LESAKA TECHNOLOGIES INC - Quarter Report: 2012 December (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2012

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from _____________ To________________

Commission file number: 000-31203

NET 1 UEPS TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

President Place, 4^th Floor, Cnr. Jan Smuts Avenue and Bolton Road
Rosebank, Johannesburg 2196, South Africa
(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: 27-11-343-2000

Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES [X] NO [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES [X] NO [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES [ ] NO [X ]

As of February 5, 2013 (the latest practicable date), 45,600,471 shares of the registrant’s common stock, par value $0.001 per share, net of treasury shares, were outstanding.

Form 10-Q

NET 1 UEPS TECHNOLOGIES, INC.

Table of Contents

1

Part I. Financial Information

Item 1. Financial Statements

NET 1 UEPS TECHNOLOGIES, INC.
Condensed Consolidated Balance Sheets

See Notes to Unaudited Condensed Consolidated Financial Statements

2

NET 1 UEPS TECHNOLOGIES, INC.
Unaudited Condensed Consolidated Statements of Operations

See Notes to Unaudited Condensed Consolidated Financial Statements

3

NET 1 UEPS TECHNOLOGIES, INC.
Unaudited Condensed Consolidated Statements of Comprehensive Income

See Notes to Unaudited Condensed Consolidated Financial Statements

4

NET 1 UEPS TECHNOLOGIES, INC.
Unaudited Condensed Consolidated Statement of Changes in Equity (dollar amounts in thousands)

See Notes to Unaudited Condensed Consolidated Financial Statements

5

NET 1 UEPS TECHNOLOGIES, INC.
Unaudited Condensed Consolidated Statements of Cash Flows

See Notes to Unaudited Condensed Consolidated Financial Statements

6

1. Basis of Presentation and Summary of Significant Accounting Policies

     Unaudited Interim Financial Information

     The accompanying unaudited condensed consolidated financial statements include all majority-owned subsidiaries over which the Company exercises control and have been prepared in accordance with US generally accepted accounting principles (“GAAP”) and the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q and include all of the information and disclosures required for interim financial reporting. The results of operations for the three and six months ended December 31, 2012 and 2011, are not necessarily indicative of the results for the full year. The Company believes that the disclosures are adequate to make the information presented not misleading.

     These financial statements should be read in conjunction with the financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments), which are necessary for a fair representation of financial results for the interim periods presented. During the three months ended December 31, 2012, the Company identified an immaterial balance sheet misclassification related to prior periods that involved an overstatement of other payables and an understatement of additional paid-in capital of $2.0 million, respectively. The Company has corrected these amounts in the current period effective June 30, 2012. This reclassification has no impact on the Company’s previously reported consolidated income, comprehensive income or cash flows.

     References to the “Company” refer to Net1 and its consolidated subsidiaries, unless the context otherwise requires. References to Net1 are references solely to Net 1 UEPS Technologies, Inc.

     Recent accounting pronouncements adopted

     In September 2011, the Financial Accounting Standards Board issued guidance regarding Testing Goodwill for Impairment. The guidance allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this guidance, an entity is not required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The guidance includes a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The Company adopted this guidance beginning July 1, 2012. The adoption of this guidance did not have a significant impact on the Company’s condensed consolidated financial statements.

     Recent accounting pronouncements not yet adopted as of December 31, 2012

     There were no new accounting pronouncements not yet adopted by the Company during the three and six months ended December 31, 2012.

2. Acquisitions

     The net cash paid related to the Company’s various acquisitions that are discussed below during the six months ended December 31, 2012 are summarized in the table below:

     SmartSwitch Botswana (Proprietary) Limited

     On December 7, 2012, the Company acquired 50% of the outstanding and issued ordinary shares in SmartSwitch Botswana, a Botswana private company, for BWP 6.3 million (approximately $0.8 million) in cash. As a result of this transaction, SmartSwitch Botswana is now a wholly-owned subsidiary and is consolidated in the Company’s financial statements. SmartSwitch Botswana had previously been recorded as an equity-accounted investment (see Note 6).

     The Company believes that the acquisition of the remaining 50% of SmartSwitch Botswana will allow it to directly pursue its growth strategy in Botswana, which includes the introduction of additional services in that country.

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2. Acquisitions (continued)

     SmartSwitch Botswana (Proprietary) Limited (continued)

     The preliminary purchase price allocation, translated at the foreign exchange rates applicable on the date of acquisition, is provided in the table below:

     The preliminary purchase price allocation is based on management estimates as of December 31, 2012, and may be adjusted up to one year following the closing of the acquisition. The purchase price allocation has not been finalized, as management has not yet analyzed in detail the assets acquired and liabilities assumed. The Company expects to finalize the purchase price allocation on or before September 30, 2013.

     Pbel (Proprietary) Limited

     On September 14, 2012, the Company acquired all of the outstanding and issued ordinary shares in Pbel, a South African private company, for ZAR 33 million (approximately $3.8 million). ZAR 23 million of the purchase price was paid in cash and the remaining ZAR 10 million will be paid in 142,236 shares of the Company’s common stock, subject to the achievement of pre-defined Pbel financial performance milestones over the next three years. The Company is entitled to vote 100% of the outstanding and issued shares of Pbel. The 142,236 shares are divided into three equal tranches of 47,412 shares and the sellers will be entitled to receive the shares for each tranche only if the milestones for that particular tranche are achieved. However, the sellers will be entitled to receive all 142,236 shares if the cumulative pre-defined Pbel projected profit over the next three years is achieved or if the Company decides to abandon its Mobile Virtual Card initiative.

     The Company had historically engaged the services of Pbel to perform software development services, primarily software utilized on mobile phones and by cash-accepting kiosks. All software developed was the Company’s property. Prior to the acquisition, Pbel was jointly owned by the Company’s chief executive officer, Dr. Serge Belamant and his son, Mr. Philip Marc Belamant. Dr. Belamant is a non-employee director of Pbel and Mr. Philip Marc Belamant is its chief executive officer. Prior to the acquisition, Mr. Philip Marc Belamant was not employed by the Company.

     The Company believes that the acquisition of Pbel is important in the execution of its strategy to commercialize and develop its world-wide virtual card patents and to supply secure, leading edge technological solutions to the global payments market with particular focus on mobile-based payment solutions. Mr. Philip Marc Belamant, in his new position as Managing Director of Mobile Solutions, will oversee the Company’s Mobile Virtual Card, Kiosk, Web and WAP application research and development activities as well as related global business development initiatives.

     The preliminary purchase price allocation, translated at the foreign exchange rates applicable on the date of acquisition, is provided in the table below:

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2. Acquisitions (continued)

     Pbel (Proprietary) Limited (continued)

     The preliminary purchase price allocation is based on management estimates as of December 31, 2012, and may be adjusted up to one year following the closing of the acquisition. The purchase price allocation has not been finalized, as management has not yet analyzed in detail the assets acquired and liabilities assumed. The Company expects to finalize the purchase price allocation on or before June 30, 2013.

     Pro forma results of operations have not been presented because the effect of the SmartSwitch and Pbel acquisitions, individually and in the aggregate, were not material to the Company. During the three and six months ended December 31, 2012, the Company incurred acquisition-related expenditure of $0.03 million and $0.1 million, respectively, related to these acquisitions. Since the closing of the SmartSwitch Botswana acquisition, it has contributed revenue and generated a net income of $0.1 million and $0.01 million, respectively. Since the closing of the Pbel acquisition, it has contributed revenue and incurred a net loss, after acquired intangible asset amortization, net of taxation, of $0.3 million and $0.2 million, respectively, for the three months ended December 31, 2012, and revenue and net loss of $0.4 million and $0.2 million, respectively, for the six months ended December 31, 2012.

3. Pre-funded social welfare grants receivable

     Pre-funded social welfare grants receivable represents amounts pre-funded by the Company to certain merchants participating in the merchant acquiring system. The January 2013 payment service commenced on January 1, 2013, but the Company pre-funded certain merchants participating in the merchant acquiring systems in the last two days of December 2012.

4. Inventory

The Company’s inventory comprised the following categories as of December 31, 2012 and June 30, 2012.

5. Settlement assets and settlement obligations

     Settlement assets comprise (1) cash received from the South African government that the Company holds pending disbursement to beneficiaries of social welfare grants, (2) cash received from health care plans which the Company disburses to health care service providers once it adjudicates claims and (3) cash received from customers on whose behalf the Company processes payroll payments that the Company will disburse to customer employees, payroll-related payees and other payees designated by the customer.

     Settlement obligations comprise (1) amounts that the Company is obligated to disburse to beneficiaries of social welfare grants, (2) amounts which are due to health care service providers after claims have been adjudicated and reconciled, provided that the Company shall have previously received such funds from health care plan customers and (3) amounts that the Company is obligated to pay to customer employees, payroll-related payees and other payees designated by the customer.

     The balances at each reporting date may vary widely depending on the timing of the receipts and payments of these assets and obligations

6. Fair value of financial instruments and equity-accounted investments

     Fair value of financial instruments

          Risk management

     The Company seeks to reduce its exposure to currencies other than the South African rand through a policy of matching, to the extent possible, assets and liabilities denominated in those currencies. In addition, the Company uses financial instruments in order to economically hedge its exposure to exchange rate and interest rate fluctuations arising from its operations. The Company is also exposed to equity price and liquidity risks as well as credit risks.

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6. Fair value of financial instruments and equity-accounted investments (continued)

     Fair value of financial instruments (continued)

          Risk management (continued)

               Currency exchange risk

     The Company is subject to currency exchange risk because it purchases inventories that it is required to settle in other currencies, primarily the euro and US dollar. The Company uses foreign exchange forward contracts in order to limit its exposure in these transactions to fluctuations in exchange rates between the South African rand, on the one hand, and the US dollar and the euro, on the other hand.

     The Company’s outstanding foreign exchange contracts are as follows:

     As of December 31, 2012

     None.

     As of June 30, 2012

     None.

               Translation risk

     Translation risk relates to the risk that the Company’s results of operations will vary significantly as the US dollar is its reporting currency, but it earns most of its revenues and incurs most of its expenses in ZAR. The US dollar to ZAR exchange rate has fluctuated significantly over the past two years. As exchange rates are outside the Company’s control, there can be no assurance that future fluctuations will not adversely affect the Company’s results of operations and financial condition.

               Interest rate risk

     As a result of its normal borrowing and leasing activities, the Company’s operating results are exposed to fluctuations in interest rates, which it manages primarily through regular financing activities. The Company generally maintains limited investment in cash equivalents and has occasionally invested in marketable securities. The Company, through its insurance business, maintains investments in fixed maturity investments which are exposed to fluctuations in interest rates.

               Credit risk

     Credit risk relates to the risk of loss that the Company would incur as a result of non-performance by counterparties. The Company maintains credit risk policies with regard to its counterparties to minimize overall credit risk. These policies include an evaluation of a potential counterparty’s financial condition, credit rating, and other credit criteria and risk mitigation tools as the Company’s management deems appropriate.

     With respect to credit risk on financial instruments, the Company maintains a policy of entering into such transactions only with South African and European financial institutions that have a credit rating of BBB or better, as determined by credit rating agencies such as Standard & Poor’s, Moody’s and Fitch Ratings.

               Equity price and liquidity risk

     Equity price risk relates to the risk of loss that the Company would incur as a result of the volatility in the exchange-traded price of equity securities that it holds and the risk that it may not be able to liquidate these securities. Liquidity risk relates to the risk of loss that the Company would incur as a result of the lack of liquidity on the exchange on which these securities are listed. The Company may not be able to sell some or all of these securities at one time, or over an extended period of time without influencing the exchange-traded price, or at all.

     Financial instruments

     The following section describes the valuation methodologies the Company uses to measure its significant financial assets and liabilities at fair value.

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6. Fair value of financial instruments and equity-accounted investments (continued)

     Financial instruments (continued)

     In general, and where applicable, the Company uses quoted prices in active markets for identical assets or liabilities to determine fair value. This pricing methodology applies to Level 1 investments. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then the Company uses quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. These investments are included in Level 2 investments. In circumstances in which inputs are generally unobservable, values typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. Investments valued using such techniques are included in Level 3 investments.

     Asset measured at fair value using significant unobservable inputs – investment in Finbond Group Limited (“Finbond”)

     The Company's Level 3 asset represents an investment of 156,788,712 shares of common stock of Finbond, which are exchange-traded equity securities. Finbond’s shares are traded on the JSE Limited (“JSE”) and the Company has designated such shares as available for sale investments. The Company has concluded that the market for Finbond shares is not active and consequently has employed alternative valuation techniques in order to determine the fair value of such stock. Currently, the operations of Finbond relate primarily to the provision of microlending products. In determining the fair value of Finbond, the Company has considered amongst other things Finbond’s historical financial information (including its most recent public accounts), press releases issued by Finbond and its published net asset value. The Company believes that the best indicator of fair value of Finbond is its published net asset value and has used this value to determine the fair value.

     The fair value of these securities as of December 31, 2012, represented approximately 1% of the Company’s total assets, including these securities.

     The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 according to the fair value hierarchy:

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6. Fair value of financial instruments and equity-accounted investments (continued)

     The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2012, according to the fair value hierarchy:

     Assets and liabilities measured at fair value on a nonrecurring basis

     The Company measures its equity-accounted investments at fair value on a nonrecurring basis. The Company has no liabilities that are measured at fair value on a nonrecurring basis. These equity-accounted investments are recognized at fair value when they are deemed to be other-than-temporarily impaired.

     The Company reviews the carrying values of its investments when events and circumstances warrant and considers all available evidence in evaluating when declines in fair value are other-than-temporary. The fair values of the Company’s investments are determined using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost of the investment exceeds its fair value and the excess is determined to be other-than-temporary. The Company has not recorded any impairment charges during the reporting periods presented herein.

     Equity-accounted investments

     During the six months ended December 31, 2012, SmartSwitch Namibia repaid its final installment related to its outstanding loans and interest. The repayments received have been allocated to the equity-accounted investments presented in the Company’s condensed consolidated balance sheet. The cash inflow from principal repayments have been allocated to cash flows from investing activities and the cash inflow from the interest repayments have been included in cash flow from operating activities in the Company’s condensed consolidated statement of cash flows for the six months ended December 31, 2012.

     During the three months ended December 31, 2012, the Company acquired the remaining 50% of SmartSwitch Botswana as described in Note 2. The Company was required to remeasure the carrying value of its investment in SmartSwitch Botswana to its fair value prior to consolidation and recognized a gain of approximately $0.3 million. In addition, during the three months ended December 31, 2012, the Company acquired a 50% interest in the ordinary shares of Netpay Solutions Private Limited (“Netpay”), a private Indian company, for $0.08 million. The Company has accounted for this investment using the equity method.

     Summarized below is the Company’s equity-accounted (loss) earnings for the three months ended December 31, 2012:

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6. Fair value of financial instruments and equity-accounted investments (continued)

     Equity-accounted investments (continued)

     Summarized below is the Company’s interest in equity-accounted investments as of June 30, 2012 and December 31, 2012:

     (1) – includes the recognition of realized net income.
     (2) – the foreign currency adjustment represents the effects of the combined net currency fluctuations between the functional currency of the equity-accounted investments and the US dollar.

     There were no significant sales to these investees that require elimination during the three and six months ended December 31, 2012 and 2011.

7. Goodwill and intangible assets

     Goodwill

     Summarized below is the movement in the carrying value of goodwill for the six months ended December 31, 2012:

     (1) – the foreign currency adjustment represents the effects of the fluctuations between the South African rand and the Korean won, and the US dollar on the carrying value.

     Goodwill associated with the acquisition of Pbel and SmartSwitch Botswana represents the excess of cost over the fair value of acquired net assets. The Pbel and SmartSwitch Botswana goodwill is not deductible for tax purposes. See Note 2 for the allocation of the purchase price to the fair value of acquired net assets. Pbel has been allocated to the Company’s South African transaction-based activities operating segment and SmartSwitch Botswana to the international transaction-based activities operating segment.

     Goodwill has been allocated to the Company’s reportable segments as follows:

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7. Goodwill and intangible assets (continued)

     Intangible assets

     Carrying value and amortization of intangible assets

     Summarized below is the carrying value and accumulated amortization of the intangible assets as of December 31, 2012 and June 30, 2012:

     (1) Includes the customer relationships and software and unpatented technology acquired as part of the Pbel acquisition in September 2012.

     Aggregate amortization expense on the finite-lived intangible assets for the three and six months ended December 31, 2012, was approximately $4.9 million and $9.6 million, respectively (three and six months ended December 31, 2011, was approximately $4.9 million and $9.6 million, respectively).

     Future estimated annual amortization expense for the next five fiscal years, assuming exchange rates prevailing on December 31, 2012, is presented in the table below. Actual amortization expense in future periods could differ from this estimate as a result of acquisitions, changes in useful lives, exchange rate fluctuations and other relevant factors.

8. Reinsurance assets and policy holder liabilities under insurance and investment contracts

     Reinsurance assets and policy holder liabilities under insurance contracts

     Summarized below is the movement in reinsurance assets and policy holder liabilities under insurance contracts during the three and six months ended December 31, 2012:

     (1) Included in other long-term assets; 
     (2) Included in other long-term liabilities;
     (3) The foreign currency adjustment represents the effects of the fluctuations between the ZAR against the US dollar.

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8. Reinsurance assets and policy holder liabilities under insurance and investment contracts (continued)

     Reinsurance assets and policy holder liabilities under insurance contracts (continued)

     The Company has agreements with reinsurance companies in order to limit its losses from large insurance contracts, however, if the reinsurer is unable to meet its obligations, the Company retains the liability.

     The value of insurance contract liabilities is based on best estimates assumptions of future experience plus prescribed margins, as required in the markets in which these products are offered, namely South Africa. The process of deriving the best estimates assumptions plus prescribed margins includes assumptions related to future mortality and morbidity (an appropriate base table of standard mortality is chosen depending on the type of contract and class of business), withdrawals (based on recent withdrawal investigations and expected future trends), investment returns (based on government treasury rates adjusted by an applicable margin), expense inflation (based on a 10 year real return on CPI-linked government bonds from the risk-free rate and adding an allowance for salary inflation and book shrinkage of 1% per annum) and claim reporting delays (based on average industry experience).

     Assets and policy holder liabilities under investment contracts

     Summarized below is the movement in assets and policy holder liabilities under investment contracts during the three and six months ended December 31, 2012:

     (1) Included in other long-term assets; 
     (2) Included in other long-term liabilities;
     (3) The foreign currency adjustment represents the effects of the fluctuations between the ZAR against the US dollar.

     The Company does not offer any investment products with guarantees related to capital or returns.

9. Short-term credit facility

     The Company has a ZAR 250 million ($29.5 million, translated at exchange rates applicable as of December 31, 2012) short-term South African credit facility. As of December 31, 2012, the overdraft rate on this facility was 7.85% . The Company has ceded its investment in Cash Paymaster Services (Proprietary) Limited, a wholly owned South African subsidiary, as security for the facility. As of December 31, 2012, and June 30, 2012, the Company had utilized none of its South African short-term facility.

     Management believes that this facility is sufficient in order to meet the Company’s future obligations as they arise.

10. Long-term borrowings

     The Company’s KRW 100.6 billion ($94.2 million, translated at exchange rates applicable as of December 31, 2012) Korean senior secured loan facility is described in Note 12 to the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended June 30, 2012. The current carrying value as of December 31, 2012, is $94.2 million. As of December 31, 2012, the carrying amount of the long-term borrowings approximated fair value. The interest rate in effect on December 31, 2012, was 6.95% . Interest expense during the three and six months ended December 31, 2012 and 2011, was $1.8 million and $2.2 million; and $3.6 million and $4.6 million, respectively.

     The fourth and fifth scheduled principal repayments are $7.6 million each, translated at exchange rates applicable as of December 31, 2012, and have been classified as current in the Company’s condensed consolidated balance sheet. The third repayment of $7.3 million was paid on October 29, 2012 and the fourth repayment is due on April 29, 2013. The first repayment of $7.2 million was paid on November 1, 2011.

11. Capital structure

     Common stock repurchases

     The Company did not repurchase any of its shares during the three and six months ended December 31, 2012, and during the three months ended December 31, 2011, respectively. The Company repurchased 180,656 shares during the six months ended December 31, 2011, for approximately $1.1 million.

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12. Stock-based compensation

     Stock option and restricted stock activity

          Options

     The following table summarizes stock option activity for the six months ended December 31, 2012:

     During the three and six months ended December 31, 2012, respectively, 159,666 and 244,666 stock options became exercisable. During each of the three and six months ended December 31, 2011, respectively, 102,333 stock options became exercisable. Included in the 244,666 stock options are 30,000 stock options with respect to which the Remuneration Committee of the Board agreed to accelerate vesting, in August 2012, prior to the resignation of a non-employee director. During the six months ended December 31, 2012, the Company received approximately $0.2 million from 30,000 stock options exercised by the non-employee director that resigned. No stock options were exercised during the three months ended December 31, 2012 or during the three and six months ended December 31, 2011. The Company issues new shares to satisfy stock option exercises.

     Restricted stock

     The following table summarizes restricted stock activity for the six months ended December 31, 2012 and 2011:

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12. Stock-based compensation (continued)

     Stock option and restricted stock activity (continued)

          Restricted stock (continued)

     The fair value of restricted stock vesting during the three and six months ended December 31, 2012 and 2011, respectively, was $0 million and $0.2 million and $0.2 million and $0.3 million. Included in the 19,715 shares of restricted stock that vested during the six months ended December 31, 2012, are 8,547 shares with respect to which the Remuneration Committee of the Board agreed to accelerate vesting prior to the resignation of a non-employee director.

     Stock-based compensation charge and unrecognized compensation cost

     The Company has recorded a stock compensation charge of $1.1 million and $0.5 million for the three months ended December 31, 2012 and 2011, respectively, which comprised:

     The Company has recorded a stock compensation charge of $2.2 million and $1.0 million for the six months ended December 31, 2012 and 2011, respectively, which comprised:

     The stock-based compensation charges have been allocated to selling, general and administration based on the allocation of the cash compensation paid to the employees.

     As of December 31, 2012, the total unrecognized compensation cost related to stock options was approximately $1.7 million, which the Company expects to recognize over approximately three years. As of December 31, 2012, the total unrecognized compensation cost related to restricted stock awards was approximately $4.8 million, which the Company expects to recognize over approximately three years.

     As of December 31, 2012, the Company has recorded a deferred tax asset of approximately $1.2 million related to the stock-based compensation charge recognized related to employees and directors of Net1 as it is able to deduct the grant date fair value for taxation purposes in the United States.

13. Earnings per share

     Basic earnings per share include restricted stock awards that meet the definition of a “participating security.” Restricted stock awards are eligible to receive non-forfeitable dividend equivalents at the same rate as common stock. Basic earnings per share have been calculated using the two-class method and basic earnings per share for the three and six months ended December 31, 2012 and 2011, reflects only undistributed earnings.

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13. Earnings per share (continued)

     Diluted earnings per share have been calculated to give effect to the number of additional shares of common stock that would have been outstanding if the potential dilutive instruments had been issued in each period. The calculation of diluted earnings per share for the three and six months ended December 31, 2012 and 2011, includes the dilutive effect of a portion of the restricted stock awards granted to employees as these restricted stock awards are considered contingently issuable shares. For the purposes of the diluted earnings per share calculation and as of December 31, 2012 and 2011, the vesting conditions in respect of a portion of the awards had not been satisfied.

     Options to purchase 11,560,863 shares of the Company’s common stock at prices ranging from $6.59 to $24.46 per share were outstanding during the three and six months ended December 31, 2012, but have not been included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the Company’s common stock during the period. The options, which expire at various dates through August 22, 2022, and include the 8,955,000 equity instrument issued pursuant to BBBEE transaction, remained outstanding as of December 31, 2012.

     The following table details the weighted average number of outstanding shares used for the calculation of earnings per share for the three and six months ended December 31, 2012 and 2011:

14. Supplemental cash flow information

     The following table presents the supplemental cash flow disclosures for the three and six months ended December 31, 2012 and 2011:

15. Operating segments

     The Company discloses segment information as reflected in the management information systems reports that its chief operating decision maker uses in making decisions and to report certain entity-wide disclosures about products and services, major customers, and the countries in which the entity holds material assets or reports material revenues. A description of the Company’s operating segments is contained in note 22 to the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended June 30, 2012.

     The following tables summarize segment information which is prepared in accordance with GAAP:

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15. Operating segments (continued)

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15. Operating segments (continued)

     The segment information as reviewed by the chief operating decision maker does not include a measure of segment assets per segment as all of the significant assets are used in the operations of all, rather than any one, of the segments. The Company does not have dedicated assets assigned to a particular operating segment. Accordingly, it is not meaningful to attempt an arbitrary allocation and segment asset allocation is therefore not presented.

     It is impractical to disclose revenues from external customers for each product and service or each group of similar products and services.

16. Income tax

     Income tax in interim periods

     For the purposes of interim financial reporting, the Company determines the appropriate income tax provision by first applying the effective tax rate expected to be applicable for the full fiscal year to ordinary income. This amount is then adjusted for the tax effect of significant unusual or extraordinary items, for instance, changes in tax law, valuation allowances and non-deductible transaction-related expenses that are reported separately, and have an impact on the tax charge. The cumulative effect of any change in the enacted tax rate, if and when applicable, on the opening balance of deferred tax assets and liabilities is also included in the tax charge as a discrete event in the interim period in which the enactment date occurs.

     For the three and six months ended December 31, 2012, the tax charge was calculated using the expected effective tax rate for the year. The Company’s effective tax rate for the three and six months ended December 31, 2012, was 53.6% and 42.2%, respectively, and was higher than the South African statutory rate primarily as a result of non-deductible expenses (including interest expense related to the Company’s long-term Korean borrowings and stock-based compensation charges) and South African dividend withholding taxes. The Company’s effective tax rate for the three and six months ended December 31, 2011, was -27.3% and 10.3%, respectively, and was lower than the South African statutory rate as a result of a change in South African tax law which resulted in a net deferred taxation benefit and, related to the six months only, a non-taxable profit on liquidation of SmartSwitch Nigeria, which was partially offset by non-deductible expenses (including interest expense related to the Company’s long-term Korean borrowings and stock-based compensation charges) and the creation of a valuation allowance.

     Uncertain tax positions

     The Company decreased its unrecognized tax benefits by $0.2 million during the six months ended December 31, 2012. There were no changes during the three months ended December 31, 2012. As of December 31, 2012, the Company had accrued interest related to uncertain tax positions of approximately $0.2 million on its balance sheet.

     The Company does not expect changes related to its unrecognized tax benefits will have a significant impact on its results of operations or financial position in the next 12 months.

     The Company files income tax returns mainly in South Africa, Korea, Austria, Botswana, the Russian Federation and in the US federal jurisdiction. As of December 31, 2012, the Company is no longer subject to any new income tax examination by the South African Revenue Service for years before December 31, 2009. In 2011, the Korea National Tax Service had effectively completed the examination of the Company’s returns in Korea related to years 2006 through 2010. The Company is subject to income tax in other jurisdictions outside South Africa and Korea, none of which are individually material to its financial position, cash flows, or results of operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended June 30, 2012, and the unaudited condensed consolidated financial statements and the accompanying notes included in this Form 10-Q.

Forward-looking statements

     Some of the statements in this Form 10-Q constitute forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed, implied or inferred by these forward-looking statements. Such factors include, among other things, those listed under Item 1A.—“Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended June 30, 2012 and in our Form 10-Q for the quarter ended September 30, 2012, and Item 1A—“Risk Factors” and elsewhere in this Form 10-Q. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of such terms and other comparable terminology.

     Although we believe that the expectations reflected in the forward-looking statements are reasonable, we do not know whether we can achieve positive future results, levels of activity, performance, or goals. Actual events or results may differ materially. We undertake no obligation to update any of the forward-looking statements after the date of this Form 10-Q to conform those statements to reflect the occurrence of unanticipated events, except as required by applicable law.

     You should read this Form 10-Q and the documents that we reference herein and the documents we have filed as exhibits hereto and which we have filed with the Securities and Exchange Commission completely and with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

Recent Developments

     DOJ and SEC investigations

     On November 30, 2012, we received a letter from the U.S. Department of Justice, Criminal Division, or DOJ, informing us that the DOJ and the Federal Bureau of Investigation have begun an investigation into whether we and our subsidiaries, including our officers, directors, employees, and agents and other persons and entities possibly affiliated with us violated provisions of the Foreign Corrupt Practices Act, or the FCPA, and other U.S. federal criminal laws by engaging in a scheme to make corrupt payments to officials of the Government of South Africa in connection with securing our SASSA contract and also engaged in violations of the federal securities laws in connection with statements made by us in our SEC filings regarding this contract. On the same date, we received a letter from the Division of Enforcement of the SEC advising us that it is also conducting an investigation concerning our company. The SEC letter states that the investigation is a non-public, fact-finding inquiry and that the SEC investigation does not mean that the SEC has concluded that we or anyone else has broken the law or that the SEC has a negative opinion of any person, entity or security. We are cooperating fully with the DOJ and the SEC regarding these investigations. See Part II, Item 1A—“Risk Factors.”

     Suit against AllPay

     We have sued AllPay Consolidated Investment Holdings (Pty) Ltd, or AllPay, alleging unlawful competition, and are seeking damages. See Part II, Item 1—“Legal Proceedings.”

     South Africa

     SASSA

     We commenced the second phase of the enrollment process in early July 2012 and plan to be substantially complete by March 2013, in accordance with the enrollment plan agreed with SASSA. Under our agreement with SASSA, we have to enroll both the grant recipients (those individuals who receive the actual payment and are issued with our UEPS/EMV smart card), as well as the grant beneficiaries (those individuals who have qualified for the social grant, but are not necessarily the recipient of the grant). By way of example, a parent who has three children and receives a grant for all three children is the grant recipient, while the three children are each classified individually as grant beneficiaries. In this case, we capture the personal and biometric information of the parent and three children, but only the parent is issued with an UEPS/EMV smart card.

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     While the number of grant recipients on a national basis has consistently been quantified by SASSA at 9.4 million individuals, the number of beneficiaries is continually being revised by SASSA on an ongoing basis from an initial estimate of approximately 15.5 million, to the current estimate of approximately 21.6 million. In order to complete the second phase of the implementation on time, and given the significantly higher number of beneficiaries, we increased the number of temporary employees that we hired for the entire second quarter of fiscal 2013 from 2,500 to approximately 5,500. The total number of temporary employees is significantly more than the 2,500 we previously expected at the beginning of fiscal 2013 as the actual number of individuals (grant recipients plus grant beneficiaries) that SASSA has asked us to enroll has increased substantially.

     During the second quarter of fiscal 2013, we enrolled a further 2.7 million grant recipients and an additional 3.8 million beneficiaries. Accordingly, as of December 31, 2012, we had enrolled a total of 9.5 million people which comprises approximately 4.4 million grant recipients and 5.1 million beneficiaries associated with these recipients in accordance with our second phase enrollment schedule, and issued them our UEPS/EMV smart card.

     The graph below presents our enrollment progress from inception to January 31, 2013:

     There is a time lag between when a current grant recipient is issued a UEPS/EMV card and when the recipient receives grants onto the UEPS/EMV smart card. For instance, recipients enrolled in December 2012 and issued a UEPS/EMV smart card were only paid onto that card in the January 2013 pay cycle. When a new grant recipient is approved by SASSA, the recipient is enrolled, issued with a UEPS/EMV smart card and immediately paid on this card. We are paid by SASSA for each recipient paid, regardless of type of card or channel and therefore for the month of December 2012, we earned revenue from SASSA based on the distribution of grants to 9,526,588 recipients The enrollment of recipients and beneficiaries was adversely impacted by the Christmas holiday season in South Africa in December. Enrollment recommenced in the second week of January 2013 and the volume of total enrollments for the month was, notwithstanding the late start during the month, one of the highest since we started with this project.

     During the second quarter of fiscal 2013 we incurred direct implementation expenses of approximately $18.0 million (ZAR 157.1 million) including staff, travel, temporary infrastructure hire, fixed premises hire for enrollment and stationery costs. We are unable to quantify the value 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 contract. Our implementation expenditure during the second quarter of fiscal 2013 was materially higher than we had previously anticipated due to the significant number of grant recipients and beneficiaries that we enrolled during the quarter, especially in the rural and deep rural areas. In order to meet our enrollment obligations in accordance with the timetable agreed with SASSA we incurred higher than anticipated temporary infrastructure hire, travel and staff expenditures. We expect this level of expenditure to reduce slightly during the third quarter of fiscal 2013, as our efforts are now focused primarily on urban areas.

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     We also expensed $3.0 million (ZAR 26.6 million) related to the cost of the UEPS/EMV smart cards issued during the quarter, which is not included in the $18.0 million (ZAR 157.1 million) above. Accordingly, during the first half of fiscal 2013, we incurred direct implementation expenses of $32.1 million (ZAR 273.7 million) and UEPS/EMV smart card expenses of $4.7 million (ZAR 40.6 million).

     We also incurred approximately $0.7 million in capital expenditures related to the implementation during the second quarter of fiscal 2013. Since inception of the implementation we have incurred cumulative capital expenditures of $25.2 million. We anticipate cumulative capital expenditures related to the ramp of our national contract to be in the $30 million range. We have lowered our expected capital expenditure range related to the implementation of our SASSA contract given the decision to expense the cost of smart cards rather than capitalize those costs.

     See Part II, Item 1—“Legal Proceedings” for an update on legal proceedings associated with our SASSA contract.

     Outside South Africa

          XeoHealth

     The commencement of the recovery audit contractor, or RAC, services and desk review recovery referrals identified through our XeoRules engine for Cognosante in North Dakota was delayed due to our customer requesting changes to the criteria which we deployed. We incorporated these changes into our XeoRules engine and commenced the auditing process, which covered five years of data in early October 2012. However, we were required to re-initiate the audit in December 2012 as a result of new files being provided by our customer in December 2012. XeoHealth now expects to recognize revenues related to these activities in the third quarter of fiscal 2013. We are currently unable to quantify the value of RAC service revenues to be recognized.

     XeoHealth has also been subcontracted by Cognosante to provide both the automated audit as well the analysis services as required by the RAC for the State of Missouri Medicaid. We have recently completed the business rules and audit findings and expect sign-off from Missouri which will enable us to commence performing services in the third quarter of fiscal 2013. Similar to North Dakota, XeoHealth will be compensated based on a percentage of the final recoveries identified by our XeoRules claims re-adjudicating service for the audit period of three years, as well as the desk review recovery referrals identified through our XeoRules engine.

          Mobile Virtual Card

     During the second quarter of fiscal 2013, we integrated and combined some of our legacy business units with Pbel to create our Mobile Solutions business unit. The Mobile Solutions unit is responsible for the coordination, support and growth of our MVC activities globally. We continue to engage with a number of interested parties regarding our MVC technology and have commenced software and system development to introduce VCPay in Spain and, along with our partners, in India.

          The African Continent and Iraq

     During fiscal 2013, NUETS recorded revenue from transaction fees under its contract with the government of Iraq. NUETS continued to service its current customers on the African continent and in Iraq and continued its business development efforts, including responding to a number of tenders, in multiple countries on the African continent during the year.

     Our partnership with MasterCard may also bring us additional business development opportunities for current or future MasterCard member banks who seek the offline and additional functionality incorporated in our new UEPS/EMV payment technology.

     Acquisition of SmartSwitch Botswana

     During the second quarter of fiscal 2013, we acquired 50% of the outstanding and issued ordinary shares in SmartSwitch Botswana, a Botswana private company, for BWP 6.3 million (approximately $0.8 million) in cash. As a result of this transaction SmartSwitch Botswana is now a wholly-owned subsidiary and is consolidated in our financial statements. SmartSwitch Botswana had previously been recorded as an equity-accounted investment. Refer to Note 2 of our condensed consolidated financial statements for additional information related to this acquisition.

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Critical Accounting Policies

     Our unaudited condensed consolidated financial statements have been prepared in accordance with US GAAP, which requires management to make estimates and assumptions about future events that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities. As future events and their effects cannot be determined with absolute certainty, the determination of estimates requires management’s judgment based on a variety of assumptions and other determinants such as historical experience, current and expected market conditions and certain scientific evaluation techniques.

     Critical accounting policies are those that reflect significant judgments or uncertainties, and potentially may result in materially different results under different assumptions and conditions. Management has identified the following critical accounting policies that are described in more detail in our Annual Report on Form 10-K for the year ended June 30, 2012:

• Deferred taxation;
• Stock-based compensation and equity instrument issued pursuant to BBBEE transaction;
• Intangible assets acquired through acquisitions;
• Business combinations and the recoverability of goodwill;
• Accounts receivable and provision for doubtful debts; and
• Research and development.

     Recent accounting pronouncements adopted

     Refer to Note 1 of our condensed consolidated financial statements for a full description of recent accounting pronouncements adopted, including the dates of adoption and the effects on our condensed consolidated financial statements.

     Recent accounting pronouncements not yet adopted as of December 31, 2012

     There were no new accounting pronouncements not yet adopted by us during the three and six months ended December 31, 2012.

Currency Exchange Rate Information

     Actual exchange rates

     The actual exchange rates for and at the end of the periods presented were as follows:

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     Translation exchange rates

     We are required to translate our results of operations from ZAR and KRW to US dollars on a monthly basis. Thus, the average rates used to translate this data for the three and six months ended December 31, 2012 and 2011, vary slightly from the averages shown in the table above. The translation rates we use in presenting our results of operations are the rates shown in the following table:

Results of operations

     The discussion of our consolidated overall results of operations is based on amounts as reflected in our unaudited condensed consolidated financial statements which are prepared in accordance with US GAAP. We analyze our results of operations both in US dollars, as presented in the consolidated financial statements, and supplementally in ZAR, because ZAR is the functional currency of the entities which contribute the majority of our profits and is the currency in which the majority of our transactions are initially incurred and measured. Due to the significant impact of currency fluctuations between the US dollar and ZAR on our reported results and because we use the US dollar as our reporting currency, we believe that the supplemental presentation of our results of operations in ZAR is useful to investors to understand the changes in the underlying trends of our business.

     Three and six months ended December 31, 2012, includes SmartSwitch Botswana from December 1, 2012, Pbel from September 1, 2012, and Eason for the entire period. Three and six months ended December 31, 2011, do not include SmartSwitch Botswana or Pbel, and include Eason from October 1, 2011.

     We analyze our business and operations in terms of five inter-related but independent operating segments: (1) South African transaction-based activities, (2) international transaction-based activities, (3) smart card accounts, (4) financial services, and (5) hardware, software and related technology sales. In addition, corporate and corporate office activities that are impracticable to ascribe directly to any of the other operating segments, as well as any inter-segment eliminations, are included in corporate/eliminations.

     Second quarter of fiscal 2013 compared to second quarter of fiscal 2012

     The following factors had an influence on our results of operations during the second quarter of fiscal 2013 as compared with the same period in the prior year:

• Unfavorable impact from the strengthening of the US dollar: The US dollar appreciated by 7% against the ZAR during the second quarter of fiscal 2013 which negatively impacted our reported results;
• SASSA implementation costs: We continued implementing our SASSA contract during the second quarter of fiscal 2013 and incurred additional implementation and staff costs; and
• Fiscal 2012 impacted by change in South African tax law: As a result of the change in South African tax law that replaced STC with a dividends withholding tax, fiscal 2012 tax expense included a net taxation benefit of $11.8 million, as we recorded a $20.0 million deferred tax benefit which was offset by an $8.2 million foreign tax credit valuation allowance.

     Consolidated overall results of operations

     This discussion is based on the amounts which were prepared in accordance with US GAAP.

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     The following tables show the changes in the items comprising our statements of operations, both in US dollars and in ZAR:

     Analyzed in ZAR, the increase in revenue was primarily due to incremental revenue resulting from our new SASSA contract and a higher contribution from KSNET.

     Analyzed in ZAR, the increase in cost of goods sold, IT processing, servicing and support was primarily due to higher expenses related to the implementation of our new SASSA contract which includes the UEPS/EMV smart cards issued to recipients during the second quarter of fiscal 2013.

     Our selling, general and administration expense increased primarily as a result of the SASSA contract implementation. Our selling, general and administration expense also includes approximately $0.5 million (ZAR 4.9 million) related to legal and accounting fees we have incurred in connection with the DOJ and SEC investigations

     Our operating income margin for the second quarter of fiscal 2013 and 2012, was 4% and 22%, respectively. We discuss the components of operating income margin under “—Results of operations by operating segment.” The decrease is primarily attributable to implementation costs related to the SASSA contract.

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     In ZAR, depreciation and amortization increased primarily as a result of an increase in depreciation related to assets used to service our obligations under our SASSA contract and an increase in KSNET depreciation. The intangible asset amortization related to our various acquisitions has been allocated to our operating segments as presented in the tables below:

     Interest on surplus cash increased to $2.6 million (ZAR 22.6 million) from $1.8 million (ZAR 14.9 million). The increase resulted primarily from higher average daily ZAR cash balances.

     In US dollars, interest expense decreased to $2.0 million (ZAR 17.7 million) from $2.3 million (ZAR 18.4 million) due to a lower average long-term debt balance.

     Total fiscal 2013 tax expense was $3.0 million (ZAR 26.0 million) compared to a tax benefit of $5.4 million (ZAR 44.0 million) in fiscal 2012. The tax benefit for 2012 includes a $20.0 million benefit related to a change in South African tax law and the creation of a valuation allowance of $8.2 million related to foreign tax credits. Our effective tax rate for the three months ended December 31, 2012, was 53.6% and was higher than the South African statutory rate primarily as a result of non-deductible expenses (including interest expense related to our long-term Korean borrowings and stock-based compensation charges) and South African dividend withholding taxes. Our effective tax rate for the three months ended December 31, 2011, was -27.3% and was lower than the South African statutory rate as a result of a change in South African tax law which resulted in a net deferred taxation benefit, which was partially offset by non-deductible expenses (including interest expense related to our long-term Korean borrowings and stock-based compensation charges) and the creation of a valuation allowance.

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Results of operations by operating segment

The composition of revenue and the contributions of our business activities to operating income are illustrated below.