Denel & SA Express Airways turnaround strategies

Meeting report

Opening Remarks by Denel board chairperson
Denel board chairperson, Ms Monhla Hlahla, introduced herself and new interim board members since April. There was also an Acting CEO, Mr Mike Kgobe, previously at Denel Aeronautics, and Acting CFO, Mr Gawie Van Zyl, who was appointed a few months ago because of the disciplinary process which was under way regarding the current CFO. Upon appointment of the new board and executives four months ago, they were tasked with curbing what was a serious liquidity crisis, stabilising the business within the first year of tenure. The second year expectation would be to present a corporate plan informed by robust strategy going forward, ultimately ensuring that Denel would be in a befitting position for South Africa in future. Since appointment, she assured that Committee that the new executives were not only trying to understand the depth of the serious cash flow problems, but the presentation would also feature some small victories en route to the goals. Leadership is an important aspect which would be mentioned because it deals with a pertinent aspect related to the organisation: State Capture, VR Laser and Denel Asia. The board had to understand and manage these aspects. Fortunately, the new board and executives had managed to come to an agreement with the previous CEO swiftly, he left within the first month of the arrival of the new appointees. An advert had been placed in terms of the PFMA to source a strong commercial leader for the organisation. The disciplinary process of the CFO would be clarified at a later stage. Disciplinary action was ongoing and would hopefully be finalised by the end of this year.

One of the most noteworthy changes brought by the new executive team is that the Auditor General is now the External Auditor for Denel. This had strengthened the organisation tremendously. This has also meant that the audited financial statements would be presented only a month later and the Denel team would come to parliament and present them. The move would also ensure that credible statements would be presented to not only Parliament, but also to shareholders, bond-buyers and the public.

Denel briefing on addressing governance challenges
Mr Mike Kgobe, Acting Group CEO, was grateful for the opportunity to contribute to the turnaround of Denel, an organisation which is important for the economy of South Africa. His presentation gave an overview of Denel, its state of governance and how lapses in governance had impacted the company, initiatives to correct deficiencies at Denel, the process related to the Auditor General, anticipated audit outcomes for 2017/18 and insight into the revised 2018/19 Corporate Plan, submitted at the end of June 2018.

Overview of Denel
Denel is a state-owned commercially-driven company and a strategic partner for innovative defence, security, aerospace and related technology solutions. It is a key partner to the South African National Defence Force. The South African government is the sole shareholder. Denel services local and international markets and is part of the global defence supply chain. There had been some success previously in providing export revenue by way of penetrating international markets. As part of resuscitating Denel, it would be important to reposition it in the global supply chain. The shareholder representative, the Minister of Public Enterprises, appoints a Board of Directors to direct and oversee the functioning of the company. Denel is governed by all legislation, applicable to the South African state, including the Public Finance Management Act (PFMA), the Companies Act, and Preferential Procurement Policy Framework Act (PPPFA). Denel is managed through a shareholder compact, signed between the Shareholder and Denel annually. The process for finalising the targets of the Corporate Plan was still in progress, given that the Corporate Plan in place at the time had old targets. These targets would be reported on at the end of the financial year.

Denel would be looking to reposition itself in order to be a significant player in the cyber security space. The structure has operating divisions in the land and naval environment. It also has strategic equity partners in companies such as Pioneer Land Systems, Reinnmetall Defence, Pamodzi Group and Tawazun Dynamics, which is domiciled in the United Arab Emirates. Denel’s offering includes artillery, security and border control, naval, aerospace, infantry as well as training done by the Denel Technical Academy.

Mr Kgobe said that the 2017/2018 financial year  was still being audited by the Auditor General. In most cases, there were lapses in management which had negatively affected the performance of the company. Some key objectives for driving change would be:
• Significant increase in order book that can be converted to cash generated revenue
• Strong relationships with customers and stakeholders, which had been strained due to its liquidity crisis the • Leverage smart partnerships, which had also been affected by the status quo.
 

In order to increase productivity, efficiency and profitability, Denel would:
• Ensure focused managing of working capital, which had been below par.
• Attain operational excellence in contract execution, which the company had not delivered on.
• Optimise the cost structure, which was a process which the organisation still needed to undergo.
• Secure lucrative contracting
• Achieve profitable cash returns
• Restructure the debt profile
• Realise a strong balance sheet, which was yet to be realised owing to the poor state of company finances.

Denel was still deficient in fostering innovation and enhancing capabilities because of the troubles faced. The company was also dealing with low morale. Denel had come fom a strong product base. However, it would need to acknowledge and deal with key challenges it was facing:
• Governance
• Programme Execution
• Capability Retention
• Market Access
• Cost Efficiencies
• Capital Structure
• Liquidity
• Technology Access

Background
Denel has suffered serious reputational damage, lost credibility and support of stakeholders and will report a sizeable loss in the short term. Lapses in governance have resulted in the following:
• Denel being implicated in the Public Protector’s State of Capture Report;
• Formation of the Denel Asia Joint Venture without approval from Department and National Treasury;
• Liquidity crisis and suppliers withholding deliveries due to delayed payments;
• Entering into loss making contracts;
• Huge loss forecast for 2017/18.
• Increase in irregular expenditure due to procurement without following due process;
• Flouting of policies and neglect of established processes in awarding of bursaries
• Knowingly entering into loss making contracts;
• Irregular appointment of staff and business partners;
• Allegations of fraud and corruption by employees, third parties and collusion with third parties;
• Formation of a parallel management structure that excluded the rest of management from decision making in the form of the Central Executive Committee.

Impact of Governance Lapses On Performance
The loss of confidence from stakeholders including funders and primary bankers resulted in:
* Accelerated repayment terms of loans;
* Cash cover collateral requirement to issue guarantees;
* Unwillingness from funding institutions to extend credit and facilities to Denel
This contributed to the liquidity crisis which had a material impact on operations and the 2018 financial results including:
* Ability to execute on projects was negatively affected: R5bn revenue of compared to R8bn budget;
* Significant under-recoveries as resources could not be utilised efficiently, some employees were not fully repaid in terms of labour hours.
* Delay and overruns in projects as suppliers could not be paid and critical components and deliverables could not be sourced from supplier base;   
* Increased cost of funding and guarantees.
* Poor execution of major contracts.

Fixing Governance
* Executive changes led to the appointment of a new Minister at the Department of Public Enterprises
* Independent Board of Directors appointed with members qualified and experienced in various fields;
* Board has established a governance framework to provide oversight over the Denel Group;
* Group Executive Committee reinstituted inclusive of Group Functional Executives and Divisional Chief Executives to assist in the delivery of the Board mandate;

Mr Kgobe said that the Board has developed and is implementing a Governance Turnaround plan to restore Denel’s reputation and rebuild leadership credibility with key stakeholders, instil a governance culture underpinned by ethical values and integrity, ensure a sound internal control environment, restore Denel’s position as a strategic national asset and industry leader to customers, suppliers, employees, competitors, financial institutions and other key stakeholders.

As part of the turnaround strategy and rationalisaton of executive management, the Central Executive Committee which held responsibility and accountability for the day to day operations of the Denel Group has been disbanded and replaced with a Group Executive Committee Chaired by the Group CEO and inclusive of Divisional Chief Executives and Functional Group Executives. The strengthening of the management team encompassed the resignation of the previous Group Chief Executive Officer in May 2018. An Acting Group Chief Executive Officer was appointed. The position was advertised last weekend to fill the position with a permanent appointment.

The Group Chief Financial Officer has been placed on special leave to allow investigations and the disciplinary process into various matters relating to his alleged conduct. There had been an appointment of an Acting Group Chief Financial Officer to ensure continuity in the financial management of the business.

The previous Group Executive: Human Resources & Transformation had resigned in January 2018 and the position was filled by an acting appointee.

Cleaning up of Denel: Mismanagement and PFMA contraventions
A legal process was underway to deregister and unwind Denel Asia in collaboration with the Singaporean authorities, given that the entity was registered there. A panel of forensic investigators was due to be appointed shortly to probe procurement done.  A forensic firm was appointed to review transactions between VR Laser and the Denel Group’s entities.

Management has been instructed to correct the irregular appointment of employees and business partners. This includes the irregular award of bursaries. Irregular awarding of salary increases was under investigation. A whistle blowing hotline is in place and management was reviewing it to ensure credibility and effectiveness. Denel is supporting the DPE Complaints Management Process linked to the Presidential Hotline. Denel is co-operating with the Special Investigating Unit in investigations and undertaking lifestyle audits. An Irregular Expenditure awareness campaign is underway to educate employees on the necessity to comply with the policy, legislative and regulatory requirements. Denel is reviewing its supply chain processes to reduce the risk of non-compliance with the PPPFA.

Progress on the clean-up: Investigations into dubious transactions were instituted by the Board. There were completed investigations and termination of irregularly awarded bursaries. Investigations into other irregular procurement transactions was in progress. There was a completed review into suspect transactions including irregular employee appointments. There was a completed review into the establishment of Denel Sovereign Security Solutions (S3). Management was mandated to take appropriate action where necessary. A multidisciplinary team was established to assess irregular, fruitless and wasteful expenditure and oversee consequence management. There was cooperation with the Special Investigating Unit and the South African Police Service (Hawks for the bursary case). An audit is underway to assess the irregularity of salary increases and adjustments between 1 November 2015 and 31 March 2018.

Improving Performance for Long-term Sustainability
A revised Corporate Plan approved by the Board was submitted to the Minister of Public Enterprises on 30 June 2018. A Denel Workshop convened by the Department of Public Works and led by the Minister was held on 13 July 2018, with the board, executives and industry experts in attendance. There were revised targets for the Shareholder Compact for 2018/19 due for submission to DPE following a revised Corporate Plan. The board was supporting the formulation of a new Growth & Turnaround Strategy that will propel Denel into a sustainable future. This comprised of a workshop held on 27-28 August 2018 to chart a new path for Denel. The process to appoint a permanent Group CEO had commenced. There was a process underway to establish a shared services model across the Group for support functions (ICT, ERP System, Human Resource Management, Financial Services Centre and Supply Chain Management). A process to reduce costs across its departments was instituted. There was also a process underway to establish Centres of Excellence for cross cutting technical areas across the Group (Common Engineering Functions, Training & Development etc). Denel needed to normalise its capital structure and inject sufficient liquidity to unlock operations. Denel had requested that current guarantees of R3.3bn that mature in September 2018 be rolled over. Denel had applied for a further R1bn guarantee to pay creditors and unlock operations. There was a request to government to bankroll all guarantees (R4.3bn) for three years. Denel had also requested recapitalisation to normalise its capital structure.

Anticipated 2017/18 Audit Outcomes
Acting Chief Financial Officer, Mr Gawie Van Zyl, said there was a plan to conclude the audit at the end of September. However, there was a process running in tandem with the Auditor General on irregular expenditure, fixed assets, revenue recognition process which required additional work done by the Auditor General. The plan was thus to conclude by 30 September but to receive sign-off by the end of October.

Key indicative outcomes of the audit were:
* An adverse going concern status for Denel - leading to a matter of emphasis in the audit opinion
* A qualified audit opinion based on: assets still in use, whose usefulness has not been assessed and the inadequate identification of irregular expenditure
* Irregular expenditure identified by management amounts to R200m in 2017/18 and R116m in 2016/17
* Management had also disclosed possible irregular expenditure of R1.3bn which was under investigation
* A major contributor was inadequate deviation processes 
* Auditor General had indicated that disclosure by management was inadequate
* There would be final quantification at completion of the audit
* Denel had requested postponement of its AGM to last week of October 2018.

Ms Hlahla believed that a significant improvement in management meant that Denel would never again have those levels of wasteful expenditure and irregular expenditure and corrupt activities. Weak management or mismanagement had led to the unfortunate outcomes which had occurred. They were positive that by the end of the year, Denel would come back to Parliament to report how they had made headway in resolving some of ills mentioned by placing strong oversight, control and governance in the company, without stifling initiative and instilling a commercial mindset in the Group to stabilise and effect a positive and sustainable turnaround of Denel.

]Due to some Committee members engaged elsewhere, it was agreed that SA Express present immediately followed by an amalgamated discussion session].

SA Express turnaround strategy
Mr Kugan Thaver, SAX board member, issued an apology for the SAX board chairperson, Ms Tryphosa Ramano, who was booked off ill and unable to attend. Mr Thaver was requested by the board to present on its behalf. He introduced the SA Express team.

Overview of SA Express
The board was appointed on 24 May, the day on which the airline was actually grounded. The mandate of the new board was to look at governance as well as the stabilisation and sustainability of the airline. The board had to look specifically at the grounding of the airline and the withdrawal of the AMO (Airline Maintenance Organisation) and AOC (Airline Operation Certification), which were dealt with by the SACAA (South African Civil Aviation Authority).

With the intervention of the board, the secondment of an Intervention Team by DPE and management, the company had managed to secure the reinstatement of its AMO in June 2018 and AOC in July 2018. This was as a result of installing various mechanisms by the board to assist management such as a Finance and Crisis Committee to which board members were delegated. On a weekly basis, those board members would sit with management and go through various matters. This was done with a view of obtaining a better understanding of items, as well as to provide support in various stakeholder meetings. In addition, the board had ensured that all the relevant board subcommittees had been formed.

Mr Thaver acknowledged that governance is a major challenge at SA Express. There was a total collapse in governance at the time of the board appointment. The SACAA Finding Types ranged from Level 3 findings representing less serious safety/security compliance to Level 1, representing severe non-compliance/conformance. Level 1 findings were as a result of a lack of management oversight and safety management systems. The lack of safety management systems in turn was due to a lack of management oversight and a lack of adherence to procedures and unit policies. It was a dysfunctional organisation.

The board had decided to drive change using a five pillar strategic focus: Governance, Profitability, Operational Efficiency, Customer Value Proposition and Human Capital (G-POCH). Human Capital was one of the pivotal pillars in steering the organisation in the right direction, as it was important to have the right people, in the right place, empowered. This included ensuring that there was consequence management as the airline had an apparent culture in which people were never held accountable for their actions. This happened over a period of time. This could be related to previous management’s inaction. The grounding of an airline was a catastrophic event and the culture that led to it had to be rectified.

Post AOC and AMO reinstatement, funding was given attention, as it was a requirement to ensure that operations could commence. Thanks to the shareholder, the funding was in place.

SAX was in breach of having Annual Financial Statements. They had requested that the shareholder give them an extension. The board had reviewed the 2016/17 AFS and it was in the process of submitting this to the Auditor General. The 2017/18 AFS had been reviewed and would, subject to board approval this week, be presenting them to the Auditor General for audit. The idea was for the 2018/19 AFS to be much cleaner. The Auditor General findings were quite severe.

Human capital was a serious matter which was being dealt with. There was a process to appoint a permanent CEO and CFO within the next four months.

SAX had two routes: Johannesburg to Lubumbashi and Johannesburg to Bloemfontein. Another route was in the pipeline. Mr Thaver concluded that gradual progress being made by the organisation.

SA Express Interim CEO briefing
SAX Interim CEO, Ms Sizakele Mzimela, said that she was recruited initially as a part of the President’s Intervention Team when the airline was grounded in order to restore the licences which had been withdrawn.
The mandate of SA Express was the transportation of passengers and cargo as well as other aviation-related services. The focus was to provide consistent service on lower-density routes and use frequency to open such routes, both domestically and regionally.

Problem Statement prior to Suspension
By 2010, the company had a fleet of 23 fully-operational aircraft. Prior to suspension, despite being down to 22 aircraft, only 13 of those were operational (59%). SAX was trying to cover the SA Express schedule by bringing in chartered aircraft. This proved problematic for the SA Express system. Out of 17 domestic routes and six regional routes, only three domestic routes and two regional routes were profitable. On Time Performance was at its lowest at 65%, which spoke to customer relations and reliability of the organisation. Some of the reasons for the decline of SAX were a lack of leadership capacity, a dysfunctional organisation due to a lack of focus over the years, a number of acting General Manager positions, as well as a loss of critical skills. However, the number of staff was high nonetheless. SAX remained with a staff complement to service 22 aircraft fleet, despite only 13 aircraft being operational prior to grounding. Poor governance led to a number of procurement shortfalls. There had been malfeasance and a level of corruption at the airline. The poor reliability of aircraft had led to an unreliable schedule. This is what, even prior to suspension, had led to the lowest airline performance in comparison to competitors.

Challenges
SAX finds itself with a weak balance sheet, long outstanding debts, frozen credit lines, a liquidity challenge, a high monthly cash-burn rate and a high cost structure. Corporate challenges include poor staff morale, high staff turnover, high rate of management vacancies, onerous agreements or contracts, zero accountability of personnel as well as a shortage of skills.

The SAX suspension was due to two major Level 1 findings by SACAA: 1. Lack of accountability and a complete breakdown in the management of safety management systems; 2. The dire financial situation of SAX which had the potential to increase maintenance risk (doing less than what was expected and necessary). It was important to deal with the reasons for the suspension to address safety concerns which patrons may have about SAX. SACAA did not ground SAX because it was unsafe. As a matter of fact, the nine aircraft already grounded were self-grounded by SAX. The only problem was that SACAA was not informed about this. This was a lack of management accountability. Some of the Level 1 findings were as a result of previous Level 3 matters which had not been resolved. The airline was allowed to respond and rectify those findings. If the airline does not respond, the findings get escalated to level 1. This was a prime example of a lack of management accountability.

What should provide confidence in allaying safety concerns is the fact that of the two licences, the AMO related to technical maintenance and airworthiness, was obtained on 22 June 2018. The AOC required a lot of reviewing of work procedures, dealing with manuals on how cabin crew would operate flights, communication between parties who operate flights ensuring good documentation.

Initiatives and Outcomes
This had further been broken down into timelines for, from 0-6 months and from 6-12 months. Under the 0-6 months initiatives, were the new board appointments and inductions and the board subcommittees had also been constituted plus a Financial Crisis sub-committee and the Technical and Operations Sub-committee. The 0-6 month timeline included a review of all critical procedures and policies, specifically procurement policies to ensure that previous challenges would not resurface. There had been a review of the Shareholder Compact and Corporate Plan for 2018/19 because the board wanted it to take into account that SAX had been grounded for three months of this financial year. There was the goal of ensuring that the 12 aircraft were back on the SAX licence. When the licence was received, only two aircraft were on their licence, six aircraft are currently on their licence and an additional four aircraft should be on SAX licence by 2 September 2018, in terms of a scheduled procedure between SACAA and SAX. There was still a lot of work to be done in determining if SAX wanted to return the nine self-grounded aircraft onto their licence or not.

Revenue
SAX had already started on 23 August with the route to Lubumbashi. There was a focus on improving revenue by focusing on high yield regional routes which they have operated before. The goal was to consolidate Johannesburg as the main hub, before moving onto another hub such as Cape Town. There were challenges before with timekeeping and disrupting the schedule, which led to loss of customers. The back-to-basics strategy was to ensure that the Johannesburg hub was operating effectively, with an on-time rate in excess of 90%. Once this was achieved, there would be a move to Cape Town.

SAX was already operating three destinations: Johannesburg-Bloemfontein, Johannesburg-Lubumbashi and Johannesburg-Gaborone. On 2 September, SAX would commence the Johannesburg-Kimberly route. Despite having only four routes in the interim, there was a consistent practice of increasing the frequency of routes weekly. There were initially two flights from Johannesburg to Bloemfontein per day. The number has now increased to four per day. A similar pattern was being replicated with other routes. The organisation had given themselves a five-week period to reach the same number of destinations previously reached from Johannesburg. SAX was looking to reopen the Cape Town base in January 2019. They would be able to reconsider opening the Cape Town base as early as November 2018 but due to the type of flights being operated, there would be lower volumes in December and January. Consequently, a decision was reached to begin Cape Town operations in January 2019, in line with anticipated demand.

To achieve cost reduction, SAX would commit to reduce their aircraft lease costs, cancel all charter flights and renegotiate their fuel contract.

Capital restructuring pertained to developing five-year financial projections and restructuring the balance sheet, looking at the capital injection to improve debt and gearing and a return to profitability.

Operations
The goal was to improve and maintain On Time Performance (OTP) at or above 90% as well as to improve the reliability of aircraft through adequate spares. Partners such as Bombardier had committed to providing training for SAX, which would assist in realizing the goal of 90% OTP. The board had outlined all these initiatives in the way that they had because they are measurable, which would supplement the holding of management to account, at the end of both the six month and 12 month period.

Financial Position
SAX was fortunate to have secured a R1.74 billion guarantee from its shareholder, the SA government. However, the company had the unenviable task of generating liquidity against the guarantee. Bankers had now agreed to open up some liquidity which would assist the airline. This was important because there were a number of long-standing creditors, a need to overhaul spares and engines specifically for the nine aircraft still on the ground. Even if the airline decided not to continue with using them, SAX was obliged to ensure that they were in a suitable condition to be returned to the company they were being leased from. There would also be money required from working capital. Due to the three months in which the fleet was grounded, there would be no profit in this financial year. This could be reversed if all that has been put in place had been implemented.

Ms Mzimela felt SAX would still need financial assistance because the guarantee obtained had increased the gearing of the company. As such, SAX would engage in a process of converting the R1.7 billion into equity. She understood that it is Parliament which would need to approve such a process, but it had been put forward as a request.

Discussion
The Chairperson noted that Mr Thaver was appointed as the Chair of the Board Audit Committee.

Mr R Tseli (ANC) gave a few general comments for both entities. This was their first encounter with the newly appointed boards and executives. He expected that the issues raised to be raised given the above. There was then an expectation that they would then be able to provide timeous feedback to Parliament thereafter.

In interaction with ESKOM, they had addressed financial sustainability of the entity. He was raising the same concern with both Denel and SAX. It was untenable to have organisations which were solely reliant on government guarantees for operation. It would be difficult for SAX and Denel to sustain themselves and fund day-to-day activities without relying on government. From their presentation, Denel had requested one more billion, over and above the R2 billion they want to roll over in September. This was unsustainable. As per engagement with the Minister, there would be much tougher action needed for entities which were solely reliant on government guarantees. These entities ought to be assisting government by delivering on their mandate and grow the economy of South Africa and tackle unemployment and poverty. This was difficult to actualise, given the status quo.

He asked about the implications of Denel having the Auditor General as their External Auditor. There was mention of reviewing major Denel contracts. There was a proliferation of court cases lost unnecessarily, instead of using such money for service delivery. This needed to be scrutinised to prevent a continuation of this practice. If need be, legal advice could be obtained to assist Denel in its review of major contracts. He pledged the support of the Committee about contracts and funds which were improperly awarded to certain people.

Mr Marais (DA) noted that there were two boards with two executive committees and most executives were acting. There were strategies in place to ensure that the entities were successfully turned around and were profitable. He proposed that they return and account in three months’ time (end of November) due to the December/January parliamentary recess.

Mr Marais noted that the CFO had been suspended for two months. There were still four months of the year remaining. He lamented that suspended individuals were still on a full salary and asked if there were alternative means of resolving the impasse sooner. In the case of SAX recapitalisation, they had secured a R1.74 billion guarantee. He asked for a specific amount Denel needed as a government guarantee.

Dr Z Luyenge (ANC) affirmed the necessity for both entities to not only be long on promises, but to also strive for excellence. He expressed his concern about the Denel, strategy, asking if it will be sufficient to salvage Denel. It was vital for Denel to remain with the South African government. It was unfathomable for a business which was in existence prior to the South African democratic dispensation to be lost in the democratic dispensation. SAX must ensure that they have reliable aircraft within the fleet. He felt that it was not the appropriate time to engage the new appointees because this was their maiden presentation. However, when they returned, Parliament would be able to assess if they were making progress. In the interim, there needed to be deep commitment and resolve not to disappoint South Africa. SAX has not considered a route to Mthatha. SAX aircraft ought to go to Mthatha, expressing his confidence that it would sustain their business.

To both CEOs, the staff establishment was already existing within their institutions. There needed to be a retention of some skills, however, this did not encourage mediocrity. Promote excellence, at the same time, retain skills.

On the politics-administration dichotomy, Dr Luyenge pleaded with both board chairpersons to ensure that they had a good working relationship with the accounting officer. He encouraged them not to take decisions which were not administratively correct. He encouraged them to deal with items informally first before coming to formal meetings. This would promote a warm relationship both professionally and at a personal level.

Mr N Singh (IFP) suggested that both entities needed to come back mid-November, with the Department of Public Enterprises. He believed that there was a cordial relationship between both entities, the Minister and the Department. He hoped that the former ACSA chairperson had a magic wand to turn around an entity that had been struggling for the last two decades.

He asked if there any hangover in terms of the State Capture inquiry such as contractual obligations and if so, what needed to be done to annul such contracts. The entities may not necessarily have the answers to these questions, but were asked to provide these answers when they return to Parliament.

Secondly, he asked if there were any old members and senior executives part of the new set-up? If so, what role did they play in bringing to the attention of the Minister items which deserved attention? He questioned the value of such people within the new set-up.

The reputational damage had been massive to SAX. In an environment where clients needed reassurance that the fleet was safe, what had SAX done to reverse this damage in the short to medium term?

Mr K Mileham (DA) noted that in Denel’s previous presentation, despite the fact that it was the previous board, it had stated it owed R350 million in unpaid bills at the time. There was R2.34 billion due in bond repayments in September. Is Denel able to meet it obligation now? There was an indication that the Denel had entered into loss-making contracts. What have you done to get out of those contracts? Are they long or short-term contracts? Is there any possibility of getting out of these contracts which are negative for Denel?

On SAX, he was a frequent flyer and the grounding of the carrier affected him personally. Has SAX entered into negotiations with SAA about certain routes. For example, SAA flies big aircraft from Johannesburg to East London, full to capacity more often than not. SAX flies smaller planes. There was an opportunity for SAA to cede some of their less profitable routes to SAX. This would allow them to use their smaller planes which would allow them to fly more frequently. SAX needed to look into this. Which routes are profitable and why are they profitable? How many aircraft are airworthy right now?

He asked about the status of the fuel contract with EML Energy. SAX had a fuel contract with SAA for 10 years. EML Energy is new on the scene. Where did it come from? Why was there a need for it if there was also a contract with SAA to provide fuel?

He was concerned about the reliance on recapitalisation by both Denel and SAX. There was a reliance on National Treasury to bail out the entities. What was the plan to ensure that they remain profitable so that they are not a drain on the fiscus.

Mr N Kwankwa (UDM) agreed. He was interested in the revenue generation and profitability of the entities in order to execute a successful turnaround strategy. Another reason they should return in November is to provide further details about key strategic objectives such as operational excellence, contract execution, optimisation of cost structures and restructuring of the debt profile. He referred to the high-yield regional routes SAX had promised to introduce. More detail was needed about the cost implications of their strategic objectives. The appointees were new, and it would be better to assess their strategic objectives and progress at a later stage. Denel must make pronouncements about its debt situation. Will Denel be able to honour the bond repayments which are maturing in September?

Ms D Rantho (ANC) said that they were happy to see women lead, especially given their experience. Over and above this, they needed to lead with integrity. Despite the challenges, they needed to be up to the task. She asked Denel if its labour force was bloated or whether it had the wrong people. Did it have a plan going forward about this as invariably the unions would not be pleased with retrenchments in this economy?

VR Laser had been in the media due to its impropriety. She asked what plans were in place if there was a three-year contract which had, hypothetically speaking, been reduced to 1.5 years. The previous board had made decisions which the new board would not necessarily be able to account for, given they were new appointees. They needed to concede that the challenges at Denel were man-made. Watching the SCOPA meeting, she found the new board and executive wants to protect the old board. This was her perspective and she could be wrong. Impropriety had been identified and they sought to change the image of the company using the King III code. Will Denel change the image of the company in a bid to eventually attract investors?

She hoped that SAX and Denel would develop a good relationship and to share experiences. Some state owned companies fail because of a failure to do what is expected. The previous SAX CEO grounded some of the fleet without reporting this to SACAA. This led to punitive measures meted out on SAX due to failure to do what was expected. There needed to be compliance with rules and regulations to avoid negative consequences.

SAX has had a skills shortage problem for a considerable period of time. Was SAX saying that there were no skills to fill certain positions? She understood the policies which promoted empowerment. However, she did not understand how this could still be a problem after such a long time, given the number of skilled people in South Africa. She asked how many aircraft SAX owns and how many are operational. How many aircraft are privately owned?

Ms Rantho said that as frequent user of SA Express, she had had some bad experiences with other airlines. SAX workers needed to be lauded for their customer service experience they provided to customers. They exemplified the spirit of Ubuntu. Recent events at the airline had caused a great deal of frustration to South Africans. The status quo needed to be improved.

The Chairperson referred to the Minister’s overview to the Committee on 2 May 2018, there was a liquidity challenge with R1.1 billion unpaid creditors at Denel, with some suppliers withholding supplies to mount pressure, with R1.3 billion irregular expenditure still being investigated, which is likely to increase by the end of the year. Quarterly reporting is not going to suffice for state owned companies because most if not all were in trouble. There needed to be more frequent reporting. Denel and SAX had made a good start, but needed to come back by the end of November. At a later stage the forensic investigations needed to be brought to Parliament. This needed to include a list of people who had been charged criminally as well as the internal disciplinary cases taking place. Fraud was systemic at some entities, and a clean-up was critical for their sustainability. The investigations and the future needed to be balanced. The SOEs needed to establish with the Minister on how far back they should launch investigations.

She encouraged the new SAX board and executives to lay criminal charges against people who engaged in corrupt activities. Resignations alone were not enough. People needed to face the might of the law if they had engaged in corrupt activities.

She expressed appreciation on behalf of the Committee for accepting the appointment to play a part in fixing these entities. She acknowledged the skills and expertise of the new appointees, with the hope that they would be applied well in these entities. She thanked the board members and chairpersons for coming to the Portfolio Committee meeting. She urged them to be present as much as they could manage.

Denel response
Ms Hlahla, Denel board chairperson, thanked the Committee Chairperson and said that despite the huge personal risk for undertaking this task, it was out of an obligation to South Africa. The successful turnaround of these entities would not necessarily be because of one individual or structure in the governance framework, but was a combination of these. Ultimately, management would make or break the business as they were hired to manage the business. The competence and care of managers was pivotal in having well-run businesses. The courage of conviction to do what was right would play a big part in turning around the organisation.

On the question of people who were undergoing disciplinary processes, but were still getting paid a salary, Ms Hlahla replied that regardless of employee rank, they all had rights to specific disciplinary processes so that they could be heard. Without financial capacity and knowledge, it became even more challenging for the organisation to deal with such staff. She apologised for saying that they would all be dealt with within the year, as she needed to be fair to the individuals as well.

She accepted the advice of not accepting a higher than necessary risk regarding major contracts.

She agreed that Denel was not for sale. But it would look at products which could be brought into South Africa and partnerships made to this effect, these would take place with the necessary oversight.

On strategy, she said the best they could do would be to provide options to shareholder. It was impractical to carry Denel’s cost structure without freeing up additional capital. The shareholder would have an opportunity to engage with the options available. There needed to be some pain experienced if there were to be a positive change. Denel’s cost structure was unaffordable. She was optimistic that if there was a future for some of Denel’s products, the stakeholder would come to that conclusion. She handed over to the Denel Audit Committee chairperson to continue the response.

The Denel Audit Committee chairperson confirmed that Denel’s contract with Nkonki Inc auditing firm had been terminated. In the past they had oversight of Denel’s financial statements, having been outsourced by the Auditor General. The Auditor General had now taken over, with direct involvement in Denel’s financial statements. This means that the AG will now be the signing authority. It does not affect their independence in any way and in fact, strengthened the governance in the organisation.

On recapitalisation, Denel was looking at various options to strengthen its balance sheet. There were some non-core assets which could be converted into cash. There was a property portfolio which was being evaluated. Engagement was taking place with the shareholder - the Ministry of Public Enterprises - and National Treasury.

On liquidity, he was aware that there were notes maturing in September. Generally, Denel had been refinancing their notes and this was what they would do once more. A roadshow had just been completed with the institutional investors which held the notes. In the past, many had walked away. The recent roadshow had been successful. The order book was sitting at R19 billion. From a rating agency point of view, with support from government, Denel was at investment grade. There was work with the shareholder ministry to sort this out.

As pointed out by the Denel board chairperson, the majority of board members were private sector individuals who were well-respected individuals. Of the board, four of the board members were in a previous Denel board of 2005. When they joined in 2005/06, the company was burning about R100 million per month and had made an overall loss of R1.6 billion in 2005/06. When they left the company, the company had won an award for the best-governed state-owned enterprise. The company moved from non-compliant BBBEE to compliant BBBEE status. The company was an employee of choice amongst engineering graduates. They had secured the largest order book. Most importantly, the company was profitable and cash-generative. These members were back on the Denel board, as well as some members from the private sector together with two generals from the Ministry of Defence. These members would help to formulate and implement the strategy.

The investor road show had provided discussion with investors that had been fairly positive. Denel was fairly positive about the support of the shareholder. However, there needed to be a move toward profitability.

The contracts linked to State Capture had been investigated and Denel was working closely with the South African Police and through the shareholder ministry with the Special Investigating Unit (SIU). Whatever actions need to take place will be followed and this was also happening with the bursary investigation. The financial impact of the unsuitable contracts were still under review. There would be financial implications, which Denel hoped to keep at a minimum. On VR Laser in South Africa, the company is under business rescue and Denel was in discussion with a business rescue practitioner to work out what Denel’s obligations would be.

Ms Hlahla, Denel board chairperson, stated that it was correct to inform the Committee that the challenge was that VR Laser was a part of Denel’s business, having taken about R400 million. This was likely to be lost. Denel was reviewing how the loss could be minimised and past Denel business recovered.

The Department of Public Enterprises representative explained that there were two sides to the VR Laser matter. There was the impropriety of the contract, to the extent that VR Laser had led to the destruction of the current business of Denel. There would be a price to cut out the cancer, but the cancer needed to be cut because going forward, that business belongs to Denel, not to VR Laser. They would work towards a minimisation of the cost implications of this.

Ms Hlahla said she appreciated the comment that SOEs were there to contribute to the economy and to make money. She encouraged the statement to be made on a regular basis. The culture within SOEs that the state is there to employ them is precarious. The Denel board appreciated this strong statement: SOEs need to be strong, self-sufficient entities.

The Committee Chairperson said that when SAX responded, it also needed to respond to what the Minister had mentioned about the performance of SAX because the entity had not been audited. That information was needed in the performance report, which had to meet a target 60%.

SA Express Airways response
The SAX Audit Committee chairperson thanked the Denel board chairperson for the secondment of Dean Khumalo, who had been assisting in getting the aircraft flight-ready. There was cooperation and he thanked Denel for its support. He noted that there had been a request by the shareholder to comply with the Zondo Commission on State Capture, as and when requested to supply information. SAX would do as requested.

Management was requested to look at all material contracts, from an affordability perspective firstly, to ensure the sustainability of the airline, whether or not they were excessive. Was there any delegation of authority? If they were excessive, was there any undue benefit? This is how the process would be started and evidence would be gathered. The current focus was to get the AOC and AMO and the airline up and running. SAX was now moving to the phase where all the contracts would be assessed within the next few months. The board and executives would be in a better position to provide better information at its next briefing to Parliament. There were a few investigations going on. Internal documentation was being gathered together with external documentation; some of the forensics had been done. This is done to understand what the entity has at present, is there sufficient evidence? On the comment about whether SAX could go forward without wasting resources, they would try to ensure that they have a case which is winnable.

As far as SAX is concerned, the EML Contract contract had been halted. It had not been carried out. The individual concerned may challenge SAX about it, but SAX felt it had a right to challenge such a position. It was a contract which was a marketing agreement which resulted in the supply of fuel, yet there was an existing contract with SAA for fuel. SAX did not understand it and were in the process of investigating it and would endeavour not to continue with it. This was from a governance or operational perspective, the Acting CEO would deal with the other aspects.

Ms Mzimela stated that the comments about a route to Mthatha would be taken as a comment and not a question, but assured the Honourable member that SAX would love to have a new fleet.

Old Executives in Place?
She said that there were a couple of people who were on suspension. The Chief Procurement Officer was on suspension. The Head of Legal was also put on suspension and has subsequently resigned. The entity was in the process of finalising the suspension which related to the Chief Procurement Officer. As the investigations continue, should other individuals be implicated, the necessary action would be taken. At this point, those were the ones which were dealt with.

The Fleet
She said that maybe the Honourable member was out of the room when she spoke about the safety of the airline. It was more a matter of dealing with the perception of whether we are safe or not, because SAX was not unsafe as an airline. This was a perception which was created by the unreliable service of SAX, which eventually led to the grounding. This is why there was a decision to go in a saved-in approach (02;54:42) in order to manage the reliability which would be much better going forward. In terms of the schedule, there was also a practice of ensuring that there would always be a back-up aircraft in order to be able to recover if there was a delay. All aircraft break now and then, what was important was how quickly you were able to recover. For the purposes of SAX, especially for the first 12 months, the organisation would always ensure that there was a back-up available in order to manage the negative perception which existed in the market place relating the reliability of SAX.

There were already discussions with the sister company SAA. The decision to move SAA back under one shareholder has also assisted because it had contributed to better working relationship. Part of that was also to try and identify where SAX could step in with their resources, at a smaller scale, at a particular timeslot, which would make sense for an SAX operation.

Which Routes are Profitable?
The most profitable routes are the ones SAX has decided to start with. The most profitable route on the system is Lubumbashi, which generated decent returns at only 50% capacity. She affirmed that the bulk of routes at SAX were profitable, at an operational level. It’s the fixed costs which are problematic, which would be the focus. How do we actually reduce the fixed costs? This is what actually led to an unprofitable result.

How Many Aircraft are Airworthy today?
SAX was operating 6. With the schedule which was mentioned earlier on, at the moment, SAX had only scheduled 3. There were plans to bring on board all 12 aircraft. Regarding how many are owned and how many are leased, only 4 aircraft which SAX has on the system are owned by SAX, the rest are leased in aircraft. This was not unusual as all airlines had a combination of leased and unleased aircraft. What has been stopped is to bring in charters on an ad hoc basis. It was an expensive exercise. However, these were long-term leases. It was just the way in which they were structured financially to bring them into the environment. Which are being operated? 6 of the leased in aircraft are already in operation. SAX aircraft should be back within the next 2 to 3 weeks.

Plan to Return to Profitability
The work has already been done. This has been built up from a network perspective. The board is also interrogating what has been put forward. What had started off initially as a 12-month plan, had been asked to be extended to at least 3 years. The work had been done and SAX would be in a position to present this to the Committee in November upon return.

Skills Shortage
On a point of clarity, this was not as a result of a lack of skills in South Africa, SAX meant that they had lost some key skills to their competitors. When highly skilled individuals start to feel uncomfortable about the organisation or its stability, they are the first people to leave. This was the challenge for SAX, to try and either attract back some of those individuals, or find from elsewhere in the market. The entity was confident that they would be able to do that. People at that point in time were uncomfortable with being associated with SAX and the board and executives hoped to change that going forward.

Mr Singh said that Ms Mzimela could be credited for removing the Durban to Johannesburg route and they all now flew using British Airways and Commair. He also encouraged a route from Bangalore, India to South Africa.

The Acting DG from the Department of Public Enterprises was given an opportunity to contribute. She expressed gratitude for being able to interact about these two entities and said it was quite evident that the extent of governance collapses experienced had translated into the financial challenges these 2 entities were currently facing. The emphasis over the last few months had been on dealing with a stabilisation and a clean-up, in order to ensure that the service expected would be provided. The resumption of flights for SAX was a good indication of the new program the board was working on. The Department was spending some time trying to understand the turnaround strategy, but also believed that for the turnaround strategies to be materialised, the right management was needed, which was clearly a problem with most of this entities, given the extent of acting positions. The Minister had communicated with the board that as part of the support that government would provide on an ongoing basis, the boards must finalise the appointment of executive management over the next 3 months to ensure that as the turnaround plans are being produced, they must be produced by people who would implement them. There needed to be 1 robust turnaround plan for each entity being implemented by permanent executive management. Given the challenges in the Department, there was also a challenge to see how oversight would be provided by the Department. With regards to the question from Hon Malhem’s question about guarantees, it was an area which the Department was also concerned about. These should be used for capital programs, not for operational activities or to pay salaries. This related to the matter raised by the President in the State of the Nation Address about providing appropriate models, where revenues were at least able to cover the cost of operations. She said the Department was happy to come back and update the Committee on progress made. The challenges faced were not being underestimated.

The Chairperson thanked the board and executives for their presentations and responses as well as the commitment they had made on the day. She said that they would be held accountable for their commitments. She was pleased with the frankness about both work done and challenges faced and being able to develop plans which would take Denel and SAX forward. The Committee was available to provide support and hold them to account as they played their oversight role. She thanked guests and media houses present.

The meeting was adjourned.