Earnings Call Transcript - LSAK Q4 2021

Operator, Operator

Ladies and gentlemen and welcome to Net1's UEPS Quarter Four of 2021 Earnings Call. All attendees will be in a listen-only mode. There will be an opportunity to ask questions in prompt. Please note that this event is being recorded. I will now hand the conference over to Dara Dierks. Please go ahead, ma'am.

Dara Dierks, Investor Relations

Thank you, Operator. Welcome to our Fourth Quarter 2021 earnings call. With me today are Chris Meyer, Group CEO, Lincoln Mali, South Africa CEO, and Alex Smith, CFO. A 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 cautionary language contained in our Form 10-K 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 and our press release in rand to assist investors' understanding of the underlying trends in 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. Chris will start this 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 fourth quarter. Therefore, we will have a Q&A session thereafter. So with that, let me turn the call over to Chris.

Chris Meyer, Group CEO

Thank you, Dara. If you can hear me okay. Good morning, good afternoon, and thank you everyone for joining us for our fourth-quarter earnings call today. I want to recognize that this is our first earnings call since the tragic passing of our former Chairman, Jabu Mabuza. Jabu played a critical role in Net1's journey of change and renewal, including the appointment of high-quality non-executive directors, the appointment of new senior executives, rebuilding Net1's relationships with key stakeholders, and lastly, the conclusion of the strategic review last year. We're fortunate to have Kuben Pillay, who became our Chairman in August, following Jabu's passing. Kuben joined the board in June 2020 as part of the various changes that I've just mentioned during Jabu's tenure, and Kuben is providing strong continuity on that journey. So this is my first earnings call at Net1, and I've been in the role as Group CEO for just over two months. The opportunity to take on the role was presented to me earlier in the year, and it was very quickly apparent that the mix of people, capabilities, and mission is unique. Simply put, the opportunity to be part of unlocking Net1's potential was too important to ignore. I'm proudly South African and have spent much of my career building businesses outside of the country, in the UK and elsewhere. I'm tremendously excited by the opportunity to reposition the Net1 platform for growth and see it as an opportunity to make a real difference in our country. Our mission of driving financial inclusion for underserved consumers and merchants in South Africa has deep personal meaning for me, and there is no one better positioned in the market than Net1. Our Company has incredible assets and capabilities in South Africa, and we aim to work towards creating a Company that will be a force for good while also unlocking value for shareholders. I also consider myself incredibly lucky to have joined a strong team of over 3,000 people here at Net1. From that team, today I have on call with me Alex Smith, our CFO, and Lincoln Mali, who joined us as our Southern African CEO in May and is a critical leader in Net1's turnaround journey. Being two months into my time here at Net1, I wanted to share a few initial observations and areas of focus going forward. Firstly, our vision is to build and operate the leading South African full-service Fintech platform, offering payment processing and financial services to underserved merchants and consumers. Our core purpose is to improve people's lives by bringing financial inclusions to South Africa's underserved customers and helping small businesses access the financial services they need to prosper. We will achieve this through our ability to efficiently digitize that last mile of financial inclusion and to provide a full-service Fintech platform across cash and digital, serving the needs of both while also facilitating the secular shift from cash to digital that we see taking place. We have a large target addressable market of more than 150 billion rand, which broadly splits into two overlapping markets. The first is providing consumer financial services to South Africa's more than 26 million adults in LSMs 1 to 6, and the second is providing merchant financial services to South Africa's micro and small businesses, of which there are an estimated 700,000 formal merchants and 1.4 million informal merchants. Our addressable market is growing and supported by long-term tailwinds. South Africa is primarily a cash-based economy with approximately 60% of transactions still conducted in cash. As you know, worldwide, there is a secular shift away from cash towards digital payment methods. South Africa is part of this, and it has a similar phase of transition as other middle-income countries. We are well-positioned to benefit from that shift. That leads me to my third observation, which is on our core competencies. On the consumer side, we currently provide transactional banking, unsecured credits, a digital wallet, as well as insurance and various value-added services to people underserved by the large banks. Our consumer offering is underpinned by our proprietary technology, which gives us the unique ability to provide secure payment processing in offline and rural environments. Our consumer offering is also backed by a network of over 350 branches and over 1,500 ATMs. The products and infrastructure were originally built to service a base of over 10 million clients, but we now have 1 million clients and are less loss-making. We, therefore, have a large and urgent strategic imperative to make the consumer offering profitable through significant interventions on customer acquisition and costs. This is a huge focus area for us right now, and my colleague Lincoln Mali will provide more information on our actions in this area shortly. On the merchant side, we currently operate one of the largest bank-independent financial switches in South Africa with integrations to over 40,000 terminals for both payments and value-added services. We also manage point-of-sale terminals for third parties and provide various cryptographic solutions. My key reflection on our offering is that it is well-positioned in the formal merchant space. However, we are not currently addressing informal merchants, particularly micro and small businesses, which is a large opportunity. From a product perspective, we are not fully addressing the opportunity in merchant acquiring, lending, and cash management. Part of that opportunity can be addressed organically, and part of it can be addressed through acquisition. These initial reflections align very well with the outcomes of the strategic review that was concluded by Net1 and communicated to the markets on the Q4 earnings call last year. We have a high degree of alignment on strategy with the board and our management team, and I can say we are going full steam ahead in building the leading Fintech platform for underserved consumers and merchants in South Africa. Being new to this role, I also want to provide an update on two investor expectations that preceded my tenure at Net1. First, Net1 is in a significant net cash position. As custodians of this capital, we have the responsibility to invest in high-return opportunities or return them to shareholders. A few months in, I can say we're working through the business cases for various potential uses of capital within the business and in the market, supported by the Capital Allocation Committee established in 2020. We will continue to apply rigorous capital allocation, and we will update the markets on any material developments in due course. Second, I would like to address the continued losses in our financial services business, which is EasyPay Everywhere (EPE), Moneyline, and Smart Life. This is a question of scale, and it requires material growth in the EPE account numbers to sustain the significant fixed cost base we have. The previous communication indicated a target of 1.4 million accounts by December 2021, reaching monthly break-even in that unit by June 2022. Achieving break-even is no longer realistic within that timeframe. We have established an entirely new senior sales capability across the country, hiring new provincial sales heads into eight of the nine provinces. This has taken longer than we anticipated. Additionally, the marketing efforts launched in June were interrupted by the riots and civil unrest in July. To be clear, we have ramped up account acquisition significantly. In August, we experienced over 50,000 sign-ups, achieving in one month the growth that previously took us one quarter. Therefore, the plan to significantly increase account numbers and reach break-even is still a top priority, and it will take time as we focus on investing in the business to position us for growth moving forward. We look forward to providing clarity on the expected growth rate and break-even timelines in the coming months. Going forward, you should expect from me a very high bar on taking guidance and executing against that guidance. You should also expect clear and transparent reporting on our business plan. I am really excited to join Net1 at such a pivotal stage in our journey. I am strongly aligned with my board and the management team on this strategy, and we are focused on execution. I will now hand it over to my colleague, Lincoln Mali, for a full update on the turnaround of the South African operations.

Lincoln Mali, South Africa CEO

Thank you, Chris. It's certainly been an incredible two months working with you, partnering as we try and work on the business together with our colleagues. I personally joined Net1 in May and can sincerely say that it's been a huge honor to be part of the Net1 family at this critical time. For a while, this was an organization under siege, but now there is a new mood and new energy across all our teams, and we're reengaging with all our stakeholders under a stronger commitment to our financial inclusion purpose. I'd like to take you through some key developments over the last few months and some of the plans for the coming months. My first step in my new role was to ensure that we have the right team and the right culture to execute our growth ambition. I found many highly competent people already within Net1, especially in operational areas; however, I also found the need to add many new skills into the business, especially in senior management ranks for product and commercial ownership. To that end, we've appointed several high-caliber, experienced, and well-regarded individuals to our management team over the last few months. We've included a page with details in the supplementary investor presentation posted on our site. Suffice to say that we have significantly strengthened our team over the last quarter, and we are humbled by the number of people showing interest in joining Net1. Historically, Net1's focus has been on the technology, logistics, and operations enabling it to successfully disburse up to 10 million grants every month, with SASSA as their main client. The task at hand now requires all of that but also a greater focus on new and existing customers as individuals. It requires us to deeply understand the needs of our clients so that we can offer them appropriate solutions. Further, whereas the network historically added a fixed base of clients based on contracts with SASSA, we now need to acquire new customers based on our value proposition and retain existing customers through great service. We are currently involved in a far-reaching training and role modeling exercise for all our team members to enable them to manage through this transition. There are already good signs that cultural change is taking hold. With the team in place and cultural changes ongoing, our focus, as Chris said, has been on significantly raising the growth trajectory of our client base. In June, we embarked on an internal communication campaign and an above-the-line campaign through nine radio stations in nine South African languages to show the market that Net1 is back and that our products are available for our clients. We set 19,000 EPE accounts in June, 20,000 EPE accounts in July despite the unprecedented civil unrest in the country during that month, and 55,000 EPE accounts in August. While it is early days, we're encouraged by this trajectory. We're also in the advanced stages of launching two new exciting products for our clients. The first is called EPE Light, a transaction account with a physical EMV debit card aimed at providing low-cost banking services to unbanked customers in South Africa. It will compete favorably with entry banking products from other banks. The second product is called EasySend; it enables individuals without a bank account to receive cash using one-time vouchers that can be withdrawn at Net1 ATMs. Our marketing tests on both products have shown strong traction, and we expect them to be in the market in the next few months. In the ATM channel, we are taking several strategic steps to drive bottom-line growth. We are introducing several value-added services on our ATMs, allowing consumers to buy airtime, data, electricity, lotto tickets, and vouchers. Customers will also be able to apply for loans using our ATMs, and we are introducing South Cash ATM recyclers for merchants because we are responding to the needs Chris mentioned regarding what merchants are looking for. Finally, we continue to invest significant time and energy to show that we're a responsible corporate citizen, offering low-cost financial services to our clients, sold in an honest and transparent manner. We are very proud that we are back at the main table in key conversations in the financial sector and are now part of the stakeholder community involved in financial services. Our infrastructure was used during the riots and civil unrest to close gaps facing the industry. Before I close, it's important to provide clarity on damages and losses sustained during the riots and civil unrest in July. 173 ATMs were damaged or destroyed, with 9.2 million rand lost across 80 ATMs and 19 branches damaged. All damages were submitted via our insurer to Sasria, the South African national riot insurer, and we await payment of these claims. Our insurers have given us the go-ahead to proceed with repairs and replacements, which is currently in progress. In conclusion, we've made significant progress over the last quarter in providing a platform for the growth of Net1's South African operations, and we have materially improved the monthly run rate on customer additions. Lots of work remains, and we are very focused on this task. I will now hand it over to my brother, Alex, to discuss our quarterly results.

Alex Smith, CFO

Thank you, Lincoln and Chris. I wanted to extend an official welcome to you both on your first earnings call. It's been an exciting few months since your arrivals, and all our people are looking forward to our future under your leadership. Now, onto the financial and operational highlights. Total revenue for the quarter was $34.5 million, which was a 41% increase year-over-year in U.S. dollar terms and a 15% increase in rand terms, primarily due to higher volume-driven transaction fees, improved lending revenue, and hardware sales. The U.S. dollar was 18% weaker against the rand during the fourth quarter of 2021 compared with the prior period, which also impacted our reported results. We reported an adjusted EBITDA loss of $8.2 million, which was 31% better than the $11.9 million EBITDA loss reported for the fourth quarter of 2020. This was primarily a result of the closure of IPG, which had a loss of $4.2 million in the prior period. Core South African operations saw EBITDA losses of $7.8 million compared to the $5.9 million in the prior period, primarily due to weaker profitability in the financial services segment linked to increased insurance claims related to the COVID pandemic. Otherwise, the cost base remains stable, and we have significant available capacity. The fourth quarter of 2021 fundamental loss per share was $0.18 compared to $0.21 per share a year ago. Corporate costs were $4.6 million, which was significantly higher than Q4 2020, primarily due to an allowance for doubtful loans receivable of $4 million, which we excluded from adjusted EBITDA and fundamental earnings. This was partially offset by a net reversal of stock-based compensation charges of $500,000. In South Africa, our consumer bank accounts EPE increased by about 43,000 gross accounts and 23,000 net accounts during the quarter. The encouraging increase seen during the first two months of fiscal '22 was discussed earlier in the call. This left us with a total number of active bank accounts on June 30, 2021, of just over 1 million. Our ATM network utilization has continued to trend positively in terms of total transactions and cash withdrawal transactions. For the quarter, total transactions were up 3.5% compared to the prior quarter and were 16% higher than the second quarter in fiscal 2020. The number of unique customers using our infrastructure was up 4.4% on the prior quarter and up 27% compared to the same quarter last year. The prior year was impacted by COVID lockdowns prevalent during that quarter. Transaction volumes through our EasyPay switch were up 7% compared to the prior quarter, while transaction values also increased by around 5%. In our financial services business, the loan book dated June 30, 2021, was ZAR 336 million versus ZAR 307 million on June 30, 2020, and ZAR 305 million on March 31, 2021. The other contributor in this segment is our insurance business, which saw its number of active policies increase to 246,000 from 233,000 a year ago. However, increasing claims, 50% higher in Q4 21 than in Q4 2020 due to the pandemic, meant this was the main driver of the increased loss in financial services. IPG was officially closed during the quarter with all staff exiting the business. We do continue with various Company deregistrations and liquidation processes; these are administrative in nature, and we can now effectively close the chapter on this operation. Turning to our various investments, we provide the following updates. During fiscal 2021, we exited our entire positions in Bank Frick and B2, which substantially reduced our equity-accounted investments compared to last year. Finbond reported its fiscal 2021 results in May, indicating further losses as it recovered from the effects of the pandemic, particularly in South Africa. As a result, we recorded a $1.7 million loss, our share of its losses for the second half of its fiscal year to February 2021. However, this was an improvement on the loss of $2.6 million recorded in the first half of that fiscal year. We quickly filed draft perspectives with relevant Indian authorities in early July, very supportive of the IPO process they are following, and look forward to seeing the Company move forward. During the 2021 fiscal year, we increased the carrying value of our investment in line with valuations from pending capital raises closed by MobiKwik. This resulted in a noncash pretax fair value increase of $23.4 million in Q4 2021, which lifted the current value for investments to $76 million as of June 30, 2021. This evaluation is based on the recent capital raise performed by MobiKwik in June 2021, based on a $700 million pre-money valuation. We continue to hold our investment in Cell C at a carrying value. We are encouraged, however, by the recent announcement by our fellow shareholder Blue Label Telecoms that they have raised funding to facilitate a recapitalization of Cell C. Cell C continues to improve its market position, reporting improving financial performance, and we are optimistic about its future prospects once the recapitalization is completed. In July 2021, we increased our short-term credit facilities from 1.2 billion to 1.4 billion to access the necessary cash to stock our ATMs. These facilities are available only for use concerning our ATMs, and we believe they are currently sufficient to optimally operate our ATM business. On June 30, 2021, we had unrestricted cash of $198.6 million and no debt. U.S. dollar-denominated balances were $169.8 million after that total. This represents $3.69 per share in cash, about 58% of our current net asset value. With that, Operator, we'd like to turn the call back over to you for the Q&A portion of our call. Thank you.

Operator, Operator

Thank you very much, sir. Ladies and gentlemen, at this time, you can ask a question. We'll pause a moment as we wait for the question queue to build. The first question comes from Raj Sharma of B. Riley Securities.

Raj Sharma, Analyst

Hi, good morning. I have a few questions to start with. Welcome aboard, Chris and Lincoln. It's a pleasure to hear you on the call. To Chris, I know that you've stated that you set a high bar on any sort of numbers going forward. But any indication of what that bar is? I know you took off the number of accounts that are going to be added by the end of fiscal '22. It seems like there's a lot of addition to the staff, and a lot of addition to the right players in your local geography. But any sort of indication on your target for account adds for the year?

Chris Meyer, Group CEO

Thank you for your question, Raj. Both Lincoln and I are very excited to be part of this business. It’s early in our journey, and we are thrilled about what we're seeing. Currently, we cannot provide guidance as we are focused on being transparent and offering achievable indicators for the business. Having been in my role for just two months, it's still early to establish formal guidance, and we are analyzing the momentum in the business to form clearer views. The EPE account growth momentum is encouraging, with significant improvements in August compared to July and June. We are optimistic about sustaining this momentum. A lot of effort has gone into hiring and replacing senior sales executives nationwide. Historically, Net1 operated primarily as a logistics company that focused on cash delivery. Our goal is to reposition the business, acknowledging our relationship with SASSA and understanding that each of our million-plus customers is important. We need to shift our culture to be client-focused, focusing on client acquisition and solutions. That’s a substantial transformation, and we're looking for data that reflects this change to support clearer guidance. I hope this answers your question and outlines our focus areas. We will provide targets and numbers in the future to hold ourselves accountable.

Raj Sharma, Analyst

It's encouraging to see the account growth and the great additions to the team. Does this indicate that the infrastructure is expanding, or should we expect an increase in costs as well?

Alex Smith, CFO

A few points on costs. No, you shouldn't expect the cost base in this financial services business to increase. We are focused on reducing costs in the financial services business, and we have several levers already being acted upon. The investments in new people are largely replacing some roles as well as investing in sales to truly drive account growth and activation within the context of reducing the cost base in that financial services business.

Raj Sharma, Analyst

Got it. Thank you, that helps. In CapEx, if I can move on to the possible acquisitions you referred to in the informal space, is there any indication of the possible size, or have you identified candidates? When could we expect something?

Chris Meyer, Group CEO

Yeah, we have several opportunities we are evaluating. We've spent time looking at the markets, cross-referencing what's out there with our capabilities. We have a good handle on potential targets. We can't say more than that right now, but as soon as we have something to announce, we will inform the market.

Raj Sharma, Analyst

Got it. Just moving on to the SASSA accounts. The post office has become in search of a reputable card scheme to issue cards over the next five years. They say they need to issue about 12 million cards that need to be replaced for a big cost. Does this recruitable card scheme assume Net1 would be a big contender?

Chris Meyer, Group CEO

I'll ask Lincoln to comment on this question.

Lincoln Mali, South Africa CEO

Thank you, Chris. Raj, we considered the tender, looked at it in detail, and decided not to participate further because we felt the commercial terms were not acceptable. We believed we could still grow the customer base organically without going through a procurement process that didn't make sense for us. However, we are open to helping as needed but felt it wasn't worthwhile to participate under those terms. We spent considerable time rebuilding our relationship with SASSA, at all levels from national leadership to provincial and local. It has been transparent and competitive, and we want clients to have a choice. If there are organizations that can offer better services than us, that's acceptable. We believe we can provide good services, and we see our customers returning to us.

Raj Sharma, Analyst

Okay, perfect, thank you. I'll get back in the queue and take this offline. Thank you for answering my questions.

Chris Meyer, Group CEO

Thanks very much.

Operator, Operator

The next question comes from Jeff Jokri of Unicom Capital.

Jeff Jokri, Analyst

Hi, guys, it's Jeff Jokri. Welcome, Chris and Lincoln, it's great to have you on the call as well. Congratulations on the recent pickup in EPE accounts. Alex, could you sort of provide a general view as to what breakeven would be in terms of EPE accounts? Just so we can gauge the growth in business to get to breakeven?

Chris Meyer, Group CEO

Hi, Jeff, the numbers on maturity differ from what we've indicated in the past regarding EPE accounts needed for breakeven. We previously indicated 1.4 to 1.5 million accounts for South Africa to achieve breakeven. We don’t see that significantly changing, but we're undergoing a system overhaul, and we will provide clearer guidance in due course.

Jeff Jokri, Analyst

The second question I had is, and this might be one for Lincoln. There were a couple of press reports recently pertaining to the COVID relief grant, suggesting that SASSA confirmed the bank account method as the most convenient and quickest way to receive the grant. It suggested a period, I believe it was September 3rd to 10th, as the window to change the method. Did you see this affect your recent account growth, and do you think SASSA is shifting its attitude towards new accounts for growth?

Lincoln Mali, South Africa CEO

Broadly, the thinking within SASSA and financial institutions is starting to align. We need one another to solve a deep South African problem. The riots reminded us of the challenges we face. We have more regular engagements with SASSA and part of other financial institutions. Today, for new grants, you can apply on the SASSA portal without going to a SASSA branch. Our staff helps clients apply, especially in rural areas, in about three to four days turnaround. If this process works for new clients, it can also be applied to existing clients wanting to change bank accounts. SASSA started to digitally approve grants, and we also want to digitalize our approach. All of this positively affects account activation, so we expect to see good results.

Jeff Jokri, Analyst

That's very encouraging. Just a last follow-up: the significant increase in August, how much do you attribute to the marketing campaign versus new staffing versus the digitization from SASSA? How much would you allocate to each of those contributors?

Lincoln Mali, South Africa CEO

It’s still very early days for us to pinpoint specifics on this. However, certainly, the new leadership in provinces is significant. We are repurposing our marketing, using more digital marketing, and leveraging our infrastructure to market. Staff confidence is improving, and we are seeing better engagement with SASSA. All these contributors aid our growth efforts. We're spending a lot of time in the field getting feedback from branch managers to understand these dynamics, which is making a big difference.

Operator, Operator

Jeff, does that conclude your questions?

Jeff Jokri, Analyst

Yes, thank you very much.

Operator, Operator

Ladies and gentlemen, I will now hand it back to management for closing comments.

Chris Meyer, Group CEO

Thank you very much, Operator. To conclude, thank you for joining us on this call. Thank you for your questions and the interest shown in our business. I hope you heard in the closing remarks from Lincoln the levels of activity and momentum occurring in our business, the excitement across our branches as we shift from a reactive, operations-focused business to one that builds momentum, client acquisition, and builds the leading South African Fintech platform focused on underserved consumers and merchants. We are all committed to this and look forward to sharing more on this journey in future calls. Thank you very much for joining us.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes today's event.