Lesaka Technologies Inc (LSAK) 2010 Q2 法說會逐字稿

Good afternoon, and welcome to the Net1 second quarter results review. All participants are now in listen-only mode, and there will be an opportunity for you to ask questions at the end of today's presentation. (Operator Instructions). Please also note that this conference is being recorded.

I would now like to hand the conference over to Dhruv Chopra. Please go ahead, sir.

Thank you, Dylan. Good morning and good afternoon to our investors around the world. Thank you for joining us on our second quarter 2010 earnings call. On the call with me today are Dr. Serge Belamant, our Chairman and CEO, and Herman Kotze, our CFO. Both our press release and our Form 10-Q are available on our website at www.Net1.com.

As a reminder, during this call, we will be making forward-looking statements. And I request you to look at our cautionary language contained in our press release and Form 10-Q regarding the risks and uncertainties associated with forward-looking statements.

In addition, during this call, we will be using certain non-GAAP financial measures, and we have provided a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures. We will discuss our results in South African rand, which is a non-GAAP measure.

We do analyze our results of operations in our latest 10-Q and our press release in South African rand to assist investors in understanding the changes in the underlying trends of our business. As you know, the Company's results can be significantly affected by currency fluctuations between the US dollar and the South African rand.

Before I hand the call over to Serge Belamant, I want to point out that our updated operating metrics, and frequently asked questions are now available on our website. Serge?

Thank you very much, Dhruv, and good day to everyone that is on the call today.

Overall, I believe that we produced another solid quarter, which was driven primarily by our ever-growing core Transaction businesses. We continued to execute on our long-term strategy by making progress on expansion, both within and outside of South Africa, and by rolling out new initiatives, as well as expanding the footprint and dimension of our existing products and services.

For the second quarter of 2010, we reported revenues of $74 million, a year-over-year increase of 20% in US dollars, but a decline of 8% in constant currency terms. Strong hardware and software sales during the second quarter 2009 adversely affected our year-over-year comparisons.

Fundamental EPS for the second quarter of 2010 was $0.51, an increase of 42% in US dollars, and 8% in constant currency terms. Movements in the South African rand versus the US dollar had a favorable impact, for a change, on our second quarter 2010 results.

As of December 31, 2009, we had $153 million in cash on the balance sheet, having generated $14 million in operating cash flow during the quarter. We remain satisfied with our cash and cash generation potential, and to that effect our Board has authorized a new $50 million share repurchase program.

I will now address the key strategic trends in our business before handing over to Herman, who will discuss our financial results in more detail.

Starting with our South African Pension and Welfare business; you are aware that effective April 1 of 2009, we entered into a new one-year contract with SASSA. Under the terms of the new contract, we moved to a standardized pricing formula, earning a flat fee per beneficiary paid versus different pricing methodologies in each of our provinces as we have previously, while we also eliminated our obligation to pre-fund welfare grants in all provinces.

During the second quarter of 2010, we grew our core Pension and Welfare revenue, including Merchant Acquiring, by 5% year-over-year on a constant currency basis. The improvement in our operating results were driven by a modest contribution from the inflation-adjusted increase in our average revenue per beneficiary when compared to a year ago, and continued migration of beneficiaries to our Merchant Acquiring network.

As of December 31, 41% of our beneficiary base loaded grant electronically, up from 35% a year ago. Such factors, as well as our focus on cost management, contributed to the 590 basis point improvement in Transaction-based Activities operating margin, which reached 61% in the second quarter of 2010, excluding the amortization of intangibles.

We were informed yesterday by SASSA that they wish to meet with us in the next few weeks to discuss an extension of our contract for an additional year. Although this extension will allow us to continue activities around our Pension and Welfare clients, such as merchant acquiring and the provision of financial services, an extension in some way limits us from growing a customer base substantially, as we will be limited, by definition, to the existing provinces in which we currently operate.

The new tender will, of course, be welcomed, although it may on the one hand introduce some new risks, but on the other hand allow us to at least attempt to grow our business, and to establish a much longer-term association with SASSA. We are confident that we will remain, in some form or other, an integral supplier of social welfare grants in South Africa.

To conclude on our Pension and Welfare business, in fiscal 2010 we expect to generate modest revenue growth in the segment, while earnings growth should be greater driven by continued migration to our merchant infrastructure and ongoing cost management efforts. Longer term, we are poised to benefit from government's continuous effort to widen the welfare net, and assist its effort to improve efficiency by leveraging our technology core platform on a national basis.

Moving to our other South African initiatives, EasyPay continues to gain share in the merchant processing industry, while driving greater efficiencies of scale and, therefore, profitability. We process in excess of 60% of retail transactions in the country. Together with the acquisition of RMT, one of the three major prepaid electricity providers in the Cape Town area during quarter four of 2009, we are able to offer additional value-added services such as bill payment, insurance, loans, prepaid utilities, and air time, etc., driving higher revenue and profitability going forward.

Retail spending during the Christmas season was stronger than expected, fuelling a 12% year-over-year increase in EasyPay volumes in the second quarter of 2010. We continue to [grow our] further penetration of value-added services, such as bill payment and prepaid utilities. In addition, the mandatory upgrade to EMV compliance in South Africa has resulted in an opportunity for us to replace the non-compliant point-of-sale devices with our new biometric UEPS-enabled devices, and we have engaged with the largest retailers in this regard. The replacement cycle is expected to take 24 and 36 months.

Turning to our wage payment initiative, last month we appointed a new general manager, tasked exclusively with accelerating growth in our financial services segment, which includes wage payment, microfinancing, and insurance. While we are successfully providing payroll and other services to our large corporate client, and discussions with a number of smaller employers are actively underway, we are not satisfied with the pace at which we are penetrating this sizeable market opportunity.

Our new general manager, who has extensive experience in the South African financial services industry, will bring a committed focus on this initiative and put in place dedicated sales and support resources to drive future growth more rapidly.

Last month, we closed our acquisition with MediKredit, a private South African company that offers a unique real time claims assessment system, a transaction switching system, as well as a financial and clinical risk management solutions to both funders and providers of healthcare.

During 2008, MediKredit assessed and switched over 60 million transactions. Strategically we can leverage our UEPS technology to present national [FMA] administration solutions to countries like South Africa, Ghana, and Nigeria.

The final leg of our strategic plan relates to international expansion and new technologies. Starting with our existing projects, our UEPS team has delivered 1.45 million cards to Iraq, and our local partners have to date enrolled over 1.1 million war victim, pension, and wage recipients. More than 7,000 new customers are enrolled every day.

Our partners have ordered a further 500 enrolment stations, 1,500 point-of-sale devices, and 800,000 additional smart cards which are expected to be delivered over the remainder of fiscal 2010. This will allow our partners to increase the enrolment to about 15,000 new customers per day. Our transaction fees in Iraq, while still modest, continue to grow rapidly each month as more people are enrolled, and as they perform more transactions.

As mentioned previously, our partners are launching their merchant acquiring system with an initial 500 cash merchants at which our full UEPS functionality such as [sale], money transfer and bill payments, and cash advances, will be activated. Further government initiatives have been concludes as, for example, with the Ministry of Defence, to pay salaries to all of the defence workforce, estimated at over 500,000 people, as well as around 40,000 new grants for widows of related war victims.

Penetration rates in Ghana continue to remain very strong, with more than 2.1 million cards delivered, and 26 banks, and 14 savings and loans institutions, already participating in the system. 900,000 cards have been set aside in order to empower the community banks of Ghana.

Ghana has issued over 385,000 cards to date, but both government and financial institutions are still focusing on building up the NPS infrastructure and access points, before a more aggressive card issuing push is commenced. In December, a further 1,000 point-of-sale devices were purchased and delivered.

New business development is currently underway to make use of our UEPS transportation wallet, to be launched imminently for buses. And, more importantly, the onboard point-of-sale unit will be utilized to perform UEPS functions offline while commuters are traveling. I think this is probably a world's first.

In 2010 we expect to launch our Phase II expansion plans in Ghana, which include our mobile UEPS technology including our new VCC offering, generating incremental and recurring transaction fees for the Company in this specific country.

[NUAT] continues its marketing drive into Africa, the Middle East, and the Philippines. And as a result of the stupendous result achieved in Iraq and Ghana, numerous potential customers have visited NUAT to date and further visits are planned for February 2010 with a number of representatives from central banks, large financial organizations and government officials. A number of contracts have been drafted and are being finalized pending some condition precedents, such as the final approval from the central banks concerned.

The business model going forward has been refined, and is a combination of the Ghanaian and Iraqi models, which delivered to Net1 upfront payments, license fees, as well as, very importantly, ongoing transaction-based revenue streams. All bodes very well NUAT over the next 12 months, and I am expecting some very, very good wins in the very near future.

Net1 Austria, formerly BGS, continues to move forward with its business model restructuring, and its pursuit of new business development activities with a transaction-orientated model. We expect the transition to a transaction model to take another 12 to 24 months. While Net1 Austria continues to serve its existing customer base during quarter two, 2010, it delivered 20,000 point-of-sale devices and pin pad to the National Bank of Uzbekistan, and last month celebrated its 15 year anniversary since the launch of the national payment system called Uzcard. Today, the Uzcard system comprises 4.8 million smart cards, and 35,000 point-of-sale devices. And in 2009 transaction volume on the system grew 78% to $800 million.

Looking forward, the progress made by business development teams in both NUAT and Net1 Austria is very encouraging and provides a clearer roadmap towards further globalization of the Net1 technology. While we are not at liberty to discuss specific projects, we continue to expect converting at least one or two of these opportunities over the next six to 12 months.

Finally, in terms of new technologies, we stepped up the marketing for our virtual card solution during quarter two, 2010, and have had a very encouraging response thus far in many different countries in the world. In order to fully commercialize our solution, we're actively addressing all of the regulatory and procedural requirements needed to participate in the global payment landscape. We remain cautiously optimistic about virtual cards' prospects in the coming quarters.

In summary, we are very pleased with the performance of the Group during the second quarter of fiscal 2010 as we are well positioned to sustain long-term growth given our pipeline of opportunities.

With that let me turn to my CFO, Herman. Herman, over to you.

Thank you, Serge. I will discuss the key results and trends for the second quarter of 2010 compared to the second quarter of 2009. My discussion will be based on our results in South African rand as this provides the best indicator of the Group's actual operating performance.

In order to review our results in US dollars and in US GAAP, please review our Form 10-Q and our press release filed yesterday evening.

For the second quarter of 2010 our average rand/dollar exchange rate was ZAR7.52 compared to ZAR9.96 a year ago and positively impacted our US dollar based results. Any fluctuation in the rand obviously influences the dollar equivalent results of our operations, which is why we provide you with constant currency information in our press release as a clearer indicator of our operating drivers.

I am pleased to report another quarter that reflects solid fundamentals of our core businesses. During the second quarter of 2010, in addition to favorable currency movements, a few items that did impact the comparability between the two periods include, $3.2 million of hardware and software revenue to Ghana, a before-tax $20.6 million foreign exchange gain, and $1.8 million of goodwill impairments related to our traditional Microlending business in the second quarter of 2009, and increased intangible amortization expenses related to the Net1 Austria and RMT acquisitions.

We use a non-GAAP measure called fundamental earnings per share, which eliminates some of these one-off items that impact year-over-year comparisons. We typically exclude the effects of irregular tax changes, amortization of intangibles, stock compensation charges and unusual, non-operating or non-cash flow items when we calculate this measure.

On a consolidated basis for the second quarter of 2010, we reported revenue of $74 million, a decline of 8% in constant currency, but an increase of 20% in US dollars.

Similarly, fundamental earnings per share of $0.51 in the second quarter of 2010 grew 8% in constant currency, and 42% in dollars. We measure the Group's profitability by looking at operating income and margin by segment.

On a consolidated basis, operating margin, adjusting for one-time items and intangible amortization, declined 80 basis points to 44% during the second quarter, primarily due to lower margins in our Hardware segment, but mostly offset by stronger profitability in Transaction-based Activities and Financial Services.

Let me now spend a few minutes on our segments. Transaction-based Activities posted revenue of $45 million during Q2 of 2010, up 6% in local currency and 38% in dollars.

Our core Welfare business, including Merchant Acquiring, grew 5% year-over-year in rand, while the number of EasyPay transactions processed increased 12% to $174 million. In constant currency, segment operating income grew 16% from Q2 2009, while operating margin improved 500 basis points to 59%. Excluding amortization of intangibles, segment margin improved to 61% in Q2 of 2010 from 55% last year. Growth in revenue and profitability was driven by EasyPay, Iraq, increased merchant adoption and cost management initiatives.

Moving to our operating metrics, during Q2 of 2010 the number of beneficiaries paid was 9% lower year-over-year and 3% sequentially. As a reminder, we are now contracted to a guaranteed minimum number of beneficiaries paid, thereby limiting any downward pressure on revenue due to a reduction of beneficiaries serviced.

Second, pricing per beneficiary was higher when compared to a year ago, but consistent with the prior two quarters. And third, continued strong performance at our Merchant Acquiring network with 41% of our beneficiaries loading grants electronically, up from 35% last year.

In the second quarter we processed a total of ZAR2.8 billion through our network on a completed pay cycle basis, representing 11% year-over-year growth. The productivity of our 4,617 store terminals declined to 982 transactions processed per POS device during a completed pay cycle, from 1,036 transactions per terminal during Q2 of 2009 due to the addition of nearly 500 more point-of-sale terminals over the last year, in line with the increased demand for merchants to offer this important service to their customers.

In Q2 of 2010 EasyPay processed 174 million transactions with an approximate value of [ZAR59 billion], an increase of 12% compared to 156 million transaction worth ZAR56 billion, processed a year ago.

In addition to increasing value-added transactions in the quarter, EasyPay also benefited from better than expected retail spending during the Christmas and holiday season. The average fee per transaction during Q2 of 2010 was ZAR0.21, consistent with our prior year period.

During Q2 of 2010 EasyPay operating margin, excluding amortization of intangibles, improved 40 basis points to 58% as the efficiencies of our new operating platforms and expense management systems bear fruit, and as we continue to sign up more bill payment issuers and other value-added service providers.

Our Smart Card Account segment posted revenue of $8 million in Q2 of 2010, a 7% year-over-year decline in constant currency. The total number of active smart card accounts was $3.7 million, a decrease of 9% from last year. Operating margin for the segment remained consistent at 45%.

Turning to our Financial Services segment, revenue in Q2 of 2010 declined 54% year-over-year in constant currency to $1 million, principally due to the sale of our traditional Microlending business to Finbond in March 2009.

Segment operating margin for Q2 2010 improved to 64% from a negative 110% in Q2 of 2009, driven by a $1.8 million goodwill impairment a year ago, the elimination of the low margin traditional Microlending business, and higher underlying profitability in our UEPS-based lending activities.

Our final operating segment is Hardware and Software, which traditionally includes Net1 Austria and revenues that occur on an irregular once-off basis, which makes it difficult to predict sales and margins from year-to-year.

Segment revenue in Q2 of 2010 was $20 million, representing a 27% year-over-year decline in constant currency. The decrease was due primarily to cyclical pressure on certain commodity hardware products we sell, non-recurring revenues from Ghana during Q2 of 2009, and lower revenues from Net1 Austria.

During Q2 of 2009 Ghana contributed $3.4 million of high margin revenue to the segment. The ever-changing contributors to this segment cause volatility in operating margin from quarter-to-quarter.

Operating margin for the segment decreased to 9% from 27% in Q2 2009, mainly due to seasonality in Net1 Austria's profitability, amortization of intangibles, the absence of high margin contributions from Ghana, and pressure on certain hardware commodity products. Excluding amortization of intangibles, segment operating margin declined to 22% in Q2 of 2010 from 41% a year ago.

Historically, our cash flow was subject to fluctuations as a result of the timing of commencement of our monthly welfare payment activities and pre-funding requirements. While we are no longer required to provide pre-funding on behalf of SASSA, we continue to provide one to two days of pre-funding for the merchants who assist us with the distribution of grants through the Merchant Acquiring network.

During Q2 of 2010 we generated cash from operating activities of $14 million and incurred capital expenditures of $700,000. Year-to-date we have generated $51 million in cash flow from operations while incurring $1.3 million in CapEx.

As of December 31, 2009 we had $153 million of cash and cash equivalents on our balance sheet. The business remains very cash generative and I remain comfortable that we have sufficient liquidity between our cash and short-term facilities to fund our working capital requirements.

On February 5, 2010 our Board of Directors approved a new $50 million share repurchase program. Our fully distributed share count for Q2 of 2010 was 45.6 million shares, down from 57.2 million a year ago.

In conclusion, we are excited about the future opportunities and prospects of our business, both in South Africa and internationally. Given our current pipeline visibility for fiscal 2010, we remain comfortable that our guidance of at least 20% in constant currency fundamental earnings per share growth is attainable.

With that operator, please open the call for Q&A.

Thank you very much, sir. (Operator Instructions).

Our first question comes from Dave Koning of Baird. Please go ahead.

Yes, hi guys. Another nice quarter.

Thanks.

And I guess first of all, seeing the beneficiaries down about 3% sequentially this quarter again, I'm just wondering if going into the SASSA discussions if they could potentially reduce the minimum payments due, given that they see the beneficiary accounts go down. Or do you have a pretty high level of confidence that the current revenue minimums are likely to hold, or maybe go up with a little inflation pricing? I just want to pursue it, if they see the beneficiary account coming down and that could cause some additional revenue or pricing pressure?

David, obviously your point is something that obviously we are considering going into negotiations in the next two weeks. I think what's important to try to understand is number one, why did the numbers or why are the numbers going down? And there's no doubt that the numbers are going down because I think every effort is being made by government to eliminate any remaining, for lack of a better word, beneficiaries that may perhaps should not be on the beneficiaries' files.

So there's still a continuous drive to try to eliminate any potential fraud or simply people that have applied for grants and being granted grants, but in fact they'd never qualified for those particular grant and certainly do not qualify now. So I think that explains, at least by what we can see from the numbers and we have obviously accurate information given to us by SASSA on a month-to-month basis, we can see that that is in fact the state of play. There's no doubt about that.

Now because of that, the numbers have come down, but it does not mean that new beneficiaries are not coming on board or we do not anticipate for new beneficiaries to come on board. In fact, the state of the nation speech I think is tomorrow and we're going to have the budget in the next couple of week, and I'm positive that a few things are going to happen. One, more people are going to come on welfare or at least there may be different categories of welfare recipients and two, you'll probably find that the amount of the grants is going to come up.

Now this is quite clever on their side because our large contract states that we have a fixed fee. So by definition we might be able to negotiate an inflationary increase, but it's unlikely that it's no longer linked, like we had in one or two provinces, to the actual amount that we disburse. So that's one thing we need to keep at the back of our mind.

On the other side, during the particular time that we negotiated with SASSA last year, we also made it very appealing to them to actually give us more beneficiaries rather than less, simply by giving them a structure whereby anything above the [$3.7 million], which was the minimum target, we actually would be charging them less for every additional beneficiary until our infrastructure would have to be modified, or would have to be increased, in order to cater for more.

So we believe that, taking all of that together, one, we would be obviously very unwilling to actually drop, either the minimum number of beneficiaries, simply because the infrastructure we have remains the same, and has to remain the same even to pay a lesser amount of people; the number of pay points remains constant; the number of trucks remains constant; ATMs remains constant. The only thing that really drops a little bit is perhaps the amount of cash that drop by a few percentage points and the bank cost associated will drop a little bit, but that in any case will be offset by the increase in grants.

In other words, our cost structure would remain the same. So there's no reason, therefore, that unless we have more beneficiary that we should therefore agree to actually drop, either the minimum number of beneficiaries or, for that matter, our price or not to try to at least negotiate a fairly good CPI increase.

So we're certainly hoping that we will fall back on our feet, and certainly not come off after the negotiation with a worse position that we're currently in.

Okay, that's very helpful. I guess the second thing is, in the first half I think your constant currency EPS growth was somewhere in the 11% or maybe 12% range if you take into account both Q1 and Q2 together. So to get the 20% plus EPS growth the back half of the year has to be pretty strong. I know you have a little easier comps, but maybe just talk through why you expect to get 30% or ballpark EPS growth in the back half?

Obviously a good question, Dave, and clearly one of the key drivers that you've got to keep at the back of your mind as you said, is the fact that there will be the full impact of the reduced share count during the second quarter, the last two quarters of this fiscal year. The full impact of the almost $10 million share buyback -- or sorry, 10 million share buyback that we did, I don't think is fully reflected in the first two quarters and will come through obviously during the second two. So that's something we have to keep at the back of our minds.

And then, of course, there are some other initiatives that we have some visibility of during the next, really four and a half months, five months that we have left of this year. And based on what we currently see, we believe that we would be able to achieve those sort of numbers.

In South Africa we have EasyPay that continues to perform very well, and certainly we hope to see a continued growth in that area. Similarly in our Financial Services area as you've seen from the results, now that we've managed to get those margins back to the positive side, we certainly hope to grow that business quite aggressively going forward, with the addition of a new management team as well in that business.

Iraq, obviously we see continued growth and adoption of the system over there. It'll be probably a combination of additional hardware sales to that specific country but, more importantly, increased transaction volumes that we see coming through. And, hopefully, one or two other initiatives that we hope to see the impact of.

The MediKredit acquisition, of course, will also go into play as of the third quarter. But as far as that's concerned, it's not really something that we believe will add a significant amount of bottom line income in the short term.

But from where we sit right now, obviously there are many variables that we have to keep in mind for the next six months. Clearly there is the SASSA negotiations that may have an impact on the final quarter, because the new extension terms will be valid from April 1. And, as Serge indicated to you, we're certainly of the opinion that that will go as well as we can hope it will.

And as far as our international -- other international endeavors are concerned, we have the team at Net1 Austria that we also hope will be able to produce some further results in terms of international expansion over the next five months or so.

And like I've mentioned as well, David, we're also expecting, what I would hope to see is certainly a couple of short-term wins on the international front. One, certainly with VCC, which is a bit long overdue for me and I'm losing a little bit of patience on it, so I think we are putting in some effort in making it happen quicker.

And I also feel quite confident we're going to hit at least one in the NUAT's environment as well. So like Herman says, I think perhaps the pipeline, what we call the pipeline, we are rather conservative type of people as you know, but we're starting to see movement which is looking very real to us. And this is why I think Herman has continued to confirm that the 20% is certainly achievable.

That's great. And if I may sneak one quick one in too, how much revenue was there in Iraq in Q2, and then is that something that, the Q2 contribution can be doubled in Q3 and Q4? Just maybe a little bit of color around that.

Dave, it's Dhruv. Iraq is not large enough at this point on the transaction side for us to break it out explicitly. But its contributions are obviously coming off a zero base, and it's continuing to grow exponentially every month. So as it becomes more meaningful to the top line we will try and provide some additional color around that.

But your point is very good, David. And to me what's exciting is that, because the number of beneficiaries registered is growing very fast as you can see. And because of the commitment of the Iraqi, our Iraqi partners to government to start to be able to register up to 15,000 new people per day, that in itself certainly confirms your own thinking whereby if the number of beneficiaries register grows at that sort of a rate, it is not unreasonable to believe, therefore, that quarter-on-quarter that the amount of volumes of transactions and, therefore, the fees should actually grow according to the same ratio. So they should double or quadruple over the next three to six months, without a shadow of a doubt.

Okay, that's great. Thank you.

Our next question comes from Tom McCrohan of Janney Montgomery. Please go ahead.

Hi, thanks for taking the question. Does your guidance for the back half of the year, does that assume that you will be converting a new country in your current business pipeline or -- I wasn't sure if I understood how you described your back-half guidance?

Tom the -- our guidance obviously has some inclusion. And when these new countries are signed, and obviously it will differ in terms of the business model adopted, it could be a straight out sell, as we've seen in places like Ghana. And obviously sometimes we have no choice but to follow that specific route. In other countries, from time to time, we form partnerships and we co-invest. And then, of course, on the VCC side the business plan is again something that is completely different, depending on whether it gets implemented with a mobile operator or a bank or a retailer.

So looking at the next six months or so, five months, and the likelihood or the probability of the transactions that we have in the pipeline, and really they're a combination of all of the things that I've mentioned above, what we also have to keep in mind is that typically the implementation and delivery times required for specifically new country wins, sometimes or most often stretches at least over a 12 to a 24 month period.

And the initial revenues generated by those country wins are obviously fairly small in relation to the way they grow as the systems are customized and as the systems are installed. And we follow the percentage of completion accounting basis really to account for specifically our software revenues and licenses.

So looking at the next year or six months and what we believe can be achieved, and will be, we hope some impact, but most definitely the bulk of it will be from our existing business activities.

(inaudible) to make you feel a little comfortable, I think it's important to say that, once again, as we are reasonable conservative, we certainly have not considered that everything we believe is in the pipeline would have to be delivered before the end of June in order to achieve the 20%.

We tend to say that there are always things that happen that we do not know, so we've taken a bit of, let's call it, a mixed bag of what we believe can happen realistically. And we're saying, worst case scenario, we should get our 20%.

Okay and the core Pension and Welfare business, are you currently operating at the minimum number of beneficiaries as per your contract, or are you above it right now?

At the moment, the number of beneficiary we pay is lower than the number of beneficiaries which is reflected in the contract, which is guaranteed. And that is due that because over the last year, like I mentioned, a number of beneficiaries have been taken off the beneficiary list, simply because either they have to reapply, or because of the fact that they simply do not qualify. Or sometimes, it becomes a budgetary issue, whereby they get taken off because there's no budget, and then they reapply a couple of months later and get put back on again when the new budget is going to be announced.

I think after the new budget that's going to be announced now, you're going to find that, in fact, beneficiary numbers, in my view or at least new beneficiaries must come on board. And then it will be a question of making sure that obviously in our provinces, we actually get those beneficiaries rather than to allow them to go to banks, which by definition are competitors, although there's not much incentive for a beneficiary to want to open a bank account a bank account where he has to pay for it, rather than to actually have one our, lack of a better word, virtual bank accounts where he pays nothing and has a better level of service.

So we think that this number will definitely grow. It would be silly of SASSA not to grow it to the minimum, considering that it's costing them nothing to actually give us back another 200,000 or 300,000 people.

Okay and a question on the Hardware and Software segment, which after three consecutive quarters, I know it's been volatile, it's been profitable this quarter, but after three consecutive quarters of losses. And I'm just trying to get a sense for the contribution from Iraq. I know you said it wasn't really meaningful, but you did issue a press release in early January talking about additional point-of-sale terminals and cards to be shipped to Iraq. So is that -- is Iraq going to help you maintain profitability in that segment, as per what your talked about in that January press release, through the next couple of quarters?

It will certainly assist, because those sales of point-of-sale terminals and cards that are, in general -- if we look across our product range, let's call it that, and we analyze the relative margins attributed to each one of our product ranges, then certainly, at the upper end of the scale you will have, obviously software sales, but also the point-of-sale devices etc.

At the lower end of the scale, and that's what also determines and causes a huge amount of fluctuations from time to time, we have our SIM card manufacturing or GSM business, which you may recall is a business that we bought three/four years ago as part of the Prism acquisition. It is a business that is under severe marginal pressure all around the world in terms of the manufacturing costs and the sales prices demanded by the mobile operators.

And so in our case, it really is a mixed bag. And depending on which one of these commodities we manage to move the most of during any specific quarter, we have this major impact on the margins in the Hardware and Software segment.

And that's why we try to go to great pains to explain that this is not our core business. It is something that is a natural outflow from the Transactional business that we try to specifically conduct in South Africa, but also internationally. And you're going to find it very difficult, I think, as we do, to put any accurate prediction on any quarter-to-quarterly movements as far as the Hardware and Software segment is concerned.

What you will see is if there is a significant software sale then the margins will be very good. But where we have some significant GSM sales, as I said, the margins will be under pressure.

Okay, my last question's just you've talked about -- this quarter and last quarter about tweaking the approach for new market entry, something along the line of in between Ghana and Iraq. And from [new to the story], that both of those deals seemed structured very similarly, an upfront cash payment and recurring revenue tail. So I'm wondering if you can expand on that. What are you looking to tweak? And what the difference really is between Ghana and Iraq, as on the surface it seems they're very similar transactions, and how you entered both markets.

No they're actually very, very different. The Ghanaian, because it was done with the central bank, the central bank were not really interested in getting into a relationship with us whereby they would pay us transaction fees based on every single transaction that's going through the system, considering the system was meant to become the national payment system in Ghana.

So we did get a huge, for lack of a better word, when I say huge, I believe they actually were lucky, they got our software for a very cheap price. But at the end of the day, were still large amounts of cash up front. And at the moment in Ghana, not only do we get money out of terminals, selling terminals, cards, ATMS, registration stations, but we make money out of every -- through license fees.

Now license fees are based on the number of cards which are active, a little bit like Visa and MasterCard works. But we do not get any fees based on the transaction that actually occurs in Ghana.

That is something that I think in my little expose, I talked about we wanted to actually introduce in Ghana, through our VCC as well our cell phone technology. Because we've renegotiated that aspect, whereby by bringing in that technology into Ghana, we would now make in [fact] transaction fees as well.

The Iraqi model from the beginning was we get very little up front, but we get a significant transaction fee on every transaction that takes place, apart from the hardware and software sales.

It's an outsourced processor model.

And it's an outsource process model. So now we decided, going forward, we're saying well, we lack the money up front we got in Ghana, and we certainly lack the money that we are starting to see being generated out of Iraq on a month-to-month basis.

So therefore, if you put those two together, that's the model that we want to go forward with.

In other words, we're unlikely to get as much upfront as we did in Ghana, but certainly more than what we got in Iraq. And going forward, we're likely to get transaction fees out of every transaction that is, in fact, effected in that particular country, rather than simply a fee based on the number of active cards.

So that's what we mean by the combination of the two particular models.

That make sense. And is there any also consideration to going into new markets more in a JV approach, because you had some skill in the game and it helps you control the implementation? Or are you happy with just how Ghana and Iraq are really just customers; there's no joint venture there?

Again, it's a very good question and, as you know, we've tried these models. We've got a 50/50 in Namibia; we have a 50/50 in Botswana; we had an 80/20 in Nigeria; we've got JVs in Colombia. So we've tried different things.

One thing that comes across out of all of this, very, very quickly, is that you need somebody locally to have a lot of skill in the game. Because we simply do not, from where we are, understand or even appreciate the difficulties that the local players may have in doing implementation. There are all sorts of things, the governments that change; the legislations; there are banking rules. There are all sorts of things we don't understand.

So we decided that we would prefer to have little, if any, financial input, or at least our money to be invested to try to get back on the share and rather work on a pure percentage of every transaction. And when I say transaction, it may be any fee that is generated from a transaction before any other expenses can come off it, okay? And this is becoming now one of the rules that is part of our agreements.

Very often, we find that the customers on the other side tend to object to it, because they can multiply a small number by a big number and get a big number. But we tend to then lower, for example, our entry point in terms of software, which is working for us because people are saying, well at least the risk I'm taking up front is actually not as big as what it could have been. And I know long term, I'm giving away perhaps a lot more than I would have. But if I give away that amount, I'm making the balance, which is eight or nine times greater than what we're making.

So that model seems to be working better than saying to them, we want 20%/30%/40% of the Company because they've got all sorts of rules and regulations all over the world in terms of what you can own and specifically as to what rights the 40% actually gives.

So we're trying to stay away from those type of, let's call it shareholdings, specifically in the developing economies.

VCC might be a different story, but certainly in developing economies, we don't believe that it's worth our while. We found that the risk might not be worth it. It's better to just take the money on a month-to-month basis and allow the people on the ground to actually drive the business according to a speed that they believe it should be driven.

But in some -- having said that, of course, there are some territories where you will find that unless you co-invest with a party, and if you have a strong belief that it is the right partner, you may well find that the partner will insist on a co-investment, simply because it provides them with the necessary comfort that the key technology provider is a partner and has put some skill into the game, as you said.

So one can never enter any or say that there will be territories where that won't be a pre-requirement because I think we'll still continue to see some of that.

Oh definitely, it's more what's preferable rather than what will be done.

Okay, thanks guys.

Thank you.

(Operator Instructions)

Our next question comes from David Togut of First Manhattan. Please go ahead.

Good afternoon gentlemen.

Hello David.

Serge, you referenced a few contracts that were being drafted with new countries that only required central bank approval. Are these possible contracts competitive situations, number one?

And number two, to the extent you only need central bank approval, is there a date certain at which you expect that, such that you would have some confidence this would occur in the next couple of quarters? Or is the date more open-ended?

Well again David, it's a good question. You know central banks round the world, it depends where you are. Obviously, there's condition precedent were built into the contract, simply because we know that many, many people would have signed with us many contracts until now, but unfortunately without doing their own homework. And we found that later on, over the -- in most countries where we operate, a specific bank or financial organization can pretty much launch whatever they want, as long as they don't need to operate with anyone else. In other words, without central bank approval they can pretty much do it.

This becomes a problem later on, because the other banks then tend to want to launch their own things and start competing, or start planning together, in order to compete with the sole bank that actually did it. So we decided that this is, maybe short term, would make us a little bit more money and would make, probably you guys a lot happier because you would see faster contracts. But long term it doesn't work, because the technology then tends to die out, simply because there's only one person or one institution that's running it.

So the central bank approval is something we've enforced to all of our partners. And in the countries that we're talking about, we obviously have already had lengthy discussions with the central banks of those countries in order to make sure that, at this point in time, we do not see any reason why that particular aspect would not be granted by them, vis-a-vis the UEPS.

They have been in communication with a number of other countries, including people from Ghana, people from Iraq, people from South Africa. So they've been phoning around to make sure that, in fact, from their point of view they're talking about something that is in fact proven. But to actually say to you it would be a week or it would be a year, is very difficult. Let us say that I would be more than upset if it was something that was going to take another year, because otherwise the contract would mean nothing.

To give you an idea, the condition precedents are only valid for a period of 90 days. So we give the people 90 days to actually conclude or to meet any condition precedent, after which the contract becomes renegotiable. So that gives you a little bit of the feel.

With central banks my experience, it depends where you go. If it was our own South African Central Bank I would say to you, it's probably years because it's highly, highly regulated as, in fact, First National Bank is going to find out with PayPal, trying to do, I believe, an association in South Africa, and have already hit the first particular barrier.

So we know that here it's very highly regulated. Most other countries, if they become government driven projects, like for example Ghana or Iraq and then many other countries are looking at doing the same thing, I believe the central bank is more a question of convincing them that the technology is solid, that it can be demonstrated, that it has industrial strength. They're already convinced that the business model obviously works and it will satisfy the presidential aspirations in that particular country.

So I think it's much easier to get central bank approval in those countries than countries that are perhaps, either a cross between first and third world or first world. So I feel quite confident that the contracts that have been pretty much drafted and are pretty close to signing, the realization should, in my view, be concluded rather short term rather than long term.

So in other words that 90 day clock that you referenced has already ticking on a few of these opportunities?

Because of the signature that we are obviously waiting for, we believe that the 90 days either has started or will commence clicking very, very soon indeed.

And then third, you referenced VCC and some frustration with that, what has to occur for you to actually sign one or two VCC contracts? Are there regulatory hurdles left, or is it just a matter of prospects doing more due diligence on the technology?

Well once again David, you've been Net space a long time, and you found that some of the things that have been frustrating me is simply that, when you deal with different banking systems, remember that we're focusing greatly at the moment with VCC in the US. And the US simply because we believe it's a fantastic market for us to get into and we believe VCC is absolutely key in that particular environment.

Now I can't tell you how many people have looked at it, and how many people are actually incredibly excited about this particular product. We have to make sure, however, that at the end of the day, we could -- we were not going to upset anybody, number one. And number two, that we're also we're going to make sure that we are in line with any organizations today, other standards or regulations, for example MasterCard, Visa whatever the case might be.

We are very pleased to say that we have convinced MasterCard. And in fact for one of our banks they actually wrote to them very, very recently, in fact this week, to actually say to them that they've reviewed VCC and they do not see VCC to, in any way whatsoever, have been a product that would not be -- that could not be used by that particular bank under the MasterCard rules, regulations or logo.

In other words they basically said, guys it's up to you to decide, but on our side we have no objections in you guys, meaning the bank, the member of MasterCard, to use this particular product. And that already is a fantastic breakthrough.

We believe that what we had done did not require MasterCard approval any way. But when you go and talk to a particular bank there is a MasterCard issuer and I'm going to require a MasterCard pin, they tend to want to hear it from MasterCard even if in fact, MasterCard did not need to give them approval. So I think that's been a huge breakthrough to get MasterCard to put pen to paper and to actually endorse something they did not have to endorse in the first place, just to make their own members comfortable.

This is the type of things that we are talking about that has been frustrating. Now I believe we have gone past most of those at this point in time. And I really think that the real excitement that VCC has created, not only in the US, but in many other countries that we have now been attempting to actually, just to see how it would be picked up, we believe VCC will become a real product in a very, very short term.

It will become a real product somewhere. I wish I could tell you that it was going to be one or two of the big customers we have identified in the US. I think that might be a little bit, maybe a little bit longer than we think. But I think one or two other countries might actually marry and implement VCC very, very shortly.

Serge, if you take a step back and look at the BGS acquisition since you made it a little over a year ago, what is your assessment of BGS overall?

In the last couple of calls you've talked mostly about your pursuit of the national payment system in Russia, and now you've talked a little about Uzbekistan, but if you take a step back, what's the performance of the business overall? Are you pleased, are you unhappy? And if you're unhappy, what needs to be done to improve that business?

David, again it's a very, very, very good question. And I wouldn't say that I'm unhappy, but I wouldn't say I'm happy. I'm getting older, so I get a little bit more -- I get more impatient than most a lot quicker. One thing I can tell you is that BGS I think is moving in the direction that we have strategically told them to move, which I think is important. We did not like the business model; I still don't like their business model. If you look at all the terminals and cards that they've sold, they're making so little money out of doing it that it's hardly worth it, is it?

So at the end of the day the new business model will work. And I'm hoping that we will surprise everybody by actually showing you that the new business model has been adopted. And in fact I think they're going to get a win very shortly, based on the new business model, which I think is going to make them very happy as well.

So from that point of view, I think we've got the right people; we didn't make a mistake as far as that's concerned. I think these people know how to go out and to market, once they understand. It took them a while to understand our technology compared to theirs, even if it was based on the same patent. I think they're reaching that stage of maturity, it might take a little longer, and I think they're going to surprise us and land something reasonably substantial in a reasonable short space of time.

When it comes to the Russian market, the Russian market, I think, is reasonably complicated, as I think Mr. [Grest] was telling everybody on television, vis-a-vis what he believes of the banking system. We still believe we will play a role in the national banking system in Russia because we are working with -- still with Sberbank which we're very close to, in terms of trying to assist them to define the right combination of technologies to create the so-called URPS, or the national payment system in Russia.

They have decided they wanted to base it on a smart card which would be open platform. What most people, in most countries start making mistakes when they don't know. In other words initially they want global platform, contact lists, Java applets, EMV fingerprint biometric, transportation. And then they suddenly realize that, in fact, if they had to do all of this the card, number one, wouldn't be issued by anyone, and number two, the card would not be compatible with anything. Because none of those systems in fact, today, actually can work together. If one is EMV the other one isn't.

So they've realized that the only way they can do that is by defining their own standards. And now they've decided to say well let's try to devise -- to use, for example the CPA which is a common payment application standard, which is EMV based but it's not really Visa nor MasterCard. And let's try to build the extra functionality that we believe we need as a country to go forward.

And this is where I think we can come in with our morphing technology and UEPS functionality. So this is what we are still, very much, pushing into Sberbank. But Sberbank is a big government owned bank, which means it takes them months to make decisions that people could do now. So we still have to plug at this, and we'll continue to plug at that. In the meantime we're working with other large banks in Russia that are commercial banks. And those particular banks already I think have caught up with what we had explained to Sberbank and are already, I believe, engaging in negotiations with ourselves. And, candidly, we might end up by lending one of those long before we will actually get Sberbank to actually do something which is on a national scale.

So I'm not unhappy with what BGS is doing, I think they're in a tough market. But I think it will take them a little bit more time to actually redeploy their resources to attack other markets with a different business model. A lot of that is in the mind; it's got nothing to do with what's written on a piece of paper. People have got to believe it, and the first time they become successful, I think that will give them the drive that they need to actually say, ah head office have told us this is the way to go, and you know what, maybe they are right because it's actually working. And I think we're getting there, David.

Serge, in the last six months you've sold --

David?

Yes.

Yes sorry, I think we're coming up to -- we've past 3 o'clock, so we can follow-up offline.

Okay.

Operator I think that's about all the questions we have time for.

Thank you very much, sir. As we have no further questions I'd like to thank you on behalf of Net1 for attending this conference. Thank you for joining us, you may now disconnect your lines.