Lesaka Technologies, Inc. (LSAK) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Net1 First Quarter 2013 Results. [Operator Instructions] Please also note that this call 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 2 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 both profitability and value over the next 3 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 cost incurred to roll out our new SASSA contract. Cash flow from operations was $26 million during the quarter. Our core established businesses, which includes 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 ZAR 8.7 billion per month, using 4 payment methodologies: Our own MasterCard-branded [indiscernible] card; our version 10 UEPS smart card as used in our old contract, bank-to-bank transfers using the national payment system; and more importantly, our world first EMB-compliant M/Chip 4 UEPS compliant smart card. We have also completed 7 months of registrations on behalf of SASSA and our technology core solutions and processing platforms have proved extremely reliable, effective and secure to the full extent anticipated. As it is known, our contract was challenging code [ph] 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 lease 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 2 of our implementation in terms of the activation of our own 12-Map or One to One -- One to Many biometric search engine to identify eliminate duplicate registrations. Till the experiences have demonstrated, that not only does this technology identify and eliminate duplicate ground registrations, it has also led to a number of illegal beneficiaries returning the existing cards because of their fear of being caught out during the reregistration process. Based on our experience, it is clear that many recipients of child support rights 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, letting which the grant may be suspended or even canceled. As of August, SASSA had publicly indicated that approximately 14,000 beneficiaries did not attempt to be reenrolled for fear of being caught. While this number should increase over a 5-year period, SASSA could stand to save over ZAR 600 million by not taking grant to these 14,000 beneficiaries or almost doubling the anticipated cost savings over the contract period by selecting a UEPS/EMV technology core solution. Our beneficiaries utilize 3 major infrastructures at which there is payments or/and make purchases for good and services. 3.1 million recipients access their funds throughout 10,000 pay points and Net1 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 automatically provided if 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 a dependent per day or a run rate of approximately 2.4 million beneficiaries per month. As of November 8, we have issued about 3.2 million UEPS/EMV card and enrolled a total of 6.6 million people, including dependents. Moving on, as a result of this 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 4 pillars of growth: First, South Africa, which incorporates CPS, merchant acquiring, EasyPay, FIHRST microfinance, SmartLife and our Grindrod underwriting contract, we're now focused on becoming the largest card issuing organization in South Africa, targeting at 10 million card holders, their family members, as well as all of the citizens would live in or in proximity of the areas we visit in service on a monthly basis. Let's be understood that by our 800 mobile banking vehicles, we visit in excess of 10,000 pay points throughout the country. We intend live with this infrastructure to not only service our pensioners as per SASSA contractual obligations, but also to service all those citizens, who also require our low-cost banking service with all of its functionality, such as our biometrically-based security, our money transfer system, as well as our 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 under bank [ph] 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 a provision of a communication system that ensures that 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 bank 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 all of our offerings and hopefully achieve financial inclusion for all South Africans. Our non-beneficiary activities will be speared by FIHRST business, which guarantee focuses on the distribution of salaries to more than 850,000 citizens. The EasyPay systems will ensure that we continue to acquire merchants and to conclude agreement with more municipality and other deal issuers. EasyPay will a play a more and more important role in providing our millions of bank customers with value-added services from which we will derive new revenue streams. Once again, in line with our general philosophy, we will charge top line [ph] as in service providers rather than our cardholders to utilize our communication, sales, collection and processing platforms to which we 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 region of the Middle East. The systems, because of their strategic nature, size and disruptive force, resulted in longer sales cycle than anticipated. In addition, timing is also unaffected because of the following 2 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 the current banking model; and b, adopt what has been referred to as a proprietary payment system. The larger the bank concern, the more difficult the leap to a UEPS systems could be, often because such larger banks were owned by international conglomerates. The NUETS, therefore, focused on working almost exclusively with governments, namely the central banks or finance ministries, which has proved our success as a more progressive of this 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 lower extend the processes were required to run the course often with much disruptive interference from traditional and influential system operators, consultancy firms and technological providers. The catalyst objection [ph] rate these cycles have been identified and include the following: One, the UEGS development. The UEGS, or universal electronic government system, addresses the growing needs of governments compliance department 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. The applications include the more known systems such as driver's licenses, A/D [ph] 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 this [ph] individual, international remittances and other financial possible force. The UEGS integrates into the UEPS payment application, thus providing a combined platform from governments and their central banks to achieve both the goal of banking to 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 increase in tax collection, but also an increase in international investments and more importantly, the 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 to be issued can run in EMV or UEPS native modes or as a combination of the 2. This implies that the UEPS card can transact seamlessly with any EMV-compliant point-of-sale from ATM. Although we believe that the smaller banks are more likely to roll out to the UEPS as it was designed to service: a, the unbanked [ph] population; b, it can operate in [indiscernible] areas in an offline manner; c, protects cardholders via biometric verification. This 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, where in our view, allow us to penetrate new territories and partnership with a well-known brand, such as Master Card rather be in competition with them. Our outsourcing services will also promote the use of EMV as the cost of these systems is normally prohibited which are purchased in-house by these smaller banks. NUETS also FIHRST [ph] can be summarized as a payment system, it can also provide a more secure and accurate data inquiry 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 provide the lowest cost of entry and delivers the ability to banks the majority of all citizens. During this quarter, for example, we have commenced the proof of its new UEGS UEPS offering with existing as well as new potential customers. It should be noted, 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. This payment in Iraq will occur every second month. The average monthly transaction value that is distributed and managed by the system now exceeds USD 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 cards with a set of funds so they can replenish the cash requirements from the participating banks. The UEPS, of course, provides security via biometric verification, so it's preventing fraud and any possibility of money laundering. The success of the Iraqi system, which is myriad [ph], or the Ghanian implementation, has led to numerous government organization approaching 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 first pillar, we have created a new mobile solutions division, which originates from the core technology skills and business initiative of our Pedal [ph] acquisition. The company that has provided us in the past with all of our mobile kiosks and web developments. It was felt by the board that if we intended to seriously focus on this payment arena that it would be preferable to own the resources and the IP concern to eliminate any conflicts of interest in the future and retain the lion share of the new income streams going forward. This division will focus on our VCC valuable PIN kiosk, both 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 nation field of business whereby most companies are focusing on providing so called mobile wallet, which in essence is an electronic file of account and card numbers, allowing the customer to make purchases without utilizing actual plastic, but rather some form of wireless transfer such NFC or barcode. Our solutions do not focus on such solutions as it is, in our view, these actually increased the risk of fraud, exposed cardholders' private information and do not really send [indiscernible] payments at the point-of-sale, ATM or in fact, the Internet. Our solutions solved these issues. We do not store any card or account information, we do not send any card or account information for our communications networks. We provide a secure offline solution, thus preventing any possible attacks based on data interception or the so-called man-in-the-middle attacks. We utilize both biometric verifications, the 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 other related technologies. We intend to promote these solutions across the globe and we have already demonstrated different models, therefore the potential within via our MetroPCS, Banamex, Axis Bank, Bank of India and Bank Inter [ph] among others, in Azerbijan, Mexico, India and Spain. We are currently refining the structure and business model we use to scale going forward. MNO's [ph] financial institutions, loyalty scheme operators and [indiscernible] payment contractors. With our fourth pillar, we are now in a position to build new income streams using our cash net with our Korean business, which currently switches credit, debit and prepaid card transaction for more than 220,000 merchants. The Korean industry model is a 3-party model whereby no acquirer is present and the vans [ph] to provide the EFT [ph] solutions to merchants, while card issuers levy an ad valorem fee from the retail store then pay a transaction switching fee to vans. The difference in these 2 income streams is substantial, as the first ends on average of USD 0.65 compared to the second of roughly USD 0.06. The work performed by the van includes the provision of the EFT and/or EFT post terminal, the contract negotiation, the routing and the switching of transaction, connectivity to all card issuers and a myriad of reconciliation reports and query resolution facilities. The mobile we are currently evaluating in terms of both legality and system ability we feel would allow us to play in a more lucrative issuers arena, thus increasing our revenue, profitability and free cash and 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 cycle of our international activities. Since founding the company in 1989, Net1 has never been better positioned to grow its multinational footprint, which in turn will deliver sustainable growth, profitability and most importantly, shareholder value. With that, let me turn it 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. We'll 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 base indicator of the group's actual operating performance. For Q1 of 2013, our average rand-dollar exchange rate was ZAR 8.26 compared to ZAR 7.09 a year ago and negatively impacted our U.S. dollar based results by approximately 16%. The year-over-year comparability of our results for the quarter was impacted by our new sets of contract in Q1 2013, the non-cash profits 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 USD 0.25 compared to USD 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 smart cards issued to cardholder grant recipients. We measured the group's profitability by analyzing operating income and margin by segment. And within our segment, these transaction-based activities posted revenue of $61 million during Q1 2013, 53% higher in local currency, driven primarily by higher volume and revenue from our new SASSA contract and higher prepaid income [ph] 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 COGS and higher low-margin prepaid income sales. As previously discussed, we expect our stability in this segment to remain under pressure or at least another 2 quarters as we continue to invest in the infrastructure, distribution and personnel required to enroll in this bus [ph] ground on a national basis before returning to a more normalized and sustainable level. Our international transaction-based activities posted revenue of $52 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 U.S. dollar, additional startup expenditures related to our XeoHealth launch in the United States, marketing and business development costs at Net1 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 Smart Card Accounts 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 regarding the maximum allowable deduction amount for liens and insurance policies from grants before transfers to bank accounts. Segment operating margin has consistently improved over the last few quarters and was 79% in Q1 2013 compared to 67% last year. We are not currently able to accurately quantify the head office and sharing the 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. Our Q1 2013 interest expense decreased by 21% in U.S. 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 serviced the 5 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 smart cards issued during the quarter, which, for clarity, is not included in the $14.1 million previously discussed. We expensed the full cost of the UEPS/EMV smart cards as and when these are issued to quarter [ph] 1 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 smart cards and including all 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 our payment vehicles and related equipment. Since the inception of implementation, we have incurred cumulative capital expenditures of $24.5 million. Our current base estimate of the total CapEx required for the complete implementation of our national contract is $55 million. This estimate is lower than originally anticipated, mainly due to the decision to expense the cost of smart cards 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. Increase in our cash balances from June 30, 2012, was primarily due to $25.7 million of cash generated from operations, offset by capital expenditures incurred to implement our SASSA contract and the position of [indiscernible] 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 date, which related to acquisition of KSNET, remains static during the quarter in the underlying currency and the increase in 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 we didn't see this to improve sequentially through the second half of the year. We previously expect that 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 2 quarters. In addition, we will also incur small card costs for the remaining 8 million ground recipients over the balance of the implementation period. Our quarterly results may still be lumpy and then the timing and quantum of investments and start up 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 USD 0.21 per share for the cost of smart cards. Our guidance also assumes a constant currency base of ZAR 7.72 to the dollar and our fiscal 2012 share count of 45 million shares. With that, we will gladly take your questions.

[Operator Instructions] Our first question comes from David Koning of Robert W. Baird.

Yes, I guess my first question is I know you talked to how 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 to 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?

It's Serge here. Obviously, that's an interesting question. It depends on the age of those particular beneficiaries. The one that obviously, baby is the in the 3 months and 6 months old and 9 months old babies are not likely to generate anything for -- in the near future. Certainly, the children that, let's say, on the border of adulthood, let's call it around the 18-year-old. There is no doubt that those beneficiaries will sooner or later or 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 is a number of million of those particular people. So there's one thing that's more creating a bit of a net for the future. The next important issue is that everybody has been quite surprised in SASSA's decision to enroll 21.5 million or 22 million, in fact, of 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 is required for us to double up on our infrastructure or at least registration infrastructure, both in terms of equipment but also in terms of people, which can at least -- 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, 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 particular enrollment is included in our payment price. But it 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 is no doubt that both parties will be talking around the table and arrive at a solution that at least fulfilled both parties or at least a portion of both parties at ease. 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? I mean, other than that, that's probably $0.30 of EPS or something like that, that was specific to this quarter and the next couple of quarters, but that fully goes away at some point, 4 to 6 quarters out?

Yes, it does. It will largely fall away obviously in the phased approach. But if we analyze the majority of the costs that make up that specific number, they do relate as such that to the -- mainly to the staff component. Together with 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 bring substantial amounts of tents and chairs to accommodate the beneficiaries while they wait to be enrolled. So from our perspective, looking forward, we will probably retain less than 20% of the temporary employee base that we currently have if we look out towards 3 or 4 quarters from now. And in terms of the other implementation costs as they relate to the transportation to rental of tents and chairs to the other incremental cost, I think they will largely fall away and cost should fall right down to the bottom line again.

Okay, great. And then 2 just quick ones. The -- 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 -- we are -- with Q2 sort of halfway done, we already know that the smart card 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?

It's Dhruv. I'll check up on that, and then I'll follow up with you.

Our next question comes from Thomas McCrohan of Janney.

In terms of getting the SASSA contract completely phased, I think you just said 3 or 4 quarters from now, but the current run rate, I think you said 3.5 million people being enrolled a month, if that's correct, and given how many, you said 5.8 million people on the system, it sounds like it's going to be closer to 3 quarters out by the time you get this will be phased. I'm just trying to understand the variability at the current run rates why it would be pushed out further beyond 3 quarters.

Sure. There's quite a bit of variability in terms of how the process works, and we 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 or -- 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, we traditionally got paid directly into their bank accounts. They also need to be enrolled and re-registered and issued with COGS. Now, in order for those beneficiary 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 the -- 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, they may well be a case 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 as a MOPAC [ph] 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 the set date to do so, we will then have to, obviously, make another ultimate 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 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 reduce 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 their bulk registration. As we progress, we will probably end up in the third quarter, in Q3 of fiscal 2013, doing the urban areas and very 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 margin 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?

Strangely enough, not entirely. You're looking -- if you look again at recipient, you're looking at about probably after -- 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 been looked after by a 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.

And I know it's still early innings with getting a feel for unit economics for urban versus rural, but is -- do you have any visibility on, given that the price you get for recipient is fixed regardless of where the recipient resides and given that you have to drive the truck and man with people at the 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 the unit basis, but you make much more money in the urban, can you just kind of talk about that conceptually? That would be helpful.

Well, 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 to pay them -- than to pay people in deep rural areas where you got to basically drive a truck with ATMs, with a bunch of guys with shotgun, that is, to protect the money. So there's no doubt that it is, in our view, probably almost 3:1 cheaper. So there is a huge difference in the actual cost. So our fundamental vision beyond that tender, which was obviously accepted by government, was that it is important that we have provided a solution. We'd use one, for lack of a better word, to cross-fund the other. In other words, knowing that our costs, although that we might be paying -- we might begin paying $16 per transaction, we know that the $16 in urban areas, we'd might be able to be using a portion of that in order to fund what we are paying in the rural areas. So the ease of cross-finding dynamic here 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 is actually that's something one should do face-to-face with everybody present, is that the idea is to convert or to take this opportunity of utilizing our rule infrastructure, including our vehicles, for lack of a better word, into movable banks. And 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 to render far more revenues than simply paying beneficiaries, and that's something that we've been thinking about for a long, long time, and it's certainly something that we are pushing now in a very, very strong way. Quite obvious at first. We wanted to show, we wanted to prove, we wanted to demonstrate to SASSA that we're 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 that 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 the debt infrastructure of ours. We will start actually becoming economically more lucrative in rural areas and what it is in urban areas, because in urban areas, we got to pay all of the other banks. But in rural areas, we are the bank.

Interesting. And 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 warrant issued to that organization. So how should we be thinking about share count as the year progresses?

Thomas, yes, 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. We -- the share price at the moment is pretty close to the strike price of that option. And so from a fully diluted shakeout point of view, we have infected the exercise of the option, and I think we should only do so once the option is physically exercised.

And if that 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 date way we believe it's expensive date and it's in our interest to do so, and to fund potential other strategic acquisition.

Our next question comes from Kevin Tracey on 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 of 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 3 or 4 quarters to compete this phase in strategy? And you mentioned that if you're unable to induce grant recipients to 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 will be required to come in to government offices. So I guess I'm just trying to ask, what's the risk that the implementation costs go beyond 3 or 4 quarters and are more than we expect? Have 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 because when you're doing your job over SASSA is what we're doing, my feelings are exactly the same as yours. I do not believe that we go into, have a cut-off point at the end of March whereby we're going to sell about 21.572 million beneficiaries in totality have been [indiscernible] it's not going to happen. There's absolutely no doubt that, 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 only arrive when they have been categorically told that they're going to lose their grants if they do not register, and it would 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 realized that that's something that's going to happen, is that SASSA's intention, even contractually, was that they want to take over the enrollment, they believe that should be done actually by SASSA, also shows which we tend to agree. And I'm hoping that by the time that we have done what we officially stated we would do mainly to enroll the first 10 million people, also which are the recipients, then SASSA would take over the registration role, and what I mean by that, they would also take over the cost of it, which means if we bet something that SASSA will continue to supply to provide of their own bet. For the foreseeable future, I don't see it 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 volution 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 solved? I imagined the problem of fraud to be solved by your biometric capabilities. But I guess who would you be competing within these tenders? And I guess have you started looking at these tenders? Or what's the timeline for -- of starting to seeing some activity there?

Again, a very, very good question. I've tried to sort of -- I've given a couple of ideas away. We've already either entered into tenders in a number of countries, and some people sometimes look at us and say, "Why would you go there?" Like, for example, Afghanistan. Well, Afghanistan, it's 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 barrier to entry with that, and that's something which is well known, is that UEPS has 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 the PIN number, and that's what we've always provided. But as you know, it doesn't matter what country you'll go in to, you do have the larger efforts. 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 label in any country. So very often, all of 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 really also control exactly the money free flows in the country in totality. Those big organizations will always be very much against it as they believe that somehow, this was a market that was for them although that 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 that barrier to entry, which was always a little bit, to be quite honest, an academic one rather than anything else. And for the simple reason that these traditional online, real-time EMV systems would simply not work in these countries, but that wasn't the problem. The problem was it was perceived that the local people we're embarking in our system, which they believe was a closed system, which was a system that may be at the end of the day could not grow or would not be able to inter-operate with the so-called big elephants. It's not chained inter-operate which is the beauty of it. And number 2, we firmly believe that MasterCard have, 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 EPS portion as well. So I think we're both getting the best of both sides of the world, but the beauty is that our barrier or philosophical barrier is gone. And from their side, I think there's a fantastic opportunity to roll out millions and millions of MasterCards. While today, those particular beneficial or those particular people would never been issued with an EMV card, MasterCard or Visa card for the foreseeable future. So I think it's a synergistic partnership which I think we're already seeing that there is a huge demand for this particular product, not only for furthering up of new countries, but even the countries we have been in for the last 5 years .

Okay, okay. That's very interesting. And then just lastly, because there's kind of a question related to your international segment. Now it looks like revenues grew very nicely. And then in your 10-Q, you've disclosed that margins were lower largely due to start-up costs related to some of your U.S. businesses. But I guess I just wanted to confirm that the margins of the cash net 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 the KSNET business have been under pressure. Well, 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 trends within the Korean market, and they've 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, at the very least, maintaining or probably growing our market share within the country itself. So from that perspective, we are very 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 spent a lot of time understanding the business, understanding the market and getting to grips growth 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 markets shared that we've enjoyed 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.

Our next question comes from Brian Steck of Mangrove Partners.

And I've got 2 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 drivers of that expected reduction?

The key driver will be the affect that during Q1, we were renting up really the employee base to end up effectively at the end of 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 over costs -- obviously, that there are some direct costs that one can ascribe to employing the 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 have to spend on transportation, accommodation, et cetera, 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 COGS 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 has increased significantly since the original numbers were put forward, that's obviously having no significant impact on the cost of the initial implementation. But on an ongoing basis, once the start-up is taken care of, your cost should really be driven by the number of recipients and the number of additional beneficiaries that will come into the system should not have a significant impact on ongoing cost. Is that correct?

I think yes, that is correct. So the way that it will work going forward is once we've completed what we call bulk enrollment, whatever the -- whenever new beneficiaries, they join the system over the next 4 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 BBB option -- the BBE option, that was issued earlier this year. From a funding perspective, the fact that, that option is denominated in U.S. 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 BEE investment opportunity denominated in rand?

That's a very interesting question. Obviously, we chose to denominate the option in U.S. dollars simply because the South African market volume is very thin. And in calculating the option price, we looked at our volume weighted average price, which we could only really accurately measure using the U.S. 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 BEE 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 banks, South African Reserve Bank, with exchange control approval if they wanted to pay for and keep the shares on the American register. So by doing it in dollars and in the U.S. currency, and that value is still obviously fixed and static and determine that $8.96 a share has given them the 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 in MasterCard, is riding Shotgun [ph]? 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 2 companies.

Again, it's a very good question. At the moment, I'm not going to give you an answer which is better than if they lose the capital basically network, namely MasterCard, I think is obviously seen the opportunity in South Africa, whereby they will now issue 10 billion MasterCard and is absolutely no doubted for them that is something that to probably make them the largest issuer from a branding point of view in the country, which they were not before. Now they've also realized our technology works obviously, and more importantly, does actually provide the solution to many countries in which they operate where they did not have the solution before. So in all of those countries, I think they are promoting the solution we've implemented in South Africa but talking obviously to the banks, the banks that issue MasterCard. 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 welfare system and at the same time, a payment instrument. We already know that they are doing this because there's 1 or 2 other tenders that have been mentioned to us which have come through directly MasterCard, whereby, in fact, they would like us to actually respond to this 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, we seeing this thing playing out is that in any country where they are, there will be a number of banks that might talk to them and say to them, this is an opportunity for you to tackle different market space. You're welcome to do it. We have looked at this thing. This thing is MasterCard-certified. It works. We know the company, we know the guys, but what they are doing, we suggest that you go ahead and actually work with them directly. And I don't think that we're going to be doing. It's not something whereby we're sharing their revenue, they're sharing ours. They're sharing theirs, and we take ours, but we certainly can do local deals. But instead of fighting MasterCard in the particular country, they are now going to be the one that are going to open a few doors rather than perhaps to be fooled when they may be the one that are closing them.

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

Our final question comes from Marc Heilweil of Spectrum.

This is Marc Heilweil from Spectrum Advisory Services. I have a balance sheet question. With regard to the risk of the cash which you'd park over night, are there any insurance or security collateral that is provided for you or to South African Bank in which you have money sales? 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 SASSA, sometimes exceed $1 billion on an overnight basis. So not easy to ensure that kind of money, but we believe that stability 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 security?

Not at all, no.

And is there anything you can tell us about -- I think you have 2 large venture [ph] 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 arrangement?

Marc, this is Dhruv Chopra here. The 2 funds you're talking about is international Value Advisers that owned about 25% of the company, and they've built their position over the last 2 or 3 years now. As far as we understand, they have taken a long-term view on the company. They still remain incredibly 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...

In general though, is that in one fund of theirs?

No, I think, I believe, it's spread across several funds. Now they have been in for 7 years now since the IPO. Logic would tell you, any private equity investment -- 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 the trigger.

Okay. I have one more in the credit risk category for Herman or the like. When -- could 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 talks that you've eliminated that credit risk through insurance. Is that right?

Well, it depends what part of the business you're referring to. On the pension and welfare side of the business, there is no credit risk. Before, many years ago, we -- on their old contracts in some of our provinces, we actually pre-funded the social grant, 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 disclose 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 that we assume on that side of the business is that we pre-fund sometimes some of the merchants who performed grant pals [ph] or who performed 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 and 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 creditworthiness of that specific merchant. And if we believe that 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 that's --- those are really -- and then in terms of our micro finance book, they, obviously, is a credit risk purely from the point of view that when we provide our beneficiaries with these microloans, what we used to do before is we used to ensure 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 5 years and we know what the loss ratio is on our microlending 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 microlending book, because the loss ratio that we've seen over the last 5 years is acceptable to us and is obviously priced into the product.

Well, I'm glad to hear good trends in longevity in South Africa, and I will give some thought to relocating there. But more seriously, I want to commend everybody for a very intelligent discussion of the business.

Thank you.

Thank you.

Thank you, Mark.

Thank you very much. On behalf of Net1, that concludes this conference. Thank you for joining us. You may now disconnect your lines.