LESAKA TECHNOLOGIES INC annual report, FY2012

Business context and reporting period

Net 1 UEPS Technologies, Inc. filed this Form 10-K for the fiscal year ended June 30, 2012. The request metadata says “2011 Q4,” but the filing covers fiscal 2012; its fourth quarter ended June 30, 2012. Net1 provides payment processing, smart-card and financial services, with major operations in South Africa and Korea. Its largest activity is distributing South African social grants under its SASSA contract.

Key financial metrics

Unless otherwise noted, amounts are in U.S. dollars; financial statement figures are in millions.

Long-term borrowings were $79.8 million, plus $14.0 million current, for approximately $93.8 million total debt. The debt financed the KSNET acquisition and was secured by KSNET assets and subsidiary equity; Net1 reported compliance with the loan covenants. A $30.2 million South African short-term credit facility was undrawn. Current assets and liabilities excluding settlement balances were $175.2 million and $75.4 million, respectively; settlement assets and obligations were each $409.2 million and are not available as general liquidity.

Material changes versus the prior comparable period

• Revenue rose 14% in U.S. dollars and 25% in rand. Growth reflected KSNET, higher SASSA revenue under the national contract, the Eason prepaid business, and increased activity in loans and Iraq. Currency translation reduced reported growth: the U.S. dollar strengthened about 10% against the rand during FY2012.
• Operating income increased 63%, and margin rose to 16% from 11%. The comparison benefits from the absence of FY2011’s $41.8 million Net1 UTA intangible-asset impairment and $6.0 million acquisition-related transaction expenses; FY2012 also included a $4.0 million noncash gain on liquidation of SmartSwitch Nigeria.
• Net income benefited from lower income tax expense: $15.9 million versus $33.5 million. FY2012 included an $18.3 million deferred tax benefit from South African tax-law changes, partly offset by an $8.2 million valuation allowance for foreign tax credits. The effective tax rate was 26.4%, compared with 92.1%.
• Operating cash flow fell to $20.4 million from $66.2 million, reflecting receivable timing, increased merchant prefunding and SASSA implementation costs. Cash declined by $56.1 million, including substantial investment spending and foreign-exchange effects.
• Fourth-quarter FY2012 revenue was $107.6 million, but Net1 reported an operating loss of $2.4 million and a net loss attributable to Net1 of $8.0 million, compared with positive operating income and net income in the preceding quarter.

Outlook, management commentary, risks and unusual items

• SASSA awarded Net1 a five-year contract beginning April 1, 2012, to distribute grants nationally. Net1 began paying approximately 9.2 million beneficiaries in April and started beneficiary re-enrollment in July 2012, targeting substantial completion by March 2013. The new fee is ZAR 16.44 per beneficiary paid, or ZAR 14.42 net of VAT.
• Management expected cumulative capital expenditures for the national SASSA rollout of $45–$50 million, with roughly two-thirds expected by the end of FY2013’s second quarter. FY2012 included $21.2 million of SASSA-related capital spending and approximately $10.9 million in direct implementation expenses; separate executive and key-employee bonuses were $5.4 million.
• Management stated cash and credit facilities should fund operations, including SASSA implementation, for at least the next four quarters. The filing does not provide formal earnings or revenue guidance. It expected about 5,000 employees through much of FY2013, then a permanent workforce of roughly 3,000 after implementation.
• Key risks include dependence on SASSA, lower near-term grant-business margins, counterparty exposure when grant funds are deposited with banks, and litigation challenging the tender award. AllPay’s challenge was argued in May 2012; the company could not predict the outcome. A successful challenge could jeopardize all or part of the contract. Competitively sensitive tender materials were also made public in the litigation.
• Other risks include foreign-exchange movements, Korean floating-rate debt and covenant limits, competition, system or security failures, regulatory and licensing requirements, and the ability to meet South African black economic empowerment objectives. The $14.2 million fair-value expense for the BBBEE option was noncash; the option covered up to 8,955,000 shares at $8.96 and was exercisable through April 19, 2013.
• Net1 did not pay dividends and said it did not anticipate cash dividends in the foreseeable future. The SASSA tender award litigation and the option-related potential dilution are material items for investors to monitor.

Important facts for investors to verify

• Progress, costs and margins under the nationwide SASSA rollout, including completion of beneficiary re-enrollment and the outcome of the AllPay challenge.
• Whether transaction growth and additional services offset the lower SASSA pricing and increased operating and capital costs.
• Cash conversion and working-capital trends, particularly receivables, merchant prefunding and the distinction between available cash and settlement funds.
• Debt repayment capacity, Korean interest-rate exposure, and continued compliance with debt covenants.
• The recurring earnings impact of tax benefits and valuation allowances, and the extent to which FY2012 earnings reflect one-time or noncash items.
• Whether the BBBEE option was exercised, its resulting dilution, and the company’s progress toward applicable empowerment objectives.