FORM 10QSB | Edgar Filings | Freestar Technology Corporation

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 Company's financial condition and results of operations is based upon, and should be read in conjunction with, its condensed consolidated financial statements and related notes included elsewhere in this Form 10-QSB.

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 per day, seven days per week.

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

The Company intends to derive revenues from its core payment processing products, which include: (1) Authorization: transaction fees it receives from processing online point of sale terminal transactions; (2) Point of Sale: sales of "Point of Sale" terminals; (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 Company's revenue for the three months ended December 31, 2005 was primarily generated from the transaction and consulting fees through its Finland operations.

BASE24 software from ACI Worldwide provides the Company 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 Company to meet the latest Visa and MasterCard standards and to pave the way for EMV Europay/MasterCard/Visa ("EMV") compliance. The Company 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. EMV is also gaining momentum in Asia and America, and may help bring about 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.

Management believes that the Company's near term growth opportunities will be derived from the European market place and a significant portion of its resources, both financial and personnel, will be directed towards developing those opportunities. The Company 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 Company's principal offices are in Dublin, Ireland. The Company also has offices in Helsinki, Finland; Stockholm, Sweden; Geneva, Switzerland; and Santo Domingo, the Dominican Republic. While the Company's offices in Finland, Sweden, 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, although no revenues are anticipated from such markets within the next 12 months. The Company has initiated discussions with regard to establishing a market for its products in Asia, specifically China.

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

Results Of Operations

THREE MONTHS ENDED DECEMBER 31, 2005 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2004

(a) REVENUE

The Company had revenue of $577,946 for the three months ended December 31, 2005 compared to $424,772 for the three months ended December 31, 2004, an increase of $153,174 or approximately 36%. The substantial majority of the increase was due primarily to the generation of consulting and development fees by the Company's

subsidiary, Rahaxi Processing Oy. The other reason for the increase in revenue was an increase in transaction processing fees by Rahaxi due to an increased volume of transactions processed. The Company expects the trend of increased processing fees to continue throughout the remainder of fiscal 2006 with the addition of new clients and 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, 2005, the Company processed 4,827,103 transactions, an increase of 541,873 or approximately 13%, over the 4,285,230 transactions that were processed in the corresponding period ended December 31, 2004.

During the three months ended December 31, 2005, the Company derived revenues of $130,668 from development and consulting services supplied to clients. The Company did not receive such fees during the comparable period ended December 31, 2004. The Company expects to receive further revenue from consulting and development fees throughout the remainder of fiscal 2006.

The Company expects revenue levels to increase throughout the next twelve months as it continues to introduce its service offerings, such as EMV transaction processing and its Internet Payment Gateway. In addition, the Company believes that it will derive further revenue from the sale of Point Of Sale terminals through its relationships with Hypercom and Global Refunds. 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."

A significant percentage of the Company's revenue for the three months ended December 31, 2005 has been derived from a limited number of its customers, primarily Finnish customers for its transaction processing products. Approximately 56% of the Company's total revenues were attributable to its ten largest customers. The Company derived additional revenue from clients outside of Finland during the three months ended December 31, 2005; this revenue accounted for approximately 24% of total revenue for the period. The Company did not obtain revenue outside of Finland during the three months ended December 31, 2004. The future loss of any major customer could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that this customer concentration will continue for the remainder of fiscal 2006, but will gradually start to be diluted beginning in the second half of fiscal 2006 as it continues to pursue operations outside of Finland.

The majority of Company's revenues for the three months ended December 31, 2005 have been generated by its operations outside of the United States, and its future growth rate is, in part dependent on continued growth in international markets. The Company expects the majority of its revenues to continue to be generated outside of the U.S. through the remainder of fiscal year 2006. (The Company's fiscal year 2006 runs from July 1, 2005 through June 30, 2006).

(b) COST OF REVENUE

Cost of revenue was $348,941 for the three months ended December 31, 2005, compared to $258,380 for the three months ended December 31, 2004, an increase of $90,561 or approximately 35%. The increase in cost of revenue is due in part to continued investment in the Company's technical infrastructure and hiring of additional staff.

Cost of revenue can be expected to increase in the coming twelve months if the Company continues its current trend of increasing sales. The Company 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.

Selling, general and administrative expenses were $1,979,927 for the three months ended December 31, 2005 compared to $1,515,843 for the three months ended December 31, 2004, an increase of $464,084 or approximately 31%. During the three months ended December 31, 2005, the primary components of selling, general, and administrative expenses were: consulting fees of $914,172, of which $685,231 were non-cash costs; payroll and related costs of $366,174; depreciation and amortization of $158,628; legal and accounting fees of $157,652; travel and entertainment costs of $138,666; facility costs, such as rent, telephone, and utilities, of $99,692; recruiting costs of $36,339; professional services of $27,042; and investor relations costs of $26,400.

The level of future selling, general and administrative expenses will largely depend on the pace of the Company'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 Company intends to focus additional resources in the areas of sales personnel salaries, trade show participation, and other promotional expenses. In addition, the Company 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.

(d) INTEREST EXPENSE

The Company had net interest expense of $18,475 during the three months ended December 31, 2005 compared to net interest expense of $852 for the three months ended December 31, 2004, an increase of $17,623 or approximately 2068%. Higher interest expense was due primarily to amortization of the discount on notes payable in the amount of $12,487.

Currently, the Company is utilizing equity financing partly in order to avoid the interest charges associated with debt financing. Accordingly, the Company 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 price for the Company's common stock could change, forcing it to pursue alternative methods of financing the Company's cash needs. In addition, the Company 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.

(e) NET LOSS

For the reasons stated above, the Company recorded a net loss of $1,769,178 for the three months ended December 31, 2005 compared to $1,350,303 for the three months ended December 31, 2004, an increase of $418,875 or approximately 31%. The increased loss is primarily due to the increase in sales, general, and administrative expenses for the period. The Company may continue to incur losses on both a quarterly and annual basis, and anticipates continued losses for at least the next 12 months. In addition, the Company expects to continue to incur significant costs of services and substantial operating expenses. Therefore, the Company will need to significantly increase revenues to achieve profitability and a positive cash flow. The Company may not be able to generate sufficient revenues to achieve profitability. The Company expects losses to continue for at least the next twelve months.

The Company will attempt to continue to fund its operations through debt and equity financing until it achieves profitability, of which there is no guarantee. The Company expects these concerns regarding its perceived viability to continue throughout the fiscal year 2006.

SIX MONTHS ENDED DECEMBER 31, 2005 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2004

(a) REVENUE

The Company had revenue of $1,180,694 for the six months ended December 31, 2005 compared to $790,724 for the six months ended December 31, 2004, an increase of $389,970 or approximately 49%. The substantial majority of the increase was due primarily to the generation of consulting fees by the Company's subsidiary, Rahaxi Processing Oy. The other reason for the increase in revenue was an increase in transaction processing fees by Rahaxi. The Company expects this trend to continue throughout the remainder of fiscal 2006 with the addition of new clients and a continued increase in consumers' preference to use credit and debit cards as against cash, will result in increased transactional volume

For the six months ended December 31, 2005, the Company processed 9,215,641 transactions, an increase of 1,169,781 or approximately 15% over the 8,045,860 transactions that were processed in the corresponding period ended December 31, 2004.

During the six months ended December 31, 2005 the Company derived revenues of $304,300 from development and consulting services supplied to clients. The Company did not receive such fees during the comparable period ended December 31, 2004. The Company expects to receive further revenue from consulting and development fees throughout the remainder of fiscal 2006.

(b) COST OF REVENUE

Cost of revenue was $762,752 for the six months ended December 31, 2005, compared to $428,295 for the six months ended December 31, 2004, an increase of $334,457 or approximately 78%. The increase in cost of revenue is due in part to continued investment in the Company's technical infrastructure and hiring of additional staff.

Selling, general and administrative expenses were $3, 089,126 for the six months ended December 31, 2005 compared to $2,689,024 for the six months ended December 31, 2004, an increase of $400,102 or approximately 15%. During the six months ended December 31, 2005, the primary components of selling, general, and administrative expenses were: consulting fees of $1,563,047, of which $1,271,379 were non-cash costs; payroll and related costs of $624,484; depreciation and amortization of $305,154; travel and entertainment costs of $253,435; legal and accounting fees of $221,034; facility fees, such as rent, telephone, and utilities, of $188,893; and fees for professional services of $60,821; recruiting costs of $36,339; and investor relations costs of $26,400. The Company also credited to selling, general, and administration expenses the amount of $263,349 representing the original issuance cost of shares issued to consultants in prior periods, which have been returned to the Company and cancelled.

(d) INTEREST EXPENSE

The Company had net interest expense of $37,246 during the six months ended December 31, 2005 compared to net interest expense of $1,904 for the six months ended December 31, 2004, an increase of $35,342 or approximately 1856%. Higher interest expense was due primarily to amortization of the discount on notes payable in the amount of $24,727.

(e) NET LOSS

For the reasons stated above, the Company recorded a net loss of $2,706,207 for the six months ended December 31, 2005 compared to $2,328,499 for the six months ended December 31, 2004, an increase of $377,708 or approximately 16%. The increased loss is primarily due to the increase in sales, genereal, and Administrative expenses.

OPERATING ACTIVITIES

The net cash used in operating activities was $1,773,872 for the six months ended December 31, 2005 compared to $642,956 for the six months ended December 31, 2004, an increase of $1,130,916 or approximately 176%. Cash used in operating activities during the six months ended December 31, 2005 is attributable primarily to the net loss of $2,669,922 partially offset by non-cash charges of $1,235,094 (net of $263,349 for stock returned to the Company and cancelled) and $305,153 of depreciation and amortization. Cash from operating activities was also decreased by $666,701 due to changes in the components of working capital.

INVESTING ACTIVITIES

Net cash used in investing activities was $350,858, which was an increase of $82,885 or approximately 31% compared to cash used in investing activities of $267,973 for the six months ended December 31, 2004. This increase was primarily due to decreased investing by the Company in software and capitalized software costs.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2005, the Company had total current assets of $1,214,368 and total current liabilities of $1,941,927, resulting in a working capital deficit of $727,559. The Company had cash and cash equivalents of $627,394 at December 31, 2005. As of December 31, 2005, the Company had an accumulated deficit of $46,820,149. These factors raise substantial doubt as to the Company's ability to continue as a going concern. The independent auditors report on our June 30, 2005 financial statements included in the Form 10-KSB states that our difficulty in generating sufficient cash flow to meet our obligations and sustain operations raise substantial doubts about the our ability to continue as a going concern.

The accompanying financial statements have been prepared assuming that the Company continues as a going concern that contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, the ability of the Company to continue as a going concern on a longer-term basis will be dependent upon its ability to generate sufficient cash flow from operations to meet its obligations on a timely basis, to obtain additional financing, and ultimately, attain profitability.

Management plans to continue raising additional capital through a variety of fund raising methods during fiscal 2006 and to pursue all available financing alternatives in this regard. Management may also consider a variety of potential partnership or strategic alliances to strengthen its financial position. Whereas the Company has been successful in the past in raising capital, no assurance can be given that these sources of financing will continue to be available to us and/or that demand for our equity/debt instruments will be sufficient to meet our capital needs, or that financing will be available on terms favorable to the Company. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. If funding is insufficient at any time in the future, the Company may not be able to take advantage of business opportunities or respond to competitive pressures, or may be required to reduce the scope of its planned product development and marketing efforts, any of which could have a negative impact on its business and operating results. In addition, insufficient funding may have a material adverse effect on the Company's financial condition, which could require the Company to:

- curtail operations significantly;

- sell significant assets;

- seek arrangements with strategic partners or other parties that may require the Company to relinquish significant rights to products, technologies or markets; or

- explore other strategic alternatives including a merger or sale of the Company.

To the extent that the Company raises additional capital through the sale of equity or convertible debt securities, the issuance of such securities may result in significant dilution to existing stockholders. If additional funds are raised through the issuance of debt securities, these securities may have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictions on the Company's operations. Regardless of whether the Company's cash assets prove to be inadequate to meet the Company's operational needs, the Company may seek to compensate providers of services by issuance of stock in lieu of cash, which may also result in dilution to existing shareholders.

The Company has been successful in obtaining cash resources through private placements and the exercise of options. Financing activities provided cash of $2,125,277 during the six months ended December 31, 2005 compared to $988,500 for the six months ended December 31, 2004, an increase of $1,136,777 or approximately 115%. During the six months ended December 31, 2005, the Company received $1,000,000 in cash from the sale of common stock, and $1,212,493 from the exercise of stock options.

On January 27, 2006, the Company signed subscription agreements with a group of offshore investors ("Investors") for the sale of an aggregate of $9.2 million in Company common stock, plus warrants (the "Financing").

The Company will issue 46 million newly issued shares of restricted common stock under Regulation S at $0.20 per share, plus warrants to purchase 50 million shares of Company common stock with two-year exercise periods and strike prices ranging from $1.50 to $8.50. Pursuant to the terms of the Financing, the Company will issue all 46 million shares immediately, which will be held in escrow by Carl Hessel ("Escrow Agent"), a director and major stockholder of the Company based in Gevena, Switzerland, along with the warrants. The Investors are to make the first payment of $4.6 million dollars within 7 days of the issuance of the shares and a second payment of $4.6 million dollars within four months thereafter. One-half of the shares and warrants will be released by the Escrow Agent to the Investors upon receipt of the first payment and the second half of the shares and warrants will be released by the Escrow Agent upon receipt of the second payment from the Investors. If any Investor fails to make the required payments, such Investor's portion of the shares and warrants will be returned to the Company by the Escrow Agent for cancellation.

As of February 20, 2006, the Company had received approximately $4,600,000 in the form of proceeds or confirmed commitments in connection with this offering.

CERTAIN INDEBTEDNESS

Paul Egan has advanced funds to the Company for its operations. These amounts include net advances of $65,551 and accrued interest of $20,972 at December 31, 2005.

Ciaran Egan has advanced funds to the Company for its operations. These amounts include net advances of $5,576 and accrued interest of $1,185 at December 31, 2005.

The Company expects to repay these amounts as soon as sufficient cash flow from operations is generated. Interest on the unpaid balances is accrued at the rate of 7% per annum.

ACCRUED SALARIES

The Company's president, Paul Egan, who is also a shareholder, has delayed payment of a portion of his salary in order to conserve the Company's cash. At December 31, 2005, the Company had recorded the amount of $10,753 in accrued salary due to Mr. Egan. This amount is shown as Due to Related Parties in the accompanying Condensed consolidated Balance Sheet as of December 31, 2005.

The Company's chief financial officer, Ciaran Egan, who is also a shareholder, has delayed payment of a portion of his salary in order to conserve the Company's cash. At December 31, 2005, the Company had recorded the amount of $22,800 in accrued salary due to Mr. Egan. This amount is shown as Due to Related Parties in the accompanying unaudited Condensed consolidated Balance Sheet as of December 31, 2005.

EXCHANGE RATES

The Company's operations are principally in Helsinki, Finland under the name of Rahaxi Processing Oy., operated in its local currency, the Euro, and in Dominican Republic under the name ePayLatina S.A., operated in its local currency, the Dominican Republic Peso. All assets and liabilities are translated at exchange rates in effect at the end of the year. Accounts for consolidated statements of operations are translated at weighted average rates for the year. Gains and losses from translation of foreign currency financial statements into U.S. dollars are included in Other - comprehensive income (loss). The accumulated foreign currency translation adjustment was $(91,561) at December 31, 2005.

Any significant change in exchange rates may have a favorable or negative effect on both the revenues and operational costs of the Company. In particular, the value of the U.S. dollar to the Euro impacts the Company's operating results. The Company's expenses are not necessarily incurred in the currency in which revenue is generated, and, as a result, it is required from time to time to convert currencies to meet the Company's obligations. In addition, a significant portion of the Company's financial statements are prepared in Euro and translated to U.S. dollars for consolidation.

INFLATION

The impact of inflation on the costs of the Company, and the ability to pass on cost increases to its customers over time is dependent upon market conditions. The Company is not aware of any inflationary pressures that have had any significant impact on the Company's operations over the past quarter, and the Company does not anticipate that inflationary factors will have a significant impact on future operations.

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not maintain off-balance sheet arrangements nor does it participate in non-exchange traded contracts requiring fair value accounting treatment.

OTHER

The Company does not provide post-retirement or post-employment benefits requiring charges under Statements of Financial Accounting Standards No. 106 and No. 112.

CRITICAL ACCOUNTING POLICIES

The SEC has issued Financial Reporting Release No. 60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of a Company's financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Company's most critical accounting policies include: (a) use of . . .