Lesaka Technologies Inc Q2 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to the Net 1 Q2 2022 Earnings Call. All participants will be in listen-only mode. There will be an opportunity to ask questions later during the conference. I would now like to hand the conference over to Dara Dierks. Please go ahead.

Thank you, Operator. Welcome to our second quarter 2022 earnings call. With me today are Chris Meyer, Group CEO; Lincoln Mali, South African CEO; and Alex Smith, CFO. Our press release and supplementary investor presentation are available on our Investor Relations website at 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 Form 10-Q regarding the risks and uncertainties associated with forward-looking statements. Also we will discuss our results in South African rand, which is non-GAAP. We analyze our results of operations in our press release in rand to assist investors' understanding of the underlying trends of our business. As you know, the company’s results can be significantly affected by the currency fluctuations between the U.S. dollar and South African rand. Chris will start the call with an update on strategy, then Lincoln will provide an update on the turnaround of the South African operations. And finally, Alex will go through the results of the second quarter. Following that, we’ll have a Q&A session. With that, I would like to turn the call over to Chris.

Thank you, Dara. Good morning, good afternoon, and thank you to all for joining us for our second quarter earnings call today. On today’s call, I’d like to focus on four key pillars that are critical to the successful transformation of Net1 into becoming a leading South African full-service FinTech platform. Delivery on each of these pillars will enable the management team to stay focused on repositioning the business for growth and capturing the long-term opportunity we see ahead. Firstly, I will provide an update on the transformation in our consumer financial services business and discuss the early progress we have made towards our strategic imperative in returning the consumer financial service business to breakeven by June 2022 and then into profitability as soon as possible thereafter. Secondly, I’ll provide a high-level update on the acquisition of Connect Group and recap on the opportunity the merged entity will provide. And thirdly, I’d like to take you through the progress we are making in transforming our organization into a world-class platform. Lastly, I will highlight the important work we are doing in South Africa to strengthen our relationships with key stakeholders. I’m encouraged by the progress we are seeing in the turnaround of our consumer financial services business, which is manifesting in some of the key performance indicators we are measuring. Each of the three levers we focused on, which are growth in active accounts, increasing average revenue per customer, and cost optimization, have all started to deliver benefits. Lincoln will give you more detail on the performance of each of these. But at a high level, I’d like to make a few points. Firstly, active EPE account numbers increased to just under 1.1 million active customers. We took a proactive approach to winning new customers with our newly trained sales force becoming more active in the communities. As an example, SASSA recently launched a new registration portal for grants, transforming a process that is very paper-based and takes weeks into an online process that can take minutes. As a result, we are empowering our sales force with the right tool to go into the communities and help grant recipients register for their grants online and at the same time, register for a new EPE account. Existing grant recipients who want to move their banking to an EPE account are also being assisted online through the portal, and we see this as a positive step in the right direction. Secondly, ARPU. ARPU performed slightly ahead of our target of $4.50 and with a focus on winning a bigger share of our customers’ wallets, we are investing our efforts into better understanding our customers and the type of products they are looking for. This has highlighted the gap in the market for the launch of two new products, which have already delivered positive signups. Cross-selling into our existing book is an important focus area to deliver growth in ARPU. We already have a 38% penetration into our loan book. However, in our insurance book, penetration remains low at around 19%. This presents an opportunity with 90% of our employees now trained on all Net1 financial services products with accreditations to follow; we can actively cross-sell into our existing base. On the last lever, cost control, a lever which is fully in our control and which moves the needle the most in returning the business to profitability in the near-term. Progress on the direct cost actions taken during the quarter can be clearly seen in the Q2 numbers. We reported a strong improvement in EBITDA, a loss in Q2, showing the operating leverage in our business. Pursuant to our review and optimization of the overall cost base, we launched Project Spring. Project Spring will include the cost reductions we have communicated to date, as well as further cost reductions realized through a restructuring of the consumer financial services business and the rationalization of our distribution network. On an annualized basis, Project Spring is targeted to deliver in excess of 300 million rand or $19.5 million in annual cost savings, which would represent just over 20% of the consumer financial services cost base, freeing up some capacity for targeted investments in the business. Lincoln will provide a detailed update on the turnaround of the South African operations later on the call, and Alex will provide more color on the cost benefits to the bottom line. Given our progress on these levers, we continue to work towards reaching our breakeven targets for the consumer financial services business by June 2022. Our second topic is regarding the Connect Group acquisition. For those who are new to Net1, it might help to briefly discuss the rationale for the acquisition. As we announced back in November last year, the Connect Group acquisition represents a transformational leap forward in Net1’s journey to becoming the leading FinTech platform for the underserved in South Africa. With this acquisition, we believe we will be able to transform our merchant business, competitively positioning the combined entity to address the 700,000 formal MSMEs and the 1.4 million informal MSMEs, which is a large and growing opportunity. The Connect Group offers four main products to its customer base. First, a prepaid value-added services platform branded Kazang. Second, a digitized cash management and supply payment solution branded Cash Connect. Third, a digitized provider of growth capital to merchants branded Capital Connect. Fourthly, a merchant acquiring solutions platform branded Card Connect and Kazang Pay. The Connect Group will form part of our merchants B2B segment with a combination broadening our footprint and enabling us to deliver on our growth aspirations. In our next set of results, provided the transaction closes, we will provide further information on the strategy for the combined entity. As a reminder, the Connect Group transaction is subject to regulatory approvals and other customary closing conditions. The respective financing group agreements have been concluded subject to usual condition precedents, and the transaction has been lodged with the competition authorities to obtain competition approval in South Africa, Namibia, and Botswana. On the whole, we feel the transaction closing process is moving forward as planned and importantly, the Connect Group is performing in-line with expectations. I’d now like to turn to my third topic, which is about building a world-class platform. We believe building a world-class platform firstly requires highly talented people; secondly, an environment where they can outperform; and thirdly, a clear vision and strategy where everyone is aligned, understands their role, and knows what winning looks like. We need to deliver on all three of these. I’m pleased to say that our leadership team of highly talented people is now largely in place with a focused goal on delivering on this vision and strategy. I want to welcome our new group CFO, Naeem Kola, who will begin his role at Net1 on March 1, 2022, and Basie Kok, our new CTO. Basie is a proven tech entrepreneur who brings over 15 years of financial technology experience to Net1. We also have our new head of Human Capital, Karabo Mothibi; a new head of consumer financial services, sales, and distribution, Simphiwe Pakathi; and shortly next week, our head of risk and compliance, Denzel Landie, will also be in place. I want to take this time to thank Alex for his dedication and commitment to Net1 and express how thrilled I am that he will be staying on as our Group Accounting Officer. With these enhancements, we have built an exceptional team who will stay laser-focused on executing our growth plans and advancing our strategic initiatives. Our fourth and last pillar is improving stakeholder relationships. We continue to build our relationship with SASSA through regular constructive engagements at both a national, provincial, and local level. As I mentioned in our Q1 results, we have made a joint submission together with Grindrod to SASSA to become one of a number of banks providing specific social grant payment services. We are also waiting for the announcement from the government on the outcome of this tender. However, this joint bid evidences the strength of our growing relationship with Grindrod. Furthermore, Net1 Moneyline is now officially registered on the national treasury database as a supplier positioning us for participation in future efforts by the government to digitize the grand payment system in South Africa. A key stakeholder, of course, is our customer. Building relationships with them at the community level is of paramount importance in building trust to ensure they choose us to safeguard their financial assets. As part of our CSI initiatives, in-line with our core purpose of improving people’s lives, we sponsored a number of branded blankets, wheelchairs, and large freshwater tanks in some of the communities in which we operate. Taken together, these partnerships are an important part of our strategy to increase Net1’s visibility and broaden our growth opportunities. Before I turn the call over to Lincoln, I would like to highlight a change in the way we segment our business. We have decided to move away from the previous segmentation of processing financial services and technology to segmenting the business based on the way we operate, analyze, and manage the business. We have therefore made the decision to segment the business into consumer and merchant. The consumer operating segment, i.e., our consumer financial services business, will group all financial services provided to customers, in other words, business-to-consumer. The merchant operating segment will group all goods and services provided to corporates, in other words, our business-to-business division. The Connect Group will be included in the merchant segment following the close of the acquisition. This segment change is reflected in our fiscal Q2 reports, and Alex will provide additional color later in his remarks. With that, I’ll now hand over to my colleague Lincoln Mali. Lincoln?

Thank you, Chris. Good morning and good afternoon, everyone. We appreciate the time you've given us. As Chris mentioned, I will explain our strategy to help the consumer business return to breakeven by June 2022 and reach profitability soon after. I'll also discuss some of the results we've experienced this quarter. We are focusing on three areas: growth in active accounts, increasing average revenue per user (ARPU), and cost optimization. I want to concentrate on the first two. To boost growth in active accounts and enhance ARPUs, we have had to fundamentally rethink our approach and gain a better understanding of our customers' needs. Our customers choose us, and to ensure their trust, we must empower our sales team with the right tools to serve them better. Building a deeper relationship of trust is essential, as is understanding their needs to increase their spending and ultimately raise ARPUs. We must also ensure we have the right distribution channels to serve our customers effectively in their communities. At the start of our fiscal second quarter, we implemented a comprehensive training program to enhance our sales force's skills nationwide on all Net1 products and to improve their sales techniques. So far, we have trained about 90% of our sales team. The insurance product requires training followed by an accreditation process, which has increased the number of accredited sales representatives from 386 in the second quarter of fiscal 2021 to 554 in the second quarter of fiscal 2022. We improved our metrics to measure performance by sales consultant, brand, and province, which allows us to assess actual performance. Although we're still early in this journey, we can see our sales culture starting to shift. Our newly trained sales teams are focusing on building relationships with our customers. Under the leadership of Simphiwe Pakathi, our head of consumer financial services sales and distribution, our sales team has actively engaged with customers in their communities to better understand their needs and develop stronger relationships. This engagement allowed us to identify market gaps for two new products. On November 1, 2021, we launched EPE Light, a competitively priced, low-cost contractual account for the entry-level market, which has exceeded expectations with around 20,000 new enrollments during the second quarter. We also relaunched our standalone insurance product, now rebranded as Smart One, increasing its insurable value to 30,000 rand and enhancing its premium coverage. Additionally, we introduced a one-month loan product, which has gained traction with around 5,300 loans issued since its launch, 60% of which were in the second quarter. To better serve our customers in their communities, we are revising our brand footprint to ensure we have the optimal number of branches with adequate productivity in the right areas. During this quarter, we identified and started the process to close 78 underperforming branches, with ATMs from these locations already relocated. We developed a framework to assess ATM locations for strategic placement closer to our customers, aiming for higher visibility and foot traffic. In partnership with strategic regional partners, we have moved many underperforming ATMs to better retail locations. We also found that ATMs in our recently launched Express branches became targets for robbery, leading to the decision to remove them from those branches and relocate them to community retailers. We partnered with various retailers, allowing EPE and EPE Light customers to make direct deposits or withdrawals at their checkout points. By December 31, 2021, over 5,480 retail outlets were available for our customers nationwide for transactions. These initiatives drove significant account growth, with 126,000 new account enrollments this quarter. With activation rates typical at 45% to 50% after three months, active EPE accounts grew to just under 1.1 million, as Chris noted. We are focusing on improving account activation and utilization, and our efforts are already showing results, with activations on new enrollments increasing in the last two months of the second quarter. Our renewed focus on cross-selling loans and insurance has helped ARPU grow slightly above our target of $4.50. The loan book showed a 38% penetration, with approximately 221,000 new loans issued valued at 321 million, up 12% quarter-on-quarter, and an outstanding balance of 382 million. The loan book's performance remains strong, with a loss ratio around 1%. Our efforts to minimize churn are effective, indicated by a trend of repeat borrowing where clients pay off existing loans and reapply for new ones regularly. We’ve observed over 200,000 customers in the current loan book as repeat borrowers, who must undergo new credit vetting to ensure they can afford the loans, keeping our loan book healthy. Engagements with customers regarding why they choose us for loans have been overwhelmingly positive. Our straightforward processes, clear disclosures on borrowing amounts and repayment, contribute to our competitive advantage. Our maximum loan amount is 2,000 rand or $125, with repayment terms up to six months, supporting financial inclusion by offering transparent, affordable lending products to underserved communities. We ensure compliance with the National Credit Act and regulations through employee training and consumer awareness. The insurance book provides ongoing opportunities for cross-selling, given its low penetration at 19% of our active account base, well below our target of 45%. In the second quarter, we wrote over 6,000 new insurance policies. Project Spring, which focuses on cost optimization, has shown promising results with a 53.5 million rand or $3.5 million reduction in fixed costs in our consumer financial services segment, supported by direct costs initiatives. We are working on shutting down our mobile payment business to create a true financial services unit that sells accounts, loans, and insurance products. Unfortunately, this requires initiating a Section 189 process, which started in January and will conclude in early March 2022, led by the CCMA. We estimate Project Spring will deliver over 300 million rand or $19.5 million in annualized cost savings, with 53.5 million rand or $3.5 million realized in this quarter and a target of 100 million over the remaining two quarters. These are challenging times for our employees, impacting morale. We've made efforts to be more visible and engaged leaders to support our employees while they continue serving customers. In our merchant business, hardware sales have been affected by the global chip shortage. However, demand for our products remains strong, with support from key customers for payment device orders. We've collaborated with suppliers to deliver outstanding devices in the coming quarters, which will help rebound our merchant business. We are excited about the potential Connect Group acquisition and its implications for our broader business. In summary, we are on track with the overall turnaround of the consumer business with all discussed initiatives progressing well. The Connect Group acquisition is advancing in line with regulatory expectations. Our responsibility is to lead with empathy during these tough times as we strive to achieve breakeven in consumer financial services by June 2022. I will now hand over to my colleague Alex to provide the financial overview for this quarter. Alex?

Thank you, Lincoln, and good day, everybody. Now let’s turn to the details of our financial metrics for the quarter. Firstly, as Chris highlighted earlier, I wanted to point out the change in our segmental disclosure beginning the second quarter. The new segments are disclosed in the financial section of our earnings press release, with more details in our fiscal second quarter 10-Q, and they show the operating results of the group split into the two business units we are now looking at in order to manage our operations. We’ve decided to label our business units as consumer and merchant, reflecting the nature of the customers we serve in each segment. Consumer will comprise the financial services business, while merchant will comprise what we’ve been referring to as payments. When the Connect Group acquisition closes, it will form part of the merchant segment. Moving on to the financial update for the quarter, our performance was characterized by continued delivery on the turnaround in our consumer financial services business, which was partially offset by a slightly weaker performance in our merchant business, primarily as a result of supply chain delays due to the global chip shortage. On a normalized constant currency basis, total revenue for the quarter was down 4% year-over-year. On a reported basis, total revenue for the quarter was $31.1 million, which was also a 4% decrease year-over-year in U.S. dollar terms. The rand was broadly at similar levels against the U.S. dollar during the second quarter of fiscal 2022 compared to the same period in the prior year. Let’s unpack this year-on-year quarterly performance in a little bit more detail, focusing on our segments. I’ll start with the merchant business, which was the main driver of the low revenue number, which was down 7% year-on-year in dollar terms. Revenue from processing fees was up 26%, underpinned by strong performance in our EasyPay business, with bill payment volumes up 9% year-on-year and an increase in the commission earned on the value of prepaid electricity and airtime sales. However, this performance was offset by a 40% decrease in revenue from technology products due to the global chip shortage which impacted sales of terminal devices. We have committed orders, but the delivery delays have led to a delay in revenue, which we expect to rebound in the third and fourth quarters once stock is received. On the consumer side, our focused efforts to return the consumer business to profitability translated into revenue of $16.6 million, up 2% year-on-year. This was underpinned by a strong performance in the insurance business and moderately higher account holder fees. Despite a loan book of 382 million rand at December 31, 2021 compared to 352 million rand a year ago, and a 19% increase in the capital value of new loans year-on-year, lending revenue was slightly down by 2%. This is because the majority of the new loans issued during the quarter were issued in December, with the revenue from these loans expected to flow through in the following quarters. On the profitability front, we’re starting to see the benefits of our cost optimization initiatives coming through. Both on a constant currency and reported basis, the adjusted EBITDA loss for the quarter improved 42% from a loss of $12.1 million in the prior year to a loss of $7.1 million. The main drivers of this improvement were the disclosure of our loss-making IPG business and stronger profitability in the consumer segment, which improved EBITDA loss by 13% year-on-year and 52% versus quarter one, 2022. This was boosted by the execution of 53.5 million rand or $3.5 million of Project Spring cost savings initiatives, largely linked to the closure of our mobile pay point infrastructure. Included in our income statement for the current quarter is a $2.4 million unrealized loss related to a fair value adjustment in respect of currency options. In anticipation of the closing of the Connect Group acquisition, we’ve entered into a currency hedge to fix the dollar amount required to meet our obligations. Of an estimated $132 million of cash, we have allocated to the transaction, $122 million has been hedged at an effective rate of 15 rand 72. According to GAAP, these hedges must be marked-to-market at each period end, resulting in this non-cash accounting charge for Q2 fiscal 2022. Turning to our various investments, Finbond has no impact on our results this quarter; any reports during our first and fourth quarters. We currently hold our investment in Finbond on our balance sheet at $7.2 million. In respect of Mobikwik, we continue to hold our investment at $76 million in-line with the valuation achieved in the June 2021 fundraise. They have postponed their planned IPO in the face of unfavorable market conditions, but are optimistic of being able to launch this during calendar 2022. They are making positive progress in expanding their B&PO business. We continue to hold our investment in Selsey at no value. We noted the renewal of the cautionary by Blue Label telecoms in respect of the recapitalization and are optimistic about their prospects of achieving this. We continue to hold around $14.5 million of Cell C airtime within our inventory balances. At December 31, 2021, we had unrestricted cash of $182.4 million, down 8% from the $198.6 million at the end of June 2021. The decrease in our unrestricted cash balances from the year end was primarily due to growth in our financial loans receivable book in December 2021 and the utilization of cash reserves to fund our operations, partially offset by the receipt of $7.5 million related to the sale of Bank Frick in fiscal 2021. U.S. dollar denominated balances were $159.4 million out of that total. The total cash represents $3.33 per share and about 59% of our current net asset value of $5.64. Our operational cash burn for the quarter amounted to $13.8 million, which included around $4.2 million of investment into working capital, principally in respect of our lending book. With that, Operator, we’d like to turn the call back over to you for the Q&A portion of our call. Thank you.

Thank you. Our first question is from Raj Sharma of B. Riley. Please go ahead.

Hello, good morning. I had a question. If you could kind of touch upon the EPE accounts, the number just under 1.1 million. Can you also talk about the churn in the accounts? Has there been substantial churn in the last quarter? And if you’re including the EPE Light numbers in the figure that you just gave of 1.1 million?.

Hi Raj. Thank you for your question. I’ll try and just make sure I cover all of it. So firstly, the 1.1 million, just under 1.1 million active accounts does include the EPE Light customers. It’s still relatively small in terms of active accounts, so the contribution numbers are still relatively low. But we have included in that number. In terms of churn, I think what I’d say is we are still learning. We still like understanding customer behavior, customer experience and really getting closer to the activity in this book. There is churn, and as I say, we’re working on that, and really trying to understand it and root cause it. We will, when we’re ready and have a clearer sort of sense of trends, be able to start giving you some sense of what that will look like. But for now, we feel it’s quite early days, and we’ve got really like two quarters, if you think about it, behind us of this new strategy, so we are learning, and we don’t believe yet that we can really with confidence give you a sense of trends. I hope you understand that. Thank you.

Yes, sure. Thank you. And then my next question is on the merchant group sales. I mean, what would the sales have been if you didn’t have the delays on the equipment? And could you reiterate that you would see a recovery in the next two quarters? How much was the impact is what I’m trying to understand on the merchant group sales because of the chip shortages.

Hi Raj. The impact on the POS devices has primarily come from the devices we were selling. It's always a bit challenging to quantify the exact number on a quarter-to-quarter basis because these sales can be quite variable. However, we are confident in our committed order book and expect it to perform well in Q3 and Q4. There's been a lot of discussion about the chip shortage, which is still a concern. Nevertheless, our suppliers have assured us they can meet our obligations based on the orders we have from our customers. We are in regular communication to ensure that we fulfill those orders and meet our expectations over the next few quarters.

Got it. Thank you. And then if I could ask about the Connect Group acquisition, what are the remaining approvals that are left? Could you talk about the timeline? Are you still expecting a close by the end of Q3?

Thanks, Raj. Yes, our timeline, as I was saying earlier, is largely unchanged. We feel the transaction is moving along in the timeframes that we previously communicated and expected. Late March is our guidance around that where we feel the transaction should close. The key requirements to closing are competition commission approval, and we are in the midst of that process with the competition commission, and it’s moving along again in the timeframes that we anticipated, and at this point, we have had no cause for concern or surprise. The timeframes are moving as expected. The competition commission is the main requirement for us to receive approval, and we’re hoping to get that all done and in place by the end of March.

Got it. Thank you. Just one last question on the account in the new account growth. I know that it was great to hear Lincoln talk extensively about all the efforts that are going into recalibrating the sales force. But could you give us a sense of what we should expect as ongoing new account, gross new account adds for the next couple of quarters? And your efforts into acquiring SASSA accounts, would those be materials for the next two quarters?

Raj, as we were saying, we feel it’s early days. We’ve really got to, in my mind, two quarters of data to base our conclusions on. We feel tremendously excited about the shift that’s going on in the business into a sales-driven sales-oriented organization. We have tremendous focus on improving our processes, training our staff as we said, getting out into the communities and really understanding our customer base. So we’re delighted with the progress we’ve made. We just feel it’s too early at this point to make predictions or try and give estimations on a steady state or even a trend around account growth. So my appeal would be to be patient with us. We are working full steam ahead. We’re giving everything to turnaround this business and get into breakeven as quickly as possible and as those trends emerge; we’ll be wanting to share them with you. Thank you.

Great, thank you so much. I’ll take my questions offline. Thank you again.

Thank you. It appears there are no additional questions. I will now turn it over to Dara for final remarks.

Dara, it’s Chris. If I may, I’d like to conclude really by emphasizing that we remain excited about the progress towards our transformation and the turnaround of the financial services business through those three levers of customer acquisition, increased ARPU, and reduced cost. Ultimately, we aim to deliver on our goal of building a leading South African FinTech platform for underserved consumers and merchants. We remain committed to this and look forward to sharing more on the journey in future calls. Thank you very much, Operator, and thank you to everybody for joining us on the call and for the interest in our business. Thank you.

Thank you. Ladies and gentlemen, that concludes this conference for today. Thank you for joining us. You may now disconnect your lines.