Earnings Call Transcript - LSAK Q2 2023

Rob Fink, IR Team Member

Hello, everyone, and welcome to Lesaka’s Fiscal Second Quarter 2023 Earnings Webcast and Conference Call. My name is Rob Fink, and I'm part of the newly appointed IR team here in the U.S. As we get started, I just wanted to remind everyone that this webcast is being recorded and the presentation can be accessed through the webcast link, as well as by dialing into the Zoom conference call dial-in numbers provided. Management will address any questions you may have at the end of the presentation. To ask a question, you must be logged into the webcast and can use the raise your hand button on the bottom of your screen to indicate your interest in participating in a Q&A session. If you have joined via the Zoom teleconference line, you cannot ask a question live, but we would encourage you to reach out to the IR team if you have questions following the completion of this call. The webcast link Zoom conference call dial-in numbers, as well as the earnings press release, and supplementary investor presentation are available on Lesaka’s Investor Relations website at ir.lesakatech.com. Additionally, Lesaka filed its Form 10-Q after the U.S. market closed yesterday, Tuesday, February 7, 2023, which is also available on the Investor Relations website. As a reminder, during this call, management will be making forward-looking statements, and I ask you to look at the cautionary language contained in Lesaka’s Form 10-Q regarding the risks and uncertainties associated with forward-looking statements. Also, as a domestic filer in the United States, Lesaka reports results in U.S. dollars under U.S. GAAP. However, it is important to note that the company's operational currency is South African Rand and as such, management analyses their performance in South African Rand. In this presentation, we will discuss results in South African Rand, which is non-GAAP. Doing so assists investors in understanding the underlying trends in the business. As you know, the company's results can significantly be affected by currency fluctuations between the U.S. dollar and the South African Rand. Take a quick look at today's agenda. Chris Meyer, Group CEO of Lesaka will begin today's call with performance highlights for the second quarter of fiscal year 2023 and review Lesaka’s progress against its key strategic objectives. Steve Heilbron, CEO, Connect & Head of the Merchant Division will provide an update on the Merchant Division, which has produced a stellar set of results this quarter. Lincoln Mali, CEO of Lesaka, South Africa, will then provide an update on the Consumer Division, which has passed a key milestone this quarter. And then Naeem Kola, Group CFO, will present an overview of Lesaka’s financial performance for the three months ended December 31, 2022. Chris will conclude the results presentation with a discussion on Lesaka’s outlook before opening the call for Q&A, where we welcome any questions you may have.

Chris Meyer, Group CEO

Thank you, Rob. Good morning, good afternoon, and welcome to our second-quarter 2023 earnings webcast and conference call. Our FY ‘23 Q2 results represent a significant milestone for Lesaka in a number of ways. Our performance this quarter provides clear evidence of the successful turnaround in our Consumer division, which has delivered its first adjusted EBITDA profitable quarter in years. At the same time, the strong outperformance in our Merchant division is testament to the robust growth fundamentals underpinning the Connect acquisition and the overall momentum we are seeing in our Merchant division. The Merchant division has delivered an excellent set of results this quarter, topping our guidance and showing growth of 19%, compared to a quarter ago being FY ‘23 Q1. This has been driven by the Connect Group, which has become the cornerstone of our Merchant division as we rapidly expand our merchant customer base in Southern Africa. The Merchant division is at the forefront of our mission of providing financial inclusion through our full-service offering across cash and digital, serving the use of both, while also facilitating the shift towards digital that is taking place. We are seeing this play out in a number of areas. For example, in our card acceptance business where we've seen card payments through our merchants in the informal sector, more than double, compared to a year ago. And also, in terms of the growth in our credit offering to MSMEs, including Capital Connect and Kazang Pay Advance, where we've advanced ZAR22 million this quarter, an increase of 16%, compared to a quarter ago being FY ‘23 Q1. The Merchant division has performed ahead of our expectations. The growth drivers and secular trends underpinning financial inclusion, cash management, and digitization for MSMEs are clear. We therefore believe the conditions for continued growth remain firmly intact. So, turning to the performance of the Consumer division. We are very pleased to be able to deliver the first adjusted EBITDA positive quarter for the Consumer division in years. The Consumer division delivered segment adjusted EBITDA of ZAR10.1 million for Q2 FY 2023, compared to a segment adjusted EBITDA loss of ZAR23.9 million for Q1 FY 2023. This is a watershed moment for the business. And in reflecting on the work of the last 18 months where we have been very clear on how we plan to return the Consumer division to profitability; we view the set of results as testament to the successful implementation of a rigorous plan that was based on the complete transformation and optimization of our branch and distribution footprint and driven by a mission of delivering financial inclusion to our customers across South Africa. The Consumer division has been fundamentally transformed, and we have built a strong and stable foundation to grow our customer base and deepen our product offering. We will achieve our growth objectives through a combination of: Firstly, shifting our points of presence to where our customers want to be, which is in retailers. Secondly, by improving the customer journey through digitization and streamlining our processes. And thirdly, by further enhancing our value proposition as we shift our product and pricing proposition to recognize and reward our most loyal customer base. Lincoln will provide more detail on these focus areas later in our presentation. And, so the third area I would like to highlight is how our improved operating performance has also meant we are generating positive cash flow in the business and have been able to further optimize Lesaka’s capital structure. Our banking partners have agreed to further extend the group's lending facilities on more favorable terms, increasing flexibility, adding further liquidity, and providing greater capacity to fund growth. For FY 2023 Q2, we saw ZAR60 million of cash generated from operations, and we ended the quarter with ZAR722 million in unrestricted cash, compared to ZAR543 million a quarter ago. We continue to focus on reducing our net debt to EBITDA ratio, in step with the growth of the business, and with our net debt to EBITDA ratio reducing to 3.3 times from 5.9 times in FY ‘23 Q1. And Naeem will address this in greater detail later in the presentation. So given the momentum in our Merchant division and the strong foundation for growth in the Consumer division, we are reaffirming our guidance which we provided for FY ’23. We believe the growth drivers remain intact, and we are confident the momentum will continue. In September 2022, we provided further earnings guidance for the first time since the transformation and repositioning of Lesaka began. Our guidance was for group revenue to be in the range of ZAR2 billion to ZAR2.3 billion for FY ‘23 Q2. We are pleased to be able to report revenue of ZAR2.4 billion, which exceeds the upper end of our guidance. Revenue growth was driven predominantly by the stellar performance in the Merchant division, primarily the Connect Group. We also guided for group adjusted EBITDA to be in the range of ZAR116 million to ZAR123 million for Q2 FY 2023. And we have delivered ZAR130 million in group adjusted EBITDA for the quarter, which surpassed the upper end of the guidance provided by 6%. This represents a significant turnaround on the loss of ZAR84 million recorded in Q2 FY 2022. Our performance specifically in the Consumer division and also across the group were supported by well-controlled costs, including our group cost line. Lesaka is a full-service fintech platform, serving the needs of consumers and merchants, and we are also facilitating the secular shift to digital that is currently taking place. We are increasing our points of presence across our ecosystem in the form of branches, retailer pay points, ATMs, satellite kiosks, and merchant devices, and these increased to more than 72,000 by quarter end. Building momentum in our footprint raises our standing as a player of scale in the market and creates growth opportunities across our ecosystem. Our Q2 FY 2023 results demonstrate that we have set a solid foundation for growth in this market, and we are very excited about this. And with that, I will hand over to Steve to discuss the performance and opportunities in the Merchant division. And as a leadership team, we are very pleased that Steve has extended his contract with Lesaka for the next three years, continuing in his current role as Head of the Merchant Division and also taking on additional responsibilities at a group level. Lesaka certainly stands to benefit from his continued involvement. And Steve, over to you to take us to the Merchant division's performance. Thank you.

Steven Heilbron, CEO, Connect & Head of Merchant Division

Thanks, Chris. At the outset, let me say that I'm very happy to have extended and broadened the scope of my activities within the group and I'm excited to work with you and the leadership team as we continue to optimize both revenue opportunities and cost synergies across our dual-sided ecosystem. Focusing on our Q2 FY ‘23 performance in the Merchant division, as Chris has mentioned, the Merchant division outperformed expectations and guidance this quarter, driven largely by a very strong performance of the Connect Group of businesses. The Merchant segment compared to Q1 has grown Q2 revenues by 12% to ZAR2.1 billion and adjusted EBITDA by 19% to ZAR160 million. The transformative impact of the Connect acquisition is evident, when compared to revenues and adjusted EBITDA of ZAR223 million and ZAR15 million respectively in FY ‘22 Q2. We have achieved growth across all products with standout performances in our Kazang VAS and Kazang Pay business units, as well as notable performance in both Merchant credit businesses, Capital Connect and Kazang Pay Advance. Focusing on the key activity drivers of revenue and EBITDA, the following lead indicators are highlighted: Kazang VAS throughput for the quarter of ZAR6.8 billion is up 40% year-on-year and up 17% for Q2 and Q1 for FY ’23. This is supported by solid growth in the onboarding of new merchants with circa 7,500 merchants being added in Q2, up 13% on Q1. The Kazang Merchant Estate closed Q2 at 64,500 merchants, this is up 47% year-on-year. Our business development team continues to focus on adding to the bouquet of products, vended by our merchants from the e-wallets, as well as broadening the added-value solutions targeted at solving for our merchant’s pain points. In our card acquiring businesses, Card Connect and Kazang Pay throughput for the quarter of ZAR3.1 billion is, up 106% year-on-year and up 35% for Q2 on Q1 for FY ’23. This performance is almost entirely attributable to the incredible growth achieved by our Kazang Pay solution. This is evidenced by the onboarding of circa 6,700 merchants in Q2, up 24% on Q1. The combined Card Connect and Kazang Pay Merchants Estate closed Q2 at 34,400 merchants versus up 129% year-on-year. The Cash Connect business throughput for the quarter of ZAR29.5 billion is up 9% year-on-year and up 7% for Q2 on Q1 for FY ’23. The Merchant Estate closed Q2 at circa 4,300 bolts, this is up 11% year-on-year. As mentioned at our last results presentation, we have integrated the ATM business into Cash Connect. This has served to enhance our focus on the ATM business as a standalone ATM acquiring unit with a heightened focus on achieving scale and efficiencies. We continue innovating in the cash recycling space with the imminent rollout of our new ATM recyclers. This is still in pilot phase with proof-of-concept testing in a selection of our merchant clients. Lincoln will touch on this a little more later. In our Merchant Credit businesses, Capital Connect and Kazang Pay Advance, credit dispersed for the quarter of ZAR262 million, is up 71% year-on-year. We have become a key provider of capital to the Vital MSME Merchant segment and have grown the receivable book from ZAR178 million to ZAR380 million, representing a 79% growth year-on-year. We are experiencing great momentum in Kazang Pay Advance and Capital Connect evidenced by strong uptake from our merchants. We are excited about the opportunities in the Merchant division and are encouraged by our ability to scale our product sets within the respective target market. The integration of Connect Group into Lesaka serves in broadening the Merchant division's reach into the informal market, which stands to benefit from enhanced inclusion from an underserved customer base. This broadens consumer access to a range of services, as well as supporting the journey to an increasingly digitized world. As evidenced by the numbers presented, we continue to see strong demand and have achieved excellent growth in the onboarding of many new merchants, as well as increased usage of our solutions by our existing merchants for the quarter and year-to-date. Both consumer and merchant clients benefit from a more secure, convenient, and efficient ecosystem enabled by our proprietary technology. Supplier payments in our Kazang VAS business continue to grow and are becoming a larger composition of the Kazang VAS throughput. This slide shows an example of our strategic partnership initiatives, which continue to drive growth. This proposition supports customer acquisition by providing more value for our merchants. To illustrate the point, this image represents multiple points of value for our merchant customers and thus our business as a merchant can accept card payments from these customers at this time using Kazang Pay. The merchant can also sell a range of VAS products to their customers using the same device for cash or card tender. And using the same platform, the merchant can settle stock purchases like VAT, Clover, Coca-Cola, SAB, and others directly from their e-wallet, reducing reliance on and the risk of holding onto cash for payments. It has scanned a unique supplier QR code when stock is delivered. This offering is quick and efficient for merchant and allows them to pay suppliers at their own convenience, reducing the need to hold cash, lowering transport costs, as well as the time taken to execute supplier payments. Now to our EasyPay business, where as expected, we continue to see a decrease in VAS throughput for prepaid electricity. This is due to the impact of load shedding and is important to emphasize that it's not due to a loss of customers. VAS throughput for prepaid airtime grew 4% year-on-year. In our EasyPay bill payments business, we are connecting approximately 650 billers through payment infrastructure. Revenue earned is on our transaction fee basis. Bill payment transaction volumes declined by 5%. We continue to reposition our EasyPay business by prioritizing commercial revenue streams in relation to existing and new clients. In our point-of-sale payment device business, revenue generated from the sale of point-of-sale devices can be lumpy given the seasonality of bulk sales. As disclosed in our Q1 results, we have reflected a 12-month rolling average as a more meaningful metric in tracking the performance of this business. The rolling average for Q2 FY ‘23 was 9,763 devices sold, an increase of over 100% on a year-on-year comparison. Rented devices have continued a steady growth trajectory at 9% year-on-year. In conclusion then, this has been a stellar period for the Merchant division. We are excited about the growth prospects and opportunities to derive more value from synergies across Lesaka, especially as we expand our footprint and deepen into the informal market. We continue to focus on opportunities to deliver services that are of tangible value to our merchant base. We have an excellent merchant team in place with a proven track record, who continue executing against a strategy and innovating in an underserved market. Lastly, but not least, thank you to all the people in the business for an incredible quarter. I would like now to hand over to Lincoln, CEO of Southern Africa to discuss the performance of the Consumer division.

Lincoln Mali, CEO, Lesaka South Africa

Thank you, Steven. It is so pleasing to see the growth and profitability coming out of the Merchant division and the progress we've made on the integration. Moving on to the Consumer division, the last 18 months have been a very busy time for everyone. As we said, how to transform it, and return it to profitability and position for growth. I'm extremely proud of the Lesaka team and specifically all the staff in our Consumer division in achieving our first EBITDA profitable quarter in years. It was a critical milestone in our journey as it removes the drain on financial and human resources and allows us to focus on growth. We are pleased to report a ZAR10 million segment EBITDA profit for the Consumer division in quarter two, which was slightly under our guidance, but a vast improvement from a year ago when we reported a consumer segment EBITDA loss of ZAR67 million. We marginally missed the guidance for Consumer segment EBITDA, due to a lower growth in our Easy Pay loan business that we had forecast. But we were encouraged by strong December growth, which has continued into January 2023. We do not need to change our guidance for the full year and are confident we are on track to deliver. Over the past four quarters, I've been speaking about the three levers we have used to retain the Consumer division to profitability, which are cost optimization, increasing our ARPU through cross-selling and growing active EPE account numbers. This result achieved was primarily through the first two levers. Under Project Spring, we committed to annual cost savings of approximately ZAR350 million in the Consumer division. Through the rightsizing and rationalizing of our infrastructure and staff complementing the consumer business, we've achieved ZAR222 million already in the first half of 2023. Our ARPU for our permanent client base has increased to ZAR74 from ZAR71 in quarter one and ZAR69 in quarter two of last year. We implemented our strategy to focus on product and efficient distribution channels, upgrading technology platforms, training staff, and we're still pulling hard on this lever. As we enhance our cross-selling initiatives, and spend more time in front of our customers, we expect the upward ARPU trend to continue. The combined effect of the first two levers have got us to a point where we now have a strong and stable base from which we can grow our consumer division. Lesaka is all about financial inclusion and offering affordable financial services to undersized consumers. Our products are specifically designed with permanent social grant recipients in mind, where we have an opportunity to build deeper relationships through lending and insurance. We do have products for people who receive temporary grants. But we don't offer the same breadth of service as permanent grant recipients. In the consumer market, approximately 19 million social grants are paid to 12 million grant recipients every month. Of which approximately 7 million grants are paid by Post Bank of South Africa. These numbers exclude the temporary SRD grants, which were instituted during COVID, which have recently been extended to the end of 2024. Social grants form an integral part of South Africa's lives. And for many, it is the only source of income to support their families. Approximately 90% of grant recipients in South Africa currently receive their grant and withdraw it all in one transaction and two to transact in cash. Further, only 20% of grant recipients have access to regulated insurance and lending products. Turning to the third lever, which is growing our active EPE account numbers. We ended quarter two with 1.2 million active EPE bank account customers of which just over 1 million are target permanent grant recipients. For the first time, we are separately reporting on our core permanent grant customer base from the more temporary SRD customer base. As of the end of December 2022, we increased our overall customer base by 18%. Within this result, the permanent grant account base grew by 4% on a net basis, which maintained our market share. Whilst this was slightly below what we had hoped for, it must be seen in the light of us going through a complete restructuring and cultural reset in the consumer division, particularly in the sales team and an entirely new national and provincial leadership, and a focus on cost optimization and cross-sell initiatives. As a reminder, we continue to apply a rigorous approach in our measurement criteria for an active account. We only classify an account as active if we have charged a monthly account fee during that specific month. We have identified actions and strategies to now leverage off our firm base and improve our EPE growth. These include, firstly, an enhanced distribution model where we're moving away from branches and now have staffed kiosks and ATMs in retailers, where our customer base has more convenient access and longer trading hours. Secondly, marketing initiatives and incentives encouraging account openings and switching to Easy Pay. Thirdly, easing the friction in the onboarding of new clients with technology interventions, opposed to incurring travel costs and specifically having to be in a branch to open an account. I mentioned in quarter one of our 2023 financial year, that Easy Pay loans, our lending product had grown at a slower rate than expected. I'm pleased that we have seen a recovery in this quarter with 18% growth in the number of loans originated. In terms of our book size, we have grown 13% year-on-year. We're encouraged by the positive results coming through already and continued momentum on loan growth in January 2023. Again, it is pleasing to see our loss ratio at less than 4% per year. Our customers place a high value in these loans to get them through difficult months, and having the facility available to them leads to a good repayment experience. Our Easy Pay insurance product continued to outperform our expectations in quarter two, growing 15% to approximately 294,000 active insurance policies. It is encouraging that this new business is of good quality with a high premium collection rate of approximately 98% being maintained. Our move to a more retail-focused distribution strategy is paying off. Our presence in the retail stores where our customer base shops has provided Easy Pay much more visibility and convenience for our customers with longer trading hours and easy access to our ATMs. We've seen an 18% increase in transactions per ATM, compared to three months ago, with a strong increase in other bank customers also using our ATM network now. We're continuing to implement our retail-focused distribution strategy, and our initiatives we're exploring with Kazang will further accelerate and expand our retail presence. We see great potential in the mutual benefits for retailers and our consumers in terms of convenience and buying power for our own ecosystem. We continue to develop our strong relationship with SASSA through proactive engagement at a local, provincial, and national level. We've also made good progress on building relationships with our various key stakeholders, including Grindrod Bank and representatives from its new owner, African Bank, who acquired 100% of Grindrod in May 2022. As highlighted by Chris earlier, the consumer division has been fundamentally transformed, and we've built a strong and stable base to grow our customer base and deepen our product offering. We’re well positioned for growth and in doing so continue to focus on establishing points of presence for our customers that are convenient and cost-effective to access. We also strive to further improve the customer journey through digitization and further enhancing our value proposition, including plans that will reward and grow our loyal customer base. Thank you, Naeem will now take you through our financial performance in more detail.

Naeem Kola, Group CFO

Thank you, Lincoln. I'm very excited to take you through the financial performance for quarter two 2023. Before I do that, as a reminder Lesaka as a domestic filer in the United States will report results in U.S. dollars and under U.S. GAAP. However, our operational currency is South African rand, and as such, we analyze our performance in South African rand. In this presentation, we will discuss our results in South African rand, which is non-GAAP. This assists investors in understanding the underlying trends of our business. As you know, our results can be significantly affected by the currency fluctuations between the U.S. dollar and the South African rand. Additionally, Q2 2023, similarly to Q1 2023, includes pre-existing Lesaka and Connect Group for the full quarter, compared to Q2 2022 that only includes a pre-existing Lesaka business. And thus, FY ‘23 Q2 versus FY ‘22 Q2 is not a meaningful comparison as Connect was not included in FY ‘22 Q2. However, FY ‘23 Q1 has Connect included for the full quarter and that is a useful sequential quarter comparison to focus on, demonstrating performance and growth rate for the quarter. I will now turn to the financial performance overview. As you have just heard, Lesaka is making significant progress in the transformation journey. And this is coming through in our improved financial performance and a strengthened financial position across the group. We are building on the momentum that started four quarters ago for both the Merchant and the Consumer division. We have also made great strides to improve our capital structure positioning us to support our growth plans. We achieved consolidated group revenue of ZAR2.4 billion for the quarter, compared to ZAR479 million in Q2 2022. This exceeded the upper end of our guidance in rands. This significant uplift in revenue was mainly related to the revenue for Connect Group being consolidated for the full quarter Q2 2023. Revenue increased by 11% from ZAR2.1 billion in fiscal Q1 2023. We delivered a group adjusted EBITDA of ZAR130 million, compared to the group adjusted EBITDA loss of ZAR84 million in Q2 2022 and an EBITDA profit of ZAR72 million in Q1 2023. This is an 81% improvement in EBITDA from Q1 2023 to Q2 2023, validating the transformation of the Consumer division to a segment adjusted EBITDA profit and continued strong growth and robustness in our Merchant division. Operating income before amortization of acquired assets is ZAR29 million compared to the operating loss of ZAR13 million in Q1 2023. This is directly related to the positive performance of the Consumer division and the significant performance of the Merchant division. In addition, the operating loss after acquired asset amortization improved by ZAR42 million to a loss of ZAR38 million for the quarter. Fundamental earnings per share showed a similar trend of positive turnaround compared to the prior quarter. This is indicative of the positive EBITDA contribution from the acquisition of the Connect Group, which has continued to exceed expectations, as well as the turnaround of the Consumer division. We generated ZAR60 million operating cash flow in the quarter, another significant landmark in the Lesaka Group being cash flow generating. I will now turn to the group income statement. Looking at the group income statement, we achieved a consolidated group revenue of ZAR2.4 billion for the quarter, compared to ZAR2.1 billion in Q1 2023, representing a growth of 11%. In USD, consolidated revenue was $136 million for the quarter, compared to $125 million in Q1 2023, representing a growth of 9%. Operating loss for the quarter is ZAR38 million, an improvement of ZAR42 million, as compared to the previous quarter and fundamental loss per share is ZAR0.22, compared to ZAR1.36 in Q1 2023, a significant movement quarter-on-quarter. Looking at our segments, Q2 2023 reflected a positive performance across both business divisions, validating our efforts to transform the business to deliver growth and strong profitability. Operating income before amortization of acquired intangible assets closed at ZAR29 million, as compared to a loss in Q1 2023 of ZAR13 million, a significant turnaround in three months. Consolidated revenue for the quarter was ZAR2.4 billion, an 11% growth, compared to Q1 2023 attributed to a strong performance across the merchant business especially in the VAS, card acquiring, and merchant capital products as highlighted earlier by Steve. In addition, we recorded ZAR97 million in revenue from the POS devices sold to the market in the quarter. As previously highlighted, this business is often quite lumpy between quarters due to the nature of the underlying client order book. In the Consumer division, revenue growth has been mainly driven by the transactional and insurance products. We achieved a group adjusted EBITDA of ZAR130 million, as compared to ZAR72 million in Q1 2023, an uplift of 81% quarter-on-quarter. The group adjusted EBITDA of ZAR130 million for the quarter was above the upper end of guidance for the quarter in rands. Group costs of ZAR40 million were consistent with guidance. The Merchant division, including the Connect Group, continues its strong performance trajectory and achieved a revenue of ZAR2.1 billion in the segment adjusted EBITDA of ZAR160 million. The performance for the quarter includes ZAR22 million EBITDA from the sale of POS devices in the quarter that is lumpy and in line with expectations. We do not see this continuing the rest of the quarters for fiscal 2023. While the segment adjusted EBITDA profit in the Consumer division is an important landmark in our journey that we embarked on in Q2 2022, where we are now reaping the benefits of a successful turnaround strategy. Including the cost savings realized from the rightsizing of the consumer division, we delivered a segment adjusted EBITDA of ZAR10 million in the quarter, as compared to a segment adjusted EBITDA loss of ZAR24 million in Q1 2023. This is a ZAR34 million positive turnaround. Stock-based compensation charges increased in the quarter compared to Q1 2023, mainly due to a one-off award of ZAR23 million issued to secure a longer-term contract with a key senior executive. Our further spend on how this will normalize going forward. At the Group adjusted EBITDA level, the impact of the turnaround continues to be evident and significant. We have turned around the group performance from an adjusted EBITDA loss of ZAR84 million in Q2 2022 to an adjusted EBITDA profit of ZAR130 million in the current quarter, a ZAR215 million turnaround over 12 months. This performance is evidence of the significant transformation the group achieved through the acquisition of Connect Group and the cost rightsizing and restructuring in the consumer division. Turning to our cash flow and capital structure, you will note that we have made further progress in creating a stable and long-term capital structure for Lesaka, as well as generating a positive operating cash flow. Our operational cash flow before working capital and loan book funding generated ZAR53 million in the quarter. Improving from negative ZAR7 million in Q1 2023. From a cash flow perspective, we continue to make improvements with stable and well-managed working capital requirements and a reduced reliance on cash reserves to fund operations and customer loan book growth. Cash available in the quarter increased from ZAR541 million to ZAR722 million. Net debt to EBITDA ratio on an annualized basis has improved to 3.3 times, as compared to 5.9 times in Q1 2022. Working capital funding requirements are stable and we do not require significant changes to support growth. We do experience peaks and troughs, which arise when taking advantage of bulk order discounts in our VAS business. We expect future loan book funding to be largely self-funded along with the banking facilities that are sized appropriately and therefore we do not envisage loan book growth to be a constraint on our cash flow. Our capital expenditure in Q2 FY 2023 amounted to ZAR70 million of which ZAR64 million or 91% related to growth capital expenditure and ZAR6 million, 9% related to maintenance capital expenditure. Capital expenditure in the business is mainly driven by growth in the merchant business. This growth CapEx is mainly in the form of point-of-sale terminals in the VAS and Card Acquiring business, as well as the manufacturing of vaults in the Cash Connect business. In both these businesses, this growth CapEx is highly cash-generative with short payback periods. I will now move on to analyze the stock-based compensation charges. Stock-based compensation is a critical part of the overall compensation proposition that enables Lesaka to attract the best talent to execute on the transformation strategy. To enable a better understanding of the stock-based compensation charge, we have divided this cost into three categories: namely executive sign-on, Connect Group acquisition awards, and long-term incentive plans. The long-term incentive plane awards are indicative of the continued run rate cost, whereas review the sign-on awards in the Connect acquisition awards are largely one-off in nature incurred at the beginning of the transformation journey. The increase in stock-based compensation costs between fiscal 2022 and 2023 is mainly due to fiscal ‘22 only includes part-year charge whereas fiscal 2023 includes a full-year charge, as well as a ZAR23 million one-off for senior executive to secure a long-term commitment. We estimate that in the medium term, once the effect of sign-ons and the Connect acquisition amortization, annual stock-based compensation charges should be in the range of ZAR60 million to ZAR70 million per annum. This would imply that the stock-based compensation charge should trend towards a single-digit percent of group adjusted EBITDA as benchmarked to market norms. Overall, Q2 2023 is evident of the efforts we implemented in fiscal 2022, and we are now reaping the positive results. Our continued focus on the strategic initiatives is progressing well, and we are optimistic about delivering on positive performance for the remainder of the year. I would now like to hand over back to Chris, who will address the group's outlook.

Chris Meyer, Group CEO

Turning to the outlook for Lesaka. We wanted to provide you with guidance on the near-term performance of the Group. And although we report results in U.S. dollars under U.S. GAAP, our operational currency is in South African rand and we analyze our performance in South African rand. And as such, we believe that providing guidance in rand is more useful. I'm very pleased to reaffirm our prior guidance provided for financial year 2023. Our outlook for group revenue is between ZAR8.7 billion and ZAR9.3 billion for the 12 months ending 30 June 2023. Merchant segment adjusted EBITDA between ZAR550 million and ZAR565 million. Consumer segment adjusted EBITDA between ZAR95 million and ZAR110 million. And adjusted for group costs, which we expect to be between ZAR165 million and ZAR150 million. This implies an adjusted group EBITDA of between ZAR480 million and ZAR525 million for FY 2023. For Q3 FY ‘23, our outlook for group revenue is between ZAR2.5 billion and ZAR2.8 billion for the three months ending March 31, 2023. And we expect Merchant segment adjusted EBITDA between ZAR140 million and ZAR145 million. Consumer segment adjusted EBITDA between ZAR40 million and ZAR45 million and group costs between ZAR45 million and ZAR40 million for Q3 FY 2023, which taken together means group adjusted EBITDA of between ZAR135 million and ZAR150 million for Q3 FY 2023. It is important to note that the Merchant segment adjusted EBITDA of ZAR160 million for FY 2023 Q2 included ZAR22 million relating to point-of-sale devices in our NUETS business. This is not forecasted to repeat in FY ‘23, Q3 or Q4 given the lumpy nature of bulk sales in this business. And in addition, seasonal trends indicate that our Q2 is usually a slightly stronger quarter, due to higher-than-average transaction volumes in December. Looking forward, we expect the Connect Group to continue to maintain its strong growth trajectory in line with historical trends. And so taken together, we believe that should current trends continue, there is potential upside. We will reevaluate this position in a few months’ time when we report Lesaka’s Q3 2023 results. Before I conclude, I want to give special thanks to Alex Smith, the Group's Chief Accounting Officer. In January 2023, we announced that Alex would be leaving Lesaka to pursue other opportunities outside the group. The past 18 months have been a time of significant transformation for Lesaka, and Alex has played a key role in Lesaka’s growth journey and its transition from Net 1 to Lesaka. Prior to my appointment, Alex was Interim Group CEO for every year and served as the Group Chief Financial Officer for more than four years. I would like to thank Alex for his valuable contribution to the company. So in conclusion, this past quarter represents a real milestone for Lesaka. Our results be a testament to the progress made since the transformation began. We will continue building on the momentum created across the business to drive growth, including by realizing the benefits and synergies of our unique dual-sided ecosystem. We believe there is tremendous scope for both our merchant and consumer divisions to grow and scale in their respective target markets in their own right, supported by the self-reinforcing business model we are building as part of Lesaka’s unique value proposition. And with that, we’d like to open up the Q&A session and take your questions. Thank you.

Rob Fink, IR Team Member

Thanks, Chris. The Q&A session will now begin. We're going to take a minute to build the queue. While we do that, we will read two questions submitted by an analyst from Anchor Securities. Chris, Spin wants to know what the impact of load shedding has been on the business, specifically in the Merchant division?

Chris Meyer, Group CEO

Lesaka’s unique value proposition. And with that, we’d like to open up the Q&A session and take your questions. Thank you. Rob Fink, from the IR team, thanked Chris and announced that the Q&A session will now begin. The operator indicated that they would take a moment to build the queue, and during this time, they would read two questions submitted by an analyst from Anchor Securities. Chris, Spin is asking about the impact of load shedding on the business, specifically in the Merchant division.

Steven Heilbron, CEO, Connect & Head of Merchant Division

Yes, sure. Thanks, Chris. I think the reality is we delivered a very strong set of results despite the load shedding. So the question really is, how much worse could it actually get? Now, we believe as we move into Q3, we have strong momentum and our business has been stress tested from, you know, Stage 3 to Stage 6 and at times even Stage 8. So the numbers speak for themselves.

Chris Meyer, Group CEO

Thanks, Steve.

Rob Fink, IR Team Member

Great. Spin’s second question is about guidance. And he wants to know, given the strong performance and guidance beat in the second quarter, why your outlook is being reaffirmed and not raised. Chris, can you unpack your thoughts on the full-year outlook and overview your expectations for growth in the second half of the fiscal year?

Chris Meyer, Group CEO

Sure. We decided to keep our guidance the same. As I mentioned, we performed better than expected in the Merchant business last quarter, which experienced a 19% growth. There are two important points to consider in those figures. First, we had a significant bulk order in our NUETS business, along with the bulk device business, which had about a ZAR22 million positive impact on EBITDA. This business can be quite inconsistent quarter-to-quarter, so it's important to assess it over a longer timeframe. Taking that fluctuation into account is essential. Secondly, December is a crucial month for us. We typically see increased volumes across the business due to seasonal expectations. So, we’re considering this in our outlook. We believe that the factors driving our growth are still strong, especially within the Connect Group, and we expect this trend to persist. We will revisit this in a few months when we present Q3 results, and if the conditions and momentum continue as they are, we might consider adjusting our guidance at that time. For now, we choose to maintain and reaffirm our current outlook.

Rob Fink, IR Team Member

Great. Thank you. And Chris, just so you know, there may be a little issue with your mic, so I'm going to give tech a minute to address it. And while I do, we did have a question from David Garrity of GCA. How does Lesaka recognize revenue from hardware terminal sales? Contemporaneously or over an expected period of use?

Chris Meyer, Group CEO

I hope you can hear me. If you need me to repeat my previous answer, I'm happy to do so. Regarding the question about revenue recognition, I'll pass it over to Naeem to address that.

Naeem Kola, Group CFO

Yes. Thanks, Chris. So just to understand the question, if we are referring to the hardware terminal sales that we sell to our NUETS business, these are sales that we do to customers, and ownership of these terminals is taken over by the customer. So we recognize our revenue at the time of delivery, and the way that is treated from an accounting perspective is that at the time of sale, the risk is transferred and we do not have any underlying ownership. We recognize the revenue as a gross number in our income statement, and the related inventory that is sold is then recognized on our cost of sales.

Chris Meyer, Group CEO

Thanks, Naeem.

Rob Fink, IR Team Member

Okay, great. Our next question is a live question from Frank Geng. Frank, your line is going to be unmuted.

Frank Geng, Analyst

Hi, guys. Thanks again, and congrats on the quarter. Just a few questions from me. They're somewhat related. You know, maybe first Naeem or Lincoln to you. Could you provide some rough commentary on how much working capital before the loan book funding you'd expect to invest per year and how much that's to maintain the business versus growing it? Second, you know, I guess, how should we think about usage of cash going forward? And third, you know, Naeem, now that you've extended the lending facilities, are there any other levers to continue to optimize capital structure, reduce debt repayments, reduce interest expense? And I guess, what's the new maturity on the debt? Thanks.

Chris Meyer, Group CEO

Thanks, Frank. I'm going to put those questions to Naeem to respond and just maybe help you that he can deal with it. I think the first question was around our working capital requirements in the business. And our requirements to invest in working for growth.

Naeem Kola, Group CFO

Yes. So look, I think Frank, from a working capital perspective, it's quite important to understand that the majority of our working capital is really in our VAS and the Card Acquiring business. If you look at our cash management business, as well as the business related to the consumer. The working capital requirements are not that significant, because we receive the funds from the customer upfront. So those are held on a wallet. If I look at the current facilities, you will see as well that as we highlighted between quarters, we can have quite a swing in terms of the working capital requirements in the Kazang business depending on when the month end or when the quarter end. And that is managed through adequate facilities that we have in the moment in terms of cash, as well as an overdraft facility. We do also take advantage of opportunities where we can earn higher margins, specifically on our value-added services business in terms of airtime and electricity. And in those circumstances, we would fund upfront, and that's then specifically through cash reserves. So I think we do those only in circumstances where we can earn a higher margin and it's a cost-effective way of increasing the margin in the business. In terms of going forward, we do not envisage a significant increase in working capital requirements. We are experiencing quite a significant growth in our Card Acquiring business. But the capital requirements in terms of working capital are well managed and within our facilities that we would be able to do in our overdraft. So I think our longer-term view in terms of working capital is that we don't believe there is a significant increase anticipated.

Chris Meyer, Group CEO

Thanks, Naeem. I think the question on debt and the change to our facilities, and we’ll leave this.

Lincoln Mali, CEO, Lesaka South Africa

Yes, sure. Look, I think for us, firstly, we’re super excited about the fact that we've been able to renegotiate a position with our bankers. Number one, over the last six to nine months, it's very indicative of the confidence that the bank is already seeing in the performance. And the extension of the facility to three years taking us up to 31st December 2025 gives us the ability to really focus on making the right decisions in terms of capital management. In addition to that, the potential upsizing of that facility will help us fund our loan book growth mainly on the consumer side of the business. So that is quite a significant change for us. In terms of levers, as we've highlighted in a number of our presentations, the focus for us in the business is really the consumer and the merchant business in South Africa. We have the non-core investments such as MobiKwik and others. And we will be looking at means and ways to exit those positions in a responsible way. And that would result in quite a significant cash inflow for us to manage. In addition to that, I think we would be looking at the right time in the market in terms of adjusting the structure of our capital position.

Frank Geng, Analyst

Okay, thanks.

Rob Fink, IR Team Member

Great. The next question is coming in from Raj Sharma of B. Riley.

Raj Sharma, Analyst

Yes, hi. Thank you for taking my question. I wanted to ask maybe, perhaps directed towards Lincoln. If you can talk a little bit about the consumer division, you know, talk about the lower transaction, the ATM transaction fees and the higher insurance fees? And also, what's happening in the ARPU? And how are you able to push it up? And what should we see that going forward in terms of the traction in the conversion of the accounts?

Lincoln Mali, CEO, Lesaka South Africa

First of all, thank you so much. I think firstly, I want to say how pleased we are with the turnaround of the consumer business. I think that we've spoken over the last few months about the work we've done to get our staff to understand the importance of cross-selling. And all of that work is starting to come through. You're starting to see more of our clients taking our insurance business and our sort of insurance products and our lending products. Those two things help to drive our ARPU. As long as we've got quality clients and those clients are able to take more of our lending products and our insurance products, we want to see that ARPU increasing. And we think that if we maintain that, you'll start to see some upside on that ARPU even further. So we're quite confident on the trajectory of our ARPU as we improve our business, as we improve our cross-sell to our existing clients. So we've been quite pleased with how our customers have responded on the lending side and the insurance side.

Raj Sharma, Analyst

And on the ATM transaction fees, was that just primarily because of reducing your infrastructure?

Lincoln Mali, CEO, Lesaka South Africa

So could you please specify your question about ATMs? Are you inquiring about…

Raj Sharma, Analyst

Yes, you know, on the ATM transaction fees, they were lower. And was that because of the reduction in the infrastructure? I know that the ATMs have become far more efficient. And productive?

Lincoln Mali, CEO, Lesaka South Africa

Yes. Let me make a macro observation regarding our ATMs and then we can discuss some of the quarter-on-quarter trends. As highlighted, we have reduced the number of ATMs from about 1,500 devices just over a year ago to around 880 currently. Approximately 60% of these are now located in retail spaces, whereas previously they were all in our branches. We are noticing a significant increase in transaction volumes from customers of other banks using our ATMs. With this shift, we are maintaining and even growing our transaction volumes, benefiting from more efficient activity per ATM than before. We are very pleased with the strategy we have implemented regarding our ATMs to enhance productivity.

Raj Sharma, Analyst

Yes, thank you. I have a question about Connect. I want to know how it has performed compared to your initial expectations upon acquisition. Has Connect exceeded your expectations in any specific area, and if so, has it been a positive surprise?

Chris Meyer, Group CEO

Overall, the Connect Group has fulfilled our vision and opportunity for the business while integrating smoothly into Lesaka. We consider this a successful transaction in every aspect. Notably, we have seen better-than-expected performance in Card Acquiring and Card Payment volumes, exceeding our forecasts, which is a positive development. Additionally, growth in our merchant numbers has surpassed our business cases, particularly in the rollout of VAS devices, which has been ahead of our expectations. This indicates a significant market opportunity, especially in the informal sector. As we mentioned, there are approximately 1.4 million informal merchants in our target market, and we currently have about 65,000 devices deployed. Furthermore, only 4% of these informal merchants can accept card payments, and we have observed our transaction volumes double. Our pipeline for the informal sector has also doubled in the past six months. These trends are well recognized and are key drivers for the Connect Group, although the pace of growth has been somewhat faster than we initially anticipated.

Raj Sharma, Analyst

Got it. Got it. Thank you so much for taking my questions. I'll take it offline. Thanks.

Rob Fink, IR Team Member

Great. Our next question was submitted by an analyst of Cloud Penny Partners. His first question is for Steve. Steve, you have a stellar growth rate in the Merchant division, even quarter-on-quarter. And we expect this type of momentum on a quarterly basis going forward?

Steven Heilbron, CEO, Connect & Head of Merchant Division

Let's revisit the earlier question about load shedding. I want to remind everyone that retailers, especially in the MSME sector, have faced numerous challenges over the last three years, including COVID, significant flooding in the Kaizen region, riots, and now ongoing load shedding. This has put a lot of stress on merchants. As we move into Q3, we need to be aware that the ongoing nature of these issues may have a cumulative effect on retail merchants. In Q2, we produced a strong set of results, and we have carried that momentum into Q3, with January showing solid performance. However, any potential slowdown related to load shedding might be mitigated by the innovations coming from our business, as Chris mentioned. Kazang Pay originated from Kazang, and Kazang Pay advance is an extension of that. Many of our initiatives, including supplier payments and capital connect, are gaining stronger momentum than we expected. Overall, we have a balanced offering and are effectively addressing the pain points of our merchants. We feel confident about our guidance for Q3, which we believe is solid, potentially even conservative.

Rob Fink, IR Team Member

Great. Another question from Judd and this is for Lincoln. Congrats on returning the consumer division to profitability. How should we look at the growth outlook of the consumer division over the medium term? Would you say that you now have fixed the cost structure in place to drive operating leverage from here? How do you think about the long-term stable margins in the consumer business?

Lincoln Mali, CEO, Lesaka South Africa

I think that if you look at the guidance that Chris has given, we can now see that this business is stable. That this business now is planned for growth and that all the cost initiatives that we've taken we will now reap those benefits. And then all of the work we've done in preparing our clients for new propositions, we will now be able to kind of build on that. And I think that in terms of the guidance, you now will have a business that is growing profitably quarter-on-quarter to be in line with the guidance. So we've done a lot on the cost in terms of the bulk of what we need to do. But obviously, there are still some tweaks that we need to do. But I think those phases of firefighting are gone, we now can start to think about what are the innovative things that we can do with our clients, what value propositions we can offer them and what can we do to compete with other players in the market. So that's how we look at the future from the consumer division.

Rob Fink, IR Team Member

Thank you. We're short on time, but I want to address three more questions before we finish. Has there been a notable increase in SASSA beneficiaries following the major issues with Post Bank since November 2022? Are you planning to aggressively acquire customers currently served by Post Bank?

Lincoln Mali, CEO, Lesaka South Africa

Yes. We have great plans around that. We are actively encouraging customers to join us. We are also making sure that we have more presence in terms of marketing, telling people what we offer and what alternative we have. But what we're trying to think about going forward is not just the mistakes of the Post Bank or challenges that they have, but to work on our value proposition and make sure that our value proposition is quite competitive and enticing for customers to join us. Those are some of the things that we're working on. What can we put in the table that makes customers excited to join us regardless of the challenges that SASSA and they are facing.

Rob Fink, IR Team Member

Great. This next question is for Steve. Steve, there are a couple of players in the merchant credit provision space such as retail capital and habitat, who have been in the space longer. Have large data set provided by Yoko and others or large balance sheets? How do you plan to differentiate yourselves from them?

Steven Heilbron, CEO, Connect & Head of Merchant Division

I want to start by expressing my admiration for our young team members who consistently innovate and deliver great solutions to the market. In terms of our Capital Connect business, the key to success here is hassle-free credit. Once customers apply, they can have their credit approved and funds in their accounts within minutes. This rapid approval process really sets us apart. We have a strong position in this market, processing nearly ZAR10 million a month through our vaulting infrastructure. In the second quarter, and also in December, our card processing business generated just under ZAR1.3 billion. All this data enables us to help retailers seize opportunities quickly. There's a saying that opportunity doesn't knock softly, and for entrepreneurs, it's essential to act immediately. Our advantage lies in our speed and ability to respond within minutes, unlike the traditional method that requires extensive management and audited accounts and can take days for a response. Additionally, we're continuously innovating to provide further value beyond just speedy service.

Rob Fink, IR Team Member

Well, great. We're at our last question for David Garrity, and it's for Chris. Chris, do you have authorization to repurchase shares in the open market? If so, what is the size of the repurchase facility? What are your plans to exercise the authorization, if any?

Chris Meyer, Group CEO

Thank you for the question. Yes, we have the capacity to repurchase shares in the market. I will confirm the exact size or provide the specific numbers shortly. The business has the authority to repurchase shares. Regarding share buybacks, our primary focus has been on stabilizing the business, particularly on the consumer side, and integrating the Connect acquisition while driving the growth journey we've discussed today. Our first quarter has generated operational cash, marking a significant milestone for us. We are committed to reducing our net debt to EBITDA ratio, which currently stands at 3.3 times, and we would like to see that decrease further. These are immediate priorities regarding cash and resources. We are confident that we are delivering a business that offers excellent returns to shareholders, and we anticipate seeing this reflected in the upcoming quarters. We will monitor the situation closely and remain attentive to this matter, as it comes up frequently.

Rob Fink, IR Team Member

Well, Chris, everyone, thank you for your time. Thank you to everybody for joining us today. We've run out of time. That concludes the call. I would encourage any investors who didn't get a chance to ask a question or have more questions to reach out to the IR team; we are here 24/7. Thank you.