Net 1 UEPS Technologies, Inc. (NASDAQ:UEPS) Q1 2019 Earnings Conference Call November 9, 2018 8:00 AM ET
Dhruv Chopra – IR
Herman Kotzé – CEO
Alex Smith – CFO
Allen Klee – Maxim Group
Good day, ladies and gentlemen, and welcome to the Net 1 UEPS First Quarter 2019 Earnings Conference. All participants are currently in listen-only mode. [Operator Instructions] Please also note that this call is being recorded.
I’d now like to turn the conference over to Dhruv Chopra. Please go ahead, sir.
Thank you, Chris. Welcome to our first quarter 2019 earnings call. With me on the call today is our CEO, Herman Kotzé; and our CFO, Alex Smith. Our press release and a supplementary financial presentation are available on our Investor Relations website, ir.net1.com.
As a reminder, during this call, we will be making forward-looking statements, and I ask you to look at the cautionary language contained in our press release regarding the risks and uncertainties associated with forward-looking statements.
In addition, during this call, we will be using certain non-GAAP financial measures, and we have provided a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures. We will discuss our results in South African Rand, which is a non-GAAP measure. We analyze our results of operations in our press release in Rand to assist investors in understanding the underlying trends of our business. As you know, the company’s results can be significantly affected by currency fluctuations between the US dollar and the South African Rand. We will have a question-and-answer session following our prepared remarks.
So with that, let me turn the call over to Herman.
Thank you, Dhruv. Good morning to all of our shareholders. October the 1, 2018 marked a new dawn for Net 1, following the expiration of our contract with SASSA on 30 September and the transition to the South Africa Post Office or SAPO. We have now been relieved of our constitutional obligations and are able to dedicate our considerable efforts and resources to the provision of financial inclusion services to the unbanked and underbanked in South Africa and internationally.
We are excited to embark on the new journey we have been planning for now that we are able to transform our business in South Africa, free from the constraints imposed on us by SASSA and the courts over the last 78 months. Despite all the challenges we faced, the SASSA contract gave us the opportunity to showcase our unique and robust biometric payment technology through the provision of an uninterrupted payment service across the country in online and offline environments.
Over the contract period, we processed more than 800 million grant payments with 780 billion manned, eliminated duplicate or fraudulent payments estimated by the [indiscernible] at approximately ZAR12 billion and established a payment network that is able to service every South African citizen within a 3 mile radius of where they live. I will discuss our future strategy in detail a bit later, but it is important to note that it is this collection of remarkable technology and logistical efforts that provide the springboard for the execution of our new business plan in South Africa as we have enabled the system to be fully interoperable with the South African payment system.
While our fixed ATM and pass [ph] network previously allowed us to acquire transactions from any bank cardholder, our mobile ATM network was restricted for use by the former SASSA cardholders at pay points only, based on a schedule dictated to us by SASSA. We have converted and certified these mobile ATMs to become fully interoperable and we are now able to pursue an acquiring strategy by making our mobile ATMs available to all South Africans, regardless of where their bank in accordance with the schedule that we can really determine according to market demand.
In the five weeks that we have been able to pursue this acquiring initiative, since the 1st of October, we have already processed more than 2.5 million transactions across our various acquiring channels. Interchange fees on ATM projections are set by the central bank and hence the ARPU for our acquiring business is approximately half of the ARPU of our EPE card issuing business. We therefore need to build volume through this infrastructure and it is encouraging to see these early trails.
On the other hand, we are forging ahead with our EPE card issuing strategy to rebuild our cardholder base after the unfortunate events that we experienced during the last three months of our contract with SASSA, as reflected in our Q1 results. It is disappointing that Q1, as the last reporting period subject to the SASSA contract, was characterized by a number of negative factors.
First, we had to deploy our entire infrastructure to ensure that there was no interruption in grant payments in accordance with the constitutional court order, despite the fact that SASSA was actively phasing out pay points and migrating beneficiaries across to the post office. As a result, the number of beneficiaries we serviced at pay points, which forms the basis of the fee we charge declined exponentially as beneficiaries were instructed to exchange their payment cards for new SAPO cards in order to ensure that they would be paid after their contract ended without informing them that they may use any other bank account of their choice.
During the September payment cycle, in an effort to meet the target of converting all beneficiaries to SAPO, SASSA restricted the number of beneficiaries being paid at pay points to less than 300,000 without any prior notice to us. As our cost base is predominantly fixed, the significant decline in the amount we could invoice, especially in August and September caused large financial losses in our CPS business unit.
We continued to deploy our full infrastructure in anticipation of receiving the endorsement from the constitutional court that we may implement the revised fee structure as had been recommended by the National Treasury, but our court application for the endorsement of the revised structure has unfortunately not been dealt with yet. In accordance with the court’s March 2018 order, we filed an audited statement of revenues, expenses and profits for the 6 month extension period as well as the cumulative 18 month extension period through the year to date.
The full impact of the diminishing revenue base, while maintaining the full service, is apparent from this filing, which indicates that CPS incurred losses of ZAR557 million during the last six months of the contract period. We believe this will provide sufficient evidence and motivation for the court to finalize the pricing and amounts due to us. We have written two letters to the court and we filed a formal urgent application in August, asking the court to deal with this matter, but it is entirely up to the courts to decide on the timing.
The second negative factor in Q1 that had a major impact on our financial results and our strategy to seamlessly transition through the SASSA contract termination was SASSA’s unilateral forced migration of approximately 900,000 EPE customers to SAPO in order to meet their targets for SAPO, which we consider to be illegal and unfortunately requires further legal action. We have tried to amicably engage directly with the minister and with SASSA to recognize the violations associated with the actions and to reinstate grants paid into our clients’ accounts.
Unfortunately, neither party acknowledged any wrongdoing and therefore, we are left with no choice but to initiate legal action to protect the interest of choices of beneficiaries who elected to open EP accounts and never provided consent to open SAPO accounts as well as the commercial consequences of the actions. In the meantime, we have observed that SASSA has begun processing the so-called extra fee forms, which are a requirement for an individual electing to be paid into a private bank account as per the constitutional rights to choose.
In the October pay cycle, the EPE churn was mildly negative and for the November pay cycle, we have returned to positive net additions to our EPE base. Should we be successful with our legal actions, we would get a boost to our efforts to manage through this transition. If we don’t, we believe we will continue to grow our number of account holders just off a lower base, but in the meantime, pickup non Net 1 customers through our acquiring strategy, specifically through our ATM network.
We ended October with approximately 1.7 million EPE issuing customers and we have processed approximately 2.5 million transactions through our acquiring infrastructure since 1 October. By June 15, 2019, we expect to have reached 2 million issuing customers and to be processing 3 million transactions through our acquiring network per month. But what it is clear to us is that Net 1, while not playing a direct role in grant payments going forward will continue to offer banking solutions to this market segment as we have accumulated the required licenses and partnerships and we have built out and operate the only payment infrastructure in place to effectively and properly service these constituents in close proximity to where they live.
After only 6 weeks following the termination of the contract, more than 2.5 million or 25% of grant recipients have already elected to make use of our issuing or acquiring services. We will continue to educate our product market about the affordability of our products and the convenience of our services and we firmly believe if we continue to lead by example in terms of accessibility and pricing, our customer base will grow accordingly. As always, we welcome any fair competition that ensures the best product at the best price to these constituents.
As we are no longer earning any revenues from SASSA for grant distribution, we have rationalized the cost structure already and redeployed our employees to our other South African businesses where we expect to generate substantial long term benefits. For the next 3 to 6 months however, we have to carry this cost base as our existing revenue streams pick up new customers while new initiatives such as acquiring rich scale where it can absorb these costs.
Our initial efforts are very encouraging and we continue to expect Q1 2019 to be the trough earnings and to demonstrate sequential improvement throughout the year. Alex will discuss guidance in more detail, but I wanted to provide the big picture trends which have got us to this point.
I will now turn to our other businesses and overall strategy. To respect our group’s strategy, we will focus primarily on the following three areas. First, South Africa, where we intend to further expand our transaction processing and financial inclusion products and services to the underbanked by leveraging our unparalleled loss and synergies with DNI, Cell C and Finbond.
Second, IPG, having aggressively consolidated our international assets under IPG during fiscal 2018, starting in mid-fiscal 2019, we will unveil our new go to market brand in the coming weeks and our new issuing and acquiring platforms in collaboration with Bank Frick as soon as we receive certification from Visa and MasterCard. This is currently scheduled for completion before the December freeze period, but we are unfortunately entirely dependent on them for timing.
IPG will also continue to expand its block chain and cryptocurrency processing and storage solutions and we expect to add our first product ready during Q3 2018 and third exporting our various payment solutions and technologies, including our UEPS/EMV payment system, virtual card and our mobile payment solutions in partnership with our strategic investments in Finbond, Bank Frick, MobiKwik and One Finance.
So starting with the first point in South Africa, EPE, both on the issuing and acquiring side remains a key driver of our South African consumer strategy and will further be supplemented by synergies with Cell C and DNI, which we believe will begin to fuel the addition of higher income EPE users. EPE remains the most affordable, fully transactional bank account with access to the cheapest loans and insurance and soon to be delinquent products in the country once the Cell C tower sharing agreement with MTN is operational.
The distribution network accessible by our customers is the most comprehensive nationwide. Recipients can elect to receive the grant in any bank account they choose and we are confident that the benefits, accessibility, functionality and additional services available from EPE will ultimately win adoption and continued loyalty once this option again becomes apparent to our customer base, the service you should currently experience by the new method and the noise around the contract expiration subsides.
We already seen in rural areas specifically, large number of post office customers accessing their grant infrastructure because the post office does not service rural areas until the 2nd week of the month and when they do, they do not have reliable network coverage, resulting in long queues, manual payments, poor reconciliation and exposure to fraud. The synergies created by our investments in DNI, Cell C and Finbond create both new distribution channels and additional product offerings as we redirect our significant resources away from our SASSA contract obligations to growing our EPE customer products and financial inclusion platform.
EPE provides access to our ATM and point of sale infrastructure, utilizing our last mile connectivity as well as access to the cheapest financial inclusion products. Our branch network has grown to 214 branches. Similarly, our fixed ATMs are expected to grow to 1500 this fiscal year to complement out 1200 mobile ATMs. In other words, we will still be the only financial services provider with the capability of providing a personal service to any South African citizen within a 3 mile radius of where they live.
With Finbond, we have completed the development for them to become an issuer of UEPS/EMV cards and the first batch of cards has been ordered to enable us to commence with the issuance, starting in January 2019. Finbond has over 450 branches in South Africa and together we would have over 600 branches and 2400 ATMs, giving us a combined network that will rival any of the retail banks in South Africa.
Our financial services offerings tie into and are an integral part and differentiator of our EPE offering. Both lending and insurance have been somewhat impacted by the EPE account migration. First on loans, we scale back on the marketing of our products until January 2019 in order to let the dust settle in the account debate. Given the forced migration of some EPE accounts, we did see some increase in the credit risk, which we believe is temporary.
The reason for this is the same as why customers take a loan in the first place. A, it is the cheapest in the market and therefore, they want to maintain their credit profile and, B, because we own the largest loan payment platform in the country, we have been able to offer clients additional and easy alternatives to make their loan and insurance repayments.
Second on insurance, we saw a similar uptick in unpaid premiums and policy lapses and we have taken the same remedial actions as for our loan customers. We have created additional specific insurance policies based on market demand we see and expect to introduce these to the markets in the third quarter of 2019.
Turning to DNI whose results were consolidated for the first quarter, following an acquisition of a controlling stake at the end of Q4 2018. DNI’s top and bottom line performance tracks in line with our expectations, despite very challenging economic conditions in South Africa with consumer spending has been under significant pressure. DNI brings additional distribution channels to us through its well established network of supply and prepaid mobile SIM cards and airtime into the South African retail markets.
In this regard, DNI is the largest distributor for Cell C. With the appropriate training and supervision, the 2000 strong DNI sales force will be able to market our EPE offering inclusive of affordable airtime and data packages that we define in collaboration with Cell C.
Speaking of Cell C, their tower sharing agreement with MTN is well underway and likely to be substantially completed by the end of this year, with operational rollout starting in early 2019. We expect Cell C’s service revenue to continue driving topline and EBITDA growth and new market segments to open with the launch of the tower sharing agreement, especially in our rural focus markets, which is largely virgin territory for Cell C.
We are also now supplying all of Cell C SIM card requirements with our Net 1 developed SIM cards, estimated at around 55 million units over a 12 month period. We are also very excited about the potential of DNI’s micro-jobbing platform called Money4Jam. In the current South African economic climate, where unemployment remains stubbornly high, this platform provides millions of South Africans with the opportunity to enhance their income by performing piece jobs issued through the platform on behalf of retailers, service providers and the government. The platform is also easily exportable to other countries.
Next, I will focus on the second component of our strategy, the international and IPG in particular. We have completed a complicated task of reorganizing our emoney licenses in Malta, which is possible to cross the EU and emoney license in the UK offices and support staff into a more efficient and scalable structure and we will be ready in the next few weeks to launch our new brand and the suite of products we have developed for the small and medium enterprise market with a specific focus on Europe in collaboration with Bank Frick, which provides us with access to the major card networks.
Over the last few earnings calls, I’ve provided a glimpse of the various new products developed by Net 1’s IT department, including our multi-currency issuing platform, Atlas, our new card management system kaleidoscope and our automated underwriting and onboarding solution that will allow merchants to save months of the usual time it takes to open a bank account and establish an acquiring and processing relationship or to issue prepaid cards if required.
As I mentioned on the last earnings call, we are investing a substantial amount of R&D to develop a new generation of crypto asset custodial and storage products using Net 1’s core cryptographic blockchain biometric verification and hardware security module knowhow, addressing what is arguably one of the most significant and unresolved challenges that exists in the crypto asset industry.
The relevance of this industry was further validated by the recent entry of Fidelity Investments, albeit, using the more traditional cold storage solutions. Bank Frick is widely regarded as the leading bank in the field of financial blockchain technology, crypto asset trading and custodial services and the critically important compliance controls within a regulated environment as Liechtenstein is one of the first countries in the world to publish comprehensive regulations for blockchain and cryptocurrency activities.
Our 35% investment in Bank Frick provides us with access to the bank’s wealth of knowledge, which is of great assistance in the development of our blockchain solutions. Our development activities are at advanced stage and we are targeting Q3 for the launch of our first products, at which time we will be able to divulge detailed information. In India, we launched our virtual card project with MobiKwik in late April this year.
To date, the number of registered users continues to be constrained by our issuing bank partner, as a result of a merger it is pursuing. Nonetheless, new regulations will permit interoperability between wallets and also permit them to become direct card issuers without the bank partner. MobiKwik expects to get Visa and MasterCard membership by the end of the third quarter of 2019, following which it will become an issuer of virtual and physical cards with us.
Our existing program however continues to grow rapidly and in the first quarter of 2019, we grew transactions and values by 266% and 178% respectively compared to the fourth quarter of 2018. MobiKwik itself has rapidly transformed from being a pure digital wallet player to a digital financial services provider, which more closely aligns to Net 1’s strategy. Their leaning business launched about 8 months ago has seen rapid adoption and by number of loans issued daily, they’ve already become one of the largest digital lenders in India.
In October 2018, they launched a wealth management product and this month have launched an insurance product. IPG with its UK and EU regulatory licenses along with Net 1 India is also defining a new international money remittance product to further leverage our strategic investment in MobiKwik.
In Nigeria, our investment company OneFi is the first neobank in sub-Saharan Africa offering loans, fixed savings and payment services to its customers via its mobile app platform called Paylater. The scalability of the platform is evident from the first quarter trading metrics. During this period, OneFi received approximately 4 loan applications per minute and granted one loan every minute.
Let me now discuss the third aspect of strategy for the international deployment of our payment technologies. We have continuously analyzed the best go to market strategy for international opportunities for our payment technologies and how we can expand our product suite with relevant offerings. We have concluded that we would be better served by working with people who are on the ground and already have important customers in specific emerging countries.
To that effect, we recently announced a strategic relationship with Zapper, the leading South African QR payments technology company. Zapper’s QR technology and payment platform is one of the most advanced and complete QR offerings and it has successfully launched operations in South Africa, United Kingdom and the United States. Net 1 and Zapper have partnered to launch a business, which is focused on deploying Zapper’s universal white label QR payment solution as well as Net 1’s various payment solutions such as UEPS/EMV and virtual card, initially targeting the key African markets of Nigeria, Ghana, Tanzania and Uganda.
Barry Lobel, a seasoned industry veteran and African business development expert will lead this business. Traditional banks in our target countries have struggled to service the unbanked population due to limited infrastructure and the high cost of providing last mile connectivity. By leveraging Net 1’s existing technologies together with Zapper’s mobile solutions, we believe we can address the needs of 70% of Africa’s population currently under served by financial institutions.
QR payments currently dominate the payments landscape in China with players such as WeChat and Alipay posting of hundreds of millions of monthly active users. Mobile and QR solutions in particular are also leapfrogging traditional card based solutions in emerging countries across Asia.
QR payments and in particular the Zapper QR payment platform cater to the needs of the users and address the issues of limited infrastructure and interoperability across various mobile money and other payment methods. Zapper’s dilution is open, universal and is also one of the first platforms to be cross compatible with Alipay. In terms of our target territories, Nigeria and Ghana are among the largest in Africa when it comes to population, mobile penetration and adoption of mobile money solutions.
We are already in advanced negotiations with some of the largest mobile operators, financial institutions and key industry players across the region and we are targeting our first country launch in Q3 2019, that’s fiscal 2019 followed by a second country launch in the second half of fiscal 2019.
Turning to KSNET. We continue to see sequential improvements in Korea. During Q1 2019, revenue declined a modest 4% in local currency, primarily due to the timing of the Korean Thanksgiving holidays, which was in Q1 this year as opposed to Q2 last year. While EBITDA margin improved sequentially again to 22% from 20% in Q4, 2018. We anniversary the loss of the regulatory price reductions in Q2 2019.
With a steady revenue and margin improvements, we remain on track to moving back towards our previously stated goal of returning to a 40 plus million dollars per year EBITDA run rate by fiscal 2020. During Q1 2019, we have engaged with a global advisory partner and invested in some specialist advice to help us better navigate the opportunities and challenges presented by this new transaction processing landscape as well or to help us assess and explore our strategic alternatives with this valuable asset.
Before I hand over to Alex, I want to comment on our investment portfolio, which I believe warrants meaningful attention by our current and potential shareholders. This portfolio now represents 90%, if not 100% of total market value despite minimal contribution to our overall EBITDA fundamental earnings per share results.
Cell C, Finbond, Bank Frick, MobiKwik and OneFi are all doing very well as seen in some metrics in our press release. We expect ongoing corporate finance activities in most of these investment companies, as they seek to expand their activities and optimize their capital structures, which in turn brings us to the topic of our own capital allocation.
In fiscal 2018, we spent $291 million on new strategic investment with each of these fitting nicely into our long term strategy of a, reaching our full potential in South Africa and b, diversifying globally. In fiscal 2019, we may engage in a few small strategic investments such as our partnership with Zap Group, however at current levels, we actually see great value in our own shares.
We currently have approximately $76 million remaining on our existing share repurchase program, but we are restricted from using our current cash surplus and South African cash flows until we paid down our outstanding loans of approximately $50 million in full and we have to reserve some of our foreign cash reserves for working capital purposes. Once our loans are repaid, or we find liquidity elsewhere, we will be in a position to consider opportunistically resuming our share repurchase program.
The steps and actions we have taken to transform the old Net 1 into the new Net 2.0 are meaningful and we expect to deliver tangible benefits of our strategy, starting in fiscal 2019, which as I state, but will reiterate is our transition year and also one that is likely to be the bottom of our earnings cycle. We have positioned the company to navigate through the short term challenges of accessing our contract with SASSA and positions our South African businesses to drive increases in our financial inclusion businesses, while internationally, the restructuring and repositioning of IPG and our Zapper strategic partnership to export our technology into developing countries will fuel our growth trajectory.
We are bitterly disappointed that we have had to adjust our earnings guidance downwards due to exogenous events in our South African business over the last 6 months, some of which were hard to quantify and change month to month, especially during September, when the number of beneficiaries we had prepared to pay were decreased substantially. Nonetheless, we have laid the foundation to return to being a high growth company.
Alex will now go over the financial performance and metrics in more detail before opening it up for Q&A.
Thank you, Herman. I would first like to cover the restatement announcement made with the release of our results and will then discuss the key results and trends within our operating segments for the first quarter of 2019 compared to a year ago. We’ve set out the financial statement impacts of the restatement in the 8-K that was filed last night. The restatement relates to a misclassification of the fair value gains made on our Cell C investment in the last fiscal year. $25.2 million or $0.44 of EPS fair value change was incorrectly recorded in our other comprehensive income instead of net income. Our fundamental earnings per share for fiscal 2018 are unchanged. The restatement does not change the carrying value of our Cell C investment or our net asset value. This restatement event has delayed the filing of our 10-Q as we need to close out a number of financial closing steps, before we can file. We are working with our advisors and we’ll file our 10-Q and amended 10-K as soon as is practically possible.
Turning to our results, for Q1 of 2019, our average rand dollar exchange rate was ZAR14.86 compared to ZAR13.17 to the dollar a year ago, which adversely impacted our US dollar based results by approximately 13%. Revenue of $126 million in the first quarter of 2019 was down 17% year-over-year in dollars and down 7% in constant currency. Our fundamental earnings per share declined to just $0.01, impacted predominantly by the losses incurred by CPS, the lower EPE customer base and a high tax charge related to CPS’ losses.
By segment, South African transaction processing reported revenue of $38 million in the first quarter of 2019, down 36% compared with the first quarter of 2018 on a constant currency basis. While the segment still generates substantial revenue, the decrease was primarily due to the substantial reduction in the number of SASSA grant recipients paid under our SASSA contract at the old contracted rate. Our revenue and operating income was also adversely impacted by the significant reduction in the number of SASSA grant recipients with SASSA branded Grindrod cards linked to Grindrod bank accounts. These decreases in revenue and operating income were partially offset by higher EPE transaction revenue as a result of increased usage of our ATMs. Our operating loss margin for the first quarter 2019 was 9.3% compared with an operating income margin of 18.6% in the first quarter of 2018.
As mentioned on our previous call, the Con court allowed us to engage with national treasury to renegotiate the monthly price we are paid regarding our contractual requirements for cash dispersal of grants at pay points. Cash distribution in rural areas has a significantly higher cost structure estimated by the expert panel and quoted by SAPO to be in excess of ZAR per month. While treasury did provide an increase to 44 and 35, excluding that to the Con court, based on paying 2 million beneficiaries per month, the court has not officially accepted this recommendation and therefore, we have only recognized revenue at our old contract price of ZAR14.42, excluding that.
This resulted in a $15.7 million operating loss for CPS during the quarter. This morning, in line with the court order, we filed the audited statement of revenue, expenses and profits related to the SASSA contract for the two extensions period. We reported losses of ZAR557 million or $37.5 million at our average first quarter 2019 exchange rate for the last six months of the contract. The court will ultimately finalize the complete matters on this contract and we hope the significant losses we have reported will motivate the court to bring this matter to swift resolution.
Operationally, the profitability of our South African transaction processing segment is largely dependent on the success of our newly launched acquiring strategy. We have redeployed our mobile payment infrastructure and we need to maximize the volumes through this infrastructure and optimize the costs in order to lift profitability. The utilization of the infrastructure in this manner could only commence on the 1st of October 2018 and we treat 6 months before we see the full benefits of the strategy.
As Herman discussed earlier, the initial indications are encouraging. International transaction processing generated revenue of $39.4 million in the first quarter of 2019, which was down 14% compared with the first quarter of 2018, primarily due to contraction in IPG transactions processed, specifically meaningfully lower China purchasing activity, due to ongoing global trade discussions. No master trading working capital finance activities, as this was discontinued in the last fiscal year and marginally lower KS net revenue.
Operating income during the first quarter of 2019 was lower due to the decrease in IPG revenues and ongoing losses at master payment, but partially offset by an increased contribution from KSNET. Operating income margin for the first quarter of 2019 and 2018 were 7% and 11.6% respectively.
For the first quarter of 2019, KSNET’s revenue decreased 4% in Korean won to 36.6 million while EBITDA margin declined to 22% compared to 25% in the first quarter of 2018, but up 20% in the last quarter of fiscal 2018. Revenue in Korea was impacted by the timing of the Korean Thanksgiving holiday, which fell in the first quarter of 2019 this year compared to the second quarter last year.
The last of the cups on the regulatory intervention or interchange pricing came through in October 2017 and thus we expect year over year comparability to improve going forward. KSNET’s cash conversion remains good and we are accessing approximately $13 million from Korea to fund our various international capital requirements. IPG had another very challenging quarter as transaction volumes declined and they pushed to complete their restructuring process in the first quarter.
With the restructuring process complete, the focus will shift to growing volumes as well as the launch of the various new products Herman discussed earlier. As a result, we expect to see performance steadily improve over the remainder of the fiscal year. Our financial inclusion and applied technology segment includes DNI from the 1st of July and reported revenue to $53.2 million in the first quarter, up 11% on a constant currency basis.
In South African rand, segment revenue increased primarily due to the inclusion of DNI and increased followings in our insurance businesses, partially offset by zero prepaid airtime and value added services sales, lower lending revenues and a decrease in intersegment revenues. Operating income was moderately higher than the first quarter of 2018, primarily due the inclusion of DNI.
DNI generated revenue of approximately ZAR267 million and operating income of approximately ZAR113 million during the first quarter of 2019 and is performing in line with our expectations. Our gross lending book, comprising of capital out and deferred service fees at the end of the first quarter of 2019 was approximately ZAR953 million compared to ZAR1.1 billion at the end of the 2019 fiscal year.
These loans are only available to EPE account holders and with the decline in EPE accounts, we’ve seen a reduction in new loan advances. Furthermore and linked to SASSA’s migration of accounts, we have seen an increase in non-performing loans and have had to revise our provisioning against this book accordingly, which has depressed profitability in the segment. Provision levels have been increased at around 9.5% from the historical levels of around 6%.
We have instituted new collection initiatives to address this and believe that as our EPE base stabilizes and returns to growth, we will see a commensurate improvement in the loan book. We have seen a similar impact on Smart Life from the impact of the SASSA transition. Every Smart Life customer has moved to a SAPO account, we are unable to collect a direct debit against such an account.
As a result, we’re seeing debit order rejections increasing over the quarter and in October, amounted to approximately 230,000, although the rates of increase have slowed compared to previous months. Policies will lapse, if premiums are uncollected for 4 months and we’ve initiated new collection methods, including access to the easy pay collection point to address this issue.
This could result in a step change in the level of the insurance booked during Q2, as these policies may lapse in due course. Our insurance company is currently developing a range of new products to address various micro-insurance needs, including in markets outside of the traditional grant beneficiary market. Despite these challenges, Smart Life’s performance in the quarter exceeded the levels of the equivalent quarter in the previous fiscal year though we will see this trend reversed in the coming quarters if the lapsing of policies materializes.
Once this step change through the system, we expect to see the business resume its growth in policies. In the October pay cycle, approximately 1.7 million EPE accounts were active compared to the 2.5 million we disclosed from the July pay cycle in our last call, while 1.3 million accounts received an incoming deposit. Of the 1.2 million reduction in accounts receiving deposits, 900,000 related to the unilateral action of SASSA while the balance represents churn impacted by the activities of SASSA and SAPO.
Our ability to sign up new EPE accounts during this stated period was limited due to the actions of SASSA in respect to the SAPO card. With our deployed infrastructure and renewed focus coupled with an associated marketing campaign, we believe the attraction of our financial inclusion services bundled around the EPE account will resonate strongly with our target market. We continue to believe our financial services offerings will sustain the segment’s growth, along with the expansion of our branch and ATM infrastructures, particularly once the legacy transition out of the grant payment contract is complete.
Operating income margin for the segment was 21.2% and 25.6% during the first quarter of 2019 and 2018 respectively. Our corporate expenses have increased primarily due to higher acquired intangible asset amortization and higher transaction related expenditures. Our first quarter 2019 net interest expense was 0.9 million compared to net interest income of $2.9 million in the comparative quarter.
This delta was due to the cash utilized for strategic investments and in particular interest expense increased due to South African lending facilities we obtained. We recognized earnings from equity accounts and investments of $1.4 million during the first quarter of 2019 compared to $2.1 million in the same period last year. Finbond contributed $1.9 million in this quarter, representing an increase of 17% compared with the first quarter of 2018.
Underlying Finbond performance was in line with the prior period, but the contribution increased as the prior period included the dilution adjustment related to Finbond corporate actions. The reduction from the comparative period is primarily due to the fact that DNI did not contribute to equity income in the first quarter of 2019 as the business is being consolidated effective 1 July 2018.
Capital expenditures for the first quarter of 2019 and 2018 were $3.1 million and $1.5 million respectively and have increased primarily due to the acquisition of ATMs in South Africa, computer equipment to maintain our processing activities and the expansion of our branch network. At September 30, 2018, our cash and cash equivalents were 98.6 million and net cash was approximately 50 million, up from 40 million at the end of June.
The increase in our cash balances from June 30, 2018 despite weaker trading results was enhanced by a release from working capital due to lower activity levels in some of our financial inclusion businesses, notably Moneyline and [indiscernible]. This was partially offset by scheduled debt repayments, dividend payments to non-controlling interests and capital expenditures.
Free cash flow generation amounted to $13 million, of which $7 million related to the working capital release. Apart from our lending arrangements, we continue to fund the group’s operation and capital investments, utilizing our cash reserves and cash generated from our business activities. We expect the majority of our cash generated in fiscal ‘19 to be used to repay principal and interest under our South African lending facilities to fund our internal growth investments and to the extent possible, we initiate a share buyback program.
We have obtained short term credit facilities of ZAR1.75 billion or $124 million to fund our ATMs in South Africa and have presented cash drawn under these facilities and in the processing system, as restricted cash. As of September 30, 2018, we have restricted cash of $85 million and an associated short term facilities utilization of $85 million. These facilities may only be used to fund the cash required in our ATMs.
As of September 30, 2018, we had outstanding long term debt of ZAR644 million or $46 million under our South African facilities. We expect to make three further principal repayments of ZAR151.3 million during the remainder of fiscal 2019, three equal repayments totaling ZAR79 million during fiscal 2020 and the remainder of that will be settled in full in June 2021.
Our first quarter 2019 tax expense was $6.5 million compared to $10.3 million in 2018. Our effective tax rate for the first quarter of 2019 has been significantly impacted by the losses incurred by CPS, as we’ve effectively not recorded a deferred tax asset benefit related to these net operating losses. Excluding the CPS losses of $15.7 million and the $1.6 million in transaction related expenditures incurred, the effective tax rate for the quarter would have been 37.4%, which was higher than the South African statutory rate as a result of non-deductible expenses.
Including non-deductible interest on our South African long term facility, we continue to expect our effective rate for 2019, excluding special items to be around 35%. Our weighted share count for the first quarter of 2019 was 56.7 million versus our actual September 30 share count of 56.8 million shares.
Turning to our guidance, we are very disappointed to have to revise our guidance down, as we underestimated the effect that the transition would have on our customer base and our related financial inclusion products. Of the $0.40 reduction in guidance, $0.30 relates to our South African businesses, split equally between the lower EPE account members and the impact that this has had on our financial inclusion businesses.
The balance relates to the weaker than expected performance of IPG in the first quarter and the funding cost in respect of our ATM infrastructure. Our revised fundamental earnings per share guidance is based on the following assumptions and performance. Firstly, no contribution to net income from CPS in fiscal 2019. We have seen that the pricing issue awaiting the termination by the constitutional court will be resolved during this fiscal year, in line with the Treasury recommendation, which will effectively eliminate the losses incurred in the first quarter in CPS.
Secondly, average active EPE accounts of 1.75 million, down from prior guidance of 2.5 million. This revision is largely caused by reducing our expected signup rate of new EPE accounts of 50,000 a month for the remainder of the year from the 100,000 to 150,000 a month we were previously targeting. This is a reflection of the difficult conditions we are facing due to SASSA’s activities with the grant beneficiaries.
Thirdly, we expect average acquiring customers of 1.75 million for the remaining 9 months of the year. The ARPU on these accounts is approximately half that of our EPE accounts. Fourthly, our South Korea full year results are expected to be consistent with fiscal 2018, although, we should see improvements in the second half of the fiscal year. Fifthly, the DNI results reflecting a 10% growth in fiscal 2019 although we see significant potential synergies with our other businesses. And finally, at constant currency base of ZAR12.70 to the dollar, 56.8 million shares and a tax rate of approximately 35%. This guidance is dependent on our ability to successfully develop our financial inclusion strategy around EPE and our new acquiring strategy, following the setbacks of the last quarter.
Given these events and the continuing headwinds created by the prevailing environment, we’ve been cautious around the growth factored into this guidance. We should have a clearer view on the success of these initiatives over the next 3 to 6 months and we would hope to be able to positively revise our guidance, if the environment improves and if some of the other initiatives, particularly in respect to the synergies of DNI and Cell C start to deliver an impact. We would like to reiterate that fiscal 2019 is likely to be our biggest transition year in the company’s history. We expect this fiscal year to be the bottom and all our various initiatives, investments and actions to drive long term growth of this base.
We can now open up the call for Q&A.
[Operator Instructions] Our first question is from Allen Klee of Maxim Group.
In terms of the EPE customers, can you give us a little more color in terms of why you feel that SASSA or for whatever reason that the number won’t go down anymore and to what degree that they can force that to happen. And then for the acquiring customers in the rural area, can you explain a little more, is this that customers actually opening an account with you or is it just that they’re transacting on your mobile ATMs or maybe understanding that business competitively, why you’re confident that’s going to grow?
On the first question, the decline in the EPE customer base and how we see this going forward, first of all, I think it’s important to note that there was a very dedicated push towards the end of the first quarter, so in August and September from SASSA who were under tremendous pressure to ensure that they would not have to approach the court for a further extension of our contract to convert as many people as possible to the post office account base.
Now that the contract has come to an end and obviously there is no further extension and our obligations have ended, we hope that that’s also brought an end to SASSA’s activities in terms of trying to do bulk transfers of beneficiaries, including EPE customers to the SAPO banks. And to that extent, we’ve seen a stabilization in the number of EPE accounts that we have that are active and that receive grants over the last two months. So I think that’s a very good indication.
The other very positive indication that we have after some intervention from our side, also with some legal ramifications is that SASSA is finally processing the so called Annexure C forms, so these are forms that people fill in when they don’t want a Post Office account and they want to be paid into an EPE account or any other account of their choice. There was a significant backlog in the processing of those forms and almost an unwillingness to process those forms.
That has changed and we now see that those forms are being processed that way people are opting for EPE accounts or they want to reopen EPE accounts. That process is now being followed. So with that in mind, we believe that barring any further illegal or unjustified activity by SASSA, we’ve seen the end of the bulk transfer of beneficiaries across. We are taking legal action and obviously because of subjugate, we can’t say much about it, but we strongly believe that the transfer of the 900,000 beneficiaries was done in a manner that is contrary to the regulations and the relevant acts, but we’ll obviously keep you updated as far as that’s concerned. We tried to resolve that as amicably as we could, but unfortunately we didn’t have much joy in that regard.
In the second part of your question, you asked us about the acquiring network and whether that is related to people opening accounts with us. The short answer is no. The acquiring network is available to any account holder whether they bank with a post office, whether they bank with us or whether they bank with any South African bank. So in the rural area specifically today, the prevalence of ATMs, whether fixed or mobile, and I may add that nobody really deploys a mobile ATM infrastructure in South Africa except us.
The prevalence of ATMs in rural areas and the distribution is quite low. It is obviously quite expensive to run and maintain fixed ATMs in locations where there isn’t a large guaranteed volume of people. There are inherent security risks specifically in our environment for the banks and for other operators to roll out these ATM networks. And so, we believe we’ve established a very unique and valuable infrastructure through our fixed ATM network, which number is about 1100 at this point in time and then obviously the crown jewel being our mobile ATMs.
So these are ATMs that are affixed to the back of a very robust pickup trucks. They are ruggedized and we send those out to service people on a roster that we determine in accordance with where the need is and where we know people have great difficulty in accessing cash and accessing financial services. So, they have a choice today in terms of how they want to withdraw their money and most of these people are grant recipients. So most of them would typically receive a grant on the first day of the month. They didn’t have a choice, if they want to access their money immediately, they would typically have to travel to the closest town where they would be either a post office or a bank ATM. The cost of travel is quite prohibitive because of the distances involved and inevitably because there is only one ATM in town or because there’s only 1 or 2 people at the post office that have the capacity to assist with over the counter payments, the queues are invariably very long and we’re talking about 4 to 6 hour waiting times in a lot of cases. So that’s the one option that people have.
The alternative that we give them now that our ATMs and our mobile ATMs are fully interoperable is that they can simply come to us when we arrive and they can present their cards at our ATMs and they can still receive their money. That doesn’t mean that they will necessarily convert to an EPE account, but obviously the account’s fee structure for EPE account holders makes it more attractive for those people to have EPE accounts and withdraw their cash from our ATMs than for other account holders to draw their cash at our ATMs.
And so, just in a nutshell, that is what our value proposition is. It’s more convenient and in the end, if you factor in the costs of travel and the cost of time, it’s a lot cheaper for anybody to access our network.
So how do you think of what kind of the total addressable market is for the, first for like the EPE accounts, given the ones that have transferred over to the post office and then also for this newer business with the — in the rural areas.
So I think the opportunity or the market opportunity for us is obviously much greater in the rural areas. Again, the bank ATMs and post offices specifically are very much concentrated in the larger city areas and in the larger towns. And so for us, the key opportunity remains in the rural areas, where we believe there are probably around 5 million potential EPE customers, so people who are unbanked, underbanked and in need of a bank account, in the urban areas, that number is north of 10 million. But the competition, as I’ve said, is much more intense. We still believe that with our pricing and value proposition, we will be able to take some market share in the urban areas as well, but for now, our target as I mentioned in my prepared remarks is to get to roughly a blended combination of 5 million to 6 million customers, whether they are EPE issued customers or whether they just use our infrastructure on a monthly basis towards the end of fiscal 2019.
And then if we move on to KSNET, so you said that there was a timing issue of – or just that of a change in the holiday, how is the process, but you still feel that this business can improve, how is the process of bringing your cross down to the agents that you’ve been trying to and just kind of your outlook to grow this business?
Sure. So in Q1 this year, there was the Korean Thanksgiving holidays, which is typically the biggest — one of the biggest holidays of the year, I would say. Last year, we had that period in Q2, so there is a bit of a timing mismatch and explains why the revenues were slightly depressed during this specific quarter.
In terms of our efforts to look at the underlying cost factors within KSNET and those are mainly driven through our expenses that or commissions rather that we pay on our agent workforce, there is a dedicated project underway. Over the last three months or so, we have engaged also the services of a global consulting firm. We’ll give more details around that when the initial results become more evident, but we are busy with an intense overhaul, an overview of the business model specifically as it relates to the use of agents.
And from our perspective, I think it’s important to note that we believe it’s important to place a specific focus on the quality of the agents that we deployed rather than the quantity of the agents that we deployed. Over time, that may well mean that we need to not renew our contract with certain of these agents. That in turn will result in a decrease in the top line, on the revenue line, but will definitely translate into an increase in the bottom line because some of these contracts are simply not sustainable after the fee cut that we got from government. So there’s a very dedicated effort underway. We will begin to really get next week to take this forward and we are positive again that we’ve seen the trough of the effect of the VAN fee cut now that we are anniversarying the last of the cuts that were imposed by the government.
Our next question is from [indiscernible].
Do you envisage having to provide any further shareholder support to Cell C over the near term and then on your product, you mentioned in telecoms providing to EPE customers, how exactly will that product look and is it going to be a discounted offering to your EPE customers?
On the first question, so Cell C is currently, as you know, in the middle of a recapitalization and refinancing process. We and along with our other shareholders, primarily Blue Label provided the initial recapitalization support when we’ve made the investment last year. In the meantime, Cell C has commenced with a further restructuring of its bit. It recently refinanced ZAR1.5 of the date with a consortium of South African banks. They dedicated ongoing focus on reducing the cost of date in Cell C. And on — obviously carefully monitoring the relevant cash flow implications there are.
To the extent that we will be required to provide any support and if that is the case, I believe, it will be temporary in nature and not material in nature. We will obviously consider that, but in our view, the master plan in terms of the recapitalization and refinancing, if it’s at Cell C are well underway and well under control.
In terms of the second part of your question, the product that we or the products I would rather say that we are designing and some of them we’ve launched for our EPE customers, obviously, we don’t want to give away too much by a way of competitive information. But what we are looking to do is to address the core needs of our target market. And if you look at the typical EPE customer who is also normally a social grant percipient, we have a fairly good idea of what the disposable income is and what the spend is on communication and when you look at that, you have to break it into the various components obviously being airtime, data in certain instances and for certain demographics as well as the finance cost of a handset.
As we find that a lot of the people obviously after a 2 or 3 year period need to replace the handset and there’s obviously a move towards smartphones as well. So when you take all of these matters into account, we are in the process of defining a suite of products depending on your requirements, whether it’s only for airtime or whether it’s a combination of airtime data and the handset that we will be able to provide you with the most affordable product, specifically again in the rural areas as soon as the Cell C tower share agreement with MTN is fully operational, that opens up huge amounts – a vast area of what was previously virgin territory for Cell C, where we’ve not had much market penetration with a surplus capacity and so the whole idea is to provide that bundled service on top of which we also have the ability to deliver content and other services, if the beneficiary or the cardholder so requires.
Our next question is a follow-up from Allen Klee.
Just following up on your talking about IPG and the restructuring, can you go over a little what the cost of the restructuring was and then what you see is kind of the opportunity once you’re combining the different abilities of the different pieces of it together of what you think the contribution could be longer term from IPG?
Sure. So in terms of the costs of the restructuring, we haven’t broken that out and given that separately. It is, I think, mainly driven by two major cost factors. The first was that they had to be a right sizing of the staff component and so we include certain retrenchment costs in that regard, which are obviously one-off in nature. The second was that we have optimized the various contracts that we have around support and office infrastructure and we had to terminate some of those early terminate some of those and then had an obvious cost implication.
Once this is all done and the reorganization and the restructuring itself is largely done and maybe if I can just give you a bit more color in terms of what that means, we now have — based all of our operations in terms of reconciliation, settlement, compliance and risk management in Malta, we chose Malta because that is the way we hold our out EU emoney license and we also chose Malta because it is substantially cheaper to run an operated office there, the quality of staff we find is very good.
And so going forward, from our Malta office, we will drive our European recon settlement and operational aspects. We also have a small office in London because we have an emoney license in the UK and obviously depending on what the outcome of the Brexit negotiations will be, that could good in itself be quite a valuable asset. But nonetheless, having an emoney license requires a company or a license holder to have a minimum amount of staff members, including a risk officer and the money laundering officer, a CEO and the CFO. So those are the people that we have in our London office.
And then of course, we’ve got a very small IT support team in Munich and from Hong Kong with driving the global IPG initiatives. The opportunity for, us once we’ve gotten our certifications complete for our card issuing and acquiring platforms is that we will be able to address what we think is a huge underserviced population of small and medium enterprises across Europe. The business case is quite simple, it takes most small merchants a number of weeks or months today to open a bank account and to establish and issuing or in acquiring relationship if they want to sell goods or services online specifically.
By the time they’ve gone through all of the compliance tastes and by the time they find a bank actually willing to deal with them, because of the cost implications involved, a long time has gone by. In our instance, we’ve developed all of the platforms and all of the technology to do what we call almost instant account verification and on boarding. That means that a merchant will be able to sign up within a 5 minute period, have an active account and will be able to process and acquire transactions online.
We think that there is a massive market opportunity and again by making the process more convenient, simpler and ultimately more cost efficient, there are tens of thousands of merchants across Europe that we see as our addressable market.
And then can you just clarify for your debt in South Africa, your timing for when you believe you will have that fully paid down. And do you have an ability to prepay that and so when would that imply that you’d be able to buy back stock?
We can’t prepay the debt, we’ve got restrictions in terms of only segment of the debt. No penalties. The bulk of it will basically be settled by the end of June 2019. The three payments of about 152 million and then there are smaller payments going forward. So we think that by the end of this fiscal year, we would be in a position to, the restrictions in terms of cash, I’d like it to be lifted.
And then if I could ask one more, one MobiKwik, you were discussing that there was some type of change in regulation with Visa and MasterCard that — could you just explain that a little of what that is and why that makes it more valuable? What they have and you have?
So about three or four weeks ago, the Central Bank issued new guidelines for the digital wallet, which do a number of things. The first, the two most important things it does is one it makes interoperability between wallet and wallets to bank accounts and the second is today issuing — card issuing is looking to methods typically through banks where the central bank has permitted the digital wallets to directly become issuers through Visa and MasterCard and locally Rupay without necessarily having a bank partner. So in our case, as you can see, with CBCC rollout, we’ve been constrained by the number of users we can add on because we’ve got limitations set by the bank because they want to manage that risk because they’re going through their own merger. And so if you just look at it from a big picture view, what these regulations do is bring wallets at par with the bank account with the only exception being that the wallet cannot pay interest. [Technical Difficulty]
No problem. Well, maybe while we wait for Dhruv to dial back in, I can just complete what he was saying. So now that these regulations have been promulgated in the Indian market, it does make it much easier for wallet operators to conduct their business in a broader sense by also becoming card issuers and acquirers. They are no longer compelled or required to partner with banks in order for them to do so. So from a Net 1 perspective and specifically the issuance of our virtual card, which in India is a Visa card, the way forward for us in terms of having access to a much bigger range of account numbers is obviously much bigger now. We will no longer be constrained in terms of how we can market and sell the product offering. And for us, that is quite a valuable proposition going forward to open up the virtual card offering to all of MobiKwik’s subscribers, which are in excess of 100 million at the moment.
Thank you very much, sir. Ladies and gentlemen, that then concludes this conference call. Thank you for joining us and you may now disconnect your lines.