Net1 UEPS Technologies, Inc. (NASDAQ:UEPS)
Q4 2008 Earnings Call
August 29, 2008 8:00 am ET
Dr. Serge Belamant - CEO
Herman Kotze – CFO
Dave Koning - Robert W. Baird
Dhruv Chopra - Morgan Stanley
Good afternoon and welcome to the Net1 results. (Operator Instructions) I would now like to turn the conference over to Dr. Serge Belamant; please go ahead sir.
Dr. Serge Belamant
Good morning to our investors in the US and good afternoon to our investors in Europe and of course in South Africa. Thank you for joining us for our fiscal 2008 fourth quarter and full year earnings call.
As usual, Herman Kotze, our CFO is with me today. Both our press releases and 10-K are available on our website at www.net1ueps.com. During this call we will be making forward-looking statements and I call your attention to the cautionary language contained in our press release regarding the risks and uncertainties associated with forward-looking statements.
In addition, during this call we will be using certain non-GAAP financial measures as defined under SEC rules, where required by these rules we have provided a 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 non-GAAP measure. We analyze our results of operations in our latest Form 10-K and in our press release in South African rand to assist investors in understanding the changes in underlying trends of our business.
Company results 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 and press release and we advise our investors and analysts to review the company’s results in terms of US GAAP.
During the fourth quarter of fiscal 2008 the South African rand as we all know was significantly weaker against the US dollar compared with quarter three 2008 and quarter four of 2007. As you are aware we also provide additional non-GAAP measurements, namely, fundamental net income and fundamental earnings per share that eliminate among other adjustments, the significant non-cash accounting increase required by GAAP for intangible assets amortization and stock based compensation charges.
On this basis we have shown an increase in fundamental net income of 34% from South African rand 135.9 million for the three months ended June 30, 2007 to South African rand 183.7 million for the three months ended June 30, 2008. This translates into a fundamental earnings per share increase in South African rand of 34% from 238 South African cents to 319 South African cents.
Please note that the increase we achieved in USD is 24%. On our yearly EPS, we have realized a US $1.52 according to GAAP measure which is a 36% increase on last year’s EPS or in fundamental earning measures a $1.55 US which is a 26% increase on last year’s EPS.
As far as I’m concerned, this is a testament for the performance of our company and of course of its people. At this point I would like to take the opportunity to compliment both my executive team as well as all of the personnel in Net1 for the passion, dedication and professionalism which they have demonstrated over the last year without which our company would not be able to achieve its long-term ambitions.
I will now take some time summarizing the activities we have been engaged in during the last year and highlight both the progress we have made and the difficulties we have encountered and how we have managed to circumvent these when necessary.
I will comment by discussing the position with SASSA. As we are all aware SASSA has until the end of September to make up their mind, vis-à-vis the award of the South African tender on the provincial by province basis. We are still of the opinion that SASSA will in the next two to three weeks finalize this decision. We have also reiterated over the last number of quarters that we also believe that whatever outcome SASSA decides upon will not, in our view, affect our current position within the South African pension and welfare business. If anything, we believe we have a better then average chance of improving our position in terms of market share and [there’s] a number of beneficiaries that we are currently servicing.
At this point we have had no further official statement from SASSA telling us what will be the final date for their final evaluation and tender award. There is still a possibility that this tender may in fact be cancelled as, as we all know, the new government namely the [ANC] government, is already changed hands and new elections will occur in South Africa during the middle next year.
This may be or prove to be one of the most difficult periods of transition which may lead to the decision, vis-à-vis the SASSA tender to be delayed further. I must however restate that our current position in the South African market is dominant. Any delay in the award of the tender cannot in any form affect our company or its earnings, and we firmly believe that in the short to medium or long-term, we will still remain the preferred company by government to deliver such an important service to the country as a whole.
I’d like to now talk a little bit about our wage payment system initiatives. We are all aware of the progress we have made, vis-à-vis been able to utilize a banking license and the breakthrough that we have made by being awarded from MasterCard the ability to [inaudible] our own UEPS application together with an EMV debit application on a MasterCard branded card. The purpose of this initiative was to ensure that any card that we would issue through Grindrod Bank to our new customer base would be able to interoperate with other and existing point-of-sale devices which are already installed within the South African territory.
Moreover this approval has been reached, MasterCard’s procedures appear to be extremely slow to implement. We therefore have been trying to implement the equipment, obtain the correct certification, obtain the tech kits and all other equipment and procedures that are required for us to be able to comply to MasterCard’s regulations.
This is something that appears to be taking far longer then we had anticipated. However, we have decided to continue our rollout in order not to delay our customer acquisitions. We have therefore established a number of initiatives all mutually exclusive from each other that will allow us to rollout our technology and acquire customers through the bank without the necessary interoperability that is provided or will be provided by a MasterCard branded card.
As an example, we all know that we have already launched in rural areas a number of payment initiatives to the farming community of South Africa. A number of farms have already been signed up and our payment system has proved to be extremely useful and successful in these areas. We have already tested a project in South African schools where each school pupil will have a bank account and will be issued with a UEPS card that will allow them to make all purchases from canteen facilities, from school books, from the payment of school fees, payment of sports equipment, payment of transportation, and thus remove the necessary for cash in the school environment.
This project has already been endorsed by a number of Head Masters throughout the country and we certainly intend to roll it out to a minimum of 300 schools throughout the country in a short to medium term. The fundamental reason for the elimination of cash is to remove the ever growing concern that school children utilize cash for the purchasing of drugs. If you remove the cash it is unlikely that drug pushers are going to continue to show interest where they are no longer capable of obtaining the cash for what they are selling.
Another project which again was independently was launched is one concerning micro financing. Micro lenders or people who finance small loans, at [high] interest rates always have the problem of insuring that they will be able to collect the repayment on a monthly basis for these loans. These micro lenders have agreed to provide their customers with a banking account in Grindrod therefore insuring that debit orders against these accounts can be insured.
Because of interoperability customers will have the ability to transfer any remaining amount from their Grindrod account into any traditional banking account within South Africa. This will allow them in the short-term to utilize both the UEPS card to gain access to low interest loans and on the other side to utilize a traditional account to gain access to traditional ATMs or point-of-sales which have been installed and are currently operated by other financial institutions.
In the longer term, we believe that these customers will remain with Grindrod bank for all of their services including services such as home loans, longer term loans, and overdraft facilities. Another initiative that is also being concluded is together with a financial arm of [Kosatu] which represents around 11 million people in South Africa who are members of one or more of these unions. The concept of [Kosatu] is to provide a package of affordable financial services to their members and to deliver those financial services through the UEPS card technology.
We have reached an MOU with the financial arm of [Kosatu] that the JV would be able to be set on a 50/50 basis between them and ourselves. This JV will allow us to deploy a number, such as 2,500 kiosks who are capable of accepting cash, accepting UEPS cards, and being able to conduct transactions such as top up cell phone vouchers, electricity, water, bill payments and money transfers.
These particular kiosks will be implemented in all government offices [inaudible] and other government departments thus providing an ideal position for huge traffic [of feet] that will be able to utilize the equipment for their own personal use. [Kosatu] of course will be able to issue bank accounts to employees of these organizations and government institutions in order to grow the customer base and migrate them to UEPS technology thus generating fees based on a transaction basis for them to re input into the unions.
The last initiative which I think is worth mentioning is what we have done with West Bank. West Bank is a company which today issues hundreds of thousands of cards for the purpose of performing their [inaudible] management and fleet management. West Bank has signed with Net1 to implement the UEPS technology at petrol stations throughout South Africa in order to replace the West Bank current credit card, namely a [Nexrod] card but a UEPS card which will be able to be used with biometric [inaudible]. The reason beyond the venture is for West Bank to securitize all of these transactions which today are too easily defrauded. This initiative will simply create a further footprint for Net1 in South Africa in the areas of petrol stations and stalls which are linked to petrol stations simply creating a greater infrastructure for our card holders to utilize.
And as mentioned that because of our pension and welfare system our merchants requiring infrastructure continues to grow in terms of its usability and access to many millions of our customers as will be seen in our 10-Q and 10-K this year.
Focusing a little bit on EasyPay you will see that EasyPay continues to command the greater portion of the South African transaction switching system outside of that bank. EasyPay continues to offer its services to more and more merchants and EasyPay continues to grow in providing these merchants with additional services such as cellular phone top ups, the selling of electricity and water tokens, bill payments and of course the introduction of money transfers.
We believe this is an extremely lucrative business which we are certainly prepared to share with the merchants that today are happy to implement and to utilize our UEPS merchant infrastructure. To focus now a little bit on international business, we all are aware of our successful our Ghanaian implementation has been. I am proud to say that I do not recall in my 30 years of IT history any company that has ever been able to sign and implement a national payment system in the period of six months.
And to do it absolutely successfully. I believe that Ghana is issuing a number of press releases on a daily basis where all participants in Ghana from British Airways to banks to financial institutions to large shopping centers, are all committed and committing to the implementation of the UEPS technology as the national payment system for the entire of Ghana. Officially [inaudible] has already published that Ghana towards the end of this year will be the first country in the world to have a national payment system that will also be provided on cellular phone technology where all functionality that UEPS provides on its cards will be made available on a cell phone as well.
This together with our virtual credit card concept will allow Ghana to enter the world of card not present transaction in a complete and utter secure manner, something that has not been achieved anywhere in the world to date. Moving on to Iraq, we are pleased to report that our Iraqi project the first project that we have done where a country outsources the processing to South Africa has also been implemented in a period of 90 days completely successfully as well.
A number of government institutions with their local partners and local banks have already issued, enrolled and transacted with a number of their clients and we are pleased to report that the strength of our system in terms of [ghost] workers in terms of identifying duplications, in terms of identifying errors, in payment files, is already proved incredibly successful and those already [are like it] all or at least the best part have the errors that were present in a number of files which of course could have led to losses by the Iraqi government, losses that really belonged to the people that deserved to be paid.
Because of our Ghanaian and Iraqi successful implementations a number of other countries have approached Net1 and a number of tenders have been issued and we are awaiting the finality in a number of countries such as Liberia, Angola, Mozambique, The Philippines, and others. We firmly believe that we are better then well placed to continue to deploy this unique technology which has now huge supporters as the proof that it works and can make a difference to the economy of any country is no longer a debate.
Further a field, our initiatives in Vietnam and Columbia vis-à-vis our VTU system have gone excessively well. The growth is growing at the rate that we had predicted and we are now in the position to introduce UEPS on those platforms in order to allow these local businesses to explode as a total technology rather then purely as a virtual top up system.
Lastly our virtual credit card initiative that has been commenced just about 12 months ago we believe is now ready for its first pilot which we hope to announce shortly and this pilot will take place in a first world country. This will achieve of course the proof that UEPS can actually be used in both third world as well as first world economies and that VCC will be the link between first and third world economies.
Of course I would like to spend a little more time discussing our latest acquisition namely that of BGS, and why this acquisition will be of great benefit to our companies in the short to medium term. The first point that needs to be understood is that BGS’s technology called [duet] is in fact the forerunner of the UEPS. Duet is based on our card to card funds transfer [inaudible] system. Duet was created in 1993-1994 and grew mainly in the CIS republics including Russia.
We are excited about BGS forming part of Net1 understanding that the largest customer of BGS today is a bank in Russia named [Stayabank] Savings Bank. [Stayabank] have a number of customers they have and the infrastructure they have in Russia probably would be if not the largest certainly in the top two or three of the largest banks in the world.
By adding a partner that will still own 19.9% of BGS, we believe that we have their commitment to continue to deploy duet/UEPS technology in Russia understanding that the UEPS will give [Stayabank] further functionality, functionality that is not available on the earlier version of UEPS namely duet. We believe that by utilizing the infrastructures that have been deployed that accept duet such as 90,000 point-of-sale devices, 15,000 ATMs, and millions of cards will allow us to provide financial services and other services in these countries as per our wave to initiatives that we normally commence once our technology has become widely accepted.
BGS also offers us the same type of opportunity in other CIS republics where the duet technology has become pretty much the de facto standard. We firmly believe that in this country the opportunities are even greater as we are able to create joint ventures with local partners that would ensure that we can convert a model which is based on hardware and software sales to one that is based on transaction and recurring revenues. BGS outside of the CIS has also made some headway in countries in which we are already playing such as Indonesia, and Vietnam and in those countries we will obviously consolidate our efforts to ensure that we can deploy faster and better for the benefit of the company.
BGS is also entered the world of India with a contractual agreement with a company called Vina. We have in the passed discussed the potential of an opportunity with Vina and decided to decline it. With the BGS initiative and the BGS people in India we will be able to review our own ideas of what can possibly be done on this huge country where 1.3 or 1.4 billion people live. We are still of the view that we will be treading in India very carefully as we know that it is easy to sign and MOU. It is easy to sign a contract, but it appears to be far more difficult to make any money.
We are a company that is always focused on the bottom line and not simply on making announcements for the sake of it or to simply increase the top line without guarding and preserving our margins. BGS also offers us some extremely capable financial business development and technology employees some of which will actually form part of our executive committee and we intend to utilize them to focus on setting UEPS in new territories, migrating a number of duet territories, into the UEPS concept and format and obviously to spearhead our phase two which is to start making transactions and generating profits out of financial services such as [inaudible], electricity, money transfers, and bill payments.
Of course they will also focus on introducing our VCC concept to the largest cellular phone operators in Russia such as NTS, and a number of others. We firmly believe that our BGS acquisition be strategically important for Net1 as in some instance it doubles up the number of countries in which we now operate and doubles up the number of cards that we have issued. As the two technologies fundamentally are the same, it will become simpler and easier to integrate them by taking the best of both and creating a product UEPS product, that will be easier to sell in many other countries in the world.
In conclusion and before I hand over to Herman, I would like to state that once again I am delighted with the result that we have created during this year. I also understand that we are given some guidance for next year, guidance that some analysts have told us was a little low, namely 15% that want us to understand that the acquisition of BGS and its implication, the evaluation and conclusion of the SASSA tender, as well as a number of other financial decisions will in fact affect this 15%.
We believe that we’ve always been reasonably conservative in our approach and what we like to tell our investors. We believe at the end of the day that 15% will certainly be on the low side and that obviously the company has within itself the power to generate far greater increases during the next year. I’d like to conclude by handing over to Herman and to wish you all a wonderful weekend.
Thank you, Serge, and greetings to our investors around the world. I will discuss the key trends of the fourth quarter of fiscal 2008 compared to the fourth quarter of fiscal 2007 along with the key trends between the fourth and the third quarters of fiscal 2008.
I will also discuss certain financial aspects of our acquisition of BGS and the proposed secondary listing on the Johannesburg Stock Exchange in South Africa. We have also updated the Frequently Asked Questions section in our press release to provide further clarity on the questions we are asked most often by our investors and the 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 review our results in terms of US dollars and GAAP, please review our Annual filing on Form 10-K as well as our earnings press release filed yesterday evening.
For Q4 2008 our average rand dollar exchange rate was significantly weaker at 7 rand 80 to the dollar compared to 7 rand 12 to the dollar for Q4 of fiscal 2007 and sequentially from Q3 we also saw a significant weakening for the 7 rand 41 to the dollar level. Looking at the current situation, the rand has remained relatively steady against the US dollar and is currently trading at around 7 rand 75 to the dollar. Any fluctuation of the rand obviously influences the dollar equivalent result of our South African operations which is why we provide 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 impressed with our fourth quarter results as we have again achieved great quarter earnings and we have met or exceeded my key financial indicators of continued fundamental earnings growth, strong operating margins, and of course excellent cash conversion. Revenue for our current quarter was 485.4 million rand, up 13% year-over-year. Our gross margin was 74% compared to 75% the same quarter last year and 74% or the same compared to our preceding quarter.
However in our business gross margin is not the best indicator of the group’s profitability due to our [various] product offering. We focus on operating income which increased by 22% for Q4 2008 compared to Q4 2007 and had increased by 1% sequentially from Q3 2008. The overall operating margin for Q4 2008 compared to last year’s Q4 improved to 44% from 41%. Sequentially the operating margin decreased slightly from the 45% in Q3 mainly as a result of the inclusion of more high margin software development revenue for the Ghana contract in Q3 partially offset by improved margins from our transaction based activities due to improved trading conditions.
Let’s now analyze the business in more detail using our reported segments, our transaction based activity segment increased its revenues year-over-year by 15% and sequentially by 7%. Our operating income increased by 32% compared to the previous year. Sequentially our operating margin improved to 58% from 55% in Q3 this year compared to the 50% of Q4 last year mainly as a result of the following three factors.
One, price increases received in our social grant payment business in the KwaZulu-Natal and Northern Cape provinces as well as higher volumes in KwaZulu-Natal and the Northwest specifically. Two, increased volume of pensioner spending at merchants in Q4 of 2008, and three increased transaction volumes through the EasyPay switch.
We continued to show strong and robust growth from this business through the combination of price increases, [granting] the number of beneficiaries and the continued migration of beneficiaries to our merchant acquiring network. The total number of payments processed to beneficiaries increased from 11.43 million for Q4 of 2007 to 11.97 million for Q4 of 2008 which is an increase of 5%.
The increase is mainly due to the transfer of beneficiaries from the Post Office to ourselves in the Northwest province during fiscal 2008 which resulted in an increase of approximately 250,000 beneficiaries paid by us in this province.
Contrary to the [trading] of other provinces, the number of beneficiaries in the Eastern Cape declined slightly due to the intensive anti fraud campaign launched by government that resulted in the removal of fraudulent beneficiary.
During the last week the Department of Social Welfare in South Africa announced the implementation of new regulations allowing higher wage earners to apply for different social grants. The most significant aspect is the increase in the income threshold required to qualify for child support grants. In the past urban dwellers only qualified for child support grants if they earned 800 rand or less while in rural areas it was 1,100 rand or less. This threshold has now been increased to include people earning less then 2,200 rand per month in all areas.
According to a statement by the Social Development Minister over a million people who were excluded before will now be in a position to apply for a social grant. Using a rule of thumb, this implies that at least 400,000 of these potential new grant recipients will be in our current provinces. These qualifiers would have to apply for the grants and go through the approval process which takes some time and we don’t expect to see an increase in numbers due to these new regulations until Q3 or Q4 of fiscal 2009.
During Q4 of 2008 our merchant acquiring system continued its impressive performance as we processed a total of 2.2 billion rand in transactions through our merchant acquiring network which is an increase of 24% compared to 1.78 billion rand during Q4 2007 and a sequential increase of 8% compared to the 1.63 billion rand during Q3 of 2008 or on a completed pay cycle basis.
The productivity of our installed terminal base of 4,394 terminals increased to 956 transactions processed through a terminal during the fourth quarter of 2008 pay cycles compared to 810 transactions processed during Q4 of 2007 and 953 processed during the preceding quarter. This increased through put from the comparable period in fiscal 2007 demonstrates the continued rapid acceptance rate of our cardholders as they become familiar with and accustomed to the convenience associated with our merchant acquiring initiative as they can receive and spend their grants at any time of the month.
During Q4 of 2008 EasyPay processed 133.4 million transactions with an approximate value of 51 billion rand compared with 114.2 million transactions processed with an approximate value of 25.1 billion rand during Q4 of 2007 and 129.2 million transactions processed with an approximate value of 28 billion rand during Q3 or the previous quarter of 2008.
The average fee per transaction during Q4 of 2008 was approximately 22 South African cents as opposed to the 20 cents for both Q2 and Q3 of 2008. This increase is the result of the change in product mix during the quarter. We expect the average fee per transaction to remain between 20 to 22 cents during the first quarter of 2009. EasyPay’s operating margins are steadily improving as the efficiencies of our new operating platforms and expense management systems become apparent.
The EasyPay operating margin for Q4 improved to 44% from 34.1% in Q3 mainly due to higher volumes of value-added services processed during the last quarter. Our Smart Card account segment had revenues of 65.9 million rand for Q4 of 2008 which is an increase of 4% year-over-year. The total number of active Smart Card accounts increased by 4% from 3.8 million during Q4 of 2007 to 4 million during Q3 of 2008, sequentially there was a 2% increase in the number of active Smart Card accounts.
Our financial services business had revenues of 15 million rand for Q4 of 2008 which is a decrease of 26% compared to Q4 of 2007 and a sequential increase of 1% compared to Q3 of 2008. Revenues from our traditional micro lending business decreased during the quarter due to increased competition, our strategic decision not to growth this business and overall lower return on traditional micro lending loans as a result of compliance with The National Credit Act. Revenues from UEPS based lending decreased during Q4 of 2008 compared with Q4 of 2007 primarily due to the lower number of loans granted.
In addition on average the return on these UEPS based loans was lower during Q4 2008 compared with Q4 2007. The final operating segment is our hardware, software and related technology sale segment. This segment traditionally includes revenues that occur on an irregular or [once-off] basis and it can be difficult to predict sales from year to year. This segment includes the sales of UEPS rated hardware and software as well as the sales of subscriber identity modules or SIM cards, cryptography services, and SIM card licenses.
This segment had revenues of 107.7 rand for Q4 of 2007 which is an increase of 16% year-over-year mainly as the result of the delivery of hardware and customization and development activities performed during the quarter related to the tender to provide Ghana with a national switch and Smart Card system from which we generated revenues of approximately $3.4 million during Q4. To date we have recognized revenues amounting to $14.2 million relating to the Ghana contract.
The operating margin of this segment decreased from 27% for Q4 of 2007 to 15% in Q4 2008 mainly as a result of significant high margin sells to Nedbank in Q4 2007 as well as the impact of the specific services rendered to Ghana during the last quarter. In February 2008, the South African Finance Minister announced a reduction in the corporate rate of taxation for South African companies from 29% to 28%. We only recognize changes in taxation legislation applicable in South Africa in our reported results once it has been promulgated in South Africa.
The change in the corporate rate of taxation for South African countries had not been promulgated as of June 30, 2008 at our year end, the change in the corporate rate of taxation for South African companies was enacted on the 22 of July, 2008 and we will reflect the change in our fully distributed rates during the first quarter of fiscal 2009. Our fully distributed tax rate will therefore decrease from 35.45% to 34.55%.
I am very happy with the progress made by our equity account investments in Namibia, Botswana, Columbia, and Vietnam. The fledgling businesses continue to grow and have exciting prospects in terms of business development as Serge had indicated before. On a GAAP basis our quarterly net income of 167.6 million rand represents an increase of 54% year-over-year and GAAP earnings per share increased by 34% on a constant currency basis while fundamental earnings per share for Q4 2008 increased by 34% compared to Q4 2007 and also increased by 8% compared to the previous quarter.
The GAAP net income for Q3 was significantly higher then in Q4 due to the adjustment of our effective tax rate in Q3 caused by the reduction from 12% to 10% in the [SCC] rate in South Africa. Before turning to our balance sheet I would again like to mention that our cash provided for operating activities can and does fluctuate significantly as a result of the planning of the commencement of our monthly welfare payment activities specifically through merchants. As a general rule however, we expect 100% or more cash conversion ratio over any complete pay cycle period. As of June 30, 2008 we had $272.5 million of cash and cash equivalents. The business remains very cash generative and I remain comfortable 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.
As I’ve stated before I view the balance sheet item called pre-funded social welfare grants receivables as a highly liquid very short-term receivable best described as a near-term equivalent. We had $35.4 million of pre-funding outstanding at the end of June. The decrease in our accounts receivable compared with June 30, 2007 is largely due to all provincial governments paying us the amounts outstanding before June 30, 2008.
Our other payables include amounts due to merchants. The increase is primarily due to merchants receiving settlement of the grants distributed on the last day of Q4 2008 in the first two days of Q1 2009. Our default income tax liabilities have decreased significantly mainly as a result of the reduction in our fully distributed tax rate during Q3 of 2008. As discussed in question 15 of the Frequently Asked Question section of our earnings press release we believe it most appropriate at this point in time to retain our cash reserves to finance the expansion of the business, to reduce the significant cost of our current and possible future prefunding of welfare grant obligations, and to execute relevant acquisition opportunities such as the BGS acquisition announced yesterday with which I would like to do now.
The financial information I am about to provide for BGS is based on Austrian GAAP and measured in Euros and is therefore classified as a non-GAAP measurement. We acquired BGS for a total cash consideration of approximately 71.5 million Euros and by issuing 40,154 Net1 shares, locked up for a period of one year to the management shareholders of BGS. Our cash offer was based on an earnings multiple of 15 for BGS’s most recent fiscal year that ended on December 31, 2007 implying a profit after-tax number for that year of 5.75 million Euros.
During the same fiscal year the revenue of BGS was 17.2 million Euros and the operating margin was 39%. I must emphasize that a significant portion of BGS’s activities are similar to those of our hardware and software and related technology sale segment and that the margins are significantly influenced by product mix and customer requirements. We are in the process of performing the required US GAAP conversion as well as the allocation of the purchase price and we intend to file a Form 8-KA with illustrative financial effects around mid-November, 2008.
We expect that a significant portion of the purchase price will be allocated to intangible assets. The cash acquisition price was financed by a six month bank loan as we have South African exchange control restrictions on our ability to use our rand cash reserves for non-South African acquisitions. However we are in the process of filing an application for a secondary listing of Net1 also known as an inward listing on the Johannesburg Stock Exchange in South Africa, call the JAC Securities Exchange.
Our primary listing will remain on the NASDAQ and we will not raise any additional capital as a result of this inward listing. Should we be successful with our application we will be able to simplify our capital structure by converting all the current special convertible preferred shares of which we have approximately 4.9 million to common stock. These shares are already included in our earnings per share calculations and the conversion will therefore not result in any EPS dilution.
We have also received permission from the South African regulators to repay the loan accounts due to our South African subsidiary to the US holding company and to redeem the B Clause preferred stock held by the US holding company in its South African subsidiary. These repayments should result in the flow of approximately $108 million at current exchange rates from our South African business to our US holding company. We will be able to affect these repayments as soon as the secondary listing process is completed which we anticipate to be during October of 2008.
We intend to settle the bank loan we are paying for the BGS acquisition with the proceeds as there is no penalty for the early settlement of the loan.
In conclusion fiscal 2008 was another exceptionally busy year and we are thrilled with the overall results and the quality of earnings. Given the amount of corporate activities, the timing of the SASSA tender outcome, and our various international business initiatives it is very difficult to provide concise earnings guidance for fiscal 2009 as Serge indicated before.
Based on the assumption that our current business activities and initiatives will continue as usual we expect to grow our fundamental earnings per share by at least 15% on a constant currency basis for fiscal 2009.
With that we are now happy to take your questions.
(Operator Instructions) Your first question comes from the line of Dave Koning - Robert W. Baird
Dave Koning - Robert W. Baird
As we look out in the core South African business how do you see grant growth in fiscal 2009 and then revenue per grant growth in fiscal 2009 just given all the dynamics with inflation etc. that are going on?
Obviously we’ll be influenced by a number of factors. The inflation rate in South Africa remains very high currently, 12.9% being the latest indicator and clearly also with us being in an election year the chances of the grant amounts being increased by anything less then inflation I personally think is fairly remote. So from that point of view, specifically in terms of the KwaZulu-Natal province where we get an automatic increase when the grant amounts go up, it certainly will grow the earnings in our biggest province quite significantly. So we will also obviously receive our price increases based on the current inflation rates in the other provinces as and when they become due and they are scattered during, throughout the year.
But the key one will be KwaZulu-Natal and the increase from the budgets allocation will probably only become effective in the fourth quarter of fiscal 2009. From a higher volume point of view, I think that’s a bit more unclear to us. SASSA doesn’t provide us with any specific details and looking at the press release that we got from the Ministry they talk about a million people who will now qualify for grants simply because they’ve increased the minimum thresholds. Again the time taken to process those applications that will come in from the various provinces, and if we use the rule of thumb and they say a million people, we could probably expect us to have at least 400,000 of those in our provinces if not more because I think a high concentration of these guys that will now qualify are probably going to be more rural then urban based.
But be that as it may, the application process, the evaluation process and until they really end up on the pay file for us to pay them, could be at least four to six months. So again I don’t think that we’ll see the numbers starting to tick up significantly as a result of this announcement at least until the end of the third quarter or the beginning of the fourth quarter of 2009. Overall we always say that we budget on a 6% growth rate in terms of the beneficiary numbers. I think if you look at the last year it’s slightly less then that, its 5%. Given all the developments within SASSA and the time they’ve spent on the tender and other processes and obviously also with the removal of quite a number of beneficiaries from the fraud eradication campaign, I think that that still is probably a fairly conservative guideline to use and in terms of price increases, given that our increases in most of the provinces are normally around 80% of the [CBI] rate, we probably look at a further 10% increase from a price increase point of view and that will obviously also be phased in during the months of the year when those increases become due in the various provinces.
Dave Koning - Robert W. Baird
One thing you didn’t mention on the call that was interesting out of the 10-K was in Botswana it looks like you’re starting a welfare beneficiary payment program sort of like in South Africa granted its only 100,000 or so beneficiaries, but what are the economics around that? Is it similar to the $3.00 or so per month that you get paid in South Africa and how big over time could Botswana be? Is that something that could be a million beneficiaries a couple of years from now?
Dr. Serge Belamant
No, Botswana is not likely to be a million beneficiaries, there’s not enough people in Botswana to give us that. We are looking at a country with around 1.8 million so the first 100,000 beneficiaries obviously we are going to be getting a price which is comparable to what we’re getting in South Africa. Obviously its in Pulas and not in rand, but remember we only own 50% of the switch which means obviously we will only be getting 50% of whatever the revenue is going to be, or the profit will be in that particular switch itself.
Personally I think the potential for Botswana in terms of number of people is between 300,000 and 400,000 simply because we are in discussions with a number of organizations including their local savings bank which really was an offshoot of the government or used to be owned by government so it should, if we look at the number of people that could be [banked] namely for example the guys that are now receiving a grant, all the people that already bank which have got a savings account or the people that are banked through a bank, we probably looking at about 400,000 to 450,000 people.
So I believe that our numbers will go up from 100,000 to maybe 250,000 to 300,000 but I think by the time it gets to that stage I think it will be saturated in terms of the number of people. That does not mean of course that those people can only generate the money that is currently being paid to us simply because we are paying them on behalf of government. Obviously by introducing financial services and all sorts of other products such as specifically bill payments and for example top up on cell phones and prepaid electricity and money transfers specifically, I think we can we can certainly [inaudible] with Africa, probably double the revenue that we are making, double to even 2.5x the revenue we’re making per person in Botswana.
So it’s [the same as looking like you said] the potential is around 700,000 or 800,000 people if we take it purely by paying them a salary every month.
Dave Koning - Robert W. Baird
Within your guidance is BGS looked at as accretive or dilutive or neutral to fiscal 2009?
Obviously on a fundamental basis, if we exclude the material amortization of the intangibles that will obviously arise, and without the benefit of having completed the full US GAAP conversion, using a rule of thumb if we look at the interest that we will forego on the loan and obviously on the surplus cash that we will then use to repay the loan compared to the earnings that BGS reported last year adjusted for some of the growth prospects, I think the safest bet right now is to say it will probably be neutral and as soon as we’ve got the 8-KA out in November, I think we’ll be able to give you a bit more color around that.
Your next question comes from the line of Dhruv Chopra - Morgan Stanley
Dhruv Chopra - Morgan Stanley
Could you help us understand how should we [inaudible] the contributions from Ghana, Iraq and which payments in fiscal 2009?
Dr. Serge Belamant
Well Ghana, it’s a little difficult to put them all in the same pot because as you know the models are completely different so from the Ghanaian point of view we’ve got to look at the fact that Ghana as you know has been very successful. You’re going to be going through there yourself so you’re going to see it. But more importantly it appears that Ghana is about to place substantial new orders certainly for terminals at this point in time and ATMs as well as cards. So there is no doubt that we still believe that over the next six months, the next two quarters, we will certainly get new orders coming out of Ghana.
The next thing in Ghana that we’ve got to look at is that if we manage to launch which I know the Deputy Governor wants us to, the cellular phone technology by the last, well the last couple of months of this year, there is no doubt that I know that Brenda has negotiated a slightly different deal whereby we would be able to benefit by a transaction fee on all transactions that actually occur through the cell phone technology which is a little bit better then simply selling them a card and waiting to make a margin.
So it’s a little bit early to say to you apart from the royalty that we are getting, apart from the maintenance that we are getting, apart from delivering the existing orders of equipment and we’ve got new orders of equipment, new orders for ATMs, point-of-sale and cards, there is also the potential of transaction fees as well. As well as one or two JVs that we are currently looking at in Ghana, namely for example the JV to set up with Central Bank in terms of providing top up facilities for cellular phones.
So all of those if we had to add them all up, it’s a question of now transforming Ghana from purely a sales of hardware and software and licenses to a transaction model and that of course will make a huge difference to what Ghana will be maybe not in 2009 but certainly what Ghana can become towards the end of 2009 and beginning of 2010. So that’s that Ghanaian thing. And obviously we can’t treat Ghana the same as we will treat either [switch] payment in South Africa because I explained that there are seven different initiatives today in [switch] payment in South Africa, all of them run independently by different people.
And each one of them generates basically an account for us in Grindrod bank and its an account which is set at around the 20 rand which is the $3.00 per month and of course after that you’re making transaction fees on anything else that is going to be sold or managed through that account specifically financial services, or any other transacting facility such as for example money transfers, bill payments, electricity, water and top ups. So this is a different model entirely and we would have to look and I think we’re going to have to spend some time with you and the other analysts to actually explain to you these seven different models because some address micro finance, some address schools, another one which nobody wants to talk about addresses prisons, which of course you know is something that lots of people don’t want to touch but we’re talking 1.5 to 2 million people.
So all of these things have got different financial parameters attached to them and obviously Herman over the next couple of months will certainly be able to come out and to explain to the analysts first and foremost what these new models look like and are these new models going to grow in essence our customer base or people that are banked through UEPS technology. So I think it’s very difficult right now, we thought going into a lot of detail, to actually go through and been able to say this is what’s going to happen.
Dhruv Chopra - Morgan Stanley
So just to be clear, you’ve already foregone how you’ve got existing orders out there, I think maybe 2.5 million or so of hardware and software rolled over for 2008, plus another 8 million of orders I think already placed, right? Other then that it sounds like you haven’t really factored in a lot of these other things in terms of quantification in your expectations for 2009?
Dr. Serge Belamant
You know that we never factor anything in that we don’t already have signed. We don’t work that way. We only tell our investors something that we are not percentage wise certain about, we only tell investors what we know we can deliver. So you are 100% right that at the end of the day, we haven’t looked at Iraq for example and you know yourself that the Iraqi model is based on transaction revenue kicking off at 10% of the top line. If what we are hearing from Iraq is obviously happens, namely we’re looking at 3 million cards to 4 million cards over the next two years and you’re looking at a 10% top line on a transaction fee of maybe $0.70 to $0.80 US that gives you a little feel that Iraq itself can deliver $0.50 million to $0.75 million a month for us which will be bottom line.
That contract is in place that’s working and there is no reason why it should not happen but we tend to be I think a little maybe sometime too conservative but its difficult to change what you’ve been for 25 years. So you are right, we always look at what we know we have, what we know exists, and what we know will be delivered. Everything else as far as we’re concerned on top of that is just a bit of cream on the top.
Dhruv Chopra - Morgan Stanley
On SASSA have you got any feedback from the High Courts as you approach them?
Dr. Serge Belamant
We did approach the High Courts, the High Courts can [inaudible] because ours was an urgent application as you know and they told us that in fact the application as far as they were concerned should not be urgent and they rationale was is that when SASSA awards the tender if we are not happy with anything in the award of the tender the Judge gave us the latitude to then re approach him as an urgent application this time in order for them to suspend any negotiation of the SLAs until our queries have been resolved. So if SASSA actually awards the tender there is a possibility they might actually award a tender that we might like in which case there wouldn’t be any point in actually for us to go to Court to actually stop the tender from being actually implemented.
If on the other hand the tender is awarded and we don’t like it, he has given us the latitude to go back as an urgent application to actually say, hey, you are right maybe something out there actually went wrong or should not have happened in this particular manner in which case he will then be able to actually look at the case and to suspend if necessary the implementation of the contract.
Dhruv Chopra - Morgan Stanley
What was the fully diluted share count for the fourth quarter?
I think you could probably use 59 million shares as a fully diluted number that includes obviously all of the options, the outstanding options, that’s really the only additional factor. So the weighted average fully diluted number is 57,612 million and on an un-weighted basis it’s probably close to I would say 58,700, no 59.
Your final question comes from the line of Unspecified Analyst
The BGS acquisition on the partner [Spurbank] were they the existing shareholder?
Dr. Serge Belamant
Yes, the BGS had nine shareholders, of which [Spurbank] was an existing shareholder, they had 19.9% of the shares in BGS before. When we made the offer to the other shareholders in BGS we discussed this with [Spurbank] and we decided with their consent to leave them in as a shareholder and to make the offer only for the other 80.1% of the shares which is obviously what we’ve now acquired. So [Spurbank] remains as a very willing I hope and happy co-shareholder with us and for us that’s very important to have them remain a shareholder. They are the biggest customer of BGS by a long, long way. There are more then 5 million duet cards issued through [Spurbank] in the Russian federation and we believe that with them as partners in BGS and also being the largest client that there is significant opportunity for us to grow the cardholder base on the one hand and also to implement a variety of value-added services on top of the cards that are already there.
The wage payment system, how many employers and employees have signed up for that so far?
When we’re talking about the wage payment system like I explained in terms of being able to, you’re looking at for example number of employers we’ve been able to sign up in excess of about 20 farms now that are actually using the technology. But more important because of this problem we have had with the delay of MasterCard we have been more focusing of signing up in cardholders, in other words employees rather than employers simply because the card in terms of its interoperability cannot really currently be used everywhere. So what we plan to do is that we’ve said that if a person is already banked and let’s say he has a standard bank or an [SNB] account we actually keep that account open for him and we look for somebody that is prepaid to carry the cost of $3.00 a month to have, for lack of a better word, an intermediate account with us.
And a lot of these people happen to be people that to take grants, short-term loans simply because they’re quite happy to carry the $3.00 a month if that $3.00 a month gives them the benefit of being able to do a deduction, a debit whereby they know that they will have a better chance to guarantee to be repaid so and fortunately we haven’t been able to strike at the employer level but we are certainly striking in a big way at the employee level. That base however happens to be a base that other open systems like a prison because those people don’t have to integrate with anybody, which is a lucky thing about that, they don’t even interoperate between prisons, the schools of course are great because these are closed systems which later on can be open because initially they only work within the school, and the rest of the people are people that have to really be who’s account has to be funded by somebody else that benefits by paying the $3.00 a month.
So our initiatives have really changed over the last quarter simply because of the inability of MasterCard to deliver to us the stuff that we need to be able to co-brand this card and to create automatically interoperability in the South African market. So all of that’s a question of is focused on the employers, I think we should rather look at the employees and the people that in fact are on the system today. Now if we look at the schools, if we look at the food [parcel] initiative with some black empowerment initiative, the food parcel is another initiative we’ve done for a lot of our people that have to open an account at Grindrod before they have access to a much lower cost food parcels, we’re talking about a couple hundred thousand people which is absolutely fantastic to have but its not through the model that we had discussed six months ago which was an employer action rather then an employee action.
The result is the same at the end of the day, it doesn’t really make any difference but the bottom line is, is that we are still awaiting and we have still got a huge sales force and people that have committed to come in from an employer point of view but we cannot put that out otherwise the system will simply fail because of lack of interoperability.
I know it’s in the 10-K that the share buyback expired, are there any plans to renew that?
Dr. Serge Belamant
What we are doing now, I think Herman mentioned about the second relisting of, the inward listing in South Africa, in order for us to make, to be able to do a share buyback we need to have access to our rand in US dollar terms. Now right we cannot do it because of the exchange control. If of course we do, we manage to lift in South African and we manage to repatriate the money that Herman is talking about we will then also be in a position to payback dividends without the huge, or without needing approval which means then we will be in a position to actually have in place if we wish to have it a share buyback which is a tangible thing that we can really service.
To everybody on the call we’d like to once again to thank you all for number one, listening. Number two reading over the information that we try to provide as concisely as we can and more importantly would like to thank our long-term shareholders for continually believing in the company. We know it’s been hard. We know that SASSA has thrown a lot of unfortunately question marks on our company. We of course being here, don’t believe that those question marks are necessarily justified but we can certainly understand why people will react they way they have.
In conclusion I’m certainly convinced that I do not see any reason at all why our company will not continue to strive and at the rate that we are going. We really are striving and reaching a point where in fact SASSA over the next couple of years will no longer become part of these discussions. So thank you very much all of you for listening and we certainly look forward to talking to all of you very soon. Thank you.
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