CHIEF FINANCIAL OFFICERS REPORT


Hannes Boonzaaier

The financial year ended 30 June 2016 marks the start of a new growth period in AfroCentric. This is due to new clients, shareholders and partners that have been added into the portfolio of service and product offerings. The acquisition of the Healthcare Retail businesses (Pharmacy Direct and Curasana) have contributed significantly to the growth in operating profit. Both the WAD acquisition and Sanlam did have, as expected, a dilutionary effect on earnings per share (“EPS”), but we believe the base is now set for these partnerships to grow the Group even further. The impact of these transactions and new clients on Group results are further explained in the analysis below.

REVENUE GROWTH

Medscheme was successful in winning the Polmed Medical Scheme contract effective 1 January 2016. The Group, therefore enjoyed six months of revenue growth from the 500 000 lives being administered for the South African Police. Another sizeable contract was concluded in August 2015 – the management of Hospital benefits and Chronic Medication for Samwumed has also contributed to the revenue growth.

The acquisition of the Pharmacy Direct and Curasana Wholesaler business effective 1 August 2015 has increased the Group’s revenue growth significantly (25% of total) based on their medication delivery and supply to the private sector and Department of Health Clinics in five provinces in South Africa.

The Group is continuously diversifying itself with other healthcare or IT related contracts, which is evident in the growth in revenue of IFM, our fraud management system, as well as Klinnika contracts.

Without continual growth and progress, such words as improvement, achievement, and success have no meaning

COST OF SALES AND OPERATING COSTS

The take-on costs of the Polmed scheme prior to implementation on 1 January 2016 is expensed in the first year, and entails items such as early uptake of employees to be trained, early office space activation to accommodate employees and IT resources for data uploading and benefit design. As a result of these once-off costs that are not capitalised to the three-year contract period tendered upon, the net profit of the scheme is not yet visible at a Group level and is at a breakeven for the 2016 financial year.

We continue to increase our spend on clinical research and analysis as well as improving our systems to manage the demands of the future. This is due to the continuous demands from clients and our vision of decreasing the healthcare spend of our schemes administered.

To effect the changes in the top executive structures of AfroCentric, the Group incurred R21 million incremental costs, most of which will not be recurring in 2017.

CAPITAL EXPENDITURE, DEPRECIATION AND AMORTISATION OF INTANGIBLE ASSETS

As a result of the acquisition of the Pharmacy Direct and Curasana businesses, the intangible assets recognised at acquisition created a significant increase in amortisation of these assets.

The IFM system has been implemented for the Bonitas Medical Fund and various other smaller schemes in the Group. However, the success of combatting fraud and reducing medical scheme healthcare cost abuse will only be seen in the 2017 financial year, as schemes start adopting various strategies to address fraud. The revenue for this product has exceeded expectations for the first year, however, there is still significant growth expected as we commence rolling this product out to many of our South African and SADEC schemes.

The table below sets out the variance in intangible asset amortisation and recognition compared to 2015.

  Carrying
value
  Amortisation  
Other intangible assets 2016
R’000
  2016
R’000
  2015
R’000
 
Customer relationships – WAD Acquisition 81 282   (8 203)    
AfroCentric Health intangible assets 435 455   (71 129)   (48 734)  
AfroCentric Health intangible PPA 68 436   (13 811)   (15 951)  
AfroCentric Health intangible Software 278 399   (39 062)   (28 589)  
Insurance Fraud Manager (Fraud Management Software) 88 620   (18 256)   (4 194)  
  516 737   (79 332)   (48 734)  
 
 

As reported on in the 2015 Integrated Annual Report, the Group is enhancing its core healthcare administration system over the next few years and incurred R38 million in the current financial year into this project. This is still the start as the total project is estimated at R150 million of which
R61 million has been spent to date. The development of this enhanced asset is being capitalised.

The Group reviewed its strategy of leasing office space and concluded the purchase of the warehouse and distribution facility for Pharmacy Direct at year-end. The purchase was funded through cash.

EARNINGS PER SHARE AND HEADLINE EARNINGS PER SHARE

The dilutionary impact of the major transactions concluded in the year affected the Group results as follows:

The WAD acquisition of the Pharmacy Direct and Curasana businesses resulted in a 18.5% dilution of shares for 11 months;
The acquisition of a 28.7% share in AHA effective 15 December 2015 has impacted shareholders return significantly in the second six months due to the noncontrolling interest component/charge on earnings; and
The Group concluded the share buyback of the minority shareholders of AHL on 30 May 2016, and a slight impact of this change in shareholding will be noticeable in 2016. 2017 will see a 5.9% retention of profits to the AHA shareholders.


NON-RECURRING EXPENDITURE

The following expenditure items were incurred during the year, which are substantially regarded as non-recurring expenditure, all of which have adversely impacted on the Group’s earnings:

Transaction and advisory costs relating to both the WAD assets and Sanlam of R11.5 million.
Legal costs on the Neil Harvey and Associates matter of R10.8 million.
Road Accident Fund (“RAF”) contract losses of R16.7 million.
Executive service contract settlement costs of R20.2 million.


CASH FLOW AND LIQUIDITY

The proceeds received from the Sanlam transaction was used to settle the long-term loan relating to the original AfroCentric acquisition of AHL (previously known as Lethimvula in 2009). The remaining funds have been invested in a conservative portfolio consisting mainly (80%) of cash instruments. The Group is currently reviewing various investment opportunities, but has not concluded anything significant enough to utilise the cash balance it has at financial year end.

The most significant cash expenditure item in 2016 was the AHL share buyback, which cost R79 million. Certain minority shareholders are still claiming their proceeds for the shares after completing various confirmation and administrative processes with the transfer secretaries. The Group envisage to still pay approximately R45 million in 2017 for shares already transferred.

Capital expenditure in the Group will be approximately R130 million for the 2017 year, of which R66 million will be regarding the enhancement of the administration system. AfroCentric is a low capital based expenditure business and therefore cash generation will continue to be positive in the 2017 financial year.

NON-CURRENT LIABILITIES

The three most significant items that have been recorded to the debt structure of the Group are:

1. The Group settled all its debt with the proceeds received from Sanlam.
2. Sanlam acquired an effective 28.7% interest in AHA for R703 million in December 2015. The acquisition agreement provides for a performance warranty in AHL of any breach of which entitles Sanlam to claim a maximum additional 4.3% interest in the shares of AHA in satisfaction of such claim. In the event that the claim calculates at an amount in excess of 4.3%, Sanlam has a right to require ACT to repurchase the shares owned by Sanlam at Sanlam’s initial cost plus interest at the 90 day deposit rate from the date of investment to the date of redemption. The Board do not expect such conditions to arise but International Accounting Standards (IAS 32) dictates the disclosure of such circumstances under Non-current liabilities rather than Capital and reserves.
3. 26 192 902 shares to the value of R134.8 million will be issued to WAD vendors subject to certain profit thresholds being attained. These shares will be issued during 2017/2018 and the value thereof has already been anticipated by inclusion in Intangible Assets.


GROWTH PROSPECTS

The 2017 financial year will yield significant growth for the Group as a result of the following:

1. Polmed will be included in the Group results for 12 months on a normalised basis without any once-off take-on costs.
2. The LMS Medical Fund (previously Liberty Medical Scheme) consisting of approximately 110 000 lives has been taken on from 1 August, which represents the biggest open scheme to join the Group since 2009. LMS Medical Fund is awaiting approval from the Council for Medical Schemes (“CMS”) to merge with Bonitas Medical Fund
3. Pharmacy Direct has been successful in winning the COID tender for chronic medication distribution, which could grow to 15% of the total Pharmacy Direct revenue once fully taken on in the latter part of 2017.
4. The salesforce of Bonitas and Fedhealth has been improved in conjunction with the Sanlam broker market and we foresee some positive organic growth from our two open schemes.
5. Our pharmacy software, via Allegra, will be installed in all Medirite pharmacies in Checkers branches countrywide, which makes us the leading provider of turnkey pharmacy management software that is not just linked to financial but also clinical information flow.


AfroCentric and its subsidiaries are starting to prove to the market that it can deliver sustainable products to manage the healthcare spend of medical schemes. Clients outside the AfroCentric Group are recognising this ability. The investments made in the past in IT and clinical research and development of systems will start reaping benefits in the financial years to come.

I would like to conclude by thanking my colleagues in the Group Finance team for their support and dedication through the various transactions concluded. Their value adding support to the operational business has contributed to the Group being more cost effective and agile enough for growth opportunities.

Hannes Boonzaaier
Chief Financial Officer