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2002
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
<Table>
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-30045
</Table>
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CATUITY, INC.
(Exact name of registrant as specified in its charter)
------------------------
<Table>
DELAWARE 38-3518829
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No)
2711 E. JEFFERSON AVE., DETROIT MICHIGAN 48207
(Address of principal executive offices) (Zip code)
</Table>
Registrant's telephone number, including area code (313) 567-4348
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common stock, par
value $.001 per share
NASDAQ Small Cap Market Australian Stock Exchange
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
At June 30, 2002 the aggregate market value of voting and non-voting stock
held by non-affiliates of the Registrant totaled approximately $24,211,014 based
on the last sale price as reported on the Nasdaq Small Cap Market. As of June
30, 2002 there were 8,070,338 shares of the Registrant's common stock
outstanding, par value $.001 per share.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant incorporates the information required by Items 11, 12, and
13 by reference to its proxy statement to be furnished to shareholders for its
Annual Meeting of Shareholders to be held in May 2003.
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FORWARD LOOKING INFORMATION
This document includes "forward-looking" statements within the meaning of
the Private Securities Litigation Act of 1995. This Act provides a "safe harbor"
for forward-looking statements to encourage companies to provide prospective
information so long as they identify these statements as forward-looking and
provide meaningful cautionary statements identifying important factors that
could cause actual results to differ from the expected results. All statements
other than statements of historical fact made in this document are forward
looking. In some cases, they can be identified by terminology such as "may,"
"will," "should," "expect," "plan," "anticipate," "believe," "estimate,"
"predict," "potential," or "continue," the negative of such terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
consider various factors that may cause actual results to differ materially from
any forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee our future results, levels of
activity, performance or achievement. Moreover, neither we nor any other person
assumes liability for the accuracy and completeness of the forward-looking
statements. Actual results may differ materially from those projected as a
result of certain risks and uncertainties, including but not limited to;
currency exchange rates, inflation rates, recession, and other external economic
factors over which the Company has no control; the timing and speed with which
major customers and prospects execute their plans for the use of loyalty and/or
smart cards; the demand for, timing and market acceptance of, new and existing
smart card products; continued development of the Company's software products;
competitive product and pricing pressures; patent and other litigation risk; the
risks of key staff leaving the Company; the risk that major customers of the
Company's products, including Visa, reduce their requirements or terminate their
arrangements with the Company; as well as other risks and uncertainties,
including but not limited to those detailed from time to time in the Company's
Securities and Exchange Commission filings. These forward-looking statements are
made only as of the date hereof, and the Company undertakes no obligation to
update or revise the forward-looking statements, whether as a result of new
information, future events or otherwise.
PART I
ITEM 1. BUSINESS
Introduction
Catuity is a software company that provides a real time multi-program
marketing platform for loyalty and incentive programs delivered at the point of
sale during the transaction process.
Our software, referred to here as the "Catuity System", delivers historical
purchase information about the consumer to the point of sale at the time of a
transaction. This capability is critical to:
- rewarding and encouraging profitable customer behavior
- enhancing the consumer's experience;
- creating habits and changing behavior; and
- the success of customer relationship management (CRM) programs.
The Catuity System empowers businesses to design, deliver and administer
consumer incentive and loyalty programs, based on this information. The Catuity
System can operate in almost any point of sale (POS) environment -- from
large-scale multi-lane retail chains, to "mom and pop" convenience stores, to
pure e-commerce retailers.
2
The Catuity System addresses the complete marketing lifecycle, irrespective
of the sales channel.
CREATING UNIQUE DIFFERENTIATED VALUE
IN A DYNAMIC MARKETING LOOP
[FLOW GRAPH]
Data derived from the use of the Catuity System allows for customer
profitability analysis and the building of long-term relationships directly
between issuers, merchants and product suppliers and their consumers based on
purchase behavioral data and value.
Real time consumer loyalty and incentive programs are increasingly viewed
as a key strategic corporate imperative and central to the future success of CRM
programs.
Our product adds value to traditional merchant/customer relationships by
supporting the following functions:
- Immediate redemption at the point of sale, at the time of the
transaction. Many industry participants are able to analyse data but few
are able to deliver a reward or incentive at the point of sale at the
time of transaction when customers are truly engaged;
- Creating a new range of loyalty and incentive program options including
new relationship options to retain more customers, increase customer
spend and attract new customers. The Catuity System answers the basic
who, what, when and where marketing questions and regardless of what
channel or what technology supports the sale, the Catuity System ensures
the consumer experience and the message are consistent;
- Seamless migration path from existing technologies (such as mag stripe
cards and older POS terminals) to new technologies (such as smart cards,
next generation POS devices and the web) without changing software or
loyalty program dynamics. The Catuity System can provide a consistent
program implementation across a range of sales channels and a wide range
of transaction and consumer devices;
- Utilizing the transaction data generated by the Catuity System in
combination with data from the legacy systems to enhance customer
relationships and create more meaningful relationship and marketing
decisions reducing the operations and fulfilment costs of incentive and
loyalty programs while providing timely and meaningful information to
deliver a strong return on investment (ROI).
3
INDUSTRY SUMMARY
The loyalty and incentive industry is an estimated $85 billion industry(1);
The amount spent on rewards and fulfillment spending totals 17% of the loyalty
and incentives market, while software and services accounts for another 18%.
These two spending categories, totaling 35% of the total amount spent by
industry participants in this category, most directly relate to Catuity
activity.
Catuity fits into the industry as follows:
- The Catuity System is a fulfillment delivery platform, and optimizes the
rewards and fulfillment process -- generally reducing costs of
traditional delivery incentive delivery methods
- The true value of the Catuity System is realized by those companies that
are able to optimize their systems to utilize data from the Catuity
system in conjunction with the data stored in data warehouses.
- Purchasing of the Catuity System would be budgeted within the software
and services segment ($15.1 billion) and periodically from the data
warehouse segment ($19.6 billion)
- The Catuity System delivers a rich data stream to the Customer Relation
Management/Analytics segment of the market.
Effective CRM utilizes the features offered by the Catuity System. The CRM
space is one of the most active with amounts spent on "analytical" CRM growing
at almost double the rate of "operational" CRM systems. Driving this growth is
the increasing evidence that using customer data to improve the bottom line has
a significant ROI. IDC Consulting Group estimated that investment in customer
strategy related to CRM resulted in a median ROI of 55%.
These numbers are significant. A CRM system once fully utilized requires a
way to deliver incentives or rewards in a targeted fashion; therefore growth and
optimization of CRM systems and activity will positively impact demand for the
Catuity System.
- ---------------
(1) Source: Kahmann Elements report dated August 2002; Altamont Partners;
IDC Consulting Group
4
In total, there are approximately 24 million business establishments in the
United States. Retailers that Catuity considers part of the targeted market make
up an estimated 12.5 million of that number. Broken down by segments, the
targeted markets are as follows:
<Table>
<Caption>
ESTIMATED NUMBER OF
MERCHANT SEGMENTS NUMBER OF STORES(2) POS DEVICES
- ----------------- ------------------- -------------------
Integrated Retail Segment
Multilane..................................... 200,000
Department Store.............................. 5,000
Entertainment & Leisure....................... 2.5 million 6.2 million(3)
General Retail
General Retail................................ 3.3 million
Small Retail.................................. 6.1 million 11 million(4)
Total........................................... 12 million 17.2 million
</Table>
The number of Americans having loyalty cards has more than doubled since 2001,
with 55% of Americans owning at least one loyalty card. Perhaps more
importantly, participation increases as income rises. Among households with
annual income over $75,000, participation is 71%. Once enrolled, participants
increase spending by 27% on average, visit the store more frequently (43% of
participants), and are more likely to choose one store exclusively (16%).(5)
THE MARKET SEGMENTATION
Catuity divides the market into three major segments: the Issuer segment;
the Integrated Retail segment and General Retail segment.
ISSUER SEGMENT
Primary customers within the Issuing Segment are banks that are issuing
Visa branded cards, MasterCard branded cards or affinity and co-branded cards.
We are approaching this segment both through the card associations and directly
to the larger card issuing banks.
Some of the larger merchants in the Integrated Retail Segment are also
large card issuers, particularly of private label or co-branded cards. These
merchants are a prime market target for Catuity.
The Issuers primarily license the Consumer Profile creation software from
Catuity.
The Issuers see the value of loyalty programs being in retention of
customers, increasing spend, and acquisition of new customers. Loyalty and
incentive program allow payment card issuers to differentiate their product from
other products.
- ---------------
(2) Catuity estimate from: US Internal Revenue Service, 1998 Statistics of
Income various publications. Count of tax returns from active retail
enterprises.
(3) Catuity estimate from various sources including major customers and
major industry players
(4) Nilson Report; January 2003
(5) Source: Incentive Magazine report dated November 1, 2002
5
The number of cards on issue in North America is as follows:
<Table>
<Caption>
SMART CARDS MAGNETIC STRIPE
2001 ----------- ---------------
NORTH AMERICA IN MILLIONS
Secure Payment Cards (Visa, MasterCard, Amex)........... 21.0 651.3(6)
Private Label and Loyalty Only Cards (excluding gift)... 20.0 636.9(8)
Total................................................... 41.0(7) 1,288.2
</Table>
There are now approximately 13 million secure payment smart Visa cards in the
United States loaded with the Catuity smart card applet. This represents more
than 60% of all smart payment cards and more than 90% of all smart payment cards
embedded with loyalty applications.
The Catuity System applies to all cards in the above chart because it can
provide a multi-program platform across the full spectrum of card technologies.
Therefore the North American market available to Catuity, excluding gift cards,
is estimated to be 1.3 billion cards.
INTEGRATED RETAILER SEGMENT
Customers within the Integrated Retail segment generally have the size and
market authority to cause customization of the Catuity Systems. These customers
are:
- Integrated Retailers:
- Multi Lane retailers are generally supermarkets, and mass merchants.
They have multiple checkout lanes at a centralized location.
- Department Stores are retailers whose environment is characterized by
payment location being in an "island" in each department.
- Convenience store (C-store)/Petroleum chains with large numbers of
outlets.
- Leisure and Entertainment. Restaurants, theatres, entertainment venues
- Private label merchant issuer. Note the private label issuer may be a
member of any one of the above merchant groups, or they may be a
stand-alone entity that has created private label programs for the
integrated market.
- Transaction processors and acquirers that cater to these merchants.
Integrated Retailers can license the complete Catuity System and operate
the system themselves. If the customer in this segment outsources payment
processing, the customer will need a processor to enter into a license for the
Catuity System.
While the card product is often run as a credit or charge card tool, and
many of the same metrics that face banks also face these issuers, there is a
strong retailing component. The card today is both a payment and a
communication/marketing medium. Traditionally the communication has been largely
blanket type advertising communication, and the marketing efforts take the form
of statement "stuffers" and direct marketing efforts weeks after the original
transaction. The Catuity System offers the opportunity to create instant
communication and marketing incentives and rewards at the time and place of
transaction.
- ---------------
(6) Nilson Report: December 2002
(7) Catuity estimate compiled based on industry sources
(8) Nilson Report: May 2002
6
Within the Integrated Retail segment Catuity approaches prospects based on
their size or market place significance (called a "tier"). Catuity will sell
directly to large merchants (i.e. tier one and larger tier two merchants). Our
sales efforts will be focused on those tier one merchant's that have a clearly
understood need for a system such as Catuity's. We leverage our Channel Partners
such as the payment associations, payment acquirers/processors, and merchant
services organizations when approaching these opportunities. Our Channel
Partners will largely be used to address the tier two and tier three
opportunities.
The value proposition is crucial to this segment. They find value in the
Catuity System:
- For acquisition, activation and retention marketing programs and
coalition marketing programs.
- Creating a richer communications medium that is innovative and
differentiated.
- Automating the current paper coupon process. Today's process for
distributing and redeeming coupons is very unfocused from a marketing
perspective, and operationally awkward and costly.
GENERAL RETAIL (SMALL RETAIL) SEGMENTS
The small to medium size retailer has neither the size nor resources to
customize the Catuity System so they accept the offering of their payment
processor or independent sales organizations (ISO's). Catuity's customers are
therefore these processors and ISO's who license our software and install
systems to re-sell services to the small retailers. These processors and ISO's
are Channel Partners of Catuity.
This segment is generally characterized by stand-alone non-integrated POS
devices, and a relatively simplistic view towards loyalty. The value of loyalty
is perceived as an extension of the gift card activity. These merchants expect a
very "packaged" product and selling process. While the packaged nature of this
segment places demands on Catuity from a product perspective, it significantly
reduces the integration effort, resulting in a quicker sales cycle than the
Integrated Retail segments.
OUR PRODUCT
Catuity provides application software that allows users to establish and
self administer customer incentive and loyalty programs, integrated to the
payment system. Our software is targeted to a broad range of sellers of goods
and services. It is especially useful for merchants who sell both through store
locations and over the Internet.
Our software supports the establishment and administration of a variety of
customer incentive and loyalty programs. Using our software, a merchant may
reward its customers with valuable benefits, hoping to attract and retain
customers and to encourage increased purchases. Due to the flexibility of our
software, reward programs may easily be established, targeted and changed. In
addition, a merchant may select from a wide variety of reward options including
using their own goods and services as a reward option. Our software directly
connects the merchant and its customer so that the customer recognizes the
merchant as the provider of the reward. The Catuity System is fully developed,
tested and packaged ready for installation.
SYSTEM FEATURES
- Multiple issuers and merchants on a single system
- Multiple terminals per merchant
- Multiple card groups per issuer
7
- Linking programs to one or a group of terminals over one or a group of
merchants
- Linking programs to one or a selection of issuer card groups over one or
many issuers
- Optional downloading of offers from the web or kiosk to be used in-store
- Optional automatic cardholder program enrollment at POS
- Customer opt-in/opt-out
- Card reinstatement at POS and Web due to card replacement (e.g.
lost/stolen/damaged/expired)
- Interfaces to financial clearing systems (e.g. ACH) for settlement of
fees and commissions
- Card blocking
- Product based reward programs based on SKU and UPC barcode data
- Protected data access by issuer
- XML based data extracts
- Multiple accumulation options: by value, frequency, products, payment
method, ratios, date ranges
- Multiple redemption options: automatic, manual, delayed, immediate, fixed
$ discount, % discount, product discount
- Multiple accumulations and redemptions on a single transaction
- Offline and Online Implementations
- Concurrent use of smart cards, memory cards and magnetic stripe cards
- Integration with widely used POS payment terminal applications and
payment methods (e.g. Cash, Debit, Credit, RFID)
- Stored value gift cards and electronic purse
- Electronic tickets and passes
- Multilingual POS applications
- Data protection, authentication, monitoring and auditing
- Hardware or software based key management
- Central program management control and automated program distribution
- The automation of the couponing process to support e-coupons
- The ability to deliver personalized messages to the consumer based on
current or desired behaviors
- Comprehensive reporting capability
REWARD ELIGIBILITY
Our product focuses on the delivery of loyalty rewards and incentives at
the time and point of the transaction. These rewards may be instant or delayed,
depending on the marketers requirements. Our product permits a merchant, a
product supplier or issuer to offer a broad range of reward eligibility,
including rewards that are:
- Triggered by reaching pre-set spending levels or performing specified
purchase activities based on:
- the value of the activities;
- the frequency of the activities;
8
- the product or group of products purchased; or
- the timing of the activities;
- Triggered by conducting specified activities at one, or a range of,
merchants (e.g. cross-sells) or on a particular card or using a
particular method of payment;
- Tiered based upon one, or a range of, activities or activity levels;
- Increased or accelerated based on achieving certain activity levels;
REWARD TYPES
The types of rewards that the merchant, product supplier or issuer may
choose to offer the customer, include:
- Fixed or percentage discounts on the immediate or the next transaction;
- Rewards using goods and services provided by the merchant, by a
complementary merchant, by a product supplier or complementary product
supplier or the issuer;
- Multiple rewards such as:
- simultaneously offering an immediate incentive for the next purchase and
a long term loyalty program reward for repeat purchases;
- simultaneously offering participation in a local retail store incentive
program, a national chain loyalty program and a complementary merchant's
Internet program; or
- simultaneously offering participation in different programs offered by a
merchant, a payment card issuer and a product supplier based on the same
activity.
In addition to our target market of customer incentive and loyalty
programs, our product also is designed to support other complementary
applications. For example, our product supports ticketing, entertainment and
sporting venues; issuing and tracking memberships in an organization; and
controlling access to facilities.
PRODUCT DEVELOPMENT
Catuity's product development focus was primarily on Target Corporation and
smart Visa Rewards activity throughout 2002, and on enhancements to our core
product.
Key enhancements or activities include:
- Next release of Catuity System (Cat X).
This release consolidates many of the features provided to different
customers, and will be the base platform for all identification devices
(mag, chip, bar code, RFID fobs, etc.) going forward. Completion of this
system allows Catuity to rationalize development and support activity
moving forward, and should reduce maintenance and support costs.
- Memory Card Support.
The addition of the memory card with a substantially lower cost enables
Catuity to market a complete "Loyalty Over the Counter" package to
processors for resale to their Independent Sales Organization (ISOs). The
off-line feature of the memory card enable processors to package this with
a fixed monthly price regardless of the number of transactions performed.
This is a key selling feature for the General Retail segment.
- PTS Tool Kit -- Enhanced Magnetic Stripe Support.
This enables third party support of the Catuity application on the
majority of the point of sale
9
devices currently installed. The Catuity loyalty program engine that
manages loyalty logic has traditionally been resident on the terminal. This
is appropriate for applications where smart cards, memory cards and
magnetic cards are required to be supported in the same device
simultaneously. However, it requires late model terminals that are not
widely deployed. The PTS Toolkit enables third party development, and can
be deployed on a wider range of older terminals that make up the majority
of the installed base. This creates numerous opportunities for the Catuity
application.
CATUITY'S INTELLECTUAL PROPERTY
Catuity respects the intellectual property rights of others and we expect
others to respect our rights.
Patents protect the rights of innovators to be rewarded for their
innovation. Without a guaranteed reward for innovation, far less research and
development would be undertaken.
We file patent applications to protect our innovations and to protect the
business from legal action by others. Patents provide recognition for our
innovations and demonstrate our capability and the expertise of our employees.
We see patents as part of our marketing strategy as they help convince others
that we are indeed specialists in our field.
Catuity believes its patents are of significant value and as part of its
agreements with licensees, Catuity grants rights to use the innovations
described in its patents.
Catuity has been issued three patents related to the management of multiple
applications in offline consumer devices. The patents broadly cover the
efficient use of memory space on data carrying devices (such as smart cards) to
store data for multiple applications and the systems to manage the applications,
customer devices and terminals. This patent "family" have a priority date of 1
April 1998 and include:
<Table>
<Caption>
COUNTRY PATENT NUMBER
- ------- -------------
United States...................................... 6,449,684
United States...................................... 6,532,518
Australia.......................................... 755,388
</Table>
Patent applications are pending in a range of other countries including
European Union, Japan and Brazil.
Catuity has also been issued a patent that relates to the use of the
Catuity System over the Internet and traditional point of sale devices. It
describes a system for manipulating data on customer devices supported and
controlled via a host system via a number of offline and online terminals. The
patent covers the operation of interactive programs and transactions between the
range of terminals including POS terminals and the Internet.
The patent is Australian patent number 746,867 with a priority date of 22
February 1999. Patent applications are pending in various other countries
including United States, European Union, Japan and Brazil.
Catuity continues to file patent applications for innovations within our
field of specialization.
CUSTOMER RELATIONSHIPS
We continue to have a strong relationship with Visa USA, a major region
within the Visa worldwide organization. During 2001 we signed a significant
agreement with Visa to license our software, provide software development, and
consulting services as they continue to move to capture
10
the U.S. market for smart cards. This system was implemented in 2002, and is now
operational and supporting Visa customers.
In 2002, Visa continued to give smart cards a high priority in the U.S.
backed by their growing investment to build the smart card value proposition and
develop smart chip products for use by their member banks. During 2002 a number
of pilot programs with specific merchants were conducted, and a number of new
financial institutions deployed smart cards. Catuity is working to help
integrate payment and loyalty cards on a wide scale and in 2002. signed an
agreement with Welcome Real Time to create, in conjunction with Visa USA, a set
of interoperability specifications. This work addresses one of the adoption
hurdles created by lack of standards for smart cards based loyalty applications.
It is our belief that Catuity is uniquely positioned to capitalize on this
opportunity. In 2002, due to the significance of Visa's investment in the U.S.
smart card market, and the size of the Company's involvement in the project,
Visa related projects represented more than 10% of Catuity's annual net
revenues.
Target Corporation is Catuity's largest merchant customer. Catuity signed a
license agreement with Target during the fourth quarter of 2002. In 2002, Target
related projects represented over 10% of Catuity's annual net revenues. The
deployment of Catuity's software is expected to be substantially complete by the
third quarter of 2003.
Catuity was recently named a Technology Provider to MasterCard's world-wide
member financial institutions. Catuity can now offer technology choices,
marketing support and critical flexibility to MasterCard member financial
institutions. Catuity is also a member of the MasterCard Vendor Program (MVP),
and the Catuity applet is certified with the Multos platform.
Electronic Merchant Systems of Cleveland Ohio has primarily been utilizing
the Catuity System to support gift card activity using mag-stripe cards.
Increasingly the Catuity System is being used to support loyalty, as the
merchant base grows to include larger more sophisticated merchants. EMS
currently has over 2,300 small and medium size merchants processing gift and
loyalty transactions via the Catuity System.
In 2002 we added our first channel partner customer -- KESM Transaction
Solutions. The Toronto-based company has launched its first Catuity-based
loyalty and incentive programs: the Fore! Honors golf course coalition program,
and the 200 outlet Pioneer Petroleum gas and convenience store program this
year.
SALES BACKLOG
As of December 31, 2002, the Company had signed agreements with customers
that are expected to result in approximately $1.9 million of revenue being
recorded in 2003. At December 31, 2001, the Company had approximately $1.3
million of revenue expected to be recorded in 2002 related to signed agreements.
Our 2003 license revenues will ultimately be determined by the size of and the
speed with which our customers roll out their loyalty programs during the year.
COMPETITION
Our product faces competition at two levels. First, we compete with
companies that provide software for customer incentive and loyalty programs for
retail store locations or for Internet merchants. Second, some ISO's,
transaction processors, and others who provide services to merchants may also
provide a basic loyalty and gift card applications that the merchant can use. We
expect competition to increase as companies expand their offerings of customer
incentive and loyalty
11
programs and provide software for retail stores and the Internet. Our ability to
compete depends upon many factors, including:
- ability to successfully market our product's features;
- effectiveness of our solution relative to the product offerings of our
competitors;
- ability to continually expand the credibility of our product in the
marketplace;
- ability to sell to strategically important merchants, card issuers and
processors;
- ability to continue to attract and retain channel partners who will sell
our product; and
- timeliness of our product enhancements from our product development
efforts.
We believe our unique product features and strong North American market
position with the largest companies in the payment industry provides us with
some significant competitive advantages. The broad functionality in our software
provides our customers with flexibility in offering the type(s) of reward
programs that suit their particular needs. Since programs are easily established
and changed within our system, merchants can initiate different programs as
their needs change.
REVENUE AND ASSETS BY GEOGRAPHIC LOCATION
During the years ended December 31, 2002, 2001 and 2000, 100%, 96% and 83%
of our revenues were derived in the United States, respectively. The remaining
revenue during the years ended December 31, 2001 and 2000 related to the
Company's Australian operations.
The Company's assets are located at its headquarters in Detroit, Michigan
its product development facility in Sydney, Australia and at its service and
demonstration office in Arlington, Virginia.
EMPLOYEES
As of January 31, 2003, we had 39 full time employees, comprised of five in
sales and marketing, five in finance, three in administration, six in customer
implementation and support and 20 in product development. In 2003, full time
employees are expected to increase to approximately 48 with the principal
increases expected to occur in customer support, product development and sales.
None of our employees is represented by a collective bargaining agreement. We
consider our relations with our employees to be very good.
FACILITIES
Our corporate headquarters is located in Detroit, Michigan. Our
implementation and support team is located in Arlington, Virginia. Our
technology and product development facilities are in Sydney, Australia. We have
no other foreign operations. Also see Item 2, Properties, below.
OPERATIONS
Catuity's U.S. operations are structured to expand as growth opportunities
unfold. Our sales and marketing team is principally located in our Detroit,
Michigan headquarters with 3 of our 5 sales personnel based there. We also have
1 sales manager located in Cincinnati, Ohio and 1 in Arlington, Virginia. There
are 3 finance and accounting staff in Detroit and 2 in Sydney. The Detroit
headquarters has 1 administrative staff member while the Sydney office has 2.
Our entire customer implementation and support team is located at our Arlington,
Virginia office. In addition, we have an agreement with Smart Dynamics Inc. in
Arlington, Virginia, to utilize their technical personnel, as we need them on
projects for customers.
12
ITEM 2. PROPERTIES
Our corporate headquarters and principal executive offices in North America
are located in leased facilities in Detroit, Michigan consisting of
approximately 1,950 square feet of office space. Our lease expired on February
1, 2003 and is renewable at our option. The Company intends to renew the lease
through February 1, 2004. Our current facilities in the United States should
meet our needs for the next 12-24 months.
Our office and development center is located in leased facilities in
Sydney, Australia, consisting of approximately 2,060 square feet. Our lease
agreement expires on December 14, 2003 with an option to renew for a new four
year term. We believe that our Australia facilities are sufficient to meet our
foreseeable operating needs.
Our implementation and support center is located in leased facilities in
Arlington, Virginia, consisting of approximately 1,000 square feet. Our lease
agreement expires on June 30, 2003. The Company intends to renegotiate the lease
prior to that date.
ITEM 3. LEGAL PROCEEDINGS
In the reporting year there were no new legal proceedings initiated either
by the Company against third parties or initiated by third parties against the
Company. As of December 31, 2002, Catuity has no legal proceedings to which it
is a party.
On March 28, 2002, the Company reached a binding agreement with Welcome
Real-Time S.A. (WRT) to settle the lawsuit which had been filed by them on July
20, 2000. The agreement resulted in the following:
- The immediate settlement and cessation of all legal action in Australia
with no material future financial consequences for either party.
- A prohibition on both WRT and Catuity from initiating any patent legal
action between them anywhere in the world.
- A commitment by both parties to compulsory mediation and compulsory
binding arbitration should any future patent disputes occur anywhere in
the world.
The WRT lawsuit had been filed in the Federal Court in Australia alleging
infringement by the Company of WRT's Australian patent and claiming damages. On
May 17, 2001, the judge on the case, in the Federal Court of Australia, ruled
that the WRT patent was valid and that the Company infringed on the patent in
Australia. The Company appealed the decision, but while waiting for the appeal
to be heard, complied with the judge's orders to refrain from infringing on the
patent in Australia and to deliver any infringing physical devices in its
possession, located in Australia. The Company and its Transcard customers had
previously decided to terminate the Transcard system trial operations and did
so, effective August 31, 2001. The cessation of the Transcard activities did not
have a material impact on the Company's 2001 operating results. Revenues in 2001
from the Transcard system were $32,000 as of August 31, 2001 when the operation
was discontinued.
The appeal was heard by the Full Bench of the Federal Court of Australia on
February 25-26, 2002 but no judgement was issued due to the settlement referred
to above.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Catuity ("CTTY") was listed on the Nasdaq Small Cap Market beginning
December 1, 2000. Chip Application Technologies was listed on the Australian
Stock Exchange (ASX) under the trading symbol "CAT" from July 11, 1997 to
November 22, 1999. On November 23, 1999, upon Catuity's acquisition of CAT, we
replaced CAT as the listed entity on the ASX under the same trading symbol. We
continue to be traded on the ASX.
Our high and low sales prices on the ASX and NASDAQ for each quarter within
the last two fiscal years are shown below, both in Australian dollars and in
U.S. dollars.
<Table>
<Caption>
HIGH LOW HIGH LOW
PERIOD (AUSTRALIAN $) (AUSTRALIAN $) (UNITED STATES $) (UNITED STATES $)
------ -------------- -------------- ----------------- -----------------
2002
First Quarter...................... $ 5.20 $3.35 $2.65 $1.91
Second Quarter..................... $ 6.49 $3.25 $3.70 $1.76
Third Quarter...................... $ 5.20 $3.65 $2.89 $2.18
Fourth Quarter..................... $ 4.06 $3.48 $2.30 $1.90
2001
First Quarter...................... $12.00 $5.50 $6.75 $2.75
Second Quarter..................... $ 9.25 $4.30 $4.72 $2.48
Third Quarter...................... $ 9.45 $4.60 $4.56 $2.52
Fourth Quarter..................... $ 7.40 $4.00 $3.90 $1.93
</Table>
As of January 31, 2003 there were approximately 3,447 shareholders of
record of our common stock as reported to us by Computershare Investor Services,
our transfer agent. To date, we have not paid any dividends on our common stock.
EQUITY COMPENSATION PLAN INFORMATION
<Table>
<Caption>
NUMBER OF SECURITIES
NUMBER OF REMAINING AVAILABLE FOR
SECURITIES TO BE WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE PRICE OF EQUITY COMPENSATION PLANS
EXERCISE OF OUTSTANDING (EXCLUDING SECURITIES
OUTSTANDING OPTIONS OPTIONS(1) REFLECTED IN COLUMN (A)
-------------------- ----------------------- -------------------------------
PLAN CATEGORY (A) (B) (C)
- ------------- -------------------- ----------------------- -------------------------------
Equity compensation plans
approved by security
holders....................... 1,026,325 $6.91 468,675
Equity compensation plans not
approved by security
holders....................... see footnote(2)
</Table>
- -------------------------
(1) Some options were issued with exercise prices denominated in Australian
Dollars. These amounts have been exchanged to U.S. dollars at .565, the
exchange rate on December 31, 2002.
(2) A total of 25,000 shares of our Common Stock are reserved for issuance under
an Executive Stock Purchase Plan. The Plan provides a means for our
executive employees, other than the Chairman and CEO, to invest a
predetermined portion of their after tax cash compensation in shares of our
Common Stock at the closing price of such shares on the last trading day of
each month.
14
SALES OF UNREGISTERED SECURITIES
In January and February 2002, a total of 6,000 shares were issued to
Greenstone Partners Inc. in exchange for investor relations services. The
aggregate price was $19,200. These shares were exempt from registration based on
selling to only one party in a private offering under Section 4(1) of the
Securities Act of 1933.
In November 2002, the Company sold 453,666 shares of its common stock in a
private placement to two accredited professional investors in Australia,
National Nominees Limited and Permanent Trustee Australia Limited. The aggregate
offering price was $1,701,247.50 AUD ($954,000 USD). A placement fee of 3% of
the purchase price was paid to each investor. These shares were exempt from
registration based on selling to accredited investors, lack of public
solicitation, an aggregate offering price of under $5,000,000 as required under
Section 4(6) of the Securities Act of 1933. 151,222 warrant shares were also
purchased at an exercise price of $4.20 AUD ($2.57 USD) and expire in November
2004.
In addition, at a special meeting of the shareholders on March 26, 2003 the
Company's shareholders approved the sale of 90,000 common shares and 30,000
warrant shares in March 2003 to Boom Australia Pty. Ltd. ("Boom"), the family
trust of Mr. Duncan P.F. Mount, an independent non-executive director of the
Company, as part of the private placement described above.
SUPPLEMENTAL SHAREHOLDER INFORMATION
The following information is provided voluntarily and is in accordance with
the Australian Stock Exchange (ASX) listing requirements.
SECURITIES ISSUED
As of February 28, 2003 the Company had issued the following securities:
<Table>
Shares of Common Stock...................................... 8,533,903
Options as listed........................................... 1,222,547
</Table>
15
I. STOCK OPTIONS LISTED BY EXPIRATION DATE (AS OF FEBRUARY 28, 2003)
<Table>
<Caption>
NUMBER OF EXERCISE (USD)-U.S. DOLLAR
OPTION EXPIRATION DATE OPTIONS PRICE (AUD)-AUSTRALIAN DOLLAR
---------------------- --------- -------- -----------------------
03/30/2003........................................ 5,000 $9.50 AUD
03/31/2003........................................ 3,000 9.50 AUD
03/31/2003........................................ 1,500 19.25 AUD
06/24/2003........................................ 50,000 12.00 AUD
06/30/2003........................................ 12,500 9.50 AUD
06/30/2003........................................ 1,000 19.25 AUD
09/30/2003........................................ 1,000 9.50 AUD
03/31/2004........................................ 1,000 19.25 AUD
04/30/2004........................................ 25,000 4.00 USD
06/24/2004........................................ 50,000 16.00 AUD
06/30/2004........................................ 20,000 9.50 AUD
06/30/2004........................................ 1,500 19.25 AUD
09/30/2004........................................ 4,000 9.50 AUD
10/31/2004........................................ 151,222 4.20 AUD
06/30/2005........................................ 29,250 3.40 USD
06/30/2005........................................ 74,225 5.67 AUD
06/30/2006........................................ 61,350 8.06 AUD
06/30/2006........................................ 3,000 4.11 USD
12/12/2006........................................ 2,000 2.30 USD
03/04/2007........................................ 5,000 2.15 USD
05/30/2008........................................ 50,000 6.18 USD
10/01/2008........................................ 30,000 15.86 AUD
10/09/2008........................................ 10,000 17.20 AUD
12/31/2008........................................ 336,000 9.50 USD
12/31/2008........................................ 150,000 7.68 USD
06/01/2009........................................ 100,000 7.75 AUD
09/28/2009........................................ 10,000 5.70 AUD
09/28/2009........................................ 10,000 3.00 USD
09/30/2010........................................ 15,000 2.24 USD
09/30/2010........................................ 10,000 3.66 AUD
--------- ----- ---
Total........................................ 1,222,547
</Table>
- -------------------------
Note:
- - All options are unlisted and are not quoted on either Nasdaq or ASX.
- - As of February 28, 2003 there were 48 optionholders of record.
16
20 LARGEST SHAREHOLDERS AND OPTION HOLDERS (AS OF FEBRUARY 28, 2003)
II. SHAREHOLDERS
<Table>
<Caption>
NAME NUMBER OF SHARES % OF ISSUED CAPITAL
---- ---------------- -------------------
Permanent Trustee Australia............................... 846,800 9.92
Boom Australia Pty Ltd. .................................. 410,000 4.80
National Nominees Limited................................. 400,746 4.70
L.D. O'Connor............................................. 270,633 3.17
D.L. Mac. Smith........................................... 251,417 2.95
Acorn Capital Limited..................................... 186,666 2.19
A.S. Dawson............................................... 185,000 2.17
Visa U.S.A. .............................................. 141,719 1.66
Merrill Lynch (Aus) Nominees P/L.......................... 72,870 0.85
Queensland Investment..................................... 71,705 0.84
Fairlawn Investments Pty Ltd. ............................ 71,000 0.83
Bellway International Limited............................. 68,150 0.80
Munbilla Investments Ltd. ................................ 60,250 0.71
Commonwealth Custodial Services........................... 58,499 0.69
Supertuft Pty Ltd. ....................................... 58,053 0.68
J.H. Marshall............................................. 50,926 0.60
Citicorp Nominees Pty Limited............................. 50,593 0.59
T. Lamros................................................. 50,000 0.59
C.J. Mc Courtie........................................... 45,000 0.53
RBC Global................................................ 45,000 0.53
--------- -----
Total Shares of Common Stock.............................. 3,398,027 39.82
Total Shares as of February 28, 2002...................... 2,637,558 32.69
</Table>
The above shareholder information is based on the Australian share register
and where known, includes additional shares held in the United States market.
17
III. OPTIONHOLDERS
<Table>
<Caption>
NAME NUMBER OF OPTIONS % OF OPTIONS ISSUED
---- ----------------- -------------------
M. Howe.................................................. 315,000 25.58
D. Mac. Smith............................................ 200,000 16.36
J. Lowry................................................. 150,000 12.27
Permanent Trustee Australia.............................. 89,000 7.28
National Nominees Limited................................ 62,222 5.09
J. Adams................................................. 50,000 4.09
B. Garton................................................ 27,500 2.25
Greenstone Partners...................................... 25,000 2.04
S. Dawson................................................ 20,000 1.64
D. Mount................................................. 20,000 1.64
A. Gilman................................................ 20,000 1.64
R. Robins................................................ 20,000 1.64
J. & P.A. Gordon......................................... 15,500 1.27
L. Schweichler........................................... 11,550 0.94
J. Chappell.............................................. 10,500 0.86
J. Oategui............................................... 10,500 0.86
D. Kilgour............................................... 10,000 0.82
R. Braxton............................................... 9,850 0.81
R. Banting............................................... 9,550 0.78
A. Peckenpaugh........................................... 9,450 0.77
--------- -----
Total Options............................................ 1,085,622 88.80
</Table>
IV. SUBSTANTIAL SHAREHOLDERS (AS OF FEBRUARY 28, 2003)
As of February 28, 2003 the following individual was recorded as a
substantial shareholder in the Company's Register of Substantial Shareholders:
<Table>
<Caption>
SUBSTANTIAL SHAREHOLDER NUMBER OF SHARES
----------------------- ----------------
Permanent Trustee Australia................................ 846,800
</Table>
18
ITEM 6. SELECTED FINANCIAL DATA
<Table>
<Caption>
FOR YEARS ENDED DECEMBER 31
-----------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(IN THOUSANDS EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Net Revenues........................... $ 2,972 $ 1,616 $ 751 $ 638 $ 292
Operating Loss(1)...................... (2,829) (4,119) (3,883) (6,170) (2,207)
------- ------- ------- ------- -------
Net Loss............................... $(2,769) $(3,875) $(3,811) $(6,211) $(2,384)
======= ======= ======= ======= =======
Net Loss per share-basic & diluted..... $ (0.34) $ (0.49) $ (0.54) $ (1.05) $ (0.53)
======= ======= ======= ======= =======
</Table>
<Table>
<Caption>
DECEMBER 31
-----------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Total Assets........................... $ 4,592(2) $ 5,870 $ 9,500(3) $ 6,189(4) $ 639
Long-Term Debt......................... -- -- -- 854 1,594
</Table>
- -------------------------
(1) Includes variable stock compensation of ($53,363) in 2002, ($973,350) in
2001, ($716,192) in 2000, $2,475,175 in 1999 and $8,627) in 1998.
(2) Includes a private placement of 453,666 shares of common stock which raised
$925,000 in net cash proceeds.
(3) Includes a private placement of 710,000 shares of common stock which raised
$6,245,000 in net cash proceeds.
(4) Includes the issuance of shares of common stock which raised $9,521,278 in
net cash proceeds.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a summary of the consolidated operating results of
Catuity, Inc. and contains forward looking statements based upon current
expectations that involve risks and uncertainties. The Company's actual results
and the timing of certain events could differ materially from those anticipated
in these forward looking statements. Refer to the section entitled Forward
Looking Statements at the beginning of this Form 10-K for a full discussion of
the risks and uncertainties associated with forward looking statements.
RESULTS OF OPERATIONS
Overview
2002 was another year of progress and growth in the U.S. market for
Catuity's loyalty software products. In addition, the U.S. market for smart
cards continued to emerge as the issuance of cards and the investment necessary
for their adoption continued to accelerate over prior years levels. In 2002,
Visa expanded its efforts and MasterCard announced its "One Smart" initiative
that will further the expansion of smart card use in the U.S. One Smart is
designed to provide card issuers with a flexible, customizable approach to
packaging applications to differentiate their smart card from all others, and to
provide retailers and cardholders unique benefits from using the card. During
the fourth quarter of 2002 Catuity underwent the extensive due diligence process
required by MasterCard and recently became a participant in the MasterCard One
Smart program. In the summer of 2002 Visa began using our loyalty software in
test markets, and in the latter part of the year, Target began a roll out of
their new POS equipment and use of our loyalty software in selected stores. The
Company also completed the installation of its software at two new customers
that will expand its use in 2003 and beyond.
19
During 2002 Catuity received a notice of allowance from the U.S. Patent and
Trademark Office on two of our patent applications. The first of the two patents
was issued in September 2002. We received the Notice of Allowance for the second
patent in December 2002 and it was formally issued in March 2003 The Company was
also granted a patent in Australia in 2002 and has patents pending in the U.S.,
Canada, Europe, Australia, Japan, Brazil, and New Zealand. The most recent
patent granted in the U.S. is particularly valuable because of its scope
involving our unique methods of data storage on smart cards. We believe our
patents help us meet our strategy of protecting our intellectual property,
protecting our customers interests, and staying on the cutting edge of
technology in our markets.
In March 2002 Catuity resolved the Welcome Real Time (WRT) legal matter.
The settlement brought the Australian lawsuit that had been active in 2001 and
early 2002 to closure. As part of the settlement, WRT and Catuity agreed to end
all legal actions in Australia with no material future financial consequences
for either party and to prohibit the initiation of any future lawsuits over
patents on a global basis by agreeing to compulsory mediation and binding
arbitration in the event of any future patent disputes.
In November 2002, Catuity completed the private placement of 453,666 shares
to two accredited institutional investors and 90,000 shares to Boom Australia
Pty. Ltd., the family trust of Mr. Duncan P.F. Mount, a non-executive director
of Catuity. Boom Australia's participation is subject to shareholder approval
and is being sought at a special meeting of shareholders to be held on March 26,
2003 in Sydney, Australia. The placement resulted in net proceeds of $925,000,
excluding Mr. Mount's, that will be used for general operating purposes,
including furthering Catuity's investigation into the data analytics and
predictive modeling aspects of Customer Relationship Management. In addition to
the private placement, during 2002, a San Francisco based fund acquired
approximately 180,000 shares in Catuity through open market purchases. As a
result of these efforts, Catuity was able to strengthen its' capital structure,
and increase the holdings of institutional investors in the Company.
During 2002 Catuity established an Executive Stock Purchase Plan (ESPP) and
an Executive Director Stock Purchase Plan (EDSPP) as a way of increasing our
executives' holdings in the Company and aligning their interests with those of
our shareholders. The EDSPP is subject to shareholder approval, which is also
being sought in the March 2003 special meeting of shareholders. The plans do not
provide the executives any discount to our share price in the open market.
Rather, they allow the executives to increase their holdings via a routine
month-end purchase of shares from the cash compensation that each executive
deferred during that month. All of the executives eligible to participate have
thus far chosen to use 10% of their cash compensation to purchase shares in the
Company each month.
There are a number of factors that impacted the smart card market in the
U.S. in 2002. The positive factors include the strong commitment by Visa USA to
the introduction of smart cards. The integration of payment and loyalty, which
began in 2001 and increased in 2002, is expected to continue in 2003. Catuity
has been actively involved in developing interoperability standards to integrate
loyalty transactions with payment transactions. The pace with which card-issuing
banks issued smart cards and merchants began installing POS devices that are
smart card compatible accelerated in 2002. The negative factors that affected
the market included the sluggishness of the U.S. economy in 2002, the relative
slowness of POS device suppliers to deliver multi-application devices and the
slowness of merchants to adopt POS devices that are smart card compatible. These
factors have resulted in a delay in the long anticipated, growth of smart cards
in the U.S. Although the smart card market in general, and the smart Visa
Rewards program are very important to us, we also continued to pursue contracts
with customers using our software with magnetic stripe cards.
20
We expect that 2003 will be the first year that the Company earns a
significant percentage of its total revenue from license fees. The speed with
which our customers progress with their plans and the success they achieve in
their product launches could have an impact on these estimates.
FISCAL YEAR ENDED 2002 COMPARED TO 2001
In 2002, gross revenues were $2,972,000. These revenues were derived from
$1,667,000 in software development (an increase of $253,000 or 18% over 2001),
$1,259,000 in services relating to implementation, training, support and
consulting activities (an increase of $666,000 or 112% over 2001) and $46,000 in
customer license fees (an increase of $33,000 over 2001). Software development
work completed in 2002 and 2001 was primarily for the Smart Visa Rewards
program. In 2002, service revenue was primarily related to support for Visa and
a national retailer Target. In 2001 service revenue related primarily to support
for Visa, Target a national retailer and two other customers.
A non-cash sales discount of $404,000 was recorded in 2001 related to the
issuance of shares of the Company's common stock to Visa a customer. No such
transaction occurred in 2002.
Direct cost of software development revenue primarily consists of salaries
and all related expenses for our technical staff located in Sydney Australia and
project managers in Arlington Virginia. Direct cost of software development
increased $368,000 or 60%, to $981,000 for the year ended December 31, 2002 from
$613,000 for the year ended December 31, 2001. Expenses were negatively impacted
in 2002 by a 5% increase in the average exchange rate for the Australian dollar
compared to the U.S. dollar. 2002 expenses also reflected an increase due to
staff bonuses earned for early delivery of development work for Visa USA. The
bonus expense was paid by Visa USA and included in the Company's software
development revenue.
Direct cost of service revenue which is primarily incurred by our customer
implementation and support staff in Arlington Virginia, increased $289,000, or
35%, to $1,105,000 for the year ended December 31, 2002 from $816,000 for the
year ended December 31, 2001. The increase principally resulted from an increase
in staff and contract labor in response to increased billable customer service
and support activities.
Research and Development expenses, which are incurred primarily by our
technical staff in Sydney, Australia, increased $67,000, or 14%, to $539,000 for
the year ended December 31, 2002 from $473,000 for the year ended December 31,
2001. The increase principally resulted from early research and development
efforts related to data analytics.
Sales and marketing expenses decreased $361,000, or 17%, to $1,758,000 for
the year ended December 31, 2002 from $2,119,000 for the year ended December 31,
2001. The decrease was due to lower professional services costs, a reduction in
travel and marketing related costs, the elimination of outside labor costs
related to non-billable pre-sales efforts, and the elimination of sales and
marketing efforts in Australia.
General and administrative expenses decreased $1,218,000, or 45%, to
$1,470,000 for the year ended December 31, 2002 from $2,688,000 for the year
ended December 31, 2001. During 2001 the Company accrued for estimated legal
expenses related to the WRT lawsuit. The settlement in 2002 resulted in lower
costs than had been previously estimated and, as a result, the Company reversed
approximately $200,000 of expense. In addition, based on better collections on
accounts receivable than previously estimated, the Company reversed
approximately $60,000 of its accounts receivable reserve in 2002.
General and administrative -- variable stock compensation expense/(credits)
are due to the Company's 1995 and 1996 non-recourse loans to a director to
acquire stock and are a non-cash expense. In 2002, credits of $53,000 were
recorded compared to a credit of $973,000 for the year
21
ended December 31, 2001. The decrease in the credit is attributable to the
relative stability in our stock price during 2002.
Other income decreased in 2002 to $60,000 compared to $244,000 in 2001. The
decrease was due to a lower average cash balance maintained by the Company in
2002 compared to 2001 and lower interest rates on the invested cash.
FISCAL YEAR ENDED 2001 COMPARED TO 2000
In 2001, gross revenues were $2,020,000. These revenues were primarily
derived from $1,414,000 in software development (an increase of 165% over 2000)
and from $593,000 in services relating to implementation, training, support and
consulting activities (an increase of 174% over 2000). A majority of the
increase in software development revenue related to the Visa contract signed in
2001. As part of this contract, we issued 141,719 shares of common stock to
Visa, which has been recorded as a non-cash sales discount of $404,000.
Comparatively, 2000 gross revenues totaled $751,000, and were derived from
$534,000 in software development and from $217,000 in services. Gross revenues
increased by $1,269,000, or 169% in 2001.
Direct cost of software development revenue primarily consists of salaries
and all related expenses for our technical staff located in Sydney Australia and
project managers in Arlington Virginia. Direct cost of software development
increased $157,000 or 34%, to $613,000 for the year ended December 31, 2001 from
$456,000 for the year ended December 31, 2000. The increase principally resulted
from an increase in salary and related costs in response to increased billable
software development work.
Direct cost of service revenue which is primarily incurred by our customer
implementation and support staff in Arlington Virginia, increased $452,000, or
124%, to $816,000 for the year ended December 31, 2001 from $364,000 for the
year ended December 31, 2000. The customer implementation and support function
did not begin operations until August of 2000. As a result, the significant
increase in 2001 reflects a full year of operation in which staff size increased
from two at the end of 2000 to six my mid 2001 as the Company built its customer
service and support capability.
Research and Development expenses, which are incurred primarily by our
technical staff in Sydney, Australia, increased $27,000, or 6%, to $473,000 for
the year ended December 31, 2001 from $446,000 for the year ended December 31,
2000. The increase principally resulted from research and development efforts in
2001 related to gift card functionality.
Sales and marketing expenses increased $38,000, or 2%, from $2,081,000 for
the year ended December 31, 2000 to $2,119,000 for the year ended December 31,
2001.
General and administrative expenses increased $685,000, or 34%, from
$2,003,000 for the year ended December 31, 2000 to $2,688,000 for the year ended
December 31, 2001. The increase principally resulted from higher estimated legal
costs related to the Welcome Real-Time patent infringement lawsuit in 2001 than
in 2000 and having a higher number of U.S. accounting and administrative staff
in place in 2001, compared to 2000.
General and administrative -- variable stock compensation expense/(credits)
are due to the Company's 1995 and 1996 non-recourse loans to a director and
employees and are a non-cash expense. In 2001, credits of ($973,000) were
recorded compared to a credit of ($716,000) for the year ended December 31,
2000. The increase in the credit is attributable to the decline in our stock
price during 2001.
22
LIQUIDITY AND CAPITAL RESOURCES
In November 2002, the Company received net proceeds of $925,000 from the
private placement of common stock to accredited professional investors in
Australia at a price of $3.75 AUD per share ($2.11 USD based on the foreign
exchange rate in effect on the date of the transaction). The price equaled the
fair market value of the shares on the Australian Stock Exchange (ASX) on the
transaction date. In addition, one warrant share at an exercise price of $4.20
AUD ($2.57 USD) for every three (3) shares purchased were granted, and expire in
November 2004. The exercise price of the warrants represented approximately a
12% premium over the fair market price of the Company's shares on the date of
transaction. A placement fee of 3% of the purchase price was paid to each
investor.
In addition, the Company will receive approximately $190,000 in March or
April 2003 from the private placement of common stock to Boom Australia Pty.
Ltd. ("Boom"), the family trust of Mr. Duncan P.F. Mount, an independent
non-executive director of the Company, due to shareholder approval having been
received at the March 26, 2003 special meeting of shareholders.
As of December 31, 2002 the Company had $1,812,000 in deferred revenue, an
increase of $977,000 over December 31, 2001. Cash collections in 2002 related to
deferred revenue at December 31, 2001 were $1,212,000. The deferred revenue
balance as of December 31, 2002 represents amounts invoiced and received from
customers, but not yet earned as revenue. $1,724,000 or 95% of this balance
relates to license fees that are expected to be recognized as revenue in the
first and second quarters of 2003 based on the anticipated delivery dates to
customers. The remaining 5% related principally to service and software
development fee amounts invoiced in advance.
Operating activities utilized $2,316,000 of cash in 2002 compared to
$3,995,000 in 2001. In 2002, net cash utilized in operating activities was
$2,276,000 less than in 2001 due primarily to a lower net loss after non-cash
adjustments. The largest components of working capital changes were an accounts
receivable decrease of $848,000 and a decrease in accrued expenses of $476,000.
Cash used in investing activities in 2002 totaled $110,000 and was
primarily related to the updating of older computer equipment for staff in the
U.S. and Australia, as well as the renewal of various computer software licenses
in the U.S. and Australia. This is a $22,000 increase from the investment of
$88,000 in 2001.
Cash obtained from financing activities was $942,000 in 2002 compared to
$41,000 in 2001. In 2002, cash obtained from financing was primarily due to the
private placement of shares in November 2002 and cash received from executives
purchases of stock through the executive stock purchase plan.
The Company had $3,611,000 in cash and cash equivalents as of December 31,
2002 and no outstanding debt. The Company believes that its existing capital
resources, combined with collected revenues, are adequate to meet its cash
requirements for the next twelve months.
As of December 31, 2002, the Company had net operating tax loss
carry-forwards of $13,075,000 expiring in various amounts in 2020 and 2021 in
the United States and $16,987,000 of net operating tax loss carry-forwards in
Australia. Utilization of the net operating loss carry-forwards in Australia are
subject to either the continuity of ownership test or the continuation of same
business test at the time the losses are utilized in accordance with Subdivision
165 and Subdivision 166 of the Australian Income Tax Assessment Act of 1997.
CRITICAL ACCOUNTING POLICIES AND ASSUMPTIONS
The accompanying consolidated financial statements were prepared in
conformity with accounting principles generally accepted in the United States.
When more than one accounting principle, or the method of its application is
generally accepted, we select the principle or method
23
that is appropriate in our specific circumstances (see Note 2 of Notes to
Consolidated Financial Statements). Application of these accounting principles
requires us to make estimates about the future resolution of existing
circumstances. As a result, actual results could differ from these estimates. In
preparing these financial statements, we have made our best estimates and
judgments of the amounts and disclosures included in the consolidated financial
statements, giving due regard to materiality.
Accounts Receivable
The Company records an allowance against gross accounts receivable to
provide for doubtful accounts. The allowance is estimated based on the age of
the receivable, specific circumstances surrounding the collection of an invoice,
and historical data on allowances as a percentage of aged accounts receivable
balances. Actual collection on accounts may differ from the allowance the
Company has estimated.
Revenue Recognition
The three distinct revenue streams that result from the Company's business
activities are license revenue, software development revenue, and service
revenue.
License revenue is recognized in accordance with Statement of Position
(SOP) 97-2, Software Revenue Recognition, which provides for recognition of
revenue when persuasive evidence of an arrangement exists, delivery of the
product has occurred, no significant obligations remain on the Company's part
with regard to implementation, the fee is fixed and determinable, and
collectibility is probable. SOP 97-2 generally requires revenue earned on
software arrangements involving multiple elements to be allocated to each
element based on the relative fair value of each element. Revenue recognized
from multiple-element arrangements is allocated to undelivered elements of the
arrangement, such as maintenance, based on the relative fair value of each
element. The Company's determination of fair value of each element in
multi-element arrangements is based on vendor-specific objective evidence
(VSOE). The Company limits its assessment of VSOE for each element to either the
price charged when the same element is sold separately or the price established
by management for an element not yet sold separately. The Company has VSOE for
maintenance services. The Company generally does not provide for a right of
return in its license contracts.
Software development revenue includes integration, customization and
development fees of both the customer's hardware and software and the Company's
software. Software development revenue is billed on a fixed price basis. The
Company recognizes revenue on fixed price contracts on the percentage of
completion basis in accordance with SOP 97-2, Software Revenue Recognition, and
SOP 81-1, Accounting for Performance of Construction-Type Contracts, based on
hours incurred as a percentage of estimated total hours of the respective
contract. The cumulative impact of any revisions in estimated total revenues and
direct contract costs are recognized in the period in which they become known.
Revenue in excess of billings is recognized as unbilled receivables and is
included in work in process in the consolidated balance sheet. Billings in
excess of revenue are recorded as deferred revenue until revenue recognition
criteria are met. Had the Company adopted the completed contract method for
revenue recognition on software development based projects, the revenue recorded
per period could materially differ from amounts recorded under the percentage of
completion method.
Service revenue includes training, consulting, installation support,
post-installation support and maintenance fees. Training, consulting,
installation support and post-installation support are generally billed on a
time and material basis and revenue is recognized as the service is provided.
Maintenance revenues are recognized ratably over the maintenance term.
The Company does not generally provide for right of return in its customer
contracts.
24
Deferred Tax Assets
The Company records a full valuation allowance against net deferred tax
assets. Based on historical operating losses, it is difficult to determine the
amount or timing of future earnings, therefore, there is currently no tax
benefit recorded by the Company.
Accounting for Equity Instruments
The Company accounts for stock-based awards issued to employees under the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock issued to Employees" ("APB 25").
For all fixed stock-based awards issued to employees, we record an expense
based on the intrinsic value, if any, of the awards and amortize the expense
over the vesting period. Had the Company adopted SFAS No. 123, "Accounting for
Stock Based Compensation," the expense recorded per period could materially
differ from amounts recorded under the intrinsic value method. For variable
awards issued to employees and awards issued to third parties, we record an
expense based on the fair value of the award at each balance sheet date using
the Black-Scholes valuation model and amortize the expense over the vesting
period.
For issuances of stock to third parties for services, we record an expense
at the date of issuance based on the number of shares issued multiplied by the
closing stock price of the date of issuance. For stock issued to customers, we
record a sales discount in a similar manner.
For the non-recourse loans previously issued to a director to purchase
stock, we record an expense based on the number of loan shares outstanding
multiplied by the closing stock price on the date of the loan. At each balance
sheet date, we adjust the cumulative expense recorded to equal the number of
non-recourse loan shares outstanding multiplied by the closing stock price at
each balance sheet date. Any increase or decrease in the cumulative expense is
recorded in the statement of operations.
LEGAL PROCEEDINGS
Details of Legal Proceedings are included in Item 3 above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to foreign currency exchange rate risk inherent in our
expenses, assets and liabilities denominated in the Australian dollar. To date,
we have not utilized any foreign currency hedging or other derivative
instruments to reduce exchange rate risk. We do not expect to employ these or
other strategies to hedge the risk in the foreseeable future.
As of December 31, 2002, and 2001 the Company's net current assets (defined
as current assets less current liabilities) subject to foreign currency risk are
$753,000 and $162,000. The potential decrease in net assets from a hypothetical
10% adverse change in quoted foreign currency exchange rates would be
approximately $75,300 and $16,200. Net current assets subject to foreign
currency risk are larger as of December 31, 2002 compared to 2001 due to larger
cash balances maintained in Australia.
We are also exposed to interest rate risk on deposits of cash, which are
affected by changes in the general level of interest rates in the United States
and Australia. Since we generally invest in very short-term interest bearing
deposits, we do not believe we are subject to any material market risk exposure.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
<Table>
Report of Independent Auditors.............................. 27
Consolidated Balance Sheet.................................. 28
Consolidated Statement of Operations........................ 29
Consolidated Statement of Cash Flows........................ 30
Consolidated Statement of Shareholders' Equity.............. 31
Notes to Consolidated Financial Statements.................. 32
</Table>
26
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
CATUITY, INC.
We have audited the accompanying consolidated balance sheets of Catuity,
Inc. as of December 31, 2002 and 2001, and the related consolidated statements
of operations, shareholders' equity, and cash flows for each of the three years
in the period ended December 31, 2002. Our audits also included the financial
statement schedule listed in the Index at Item 15(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Catuity, Inc.
at December 31, 2002 and 2001, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
2002, in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Detroit, Michigan
February 7, 2003
27
CATUITY, INC.
CONSOLIDATED BALANCE SHEET
<Table>
<Caption>
DECEMBER 31
----------------------------
2002 2001
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 3,611,447 $ 4,464,863
Accounts receivable-trade, less allowance of $54,000 in
2002, and $114,000 in 2001............................. 377,218 668,482
Restricted cash........................................... 106,568 94,712
Work in process........................................... 2,407 208,823
Prepaid expenses and other................................ 294,195 218,416
------------ ------------
Total current assets........................................ 4,391,835 5,655,296
Property and equipment, net................................. 200,417 215,197
------------ ------------
Total Assets................................................ $ 4,592,252 $ 5,870,493
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 302,714 $ 271,435
Deferred revenue.......................................... 1,811,926 834,514
Accrued compensation...................................... 146,143 153,415
Other accrued expenses.................................... 168,417 620,500
Trust liability........................................... 85,492 78,745
------------ ------------
Total current liabilities................................... 2,514,692 1,958,609
Accrued compensation........................................ 79,359 54,910
Shareholders' equity:
Common stock -- $.001 par value; Authorized -- 100 million
shares: issued and outstanding 8,530,610 in 2002 and
8,063,338 in 2001...................................... 8,531 8,064
Preferred stock -- $0.001 par value; Authorized -- 10
million shares......................................... -- --
Additional paid-in capital................................ 33,131,863 32,216,113
Shareholder loans......................................... (757,733) (757,733)
Foreign currency translation adjustment................... (322,115) (316,280)
Accumulated deficit....................................... (30,062,345) (27,293,190)
------------ ------------
Total shareholders' equity.................................. 1,998,201 3,856,974
------------ ------------
Total Liabilities and Shareholders' Equity.................. $ 4,592,252 $ 5,870,493
============ ============
</Table>
See accompanying notes
28
CATUITY, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
---------------------------------------
2002 2001 2000
---- ---- ----
REVENUES:
Software development revenue..................... $ 1,666,890 $ 1,414,214 $ 534,560
Service revenue.................................. 1,258,996 593,470 216,913
License revenue.................................. 45,788 12,600 --
----------- ----------- -----------
Gross revenue.................................... 2,971,674 2,020,284 751,473
Sales discount (non-cash)........................ -- (403,899) --
----------- ----------- -----------
Net revenue...................................... 2,971,674 1,616,385 751,473
Direct cost of revenue:
Software development revenue..................... 981,329 613,092 456,388
Service revenue.................................. 1,105,207 815,894 363,474
----------- ----------- -----------
Total direct cost of revenue..................... 2,086,536 1,428,986 819,862
Gross margin..................................... 885,138 187,399 (68,389)
Operating costs and expenses:
Research and development......................... 539,282 472,667 446,067
Sales and marketing.............................. 1,758,245 2,119,502 2,081,288
General and administrative....................... 1,470,324 2,687,628 2,003,408
General and admin. -- variable stock
compensation................................... (53,363) (973,350) (716,192)
----------- ----------- -----------
Total operating expenses......................... 3,714,488 4,306,447 3,814,571
----------- ----------- -----------
Operating loss................................... (2,829,350) (4,119,048) (3,882,960)
OTHER INCOME/(EXPENSE):
Interest income.................................. 60,195 243,846 246,200
Interest expense -- related party................ -- -- (47,145)
----------- ----------- -----------
Total other income............................... 60,195 243,846 199,055
----------- ----------- -----------
Loss before extraordinary item................... (2,769,155) (3,875,202) (3,683,905)
Extraordinary loss on early extinguishment of
debt........................................... -- -- (127,446)
----------- ----------- -----------
Net loss......................................... $(2,769,155) $(3,875,202) $(3,811,351)
=========== =========== ===========
Loss per share before extraordinary item -- basic
& diluted...................................... $ (0.34) $ (0.49) $ (0.52)
Loss per share on extraordinary item -- basic &
diluted........................................ -- -- (0.02)
----------- ----------- -----------
Net loss per share -- basic & diluted............ $ (0.34) $ (0.49) $ (0.54)
=========== =========== ===========
Weighted average shares outstanding -- basic &
diluted........................................ 8,123,357 7,935,137 7,020,534
=========== =========== ===========
</Table>
See accompanying notes
29
CATUITY, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<Table>
<Caption>
YEAR ENDED DECEMBER 31
---------------------------------------
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss......................................... $(2,769,155) $(3,875,202) $(3,811,351)
Adjustments used to reconcile net loss to net
cash used in operating activities:
Stock based compensation....................... (53,363) (973,350) (716,192)
Depreciation and amortization.................. 125,273 110,096 117,525
Non cash sales discount........................ -- 403,899 --
Non cash services.............................. 27,751 117,797 --
Extraordinary loss on early extinguishment of
debt........................................ -- -- 127,446
Changes in assets and liabilities:
Accounts receivable............................ 291,264 (556,784) 317,461
Accounts payable............................... 31,279 (107,548) (181,923)
Deferred revenue............................... 977,412 767,514 67,000
Accrued expenses and other liabilities......... (428,159) 47,556 281,280
Other assets................................... 118,781 70,671 (298,475)
----------- ----------- -----------
Net cash used in operating activities............ (1,678,917) (3,995,351) (4,097,229)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment............. (110,493) (88,461) (112,319)
----------- ----------- -----------
Net cash used in investing activities............ (110,493) (88,461) (112,319)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net of expenses...... 941,829 41,045 8,193,904
Net proceeds from sale of option............... -- -- 924,805
Payments on borrowings from related parties.... -- -- (854,230)
Fees paid for early extinguishment of debt..... -- -- (127,446)
----------- ----------- -----------
Net cash provided by financing activities........ 941,829 41,045 8,137,033
Foreign exchange effect on cash.................. (5,835) (51,213) (638,399)
----------- ----------- -----------
Net increase/(decrease) in cash and cash
equivalents.................................... (853,416) (4,093,980) 3,289,086
Cash and cash equivalents, beginning of period... 4,464,863 8,558,843 5,269,757
----------- ----------- -----------
Cash and cash equivalents, end of period......... $ 3,611,447 $ 4,464,863 $ 8,558,843
=========== =========== ===========
Supplemental disclosure of cash flow information:
Taxes paid..................................... $ -- $ -- $ --
=========== =========== ===========
Interest paid.................................. $ -- $ -- $ 47,145
=========== =========== ===========
</Table>
See accompanying notes
30
CATUITY, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
<Table>
<Caption>
COMMON STOCK ADDITIONAL FOREIGN TOTAL
------------------ PAID IN SHAREHOLDER CURRENCY ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL LOANS TRANSLATION DEFICIT EQUITY
------ ------ ---------- ----------- ----------- ----------- -------------
Balances at January 1, 2000... 6,729,269 $6,729 $24,197,799 $(757,733) $ 401,073 $(19,606,637) $ 4,241,231
Issuance of common stock.... 713,636 714 6,289,812 6,290,526
Exercise of options......... 426,714 427 1,902,952 1,903,379
Sale of option right........ 952,545 952,545
Stock based compensation.... (716,192) (716,192)
Net loss...................... (3,811,351) (3,811,351)
Foreign currency
translation................. (666,140) (666,140)
-----------
Comprehensive loss.......... (4,477,491)
--------- ------ ----------- --------- --------- ------------ -----------
Balances at December 31,
2000........................ 7,869,619 7,870 32,626,916 (757,733) (265,067) (23,417,988) 8,193,998
Issuance of common stock.... 165,719 166 480,530 480,696
Exercise of options......... 28,000 28 41,017 41,045
Sale of option right........ 41,000 41,000
Stock based compensation.... (973,350) (973,350)
Net loss...................... (3,875,202) (3,875,202)
Foreign currency
translation................. (51,213) (51,213)
-----------
Comprehensive loss.......... (3,926,415)
--------- ------ ----------- --------- --------- ------------ -----------
Balances at December 31,
2001........................ 8,063,338 8,064 32,216,113 (757,733) (316,280) (27,293,190) 3,856,974
Issuance of common stock.... 466,272 466 958,873 959,339
Exercise of options......... 1,000 1 1,690 1,691
Sale of option right........ 8,550 8,550
Stock based compensation.... (53,363) (53,363)
Net loss...................... (2,769,155) (2,769,155)
Foreign currency
translation................. (5,835) (5,835)
-----------
Comprehensive loss.......... (2,774,990)
--------- ------ ----------- --------- --------- ------------ -----------
Balances at December 31,
2002........................ 8,530,610 $8,531 $33,131,863 $(757,733) $(322,115) $(30,062,345) $ 1,998,201
========= ====== =========== ========= ========= ============ ===========
</Table>
See accompanying notes
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF BUSINESS
Catuity, Inc. and subsidiaries (the "Company") designs, develops, operates
and markets multi-program systems that provide loyalty and incentive marketing
solutions. The Company's principal customers are retailers, card issuing banks
and processors for consumer purchases in stores as well as over the Internet.
These solutions are intended to increase customer retention, increase the
customer base and reduce costs for merchants. The Company provides full program
services and network system software that directly connect the seller and the
buyer across all purchasing channels, irrespective of payment method.
NOTE 2. SUMMARY OF ACCOUNTING POLICIES
Principles of Consolidation
The accompanying financial statements include the consolidation of the
accounts of the Company and its wholly owned subsidiaries. All significant
inter-company transactions and balances have been eliminated.
Revenue Recognition
The three distinct revenue streams that result from the Company's business
activities are license revenue, software development revenue, and service
revenue.
License Revenue: License revenue is recognized in accordance with
Statement of Position (SOP) 97-2, Software Revenue Recognition, which
provides for recognition of revenue when persuasive evidence of an
arrangement exists, delivery of the product has occurred, no significant
obligations remain on the Company's part with regard to implementation, the
fee is fixed and determinable, and collectibility is probable. SOP 97-2
generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative
fair value of each element. Revenue recognized from multiple-element
arrangements is allocated to undelivered elements of the arrangement, such
as maintenance, based on the relative fair value of each element. The
Company's determination of fair value of each element in multi-element
arrangements is based on vendor-specific objective evidence (VSOE). The
Company limits its assessment of VSOE for each element to either the price
charged when the same element is sold separately or the price established
by management for an element not yet sold separately. The Company has VSOE
for maintenance services. The Company does not generally provide for a
right of return in its license contracts.
Software Development Revenue: Software development revenue includes
integration, customization and development fees of both the customer's
hardware and software and the Company's software. Software development
revenue is billed on a fixed price basis. The Company recognizes revenue on
fixed price contracts on the percentage of completion basis in accordance
with SOP 97-2, Software Revenue Recognition, and SOP 81-1, Accounting for
Performance of Construction-Type Contracts, based on hours incurred as a
percentage of estimated total hours of the respective contract. The
cumulative impact of any revisions in estimated total revenues and direct
contract costs are recognized in the period in which they become known.
Revenue in excess of billings is recognized as unbilled receivables and is
included in work in process in the consolidated balance sheet. Billings in
excess of revenue are recorded as unbilled revenue until revenue
recognition criteria are met. The Company generally does not provide for a
right of return in its software development contracts.
Service Revenue: Service revenue includes training, consulting,
installation support, post-installation support and maintenance fees.
Training, consulting, installation support and post-
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
installation support are generally billed on a time and material basis and
revenue is recognized as the service is provided. Maintenance revenues are
recognized ratably over the maintenance term. Payments for service revenues
are generally not refundable.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results may
differ from those estimates.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
CASH AND CASH EQUIVALENTS
The Company considers all cash and highly liquid investments purchased with
an original maturity of three months or less to be cash equivalents.
ACCOUNTS RECEIVABLE AND CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of trade receivables. The credit
risk associated with trade receivables is limited due to the size and
creditworthiness of the Company's customers. The Company generally does not
require collateral for its trade receivables. The Company generated 80% of net
revenue from one U.S. customer in 2002. The loss of that customer would have a
material effect on the Company's operations.
The Company records an allowance against gross accounts receivable to
provide for doubtful accounts. The allowance is estimated based on the age of
the receivable, specific circumstances surrounding the collection of an invoice,
historical data on allowances as a percentage of aged accounts receivables.
Actual collection on accounts may differ from the allowance the Company has
estimated.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
expense is recorded using the straight-line method over the estimated useful
lives of the respective assets (which range from three to ten years).
FOREIGN CURRENCY TRANSLATION
The accounts of the Company's subsidiaries are translated in accordance
with Statement of Financial Accounting Standards No. 52, "Foreign Currency
Translation". All balance sheet accounts for the Australian subsidiaries are
translated at the exchange rates in effect at the balance sheet date. Revenues
and expenses for the Australian subsidiaries are translated at the average
exchange rate during the year. All cumulative translation gains and losses are
included as a separate component of shareholders' equity in the consolidated
balance sheet. Currency transaction gains and losses are included in the
consolidated statement of operations.
The Company accounts for foreign currency exchange gains or losses on
inter-company transactions in accordance with SFAS No. 52, "Foreign Currency
Translation". Transactions
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
occurring between the Company's U.S. office and the Australian office are
considered to be of a long-term investment nature as settlement is not
anticipated in the foreseeable future. Inter-company balances are eliminated and
do not appear on the consolidated financial statements of the Company. Any gain
or loss on the inter-company balance caused by foreign currency translation
adjustments is shown in the equity section of the balance sheet and is not
included in determining net profit/(loss).
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of certain financial instruments such as cash and cash
equivalents, accounts receivable-trade, and accounts payable approximate their
fair values.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No.
109"), which requires the use of the liability method in accounting for income
taxes. Under SFAS No. 109, deferred tax assets and liabilities are measured
based on differences between the financial reporting and tax bases of assets and
liabilities using enacted tax rates and laws that are expected to be in effect
when the differences are expected to reverse.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards issued to employees under the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and has adopted
the disclosure-only alternative of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
Had compensation costs for stock-based awards issued to employees been
determined consistent with SFAS No. 123, the Company's net loss and net loss per
share would have been reported as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
-----------------------------------------
2002 2001 2000
---- ---- ----
Net Loss as Reported................. $(2,769,155) $(3,875,202) $(3,811,351)
=========== =========== ===========
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards......................... 700,604 779,530 1,648,733
----------- ----------- -----------
Pro forma net loss................... $(3,469,759) $(4,654,732) $(5,460,084)
=========== =========== ===========
Earnings per share: basic &
diluted -- as reported............. $ (0.34) $ (0.49) $ (0.54)
=========== =========== ===========
Pro forma basic & diluted loss per
share.............................. $ (0.43) $ (0.59) $ (0.78)
=========== =========== ===========
</Table>
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For disclosure purposes, the fair value of stock based compensation was
computed using the Black-Scholes option pricing model with the following
weighted average assumptions used for 2002, 2001, and 2000 grants:
<Table>
<Caption>
DECEMBER 31
-----------------------
2002 2001 2000
---- ---- ----
Risk Free Interest Rate.............................. 3.00% 5.00% 6.00%
Expected Dividend Yield.............................. -- -- --
Expected Lives (years)............................... 1.27 2.23 4.95
Expected Volatility.................................. 0.773 0.789 0.917
</Table>
For all fixed awards issued to employees, the Company records an expense
based on the intrinsic value at the date of grant and amortizes it over the
vesting period. For variable awards issued to employees or non-employees, the
Company records an expense based on the fair value of the options at each
balance sheet date.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS No. 144) was issued in July
2001, and addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. This statement replaced Statement of Financial
Accounting Standards No. 121 on the same topic and established an accounting
model for the impairment of long-lived assets. The Company adopted this
statement on January 1, 2002, and the adoption did not have any effect on its
consolidated statement of operations, financial position or cash flows.
Statement of Financial Accounting Standards No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure" (SFAS No. 148) was issued
in December 2002 amending SFAS No. 123, "Accounting for Stock-Based
Compensation." SFAS No. 148 provides alternative methods of transition to SFAS
No. 123's fair value method of accounting for stock-based employee compensation,
however, it does not require a change to a fair value approach. It also requires
disclosure in the summary of significant accounting policies of the effects of
the Company's accounting policy with respect to stock-based employee
compensation on reported net income and earnings per share in annual and interim
financial statements. The Company adopted the disclosure provisions of this
interpretation for the year ended December 31, 2002. The adoption of this
statement did not have any effect on the Company's consolidated statement of
operations, financial position or cash flows.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consists of:
<Table>
<Caption>
DECEMBER 31
----------------------
2002 2001
---- ----
Computer equipment.................................. $ 532,800 $ 435,368
Leasehold improvements.............................. 50,635 45,840
Office furniture and equipment...................... 122,707 114,441
--------- ---------
$ 706,142 $ 595,649
Less accumulated depreciation....................... (505,725) (380,452)
--------- ---------
$ 200,417 $ 215,197
========= =========
</Table>
NOTE 4. COMMITMENTS AND CONTINGENCIES
Lease Commitments -- The Company has commitments under non-cancelable
office leases of $144,000 at December 31, 2002.
Total rent expense on all office leases was $220,000, $176,000, and $91,000
for the years ended December 31, 2002, 2001 and 2000, respectively.
CONTINGENCIES
GRANTS
While the Company received no grants in 2002 or 2001, research &
development and export market development grants were received in Australia in
2000. The grants were recognized using contract accounting when the underlying
performance objective was attained or services were provided. The revenue was
offset against the expenses to which it related.
Under the terms of a Grant Agreement with the Commonwealth of Australia,
the Company was required to meet certain obligations with regard to the
development and commercialization of a Multi Card Acceptance Device. In the
event that those obligations were not met, the Company would have been required
to repay all or part of the grant monies received. As of December 31, 2002, the
Company had no liability for the repayment of grant monies received.
NOTE 5. SHAREHOLDERS' EQUITY
LIMITED RECOURSE LOANS
In 1995 and 1996, the Company issued non-recourse loans to an Australian
director in the amount of approximately $975,000 AUD ($729,000 USD at the
exchange rates in effect on the dates of the transactions in 1995 and 1996) for
the purpose of purchasing approximately 276,000 shares of the Company's stock.
The loan amount is denominated and repayable in Australian dollars. The loan
amount has remained unchanged since 1999 when $75,000 AUD of the loan for 25,000
shares was repaid ($48,000 USD at the exchange rate in effect on the date of the
transaction ). The loans have been offset against shareholders' equity. The
Company's recourse for repayment of the loans is limited to after-tax dividends
and proceeds from the sale of the shares. As a result, the recoverability of the
loan is dependent upon the value of the shares. The loans do not have a
specified repayment date and were provided interest-free. Consequently, the
awards have been treated as a variable award and variable accounting has been
adopted. The Company has recorded a credit related to these awards based on the
change in the price of common stock from the date of the award to the
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
respective balance sheet dates. The credit was $53,363, $973,350 and $716,192
for the years ended December 31, 2002, 2001 and 2000, respectively.
EMPLOYEE STOCK OPTION PLAN
The Board of Directors approved the establishment of an Employee Stock
Option Plan ("Plan") on December 6, 1999. Under the Plan the Company grants
stock options at an exercise price that may be determined by the Board of
Directors at the time of issuance, but is generally at the closing price of the
stock on the date of the grant or the average closing price of the stock for the
30 calendar days preceding the grant date, whichever is higher. Option vesting
schedules are determined by the Board of Directors at the time of issuance, but
are generally over three to five years from the date of the grant. Employees
must exercise the options within two to six months of terminating their
employment with the Company or the options lapse.
DIRECTOR STOCK OPTION PLAN
On October 24, 2000 the members of the Board of Directors, who are
employees of the Company, approved the establishment of a Director Stock Option
Plan ("Plan") effective October 1, 2000 for outside Directors. The Plan is
designed to provide a portion of the outside Director's compensation through
stock options. Under the Plan, outside Directors receive 10,000 non-qualified
option shares on the date they join the Board or on the date the plan became
effective, in the case of existing outside Directors. In addition, each outside
Director receives 5,000 non-qualified option shares on the last business day in
September of each succeeding year for as long as the Director remains on the
Board. The option issue price will be the closing price on the grant date, or
the closing price on the last trading day preceding the grant date in the event
the grant date falls on a weekend or holiday. The options vest on the date of
grant and expire after eight years, or six months after the Director ceases to
be a member of the Board, whichever occurs first. The Plan is limited so that no
more than 100,000 option shares may be outstanding at any one time.
OPTIONS ISSUED TO THIRD PARTIES
The Company granted options to purchase shares of common stock to third
parties during the period January 1, 2000 to December 31, 2002 primarily for
services provided to the Company. The Company valued these options using the
Black-Scholes option-pricing model. Expense relating to these options amounted
to $8,550, $41,000 and $30,000 for the three years ended December 31, 2002,
2001, and 2000 respectively. The expense was charged to operations in the year
they were granted as they vested immediately.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SUMMARY OF STOCK OPTIONS/WARRANTS
The following is a summary of stock and warrant activity:
<Table>
<Caption>
WEIGHTED
NUMBER OF AVERAGE
OPTION & WARRANT EXERCISE PRICE
SHARES PER SHARE
---------------- --------------
Outstanding at January 1, 2000............. 821,623 $5.96
Granted.................................... 736,000 $8.25
Cancelled/lapsed........................... (56,750) 5.10
Exercised.................................. (426,714) 4.46
--------- -----
Outstanding at December 31, 2000........... 1,074,159 $7.76
Granted.................................... 353,550 $4.26
Cancelled/lapsed........................... (247,309) 5.11
Exercised.................................. (28,000) 1.47
--------- -----
Outstanding at December 31, 2001........... 1,152,400 $6.90
Granted.................................... 306,097 $2.71
Cancelled/lapsed........................... (233,450) 5.27
Exercised.................................. (1,000) 1.69
--------- -----
Outstanding at December 31, 2002........... 1,224,047 $6.35
========= =====
</Table>
The weighted average fair value of options/warrants granted during the
three years ended December 31, 2002, 2001 and 2000 were $1.14, $2.69 and $4.78,
respectively.
The following is additional information relating to options outstanding as
of December 31, 2002:
<Table>
<Caption>
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED ---------------------
WEIGHTED AVERAGE WEIGHTED
AVERAGE CONTRACTUAL AVERAGE
EXERCISE NUMBER OF EXERCISE LIFE NUMBER OF EXERCISE
PRICE RANGE SHARES PRICE (YEARS) SHARES PRICE
----------- --------- -------- ----------- --------- --------
$2.07 - $ 4.11.............. 336,197 $2.81 2.80 223,722 $2.61
$4.38 - $ 4.55.............. 161,350 $4.45 5.31 119,800 $4.43
$5.37 - $ 7.68.............. 295,500 $6.92 4.20 215,500 $6.84
$8.96 - $10.88.............. 431,000 $9.43 5.40 335,000 $9.41
</Table>
The dilutive effect of stock options has not been included in the loss per
share calculation, as the effect would be anti-dilutive.
COMMON STOCK
On November 20, 2002 the members of the Board of Directors approved the
establishment of an Executive Stock Purchase Plan ("Plan") for executives of the
Company. Under the plan executive employees may elect to purchase shares of the
Company's common stock at the closing price of the stock on the last trading day
of each month beginning in December 2002. The maximum number of shares that may
be purchased under the plan is 25,000 shares.
On January 21, 2003 the members of the Board of Directors adopted the
Catuity, Inc. 2003 Executive Director Stock Purchase Plan ("Plan") to become
effective upon approval by the Company's shareholders at a March 2003 special
meeting of shareholders. Under the Plan executive directors may elect to
purchase shares of the Company's common stock at the closing price of the
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stock on the last trading day of each month. The plan automatically terminates
on the date all shares approved under the Plan have been purchased unless
terminated earlier by the Board of Directors. The maximum number of shares that
may be purchased under the plan is 100,000 shares.
On May 1, 2001 the Company entered into an agreement with Greenstone
Partners Inc. whereby the Company agreed to issue shares of common stock, and
options to purchase shares of common stock, in exchange for Greenstone's
investor relations services. Under the terms of the agreement, Greenstone
received a total of 30,000 shares of the Company's common stock, vesting at the
rate of 3,000 shares per month and the option to purchase 25,000 shares of the
Company's common stock at $4.00 per share between August 1, 2001 and May 1, 2004
unless the agreement was terminated prior to its completion In addition,
Greenstone could earn up to 120,000 additional options if certain performance
based objectives were achieved between May 1, 2001 and May 1, 2003. On February
15, 2002, the agreement with Greenstone Partners Inc. was terminated by the
Company. As a result of the termination, none of the performance-based options
were earned.
In 2001 the Company entered into a licensing and services agreement with
Visa USA Inc. that included the Company granting Visa 141,719 unregistered
shares of the Company's common stock. The stock grant was recorded as a non-cash
sales discount of $404,000 in the 2001 statement of operations.
PREFERRED STOCK
The Company's Certificate of Incorporation authorizes 10 million shares of
preferred stock, with a par value of $0.001 per share, none of which is issued
or outstanding. The Board of Directors has the authority to issue the preferred
stock in one or more series and to fix rights, preferences, privileges and
restrictions, including dividends, and the number of shares constituting any
series or the designation of such series, without any further vote or action by
the shareholders.
PRIVATE PLACEMENT
In November 2002, the Company received net proceeds of $925,000 from the
private placement of common stock to accredited professional investors in
Australia at a price of $3.75 AUD per share ($2.11 USD based on the foreign
exchange rate in effect on the date of the transaction). The price equaled the
fair market value of the shares on the Australian Stock Exchange (ASX) on the
transaction date. In addition, one warrant share at an exercise price of $4.20
AUD ($2.57 USD) for every three (3) shares purchased were granted, and expire in
November 2004. The exercise price of the warrants represented approximately a
12% premium over the fair market price of the Company's shares on the date of
transaction. A placement fee of 3% of the purchase price was paid to each
investor. Net proceeds from the placement were $925,000.
In addition, the Company expects to receive approximately $190,000 in March
or April 2003 from the private placement of common stock to Boom Australia Pty.
Ltd. ("Boom"), the family trust of Mr. Duncan P.F. Mount, an independent
non-executive director of the Company. Pursuant to Australian Stock Exchange
rules, Boom's subscription for 90,000 common shares was subject to shareholder
approval, which was received at a special meeting of shareholders on March 26,
2003.
On November 16, 2000 the Company completed the private placement of 710,000
shares of common stock to six accredited institutional investors at a price of
$9.47 per share. The settlement date of the transaction was November 21, 2000.
Net proceeds from the placement were $6,245,000. The price of the issue was
based on the average closing price for the Company's shares on the Australian
Stock Exchange for the thirty-day period prior to the placement.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SALE OF OPTION RIGHT AND EARLY EXTINGUISHMENT OF DEBT
On June 30, 2000, Chip Application Technologies Limited (CAT), a wholly
owned subsidiary of the Company, entered into an Option Assignment Agreement
with BNP Paribas Equities (Australia) Limited (BNP) whereby CAT transferred all
its rights, title and interests under the Loan Repayment and Option Agreement as
amended (the "Agreement") it had entered into with Health Group Australia
Limited (HGA) and Industrial Superannuation Administration Services Limited
(ISAS) dated May 4, 1999 for the right to acquire 309,150 and 23,437 shares held
respectively by HGA and ISAS in the Company. The agreement provided the Company
the right to purchase its shares owned by HGA and ISAS at $4.92 per share prior
to July 19, 2000. Also on June 30, 2000 CAT signed a Mandate Letter with BNP for
disposal of the shares at $8.11 per share.
The transactions were completed on July 14, 2000. In accordance with the
Agreements and Mandate Letter, BNP paid CAT $1,059,672 after deducting $134,867
of fees resulting in $924,805 of net proceeds from the transaction. As a
condition of the option being exercised, CAT repaid the outstanding loans due
HGA of $777,530 plus $127,446 for early repayment.
NOTE 6. INCOME TAXES
The components of profit/(loss) before income taxes and extraordinary items
consisted of the following:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
-----------------------------------------
2002 2001 2000
---- ---- ----
Domestic............................. $(3,904,994) $(4,904,115) $(3,440,602)
Foreign.............................. 1,135,839 1,028,913 (243,303)
----------- ----------- -----------
Loss before income taxes and
extraordinary item................. $(2,769,155) $(3,875,202) $(3,683,905)
=========== =========== ===========
</Table>
There has been no provision for income taxes for any period as the Company
has incurred operating losses and provided a full valuation allowance against
the tax benefit of those operating losses in the United States. The Company has
utilized net operating loss carryforwards to offset operating earnings in
Australia. The provision for income taxes at statutory rates is reconciled to
the reported provision for income taxes as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31
----------------------------------------
2002 2001 2000
---- ---- ----
Income taxes at statutory tax rate.... $ (941,513) $(1,338,147) $(1,254,961)
Stock compensation.................... (18,143) (330,939) (243,505)
R&D grant 25% deduction............... -- -- (97,405)
Grant revenue......................... -- -- (101,660)
Utilization of operating loss
carryforward........................ (340,752) (308,674) --
Valuation allowance................... 1,206,029 1,713,647 1,697,531
Other................................. 94,378 264,113 --
---------- ----------- -----------
Provision for income taxes............ $ -- $ -- $ --
========== =========== ===========
</Table>
The statutory tax rate was 34% for the years ended December 31, 2002, 2001
and 2000. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. Significant components of the Company's deferred tax
liabilities and assets are as follows:
<Table>
<Caption>
DECEMBER 31
---------------------------
2002 2001
---- ----
Deferred tax assets:
Net operating loss carry-forwards............... $ 9,541,600 $ 8,554,700
Other........................................... 705,113 485,984
------------ -----------
Total deferred tax assets....................... 10,246,713 9,040,684
Valuation allowance............................. (10,246,713) (9,040,684)
------------ -----------
Total net deferred tax assets................... $ -- $ --
============ ===========
</Table>
Realization of deferred tax assets is dependent upon future earnings, if
any, the timing and amount of which are uncertain. Accordingly, the net deferred
tax assets have been fully reserved by a valuation allowance.
As of December 31, 2002, the Company had operating loss carry-forwards of
$13,075,000 expiring in various amounts in 2020 and 2021 in the United States
and $16,987,000 in Australia. Utilization of the net operating loss
carry-forwards in Australia are subject to either the continuity of ownership
test or the continuation of same business test at the time the losses are
utilized in accordance with Subdivision 165 and Subdivision 166 of the
Australian Income Tax Assessment Act of 1997. The limitation may result in the
expiration of net operating losses before utilization.
NOTE 7. DEFINED CONTRIBUTION PLAN
On behalf of its Australian employees, the Company contributes a government
mandated percentage of each employees' gross salary to a defined contribution
plan. The prescribed charge percentage was 9% for the year ended December 31,
2002 and 8% for the two years ended December 31, 2001 and 2000. The Company's
contributions were $115,001, $79,692, and $78,019 for the three years ended
December 31, 2002, 2001 and 2000 respectively.
There is a 401-K plan available for employees in the U.S. The Company has
not made matching contributions to the 401-K plan to date.
NOTE 8. RESTRICTED CASH
The Company was and continues to be the trustee of a bank account related
to the use of its Transcard software product that was discontinued in August
2001. When consumers transferred funds to their cards, the funds were deposited
into this trust account. The funds were debited from the account electronically
and paid to merchants when transaction information relating to cardholder usage
was downloaded from merchants through a central host processing system. The
Company is not entitled to the funds other than in specified circumstances such
as when cards are inactive or expired. Consequently, an amount corresponding to
the trust account balance is recorded as a current liability. The trust account
had an ending balance of $88,778, and $78,745, at December 31, 2002 and 2001,
respectively.
On August 31, 2001, in accordance with an agreement between the Company and
Westbus Pty Limited, the Transcard system was discontinued. As of that date, no
additional cards were issued and consumers could no longer use their cards to
purchase goods or services. The Company is serving as the administrator to
refund all requested prepaid balances remaining on consumers' cards as of the
date the system was discontinued.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In addition, the Company had restricted cash of $17,790, and $15,967 as of
December 31, 2002 and 2001, respectively, related to an amount held as security
for an operating lease.
NOTE 9. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA
As of December 31, 2002, the Company is organized and operates in one
business segment, providing loyalty software for retailers and card issuing
banks in North America. Two U.S. customers represented 80% and 16% of net
revenue for the year ended December 31, 2002. One U.S. customer represented 70%
of net revenue for the year ended December 31, 2001. Two U.S. customers
represented 72% and 10% of net revenue for the year ended December 31, 2000.
The following table shows net revenues and long-lived assets by geographic
area.
<Table>
<Caption>
2002 2001 2000
------------------------ ------------------------ ----------------------
LONG-LIVED NET LONG-LIVED NET LONG-LIVED NET
ASSETS REVENUES ASSETS REVENUES ASSETS REVENUES
---------- -------- ---------- -------- ---------- --------
U.S. ..................... $ 98,402 $2,971,674 $112,004 $1,546,748 $ 90,883 $626,417
Australia................. 102,015 -- 103,193 69,637 145,949 125,056
-------- ---------- -------- ---------- -------- --------
Total................ $200,417 $2,971,674 $215,197 $1,616,385 $236,832 $751,473
======== ========== ======== ========== ======== ========
</Table>
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED
-------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
2002 2002 2002 2002
-------- ----------- ------------ -----------
Net revenues.............................. $ 976,126 $ 917,637 $ 550,487 $ 527,424
Total direct cost of revenue.............. 685,379 644,311 386,520 370,326
--------- ----------- --------- ----------
Gross Margin.............................. 290,747 273,326 163,967 157,098
Total operating expenses(1)............... 661,343 1,276,995 927,720 848,430
--------- ----------- --------- ----------
Operating loss............................ (370,596) (1,003,669) (763,753) (691,332)
Total other income........................ 15,128 16,356 13,048 15,663
--------- ----------- --------- ----------
Net loss.................................. $(355,468) $ (987,313) $(750,705) $ (675,669)
========= =========== ========= ==========
Net loss per share -- basic & diluted..... $ (0.04) $ (0.12) $ (0.09) $ (0.09)
========= =========== ========= ==========
</Table>
<Table>
<Caption>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
2001 2001 2001 2001
--------- ----------- ------------ -----------
Gross revenues............................ $ 145,225 $ 176,706 $ 490,200 $1,208,153
Sales discounts........................... -- -- -- (403,899)
--------- ----------- ---------- ----------
Net revenues.............................. 145,225 176,706 490,200 804,254
Total direct cost of revenue.............. 102,720 124,988 346,728 854,550
--------- ----------- ---------- ----------
Gross Margin.............................. 42,505 51,718 143,472 (50,296)
Total operating costs and expenses(2)..... 648,456 2,256,875 1,028,178 372,938
--------- ----------- ---------- ----------
Operating Loss............................ (605,951) (2,205,157) (884,706) (423,234)
Total other income........................ 105,172 75,110 52,385 11,179
--------- ----------- ---------- ----------
Net loss.................................. $(500,779) $(2,130,047) $ (832,321) $ (412,055)
========= =========== ========== ==========
Net loss per share -- basic & diluted..... $ (0.06) $ (0.27) $ (0.11) $ (0.05)
========= =========== ========== ==========
</Table>
- -------------------------
(1) Includes non-cash variable stock compensation expense/(credit) of ($63,019),
$184,847, ($167,754), and ($7,437) in the three month periods ended March
31, June 30, September 30, and December 31, 2002, respectively.
(2) Includes non-cash variable stock compensation expense/(credit) of
($836,272), $340,374, ($305,874), and ($171,578) in the three month periods
ended March 31, June 30, September 30, and December 31, 2001, respectively.
43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth our executive officers and directors, and
their ages as of February 28, 2002.
<Table>
<Caption>
NAME AGE POSITION(S)
- ---- --- -----------
David L. Mac. Smith.................. 52 Director and Chairman(2)
Michael V. Howe...................... 54 Director, President and Chief Executive Officer(2)
Alexander S. Dawson.................. 59 Director(1),(2)
Duncan P.F. Mount.................... 55 Director(1)
Alan L. Gilman....................... 59 Director(1),(2)
Robert C. Robins..................... 61 Director
John H. Lowry III.................... 55 Vice President, Chief Financial Officer, Treasurer
and Secretary
Douglas G. Kilgour................... 50 Vice President -- Sales and Marketing
Jonathan R.E. Adams.................. 40 Vice President -- Corporate Development
Benjamin A. Garton................... 36 Vice President -- Development and Implementation
</Table>
- -------------------------
(1) Member, Audit Committee
(2) Member, Compensation Committee
David L. Mac. Smith is our founder and currently our Chairman of the Board.
He has been the Chief Executive Officer and Managing Director of CAT, our wholly
owned subsidiary, since November 1992. In December 1999, he became our President
and CEO pending the appointment of a new President and CEO. In January 2000, he
resigned as our President and CEO and became our Chairman. Prior to November
1992, he was the founder and, from 1982 to 1991, CEO of Technology Investment
Management Limited, a funds management company with specific focus on technology
related businesses. He has a Bachelor of Law degree from the Australian National
University.
Michael V. Howe has served as our President and Chief Executive Officer
since January 2000. From December 1995 through December 1999, he was the
Director of Marketing Communications for United Airlines, responsible for the
United Mileage Plus loyalty rewards program and the United partnership program.
Prior to joining United Airlines, he served as the Chief Executive Officer of
Young and Rubicam Advertising in Detroit, Michigan from October 1990 to November
1995. He has a Bachelor of Business Administration from John Carroll University
and a Master of Business Administration from Michigan State University.
Alexander S. Dawson is currently one of our non-employee Directors. He
served as the Chairman of CAT, our wholly owned subsidiary, from November 1992
to December 1999. From April 1987 to January 1991, he was Chief Executive
Officer of Arnotts Ltd., Australia's largest biscuit and snack food
manufacturing company. From January 1988 to December 1990, he was a member of
the Business Council of Australia. He served as Chairman of United Distillers
(Australasia) Limited from August 1994 to March 1996. He has a Bachelor of
Commerce degree from the University of New South Wales and a Master of Business
Administration from Columbia University.
44
Duncan P.F. Mount is currently one of our non-employee Directors. He served
as a non-employee Director of CAT, our wholly owned subsidiary, from March 1999
to December 1999. From October 1996 to September 1999, he was the Asian adviser
to CEF.TAL Investment Management Limited, a Hong Kong based joint venture
between the Canadian Imperial Bank of Commerce, Cheung Kong Holdings Limited and
TAL Investment Counsel. He spent 17 years in Hong Kong as the Managing Director
of Gartmore Investment Management Limited, from May 1980 to October 1988, and as
managing director of CEF Investment Management Limited from May 1988 to October
1996, entities which are fund management and investment companies. From October
1996 to December 1998, he was Managing Director of CEF.TAL Australia Limited. He
holds a Bachelor and Master of Arts degree in Economics and Law (Hons) from
Cambridge University.
Alan L. Gilman joined the Board of Directors on July 1, 2000 following his
retirement from Arthur Andersen LLP. For 22 years prior to retirement, Mr.
Gilman was a partner with Arthur Andersen LLP and specialized in the retail
industry. Most recently he managed the Arthur Andersen Competency Center,
specializing in retail consulting. From September 1992 to August 1999 he served
as the managing partner of Senn-Delaney, a unit of Arthur Andersen specializing
in the retail industry. In addition to his role with Senn-Delaney, he held
worldwide leadership responsibility for Arthur Andersen's retail industry and
consumer products activities. Prior to September 1992, he was an Audit Partner
at Arthur Andersen focusing primarily on retail distribution and advertising.
Mr. Gilman is also serving as the chairman of the Audit and Compensation
Committees of the Board.
Robert C. Robins joined the Board of Directors on October 9, 2000 following
his retirement from Visa USA. He is currently an Executive Vice President of
Business Development with National Processing Corporation. Mr. Robins was
Executive Vice President of Visa USA in charge of the bank card association's
division that markets Visa products and services to merchants across the United
States. Prior to that he spent seven years in various sales and marketing
management positions with American Cyanamid Company. He also was with Alba Inc.
and the Nestle Corporation in both field sales and corporate management
positions.
John H. Lowry III has served as our Vice President and Chief Financial
Officer since May 2000 and since July 2000, has also served as Secretary and
Treasurer. From August 1992 to January 2000, he was Vice President Finance for
Kelly Services, a Michigan based publicly held staffing services company,
responsible for all financial activities for operations of over 500 staffing
offices in 190 cities with annual sales exceeding $800 million. From August 1982
to July 1992 he was Corporate Controller and Senior Financial Officer for Crain
Communications, a magazine publishing company in Michigan. Prior to this he was
a Senior Manager at Arthur Andersen. He holds a Masters degree in Business
Administration and a Bachelor of Engineering degree from the University of
Michigan.
Douglas G. Kilgour joined Catuity, Inc. March 4, 2002 as our Vice
President, Sales and Marketing. From May 2001 until joining Catuity, Mr. Kilgour
was the Vice President, Financial Services Markets for Xdrive Technologies, the
leader in enterprise software solutions for information management via the
Internet. He was also founder of Smart Card Retail Systems, a pioneer in chip-
based gift card programs for shopping malls, and its predecessor
ExtraValueNetwork, Inc. where he served as the VP Sales and Marketing from
January 1995 until joining Xdrive. Additionally, he has senior sales and
marketing experience in both Canada and the U.S. and has been a principal in
ground breaking Internet, telecommunications and media firms. He holds a
Bachelor of Arts degree from McMaster University in Hamilton, Ontario.
Jonathan R.E. Adams is our Vice President -- North American Implementation
and Technical Services. From May 1996 to July 1998 he was the Director,
Financial Markets, for Schlumberger Smart Cards and Systems based in New Jersey.
From June 1994 to May 1996 he worked with MBNA America Corporation in strategic
planning, involved with card system implementation and
45
electronic commerce. He holds a Bachelor of Arts degree from Washington College
and Master of Business Administration from Georgetown University.
Benjamin A. Garton is currently Vice President -- Product Management &
Development. He served in the same role with CAT, our wholly owned subsidiary,
from March 1999 to December 1999. From November 1996 to February 1999 he was
Manager of Development for CAT and from September 1994 to October 1996 he was a
Senior Systems Analyst for CAT. From October 1992 to August 1994, he was
Development Manager at Citibank Australia with responsibilities for electronic
funds transfer switching systems.
Each of our directors holds office until the next annual meeting of
shareholders or until his successor has been duly elected or qualified or until
his earlier death, resignation or removal. Executive Officers are appointed by,
and serve at the discretion of, our board of directors.
Our board of directors has an audit committee. The audit committee, among
other things, makes recommendations to the board of directors concerning the
engagement of independent auditors and monitors the results of our operating and
internal controls as reported by management and the independent auditors.
Effective February 26, 2001, the board of directors established a
compensation committee. The compensation committee is responsible for
establishing the compensation levels for our executive officers. Members of the
committee who are also executive officers do not participate in discussions or
decisions about their own compensation level or changes in it. In recommending
and determining compensation, the committee takes into consideration the
compensation practices of companies in the markets that the Company competes for
executive talent.. Incentives in the form of stock options are generally
offered.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the section entitled "Director Compensation"
and the section entitled "Summary Compensation Table" of the registrant's 2003
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the section entitled "Ownership of Securities"
of the registrant's 2003 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the section entitled "Certain Relationships
and Related Transactions" of the registrant's 2003 Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Rule 13a-15 of the
Securities and Exchange Act of 1934. The Company's disclosure controls and
procedures are designed to ensure that information required to be disclosed by
the Company in its periodic SEC filings is recorded, processed and reported
within the time periods specified in the SEC's rules and forms. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic SEC
filings. Except as otherwise discussed herein, subsequent to the date of
evaluation, there have been no significant changes in the Company's internal
controls or in other factors that could significantly affect internal controls.
46
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of the Annual Report on Form 10-K:
1. All Financial Statements: The consolidated financial statements are
filed as part of this report under Item 8 -- "Financial Statements and
Supplementary Data."
2. Financial Statement Schedules:
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS CATUITY, INC.
<Table>
<Caption>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ---------------------------------------------------------------- ------------- -----------
ADDITIONS
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND DEDUCTIONS -- AT END
DESCRIPTION OF PERIOD EXPENSES DESCRIBE OF PERIOD
- ----------- ---------- ---------- ------------- ---------
Year Ended December 31, 2002
Valuation allowance for trade
receivable...................... $ 113,550 $ -- $ (59,523)(1) $ 54,027
Valuation allowance for deferred
tax assets...................... 9,040,684 1,206,029 10,246,713
Year Ended December 31, 2001
Valuation allowance for trade
receivable...................... $ 44,421 $ 113,550 $ (44,421)(2) $ 113,550
Valuation allowance for deferred
tax assets...................... 7,327,037 1,713,647 9,040,684
Year Ended December 31, 2000
Valuation allowance for trade
receivable...................... $ 157,704 $ 44,421 $(157,704)(2) $ 44,421
Valuation allowance for deferred
tax assets...................... 5,629,506 1,697,531 7,327,037
</Table>
- -------------------------
(1) reduction in valuation allowance estimate
(2) Uncollectible accounts written off
All other schedules are omitted as the required information is inapplicable
or the information is presented in the Consolidated Financial statements and
notes thereto in Item 8 above.
47
3. EXHIBITS
(a) The following exhibits are filed herewith or are incorporated by
reference to exhibits previously filed with the SEC. Catuity shall furnish
copies of exhibits for a reasonable fee (covering the expense of furnishing
copies) upon request.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3(a) Registrant's Certificate of Incorporation, which appears as
Exhibit 3.3 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.
3(b) Registrant's Certificate of Amendment to the Certificate of
Incorporation, which appears as Exhibit 3.4 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.
3(c) Registrant's By-Laws, which appears as Exhibit 3.5 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
3(d) Certificate of Registration of Card Technologies Australia
Limited, which appears as Exhibit 3.1 to Registrant's Form
10-12G filed March 21, 2000, which is incorporated herein by
reference.
3(e) Certificate of Registration on change of name from Card
Technologies Australia Limited to Chip Application
Technologies Limited, which appears as Exhibit 3.2 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
3(f) Bylaws of Catuity, Inc. (formerly Novatec Inc.) as amended
June 25, 2001, which appears as Exhibit 3(ii) to
Registrant's Form 10-Q for the quarter ended June 30, 2001,
which is incorporated herein by reference.
10(a) Registrant's 2000 Director Stock Option Plan, which appears
as Exhibit 4.2 to Registrant's Form S-8 filed December 20,
2000, which is incorporated herein by reference.*
10(b) Employment agreement of Michael V. Howe, which appears as
Exhibit 10.3 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(c) Services agreement of Jonathan Adams, which appears as
Exhibit 10.8 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(d) Employment agreement of John H. Lowry III, which appears as
Exhibit 10.10 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(e) Employment agreement of Robert Kosnik, which appears as
Exhibit 10.26 to Registrant's Form 10-12G filed August 11,
2000, which is incorporated herein by reference.*
10(f) Put and Call Option Deed of A.S. Dawson in Respect of Shares
of Chip Application Technologies Limited, which appears as
Exhibit 10.1 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(g) Share Option Deed of A.S. Dawson in Respect of Shares of
NovaTec Inc.,which appears as Exhibit 10.2 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.*
10(h) Lease for premises located at 68-72 Wentworth Avenue Surry
Hills, New South Wales, Australia, which appears as Exhibit
10.11 to Registrant's Form 10-12G filed March 21, 2000,
which is incorporated herein by reference.
10(i) Lease for premises located at 2711 East Jefferson Avenue,
Detroit, Michigan, which appears as Exhibit 10.12 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
</Table>
48
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10(j) Research and Development Start Grant for Chip Application
Technologies Limited, which appears as Exhibit 10.13 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
10(k) Smart Loyalty Technical Work Group Agreement between Visa
U.S.A. and Chip Application Technologies limited, which
appears as Exhibit 10.14 to Registrant's Form 10-12G filed
March 21, 2000, which is incorporated herein by reference.
10(l) Partner Program Loyalty Services Agreement between Visa
International Service Association and Chip Application,
Technologies Limited, which appears as Exhibit 10.15 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
10(m) Loan Repayment and Option Agreement among Chip Application
Technologies Limited, Health Group Australia Pty Limited and
Industrial Superannuation Administration Services Limited,
which appears as Exhibit 10.23 to Registrant's Form 10-12G
filed March 21, 2000, which is incorporated herein by
reference.
10(n) Form of Indemnification Agreement, which appears as Exhibit
10.24 to Registrant's Form 10-12G filed March 21, 2000,
which is incorporated herein by reference.
10(o) Form of Stock option Plan and Form of Stock Option Agreement
under Plan, which appears as Exhibit 10.25 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.*
10(p) Catuity, Inc. 2000 Director Stock Option Plan as approved by
the Shareholders of Catuity, Inc. on May 23, 2001, which
appears as Exhibit 10.2(bb) to Registrant's Form 10-Q for
the quarter ended June 30, 2001, which is incorporated
herein by reference.*
10(q) Executive Services Agreement between Catuity, Inc. and David
Machattie Smith dated June 1, 2001 and Executed September
10, 2001, which appears as Exhibit 10.2(cc) to Registrant's
Form 10-Q for the quarter ended September 30, 2001, which is
incorporated herein by reference.*
10(r) Employment agreement between Benjamin Garton and Catuity,
Inc., signed December 6, 2001, which appears as Exhibit
10(r) to Registrant's Form 10-K for the year ended December
31, 2001, which is incorporated herein by reference.*
10(s) Amendment to Stock Option Plan, as approved by the
Shareholders of Catuity, Inc. on May 24, 2001, which appears
as Exhibit 10(r) to Registrant's Form 10-K for the year
ended December 31, 2001, which is incorporated herein by
reference.*
10(t) Consulting agreement between Visa U.S.A and Catuity, Inc.,
signed November 17, 2000, which appears as Exhibit 10(r) to
Registrant's Form 10-K for the year ended December 31, 2001,
which is incorporated herein by reference.
10(u) Catuity, Inc. 2002 Executive Stock Purchase Plan, which
appears as Exhibit 4.1 to Registrant's Form S-8 filed
December 6, 2002, which is incorporated here in by
reference.*
21 Subsidiaries of Registrant as of March 11, 2003
23.1 Consent of Independent Auditors
24 Powers of Attorney Contained on Page 41 of this Annual
Report on Form 10-K and incorporated herein by reference.
99.1 Audit Committee Charter, which appears as Exhibit
Registrants 99.1 to Registrant's Form 10-Q filed November
14, 2000, which is incorporated herein by reference.
</Table>
49
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
99.2 Catuity, Inc. Audit Committee charter as amended October 22,
2001, which appears as exhibit 99.2 to Registrant's Form
10-Q for the quarter ended September 30, 2001, which is
incorporated herein by reference
99.3 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by Michael V. Howe
99.4 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by John H. Lowry III
</Table>
- -------------------------
* Indicates that exhibit is a management contract or compensatory plan or
arrangement.
b) Reports on Form 8-K
The following reports were filed on Form 8-K during the twelve month period
ended December 31, 2002:
<Table>
<Caption>
ITEM REPORTED FINANCIAL STATEMENTS FILED? FILING DATE
- ------------- --------------------------- -----------
Changes in the list of top 20 shareholders.............. No 5-9-02
Mid-year review of forward looking statements........... No 6-27-02
Rights offering in Australia and New Zealand............ No 6-27-02
</Table>
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 27, 2003 CATUITY, INC.
By: /s/ JOHN H. LOWRY
------------------------------------
John H. Lowry
Vice President, CFO and Secretary
POWER OF ATTORNEY
Know All Persons By These Presents, that each person whose signature
appears below constitutes and appoints John H. Lowry his or her
attorneys-in-fact, for such person in any and all capacities, to sign any
amendments to this report and to file the same, with exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that either of said attorney-in-fact, or
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<Table>
<Caption>
SIGNATURE TITLE(S) DATE
--------- -------- ----
/s/ DAVID L. MAC. SMITH Chairman and Director March 27, 2003
- ---------------------------------------------
David L. Mac. Smith
/s/ MICHAEL V. HOWE President, CEO and Director March 27, 2003
- ---------------------------------------------
Michael V. Howe
/s/ ALEXANDER S. DAWSON Director March 27, 2003
- ---------------------------------------------
Alexander S. Dawson
/s/ DUNCAN P F. MOUNT Director March 27, 2003
- ---------------------------------------------
Duncan P. F. Mount
/s/ ALAN L. GILMAN Director March 27, 2003
- ---------------------------------------------
Alan L. Gilman
/s/ ROBERT C. ROBINS Director March 27, 2003
- ---------------------------------------------
Robert C. Robins
/s/ JOHN H. LOWRY Vice President, CFO and Secretary March 27, 2003
- ---------------------------------------------
John H. Lowry
</Table>
51
CERTIFICATION
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Michael V. Howe, certify that:
1. I have reviewed this annual report on Form 10-K of Catuity, Inc;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By /s/ MICHAEL V. HOWE
------------------------------------
Michael V. Howe
President and Chief Executive
Officer
Date: March 27, 2003
52
CERTIFICATION
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John H. Lowry, certify that:
1. I have reviewed this annual report on Form 10-K of Catuity, Inc;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
By: /s/ JOHN H. LOWRY
------------------------------------
John H. Lowry
Chief Financial Officer
Date: March 27, 2003
53
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3(a) Registrant's Certificate of Incorporation, which appears as
Exhibit 3.3 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.
3(b) Registrant's Certificate of Amendment to the Certificate of
Incorporation, which appears as Exhibit 3.4 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.
3(c) Registrant's By-Laws, which appears as Exhibit 3.5 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
3(d) Certificate of Registration of Card Technologies Australia
Limited, which appears as Exhibit 3.1 to Registrant's Form
10-12G filed March 21, 2000, which is incorporated herein by
reference.
3(e) Certificate of Registration on change of name from Card
Technologies Australia Limited to Chip Application
Technologies Limited, which appears as Exhibit 3.2 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
3(f) Bylaws of Catuity, Inc. (formerly Novatec Inc.) as amended
June 25, 2001, which appears as Exhibit 3(ii) to
Registrant's Form 10-Q for the quarter ended June 30, 2001,
which is incorporated herein by reference.
10(a) Registrant's 2000 Director Stock Option Plan, which appears
as Exhibit 4.2 to Registrant's Form S-8 filed December 20,
2000, which is incorporated herein by reference.*
10(b) Employment agreement of Michael V. Howe, which appears as
Exhibit 10.3 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(c) Services agreement of Jonathan Adams, which appears as
Exhibit 10.8 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(d) Employment agreement of John H. Lowry III, which appears as
Exhibit 10.10 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(e) Employment agreement of Robert Kosnik, which appears as
Exhibit 10.26 to Registrant's Form 10-12G filed August 11,
2000, which is incorporated herein by reference.*
10(f) Put and Call Option Deed of A.S. Dawson in Respect of Shares
of Chip Application Technologies Limited, which appears as
Exhibit 10.1 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.*
10(g) Share Option Deed of A.S. Dawson in Respect of Shares of
NovaTec Inc.,which appears as Exhibit 10.2 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.*
10(h) Lease for premises located at 68-72 Wentworth Avenue Surry
Hills, New South Wales, Australia, which appears as Exhibit
10.11 to Registrant's Form 10-12G filed March 21, 2000,
which is incorporated herein by reference.
10(i) Lease for premises located at 2711 East Jefferson Avenue,
Detroit, Michigan, which appears as Exhibit 10.12 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
10(j) Research and Development Start Grant for Chip Application
Technologies Limited, which appears as Exhibit 10.13 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10(k) Smart Loyalty Technical Work Group Agreement between Visa
U.S.A. and Chip Application Technologies limited, which
appears as Exhibit 10.14 to Registrant's Form 10-12G filed
March 21, 2000, which is incorporated herein by reference.
10(l) Partner Program Loyalty Services Agreement between Visa
International Service Association and Chip Application,
Technologies Limited, which appears as Exhibit 10.15 to
Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
10(m) Loan Repayment and Option Agreement among Chip Application
Technologies Limited, Health Group Australia Pty Limited and
Industrial Superannuation Administration Services Limited,
which appears as Exhibit 10.23 to Registrant's Form 10-12G
filed March 21, 2000, which is incorporated herein by
reference.
10(n) Form of Indemnification Agreement, which appears as Exhibit
10.24 to Registrant's Form 10-12G filed March 21, 2000,
which is incorporated herein by reference.
10(o) Form of Stock option Plan and Form of Stock Option Agreement
under Plan, which appears as Exhibit 10.25 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.*
10(p) Catuity, Inc. 2000 Director Stock Option Plan as approved by
the Shareholders of Catuity, Inc. on May 23, 2001, which
appears as Exhibit 10.2(bb) to Registrant's Form 10-Q for
the quarter ended June 30, 2001, which is incorporated
herein by reference.*
10(q) Executive Services Agreement between Catuity, Inc. and David
Machattie Smith dated June 1, 2001 and Executed September
10, 2001, which appears as Exhibit 10.2(cc) to Registrant's
Form 10-Q for the quarter ended September 30, 2001, which is
incorporated herein by reference.*
10(r) Employment agreement between Benjamin Garton and Catuity,
Inc., signed December 6, 2001, which appears as Exhibit
10(r) to Registrant's Form 10-K for the year ended December
31, 2001, which is incorporated herein by reference.*
10(s) Amendment to Stock Option Plan, as approved by the
Shareholders of Catuity, Inc. on May 24, 2001, which appears
as Exhibit 10(r) to Registrant's Form 10-K for the year
ended December 31, 2001, which is incorporated herein by
reference.*
10(t) Consulting agreement between Visa U.S.A and Catuity, Inc.,
signed November 17, 2000, which appears as Exhibit 10(r) to
Registrant's Form 10-K for the year ended December 31, 2001,
which is incorporated herein by reference.
10(u) Catuity, Inc. 2002 Executive Stock Purchase Plan, which
appears as Exhibit 4.1 to Registrant's Form S-8 filed
December 6, 2002, which is incorporated here in by
reference.*
21 Subsidiaries of Registrant as of March 11, 2003
23.1 Consent of Independent Auditors
24 Powers of Attorney Contained on Page 41 of this Annual
Report on Form 10-K and incorporated herein by reference.
99.1 Audit Committee Charter, which appears as Exhibit
Registrants 99.1 to Registrant's Form 10-Q filed November
14, 2000, which is incorporated herein by reference.
99.2 Catuity, Inc. Audit Committee charter as amended October 22,
2001, which appears as exhibit 99.2 to Registrant's Form
10-Q for the quarter ended September 30, 2001, which is
incorporated herein by reference
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
99.3 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by Michael V. Howe
99.4 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by John H. Lowry III
</Table>
- -------------------------
* Indicates that exhibit is a management contract or compensatory plan or
arrangement.