LESAKA TECHNOLOGIES INC - Quarter Report: 2005 December (Form 10-Q)

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, 2005

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, 4^th Floor, Cnr. Jan Smuts Avenue and Bolton Road
Rosebank, Johannesburg, South Africa
(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: 27-11-343-2001

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 the filing requirements for at least the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in rule 12b-2 of the exchange act (check one):
 ¨ Large accelerated filer x Accelerated filer ¨ Non-accelerated filer

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 December 31, 2005 (the latest practicable date), 45,451,317 shares of the registrant’s common stock, par value $ 0.001 per share, and 11,219,263 shares of the registrant’s special convertible preferred stock, par value $0.001 per share, which are convertible into common stock on a one-for-one basis, were outstanding.

Form 10-Q

NET 1 UEPS TECHNOLOGIES, INC.

Table of Contents

1

Part I. Financial Information

NET 1 UEPS TECHNOLOGIES, INC.
Condensed Consolidated Balance Sheets

          (A) – amounts derived from audited financial statements
          See Notes to Unaudited Condensed Consolidated Financial Statements

2

NET 1 UEPS TECHNOLOGIES, INC.
Unaudited Condensed Consolidated Statements of Operations

     See Notes to Unaudited Condensed Consolidated Financial Statements

3

NET 1 UEPS TECHNOLOGIES, INC.
Unaudited Condensed Consolidated Statements of Cash Flows

     See Notes to Unaudited Condensed Consolidated Financial Statements

4

NET 1 UEPS TECHNOLOGIES, INC.
Notes to the Unaudited Condensed Consolidated Financial Statements
for the three and six months ended December 31, 2005 and 2004
(All amounts stated in thousands of United States Dollars, unless otherwise stated)

     Unaudited Interim Financial Information

     On June 7, 2004, the Company completed a transaction, which is more fully described in the Company’s Annual Report on Form 10-K for the year ended June 30, 2005, in which the former shareholders of Net 1 Applied Technology Holdings Limited, or Aplitec, acquired a majority voting interest in the Company. In accordance with U.S. generally accepted accounting principles (“US GAAP”), the Company accounted for the Aplitec transaction as a reverse acquisition, which requires that the company whose shareholders retained a majority voting interest in a combined business be treated as the acquiror for accounting purposes. References to the “Company” refer to Net1 and its consolidated subsidiaries, including Aplitec, unless the context otherwise requires. References to Net1 are references solely to Net 1 UEPS Technologies, Inc.

     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 the rules and regulations of the Securities and Exchange Commission for Quarterly Results on Form 10-Q and include all of the information and disclosures required by US GAAP for interim financial reporting. The results of operations for the three and six months ended December 31, 2005 and 2004 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, 2005. 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.

     Stock-Based Compensation

     Financial Accounting Standards Board (“FASB”) Statement No. 123 (revised 2004), Share-Based Payment, (“FAS 123R”) was issued in December 2004 and replaces FASB Statement No. 123, Accounting for Stock-Based Compensation (“FAS 123”) and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). FAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements at fair value and that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. FAS 123R is effective for the Company from July 1, 2005. FAS 123R requires public companies to account for share-based payments using the modified-prospective method and permits public companies also to account for share-based payments using the modified-retrospective method. Under the modified-prospective method, from the effective date, compensation cost is recognized based on the requirements of FAS 123R for all new share-based awards and based on the requirements of FAS 123 for all awards granted prior to the effective date of FAS 123R that remain unvested on the effective date. The modified-retrospective method permits companies to restate, based on the amounts previously recognized under FAS 123 for pro forma disclosure purposes, either all prior periods presented or prior interim periods in the year of adoption. The adoption of the modified-prospective method on July 1, 2005 by the Company did not have an impact on its overall results of operations or financial position

     There was no stock-based compensation charge under FAS 123R for the three or six months ended December 31, 2005. There was no stock compensation charge under APB 25 for the three and six months ended December 31, 2004. There would have been no charge had compensation expense for share options granted under the stock option plan been determined based on fair value at the grant dates consistent with the method required in accordance with FAS 123.

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     Translation of foreign currencies

     The functional currency of the Company is the South African rand, or ZAR, and its reporting currency is the U.S. dollar. The current rate method is used to translate the financial statements of the Company to U.S. dollars. 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.

     Recent accounting pronouncements adopted

     In November 2005, the FASB issued FASB Staff Position (“FSP”) FAS No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” (“FSP FAS 123(R)-3”) This FSP provides a practical exception when a company transitions to the accounting requirements in FAS 123R. FAS 123R requires a company to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting FAS 123R (termed the APIC Pool), assuming the company had been following the recognition provisions prescribed by FAS 123. The FASB learned that several companies do not have the necessary historical information to calculate the APIC pool as envisioned by FAS 123R and accordingly, the FASB decided to allow a practical exception as documented in the FSP. FSP FAS 123(R)-3 is effective immediately. The adoption of the statement by the Company did not have an impact on its overall results of operations or financial position.

     In December 2005, the FASB issued FSP SOP 94-6-1, "Terms of Loan Products That May Give Rise to a Concentration of a Credit Risk." The FSP addresses (1) the circumstances under which the terms of the loan products give rise to a concentration of credit risk and (2) the disclosures or other accounting considerations that apply for entities that originate, hold, guarantee, service, or invest in loan products with terms that may give rise to a concentration of credit risk. The FASB believes judgment is required to determine whether loan products have terms that give rise to a concentration of credit risk. Companies are required to apply the guidance in the FSP to reporting periods ending after December 19, 2005. The adoption of the statement by the Company did not have an impact on its overall results of operations or financial position.

     In June 2005, the Emerging Issues Task Force (“EITF”) ratified the modification of Paragraph 19 of FASB Statement No. 131, Disclosures About Segments of an Enterprise and Related Information (“FAS 131”), which indicates that operating segments that do not meet the quantitative thresholds included in paragraph 18 of FAS 131 may be combined with information about other operating segments that also do not meet these quantitative thresholds to produce a reportable segment if they share a majority of the aggregation criteria listed in paragraph 17 of FAS 131. The disclosure requirements are effective for fiscal years ending after September 15, 2005. The adoption of the statement by the Company did not have an impact on its segmental disclosures.

     Recent accounting pronouncements not yet adopted as of December 31, 2005

     In November 2005, the FASB issued FSP FAS No. 115-1 and 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The guidance in this FSP addresses the determination of when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP FAS No. 115-1 and FAS 124-1 is effective for the Company in the third quarter of fiscal year 2006. The adoption of the statement by the Company is not expected to have an impact on its overall results of operations or financial position.

     In October 2005, the FASB issued FSP FAS 13-1, "Accounting for Rental Costs Incurred during a Construction Period." The FASB concludes in this FSP that rental costs associated with ground or building operating leases that are incurred during a construction period should be expensed. The FASB believes there is no distinction between the right to use a leased asset during the construction period and the right to use that asset after the construction period. Companies are required to apply the guidance in the FSP to the first reporting period beginning after December 15, 2005. The adoption of the statement by the Company is not expected to have an impact on its overall results of operations or financial position.

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     Summarized below is the movement in the gross carrying value and accumulated amortization of goodwill for the six months ended December 31, 2005.

     Summarized below is the movement in the gross carrying value and accumulated amortization of goodwill for the year ended June 30, 2005.

     Summarized below is the carrying value and accumulated amortization of the intangible assets as of December 31 and June 30, 2005:

     Aggregate amortization expense on the finite-lived intangible assets for the three and six months ended December 31, 2005 was approximately $0.5 million and $1.2 million, respectively (three and six months to December 31, 2004: $0.6 million and $1.1 million, respectively). Estimated amortization expense to be reported in future periods is estimated at $2.1 million per annum, however this amount could differ from the actual amortization as a result of changes in useful lives and other relevant factors.

     As required by FASB Statement No. 141, Business Combinations, goodwill has been allocated to the Company’s reportable transaction-based activities, smart cards accounts, financial services and hardware, software and related technology sales segments as follows:

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The Company’s balance sheet reflects two classes of equity - common stock and linked units.

The linked units comprise the following instruments which are linked and cannot be traded separately:

• a right to special convertible preferred stock,
   
• B Class preference shares in Net 1 Applied Technologies South Africa Limited (“New Aplitec”) and
   
• B Class loans issued by New Aplitec.

     Although the linked units include certain instruments (the B Class preference shares and the B Class loans) that are legally equity of a subsidiary of the Company, they have been treated as equity of the Company and recorded as part of shareholders’ equity in these condensed consolidated financial statements, in recognition of their substance, which is economically equivalent to that of common stock.

     The B Class loans referred to above are not considered to be a liability in accordance with FAS 150, Accounting for Certain Financial Instruments with Characteristics of Both Equity and Liability, as New Aplitec does not have an obligation to transfer assets to its shareholders in respect of the loans. In addition, any distributions relating to the loans are solely at the discretion of New Aplitec.

     Voting rights –Holders of shares of special convertible preferred stock have the same voting rights as holders of common stock. Therefore, a linked unit-holder is able to vote on the same matters as a holder of common stock, including the selection of directors, corporate decisions submitted to shareholder vote, and decisions regarding distribution of earnings. In addition, the special convertible preferred stock does not provide any additional rights with respect to control of the Company not shared by holders of common stock.

     Dividend rights –Holders of common stock and linked units have similar rights to the distribution of the Company’s earnings.

     Liquidation rights – In the event of a liquidation of the Company or New Aplitec, the linked units are automatically convertible into common stock of the Company, thereby allowing a linked unit holder to have identical liquidation rights to a holder of common stock in the event of liquidation.

     Sale rights – A linked unit holder can only dispose of its interest in the Company by 1) converting the linked units into common stock and 2) selling the common stock on the open market. Therefore, a holder of the linked units receives the same risk and rewards in market price fluctuation as a common stockholder of the Company.

     Common stock

     Holders of shares of the Company’s common stock are entitled to receive dividends and other distributions when declared by the Company’s board of directors out of funds available. Payment of dividends and distributions is subject to certain restrictions under the Florida Business Corporation Act, including the requirement that after making any distribution the Company must be able to meet its debts as they become due in the usual course of its business.

     Upon voluntary or involuntary liquidation, dissolution or winding up of the Company, holders of common stock share ratably in the assets remaining after payments to creditors and provision for the preference of any preferred stock according to its terms. There are no pre-emptive or other subscription rights, conversion rights or redemption or scheduled installment payment provisions relating to shares of common stock. All of the outstanding shares of common stock are fully paid and non-assessable.

8

     Each holder of common stock is entitled to one vote per share for the election of directors and for all other matters to be voted on by shareholders. Holders of common stock may not cumulate their votes in the election of directors, and are entitled to share equally and ratably in the dividends that may be declared by the board of directors, but only after payment of dividends required to be paid on outstanding shares of preferred stock according to its terms. The shares of Company common stock are not subject to redemption.

     Special convertible preferred stock

     The special convertible preferred stock ranks, on parity, without preference and priority, with the Company’s common stock with respect to dividend rights (except as described below) or rights upon liquidation, dissolution or winding-up of the Company. The stock is junior in preference and priority to each other class or series of preferred stock or other equity security of the Company under terms which may be determined by the board of directors to expressly provide that such other security rank senior in preference or priority to the special convertible preferred stock with respect to dividend rights or rights upon liquidation, dissolution or winding-up of the Company.

     So long as any shares of special convertible preferred stock are outstanding, the Company’s board will determine immediately prior to the declaration of any dividend or distribution (i) the portion, if any, of the Company’s assets available for such dividend of distribution that is attributable to funds or assets from New Aplitec, regardless of the manner received (the “South African Amount”) and (ii) the portion of such funds or assets that is not from New Aplitec (the “Non-South African Amount”). The South African Amount will not include amounts received from New Aplitec due to its liquidation, distribution or dividend after insolvency or winding up.

     So long as any shares of special convertible preferred stock are outstanding, (i) any dividends or distributions by the Company’s board of Non-South African Amounts must be paid pro rata to all holders of common stock and special convertible preferred stock, and (ii) and dividends or distributions by the Company’s board of South African Amounts can be paid only to holders of common stock. The Company’s board has complete discretion to declare a dividend or distribution with respect to South African Amounts or Non-South African Amounts.

     In the event of the voluntary or involuntary liquidation, dissolution, distribution of assets or winding-up of the Company, all outstanding shares of special convertible preferred stock will automatically convert and holders of such stock will be entitled to receive pari passu with holders of common stock, any assets of the Company distributed for the benefit of its shareholders.

     Holders of special convertible preferred stock have the right to receive notice of, attend, speak and vote at general meetings of the Company, and are entitled to vote on all matters on which holders of common stock are entitled to vote. Each holder of special convertible preferred stock present in person, or the person representing such holder, is entitled to a number of votes equal to the number of shares of common stock that would be issued upon conversion of the special convertible preferred stock held by such holder on the record date.

     B class preference shares

     Net1 owns 100% of the A class common stock and A class loans in issue of New Aplitec. The B class preference shares rank pari passu with the New Aplitec A class stock in respect of participation in dividends and return of capital prior to winding-up of New Aplitec. The B class preference shares shall not, however, participate in dividends or a return of capital on a winding-up of New Aplitec for any reason. However, the unit holders will participate, as the B class preference stock will automatically convert into Company common stock on a winding-up of New Aplitec. The B class preference shares cannot be sold or transferred other than to the Company pursuant to the occurrence of a trigger event. Therefore, the B class preference shares, the B class loans and the rights to receive Company special convertible preferred stock are linked together and cannot be traded separately.

     The holders of B class preference shares will only be entitled to vote on matters which directly affect the rights attaching to the B class preference shares. At every general meeting of New Aplitec at which more than one class of shareholders are present and entitled to vote, unit holders of the South African Trust which in turn holds the B class preference shares, shall be entitled, upon a poll, to that proportion of the total votes in New Aplitec which the aggregate number of B class preference shares held bears to the aggregate number of all shares entitled to be voted at such meeting (provided that no resolution for the declaration of a dividend or for the disposal of any intellectual property of New Aplitec shall be passed unless unit holders representing 50.1% of the B class preference shares present at the meeting in person or represented by proxy vote in favor of such resolution).

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     B class loans

     The B class loans are unsecured and repayable as and when directed by the board of directors of New Aplitec provided that no capital may be repaid until at least 30 days have lapsed from the date of drawdown of the loans, and subject to South African Exchange Control approval. The loans will bear interest at such rates as may be determined by the board of directors of New Aplitec at the beginning of each year, but shall not be more than the prime rate as quoted by Standard Bank of South Africa Limited from time to time. Interest, if so declared by the board of directors of New Aplitec, will be payable by New Aplitec semi-annually in arrears.

     Conversion of special convertible preferred stock to common stock

     Special convertible preferred stock is convertible into shares of common stock on a one-for-one basis upon the occurrence of a trigger event. With each converted share of special convertible preferred stock that is converted, the Company will receive:

• 7.368421056 B class preference shares; and
   
• such holder’s interest in the New Aplitec B loan accounts.

     Upon conversion, all rights with respect to shares for special convertible preferred stock will cease. Converted shares will be cancelled and have the status of authorized but unissued preferred stock, without designation as to series until such shares are once more designated as part of a particular series by the board of directors.

     During the three and six months ended December 31, 2005, 4,022,118 and 15,514,258 shares of special convertible preferred stock were converted to common stock. The trigger events that gave rise to these conversions were requests by linked unit-holders to sell and/or convert 29,636,655 and 114,315,569 linked units during the three and six months ended December 31, 2005. The net result of these conversions was that 29,636,655 and 114,315,569 B class preference shares and B class loans were ceded to Net1 during the three and six months ended December 31, 2005, which converted 4,022,118 and 15,514,258 shares of special convertible preferred stock to 4,022,118 and 15,514,258 common stock in return for the ownership of the 29,636,655 and 114,315,569 B class preferred shares and B class loans. As a result of the conversion, the number of outstanding shares of common stock has increased by 15,514,258 and the number of outstanding shares of special convertible preferred stock has decreased by 15,514,258. In addition, as a consequence of the conversion, the Company now owns an additional 114,315,569 B class preferred shares and B class loans. The reduction in the B class preference shares from $0.031 million to $0.013 million is due to the cession to the Company of the B class preference shares as a result of the trigger events. The value of the B class preference shares and B class loans held by the Company is eliminated on consolidation.

     During the three and six months ended December 31, 2004, 1,147,967 and 3,676,134 shares of special convertible preferred stock were converted to common stock. The trigger events that gave rise to these conversions were requests by linked unit-holders to sell and/or convert 8,458,704 and 27,087,057 linked units during the three and six months ended December 31, 2004. The net result of these conversions was that 8,458,704 and 27,087,057 B class preference shares and B class loans were ceded to Net1 during the three and six months ended December 31, 2004, which converted 1,147,967 and 3,676,134 shares of special convertible preferred stock to 1,147,967 and 3,676,134 common stock in return for the ownership of the 8,458,704 and 27,087,057 B class preferred shares and B class loans. As a result of the conversion, the number of outstanding shares of common stock has increased by 3,676,134 and the number of outstanding shares of special convertible preferred stock has decreased by 3,676,134. In addition, as a consequence of the conversion, the Company now owns an additional 27,087,057 B class preferred shares and B class loans. The reduction in the B class preference shares from $0.038 million to $0.034 million is due to the cession to the Company of the B class preference shares as a result of the trigger events. The value of the B class preference shares and B class loans held by the Company is eliminated on consolidation.

     The entire consolidated net income of the Company is attributable to the shareholders of the Company comprising both the holders of Net1 common stock and the holders of linked units. As described in Note 3, the linked units have the same rights and entitlements as those attached to common shares.

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     As the linked units owned by holders, other than the Company, are exchangeable for special convertible preferred stock at the ratio of 7.37:1, which is then converted to common stock at the ratio of 1:1, the basic earnings per share for the three months ended December 31, 2005, for the common stock and linked units are the same and is calculated by dividing the net income by the combined weighted average number (56.7 million) of common stock (45.5 million) and special convertible preferred stock (11.2 million) in issue. Diluted earnings per share has been calculated to give effect to the number of additional shares of common stock/ linked units that would have been outstanding if the potential dilutive instruments had been issued in each period.

     The basic earnings per share for the six months ended December 31, 2005, for the common stock and linked units are the same and is calculated by dividing the net income by the combined number (56.3 million) of common stock (45.1 million) and special convertible preferred stock (11.2 million) in issue. Included in the weighted average number of shares in issue to calculate earnings and diluted earnings per share were 1,538,794 shares of the Company’s common stock issued in connection with the Company’s August 2005 public offering.

     The basic earnings per share for the three and six months ended December 31, 2004, for the common stock and linked units are calculated in the same manner by dividing the net income by the combined number (54.7 million) of common stock (25.1 million) and special convertible preferred stock (29.6 million) in issue. The common stock and special convertible preferred stock used to calculated earnings per share has been adjusted for the one-for-six reverse stock split approved by the Company’s board of directors on June 2, 2005, which became effective June 13, 2005.

     The weighted average number of outstanding shares for the three and six months ended December 31, 2005 and 2004, presented below includes the common stock as well as the special convertible preferred stock, as the holders of special convertible preferred stock have the same rights and entitlements as those attached to the common stock.

     The following tables detail the weighted average number of outstanding shares used for the calculation of earnings per share for the three and six months ended December 31, 2005 and 2004.

11

     The Company’s comprehensive income consists of net income and foreign currency translation gains and losses which, under US GAAP, are excluded from net income. Total comprehensive income for the three and six months ended December 31, 2005 and 2004 was:

     The Company discloses segment information in accordance with FAS 131, 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 which each operate mainly within South Africa: Transaction-based activities, Smart card accounts, Financial services and Hardware, software and related technology sales. The Company also has a Corporate/ Eliminations segment. The Company’s reportable segments offer different products and services and require different resources and marketing strategies and share the Company’s assets.

     The Transaction-based activities segment currently consists mainly of a state pension and welfare benefit distribution service provided to provincial governments in South Africa. Fee income is earned based on the number of beneficiaries included in the government pay-file. This segment also includes fee income from the merchant retail application launched during the year ended June 30, 2005. 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, 2005, there were three such customers, providing 38, 19 and 11 per cent, respectively, of total revenue (three and six months ended December 31, 2004: three customers 37, 19 and 12 per cent and 36, 20 and 12 per cent, 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 derives revenue from the provision of short-term personal lending activities and life insurance products. Interest income is recognized in the income statement as it falls due, using the interest method by reference to the constant interest rate stated in each loan agreement.

     The Hardware, software-related and technology sales segment markets, sells and implements the Universal Electronic Payment System (“UEPS”). The segment undertakes smart card system implementation projects, delivering hardware, software and business solutions in the form of customized systems. This segment also generates rental income from hardware sold to merchants enrolled in the Company’s merchant retail application launched during the year ended June 30, 2005.

     Corporate / eliminations include the Company’s head office cost centers in addition to the elimination of inter-segment transactions.

12

     The Company evaluates segment performance based on operating income. The following tables summarize segment information which is prepared in accordance with US GAAP:

13

     The comparative segment information has been restated to reflect the new Smart card accounts segment which derives revenue from the provision of smart card accounts, as a fixed monthly fee per card is charged for the maintenance of these accounts. In addition, the Company’s chief operating decision maker began reviewing the segment information using US GAAP measures in May 2005. Previously this information was reviewed using South African generally accepted accounting principles measures.

     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.

     The pre-funded social welfare grants receivable represents the amounts due from the Eastern Cape and Kwa-Zulu Natal provincial governments, as the Company pre-funds social welfare grant payments on behalf of the government in these provinces. The pre-funded amounts are typically reimbursed to the Company within two weeks after the disbursement of the grants. The grant payment service normally commences a week before the start of a calendar month, with the exception of January. The January payment service typically commences during the first week of January. As no pre-funding of the January grants is necessary during the last week in December, the Company’s pre-funded social welfare grant receivable at the end of December is significantly lower, compared to other quarter ends. Conversely, the cash and cash equivalents balance on hand at the end of December is significantly higher.

     The June 30, 2005 amount was previously included in accounts receivable in the Company’s Annual Report on Form 10-K. Management believes that the nature of the pre-funded social welfare grants receivable is substantially different to those of other accounts receivable and has therefore disclosed the balances separately.

     The deferred expenditure on smart cards represents amounts paid for smart cards used in the administration and distribution of grants to beneficiaries. These expenditures are deferred and written off over the period of the contract with the provincial government.

14

     The Company completed a public offering and Nasdaq listing in August 2005. The Company incurred the following costs in connection with this transaction during the three months ended December 31 and 2005, September 30, 2005, and the year ended June 30, 2005:

     The Other category includes costs to date related to venue hire, travel, bank charges and other miscellaneous expenses related to the public offering and Nasdaq listing. All costs related to the public offering are non-deductible for taxation purposes.

     Underwriting discounts and commissions of $2.4 million were incurred relating to the underwriters exercising their over allotment option. The discounts and commissions have been charged directly to additional paid-in capital.

     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, and FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods. 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 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.

     In respect of the three and six month periods ended December 31, 2005, the tax charge was calculated using the expected effective tax rate for the year (36.89%) and was adjusted for the effect of non-deductible costs which primarily relate to the public offering and Nasdaq listing, resulting in an effective tax rate for the three and six months of 38.1% and 38.8%, respectively.

     During December 2005 the Company, together with Namibia Post Limited (“NamPost”) and SmartSwitch Namibia (Pty) Limited (“SmartSwitch Namibia”) executives, discussed the need for an additional contribution to SmartSwitch Namibia by each shareholder of $0.8 million (ZAR 4.75 million, at December 31, 2005 foreign exchange rates). The proceeds are expected to be utilized by SmartSwitch Namibia for the acquisition of hardware from the Company. In January 2006, each shareholder advanced an additional $0.8 million (ZAR 4.75 million, at December 31, 2005 foreign exchange rates) to SmartSwitch Namibia.

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     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 Form 10-Q. On June 7, 2004, we completed a transaction, which we more fully describe in our Annual Report on Form 10-K for the year ended June 30, 2005 in which the former shareholders of Net 1 Applied Technology Holdings Limited, or Aplitec, acquired a majority voting interest in us. In accordance with U.S. generally accepted accounting principles, or US GAAP, we accounted for the Aplitec transaction as a reverse acquisition, which requires that the company whose shareholders retain a majority voting interest in a combined business be treated as the acquiror for accounting purposes.

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, 2005. 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.

Overview

     We provide our universal electronic payment system technology as an alternative payment system to the un-banked and under-banked populations of developing economies. We believe that we are the first company worldwide to implement a system that can enable the estimated four billion people who generally have limited or no access to a bank account to effect affordably electronic transactions with one another, government agencies, employers, merchants and other financial services providers. To do this, we have developed and deployed the universal electronic payment system, or UEPS. This system uses secure smart cards that operate in real time but offline, unlike traditional payment systems offered by major banking institutions that require immediate access through a communications network to a centralized computer. This offline capability means that users of our system can enter into transactions at any time with other card holders in even the most remote areas so long as a portable offline card reader is available. In addition to payments and purchases, our system can be used for banking, health care management, international money transfers, voting and identification.

     South Africa is the first major market where we achieved significant success and a high penetration rate in the areas we targeted. We believe that our operating experience in South Africa demonstrates the success of our business model in a developing economy. According to estimates made by Statistics South Africa, as of mid-2005, South Africa has a population of approximately 46.9 million people, of which an estimated 50% live below the poverty line. The South African unemployment rate is estimated at approximately 26.7% . The success we have achieved in South Africa since commencing operations in December 1997 has primarily resulted from servicing the needs of the poorest section of the population – those who are dependent on government social welfare grants. We have designed and implemented a complete business model involving the payment, and subsequent spending, of these grants through our smart cards and UEPS technology, which provides us with the opportunity to earn multiple sources of revenue and provides our card holders with affordable functionality and lifestyle improvement. The South African government is also actively involved in a number of initiatives which may present us with opportunities to export our South African achievements, such as the New Partnership for Africa’s Development and the India-Brazil-South Africa Dialogue Forum, which is currently considering the establishment of an economic trade bloc between these three countries.

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     On the African continent outside South Africa, we have implemented our systems at the request of a variety of customers in Namibia, Ghana, Rwanda, Burundi, Malawi and Mozambique, some of which are considered among the poorest countries in the world. In Malawi, our system has been implemented by the Reserve Bank of Malawi as a national payment system. With the exception of Namibia, we are not actively involved as either investors or operators in any of these systems, but we believe that our experience and success in South Africa, together with our understanding of trade in Africa, will permit us to take advantage of new opportunities both in and outside South Africa, which in some instances, may involve acquiring an equity stake in new or existing businesses.

     In Namibia, we are a 50% shareholder in SmartSwitch Namibia (Pty) Ltd, or SmartSwitch Namibia, with the other 50% of the shares held by Namibia Post Limited, or NamPost, a government entity which provides post office services across Namibia. SmartSwitch Namibia will initially provide NamPost with a UEPS banking platform and NamPost will issue a UEPS smart card to its 300,000 customers. The card will replace the existing paper based books and allow secure transacting across all of NamPost’s 120 branches and all installed point of sale, or POS, devices. The card will also be issued to participating retailers, medical insurance companies and other government institutions.

     Public Offering and Nasdaq Listing

     In August 2005, we completed an underwritten public offering of our common stock and listed our common stock on the Nasdaq National Market. In the offering, selling shareholders sold 10,258,625 shares of our common stock at a public offering price of $22.00 per share. The selling shareholders included employees that sold our stock and officers that exercised and sold stock options which resulted in proceeds to us of $0.7 million. Pursuant to the underwriting agreement, we granted the underwriters an option to purchase 1,538,794 shares at the public offering price to cover overallotments. The underwriters exercised this option and concurrently with the closing of the offering, we received net proceeds of $31.5 million from the underwriters. In addition, concurrently with the offering, certain of the selling shareholders sold 3,409,091 shares of our common stock at the public offering price in a private placement to investment entities affiliated with General Atlantic LLC. In connection with the public offering and Nasdaq listing, we effected a one for six reverse stock split which became effective on June 13, 2005.

Current Trends Affecting Our Business

     Government decision making

     We currently derive a significant portion of our revenues from our contracts with various South African provincial governments. The national South African government passed legislation in 2004 for creation of the South African Social Security Agency, or SASSA. The primary purpose of SASSA is to consolidate at the central government level the administration of social welfare grants. We believe that our successful record with our provincial government contracts will provide us with a good opportunity to benefit from the transition to national administration of social welfare grants because we may be able to obtain contracts to distribute grants in provinces with which we do not currently have a contractual relationship. However, there is a chance that this consolidation could lead to our losing one or more of our current contracts if the SASSA decides to appoint a single (or other) contractor to provide social welfare grant distribution and we were not chosen. During this transition period, which we estimate to be in the region of 12 to 18 months, our existing provincial government contracts will continue to be governed by their respective terms.

     When a provincial government contract expires, whether at its originally scheduled expiration date or at the end of any applicable extension period, we must successfully re-tender in order to retain the contractual relationship. Usually, such a tender must be submitted as part of a competitive tender process. The fact that we previously held a particular contract does not necessarily mean that it will be awarded to us again. To date, we have successfully renewed every provincial government contract which we have been awarded. In addition, there have been occasions when a contract has not been formally renewed prior to its originally scheduled expiration date or expiration of the extension period, as is currently the case with the Eastern Cape, KwaZulu-Natal and North West contracts, but in each of these cases we and the provincial government have continued to operate under the terms of the expired contract until the execution of a new contract or receipt of a formal extension notice.

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     Progress of our Merchant Acquiring Project

     During July 2004, we began a major drive to install POS devices in rural areas where the majority of our card holders spend their social welfare grants. The ability of our card holders to load their grants at these retailers and to spend these grants securely on goods and services, without the need to withdraw the full amount in cash, represents one of the basic underlying principles of the UEPS functionality. We believe that the installation of these POS devices has resulted in a significant improvement in the lifestyle of our card holders, while introducing a new revenue source for us in the form of merchant acquiring and other transaction fees. Use of the POS devices also lowers our costs by reducing the amount of cash we need to deliver to social welfare grants in cash at our mobile paypoints. For a discussion of the most recent results of our merchant acquiring project see Results of Operations - Continued adoption of our merchant acquiring system.

     The following chart shows the number of POS devices installed and the average spend per POS device during the twelve month period ending December 31, 2005:

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     The following chart shows the growth in the value of loads at merchant locations and the transactions (expenditures) processed through our installed base of Point of Sale, or POS, devices during the eighteen month period beginning July 1, 2004, when we first implemented our merchant acquiring project, through December 31, 2005, by pay cycle:

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     The following graph shows the number of beneficiary grants loaded at merchant locations, per pay cycle, for the eighteen month period ended December 31, 2005:

     Progress of wage payment implementation

     The implementation of our wage payment in South Africa requires us to be registered as a bank in South Africa, or to have access to an existing deposit taking license. We are currently pursuing all available avenues to either obtain our own license, or gain access to one. These approaches include:

• applying for a new banking license;
• purchasing an exisiting banking license; and
• entering into a joint venture arrangement with an existing banking institution to gain access to its banking license

     These alternatives all have different inherent risks and timing considerations. Accordingly, it may take us some time to obtain or gain access to a license and commence the implementation of our wage payment system in South Africa.

     Implementation of new UEPS systems

     The implementation of new UEPS systems, particularly in developing economies outside our current markets, is a vital component of our future growth. We are currently exploring a number of opportunities to implement UEPS systems and to participate as minority investors in these projects. The success of these endeavors are, however, subject to a number of factors over which we have little or no control, such as finding suitable partners with the appropriate financial, business and technical backing and continued governmental support for planned implementations. In some countries, finding suitable partners and obtaining the appropriate support from the government involved may take a number of years before we can commence implementation.

     As part of our strategy to implement new UEPS systems in developing economies we entered into a shareholders agreement with NamPost, to create SmartSwitch Namibia, a Namibian company. Under this agreement, we, together with NamPost, have agreed to implement and operate a UEPS smart card-based switching system in Namibia. We and NamPost each own 50% of SmartSwitch Namibia, which will own the Namibian switch. The Service Level Agreement between SmartSwitch Namibia and NamPost was finalized and signed during the second quarter of fiscal 2006. Our marketing and information technology teams began implementation and testing of the switch in the second quarter of fiscal 2006 and operations in Namibia are expected to commence in the middle of the third quarter of fiscal 2006.

     The system, the first of its kind in Namibia, is intended to improve the banking system in the country. NamPost, as the first customer of the switch, is expected to increase its market share in the financial services arena and position itself as the leading service provider for the unbanked and under-banked citizens of Namibia. We expect that SmartSwitch Namibia will initially issue approximately 300,000 UEPS smart cards to NamPost’s existing customer base.

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     Together with NamPost we have capitalized SmartSwitch Namibia with approximately $3.6 million (ZAR 23 million, at December 31, 2005, foreign exchange rates), in start-up capital and loans, contributed equally by both parties. The proceeds will be utilized by SmartSwitch Namibia for the acquisition of hardware and software from us and for general working capital purposes. During December 2005 we, together with NamPost and SmartSwitch Namibia executives, discussed the need for an additional contribution to SmartSwitch Namibia by each shareholder of $0.8million (ZAR 4.75 million, at December 31, 2005, foreign exchange rates). The proceeds will be utilized by SmartSwitch Namibia for the acquisition of hardware from us. In January 2006, each shareholder advanced an additional $0.8million (ZAR 4.75 million, at December 31, 2005, foreign exchange rates) to SmartSwitch Namibia.

     As we own 50% of SmartSwitch Namibia we are required under US GAAP to eliminate 50% of the net income generated from sales to SmartSwitch Namibia. In accordance with US GAAP, we will recognize this net income from these hardware and software sales during the period in which the hardware and software we have sold to SmartSwitch Namibia is utilized in its operations, or has been sold to third party customers, as the case may be.

     SmartSwitch Namibia did not operate during the first six months of fiscal 2006. However, during the first quarter of fiscal 2006, licenses and software were made available for collection to SmartSwitch Namibia and we have recognized net income. During the second quarter, hardware was made available for collection, and in certain instances was collected by SmartSwitch Namibia, however this hardware has not been used by SmartSwitch Namibia as of December 31, 2005. We expect that additional deliveries of hardware will be made in the third quarter of fiscal 2006. We will recognize net income related to these third quarter of fiscal 2006 sales once the hardware has been made available for collection to SmartSwitch Namibia, which we expect to occur in January and February 2006.

     Phase 1 of the project involves the transfer of all of NamPost’s banking products to the smart card, offering affordability, security, simplicity and flexibility. Negotiations are currently in place with other financial institutions and companies that wish to participate as customers of SmartSwitch. We expect the suite of smart card applications to include banking, retail, money transfers, third party bill payments, wages and social security grants.

     We began the rollout of the switch infrastructure to NamPost’s 120 service branches and merchant stores during the three months ended December 31, 2005, and expect the official launch of the operations of SmartSwitch Namibia in mid-February 2006.

     Involvement with USAID

     On September 27, 2005, the Washington D.C.-based President’s Emergency Plan for AIDS Relief, through the U.S. Agency for International Development, or USAID, announced a contract to strengthen the lifeline of essential drugs and supplies for people living with and affected by HIV/AIDS and other infectious diseases in developing countries. The contract, called the Supply Chain Management System, or, SCMS, was awarded by USAID to the Partnership for Supply Chain Management, or PfSCM, of which we are a member.

     PfSCM is an organization formed by JSI Research and Training Institute, Inc., or JSI, and Management Sciences for Health, or MSH, both U.S.-based non-profit organizations with extensive experience in public health and logistics management in developing countries. PfSCM’s project team includes 17 institutions from the private sector, non-profit, and faith-based communities.

     Over the past two years, we have been working with JSI in South Africa to develop a system to track anti-retroviral drugs and to provide patient information and reporting capability for antiretroviral therapy, or ART, patients and HIV positive persons receiving care and support but not yet requiring ART. In this public-private partnership, JSI facilitated the field-testing and refinement of the system at the service delivery level in both static and community outreach settings, and developed the reporting database, using Emergency Plan funding from USAID/South Africa.

     The system, Secure Technology Advancing Treatment, or STAT™, is based on our biometrics and smart card technology. It is particularly responsive to the challenges of ART as it provides authentication of health care provider and patient, enables patient mobility, facilitates referral and follow up care, and fulfills the critical requirement for effective ART by operating offline when needed. This last feature is essential, since many elements of HIV/AIDS care must be provided at the community level, where electricity and connectivity are often lacking. Furthermore, the reporting database provides programme managers and donors with accurate performance indicators and provides health facility managers with essential information to improve operational efficiency, on a 24-hour update basis.

     The STAT™ system was included in PfSCM’s proposal for the SCMS as a viable solution for incorporation into individual country plans. The implementation of the SCMS is a complex process and we cannot yet provide an indication regarding overall timing or the exact form of our ultimate participation. In the near term, we are discussing with SCMS senior management a pilot deployment of our technology in one of the SCMS target countries to demonstrate the solution within the SCMS. David Schwarzbach, our Vice President for business development in the Americas, is our primary point of contact with the SCMS. He is actively working with the SCMS staff and represents us on the SCMS Advisory Board.

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     In South Africa the STAT™ system is already operational in six Catholic Relief Services/South African Catholic Bishops Conference ART clinics and eight ART community outreach projects, and in a palliative care NGO project in Soweto, and is currently being rolled out in two hospitals and surrounding multiple referral clinic settings. This selection of diverse sites has clearly demonstrated that our technology operates successfully in the full range of ART and care and support health care settings and that it is beneficial to patients, health care providers, and programme managers.

Critical Accounting Policies

     Our annual 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, 2005.

• Deferred taxation
• Accounts receivable and provision for doubtful debts
• Research and development

     Recent accounting pronouncements adopted

     Refer to Note 1 of the unaudited condensed consolidated financial statements for a full description of recent accounting pronouncements, including the expected dates of adoption and effects on financial condition, results of operations and cash flows.

     Recent accounting pronouncements not yet adopted as of December 31, 2005

     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, 2005, including the expected dates of adoption and effects on financial condition, results of operations and cash flows.

Currency Exchange Rate Information

     Actual exchange rates

     The actual exchange rates for and at the end of the periods presented were as follows:

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     Translation exchange rates

     We are required to translate our results of operations from ZAR to U.S. dollars on a monthly basis. Thus, the average rates used to translate this data for the three and six months ended December 31, 2005 and 2004, 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:

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 U.S. dollars and are prepared in accordance with US GAAP. Our discussion analyzes our results of operations both in U.S. dollars and supplementally in 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 U.S. dollar and ZAR on our reported results and because we use the U.S. 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.

     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 eliminations is a fifth segment which we analyze and which consists of 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.

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     Three Months Ended December 31, 2005 Compared to the Three Months Ended December 31, 2004

     The following factors had a significant influence on our results of operations during the periods:

• weakening of the South African rand, or ZAR, which is our functional currency, against the U.S. dollar, which is our reporting currency;
• continuation during the second quarter of fiscal 2005 of the Nedbank project to deliver POS devices that was concluded during the third quarter of fiscal 2005;
• continuation during the second quarter of fiscal 2006 of another Nedbank project to deliver POS devices and related hardware to Nedbank;
• continuation during the second quarter of fiscal 2006 of our agreement to supply SmartSwitch Namibia with hardware; and
• the continued adoption of our merchant acquiring project.

     Consolidated overall results of operations

     This discussion is based on the amounts which were prepared in accordance with US GAAP.

     The following tables show the changes in the items comprising our statements of operations, both in U.S. dollars and in ZAR:

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     Analyzed in ZAR, the increase in revenue for the three months ended December 31, 2005, was primarily due to the higher volumes in our transaction-based activities and increased hardware, software and related technology sales activity.

     The increase in operating income margin to 45% for the three months ended December 31, 2005, from 40% for the three months ended December 31, 2004, was primarily due to improved efficiencies across all activities, the continued adoption of our merchant acquiring initiative, price increases in certain of the provinces where we administer and distribute social welfare grants and a significantly improved contribution from our contract to pay social welfare grants in the Eastern Cape province.

     General and administration expenses have increased due to increased expenditure due to additional corporate and governance requirements including compliance with the Sarbanes Oxley Act of 2002, or Sarbanes, particularly Section 404 of Sarbanes, director’s fees, legal fees, auditor fees, bonuses, as well as due to directors and officer’s insurance premiums, salary increases and legal fees incurred to defend ourselves against claims brought against us. Our continued compliance with Sarbanes and these requirements may require similar levels of internal and external time and expense in the future. Depreciation and amortization expense has decreased due to a reduction in smart card amortization expense as the majority of these cards have now been amortized in full.

     Interest Received and Finance Costs

     Interest received consists of interest received on our surplus cash, while finance costs consist of interest paid on short-term borrowings. We have a unique cash flow cycle due to our obligations to pre-fund the payments of social welfare grants in the KwaZulu-Natal and Eastern Cape provinces. We provide the funds required for the grant payments on behalf of these provincial governments from our own cash resources and are reimbursed within two weeks by the KwaZulu-Natal and Eastern Cape governments, thus exposing ourselves to these provinces’ credit risk. These obligations result in a peak funding requirement, on a monthly basis, of approximately $53.5 million (ZAR 340 million) for each of the KwaZulu-Natal and Eastern Cape contracts. The funding requirements are at peak levels for the first three weeks of every month during the year. The pre-funding requirement for the KwaZulu-Natal and Eastern Cape contracts has increased, however our finance costs have decreased due to the adjustment in the South African prime interest rate from an average of approximately 11.00% per annum for the three months ended December 31, 2004, to 10.5% per annum for the three months ended December 31, 2005. Thus, finance costs decreased from $3.6 million (ZAR 21.8 million) for the three months ended December 31, 2004, to $2.2 million (ZAR 14.5 million) for the three months ended December 31, 2005.

     Interest on surplus cash for the three months ended December 31, 2005, decreased to $3.5 million (ZAR 23.0 million) from $4.1 million (ZAR 24.9 million) for the comparable period during the prior year due to the lower interest rates during this period, which was partially offset by higher average cash balances on hand during this period.

     Taxation

     Total tax expense for the three months ended December 31, 2005 was $8.6 million (ZAR 56.4 million) compared with $6.7 million (ZAR 40.7 million) during the same period in the prior year. The increase was due to our increased profitability in our transaction-based activities and hardware, software and related technology sales segments. The increase in our effective tax rate from 35.6% for the three months ended December 31, 2004, to 38.1% is largely due to professional and consulting fees incurred that are not deductible for taxation purposes.

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     Results of operations by operating segment

     The composition of revenue and the contributions of our business activities to operating income are illustrated below.

     Transaction-based activities

     In U.S. dollars, revenues increased by 3% for the three months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 31% for the three months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues increased by 12% for the three months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 42% for the three months ended December 31, 2005, from the comparable period in 2004.

     These increases in revenues and operating income were due primarily to the continued adoption of our merchant acquiring system in all of the provinces where we distribute welfare grants, increased transacting ability at participating retailers’ POS devices in these provinces, and higher volumes from our provincial contracts. We discuss these factors in more detail below.

     Continued adoption of our merchant acquiring system:

      During July 2004, we began a major drive to install POS devices in rural areas where the majority of our card holders spend their social welfare grants. The ability of our card holders to load their grants at these retailers and to spend these grants on goods and services, without the need to withdraw the full amount in cash, represents the basic underlying principles of the UEPS functionality. We believe that the installation of these POS devices has resulted in a significant improvement in the lifestyle of our card holders, while introducing a new revenue source for us in the form of merchant acquiring transaction fees and reducing our costs to deliver social welfare grants in cash to these individuals at our mobile paypoints. The key statistics and indicators of our merchant acquiring initiative is summarized in the tables below:

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     (1) NC = Northern Cape, EC = Eastern Cape, KZN = KwaZulu-Natal, L = Limpopo, NW = North West

     We have completed the installation of our POS terminals at the majority of those merchant locations we deem the most important to service the bulk of our cardholder base. The negative growth rate of POS terminals installed and the reduced growth in the number of participating UEPS retail locations is primarily due to the improvement in the utilization of our existing terminal base. The productivity of the existing terminal base is constantly improving, as is evident from the increase in the number of transactions processed per POS terminal installed. We believe that the existing terminal base still has abundant spare capacity and that the upward trend in transactions per terminal will continue. Another factor that contributed to the decline of the growth rate during this quarter is the reduced accessibility of retailers during the summer holiday period. From the second week of November to the end of December, South African retailers generally experience a significant increase in their trading activities. During this period, retailers are reluctant to install and implement any new payment systems / POS devices. The effects of this annual six week quiet period for us was more pronounced this year as we had not expanded our merchant acquiring activities into a new province, as was the case in the second quarter of fiscal 2005. Our ongoing POS deployment plan is now focused on secondary locations and retailers, where we will install fewer terminals over a longer period of time.

     Higher volumes from our provincial contracts:

     During the three months ended December 31, 2005, we experienced growth in all of the provinces where we administer payments of social welfare grants. This growth has been mainly due to an increase in the number of child support grants and disability grants approved by the various provincial governments. In total, the volume of payments processed during the three months ended December 31, 2005 increased 5.40% to 10,416,329 from the comparable period during 2004.

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     The higher volumes under existing provincial contracts during the three months ended December 31, 2005, as well as average revenue per grant paid, are detailed below:

     (1) Average Revenue per Grant Paid excludes $0.84 (ZAR 5.50) related to the provision of smart card accounts.

     (2) Average Revenue per Grant Paid excludes $0.91 (ZAR 5.50) related to the provision of smart card accounts.

     A - in ZAR, the increase in the Average Revenue per Grant Paid in KwaZulu-Natal is primarily due to the re-registration fees for mainly disability grant recipients, who were removed off the government’s system during fiscal 2005 and subsequently re-instated during fiscal 2006.

     B - in ZAR, the increase in the Average Revenue per Grant Paid in Limpopo is due to the continued once-off registration fees charged for the ongoing enrollment of new beneficiaries and a price increase from December 2005. The fee charged for payment is significantly less than the fee charged for registration.

     C - in ZAR, the increase in the Average Revenue per Grant Paid in North West is primarily due to an inflation price increase negotiated with the North West government during July 2005 and more registrations.

     D - in ZAR, the decrease in the Average Revenue per Grant Paid in Northern Cape is primarily due to fewer registration fees charged.

     E - in ZAR, the decrease in the Average Revenue per Grant Paid in the Eastern Cape is due to fewer registration fees charged. The fee charged for payment is significantly less than the fee charged for registration.

     Through our merchant acquiring initiative, beneficiaries are now able to load their grants onto their cards as soon as the grant payment file is activated, which typically happens during the week preceding the commencement of a calendar month. We recognize the fee revenue related to the distribution of welfare grants when the beneficiaries load the grants to their cards. The general exception to this rule is the January payment cycle, when the payment file is normally activated during the first week of January and not the last week of December. Accordingly, our December revenue from the distribution of welfare grants is lower than the revenue recognized during the other calendar months during the year. Assuming no price increases or beneficiary growth, this has the result of reducing our second quarter revenues and results when compared with the first quarter.

     Our annual results are not expected to be affected as we anticipate twelve full payment cycles to be included in the fiscal 2006 results. We expect our third quarter transaction-based revenue to be higher than the second quarter as it should include revenues from loading fees for the entire January, February and March 2006 payment cycle and a small portion of the April 2006 payment cycle.

     Operating income margin for the three months ended December 31, 2005 increased to 50% from 39% for the three months ended December 31, 2004. These profit margin improvements were mainly due to:

• the increased volumes as detailed in the table above;
   
• the inflation adjustment to the price charged in the North West and Limpopo provinces; and
   
• the increase in the number of social grant beneficiaries paid through our POS device infrastructure at participating retailers, instead of payment using more costly automated cash dispensers.

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     Smart card accounts

     In U.S. dollars, revenues decreased by 3% for the three months ended December 31, 2005, from the comparable period in 2004. Operating income decreased by 3% for the three months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues increased by 5% for the three months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 5% for the three months ended December 31, 2005, from the comparable period in 2004.

     Operating income margin from providing smart card accounts was constant at 45% for each of the three months ended December 31, 2005 and 2004.

     In ZAR, revenue from the provision of smart card based accounts grew in proportion to the higher number of beneficiaries serviced through our social welfare payment contracts. A total number of 3,497,664 smart card-based accounts were active at December 31, 2005, compared to 3,308,194 active accounts as of December 31, 2004. The increase in the number of active accounts resulted from an increase in the number of beneficiaries in all provinces qualifying for government grants due to the efforts of the South African government to provide social assistance to the very old and very young.

     Financial services

     In U.S. dollars, revenues decreased by 24% for the three months ended December 31, 2005, from the comparable period in 2004. Operating income decreased by 22% for the three months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues decreased by 18% for the three months ended December 31, 2005, from the comparable period in 2004. Operating income decreased by 15% for the three months ended December 31, 2005, from the comparable period in 2004.

     Revenues and operating income from UEPS-based lending decreased during the second quarter of fiscal 2006 compared with the second quarter of fiscal 2005. We offer the UEPS-based loans to our beneficiaries with the primary purpose of assisting them to repay expensive loans with other loan providers and to escape the debt spiral that they are trapped in. Once our UEPS-based loans are repaid, we believe that the beneficiaries have an enhanced ability to remain debt-free, or take loans in amounts smaller than the original refinancing facility we offered to them. In addition, we continuously revise the interest rates charged on our UEPS-based loans, as part of our ongoing commitment to the South African government to provide affordable financial services to the unbanked population of the country. As a result the interest rate charged on our UEPS based loans was lower during the three months ended December 31, 2005. A further benefit of our UEPS-based lending is that cardholders have more disposable income to spend, including through our merchant acquiring base.

     The loan portfolio of the traditional microlending businesses remained static as a result of our strategic decision not to grow this business. However, when compared to June 30, 2005, our UEPS-based lending portfolio has increased due to increased lending activities during the December festive holiday season in South Africa.

     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 provision is required. We consider UEPS-based lending less risky than traditional microfinance loans because the grants are distributed to these lenders by ourselves and these loans are insured. We establish an allowance for doubtful traditional microlending loans in respect of which we consider it likely that all or a portion of the principal amount of the loan or interest thereon will not be repaid by the borrower. We consider default likely after a specified period of non-payment, which is generally not more than 150 days. We assess this allowance based on a review by management of the ageing of outstanding amounts, the payment history in relation to those specific accounts and the overall default history.

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     The key indicators of these businesses are illustrated below:

     As described in our Annual Report on Form 10-K for the year ended June 30, 2005, the significant reduction in both gross finance loans receivable and allowance for doubtful finance loans receivable is due to the write-off in fiscal 2005 of amounts that were not recoverable, of approximately $5.5 million (ZAR 32.3 million). This did not have an impact on net income as the loans had been fully provided for in previous periods.

     Operating income margin for the financial services segment increased to 46% for the three months ended December 31, 2005 from 45% for the three months ended December 31, 2004, primarily due to a decrease in the UEPS-based salary costs.

     Hardware, software and related technology sales

     In U.S. dollars, revenues increased by $2.1 million for the three months ended December 31, 2005, from the comparable period in 2004. Operating income increased by $1.6 million for the three months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues increased by ZAR 16.5 million for the three months ended December 31, 2005, from the comparable period in 2004. Operating income increased by ZAR 11.9 million for the three months ended December 31, 2005, from the comparable period in 2004.

     The increase in revenue for the three months ended December 31, 2005, was due primarily to revenues earned from the September order to supply Nedbank with POS devices and pin-pads and the sale of hardware to SmartSwitch Namibia. Total revenues from the September Nedbank order during the three months ended December 31, 2005, were approximately $3.4 million (approximately ZAR 22.6 million). Revenues from sales of hardware to SmartSwitch Namibia during the three months ended December 31, 2005, totaled approximately $1.5 million (ZAR 9.8 million) of which approximately $0.2 million (ZAR 1.2 million), after taxation, has been eliminated and included in the corporate/eliminations segment.

     During the three months ended December 31, 2004, we delivered hardware totaling approximately $3.9 million (approximately ZAR 23.5 million) to Nedbank. These deliveries related to the $10.5 million (approximately ZAR 67.0 million) order received from them in the first quarter of fiscal 2005.

     During January 2006, we announced that we had obtained another order to provide Nedbank with additional POS terminals and pin-pads. We expect to generate revenue of approximately $6.4 million (ZAR 40.9 million), at the December 31, 2005, exchange rate, from these transactions. Deliveries are expected to commence at the end of our third quarter of fiscal 2006 and are expected to be completed during our second quarter of fiscal 2007.

     Historically, we have obtained these types of contracts to sell hardware from time to time. It is difficult to predict when and if we will obtain new contracts.

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     Corporate/ Eliminations

     In U.S. dollars, operating losses increased by $1.3 million, or 183%, for the three months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, operating losses increased by ZAR 9.0 million, or 207%, for the three months ended December 31, 2005, from the comparable period in 2004.

     The increase in the operating loss during the three months ended December 31, 2005, compared with the three months ended December 31, 2004, is due to increased expenditures resulting from additional corporate and governance requirements including compliance with Sarbanes, director’s fees, legal fees, auditor fees, bonuses, as well as due to directors and officers insurance premiums, salary increases and legal fees incurred to defend ourselves against claims brought against us.

     Six Months Ended December 31, 2005 Compared to the Six Months Ended December 31, 2004

     The following factors had a significant influence on our results of operations during the periods:

• weakening of the South African rand, or ZAR, which is our functional currency, against the U.S. dollar, which is our reporting currency;
• commencement during the first quarter of fiscal 2005 of the Nedbank project to deliver POS devices and the conclusion of the project in during the third quarter of fiscal 2005;
• commencement during the first and second quarters of fiscal 2006 of projects to deliver POS devices and related hardware to Nedbank;
• our agreement to supply SmartSwitch Namibia with hardware and software;
• expenses related to our public offering and listing on the Nasdaq National Market; and
• the continued adoption of our merchant acquiring project.

          Consolidated overall results of operations

     This discussion is based on the amounts which were prepared in accordance with US GAAP.

     The following tables show the changes in the items comprising our statements of operations, both in U.S. dollars and in ZAR:

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     Analyzed in ZAR, the increase in revenue for the six months ended December 31, 2005, was primarily due to the higher volumes in our transaction-based activities and increased hardware, software and related technology sales activity.

     The increase in operating income margin to 45% for the six months ended December 31, 2005, from 39% for the six months ended December 31, 2004, was primarily due to improved efficiencies across all activities, the continued adoption of our merchant acquiring initiative, the sale of hardware and high-margin software to SmartSwitch Namibia and a significantly improved contribution from our contract to pay social welfare grants in the Eastern Cape province.

     We also incurred additional corporate and governance expense which included charges related to compliance with Sarbanes, director’s fees, legal fees, auditor fees, bonuses, as well as directors and officer’s insurance premiums, salary increases and legal fees incurred to defend ourselves against claims brought against us. We devoted significant management time and incurred significant expenses during the six months ended December 31, 2005, in order to complete and comply with the provisions of Sarbanes. The majority of the $0.2 million (ZAR 1.0 million) incurred represents fees paid to external advisors and auditors related to our Section 404 compliance. These costs are included in the General and Administration expenses line-item. Our continued compliance with Sarbanes may require similar levels of internal and external time and expense in the future.

     Depreciation and amortization expense has decreased due to a reduction in smart card amortization expense as the majority of these cards have now been amortized in full.

     We completed our public offering and Nasdaq listing in August 2005. In addition to the $1.8 million (ZAR 11.3 million) incurred during the fourth quarter of fiscal 2005, we incurred an additional $1.5 million (ZAR 9.6 million) in the first quarter of fiscal 2006 and $0.03 (ZAR 0.2 million) in the second quarter of fiscal 2006, related to legal fees, printing costs, registration and filing and accounting fees.

     Interest Received and Finance Costs

     Interest received consists of interest received on our surplus cash, while finance costs consist of interest paid on short-term borrowings. We have a unique cash flow cycle due to our obligations to pre-fund the payments of social welfare grants in the KwaZulu-Natal and Eastern Cape provinces. We provide the funds required for the grant payments on behalf of these provincial governments from our own cash resources and are reimbursed within two weeks by the KwaZulu-Natal and Eastern Cape governments, thus exposing ourselves to these provinces’ credit risk. These obligations result in a peak funding requirement, on a monthly basis, of approximately $53.5 million (ZAR 340 million) for each of the KwaZulu-Natal and Eastern Cape contracts. The funding requirements are at peak levels for the first three weeks of every month during the year. The pre-funding requirement for the KwaZulu-Natal and Eastern Cape contracts has increased, however our finance costs have decreased due to the adjustment in the South African prime interest rate from an average of approximately 11.1% per annum for the six months ended December 31, 2004, to 10.5% per annum for the six months ended December 31, 2005. Thus, finance costs decreased from $6.5 million (ZAR 40.4 million) for the six months ended December 31, 2004, to $4.1 million (ZAR 26.8 million) for the six months ended December 31, 2005.

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     Analyzed in ZAR, interest on surplus cash for the six months ended December 31, 2005, decreased to $6.3 million (ZAR 41.2 million) from $7.7 million (ZAR 47.8 million) for the comparable period during the prior year due to the lower interest rates during this period, which was partially offset by higher average cash balances on hand during this period.

     Taxation

     Total tax expense for the six months ended December 31, 2005 was $17.0 million (ZAR 111.1 million) compared with $13.9 million (ZAR 86.5 million) during the same period in the prior year. The increase was due to our increased profitability in our transaction-based activities and hardware, software and related technology sales segments.

     In February 2005, the Finance Minister of South Africa announced in his annual budget speech for the 2005/2006 tax year the decrease in statutory rate of taxation for South African domiciled companies from 30% to 29% for all fiscal years ending on or after April 1, 2005. As of June 30, 2005, the change in the rate had not been promulgated by parliament in South Africa and thus was not the enacted rate as described in Statement of Financial Accounting Standard 109, Accounting for Income Taxes. The rate was promulgated on July 19, 2005, which has resulted in a decrease in our distributed rate (i.e. the statutory rate plus the effects related to a charge for Secondary Tax on Companies, or STC, which is currently 12.5%) from 37.78% to 36.89% . The effect of this change is included in the six months to December 31, 2005 tax expense and is approximately $0.2 million (ZAR 1.0 million).

     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 U.S. dollars, revenues increased by 8% for the six months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 38% for the six months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues increased by 14% for the six months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 45% for the six months ended December 31, 2005, from the comparable period in 2004.

     These increases in revenues and operating income were due primarily to the continued adoption of our merchant acquiring system in the provinces where we distribute welfare grants, increased transacting ability at participating retailers’ POS devices in these provinces, and higher volumes from our provincial contracts. We discuss these factors in more detail below.

     Continued adoption of our merchant acquiring system:

     Refer to discussion and Table 7 within Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     Higher volumes from our provincial contracts

     We have experienced growth in most of the provinces where we administer payments of social welfare grants. This growth has been mainly due to new qualifying criteria announced in 2003 by the South African government that increased the eligibility for child support grants, and an increase in the number of disability grants approved by the various provincial governments. In total, the volume of payments processed during the six months ended December 31, 2005 increased 5.8% to 20,555,571 from the comparable period during 2004.

     The higher volumes under existing provincial contracts during the six months ended December 31, 2005, as well as average revenue per grant paid, are detailed below:

     (1) Average Revenue per Grant Paid excludes $0.84 (ZAR 5.50) related to the provision of smart card accounts.

     (2) Average Revenue per Grant Paid excludes $0.89 (ZAR 5.50) related to the provision of smart card accounts.

     A - in ZAR, the increase in the Average Revenue per Grant Paid in KwaZulu-Natal is primarily due to the re-registration fees for mainly disability grant recipients, who were removed off the government’s system during fiscal 2005 and subsequently re-instated during fiscal 2006.

     B - in ZAR, the increase in the Average Revenue per Grant Paid in Limpopo is due to the continued once-off registration fees charged for the ongoing enrollment of new beneficiaries and a price increase from December 2005. The fee charged for payment is significantly less than the fee charged for registration.

     C - in ZAR, the increase in the Average Revenue per Grant Paid in North West is primarily due to an inflation price increase negotiated with the North West government during July 2005 and more registrations. This inflation price increase included an amount of $0.4 million (ZAR 2.6 million) which was granted retrospectively to July 2004 and paid in the first quarter of fiscal 2006. The effect of this retroactive payment is not reflected in the Average Revenue per Grant Paid in the table above.

     D - in ZAR, the decrease in the Average Revenue per Grant Paid in Northern Cape is primarily due to fewer registration fees charged.

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     E - in ZAR, the decrease in the Average Revenue per Grant Paid in the Eastern Cape is due to fewer registration fees charged. The fee charged for payment is significantly less than the fee charged for registration.

     Through our merchant acquiring initiative, beneficiaries are now able to load their grants onto their cards as soon as the grant payment file is activated, which typically happens during the week preceding the commencement of a calendar month. We recognize the fee revenue related to the distribution of welfare grants when the beneficiaries load the grants to their cards. The general exception to this rule is the January payment cycle, when the payment file is normally activated during the first week of January and not the last week of December. Accordingly, our December revenue from the distribution of welfare grants is lower than the revenue recognized during the other calendar months during the year.

     Our annual results are not expected to be affected as we anticipate twelve full payment cycles to be included in the fiscal 2006 results. We expect our third quarter transaction-based revenue to be higher than the second quarter as it should include revenues from loading fees for the entire January, February and March 2006 payment cycle and a small portion of the April 2006 payment cycle.

     Operating income margin for the six months ended December 31, 2005 increased to 50% from 39% for the six months ended December 31, 2004. These profit margin improvements were mainly due to:

• the increased volumes as detailed in the table above;
   
• the inflation adjustment to the price charged in the North West and Limpopo provinces; and
   
• the increase in the number of social grant beneficiaries paid through our POS device infrastructure at participating retailers, instead of payment using more costly automated cash dispensers.

     Smart card accounts

     In U.S. dollars, revenues increased by 1% for the six months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 1% for the six months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues increased by 6% for the six months ended December 31, 2005, from the comparable period in 2004. Operating income increased by 6% for the six months ended December 31, 2005, from the comparable period in 2004.

     Operating income margin from providing smart card accounts was constant at 45% for each of the six months ended December 31, 2005 and 2004.

     In ZAR, revenue from the provision of smart card based accounts grew in proportion to the higher number of beneficiaries serviced through our social welfare payment contracts. A total number of 3,497,664 smart card-based accounts were active at December 31, 2005, compared to 3,308,194 active accounts as of December 31, 2004. The increase in the number of active accounts resulted from an increase in the number of beneficiaries in all provinces qualifying for government grants due to the efforts of the South African government to provide social assistance to the very old and very young.

     Financial services

     In U.S. dollars, revenues decreased by 20% for the six months ended December 31, 2005, from the comparable period in 2004. Operating income decreased by 23% for the six months ended December 31, 2005, from the comparable period in 2004.

     In ZAR, revenues decreased by 16% for the six months ended December 31, 2005, from the comparable period in 2004. Operating income decreased by ZAR 19% for the six months ended December 31, 2005, from the comparable period in 2004.

     Revenues and operating income from UEPS-based lending decreased during the six months end December 31, 2005 compared with the six months ended December 31, 2004. We offer the UEPS-based loans to our beneficiaries with the primary purpose of assisting them to repay expensive loans with other loan providers and to escape the debt spiral that they are trapped in. Once our UEPS-based loans are repaid, we believe that the beneficiaries have an enhanced ability to remain debt-free, or take loans in amounts smaller than the original refinancing facility we offered to them. In addition, we continuously revise the interest rates charged on our UEPS-based loans, as part of our ongoing commitment to the South African government to provide affordable financial services to the unbanked population of the country. As a result the interest rate charged on our UEPS-based loans was lower during the six months ended December 31, 2005, compared with six months ended December 31, 2004. A further benefit of our UEPS-based lending is that cardholders have more disposable income to spend, including through our merchant acquiring base.

     The loan portfolio of the traditional microlending businesses remained static as a result of our strategic decision not to grow this business. However, when compared to June 30, 2005, our UEPS-based lending portfolio has increased due to increased lending activities during the December festive holiday season in South Africa.

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     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 provision is required. We consider UEPS-based lending less risky than traditional microfinance loans because the grants are distributed to these lenders by ourselves and these loans are insured. We establish an allowance for doubtful traditional microlending loans in respect of which we consider it likely that all or a portion of the principal amount of the loan or interest thereon will not be repaid by the borrower. We consider default likely after a specified period of non-payment, which is generally not more than 150 days. We assess this allowance based on a review by management of the ageing of outstanding amounts, the payment history in relation to those specific accounts and the overall default history.

     The key indicators of these businesses are illustrated below: