I'm at a loss on how to turn a company name like Net 1 UEPS (NASDAQ:UEPS) into even a passable pun. This company's name reads more like source code and poetry.

Um, "Net 1, Purl Q2"? That would have worked six months ago, but today, we're previewing not the second quarter's results, but those for Q4 and fiscal 2007. Speaking of which, these numbers come out Wednesday afternoon.

What analysts say:

  • Buy, sell, or waffle? All of five analysts follow this little South African smart-card purveyor. Three think you should buy it; two say hold.
  • Revenues. On average, they're looking for 11% quarterly sales growth to $59.9 million.
  • Earnings. Profits are predicted to grow by a penny to $0.31 per share.

What management says:
We haven't written a lot about Net 1 here at the Fool, so rather than dive right into the specifics of what CEO Serge Belamant has to say about its prospects, let's start our introduction off slow. Herewith, the company's own description of how it makes money:

"Net1 provides its universal electronic payment system, or UEPS, as an alternative payment system for the unbanked and under-banked populations of developing economies." The company does most of its business in Africa -- Malawi, Ghana, Rwafnda, Burundi, Mozambique, Botswana, Namibia, Nigeria, as well as its home state, South Africa. Elsewhere around the globe, you'll find Net 1 working in Latvia and the Commonwealth of Independent States, and it also aims to expand into India, Brazil, Mexico, and Indonesia.

How it does business is by providing an end-to-end cashless payment services for people without, or with limited, access to traditional banking services. Net 1 provides smart cards that "carry" funds; portable, non-Internet-connected card readers to swap funds from one person to another; and a payment network to keep track of where all those funds are and are going. It also acts as a bank of sorts and extends loans to borrowers by use of said smart cards, hardware, and payment system.

In doing so, it meets competition on the infrastructure side from a division of STMicroelectronics (NYSE:STM), and on the services side from MasterCard (NYSE:MA), Visa, and American Express (NYSE:AXP). But to be honest, Net 1's solution to providing banking services to the great "unbanked" has no real, direct analog.

What management does:
As Net 1 gains scale, its gross margins are slowly but surely expanding. Operating and net margins, however, are encountering difficulties sustaining the top-line momentum.

Margins

12/05

3/06

6/06

9/06

12/06

3/07

 Gross

74.2%

74.3%

74.2%

74.4%

75.7%

76.7%

 Operating

45.4%

45.8%

46.7%

45.6%

45.6%

46.0%

 Net

27.3%

28.4%

30.2%

30.1%

29.2%

29.1%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

One Fool says:
Why the disconnect between steady gross margin expansion and more erratic performance farther down the income statement? Well, gross margins are expanding because the cost of services is dropping (down 3% year to date, even as sales rose 11%). The reason Net 1 is not enjoying all of these benefits on the bottom line is threefold:

  • Sales, general, and administrative costs have risen 19%, outpacing sales growth.
  • The firm began expensing stock options. While not a huge expense, the introduction of expensing is taking a toll on operating margin.
  • Net 1's acquisition last year of Prism (a complementary business with smart card production, software, and payment transaction services) has nearly doubled depreciation and amortization charges.

Also worrisome is the fact that free cash flow production has declined markedly this year. In comparison to fiscal 2006, it's down a good two-thirds to just $16.5 million. While it's true that free cash flow is a "lumpier" metric than generally accepted accounting principles earnings, I can tell you right now that what I'll be most interested in on Wednesday is seeing whether the firm manages to smooth out its cash profits generation. Investing in foreign lands is worrisome enough without having to wonder why a supposedly profitable firm is generating less and less cash over time.

For further related Foolishness:

Net 1UEPS is a Motley Fool Rule Breakers recommendation. MasterCard is a former Inside Value recommendation. You can check out any of our newsletters absolutely free for 30 days.

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a worldly disclosure policy.