Denel & Safcol Annual Report + Denel outstanding controversies

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Public Enterprises

06 February 2018
Chairperson: Ms L Mnganga-Gcabashe (ANC)
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Meeting Summary

Annual Reports 2016/17 

Both the Minister and Deputy Minister of Public Enterprises were unable to attend due to a Cabinet meeting. The Denel delegation was lead by Mr Dan Mantsha, Board Chairperson, Mr Zwelakhe Ntshepe, Group Chief Executive Officer and Mr Odwa Mlhlwana, Group Chief Financial Officer.

The Committee suggested the disagreement about the outstanding audit  be dealt with first. The Denel Chairperson referred to this as the “audit controversy” and he and CFO said this had been resolved in January 2018.

Members noted that Auditor General had recorded his dismay with Denel during the audit process. Had the “fight” between Denel and the Auditor General truly been resolved?

On the VR Laser and Denel Asia matter, it was suggested a further meeting with Denel and Treasury would be needed on this matter.

Members said it was unprecedented for the Denel Chairperson, as the head of a state owned enterprise (SOE), to actively challenge the decision of the Minister in public about Denel Asia

Denel's presentation on its Annual Report showed that Denel is in a dire financial situation and various strategies to turn itself around had not shown success.

A Member noted the Gupta emails provided evidence that the Denel Chairperson, Dan Mantsha, is close to the Gupta family. Denel had suffered a marked downturn in investor confidence arising from that relationship and allegations of corruption. Procurement regulations appear not to have been complied with and OUTA had laid criminal charges against the Denel Chairperson. The organisation was suffering from a lack of sound corporate governance.

The Denel Chairperson replied that if the evidence was limited to the Gupta emails, then he was not in a position to provide any opinion on questions or evidence based on pure speculation.

SAFCOL provided a more upbeat report than the previous year and had achieved a net profit. Aspects of its qualified audit were discussed and how it had resolved the audit findings.

Meeting report

The Chairperson noted that Mr Richard Seleke, Director General, Department of Public Enterprises (DPE) was unwell and thus unable to attend. Apologies had been received from Minister Lynne Brown and Deputy Minister Ben Martins as they were engaged in a cabinet meeting that would run both during the morning and afternoon session.

A DPE Deputy Director General introduced the Denel delegation (Mr Dan Mantsha, Board Chairperson, Denel and various other board members; Mr Odwa Mlhlwana, Group Chief Financial Officer, and Mr Zwelakhe Ntshepe, Group Chief Executive Officer; Ms Pinkie Mahlangu and Ms Mpho Kgomongoe, Board Members; Ms Vuyokazi Xaxa, Group Company Secretary, Ms Vuyelwa Qinga, Group Executive: Communication and Public Affairs. The DDG began to give an overview of Denel’s operations and financial performance in 2016/17.

Dr Z Luyenge (ANC) interjected and said it was irregular for the DDG to give the overview of Denel’s performance and operations. This should be done by the Denel Group Chairperson. The political overview should be done by the Board Chairperson, not the DPE.

The Chairperson noted Mr Luyenge’s comments. The DDG, as the representative of the DPE, was simply introducing the Denel delegation and not providing a political overview of their performance.

Mr Luyenge noted the Chairpersons’ reply and stated this was in order.

Mr Singh noted the Chairperson’s reply to Dr Luyenge. However, before Denel proceeded to give the presentation it would be advisable, in his view, for the Committee to deal with outstanding matters pertaining to Denel.  

The Chairperson agreed with this suggestion. The Committee was asked by the Chairperson if this approach was acceptable and the Committee agreed.

The Chairperson formally welcomed the Denel board and noted the Committee’s gratitude that many of the board members had availed themselves for the meeting. This was appreciated given their busy schedule.

Outstanding issue: Audit opinion from Auditor General South Africa
Before the presentation, Denel Chairperson, Dan Mantsha, dealt with what he termed the Denel “audit controversy”. As had been reported to the Committee on 30 January 2018 there was a dispute between Denel and auditors in respect of the unqualified audit finding given to Denel. That matter had been settled. The audit report does however remain unqualified per an agreement between Denel and the auditors. Mr Mantsha requested that the CFO present on that matter as he was leading that audit process.

Mr Odwa Mlhlwana, Denel Group Chief Financial Officer, noted that as stated by the board chairperson the matter has since been closed. It was however an unfortunate situation. At the time the presentation on that had been given to the Committee, Denel had been facing differences of opinion with the auditors on various matters. The auditors had filed their audit report on 17 July 2017 which was then run through the Denel audit and risk board committee and then presented at the Annual General Meeting (AGM) of Denel as part of their own internal processes. However, during the AGM the auditors had informed Denel that there was an error in their audit report. The position of Denel was that there was no way that an error could have occurred given the extensive internal processes of the auditors and the fact that the audit report had been signed.

Further engagements were thus scheduled to resolve that matter but whilst those engagements were taking place, Denel had come to Parliament to present on their performance and audit report findings. In short, an agreement had been subsequently concluded between Denel and auditors to the effect that an amendment was effected to the audit report which was accepted by Denel. The amendment specifically draws attention to a note which was disclosed by Denel during the presentation on their annual financial statements. This aspect was dealt with during the substance of the main presentation before the Committee. In sum, the dispute arose as to an amendment which the auditors wanted to effect which would draw attention to a specific note which was disclosed by Denel. Thus, there was no difference in terms of the substance of their numbers and calculations. The amendment did specifically state however that it was required due to an error on the part of the auditors. Since that engagement Denel and the auditors had come to an agreement and their numbers now align. In the view of Denel, this matter is now resolved and thus closed.

Ms D Rantho (ANC) stated that, according to her knowledge, the report provided by the Auditor General (AG) had been provided at the end of the previous year. That report had been circulated in the Committee with a disclaimer drawing the attention of the Committee to the fact that the Auditor General had made an error in that report which had subsequently been corrected. Is the correction referred to by the CFO one that had been effected at the end of 2017 or at the beginning of 2018? The Auditor General reported to the Committee on 4 October 2017. When exactly had the correction mentioned by the CFO been done?

The CFO replied that the final clearance of the matter occurred during January 2018. An updated set of financial statements had been provided which is included in the final report. When Denel had reported to the Committee in July and October 2017, the Auditor General had drawn the attention of the Committee to that discrepancy between Denel and the Auditor General. This would be covered in more detail during the the CFO presentation on the Denel financials.

Ms N Mazzone (DA) stated the Auditor General had been frank in his dismay about the dealings of his office with Denel. The Auditor General had drawn the attention of the Committee to various outstanding issues which had been caused, for lack of a better word, by the “fight” between Treasury and Denel on certain outstanding issues. Had those outstanding issues between Denel and Treasury been resolved? A joint Committee meeting with Denel and Treasury still needed to take place to resolve those outstanding issues and to ensure that each entity has a fair opportunity to place their side of the story before the Committee. Could Denel provide an indication as to when that joint meeting would be able to occur?

Mr N Singh (IFP) noted the remarks of the CFO that, in the opinion of Denel, the audit matter had been resolved. However, had the Committee received any response from the Office of the Auditor General to that effect? The Auditor General’s presentation to the Committee on this matter on 4 October 2017 indicated that the Auditor General was “dismayed” at the incorrect reflection contained in the Denel Annual Report. Nothing from the Office of the Auditor General to the effect that this matter has been resolved has been given to the Committee. Not to say that the CFO’s word on this issue should be treated as untrustworthy but it would be prudent for the Committee to receive confirmation to this effect from the Office of the Auditor General before the matter can properly be treated as resolved. If there are two sides engaged in the matter the Committee should confirm this officially.

Dr Luyenge stated the Committee should, at this point, defer to what Denel had stated to the effect that the matter had been resolved. The Committee has the power to embark on further enquiries into this matter. It would not be fair to the Denel board for the Committee to question the truthfulness of what has been provided at this point. The Passenger Rail Authority of South Africa (PRASA) inquiry did reveal the Auditor General had issues with various audit service providers the Auditor General had engaged. Before a final conclusion on this matter could be reached, the Auditor General should be engaged to inform the Committee on this issue.

The Chairperson requested Mr Singh and Mr Luyenge to confirm that they have not received any correspondence from the Office of the Auditor General on this matter. Both members confirmed this. The Chairperson stated the meeting should continue as planned and then further enquiries to the Office of the Auditor General would take place in due course.

The Denel Chairperson stated there are no issues between Denel and Treasury. The impasse which did exist has been settled. As the Committee is aware Denel had attended several meetings the previous year where Treasury had been invited. Denel is prepared to attend a committee meeting with Treasury. He stressed that Denel had no issues with the National Treasury.

Outstanding issue: Denel Asia
Mr P Gordhan (ANC) stated the Committee was speaking in generalities. Mr Rantsho had been very vocal in 2016/17. It was during this time that the Gupta Leaks had revealed the Denel Chairperson has a very close relationship with the Gupta family. It was precisely at this time that the VR Laser Asia project had been championed by the Denel Chairperson in the media. This was quite unusual as no chairperson of any state-owned enterprise (SOE) has challenged any sitting Minister as the Denel Chairperson had done. In Mr Gordhan’s view, the Denel Chairperson’s conduct in this regard was a direct result of his close relationship with the Gupta family. As a result, any answers provided by the Denel Chairperson and Board members should be treated with a degree of caution. The presentation should proceed as planned but the Committee must embark on further enquiries into this matter. He was not entirely convinced with the assertion that the matter with Treasury had been fully resolved. The issue with Treasury was whether Denel was entitled without Treasury consent, to launch a venture called Denel Asia. It was with great insistence that Denel had embarked on this project. Denel Asia had been linked to the Gupta business empire. The Organisation for Undoing Tax Abuse (OUTA) chairperson had placed information in this respect, against the Denel Chairperson, in the public domain both in the form of complaints and the lodging of criminal charges with the South African Police Service (SAPS). More information was requested from the Denel Chairperson to this effect. What is the precise relationship between the Denel Chairperson and the Board generally, with the Gupta family? Is the Board or the Chairperson involved in any relationship with the Gupta family? When and how was the matter of Denel Asia resolved?

The Committee Chairperson stated that some of the issues raised by Mr Gordhan properly belonged within the ambit of the State Capture Inquiry, a comment which was agreed on by various Members. It would not be proper to require the Denel Chairperson to provide answers on matters belonging to the Inquiry in the current forum. The Chairperson requested that Denel only reply to those matters which are properly relevant to the current committee meeting.

Mr R Tseli (ANC) agreed with the Chairperson. The Committee should not change the nature of the current meeting into an inquiry. The agenda for the current meeting is to go through the Denel presentation. If further enquiries need to be conducted at a later stage that could occur.

Ms Mazzone disagreed that this matter should not be interrogated at the current meeting. On 21 February 2018 the Budget is scheduled to be tabled before Parliament. Various discrepancies had been noted. Two Denel presentations had been circulated amongst the Committee. The first presentation, the Committee was informed, is an “incorrect presentation” whilst the second is the “correct presentation”. However, this is concerning as the “incorrect presentation” has a far greater amount of detail than the “correct” presentation. This included a request for a R3.2 billion government bailout. If this matter is not discussed now, this amounts to a disservice to the country. This is a matter of urgency as the Budget is scheduled for tabling in the National Assembly on 21 February. This is not a matter of simply been procedural and attempting to ascertain information from a source which may not be ready to present such information. It would be a disservice for the Committee to now postpone this matter until the Inquiry has completed its work, but which may take a long time to finalise. The Committee has less than two weeks to interrogate this matter until the National Budget is tabled. Difficult and hard issues need to be urgently engaged with.

The Committee Chairperson stated the matter properly fell within the ambit of the Inquiry, especially as the Inquiry was established to deal with issues inclusive of the Guptas which was the question raised by Mr Gordhan. The terms of reference and mandate of the Inquiry do not necessarily pertain to budget issues as raised by Ms Mazzone.

Mr Singh stated the Committee could not accept at face value the claim that the matter between Treasury and Denel had been fully resolved. This is a large and complex issue which will be subject to further inquiry. During the Inquiry process the Committee will be fully appraised of whether those outstanding issues have truly been fully resolved. He accepted that the current Denel presentation did need to be presented in order for the Committee to fully go through all the motions.

Dr Luyenge reiterated his earlier remark that Denel should be given the benefit of the doubt. At present, contrary information indicating that the Treasury/Denel issue has not been resolved is not before the Committee. He supported the proposal that Denel give their scheduled presentation and that issues properly pertaining to the Inquiry be avoided at the present time. He disagreed with comments made by Ms Mazzone that a failure to interrogate this at the present time would amount to sweeping this under the carpet. The Inquiry was established by Parliament and should be accorded due process to complete its work properly and not be usurped by the Committee engaging and interrogating matters better left to the Inquiry forum. It was important for the Committee to properly observe procedural rules pertaining to those different processes.

Mr Gordhan wanted to clarify his earlier remarks and respond to the concerns raised by other Committee members. His questions are not intended to pre-empt the work of the Inquiry. The Annual Financial Report cannot readily be separated from issues that may also be relevant to the Inquiry. To the extent that those issues are apparent from the presentation, it would not be improper or unprocedural to expect Denel to reply to questions. To simply engage with the presentation in a mechanical and formalistic manner would be a waste of time and would not be conducive to the manner in which the Committee wishes to operate. At the same time he accepts that the Inquiry must be allowed to conduct it business properly but a “Chinese wall” should not be erected between the business of the Denel and the current meeting. Denel is a strategic organ of state and the manner in which it conducts its business and finances are matters of vital public importance. He accepted the Chairperson’s suggestion that the meeting continue as scheduled but where issues of relevance are identified they should and will be raised.

The Chairperson noted the concerns of the Committee. She said that whatever was stated by Denel at the present meeting may arise later at the Inquiry and that further investigations would take place.

Denel Annual Report 2016/17 presentation
Mr Dan Mantsha, Board Chairperson, said Denel had achieved 87% of their performance indicators. The Board was satisfied with this progress, but it was stressed that is always room for further improvement. The Chairperson was of the view that further improvements should always be implemented in order to achieve all of their performance targets. The first part of the presentation dealt with strategy and performance targets. The second part of the presentation would be dealt with by the CFO pertaining to the financial performance in the last financial year.

Denel Strategy and Performance Targets
Denel had been existence since 1992. Denel was compartmentalised, and each division operated independently of one another. As part of the strategic planning of Denel a decision was made to further integrate the divisions of Denel. The previous approach led to a waste of money and resources and various individuals and stakeholders were not properly aware that Denel operates as a single entity.

Economic growth at Denel must be maintained. Initially Denel was worth between R2 to 3 billion and presently is worth around R18 billion. Of the R8 billion turnover however there are various hidden figures and consequences as Denel needs to have sufficient funding on hand to ensure they can deliver on their contractual obligations. Denel would like to leverage their capabilities. There are areas in which this process has already occurred.

As had been explained in previous meetings with the Committee, Denel has never been a “cash cow” SOE. The nature of Denel’s products requires that cash is absorbed into the entity in order to provide the services and products which Denel manufactures. The nature of armaments manufacture is resource intensive requiring extensive amounts of capital to function. The process of research and development requires a large amount of money. This is inclusive of striving to ensure that Denel remains internationally competitive.

It should not be forgotten that Denel is a SOE and not privately owned. Whilst the Board has a duty to Denel generally it also has other duties to act in the public interest as a state-owned enterprise. The objectives of Denel thus must be aligned with broader governmental objectives such as socio-economic upliftment and the further training of South Africans in areas such as maths and science and providing them with employment opportunities at Denel or other engineering firms.

The strategy of Denel, to a large extent, has not changed. This is borne out by the fact that Denel has improved its worth to R8 billion indicating that its current strategy is providing success, at least to some extent.

The Denel Chairperson referred to slide 3 and 4 which outlined the strategic objectives of the entity. Those objectives coloured in green indicated full achievement of that objective; yellow a partial achievement and red non-achievement. Areas of concern specifically related to ensuring a healthy balance sheet and ensuring the continued profitability of the organisation. Profitability is measured in terms of Denel’s overall cash reserves. The Committee had received briefings on Denel strategy in the past and in the past four years, not much has changed in the overall Denel strategy as the Board is of the view that the current strategy has borne success in most respects.

A key strategic goal is to enhance capabilities and innovation. The long term goal is not only to improve the current products and services offered by Denel but also to expand their services to provide equipment which can achieve various other strategic and governmental goals.

Slide 6 dealt with Denel financial performance from the year 2008-2017. Financial performance is a fundamental concern for the Board. In the 2008 financial year it was approximately R5.8 billion which rose to approximately R35 billion in October 2015. At present the financial value is around R19 billion. It was stressed that the discrepancy between the current value of the business and its value in 2015 must be understood in context. This is because Denel’s services and products operate according to a cyclical business cycle. Opportunities going forward have been indemnified to ensure further economic growth and improvement in terms of their overall order book. The primary change going forward is to ensure that Denel can deliver its products and services both in time and according to specifications. In the 2017/18 order book approximately 87% of their targets have been met. Denel is confident that the remainder of the targets will be met during the financial year.

The shareholder compact was agreed to between the shareholder and Denel and various targets were agreed upon. Five of the targets had not been met. These included:
• One such target was in research and development (R&D) which was to invest approximately 8.5% of revenue in R&D amounting to R740 million. The actual figure achieved was 7.6% of revenue amounting to R609 million. This discrepancy largely came down to an issue of cash reserves. Various payments had been fulfilled which resulted in this discrepancy.
• The second target related to employment. The indicator was to maintain employment targets with the target set at retaining 5 114 jobs. The actual target achieved was retention of 4 941 jobs. This related to the lack of availability of cash reserves. As the entity had been enabled to grow in that respect, it had resulted in a lower employee retention rate than envisaged leading to non-performance in this respect. This is however a temporary problem and when the order book becomes balanced later in the year that will ameliorate various cash reserves problems and lead to a greater employee retention rate.
• The third target was preferential procurement with companies owned by people with disabilities. The procurement target was set at 0.20% and actual performance was 0%. Procurement in the current financial year had already shown improvement in this respect with around R25 million in procurement contracts concluded with companies owned by people with disabilities.
• The fourth target was artisan training. The target was set at 85 and actual performance was 66. Again, this primarily came down to a lack of cash reserves. Even if Denel is technically making a profit, it becomes an issue if they lack cash reserves to utilise on various projects such as artisan training. At the previous year end, Denel had around R650 million in cash, but this figure was later reduced to around R385 million in cash reserves. This is explained partly by the need for Denel to advance payments to suppliers in order for Denel to embark on product development. Whilst some cash reserves had been maintained, it was stressed that that amount was not sufficient for Denel to meet all of their targets sufficiently as identified in the shareholder compact.

Denel Financial Performance
Mr Odwa Mlhlwana, Denel Group Chief Financial Officer, stressed that the overall financial performance of Denel must be seen in context; in particular, the reduced Defence budget of government of around 1.3% of GDP as compared against the international benchmark of 2.2% of GDP. This discrepancy has resulted in a situation where it is more difficult for Denel to remain competitive against other international manufacturers. This directly affects the ability of Denel to properly compete against competitors from other countries. A detailed percentage breakdown of Denel’s exports, in comparison to other international manufacturers by country, appeared on slide 12. A further significant factor is that the majority of international manufacturers base the bulk of their sales within their own domestic market. In contrast, the vast majority of Denel sales, up to 63% in 2016/17, comprised exports.

This leads to two conclusions: first, Denel is placed in a far tougher position, in terms of international sales, to leverage sales and maintain or acquire business in comparison to other international manufacturers. Second, other international manufacturers enjoy an additional comparative in that they can leverage a far higher degree of their business in terms of sales to their own domestic governments without having to necessarily rely on international exports. Both of these facts have a constraining effect on the ability of Denel to maintain profitability as measured against other comparable international manufacturers.

On the debt to equity ratio of Denel within South Africa’s current macro-economic environment, it was stressed that Denel is currently running a business which is highly indebted to various creditors. This leads to two elements. First, this has a negative constraining effect on Denel’s profitability as most of the income which Denel does make is utilised towards the servicing of debt. Second, this has a negative effect in terms of the number of sales, in terms of profit, per an employee. The ideal position for a business of the nature and size of Denel is to have a revenue sale figure per employee of R4.7 million, which is the target that has been set for the year 2022. Currently, this figure is sitting at around R1.6 million per employee. Taking both of these elements together, a picture does begin to emerge of the challenges that Denel is facing in terms of aggressive profitability and cash generation.

The revenue of Denel has plateaued in that in the last five years the business has experienced a positive annual growth rate of around 5.8%. An expectation that this growth would continue into perpetuity would be unrealistic. The present focus is ensuring that Denel maintains a satisfactory and realistic degree of profitability and cash flow income. This is an important element in assessing the financial performance of Denel overall.

The net finance costs refer to the debts which the entity has to service and is vital. Again, this talks to maintaining a certain amount of sales and profitability per an employee. This is currently at R203 million which is far lower than the levels faced by competitors. This does require tough decisions to be made to ensure a profitability increase. The operating cash flow is also below what can be considered a healthy figure and a substantial number of assets have had to be leveraged to maintain a healthy financial status.

On the 2016/17 audit opinion, Denel uses the services of Sizwe Ntsaluba Gobodo (SNG) as their auditors whilst the Auditor General had conducted a separate independent report. Denel does accept that the current Auditor General report does require further engagement with the Office of the Auditor General. The matter has been closed with SNG who signed an updated audit report on 24 January 2018 which is the latest report. This is what the CFO referred to as closing the matter with SNG. It is important to note that nothing in the document pack circulated to Committee was different to the earlier pack. The only difference is the amended audit report which remains unqualified. The amendment dealt with irregular expenditure which had been disclosed in the documents which had earlier been given to Committee. The Committee did have a right to further engage with SNG on that issue.

Denel had inherited a business with various challenges and which is currently facing a number of issues. There is a difference of interpretation as to what gave rise to the current difficulties. A primary performance target is to transform the business into a sustainable and profitable entity. On a positive note revenue had been escalated from the R6 to R8 billion level. The bulk of Denel’s international business relates to the servicing of international supply chain management systems. However, there are problems in terms of the end impact percentages as Denel has always been a “business doomed to die”. If one looks at various periods during Denel’s history, it faced continual losses on a yearly basis. At present, Denel still has a far way to go to achieve its overall long-term goal of becoming a sustainably profitable entity. The profitability of Denel, to achieve that long-term goal, needs to increase to between 8% to 12%.

Operating cash flow indicated that Denel utilises the majority of its cash reserves as they receive it. This again is an indicator that Denel was always a “business doomed to fail”. While a degree of cash has been generated this inflow is haphazard and does not come in a rate sufficient to maintain a profitable business. This is an area which has been focused on by the entity and must improve.

Revenue per employee has improved but there is currently an overcapacity aspect to those figures which has resulted in poor performance in this area. The overcapacity of the business is having a severe impact on the profitability of the business as a large amount of the revenue accrued by Denel goes towards employee remuneration. The employee profitability ratio is an important indicator to measure the overall health of the business which currently indicates a poor financial performance. Whilst the business did generate a large amount of cash in the 2002 to 2012 period by generating around R6.2 billion worth of cash, the vast majority of that amount remains tied up in banks at around R4.6 billion. This means that as cash is collected it is then quickly spent. In the past five years R31 billion in cash was received but only R257 million remained in the bank following the servicing of other expenses. This is an absolutely inadequate figure in terms of overall financial performance.

Due to Denel’s weak balance sheet and poor profitability, numerous challenges have arisen in terms of taking on new business. Denel is unable to fully access various banking facilities as banking facilities do not permit Denel to take on new business in terms of making advance payments to customers by making an advance payment guarantee. Denel cannot issue those guarantees as their banking facilities do not currently allow them to make those guarantees as most of their cash reserves are caught up in servicing debt and other expenses. The only realistic way to deal with this is to improve profitability in order to more effectively service that debt so that banking facilities can fully be accessed and exploited to facilitate the taking on of new business.

The lack of proper banking facilities has resulted in Denel been unable to properly pay various suppliers. This has created a very difficult situation in suppliers’ overall relationship with Denel. Suppliers have now insisted on advance payments if further business is to be forthcoming. On the other hand, various suppliers have also not properly delivered on various contracts which have also had a negative impact on overall financial growth.

Slide 18 dealt with the assistance provided by various creditors, inclusive of government, to aid the entity in its financial performance and overall health. Close to a billion rands worth of guarantees have been received by government in the 2016/17 financial year. In 2002 close to R2.7 billion was advanced to assist Denel with its financial predicament. However, despite the advancement of those amounts, the underlying issues on the continued profitability of Denel have not been properly addressed. The current approach now is to interrogate what the underlying reasons are for the poor financial health and low profitability of the entity as opposed to simply relying on further cash injections alone to keep the entity alive. At the same time, despite those injections, there has not been a proper improvement and the majority of those injections have gone towards the debt servicing instead of investments into other ventures which can improve overall growth and long-term profitability. Various difficult decisions will have to be made to improve overall growth.

Cash flow problems lead directly into various issues pertaining to liquidity. At present there is approximately R6.5 billion sitting on the balance sheet which cannot be accessed for around 18-24 months. Until that point that cash cannot be accessed. The issue is then to discover a manner to access those reserves or alternative cash flows to conduct the business of the entity. This has also led to various suppliers remaining unpaid. However, at the same time, what Denel is owed has always been substantially greater than what Denel owes other creditors. This has resulted in a situation where Denel is unable to pay other suppliers which is necessary for the entity to access capital to pay other suppliers in order to generate further profits.

There are structural issues relating to the performance of various contracts. In Asia there is a contract for the provision of various services and products which forms part of a larger system for which the customer is paying. However, various other aspects of the product are being procured by the customer from other service providers. The terms of the contract is such that the amount for the contract will only be paid once all of the other service providers have also performed their contractual obligations. This means that any amount due from that contract can only be paid once other service providers have performed which is outside of Denel’s control. This does not mean that that cash will not be forthcoming however it will not immediately be available and will only be forthcoming once the final product has been fully completed.

Denel’s negative financial performance has resulted in a marked downturn in funder confidence. In turn this has resulted in various funders refusing to extend further financial investments which has created various other challenges inclusive of restricted access to banking and other financial facilities. In the past 12 months alone money has had to be borrowed to service an unscheduled debt repayment of R766 million which is money Denel does not readily have. This was due to various funders insisting on terminating their relationship with Denel who terminated a previous agreement where Denel had a five-year financial relationship. To avoid a default, Denel thus had to find other money to service that debt.

On a related note, Denel is strongly opposed to the practice whereby government departments do business with one another and then ask for bank guarantees of one another. Essentially this only benefits the banks as opposed to government entities. In the last three years various guarantees were provided to another state-owned organ of around R150 million which is money that could have been used to finance other business of the entity. Armscor and National Treasury have subsequently been engaged to address this at a larger level. Denel was not attempting to lay the blame at the feet of anyone else as the entity does also have their own internal challenges which need to be addressed.

The business is in dire need of an equity injection. The phrase “equity” was stressed as it cannot be the case that the injection is used as a debt instrument which would have the effect of compounding the current funding and related debt challenge. As Denel cannot issue new guarantees or secure repeat business that injection is vital to address the balancing of its overall balance sheet. This requires a re-think in the debt to equity ratio which is having a severe constraining effect on overall growth.

To address a number of the challenges currently facing Denel, a process of deep restructuring had been engaged upon. One such area is cash inflow and over the last ten years R9 billion had been received but that amount had disappeared into servicing the core needs and other debts of the business. A drastic restructuring is required to create the necessary profitability and ensure the continued health of the business.

Slide 21-23 dealt with the various initiatives undertaken by Denel to address the various cash flow challenges. A specific issue was the Qatar matter which was detailed in the news in the previous year. A position had been taken that opportunities to raise funding urgently had to be exploited. One initiative was to identify various assets which could be leveraged to convert those assets into cash on an urgent basis. A second initiative was to potentially engage in a shareholder bailout. A position had been taken that whilst Denel has some ability to settle various debts, a shareholder bailout is not necessarily a sustainable and strategically sound option. A third option was to engage with various strategic partners in offshore markets and request further financial assistance. An entity called Public Investment Fund in Saudi Arabia had been engaged to this effect. Some organisations and funders did express an interest in purchasing a stake in Denel, but the engagement was stopped at that point as it was not a viable option to pursue. Subsequently however further engagements had occurred, but it was made clear that selling a stake in Denel was not on the table. A state-owned entity in the United Arab Emirates (UAE) had also been engaged with a view to obtaining some form of financial assistance. In short however there was no interest in that market to assist Denel. As a final measure the Qatar Ministry of Defence had been engaged who provided an interest in extending a loan facility to the effect of 350 million US dollars. The Qatar Defence Ministry did indicate an interest in obtaining an equity stake in Denel, but it was made clear in a memorandum of understanding (MOU) signed with the defence ministry that such a deal was not possible and beyond the mandate and authority of Denel. Such a deal would require engagement with Treasury and no approval or guarantee was given to that effect. Subsequently however, largely due to the negative finance partner responses following Denel’s recent negative economic outlook, that deal had collapsed.  

A major challenge arising from the lack of adequate cash reserves is a corresponding decrease in the ability of Denel to invest in R&D. An irony of the business is that they are a high-tech engineering entity which requires innovation and investment in R&D to maintain profitability. A squeeze in cash flow has a negative effect on the ability to invest in R&D which places further pressure on the ability of Denel to remain profitable and competitive.

Supply chain management figures reveal that the suppliers of Denel have benefited substantially because of its growth in the past. Correspondingly however the majority of their suppliers, if not all, are making double digit profits whilst Denel is facing various losses. This illustrates that various financial benefits which should accrue to Denel are being lost in the supply chain management process.

Slide 28 speaks to the various interventions which have been introduced to improve the sustainability of the business and ensure improved financial health. One initiative is the Opex restructuring by consolidating it into a single entity to save costs by improving efficiency. The engineering corps of the business also requires restructuring as it is currently over capacitated in relation to the amount of business Denel is currently undertaking. As a result, engineering human capital is being paid for but not utilised. In part this arises due to the fractured nature of the business which will require further consolidation to address this.

In conclusion, the various issues at Denel requiring establishing an innovative, competitive and transformed business model. By “transformed” the business should spend far more than the current 30% on transformed entities. Of the current amounts which Denel spends more than 70% goes towards untransformed business which means businesses which are not majority black owned. To achieve its various goals, relationships with government stakeholders must be strengthened. If there is a fragmented relationship with government, then the business cannot succeed. The sourcing of security cluster materials is one such initiative as Denel is a provider of strategic defence capabilities for the country. Further funding and strategic partnerships with the Department of Defence (DoD) must be fostered. At present Denel is not even amongst the top three recipients of funding from the DoD for R&D. If government is serious about the Defence Review paper and the future of Denel, then future investment in this must be done. In addition, the practice of inter-governmental bank guarantees should be stopped.

Mr Zwelakhe Ntshepe, Group Chief Executive Officer (CEO): Denel, said a core part of Denel’s mandate is the socio-economic development of previously disadvantaged South Africans. To this end Denel has now improved on the level 5 Broad Based Black Economic Empowerment (B-BBEE) Code. Various initiatives in engineering development and education have also been invested upon. The demographics in the employment of women has also seen improved figures. Bursary initiatives are given to high school students for further tertiary study who later participate in internships and become employed at Denel. It is vital to foster new talent to participate in the activities of Denel through initiatives such university bursaries to assist Denel in achieving its mandate and business objectives moving forward into the future.

Approximately R6.4 billion of the total revenue generated from Denel has come from black owned companies. This constitutes around 73% of the total business and further strategies are being developed to further expand on this figure.

Dr Luyenge welcomed the frank attitude adopted by the presenters in outlining the difficulties currently facing Denel. It is clear that the situation is far from ideal at Denel but there are a number the issues raised that have been inherent in the business for some time and were inherited, not self-made. It is important to be open, transparent and honest to properly inform the Committee of the issues currently facing Denel and the strategic plans which will be implemented to address these. The Denel board does still however have a responsibility to apply sound and transparent corporate governance methods to ensure continued growth and to assist in achieving the socio-economic and other objectives in South Africa. Does Denel have a plan to ensure that they will retain their current available capacity? This is to ensure that people are not trained by Denel through initiatives such as bursaries and vocational training and then later simply leave for alterative employment elsewhere. What strategies has Denel implemented to ensure an adequate staff retention rate? Even if Denel is not fully populated in its workforce capacity, has Denel prioritised the filling of critical positions? The presentation made clear that Denel does not receive much support from government. The Committee must engage further with government as Denel’s shareholder. In his understanding the shareholder bears a responsibility to show the outside world that there is a cordial and sound relationship between the shareholder and broader stakeholders within South Africa and the world as a whole. In procurement is there a strategy to develop black owned service providers? Are there any entities within the country that Denel has engaged with to ensure that black owned entities benefit from Denel or to enter into empowerment deals to further empower black owned business? Further communication about Denel should be considered in engaging with communities on the role that Denel can play in economic empowerment.

Ms Mazzone asked about the terms of engagement and proposed bank loans with foreign banks. What were the terms of the engagement for the bank loan with Qatar? The presentation stated that foreign partners have been engaged but foreign banking, in her opinion, can always be somewhat concerning. The cost base of Denel has now reached R9 billion and in the foreseeable future it does not appear as though the forecast indicates much improvement. The board must account for this fact. It is her duty as a Member of Parliament to inform members of the public how an entity such as Denel can continue to fall further into debt with their cost base continuing to grow. The future financial prospects of Denel do not appear favourable. At the last engagement with the Denel board, a turnaround strategy was presented. However, it does not appear as though that strategy has borne much success in turning around Denel. Media reports have indicated that the Public Investment Corporation (PIC) will be loaning Eskom R5 billion which is concerning for the country as a whole. Denel now also wants further government bailouts. Has government made any commitment to loan further money to Denel and if yes, from where is that money coming? There must be some form of debt rescue plan with proper concrete targets. Absent such a plan, it will be difficult to justify to the public the notion that Denel can actually turn its financial prospects around. A proper debt rescue plan must be drafted and presented within the next few months. It would assist the Committee greatly if Denel could provide a cash flow projection for the next 12 months. The elephant in the room is Denel Asia. One minute it was operating and all was above board but now the presentation has informed the Committee that project has been scrapped. Further details must be provided on the cancellation of that project and why. When SNG and the Auditor General came to the Committee to give its report on the financial woes of Denel, the Auditor General stated that it had instructed SNG to change Denel’s financial statements in certain respects. Denel in turn told the Auditor General, in no uncertain terms, that their financial statements would not be changed. At the time the Committee had expressed its dismay that a direct instruction from a Chapter 9 institution had been disobeyed by an SOE. Answers must be provided why Denel has now subsequently changed its financial statements and secondly why it refused that initial instruction in the first place.

Mr Singh stated that 95% of the presentation appeared to revolve around requests for equity injections to improve the debt to equity ratio. This was the recurring theme throughout the entire presentation. In terms of Denel Asia and the VR Laser deal, whilst both deals were cancelled, did costs take place and if so, how much and to whom was it paid? The presentation indicates that the margins of Denel are low. What about the middleman concept? As far as he knows Denel employs a number of middlemen to acquire contracts for Denel. Who are those middlemen companies and how much are they paid? A closer examination of the middlemen fees could reveal that a large amount of its money is spent unnecessarily on engaging services of middlemen. Various internal disciplinary hearings have been recorded with 142 instances of irregular expenditure giving rise to those hearings. However, there is no indication that any criminal proceedings have been instituted. Why have no criminal proceedings been instituted and what kind of proceedings have been instituted pursuant to that irregular expenditure?

Mr Gordan thanked the CFO for his frank analysis. Denel is performing miserably in its financials which is self-evident. What is lacking from the presentation is a proper and coherent analysis as to why that is the case. It cannot be that the issues are identified and then the only solution offered is an equity injection. Where should the funding for that injection come from? Secondly, the area of corporate governance is not properly dealt with in the presentation. What are the implications of Denel potentially being a captured institution? State Capture is a well-known concept and it would not endear Denel to the Committee to play games about this. The Gupta emails have provided a high degree of proof for that concept. Has this had an effect on the corporate governance of Denel? It appears the CEO is questioning the business model of Denel. What is the total number of entities that Denel has? Some may be companies, but other entities may have a different legal status. A related issue is that some may be profitable, and others may not be. A report should thus be given on each entity so that each entity can be dealt with individually. Is the current business model for Denel actually appropriate? Is Denel actually producing the right product? It is not useful to produce a product which is expensive and not market competitive which in turn will have an impact on the overall financial health of the company. The CFO refers to Denel as a cyclical business to explain its current financial state. The business of Denel cannot be described as cyclical as it is not subject to the same business cycles as other business and cannot really be described as cyclical in that sense, to explain its current poor financial status. In the past few years Denel’s performance has been sub-par. What is the relationship between the human resource base of the employees at Denel and their total productivity? What is the debt to equity ratio in terms of individual employees? It is highly concerning that various funders have lost faith in the business, but this is a direct result of poor corporate governance and other avoidable issues at the business. If the business was still profitable this would be less of the case, but state capture allegations have a direct negative effect on investor confidence. As has happened with other SOEs such as Eskom there must be a full investigation and if any person is implicated in state capture they must be held to account. Only credible people should be employed who are of utmost integrity and not implicated in state capture. If the government as shareholder fails to take such steps, then the issues at Denel will only worsen. What bonuses have been paid during the recent period of poor financial performance? Performance indicators can be managed to give a false indication of profitability and this must be guarded against to prevent a box ticking exercise which hides the true state of affairs. Further time with Denel needs to be scheduled to properly get to the bottom of the issues facing Denel. As noted by the CFO, Denel is a business in financial crisis and requires urgent restructuring. The Committee must make a judgment call on this to examine the corporate governance practices and financial stability of the organisation. Currently, not enough information is before the Committee to make that judgment call.

Mr Tseli said the Board Chairperson should be commended for their corporate social investment and their efforts to promote socio-economic investment. Further details were requested on the potential sale of Denel assets and the amount of capital which can potentially be accrued as a result of those sales. In terms of Denel’s business model, the presentation appeared to indicate that it is not currently sustainable. What steps should the Committee take to address that? The issue of funding had also been raised which is a recurring theme which is raised as government is the sole shareholder of Denel. From the perspective of Parliament what type of funding should be provided? A rigorous communications strategy may also need to be developed and it cannot be the case that Denel is only mentioned or heard about in a negative sense. What is the relationship between customers and Denel?

Mr E Marais (DA) noted the cash flow situation at Denel is under great pressure. He requested additional information on capital expenditure. Congratulations were offered on the engineering initiatives taken to train a new corps of engineers. In 2015/16 there were 11 audit committee meetings at Denel. However, in 2016/17 there were only four. Are people paid per meeting or is there another reason for that discrepancy?

Mr D Rantho (ANC) stated that in many instances Denel had people in acting positions for too long who were not permanently appointed. This needs to be addressed. The presenters had expressed a strong commitment to turning Denel around which is positive to hear. She aligned herself with the comments of Ms Mazzone about her hesitancy about the loan with Qatar. Were any other government departments involved in that interaction and if so which ones? The NCOP should be engaged about youth empowerment and rural development plans. Every government entity should have a plan for rural development which forms part of government’s manifesto.

She requested that each board member provide their educational and qualification background. This had been done for other entities and the Committee should be consistent. The Denel Asia issue had been “sold” quite strongly at the time. What effect did the closure of this project have on the profile of the company overall? What is the current situation with former CEO? Has he been completely removed and has he been charged? When public money is misused those amounts must be properly accounted for. A failure to properly account for public money lost through mismanagement must be properly accounted for in order for the public to retain confidence in the performance and continued business of Denel. The Committee had taken a decision to have quarterly meetings with entities to properly monitor the progress of turnaround strategies. Whilst it can be difficult for entities to travel to Parliament in Cape Town to account for their turnaround strategies it is vitally important that proper Committee oversight is pursued and implemented.

The Chairperson asked the CEO if he is acting or permanently appointed?

The CEO replied that he had been permanently appointed.

The Chairperson made a few remarks. It was noted that the Eskom board, on a side note, is a new board. The Committee will, as a matter of procedure, in future request the board chairpersons of entities to inform the Committee of respective qualifications and expertise to maintain consistency. The current board of Denel has however already been in existence for three years and it would potentially be unfair to begin questioning qualifications at this point. The Committee also does not wish to usurp the functions of the Minister who appoints the board and not the Committee.

Dr Luyenge stated a Committee resolution had been taken whereby SOE boards would inform the Committee of their qualifications in order to be fully appraised of their relevant areas of expertise.

The Chairperson noted this and requested the Denel Chairperson outline his qualifications and areas of expertise as well as the other Denel Board members.

The Denel Chairperson stated he is a qualified lawyer. His area of expertise is business law, transitional advice and general corporate law. Ms Pinkie Mahlangu stated that she is a qualified attorney who has been practising since 2007. She is also an owner of two business franchises and is involved in artisan development. Ms Mpho Kgomongoe stated that she has a B Com degree and another degree in management. She has trained as an internal auditor.

The CEO stated that other Board members, who were not present, have various fields of expertise such as business leadership and military backgrounds. If the Committee wishes, that information can be provided.

Mr Gordhan requested that the Denel Board Chairperson acts as the guardian of corporate governance over the business of Denel. Section 217 of the Constitution dealing with government procurement requires them to observe certain ethics. Additionally, as a lawyer he has taken an oath to abide by the law. In terms of the Public Finance Management Act (PFMA) the board is designated as the accounting authority of an SOE. The PFMA is intended to ensure that government resources are properly utilised. Is Denel a captured organisation, has Denel been implicated in the State of Capture Report? Does any board member have any relationship with the Guptas or Dubai? The board must take credit for both the good and bad that happens at Denel as it is their legal duty.

Denel Chairperson, Mr Dan Mantsha, responded that the State of Capture Report by the Public Protector made no findings that Denel contravened the PFMA or any other legislation. The Report indicated that the next phase of the investigation would investigate the contract between Denel and VR Laser. That contract was concluded almost five years ago which was before the constitution of the current board. This was indicated in the Public Protector Report and the second phase would focus on whether the contract with VR Laser was concluded correctly or not. In terms of the relationship between Denel and the Public Protector during the State of Capture Report, the Public Protector had visited Denel and requested information which was given to her Office. At the time of the first report no finding was made against Denel in respect of any allegation of State Capture. The Committee should confine itself to the facts and not engage in speculation. Any allegations of state capture have been denied and there are no such findings thus far based on any documentation which has been given to the Public Protector. The board is conscious of the duties legally imposed by the PFMA and the constitutional provisions dealing with procurement. On procurement, if allegations are made by Committee members that Denel is failing to procure goods and services in accordance with the law then it would be prudent to provide details of those allegations so Denel can properly respond. The board and Denel are annually audited by an independent service provider. He reiterated that Denel is not a captured entity and no adverse findings have been made about a failure by the board to exercise their fiduciary duties or any other duties imposed by the Constitution or the law that the board or any other person at Denel is currently aware of.

Mr Gordhan said the Gupta Leak emails stated that the Guptas had financed various trips for the Chairman to Dubai. What deals, if any, were made on that trip which affect the financial health and/or future of Denel? What was the subject matter of that trip in so far as it related to the official business of Denel?

Mr Tseli said it would not be prudent to expect Denel to answer some of the questions raised by Mr Gordhan at this time. The Committee cannot elevate the current meeting into an inquiry. Not that he was necessarily opposed to Denel answering the questions which had been posed by Mr Gordhan. However, to expect Denel to provide answers to questions they have not had sufficient time to prepare for would be procedurally unfair.

The Chairperson said to Mr Gordhan that the current meeting should not be elevated into a debate on the desirability of Denel answering questions pertaining to State Capture and the Gupta Leaks.

Mr Gordhan replied that the primary concern is whether the questions he had posed to Denel are relevant. At the Inquiry more questions in this respect would be asked and should be answered. The question of the Dubai trip is directly relevant to the present meeting as it may have had an impact on the overall financial performance of Denel. The question is essentially one about sound corporate governance.

The Chairperson stated that the Denel Chairperson should then limit his answers to the overseas trip and whether it had any impact on the current financial year under review and refrain from dealing with issues related to the Guptas.

The Denel Chairperson questioned from where the evidence of the “so called trip” as posed by Mr Gordhan was coming. If the evidence was limited to the Gupta emails, then he was not in a position to provide any opinion on questions or evidence based on pure speculation.

The Chairperson requested the Denel Chairperson to limit his answer to whether he has taken any international trips and what the effect, if any, those trips have had on the financials of Denel in the current financial year under review.

The Denel Chairperson responded that up to 60% of their revenue is from the international market. Denel is very active in attending international defence fairs and meet with international clients, governments and investors. In many cases the Board Chairperson is expected to attend those meetings. In most cases those international trips are led by the CEO and CFO. As the international market is central to Denel’s financials they are expected to go on a large number of international trips. In addition, domestic market spending has decreased gradually in recent years with additional competition in the domestic market from international sellers. In order for Denel to survive financially it is central that they go on a large number of international trips.

The CEO replied to Dr Luyenge that Denel has taken various initiatives to ensure that their critical engineering corps remain productive and have incentivised other employees with various retirement and other packages – short of retrenchment or of reducing the overall capacity of the organisation. Denel does receive government support, especially from the Department of Defence, but this is not always as large as they would like it to be. Procurement from black owned providers is a key area of focus for Denel. This is to ensure the country as a whole is sufficiently looking after its citizens and promoting overall socio-economic development.

On Ms Mazzone’s question about the bank loans from Qatar, those engagements were with the Qatar government and not a private bank. The Qatar government has a Public Investment Fund that is related to their defence industry which was approached. This would involve approaching its Defence Department or the Public Investment Fund itself.

On the cost base in terms of the employee to profit ratio, the cost base of the company needed to be examined in order to properly get to the root cause of that issue.

Ms Mazzone pointed out that her question did not relate to a loan from the banks specifically, but rather to the R3 billion government guarantee which Denel had secured.

The CEO replied that no other commitment was made to Qatar as it fell outside the mandate of Denel to negotiate further guarantees on that issue. Denel is reliant on state assistance to a certain extent but an overall reliance on government bailouts to keep the business afloat is not reliable. An extension for the government bailout had been applied for from the state but alternative sources of financing are also being explored. Constant monitoring of the execution of Denel’s restructuring strategy must be engaged upon and engagements with National Treasury to that effect have occurred. The current guarantee expires in September this year and thus options of extending that guarantee are been explored which will be contingent on the ability of Denel to illustrate to National Treasury that the turnaround strategy will be properly implemented. On equity injections, that process is been handled with care and based on the understanding that Denel must secure additional funding to secure its financial health and not rely solely on government bailouts to ensure its continued financial viability.

The CEO replied that in terms of the middlemen question, in most cases the middlemen come from the military and have retired. Those middlemen are usually situated in foreign countries which purchase Denel products. A review had embarked on to review the payments given to middlemen. However, middlemen do more than just introduce Denel to potential clients but also provide other advice in terms of oversight and strategic development in foreign markets.

The CEO stated that a process had been embarked on to re-examine various divisions of Denel in terms of their profitability and restructure and make contingency plans for those divisions which are not currently profitable and thus affect the financial health of Denel as a whole.

In reply to Mr Gordhan’s question about whether Denel is producing the right product, Denel is a relatively small company in comparison to other armaments manufacturers. Denel is however known worldwide due to the quality and type of products that they produce to meet changing market needs.

The CEO stated that he was confident that the order book would grow which is a process that he has been intimately involved in. However, the growth of the business cannot be disproportionate to the ability of the business to deliver which will lead to a negative pushback. Currently Denel can handle R50 billion worth of business per year but anything above that could create a challenge in its ability to deliver on those orders.

The CEO replied that rural development remains a core priority for the business. Much success has been achieved in rural development and developing new talent which has delivered success in Denel’s overall corporate social responsibility to society.

The CEO replied that he was unaware of any further charges laid against the former CEO. The proposal by Ms Rantho that Denel engage in quarterly report-backs on turnaround strategy was accepted as a good proposal which will assist Denel in fulfilling their turnaround strategy and their broader SOE mandate.

The CFO stated that on the transformation front Denel is unapologetic in promoting black economic empowerment. Supply chain management processes had been revised to create a necessary narrative and change of mindset to facilitate a competitive process of procurement from black owned enterprises. Transfer contracts have also been looked at to assist in consolidating the various entities within Denel generally.

The CFO replied that Denel is audited by SNG therefore its audit relationship is with SNG even though they still bear various duties to the Auditor General as an SOE. However, it is not correct to state that the Auditor General instructed SNG or Denel to alter its financial statements. Denel has engaged the Auditor General about auditing standards and an independent professional opinion had been obtained about Denel’s financials. The Auditor General cannot instruct another auditor to perform a particular task or make a particular finding as auditors must make a conclusion or finding based on their own independent judgment. In spite of that, the Auditor General does review the SNG auditing process and participate in that process which was signed by the Auditor General on 17 June 2017. At that meeting the Auditor General and SNG never raised this issue. The Auditor General was thus involved in the entire process. As the Auditor General had not seen the audit evidence examined by SNG they had no basis to instruct SNG to change the financial statements of Denel.

On irregular expenditure, the CFO replied that in the previous financial year irregular expenditure amounted to R46 million. In the current financial year there was around R150 million of irregular expenditure. Of that R150 million around R83 million was from another company called DVS which was recently acquired by Denel and which was privately owned, thus never subjected to PFMA or other regulations. An exemption application was made to Treasury to receive an exemption from those regulations whilst processes are put in place to deal with that irregular expenditure and ensure compliance with the PFMA. However, no response was received from the Auditor General or National Treasury. Thus, in reality the true figure is R150 million minus R83 million because that entity did not have to comply with regulations so the true figure is around R39 million meaning this has gone down. However, even in terms of the R39 million various issues still need to be addressed. In terms of single sourcing, various suppliers have been engaged who do not properly comply with the PFMA and created designs which have been incorporated into Denel products. In response, various interactions were done with Treasury to moderate that process and ensure that compliance with the relevant regulations occurs. In other cases, suppliers did not have clear tax clearance certificates. This is a big issue in terms of procurement as Denel has to secure those products, but it was stressed that Denel did not do business with suppliers who did not supply tax clearance certificates.

On misconduct and resultant disciplinary processes, the CFO replied that there is a difference between irregular expenditure and criminal proceedings. Of all the irregular expenditure none of it is fruitless which means that there is not necessarily any evidence of criminal activity. Irregular expenditure arises when internal processes are not properly adhered to but a violation of those internal processes will not necessarily mean that criminal activity has occurred.

On the criticism by Mr Gordhan that Denel’s business is not cyclical, the CEO replied that the reality of the matter is that the best local benchmark to measure Denel’s business is the construction industry. To expect continual growth in perpetuity has never been realistic. The best way to keep the business profitable is to conclude contracts which persist over a period of time to compensate for periods of cyclical downturn.

On the cost base, Denel cannot improve its competitiveness unless it resolves its various cost base issues. The building process does not necessarily result in profitability and thus cost base issues must be addressed to ensure that products can be produced at a rate that is competitively priced.

Denel replied to the question about its communications strategy, saying that this involves exploring the ways in which Denel can communicate its role and strategy in a positive manner that will facilitate growth and future investment. Learners in schools are one such initiative that has been prioritised to leverage the expertise of Denel in technology. This has included opening up opportunities for bursaries and going to various universities in the country to expose them to the business of Denel and to encourage them to potentially pursue careers at Denel. Learners who are offered bursaries also intern at Denel following the completion of their studies which also facilitates a positive communications strategy.  

South African Forestry Company Ltd (SAFCOL)
The Chairperson appreciated the effort of the SAFCOL board members to attend the meeting. Members of the Board and the Minister had engaged with the Committee on 30 January.

The SAFCOL delegation included Mr Lungile Mabece, Board Chairperson and Board Members, Petrus Mahlangu and Maroale Rachidi, Mr Klaas Mokobane, Acting CEO, Ms Vuyo Tlale, Acting CFO, Mr OR Kwape, Executive: Strategy and Innovation, Ms Dimakatso Motseko, Executive: Human Capital.

The SAFCOL presentation gave an overview of the company pertaining to its mandate, group structure and the manner in which SAFCOL does its business. It was noted that SAFCOL’s public profile is not necessarily as prolific as other entities and thus an overview would be useful. SAFCOL is a 100% state owned company. Four businesses fall under SAFCOL: Abacus Forestries SOC Ltd; Kamlahabne Timber SOC Ltd; Komatiland Forestries (KLF) and IFLOMA. SAFCOL was established as an SOE in 1992 to manage state forests. The business of SAFCOL is supplying the market with timber logs and processed timber which is used in construction as well as various industrial applications. Going forward further diversification of the business is envisaged as the current business model does restrict the profitability of Safcol.

SAFCOL strategic objectives consist of four pillars: growth and new markets; financial stability; operational excellence and rural development. It was stressed that the business of SAFCOL must be seen in the overall context of community empowerment and creating products which are ecologically sustainable and financially competitive in the international sphere. Financial stability however begins with their operations as if they conduct their business in an ecologically harmful manner then the overall financial stability of SAFCOL will be threatened. SAFCOL is unapologetic about the rural development initiatives they have engaged upon which is one of the core pillars of their overall business strategies. Human capital development is essential to achieve the objective of financial competitiveness both presently and going forward into the future. Customer and shareholder satisfaction furthermore are vital in maintaining the overall health of the business alongside socio-economic empowerment of black owned businesses.

The operations of SAFCOL are primarily in rural areas in Kwa-Zulu Natal, Mpumulanga, Limpopo and in some areas in Mozambique. It is important to operate in areas where there is a market for SAFCOL products. The primary business of SAFCOL is in rural and not urban areas, which is why rural development is central to their overall mandate and success. The business in Mozambique was established as part of an initiative to expand the overall business. The business is not yet profitable, but it is envisaged that it will break even in the current financial year and potentially even begin to yield a profit. SAFCOL is responsible for managing around 2000 hectares which is inclusive of the area in Mozambique. This is part of the overall strategy that wherever there is market for their products they will conduct business in those areas. Supply chain sustainability is also a core part of SAFCOL’s mandate as many suppliers depend on its overall success and continued sustainability.

The Acting CFO, gave the financial highlights of the entity. In 2016/17 SAFCOL revenue increased to approximately R1.03 billion which is an overall increase from the R891.91 million in 2015/16. Costs have been reduced by around 7% whilst the company recorded an overall net profit of R114.44 million which is a positive result given the net loss of R43 million in 2015/16. The current balance sheet remains stable and there is considerable leeway on the books to finance further investments and various contingencies. The liquidity of the company is being soundly managed in order to raise further revenue for capital expenditure programmes.

Five-year trends in sales reveal an overall increase the sales of logs but a corresponding decline in lumber volumes. The decline in lumber sales is primarily due to poor market conditions for that commodity.

The Acting CEO gave the operational highlights. KLF showed positive results as 100% of the Forest Stewardship Council (FSC) certification was maintained. KLF has continued its certification for the past 19 years and is the first organisation in Africa, and secondly globally, to be 100% FSC certified. Eucalyptus log sales volume and revenue targets were met for the first time while total log sales increased by 23% and the temporary unplanted area was maintained at the previous figure of 3%.

Ms Motseko spoke on human resource. She had only recently taken over the position in January of this year and was thus still familiarising herself with all aspects of the position. SAFCOL had 2 283 employees by the end 2016/17. Highlights included the continuation of the mentorship and training programme for women in forestry, the award of 103 forestry and processing learnerships, the award of 37 bursaries to students and employees for further training and the appointment of 15 apprentices. Bursaries are also provided to the dependents of employees. The Platorand Training Centre continues to service local communities. Highlights include that the training is accredited with Fibre Processing and Manufacturing (FP&M) Seta, the registration of the training centre as an Independent Examination Board (IEB) and Nelson Mandela Metropolitan University (NMMU) exam centre and the current offering of 20 learning and development forestry technical skills programmes all of which are accredited.  

SAFCOL operates primarily in rural areas upon which there are often various land claims which are adjacent to operations. SAFCOL has signed 13 social compacts with various communities and land claimants adjacent to operations. The formalisation of those relationships is necessary in order to establish a formalised structure of engagement to properly understand and engage with the needs of the community.

SAFCOL continues to play an important in role in socio-economic development in local communities. Various resources continue to be put by SAFCOL into schools such as the donation of computers. In addition 6.76% of net profit, after tax, was used for social and economic development as against the Forestry Charter target of only 1%. The increased investment in communities is necessary as in the future, many of the people in those communities are likely to be their business partners. Fire awareness programmes had been conducted in schools in all three provinces where SAFCOL operates. A learnership programme had been developed by establishing two youth manufacturing co-operatives where members of the community are identified, given a stipend and additional training with the overall aim of providing a new corps to assist both SAFCOL in their activities and to assist local communities where they live.

The Acting CFO dealt with the lowlights of 2016/17 (see slide 35) which included the loss of three lives: two chainsaw operators and one logger operator. Initiatives inclusive of increased safety awareness and the strict application of consequence management, alongside consultation with union officials for non-compliance with safety regulations, had been implemented. A qualified audit opinion was received but it was stressed that this was based on incompleteness based on irregular expenditure which was disclosed in the financial statements. The solution implemented was to update the irregular expenditure register and develop a policy on irregular, wasteful and fruitless expenditure. An internal audit function had also been established.

Internal control deficiencies were identified by the Auditor General such as a lack of policies and procedures to support the figures reported. The solution implemented was inclusive of prioritising quality management resources in the company and putting audit trackers in place to monitor overall progress. Additionally, policies and procedures were developed where they did not exist and were required.

Supply Chain Management (SCM) challenges included a risk management deficiency due to transition from a decentralised to a centralised model and Auditor General findings about various SCM vacant posts. Remedial measures included: a review of delegation of authority and the SCM policy, stricter implementation of demand management, the establishment of a bid and contracts committee and the wholesale implementation of training initiatives.

The Acting CFO spoke to the achievements and overall performance in terms of the shareholder compact. This has four strategic elements: financial and commercial sustainability which had a weighting of 30% and achievement of 26%; sustainable forest management and expansion which had a weighting of 30% and achievement of 8%; strategy implementation which had a weighting of 10% and an achievement of 2.5%; socio-economic development which had a weighting of 30% and an achievement of 17.78%.

The SAFCOL Chairperson in conclusion said that it is important for the Committee to properly understand the progress that SAFCOL has made. In terms of the Act, SAFCOL is intended to lead the country in the preservation of the country’s forests which led to the convening of a conference last year. SAFCOL is intended to play a leading role in transformation of the industry which continues to remain completely untransformed. SAFCOL is looking at further expanding its operations not only into Mozambique but throughout the whole continent. UN reports  reveal that the rest of the continent has larger amounts of forest than South Africa and therefore further expansion deeper into Africa will hopefully bring further success.

Mr Tseli noted that SAFCOL had a qualified audit. However, the company should be commended in the area of socio-economic development. The improvement from making a net loss to a net profit in the space of a single year should also be welcomed however clarification should be provided on how that was achieved.

Mr Marais asked if the COO could expand on the KLF in Mozambique. Often there have been number of problems about the management of that entity in Mozambique. It is positive however that its revenue has increased and is now profitable. It is important for all SOEs to be profitable.

Dr Luyenge welcomed the report. The current performance of SAFCOL appears to be positive and credit should be given where credit is due. The intervention by the shareholder indicated a clear intention that all stakeholders concerned are serious about the success and fulfilment of the mandate of SAFCOL. Forests are a very important natural resource and asset which can be used to economically uplift the poor who were previously excluded from that resource. The Member asked the acting CFO whether any mechanisms could be employed, from a legal perspective, that the various forests which have been signed up to very long leases could be returned to poor people? SAFCOL should manage far more forests than they currently manage now. There must be a clear establishment of a mechanism to look at the various structural arrangements of SAFCOL to ensure that any root causes of issues facing SAFCOL are properly dealt with.

Ms Rantho made the comment that she thought SAFCOL would have a far greater influence in government than it is currently. SAFCOL does not appear to be well-known by the public. SAFCOL has also indicated an intention to expand within South Africa, but there is no intention to also expand within South Africa domestically? During her term in the NCOP she toured various provinces where it was discovered that huge tracts of land are privately owned and not been properly utilised by the owner company. Providing further education was positive but other initiatives should also be taken in terms of industrialising local rural areas where they operate. This is an area where SAFCOL has room to improve quite drastically. A clearer plan should be formulated and provided about the potential expansion to other countries. It is also very worrying that three deaths were recorded. Proper consequence management and a proper monitoring should be implemented at the outset in order to prevent such deaths occurring. Furthermore, given the fact that SAFCOL is state owned those deaths also reflect poorly on the government and is traumatic for the families of the deceased. Has any counselling or support been given to those families of the deceased? It is also concerning given the various findings of irregular expenditure which have occur. Incomplete financial statements could, in the view of the member, give rise to an inference that someone may be hiding information. A full and comprehensive strategy must be implemented to deal with that issue. Have all of land claims from the various communities were SAFCOL operates been finalised? What is the strategy for the expansion into Mozambique and are there any highlights in this regard which SAFCOL would like to share? Finally, would it be possible for SAFCOL to provide a breakdown of their workforce by demographics and in terms of position.

The Chairperson noted with approval the comments of the members that SAFCOL had performed good work and made numerous improvements. It is concerning however that most of the targets in terms of their shareholder compact have not been achieved. Those targets would be closely monitored in terms of their quarterly engagements and the spending of money would be closely monitored. The targets must thus be closely monitored to ensure that they are properly achieved. A timeline should also ideally be provided in the future to show the intended dates when the various targets are intended to be completed. The breakdown of human resources, while progress has been made, should do more to accommodate people with disabilities. While it is understandable that the work of SAFCOL often involves the use of dangerous machinery, efforts can still be made to accommodate people with disabilities where possible. The fatalities are a cause for concern as one death is too many. Efforts must be made to ensure health and safety laws are complied with and consequence management must be properly implemented. Health and safety inspectors from the Department of Labour (DoL) should also conduct inspections to ensure compliance. In terms of the remedial action intended to address the qualified audit, a timeline should be compiled about the progress in implementing that remedial action. While the expansion to foreign markets is not necessarily a bad thing is SAFCOL examining any possibility of engaging in beneficiation of local markets and individuals to further benefit the domestic economy. Currently it seems that most furniture comes from foreign markets and further beneficiation domestically would be a positive development to promote socio-economic development locally. In addition, local furniture and goods appear to be more expensive than foreign products and perhaps additional research may need to be done in this regard to discover what the root cause of that price difference is.

The SAFCOL Chairperson replied that SAFCOL already engages in beneficiation through the establishment of a number of cooperatives. The school furniture donated by SAFCOL to schools in the Eastern Cape was manufactured by young people who have graduated from the enterprise development programme in SAFCOL and some even now independently compete for government tenders. Part of the drive towards industrialisation is a further drive to include and empower young people. As part of their engagement with local communities it has also been discovered that not all SAFCOL forestry assets are fully exploited. Partnerships should however also be engaged in with the private sector and the Minister to drive a process where the country properly understands the important role that SAFCOL plays and the role that the country’s forest resources can play in growing the economy and ensuring local empowerment. It was agreed that further targets should be set in employing more people with disabilities as there is no reason that people with disabilities should not be further involved in the business. Timelines would be provided in future in terms of concrete goals and targets as to when they would be achieved. He noted that the Committee had planned to visit SAFCOL the previous year, but that visit was cancelled. SAFCOL however is still very interested in the Committee visiting its operations which could play a role in further expanding its public profile. SAFCOL does however welcome the recommendations of the Committee as a whole.

In terms of further engagement with government, SAFCOL had engaged with various spheres of government and municipalities in order to strengthen those ties with the primary shareholder and also to improve on the public profile of SAFCOL. Engagements with municipalities have been fruitful and numerous positive developments have emerged as a result of those engagements. However more work can always be done. SAFCOL has been invited to form part of the government advisory council on township development which is taking place the following month in Umtata. Currently SAFCOL is therefore fully engaging with all available avenues to ensure full engagement and promotion of its overall public profile. Promoting the public profile of SAFCOL is all the more vital given the central role that SAFCOL is intended to play in forestry conservation.

Mr Mahlangu added that SAFCOL firstly considers its strategic duty to ensure that SAFCOL achieves its overall strategic objective and mandate. The advice about timelines was accepted and would provided at future meetings.

A SAFCOL delegate responded that in terms of employment of people with disabilities a target of 2% had been set and the current figure is 1.5%. It is hoped that by the end of this financial year that target will be fully achieved. An academy would also be established in local communities to assist in developing various skills at local level. It is hoped that by the end of the current financial year all the remaining targets will be met. The entity does have a strategic relationship with the Department and they should work together to fully achieve the strategic mandate of SAFCOL.

The SAFCOL Chairperson said IFLOMA in Mozambique is now fully operational. Dialogues had since been initiated to strengthen inter-governmental relationships with an aim to procuring potential government contracts for SAFCOL services. Initiatives had also begun to improve safety and security given the issues that arose during the previous year. It is acknowledged that SAFCOL does not have a very prolific public profile but public communications would be strengthened to improve that profile with an aim to highlight both the work of SAFCOL and the vital role that forests play within the country as a valuable social resource. Positions for various advisors had been advertised to obtain further advice about compliance with safety legislation, procurement and the potential restructuring of parts of the organisation to improve efficiency.

The COO noted the comment about the fatalities. In the current financial year the accident rate has dropped and a continual focus on safety and constant monitoring would be implemented.

The Acting CFO noted that in terms of irregular expenditure there are two different elements which must be taken into account. First, there is an irregular expenditure policy which has been updated dealing with the identification and condonation of irregular expenditure at SAFCOL. In response to Ms Rantho on the lack of completeness of SAFCOL financial records, he explained this arose from a decision taken by the previous CFO to utilise a service provider who excluded all transactions below R100 000. It was this decision that led to the finding of incompleteness and irregular expenditure. On asset management, an asset register had been completed and updated. Currently that register was not in the ERP accounting system but a 12-month plan had been implemented with the aim to place that register into the ERP and a prioritisation plan had been implemented. A plan for quality management had also been drafted which would be taken to the board in the foreseeable future.

Meeting adjourned.

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