Armscor and Castle Control Board on their 2015/16 Annual Reports

Meeting report

Armscor: Annual Report

Mr Kevin Wakeford, Chief Executive Officer (CEO) of Armscor, said the corporation was a state-owned entity, listed as two public entities in terms of the Public Finance Management Act (PFMA).  Within its mandate, Armscor had to effectively, efficiently and economically meet the Department of Defence’s (DoD’s) requirements through providing defence materiel needs, technology development, research and development, and test and evaluation.

In terms of its strategic context under the new board, Armscor believed that it was becoming irrelevant and unsustainable, particularly in respect of delivering in time and on time. The funding shortfall in the South African National Defence Force (SANDF) was an existential threat to Armscor. Its relevance was determined by two pillars of the SANDF, hence the new strategy of “in time, on time, towards a sustainable future.”  Government, as the main shareholder, required a commitment to national agenda objectives, such as reducing the burden on the fiscus, increasing employment and growing the RSA economy.

A turnaround strategy had been initiated, based on the premise that the benefits of the defence sector went beyond the military and technological advances, and included domestic employment, high-technology skills and economic growth. The Defence Force and Armscor had to become a greater and visible asset to the economy. The three key focus areas for the turnaround strategy planned during the financial year were sustainability and commercialisation, organisational transformation and the expansion of Armscor services. There were a number of active work streams, which included designing a new vision for the future involving collaboration with state-owned entities (SOEs) and Key Performance Indicator (KPI) dashboard development, developing new revenue-driven strategies, enhancing and improving core functions, change management and stakeholder relations, a new governance model for a “new” Armscor, and driving greater efficiencies. This would include a cost-spend analysis, project review, supplier contract management, procurement transformation and finance function redesign.  

In terms of strategic relevance, the relationship between Armscor and the DoD had grown through the development of alternative funding concepts for the Defence Review, specific measures relating to Denel, substantial support to the development of the National Defence Industry Strategy, and proactively developing and applying new policies to improve the chances of the small player in the defence industry. Armscor’s relevance to the SANDF had improved through the business remodeling of the SA Navy dockyard, processes to increase the tempo of acquisition, and continuous support for the implementation of the Defence Intelligence Headquarters.

On strategic progress, Armscor continued to grow the RSA economy through value extraction from its already existing intellectual property (IP) – available to small business without risking alienation and international leveraging – and by becoming an interface between the United Nations (UN) and peace keeping in Africa, and providing services to African clients. It empowered smaller players through measures such as no longer applying a winner-takes-all approach in acquisition, and a broad-based black economic empowerment (BBBEE) defence charter was making rapid progress under the guidance of the National Defence Industry Council (NDIC). It also reduced the burden on the fiscus by activating alternative income via fees on services rendered to international entities and sweating its own assets.

Armscor still needed ongoing support. The new Treasury regulations were not aligned with the complex acquisition environment. A DoD funding model validation process was underway, Treasury approval would be required for the ring-fencing of revenue, and the Department of Public Works’ (DPW’s) concurrence would be needed for DoD properties under their custodianship. Another area was the Department of Science and Technology (DST), involving co-existence with regard to the Square Kilometre Array (SKA), and new legislation to prevent the exploitation of IP.

Upgrades of communication and navigation systems on all Oryx 39 aircraft had been successfully completed and delivered to the SA Air Force (SAAF). The first batch of A-Darter Missiles would be delivered in the third quarter of 2016. The contract for the integration of the A-Darter Missile on to the Hawk aircraft was expected to be concluded in the first half of the 2016/17 financial year. Acquisition of hydrographic survey and multi-mission patrol capabilities was awaiting a decision by the DOD and the SA Navy (SAN), as the budget was being reviewed. On the tug replacement programme, new and fully qualified tugs had been delivered during July 2015 and February 2016 respectively, and the SAN had successfully taken them into operational use.

The new generation infantry combat vehicle programme had been localized, with 221 vehicles out of 242 produced locally by Denel Land Systems, and the remaining 21 delivered by Patria Land. The transfer of technology to ensure local industrialisation and production was progressing well, with the initial training of artisans completed in October 2015 in Finland. Section variant development had been completed during 2015/16, and the first locally assembled unit would be completed in 2016/17. Final training would take place during the local assembly. Phase 1 of the Ground-Based Air Defence System (GBADS) programme had been completed and delivered to the SA Army. Phase 2 entailed upgrading of the fire-control system of the 35 mm ant-aircraft guns, to enhance operational capability. During the reporting period, eight guns (MK 5A and MK 7) were locally upgraded and accepted, and various systems upgraded, procured and tested at Alkantpan.

Armscor was currently managing 13 Defence Industrial Participation (DIP) agreements from capital acquisition projects, one obligation from Strategic Defence Packages and one agreement for the procurement of pistols for SAPS.

Military and commercial vehicle testing was conducted during 2015/16. There was a significant increase in the number of tests conducted at the Alkantplan test range, resulting in a 15% growth in the planned sales. International clients contributed 64% of the total sales of R81.8 million. A two-year contract with Singapore clients was concluded and new equipment was bought, and a tracking radar was upgraded to enhance capability.

Protechnik had single-handedly and successfully hosted the analytical chemistry course for African parties that are signatories to the Chemical Weapons Convention (CWC). Hazmat had managed to exceed budget sales by 30%, despite the current economic climate and decline in the mining industry. Ergotech was once again involved in the selection of SAAF flight crew. According to the Institute for Maritime Technology (IMT), the new version of Ultra Sonic Rail Detector systems would be ready for market in 2017.

The completion date of the SAS Mendi project had had to be revised due to funding constraints. The revised planned completion date was November 2016, depending on funding. The SAS Makhanda project was under consideration by the SA Navy. The tug and independent vessels projects had been completed in time.

Armscor continued to drive transformation through its employment equity plan, and focus areas included women and physically challenged individuals. The transformation target to increase black employees had been exceeded -- 75% achieved against a target of 66%. There had been a continuous Improvement in the employee satisfactory survey, from 64.5% (2014) and 67.7% (2015), to 68.7% (2016). As part of succession planning, 174 successors had been chosen for 153 key positions. 77 apprentices had been appointed in the dockyard, of whom 33 belonged to the Western Cape Department of Economic Development and Tourism. Armscor was currently providing 55 undergraduate with bursaries, including six beneficiaries of military veterans.

Corporate social investment programmes included the establishment of the Women Military Veterans Association of South Africa (WOMVASA), which Armscor was involved in, the Military Veterans’ outreach programme, the SANDF Education Trust, a number of career awareness programmes, and assistance in a variety of enterprise programmes.

Revenue had declined by 8%, which was a direct reflection of the DOD and Treasury reducing the budget. Investment revenue had declined by 13% and grants by 6%, also because of the Treasury decision. Operating expenditure had increased by 13%, mainly due to the inclusion of an unrecognised actuarial loss of R139.5m from the settlement of post-retirement medical liability, as well as a loss on the revaluation of investment property of R37.1m. The group had retained a healthy liquidity and solvency position, maintained a clean audit and achieved a level 2 B-BBEE rating.

Discussion

Mr B Bongo (ANC) asked about the effort put forward by Armscor in terms of youth involvement -- not just bursaries, but in terms of knowing the technical side of business. He asked for further comment on Armscor’s concerns regarding the funding and reduction in revenue. How could it make use of its intellectual property in an implementable way so that it could generate revenue?

Ms N Mnisi (ANC) sought clarity on the decreased revenue and changes resulting from this. What was the reason for personnel reductions? 21 professional qualified experienced specialists and mid-level employees had been lost. Future pressure due to the decreased financial allocation to the DoD raised the question of whether the implementation of some projects and programmes of the Defence Review would be sufficient to improve Armscor’s future financial position. She asked Armscor to unpack the future ramifications of the financial constraints.

Mr S Marais (DA) also referred to the decreased revenue, and pointed out that finding alternative revenue and revenue from outside had not seemed to be successful. The national defence force environment had changed totally, which impacted on the relevance and sustainability of Armscor. He asked for clarity regarding the risks surrounding revenue, as decisions by the DoD and Treasury must speak to the strategic objectives of Armscor. He asked about the other shareholders of Armscor, as the CEO had pointed out that the government was the major shareholder. There had been a reference to increasing employment -- would Armscor fulfill this task directly or indirectly? He asked about the issues regarding Alkantpan and the SKA, and how the Portfolio Committee could assist in that regard. He pointed out a new jet was in the process of being bought, but had not been mentioned in the presentation, and asked if Armscor had the money to buy it or not. He wanted clarity on the reference to “physically challenged individuals.” How did the dockyard transfer impact on national security? Was Armscor satisfied that there had been no breaches in security?

Mr D Gamede (ANC) asked if there were any ways of expanding the commercial viability of the Institute of Maritime Technology. He also wanted to know if there were ways to expand the artisan training to other departments.

Mr S Esau (DA) referred to the mutual agreement between the SAN as the custodian and Armscor as the constructing agent of the dockyard system agreed upon a few years back, and talked about the regional strategy and studies that were supposed to make it viable and a source of revenue, which was 75% complete. He asked if there was documentation regarding the development and if it was available. Was the original strategy to generate revenue for Armscor, since Armscor was only a contracting agent, or were there some payments due to Armscor for doing the job? Armscor claimed in its report that it had achieved 97.3% regarding the repairs and maintenance, but historically the DoD and the SAN complained a lot about capacity, lack of funding, and lack of skills on site. Was it fair to say that Armscor had achieved 97.3% on maintenance and repairs? Had the principle regarding the sweating of assets been discussed between Armscor and the DoD? If it had, what was the progress on it? What time frame had been set for the actual delivery of the marine vessels? The Defence Industrialisation Programme (DIP) in Europe had been extended to 2019, and only a small amount of that DIP budget had been used. What plans had been put forward to put that money to good use?

Armscor response

Mr Wakeford responded to the Members’ questions, starting with youth participation. African Aerospace and Defence (AAD) had hosted around 7 000 youths from across the country, who were taken through a wealth counselling programme. Armscor placed graduates from universities in the aerospace and maritime industries and paid their salaries, and then absorbed them over time once they had acquired the necessary skills in the value chain. In addition to that, the career-counselling programme in particular had been extended and had reached over 6 000 young people in rural areas across the country, counselling them with regard to available careers in the Defence Force, with an emphasis on mathematics and science.

The issue of the reduction in revenue was an extended discussion. It required a joint meeting arranged with the DoD and the SANDF. At the moment, the thinking was that South Africans were living in a democracy with peace and there was no need to properly resource the Defence Force. The policy makers had not really applied their minds to the importance of the Defence Force, not only in terms of territorial sovereignty and protection, but also in terms of new dynamics such as human trafficking, the whole refugee migration situation in Africa, and issues related to syndicated crime. If one put all these factors together, then one would see that the Defence Force needed a realistic allocation. In addition, Armscor should be allowed to sweat its assets and sell some that were old and not in use. There was about R4 trillion worth of assets that would never be used again, and that would bring the desired funding to populate the Defence Force with young people.

Dr Noel Mkaza, General Manager: Research and Development,Armscor, said the first thing the entity had to do regarding the commercialisation of IP was to ensure control of the DoD’s IP, and there had been a number of initiatives to that end. One of them had been to engage with the Department of Science and Technology, as there was an agreement that all DoD-funded research and all IP generated from that belonged to the DoD so that companies could not lay claim to the IP. The legal framework agreement involves control over any future contracting with the company, and makes it very clear that all IP generated from all activities funded by the DoD belonged to the DOD. Lastly, there was an internal process within Armscor in terms of IP approval.

The biggest issue regarding the SKA and Alkantpan was radio interference. Armscor had come up with a mitigation plan to see what kind of technology it could use to solve the problem. Some of the plans put forward included timesharing, and technology movement from analog to digital. There was a co-existence agreement that would be signed by end of October, which would include the mitigation plan.

Mr Solomzi Mbada, General Manager: Human Resources, said that Armscor was in the process of collaborating with universities around the country to assist children from disadvantaged backgrounds in subjects like mathematics and science. It had already collaborated with the University of Fort Hare and cater for 70 schools, with the expectation of increased demand. In terms of people living with disabilities, Armscor was in the process of collaborating with major institutions in South Africa for people living with disabilities, and had a three-year employment equity target aimed at having an intake of 19 people living with disability.

Armscor had collaborated with some of technical training facilities in Port Elizabeth and Cape Town in providing artisan training programmes. Young people were being trained at these facilities and in the dockyard. The challenge was that Armscor could not absorb all the newly qualified artisans. 

Mr Sam Mkwanazi, General Manager: Acquisitions, said Armscor continued to maintain missiles for the navy. Due to lack of funding, the navy had not been able to afford to move from block 3 to 4.

Mr Gerhard Grobler, Chief Financial Officer (CFO) said Armscor had reduced the corporation’s liability significantly, and had also sought ways to reduce it further in the remaining portion of the financial year, but currently it was fully funded for the liability.

Mr Esau asked a follow-up question about Armscor’s dependency on the strategies put forward in the Defence Review.

Mr Wakeford said there was a plan A and plan B. Plan A assumed that at some point everyone would understand the importance of the SANDF, the whole emphasis would change, Armscor would get all the required approvals, and in addition it would be able to sweat assets and generate income. Plan B looked and spoke to the sustainability of Armscor. It aimed at taking human capital, which had a number of skills sets, and using them in foreign countries and charging a fee for this. It would also assist local industries in promoting their goods and services in outside countries, and charge a fee for that as well.

Castle Control Board (CCB): Annual Report

Lt Gen Morris Moadira, Chairman of the Castle Control Board, thanked members of the board for ensuring that the CCB had achieved a clean audit.

Mr Calvin Gilfellan, CEO: CCB, highlighted overall expenditure. Salaries and wages had increased to R3 361 000 from R3 092 000, which was not a major movement. Audit fees had increased to R453 000 from R380 000, while cleaning services’ expenditure had been almost halved, to R102 000, by in-sourcing cleaning staff members.

The CCB had delivered excellent results in terms of administration and corporate governance. An additional 350-year commemoration programme, starting in quarter 3, had increased the number of new, innovative projects and programmes. The total gross tourism revenue per annum had increased by 9.23%, driven by a couple of high-yield film and leisure events.

Focus areas that had required more funding included expansion of the heritage exchange programme (R500 000), the preventative built heritage maintenance programme (R1 500 000), increased funding for marketing (R310 000) which could be done internally, increased resources for security (Military Veterans - R710 000) and expansion and modernisation of the internal security system (R1.2 million).

Challenges facing the CCB were its human resources complement, the real cost of conservation management, and balancing it with access and tourism programmes. There were plans to address these issues.

Discussion

Ms Mnisi asked when the CCB planned to finish with the renovations.

Mr Esau asked about innovative ways of generating money for the CCB in order to mitigate the risk of depleting the surplus. He asked about the section that dealt with risk and mitigation that had not been included. There was an environment for proper delegation, proper policy implementation. What procedures had been taken towards officials’ irregular expenditure? He asked how to deal with the Military Tattoo, it as it was not part of the budget and continued to deplete it. For the 350-year commemoration programme, R800 000 had been earmarked for maintenance and repairs, but only R500 000 had been used, yet there was an appeal for R500 000 for the next year. There had been consensus that this surplus would be used to generate more interest in the Castle, and there would be spin offs from that. What had the reasons been for the request -- was there a financial spin off for the Castle? There were only two officials receiving performance bonus contracts, at a maximum of 20%. Did the board consider revising this due to financial constraints? The Guberniya restaurant owed R100 000, which was considered an irrecoverable debt. Why had the board come to that conclusion? What could be recovered and not just written off? Did the CCB make money out the restaurant or was it paying them to use it?

Security costs had dropped from R41 000 to R4 000 -- why the huge drop? Why had telephone and fax expenses increased from R34 000 to R86 000?  Why was there no allocation for overseas and local travel? He asked for clarification for the huge jump in other expenses, from R90 000 to R583 000. What were the other expenses? Why would one lose on the disposal of an asset? He asked about the employee structure, and on expenditure sought an explanation for why there was such a big margin between over- and under-spending. Why had there been such a huge drop in sales and rental income?

Mr Gilfellan replied to the questions. He said renovations were due to end at the end of September 2016 but this had been extended to the end of October. Regarding sustainability, there was a commercial plan at hand and it was a matter of breaking it down to short term, medium term and long term. Strategic risk was included in the report, and the CCB would make the breakdown of risk management available. The military tattoo had been discontinued. Most events done on the commemoration programme were done free of charge, thus there were no financial spin offs from the programme. All of the new managers had performance contracts, and no one had achieved the maximum 20% bonus. There had been many meetings regarding the Guberniya debt with the people involved on the matter, and the CCB had ended up having to keep what was left of the Guberniya restaurant on the premises.

Mr Mandla Ngewu, CFO, CCB, said the entity had lost its data line on telephone and faxes, and had had to use mobile communication, which had contributed greatly to the costs on general expenses. On the loss on the asset disposal, two laptops had been stolen, and the rest was worn assets for which money could not be realised. The R583 000 expense included the military tattoo expenses, and was not just for general expenses. Funds had been shifted between projects, but this could not be shown in the report because the shifts had happened at a later stage. This could not be communicated with the National Treasury, and that was why there was huge over- and under-spending.

The meeting was adjourned.