DOWNER EDI has a lot of explaining to do over leaked emails that reveal a culture that deliberately stops payments to suppliers for the sole purpose of tarting up the end-of-year cash flow position to meet targets.
For the past two years, documents leaked to BusinessDay reveal, payments to suppliers have been withheld to meet cash flow targets.
The revelations could not come at a worse time for the company, which is battling credibility issues and facing significant operational and financial issues relating to an $8 billion contract for Sydney's next generation of trains. Downer is leading the Reliance Rail consortium, which won the tender three years ago.
Issuing a directive that all creditor payments are to be stopped, otherwise the company would record a net cash outflow for the year, is dynamite.
It calls into question the group's corporate governance standards, transparency and already damaged credibility.
As a senior executive said: "These guys must be mad or smoking something to go to print with that sort of thing. No doubt we are going to hear a lot more about Downer's woes before it is all over."
Chairman Peter Jollie and chief executive Geoff Knox will need to think carefully about how they handle this, particularly given Knox appears to have known that the practice was going on before the 2009 books were closed off, going by an internal memo he was copied in on dated June 23, 2009.
The latest email, sent by Downer EDI Works chief financial officer Chris Storey on June 17, two weeks ago, says that by stopping an estimated $35 million in supplier payments due this month, the company will meet revised cash targets of $45 million for the division, and likely avoid a net cash outflow for the year.
In the email, Storey outlines why he believes the situation came to this: failure to achieve targets and execute work appropriately, leading to a high value of disputed amounts that have not been dealt with in a timely manner.
It is a big statement that throws into question that division's ability to manage cash flow. According to Downer, more than 70 per cent of works revenue is derived from government at the federal, state and council levels - so it is not a great vote of confidence that there appear to be issues relating to the way it performs its work.
From a financial perspective, resorting to such methods to turn a net cash outflow into a net cash position isn't a good look. It throws into question whether Downer's cash position matches its declared earnings before interest and tax (EBIT) and profit.
Downer's chief financial officer, Grant Fenn, vigorously defended the integrity of the group's results. But he did admit the decision to stop payments to creditors and put it in an email was overzealous.
Downer EDI's Works division reported an EBIT of $114 million in 2009, so assuming it makes a similar amount in 2010, deferring supplier payments to the tune of $35 million is material.
The problem for Downer is it has been dogged by issues of credibility in one form or another for years.
Fenn has been trying to improve credibility but with scandals like the leaked emails, it will be a hard fight.
Before the appointment of Knox in February 2008, the company had a history of being a habitual profit downgrader and announcer of nasty surprises, some of which resulted in high-cost litigation.
The latest disappointment was on June 1, when Downer made a shock $260 million write-down. It was followed by news that Fitch had reduced its credit rating below investment grade status.
Not surprisingly, investors have fled the stock in droves.
The reason is simple: construction companies, engineering service companies and mining contractors live and die by their ability to assess risk.
Downer EDI has failed too many times on this count. They also live and die by managing their debtors and creditors. To have to stop payments to creditors to ensure net cash flow is not negative is a sign of poor cash management.
Downer's credibility took a big whack when it put out a statement to the ASX on May 21 denying ''market speculation and misinformation'' that its rail contract, Reliance Rail, needed to raise equity.
Implicit in the briefings was that nothing was wrong with the Waratah trains rail contract. Less than two weeks later, on June 1, it wrote off $190 million from the Waratah contract due to cost overruns on manufacturing rolling stock and another $70 million in impairments. Right up until June 1, Downer boss Geoff Knox had assured investors nothing was wrong.
These latest revelations, that the group's works division has been deliberately delaying payments to suppliers to make its net cash flow look better, is not the sort of behaviour that investors expect of a company.
It is not the sort of behaviour that investors expect a chief executive to tolerate or a board to accept.
On Friday, the company announced the appointment of two new directors to try to restore some credibility to its battered image. Along with Rio Tinto executive, Grant Thorne, Downer appointed its CFO, Grant Fenn, to the board. Fenn joined the company last October with a strong reputation and an appetite to clean up the mess.
DOW Price at posting:
$3.66 Sentiment: None Disclosure: Held
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