ARMSCOR Annual Report 2012 briefing, Defence Budgetary Review & Recommendations Report adopted

Meeting report

ARMSCOR 2011/2012 Annual Report briefing
Mr Sipho Mkwanazi, Acting Chief Executive Officer, ARMSCOR, presented an overview of the ARMSCOR 2011/2012 Annual Report and said that the issue of having an acting Chief Executive Officer would soon be resolved, as the new Minister of Defence and Military Veterans had set into motion the process of finalising a permanent appointment.

He added that ARMSCOR had put a strategy in place to address the challenges that it was facing, particularly on financial sustainability. It had set in motion meetings to work together with the National Conventional Arms Control Committee (NCACC). It had also been dealing with issues relating to the majority shareholding of South African defence companies, and the Defence Industry Participation (DIP) programme was particularly important in dealing with its defence acquisitions. The issue of how to make ARMSCOR’s dockyard sustainable and able to provide services for the South African Navy was important, and a process was in place as companies had already been asked to show interest in assisting financially with this. It had begun to work diligently to implement this new strategy.

Mr Mkwanazi said that, in terms of the overall organizational performance of the corporation, there had been success. It had achieved a clean audit with no qualifications and most of the corporate goals were achieved or exceeded, although there were still some areas that needed improvement. It had realised a profit of R73.3 million, which was an improvement on the previous year.

He said that the highlights of the Acquisition Programmes were the winding down of the Strategic Defence Package (SDP) and the focus on its support and maintenance, while the major capital programmes had performed well. In its human resources, ARMSCOR was still facing challenges with gender balance and the retention of skills and talent, but it had achieved most of its goals in this area. It managed to retain critical skills by achieving a staff turnover of 2.4% in technical positions, excluding retirements. Transformation was a continuing process but the organisation was moving towards reflecting the demographics of the country with its employment equity requirements. In relation to compliance, in 2008, surveillance audits had been conducted by SABS and certification as confirmed.

Mr Mkwanazi said that ARMSCOR had been involved in two major social investment programmes in the year under review. The first was the School Learner Enhancement Programme for nine schools in Pretoria, while the second was an initiative to donate 75 computers and related software to three schools in Prieska for learning purposes. The impact of these programmes, in terms of academic performance at those schools, would be available in the next reporting period.

Mr Mkwanazi moved onto the review of operations, involving acquisitions of maritime, airborne and landward systems as well as the dockyard research and development. There were two maritime system acquisitions, being the MEKO A-200 Frigates, and the Type-209 Submarines. The Frigates were focused on the completion of the systems integration and performance acceptance of the 35/65 Double Purpose Gun (DPG) system, while the Submarines, of which three were commissioned, focused on implementing engineering changes to be completed during 2012.

There were many airborne system acquisitions, with one project being closed. There were 30 Light Utility Helicopters (LUH) that were updated to the final production standard. The Airbus A400 Strategic Heavy Lift Transport Aircraft project orders had closed and Airbus Military had reimbursed ARMSCOR with all the advance payments, plus interest and escalation. 22 out of 26 Gripen aircraft had been delivered in the financial year, but the remaining four had been delivered after the end of this period. The integration of the A-Darter Missile with these had been completed. The Hawk fleet had been fully operational and had achieved 1 650 flying training hours during 2011/2012. Eleven Rooivalk helicopters had been upgraded and delivered in the year, while 39 Oryx Medium Transport Helicopters (MTHs) were being upgraded by DENEL Aviation, but had experienced delays, and this programme was set for completion in November 2014. There had also been delays in the A-Darter Missile development programme due to technical risks.

ARMSCOR had made two landward system acquisitions in the year. The Ground Based Air Defence System had been subject to delays as a result of technical problems, but was now back on track. The development and delivery of the new Local Warning Segment of this programme had been completed and qualified for delivery to the SA Army. The New Generation Infantry Combat Vehicle was undergoing final environmental testing and evaluation.

The research and development progress during the year had been in aerospace technology and support technology. The technology demonstrator of the Precision Bomb Guidance Kit that was attached to existing bombs had been successfully tested in 2011 and had matured enough to implement. The BIO-CHEM Laboratory technology demonstrator for field experimentation was completed and handed over to the South African Military Health Service (SAMHS).

The dockyard, despite challenges of insufficient funding, achieved 88% compliance against a target of 90% during the year under review. As stated before, a process has already been implemented to make the dockyard capable of meeting all the requirements of the SA Navy.

Mr Mkwanazi gave a brief financial overview of the year. The net asset value of the organisation had increased by 13.2% to R627.1 million, due to surplus in the period, while total revenue had increased by 6.1% to R1.07 billion. There were numerous factors that influenced the financial position positively. There had been an increase in allocation for operating expenditure as a result of payment for services rendered, due to scope increase, and reduced spending on other expenses as a result of continuous effort to reduce costs and increase efficiency. There was a strategic decision to delay IT related expenditure. Finally, an increase in investment revenue generated and actuarial gain was recognised from post-retirement medical benefits.

Mr Mkwanazi said that ARMSCOR had achieved four out of the six strategic objectives measuring functions in terms of the Service Level Agreement (SLA) with the management of the dockyard and contracting acquisitions objectives not fully fulfilled.  The strategic goals that had been achieved related to funding and growth of people and capabilities, Broad Based Black Economic Empowerment (BBBEE), stakeholder relationships and operation efficiency. The local industry objective was not achieved, as spending on local industry was affected by large foreign payments.

Mr Mkwanazi explained that there were four main challenges that ARMSCOR faced. The first was financing the corporation, as the current funding model had a negative influence on the ability to rejuvenate the workforce. There needed to be renewal of infrastructure, particularly with IT application systems, and maintaining technical capabilities. Therefore, a new funding model was being developed which was based on levying charges for services rendered. The second challenge concerned the insufficient funding of the dockyard, which had been previously explained. The third was the management of DIP obligations, as the focus on sales rather than on technology transfer and investment made it difficult to show its impact on the economy. Fourthly, transformation of the defence sector was still a major challenge as foreign majority share ownership in South African defence companies was still prevalent, and there was a general reluctance by the industry to implement employment equity and BBBEE.

Discussion
Ms P Daniels (ANC) asked within what timeframe the final Chief Executive Officer appointment was likely to happen.

Mr Mkwanazi said that the process to appoint a CEO was complete, and a report was now being made to the Minister.  There was a deadline to finish the process in October and ARMSCOR was on track to do this.

Ms Daniels asked for more explanation on the new funding model that would be based on levying charges for services rendered, and about the standards of the Hawks, Gripens and other new acquisitions and the structure of people for whom these were designed.

Mr J Grobler, Chief Financial Officer, ARMSCOR, explained the new funding model further. He said that the income would be derived from transfer payments from the Department of Defence, finance income on investments, and sales. The model did not make provisions for increases in cost. In terms of external income, ARMSCOR always levied charges. This kind of model had also worked for different countries such as Singapore and Germany.

Mr Maomela Motau, Chairperson of the Board of ARMSCOR, said that the interface of the system, in terms of structure relating to features such as size and height was done by the Ergonomic department of ARMSCOR, which was in a position to structure machines in accordance with people’s individual requirements.

Ms Daniels noted that this Committee had been told, by the Portfolio Committee on Public Enterprises, that Denel had a problem with ARMSCOR. Both were parastatals. She requested more information and clarification on this.

Ms H Mgabadeli (ANC) noted that there were further delays and problems with DENEL and asked for assurance that these problems would not have to be dealt with again.

Mr Motau responded that this was not entirely true, and that there was a quite good relationship between Denel and ARMSCOR, but there were certain legal challenges. ARMSCOR could not tolerate Denel selling majority holdings in certain defence companies, and also had to enforce the law, which was the reason why ARMSCOR also demanded of Denel that it perform according to set contracts, despite the fact that Denel was expecting special treatment. This was not a problem with Denel itself, but was related to the duty to enforce a contract. He explained that members of the Board had gone to different countries, but been informed that ARMSCOR could not hold majority shares in other countries. Only European countries could buy shares in most foreign defence companies. Therefore, ownership of South African companies also needed to be guarded carefully.

Ms Daniels said that according to the Auditor General, even though there was an unqualified report, there were challenges with IT. She asked what was in place to deal with the IT problems.

Mr Mkwanazi explained that the previous IT contract was not good but the previous Board kept on renewing it, despite the fact that this contract effectively allowed the IT companies to hold ARMSCOR to ransom. The Auditor-General had commented adversely on this contract. The Board indicated that it was waiting for the contract to expire, and had a strategy and task team to ensure progress in terms of IT. After approval by the board, the new strategy would be shared with the Committee.

Ms Daniels said that the issue with the A400 airbus had been problematic for a long time and asked for further details.

Mr Grobler explained that the A400 Airbus programme was terminated because timelines and schedules could not be met, in accordance with the contract. The amount was paid with all interest in incurring costs to ARMSCOR and there were no further costs.

Ms Daniels asked if ARMSCOR was supposed to deal with the incinerator or just commission it.

Mr Motau said that the disposal plant for the South African Defence Force (SADF) was a homegrown system used to dispose of weapon systems and ammunitions. ARMSCOR had looked into foreign companies for this because it was uncertain how effective this homegrown system would be.

Ms Daniels asked who funded the dockyard and how it could become sustainable in the future.

Mr Grobler said that the dockyard was funded mainly by SA Navy and that, currently, funding was based on actual work from 2007. There was a need to rejuvenate this old dockyard but SA Navy funding was not sufficient to do so, with the result that external funding was being investigated. The intention was eventually to make the dockyard self-sustainable.

Ms Daniels asked for more detail on the business ARMSCOR did internationally, and within South Africa.

Mr D Maynier (DA) said that previous annual reports had indicated that the DIP programme has been a success, particularly compared to Department of Trade and Industry National Participation Programme. The current report, however, indicated that management of the DIP programme was not ideal, that it had limited success and that ARMSCOR could not even measure the impact of the DIP programme on the economy. He asked if this was now a case of ARMSCOR misleading Parliament, or if there was something wrong with the DIP programme before. He asked if some companies exchanged credit within themselves and others acted as agents or bought them out. He said the information given on the DIP programme raised questions on effectiveness of technology transfer. He requested a detailed explanation on what the problem was with companies, and the programme, with examples.

Mr Motau did not believe that there was any deliberate effort to mislead Parliament by the previous board on the DIP programme. However, when the new board did an assessment of the programme, it had isolated some areas that the old board may have missed. The new Board had looked at funding challenges, and through this process came to the conclusion that something was not right with the programme. The new Board had gone to individual companies who had problems with the DIP funding, and, having conducted an analysis, thought that the previous way of handling matters had not been ideal. This was an issue very close to his heart and he hoped that he could give more details and a better reflection on it in the next report. The majority of income was on sales, and it needed sustainable programmes including more investment programmes and technology transfers into the future.

Ms H Mgabadeli (ANC) asked why ARMSCOR was concentrating its social investment in Pretoria and not elsewhere.

Ms N Mabedla (ANC) said she welcomed the social investment and school programmes but would like to see more.

Mr Motau noted that the social investment programmes of ARMSCOR only operated in areas where there were plants, but acknowledged the need to stretch to new places.

Ms Mgabadeli asked for clarification on the technical problems that delayed the Ground Based Air Defence System.

Ms Mgabadeli congratulated ARMSCOR on its success with BIOCHEM.

Ms Mgabadeli asked what the foreign majority share ownership in SA Defence companies were and if ARMSCOR did business with private security companies.

Mr Mkwanazi said that ARMSCOR did not do business with private security companies, but that it was looking to improve relationships with them. ARMSCOR did make use of security companies to guard their facilities, but not in terms of acquisitions and sales. The question on ownership was answered earlier.

Ms Mabedla commented on numerous errors in the report, referring specifically to the Rooivalk helicopters numbers being delivered, and asked if ARMSCOR had a chance to update the presentation She said there was out of date and contradicting information which made the report less credible.

Mr Mkwanazi said that it was a technical issue, and that the report may have looked as if it was out of date with some figures since presented, because of the dates that the report covered. This report ran up to the end of the financial year; to April 2012. The presentation figures had been updated after the end of the financial year, but the report still detailed the progress taking place in the year in question.

Ms Mabedla noted the reluctance by industry to implement employment equity and BBBEE and asked what ARMSCOR’s intervention in this was. She asked about retention of skills, the staff turnover of 2.4% and if ARMSCOR had reached its targets, as also for a report on what was being done to correct the gender balance.

Mr Motau answered that ARMSCOR had taken steps to ensure companies attempted to meet BBBEE requirements and it had blacklisted a company that did not attempt to meet BBBEE requirements. As public representatives, it was important that ARMSCOR inform the Committee why the company was blacklisted.

Mr Motau added, in relation to skills, that ARMSCOR had bursaries, a talent development pool, and a specific employment process for transformation and gender equality, but it was still difficult to make progress. It was very difficult to attract women to the industry, but it was trying to prioritise equality with such bursaries.

Mr Grobler added that ARMSCOR had managed to reduce its staff turnover to 2.4%. 
 
Mr S Esau (DA) asked for an explanation of the underspending on personnel costs, and noted that such reduced spending had been highlighted as a factor that affected the financial position positively. However, he commented that only some critical positions had been filled, and said it was a contradiction as this in fact meant that full efficiency could not be achieved.

Mr Mkwanazi confirmed that all the critical positions had been filled.

Mr Esau asked if there had been any corrective measures between the Accounting authority and the Executive authority, to ensure that the shareholders’ contract was updated every year.

Mr Esau commented that although the issue of IT had been addressed earlier, he was still not happy with the response. ARMSCOR had to have a world-class system and it was counterproductive to not have such a system in place.

Mr Esau wanted clarification on ARMSCOR’s role in sales. He said in terms of the new funding model, ARMCOR needed to be clear on the direction that it were taking and what planning was taking place to be make it sustainable. He also raised the issue of unrecovered debt, and urged that that there should be no waste. Mr Esau asked if the internal controls were effective in the organisation and if measures were put in place to make sure mistakes were not repeated.

Mr Mkwanazi said that there was a decrease in sales as a result of the transportation of the SDPs.

Mr Maynier noted that the Annual Report stated that R50 billion of DIP obligations had been met. The new board’s review had found that the calculation was probably incorrect. He asked if it had revised this value. He asked what the names were of the companies that were the primary wrongdoers in relation to this. He also wanted reassurance about the board about the issue of the former Minister of Defence firing the Chairman of ARMSCOR last year, and the new Minister then confirming that the Chairman was not fired. He asked for clarification on what happened and the facts involved.

Mr A Maziya (ANC) raised a point of order, saying that the dismissal of the CEO was not a matter resting with the current board, and that there should not be disclosure of the names of specific companies. He asked for a ruling that these questions not be answered.

The Chairperson said that there was no dispute in the Committee about who the Chairperson of the board of ARMSCOR was.

Mr Maynier replied that this was where the Committee needed to ask the hard questions, and hold ARMSCOR accountable for its actions.

The Chairperson reiterated that it did not have a dispute, and ruled that the question not be answered.

Mr Maynier objected to this as he felt that the Committee should not shut down the hard questions.

Ms Daniels said that there was no report to the Committee that the CEO of ARMSCOR was fired.

Mr Motau responded that Mr Maynier’s questions were difficult to answer, in terms of names of companies.

Mr Maynier hoped that the Committee could create an opportunity for ARMSCOR to explain its new strategy, as he was under the impression that it was rejected by the Department of Defence. He wanted confirmation of this and asked if it had been approved within ARMSCOR and by its shareholders.

Mr Motau responded that he was not aware of the strategy being rejected by the Department of Defence and that it was the responsibility of the board to run ARMSCOR. He was aware of debates, but said that there had been no rejections. The Minister knew of the strategy, although it may be that some people were resisting change.

Mr Maynier understood that the firing of the A-Darter Missile was not going well, and asked it was successful. If not, he asked if it was because of the budget or the impact of the scheduling.

Mr Motau responded that there were invariably challenges and problems with development programmes. The A-Darter missile was a development programme and therefore faced such challenges and problems. The budget was between R600 million and R1 billion.
 
Ms Daniels asked when ARMSCOR would get capabilities with local companies that had sold shares to foreign companies, if the capabilities did not lie with DENEL. She wondered if this was suggesting that these companies sold to the highest bidder. She asked if ARMSCOR had no control of the shareholdings.

Mr Motau said that sovereign technologies were technologies that states wanted to keep under their own control. Reunion was French and therefore would not deal with their sovereign technologies. This meant that ARMSCOR was sometimes unable to sell equipment in some places. He confirmed that DENEL was owned 100% by the state.

Draft Budgetary Review and Recommendations Report (BRRR) of the Committee
The Chairperson asked Members to move straight to the Recommendations section of the Budgetary Review and Recommendations Report (the Report) , unless there were other issues.

Ms Daniels said that the report talked about the Department of Defence being cash strapped and increasingly difficult to handle. Under the recommendations, there was no mention of the Department of Military Veterans, and she asked for a recommendation on the Department of Defence providing funding for the Department of Military Veterans.

Mr Esau said that a reference had been made in the report that dealt with military veterans, and that a separate recommendation would be included on this.

The Chairperson confirmed that the Committee would be making another report on the Department of Veterans.

Mr Maynier said he would like to address the process. He felt that the Committee was not in a position to properly assess the Department. The structure of the hearings was completely inadequate, and there was not enough time to consider issues. In addition, there were not sufficient levels of transparency and Members knew nothing about the Department’s acquisitions budgets. He strongly believed that since the Committee had not enough information, it was unable to come up with a credible BRRR Report.

The Chairperson asked for any other recommendations on amendments to the Report.

Mr Esau recommended that the Report should capture that the timeframes were unreasonable. Reporting on the other reports took a long time and this then left insufficient time to produce the BRRR report. He felt that the Annual Report briefings should be shifted two weeks or a month earlier. This Committee had not been able to conclude hearings on all the Annual Reports yet, including the Department of Military Veterans. It was unfair to make recommendations without information.

Ms Daniels said that the Committee could still deal with outstanding reports. She proposed that the Committee adopt the BRRR.

Mr Maziya seconded the adoption.

Mr Maynier objected to the adoption of the BRRR, but the majority of Members voted in favour of it.

The meeting was adjourned.