UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended September 30, 2005.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______ to _______
Commission File No: 000-30045
CATUITY INC.
(Exact Name of Registrant as specified in its charter)
Delaware 38-3518829
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2711 E. Jefferson Avenue
Detroit, MI 48207
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(313) 567-4348
Indicate by check mark whether the registrant (1) has filed all reports
required 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of stock as of the latest practical date: Common stock outstanding - 2,069,039
shares as of October 31, 2005.
1
CATUITY INC.
FORM 10-QSB
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets - September 30, 2005 and December 31, 2004 3
Consolidated statements of operations - Three and nine months ended
September 30, 2005 and 2004 4
Consolidated statements of cash flows - Nine months ended
September 30, 2005 and 2004 5
Notes to Consolidated Financial Statements - September 30, 2005 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Controls And Procedures 15
PART II. OTHER INFORMATION 16
Item 1. Legal Proceedings 16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 16
Item 5. Other Information 16
Item 6. Exhibits 16
SIGNATURES AND CERTIFICATIONS 17
2
Part I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATUITY INC.
CONSOLIDATED BALANCE SHEETS
--------------------------------------
SEPTEMBER 30, 2005 DECEMBER 31, 2004
------------------ -----------------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,390,036 $ 2,560,683
Accounts receivable, less allowance of $163,900 at September 30, 2005
and $5,000 at December 31, 2004 341,034 36,211
Restricted cash 109,213 116,012
Prepaid expenses and other 238,325 127,429
------------ ------------
Total current assets 5,078,608 2,840,335
Property and equipment, net 274,767 162,780
Goodwill 2,786,090 --
Intangible Assets, Net 2,128,695 --
------------ ------------
5,189,552 162,780
------------ ------------
Total assets 10,268,160 $ 3,003,115
============ ============
LIABILITIES AND SHAREHOLDERS'
EQUITY
CURRENT LIABILITIES:
Accounts payable $ 254,988 $ 150,584
Accrued compensation 224,694 317,433
Deferred Revenue 200,195
Other accrued expenses 286,668 87,474
Trust liability 85,644 91,722
------------ ------------
Total current liabilities 1,052,189 647,213
Accrued compensation 49,447 --
Leasing Liability 21,699 --
------------ ------------
71,146
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock - $.001 par value; Authorized - 6,666,667 shares:
2,123,499 issued and 2,084,466 outstanding 2,124 778
at September 30, 2005 and 778,184 Issued and Outstanding
at December 31, 2004
Preferred stock - $.001 par value Authorized - 666,667 shares -- --
Additional paid-in capital 45,970,880 36,603,127
Shareholder loans (189,134) (79,533)
Deferred Compensation - Restricted Stock (219,906) --
Foreign currency translation adjustment 45,242 96,656
Accumulated deficit (36,464,381) (34,265,126)
------------ ------------
Total shareholders' equity 9,144,825 2,355,902
------------ ------------
Total liabilities and shareholders' equity 10,268,160 $ 3,003,115
============ ============
See accompanying notes.
3
CATUITY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2005 2004 2005 2004
---------- ----------- ----------- -----------
REVENUES:
Project related $ 0 $ 0 $ 0 $ 231,388
Loyalty Processing and Service 149,727 93,503 172,747 383,445
License 24,265 10,800 47,665 103,285
---------- ----------- ----------- -----------
Total revenues 173,992 104,303 220,412 718,118
COST OF REVENUE AND OTHER OPERATING EXPENSES:
Cost of project related 0 0 0 90,544
Cost of loyalty processing and service 191,351 82,331 278,232 240,634
Cost of license 1,542 4,939 4,296 70,205
Sales and marketing 127,797 225,891 414,865 704,329
Research and development 301,939 269,030 554,268 1,071,398
General and administrative 505,022 669,185 1,231,615 1,485,431
---------- ----------- ----------- -----------
Total costs and expenses 1,127,651 1,251,376 2,483,276 3,662,541
---------- ----------- ----------- -----------
Operating loss (953,659) (1,147,073) (2,262,864) (2,944,423)
Interest income 21,486 19,614 63,611 73,819
---------- ----------- ----------- -----------
Net loss $ (932,173) $(1,127,459) $(2,199,253) $(2,870,604)
========== =========== =========== ===========
Net (loss) per share - basic and diluted $ (0.82) $ (1.45) $ (2.41) $ (3.69)
========== =========== =========== ===========
Weighted average shares outstanding-basic & diluted 1,131,497 778,459 912,501 777,848
========== =========== =========== ===========
See accompanying notes.
4
CATUITY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2005 2004
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,199,253) $(2,870,604)
Adjustments used to reconcile net income/(loss) to net cash
used in operating activities:
Depreciation and amortization 75,185 56,245
Changes in assets and liabilities:
Accounts receivable (304,823) 390,110
Other assets, net 103,525 82,635
Deferred revenue 199,929 (57,626)
Accounts payable 104,404 (7,659)
Accrued expenses and other liabilities 171,943 (5,145)
----------- -----------
Net cash used in operating activities (1,849,090) (2,412,044)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (176,963) (16,406)
Goodwill and Other Intangible Assets (5,971,204) --
----------- -----------
Net cash provided by/ (used in) investing activities (6,148,167) (16,406)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of fractional shares related to reverse stock split (1,055) --
Issuance of common stock, net of expenses 7,357,758 14,057
----------- -----------
Net cash provided by/(used in) financing activities 7,356,703 14,057
----------- -----------
Stock portion of Loyalty Magic acquisition 2,512,500
Foreign exchange effect on cash and cash equivalents (42,593) (60,782)
----------- -----------
Net decrease in cash and cash equivalents 1,829,353 (2,475,175)
Cash and cash equivalents, beginning of period 2,560,683 5,768,828
----------- -----------
Cash and cash equivalents, end of period $ 4,390,036 $ 3,293,653
=========== ===========
See accompanying notes.
5
CATUITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Catuity Inc.
(the "Company") have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information and
with the instructions to Form 10-QSB and Item 310 of Regulation S-B.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for annual
financial statements and notes. The balance sheet at December 31, 2004 has been
derived from the audited financial statements at that date but does not include
all of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring items) considered
necessary for a fair presentation have been included. Operating results for the
three and nine month periods ended September 30, 2005 are not necessarily
indicative of the results that may be expected for any subsequent quarter or for
the entire year ended December 31, 2005. The accompanying interim, consolidated
financial statements should be read in conjunction with the consolidated
financial statements and footnotes included in the Company's Annual Report on
Form 10-K and 10-KA filed with the Securities and Exchange Commission for the
year ended December 31, 2004.
Certain prior year amounts have been reclassified to conform with the current
year presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)") which requires the
measurement of all employee share-based payments to employees, including grants
of employee stock options, using a fair-value-based method and the recording of
such expense in the consolidated statement of operations. The accounting
provisions of SFAS 123(R) are effective for reporting periods beginning after
December 15, 2005. We will adopt SFAS 123(R) effective as of the first quarter
of 2006. The pro forma disclosures previously permitted under SFAS 123 no longer
will be an alternative to financial statement recognition. As a result, because
SFAS 123(R) requires the expensing of stock options, it will have an adverse
effect on our reported financial results. The level of impact on the Company's
financial statements will depend, in part, on future grant awards. We have not
yet assessed the level of impact to be able to quantify the adverse effect.
In July 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations ("FAS 141") and
No. 142, Goodwill and Other Intangible Assets ("FAS 142"). FAS 141 requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. Under FAS 142, goodwill and intangible assets with
indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have indefinite lives will continue to be
amortized over their useful lives (but with no maximum life). The amortization
provisions of FAS 142 pertain to goodwill and intangible assets acquired after
June 30, 2001, and as such, will be applied to the goodwill and intangible
assets resulting from the purchase of Loyalty Magic Pty. Ltd.
6
3. COMPREHENSIVE INCOME/ (LOSS)
Comprehensive income/ (loss) is summarized as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2005 2004 2005 2004
---------- ------------ ----------- -----------
Net loss ($932,173) $ (1,127,459) $(2,199,253) $(2,870,604)
Foreign currency translation (23,467) 36,096 (51,414) (60,782)
---------- ------------ ----------- -----------
Total comprehensive loss $ (955,640) ($1,091,363) $(2,250,667) $(2,931,386)
========== ============ =========== ===========
4. 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 income/(loss) and net
income/( loss) per share would have been reported as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- ----------- -
Net (loss) as reported $ (932,173) $(1,127,459) $(2,199,253) $(2,870,604)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (253,372) (7,544) (257,204) (19,211)
----------- ----------- ----------- -----------
Pro forma net (loss) $(1,185,545) $(1,135,003) $(2,456,457) $(2,889,815)
=========== =========== =========== ===========
Net (loss) per share: basic & diluted -
as reported $ (0.82) $ (1.45) $ (2.41) $ (3.69)
=========== =========== =========== ===========
Pro forma basic & diluted (loss) per share $ (1.05) $ (1.46) $ (2.69) $ (3.72)
=========== =========== =========== ===========
Additionally, 17,500 shares of restricted stock were granted on September 26,
2005 under the Employee Restricted Stock Plan and 1,533 shares of restricted
stock were granted on September 30, 2005 under the Director Restricted Stock
Plan. The total value of the shares, which is the closing price of the shares on
the date of grant times the number of shares, is approximately $220,000. This
amount is reflected in the Additional Paid-In Capital account and in the
Deferred Compensation - Restricted Stock account in the Stockholder's equity
section of the balance sheet. The Deferred Compensation amount will be expensed
on a monthly basis, over the respective vesting periods of the stock grants,
starting in October, 2005.
7
5. COMMITMENTS AND CONTINGENCIES
During December 2004 the Company's R&D team, located in Sydney Australia,
vacated its existing office space and relocated to a new office building.
Although there has been no formal claim filed and no legal proceedings have been
instituted, the Company believes it is possible for the Company to have an
outstanding monetary obligation if the lease agreement related to the vacated
space that expired in December 2003, is determined to have been extended for an
additional 4 year period. The Company believes that at the time the office space
was vacated, there was only a month-to-month rental agreement in effect. If, in
the future a claim is filed, and a legal determination is subsequently made that
a long-term lease did in fact exist, then the Company could be obligated to pay
the landlord for some amount of rental losses, which can not be estimated at
this time.
In December 2004, the Company entered into employment agreements with 3
employees. Under each of the three agreements, in the event employment is
terminated (other than voluntarily by the employee or by the Company for cause),
the Company is committed to make a one-time severance payment equal to 30% of
annual salary or approximately $80,000 in total.
Additionally, in September, 2005 the company finalized the employment agreements
with Chris Leach, the CEO of Loyalty Magic, John H Lowry, the CFO of Catuity,
Inc and Alfred H. Racine III, the CEO of Catuity, Inc. The contracts for Mr.
Leach and Mr. Lowry were executed in September, 2005 and the contract for Mr.
Racine was executed subsequent to the end of the quarter in October, 2005.
Copies of these agreements are included as exhibits to this Form 10-Q.
6. ACQUISITION, CAPITAL RAISINGS, AND PRO FORMA INFORMATION
On September 1, 2005 Catuity Inc. completed the acquisition of all of the
outstanding shares of Loyalty Magic Pty. Ltd. (Loyalty Magic), headquartered in
Melbourne Australia. Loyalty Magic is now a wholly-owned subsidiary of Catuity.
As a result, Catuity effectively acquired all of the assets of Loyalty Magic,
which include: all net working capital; all property, plant, and equipment;
identifiable intangible assets of $2,139,000 million and goodwill. In the month
of September, $206,000 of in-process research and development that was
identified as an intangible was expensed as required by U.S. GAAP accounting
standards
The Shareholders of Loyalty Magic received $2,700,000 (A$3,600,000) in cash and
335,000 shares of Catuity common stock in consideration for Loyalty Magic. The
shares were issued pursuant to an exemption from registration under Regulation D
of the Securities Act of the United States.
Also on September 1, 2005, the Company issued 700,000 shares of its common stock
to existing Australian shareholders who opted to subscribe for shares,
accredited Australian institutional buyers, and certain U.S. accredited
institutional investors who purchased shares that were not subscribed for by
Australian buyers. 256,520 shares of common stock were issued to existing
Australian shareholders and accredited Australian institutional buyers pursuant
to an exemption from registration under Regulation S of the United States
Securities Act. 443,480 shares of common stock were issued to accredited U.S.
institutional investors and members of Catuity's Board of Directors pursuant to
an exemption from registration under Regulation D of the Securities Act of the
United States. The shares were sold for A$10.00 per share in Australia and $7.50
per share in the U.S. (A$10.00 per share at a .7500 foreign currency exchange
rate). The sale of shares to Australian shareholders and institutional buyers
resulted in $1,923,900 (A$2,565,200). The sale of shares to U.S. accredited
institutional investors and Directors resulted in $3,326,100 (A$4,434,800) to
the Company. $2,700,000 (A$3,600,000) of the cash raised was used for the cash
portion of the purchase price paid for Loyalty Magic. The remaining cash will be
used by the Company for working capital purposes. The Company paid a total of
$366,200 (A$488,300) in brokerage commissions and placement fees in order to
raise the $5,250,000 (A$7,000,000). All U.S. dollar amounts shown above were
determined using a foreign currency exchange rate between the Australian and
U.S. dollar of .7500.
Additionally, the Company completed a second, smaller capital raising on
September 19, 2005 for $2,025,000 (270,000 shares of common stock) on the same
terms as the September 1, 2005 capital raise. This offering was completed on
September 19, 2005 and was done under an exemption from registration pursuant to
Regulation D of the United States Securities Act.
8
The acquisition of Loyalty Magic is reflected in the consolidated balance sheet
of the Company as of September 30, 2005 and has been accounted for in accordance
with Statement of Financial Accounting Standards ("SFAS") No 141, Business
Combinations.
The purchase price (In US Dollars) has been tentatively allocated as follows:
Current Assets $ 840,795
Long Term Assets 164,330
Intangible Assets 2,139,200
Goodwill 2,786,090
----------
Total Assets 5,930,415
Liabilities (680,835)
----------
Purchase Price $5,249,580
==========
The purchase price allocation is preliminary and has not been finalized since
the independent valuation of Loyalty Magic has not been finalized. The Company
is currently evaluating the extent of amortizable intangibles acquired and, for
purposes of the pro forma results has estimated that $2,139,200 of the purchase
price will be amortizable intangibles (primarily trademarks - 30 year life,
customer contracts - 5 year life, customer relationships - 10 year life,
proprietary software - 5 year life and non-compete agreements - 5 year life).
These amounts will be finalized upon completion of the valuation. Such estimated
amortizable intangibles are amortized over the periods noted above in the
quarterly pro forma data shown below. As the amount of amortizable intangibles
and the amortization periods are estimates, the final amounts may vary from the
amounts presented below.
Pro forma information for the Company and Loyalty Magic is as follows:
QUARTER ENDING
--------------------------
Three months Three months YTD
ending ending --------------------------
9/30/2005 9/30/2004 9/30/2005 9/30/2004
----------- ------------ ------------ -----------
Revenue $ 457,858 $ 591,932 $ 1,578,036 $ 2,828,536
Net Earnings $(1,059,383) $(1,193,552) $(2,201,895) $(2,865,500)
Earnings per share $ (0.94) $ (1.53) $ (2.41) $ (3.68)
7. SHAREHOLDERS' EQUITY
In 1995 and 1996, the Company issued non-recourse loans to a former Chairman and
Australian director of Catuity Inc., for the purpose of purchasing approximately
276,000 shares of the Company's stock. The Company's recourse for repayment of
the loans is limited to after-tax dividends and proceeds from the disposal of
the shares. In 1999, $75,000 AUD of the loan was repaid related to the sale of
25,000 shares. In the fourth quarter of 2003, approximately $60,750 AUD was
repaid related to the sale of 20,250 shares. The amount of the loan outstanding
is re-valued at each respective balance sheet date if the Company's period
ending fair market price per share is below the price per share at which the
loan was made. The offsetting entry is made to additional paid in capital. In
October 2005, pursuant to its rights under the former director's employment
agreements and the 1995 Plan under which the loans were made, Catuity completed
the buyback of the loan shares. Since the amount of the loans exceeded the value
of the loan shares, no cash was required to complete the buyback.
9
8. NASDAQ LISTING
On July 21, 2005 the Company received notice from Nasdaq Staff that it had
determined the Company was out of compliance with Marketplace Rule 4310
(2)(c)(B) for having Shareholders Equity of less than $2.5 million and
Marketplace Rule 4350 for having fewer than three independent Directors on the
Audit Committee of the Board. The Company was notified it would be delisted on
August 1, 2005 unless it appealed the Staff's determination. On July 28, 2005,
Catuity filed an appeal for a hearing with the Nasdaq Listing Qualifications
Panel for an extension of time to regain compliance with both of its listing
compliance deficiencies and, on August 11, 2005, presented its plan of
compliance to Nasdaq's Listing Qualifications Panel. The Company requested that
the Panel grant Catuity an extension of time, until September 30, 2005, to
regain initial compliance and provide evidence it would sustain compliance with
all of Nasdaq's continuous listing requirements over the long term. On September
20 the Panel acknowledged that the Company had regained compliance with Nasdaq's
audit committee requirements via: (1) the naming of Mr. Donald Campion, the
former CFO of Verifone Inc., North America's leading manufacturer of
point-of-sale technology, to the Board and as Chairman of the Audit Committee on
August 26, 2005 and, (2) the naming of Mr. Geoff Wild, the non-executive
chairman of WPP Group - Australia to the Board and the Audit Committee on
September 2, 2005. In addition, considering that the Company had recently
completed the acquisition of Loyalty Magic and had raised approximately $7.28
million in two separate capital raises, the Panel determined to grant the
Company's request for continued listing in order to demonstrate compliance with
Nasdaq's $2.5 million shareholders' equity requirement. The Panel determined
that, until the Company had filed its third quarter 2005 Form 10-Q demonstrating
that its shareholder' equity exceeds $2.5 million, the letter "C" must be
appended to the Company's normal trading symbol (CTTY). The Company believes
that, upon filing its third quarter 2005 Form 10-Q, it will demonstrate that it
is in compliance with Marketplace Rule 4310 (2)(c)(B) and all other requirements
for continued listing. As indicated within this document, Catuity ended the
third quarter with a consolidated balance sheet reflecting shareholders equity
of approximately $9.2 million.
ITEM 9. MANAGEMENT PLANS
In early 2004, management determined it was necessary to substantially revise
its corporate strategy away from the smart card market and began work on a new
strategic plan. Prior to the Target Corporation decision to discontinue issuing
smart cards, the Company had focused its efforts on licensing its smart card
based loyalty software to large retailers in North America. From its strategic
planning efforts, the Company determined that its business focus should be on
providing a hosted or customized loyalty and gift card software solution for
tier two chain retailers (and their partners) and on providing services to
retailers, merchant service providers, and POS equipment manufacturers for their
needs at the point of sale. As a result, the Company's market focus is on tier
two retailers with approximately $100 million to $1 billion in sales, and in
particular, pharmacy chains, home improvement, selected franchise-driven and
other chain retailers looking to improve customer retention, add new customers,
and increase each customer's average spend amount.
The Company also determined that it needed to become active in mergers and
acquisitions as a means to provide growth in as short a period of time as
possible. As a result, in the middle of 2004, the Company began an active effort
to identify companies that would represent an appropriate business fit with
Catuity's business, provide positive cash-flow, and profits from their
operations. (See Note 6 for information on the acquisition of Loyalty Magic that
was completed on September 1, 2005.)
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW OF SIGNIFICANT ACTIVITIES
Catuity provides loyalty processing services to chain retailers which are
designed to make their customers more profitable at the Point of Sale (POS).
Today, the Company sells a hosted, Application Service Provider (ASP) based
system that enables the processing of member-based loyalty programs that can
deliver customized discounts, promotions, rewards and points-based programs
designed to help retailers find, keep and profit from their best customers. The
Company also enables gift card solutions. In late 2004, the Company introduced
the first version of its new loyalty processing system. The system enables
robust and highly customizable programs which work on a retailer's payment
terminals and Electronic Cash Registers via their internal store networks. In
2005, the company integrated to the Verifone and Lipman POS terminal lines,
which are among the most widely used by retailers of all sizes. Going forward,
the Company's strategy is to continue to integrate to commercially popular POS
systems, payments processors and other third parties with a strategy of making
it easier for new customers to connect to the Catuity platform. Management
believes that this strategy will reduce the perceived IT risks for its retailer
clients and give it a competitive advantage over other providers.
Catuity completed several important steps in its turnaround efforts during the
third quarter of 2005. On July 18, the Company's shareholders approved the
acquisition of Loyalty Magic Pty. Ltd. and the issuance of 700,000 shares of
common stock to raise capital for the cash portion of the acquisition purchase
price as well as for working capital purposes. On September 1, 2005 the Company
completed the acquisition and raised A$7.0 million ($5.25 million USD).
Additionally, the Company completed a second, smaller capital raising on
September 19, 2005 for $2.025 million (270,000 shares of common stock) on the
same terms as the September 1, 2005 capital raise. As a result, Catuity
increased its cash balance at the end of the quarter to $4.39 million and its
shareholders' equity to $9.2 million. Loyalty Magic's business is an excellent
fit with the loyalty processing business that Catuity is establishing in North
America.
Catuity also made significant progress in the third quarter in executing the
Company's transition to a loyalty processor. As previously disclosed, in early
2004, management determined it was necessary to substantially revise its
corporate strategy away from the struggling smart card market and began work on
a new strategy to position the company as a provider of member-based loyalty and
gift card solutions to tier two chain retailers in the U.S., Canada and
Australia. Today, the Company is focused on delivering loyalty and gift card
programs to retailers (and their partners) at the point of sale. The company is
focused on the needs of retailers with $100 million to $1 billion in annual
sales with an average of 150-450 stores and who have a preference for purchasing
a hosted solution over an in-house solution. In particular, the Company has
targeted its sales at pharmacy chains; home improvement chains and selected
franchise-driven retailers who are looking for programs which improve customer
retention, increase customer spending in targeted categories along with
increasing average per visit sales and improve the frequency of their visit. The
Company's greatest strength lies in helping retailers execute merchandising
strategies, especially those which want to switch consumers from buying branded
product to higher-margin private label products. To date, the Company has
qualified more than 800 prospects which meet its criteria and are focused on
making sales proposals to 50-70 of those who are expected to make a buying
decision in 2006.
In 2004, the Company announced that it would selectively use acquisitions to
re-establish its business, diversify its product offering to retailers and
achieve an operational critical mass by year-end 2006. Catuity is most
interested in acquiring profitable companies which share its strategy of
providing a range of transaction-based products to chain retailers. These
products include loyalty programs, closed loop gift card programs; open gift
card programs (those operating across Visa, MasterCard or Discover's open
networks); credit and debit card processing; and prepaid services in what is
commonly referred to as the POSA (Point Of Sale Application) market. All of
these markets are heavily fragmented and most exhibit high growth
characteristics. The Company believes that the ability to offer a bundled
solution to retailers will enhance its ability to close new sales and retain
existing customers. The Company continues to have discussions with numerous
parties about possible business combinations. Many factors impact the timing,
structure, pricing and potential to close such transactions. (See Note 6 for
information on the acquisition of Loyalty Magic that was completed on September
1, 2005.) As the Company has previously disclosed, acquisitions
11
carry diverse risks that could affect the timely execution of its strategy. The
Company will not reach its performance goals by year-end 2006 unless it is able
to execute 1-2 acquisitions of profitable companies in the U.S. in 2006.
On July 21, 2005 the Company received notice from Nasdaq Staff that it had
determined the Company was out of compliance with Marketplace Rule 4310
(2)(c)(B) for having Shareholders Equity of less than $2.5 million and
Marketplace Rule 4350 for having fewer than three independent Directors on the
Audit Committee of the Board. The Company was notified it would be delisted on
August 1, 2005 unless it appealed the Staff's determination. On July 28, 2005,
Catuity filed an appeal for a hearing with the Nasdaq Listing Qualifications
Panel for an extension of time to regain compliance with both of its listing
compliance deficiencies and, on August 11, 2005, presented its plan of
compliance to Nasdaq's Listing Qualifications Panel. The Company requested that
the Panel grant Catuity an extension of time, until September 30, 2005, to
regain initial compliance and provide evidence it would sustain compliance with
all of Nasdaq's continuous listing requirements over the long term. On September
20 the Panel acknowledged that the Company had regained compliance with Nasdaq's
audit committee requirements via: (1) the naming of Mr. Donald Campion, the
former CFO of Verifone Inc., North America's leading manufacturer of
point-of-sale technology, to the Board and as Chairman of the Audit Committee on
August 26, 2005 and, (2) the naming of Mr. Geoff Wild, the non-executive
chairman of WPP Group - Australia to the Board and the Audit Committee on
September 2, 2005. In addition, considering that the Company had recently
completed the acquisition of Loyalty Magic and had raised approximately $7.28
million in two separate capital raises, the Panel determined to grant the
Company's request for continued listing in order to demonstrate compliance with
Nasdaq's $2.5 million shareholders' equity requirement. The Panel determined
that, until the Company had filed its third quarter 2005 Form 10-Q demonstrating
that its shareholder' equity exceeds $2.5 million, the letter "C" must be
appended to the Company's normal trading symbol (CTTY). The Company believes
that, upon filing its third quarter 2005 Form 10-Q, it will demonstrate that it
is in compliance with Marketplace Rule 4310 (2)(c)(B) and all other requirements
for continued listing. With this filing, the Company will report shareholders
equity of approximately $9.2 million.
Since completing the acquisition and two capital raises in September 2005,
Catuity and Loyalty Magic's management teams have been actively working on the
integration of the two companies into one. The Company expects that integration
of common systems, procedures, financial management practices and business focus
to be completed by year-end 2005. In addition, as previously noted, the Company
is also actively focused on completing one or more additional acquisitions
between the fourth quarter of 2005 and the end of 2006. The Company's focus is
on acquisition candidates that are in a line of business that fits with
Catuity's strategy, have positive cash flow, and are profitable.
OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND
SEPTEMBER 30, 2004
On September 1, 2005, Catuity completed its acquisition of Loyalty Magic. As a
result, Catuity's third quarter financial statements reflect three months of
Catuity's operations and one month of Loyalty Magic's operations.
REVENUE
Total revenues for the three month period ended September 30 ("third quarter")
increased $70,000, to $174,000 in 2005 compared to $104,000 in 2004. The
increase of $70,000 was primarily due to increased loyalty processing and
services revenue. Third quarter 2005 revenues consisted of approximately
$150,000 in loyalty processing & service revenue and approximately $24,000 in
license revenue. License revenue consists of software license and maintenance
fees. Third quarter 2004 revenues consisted of approximately $94,000 in service
revenue related to Visa support services and approximately $11,000 in software
license and maintenance fees from clients.
Total revenues for the nine month period ended September 30 decreased by
$498,000, to $220,000 in 2005, from $718,000 in 2004. The higher revenue in 2004
was due to work performed for Visa and Target prior to Visa's phase-out of its
Smart Rewards platform that concluded in September 2004. The Company recognized
no project revenue during the first nine months of 2005, whereas in the
corresponding 2004 period $231,000 in project revenue was recognized for Visa
and Target. Service revenue decreased by $211,000 in 2005 compared to 2004. The
decrease was due to a decline in customer support services in the U.S., License
revenue decreased by $56,000 in 2005 compared to the same period in 2004
primarily due to the termination of the Target maintenance agreement.
12
COST OF PROJECT RELATED REVENUE
Cost of project related revenue primarily consists of salaries, employee
benefits, related expenses and overhead for the portion of time spent by our
technical staff who works on software development activities. The Company did
not engage in any software development activities on behalf of customers in the
first nine months of 2005 and therefore did not incur any costs related to
project revenue. Cost of project revenue was approximately $91,000 for the first
nine months of 2004 and was related to Visa development projects.
COST OF LOYALTY PROCESSING AND SERVICE REVENUE
Cost of loyalty processing and service revenue primarily consists of co-location
facility and other processing cost, salaries, employee benefits, related
expenses and overhead for the client services staff that work on supporting
customer programs, Cost of loyalty processing and service revenue increased from
$82,000 in the third quarter of 2004 to $191,000 or 132% in the third quarter of
2005 while loyalty processing and service revenue increased by $56,000 or 60%
over the same period. The increase in expenses for the three month period is
primarily due to the increased staffing in this department along with the
increase in quarterly revenue. Expenses for the nine months ended September 30,
2005, were $278,000 compared to $241,000 for the first nine months of 2004.
Loyalty processing and service revenue for the first nine months of 2005
decreased $211,000 or 55% compared to the nine months of 2004 attributable to
the loss of revenue from Target and VISA while partially offset by the addition
of Loyalty Magic in September.
COST OF LICENSE REVENUE
Cost of license revenue primarily consists of salaries, employee benefits,
related expenses and overhead for the hosting activities and our client support
staff along with the technical staff's time spent on maintenance activities
related to licensed software. Cost of license revenue decreased by $3,000 in the
third quarter of 2005 compared to the third quarter of 2004, while license
revenue increased by $14,000, over the same period. The decrease in expenses for
the three-month period was due to a reduction in staff of the existing
operations. For the nine month period ended September 30, 2005, cost of license
revenue decreased $66,000 from the same period in 2004. The decrease over the
prior year was due to a reduction in staff of the existing operations. Total
license revenue for the nine months of 2005 decreased $56,000 or 54% compared to
the same period in 2004.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, employee benefits,
travel, marketing, public relations and related overhead costs of the sales and
marketing department. Sales and marketing expenses decreased $98,000, or 43%, in
the third quarter of 2005 compared to the third quarter of 2004. Expenses for
the nine months ended September 30, 2005, decreased $290,000, or 41%, compared
with the corresponding 2004 period. The decrease in cost for both the three and
nine month periods was principally due to reductions in staff size, travel and
lower overhead allocations to the sales department.
RESEARCH AND DEVELOPMENT
Research and Development expenses consist primarily of salaries, employee
benefits and overhead cost, incurred mainly by the technical staff in Australia
for work on upgrades and future releases of the Company's software. Research and
development costs increased $33,000 in the third quarter of 2005 compared to the
third quarter of 2004. The increase was a result of the $206,000 of in-process
research and development that was acquired from Loyalty Magic and expensed in
the third quarter as required by U.S. GAAP accounting standards. The increase
was offset by significant reductions in staffing that occurred in the fourth
quarter of 2004 which lowered salary and related costs. Also included in the
third quarter of 2004 was larger overhead and service department allocations for
the portion of service department time spent furthering Catuity's software
products. Expenses for the nine month period ended September 30, 2005 decreased
$517,000 over the same period in 2004. The decrease in cost was primarily due to
lower staffing levels and lower allocations for overhead and service department
costs in 2005.
13
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of salaries, employee
benefits, general overhead costs and professional services fees related to the
management of the company. General and administrative expenses decreased
$176,000, or 30%, in the third quarter of 2005 compared to the third quarter of
2004 due principally to the inclusion of one-time severance costs related to the
Company's former President & CEO in 2004.. Expenses for the nine months ended
September 30, 2005, decreased $265,000, or 19%, compared with the corresponding
2004 period. Costs were primarily lower in 2005 compared to 2004, due to the
one-time severance costs in 2004 and lower professional fees rent and
depreciation expense in 2005
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our operations with proceeds from the issuance of
common stock and cash collections from customers. As of September 30, 2005, the
Company had approximately $4,390,000 in cash and cash equivalents, an increase
of $1,829,000 from December 31, 2004.
Net cash used in operating activities was $1,849,000 for the nine month period
ended September 30, 2005 compared with $2,412,000 for the nine month period
ended September 30, 2004. The lower net loss in 2005 was the primary factor
contributing to the decrease in net cash used in operating activities in 2005.
Cash used by investing activities was $6,148,000 for the nine month period ended
September 30, 2005 compared with a usage of $16,000 for the nine month period
ended September 30, 2004. The cash used in investing activities in 2005 is
principally due to the Loyalty Magic acquisition and capital raise.
Net cash provided by financing activities in the first nine months of 2005 was
$7,357,000, and was principally related to the issuance of stock for the Loyalty
Magic acquisition and to increase working capital. Cash provided by financing
activities for the same period in 2004 was $14,000 and related to shares of the
Company's common stock purchased at fair market value under the Company's
Executive Director Stock Purchase Plan. Non-cash activities of $2,512,500
(A $3,350,000) represented stock issued to Loyalty Magic shareholders for
a portion of the purchase price.
At the Company's July 18, 2005 (July 19, 2005 in Australia) Annual Meeting,
shareholders approved the Company's proposal to raise equity capital to fund the
cash portion of the Loyalty Magic Pty Ltd. acquisition and to provide additional
working capital to the Company. In September 2005 the Company completed the
acquisition of Loyalty Magic Pty. Ltd. and two capital raises totaling $7.27
million in addition to the $2,512,500 (A$3,350,000) paid to Loyalty Magic in
stock. After using a portion of the proceeds to pay the cash portion of the
acquisition and deducting the costs associated with raising the capital, the
Company has $4,390,000 million in cash as of September 30, 2005. The Company
believes that its existing capital resources are adequate to meet its cash
requirements for the next twelve months.
FORWARD LOOKING INFORMATION
The Management Discussion and Analysis of Financial Condition and Results of
Operations include "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 about themselves 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
Form 10-QSB 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 our actual
results to differ materially from any forward-looking statements.
14
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. Various factors may cause actual performance to differ from any of
the forward-looking statements contained in the Management Discussion and
Analysis of Financial Condition and Results of Operations. These include, but
are not limited to; changes in currency exchange rates from period to period,
inflation rates in the United States and Australia, recession, and other
external economic factors over which the Company has no control; the successful
completion of the Company's acquisition strategy; the timing and speed with
which our major customers and prospects execute their plans for the use of our
loyalty software; continued development of the Company's software products;
competitive product and pricing pressures; use of internally developed software
applications; patent and other litigation risks; the risk of key staff leaving
the Company; the risk that major customers of the Company's products 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.
ITEM 3. CONTROLS AND PROCEDURES
Management, including the Company's Chief Executive Officer and Chief Financial
Officer, evaluated 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: (1) that information required to be disclosed
by the Company in its periodic SEC filings is recorded, processed and reported
within the time periods specified by the SEC and (2) that information required
to be disclosed is accumulated and communicated to the Company's management,
including its principal executive and principal financial officers, to allow
timely decisions regarding required disclosure. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective. The disclosure controls and
procedures are designed to provide reasonable assurance that the information
required to be disclosed in the reports the Company files and submits under the
Exchange Act is recorded, processed, summarized and reported as required on a
timely basis.
There has not been any change in the Company's internal controls during the last
fiscal quarter that materially affected, or is reasonably likely to materially
affect the Company's internal control over financial reporting. . There were no
significant deficiencies or material weaknesses identified in the evaluation
and, therefore, no corrective actions were taken.
15
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a) Exhibit Description
------- -----------
EX-10(a) Amendment to Alfred H. Racine III Employment Agreement with
Catuity, Inc. Dated September 23, 2004
EX-10(b) Amendment to John H. Lowry Employment Agreement with Catuity,
Inc. Dated April 18, 2000
EX-10(c) Agreement between Catuity, Inc. and MIA Pty. Ltd. and Chris
Leach, Individually, for Management Services.
EX-31.1 Certification by Alfred H. Racine III, President and Chief
Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
EX-31.2 Certification by John H. Lowry, Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
EX-32 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
16
SIGNATURES AND CERTIFICATIONS
Pursuant to the requirements 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.
By: /s/ Alfred H. Racine III
------------------------------------
Alfred H. Racine III
President and
Chief Executive Officer
By: /s/ John H. Lowry
------------------------------------
John H. Lowry
Chief Financial Officer
Date: November 14, 2005
17
EXHIBIT INDEX
Exhibit No Description
- ---------- -----------
EX-10(a) Amendment to Alfred H. Racine III Employment Agreement with
Catuity, Inc. Dated September 23, 2004
EX-10(b) Amendment to John H. Lowry Employment Agreement with Catuity, Inc.
Dated April 18, 2000
EX-10(c) Agreement between Catuity, Inc. and MIA Pty. Ltd. and Chris Leach,
Individually, for Management Services.
EX-31.1 Certification by Alfred H. Racine III, President and Chief
Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
EX-31.2 Certification by John H. Lowry, Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
EX-32 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of
2002