LESAKA TECHNOLOGIES INC quarterly report, Q3 FY2011

Business context and reporting period

This is Net 1 UEPS Technologies, Inc.’s Form 10-Q for the quarter and nine months ended March 31, 2011 (fiscal 2011 Q3). The filing identifies Net 1 UEPS Technologies, Inc. as the registrant; it does not identify the registrant as Lesaka Technologies Inc. Amounts below are in U.S. dollars unless noted.

The company provides payment processing, social-welfare grant distribution, smart-card, financial-services and related technology solutions. The quarter’s results include KSNET from November 1, 2010, following its acquisition in October 2010.

Financial performance and position

• The quarter’s $41.8 million impairment of Net1 UTA customer relationships drove the reported operating loss. Excluding that impairment, quarterly operating income was approximately $19.6 million; management reported a 21% operating margin before impairment, compared with 37% a year earlier. Nine-month margin before impairment was 21%, versus 39%.
• Quarterly cost of goods sold and support costs rose 64% to $29.3 million; selling, general and administrative expense rose 46% to $32.6 million; and depreciation and amortization rose 118% to $11.2 million. These increases reflected acquisitions, growth and related amortization and expenses.
• At March 31, cash and cash equivalents were $88.9 million, down from $153.7 million at June 30, 2010. Nine-month investing cash outflow was $279.4 million, principally reflecting the KSNET acquisition; financing provided $145.8 million.
• Balance-sheet borrowings totaled $122.6 million, including $7.3 million current and $115.2 million long-term. Current assets were $348.0 million and current liabilities $245.6 million; both include matching settlement assets and obligations of $146.4 million. Excluding those items, current assets were $201.6 million and current liabilities $99.1 million.
• Management said cash and available credit facilities were sufficient for at least the next four quarters. Short-term facilities in South Africa and Austria were unused at quarter-end. Capital expenditures were $9.5 million for the nine months; outstanding capital commitments were $0.1 million.

Material changes versus the prior comparable period

• KSNET added international transaction-processing revenue and increased the company’s scale, but management said its margins were below those of legacy South African transaction businesses. KSNET contributed $41.0 million revenue and a $4.3 million net loss, including acquisition-related interest and intangible amortization, since closing.
• Revenue growth was partly offset by lower SASSA contract pricing and volumes, lower hardware and technology sales, and weaker MediKredit revenue. In South African rand, nine-month revenue increased 8%, while operating income before impairment fell sharply.
• Net1 UTA’s largest customer planned to move to another payment platform, prompting the full $41.8 million impairment of acquired customer relationships. The company also reversed the related $10.4 million deferred tax liability.
• The KSNET purchase was funded partly with cash and a five-year secured, floating-rate loan. Debt and interest expense increased, while interest earned on surplus cash declined. The loan rate was the Korean CD rate plus 4.10% for Facility A; the Korean CD rate was 3.00% at quarter-end.
• Foreign-currency translation contributed $29.8 million of other comprehensive income for the nine months, despite the net loss attributable to Net1.

Outlook, commentary, risks and unusual items

• SASSA concentration and tender: SASSA provided 44% of quarterly revenue and 48% of nine-month revenue. The contract covering five South African provinces was extended through September 30, 2011. SASSA issued a new tender on April 15, with bids due May 27; Net1 said it would participate. The company warned that losing the work, or receiving less favorable terms, could materially harm revenue, earnings and cash flow.
• SASSA litigation: The South African Supreme Court of Appeal reversed a lower-court ruling in Net1’s favor concerning SASSA’s contracting with the South African Post Office. Net1 sought leave to appeal to the Constitutional Court. The filing says the current contract remains in effect through September 30, 2011, but the litigation and tender outcome are uncertain.
• Management outlook: Management expected ongoing Iraqi transaction-fee revenue in fiscal Q4 and continued transaction fees from SmartSwitch Namibia and Botswana. It described KSNET’s performance as broadly in line with expectations and its integration as progressing well. It planned Korean growth initiatives funded from Korean cash reserves. No consolidated earnings or revenue guidance was provided.
• Other risks: Results are exposed to ZAR, KRW and other currency movements; floating Korean interest rates; and liquidity and valuation risks associated with the company’s Finbond investment. One South African customer represented 44% of quarterly revenue and 48% of nine-month revenue.
• Unusual items and contingencies: The $41.8 million impairment, $5.7 million of nine-month acquisition-related transaction expenses, and $3.1 million KSNET facility fee were significant. KSNET’s purchase-price allocation remained preliminary, and its post-closing working-capital adjustment was still being determined. The company reported no off-balance-sheet arrangements and no other material pending litigation beyond the SASSA matters and routine business litigation.
• Management concluded that disclosure controls were effective at March 31, 2011, and reported no material change in internal control over financial reporting during the quarter.

Most important facts for investors to verify

1. Confirm the registrant and security being reviewed: this filing is for Net 1 UEPS Technologies, Inc., not a registrant named Lesaka Technologies Inc.
2. Track the SASSA tender, contract terms and litigation, given the substantial revenue concentration and September 30, 2011 contract expiry.
3. Assess whether the Net1 UTA customer departure causes further revenue, cash-flow or asset impairment impacts beyond the recorded charge.
4. Review KSNET’s final purchase-price allocation, working-capital settlement, integration performance and contribution to margins and cash generation.
5. Monitor debt repayment, variable-rate interest exposure, cash levels and the effect of acquisition-related spending on liquidity.