Audit, Risk and Compliance Committee's report

The Audit, Risk and Compliance Committee (ARCC) is pleased to present its report for the financial year ended 31 May 2019.

The Committee is an independent statutory committee appointed by the shareholders of the Company. In addition to its statutory duties, the Board has delegated further duties to the Committee. This report covers both these sets of duties and responsibilities.

Mandate and terms of reference

The Committee has adopted comprehensive and formal terms of reference which have been approved by the Board and which are reviewed on an annual basis. The responsibilities of the ARCC include:

• examining and reviewing the Group's financial statements and reporting of interim and final results;
• review and consider, for recommendation to the Board, the consolidated budget for the ensuing financial year;
• overseeing integrated reporting;
• overseeing the Internal Risk and Compliance Committee function;
• overseeing the function of the Compliance Officer;
• ensure that Blue Label implements an effective policy and plan for risk management that has been disseminated throughout the organisation and integrated within day-to-day activities in order to enhance the Company's ability to achieve its strategic objectives;
• ensure that the disclosure regarding risk is comprehensive, timely and relevant;
• ensure that a combined/integrated assurance model is applied to provide a coordinated approach to all assurance activities and appropriately addresses all the significant risks facing Blue Label;
• reviewing and satisfying itself of the expertise, resources and experience of the Blue Label finance function;
• overseeing the Group internal audit function;
• establish, implement and maintain a compliance function with adequate policies and procedures to ensure compliance with rules, regulations, statutes and procedures applicable to Blue Label;
• report annually to the Board and shareholders describing the Committee's composition, responsibilities and how they were discharged, and any other information required by rule, including the approval of non-audit services;
• resolve any disagreements between management and the auditor regarding financial reporting;
• retain independent counsel, accountants, or others to advise the Committee or assist in the conduct of an investigation;
• seek any information it requires from employees – all of whom are directed to cooperate with the Committee's requests – or external parties; and
• meet with the organisation's officers, external auditors, or outside counsel as necessary.

Membership and meetings held

In accordance with the requirements of the Companies Act, No 71 of 2008 (the Act), Messrs JS Mthimunye, GD Harlow and SJ Vilakazi were appointed to the Committee by shareholders at the Annual General Meeting held on 29 November 2018.

• JS Mthimunye (Independent Non-Executive Chairman)
• GD Harlow (Independent Non-Executive Director)
• J Vilakazi (Independent Non-Executive Director)

P Mahanyele who was a member of the ARCC previously resigned on 23 November 2018.

The members of the Committee collectively have experience in audit, accounting, commerce, economics, law, corporate governance and general industry. All of the members of the ARCC are independent non-executive directors.

The Committee meets quarterly and the quorum for each meeting is three members present throughout the meeting. Mandatory attendees at the meetings are the Joint Chief Executive Officers and the Financial Director of Blue Label. The external audit partner from PricewaterhouseCoopers Inc. (PwC) and a director from KPMG Services Proprietary Limited (KPMG), to whom Blue Label outsources its internal audit function, are also attendees. Both internal and external auditors are afforded the opportunity to address the meeting and have unlimited access to the Committee. During the year, the Committee met with the external and internal auditors respectively without the presence of management. The internal audit function reports directly to the ARCC and is also responsible to the Financial Director on day-to-day administrative matters.

Statutory duties discharged

In execution of its statutory duties during the year under review, the Committee:

• nominated and recommended to shareholders the reappointment of PwC as independent external auditors, with Deon Storm the audit partner, as the registered independent auditor;
• approved the fees to be paid to PwC and other external auditors, where applicable, and approved the terms of engagement;
• maintained a non-audit services policy which determines the nature and extent of any non-audit services that PwC may provide to the Group;
• discharged those statutory duties as prescribed by section 94 of the Act, acting in its capacity as the appointed Audit Committee of the subsidiary companies of Blue Label;
• considered the Committee's report describing how duties have been discharged; and
• submitted matters to the Board concerning the Company's accounting policies, financial controls, records and reporting, as appropriate.

Other duties discharged

Financial statements and reporting

The Committee:

• monitored compliance with accounting standards and legal requirements and ensured that all regulatory compliance matters had been considered in the preparation of the financial statements;
• reviewed the external auditor's report to the Committee and management's responses thereto and made appropriate recommendations to the Board of Directors regarding actions to be taken;
• reviewed and commented on the annual financial statements, interim reports, paid advertisements, announcements and the accounting policies and recommended these to the Board for approval;
• reviewed and recommended to the Board for adoption the consolidated budget for the ensuing financial year; and
• considered the going concern status of the Company and Group on the basis of review of the annual financial statements and the information available to the Committee and recommended such going concern status for adoption by the Board. The Board statement on the going concern status of the Group and Company is contained in the Directors' report.

External audit and non-audit services

The ARCC has satisfied itself as to the independence of the external auditor, PwC, as set out in section 94(7) of the Act, which includes consideration of compliance with criteria relating to independence or conflicts of interest as prescribed by the Independent Regulatory Board for Auditors. Requisite assurance was sought from and provided by PwC that internal governance processes within the firm support and demonstrate its claim to independence.

To assess the effectiveness of the external auditors, the Committee considered PwC's fulfilment of the agreed audit plan and variations from the plan, and the robustness and perceptiveness of PwC in its handling of key accounting treatments and disclosures.

The Committee, in consultation with Executive Management, agreed to the engagement letter, terms, audit plan and budgeted audit fees for the 2019 financial year.

Any non-audit services to be provided by the external auditors are governed by a formal written policy which incorporates a monetary delegation of authority in terms of non-audit services to be provided. The non-audit services rendered by the external auditors during the year ended 31 May 2019 comprised tax advisory services, tax compliance services and general advisory services. The fees applicable to the aforementioned services totalled R1.56 million (2018: R4.1 million), of which Rnil (2018: R2.8 million) relate to non-audit services and the remainder to acquisition-related costs.

The ARCC has nominated, for approval at the Annual General Meeting, the reappointment of PwC as registered auditors for the 2019 financial year. The Committee also satisfied itself in terms of paragraph 3.84(g)(iii) of the JSE Listings Requirements that PwC is accredited. In addition, the Committee has also satisfied itself that Deon Storm, the PwC audit partner, is accredited and appears on the JSE List of Accredited Auditors.

Internal audit and internal controls

Blue Label's internal audit function is outsourced to KPMG Services Proprietary Limited and the role of the Chief Audit Executive is fulfilled by the Engagement Director. The ARCC concludes that the Chief Audit Executive and internal audit arrangements are effective and independent.

The Committee:

• reviewed the cooperation and coordination between the internal and external audit functions in order to avoid duplication of work and to work towards an effective and efficient combined/integrated assurance approach;
• examined and reviewed the progress made by internal audit against the approved 2018/19 audit plan;
• considered the combined/integrated assurance plan for the 2018/19 financial year;
• approved the revised Group Internal Audit terms of reference;
• approved the risk-based internal audit plan for the 2019/20 financial year;
• considered the effectiveness of internal audit;
• considered internal audit findings and corrective actions taken in response to such findings; and
• reviewed the annual statement from internal audit on the effectiveness of the organisation's governance, risk management and internal control processes.

The ARCC concludes that the design and implementation of internal controls, including financial controls and risk management, are effective.

The ARCC concludes that the combined assurance arrangement is effective and will continue to evolve as the Group grows.

Risk management and compliance

In relation to the governance of risk, the Committee:

• reviewed the integrity of the risk control systems and ensured that the risk policies and strategies of the Company are effectively managed;
• made recommendations to the Board concerning the levels of tolerance and risk appetite, and monitored the management of risk exposures against these levels;
• reviewed and recommended to the Board approval of the Integrated Risk Assurance Policy and Framework;
• monitored bi-annual risk assessments and reviewed the consolidated strategic risk profile to evaluate and ensure all material risks have been identified as they pertain to the triple context of Blue Label, and are being managed appropriately;
• provided feedback to the Board on significant risks, including emerging risks, and significant changes to the risk profile;
• ensured that management considered and implemented appropriate risk responses to significant risks;
• considered the relevance and effectiveness of Information and Technology Governance systems, processes and mechanisms to manage technology-related risks;
• reviewed and recommended to the Board risk information for disclosure, in accordance with King IV principles;
• reviewed legal matters that could have a material impact on the Group in conjunction with Blue Label's legal adviser; and
• reviewed developments in corporate governance and best practice and considered their impact and implications across the Group with particular reference to the principles of King IV™*.

The ARCC is satisfied that it has dedicated sufficient time to its responsibility towards the governance of risk.

* Copyright and trademarks are owned by the Institute of Directors in Southern Africa NPC and all of its rights are reserved.

The Committee is satisfied that it has exercised sufficient, ongoing oversight of compliance through:

• the appointment of a dedicated Compliance Officer for the Group;
• the approval of the compliance strategy;
• the approval of the regulatory compliance policy and the compliance process;
• annual review of the Company's regulatory universe in order to prioritise regulatory compliance efforts;
• ongoing development and review of compliance risk management plans;
• continuous monitoring of the regulatory environment to ensure that the Group keeps abreast of matters affecting its regulatory environment;
• identification and monitoring of key compliance risks across the Group; and
• making use of a compliance maturity model to assess progress in the management of compliance.

Expertise and experience of the Financial Director and finance function

The Committee considered the appropriateness of the expertise and experience of the Financial Director and finance function in accordance with the JSE Listings Requirements and governance best practice. The ARCC concluded that the finance function is adequately resourced with technically competent individuals and is effective. The Committee confirms that it is satisfied that Dean Suntup possesses the appropriate expertise and experience to discharge his responsibilities as Financial Director.

Annual financial statements

The Committee has reviewed the accounting policies and financial statements of the Company and the Group and is satisfied that they are appropriate and comply with International Financial Reporting Standards, the JSE Listings Requirements and the requirements of the Act.

The Committee has evaluated the Group annual financial statements of Blue Label Telecoms Limited for the year ended 31 May 2019 and based on the information provided to the Committee, the Committee recommends the adoption of the annual financial statements by the Board.

The significant audit matters considered by the Committee were:

1. the impairment assessment of goodwill arising from business combinations;
2. the impairment assessment of the investment in BLM;
3. the impairment assessment of the investment in Oxigen, Oxigen Online and 2DFine;
4. the impairment assessment of the investment in Cell C Limited;
5. accounting for the bond notes and liquidity support; and
6. the fair value estimate of the Glocell loan.

These matters were addressed as follows:

The impairment assessment of goodwill arising from business combinations

For the year ended 31 May 2019, management performed an impairment assessment over the goodwill balance as follows:

• assessing the recoverable amount as being value-in-use, as entities are held-for-trading and not for sale;
• calculating the value-in-use for each cash-generating unit (CGU) using a discounted cash flow model; and
• performing a sensitivity analysis over the value-in-use calculations, by varying the assumptions used (growth rates, terminal growth rate and WACC, i.e. discount rate) to assess the impact on the valuations.

Based on the above impairment assessments, as well as management judgement, the following impairments were applied:

Viamedia goodwill impairment of R74 million

Viamedia's performance has been negatively impacted as a result of a sector-wide decline in the B2C (direct to consumer) WASP industry. Previously this was significantly offset by growth in its Enterprise division. However, over the past six months, the latter division has flat-lined which, together with the continued decline in the B2C channel, has caused a negative impact on operating profits with marginal growth expectations going forward.

SupaPesa investment impairment of R30 million

A decline in revenue, primarily attributable to legislative changes and loss in clientele, has resulted in the impairment.

Blue Label Connect goodwill impairment of R49 million

Blue Label Connect's performance has been negatively impacted as a result of challenging economic conditions that have affected one of its major clients. Furthermore, margin compression resulting from reduced incentives from the networks, as well as an increase in product costs, has resulted in an impairment to goodwill.

Management concluded there was no need for any further impairment.

The impairment assessment of the investment in BLM

For the year ended 31 May 2019, management performed an impairment assessment over the investment in BLM as follows:

• assessing the recoverable amount as being value-in-use, as BLM is held-for-trading and not for sale;
• calculating the value-in-use for BLM using a discounted cash flow model;
• performing a sensitivity analysis over the value-in-use calculations, by varying the assumptions used (growth rates, terminal growth rate and WACC, i.e. discount rate) to assess the impact on the valuation; and
• as a final check, comparing the carrying value of the Group's investment in BLM with the calculated value-in-use.

Management concluded there was no need for any impairment.

The impairment assessment of the investment in Oxigen, Oxigen Online and 2DFine

The investments in Oxigen Services India, Oxigen Online Services India, collectively Oxigen Services India, and 2DFine Holdings Mauritius (2DFine) were historically accounted for as investments in associates and joint ventures, applying the equity method up until 30 November 2016. From that date, the exemption available in IAS 28 – Investments in Associate and Joint Ventures for venture capital organisations has been applied to these investments and 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. In the current year a fair value loss was recognised in the income statement.

This accounting treatment was accepted by the Group's auditing firm following rigorous debates and internal consultations. This accounting treatment was highly judgemental, therefore the Group included detailed disclosure on the critical judgement it had applied. This judgement was also listed as a key audit matter in the audit report.

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 various letters and face to face meetings to ultimately get to the correct accounting treatment. After months of debates the JSE asked the Financial Reporting Investigation Panel to review and they found in favour of the JSE.

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 India and 2DFine and now account for these associates and joint venture using equity accounting principles.

For the year ended 31 May 2019, management utilised an independent third-party valuation specialist to calculate the fair value less cost of disposal. The fair value less cost of disposal is calculated by utilising relevant information generated by similar market transactions that have been concluded by comparable businesses. The assumptions and inputs used in calculating the fair value less cost to sell are regarded as level 3 fair value estimates.

The fair value of the 2DFine Group is based on its share of the fair value of Oxigen Services India and Oxigen Online, less the liabilities of the 2DFine Group.

Based on the fair value less cost of disposal, combined with the corporate transaction, referred to in the 30 November 2018 interim results, that did not materialise, and the resultant lack of funding, management concluded that an impairment of its full investment of R118 million in the Oxigen Group was required. The full value of loans to Oxigen Services India of R31 million and 2DFine Holdings Mauritius of R101 million, net of a surety asset raised, were also impaired. In addition, the Group has accounted for a R103 million liability relating to financial guarantee contracts.

The impairment assessment of the investment in Cell C Limited

On 2 August 2017, Blue Label, through its wholly owned subsidiary, The Prepaid Company, acquired 45% of the issued share capital of Cell C for a purchase consideration of R5.5 billion.

For the year ended 31 May 2019, management appointed an independent third-party valuation specialist to determine the value-in-use based on cash flow projections incorporated in the five-year Cell C business plan. They applied assumptions relating to the business, the industry and economic growth. Cash flows beyond this point were then extrapolated, applying terminal growth rates that did not exceed the expected long-term economic growth rate.

TPC's share of the value-in-use as at 30 November 2018 amounted to R6.04 billion. The valuation declined to a nil value at 31 May 2019. This was primarily attributable to:

• A significant downward revision of the mobile subscriber base. The valuation at November 2018 was based on the assumption the CAGR forecast would average 9.3% per annum over a five-year period. In May 2019 the CAGR forecast was revised to an average of 4.6% per annum. This resulted in an originally expected 23.4 million subscribers after five years declining to a revised expectation of 17.9 million.
  • Cell C previously anticipating gaining approximately 6% additional market share by accessing new territories. Instead, Cell C's market share declined by approximately 2% from 16% at November 2018 to 14% at May 2019. This was in line with re-evaluating the inactive subscriber base and a loss of customers to competitors.
  • A deteriorating South African economy since November 2018, with an initial GDP forecast of 1.9% for the calendar year ended 2019 to a revised forecast contraction of 0.2%. Accordingly, the forecast GDP was adjusted downwards each year for the following four years. In addition, Business Monitor Intelligence revised their mobile subscriber growth in April 2019 from a CAGR of 2.2% for the period FY18 to FY23 to 1.8%.
  • Year to date trading being below budget.
• A substantial decline in forecast other revenue. This is largely due to a significant decline in equipment, Mobile Virtual Network Operator and Business Service Provider revenues over the five-year period in comparison to the initial forecast. Cell C had previously forecast gaining market share from its competitors. This did not materialise.
• Lower taxation benefit relating to depreciation as a result of a revised forecasted reduction in capital expenditure.

In determining the revised valuation, cognisance was taken into account of positive cash flow generation from:

• A decline in forecast direct expenditure on handset, SIM costs, ongoing commissions and discounts due to lower subscriber growth.
• A reduction in forecast payroll costs.
• A decline in capital expenditure due to cash flow constraints and lower subscriber base forecast.
• A decrease in cash lease payments as a result of less network towers required due to the lower forecast of the subscriber base.

The impact of the transactions in progress relating to a national roaming agreement and the recapitalisation of Cell C were not in effect as at 31 May 2019 and as such have not been accounted for in the valuation at that date.

Accounting for the bond notes and liquidity support

On 2 August 2017, TPC purchased bond notes, issued by Cedar Cellular Investments 1 Proprietary Limited (SPV1), from Saudi Oger Limited with a capital redemption value of USD42 million and with a coupon rate of 8.625% per annum for a purchase consideration of USD18 million. TPC was entitled to assign its rights and obligations, in whole or in part, to a nominee. Accordingly, it has assigned such rights and obligations in respect of 50% of the bond notes, resulting in an effective purchase consideration of USD9 million with a capital redemption value of USD21 million.

As part of the restructure of the debt into Cell C by third-party lenders, TPC will be required to provide liquidity support to Magnolia Cellular Investment 2 (RF) Proprietary Limited (SPV2), which is 100% held by 3C Telecommunications Proprietary Limited, of up to USD80 million, which liquidity support will be provided over 24 months and will be in the form of subordinated funding to SPV2. Oger Telecoms contributed USD36 million of the aforesaid USD80 million thus reducing TPC's obligation in this regard to a maximum of USD44 million. As at 31 May 2019, the Group has contributed USD24 million to SPV2, toward the latter amount.

SPV1 and SPV2 own 11.8% and 16% of the shares issued by Cell C respectively. No other assets are held by these entities, and as such the Group's bond note and liquidity support arrangements will be settled only when the value of the Cell C shares are realised by SPV1 and SPV2. The substance of these arrangements are therefore derivatives exposing the Group to the share price of Cell C.

The derivatives are initially recognised by the Group at fair value and subsequently measured at fair value through profit or loss.

The fair value of the derivatives are not traded in an active market and are therefore determined by the use of a valuation technique. Management performed the valuations using a Monte Carlo simulation taking into account the expected exit event date of Cell C in the next 11 to 24 months. These calculations use a valuation of Cell C provided by a qualified independent third-party valuation specialist. By way of simulation, the model generates a large number of random paths for the value of the Cell C share price from 31 May 2018 to the expected listing date. The average payoffs across the simulated paths are then discounted at the risk-free rate to obtain the present value of the shares owned by SPV1 and SPV2. As both arrangements are USD denominated, the model accounts for the forward rate of the US dollar at the expected listing date.

As at 31 May 2019, an independent third-party valuation specialist attributed a nil value to Cell C Limited. As a result, an unrealised fair value loss totalling R750 million was recognised in the current year, of which R167 million related to SPV1 and R583 million to SPV2.

The derivatives are level 3 instruments in the fair value hierarchy.

The fair value estimate of the Glocell loan

TPC acquired a 48% share in Glocell Distribution Proprietary Limited (Glocell Distribution) on 30 June 2018 (refer to note 2.4).

In terms of an agreement entered into between TPC and Glocell Proprietary Limited (Glocell), Glocell has pledged its 40% shareholding in Glocell Distribution to TPC in the event of Glocell defaulting on amounts owing of R343 million to TPC as at 31 May 2019. The right to enforce this pledge is currently not exercisable.

This right only becomes exercisable once Glocell has settled its outstanding debt of R121 million to Investec Bank Limited.

Glocell's ability to repay TPC the amounts owing to it is dependent on the extent of dividends receivable from Glocell Distribution on a piecemeal basis. TPC is therefore exposed to the value of Glocell Distribution and accordingly has reclassified the amount due by Glocell to it from trade receivables to financial assets at fair value through profit or loss.

A discounted cash flow valuation of Glocell Distribution has been used to determine the value of Glocell's 40% shareholding in Glocell Distribution. This is used to determine the fair value of the loan. This valuation has been performed by the finance department of the Group using cash flow projections based on forecasts for up to five years which are based on assumptions of the business, industry and economic growth.

A fair value downward adjustment of R141 million of the R343 million owing to TPC was required due to unfavourable wholesale trading conditions impacting on Glocell Distribution's financial performance.

The derivatives are level 3 instruments in the fair value hierarchy.

The ARCC is satisfied that it has complied with its legal, regulatory and other responsibilities as per its terms of reference.

On behalf of the Audit, Risk and Compliance Committee

JS Mthimunye

Chairman

26 September 2019