LESAKA TECHNOLOGIES INC quarterly report, Q2 FY2012

Business context and reporting period

Net 1 UEPS Technologies, Inc. (the registrant named in this filing) reported its fiscal second quarter and six months ended December 31, 2011. The unaudited statements are in U.S. dollars; amounts below are in millions unless stated otherwise. The filing covers payment processing, smart-card, financial-services and technology businesses, with significant operations in South Africa and Korea.

Financial performance and condition

At December 31, cash and equivalents were $80.9, down from $95.3 at June 30; reported cash includes about $4.8 of restricted funds earmarked for Korean debt prepayment. Total assets were $685.2 and equity $331.0. Borrowings were $105.5 long-term, plus $18.8 current, for total balance-sheet borrowings of about $124.3. The $30.7 South African short-term credit facility was undrawn. Settlement assets and obligations were each $125.6 and are matched; they are not available general-purpose liquidity.

Six-month capital expenditures were $9.6. Cash used in financing activities was $42.0, including $7.2 of scheduled debt repayment and $1.1 of share repurchases. Cash declined by $14.4 over the half year, including a $16.7 adverse effect from exchange-rate changes.

Material changes versus prior comparable periods

• Quarterly revenue grew 3% in reported dollars; six-month revenue grew 25%. Management attributed much of the growth to the full-period inclusion of KSNET, acquired in 2010, alongside Eason prepaid airtime and electricity, growth in lending, and activity in Iraq. In rand, revenue increased 22% for the quarter and 37% for the half year; the stronger U.S. dollar weighed on reported results.
• Quarterly operating income fell 8% and margin declined to 22% from 25%, reflecting lower-margin KSNET and prepaid airtime activity, among other items. Six-month operating income rose 55%, with margin increasing to 27% from 22%, aided by lower stock-based and prior-year acquisition costs and a $4.0 non-cash gain on liquidation of SmartSwitch Nigeria.
• Hardware, software and technology revenue fell 49% for the quarter and 31% for the half year. International transaction-based revenue rose sharply, principally with KSNET included for a full quarter or half year, but acquired-intangible amortization weighed on segment earnings.
• Quarterly attributable net income rose substantially, principally because of a tax benefit; it should not be read as equivalent growth in recurring operating performance.

Outlook, commentary, risks and unusual items

• New SASSA contract: In February 2012, after the quarter-end, the company signed a five-year contract to distribute social grants in all nine South African provinces, beginning April 1, 2012. The price is ZAR 16.44 per beneficiary paid, inclusive of VAT, with no minimum or maximum beneficiary count. Management expects substantial implementation capital spending and increased operating costs, and anticipated negative operating margins during the next three quarters as the service rolls out; it expected to be fully phased in by fiscal Q2 2013.
• Contract litigation: Two unsuccessful bidders challenged or sought information concerning the SASSA award. The company said it would oppose the applications but could not predict their timing or outcome. A successful challenge could set aside the contract; disclosure of tender information could affect its competitive position.
• Tax and unusual items: The South African tax-law change generated a $20.0 deferred tax benefit in the quarter and $18.3 for the half year; an $8.2 valuation allowance for foreign tax credits offset part of the benefit. The quarter’s income-tax line was a $5.4 benefit. The half-year also included the $4.0 non-cash liquidation gain. Both materially affect comparisons and reported earnings.
• Operating and market risks: Management cited reduced EasyPay transaction volumes after a major customer moved EFT/switching in-house, ongoing competition and expected modest margin pressure in Korea, start-up losses in XeoHealth and virtual-card businesses, and exposure to currency, interest-rate, counterparty and investment-liquidity risks. The company cautioned that SASSA expansion increases customer concentration and may require more spending or take longer than planned.
• Other developments: The Eason business was acquired for about $4.5 million and contributed $5.3 million revenue and a $0.3 million net loss since acquisition. SmartLife contributed $0.3 million revenue and a $0.3 million net loss since acquisition. A proposed BEE transaction would grant an option to buy up to 8,955,000 shares at $8.96, subject to conditions and approvals, creating potential dilution if exercised.
• Management said cash and available credit were sufficient to fund operations for at least the next four quarters. This is an outlook statement, not a guarantee.

Most important facts for investors to verify

1. Whether the SASSA contract withstands the legal challenges, and whether nationwide implementation meets cost, timing and service requirements.
2. How much of the reported earnings improvement reflects recurring operations versus tax benefits, the Nigeria liquidation gain, acquisitions and currency translation.
3. Cash conversion and working-capital collection trends, particularly given first-half operating cash flow was below the prior year and quarterly operating cash flow was negative.
4. Debt repayment, restricted cash treatment and funding needs for SASSA-related capital expenditures; confirm the reported post-quarter KSNET debt prepayment.
5. Segment profitability after acquired-intangible amortization, especially for international transaction-based activities and lower-margin prepaid airtime.
6. Potential share dilution and final terms or approvals for the BEE option transaction.