The Daily Magic Formula Stock for 07/15/2008 is Net 1 Ueps Technologies Inc. According to the Magic Formula Investing Web Site, the ebit yield is 11% and the EBIT ROIC is >100 %.
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We provide our universal electronic payment system, or UEPS, as an alternative payment system for the unbanked 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 enter affordably into electronic transactions with each other, government agencies, employers, merchants and other financial service providers. To accomplish this, we have developed and deployed the 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 smart card reader, which is often portable and offline, is available. In addition to payments and purchases, our system can be used for banking, health care management, international money transfers, voting and identification.
We generate our revenues by charging transaction fees to government agencies, employers, merchants and other financial service providers, by providing financial services such as loans and insurance products and by selling hardware, software and related technology. Our technology is widely used in South Africa today, where we have over 3.8 million clients in five provinces who receive social welfare grants using our smart cards and increasingly use their smart cards at participating merchants to receive and spend their grants. As part of our strategy to expand into new geographical markets we have formed joint ventures in Namibia, Botswana and Nigeria to operate UEPS smart card-based switching systems in those countries. As these UEPS systems become operational, we generate revenues from sales of equipment, software and related technology to the joint ventures and from our share of the revenues earned by the ventures from operation of the switching systems.
On July 3, 2006, we acquired Prism Holdings Limited, or Prism, a South African public company, which focuses on the development and provision of secure transaction technology, solutions and services. Prismâ€™s core competencies around secure online transaction processing, cryptography and integrated circuit card (chip/smart card) technologies are principally applied to electronic commerce transactions in the telecommunications, banking, retail, petroleum and utilities market sectors. These technologies form the cornerstones of the â€śtrusted transactionsâ€ť environment and provide us with the building blocks for developing secure end-to-end payment solutions. We believe that Prism will help us expand our merchant footprint in South Africa, extend our ability to deliver solutions across the entire spectrum of transaction processing and assist us in expanding our international operations. Since our acquisition of Prism, we have formed joint ventures in Colombia and Vietnam to implement the Prism virtual top-up, or VTU, solution for mobile phone-based prepaid airtime vending.
We are headquartered in Johannesburg, South Africa. Net 1 UEPS Technologies, Inc. was incorporated in 1997 as a Florida corporation and is the successor to operations originally begun in 1989. Under â€ś-Corporate Historyâ€ť below, we describe the historical development of our business, including the June 2004 acquisition of Net 1 Applied Technologies Holdings Limited, or Aplitec, which was a South African public company. All references to â€śNet1,â€ť â€śthe Company,â€ť â€śwe,â€ť â€śus,â€ť or â€śourâ€ť are references to Net 1 UEPS Technologies, Inc. and its consolidated subsidiaries, collectively, except as otherwise indicated or where the context indicates otherwise.
According to the United States Census Bureau, the worldâ€™s population currently exceeds 6.6 billion people. Yet of this total, it has been reported that over four billion people earn less than the purchasing parity equivalent of two dollars per day. In general, these people either have no bank account or very limited access to banking services. This situation arises when banking fees are too high relative to an individualâ€™s income, a bank account provides little or no meaningful benefit or there is insufficient infrastructure to provide banking services economically in the individualâ€™s geographic location. We refer to these people as the unbanked and the under-banked. These individuals generally receive wages, welfare benefits, money transfers or loans in the form of cash and conduct commercial transactions, including buying food and clothing, in cash.
The use of cash, however, presents significant problems. In the case of recipients, they generally have no secure way of protecting their cash other than by converting it immediately into goods, carrying it with them or hiding it. In cases where an individual has access to a bank account, the typical deposit, withdrawal and account fees meaningfully reduce the money available to meet basic needs. For government agencies and employers, using cash to pay welfare benefits or wages results in significant expense due to the logistics of obtaining that cash, moving it to distribution points and protecting it from theft.
The use of cash or lack of access to a bank account can dramatically increase the cost to, and in some cases completely prevent, individuals from engaging in basic financial transactions. These basic transactions include the routine payment of insurance premiums, the transfer of money to relatives and the use of credit. Without a bank account, it is also difficult for an individual to obtain a loan on attractive terms since that individual lacks a credit history and usually cannot present a reliable means of repayment to the lender.
For governments, assistance programs face significant challenges when dependent on the use of cash. In addition to the costs and difficulties of using cash, corruption becomes an even more challenging problem since there is no clear audit trail. In fact, the absence of an electronic system for the distribution of goods, including foodstuff or medicine, or welfare benefits presents a significant obstacle to ensuring the fair and reliable implementation of government policy or deployment of foreign aid.
Traditional payment systems offered today by the major banking institutions do not address the key requirements of the unbanked and the under-banked populations. In addition to the high cost of maintaining a bank account relative to a customerâ€™s income level, customers must generally have basic literacy, administrative and record-keeping abilities and a minimum income level. Additionally, banks operate through online transaction settlement systems, which are often unavailable or costly to implement in undeveloped areas. Finally, having a bank account does not eliminate the need for significant quantities of cash in many instances because customers must withdraw large sums at one time to avoid incremental transaction fees.
We believe that we are the first company to enable the affordable delivery of financial products and services to the worldâ€™s unbanked and under-banked people. Our approach takes full advantage of moving processing away from a centralized point to the computer chip embedded on a smart card. A smart card reader, or POS device, is used to enable communication between smart cards in real-time during a transaction and indirectly with our mainframe computer at a later time. This architecture has significant implications in terms of the products and services that we can deliver compared to those offered by banking institutions or other card providers.
First, our system enables offline transactions, which is essential in serving the unbanked and under-banked. Second, it means that while offline, the smart card can engage in sophisticated transaction processing, using data encryption and biometric fingerprint protection to ensure security. In fact, our smart cards can calculate the interest owed to the card holder for having funds recorded onto our system without ever coming online. Third, with all of the software and transaction records on the smart card, the POS device itself requires far fewer components, circuitry and memory, substantially reducing costs. Fourth, each transaction is recorded on both participating smart cards, copied in subsequent transactions to additional smart cards, and ultimately reported to our mainframe computer. This creates a full audit trail that significantly reduces the potential for corruption, theft and fraud. Lastly, instead of having to build the overall system to handle peak loads, our system further reduces costs by smoothing the transaction flow over time.
We believe that our solution delivers benefits to each of the users of our system, including:
Individuals. There is no minimum income requirement for individuals to use our smart card, making our solution universally accessible. It is also inexpensive since the overall cost of the system is much less than widely available solutions, including cash, bank accounts and bank cards that require online access. Our solution additionally has the advantage of working everywhere, including remote areas where many unbanked and under-banked people live. Even more importantly, our solution is secure and smart cards are replaceable. This means that individuals do not have to fear that their money will be stolen or that they will be charged for fraudulent transactions as all transactions are verified biometrically through fingerprints. Since the smart card performs all of the required computing processing and contains all of the different service features, the smart card can be tailored to meet the needs of the individual. Card holders can also receive interest on their card balances, a benefit not available to them when transacting solely in cash. We believe our solution has the potential to enhance significantly the living standards of the unbanked and under-banked by reducing transaction costs and providing them with new and additional financial products and services.
Merchants and Financial Service Providers . Merchants derive several different benefits from our system. Our system decreases the amount of cash they must hold, improving security and reducing expenses, such as cash deposit fees and cash losses. By providing financial services through our POS devices, merchants also benefit from new income streams at no additional incremental cost. In addition, our system provides a record of transactions that is useful for administrative purposes. For formal financial service providers, the use of smart cards provides opportunities to directly sell products and services to a market that was previously difficult to reach. For instance, insurance companies can offer their products with the premium deducted directly from the individualâ€™s smart card. In the case of lending, administrative costs are decreased along with the expense of holding cash. Again, the collection of payments can occur directly from the smart card, reducing credit risk and helping to establish credit history.
Employers . Our system enables employers to eliminate cash from the wage payment process. This reduces expenses by avoiding cash handling and management, the need to insure, secure and transport that cash and the bank transaction fees associated with obtaining cash in the first place. The process of paying employees using cash is also time consuming, taking up to half a day per pay period in some instances. The use of our system eliminates this process and thereby increases productivity. In addition, because cash payments are distributed in packets to employees, disputes can arise as to the amount of cash in the packet. Our system also eliminates this problem since the amount reflected on the card holdersâ€™ accounts are recorded on the back-end system and then distributed on the smart cards. Finally, employers frequently provide additional services to their employees out of necessity, particularly loans. Our system enables other service providers to deliver these products.
Government Agencies. A fundamental policy goal for almost any government is to enhance the welfare of the poorest citizens in the country. Yet the use of cash is a poor method for delivering social welfare grants since it is difficult to track, and the recipients endure a range of expenses and dangers that reduce their options. By using our system, government agencies enjoy reduced costs in the delivery of benefits to recipients by eliminating the use of cash while increasing the options available to the recipient. This use of our system intrinsically increases the welfare that government agencies can provide from the same amount of taxes collected. Our system also has the potential to increase the amount of taxes collected by bringing informal businesses into the formal economy. The presence of a full audit trail also means that government agencies can combat corruption. Moreover, the use of smart cards for the delivery of additional services, including insurance products, means that regulatory bodies can expand their oversight of transactions for individuals who are frequently least able to protect themselves. In regard to medical benefits, our system provides comprehensive inventory management and has the potential to improve the treatment of patients significantly. For instance, we have deployed an artificial intelligence program on our smart cards used for the treatment of HIV/AIDS in South Africa that can be used to adjust a patientâ€™s prescription based on data entered by a trained medical worker through the POS device.
Our Business Strengths
We believe our business strengths include:
Technology Leadership . We believe we are the first company to develop, implement and operate an affordable, flexible and secure electronic payment system for the unbanked and under-banked that works offline. Of equal importance, our smart cards are secured through biometric fingerprint authentication and have a broad range of additional functionality through the use of â€śwalletsâ€ť that can be turned on as needed or as services become available. We can deliver these services to the unbanked population at a fraction of the cost of traditional systems. Our ability to implement an HIV/AIDS system on the same smart card as financial services demonstrates the flexibility of our approach. In addition, we have validated the security of our smart cards along with our overall system, forming the foundation for a trusted solution. Independent third parties have reviewed and published our security protocols and we have refined our system in a way to provide system integrity over the life of the smart cards. From our inception in 1989 to date, we have not suffered any security breaches or losses of transactions or funds on our system. In addition, Prism gives us access to Prismâ€™s well-established core cryptography, software, hardware, embedded chip, wireless and payment expertise.
Proven Solution. Our system is proven and has been increasingly used. Today over 3.9 million clients in South Africa receive monthly welfare or pension payments through our system under contracts with five provinces. Historically, welfare and pension recipients would only download cash from smart cards, but since we began our merchant acquiring initiative in July 2004, these recipients increasingly choose to use their smart cards at merchant locations, which generates additional revenue for us. During the year ended June 30, 2007, the number of our clients that opted to receive their grants through our retail infrastructure grew to approximately 1,129,000, an increase from approximately 849,000 during fiscal 2006. For the years ended June 30, 2007 and 2006, the total value of transactions processed through our UEPS merchant network was approximately $875 million and $614 million, respectively. As of June 30, 2007, we had 4,357 POS devices installed at 2,598 participating retail merchants compared to June 30, 2006, when we had 4,038 POS devices installed at 2,381 participating retail merchants
Versatile Application. Once an individual begins using our smart card, we become a logical provider of a broad range of additional products and services. For instance, a card holder using our system for the administration of medical treatment can also use the same smart card for receiving welfare payments or wages as well as making purchases. Because use of each smart card is secured biometrically, the smart card can also be used for identification and voting. The additional uses mean that once we have enrolled and delivered a smart card to an individual, our revenue potential increases significantly beyond the initial service for which that individual has signed up.
Broad Appeal that Drives Opportunities. Because our system provides economic benefits to all participants, we believe there are strong incentives for government agencies and employers to adopt our system in many developing countries. Our solution is also appealing because a single deployment enables the delivery of a broad array of new services to those who are potentially most in need of them, often at a lower cost than alternative distribution methods.
Increasing Returns to Scale . The initial establishment of our system in a province or country requires upfront expenditures for computers, distribution infrastructure and card holder registration. Once in place, though, the cost to us of supplying additional products to users is low. For instance, if a customer receives welfare payments on one of our smart cards and then chooses to purchase insurance through our system, there is almost no additional expense for us to deduct the insurance premium regularly. As a result, the operating margin for that customer increases significantly, offset only by any marketing or administrative costs associated with that product.
We intend to provide the leading system for the worldâ€™s estimated four billion unbanked and under-banked people to engage in electronic transactions globally. To achieve this goal, we intend to pursue the following strategies:
Disciplined Approach to New Markets . We carefully evaluate new opportunities in order to deploy our business development resources effectively. We believe there are significant opportunities for our system in the developing countries of Africa, Central and South America and the Asia-Pacific Rim, where the unbanked and under-banked comprise a majority of the population. Where we believe it makes sense, we will use partnerships or make acquisitions to accelerate our entry into new markets. During our 2007 and 2006 fiscal year, we established, together with local investors, companies to create and implement UEPS systems in three African countries, Namibia, Botswana and Nigeria.
Unlock Target Markets with a Key Product . The first step in establishing our system within a new province or country is to establish a broad base of smart card users around a single application. One of our preferred routes is to secure contracts to implement payment systems for government programs having large numbers of potential card holders. We believe another effective route will be the delivery of medical management applications, such as for HIV/AIDS. However, we are not dependent on government agencies to establish an initial base. Employers are widely examining our system to address their wage payment challenges and we are currently pursuing opportunities to deliver this solution. Similarly, banking institutions implement the UEPS banking application and distribute smart cards to their clients to replace ageing legacy systems, including paper or book- based systems.
Expand Our Products Within the Markets We Serve . With the establishment of a strong base of card holders and related infrastructure, we can then move to providing additional products and services. As part of broadening our card holdersâ€™ options, we will also sell our smart card readers and POS devices to merchants to enable them to enter into transactions. Additionally, we will work to establish relationships with post offices, banks and other financial service providers with the goal of making our system ubiquitous in the markets we serve.
Provide Products and Services Ourselves Where the Profit Potential is Compelling . Our system can dramatically reduce transaction costs and improve data collection for a broad set of products and services. We intend to offer those products and services ourselves where the profit potential is significant. For instance, we engage in lending in South Africa. We are able to offer this service at a lower interest rate than competitors due to our ability to deduct interest and principal directly from a borrowerâ€™s smart card and our knowledge of that individualâ€™s payment history.
Establish Partnerships or Make Acquisitions When Appropriate . As part of our disciplined approach to growing our presence globally, we will evaluate and enter into partnerships where we can draw on local knowledge and infrastructure to drive the rapid adoption of our system. We believe that this will enable us to focus on our core strength in technology as well as product development and delivery. In some instances, we will make acquisitions where we believe that our approach will enable us to gain customers and realize operational benefits rapidly from the deployment of our more efficient solution.
We developed our technology to enable the affordable delivery of financial products and services to the worldâ€™s unbanked and under-banked people. Our proprietary technology is designed to provide the secure delivery of these products and services in the most under-developed or rural environments, even in those that have little or no communications infrastructure. Unlike a traditional credit or debit card where the operation of the account occurs on a centralized computer, each of our smart cards effectively operates as an individual bank account for all types of transactions. All transactions that take place through our system occur between two smart cards at the point of service, or POS, as all of the relevant information necessary to perform and record transactions reside on the smart cards.
The transfer of money or other information can take place without any communication with a centralized computer since all validation, creation of audit records, encryption, decryption and authorization take place on, or are generated between, the smart cards themselves. Importantly, the cards are protected through the use of biometric fingerprint identification, which is designed to ensure the security of funds and card holder information. Transactions are generally settled by merchants and other commercial participants in the system by sending transaction data to a mainframe computer on a batch basis. Settlements can be performed online or offline. The mainframe computer provides a central database of transactions, creating a complete audit trail that enables us to replace lost smart cards while preserving the notional account balance, and to identify fraud.
Our platform consists of three fundamental components: (1) our FTS patent, (2) our UEPS and (3) our security protocol.
FTS Patent . The FTS patent describes a method by which funds can be transferred from one smart card to another in a secure and offline manner. The term â€śofflineâ€ť refers to transactions that are effected without the need to contact or communicate with the issuer when the transactions occur, as the smart cards themselves perform the authorizations required. The FTS patent also describes how smart cards can be loaded or re-loaded with funds and how these can be redeemed for value in either banking or non-banking environments.
UEPS . Our UEPS is a suite of software programs that make use of the FTS methodology to deliver an integrated information, payment, switching and settlement environment that underpins our transaction processing system. Our software principally runs on three devices: the smart card, the POS device and the back-end system mainframe. When we sell a complete system to a customer or license our technology, we provide all of the software required to operate the UEPS, including the smart card functionality, the POS devices that allow our smart cards to transact with each other in an offline manner and our back-end system that primarily stores an audit trail of all transactions effected.
The primary strengths of the UEPS are its affordability, security and flexibility. The system is affordable because the computer chips on the smart cards contain all the software necessary to process UEPS transactions, thereby allowing the POS devices required to conduct these transactions to contain far fewer components and less circuitry than traditional POS devices. There is also a reduced need for processing power and on-board memory given that online communication is not necessary. This eliminates the need for an internal or external modem and its associated hardware, maintenance and call costs. As a result, the UEPS terminals are relatively inexpensive and do not require specialized technical expertise for installation. The UEPS also reduces or eliminates the need for national infrastructures, including electricity, telephone or data transmission. The UEPS is secure because the funds in each smart card are protected from illegal access through biometric fingerprint technology. In addition, every transaction is verified by the two smart cards involved in the transaction using state-of-the-art cryptographic systems in conjunction with protocols and techniques that we have developed. Finally, our UEPS is flexible because transactions are completed offline, eliminating virtually all restrictions where verified transactions can occur.
We released the first version of our UEPS in 1991. It included software to operate each smart card as well as the main payment system. Later versions of our UEPS provided all of the functions necessary to issue and manage a smart card and terminal base as well as those needed to effect settlement between all of the operators and participants. Our UEPS is fully traceable and auditable. It can also provide advanced capabilities including loss tolerance and smart card-based interest distribution. Finally, our UEPS is scalable and capable of working in small applications including a hospital setting as well as large settings such as country-wide implementations.
Security Protocol. Our security protocol was designed to prevent opportunistic fraud and enforce the correct transaction flow. The symmetric triple data encryption standard, or DES, is used extensively in association with a native random number generator that ensures that all transactions are performed by using a random session key pair. The DES encryption algorithm can be easily modified to use alternative symmetric or asymmetric encryption algorithms such as the Rivest, Shamir and Adleman or elliptic curves. Each message exchanged during a transaction names both transacting parties, includes unique information to guarantee freshness and depends explicitly on all the messages that occur before it.
The UEPS we sell to clients is a platform with the potential to provide all of the products we develop which, when grouped together, form complete systems serving the specific needs of various business segments. Depending on the requirements of a particular customer, we assist the customer in the setup of its application which is tailored to provide only the products and services initially required, although the UEPS can later be updated to provide additional products. We outsource the manufacturing of the hardware components of our system, including smart cards, POS devices, automated teller machines, or ATMs, PCs and back-end mainframes. However, we have developed all of our application software modules so that they will run on different hardware platforms which allows us to be hardware-independent and to provide our customers with the latest and most economical hardware solutions.
Scalability. Our UEPS can be implemented in different environments, from small closed systems to national implementations. In closed-system environments, the UEPS front-end equipment is personal computer-based and can therefore be implemented at relatively low cost. In these instances, we provide the back-end system on a transaction fee basis, thus limiting the overall set up cost. This approach can also be used whenever larger implementations are required but where the customer prefers to focus on marketing and selling its products rather than initially concentrating on operating the back-end system. The cost to entry can thus be greatly reduced as the operations can first become profitable before expending large amounts of capital. On the other hand, large governmental institutions, financial institutions or medical insurers typically prefer to maintain control over the entire payment system and therefore invest in a full system implementation. The time to launch these projects tends to be longer due to the time that is required to train the end-user to operate the system.
Once a UEPS is installed on behalf of a customer, we believe that we are well-positioned to benefit from the scalability of the system as minimal changes are required to be made to the application base for the system to manage significantly greater numbers of users. We can therefore provide additional smart cards while leveraging the existing cost base in a market. In addition, we have a dedicated team of technicians and developers and an infrastructure capable of supporting a significant volume of customers and their transactions. As a result, we expect to benefit from economies of scale that pertain to increases in the number of products and services using the infrastructures we sell and/or implement.
UEPS Smart Card Functionality
We have combined these technologies to create a smart card application that incorporates and controls the functionality that is normally found on banking host systems. Our technology reverses the traditional approach where the card acts as an access mechanism to a host-managed account. Instead, the smart card controls the account itself while the host system is relegated to backing up and creating an audit trail for the smart card base.
As a result, our technology provides extensive and flexible functionality through a system that is practical, secure and auditable. The following list itemizes some of the unique and critical functions provided by our smart card technology.
Identification, Authentication, Non-Repudiation and Affirmation of UEPS Transactions. Traditional payment systems provide customers with paper receipts that reflect transaction details. Customers normally keep these receipts to reconcile their monthly account statements. During reconciliation, customers can detect fraudulent transactions and errors by matching account entries against their paper receipts, which may lead to disputes, financial losses and the repudiation of transactions. Fraud committed by people taking advantage of the inherent security weaknesses of traditional payment systems increases the cost of managing transactions effected through these systems. As a result, financial institutions and other system participants must invest significant resources to minimize the risk associated with fraud and errors.
A fundamental element of the UEPS is that all payment and money transfer transactions take place between two UEPS smart cards â€“ the smart card to be debited and the smart card to be credited. During the transfer of value between the two smart cards, the transaction is written to a dedicated history file on each of the smart cards. These history files are subsequently used to ensure settlement either directly or through the activation of the UEPS multiple streams audit trail feature. Thus, smart card holders can reconcile their monthly accounts directly from the smart cardâ€™s transaction history file. Also, each smart card authorizes all debit transactions through the presentation and verification of one of the card holderâ€™s biometric fingerprint templates that are stored in the smart card, and each UEPS transaction is signed by both smart cards. Taken together, these features of the UEPS help prevent the fraudulent creation, duplication or alteration of a transaction, as well as any potential repudiation of a transaction. As a result, the UEPS helps to minimize the costs associated with account management and inquiry resolution and helps ensure that customers do not incur losses from undetected errors, fraud or transaction mismanagement.
Continuous Debit. People with limited economic means or unestablished credit histories may find it difficult to obtain access to public utility services such as telephone, fuel, water or electricity unless they purchase pre-paid units for these services. A prepaid unit of service may be a liter of fuel, a kiloliter of water, ten minutes of electricity or a two minute local phone call, and may need to be used within a specified period of time before it expires. Pre-paying for services can deprive purchasers of flexibility to redeploy their funds to meet other financial needs.
The continuous debit feature of the UEPS eliminates the need for customers to buy pre-paid units by allowing them to use their smart cards to pay for these services as and when they need and use them. All a customer needs to do is to insert his smart card into the utility equipment and the smart card will debit itself whenever a unit of service is used. The continuous debit feature provides significant financial flexibility to customers and can be tailored to be used in any â€śpay as you goâ€ť environment, including Internet access.
Continuous debit transactions are typically a large number of small transactions that can quickly fill up the space on a smart cardâ€™s transaction file. We eliminated this problem by designing the UEPS to minimize the file space that these transactions require by enabling subsequent transactions to replace and aggregate with earlier ones, thereby treating multiple transactions as one global transaction.
Multiple and Restricted Wallets. Unbanked people who keep their cash at home risk the loss of their funds from misplacement, theft or disasters such as floods or fires, which can have a devastating impact on their financial lives. Keeping funds at home does not generate any interest income and cannot help demonstrate financial responsibility or provide collateral security for the extension of credit. Finally, keeping funds in cash can make it more difficult for people to segregate their funds for specific purposes, whereas having one or more bank accounts can facilitate budgeting for various categories of expenses.
The multiple wallet feature allows card holders to use their smart cards to help manage their budgets. Up to 255 wallets can be configured and activated per card holder depending on the electrically erasable programmable read-only memory, or EEPROM, available on the particular smart card. Each of the wallets can be configured to meet the specific requirements of the card holder, and can be used for interest-generating savings, pre-paid utilities, medication management, credit, debit orders and for many other purposes. In addition, a wallet can be either protected or unprotected. Protected wallets require the biometric verification of the card holder to effect transactions. Unprotected wallets are normally used for low value transactions such as transportation for which speed of processing is critical.
Since the audit trail of all transactions performed by the active wallets is stored on the smart cardâ€™s history file, card holders can provide third parties with a comprehensive record of their transaction histories, which can help evidence payments, such as insurance premiums and demonstrate a regular income stream from wages or other sources. This audit trail can provide unbanked people the opportunity to obtain affordable services from formal financial service providers which might otherwise deny or limit services to them.
Wallets can also be restricted. Restricted wallets allow transactions to be performed only at specific merchants. For example, if an employer desire to subsidize an employeeâ€™s transportation costs, a wallet can be configured that permits the holder to spend the value loaded into that wallet only at specified transportation points. Restricted wallets can also be used by governments to prevent social welfare grant recipients from using payment for particular goods or services.
Offline Loading. The use of payment systems that depend on online authorizations is difficult to implement in developing economies and countries that do not have advanced or reliable telecommunication infrastructures. Online systems include magnetic stripe-based solutions that are widely used in first world economies and require that all transactions, including retail sales, the dispensing of cash, the loading of value to smart cards and the authorization of credit transactions, be performed only at self-service terminals, or SSTs, ATMs or POS devices that operate online. Thus, online systems cannot be used to provide financial or banking services to the millions of people, such as those in developing countries, that live in geographical areas that have little or no infrastructure. Most smart card systems therefore, such as EMV, also operate online. We believe that this reliance on online communication has limited the exploitation of smart card technology, has resulted in high system implementation and operational costs and has not addressed many of the needs of the worldâ€™s unbanked population.
Our offline loading feature has been designed to solve these problems associated with reliance on limited infrastructures and allows value to be distributed through existing infrastructures such as the postal service, fixed line telephones, cellular phones, verbal communication and newspapers. Our solution is a unique ten-digit signature code that the UEPS back-end system generates to enable specific amounts to be loaded to specific smart cards. When a ten-digit signature code is presented at any offline POS device to the smart card for which it was created, the code will, after validation, allow the smart card to credit one or a number of its internal wallets in the appropriate amount.
The offline loading function can be used to transfer funds remotely for payments such as wages, pensions, welfare grants, refunds and third party transfers. When a number of ten-digit signature codes are created for a specific smart card, each ten-digit signature code can then only be applied to that smart card once. Ten-digit signature codes can be presented to a smart card in a different order from the one in which the codes were created but can be effected only by that particular smart card.
Biometric Identification. The magnetic stripe credit and debit card systems available today use a written signature or a personal identification number, or PIN, in an effort to verify the customerâ€™s identity minimize the repudiation of transactions. However, PINs can be compromised, magnetic stripes can be cloned and if a card is stolen together with its PIN number, the card can be used to transact until it is reported stolen or its offline limits are reached. The PIN and card can also be used to gain access to back-end account information to defraud further the genuine card holder. Therefore, positive offline card holder verification is critical to ensure that a payment system does not effect fraudulent transactions. At the same time, the system must ensure that the genuine card holderâ€™s transactions are not rejected.
As an alternative form of customer identification, the UEPS supports biometrics in the form of fingerprint recognition. Biometric scanners are used to record a customerâ€™s fingerprint images. The fingerprint templates that result are stored in the holderâ€™s smart card and used for identification whenever the smart card is used.
Before a smart card is issued, the following fingerprint recordation process occurs:
All ten fingers are captured, with three fingerprint images captured per finger.
The three fingerprint images for each finger are consolidated and filtered to create the best image for that finger. This results in ten-high quality fingerprint images.
The ten fingerprint images are scored and the four highest scoring images are used to generate fingerprint templates. A fingerprint template is a unique geometric representation of one fingerprint.
The card holder is verified against these four templates using the highest fingerprint matching threshold to ensure the best recordation process. This process assists to eliminate the false rejection of genuine card holders due to initial bad fingerprint template recordation.
The four fingerprint templates are signed by an â€śissuing UEPS smart cardâ€ť and stored on the card holderâ€™s smart card.
When a transaction is performed, the card holderâ€™s fingerprints are verified against those stored on the smart card. The verification process occurs in a secure session between the smart card and the fingerprint scanner. During the verification phase, a moderate matching threshold is used to compensate for the changes in the card holderâ€™s fingerprint conditions.
Our biometric identification feature is designed to protect our card holders against fraud, helps eliminate transaction repudiation and reduces the complexity associated with hot card management systems and hot line centers, as well as the cost of the systems that are utilized to deal with stolen and lost cards.
Automatic Credit. The distribution of social welfare benefits, unemployment insurance, food parcels or vouchers and medical supplies is personnel intensive. Furthermore, beneficiaries must present themselves regularly at designated distribution locations in order to receive their benefits. These requirements create a number of operational and logistical problems, which increase the direct or indirect costs for system owners, operators and members, including:
The costs of transporting beneficiaries and payment personnel to and from distribution points;
The time beneficiaries must spend waiting in line at distribution points rather than working or engaging in other activities;
The need to provide adequate staff, water, toilets, medical emergency services, shelters and security at distribution points;
The need to provide personnel to deal with beneficiary communications and inquiries; and
The need to create itineraries and schedules for payment delivery personnel, as well as to establish distribution centers and purchase vehicles to travel to distribution points.
Dr. Belamant has been a director since our inception in May 1997, our chief executive officer since October 2000 and the chairman of our board since February 2003. He has also been a director of our subsidiary, Net 1 Applied Technologies South Africa Limited, or New Aplitec, since its inception in June 2004. From June 1997 until June 2004, Dr. Belamant served as chief executive officer and a director of Net 1 Applied Technology Holdings, or Aplitec. From 1996 to 1997, Dr. Belamant served as a consultant in the development of Chip Off-Line Pre-Authorized Card, or COPAC, a Visa product. From October 1989 to September 1995, Dr. Belamant served as the managing director of Net 1 (Pty) Limited, a privately owned South African company specializing in the development of advanced technologies in the field of transaction processing and payment systems. Dr. Belamant also serves on the board of a number of other companies that perform welfare distribution services and the provision of microfinance to customers. Dr. Belamant spent ten years working as a computer scientist for Control Data Corporation where he won a number of international awards. Later, he was responsible for the design, development, implementation and operation of the Saswitch ATM network in South Africa that rates today as the third largest ATM switching system in the world. Dr. Belamant has patented a number of inventions besides the FTS ranging from biometrics to gaming-related inventions. Dr. Belamant has more than twenty-five years of experience in the fields of operations research, security, biometrics, artificial intelligence and online and offline transaction processing systems. Dr. Belamant holds a PhD in Information Technology and Management.
Mr. Kotze has been a director and our secretary, treasurer and chief financial officer since June 2004. Mr. Kotze is a member of the South African Institute of Chartered Accountants, or SAICA, who joined Aplitec in November 1998 as a strategic financial analyst. He has also been a director of New Aplitec since June 2004. From January 2000 until June 2004, he served on the board of Aplitec as Group Financial Director. Mr. Kotze served his articles from 1993 to 1997 at KPMG in Pretoria, South Africa, where he was the audit manager for several major corporations in the manufacturing, mining, retail and financial services industries. During 1998, he joined the Industrial Development Corporation of South Africa Limited, or IDC, as a business analyst. His main duties at the IDC were the evaluation and investigation of ventures requiring funding from the IDC, from small manufacturing concerns to huge multinational projects, as well as the structuring and implementation of loan and equity products for these concerns.
Ms. Stewart has served as our Senior Vice President of Marketing and Sales since June 2004. Ms. Stewartâ€™s primary function is to manage all marketing and sales activities for us. Her secondary function is to oversee implementation and operation of specific projects such as Namibia and Botswana as well as our pension and welfare systems. Ms. Stewart was a director of Net 1 Investment and a director of Net 1 Holdings which were subsidiaries of Aplitec until June 2004. Ms. Stewart joined Aplitec in 1997, and has worked with Dr. Belamant for over 20 years at various companies including, Volkskas Industrial Bank, SASWITCH and Net 1 Southern Africa, Net 1 Solutions and Net 1 Investment.
Mr. Soma has served as our Senior Vice President of Information Technology since June 2004. Mr. Soma joined Aplitec in 1997. He specializes in transaction switching and interbank settlements. Mr. Soma represented Nedcor Bank in assisting with the technical specifications for the South African Interbank Standards. He is also responsible for the ATM settlement process to balance ATMâ€™s with the host as well as balance the host with different card users. Mr. Soma designed the Stratus Back-End System for Aplitec, and is responsible for the Nedbank Settlement System for the Point of Sales Devices. Mr. Soma has over 11 years of experience in the development and design of smart card payment systems.
MANAGEMENT DISCUSSION FROM LATEST 10K
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 published by Statistics South Africa, as of mid-2007, South Africa had a population of approximately 47.9 million people, of which an estimated 50% lived below the poverty line and, as of September 2006, the South African unemployment rate was estimated at approximately 25.5% . The success we have achieved in South Africa has primarily resulted from servicing the needs of the poorest section of the population â€“ 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 Africaâ€™s Development and the India-Brazil-South Africa Dialogue Forum, which resulted in the establishment of an economic trade bloc between these three countries.
In July 2004, we began a major drive to install POS devices at merchants located 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 beneficiaries in cash at our mobile paypoints. We discuss the progress of our merchant acquiring efforts since implementation of these efforts under â€śâ€”Progress of Our Merchant Acquiring System.â€ť
The implementation of new UEPS systems, particularly in developing economies outside our current markets, is a vital component of our future growth. We have implemented or are in the process of implementing our systems on the African continent outside South Africa. During fiscal 2006, we formed joint ventures with government entities and financial institutions to operate UEPS smart card-based switching systems in Namibia, Botswana and Nigeria. These joint ventures, which are described in more detail under â€śâ€”International Expansion,â€ť are in various stages of development and operation.
In July 2006, we acquired Prism which owns EasyPay, the largest bank-independent financial switch, or transaction processor, in Southern Africa. The bulk of the 441 million transactions processed by EasyPay during the year ended June 30, 2007, on behalf of retailers, bill issuers and financial institutions were transacted through a base of approximately 50,000 customer owned terminals, the majority of which are installed at all the retail locations of South Africaâ€™s two largest retailers, who have approximately 65% of the South African retail market share between them. The addition of the Prism merchant acquiring network will extend our footprint in South Africa from the deep rural areas, where we are active today, to the urban environment. We intend to upgrade, where appropriate, the 50,000 terminals that form part of Prismâ€™s network to accommodate our biometric-based UEPS technology, which will significantly enhance our wage payment program once we launch that service.
We believe that the acquisition of Prism will also help us extend our ability to deliver solutions across the entire spectrum of transaction processing and assist us in expanding our international operations throughout Africa, Asia and Europe. The results of Prismâ€™s operations are reflected in our financial statements from July 3, 2006. We have also begun to explore strategic partnership and business opportunities across the Americas and Asia. For example, we are in the process of launching VTU solutions in Colombia and Vietnam.
In January 2007, we signed a co-operation agreement with Grindrod Bank Limited, or Grindrod Bank, a fully registered bank in South Africa, for the establishment of a retail banking division within Grindrod Bank that will focus on deploying our wage payment solution in South Africa.
Sources of Revenue
We have structured our business and our business development efforts around four related but separate approaches to deploying our technology. In our most basic approach, we act as a supplier, selling our equipment, software, and related technology to a customer. As an example, in Malawi, we sold a complete UEPS to the Central Bank, which owns and operates the resulting transaction settlement system. The revenue and costs associated with this approach is reflected in our Hardware, software and related technology sales segment.
We have found that we have greater revenue opportunities, however, by acting as a service provider instead of a supplier. In this approach we own and operate the UEPS ourselves, charging one-time and on-going fees for the use of the system either on a fixed or ad valorem basis. This is the case in South Africa, where we distribute welfare grants on behalf of the provincial governments and employers on a fixed basis, but charge a fee on an ad valorem basis for goods purchased using our smart card. The revenue and cost associated with this approach are reflected in our Smart card accounts, Transaction-based activities and Financial services segments. Three of the provincial governments each provide more than 10 per cent of our total revenues and the loss of any one of these customers may have a material adverse effect on us.
Because our smart cards are designed to enable the delivery of more advanced services and products, we are also willing to supply those services and products where the profit potential is compelling. For instance, we act as a lender today. This is an example of the third approach that we have taken. Here we can act as the principal in operating a business that can be better delivered through our UEPS. We can also act as an agent, for instance, in the provision of insurance policies. In both cases, the revenue and costs associated with this approach are reflected in our Financial services segment.
Finally, we have entered into business partnerships or joint ventures, such as SmartSwitch Namibia and SmartSwitch Botswana (Proprietary) Limited, or SmartSwitch Botswana, to introduce our solution to new markets. In these situations, we take an equity position in the business while also acting as a supplier of technology. In evaluating these types of opportunities, we seek to maintain a highly disciplined approach, carefully selecting partners, participating closely in the development of the business plan and remaining actively engaged in the management of the new business. In most instances, the joint venture or partnership has an exclusive license to use the UEPS in the specific territory, including the back-end system. We account for our equity investments using the equity method.
We believe that this flexible approach enables us to drive adoption of our solution while capturing the value created by the implementation of our technology.
Trends and Material Developments Affecting out Business
Seasonality of Transaction-Based Activities
We experience seasonality in our transaction-based activities operating segment. Our beneficiaries are 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 activation of the payment file is done on a limited basis at merchant locations only. As a result, the revenue recognized in the second quarter of our fiscal year is generally lower than the other three quarters due to the limited number of grants distributed during the last week of December. The activation of the payment file for any month also depends on whether the first calendar day of a month is a weekday, or a Saturday, Sunday or public holiday.
Status of South African Provincial Contracts
We currently derive the majority of our revenues from our contracts with various South African provincial governments. The South African national government passed legislation in 2004 for the 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. SASSA commenced operations on April 1, 2006.
SASSA commenced operations on April 1, 2006 and is in the process of conducting a national tender for the distribution of welfare grants in which bidders had the opportunity to bid for all of South Africa or on a province-by-province basis. In late July 2006, SASSA published a request for pre-qualification of bidders, or RFQ, which included a proposed timetable for pre-qualifying bidders, distributing requests for proposals, or RFPs, from pre-qualified bidders and evaluating RFP submissions, indicating that the process should be completed by late November 2006. However, in mid-August 2006, SASSA withdrew the RFQ. In February 2007 SASSA issued a request to submit proposals for the provision of payments services to social assistance grant recipients, or RFP. Pursuant to the RFP, potential bidders are invited to submit proposals for the provision of a payment service to social welfare grant recipients on province-by-province basis or for all of South Africa's nine provinces. According to the RFP, submissions of proposals were due by May 4, 2007, the final evaluation process was to be completed by July 13, 2007, and implementation of the new contract will commence on April 1, 2008. On May 4, 2007 we filed proposals for each of South Africaâ€™s nine provinces, as well as a proposal for the entire country. SASSA provided an indicative time-frame for the evaluation of the tender proposals and the award of the contract to successful bidders, but some of the key dates have already been missed.
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 a national tender could lead to our losing one or more of our current contracts if SASSA decides to appoint a single (or other) contractor to provide social welfare grant distribution and we are not chosen. During this transition period our existing provincial government contracts will continue to be governed by their respective terms.
We believe that based on the number of beneficiaries, we currently have approximately 45% of the market share in South Africa for the distribution of social welfare grants. Our main competitors are the South African Post Office and the formal banking sector.
Progress of Our Merchant Acquiring System
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 productivity of the existing terminal base continues to improve, as is evident from the increase in the number of transactions processed per POS terminal installed. We believe that the existing terminal base has reached or is close to saturation and do not expect significant growth in future. 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. The acquisition of EasyPay provides us with potential access to an existing terminal base of approximately 50,000 customer owned terminals, the majority of which are situated in retailers in the urban and semi-urban areas of South Africa. These 50,000 terminals were acquired from Prism in prior periods and are owned by the retailers. In order for these terminals to become UEPS enabled, we will need to equip these terminals with biometric readers and install our UEPS software. We have already successfully demonstrated the integration of the biometric readers to the major retailers and we are currently negotiating the commercial terms and conditions of implementing the biometric solution.
Year Ended June 30, 2007 Compared to Year Ended June 30, 2006
The following factors had a significant impact on our results of operations for the year ended June 30, 2007 as compared to the prior year:
* significant weakening of the South African rand, or ZAR, our functional currency, against the U.S. dollar, our reporting currency, which had a negative impact on our reported revenues and net income in U.S. dollars;
* impact of the Prism acquisition, which has increased our reporting revenues and net income but had a negative impact on our operating margin;
* amortization of Prism-related intangibles, which had a negative impact on our net income;
* revenues from hardware and software sales to SmartSwitch Botswana, which increased our revenue and net income;
* continued decrease in margins in our traditional micro-lending operations;
* reduced interest income, net resulting from the utilization of cash resources for the acquisition of Prism at the beginning of the year;
* receipt of a settlement payment from SASSA related to contract variation fees and price increases; and
* increasing use by grant recipients of their smartcards at participating retailers to receive and spend their grants, which resulted in higher volumes in our transaction-based activities.
Consolidated overall results of operations
This discussion is based on the amounts which were prepared in accordance with US GAAP.
Analyzed in ZAR, the increase in revenue and cost of goods sold, IT processing, servicing and support for the year ended June 30, 2007, was primarily due to the higher volumes in our transaction-based activities, a greater number of UEPS-based smart card holders, a contract variation fee settlement payment received from SASSA and the inclusion of the operations of Prism from July 3, 2006.
Our operating income margin for the year ended June 30, 2007, decreased to 43% compared with 46% for the year ended June 30, 2006. The inclusion of Prism operations during the year ended June 30, 2007, has reduced our overall operating margin as Prism operations generate a lower operating margin than our historical operations. In addition, our margin during the year ended June 30, 2007, was further reduced by intangible amortization charges related to Prism intangible assets acquired. This reduction was partially offset by the continued adoption of our merchant acquiring system, increased volumes and pricing in our pension and welfare business and the SASSA settlement payment.
Selling, general and administration expenses increased during the year ended June 30, 2007 from the comparable quarter in 2006 primarily due to the inclusion of Prismâ€™s operations and increases in goods and services purchased from third parties, including the effects of the increase in inflation in South Africa and expenses of $1.6 million (ZAR 11.7 million) relating to a potential acquisition which we ultimately determined not to pursue.
Cost of goods sold, IT processing, servicing and support includes a stock-based compensation charge of $0.3 million (ZAR 2.0 million) related to options granted to Prism employees. Selling, general and administration expenses includes a stock-based compensation charge of $0.6 million (ZAR 4.6 million) related to options granted to employees. The stock-based compensation charges included in cost of goods sold, IT processing, servicing and support and selling, general and administration are net of adjustments as a result of forfeitures of $0.2 million (ZAR1.5 million) and $0.4 million (ZAR 3.0 million), respectively. Selling, general and administration also includes the stock-based compensation charge of $0.07 million (ZAR 0.5 million) related to options granted to an employee in January 2006. The employee resigned before any of the options vested and accordingly the stock-based compensation charge of $0.2 million (ZAR 1.4 million) recorded from January to September 2006 has been reversed. The reversal has been included in selling, general and administration.
Our total costs of maintaining a listing on Nasdaq as well as compliance with Sarbanes, particularly Section 404 of Sarbanes, resulted in expenditures of $1.5 million (ZAR 10.8 million) and $3.0 million (ZAR 19.5 million) during the year ended June 30, 2007 and 2006, respectively. We completed our public offering and Nasdaq listing in August 2005. We incurred approximately $1.5 million (ZAR 9.8 million) during the year ended June 30, 2006, related to legal fees, printing costs, registration and filing and accounting fees.
The increase in depreciation and amortization during the year ended June 30, 2007 compared to the year ended June 30, 2006, was mainly due to the amortization of intangible assets acquired related to the Prism acquisition and acquisition of the remaining 25.1% of EasyPay. The total amortization of these intangible assets during the year ended June 30, 2007 was approximately $5.4 million (ZAR 39.0 million). The deferred tax benefit included in our statement of operations related to the intangible amortization charge for the year ended June 30, 2007 was $2.0 million (ZAR 14.2 million). Property, plant and equipment acquired to provide administration and distribution services to our customers is depreciated over the shorter of expected useful life and the contract period with the provincial government. We are currently in an extension phase with all of our contracts and the majority of our property, plant and equipment related to the administration and distribution of social welfare grants has been written off. Accordingly, depreciation expense related to these activities decreased during the year ended June 30, 2007 compared with the year ended June 30, 2006. This reduction was partially offset by the increase in depreciation of our participating merchant POS terminals and Prism property, plant and equipment acquired.
Interest on surplus cash for the year ended June 30, 2007 increased to $16.4 million (ZAR 118.2 million) from $14.6 million (ZAR 93.6 million) for the year ended June 30, 2006. The increase in interest on surplus cash held in South Africa was due to the adjustment in the South African prime interest rate from an average of approximately 10.50% per annum for the year ended June 30, 2006, to 12.12% per annum for the year ended June 30, 2007. In addition, interest on surplus cash held in the United States increased due to the increase in the federal funds rate from an average of 4.18% per annum during fiscal 2006 to 5.25% per annum during fiscal 2007. These increases in interest rates were offset by lower surplus cash balances as a result of the $95.2 million paid in cash for the acquisition of Prism.
During the year ended June 30, 2007, our finance costs increased due to an increase in our pre-funding obligation. Finance costs increased to $12.0 million (ZAR 86.5 million) for the year ended June 30, 2007, from $8.7 million (ZAR 55.8 million) for the year ended June 30, 2006.
Total tax expense for the year ended June 30, 2007 was $37.6 million (ZAR 270.9 million) compared with $36.7 million (ZAR 235.0 million) during the same period in the comparable prior fiscal year. The increase was due to our increased profitability in our transaction-based activities and the settlement payment received.
Our effective tax rate for the year ended June 30, 2007 was 37.10%, compared to 38.38% for the year ended June 30, 2006. Our effective tax rate for the year ended June 30, 2007 was lower than the statutory tax rate due to foreign tax credits and fewer non-deductible expenses incurred during the year ended June 30, 2007. The effect of the change in tax rate during the year ended June 30, 2006 is included in our tax expense and was approximately $0.2 million (ZAR 1.0 million).
For the year ended June 30, 2007 and 2006, earnings from Permit totaled approximately $1.3 million and $1.0 million (ZAR 9.4 million and ZAR 6.4 million), respectively. In May 2007 we sold our 43.16% interest in the outstanding share capital of Permit and incurred a loss of approximately $0.6 million (ZAR 4.1 million).
Included in earnings from equity-accounted investments are losses from equity accounted investment of approximately $0.3 million (ZAR 2.5 million) and $0.07 million (ZAR 0.4 million), before the realization of income from prior periods, related to SmartSwitch Namibia for the year ended June 30, 2007 and 2006, respectively. During the year ended June 30, 2007 we realized income from license fees, software and hardware sales made to SmartSwitch Namibia in prior periods of approximately $0.09 million (ZAR 0.6 million). This income has been included in earnings from equity-accounted investments. During the year ended June 30, 2006 we eliminated hardware sales and other services made to SmartSwitch Namibia of approximately $0.5 million (ZAR 3.2 million).
Earnings from equity-accounted investments includes a loss of $0.2 million (ZAR 1.8 million) for the year ended June 30, 2007 related to SmartSwitch Botswana. During the fourth quarter of fiscal 2007 SmartSwitch Botswana commenced operations and we do not expect it to generate net income during its first year of operations.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Three Months Ended March 31, 2008 Compared to the Three Months Ended March 31, 2007
The following factors had a significant influence on our results of operations during the three months ended March 31, 2008 as compared with the same period in the prior year:
* significant weakening of the South African rand, our functional currency, against the U.S. dollar, our reporting currency, which had a negative impact on our revenues and net income in U.S. dollars;
* settlement payment received from SASSA during the third quarter of fiscal 2007 which affects the comparability of revenue and net income between the periods due to the non-recurring nature of a substantial portion of that payment;
* increased revenues from price increases, effective from July 1, 2007 from the KwaZulu-Natal provincial government for welfare distribution and administration services;
* increased number of grants paid in the North West province;
* continuation of the contract to provide the Central Bank of Ghana with a National Switch and Smart Card Payment System utilizing our UEPS technology;
* increased revenues from continued adoption of our merchant acquiring system by cardholders;
* stock-based compensation charges related to grants of restricted stock in August 2007 and February 2008 under the 2004 Amended and Restated Stock Incentive Plan; and
* change in our fully distributed tax rate from 36.89% to 35.45%, which had a positive impact on net income.
Consolidated overall results of operations
This discussion is based on the amounts which were prepared in accordance with US GAAP.
Analyzed in ZAR and ignoring the effects of the third quarter 2007 settlement payment received from SASSA of $5.9 million (ZAR 43.0 million), the increase in revenue and cost of goods sold, IT processing, servicing and support for the three months ended March 31, 2008, was primarily due to the higher volumes in our transaction-based activities, a greater number of UEPS-based smart card holders and the sale of hardware and software development and customization to the Bank of Ghana.
Our operating income margin for the three months ended March 31, 2008, decreased to 45% compared with 47% for the three months ended March 31, 2007, primarily as a result of the SASSA settlement payment.
Selling, general and administration expenses increased during the third quarter of fiscal 2008 from the comparable quarter in fiscal 2007 primarily due to the stock-based compensation charge related to the restricted stock grants awarded in the first and third quarters of fiscal 2008 and increases in goods and services purchased from third parties, including the effects of the increase in inflation in South Africa.
Our direct costs of maintaining a listing on Nasdaq as well as compliance with the Sarbanes-Oxley Act of 2002, or Sarbanes, particularly Section 404 of Sarbanes, includes independent directorsâ€™ fees, legal fees, fees paid to Nasdaq, our compliance officerâ€™s salary, fees paid to consultants who assist with Sarbanes compliance and fees paid to our independent accountants related to the audit and review process. This has resulted in expenditures of $0.4 million (ZAR 3.2 million) and $0.4 million (ZAR 2.6 million) during the three months ended March 31, 2008 and 2007, respectively.
Depreciation and amortization includes the amortization charge related to the acquisition of Prism of $1.3 million (ZAR 10.0 million) and $1.4 million (ZAR 10.0 million), respectively, for the three months ended March 31, 2008 and 2007. The deferred tax benefit included in our statement of operations related to the intangible amortization charge for the three months ended March 31, 2008 and 2007, respectively was $0.5 million (ZAR 3.6 million). Property, plant and equipment acquired to provide administration and distribution services to our customers is depreciated over the shorter of expected useful life and the contract period with the provincial government. We are currently in an extension phase with all our contracts and the majority of our property, plant and equipment related to the administration and distribution of social welfare grants has been written off. Accordingly, depreciation expense related to these activities has decreased during the three months ended March 31, 2008 compared with the three months ended March 31, 2007. This reduction in depreciation was partially offset by the increase in depreciation of our participating merchant POS terminals.
Interest on surplus cash for the three months ended March 31, 2008 increased to $6.9 million (ZAR 51.1 million) from $4.1 million (ZAR 29.6 million) for the three months ended March 31, 2007. The increase in interest on surplus cash held in South Africa was due to a higher average daily ZAR cash balance during the three months ended March 31, 2008 compared with the three months ended March 31, 2007 and higher deposit rates resulting from the adjustment in the South African prime interest rate from an average of approximately 12.50% per annum for the three months ended March 31, 2007, to 14.50% per annum for the three months ended March 31, 2008.
During the three months ended March 31, 2008, our finance costs decreased due to an increase in available cash for our pre-funding obligation which resulted in less utilization of our short-term facilities which was offset by the increase in the average rates of interest on short-term facilities. Finance costs decreased to $3.1 million (ZAR 22.9 million) for the three months ended March 31, 2008, from $3.4 million (ZAR 24.5 million) for the three months ended March 31, 2007.
Total tax expense for the three months ended March 31, 2008 was $5.2 million (ZAR 38.2 million) compared with $11.4 million (ZAR 82.2 million) during the same period in the comparable quarter of the prior fiscal year. Deferred tax assets and liabilities are measured utilizing the enacted fully distributed tax rate. Accordingly, a reduction in the fully distributed tax rate from 36.89% to 35.45% results in lower deferred tax assets and liabilities and the net change of $5.9 million (ZAR 43.9 million) is included in our income tax expense in our unaudited condensed consolidated statement of operations for the third quarter of fiscal 2008. In ZAR, if the effect of the change in our fully distributed tax rate is ignored the increase in our total tax expense was primarily due to our increased profitability in our transaction-based and hardware, software and related technology sales activities. Our effective tax rate for the three months ended March 31, 2008 was 15.9%, compared to 38.2% for the three months ended March 31, 2007. The change in our effective tax rate was primarily due to reduction in our fully distributed tax rate to 35.45% and fewer non-deductible expenses during the three months ended March 31, 2008 compared to the three months ended March 31, 2007. The adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB 109 , or FIN 48, did not have a significant impact on our effective tax rate during the three months ended March 31, 2008.
Loss from equity-accounted investments for the three months ended March 31, 2008, of $0.3 million (ZAR 2.1 million) does not include equity-accounted earnings attributable to Permit Group 2 (Pty) Ltd (â€śPermitâ€ť) because Permit was sold in the fourth quarter of fiscal year 2007. Loss from equity-accounted investments for the three months ended March 31, 2007 of $0.2 million (ZAR 1.1 million) does not include equity-accounted losses attributable to VinaPay because we had not invested in this entity as of March 31, 2007. During the three months ended March 31, 2008, we recognized income from license fees, software and hardware sales made to equity-accounted investees in prior periods of approximately $0.2 million (ZAR 1.1 million). Eliminations of hardware sales and other services and income from license fees, software and hardware sales made in prior periods have been included in (loss) earnings from equity-accounted investments.
Dr. Serge C. P. Belamant - Chairman of the Board and Chief Executive Officer
Thank you. Good morning to our investors in the US, and good afternoon to our investors in Europe and to those in South Africa. Thank you very much for joining us for our third quarter and fiscal 2008 earnings call.
With me today as usual, Herman Kotze, our CFO, and also with me a member of our senior management team. Both our press release and our 10-Q are available on our website at www.net1ueps.com. We will be making forward-looking statements on this call and I call your attention to the cautionary language contained in our press release regarding the risks and uncertainties associated with forward-looking statements. In addition, during this call weâ€™ll be using certain non-GAAP financial measures as defined under SEC rules, where required by these rules we have provided a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures and exhibits in the press release dated yesterday.
As mentioned on our previous call, itâ€™s become apparent to Herman and I with previous practice of presenting our results in US dollars which is that in South African rand, which is non-GAAP is considered. Therefore, based on request and recommendation of our investors and analysts during this call we will primarily discuss our results in South African rand. We achieved a non-GAAP measure. We analyze our results of operations in annual report on Form 10-K. I would like to thank you and in our press release in South African rand to assist investors in understanding the changes in the real underlying trends of our business.
Companyâ€™s results are significantly impacted by currency fluctuations between the US dollar and the South African rand. And, therefore, for clarification purposes I would like to reiterate that the use of South African rand is a non-GAAP measure and that the appropriate GAAP presentation is included in our report on Form 10-Q and press release and we advise our investors and analysts to review these results in terms of US GAAP.
Finally, it is worthwhile noting that the South African rand was significantly weaker against the US dollar than during the same period they look while yeah. Regardless of the weakness of the rand I am once again delighted to report another set of number that have exceeded our expectation.
Operations have continued to deliver solid financial results and cash flows and we remain firmly onset to achieve great feet our targeted growth for the current fiscal year. In analyzing these results we provide additional non-GAAP measurement, namely fundamental net income and fundamental earnings per share, that eliminate among other adjustments, the significant non-cash accounting increase required by GAAP specifically for the Prism acquisition. On this basis we recorded an increase in fundamental net income of 22% from South African rand 139.3 million for the three-months ended March 31, 2007 to South African rand 170.5 million for the three months ended March 31st, 2008, an increase in fundamental earnings per share of 32% to 298 cent South African for the three months ended March 31st, 2008. Our GAAP results in comparison would reflect a 52% increase in net income and 51% increase in EPS. Certainly, our best results for any quarter to-date.
I am also pleased to report that the companyâ€™s in margin performing above my expectations when measured against the values goal that we set at the beginning of the financial year. These goals of course included certain formals, our EPS growth, our cash conversion ratio, liquidity of our earnings, the selection of sustainable business deals, meaningful market penetration, technological robustness, technological innovation, our new M&A program, our investment in social program, and the structuring and restructuring of the company to meet our worldwide objectives and ambitions.
At this point, I would like to take a step back to reiterate to all our shareholders the vision of Net 1 and now we converted vision into strategy and action. And to focus on those deliverables rather than on the financial numbers themselves. These have been set up in detail related in 10Q and Herman will present them in detail later.
Our core competitors as a technology group is to provide a multi platform secure payment and transacting processing system for environmental are not suited to technical solutions.
We have consciously chosen to follow this route as we believe that we have a huge competitive advantage in this arena for a number of reasons including our experience is operated in this environment, our technological solutions and innovations which are a lot in top country to reproof existing technological platform, the cost effectiveness of our solutions, the equitability of our business model, our broader understanding of the complexities present in this environment. And I accept and support of the specific social economic and social political environment that we target.
We also understand that working with and being part of such dramatic change in business, technological and social concepts can on occasion lead to term lines which are longer than anticipated or not inline with this world expectations, hence we are always redistributing projects, repricing initiatives and development to ensure that we are neither too early nor too late to cease a specific market opportunity.
Our penetration can be greatly affected by the election program, budget approval, market readiness and many other factors which we have to manage at any one point in time. We never fall in short that we always have a number of opportunities which appear to be in a not ready state and others which are waiting on the wing. It often happens that somebodyâ€™s opportunities do not always materialize during the campaign they try. These opportunities do not go away, but extently swap priority with others which are in a more ready state. We continuously monitor in many job platform to ensure that weâ€™ll continue to deliver our projected earnings growth while not entering into short-term deals which are neither sustainable nor inline with our strategic vision.
Let me now take you to some of our initiatives. Firstly, a number of our investors have asked us to give some color on the latest SASSA press release. It must be noted that this tender is a second largest tender ever issued in South Africa. The value of this tender over a period of five years which is the average legal lines of these type of tenders is in a region of $2 billion. The reason of formal doubt that many organizations upfronting for this business.
Governments and therefore being prudent by ensuring that the tender process has been followed correctly. These duly durations however point us to the fact that it is their intention to award this tender in a near term. We reiterate -- let me feel that we have a better chance in May waiting this tender as a whole or to be put in a position which is better than an existing one. Our track record, financial proposal, technological solution, and our social development programs is now likely to be matched by anyone of our competitors. Secondly, let me update you on our Ghanaian initiative. The Ghanaian contract was signed on 15th June 2007 for the implementation of the National Switch which is now branded E-ZWICH.
Net1 was awarded its entire contract as a end-to-end solution. Over 42 companies actually tendered against us during this tendering process. The initial orders, which were placed to show the size of this tender exceeded 500,000 cards, 5,000 tender sale terminals to structure service which are our largest computer â€“ back-end computer systems, production in call center, hardware and software, our UEPS banking application, our UEPS mobile banking application, debit and credit card switching software, integration to 24 banks, and the additional bank of what they call APEX bank which is responsible for an access of about 120 local community banks. The official launch of E-ZWICH by the President of Ghana took place on Monday the 20th of April 2008 at the state here that in Accra. More than 800 delegates from Ghana attended the launch. Successful one is implementation what performed inside leading banks in Ghana. Zenith Bank, Chuck Bank, Fidelity Bank, Guarantee Trust Bank and Merchant Bank. The central bank pilot play is to monitor these five banks for the period of one month then to allow further soft banks for another month. By July we anticipate participation from all banks which will take place. Each some of banks can then sign up and acquire a maximum of 50 merchants for the first month on a period, and Net 1 teens are all on same buy to assist with its massive rollout.
Phase II of implementation is already commenced and here we are talking about integration of the ATM network system, our 12 map which is our one too many search engine power borrow metric search station, offline settlement as well as do offline card registration. New orders have already been placed in excess of the original one. In December and January of 2008 another 2000 point-of-sale devices were purchased and an additional 1.5 million cards were purchased. 810 registration devices and 254 wage payment workstations.
Further more, further order weâ€™ve placed in February and April as more banks joining the system, and further 1 million card were ordered, a further 3,500 point-of-sale devices another 528 registration stations and another 76 wage payment stations as well as from personal analyzation equipment.
It is clear looking at these results that our Ghanian implementation has been improved the success for and is being completely backed in its entirety by the Central Bank of Ghana as well as the people network in it. Once again this project demonstrates the power of our teams, our sales force and technological solutions. We totally believe that due to this Ghanaian project, we will be able to implement other such large projects in many other African and Middle East countries.
If I now turn my attention to another launch that was performed over the last during this quarter and that of course profit includes the launch in Iraq. Our contract in Iraq was signed on 25th of February 2008. The project has commenced and is on target for implementation in the back date during June for large registration in July for the commencement of war victim and martyrdom grant. An initial amount of $100,000 will be utilized for the initial pilot project and allocated for the various projects as stipulated below. If successful a further 900,000 beneficiaries will be paid through VPS totally one million in respect of government rand. The project will include 70,000 war victims and 10,000 martyrdoms and 20,000 employees salary and wages split between our Al Rashid (Ph) and now letâ€™s begin then.
Our initial orders included 100,000 cards, 100 place of sale devices, 50 case expenses and a number of registration patients. The terms and condition of these contract are somewhat different to our practitioner businesses in which we sometime have equity. In this particular case our fees are 10% of the value of each transaction, 10% of the top line. We also get paid quarterly Larsonâ€™s fees at 29 U.S. cents per card, and we also get $1 per card when we perform any biometric search. Weâ€™ve also received mostly progressing fees of $25,000 per month.
At the moment the Iraqian has committed to putting out in excess of the million cards during the first 6 to 9 months, 3 million cards in year two, and 5 million cards in year three. This is of course cumulative as we could expect to have up to 5 million cards within three years. This project once again demonstrates our ability to be able to enter a new country and to immediately over a very short period of time to provide this country with solutions which we have been searching for many, many years.
We would thank at this point in time for the huge effort that have been made by sales, technical and business teams all led by I (Ph), Senior Vice President, Marketing and Sales, Brenda Stewart, present with us today, that have taken huge amount of the time to spend in the different countries. To teach implement, change our views, modify peopleâ€™s thinking and assure that at the end of the day the UEPS become the payment instrument of choice in the developing economies of this world.
If I now focus on a number of other countries in which we are already present, Namibia, Botswana and Nigeria. We are pleased to report that Namibia is a country which is now signing up a deal at the much faster rate with sometimes governments and sometimes the public sector, and is talking to now generate some profits. Our Botswana initiatives, which were a middle slow to kick-off adjust side a Government Deal for 100,000 people to pay a 100,000 gross on a monthly basis and that by itself will make up Botswanian venture profitable.
Our Nigerian initiative is also commencing to show a little bit more activity with Diamond Bank that has commenced the implementation of their first project. But because of what has happened in Ghana we are now being approached by similar banks. When we takes banks we brought to in Ghana, the Nigeria banks they are now wishing to actually drain the Nigerian switch as they believe that Nigeria lucky to follow in the tracks of Ghana. We must also note that the tender, that had been canceled these are National IV System in Nigeria itâ€™s just been reissued and of course it is our intention to follow this and to tender directly for this particular business, reinitiating the potential that we had all seen and perceived to be present in the Nigerian, in the Nigerian continent, in the Nigerian country.
When we look at countries like Columbia you will see, you have press releases that our systems are now starting to generate good income but more importantly are starting to actually grab a last chunk of the production market. To believe that in a short while this business will become focusable and we will then be able to expand this activity into a fully-fledged UEPS system. Once again using prepaid cellphones as an entry to generate customer acquisition and to then allow these particular customers to make use of the full UEPS functionality.
All in all, our hope let your both will assist you all to understand the little data our modus operandi. I am also exited to add that at last, our wage payment system in South Africa is about to delaunch in effect Monday at 4 p.m. in the region of KwaZulu-Natal. We are now able to utilize our version 14 technology that has been implemented successfully in Ghana. We are able to have a full access to banking last month and we have now picturized a number of financial products, which are going to be loans a staff and parcel of our offering. I am exited at our program and that we continue to be able to deliver the growth that we have managed to achieve for such a long time.
Okay, thank you for your attention and would like to hand over to our CFO, Mr. Herman Kotze. Herman, over to you.
Herman Gideon Kotze - Chief Financial Officer
Thank you, Serge, and greetings to our investors around the world. I will discuss the key trends of the third quarter of fiscal 2008 compared to the third quarter of fiscal 2007 along with the key trends between the third and the second quarters of fiscal 2008.
We have also updated the Frequently Asked Questions section in our press release to provide further clarity on the questions we are asked most often by our investors and the analysts. Again, for clarification purposes, I would like to mention that my following discussion will be based on our results in South African rand as this provides the best indicator of the groupâ€™s actual operational performance and this is a non-GAAP measure. In order to review our results in terms of US dollars and US GAAP, please review our quarterly filing on Form 10-Q as well as our press release filed yesterday.
For Q3 of 2008, our average rand-dollar exchange rate was 7.41 compared to 7.21 for Q3 of fiscal 2007. But sequentially from the second quarter we saw a significant weakening from the 6 rand 78 to the dollar level for Q2 of fiscal 2008.
Looking at the current situation, the rand has strengthened against the US Dollar during the second half of our current quarter Q4 from a tied about 8 rands of a dollar during the last weeks of Q3 and it is currently trailing at around 7 rand 60 to the dollar. Any fluctuation of the rand obviously influences the dollar equivalent as a result of our South African operations, which is why we provide you with constant currency information in our press release and on this call, as the core operational drivers are clearly visible from these numbers.
I am very pleased with our third quarter results as we have again achieved record selling and we have met or exceed mighty financial indicators of continued fundamental earnings growth, strong operating margins, and fantastic cash conversion.
Before I continue further with the discussion of our results, I would like to discuss two key factors that I believe it will take us to comparability of our results. The first factor is the enactment of the Legislation to change the record secondary tax on companies in South Africa or STC from 12.5% to 10%. This change has resulted in a decrease in our fully distributed tax rates from 35.45 to 10, from the 36.89% during Q3 of 2008.
In terms of US debt, we have to adjust our net deferred tax liability to restrict the new rate, which resulted in a reduction of our income tax expense and by implication increased our net income by approximately $5.9 million during this quarter. The adjustments in this quarter resulted in an overall effect of tax rate of 15.9%, which will obviously reverse to the new rate of around 35.45% going forward, excluding any impact.
The change in the tax rate does not affect our revenues and operating income numbers. In addition, our fundamental net income and earnings per share excludes this positive impact of the change in the tax rate, as we view this event as non-recurring income direction, which occurs on ad hoc basis.
The second factor affecting the comparability of our results is the large settlement payment from SASSA last year during the third quarter of 2007. Last year this payment received contributed to an increase in our net income for approximately $4 million and increased our earnings per share range by 4.4 USD. We discussed this payment as a link on the Q3 2007 earnings call and again I would like reiterate my belief that it would be incorrect to exclude this amount from our comparable fundamental net income and earnings per share on the basis of the loss in frequent nature and payment like these relates to contract cost affecting adjustments at one of our core activities and are not different from any of our many other non-recurring revenues, such as hardware and software sales but are not specifically excluded from the calculation of fundamental earnings per share.
We indicated during the earning call last year that the settlement payments we had received constituted of recurring and non-recurring elements in order to facilitate a meaningful comparison and interpretation of the trend in our recurring transaction based activity. In last nightâ€™s earnings press release we specifically included the attachments C and D to provide you with a comprehensive analysis and comparison of the recurring and non-recurring items associated with the payments received last year. Accordingly, I believe that my following discussion describing the movement in our revenue and operating income for the Group and our transaction based operating segments, will be most meaningful if we exclude the non-recurring portion of the settlement payment received from SASSA in Q3, 2007.
Revenue for our current quarter was 467.4 million rands up 17% year-over-year. Our gross margin 74% compared to 75% in the same quarter last year and 71% compared to our preceding quarter. However, in our business gross margin is not the best indicator of the Groupâ€™s profitability due to our diverse product offering. We focus on operating income, which increased by 17% year-over-year and by 11% quarter on quarter. The overall operating volume compared to last year was the same at 45%. Sequentially operating margin increased from the 41% in Q2, mainly as a result of the inclusion of more high margin software development revenues and increased margins from all of our operating segments due to improved trading conditions.
Letâ€™s now analyze the business in more detail using our reported segment. Our transaction-based activity segments increased revenues year-over-year by 9% and sequentially by 2%. Our operating income was static compared to the previous year but improved by 4% to a 150.8 million rand for this quarter.
Our operating margin improves to 55% from 53% in Q2 this year compared to the 60% of Q3 last year mainly as the result of the following three factors and this is why there has been a reduction in the operating margin from last year. One, a record increase in the South African inflation rate over the last year has resulted in inflation increases in our cost component that were higher than the increases we negotiated with our customers. Two, lower revenues earned during Q3 2008 compared to the Q3 2007 period, which resulted from the opening in March 2008 of the April 2008 pay cycle where all provinces would go to KwaZulu-Natal whereas in March 2007, the April 2007 pay cycle was opened in all provinces. And three lower margins identified mainly as a result of a comprehensive overhaul of the operational and technical platforms.
This profit margin decreases was partially offset by the increased revenue from annual price increases received for welfare distribution and administration services. The price increases from our welfare payment contracts are regulated by the various service level agreements and are generally a factor of the South African inflation rate. We will continue to receive these inflation adjustments for as long as our current contracts are valid.
In other words as long as the new tender order is delayed we will continue to show strong and robust growth from this business through the combination of slight increases mostly in the number of beneficiaries and the continued migration of our beneficiaries to our merchant acquiring network. The total number of payments services to beneficiaries increased from a 11.41 million for Q3 2007 to a 11.89 million during the current quarter, which is an increase of 4%. Sequentially the total number of payments services to beneficiaries does not increase as the guide in new beneficiary terms growth was offset by the much established renewal of beneficiaries following by a lengthy investigation by SASSA facilitated by ourselves into the eligibility of certain grant recipient.
On the 29th of January this year, the Minister of Special Development announced that 288,682 beneficiaries had been removed from the Social Welfare system. We will estimate that a 110,000 of these beneficiaries were previously included in the 5,000 from SASSA.
Looking forward we believe that the growth raising beneficiaries were reviewed based on the following reasons. One, we expect to complete the transfer of beneficiaries from the both of itâ€™s sales and growth rate province by the end of June which will result in an incremental increase of another 70,000 beneficiaries saved by KwaZulu-Natal province. Two, on the 17th of March, the Minister of Social Development announced that there will be a review of the new states undertaken to ascertain eligibility for social grants. To ensure that to many South Africans who are currently excluded from the Social Welfare System as a result of updated evaluation criteria are included in the future. The Minister mentioned that the efforts to eliminate social grants that we spoke about before has resulted in additional available funds, which should be distributed to those who are most needing. And three, on 5th April, the Minister of Social Development reacted to a court order that requires the granting of social grants to Africans who were previously denied due to the lack of adequate identification document and specifically. The Minister indicated that SASSA would intervene the court order as a matter of urgency and that specific emphasis will be placed on the redesign of the information technology systems at the same time.
During Q3 2008, our merchant acquiring system continued its impressive performance as we processed a total of 2.02 billion rand in transactions through our merchant acquiring network, compared to 1.63 billion rand during Q3 of 2007 and 1.87 billion rand during the preceding quarter, all on a completed pay cycle basis.
The productivity of our installed terminal base of 4222 terminals increased to 953 transactions processed per terminal during the second quarter completed pay cycles compared to 807 during Q3 of last year and 815 during Q2 of fiscal 2008. This increase throughputs from the comparable period of fiscal 2007 demonstrates the continued rapid expectancy rate of our cardholders as they become familiar with and accustomed to the convenience associated with our merchant acquiring initiatives as they can receive and spend their grants at any time of the month.
Compared with Q3 2007, the increase in the number of terminals installed is primarily as a result of additional terminals in the Northwest province to accommodate the anticipated additional beneficiaries transferred from the South African Post Office to us. Please note that we are the only service provider capable of offering this very convenient service at merchants, which we believe is a key strength of our continued offering.
During the current quarter EasyPay processed a 129.2 million transactions with an approximate value of 28.1 billion rand compared with a 108.8 million transaction proceeds with an approximate value of 24.3 rand during Q3 of 2007. And 135.3 million transactions processed with an approximate value of 30.3 billion rand during the preceding quarter.
Due to the early Easter because we have accommodation for that this year, which typically results in increased consumer spending, we experience an increase in annual transactions versus to retailers during the first quarter of 2008 compared to the third quarter in 2007. Accordingly, due to this year of Easter holidays we expect the number of transactions processed during Q4 2008 to be slightly better than those during Q3 2008. The average fee per transaction during the second and third quarter of 2008 was approximately 20 South African cents. We do not expect a significant fluctuation in South African rand in the average people transaction during our next quarter.
EasyPayâ€™s operating margin excluding the effects of intangible amortization was 34% for Q3 of 2008 compared to 45% for Q3 of 2007 and 53% for Q3 of 2008. Our operating income margins and EBITDA has decreased as a result of cost incurred related to the implementation of a new integrated switch and operating platform, which we expect will improve operating efficiencies and reduce cost at EasyPay, once completed we expect the new integrated switch to greatly enhance our offering at EasyPay and enable us to take advantage of new business opportunity. We expect a new integrated switch to be at full operating capacity during the first quarter of 2009.
Our Smart Card account segment had revenues of 64.5 million rands for Q3 of 2008, which is an increase of 3% year-over-year. The total number of active Smart Card accounts increased by 4% from 3.8 million during Q3 in 2007 to 4 million during Q3 of 2008. Sequentially, there was no significant movement in the number of active Smart Card.
Our financial services business had revenues of 14.8 million rands for the third quarter of 2008, which is a decrease of 28% compared to Q3 of 2007 and a sequential increase of 2% compared to Q2 of 2008. Revenues from our traditional microlending business decreased during the quarter due to increased competition, our strategic decision not to grow this business and an overall lower return on traditional microlending loans as a result of compliance with the National Credit Act.
Revenues from UEPS-based lending decreased during Q3 2008 compared to Q3 2007 primarily due to the lower number of loans granted. In addition, on average, the return on these UEPS-based loans was lower during Q3 2008 compared to Q3 2007.
The final operating segment is our hardware, software and related technology sales segment. This segment traditionally includes revenues that occur on an irregular or once-off basis and it can be difficult to predict sales from year-to-year. This segment includes the sales of UEPS-related hardware and software as well as the sales of the Subscriber Identity Modules, SIM cards, cryptography services and SIM card licenses.
The segment had revenues of 112 million rand for Q3 of 2008, which is an increase of 77% year-over-year, mainly as a result of the delivery of hardware and customization and development activities performed during the quarter related to the tender to provide Ghana with a National Switch and Smart Card system from which we generated revenues of approximately $4.3 million during Q3.
To-date, we have recognized revenue amounting to $10.8 million relating to the Ghana contract. As mentioned by Serge earlier the e-zwich was officially launched in Ghana in April and we expect to complete the initial installation and customization of this system during Q4. We anticipate that the initial contract phase will have an overall value of $17.4 million.
The operating margin of this segment increased from 11% for Q3, 2007 to 36% in Q3, 2008 mainly as a result of the high margin software deliveries to Ghana, terminal sales to our bank customers in Africa and improved trading conditions in Western Africa.
As discussed previously, the reduction in the STC rate was in excess during Q3 of 2008 which resulted in an effective tax rate for Q3 of 2008 of 15.9% compared to 38.2% for the third quarter of 2007 and 36.7% for the second quarter of 2008.
As previously announced on February 20 of 2008 the Finance Minister of South Africa announced another decrease in the sector created from [inaudible] and domicile companies from 29% to 8% for the fiscal year ended in the month of April the 5th 2008. Once enacted, our fully distributed sector (Ph) will be further reduced from the current rates of 35.4% to 34.55% by some African domicile subsidiary. Of course when ATC is abolished as expected next year, our effective tax rate for the South African operations will decrease to 28%. We have illustrated our interpretation of the potentially effects of the abolishment of ATC in question 21 of the frequently asked question section vide attachment E of our press release.
Iâ€™m very happy with the progress made by equity accounted investments in Namibia, the former Columbia and Vietnam. These fledgling businesses continued to grow and as certain indicators they all have exciting prospects in terms of business development. And I guess, I said our positive net income of a 199.9 million rand net of interest increased to 52% year-over-year and GAAP earnings per share increased by 51% on a constant currency basis. On the same basis, fundamental earnings per share for Q3 of 2008 increased by 21% compared to Q3 of 2007.
Before turning to our balance sheet, I would again like to mention that our tax provided for operating activities can and does fluctuate significantly as a result of the timing for the commencement of our commencement of our monthly welfare payment activity, specifically through merchant stores. As a general rule however, we expect a 100% or more cash conversion ratio over any completed pay cycle period.
Now turning to our balance sheet, as of March 31, 2008 we had $235.6 million of cash and cash equivalents. The business remains very cash generative and I will remain comfortable that we have sufficient liquidity between our cash and cash equivalents and our current credit facilities to fund our working capital requirements through the next four quarters.
As I have cited before, I will give the balance sheet item called pre-funded social royalty grants receivable highly liquid, very short-term receivable, best described as a near cash equivalent. We had $24.3 million of pre-funding outstanding at the end of March. The decrease in our accounts receivable compared to June 15, 2007 is largely due to all provincial governments paying us the amounts outstanding before March 31, 2008.
Our other payable, weâ€™ll not be diligent. The increase is primarily due to merchants receiving settlement of the grant facilities in the last day of Q3, 2008 during the first days of Q4, 2008. Our VISA income tax liability did decrease significantly mainly as a result of the reduction in our previous years tax rate during the third quarter.
As discussed in question 20 of the frequently asked question section of our press release, we believe itâ€™s most appropriate at this point in time to retain our cash reserves to finance the expansion of the business, to reduce the significant costs of our current and possible future pre-funding of welfare grant obligations and to execute relevant acquisition opportunities. Overall, the quality of our earnings and financial strength as reflected by our balance sheet is testimony to the groupâ€™s activity and our ongoing achievements.
Based on the assumption that our current business activities and initiatives will continue as usual, we expect to comfortably meet our fundamental earnings per share target on a constant currency basis for fiscal 2008. I want to reiterate that regardless of prevailing market conditions, market sentiments and inherent or implied activity, we will continue to focus on those activities and opportunities that will result in the profitable expansion of our brand business and products. We believe that our tangible earnings track record and operational successes show us the way in the intangible consumed about the future success of our Group.