currently finds itself with such a large negative equity balance.

Far more financially significant is EY’s inability to obtain evidence for DSI’s material subsidiaries which, in aggregate, reported 1.4 billion dirhams in assets and 2.6 billion dirhams in liabilities for a deficit of 1.2 billion dirhams against revenues of only 20 million dirhams to meet the shortfall. Given that the consolidated statements show impairments of customer, associate and trade receivables as well as intangible assets aggregating 3.1 billion dirhams it would seem essential that DSI be in possession of all information necessary to manage its balance sheet if it is to be successful in its restructuring plan.

Breaking down the financial impairments

The aggregate impairments of receivables is 2.97 billion dirhams (note 11), of which 787 million dirhams is identified as trade receivables. As prepayments stands at 366 million dirhams, whilst customer dues stands at 2.3 billion dirhams, it would indicate that the preponderance of the 2.2 billion dirhams in impairments is due to customers. This large write-off does not bode well for future business.

More intriguing is the impairment of intangible assets of 901 million dirhams (note 6). This was mostly goodwill which had a carrying value of 815 million dirhams on January 1, 2018 before being completely written off by year-end. This large goodwill saw only a single impairment in 2016 of 29 million dirhams between 2015-2017. How did a company that saw losses of over 800 million dirhams in each of those three years, and negative cashflows in the hundreds of millions, feel that it had 814 million dirhams of goodwill? There might be standard impairment tests that allow this, but just because you can do it does not mean that you should. The impairment in goodwill may very well have been matched by an impairment in judgement.

DSI’s judgment effectiveness

In 2017, DSI bought Golden Sands Investment (GSI) for 70 million dirhams. GSI owned at the time 28 percent of Waha Bay Investment and Real Estate Development.  GSI was revalued at 284 million dirhams by an unnamed independent valuer resulting in an immediate profit termed “bargain purchase gain” of 214 million dirhams. The auditor at the time stated that it had not obtained sufficient audit evidence to satisfy them as to the accuracy of the revaluation (page 20). In 2018, DSI sold the renamed Wahat Al Zawya Holding for 96 million dirhams, recording an impairment of dirhams 188 million on the transaction. Tabarak Investment lists Wahat Al Zaweya Investment & Real Estate Development as well as DSI as part of its portfolio. Although Tabarak did not participate in DSI’s shareholder vote to sell Wahat, there is no mention in the AGM minutes of Tabarak’s role. The audited financials do not mention the transaction in the related party section, and as the total related parties recorded stand at 19.8 million dirhams it is clear that this was not included.

There are potentially three judgment errors that DSI made here: 1. Recognising a 311 percent revaluation of an asset that it bought, 2. Not providing its 2017 auditors with the necessary documentation to validate the revaluation, and 3. Apparently not providing full transparency on the transaction in its related party notes.

This is simply a further example of potential judgment impairment by DSI.

The future of DSI’s creditors

DSI recorded on its financial statements 2.2 billion dirhams in bank borrowings and a further 2 billion dirhams of off-balance sheet guarantees. Although the total would have no impact on the UAE’s banking system, it is nevertheless a material amount. More concerning is trade payables of 3 billion dirhams, which might have a significant impact on the business operations of DSI’s suppliers. With a large, negative equity balance and a multi-year history of large losses and negative cashflows, it is not clear how a restructuring would enable DSI to meet its obligations.

Any opinions expressed here are the author’s own.

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