Armscor on Project Hoefyster; Progress Report on financial challenges & Research and Development

Meeting report

The Chairperson opened the virtual meeting, welcoming everyone in attendance. The agenda was adopted without any amendments. The Chairperson encouraged the Department of Defence (DOD) and Armscor to feel free to give their views in the meeting.

Foreword by the Department of Defence

The Secretary of Defence, Ms Gladys Sonto Kudjo, indicated to the Committee that Armscor would lead the discussion. She highlighted that all matters, except for the sweating of assets, were primarily under the purview of Armscor since they involved acquisition. She would only raise issues around the acquisitions as an end user. She highlighted that, at that time, the Military had its own workstation to implement a defence review due to the budget cuts. The Military had to review its level of ambition to allocate its resources and design and structure. She said that the Minister's view was that the Department should not be sweating assets while reviewing its plans and ambitions since other assets would still be needed. The Department hoped to take the review to Cabinet for approval. She also highlighted that the Department had interacted with Denel on several matters contained in the presentation.

Briefing by Armscor

Ms PN Mashinini, a board member of Armscor, highlighted that board had set up a committee to look into Project Hoefyster and to deal with the issue pertaining to the IP.

Adv Solomzi Mbada, Armscor's Chief Executive Officer,  stated that they founded a steering committee, and it was meeting weekly. The committee had begun making some inroads, even though there were still outstanding decisions from the client environment. The engagements at the PDAC and the end-user environment were ongoing.

Regarding resolving the issues of intellectual property (IP) ownership with the CSIR and Denel, Armscor had engaged with them and found alignment in terms of who the owners were and the possibilities and opportunities. Armscor had been to the Council of Defence (COD), and it was given direction on how to progress. Armscor was busy formulating a proposal for its environment regarding how best to participate in IP exploitation. He highlighted that it would be a structured process that would be fair to all the potential entities wanting access to the relevant IPs.

Armscor Briefing: Project Hoefyster

Mr Malose Teffo, Group Executive: Acquisition and Supply Chain Management and Dr Noel Mkaza, Group Executive: Research and Development, presented on behalf of Armscor.

Project Hoefyster provides for the development, industrialisation and production of the New Generation Infantry Combat Vehicle (ICV) Products System to replace the Ratel ICV that was taken into service circa 1974. The original requirement was for 264 vehicles (three battalions), comprising five variants (Section, Mortar, Fire Support, Command and Missile variants).

The contract was activated in June 2007. The contract activated Phase one (Design and Development of five variants), with a contract value not exceeding R1 048 673 907 (2006 Rand value excl. escalation, ROE and VAT). The original contracted delivery period was over a 66-month period (from May 2007 to May 2012). The contract also provided for activation of Phase two (industrialisation and production of 238 vehicles) once predefined suspensive conditions were met. This phase was activated in February 2013. The quantity was later increased to 244, with increase in advance payments. Production is scheduled to be completed by November 2023. With Phase 2 activation, the SA Army added four new variants (Tactical Command Post, Signal, Basic Artillery Observation System, and Ambulance)

Armscor and Denel have constituted a Steering Committee (with Armscor and Denel chairpersons as co-chairs), where issues relating to the recovery of Denel are discussed at an executive level. The status and continuation of Projects Hoefyster and Kamas have been investigated in detail. Recommendations have been presented to the Steering Committee for consideration and agreement. Armscor and Denel have had several positive engagements at technical and executive level regarding the continuation of Phase one of the Project, and have reached agreement on a way forward. The number of demonstrated non-compliances to the contracted specifications for the Badger system has been the major hold-up on the Project. It is being addressed by both Armscor and the SA Army.

An evaluation of the outstanding contractual payments versus projected cost to complete Phase one of the Project indicates that sufficient funds are available to complete the Project. Armscor should, however, consider the waiving of future penalties, which would have a negative impact on the affordability of the Project. The entity should also consider the introduction of shorter payment milestones for the remaining work to generate operating capital for the project continuation.

An audit of the skills and capacity required by Denel to complete Phase one of the Project has revealed that an additional 21 persons need to be insourced to facilitate concurrent development of the vehicle variants. The required skilled persons are available and the cost to insource them, has been factored into the total required cost to complete Phase 1 of the Project. Outstanding payments to suppliers and projected future costs such as hiring of firing ranges etc. have been factored into the total cost to completion.

[See presentation document for more details]

Discussion

Mr S Marais (DA) commended the presentation. He asked on what the timelines were for the competition of phase-one project Hoefyster. What would happen after that? Is there enough money for the completion of the Project? Was there a need to scale down the Project to +-80 battalions of vehicles? Was there still a consideration for the South African defence companies to take over the work of Denel? Were there any discussions or provisional agreements? He asked how many bodies, gearboxes, and drive trains were available at the Denel. Could that be scheduled for future construction and manufacturing if they were to delay the Project?

Regarding the second presentation, he asked if any discussions were finalised with OEMs of the Gripens, the Hawks, the Pilaters (sp), the Augusta, the super leagues, and the engine manufacturers. He asked why it was dragging on for a long time. The delays had compromised security and the ability to defend South Africa. He asked if it was true that the disagreement between Armscor and OEMs was that Armscor was adamant about appointing certain preferred local partners. Was it true, and had it been resolved? He asked about the discussions with SANDF with SAPS – when they would be finalised. When would it be expected for the contracts to be finalised so they could put their fighter jets up in the air?

He asked whether the outstanding agreements had to do with the spare parts for equipment maintenance, such as the C130, had been resolved.

Mr T Mmutle (ANC) raised a point of order. He asked if Mr Marais's line of questioning concerned the report received or if it was something else. He argued that Mr Marais was no longer talking about the subject matter of the report.

Mr Marais said his questions pertained to foreign contract sourcing. He continued asking if Armscor was involved in lapsing subscriptions to the Jeppesen fly database. If they were involved, what were the reasons for those things, since all the foreign contracts kept the aircraft on the ground, therefore compromising the standards?

Dr M Basopu (ANC) said there was an improvement in the two organisations in terms of the presentation. Most of the product in the presentation was above 50% in terms of completion, except for the motor variant at 44.5%. He asked for an explanation and how it would be addressed. He commended the mechanisms put in place to address the gaps. He however highlighted that there was a need for clear timeframes. He asked whether the Department of International Relations and Cooperation (DIRCO) or the regulations allowed them to continue to engage in a foreign contract without engaging them.

The Chairperson said that, in prior meetings, the future viability of the Project was in doubt. The doubt was because the Project had been delayed for over ten years due to Denel's inability to deliver. Denel was not able to meet the specification of the Project. What he was getting from them was they had agreed and that the products would depend on the end users and the suppliers. He highlighted that, for as long as issues of the waiver of non-compliance with the specification, suppliers' willingness and the issue of funding remained unresolved. He was not satisfied that they had made substantial progress. He asked if they could further remove the Members' doubts.

Responses

Admiral Anthony Morris, Chief Director, Armscor, responded that they would shorten the timelines to complete phase one. Denel has presented many turnaround strategies. These were shared at the plenary defence council, which the Minister had chaired. To cut out on the timelines, Armscor had already engaged the end user, the South African Army to appraise the duration required to either be accepted or rejected. The end users just had to consider these deviations. That would impact the timelines because some of the deviations could be accepted or not. Once done, the project control board would then table the matter. This would then be fed through to the Armscor acquisition council by the Minister. 

Regarding scaling down on vehicles, he responded that the battalion was +- 88 vehicles. The focus of the end user and Armscor was to see if they could at least achieve phase one. There would be enough funding available to be allocated to the Army through National Treasury to refurbish some of the Ratels. There was already a submission that was drafted. They had to now look at the specific amount and how much it would cost.

Regarding servicing equipment bought for phase two, Armscor would look at the options. If they were to complete phase one, they would have to defer the Project. The obvious logic would be to terminate the contract for phase two, which would have catastrophic results.

Adv. Mbada responded to the issue of scaling down. He said that the end user environment would take the lead regarding the outcomes and the different options. The priority was to propose a revised solution to the client environment whereupon there would be concessions and deviations to be considered. Once resolved, the next part of the discussion would be to see the level of resources available to see if the client is amenable to scaling down options based on their operational requirements and funding availability. The issue was always about completing phase one. Now, these issues were almost resolved because they had been engaging in meetings to come up with a way forward.

Regarding the OEMs, he responded that what the media outlets had put out about the delays being because of the BE part that Armscor was said to be insisting on it not being true. Armscor was never approached to tell their side of the story. The matter had always been around the maintenance model regarding labour hours and the cost structure. Regarding the maintenance contract, all the aircraft platform contracts had been either signed, new contracts, or extended. The board had been busy, so all the maintenance contracts were valid, and the aircraft were supported. All the issues raised had been resolved, including the one regarding the VIP fleet.

Regarding the question about the data subscriptions, Armscor was not involved, and the questions could be responded to by the Air Force. They were brainstorming a lot of options for the client's consideration. If option one is accepted, they could then work on phase two.

Mr Teffo responded regarding the issue of a timeline. The provisional date Denel gave was November 2023 to complete phase one of the contract, which was dependent on the fulfilment of several dependencies. Regarding the funding, there was sufficient funding to proceed and execute phase one of the Project. The challenge would be the execution of phase two because of the scarcity of funding. The matter of abridging finance was an area Denel was dealing with in terms of paying suppliers and subcontractors.

On the trust deficit: one of the considerations by Armscor was to proceed with the direct payment to all the suppliers and subcontractors. Many have been providing subsystems and components to Denel and have not been paid yet.

Adv. Mbada responded regarding the involvement of DIRCO. He highlighted that they had been getting support from DIRCO on a continuous basis. As standard procedure, they always made sure to engage the ambassadors and the high commissioners when they visit various countries to ensure that there are aware of the nature of the visit so they could share the various opportunities and have an ongoing relationship.

Regarding the motor variant, the execution had faced technical challenges and there was a need for working capital to implement the proposed solution.

The Chairperson reiterated what he understood from the responses. He said that the Department was the key to resolving the problem. The proposal was to deviate from the project plan, and the end user needed to accept some conditions. The proposed plans would be revised only if the client accepts them. The entities also said funding was available, but the issue was with Denel and the suppliers. There was a trust deficit, and they were proposing that paying the suppliers directly would address the deficit issue and ensure that the Project moves forward.

The Secretary of Defence, Ms Gladys Sonto Kudjo, responded that the Chairperson was correct. Armscor, as the Department's acquisition arm, was the one that was contracted to deal with Denel on the Department's behalf. Therefore, it relied on them for advice on what needed to be done. The DoD did not have any money for the Hoefyster project. There were reasons several reasons why Project Hoefyster did not proceed. Denel faced challenges, such as test compliance, and human resource capacity, in terms of finalising everything. The programme started in 2006. A lot of time has passed, and many things have changed. At that time, the country was in a better financial position, and the budget was at a different level. Surely, they would scale down since they would be unable to adhere to all the numbers unless the economic situation changed. The DoD had been engaging with Armscor and Denel through the Chief Restructuring Officer.

There were expectations and promises made to Armscor by Treasury. They only got about R1 billion of the amount promised, which meant that R2.3 billion was left from what they were meant to be given. The competition of phase one required R340 million. Concluding phase one would only mean that data packs could only be utilised to go to phase two. The DOD had decided they would not put any money unless they had absolute assurance that the money would translate into production. They asked the plenary defence council that, before they go to the COD, the colleges in Armscor had to do their research with the South African defence industry to see that in the event they conclude phase one, they would be able to work with them to go to phase two.

Only when the DoD knows the potential of getting such partners to complete the Project would it look at finishing phase one. It had to be able to go outside for partners before going ahead. Without that assurance, it would be difficult to continue with the numbers agreed upon. The COD decided that, due to the precarious position that Denel was in, it was not going to put in more money. The Chief Restructuring Officer (CRO) had an invitation to come to address the COD on how they could move forward. They had to be assured that these issues that had brought the projects to a standstill were addressed before moving forward. What remained was that the Army still needed combat vehicles. The Department wanted to see themselves getting to phase two, which was about production. So, they had to apply their minds to what it was that they could live with and not. Even if they received the money, they had to ensure that Denel had the capacity. Phase one was necessary before eventually going to phase two.

Regarding the OEM, DoD was able to solve some of them in the country. The defence industry was in a precarious position, and they could not continue being connected to some of the OEM suspects looking at how old, even though they were struggling, they were making headway.

Mr Marais thanked the SecDef for the context because it confirmed that there were not out of the woods. They had to scale down because they could not afford the Project as intended. He asked if they could be told the various proposed scenarios. There were many conditions for phase one so that, if there is ever a scenario to get vehicles on the road and in the field, that would be several years down the line. He asked if the Committee could put me on the agenda of the closed meeting. He expressed that he was even more concerned about going out of the meeting. He accepted what the SecDef said about the sweating of assets, but they had to consider that there were vehicles that could be sold off as scrap metals. An unused land parcel in Pretoria could be sold and leased.

The Chairperson said that the sweating of assets was an item that the Minister requested that they withdraw from the agenda until they finalised what level of ambition; they would aim for the given budget. The sweating of assets was not to be approached as assets being sold but as assets being improved with partnerships to leverage a source of revenue for Armscor. He highlighted that SecDef was right that Armscor was the one that contracted with Denel. Therefore, it had to advise in the best possible way. Armscor was proposing a revision to the Project, which could be taken to the client and would be discussed at the COD level. They had to address the concerns on whether phase one will lead to phase two. Phase one with no phase two was not a solution to the challenges of the Department. The DoD still needed the vehicles, and Armscor would therefore present several scenarios during the COD.

The Chairperson demanded that the proposals be developed as soon as possible, and they had to be presented before the Council of Defence. The Project was needed in 2012, and it was nowhere near completion, having spent billions on it.

Mr Mmutle said that Armscor had to give a timeframe. This was necessary because it was way behind schedule by a decade, and resources would be scarce henceforth. They needed to look closely at the developments to deliver some results.

Adv Mbada said they had noted the input and would go back and further make sure that they refine the options they were considering. He proposed that there would ensure they were done in two months, and they would have engaged all the key stakeholders, including the DoD. He said a lot of thinking had already gone through the various scenario options. They had also thought of partnerships with other entities and other countries. Because it was an acquisition project that included various entities, they wanted to respect the internal processes. They would come back within 60 days with the options with the stakeholders.

The Chairperson said that the Committee would have them in the first meeting of the first quarter to present the agreements since they would have done the consultations. Only then would they be able to respond when phase one would be concluded.

Armscor Briefing: Research and Development

The presentation provided information on Armscor's custodianship of the DOD's IP mandate, the IP exploitation strategy, governance process, and the approval process.

[See presentation document for more details]

Discussion

Adv Mbada added that they were working on the model and would do some consultation with the DoD for guidance. There was IP that they believed was not sensitive and could stimulate the industry fairly and transparently since the economy was big.

Mr Marais said there were questions about whom the IPs belonged to, and there were discussions to leverage the money, while Armscor stated that many of the IPs belonged to the Department. He asked which IPs belonged to the DoD that could be used. Was there assurance that the IPs were still cutting edge in defence technology? To what extent were the IPs competitive in the industry?

The Chairperson also concurred that he wanted to find out the value of the IP since if they were not being updated, they would go obsolete.

Adv. Mbada responded that with no question, the IPs belonged to the DoD, but it was Denel's license under the arrangement. The agreement was a separation agreement, which meant that if Denel wanted to improve the IP, they would need permission from Armscor. That was the regime around it. Several companies that improved the IPs wanted to claim that the IPs because of their improvements but Armscor had settled the matter.

Regarding IP relevance, some of the products proved resilient and were ahead of their time. Developments in terms of R&D were imperative, but there was a limitation. Therefore, partnerships were important.

Dr Mkaza said that Armscor had a whole register of the DoD IPs. They had various regimes - owned and co-owned IPs. The IPs were valued in billions, and most of them were still relevant because defence evaluation institutes made sure that there was constant development. Their technology was still sought after because they developed a niche in some areas.

The Chairperson asked about the law that stated that whoever develops an IP owns it.

Adv. Mbada said it was the IPR Act and it had been sorted. Armscor had sought legal opinion to clarify the matter. Entities that used that as a trap had since confirmed in writing that the IPs belonged to the DoD.

Dr Mkaza said that the entities came to challenge the ownership of the IP. The issue had been settled. They were at a stage with one of the ADDs that was considering the IP assignment agreement. Further, they were considering the amendment of the Act itself. The legal opinion they sought strengthened their position and gave them more confidence to proceed.

An official from Armscor explained the legal opinion on whether they could amend the IPR Act. Armscor wanted to own the current IP developed since the Act came into effect in 2010. The opinion quoted the Armscor section 22, which provided that, notwithstanding any other law, the IP that has been developed and invested under the Department belongs to the Department. The conclusion was that the IPR Act did not supersede Armscor Act. The view was that the IP, which was developed after the IPR Act, was owned by the Department. Due to uncertainty, they recommended that they try to amend the IPR Act 8 to read in the exclusion of the DoD. They also made a recommendation to approach the court to make an order that the IP funded by the DoD was owned by the DoD to prevent the defence industry from invoking the IPR 8, because they were also seeking other opinions.

The Chairperson said that he was happy with the progress on the matter. They had dealt with the questions and seemed to be alive to all the concerns of the Committee. They would meet in the next quarter, and they would also meet to deal with the AG's report.

The Chairperson thanked the Department for appearing before the Committee.

Committee minutes were considered and adopted.

The Chairperson then thanked the Members for attending the meeting.

The meeting was adjourned.