SA Express on its Annual Reports for 2011/12 and 2012/13

Meeting report

Briefing by SA Express (SAX)
Mr Andile Mabizela, Chairperson of the board, SAX, said the entity would be presenting its annual reports and annual financial statements for the 2011/2012 and 2012/2013 financial years.  He outlined the format of the presentation, and handed over to the airline’s Chief Executive Officer, Mr Inati Ntshanga.

2011/2012 Financial Year
Mr Ntshanga said that revenue for the year had grown by 22.9%, with passenger numbers increasing by 12%. The load factor had stayed stable at 61%, which was well below the international average of 78%.  The revenue per available seat per kilometre (RASK) had been 104c, compared to the cost per available seat per kilometre (CASK) of 89c.  The loss for the year had been R313m. The airline covered 19 domestic routes, seven regional routes into neighbouring countries, and planned six new routes.

There had been a number of key challenges to the sustainability of SAX. Costs were very high, with fuel going up by almost 50% year on year. It was the main contributing factor to the huge loss, but there were also sharp increases in legislative tariffs. The Airports Company of SA (ACSA), for instance, had increased prices by 70% and in the depressed economic environment it had been very difficult to pass on these increases to customers. Following a negative audit report, internal controls had been improved. Almost 23% of the airline’s costs had been allocated to human resources.  Because the aircraft were small, there was not enough cargo carrying capacity. The on time performance was 88%, but the airline aimed to improve this to above 90%. The passenger revenue budget had been met for the first time in five years, and the number of passengers carried had exceeded the previous highest level achieved in 2009.

SA Express had hired pilots during the year, nearly all of whom had been black. The airline had some 250 pilots, of whom 86% were white, so the issue of equity was being addressed. Of the 1 090 total employees, 59% were black, and 64% were male. The shortage of skilled pilots and technicians remained a challenge.  Internal control weaknesses were being addressed, especially in the finance department, and the risk department would be monitoring compliance issues with frequent and tighter audits. The internal audit function was no longer outsourced, so it was available on a daily basis to assist in implementing controls.

Turning to the shareholder’s compact, Mr Ntshanga said that only six of the 14 targets had been achieved.  This was because once the profitability target had not been met, this had had a knock-on effect on the other inter-related targets.

Mr Zanele Ngwenya, Chief Financial Officer, SAX, provided a financial overview and synopsis for 2012. The escalation of operating costs had more than offset the increase in revenue. The impairment of some of the old aircraft had added to the problem. However, the company still had assets of almost R1bn, and these exceeded total liabilities of R808m. The company was still solvent.  Because of the cost pressures, including the R95m cost of maintaining an ageing fleet, SAX had ended the year with an overdraft of R61.7m. The cost of fuel had increased by almost R200m for the year. Old aircraft that had been sold had been replaced by leased aircraft, which had impacted on profitability. All costs had increased by well over the inflations rate.

Because the company had not cleared up some of the issues from the previous year, it had received an audit disclaimer, with findings.  Most of the issues identified by the Auditor General (AG) had been corrected in 2013.  The company had a high debt/equity ratio as a direct result of its R313m loss, but it was solvent and able to meet its short-term obligations.

2012/2013 Financial Year
Mr Ntshanga took over the presentation to provide an overview of the entity’s operational performance for 2012/2013, where the results were compared with the previous year’s performance.  Although flights had decreased by 22%, and the number of passengers had dropped by nearly 2%, revenue had actually grown by 14%, and the load factor had increased from 63% to 69% - although still far below the international benchmark. This had been achieved by reducing the airline’s capacity and “sweating the assets.”  Operating costs had been contained at the same level as the year before, and an employee-led cost containment programme had resulted in savings of R129m, against a target of R70m.  The net profit had improved to R650 000 – just above break even.

The key sustainability challenges had remained the same – pressure on profitability through high fuel costs and legislated tariffs, reduced passenger numbers because of the depressed economy, the need for improved internal controls, high employment costs and the need to replace the old jets with more modern, fuel-efficient aircraft.

In terms of the shareholder’s compact, the airline had achieved nine of the 14 targets, which was an improvement to 64%, compared to 43% the previous year. Of the 1 126 employees, 64% were black, coloured and Indian, and 36% white, while males still represented 64% of the total.  Attempts were being made to increase the number of female employees – at board level, it was already 50/50.

Mr Ngwenya presented the financial performance. Revenue had increased by 14% and operating expenses had been contained, but a major element had been the R143m depreciation and amortisation attributable to the ageing fleet. There had been a R157.7m loss before taxation, but the realisation of a deferred tax amount of R158.4m had enabled SA Express to show a small profit of R650 461. The passenger revenue growth in both domestic and regional routes indicated there was still demand to allow for future growth.  Optimised schedules and flying aircraft at optimum altitudes and speeds had enabled fuel costs to be reduced by 3%, from the previous year. Assets still exceeded liabilities, and the company was solvent. However, engine overhauls and major maintenance costs had impacted on cash flows, and the overdraft had risen from R61.7m to R68.9m. 

A number of changes in accounting policies and estimates had taken place, and in 2013 the airline had moved from a disclaimed audit opinion to an “except for” audit opinion.  Most of the issues from the previous year had been dealt with, although there were still problems with rotables and inventory.  SA Express was engaged in a funding plan to ensure that by the time its government guarantee expired in February 2015, it was sustainable as a company.  A revolving facility of R100m would be secured by the end of October against the current government guarantee for funding maintenance requirements.  A further tax assessment of about R100m was refundable from SARS, a Standard Bank investment of R75m matured in 2015, and there was a sale and leaseback option on four aircraft which would amount to R65m.

Mr Mabizela said the board and senior management had developed a “20:20 Strategy” which had been endorsed by the shareholder, and which provided a charter for SA Express for the next 20 years, based on the lessons learnt in the company’s first 20 years.  The strategy analysed every aspect of the business, identifying strengths and weaknesses, opportunities and strengths.   The future would depend on the strength of partners in the aviation business, and SA Express would have to develop joint ventures.  With its hub in Durban, it was already punching well above its weight.

Looking at the way forward, the shareholders’ compact for 2014 had already been submitted, and the compact for 2015 was under negotiation. Because of the guarantee agreement with the shareholder, regular monthly progress meetings were held to discuss the key issues. The funding plan, for implementation in February 2015, had not yet been unveiled, and would be the outcome of a board engagement in the next few weeks. This was critical, because the guarantees expired in February 2015, and the mission was for SA Express, by that time, to have the plans and cash in place to operate independently of state support.

Discussion
Mr A Mokoena (ANC) said he had identified four “heroes.”  They were the “whistle blower” who had drawn attention to the false information included in a presentation to Parliament, the DPE for its sterling leadership, the new board of SA Express for its vision and commitment, and the airline’s workers, who had subdued their salary demands and allowed costs to be contained. He wondered what the fate of the “whistle blower” had been. He asked if the anomaly of a member serving on the boards of both South African Airways and SA Express still existed.

Dr G Koornhof (ANC) said he had commented that the disclaimed 2010/2011 SA Express annual report and financial statement was the worst he had ever seen, and the chairman of SA Express had wisely said that the next one would be worse.  He had kept his word!  The AG had also given the 2011/2012 report the worst opinion possible. Looking at 2012/2013, he was pleased to see an improvement in internal controls, but four out of six leadership issues were cause for concern, as were four out of five financial matters, and three out of three, for governance.  How was the improvement going to be achieved?  For both years, the AG had made very valuable findings and put forward specific recommendations.  He wanted to know whether the board and senior management were implementing these recommendations. In 2012, when SA Express had received a disclaimer, the report indicated that R19m had been paid out in benefits to key management. The figure for 2013 was R16m.  How could this be possible? 

Ms G Borman (ANC) asked for confirmation that the company’s funding plan aimed to free it from government assistance by February 2015.  It was finance that kept a company going, and SA Express’s overdraft was growing, so what controls were in place to help meet its funding goals.  The organisation had suffered “reputational damage” in the recent past, and she want to know if it had recovered from this yet.  She also asked if, in the absence of SAA, SA Express could increase its daily flights from Cape Town to Durban.

Mr C Gololo (ANC) asked how SA Express went about attracting pilots to the company.  With the high incidence of strikes in the country, how had the airline averted strike action?

Mr K Dikobo (Azapo) said if the RASK was 104c and the CASK was 89c, the difference should mean the airline was profitable, so why had it shown a loss?  He queried how far SA Express was casting its net in trying to attract skilled personnel, because people were being trained and acquiring skills, but were still finding it difficult to obtain jobs.  He also urged the airline to improve its Cape Town to Bloemfontein service.

Ms N Michael (DA) said she was interested in finding out how SA Express had reduced its carbon emissions, despite having an ageing fleet.  She had read in an aviation magazine that SA Express was one of the last airlines in the world to fly a range of Bombardier aircraft, as the rest of the world had disposed of them.  Were they safe, and would they help SAX get into profitability? She suggested the company should start running advertisements that made it look “sexy and attractive” to be a pilot, in order to appeal to young people.  She asked why there was a so-called “feud” between SA Express and SA Airlink, being reported in the media.  Incentives should not be paid when targets were not met.   The figures showing fewer passengers but higher revenues were confusing, and needed to be explained.

Ms C Pilane-Majake (ANC) said that for a company with operating costs of R2.3bn, a profit of R650 000 was not good enough, and an improvement would be needed if it wanted to succeed as a business.  The presentation had not mentioned performance in terms of human capital, and this should be covered in future.  The audit opinion had indicated that SA Express had not followed policies and procedures, and it was critical that this be corrected, otherwise there would continue to be irregular and wasteful expenditure.  She asked if SA Express was stuck with leased aircraft, as it appeared that leases were expensive – paying for something that did not really belong to you.

Mr E Marais (DA) also criticised the SA Express service to Bloemfontein, as well as the lack of management in the airport’s lounge.   The rapid progress in technology meant that aircraft were becoming increasingly fuel efficient, and an aircraft obtained now might need to be replaced by a better version in three years’ time.   If a plane’s lifespan is 20 years, one had a problem.  How could it be resolved?

The Committee Chairperson said airport lounges were the responsibility of ACSA.  He said that if there were any laws that were hampering the airline, they should let the Committee know.

Mr Ntshanga said the “whistle blower” had been anonymous, but even if his identity had been known, he would have been protected by the company.  There was now an ethics hotline in the organisation, and employees were encouraged to raise issues and remain anonymous if they wished.  (Mr Mokoena commented that this was a very progressive approach, but the previous incumbent had been very irritated that the issue had been exposed, as it had cost her her job.)

Mr Mabizela said that he was chairman of SA Express and also sat on the SAA board.  The rationale for this situation had been driven by the shareholder, whose view was that SAX was a feeder airline, and its relationship with SAA would be optimised through coordination between the boards.

The AG had made several recommendations and had set objectives following the 2012 audit report, and what was clear was that the organisation had not met the reporting standards of the AG or the National Treasury reporting framework.  The airline was now engaging with the AG and had developed a strategy which it was looking to discuss with the Portfolio Committee.

Ms Karabo Nondumo, chairperson of the Audit and Risk Committee, SA Express board, said that with regard to the AG’s recommendations, the company had to comply with the internal and external audit report, the risk management report, the procurement report, and the guarantee framework agreement.   At every meeting of the Committee, there was a standing schedule to track progress.

Mr Mabizela said the funding plan was core to the company’s strategy.  There had been two recent meetings to discuss fleet strategy, and how to finance the fleet.  The plan was to work towards the February 2015 cut-off date, and the intention was to be cash positive by then.  It was a huge task, but the company was working on it as a team.

The board’s view on the reputational damage suffered by SA Express was that, because the organisation had been transparent over the issues raised in the AG’s report and the turnaround strategy, it was no longer “on the back foot.”  The company had handled the misappropriation and fraud issues, and was seen to be on the right track.

Regarding the perceived feud between SA Express and SA Airlink, he said the market situation had changed, and the stance of SA Express might have caused some discomfort to SA Airlink, as a franchisee of SAA.  A meeting was scheduled for Thursday, and he was sure there would be resolution.

Ms Nondumo, responding to the issue of fruitless and wasteful expenditure, said there had been no policies in place, and therefore the company could not track how much fruitless and wasteful expenditure it was incurring.  The policy was now in place, and tracking of the amounts would start in the new year.

Mr Ngwenya said operating leases were more expensive overall than purchasing, because own did not own the asset, but they were very convenient when one did not have the balance sheet to acquire new assets.

He said the compensation for key personnel had been reduced over the years, and this was due to the reduction in the organisational structure.

Mr Ntshanga said that between SA Express and Mongo, there had been an increase in capacity on the Cape Town-Durban route.  SA Express had identified the need for a premium product on the route – maybe a business class option – and would consider this at a later stage.

SA Express was the leading recruiter of young pilots coming from schools.  The average number of black pilots employed by airlines was only 2%, while SA Express was over 20%, if one included those being trained and those who had been hired.  It could cost over R1m to train a pilot, so it was an expensive exercise.  The SAX 20:20 vision was to be the incubator for training.

Ms Kgatile Nkala, General Manager, Human Capital, said SA Express had partnered with the SABC to cast the net wider and attract matric students.  The company had also partnered with the Department of Science and Technology and the DPE, to go to schools throughout the country to promote being a pilot as a career.

Mr Ntshanga said the company worked very closely with its workers, and this could be why it was avoiding strike action.  They were made to feel like part of the team, building the company as it went forward.  There was no “us” and “them.”  Management was able to speak openly and share its plans with the workers.

On the issue of RASK vs CASK, the revenue side was made up of the cash coming from the customer, and income from the sale of aircraft, for instance, was not included.  CASK was merely the cost to fly passengers, but did not include all the overheads, like office accommodation, finance costs, and other expenses not involved in getting the aircraft to fly.

The reason for improved carbon efficiency was that the old 50-seater aircraft had been replaced with 74-seaters which were much more fuel efficient, and because the calculation was based on the number of seats, there had been an improvement.  He conceded that in five years’ time, they would need to look for more fuel efficient aircraft again.  He pointed out that fuel costs had increased from $32 to $110 in the past ten years.

The Bombardier Q400 incorporated brand-new technology, with very advanced turbo-prop engines capable of matching the speed of jet aircraft.  They were very fuel efficient, and there was nothing wrong with them.

The company had been recruiting mainly in the big cities, but now wanted to move away from Johannesburg, Durban and Cape Town, and focus on other areas.  There was also a drive to recruit females, and ten had been found who would be part of the next intake.

Members’ confusion over passenger and revenue numbers was because statistics were being shown for two financial years, so the first set of numbers referred to growth over 2011, which accounted for the growth percentage.  Also, passenger revenue sometimes grew faster than passenger numbers.

The airline industry tended to have very marginal profits.  The International Air Transport Association (IATA) was forecasting a R100m loss for the whole of Africa this year.  Although airlines on their own tended not to be profitable, if one looked at the entire aviation value chain, the industry was responsible for creating a large number of direct and indirect jobs, and of stimulating market activity.

More information on human capital would be included in the annual report.  Although the company’s leadership had been reduced, it represented more of an alignment to ensure added value to SA Express.

Mr Mabizela said senior management had been labouring for the past two years without an increase in their base salaries.  The issue that had been raised was the interpretation of the benefits, as they had been reported.  These were not bonus payments, but components of provisions for pensions, funeral cover, medical aid, and other benefits.  A number of senior executives had left the company, so the figure would decrease.

Mr Ntshanga added that no bonuses had been paid in 2013, as targets had not been met.

The Chairperson invited Members to engage in a second round of questions and comments.

Dr Koornhof said SA Express was the worst performing state-owned company (SOC) in terms of drivers of internal control, on leadership and financial and performance management governance, and urged management to meet with the AG to see what action needed to be taken.   Strategic objectives were at the core of the company, so why had they been changed over the two years?  The same applied to the company’s core values.  He asked whether the SA Express board was comfortable, halfway through the 2013-14 year, that the current 
strategy was good and the company was improving.

Mr Gololo referred to the company’s cost reduction efforts, and asked if they had come at the expense of a drop in service levels, or unhappiness among employees.  Could this approach be maintained?

Ms Borman said there had been a huge increase in corporate social responsibility expenditure – from R352 000 to over R3m.  Why had there been such a big increase?

Mr Mokoena asked what benefits had accrued from the SA Express chairman “straddling the divide” by sitting on the board of SAA.

Ms Pilane-Majake said she accepted profit margins were low in the aviation industry, but it was important for SA Express at least to break even, so that it did not come running to Parliament for “bail outs.”  What was concerning was that the marketing strategy had not been clearly articulated – was the intention to grow in order to increase profits?   She was also disturbed to hear that the company had had no policy to deal with fruitless and wasteful expenditure, as this could only have led to serious problems.  Now that there were audit and risk management committees, their involvement needed to be taken very seriously.

Mr Mabizela said the company had come through a very turbulent period, with serious financial and operational challenges.  The talk now was about sustainability, and the principal challenge was turnover.  There were limits to the extent it could manage acquisition costs, one of which was the need to de-link itself from external currency fluctuations.  There was the challenge of establishing new routes in a competitive environment, in the middle of which it would have to re-fleet.  This meant the board and management would have to work very closely to achieve profitability.  The strategic session on November 5 would answer whether the funding plan would enable the company to meet the February 2015 cut-off date.  At this stage, he could not give Dr Koornhof and the Committee the comfort it sought.   Six months into the current financial year, SA Express intended to report a profit which would have more of a cash-based operational flavour, as the entity was still a cash-strapped business.

Mr Ntshanga said the six values entrenched in the organisation had not changed.  However, the strategies had had to be adapted to meet the challenges that had been identified in the review of 2011 operations.   The main problem had been that cash outflows were greater than cash inflows.  This was because short-term cash was being used to fund long-term capital expenditure, so a strategy was needed to turn this around.  Issues of governance and human resources also needed to be addressed, and then the gains had to be consolidated, so there was a link between the strategies.

SA Express had taken note of the AG’s findings on leadership and financial performance management, and was working with the AG to address the issues.

Mr Ngwenya said the company was managing its bank overdraft.  A cash management system was in place, and this ensured that it stayed within its borrowing limits.

Mr Brian van Zyl, General Manager: Commercial, said the increase in corporate social responsibility spending was part of the financial “cleaning up” process.  SA Express did not provide money in this area, but offered free tickets for fund raising and other worthy causes.  In the past, these tickets had not been valued, so the increase merely represented more accurate financial reporting.

He said the company’s financial situation had been clearly explained to employees, and the cost saving initiative had come from them.  They had made suggestions such as reducing travel, staying in less expensive hotels, and tele-conferencing.  Pilots were adjusting their speeds and altitudes to reduce fuel consumption.  The employees had now given a commitment to save R140m, and in the past six months, about R68m had been saved.  (This drew applause from Members).

Mr Mabizela referred to his participation on the SAA board, which meant he had been involved in SAA’s long-term turnaround strategy, and he was able to provide background to SA Express as the strategy was developed.  It had been a bridging role in recent months, and the facilitation aspect had had benefits.

The Committee Chairman acknowledged that good work had been done, but said SA Express had to address the issues raised by the AG, and keep the Committee regularly informed about progress.   Management must ensure that next time the AG’s report was more favourable.

Minutes
The minutes of the Portfolio Committee meeting of 10 September and October 9 were approved without amendment.   Ms Michael, who proposed the adoption of both minutes, commented on the marked improvement in the quality of minutes recently.

Oversight visit
The report on the Portfolio Committee’s oversight visit to the Transnet port in Durban was adopted, with minor changes.

The meeting was adjourned.