Lesaka Technologies, Inc.
Q2 2020 Earnings Call Transcript

Published: 7 Feb 2020

[Operator:]

Good day, ladies and gentlemen, and welcome to Net 1 UEPS Q2 2020 Earnings Call. All participants will be in listen-only mode.[Operator Instructions]Please note that this call is being recorded.I would now like to hand the conference over to Dhruv Chopra. Please go ahead, sir.

[Dhruv Chopra:]

Thank you, Claudia. Welcome to our second quarter 2020 earnings call. With me today is our CEO, Herman Kotzé, and our CFO, Alex Smith. Our press release is available on our Investor Relations website, ir.net1.com.As a reminder, during this call, we will be making forward-looking statements, and I ask you to look at the cautionary language contained in our press release regarding the risks and uncertainties associated with forward-looking statements.In addition, during this call, we will be using certain non-GAAP financial measures. And we have provided a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.We will discuss our results in South African rand, which is a non-GAAP measure. We analyze our…[Technical Difficulty]

[Herman Kotzé:]

Sorry, everybody. We had a temporary technical glitch. But thank you to Dhruv and good day to everybody again.We have continued to execute towards our strategy and corporate actions outlined on our fourth quarter 2019 earnings call.I would like to focus today's discussion on our three strategic areas, namely South Africa, Europe and Africa, as well as the progress of our various corporate actions and related to that of our capital allocation.The highlights of our Q2 2020 results include

[Alexander Smith:]

Thank you, Herman. And good day to everybody. I'll discuss the key results and trends within our operating segments for the second quarter of fiscal 2020 compared to a year ago as well as compared to quarter one 2020 as sequential comparisons are more relevant today, given the changes endured by the group over the past year.For the second quarter of 2020, our average rand-dollar exchange rate was ZAR 14.60 compared to ZAR 14.32 a year ago and ZAR 14.75 in the first quarter.We recorded a fundamental loss per share of $0.10 this quarter compared to the $0.90 fundamental loss per share a year ago, which includes a substantial impairment of our loan book as well as a contribution from DNI. This compares to a fundamental loss per share in the first quarter of $0.02. This deterioration in performance against the previous quarter was mainly due to a reduction in ad hoc revenues in the South African business.By segment, South African transaction and processing reported revenue of $20.4 million in the second quarter of 2020, down 6% compared with the second quarter 2019, but up 4% from the first quarter of 2020 on a constant currency basis.The year-over-year decrease is primarily due to the combination of the SASSA contract, including those with SASSA Grindrod cards and, to a lesser extent, the reduction in the number of EPE accounts.The decreases in revenue and the resulting impact on operating income were partially offset by a higher transaction revenue as a result of increased usage of our ATMs.Our operating margin for the second quarter of 2020 and 2019 was negative 14.6% and negative 53.8% and compared to a negative 17.4% in the first quarter of 2020. The improvement in the operating margin in the latest quarter is encouraging, but we remain subscale at this level of accounts and the focus is on lifting revenue.International transaction processing generated revenue of $34.4 million in the second quarter of 2020, which was down 10% compared to the second quarter of 2019 and flat compared to the first quarter of 2020 in US dollar terms. The year-over-year decrease in revenue in the segment was contributed equally by the Korean operations and IPG.Segment operating margin improved to 8.2% in the second quarter of 2020 compared to the negative 10.6% a year ago, but down from the 11.1% recorded in the first quarter.For the second quarter of 2020, KSNET revenue in Korean won was down 1% year-over-year to $33.5 million and consistent with the first quarter of 2020. EBITDA margins were the same as the second quarter last year at around 22%, although slightly lower than what was achieved in the first quarter. KSNET's cash conversion remains strong, with limited need for capital investment in what is now a relatively capital-lite business.With the expected closing of the disposal transaction, we will stop consolidating KSNET from March 2020.In respect of the transaction, it is worth just covering off some of the tax effects of the transaction. We will be required to pay withholding taxes of approximately $19 million on closing the transaction, but these should be recoverable over a period of 6 to 12 months.In addition, we have a US tax liability arising from the disposal, which we currently estimate at between $15 million and $21 million. We will also incur a transaction-related cost of around $7 million in respect of the disposal.Returning to operational performance, IPG's legacy businesses have continued to decline. And once we roll out our new products, we expect the business to return to growth and pare its current losses.IPG losses also include approximately $100,000 of development costs in respect of the crypto asset storage product incurred during Q2, on top of the $1.7 million invested prior to this quarter, meaning development costs will start to reduce during fiscal 2020 once we launch the product.Financial inclusion and applied technologies generated revenue of $22 million in the second quarter of 2020, which was up 15% compared with the same period last year, but 27% lower compared to the first quarter of 2020.Increase in revenue over the prior fiscal year is primarily due to higher accountancy income, though this will reduce over time and needs to be replaced with new customer accounts.Ad hoc sales reduced from the $8 million of the previous quarter to around $3 million, comprising airtime sales and higher-than-normal hardware sales. In addition, fee income reduced by approximately $2 million against the previous quarter as non-recurring fee sources reduced.Operating margin was a negative 4% compared to negative 142% in the same period last year and 5% in quarter one of 2020. The operating margin in this business is heavily influenced by the revenue level as there is a significant fixed cost component in this segment, primarily related to the costs incurred to operate our financial services branch infrastructure.Active EPE accounts remained fairly steady through the first quarter. And with a stable EPE base, our lending and insurance businesses have also returned to more normalized operating performance levels.Our new Finbond-sponsored products have grown over the last quarter and the acceleration of this growth is critical for the South African operation.Our net loan book increased by about ZAR 25 million or 7% over the quarter and default rates remain in line with the historical levels seen prior to the loss of our customers last year.Our new variable loan products are proving popular with the existing customer base and we need to expand the take-up of this product into new customers for the group.Our micro insurance policyholders have also remained largely flat at around 220,000 over the last three quarters, and we are progressing in this to expand the distribution channels, though with limited success to date.Our corporate expenses in the second quarter of 2020 were slightly higher than the first quarter. They were also slightly higher than the equivalent quarter last year due to higher advisor fees related to some of our strategic initiatives, but this is offset by lower acquired intangible asset amortization following the deconsolidation of DNI and the fact that IPG's acquired intangible assets are now fully amortized.We continue to assess the fair value of our investment in Cell C at a zero value. We do not see any likelihood of increasing that fair value until the recapitalization has been completed.Cell C itself is seeing some benefits from an increasing focus on the core operations, but needs to complete the recapitalization to create a sustainable business. We're continuing to provide support to the management team and are working on providing access to our distribution network for Cell C's benefit.We recognized income from equity accounted investments of $0.5 million during the second quarter of 2020 compared to a loss of $1.3 million in the same period last year. Within that amount, we saw a contribution of $0.4 million from our 30% investment in DNI, a business that was consolidated in the equivalent period last year.Bank Frick's contribution lifted in the quarter, but its near-term profitability continues to be impacted by its investment in people to expand its operations. We expect to see a stronger performance in the next fiscal year as some of the investments started to deliver, but their earnings will move into the group's statement of operations once the exercise of the option closes.Finbond did not contribute to earnings in the quarter as they only report earnings in our first and fourth quarters.We expect the contribution from our equity-accounted investments to be positive on an annual basis as it is impacted by the timing of reported results by our various investments.At December 31, 2019, our unrestricted cash was approximately $50.7 million compared to $46.1 million at the end of June. Setting these amounts off against short-term credit facilities of $13.9 million and $9.5 million respectively means our net unrestricted cash increased marginally from $36.6 million to $36.8 million.However, this cash position was distorted by the early settlement of the January micro loan repayments of approximately $8 million, meaning the underlying cash balance was approximately $28.5 million.The decrease in our cash balances was lower in this quarter than we experienced in the last quarter as some investment in working capital reversed, and largely reflects the impact of the current operating performance. Adjusting from the loan book cash flows, there was a $4 million outflow from operating activities which includes a $2 million release from working capital.Capital expenditures in the quarter of $0.8 million was well below all the comparative periods, but is not expected to change significantly going forward as capital expenditure is largely limited to replacement.We had short-term banking facilities available to us in various territories of $32.2 million at December 31, 2019, $13.9 million of which have been utilized. This excludes the facilities used to fund the ATMs.As of December 31, 2019, we had restricted cash of $84.4 million and associated short-term facilities utilization of $84.4 million. We have in place short-term credit facilities of ZAR 1.45 billion or $103.2 million, specifically to fund our ATMs in South Africa, and represented cash drawn under these facilities and in the processing system as restricted cash on the balance sheet.The only debt on the balance sheet of $4.1 million relates to the funding of Cell C airtime purchase, which we expect to be able to settle once Cell C's recapitalization is complete or under the terms of our borrowing arrangements. This has reduced from $14.5 million at the end of last quarter as the proceeds from the first disposal were required to be used to partially settle these borrowings.As Herman has discussed, the sale of our Korean operations will release significant capital into the business, which will allow us to settle all borrowings, reinvest in our businesses that have been starved of liquidity over the last 12 months and return capital to shareholders.Our second quarter 2020 tax expense was $1.7 million compared to a tax benefit of $4.4 million in Q2 2019. Our effective tax rate continues to be impacted by the losses incurred by certain South African businesses as we have effectively not recorded a deferred tax asset benefit related to these net operating losses. Our effective tax rate, therefore, likely to continue to be distorted by the losses incurred by certain of our businesses.Our weighted average share count has remained relatively constant at 56.6 million shares through quarter two 2020.Given the timing of our various corporate actions and availability of liquidity as well as certain pending European regulatory approvals, there are a number of moving parts in our business this year.Using the same assumption of a constant currency base of ZAR 14.27 to the dollar, we believe fiscal 2020 adjusted EBITDA is likely to be a loss of approximately $3 million, a decrease from my previous guidance of $16 million profit.This decrease is primarily due to an $11 million reduction related to foregone contributions as a result of the sale of KSNET and FIHRST as well as an $8 million negative impact related to the delayed liquidity injection in South Africa due to the timing of our asset realizations and IPG's inability to launch its new product due to the dependencies on Visa's certification.Our focus following the injection of liquidity during the fourth quarter of 2020 will be to drive new account growth and financial services in South Africa and commence with the scaling up of our new initiatives in Europe. In turn, returning the group to a positive adjusted EBITDA position in fiscal 2021.We can now open up the call for Q&A.

[Operator:]

Thank you. [Operator Instructions]. We have a question from Scott Buck of B. Riley. Please go ahead.

[Scott Buck:]

Yeah. Good morning, guys. I'm curious, in the 2020 adjusted EBITDA guide, whether or not there's any contribution from Bank Frick in that $3 million loss number?

[Alexander Smith:]

No. We haven't incorporated any Bank Frick contribution in that guidance. We'll bring that in once the deal effectively closes.

[Scott Buck:]

Okay. But you will be consolidating results beginning in the June quarter, I guess?

[Alexander Smith:]

Yeah, that's right. So, expect it to close in April. So, from April onwards.

[Herman Kotzé:]

Yeah.

[Scott Buck:]

Okay, perfect. And then, second, can you remind us of what returns have looked like historically in the core South African business, maybe when you were at kind of 3 million active account level?

[Herman Kotzé:]

Scott, it depends across which products and businesses you measure the total returns. I guess the easiest way for us to outline the revenues and the returns is to look at it on a per customer basis. And so, the average sort of revenue that we realized from, let's say, margin that we realized from our South African customers and cardholders and, obviously, excluding the old pension welfare distribution component of it, so focusing on the provision of a bank account, transactional services, loans, insurance products, et cetera, across the entire base, we would anticipate probably around ZAR 25 to ZAR 50 contribution from each one of our cardholders. The margin, obviously, increases exponentially with the amount of clients that are increased because the cost base is relatively fixed as far as the South African core business is concerned.And if you look at the 3 million people that we had, let's say, roughly two years ago, I think the revenues that we had at that point was approximately $250 million. That, obviously, excludes KSNET and the SASSA business. And EBITDA probably in the region of $50 million on that number. So, roughly a margin of, I would say, 20%.

[Scott Buck:]

Great, that's really helpful. Third, what gives you confidence that without having the SASSA contract as kind of a distribution feeder that you'll be able to grow the account base from just over a million now to 2 million to 3 million over time?

[Herman Kotzé:]

It's purely our distribution network that we haven't scaled down as a result of the loss of that contract. So, we have retained – in fact, we've grown our financial services branch infrastructure. We have also deployed sort of semi portable branches through the use of customized containers. And in combination with the Finbond branch infrastructure, if we just look at physical brick and mortar branches, we are just sort of between 700 and 800. These are mainly distributed in the rural and semi-rural areas, which in the South African context is fairly unique and gives us access to a part of the market that few of the other banks or our competitors actually service.The second thing I think that's quite important is that we have the technology that enables us to operate in these rural and deep rural areas in an offline manner where required. We also have the experience of having serviced our customer base for the last 20 years or so, which gives us the unique advantage.And finally, when you just look at the product slate that we offer in terms of the bank accounts, the functionality and the pricing of what we offer, combine that with the financial services, and the fact that these are specifically designed for our target market, we know because we do regular benchmarking that we are still by far the cheapest product set on offer to that customer base.And so, that's effectively the factors that provide me with the confidence that we'll be able to grow back this business.

[Scott Buck:]

Super. I appreciate the color there. Last one from me. If I'm doing my math right it looks like you guys should have roughly $160 million or so. If all the proceeds work out with DNI and you keep to the, I guess, investment or capital allocation schedule that you've laid out, how much cash do you need on the balance sheet to run the business? And I guess what I'm really asking is, how much of that $160 million is actually available for repurchases?

[Herman Kotzé:]

I think it's – great question, obviously. The $160 million is also a factor of the combination, I guess, of the KSNET and the DNI proceeds. And as you say, net of the investments, as I've outlined, Net 1 historically has been a business that is more comfortable having a net cash position and a safety cushion in order for us to grow specifically the working capital side of things when it comes to the growing of the book, et cetera.At this stage, we don't foresee any specific need for further meaningful material acquisitions. Most of our businesses are CapEx lite. Or the Capex that we required has been invested. And so, we would, I think, be comfortable with a cash buffer of probably between $30 million to $50 million to grow any of our initiatives over time. And at the same time, we obviously have to assume that we've extinguished all of the debt that remains within the group. That is not a material number, but it's something that we will also be attending to.So, we've set up the repurchase limit up to $100 million. And I think as we realize these proceeds from the various investments, which I hope is sort of in the early part of Q4, we will be able to provide more color of the exact quantum and nature of the repurchase program.

[Scott Buck:]

Great. I appreciate the time today, guys.

[Herman Kotzé:]

Thank you, Scott.

[Operator:]

[Operator Instructions]. We have a question from Bill Gordon from Gordon Capital. Please go ahead, sir.

[Bill Gordon:]

When we complete the Bank Frick deal, what do you see the prospects are for Bank Frick, Visa and the other payments?

[Herman Kotzé:]

The answer, I think, is simply that we will then become as Net 1 a principal member through Bank Frick of both Visa and MasterCard. So, we will have unfettered access as a principal member to both the issuing and the acquiring licenses. That enables us to price our products and our offerings to merchants specifically for acquiring at a level which is competitive to those offered by our competitors.Compare that to a situation where we need to leverage of other third-party financial institutions where you are provided with a buy rate and then you still have to markup your offering from that buy rate. I think, for us, that is one of the key important and differentiating matters. It also allows us to launch all of our new technologies that we've been developing over the last two years, ranging from instant onboarding to virtual bank account issuance in a fully regulated environment within the EEA.And finally, also the products that we've developed on the Blockchain and virtual financial asset side, we will be able to offer those through a bank that is a member of the group, which is widely regarded as the leader in the European space within the Blockchain and virtual financial asset space. So. that, in a nutshell, is the benefits that we see – the immediate benefit of completing the transaction.

[Bill Gordon:]

And how do you see DNI working now?

[Herman Kotzé:]

DNI, we've granted the option. It expires on 30 March, as I said. At this point in time, the process – we granted the option effectively to the management team of DNI, and so they are very well advanced in finding the institutional investors who are interested in acquiring our 30% stake. At this stage, the process I think is relatively advanced and we have no reason to believe that the option will not be completed by March 30.

[Bill Gordon:]

Thank you.

[Operator:]

We have no further questions. Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.