TMCnet News
NET 1 UEPS TECHNOLOGIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with Item 6-"Selected Financial Data" and Item 8-"Financial Statements and Supplementary Data." In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See Item 1A- "Risk Factors" and "Forward Looking Statements." Overview We are a leading provider of payment solutions and transaction processing services across multiple industries and in a number of emerging economies. We have developed and market a comprehensive transaction processing solution that encompasses our smart card-based alternative payment system for the unbanked and under-banked populations of developing economies and for mobile transaction channels. Our market-leading system can enable the billions of people globally who generally have limited or no access to a bank account to enter affordably into electronic transactions with each other, government agencies, employers, merchants and other financial service providers. Our universal electronic payment system, or UEPS, uses biometrically secure smart cards that operate in real-time but offline, unlike traditional payment systems offered by major banking institutions that require immediate access through a communications network to a centralized computer. This offline capability means that users of our system can conduct transactions at any time with other card holders in even the most remote areas so long as a smart card reader, which is often portable and battery powered, is available. Our off-line systems also offer the highest level of availability and affordability by removing any elements that are costly and are prone to outages. Our latest version of the UEPS technology has now been certified by EMV, which facilitates our traditionally proprietary UEPS system to interoperate with the global EMV standard and allows card holders to transact at any EMV-enabled point of sale terminal or ATM. The new UEPS/EMV technology has been deployed on an extensive scale in South Africa through the issuance of MasterCard-branded UEPS/EMV cards to our social welfare grant customers. In addition to effecting purchases, cash-backs and any form of payment, our system can be used for banking, healthcare management, international money transfers, voting and identification. We also provide secure transaction technology solutions and services, by offering transaction processing, financial and clinical risk management solutions to various industries. We have extensive expertise in secure online transaction processing, cryptography, mobile telephony and integrated circuit card (chip/smart card) technologies. Our technology is widely used in South Africa today, where we distribute pension and welfare payments, using our UEPS/EMV technology, to over nine million recipient cardholders across the entire country, process debit and credit card payment transactions on behalf of a wide range of retailers through our EasyPay system, process value-added services such as bill payments and prepaid airtime and electricity for the major bill issuers and local councils in South Africa, and provide mobile telephone top-up transactions for all of the South African mobile carriers. We are the largest provider of third-party and associated payroll payments in South Africa through our FIHRST service. Our XeoHealth service provides funders and providers of healthcare in United States with an on-line real-time management system for healthcare transactions. Internationally, through KSNET, we are one of the top three VAN processors in South Korea, and we offer card processing, payment gateway and banking value-added services in that country. Our N1MS business unit is responsible for the worldwide technical development and commercialization of our array of web and mobile applications and payment technologies, such as MVC, Chip and GSM licensing and VTU and has deployed solutions in many countries, including South Africa, Namibia, Nigeria, Cameroon, the Philippines and Colombia. Sources of Revenue We generate our revenues by charging transaction fees to government agencies, merchants, financial service providers, utility providers, bill issuers, employers and healthcare providers; by providing loans and insurance products and by selling hardware, licensing software and providing related technology services. We have structured our business and our business development efforts around four related but separate approaches to deploying our technology. In our most basic approach, we act as a supplier, selling our equipment, software, and related technology to a customer. The revenue and costs associated with this approach are reflected in our Financial inclusion and applied technologies segment. 33 -------------------------------------------------------------------------------- We have found that we have greater revenue and profit opportunities, however, by acting as a service provider instead of a supplier. In this approach we own and operate the UEPS ourselves, charging one-time and on-going fees for the use of the system either on a fixed or ad valorem basis. This is the case in South Africa, where we distribute welfare grants on behalf of the South African government on a fixed fee basis, but charge a fee on an ad valorem basis for goods and services purchased using our smart card. The revenue and costs associated with this approach are reflected in our South African transaction processing and Financial inclusion and applied technologies segments. Because our smart cards are designed to enable the delivery of more advanced services and products, we are also willing to supply those services and products directly where the business case is compelling. For instance, we provide short-term UEPS-based loans to our smart card holders. This is an example of the third approach that we have taken. Here we can act as the principal in operating a business that can be better delivered through our UEPS. We can also act as an agent, for instance, in the provision of insurance policies. In both cases, the revenue and costs associated with this approach are reflected in our Financial inclusion and applied technologies segment. In South Africa, we also generate fees from debit and credit card transaction processing, the provision of value-added services such as bill payments, mobile top-up and pre-paid utility sales, transaction processing for both funders and providers of healthcare and from providing a payroll transaction management service. The revenue and costs associated with these services are reflected in our South African transaction processing and Financial inclusion and applied technologies segments. Through KSNET, we earn most of our revenue from payment processing services we provide to approximately 225,000 merchants and to card issuers in South Korea through our value-added-network. In the US, we earn transaction fees from our customers utilizing our XeoRules on-line real-time management system for healthcare transactions. We also generate fees from our customers who utilize our VCPay technology to generate a unique, one-time use prepaid virtual card number to securely purchase goods and services or perform bill payments in any card-not-present environment. The revenue and costs at KSNET, XeoHealth and VCPay as well as those from our expired Iraqi contracts to February 2013, are reflected in our International transaction processing segment. Finally, we have entered into business partnerships or joint ventures to introduce our UEPS and VTU solutions to markets such as Namibia. In these situations, we take an equity position in the business while also acting as a supplier of technology. In evaluating these types of opportunities, we seek to maintain a highly disciplined approach, carefully selecting partners, participating closely in the development of the business plan and remaining actively engaged in the management of the new business. In most instances, the joint venture or partnership has a license to use the UEPS in the specific territory, including the back-end system. We account for our equity investments using the equity method. When we equity-account these investments, we are required under US GAAP to eliminate our share of the net income generated from sales of hardware and software to the investee. We recognize this net income from these equity-accounted investments during the period in which the hardware and software is utilized in the investee's operations, or has been sold to third-party customers, as the case may be. We believe that this flexible approach enables us to drive adoption of our solution while capturing the value created by the implementation of our technology. Developments during Fiscal 2014 Constitutional Court pronounces remedy for SASSA tender award On April 17, 2014, the South African Constitutional Court, or Constitutional Court, ruled on the appropriate remedy following its declaration on November 29, 2013, that the tender process followed by the South African Social Security Agency, or SASSA, in awarding a contract to Net1's wholly-owned subsidiary, Cash Paymaster Services, or CPS, was constitutionally invalid. The declaration of invalidity of the contract between SASSA and CPS was upheld, but suspended until a new tender is awarded, or for the remainder of the existing contract period if no tender is awarded. SASSA is required to initiate a new tender process within 30 days of the Constitutional Court's ruling and any award must be for a period of five years. See Part I, Item 3-"Legal Proceedings," for additional details. December 2013 BEE transactions and buy back of shares from BEE partners During fiscal 2014, we signed two BEE Relationship Agreements pursuant to which we issued, in April 2014, an aggregate of 4,400,000 shares of our common stock to our BEE partners for ZAR 60.00 per share. Our share price exceeded ZAR 120.00 on June 4, 2014 and all outstanding amounts under the Relationship Agreements became due and payable. The BEE partners were unable to pay all outstanding amounts due on June 5, 2014, and accordingly a trigger event occurred. In June 2014, we repurchased a total of 2,428,122 shares of our common stock, at the determined volume weighted average price of ZAR109.98, from the BEE partners. Accordingly, the BEE partners owned 1,971,878 shares of our common stock as of June 30, 2014. Refer to notes 14 and 17 to our consolidated financial statements for a full description of and accounting for the BEE transactions. 34 -------------------------------------------------------------------------------- Recovery of additional implementation costs from SASSA In the fourth quarter of fiscal 2014, we received ZAR 277 million (or $26.6 million) from SASSA related to the recovery of additional implementation costs incurred during the beneficiary re-registration process in fiscal 2012 and 2013. At the time, SASSA requested us to biometrically register all social grant beneficiaries (including all child beneficiaries), in addition to the grant recipients who were issued with the SASSA-branded UEPS/EMV smart cards. As a result, we performed approximately 11 million additional registrations that did not form part of its monthly service fee. After an independent verification process, SASSA agreed to pay the ZAR 277 million as full settlement of the additional costs incurred. Growth in mobile value-added services Our N1MS business unit introduced a new suite of mobile value-added services, commencing with a prepaid airtime product during the first quarter of fiscal 2014 and experienced strong adoption throughout fiscal 2014. This product allows our customers in South Africa to electronically purchase prepaid airtime without having to visit a physical prepaid airtime vendor. N1MS also introduced a similar service under the brand "Pasavute" in partnership with Telecom Networks Malawi in the second half of fiscal 2014. Traditional prepaid airtime procurement is usually time consuming for the customer and results in them having to pay additional costs. Our product allows our customers, many of whom do not have their own means of transport or ready access to transport, to purchase prepaid airtime without having to travel. We also believe that our product is substantially cheaper than traditional prepaid airtime channels, which often require customers to pay a substantial premium to obtain airtime. At June 30, 2014, we had approximately 3.0 million registered users, effecting more than one million transactions per day during peak periods. N1MS has also launched additional mobile value-added services, including prepaid electricity, and adoption rates of these products could be similar to its prepaid airtime offering. We believe that these new products are also cheaper than existing offerings and will make a meaningful difference in the lives of users of these new products. Financial services During fiscal 2014, we commenced the national rollout of our financial services offering in the six provinces in which we did not offer our product during fiscal 2013. The rollout has required us to employ and train additional staff and incur set up costs, and rent additional premises in order to establish a physical presence in these six provinces. We experienced significant growth in our lending book during fiscal 2014 compared with 2013. Disposal of non-core businesses During fiscal 2014, we concluded a number of corporate transactions as we continue to restructure and re-focus our business on key long-term growth opportunities. We sold MediKredit, our medical claims processing business in South Africa, and NUETS' business, which consisted primarily of customer contracts in Africa except for Namibia and Botswana. We have also substantially liquidated our Net1 UTA business. Refer to notes 18 to our consolidated financial statements for a full description of these transactions. Change to internal reporting structure and restatement of previously reported information During June 2014, we simplified our operating and internal reporting structures from five reportable segments to three. Previously reported information has been restated. Refer to Note 23 to our consolidated financial statements and see -"Presentation of quarterly revenue and operating income by segment for fiscal 2012 to 2014" below for more information. Critical Accounting Policies Our 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. Management believes that the following accounting policies are critical due to the degree of estimation required and the impact of these policies on the understanding of the results of our operations and financial condition. Business Combinations and the Recoverability of Goodwill A component of our growth strategy has been to acquire and integrate businesses that complement our existing operations. The purchase price of an acquired business is allocated to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair value at the date of purchase. 35 -------------------------------------------------------------------------------- The difference between the purchase price and the fair value of the net assets acquired is recorded as goodwill. In determining the fair value of assets acquired and liabilities assumed in a business combination, we use various recognized valuation methods, including present value modeling. Further, we make assumptions using certain valuation techniques, including discount rates and timing of future cash flows. We review the carrying value of goodwill annually or more frequently if circumstances indicate impairment may have occurred. In performing this review, we are required to estimate the fair value of goodwill that is implied from a valuation of the reporting unit to which the goodwill has been allocated after deducting the fair values of all the identifiable assets and liabilities that form part of the reporting unit. The determination of the fair value of a reporting unit requires us to make significant judgments and estimates. In determining the fair value of reporting units, we consider the earnings before interest, taxation, depreciation and amortization, or EBITDA, and the EBITDA multiples applicable to peer and industry comparables of the reporting units. We base our estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. In addition, we make judgments and assumptions in allocating assets and liabilities to each of our reporting units. The results of our impairment tests during fiscal 2014 indicated that the fair value of our reporting units exceeded their carrying values and therefore our reporting units were not at risk of potential impairment. Intangible Assets Acquired Through Acquisitions The fair values of the identifiable intangible assets acquired through acquisitions were determined by management using the purchase method of accounting. We completed acquisitions during fiscal 2013 and 2012, where we identified and recognized intangible assets. We have used the relief from royalty method, the multi-period excess earnings method, the income approach and the cost approach to value acquisition-related intangible assets. In so doing, we made assumptions regarding expected future revenues and expenses to develop the underlying forecasts, applied contributory asset charges, discount rates, exchange rates, cash tax charges and useful lives. The valuations were based on information available at the time of the acquisition and the expectations and assumptions that have been deemed reasonable by us. No assurance can be given, however, that the underlying assumptions or events associated with such assets will occur as projected. For these reasons, among others, the actual cash flows may vary from forecasts of future cash flows. To the extent actual cash flows vary, revisions to the useful life or impairment of intangible assets may be necessary. Deferred Taxation We estimate our tax liability through the calculations done for the determination of our current tax liability, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities which are disclosed on our balance sheet. Management then has to assess the likelihood that deferred tax assets are more likely than not to be realized in future periods. In the event it is determined that the deferred tax assets to be realized in the future would be in excess of the net recorded amount, an adjustment to the deferred tax asset valuation allowance would be recorded. This adjustment would increase income in the period such determination was made. Likewise, should it be determined that all or part of the net deferred tax asset would not be realized in the future, an adjustment to increase the deferred tax asset valuation allowance would be charged to income in the period such determination is made. In assessing the need for a valuation allowance, historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and practicable tax planning strategies are considered. During fiscal 2014, we recorded a decrease of $29.0 million, and in fiscal 2013, and 2012, we recorded an increase of $6.6 million and $1.6 million, respectively, to our valuation allowance. Stock-based Compensation and Equity Instrument issued pursuant to BEE transactions Stock-based compensation Management is required to make estimates and assumptions related to our valuation and recording of stock-based compensation charges under current accounting standards. These standards require all share-based compensation to employees to be recognized in the statement of operations based on their respective grant date fair values over the requisite service periods and also requires an estimation of forfeitures when calculating compensation expense. We utilize the Cox Ross Rubinstein binomial model to measure the fair value of stock options granted to employees and directors and recognize compensation cost on a straight line basis. Option-pricing models require estimates of a number of key valuation inputs including expected volatility, expected dividend yield, expected term and risk-free interest rate. Our management has estimated forfeitures based on historic employee behavior under similar compensation plans. The fair value of stock options is affected by the assumptions selected. Net stock-based compensation expense from continuing operations was $3.7 million, $3.9 million and $2.8 million for fiscal 2014, 2013 and 2012, respectively. 36 -------------------------------------------------------------------------------- Equity instruments We recorded non-cash charges of $11.3 million and $14.2 million associated with the issuance of equity instruments as part of the BEE transactions during fiscal 2014 and fiscal 2012, respectively, as these awards were fully vested during those periods. The option granted in fiscal 2012 expired unexercised in fiscal 2013, however, the expense recorded during fiscal 2012 was not reversed during fiscal 2013 because the option had vested in full on the grant date in 2012. Accounts Receivable and Allowance for Doubtful Accounts Receivable We maintain an allowance for doubtful accounts receivable related to our Financial inclusion and applied technologies and international transaction-based activities segments as a result of sales or rental of hardware, support and maintenance services provided; or sale of licenses to customers; or the provision of transaction processing services to our customers. Our policy is to regularly review the aging of outstanding amounts due from customers and adjust the provision based on management's estimate of the recoverability of the amounts outstanding. Management considers factors including period outstanding, creditworthiness of the customers, past payment history and the results of discussions by our credit department with the customer. We consider this policy to be appropriate taking into account factors such as historical bad debts, current economic trends and changes in our customer payment patterns. Additional provisions may be required should the ability of our customers to make payments when due deteriorate in the future. A significant amount of judgment is required to assess the ultimate recoverability of these receivables, including on-going evaluation of the creditworthiness of each customer. UEPS-based lending We created an allowance for doubtful finance loans receivable related to our Financial inclusion and applied technologies segment as a result of UEPS-based loans provided to our customers. Our policy is to regularly review the ageing of outstanding amounts due from borrowers and adjust the provision based on management's estimate of the recoverability of finance loans receivable. We write off UEPS-based loans and related service fees if a borrower is in arrears with repayments for more than three months or dies. Management considers factors including the period of the UEPS-loan outstanding, creditworthiness of the customers and the past payment history and trends of its established UEPS-based lending book. We consider this policy to be appropriate taking into account factors such as historical bad debts, current economic trends and changes in our customer payment patterns. Additional allowances may be required should the ability of our customers to make payments when due deteriorate in the future. A significant amount of judgment is required to assess the ultimate recoverability of these finance loan receivables, including on-going evaluation of the creditworthiness of each customer. Research and Development Accounting standards require product development costs to be charged to expenses as incurred until technological feasibility is attained. Technological feasibility is attained when our software has completed system testing and has been determined viable for its intended use. The time between the attainment of technological feasibility and completion of software development has been short. Accordingly, we did not capitalize any development costs during the years ended June 30, 2014, 2013 or 2012, particularly because the main part of our development is the enhancement and upgrading of existing products. Costs to develop software for our internal use is expensed as incurred, except to the extent that these costs are incurred during the application development stage. All other costs including those incurred in the project development and post-implementation stages are expensed as incurred. A significant amount of judgment is required to separate research costs, new development costs and ongoing development costs based as the transition between these stages. A multitude of factors need to be considered by management, including an assessment of the state of readiness of the software and the existence of markets for the software. The possibility of capitalizing development costs in the future may have a material impact on the group's profitability in the period when the costs are capitalized, and in subsequent periods when the capitalized costs are amortized. Recent Accounting Pronouncements Recent accounting pronouncements adopted Refer to Note 2 of our consolidated financial statements for a full description of recent accounting pronouncements, including the expected dates of adoption and effects on financial condition, results of operations and cash flows. 37 -------------------------------------------------------------------------------- Recent accounting pronouncements not yet adopted as of June 30, 2014 Refer to Note 2 of our consolidated financial statements for a full description of recent accounting pronouncements not yet adopted as of June 30, 2014, including the expected dates of adoption and effects on financial condition, results of operations and cash flows. Currency Exchange Rate Information Actual exchange rates The actual exchange rates for and at the end of the periods presented were as follows: Table 1 Year ended June 30, 2014 2013 2012 ZAR : $ average exchange rate 10.3798 8.8462 7.7920 Highest ZAR : $ rate during period 11.2579 10.3587 8.6987 Lowest ZAR : $ rate during period 9.6259 8.0444 6.6096 Rate at end of period 10.5887 9.8925 8.2881 KRW : $ average exchange rate 1,068 1,112 1,130 Highest KRW : $ rate during period 1,147 1,162 1,202 Lowest KRW : $ rate during period 1,014 1,019 1,029 Rate at end of period 1,014 1,144 1,159 [[Image Removed]] 38 -------------------------------------------------------------------------------- [[Image Removed]] Translation Exchange Rates We are required to translate our results of operations from ZAR to US dollars on a monthly basis. Thus, the average rates used to translate this data for the years ended June 30, 2014, 2013 and 2012, 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: Year ended Table 2 June 30, 2014 2013 2012 Income and expense items: $1 = ZAR 10.3966 8.7105 7.7186 Income and expense items: $1 = KRW 1,049 1,072 1,104 Balance sheet items: $1 = ZAR 10.5887 9.8925 8.2881 Balance sheet items: $1 = KRW 1,014 1,144 1,159 Results of Operations The discussion of our consolidated overall results of operations is based on amounts as reflected in our audited 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. Our operating segment revenue presented in "-Results of operations by operating segment" represents total revenue per operating segment before intercompany eliminations. A reconciliation between total operating segment revenue and revenue presented in our consolidated financial statements is included in Note 23 to those statements. Fiscal 2013 results include SmartSwitch Botswana from December 1, 2012 and N1MS from September 1, 2012. Fiscal 2012 results include Smart Life from July 1, 2011 and Eason from October 1, 2011. Refer also to Note 3 to the consolidated financial statements. 39 -------------------------------------------------------------------------------- The discussion below gives effect to the reallocation of certain activities among our various operating segments as discussed above. Fiscal 2014 Compared to Fiscal 2013 The following factors had an influence on our results of operations during fiscal 2014 as compared with the same period in the prior year: º Unfavorable impact from the strengthening of the US dollar against the ZAR: The US dollar appreciated by 19% against the ZAR during fiscal 2014 which negatively impacted our reported results; º $26.6 million recovery of expenses and 2013 implementation costs: Our SASSA contract implementation is complete. During fiscal 2014 we received approximately $26.6 million, or approximately $19.1 million, net of tax, from SASSA related to the recovery of additional implementation costs incurred during the beneficiary re-registration process in fiscal 2012 and 2013. Fiscal 2013 results include implementation-related expenditure, including smart card costs, of approximately $66.5 million; º Fair value charge resulting from issue of equity instruments pursuant to BEE transactions: The fair value non-cash charge of $11.3 million related to our BEE transactions adversely impacted our reported results during fiscal 2014; º Increased contribution by KSNET: Our results were positively impacted by growth in our South Korean operations; º Higher revenue resulting from an increase in low-margin prepaid airtime sales: Our revenue has increased as a result of the growth of our prepaid airtime offering during fiscal 2014, which has lower margins compared with our other South African businesses; º National rollout of our financial services offering: We continued the national rollout of our financial services offering during fiscal 2014, which resulted in higher revenue from UEPS-based lending. Profitability in the Financial inclusion and applied technologies segment however was lower due to rollout costs, including hiring and training of additional staff and infrastructure deployment as well as the creation of an allowance for doubtful finance loans receivable; º Ad hoc hardware sales in fiscal 2014: We sold more terminals and cards during fiscal 2014 as a result of ad hoc orders received from our customers; º Lower DOJ and SEC investigation-related expenses: We incurred DOJ and SEC investigation-related expenses of $3.9 million during fiscal 2014 compared to $5.9 million during 2013; and º Fiscal 2013 bad debt provision: In fiscal 2013 we provided $2.3 million related to the expired NUETS Iraqi customer contracts. Consolidated overall results of operations This discussion is based on the amounts which were prepared in accordance with US GAAP. The following tables show the changes in the items comprising our statements of operations, both in US dollars and in ZAR: In United States Dollars Table 3 (US GAAP) Year ended June 30, 2014 2013 % $'000 $ '000 change Revenue 581,656 452,147 29% Cost of goods sold, IT processing, servicing 260,232 196,834 32% and support Selling, general and administration 168,072 191,552 (12% ) Equity instruments issued pursuant to BEE 11,268 - nm transactions Depreciation and amortization 40,286 40,599 (1% ) Operating income 101,798 23,162 340% Interest income 14,817 12,083 23% Interest expense 7,473 7,966 (6% ) Income before income taxes 109,142 27,279 300% Income tax expense 39,379 14,656 169%Net income before income from equity-accounted 69,763 12,623 453% investments Income from equity-accounted investments 298 351 (15% ) Net income 70,061 12,974 440% Add net loss attributable to non-controlling (50 ) (3 ) nm interest Net income attributable to Net1 70,111 12,977 440% 40 -------------------------------------------------------------------------------- In South African Rand Table 4 (US GAAP) Year ended June 30, 2014 2013 ZAR ZAR % '000 '000 change Revenue 6,047,244 3,938,426 54% Cost of goods sold, IT processing, servicing 2,705,528 1,714,523 58% and support Selling, general and administration 1,745,784 1,668,514 5% Equity instruments issued pursuant to BEE 118,740 - nm transactions Depreciation and amortization 418,838 353,637 18% Operating income 1,058,354 201,752 425% Interest income 154,046 105,249 46% Interest expense 77,694 69,388 12% Income before income taxes 1,134,706 237,613 378% Income tax expense 409,408 127,661 221%Net income before income from equity-accounted 725,298 109,952 560% investments Income from equity-accounted investments 3,098 3,057 1% Net income 728,396 113,009 545% Add net loss attributable to non-controlling (520 ) (26 ) nm interest Net income attributable to Net1 728,916 113,035 545% The increase in revenue was primarily due to the recovery of implementation costs related to our SASSA contract, a higher contribution from KSNET, more low-margin transaction fees generated from beneficiaries using the South African National Payment System, higher prepaid airtime sales driven by the rollout of our prepaid airtime product, an increase in the number of UEPS-based loans and more ad hoc terminal and card sales. The increase in cost of goods sold, IT processing, servicing and support was primarily due to higher expenses incurred from increased usage of the South African National Payment System by beneficiaries and higher prepaid airtime, terminal and card sales. These increases were offset by the substantial elimination of expenses related to our SASSA contract implementation, which we completed in the fourth quarter of fiscal 2013. In USD, our selling, general and administration expense decreased due to the substantial elimination of SASSA contract implementation costs and lower legal fees in connection with the US government investigations in the current year, which was offset by increases in goods and services purchased from third parties. Our operating income margin for fiscal 2014 and 2013 was 18% and 5%, respectively. We discuss the components of operating income margin under "-Results of operations by operating segment." The increase is primarily attributable to the recovery of implementation costs related to our SASSA contract and the substantial elimination of implementation costs in fiscal 2014, and was partially offset by the non-cash charge related to the equity instruments issued pursuant to our BEE transactions. The grant date fair value of the equity instruments issued pursuant to our December 2013 BEE transactions was $11.3 million (ZAR 118.7 million) and was expensed in full in fiscal 2014. In ZAR, depreciation and amortization were higher primarily as a result of an increase in depreciation related to assets used to service our obligations under our SASSA contract, which was partially offset by no MediKredit and FIHRST intangible asset amortization as the these intangible assets were fully amortized at the end of June 2013. Interest on surplus cash increased to $14.8 million (ZAR 154.0 million) from $12.1 million (ZAR 105.2 million), due primarily to higher average daily ZAR cash balances. In US dollars, interest expense decreased to $7.5 million (ZAR 77.7 million) from $8.0 million (ZAR 69.4 million), due to a lower average long-term debt balance on our South Korean debt as well as lower interest rate resulting from our refinancing concluded in October 2013. Fiscal 2014 tax expense was $39.4 million (ZAR 409.4 million) compared to $14.7 million (ZAR 127.7 million) in fiscal 2013. Our effective tax rate for fiscal 2014, was 36.1% and was higher than the South African statutory rate as a result of non-deductible expenses (including the expense related to the equity instruments issued pursuant to our BEE transactions, interest expense related to our long-term South Korean borrowings and stock-based compensation charges). 41 -------------------------------------------------------------------------------- Our effective tax rate for the fiscal 2013, was 53.7% 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 South Korean borrowings and stock-based compensation charges) and South African dividend withholding taxes. Results of operations by operating segment The composition of revenue and the contributions of our business activities to operating income are illustrated below Table 5 In United States Dollars (US GAAP) Year ended June 30, 2014 % of 2013 % of % Operating Segment $ '000 total $ '000 total change Revenue: South African transaction 261,577 45% 242,739 54% 8% processing International transaction 152,725 26% 135,954 30% 12% processing Financial inclusion and 207,595 36% 108,001 24% 92% applied technologies Subtotal: Operating 621,897 107% 486,694 108% 28% segments Intersegment (40,241 ) (7% ) (34,547 ) (8% ) 16% eliminations Consolidated revenue 581,656 100% 452,147 100% 29% Operating income (loss): South African transaction 61,401 60% (21,316 ) (92% ) nm processing International transaction 21,952 22% 14,208 61% 55% processing Financial inclusion and 60,685 60% 57,491 248% 6% applied technologies Subtotal: Operating 144,038 142% 50,383 217% 186% segments Corporate/Eliminations (42,240 ) (42% ) (27,221 ) (117% ) 55% Consolidated 101,798 100% 23,162 100% 340% operating income Table 6 In South African Rand (US GAAP) Year ended June 30, 2014 2013 ZAR % of ZAR % of % Operating Segment '000 total '000 total change Revenue: South African transaction 2,719,511 45% 2,114,378 54% 29% processing International transaction 1,587,821 26% 1,184,227 30% 34% processing Financial inclusion and 2,158,282 36% 940,743 24% 129% applied technologies Subtotal: Operating 6,465,614 107% 4,239,348 108% 53% segments Intersegment 418,370 (7% ) 300,922 (8% ) 39% eliminations Consolidated revenue 6,047,244 100% 3,938,426 100% 54% Operating income (loss): South African transaction 638,362 60% (185,673 ) (92% ) nm processing International transaction 228,226 22% 123,759 61% 84% processing Financial inclusion and 630,918 60% 500,775 248% 26% applied technologies Subtotal: Operating 1,497,506 142% 438,861 217% 241% segments Corporate/Eliminations (439,152 ) (42% ) (237,109 ) (117% ) 85% Consolidated 1,058,354 100% 201,752 100% 425% operating income South African transaction processing In ZAR, the increase in segment revenues was primarily due the recovery of implementation costs related to our SASSA contract and more low-margin transaction fees generated from beneficiaries using the South African National Payment System. In addition, revenue from the distribution of social welfare grants grew modestly during the year and was in-line with the increase in unique welfare cardholder recipients, net of removal of invalid and fraudulent beneficiaries. Our operating income (loss) margin for fiscal 2014 and 2013 was 23% and (9)%, respectively, and has increased primarily due to the recovery of implementation costs related to our SASSA contract and the substantial elimination of SASSA implementation costs in fiscal 2014. 42 -------------------------------------------------------------------------------- International transaction-based activities Revenue increased primarily due to higher transaction volume at KSNET during fiscal 2014 but was partially offset by the expiration and non-renewal of NUETS' contract with its Iraqi customer in the third quarter of fiscal 2013. Operating income during fiscal 2014 was higher due to increase in revenue contribution from KSNET, but partially offset by the loss of the NUETS Iraqi contract as well as ongoing losses related to our XeoHealth launch in the United States. Operating income margin for the segment is lower than for most of our South African transaction processing businesses. Operating income margin for the year to date fiscal 2014 and 2013 was 14% and 10%, respectively. Financial inclusion and applied technologies Financial inclusion and applied technologies revenue and operating income increased primarily due to higher prepaid airtime sales driven by the rollout of our prepaid airtime product, an increase in the number of UEPS-based loans as we rolled out our product nationally, an increase in intersegment revenues and more ad hoc terminal and smart card sales. The increase in operating income was partially offset by UEPS-based lending national roll-out expenses and the establishment of the allowance for doubtful finance loans. Smart Life did not contribute to operating income in fiscal 2014 due to the FSB suspension of our license. Operating income margin for the Financial inclusion and applied technologies segment decreased to 29% from 53%, primarily as a result of more low-margin prepaid airtime and hardware sales. Corporate/ Eliminations The increase in our corporate expenses resulted primarily from the non-cash charge related to the equity instruments issued pursuant to our BEE transactions, increases in general corporate audit fees, executive emoluments and other corporate head office-related expenses purchased from third parties, partially offset by lower US government investigation expenses. Our corporate expenses also include acquisition-related intangible asset amortization; expenditure related to compliance with Sarbanes; non-employee directors' fees; employee and executive bonuses; stock-based compensation; audit fees; directors and officers insurance premiums; telecommunications expenses; property-related expenditures including utilities, rental, security and maintenance; and elimination entries. Fiscal 2013 Compared to Fiscal 2012 The following factors had an influence on our results of operations during fiscal 2013 as compared with the same period in the prior year: º Unfavorable impact from the strengthening of the US dollar: The US dollar appreciated by 14% against the ZAR during fiscal 2013 which negatively impacted our reported results; º SASSA implementation costs: We completed the bulk enrollment of recipient cardholders and beneficiaries under our SASSA contract during fiscal 2013 and incurred implementation and staff costs of $66.5 million, including the cost of UEPS/EMV smart cards issued, compared with $10.9 million in fiscal 2012; º DOJ and SEC investigation-related expenses: We incurred DOJ and SEC investigation-related expenses of $5.9 million in fiscal 2013; º Allowance for doubtful accounts receivable relating to expired Iraqi contracts: We have provided $2.3 million related to expired NUETS Iraqi customer contracts; º Fair value charge resulting from issue of equity instrument pursuant to BEE transaction: The fair value charge of $14.2 million related to our BEE transaction negatively impacted our reported results during fiscal 2012; º 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 $10.1 million, as we recorded a $18.3 million deferred tax benefit which was offset by an $8.2 million foreign tax credit valuation allowance; and º Profit on liquidation of SmartSwitch Nigeria: In fiscal 2012, we recorded a non-cash profit of $4.0 million on the liquidation of SmartSwitch Nigeria. 43 -------------------------------------------------------------------------------- Consolidated overall results of operations This discussion is based on the amounts which were prepared in accordance with US GAAP. The following tables show the changes in the items comprising our statements of operations, both in US dollars and in ZAR: In United States Dollars Table 7 (US GAAP) Year ended June 30, 2013 2012 % $ '000 $ '000 change Revenue 452,147 390,264 16% Cost of goods sold, IT processing, servicing 196,834 141,000 40% and support Selling, general and administration 191,552 137,404 39% Equity instrument issued pursuant to BEE - 14,211 nm transaction Depreciation and amortization 40,599 36,499 11% Operating income 23,162 61,150 (62% ) Interest income 12,083 8,576 41% Interest expense 7,966 9,345 (15% ) Income before income taxes 27,279 60,381 (55% ) Income tax expense 14,656 15,936 (8% )Net income before income from equity-accounted 12,623 44,445 (72% ) investments Income from equity-accounted investments 351 220 60% Net income 12,974 44,665 (71% ) (Add) Less net (loss) income attributable to (3 ) 14 nm non-controlling interest Net income attributable to Net1 12,977 44,651 (71% ) In South African Rand Table 8 (US GAAP) Year ended June 30, 2013 2012 ZAR ZAR % '000 '000 change Revenue 3,938,426 3,012,292 31% Cost of goods sold, IT processing, servicing 1,714,523 1,088,322 58% and support Selling, general and administration 1,668,514 1,058,190 58% Equity instrument issued pursuant to BEE - 112,066 nm transaction Depreciation and amortization 353,637 281,722 26% Operating income 201,752 471,992 (57% ) Interest income 105,249 66,195 59% Interest expense 69,388 72,130 (4% ) Income before income taxes 237,613 466,057 (49% ) Income tax expense 127,661 123,004 4%Net income before income from equity-accounted 109,952 343,053 (68% ) investments Income from equity-accounted investments 3,057 1,698 80% Net income 113,009 344,751 (67% ) (Add) Less net (loss) income attributable to (26 ) 108 nm non-controlling interest Net income attributable to Net1 113,035 344,643 (67% ) The increase in revenue was primarily due to incremental revenue resulting from our new SASSA contract and a higher contribution from KSNET. 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 during fiscal 2013. Our selling, general and administration expense increased primarily due to the SASSA contract implementation costs described above, legal fees of approximately $5.9 million (ZAR 51.7 million) in connection with the government investigations and the allowance for doubtful accounts receivable for expired NUETS contracts. Our selling, general and administration expense for fiscal 2012 included SASSA contract implementation costs of $10.9 million (ZAR 83.9 million) and cash bonuses of $5.4 million (ZAR 41.8 million) related to our SASSA tender award and a non-cash profit related to the liquidation of SmartSwitch Nigeria of $4.0 million. 44 -------------------------------------------------------------------------------- The grant date fair value of the equity instrument issued pursuant to our January 2012 BEE transaction was $14.2 million (ZAR 112.1 million) and was expensed in full in fiscal 2012. The option expired unexercised in fiscal 2013. Our operating income margin for fiscal 2013 and 2012 was 5% and 16%, respectively. We discuss the components of the operating income margin under "-Results of operations by operating segment." The decrease is primarily attributable to higher implementation costs related to the SASSA contract, DOJ and SEC investigation costs and the NUETS allowance for doubtful accounts receivable in fiscal 2013. 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. Interest on surplus cash increased to $12.1 million (ZAR 105.2 million) from $8.6 million (ZAR 66.2 million). The increase resulted primarily from higher average daily ZAR cash balances offset by lower deposit rates resulting from the decrease in the South African prime interest rate from an average of approximately 9.0% to 8.5% per annum. Interest expense decreased to $8.0 million (ZAR 69.4 million) from $9.3 million (ZAR 72.1 million) due to a lower average long-term debt balance. Total fiscal 2013 tax expense was $14.7 million (ZAR 127.7 million) compared to $16.0 million (ZAR 123.0 million) in fiscal 2013. Our fiscal 2012 tax expense includes $18.3 million 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 fiscal 2013, was 53.7% 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 South Korean borrowings and stock-based compensation charges) and South African dividend withholding taxes. Our effective tax rate for fiscal 2012, was 26.4% 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 a non-taxable profit on liquidation of SmartSwitch Nigeria, which was partially offset by an equity instrument issued pursuant to our BEE transaction and non-deductible expenses (including interest expense related to our long-term South Korean borrowings and stock-based compensation charges) and the creation of a valuation allowance. Results of operations by operating segment The composition of revenue and the contributions of our business activities to operating income are illustrated below Table 9 In United States Dollars (US GAAP) Year ended June 30, 2013 % of 2012 % of % Operating Segment $ '000 total $ '000 total change Revenue: South African transaction 242,739 54% 194,630 50% 25% processing International transaction 135,954 30% 120,625 27% 13% processing Financial inclusion and 108,001 24% 90,792 20% 19% applied technologies Subtotal: Operating 486,694 108% 406,047 97% 20% segments Intersegment (34,547 ) (8% ) (15,783 ) 3% 119% eliminations Consolidated revenue 452,147 100% 390,264 100% 16% Operating income (loss): South African transaction (21,316 ) (92% ) 33,906 55% nm processing International transaction 14,208 61% 14,649 24% (3% ) processing Financial inclusion and 57,491 248% 45,884 75% 25% applied technologies Subtotal: Operating 50,383 217% 94,439 154% (47% ) segments Corporate/Eliminations (27,221 ) (117% ) (33,289 ) (54% ) (18% ) Consolidated 23,162 100% 61,150 100% (62% ) operating income 45 -------------------------------------------------------------------------------- Table 10 In South African Rand (US GAAP) Year ended June 30, 2013 2012 ZAR % of ZAR % of % Operating Segment '000 total '000 total change Revenue: South African transaction 2,114,378 54% 1,502,271 50% 41% processing International transaction 1,184,227 30% 931,056 31% 27% processing Financial inclusion and 940,743 24% 700,787 23% 34% applied technologies Subtotal: Operating 4,239,348 108% 3,134,114 104% 35% segments Intersegment (300,922 ) (8% ) (121,822 ) (4% ) 147% eliminations Consolidated revenue 3,938,426 100% 3,012,292 100% 31% Operating (loss) income: South African transaction (185,673 ) (92% ) 261,706 55% nm processing International transaction 123,759 61% 113,070 24% 9% processing Financial inclusion and 500,775 248% 354,160 75% 41% applied technologies Subtotal: Operating 438,861 217% 728,936 154% (40% ) segments Corporate/Eliminations (237,109 ) (117% ) (256,944 ) (54% ) (8% ) Consolidated 201,752 100% 471,992 100% (57% ) operating income South African transaction processing In ZAR, the increases in segment revenue were primarily due to higher revenues earned for a full year under our new SASSA contract and low-margin transaction fees generated from beneficiaries using the South African National Payment System. Our operating (loss) income margin for fiscal 2013 and 2012 was (9%) and 17%, respectively, and has declined primarily due to the higher SASSA implementation costs. International transaction-based activities KSNET continues to contribute the majority of our revenues and operating income in this operating segment. Revenue increased primarily due to KSNET's revenue growth during fiscal 2013 and was offset by the expiration and non-renewal of NUETS' contract with its Iraqi customer. Operating income was negatively impacted by this expiration and non-renewal and the related allowance for doubtful accounts receivable, ongoing start-up expenditures related to our XeoHealth launch in the United States, ongoing losses at Net1 Virtual Card and Net1 UTA as well as ongoing competition in the South Korean marketplace, but was partially offset by increased revenue contributions from KSNET. Operating margin for the segment is lower than most of our South African transaction processing businesses. Operating income margin for fiscal 2013 and 2012 was 10% and 12%, respectively. Financial inclusion and applied technologies Our revenue from this operating segment increased because of higher intersegment fees and ad hoc hardware sales to external customers and an increase in the number of smart card-based accounts as a result of the new SASSA contract, offset lower UEPS-based lending revenue as a result of a decrease in the number of loans granted. Our revenue per smart card account decreased in fiscal 2013, as a result of a change in our pricing for these accounts after taking into consideration the lower price and higher volumes under the new SASSA contract. The new pricing was effective from April 1, 2012, and reduced the average monthly revenue per smart card from ZAR5.50 to ZAR4.00 and the operating income margin from 45.45% to 28.50% . Segment operating income increased due to the higher intersegment fees and ad hoc hardware sales to external customers, offset by a lower smart-card account operating margin, on-going start-up expenditure incurred to establish our Smart Life insurance business and lower UEPS-based lending activity. Smart Life did not contribute to operating income in fiscal 2013 or 2012. Operating income margin for the Financial inclusion and applied technologies segment increased to 53% from 51%, primarily as a result of higher intersegment fees, offset by increased start-up expenditures related to Smart Life and other financial services offerings. 46 -------------------------------------------------------------------------------- Corporate/ Eliminations Our fiscal 2013 corporate expenses include increased legal and other fees we incurred in connection with the US government investigations and higher stock-based compensation charges. Our fiscal 2012 corporate expenses include a charge related to our equity instrument issued pursuant to our BEE transaction and a $4.0 million profit related to the liquidation of SmartSwitch Nigeria. Our corporate expenses also include acquisition-related intangible asset amortization; expenditure related to compliance with Sarbanes; non-executive directors' fees; employee and executive bonuses; stock-based compensation; legal and audit fees; directors and officers insurance premiums; telecommunications expenses; property-related expenditures including utilities, rental, security and maintenance; and elimination entries. Presentation of quarterly revenue and operating income by segment for fiscal 2012 to 2014 The tables below present quarterly revenue and operating income generated by our three reportable segments for the fiscal 2014, 2013 and 2012, and reconciliations to consolidated revenue and operating income (loss), as well as the US dollar/ ZAR exchange rates applicable per fiscal quarter and year: Table 11 In United States Dollars (US GAAP) Fiscal 2014 Quarter Quarter Quarter Quarter Full 1 2 3 4 Year Operating Segment $'000 $'000 $'000 $'000 $'000 Revenue: South African transaction 57,161 58,754 57,397 88,265 261,577 processing International transaction 37,541 37,738 35,245 42,201 152,725 processingFinancial inclusion and applied 36,796 50,480 56,226 64,093 207,595 technologies Subtotal: Operating segments 131,498 146,972 148,868 194,559 621,897 Intersegment eliminations (8,004 ) (9,689 ) (10,742 ) (11,806 ) (40,241 ) Consolidated revenue 123,494 137,283 138,126 182,753 581,656 Operating (loss) income: South African transaction 6,461 7,128 9,137 38,675 61,401 processing International transaction 5,524 5,139 4,642 6,647 21,952 processingFinancial inclusion and applied 12,835 13,265 16,459 18,126 60,685 technologies Subtotal: Operating segments 24,820 25,532 30,238 63,448 144,038 Corporate/Eliminations (8,420 ) (6,730 ) (6,289 ) (20,801 ) (42,240 ) Consolidated 16,400 18,802 23,949 42,647 101,798 operating income Income and expense items: $1 = ZAR 10.0001 10.1592 10.8743 10.4218 10.3966 Table 12 In United States Dollars (US GAAP) Fiscal 2013 Quarter Quarter Quarter Quarter Full 1 2 3 4 Year Operating Segment $'000 $'000 $'000 $'000 $'000 Revenue: South African transaction 62,420 61,708 60,415 58,196 242,739 processing International transaction 32,397 33,664 33,700 36,193 135,954 processing Financial inclusion and 26,615 25,563 26,214 29,609 108,001 applied technologies Subtotal: Operating 121,432 120,935 120,329 123,998 486,694 segments Intersegment (9,750 ) (9,493 ) (9,188 ) (6,116 ) (34,547 ) eliminations Consolidated revenue 111,682 111,442 111,141 117,882 452,147 Operating (loss) income: South African transaction (3,299 ) (6,233 ) (11,587 ) (197 ) (21,316 ) processing International 3,329 3,583 2,033 5,263 14,208 transaction-based activities Financial inclusion and 14,913 14,286 14,038 14,254 57,491 applied technologies Subtotal: Operating 14,943 11,636 4,484 19,320 50,383 segments Corporate/Eliminations (5,618 ) (6,664 ) (9,210 ) (5,729 ) (27,221 ) Consolidated 9,325 4,972 (4,726 ) 13,591 23,162 operating income (loss) . Income and expense items: $1 = 8.2606 8.7405 8.4662 9.1863 8.7105 ZAR 47 -------------------------------------------------------------------------------- Table 13 In United States Dollars (US GAAP) Fiscal 2012 Quarter Quarter Quarter Quarter Full 1 2 3 4 Year Operating Segment $'000 $'000 $'000 $'000 $'000 Revenue: South African transaction 45,632 43,985 43,753 61,260 194,630 processing International transaction 31,053 29,446 28,635 31,491 120,625 processing Financial inclusion and 24,454 19,771 19,591 26,976 90,792 applied technologies Subtotal: Operating 101,139 93,202 91,979 119,727 406,047 segments Intersegment (1,213 ) (1,144 ) (1,315 ) (12,111 ) (15,783 ) eliminations Consolidated revenue 99,926 92,058 90,664 107,616 390,264 Operating (loss) income: South African transaction 17,001 13,549 5,590 (2,234 ) 33,906 processing International transaction 4,346 3,519 3,295 3,489 14,649 processing Financial inclusion and 11,968 9,479 9,078 15,359 45,884 applied technologies Subtotal: Operating 33,315 26,547 17,963 16,614 94,439 segments Corporate/Eliminations (2,469 ) (6,319 ) (5,485 ) (19,016 ) (33,289 ) Consolidated 30,846 20,228 12,478 (2,402 ) 61,150 operating income (loss) . Income and expense items: $1 = 7.0939 8.1752 7.8521 8.0329 7.7186 ZAR Liquidity and Capital Resources At June 30, 2014, our cash balances were $58.7 million, which comprised mainly ZAR-denominated balances of ZAR 411.9 million ($38.9 million), KRW-denominated balances of KRW 14.9 billion ($14.7 million) and US dollar-denominated balances of $3.7 million and other currency deposits, primarily euro, of $1.4 million. The increase in our cash balances from June 30, 2013, was primarily due to higher cash generated from our core business and the recovery of implementation costs from SASSA, which increase was partially offset by higher corporate tax payments, the expansion of our UEPS-based lending business, acquisition of terminals to maintain and expand our South Korean business activities, the repayment of a portion of our South Korean debt and acquisition of substantially all of the remaining shares of KSNET that we did not already own. We currently believe that our cash and credit facilities are sufficient to fund our future operations for at least the next four quarters. We generally invest the surplus cash held by our South African operations in overnight call accounts that we maintain at South African banking institutions, and surplus cash held by our non-South African companies in the US and European money markets. We have invested surplus cash in South Korea in short-term investment accounts at South Korean banking institutions. In addition, we are required to invest the interest payable under our South Korean debt facilities due in the next six months in an interest reserve account in South Korea. Historically, we have financed most of our operations, research and development, working capital, capital expenditures and acquisitions through our internally generated cash. When considering whether to borrow under our financing facilities, we consider the cost of capital, cost of financing, opportunity cost of utilizing surplus cash and availability of tax efficient structures to moderate financing costs. During December 2013, we increased our short-term South African credit facility with Nedbank Limited to ZAR 400 million ($37.8 million). The short-term facility comprises of an overdraft facility of up to ZAR 250 million and indirect and derivative facilities of up to ZAR 150 million, which includes letters of guarantee, letters of credit and forward exchange contracts. As of June 30, 2014, we have used none of the overdraft and ZAR 139.0 million ($13.1 million) of the indirect and derivative facilities to obtain foreign exchange contracts and to support guarantees issued by Nedbank to various third parties on our behalf. Refer to Note 12 to the consolidated financial statements for more information about the terms of this facility. 48 -------------------------------------------------------------------------------- As of June 30, 2014, we had outstanding long-term debt of KRW 78.3 billion (approximately $77.2 million translated at exchange rates applicable as of June 30, 2014) under credit facilities with a group of South Korean banks. The loans bear interest at the South Korean CD rate in effect from time to time (2.65% as of June 30, 2014) plus a margin of 3.10% for one of the term loan facilities and the revolver and a margin of 2.90% for the other term loan facility. Scheduled repayments of the term loans and loan under the revolving credit facility are as follows: October 2014 (KRW 15 billion), April 2016, 2017 and 2018 (KRW 10 billion each) and October 2018 (KRW 30 billion plus all outstanding loans under our revolving credit facility). Refer to Note 13 to the consolidated financial statements for more information about the terms of this facility. We have a unique cash flow cycle due to the funding mechanism under our SASSA contact and our pre-funding of certain merchants. We generally receive the grant funds 48 hours prior to the provision of the service in a trust account and any interest we earn on these amounts is for the benefit of SASSA. We are required to initiate payments before the start of the pay cycle month in order to have cash, merchant and interbank funds available when the payment cycle commences and this process requires that we have access to the grant funds to be paid. These funds are recorded as settlement assets and liabilities. Historically, we opened the pay cycle at certain participating merchants a few days before the payment of grants at pay sites, however, currently we do not commence the payment cycle at participating merchants before the start of the pay cycle month. We use our funds to pre-fund certain merchants for grants paid through our merchant acquiring system on our behalf a day or two before the pay cycle opens. We typically reimburse merchants that are not pre-funded within 48 hours after they distribute the grants to the social welfare recipient cardholders. In addition, as a transaction processor, and in certain instances as a claims adjudicator, we receive cash from: • customers on whose behalf we processes off-payroll payments that we will disburse to customer employees, payroll-related payees and other payees designated by the customer; and • credit card companies (as well as other types of payment services) which have business relationships with merchants selling goods and services via the internet in South Korea that are our customers and on whose behalf we process the transactions between various parties and settle the funds from the credit card companies to our merchant customers. These funds do not represent cash that is available to us and we present these funds, and the associated liability, outside of our current assets and liabilities on our consolidated balance sheet. Movements in these cash balances are presented in investing activities and movements in the obligations are presented in financing activities in our consolidated statement of cash flows. Cash flows from operating activities Cash flows from operating activities for fiscal 2014 decreased to $37.1 million (ZAR 386.2 million) from $55.9 million (ZAR 513.7 million) for fiscal 2013. Excluding the impact of interest paid under our South Korean debt facility and taxes presented in the table below, the decrease in cash from operating activities resulted from the expansion of our UEPS-based lending book, offset by cash inflows from improved trading activity, the recovery of implementation costs from SASSA and the substantial elimination of implementation costs related to our SASSA contract in fiscal 2014. During fiscal 2014, we paid interest of $5.2 million under our South Korean debt facility. Cash flows from operating activities for fiscal 2013 increased to $55.9 million (ZAR 513.7 million) from $20.4 million (ZAR 157.5 million) for fiscal 2012. Excluding the impact of interest paid under our South Korean debt facility and taxes presented in the table below, the increase in cash provided by operating activities resulted from a more favorable trading environment, notwithstanding the significant implementation costs paid in fiscal 2013, an increase in accounts payable and a decrease in prefunding to merchants participating in our merchant acquiring system. These increases to operating cash flows were offset by a moderate increase in accounts receivable and inventory and lower other payables and taxes which all decrease operating cash flow. During fiscal 2013, we paid interest of $7.1 million under our South Korean debt facility. During fiscal 2014, we made a first provisional tax payment of $13.3 million (ZAR 137.8 million) and a second provisional tax payment of $25.0 million (ZAR 266.6 million) related to our 2014 tax year in South Africa. We also paid taxes totaling $3.9 million in other tax jurisdictions, primarily South Korea. During fiscal 2013, we made a first provisional tax payment of $6.8 million (ZAR 58.7 million), a second provisional tax payment of $7.2 million (ZAR 72.5 million) related to our 2013 tax year in South Africa and paid dividend withholding taxes of $1.6 million (ZAR 14.9 million) related to cross-border intercompany dividends paid. We made an additional second provisional tax payments of $3.1 million (ZAR 25.5 million) related to our 2012 tax year in South Africa. We also paid taxes totaling $3.3 million in other tax jurisdictions, primarily South Korea. 49 -------------------------------------------------------------------------------- Taxes paid during fiscal 2014, 2013 and 2012 were as follows: Table 14 Year ended June 30, 2014 2013 2012 2014 2013 2012 $ $ $ ZAR ZAR ZAR '000 '000 '000 '000 '000 '000 First provisional payments 13,292 6,757 15,014 137,773 58,693 123,271 Second provisional payments 25,004 7,228 8,485 266,573 72,451 71,458 Taxation paid related to 228 3,072 3,326 2,360 25,517 24,803prior years Taxation refunds received (36 ) (65 ) (287 ) (400 ) (480 ) (2,121 ) Dividend withholding taxation - 1,610 - - 14,916 - Secondary taxation on - - 1,811 - - 14,615 companies Total South African 38,488 18,602 28,349 406,306 171,097 232,026 taxes paid Foreign taxes paid, primarily South Korea 3,929 3,298 2,355 41,506 29,468 18,288 Total tax paid 42,417 21,900 30,704 447,812 200,565 250,314 Cash flows from investing activities Cash used in investing activities for fiscal 2014 includes capital expenditure of $23.9 million (ZAR 248.5 million), primarily for the acquisition of payment processing terminals in South Korea. Cash used in investing activities for fiscal 2013 includes capital expenditure of $22.7 million (ZAR 198.1 million), primarily for payment vehicles and related equipment for our SASSA contract and acquisition of payment processing terminals in South Korea. Cash used in investing activities for fiscal 2012 includes capital expenditure of $39.2 million (ZAR 302.2 million), primarily for payment vehicles for our SASSA contract, acquisition of payment processing terminals in South Korea and POS devices to service our merchant acquiring system in South Africa. During fiscal 2013 we paid, net of cash acquired, $1.9 million (ZAR 16.8 million) for N1MS and $0.2 million for SmartSwitch Botswana. During fiscal 2012, we received a net settlement of $4.9 million from the former shareholders of KSNET. We also paid $4.5 million (ZAR 34.8 million) for the Eason prepaid electricity and airtime business during fiscal 2012. Cash flows from financing activities During the fiscal 2014, we refinanced our South Korean debt and used $70.6 million of these new borrowings and $16.4 million of our surplus cash to repay the $87.0 million due under our old facility. In addition, we paid the facility fees related to our new South Korean borrowings of approximately $0.9 million. During fiscal 2014, we utilized approximately $2.1 million of these new borrowings to pay quarterly interest due in South Korea. During fiscal 2014, we paid approximately $2.0 million for substantially all of the shares of KSNET we did not already own. We utilized our South African short-term facility during fiscal 2014 and have repaid the full amount outstanding as of June 30, 2014. During fiscal 2013, we made a scheduled $14.5 million long-term debt repayment. During fiscal 2012, we made long-term debt repayments of $19.2 million and acquired 180,656 shares of our common stock for $1.1 million. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. 50 -------------------------------------------------------------------------------- Capital Expenditures Capital expenditures for the years ended June 30, 2014, 2013 and 2012 were as follows: Table 15 Year ended June 30, 2014 2013 2012 2014 2013 2012 $ $ $ ZAR ZAR ZAR Operating Segment '000 '000 '000 '000 '000 '000 South African transaction 3,425 9,400 23,332 35,608 81,879 180,090 processing International transaction 19,393 12,490 14,994 201,621 108,794 115,733 processing Financial inclusion and 1,088 857 841 11,312 7,465 6,491 applied technologies Consolidated total 23,906 22,747 39,167 248,541 198,138 302,314 Our capital expenditures for fiscal 2014, 2013 and 2012, are discussed under "-Liquidity and Capital Resources-Cash flows from investing activities." All of our capital expenditures for the past three fiscal years were funded through internally-generated funds. We had outstanding capital commitments as of June 30, 2014, of $0.2 million related mainly to computer equipment required to maintain and expand operations. We expect to fund these expenditures through internally-generated funds. In addition to these capital expenditures, we expect that capital spending for fiscal 2015 will also relate to expanding our operations in South Korea and South Africa. Contractual Obligations The following table sets forth our contractual obligations as of June 30, 2014: Table 16 Payments due by Period, as of June 30, 2014 (in $ '000s) Less More than 1 1-3 3-5 than 5 Total year years years years Long-term debt 88,049 18,605 26,024 43,420 - obligations (A) Operating lease 7,587 3,490 3,734 363 - obligations Purchase 5,541 5,541 - - - obligations Capital 190 190 - - - commitments Other long-term 23,477 - - - 23,477 obligations (B) Total 124,844 27,826 29,758 43,783 23,477 (A) - Includes $77.2 million of long-term debt discussed under "-Liquidity and capital resources" and includes interest payable at the rate applicable as of June 30, 2014. (B) - Includes policy holder liabilities of $22.2 million related to our insurance business. 51 -------------------------------------------------------------------------------- |