Armscor First Quarter Financial Performance Report: briefing

DEFENCE PORTFOLIO COMMITTEE
11 September 2006
ARMSCOR FIRST QUARTER FINANCIAL PERFORMANCE REPORT: BRIEFING

Acting Chairperson: Mr O Monareng (ANC)

Documents handed out:
Armscor Performance presentation

SUMMARY
Members met with Armscor to receive a briefing on the First Quarter financial report. Detail on financial statements was provided. The relationship between the Department and Armscor was explained. Transfer payments to Armscor and the five specific goals linked to the budget were explained as were research and development activities. The Auditor-General’s report had indicated one matter of emphasis.

Members asked various questions including late receival of government requirements, the role of the National Conventional Arms Control Committee, reasons for delays in stock sales, clarity on the matter of emphasis, whether a portion of the allocated funds accrued to Armscor, the disposal of surplus stocks, where surplus military stock was sold and whether Armscor required additional operating funds.

MINUTES
Armscor presentation
Mr C Hoffmann (Armscor Chief Financial Officer) provided Group Financial Statements for the period 1 April 2006 to 30 June 2006. An improvement in Estimates had been achieved coupled with an increase in costs. The First Quarter was characterised as a start-up period with new requirements received from the Department of Defence. The Department’s acquisition activities were outlined. R12.2 billion had been allocated to Armscor and the planned cash flow at the end of June 2006 was R8.7 billion. The funds allocated were reviewed on a regular basis. Detail on the Performance Report for 1 April to 30 June 2006 was presented. Five specific goals linked to the budget were explained:
- Goal 1 focused on the acquisition of Category One Defence materiel and its achievements on particular objectives were assessed. Late receival of requirements had resulted in a low cash flow.
- Goal 2 related to the acquisition of product systems under the government’s strategic defence package programme. The cash flow was at an acceptable level.
- Goal 3 dealt with procurement and product system management. A slight adjustment in the base line was recorded.
- Goal 4 focused on the management of the Defence Industrial Participation programme involving local manufacturing companies.
- The final goal revolved around research and development activities for the Department. Various strategic facilities had to be managed and maintained. First Quarter expenditure was within the projected cash flow and the operational budget. The Auditor-General’s report had highlighted only one matter of emphasis during the past financial year. Various external factors were outlined that had adversely affected business income.

Discussion
Dr G Koornhof (ANC) asked whether the late receival of government’s requirements and delayed inputs was a regular occurrence or an anomaly particular to the quarter under review. The National Conventional Arms Control Committee (NCACC) was an important body empowered by legislation and delays in permits for stock sales was a concern. Clarity was sought on reasons for the delays. The Committee should follow up the matter with the NCACC.

Ms C Johnson (ANC) sought clarity on other possible reasons for the delays in stock sales. She asked whether problems related to Armscor logistics were recurring. More detail was requested on the matter of emphasis highlighted in the Auditor-General’s 2005 Report.

Mr S Ntuli (ANC) noted that the distinction between Armscor and the Armscor business had to be made clear. Clarity was sought on the allocated amount to Armscor. He asked whether Armscor had its own plan to deal with late stocks in terms of disposals.

Mr H Thomo (Armscor Chief Executive Officer) admitted that the receival of late requirements was an ongoing problem. Certain projects were carried over from the previous financial year. The Department tended to submit instructions for new projects late in the financial year that impacted on expenditure. However, the severity of the problem varied from year to year. The NCACC-related problem rested with the Department. He explained that the Department would instruct Armscor to sell certain equipment. Armscor would seek to identify a potential buyer and initiate a sale following confirmation from the Department. Unfortunately, the sale would tend to be halted by the Department due to various factors causing financial disruptions. The problem had been resolved in June following a meeting with the Deputy Minister.

He continued that Armscor Logistics sold surplus Department materiel. Armscor activities could be divided into two distinct yet related functions, namely the facilitation of acquisitions on behalf of the Department and the management of strategic facilities such as laboratories and testing establishments. Department allocations to Armscor totalled R12.2 billion and were sourced from the Special Defence Account and the General Defence Account. Stock sales were disposed at the Armscor disposal facility. Armscor acquired a 7% commission for such disposal of military hardware through sales. Certain items could also be donated after ministerial approval. Negotiations were underway with Sweden to acquire a new incinerator unit to dispose of outdated and obsolete equipment. 

Mr Ntuli asked whether the current disposal facility was not adequate to deal with disposal requirements and questioned the need for additional expenditure to acquire a new facility.

Dr Koornhof stated that the transfer payment from the Department had to be accounted for in the Annual Report. He asked whether Armscor was satisfied with the achievements as reflected in the quarterly report.
 
Mr J Schippers (ANC) asked what percentage of the Special Defence Account went to Armscor. He asked whether a difference existed between the planned cash flow and the projected cash flow.

Mr L Diale (ANC) asked where surplus military stock such as bullets were sold and whether the envisaged disposal plant would be able to destroy outdated military hardware.

Mr Thomo responded that the new disposal plant, when acquired, would be able to destroy all obsolete equipment. The majority of military materiel had to be destroyed once its life cycle had expired for safety reasons. The Department wanted one ammunition disposal plant to create a cost-effective disposal mechanism. Armscor management were satisfied with the overall financial position given certain predominant limitations. The resolution of the NCACC-related problem would reduce the fixed cost requirement. No percentage of the Special Defence Account accrued to Armscor. The funds were only utilised to acquire military hardware. Armscor received a total of R347 million from the Department as a transfer payment for operating expenses. Projected cash flow was a preliminary assessment of needs without extensive detail. Planned cash flow incorporated greater clarity on programmes to be implemented. The earlier placement of contracts would result in improved rates of delivery. Stock sales were sold to governments and not to individuals. The NCACC had to approve all sales.

The Chairperson noted that Armscor seemed to imply that the Department was not allocating sufficient operating funds. He asked whether Armscor could not use excess funds made in other areas to cover outstanding financial commitments.

Mr Ntuli declared that short periodic reports on progress in Armscor would be advantageous to Members. Detail was sought on the envisaged future of Armscor in terms of transformation. Local companies could serve as valuable job creators but tended to be marginalised in tender applications.  Armscor subsidiaries had to adapt to the competitive environment and create business opportunities for themselves in order to justify continued budget allocations.

Mr Thomo reminded Members that Armscor was not a manufacturer but rather a project management company. Armscor made use of project management skills to acquire military hardware on behalf of the Department. Additional technical staff were required to enable Armscor to operate at an optimal level. The current workforce was aging and suitable replacements were needed to maintain Armscor’s functionality. The job market also attracted skilled personnel away from Armscor, further undermining capacity. Armscor sought to transform in accordance with government policy dictates. A transfer payment was received from the state for operational expenses. Additional funding was requested to drive an appropriate training programme. The state as the principal shareholder of Armscor had to determine its future strategy in conjunction with the Armscor Board and management. The Minister wanted Armscor to focus on acquisitions. The majority of Armscor subsidiaries were not stand-alone businesses but merely provided specific services to clients such as vehicle testing to support Armscor’s operations. The subsidiaries required additional funding to function effectively. Attempts had also been made to market the subsidiaries’ services to private sector companies to bolster income.

The Chairperson stated that the Committee had found the presentation useful in assisting Members to garner additional information to support oversight responsibilities. Transparency in Armscor had to be promoted. More detail should be provided in future on Armscor’s transformation agenda. Members would continue to engage with Armscor on an ongoing basis.

The meeting was adjourned.