U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND NATURE OF BUSINESS OPERATIONS
Basis Of Presentation
The accompanying unaudited condensed consolidated financial statements of FreeStar Technology Corporation, a Nevada corporation ("Company"), have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. These condensed consolidated financial statements and related notes should be read in conjunction with the Company's Form 10-KSB for the fiscal year ended June 30, 2007. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are of a normal recurring nature and which are necessary to present fairly the financial position of the Company as of December 31, 2007, and the results of operations and cash flows for the six months ended December 31, 2007 and 2006. The results of operations for the three and six months ended December 31, 2007 are not necessarily indicative of the results that may be expected for the entire fiscal year.
Nature Of Business Operations
The Company (formerly Freestar Technologies) was formed on November 17, 1999 as a Nevada corporation. The Company is a provider of payment services and processing. Its principal offices are in Dublin, Ireland; the Company also has offices in Helsinki, Finland; Stockholm, Sweden; Geneva, Switzerland; and Santo Domingo, the Dominican Republic.
The Company derives revenues from its core payment processing products, which include: (1) Authorization / Transaction Fees: transaction fees it receives from processing point of sale terminal transactions; (2) Hardware Sales / Point of Sale Terminals: sales of “Point of Sale” terminals and related maintenance and service initiation fees; (3) Dynamic Currency Conversion: in addition to transaction authorization, the Company offers certain clients real-time, dynamic currency conversion, allowing a customer to pay for a product or service with their credit card in their local currency; (4) Private Label Cards: transaction management services provided for a private label card issuer; and (5) Consulting Fees: consulting services provided to financial institutions and merchants.
Going Concern
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has reported a net loss of $4,568,270 and $10,207,548 for the three and six months ended December 31, 2007 and $16,305,197 for the year ended June 30, 2007, and had an accumulated deficit of $84,624,675 as of December 31, 2007.
The Company believes that anticipated revenues from operations will be insufficient to satisfy its ongoing capital requirements for at least the next 12 months. If the Company’s financial resources are insufficient, the Company will require additional financing in order to execute its operating plan and continue as a going concern. The Company cannot predict whether this additional financing will be in the form of equity or debt, or be in another form. The Company may not be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all. In any of these events, the Company may be unable to implement its current plans for expansion, repay its debt obligations as they become due, or respond to competitive pressures, any of which circumstances would have a material adverse effect on its business, prospects, financial condition and results of operations.
Management plans to take the following steps that it believes will be sufficient to provide the Company with the ability to continue as a going concern. Management intends to raise financing through the sale of its stock in private placements to individual investors. Management may also raise funds in the public markets, although there are no current plans or expectations to do so. Management believes that with this financing, the Company will be able to generate additional revenues that will allow the Company to continue as a going concern. This may be accomplished by hiring additional personnel and focusing sales and marketing efforts on the distribution of services and products through key marketing channels. The Company may also pursue the acquisition of certain strategic industry partners where appropriate.
Revenue Recognition
The Company recognizes revenues from contracts in which the Company provides only consulting services as the services are performed. The contractual terms of the agreements dictate the recognition of revenue by the Company. Payments received in advance are deferred until the service is provided.
Contract costs include all direct equipment, material, and labor costs and those indirect costs related to contract performance, such as indirect labor. Selling, general and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in contract performance, contract conditions, and estimated profitability that may result in revisions to costs and income are recognized in the period in which the revisions are determined.
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
For revenue from product sales, the Company recognizes revenue in accordance with Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition," which superseded SAB No. 101, "Revenue Recognition in Financial Statements." SAB No.101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. The Company defers any revenue for which the product has not been delivered or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered or no refund will be required. SAB No. 104 incorporates Emerging Issues Task Force ("EITF") No. 00-21, "Multiple-Deliverable Revenue Arrangements." EITF No. 00-21 addresses accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The effect of implementing EITF No. 00-21 on the Company's consolidated financial position and results of operations was not significant. This issue addresses determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how the arrangement consideration should be measured and allocated to the separate units of accounting. EITF No. 00-21 became effective for revenue arrangements entered into in periods beginning after June 15, 2003. For revenue arrangements occurring on or after August 1, 2003, the Company revised its revenue recognition policy to comply with the provisions of EITF No. 00-21.
For those contracts which contain multiple deliverables, management must first determine whether each service, or deliverable, meets the separation criteria of EITF No. 00-21. In general, a deliverable (or a group of deliverables) meets the separation criteria if the deliverable has standalone value to the customer and if there is objective and reliable evidence of the fair value of the remaining deliverables in the arrangement. Each deliverable that meets the separation criteria is considered a “separate unit of accounting.” Management allocates the total arrangement consideration to each separate unit of accounting based on the relative fair value of each separate unit of accounting. The amount of arrangement consideration that is allocated to a unit of accounting that has already been delivered is limited to the amount that is not contingent upon the delivery of another separate unit of accounting. After the arrangement consideration has been allocated to each separate unit of accounting, management applies the appropriate revenue recognition method for each separate unit of accounting as described previously based on the nature of the arrangement. All deliverables that do not meet the separation criteria of EITF No. 00-21 are combined into one unit of accounting, and the appropriate revenue recognition method is applied under SAB No. 101. Processing fee revenue is earned based upon the actual number of transactions processed through the Company’s processing system. Transaction processing fees are recognized in the period that the service is performed. These fees are typically charged on a per transaction basis, depending on the arrangement with the customer. Maintenance fees for processing terminals are recognized over the period for which maintenance is provided.
The Company’s subsidiary Rahaxi charges certain customers for one-time initiation fees and annual maintenance fees. These fees are charged to deferred revenue when billed, and revenue from these fees is recognized straight-line over the billing coverage period, typically twelve months.
Stock Based Compensation
Effective January 1, 2006, the Company adopted SFAS No. 123 (revised), “Share-Based Payment” (SFAS 123R) utilizing the modified prospective approach. Prior to the adoption of SFAS 123R we accounted for stock option grants in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (the intrinsic value method), and accordingly, recognized compensation expense for stock option grants.
Aggregate intrinsic value of options outstanding and options exercisable at December 31, 2007 was $5,000 and $5,000, respectively. Aggregate intrinsic value represents the difference between the company's closing stock price on the last trading day of the fiscal period, which was $0.15 as of December 31, 2007, and the exercise price multiplied by the number of options outstanding. As of December 31, 2007, total unrecognized stock-based compensation expense related to non-vested stock options was $0. The total fair value of options vested was $62,104 and $0 for the six-month periods ended December 31, 2007 and 2006, respectively.
Capitalized Software Development Costs
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," the Company capitalizes certain costs related to the development of new software products or the enhancement of existing software products for use in our transaction processing software. These costs are capitalized from the point in time that technological feasibility has been established, as evidenced by a working model or detailed working program design to the point in time that the product is available for general release to customers. Capitalized development costs are amortized on a straight-line basis over the estimated economic lives of the products, beginning when the product is placed into service. Research and development costs incurred prior to establishing technological feasibility and costs incurred subsequent to general product release to customers are charged to expense as incurred. The Company periodically evaluates whether events or circumstances have occurred that indicate that the remaining useful lives of the capitalized software development costs should be revised or that the remaining balance of such assets may not be recoverable.
The Company often has under development several discreet design features or enhancements, each of which may be completed and released to customers at different times. During the six months ended December 31, 2007, the Company placed into service and began amortizing $0 of software. The total net book value of software in service at December 31, 2007 is approximately $786,662. During the six months ended December 31, 2007, the Company has capitalized software totaling $209,380. The total net book value of software under development at December 31, 2007 is approximately $2,127,831. At December 31, 2007, total software capitalized at under SFAS No. 86 is approximately $4,312,418 net of accumulated amortization of $1,397,925.
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Inventories
Inventory is stated at the lower of cost or market determined by the first-in, first-out method. Inventories consist primarily of equipment held for resale.
2. ACQUISITION OF PROJECT LIFE CYCLE PARTNERS, LTD.
Effective November 21, 2006, the Company acquired 50% of the outstanding capital stock of Project Life Cycle Partners, Ltd. (“PLC Partners”), a technology consulting firm located in Dublin, Ireland. PLC Partners is a niche project consulting firm specializing in the management and implementation of information systems projects. PLC Partners has international experience within the financial services sector.
The 50% acquisition of PLC Partners was accounted for using the purchase method in accordance with SFAS 141, “Business Combinations”. Total consideration for the transaction was $1,000,000, consisting of $200,000 cash and 2,222,222 shares of the Company's common stock, valued at $0.36 per share based upon a 30-day average closing price per share. The Company also assumed 50%, or approximately $132,000, of PLC's liabilities at the date of acquisition. The Company was required to issue additional shares, capped at a maximum of an additional 50%, since, on the one-year anniversary of the acquisition, the 30-day average closing price per share of the Company's stock was less than $0.36. In November 2007, the Company issued 1,111,111 of additional common shares valued at $192,555. The additional shares were accrued and charged against operations during the three months ended September 30, 2007.
The 50% acquisition of PLC Partners is not a significant acquisition pursuant to Rule 3-01 of regulation S-X of the Securities and Exchange Commission, and the Company is not required to submit pro forma financial statements under Item 9.01(b).
The results of operations for PLC Partners have been included in the Consolidated Statements of Operations since the date of acquisition. The components of the purchase price were as follows:
| Common stock | | $ | 800,000 |
| Cash | | | 200,000 |
| Total | | $ | 1,000,000 |
In accordance with Financial Accounting Standard (SFAS) No. 141, Business Combinations, the total purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The fair value of the assets acquired was based on management's best estimates. The purchase price was allocated to the fair value of assets acquired and liabilities assumed as follows:
| Cash and cash equivalents | | $ | 22,213 | |
| Accounts receivable | | | 273,740 | |
| Equipment and other assets | | | 2,381 | |
| Customer relationships and contracts | | | 982,045 | |
| Subtotal | | | 1,280,379 | |
| Current liabilities | | | (262,423 | ) |
| Minority interest | | | (17,956 | ) |
| Total | | $ | 1,000,000 | |
The financial information in the unaudited table set forth below summarizes the combined results of operations of PLC and Freestar, on a pro forma basis, as though the companies had been combined at the beginning of fiscal year 2007 or July 1, 2006.
The unaudited pro forma condensed combined results of operations do not purport to represent what the companies' combined results of operations would have been if such transaction had occurred at the beginning of the periods presented, and are not necessarily indicative of the Company's future results.
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
| | | Three months ended December 31, | | | Six months ended December 31, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| | | Actual | | | Proforma | | | Actual | | | Proforma | |
| Revenue: | | | | | | | | | | | | |
| Freestar | | | 764,852 | | | | 598,457 | | | | 1,513,370 | | | | 1,060,317 | |
| PLC | | | 683,861 | | | | 365,711 | | | | 1,289,838 | | | | 736,633 | |
| Combined | | | 1,448,713 | | | | 964,168 | | | | 2,803,208 | | | | 1,796,950 | |
| | | | | | | | | | | | | | | | | |
| Net income (loss): | | $ | (4,293,806 | ) | | $ | (2,978,172 | ) | | $ | (9,690,693 | ) | | $ | (5,300,025 | ) |
| | | | | | | | | | | | | | | | | |
| Net loss per share – basic and diluted | | $ | (0.02 | ) | | $ | (0.02 | ) | | $ | (0.05 | ) | | $ | (0.03 | ) |
Pursuant to the terms of the 50% acquisition of PLC, the Company is obligated to issue to the PLC shareholders additional shares of Freestar common stock representing the difference between $800,000 and the value of the FreeStar Shares, calculated based on the one-year closing price. The number of shares issuable pursuant to this calculation was capped at 1,111,111. The one year closing price was calculated as of November 21, 2007. As of such date, the Company owed to the PLC shareholders an additional 1,111,111 shares of common stock with a fair value of $192,555. The Company has accrued this amount to operations during the three months ended September 30, 2007, and the shares were issued during the three months ended December 31, 2007.
3. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
| | | December 31, | | | June 30, |
| | | 2007 | | | 2007 |
| Amounts receivable from customers | | $ | 775,560 | | | $ | 1,032,405 | |
| Less: Reserve for doubtful accounts | | | 56,839 | | | | 54,903 | |
| Accounts receivable, net | | $ | 718,721 | | | $ | 977,502 | |
4. OTHER CURRENT ASSETS
Other current assets consists of the following:
| | | December 31, | | June 30, |
| | | 2007 | | 2007 |
| Prepaid expenses | | $ | 42,003 | | $ | 79,433 |
| Advances to employees | | | 9,773 | | | 12,830 |
| Deposits | | | 41,628 | | | 11,725 |
| | | $ | 93,404 | | $ | 103,988 |
5. INVENTORY
Inventory consists of the Company's Point of Sale Terminals which have been purchased from third party manufacturers. Components of inventories are as follows:
| | | December 31, | | | June 30, | |
| | | 2007 | | | 2007 | |
| Finished goods | | $ | 732,258 | | | $ | 918,947 | |
| Total | | $ | 732,258 | | | $ | 918,947 | |
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
| | | December 31, | | | June 30, | |
| | | 2007 | | | 2007 | |
| Computer equipment | | $ | 201,235 | | | $ | 171,372 | |
| Furniture and office equipment | | | 217,000 | | | | 186,755 | |
| | | | 418,235 | | | | 358,127 | |
| Less: accumulated depreciation | | | (229,146 | ) | | | (170,804 | ) |
| Property and equipment, net | | $ | 189,089 | | | $ | 187,323 | |
Total depreciation and amortization expense for property and equipment amounted to $47,712 and $26,004 for the six months ended December 31, 2007 and 2006, respectively.
7. ACQUISITION OF INTANGIBLE ASSETS
The costs to acquire intangible assets have been allocated to the assets acquired according to the estimated fair values. The Company has adopted SFAS No. 142, Goodwill and Other Intangible Assets, whereby the Company periodically tests its intangible assets for impairment. On an annual basis, and when there is reason to suspect that their values have been diminished or impaired, these assets are tested for impairment, and write-downs will be included in results from operations.
The identifiable intangible assets acquired and their carrying values at December 31, 2007 are:
| | | Gross Carrying Amount | | | Accumulated Amortization | | | Net | | | Residual Value | | Average Amortization Years |
| Amortizable Intangible Assets: | | | | | | | | | | | | | |
| Software and related development costs | | $ | 4,312,418 | | | $ | 1,397,925 | | | $ | 2,914,493 | | | $ | - | | 4.1 |
| Customer Relationships and Contracts | | $ | 2,949,249 | | | $ | 1,003,453 | | | $ | 1,945,796 | | | $ | - | | 9.5 |
| Software Licenses | | $ | 2,261,156 | | | $ | 1,138,767 | | | $ | 1,122,389 | | | $ | - | | 9.5 |
The identifiable intangible assets acquired and their carrying values at June 30, 2007 are:
| | | Gross Carrying Amount | | | Accumulated Amortization | | | Net | | | Residual Value | | Average Amortization Years |
| Amortizable Intangible Assets: | | | | | | | | | | | | | |
| Software and related development costs | | $ | 3,784,354 | | | $ | 1,175,908 | | | $ | 2,608,446 | | | $ | - | | 4.6 |
| Customer Relationships and Contracts | | $ | 2,949,249 | | | $ | 848,493 | | | $ | 2,100,756 | | | $ | - | | 10.0 |
| Software Licenses | | $ | 2,261,156 | | | $ | 1,027,457 | | | $ | 1,233,699 | | | $ | - | | 10.0 |
Total amortization expense charged to operations for the six months ended December 31, 2007 and 2006 was $409,948 and $368,164, respectively.
8. OTHER LONG TERM ASSETS
Other long-term assets at December 31, 2007 and June 30, 2007 consists of prepaid rent of $83,631 and $19,966, respectively.
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities at December 31 and June 30, 2007 are as follows:
| | | December 31, | | June 30, |
| | | 2007 | | 2007 |
| Accounts payable and accrued expenses | | $ | 2,584,404 | | $ | 2,312,644 |
| Accrued payroll and related expenses | | | 317,034 | | | 172,985 |
| | | $ | 2,901,438 | | $ | 2,485,629 |
10. DUE TO RELATED PARTIES
The Company’s President and Chief Executive Officer (“CEO”) and the Company’s Chief Financial Officer (“CFO”) occasionally forego taking their salary payments in order to conserve the Company’s cash. The Company’s CEO has also advanced funds to the Company. These advances accrue interest at the rate of 7% per annum. The CEO and CFO also each receive a car allowance in the amount of $2,140 per month. These car allowances have not yet been paid.
The Company owed the following to these executives for accrued salaries, advances, accrued interest, and car allowance:
| | | December 31, | | June 30, |
| | | 2007 | | 2007 |
| Accrued salaries | | $ | 274,001 | | $ | 131,550 |
| Advances | | | 195,489 | | | 56,126 |
| Accrued Interest | | | 4,179 | | | 264 |
| Accrued car allowance | | | 30,910 | | | 4,044 |
| | | $ | 504,579 | | $ | 191,984 |
11. EQUITY
Minority Interest
Minority interest consists of the minority owned portion of the Company’s 50% owned subsidiary PLC Partners.
Private Placement of Common Stock
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 shares were 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 June 30, 2007, the Company had received cash in the amount $7,169,924 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. The Company also issued to consultants 7,600,000 shares of unregistered common stock with a fair value of $2,912,000; warrants to purchase 12,000,000 shares of common stock at a price of $1.00 per share with a fair value of $2,212,684; and warrants to purchase an additional 1,000,000 shares of common stock at a price of $1.50 with a fair value of $148,086 as commission to consultants related to the March Financing. The Company charged the aggregate amount of $5,272,770 to operations during the twelve months ended June 30, 2006 with regard to the issuance of these shares and warrants.
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
During three months ended September 30, 2007, the Company received an additional $500,000 pursuant to the March Financing, and the Company issued a total of 23,000,000 shares of common stock and warrants to purchase an additional 25,000,000 shares. During the three months ended December 31, 2007, the Company received an additional $465,000 pursuant to the March financing. At December 31, 2007, there remains a total of $1,035,000 due on the 23,000,000 shares which were issued during the quarter. This amount is recorded as Subscriptions Receivable on the Company’s balance sheet at December 31, 2007.
The warrants issued pursuant to the investors in the March Financing are as follows:
| | | | Number of shares of Company Common Stock underlying Warrants |
| Exercise Price Per Share | | | When fully subscribed | | At December 31, 2007 |
| $ | 1.50 | | | | 14,000,000 | | 13,954,348 |
| $ | 2.50 | | | | 11,000,000 | | 10,964,130 |
| $ | 4.50 | | | | 7,000,000 | | 6,977,174 |
| $ | 5.50 | | | | 7,000,000 | | 6,977,174 |
| $ | 6.50 | | | | 7,000,000 | | 6,977,174 |
| $ | 8.50 | | | | 4,000,000 | | 3,986,957 |
| | | | | | 50,000,000 | | 49,836,957 |
All warrants have a two-year exercise period from the date of issuance of the warrants. No registration rights were granted to the Investors in connection with the March Financing and the shares and warrants issued in the March Financing will be restricted securities, subject to the applicable restrictions set forth in Regulation S promulgated under the Securities Act of 1933, as amended.
Sales Of Securities
During the three months ended September 30, 2007, the Company issued the following shares of common stock:
The Company issued 11,225,000 shares of common stock with a fair value of $2,103,375 to consultants for services.
The Company issued 750,000 shares of common stock with a fair value of $163,750 to employees for services.
The Company issued 7,000,000 shares of common stock pursuant to the exercise of an option by a consultant for $700,000 cash.
The Company issued 857,143 shares of common stock pursuant to the conversion of 500,000 shares of Series B preferred stock by a director.
The Company issued 13,000,000 shares of common stock in a financing transaction for cash of $2,600,000 which was received in prior periods.
The Company issued 2,500,000 shares of common stock in a financing transaction for cash of $500,000 received during the three months ended September 30, 2007.
The Company issued 7,500,000 shares of common stock in a financing transaction for subscriptions receivable in the amount of $1,500,000.
The Company adjusted the number of shares issuable to an officer for preferred stock converted to common stock in a prior period. The number of shares issuable was reduced from 14,286 to 0, and this transaction was deemed complete.
During the three months ended December 31, 2007, the Company issued the following shares of common stock:
The Company issued 10,536,000 shares of common stock with a fair value of $1,803,540 to consultants for services.
The Company issued 100,000 shares of common stock with a fair value of $18,000 to an employee for services.
The Company issued 6,196,138 shares of common stock pursuant to the exercise of options by consultants for $792,000 cash.
The Company issued 1,111,110 shares of common stock with a fair value of $192,555 pursuant to the terms of the PLC acquisition.
12. STOCK OPTIONS AND WARRANTS
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Non-Employee Stock Options
The following table summarizes the changes in options outstanding and the related prices for the shares of the Company's common stock issued to the Company consultants. These options were granted in lieu of cash compensation for services performed (amounts have been adjusted to reflect the reverse stock split and other adjustments):
| Range of exercise prices | | | Number of shares outstanding | | | Weighted average remaining contractual life (years) | | | Weighted average exercise price of outstanding options | | | Number of shares exercisable | | | Weighted average exercise price of options |
| $ | 0.15 | | | | 166,666 | | | | 7.7 | | | $ | 0.15 | | | | 166,666 | | | $ | 0.15 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 0.20 | | | | 1,350,000 | | | | 8.8 | | | | 0.20 | | | | 1,350,000 | | | | 0.20 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 0.49 | | | | 756,303 | | | | 5.2 | | | | 0.49 | | | | 756,303 | | | | 0.49 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 0.70 | | | | 756,303 | | | | 5.2 | | | | 0.70 | | | | 756,303 | | | | 0.70 |
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | 3,029,272 | | | | 7.0 | | | $ | 0.39 | | | | 3,029,272 | | | $ | 0.39 |
Transactions involving stock options issued to non-employees are summarized as follows:
| | | Number of Shares | | Weighted Average Exercise Price |
| Options exercisable at June 30, 2007 | | | 3,029,272 | | $ | 0.39 |
| | | | | | | |
| Granted | | | 7,000,000 | �� | | 0.10 |
| Exercised | | | (7,000,000 | ) | | (0.10 |
| Cancelled / Expired | | | - | | | - |
| Options exercisable at September 30, 2007 | | | 3,029,272 | | $ | 0.39 |
| | | | | | | |
| Granted | | | 6,196,138 | | | 0.13 |
| Exercised | | | (6,196,138 | ) | | (0.13 |
| Cancelled / Expired | | | - | | | - |
| Options exercisable at December 31, 2007 | | | 3,029,272 | | $ | 0.39 |
The non-employee stock-based compensation expense recognized in the unaudited condensed consolidated statements of operations for the six months ended December 31, 2007 and 2006 was $1,410,028 and $625,860, respectively.
The weighted-average fair value of stock options granted to non-employees during the six months ended December 31, 2007 and the weighted average significant assumptions used to determine those fair values, using a Black-Scholes option pricing model are as follows:
| Significant assumptions (weighted-average): | | 2007 | | | 2006 | |
| Risk-free interest rate at grant date | | | 4.75 | | | | 4.75 | % |
| Expected stock price volatility | | | 104 | % | | | 108-111 | % |
| Expected dividend payout | | | 0 | | | | 0 | |
| Expected option life (in years) | | | 1.0 | | | | 0.5 | |
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Employee Stock Options
The following table summarizes the changes to employee stock options outstanding and the related prices of the Company's common stock options issued to employees under a non-qualified stock option plan (amounts have been adjusted to reflect the reverse stock split and other adjustments):
| Range of exercise prices | | | Number of shares outstanding | | | Weighted average remaining contractual life (years) | | | Weighted average exercise price of outstanding options | | | Number of shares exercisable | | | Weighted average exercise price of exercisable options | |
| $ | 0.14 | | | | 500,000 | | | | 9.7 | | | $ | 0.14 | | | | 500,00 | | | $ | 0.14 | |
| | 0.15 | | | | 200,000 | | | | 8.4 | | | | 0.15 | | | | 200,000 | | | | 0.15 | |
| | 0.47 | | | | 375,000 | | | | 8.3 | | | | 0.47 | | | | 375,000 | | | | 0.47 | |
| | | | | | 1,075,000 | | | | 9.0 | | | $ | 0.26 | | | | 1,075,000 | | | $ | 0.27 | |
Transactions involving stock options issued to employees are summarized as follows:
| | | Number of Shares | | | Weighted Average
Exercise Price |
| Options outstanding at June 30, 2007 | | | 1,075,000 | | | $ | 0.26 |
| | | | | | | | |
| Granted | | | -- | | | | -- |
| Exercised | | | | | | | -- |
| Cancelled / Expired | | | -- | | | | -- |
| Options outstanding at September 30, 2007 | | | 1,075,000 | | | $ | 0.26 |
| | | | | | | | |
| Granted | | | - | | | | - |
| Exercised | | | - | | | | - |
| Cancelled / Expired | | | - | | | | - |
| Options outstanding at December 31, 2007 | | | 1,075,000 | | | | 0.26 |
| | | | | | | | |
| Non-vested at December 31, 2007 | | | - | | | | - |
| Exercisable at December 31, 2007 | | | 1,075,000 | | | | 1,075,000 |
The employee stock based compensation expense recognized in the unaudited condensed consolidated statements of operations for the six months ended December 31, 2007 and 2006 was $33,892 and $0, respectively.
Warrants
The following table summarizes the warrants outstanding and the related prices of the Company's common stock issued to non-employees of the Company. These warrants were granted instead of cash compensation for services performed and settlement of legal dispute (amounts have been adjusted to reflect the reverse stock split and other adjustments).
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
| Range of exercise prices | | | Number of shares outstanding | | | Weighted average remaining contractual life (years) | | | Weighted average exercise price of outstanding warrants | | | Number of shares exercisable | | | Weighted average exercise price of exercisable options |
| $ | 0.75 | | | | 750,000 | | | | 0.4 | | | $ | 0.75 | | | | 750,000 | | | $ | 0.75 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 0.98-1.00 | | | | 13,392,857 | | | | 1.8 | | | | 0.98-1.00 | | | | 13,392,857 | | | | 0.98-1.00 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 1.50 | | | | 14,954,348 | | | | 0.8 | | | | 1.50 | | | | 14,954,348 | | | | 1.50 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 2.50 | | | | 10,964,130 | | | | 1.0 | | | | 2.50 | | | | 10,964,130 | | | | 2.50 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 4.50 | | | | 6,977,174 | | | | 1.0 | | | | 4.50 | | | | 6,977,174 | | | | 4.50 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 5.50 | | | | 6,977,174 | | | | 1.0 | | | | 5.50 | | | | 6,977,174 | | | | 5.50 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 6.50 | | | | 6,977,174 | | | | 1.0 | | | | 6.50 | | | | 6,977,174 | | | | 6.50 |
| | | | | | | | | | | | | | | | | | | | | | |
| | 8.50 | | | | 3,986,957 | | | | 1.0 | | | | 8.50 | | | | 3,986,957 | | | | 8.50 |
| | | | | | | | | | | | | | | | | | | | | | |
| $ | 3.22 | | | | 64,979,814 | | | | 0.9 | | | $ | 3.22 | | | | 64,979,814 | | | $ | 3.22 |
Transactions involving warrants are summarized as follows:
| | Number of Shares | | Weighted Average Exercise Price |
| Warrants exercisable at June 30, 2007 | | 41,184,600 | | $ | 2.77 |
| Granted | | 25,000,000 | | | 3.96 |
| Exercised | | - | | | - |
| Cancelled / Expired | | - | | | - |
| Warrants exercisable at September 30, 2007 | | 66,184,600 | | $ | 3.22 |
| Granted | | - | | | |
| Exercised | | - | | | |
| Cancelled / Expired | | (1,204,814) | | | 0.214 |
| Warrants exercisable at December 31, 2007 | | 64,979,814 | | | 3.27 |
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
13. SEGMENT INFORMATION
The Company currently operates three business segments: (1) the sale of its hardware terminals and in the Dominican Republic (Dominicana); (2) transaction processing fees and hardware sales generated through its wholly owned subsidiary, Rahaxi Processing Oy; and (3) consulting services offered through its 50% owned subsidiary PLC Partners, LTD. All intercompany transactions, including receivables and payables, are eliminated in consolidation and from the segment amounts presented below.
| | | Three months ended December 31, | | | Six months ended December 31, | |
| | | 2007 | | | 2006 | | | 2007 | | | 2006 | |
| Sales to external customers: | | | | | | | | | | | | |
| Corporate | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| Dominicana | | | 27,240 | | | | - | | | | 95,084 | | | | - | |
| Rahaxi | | | 737,612 | | | | 598,457 | | | | 1,418,286 | | | | 1,060,317 | |
| PLC | | | 683,861 | | | | 213,445 | | | | 1,289,838 | | | | 213,445 | |
| Total sales to external customers: | | $ | 1,448,713 | | | $ | 811,902 | | | $ | 2,803,208 | | | $ | 1,273,762 | |
| | | | | | | | | | | | | | | | | |
| Depreciation and amortization: | | | | | | | | | | | | | | | | |
| Corporate | | $ | 80,849 | | | $ | 1,230 | | | $ | 161,442 | | | $ | 2,460 | |
| Dominicana | | | 3,635 | | | | - | | | | 9,011 | | | | 4,605 | |
| Rahaxi | | | 144,774 | | | | 194,513 | | | | 287,090 | | | | 381,488 | |
| PLC | | | 34 | | | | 5,615 | | | | 117 | | | | - | |
| Total depreciation and amortization: | | $ | 229,292 | | | $ | 201,358 | | | $ | 457,660 | | | $ | 388,553 | |
| | | | | | | | | | | | | | | | | |
| General and administrative expense: | | | | | | | | | | | | | | | | |
| (not including depreciation and amortization) | | | | | | | | | | | | | | | | |
| Corporate | | $ | 3,451,081 | | | $ | 2,017,989 | | | $ | 7,854,957 | | | $ | 3,925,434 | |
| Dominicana | | | 134,700 | | | | 192,463 | | | | 282,896 | | | | 274,388 | |
| Rahaxi | | | 796,856 | | | | 673,392 | | | | 1,497,873 | | | | 971,293 | |
| PLC | | | 149,719 | | | | 58,769 | | | | 227,182 | | | | 58,769 | |
| Total general and administrative expense (not including depreciation and amortization) | | $ | 4,532,356 | | | $ | 2,942,613 | | | $ | 9,862,908 | | | $ | 5,229,884 | |
| | | | | | | | | | | | | | | | | |
| Capital expenditures: | | | | | | | | | | | | | | | | |
| Corporate | | $ | 1,796 | | | $ | - | | | $ | 1,796 | | | $ | - | |
| Dominicana | | | - | | | | 24,317 | | | | - | | | | 24,317 | |
| Rahaxi | | | 127,163 | | | | 176,237 | | | | 242,663 | | | | 356,429 | |
| PLC | | | - | | | | 177,787 | | | | - | | | | 177,787 | |
| Total capital expenditures | | $ | 128,959 | | | $ | 378,341 | | | $ | 244,459 | | | $ | 558,533 | |
| | | | | | | | | | | | | | | | | |
| Operating income (loss): | | | | | | | | | | | | | | | | |
| Corporate | | $ | (3,643,187 | ) | | $ | (2,017,989 | ) | | $ | (8,127,709 | ) | | $ | (3,925,434 | ) |
| Dominicana | | | (128,851 | ) | | | (187,856 | ) | | | (262,072 | ) | | | (274,388 | ) |
| Rahaxi | | | (749,054 | ) | | | (904,110 | ) | | | (1,628,413 | ) | | | (1,380,367 | ) |
| PLC | | | (71,947 | ) | | | (19,463 | ) | | | 67,225 | | | | (19,463 | ) |
| Total operating income (loss) | | $ | (4,593,045 | ) | | $ | (3,129,418 | ) | | $ | (9,950,969 | ) | | $ | (5,599,652 | ) |
| | | | | | | | | | | | | | | | | |
| Interest Expense, Net: | | | | | | | | | | | | | | | | |
| Corporate | | $ | 659 | | | $ | 791 | | | $ | 1,317 | | | $ | 779 | |
| Dominicana | | | 1,342 | | | | - | | | | 1,849 | | | | - | |
| Rahaxi | | | 9,197 | | | | - | | | | 27,245 | | | | - | |
| PLC | | | - | | | | - | | | | - | | | | - | |
| Total Interest Expense | | $ | 11,198 | | | $ | 791 | | | $ | 30,411 | | | $ | 779 | |
| | | | | | | | | | | | | | | | | |
| Segment assets: | | | | | | | | | | | | | | | | |
| Corporate | | $ | 3,174,405 | | | $ | 1,048,140 | | | $ | 3,174,405 | | | $ | 1,048,140 | |
| Dominicana | | | 187,284 | | | | 159,031 | | | | 187,284 | | | | 159,031 | |
| Rahaxi | | | 4,162,897 | | | | 5,860,783 | | | | 4,162,897 | | | | 5,860,783 | |
| PLC | | | 676,400 | | | | 1,451,940 | | | | 676,400 | | | | 1,451,940 | |
| Total segment assets | | $ | 8,200,986 | | | $ | 8,519,894 | | | $ | 8,200,986 | | | $ | 8,519,894 | |
FREESTAR TECHNOLOGY CORPORATON NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
14. SUBSEQUENT EVENTS
Subsequent to December 31, 2007, the Company issued a total of 8,345,500 shares of common stock:
A total of 1,312,500 shares of common stock were issued to consultants for services;
A total of 1,700,000 shares of common stock were issued to a director as compensation;
A total of 5,333,333 shares of common stock were issued pursuant to the exercise of options by a consultant.
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.
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.
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.
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.
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
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.
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%.
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 $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.
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, and an accumulated deficit of $84,626,459.
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 shares were 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 six months thereafter.
As of June 30, 2007, the Company had received cash in the amount $7,169,924 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. The Company also issued to consultants 7,600,000 shares of unregistered common stock with a fair value of $2,912,000; warrants to purchase 12,000,000 shares of common stock at a price of $1.00 per share with a fair value of $2,212,684; and warrants to purchase an additional 1,000,000 shares of common stock at a price of $1.50 with a fair value of $148,086 as commission to consultants related to the March Financing. The Company charged the aggregate amount of $5,272,770 to operations during the twelve months ended June 30, 2006 with regard to the issuance of these shares and warrants.
During three months ended September 30, 2007, the Company received an additional $500,000 pursuant to the March Financing, and the Company issued a total of 23,000,000 shares of common stock and warrants to purchase an additional 25,000,000 shares. During the three months ended December 31, 2007, the Company received an additional $465,000 pursuant to the March financing. At December 31, 2007, there remains a total of $1,035,000 due on the 23,000,000 shares which were issued during the quarter. This amount is recorded as Subscriptions Receivable on the Company’s balance sheet at December 31, 2007.
The independent auditor's report on the Company's June 30, 2007 financial statements included in our Annual Report states that the Company's recurring losses raise substantial doubts about the Company's ability to continue as a going concern. The accompanying financial statements have been prepared assuming that the Company continues as a going concern that contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, the ability of the Company to continue as a going concern on a longer-term basis will be dependent upon its ability to generate sufficient cash flow from operations to meet its obligations on a timely basis, to obtain additional financing, and ultimately, attain profitability.
Management plans to continue raising additional capital through a variety of fund raising methods during fiscal 2008 and to pursue all available financing alternatives in this regard. Management may also consider a variety of potential partnership or strategic alliances to strengthen its financial position. The Company also recently considered selling all or a portion of its assets, although no offers were accepted. Although the Company has been successful in the past in raising capital, no assurance can be given that these sources of financing will continue to be available to us and/or that demand for our equity/debt instruments will be sufficient to meet our capital needs, or that financing will be available on terms favorable to the Company. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. If funding is insufficient at any time in the future, the Company may not be able to take advantage of business opportunities or respond to competitive pressures, or may be required to reduce the scope of its planned product development and marketing efforts, any of which could have a negative impact on its business and operating results. In addition, insufficient funding may have a material adverse effect on the Company's financial condition, which could require the Company to:
· curtail operations significantly;
· sell significant assets;
· seek arrangements with strategic partners or other parties that may require us to relinquish significant rights to products, technologies or markets; or
· explore other strategic alternatives including a merger or sale;
To the extent that we raise additional capital through the sale of equity or convertible debt securities, the issuance of such securities may result in dilution to existing stockholders. If additional funds are raised through the issuance of debt securities, these securities may have rights, preferences and privileges senior to holders of common stock and the terms of such debt could impose restrictions on our operations. Regardless of whether our cash assets prove to be inadequate to meet our operational needs, we may seek to compensate providers of services by issuance of stock in lieu of cash, which may also result in dilution to existing shareholders.
Certain Indebtedness
Paul Egan and Ciaran Egan have delayed payment of a portion of their salary in order to conserve our cash. At December 31, 2007, $179,627 and $94,374 of accrued salaries were owed to Paul Egan and Ciaran Egan, respectively.
Paul Egan has also advanced the funds to the Company. These advances accrue interest at the rate of 7% per annum. At December 31, 2007, the Company owned the amount of $58,507 to Paul Egan for advances, plus $637 of accrued interest.
Pursuant to Paul Egan’s and Ciaran Egan’s employment agreements, the Company provides the officers a car allowance. These allowance have not been paid during the six months ended December 31, 2007. At December 31, 2007, the Company has accrued the amount of $8,559 to Paul Egan and $8,559 to Ciaran Egan for car allowances.
Exchange Rates
Our operations are principally conducted in Finland through our subsidiary Rahaxi, which operates in its local currency, the Euro. We also have operations in the Dominican Republic under the name ePayLatina S.A., and Freestar Dominicana, Inc. operating in its local currency, the Dominican Republic Peso. All assets and liabilities are translated at exchange rates in effect at the end of the year. Accounts for consolidated statements of operations are translated at weighted average rates for the year. Gains and losses from translation of foreign currency into U.S. dollars are included in other comprehensive income (loss). The accumulated foreign currency translation adjustment was $210,600 for the six months ended December 31, 2007.
A significant portion of our revenues and expenses is denominated in currencies other than U.S. dollars; Rahaxi generates its revenue in Euros. Any significant change in exchange rates may have a favorable or negative effect on both our revenues and operational costs. In particular, the value of the U.S. dollar to the Euro impacts our operating results. Our expenses are not necessarily incurred in the currency in which revenue is generated, and, as a result, we are required from time to time to convert currencies to meet our obligations. In addition, a significant portion of our financial statements are prepared in Euro and translated to U.S. dollars for consolidation.
Inflation
The impact of inflation on our costs, and the ability to pass on cost increases to our customers over time is dependent upon market conditions. We are not aware of any inflationary pressures that have had any significant impact on our operations over the past fiscal year, and we do not anticipate that inflationary factors will have a significant impact on future operations.
Off-Balance Sheet Arrangements
We do not maintain off-balance sheet arrangements nor do we participate in non-exchange traded contracts requiring fair value accounting treatment.
Contractual Obligations and Commercial Commitments
The following table of contractual obligations sets forth the contractual obligations of the Company as of December 31, 2007:
| | | | | | Less than | | | 1 - 3 | | | 3- 5 | | | More than |
| Contractual obligation | | Total | | | 1 year | | | years | | | years | | | 5 years |
| Operating lease obligations | | $ | 1,175,904 | | | $ | 303,362 | | | $ | 768,026 | | | $ | 19,677 | | | | - |
Other
We do not provide post-retirement or post-employment benefits requiring charges under Statements of Financial Accounting Standards No. 106 and No. 112.
Critical Accounting Policies
The SEC has issued Financial Reporting Release No. 60, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of a company's financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include: (a) use of estimates in the preparation of financial statements; (b) stock-based compensation arrangements; (c) revenue recognition; and (d) long-lived assets. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our financial statements.
(a) USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates these estimates, including those related to revenue recognition and concentration of credit risk. The Company bases its estimates on historical experience and on various other assumptions that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
(b) STOCK-BASED COMPENSATION ARRANGEMENTS
The Company intends to issue shares of common stock to various individuals and entities for management, legal, consulting and marketing services. These issuances will be valued at the fair market value of the service provided and the number of shares issued is determined, based upon the open market closing price of common stock as of the date of each respective transaction. These transactions will be reflected as a component of selling, general and administrative expenses in the accompanying statement of operations.
(c) REVENUE RECOGNITION
The Company recognizes revenues from contracts in which the Company provides only consulting services as the services are performed. The contractual terms of the agreements dictate the recognition of revenue by the Company. Payments received in advance are deferred until the service is provided.
Contract costs include all direct equipment, material, and labor costs and those indirect costs related to contract performance, such as indirect labor. Selling, general and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in contract performance, contract conditions, and estimated profitability that may result in revisions to costs and income are recognized in the period in which the revisions are determined.
For revenue from product sales, the Company recognizes revenue in accordance with Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition," which superseded SAB No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the fixed nature of the selling prices of the products delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. The Company defers any revenue for which the product has not been delivered or is subject to refund until such time that the Company and the customer jointly determine that the product has been delivered or no refund will be required. SAB No. 104 incorporates Emerging Issues Task Force ("EITF") No. 00-21, "Multiple-Deliverable Revenue Arrangements." EITF No. 00-21 addresses accounting for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The effect of implementing EITF No. 00-21 on the Company's consolidated financial position and results of operations was not significant. This issue addresses determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how the arrangement consideration should be measured and allocated to the separate units of accounting. EITF No. 00-21 became effective for revenue arrangements entered into in periods beginning after June 15, 2003. For revenue arrangements occurring on or after August 1, 2003, the Company revised its revenue recognition policy to comply with the provisions of EITF No. 00-21.
For those contracts which contain multiple deliverables, management must first determine whether each service, or deliverable, meets the separation criteria of EITF No. 00-21. In general, a deliverable (or a group of deliverables) meets the separation criteria if the deliverable has standalone value to the customer and if there is objective and reliable evidence of the fair value of the remaining deliverables in the arrangement. Each deliverable that meets the separation criteria is considered a "separate unit of accounting." Management allocates the total arrangement consideration to each separate unit of accounting based on the relative fair value of each separate unit of accounting. The amount of arrangement consideration that is allocated to a unit of accounting that has already been delivered is limited to the amount that is not contingent upon the delivery of another separate unit of accounting. After the arrangement consideration has been allocated to each separate unit of accounting, management applies the appropriate revenue recognition method for each separate unit of accounting as described previously based on the nature of the arrangement. All deliverables that do not meet the separation criteria of EITF No. 00-21 are combined into one unit of accounting, and the appropriate revenue recognition method is applied.
Processing fee revenue is earned based upon the actual number of transactions processed through the Company's processing system. Transaction processing fees are recognized in the period that the service is performed. These fees are typically charged on a per transaction basis, depending on the arrangement with the customer.
(d) LONG-LIVED ASSETS
Long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value of asset less the cost to sell.
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.
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:
| · | market acceptance of and changes in demand for products and services; |
| · | 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; |
| · | gain or loss of clients or strategic relationships; |
| · | announcement or introduction of new services and products by the Company or by its competitors; |
| · | the ability to upgrade and develop systems and infrastructure to accommodate growth; |
| · | the ability to introduce and market products and services in accordance with market demand; |
| · | changes in governmental regulation; and |
| · | reduction in or delay of capital spending by clients due to the effects of terrorism, war and political instability. |
The Company believes that any future 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 is 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 is 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 point of sale (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 vendor in the Finnish market, as well as companies such as Screenway and Altdata, which are POS software vendors. In addition, the companies with whom we have strategic relationships could develop products or services that 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. Further, the Company expects that its revenue during fiscal 2008 could be significantly affected by the timing and success of the introduction of new products and services during the fiscal year.
(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 new products or services. 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. Market acceptance of the Company's products will be dependent, among other things, upon 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 services 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. 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 effect on the Company's business, financial condition or operating results.
There is a risk that some of the Company's products may infringe the proprietary rights of third parties. In addition, whether or not the Company's products infringe on proprietary rights of third parties, infringement or invalidity claims may be asserted or prosecuted against it and it could incur significant expense in defending them. If any claims or actions are asserted against the Company, it may be required to modify its products or seek licenses for these intellectual property rights. The Company may not be able to modify its products or obtain licenses on commercially reasonable terms, in a timely manner or at all. The Company's failure to do so could have a negative affect on its business and revenues.
(g) DEPENDENCE ON SUPPLIERS
The Company depends upon a number of suppliers for components of its products. There is an inherent risk that certain components of the Company's products will be unavailable for prompt delivery or, in some cases, discontinued. The Company only has limited control over any third-party manufacturer as to quality controls, timeliness of production, deliveries and various other factors. Should the availability of certain components be compromised, it could force the Company to develop alternative designs using other components, which could add to the cost of goods sold and compromise delivery commitments. If the Company is unable to obtain components in a timely manner, at an acceptable cost, or at all, the Company may need to select new suppliers or redesign or reconstruct processes used to build its products. In such an instance, the Company would not be able to manufacture any security devices for a period of time, which could materially adversely affect its business, results from operations, and financial condition.
(h) KEY PERSONNEL
The Company's success is largely dependent on the personal efforts and abilities of its senior management. The loss of certain members of the Company's senior management, including the Company's chief executive officer, chief financial officer and chief technical officer, could have a material adverse effect on the Company's business and prospects.
As needed from time to time, the Company may continue to recruit in fiscal year 2008 employees who are skilled in e-commerce, payment, funds management, payment reconciliation, Internet and other technologies. The failure to recruit these key personnel could have a material adverse effect on the Company's business. As a result, the Company may experience increased compensation costs that may not be offset through either improved productivity or higher revenue. There can be no assurances that we will be successful in retaining existing personnel or in attracting and recruiting experienced qualified personnel.
(i) LIMITATIONS ON LIABILITY AND INDEMNIFICATION
The Company's articles of incorporation and bylaws include provisions to the effect that we may indemnify any director, officer, or employee, as well as limit the liability of such persons. In addition, provisions of Nevada law provide for such indemnification, as well as for a limitation of liability of our directors and officers for monetary damages arising from a breach of their fiduciary duties. Any limitation on the liability of any director or officer, or indemnification of any director, officer, or employee, could result in substantial expenditures being made by the Company in covering any liability of such persons or in indemnifying them.
(j) LITIGATION
As described under Legal Proceedings in our Form 10-KSB for the fiscal year ended June 30, 2007, the Company is subject to one lawsuit. From time to time, the Company is involved in a variety of claims, suits, investigations and proceedings arising from the operation of the Company's business. It is possible that such a matter could arise in the future and be resolved in a manner that ultimately would have a material adverse impact on the Company's business, and could negatively impact its revenues, operating margins, and net income.
(k) OPERATING LOSSES
We have a history of operating losses and we may not be able to meet our obligations or continue operating as a going concern without attracting additional capital. In light of the net losses experienced by us, there can be no assurance that we will be profitable. If we are not profitable, we may not be able to meet our obligations or continue operating as a going concern without attracting additional capital. It is also possible that additional capital may not be available to us. If additional capital is required and is not available, we may not be able to continue operating as a going concern.
(l) IMPLEMENTATION OF SECTION 404 OF THE SARBANS-OXLEY ACT
We may not be able to implement Section 404 of the Sarbanes-Oxley Act on a timely basis. The SEC, as directed by Section 404 of the Sarbanes-Oxley Act, adopted rules generally requiring each public company to include a report of management on the company’s internal controls over financial reporting in its annual report on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal controls over financial reporting. This requirement will first apply to our annual report on Form 10-K for the fiscal year ending June 30, 2008. In addition, commencing with our annual report for the fiscal year ending June 30, 2009 our independent registered accounting firm must attest to and report on management’s assessment of the effectiveness of our internal controls over financial reporting.
We have not yet developed a Section 404 implementation plan. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. How companies should be implementing these new requirements including internal control reforms to comply with Section 404’s requirements and how independent auditors will apply these requirements and test companies’ internal controls, is still reasonably uncertain.
We expect that we will need to hire and/or engage additional personnel and incur incremental costs in order to complete the work required by Section 404. We can not assure you that we will be able to complete a Section 404 plan on a timely basis. Additionally, upon completion of a Section 404 plan, we may not be able to conclude that our internal controls are effective, or in the event that we conclude that our internal controls are effective, our independent accountants may disagree with our assessment and may issue a report that is qualified. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could negatively affect our operating results or cause us to fail to meet our reporting obligations.
ITEM 3. QUALITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
In the normal course of business, operations of the Company are exposed to risks associated with fluctuations in foreign currency exchange rates.
To ensure the adequacy and effectiveness of the Company's foreign exchange positions, the Company continually monitors its foreign currency exposures from an accounting and economic perspective. However, given the inherent limitations of forecasting and the anticipatory nature of the exposures, there can be no assurance that our continual monitoring will offset more than a portion of the adverse financial impact resulting from unfavorable movements in foreign exchange rates.
Foreign Currency Risk
Overall, the Company is a net recipient of currencies other than the U.S. dollar and, as such, benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may negatively affect the Company's consolidated sales and gross margins as expressed in U.S. dollars.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of December 31, 2007, our management carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of our system of disclosure controls and procedures pursuant to the Securities and Exchange Act, Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in internal controls
We determined that there were errors in accounting for the status of certain shares of the Company’s common stock which had been issued pursuant to a financing agreement. The Company previously reported that these shares of stock had been held in escrow, when in fact these shares were improperly in the possession of third parties. During the quarter ended December 31, 2007, the Company completed its review of the relevant controls and procedures.
The Company concluded that escrowing shares should generally be avoided in any future financings. In addition, the Company determined that if any escrows of shares are utilized in subsequent financings, the Company enlist the services of a professional outside escrow company, or utilize legal counsel. In addition, the Company shall require periodic reports or statements confirming the escrowed status of such shares. As described under Legal Proceedings in our Form 10-KSB for the fiscal year ended June 30, 2007, a Federal Court in Nevada ordered that the shares that were inadvertently released from the previous financing escrow have been ordered by to be cancelled and not considered issued or outstanding.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to certain legal proceedings as reported in Part II, Item 1 - "Legal Proceedings" in the Company's Form 10-KSB filed with the SEC on September 28, 2007. During the six months ended December 31, 2007, there were no material changes to the legal proceeding or investigations reported in such 10-KSB.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES.
The Company made the following sales of unregistered (restricted) securities during the quarter ended on December 31, 2007 (not previously reported in a Form 8-K):
In November 2007, the Company issued 250,000 shares of common stock with a fair value of $42,500 to a consultant for services.
In November 2007, the Company issued 186,000 shares of common stock with a fair value of $186,000 to a consultant for services.
In November 2007, the Company issued 100,000 shares of common stock with a fair value of $18,000 to a consultant for services.
In November 2007, the Company issued 1,111,110 shares of common stock pursuant to the provisions of the PLC acquisition.
No commissions were paid in connection with any of these sales. We did not employ any form of general solicitation or advertising in connection with the offer and sale of the securities described below. Except as otherwise noted above, the offer and sale of the securities listed below were made in reliance on the exemption from registration provided by Section 4(2) of the Securities Act or Regulation D or Regulation S promulgated by the Securities and Exchange Commission as transactions by an issuer not involving any public offering.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
SUBSEQUENT EVENTS
ITEM 6. EXHIBITS.
| Number | | Description |
| 31.1 | | Rule 13a-14(a)/15d-14(a) Certification of Paul Egan (filed herewith). |
| 31.2 | | Rule 13a-14(a)/15d-14(a) Certification of Ciaran Egan (filed herewith). |
| 32 | | Section 1350 Certification of Paul Egan and Ciaran Egan (furnished herewith). |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | FREESTAR TECHNOLOGY CORPORATION |
| | |
| | | |
| Date: February 19, 2008 | By: | /s/ Paul Egan |
| | Chief Executive Officer |
| | | |
| | |
| | | |
| Date: February 19, 2008 | By: | /s/ Ciaran Egan |
| | Secretary/Treasurer/ Chief Financial Officer |
EXHIBIT INDEX
| Number | | Description |
| 31.1 | | Rule 13a-14(a)/15d-14(a) Certification of Paul Egan (filed herewith). |
| 31.2 | | Rule 13a-14(a)/15d-14(a) Certification of Ciaran Egan (filed herewith). |
| 32 | | Section 1350 Certification of Paul Egan and Ciaran Egan (furnished herewith). |
