What is the status of the SASSA tender litigation?
AllPay challenge to tender award
On March 27, 2013, a full bench of the South African Supreme Court of Appeal dismissed AllPay's appeal against the earlier ruling by the North Gauteng High Court that SASSA's award of the tender to us would not be set aside. Accordingly, our South African Social Security Agency, or SASSA, contract to distribute social welfare grants to ten million South Africans every month, for a period of five years, remains in full force and effect. On April 18, 2013, AllPay applied for leave to appeal to the South African Constitutional Court, the highest court in the country, against the judgment of the Supreme Court. We and SASSA have opposed AllPay's application. The hearing has been scheduled for September 10, 2013. Both the application for leave to appeal and appeal itself will be argued on September 10, 2013. We cannot predict when or how the Constitutional Court will rule on the matter. The background of this lawsuit is that on February 8, 2012, AllPay filed an application in the High Court seeking to set aside the award of the SASSA tender to us. AllPay was one of the unsuccessful bidders during the SASSA tender process and was a former contractor to SASSA. We and SASSA were included among the respondents in this proceeding. We and SASSA both opposed AllPay's application. When SASSA publicly announced the award of the tender to us in January 2012, it stated that it had conducted the tender in accordance with all relevant legislation. The High Court heard the matter in May 2012. We applied to the High Court to strike the allegations of corruption contained in AllPay's court papers, as well as the newspaper articles relied upon by AllPay, from the court record. At the outset of the hearing, the High Court ordered that all these allegations and newspaper articles be struck from the court record, with a cost order against AllPay. The High Court issued its ruling, in relation to the application to set aside the award, on August 28, 2012. The result of the ruling was that our contract with SASSA remained valid and was not set aside. Specifically, the High Court ruled that the tender process conducted by SASSA was illegal and invalid but that the award of the tender to us was not set aside. The court also ordered the CEO of SASSA, SASSA and us to pay costs. SASSA and we appealed the ruling that the tender process was illegal and invalid as well as the cost order. AllPay appealed the ruling that the award of the tender by SASSA to us should not be set aside. The appeal was heard on February 15, 2013, before the Supreme Court. On March 27, 2013, a full bench of the Supreme Court dismissed AllPay's appeal against the earlier ruling by the North Gauteng High Court that SASSA's award of the tender to us would not be set aside. The Supreme Court also upheld our and SASSA's appeal against the High Court's orders that the process conducted in awarding the contract was illegal and invalid and that we and SASSA pay AllPay's costs occasioned by the court proceedings. The Supreme Court also ordered AllPay to pay our and SASSA's costs occasioned by the court proceedings, including the cost of three counsel. The judges presiding at the Supreme Court hearing unanimously ruled that there were no unlawful irregularities in the tender process followed by SASSA. After the High Court ruling, AllPay approached the Constitutional Court for leave to appeal the High Court ruling directly to the Constitutional Court. We and SASSA opposed AllPay's application. On November 1, 2012, the Constitutional Court concluded that the AllPay application should be dismissed as it was not in the interest of justice to hear the matter at that stage. The leave to appeal filed by AllPay on April 18, 2013 is thus AllPay's second approach to the Constitutional Court in this matter.
Suit against AlPay
On December 11, 2012, we commenced a lawsuit in the South Gauteng High Court in South Africa against AllPay. In our lawsuit, we have alleged that AllPay, wrongfully and unlawfully and with the intention of injuring our reputation, infringing our goodwill and reducing our share price, competed unlawfully with us, by
- directly or indirectly making false reports and providing false information to members of the South African media which AllPay orchestrated thereby creating the basis for false media reports which alleged or implied that the SASSA tender process was tainted by corruption through bribes by or on behalf of our subsidiary, Cash Paymaster Services;
- introducing the media reports and allegations of corruption by or on behalf of us in connection with the SASSA tender process into the court proceedings in South Africa instituted by AllPay which sought to set aside the award of the tender to us;
- causing an unfounded report to be made to the JSE Limited, or JSE, regarding disclosure that we made in relation to the SASSA contract;
- making a report to the DOJ, bringing to the attention of the DOJ the corruption allegations and the South African media reports and repeating the allegations made in the report to the JSE; and
- falsely seeking to create the impression in media reports and radio interviews that it had been found in the South African court proceedings described above that the tender process was tainted by corruption.
In the lawsuit, we are seeking damages in the aggregate amount of ZAR 478 million (approximately US$55 million based on the ZAR/US dollar exchange rate on December 11, 2012) plus interest and costs. The damages claimed may increase as we quantify the continued impact of AllPay's actions. A trial date will be applied for after the exchange of the required pleadings and finalization of any interlocutory issues which may arise. We cannot predict when this matter will go to trial.Our application to prompt the Hawks to conduct an investigation into corruption allegations that appeared in the South African media
On February 14, 2013, we filed an application pursuant to Section 34 of the South African Prevention of Corrupt Activities Act in South Africa with the South African Police Service. Section 34 deals with the reporting of suspected fraud, theft, extortion and forgery. Matters reported under Section 34 are usually referred for investigation to the South African Directorate for Priority Crime Investigation, known as the Hawks. We filed the Section 34 application to prompt the Hawks to conduct an investigation into who may have made corruption allegations that appeared in the South African media after we were awarded the SASSA tender in January 2012. The Hawks have confirmed to us that our Section 34 application has been accepted for investigation. We have provided certain electronic information to the Hawks at their request and we will cooperate with the Hawks in their investigation.
Can you provide an update on the government investigations?
On November 30, 2012, we received a letter from the U.S. Department of Justice, Criminal Division, 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 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 continuing to cooperate with the DOJ and the SEC regarding these investigations.
We have been, and will continue to be, exposed to a variety of negative consequences as a result of these investigations. There could be one or more enforcement actions in respect of the matters that are the subject of one or both of the investigations, and such actions, if brought, may result in judgments, settlements, fines, penalties, injunctions, cease and desist orders or other relief, criminal convictions and/or penalties. We cannot predict accurately at this time the outcome or impact of the investigations. In addition, we have incurred and will continue to incur significant legal and other costs in responding to requests for information seeking documents, testimony and other information in connection with the investigations and cannot predict at this time the ultimate amount of all such costs. These matters have required the involvement of certain members of our senior management that has materially and adversely affected their ability to devote their time to other matters relating to our business. The investigations have negatively impacted our ability to maintain our existing business relationships and to obtain new business, as our business reputation has already suffered significant damage due to the perceptions created by an investigation of this nature. We believe that this damage to our reputation has, and will continue, to have a significant impact on our ability to execute certain aspects of our business strategy effectively. For example, the FSB has suspended Smart Life's license and prohibited it from writing any new long-term insurance policies in South Africa. We believe that the suspension was triggered by the adverse publicity we have received as a result of the DOJ and SEC investigations. Although we are appealing this decision, we cannot predict whether our appeal will be successful. While Smart Life's operations are not currently material, providing a variety of financial products, such as insurance, to our cardholder base is an important part of our future business strategy. We have also been unable to conclude our BEE transaction, as described below. In addition, in order to continue to fund the costs of the investigations, we have had to upstream a portion of our ZAR cash reserves to the U.S., which has resulted in unfavorable currency conversion rates and the incurrence of dividend withholding taxes that we would not otherwise have had to pay.
What progress have you made with the implementation of the new SASSA contract?
We commenced the second phase of the enrollment process in early July 2012 and completed the bulk enrollment by April 30, 2013, in accordance with the implementation plan agreed with SASSA. Under our agreement with SASSA, we have to enroll both the grant recipient cardholders (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 cardholder 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 cardholder, 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. Our monthly service fee is calculated on the number of grant recipient cardholders.
While the number of grant recipient cardholders on a national basis has consistently been quantified by SASSA at approximately 9.4 million individuals, the number of beneficiaries was revised higher by SASSA from an initial estimate of approximately 15.5 million, to the revised 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 in the second quarter of fiscal 2013 from 2,500 to approximately 5,500 and retained the higher employee base through all of the third quarter of fiscal 2013. Having substantially concluded bulk enrollment in fiscal 2013, our temporary employee headcount has since declined to 1,392 at June 30, 2013.
As of June 30, 2013, we had enrolled a total of 21.7 million people which comprises approximately 9.5 million grant recipient cardholders and 12.2 million beneficiaries associated with these recipient cardholders in accordance with our second phase enrollment schedule, and issued them our UEPS/EMV smart card.
During March 2013, the Minister of Social Development and SASSA announced that the deadline for the enrollment of grant recipient cardholders would be extended to April 30, 2013. We therefore continued with the enrollment process for the month of April 2013. SASSA sent termination notices to all cardholder recipients and beneficiaries who had not presented themselves for enrollment during May, June and July 2013 in terms of the Promotion of Administrative Justice Act. As of July 30, 2013 there were approximately 372,870 former grant recipient cardholders who had not presented themselves for enrollment. The grants applicable to these grant recipient cardholders will be suspended with from September 2013 and these beneficiaries will have to reapply for their grants. Our revenue for fiscal 2014 will decline to the extent that these beneficiaries do not reapply for their grants, but such decline may be offset by the amount of new grant recipient cardholders approved by SASSA.
The graph below presents our enrollment progress from inception to June 30, 2013:
The enrollment statistics included in the graph above reflect the cumulative number of cardholder recipient and beneficiary enrollments since the inception of the new contract. The statistics therefore do not reflect any cardholder recipients and beneficiaries that may have been removed from the payment file subsequent to enrollment due to the suspension or disqualification of a social welfare grant or death. There is a time lag between when a current grant recipient cardholder is issued a UEPS/EMV card and when the recipient cardholder receives grants onto the UEPS/EMV smart card. For instance, recipient cardholders enrolled in March 2013 and issued a UEPS/EMV smart card were only paid onto that card in the April 2013 pay cycle. When a new grant recipient cardholder is approved by SASSA, the recipient cardholder is enrolled, issued a UEPS/EMV smart card and immediately paid on this card. We are paid monthly by SASSA for each recipient cardholder paid by us, regardless of the number of grants received by the recipient cardholder, the channel utilized and therefore for the month of June 2013, we earned revenue from SASSA based on the distribution of grants to 9,591,950 recipient cardholders.
During fiscal 2013, we incurred direct implementation expenses of approximately $56.2 million (ZAR 488.3 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. During fiscal 2012, we incurred direct implementation expenses of approximately $10.9 million (ZAR 83.9 million).
We also expensed $10.3 million (ZAR 90.2 million) related to the cost of the UEPS/EMV smart cards issued during fiscal 2013, which is not included in the $56.2 million (ZAR 488.3 million) of direct implementation expenses described above. We did not expense any smart cards in fiscal 2012.
We also incurred approximately $6.9 million in capital expenditures related to the implementation during fiscal 2013. Since inception of the implementation we have incurred cumulative capital expenditures of $28.1 million. We have substantially completed the bulk enrollment of recipient cardholders and beneficiaries and do not expect any further significant capital expenditures related to this process.
Our total cash outlay through June 30, 2013 has been $105.5 million for direct implementation expenses, smart card costs and capital expenditures. We would have been in-line with the mid-point of our initial total cash outlay range assuming the volume of enrollments had not changed. Our revised estimate including the registration of the incremental beneficiaries was between $100 and $105 million and included expanding our temporary staff for longer.
Why did operating margin in Financial Services decline in Q4 2013?
UEPS-based lending contributes the majority of the revenue and operating income in this operating segment. Segment revenue was $2.1 million in Q4 2013, up 16% compared with Q4 2012 in USD and 33% higher on a constant currency basis, principally due to an increase in lending activities. Q4 2013 segment operating income margin was 17% compared with 54% during Q4 2012 primarily due to the allocation of UEPS-based lending corporate administration and overhead expenses to this segment from South African transaction-based activities. We have allocated all fiscal 2013 expenses to this segment in Q4 2013. We expect to allocate expenses to this operating segment on a quarterly basis in fiscal 2014 and therefore we expect an improved margin in Q1 2014 compared with Q4 2013.
The operating income margin for fiscal 2012 would have been 52% compared to the 56% reported if these expenses had been allocated. The allocation of these expenses from the South African transaction-based activities segment has no meaningful impact on its operating margin for fiscal 2012.
These frequently asked questions contain forward-looking statements that involve known and unknown risks and uncertainties. A discussion of various factors that could cause the Company's actual results, levels of activity, performance or achievements to differ materially from those expressed in such forward-looking statements are included in the Company's filings with the Securities and Exchange Commission. The Company undertakes no obligation to revise any of these statements to reflect future events.