Group CFO's
REPORT

AfroCentric's financial objective for 2018 was to stabilise the business after its significant operational growth in 2017. This growth followed the various scheme mergers, new scheme take-ons and completion of corporate transactions that impacted the 2017 earnings significantly.

The Group continued delivering above-inflationary growth on revenue and operating profit, which is pleasing considering the market conditions and healthcare affordability for schemes members in South Africa. The Group continued in its objective of enhancing its healthcare service offerings with three smaller acquisitions during 2018.

Healthcare service operating profit

The Medscheme business, which is the core contributor to the healthcare operating profit, heavily depends on the membership growth of its administered schemes. South African consumers are having trouble affording medical aid – they are buying down options, and businesses are retrenching employees resulting in them cancelling or leaving the schemes. The Group has a fairly diversified membership base across all sectors of the economy, and we have been able to offset some of the losses in private sector with marginal growth in the open schemes and GEMS.

The business units have been innovative in driving further efficiencies throughout the Group to address the above-mentioned pressures on the revenue line. These include five robotics processes that were implemented in the managed care and administration units to perform mundane tasks more efficiently and accurately. During the year, the Group implemented an Optical Recognition solution in its assessing unit which allows manual paper claims to be processed more quickly. Although small, the paper claims volume represents 3% of total claims received.

Healthcare operating profit includes the net losses from the new acquisitions in Essentialmed (low-cost health insurance provider), MMed Distribution (surgical wholesaler) and Scriptpharm (chronic and acute medicine capitation manager) amounting to R6 million for the year under review. Each of these new businesses has already demonstrated value to its clients and will start generating profits during the 2019 financial year.

Healthcare retail operating profit

Pharmacy Direct had another year of monumental growth in scripts that had to be dispensed for the government contract relating to the Department of Health (DoH). The Group increased its volumes month on month during the year at its premises in Centurion, which finally necessitated a standalone pharmacy warehouse exclusively for the DOH contract. This new facility became officially operational following the conclusion of the new contract awarded by the DOH, effective 1 April 2018.

The DOH contract previously entailed Pharmacy Direct dispensing chronic medication to seven provinces, excluding KwaZulu-Natal. The new five-year contract includes KwaZulu-Natal, which represents the highest volumes in the country, and another three provinces. The 2019 volumes will therefore grow exponentially on the 2018 base as more scripts are being loaded during the take-on phase.

The Retail unit's profitability grew by double digits, which was pleasing, but it should be known that this includes take-on costs for the new tender as well as increased infrastructure costs for the new facility. We envisage optimal efficiency on the new contract volumes by the second quarter of the 2019 financial year.

Financial position and cash flow

The following strategic payments hallmarked 2018 as a significant cash outflow year:

• WAD tranche 2 settlement in cash versus shares
  R139 million (net after Sanlam contribution)
• Pharmacy Direct Warehouse and related infrastructure
  R98 million
• Namibia new offices R31 million
• Extension of licence until 2023 for analytical software used in the Fraud, Waste and Abuse unit – R86 million
• Fusion project to enhance the main administration system of the Group amounted to R52 million

The Group is using the above mentioned major capital expenditure items to build capacity for new business, and it continues investing in items that will increase shareholder value over the long term.

Group cash resources as at year-end are represented as follows:

Total group cash resources	Audited year ended 30 June 2018 R'000		Audited year ended 30 June 2017 R'000	Audited year ended 30 June 2016 R'000
Cash and cash equivalents	212 918		361 738	373 068
Managed funds and deposits (current)	152 250		347 635	–
Total current cash, managed funds and deposits	365 168		709 373	373 068
Managed funds and deposits (non-current)	65 028		59 976	411 934
	430 196		769 349	785 002

Therefore, the Group continues being ungeared, and we are fortunate to have cash on hand for any opportunity that could enhance our product offering in the short term.

Intangible assets grew by approximately R200 million due to the investment in the IT systems and in developing core administration capabilities. The material items growing the intangible assets are:

• Fusion development of R52 million;
• Nexus (core administration system) development amounting to R72 million which included the take-on costs of the Hosmed medical schemes in December;
• Fraud, Waste and Abuse software licence of R86 million; and
• general software licences for IT servers and desktops amounting to R65 million (which is an annual occurrence).

Diversification of revenue streams

The Group's strategy to diversify its revenue streams across clients and various services has been successful during 2018, but still requires significant work to completely manage our reliance on the per-member per-month fee that our client medical schemes pay us. Revenue diversification between 2018 and 2017 is noted in the graphs below.

2018 Revenue		2017 Revenue

Normalised earnings and shareholder returns

The 2017 financial year was highly impacted, especially in earnings, by corporate transactions, including activity that contained non-cash flow and non-recurring items. These items are no longer continuing except for a small amount relating to the profit warranty still in existence for the Sanlam transaction, relating to the Fusion IT project that will end in 2019

In 2017, the Group defined its normalised earnings, which is a non-IFRS measure, as "the earnings excluding the impact of any corporate transactions". These are listed below.

Normalised earnings (non-IFRS measure)	Audited year ended 30 June 2018 R'000		Audited year ended 30 June 2017 R'000	% change	Audited year ended 30 June 2016 R'000
Headline earnings	260 916		123 838		145 567
Adjusted by:	3 150		120 275		24 960
– Conditional put option finance obligation (Note 2)	–		45 906		24 960
– Fair value of second tranche consideration (Note 4)	–		59 582		–
– Sanlam indemnity exposure (Note 5)	3 150		14 787		–
Normalised headline earnings	264 066		244 113	8.2	170 527
Normalised headline earnings per share (cents)
– Attributable to ordinary shares (cents)	47.63		44.03	8.2	30.84
– Diluted earnings per share (cents)	47.27		44.03	7.4	29.44

It should be noted that the compounded normalised earnings growth since 2016, which marks the starting point of the Group's new acquisitions, amounts to approximately 24%.

Further to our core operations' continued growth, we have had a consistent and growing dividend for the past five years as noted in the "Results at a glance" section. Over the past five years, the annual dividend has more than doubled from the 15 cents that was paid in 2013. The Board has approved a dividend cover ratio of 1.5 to its HEPS which will be implemented in the 2019 financial year. The strong cash generation of the Group has been a testimony to the types of contracts it engages upon with its clients, as well as each division's operational performance.

Growth prospects

As the Group continues consolidating the medical schemes and administrators in the value chain to reduce our clients' healthcare spend, we believe the growth in 2019 could include the following:

1. Better retention of open scheme members through better service and new complementary products that will be launched in partnership with Sanlam.
2. Improved scheme member growth, as the distribution channel and Sanlam brokers become healthcare accredited, and are able to sell a basket of products to its individual and corporate members.
3. The acquisition of Private Healthcare Administrators (PHA) will ensure that the Group further consolidates at an administrator level.
4. Double-digit growth in the Retail unit, via Pharmacy Direct, through the increased monthly scripts it will be dispensing – these could reach 900 000 per month in the second quarter of 2019.
5. The proposed purchase of the remaining 74% of Activo Health (pharmaceutical supplier) will increase operating profits, but could be slightly offset with any amortisation relating to the acquisition.
6. The continued efficiency projects already undertaken in 2018, which will ensure that our administration platform becomes less expensive and that these initiatives will support the rollout of the Fusion system in the second quarter of 2018.

Conclusion

I would like to express my gratitude to my colleagues in Group Finance for their diligence in their daily work and in presenting this Integrated Report. Your work underpins our performance, growth and strategy.

Hannes Boonzaaier
Group Chief Financial Officer