Lesaka Technologies, Inc.
Q4 2019 Earnings Call Transcript

Published: 27 Sep 2019

[Operator:]

Good day, ladies and gentlemen and welcome to the Net 1 UEPS Quarter Four of 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this call is being recorded.I would now like to turn the conference over to Mr. Dhruv Chopra. Please go ahead, sir.

[Dhruv Chopra:]

Thank you, Juliet. Welcome to our fourth quarter 2019 earnings call. With me on the call today is our CEO, Herman Kotze and our CFO, Alex Smith. Our press release and supplementary investor presentation are available on our Investor Relations website, ir.net1.com. We expect our Form 10-K with the audited financial statements to be filed on Monday, September 30th.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 results of operations in our press release in rand to assist investors in understanding the underlying trends of our business.As you know, the company's results can be significantly affected by currency fluctuations between the U.S. dollar and the South African rand. We will have a Q&A session following our prepared remarks.And with that, let me turn the call over to Herman.

[Herman Kotzé:]

Thank you, Dhruv and good day to everybody. This morning, I will review our fourth quarter highlights and specifically the progress on the key focus areas we highlighted on the last call as well as where we go from here in fiscal 2020.Net 1 went through transformational changes during fiscal 2019 as we implemented a comprehensive restructuring of our business and cost base, following the expiration of our SASSA contract, and more importantly, the auto-migration of a substantial portion of our EPE customer base.We have been focused and nimble and have largely completed the restructuring of our South African operations. I'm extremely pleased that we were able to complete our -- and make significant progress towards the three main objectives we set for ourselves over the past six months, which were as follows

[Alexander Smith:]

Thank you, Herman, and good day to everybody. I’ll discuss the key results and trends within our operating segments for the fourth quarter of 2019, compared to a year ago as well as to the third quarter of 2019, as sequential comparisons are more relevant today given the changes endured by the Group over the past year.For the fourth quarter of 2019, our average rand-dollar exchange rate was ZAR 14.29 to the $1 compared to ZAR 11.45 a year ago, which adversely impacted our U.S. dollar based results by approximately 25%. Our fundamental earnings per share declined to a loss of $2.45, which includes the $2.21 non-cash negative impact of the fair value adjustment for Cell C and $0.24 for impairments of goodwill and the Cedar Cell note.Operationally, the breakeven position at a fundamental earnings level reflects the work we’ve done in rightsizing the South African business. Our fourth quarter 2019 revenue and operating loss did not include any contributions from DNI as that business was deconsolidated at the end of the third quarter, following the sale of our controlling interest. DNI was equity accounted during the fourth quarter of 2019, with a further 8% being disposed off in May 2019.By segment, South African transaction processing reported revenue of $18.9 million in the fourth quarter of 2019, down 63% compared with the prior period, but up 10% from the third quarter 2019 on a constant currency basis. The year-over-year decrease was primarily due to the termination of the SASSA contract, including those with SASSA Grindrod cards and to a lesser extent the reduction in the number of EPE accounts.These decreases in revenue and operating income were partially offset by a higher transaction revenue, as a result of increased usage of our ATMs and double-digit growth with EasyPay. Our operating margins for the fourth quarter of 2019 and 2018 was negative 13.1% and positive 6.7% respectively, but an improvement from negative 74.6% in the third quarter of 2019. Excluding restructuring cost, the operating loss margin for the fourth quarter of 2019 was negative 7.5% compared to a negative 57.5% in the third quarter of 2019.International transaction processing generated revenue of $35.6 million in the fourth quarter of 2019, which was down 18% compared with the fourth quarter of 2018, and up 4% compared to the third quarter of 2019 in U.S. dollars. A year-over-year decrease in IPG revenue was the largest contributor to the year-over-year decline. Segment operating margin improved to 6.1% in the fourth quarter of 2019, compared to 4.8% a year ago, and 5.6% in the third quarter of 2019.For the fourth quarter of 2019, KSNET revenue in Korean won was down 6% year-over-year to $34.4 million, primarily due to lower volumes processed compared to a year ago, but up 11% sequentially following a rebound from a seasonally weak third quarter. As Herman mentioned, we are in the midst of implementing our restructuring in Korea, in addition to managing through the regulatory environment on interchange fees. KSNET cash conversion remains strong, with capital investment staying low.IPG’s legacy businesses have continued to decline, but once we roll out new products we expect the business to return to growth, and pay its current losses. IPG losses also include approximately $760,000 of development costs in respect of the crypto asset storage product incurred during Q4, and $1.4 million for fiscal 2019. These development costs will start to reduce during fiscal 2020 once we launch the product.Financial inclusion and applied technologies generated revenue of $17.6 million in the fourth quarter of 2019, which was down 59% compared with the fourth quarter of 2018 and down 51% compared to Q3 2019, primarily due to no contribution from DNI in the fourth quarter given its deconsolidation, fewer prepaid airtime and value added services sales, lower lending and insurance revenue, and a decrease in intersegment revenues.Operating margin excluding impairments was negative 26%, compared to positive 25.5% in the fourth quarter of 2018, and positive 8.8% in the third quarter of 2019. The third quarter included a contribution from DNI. Excluding this, the operating margin was a negative 17.8%. The decline in performance from Q3 to Q4 2019 is due to the last effects of the reduction in monthly accounts fees relating to the SASSA Grindrod accounts.Active EPE accounts have remained steady around the 1.1 million mark through the fourth quarter. And these numbers have remained stable through Q1 2020 to-date, and we are now starting to rollout new product offerings in partnership with Finbond. With a stable EPE base our lending and insurance businesses have also returned to more normalized operating performance levels. Our net loan book increased by approximately 3% in the fourth quarter of 2019, compared to the first quarter of 2019.Our micro insurance policy holders have also remained largely flat at around 220,000 in Q4 and Q3 2019. We are developing new loan and insurance products to address a broader base of unbanked customers, which we are piloting during the first quarter of 2020.Our corporate expenses reduced in the fourth quarter of 2019 compared to the fourth quarter of 2018 and the prior quarter as a result of a $1.8 million right back of stock compensation charges. Normalizing for this, corporate expenses we’re in line with the previous quarter, and slightly higher than the prior year due to higher acquired intangible asset amortization.As a result of the challenges currently being faced by Cell C, we have assessed the fair value of our 15% investment in the company as zero at June 30, 2019. This resulted in a non-cash fair value adjustment of $125.4 million for the quarter and $167.5 million for the fiscal year. We’ve changed our valuation methodology to a discounted cash flow approach as the changes to Cell C’s business going forward made the use of historic easy EBITDA multiple no longer appropriate.We've been working closely with Cell C and its stakeholders to provide liquidity platform through to a recapitalisation, which we believe will create a long-term sustainable business. Our conclusion on the fair value of Cell C meant we also had to impair the carrying value of the Cedar Cellular notes in full. Operationally Cell C delivered lower EBITDA for the first six months of the current calendar year due to increased roaming costs and low revenue growth. But there has been a steady improvement in performance into the first half year, as the management team focuses on its turnaround initiatives.Our fourth quarter 2019 net interest expense, excluding a $7.4 million impairment Cedar Cell notes fell to $0.4 million, compared to $1.9 million in the third quarter of 2019 as a result of the early settlement of our debt. We recognize the income from equity accounted investments of $1.8 million during the fourth quarter of 2019, compared to $4.2 million in the same period last year. The main cause of the decline was a reduced contribution from Finbond, who like us wrote off their loan book due from SASSA customers as part of the migration to the South African Post Office.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 June 30, 2019, our unrestricted cash was approximately $46.1 million, compared to $48.8 million at the end of March.Setting these amounts off again short-term credit facilities of $9.5 million and $8.9 million respectively, means our net unrestricted cash reduced from $39.9 million to $36.6 million in the quarter. The decrease in our cash balances was primarily due to capital expenditures in the quarter of $2.1 million and $1.5 million of cash absorbed by operating activities, which was significantly less than what we experienced in the third quarter.We had short-term banking facilities available to us in various territories of $32.2 million at June 30, 2019, $9.5 million of which have been utilized. As of June 30, 2019, we had restricted cash of $75.4 million and associated short-term facilities utilized of $75.4 million. We have in place short-term credit facilities of ZAR 1.45 billion or $103 million specifically to fund our ATMs in South Africa, and have presented cash drawn under these facilities and in the processing system as restricted cash on the balance sheet.Free cash flow utilization amounted to $3.7 million, which included a $2.3 million release from working capital. At June 30, 2019, there was no term debt left on the Group's balance sheet following our disposal of an 8% stake in DNI in settlement of that remaining term debt. While we have no long-term debt outstanding and have $37 million in net cash on the balance sheet. We have liquidity requirements in the short-term that constraint our ability to commit resources to share buybacks or fund investments required to fuel internal growth.In particular, there are working capital funding requirements and respective intermonth cash flows in all of the businesses, we need to continue funding the international operations and the SA operations. And we have some new product launches and some operational requirements on growth opportunities in some of the SA business units.However, on the occurrence of a liquidity event, such as the disposal of the remaining DNI investment, or the sale of other businesses, this will create capacity for share buybacks and or dividend.Our fourth quarter 2019 tax expense was $2 million, compared to an expense of $8.8 million in the fourth quarter of 2018. Our effective tax rate for this quarter has been significantly impacted by impairments and the losses incurred by certain South African businesses.As we’ve effectively not recorded a deferred tax asset benefit related to these net operating losses. Our effective tax rate is likely to continue to be distorted by losses incurred by certain of our businesses. Our weighted average share count has remained constant at 56.8 million shares in the fourth quarter of 2019.And looking forward to fiscal 2020, we expect to generate adjusted EBITDA of at least $16 million using our fiscal 2019 exchange rate of ZAR 14.27 to $1 with improvements in South Africa and South Korea being partially offset by losses in IPG, new startup operations internationally and corporate overhead. Over the course of the year, and as we get more clarity on any corporate actions, we will review our communication and reporting in an effort to continue to simplify our story.We can now open up the call for Q&A.

[Operator:]

Thank you very much, sir. [Operator Instructions] The first question comes from Allen Klee of Maxim Group.

[Allen Klee:]

Yes, hello. For your three main segments for fiscal 2020, can you go through your thoughts on revenue changes -- percentage change and operating margins that we should think about? Thank you.

[Alexander Smith:]

So Allen, in terms of the three segments that we are disclosing, the South African transaction processing business we would expect to see some revenue growth and a return to profitability, but probably relatively small profitability at this point. It is after all a scale business. In terms of revenue growth in there, we’re probably looking at in the order of the high-single digits. In international transaction processing, the revenue growth will be largely dependent there on the success of the IPG strategy and their new product rollout, but that’s a little bit more difficult to call.Certainly in Korea, we’re looking -- we’re probably looking at some revenue decline in the short term because of the elimination in some of the underperforming agents in our portfolio, but we are looking to see an enhanced profitability position, and certainly at the operating margin level we would expect to see an uplift in the operating margins in the international transaction processing space.Financial inclusion and implied technologies, which would contain our financial services businesses in South Africa, the continuing component of that we would expect to see some good growth in there as we plan on expanding, in particular, our loan book, and we should see a return to profitability in that component too.

[Dhruv Chopra:]

Allen, this is Dhruv. Just to add one clarification point for Alex, when we’re talking about the growth Alex alluded to in his remarks, that we’re using Q4 as the baseline, so we’re not looking -- we’re not talking about a year-over-year improvement, but use Q4 as your base from where you start.

[Allen Klee:]

Okay, thank you. And then a couple of other items, housekeeping, for fiscal 2020 what are your expectations for depreciation and amortization, CapEx, intangible amortizations, stock-based comp, and tax rate?

[Alexander Smith:]

So, let me work backwards; tax rate, we should be starting to move more into line with somewhat normal 30%. We should get some benefit out of some of the loss the deferred, not having recognized the deferred tax assets. But I think work on around about a 30% kind of tax rate.CapEx should be largely similar to this year, in terms of the CapEx position, obviously you would have to strip out a little bit than what would have been incurred in DNI, but that wasn’t significant. But, we wouldn’t expect to see a significant change in the CapEx position. Then, depreciation and amort, that is coming down, it was on a downward trend because our replacement CapEx levels have come down effectively. So I’d expect to see that drop a little bit.What was the other thing, Allen?

[Allen Klee:]

Just intangible amortization and stock-based comp.

[Alexander Smith:]

Intangible amort, we would expect to see a decline in this coming year, a number of intangible assets have been fully amortized in the course of this year. So, we’d expect to see a decline in that space. And then stock-based comp has been lower this year because of some reversals, we’d expect to see that move back into line with where it’s been historically.

[Allen Klee:]

Okay. And then in terms of Bank Frick and your decision to potentially increase your position, how do you think about the return on capital that Bank Frick should be generating longer term?

[Herman Kotzé:]

Allen, we obviously are in the process of analyzing the options available to us. There are a number of considerations that we take into account when we will arrive -- before we arrive at our decision. The key for us obviously is the availability of liquidity to be able to exercise the option, which needs to be done in the next couple of weeks and payment then will follow in the next six months or so.So, those are the key considerations that will influence our decision, but as a standalone entity, of course we are still a 35% shareholder in Bank Frick. The returns that have been generated -- return on equity generated by the bank over the last few years have been quite low. But very good reasons over the last few [ph] years, we have effectively doubled the workforce in the bank from roughly 60 to 120 employees, and that was with specific intent to scale up the knowledge base within the bank on the blockchain and crypto initiatives.The last two years have been quite intense from a learning curve perspective but I do believe that during the next two quarters we will see substantial improvement and actual deal flow emanate from the investment that we have made over the last two years.And so going forward, whether or not we are a controlling shareholders in Bank Frick, we would expect the bank’s return on equity numbers to return to a respectable sort of 12% to 15% number.

[Allen Klee:]

Okay, thank you. And then can you help us understand for your EPE business and growing customers where that’s been stable like 1.1 million recently, to what extent do you still have to interact with SASSA to get any of those customers process? And do you feel comfortable -- like to what extent can they hinder your ability to grow or do you feel comfortable that that’s not an issue?

[Herman Kotzé:]

So, there is no direct interaction between us and SASSA regarding this matter any longer. The only part where SASSA would play a role is where a customer also receives a social welfare grant decides to open one of our new accounts. If that person wants his social grants to be paid into account, they need to inform SASSA, and SASSA needs to change the bank account details on their bank end system. This is the infamous Annexure C form that needs to be submitted by the customer to SASSA and they have to then process it.And I have to say after the initial troubles that we had in September, October, November last year, I think SASSA have streamlined the process and we now have very little delay in then processing those forms as and when they are presented to them. But other than that there is no other interaction required between us and them, we offer these accounts not only to social grant recipients but to the public at large. And so anybody who decides that they like the pricing, they like the bundle that comes with it is more than welcome to apply for these cards.

[Allen Klee:]

Okay, thank you. I’ll get in the queue to ask more questions later. Thank you.

[Herman Kotzé:]

Thanks.

[Operator:]

Thank you very much, sir. The next question comes from Scott Buck of B. Riley FBR.

[Scott Buck:]

Good morning, guys. I am hoping that maybe you can give us a quick kind of step-by-step overview here of what the remaining steps are to complete the recapitalization of Cell C? And maybe give us a sense of timing of when that could be complete and what value you think you will be able to realize post re-cap?

[Herman Kotzé:]

Sure. Hi, Scott. So Cell C is currently finalizing the network sharing arrangement with MTN as we said and that will have a material impact on the business model and the financial performance and obviously the debt carrying capacity of the business. So Cell C is currently engaged in discussions with various -- of the stakeholders around the re-cap and the value post will largely depend on the ultimate structure that the recapitalization will take in and that obviously is, will be heavily influenced by the outcome and the commercial substance of the network sharing deal.So, a bit early for us to speculate on that, but the discussions of all the various stakeholders obviously taking place on the daily basis. So, we expect some movement and some announcements around that to slow in the next quarter.

[Scott Buck:]

That’s great thanks. On the EPE card accounts, where is the incremental growth coming from? Are these post office account holders that are coming back to you guys for a card, or are these new kind of first time customers?

[Herman Kotzé:]

I would say a fair amount of them are former clients, so people that are coming back to us, who simply need to have access to the financial services that they enjoyed before. Remember, the post office account is very restrictive in terms of its ability to handle debit orders. And so, we find that I would say probably more than 70% of our new clients are return or repeat customers, coming back to open these accounts.

[Scott Buck:]

That’s helpful. Prior to all the disruption a year ago, how many accounts were you opening on average during a quarter?

[Alexander Smith:]

Yes, so well initially, when we were in full launch mode two and half, three years ago, we peaked at opening roughly about 120,000 accounts a month, and yes that scaled down after the initial period I would say to an average of about 50,000 a month. And so going forward, we’ve set ourselves some pretty conservative goals. As we’ve said over the last -- over the next year we would like to grow the account base by 10%.But, to the extent that we are able to scale back-up the operations and obviously that’s largely also determined by the liquidity position of the Group, in terms of being able to provide all of the other services around an account being opened. So, typically there is accompanied where they request for a -- with a loan application, we hope to increase those numbers substantially over the next two to three years and, we’ve set ourselves the medium term goal of getting back to around 3 million customers.

[Scott Buck:]

Great, thanks for that. Last one, you mentioned some of the ongoing SASSA issues, could you remind us what the potential liability is on the 2014 bulk registration suite? And then, what the figures are around the fees payable for the last six months?

[Alexander Smith:]

Sure, they are largely the same, coincidentally the same. The claim against us for the fees paid in 2017 amounts to roughly ZAR 300 million. So call it $20 million at today’s exchange rates. That number may increase obviously to the extent that in interest is levied on the payment of the amount. Conversely the amounts owing to us for the last six months of the contract also amounts to roughly ZAR 300 million, so $20 million, and potentially also could be an interest bearing liability for SASSA.So, the two are pretty much the same size and magnitude.

[Scott Buck:]

Okay, appreciate that. Thanks, guys.

[Operator:]

Thank you. [Operator Instructions] The next question comes from Paul Gordon of Gordon Capital.

[Unidentified Analyst:]

In the light of the restructuring going on the allocation of funds in many different directions, not well use the funds to the area that we know best are undervalued stock as oppose to going with Bank Frick and other places where we’re dealing with decisions that may or may not worked out, our under-value stock is clear and unmistakable, certainly management feels that way they bought stock about over a year ago.

[Herman Kotzé:]

Yes, fully agree. We are -- over the last year or two years, I think there have been substantial purchases by insiders. As I said, looking at the -- our capacity to buyback stock going forward, we have more than adequate headroom left on the authority that we've -- that we sought a year ago, I think there's $100 million authority that we put in place and we utilized a little bit of it.So from that perspective, we do have the ability to do so. Right now, all of our decisions whether it's to allocate capital to the exercising of options or to acquire controlling stakes whether it’s Bank Frick or in Finbond or increasing the size of our lending book, those are all impacted by the short-term liquidity needs of the business.And so as soon as we unlock enough liquidity to be in a position to consider significant investment in buybacks or any of the other opportunities for asset will be a simple decision of ranking them in terms of the appropriate returns.

[Unidentified Analyst:]

Thank you.OperatorRight, ladies and gentlemen, fortunately that was the final question. On behalf of Net 1 that concludes today's conference.