Lesaka Technologies, Inc. (LSAK) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Net 1 Second Quarter 2019 Earnings Conference. [Operator Instructions]. Please note that this call is being recorded. I would now like to turn the conference over to Dhruv Chopra. Please go ahead, sir.

Thank you, Chris. Welcome to our Second Quarter 2019 Earnings Call. With me on the call today is our CEO, Herman Kotzé; and our CFO, Alex Smith. Our press release and a supplementary financial presentation are available on our Investor Relations website, ir.net1.com. As a reminder, during this call, we will be making forward-looking statements, and I ask you to look at the cautionary language contained in our press release regarding the risks and uncertainties associated with forward-looking statements. In addition, during this call, we will be using certain non-GAAP financial measures, and we have provided a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures. We will discuss our results in South African Rand, which is a non-GAAP measure. We analyze our results of operations in our press release in Rand to assist investors in understanding the underlying trends of 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. We will have a question-and-answer session following our prepared remarks. So with that, let me turn the call over to Herman. Herman Kotzé: Thank you, Dhruv, and good day to everybody else. As you are all aware, this was a very difficult quarter for our company, and the transition out of our SASSA contract has been more challenging than anticipated, given the auto migration of our EPE account holders. Alex will go over our financial results in more detail shortly, but our operating loss for the quarter was predominantly attributable to our rural South African businesses. Our remaining transaction-related businesses continue to operate in line with our expectations and provide a substantial source of EBITDA to the group. The annualized EBITDA contribution of these businesses based on Q2 2019 results was approximately $56 million. Furthermore, we have net cash of $35 million and remain comfortable with the group's liquidity position over the next 12 months. Our immediate focus is to return our EPE-related businesses to a monthly breakeven level by the end of the fourth quarter, in turn being both EBITDA and cash flow positive as a result. Going forward, the four pillars of Net 1 will be more geographic focused than business unit focused, and we expect will greatly reduce the complexity in analyzing our business. The four pillars will be, A, South Africa; B, Africa, C, Europe and Asia; and D, Korea. I will spend some time discussing each of these shortly. But before I address these pillars, I would like to briefly discuss my thoughts on current valuation, as I know this is top of mind. We believe that the issues we are facing are contained and manageable. We know where we need to quickly cut costs. We know how to do it, and we are confident that these changes will not impact the long-term viability of our strategic advantages or market opportunity. I want to reiterate that the company remains financially sound with sufficient liquidity, and as I mentioned, our other transaction processing business ex rural South Africa currently generates annualized EBITDA of $56 million, with the individual growth characteristics intact. When adding our investment portfolio, conservatively valued on our balance sheet at approximately $270 million plus our new initiatives in Europe and Africa, you have a robust profitable company with far more, certainly, in my opinion, than the stock price suggests. I would like to add that the management team and our Board of Directors all own stock at much higher prices and we are committed to seeing the value of our businesses properly recognized. Let me now address the first of our four pillars, namely South Africa. Starting with EPE and its related financial and value-added services businesses. As we disclosed last week, the High Court of South Africa recently unexpectedly reversed the portion of its November interim ruling that would have required SASSA to reinstate over 1.5 million EPE accounts that were auto migrated to South African Post Office, or SAPO, accounts. This setback and other headwinds, coupled with the interrelated nature of our consumer financial services, added significant bearing on our rural South African business segment in the second quarter. This rural South African segment includes EPE consumer bank accounts, Moneyline microlending services, Smart Life micro insurance and our mobile ATM network, and its roots stem from the infrastructure we have built out over the last 20 years to deliver services to this consistency. As recently, at the fourth quarter of fiscal 2018, this rural segment had been consistently profitable as we were approaching 3 million EPE accounts with many of those individuals also buying insurance and taking out loans, validating the strategy and value proposition we embarked upon 3.5 years ago. And importantly, we were quite confident that we could grow the business meaningfully from those levels. Our infrastructure, technology and experience of providing the most affordable financial services for the underbanked, low income, rural demographic in South Africa is second to none, and we believe would carry us through the transition. Unfortunately, we got it wrong for the sole reason that we have not been allowed to compete on a level playing field. We believed that we could rely on our contractual agreements with our EPE customers, particularly as this was confirmed by the High Court's interim order in November. The aggressive tactics employed by SASSA and SAPO over the last six months, without regard to commercial practices or rights and benefits of grant recipients, came as a surprise and have resulted in significant operating losses and write-offs for the company, not to mention the management bandwidth required to deal with the situation, rather than focusing on our newer business opportunities. We are still pursuing legal options at our disposal as we believe our EPE customers fulfilled all the regulatory requirements at the time of opening their accounts. At this junction, we are evaluating all options with regards to this business, but our immediate focus is to ensure that we rightsize our South African operations and get them to a immensely breakeven level in Q4 2019. We have already commenced with an extensive cost-reduction exercise, but given our local labor laws, will take 2 to 3 months before they can become fully effective. We have also dramatically scaled back the distribution footprint and mobile ATM fleet to focus only on high-volume areas at this time. Once the business is rightsized, we can always look to increase capacity again based on the amount at that time without having to include any significant capital expenditure. We believe we are currently running at a stable base of EPE customers, which have been consistent at these levels for December, January and February. There is a risk that our remaining base could also be auto migrated, and if we do see further deterioration in this business, we are willing to sell, merge or close this entire operation. It would be sad for us and devastating for our employees and the people of South Africa living in these rural communities, but given surface actions, we would have no other option. Having said that, we are actively engaging with SASSA to ensure that the million plus Annexure C forms that were presented by every single EPE account holder opening an account from 1 January, 2018 onwards is processed in line with the High Court's order, and those customers can continue to enjoy the benefits of their voluntary election. In addition to all of this, we need to focus our efforts on immediate changes to the business and will adapt if necessary in the future. We will proactively provide updates to any changes in the regulatory, legal, operational or strategic developments related to these businesses. Regarding Moneyline and Smart Life, both these products form a key part of the attractiveness of our EPE offering, namely access to the cheapest credit and insurance. We took an allowance on our doubtful finance loans receivable of approximately $23 million towards all the EPE customers who is accounts have not being funded until December 2018. The remaining book relates to all those customers who are current with their repayments in February 2019. Smart Life continues to be profitable even at a lower base. Our transaction processing and bulk payment platform, EasyPay, continue to post double-digit top line growth during Q2 2019. The UEPS/EMV certification for Finbond is now complete, and we are in a position to commence issuing cards next week. As with all other creditors exposed to the social grant recipients, Finbond has also experienced challenges in the recovery of loans from this market segment and has taken remedial measures to address this part of this business. As we work closely with Finbond on our go-to-market strategy, each business has a number of complementary assets, and we are evaluating the best way to maximize these synergies. DNI continues to grow ahead of budgets, despite the particularly challenging consumer spending environment and has begun to expand its offerings. It is also in the process of working with Smart Life to create new micro insurance products for its end market users. Cell C's operating performance continues to be in line with the performance of its peer in South Africa. They have concluded the implementation of their tower-sharing arrangement with MTN and now have a much larger geographic footprint in the country to address customers that were previously unable to service. While there have been market concerns about their competitive position and short-term liquidity, we believe, they have the mechanisms in place to manage their liquidity. An update on the operating performance will be provided when Cell C and Blue Label reports at the end of February 2019. Now let me address our second pillar, which is Africa. As a group, we want to meaningfully increase our focus on using our technology to address the financial inclusion opportunities on the continent. Depending on the country, 10% to 50% of the adult populations have access to financial services, and thus the deployment of cloud-based card and mobile-based solutions, together with strong local partners presents a substantial opportunity for us. Today, we are operational in Namibia and Botswana. We have footholds in nine other countries through our VTU offering in partnership with MTN. We have UEPS as a national payment system in Ghana, a rapidly growing consumer finance operation in Nigeria through OneFi and our brand-new QR-based payment initiatives with V2 and ZAP Group Africa, which in a few short months is already live in beta with one of the largest banks in Ghana and in advance discussions with one of the largest mobile operators in West Africa. We expect V2 to play an integral role in the deployment of our technology across Africa as its management team has an extensive network spanning across banks and telcos in Africa. There are clear synergies in having a single business development channel to promote a range of mobile and card-based payment technologies for the unbanked markets, and we are currently in the process of creating the appropriate structures, business model and prioritization of countries and hope to be able to provide a clearer road map on our next earnings call. OneFi in Nigeria has grown its revenue over 300% over the past year and ended calendar 2018 in the black. Its management team expects to more than double revenue again in 2019. As one of the first neobanks and digital lenders in Africa, OneFi's core app called, Paylater, continues to gain traction with over 1 million downloads and a remarkable customer conversion rate. They have also expanded into payments and soon expect to launch card-based products. OneFi also recently became the first digital lender in Africa to obtain a BB credit rating. The third pillar is Europe and Asia, driven primarily through IPG, or the International Payments Group. IPG continues to work in close collaboration with Bank Frick and our other specialist departments to develop bespoke blockchain-based solutions, including a highly secure, but easily accessible crypto asset storage solution for crypto asset investors and exchangers for which we have filed two patents during Q2. We are on track to have a live prototype in Q4. During the last 12 months, we have been focused on creating a world-class end-to-end solution to service the specific needs of underserviced SME merchants in Europe. These merchants require seamless and fast onboarding, bank accounts, payment gateway services and often the ability to issue cards to their customers. While our IT development teams have been creating the required solutions, which has now been certified by the required organizations, we have established our core operational center in Malta and exited our various offices in high-cost jurisdictions. We believe that IPG together with Bank Frick is finally in a position to be a challenger bank for the SME market in Europe. In India, MobiKwik continues its successful transition from being a mobile wallet-only provider to a full digital financial services provider. They currently issue more than 1,000 microloans a day through the app, which is able to approve and disburse an application in an industry-leading 90 seconds. In addition, during Q2, MobiKwik has also launched its micro insurance and micro investment products, allowing Indians to invest in mutual funds for as little as INR 100 or approximately $1.50. Our fourth pillar is Korea, or KSNET specifically. Operationally, KSNET put up another solid quarter, and we continue to see improvements in that unit. During Q2 2019, revenue declined a modest 3% in local currency, primarily due to a shift towards higher margin direct sales from lower margin agent sales, and as a result, EBITDA margins increased to 22% from 20% in Q2 2018. As we discussed last quarter, we appointed an external adviser to assist with the acceleration of top line growth and improving profitability as well as to evaluate our strategic alternatives for this business. We have made good progress over the past couple of months and our advisers are actively engaged both with KSNET management and head office. While its card VAN business was primarily impacted by the regulatory effects over the past couple of years, KSNET's banking VAN, payment gateway and working capital finance offerings are growing at significantly better rates and are accretive to overall margins. We continue to believe that we are on track to return EBITDA to a $40 million run rate in fiscal 2020. KSNET is a fabulous business with a great management team, who have proven their worth by expertly navigating some very difficult regulatory headwinds over the last several years. It is also a very unique business as there is only one other international payment processing company that operates in Korea. While we have stated several times in the past that Korea is not as strategic to the rest of our business, it has been a great free cash flow generator and does fit nicely in our core transaction processing portfolio. To conclude, before I hand over to Alex, I want to comment on our investment portfolio, which I believe, warrants meaningful attention by our current and potential shareholders. Taken together, these investments well exceed our total market cap, despite no contribution to our overall EBITDA and minimal contribution to our fundamental earnings per share results. We continue to see great value in our own shares and have approximately $76 million remaining on our existing share repurchase program. We remain restricted from using our current cash surplus and South African cash flows until we pay down our outstanding loans of approximately $35 million in full, and we have to reserve some of our foreign cash reserves for working capital purposes. Once our loans are repaid by June, or we find liquidity elsewhere, we expect to be in a position to consider opportunistically resuming our share repurchase program. Net 1 is transitioning through the most complex period in its history and despite our setback to the latest SASSA ruling, we believe we have a great foundation to return to being a high-growth company. We want to assure our shareholders that management and our Board of Directors are highly committed to limiting any future losses and are focused on growing our other profitable businesses, while launching several new and exciting ones. We are pleased with the performance of KSNET, DNI and our EasyPay financial switch and other transaction processing businesses in South Africa. We are considering all options with regard to the South African business, and our near-term focus is to ensure that we resize these operations and get them to a breakeven level by Q4 2019. Alex will now go over the financial performance and metrics in more detail before opening it up for Q&A.

Thank you, Herman, and good day to everybody. I will discuss the key results and trends within our operating segments for the second quarter of 2019 compared to a year ago. Turning to our results. For Q2 of 2019, our average Rand dollar exchange rate was ZAR 14.32 compared to ZAR 13.67 a year ago, which adversely impacted our U.S. dollar-based results by approximately 5%. The Rand has strengthened slightly since quarter-end and is currently trading around ZAR 13.60 to the dollar. Revenue of $97 million in Q2 2019 was down 35% year-over-year in dollars and down 31% in constant currency. Our fundamental earnings per share declined to a loss of $0.88 impacted predominantly by the losses incurred by our South African financial inclusion business as a result of the forced migration of SASSA grant recipients from EPE cards to SASSA cards. Fundamental EPS includes $0.74 per share of noncash adjustments, including a $0.41 allowance for doubtful loans receivable, a $0.28 Cell C fair value loss adjustment and a $0.05 Cedar Cellular note impairment loss. By segment, South African transaction processing reported revenue of $22 million in Q2 2019, down 66% compared with Q2 2018 on a constant-currency basis. The decrease was primarily due to the termination of the SASSA contract and to a lesser extent to the migration from EPE as mentioned above. Our revenue and operating income was also adversely impacted by the significant reduction in the number of SASSA grant recipients with SASSA branded Grindrod cards linked to Grindrod bank accounts as the contract ended in the end of Q1 2019 as well as the lower EPE numbers. These decreases in revenue and operating income were partially offset by higher transaction revenue as a result of increased usage of our ATMs as well as higher volumes in EasyPay. Our operating margin for Q2 2019 and 2018 was negative 53.8% and 21%, respectively. We have so far been unable to recover any additional fees in respect of the extension period of the SASSA CPS contract. We have engaged directly with SASSA to try and reach agreement on the pricing and this is ongoing. We have no visibility of the time lines to resolving this matter, despite the pricing recommendations of National Treasury, which were around 3x the original contract rate. International transaction processing generated revenue of $38.1 million in Q2 2019, which was down 14% compared with Q2 2018, primarily due to a contraction in IPG transactions processed, specifically meaningfully lower crypto exchange and China processing and modestly lower KSNET revenue. The segment generated an operating loss of $4 million in Q2 2019, which includes a noncash goodwill impairment of $7 million. Excluding this impairment, operating income during Q2 2019 was higher than in Q2 2018 due to the improved contribution from KSNET. Q2 2018 included an allowance for doubtful working capital finance receivables of $7.8 million. Normalizing for both these items, operating margin of 7.8% in Q2 2019 was stronger than the 6.4% margin in Q2 2018 and was sequentially stronger than the 7% recorded in Q1. KSNET has largely contributed to this margin improvement. For Q2 2019, KSNET's revenue decreased 3% in Korea Won to $35.4 million, while EBITDA margin increased 22% compared to 20% in Q2 2018. We experienced modest revenue pressures due to a change in mix in the business to higher margin direct sales from lower margin agent sales and operating income and margin continued to show improvements compared to the second quarter of fiscal 2018. The last of the cuts under the previous regulatory intervention on an interchange pricing came through in October 2018. Further rate adjustments are expected from February 2019, but the impact is not expected to be as significant as the previous adjustments, and we are taking actions to mitigate these effects. KSNET's cash conversion remains good, and we have access to approximately $12 million from Korea during the last quarter and a further $18 million in January 2019. IPG had another very challenging quarter as transaction volume remain low and they push to conclude their restructuring processes in Q2 2019. The impairment loss recognized relates primarily to goodwill within IPG. Given the consolidation and restructuring of IPG over the past year, several business lines were terminated or meaningfully reduced, and so we've written-off the associated goodwill despite our confidence in the long-term prospects of IPG. With the restructuring process largely complete, the focus has shifted to growing volumes as well as the launch of the various new products discussed previously. As a result, we expect to see performance steadily improve over the remainder of the fiscal year, albeit at a slower pace than previously communicated. Our financial inclusion and applied technology segment includes DNI from July 1, 2018 and reported revenue of $38.8 million in Q2 2019, down 25% on a constant-currency basis. Segment revenue decreased primarily due to a -- due to fewer prepaid airtime and value-added service sales, lower lending and insurance revenue and a decrease in intersegment revenue, partially offset by the inclusion in DNI. Operating margin was minus 47.8% compared to 23.5% in Q2 2018. Our gross lending book has been adversely impacted by SASSA's migration of EPE accounts, which effectively prevents us from collecting loan repayments as no direct debits can be run against the SAPO bank accounts. In Q2 2019, we created an allowance of $23.4 million, approximately ZAR 335 million, to compensate for the nonrecoverability of debtors. We have effectively provided for all loans when no repayments have been received since December and consistently maintained a conservative allowance against the remaining book. With the stability we've seen in the EPE account base since December, collections, both the quarter-end, post the quarter-end, have stabilized, and we would expect this to continue provided there is no further reduction in the customer base. We have seen a similar impact on Smart Life from the impact of the SASSA transition. Where Smart Life customers moved to a SAPO account, we are unable to collect the direct debit against that account. We have initiated various new collection mechanisms to deal with these issues, and we experienced increasing very limited success to date. As a result of the SASSA migration, we have seen policy numbers drop from around 480,000 at its peak to 400,000 at the end December, but based on uncollected premiums, this is expected to drop to around 200,000 in the next quarter as the policies only lapse after four months. With the expected reduction in claims and with the reduction in provisioning levels, we expect Smart Life to remain profitable with a much reduced levels with these policy numbers. In the December pay cycle, just under 1.1 million of our EPE customers received an incoming deposit into their accounts compared to 1.3 million in October, and these numbers remain stable in the January and the February 2019 payment cycles. Our ability to sign up new EPE accounts during this period was limited due to the accounts of SASSA, thus despite opening up new accounts, only about 40% of them have received a grant to date. Our corporate expenses have increased primarily due to higher acquired intangible asset amortization. We carry our investment in Cell C at fair value and fluctuations in its carrying value from reporting period to reporting period are expected. During Q2 2019, we recorded a noncash fair value adjustment of $16 million, which adversely impacted our results. Our valuation methodology has remained unchanged and the decline in fair value is solely attributable to a decline in the market multiples of the peer group of eight African and emerging market mobile, telecoms operators. We also had to impair the carrying value of the Cedar Cellular notes in line with this reduction in fair value. Our Q2 2019 net interest expense was $3.1 million compared to net interest income of $2.4 million in the comparative quarter. However, this included the impact of a $2.7 million impairment of the Cedar Cellular notes, which affected interest income. Excluding this effect, net interest expense was $0.4 million. This change was due to the cash utilized for strategic investments in fiscal 2018 and the interest expense increased due to the South African lending facilities we obtained, particularly in respect of the funding of our ATMs. We recognized losses from equity accounted investments of $1.3 million during Q2 2019 compared to earnings of $1.3 million in the same period last year. The reduction from the comparative period is primarily due to the fact that DNI did not contribute to equity income in Q2 2019, as the business is being consolidated effective July 1, 2018. We expect the contribution from our equity accounted investments to be positive on an annual basis, as it is impacted by the timing of reported results by our various investments. At December 31, 2018, our unrestricted cash was approximately $70 million compared to $90 million at the end of June. The decrease in our cash balances from June 30, 2018 was primarily due to significantly weaker trading activities, scheduled debt repayments, dividend payments to noncontrolling interest and capital expenditures, which was partially offset by the utilization of our debt facilities to fund our ATMs and finance our lending to Cell C to fund the construction in mobile, telephone network infrastructure, the contribution from the inclusion of DNI and a decrease in our South Africa lending book. Free cash flow utilization amounted to $7.8 million, which included a $7 million working capital release. Apart from our lending arrangements, we continue to fund the group's operations utilizing our cash reserves. We have in place short-term credit facilities of ZAR 1.75 billion or $121 million, specifically to fund our ATMs in South Africa and have presented cash gone under these facilities and in the processing system as restricted cash on the balance sheet. As of December 31, 2018, we had restricted cash of $63 million and associated short-term facilities utilization of $63 million. We had short-term banking facilities available to us in various territories of $31 million at December 31, 2018, none of which had been utilized. As of December 31, 2018, we had outstanding long-term debt of ZAR 380 million, or $26 million, under our South African facilities. We expect to make two further principal repayments of ZAR 151 million during the remainder of fiscal 2019, three equal repayments totaling ZAR 79 million during fiscal 2020 and the remainder of our debt will be settled in full in June 2021. Our Q2 2019 tax benefit was $2.3 million compared to an expense of $10.1 million in Q2 2018. Our effective tax rate for Q2 2019 has been significantly impacted by impairments and the losses incurred by certain South African businesses as we have effectively not recorded a deferred tax asset benefit related to these net operating losses. Our effective tax rate will continue to be heavily distorted by losses incurred by certain of our businesses until we return the affected operations to at least a breakeven position. Our actual and weighted average share count for each of December 31, 2018 and Q2 2019 was 56.8 million shares. In light of the losses in the South African EPE-related operations, we have initiated a cost-reduction exercise, which will take these operations to a monthly breakeven position by the end of the fourth quarter of fiscal 2019. The key components of the cost base that need to be reduced our headcount, security and related infrastructure costs. Respecting local labor law, we will only see the full benefits of the cost cutting on a monthly basis in the fourth quarter of fiscal 2019. Once we achieve breakeven on the South African operations, it should return the group to a positive EBITDA and cash flow position. We can now open up the call for Q&A.

[Operator Instructions]. Our first question is from Allen Klee from Maxim Group.

So my first question is, if you could help us simplify the analysis of what your earnings or losses would have been if you excluded the challenged South African businesses? And how much of the losses from the, say, financial inclusion business kind of and you think about, what the -- you mentioned that you could have a positive operating margin in that business, maybe starting next year, but what type of margin are we talking about?

Allen, I think, in terms of the impact of the South African rural and financial inclusion businesses on the results are roundabout $37 million of operating loss came out of that segment or out of those business units in the quarter. So you can see a very substantial portion of the loss is really coming from those businesses. And that's really the -- our Moneyline business, our Smart Life business and the mobile ATM infrastructure and the various cost bases related to it. We think that for the third quarter, our overall sort of group EBITDA number should be in the region of a loss of about $5 million based on a normal -- on the current run rate and the current account -- customer base, particularly in the EPE space. And that would, obviously, exclude any once-off items, which will occur in the third quarter as we go through the various cost-cutting exercises.

Okay. And then another kind of bigger picture question. You have a significant value in your investments and KSNET in my view. But the market's not giving you credit for them, and it seems that management will need to take actions to unlock this value in order to likely get credit. So my question is, how does the management think about this? Herman Kotzé: Allen, there are obviously various assets within the portfolio and they -- of different sizes and in different geographies. The way we look at them is individually. We understand that some of these individual portfolio assets have a longer path to liquidity potentially than others, and so we evaluate and look at each of these on an ongoing basis. And so I think it's important to stress that clearly, the KSNET is by far the largest contributor to the group earnings, not necessarily part of the investment portfolio, but I think, a lot of our shareholders look at KSNET as a bit of an outsider in terms of the overall group structure, and as I've said, it fits very nicely into our transaction processing portfolio, but we are busy with an ongoing exercise and where appropriate, we do bring in expertise and help from the relevant management advisers and/or banks to help us understand what the potential opportunities are out there for the businesses. So it's an ongoing process. It's something that we are very aware of, and obviously, we will keep our shareholders updated as to any developments as and when they happen.

The next question is from Scott Buck from B. Riley FBR.

I'm curious, are you continuing to issue new loans within the microlending book? Herman Kotzé: Scott, yes, we are. So there is a different methodology that we actually adopted in as far ago as February last year. So on a very selected basis, we provide loans to people that have obviously got EPE accounts. Those accounts need to be active for at least a minimum period of three months, and we, obviously, do have comprehensive affordability assessment on them. The extent of -- just to give you an idea of the application versus actual disbursement ratio is that we reject more than 60% of all the applications that we receive. And I think, the indication of the quality of the book that remains is such that the first strike collection rate on the booking in -- for the month of February was in excess of 98%. So short answer, yes.

Okay. That's helpful. And then I know you had some trouble growing EPE accounts organically this quarter. What's the thought process going forward on what the marketing efforts are going to be to try to continue to grow some of those account numbers organically? Herman Kotzé: Yes. So the account numbers have been fairly static over the last three months, and we have registered some nominal growth in the uptake rate. The big plan for the next 3 to 6 months is to focus on the distribution channel that we have now unlocked through our relationship with Finbond. So over the last quarter, we have also been able to obtain the required certifications for Finbond to become an issuer of our UEPS/EMV cards. And so with that behind us, we now have access to Finbond's 450-odd branches in addition to our own 250-odd branches, we have of approximately sort of 670, 680-odd locations across South Africa to really market the EPE offering. We hope to add additional products to this offering specifically in the field of low-cost telephony and data access, which we believe, is still an important consideration for our customer base. But there will be a lot of focus and effort, not only, obviously, from ourselves, but also in collaboration with Finbond to grow this customer base going forward.

The next question is from Joshua Raisen from Edell Street Asset Management [ph].

Given the changes to bring the EPE base back to breakeven, do you have a clear idea how many current EPE customers fall outside of what will be the new geographical operating area? Herman Kotzé: None. So we will still able to service all of the current EPE customer base. The rightsizing that we are doing is of such a nature that we are not at all closing down specific geographies. It is a factor of rightsizing the individual teams within each of those areas, but making sure that we retain a core team that is capable of servicing those EPE cardholders. Our fixed ATM base obviously remains in place, so there is over 1,100 of those. We hope to grow that quite significantly over the next 12 months by another 500 or so. It is really only on the mobile ATM base, which is by far the most expensive of all of our distribution channels that we are scaling back. But again, where the volume warrants the actual deployment of those ATMs, we will continue to service the cardholders in that area.

[Operator Instructions]. The next question is a follow-up from Allen.

The financial inclusion segment looks like, if you excluded the doubtful finance account loan allowances, you'd have around 12.5% operating margin. The segment had been running at around 20%, 25-ish percent or so. Is this 12.5% kind of the right number to think about going forward?

I think the 12.5% is certainly at the bottom end of where we would expect to be, Allen. The financial inclusion segment is highly sensitive to the addition of other goods and services and products into the customer base. And so given the amount of containment exercises that's been going on over the last three months or so, we haven't really focused on expanding the product base. But as that gathers momentum, we would expect the margin in the financial inclusion business to start recovering back towards the sort of 20% region.

Okay. And then a follow-up. Explain a little more KSNET's revenue declined and that you've been running around an $8 million quarterly EBITDA for KSNET. So what -- I'd like to understand, what makes you confident that next fiscal year you can get to that $10 million run rate to get you to a $40 million annualized EBITDA. What -- I know you have a third party you're working, but what's going to -- what do you think is the actions that's going to increase that? Herman Kotzé: There are a few of them. In no order of importance, the work that we're doing at the moment, really focuses across all the key product areas of the business. So if we look at the first one, which is the card VAN or the proper sort of card processing business, and that by far is obviously the biggest contributor to KSNET's financial results. The key focus for us in that specific segment is twofold. First, we are specifically focusing on diversifying our merchant portfolio to not be completely focused on the SME market in South Korea, but to include some of the more sort of medium and larger size merchants within that specific portfolio. Those merchants, although the sales cycle is slightly longer, have a slightly more profitable contribution to the overall EBITDA result. The second element that we are focusing on really involves around the difference between the agent-based distribution model that we follow quite extensively in South Korea and a direct sales-based model. And so obviously, with the use of agents, there is the introduction of an intermediary party, that introduces all sorts of different cost and complications. And so we are in the process of carefully analyzing all of those individual relationships to make sure that we focus on the profitable ones, and that we reduce our exposure to the regions or the agents, who are less profitable for the business. The second area or the product that we are focusing on is our banking VAN product. I think this is by far our most profitable offering in the South Korean market, and we are the only VAN company that actually offers this as a service. I think the barriers to entry are pretty high, and so we are focusing on aggressively marketing VAN product into the larger sort of Korean space. And finally, we have a working capital finance business, which was conceived about 2.5 years ago. And with very careful and conservative initial testing and prototyping, we are now finally in a position where we can offer this as an additional product to all of our merchants, specifically, the SME merchants. Again, these will be loans that are very relatively small in size, but are absolutely critical for these businesses to grow their own activities. And obviously, as the process we have full visibility of what those businesses actually do in terms of revenue and throughput, and we, obviously, have very good security against those advances. And so the combination of those three with obviously a few other things that are not as important, we hope to get back to the sort of $40 million EBITDA rate in 2020.

Next question is from Thomas Zeifang of Lucrum.

Could you help me understand what the recurring revenue and recurring operating profits are by business unit using Q2 '19 as your base? Herman Kotzé: Business unit.

Yes. The recurring revenues in terms of the individual segments that we report...

Yes. So if you back out the main levy that you guys had in the second quarter knowing that that's going to go away. Can you give me those what you're -- recurring what you consider recurring revenues and EBITDA, so we can get a sense of what the current businesses worth? And also, if you could do that on a -- from the investment portfolio, what that generates relative to your share of those percentages?

I can cover it by segments as opposed the business units. Our total sort of revenue run rate of the recurring businesses, and really here we're talking about sort of five business units. So we've sort of identified DNI, the KSNET and some of the South African sort of processing businesses, excluding the troubled businesses. Then there is about $56 million of recurring EBITDA sitting within that space and the annual revenue of about $300 million. Does that make sense?

That's recurring? Herman Kotzé: Yes.

Yes. We obviously have to rightsize and fix the troubled areas in order for that to be evident in the results. Herman Kotzé: Yes.

And is -- of the $56 million annualized, KSNET is part of that, correct?

Yes, a very substantial portion of that, yes.

So it's $32 million of the $56 million?

Yes, approximately.

And so when you make these adjustments going forward, what do you think the exit rate for June will be?

For June, difficult to say given we are -- the cost-cutting exercise is obviously a big one, and we expect to be breakeven on a monthly basis by the end of Q4, but there will obviously be recurring -- there'll be -- there will have been losses during that fourth quarter, and there's like to be a lot of once-off costs in both Q3 and Q4 associated with the cost-reduction process.

How much we're losing on a monthly basis right there? Herman Kotzé: On those South African businesses. I mentioned earlier that...

Correct. Herman Kotzé: For the quarter... Herman Kotzé: Q3.

For Q2, we saw about $37 million losses in those South African businesses. That obviously includes some of the -- obviously includes the $23.4 million of write-offs. But really, Q3, on the basis of what we see now and assuming there's no further significant events, from a group perspective, we'd expect to see EBITDA losses of about $5 million for third quarter.

For the quarter, but not for each month?

No. For the quarter. That's on a group-wide basis.

We have a follow-up question from Allen.

For the South African transaction business, how do you visualize going into next fiscal year, if you do rightsize it, is this a business that you think you can get a margin on it? And if so, what type of margin would that be? Herman Kotzé: Yes. I think, definitely, this is -- remember, the South African transaction processing businesses include some of the other perennially good performance, including the EasyPay, bulk payment and transaction processing switch. The biggest sector when we look at the margins and what this business will contribute going forward, Allen, is that the CPA, let's call it, the traditional, rural South African mobile banking base will be gone going into fiscal 2020. It obviously has been depressing our margins for quite some time as the volumes -- the payment volumes in those specific -- for those specific channels came down. By the end of this year, we would have eliminated all of the high cost associated with the running that part of the business, so that would include staff, security and cash handling costs. And so entering the new year, I think, the business will be profitable as it has been, if you stripped out those specific cost over the last year or so. And again, we would like to see the overall margin of that business recover over the course of next year to the sort of levels that we had in 2017 and 2016.

Ladies and gentlemen, this does conclude the conference call. And you may now disconnect your lines.