FORM 10-Q | Edgar Filings | Freestar Technology Corporation

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

Special Note About Forward-Looking Statements

This Form 10-Q contains "forward looking statements" within the meaning of Rule 175 of the Securities Act of 1933, as amended, and Rule 3b-6 of the Securities Exchange Act of 1934, as amended. When used in this Form 10-Q, the words "expects," "anticipates," "believes," "plans," "will" and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements regarding our adequacy of capital resources, need and ability to obtain additional financing, the features and benefits of our services, our operating losses and negative cash flow, and our critical accounting policies.

Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those discussed above, as well as the risks set forth under "Factors That May Affect Operating Results." These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in its expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

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 1,580,000 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.

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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 1,600 merchants each day and processing on average approximately 1,580,000 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; Geneva, Switzerland; and Santo Domingo, the Dominican Republic. While the Company's offices in Finland and Ireland 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 UnionPay.

Results of Operations

THREE MONTHS ENDED MARCH 31, 2008 COMPARED TO THREE MONTHS ENDED MARCH 31, 2007

Revenue

For the reasons below, total revenue for the three months ended March 31, 2008 was $1,629,150 compared to $1,125,634 for the three months ended March 31, 2007, an increase of $503,516 or approximately 45%.

Transaction processing and related revenue

Transaction processing and related revenue was $575,002 for the three months ended March 31, 2008, compared to $484,093 during the prior year, an increase of $90,909 or approximately 19%. The Company processed a total of 4,047,161 transactions during the three months ended March 31, 2008, a decrease of 464,875 or approximately 10% compared to 4,512,036 transactions processed during the prior year. The slight decrease in the number of transactions processed 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 a per transaction fee structure. Transactions processed for these clients are not included in the transactions total. The Company also lost one significant client during the quarter. The Company invoices its customers in Euro. The average exchange rate of the U.S. Dollar compared to the Euro for the three months ended March 31, 2008 has declined by approximately 13% compared to the three months ended March 31, 2007, and this exchange rate difference should be taken into consideration when analyzing our transaction processing sales.

Consulting services revenue

Consulting services revenue was $760,119 for the three months ended March 31, 2008, compared to $474,505 during the prior year, in increase of $285,614 or approximately 60%. Consulting services revenue is primarily generated primarily by the Company's 50% stake in PLC.

Hardware and related revenue

Hardware and related revenue was $294,029 during the three months ended March 31, 2008, compared to $167,036 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.

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FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008 (UNAUDITED)

We expect revenue levels to increase throughout the next twelve months as we continue to increase our client base and service offerings, such as China UnionPay transactions in France, 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 three months ended March 31, 2008 has been derived from a limited number of customers, primarily Finnish customers for its transaction processing products. Approximately 57% 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 gradually diluted in the latter half of fiscal 2008 as we continue to pursue operations outside of Finland. All of our revenues for the nine months ended March 31, 2008 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 $623,110 for the three months ended March 31, 2008, compared to $616,430 for the prior three months ended March 31, 2007, an increase of $6,680 or approximately 1%. The reason for the relatively small increase is an increase 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 $134,856 and $129,584 for the three months ended March 31, 2008 and 2007, respectively.

Cost of consulting services

Cost of consulting services revenue was $487,860 for the three months ended March 31, 2008, compared to $440,052 for the three months ended March 31, 2007, an increase of $47,808 or approximately 11%. 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 $207,402 during the three months ended March 31, 2008, compared to $162,884 during the prior year, an increase of $44,518 or approximately 27%. The primary reason for the increase was an increase in volume.

For the reasons above, total cost of revenue was $1,318,872 for the three months ended March 31, 2008, compared to $1,219,366 for the three months ended March 31, 2007, an increase of $99,006 or approximately 8%.

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 $2,774,702 for the three months ended March 31, 2008 compared to $2,528,718 for the three months ended March 31, 2007, an increase of $245,984 or approximately 10%. The primary components of selling, general, and administrative expenses for the three months ended March 31, 2008 were: payroll and related costs of $1,221,476; consulting fees of $1,000,503 to service providers for financial consulting and other professional services; $922,946 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 March 31, 2008 included facilities expense (rent, telephone, utilities, and maintenance) of $166,187; depreciation and amortization of $101,896; travel and entertainment costs of $91,681; and other professional services of $83,779.

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. 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.

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Interest Expense

Interest income (expense) net was ($6,660) for the three months ended March 31, 2008, compared to ($838) for the three months ended March 31, 2007, an increase of ($5,822) or approximately 695%. The increase is due primarily to cash advances from officers.

Historically, we have primarily utilized equity financing partly in order to avoid the interest charges associated with debt financing. Accordingly, we do 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 recent price and performance of our common stock could make equity financings more difficult, and require us to pursue alternative methods of financing our cash needs. 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 significantly increase.

Net Loss

For the reasons stated above, we recorded a net loss of $2,510,373 for the three months ended March 31, 2008 compared to $2,619,044 for the three months ended March 31, 2007, a decrease of $108,671 or approximately 4%.

NINE MONTHS ENDED MARCH 31, 2008 COMPARED TO NINE MONTHS ENDED MARCH 31, 2007

Revenue

For the reasons below, total revenue for the nine months ended March 31, 2008 was $4,432,358 compared to $2,399,396 for the nine months ended March 31, 2007, an increase of $2,032,962 or approximately 85%.

Transaction processing and related revenue

Transaction processing and related revenue was $1,575,507 for the nine months ended March 31, 2008, compared to $1,443,763 during the prior year, an increase of $131,744 or approximately 9%. The Company processed a total of 14,233,019 transactions during the nine months ended March 31, 2008, a decrease of 489,019 or approximately 3% compared to 14,722,038 transactions processed during the prior year. The slight decrease in the number of transactions processed 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 a per transaction fee structure. Transactions processed for these clients are not included in the transactions total. The Company also lost one significant client during the quarter. The Company invoices its customers in Euro. The average exchange rate of the U.S. Dollar compared to the Euro for the nine months ended March 31, 2008 has declined by approximately 10% compared to the nine months ended March 31, 2007, and this exchange rate difference should be taken into consideration when analyzing our transaction processing sales.

Consulting services revenue

Consulting services revenue was $2,049,958 for the nine months ended March 31, 2008, compared to $738,449 during the prior year, an increase of $1,311,509 or approximately 178%. 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 $806,893 during the nine months ended March 31, 2008, compared to $217,184 during the prior year, an increase of $589,709 or approximately 272%. 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.

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 China UnionPay transactions in France, 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.

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All of our revenue for the nine months ended March 31, 2008 has been derived from a limited number of its customers, primarily Finnish customers for its transaction processing products. Approximately 58% 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 nine months ended March 31, 2008 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 $1,866,738 for the nine months ended March 31, 2008, compared to $1,776,774 for the prior nine months ended March 31, 2007, an increase of $89,964 or approximately 5%. 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 $400,303 and $223,984 for the nine months ended March 31, 2008 and 2007, respectively.

Cost of consulting services

Cost of consulting services revenue was $1,483,174 for the nine months ended March 31, 2008, compared to $652,065 for the nine months ended March 31, 2007, an increase of $831,109 or approximately 127%. 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 $657,057 during the nine months ended March 31, 2008, compared to $211,814 during the prior year, an increase of $445,243 or approximately 210%. 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 $4,006,969 for the nine months ended March 31, 2008, compared to $2,640,653 for the nine months ended March 31, 2007, an increase of $1,366,316 or approximately 52%.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $12,840,282 for the nine months ended March 31, 2008 compared to $7,980,845 for the nine months ended March 31, 2007, an increase of $4,859,437 or approximately 61%. The primary components of selling, general, and administrative expenses for the nine months ended March 31, 2008 were: consulting fees of $7,296,203 to service providers for financial consulting and other professional services; $6,287,087 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 nine months ended March 31, 2008 included payroll and related costs of $3,668,405; facilities expense (rent, telephone, utilities, and maintenance) of $634,352; travel and entertainment costs of $360,187; depreciation and amortization of $307,172.

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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 if the average closing price was under $0.36 for the thirty day period preceding the one-year anniversary of the transaction, or November 21, 2007. The number of shares issuable pursuant to this clause was capped at 1,111,111. The Company calculated this additional payment amount effective November 12, 2007, and determined that at that date the maximum number of additional shares, or 1,111,111, would be issuable. The Company accrued the value of these shares, or $192,555, to operations during the nine months ended March 31, 2008. There was no comparable expense during the prior year.

Interest Expense

Interest income (expense) net was ($37,071) for the nine months ended March 31, 2008, compared to ($1,617) for the nine months ended March 31, 2007, an increase of $35,454 or approximately 2193%. The increase is due primarily to vendor financing which the Company utilized during nine months ended March 31, 2008, and to cash advances provides by officers.

Net Loss

For the reasons stated above, we recorded a net loss of $12,717,921 for the nine months ended March 31, 2008 compared to $8,213,724 for the nine months ended March 31, 2007, an increase of $4,504,197 or approximately 55%.

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.

Operating Activities

The net cash used in operating activities was $3,092,865 for the nine months ended March 31, 2008 compared to $4,176,211 for the nine months ended March 31, 2007, a decrease of $1,083,346 or approximately 26%. The primary components of cash used in operating activities during the current period are the net loss of ($12,717,921), partially offset by the non-cash charges of non-cash compensation of $6,837,135 and depreciation and amortization of $707,474. The total amount of cash used in operating activities was also reduced by changes in the following components of working capital: accounts payable and accrued expenses of . . .