LESAKA TECHNOLOGIES INC quarterly report, Q2 FY2018

Business context and reporting period

Net 1 UEPS Technologies, Inc. filed this unaudited Form 10-Q for the quarter and six months ended December 31, 2017, the second quarter and first half of fiscal 2018. The company operates in South African transaction processing, international transaction processing, and financial inclusion and applied technologies. Figures below are U.S. dollars; financial statement amounts are in millions unless noted.

Financial performance

• Quarterly and six-month revenue each declined 2%. Operating income fell 36% for the quarter and 28% for the half; net income attributable to Net1 fell 48% and 33%, respectively.
• Quarterly SG&A rose 18% to $49.4 million, including a $7.8 million allowance for doubtful working-capital finance receivables. Management said quarterly operating margin would have been 16% rather than 11% excluding that allowance; first-half margin would have been 16% rather than 14%.
• Equity-accounted investment earnings increased to $1.4 million for the quarter and $3.4 million for the half, largely reflecting the DNI and Bank Frick investments. Higher borrowing costs and reduced interest income following investment of cash also weighed on results.
• Investing cash flow was negative $39.9 million for the half, including investments in Cell C, DNI and Bank Frick. Financing cash flow was negative $169.2 million. Cash and cash equivalents fell to $64.9 million from $258.5 million at June 30, 2017. The company attributed the decline mainly to investments, debt repayments and growth in its South African lending book.
• At December 31, reported short-term credit facilities were $35.6 million; long-term borrowings were $70.4 million, including $50.5 million current and $19.9 million long-term. Current assets included $412.2 million of settlement assets, offset by equal settlement obligations; excluding these pass-through balances, current assets were $314.9 million and current liabilities $147.5 million.

Material changes, outlook and risks

• Portfolio and strategy: The company bought 15% of Cell C for $151.0 million, 45% of DNI for $72.0 million, and 30% of Bank Frick for approximately $40.9 million. Cell C was valued at $161.7 million using a Level 3 model, representing about 12% of total assets. The DNI agreement includes up to $29.1 million in contingent consideration, subject to performance targets; none was accrued at quarter-end.
• Working-capital finance: Management decided to wind down lending to non-payment-solutions customers. The book was $35.8 million net of an $11.8 million allowance at December 31, compared with $56.5 million net of a $4.0 million allowance in September. Two U.S. petroleum-sector customers owed about $7.8 million; the company provided an allowance for the full amount. In January 2018, Bank Frick purchased the remaining European book for face value, and proceeds were used to repay the Bank Frick overdraft facilities, which were then to be cancelled.
• SASSA contract uncertainty: The South African social-grant payment contract was scheduled to expire March 31, 2018. SASSA reported that SAPO was expected to assume distribution from April 1, but would need a transition period; SASSA sought an interim extension through September 30, 2018, and issued a tender for cash payments. The company continued to process grants and reported paying 10.7 million recipients monthly. Contract transition, tender outcomes and related court proceedings pose material business uncertainty.
• Business trends: Management cited South Korean card-fee regulation, lower prepaid and terminal sales, higher credit-loss allowances and salary costs as pressures. EPE adoption, insurance activity, ATM use and cryptocurrency-related processing at Masterpayment supported results. EPE had more than 2.3 million active accounts at January 31, 2018.
• Liquidity and spending: Management believed cash and credit facilities were sufficient for at least the next four quarters. It expected third-quarter capital spending mainly for Korean payment terminals and South African ATMs and branches. This is not earnings guidance. The company also disclosed foreign-exchange, credit, customer-concentration, interest-rate and liquidity risks; guarantees to Nedbank had a maximum potential amount of $10.2 million.
• Tax and reporting: Effective tax rates were 53.8% for the quarter and 43.6% for the half, affected by valuation allowances, nondeductible expenses and U.S. tax-law changes. The company said the full impact of the Tax Cuts and Jobs Act was still under evaluation. A $107.7 million redeemable-stock reclassification reduced reported permanent equity but did not affect income or cash flows.
• Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no off-balance-sheet arrangements and said ordinary-course claims were not expected to have a material adverse effect.

Important facts for investors to verify

• Whether SASSA’s contract was extended, how the transition and tenders proceeded, and the effect on payment volumes and revenue.
• Actual recovery on the $7.8 million U.S. customer exposure and the run-off, sale or further impairment of the working-capital finance book.
• Post-quarter settlement and cancellation of Bank Frick facilities, and the resulting cash, debt and available credit position.
• Cell C’s operating performance and valuation assumptions, DNI’s performance-linked payment, and the strategic and financial returns from the three investments.
• Whether the company sustained operating cash generation as lending expanded, and how credit-loss provisions, South Korean regulation and currency movements affected margins.