Lesaka Technologies Inc (LSAK) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Net 1 first-quarter 2013 results. All participants are now in listen-only mode and there will be an opportunity for you to ask questions after 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 first-quarter fiscal 2013 earnings call.

With me today are Dr. Serge Belamant, our Chairman and CEO, and Herman Kotze, our CFO.

Both our press release and Form 10-Q are available on our website, www.Net1.com.

As a reminder, during this call we will be making forward-looking statements, and I request you to look at the 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 analyze our results of operations in our 10-Q and our press release in rand to assist investors in understanding the underlying trends of our business. As you know, the Company's results can be significantly affected by currency fluctuations between the dollar and the rand.

With that, let me turn it over to Serge.

Thank you, Dhruv. Good morning, good afternoon, good evening to all of our shareholders.

During this call, I will focus primarily on two areas, the first being the implementation of our national SASSA contract and the second on our strategic vision for the group as we look to drive growth, profitability, and value over the next three years.

For Quarter 1, 2013, we reported revenues of $112 million, which is a year-over-year increase of 30% in constant currency. Fundamental EPS in the quarter was $0.25, down 33% in constant currency, largely due to the implementation costs incurred to roll out our new SASSA contract.

Cash flow from operations was $26 million during the quarter.

Our core established businesses, which include CPS, KSNET, and EasyPay, together in Quarter 1 of 2013 accounted for approximately 82% of our revenue, while our growth businesses were collectively 6% of the revenue.

As you know, our national SASSA contract commenced on April 1, 2012, and our Phase II implementation commenced in early July of 2012.

During Quarter 1, 2013, we have paid approximately 9.5 million beneficiaries in excess of ZAR8.7 billion per month, using four payment methodologies -- our own MasterCard-branded magnetic stripe card, our Version 10 UEPS smartcard, as used in our old contract; bank to bank transfers using the national payment system, and, more importantly, our world first EMV-compliant M chip 4 UEPS compliant smartcard.

We have also completed seven months of registrations on behalf of SASSA, and our technological solutions and processing platforms have proved extremely reliable, effective, and secure to the full extent anticipated.

As it is known, our contract was challenged in court by Allpay. Allpay used to be a previous contractor. The current status is that Allpay -- the Allpay appeal could be heard by the appeals court during the first quarter of calendar 2013. Allpay had also filed for leave to appeal the high court's decision to the Constitutional Court, which is the highest court in South Africa. Their application to this court was dismissed last week.

Phase II of our implementation in entails the activation of our own 12MAP or one-to-one, one to many biometric search engine, to identify and eliminate duplicate registrations. Field experiences have demonstrated that not only does this technology identify and eliminate duplicate grant registrations, but it has also led to a number of illegal beneficiaries returning their existing card because of the fear of being caught out during the re-registration process.

Based on our experience, it is clear that many recipients of child support grants do not bring the children in their care for registration. The number of instances where this occurs exceeds 20%. Because of this trend, SASSA is now making it mandatory for guardians to enroll all of their dependents, failing which their grants may be suspended or even canceled.

As of August, SASSA had publicly indicated that approximately 14,000 beneficiaries did not attempt to be re-enrolled for fear of being caught. While this number should increase over a five-year period, SASSA could stand to save over ZAR600 million by not paying grants to these 14,000 beneficiaries, or almost doubling the anticipated cost savings over the contract period by selecting our UEPS EMV technology solution.

Our beneficiaries utilize three major infrastructures at which they receive payments or and make purchases for goods and services. 3.1 million recipients access their funds throughout our 10,000 pay points and Net 1 participating merchants, 1 million are being paid at ATMs, and the balance are being paid through national merchant stores.

All recipients who have been registered are automatically provided with one of our Grindrod bank accounts through which they can effect any type of banking transactions. We currently have 4,500 enrollment stations in the field and, based on our latest data, we are currently registering approximately 110,000 beneficiaries, inclusive of their dependants, per day, for a run rate of approximately 2.4 million beneficiaries per month.

As of November 8, we have issued about 3.2 million UEPS EMV cards and enrolled a total of 6.6 million people, including dependents.

Moving on, as a result of the strategic review conducted by our Board during the last quarter, we have commenced finalizing and implementing the business plan for each of our business divisions. Our business is now structured along the following four pillars of growth. First, South Africa, which incorporates CPS, merchant acquiring, EasyPay, FIHRST, micro-finance, SmartLife, and our Grindrod underwriting contract, will now focus on becoming the largest card-issuing organization in South Africa, targeting our 10 million card holders, their family members, as well as all of the citizens who live in or in proximity of the areas we visit and service on a monthly basis.

It must be understood that via our 800 mobile banking vehicles, we visit in excess of 10,000 pay points throughout the country. We intend to leverage this infrastructure to not only service our pensioners as per our SASSA contractual obligations, but also to service all those citizens who also require a low-cost banking service with all of its functionality, such as our biometric based security, our money transfer system, as well as other associated financial services. This plan was a fundamental part of our tender submission, resulting in a vast improvement in the quality of service delivery nationally by increasing the frequency of our visits to each pay point, thus providing our beneficiaries and many other unbanked and underbanked citizens affordable access to all the financial services they require at outlets which they now know and trust.

These services include banking, specific and general loan finance, life insurance, prepaid services, information access, and the provision of a communications system that ensures they are able to send and receive important notices and advices from us, as well as from SASSA. This network of mobile branches, together with our fixed-point infrastructure and our 4,500 registration stations, provides us with the largest number of access service points in the country, specifically in semi and rural areas.

Through this infrastructure, we will be able to market, sell, and manage both of our offerings, and hopefully achieve financial inclusion for all South Africans.

Our non-beneficiary activities will be speared by our FIHRST Business, which currently focuses on the distribution of salaries to more than 850,000 citizens. Our EasyPay systems will ensure we continue to acquire merchants and to conclude agreements with more municipalities and other bill issuers. EasyPay will play a more and more important role in providing our millions of banked customers with value-added services from which we will derive new revenue streams.

Once again, in line with our general philosophy, we will charge suppliers and service providers, rather than our cardholders, to utilize our communication, sales, collection, and processing platforms through which they will be able to compete for the provision of their services.

The second pillar, our NUETS division, will continue to develop, market, sell, implement, and support our UEPS UEGS activities on the African continent and specific regions in the Middle East. These systems, because of their strategic nature, size, and disruptive force, have resulted in longer sales cycles than anticipated.

In addition, timing is also affected because of the following two fundamental reasons. The first is the fact that the UEPS has historically been marketed and sold to financial institutions, mainly banks, which have found it difficult to, A, move away from their current banking model and, B, to adopt what has been referred to as a proprietary payment system. The larger the bank concerned, the more difficult the leap to a UEPS system could be, often because such large banks were owned by international conglomerates.

NUETS, therefore, focused on working almost exclusively with governments, namely the central banks or finance ministries. This has proved a success as the more progressive of these ministries and the political parties have always aimed at banking the so-called unbankables and providing financial inclusion for all their citizens.

Systems such as those implemented in Ghana, Iraq, Malawi, Botswana, and Namibia have proved very successful in terms of reaching the poorest of the poor and the general population.

The sales cycle, however, proved far slower as tender processes were required to run their course, often with much disruptive interference from traditional and influential system operators, consultancy firms, and technological providers.

The catalyst to accelerate these sales cycles have been identified and include the following. One, the UEGS development. The UEGS, or universal electronic government system, addresses the growing need of government's compliance departments to implement technological solutions that, first and foremost, guarantee the quality of the data being captured at any point in time and to then be able to utilize this data across a number of different applications. These applications include the more known systems such as driver's licenses, ID, border control, know your client, and voting systems, but more importantly the system that can identify or eliminate fraudulent activities such as money laundering, ghost workers, payment to deceased individuals, international remittances, and other financial possible fraud.

The UEGS integrates into the UEPS payment application, thus providing a combined platform for government and the central banks to achieve both the goal of banking the many, but also the goal of increasing the country's profile in terms of compliance and integrity. This results in not only monetary savings and an increasing tax collection, but also an increasing international investment and, more importantly, the process participation of all citizens in the economy.

UEGS will also in the short term provide a cloud-based solution for smaller banks that wish to implement the UEPS, but need to interoperate with the existing larger banking system. Our EMV UEPS solution, or morphing, as it is described, accomplishes just that. The UEPS EMV card issued can run in EMV or UEPS native mode or as a combination of the two. This implies that the UEPS card can transact seamlessly in any EMV compliant point-of-sale or ATM.

Although we believe that the smaller banks are more likely to roll out the UEPS, as it was designed to service, A, the unbanked population, B, can operate in rural areas in an off-line manner, C, protects cardholders by biometric verification, it's new ability to transact at any EMV compliant infrastructure, eliminates the closed-loop argument, and protects the investments made in the existing payment infrastructures.

The above breakthroughs really, in our view, allow us to penetrate new territories in partnership with the well-known brands, such as MasterCard, rather than in competition with them. Our outsourcing services will also promote the use of EMV as the cost of these systems is normally prohibitive if purchased in-house by the smaller banks.

NUETS' offering can first be summarized as a payment system that can also provide a more secure and accurate data entry and validation system, eliminates duplicate registration, identifies possible fraudulent activities, eliminates money-laundering activities, adheres to the most stringent compliance regulations, interoperates with existing payment systems and infrastructures, and provides the lowest cost of entry and delivers the ability to bank the majority of all citizens.

During this quarter, for example, NUETS commenced the push of its new UEGS UEPS offering to its existing, as well as its new and potential, customers. It should be noted that during the period in the review, NUETS Iraqi system has reached 2.5 million cards issued, which represents about half of the anticipated market size. As payment in Iraq occurs every second month, the average monthly transaction valued and distributed and managed by the system now exceeds $800 million per month.

The majority of these funds are paid at point-of-sale devices, installed at merchant stores. These merchants, in turn, settle and load the UEPS card with the settled funds, so they can replenish their cash requirements from the participating banks. The UEPS, of course, provides security via biometric verification, thus preventing fraud and any possibility of money laundering.

The success of the Iraqi system, which is mirrored by the Ghanaian implementation, has led to numerous government organizations approaching the NUETS for similar solutions. These countries include the Republic of Guinea, Republic of Gabon, Malawi, the Congo, Botswana, South Sudan, as well as Jordan, Afghanistan, and Nigeria.

With our third pillar, we have created a new mobile solutions division, which originates from the core technology skills and business initiative of our Pbel acquisition, a company that has provided us in the past with all of our mobile kiosks and web developments. It was felt by the Board that as we intended to seriously focus on this payment arena that it would be preferable to own the resources and the IP concerned to eliminate any conflicts of interest in the future and retain the lion's share of the new income streams going forward.

This division will focus on our VCC, Variable PIN, kiosk voice biometric solutions and our virtual top-up technology business developments, as well as our promotional, gaming and social networking contracts and opportunities.

All of these activities are centric to the mobile phone industry, specifically in terms of payment-related applications. We have identified major opportunities in this nascent field of business, whereby most companies are focusing on providing the so-called mobile wallet, which, in essence, is an electronic file of account numbers, allowing the customer to make purchases without utilizing actual plastic, but rather some form of wireless transfer such as NFC or barcode.

Our solutions do not focus on such solutions as it is our view these actually increase the risk of fraud, expose cardholders' private information, and do not really simplify or secure payments at the point of sale, ATM, or in fact the Internet.

Our solutions do solve these issues. We do not store any card or account information. We do not send any card or account information across communications networks. We provide a secure off-line solution, first preventing any possible attacks based on data interception or the so-called man in the middle attacks. We utilize voice biometric verification as a means of securing our VCC generation, and we do not require any changes to be made to the existing payment infrastructures, including point of sale, ATM, the Internet or any of their related technologies.

We intend to promote these solutions across the globe, and we have already demonstrated different models and therefore the potential within via MetroPCS, Banamex, Axis Bank, Bank of India, and Bankinter, among others, in Azerbaijan, Mexico, India, and Spain. We are currently refining the structure and business model we wish to scale going forward for MNOs, financial institutions, loyalty scheme operators, and healthcare payment contractors.

With our fourth pillar, we are now in a position to build new income streams using our KSNET Korean business, which currently switches credit, debit, and prepaid card transactions for more than 220,000 merchants. The Korean industry model is a three-party model whereby no acquirer is present, and the VANs provides EFT solutions to merchants while card issuers levy an ad valorem fee from the retail stores, and pay a transaction switching fee to the VANs.

The difference in these two income streams is substantial, as the first earns on average $0.65 compared to the second of roughly $0.06. The work performed by the VANs includes the provision of the EFT and or EFTPOS terminal, the contract negotiation, the routing and the switching of transactions, connectivity to all card issuers, and the myriad of reconciliation reports and query resolution facilities.

The model we are currently evaluating, in terms of both legality and sustainability, we feel would allow us to play in the more lucrative issuers' arena, thus increasing our revenue, profitability, and free cash, allowing us to further grow our merchant network.

To conclude, I believe that following our extremely successful SASSA implementation that the company can now leverage this success, our new and interoperable payment technology, as well as partnership with leading global institutions, to accelerate the sales cycles of our international activities.

Since starting the company in 1989, Net 1 has never been better positioned to grow its multinational footprint, which, in turn, will deliver sustainable growth, profitability, and, more importantly, shareholder value.

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

Thank you, Serge.

I will discuss the key results and trends of our significant operating segments for the first quarter of 2013, compared to the first quarter of 2012. I will also discuss, to the extent possible, the financial implications of the implementation progress made related to our new SASSA contract.

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.

For Q1 of 2013, our average rand dollar exchange rate was ZAR8.26, compared to ZAR7.09 a year ago and negatively impacted our US dollar-based results by approximately 16%.

The year-over-year comparability of our results for the quarter was impacted by our new SASSA contract in Q1 2013 and the non-cash profit related to the liquidation of SmartSwitch Nigeria in Q1 2012.

On a consolidated basis, for the first quarter of 2013 we reported revenue of $112 million, an increase of 30% in constant currency. Fundamental earnings per share was $0.25, compared to $0.44 a year ago, and Q1 2013 includes $14.1 million of direct implementation costs and $1.7 million related to the expensing of the UEPS EMV smartcard issued to cardholder grant recipients.

We measure the group's profitability by analyzing operating income and margin by segment. And within our segments, SA transaction-based activities posted revenue of $61 million during Q1 2013, 43% higher in local currency, driven primarily by higher volume and revenue from our new SASSA contract and higher prepaid airtime sales, offset by lower volumes at EasyPay and MediKredit.

Our segment operating margin, excluding amortization of intangibles, declined to 13% from 43% last year, primarily due to SASSA implementation costs, including cards, and higher low-margin prepaid airtime sales.

As previously discussed, we expect our profitability in this segment to remain under pressure for at least another two quarters as we continue to invest in the infrastructure, distribution, and personnel required to enroll and disburse grants on a national basis, before returning to a more normalized and sustainable level.

Our international transaction-based activities posted revenue of $32 million during Q1 2013, an increase of 22% in constant currency. Segment operating income was negatively impacted by a 5% adverse currency movement between the Korean won and the US dollar, additional startup expenditures related to our XeoHealth launch in the United States, marketing and business development costs at Net 1 virtual card. But these expenses were partially offset by increased revenue contributions from KSNET and NUETS' initiative in Iraq.

For Q1 2013, KSNET revenue grew 12% in Korean won and was $30.7 million, while EBITDA margin of 25% was down compared to last year as a result of higher transaction volumes at lower pricing levels.

For fiscal 2013, we expect continued revenue growth in this segment, driven by KSNET, as well as increasing contributions from XeoHealth from Q2 2013.

Our smartcard account segment posted revenue of $8 million, 18% higher in constant currency as the number of cardholders grew to 5.8 million from 3.6 million last quarter as a result of issuing new cards to customers under the SASSA contract.

For our financial services segment, revenue in Q1 2013 declined 24% year over year in constant currency to $1.4 million. This decrease in our lending book was primarily due to new rules introduced by SASSA requiring the maximum allowable deduction amounts for loans and insurance policies from grants before transfers to bank accounts.

Segment operating margin has consistently improved over the last few quarters. It was 79% in Q1 2013, compared to 67% last year.

We are not currently able to accurately quantify the head office and shared inter-company administration, operational, and overhead expenses related to this segment and therefore don't allocate such costs to this segment.

For Q1 2013, hardware and software revenue was $9 million, 10% higher on a constant currency basis and improved due to an increase in royalty fees, offset by a lower contribution from our traditional hardware resellers. Segment operating margin improved to 22% from 21% last year, due to the same reasons.

That said, please remember that profitability in this segment will also vary depending on the timing and quantum of ad hoc sales.

For Q1 2013 interest expense decreased by 21% in US dollars, driven primarily by lower average debt outstanding during this period.

As mentioned above and discussed by Serge, we incurred direct implementation expenses for our new SASSA contract of approximately $14.1 million, which included 5,500 temporary staff members, transportation and accommodation, premises and infrastructure, higher costs for bulk enrollments. This cost is in addition to the value, which is difficult to quantify, of time spent by our executives and pension and welfare operations managers and staff that service the five provinces in which we operated under the previous contract and that have assisted in the implementation of the national award.

We also expensed $1.7 million related to the cost of the UEPS EMV smartcards issued during the quarter, which, for clarity, is not included in the $14.1 million previously discussed.

We expense the full cost of the UEPS EMV smartcards as and when these are issued to cardholder grant recipients following a successful enrollment.

Our SASSA contract operating margin is anticipated to be at its lowest level during Q2 and Q3 of fiscal 2013, as this is the period where our enrollment volume will be at its highest level, resulting in us employing the highest number of temporary staff members, issuing the majority of the smartcards, and incurring all the related costs inherent to this massive logistical operation.

We also include a further $3.3 million in capital expenditures in Q1 2013, primarily to acquire payment vehicles and related equipment.

Since inception of implementation, we have incurred cumulative capital expenditures of $24.5 million. Our current best estimate of the total CapEx required for the complete implementation of our national contract is $35 million. That estimate is lower than originally anticipated, mainly due to the decision to expense the cost of smartcards rather than to capitalize these costs.

Once we are fully phased in, we still expect at the very least to maintain our operating income on an absolute basis that we generated from our previous SASSA contract. We currently expect to be fully phased in towards the end of the third quarter of fiscal 2013.

As of September 30, 2012, we had $58 million of cash and cash equivalents on our balance sheet. The increase in our cash balances from June 30, 2012, was primarily due to $25.7 million in cash generated from operations, offset by capital expenditures included to implement the SASSA contract and the acquisition of Pbel for $1.9 million.

We continue to fund the group's operations and capital investments utilizing our cash reserves and cash generated from our business activities. Our long-term debt, which related to our acquisition of KSNET, remained static during the quarter in the underlying currency, and the increasing dollar terms is due to currency fluctuation.

Our effective tax rate for Q1 2013 was 36%. Our tax rate may fluctuate depending on our intention regarding undistributed South African earnings and the timing of any payments, but we expect our effective rate for fiscal 2013 to generally remain between 36% and 40%.

Our fully weighted diluted share count for Q1 2013 was 45 million shares.

To conclude on guidance, we expect second-quarter fiscal 2013 fundamental earnings per share to be flat to down from Q1, due to higher implementation expenses, but then to improve sequentially through the second half of the year. We previously expected direct implementation expenses to be between $5 million and $10 million per quarter, but given the higher temporary employee base, we now expect our direct implementation expenses to be closer to the high end of that range for the next two quarters.

In addition, we will also incur smartcard costs for the remaining 8 million grant recipients over the balance of the implementation period.

Our quarterly results may still be lumpy, given the timing and quantum of investments and smartcard costs to be incurred to ensure the implementation of our SASSA contract.

To summarize, for fiscal 2013 we expect fundamental earnings per share to be at least $1.25 on a constant-currency basis, which includes approximately $0.21 per share for the cost of smartcards. Our guidance also assumes a constant-currency base of ZAR7.72 to the dollar, and our fiscal 2012 share count of 45 million shares.

With that, we will gladly take your questions.

(Operator Instructions). David Koning, Robert W. Baird.

I guess my first question is I know you talked about the beneficiaries -- the increase in beneficiaries don't really provide extra economics. It's really the 9.4 million that provides your economics, but is there anything extra those beneficiaries can generate for you in terms of revenue over time, maybe not direct SASSA-based revenues, but are there other revenue streams that those beneficiaries can add for you over time?

Obviously, that's an interesting question. It depends on the age of those particular beneficiaries.

The ones that are obviously babies and the three months and six months old and nine months old babies are not likely to generate anything in the near future. Certainly the children that, let's say, are on the border of adulthood, let's call it around 18 years old, there's no doubt that those beneficiaries sooner or later will hopefully become people that are going to have employment, and if they have employment, we are hoping that they will remain with our banking infrastructure and therefore will become banking customers in their own right but within a short period of time, and there's a number of 1 million of those particular people. So there's one thing, it's more creating a bit of a net for the future.

The next important issue is that everybody has been quite surprised and excessive decision to enroll 21.5 million or 22 million, in fact, beneficiary, and the number keeps on climbing. And obviously, we all understand that this is approximately twice as many people to be enrolled as was originally anticipated.

Now, we obviously, contractually, have obviously looked at that very seriously, simply because it has required for us to double up on our infrastructure or registration infrastructure, both in terms of equipment, but also in terms of people, which, candidly, is far more expensive than the equipment over time. That is something that we're going to be discussing at length with our partner; in this case, SASSA.

And also, SASSA, as you probably know from the disclosures, had intimated for quite a while now that their intention was over time to take over within the SASSA environment the actual registration or enrollment of beneficiaries, rather than to actually outsource it. As you know, that particularly enrollment is included in our payment price, but that does not mean that that infrastructure could not be either sold to SASSA for them to be able to continue to do the job themselves.

So certainly it's a negotiation simply because a deviation from 10 million to 22 million is obviously extreme, and there's no doubt that both parties will be talking around the table and arrive at a solution that at least fulfills both parties', or at least a portion of both parties', ideas. I hope that gives a little bit of background.

Yes, that was great. That was great. I appreciate it.

The second question, the $14 million or so of implementation costs this quarter, plus the $1.7 million that originally was going to be capitalized, but you expensed, does that eventually all go away, other than the 1,200 or 1,500 of employees, the temporary employees now, but the ones that will continue? Other than that, that's probably $0.30 of EPS or something like that that was specific to this quarter and the next couple quarters, but that fully goes away at some point four to six quarters out?

Hi, David. Yes, it does. It will largely fall away, you know, obviously in a phased approach, but if we analyze the majority of the costs that make up that specific number, they do relate, as Serge said, to the -- mainly to the staff component.

Together with the cost of the staff, of course, there is the quite substantial cost of transporting those temporary staff members around the country to do the enrollment. We also have to rent substantial amounts of tents and chairs to accommodate the beneficiaries while they wait to be enrolled.

So from our perspective, you know, looking forward we will probably retain less than 20% of the temporary employee base that we currently have, if we look out towards three or four quarters from now, and in terms of the other implementation costs as they relate to the transportation, to the rental of tents and chairs, to the other incremental costs, I think they will largely fall away and that cost should fall right down to the bottom line again.

Okay, great. Then two just quick ones, I think you mentioned EPS should be down sequentially, but I think you said implementation costs should be at the high end of the $5 million to $10 million range. So in other words, if implementation costs next quarter are $10 million and we just had about $14 million in Q1, why would EPS be down sequentially?

We'll be issuing -- Q2, sort of halfway down, we already know that the smartcard costs and the amount of enrollments at the rate of 120,000 a day, obviously that includes both the cardholders as well as their dependents. But just based on that metric, the cost of the cards themselves will be a lot higher than the 1.7 million that you saw in Q1.

Got you, okay. And then, what was EASON revenue in Q1?

David, it's Dhruv. I'll check up on that and follow up with you.

Great. Thanks, guys.

Thomas McCrohan, Janney.

In terms of getting the SASSA contract completely phased, I think you said three or four quarters from now at the current rate, I think you said 2.5 million people being enrolled a month, if that's correct, and given how many -- I think you said 5.8 million people on the system, it sounds like it's going to be closer to three quarters out by the time you get to this totally phased. So I'm just trying to understand the variability at current run rates why it would be pushed out further beyond three quarters.

Sure, Tom, there is quite a bit of variability in terms of how the process work, and you'll appreciate that not all of this is under our control.

I think the key aspect of this that we need to understand is that the beneficiaries are, to the extent that they're not paid by us, either in terms of the old contract or in terms of the cash payments that we already took over during the initial stages of the contract, but if we look at those beneficiaries who traditionally got paid directly into their bank accounts, they also need to be enrolled and re-registered and issued with cards.

Now, in order for those beneficiaries to be enrolled, they have to be informed by SASSA regarding the time and the place of enrollment. They need to be made aware of the schedule, and so all of that information is disseminated by SASSA, and obviously we then need to see how those beneficiaries react to these letters that they receive. And so, there may well be a case where if a substantial percentage of those beneficiaries do not arrive at the initial set date for enrollment, we then have to perform what we would term is a mop-up operation to make sure that all of those beneficiaries that we didn't have before or failed to arrive for whatever reason when it was their set date to do so, we would then have to obviously make another alternate arrangement to get those beneficiaries enrolled, and we simply don't know exactly how long that exercise will take.

Obviously, there will be a time when those beneficiaries who have not been enrolled will simply be removed off the payment file or they will be required to go to a government office to be enrolled, rather than for us to provide that specific service.

Also, I think it's important that you note that the way that we've planned our implementation with SASSA and the way we've agreed it with SASSA is that we first focused on the rural areas, and specifically the deep rural areas, to do the registrations. Those are the areas that are very expensive to service in terms of taking out equipment and people into these areas to do that bulk registration.

As we progress, we will probably end up in the third quarter, in Q3 of fiscal 2013, doing the urban areas and the semi-urban areas where we require less staff members and where it's a lot less expensive for us to perform the enrollment service, and that's when the margins should start normalizing. So by Q4, we should be close to normal again.

Great, and the breakdown between urban and rural in terms of number of recipients, is it 50-50?

It's frankly not entirely. If you look again at recipients, you're looking at about probably -- out of -- if we work out on big numbers, you're looking at about 40% is more urban, 60% is rural.

And in terms of the 22 million people, it's slightly higher because the number of, for lack of a better word, the number of children in the rural areas that are being looked after by single recipient is higher. So the number of registrations of recipients, 60/40; total number in terms of people, it's probably closer to 70/30.

I know it's still early innings with getting a feel for unit economics for urban versus rural, but do you have any visibility on -- given that the price you get per recipient is fixed regardless of where the recipient resides and given that you have to drive a truck and (multiple speakers) people out to a rural location, the cost to deliver a payment obviously is a lot higher in the rural areas. So can you give us any sense? Are you breakeven at the SASSA-mandated price in the rural locations on a unit basis, but you make much more money in urban? Can you just talk about that conceptually? That would be helpful.

It's obviously -- it's obviously logical to think that when you are going to pay someone in an urban area, specifically if you're paying them through an existing system, which happens to be the national payment system, that it's going to be fundamentally cheaper than if you pay people in deep rural areas where you've got to basically drive a truck with ATMs, with a bunch of guys with shotguns attached to protect the money.

So there's no doubt that it is, in our view, probably almost three to one cheaper. So there is a huge difference in the actual cost.

So our fundamental vision beyond our tender, which was obviously accepted by government, was that it is important that whoever provided a solution would use one, for lack of a better word, to cross-fund the other. In other words, knowing that our cost [although] we might be paying, we might begin paying $16 per transaction, we know that the $16 in urban areas, we might be able to be using a portion of that in order to fund what we are paying in the rural areas.

So these are cross-funding dynamics that we've got to understand. This is why if we also look at our strategy, and I've tried to describe it, perhaps not as well as I should, that's something I think one should do face to face with everybody present, is that the idea is to convert or take this opportunity of utilizing our rural infrastructure, including our vehicles, for lack of a better word, into movable banks, not only to bank obviously and service the beneficiaries, but to service everybody else that actually lives in rural areas as well, and therefore making this infrastructure [surrender] far more revenue than simply paying beneficiaries, and that's something that we've been thinking about for a long, long time.

And it is certainly something that we are pushing now in a very, very strong way. Part of the effort first, we wanted to show, we wanted to prove, we wanted to demonstrate to SASSA that we were capable of doing the job, which I think now everybody in the country certainly believes that, knows that. Now it's a question of utilizing and starting to utilize an infrastructure to do all of the other things that we wanted to do, which is probably to attempt to bank and to service at least, in our view, another 3 million or 4 million people in rural areas that are not beneficiaries, and then we're going to fund -- that infrastructure of ours will start actually becoming economically more lucrative in rural areas than what it is in urban areas, because in urban areas we've got to pay all of the other banks, while in rural areas we are the bank.

Interesting. My last question is on share count. Herman, how should we be thinking about that in the context of -- I guess you still have some warrants issued to that organization, so how should we be thinking about share count as the year progresses? Thanks.

I think for now, the share count is roughly 45 million shares. The option is valid; we're probably halfway through that option period at the moment. The share price at the moment is pretty close to the strike price of that option, and so from a fully diluted share count point of view, we have affected the exercise of the option, and I think we should only do so once the option is physically exercised.

And if the option was exercised, would you take the funds and buy back stock or what would you do with the proceeds?

The uses of our cash will probably remain pretty much in line with what it's been in the past, so that would include a combination of considering stock buybacks, obviously retiring some of the debt the way we believe it's expensive based it's in our interest to do so, and to fund potential other strategic acquisitions.

Okay, thanks.

Kevin Tracey, Oberon Asset Management.

I guess I just wanted to follow up on, Serge, you made some comments regarding the failure of 20%, I believe you said it was, of grant recipients to bring in their beneficiaries to be enrolled, and as a result this problem, SASSA has required beneficiaries to be present for recipients to be enrolled.

And I guess I'm just wondering, given this problem, I guess, what is the risk that it takes longer than three or four quarters to complete this phase-in strategy? And you mentioned that if you're unable to induce grant recipients be enrolled, you would execute a mop-up kind of strategy, but at the same time, you said there might be an understanding between you and SASSA that some of these people would be required to come into government offices.

So I guess I'm just trying to ask, what's the risk that the implementation costs go beyond three or four quarters and are more than we expect if you try to rein in stragglers to enroll them?

Well, your question, by the way, is an excellent question because there's absolutely no doubt that when you're doing a job of this size as what we are doing, my feelings are exactly the same as yours. I do not believe that we are going to have a cutoff point at the end of March whereby we're going to say, well, 21.572 million beneficiaries in totality have been registered. It's not going to happen.

There's actually no doubt, in my view, you're going to be left with at least 10% to 15% of those that are going to come in bits and pieces. Some of them will already arrive when they have been categorically told that they're going to lose their grants if they do not register, and I hope it will be the last resort. So you're going to have a little bit of a burst at the very last minute.

What we're doing on our side, because we realize that that's something that's going to happen, is that SASSA's intention, even contractually, was that once we take over the enrollment, they believe that's something that should be done, actually, by SASSA officials, which we tend to agree. And I'm hoping that by the time we have done what we officially stated we were do, namely to enroll the first 10 million people also which are the recipients, then SASSA would take over the registration roll, and what I mean by that they would also take over the cost of it, which means I think that's something that SASSA will continue to supply or to provide of their own debt.

For the foreseeable future, I don't see us stopping in March or stopping in April. I'm just hoping that our costs are going to stop in March or April, but certainly not registration.

Okay, okay, I see. And then, I guess with regard to your comments about your strategy of participating in tenders outside of South Africa or selling the UEPS solution to banks, I understand how the EMV technology makes you much more competitive in these tenders, but I guess I was just wondering who would you be competing with in these tenders? And I guess, what problems would you be solving? I imagine the problem of fraud at least by your biometric capabilities, but who would you be competing with in these tenders? And I guess, have you started looking at these tenders or what is the timeline for starting to do some activity there?

Again, a very, very good question. I have tried to sort of -- I've given a couple of ideas the way we've already either entered into tenders in a number of countries, and some people sometimes look at us and say, why would you want it there? Why, for example, Afghanistan? Well, Afghanistan is no different to us than Iraq. So there is no doubt that there is a need for our solutions in those countries.

Now, one of the biggest barriers to entry with that, and that's something which is well known, is that UEPS is always been a perfect product for developing economies with very little communication infrastructure, and that requires very, very adequate security which is not based purely on a PIN number, and that's what we've always provided. But, as you know, it doesn't matter what country you're going to, you do have the large elephants, the MasterCards, the Visas, and you do have international banks who follow the Visa and MasterCard rules and regulations, and these particular organizations are extremely powerful at all levels in any country.

So very often, all that government would be very keen to implement our technology because they could see that this technology can be used to bank the unbanked and to maybe -- to really also control exactly the money free flows in the country in totality. Those big organizations were always very much against it as they believe that somehow this was a market that was for them, but they have not penetrated it themselves.

We believe the breakthrough we have made with the MasterCard EMV product will solve these problems, if not practically, certainly from a mental or philosophical point of view, simply because the barrier to entry, which was always a little bit, to be quite honest, an academic one rather than anything else, for the simple reason that these traditional online real-time EMV systems would simply not work in these countries, but that wasn't a problem. The problem was it was perceived that the local people were embarking in our system, which they believed was a closed system, which was a system that maybe at the end of the day could not grow or would not be able to interoperate with the so-called big elephants, [it mark] can interoperate, which is the beauty of it.

And number two, we firmly believe that MasterCard, to some extent, also accepted that our UEPS portion can allow them to actually roll out many, many millions of MasterCards, which they would never have rolled out if it were not for the UEPS portion as well.

So I think we're both getting the best of both sides of the world, but the beauty is is that our barrier or philosophical barrier is gone, and from their side, I think there's a fantastic opportunity to roll out millions, millions of MasterCards while today those particular -- or those particular people would never have been issued within EMV card, MasterCard, or Visa card for the foreseeable future.

So I think it's a synergistic partnership, which I think is -- we're already seeing that there's a huge demand for this particular product, not only for furthering up of new countries, but even the countries we've been in for the last five years.

Okay, that's very interesting. Thanks. And then, I guess, lastly, I guess this is a question related to your international segment. Now in -- it looks like revenues grew very nicely, and in your 10-Q, you espoused that margins were lower largely due to startup costs related to some of your US businesses. But I guess I just wanted to confirm that the margins of your KSNET business were holding up, and I guess if you could comment maybe more broadly about the competitive environment with that business?

Sure, the margins of our KSNET business have been under pressure. This quarter, we reported 25% EBITDA margins.

Those margins do fluctuate during the course of the year. They are, in a way -- I wouldn't use the word seasonal, but they do fluctuate depending on specific [streams] within the Korean market and they have historically been between 25% and 28%.

So right now, we're quite happy with the performance of the business. Revenue keeps on growing, which for us is a very important indicator. The Korean market is highly competitive, and obviously an increase in revenue shows that we're, at the very least, maintaining or probably growing our market share within the country itself.

So from that perspective, we are really happy with what the KSNET management team is achieving at the moment.

But having said that, we do believe that now that we've been the owners of this business for 18 months and we've spent a lot of time understanding the business, understanding the markets, and getting to grips with all of those various elements, we are now finally in a position to capitalize on the real strength of this business, which is the significant market share that it enjoys in Korea. 200,000 merchant locations that it services, and with the current new product ideas that we have, we think that we can have -- that when implemented, those will have a major impact on the margins in the business.

But for now, the traditional historic business of that entity is safe, in our view, and it continues to trade well in very difficult conditions.

Okay, all right. Well, thank you.

Brian Stack, Mangrove Partners Fund.

I've got two questions, both of which have been touched on by Tom and Dave and others. First, with regard to the direct implementation cost of the SASSA contract, which were $14.1 million this quarter, and the going-forward guidance is at the high end of your $5 million to $10 million range, what are the cost differences that we should expect in this quarter and the following quarter that would be substantially lower than what you experienced in Q1? What are the drivers of that expected reduction?

The key driver will be the fact that during Q1, we were ramping up, really, the employee base to end up effectively at the end of our September with the approximately 5,000, 5,500 temporary staff members.

So during July and August, we were still growing those numbers, so for Q2 we'll have the full staff complement fully occupied and all the costs. Obviously, there are some direct costs that one can ascribe to employing these additional people, so that will be a definite additional cost driver in both Q2 and Q3.

In Q1, obviously, we had the rural implementation as our primary focus points, which means obviously that the distance is covered and the amount of money that we had to spend on transportation, accommodation, etc., was also quite high. We expect that to come down towards the end of Q2. So that will be something that I think will offset the increased staff costs that we will have over and above what we saw in Q1.

And then, of course, again the cost of our cards specifically, which wasn't included in the $14 million, just to be clear, will also increase in Q2 and Q3. But the main driver really is going to be the staff cost, which wasn't fully in in Q1.

And then, as we think about the fact that the number of beneficiaries is increasing significantly since the original numbers were put forward, that's obviously having a significant impact on the cost of the initial implementation. But on an ongoing basis, once the startup is taken care of, costs should really be driven by the number of recipients and the number of additional beneficiaries that have come into the system. It should not have a significant impact on ongoing costs, is that correct?

Yes, that is correct. So the way that it will work going forward is once we have completed what we call bulk enrollment, whatever the -- whenever new beneficiaries then join the system over the next four years, those beneficiaries will be enrolled and issued with cards at the SASSA offices, and those locations will be serviced and manned, obviously, by SASSA, not by us.

And then, one other question on a separate issue, with regard to the BVD option, the BBE that was issued earlier this year, from a funding perspective, the fact that that option is denominated in US dollars, I was curious as to whether that presented any issues to your partner that would not be there if this was a more traditional BBE investment opportunity and, you know, denominated in rand.

That's a very interesting question. Obviously, we chose to denominate the option in US dollars simply because the South African market in volume is really thin.

And in calculating the option price, we looked at a volume-weighted average price, which we could only really accurately measure using the US sort of reference share price and data. So although the option is priced in dollars, we do have in terms of our agreement with our BBE partner, they do have the right to exercise the option on the South African register, if they chose to do so, failing which, obviously, they would then have to obtain reserve bank -- South African reserve bank or exchange control approval if they wanted to pay for and keep the shares on the American register.

So by doing that in dollars and in the US currency, and that that value is still obviously fixed and static and determined at $8.96 a share, we've given them full flexibility to do it both in South Africa or internationally, depending on where the funding is available and what their intentions are.

And then, with regard to the opportunities that you're pursuing with the UEPS platform outside of South Africa with MasterCard, are these opportunities in which you're pursuing the tender and MasterCard is riding shotgun? Are they playing lead on these opportunities? Are you both in side by side? How does that partnership work in terms of securing new business opportunities?

And the opportunity to tender, are those requests being sent primarily to you, primarily to MasterCard? Are you both receiving them? I'm interested in how that new business generation is working between the two companies.

It's -- again, it's a very good question. At the moment, I'm not going to try to give you an answer, which is better than [if the] loosely [careful] basically network.

Namely MasterCard, I think has obviously seen the opportunity in South Africa whereby they will now issue 10 billion MasterCards, and there's absolutely no [velvet] for them. That is something that to probably make them the largest issuer from a branding point of view in the country, which they would were not before.

Now, they've also realized that our technology works, obviously, and, more importantly, does actually provide a solution to many countries in which they operate where they did not have a solution before. So in all of those countries, I think they are promoting the solution we're implementing in South Africa by talking, obviously, to their banks, the banks that issue MasterCards. And obviously, very often, as you know MasterCard in terms of government will certainly talk to the different financial departments and to the different ministers, and certainly do mention to them that there is a solution that can fulfill the requirements, for example, of the welfare system and, at the same time, a payment instrument.

We already know they are doing this because there's one or two other tenders that have been mentioned to us, which have come through directly MasterCard, whereby in effect they would like us to actually respond to these particular tenders in association with them or with them to become the brand through, of course, a local bank, which they themselves would identify.

In other words, the way I see this thing playing out is that in any country where they are, there will be a number of banks. They might talk to them and say to them, this is an opportunity for you to tackle a different market space. You're welcome to do it. We've looked at this thing. This thing is EMV certified. It works. We know the company; we know the guys and what they are doing; we suggest you go ahead and actually work with them directly.

Because another thing we're going to be doing -- it's not something whereby we share in their revenue or they share in ours. They are sharing theirs and we take ours, but we certainly can do local deals, but instead of fighting MasterCard in a particular country, they are now often going to be the ones that are going to open a few doors, rather than perhaps before where they may have been the one that were closing them.

That's excellent. They did a wonderful job of highlighting your technology at their investor day earlier this year, and to the extent that they're acting as a marketing department for you is very encouraging. So congratulations. Thank you, guys.

Thank you very, very much.

Dylan, we have time for one last question.

Mark Heilweil, Spectrum.

Yes this is Mark Heilweil from Spectrum Advisory Services. I have a balance-sheet question with regard to the risk of the cash which you park overnight. Are there any insurance or security collateral that is provided for you, or if the South African bank in which you have the money fails, would you lose that cash?

No, the cash that we have, which is obviously held by one of the South African registered banks, fully registered banks, is not insured.

You will appreciate that the quantum of the grant money alone that we hold on behalf of the SASSA sometimes exceeds $1 billion on overnight basis, so not easy to insure that kind of money, but we believe that the ability of the South African banking system, obviously, and the oversight that is performed by our regulators on these banks is particularly rigorous, and so, we're quite comfortable that there is very little risk in terms of the overnight cash holdings that we have.

So it's not collateralized by any securities?

Not at all, no.

And is there anything you can tell us about -- I think you have two large venture funds. Did these funds have deadlines for distribution which will require them to distribute their shares to their investors, or can you give us any color at all on those arrangements?

Hi, Marc, this is Dhruv Chopra here. The two funds you're talking about is International Value Advisors that own about 25% of the Company, and they've built their position over the last two or three years now. As far as we understand, they have taken a long-term view on the Company. They still remained encouragingly supportive. And based on their track record, they tend to be long-term holders, but for an actual response, you would probably have to talk to them.

As far as (multiple speakers)

(Multiple speakers) Atlantic, though, is that in one fund of theirs?

No, I think it -- I believe it's spread across several funds. Now they have been in for seven years now, since the IPO.

You know, logic would tell you any private-equity investor has a finite time period, but as far as we understand, they have not specifically expressed any interest, and nor do they have any specific time pressure where they have to pull a trigger.

Okay, I have one more in the credit risk category for Herman or the like. Can you just give us a more general view of -- I'm a little confused from reading the documents as to what credit risk you take in your banking business because there's some talk that you've eliminated that credit risk through insurance, is that right?

(Multiple speakers). It depends what side of the business you're referring to. On the pension and welfare side of the business, there is no credit risk.

Before, you know, many years ago, we -- under our old contracts in some of our provinces, we actually pre-funded the social grants, and obviously there was some credit risk, which was really equivalent to sovereign risk that we had to take on the South African government at that period in time.

Under the new contract, there is no pre-funding of grants at all, so we do not disperse the grants until we actually get paid by SASSA and until our accounts are funded with the grant money, so there's no credit risk as far as that's concerned. The only credit risk we assume on that side of the business is that we pre-fund sometimes some of the merchants who perform grant payouts or who perform cash back at the point of sale, and obviously, you can appreciate that some of these merchants are relatively small. The volume of money that flows through that system, specifically during the first or the second day of payment, can be quite significant.

And so, when those merchants approach us and ask us to assist them with some pre-funding, we evaluate the credit worthiness of that specific merchant, and if we believe the risk is acceptable, we then provide a line of pre-funding to make it possible for that merchant to perform cash back at the point of sale for our grant recipients.

So those are really -- and then, in terms of our micro-finance book, there obviously is a credit risk purely from the point of view that when we provide our beneficiaries with these micro-loans, what we used to do before is we used to insure the credit risk of these loans through a simple credit life product. Now that we have the experience of having done this for the last five years and we know what the loss ratio is on our micro-lending book, and bear in mind that the only time that there really is a default event on any one of these microloans is when the beneficiary passes away or is removed from the SASSA payment file, and that very rarely happens, so our only risk, really, is the risk of death.

We know what that loss ratio is, and at the moment we self-insure our credit book, our micro-lending book, because the loss ratio that we've seen over the last five years is acceptable to us and is obviously priced into the product.

I'm glad to hear of the trends and longevity of South Africa, and I'll give some thought to relocating there. But I, more seriously, want to commend everybody for a very intelligent discussion. Thank you very much.

Thank you very much. On behalf of Net 1, that concludes this conference. Thank you for joining us. You may now disconnect your lines.