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EDGAR FILINGS

Year 2006 / February 14

FREESTAR TECHNOLOGY CORPORATION (FSRT.OB)

Quarterly Report

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis of the Registrant's financial condition and results of operations is based upon, and should be read in conjunction with, its unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-QSB, which have been prepared in accordance with accounting principles generally accepted in the United States.

Overview.

The e-payments and e-commerce market is composed of debit and credit card issuers, switch interchanges, transaction acquirers and transaction generators, including Automated Teller Machine ("ATM") networks, retail merchant locations and the Internet. The routing, control and settlement of e-payments is a complex activity due to the large number of locations and variety of sources from which transactions can be generated, the large number of issuers in the market, high transaction volumes, geographically dispersed networks, differing types of authorization and varied reporting requirements. These activities are typically performed online and must be conducted 24 hours a day, seven days a week.

The Registrant's products and services are primarily focused on facilitating electronic payments ("e-payments") and electronic commerce ("e-commerce"). These products and services are used principally by financial institutions, retailers, and e-payment processors, both in domestic and international markets.

The Registrant intends to increase its operations from its core payment processing products, which include: (1)Authorization: transaction fees it receives from processing online point of sale terminal transactions; (2) Sale of Point of Sale Solutions: sales of Point of Sale terminals as well as integrated cash register systems; (3) transaction fees stemming from its Internet Payment Gateway; (4) Dynamic Currency Conversion credit card services to merchants and acquiring banks (the company will provide transaction gateway services and settlement with participating banking institutions); (5) Private Label Cards: transaction management services provided for a private label card issuer; and (6) Consulting Fees: consulting services provided to financial institutions and merchants. The Registrant's revenue for the 12 months ended June 30, 2004 was primarily generated from the transaction fees through its Finland operations.

For the Registrant to derive revenue outside of its Finnish operations, the Registrant first had to perform a major hardware and software upgrade at Rahaxi, as Rahaxi is the core operating system of the Registrant's products. This upgrade was completed in December 2003, and evolved the Registrant's business critical systems to the latest Hewlett-Packard ("HP") NonStop servers and BASE24 e-payment processing software. HP NonStop servers are estimated to run approximately 95% of the world's secure transactions, making the NonStop platform the backbone for the world's most demanding and critical environments and offering the Registrant a secure, continuously available processing

platform. A vastly scalable platform, HP NonStop provides the Registrant with the ability to achieve an adaptive enterprise by enabling it to respond quickly and easily to changing business needs, such as managing the expected growing number of transactions and the need for increased capacity.

BASE24 software from ACI Worldwide provides the Registrant with a fast, powerful authorization system. BASE24 software offers high data integrity for mission-critical environments. ACI and HP have a strong and long-standing relationship in e-payment implementations worldwide.

The new system will enable the Registrant to meet the latest Visa and MasterCard standards and to pave the way for EMV Europay/MasterCard/Visa ("EMV") compliance. The Registrant will also be capable of supporting the latest Visa 3D secure payment technology. EMV is an agreed-upon protocol for the introduction of smart cards. Chip-based bank and payment cards provide a substantial increase in the security of consumer payment transactions, and the Registrant expects it will be the standard throughout Europe by sometime in 2005. EMV is also gaining momentum in Asia and America, and promises complete global interoperability of bankcards for consumers. All payment processors will have to be able to accept payments mediated by smart cards in order to remain competitive, and meeting EMV compliance has major implications for all aspects of the payment handling processes. Management believes that with the company's investment in the upgraded NonStop systems running the newest ACI software, it can meet its projected increasing capacity needs and ensure future volume growth.

The Registrant, under the current management, began generating more revenue since its acquisition of Rahaxi Processing Oy. in January 2003. Its business is rapidly changing, and it expects the coming twelve months to be quite different from the previous twelve months as the company makes ready and further rolls-out its products and services. This process will require the Registrant to react quickly to problems and opportunities as they arise, and may involve costs that it does not currently anticipate. The Registrant also expects that further acquisitions may help it to quickly move forward in achieving its goals.

Management believes that the company's near term growth opportunities will be derived form the European market place and a significant portion of its resources both financial and personnel, will be directed towards developing those opportunities. The Registrant also believes that from a technological infrastructure point of view it will centralize the hosting and development of its processing system in Europe from its operations in Helsinki, Finland.

The Registrant's principal offices are in Santo Domingo, Dominican Republic; the Registrant also has offices in Helsinki, Finland; Dublin, Ireland; and Geneva, Switzerland. While the Registrant's offices in Finland, Ireland and Switzerland will primarily focus on the European market, the company's office in the Dominican Republic will continue to pursue opportunities in the Caribbean and Latin America. Management believes that these emerging markets could offer favorable opportunities in the longer term. The Registrant has initiated discussions with regard to establishing a market for its products in Asia, specifically China; representatives of the company have visited China, the introductions being hosted and arranged by Xinhua Financial Network.

Effective November 8, 2004, the Registrant implemented a one for seven reverse split of its common stock. The company's condensed consolidated financial statements for the three months ended December 31, 2004 reflect the effects of this reverse stock-split. The new trading symbol for the Registrant's common stock as of that date is "FSRT."

RESULTS OF OPERATIONS - THREE MONTHS ENDED DECEMBER 31, 2004 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2003

(a) Revenue.

The Registrant recognized revenue of $424,772 for the three months ended December 31, 2004 compared to $361,431 for the three months ended December 31, 2003, a increase of $63,341 or approximately 18%. The increase was due to an increase in processing fees generated by the Registrant's subsidiary Rahaxi Processing Oy. The Registrant expects this trend to continue throughout the remainder of fiscal 2005 as a continued increase in consumers' preference to use credit and debit cards as against cash will result in increased transactional volume

For the three months ended December 31 ,2004 the Registrant processed 4,285,230 transactions, an increase of 1,127,946, or 33.58%, over the 3,358,284 transactions that were processed in the corresponding period ended December 31,2003.

The Registrant expects revenue levels to increase throughout the next twelve months as the company continues to introduce its service offerings such as EMV transaction processing , the Registrant believes that it will derive a higher price per transaction for processing EMV transactions as compared to non EMV transactions; however, there can be no guarantee that the company's products will be accepted in the marketplace or that its sales efforts will be successful. Please see "Factors That May Affect Operating Results."

The majority of the Registrant's revenue for the three months ended December 31, 2004 was from indirect merchant services, where revenue is generated on services primarily priced on a specified amount per transaction. The company believes that for the remainder of fiscal 2005 it will also begin to derive revenue from direct merchant services which revenue is generated on services primarily priced as a percentage of the transaction value. The majority of the Registrant's revenue for the three months ended December 31, 2003 was also generated from indirect merchant services.

A significant percentage of the Registrant's revenue for the three months ended December 31, 2004 has been derived from a limited number of the company's customers, primarily Finnish customers for its transaction processing products. Approximately 55% of the company's total revenue was attributable to its ten largest customers. The future loss of any major customer could have a material adverse effect on the Registrant's business, financial condition and results of operations. The Registrant believes that this customer concentration will continue for the remainder of fiscal 2005. The Registrant believes that this customer concentration will be diluted in the second half of fiscal 2006 as it pursues operations outside of Finland. The majority of Registrant's revenues for the three months ended December 31, 2004 have been generated by its operations outside of the United States, and the company's future growth rate is, in part,

dependent on continued growth in international markets. The Registrant expects this trend to continue through the remainder of fiscal year 2005.

(b) Cost of Revenue.

Cost of revenue was $258,380 for the three months ended December 31, 2004 compared to $282,776 for the three months ended December 31, 2003, a decrease of $24,396 or approximately 9%. The decrease in cost of revenue is due in part to increased business volume. In addition, the Rahaxi has upgraded both the hardware and software of its processing platform, and these costs are recognized in the cost of revenue for the current period but not the prior period. The Registrant will continue to invest in its technical infrastructure to ensure delivery of cost effective and competitive products to its customers.

Cost of revenue can be expected to increase in the coming twelve months if the company continues its current trend of increasing sales. The Registrant also intends to expand its service offering and its business mix will necessarily change, so that gross margin as a percent of sales may not remain constant.

(c) Non-cash Compensation.

The Registrant recorded non-cash compensation of $692,526 for three months ended December 31, 2004 compared to $611,552 for the three months ended December 31, 2003, an increase of $80,974 or approximately 13%. During the three months ended December 31, 2004, the Registrant charged to operations the amount of $437,236, representing the cost of common stock issued to consultants for services rendered during the period. The Registrant also issued warrants valued at approximately $255,000 and common stock valued at approximately $125,000 to consultants for services.

The Registrant expects non-cash compensation to increase during the coming twelve months. The Registrant's expected continued expansion in its various geographic markets will create a growing need for local consultants and advisors that will be satisfied in large part via non-cash compensation. Management intends to continue to utilize non-cash compensation in order to conserve cash.

(d) Selling, General and Administrative Expenses.

Selling, general, and administrative expenses were $823,317 for the three months ended December 31, 2004 compared to $720,151 for the three months ended December 31, 2003, an increase of $103,166 or approximately 14%. The Registrant continued to add to its product capabilities, with higher values for capitalized software and software licenses generating higher amortization expense. Depreciation expense also increased for similar reasons.

During the three months ended September 30, 2004, the primary components of selling, general, and administrative expenses were: legal and accounting fees of approximately $191,000; payroll and employee costs of approximately $181,000; depreciation and amortization expense of approximately $141,000; facility costs (rent, telephone, utilities, and building maintenance) of approximately $89,000; and consulting fees of approximately $49,000.

The level of future selling, general, and administrative expenses will largely depend on the pace of the Registrant's growth in the market for payment processing products and upon the cost of outside services and professional fees, including legal fees relating to litigation. The company fully expects these costs to increase as it continues its expected rollout of product offerings. In addition, selling expenses will continue to increase due to increased focus on obtaining new customers. The Registrant intends to focus additional resources in the areas of sales personnel salaries, trade show participation, and other promotional expenses. In addition, the Registrant may pursue further acquisitions in order to facilitate its growth and exploit market opportunities, which would further drive up legal and accounting fees, payroll, and travel costs.

(e) Interest Expense.

The Registrant recognized net interest expense of $852 during the three months ended December 31, 2004 compared to interest expense of $15,910 for the three months ended December 31, 2003, a decrease of $15,058 or approximately 95%. Lower interest expense was due to lower levels of debt during the most recent quarter. Pursuant to the vFinance settlement agreement, the Registrant reversed the liability it had recorded to its president in the amount of $679,869, which had been accruing interest on this amount at the rate of 7% per annum.

Currently, the Registrant is utilizing equity financing partly in order to avoid the interest charges associated with debt financing. Accordingly, the Registrant does not expect interest expense to materially increase in the coming twelve months. There can be no guarantee that this will be the case; however, as the market for the Registrant's stock could change, forcing the company to pursue alternative methods of financing the company's cash needs; in addition, the Registrant could receive an offer of attractive debt financing or could undertake additional financing with regard to an acquisition, in which cases interest expense would significantly increase.

(f) Net Loss.

For the reasons stated above, the Registrant recorded a net loss of $1,350,302 for the three months ended December 31, 2004 compared to $1,268,958 for the three months ended December 31 2003, an increase of $81,344 or approximately 6%.

The Registrant may continue to incur losses on both a quarterly and annual basis. In addition, the Registrant expects to continue to incur significant costs of services and substantial operating expenses. Therefore, the Registrant will need to significantly increase revenues to achieve profitability and a positive cash flow. The Registrant may not be able to generate sufficient revenues to achieve profitability. The Registrant expects losses to continue for at least the next twelve months.

The Registrant will attempt to continue to fund its operations through debt and equity financing until it achieves profitability, of which there is no guarantee. The Registrant expects these concerns regarding its perceived viability to continue throughout the fiscal year 2005.

RESULTS OF OPERATIONS - SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2003

(a) Revenue.

The Registrant recognized revenue of $790,724 for the six months ended December 31, 2004 compared to $661,374 for the six months ended December 31, 2003, an increase of $129,350 or approximately 20%. The primary reason for the increase in revenue is directly related to the increase in transactions processed by the Registrant during the period. For the six months ended December 31, 2004, the Registrant processed 8,045,860 transactions, an increase of 1,439,193, or 21.78%, over the 6,606,664 transactions that were processed during the six months ended December 31, 2003.

(b) Cost of Revenue.

Cost of revenue was $428,295 for the six months ended December 31, 2004 compared to $435,435 for the six months ended December 31, 2003, a decrease of $7,140 or approximately 2%. The decrease in cost of revenue is due in part to the Registrant deciding to bring some outsourced fixed cost services, such as its Rahaxi call center, under its own control. The Registrant also gained favorably from the decline in the United States Dollar versus the Euro, as some of its fixed costs related to development are priced in United States dollars and revenue is derived in the Euro.

(c) Non-cash Compensation.

The Registrant recorded non-cash compensation of $1,273,192 for six months ended December 31, 2004 compared to $1,643,408 for the six months ended December 31, 2003, a decrease of $370,216 or approximately 23%. During the six months ended December 31, 2004, the Registrant charged to operations the amount of $1,017,992 representing the fair value of stock issued for services rendered during the period. Also during the six months ended December 31, 2004, the Registrant charged to operations the amount of $255,200 representing the fair value of options and warrants issued to consultants during the period. During the six months ended December 31, 2003, the Registrant issued restricted shares of common stock valued at $1,100,000 to an investment banker for consulting services with regard to with regard to the development and implementation of a plan for the Company's financial structure; there was no such charge during the six months ended December 31, 2004.

(d) Selling, General and Administrative Expenses.

Selling, general, and administrative expenses were $1,415,832 for the six months ended December 31, 2004 compared to $1,315,956 for the six months ended December 31, 2003, an increase of $99,876 or approximately 8%. The Registrant continued to add to its product capabilities, with higher values for capitalized software and software licenses generating higher amortization expense. Depreciation expense also increased for similar reasons.

(e) Interest Expense.

The Registrant recognized net interest expense of $1,904 during the six months ended December 31, 2004 compared to interest expense of $32,461 for the six months ended December 31, 2003, a decrease of $30,557 or approximately 94%. Lower interest expense was due to lower levels of debt during the most recent quarter. Pursuant to the vFinance settlement agreement, the Registrant reversed the liability it had recorded to its president in the amount of $679,869, which had been accruing interest on this amount at the rate of 7% per annum during the six months ended December 31, 2003.

Currently, the Registrant is utilizing equity financing partly in order to avoid the interest charges associated with debt financing. Accordingly, the Registrant does not expect interest expense to materially increase in the coming twelve months. There can be no guarantee that this will be the case; however, as the market for the Registrant's stock could change, forcing the company to pursue alternative methods of financing the company's cash needs; in addition, the Registrant could receive an offer of attractive debt financing or could undertake additional financing with regard to an acquisition, in which cases interest expense would significantly increase.

(f) Net Loss.

For the reasons stated above, the Registrant recorded a net loss of $2,328,498 for the six months ended December 31, 2004 compared to $2,765,886 for the six months ended December 31 2003, a decrease of $437,388 or approximately 16%.

FACTORS THAT MAY AFFECT OPERATING RESULTS.

The operating results of the Registrant can vary significantly depending upon a number of factors, many of which are outside the company's control. General factors that may affect the Registrant's operating results include:

- market acceptance of and changes in demand for products and services;
- a small number of customers account for, and may in future periods account for, substantial portions of the Registrant's revenue, and revenue could decline because of delays of customer orders or the failure to retain customers;
- gain or loss of clients or strategic relationships;
- announcement or introduction of new services and products by the Registrant or by its competitors;
- price competition;
- the ability to upgrade and develop systems and infrastructure to accommodate growth;
- the ability to introduce and market products and services in accordance with market demand;
- changes in governmental regulation; and
- reduction in or delay of capital spending by clients due to the effects of terrorism, war and political instability.

The Registrant believes that its planned growth and profitability will depend in large part on the ability to promote its services, gain clients and expand its relationship with current clients. Accordingly, the Registrant intends to invest in marketing, strategic partnerships, and development of its client base. If the Registrant is not successful in promoting its services and expanding its client base, this may have a material adverse effect on its financial condition and the ability to continue to operate the business.

The Registrant is also subject to the following specific factors that may affect the company's operating results:

(a) Competition.

The market for electronic payment systems and electronic POS systems is intensely competitive and we expect competition to continue to increase. The Registrant's competitors for POS systems include VeriFone and Ingenico amongst others, and companies such as Global Payments, First Data and Euroconnex for the Registrant's electronic payment software. In addition, the companies with whom we have strategic relationships could develop products or services, which compete with the Registrant's products or services. In addition some competitors in the Registrant's market have longer operating histories, significantly greater financial, technical, marketing and other resources, and greater brand recognition than the company does. The Registrant also expects to face additional competition as other established and emerging companies enter the market for electronic payment solutions. To be competitive, the Registrant believes that it must, among other things, invest significant resources in developing new products, improve its current products and maintain customer satisfaction. Such investment will increase the Registrant's expenses and affect its profitability. In addition, if it fails to make this investment, the Registrant may not be able to compete successfully with its competitors, which could have a material adverse effect on its revenue and future profitability

(b) Technological and Market Changes.

The markets in which the Registrant competes are characterized by rapid technological change, frequent new product introductions, evolving industry standards and changing needs of customers. There can be no assurance that the Registrant's existing products will continue to be properly positioned in the market or that the company will be able to introduce new or enhanced products into the market on a timely basis, or at all. Currently, the Registrant is focusing on upgrading and introducing new products. There can be no assurance that enhancements to existing products or new products will receive customer acceptance. As competition in the electronic payments industry increases, it may become increasingly difficult for the company to be competitive.

Risks associated with the development and introduction of new products include delays in development and changes in payment processing, and operating system technologies that could require the Registrant to modify existing products. There is also the risk to the Registrant that there may be delays in initial shipments of new products. Further risks inherent in new product introductions include the uncertainty of price-performance relative to products of competitors, competitors' responses to the introductions and the desire by customers to evaluate new products for longer periods of time.

(c) New Versions of Registrant's Products May Contain Errors or Defects.

The Registrant's electronic payment software products and point of sale devices are complex and, accordingly, may contain undetected errors or failures when first introduced or as new versions are released. This may result in the loss of, or delay in, market acceptance of the Registrant's products. The Registrant has in the past discovered software errors in its new releases and new products after their introduction. The Registrant has experienced delays in release, lost revenues and customer frustration during the period required to correct these errors. The Registrant may in the future discover errors and additional scalability limitations in new releases or new products after the commencement of commercial shipments or be required to compensate customers for such limitations or errors, as a result of which the Registrant's business, cash flow, financial condition and results of operations could be materially adversely affected.

(d) No Assurance of Successful and Timely Product Development.

The Registrant's products and proposed enhancements are at various stages of development and additional development and testing will be required in order to determine the technical feasibility and commercial viability of the products.

There can be no assurance that the Registrant's product development efforts will be successfully completed. The Registrant's proposed development schedule may be affected by a variety of factors, many of which will not be within the control of the Registrant, including technological difficulties, access to proprietary technology of others, delays in regulatory approvals, international operating licenses, and the availability of necessary funding. In light of the foregoing factors, there can be no assurance that the Registrant will be able to complete or successfully commercialize its products. The inability of the Registrant to successfully complete the development of new products or to do so in a timely manner, could force the Registrant to scale back operations, or cease operations entirely.

(e) Market Acceptance.

The Registrant's success is dependent on the market acceptance of its products. Despite the increasing demand for security devices, the Registrant's products represents an advanced approach to the industry, and market acceptance of the company's products will be dependent, among other things, upon its quality, ease of use, speed, reliability, and cost effectiveness. Even if the advantages of the Registrant's products are established, the company is unable . . .