Net 1 UEPS Technologies Inc. Attachment D. FAQ
Net 1 UEPS Technologies, Inc. Attachment D FREQUENTLY ASKED QUESTIONS
1. What is the status of the SASSA tender and on what basis did Net1 submit a proposal?
Net1 submitted ten proposals in response to the SASSA tender on Friday, May 4, 2007. We submitted a proposal for each one of South Africa's nine provinces and a separate proposal for the country as a whole. SASSA provided an indicative time-frame for the evaluation of the tender proposals and the award of the contract to successful bidders, but some of the key dates have already been missed. According to the tender specification, the new contracts will commence on April 1, 2008 and our existing contracts have all been extended to March 31, 2008. We expect SASSA to complete the tender evaluation process before the end of December 2007, or otherwise extend the existing contracts until SASSA is ready to make a decision.
2. How will the tenders be adjudicated?
The tenders will be adjudicated by a committee appointed by SASSA. The submissions will be evaluated in terms of the following 100-point scoring system:
-- Technological solution: 60 points -- Financial proposal: 30 points -- Black economic empowerment procurement objectives: 10 points
3. How does Net1 view its chances of success for the SASSA tender and who are the competitors?
We are confident that we will at least maintain our existing market share in the social grant payment business in South Africa for the following main reasons:
-- our successful track record with our provincial government contracts over an extended period of time; -- our unique UEPS technology and biometric identification systems that enables us to effect secure off-line payments -- especially in rural areas where communications infrastructure is limited or non-existent; -- our unique solution that gives SASSA the flexibility to utilize various distribution methods to conduct beneficiary registration, electronic voucher generation, electronic voucher distribution, proof of life and pay-out and payment transacting. Our solution is based on simplifying the existing processes and providing significantly improved convenience to beneficiaries to access and receive their grants; -- our financial strength that enables us to arrange finance for the significant amount of money required to pre-fund social grants in any, or all of the provinces, which is a requirement of the tender; and -- our commitment to the principles of black economic empowerment, underscored by our demonstrable high levels of employment equity, financial participation by local black partners, preferential procurement policies and community upliftment programs.
However, as this is a competitive tender process, there can be no assurance that we will retain any or all of our existing contracts.
We believe the other bidders who will participate in the process consist of the major South African banks and the other contractors currently engaged in the grant payment business, being Allpay (Pty) Ltd (a subsidiary of ABSA Bank) and Empilweni Payout Services (Pty) Ltd.
4. How will the pricing for any future contracts with SASSA change from the current base?
Our pricing proposals are obviously confidential during this stage of the tendering process and we cannot reveal any details of what we have proposed. Should we be successful with some or all of our proposals, the final pricing will depend on the options selected by SASSA and the service level agreement negotiations. As soon as we have finality on these prices upon completion of the tender process, we will provide a detailed update on the financial implications for Net1.
5. Can any interested party, such as an investor or analyst, talk to SASSA about the tenders and the process?
Please refrain from contacting SASSA during the tender process as the tender evaluation process is conducted in a secure and confidential manner.
6. How do you forecast growth in beneficiary numbers?
There are no official beneficiary growth forecasts. We forecast beneficiary numbers using the budgeted expenditure on social welfare grants provided in the South African government's budget, taking into account that the amount budgeted for is a function of beneficiary numbers, as well as the average amount paid to each beneficiary class. Based on past experience and an analysis of the information at hand, we anticipate beneficiary growth of approximately 6% per annum. The growth in beneficiary numbers is fairly "lumpy" and is influenced by factors such as the government's marketing and registration programs and the time taken by SASSA to process new grant applications.
7. What is the status of the wage payment system implementation with Grindrod Bank and how will Net1 derive income from the relationship with Grindrod Bank?
In January 2007, we signed a co-operation agreement with Grindrod Bank, a fully registered bank in South Africa, for the establishment of a retail banking division within Grindrod Bank that will focus on deploying our wage payment solution in South Africa. Under the agreement, Grindrod Bank is responsible for the human resources, administration, compliance, risk management and financial affairs of the division. Net1 is responsible for the supply and maintenance of all UEPS hardware and software required to implement and run its wage payment system, for which it will charge a monthly fee per smart card account at Net1's cost price, and will receive ongoing fee payments based on the amount of business transacted by the division utilizing the UEPS technology. Net1 is assisting Grindrod Bank with the implementation of the business plan and operational activities and both parties have contributed $0.7 million (ZAR 5 million) to assist with the set-up costs of the division. The division reports to an executive committee consisting of two Net1 and two Grindrod representatives.
Net1 and Grindrod Bank commenced with the establishment of the division during the third quarter of fiscal 2007. During the establishment phase, all the relevant technological platforms will be installed, where required, or integrated between Net1 and Grindrod. Grindrod Bank, with Net1's assistance, has also initiated the process that will enable it to become a member of the South African National Payment System and the various payment clearing houses in South Africa and significant progress was made in this regard during the fourth quarter of fiscal 2007. Our project plan to achieve these goals consists of 150 different tasks that were initiated during the last six months. A key milestone already achieved is the Payments Association of South Africa, or PASA, granting Grindrod Bank provisional membership. We expect the process of obtaining membership of the various payment clearing houses in South Africa to be completed during the second quarter of fiscal 2008. In parallel, Net1 and Grindrod Bank have defined the products, pricing and marketing strategy for the wage payment system. During the fourth quarter of fiscal 2007, Net1 and Grindrod Bank commenced pilot operations of the wage payment system and 1,807 people, mainly in the agricultural sector, were registered, issued with smart cards and paid. During the first quarter of fiscal 2008, the pilot will be extended to cover multiple employers in a specific geographic area, where after the solution will be made available on a national basis.
8. What is the size of the market opportunity for the wage payment system and how successful will Net1 and Grindrod Bank be in penetrating this market? What goals have been set and when will the first customers be signed up?
The target markets for the wage payment system are the un-banked and under-banked wage earners in South Africa, estimated at five million people. These wage earners are typically paid in cash on a weekly, bi-weekly or monthly basis and have all the risks associated with cash payments, but none of the benefits associated with having a formal bank account. Net1 and Grindrod Bank plan to offer these wage earners a UEPS smart card that will allow the card holder to receive payment, transact and access other financial services in a secure, cost-effective way.
We market the wage payment system to medium and large employers and to trade unions. The value proposition presented to employers focuses on the following key features:
-- Safety -- Security risks associated with cash transportation and short- payment disputes are eliminated; -- Cost-effectiveness -- Our wage payment solution is significantly cheaper than the current cost to employers of preparing and distributing cash pay packets; -- Improved productivity -- Our solution obviates the need to set aside valuable production time to physically pay employees; and -- Convenience -- With our system, wages can be distributed off-line at any time, and financial products, such as cash advances, can be offered to the employee without placing any administrative burden on the employer.
Our value proposition to unions and employees has the following key elements:
-- Safety -- The personal safety risk of carrying cash is eliminated; -- Security -- Our smart cards can only be used in conjunction with biometric verification and are completely loss tolerant -- no money is lost if the card is lost or stolen; -- Convenience -- Our cards can be used at any participating retailer or service provider at any time. Card holders can obtain cash from any participating retailer, eliminating the need to search for an available ATM; -- Cost effectiveness -- Our solution is significantly cheaper than any other bank product, as we recover our fees mainly from employers, merchants and service providers; and -- Access to credible and affordable facilities, such as money transfers, loans, interest paying savings, life insurance and third party payments.
During the fourth quarter of fiscal 2007, Net1 and Grindrod Bank commenced pilot operations of the wage payment system and 1,807 people, mainly in the agricultural sector, were registered, issued with smart cards and paid. During the first quarter of fiscal 2008, the pilot will be extended to cover multiple employers in a specific geographic area, where we already have a strong presence in terms of infrastructure, and where there is a pressing need for our solution from the mining, agricultural and fishing industries. Our target is to have a customer base of at least 1.5 million customers after three years of operation.
9. What is Net1's strategy in expanding the UEPS technology outside South Africa?
Our strategy to introduce the UEPS technology outside of South Africa consists of the following key components:
The financial implications to Net1 of a new SmartSwitch implementation consist of the following elements:
-- Sale of hardware and software licenses to the SmartSwitch: Net1 provides all the necessary hardware and software licenses to any new SmartSwitch on market-related and arms-length terms, regardless of whether we are a shareholder in the SmartSwitch. If we are a shareholder in the SmartSwitch, we eliminate the appropriate portion of the profit on the sale of hardware and software licenses to the SmartSwitch in our reported financial statements. Any ongoing sales of hardware, additional software licenses, customization and maintenance services are treated in the same manner. -- Transaction fees, license fees and profit sharing: We receive annual license fees from any new switch that has been licensed with our technology. In some cases, we also negotiate a transaction fee payable to us for each transaction processed through the SmartSwitch. If we are a significant minority shareholder in the SmartSwitch, as is the case with SmartSwitch Namibia and SmartSwitch Botswana, we will include the financial results of the SmartSwitch in our reported financial statements on an equity accounting basis. If we are the majority shareholder in a SmartSwitch, such as SmartSwitch Nigeria, we consolidate the financial results of the SmartSwitch as part of the Net1 group. Our business plans and experience indicate that a SmartSwitch implementation will generally break even, on an operating profit basis, after twelve months of operation. We expect the SmartSwitch to generate revenues of $0.50 per card holder per month after another year of operation, increasing to $3.00 per cardholder after five years of operation. These numbers are indicative only and are dependent on several factors such as the relevant territory's income per capita, the products and applications launched, currency strength and the size of the cardholder base. -- Investment in the SmartSwitch: Where we participate as a shareholder in a SmartSwitch, we contribute our share of the capital required to establish and fund the business pro-rata to our shareholding by way of subscribing for equity and shareholders' loans. 11. What is the status of SmartSwitch Nigeria?
We have completed the SmartSwitch Nigeria computer room which houses the UEPS backend processing hardware and software in Nigeria. In addition, the switch has been commissioned and the required Nigerian staff have been appointed and trained. A key milestone achieved during the fourth quarter of fiscal 2007 was the approval SmartSwitch Nigeria received from the Central Bank of Nigeria to:
-- conduct a multi-lateral clearing and settlement system that will allow other financial institutions to participate in the switch; and -- utilize the UEPS smart card as a payment system in Nigeria.
Diamond Bank, one of Nigeria's largest banking institutions, has ordered 50,000 smart cards from us for their initial deployment into a village community bank later this year.
One of SmartSwitch Nigeria's initial objectives is to have an impact on the financial industry in Nigeria, where approximately 90% of the population of 140 million people is un-banked and transacts in cash. SmartSwitch Nigeria's other objectives will be to deploy the UEPS technology through several applications, including banking, health care, money transfers, pre- paid utilities and telephony and voting. SmartSwitch Nigeria, as a member of the CHAMS consortium, tendered to provide the Nigerian government with a multi-purpose smart card. The multi-purpose card tender comprises:
-- a national identity authentication/ verification system, -- a government financial payments for services system, and -- an affordable banking solution.
The Nigerian government has awarded the above tender jointly to the two shortlisted bidders, the CHAMS and IRIS consortia. Negotiations are currently underway to define the responsibilities of each of the consortia, which will ultimately determine the role of SmartSwitch Nigeria in this tender.
12. What is the Ghana contract all about?
In June 2007 we were awarded the National Switch and Smart Card Payment System tender by the Central Bank of Ghana. The tender was issued pursuant to the vision of the Central Bank of Ghana to provide the Ghanaian financial services industry access to a robust technological platform that will allow for the switching of all existing payment instruments and introduce a new biometrically protected smart card designed to deliver affordable financial services to the majority of Ghanaian citizens. We believe this to be the first time that a national electronic payment system will allow so many different technologies to inter-operate with each other for the benefits of all stakeholders.
The initial contract value for the delivery, installation and customization of the switch and UEPS hardware and software is estimated at approximately US$20 million. The solution will be implemented over the first three quarters of fiscal 2008 and is designed to achieve interoperability between all the existing ATM's, POS's and teller terminals owned by individual banks, will deploy new ATM's and POS's which will be connected directly to the new processing system and will introduce our UEPS smart card to be issued by the switch and all Ghanaian banks. The system will also incorporate a card risk management applet as well as the ability to provide biometric protection to PIN-based applications as an additional, but independent, verification process.
We expect to generate an ongoing license fee based on the number of smart cards acquired for use through the Ghanaian national switch, as well as ongoing revenues from hardware and software maintenance and ongoing sales of hardware.
13. What territories are currently being targeted and how long is the sales cycle?
We target any developing economy where the advantages of our payment system are obvious and in demand. The sales cycle in any new territory, although very difficult to predict, generally spans several months (in some cases, years) as a myriad of factors need to be considered, such as the corporate regulatory environment, central bank requirements, tax regimes, compilation of business plans, etc. Our strategic goal is to enter and introduce our UEPS technology in at least four new territories, of any size, during a twelve month period.
14. What is VTU and how does the revenue model work?
VTU, or Virtual Top Up, facilitates mobile phone-based pre-paid airtime vending. The VTU technology enables prepaid cell users to purchase additional airtime simply, securely and conveniently through the distribution of airtime value from a vendor's cellular handset to that of the customer, as opposed to through the use of a voucher. We derive revenue from the sale of VTU licenses to mobile operators and we have recently established VTU businesses in Colombia and Vietnam, where we are minority shareholders in companies that will provide a VTU service to prepaid cell phone users. These businesses will generate revenue by charging a percentage of the value of the airtime distributed through VTU.
15. What are your new patents for mobile payments all about?
Our latest patents incorporate our UEPS and SIM card expertise into a system that will seamlessly bridge mobile phones to existing payment infrastructures such as ATM's, POS devices, the Internet and voice channels. The application of these patents will allow any mobile phone user to effect payments that are generally referred to as "card not present" payments completely securely, through the utilization of a once off, disposable, virtual credit or debit card.
16. Why is the Net1 Financial Services segment constantly declining in revenue and profit?
We offer UEPS-based loans to our social welfare cardholders with the primary purpose of assisting them to repay expensive loans with other loan providers and to escape the debt spiral that they are trapped in. Once our UEPS-based loans are repaid, we believe that the beneficiaries have an enhanced ability to remain debt-free, or take loans in amounts smaller than the original refinancing facility we offered to them. In addition, we continuously revise the interest rates charged on our UEPS-based loans, as part of our ongoing commitment to the South African government to provide affordable financial services to the unbanked population of that country. We believe that once cardholders escape the debt spiral they will have more disposable income to spend, including through our merchant acquiring base.
Revenues and profit from our traditional microlending business have decreased due to our strategic decision not to grow this business, increased competition and lower interest rates charged on traditional microlending loans.
In addition, the final phase of the National Credit Act (No. 34 of 2005), or NCA, became effective in South Africa on June 1, 2007. The NCA has impacted our traditional and UEPS-based lending activities in South Africa. In compliance with the provisions of the NCA, we are permitted to charge an initiation fee and a service fee on all traditional and UEPS-based lending activities as well as levy interest on a monthly basis. Our management has decided, effective June 1, 2007, to cease charging interest on all new UEPS- based lending activities and now charges a service fee. The fees generated from new UEPS-based lending activities approximate the interest that was historically generated from these activities. We were required, effective June 1, 2007, to reduce the interest charged on all new traditional lending activities and introduce a fee for initiation and servicing of all the new loans. The interest and fees generated from new traditional lending activities approximate the interest that was historically generated from these activities. Our management has included, and will continue to include in the foreseeable future, the initiation and service fees in the financial services segment.
As the NCA regulates fees and interest charged on micro-lending loans and imposes obligations prior to granting of credit to individuals, we are unable to predict the impact on our financial services segment revenues and operating income for the year ended June 30, 2008, as a result of the introduction of the NCA from June 1, 2007.
17. What is the "pre-funded social welfare grant receivable" line item on the balance sheet?
We have a unique cash flow cycle due to our obligations to pre-fund the payments of social welfare grants in the KwaZulu-Natal and Eastern Cape provinces. We provide the funds required for the grant payments on behalf of these provincial governments from our own cash resources and are reimbursed within two weeks by the KwaZulu-Natal and Eastern Cape governments, thus exposing ourselves to these provinces' credit risk. In addition, through our merchant acquiring system, we may also pre-fund social welfare grants in the provinces where we operate. These obligations result in a peak funding requirement, on a monthly basis, of approximately $48.0 million (ZAR 340 million) for each of the KwaZulu-Natal and Eastern Cape contracts. The funding requirements are at peak levels for the first three weeks of every month during the year.
The actual quantum of Net1's cash reserves should be evaluated by regarding this highly liquid, very short-term government receivable as a near- cash equivalent.
18. How does Net1 view its investor relations function?
We believe that a proper investor relations function requires a full-time employee that is intricately involved with the group's daily activities and operations. We are at the final interview stage with suitable candidates and expect to make an announcement in this regard soon. In the interim, we have formulated the following plan to address the immediate needs of our investors:
-- Our Vancouver based IR team, consisting of Randy Saunders and Bill Espley, will continue to handle all initial communication with prospective investors and supply investor packs and historical information. The Vancouver office can be reached at +1 (604) 484-8750 or toll free at 1-866-412-NET1 (6381). -- We have also set up a communication matrix that will allow our Vancouver team to access the relevant persons in Net1 to answer any technical or accounting queries. Any such queries can be directed to the Vancouver office, from where Randy and Bill will communicate with the designated person in Johannesburg to obtain the answers and respond to the query. -- We understand that our key shareholders desire to speak directly to executive management, regardless of the existence of an IR function. Any request to talk to the executive management team should be directed to the Vancouver office, where Randy and Bill will access our diaries to schedule any meeting requests. -- The executive management team will continue to visit the United States at least twice a year, specifically to meet with analysts and investors. -- We welcome visits by all shareholders and analysts to our head office and operations in South Africa. Any scheduling requests should be given to the Vancouver office and we will confirm the appointment as soon as we can. 19. How are you growing the management team?
During the last year, we made significant progress in strengthening the Net1 management team. Our acquisition of Prism provided us with a pool of IT professionals who have been integrated into the Net1 research and development environment and we now have forty IT professionals who are working full time on the enhancement, customization and maintenance of our UEPS flagship. We have also appointed senior Prism managers to oversee our in-house legal function as well as our Easypay, cryptography, VTU, SIM card development and production activities.
We have appointed three senior managers to assist Brenda Stewart, our senior vice-president of marketing and sales with project management, marketing and implementation activities on a global basis. We have also appointed a senior manager to oversee the established activities of our international and SmartSwitch operations and we have created an investment forum to consider all aspects of prospective investments in new territories.
Our finance, administration, human resources, compliance and treasury functions are growing continuously to provide a high level of support to the group.
Finally, we have restructured and strengthened our operations teams to ensure ongoing effective management of our South African social welfare and wage payment activities.
We are committed to growing the Net1 management team to ensure that we are able to capitalize on the myriad of opportunities we are presented with on an ongoing basis.
20. What is the status of your share buy-back program?
On May 17, 2007, we announced a share buy-back program for the repurchase of up to $50 million of the Company's common stock at any time and from time to time through June 30, 2008. To date, we have repurchased 40,100 shares of our common stock.
21. What effect will the proposed abolishment of Secondary Taxation on Companies in South Africa have on Net1?
On February 21, 2007, the South African Minister of Finance announced in his National Budget speech that the National Government intends to phase out Secondary Taxation on Companies, or STC, and introduce a dividend tax at a shareholder level. Currently South African companies are required to pay STC at a rate of 12.5% on dividends distributed, subject to certain exemptions. If a dividend tax is introduced South African companies will no longer be liable to pay STC, and the shareholder will be liable to pay the dividend tax. We have not yet determined whether we would qualify for the treaty relief available to foreign shareholders.
The reform will be implemented in two phases, the first phase entailing a reduction of the STC rate, effective October 1, 2007, to 10% and the second phase, expected in 2008, a total conversion to a dividend tax. It is likely that South Africa companies will be required to withhold the dividend tax on all dividends paid.
We cannot reasonably determine whether these proposals will be enacted as proposed and we will comply with the new tax legislation once it has been enacted. We expect the proposed replacement of STC with a dividend tax to reduce our current fully distributed rate of 36.89% to 29%. In addition, under GAAP we apply the fully distributed rate of 36.89% to our deferred taxation assets and liabilities. The change in the fully distributed rate is expected to reduce our deferred taxation assets and liabilities.
Included in our earnings for the year ended June 30, 2007, is deferred income tax expense of approximately $8.3 million (ZAR 59.6 million), respectively, related to the application of the fully-distributed rate of 36.89% compared with the South African statutory rate of 29% to our Income before income tax. The following table illustrates the effect on our June 30, 2007, income tax expense, earnings per share and net deferred tax liability as if the first and second phases described above had been enacted on July 1, 2006:
Year ended June 30, 2007 Illustrative Illustrative effect effect Actual scenario 1(1) scenario 2(2) Fully distributed tax rate 36.89% 35.45% 29.00% Income tax expense $37,574 $35,920 $29,306 Net deferred tax liability reversal to net income (3) - $3,389 $16,946 Earnings per share, in U.S. cents 111.8 114.7 126.3 Net deferred tax liability as at June 30 $29,191 $23,584 $1,157
(1) Scenario 1 illustrates the reduction in the fully distributed rate from 36.89% to 35.45% had the reduction in the STC rate been enacted on July 1, 2006.
(2) Scenario 2 illustrates the abolishment of STC had this been enacted on July 1, 2006. Accordingly, the fully-distributed rate decreases from 36.89% to 29%. All South African deferred tax assets and liabilities are now measured at 29% which results in a reversal of net deferred tax liabilities recognized.
(3) The net deferred tax liability reversal to net income represents the net deferred tax liability rate adjustment as of June 30, 2006 translated at rates applicable as of June 30, 2006 assuming a) the fully-distributed tax rate, prior to the abolishment of STC, was 35.45% (potential outcome scenario 1) and b) the fully-distributed tax rate is thereafter 29% (potential outcome scenario 2).
As discussed above, we cannot reasonably determine whether, or when, these amendments will be enacted as proposed and what the ultimate effect on our reported earnings will be.
Net 1 UEPS Technologies, Inc.