FORM 10-Q | 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 unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q.

Overview

We are a provider of electronic payment processing services, including credit and debit card transaction processing, point-of-sale related software applications and other value-added services. We currently process on average approximately 1,620,000 transactions per month and serve in excess of 1,100 merchant locations. We provide transaction processing support for all major credit cards, including Visa, MasterCard, American Express, Diners Club and JCB, and all bank-issued Finnish debit cards. We enable merchants and financial institutions to accept, and their consumers to utilize, electronic payments using credit and debit cards to purchase goods and services. Our role is to serve as an intermediary in the exchange of information and funds that must occur between parties so that a payment transaction can be completed. We provide merchants with various transaction processing services, including authorizing card transactions at the merchant's retail location (also known as the point-of-sale), and capturing and transmitting transaction data. Through agreements with Hypercom Corporation, the world's second largest manufacturer of payment terminals, Spectra Technologies, a leading Chinese electronic payment solution provider, and Thyron Systems, we also offer our customers point-of-sale terminals, which are integrated with our software products to provide merchants with a complete solution for credit and debit card transaction processing.

Our role in a transaction is to serve as a link between the merchant and the merchant's bank, known as the acquiring bank, and the bank that issued the consumer's credit or debit card, known as the issuing bank. The electronic authorization process for a credit card transaction begins when the merchant "swipes" or inserts the card into its point-of-sale terminal and enters the amount of the purchase. After capturing the data, the point-of-sale terminal transmits the authorization request through our switching center, where the data is routed to the issuing bank (typically via the Interchange Network, a telecommunication network operated by international card corporations) for authorization. The issuing bank confirms that the credit card is authentic and whether a transaction will cause the cardholder to exceed defined limits. The approval or disapproval of the transaction is transmitted back to our switching center, where it is routed to the appropriate merchant's acquiring bank.

We were originally organized on August 2, 1997, under the laws of the State of Delaware as Interstate Capital Corporation. On November 17, 1999, we merged into a newly formed Nevada corporation, Freedom Surf, Inc., for the purpose of changing the corporate domicile to Nevada. On February 24, 2003, we filed a Certificate of Amendment to our Articles of Incorporation with the Nevada Secretary of State changing our name to "FreeStar Technology Corporation". On September 10, 2002, we entered into an agreement with Heroya Investments Limited for the acquisition of Rahaxi Processing Oy through a combination of cash and stock. The agreement with Heroya was subsequently amended three times to increase the stock consideration and decrease the cash component. Rahaxi, our wholly owned subsidiary, is based in Helsinki, Finland.

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.

Our switching and transaction processing platform is operated by our wholly-owned subsidiary, Rahaxi, which is located in Finland. We are one of the leading players in the Finnish transaction processing market, serving approximately 1,400 merchants each day and processing on average approximately 1,620,000 transactions per month.

Until recently, our primary source of revenue was from transaction fees we receive from processing credit and debit card transactions through point-of-sale terminals at a merchant's retail location. In fiscal year 2006, we also began generating revenue from sales of point-of-sale terminals as well as consulting fees, which include customization of software applications for merchants and other customers. Other anticipated revenue streams include additional processing fees from processing dynamic currency conversion through our agreement with Global Refund Group and Monex. In fiscal year 2007, the period from July 1, 2006 through June 30, 2007, transaction fees from point-of-sale terminal transactions were primarily from merchants and customers based in Finland. We also derived revenue from transaction fees from clients in Estonia, Spain and Iceland. In addition, we derived revenue from consulting and development fees from our customers in Finland, Sweden, the United Kingdom, Dominican Republic and in Ireland through our 50% stake in PLC, Project Life Cycle Partners Limited.

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.

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Results of Operations

THREE MONTHS ENDED DECEMBER 31, 2007 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2006

Revenue

Transaction processing and related revenue

Transaction processing and related revenue was $512,782 for the three months ended December 31, 2007, compared to $497,810 during the three months ended December 31, 2006, an increase of $14,972 or approximately 3%. The Company processed a total of 5,060,184 transactions during the three months ended December 31, 2007, a decrease of 231,865 or approximately 4.4% compared to 5,292,049 transactions processed during the three months ended December 31, 2006. The slight decrease was primarily related to the increase in hardware sales, whereby some clients who purchase a Point of Sale terminal are charged a flat recurring monthly fee rather than per transaction fee .The slight decrease is more than offset by the increase in hardware and related revenue which was $252,069, an increase of $201,921 over the comparable period in the prior year. We expect this trend to continue throughout fiscal 2008 as we continue to expand our customer base. The Company invoices its customers in Euro. The average exchange rate of the Euro to the U.S. Dollar for the three months ended December 31, 2007 has declined by approximately 11% compared to the three months ended December 31, 2006, and this exchange rate difference should be taken into consideration when analyzing our transaction processing sales.

Consulting services revenue

Consulting services revenue was $683,862 for the three months ended December 31, 2007, compared to $263,944 during the three months ended December 31, 2006. Consulting services revenue is primarily generated by the Company's 50% stake in PLC.

Hardware and related revenue

Hardware and related revenue was $252,069 during the three months ended December 31, 2007, compared to $50,148 during the three months ended December 31, 2006. The Company began selling processing terminals and related equipment in December 2006. We expect to report increased hardware and related sales in the year ending June 30, 2008 as we not only increase actual hardware sales to our expanding customer base, but began to recognize revenue from annual maintenance fees and service initiation fees, which were not recognized during fiscal year 2007.

For the reasons above, total revenue for the three months ended December 31, 2007 was $1,448,713 compared to $811,902 for the three months ended December 31, 2006, an increase of $636,811 or approximately 78%.

We expect revenue levels to increase throughout the next twelve months as we continue to increase our client base and continue to diversify our service offerings, such as EMV-compliant transaction processing, dynamic currency conversion, sales of point of sale terminals and consulting fees. However, there can be no guarantee that our products will be accepted in the marketplace or that our sales efforts will be successful.

All of our revenue for the three months ended December 31, 2007 has been derived from a limited number of its customers, primarily Finnish customers for its transaction processing products. Approximately 62% of our total revenue was attributable to our ten largest customers. The future loss of any major customer could have a material adverse effect on our business, financial condition and results of operations. We believe that this customer concentration will continue for much of fiscal 2008. We believe that this customer concentration will be diluted in the latter half of fiscal 2008 as we pursues operations outside of Finland. All of our revenues for the twelve months ended June 30, 2007 have been generated by our operations outside of the United States, and our future growth rate is, in part, dependent on continued growth in international markets. We expect this trend to continue through fiscal year 2008.

Cost of Revenue

Cost of transaction processing and related revenue

Cost of transaction processing and related revenue was $609,361 for the three months ended December 31, 2007, compared to $626,365 for the prior three months ended December 31, 2006, a decrease of $17,004 or approximately 3%. The reason for the relatively small decrease is a decrease in expenditures made for our processing infrastructure. Though we capitalize the acquisition and installation costs of certain software components purchased from third party suppliers, we expense all costs associated with maintaining, and many of the costs of improving, our processing and customer support capabilities. These costs do not always change in direct relation to sales, and in fact often increase in advance of any potential increase in sales which they may support. Included in cost of transaction processing and related revenue is depreciation and amortization of $125,282 and $129,196 for the three months ended December 31, 2007 and 2006, respectively.

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Cost of consulting services

Cost of consulting services revenue was $606,054 for the three months ended December 31, 2007, compared to $212,013 for the three months ended December 31, 2006, an increase of $394,041 or approximately 186%. The primary reason for the increase was an increase in consulting service revenue.

Cost of hardware and related revenue

Cost of hardware and related revenue was $192,312 during the three months ended December 31, 2007, compared to $48,930 during the prior year, an increase of $143,382 or approximately 293%. The primary reason for the increase was an increase in volume, as the Company began selling processing terminals and related equipment in December 2006.

For the reasons above, total cost of revenue was $1,407,727 for the three months ended December 31, 2007, compared to $887,308 for the three months ended December 31, 2006, an increase of $520,419 or approximately 59%.

We expect cost of revenue to increase in the coming year as we continue our current trend of increasing sales and expanding our product offering. As our service offerings and business mix changes, gross margin as a percent of sales may not remain constant.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $4,634,031 for the three months ended December 31, 2007 compared to $3,054,011 for the three months ended December 31, 2006, an increase of $1,580,020 or approximately 52%. The primary components of selling, general, and administrative expenses for the three months ended December 31, 2007 were: consulting fees of $2,729,006 to service providers for financial consulting and other professional services; $2,362,642 of this amount consisted of non-cash compensation in the form of stock, stock options, and warrants. Other components of selling, general, and administrative expenses for three months ended December 31, 2007 included payroll and related costs of $1,284,552; facilities expense (rent, telephone, utilities, and maintenance) of $246,014; legal and accounting fees of $52,132; travel and entertainment costs of $165,298; depreciation and amortization of $99,326; other professional services of $92,871; and $45,429 for marketing.

The amount of future selling, general, and administrative expenses will largely depend on the pace of our 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. We fully expect these costs to increase as we continue our expected rollout of product offerings. We also intend to continue to build out our infrastructure, which may include adding support staff. Selling expenses may also continue to increase due to increased focus on obtaining new customers. We intend to focus additional resources in the areas of sales personnel salaries, trade show participation, and other promotional expenses. In addition, we may pursue further acquisitions in order to facilitate our growth and exploit market opportunities, which would further drive up legal and accounting fees, payroll, and travel costs.

Interest Expense

Interest income (expense) net was ($11,198) for the three months ended December 31, 2007, compared to ($791) for the three months ended December 31, 2006, an increase of ($10,407) or approximately 1316%. The increase is due primarily to vendor financing which the Company utilized during the three months ended December 31, 2007.

Net Loss

For the reasons stated above, we recorded a net loss of $4,568,270 for the three months ended December 31, 2007 compared to $3,124,456 for the three months ended December 31, 2006, an increase of $1,443,814 or approximately 46%.

SIX MONTHS ENDED DECEMBER 31, 2007 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2006

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Revenue

Transaction processing and related revenue

Transaction processing and related revenue was $1,000,505 for the six months ended December 31, 2007, compared to $959,670 during the six months ended December 31, 2006, an increase of $40,835 or approximately 4%. The Company processed a total of 10,185,858 transactions during the six months ended December 31, 2007, an decrease of 24,144 or approximately 0.2% compared to 10,210,002 transactions processed during the six months ended December 31, 2006. The slight decrease was primarily related to the increase in hardware sales, whereby some clients who purchase a Point of Sale terminal are charged a flat recurring monthly fee rather than per transaction fee .The slight decrease is more than offset by the increase in hardware and related revenue which was $512,864 an increase of $50,148 over the comparable period in the prior year. We expect the increase in revenue trend to continue throughout fiscal 2008 as we continue to expand our customer base. The Company invoices its customers in Euro. The average exchange rate of the Euro to the U.S. Dollar for the six months ended December 31, 2007 has declined by approximately 9% compared to the six months ended December 31, 2006, and this exchange rate difference should be taken into consideration when analyzing our transaction processing sales.

Consulting services revenue

Consulting services revenue was $1,289,839 for the six months ended December 31, 2007, compared to $263,944 during the prior year. Consulting services revenue is primarily generated by the Company's 50% stake in PLC. The Company acquired PLC in November, 2006. We expect to report increased revenue from consulting services in the fiscal year ending June 30, 2008.

Hardware and related revenue

Hardware and related revenue was $512,864 during the six months ended December 31, 2007, compared to $50,148 during the prior year. The Company began selling processing terminals and related equipment in December 2006. We expect to report increased hardware and related sales in the year ending June 30, 2008 as we not only increase actual hardware sales to our expanding customer base, but began to recognize revenue from annual maintenance fees and service initiation fees, which were not recognized during the comparable period.

For the reasons above, total revenue for the six months ended December 31, 2007 was $2,803,208 compared to $1,273,762 for the six months ended December 31, 2006, an increase of $1,529,446 or approximately 120%.

We expect revenue levels to increase throughout the next twelve months as we continue to increase our client base and introduce service offerings, such as EMV transaction processing, dynamic currency conversion, sales of point of sale terminals and consulting fees. However, there can be no guarantee that our products will be accepted in the marketplace or that our sales efforts will be successful.

All of our revenue for the six months ended December 31, 2007 has been derived from a limited number of its customers, primarily Finnish customers for its transaction processing products. Approximately 62% of our total revenue was attributable to our ten largest customers. The future loss of any major customer could have a material adverse effect on our business, financial condition and results of operations. We believe that this customer concentration will continue for much of fiscal 2008. We believe that this customer concentration will be slightly diluted in the latter half of fiscal 2008 as we pursues operations outside of Finland. All of our revenues for the twelve months ended June 30, 2007 have been generated by our operations outside of the United States, and our future growth rate is, in part, dependent on continued growth in international markets. We expect this trend to continue through fiscal year 2008.

Cost of Revenue

Cost of transaction processing and related revenue

Cost of transaction processing and related revenue was $1,243,628 for the six months ended December 31, 2007, compared to $1,160,343 for the prior six months ended December 31, 2006, an increase of $83,285 or approximately 7%. The reason for the increase is our continued investment in our processing infrastructure, as we further build out our processing capabilities and service offerings. Though we capitalize the acquisition and installation costs of certain software components purchased from third party suppliers, we expense all costs associated with maintaining, and many of the costs of improving, our processing and customer support capabilities. These costs do not always change in direct relation to sales, and in fact often increase in advance of any potential increase in sales which they may support. Included in cost of transaction processing and related revenue is depreciation and amortization of $254,988 and $257,807 for the six months ended December 31, 2007 and 2006, respectively.

Cost of consulting services

Cost of consulting services revenue was $995,314 for the six months ended December 31, 2007, compared to $212,013 for the six months ended December 31, 2006. The primary reason for the increase was an increase in labor costs due required in connection with generating increased consulting service revenue.

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Cost of hardware and related revenue

Cost of hardware and related revenue was $449,655 during the six months ended December 31, 2007, compared to $49,980 during the prior year. The reason for the increase is an increase in hardware sales. The Company began selling processing terminals and related equipment in December 2006. Included in cost of hardware revenue are terminals shipped to customers as test and demonstration units, as well as items replaced or returned.

For the reasons above, total cost of revenue was $2,688,597 for the six months ended December 31, 2007, compared to $1,421,286 for the six months ended December 31, 2006, an increase of $1,267,311 or approximately 89%.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $10,065,580 for the six months ended December 31, 2007 compared to $5,452,127 for the six months ended December 31, 2006, an increase of $4,613,453 or approximately 85%. The primary components of selling, general, and administrative expenses for the six months ended December 31, 2007 were: consulting fees of $6,295,700 to service providers for financial consulting and other professional services; $5,688,654 of this amount consisted of non-cash compensation in the form of stock, stock options, and warrants. Other components of selling, general, and administrative expenses for six months ended December 31, 2007 included payroll and related costs of $2,446,929; facilities expense (rent, telephone, utilities, and maintenance) of $468,159; legal and accounting fees of $264,694; travel and entertainment costs of $268,506; depreciation and amortization of $202,672; other professional services of $159,575; and $60,843 for marketing.

The amount of future selling, general, and administrative expenses will largely depend on the pace of our 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. We fully expect these costs to increase as we continue our expected rollout of product offerings. We also intend to continue to build out our infrastructure, which may include adding support staff and branch offices. Selling expenses may also continue to increase due to increased focus on obtaining new customers. We intend to focus additional resources in the areas of sales personnel salaries, trade show participation, and other promotional expenses. In addition, we may pursue further acquisitions in order to facilitate our growth and exploit market opportunities, which would further drive up legal and accounting fees, payroll, and travel costs.

Cost of Acquisition

Pursuant to the acquisition agreement for the Company's 50% owned subsidiary PLC Partners, the Company was obligated to issue additional shares of the Company's common stock, since the average closing price was under $0.36 for the thirty day period preceding November 21, 2007, the one-year anniversary of the transaction. The number of shares that we were required to issue pursuant to this clause was capped at 1,111,111, and the maximum amount of 1,111,111 additional shares were issued in November 2007. The Company accrued the value of these shares, or $192,555, to operations during the six months ended December 31, 2007. There was no comparable expense during the prior year.

Interest Expense

Interest income (expense) net was ($30,411) for the six months ended December 31, 2007, compared to ($799) for the six months ended December 31, 2006, an increase of ($29,632) or approximately 3804%. The increase is due primarily to vendor financing which the Company utilized during six months ended December 31, 2007.

In the past, we have relied primarily on equity financing partly in order to avoid the interest charges associated with debt financing. To the extent that we continue to sell hardware and carry inventory, we may continue to use vendor or other third-party debt financing for such inventory, further increasing out interest charges in the future. In addition, we could receive an offer of attractive debt financing or could undertake additional financing with regard to an acquisition, in which cases interest expense would also significantly increase.

Net Loss

For the reasons stated above, we recorded a net loss of $10,207,548 for the six months ended December 31, 2007 compared to $5,594,678 for the six months ended December 31, 2006, an increase of $4,612,870 or approximately 82%.

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

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Operating Activities

The net cash used in operating activities was $2,426,606 for the six months ended December 31, 2007 compared to $2,880,745 for the six months ended December 31, 2006, a decrease of $454,139 or approximately 16%. The primary components of cash used in operating activities during the current period are the net loss of ($10,205,764), partially offset by the non-cash charges of non-cash compensation of $5,914,187 and depreciation and amortization of $457,660. The total amount of cash used in operating activities also reduced by changes in the following components of working capital: accounts payable and accrued expenses of $806,647; accrued salary due to officers of $312,595; accounts receivable of $181,905; Inventory of $114,921; and deferred revenue of $15,683.

Investing Activities

Net cash used in investing activities was $244,459 during the six months ended December 31, 2007 compared to $558,533 for the six months ended December 31, 2006, a decrease of $314,074 or approximately 56%. This change was primarily due to the cash used in the investment in PLC of $177,787 during the prior year, and a decrease of the amount of capitalized software of $90,926.

Financing Activities

Net cash provided by financing activities was $2,696,777 for the six months ended December 31, 2007, compared to $1,762,500 for the six months ended December 31, 2006, an increase of $934,277 or approximately 53%. The reason for the increase was cash provided from the exercise of stock options and warrants of $1,542,000, an increase of $1,489,500 from the prior period; this was partially offset by a decrease in cash provided from the sale of common stock, which was $965,000 or $935,000 less than the prior period.

Liquidity and Capital Resources

As of December 31, 2007, we had total current assets of $1,945,907 and total current liabilities of $3,509,597, resulting in a working capital deficiency of ($1,563,690). We had cash and cash equivalents of $401,524 at December 31, 2007, . . .