QI Systems (QIIU) 10QSB 2007 Q2 Quarterly report (small business)

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-QSB

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2006

or

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission File Number 000-30948

QI SYSTEMS INC.

(Exact name of registrant as specified in its charter)

Delaware	20-5126146
(State or other jurisdiction of incorporate of organization)	(IRS Employer Identification Number)

609 Cheek Sparger Road, Suite 300; Colleyville, TX 76034

(Address of principal executive offices) (Zip Code)

(817) 485-8111

(Registrant’s telephone number, including area code)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Shares outstanding as of February 12, 2006
Common Stock, par value $0.001 per share	45,544,630

Transitional Small Business Disclosure Format (check one);

Yes o No x

QI SYSTEMS INC.

FORM 10-QSB

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2006

TABLE OF CONTENTS

	PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 2006 and June 30, 2006	4
Consolidated Statements of Income for the three and six months ended December 31, 2006 and 2005	5
Consolidated Statements of Cash Flows for the three and six months ended December 31, 2006 and 2005	6
Notes to Consolidated Financial Statements	9
Item 2. Management's Discussion and Analysis or Plan of Operations	17
Item 3. Controls and Procedures	21
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Securities and Use of Proceeds	21
Item 5. More information	22
Item 6. Exhibits	22
SIGNATURES	22

2

QI SYSTEMS INC.

A Delaware Company

REPORT AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

For Three and Six Months Ended December 31, 2006 and 2005

(Expressed in US dollars)

3

QI SYSTEMS INC.

Interim Consolidated Balance Sheets

December 31, 2006 and June 30, 2006

(Expressed in US Dollars)

(Unaudited)

	December 31, 2006			June 30, 2006
	$			$
Assets
Current
Cash and cash equivalents		102,343			73,559
Receivables		53,459			31,963
Prepaid expenses		5,729			227,566
Inventory		214,934			149,902
		376,465			482,990
Deposit		1,000			1,000
Equipment		32,020			32,680
		409,485			516,670
Liabilities
Current
Payables and accruals		341,702			350,954
Shareholder loans - Note 5		252,789			2,575
Deposits received		36,368			20,059
Unearned revenue		51,211			10,734
		682,070			384,322
Long term shareholder loans - Note 5		154,708			-
		836,778			384,322
Stockholders’ Equity (Deficiency)
Capital stock - Note 6
Authorized: 100,000,000 common stock, $0.001 par value
Issued: 45,544,630 common stock (June 30, 2006: 42,095,756)		45,545			42,096
Additional paid in capital		15,031,421			14,613,929
Accumulated Deficit		(15,450,493	)		(14,508,086	)
Cumulative translation adjustment		(53,766	)		(15,591	)
		(427,293	)		132,348
		409,485			516,670

The accompanying notes are an integral part of these financial statements.

4

QI SYSTEMS INC.

Interim Consolidated Statements of Operations

for the three and six months ended December 31, 2006 and 2005

(Expressed in US Dollars)

(Unaudited)

	Three months ended December 31,						Six months ended December 31,
	2006			2005			2006			2005
	$			$			$			$
Revenue		187,676			72,767			260,721			122,966
Cost of goods sold		108,935			34,319			142,769			53,464
		78,741			38,448			117,952			69,502
Expenses
Administration		134,597			194,755			320,684			369,207
Amortization		2,520			1,173			4,473			2,345
Development costs		26,272			31,936			59,050			80,435
Financing costs and interest		30,807			491			73,745			1,411
Interest on long term debt - Note 5		2,566			-			152,601			-
Investor relations		126,095			125,886			267,115			268,067
Sales and marketing		70,705			31,179			113,889			68,677
Professional fees		37,774			62,122			59,638			77,415
Stock-based compensation		9,850			24,836			9,850			49,263
		441,186			472,378			1,061,045			916,820
Operating loss		(362,445	)		(433,930	)		(943,093	)		(847,318	)
Interest income		639			-			686			-
Gain on settlement of debt		-			42,678			-			42,678
Net loss		(361,806	)		(391,252	)		(942,407	)		(804,640	)
Other comprehensive income:
Foreign currency translation adjustment		27,316			9,212			38,175			33,281
Comprehensive loss		(334,490	)		(382,040	)		(904,232	)		(771,359	)
Net Loss per share - basic and diluted	$	(0.01	)	$	(0.01	)	$	(0.02	)	$	(0.02	)
Weighted average number of shares outstanding		44,822,495			37,792,972			43,459,127			34,232,934

The accompanying notes are an integral part of these financial statements.

5

QI SYSTEMS INC.

Interim Consolidated Statements of Cash Flows

for the three and six months ended December 31, 2006 and 2005

(Expressed in US Dollars)

(Unaudited)

	Six months ended December 31,
	2006			2005
	$			$
Cash Flows related to Operating Activities
Net loss for the period		(942,407	)		(804,640	)
Adjustments to reconcile net loss used in operations
Stock-based compensation		9,850			49,263
Employment Incentive paid with shares		9,256			37,500
Investor relations expense		230,177			222,333
Finance fee		72,468			-
Gain on settlement of debt		-			(42,678	)
Amortization		4,473			2,345
Interest Expense		147,939			-
Inventory write-down		3,542			-
Changes in non-cash working capital items
Receivables		(21,496	)		(39,993	)
Share subscriptions receivable		-			(16,189	)
Prepaid expenses		(5,044	)		202,495
Inventory		(68,464	)		364
Payables and accruals		4,369			(430,172	)
Deposits received		32,586			9,821
Unearned revenue		26,798			-
		(495,953	)		(809,551	)
Cash Flows related to Investing Activity
Investment in capital assets		(3,813	)		(17,681	)

…/cont’d

The accompanying notes are an integral part of these financial statements.

6

Continued

QI SYSTEMS INC.

Interim Consolidated Statements of Cash Flows

for the three and six months ended December 31, 2006 and 2005

(Expressed in US Dollars)

(Unaudited)

	Six months ended December 31,
	2006			2005
	$			$
Cash Flows related to Financing Activities
Proceeds from (repayment of) shareholder loans		404,708			(20,109	)
Proceeds from share issuances, net of issue costs		155,000			992,175
Proceeds from exercise of stock options and warrants		7,500			206,666
		567,208			1,178,732
Effect of foreign currency translation on cash		(38,658	)		(60,665	)
Net increase in cash		28,784			290,835
Cash, beginning		73,559			59,950
Cash and cash equivalents, ending		102,343			350,785

Non-cash transactions - Note 10

The accompanying notes are an integral part of these financial statements.

7

QI SYSTEMS INC.

Interim Consolidated Statements of Stockholders' Equity (Deficiency)

for the year ended June 30, 2006 and for the six months ended December 31, 2006 

(Expressed in US Dollars)

(Unaudited)

							Additional			Share						Cumulative			Stockholders’
	Common Shares						Paid-in			Capital			Accumulated			Translation			Equity
	Number			Par Value*			Capital*			Subscribed			Deficit			Adjustment			(Deficiency)
Balance, June 30, 2005		24,230,053		$	24,230		$	11,962,199		$	692,333		$	(12,718,653	)	$	(86,916	)	$	(126,807	)
Issued pursuant to private placements
for cash		12,620,500			12,620			1,609,430			(270,300	)		-			-			1,351,750
for settlement of debts		241,667			242			36,008			-			-			-			36,250
Issued pursuant to a debt settlement agreement		100,000			100			30,900			-			-			-			31,000
Issued for services		4,292,500			4,293			758,520			(444,063	)		-			-			318,750
Share issue costs		150,000			150			(95,854	)		22,030			-			-			(73,674	)
Stock-based compensation		-			-			58,047			-			-			-			58,047
Exercise of options for cash		32,250			32			4,806			-			-			-			4,838
Exercise of warrants
for cash		966,665			967			192,366			-			-			-			193,333
for settlement of debts		212,121			212			56,757			-			-			-			56,969
Escrow shares cancelled		(750,000	)		(750	)		750			-			-			-			-
Foreign currency translation adjustment		-			-			-			-			-			71,325			71,325
Net loss		-			-			-			-			(1,789,433	)		-			(1,789,433	)
Balance, June 30, 2006		42,095,756			42,096			14,613,929			-			(14,508,086	)		(15,591	)	$	132,348
Issued pursuant to private placements																				-
for cash		2,214,287			2,214			152,786			-			-			-			155,000
for settlement of debts		194,587			195			13,426			-			-			-			13,621
Issued for Services		210,000			210			12,390												12,600
Beneficial conversion feature - Note 5		-			-			150,000			-			-			-			150,000
Stock based compensation		-			-			9,620												9,621
Exercise of stock options for cash		50,000			50			7,450			-			-			-			7,500
Pursuant to loan agreements		780,000			780			71,820			-			-			-			72,600
Foreign currency translation adjustment		-			-			-			-			-			(38,175	)		(38,175	)
Net loss		-			-			-			-			(942,407	)		-			(942,407	)
Balance, December 31, 2006		45,544,630		$	45,545		$	15,031,421		$	-		$	(15,450,493	)	$	(53,766	)	$	(427,293	)

*The par value of common shares has been retroactively restated to reflect a change from no par value to a par value of $0.001 effective July 1, 2006.

The accompanying notes are an integral part of these financial statements.

8

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 1 Interim Reporting

QI Systems Inc. (“QI” or “the Company”) was incorporated in 1978 under the British Columbia Company Act. Effective July 1, 2006, the Company changed its jurisdiction of incorporation to the State of Delaware, USA. The Company manufactures, designs and sells readers that allow the use of cash-card payment systems for self-serve applications such as vending, gaming, laundromat machines, transit fare collection systems and newspaper vending machines.

The accompanying unaudited interim consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and disclosures normally included in annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments and disclosures necessary for a fair presentation of these consolidated financial statements have been included. Such adjustments consist of normal recurring adjustments. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the fiscal year ended June 30, 2006.

The results of operations for the six months ended December 31, 2006 are not indicative of the results that may be expected for the full year.

Note 2 Continuance of Operations

These financial statements have been prepared in accordance with generally accepted accounting principles applicable to a going concern, which assumes that the Company will be able to meet its obligations and continue its operations for its next twelve months. Realization values may be substantially different from carrying values as shown and these financial statements do not give effect to adjustments that would be necessary to the carrying values and classification of assets and liabilities should the Company be unable to continue as a going concern. At December 31, 2006, the Company had not yet achieved profitable operations, has accumulated losses of $15,450,493 since its inception, has a working capital deficit of $305,605 and expects to incur further losses in the development of its business, all of which casts substantial doubt about the Company’s ability to continue as a going concern. The Company’s ability to continue as a going concern is dependent upon its ability to generate future profitable operations and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. Management has no formal plan in place to address this concern but considers that the Company will be able to obtain additional funds by equity financing and/or related party advances; however there is no assurance of additional funding being available.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

9

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 3 Additional Significant Accounting Policy

Beneficial Conversion Feature

When the Company issues convertible debt securities with a non-detachable conversion feature that provides for a rate of conversion that is below market value on the commitment date, it is known as a beneficial conversion feature (“BCF”). Pursuant to Emerging Issues Task Force (“EITF”) Issue No. 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and EITF Issue No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments”, the conversion feature of the security that has characteristics of an equity instrument is measured at its intrinsic value at the commitment date and is recorded as additional paid in capital. A portion of the proceeds of the security issued is allocated to the conversion feature equal to its intrinsic value to a maximum of the proceeds received. The resulting discount of the debt instrument is amortized into income as interest expense over the conversion feature’s vesting period.

Note 4 Related Party Transactions

During the six months ended December 31, 2006, the Company entered into four separate loan agreements with two shareholders of the Company and a related party to one of the shareholders (Note 5). A portion of the proceeds from the loan with the related party to one of the shareholders was used to pay off two earlier loans from the same shareholder.

Note 5 Shareholder Loans

The following borrowing transactions occurred during the six months ended December 31, 2006:

By a loan agreement dated August 4, 2006, the Company was loaned $50,000 by a shareholder of the Company. This loan is unsecured and non-interest bearing. The agreement provides that if the loan is not repaid within 60 days, interest will accrue at a monthly rate of 2% of the principal unpaid balance. As a funding fee for the loan, the Company agreed to issue the shareholder 30,000 shares of the Company's common stock. The shares were issued in October 2006. This loan was subsequently paid off as part of a new loan agreement dated December 18, 2006. Interest accrued on this loan was forgiven.

10

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 5 Shareholder Loans (continued)

By an agreement dated August 31, 2006, the Company was loaned $100,000 by the above noted shareholder. This loan is secured and non-interest bearing. The loan is secured by the Company’s inventory, equipment, trademarks, trade names, contract rights and leasehold interests. The agreement provides that if the loan is not repaid within 90 days, interest will accrue at a monthly rate of 2.5% of the principal unpaid balance. As a funding fee for the loan, the Company agreed to issue the shareholder 250,000 shares of the Company's common stock. The shares were issued in October 2006. This loan was subsequently paid off as part of a new loan agreement dated December 18, 2006. Interest accrued on this loan was forgiven.

By an agreement dated September 5, 2006, the Company was loaned $150,000 by a shareholder of the Company. The subordinated loan has a term of five years; bears interest at 10% per annum and is convertible into common stock of the Company at $0.07 per share. In addition, for each share of common stock issued upon conversion, a warrant to purchase additional shares of common stock of the Company will be issued at an exercise price of $0.20 per share for two years from the date the loan is converted. An amount of $150,000 was recognized during the three months ended September 30, 2006 as the fair value of the beneficial conversion feature of this loan. This amount has been included in interest on long term debt. At December 31, 2006, accrued interest of $4,708 has been recorded.

By an agreement dated December 18, 2006, the Company was loaned $250,000 by a company affiliated with a shareholder. The loan is secured by the Company’s inventory, equipment, trademarks, trade names, contract rights and leasehold interest. The agreement provides that if the loan is not repaid within 90 days, interest will accrue at a monthly rate of 2.5% of the principal unpaid balance. As a funding fee for the loan, the Company issued 500,000 restricted shares of its common stock. As a condition of the loan, the Company agreed to pay off the August 5, 2006 loan for $50,000 and the August 31, 2006 loan for $100,000 from the same shareholder. Interest accrued on those two loans was forgiven.

Note 6 Share Capital - Notes 8 and 9

Share Issuance:

Pursuant to three loan agreements entered into during the six months ended December 31, 2006 with a shareholder of the Company and a related party to the shareholder, the Company issued 30,000 shares valued at $0.17 per share issued in October 2006; 250,000 shares valued at $0.15 per share issued in October 2006; and 500,000 shares valued at $0.06 per share issued in December 2006.

A director of the Company exercised 50,000 share purchase options at $0.15 per share for total proceeds of $7,500. The shares were issued in October 2006.

11

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 6 Share Capital - Notes 8 and 9 (continued)

Share Issuance: (continued)

On October 3, 2006, the Company completed a private placement of 2,408,874 Units at $0.07 per Unit for gross proceeds of $168,621. $13,621 of the proceeds were paid by the settlement of debts outstanding at that time. Each Unit is comprised of one share of common stock of the Company and one share purchase warrant. Each warrant entitles the holder to purchase one share of common stock of the Company at $0.20 per share. The warrants expire on October 3, 2008.

On December 22, 2006, the Company issued 50,000 shares of its common stock at $0.06 to an employee of the Company as part of his employment arrangement.

On December 22, 2006, the Company issued 100,000 shares of its common stock at $0.06 to a consultant to the Company as part of his service agreement.

On December 22, 2006, the Company issued 60,000 shares of its common stock at $0.06 to a related party of an investor relations consultant for services rendered on the Company’s behalf.

Commitments:

Warrants:

On October 3, 2006, pursuant to a private placement, the Company issued 2,408,874 warrants exercisable at $0.20 per share which expire on October 3, 2008.

A summary of the status of the Company's warrant activity as of December 31, 2006 and June 30, 2006 and changes during the period ending on those dates, is presented below:

	December 31, 2006					June 30, 2006
	Number of options			Weighted Average Exercise Price		Number of options			Weighted Average Exercise Price
Outstanding, beginning  of period		14,225,803		$	0.29		6,625,574		$	0.28
Issued		2,408,874		$	0.20		12,862,167		$	0.29
Exercised		-			-		(1,178,786	)	$	0.21
Expired		(8,184,136	)	$	0.26		(4,084,152	)	$	0.30
Outstanding, end of  period		8,450,541		$	0.29		14,225,803		$	0.29

12

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 6 Share Capital - Notes 8 and 9 (continued)

Commitments: (continued)

Warrants: (continued)

Share purchase warrants outstanding to acquire an equal number of common shares as of December 31, 2006 and June 30, 2006 are as follows:

Number of Warrants			Exercise		Expiry
December 31, 2006	June 30, 2006		Price		Date
-		6,820,500	$	0.25		October 30, 2006
-		1,363,636	$	0.30		November 17, 2006
4,641,667		4,641,667	$	0.30		September 01, 2007
1,400,000		1,400,000	$	0.40		June 20, 2008
2,408,874		-	$	0.20		October 3, 2008
8,450,541		14,225,803

Stock Options:

The Company issues stock options as approved by the board of directors to employees, consultants and directors. Options are issued at the fair market price at the time of grant and may be granted for periods of up to five years. The vesting schedule for each grant is determined by the board of directors.

On December 20, 2006 the board of directors granted 2,000,000 options to its directors, employees and certain contractors. The option price is $0.06 per share and will vest quarterly over the next two years. The options will expire on December 20, 2011.

On December 20, 2006, the board of directors repriced 384,000 options issued on December 31, 2002 from an exercised price of $0.50 per share to $0.06 per share. These options remain fully vested and will expire on December 31, 2007.

13

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 6 Share Capital - Notes 8 and 9 (continued)

Commitments: (continued)

Stock Options: (continued)

A summary of the status of the Company's stock option plan as of December 31, 2006 and June 30, 2006 and changes during the period ending on that dates, is presented below:

	December 31, 2006					June 30, 2006
	Number of options			Weighted Average Exercise Price		Number of options			Weighted Average Exercise Price
Outstanding, beginning  of period		1,050,000			(A) 0.12		1,780,500			0.43
Issued		2,000,000			0.06		-			-
Exercised		(50,000	)		0.15		(32,250	)		0.15
Expired		-			-		(167,000	)		1.79
Forfeited		-			-		(531,250	)		0.38
Outstanding, end of  period		3,000,000			0.08		1,050,000			(A) 0.12

(A) Reflects restatement of 384,000 options originally priced at $0.50 per share, repriced to $0.06 per share in December 2006.

Options Outstanding					Options Exercisable
Exercise Price	Number Outstanding at December 31,2006		Weighted Average Remaining Contractual Life (Years)		Number Exercisable at December 31,2006
0.15		616,000		3.00		616,000
0.06		2,384,000		4.33		384,000
		3,000,000		2.49		1,000,000

The options expire December 31, 2007 as to 384,000 options at $0.06 per share; December 31, 2009 as to 616,000 options at $0.15 per share and December 20, 2011 as to 2,000,000 options at $0.06 per share.

14

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 7 Segmented Information

The Company operates in one business segment: the development, manufacture and installation of unattended smartcard applications.

For the six months ended December 31, 2006, revenues by country are as follows:

	2006
	$
Canada		184,705
United States		65,078
Other		10,938
		260,721

As at December 31, 2006, the net book value of capital assets located in Canada and the United States are $9,354 and $22,666, respectively.

During the six months ended December 31, 2006, one customer accounted for 66% of revenues.

Note 8 Commitments and Contingencies

Obligations under the operating leases on office premises are:

	$
Remaining for fiscal period:
2007		39,919
2008		25,618
2009		16,412
		81,949

The Company signed an employment agreement dated December 19, 2005 with the president of the Company whereby the president will receive a salary of $17,500 per month plus $1,000 per month in benefits. In addition, the president is entitled to receive bonuses not to exceed 200% of his salary based on the achievement of certain financial targets. The term of the contract is indefinite.

The Company signed an employment agreement dated March 1, 2006 with an officer of the Company whereby the officer will receive a salary of $13,000 per month plus benefits. In addition, the officer is entitled to receive bonuses not to exceed 150% of his salary based on the achievement of certain financial targets. The term of the contract is indefinite.

15

QI SYSTEMS INC.

Notes to the Interim Consolidated Financial Statements

for the six months ended December 31, 2006

(Expressed in US Dollars)

(Unaudited)

Note 8 Commitments and Contingencies (continued)

On December 5, 2006, the Company signed a service agreement with a consultant to the Company. Pursuant to the agreement, the consultant received 100,000 shares of the Company’s common stock at the start of his assignment and will receive a monthly fee of $8,333 for a period of six months and an additional 100,000 shares of the Company’s restricted common stock after completing six months of service.

A notice of claim has been filed in the Provincial Court of British Columbia against the Company whereby the claimant is claiming $25,000 in damages plus costs from misrepresentation. Management of the Company believes the claim is without merit and is unlikely to succeed.

Note 9 Subsequent Event

In February 2007, the Company received share subscriptions for 1,428,571 Units at $0.07 per Unit for gross proceeds of $100,000. Each Unit is comprised of one restricted share of common stock of the Company and one share purchase warrant. Each warrant entitles the holder to purchase one share of common stock of the Company at $0.20 per share. The warrants will expire in February 2009.

Note 10 Non-cash Transactions

Investing and financing activities that do not have an impact on current cash flows are excluded from the statements of cash flows.

During the six months ended December 31, 2006, the Company issued 780,000 common shares valued at $72,600 as a funding fee pursuant to three shareholder loan agreements. The Company also issued 210,000 common shares valued at $12,600 for services. These transactions have been excluded from the statement of cash flows.

16

Item 2. Management’s Discussion and Analysis or Plan or Operation

Forward Looking Statements

We are including the following cautionary statement in this Form 10-QSB for any forward-looking statements made by, or on behalf of, us. Certain statements contained herein and other materials we file with the Securities and Exchange Commission are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Act of 1934, as amended and, accordingly, involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. Forward-looking statements include statements concerning plans, objectives, goals, strategies, expectations, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. Forward looking statements are accompanied by words such as “may”, “will”, “could”, “should”, “anticipate”, “believe”, “budgeted”, “expect”, “intend”, “plan”, “project”, “potential”, “estimate”, or “future” or variations thereof or similar statements. Our expectations, beliefs and projections are expressed in good faith and are believed by us to have a reasonable basis, including without limitation, management's examination of historical operating trends, data contained in our records and other data available from third parties, but we cannot assure you that management's expectations, beliefs or projections will result or be achieved or accomplished.

Our Business

We operate as a designer, developer and marketer of hardware and software for smart cards. We are a leading supplier of smart card systems for various vertical markets including vending machines, parking meters, gaming, photocopiers, laundry machines and water operators. Our products have been installed in Canada, the United States of America, Venezuela, the United Kingdom and Norway.

Results of Operations

Three Months Ended December 31, 2006 and 2005

Revenues during the three months ended December 31, 2006 were $187,676, primarily derived from the sale of smart cards and ancillary products to our client base, fundamentally within the parking and newspaper vending industries. Sales of our products in the first quarter of fiscal 2007 increased 157% from sales achieved in the preceding quarter. This represents $114,631 in additional sales. Sales continue to be concentrated in a few clients. Sales in the second quarter of fiscal 2007 increased by $114,909, or158%, over sales in the comparative fiscal 2006 period. The increase in sales is the result of demand changes from our most significant clients in the parking and newspaper vending industries.

We incurred a net loss of $361,806 in the quarter ended December 31, 2006 and have incurred losses in past periods. Losses were funded by the receipt of share capital and the exercise of stock purchase warrants. We expect to be able to fund working capital requirements in future periods with cash flow from operations and the issuance of equity.

Cost of sales during the period was $108,935, which represents 58% of sales, an increase from total cost of sales of $34,319, or 47% of sales, in the comparative quarter. Gross margins were $78,741 or42% of sales (comparative quarter: 53% of sales).

Our expenses in the quarter are categorized as administration, amortization, development costs, financing costs and interest, investor relations, sales and marketing and professional fees.

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During the second quarter of fiscal 2007, administration expenses were $134,597 (comparative period: $194,755), which include the following three major expenses: salaries and benefits paid to employees performing administrative duties, foreign exchange expense (most of which is unrealized and refers to adjustments of monetary items at quarter end) and rent expense.

Development costs in the quarter ended December 31, 2006 were $26,272 (comparative period: $31,936), of which the most significant expense was for salaries and benefits paid to employees involved in the development of our products. We anticipate that development costs will increase in fiscal 2007 to accommodate our projected increased commercial activity.

Financing costs of $30,807 during the three months ended December 31, 2006 included $30,000 relating to the fair value of shares issued to a shareholder as funding fees for a loan made to us.

During the quarter ended December 31, 2006, we incurred investor relations expenses of $126,095, (comparative period $125,886), most of which refers to the amortization of the cost attributed to shares committed for issuance to investor relations providers. Other costs are for consulting fees provided to us relating to investor relations services.

Sales and marketing expense in the quarter ended December 31, 2006 totalled $70,705 (comparative period: $31,179), which consists fundamentally of salaries, commissions and benefits.

Professional fees of $37,774 during the quarter (comparative quarter $62,122) were for audit and legal fees incurred in connection with regulatory and compliance work. It is expected that fiscal 2007 professional fees will be lower than those in the prior year due to the completion of our change in domicile at the end of fiscal 2006.

We recorded an operating loss of $362,445 in the quarter ended December 31, 2006, compared to an operating loss of $433,930 in the three months ended December 31, 2005. In the quarter ended December 31, 2006, we posted a net loss of $361,806, or $0.01 per share, compared to a net loss of $391,252 or $0.01 per share in the comparative period.

During the quarter, we invested in $3,813 of capital equipment compared to $8,276 in the comparative quarter of fiscal 2006. We will face the need to incur capital expenditures in fiscal 2007 to upgrade certain hardware used by our employees to perform their development duties.

At December 31, 2006, our cash position was $102,343, with a working capital deficit of $305,605.

Six Months Ended December 31, 2006 and 2005

Revenues during the six months ended December 31, 2006 were $260,721, primarily derived from the sale of smart cards and ancillary products to our client base, fundamentally within the parking and newspaper vending industries. Sales continue to be concentrated in a few clients. Sales in the first six months of fiscal 2007 increased by $137,755, or 112%, from sales in the comparative fiscal 2006 period. The increase in sales is the result of demand changes from our most significant clients in the parking and newspaper vending industries.

Cost of sales during the period was $142,769, which represents 55% of sales, an increase from a total cost of sales of $53,464, or 44% of sales, in the comparative six-month period. Gross margins were $117,952 or 45% of sales (comparative six month period quarter: 56% of sales).

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During the first six months of fiscal 2007, administration expenses were $320,684 (comparative period: $369,207), which include the following three major expenses: salaries and benefits paid to employees performing administrative duties, foreign exchange expense (most of which is unrealized and refers to adjustments of monetary items at each quarter end) and rent expense.

Development costs in the six months ended December 31, 2006 were $59,050 (comparative period: $80,435), of which the most significant expense was for salaries and benefits paid to employees involved in the development of our products. We anticipate that development costs will increase in fiscal 2007 to accommodate our projected increased commercial activity.

Financing costs of $73,745 during the six months ended December 31, 2006 included $72,600 relating to the fair value of shares issued to a shareholder as funding fees for loans made to us. During the comparative six month period, we had no formal debt and our financing costs were only $1,411.

Interest expense on long term debt of $152,601 in the six months ended December 31, 2006 included $147,939 of beneficial conversion expense relating to a loan agreement with one of our shareholders.

During the six months ended December 31, 2006, we incurred investor relations expenses of $267,115, (comparative period $268,067), most of which refers to the non-cash amortization of the cost attributed to shares committed for issuance to investor relations providers. Other costs are for consulting fees provided to us relating to investor relations services.

Sales and marketing expense in the six months ended December 31, 2006 totalled $113,889 (comparative period: $68,677), consisting fundamentally of salaries and benefits. The increase is attributable to salary and commissions earned by our VP of Business Development who was not an employee in the comparable six month period.

Professional fees of $59,638 during the six months in fiscal 2007 decreased over the prior year’s expense of $77,415. Current expenses are primarily for audit and legal fees incurred in connection with regulatory and compliance work. It is expected that future professional fees will continue to be lower than those in the current six months due to the completion of our change in domicile at the end of fiscal 2006.

We recorded an operating loss of $943,093 in the six months ended December 31, 2006, compared to an operating loss of $847,318 in the six months ended December 31, 2005. In the six months ended December 31, 2006, we posted a net loss of $942,407, or $0.02 per share, compared to a net loss of $804,640 or $0.02 per share in the comparative period.

During the six months ended December 31, 2006, we invested in $3,813 of capital equipment compared to $17,681 in the comparative six months of fiscal 2006. We will face the need to incur capital expenditures in fiscal 2007 to upgrade certain hardware used by our employees to perform their development duties.

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Summary of Quarterly Results

	Qtr ended Dec. 31, 2006			Qtr ended Sept. 30, 2006			Qtr ended June 30, 2006			Qtr ended March 31, 2006
Total revenues	$	187,676		$	73,045		$	26,715		$	256,487
(Net loss)		(361,806	)		(580,601	)		(669,563	)		(315,229	)
(Loss) per share, basic and diluted		(0.01	)		(0.01	)		(0.02	)		(0.01	)

	Qtr ended Dec. 31, 2005			Qtr ended Sept. 30, 2005			Qtr ended June 30, 2005			Qtr ended March 31, 2005
Total revenues	$	72,767		$	50,199		$	22,382		$	96,208
(Net loss)		(391,252	)		(413,389	)		(549,745	)		(181,897	)
(Loss) per share, basic and diluted		(0.01	)		(0.01	)		(0.02	)		(0.01	)

Liquidity and Capital Resources

We have incurred operating losses in the reporting period and in past periods. Our ability to continue operating as a going concern is contingent on our ability to rely on equity or debt financing to cover operating deficits until such time as our operations become cash neutral or cash positive.

In December 2006, we became obligated to repay a secured, non-interest bearing loan in the amount of $250,000 to a company affiliated with a shareholder. The agreement, pursuant to which the loan was made, provides that if the loan is not repaid within 90 days, interest will accrue at a monthly rate of 2.5% of the principal unpaid balance. As a funding fee for the loan, we issued 500,000 restricted shares of our common stock. As a condition of the loan, we agreed to pay off the August 5, 2006 loan for $50,000 and the August 31, 2006 loan for $100,000 from the same shareholder. Interest accrued on these two loans was forgiven.

On October 3, 2006, we completed a private placement of 2,408,873 units at $0.07 per unit for total proceeds of $168,621. Each unit is comprised of one common share and one share purchase warrant. Each warrant entitles the holder to purchase one common share at $0.20 per share until October 3, 2008.

In February 2007, we completed a private placement of 1,428,571 units at seven cents ($0.07) per unit for gross proceeds of $100,000. Each unit is comprised of one restricted share of our common stock and one share purchase warrant. Each warrant entitles the holder to purchase one share of our common stock at $0.20 per share. The warrants expire in February 2009.

As disclosed in Results of Operations, we posted a net loss in the six months ended December 31, 2006 of $942,407. Losses in subsequent periods will be reduced or eliminated if we are able to secure sales streams that are still not fully in place at the date of this report. Even if we achieve decreasing quarterly losses in subsequent periods, we still may face the need to raise additional funding in the capital markets or through further short or long-term debt in the near future, until we can achieve positive cash flows from operations.

We are not currently committed to further capital expenditures for the purchase of property, plant and equipment.

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Item 3. Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

Our principal executive officer and principal financial officer have evaluated our disclosure controls and procedures as of December 31, 2006. Based on this evaluation, they conclude that the disclosure controls and procedures effectively ensure that the information required to be disclosed in our filings and submissions under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.

(b) Changes in internal controls.

There were no changes in our internal controls over financial reporting, known to the principal executive and principal financial officer that occurred during the period of this report, that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On August 9, 2006, we committed to issue 30,000 shares of our common stock to a shareholder as a funding fee for the loan he made to us in the principal amount of $50,000. The shares were issued in October 2006.

On August 31, 2006, we committed to issue 250,000 shares of our common stock to the same shareholder as a funding fee for a second loan he made to us in the principal amount of $100,000. The shares were issued in October 2006.

On September 5, 2006, we were loaned $150,000 by another shareholder. The subordinated loan has a term of five years, bears interest at 10% per annum and is convertible into our common stock at a price of $0.07 per share. In addition, for each share of common stock issued, a warrant to purchase additional shares of our common stock will be issued to the shareholder at an exercise price of $0.20 per share for two years from the date the loan is converted.

On October 3, 2006, we completed a private placement of 2,408,873 units at $0.07 per Unit for total proceeds of $168,621. Each Unit is comprised of one common share and one share purchase warrant. Each warrant entitles the holder to purchase one common share at $0.20 per share until October 3, 2008.

On December 21, 2006, we committed to issue 500,000 shares of our common stock to an affiliated company of a shareholder as a funding fee for a loan made to us in the principal amount of $250,000. The shares were issued in December 2006.

On February 12, 2007, we completed a private placement of 1,428,571 units (the "Units") at seven cents ($0.07) per unit for gross proceeds of $100,000. Each unit is comprised of one restricted share of our common stock and one share purchase warrant. Each warrant entitles the holder to purchase one share of our common stock at $0.20 per share until February 2009.

All of the above offerings and sales were deemed to be exempt under Regulation D of the Securities Act of 1933, as amended. No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors and transfer was restricted by us in accordance with the requirements of the Securities Act of 1933, as amended. In addition to representations by the above-referenced persons, we have made independent determinations that all of the above-referenced persons were accredited or sophisticated investors, and that they were capable of analyzing the merits and risks of their investment, and that they understood the speculative nature of their investment. Furthermore, all of the above-referenced persons were provided with access to our Securities and Exchange Commission filings.

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Item 5. Other Information

On February 12, 2007, we closed a private placement transaction to an accredited investor. For more information on this private placement, please refer to Part II, Item 2 (Unregistered Sales of Equity Securities and Use of Proceeds) of this Report.

Item 6. Exhibits

The following are exhibits to this report:

Exhibit No.	Description
3.1	Certificate of Incorporation of QI Systems Inc., filed as an exhibit to Form 8-A of QI Systems Inc. filed with the Securities and Exchange Commission on July 3, 2006 and incorporated by reference herein.
3.2	Bylaws of QI Systems Inc., filed as an exhibit to Form 8-A of QI Systems Inc. filed with the Securities and Exchange Commission on July 3, 2006 and incorporated by reference herein.
10.1	Form of Subscription Agreement, filed as an exhibit to our current report on Form 8-K, filed with the Securities and Exchange Commission on October 4, 2006 and incorporated by reference herein.
*31.1	Certifications of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
*31.2	Certifications of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
*32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

______________

*Filed herewith

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	QI SYSTEMS INC.
	(Registrant)
Date: February 14, 2007	By:	/s/ Steven R. Garman
	Steven R. Garman
	President and Chief Executive Officer
Date: February 14, 2007	By:	/s/ Robert I. McLean Jr.
	Robert I. McLean Jr.
	Chief Financial Officer (Chief Accounting Officer) and Chief Operating Officer

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