South African Airways 2008/09 Annual Report

Meeting report

Briefing by South African Airways (SAA)
Ms Cheryl Carolus, Chairperson of the SAA Board, informed the Committee that the new Board had been constituted the previous day. The airline was facing a number of challenges, which included the current global circumstances. SAA was in the process of concluding its restructuring programme. The restructuring programme had resulted in the recent turnaround. The KPMG process was initiated by the outgoing Board.  The KPMG process was a thorough and objective external investigation into the systems and processes of SAA. The Board was committed to ensuring that the right skills were at the carrier’s disposal. The Board had engaged with auditors, who had identified some weaknesses regarding the Public Finance Management Act (PFMA). The issue of the vacant Chief Executive Officer (CEO) position was being taken seriously by the Board and she assured the Committee that the matter would be concluded as soon as possible.

Mr Chris Smyth, Acting CEO; SAA, outlined the challenges faced by the industry. Airline companies had been severely affected by the economic downturn. Escalating oil prices had wreaked havoc in the industry. The amount expected to be lost by the industry was estimated at R120 billion.

SAA’s restructuring programme consisted of global initiatives and a 20% reduction of staff at all levels within the organisation. All the Boeing 747’s were grounded, with the exception of two aircraft. Operational performance levels were found to be poor but had been turned around and SAA had become one of the most on-time carriers in the country. The amount of revenue earned per flight was increased as well as getting the highest-paying passengers on board.  As a national carrier, SAA had a lower share of the market but this had been turned around. Every single cost-line was reduced within all departments.  Cost savings were achieved by eliminating duplication, contracts with suppliers were re-negotiated and reduced and all personnel were bound to a performance contract. A target of R2.3 billion in savings was set but the target was surpassed and savings of R2.5 billion were achieved.

The restructuring programme was initiated in 2007. Phase one of the restructuring was the “hard” phase and included head count reduction, improved revenue and cost reduction efforts. The company was currently in the “soft” phase of the programme; which focused on customer service - ensuring that customers got what they wanted and reducing causes of irritation. Restructuring had now become part of SAA’s operations. On-time performance had been increased to 90%. The improvement of on-time performance in Africa had been problematic because certain airports were not fully operational and the fact that African travelers generally carried lots of luggage (mainly traders with goods bought in South Africa). On-time performance in Africa was nonetheless improved to a level exceeding that achieved in the previous seven years.

Turnover had been increased by approximately 20% in 2009. The major contributor to the increase in turnover was increased passenger revenue. Cargo revenue had declined. Operating costs had increased by 5% in 2008 and 10% in 2009. One of the reasons behind the increase was the rise of the oil price to $140 earlier this year. The increase in energy costs over the last two years amounted to R2.4 billion.

Mr Kaushik Patel, Chief Financial Officer, presented the financial statements for the period 2008/09. The net finance costs were R130 million, including the interest payable on subordinated loans. The biggest contributor to revenue was passengers, increasing by 19%. Passenger revenue was derived from fares, the applicable fuel levies and an increase in the total volume of passengers. However, cargo revenues had dropped by 26%. World-wide, cargo revenues had decreased by 40%. Technical services increased by 89%. Certain increases in operating costs were as a result of the weakened Rand.  If the currency impact was excluded, costs had actually declined. Some cost savings were achieved as a result of re-negotiated contracts with foreign hotels where staff stayed between flights. Lease costs decreased by 25% as a result of the return of the Boeing 747 aircraft to the lessors. As a result of the re-negotiation of contracts with various companies, electronic data costs had decreased by 15%. SAA was very conservative where hedging was concerned. Between 40% and 60% of the company’s fuel purchases and between 50% and 75% of its currency requirements were hedged. SAA had a significant amount of debt; which was reduced from income earned.

In conclusion, Mr Smyth highlighted the importance of the airline to the country. SAA’s mandate was to be an African airline with a global reach. The strategy was to develop a strong presence in Africa.

Discussion
Mr M Nhanha (COPE) noted that no mention was made of the loyalty programme in the balance sheet. He wanted to know how much was spent on the loyalty programme per year. He asked for details of the deal struck with Airbus and whether the deal was beneficial to SAA. He was concerned over the possibility of a tariff hike and the impact thereof ahead of the 2010 World Cup. He asked if it was true that one of the employment criteria for cabin crew was the demonstrable ability to swim. If this was true, in his opinion it was a very discriminatory requirement.

Mr Patel replied that the cost of the Voyager loyalty programme was reflected on page 91, note 47 of the annual report. The cost per mile was 9.37 cents.

Mr Smyth explained that the figure was at full sales value. Voyager miles were allowed even if the aircraft was empty. The programme would be changed so that it became more expensive. The Voyager entry had no cash flow impact to the airline.  He said that SAA had re-signed and re-committed to the Airbus deal, which was increased to include 20 aircraft. The deal was postponed to 2015. This allowed SAA to renew the leases on the Boeing 737’s for an additional 4 to 5 years. The company would be saving R21 million per month on the lease of the aircrafts. The pre-delivery payment had also been postponed for another two years. SAA would be replacing the aging fleet with new aircraft, which would cost considerably less to maintain. SAA’s mandate was to be a self-sustaining airline. SAA did not intend to rip the public off or increase its prices without justification. The requirement that cabin crew members had to be able to swim was not intended to be discriminatory.  A number of SAA’s flights were over water. The requirement was specified in legislation as well as in the regulations applicable to SAA.

Mr G Koornhof (ANC) remarked that SAA’s achievements could not be measured against set targets. Strictly speaking, SAA had in fact broken even. He asked for comment on the reports in the media about the sale of the technical assets. On page 11 of the annual report, reference was made to non-core immovable assets.  He wanted to know which assets were referred to, where the assets were located and which department was responsible for the assets. The number of staff was reduced and a wage freeze imposed but the previous CEO was paid a R14 million bonus. He wanted to know how the payment of the bonus was justified under the circumstances. He requested comment on the issue of bonus payments and incentive schemes.  The investment made in the Mango airline was R535 million but the profit declared was only R10 million.  He asked where flight tickets for Mango were purchased and what SAA’s view was on Mango.

Mr Smyth replied that there was no intention to avoid being measured.  It was simply a matter of trying to come to terms with the re-capitalisation issue. The Airbus deal had a major effect on the balance sheet. The R400 million profit reflected in the balance sheet was not sustainable. Hedging losses incurred were not expected to be repeated in subsequent years. The R427 million Airbus grounding costs would not be incurred after the end of the year. If the R400 million profit was reversed, then the same should be done with the Airbus and hedging costs. In this case, the profit would be R1.5 billion. SAA Technical services, Cargo, Airshifts, Voyager and Galileo were support business for the airline. Mango operated independently as a separate business.  Mango was a low cost carrier whereas SAA was a full cost carrier. Outsourcing of specialised services was a global trend. SAA planned to sell off non-core assets but would retain an interest in technical services.  Non-core assets included SAA Technical, Cargo and Airshifts.

Mr A Shaw, Deputy Director-General; Department of Public Enterprises advised that the Department had worked with SAA Technical.  Both parties agreed that the full potential of SAA Technical was not being realised.  There was potential to convert SAA Technical into a Southern African hub of interest to multiple carriers.

Mr Patel pointed out that the non-core properties had to be offered to state-owned entities in the first instances.  If there was no interest from state-owned entities, the assets could be offered for sale on the open market.

Prof Jakes Gerwil, former Chairperson of the SAA Board, commented that the disposal of non-core assets was part of the restructuring programme and generated income.

Mr Smyth referred the Committee to page 75 of the annual report and explained that the figure of R13.65 million included the salary of the previous CEO. The retention bonus was paid in full. The actual termination benefit was R9.35 million.

Prof Gerwil said that once the investigation into the previous CEO was launched, the Board decided to allow him to go on special leave. It became clear that the investigation would be lengthy and it was decided that a mutually-agreed departure would be acceptable to both parties. The terms of the contract were adhered to and it was decided that a long drawn-out court battle had to be avoided.

Mr Smyth reported that morale of personnel was badly affected by the restructuring. The airline had suffered a depression and the retention scheme was devised to lock-in employees with critical or scarce skills. This was not a performance bonus. The company had succeeded in retaining the best staff.

Prof Gerwil explained that the KPMG investigation was launched to determine if there were any irregularities in the implementation of the retention scheme. The Board was convinced that a retention scheme had to be implemented.

Mr Smyth advised that the wage freeze was applicable to all employees. The wage situation had been stabilised. The actual start-up cost of Mango was R336 million.  No loans were granted to Mango by SAA.

Prof Gerwil said that Mango was initiated as a defensive measure as SAA was losing market share to other low cost carriers.

Mr Patel said that Mango had become the market leader within 18 months of starting operations and continued to be profitable.

The Chairperson requested Mango’s financial statements.

Mr Smyth replied that holding companies were legally prevented from releasing the financial statements of subsidiary companies.

Mr S Van Dyk (DA) said that since Mango was part of SAA, which was a public entity, it was in the public interest that the financial statements were released to the Committee.

The Chairperson reminded Mr Van Dyk that the Ministry was the shareholder and not the Committee.  The financial statements could only be requested through the Minister of Public Enterprises.

Mr Smyth said that Mango flight tickets could be purchased on the Internet, at Mango counters and at Checkers stores.

Mr Van Dyk referred to a written reply to a question, wherein the Minister had stated that SAA had made a total loss of R14 billion since 2002. In 2008 the airline had a debt of R17 billion. According to the Minister, the carrier had received R12 billion over a six-year period from taxpayers. The profit made in the previous year was a net profit and not a real commercial profit. He wanted to know if it was true that SAA needed a further R11 billion to achieve its turnaround strategy.  The only credible turnover reported was the passenger turnover. The previous CEO had received R5 million in salaries, R20 million in payouts as well as a R13 million “golden handshake”.  He asked when the results of the investigation into the matter concerning the previous CEO would be made available.  He asked what allegations were made and on what the decision to award the R13 million “golden handshake” was based. Mango was not mentioned in the presentation.  He asked if Mango was totally independent of SAA. He asked of SAA had provided any guarantees for Mango.  He noted that 1192 employees were retrenched by the airline; there were 240 vacancies for technicians and 53 pilots had resigned, yet R72 million was paid out in retrenchment bonuses to 128 senior managers. On page 75 of the annual report, there was a further mention of bonuses and retrenchment package paid out to executives. He asked if SAA considered the actions taken to be sound financial practice.

Mr Smyth replied that SAA required a substantial capital injection in order to deliver a healthy balance sheet.  SAA realised that there would be no further cash injections from the Government and the airline did not plan to ask for more money from the National Treasury.

The Chairperson interjected and explained that the official view of Government was that it would not bail out state-owned entities.  Capital injections from Government would be carefully considered.  Government intended state-owned entities to maintain sustainability, rather than to generate massive profits.

Ms MP Mentor (ANC) added that subordinated loans were capital injections as well.

Mr P Van Dalen (DA) remarked that profitability and sustainability had to be taken into consideration.  A private company would declare bankruptcy if the cost of a bailout was too expensive.

The Chairperson advised that the decision was taken after the pros and cons were weighed up in terms of the Governments’ priorities.

Responding to earlier questions asked by Members, Mr Smyth said that bonuses were a reward structure that the company intended to continue.  Bonuses were extremely effective as rewards and should not be viewed as handouts.

The Chairperson remarked that Transnet viewed bonuses as an alternative remuneration strategy.

Mr Van Dalen asked if customer surveys were conducted and what procedure had been followed. He asked what the impact would be on SAA if Government banned labour brokering.  He wanted to know if SAA had a strategy in place if the company could no longer use the services of labour brokers.

Mr Smyth replied that three types of surveys were conducted at SAA. The first was a departmental survey and the second was an international survey. Skytrax, which was based in the United Kingdom, had also recently rated SAA the 11^th best airline in the world.

The Chairperson interjected and said that the Department had already explained the ratings to the Committee, including the Skytrax ratings.

Mr Van Dalen said that he wanted to know about local customer surveys and not international surveys.

Ms V Kriel, Corporate Strategy, SAA explained that local surveys were conducted twice a year. The surveys were randomly allocated. Surveys were conducted on a regional, domestic and international basis. The results were compared with the results of Skytrax and Star Alliance surveys.

Mr Smyth advised that the airline had improved from a customer satisfaction rating of 60% to the current rating of 77%. He said that SAA had a flexible labour demand. The airline had agreed with the Unions to phase out the use of labour brokers after 2010. The airline would work with the unions to find an alternative method of sourcing staff thereafter. A strategy was in place.

Ms Mentor interjected and asked if SAA was making use of job placement agencies or labour brokers.

Mr Smyth replied that SAA used a number of different organisations to provide personnel.  All personnel were employed by SAA.

Ms D Ramodibe (ANC) asked if the profit declared was attributable to the deal struck with Airbus.

Ms Mentor congratulated Ms Carolus on her appointment as Chairperson of the Board of SAA.  She asked if new Board members would be appointed. She wanted to know what skills were represented on the Board and what the racial and gender representation of the Board was. She asked if the Board strictly adhered to its mandate.  She asked if the effect of SAA on the South African economy and GDP had been determined.  She remarked on the tendency of SAA to disown SA Express and SA Airlink when these subsidiary companies had not performed well.

Ms Carolus advised that not all the vacant positions on the Board had been filled. SAA was discussing the matter with the Minister. The Board needed to have a balance between skill and diversity.

Mr Smyth said that he accepted the criticism regarding the affiliated companies.  SAA staff was expected to take responsibility for the other airlines operating under SAA.  A study of the impact of SAA on the South African economy had not been undertaken because many of the knock-on effects were immeasurable.

Ms F Majiet (ANC) commended SAA for servicing 19 African countries.  She said that the interior of planes servicing Nigeria left a lot to be desired and she wanted to know if different standards applied to aircraft flying to African destinations.  She wondered what would have happened to SAA if Government had not bailed out the airline in the past.  She asked how many technical personnel had left the employ of the airline, the reasons for the resignations and what measures were in place to fill the vacancies.  She remarked that research and development activity was centered on marketing and branding.

Mr Smyth advised that the older Boeing 747 aircraft were utilised on the Lagos route.  The aircraft were due to be replaced by the 343’s by the end of the year.

Ms Kriel advised that SAA had no formal relationships with research institutes. Recently, SAA had started working with the Department of Science and Technology.

Mr Smyth stated that SAA would have ceased to exist if they had not received an equity injection from Government in previous years.

Ms G M Borman (ANC) commented on the low staff morale resulting from the restructuring.  She asked for comment on the agreements reached with the South African Pilot’s Association (SAPA) referred to on page 10 of the annual report. She asked if there were challenges in the recruitment of pilots.

The Chairperson asked if SAA was involved in any anti-competitive practices and what the chances were of successfully defending such charges.  SAA had a contingent liability and this meant that the risk of liability materialising was less than 50%.

Mr Koornhof hoped that the Board would give direction to management regarding compliance with the PFMA.

Ms Ramodibe congratulated SAA on its unqualified audit report.

The Committee adopted the Committee Programme and the minutes of the last meeting.

The meeting was adjourned.