[ Back ]

EDGAR FILINGS

Year 2006 / November 03

FREESTAR TECHNOLOGY CORPORATION (FSRT.OB)

Annual Report

ITEM 6. 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 audited consolidated condensed financial statements and related notes included elsewhere in this Form 10-KSB/A, 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 Company'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 Company intends to increase revenue 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; (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 year ended June 30, 2005 was primarily generated from the transaction fees through its Finland operations.

For the Company to derive revenue outside of its Finnish operations, the Company first had to perform a major hardware and software upgrade at Rahaxi, as Rahaxi is the core operating system of the Company's products. This upgrade was completed in December 2003, and evolved the Company'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 Company a secure, continuously available processing platform. A vastly scalable platform, HP NonStop provides the Company 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 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.

The Company, 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 Company to react quickly to problems and opportunities as they arise, and may involve costs that it does not currently anticipate. The Company 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 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 Santo Domingo, Dominican Republic; Helsinki, Finland; Stockholm, Sweden; and Geneva, Switzerland. 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. 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 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.

(a) Revenue.

The Company reported revenue of $1,602,819 for the year ended June 30, 2005 compared to $1,333,826 for the year ended June 30, 2004, an increase of $268,993 or approximately 20%. The increase was due to an increase in processing fees generated by the Company's subsidiary, Rahaxi Processing Oy. The Company expects this trend to continue throughout 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 year ended June 30, 2005, the Company processed approximately 15,480,000 transactions, an increase of 2,426,000, or approximately 18.6%, over the approximate 13,054,000 transactions that were processed in the year ended June 30, 2004.

The Company expects revenue levels to increase throughout the next twelve months as it continues to introduce its service offerings and increases it client base , such as EMV transaction processing and its Internet Payment Gateway. The Company 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."

All of the Company's revenue for the year ended June 30, 2005 was from fees it received from processing Point of Sale transactions, where revenue is generated from services which are priced on a specified amount per transaction. The Company believes that for fiscal 2006 it will also begin to derive revenue from its other transaction processing related service offerings.

All of the Company's revenue for the year ended June 30, 2005 has been derived from a limited number of its 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 Company's business, financial condition and results of operations. The Company believes that this customer concentration will continue for much of fiscal 2006. The Company 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 Company's revenues for the twelve months ended June 30, 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 this trend to continue through fiscal year 2006.

(b) Cost of Revenue.

Cost of revenue was $1,695,069 for the year ended June 30, 2005 compared to $1,584,852 for the year ended June 30, 2004, an increase of $110,217 or approximately 7%. Cost of revenue increased in the current year compared to the prior year because of the increased levels of support needed for extra business that was generated during the year. Approximately $404,163 of the cost of revenue is attributed to the amortization of capitalized software; this cost will not increase directly with an increase in sales, but will only increase as the Company adds to or improves its operating software.

Cost of revenue can be expected to increase in the coming year 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; for this reason, gross margin as a percent of sales may not remain constant. The fixed portion of cost of revenue attributable to the amortization of software costs will become smaller as a percentage of sales if sales continue to increase, thus increasing the Company's operating margin.

(c) Selling, General and Administrative Expenses.

Selling, general and administrative expenses ("SG&A") were $21,299,941 for the year ended June 30, 2005 as compared to $6,774,623 for the year ended

June 30, 2004, an increase of $14,525,318 or approximately 214%. During the year ended June 30, 2005, the Company completed the long-term incentive compensation package for its senior executives consisting of 20,000,000 shares of restricted common stock valued at $4,600,000; 1,500,000 shares of Series B Preferred stock valued at $4,140,000; and options to purchase 5,000,000 shares of common stock at price of $0.01 per share, valued at $1,100,000, and options to purchase 500,000 shares of common stock at a price of $0.15 per share, valued at $125,000. The Company also forgave the conversion cost of $50,000 related to 5,000,000 of these options. The Company also issued options and warrants valued at $647,150 to a corporation pursuant to an agreement to undertake joint product development. The Company also charged to operations the amount of $2,434,628 representing the cost of 2,629,802 shares of stock which have been issued and which the Company intends to recover, and consulting fees in the amount of $5,832,348. Other primary components of SG&A were: depreciation and amortization of approximately $241,345 as the Company continued to add to its infrastructure; payroll expenses of approximately $776,955; legal and accounting fees of approximately $318,259, primarily due to ongoing litigation; travel and entertainment costs of approximately $394,538 due to the focus on its Finland subsidiary and the Finnish market; facilities expense (rent, telephone, utilities, and building maintenance) of approximately $290,022; a credit to merchant services of approximately $80,600 as the Company received a refund of a prior period payment; and other professional services of $59,229.

The rate of future SG&A 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 and acquisitions. 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) Loss on Investment

Loss on investment was $0 for the year ended June 30, 2005, compared to $100,000 for the year ended June 30, 2004.

During the year ended June 30, 2004, the Company advanced cash in the amount of $25,000 to Unipay, Inc., a potential acquisition target. In June 2004, the Company made the decision not to pursue Unipay, Inc. as an acquisition candidate and wrote-off the $25,000 advance to loss on investment in the consolidated statement of operations for the year ended June, 2004.

On June 17, 2004, the Company terminated the TransAxis acquisition agreement and wrote-off a Note Receivable from TransAxis, Inc. in the amount of $75,000 as loss on investment in the consolidated statement of operations for the year ended June 30, 2004.

(e) Gain on Settlement

Gain on legal settlement was $350,000 for the year ended June 30, 2005, compared to $825,459 for the year ended June 30, 2004.

In December 2002, a lender group exercised their rights against 14,400,000 shares pledged by the president of the Company in full satisfaction of outstanding notes payable to this lender group of $637,000, interest payable of $18,569, and accrued penalties of $24,300 totaling $679,869.

In March 2004, this lender group entered into a settlement agreement with the Company (see "Legal Proceedings"). As part of the settlement, this lender group returned the 14,400,000 pledged shares to the president of the Company and the Company is relieved from any other indebtedness to this lender group. Prior to this settlement, the Company considered the notes payable of $679,869 and related interest of $47,590 totaling $727,459 payable to the president related to the his 14,400,000 shares given to this lender group.

In addition, this lender group returned 1,000,000 shares to the Company that was issued to this lender group as collateral for borrowings in June 2002. The Company recorded an additional gain on legal settlement at cost based on the date of the issuance, or $98,000.

Thus, the Company recognized a gain on the settlement of the vFinance lawsuit of $825,459 during the year ended June 30, 2004.

(f) Cost of Legal Settlement.

During the year ended June 30, 2005, the Company charge to operations the amount of $1,032,289 representing the cost of settling a legal dispute. This amount consists of warrants with a fair value of $431,717 and a convertible note payable with a fair value, net of the discount associated with the beneficial conversion feature, of $600,572. There were no such charges during the comparable period of the prior year.

(g) Interest Expense.

The Company recognized net interest expense (net) of $26,774 during the year ended June 30, 2005 compared to $35,083 for the year ended June 30, 2004, a decrease of $8,309 or approximately 24%. The reason for this decrease is lower borrowings during the year ended June 30, 2005. The Company had outstanding convertible debentures of approximately $600,000 during the year ended June 30,

2003 that were settled with common stock personally owned by the president of the Company. The Company recorded a liability to its president in the amount of $679,869 and accrued interest on this amount at the rate of 7% per annum in 2003. This liability was eliminated during the year ended June 30, 2004, pursuant to the vFinance settlement agreement. Also, during the year ended June 30, 2004, the Company had reduced balances due to related parties for amounts advanced to the Company. In addition, during the year ended June 30, 2003, interest expense included substantially higher interest charges for the convertible debentures, including amortization of an amount attributable to the beneficial conversion feature of those instruments.

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 year. There can be no guarantee that this will be the case; however, as the market for the Company's stock could change, forcing the Company 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.

(h) Net Loss.

For the reasons stated above, the Company recorded a net loss of $22,102,463 for the year ended June 30, 2005 as compared to $6,335,273 for the year ended June 30, 2004, an increase of $15,767,190 or approximately 249%.

The Company may continue to incur losses on both a quarterly and annual basis. 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.

Commitments.

The Company's total commitments under non-cancelable operating leases at June 30, 2005 are as follows:

Factors That May Affect Operating Results.

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

o market acceptance of and changes in demand for products and services;

o a small number of customers account for, and may in future periods account for, substantial portions of the Company's revenue, and revenue could decline because of delays of customer orders or the failure to retain customers;

o gain or loss of clients or strategic relationships;

o announcement or introduction of new services and products by the Company or by its competitors; o price competition;

o the ability to upgrade and develop systems and infrastructure to accommodate growth;

o the ability to introduce and market products and services in accordance with market demand;

o changes in governmental regulation; and

o reduction in or delay of capital spending by clients due to the effects of terrorism, war and political instability.

The Company 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 Company intends to invest in marketing, strategic partnerships, and development of its client base. If the Company's 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 Company's 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 Company's competitors for POS systems include VeriFone and Ingenico, amongst others, and companies such as Global Payments, First Data and Euroconnex for the Company's electronic payment software. In Finland the company faces competition

from companies such as Point, which is the largest terminal vendors in the Finnish market, as well as companies such as Screenway and Altdata, which are Point of Sale software vendors. In addition, the companies with whom we have strategic relationships could develop products or services, which compete with the Company's products or services. In addition some competitors in the Company's market have longer operating histories, significantly greater financial, technical, marketing and other resources, and greater brand recognition than the Company does. The Company also expects to face additional competition as other established and emerging companies enter the market for electronic payment solutions. To be competitive, the Company 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 Company's expenses and affect its profitability. In addition, if it fails to make this investment, the Company 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 Company 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 Company'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 Company 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 Company to modify existing products. There is also the risk to the Company 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 Company's Products May Contain Errors or Defects.

The Company'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 Company's products. The Company has in the past discovered software errors in its new releases and new products after their introduction. The Company has experienced delays in release, lost

revenues and customer frustration during the period required to correct these errors. The Company 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 Company'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 Company'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 Company's product development efforts will be successfully completed. The Company's proposed development schedule may be affected by a variety of factors, many of which will not be within the control of the Company, 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 Company will be able to complete or successfully commercialize its products. The inability of the Company to successfully complete the development of new products or to do so in a timely manner, could force the Company to scale back operations, or cease operations entirely.

(e) Market Acceptance.

The Company's success is dependent on the market acceptance of its products. Despite the increasing demand for security devices, the Company'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 Company's products are established, the Company is unable to predict how quickly, if at all, the products will be accepted by the marketplace.

(f) Protection of Proprietary Rights.

The Company's success and ability to compete will be dependent in part on the protection of its potential patents, trademarks, trade names, service marks and other proprietary rights. The Company intends to rely on trade secret and copyright laws to protect the intellectual property that it plans to develop, but there can be no assurance that such laws will provide sufficient protection to the Company, that others will not develop a service that are similar or superior to the Company's, or that third parties will not copy or otherwise obtain and use the Company's proprietary information without authorization. In addition, certain of the Company's know-how and proprietary technology may not be patentable.

The Company may rely on certain intellectual property licensed from third parties, and may be required to license additional products or services in the future, for use in the general operations of its business plan. There can be no assurance that these third party licenses will be available or will continue to be available to the Companion acceptable terms or at all. The inability to enter into and maintain any of these licenses could have a material adverse . . .