Business context and reporting period
Net 1 UEPS Technologies, Inc. (now Lesaka Technologies Inc.) filed this Form 10-Q for the three months ended September 30, 2018, its first quarter of fiscal 2019—not calendar 2018 Q1. The company provides transaction processing, payment technology and financial-inclusion products, including banking, lending and insurance services. Unless noted, financial amounts below are U.S. dollars.
The quarter coincided with the September 30 expiration of the company’s South African Social Security Agency (SASSA) contract for cash grant payments. The filing’s prior-year June 30, 2018 balance-sheet figures are restated where indicated.
Financial performance and liquidity
- Revenue: $125.9 million, down 17% from $152.6 million. The decline reflected the SASSA contract wind-down, weaker lending and international processing activity, and unfavorable currency translation; consolidation of DNI partly offset the decline.
- Profitability: Operating income fell 96% to $0.9 million from $25.0 million; operating margin was 0.7%, versus 16.4%. Net loss was $5.1 million, compared with net income of $19.7 million. Net loss attributable to Net1 was $5.2 million, or $0.09 per diluted share, versus attributable income of $19.5 million, or $0.34 per share.
- Costs and tax: Depreciation and amortization increased 20% to $10.8 million, mainly from DNI-related acquired intangibles. Interest income decreased to $1.9 million from $5.0 million, while interest expense rose to $2.8 million from $2.1 million. The $6.5 million tax expense despite near break-even pretax income included a valuation allowance on CPS tax losses and non-deductible expenses.
- Cash flow: Operating activities provided $16.5 million, versus $0.8 million used a year earlier. Investing activities provided $73.4 million, principally reflecting a $75.9 million net decrease in settlement assets; financing activities provided $4.4 million. Capital expenditures were $3.1 million.
- Cash and liquidity: Cash and cash equivalents were $98.6 million; restricted cash was $84.8 million, reserved for ATM funding. Cash, cash equivalents and restricted cash totaled $183.3 million. Management said cash and credit facilities were expected to fund operations for at least the next four quarters.
- Debt and balance sheet: Reported borrowings included $88.1 million of utilized short-term credit facilities, $33.9 million current long-term borrowings and $11.7 million long-term borrowings. Most ATM-related short-term borrowing is matched by restricted cash and cannot be used freely. Total assets were $1.20 billion and total liabilities $368.6 million at September 30, 2018.
Material changes versus the prior-year quarter
- South African transaction-processing revenue declined 43% to $37.7 million, and the segment recorded a $3.5 million operating loss versus $12.3 million income. CPS incurred a $15.7 million operating loss as grant volumes fell and the company maintained its payment infrastructure through contract expiry.
- International transaction-processing revenue declined 14% to $39.4 million, with lower IPG activity and ongoing Masterpayment losses partly offset by improved KSNET contribution.
- Financial inclusion and applied technologies revenue was $53.2 million, down 2%; segment operating income was $11.3 million, down 19%. DNI was consolidated for the full quarter and contributed $266.5 million of revenue and $112.8 million of operating income in South African rand.
- The South African rand weakened against the U.S. dollar; management cited approximately 13% year-over-year appreciation of the dollar against the rand as an adverse translation factor. Results in rand also showed operating income down 96%.
Outlook, risks, contingencies and unusual items
- SASSA pricing and litigation: The contract ended September 30, 2018. The court had not confirmed the price payable for services during the extension, so the company recorded no additional revenue for the disputed amount. CPS is appealing an order requiring it to refund ZAR 317 million plus interest to SASSA; the appeal was expected to be heard in the first half of calendar 2019. Outcomes and any additional compensation remain uncertain.
- Customer and credit risks: Management said SASSA’s transition to SAPO accounts had reduced active EPE accounts to 1.7 million by October 2018, after approximately 900,000 accounts were moved. The company reported higher loan defaults and insurance lapses, and 230,000 Smart Life debit-order rejections in October that could lead to further lapses. Management reduced expectations for EPE account growth for the rest of the fiscal year.
- Strategy and investment: The company was expanding its rural ATM and branch network. It expected Cell C’s network-sharing arrangement with MTN to support telecom offerings from January 2019, and expected to issue Finbond-sponsored cards in January 2019. On October 4, 2018, it acquired a 50% interest in V2 for $2.5 million and committed to possible further investment and working-capital support subject to conditions.
- Contingent obligations: The company recorded $26.8 million of present-value DNI contingent consideration, subject to performance targets. It also had $6.8 million of counter-guarantees and reported $0.4 million of capital commitments. The possible additional V2 commitments were conditional.
- Restatement and controls: Net1 restated its June 30, 2018 financial statements after correcting Cell C investment accounting: a $25.2 million after-tax fair-value gain was moved from other comprehensive income into earnings. The filing says this restatement did not affect the current quarter. Management concluded disclosure controls were ineffective as of September 30 because of a material weakness in controls over complex, non-routine accounting; remediation was planned but not yet demonstrated effective.
- Other uncertainties: Cell C’s $167.8 million fair value was based on a Level 3 valuation model and was sensitive to assumptions. Foreign-currency, lending-credit, liquidity and regulatory risks were also disclosed. The company had not completed its accounting assessment of certain U.S. tax-law effects; future adjustments could affect tax expense.
Important facts for investors to verify
- Any court decision on SASSA extension pricing, the ZAR 317 million refund order and related interest, and the progress and outcome of the appeal.
- Whether EPE account transfers, customer retention and ATM usage stabilize, and whether loan defaults and insurance lapses improve.
- Availability and terms of ATM funding facilities, scheduled debt repayments, and the distinction between unrestricted and restricted cash.
- The assumptions supporting Cell C’s Level 3 valuation and any subsequent changes in its operating or financing position.
- Implementation and effectiveness of the accounting-control remediation plan, including any further restatements or adjustments.
- Whether the stated four-quarter liquidity outlook holds as operating performance, lending collections and strategic investment funding develop.