Denel on its 2015/16 Annual Report; Public Enterprises Budget Review and Recommendations Report

Meeting report

Mr Zwelakhe Ntshepe, Acting Chief Executive Officer: Denel, told the Committee that the group had continued to improve on historic results through restructuring and turnaround interventions and had posted a profit for five consecutive years. The strategic focus was on increasing profitable cash returns by aggressively driving business development, as well as enhancing technology and capabilities, while continuing transformation and efficiency imperatives.

Denel’s long-term growth strategy was aimed at increasing sales, the product portfolio and service offerings, and to ensure on time and on cost deliveries on major programmes. The entity aimed to pursue financial recovery and stability based on achieving profitability targets by increasing market share and achieving its revenue targets, as well as reducing costs. This meant negotiating with international clients to accept corporate guarantees instead of bank guarantees, government guarantees, working capital management, and finding alternative sources of funding.

With regard to self funded research and development as a percentage of revenue, he reported that the target of 3% had not been met due to the significant increase in revenue of 41%. On the employment of women within the organisation, there had been an improvement from previous years and Denel was committed to improve further. The total number of employed women was 1 227. They represented 15% of the entire staff. Concerning the Denel Training Academy (DTA) artisan and technical trainees, the target was not met due to limited funding available.

The entity had maintained an average 20% gross profit margin over the last six years. It had improved the normalised operating expenditure margin of 15% in 2015/16, when excluding impairments and restructuring provisions. The focus continued to be on efficient programme execution, cost optimisation and resource planning. There was increased reliance on debt for funding, due to project cycles. Working capital management continued to be key in improving the cash position as well as maintaining acceptable debt levels.

Denel had acquired all of the shares in Denel Vehicle Systems (DVS) on 28 April 2015 and this had resulted in DVS being a Schedule 2 entity in terms of the Public Finance Management Act (PFMA) from that date. As a Schedule 2 entity, the DVS was required to comply with the requirements of the PFMA, the Preferential Procurement Policy Framework Act (PPPFA) and the Treasury regulations in relation to procurement and contract management from 29 April 2015 onwards. The management of Denel had applied to the Minister of Finance to exempt DVS from the requirements of the legislation and regulations relating to procurement and contract management for the period ended 31 March 2016, to enable the management of the entity to develop internal control systems to ensure compliance with the requirements. As at the reporting date of the consolidated financial statements, engagements with the Minister of Finance were still on-going, and the management was not aware whether the exemption would be provided or declined. The possible irregular expenditure was R7m.

Concerning procurement, the key focus areas were on:

• getting value from smart contracting;
• increasing procurement spend on black-owned businesses, black women, black youth, military veterans and black persons with disabilities;
• targeting small emerging black businesses;
• reduced reliance on imports;
• transformation of the current key supplier base.

(Tables and graphs were shown to illustrate budgets and expenditure, sales and profit, corporate structure, group financial performance, and organisational demographics).

Discussion

Ms D Rantho (ANC) remarked that the 15% representation of females, which Denel saw as a sizeable number, was going to remain the norm. The entity must not accept it as a sizeable number. It must have a programme to come up with an expected and acceptable number of 50% or 60%. She also wanted to know why Denel had not employed a person with a disability, especially when one looked at all the types of disabilities existing in the country.

Mr Ntshepe admitted that 15% was very low. Females played a pivotal role in research and development. The entity was aiming at 40%, though the Board had indicated it should be 60%. Denel had embarked on an initiative to set up a research unit in order to identify critical scarce skills and to head hunt the individuals they need.

Mr Odwa Mhlwana, Acting Chief Financial Officer: Denel, responded on the issue of disabilities, and said there was a specific designated group they were targeting, which was comprised of youth, women and military veterans, especially for supply chain opportunities. Procurement had been divided into two categories -- technical services and buying. The technical services category was opening up opportunities for black businesses.

Ms L Mathys (EFF) remarked that the Committee did not have time to engage with the National Treasury on the matters of corruption facing Denel. There was a cloud hanging over Denel, and the Committee would like to know if the entity was captured or not. The Committee wanted to get to the bottom of problems raised by the Auditor-General. The Committee was not happy that allegations about Denel had not been mentioned or answered in the annual report, and it would like to set up a date to engage with the Board on these matters.

Mr Lungisani Mantsha, Board Chairperson: Denel, said that Denel had nothing to hide and would continue to honour invitations from the Committee to account on the activities taking place within the organisation. The Defence Department budget had been cut by 15%. This meant Denel’s efforts to procure had also been reduced. Denel needed more money for research and development, and that was why it had to look at foreign markets. It had therefore entered into a transaction with VR Asia in order to grow the export markets. Denel had never financed that joint venture or transaction. The content of the joint venture was to form Denel Asia. VR Asia had had to provide R100 million to set up plants and marketing. The products were made by Denel. It was agreed that some items would have to be assembled in Asia so that the host nation could create jobs for its own people, and Denel had to follow all the required processes to finalise the transaction of starting Denel Asia. The conditions had been fulfilled.

Denel had met the Department of Public Enterprises (DPE) and National Treasury to find out if there were problems in respect of the joint venture. Denel wanted this to be dealt with urgently, because there was no work reserved for the entity, as it had to bid in order to fund itself. So when there was a business opportunity, there must be aggressive efforts on Denel’s part. Denel had submitted the application according to the regulations of the PFMA so that the matter could be treated urgently. Denel had to team up with a partner in order to handle the marketing efforts and these issues had been reported, with no objections from the DPE and National Treasury. According to the law, if after 30 days there were no objections, the entity could continue with its efforts of doing business. That was why, after 30 days, Denel Asia was formed.

Denel Asia was not active now because of a directive from the Department. VR Asia was not trading. When Denel came with a proposal for a joint venture, that meant the entity needed the support of the Committee, because the aim was to grow the foreign market and generate revenue for the entity. This must not be seen as corruption.

Mr Mantsha said the entity spends more than R3 billion through its supply chain, and 70% of that was spent on black-owned businesses. The other 30% still benefited the white-owned companies. The pie had to grow, not only in SA, but outside as well. The entity was available to talk with the Committee at any time.

The Chairperson said the fact that VR Asia was not trading meant there were no transactions taking place, therefore Denel was not ‘captured.’

Mr Mantsha maintained that Denel was not captured by anybody, because some of the agreements were made during the time when the new management was not there, including the current board.

Dr Z Luyenge (ANC) commented that the Committee should give credit where it was due. He saw progress in the way thing things were done, and what the Committee was hearing. The Denel of prior to 1994 was different from the one of today. The board had to make sure it did not have people in acting positions for a long time. He asked for clarity on the entity’s retention strategy, and wanted to establish what the relationship of the entity was with the Southern African Development Community (SADC) and other African countries. Lastly, he asked where the entity located its expansion projects, because the majority of the voters were in the poor, rural communities, and the entity should not confine itself to Johannesburg, Cape Town and Durban.

Mr Ntshepe said that reaching the rural areas was one of their targets, in terms of their national duty. Denel’s corporate social investment (CSI) projects were located in rural areas like Mpumalanga. Career exhibitions were frequently done in high schools and universities all over the country. A recent exhibition was held at the Umthatha military base.

With regard to the retention strategy, what was important to them was to have people working at Denel so that they got experience. They were giving young people projects to work on and most had proved to be competent.

Pertaining to SADC and other African countries, he said the competition was huge. They struggled in some markets, where customers did not want it to be known what kind of ammunition they were using.

Ms G Nobanda (ANC) remarked that most state-owned entities (SOEs) presented figures and provinces, but did not state where exactly in the province. Members would like to make follow-ups and visit these areas. She also wanted to know if the children who attended these exhibitions were from Model C schools or rural areas.

Mr Ntshepe replied that the criteria were decided on by the Communications Department of Denel, and everything was based on the multi-pronged strategy.

Mr R Tseli (ANC) wanted to know how long it was going to take to correct irregular expenditure, and what had led to the unacceptable 23% under-expenditure.

Mr Mhlwana said they had applied for exemption, and it had been made clear to Treasury that by March 2016, everything would be put in place. The entity was sitting in a position where they had a growing business but with only one source of funding, and that was the commercial banks. The entity could no longer borrow. They were trying to juggle and reprioritise. The entity was severely under-funded and with the little they had, they had to see what they could do. The challenge was always to do more.

The Chairperson wanted to establish if the decline in revenue in the Overberg area was related to the oil exploration. He also asked when the acting positions were going to be finalised, and what had determined the sale of non-core assets.

Mr Mantsha reported that the process regarding the filling of acting positions was under way. An announcement would be made in the near future. Many people in the country did not have exposure to the defence industry, so it was one area where there were rare skills. The board was doing all it could to fill the vacancies.

Concerning non-core assets, the Airports Company of South Africa (ACSA) had approached Denel about its Philippi land for an extension to the Cape Town runway. The offer was lucrative and plans now were to review all their assets.

About the Overberg testing range, he explained that work there was cyclical or seasonal. Flight tests were done there, but there had been no negative information reported on it.

Ms T Stander (DA) remarked that Denel should put its money in a money market account to make good returns. Currently, there was an environment of state capture, and it was illogical to enter into an agreement with a company that had only one shareholder. The whole thing was rotten from the top. Denel could not keep on borrowing. She asked for clarity on three issues: Denel’s capacity to protect the country’s sovereign space and ocean economy; Khwane Capital; and government guarantees.

Mr Mantsha, responding on the protection of SA’s space and oceans, reported that Denel had started the maritime division with the purpose of protecting the country’s marine space. Denel had submitted bids for two projects, and the businesses had been awarded already.

On Khwane Capital, he said that the 49% stake that was reported in the media did not belong to Denel. Pamodzi had 30% of that business, and Denel had got no share in it. About government guarantees, he said that the guarantees were there to stand for Denel, but they were not a protection. This business was not capitalised by the shareholder, which was the government. The net profit was so meagre that it could not fund the operations.

Budgetary Review and Recommendations Report (BRRR): Adoption

Ms Stander stated that the Committee should not discuss the BRRR because it would not be able to finalise it during the meeting. It should be set aside for another meeting.

The Chairperson admitted they would not be able to do justice to the BRRR, and needed to ensure it was serving its purpose. Unfortunately, however, they had to do their work for compliance purposes.

Mr Tseli proposed that the report on the BRRR should be done quarterly.

The Chairperson took the Members through the document, page by page.

Dr Luyenge moved the adoption of the document.

Mr Tseli seconded the motion.

The document was adopted, with minor amendments.

The meeting was adjourned.