Independent auditors' report

for the year ended 31 March 2020

To the Shareholders of Telkom SA SOC Limited
Report on the audit of the consolidated and separate financial statements
Our opinion

In our opinion, the consolidated and separate financial statements present fairly, in all material respects, the consolidated and separate financial position of Telkom SA SOC Limited (the Company) and its subsidiaries (together the Group) as at 31 March 2020, and its consolidated and separate financial performance and its consolidated and separate cash flows for the year then ended in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa.

What we have audited

Telkom SA SOC Limited’s consolidated and separate financial statements comprise:

  • the consolidated and separate statements of financial position as at 31 March 2020;
  • the consolidated and separate statements of profit or loss and other comprehensive income for the year then ended;
  • the consolidated and separate statements of changes in equity for the year then ended;
  • the consolidated and separate statements of cash flows for the year then ended; and
  • the notes to the financial statements, which include a summary of significant accounting policies.
Basis for opinion

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated and separate financial statements section of our report.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence

We are independent of the Group in accordance with the sections 290 and 291 of the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (Revised January 2018), parts 1 and 3 of the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (Revised November 2018) (together the IRBA Codes) and other independence requirements applicable to performing audits of financial statements in South Africa. We have fulfilled our other ethical responsibilities, as applicable, in accordance with the IRBA Codes and in accordance with other ethical requirements applicable to performing audits in South Africa. The IRBA Codes are consistent with the corresponding sections of the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants and the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants (including International Independence Standards) respectively.

Our audit approach

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated and separate financial statements of the current period. These matters were addressed in the context of our audit of the consolidated and separate financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.

Key audit matter     How our audit addressed the key audit matter

Adoption of International Financial Reporting Standard 16 - Leases (IFRS 16) (applicable to the consolidated and separate financial statements)

The Group adopted IFRS 16 with effect from 1 April 2019. The Group opted to use the modified retrospective approach in transitioning to the new standard.

The adoption of the standard resulted in the Group recognising a right-of-use asset (ROU Asset) and related lease liability of R4.2 billion as at adoption date of 1 April 2019.

In determining the retained earnings opening balance impact, management applied judgement to conclude on certain key inputs in the calculations, namely:

  • Determining the lease term where leases were contractually agreed to continue on a month to month basis upon expiry, and where leases were silent on expiry;
  • Determining the lease term where there are renewal and termination options;
  • Determining non-lease components included in the total lease payments where these were not clearly identified in the lease contract; and
  • Determining the lease discount rate (incremental borrowing rate).

A number of lease contracts included renewal options, escalation rates and/or excluded specifics regarding non-lease components.

The impact of the new standard was a matter of most significance to our audit as:

  • the balances recorded upon adoption were material;
  • the updating of the accounting policies required policy elections to be made; and
  • the identification and processing of all the relevant data associated with the leases was complex and required management to apply significant judgement.

The above judgments were more prevalent in relation to the Group’s network infrastructure.

This matter is disclosed in the following notes to the consolidated and separate financial statements:

    

We obtained an understanding and evaluated the Group’s implementation process, which included consideration of the updated accounting policy and policy elections made against the requirements of IFRS 16.

We made use of our IFRS expertise to assess the appropriateness of the judgement applied by management in determining the lease terms, including taking into account the exercising of renewal options and determining the non-lease components included in the lease payments. We further made use of our actuarial expertise to calculate the lease discount rate. We assessed information against lease contracts, as follows:

  • Compared the lease term applied to factors such as the Group’s business planning cycle, past history of terminating or not renewing a lease, how far into the future the renewal option is exercisable, and the likelihood of renewal/termination options being exercised. Based on the work that we performed, we accepted the lease terms;
  • Obtained management’s calculation for allocating lease payments between lease and non-lease components and assessed the appropriateness of the assumptions applied in this allocation with reference to factors such as the relative standalone selling prices. Where the relative standalone selling prices could not be determined we assessed management’s estimate which was based on the average percentage split of similar leases where suppliers had provided a split between lease and non-lease components. We did not identify material differences; and
  • Using our actuarial expertise, we evaluated the appropriateness of the incremental borrowing rate with reference to market related borrowing rates prevalent in the country. We did not identify material differences.

We further performed the following procedures on a sample basis:

  • Tested the accuracy of the underlying lease data by agreeing the information to original contracts;
  • Agreed the lease data from the third-party lease administrator to the input data used in the IFRS 16 calculations, to evaluate whether the data was complete;
  • Agreed lease payments to the underlying lease contracts after taking into account any allocation between lease and non-lease components as detailed above; and
  • Tested management’s assessment of the recognition exemptions in relation to short-term leases or leases for which the underlying asset is of low value against the requirements of IFRS 16.

In performing the procedures described in the above 4 bullet points, we did not note material differences.

We assessed the mathematical accuracy of the IFRS 16 calculations for the entire population by performing an independent recalculation of the expected IFRS 16 adjustment.

We assessed the adequacy of the Group’s disclosures made in the financial statements pertaining to leases, including checking whether the disclosures relating to transition to IFRS 16 were in accordance with the requirements of IFRS.
Assessment of impairment of goodwill, investment in Business Connexion Group Limited (BCX) and property, plant and equipment (applicable to the consolidated and separate financial statements)     How our audit addressed the key audit matter

The Group’s net assets include R1.3 billion of goodwill at the reporting date. The goodwill is attributable to two cash generating units (CGUs), Telkom and Business Connexion Group Limited (BCX).

The Group assessed internal and external indicators of impairment of the CGUs.

Key indicators of impairment included the market capitalisation which fell below the net asset value; the budget was not achieved in 2020 due to a decline in fixed line revenue; and the impacts of COVID-19 on the macro-economic environment, contractual obligations and the supply chain, which may trigger impairment of the underlying assets.

As required by International Accounting Standard 36, Impairment of Assets (IAS 36), the Group performs an impairment assessment of goodwill on an annual basis and when impairment indicators are identified.

The goodwill impairment assessment was a matter of most significance to our audit of the consolidated financial statements due to the significant judgements and assumptions made by management when performing the impairment assessment, and in estimating the key assumptions applied, particularly:

  • BCX cash flows are generated using Telkom’s network assets. A fair value contributory asset income/charge was derived for the use of the network asset between Telkom Company and BCX, which informed the identification of BCX as a separate CGU;
  • Weighted average cost of capital discount rate (WACC);
  • Cash flow forecasts in particular the revenue growth rates and EBITDA margin;
  • Terminal growth rates; and
  • Forecast period.

For the year ended 31 March 2020 management performed an impairment assessment over the goodwill balance by doing the following:

  • Assessing the recoverable amount through determination of a value in use amount and comparing this to the carrying amount, and if an impairment was identified, performing a fair value less costs of disposal calculation to determine the highest recoverable amount;
  • A five-year period was used for the discounted cash flows;
  • The valuation was performed taking into account the impacts of IFRS 16;
  • The value in use for each CGU was calculated using a discounted cash flow model; and
  • Performing a sensitivity analysis over the Telkom CGU value in use calculations, by varying the key assumptions used (terminal growth rate and the discount rate) in order to determine if a reasonably possible change in these key assumptions would cause the carrying amount of the Telkom CGU to exceed its recoverable amount.

This matter is disclosed in the following notes to the consolidated and separate financial statements:

In addition to the goodwill in the consolidated financial statements, the impairment considerations apply equally to the investment in BCX and the property plant and equipment (PPE) in the separate financial statements.

    

We evaluated management’s identification of the Group’s CGUs based on the smallest identifiable Group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or Groups of assets. A key consideration in this evaluation was the assessment of the Enterprise cash flows within BCX which are generated using Telkom’s network assets. The fair value contributory asset cash flows were assessed to be correctly included in the calculation of the recoverable amount of the BCX CGU which supported the identification of BCX as a separate CGU.

We tested the mathematical accuracy of the value in use model used by management and found no material differences. We also assessed the appropriateness of the valuation model applied by management, with reference to market practice and the requirements of IAS 36.

We assessed whether the impact of the implementation of IFRS 16 was included in the valuation model used by management and noted that the cash outflows in respect of the lease payments were excluded from the model, and the discount rate was adjusted to include the lease liability and the cost of leasing as required by IAS 36.

We assessed the reasonability of the respective CGUs’ budgets included in the business plans (which forms the basis of the cash flow forecasts) through discussions with management regarding the process followed to develop the budgets, forecasts and the assumptions utilised. We also compared the prior year budgets to the current year actual results to understand the efficacy of management’s budgeting process and found that the budgeting inputs were reasonable.

We assessed the assumptions contained within the calculations including growth assumptions, discount rates and implications of industry changes. Our audit procedures included:

  • Agreed the revenue growth rates and EBITDA margins used to calculate cash flow forecasts to the latest Board approved budgets, both of which cover a period of five years. We further benchmarked the revenue growth rate assumptions to industry data, history and noted the forecast assumptions to be within a reasonable range;
  • Compared the terminal growth rates to forecast industry trends and to past growth rate trends. This was found to be within a reasonable range;
  • Enquired from management regarding the adjustments made to the approved budgets by the Group with respect to cost saving initiatives and evaluated management’s explanations and supporting information in order to assess the reasonability of these adjustments. No material exceptions were noted; and
  • Evaluated whether the assumptions used, such as working capital and capital expenditure, had been determined and applied consistently across the CGUs. We agreed the capital expenditure to the approved budget. For the fair value contributory asset income/ charge with respect to the use of Telkom’s network assets, we assessed the reasonability of management’s calculation through discussions with management regarding the process to develop the fair value charges as well as the assumptions utilised, and traced these into the valuation models.
Assessment of impairment of goodwill, investment in Business Connexion Group Limited (BCX) and property, plant and equipment (applicable to the consolidated and separate financial statements)     How our audit addressed the key audit matter

The Company holds a 100% interest in BCX and accounts for this investment as a subsidiary in terms of International Accounting Standard 27 – Separate Financial Statements (IAS 27).

Under IAS 36, the Group is required to test investments in subsidiaries carried at cost for impairment if there is an indicator of impairment. Management identified an impairment indicator regarding the material investment in BCX due to the matters noted in the goodwill section above and performed impairment tests as a result.

PPE consists mainly of network equipment. The network equipment within the Company does not generate cash inflows that are largely independent of those from other assets or Groups of assets. This resulted in PPE having to be assessed for impairment as part of the Telkom CGU. The recoverability of PPE is largely dependent on macro-economic factors, which includes cash flows to be generated through the network assets, as well as internal assumptions and estimates related to realisation levels and operating costs. The impairment test included assessing the recoverable amount of PPE, with reference to all cash flows (including the fair value contributory asset income), and comparing this to the carrying amount of the PPE.

The impairment of the investment in BCX and the PPE is a matter of most significance to our audit of the separate financial statements due to the significant judgements and assumptions made by management when performing the impairment assessment, and in estimating the key assumptions applied, as specified under the goodwill section above.

This matter is disclosed in the following notes to the consolidated and separate financial statements:

    

Utilising our valuation expertise, we independently sourced data such as the long-term growth rates and WACC, cost of debt, risk-free rates in the applicable market, market risk premiums, debt/equity ratios, as well as the beta of comparable companies. We independently calculated a discount rate for each cash generating unit using our independently sourced data. This was compared to the discount rates used by management. We found the discount rates used by management to be within acceptable ranges of our independent calculations.

We performed independent sensitivity analysis to determine the minimum changes in discount rates and terminal growth rates that would result in no headroom being available, and compared our results to that of management in order to identify those cash generating units considered sensitive to a change in assumptions for disclosure purposes.

We assessed the appropriateness of the disclosures in the consolidated financial statements as set out in Note 2.5.4, 12 and 14 against the requirements of IAS 36.

With respect to the investment in BCX in the separate financial statements, we compared the recoverable amount of the BCX CGU as determined by the procedures above to the carrying amount of the investment in BCX and noted the value in use range exceeded the carrying amount of the BCX investment.

With respect to the PPE in the separate financial statements, we compared the recoverable amount of the Telkom CGU as determined by the procedures above to the carrying amount of the Telkom CGU which includes PPE and goodwill, and noted no impairment was necessary.
Other information

The directors are responsible for the other information. The other information comprises the information included in the document titled “Telkom Annual Financial Statements for the year ended 31 March 2020” , which includes the Directors’ Report, the Audit Committee Report and the Certificate from the Group Company Secretary as required by the Companies Act of South Africa, which we obtained prior to the date of this auditor’s report, and the document titled “Telkom SA SOC Limited Integrated Report for the year ended 31 March 2020”, which is expected to be made available to us after that date. The other information does not include the consolidated or the separate financial statements and our auditor’s report thereon.

Our opinion on the consolidated and separate financial statements does not cover the other information and we do not and will not express an audit opinion or any form of assurance conclusion thereon.

In connection with our audit of the consolidated and separate financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated and separate financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated.

If, based on the work we have performed on the other information that we obtained prior to the date of this auditor’s report, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.

Responsibilities of the directors for the consolidated and separate financial statements

The directors are responsible for the preparation and fair presentation of the consolidated and separate financial statements in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa, and for such internal control as the directors determine is necessary to enable the preparation of consolidated and separate financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated and separate financial statements, the directors are responsible for assessing the Group and the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group and/or the Company or to cease operations, or have no realistic alternative but to do so.

Auditor’s responsibilities for the audit of the consolidated and separate financial statements

Our objectives are to obtain reasonable assurance about whether the consolidated and separate financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated and separate financial statements.

As part of an audit in accordance with ISAs, we exercise professional judgement and maintain professional scepticism throughout the audit. We also:

  • Identify and assess the risks of material misstatement of the consolidated and separate financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
  • Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s and the Company’s internal control.
  • Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by the directors.
  • Conclude on the appropriateness of the directors’ use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Group’s and the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated and separate financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Group and / or Company to cease to continue as a going concern.
  • Evaluate the overall presentation, structure and content of the consolidated and separate financial statements, including the disclosures, and whether the consolidated and separate financial statements represent the underlying transactions and events in a manner that achieves fair presentation.
  • Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the Group audit. We remain solely responsible for our audit opinion.

We communicate with the directors regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide the directors with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.

From the matters communicated with the directors, we determine those matters that were of most significance in the audit of the consolidated and separate financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.

Report on other legal and regulatory requirements

In terms of the IRBA Rule published in Government Gazette Number 39475 dated 4 December 2015, we report that PricewaterhouseCoopers Inc. and SizweNtsalubaGobodo Grant Thornton Inc have been the joint auditors of Telkom SA SOC Limited for 2 years.

PricewaterhouseCoopers Inc.
Director: KJ Dikana
Registered Auditor
Johannesburg

20 June 2020

    

SizweNtsalubaGobodo Grant Thornton Inc.
Director: GM Hafiz
Registered Auditor
Johannesburg

20 June 2020

PricewaterhouseCoopers Inc., 4 Lisbon Lane, Waterfall City, Jukskei View, 2090

Private Bag X36, Sunninghill, 2157, South Africa T: +27 (0) 11 797 4000, F: +27 (0) 11 209 5800, www.pwc.co.za

Chief Executive Officer: L S Machaba

The Company’s principal place of business is at 4 Lisbon Lane, Waterfall City, Jukskei View, where a list of directors’ names is available for inspection.

Reg. no. 1998/012055/21, VAT reg.no. 4950174682.

    

SNG GT Grant Thornton, 20 Morris Street East, Woodmead, 2191

P.O. Box 2939, Saxonwold, 2132, T: 011 231 0600

SNG GT Grant Thornton are a member firm of Grant Thornton International Ltd (GTIL). GTIL and the member firms are not a worldwide partnership. Services are delivered independently by the member firms. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another’s acts or omissions.

SizweNtsalubaGobodo Grant Thornton Incorporated Registration Number: 2005/034639/21

Victor Sekese [Chief Executive]

A comprehensive list of all Directors is available at the Company offices or registered office