(* cut and paste if link does not work for some) EML Payments...

(* cut and paste if link does not work for some) EML Payments (EML) - Breaking Down Breakage Purpose of this article is to clarify misperceptions and explain the accounting recognition for revenue and cashflows of EML’s breakage income and explain the different rules that apply in the different jurisdictions EML operates in. Overview: EML currently derives a large proportion of its revenue from Non-reloadable programs mainly in North America and Europe. Australia contributes a negligible amount to this division so I will not focus here too much but generally it works in a similar manner to Europe. Majority of EML non reloadable programs are shopping mall gift cards. When EML signs on a new customer they negotiate their program fee depending on the customer’s preference. Majority of programs are negotiated as a share of breakage income plus transactional costs. In some instances a GDV management fee is negotiated or even a fixed fee per card issued. Currently most programs are operating under the breakage income model, where historical data has shown that over 5% of all funds loaded on a gift card will never be redeemed. Accounting rules are changing globally to align reporting amongst prepaid companies on how the current revenue recognition standards are applied. The new standards (AASB15) specifically deal with breakage revenue recognition. Under AASB15, revenue recognition is to be aligned with the pattern of historical card redemption. EML can demonstrate that this is done within 3 months from the purchase of a gift card. Therefore there will be no material difference to EML current accounting policy of recognising revenue in the first month of card purchase, and hence NEGLIGIBLE impact on EML P&L or cashflow reporting. Europe region: Currently across most European countries gift cards have a 1 year expiry period. European regulatory bodies across the countries which EML operates in tend to publish their regulatory agenda 3 years in advance. The topic of gift card expiry period is NOT currently on their agenda. When a customer purchases a $100 gift card in Europe, EML recognizes the breakage income of circa 5% (as an example) upfront to the revenue line and books that $5 amount to the balance sheet as “breakage accrual”. The $100 of funds are held by a bank on behalf of EML and earns interest for EML until those funds are redeemed. In most cases, the banks take a small base interest fee and EML keeps the bulk share as interest income. At the 1 year expiry date of the gift card, the bank releases the $5 Breakage amount as cashflow to EML. European regulators are currently pushing for mall operators to move away from paper based gift programs to card/electronic based ones. This shift is driving demand for EML products and there are only a couple of credible operators in Europe which can offer this service on a large scale across multiple jurisdictions. EML is the largest. If hypothetically European rules change where expiry periods extend longer than a year, then in this case EML will know several years in advance and have the option to renegotiate contracts if it wishes to do so. It is important to note that any changes to expiry periods will have NO impact on the P&L but will impact cashflows. The flip side to this, is EML will hold the funds for a longer period of time and will benefit from greater interest income. As interest rates rise in Europe or in the US, this will become a material revenue contributor. US region: In the US the rules operate on a state by state level but are essentially mostly the same. There is no expiry period for gift cards and EML recognises breakage to the P&L in a similar manner to Europe. In the US the breakage estimate is done using the “derecognition model” where data is sourced from actuarial firms that specialize in capturing historical gift card redemption patterns on Breakage for many years. In terms of cashflow, the breakage accrual is gradually released by EML’s bank partner as cash over the first few months of a card’s issue date. This is actually a BETTER cashflow profile than the European or Australian method. Canada: In Canada again the Breakage income is mostly recognized in a similar manner to the US but cashflows are released to EML normally 15 months after the issue of a card as it is considered at this point in time the likelihood of card redemption are very low. In addition EML also runs programs on a derecognition model in Canada (i.e. actuarial model) and it is becoming more prevalent over time, although transition is still behind the US at this point in time. Summary: It is important to understand that breakage income typically represents approximately 70-75% of a non reloadable program’s revenue and the rest is derived from transactional fees which have immediate cashflow benefits to EML. It also important to note that EML can and may over time depending on their customer profile and preferences, transition to charging management fees or once off fixed fees which are of similar value to the breakage income it currently generates. For example, PreSend, which was acquired by EML earlier this year, has 100 programs in market where it does not earn Breakage income but rather, charges management and transactional fees which overall add up to the same percentage value as the breakage model does for EML. Key catalyst: Currently the market is awaiting on EML to receive regulatory approval from the German regulator in relation to its large contract with ECE. EML currently has 25 mall programs in Germany but has never gone through such a comprehensive approval process such as now. Therefore this may take longer than expected. If the contract is approved by regulators by August, EML will have sufficient time to manufacture the cards and launch the programs in time for the busy October to December period for FY19. The Future: On a longer term basis, card based programs will move away to mobile based ones, and the breakage income model may slowly shift away to a transactional and management fee based model. This should benefit EML from a cashflow basis and also on a Gross Margin level as the cost of issuing cards will decrease. Follow me @RonShamgar