UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2009
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from ____________________ to ____________________
Commission file number: 000-31203
NET 1 UEPS TECHNOLOGIES, INC. (Exact name of registrant as specified in its charter)
President Place, 4th Floor, Cnr. Jan Smuts Avenue and Bolton Road Rosebank, Johannesburg 2196 , South Africa (Address of principal executive offices, including zip code)
Registrant’s telephone number, including area code:27-11-343-2000
Not Applicable (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [ ] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X ]
As of January 31, 2010 (the latest practicable date), 45,378,397 shares of the registrant’s common stock, par value $0.001 per share, net of treasury shares, were outstanding.
Form 10-Q
NET 1 UEPS TECHNOLOGIES, INC.
Table of Contents
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Part I. Financial Information
Item 1. Financial Statements
NET 1 UEPS TECHNOLOGIES, INC. Condensed Consolidated Balance Sheets
(A) – Derived from audited financial statements
See Notes to Unaudited Condensed Consolidated Financial Statements
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NET 1 UEPS TECHNOLOGIES, INC. Unaudited Condensed Consolidated Statements of Operations
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NET 1 UEPS TECHNOLOGIES, INC. Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
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NET 1 UEPS TECHNOLOGIES, INC. Unaudited Condensed Consolidated Statements of Cash Flows
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NET 1 UEPS TECHNOLOGIES, INC. Notes to the Unaudited Condensed Consolidated Financial Statements for the Three and Six Months Ended December 31, 2009 and 2008 (All amounts stated in thousands of United States Dollars, unless otherwise stated)
1. Basis of Presentation and Summary of Significant Accounting Policies
Unaudited Interim Financial Information
The accompanying unaudited condensed consolidated financial statements include all majority-owned subsidiaries over which the Company exercises control and have been prepared in accordance with US generally accepted accounting principles (“GAAP”) and the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q and include all of the information and disclosures required for interim financial reporting. The results of operations for the three and six months ended December 31, 2009 and 2008 are not necessarily indicative of the results for the full year. The Company believes that the disclosures are adequate to make the information presented not misleading.
These financial statements should be read in conjunction with the financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2009. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments), which are necessary for a fair representation of financial results for the interim periods presented.
References to the “Company” refer to Net1 and its consolidated subsidiaries, unless the context otherwise requires. References to Net1 are references solely to Net 1 UEPS Technologies, Inc.
Translation of foreign currencies
The primary functional currency of the Company is the South African Rand (“ZAR”) and its reporting currency is the US dollar. The Company also has consolidated entities which have the euro, Russian ruble or Indian rupee as their functional currency. The current rate method is used to translate the financial statements of the Company to US dollar. Under the current rate method, assets and liabilities are translated at the exchange rates in effect at the balance sheet date. Revenues and expenses are translated at average rates for the period. Translation gains and losses are reported in accumulated other comprehensive income in shareholders’ equity.
Foreign exchange transactions are translated at the spot rate ruling at the date of the transaction. Monetary items are translated at the closing spot rate at the balance sheet date. Transactional gains and losses are recognized in income for the period.
Subsequent Events
The Company has evaluated events occurring between the end of its fiscal quarter, December 31, 2009 and February 9, 2010, when these financial statements were issued.
Recent accounting pronouncements adopted
On July 1, 2009, the Company adopted authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) regarding business combinations. This guidance retains the fundamental requirements on business combinations that the acquisition method of accounting (defined as the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination. The adopted guidance requires the acquiring entity in a business combination to recognize the assets acquired and liabilities assumed at the acquisition date. In addition, it also requires acquisition-related costs to be recognized separately from the business combination. The adopted guidance applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this authoritative guidance on business combinations has not had a material effect on the Company’s results of operations or financial position.
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1. Basis of Presentation and Summary of Significant Accounting Policies (continued)
Recent accounting pronouncements adopted (continued)
On July 1, 2009, the Company adopted authoritative guidance issued by the FASB regarding non-controlling interests. This guidance establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that does not result in deconsolidation. It clarifies that all of those transactions are equity transactions if the parent retains its controlling financial interest in the subsidiary. The adopted guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. However, the adopted guidance shall be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. Accordingly, the Company’s consolidated balance sheet as of June 30, 2009 and unaudited condensed consolidated statement of operations and unaudited condensed consolidated statement of cash flows for the three and six months ended December 31, 2008, has been revised to conform to the new presentation requirements.
On July 1, 2009, the Company adopted Statement of Financial Accounting Standards No. 168, The “FASB Accounting Standards CodificationTM” and the Hierarchy of Generally Accepted Accounting Principles, (“FAS 168”). FAS 168 establishes the FASB Accounting Standards CodificationTM(“Codification”) as the single source of authoritative US GAAP recognized by the FASB to be applied by nongovernmental entities. FAS 168 is effective prospectively from July 1, 2009 and has superseded all existing non-SEC accounting and reporting standards. Following FAS 168, the FASB has issued new guidance in the form of Accounting Standards Updates (“Update”).
On July 1, 2009, the Company adopted Update 2009-01, (Topic 105) Generally Accepted Accounting Principles amendments based on Statement of Financial Accounting Standards No. 168, The “FASB Accounting Standards CodificationTM” and the Hierarchy of Generally Accepted Accounting Principles, (“Update 2009-01”). Update 2009-01 amends the Codification for the issuance of FAS 168. Update 2009-01 is effective prospectively from July 1, 2009.
On July 1, 2009, the Company adopted authoritative guidance issued by the FASB which delays the effective date of guidance for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. In addition, the Company adopted guidance which requires disclosure about fair value of financial instruments for interim reporting periods. The adoption of this authoritative guidance has not had a material effect on the Company’s results of operations or financial position.
On July 1, 2009, the Company adopted authoritative guidance issued by the FASB which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under current guidance. The intent of the new guidance is to improve the consistency between the useful life of an intangible asset determined and the period of expected cash flows used to measure the fair value of the asset under. The adopted guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The adoption of this authoritative guidance has not had a material effect on the Company’s results of operations or financial position.
On July 1, 2009, the Company adopted authoritative guidance issued by the FASB regarding unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. The Company issued restricted stock during fiscal 2010, 2009 and 2007 and these instruments are considered participating securities as they are eligible to receive non-forfeitable dividend equivalents at the same rate as common stock. The adopted guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Prior period basic earnings per share have been retrospectively adjusted to reflect the impact of the adoption.
On July 1, 2009, the Company adopted guidance issued by the FASB which requires an acquirer in a business combination to recognize, at fair value, an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period. The adopted guidance is effective for business combinations whose acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this authoritative guidance has not had a material effect on the Company’s results of operations or financial position.
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On October 1, 2009, the Company adopted Update 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash—a consensus of the FASB Emerging Issues Task Force (“Update 2010-01”), as codified in Accounting Standards Codification (“ASC”) 505, “Equity.” Update 2010-01 clarifies the treatment of certain distributions to shareholders that have both stock and cash components. The stock portion of such distributions is considered a share issuance that is reflected in earnings per share prospectively and is not a stock dividend. The adoption of this Update did not have a material effect on the Company’s results of operations or financial position; however, it may affect any future stock distributions.
On October 1, 2009, the Company adopted Update 2010-02, Consolidation (Topic 810) Accounting and Reporting for Decreases in Ownership of a Subsidiary—a Scope Clarification (“Update 2010-02”), as codified in ASC 810, “Consolidation.” This Update clarifies the applicable scope of ASC 810 for a decrease in ownership in a subsidiary or an exchange of a group of assets that is a business or nonprofit activity. The Update also requires expanded disclosures. The adoption of this Update did not have a material effect on the Company’s results of operations, however, it may affect future divestitures of subsidiaries or groups of assets within its scope.
Recent accounting pronouncements not yet adopted as of December 31, 2009
In June 2009, the FASB issued guidance which changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities of the other entity that most significantly impact the other entity’s economic performance. This new guidance also requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. This new guidance is effective for financial statements issued for fiscal years and interim periods within those fiscal years beginning after November 15, 2009. Early adoption is not permitted. The Company is currently evaluating the impact of the adoption of this new guidance.
In October 2009, the FASB issued Update 2009-13, Revenue Recognition (Topic 605) Multiple Deliverable Revenue Arrangements, (“Update 2009-13”). This Update provides amendments to the criteria in subtopic 605-25 of the Codification for allocating the consideration between the elements in a multiple-deliverable arrangement. The amendments establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor specific objective evidence (“VSOE”) if available, third party evidence if VSOE is not available, or estimated selling price if neither VSOE or third party evidence is available. It replaces the term fair value in the revenue allocation with selling price to clarify that the allocation of revenue is based on entity specific assumptions rather than the assumptions of a market place participant. This amendment will eliminate the residual method of allocation and require that arrangement consideration be allocated using relative selling price method. It will also significantly expand the disclosures related to vendor’s multiple-deliverable revenue arrangements. The amendment will be effective prospectively for revenue arrangements entered into or materially modified in fiscal year beginning on or after June 15, 2010. Early adoption is permitted. The Company is currently evaluating the impact of the adoption of Update 2009-13.
In October 2009, the FASB issued Update 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (a consensus of the FASB Emerging Issues Task Force) (“Update 2009-14”). Update 2009-14 amends ASC 985-605, “Software: Revenue Recognition,” such that tangible products, containing both software and non-software components that function together to deliver the tangible product’s essential functionality, are no longer within the scope of ASC 985-605. It also amends the determination of how arrangement consideration should be allocated to deliverables in a multiple-deliverable revenue arrangement. This Update will become effective for us for revenue arrangements entered into or materially modified on or after July 1, 2010. Earlier application is permitted with required transition disclosures based on the period of adoption. The Company is currently evaluating the impact of the adoption of Update 2009-14. Both Update No. 2009-13 and Update No. 2009-14 must be adopted in the same period and must use the same transition disclosures.
In December 2009, the FASB issued Update 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, (“Update 2009-17”). Update 2009-17 amends the guidance for consolidation of VIEs primarily related to the determination of the primary beneficiary of the VIE. This ASU will become effective for us on July 1, 2010. The Company is currently evaluating the impact of the adoption of Update 2009-17.
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Recent accounting pronouncements not yet adopted as of December 31, 2009(continued)
In January 2010, the FASB issued Update 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements, (“Update 2010-06”). Update 2010-06 amends ASC 820 and clarifies and provides additional disclosure requirements related to recurring and non-recurring fair value measurements and employers’ disclosures about postretirement benefit plan assets. This Update became effective for us on January 1, 2010. The Company is currently evaluating the impact of the adoption of Update 2010-16.
2. Pre-funded social welfare grants receivable
Pre-funded social welfare grants receivable represents amounts pre-funded by the Company to certain merchants participating in the merchant acquiring system. The January 2010 payment service commenced during the last four days of December 2009 and was offered at merchant locations only.
3. Inventory
The Company’s inventory comprised the following categories as of December 31, 2009 and June 30, 2009.
4. Fair value of financial instruments and equity-accounted investments
Fair value of financial instruments
Risk management
The Company seeks to reduce its exposure to currencies other than the ZAR through a policy of matching, to the extent possible, assets and liabilities denominated in those currencies. In addition, the Company uses financial instruments in order to economically hedge its exposure to exchange rate and interest rate fluctuations arising from our operations. The Company is also exposed to equity price and liquidity risks as well as credit risks.
Currency exchange risk
The Company is subject to currency exchange risk because it purchases inventories that it is required to settle in other currencies, primarily the euro and US dollar. The Company has used forward contracts in order to limit its exposure in these transactions to fluctuations in exchange rates between the ZAR, on the one hand, and the US dollar and the euro, on the other hand.
The Company’s outstanding foreign exchange contracts are as follows:
As of December 31, 2009
As of December 31, 2008
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4. Fair value of financial instruments and equity-accounted investments (continued)
Fair value of financial instruments (continued)
Equity Price and Liquidity Risk
Equity price risk relates to the risk of loss that the Company would incur as a result of the volatility in the exchange-traded price of equity securities that it holds and the risk that it may not be able to liquidate these securities. On March 1, 2009, the Company acquired approximately 22% of the issued share capital of Finbond Group Limited (“Finbond”), which are exchange-traded equity securities. The fair value of these securities as of December 31, 2009, represented approximately 2% of the Company’s total assets, including these securities. The Company expects to hold these securities for an extended period of time and it is not concerned with short-term equity price volatility with respect to these securities provided that the underlying business, economic and management characteristics of the company remain sound.
The market price of these securities may fluctuate for a variety of reasons, consequently, the amount the Company may obtain in a subsequent sale of these securities may significantly differ from the reported market value.
Liquidity risk relates to the risk of loss that the Company would incur as a result of the lack of liquidity on the exchange on which these securities are listed. The Company may not be able to sell some or all of these securities at one time, or over an extended period of time without influencing the exchange traded price, or at all.
Financial instruments
The following section describes the valuation methodologies the Company uses to measure financial assets and liabilities at fair value.
Investments in common stock
In general, and where applicable, the Company uses quoted prices in active markets for similar assets or liabilities to determine fair value. This pricing methodology would apply to Level 1 investments. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then the Company uses quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. These investments would be included in Level 2 investments. In circumstances in which inputs are generally unobservable, values typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. Investments valued using such techniques are included in Level 3 investments.
The Company's Level 3 asset represents an investment of 84,632,525 shares of common stock of Finbond. The Company’s ownership interest in Finbond, as of December 31, 2009 is approximately 22%. The Company has no rights to participate in the financial, operating, or governance decisions made by Finbond. The Company also has no participation on Finbond’s board of directors whether through contractual agreement or otherwise. Consequently, the Company has concluded that it does not have significant influence over Finbond and therefore equity accounting is not appropriate.
Finbond’s shares are traded on the JSE, and consequently are within the scope of FAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (Topic 320); the Company has designated such shares as available for sale investments. Pursuant to FSP 157-3, however, the Company has concluded that the market for Finbond shares is not active and consequently has employed alternative valuation techniques in order to determine the fair value of such stock. Currently, the operations of Finbond include primarily mortgage brokering services and microlending. In determining the fair value of Finbond, the Company has considered amongst other things Finbond’s historical financial information (including its most recent public accounts), press releases issued by Finbond and its published net asset value. The Company believes that the best indicator of fair value of Finbond is its published net asset value and has used this value to determine the fair value.
Derivative transactions - Foreign exchange contracts
As part of the Company’s risk management strategy, the Company enters into derivative transactions to mitigate exposures to foreign currencies using foreign exchange contracts. These foreign exchange contracts are over-the-counter customized derivative transactions. Substantially all of the Company’s derivative exposures are with counterparties that have long-term credit ratings of BBB or better. The Company uses quoted prices in active markets for identical assets and liabilities to determine fair value. The Company has no derivatives that require fair value measurement under level 1 and 3 of the fair value hierarchy.
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Financial instruments (continued)
The following table presents the Company’s assets measured at fair value on a recurring basis as of December 31, 2009 according to the fair value hierarchy:
Assets and liabilities measured at fair value on a nonrecurring basis
The Company measures its equity-accounted investments at fair value on a nonrecurring basis. The Company has no liabilities that are measured at fair value on a nonrecurring basis. These equity-accounted investments are recognized at fair value when they are deemed to be other-than-temporarily impaired.
In accordance with the provisions of APB No. 18, The Equity Method of Accounting for Investments in Common Stock (Topic 323), the Company reviews the carrying values of its investments when events and circumstances warrant and considers all available evidence in evaluating when declines in fair value are other-than-temporary. The fair values of the Company’s investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost of the investment exceeds its fair value and the excess is determined to be other-than-temporary. The Company determined that there was not a decline in the fair value below cost of the equity-accounted investments during the reporting periods presented herein, and therefore has not recorded an impairment charge during three and six months ended December 31, 2009.
The Company has sold hardware, software and/or licenses to SmartSwitch Namibia, SmartSwitch Botswana and VTU Colombia and defers recognition of 50% of the net income after tax related to these sales until SmartSwitch Namibia, SmartSwitch Botswana and VTU Colombia has used the purchased asset or has sold it to a third party. The deferral of the net income after tax is shown in the Elimination column in the table below.
The functional currency of the Company’s equity-accounted investments is not the US dollar and thus the investments are restated at the period end US dollar/foreign currency exchange rate with an entry against accumulated other comprehensive loss. The functional currency of SmartSwitch Namibia is the Namibian dollar, the functional currency of SmartSwitch Botswana is the Botswana pula, the functional currency of VTU Colombia is the Colombian peso and the functional currency of Vinapay is the Vietnamese dong.
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Assets and liabilities measured at fair value on a nonrecurring basis (continued)
Summarized below is the Company’s interest in equity-accounted investments as of June 30, 2009 and December 31, 2009:
(1) – includes the recognition of realized net income as described below. (2) – the foreign currency adjustment represents the effects of the combined net fluctuations between the functional currency of the equity-accounted investments and the US dollar.
Summarized below is the Company’s equity-accounted (loss) earnings for the three months ended December 31, 2009:
There were no significant sales to these investees that require elimination during the three and six months ended December 31, 2009 and 2008. During the year ended June 30, 2007, the Company sold a license to VTU Colombia and sold hardware and software to SmartSwitch Botswana. The Company recognizes this net income from these hardware and software sales during the period in which the hardware and software it has sold to SmartSwitch Namibia, SmartSwitch Botswana and VTU Colombia are utilized in its operations, or has been sold to third party customers, as the case may be.
5. Goodwill and intangible assets
Goodwill
Summarized below is the movement in carrying value of goodwill for the six months ended December 31, 2009.
(1) – the foreign currency adjustment represents the effects of the fluctuations between the ZAR and the euro against the US dollar on the carrying value of goodwill.
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5. Goodwill and intangible assets (continued)
Goodwill (continued)
Goodwill has been allocated to the Company’s reportable segments as follows:
Intangible assets
Summarized below is the carrying value and accumulated amortization of the intangible assets as of December 31, 2009 and June 30, 2009:
Aggregate amortization expense on the finite-lived intangible assets for the three and six months ended December 31, 2009, was approximately $3.7 million and $7.3 million, respectively (three and six months ended December 31, 2008, was approximately $3.4 million and $5.8 million, respectively). Future annual amortization expense is estimated at approximately $12.5 million, however, this amount could differ from the actual amortization as a result of changes in useful lives, exchange rate fluctuations and other relevant factors.
6. Short-term facilities
As of December 31, 2009, the Company had short-term facilities in ZAR of approximately $67.4 million, translated at exchange rates applicable as of December 31, 2009. As of December 31, 2009 the overdraft rate on these facilities was 9.35%, and the facility was fully undrawn. In addition, Net 1 Universal Technologies (Austria) AG (“Net1 UAT), formerly BGS Smartcard Systems AG (“BGS”) has short-term facilities of approximately $1.5 million, translated at exchange rates applicable as of December 31, 2009, with each of two of Austria’s largest banks. These facilities are available to the Company. The interest rate applicable to these short-term facilities is negotiated when the facilities are utilized. As of December 31, 2009, the Company had utilized none of its South African short-term facilities. The Company’s management believes its current short-term facilities are sufficient in order to meet its future obligations as they arise.
7. Capital structure
The Company’s capital structure is described in Note 12 to the Company’s audited consolidated financial statements included within the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2009.
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7. Capital structure (continued)
Common stock repurchases
On July 28, 2009, the Company repurchased an aggregate of 9,221,526 shares of its common stock from two shareholders, who originally acquired their shares in connection with the Aplitec transaction. The purchase price was $13.50 (ZAR 105.98) per share and was paid from the Company’s cash reserves in ZAR for an aggregate purchase price of $124.5 million (ZAR 977.3 million).
8. Earnings per share
The entire consolidated net income of the Company was attributable to the shareholders of the Company comprising both the holders of Net1 common stock and the holders of linked units prior to the Company’s listing on the JSE Limited (“JSE”). As discussed in Note 12 to the Company’s audited consolidated financial statements included within the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2009, all of the remaining linked unit holders converted their linked units to common stock in October 2008 as a result of listing of all of the Company’s common stock on the JSE. As a result of the conversion of all the linked units, the entire consolidated net income of the Company is attributable to the holders of Net1 common stock.
Basic earnings per share includes restricted stock awards that meet the definition of a “participating security” as described in FSP EITF 03-6-1 (Topic 260). Restricted stock awards are eligible to receive non-forfeitable dividend equivalents at the same rate as common stock. Basic earnings per share have been calculated using the two-class method and basic earnings per share for the three and six months ended December 31, 2009 and 2008, reflects only undistributed earnings. Basic earnings per shares for the three and six months ended December 31, 2008, have been retrospectively adjusted, as required by FSP EITF 03-6-1 (Topic 260), to include participating securities in the weighted average number of outstanding shares of common stock.
Diluted earnings per share have been calculated to give effect to the number of additional shares of common stock that would have been outstanding if the potential dilutive instruments had been issued in each period. The calculation of diluted earnings per share for the three months and six ended December 31, 2009 and 2008, includes the dilutive effect of a portion of the restricted stock awards granted to employees in August 2007 as these restricted stock awards are considered contingently issuable shares for the purposes of the diluted earnings per share calculation and as of December 31, 2009 and 2008, the vesting conditions in respect of a portion of the awards had been satisfied.
The following table details the weighted average number of outstanding shares used for the calculation of earnings per share for the three and six months ended December 31, 2009 and 2008.
(1) the weighted average number of outstanding shares have been retrospectively adjusted to conform with the requirements of FSP EITF 03-6-1 (Topic 260).
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9. Stock-based compensation
Stock option and restricted stock activity
Options
The following table summarizes stock option activity for the six months ended December 31, 2009, and 2008:
No stock options became exercisable during the three and six months ended December 31, 2009 and 2008.
No stock options were exercised during the three months ended December 31, 2009 and 2008. During the six months ended December 31, 2009 and 2008, the Company received approximately $0.3 million and $0.2 million, respectively, from stock options exercised and approximately $0.4 million and $0 million from repayment of stock option-related loans. The Company issues new shares to satisfy stock option exercises.
Restricted stock
The following table summarizes restricted stock activity for the six months ended December 31, 2009, and 2008:
The fair value of restricted stock vested during the six months ended December 31, 2009, was $3.8 million (2008: Nil).
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9. Stock-based compensation (continued)
Stock-based compensation charge and unrecognized compensation cost
The Company has recorded a stock compensation charge of $1.4 million and $1.3 million for the three months ended December 31, 2009 and 2008, respectively, which comprised:
The Company has recorded a stock compensation charge of $1.4 million and $2.6 million for the six months ended December 31, 2009 and 2008, respectively, which comprised:
The stock-based compensation charges have been allocated to cost of goods sold, IT processing, servicing and support and selling, general and administration based on the allocation of the cash compensation paid to the employees.
As of December 31, 2009, the total unrecognized compensation cost related to stock options was approximately $5.7 million, which the Company expects to recognize over approximately four and a half years. As of December 31, 2009, the total unrecognized compensation cost related to restricted stock awards was approximately $5.8 million, which the Company expects to recognize over approximately two years.
As of December 31, 2009, the Company has recorded a deferred tax asset of approximately $0.9 million related to the stock-based compensation charge recognized related to employees of Net1 as it is able to deduct the grant date fair value for taxation purposes in the United States.
10. Operating segments
The Company discloses segment information in accordance with FASB SFAS 131, Disclosures about Segments of an Enterprise and Related Information (Topic 280), which requires companies to determine and review their segments as reflected in the management information systems reports that their managers use in making decisions and to report certain entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenues.
The Company currently has four reportable segments: Transaction-based activities, Smart card accounts, Financial services and Hardware, software and related technology sales. Each segment, other than the Hardware, software and related technology sales segment, operates mainly within South Africa. The Company’s reportable segments offer different products and services and require different resources and marketing strategies and share the Company’s assets.
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10. Operating segments (continued)
The Transaction-based activities segment currently consists mainly of a state pension and welfare benefit distribution service provided to provincial governments in South Africa, transaction processing for retailers, utilities and banks and transaction fees generated from UEPS-enabled smartcards used in Iraq. Fee income is earned based on the number of beneficiaries included in the government pay-file as well as from merchants and card holders using the Company’s merchant retail application. In addition, utility providers and banks are charged a fee for transaction processing services performed on their behalf at retailers. This segment has individually significant customers that each provides more than 10% of the total revenue of the Company. For the three and six months ended December 31, 2009, there were three and six such customers, providing 27%, 16% and 10% and 29%, 17% and 11%, respectively, of total revenue (the three and six months ended December 31, 2008: two customers providing 30% and 12%, and 30% and 13%, respectively, of total revenue).
The Smart card accounts segment derives revenue from the provision of smart card accounts, as a fixed monthly fee per card is charged for the maintenance of these accounts.
The Financial services segment provides short-term loans as a principal and life insurance products on an agency basis and generates interest income and initiation and services fees. Interest income is recognized in the consolidated statement of operations as it falls due, using the interest method by reference to the constant interest rate stated in each loan agreement. The Company sold its traditional microlending business included in this segment on March 1, 2009, and therefore the Financial services segment for the three and six months ended December 31, 2009, comprised only the Company’s UEPS-based microlending business.
The Hardware, software and related technology sales segment markets, sells and implements the UEPS as well as develops and provides Prism secure transaction technology, solutions and services. From September 1, 2008, the segment includes the operations of Net1 UAT, which comprise mainly hardware sales and licenses of the DUET system. The segment undertakes smart card system implementation projects, delivering hardware, software and business solutions in the form of customized systems. Sales of hardware, SIM cards, cryptography services, SIM card licenses and other software licenses are recorded within this segment. This segment also generates rental income from hardware provided to merchants enrolled in the Company’s merchant retail application. Sales to SmartSwitch Nigeria Limited and the related taxation implications are not reflected in revenue to external customers, operating income, income taxation expense or net income after taxation presented in the tables below.
Corporate/Eliminations includes the Company’s head office cost centers in addition to the elimination of inter-segment transactions.
The Company evaluates segment performance based on operating income. The following tables summarize segment information which is prepared in accordance with GAAP:
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The segment information as reviewed by the chief operating decision maker does not include a measure of segment assets per segment as all of the significant assets are used in the operations of all, rather than any one, of the segments. The Company does not have dedicated assets assigned to a particular operating segment. Accordingly, it is not meaningful to attempt an arbitrary allocation and segment asset allocation is therefore not presented.
It is impractical to disclose revenues from external customers for each product and service or each group of similar products and services.
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11. Income tax in interim periods
For the purposes of interim financial reporting, the Company determines the appropriate income tax provision in accordance with the guidance in APB Opinion 28, Interim Reporting (Topic 740), and FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods (Topic 740). Accordingly, the tax charge is calculated by first applying the effective tax rate expected to be applicable for the full fiscal year to ordinary income. This amount is then adjusted for the tax effect of significant unusual or extraordinary items that are reported separately, and have an impact on the tax charge. The cumulative effect of any change in the enacted tax rate, if and when applicable, on the opening balance of deferred tax assets and liabilities is also included in the tax charge as a discrete event in the interim period in which the enactment date occurs.
For the three and six months ended December 31, 2009, the tax charge was calculated using the expected effective tax rate for the year (34.55%) . Our effective tax rate for the three and six months ended December 31, 2009, was 36.7% and 37.4%, respectively.
The Company increased its unrecognized tax benefits by $0.1 million and $0.3 million during the three and six months ended December 31, 2009. As of December 31, 2009, the Company had accrued interest related to uncertain tax positions of approximately $0.1 million on its balance sheet.
The Company does not expect the change related to unrecognized tax benefits will have a significant impact on its results of operations or financial position in the next 12 months.
The Company files income tax returns mainly in South Africa, Austria, the Russian Federation and in the US federal jurisdiction. As of December 31, 2009, the Company is no longer subject to income tax examination by the South African Revenue Service for years before December 31, 2005. The Company is subject to income tax in other jurisdictions outside South Africa, none of which are individually material to its financial position, statement of cash flows, or results of operations.
12. Subsequent events
In January 2010, the Company acquired 100% of MediKredit Integrated Healthcare Solutions (Pty) Ltd (“MediKredit”) for ZAR 74 million (approximately $10 million) in cash after all regulatory approvals were obtained. MediKredit is a South African private company that offers transaction processing, financial and clinical risk management solutions to both funders and providers of healthcare. The Company has not concluded the allocation of the purchase price to the acquired assets and liabilities.
On February 5, 2010, the Company’s Board of Directors authorized the repurchase of up to $50 million of the Company's common stock. The authorization does not have an expiration date.
The share repurchase authorization will be used at management’s discretion, subject to limitations imposed by SEC Rule 10b-18 and other legal requirements and subject to price and other internal limitations established by the Board. Repurchases will be funded from the Company’s available cash. Share repurchases may be made through open market purchases, privately negotiated transactions, or both. There can be no assurance that the Company will purchase any shares or any particular number of shares.
The authorization may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, liquidity and other factors that management deems appropriate.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
Forward-looking statements
Some of the statements in this Quarterly Report on Form 10-Q constitute forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed, implied or inferred by these forward-looking statements. Such factors include, among other things, those listed under “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended June 30, 2009. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of such terms and other comparable terminology.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we do not know whether we can achieve positive future results, levels of activity, performance, or goals. Actual events or results may differ materially. We undertake no obligation to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform those statements to reflect the occurrence of unanticipated events, except as required by applicable law.
You should read this Quarterly Report on Form 10-Q and the documents that we reference herein and the documents we have filed as exhibits hereto and which we have filed with the Securities and Exchange Commission completely and with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.
Business Developments During Fiscal 2010
South Africa
SASSA update
The South Africa Social Security Agency, or SASSA, has not yet released a request for tender and accordingly we continue to provide our service under the one year extension which expires on March 31, 2010. We continue to believe it likely that SASSA will provide current service providers with an extension, however, we can not accurately predict the period of such extension, if any.
Progress of wage payment implementation
Under our wage payment initiative, we continue to enroll employees at our existing corporate customers as well as pursue business development activities with additional prospects. To support future growth, we are adding and training management and business development staff dedicated to wage payment. We recently appointed a dedicated general manager for our Financial Services Cluster, who will focus exclusively on growing our UEPS-based lending and wage payment initiatives.
Acquisition of MediKredit Integrated Healthcare Solutions (Pty) Limited, or MediKredit
In January 2010, we completed the acquisition of 100% of MediKredit, a South African private company, for a purchase price of ZAR 74 million (approximately $10 million). MediKredit offers transaction processing, financial and clinical risk management solutions to both funders and providers of healthcare.
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We believe that MediKredit will provide us the opportunity to expand our technology to another adjacent market and to cross-sell our payment technologies. Management believes that the acquisition is strategically important for the following reasons:
MediKredit expands our position as the leading independent transaction processor in South Africa. Our market leadership in the merchant processing space (through EasyPay) in South Africa will be complemented by the acquisition of the South African market leader in the healthcare transaction processing space. Management believes that the South African government’s stated intention to implement a national health insurance program will create significant opportunities going forward for MediKredit and us. MediKredit has 165 employees and provides its services to approximately 5,000 health care providers in South Africa (90% of total market size), 90 healthcare plans (60% of total market size), 12 healthcare administrators (65% of total market size) and processed 60 million transactions during calendar 2008. MediKredit also owns a globally unique national coding system for all pharmaceutical, surgical and healthcare consumable products, the National Pharmaceutical Product Index, or NAPPI, product suite, which has become the national electronic standard for the transfer of information throughout the healthcare delivery chain in South Africa.
The acquisition will expand our offering in some of our existing markets like Ghana and Nigeria, where national health insurance schemes have been introduced and where the UEPS platform and installed card base could offer a complete national solution when combined with the MediKredit system.
MediKredit provides us with a small, strategic entry point for the US healthcare administration market. The rapidly changing US healthcare and administration industry provides a significant opportunity for the introduction of MediKredit’s technology. MediKredit’s wholly owned subsidiary in the US, XeoHealth Corporation, recently launched its proven Real Time Adjudication rules engine for the health care industry in the US.
Enhancement of our technology platforms and IT development resources. We both operate similar back-end systems, which require skilled developers and technicians. The addition of MediKredit would significantly broaden our base of qualified development employees.
Increase in the depth and diversity of our management team with the addition of experienced executives. The MediKredit management team has significant experience in the healthcare industry, which has always been a key focus area and potential market entry point for us.
Outside South Africa
The African Continent and Iraq
During the second quarter of fiscal 2010, we recorded revenue from transaction fees and the delivery of smartcards under our contract with the government of Iraq. During early January 2010, we passed a key milestone in the implementation of this contract by enrolling the one-millionth beneficiary and also received additional orders for 800,000 UEPS-enabled smart cards and 1,500 point of sale devices. We expect to generate ongoing revenues from these sales as well as transaction fees under our Iraqi contract during the third quarter of fiscal 2010. We have entered the second phase of our initiative in Ghana and now generate recurring income in the form of hardware and software maintenance fees.
We continue to service our current customers on the African continent and in Iraq. Our UETS business unit continued its business development efforts in multiple new countries on the African continent during the quarter.
During the second quarter of fiscal 2010, SmartSwitch Namibia generated incremental transaction fees from prepaid airtime and electricity transactions and transactions conducted between merchants and UEPS-enabled smartcards in Namibia. SmartSwitch Botswana generated transaction fees during the second quarter of fiscal 2010 from the payment of food voucher grants and sold hardware to merchants participating in the food voucher program. We expect SmartSwitch Namibia and Botswana to continue generating transaction fees during the third quarter of fiscal 2010.
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Net 1 Universal Technologies (Austria) AG, or Net1 UAT
BGS Smartcard Systems AG, or BGS, has changed its name to Net1 UAT.
Net1 UAT’s operations are seasonal and the first quarter and third quarters are historically its weakest. Growth at Net1 UAT during the second quarter of fiscal 2010 continued to be adversely impacted by our transitioning of its business model from a hardware and software sale-oriented company to one which generates recurring transaction fees, as well as by challenging economic conditions in Eastern Europe. During the second quarter of fiscal 2010, Net1 UAT delivered 20,000 POS devices and PIN pads under its contract with the National Bank of Uzbekistan, or NUTA, and in January 2010 marked its 15th anniversary of the creation of the National Payment System of Uzbekistan – UZKART. Net1 UAT continues to pursue further business development opportunities within its geographical markets. For the fiscal third quarter of 2010, we expect revenue from Net1 UAT to decline due to seasonality and weak market conditions.
Net1 Virtual Card
During the second quarter of fiscal 2010, we increased our business development efforts of our Virtual Card offering in the continental United States and surrounding territories and successfully demonstrated, in a live environment, this product to a number of prospective partners, including mobile operators, banks and card associations.
Critical Accounting Policies
Our unaudited condensed consolidated financial statements have been prepared in accordance with US GAAP, which requires management to make estimates and assumptions about future events that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities. As future events and their effects cannot be determined with absolute certainty, the determination of estimates requires management’s judgment based on a variety of assumptions and other determinants such as historical experience, current and expected market conditions and certain scientific evaluation techniques.
Critical accounting policies are those that reflect significant judgments or uncertainties, and potentially may result in materially different results under different assumptions and conditions. Management has identified the following critical accounting policies that are described in more detail in our Annual Report on Form 10-K for the year ended June 30, 2009.
Refer to Note 1 of the unaudited condensed consolidated financial statements for a full description of recent accounting pronouncements adopted as of December 31, 2009, including the expected dates of adoption and effects on financial condition, results of operations and cash flows.
Refer to Note 1 of the unaudited condensed consolidated financial statements for a full description of recent accounting pronouncements not yet adopted as of December 31, 2009, including the expected dates of adoption and effects on financial condition, results of operations and cash flows.
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Currency Exchange Rate Information
Actual exchange rates
The actual exchange rates for and at the end of the periods presented were as follows:
We are required to translate our results of operations from ZAR to US dollars on a monthly basis. Thus, the average rates used to translate this data for the three and six months ended December 31, 2009 and 2008, vary slightly from the averages shown in the table above. The translation rates we use in presenting our results of operations are the rates shown in the following table:
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Results of operations
The discussion of our consolidated overall results of operations is based on amounts as reflected in “Item 1 – Financial Statements” which are reported in US dollars and are prepared in accordance with US GAAP. Our discussion analyzes our results of operations both in US dollars and ZAR, because ZAR is the functional currency of the entities which contribute the majority of our profits and is the currency in which the majority of our transactions are initially incurred and measured. Due to the significant impact of currency fluctuations between the US dollar and ZAR on our reported results and because we use the US dollar as our reporting currency, we believe that the supplemental presentation of our results of operations in ZAR is useful to investors to understand the changes in the underlying trends of our business. Our results of operations for the three and six months ended December 31, 2008, include the operations of Net1 UAT from September 1, 2008. Net1 UAT’s operations are included in our consolidated financial statements for the entire second quarter of fiscal 2010 and 2009 and the first half of fiscal 2010.
We analyze our business and operations in terms of four inter-related but independent operating segments: (1) transaction-based activities, (2) smart card accounts, (3) financial services, and (4) hardware, software and related technology sales. In addition, corporate and corporate office activities that are impracticable to ascribe directly to any of the other operating segments, as well as any inter-segment eliminations, are included in corporate/eliminations.
Second quarter fiscal 2010 compared to the second quarter of fiscal 2009
The following factors had a significant influence on our results of operations during the second quarter of fiscal 2010 as compared with the same period in the prior year:
Consolidated overall results of operations
This discussion is based on the amounts which were prepared in accordance with US GAAP.
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The following tables show the changes in the items comprising our statements of operations, both in US dollars and in ZAR:
Analyzed in ZAR, the decrease in revenue and cost of goods sold, IT processing, servicing and support for the second quarter of fiscal 2010, was primarily due to lower sales of hardware, software and related technologies, which was partially offset by higher revenues in our transaction-based activities operating segment.
Our operating income margin for the second quarter of fiscal 2010 increased to 40% from 37% for the second quarter of fiscal 2009. We discuss the components of the operating income margin under “—Results of operations by operating segment”.
Analyzed in ZAR, selling, general and administration expenses decreased during the second quarter of fiscal 2010 primarily due to fewer regulatory and consulting fees incurred during fiscal 2010. Selling, general and administration expenses include the stock-based compensation charge related to the stock options awarded in the May 2009 and restricted stock granted in August 2009.
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Our direct costs of maintaining a listing on Nasdaq and obtaining a listing on the JSE, as well as compliance with the Sarbanes-Oxley Act of 2002, or Sarbanes, particularly Section 404 of Sarbanes, includes independent directors’ fees, legal fees, fees paid to Nasdaq and the JSE, our compliance officer’s salary, fees paid to consultants who assist with Sarbanes compliance and fees paid to our independent accountants related to the audit and review process. This has resulted in expenditures of $0.5 million (ZAR 3.7 million) and $0.4 million (ZAR 4.3 million) during the second quarter of fiscal 2010 and 2009, respectively.
Depreciation and amortization and deferred tax expenses increased during fiscal 2010 primarily as a result of the RMT acquisition, as summarized in the tables below:
Property, plant and equipment acquired to provide administration and distribution services to our customers is depreciated over the shorter of expected useful life and the contract period with the provincial government. Through December 31, 2009, we were in an extension phase with all our contracts thus and the majority of our property, plant and equipment related to the administration and distribution of social welfare grants had been fully depreciated in prior periods. Accordingly, depreciation expense related to these activities decreased during the second quarter of fiscal 2010 compared with the second quarter of fiscal 2009. This reduction in depreciation was partially offset by the increase in depreciation related to new back-end processing computers and our participating merchant POS terminals.
The foreign exchange gain during fiscal 2009 resulted from an asset swap arrangement (in the form of a 32-day call account instrument) that we entered into in connection with the short-term bank financing we obtained to fund the Net1 UAT acquisition. The call account instrument was repaid to us with accrued interest on October 16, 2008.
Interest on surplus cash for the second quarter of fiscal 2010 decreased to $2.2 million (ZAR 16.3 million) from $5.1 million (ZAR 50.0 million) for the second quarter of fiscal 2009. The decrease in interest on surplus cash held in South Africa was due to a lower average daily ZAR cash balance during the second quarter of fiscal 2010 compared with the second quarter of fiscal 2009 and lower deposit rates resulting from the adjustment in the South African prime interest rate from an average of approximately 15.39% per annum for the second quarter of fiscal 2009 to 10.50% per annum for the second quarter of fiscal 2010. The lower cash balances resulted primarily from our repurchase of our shares from Brait S.A’s investment affiliates in August 2009.
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Included in interest expense is the facility fee of approximately $0.4 million (ZAR 3.5 million) that we paid to the lender under the short-term loan facility we obtained to fund the Net1 UAT acquisition and approximately $0.3 million (ZAR 3.2 million) interest on the short-term loan facility. Excluding the impact of this facility fee and the interest on the short-term loan facility, interest expense decreased during the second quarter of fiscal 2010 due to a decrease in the average rates of interest on our short-term facilities and the elimination of our obligation to provide prefunded social welfare grants to provincial governments. In ZAR, excluding the impact of the facility fee, finance costs decreased to $0.3 million (ZAR 2.0 million) for the second quarter of fiscal 2010 from $2.1 million (ZAR 20.3 million) for the second quarter of fiscal 2009.
Total tax expense for the second quarter of fiscal 2010 was $11.5 million (ZAR 86.5 million) compared with $17.0 million (ZAR 167.0 million) during the same period in the prior fiscal year. Our total tax expense decreased, primarily due to the foreign exchange gain discussed above. Our effective tax rate for the second quarter of fiscal 2010 was 36.7%, compared to 37.2% for the second quarter of fiscal 2009. The change in our effective tax rate was primarily due to a decrease in non-deductible expenses during the second quarter of fiscal 2010 compared to the second quarter of fiscal 2009.
Results of operations by operating segment
The composition of revenue and the contributions of our business activities to operating income are illustrated below.
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Transaction-based activities
In ZAR, the increases in revenue were primarily due to increased transaction volumes at EasyPay and a modest contribution from our pension and welfare operations.
Revenues for transaction-based activities include the transaction fees we earn through our merchant acquiring system and reflect the elimination of inter-company transactions.
Operating income margin of our transaction-based activities increased to 59% from 54%. The increase was due primarily to cost management in our pension and welfare operations, increased transaction fees from the utilization of our UEPS system in Iraq and improved margins at EasyPay.
Pension and welfare operations:
Our contract extension commenced on April 1, 2009, and expires on March 31, 2010. The new contract contains a standard pricing formula for all provinces based on a transaction fee per beneficiary paid regardless of the number or amount of grants paid per beneficiary, calculated on a guaranteed minimum number of beneficiaries per month. Under our previous contracts, depending on the province, we received either a fee per grant distributed, or per beneficiary paid, or as a percentage of the total grant amount distributed. In addition, commencing with the May 2009 pay cycle, SASSA has assumed responsibility for the pre-funding of all social welfare grants. Our average revenue per beneficiary paid will therefore remain unchanged during the current contract period. From time to time, we are requested to assist with the payment of ad-hoc special grants or benefits (such as disaster relief payments), which may be at a different rate than the standard welfare distribution price. We also receive a once-off registration fee for every new beneficiary we enroll on our system.
Key statistics of our merchant acquiring system:
The increase in the number of POS devices and number of participating UEPS retail locations since December 31, 2008, is due to increased rental or purchase of POS devices by current merchants requesting additional equipment and new merchants joining our UEPS merchant acquiring system.
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The key statistics and indicators of our merchant acquiring system during the second quarter of fiscal 2010 and 2009, in each of the South African provinces where we distribute social welfare grants are summarized in the table below:
(1) NC = Northern Cape, EC = Eastern Cape, KZN = KwaZulu-Natal, L = Limpopo, NW = North West. (2) Refers to events occurring during the quarter (i.e., based on three calendar months). (3) Refers to events occurring during the completed pay cycle.
EasyPay transaction fees:
During the second quarter of fiscal 2010 and 2009, EasyPay processed 173 million and 156 million transactions with an approximate value of $5.2 billion (ZAR 39.2 billion) and $3.7 billion (ZAR 36.2 billion), respectively. The increase in transaction volumes results from more value-added services processed by EasyPay during the second quarter of fiscal 2010 compared with 2009 and stronger than expected retail spending during the Christmas season. The average fee per transaction during the second quarter of fiscal 2010 and 2009, was $0.03 (ZAR 0.21) and $0.02 (ZAR 0.21), respectively. We expect transaction volumes to increase as a result of higher value-added services processed by EasyPay during the third quarter of fiscal 2010 compared with fiscal 2009. In ZAR, we do not expect a significant fluctuation in the average fee per transaction during the third quarter of fiscal 2010.
Operating income margin generated by EasyPay during the second quarter of fiscal 2010 and 2009, were 52% and 47%, respectively, which is lower than those generated by our pension and welfare business and reduced the operating income margins within our transaction-based activities segment. Certain EasyPay intangible assets were fully amortized at the end of fiscal 2009. Accordingly, our results for the second quarter of fiscal 2010 includes less EasyPay intangible asset amortization compared with fiscal 2009 which has resulted in a higher operating income margin at EasyPay.
Amortization of EasyPay intangible assets during the second quarter of fiscal 2010 and 2009, of $0.3 million (ZAR 2.1 million) and $0.3 million (ZAR 3.2 million), respectively, is included in the calculation of EasyPay operating margins. Operating income margin before amortization of EasyPay intangible assets during the second quarter of fiscal 2010 and 2009 was 58% and 57%, respectively.
Smart card accounts
In ZAR, revenue from the provision of smart card-based accounts decreased in proportion to the lower number of beneficiaries serviced through our SASSA contract. A total number of 3,680,888 smart card-based accounts were active at December 31, 2009, compared to 4,061,100 active accounts as at December 31, 2008. The decrease in the number of active accounts resulted from the suspension and removal of invalid or fraudulent grants by SASSA.
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Operating income margin from providing smart card accounts was constant at 45% for the second quarter of fiscal 2010 and 2009.
Financial services
On March 1, 2009, we sold our traditional microlending business to Finbond, and therefore our segment results for the second quarter of fiscal 2010 do not include any revenue or loss from this business.
Revenue from UEPS-based lending decreased primarily due to the lower number of loans granted. In addition, on average, the return on these UEPS-based loans was lower. Our current UEPS-based lending portfolio comprises loans made to elderly pensioners in some of the provinces where we distribute social welfare grants. We insure the UEPS-based lending book against default and thus no allowance is required.
We recorded a goodwill impairment of $1.8 million during the second quarter of fiscal 2009 as a result of deteriorating trading conditions of this operating segment and from our strategic decision not to grow our traditional microlending business.
Operating income margin before goodwill impairment for the financial services segment increased to 64% for the second quarter of fiscal 2010 from 21% for the second quarter of fiscal 2009 primarily due to sale of the traditional microlending business, which had an overall lower operating income margin compared with UEPS-based lending.
Hardware, software and related technology sales
The table below presents the contribution of Net1 UAT to our revenue and operating income during the second quarter of fiscal 2010 and 2009:
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In ZAR, the decrease in revenue was primarily due to lower revenues at Net1 UAT and lower ad hoc hardware and software development sales in 2010 as compared with the prior year when we recorded revenue from sales under our Ghana contract, offset marginally by increase hardware sales to Iraq. In addition, our revenues in ZAR are further impacted by the depreciation of the USD against the ZAR as sales to customers in Europe, Ghana and Iraq are primarily denominated in USD. In ZAR, the decrease in operating income was primarily due to amortization of Net1 UAT intangible assets and lower sales activity.
Amortization of Prism intangible assets during the second quarter of fiscal 2010 and 2009 was approximately $0.2 million (ZAR 1.1 million) and $0.7 million (ZAR 6.7 million), respectively, and reduced our operating income.
As we expand internationally, whether through traditional selling arrangements to provide products and services (such as in Ghana and Iraq) or through joint ventures (such as with SmartSwitch Namibia and SmartSwitch Botswana), we expect to receive revenues from sales of hardware and from software customization and licensing to establish the infrastructure of POS terminals and smart cards necessary to enable utilization of the UEPS and DUET technology in a particular country. To the extent that we enter into joint ventures and account for the investment as an equity investment, we are required to eliminate the sale of hardware, software and licenses to the investees. The sale of hardware, software and licenses under these arrangements occur on an ad hoc basis as new arrangements are established, which can materially affect our revenues and operating income in this segment from period to period.
Corporate/eliminations
The increase in our losses in this segment resulted from increases in corporate head office-related expenditure, including the effects of the increase in inflation in South Africa and stock-based compensation charges.
Our operating loss includes expenditure related to compliance with Sarbanes; non-executive directors’ fees; employee and executive salaries and bonuses; stock-based compensation; legal and audit fees; directors and officer’s insurance premiums; telecommunications expenses; property-related expenditures including utilities, rental, security and maintenance; and elimination entries.
First half of fiscal 2010 compared to the first half of fiscal 2009
The following factors had a significant influence on our results of operations during the first half of fiscal 2010 as compared with the same period in the prior year:
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Analyzed in ZAR, the decrease in revenue and cost of goods sold, IT processing, servicing and support for the first half of fiscal 2010, was primarily due to lower sales of hardware, software and related technologies, which was partially offset by higher revenues in our transaction-based activities operating segment.
Our operating income margin for the first half of fiscal 2010 increased to 40% from 39% for the first half of fiscal 2009. We discuss the components of the operating income margin under “—Results of operations by operating segment”.
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In ZAR, selling, general and administration expenses decreased during the first half of fiscal 2010 due to fewer regulatory and consulting fees incurred during fiscal 2010 and the JSE Limited listing costs of approximately $0.5 million incurred during fiscal 2009. Selling, general and administration expenses include the stock-based compensation charge related to the stock options awarded in the May 2009 and restricted stock granted in August 2009.
Our direct costs of maintaining a listing on Nasdaq and obtaining a listing on the JSE, as well as compliance with the Sarbanes-Oxley Act of 2002, or Sarbanes, particularly Section 404 of Sarbanes, includes independent directors’ fees, legal fees, fees paid to Nasdaq and the JSE, our compliance officer’s salary, fees paid to consultants who assist with Sarbanes compliance, fees paid to our independent accountants related to the audit and review process and, during fiscal 2009, fees paid to our consultants and advisors assisting with the JSE listing. This has resulted in expenditures of $1.2 million (ZAR 8.8 million) and $1.3 million (ZAR 11.8 million) during the first half of fiscal 2010 and 2009, respectively.
Property, plant and equipment acquired to provide administration and distribution services to our customers is depreciated over the shorter of expected useful life and the contract period with the provincial government. Through December 31, 2009, we were in an extension phase with all our contracts thus and the majority of our property, plant and equipment related to the administration and distribution of social welfare grants had been fully depreciated in prior periods. Accordingly, depreciation expense related to these activities decreased during the first half of fiscal 2010 compared with the first half of fiscal 2009. This reduction in depreciation was partially offset by the increase in depreciation related to new back-end processing computers and our participating merchant POS terminals.
We recognized a foreign exchange gain of $26.7 million (ZAR 234.6 million) during the first half of fiscal 2009 resulting from an asset swap arrangement we entered into in August 2008.
Interest on surplus cash for the first half of fiscal 2010 decreased to $4.9 million (ZAR 36.9 million) from $11.8 million (ZAR 103.7 million) for the first half of fiscal 2009. The decrease in interest on surplus cash held in South Africa was due to a lower average daily ZAR cash balance during the first half of fiscal 2010 compared with the first half of fiscal 2009 and lower deposit rates resulting from the adjustment in the South African prime interest rate from an average of approximately 15.45% per annum for the first half of fiscal 2009 to 10.62% per annum for the first half of fiscal 2010. The lower cash balances resulted primarily from our repurchase of our shares from Brait S.A’s investment affiliates in August 2009.
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Included in interest expense for the first half of fiscal 2009 is the facility fee of approximately $1.1 million (ZAR 9.7 million) that we paid to the lender under the short-term loan facility we obtained to fund the Net1 UAT acquisition and approximately $0.8 million (ZAR 7.3 million) interest on the short-term loan facility. Excluding the impact of this facility fee and the interest on the short-term loan facility, interest expense decreased during the first half of fiscal 2010 due to a decrease in the average rates of interest on our short-term facilities and the elimination of our obligation to provide prefunded social welfare grants to provincial governments. In ZAR, excluding the impact of the facility fee, finance costs decreased to $0.5 million (ZAR 4.2 million) for the first half of fiscal 2010 from $4.4 million (ZAR 38.7 million) for the first half of fiscal 2009.
Total tax expense for the first half of fiscal 2010 was $22.5 million (ZAR 172.8 million) compared with $26.9 million (ZAR 236.8 million) during the same period in the prior fiscal year. Deferred tax assets and liabilities are measured utilizing the enacted fully distributed tax rate. Accordingly, a reduction in the fully distributed tax rate from 35.45% to 34.55% results in lower deferred tax assets and liabilities and the net change of $3.5 million (ZAR 26.5 million) is included in our income tax expense in our unaudited condensed consolidated statement of operations for the first half of fiscal 2009. Our total tax expense decreased primarily due to the foreign exchange gain discussed above. Our effective tax rate for the first half of fiscal 2010 was 37.5%, compared to 32.7% for the first half of fiscal 2009. The change in our effective tax rate was primarily due to reduction in our fully distributed tax rate to 34.55% during fiscal 2009, offset by an increase in non-deductible expenses, including stock-based compensation charges and legal fees, during the first half of fiscal 2010 compared to the first half of fiscal 2009.
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In ZAR, the increases in revenue were primarily due to our inflation-adjusted fixed fee, ad hoc grants distributed on behalf of the South African government as well as increased transaction volumes at EasyPay. We discuss these factors in more detail below.
Operating income margin of our transaction-based activities increased to 59% from 54%. The increase was due primarily to inflation-adjusted fixed fee for the distribution of a minimum number of social welfare grants and ad hoc grants distributed on behalf of the South African government, increased transaction fees from the utilization of our UEPS system in Iraq and improved margins at EasyPay.
Refer to discussion under “—Second quarter of fiscal 2010 compared to the second quarter of fiscal 2009—Results of operations by operating segment—Transaction-based activities— Pension and welfare operations.”
During the first quarter of fiscal 2010 we paid ad hoc grants on behalf of the South Africa government which resulted in higher revenue and operating income during the first half of 2010 compared with 2009.
Continued adoption of our merchant acquiring system:
Refer to discussion under “—Second quarter of fiscal 2010 compared to the second quarter of fiscal 2009—Results of operations by operating segment—Transaction-based activities— Key statistics of our merchant acquiring system.”
During the first half of fiscal 2010 and 2009, EasyPay processed 326 million and 291 million transactions with an approximate value of $9.4 billion (ZAR 72.1 billion) and $7.7 billion (ZAR 67.9 billion), respectively. The increase in transaction volumes results from more value-added services processed by EasyPay during the first half of fiscal 2010 compared with 2009.The average fee per transaction during each of the first half of fiscal 2010 and 2009, was $0.03 (ZAR 0.22) .
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Operating income margin generated by EasyPay during the first half of fiscal 2010 and 2009, were 50% and 45%, respectively, which is lower than those generated by our pension and welfare business and reduced the operating income margins within our transaction-based activities segment. Certain EasyPay intangible assets were fully amortized at the end of fiscal 2009. Accordingly, our results for the first half of fiscal 2010 includes less EasyPay intangible asset amortization compared with fiscal 2009 which has resulted in a higher operating income margin at EasyPay.
Amortization of EasyPay intangible assets during the first half of fiscal 2010 and 2009, of $0.5 million (ZAR 4.2 million) and $0.7 million (ZAR 6.5 million), respectively, is included in the calculation of EasyPay operating margins. Operating income margin before amortization of EasyPay intangible assets during each of the first half of fiscal 2010 and 2009 was 56% and 55%, respectively.
Operating income margin from providing smart card accounts was constant at 45% for the first half of fiscal 2010 and 2009.
On March 1, 2009, we sold our traditional microlending business to Finbond, and therefore our segment results for the first half of fiscal 2010 do not include any revenue or loss from this business.
We recorded a goodwill impairment of $1.8 million during the first half of fiscal 2009 as a result of deteriorating trading conditions of this operating segment and from our strategic decision not to grow the business.
Operating income margin before goodwill impairment for the financial services segment increased to 65% for the first half of fiscal 2010 from 26% for the first half of fiscal 2009 primarily due to sale of the traditional microlending business, which had an overall lower operating income margin compared with UEPS-based lending.
Operating results include Net1 UAT for the entire first half of fiscal 2010 and from September 1, 2008, for the first half of fiscal 2009. The table below presents the contribution of Net1 UAT to our revenue and operating income during the first half of fiscal 2010 and 2009:
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In ZAR, the decrease in revenue was primarily due to lower revenues at Net1 UAT and software development sales in 2009 from sales under our Ghana contract, offset marginally by increase hardware sales to Iraq. In addition, our revenues in ZAR are further impacted by the depreciation of the USD against the ZAR as sales to customers in Europe, Ghana and Iraq are primarily denominated in USD. In ZAR, the decrease in operating income was primarily due to amortization of Net1 UAT intangible assets and lower sales activity.
During the first half of fiscal 2010 and 2009, we delivered hardware, including smart cards and terminals, to the Bank of Ghana and recognized revenue of approximately $2.3 million (ZAR 17.9 million) and $7.3 million (ZAR 63.4 million), respectively.
During the first half of fiscal 2009 we recognized revenue of $2.5 million (ZAR 19.5 million) from sales of hardware to Nedbank. Sales to Nedbank occur on an ad hoc basis and there were no significant sales during the first half of fiscal 2010.
Amortization of Prism intangible assets during the first half of fiscal 2010 and 2009, respectively, was approximately $0.3 million (ZAR 2.3 million) and $1.5 million (ZAR 13.4 million), respectively, and reduced our operating income.
Liquidity and Capital Resources
Our business has historically generated and continues to generate high levels of cash. At December 31, 2009, our cash balances were $152.9 million, which comprised mainly ZAR-denominated balances of ZAR 962.5 million ($129.8 million), US dollar-denominated balances of $12.7 million and other currency deposits, primarily euro, of $10.4 million. Our cash balances decreased from June 30, 2009, levels mainly as a result of the repurchase of our common stock from Brait S.A. and its investment entities affiliates, which decrease was offset by cash generated by operating activities. In January 2010, we paid approximately $10.0 million (ZAR 74.0 million) to acquire the outstanding claims in and 100% of the outstanding issued share capital in MediKredit.
On February 5, 2010, our Board of Directors authorized the repurchase of up to $50 million of our common stock. The authorization does not have an expiration date. The authorization may be suspended, terminated or modified at any time for any reason, including market conditions, the cost of repurchasing shares, liquidity and other factors that management deems appropriate.
We generally invest the surplus cash held by our South African operations in overnight call accounts that we maintain at South African banking institutions, and surplus cash held by our non-South African companies in the US and European money markets.
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Historically, we have financed most of our operations, research and development, working capital, capital expenditures and acquisitions through our internally generated cash. We take the following factors into account when considering whether to borrow under our financing facilities:
cost of capital;
cost of financing;
opportunity cost of utilizing surplus cash; and
availability of tax efficient structures to moderate financing costs.
We have a unique cash flow cycle due to the funding mechanism under our SASSA contact and our pre-finding of merchants. Under our SASSA contract, we receive the grant funds 48 hours prior to the provision of the service and any interest we earn on these amounts is for the benefit of SASSA. In addition, we pre-fund certain merchants who facilitate the distribution of grants through our merchant acquiring system. When grants are paid at merchant locations before the start of the payment service at pay points, we pre-fund these payments to the merchants distributing the grants on our behalf. We typically reimburse these merchants within 48 hours after they distribute the grants to the social welfare beneficiaries.
We currently believe that our cash and credit facilities are sufficient to fund our current operations for at least the next four quarters.
Cash flows from operating activities
Three months ended December 31, 2009
Net cash provided by operating activities for the second quarter of fiscal 2010 was $13.8 million (ZAR 103.6 million) compared to $45.9 million (ZAR 450.9 million) for the second quarter of fiscal 2009. The difference was due mainly to the net cash inflow during the second quarter of fiscal 2009 resulted from the foreign exchange gain.
During the second quarter of fiscal 2010 we made our first provisional tax payments of $15.8 million (ZAR 118.8 million) related to our 2010 tax year in South Africa.
During the second quarter of fiscal 2009 we made our first provisional tax payments of $9.9 million (ZAR 99.1 million) related to our 2009 tax year and our third provisional payments related to our 2008 tax year of $2.9 million (ZAR28.7 million) in South Africa. We made second provisional payments of $1.0 million (ZAR 9.9 million) related to our 2008 tax year in Europe, primarily Austria. In addition, we paid Secondary Tax on Companies, or STC, of $2.2 million (ZAR 22.3 million) related to dividends paid by New Aplitec to Net1.
Taxes paid during the second quarter of fiscal 2010 and 2009 were as follows:
We expect to pay additional first provisional payments in South Africa related to our 2010 tax year in the third quarter of fiscal 2010 of ZAR 16.6 million.
Six months ended December 31, 2009
Net cash provided by operating activities for the first half of fiscal 2010 was $50.7 million (ZAR 389.3 million) compared to $12.9 million (ZAR 113.5 million) for the first half of fiscal 2009. The difference was due mainly to the elimination of our obligation to provide prefunded social welfare grant payments on behalf of provincial governments.
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During the first half of fiscal 2010 we made an additional second provisional tax payment of $3.9 million (ZAR 29.6 million) related to our 2009 tax year in South Africa. In addition, we made a first provisional payment of $15.8 million (ZAR 118.8 million) related to our 2010 tax year in South Africa. See the table below for a summary of all taxes paid (refunded).
During the first half of fiscal 2009 we made a third provisional payment of $2.9 million (ZAR28.7 million) and an additional second provisional payment of $8.6 million (ZAR 66.9 million) related to our 2008 tax year in South Africa. In addition, we paid our first provisional tax payments of $9.9 million (ZAR 99.1 million) related to our 2009 tax year in South Africa. We paid taxes of $1.2 million related to our 2008 tax year in the United States and $1.0 million (ZAR 9.9 million) related to our 2008 tax year in Europe, primarily Austria. Finally, we paid Secondary Tax on Companies of $2.2 million (ZAR 22.3 million) related to dividends paid by New Aplitec to Net1.
Taxes paid during the first half of fiscal 2010 and 2009 were as follows:
Cash flows from investing activities
Cash used in investing activities for the second quarter of fiscal 2010 includes capital expenditure of $0.7 million (ZAR 5.2 million), primarily for the acquisition of POS devices to service our merchant acquiring system, improvements to leasehold property and the acquisition of computer equipment.
Cash used in investing activities for the second quarter of fiscal 2009 includes capital expenditure of $0.4 million (ZAR 4.3 million), related to equipment acquired for our card manufacturing facility. We were required to relocate the card manufacturing facility because our landlord gave us notice and cancelled our lease. We were required to upgrade the new premises and install new support equipment, including air-conditioning and networking, in order to commission our card manufacturing equipment.
During the second quarter of fiscal 2009 we paid $0.5 million (ZAR 4.9 million) to consultants related to the Net1 UAT acquisition. In November 2008, we acquired additional shares of VTU Colombia for approximately $0.1 million.
Cash used in investing activities for the first half of fiscal 2010 includes capital expenditure of $1.3 million (ZAR 10.2 million), primarily for the acquisition of POS devices to service our merchant acquiring system, improvements to leasehold property and the acquisition of computer equipment.
Cash used in investing activities for the first half of fiscal 2009 includes capital expenditure of $3.3 million (ZAR 28.9 million), related to six backend processing machines to maintain and expand current operations, equipment acquired for our card manufacturing facility and modifications to vehicles acquired to distribute social welfare grants.
During the first half of fiscal 2009 we paid $95.8 million (ZAR 748.2 million), net of cash received, for 80.1% of the outstanding ordinary capital of Net1 UAT, which includes approximately $0.5 million paid to consultants. During the first half of 2009 we acquired additional shares of VinaPay for approximately $0.3 million. During the first half of 2009 we acquired additional shares of VTU Colombia for approximately $0.3 million.
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Cash flows from financing activities
There were no significant cash flows from financing activities during the three months ended December 31, 2009.
During the second quarter of fiscal 2009, we repaid the $110 million short-term loan facility we obtained during August 2008 to fund the Net1 UAT acquisition. In addition, during the second quarter of fiscal 2009 we acquired 2,419,581 shares of our common stock in open market purchases for an aggregate of $24.8 million. These shares were allocated to our treasury stock.
During the first half of fiscal 2010 we repurchased, using our ZAR reserves, 9,221,526 shares of our common stock from Brait S.A. and its investment entities affiliates for $13.50 (ZAR 105.98) per share, for an aggregate repurchase price of $124.5 million (ZAR 977.3 million). In addition, we incurred costs of approximately $0.5 million (ZAR 3.9 million) related to the repurchase of these shares. During the first half of fiscal 2010, we also paid $1.3 million on account of shares we repurchased on June 30, 2009, under our share buy-back program.
During the first quarter of fiscal 2010 and 2009 we received $0.7 (ZAR 5.5 million) and $0.2 (ZAR 1.2 million), respectively, from employees exercising stock options and repaying loans.
During the first half of fiscal 2009, we received and repaid the $110 million short-term loan facility described above. In addition we paid the $1.1 million facility fee related to this facility. During the first half of fiscal 2009 we acquired 2,419,581 shares of our common stock for $24.8 million.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Capital Expenditures
All of our capital expenditures for the past three fiscal years have been funded through internally generated funds. We had outstanding capital commitments of $0.2 million as of December 31, 2009. We anticipate that capital spending for the third quarter of fiscal 2010 will relate primarily to on-going replacement of equipment used to administer and distribute social welfare grants and provide a switching service through EasyPay. We expect to fund these expenditures through internally generated funds.
We discuss our capital expenditures during the second quarter of fiscal 2010 under – “Liquidity and capital resources – Cash flows from investing activities.”
Contingent Liabilities, Commitments and Contractual Obligations
We lease various premises under operating leases. Our minimum future commitments for leased premises as well as other commitments are as follows:
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We seek to reduce our exposure to currencies other than the South African rand, or ZAR, through a policy of matching, to the extent possible, assets and liabilities denominated in those currencies. In addition, we use financial instruments to economically hedge our exposure to exchange rate and interest rate fluctuations arising from our operations. We are also exposed to equity price and liquidity risks as well as credit risks.
Currency Exchange Risk
We are subject to currency exchange risk because we purchase inventories that we are required to settle in other currencies, primarily the euro and US dollar. We have used forward contracts to limit our exposure in these transactions to fluctuations in exchange rates between the ZAR, on the one hand, and the US dollar and the euro, on the other hand. As of December 31, 2009 and 2008, our outstanding foreign exchange contracts were as follows:
Translation Risk
Translation risk relates to the risk that our results of operations will vary significantly as the US dollar is our reporting currency, but we earn most of our revenues and incur most of our expenses in ZAR. The US dollar to ZAR exchange rate has fluctuated significantly over the past three years. As exchange rates are outside our control, there can be no assurance that future fluctuations will not adversely affect our results of operations and financial condition.
Interest Rate Risk
As a result of our normal borrowing and leasing activities, our operating results are exposed to fluctuations in interest rates, which we manage primarily through our regular financing activities. We generally maintain limited investment in cash equivalents and have occasionally invested in marketable securities. The interest earned on our bank balances and short term cash investments is dependent on the prevailing interest rates in the jurisdictions where our cash reserves are invested.
Credit Risk
Credit risk relates to the risk of loss that we would incur as a result of non-performance by counterparties. We maintain credit risk policies with regard to our counterparties to minimize overall credit risk. These policies include an evaluation of a potential counterparty’s financial condition, credit rating, and other credit criteria and risk mitigation tools as our management deems appropriate.
With respect to credit risk on financial instruments, we maintain a policy of entering into such transactions only with South African and European financial institutions that have a credit rating of BBB or better, as determined by credit rating agencies such as Standard & Poor’s, Moody’s and Fitch Ratings.
Equity price risk relates to the risk of loss that we would incur as a result of the volatility in the exchange-traded price of equity securities that we hold and the risk that we may not be able to liquidate these securities. We have invested in approximately 22% of the issued share capital of Finbond Group Limited, or Finbond, which are exchange-traded equity securities. The fair value of these securities as of December 31, 2009, represented approximately 2% of our total assets, including these securities. We expect to hold these securities for an extended period of time and we are not concerned with short-term equity price volatility with respect to these securities provided that the underlying business, economic and management characteristics of the company remain sound.
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The market price of these securities may fluctuate for a variety of reasons, consequently, the amount we may obtain in a subsequent sale of these securities may significantly differ from the reported market value.
Liquidity risk relates to the risk of loss that we would incur as a result of the lack of liquidity on the exchange on which these securities are listed. We may not be able to sell some or all of these securities at one time, or over an extended period of time without influencing the exchange traded price, or at all.
The following table summarizes our exchange traded equity securities with equity price risk as of December 31, 2009. The effects of a hypothetical 10% increase and a 10% decrease in market prices as of December 31, 2009 is also shown. The selected 10% hypothetical change does not reflect what could be considered the best or worst case scenarios. Indeed, results could be far worse due both to the nature of equity markets and the aforementioned liquidity risk.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2009. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, the chief executive officer and the chief financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2009.
Changes in Internal Control over Financial Reporting
There have not been any changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Part II. Other Information
Item 1A. Risk Factors
See Item 1A RISK FACTORS in Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2009, for a discussion of the Company’s risk factors. We do not believe that there have been any material changes to these risk factors.
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Shareholders was held on November 25, 2009 to consider the following proposals:
Proposal 1. Election of directors; Proposal 2. Amend and restate our 2004 Stock Incentive Plan: Proposal 3. Ratification of appointment of independent registered public accounting firm.
The following proposals were adopted by the votes indicated: Proposal 1:
Proposal 2:
Proposal 3:
Item 6. Exhibits
The following exhibits are filed as part of this Form 10-Q
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 9, 2010.
By: /s/ Dr. Serge C.P. Belamant
Dr. Serge C.P. BelamantChief Executive Officer, Chairman of the Board and Director
By: /s/ Herman Gideon Kotzé
Herman Gideon KotzéChief Financial Officer, Treasurer and Secretary, Director
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