Armscor Annual Report 2021/22; DoD audit responses; DoD spending on Border Technology; with Deputy Minister

Meeting report

The Chairperson opened the meeting and welcomed all those in attendance. He deferred the discussion of the programme for the end of the meeting, before handing over to Armscor for the entity’s presentation.

Briefing by Armscor: 2021/22 Annual Report and Responses to the AGSA Audit Outcomes

The Chief Executive Officer (CEO), Adv Solomzi Mbada, and the Chief Financial Officer (CFO), Mr Gerhard Grobler, led the presentation on behalf of Armscor. Mr Meshack Teffo, Group Executive of Acquisition and SCM, presented on project Hoefyster.

Armscor performed well in terms of its corporate and strategic goals. Among the several goals, the entity exceeded goal one by achieving 100% on capital requirements converted to orders and 107.42% on executing contracts measured through cashflow. Armscor also performed well in goal two: system support, acquisition and procurement. The entity exceeded its targets by achieving 96% in terms of the percentage of DOD system support and procurement converted into placed order, and 103.2% in the execution of contracts. Armscor also exceeded its targets in terms of the schedule placement, to mention a few.

Armscor received an unqualified audit report. The report on the annual performance did not identify any material findings on the usefulness and reliability of the reported performance information. On compliance with legislation, the annual financial statements recorded a material misstatement of the contractual commitment due to inconsistent disclosure of contractual commitments and incomplete recognition of capital and contractual commitments. Armscor also registered a finding in terms of R11.5 million due to contract extensions and single-source procurement. On the engagements with Denel, Armscor reported that their project teams had fully achieved alignment with regards to the work that was required to achieve phase one.

[See presentation for more details]

Discussion

Mr S Marais (DA) highlighted that, from 2021 to 2022, there was a reduction in commercial services revenue, unlike the increase reported. He asked for the revenue from the individual commercial services for years before 2022, to make a comparison. He asked for the status of the upgrades in the Dockyard programme. He pointed out that there was no confirmed funding from the Department of Defence (DoD) for most of the projects, which would mean that all the exercises would be worthless if the funding would not be secured.

He asked about the status of the aircraft contracts. How much was in there, and how much had been concluded? He asked for the status of the hawks and the aircraft at Langebaanweg. How was Armscor dealing with contracts for the maintenance and repair of the environmental warehouses of the army? What was the practical implication of the delay of Projects Biro and Hotel? What was the situation in terms of the penalties and additional costs? What was the status of neo-dynamics?

Regarding the projects provided on slides 21 and 24, what was the status of the projects in terms of funding? To what extent had project Hoefyster been scaled down? When would they get their final confirmation on the PCB, and how would that impact the current allocations?

Ms A Mthembu (ANC) appreciated the Department for getting an unqualified audit finding, with the hope that they would get a clean audit in the next phase. She highlighted that the report had given the Committee and the country hope.

Dr M Basopu (ANC) said there was an improvement in the organisation. He asked about the targets set, since some had been exceeded and some had not been achieved. He asked what the financial implications were, since the targets were meant to be linked to the budgets of the organisations. He also asked if Armscor had other plans to engage with other organisations to ensure that they had funding instead of relying only on government.

Mr T Mmutle (ANC) asked for clarity on how Armscor had arrived at the conclusion that Denel was having a negative impact on the strategic second-tier suppliers. The AD exhibitions gave a different picture in that there were no companies that were affected negatively by Denel. Companies were thriving because they were not dependent on the South African market to survive.

The Chairperson commended the Department that, with the R1.4 billion in allocation for 2021/22, it managed to engage in contracts to the value of R12.4 billion.

Mr Marais asked Armscor to report on the C130, because of the huge challenge of the logistical support with the soldiers. He asked about the contracts and whether other players in the defence industry had invited them to participate in any of the DoD projects.

Mr Mmutle asked about the Telkom One Link tender renewal and the irregular expenditure of R11.5 million due to the 15% contract extension. What steps were taken upon realising that the irregular expenditure had been incurred? Were any steps taken against those that acted negligent of the extension?

Responses

Adv. Mbada responded to the first question. He highlighted an error on page six of the annual report presentation, where it read 2020, it was meant to read 2022. On the various projects, he highlighted that Alkantpan used to generate over R30 million pre-Covid. There was a lot of effort in ensuring all support contracts were in place except for the falcon fleet, which was going to be finalised in the following week. All the support contracts were in place, including the C130. There were still discussions with the air force to iron out some hindrances.

Regarding what Armscor was doing over and above the work of the SANDF, Armscor had several MOUs with the various departments and SOCs. Some departments had come forward to be their acquisition partners on armoured vehicles for their activities. They were doing a lot of work for the police correctional services. They were approached by PRASA and several other entities to look at several armoured vehicles. Regarding Telkom's findings, Armscor had received an internal audit report, which would talk to the matters.

On Denel, most exhibitors were entities manufacturing the full systems, whereas Denel negatively impacted second-tier suppliers. These smaller suppliers manufactured specific specialised components and solely relied on Denel. For example, the number of suppliers supporting Hoefyster was over 200, whereas at the AD, there were not 200 local companies. Regarding the transformations, it was better to talk to the entities. Some of these entities had closed shop. 

Mr Teffo responded on the serviceability of the aircrafts. He confirmed that many of the contracts were in place. On the Gripen, they had an agreement with SAP. For the Hawk aircraft, there was an agreement with the BAE. For the C130, there was still a contract with Denel and the Oryx.

Regarding the delays in Project Hotel, there were several factors: covid-19, civil unrest and flooding in KwaZulu-Natal. Due to these, they had asked for a contract extension, which would lead to the late delivery of the vessel. On reviving the A-Darter capability and the participation of the local defence industry: Denel lost most of the key skilled personnel, who were resident in several defence industry companies. If they were to proceed and revive the A-Darter missile capability, they would have to look at the participation of the local defence industry. As a strategy, moving forward, it was envisioned that Denel did not have the requisite to participate in the project alone. They were in the process of determining where the skillset was and would make the presentation to the PCB and then present the various options to the Air Force.

Regarding project Hoefyster, he confirmed that the downscaling of the requirements was due to the shortage of funding. The PCB would be convened in the last week of October, and various issues would be presented. The shortage of funding had affected the serviceability of some of the systems of the DOD, and they could only contract with limited funding. Therefore, instead of long-term contracts, they were only doing short-term contracts.

An official from Armscor [note: the team was present in one venue and individual officials could not always be identified]  responded on the maintenance and refit programme for the frigates and submarines. The two capital acquisition programmes focused on the midlife upgrades of the frigates and the submarines. Those programmes were stopped due to funds being taken away. However, the programmes progressed up to the point where the modification of both vessels was identified and specified. The SANDF would prioritise the upgrades, and they would be done as refits under the operating funds budget of the navy.

The CFO, Mr Grobler, responded that he did not have the figures for the comparison between the various facilities for the past few years at hand. However, for Alkantpan, there was a serious deficit for the past two years due to the testing from foreign companies not happening. The facilities were also impacted during the previous year, since they did not receive any technology funding.

Regarding the income targets, he responded that it did affect the budget and the actual spending if they did not achieve the income. The cooperation did not achieve the income and therefore had to reduce the costs and get a positive result. They had to achieve their cost base to achieve the net goal that was set. It was quite critical that they achieve regardless of the budget.

The Acting Chief Auditor Executive responded regarding the Telkom contract. There was an irregular expenditure of about R8 million. However, during the investigation, it revealed there was no financial loss to the organisation. Therefore, per Treasury regulations, the money would not be received, as the services continued. Negligence was noted within the processes, and they recommended that there should be consequence management.

Follow-up discussion

The Chairperson asked what to make of the reports in the media that, at some point, the presidential aircraft needed to be grounded because of serviceability questions. Early in the year, the DOD presented its third quarter report and the programme for defence. They reported a project under-expenditure of 67%, when it should have been 75%. The expenditure was R545 million, which was 12.2% of the projected expenditure. The reason was due to prolonged negotiations regarding the placement of the new aircraft system contracts with SAAB for the Gripen and Hawks’ airframes and engines.

He noted that, under programme five, the entity reported that there was 11.8% under-expenditure against the projected expenditure in the third quarter, reporting that the delivery date of the spares was shifted to the right by the contractors. It affected the availability of spares required for the M&R of vessels, which, in turn, directly impacted the availability of the navy platforms. Any delay on their side had a negative impact on the performance of the Defence Force. It impacted the availability of the platforms and therefore reduced the hours of training and other preparations. 96% was a good percentage on paper, but it was confusing when merged with other reports from the DOD and the media.

Mr Marais asked about the income and expenditure of the individual business units. He also asked about the contract for the repair and maintenance of the environmental warehouse and all the prime mission equipment that was now vulnerable to rust, corrosion, and dust. On the C130, he highlighted the need for assurance that Denel could do the work, or they would outsource it to someone else. He also asked if there was a project to upgrade or increase the logistical support aircraft C130.

The Chairperson noted they were out of time, as they needed to hear the presentation from DoD. Members asked that the outstanding responses be submitted in writing to the Committee.

Dr Phillip Dexter, Chairperson of Armscor, said that some matters raised required a more in-depth discussion. It was quite a complex issue in that without funding, one could not penalise the executive for not executing what was meant to be executed using those funds. The most important thing was that they had come a long way, even though they were not where they needed to be. Regarding Denel, even though they were companies that survived the Denel crisis and managed to stand, the industry had taken a huge hit. Armscor had been given a clear mandate, and it had been working towards it with Denel, but it changed its strategy to see where else it could go since Denel did not have the capacity in the industry mindful of the issue of transformation. The next strategy was to commercialise and reach out for business into the continent and the rest of the world, of which there had been much progress.

Regarding Hoefyster and Kamas, the project was not in good condition when they took over. He was pleased that Armscor management and the board resolved those issues, and that they were now at a point where concrete decisions could be made for taking the projects forward, so that not all the money would have been wasted there. There was good progress, and it was worth noting that and not just the abstracts of numbers.

The Chairperson thanked the Chairperson of the board for taking the time to attend the meeting despite his busy schedule in China. The Chairperson said that they would engage with the board further. It was important to find time to engage on the under-expenditure reports because some of the delays did not sit well with the report figures. He thanked the Armscor delegation, and released it from the meeting.

Briefing by the Department of Defence Response to AGSA 2021/22 audit outcomes

Ms Gladys Sonto Kudjoe, Secretary of Defence (SecDef), led the Department in the presentation. The presentation highlighted that the Department received a qualified audit opinion on the following: account balances, goods and services, and investments within the special defence account; irregular expenditure; movable tangible assets; employee leave benefits.

The presentation provided the Committee with the background to the audit findings and detailed the Department’s response to deal with the findings.

[See presentation for more details]

Discussion

The Chairperson highlighted that the AG concluded that the contracts were open-ended, even though the DOD did not agree. The AG felt that, because those contracts were capable of being supplemented up to seventeen times, it meant that it was open-ended, as some of the things that were not included in the contracts could be done in the supplementary contract. On the value for money, the DoD had stopped the AG from conducting a value-for-money assessment because of providing limited information. Therefore, the Committee could not accept their argument.

Mr Marais agreed with the Chairperson and said that if they were fighting amongst themselves, they were going to get nowhere. He perceived that the attitude of DoD was that the AG was wrong, and they were right. The Department was in the wrong and remained arrogant in spending the money. Regarding slides 45-47, he pointed out that there was a reduction in flying hours, yet the Department still said it had nearly achieved 100%. This meant that, in the current year, there would be fewer hours flown and sailed on the sea. Everything was reduced and yet it seemed like it was doing well. It was about value for money, where it achieved what it was supposed to be achieved in terms of protecting the country.

On the deployment to the borders, he noted that the Department recorded 100% achievement because there was a target of only 15, which was not enough. Similarly, 17 000 fly hours, 8 000 hours sea hours, and the four maritime patrols were not enough. As a Committee, Members would have to go and analyse these targets because it would mean nothing if they could not protect South Africa.

Regarding the budget, it was reported that there was an increase of 9.87% year on year. However, the table on the slides showed a decrease from R54 million to R48 million. That was a decrease and not an increase. There was a need to correct that. Mr Marais asked about the state of the facilities, such as the Air Force and Defence headquarters – the state of the buildings, and air-conditioning. He also asked about the challenges with DPWI and defence work formation. Who was responsible for tenders and leases – was it DPWI or the DoD? When was the St. George Hotel leased? In a written response, the Minister said that the Public Finance Management Act (PFMA) was not followed when the St George Hotel was leased. Therefore, it was an irregular expenditure, yet it was not reported.

Mr Marais asked if funding was provided for the various projects that Armscor had presented. He also asked about the renewal of contracts, specifically those regarding the maintenance and repair of the environmental controlled warehouses in Wallmansthal, Centurion, Durban, and others. What was the solution to that? It had a huge impact because it affected the immediate availability and deplorability of vehicles and prime mission equipment. What had been done on Waterkloof air force base over the financial year, and what has been done in the year? What was planned for the coming year?

He asked if the Department used the Reserve Force employees, and if ‘many days’ was part of goods and services or part of the compensation of employees. Was there any development on the Defence review, since there were reports that it would go to Cabinet? He asked if there would be a reconsideration of the current contracts for Thusano, going forward. What would it imply, since there was a sour relationship between the DoD and the Treasury?

He asked about the status of Project Hoefyster, since it was reported that there was no funding provided. What would happen regarding funding? He asked on the cost implications on Biro and Hotel due to delays. He asked if there any plans to increase the numbers C130 or to purchase second hand.

Mr Mmutle asked if, in future, the Department could give an internal audit outcome before dealing with the AG’s findings, so that the Committee could strike a balance and see if the internal audit was performing its duties or just there for compliance. The internal audit could have picked up and addressed some of the issues. The AG reported a financial loss of R250 million in material regularities, inventories and asset management contracts, while the Department stated that there was no financial loss since, out of the 922, only 617 was spent. He asked for clarity on whether the company that pulled out of the contract was the one that was paid R250 million. This meant that money was paid but no services were received. The Department was shying away from ensuring those responsible were held accountable. Similarly, on the drug matter, the Department had paid R33.85 million for the drug. When the MTT made the recommendation, there was no contestation to say that they had paid for it, and there was therefore the process to dispose of it.

Responses

The SecDef responded to the issue of internal audit. She highlighted that the DoD had an audit committee per Treasury regulations. The internal audit committee was required to make their audit requirements yearly in the Department. How many audits would they conduct each year? The AG uses the internal audit reports to assess risk before discussing the management letter with the Department. Some of the things that the AG raised were some of the issues that were already picked up by the internal audit. The internal audit was not at the capacity it wanted to be, but there was work being done. The R300 million that was included in the irregular expenditure resulted from internal audit being mandated to audit the procurement.

Regarding the Projects Biro and Hotel, the Department had already received one IPP, which was already done by Damen Shipyard. On the following day, it would be testing the IPV. The money for both projects was there in the SDA. It struggled in the beginning because there were some years when there was insufficient funding for both projects. The delays in Project Hotel were not because of the Department but the companies involved. There was also an escalation due to the exchange rate.

Regarding the defence review, it had not been able to deliver on the defence review. Initially, it was to arrest the decline, but things were worse off than when the defence review was adopted. The defence review would assist in the rejuvenation. Because of the over-expenditure of the CEO, the rejuvenation was done once every two years. Since the Department was not able to deliver, the Minister, in her speech, said that there would be a different level of defence dictated by the defence review. The Minister said that the Department had to go back to the drawing board and decide how it could deliver its mandate, given its financial situation. The Department had various work sessions to respond to the commitments of the Minister to Parliament. The defence review was approved by Cabinet. Once done, the Minister would carry what the Department had decided back to Cabinet.

Regarding the use of Reserve Force members that fall under the COP: the reliance was placed on the reserve members. The problem was that, when the budgets were cut, it would impact those that had already been deployed. This meant that the Department had a certain number of goods on the ground, without the resources. The Department was also not in complete control of the assignments given. For example, the floods in KZN were not things that are included in the APPs.

Regarding Project Hoefyster, the Department needed the Badger vehicles, but the situation has changed financially. The Department expected Armscor to do its due diligence so that the entity could tell the Department the amount of money needed to finish phase one. The DoD would then need assurance that, in their interactions with the defence industry, Armscor would have partners to proceed with phase two. Due to the challenges with Denel, the Department had to go back to the drawing board as end users. Armscor asked what weavers could be made on the specifications that had been made in the beginning.

Mr Eric Sokhela, CFO, DOD, confirmed, regarding the increase of 9.87%, that there was an error, and that it was meant to read as a decrease of 9.87% of the prior appropriation, instead. Regarding St George’s Hotel, he said the lease started in February 2022, and the first agents were made in 2022. So, by the end of the financial year, no payments had been made. Hence, the irregular expenditure was not recorded. However, the Department had recorded what was paid, insofar as irregular expenditure in its books. Regarding material irregularity on the asset management contracts, the AG’s finding indicated that, if the Departments spent the entire R922 million, there would likely be a financial loss of R250 million. The Department did not pay the entire R922 million; about R617 million that was paid was irregular and was recorded as so. There was no loss at that stage because the lowest contract amounted to R671 million, and R617 million had been paid from the R922 million. So, there was no financial loss and just irregular expenditure that was recorded.

The SecDef responded regarding the Project Thusano. She agreed with the sentiments that the contracts were open-ended. She acknowledged that the Department got permission on two occasions to allow the auditors to get more information, and that it needed to open its four arms of services to the AG so it could do a value-for-money assessment. The Department took full responsibility in that, during the time, information was provided to the AG. The process was already advanced, where the AG could not utilise the information.

The Chairperson said he was happy with the response by the SecDef, and highlighted that the CFO had to amend the presentation to reflect that accurately.

Briefing by DOD: Breakdown of the Spending on Border Technology as per MTEF allocation

Mr Siphiwe Sangweni, Chief of Joint Operations Officer, presented on behalf of the Department. The presentation highlighted that R65 million for year one (FY 2020/21) was reallocated and utilised in the fight against the COVID-19 pandemic. R75m for year two (FY 2021/22) was utilised and spent on improving the conditions of facilities and critical PME requirements in the borderline operational areas. The R85m funding for year three (FY 2022/23) was utilised to acquire technology systems deployed in borderline operational areas.

Discussion

The Chairperson highlighted that his concern was that the money was not used for the purpose it was allocated for, but was spent on COVID-19-related matters and other matters. Only in the third year was the Department looking to apply it to technology. The money resulted from lobbying Treasury through the BRRR. The Committee had said that, if they did not have the money to increase the number of companies from 15 to 22, they would consider using a force multiplier. Technology was used to augment the services that the soldiers were providing. It was very clear what the money had to be used for. He insisted that the money be used for what it was intended for. The presentation that had been presented a while back differed from the presentation just delivered. It was said that Treasury allocated R255 million to the DOD 2021-2022-2023. In the first year, R32 million was used to procure unmanned aerial vehicles and training of 20 UAV pilots orders. The remaining R32.5 million was cancelled because of the failure of the industry to supply the required equipment. This was then used for the upgrading of borderline infrastructure. The Chairperson asked if the Department could ensure it gave consistent explanations instead of conflicting information.

Mr Marais supported the Chairperson, stating that the money was going to be flagged as irregular expenditure, because he was not aware if the Department had applied for any deviations. The concern was that the Department was not the leading department in COVID-19. Therefore, why did it spend the money that the Committee fought for to make available for the much-needed technology on the borders for something else, without any communication? There was still a need for the equipment, and there was still a backlog. He asked for a suggestion on how the Department would deal with the backlog without going back to the Treasury to say the money was spent on something else. It was unacceptable and would make the Committee's task so much more difficult – having to go to Treasury and fight for the Department.

Mr Mmutle commented on the R65 million spent on COVID-19. He asked if the Department could explain what necessitated the use of the money since R4.5 billion had been allocated to the Department to execute its responsibility, in line with its deployment to fight COVID-19.

Responses

The SecDef asked if the Department could be allowed to come back on the matter. She said that, at the point of entry into the Department, the money had already been given to the Department. She would investigate the reasons why the money was allocated to COVID-19.

The Chairperson said that the Committee would not accept the report until it came back with the reasons. The Committee had fought to make the money available, and it was unacceptable that the money was used for other purposes.

The Deputy Minister, Mr Thabang Makwetla, thanked the Committee for the opportunity. He acknowledged that there was a need for more time to address some aspects of the discussion of Armscor and the DOD. The Minister had taken note of several concerns, most of which related to the decision of the defence review 2050. There were work sessions initiated by SecDef that were ongoing, looking at the various aspects of the review. It was an important exercise to address issues. As the DoD had raised, numerous unforeseen occurrences were compelling it to do things that it was not prepared for, and this was a challenge. The Department had to cope with the functions and obligations appropriately, while also anticipating threats in the immediate and long-term accurately. He was not sure whether the project of the naval assets and the in-shore patrol vessels was still on the table because the level of funding for the Department was low. The defence review would clarify some of these issues. 

He expressed that he was happy that the Committee Members had placed a lot of concern about the things that suggested the Department was not working within the laws. He was privileged to be part of the oversight committee of Parliament, the joint standing committee and then later the portfolio committee of Parliament to reposition the defence establishment in 1994. It was important to do away with the past legacy in which the DoD did things outside the law and the Defence establishment itself was the law. A lot of work had been done by Parliament, and they had to remain vigilant in that respect. He would share his concerns and comments with the Minister.

The Chairperson appreciated the DM for availing himself for such a critical meeting. He also thanked the SecDef and the team attending. He highlighted that the information would be required before 26 October 2022.

The Committee considered and adopted the Fourth Term Programme, with some amendments.

The meeting was adjourned.