Financial Director's report

Financial review

Core headline earnings for the year ended 31 May 2019 equated to a negative 304.77 cents per share. Although the core businesses of the Blue Label Group continued to generate profit, the predominant negative contributions to Group earnings were attributable to:

• Cell C's trading losses, impairment of certain of its property, plant and equipment, the impact of the derecognition of its deferred tax asset and the impairment of Blue Label's total investment in Cell C
• fair value downward adjustments of the exposure relating to SPV1 and SPV2 pertaining to the initial recapitalisation of Cell C (the structure of SPV1 and SPV2 as detailed in the trading statement published on SENS on 22 February 2019) and the Glocell loan;
• an impairment of Blue Label's total investment in the Oxigen India group, including 2DFine Holdings Mauritius (collectively, OSI) as well as providing for loan impairments and guarantees payable therein; and
• partial impairments of goodwill and an investment in a joint venture.

On exclusion of the above negative contributions, core headline earnings amounted to R904 million* compared to R716 million in the prior year, equating to growth of 26%. After taking into account the increase in the weighted average number of shares in issue, core headline earnings per share from the balance of the entities within the Blue Label Group increased by 18% from 83.65 cents to 98.98 cents for the year ended 31 May 2019, as detailed in the table below.

It is evident that the investment in Cell C had a significant negative impact on Group earnings. However, the contemplated national roaming agreement is anticipated to result in substantial cost savings for Cell C by reducing network and capital expenditure when implemented. These savings are expected to be further enhanced on completion of an intended Cell C capital restructure.

* On exclusion of the negative impact attributable to:

• Cell C's trading losses, impairment of certain of its property, plant and equipment, the impact of the derecognition of its deferred tax asset and the impairment of Blue Label's total investment in Cell C;
• Fair value downward adjustments of the exposure relating to SPV1 and SPV2 pertaining to the initial recapitalisation of Cell C and the Glocell loan;
• An impairment of Blue Label's total investment in the Oxigen India group, including 2Dfine Holdings Mauritius, as well as providing for loan impairments and guarantees payable therein; and
• Partial impairments of goodwill and an investment in a joint venture.

* As a result of prior year errors the Group has restated their comparative financial information. Refer to note 11 in the Group annual financial statements for details.

group income statement

* As a result of prior year errors the Group has restated their comparative financial information. Refer to note 11 in the Group annual financial statements for details.

revenue

Group revenue declined by 3% to R25.9 billion. As only the gross profit earned on "PINless top-ups", prepaid electricity and ticketing are accounted for, on imputing the gross revenue generated thereon, the effective growth in transactional values equated to 10% from R52.6 billion to R57.8 billion.

Gross Profit

Gross profit increased by 16% from R2.28 billion to R2.65 billion, underpinned by an increase in margins from 8.54% to 10.23%.

Overheads

Overheads, comprising employee costs and operating expenses, increased by 15% to R1.09 billion, of which the former accounted for 13% and the latter 16%.

The 3G Mobile group, which became a wholly owned subsidiary on 6 December 2017, incurred overheads of R101 million in the current year compared to R47 million for part of the prior year. Glocell Distribution was acquired during the current year and Wi-Connect became a subsidiary in the current year, incurring overheads of R36 million and R46 million respectively.

Impairments and fair value losses

Impairments and fair value losses of R1.21 billion, for the year ended 31 May 2019, were predominately attributable to fair value downward adjustments of R874 million relating to the non-recoverability of the exposure to SPV1 and SPV2 and the Glocell loan, guarantees payable recognised on behalf of OSI for R62 million and loan impairments therein of R161 million, offset by sureties receivable of R30 million on the latter amount. Further declines related to partial impairments of goodwill in both Via Media and Blue Label Connect of R74 million and R50 million respectively.

EBITDA

The decline in EBITDA from R1.34 billion to R463 million was attributable to the impairments and fair value downward adjustments mentioned above. On exclusion of these negative contributions, EBITDA generated by the Group increased by 24% from R1.34 billion to R1.65 billion.

Depreciation and amortisation

Depreciation, amortisation and impairment charges increased by R97 million to R253 million. Of this increase, R26.9 million pertained to depreciation on additional capital expenditure incurred during the year, impairments of R3.2 million and R67.4 million relating to the amortisation of intangible assets, of which R52.6 million emanated from purchase price allocations on historical acquisitions which increased from R46.5 million to R99.1 million.

Net finance costs

Finance costs totalled R246 million, of which R231 million related to interest paid on borrowed funds and R15 million to imputed IFRS interest adjustments. On a comparative basis, interest paid on borrowed funds amounted to R167 million and the imputed IFRS interest adjustment equated to R140 million. Of the latter amount, R75 million was attributable to credit received from suppliers and R65 million to the acquisition of 3G Mobile and Airvantage. The increase of R64 million was attributable to additional borrowings utilised from existing facilities.

Finance income totalled R100 million, of which R97 million was attributable to interest received on cash resources and R3 million to imputed IFRS interest adjustments on credit afforded to customers. In the prior year, interest received on cash resources amounted to R192 million and the imputed IFRS interest adjustment to R3 million.

Impairments on associates and joint venture

Impairments on associates and joint venture amounted to R2.67 billion, of which R2.52 billion related to the impairment of the investment in Cell C, R118 million to OSI and R29.5 million to Supa Pesa.

As at 31 May 2019, no value was attributed to the underlying value of Cell C and as a consequence thereto the balance of the carrying value of Blue Label's investment therein, amounting to R2.52 billion, was impaired.

The proposed corporate transaction in OSI, referred to in the subsequent events of the 30 November 2018 interim results, did not materialise, and the resultant lack of funding necessitated BLT to impair its full investment therein of R118 million.

Share of (losses)/gains from associates and joint ventures

For the year ended May 2019, Cell C incurred trading losses of R1.56 billion, impairments of its property, plant and equipment of R2.2 billion and derecognised its deferred tax asset of R4.09 billion. The Group's 45% share amounted to R3.609 billion on inclusion of the amortisation of intangible assets of R10 million and an expense of R65 million relating to equity-settled share-based payment charges that were previously added back in the prior year in line with the Group's accounting policy. In the current year the share-based payment is regarded as cash settled.

In addition, the financial performance of OSI was equity accounted for, of which the Group's share of losses amounted to R86 million. Of this amount, the Group has accounted for a R41 million liability relating to financial guarantee contracts and R46 million for its share of losses.

United Call Centre Solutions generated earnings of R45.1 million, of which Blue Label Data Solution's share amounted to R22.5 million.

Non-controlling interests

Non-controlling interest comprises minority share of profits in Cigicell, Transaction junction, Via Media, Blue Label Data Solutions, Airvantage, AV Technologies, Reware and Glocell Distribution, the total of which equated to R24 million.

Core headline earnings

Core headline earnings declined by R3.94 billion to a loss of R2.78 billion. This equated to core headline loss per share of 304.77 cents.

On exclusion of the above negative contributions by Cell C, Oxigen Service India group, fair value downward adjustments and impairments, core headline earnings amounted to R904 million* compared to R716 million in the prior year, equating to growth of 26%. After taking into account the increase in the weighted average number of shares in issue, core headline earnings per share from the balance of the entities within the Blue Label Group increased by 18% from 83.65 cents to 98.98 cents for the year ended 31 May 2019.

* On exclusion of the negative impact attributable to:

• Cell C's trading losses, impairment of certain of its property, plant and equipment, the impact of the derecognition of its deferred tax asset and the impairment of Blue Label's total investment in Cell C;
• Fair value downward adjustments of the exposure relating to SPV1 and SPV2 pertaining to the initial recapitalisation of Cell C and the Glocell loan;
• An impairment of Blue Label's total investment in the Oxigen India group, including 2Dfine Holdings Mauritius, as well as providing for loan impairments and guarantees payable therein; and
• Partial impairments of goodwill and an investment in a joint venture.

* As a result of the prior year errors the Group has restated their comparative financial information. Refer to note 11 of the Group annual financial statements.

The above table reflects the negative contribution by Cell C, the fair value downward adjustments relating to the exposure in SPV1 and SPV2 and the Glocell loan, the partial impairment of Blue Label Connect's goodwill as well as the positive contribution by the remaining entities within this segment. These entities include the 3G Mobile group, Airvantage and the core distribution companies, generating a combined contribution of R919 million to core headline earnings.

Cell C

For the 12 months ended May 2019, Cell C incurred trading losses of R1.56 billion, impairments of its property, plant and equipment of R2.2 billion and derecognised its deferred tax asset of R4.09 billion. The Group's 45% share amounted to R3.609 billion on inclusion of the amortisation of intangible assets of R10 million and an expense of R65 million relating to equity-settled share-based payment charges that were previously added back in the prior year in line with the Group's accounting policy. In the current year the share-based payment is regarded as cash settled. As at 31 May 2019, no value was attributed to the underlying value of Cell C and as a consequence thereto the balance of the carrying value of Blue Label's investment therein, amounting to R2.52 billion, was impaired.

Cell C Limited performs an annual impairment test on the carrying value of its property, plant, equipment and intangible assets (cash-generating unit (CGU)). The impairment was calculated by applying the value-in-use (VIU) method, on a discounted cash flow basis. The impairment assessment was based on the carrying value of the CGU and is reflective of the conditions that existed at the reporting date. Assumptions were made on the cash flows, which were limited to the generation of cash by the CGU, not taking into account new technology, expansionary growth or the pending recapitalisation transaction. The exclusion thereof are requirements of IAS 36 – Impairment of Assets.

The recoverability of the deferred tax asset is required to be performed on an annual basis. A deferred tax asset is recognised in respect of deductible temporary differences and tax losses to the extent that it is probable that future taxable profits will be available. At the reporting date, based on estimated future profitability with no regard to new technology, expansionary growth or the pending recapitalisation transaction, the deferred tax asset was impaired.

For the 10 months ended 31 May 2018, Cell C's net profit amounted to R1.125 billion. This comprised trading losses of R765 million, impairment of certain of its property, plant and equipment of R32 million offset by the recognition of a deferred tax asset amounting to R1.92 billion. The Group's share of this net profit was R498 million after the amortisation of intangible assets of R9 million. In line with BLT's accounting policies, an exclusion relating to equity-settled share-based payment charges from its associates resulted in a positive adjustment of R65 million. The net result was a positive contribution of R563 million to BLT's earnings in the prior year.

Fair value adjustments and impairment

The fair value adjustments of R838 million for the year ended 31 May 2019 were attributable to downward adjustments of R750 million relating to the non-recoverability of the exposure to SPV1 and SPV2 and R88 million, net of taxation, to the Glocell loan. The impairment of R50 million pertained to Blue Label Connect.

Remaining entities

These entities incorporate the core distribution companies, 3G Mobile group and Airvantage.

Revenue declined by 3% from R26.2 billion to R25.4 billion, in that only the gross profit earned on "PINless top-ups", prepaid electricity and ticketing are accounted for. On imputing the gross revenue generated thereon, the effective growth in revenue equated to 10% from R52.1 billion to R57.2 billion.

Net commissions earned on the distribution of prepaid electricity continued to increase, escalating by R39 million to R278 million (17%) on an increase in revenue generated on behalf of the utilities from R16.9 billion to R20 billion (19%).

Gross profit increased by 17% from R2.01 billion to R2.35 billion, underpinned by an increase in margins from 7.67% to 9.28%. EBITDA increased by 18% from R1.34 billion to R1.58 billion, equating to an EBITDA margin of 6.23%.

Contribution to core headline earnings increased by 13% from R812 million to R919 million.

The following illustrates the contribution to the above by the 3G Mobile group and Airvantage.

3G Mobile group

The 3G Mobile group comprises a mobile handset trading division (3G) and, through its wholly owned subsidiary, Comm Equipment Company (CEC) which provides the financing for the handset element of postpaid contracts on behalf of Cell C as well as the financing of other hardware.

The underlying table reflects 3G's financial results for the year ended 31 May 2019 in comparison to 10 months ended 31 May 2018:

* Prior year revenue has been restated for the adoption of IFRS 15 for comparative purposes and has not been audited on this basis.

Revenue generated for the year ended 31 May 2019 amounted to R2.2 billion, gross profit to R505 million at a margin of 22.50% and EBITDA to R407 million. Core net profit amounted to R278 million.

From the date of acquisition of 47.37% in August 2017 until 30 November 2017, 3G's financial results for the four-month period were equity accounted for as an associate. Its core net profit during that period amounted to R75 million, of which the Group's share equated to R35 million.

On 6 December 2017 the remaining 52.67% of the company was acquired, at which date it became a wholly owned subsidiary. Revenue generated for the six months to 31 May 2018 amounted to R765 million, gross profit to R226 million at a margin of 29.57% and EBITDA to R181 million. Its core net profit for the six months as a wholly owned subsidiary amounted to R122 million.

Airvantage

Airvantage advances emergency top-up airtime and data to prepaid subscribers, utilising sophisticated algorithms to assess their creditworthiness. On 2 January 2018, Blue Label acquired 60% of the company.

The underlying table reflects Airvantage's financial results for the full year ended 31 May 2019 in comparison to five months ended 31 May 2018.

Revenue generated for the year ended 31 May 2019 amounted to R89 million, gross profit to R75 million at a margin of 84.41%, EBITDA to R59 million and core net profit to R41 million. The Group's share thereof equated to R24 million.

Revenue generated by it for the five months to 31 May 2018 amounted to R37 million, gross profit to R29 million at a margin of 79.18%, EBITDA to R21 million and core net profit to R14 million, of which the Group's share equated to R8.3 million.

* As a result of the prior year errors the Group has restated their comparative financial information. Refer to note 11 of the Group annual financial statements.

Oxigen Services India and 2DFine

As from 30 November 2016 the Group applied the exemption available in IAS 28 – Investments in Associates and Joint Ventures to account for the investment in Oxigen Services India, Oxigen Online and 2DFine Holdings Mauritius as venture capital investments. Therefore, the investment was accounted for in accordance with IAS 39 – Financial Instruments: Recognition and Measurement at fair value with changes in fair value recognised in profit or loss. Any changes in the fair value would have been recognised in the Group income statement.

This accounting treatment was highly judgemental therefore the Group included detailed disclosure on the critical judgement it had applied.

In June 2018 the Group received notification from the JSE proactive monitoring panel stating that they did not agree with the exemption we had applied in IAS 28. This resulted in a protracted engagement with the JSE to determine the appropriate accounting treatment. After lengthy discussions with the JSE, including the JSE consulting with the Financial Reporting Investigation Panel, the JSE concluded that the Group should not have applied venture capital accounting.

The Group has therefore agreed to not apply the exemption available under IAS 28 – Investments in Associates and Joint Ventures to the investment in Oxigen Services India, Oxigen Online and 2DFine Holdings and now account for these associates and joint venture using equity accounting principles.

The proposed corporate transaction, referred to in the subsequent events of the 30 November 2018 interim results, did not materialise, and the resultant lack of funding necessitated BLT to impair its full investment of R118 million in the Oxigen Group. The full value of loans to Oxigen Services India of R30 million and 2DFine Holdings Mauritius of R41 million, net of a surety asset raised, were impaired. In addition, the Group has accounted for a R41 million liability relating to financial guarantee contracts and R46 million for its share of losses in OSI. The resultant negative contribution to core net loss totalled R276 million.

Remaining entities

The remaining entities within the international segment comprise shareholdings of 48% in Airvantage Brazil with effect from 2 January 2018, 60% in AV Technology with effect from 1 August 2018, 47.56% in Blue Label Mexico and 100% of Gold Label Investments.

The increases in revenue of R35 million and gross profit of R34 million were entirely attributable to AV Technology.

The increase in EBITDA of R54 million was attributable to positive foreign exchange movements of R26 million, the non-recurrence of start-up costs of R12 million incurred by Airvantage pertaining to its operation in Brazil, non-comparatives applicable to AV Technology amounting to R32 million, offset by loan releases of R16 million relating to the winding up process of the Africa Prepaid Services group in the comparative year.

Losses in Blue Label Mexico increased from R43 million to R47 million, of which the Group's share amounted to R24 million after the amortisation of intangible assets. In the comparative year the Group's share of losses amounted to R22 million.

The increase in loss was attributable to a decline in revenue from R4.0 billion to R3.6 billion (9%), with gross profit margins remaining static at 3.8%. In spite of limiting overheads to a growth of 4% and a reduction in depreciation, the above resulted in the Group's share of losses increasing by R2 million.

In order to mitigate such losses incurred, various initiatives that were implemented in the last quarter of the financial year resulted in positive improvements to its financial performance. These initiatives included a reduction in staff complement, increases in cash collection and daily rental fees, the closure of unprofitable retail stores, the outsourcing of certain sales functions on a variable cost basis, the enhancement of its technology platform and the increase in the distribution of starter packs generating monthly compounded annuity income. Bill payments, credit and debit card acquiring and food vouchers are increasing on a monthly basis. These initiatives will perpetuate in the year ahead, resulting in an expected turnaround to sustainable profitability.

Non-controlling interest declined by R19 million, of which R13 million related to minority shareholders in both Airvantage Brazil and AV Technology. In the comparative year, R32 million related to the Africa Prepaid Services group for its share of the loan releases as a consequence of the winding up process therein.

Net contribution to core headline earnings amounted to R21 million.

Mobile

This segment comprises Via Media, Cellfind, Panacea, Simigenix, Blue Label One and Supa Pesa.

* As a result of the prior year errors the Group has restated their comparative financial information. Refer to note 11 of the Group annual financial statements for more details.

Of the impairments of R96 million, R74 million pertained to a partial impairment of goodwill in Via Media and R22 million to a partial impairment of an investment in Supa Pesa, a joint venture company.

Although revenue declined by 9%, gross profit margins increased from 69.52% to 74.04%, limiting the decline in gross profit to 3% and EBITDA to 3%.

Contribution to Group core headline earnings declined by 3% to R58 million.

SOLUTIONS

This segment comprises Datacel, Blue Label Data Solutions (BLDS), a data aggregation and lead generation entity in which the Group owns 81%, and a 50% joint venture shareholding by BLDS in United Call Centre Solutions, an outbound call centre operation.

The growth in revenue of 4% to R203 million was attributable to increased demand for aggregated data and lead generations. A marginal decline in gross profit margins from 32.59% to 30.45% resulted in a nominal movement in gross profit. After overhead increases of 10%, EBITDA equated to R38 million.

Of the core headline earnings of R44 million, BLDS accounted for R26 million. United Call Centre Solutions generated earnings of R45.1 million, of which BLDS's share amounted to R22.5 million. After accounting for a minority shareholding of 19%, the Group's share thereof amounted to R18 million.

Corporate

On exclusion of the loan impairment of R60 million pertaining to 2DFine and R62 million to the liability relating to financial guarantee contracts, the negative contribution to Group core headline earnings declined by R3 million to R138 million.

Statement of financial position

Total assets decreased by R5.9 billion to R12.1 billion of which non-current assets accounted for R5.9 billion net of an increase in current assets of R78 million.

The negative movement in non-current assets included a decline in investments in and loans to associates and joint ventures of R6.5 billion, in loans receivable of R12 million and in the long-term portion of trade and other receivables of R23 million. These decreases were offset by increases in intangible assets and goodwill of R205 million, in capital expenditure net of depreciation of R101 million, in advances to customers of R228 million and deferred tax assets of R31 million.

A net decrease of R7.5 billion in investments in and loans to associates and joint ventures was predominately attributable to net loan repayments of R1 billion, impairments of loans in OSI of R161 million and impairments of investments totalling R2.7 billion, of which Cell C accounted for R2.5 billion, OSI for R118 million and Supa Pesa for R29.5 million. This was compounded by the Group's net share of losses in associates totalling R3.7 billion, of which Cell C accounted for R3.6 billion inclusive of the amortisation of applicable intangible assets.

Of the net increase of R205 million in intangible assets and goodwill, R199 million related to goodwill and R6 million to intangible assets. Of the goodwill increase, R219 million pertained to Glocell Distribution, R49 million to AV Technology and R46 million to Wi-Connect. These increases were offset by partial impairments to goodwill in both Via Media and Blue Label Connect for R74 million and R50 million respectively.

Of the increase in intangible assets of R6 million, R130 million related to the purchase price allocations raised in terms of IFRS 3 and intangibles assets within the companies prior to the acquisition thereof, of which R78 million pertained to AV Technology and R52 million to Glocell Distribution. In addition R76 million was incurred on the purchase of software and internally generated software development costs with a further R8 million allocation in line with foreign currency translation movements. These intangible increases were offset by amortisations of R203 million and impairments of intangible assets of R5 million.

Of the increase in current assets, material movements included increases in inventory of R917 million and cash resources of R438 million, offset by decreases in advances to customers of R206 million.

The stock turn equated to 24 days compared to nine days for the financial year ended 31 May 2018.

The average debtor's collection period remained unchanged year-on-year at 75 days.

Net loss attributable to equity holders of R6.7 billion, resulted in retained earnings declining to R2.4 billion.

Share capital and share premium decreased by R246 million congruent with the repurchase of 32.9 million shares at a weighted average price of R6.78, the purchase of treasury shares amounting to R42 million less R21 million of shares that vested.

Borrowings increased by R265 million, of which R155 million was for facilities utilised by CEC for the financing of mobile handsets.

Trade and other payables increased by R381 million, with average credit terms increasing from 66 days to 87 days.

Statement of cash flows

Cash available from operations amounted to a negative R81 million, attributable to increased inventory of R864 million, trade receivables of R434 million, advances to customers of R22 million offset by additional credit of R208 million afforded to the Group by its suppliers.

The increase in inventory was attributable to bulk purchasing at favourable discounts. Although this resulted in a temporary increase in inventory holding days, being a highly liquid asset, such excess inventory is capable of reduction within any given month. Of the increase in accounts receivable, R157 million related to a prepayment to utilities for prepaid electricity, which was replaced by inventory shortly after the reporting period due to timing differences. Further supplier prepayments amounted to R128 million.

Cash flows received from investing activities amounted to R561 million, mainly attributable to the R1 billion loan that was repaid by Cell C, offset by funds applied, net of cash acquired, to the acquisition of Airvantage Mauritius amounting to R19 million. A further R326 million was granted for the liquidity support to SPV2, R76 million for the purchase of intangible assets and R134 million for capital expenditure.

Cash flows applied to financing activities amounted to R42 million, of which R224 million related to share buybacks, R42.4 million to the acquisition of treasury shares and a dividend payment of R35.6 million to non-controlling interests. After additional borrowings of R260 million, cash on hand at year-end amounted to R1.4 billion.

Dividends

The Board of Directors has elected not to declare a dividend.

Going concern

The Board of Directors evaluated the going concern assumption as at 31 May 2019 and considered it to be appropriate in the preparation of these financial statements.

The Prepaid Company's Investec banking facilities, which would have expired on 30 September 2019, have been extended to 29 November 2019 and discussions are in progress for a further extension beyond that date.

As at the date of these financial statements, the renegotiation of these facilities had not yet been completed, and although the directors are of the opinion that the facilities would be extended beyond November 2019, material uncertainty exists should these facilities not be extended. In this event, certain liabilities within the Group would not be settled in the normal course of business.

The directors are confident that the successful completion of the disposal transactions relating to 3G and the Blue Label Mobile group, will result in a significant reduction in interest-bearing debt and in turn the strengthening of the Group's balance sheet.

Appreciation

I once again wish to express my gratitude to the Group's finance team for their professional input and dedication throughout the year.

Dean Suntup

Financial Director

29 October 2019