FORM 10QSB | Edgar Filings | Freestar Technology Corporation

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 electronic payment transaction industry is composed of debit and credit card issuers, switch interchanges, transaction acquirers and transaction generators, including Automated Teller Machine networks, retail merchant locations and the Internet. The routing, control and settlement of electronic 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 must be conducted 24 hours a day, seven days a week.

Our products and services are primarily focused on facilitating electronic card payment transactions. These products and services are used principally by financial institutions, retailers, and payment processors, in international markets.

We intend to increase revenue from our core payment processing products, which include: (1) Authorization: transaction fees derived from processing point of sale terminal transactions, including EMV-compliant transactions; (2) Dynamic Currency Conversion support services: fees for facilitating real-time currency conversion and transaction authorization and settlement services for merchants and acquiring banks; (3) Consulting and Software Development Fees: consulting services and customized software development provided to financial institutions and merchants; (4) Sale of Point of Sale solutions: sales of point of sale terminals; (5) Internet Payment Gateway: transaction fees from processing internet transactions through our Internet Payment Gateway; and (6) Private Label Cards: transaction management services provided for a private label card issuer. Our revenue for the quarter ended December 31, 2006 was primarily generated from transaction fees through our Finland operations.

We are continuously reviewing our product and service offerings to ensure that we maintain our competitive position in our target markets. Subsequent to our systems upgrade in December 2003 to the latest Hewlett-Packard NonStop servers and BASE24 e-payment processing software, the company has continued to invest heavily in its technical infrastructure in order to meet the highest industry standards. The company believes that this continued investment in our technical infrastructure would enhance our position in the market place ensuring that our product offerings are attractive to both our existing and potentially new clients alike.

Our business is continually evolving. Market conditions may require us to react quickly to problems and opportunities as they arise, and we may incur costs that we do not currently anticipate. Our business strategy to maximize growth and shareholder value may include future strategic acquisitions where we believe such acquisitions will help us quickly move forward in achieving our goals.

Management believes that our primary short-term growth opportunities will be derived from the European marketplace and a significant portion of our resources, both financial and personnel, will be directed towards developing those opportunities. We believe that our anticipated growth and ultimate profitability will depend in large part on the ability to promote our services, gain clients and expand our relationship with current clients. Accordingly, we intend to invest in marketing, strategic relationships, and development of our client base.

The Company's revenue for the three months ended December 31, 2006 was primarily generated from the transaction processing fees through our Finland operations. During the three months ended December 31, 2006, the Company also began recognizing consulting revenue from its interest in Project Life Cycle Partners, Ltd. ("PLC Partners"). The Company acquired a 50% interest in PLC Partners during the three months ended December 31, 2006. PLC Partners is a technology consulting firm located in Dublin, Ireland, and provides niche project consulting services in the management and implementation of information systems projects. PLC Partners has international experience within the financial services sector. Also during the three months ended December 31, 2006, the Company began generating revenue from the sale of Point of Sale transaction processing terminals shipped from our warehouse in Finland.

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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. The Company has achieved certification to become a third party services provider for China Union Pay.

Results Of Operations

THREE MONTHS ENDED DECEMBER 31, 2006 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2005

(a) REVENUE

The Company had revenue of $811,902 for the three months ended December 31, 2006 compared to $577,946 for the three months ended December 31, 2005, an increase of $233,956 or approximately 40%. The increase was due primarily to revenue derived from the Company's acquisition of a 50% interest in PLC Partners. The Company also began selling its transaction processing terminals during the three months ended December 31, 2006. The Company's anticipates increased shipments of its terminals throughout the remainder of fiscal 2007.

For the three months ended December 31, 2006, the Company processed 4,827,103 transactions, an increase of 529,415 or approximately 9.6%, over the 4,827,103 transactions that were processed in the corresponding period ended December 31, 2005.

The Company expects the trend of increased processing fees to continue throughout the remainder of fiscal 2007 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. The Company expects revenue levels to increase throughout the next twelve months as it continues to introduce its service offerings, such as EMV compliant transaction processing. In addition, the Company believes that it will derive further revenue from the sale of Point Of Sale terminals through its relationships with Hypercom, Global Refunds and Thyron. The Company has placed orders for in excess of 1,500 point of sale terminals from vendors such as Hypercom and Thyron, and the Company expects to sell these terminals to its clients and resellers during the remainder of fiscal 2007. 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, 2006 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 revenues were 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 the remainder of fiscal 2007, but will gradually start to be diluted beginning at the end of the second half of fiscal 2007 and into fiscal 2008 as it continues to pursue operations outside of Finland. The Company is currently pursuing opportunities in several European countries through our relationship with Global Refunds. Initial pilot terminals have been deployed in Spain. The pilot program has been successful and the Company expects to deploy additional terminals in Spain and other countries through the remainder of fiscal 2007. Through our relationship with Hypercom, we have also identified opportunities for terminal deployment in the Dominican Republic and Sweden. The Company is also vigorously active in establishing relationships with acquiring banks in Europe after achieving certification of its payment gateway from China Union Pay. The certification means European bank acquirers will be able to process CUP transactions at their merchant terminals and at their ATMs. This allows Chinese visitors to use their CUP credit and debit cards during their visits to Europe.

All of Company's revenues for the three months ended December 31, 2006 have been generated by our operations outside of the United States, and our future growth rate is dependent on continued growth in international markets. The Company expects all of our revenue to continue to be generated outside of the U.S. through the remainder of fiscal year 2007.

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(b) COST OF REVENUE

Cost of revenue was $887,309 for the three months ended December 31, 2006, compared to $444,816 for the three months ended December 31, 2005, an increase of $442,493 or approximately 99%. The increase in cost of revenue is due primarily to increased sales, as well as 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 our current trend of increasing the number of transactions processed. The Company also intends to expand our 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 $ 3,054,011 for the three months ended December 31, 2006 compared to $1,884,052 for the three months ended December 31, 2005, an increase of $1,169,959 or approximately 62%. During the three months ended December 31, 2006, the primary components of selling, general, and administrative expenses were: consulting fees of $1,552,352 of which $1, 218,794 were non-cash costs; payroll and related costs of $819,113; facility costs, such as rent, telephone, and utilities, of $214,345; travel and entertainment costs of $128,580; legal and accounting fees of $106,466; depreciation and amortization of $86,331; and professional services of $49,271. The components of selling, general and administrative costs that increased most significantly during the quarter ended December 31, 2006, compared to the quarter ended December, 31, 2005 were consulting fees, which increased by $638,180 or 70% and payroll and related costs, which increased by $452,939 or 124%.

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 income of $791 during the three months ended December 31, 2006 compared to net interest expense of $18,475 for the three months ended December 31, 2005, a decrease of $17,684. Lower interest expense was due to a decrease in the company's debt.

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) INCOME TAXES

The Company recognized income taxes expense of $7,961during the three months ended December 31, 2006, compared to income tax expense of $0 during the prior year. The increase was due to income taxes paid in Ireland by the Company's new subsidiary, PLC Partners.

(f) MINORITY INTEREST IN NET LOSS OF SUBSIDIARY

The Company recorded the minority interest in the net loss of its subsidiary PLC Partners, Ltd. of $13,712 during the three months ended December 31, 2006. There was no such comparable minority interest during the prior year period.

(g) NET LOSS

For the reasons stated above, the Company recorded a net loss of $3,124,457 for the three months ended December 31, 2006 compared to $1,769,178 for the three months ended December 31, 2005, an increase of $1,355,279 or approximately 77%. The increased loss is primarily due to the increase in sales, general, and administrative expenses for the period, as well as the decreased margins on sales. 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.

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The Company will attempt to continue to fund its operations primarily through equity financing, and possibly debt financing, until it achieves profitability, of which there is no guarantee. The Company expects these concerns regarding its perceived viability to continue throughout fiscal year 2007.

SIX MONTHS ENDED DECEMBER 31, 2006 COMPARED SIX MONTHS ENDED DECEMBER 31, 2005

(a) REVENUE

The Company had revenue of $1,273,762 for the six months ended December 31, 2006 compared to $1,180,694 for the six months ended December 31, 2005, an increase of $93,068 or approximately 7%. The increase was due primarily to sales derived from the Company's acquisition of a 50% interest in PLC Partners. The Company also began selling its transaction processing terminals during the three months ended December 31, 2006. The Company's anticipates increased shipments of its terminals throughout the remainder of fiscal 2007.

For the six months ended December 31, 2006, the Company processed 10,210,002 transactions, an increase of 994,361 or approximately 10.8%, over the 9,215,641 transactions that were processed in the corresponding period ended December 31, 2005.

The Company expects the trend of increased processing fees to continue throughout the remainder of fiscal 2007 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. 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 , Global Refunds and Thyron. The Company has placed orders for in excess of 2000 point of sale terminals from vendors such as Hypercom and Thyron, and the Company expects to sell these terminals to its clients during the remainder of fiscal 2007.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 six months ended December 31, 2006 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 revenues were 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 the remainder of fiscal 2007, but will gradually start to be diluted beginning at the end of the second half of fiscal 2007 and into fiscal 2008 as it continues to pursue operations outside of Finland. The Company is currently pursuing opportunities in several European countries through our relationship with Global Refunds. Initial pilot terminals have been deployed in Spain. The pilot program has been successful and the Company expects to deploy additional terminals in Spain and other countries through the remainder of fiscal 2007. Through our relationship with Hypercom, we have also identified opportunities for terminal deployment in the Dominican Republic and Sweden. The Company is also vigorously active in establishing relationships with acquiring banks in Europe after achieving certification of its payment gateway from China Union Pay.

All of the Company's revenues for the six months ended December 31, 2006 have been generated by our operations outside of the United States, and our future growth rate is dependent on continued growth in international markets. The Company expects all of our revenue to continue to be generated outside of the U.S. through the remainder of fiscal year 2007.

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(b) COST OF REVENUE

Cost of revenue was $1,421,287 for the six months ended December 31, 2006, compared to $943,372 for the six months ended December 31, 2005, an increase of $477,915 or approximately 51%. The increase in cost of revenue is due in primarily to increased sales, as well as continued investment in the Company's technical infrastructure and hiring of additional staff.

Selling, general and administrative expenses were $5,452,127 for the six months ended December 31, 2006 compared to $2,908,506 for the six months ended December 31, 2005, an increase of $2,543,621 or approximately 88%. During the six months ended December 31, 2006, the primary components of selling, general, and administrative expenses were: consulting fees of $2,753,844, of which $2,553,693 were non-cash costs; payroll and related costs of $1,316,606; facility costs, such as rent, telephone, and utilities, of $356,781; legal and accounting fees of $286,060; travel and entertainment costs of $282,194; professional services of $128,049; and depreciation and amortization of $167,744; marketing costs of $63,505; investor relations costs of $39,000; and recruiting costs of $36,284. The components of selling, general and administrative costs that increased most significantly during the six months ended December 31, 2006, compared to the six months ended December, 31, 2005 were consulting fees, which increased by $1,190,797 or 76% and payroll and related costs, which increased by $692,122 or 111%,.

(d) INTEREST EXPENSE

The Company had net interest income of $779 during the six months ended December 31, 2006 compared to net interest expense of $37,246 for the six months ended December 31, 2005, a decrease of $36,467. Lower interest expense was due to a decrease in the company's debt.

(e) INCOME TAXES

The Company recognized income taxes expense of $7,961 during the six months ended December 31, 2006, compared to income tax expense of $0 during the prior year. The increase was due to income taxes paid in Ireland by the Company's new subsidiary, PLC Partners.

(f) MINORITY INTEREST IN NET LOSS OF SUBSIDIARY

(g) NET LOSS

For the reasons stated above, the Company recorded a net loss of $5,594,679 for the six months ended December 31, 2006 compared to $2,706,207 for the six months ended December 31, 2005, an increase of $2,888,472 or approximately 107%. The increased loss is primarily due to the decrease 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.

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OPERATING ACTIVITIES

The net cash used in operating activities was $2,880,745 for the six months ended December31, 2006 compared to $1,773,872 for the six months ended December 31, 2005, an increase of $1,106,873 or approximately 62%. Cash used in operating activities during the six months ended December 31, 2006 is attributable primarily to the net loss of $5,594,679 partially offset by non-cash charges of $2,566,590 and $394,168 of depreciation and amortization. During the six months ended December 31, 2006, cash used in operating activities of $233,112 was due to changes in the components of working capital. During the six months ended December 31, 2005, cash used in operating activities of $666,701 was due to changes in the components of working capital

INVESTING ACTIVITIES

Net cash used in investing activities was $558,533 for the six months ended December 31, 2006, compared to cash used in investing activities of $350,858 during the six months ended December 31, 2005. This increase was primarily due to increased investing by the Company in software and capitalized software costs, and the cash component of the PLC Partners acquisition.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2006, the Company had total current assets of $ 2,640,280 and total current liabilities of $1,562,965 resulting in working capital of $1,077,315. The Company had cash and cash equivalents of $1,323,370 at December 31, 2006. As of December 31, 2006, the Company had an accumulated deficit of $63,708,394. 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, 2006 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.

On January 27, 2006, the Company signed subscription agreements with a group of offshore investors for the sale of an aggregate of $9.2 million in Company common stock, plus warrants (the "January Financing"). Due to the failure of the investment group to timely fund in full the first payment required for the purchase of shares and warrants, the Company terminated the January Financing; all shares and warrants issued thereunder were returned by the escrow holder to the Company for cancellation, and any funds received pursuant to the January Financing were returned by the escrow holder to the investors.

In March 2006, a group of European investors, lead by Olympia Holding AS, informed the Company that they were willing to invest on the same terms and conditions that were negotiated for the now-terminated January Financing, and the Company agreed to this financing transaction with these investors (the "March Financing").

Pursuant to the March Financing, the Company agreed to issue 46 million shares of restricted common stock under Regulation S at $0.20 per share, plus warrants to purchase 50 million shares of common stock with two-year exercise periods and strike prices ranging from $1.50 to $8.50, as set forth below. The Company intends to issue these shares in two tranches of 23,000,000 shares each. The shares which will be held in escrow by Carl Hessel, a director and major stockholder of the Company based in Geneva, Switzerland, along with the warrants. Pursuant to the terms of the March Financing, the first payment of $4.6 million was due immediately, with a second payment of $4.6 million due within three months thereafter. As of December 31, 2006, the Company had received cash in the net amount $6,469,924 pursuant to the March Financing, and had issued 22,850,000 shares of common stock and warrants to purchase an additional 24,836,957 shares.

Of the $6,469,924 collected as of December 31, 2006, the Company received $1,600,000 under the March Financing during the three months ended September 30, 2006, and $300,000 and during the three months ended December 31, 2006. The . . .