Serge Belamant – Chairman CEO
Herman Gideon Kotz – CFO
Drew Chappell -- Morgan Stanley
Ryan Mcgaver - Capstone Investment
Mark Brown – IM Portfolios
David Koning - Robert W. Baird & Co., Inc.
David Pickering – Noonday Asset Management
Net 1 Ueps Technologies Inc. (UEPS) F2Q08 Earnings Call February 7, 2008 8:00 AM ET
Good afternoon and welcome to the Net 1 Second Quarter Fiscal 2008 Earnings conference.
I would like to turn the conference over to Dr. Serge Belamant, please go ahead sir.
Good morning to our investors in the US and good afternoon to our investors in Europe and of course in South Africa. Thank you very much for joining us all in our Fiscal 2008 Second Quarter Earnings Call. Let me take this opportunity to wish you all a prosperous and healthy 2008. As usual, Herman Gideon Kotz our CFO is with me today. Both our Press Release, and 10-Q are available in our website, at www.net1ueps.com.
We will be making forward-looking statements on this call and I call your attention to the cautionary language contained in our press release regarding the risk and uncertainties associated with forward-looking statements. In addition, during this call we will be using certain non-GAAP financial measures as defined in the SEC rules. We are required by these rules. We have provided the reconciliation of the non-GAAP measures to the most directly comparable GAAP measures as exhibits in the press release dated yesterday.
We will primarily discuss our results in South African Rand, which is a non-GAAP measure. We analyzed our results of operation in our latest 10-Q and in our press release in South African Rand to assist investors in understanding the changes in the actual underlying trends of our business.
The company’s result can be significantly impacted by currency fluctuations between the US dollar and the South African Rand and therefore for clarification purposes. I would like to reiterate that the use of South African Rand is a non-GAAP measure and the appropriate GAAP presentation is included in our annual report on Form 10-K, our 10-Q and press release and we advise our investors and analysts to review the company’s result in terms of US GAAP.
During the Second Quarter of Fiscal 2008 the South African Rand strengthened against the US dollar. However, as most of you are probably aware, the trend in the USD/ZAR Exchange rate is reversed. And the USD has strengthened significantly against the South African Rand in the last few weeks and we expect this volatility to continue during our third quarter.
At the risk of sounding a little repetitive, I am once again extremely pleased to report on an excellent good quarter for the company as a whole especially at the second quarter of the fiscal year is traditionally our weakest quarter. As you are aware, we provide additional down GAAP measurement namely fundamental net income and fundamental earning per share that eliminate among other adjustments the significant non-cash accounting increase required by GAAP or intangible asset amortization and stock-based compensation charges.
On this basis, we are sure that increase in fundamental net income of 53%. From South African Rand 112.7 million for the three months ended December 31, 2007 to South African Rand 150.2 million for the three months ended December 31, 2008.
This translates into fundamental earnings per share increase in South African Rand of 33%. From $1.98 per share to $200.53 per share. As in the side, please note that this increase that we have achieved in USD would have been around the 44%. I would like at this stage to thank very much my executive team and all the personnel of Net1 for the incredible work that they have achieved during this quarter, taking into consideration A) That December is a summer holiday month and season and B) That very often they had to work without electricity, the problem which has and is affecting us and many other company’s productivity.
We of course have not initiated the fund business continuity plans, which amongst other things provide full power to all of our department or units, thus ensuring as little disruptions is possible to our business activities. I should also mention that because our UEPS Systems were designed to work in governments, they did not have power or telecommunications infrastructures. We were able to continue operations without any impact whatsoever on our customer base. In other words, although not desired, the power cuts we are experiencing have demonstrated that technology can operate and in fact does operate perfectly well in any environment that elects basic infrastructures.
You will recall that that I indicated during our last call that I was optimistic that the Sasa Tender would be awarded before the middle of December. My view at that time was based on the set that the ruling party in South Africa, namely the African National Congress or ANC, held the elections during the early parts of December and that as such the current Ministry of Social Development would wish to finalize such a Tender if any change in the party’s leadership could lead to delays due to the responsibilities and portfolios from the current to the newly elected members of the ANC’s national executives.
As you are aware, we received notification in the middle of December 2007 from Sasa asking us for further information on our tender bid and specifically on our pricing model. We submitted the additional information requested on the December 28, 2007. Last week, Sasa requested all business to extend the validity of the submission from February 9 to the end of March 2008. The reason was not yet clear as we all wished it would have been.
We have confirmed to Sasa that that tender bid will remain in full force and effect until March 2008. As you may be aware, our five existing contracts to provide welfare administration, electronic and case distribution services, expire on March 31, 2008. We currently believe that these existing contracts and those of our competitors will be extended by at least six months in order for Sasa to adhere to the minimum implementation timeframe specified in the tender’s specifications. I would again like to reiterate that that successful record with our provincial government contracts and our ability to provide an uninterrupted service even under the most difficult condition will ensure that we retain our existing contracts for the foreseeable future enough to regain further contracts in provinces in which we do not operate.
I am with a strong opinion that under any circumstances we will continue to play a major role in the delivery of such critical and essential service to the people of South Africa. I also believe that under any of the possible outcomes including the extension of our existing contracts, the cancellation of the tender or the award of the new tender. We will continue to generate and grow the revenue and profitability of this segment of our business in the medium to long-term. As always we will keep our shareholders fully briefed on the developments which we got to the Sasa Tender.
Our contract with the Central Bank of Ghana to implement the new modern and secured national payment system continues to gather momentum. And at this point it exceeded certainly all of my expectations. The international division has made better than good progress during quarter two 2008 and a completion then launched the first phase is scheduled for the beginning of the fourth quarter. It is expected that the Ghanaian National Switch and Smart Card Payment system will be fully operational by the end of the fourth quarter of fiscal 2008.
During January of 2008, the Central Bank of Ghana announced that it is mandatory for all financial institutions that its banks, community banks, credit unions and the like to participate in the UEPS national switch. As a result, we anticipate that 169 different financial institutions will drain the new payment system. It is also mandatory for all of these existing and new account holders of any financial institution to be issued with a UEPS Smart card.
We are also very excited by the new Central Bank of Ghana’s order for an additional 1.5 million Smart cards 2000 point-of-sale devices, 810 registration work stations and 254 wage payment workstations. We have also been asked to facilitate the upgrade of all existing ATMs in Ghana, in order for them to be and become UEPS compliant. We anticipate delivery of these additional requirements to be completed by the end of Calendar 2008. We have also been given the authority by the Central Bank of Ghana to put in place relationships with any number of the Ghanaian Financial Institutions, to assist them with product definition of the best message to utilize the UEPS. This authority should give us another avenue through which we can derive transaction fees and fee-based recurring income.
This will I hope, explain to our investors that the setting of technology does not preclude recurring income streams and that in fact it may as well facilitate the state. As I have said previously, the deployment of UEPS in Ghana is a catalyst which will allow us to deploy our technology across West and Central Africa as many as Ghana’s neighboring Central Banks, our great issue and great interest in the Ghanaian implementation.
I firmly believe that we are the first company worldwide, which has been given the opportunity to deploy a national payment system based on its technology and we intend to make an absolute success of this implementation as it could lead to our UEPS becoming a world standard as it is installed in many other emerging economies.
Back to South Africa, I am pleased to report that we have made strong headway in our partnership with Grindrod Bank. While it may seem to a lot of people that this project is moving slowly, many beyond the scenes but fundamental events needed to and has taken place in order for this project to be rolled out on a national basis.
Some of these include strategic issues, commercial contracts, technological adaptations, the development of financial products and more importantly the added allocation and appointment and training of the organization that will perform customer acquisitions on a large scale. Other essential criteria include the future ownership of the bank itself, retailer long-term contracts. The acceptance of the UEPS and point of sales are morphing EMV UEPS technology and of course further identification and agreement with organizations that will not only acquire customers but of course will also assist us to sign up (inaudible).
Our international market penetration continues to gain momentum. This can be demonstrated by our negotiations and we have already signed a temporary agreement in Indonesia. This agreement is structured a little differently to our standard agreements as it provides for the commercial and legal facets of Islamic or commonly known as Sharia banking. There is no doubt but there are many countries in the world with the Sharia banking concept have prevented investments, as well as the deployment of technological solutions.
The basic fundamental of Sharia Banking is that, no one party should carry the risk in any venture and that the party should be rewarded proportionally to the benefits derived by the business implemented.
We are of the opinion that our systems are designed and thus capable to support those philosophies. And as a result, we can see that many opportunities exist for us, to penetrate these markets while taking into consideration the beliefs and cultures of these communities. We have also decided to modify our current product offering to allow smaller countries to use the technology we have started into purchase install and operate on backend UEPS system.
This of course will break down barriers by allowing smaller developing countries to outsource all of their payment system requirements to us and to then focus on product sales and customer acquisition. We believe that this methodology will allow the rapid deployment of our systems and shorten the time of implementations. Furthermore, our reward for such outsourcing will be based on ongoing transaction fees for all transactions processed rather than purely on the upfront sales of system and the associated ROE components. It will also put us in a much better position to manage and maintain these systems allowing us to add further value to local financial organizations by offering advice in resolving problems in a much faster manner.
This outsourcing model is about to be launched for a number of smaller counties that has no infrastructures and we intend to replicate this model by setting our processing centers in other continents. These countries already include Mozambique, La Sutu, Liberia, Swaziland, Iraq and Tanzania.
It is anticipated that we would implement such centers of service in Asia-Pacific, probably spearheaded in Australia, Africa and the Middle East to South Africa, Eastern Europe, Russia and in the CIS Republic through Austria or Switzerland, as well as North and South America through North America.
We have also made our way in defining our marketing attack for the world of card present transactions. Our dedicated team has demonstrated the technology to many different organizations in first world economies and the responses we have received thus far are more than encouraging. As we all know, card present transaction, that these payments made across the internet or over the phone are by far the most convenient channels but are not used to the fullest due to security risk and the potential for fraud.
Our latest patents together with the products we have developed on mobile handsets eliminate these risks and barriers to increase. And we thus believe that the growth for these top transactions, which include local and international money transfers can be accelerated and made available in countries where they have never been implemented in the past.
As our company matures, and as we become better known on the world stage due to the power of our technologies and the proof that this work, we continue to build capacity in our tier offerings in order to generate the best possible returns for our shareholders. I predict that we would have a very good third and fourth quarter and that our long-term growth, the ability and possibility look extremely positive.
We would like to thank you all for your attention and hand over to Herman for him to give you some detail of the financial results. Thank you very much for your plan.
Herman Gideon Kotz
I will discuss the key trends of the second quarter fiscal 2008 compared to the second quarter fiscal 2007 along with the key trends sequentially between the second and first quarter for fiscal 2008.
We have also updated the frequently asked questions section in our press release to provide further clarity on the questions we are most often asked by our investors and analysts.
Again, for clarification purposes, I would like to mention that my following discussion will be based on our results in South African Rand as this provides the best indicator of the group’s actual operational performance and this is a non-GAAP measure. In order to order to review our results in terms of unit dollars and GAAP, please review our quarterly filing on Form 10-Q as well as our press release filed yesterday.
For Q2 of 2008, our average rand-dollar exchange rate was 6.78, compared to 7.32 for Q2 of fiscal 2007 and 7.12 for Q1 of fiscal 2008. Looking at the current situation the rand has weakened significantly against the US dollar during the first half of our current quarter of Q3 and is currently trading at around 7 rand 70 to a dollar.
Any significant weakening of the rand obviously reduces the dollar equivalent results of our South African operations, which is why we provided you with constant currency information in our press release and on this call as the core operational drivers are clearly visible from these numbers.
I am very pleased with our second quarter results, which reflect our most profitable quarter ever. Due to the seasonal nature of some of our core activity, the second quarter is traditionally the softest quarter which further underlines the exceptional trading performance of the group during the period.
Revenue for the second quarter of 2008 was 464.2 million rand up 28% year-over-year. Our gross margin for Q2 2008 was 71% compared to 77% for Q2 2007 and 75% for Q1 2008. However, in our business, gross margin is not the best indicator of the group’s profitability due to our dollar less product offering. We focused on operating income, which increased by 50% to 191.3 million rand between Q2 2008 and Q2 2007. The overall operating margin for Q2 2008 and for Q2 2007 was 41%.
Sequentially, the operating margin decreased from the 43% in Q1 2008, mainly as a result of inflationary increases in our cost components, specifically, our annual salary adjustment effective in October every year and lower high margins in softer development revenues related to the Ghana contract compared with Q1 2008.
Let us now analyze the business along in more detail using our reported segments. Our transaction based activity segments had revenues of 271 million Rand for Q2 2008, which is an increase of 24% year-over-year on a rand basis. In addition, our transaction based activity segment operating income of 143.9 million is 13% higher than Q2 of fiscal 2007.
Our operating margin in this segment has decreased from 58% to 53% for Q2 2008 mainly as a result of the following three factors. One, inflationary increases in our cost components led to a higher in the increases we negotiated with our customers. Two, timing differences relating to our annual price increase negotiations, specifically in the (inaudible) where we received a back dated price increase in Q2 of the prior year. And three, lower revenues earned during the first half of fiscal 2008 compared with the first half of fiscal 2007 from our special wealth business due to the timing of the commencement of our January payment activities.
To clarify, in late December 2006, we had commenced payment activities in all five of our provinces which was not the case during late December 2007.
These timing differences will occur from year-to-year and month-to-month as our decision on when to commence activities with any base cycle depends on factors such as middle of the first calendar of the month is a week pay or a Saturday, Sunday or Public Holiday as well as specific requests from the government.
These profit margin decreases were partially offset by the increased revenues for price increases from the four provincial governments, for wealthy distribution and administration services. The price increases from our wealth repayment contracts are regulated by the various service labor agreements and are generally a factor of the inflation rate. We will continue to receive these inflation adjustments for as long as our current contracts are valid.
The margin for Q2 2008 of 53% is sequentially lower than the margin of 54% for Q1 2008 primarily due to the timing of revenue recognition resulting from the timing of the opening of the January, as I explained earlier. If we disregard this disruptive effect of the timing of payment activities, the operating margin of this segment remains between 55% and 60% a month.
We will discuss our cash flow results later but I want to emphasize that the timing of our payment activities also were generally fixed on our cash flow results. The total number of payments processed to beneficiaries increased from 11.32 million rand for Q2 2007 and 11.9 million rand for Q2 2008, which is an increase of 5%. Sequentially the total number of payments processed to beneficiaries increased by 0.6% from the 11.83 million Rand for Q1 2008 in other words they deflect. The larger annual increases in the North West province, the government continued with the transfer of beneficiaries to us, from the South African post office, there was also a significant increase in the northern cape, but this is the result of the South African government’s rezoning of provincial boundaries, with beneficiaries previously put in the northwest transferred to the northern cape, sequentially, the increase in beneficiary numbers is low as a result of reduced activity during the summer holiday period in South Africa.
The transfer rate of beneficiaries submitted at the African Post Office in the Northwest Province to us decreased significantly during Q2 as a result of technical difficulties experienced by the various agencies responsible for the process.
We believe that this transfer rate should improve in the next four months. During Q2 of 2008, our merchants acquiring system continued its impressive performance as we processed the total of 1.8 billion rand in transactions through our merchant acquiring network compared to 1.38 billion rand during Q2 of 2007 and 1.9 billion rand during the first quarter of 2008. All are completed base cycle basis.
The productivity of our installed terminal base of 4304 terminals has stabilized, and an average of 851 transactions per fees per terminal during the completed base cycles of Q2 of 2008 compared to 683 during the second quarter of 2007 and 858 during the fourth quarter of fiscal 2007.
This increased records from the comparable period in fiscal 2007, demonstrates the continued rapid acceptance of our card holders as they become familiar with and accustomed to the convenience associated with our merchant acquiring initiative as they can receive and spend at anytime of the month. Compared with Q2 2007, the increase in the number of terminal installed is primarily as a result of additional terminal and board in the North West province to accommodate the anticipated additional beneficiaries’ transferred from South African post office to us.
During Q2 of 2008 EasyPay’s process had 135.3 million transactions with an approximate value of 50.3 billion South African Rand compared with the 117.6 million transactions persist with an approximate value of 27.2 billion rand during Q2 of 2007 and a 119 million transactions processed with an approximate value of 26.1 billion rand during the first quarter of 2008.
The average fee per transaction during Q1 and Q2 of 2008 was approximately 21 South African cents. We do not expect a significant fluctuation in Rand0 in the average people transaction during the third quarter of 2008. EasyPay’s operating module excluding the effects of intangible amortization was 53% for Q2 of 2008 compared to 52% for Q2 of 2007, and 53% for Q1 of 2008.
EasyPay’s margins are affected by the seasonal nature of its business as we switch a higher number of transactions during the December and March, April festive periods in South Africa. A small card account segment had revenues of 65.3 million rand for Q2 2008, which is an increase of 5% year-over-year. The total number of active smart card accounts increased by 5% from 3.8 million during Q2 of 2007 to 4 million during Q1 of 2008. Sequentially, there was no significant movement in the number of active smart card accounts.
We realized that there is some frustration that our wage payment initiative has yet to result in a significant number of new card holders, but we want to reiterate that we are currently focused on putting in place all co-aspects of launching such an important and massive initiative. That includes product definition, pricing and the establishment of the robust marketing and distribution network. We have made significant progress on all these fronts and we remain confident that our strategic goal of servicing 1 million wage payment card holders over the next three years is achievable.
Our financial services business has revenues of 14.5 million rand for Q2 of 2008. A decrease of 29% compared to Q2 of 2007, and a sequential decrease of 7% compared to Q1 of 2008. Revenues from our traditional training business decreased during the quarter due to increased competition and our strategic decision not to grow this business and an overall lower return on traditional micro lending loans as a result of compliance of the national credit act.
Revenues from UEPS space lending decreased during Q2 of 2008 compared to Q2 of 2007 primarily due to the lower number of loans granted.
In addition on average, the return on UEPS base loans was lower during Q2 of 2008 compared with Q2 of 2007.
The final operating segment is our hardware, software and related technologies sales segment. This segment traditionally includes revenues that occurred on an irregular or or one off basis, and it can be difficult to predict results from year to year. This segment includes the sales of UEPS related hardware and software as well as the sales of subscribed identity modules or simcards, cryptography services, and some card licenses. The segment had revenues of 130.14 million rand for Q2 of 2008, which an increase of 86% year over year, mainly as a result of the delivery of hardware and customization and development activities performed during the quota related to tender to provide Ghana with a national switch and smart card system from which we generated revenues of approximately $5.6 million during Q2.
To date, we have recognized revenue amounting to $6.5 million relating to the Ghana contract and we expect to complete the initial installation and customization of the system during the fifth quarter of fiscal 2008.
In addition, we generated revenue of approximately 13.8 million rand from sales of terminals to Nedbank. Overall, the operating margin of this segment increased from 7% for Q2 2007 to 14% in Q2 2008. Now effective tax rate for Q2 2008 with 36.1% compared to 14.7% for Q2 of 2007 and 37.6% for Q1 2008, the change in our effective tax rate year on year was primarily due to a fewer, non-deductible expenses during Q2 2008 compared to Q2 2007.
On January 8, 2008, there is a new law second amendment act, Act 36 of 2007 was promulgated. The Revenue Law Act included the legislation to reduce the rate of second rate taxation on companies in South Africa from 12.5% to 10%, effective from October 1, 2007, since the Revenue Law Act was early promulgated in the third quarter of 2008 in terms of US GAAP, the fully distributed tax rate for the second quarter of fiscal 2008 remains at 36.89%.
The fully distributed tax rate will be reduced from 35.45% from 36.89% during Q3 of 2008. We have illustrated our interpretation of the potentially fixed reduction in the SEC rates will have in our results as well as the effect of the abolishment of SEC in its entirety in question 20 of the frequently asked question sections or attachment C of our earnings press release.
Our Q2 2008 net income was a 137.7 million rand, an increase of 47% year over year. GAAP earnings per share increased by 57% from $0.23 in Q2 of 2007 to $0.36 in Q2 of 2008. In constant currency terms, GAAP earnings per share increase by 47% compared to Q2 2007. Fundamentals earnings per share for Q2 for 2008 was $0.39 compared to $0.27 Q2 2007, an increase of 44%.
On a constant currency basis, fundamentals earnings per share for Q2 of 2008 increased about 34% compared to Q2 of 2007. The grant of restricted stock awards in August 2007 has resulted in stock based compensation charge of approximately $800,000.00 which is excluded from our fundamental earnings per share.
In addition, the calculation of the diluted earning per share for Q2 2008 increased the dilutive effect of the portion of the restricted stock awards granted as these restricted stock awards are considered contingently issueable shares with the purposes of the diluted earnings per share calculation and as of December 1, 2007 divesting conditions in respect of the portion of the awards had been satisfied. Before turning to our balance sheet I would like again to mention that our cash provider of the operating activities can and does fluctuate significantly as a result of the turning for the commencement of our monthly wealthy payment activities, specifically through merchant stores.
Our cash flows from operating activities for Q2 of 2008 illustrates this impact that the timing can have on reported cash flows. You would expect positive operating cash flow for Q3 of 2008, however, this might again be impacted by the timing of the payment of pre-funded grants and receipt of cash from the provincial government. The most important message to our investors has be that our cash conversation ratio over any completed base cycle, in generally always more than a 100%.
Now, turning to our balance sheet, as of December 31, 2007 we have $200.7 million of cash and cash equivalents. The Business remains cash generative and we remain constable that we have sufficient liquidity between our cash and cash equivalents in our current credit facilities to fund our working capital requirements for the next four quarters. When I assess the actual quantum of our cash results, I include our pre-funded social wealth grants receivable as it is a highly liquid, very short term receivable best described as a new cash equivalent.
The increase in our accounts receivable compared with June 30, 2007 is largely due to an amount due from the cost unit of our provincial government as of December 31, 2007 which was settled in early January 2008 an amount due from the Bank of Ghana. The decrease is now income taxes payables are due to the obligatory payments of large provisional taxes during the half year to December 2007.
Discussing Question 19 of the frequently asked question section of our earnings press release, we believe that it is most appropriate at this point in time to return our cash reserves to finance the expansion of the business, to reduce the significant cost of our current and possible future pre-funding of all the grown populations and to execute relevant acquisition opportunity.
Overall, I remain satisfied with the quality of our earnings and financial strings as reflected by our balance sheet based on the assumption that our current business activities and initiatives will continue as usual, we still have to anticipate our fundamentals earnings per share growth rate to exceed 20% on a constant currency basis for fiscal 2008.
We are on track to achieve this growth rate through a combination of growth in the attributable revenue per unit in our wealthy payment business, improved efficiencies across the group, the contribution of the Ghana contract and contributions from the various other initiatives in the group. With that we will be happy to take your questions. Operator you can proceed with the Q and A now.
Question and Answer Session
Our first question is from Drew Chapel of Morgan Stanley, please go ahead.
Drew Chapel - Morgan Stanley
I guess, let me just start with the newest issue which is the power crisis and I think we follow why some of your service does not get disrupted and what issues or impact that the productivity have? And secondly, are you seeing any change in impact on some of your competitors in banks?
Yes, obviously the sudden implementation of load shedding which is really the same as load sharing considering we have to share what is there. Certainly, really created an environment that made it difficult people to operate, from the point of view that in terms of productivity in the office environment where people cannot work on APCs or you suddenly have no light or your service does not work or it takes you two hours to go to a next meeting rather than 20 minutes because the traffic lights are out. So there is absolutely no doubt that there have been a lot of disruptions for many businesses throughout South Africa because of the lack of power, obviously no involvement. We have aired always our disaster recovery plan in place and we have obviously activated some of those plans that have allowed all of our, let us call them, critical services to operate with immediate effect.
I do not believe in anybody thought that power disruptions were going to continue and in fact we did not know they are likely to continue for the foreseeable future so we have obviously activated our plan B, which means that within the next few weeks, we will be in the position that all of our services, critical or not we would be able to continue to operate with out any interruption.
But does not mean of course that other businesses are not affected, it does not mean that we can obviously provide power to traffic lights. So there is no doubt that it is affecting still the ability to perhaps communicate face to face with other people or other costumers. As far as we are concerned we are back on track and at this point in time, we do not really believe that the electricity unavailability is going to have any solid impact on our productivity in the next quarter.
There is no doubt that your point was valid that obviously when it comes to banks, when it comes to obviously technologies, which are really most dependent on electricity or networking because obviously people (inaudible) cellular phone networks, other communication networks were also affected by past failures and resulted in many different online system going down. There is no doubt that this is giving us a very big advantage by effect it includes categories in our government and can do it to other organizations that our system can continue to operate absolutely and completely as before regardless of any electricity failures.
And that I think has been something which has been very good for us because nobody before wanted to switch off the grid in order to prove our point. This way, we did not have to ask for it. They did it all by themselves but at the end of it, it was great to be able to show everybody that we could pay all 4 million people on time without any disruptions whatsoever.
So I think it answers the questions, but going forward with your very confident that we as NET 1 are not going to be affected in terms of implementing our business plans as much as perhaps many other organization will be, simply because they will not be able to operate effectively or in fact operate at all.
Drew Chappell -- Morgan Stanley
Great work on Ghana! If we could just spend a minute there and sort of just walk us through. So what has change in the last couple of months when you went in with initially the 23 banks? And the Central bank recommended that now making it mandatory. So walk us through the process of what happened? And secondly, is that likely to impact or accelerate some of the work that has happened in Nigeria with poor countries opposed?
I think that is a very very good point and I would feel that many people have underestimated what this Ghanaian contract actually means. As you are aware, the tender was purely for us to deploy and national payment system was very much the smart card component. Ghana to basically offer banking services at an affordable cost to more of Ghanaian people.
Now that is the way it kicked off and initially across the people that are normally targeted to do this are what I would call other first tier banks. What the central bank then decided to do is to say, there are many other financial organization in Ghana, who are not what you call the first tier banks, second tier banks, credit unions, building society top banks as well as what they call the Apex bank, which are already community based banks. And what then the Central Bank decided to do is to say, “no, in order for this to work correctly, we need to ensure that all financial institution in Ghana have to and must participate in a new payment, a national payment system, and that is one of the very first regulations that was stipulated.
Now , following this, the next change of mind by this bank was to say, we believe that if we want to take full advantage of the benefit of the UEPS technology including the ability, for example, to detect and to prevent money laundering, the ability to eliminate ghost workers, through our one too many search engines as well as a finger print technology and the ability to eliminate forth, to eliminate the possibility of card stealing, is as you know cannot go with an extra or in fact enable the people to steal cards, which may of may not be protected by PINs.
In order to achieve all of that and to get real benefits, the Central Bank of Ghana decided that it will be mandatory for all the card holders regardless of the institutions in which they are banked, to be issued with a UEPS card. In other words, all people in Ghana, that have a bank account in any bank, it is mandatory for their bank to issue them with a UEPS card. So UEPS becomes by definitions mandatory and becomes the only payment of choice. So the payment system channel that has to be implemented.
This led to a lot more orders that Brenda of course took immediately, namely that kicked off the system to with around half a million cards. They immediately placed a further order for 0.5 million cards giving us a total of two which in my odd calculation implies that those two million cards that are initially going to be issued to in fact the people that are currently banked, which is around 10% of the population. So we can expect further orders to come through and in fact the intention of the Central Bank was not only to bank the existing people but certainly to bank the people that were un-banked.
Now that also led to a member of new orders regarding point of sale devices and the further breakthrough that came through is when the Central Bank made it mandatory for existing ATMs’ and all new ATMs’ to become UEPS compliant, and that is something that technicalities and business teams are working on, in order to ascertain what are going to be the difficulties if any to work with ATM suppliers around the world because they are all there. You can imagine as well as the people that supplies ATM software that today, we are very good at providing system that you would augment ala Visa MasterCard, unfortunately these systems are no longer the mandatory one, they have now to support UEPS as a mandatory one. The other systems are becoming optional.
So we are working very hard at defining what modification and how these modifications can be made very quickly by working with the suppliers, both on hardware and the software to ensure that Ghana becomes UEPS country as further requirement of the central bank. The last thing that is I think which is important, and I tried to say it in my opening statement but might not have been clear is that many investors keep on asking us is that we are not really, we are keen but we are not interested in one off sales.
One thing that we have to understand is that the deployment of UEPS technology in any specific country, medium to long-term allows us to create an infrastructure for money transfers and transactions across boarders regardless of the fact that it was a one off sale or if it was a recurring revenue sale that is the first point.
The second point which is important has happened in Ghana. Brenda immediately went back to the central bank to say, this is great that we are able to deploy this technology but how are the banks going to be able to utilize it to their best advantage , we have got the right level of education, and the right level of support which means that we are now officially able to engage any bank that wishes to use NET 1 as the company to help them to, for example, implement or target specific portions of the population with specific UEPS products in order for them to generate new revenues, which means that this line of opportunity, not only if you go into Ghana to be able to sell hardware and software with royalty fees in terms of fees based for example, yearly annual liaison’s fee but now to be able to engage banks individually under any form of agreement that we wish to sign, therefore, it would have been very possibly be able to get back into their transactions stream.
Now, you are probably aware to many years have working with us that for every dollar that you sold in technology, $9.00 is made after the technology. So even the small fraction of the transaction fee by working with individual paying that they are going to use the technology in Ghana to generate far more revenues for us that you take the sales we have made in hardware and software. Let along of course the international money transfers or other across boarder transactions.
So we think that this is a fantastic breakthrough and from that point of view, I know that when the authority had been visiting and have been visited by other nearby countries so should Liberia, Cod Dubois , and a number of others which of course have seen what Ghana is doing and now definitely wanting to do the same. Since the model of outsourcing which I talked about simply because we do not want to continue to bring $4 million to $10 million up front as the value to enter in this low countries, we would rather let them outsource everything to us and let them use the $4 million or $5 million to actually go out and implement and market the system rather than to try to actually operate the technology.
By doing it this way of course, it will allow us to have assistance where we will be taking probably 10% of the top line of the transaction fee. In a long term, this is likely to generate far more money than upfront money we are making today simply after sending hardware and software.
Our next question is from Ryan Mcgaver of Capstone investment, please go ahead.
Ryan Mcgaver - Capstone Investment
I guess we could briefly reassess the power issues, when electricity go out for a couple of hours a day, a few days a week, and out for a whole day.
It varies, the status of the load shedding as they call it or the rolling blackouts I think is the most appropriate term is determined by the ability of the grid at any given point in time. Added to worst point which was around two weeks ago, we were at ground stage two which is supposed is like Discom1 and at that point in time there would be up to three outages a day lasting approximately 2.5 hours each. That happened for one or two days generally, there will be one power failure of two and a half or three hours, but I must say since this has been declared as a natural emergency and the measures have been taken, specifically around the mining industry, the power supply situation has improved quite a bit and for the last week or so, specifically at the head office at Rose Bank, we have not had any power outages.
Ryan Mcgaver – Capstone Investment
Okay, thank you for that. Since, Ghana the hardware sales were almost better you have expected, should you expect in Q3 for that, for hardware sales to get lower than in Q2.
Remember that in the hardware sale and software sale segment, we include the software portion, as well and out of the total Ghana initial contract value for the first phase of around $18 million. We recognized and that is for the hardware, the software and the customization portion. We have recognized $6.5 million to date. So, the contributions that you can expect from the Third and the Four Quarters, I think it would be equal in size, if not slightly higher, than what you have seen in for Q2.
Ryan Mcgaver – Capstone Investment
Okay, my final question before I jump back into Q, as far as the STC, I realized you have no way of knowing whether or not it will be enacted. Is there a key date we should look for?
You mean the complete abolishment of the STC.
Ryan Mcgaver – Capstone Investment
Correct, that second phase.
The second phase is really a laborious process that the government has to embark on and revolves mainly around our treasury department renegotiating all of the major international tax treaties, because they are replacing a company-based tax with shareholder based tax and clearly, the main issue resides around foreign shareholders. We understand from the updates that we get provided with, every couple of months that those process is well underway and that they still hope to complete the process to replace STC with a shareholder-based tax toward the end of this year, but most likely in the First Quarter of next year.
So, I would say that most probably the best news that we could look forward, most accurate that we could look forward to will be in the Annual Budget Speech, which we will have in the 20th of February this year. I am sure that the Finance Minister will give us an update on the progress and I think for a year, following that, there is not much that will happen formally.
Our next question from Mark Brown of IM Portfolios, please go ahead.
Mark Brown – IM Portfolios
Mine is a really two-part more philosophical question that centers really on communication with current shareholders and potential shareholder of which Serge, in your opening comments, you said that we have signed a temporary agreement with Indonesia right now and that is a prime example, if we have done that, why we have not made a press release with details of that temporary agreement and maybe outline for the plans, timetable and so forth for movement from a temporary agreement to a contract.
That is a very, very good question and I would try to answer that the best I can. We have been called many things and one things that we have not been called is that we are not the type of company that just announce anything, until we are very, very sure that in fact, it will happen and until we have a very clear understanding of what it will mean. In other words, when we look at Indonesia and Indonesia as you know is a fairly large country with a huge potential. What wanted to make sure, because of the uncertainty around this new top of contractual make-up that we led to entering to, which is very different to the type of thing that we have done in the past where we have to basically entered in terms of the risk reward scenario. We are already the quantifying the risk reward scenario and we are also busy looking at the time frame for what Brenda has already agreed in Indonesia, namely the installation of our first palette in one of the Islands, which we believe we can probably do very, very quickly, but that purely would demonstrate a working system.
So, I think what we will be doing over the next couple of weeks or couple of months is certainly to try to formulate, something a little bit more exact in terms of the way we are in the first phase, and let the second or third stage of Indonesia could look like, assuming that the base actually happens. You are right, maybe you know we have been told that maybe we did not give our investors enough information, we tend to agree to that, simply because that we have informed, but perhaps it is better not to say too much, rather than too little. You know that we have not hired a new higher Executive and we are hoping that everything is now more on faith with the company, the people in the company and, what we do that it is going to start giving almost week by week, sort of blows, in terms of each business unit.
Not to tell the investor on a day-to-day basis that we can make a another $0.10, but at least to update you all, in terms of the progress, which unfortunately none of the investors seem to know about, but for the people that work in NET 1 have generated for them a huge amount of work and efforts. And, I think we need to be able to be a little better in conveying the top of the effort that has been conducted by the people. We thought creating an expectation as a certain thing for the future and it is always this dilemma that we have got to manage and we have always been a little cautious that perhaps we are a little too cautious.
Mark Brown – IM Portfolios
Let me encourage you, at least in the opposite side of that and I respect the legal community, but I respect the way you guys run the company and I would encourage you to run it from your head, your debt more than from the legal community. The second part of my question would be from, you were talking about the developing reputation of our company, do we have a strategy, because we get news from you guys once a Quarter and that is about it. The analyst community is either quiet or non-existent. Do we have a strategy for any more communication from the financial sector or to the financial sector to inform people more even just about the company.
Again, very, very valid point and I can assure you that in fact our last board meeting, which was only a few days ago that there is something that has come about again and I think as we have lifted now for I think for so much for four years and to be quiet on some mistakes, some of the blame, because we are conservative. But, I think we are starting to understand the difference between the legal requirement, the compliance requirement in the US and NASDQ. And also, what both retail and long-term investors and hedge fund naturally expect us to say.
It has taken us awhile that we got this balance and I can assure you that you will see something changing, very much in a short term and that we are beefed-up the carrier of the company, because we do intend to start telling people a little bit more about what we do and certainly while we do it. I think everybody actually deserves to know and candidly, our own people internally deserve to get that recognition. So, I can only give you my apologies for not doing that in the past, but we understand this a little bit that we know it is needed and we are going to do it.
Mark Brown – IM Portfolios
I step out of line, let somebody ask question and I appreciate that; you drew the differentiation between retail investors and long-term investors. I have been and have clients that have invested in this company for five years and as I look at the turn over in Institutional Investors, I think it maybe just opposite from that you are actually inferring. Thanks a lot guys.
Our next question is from David Koning of Robert W. Baird.
David Koning - Robert W. Baird & Co., Inc.
First of all, thanks for all the detailed disclosures again in the Q1, one that found that was particularly interesting was the first time you kind of broke out Columbia and just showed how well, once you get something get going, you can really ramp it. I think in September, your 10,000 transactions and by December you were already close to 30,000 transactions and I am wondering you are still in a little bit of a lost mode, given it is early. How many transactions that you think you will get to on a kind of a normalized run rate. First of all, per off and secondly where do we need be to break even and then, what could long-term profits be in that subject.
Again a good question, we are getting one of financial guys to quickly look this up for you, because as you know at the moment this is pretty small talks about business, but I think you picked up and something, which is very important. You know, when we ramp up something, like for example Columbia or Vietnam and candidly the two of them are very similar. You have picked on the fact that now that we have gotten the technology embedded and we have got the right place, for example in Columbia we were looking I think what is the fifth largest, probably the third largest cellular phone operator, we have now signed the biggest cellular phone operator, in terms of an MOU, but it always starts with an MOU. Now, the bottom line is that if you look at the population, of course, in Columbia, which is probably about the size of South Africa and you look at for the size or the amount of transaction that come through in South Africa, in terms of prepaid.
We are basically, very much, at the very beginning of what could be an exponential curve, so there is no doubt that, that business in its own right and I can name one business in South Africa called Blue Label. That this business, or least the ceiling income that they have listed on the stock exchange and roughly the market cut is around 4 billion rand, so we believe that each one of these businesses that is running VTU has the potential to go to at least that size. We must also understand however that the intention of using VTU for us was having the foot in the door that as soon as VTU stopped operating is to bring in the UEPS Technology as for lack of the better word, the second wave on the tech, only at customer based. So, I think you picked on something both Columbia and Vietnam, which is no doubt and I say thank you for saying that we are good at this, but I think we are good at this.
That we can actually, when we set our minds to something, we actually can make it happen and we are very good at breaking the barriers if there are any barriers in our ways. So, yes, this is going to be a field of two exciting projects, the breakeven and I think if we got the numbers of guys of break even? No, unfortunately, I am not going to lie to you, we have not in this point in time looked up the breakeven breadth, but in my view is that you look at the numbers that have been calculated, our spending at the moment in this particular company is not actually that high. I think we are talking about with $100,000.00 a month.
So, fully staffed, $100,000.00 a month, which means it will not going take long, before we start actually breaking even, it is not making positive profit. So, I am very comfortable that during this financial year of 2008. I would be very surprised if that curve were not at the growth rate that we are experiencings at the moment.
David Koning of Robert W. Baird & Co., Inc.
Great, that is very helpful, thank you. Secondly on Ghana, what do you expect your hardware, software reps to be in the first half of ’09, because that was a nice disclosures, as well that, that contract will generate additional incremental revenue in the first half of ’09 and so maybe you can just give us that . And then, secondly in Ghana, what is the on-going revenue recurring kind of piece on the 2 million cards, as well.
Again, it is good points though, in Ghana, remember that we have gotten some further order to the deed, so I think the initial contract value was around $27 million or $28 million, which includes the recurring piece, it is going up again by a couple of million dollars as 41 to 30 mark now. Now, we expect the Presidential Loans to occur in the first couple of weeks in (inaudible) that is when they have planned it. It might be a couple weeks later, but it does not really matter, which means the systems phase 1 must be implemented and we are expecting toward the end of May or June. Certainly to have already a lot of the cards have been issued and that is going to depend very much on the ability of the financial institutions to register two million people, which is not quite simple as I think what everybody thinks.
So, in my view, because the way that we recognize revenue in Ghana. I think we have chosen a method, which is percentage based. In other words, it is percentage completion that over the next two Quarters, and when I say two Quarters we are talking about Third and Fourth Quarters. We probably found that we will probably be around 60% to 70% of the revenue specifically on the software side.
That is the high margin business and the remaining will probably happen in the Third or the First Quarter of next year of 2009, but then I think you will see even further order of the Ghana for ATMs, for cards that are also going up to beef up as Second Quarter of 2009 and of course, at that stage we are also going to start getting revenues coming in from what we call annual revenue so it has got maintenance, which is quite a high maintenance charge, but I do not know the total package. I think it is around the 12% to 12.5% in some cases, which can bring easily a million and a million and half dollars and of course, we also got card-based royalties, which is a 60 filled-card that we are also going to be getting on an annual basis, in terms of recurring revenue apart from hardware sales. So, I have always estimated that when the systems start running and assuming it runs, as well as it looks.
We should be able to generate $3 million to $4 million a year just in what I would call on-going sale, as well as simple card-base transactions, in terms of liaison fees and maintenance. The exciting piece is, I think it will come in the next six months, when we start working with individual financial institution and doing side deals, in terms of assisting them to actually now use the technology and adopt of technology for them, to the product that they wish to sell. And, there I think we will have the ability to actually build our sales into the transaction fee. So, I think Ghana in its own right is going to be very good for the next year, for our next financial year regardless how you look at it, but as we move towards the third, fourth quarter of 2009 and onwards. I think it will generate some nice revenue at the bottom line, minimum of 7,8,9 cents per annum as a minimum, plus additional revenue we will make after signing some deals with potential 150 other financial institutions.
David Koning of Robert W. Baird & Co., Inc.
I just have one final question, in South Africa; you mentioned that you are starting to come to sell into the Union to some employers. I am wondering, when would you expect the first real card sale, the first revenues to really start coming in, you know maybe six to 12 months. How many card that you kind of expect early on?
You know once again, this is a question that everybody asks and I wish we could predict the entire future, but I can only tell you what we are attempting to do and it does not necessarily mean we will do it, although we are normally pretty good in doing what we say we are going to do. We made the call that there was no point, once we have proven that technology and the fact that people wanted it, to try to continue to market or to sell double UEPS to individual people. It will take far too long and candidly would become like a bank. Whereby we would simply try to advertise and spend millions of dollars in advertising, hoping that somebody would knock on the door and sign and say, ‘Please kindly open an account.’
We decided the only way to do that without going through organizations that is already today service for whatever reason, million of customers. We have got these organizations, we are in the final steps of signing some exclusivity deals with a lot of them and a lot of them see a huge of amount value to work with us simply, because we do not compete with what they do today, but we can only sell the end-product. So, these organizations vary in terms of numbers of customers from 350 thousand down to about 2.7 to 2.8 million. If we can simply engage one or two of those, of which we have four big ones. To actually start selling directly to end-users themselves and also the organization, they are going to sell to impress.
We feel that confident as Herman has mentioned that we should be able to pick up our first million customers very, very quickly indeed. I think Herman mentioned three years, but that is because he is a chartered accountant and it is because as an accountant he is obviously very pessimistic and very cautious. I would be certainly disappointed if we only manage to sell a million people over the next three years. Imagine that would mean that something in our plan did not work and we are not going to wait for three years, waiting for it not to work, if we see it is not working we are going to adapt the plan, where we believe we know that we can actually accelerate this penetration.
We have two further question, the first is from David Pickering of Noonday Asset Management, please go ahead.
David Pickering – Noonday Asset Management
Serg, I think you said in your opening comments that the reasons given by Sasa for the extension request were less than clear or not as clear as you would have liked. Perhaps you could just elaborate it, what do you mean by that.
The reason why I said that is because I had forgotten the exact wording that they have given us in the letter and I think that the wording was due to unforeseen circumstances. My view, you know you fight to say due to unforeseen circumstances, I will not be able to bid my target by 20%. I do not think you would necessarily think that I am being really, really clear and I think if you look and try to remember. What I did mention is that we firmly believe that the change in the National Executive of the ANC. Whereby, a new set of people are going to come in and are going to become the people that basically run the party.
We believe that they have to be a freely major hand-over, between the existing government officials and basically the new incumbents and we firmly believed that that in itself is actually slowed down if not arrested of the process until that negotiation on its handover will take place. So, we think it is no more difficult than that and that is why I have always said if this thing does not happen before Christmas or before the 15th of December. In my view, it would not really happen at all, simply because this thing could not be delayed until of effect the new election in 2009. Whereby, another tender could then go out after that. I am still reasonably confident by what we are hearing that there is a good chance that there might still be fraud even if they give an extension to actually award the tender before the end of March of 2008. But, they will only do this once that the handover has taken place and both sides agree with each other, in terms of the windfall. If they do not, nothing is going to happen until a new government of 2009. But, of course, this is entirely mass speculation and I am not a politician.
Our final question is from Peter Boelhouwer of Matrix Capital, please go ahead.
Peter Boelhouwer - Matrix Capital
I just have a quick question in the last conference call you alluded to a trip Brenda was making to Dubai, just wondering if there is anything happening in that region, as well if there is any update.
You are right; Brenda did make the trip to Dubai, because I would not allow her to go to the actual destination country at this point in time. And, it is absolutely no doubt that that is moving very, very well and we expect and I think I did put the word in my initial opening and we still feel very, very confident. That certainly and specifically a country like Iraq, will be a country that I think mentally, they decided that they would like to use our technology because it will solve a lot of their problems and I know that Brenda ahs been working very, very hard between our attorneys and the ones from Iraq to actually finalize these agreements. I think this could be one of the effective deal in my view that if it comes to that will be even far better than the one that we did in Ghana.
So, let is touch wood and hope that that happens sooner rather than later.
Peter Boelhouwer - Matrix Capital
Any sort of skeleton details on the business model or is it too early?
It is a little too early, but it will certainly not be the sale of technology as you have seen it in Ghana. It is going to be based on whether an outsourcing agreement with some sort of percentage top line that we would be taking for our efforts. So, I think it is going to be something a little safer for us and at the same time, in the long-term it will be something more lucrative, but it will be a little less money up front. I would rather go for the medium to long-term benefit, in terms of recurring revenue rather than the initial hit, which us very natural as well, but often you come above.
Dr. Belamant, there are no further questions, would you like to make concluding remarks?
Yes, I think at this point, I would just like say thank you very, very much to all of the investors and all of our shareholders, and it is great to know that a lot of you still very much believe in what we do. We certainly do and we think that every month, every birth of new contract or every new technology that we put up, I think positions us to become certainly one of the leading payment systems in the world and hopefully, we will still strongly believe that we can become well tended in payment system, specifically for developing economies. I really believe it, I really believe they need it and I really believe and candidly today, there is not out there who can do it. So, for all its worth, I hope you all have a either wonderful afternoon or wonderful morning. Thank you very much for attending.
On behalf of Net 1, that concludes today’s conference. Thank you for joining us. You may now disconnect your lines.
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