ATC081117: Report on Armscor ‘s Annual Report for 2007/ 2008

Defence and Military Veterans

Report of the Portfolio Committee on Defence on the 2007/2008 annual report of the Armaments Corporation of South Africa, Pty Ltd

 

The Portfolio Committee on Defence, having conducted hearings on the 2007/2008 Annual Report and Financial Statements of the Armaments Corporation of South Africa, Limited (Armscor), reports as follows:

 

A.  INTRODUCTION

 

The Portfolio Committee on Defence has scrutinised the 2007/2008 Annual Reports of the Armaments Corporation of South Africa (Armscor), tabled on 19 September 2008. A hearing on this Annual Report was held on 17 November 2008.

 

This Committee report is based on the following sources:

 

• Armscor 2007/2008 Annual Report
• Armscor’s Integrated Corporate and Business Plan: 2007/2008 - 2008/2009
• Analysis of the 2007/2008 Annual Report of Armscor: Parliamentary Research Unit
• Committee comments and observations.

 

B.         2007/2008 ANNUAL REPORT OF ARMSCOR

 

Mr S Thomo of Armscor, the Chief Executive Officer of Armscor, presented the Annual Report.  The Committee expressed concern over the absence of the Chairperson of the Board of Armscor, Dr P Molefe and stressed the importance of the presence of the Chairperson in future presentations of the Annual Reports to Parliament.

 

The Committee requested Armscor to provide clarity on the following matters during its presentation:

 

• The restructuring of Armscor.
• The finalisation of the grievance instituted by the General Manager of Corporate Affairs against the CEO.
• The investigation into the tender process of Project Vistula.
• The funding of Armscor.
• The review of operations and acquisitions objectives.
• The Defence Industrial Participation (DIP) programme and the projected six month delay in the delivery of the A400M Heavy Lift Transport Aircraft.
• The status of the Rooivalk Helicopter and Project Hoefyster.
• The future plans for the entity.

 

 

 

1.  OVERVIEW OF PERFORMANCE AGAINST OBJECTIVES

 

Armscor outlined the outputs of the entity through the following nine objectives:

 

• Objective 1:                   Acquire Defence matériel, facilities and services.
• Objective 2:                   Establishment of a programme management system.
• Objective 3:                   Provision of a quality assurance capability.
• Objective 4:                   Disposal of Defence matériel.
• Objective 5:                   Support, maintain and manage strategic and essential  

defence industrial capabilities, resources and technologies.

• Objective 6:                   Establishment of a Defence Industrial Participation

Programme Management System.

• Objective 7:                   Corporate Governance.
• Objective 8:                   Armscor’s Strategic Initiatives in support of national

          Initiatives.

• Objective 9:                 Armscor’s Operational Strategic Objectives.

 

The following achievements were highlighted:

 

• The receipt of an unqualified Auditor-General report for the period under review but with the restructuring of Armscor remaining a matter of emphasis.
• The completion of an investigation into the preferred corporate form and position of Armscor, which was presented to the Minister ofDefence. This will ensure that Armscor focuses on its main objective - to meet the Defencematériel Requirements of the Department ofDefence.
• The study into the establishment of the Defence Evaluation and Research Institute (DERI) was complete. This was presented to the various stakeholders and the Minister of Defence.
• The transfer of management of the Simonstown Dockyard to Armscor on 1 September 2007.
• The entity achieved its Black Economic Empowerment (BEE) objectives.
• Most of the objectives set to improve the demographic profile of the Corporation were achieved.
• Progress made in the fulfilment of Defence Industrial Participation (83 per cent of total obligations) by 31 March 2008.

 

 

Progress made with the Strategic Defence Packages (SDPs) was also reported.

 

• The last of the four frigates were commissioned and handed over to the South African Navy. All four frigates are now fully operational and maintenance support contracts had been concluded both with local and foreign contractors for the platforms and combat suites of the vessels.
• All 4 maritime patrol helicopters were delivered by July 2007. These helicopters will be deployed to the frigates performing anti-surface warfare, maritime patrol and search and rescue roles.
• A total of 23 out of the 30 Light Utility Helicopters have been delivered to date.
• SAAF will be supplied with 26 Gripen advanced light aircraft. While the manufacturing of these aircraft continues, the first dual seat Gripencompleted the initial flight test programme. A second duel seat Gripen had been delivered to Air Force Base Makhado in March 2008 for the start of ground crew training.
• To date, 21 of the 24 Hawk Lead-In-Fighter Trainer aircraft have been delivered to 85 Combat Flying School. The 24 aircraft will be assembled locally by Denel Aviation, according to a DIP agreement with BAE.

 

The Committee notes the following challenges as outlined in the Annual Report:

 

• While the annual financial transfer from the Department of Defence to Armscor increased by 5 percent for the past two years, this represents a decrease in real terms considering the current rate of inflation which fluctuates between 3.8 and 10.1 percent during the period under review.
• Armscor salary increases were not market - related. This resulted in more frequent resignations and the loss of critical capabilities. Armscoris losing key personnel and this hampers the Corporation’s ability to provide quality service to its clients and to meet the set objectives specified in the Service Level Agreement signed between Armscor and the Department of Defence.
• Armscor has an ageing and predominantly white workforce. Inadequate funding and the loss of scarce skills are key challenges to therealisation of key transformation goals. An increased transfer payment would partly address these difficulties. Discussions between the DOD and National treasury regarding this matter continue.
• The tendency of DOD members to issue direct instruction to senior managers, without due regards for the official channels remains a problem, but measures are in place to address these.

 

The Committee evaluated the following nine key performance indicators against the reported actual performance:

 

1.1        Objective 1: The acquisition of defence materiel, facilities and services

 

(a)        Key performance indicators  

(i)         The establishment and implementation of a Capability Management Model by 1

          September 2007.

(ii)         Armscor is subjected to annual ISO 9001 audits. Zero significant audit findings   

          allowed while ISO listing should be maintained at the end of each financial

          year.

(iii)        The establishment of a Naval Ship Support Agency.

 

(b)        Actual performance    

(i)         While the entity reported a delay in the full implementation of the capability   

management initiative, this will be completed within six months subject to the completion of the finalisation of all employees’ job descriptions. The business register and system development have been integrated and the roll-out of the authorisation system continues. This objective was not fully achieved.  

(ii)         Scheduled internal audits were scheduled according to the three-year audit  

            plan, and no major findings were reported. This objective was achieved.

(iii)        The Naval Ship Support Centre was initiated during April 2007 at Simonstown  Naval Base. This objective was achieved.

 

 

1.2        Objective 2: The establishment of a programme management system

 

(a)        Key performance indicator

(i)         Improve the tool to be integrated with the Departmental Acquisition and Procurement Division (DAPB) Baseline Approval Data, Capability Management, Job Description and the link to the tool to project management system.

 

(b)        Actual performance

(i)         This objective could not be fully achieved due to the replacement of the initial project management system with the Acquisition Business Register. While the implementation of the Business Register and the inclusion of the Status Reporting and Works Authorisation and Intellectual Property Management System commenced, the full implementation of the project management system can only be achieved once the computer based contract and order and administration based system (COMAS) is delivered.

 

1.3        Objective 3: Provision of a quality assurance capability

 

(a)        Key performance indicator:

(i)         Accepted and approved learnerships by the Service Sector and Education and

            Training Authority (SETA) in the Quality Assurance Environment of Armscor.

(ii)         The establishment of a baseline for Quality Assurance Competency and the  

           development and implementation of Competency Management Model.

 

(b)        Actual performance:

(i)         The learnerships have been submitted to the South African Qualifications

          Authority. The speed of the process is now determined by SAQA. Objective

            was partially achieved.

(ii)         The capability management model was developed and implemented by the end

            of March 2008. This objective was achieved.

 

 

 

 

1.4               Objective 4: Disposal of Defence Matériel in consultation with the original

equipment manufacturer (OEM)

 

(a)        Key performance indicator

(i)         Sales turn-over to be reached was set at 90 percent of Sales Plan.

 

(b)        Actual performance

(i)         This objective was not achieved due to the following factors:

• Changes in the sales approval processes resulted in a delay of sales to the value of R106 million.
• Restrictions on the sale of Samil vehicles due to its reclassification as controlled items.
• Delays in the disposal of SANDF vehicles since these were not registered on NATIS.
• The donation of disposed stock by the Department of Defence, valued at R40 million, which had to be withdrawn from the Sales Plan.
• The Committee raised concerns regarding the sale of vehicles to the Central African Republic, as well as the loss of income to Armscor due to changes imposed upon Defence matériel Disposal regarding the sale processes and restrictions placed by the NCACC on the sale ofSamil vehicles. Armscor responded that the matter was an internal DoD matter. This has subsequently been resolved.

 

1.5               Objective 5:  Support, maintain, and manage strategic defence industrial capabilities, resources  and technologies

 

(a)        Key performance indicator

(i)         The transfer of the management of the Simonstown Naval Dockyard to

          Armscor.

 

 

(b)        Actual performance

(i)         The transfer of management has been completed and the full staff support     

           provided. The Business Plan for Simonstown Dockyard is still to be finalised.

 

In response to further questions raised by the Committee, Armscor stated that the recapitalisation of the Simonstown Dockyard was a priority. A memorandum of understanding with an international company was signed to assist in the rejuvenation of the Dockyard through the establishment of an apprentice school to provide training in technical areas that are much needed in the maritime environment. The proposal for such an initiative as well as the possible value of the total investment would be finalised in the beginning of 2009.  Armscor plan the management of the Dockyard carefully without compromising the Dockyard’s primary function, i.e  the maintenance of services for the Navy. 

 

1.6        Objective 6: The Corporation must establish a Defence Industrial Participation (DIP) Programme Management System

 

(a)        Key performance indicator

(i)         Approval of DIP credits in line with the Strategic Defence Packages and other acquisitions contracts.          

 

(b)        Actual performance 

(i)         Total DIP credits of R1.4 billion were approved, exceeding its target of R1.2 billion credits.  DIP obligations on the Strategic DefencePackages, managed by Armscor, represent an 83 percent of actual performance against obligations. This objective was achieved.

 

In response to questions raised regarding the total DIP obligation for the Gripen aircraft and the maritime helicopters, it was explained that the total obligations for the period ending 31 March 2008 were recorded as follows: Gripen aircraft sales amounted to R170 million, R180 million for technology transfers as well as R172 million in investments. The total obligations for maritime helicopters were recorded as follows: R170 million for sales,  R29 million for technology transfers and R2 million for investments.

 

1.7        Objective 7: Corporate Governance

 

(a)        Key performance indicator

(i)         Armscor’s external audit report to contain zero Audit Report Matters.

 

(b)        Actual performance

(i)         The Auditor-General indicated that no material weaknesses were identified in the internal control systems. The audit report contained no significant matters identified by external auditors. This objective was achieved.

 

1.8        Objective 8: Armscor strategic initiatives in support of national initiatives

 

(a)        Key performance indicator

(i)     Increase Armscor’s spending in respect of its operating budget and the Strategic

        Defence Account (SDA), and the General Defence Account (GDA) on BEE

        companies. 

(ii)    Execute Energy Savings Plan by conforming to 90 percent of the Energy 

        Savings Plan. 

           

(b)        Actual performance

(i)         Operating budget – 59 percent: This objective was exceeded.

SDA and GDA: 26 percent. This objective was exceeded

Armscor business: 48 percent of discretionary costs: This objective was

exceeded.

(ii)         This objective was achieved.

 

1.9.       Objective 9: ARMSCOR’s operational strategic objectives

 

(a)        Key performance indicator

(i)         Improve the demographic profile of Armscor to reflect the national and regional demographic profile.

(ii)         Bursaries.

(iii)        Talent Development Programme.

 

 

(b)        Actual performance

(i)         The entity reported the following achievements:

·         90.9 percent (targeted 80 percent) of all external appointees were black;

·         Women make up 20 percent (target 20 percent)  of external appointees  in the technical functional groups;

·         63.83 percent (target 65 percent) of external appointees in the non-technical functional groups were women; and

·         29.07 percent (targeted 29 percent) of employees at supervisory levels and above were women.

(ii)                 Bursaries, granted to students in engineering fields, were initially awarded to

          four students prior to the review of the bursary programme. Bursaries have

          been awarded to 1 African male, 4 African females and 4 Indian females, in

          April 2008. All bursaries were granted to students in engineering. 

(iii)                Fifteen people were drawn into the Talent Development Programme during

          the period under review.

 

Armscor further highlighted the age and demographic profile of the organisation as a key human resource risk. The entity is currently developing a strategy to ensure the transfer of skills to younger employees, especially those in technical areas.

 

1.10            Additional matters

Armscor provided clarity on the following additional matters, as requested by the Committee:

 

(a)        Airbus A400M heavy Lift Transport Aircraft

The six month delay in the delivery of the A400M is reported in the Annual Report. In response to queries raised by the Committee, Armscorexplained that this delay could be extended to one year.  Problems relating to software used and assembly lines contributed to the delays. This is a multi-national project and the precise impact on the South African production could not currently be reported.  Milestones are attached to the project and are subject to penalties. 

 

 

(b)        Project Vistula

Armscor stated that the cancellation of the tender process was due to the bidders failing to meet the critical criteria. Non-compliance with Armscorprocesses and procedures were also reported. Armscor further explained that after a lengthy investigation instituted by the then Secretary ofDefence, disciplinary actions had been taken against the officials concerned. A new tender process will start by February 2009.   Measures have been taken to resolve weaknesses in the tender processes. The Department of Defence committed itself to provide the Committee with all relevant information regarding this project. It requested that this be done in a closed session, given the sensitive nature of information.  The Committee requested that this report be submitted to within seven working days of the hearing.

 

(c )       Grievance against the CEO

The Committee raised concerns over the delay in finalising the grievance instituted by the General Manager of Corporate Affairs against the CEO.Armscor indicated that this grievance has indeed been finalised and that it would submit the relevant information to the Committee in this regard. The total cost of the grievances case of the General Manager of Corporate Affairs against the CEO of Armscor amount to R1.8 million. The Committee received a letter from the Chairperson of Armscor on 4 December 2008 regarding the finalisation of this matter. 

 

2.         FINANCIAL STATEMENTS AND REPORT OF THE AUDITOR GENERAL

 

2.1        Financial Statements

The reported revenue of the Armscor Group for the period under review, R1.462 billion, represents a decline from the R1.653 billion reported for the previous financial year.  Sources of revenue include an increased transfer payment of R415.6 million, mainly due to an additional R51.3 million allocated to fund the transfer of the Simonstown Naval Dockyard, but also a R269 000 decline in the sales of goods.

 

A loss of R8 million, compared to a surplus of R27.8 million for the previous financial year is recorded by subsidiaries.  This is attributed to the declining performance of Armscor Business (Pty) Ltd due to a delay in the approval to dispose of surplus defence materiel. Delays on the part of the Department of Defence, in placing orders timeously with the defence industry resulted in a delay in service delivery for the financial year under review. However Gerotek and Alkantpan performed better than expected and the company managed to recover some of the losses incurred.

 

2.2        Report of the Auditor–General (A-G)

While Armscor received an unqualified audit opinion, the AG drew attention to the emphasis of matter, namely, the process of restructuringArmscor and the impact this will have on the group in future periods.

 

In its briefing to the Committee, Armscor highlighted the following related matters:

 

• Aim of the restructuring process: Based on a Cabinet decision, the transformation process would refocus Armscor as a defence acquisitionorganisation for the State. This entails the reclassification of the entity from a Schedule 2 company to a Schedule 3A public entity, in terms of the PFMA.
• The proposed establishment of the Defence, Evaluation and Research Institute (DERI): This will consolidate defence technology, research, development, test and evaluation capabilities.

 

Responding to concerns raised by the Committee regarding the restructuring process, Armscor explained that the Minister requested the restructuring of the entity to ensure that it focuses on the acquisition of defence materiel as well as the formation of the DERI. A process was put in place to investigate the best corporate form for Armscor as well as the establishment of the DERI. The latter was done in consultation with the Ministers of Defence, Science and Technology and Public Enterprises. While the Minister of Defence approved some of the suggested changes, namely the reclassification of Armscor from a Schedule 2 to a Schedule 3A entity as well as the possible legislative changes for the restructuring and establishment of the DERI, formal approval had not been finalised prior to the Minister’s resignation. Parliament will be consulted and informed subsequent to the finalisation of all relevant details and legislative proposals.

 

C.         COMMITTEE RECOMMENDATIONS

 

The Portfolio Committee on Defence makes the following recommendations with respect of the 2007/2008 Annual Report and Financial Statements of Armscor:

 

• Restructuring of Armscor:  The Committee notes with concern that it was not continually informed and consulted about the restructuring of Armscor and the Defence Related Industry; especially as it has an impact on the mandate, the funding and the attraction of sufficiently skilled personnel, and the operation of the entity. The Committee requests Armscor and the Department of Defence to provide a detailed report on the restructuring of Armscor and the Defence Related Industry.

 

• Project Vistula:  This is a project to acquire future tactical trucks for the South African Army. Armscor indicated that the tender process was cancelled and would re-commence by February 2009, pending the review of processes and procedures governing the management of similar projects. The cancellation of the tender process of Project Vistula was due to the non-compliance with Armscor tender processes and practices. The Committee recommends that Armscor submits a detailed report on the outcomes of internal disciplinary investigations against the relevant officials of Armscor, present to the Committee the details regarding the cancellation of the tender process and measures to avoid similar incidents. Such a report must be submitted to the Committee within seven days after this hearing. Due to the fact that this report was not submitted to the Committee at the time of writing this report, such a report must be submitted to the Committee within seven days of receipt of a letter from the Chairperson of the Portfolio Committee. 

 

• Grievances instituted against the Chief Executive Officer:   The internal investigation and Armscor Board recommendations on grievances instituted by the General Manager of Corporate Affairs against the CEO have been finalised. Armscor should submit a report to the Committee on how this matter had been concluded.

 

Subsequently, the Chairperson of the Portfolio Committee received a letter dated 4 December 2008, from the Chairperson of Armscor. Following the consideration of this letter, the Committee has decided to call on the Committee of the Armscor Board, Secretary ofDefence, CEO and CFO to appear before it. The Committee will summon all stakeholders to appear before it to discuss this matter. The Chairperson will write a letter to the Auditor-General regarding the total cost of the grievance case as well as the letter detailing thefinalisation of the case.

 

D.         CONCLUSION

 

The Portfolio Committee on Defence commends Armscor for the clear and detailed presentation of actual performance against targets in its Annual Report and for achieving an unqualified audit opinion from the AG. The Committee further noted that a prior apology for the absence of the Chairperson of the Board was not received, and recommends that the Chairperson should attend future presentations of the Annual Report to Parliament.

 

Report to be considered.