AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 8, 2007
REGISTRATION NO. ______
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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CATUITY INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 7371 38-3518829
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INCORPORATION INDUSTRIAL CLASSIFICATION IDENTIFICATION NUMBER)
OR ORGANIZATION) CODE NUMBER)
300 PRESTON AVENUE SUITE 302
CHARLOTTESVILLE, VA 22902
(434) 979-0724
(ADDRESS AND TELEPHONE NUMBER OF
PRINCIPAL EXECUTIVE OFFICES AND PRINCIPAL PLACE OF BUSINESS)
DEBRA R. HOOPES
CHIEF FINANCIAL OFFICER
300 PRESTON AVENUE SUITE 302
CHARLOTTESVILLE, VA 22902
(434) 979-0724
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: From time
to time after the effective date of this registration statement as determined by
market conditions.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
1
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
CALCULATION OF REGISTRATION FEE
================================================================================================================
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AGGREGATE AMOUNT OF
SECURITIES TO AMOUNT TO BE OFFERING PRICE OFFERING PRICE REGISTRATION
BE REGISTERED REGISTERED PER UNIT(1) (1) FEE
- ----------------------------------------------------------------------------------------------------------------
Common Stock, $.001 par value per share,
underlying convertible preferred stock 215,384 shares $3.25 $ 700,000 $74.90
- ----------------------------------------------------------------------------------------------------------------
Common Stock underlying convertible
debentures 553,846 shares $3.25 $ 1,800,000 $192.60
- ----------------------------------------------------------------------------------------------------------------
Total 769,230 shares $2,500,000 $267.50
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(1) Calculated solely for the purposes of determining the registration fee
pursuant to Rule 457(g) promulgated under the Securities Act of 1933, as
amended.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
2
THE INFORMATION CONTAINED IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
THE SELLING STOCKHOLDERS MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT CATUITY INC. FILES WITH THE SECURITIES AND EXCHANGE COMMISSION IS
EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT
SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE
IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED FEBRUARY 8, 2007
PROSPECTUS
(CATUITY LOGO)
REACH - REWARD - RETAIN(R)
769,230 SHARES OF COMMON STOCK
We have prepared this prospectus to allow the selling stockholders to
offer for resale up to 769,230 shares of our common stock to be issued by us to
the selling stockholders pursuant to conversion of convertible notes and shares
of convertible preferred stock that we sold to the selling stockholders in a
private placement completed on November 22, 2006 and approved by our
stockholders on February 5, 2007.
The shares of common stock offered by this prospectus could be sold in
several ways, including in the open market or otherwise at prevailing market
prices at the time of sale, in privately negotiated transactions at prices
agreed upon by the parties or through any other means described under the
heading "Plan of Distribution" beginning on page 42. The selling stockholders
may elect to sell all, a portion of, or none of the shares of common stock
offered hereby. Our company is not selling any shares of common stock in this
offering and therefore we will not receive any proceeds from any sale of
securities offered by this prospectus. We are registering the shares of common
stock offered under this prospectus to satisfy registration rights that we
granted to the selling stockholders in connection with the purchase of the
common stock by the selling stockholders. We have agreed to pay for all expenses
in connection with the registration of the securities offered by this
prospectus.
Our common stock is quoted on the Nasdaq SmallCap Market under the
symbol "CTTY" and is traded on the Australian Stock Exchange under the symbols
"CAT" and "CATN". On February 5, 2007, the last sales price of our common stock
as reported on the Nasdaq SmallCap Market was $3.52 per share.
No underwriter or any other person has been engaged to facilitate the
sale of the securities in this offering.
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK THAT IS
DESCRIBED IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 1 OF THIS PROSPECTUS.
WE URGE YOU TO CAREFULLY READ THE "RISK FACTORS" SECTION BEFORE YOU MAKE YOUR
INVESTMENT DECISION.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THE COMMON STOCK OFFERED HEREBY OR
PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS FEBRUARY 8, 2007.
3
TABLE OF CONTENTS
PART I
FORWARD LOOKING INFORMATION............................................... 5
PROSPECTUS SUMMARY........................................................ 6
ABOUT THE OFFERING AND THIS PROSPECTUS.................................... 6
RISK FACTORS.............................................................. 7
USE OF PROCEEDS........................................................... 16
THE COMPANY............................................................... 16
THE BUSINESS.............................................................. 17
PROPERTIES................................................................ 22
LEGAL PROCEEDINGS......................................................... 22
DIRECTORS AND EXECUTIVE OFFICERS.......................................... 23
DIRECTOR AND EXECUTIVE COMPENSATION....................................... 25
SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS............ 28
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS............................................................. 29
MARKET PRICE OF AND DIVIDENDS ON COMMON STOCK............................. 38
DESCRIPTION OF CAPITAL STOCK.............................................. 39
SELLING STOCKHOLDERS...................................................... 41
PLAN OF DISTRIBUTION...................................................... 42
EXPERTS................................................................... 44
LEGAL MATTERS............................................................. 44
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES............................................................ 44
WHERE YOU CAN FIND MORE INFORMATION....................................... 45
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE............................................................. 45
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS.................................... 46
INDEMNIFICATION OF DIRECTORS AND OFFICERS.............................. 46
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION............................ 46
RECENT SALES OF UNREGISTERED SECURITIES................................ 46
EXHIBITS............................................................... 48
UNDERTAKINGS........................................................... 48
INDEX TO FINANCIAL STATEMENTS............................................. F-1
4
PART I
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: 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 timing and speed with which
our major customers and prospects execute their plans for the use of our loyalty
software and services; 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 and
services 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.
5
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
It does not contain all of the information that you should consider before
investing in our common stock. You should read the entire prospectus carefully,
including the section entitled "Risk Factors" and our consolidated financial
statements and the related notes. In this prospectus, we refer to Catuity Inc.
and our wholly owned subsidiary, Loyalty Magic Pty Ltd as "our company," "we,"
"us" and "our."
Catuity provides technology-based solutions to retailers that are designed
to increase the profit they receive from their customers at the Point of Sale
(POS). Today, the Company sells a hosted, ASP-based system that enables the
processing of member-based loyalty programs and which can deliver customized
discounts, promotions, rewards and points-based programs which are 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 platform, the Catuity Advanced Loyalty System (CALS). The
system enables robust and highly customizable programs which work on a
retailer's payments terminals, Electronic Cash Register and on their internal
store networks. Catuity also offers IT services to retailers to support their
POS systems maintenance and custom development needs for both the deployment of
our technology solution and those of third parties which also touch the point of
sale.
Our executive offices are located at 300 Preston Avenue, Suite 302,
Charlottesville, VA 22902, and our telephone number is (434) 979-0724. We
maintain a site on the World Wide Web at the address http://www.catuity.com. The
information on our web site is not a part of this prospectus or incorporated by
reference herein.
WE URGE YOU TO REFER TO THE SECTION ENTITLED "RISK FACTORS" FOR AN
EXPLANATION OF THE RISKS OF INVESTING IN OUR COMMON STOCK.
ABOUT THE OFFERING AND THIS PROSPECTUS
This prospectus covers the resale of up to 769,230 shares of Common Stock
by the Selling Stockholders identified in this prospectus under the section of
this document titled "Selling Stockholders." On November 22, 2006, we closed on
a sale of convertible notes and convertible preferred shares to the Selling
Stockholders pursuant to a certain Securities Purchase Agreement, for aggregate
proceeds of US$2,250,000. The Selling Stockholders will acquire the shares
offered by this prospectus from us by conversion of the convertible notes and
convertible preferred shares they now hold. We will not receive any proceeds
from the resale of shares by any Selling Stockholder. We have agreed to bear all
expenses of registration of the Common Stock offered by this prospectus.
This prospectus is part of a registration statement that we have filed
with the Securities and Exchange Commission (the "SEC") utilizing a "shelf"
registration process. Under the shelf registration process, the Selling
Stockholders may, from time to time, sell the Common Stock described in this
prospectus. We may prepare a prospectus supplement at any time to add, update or
change the information contained in this prospectus. This prospectus does not
contain all the information you can find in the registration statement or the
exhibits filed with or incorporated by reference into the registration
statement. You should read this prospectus and any prospectus supplement
together with the registration statement, the exhibits filed with or
incorporated by reference into the registration statement and the additional
information described under the section of this document titled "Where You can
Find More Information."
6
RISK FACTORS
The Company's business, financial condition and operating results
could be adversely affected by any of the following factors. These risks and
uncertainties, however, are not the only ones that the Company faces. Additional
risks and uncertainties not currently known to the Company, or that the Company
currently thinks are immaterial, may also impair its business operations.
FACTORS AFFECTING OUR OPERATING RESULTS, OUR BUSINESS AND OUR SHARE PRICE
RISKS RELATED TO OUR BUSINESS
WE HAVE A HISTORY OF LOSSES.
As of December 31, 2005, we had an accumulated deficit of $37,246,156
and as of September 30, 2006 we had an accumulated deficit of $40,709,742. To
date, we have not achieved profitability. While management believes our
strategies will be successful, there can be no assurance that our business
strategies will be successful or that significant revenues or profitability will
be achieved. If we do achieve profitability, we cannot be certain that we can
sustain or increase profitability on an ongoing basis. Further, customer
perceptions concerning our financial condition - particularly if our auditors
include a "going concern" explanatory paragraph in our auditor report in the
2006 financial statements - may adversely affect our customers' decisions to do
business with us.
In 2004, Catuity underwent a significant change in its business
strategy following the 3rd quarter decision of a large U.S. chain retailer to
stop issuing smart cards to its customers that held their Visa co-branded credit
card. This resulted in Catuity adopting a change in its business strategy. As of
September 30, 2004, the accumulated deficit stood at $33,528,279 and since that
time has increased by $7,181,463 in the following 24 months. We currently
anticipate that we will need additional outside capital before the end of the
second quarter of 2007.
WE MAY BE ADVERSELY AFFECTED IF WE FAIL TO RETAIN KEY PERSONNEL AND
ATTRACT NEW QUALIFIED PERSONNEL.
Our operations will depend on our ability to attract new key personnel
and retain existing key personnel. We have from time to time in the past
experienced, and we expect to experience in the future, difficulty in hiring and
retaining highly skilled employees with appropriate qualifications. If we are
unable to hire or retain key employees, our business, results of operations and
financial condition will be harmed.
WE WILL BE ADVERSELY AFFECTED IF OUR CALS PRODUCT DOES NOT ACHIEVE
MARKET ACCEPTANCE.
We will be adversely affected if the generation of software, the
Catuity Advanced Loyalty Systems ("CALS") introduced in late 2004, does not
achieve market acceptance. There can be no assurance that the product will
perform all the desired functions, or offer sufficient price/performance
benefits or meet the technical or other requirements of customers. Despite
testing of our product prior to its commercial release, there can be no
assurance that all performance errors or deficiencies have been discovered and
remedied, that additional errors or deficiencies will not occur, or if they
occur, that we will be able to correct such errors and deficiencies.
FAILURE TO OBTAIN CERTIFICATIONS IN A TIMELY MANNER.
To deploy our technology on behalf of a client, Catuity must install a
specialized application in the point of sale device used by its client. Because
of the diverse range of payment terminals, readers, electronic cash registers
and proprietary checkout systems used by merchants and retailers, Catuity must
certify its application to meet the standards of the independent manufacturers
of each model and series of terminals. Equally important, in some cases,
Catuity's POS application must be certified by the payments processor who
manages payment transactions for merchants and retailers. Catuity has been
successful in previous efforts with market leaders in terminal manufacturing
including Verifone, Hypercom and Schlumberger. However, we can make no assurance
that the Company will be able to obtain future certifications in a timely
manner. If we fail to obtain the necessary certifications, it could have a
material adverse impact us, including the loss of existing business, extended
delays in closing new business and/or the impairment of future revenues.
7
SALES ACTIVITIES WITH PROSPECTIVE CUSTOMERS MAY NOT GENERATE REVENUE
FOR THE COMPANY.
The success of our operations will be highly dependent on our ability
to generate revenue from current and future prospective customers. While
management believes that the Company will be successful in generating revenue
from prospective customers there can be no assurance of the level of revenue
that will be generated.
RISKS RELATED TO OUR INDUSTRY
COMPETITION IN THE APPLICATION SOFTWARE INDUSTRY COULD HARM OUR
BUSINESS.
The application software industry is highly competitive, rapidly
developing and subject to constant innovation and change. Numerous other
companies operate incentive marketing programs using both electronic and paper
based systems, both for retail stores and the Internet. Many of these companies
have significantly longer operating histories, greater name recognition, larger
customer bases and greater financial, technical and marketing resources than we
do.
Our competitors may respond more quickly than we can to changing
technologies and customer requirements. For example, these competitors may:
- conduct more extensive marketing campaigns to capture market share;
- provide more attractive incentive and pricing packages to customers;
- negotiate more favorable contracts with existing and potential
employees and strategic partners;
- establish cooperative relationships among themselves or with third
parties, including large Internet participants, to increase the
ability of their products and services to address the needs of
prospective customers;
- bundle their products with other software or hardware, including
operating systems and browsers, in a manner that may discourage users
from purchasing products offered by us;
- establish cooperative relationships with our current or potential
competitors, thereby limiting our ability to sell our products through
particular reseller channels; and
- more quickly develop new products and services or enhance existing
products and services.
Our ability, and the ability of our resellers, to compete effectively
in the market for application software for incentive and loyalty marketing
programs will depend upon a variety of factors, including our ability to provide
high quality products and services at prices generally competitive with, or
lower than, those charged by our competitors. There can be no assurance that we
will be able to compete successfully. Moreover, there can be no assurance that
certain of our competitors will not be better situated to negotiate contracts
with retailers and resellers that are more favorable than contracts we
negotiate. In addition, there can be no assurance that the competition from
existing or new competitors or a decrease in the rates charged for products and
services by our competitors will not materially and adversely affect us.
NEW TECHNOLOGIES COULD RENDER OUR PRODUCT OBSOLETE.
The application software business is characterized by rapid
technological change, new product introduction and evolving industry standards.
Advances in applications software or the development of entirely new
technologies to replace existing applications software could render our product
obsolete and unmarketable. Our success will depend, in significant part, on our
ability to make timely and cost- effective enhancements and additions to our
technology and to introduce new products and services that meet customer
demands. There can be no assurance that we will be successful in developing new
products, services and enhancements. Delay in the introduction of new products,
enhancements or services, the inability to develop such new products,
enhancements or services or their failure to achieve market acceptance could
have a material adverse effect on us.
8
WE MAY FACE RISKS RELATED TO THE STORAGE OR PROVISION OF INACCURATE OR
CONFIDENTIAL INFORMATION.
It is possible that information provided through the use of our
product or information that is copied and stored by customers that have deployed
our product may contain errors. In such event, third parties could make claims
against us for losses incurred in reliance on such information. Although we
carry general liability insurance, our insurance may not cover potential claims
of this type or may not be adequate to indemnify us for all liability that may
be imposed. Any imposition of liability or legal defense expenses that is not
covered by insurance or that is in excess of insurance coverage could have a
material adverse effect on our business, financial condition and results of
operations.
In addition, from time to time, persons may unlawfully obtain
information concerning a customer's or retailer's program by unlawfully
utilizing access numbers, passwords and personal identification numbers. No
assurance can be given that future losses due to claims by third parties for
unauthorized use will not be material. We maintain no reserves for such risks.
There can be no assurance that our risk management practices will be
sufficient to protect us from unauthorized thefts of information that could have
a material adverse effect on us.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS FOR USE OR MISUSE OF OUR
PRODUCT.
Retailers rely on our product in connection with providing promotions
that have a direct financial impact on their businesses and their customers. Use
or misuse of our product, whether due to accident, employee fraud, or otherwise,
may result in unintended or undesirable consequences that could result in
financial or other damages to our customers and to our customers' customers. A
product liability claim brought against us, even if not successful, would likely
be time consuming and costly and could have a material adverse effect on us.
WE MAY FACE RISKS RELATED TO THE USE OF ELECTRONIC PAYMENT CARDS.
Portions of our software may be integrated with or co-reside with a
range of third party payment and other software. For example, a payment card
number may be used as an identifier with our product. Alternatively, a portion
of the software comprising our product may be added to existing or new POS
devices, so that such software co-resides with payment programs. On the Internet
and in other environments, a portion of our software may be integrated with a
third party supplied e-commerce program. There can be no assurances that such
integration or co-residence will not adversely affect the payment system,
potentially giving rise to a claim that may have a material adverse effect on
our business, financial condition and results of operations. In addition, if our
customers experience problems with a payment system, it may be difficult to
determine if those problems originate from our product or other products with
which ours co-reside. Such difficulty may delay resolution of any such problem
and prove costly to us.
WE MAY BE AFFECTED BY POTENTIAL PRIVACY REGULATION.
The Federal Trade Commission is considering the adoption of
regulations regarding the collection and use of personal information obtained
from individuals when accessing Internet sites. These regulations could restrict
our ability to provide demographic data to retailers. At the international
level, the European Union has adopted a directive that will impose restrictions
on the collection and use of personal data. These developments could have an
adverse effect on our business, results of operations and financial condition.
WE MAY FACE INCREASED GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES.
Catuity will host or manage confidential customer information on
behalf of our clients. Certain high profile cases of customer information being
compromised have heightened concerns among our prospects, investors and state
and federal legislators about the need to ensure that the information of
individuals be protected. Since Sept. 11, 2001, regulation of public and
non-public information has increased significantly. Even though Catuity's
customers generally seek written permission from loyalty program participants to
collect and use information on their shopping behavior, the Company cannot
ensure that its customers will comply with appropriate regulations or industry
best practices. The gift card industry also continues to face regulatory,
legislative and judicial scrutiny. Attorney
9
Generals have initiated lawsuits against high profile gift card providers
targeting their disclosure and management practices. Proposed state and federal
legislation, such as the Fair Gift Card Act, is specifically directed at
"escheatment", "breakage" and liability management practices of card issuers.
Broadly, this concerns the level of required disclosure to consumers about fees
and charges associated with their accounts. To manage these risks, Catuity takes
appropriate and customary steps in our client agreements and through our
operational procedures. Catuity has no control over the pricing, disclosure and
management strategies of its clients and cannot ensure that our clients will
comply with appropriate regulations or industry best practices. To the extent
that Catuity's customers face regulatory, legislative or judicial action, the
Company could be made a party to those actions. These could materially and
adversely affect us.
Catuity is in the business of managing vital business information on
behalf of our clients. This includes, but is not limited to, customer data,
purchase behavior, and payment transaction information. A myriad of laws,
regulations and industry standards apply to the management of this information
across all the jurisdictions in which we do business. A failure to comply with
these laws, regulations and standards - even if it were unintentional - could
result in financial penalties, additional cost to come into compliance, and loss
of reputation that could harm our business and impair our ability to meet our
strategic objectives. We make ongoing efforts to remain up to date on current
and pending changes in these laws, regulations and standards and to ensure that
our business practices meet or exceed applicable requirements. Further, while we
are not responsible for our clients' compliance, we make efforts to encourage
best practices by our clients and to actively support industry groups which
monitor, lobby for, and advocate regulation of our industry.
WE MAY FACE INTELLECTUAL PROPERTY CHALLENGES.
Our success and ability to compete are substantially dependent on our
proprietary technology and trademarks, which we attempt to protect through a
combination of patent, copyrights, trade secret and trademark laws as well as
confidentiality procedures and contractual provisions. However, any steps we
take to protect our intellectual property may be inadequate, time consuming and
expensive, and there can be no assurance that the steps taken by us will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as do the laws of the
United States. In addition, we may infringe upon the intellectual property
rights of third parties, including third party rights in patents that have not
yet been issued. Third-party infringement claims involving Internet technologies
and software products may increase. Any claims regarding the rights of third
parties, with or without merit, could be time consuming to defend, result in
costly litigation, divert management's attention and resources, cause product
shipment delays or require us to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
favorable to us, if at all. We have agreed, and may agree in the future, to
indemnify certain of our customers against claims that our products infringe the
intellectual property rights of others. We could incur substantial costs in
defending our sellers and our customers against infringement claims. A
successful claim of product infringement against us and our failure or inability
to license the infringed or similar technology could have a material adverse
effect on our business, financial condition and results of operations.
We have applied in the past for patents in relation to the method of
operation of incentive marketing programs using electronic means. We cannot
assure you that our patent applications will be approved. Moreover, even if
approved, they may not provide us with any competitive advantages or may be
challenged by third parties. In recent times a number of patents have been
granted in this area. Although we are not aware of any issued patent that our
product would infringe, legal standards relating to the validity, enforceability
and scope of intellectual property rights in Internet-related industries and use
of electronic data for granting of benefits and rewards are uncertain and still
evolving, and the future viability or value of any of our intellectual property
rights is uncertain.
CORPORATE AND MARKET RISKS
OUR TRADING VOLUME MAY BE LOW AND OUR SHARE PRICE MAY BE VOLATILE.
We are currently listed on two exchanges, the ASX in Australia, and
the NASDAQ Small Cap Market in the United States. There can be no assurance that
an adequate volume of trading in our shares will be achieved and maintained, on
NASDAQ or the ASX, in order to provide liquidity for our investors. Trading
volume in Catuity
10
shares on NASDAQ and the ASX has been mixed with low volume days and some very
active periods. In 2006 the combined average daily trading volume was of 92,380
shares while the average was 266,864 shares per day in 2005.
The market price of our common stock may fluctuate significantly in
response to the following factors, some of which are beyond our control:
- variations in actual or anticipated quarterly or annual operating
results;
- changes in financial estimates by securities analysts;
- changes in market valuations of loyalty software & service companies;
- announcements by us of significant contracts, reseller arrangements,
strategic partnerships, joint ventures or capital commitments;
- additions or departures of key personnel;
- sales of common stock or termination of stock transfer restrictions;
and
- fluctuations in stock market price and volume, which are particularly
common among securities of small technology companies.
The market prices and volumes of the common stock of many publicly
held technology based companies have in the past been, and can in the future be
expected to be, especially volatile, which could cause the market price of our
common stock to fall for reasons not necessarily related to our business,
results of operations or financial condition. The market price of our stock also
might decline in reaction to events that affect other companies in our industry
even if these events do not directly affect us. Accordingly, you may not be able
to resell your shares of common stock at or above the price you paid. In the
past, following a period of volatility in the market price of a company's
securities, securities class action litigation often has been instituted against
such a company. Any such litigation could result in substantial costs and a
diversion of management's attention and our resources.
WE MAY BE SUBJECT TO ARBITRAGE RISKS.
Investors may seek to profit by exploiting the difference, if any, in
the price of our stock on the ASX and NASDAQ. Such arbitraging activities could
cause our stock price in the market with the higher value to decrease to the
price set by the market with the lower value.
COMPLYING WITH NASDAQ'S CONTINUED LISTING REQUIREMENTS.
We have experienced difficulty in the past maintaining all of NASDAQ's
continued listing requirements, due to the small size of our Company. The
requirements for continued listing on the NASDAQ SmallCap Market are as follows:
(1) either (a) stockholders' equity of $2,500,000, (b) net income in
the most recently completed fiscal year or in two of the last three years of
$500,000, or (c) market capitalization of $35,000,000;
(2) a public float of 500,000 shares;
(3) a market value of public float of $1,000,000;
(4) a minimum bid price of $1.00 per share;
(5) at least two market makers;
(6) at least 300 round lot stockholders
11
(7) compliance with NASDAQ corporate governance rules.
CERTAIN DELAWARE ANTI-TAKEOVER PROVISIONS MAY PRODUCE RESULTS
DISFAVORED BY OUR SHAREHOLDERS.
Provisions of Delaware law could make it more difficult for a third
party to acquire control of us without the consent of our board of directors,
even if our stockholders favored such a change. We are subject to Section 203 of
the Delaware General Corporation Law, which, subject to certain exceptions,
prohibits a publicly held Delaware corporation from engaging in any "business
combination" with any "interested stockholder" for a period of three years
following the date that such stockholder became an interested stockholder,
unless:
- prior to such date, the board of directors approved either the
business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
- upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned
at least 85% of our voting stock outstanding at the time the
transaction commenced; and
- on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting
of stockholders, and not by written consent, by the affirmative vote
of at least 66% of the outstanding voting stock that is not owned by
the interested stockholder.
Section 203 defines "business combination" to include:
- any merger or consolidation involving the corporation and the
interested stockholder;
- any sale, transfer, pledge or other disposition of 10% or more of our
assets involving the interested stockholder;
- subject to certain exceptions, any transaction that results in the
issuance or transfer by us of any of our stock to the interested
stockholder;
- any transaction involving us that has the effect of increasing the
proportionate share of the stock of any class or series beneficially
owned by the interested stockholder; and
- the receipt by the "interested stockholder" of the benefit of any
loans, advances, guarantees, pledges or other financial benefits
provided by us or through the corporation.
In general, Section 203 defines an interested stockholder as an entity
or person beneficially owning 15% or more of our outstanding voting stock and
any entity or person affiliated with or controlling or controlled by such entity
or person.
CHANGES IN, OR INTERPRETATIONS OF, ACCOUNTING RULES AND REGULATIONS,
SUCH AS EXPENSING OF STOCK OPTIONS, COULD RESULT IN UNFAVORABLE ACCOUNTING
CHARGES.
We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America. These
principles are subject to interpretation by the SEC and various bodies formed to
interpret and create appropriate accounting policies. A change in these policies
can have a significant effect on our reported results and may even retroactively
affect previously reported transactions. In particular, the FASB recently
enacted SFAS No. 123(R) (revised 2004), "Share-Based Payment" ("SFAS 123(R)")
which we adopted effective January 1, 2006. As a result, because SFAS 123(R)
requires the expensing of share based payments, it will have an adverse effect
on our reported financial results.
12
THE APPLICATION OF THE PENNY STOCK RULES COULD ADVERSELY AFFECT
TRADING IN OUR COMMON STOCK.
Our shares have frequently traded at prices below $5.00 per share.
While trading below $5.00 per share, our common stock is considered to be a
"low-priced" security under the "penny stock" rules promulgated under the
Securities Exchange Act of 1934. The "penny stock" rules impose additional sales
practice requirements on broker-dealers who sell securities to persons other
than established customers and accredited investors (generally those with assets
in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with their spouse). In accordance with these rules, broker-dealers participating
in transactions in low-priced securities must first deliver a risk disclosure
document which describes the risks associated with such stocks, the
broker-dealer's duties in selling the stock, the customer's rights and remedies
and certain market and other information. Furthermore, the broker-dealer must
make a suitability determination approving the customer for low-priced stock
transactions based on the customer's financial situation, investment experience
and objectives. Broker-dealers must also disclose these restrictions in writing
to the customer, obtain specific written consent from the customer, and provide
monthly account statements to the customer. The effect of these restrictions
will probably decrease the willingness of broker-dealers to make a market in our
common stock, decrease liquidity of our common stock and increase transaction
costs for sales and purchases of our common stock as compared to other
securities.
Stockholders should be aware that, according to Securities and
Exchange Commission Release No. 34-29093, the market for penny stocks has
suffered in recent years from patterns of fraud and abuse. Such patterns include
(i) control of the market for the security by one or a few broker-dealers that
are often related to the promoter or issuer; (ii) manipulation of prices through
prearranged matching of purchases and sales and false and misleading press
releases; (iii) boiler room practices involving high-pressure sales tactics and
unrealistic price projections by inexperienced sales persons; (iv) excessive and
undisclosed bid-ask differential and markups by selling broker-dealers; and (v)
the wholesale dumping of the same securities by promoters and broker-dealers
after prices have been manipulated to a desired level, along with the resulting
inevitable collapse of those prices and with consequent investor losses. Our
management is aware of the abuses that have occurred historically in the penny
stock market. Although we do not expect to be in a position to dictate the
behavior of the market or of broker-dealers who participate in the market,
management will strive within the confines of practical limitations to prevent
the described patterns from being established with respect to our securities.
NASD SALES PRACTICE REQUIREMENTS MAY ALSO LIMIT A STOCKHOLDER'S
ABILITY TO BUY AND SELL OUR STOCK.
In addition to the "penny stock" rules described above, the NASD has
adopted rules that require that in recommending an investment to a customer, a
broker-dealer must have reasonable grounds for believing that the investment is
suitable for that customer. Prior to recommending speculative low priced
securities - which will be the case if and when our stock is trading below $5.00
per share (which it frequently has) - to their non-institutional customers,
broker-dealers must make reasonable efforts to obtain information about the
customer's financial status, tax status, investment objectives and other
information. The NASD requirements make it more difficult for broker-dealers to
recommend that their customers buy our common stock, which may limit your
ability to buy and sell our stock and have an adverse effect on the market for
our shares.
WE DO NOT ANTICIPATE PAYING ANY CASH DIVIDENDS IN THE FORESEEABLE
FUTURE, WHICH MAY REDUCE YOUR RETURN ON AN INVESTMENT IN OUR COMMON STOCK.
Other than the dividends owed to holders of Series A Preferred Shares,
we plan to use all of our earnings, to the extent we have earnings, to fund our
operations. We do not plan to pay any cash dividends in the foreseeable future.
We cannot guarantee that we will, at any time, generate sufficient surplus cash
that would be available for distribution as a dividend to the holders of our
common stock. Therefore, any return on your investment would derive from an
increase in the price of our stock, which may or may not occur.
SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY
DEPRESS OUR STOCK PRICE.
Upon effectiveness of this registration statement, and based on the
number of shares outstanding as of December 31, 2006, we will have 3,011,573
registered shares outstanding. The shares in this offering will be freely
13
tradable without restriction or further registration under the federal
securities laws, subject in some cases to volume and other limitations.
If our stockholders sell substantial amounts of common stock in the
public market, or the market perceives that such sales may occur, the market
price of our common stock could fall. The sale of a large number of shares could
impair our ability to raise needed capital by depressing the price at which we
could sell our common stock.
WE MAY RAISE ADDITIONAL CAPITAL THROUGH A SECURITIES OFFERING THAT
COULD DILUTE YOUR OWNERSHIP INTEREST AND VOTING RIGHTS.
The power of the board of directors to issue shares of common stock,
preferred stock or warrants or options to purchase shares of our stock is
generally not subject to stockholder approval.
We anticipate that we will require additional working capital before
the end of the second quarter of 2007 to fund our business. If we raise
additional funds through the issuance of equity, equity-related or convertible
debt securities, these securities may have rights, preferences or privileges
senior to those of the holders of our common stock. The issuance of additional
common stock or securities convertible into common stock by our board of
directors will also have the effect of diluting the proportionate equity
interest and voting power of holders of our common stock.
WE ANTICIPATE THAT OUR BUSINESS WILL NOT GENERATE SUFFICIENT CASH FLOW
TO SUSTAIN THE CURRENT LEVEL OPERATIONAL ACTIVITY AND ADDITIONAL CASH RESOURCES
WILL BE NEEDED.
If we are not able to secure additional cash resources by the second quarter of
2007, operations will be negatively impacted and this may impair our ability to
secure new business as well as raising additional capital.
OUR INCORPORATION DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER
THAT STOCKHOLDERS CONSIDER FAVORABLE AND COULD ALSO LIMIT THE MARKET PRICE OF
YOUR STOCK, WHICH MAY INHIBIT AN ATTEMPT BY OUR STOCKHOLDERS TO CHANGE OUR
DIRECTION OR MANAGEMENT.
Our amended and restated certificate of incorporation and bylaws
contain provisions that could delay or prevent a change in control of our
company. Some of these provisions:
- - authorize our board of directors to determine the rights, preferences,
privileges and restrictions granted to, or imposed upon, the preferred
stock and to fix the number of shares constituting any series and the
designation of such series without further action by our stockholders;
- - establish advance notice requirements for submitting nominations for
election to the board of directors and for proposing matters that can be
acted upon by stockholders at a meeting; and
In addition, we are governed by the provisions of Section 203 of
Delaware General Corporate Law. These provisions may prohibit large
stockholders, in particular those owning 15% or more of our outstanding voting
stock, from merging or combining with us, which may prevent or frustrate any
attempt by our stockholders to change our management or the direction in which
we are heading. These and other provisions in our amended and restated
certificate of incorporation and bylaws and under Delaware law could reduce the
price that investors might be willing to pay for shares of our common stock in
the future and result in the market price being lower than it would be without
these provisions.
New rules, including those contained in and issued under the
Sarbanes-Oxley Act of 2002, may make it difficult for us to retain or attract
qualified officers and directors, which could adversely affect the management of
our business and our ability to obtain or retain listing of our common stock.
14
We may be unable to attract and retain qualified officers, directors
and members of board committees required to provide for our effective management
as a result of the recent and currently proposed changes in the rules and
regulations which govern publicly-held companies, including, but not limited to,
certifications from executive officers and requirements for financial experts on
the board of directors. The perceived increased personal risk associated with
these recent changes may deter qualified individuals from accepting these roles.
The enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of
a series of new rules and regulations and the strengthening of existing rules
and regulations by the SEC. Further, certain of these recent and proposed
changes heighten the requirements for board or committee membership,
particularly with respect to an individual's independence from the corporation
and level of experience in finance and accounting matters. We may have
difficulty attracting and retaining directors with the requisite qualifications.
If we are unable to attract and retain qualified officers and directors, the
management of our business could be adversely affected.
OUR INTERNAL CONTROLS OVER FINANCIAL REPORTING MAY NOT BE EFFECTIVE,
AND OUR INDEPENDENT AUDITORS MAY NOT BE ABLE TO CERTIFY AS TO THEIR
EFFECTIVENESS, WHICH COULD HAVE A SIGNIFICANT AND ADVERSE EFFECT ON OUR
BUSINESS.
We are subject to various regulatory requirements, including the
Sarbanes-Oxley Act of 2002. We, like all other public companies, must incur
additional expenses and, to a lesser extent, diversion of our management's time
in our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002
regarding internal controls over financial reporting. We have not evaluated our
internal controls over financial reporting in order to allow management to
report on, and our independent auditors to attest to, our internal controls over
financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of
2002 and the rules and regulations of the SEC, which we collectively refer to as
Section 404. We have never performed the system and process evaluation and
testing required in an effort to comply with the management assessment and
auditor certification requirements of Section 404, which currently applies to us
in 2007 related to the management assessment requirements and applies to us in
2008 related to the auditor certification. Our lack of familiarity with Section
404 may unduly divert management's time and resources in executing the business
plan. If, in the future, management identifies one or more material weaknesses,
or our external auditors are unable to attest that our management's report is
fairly stated or to express an opinion on the effectiveness of our internal
controls, this could result in a loss of investor confidence in our financial
reports, have an adverse effect on our stock price and/or subject us to
sanctions or investigation by regulatory authorities.
THE MARKET PRICE FOR OUR COMMON SHARES IS PARTICULARLY VOLATILE GIVEN
OUR STATUS AS A RELATIVELY UNKNOWN COMPANY WITH A SMALL AND THINLY-TRADED PUBLIC
FLOAT AND LIMITED OPERATING HISTORY. THE PRICE AT WHICH YOU PURCHASE OUR COMMON
SHARES MAY NOT BE INDICATIVE OF THE PRICE THAT WILL PREVAIL IN THE TRADING
MARKET. YOU MAY BE UNABLE TO SELL YOUR COMMON SHARES AT OR ABOVE YOUR PURCHASE
PRICE, WHICH MAY RESULT IN SUBSTANTIAL LOSSES TO YOU.
The market for our common shares is characterized by significant price
volatility when compared to seasoned issuers, and we expect that our share price
will continue to be more volatile than a seasoned issuer for the indefinite
future. The volatility in our share price is attributable to a number of
factors. First, as noted above, our common shares are sporadically or thinly
traded. As a consequence of this lack of liquidity, the trading of relatively
small quantities of shares by our stockholders may disproportionately influence
the price of those shares in either direction. The price for our shares could,
for example, decline precipitously in the event that a large number of our
common shares are sold on the market without commensurate demand, as compared to
a seasoned issuer which could better absorb those sales without adverse impact
on its share price. Secondly, we are a speculative or "risky" investment due to
our limited operating history and lack of profits to date, lack of capital to
execute our business plan, and uncertainty of future market acceptance for our
business strategy. As a consequence of this enhanced risk, more risk-adverse
investors may, under the fear of losing all or most of their investment in the
event of negative news or lack of progress, be more inclined to sell their
shares on the market more quickly and at greater discounts than would be the
case with the stock of a seasoned issuer. The following factors may add to the
volatility in the price of our common shares: actual or anticipated variations
in our quarterly or annual operating results, market acceptance of our business
strategy, government regulations, announcement of significant acquisitions,
strategic partnerships or joint ventures, our capital commitments, and additions
or departures of our key personnel. Many of these factors are beyond our control
and may decrease the market price of our common shares, regardless of our
15
operating performance. We cannot make any predictions or projections as to what
the prevailing market price for our common shares will be at any time, including
as to whether our common shares will sustain their current market prices, or as
to what effect, if any, that the sale of shares or the availability of common
shares for sale at any time will have on the prevailing market price.
USE OF PROCEEDS
This prospectus relates to shares of our Common Stock that may be
offered and sold from time to time by Selling Stockholders. We will receive no
proceeds from the sale of shares of Common Stock in this offering.
THE COMPANY
OUR BUSINESS
Catuity is a loyalty and gift card processor targeting the needs of
chain retailers and their partners. Our focus is primarily on retail
organizations with 50 to 250 stores, a group commonly referred to as tier two
retailers, and on smaller, tier three retailers through resellers. We offer
member-based loyalty programs at the point-of-sale and gift card programs. These
programs are designed to help retailers improve customer retention, add new
customers and increase each customer's average spend amount.
Our operational priorities as a Company are in three areas.
Loyalty and Gift Card Processing: We believe the U.S. reseller market
is adopting the type of technology that Catuity offers. There is an apparent
demand for a turnkey solution for small to mid-sized chains and small merchants
through re-sellers, including merchant services companies, Independent Sales
Organizations, marketing companies and operators of coalition loyalty programs
in local markets. This is a good fit for Catuity because we believe that we have
an efficient product with an operational service capability that provides
turnkey outsourcing to resellers. This gives us the ability to leverage
Catuity's fixed costs faster than by selling exclusively to chain retailers.
Packaged Loyalty and Gift Card Products: Catuity also sells packaged products to
broaden our offering to retailers. We believe there is demand in the chain world
for packaged products, such as bundled loyalty, gift card and payments
processing services. Packaged products are generally co-branded with the
retailer, offered with a fixed set of benefits to the consumer, and at a
pre-determined cost per unit to the retailer. It is important to note that
introducing product packages does not require significant new development of our
technology.
Mergers and Acquisitions: Acquiring a profitable operating business
remains important to our strategy. Catuity continues to seek the acquisition of
complementary businesses such as traditional loyalty services and/or database
marketing firms to expand our range of products and services. Catuity's
technology generates a robust stream of information and our prospective clients
often rely on others to manage and maximize this type of data.
INDUSTRY
Catuity competes in the loyalty market within the retail industry at
the intersection of three significant and positive trends in retailing: upgrades
of POS systems; rising gift card usage; and the growing budgets of retailers to
enhance sales by driving loyalty among new and prospective customers.
POS Spending by Retailers: The Catuity Advanced Loyalty System works
by installing a proprietary application at the point of sale inside a retailer
or merchant's stores. As might be expected, retailers are cautious about changes
which affect their ability to accept payment. As such, Catuity gives priority to
sales prospects, which have already decided to upgrade their POS systems, be it
in hardware, software or both. Catuity may benefit when a POS upgrade is already
anticipated because it has the potential to shorten the sales and deployment
cycles.
16
Numerous surveys and industry experts have reported that chain retailers are
continuing to aggressively upgrade their point of sale systems, a trend first
triggered by Y2K compliance concerns. In the Annual Survey of Retail Information
Technology Trends, Chain Store Age (www.chainstoreage.com) magazine found that
an average of 25% of the IT budgets was allocated for POS hardware and software
in 2005. Equally significant, Catuity's target market of tier two chain stores,
those with sales of $100 million to $1 billion a year spent the largest portion
of their technology budgets on POS needs; with most saying it was a top
priority. Generally speaking, the lifecycle of POS upgrades continues to
shorten. Except in extraordinary circumstances, hardware is replaced in a 5-7
year cycle at a typical chain store retailer, while software applications are
replaced more quickly based on advancements and new functionality. In a separate
study released in 2005, independent chain retailer research firm IHL Services
(www.ihlservices.com) reported that retailers spent $6.5 billion on POS
hardware, software and services last year for PC-based checkout systems. Catuity
targets these types of retailers through its direct sales effort.
Gift Card Usage Trends: In the past decade, stored value cards have
become one of the most sought after products at retailers. Gift cards are viewed
as a key customer acquisition tool since they are typically purchased by a
friend or relative and given to a potential shopper in lieu of cash. In fact,
Deloitte & Touche (www.deloitte.com) found in their annual study that gift cards
were now the No. 1 gift with a majority of shoppers choosing receiving a gift
card as their preferred gift. At the same time, Deloitte reported that consumers
now favor gift cards over cash by a two-to-one measure. For retailers, gift
cards have become vital to their success during the active Christmas holiday
season and throughout the year. In its annual year-end survey of consumers, the
National Retail Federation (www.nrf.org) found that consumers would spend at
least $17 billion in value during the 2005 holiday season. Gift cards are not
just a seasonal business. They are a year-round part of the strategy of
retailers and a key profit center.
Retailers Emphasize Loyalty in Growth Strategy: Since Catuity entered
the North American market in 2000, loyalty has evolved from an emerging strategy
to an established practice and budgeted expenditure for retailers. Estimates of
the size of the loyalty market vary widely and are often interchanged with
estimates of the customer relationship management ("CRM") market. These
estimates can include everything from direct marketing services, branding and
call center support to technology spending. Catuity defines our services to
enable loyalty as the application, creation and management of the individual
profile created when a customer joins a membership or reward program; and the
transactional support necessary to make a loyalty program work seamlessly at the
point of sale. Today, this does not include full-service database management,
direct mail support, web-related services and full service analytics. These are
capabilities that the Company expects to add through new development and
acquisition. We would note that our acquisition of Loyalty Magic Pty. Ltd.
increased our in-house ability to manage databases on behalf of clients.
Additionally, Loyalty Magic includes some key functional capabilities,
including, but not limited to, interfaces with kiosks and e-commerce platforms.
For the services that we offer today, merchants (those with one to 25
locations) spend an average of $850 to $1,100 annually per store on basic
loyalty programs. These fees are often charged in the form of a flat monthly
subscription and transactional service for a turnkey program. While Catuity
targets this market through resellers and referral, such as merchant services
providers, we believe there is a potential market of at least 1.2 million small
merchants -- about one in four of the total market -- in North America who do
not yet have a loyalty or gift card solution. Using the lowest estimates for
each, we believe that the small merchant market will spend at least $750 million
on loyalty and gift card solutions annually. As Catuity expands our sales focus
beyond our core market, the size of our opportunity will increase.
By the same measure, chain store retailers, which Catuity targets
through direct sales, spend an average of $3,700 to $6,900 per store annually
for the services which we sell to support loyalty and gift card solutions. The
retailers in three market segments that we have targeted represent at least
55,000 locations in North America.
THE BUSINESS
BUSINESS SEGMENTS
Catuity conducts all of its business in a single business segment -
providing loyalty and gift card technology along with related services to
retailers and their processor partners. During Catuity's last two fiscal years,
its revenue by type of product or service has been as shown below:
17
2005 2005 2004 2004
Revenue Type Amount % Amount %
- ------------ -------- ---- -------- ----
Processing & Services $839,645 86% $467,533 62%
License 141,277 14% 43,200 6%
Project Related -- 0% 248,379 32%
-------- --- -------- ---
Total Revenue $980,922 100% $759,112 100%
In 2004 and 2005, Catuity underwent a major shift in business focus
which directly impacted our full year results. In the first quarter of 2004, the
Company learned that one of its clients, a large U.S. retailer, was
discontinuing its use of smart cards. As a result, Visa USA determined that it
would discontinue the development of its Smart Visa Rewards Platform and phase
out the platform's operations during 2004. Catuity's loyalty software was a key
component of the platform and this Visa-issuing retailer represented the vast
majority of the Company's revenue. The Company then embarked on an extensive
effort to replace its existing technology with the new Catuity Advanced Loyalty
System, or CALS. That system was designed to be architecturally flexible to meet
the changing needs of clients and prospects. The first version of that
technology was announced in the third quarter of 2004 and consumed substantially
all of the internal technology resources of the Company. Late in the third
quarter of 2004, the Board of Directors named a new CEO, who embarked on an
internal restructuring of the efforts and focus of the sales team and a
reduction in the size of the technology team. These changes were implemented
during the fourth quarter of 2004 and into 2005. During the Company's refocusing
efforts, the Company made limited progress in pursuing, managing and closing new
sales.
During 2005, the Company established the operational team and the
secure facility needed to enable it to host loyalty and gift card programs for
customers. In addition, the Company successfully completed two capital raises,
the acquisition of Loyalty Magic Pty. Ltd. and the post acquisition integration
needed for efficient operations between Catuity's and Loyalty Magic's staffs.
PRODUCTS AND SERVICES
Most retailers are interested in achieving one or more of the
following from their loyalty and reward programs:
- Increasing basket lift (giving customers reasons to spend more on
targeted products and categories);
- Improving gross margin (giving customers reasons to buy higher margin
products);
- Increasing customer purchase frequency (driving customers back to the
store more often); and
- Increasing customer response rates
Our loyalty technology, CALS, provides the capabilities retailers need to
achieve these goals via:
- Launching and managing membership-based programs;
- Managing points-based programs;
- Delivering discounts based on shopping behavior; and
- Offering customizable gift card programs which can be enhanced with
loyalty functionality.
Because CALS requires integration to a client's point of sale system,
Catuity offers traditional IT services to retailers. While our primary focus is
on serving the needs of clients in relation to a planned deployment of our
system in their chain of stores, Catuity will perform contract work to manage
projects for retailers. Industry research firm IHL Services reports that
maintenance and development of existing retail systems represents more than half
of the average chain retailer's IT budget for projects ranging from installation
of new POS software systems to upgrades of hardware and the addition of new
technologies. In 2005, examples of leading types of projects,
18
according to researchers, include the installation of in-store kiosk systems
which are linked to the POS; the addition of RFID-reader systems and the
addition of specialized check readers to comply with the new U.S. check
truncation laws. Catuity does not maintain a bench of consultants or
technologists to manage such projects. However, the Company has established
relationships with companies and teams of experienced technologists which it can
contract with to provide these services.
COMPETITION
Catuity is focused on enabling loyalty and gift card programs in the
U.S. and Canada where demand is high and customers consider loyalty to be an
established part of their growth strategies. In North America, as in other
predominantly English-speaking markets globally, budgets for loyalty are
established -- not emerging -- but are not considered mature. Catuity's
prospects do not lack options in how they choose to spend their budgets to
acquire, retain and upsell their customer relationships. We have found that they
make one of three financial and strategic choices in executing their loyalty
strategy. These are:
- IN-HOUSE SOLUTION: Retailers, especially the largest, often seek
competitive advantage by custom development of proprietary in-house
solutions. This is generally done in conjunction with loyalty
consultancies, database service firms and IT service firms. This is
not a primary market for Catuity due to the typically lengthy and
complex sales cycle and the strict financial requirements placed on
the provider, which tend to exclude smaller companies. While Catuity
does not actively target tier one retailers or custom installation
projects, we will provide this option at the request of our core
customers.
- HOSTED SOLUTION: Retailers, especially the tier two chain retailers
targeted by Catuity, favor a turnkey hosted solution which enables
them to minimize capital investment; avoid the need for large,
specialized IT; and reduce the risks associated with complex
integration, deployment and upgrades. This market typically prefers a
hosted solution which allows them to customize their programs -- not
their technology -- to be aligned with the retailers' merchandising
and branding strategy. Many players, including payments processors,
gift card solutions providers and marketing services firms are
generally focused by vertical market.
- PROGRAM-BASED SOLUTION: Retailers actively participate in promotional
programs which are generally designed to drive a single type of
customer behavior, such as new account acquisition or customer
retention, or target the sale of specific products. These programs are
generally attractive because they have a defined cost; require little
to no technology adoption and require no complex back-end technology
to manage beyond a specific promotion. Catuity does not compete in
this market.
Our ability to be successful depends on many factors, including:
- Our ability to establish a clear business case that is aligned with
the strategy of our client and which has a clearly defined return on
investment.
- Our ability to successfully market the features of our product and to
continually make it easier for our clients to use.
- Our ability to continually expand our reputation and credibility in
our markets and to differentiate Catuity from the many competitive
alternatives.
- Our ability to leverage marquee client relationships to establish a
more visible presence in North America and Australia.
- Our ability to execute on schedule and on budget and to consistently
exceed our customers' ongoing service requirements.
While Catuity focused on a new market in 2005, we believe that our
reputation for innovation and delivery on behalf of our customers provides a
foundation for our growth plans. CALS is a robust and flexible platform which
enables our customers to create, manage and measure the success of their
proprietary loyalty programs.
19
RESEARCH AND DEVELOPMENT
Catuity's product development efforts in 2005 were primarily focused
on completing subsequent releases of its new generation loyalty platform --
CALS. The Company has enhanced existing functionality while constantly striving
to make the system easier to use by retailers who generally lacked large or
sophisticated technology departments. In 2006, the Company enhanced the
management reporting capabilities of the system; continued to expand the number
of POS systems to which we integrate and added new functionality that helped us
deliver a technologically superior product in our markets. In the North American
market, CALS replaces the Company's older smart loyalty platform which was used
primarily for smart card-based loyalty. While the Company continues to support
existing customers who use the smart loyalty platform, Catuity is not actively
marketing the system. The smart loyalty platform is designed to meet the
Europay-MasterCard-Visa ("EMV") requirements in Europe, Asia-Pacific, South
America and other regions. The Company has previously announced that it may sell
the smart loyalty system and/or the associated patent portfolio. To date,
discussions with potential buyers, re-sellers and other partners have not
produced a viable transaction.
Through the acquisition of Loyalty Magic, Catuity acquired the LMX
loyalty platform. For the most part, that technology platform is used by clients
in Australia, New Zealand and the United Kingdom. The Company does not currently
plan to market the software directly in North America. Additionally, most of the
enhancements to the LMX system are client directed and funded and are not
considered R&D investments. When assessing projects for possible R&D investment,
Catuity makes efforts to ensure that new functionality can be used with both
platforms.
Catuity believes that focus and consistent application of some basic
design principles will ensure that we deliver a product that is strategically
advantaged in our markets. To that end, the Company's management balances every
proposed development project against four design principles. These principles
are:
- EVERY DEVELOPMENT PROJECT MUST GIVE OUR CUSTOMER CONTROL OF THEIR
PROGRAMS. This is important because retailers of all sizes want to be
able to quickly and easily implement, measure and modify their
marketing and loyalty programs. Because we are delivered in an ASP
model, a key element of our R&D strategy is to always make it simpler
and more intuitive for our customers to use the technology.
- EVERY DEVELOPMENT MUST OFFER SUPERIOR DATA SECURITY. The security of
customer information remains a major concern among retailers and
payments industry players. Catuity addresses the security of our own
system through the training of our people; clearly drafted policies
and procedures; ongoing review and discussions with our customers
about their best practices; and compliance with industry standards.
Catuity is in the process of certifying its U.S. operations as being
compliant with industry standards around customer data security.
- EVERY DEVELOPMENT MUST NOT IMPACT THE TIME OF THE TOTAL TRANSACTION.
Because our programs work at the point of sale, it is critical that
our technology never slow down the checkout process. Retailers equate
delays at the checkout with lost business. Our technology, which
requires a proprietary application to be installed at the POS, is
designed to operate under the ISO 8583 message format, simultaneously
with the approval of the payment transaction. Before any version of
our applications are released, they are tested and improved to
streamline the total transaction time so that Catuity never hurts the
checkout time of one of its customers.
- EVERY DEVELOPMENT MUST MINIMIZE OR ELIMINATE INTEGRATION AND OTHER
IT-RELATED RISKS FOR OUR CUSTOMERS. Like most buyers of technology
driven solutions, retailers assess the total cost of deploying and
managing a solution. Our investment in our Application Program
Interface ("API") development and integration with market-standard
protocols is designed to reduce the upfront cost of doing business
with Catuity. These upfront costs can act as a deterrent to a buying
decision. We believe that a critical success factor in
transaction-driven companies is to make it easy for customers to start
doing business with us.
Development projects that do not meet these four standards are
generally only considered if they are funded by a client.
20
INTELLECTUAL PROPERTY
Catuity respects the intellectual property rights of others and we
expect others to respect our rights. Patents protect the rights of innovators
and allow them to be rewarded for their innovation. Without protection for the
reward from innovation, far less research and development would be undertaken.
We file patent and trademark applications to protect our innovations
and to protect the business from legal action by others. Patents also provide
recognition for our innovations, demonstrate our capabilities, and reflect 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 efficient storage
and management of multiple applications in offline consumer devices and the
systems to manage the applications, customer devices and terminals. This patent
"family" has a priority date of December 4, 1998 and includes:
Country Patent Number
- ------- -------------
United States 6,449,684
United States 6,532,518
Australia 755,388
Patent applications are pending in the European Union, Japan and
Brazil.
Catuity has also been issued patents in seven countries, with a
priority date of February 22, 1999, which relate to the use of the Catuity
System over the Internet and with traditional point of sale devices. It covers
our system for managing and updating data on customer devices that are supported
and controlled by a host system integrated to any number of offline and online
terminals. The patent covers the operation of interactive programs and
transactions that use methods ranging from POS terminals to the Internet. This
patent "family" includes:
Country Patent Number
- ------- -------------
Australia 746,867
New Zealand 513,678
Belgium 1,163,633
Finland 1,163,633
France 1,163,633
Germany 60020818.4
Great Britain 1,163,633
This patent is also pending in Canada and Japan.
SALES BACKLOG AND PIPELINE
As of December 31, 2006, the Company has 2,000 potential deployable
locations signed in the U.S. market, through our direct sales efforts to chain
retailers, franchise and merchant groups. As of this filing, the Company has a
defined prospect base of approximately 2,100 companies which we are targeting
for the purchase of loyalty programs, gift card programs or credit and debit
card processing, or a combination of those services. Our contracts are typically
for a minimum of three years and are generally exclusive. Last year, we gained
traction in the large and growing reseller market in the U.S. To date, we have
reseller agreements with five re-sellers. These re-sellers are strategically
designed to give Catuity access to non-core markets. A re-seller agreement
ranges from 3-5 years in length and is generally exclusive. These resellers have
generally been ISO sales agent groups who have a defined geographic territory.
In 2006, we signed our first reseller who was fully national in their reach and
we have begun deploying locations for that reseller. At present, our resellers
are deploying at least 7,000 signed merchant contracts
21
a year and are offering a package of our services to those merchants. We are
also in discussion with channel partners. These prospective channel partners
typically provide proprietary software and related services to a vertical market
within retailing, but do not offer the same products and services sold by
Catuity. We are seeking an exclusive or proprietary relationship to market our
products as a fully integrated product to their existing and new customers. We
do not expect revenue to be generated from these channel opportunities until at
least the second half of 2007.
In Australia, we continue to see success in cross-selling our
marketing services to existing customers. We have 4-6 existing clients in our
Australian subsidiary with which we are pursuing expansion of the range of
loyalty related services that they purchase to support their programs. These
efforts have improved our mix of recurring revenues and believe will give us the
opportunity to improve our margin in 2007. Additionally, we continue to expand
our integration to leading bank-owned payment networks to increase the number of
merchants and retailers that we can reach. As of December 31, 2006 we have
secured agreements to reach over 50% of the Australian retail market. Management
believes we will increase our market penetration in 2007.
REVENUE AND ASSETS BY GEOGRAPHIC LOCATION
Through the third quarter of 2006, 93% of our revenue was derived from
operations in Australia and 7% from operations in the United States. During the
three quarters ended September 30, 2005 73% of our revenues was derived from
operations in Australia, and 27% from operations in the United States. It should
be noted that Loyalty Magic, based in Australia, was acquired in September 2005
and only had one month's activity through the third quarter 2005.
The Company's assets are located at its headquarters in
Charlottesville, VA along with its offices in Denver, CO, Melbourne, Australia
and in Sydney, Australia.
EMPLOYEES AND FACILITIES
As of December 31, 2006 we had 35 full time employees, 14 of which are
located in the U.S. and 21 of which are located in Australia. We expect the
number of full time employees in the U.S. to increase in 2007. None of our
employees is covered by a collective bargaining agreement. We consider our
relations with our employees to be very good. Our corporate headquarters is
located in Charlottesville, Virginia.
PROPERTIES
During 2006, our corporate headquarters was located in leased
facilities in Livonia, Michigan (a suburb of metropolitan Detroit). The property
consisted of approximately 1,500 square feet of office space with a lease
expiring in February, 2008. In January 2007, we relocated our corporate
headquarters to leased facilities in Charlottesville, VA consisting of
approximately 1,000 square feet of office space. Our Client Management
department is also located in our Charlottesville office. The facilities are
leased through September 2007.
Our Sales department is located in leased facilities in Denver, CO
consisting of approximately 800 square feet of office space. The facilities were
leased for a two year period ending in December, 2007.
Our primary office in Australia is Loyalty Magic's premises that are
located in leased facilities in Melbourne Victoria consisting of approximately
3,460 square feet of office space. The facilities are leased for a term of 5
years beginning August 1, 2002 with a further term of five years at the
Company's option.
We also have a Research and Development center located in leased
facilities in Sydney, Australia, consisting of approximately 330 square feet.
Our lease agreement expired on December 28, 2005 and has continued on a
month-to-month basis.
LEGAL PROCEEDINGS
Catuity was not during 2006 and is not as of the date of this
prospectus a party to any legal proceedings.
22
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth our Directors, Executive Officers,
Promoters and Control persons and their ages as of January 25, 2007.
NAME AGE POSITION(S)
---- --- -----------------------------------------------
Alexander S. Dawson 63 Chairman (1), (2), (3)
Alfred H.(John) Racine III 42 Director, President and Chief Executive Officer
Geoffrey C. Wild 67 Director (1), (3)
Donald C. Campion 58 Director (1), (2)
Clifford W. Chapman Jr. 37 Director (2), (3)
Debra R. Hoopes 46 Sr. Vice President, Chief Financial Officer,
Treasurer and Secretary
Graham McStay 40 Managing Director of Loyalty Magic Pty. Ltd.
(Australia)
(1) Audit Committee
(2) Compensation Committee
(3) Governance and Nominating Committee
Alexander S. Dawson is our non-executive Chairman of the Board of
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. Mr. Dawson is a Fellow of
The Institute of Chartered Accountants in Australia, has a Bachelor of Commerce
degree from the University of New South Wales and a Master of Business
Administration from Columbia University.
Alfred H. (John) Racine III is our President and Chief Executive
Officer and is a member of the Board of Directors. Prior to joining Catuity Mr.
Racine founded Altamont Partners in Charlottesville, Virginia in 1997. Altamont
Partners has advised many of the leading payment organizations in North America
and Europe regarding strategic and merger related issues. Prior to his tenure
with Altamont Partners, Mr. Racine was a principal at SNL Financial, also in
Charlottesville, Virginia, the highly regarded merger and financial analytics
provider for the financial services industry. From 1995-1997 Mr. Racine played a
key role in SNL's emergence as a market leader in the face of larger,
established competitors. Prior to that he spent five years in a variety of
operational and strategic roles in the financial services division at Thomson
Financial. Before spending the last 14 years working in the financial services
and payments industries Mr. Racine worked in the media industry at leading
companies including Ingersoll Publishing Co. and Capital Cities-ABC. He attended
Southern Illinois University at Carbondale.
Clifford W. Chapman, Jr. is one of our independent directors and the
Chairman of our Compensation Committee. Cliff Chapman is currently the head of
investment banking for Broadband Capital Management, a boutique investment and
merchant bank. In addition to working with Andersen Consulting and Booz Allen &
Hamilton, Mr. Chapman has also played key leadership roles in two high profile
successes. Most recently he was the CEO and investor in the turnaround of
mindSHIFT Technologies, a managed services provider focused on IT outsourcing
for small and medium enterprises. From June 2002 through October 2003 he
restructured the sales process, cut costs and acquired three companies to take
mindSHIFT to profitability. Prior to MindSHIFT, Mr. Chapman was the VP of
Business Integration for AppNet, a full-service Internet professional service
and managed hosting company. Prior to AppNet, Mr. Chapman co-founded NMP, a
full-service consulting business and managed hosting company. He has also worked
with numerous start-up businesses. Mr. Chapman holds an MBA from Columbia
Business School and a BS in Computer Engineering from Lehigh University.
Geoffrey C. Wild is one of our independent directors and is Chairman
of the Governance and Nominating Committee. He had a distinguished career in
advertising and marketing for 30 years and was awarded Australia's highest
honor, the Order of Australia (AM). In 1972, he founded Clemenger Advertising
Agency in Sydney and merged with US-based BBDO Group where he oversaw a
Pan-Asian expansion strategy through acquisition and start-up. He was Chairman
of the Advertising Federation of Australia, chairman of the Advertising Industry
Council
23
and is a recognized authority on branding, advertising, marketing and loyalty.
Mr. Wild currently serves as the non-Executive Chairman of WPP Holdings
(Australia) Pty Ltd, the Group which owns Ogilvy & Mather, J Walter Thompson,
Young & Rubicam, Hill & Knowlton and Burson Marsteller. He was a director of TAB
Limited and currently serves on the boards of ComOps Limited, and the Arab Bank
Australia Limited. He is also a long serving Board member of the PGA
(Professional Golf Association) and IBIS World, the business and economic
forecasting group. He was awarded the Order of Australia (AM) for his
contribution to tourism, business and the Olympics. He is a Fellow of the
Advertising Institute (by examination) FAIA, and a Fellow of the Australian
Institute of Company Directors FICD.
Donald C. Campion is one of our independent directors and is Chairman
of our Audit Committee. Mr. Campion is a member of the Board of Directors for
Haynes International and also serves as the Chairman of its Audit Committee and
as a member of its Compensation Committee. He is also a member of the Board of
Directors of McLeodUSA, Inc., a privately held telecommunications company, where
he serves as the Chairman of its Audit Committee. Mr. Campion served as the
Chief Financial Officer for VeriFone Inc., North America's largest point of sale
terminal manufacturer. He was also the Chief Financial Officer of several other
corporations, including Special Devices, Inc., Cambridge Industries, Inc.,
Oxford Automotive, Inc., and Delco Electronics Corporation. Previously, Mr.
Campion held a variety of Senior Management roles with General Motors and its
affiliates. He holds an MBA and a BS in Applied Mathematics from the University
of Michigan.
Debra R. Hoopes began service as our Sr. Vice President, Chief
Financial Officer, Secretary and Treasurer on January 2, 2007. Ms. Hoopes was
most recently the interim Chief Financial Officer of Catcher Holdings, Inc.,
through her relationship with Tatum Partners and prior to that was the Chief
Financial Officer of Intersections Inc., a Chantilly, Virginia-based company
that provides credit reporting and identity theft products for the consumer
market. Ms. Hoopes has eight years of experience as Chief Financial Officer or a
senior financial officer in private equity backed and public companies including
Compel Holdings; CityNet Telecommunications; and Winstar Telecommunications.
Prior to that, Ms. Hoopes managed a line of businesses for Cable & Wireless and
was with MCI Communications. Ms. Hoopes holds a B.S. in Accounting from Virginia
Tech and an MBA in Finance from George Washington University and is a CPA.
Graham McStay was appointed as Managing Director of our Australian
subsidiary, Loyal Magic, on January 30, 2007. Previously, he spent two years as
the head of operations at Loyalty Magic. In that capacity, he oversaw all client
management and the company's technology team. He has more than 10 years of
extensive operational management experience in leading Australian companies.
While at Retail Decisions, the fuel card division, Mr. McStay was the national
customer service and sales manager who oversaw the merger of two business units.
He held a similar position at the Centre for Adult Education, UCMS and at Ansett
Australia.
Each of our directors other than Mr. Racine is "independent" under the
independence standards applicable to Catuity pursuant to applicable securities
regulations. Each director 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. In the case of Mr.
Racine however, he will serve as President and Chief Executive Officer until the
expiration of his current agreement on September 30, 2007. Mr. Racine's
agreement may be extended for one year by mutual agreement between himself and
Catuity.
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.
The audit committee contains at least one Financial Expert as that term is
defined in SEC rules.
Effective February 26, 2001, the board of directors established a
compensation committee. In 2003, the board of directors resolved that only
independent directors could serve on the compensation committee. The
compensation committee is responsible for establishing the compensation levels
for our executive officers. 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.
24
On March 22, 2005, the Board approved the establishment of a
Nomination and Governance Committee, which became effective on July 1, 2005. The
Nomination and Governance functions, which include selecting qualified
individuals for approval by shareholders to serve as members of the Board and
developing a set of corporate governance principles applicable to the Company,
was previously carried out by the independent members of the Board as part of
their Board responsibilities.
There are no family relationships among any of our directors. No
arrangement or understanding exists between any director and any other person
pursuant to which any director was selected to serve as a director. To the best
of our knowledge, (i) there are no material proceedings to which our director is
a party, or has a material interest, adverse to us; and (ii) there have been no
events under any bankruptcy act, no criminal proceedings and no judgments or
injunctions that are material to the evaluation of the ability or integrity of
any of the directors during the past five years.
DIRECTOR AND EXECUTIVE COMPENSATION
The following tables provide certain summary information concerning
compensation and stock options for our Principal Executive Officer, the named
executive officers that earned more than $100,000 (salary and bonus), and our
directors for all services rendered in all capacities to Catuity during the year
ended December 31, 2006.
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
Salary (1) Stock (2) Option All Other
\Name and Principal Position Year ($) Awards ($) Awards ($) Compensation ($) Total ($)
- ----------------------------------- ---- ------- ----------- ------------ ----------------- ---------
Alfred H. (John) Racine, III 2006 253,365 109,073 182,190 7,600 552,228
President and CEO
John H. Lowry, III
Vice President -- CFO, Secretary and 2006 170,000 65,190 15,045 5,100 255,335
Treasurer
Chris Leach CEO of Loyalty Magic 2006 134,150 0 11,681 0 145,831
</Table>
(1) The amount expensed per 123(R) in 2006 for stock awarded in 2006.
(2) The amount expensed per 123(R) in 2006 for options awarded in 2005 and
2006.
25
OUTSTANDING EQUITY AWARDS AT FISCAL YEAREND 2006
<Table>
<Caption>
Option Awards Stock Awards
------------------------------------------------------------------------------------- -----------------------
Market
Number of Number of Number Value
Shares Securities Securities of Shares of Shares
Acquired Underlying Underlying or Units or Units
on Value Unexercised Unexercised Option of Stock of Stock
Exercise Realized Options (#) Options (#) Option Exercise Expiration That Have That Have
Name (#) ($) Exercisable Unexercisable Price ($) Date Not Vested Not Vested
- ---- -------- -------- ----------- ------------- --------------------- ---------- ---------- ----------
Alfred H. (John) 77,914 @ $4.20(2) and
Racine, III 0 0 102,914 25,000 50,000 @ $6.86(3) 9-23-09 and 100,000(1) 444,000
9-23-15
John H. Lowry, 8,333 @ $7.50 and
III 0 0 13,333 5,000 10,000(5) @ $10.52 6-20-10 and 20,000(4) 88,800
9-20-15
Chris Leach 5,000 @ $16.99 and
0 0 15,000 0 10,000 @ $18.35 (6) 9-1-10 0 0
</Table>
(1) 33,334 restricted shares will vest when the 30 day average closing
price of our common stock on the NASDAQ exceeds $15.00; 33,333
restricted shares will vest when the 30 day average closing price of
our common stock on the NASDAQ exceeds $20.625; and 33,333 restricted
shares will vest when the 20 day average closing price of our common
stock on the NASDAQ exceeds $26.25.
(2) Vesting occurred between Nov. 2004 and Sep. 2005.
(3) Option exercise price is $6.86 and vesting as follows: twenty-five
percent (25%) on September 23, 2005 (actually vested on May 11, 2006
when shareholders approved it); twenty-five percent (25%) on September
23, 2006; and the remaining fifty percent (50%) on September 23, 2007.
(4) 20,000 restricted shares at $11.62 vesting: 6,667 shares when the
30-day average closing price of Catuity stock equals $15; 6,667 shares
when the 30-day average closing price of Catuity stock equals $20.625;
and 6,666 shares when the 30-day average closing price of Catuity stock
equals $26.25.
(5) 10,000 options at $10.52 with 5,000 vesting Sept. 28, 2006 and 5,000
vesting on Sept. 28, 2007. 8,333 options at $7.50 and vested on Dec.
29, 2005.
(6) Options to purchase 15,000 shares common stock vesting: 5,000 vested on
September 1, 2005 with an exercise price equal to 25% above the 30-day
average closing price on NASDAQ preceding the grant ($16.99 USD); 5,000
vested on January 1, 2006 with an exercise price equal to 35% above the
30-day average closing price on NASDAQ preceding the date of the grant
($18.35 USD); and 5,000 vested on January 1, 2007 with the exercise
price equal to 35% above the 30-day average closing price on NASDAQ
preceding the date of the grant ($18.35 USD.)
DIRECTOR COMPENSATION
<Table>
<Caption>
Fees
Earned or
Paid in Stock (1) Option (2)
Name Cash ($) Awards ($) Awards ($) Total ($)
- ---- --------- ---------- ---------- ---------
Alexander S. Dawson 30,250 30,254 9,330 69,834
Alfred H.(John) Racine III 0 0 0 0
Geoffrey C. Wild 20,000 19,996 7,775 47,771
Donald C. Campion 20,750 20,753 7,775 49,278
Clifford W. Chapman Jr. 18,250 18,251 7,775 44,276
</Table>
(1) Restricted stock awards vest on the first calendar day after the
Company has achieved profitability and positive cash flow for two
consecutive fiscal quarters. Total shares outstanding at YE '06 for
Dawson: 8,745; Campion: 5,651; Chapman: 5,310; and Wild: 5,446.
(2) The options outstanding at YE '06 for Dawson: 8,000; Campion: 5,000;
Chapman: 5,667; and Wild: 5,000.
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL AGREEMENTS
Alfred H. (John) Racine, III. We have an employment agreement with our
President and Chief Executive Officer, Alfred H. (John) Racine, III. Pursuant to
the agreement, Mr. Racine's salary is currently $262,500 per year. We have
granted Mr. Racine stock options and restricted shares pursuant to his
employment agreement, as depicted in the Summary Compensation Table above (note:
approved by shareholders on May 11, 2006; considered the grant date for
reporting purposes). The options have a term of ten (10) years from September
23, 2005 (September 23, 2015), and vest on the following schedule: (i)
twenty-five percent (25%) on September 23, 2005; (ii) twenty-five percent (25%)
on September 23, 2006; and (iii) the remaining fifty percent (50%) on September
23, 2007. The restricted shares vest on the following schedule: (i) 33,334
restricted shares will vest when the 30 day average closing price of our common
stock on the NASDAQ exceeds $15.00; (ii) 33,333 restricted shares will vest when
the 30 day average closing price of our common stock on the NASDAQ exceeds
$20.625; and (iii) 33,333 restricted
26
shares will vest when the 20 day average closing price of our common stock on
the NASDAQ exceeds $26.25. The restricted shares will vest immediately upon a
change of control where Mr. Racine loses his position as long as the
consideration paid to Catuity stockholders in such transaction is greater than
$10.00 per share. Any unvested restricted shares are forfeited if Mr. Racine
voluntarily resigns or if his employment is terminated for cause.
Debra R. Hoopes. Effective January 2, 2007, John H. Lowry, III
resigned as Chief Financial Officer, and was replaced by Debra R. Hoopes, who
serves as our Senior Vice President and Chief Financial Officer. We have an
employment agreement with Ms. Hoopes. Ms. Hoopes' employment agreement is for an
initial term commencing on January 2, 2007 and ending on December 31, 2009. The
employment agreement is automatically renewable for successive one year terms
thereafter unless either party timely terminates the agreement. Pursuant to the
employment agreement, Ms. Hoopes is paid an annual base salary of $185,000,
which will be reviewed annually by the Company's Chief Executive Officer and
Board of Directors. In addition to her base salary and in accordance with the
terms of her employment agreement, Ms. Hoopes is entitled to certain
incentive-based compensation payable in shares of the Company's common stock if
the Company satisfies certain performance criteria.
In addition, Ms. Hoopes received options to purchase 25,000 shares of
the Company's common stock (the "Options") at an exercise price equal to the
volume weighted average of the trading price of the Company's common stock on
the Nasdaq small cap market ("Nasdaq") during the thirty calendar days preceding
(and ending on) December 6, 2006 (the "Initial Market Price"). Twenty-five
percent of the Options will vest on each of January 2, 2007 and December 31,
2007 and the remaining fifty percent will vest on December 31, 2008. Ms. Hoopes
will receive 50,000 shares of restricted stock (the "Restricted Stock").
One-third of the shares Restricted Stock will vest when the thirty calendar day
volume weighted average trading price of the Company's common stock on Nasdaq
(the "30-day VWAP") exceeds two times the Initial Market Price, one-third of the
shares of Restricted Stock will vest when the 30-day VWAP exceeds three times
the Initial Market Price and the remaining one-third of the shares of Restricted
Stock will vest when the 30-day VWAP exceeds four times the Initial Market
Price.
John H. Lowry, III. Mr. Lowry served as Chief Financial Officer until
January 2, 2007. From January 2, 2007 through the end of the term of his
employment agreement (July 1, 2007), he will remain employed by the Company for
a limited role in order to assist with the transition of duties to Ms. Hoopes.
Under the terms of Mr. Lowry's employment agreement, Mr. Lowry's base salary is
currently $170,000. In addition, he was granted options to purchase shares of
our common stock and was awarded shares of restricted stock, as depicted in the
Summary Compensation Table above. One half of the options expired on September
28, 2006 and the remaining half will expire on September 28, 2007. One third of
the restricted shares will vest when the Company's 30 day average closing price
on NASDAQ exceeds $15.00, $20.625, and $26.25 respectively. Any unvested option
shares or restricted shares are forfeited if Mr. Lowry voluntarily resigns or if
his employment is terminated for cause.
Chris Leach. Mr. Leach served as CEO of Loyalty Magic until his
resignation on January 30, 2007. Chris will remain an employee until February
28, 2007 to assist with the CEO transition. On September 1, 2005 Catuity entered
into a services agreement with MIA Pty. Ltd. ("MIA") and Chris Leach requiring
Mr. Leach to provide executive management services to Catuity. Mr. Leach is an
officer and director of MIA and is authorized to approve and execute contracts
on its behalf. Mr. Leach, under contract with MIA, served as the Chief Executive
Officer of Loyalty Magic Pty. Ltd. prior to its acquisition by Catuity on
September 1, 2005. The contracted services with Catuity commenced on September
1, 2005 and continue until December 31, 2007. The services consist of general
executive management including the management of all Australian sales and
research and development efforts along with Catuity's existing and future
Australian operations.
Under the terms of the agreement, Mr. Leach's base salary was $195,000
AUD (approximately $146,000 USD) plus a lump sum payment to MIA that is equal to
the cost of customary benefits to be paid in twelve (12) equal monthly
installments.
In addition, Mr. Leach was awarded options to purchase 15,000 shares
of our common stock. The options vest on the following schedule: (1) 5,000
vested on September 1, 2005 with an exercise price equal to 25% above the 30-day
average closing price on NASDAQ preceding the grant ($16.99 USD); (2) 5,000
vested on January 1, 2006 with an exercise price equal to 35% above the 30-day
average closing price on NASDAQ preceding the date of the grant ($18.35 USD);
and (3) 5,000 vested on January 1, 2007 with the exercise price equal to 35%
above the 30-day average closing price on NASDAQ preceding the date of the grant
($18.35 USD.) Mr. Leach was also
27
provided with an opportunity to earn 20,000 restricted stock shares as follows:
(1) 5,000 shares to be granted on January 30, 2006 if Mr. Leach meets 100% of
the revenue and EBITDA goals for the second half of 2005, which did not occur;
(2) 7,000 shares to be granted on January 30, 2007 for meeting 100% of the
revenue and EBITDA goals for 2006, which did not occur; and (3) 8,000 shares to
be granted on January 30, 2008 for meeting 100% of the revenue and EBITDA goals
for 2007.
SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS
The following table provides certain information regarding beneficial
ownership of our capital stock as of December 31, 2006 by: (i) each person who
is known by us to beneficially own more than five percent of our common stock;
(ii) our Principal Executive Officer and the four most highly compensated
executive officers that earned more than US$100,000 (salary and bonus) for all
services rendered in all capacities to Catuity during the year ended December
31, 2006; (iii) each of our Directors; and (iv) all of our Directors and
executive officers as a group.
AMOUNT AND NATURE OF COMMON STOCK PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED (1) OWNED (2)
- ------------------------------------ --------------------------------- ---------
A&B Venture Fund
Level 13, 18 Bulletin Place 251,467 Direct 11.2%
Sydney, NSW 2000
Alfred H. Racine III 1,998 Direct
11 Altamont Circle, #51 102,914 Vested Options
Charlottesville, VA 22902 104,912 4.7%
Geoffrey C. Wild 7,946 Direct
Level 5, 132 Arthur Street 5,000 Vested Options
North Sydney, NSW 2060 12,946 *
Alexander S. Dawson 29,745 Direct
38 McLeay Street 8,000 Vested Options
Potts Point, NSW 2011 Australia 37,745 1.7%
John H. Lowry III (3) 20,422 Direct
21972 Heatheridge 13,333 Vested Options
Northville, MI 48167 33,755 1.5%
Donald C. Campion 7,628 Direct
3747 Loch Bend Dr. 5,000 Vested Options
Commerce, MI 48382 12,628 *
Clifford W. Chapman Jr. 18,634 Direct
10 Warren Ave. 5,667 Vested Options
Spring Lake, NJ 07762 24,301 1.1%
Chris P. Leach 28,409 Direct
23 Grover Ave. 10,000 Vested Options 1.7%
Cromer, NSW 2099 38,409
All directors and executive officers as a 114,782 Direct
group (7 persons) 149,914 Vested Options 11.8%
264,696
- ----------
(1) Beneficial ownership is determined in accordance with the SEC rules and
generally includes voting or investment power with respect to securities.
Shares of common stock subject to options, warrants or other
28
rights to purchase common shares which are currently exercisable or are
exercisable within 60 days after December 31, 2006 are deemed vested and
outstanding for purposes of computing the percentage ownership of any
person. Except as indicated by footnotes and subject to community property
laws, where applicable, the persons named above have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them. Share data does not include any shares the
beneficial ownership of which has been disclaimed pursuant to SEC Rules.
Restricted stock held by the beneficial owner is included in the direct
holdings in the above table.
(2) Percentage of beneficial ownership is calculated on the basis of the amount
of outstanding securities plus those securities of the named person deemed
to be outstanding under Rule 13d-3 (promulgated under the Exchange Act) by
virtue of such securities being subject to rights to acquire beneficial
ownership within 60 days after December 31, 2006. An asterisk indicates
beneficial ownership of less than 1% of the common stock outstanding.
(3) Mr. Lowry served as Chief Financial Officer during 2006, stepping down from
that position on January 2, 2007.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with the acquisition of Loyalty Magic Pty. Ltd., which
closed on September 1, 2005 Chris Leach, as a stockholder of Loyalty Magic Pty.
Ltd., received 38,409 shares of our common stock and $152,217 AUD (approximately
$114,163 USD).
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a summary of the consolidated operating results of
Catuity 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 prospectus for a full discussion of the
risks and uncertainties associated with forward looking statements.
CATUITY'S BUSINESS
Catuity is a transaction processing company providing loyalty and
stored value card processing services designed to increase retailers' profits
earned from their customers. Catuity services customers in the U.S. and, via its
subsidiary Loyalty Magic, in Australia.
The Company provides hosted, Application Service Provider (ASP) based
systems that enable retailers to offer member-based loyalty programs. These
programs can deliver customized discounts, rebates, cash back and other rewards,
promotions, and points-based programs; all designed to help retailers find, keep
and profit from their best customers.
The Company also provides its retail customers with a full range of
stored value solutions. These solutions include proprietary gift card programs
that work inside retailer stores as well as those which are processed on
existing, open payments networks, specifically those operate by Visa USA,
MasterCard and Discover.
In the U.S., our proprietary technology platform is known as the
Catuity Advanced Loyalty System (CALS). CALS enables robust and highly
customizable programs that work on a retailer's payment terminals and Electronic
Cash Registers (ECR's) via their internal store networks. Throughout 2006, the
Company has continued to integrate its CALS product into widely used terminal
and point of sale platforms. The Company has completed integration to leading
32-bit terminal platforms sold by Verifone, Hypercom, Ingenico, and Lipman.
Additionally, the company is introducing its own virtual terminal to service the
growing demands of retailers who manage their point of sale through a standard
PC. Our strategy is to continue to make it easier for new customers to connect
to the Catuity platform. Management believes that this strategy will reduce the
perceived IT risks that its retailer clients may have and gives us a competitive
advantage over other providers.
29
In addition to providing services on our proprietary technology
platform, Catuity offers credit and debit card processing services through a
variety of third party payments processors.
Through the third quarter of 2006 the U.S. operations have focused on
establishing CALS in the loyalty market for tier two retailers. As of September
30, 2006 we signed agreements in the U.S. with 10 clients which have the
potential to deploy up to 1,800 locations in 2007. These clients are in various
stages of deployment and range from a franchise restaurant chain, to a coalition
marketing program, to a nationwide motorcycle dealer group. In addition to these
direct sales relationships, Catuity has contractual relationships with six
resellers, which includes the signing of a national independent sales
organization (ISO) which came online in October and has begun deploying Catuity
services to its customer base.
In the third quarter, and as we moved into the fourth quarter of 2006,
we have increasingly signed agreements with larger clients who have greater
revenue potential. The Company plans to continue to demonstrate the viability of
our product and the Company to prospects so as to continue on a path of
increased sales with sizeable customers.
Our clients and prospects are divided between those who want to
self-service their card programs and those who want managed services.
Consequently, our sales effort is divided between these two types of prospects.
As we have said publicly, our "sweet spot" clients are fast-growth chains,
generally franchise models, which have 75-250 stores either in operation or
under development. Development of our sales pipeline continues to demonstrate
that this is an underserved market that tends to prefer managed services.
2006 SIGNIFICANT ACTIVITIES
In 2006, we completed investment in primary infrastructure for doing
business in the U.S. This represented the end of the investment that began in
2005 when the company launched its current turnaround strategy. Today, this
investment is reflected in three primary areas: completion of the core
functionality of CALS; implementation of the necessary infrastructure to support
our clients in North America; and completion of the work to meet or exceed
industry standards for data security.
CALS has now been successfully deployed and is in use in the U.S.
market. Our current level of functionality is competitive with alternatives in
the market and customers and prospects recognize that our system meets all
current standards. Importantly, our system is easy for customers to use to
self-service their programs. This is an important competitive advantage and, we
believe, over time reduces Catuity's cost to service its clients. Through
feedback from our customers, we continue to make improvements to the system.
Looking ahead, we continue to review new POS systems to which we want to
integrate to broaden the markets that we serve. We are always looking to add
functionality that makes our technology stronger than that of our competitors.
In the third quarter of 2006, we completed the set-up of all elements
of our network management capability so that we are now able to support
retailers' store locations across the U.S. and Canada. To minimize our capital
outlays and to give us a competitive cost structure, we have relied on the
services of specialized partners to broaden our capabilities and demonstrate our
ability to service customers. For instance, we have contracted with HD Net, a
division of Hypercom Inc., to provide national telecommunications services for
our customers; LiveVault, a division of Iron Mountain Corp., to provide
continuous network back-up services; and BRI, a specialized hosting facility.
These vendor relationships are critical to our ability to provide scalable, cost
effective solutions by relying on some of the best known names in our market.
Today, we meet the strictest of security standards our customers
demand for operations, telecommunications, back up and disaster recovery. In
November 2006, Catuity completed the work necessary to gain compliance with
Payment Card Industry (PCI) standards. As of the date of this filing, the
Company has received confirmation of our compliance. We expect final
documentation of our compliant data security practices by month-end. Management
believes that we now have a solid foundation upon which to service our clients.
In our industry, legal requirements and certification standards will continue to
evolve and we are committed to maintaining the certifications that are vital to
customers in adopting our technology.
30
Daily management of our R&D process shifted in the third quarter from
our Sydney office to our Charlottesville, Virginia operational center. While the
cost of R&D has declined, our commitment to investing in integration to
established point of sale platforms is essential to our sales success.
Increasingly, integration work is managed by our U.S. team as they are actively
involved with crafting solutions for our clients and partners.
Catuity has been, and is, in the process of re-building its business
in the United States. The Company's net loss in the third quarter of 2006 was
$229,000 higher than in the same period last year. The increase in the loss
compared to 2005 is principally attributable to: $105,000 of non-cash expense
related to stock-based compensation due to the adoption of SFAS 123 (R); $64,000
of amortization expense related to the acquisition of Loyalty Magic; and
$122,000 in additional sales expenses to increase our U.S. sales efforts; all of
which was partially offset by a decrease of $206,000 for the expense of research
and development as the initial development of Catuity's Advanced Loyalty System
(CALS) has been completed.
In Australia, a significant majority of businesses have a June 30
fiscal year end. As a result, Loyalty Magic's third quarter is usually slow
because most retailers are recovering from fiscal year end discounting.
Additionally, there are few significant marketing events for retailers in July -
September.
As announced on August 30, 2006, Loyalty Magic is ready to service the
163,000 merchants on the Australian Commonwealth Bank's XPOS platform. The bank
provides credit and debit card processing services and a growing list of
value-added services through the EFTPOS facility that create revenue-generating
opportunities for merchants. Loyalty Magic's diverse range of loyalty programs
is now available on this platform.
THE ROLE OF M&A
The Company believes that the ability to offer a bundled solution of
products and services to retailers will enhance its ability to close new sales
and retain existing customers. Interest continues in acquiring additional
companies to diversify our product offering to retailers and achieve an
operational critical mass. Catuity is most interested in acquiring companies
that 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 network gift card programs; and credit and debit card processing.
The Company continues to identify companies in these heavily fragmented markets
that meet its acquisition criteria and exhibit growth characteristics. Many
factors impact the timing, structure, pricing and potential to close such
acquisitions. As the Company has previously disclosed, acquisitions carry
diverse risks that could affect the timely execution of its strategy.
CAPITAL RAISE
On November 22, 2006, Catuity completed a $2,250,000 raise of new
capital in the form of notes convertible into shares of common stock, warrants
and the issuance of preferred stock convertible into common stock. The capital
is being used to fund company operations, including the expansion of our sales
and marketing function in the U.S. We believe that the capital we have raised
will enable us to support our sales strategy into 2007. The company plans to
raise additional capital in 2007.
FISCAL YEAR ENDED 2005 COMPARED TO 2004(ALL FIGURES IN USD AND ROUNDED
TO NEAREST $1,000)
On September 1, 2005, Catuity completed its acquisition of Loyalty
Magic. As a result, Catuity's financial statements reflect twelve months of
Catuity's operations and four months of Loyalty Magic's operations.
In 2005, total revenues were $981,000. These revenues were derived
from $840,000 in processing and service revenue (an increase of $372,000 from
2004) and $141,000 in licensing revenue (an increase of $98,000 from 2004). The
significant change in the revenue categories was due to Catuity's transition to
a loyalty processor and the impact on revenue due to the acquisition of Loyalty
Magic. There was no project related revenue in 2005 compared to $248,000 in
2004, which represented revenue for a project for a large, retail client that
was ended in 2004.
31
Cost of processing and service revenue primarily consists of salaries,
employee benefits, related expenses and office overhead for the customer
implementation and support staff for the portion of their time spent on
processing and service related activities for customers. Cost of processing and
service revenue increased $469,000, or 158%, to $766,000 for the year ended
December 31, 2005 from $297,000 for the year ended December 31, 2004. The
increase in cost of processing and service reflects the addition of Loyalty
Magic expenses along with the additional staffing and related expenses in our
U.S. Client Management department.
Cost of licensing revenue primarily consists of salaries, employee
benefits, related expenses and overhead for our client support staff along with
the technical staff's time spent on maintenance activities related to licensed
software. Cost of license revenue increased to $21,000 for the year ended
December 31, 2005 from zero for the year ended December 31, 2004.
Cost of project related revenue was zero in 2005 compared to $103,000
in 2004; these expenses represented salaries, employee benefits, related
expenses and overhead for our staff that was responsible for a project for a
large, retail client that was ended in 2004.
Research and Development expenses consist primarily of salaries,
employee benefits and overhead costs, incurred primarily by our technical staff
for the portion of their time spent furthering the development of our various
products. Research and development expenses decreased $555,000, or 43%, to
$728,000 for the year ended December 31, 2005 from $1,283,000 for the year ended
December 31, 2004. Cost was higher in 2004 because of the substantially higher
investment made in 2004 on the development of our CALS software. At the end of
2004, the Company reduced its Research and Development staff and overhead.
Overhead costs were reduced by $220,000 and Salary and Related Costs were
reduced by $554,000. In 2005, as required by U.S. GAAP, the Company expensed
certain software development costs that had been previously capitalized by
Loyalty Magic. The $206,000 in development costs, described in this document as
In Process Research & Development was charged to Research and Development in
2005.
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 $275,000,
or 32%, to $592,000 for the year ended December 31, 2005 from $867,000 for the
year ended December 31, 2004. The decrease was primarily related to reductions
in allocations from G&A and Services ($170,000), lower Salary and Related Costs
($27,000), lower professional services costs ($19,000), and a decrease in travel
related expenses ($7,000).
General and administrative expenses consist primarily of salaries,
employee benefits, related overhead costs and professional service fees. General
and administrative expenses decreased $228,000, or 12%, to $1,685,000 for the
year ended December 31, 2005 from $1,913,000 for the year ended December 31,
2004. General and administrative expenses in 2004 included an accrual of
$225,000 related to severance pay for the Company's former CEO that did not
occur in 2005. The general and administrative expenses for Catuity declined in
2005 but this decline was offset by the addition of four months of general and
administrative expenses from Loyalty Magic.
General and administrative-stock based compensation expense occurred
as a result of issuing options to certain employees whose grant price was less
than the closing price of Catuity common stock on the date of the grant and due
to the Restricted Stock plans started in 2005. In 2004, no expense was recorded
as there were no options issued at a price less than the fair market value on
the date of grant.
Amortization of intangibles represents the amortization expenses
associated with the intangibles acquired in the Loyalty Magic transaction.
$1,933,300 of the Loyalty Magic purchase price was established as 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.) The amount expensed for the four
months of amortization in each category is detailed below in Note 6.
Other income increased in 2005 to $109,000 compared to $97,000 in 2004
due to interest received on investments in the United States and Australia.
32
OPERATING RESULTS FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2006 AND
2005
Catuity completed the acquisition of Loyalty Magic on September 1,
2005. As a result, the financial information for the nine and three month
periods ended September 30, 2006 includes the operating results of Loyalty Magic
while the financial information for the nine and three month periods ended
September 30, 2005 includes only the month of September for Loyalty Magic.
REVENUE
Total revenues for the three month period ended September 30 ("third
quarter") increased to $435,000 in 2006 compared to $174,000 in 2005. Total
revenues for nine months increased to $1,395,000 in 2006 from $220,000 in 2005.
Although U.S. revenue has increased year-over-year, the $261,000 3rd quarter and
$1,175,000 nine month increases are principally attributable to the operations
of Loyalty Magic. Processing revenues are generally recurring in nature and
result from the hosting of loyalty and gift card programs on our servers and
related on-going support for the customer's programs. Most of our revenue was
from processing and hosting programs (79% in the 3rd quarter and 75% through
nine months). Service revenue is generally non-recurring and results from one
time projects for customers. Service revenue represented 16% of our revenue in
the third quarter of 2006 and 21% through the first nine months of 2006. License
revenue consists of software license and maintenance fees for customers who
operate our software on their own equipment. In the third quarter 2006, 5% of
our revenue came from licensing arrangements with our customers (4% through the
first nine months of 2006).
Third quarter 2005 revenues consisted of approximately $140,000 in
processing revenue; $10,000 in service revenue; and approximately $24,000 in
license revenue. For the nine months ended September 30, 2005 there was $140,000
processing revenue; $31,000 service revenue; and $49,000 licensing revenue.
COST OF PROCESSING REVENUE
Cost of processing revenue primarily consists of co-location facility
costs, other processing costs, third party costs, salary and related expenses,
office costs, and overhead for the staff that work on supporting customer
programs. Of the $422,000 of cost of processing revenue in the third quarter of
2006, $195,000 was due to U.S. based cost and $227,000 related to Loyalty Magic.
Cost of processing revenue in the third quarter of 2005 was $63,000 for Loyalty
Magic with $85,000 related to building U.S. processing and customer support
capabilities. Cost of processing revenue at the end of nine months was
$1,237,000 in 2006 and $215,000 in 2005.
COST OF SERVICE REVENUE
Cost of service revenue primarily consists of employee salary and
related costs, third party costs and overhead cost associated with the staff
that works on special projects and software customization for customers. Cost of
service revenue for the third quarter increased from $58,000 in 2005 to $74,000
in 2006. The $74,000 cost in the third quarter of 2006 related to project work
performed for customers of Loyalty Magic. For the nine months ended September
30, 2006 cost of service revenue was $219,000 and $76,000 in 2005.
COST OF LICENSE REVENUE
Cost of license revenue consists of the salary related expenses,
overhead for client support and technical staff time spent on maintenance
activities related to software that has been licensed to customers. In the first
nine months of 2006 there were no costs associated with licensing.
COST OF REVENUE - AMORTIZATION OF INTANGIBLES
The cost of amortization of intangible assets represents the monthly
amortization expense from the purchase price of Loyalty Magic allocated to
software that relates to processing. These intangible assets are amortized on a
cash flow basis over the estimated useful life in years.
33
COST OF REVENUE - STOCK-BASED COMPENSATION
Cost of Revenue - stock-based compensation expense represents the
costs related to equity based compensation awards under the Company's employee
restricted stock and stock option plans for those employees whose compensation
cost is charged to cost of revenue.
RESEARCH AND DEVELOPMENT
Research and Development expenses consist primarily of salaries,
employee benefits and overhead cost for work on upgrades and future releases of
the Company's software. Research and Development expenses were $111,000 in the
third quarter of 2006 compared to $317,000 in the third quarter of 2005 and
through nine months of 2006 the expense was $370,000 versus $570,000 in 2005.
The decrease of $206,000 in the third quarter and $189,000 for nine months is
attributable to a write-off of in-process R&D expense in conjunction with the
Loyalty Magic acquisition.
RESEARCH AND DEVELOPMENT - STOCK-BASED COMPENSATION
Research and Development - stock-based compensation expense represents
the costs related to equity based compensation awards under the Company's
employee restricted stock and stock option plans for those employees whose
compensation cost is charged to research and development.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, employee
benefits, travel, marketing, and related overhead costs of the Company's sales
and marketing departments. Sales and marketing expenses increased $122,000, or
110%, in the third quarter of 2006 compared to the third quarter of 2005. In the
third quarter approximately $40,000 of the increase was from the addition of
Loyalty Magic, while approximately $82,000 of the increase was principally due
to salary, employee benefits, and office costs associated with the growth of
Catuity's U.S. sales staff in 2006 compared to 2005. In the nine months ended
September 30, 2006 sales and marketing expense was $757,000 compared to $398,000
in the first nine months of 2005.
SALES AND MARKETING - AMORTIZATION OF INTANGIBLES
The cost of amortization of intangible assets represents the monthly
amortization expense from the purchase price of Loyalty Magic allocated to
customer contracts and customer relationships. The intangible assets of customer
contracts and customer relationships are amortized on a cash flow basis over
their estimated useful life in years.
SALES AND MARKETING - STOCK-BASED COMPENSATION
Sales and Marketing - stock-based compensation expense represents the
costs related to equity based compensation awards under the Company's employee
restricted stock and stock option for those employees whose compensation cost is
charged to sales and marketing.
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 increased
$72,000, or 16%, in the third quarter of 2006 compared to the third quarter of
2005 due principally to the addition of Loyalty Magic. In the nine months ended
September 30, 2006 general and administrative expense was $1,583,000 compared to
$1,178,000 in the first nine months of 2005.
34
GENERAL AND ADMINISTRATIVE - STOCK-BASED COMPENSATION
General and administrative stock-based compensation expense represents
the costs related to equity based compensation awards under the Company's
employee and director restricted stock and stock option plans for those
employees and directors whose compensation cost is charged to general and
administrative expense.
GENERAL AND ADMINISTRATIVE - AMORTIZATION OF INTANGIBLES
The cost of amortization of intangible assets represents the monthly
amortization expense from the purchase price of Loyalty Magic allocated to
trademark and non-compete agreements. The intangible for trademarks is amortized
on a straight line basis over a 30 year life, while the value of non-compete
agreements is amortized over a 5 year life on a straight line basis.
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, 2006, the Company had approximately $640,000 in cash and cash equivalents, a
decrease of $319,000 from the cash balance on December 31, 2005. The decrease is
due to cash utilization of approximately $2,565,000 during the first nine months
of the year, partially offset by a short term investment of approximately
$2,246,000 held at December 31, 2005 which matured during this nine month
period.
Net cash used in operating activities was $2,449,000 for the nine
month period ended September 30, 2006 compared with $1,849,000 for the nine
month period ended September 30, 2005. The $600,000 increase is attributable to
an increase of $1,265,000 in the 2006 net loss over 2005. Much of the loss
experienced in the first three quarters of 2006, versus the first three quarters
of 2005, is attributed to increases in non-cash expenses for depreciation and
amortization of $286,000, and an increase in stock-based compensation of
$471,000.
Cash from investing activities was $2,114,000 for the nine month
period ended September 30, 2006 compared with a usage of $6,148,000 for the nine
month period ended September 30, 2005. The cash from investing activities in
2006 was from the maturity of a short term investment of $2,246,000 during the
period, offset by purchases of property and equipment of $132,000. Of the
$6,148,000 of cash used in 2005, $5,971,000 was for the purchase price and
associated legal, accounting, and other professional services incurred in the
acquisition of Loyalty Magic, and $177,000 for the purchase of property and
equipment.
Net cash used in financing activities in the nine months of 2006 is
due to repayment of fractional shares in conjunction with the Company's reverse
stock split in November 2004 and approximately $7,358,000 in 2005 in conjunction
with the Loyalty Magic acquisition.
The Company has $639,707 in cash as of September 30, 2006.
On November 22, 2006, Catuity completed a $2,250,000 raise of new
capital in the form of notes convertible into shares of common stock, warrants
and the issuance of preferred stock convertible into common stock. The capital
is being used to fund company operations, including the expansion of our sales
and marketing function in the U.S.
The Company believes that, in addition to funds currently on hand and
together with existing revenue opportunities and capital resources, funds from
additional financing activities (such as an acquisition or another capital
raise) will be needed in order to finance anticipated liquidity needs through
2007.
35
CONTRACTUAL OBLIGATIONS
The following table presents our contractual obligation and
commitments as of January 1, 2006 over the next 5 years.
Contractual Obligations: Total 2006 2007 2008 2009 2010
- ------------------------ -------- -------- -------- -------- ---- ----
Operating Leases $221,710 $143,268 $ 93,040 $ 2,274 -- --
Capital Leases 33,188 23,566 9,622 -- -- --
-------- -------- -------- -------- --- ---
Total $254,898 $166,835 $102,662 $ 2,274 -- --
======== ======== ======== ======== === ===
There have been no material changes in our obligations in 2006.
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 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.
REVENUE RECOGNITION
The three distinct revenue streams that result from the Company's
business activities are processing & service revenue, license revenue and
project related revenue.
Processing and Service Revenue: Processing and service revenue
includes training, consulting, installation support, post-installation support,
maintenance fees and application processing/hosting. 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.
Application processing/hosting is generally recognized as revenue in the month
that the services are performed. Payments for service revenues are generally not
refundable.
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
established VSOE for maintenance services. The Company does not generally
provide for a right of return in its license contracts.
Project Related Revenue: Project related revenue includes integration,
customization and miscellaneous project related fees for work performed for a
customer to deploy or modify the Company's loyalty and gift card applications.
Project related revenue is billed on a fixed price basis. The Company recognizes
revenue on fixed price contracts using the proportional performance method in
accordance with SAB 101, Revenue Recognition in Financial Statements, and SAB
104, Revenue Recognition, based on hours incurred as a proportion of estimated
total hours of the respective contract. The cumulative impact of any revisions
in estimated total revenues and direct
36
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. The
Company generally does not provide for a right of return in its project related
contracts.
Deferred Revenue: Revenue is deferred for any undelivered elements and
is recognized upon product delivery or when the service has been performed.
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 due to the full valuation allowance.
ACCOUNTING FOR EQUITY INSTRUMENTS
The Company accounted 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
adopted the disclosure-only alternative of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
We adopted SFAS 123(R) as of January 1, 2006, as required. SFAS 123(R) requires
the measurement of all employee share-based awards using a fair-value-based
method. The level of impact on the Company's financial statements will depend,
in part, on future grant awards.. See note 4 for a description of the expense
recorded for the three and nine month periods of 2006 under SFAS 123(R).
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004 and 2005), "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 adopted SFAS 123(R) effective
January 1, 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 future financial results. The level of impact on
the Company's financial statements will depend, in part, on future grant awards.
In July 2006, the FASB issued FASB Interpretation ("FIN") No. 48 Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement 109. FIN
48 prescribes a comprehensive model for recognizing, measuring, presenting and
disclosing in the financial statements tax positions taken or expected to be
taken on a tax return, including a decision whether to file or not to file in a
particular jurisdiction. FIN 48 is effective for fiscal years beginning after
December 15, 2006. If there are changes in net assets as a result of application
of FIN 48 these will be accounted for as an adjustment to retained earnings. The
Company is currently assessing the impact of FIN 48 on its consolidated
financial position and results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS No. 157"), which establishes a framework for measuring fair value and
requires expanded disclosure about the information used to measure fair value.
The statement applies whenever other statements require, or permit, assets or
liabilities to be measured at fair value. The statement does not expand the use
of fair value in any new circumstances and is effective for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years, with early adoption encouraged. The Company is currently assessing any
potential impact of adopting this pronouncement.
In September 2006, the SEC Staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in the Current Year Financial Statements" ("SAB No. 108"). SAB No.
108 requires the use of two alternative approaches in quantitatively evaluating
materiality of
37
misstatements. If the misstatement as quantified under either approach is
material to the current year financial statements, the misstatement must be
corrected. If the effect of correcting the prior year misstatements, if any, in
the current year income statement is material, the prior year financial
statements should be corrected. SAB No. 108 is effective for fiscal years ending
after November 15, 2006. The Company has determined that there is no impact from
applying this interpretation.
MARKET PRICE OF AND DIVIDENDS ON COMMON STOCK
Catuity ("CTTY") was listed on the NASDAQ Small Cap Market beginning
December 1, 2000. Chip Application Technologies (then named Card Technologies
Australia) 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 Chip Application Technologies, we replaced Chip
Application Technologies as the listed entity on the ASX under the same trading
symbol. We continue to be traded on the ASX. Also, 256,520 shares of common
stock were issued on September 1, 2005 to existing Australian shareholders and
accredited Australian institutional buyers pursuant to an exemption from
registration under Regulation S of the Securities Act of 1933, as amended. These
shares are traded under the symbol CATN since they cannot be owned by US persons
in compliance with regulations.
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.
SYMBOL - CAT SYMBOL - CATN SYMBOL - CTTY
------------------------------- ------------------------------- -------------------------------------
HIGH LOW HIGH LOW HIGH LOW
PERIOD (AUSTRALIAN $) (AUSTRALIAN $) (AUSTRALIAN $) (AUSTRALIAN $) (UNITED STATES $) (UNITED STATES $)
- -------------- -------------- -------------- -------------- -------------- ----------------- -----------------
2005
First Quarter $ 7.00 $ 3.90 N/A N/A $ 8.30 $3.47
Second Quarter $18.50 $ 4.50 N/A N/A $22.58 $3.75
Third Quarter $23.00 $10.50 $13.50 $10.50 $20.39 $8.53
Fourth Quarter $14.20 $ 9.25 $11.00 $ 7.50 $12.10 $5.97
2006
First Quarter $11.00 $ 8.00 10.00 5.75 $ 9.17 $5.68
Second Quarter $10.00 $ 5.00 8.00 3.00 $ 8.03 $4.49
Third Quarter $ 7.00 $ 3.50 5.00 3.00 $ 4.97 $3.06
Fourth Quarter $ 7.50 $ 4.00 5.20 3.00 $ 6.19 $3.14
As of December 31, 2006 there were approximately 2,000 shareholders of
record of our common stock as reported to us by Computershare Investor Services,
our transfer agent.
DIVIDEND POLICY
The Company has never paid any cash dividends on its common stock, and
currently does not intend to pay any cash dividends on common stock. The Company
has paid dividends on its shares of convertible preferred stock starting
December 1, 2006.
38
Any decision to declare and pay dividends in the future will be made
at the discretion of the Board of Directors and will depend on, among other
things, the results of operations, capital requirements, financial condition,
contractual restrictions and other factors that the Board of Directors may deem
relevant. In addition, the terms of the 10% convertible preferred stock
restricts the Company's ability to pay dividends on its common stock. The
holders of the 10% convertible preferred stock are entitled to receive
cumulative preferential cash dividends at the rate equal to 10% of the purchase
price of the preferred stock payable monthly in arrears, on the first day of
each month. The Company may not pay any dividends on its common stock before all
dividends are paid on the 10% convertible preferred stock.
EQUITY COMPENSATION PLAN INFORMATION
The following table reflects information about the securities
authorized for issue under our equity compensation plans as of December 31,
2006.
NUMBER OF SECURITIES REMAINING
NUMBER OF SECURITIES AVAILABLE FOR FUTURE ISSUANCE UNDER
TO BE ISSUED UPON WEIGHTED-AVERAGE EQUITY COMPENSATION PLANS
EXERCISE OF EXERCISE PRICE OF (EXCLUDING SECURITIES REFLECTED IN
OUTSTANDING OPTIONS OUTSTANDING OPTIONS COLUMN (A)
PLAN CATEGORY: (A) (B) (C)
- -------------- -------------------- ------------------- -----------------------------------
Equity compensation plans approved by
security holders 259,348 $20.10 40,652
Equity compensation plans not approved
by security holders -0- -0- -0-
DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
The securities being offered by the selling stockholders are shares of
our common stock. As of December 31, 2006 there were issued and outstanding,
2,242,343 shares of common stock.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. The holders of common stock are
entitled to receive any dividends that may be declared from time to time by the
board of directors out of funds legally available for that purpose. In the event
of our liquidation, dissolution or winding up, the holders of common stock are
entitled to share in all assets remaining after payment of liabilities. The
common stock has no preemptive or conversion rights or other subscription
rights. All outstanding shares of common stock are fully paid and
non-assessable. Please review our certificate of incorporation, as amended, and
bylaws, copies of which have been filed with the SEC, as well as the applicable
statutes of the State of Delaware for a more complete description of the rights
and liabilities of holders of our shares.
The holders of common stock do not have a cumulative voting right,
which means that the holders of more than fifty percent of the shares of common
stock voting for election of directors may elect all the directors if they
choose to do so. In this event, the holders of the remaining shares aggregating
less than fifty percent will not be able to elect directors. Except as otherwise
required by Delaware law, and subject to the rights of the holders of preferred
stock then outstanding, all stockholder action is taken by the vote of a
majority of the issued and outstanding shares of common stock present at a
meeting of stockholders at which a quorum consisting of a majority of the issued
and outstanding shares of common stock is present in person or proxy.
SENIOR CONVERTIBLE NOTE
The Senior Notes are in the aggregate face amount of US$1.8 million.
The Senior Notes carry interest at the rate of 10% per annum compounded monthly.
The Company issued and sold the Senior Notes and warrants at a discount
39
off of face amount, for an aggregate sales price of US$1.62 million. The Senior
Notes are secured by a senior security interest in all of our and our
subsidiaries' assets.
Upon a change of control of Catuity involving the acquisition of
voting control or direction over 50% or more of our outstanding common stock,
the Investors have the right to cause Catuity to repurchase the Senior Notes in
cash for the greater of (A) 130% of the equity value or (B) 150% of the issue
price plus accrued but unpaid interest. In the event of a change of control at a
per share price which is equal to or greater than 200% of the Conversion Price,
then 130% in (A) above will be reduced to 120%.
The Company has the right to redeem in cash any or all of the
outstanding Senior Notes at any time prior to maturity, upon three (3) business
days prior written notice, at the greater of (x) one hundred twenty percent
(120%) of the principal amount to be redeemed or (y) the product of (i) the
remaining principal balance of the Convertible Note divided by the Conversion
Price in effect on the day before such redemption notice is sent and (ii) the
closing sale price of the Common Stock on the day before such redemption notice
is sent, plus in each case, the amount of any accrued but unpaid interest,
subject to the maximum amount of interest allowed to be charged by law, payable
in cash. In the event of any redemption of the Senior Notes, the Investors shall
retain the Warrants and the "Registration Rights" that attached thereto.
PREFERRED STOCK
The Company's Board of Directors is authorized to issue up to 666,667
shares of preferred stock, par value $.001 per share, in one or more series and
to fix, by resolution, conditional, full, limited or no voting powers, and the
designations, preferences, the number of shares, dividend rates, conversion or
exchange rights, redemption provisions or other special rights of the shares
constituting any class or series as the Board of Directors may deem advisable
without any further vote or action by the stockholders. Any shares of preferred
stock issued by Catuity could have priority over Catuity common stock with
respect to dividends or liquidation rights and could have voting and other
rights of stockholders.
SERIES A CONVERTIBLE PREFERRED STOCK
The Company's Board of Directors has designated 700 shares of
preferred stock as "Series A Convertible Preferred Stock" with a stated value of
$1,000 per share. There are presently 700 shares of Series A Convertible
Preferred Stock outstanding. The holders of Series A Convertible Preferred Stock
will have no voting rights other than as may be required by law.
When and if declared by the Board of Directors, dividends-A holder of
the Series A Convertible Preferred Stock is entitled to receive monthly
cumulative cash dividends in arrears, commencing on December 1, 2006. The
dividend rate is 10% of the stated value.
A liquidation preference is granted to the holders of the Series A
Convertible Preferred Stock and they shall be entitled to receive cash out of
the assets of the Company equal to the stated amount before any amount shall be
paid to the holders of any of the capital shares of the Company of any class
junior in rank to the shares of Series A Preferred Stock.
Voluntary Conversion-Holders of the Series A Convertible Preferred
Stock are entitled, at any time, subject to prior redemption, to convert each
share of Series A Convertible Preferred Stock into shares of common stock at the
conversion price equal to $3.25 per share.
WARRANTS
We currently have outstanding warrants to acquire up to 357,143 shares
of common stock.
Each Warrant is exercisable at any time prior to five years after the
date of issuance of the warrant, at an initial exercise price equal to $3.58 per
share of common stock. The warrants contain a cashless exercise feature and
full-ratchet and other standard anti-dilution protection. We have the right to
redeem the warrants at $.01 per share on
40
ten (10) days prior written notice provided (i) the shares of common stock
underlying the warrants are free trading, (ii) the average daily dollar trading
volume of our common stock is at least $400,000.00, and no single trading day is
less than $200,000.00, based upon a closing bid price of at least $7.87 for each
of the twenty (20) trading days immediately preceding the notice of redemption
as reported by Bloomberg and (iii) such redemption shall be limited to 100,000
warrants every thirty (30) calendar days.
Upon a change of control of Catuity that is within Catuity's control,
the warrant holders have the right to cause us to pay the Black-Scholes value of
the warrants subject to a volatility cap of 60. To the extent not redeemed upon
a change of control, each warrant holder has the right to cause the ultimate
parent company of the acquiring or surviving company in the change of control to
issue new warrants in replacements of the warrants with terms (including,
without limitation, exercise rights and anti-dilution rights) equivalent to
those contained in the warrants.
PRO FORMA CAPITALIZATION TABLE
Set forth below is the historical capitalization of the Company as of
September 30, 2006 and pro forma capitalization reflecting the November 2006
capital raise. The pro forma amounts are based on estimates of the fair value of
the securities sold. The Company is evaluating these estimates and will finalize
them when it prepares the December 2006 financial statements.
Historical Pro Forma
------------ -------------
LONG TERM DEBT:
Senior debt (10% convert. notes) $ 0 $ 0 1
------------ ------------
Total long term debt 0 0
------------ ------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, authorized
6,666,667 shares; issued and outstanding 2,237,000 shares 2,253 2,253
Preferred Stock 0 630,000 2
Warrants 0 606,269 3
Additional paid-in capital 46,211,592 47,614,293
Accumulated deficit (40,709,742) (41,098,511)4
Foreign currency translation adjustment (49,310) (49,310)
------------ ------------
Total stockholders' equity 5,454,793 7,704,793
------------ ------------
TOTAL CAPITALIZATION $ 5,454,793 $ 7,704,793
============ ============
</Table>
1 -- Senior debt "Pro Forma" is reflected at the net proceeds received of $1.62
million net of a $1.62 million debt discount related to the allocation of a
portion of the proceeds to the fair value of the warrants and a beneficial
conversion feature contained in the Senior debt. This debt discount will be
amortized to interest expense over the three year term of the debt using the
effective interest method.
2 -- Represents the estimated net proceeds received for the preferred stock.
3 -- Represents the relative fair value of the 357,143 warrants that were
issued.
4 -- Reflects the estimated charge to earnings available to the common
stockholder to be recorded in the fourth quarter of 2006 related to the
beneficial conversion feature on the preferred stock. This charge will increase
the loss applicable to common stock. The Company estimates this charge will
increase the basic and diluted loss per common share by $0.17.
SELLING STOCKHOLDERS
The Selling Stockholders listed in the table below may use this
prospectus for the resale of shares of Common Stock being registered hereunder,
although no Selling Stockholder is obligated to sell any such shares. None of
the shares of Common Stock offered by this prospectus are outstanding as of the
date hereof, and all such shares of Common Stock are issuable upon the
conversion of certain outstanding convertible securities. The Selling
Stockholders who hold such convertible notes and convertible preferred shares
are not required to convert, as applicable, such securities. The table below
sets forth information as of December 31, 2006 to reflect the sale of shares
being offered by the Selling Stockholders. No Selling Stockholder has, or within
the past three years has had, any position, office or other material
relationship with us or any of our predecessors or affiliates.
We are not able to estimate the number of shares that will be held by
the Selling Stockholders after the completion of this offering because the
Selling Stockholders may offer all or some of the shares and because there are
currently no agreements, arrangements or understandings with respect to the sale
of any shares offered hereby, except as otherwise noted below. The following
table assumes that all of the shares being registered hereby will be sold.
41
SHARES OF COMMON
SHARES OF COMMON STOCK STOCK BENEFICIALLY
BENEFICIALLY OWNED OWNED AFTER THE
PRIOR TO OFFERING NUMBER OF SHARES OF OFFERING
---------------------- COMMON STOCK TO BE ------------------
SELLING STOCKHOLDERS NUMBER PERCENT SOLD IN THE OFFERING NUMBER PERCENT
- -------------------- ---------- --------- -------------------- ------- --------
Gottbetter Capital Master, Ltd. 474,835 15.77 474,835 0 0
BridgePointe Master Fund Ltd. 294,396 9.78 294,396 0 0
TOTAL 769,230 25.54 769,230 0 0
(0.77 shares account for rounding error)
The name of the person who has voting or investment control over the
securities owned by Gottbetter Capital Master, Ltd., is Adam Gottbetter.
Gottbetter Capital Master, Ltd. is managed by Gottbetter Capital Management, LP.
Mr. Adam Gottbetter also has voting and investment control over that entity and
ultimately Gottbetter Capital Master, Ltd.
The name of the person who has voting or investment control over the
securities owned by BridgePointe Master Fund Ltd. is Michael Kendrick and Eric
Swartz..
Our written agreements with the Selling Stockholders provide that they
and their respective affiliates cannot convert its note or its convertible
preferred shares, or exercise any warrants, if such action would cause a Selling
Stockholder and its affiliates to own in excess of 4.99% of our outstanding
common stock.
PLAN OF DISTRIBUTION
Each Selling Stockholder of our Common Stock and any of their
pledgees, assignees and successors-in-interest may, from time to time, sell any
or all of their shares of Common Stock on our principal markets or any other
stock exchange, market or trading facility on which the shares are traded or in
private transactions. These sales may be at fixed or negotiated prices. A
Selling Stockholder may use any one or more of the following methods when
selling shares:
- ordinary brokerage transactions and transactions in which the
broker-dealer solicits buyers;
- block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
- purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
- an exchange distribution in accordance with the rules of the
applicable exchange;
- privately negotiated transactions;
- settlement of short sales entered into after the date of this
prospectus;
- broker-dealers may agree with the Selling Stockholders to sell a
specified number of such shares at a stipulated price per share;
- a combination of any such methods of sale;
- through the writing or settlement of options or other hedging
transactions, whether through an options exchange or otherwise; or
- any other method permitted pursuant to applicable law.
The Selling Stockholders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this prospectus.
42
Broker-dealers engaged by the Selling Stockholders may arrange for other
brokers-dealers to participate in sales. Broker-dealers may receive commissions
or discounts from the Selling Stockholders (or, if any broker-dealer acts as
agent for the Buyer of shares, from the Buyer) in amounts to be negotiated. Each
Selling Stockholder does not expect these commissions and discounts relating to
its sales of shares to exceed what is customary in the types of transactions
involved.
In connection with the sale of our common stock or interests therein, the
Selling Stockholders may enter into hedging transactions with broker-dealers or
other financial institutions, which may in turn engage in short sales of the
common stock in the course of hedging the positions they assume. The Selling
Stockholders may also sell shares of our common stock short and deliver these
securities to close out their short positions, or loan or pledge the common
stock to broker-dealers that in turn may sell these securities. The Selling
Stockholders may also enter into option or other transactions with
broker-dealers or other financial institutions or the creation of one or more
derivative securities which require the delivery to such broker-dealer or other
financial institution of shares offered by this prospectus, which shares such
broker-dealer or other financial institution may resell pursuant to this
prospectus (as supplemented or amended to reflect such transaction).
The Selling Stockholders and any broker-dealers or agents that are involved
in selling the shares may be deemed to be "underwriters" within the meaning of
the Securities Act in connection with such sales and may have civil liability
under Sections 11 and 12 of the Securities Act for any omissions or
misstatements in this prospectus and the registration statement of which it is a
part. In such event, any commissions received by such broker-dealers or agents
and any profit on the resale of the shares purchased by them may be deemed to be
underwriting commissions or discounts under the Securities Act. Each Selling
Stockholder has informed us that it does not have any agreement or
understanding, directly or indirectly, with any person to distribute the Common
Stock.
We are required to pay certain fees and expenses we incur incident to the
registration of the shares. We have agreed to indemnify the Selling Stockholders
against certain losses, claims, damages and liabilities, including liabilities
under the Securities Act.
Because Selling Stockholders may be deemed to be "underwriters" within the
meaning of the Securities Act, they will be subject to the prospectus delivery
requirements of the Securities Act. In addition, any securities covered by this
prospectus which qualify for sale pursuant to Rule 144 under the Securities Act
may be sold under Rule 144 rather than under this prospectus. Each Selling
Stockholder has advised us that they have not entered into any agreements,
understandings or arrangements with any underwriter or broker-dealer regarding
the sale of the resale shares. There is no underwriter or coordinating broker
acting in connection with the proposed sale of the resale shares by the Selling
Stockholders.
We agreed to keep this prospectus effective until the earlier of (i) the
date on which the shares may be resold by the Selling Stockholders without
registration and without regard to any volume limitations by reason of Rule
144(e) under the Securities Act or any other rule of similar effect or (ii) all
of the shares have been sold pursuant to the prospectus or Rule 144 under the
Securities Act or any other rule of similar effect. The resale shares will be
sold only through registered or licensed brokers or dealers if required under
applicable state securities laws. In addition, in certain states, the resale
shares may not be sold unless they have been registered or qualified for sale in
the applicable state or an exemption from the registration or qualification
requirement is available and is complied with.
Under applicable rules and regulations under the 1934 Act, any person
engaged in the distribution of the resale shares may not simultaneously engage
in market making activities with respect to our common stock for a period of two
business days prior to the commencement of the distribution. In addition, the
Selling Stockholders will be subject to applicable provisions of the 1934 Act
and the rules and regulations thereunder, including Regulation M, which may
limit the timing of purchases and sales of shares of our common stock by the
Selling Stockholders or any other person. We will make copies of this prospectus
available to the Selling Stockholders and have informed them of the need to
deliver a copy of this prospectus to each Buyer at or prior to the time of the
sale.
43
EXPERTS
The Company's full-year financial statements included in this prospectus
have been audited by BDO Seidman, LLP, an independent registered public
accounting firm, and full-year pre-acquisition Loyalty Magic financial
statements have been audited by the independent firm of McInnes, Graham & Gibbs,
to the extent and for the periods set forth in their respective reports
appearing elsewhere herein and are included in reliance upon such report given
upon the authority of those firms as experts in auditing and accounting.
LEGAL MATTERS
The validity of the issuance of the common shares to be sold by the selling
stockholders under this prospectus and warrants was passed upon for our company
by Jaffe, Raitt, Heuer & Weiss, Professional Corporation.
DISCLOSURE OF COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
We have adopted provisions in our certificate of incorporation that
limit the liability of our directors for monetary damages for breach of their
fiduciary duty as directors, except for liability that cannot be eliminated
under the Delaware General Corporation Law. Delaware law provides that directors
of a company will not be personally liable for monetary damages for breach of
their fiduciary duty as directors, except for liabilities:
- - for any breach of their duty of loyalty to us or our stockholders;
- - for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- - for unlawful payment of dividend or unlawful stock repurchase or
redemption, as provided under Section 174 of the Delaware General
Corporation Law; or
- - for any transaction from which the director derived an improper personal
benefit.
In addition, our bylaws provide for the indemnification of officers,
directors and third parties acting on our behalf, to the fullest extent
permitted by Delaware General Corporation Law, if our board of directors
authorizes the proceeding for which such person is seeking indemnification
(other than proceedings that are brought to enforce the indemnification
provisions pursuant to the bylaws). We maintain directors' and officers'
liability insurance.
These indemnification provisions may be sufficiently broad to permit
indemnification of the registrant's executive officers and directors for
liabilities (including reimbursement of expenses incurred) arising under the
Securities Act of 1933.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to our directors, officers and
controlling persons pursuant to the foregoing provisions, or otherwise, we have
been advised that in the opinion of the SEC such indemnification is against
public policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable. No pending material litigation or proceeding involving our
directors, executive officers, employees or other agents as to which
indemnification is being sought exists, and we are not aware of any pending or
threatened material litigation that may result in claims for indemnification by
any of our directors or executive officers.
44
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and
other information with the SEC. You may read and copy any reports, statements or
other information the Company files at the SEC's public reference room at 450
Fifth Street, N.W., Washington, D.C., 20549. Please call the SEC at
1-800-SEC-0330 for further information on the operation of public reference
room. Our SEC filings are also available to the public from commercial document
retrieval services and through the web site maintained by the SEC at
www.sec.gov.
This prospectus is part of a registration statement on Form SB-2 that
we have filed with the SEC utilizing a "shelf" registration process. Under the
shelf registration process, the Selling Stockholders may, from time to time,
sell the Common Stock described in this prospectus. We may prepare a prospectus
supplement at any time to add, update or change information contained in this
prospectus.
As allowed by SEC rules, this prospectus does not contain all the
information you can find in the registration statement or the exhibits filed
with or incorporated by reference into the registration statement. Whenever a
reference is made in this prospectus to an agreement or other document of the
Company, be aware that such reference is not necessarily complete and that you
should refer to the exhibits that are filed with or incorporated by reference
into the registration statement for a copy of the agreement or other document.
You may review a copy of the registration statement at the SEC's public
reference room in Washington, D.C., as well as through the web site maintained
by the SEC at www.sec.gov.
You should read this prospectus and any prospectus supplement together with
the registration statement and the exhibits filed with or incorporated by
reference into the registration statement. The information contained in this
prospectus speaks only as of its date unless the information specifically
indicates that another date applies.
We have not authorized any person to give any information or to make any
representations that differ from, or add to, the information discussed in this
prospectus. Therefore, if anyone gives you different or additional information,
you should not rely on it.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
There were no changes in or disagreements with our accountants on
accounting and financial disclosure during the last two fiscal years or the
interim period from January 1, 2006 through the date of this prospectus.
45
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court
to award, or a corporation's board of directors to grant, indemnity to officers,
directors and other corporate agents in terms sufficiently broad to permit such
indemnification under certain circumstances and subject to certain limitations.
The registrant's certificate of incorporation includes a provision
that eliminates the personal liability of its directors for monetary damages for
breach of their fiduciary duty as directors.
In addition, the registrant's bylaws provide for the indemnification
of officers, directors and third parties acting on our behalf, to the fullest
extent permitted by Delaware General Corporation Law, if our board of directors
authorizes the proceeding for which such person is seeking indemnification
(other than proceedings that are brought to enforce the indemnification
provisions pursuant to the bylaws). The registrant maintains director and
officer liability insurance.
These indemnification provisions may be sufficiently broad to permit
indemnification of the registrant's executive officers and directors for
liabilities (including reimbursement of expenses incurred) arising under the
Securities Act of 1933.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the estimated expenses to be incurred
in connection with the issuance and distribution of the securities being
registered.
Registration Fee $ 76.75
Legal Fees and Expenses $ 10,000
Accounting Fees and Expenses $ 10,000
Miscellaneous $ 5,000
Total $25,076.75
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
2006
On November 22, 2006, Catuity entered into a Securities Purchase
Agreement, pursuant to which Catuity sold or issued $1,800,000 in aggregate
principal amount of its 10% Senior Convertible Notes (the "Senior Notes"), 700
shares of Series A Convertible Preferred Stock ($700,000 aggregate stated
value)(the "Preferred Shares"), and warrants to purchase 357,143 shares of its
common stock (the "Warrants") (the "2006 Private Placement"). These Senior Notes
and Preferred Shares were issued at a discount to face or stated value, for
aggregate gross proceeds to Catuity (before deduction of advisory and other
transaction-related fees and expenses) of $2,250,000.
46
The Private Placement was made to two accredited investors in a
transaction that was exempt from the registration requirements of the Securities
Act of 1933, as amended (the "Securities Act") pursuant to Regulation D
promulgated thereunder. Pursuant to a Registration Rights Agreement entered into
pursuant to the Securities Purchase Agreement, Catuity agreed to file a
registration statement under the Securities Act registering the resale of the
common shares that are issuable on conversion of the Senior Notes and Preferred
Shares that were issued in the Private Placement.
Catuity paid the placement agent for the financing (Broadband Capital
Management, LLC) a fee of 7% of the gross cash proceeds received by Catuity in
the financing, together with reimbursement of its actual expenses. Catuity paid
the lead investor's due diligence and legal fees and expenses and shall bear all
of its own legal and professional fees and expenses, including but not limited
to those associated with the filing of its Registration Statement as
contemplated by this transaction. The total legal and due diligence costs
Catuity incurred as a result of the financing were approximately $120,000.
2005
On September 19, 2005, Catuity issued 270,000 shares of its common
stock in a private placement to five accredited institutional investors. These
shares were issued pursuant to an exemption from registration under Regulation D
of the Securities Act. The shares were issued under the same pricing, terms and
conditions as the shares issued on September 1, 2005 as part of the Company's
acquisition of Loyalty Magic Pty. Ltd and its associated capital raise. The
shares were issued at $7.50 per share and raised $2,025,000. The Company paid
fees of $160,620 in order to raise the $2,025,000.
On September 1, 2005, the Company issued 335,000 shares of its common
stock to the shareholders of Loyalty Magic as part of the consideration for the
Company acquiring Loyalty Magic. These 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 Securities Act of
the United States. 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 (A$10.00 per share at a .7500 foreign currency exchange rate). The
sale of shares to Australian shareholders and institutional buyers resulted in
A$2,565,200 ($1,923,900). The sale of shares to U.S. accredited institutional
investors and Directors resulted in A$4,434,800 ($3,326.100) to the Company. The
Company paid a total of A$488,300 ($366,200) in brokerage commissions and
placement fees in order to raise the A$7,000,000 ($5,250,000). All U.S. dollar
amounts shown above were determined using a foreign currency exchange rate
between the Australian and U.S. dollar of .7500.
47
ITEM 27. EXHIBITS
(a) Exhibits.
The exhibits filed with this registration statement or incorporated
herein by reference are set forth on the Exhibit Index set forth elsewhere
herein.
(b) Financial Statement Schedules.
Schedules filed with this registration statement are set forth on the
Index to Financial Statements set forth elsewhere herein.
ITEM 28. UNDERTAKINGS
(a) The undersigned registrant hereby undertakes:
1. To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the registration
statement. Notwithstanding the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of securities offered would not
exceed that which was registered) and any deviation from the low or high end of
the estimated maximum offering range may be reflected in the form of prospectus
filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in the
effective registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
2. that, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
3. to remove from registration by means of a post-effective amendment
any of the securities being registered which remains unsold at the termination
of the offering.
(b) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers or persons
controlling the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the SEC such
indemnification is against public policy as expressed in the Securities Act of
1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred by a director, officer or controlling person of
the registrant in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act of 1933 and will be
governed by the final adjudication of such issue.
48
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of
Charlottesville, Commonwealth of Virginia, on February 5, 2007.
CATUITY INC.
By: /s/ Alfred H. (John) Racine, III
------------------------------------
Alfred H. (John) Racine, III
Chief Executive Office
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers
and directors of Catuity Inc. hereby constitutes and appoints each of Alfred H.
(John) Racine, III and Debra R. Hoopes, his attorney-in-fact and agent, with
full power of substitution and resubstitution for him in any and all capacities,
to sign any or all amendments or post-effective amendments to this registration
statement, and to file the same, with exhibits thereto and other documents in
connection therewith or in connection with the registration of the shares of
Common Stock under the Securities Act of 1933, with the Securities and Exchange
Commission, granting unto each such attorney-in-fact and agent full power and
authority to do and perform each and every act and thing requisite and necessary
in connection with such matters as fully to all intents and purposes as he might
or could do in person, hereby ratifying and confirming all that such
attorney-in-fact and agent or his substitute may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date indicated.
Name Title Date
---- ----- ----
/s/ Alexander S. Dawson Chairman February 5, 2007
- -----------------------------------
Alexander S. Dawson
/s/ Alfred H.(John) Racine III President, Chief February 5, 2007
- ----------------------------------- Executive Officer and
Alfred H.(John) Racine III Director (Principal
Executive Officer)
/s/ Geoffrey C. Wild Director February 5, 2007
- -----------------------------------
Geoffrey C. Wild
/s/ Donald C. Campion Director February 5, 2007
- -----------------------------------
Donald C. Campion
/s/ Clifford W. Chapman Jr. Director February 5, 2007
- -----------------------------------
Clifford W. Chapman Jr.
/s/ Debra R. Hoopes Sr. Vice President, Chief February 5, 2007
- ----------------------------------- Financial Officer and
Debra R. Hoopes Secretary (Principal
Accounting Officer)
49
EXHIBIT LIST
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.
EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.1 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.
3.2 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.
3.3 Registrant's Certificate of Designations for Series A Convertible
Preferred Stock, which appears as Exhibit 3.1 to Registrant's Form 8-K
filed September 22, 2006, which is incorporated herein by reference.
3.4 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.
3.5 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.
3.6 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.
3.7 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.
3.8 Bylaws of Catuity Inc. (formerly Novatec Inc.) as amended effective
September 1, 2004, which appears as Exhibit 3(g) to Registrant's Form
10-Q for the quarter ended June 30, 2004, which is incorporated herein
by reference.
3.9 Certificate of Amendment of Amended Certificate of Incorporation of
Catuity Inc. which appears as Exhibit 3(h) to Registrant's Form 10-K
for the year ended December 31, 2004, which is incorporated herein by
reference.
5 Opinion of Jaffe, Raitt, Heuer & Weiss, Professional Corporation, as
to legality of the securities being offered.
10.1 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.*
10.2 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.*
10.3 Amendment to John H. Lowry III Employment Agreement with Catuity Inc.,
which appears as Exhibit 10(d-1) to Registrant's Form 10-Q for the
quarter ended June 30, 2004, which is incorporated herein by
reference. *
10.4 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.
10.5 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.*
10.6 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.*
50
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.7 Amendment to Stock Option Plan, as approved by the Shareholders of
Catuity, Inc. on May 24, 2001, which appears as Exhibit 10(s) to
Registrant's Form 10-K for the year ended December 31, 2001, which is
incorporated herein by reference. *
10.8 Consulting agreement between Visa U.S.A and Catuity, Inc., signed
November 17, 2000, which appears as Exhibit 10(t) to Registrant's form
10-K for the year ended December 31, 2001, which is incorporated
herein by reference.
10.9 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.*
10.10 Catuity, Inc. 2003 Executive Director Stock Purchase Plan which
appears as exhibit 10(v) to Registrant's Form 10-K for the year ended
December 31, 2003, which is incorporated herein by reference
10.11 Employment Agreement of Alfred H. Racine, with Catuity Inc. dated
September 23, 2004, which appears as exhibit 10(w) to Registrant's
Form 8-K filed September 28, 2004, which is incorporated herein by
reference *
10.12 Nonqualified Stock Option Agreement with Alfred H. Racine approved by
the Shareholders of Catuity Inc. on July 18, 2005, which appears as
Appendix A to Registrant's proxy dated June 6, 2005, which is
incorporated herein by reference.*
10.13 Catuity Inc. 2005 Employee Restricted Stock Plan approved by the
Shareholders of Catuity Inc. on July 18, 2005, which appears as
Appendix B to Registrant's proxy dated June 6, 2005, which is
incorporated herein by reference.*
10.14 Catuity Inc. 2005 Nonemployee Director Restricted Stock Plan approved
by the Shareholders of Catuity Inc. on July 18, 2005, which appears as
Appendix C to Registrant's proxy dated June 6, 2005, which is
incorporated herein by reference.*
10.15 Amendment dated September 21, 2005 to Alfred H. Racine employment
agreement with Catuity Inc. dated September 23, 2004, which appears as
exhibit 10(a) to Registrant's Form 10-Q for the quarter ended
September 30, 2005, which is incorporated herein by reference.*
10.16 Amendment dated September 21, 2005 to John H. Lowry employment
agreement with Catuity Inc. dated April 18, 2000, which appears as
exhibit 10(b) to Registrant's Form 10-Q for the quarter ended
September 30, 2005, which is incorporated herein by reference.*
10.17 Agreement between Catuity Inc. and MIA Pty. Ltd. and Chris Leach,
individually for Management services dated August 31, 2005, which
appears as exhibit 10(c) to Registrant's Form 10-Q for the quarter
ended September 30, 2005, which is incorporated herein by reference.*
10.18 Amendment dated December 21, 2005, to Alfred H. Racine III Employment
Agreement With Catuity Inc. Dated September 23, 2004 As Amended
Effective September 7, 2005.*
10.19 Employment Agreement of Debra Hoopes with Catuity Inc. dated December
6, 2006, which appears as exhibit 10.1 to Registrant's Form 8-K filed
December 12, 2006, which is incorporated herein by reference *
10.20 Amendment dated January 24, 2007 to Employment Agreement of Debra
Hoopes with Catuity Inc. dated December 6, 2006*
10.21 Securities Purchase Agreement for the Senior Notes, Preferred Shares
and Warrants, dated November 22, 2006, by and among Catuity, Inc. and
the investors thereto which appears as Exhibit 10.1 to Registrant's
Form 8-K filed September 22, 2006, which is incorporated herein by
reference.
10.22 Senior Notes issued pursuant to Securities Purchase Agreement which
appears as Exhibit 10.2 to Registrant's Form 8-K filed September 22,
2006, which is incorporated herein by reference.
10.23 Warrants issued pursuant to Securities Purchase Agreement which
appears as Exhibit 10.3 to Registrant's Form 8-K filed September 22,
2006, which is incorporated herein by reference.
10.24 Registration Rights Agreement executed pursuant to the Securities
Purchase Agreement which appears as Exhibit 10.4 to Registrant's Form
8-K filed September 22, 2006, which is
51
EXHIBIT
NUMBER DESCRIPTION
------ -----------
incorporated herein by reference.
10.25 Security Agreement executed pursuant to the Securities Purchase
Agreement which appears as Exhibit 10.5 to Registrant's Form 8-K filed
September 22, 2006, which is incorporated herein by reference.
10.26 Guaranty executed by Catuity subsidiaries pursuant to the Securities
Purchase Agreement which appears as Exhibit 10.6 to Registrant's Form
8-K filed September 22, 2006, which is incorporated herein by
reference.
16.1 Letter from Ernst & Young LLP to the Securities and Exchange
Commission regarding change in certifying accountant, which appears as
exhibit 16.1 to Registrant's Form 8-K dated September 24, 2004.
21 Subsidiaries of Registrant, which appears as Exhibit 21 to
Registrant's Form 10-KSB dated March 30, 2006
23.1 Consent of Independent Accountants -- BDO Seidman, LLP
23.2 Consent of Independent Accountants -- McInnes, Graham & Gibbs
23.3 Consent of Counsel - Jaffe, Raitt, Heuer & Weiss, Professional
Corporation (included in Exhibit 5)
24 Powers of Attorney Contained on Signature Page
- ----------
* Indicates that exhibit is a management contract or compensatory plan or
arrangement.
52
CATUITY INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
F - PAGE
--------
CATUITY INC.
2005 AND 2004 INDEPENDENT AUDITORS' REPORTS.......................... 2
CONSOLIDATED BALANCE SHEETS - DECEMBER 31, 2005 AND 2004............. 3
CONSOLIDATED STATEMENTS OF OPERATIONS - YEAREND 2005 AND 2004........ 4
CONSOLIDATED STATEMENTS OF CASH FLOWS - YEAREND 2005 AND 2004........ 5
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - DECEMBER 31, 2005,
2004 AND 2003..................................................... 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS........................... 7
CONSOLIDATED BALANCE SHEETS - SEPTEMBER 30, 2006 AND DECEMBER 31,
2005.............................................................. 19
CONSOLIDATED STATEMENTS OF OPERATIONS - THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 2006 AND 2005....................................... 20
CONSOLIDATED STATEMENTS OF CASH FLOWS - NINE MONTHS ENDED
SEPTEMBER 30, 2006................................................ 21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - SEPTEMBER 30, 2006...... 22
LOYALTY MAGIC
2005 AND 2004 INDEPENDENT AUDITOR'S REPORT........................... 29
BALANCE SHEET - JUNE 30, 2005 AND 2004............................... 31
PROFIT AND LOSS - YEAREND JUNE 30, 2005 AND 2004..................... 32
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS................ 33
STATEMENT OF CASH FLOWS - YEAREND JUNE 30, 2005 AND 2004............. 38
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR
ENDED DECEMBER 31, 2005.............................................. 40
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Catuity, Inc.
Livonia, Michigan
We have audited the accompanying consolidated balance sheets of Catuity, Inc.
and subsidiaries as of December 31, 2005 and 2004 and the related consolidated
statements of operations, shareholders' equity, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (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. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Catuity, Inc. and
subsidiaries at December 31, 2005 and 2004, and the results of its operations
and its cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
BDO SEIDMAN, LLP
Troy, Michigan
March 24, 2006
F-2
CATUITY INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
---------------------------
2005 2004
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 958,746 $ 2,560,683
Short term investments 2,245,839 --
Accounts receivable-trade, less allowance of $122,000 in 2005, and $5,000 in 2004 543,200 36,211
Restricted cash 81,443 116,012
Work in process 39,760 --
Prepaid expenses and other 159,797 127,429
------------ ------------
TOTAL CURRENT ASSETS 4,028,785 2,840,335
LONG TERM ASSETS:
Property and equipment, net 273,941 162,780
Goodwill 3,004,667 --
Other intangible assets, net 1,811,752 --
------------ ------------
TOTAL LONG TERM ASSETS 5,090,360 162,780
TOTAL ASSETS $ 9,119,145 $ 3,003,115
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 175,643 $ 150,584
Deferred revenue 114,721 266
Accrued compensation 98,160 278,250
Taxes, other than income 98,330 9,669
Other accrued expenses 150,412 77,539
Trust liability 81,443 91,722
------------ ------------
TOTAL CURRENT LIABILITIES 718,709 608,030
LONG TERM LIABILITIES:
Leasing Liability 4,861 --
Accrued compensation 56,009 39,183
------------ ------------
TOTAL LONG TERM LIABILITIES 60,870 39,183
SHAREHOLDERS' EQUITY:
Common stock -- $.001 par value; Authorized - 6,666,667 shares: 2,111,807 shares
issued and 2,069,039 shares outstanding, 778,184 issued and outstanding in 2004 2,112 778
Preferred stock -- $0.001 par value; Authorized - 666,667 shares -- --
Additional paid-in capital 45,797,503 36,603,127
Shareholder loans (16,738) (79,533)
Deferred equity compensation (131,566) --
Foreign currency translation adjustment (65,589) 96,656
Accumulated deficit (37,246,156) (34,265,126)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 8,339,566 2,355,902
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 9,119,145 $ 3,003,115
============ ============
See accompanying notes to consolidated financial statements
F-3
CATUITY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31
2005 2004
REVENUES:
Processing $ 510,826 $ 0
Service 404,611 715,912
License 65,485 43,200
--------------------------------
TOTAL REVENUES 980,922 759,112
--------------------------------
COST OF REVENUE AND OTHER OPERATING EXPENSES:
Cost of processing revenue 533,163 0
Cost of service revenue 233,056 398,385
Cost of license revenue 21,384 457
Cost of revenue - amortization of intangibles 49,886 0
Cost of revenue - stock-based compensation 19,770 0
Research and development 728,108 1,248,645
Research and development - stock-based compensation 23,571 0
Sales and marketing 592,498 902,850
Sales and marketing - amortization of intangibles 54,813 0
Sales and marketing - stock-based compensation 35,305 0
General and administrative 1,685,152 1,913,003
General and administrative - amortization of intangibles 16,848 0
General and administrative - stock based compensation 77,050 0
--------------------------------
TOTAL COSTS AND EXPENSES 4,070,604 4,463,340
--------------------------------
OPERATING LOSS (3,089,682) (3,704,228)
INTEREST INCOME 108,652 96,777
--------------------------------
NET LOSS $ (2,981,030) $ (3,607,451)
--------------------------------
NET LOSS PER SHARE -- BASIC & DILUTED $ (2.48) $ (4.64)
WEIGHTED AVERAGE SHARES OUTSTANDING--BASIC & DILUTED 1,203,584 777,226
See accompanying notes to consolidated financial statements
F-4
CATUITY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31
-------------------------
2005 2004
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(2,981,030) $(3,607,451)
Adjustments used to reconcile net loss to net cash used in operating activities:
Stock based compensation 155,694 --
Depreciation and amortization 217,751 127,926
In Process Research and Development 205,900 --
Changes in assets and liabilities:
Accounts receivable (54,770) 365,898
Accounts payable (167,330) 274,249
Deferred revenue (78,618) (110,295)
Accrued expenses and other liabilities (344,740) (346,194)
Other assets 245,453 134,683
----------- -----------
Net cash used in operating activities (2,801,690) (3,161,184)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (52,691) (71,492)
Sale of Assets -- 4,253
Short Term Investments (2,245,839) --
Acquisition net of cash acquired (2,810,280) --
----------- -----------
Net cash used in investing activities (5,108,810) (67,239)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issue of common stock, net of expenses 6,460,184 14,057
Repayment of fractional shares related to reverse stock split (1,104) (2,136)
----------- -----------
Net cash provided by financing activities 6,459,080 11,921
Foreign exchange effect on cash (150,517) 8,357
----------- -----------
Net increase/(decrease) in cash and cash equivalents (1,601,937) (3,208,145)
Cash and cash equivalents, beginning of period 2,560,683 5,768,828
----------- -----------
Cash and cash equivalents, end of period $ 958,746 $ 2,560,683
=========== ===========
Non cash investing & financing activities:
Shares Issued in Acquisition $ 2,512,000 $ --
=========== ===========
See accompanying notes to consolidated financial statements
F-5
CATUITY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK
(AT PAR) ADDITIONAL FOREIGN TOTAL
----------------- PAID IN DEFERRED SHAREHOLDER CURRENCY ACCUMULATED SHAREHOLDERS
SHARES AMOUNT CAPITAL COMP LOANS TRANSLATION DEFICIT EQUITY
--------- ------ ----------- --------- ----------- ----------- ------------- ------------
Balances at December 31, 2003 776,374 $ 776 $36,979,841 -- $(468,166) $ 88,299 $ (30,657,675) $ 5,943,075
Issuance of common stock 1,810 2 14,055 14,057
Repayment of fractional shares
related to stock split (2,136) (2,136)
Adjust shareholder loan to
current fair market value (388,633) 388,633
Net loss (3,607,451) (3,607,451)
Foreign currency translation 8,357 8,357
-----------
Comprehensive loss (3,599,094)
--------- ------ ----------- --------- ---------- --------- ------------- -----------
Balances at December 31, 2004 778,184 $ 778 $36,603,127 -- ($79,533) $ 96,656 ($34,265,126) $ 2,355,902
Issuance of common stock
Exercise of options 1,282 1 6,300 6,301
Restricted Stock Granted 42,768 43 242,200 (242,243) --
Capital Raise & Acquisition
Shares 1,305,000 1,305 8,964,758 8,966,063
Stock Option Expense 45,017 45,017
Deferred Stock Compensation 110,677 110,677
Repayment of fractional shares
related to stock split (1,104) (1,104)
Adjust shareholder loan to
current fair market value (62,795) 62,795 --
Buyback of shares (15,427) (15) (15)
Net loss ($2,981,030) (2,981,030)
F-6
Foreign currency translation (162,245) (162,245)
-----------
Comprehensive loss (3,143,275)
--------- ------ ----------- --------- ---------- --------- ------------- -----------
Balances at December 31, 2005 2,111,807 $2,112 $45,797,503 ($131,566) ($16,738) ($65,589) ($37,246,156) $ 8,339,566
========= ====== =========== ========= ========== ========= ============= ===========
See accompanying notes to consolidated financial statements
NOTE 1. DESCRIPTION OF BUSINESS
Catuity provides loyalty and gift card processing and services to retailers
which are designed to increase their profitability at the Point of Sale (POS).
The Company hosts, on an Application Service Provider (ASP) basis, its unique
system that provides for the processing of member-based loyalty and gift card
programs that can deliver customized discounts, promotions, rewards and
points-based programs. These programs are designed to help retailers find, keep
and profit from their best customers.
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.
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.
REVENUE RECOGNITION
The three distinct revenue streams that result from the Company's business
activities are processing & service revenue, license revenue and project related
revenue.
Processing and Service Revenue: Processing and service revenue includes
training, consulting, installation support, post-installation support,
maintenance fees and application processing/hosting. 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.
Application processing/hosting is generally recognized as revenue in the month
that the services are performed. Payments for service revenues are generally not
refundable.
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
established VSOE for maintenance services. The Company does not generally
provide for a right of return in its license contracts.
F-7
Project Related Revenue: Project related revenue includes integration,
customization and miscellaneous project related fees for work performed for a
customer to deploy or modify the Company's loyalty and gift card applications.
Project related revenue is billed on a fixed price basis. The Company recognizes
revenue on fixed price contracts using the proportional performance method in
accordance with SAB 101, Revenue Recognition in Financial Statements, and SAB
104, Revenue Recognition, based on hours incurred as a proportion 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. The Company generally does not
provide for a right of return in its project related contracts.
Deferred Revenue: Revenue is deferred for any undelivered elements and is
recognized upon product delivery or when the service has been performed.
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.
SHORT TERM INVESTMENTS
The Company invests in short-term commercial paper with an original maturity
greater than three months. At December 31, 2005 there was no difference between
cost and fair value. The Company places its cash with high credit qualified
institutions.
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 receivables.
Actual collection on accounts may differ from the allowance the Company has
estimated.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of cash equivalents and Accounts Receivable. The
Company places its cash with high credit qualified institutions. At times, the
amount of cash on deposit in banks may be in excess of the respective financial
institution's FDIC insurance limit. The risk with respect to Accounts Receivable
and major customers is mitigated by our customer evaluations along with the
short duration of our collection terms.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation 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
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 month in which the transaction occurs. 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
F-8
included in the consolidated statement of operations and are not material for
all years presented. The accounts of the Company's Australian subsidiaries are
translated in accordance with Statement of Financial Accounting Standards No.
52, "Foreign Currency Translation".
The Company accounts for foreign currency exchange gains or losses on
inter-company transactions in accordance with SFAS No. 52. Transactions
occurring between the Company's U.S. and Australian offices 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).
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of the purchase price in a business combination
over the fair value of net tangible and intangible assets. Goodwill amounts are
not amortized, but will be tested for impairment at least annually. Intangible
assets that are not considered to have an indefinite useful life are amortized
over their useful lives, which range from 5 to 30 years. The carrying amount of
these assets will be reviewed whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
Recoverability of these assets is measured by comparison of the carrying amount
of the asset to the future undiscounted cash flows the asset is expected to
generate. If the asset is considered to be impaired, the amount of any
impairment is measured as the difference between the carrying value and the fair
value of the impaired asset. We did not recognize any goodwill or intangible
asset impairment charges in 2005.
BUSINESS COMBINATIONS
The acquisition, discussed in Note 6, has been accounted for in accordance with
Statement of Financial Accounting Standards ("SFAS") No 141, Business
Combinations.
RESEARCH AND DEVELOPMENT
All research and development costs are expensed as incurred. The Company did not
incur any costs eligible for capitalization under FASB Statement No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed.
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. The Company records a valuation
allowance to reduce deferred tax assets to the amount that it expects is more
likely than not to be realized.
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 (R), "Accounting for Stock-Based Compensation" ("SFAS No. 123 (R)"). The
Company adopted SFAS No. 123 (R) on January 1, 2006 which will have a
significant impact on earnings.
F-9
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:
YEAR ENDED DECEMBER 31
-------------------------
2005 2004
----------- -----------
Net Loss as Reported $(2,981,030) $(3,607,451)
=========== ===========
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards 259,989 47,224
----------- -----------
Pro forma net loss $(3,241,019) $(3,654,675)
=========== ===========
Loss per share:
basic & diluted - as reported $ (2.48) $ (4.64)
----------- -----------
Pro forma basic & diluted loss per share $ (2.69) $ (4.70)
----------- -----------
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 2005 and 2004 grants:
DECEMBER 31
-------------
2005 2004
----- -----
Risk Free Interest Rate 3.00% 2.00%
Expected Dividend Yield -- --
Expected Lives (years) 1.00 1.13
Expected Volatility 0.968 0.862
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, we record an expense based on
the intrinsic value at each balance sheet date until the contingency is resolved
and number or price is known. For variable awards issued to non-employees, the
Company records an expense based on the fair value of the options at each
balance sheet date.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004 and 2005), "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.
F-10
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consists of:
DECEMBER 31
----------------------
2005 2004
---------- ---------
Computer equipment $ 858,821 $ 558,759
Leasehold improvements 65,431 69,912
Office furniture and equipment 98,536 99,622
Capital Leases 67,575 --
---------- ---------
$1,090,363 $ 728,293
Less accumulated depreciation (816,422) (565,513)
---------- ---------
$ 273,941 $ 162,780
========== =========
NOTE 4. COMMITMENTS AND CONTINGENCIES
In September, 2005 the Company entered into 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 agreements expire on December
31, 2007, July 1, 2007, and September 30, 2007 respectively. Under the terms of
the three agreements, in the event the employment of all three individuals is
terminated by the Company without cause, the Company is committed to an
aggregate amount of a maximum of $414,000 in severance payments. Contractually,
Mr. Racine's severance is only paid in the event of a change in control of the
company.
Additionally, a former employee has alleged that she is owed severance and has
threatened legal action. We believe the claim to be without merit and cannot
estimate the potential costs, if any. We do not expect this to have a material
impact on future results.
NOTE 5. SHAREHOLDERS' EQUITY
REVERSE STOCK SPLIT
On November 1, 2004, the Company held a special shareholders meeting in Sydney
Australia for the purpose of seeking support of a majority of all shares
outstanding for a reverse stock split, also known as a share consolidation. The
reverse stock split became necessary to bring the Company into compliance with
NASDAQ's on-going listing rule requiring that shares on NASDAQ trade above
$1.00. The proposal passed, authorizing the Board to affect a split. Immediately
after the special shareholder meeting, the Board of Directors unanimously
authorized a 1 for 15 reverse split effective on November 12, 2004, the earliest
date that trading could begin in the post-reverse shares. The earnings per share
and all other appropriate data have been restated to reflect the reverse split.
RESTRICTED STOCK
37,500 shares of restricted stock were granted in 2005 under the Employee
Restricted Stock Plan and 5,268 shares of restricted stock were granted in 2005
under the Director Restricted Stock Plan. The shares are valued at the closing
price of the shares on the date of grant. The amount attributable to these
shares 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. Deferred Compensation is expensed on a monthly
basis, over the respective vesting periods of the stock grants, and began in
October, 2005. The Plans are limited so that no more than 267,000 Restricted
Stock shares may be outstanding under the Employee Plan and no more than 50,000
Restricted Stock shares may be outstanding under the Director Plan.
F-11
LIMITED RECOURSE LOANS
In 1995 and 1996, the Company issued loans to a former Australian director and
certain executive employees for the purpose of purchasing 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 director's loan was repaid ($48,000 USD at the exchange rate
in effect on the date of the transaction) related to the sale of 1,667 shares.
In the fourth quarter of 2003, approximately $60,750 AUD of the director's loan
was repaid ($42,000 USD at the exchange rate in effect on the date of the
transaction) related to the sale of 1,350 shares. In each reporting period the
Company records a debit or a credit to expense for the loans based on the
difference between the loan share grant price and the Company's share price at
the respective period ending balance sheet dates, on a cumulative basis. For the
years ended December 31, 2005 and 2004, no credits or debits to expense were
recorded. 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 former director's loan
shares. Since the amount of the loans exceeded the value of the loan shares, no
cash was required to complete the buyback
EMPLOYEE STOCK OPTION PLAN
The Company's shareholders approved the establishment of an Employee Stock
Option Plan ("Plan") at a March 2000 special meeting of shareholders. 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 issue, 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. Option
vesting schedules are determined by the Board of Directors at the time of issue,
but are generally over one to three 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. The Plan is limited so that no
more than 300,000 option shares may be outstanding at any time.
DIRECTOR STOCK OPTION PLAN
On May 1, 2001 the Company's shareholders 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. At the July 18, 2005 Annual Meeting,
shareholders approved that, under the plan, outside Directors shall receive
2,500 non-qualified option shares on the date they join the Board. In addition,
the Board Chairman will receive 3,000 non-qualified option shares, and each
other outside Director will receive 2,500 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 58,667 option shares may be outstanding
at any one time.
F-12
SUMMARY OF STOCK OPTIONS/WARRANTS
The following is a summary of stock and warrant activity:
NUMBER OF WEIGHTED AVERAGE
OPTION EXERCISE PRICE
SHARES PER SHARE
--------- ----------------
Outstanding at December 31, 2003 79,732 $86.85
Granted 7,179 $ 5.21
Cancelled/lapsed (33,281) 53.58
Exercised -- --
------- ------
Outstanding at December 31, 2004 53,630 $91.02
NUMBER OF WEIGHTED AVERAGE
OPTION EXERCISE PRICE
SHARES PER SHARE
--------- ----------------
Granted 182,802 $ 7.00
Cancelled/lapsed (29,482) 49.02
Exercised (1,282) 4.80
------- ------
Outstanding at December 31, 2005 205,668 $23.16
The weighted average fair value of options/warrants granted during the years
ended December 31, 2005 and 2004 were $7.59 and $3.09, respectively. The
weighted average fair value is calculated using the Black-Scholes valuation
model.
The following is additional information relating to options outstanding as of
December 31, 2005:
OPTIONS OUTSTANDING
- --------------------------------------------------------------
WEIGHTED OPTIONS EXERCISABLE
AVERAGE ----------------------------
EXERCISE PRICE NUMBER OF WEIGHTED AVG. CONTRACTUAL LIFE NUMBER OF WEIGHTED AVERAGE
RANGE SHARES EXERCISE PRICE (YEARS) SHARES EXERCISE PRICE
- -------------- --------- -------------- ---------------- --------- ----------------
$4.05-$4.27 78,914 $ 4.20 4.59 78,914 $ 4.20
$5.31-$7.50 38,586 $ 6.64 3.78 15,222 $ 7.46
$10.52-$33.60 56,499 $ 14.68 4.98 16,166 $ 15.61
$39.60-$178.38 31,669 $ 106.76 3.29 31,669 $ 106.76
There were 50,013 options exercisable at December 31, 2004.
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 January 21, 2003 the members of the Board of Directors adopted the Catuity
Inc. 2003 Executive Director Stock Purchase Plan ("Plan") which became 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 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 6,667 shares. Pursuant to the terms and conditions of the plan, the
plan terminated on August 31, 2004.
F-13
PREFERRED STOCK
The Company's Certificate of Incorporation authorizes 666,667 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.
CAPITAL RAISE
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
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).
$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. 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
The Company paid approximately $821,000 (A$1,095,000) in brokerage commissions
and other fees for the two capital raises.
NOTE 6. ACQUISITION
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. 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.
Loyalty Magic is now a wholly-owned subsidiary of Catuity. The acquisition of
Loyalty Magic was reflected in the consolidated financial statements of the
Company beginning September 1, 2005 and has been accounted for in accordance
with Statement of Financial Accounting Standards ("SFAS") No 141, Business
Combinations. Catuity's financial statements reflect twelve months of Catuity's
operations and four months of Loyalty Magic's operations.
The Company, as part of its turnaround strategy, determined that the acquisition
of Loyalty Magic and its combination with our company would create a stronger,
more competitive industry participant, based on potential benefits that include:
(1) the complementary nature of the companies' markets, products, technologies
and customers; (2) the more diversified portfolio of products that will result
from the combination of the companies; (3) the opportunity to accelerate revenue
growth as a result of being able to offer Loyalty Magic's products to Catuity's
customers and prospective customers and to offer Catuity's products to Loyalty
Magic's customers and prospective customers; (4) the potential ability of the
combined company to effectively develop new products and improve existing
products by sharing technologies and intellectual property; (5) the expansion of
our presence in new and current markets; (6) the development of an international
platform for future acquisitions as and when attractive opportunities arise; and
(7) the management team in place at Loyalty Magic
Although the transaction generated a significant amount of goodwill, the Company
believes that the combination of the two entities will generate sufficient
positive results to justify these amounts. This is based on our evaluation of
the experience and skill of the Loyalty Magic personnel, the potential of the
existing customer base and the future potential of the Loyalty Magic sales
pipeline.
F-14
The purchase price (In US Dollars) has been tentatively allocated as follows:
Condensed Balance Sheet
Current Assets $ 840,865
Long Term Assets 164,330
Other Intangible Assets & In-process R&D 2,139,200
Goodwill Including Acquisition Cost 3,004,667
----------
Total Assets 6,149,062
Liabilities (680,835)
----------
Purchase Price $5,468,227
----------
Transaction Cash & Equity
Cash Paid to Loyalty Magic Shareholders $2,700,000
Shares of Catuity Stock @ $7.50* 2,512,000
Acquisition and Other Costs 256,227
----------
Purchase Price $5,468,227
* The shares were valued at the price used for the public offering, or $7.50
per share, that was completed on the same day as the acquisition.
Management determined that this represented the fair value of the shares at
the time the transaction was finalized, due to the size of the capital
raise, the number of shares issued and the high volatility of our stock
price.
The purchase price allocation is preliminary and has not been finalized as we
are still working with an outside consultant on intangible asset allocation. The
Company is currently evaluating the extent of amortizable intangibles acquired
and, for purposes of the pro forma results has estimated that $1,933,300 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. The
weighted average amortization period is 13 years for amortizable intangibles).
Trademarks and the Non Compete Agreement are amortized on a straight line (SL)
basis over the estimated useful life in years. Software, Customer Contracts and
Customer relationships are amortized over the estimated useful life in years and
the amortization expense amount is based on the expected annual cash flows (CF)
of the respective category. In Process Research and Development (IPR&D) of
$205,900 was expensed on the acquisition date and charged to Research &
Development.
The following table details the anticipated amortization of the intangibles:
2111 to
Annual Totals Value Method 2005 2006 2007 2008 2009 2010 2029
------------- ---------- -------- -------- -------- -------- -------- -------- -------- --------
Trademarks $ 566,700 SL $ 6,296 $ 18,888 $ 18,888 $ 18,888 $ 18,888 $ 18,888 $465,964
Software 644,800 CF based 49,887 166,236 163,764 137,580 92,604 34,729 --
Customer Contracts 285,100 CF based 30,991 80,580 69,888 52,140 35,028 16,473 --
Customer
Relationships 278,400 CF based 23,823 48,168 43,092 38,028 32,952 27,888 64,449
Non-compete
agreements 158,300 SL 10,552 31,656 31,656 31,656 31,656 21,124 --
---------- -------- -------- -------- -------- -------- -------- --------
Totals $1,933,300 $121,549 $345,528 $327,288 $278,292 $211,128 $119,102 $530,413
========== ======== ======== ======== ======== ======== ======== ========
The amortization of Goodwill and Other Intangible Assets associated with the
transaction are currently not deductible for tax purposes, although the Company
is still investigating strategies that could be used to deduct these items as
"Section 197" intangibles under the applicable IRS codes.
F-15
Pro forma information for the Company and Loyalty Magic as if the acquisition
had been completed on January 1, 2004 is as follows:
YTD 12/31/2005 YTD 12/31/2004
(unaudited) (unaudited)
-------------- --------------
Revenue $ 2,377,192 $ 2,833,315
Net Loss ($3,702,618) ($4,229,770)
Earnings per share $ (1.79) $ (2.04)
NOTE 7. INCOME TAXES
The components of profit/ (loss) before income taxes and extraordinary items
consisted of the following:
YEAR ENDED DECEMBER 31
--------------------------
2005 2004
----------- ------------
Domestic ($3,350,057) ($4,251,120)
Foreign 369,027 643,669
----------- -----------
Loss before income taxes ($2,981,030) ($3,607,451)
=========== ===========
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 carry forwards 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:
YEAR ENDED DECEMBER 31
-------------------------
2005 2004
----------- -----------
Income taxes at statutory tax rate $(1,013,550) $(1,226,533)
Variable stock compensation -- --
Utilization of operating loss carry forward (110,708) (193,101)
Valuation allowance 1,139,019 1,445,381
Other (14,761) (25,747)
----------- -----------
Provision for income taxes $ -- $ --
=========== ===========
The statutory tax rate was 34% in the United States and 30% in Australia for the
years ended December 31, 2005 and 2004. Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of 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:
DECEMBER 31
---------------------------
2005 2004
------------ ------------
Deferred tax assets:
Net operating loss carry-forwards $ 12,059,673 $ 11,579,661
Other 108,188 48,068
------------ ------------
Total deferred tax assets 12,167,861 11,627,729
Deferred tax liabilities:
Intangibles (616,080) --
------------ ------------
Total deferred tax liabilities (616,080) --
Valuation allowance (11,551,781) (11,627,729)
------------ ------------
Total net deferred tax assets $ -- $ --
============ ============
F-16
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, 2005, the Company had net operating loss carry-forwards of
$21,590,000 expiring in various amounts in 2020 and 2021 in the United States
and $15,730,000 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. Utilization of the net operating
loss carry-forwards in the United States is subject to limits due to continuity
of ownership tests under Section 382 of the Internal Revenue Service Code.
NOTE 8. DEFINED CONTRIBUTION PLAN
On behalf of its Australian employees, the Company contributes a government
mandated percentage of each employee's gross salary to a defined contribution
plan. The prescribed charge percentage was 9% for the two years ended December
31, 2005 and 2004. The Company's contributions were $58,339 and $96,111 for the
years ended December 31, 2005 and 2004 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 9. 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 $81,443 and $91,722 at December 31, 2005 and 2004,
respectively.
On August 31, 2001, in accordance with an agreement between the Company and
Westbus Pty. Ltd., 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.
In addition, the Company had restricted cash of $0 and $24,290 as of December
31, 2005 and 2004, respectively, related to an amount held as security for an
operating lease of our former office in Sydney.
NOTE 10. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA
As of December 31, 2005, the Company is organized and operates in one business
segment, providing loyalty and gift card processing and services for retailers.
The following table shows net revenues and long-lived assets by geographic area.
2005 2004
--------------------- ---------------------
LONG-LIVED NET LONG-LIVED NET
ASSETS REVENUES ASSETS REVENUES
---------- -------- ---------- --------
U.S. $ 84,906 $ 77,618 $ 81,101 $759,112
Australia 189,035 903,304 81,679 --
-------- -------- -------- --------
Total $273,941 $980,922 $162,780 $759,112
======== ======== ======== ========
F-17
Revenue from two of Loyalty Magic's customers each exceeded 10% of Catuity's
revenue and, in total, represented approximately 28% of revenue in 2005. In
2004, revenue from two U.S. customers each exceeded 10% of Catuity's revenue
and, in total, represented approximately 86% of revenue.
NOTE 11. MANAGEMENT'S PLANS (UNAUDITED)
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 one of our major client's decision to discontinue
issuing smart cards, the Company had focused its efforts on licensing its
existing 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 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 50 to 250 stores, 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 the mergers and
acquisitions market 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
which resulted in the acquisition of Loyalty Magic in September, 2005.
Catuity's goal remains to become a consistently profitable company and we
believe that Catuity can only become profitable on a monthly basis by the end of
calendar year 2006 through the acquisition of one or more profitable US
companies that are complementary to our strategy. Our priorities in 2006 focus
on three important areas.
Mergers remain important to our strategy, and our goal is to complete at least
one acquisition in 2006. Catuity is currently seeking the acquisition of a
traditional loyalty services and/or database marketing firm to expand our range
of products and services. Catuity's technology generates a robust stream of
information and our prospective clients often rely on others to manage and
maximize this type of data.
We believe that the U.S. reseller market is moving to adopt the type of
technology that Catuity offers. There is an apparent demand for a turnkey
solution for merchants and small chains through re-sellers, including merchant
services companies, Independent Sales Organizations, marketing companies and
operators of coalition loyalty programs in local markets. This is a good fit for
Catuity because we believe that we have an efficient product, an operational
service capability that provides turnkey outsourcing to resellers, which gives
us the ability to leverage Catuity's fixed costs faster than by only selling to
chain retailers.
Catuity also plans to introduce packaged products to broaden our offering to
retailers. Catuity believes that there is demand in the chain world for packaged
products. Catuity is also looking at ways to modify these packages for the
reseller market. It is important to note that introducing product packages does
not require significant new development of our technology.
F-18
INTERIM FINANCIAL STATEMENT (September 30, 2006)
CATUITY INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30 DECEMBER 31
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 639,707 $ 958,746
Short term investments 0 2,245,839
Accounts receivable-trade, less allowance of
$217,000 and $122,000 413,895 543,200
Restricted cash 81,389 81,443
Work in process 3,075 39,760
Prepaid expenses and other 271,457 159,797
------------ ------------
TOTAL CURRENT ASSETS 1,409,523 4,028,785
LONG TERM ASSETS:
Property and equipment, net 304,262 273,941
Notes receivable 48,750 0
Goodwill 3,004,667 3,004,667
Other intangible assets, net 1,553,930 1,811,752
------------ ------------
TOTAL LONG TERM ASSETS 4,911,609 5,090,360
TOTAL ASSETS $ 6,321,132 $ 9,119,145
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 213,372 $ 175,643
Deferred revenue 163,184 114,721
Accrued compensation 105,616 98,160
Taxes, other than income 69,242 98,330
Other accrued expenses 197,608 150,412
Trust liability 81,389 81,443
------------ ------------
TOTAL CURRENT LIABILITIES 830,411 718,709
LONG TERM LIABILITIES:
Leasing Liability 0 4,861
Accrued compensation 35,928 56,009
------------ ------------
TOTAL LONG TERM LIABILITIES 35,928 60,870
SHAREHOLDERS' EQUITY:
Common stock - $.001 par value; Authorized -
6,666,667 shares; 2,252,593 issued and 2,237,166
outstanding at September 30, 2006 and 2,127,234
issued and 2,111,807 outstanding at December 31, 2005 2,253 2,127
Preferred stock - $0.001 par value; Authorized -
666,667 shares 0 0
Additional paid-in capital 46,211,592 45,649,184
Foreign currency translation adjustment (49,310) (65,589)
Accumulated deficit (40,709,742) (37,246,156)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 5,454,793 8,339,566
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 6,321,132 $ 9,119,145
============ ============
See accompanying notes to consolidated financial statements
F-19
CATUITY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------ -------------------------
2006 2005 2006 2005
----------- ---------- ----------- -----------
REVENUES:
Processing $ 342,004 $ 139,582 $ 1,039,854 $ 139,582
Service 69,854 10,145 295,135 31,365
License 23,458 24,265 60,037 49,465
----------- ---------- ----------- -----------
TOTAL REVENUES 435,316 173,992 1,395,025 220,412
COST OF REVENUE AND OTHER OPERATING EXPENSES:
Cost of processing revenue 421,881 148,142 1,268,813 215,477
Cost of service revenue 74,358 58,161 219,058 75,526
Cost of license revenue 0 150 0 4,019
Cost of revenue - amortization of intangibles 41,559 10,747 124,677 10,747
Cost of revenue - stock-based compensation 33,410 202 66,098 202
Research and development 110,783 316,742 369,550 570,136
Research and development - stock-based compensation 16,728 0 43,387 0
Sales and marketing 233,512 111,220 757,334 398,288
Sales and marketing - stock-based compensation 16,830 17,875 7,229 17,875
Sales and marketing - amortization of intangibles 32,187 7,072 96,561 7,072
General & administrative 523,641 451,498 1,583,076 1,178,092
General & administrative - stock-based compensation 91,307 1,630 354,589 1,630
General & administrative - amortization of intangibles 12,636 4,212 37,908 4,212
----------- ---------- ----------- -----------
TOTAL COSTS AND EXPENSES 1,608,832 1,127,651 4,928,280 2,483,276
----------- ---------- ----------- -----------
OPERATING LOSS (1,173,516) (953,659) (3,533,255) (2,262,864)
INTEREST INCOME 12,304 21,486 69,669 63,611
----------- ---------- ----------- -----------
NET LOSS (1,161,212) (932,173) (3,463,585) (2,199,253)
=========== ========== =========== ===========
NET LOSS PER SHARE - BASIC & DILUTED $ (0.54) $ (0.82) $ (1.62) $ (2.41)
=========== ========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING-BASIC & DILUTED 2,167,065 1,131,497 2,139,299 912,501
=========== ========== =========== ===========
See accompanying notes to consolidated financial statements
F-20
CATUITY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30
------------------------------
2006 2005
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(3,463,585) $(2,199,253)
Adjustments used to reconcile net loss to net cash used
in operating activities:
Stock-based compensation 471,303 0
Depreciation and amortization 360,856 75,185
Changes in assets and liabilities:
Accounts receivable 129,305 (304,823)
Accounts payable 37,729 104,404
Deferred revenue 48,463 199,929
Accrued expenses and other liabilities 573 171,943
Other assets (33,739) 103,525
----------- -----------
Net cash used in operating activities (2,449,095) (1,849,090)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (132,031) (176,963)
Short Term Investments 2,245,839 0
Acquisition net of cash acquired 0 (3,458,704)
----------- -----------
Net cash provided/(used) in investing activities 2,113,808 (3,635,667)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issue of common stock, net of expenses 0 7,357,758
Repayment of fractional shares related to reverse stock split (31) (1,055)
----------- -----------
Net cash provided by / (used) in financing activities (31) 7,356,703
Foreign exchange effect on cash 16,279 (42,593)
----------- -----------
Net increase/(decrease) in cash and cash equivalents (319,039) 1,829,353
Cash and cash equivalents, beginning of period 958,746 2,560,683
----------- -----------
Cash and cash equivalents, end of period $ 639,707 $ 4,390,036
=========== ===========
See accompanying notes to consolidated financial statements
F-21
CATUITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
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, 2005 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, 2006 are not necessarily
indicative of the results that may be expected for any subsequent quarter or for
the entire year ended December 31, 2006. 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-KSB filed with the Securities and Exchange Commission for the year ended
December 31, 2005.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123 (revised 2004 and 2005), "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 adopted SFAS 123(R) effective January 1,
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 future financial results. The level of impact on the Company's
financial statements will depend, in part, on future grant awards. See note 4
for a description of the expense recorded for the three and nine month periods
of 2006 under SFAS 123(R).
In July 2006, the FASB issued FASB Interpretation ("FIN") No. 48 Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement 109. FIN 48
prescribes a comprehensive model for recognizing, measuring, presenting and
disclosing in the financial statements tax positions taken or expected to be
taken on a tax return, including a decision whether to file or not to file in a
particular jurisdiction. FIN 48 is effective for fiscal years beginning after
December 15, 2006. If there are changes in net assets as a result of application
of FIN 48 these will be accounted for as an adjustment to retained earnings. The
Company is currently assessing the impact of FIN 48 on its consolidated
financial position and results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS No. 157"), which establishes a framework for measuring fair value and
requires expanded disclosure about the information used to measure fair value.
The statement applies whenever other statements require, or permit, assets or
liabilities to be measured at fair value. The statement does not expand the use
of fair value in any new circumstances and is effective for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years, with early adoption encouraged. The Company is currently assessing any
potential impact of adopting this pronouncement.
In September 2006, the SEC Staff issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in the Current Year Financial Statements" ("SAB No. 108"). SAB No.
108 requires the use of two alternative approaches in quantitatively evaluating
materiality of misstatements. If the misstatement as quantified under either
approach is material to the current year financial
F-22
statements, the misstatement must be corrected. If the effect of correcting the
prior year misstatements, if any, in the current year income statement is
material, the prior year financial statements should be corrected. SAB No. 108
is effective for fiscal years ending after November 15, 2006. The Company has
determined that there is no impact from applying this interpretation.
3. COMPREHENSIVE INCOME/(LOSS)
Comprehensive income/(loss) is summarized as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
2006 2005 2006 2005
----------- --------- ----------- -----------
Net loss $(1,161,212) $(932,173) $(3,463,585) $(2,199,253)
Foreign currency translation 8,934 (23,467) 16,279 (51,414)
----------- --------- ----------- -----------
Total comprehensive loss $(1,152,278) $(955,640) $(3,481,864) $(2,250,667)
=========== ========= =========== ===========
4. STOCK-BASED COMPENSATION
Effective January 1, 2006, under the modified prospective method, the Company
adopted the provisions of SFAS 123(R), Share-Based Payment, a replacement of
SFAS No. 123, Accounting For Stock-Based Compensation, and rescission of APB
Opinion No. 25, Accounting for Stock Issued to Employees. This statement applies
to all awards granted after the effective date and to modifications, repurchases
or cancellations of existing awards, and awards granted prior to January 1, 2006
that were not fully vested. The adoption of SFAS No. 123(R) had a significant
impact on the Company's results of operations. The Company's consolidated
statement of operations for the three months ended September 30, 2006 and
September 30, 2005 includes $158,275 and $31,492 of stock-based compensation
expense respectively. Stock-based compensation expense for the nine months ended
September 30, 2006 and September 30, 2005 was $471,303 and $31,492,
respectively. Unrecognized stock-based compensation expense expected to be
recognized over an estimated weighted-average amortization period of 1.84 years
was $891,486 at September 30, 2006. We expect to expense $122,000 of that total
in the remaining three months of 2006.
Compensation expense in calendar year 2005 related to stock options continues to
be disclosed on a pro forma basis only.
The fair value of the option grants is estimated as of the date of the grant
using the Black-Scholes option pricing model with the following assumptions:
2006 2005 2004
---- ----- -----
Risk Free Interest Rate 5.12% 3.00% 2.00%
Expected Dividend Yield -- -- --
Expected Lives (years) N/A 1.00 1.13
Expected Volatility 1.09 0.968 0.862
SFAS No. 123(R) also requires the benefits of tax deductions in excess of
recognized compensation cost to be reported as a financing cash flow, rather
than as an operating cash flow as previously required under EITF Issue No.
00-15, "Classification in the Statement of Cash Flows of the Income Tax Benefit
Received by a Company upon Exercise of a Nonqualified Employee Stock Option".
This requirement had no effect on the Company's net operating cash flows or its
net financing cash flows in the three or nine month periods ended September 30,
2006.
EMPLOYEE STOCK-BASED COMPENSATION PLANS
F-23
The Company issues new common stock from its pool of authorized stock upon
exercise of stock options or upon granting of restricted stock. The Company has
established four stock-based compensation plans:
SHARES DATE OF SHAREHOLDER
PLAN NAME AUTHORIZED APPROVAL
- --------- ---------- -------------------
The 2000 Employee Stock Option Plan (the "ESOP") 300,000 March 16, 2000
The 2000 Non-employee Director Stock Option Plan (the "DSOP") 58,667 May 21, 2001
The 2005 Employee Restricted Stock Plan (the "ERSP") 267,000 July 18, 2005
The 2005 Non-employee Director Restricted Stock Plan (the "DRSP") 50,000 July 18, 2005
The Company's Compensation Committee of the Board administers the above plans
and the stock-based awards are granted at terms approved or determined by them.
As of September 30, 2006, the total number of shares awarded under these plans
is 425,608, of which 264,981 are options and 160,627 are restricted shares. The
plans do not provide for unvested options to automatically vest upon a change in
control of the Company. The Company recognizes compensation expense associated
with share-based awards over the vesting period on a straight-line basis.
STOCK OPTIONS
The maximum contractual term for awards under the ESOP and DSOP is ten years
from the date of grant. The maximum contractual vesting period for awards
granted under the ESOP is five years from the date of grant. The DSOP does not
have a maximum vesting period specified. Awards granted under the ESOP may be
service, market, or performance based. Market based options include shares that
vest once the Company's share price reaches a certain target level defined in
the award. Performance based awards include those where vesting is tied to the
achievement of certain personal or Company targets or goals, such as achieving a
targeted number of customer location deployments or achieving a targeted sales
goal as measured by revenue over the term of new customer agreements.
The following table sets forth the summary of option activity under the
Company's stock option program for the nine months ended September 30, 2006:
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
OUTSTANDING OPTIONS AT DECEMBER 31, 2005 205,668 $23.16
Granted 87,500 $10.08
Forfeited (28,187) $14.77
------- ------
OUTSTANDING OPTIONS AT SEPTEMBER 30, 2006 264,981 $19.86
The weighted average estimated grant date fair values of options granted under
the Company's stock option plans for the three and nine month periods ended
September 30, 2005 and 2006 were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
----- ----- ----- -----
Weighted Average Fair Value $1.80 $5.32 $1.85 $4.58
F-24
A summary of the changes in the Company's nonvested shares during the nine
months ended September 30, 2006 is presented below:
WEIGHTED AVERAGE
GRANT DATE FAIR
SHARES VALUE
------- ----------------
NONVESTED OPTIONS AT DECEMBER 31, 2005 63,364 $5.21
Granted 87,500 1.55
Vested (34,159) 3.90
Forfeited (21,610) 5.56
------- -----
NONVESTED OPTIONS AT SEPTEMBER 30, 2006 95,095 $2.63
All options granted by the Company had a fair market value assigned at grant
date based on the use of the Black-Scholes option pricing model. There were no
options exercised during the quarters ended September 30, 2006 and 2005. As a
result the total intrinsic value of options exercised in both periods was $0.
Information regarding the stock options outstanding at September 30, 2006 is
summarized below:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- --------------------------------------------------
Weighted Average Weighted Average
Number Remaining Weighted Number Remaining Weighted
Range of Outstanding at Contractual Average Outstanding at Contractual Average
Exercise Price Sept. 30, 2006 Life (Years) Exercise Price Sept. 30, 2006 Life (Years) Exercise Price
- --------------- -------------- ---------------- -------------- -------------- ---------------- --------------
$ 3.11 4.27 99,414 5.26 $ 3.97 89,414 4.63 $ 4.07
5.31 7.50 45,066 3.33 6.34 23,971 3.08 5.84
10.52 33.60 89,833 6.36 14.51 25,833 6.52 14.91
39.60 178.38 30,668 2.55 106.93 30,668 2.55 106.93
------- -------
264,981 3.71 $ 19.86 169,886 3.26 $ 24.54
The aggregate intrinsic value of options outstanding and options exercisable as
of September 30, 2006 was -$4,439,000 and -$3,662,000, respectively. The
intrinsic value is calculated as the difference between the market value as of
September 30, 2006 and the exercise price of the shares.
RESTRICTED STOCK
The Company awards restricted stock to employees and Directors pursuant to the
ERSP and DRSP respectively. There is no contractual maximum term or vesting
period for awards under either plan. ERSP awards may be service, market and
service, or performance based. Market and service based awards include shares
that vest once the Company's share price reaches a certain target level defined
in the award, and the individual remains in the employ of the Company.
Performance based awards include those where vesting is tied to the achievement
of certain personal or Company targets or goals, such as achieving a targeted
number of customer location deployments or achieving a targeted sales goal as
measured by revenue over the term of new customer agreements. DRSP awards are
performance based and are restricted until the Company achieves profitability
and is cash flow positive for two consecutive quarters. Restricted shares
granted by the company are valued based on the closing market price as of the
award date and are expensed over the anticipated vesting period.
F-25
A summary of the unvested restricted stock as of September 30, 2006, and changes
during the nine months then ended, is as follows:
WEIGHTED
AVERAGE GRANT
DATE
SHARES FAIR VALUE
------- -------------
UNVESTED RESTRICTED STOCK AT DECEMBER 31, 2005 42,768 $10.58
Granted 135,359 9.11
Vested (7,500) 11.62
Forfeited (10,000) 11.62
------- ------
UNVESTED RESTRICTED STOCK AT SEPTEMBER 30, 2006 160,627 $ 9.23
PRO FORMA STOCK-BASED COMPENSATION 2005
Had compensation cost for the plans been determined based on the fair value at
the grant dates for awards under the plans consistent with the fair value method
of SFAS No. 123, the effect on the Company's net income (loss) in the three and
nine months ended September 30, 2005 would have been the following:
THREE MONTHS ENDED NINE MONTHS ENDED
2005 2005
------------------ -----------------
Net (loss) as reported ($932,173) ($2,199,253)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards ($253,372) ($257,204)
----------- -----------
Pro forma net (loss) ($1,185,545) ($2,456,457)
=========== ===========
Net (loss) per share: basic & diluted - as reported ($0.82) ($2.41)
=========== ===========
Pro forma basic & diluted (loss) per share ($1.05) ($2.69)
=========== ===========
5. COMMITMENTS AND CONTINGENCIES
In September, 2005 the Company entered into 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 agreements expire on December
31, 2007, July 1, 2007, and September 30, 2007 respectively. Under the terms of
Mr. Leach's agreement, if Mr. Leach is terminated without cause he will receive
3 months salary which would represent a payment of $37,000. Under the terms of
Mr. Lowry's agreement, if Mr. Lowry is terminated without cause he will receive
9 months salary which would represent a payment of $128,000. Under the terms of
Mr. Racine's agreement, if Mr. Racine is terminated after a "Change of Control
Transaction" he will receive severance in an amount equal to the greater of 12
months salary or the balance of his contract, which as of September 30, 2006 is
12 months and represents a payment of $262,500. If Mr. Racine is terminated
without cause for any reason, other than a change of control, he will receive 1
month's salary which would represent a payment of $22,000.
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. 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.
Loyalty Magic is now a wholly-owned subsidiary of Catuity. The acquisition of
Loyalty Magic was reflected in the consolidated financial statements of the
Company beginning September 1, 2005 and has been accounted for in accordance
with Statement of Financial Accounting Standards ("SFAS") No 141, Business
Combinations. Catuity's nine month and third quarter, 2006 financial statements
reflect nine and three months of Loyalty Magic's operations, while the 2005
financial information included only the month of September 2005 results of
Loyalty Magic's operations.
F-26
The Company, as part of its turnaround strategy, determined that the acquisition
of Loyalty Magic and its combination with our company would create a stronger,
more competitive industry participant, based on potential benefits that include:
(1) the complementary nature of the companies' markets, products, technologies
and customers; (2) the more diversified portfolio of products that will result
from the combination of the companies; (3) the opportunity to accelerate revenue
growth as a result of being able to offer Loyalty Magic's products to Catuity's
customers and prospective customers and to offer Catuity's products to Loyalty
Magic's customers and prospective customers; (4) the potential ability of the
combined company to effectively develop new products and improve existing
products by sharing technologies and intellectual property; (5) the expansion of
our presence in new and current markets; (6) the development of an international
platform for future acquisitions as and when attractive opportunities arise; and
(7) the management team in place at Loyalty Magic.
Although the transaction resulted in a significant amount of goodwill on the
consolidated balance sheet, the Company believes that the combination of the two
entities will generate sufficient positive results to justify these amounts.
This is based on our evaluation of the experience and skill of the Loyalty Magic
personnel, the potential of the existing customer base and the future potential
of the Loyalty Magic sales pipeline.
The following table details the amortization of the intangibles:
Useful Life 2111 to
Annual Totals Value (Years) Method * 2005 2006 2007 2008 2009 2010 2029
- ------------- ---------- ----------- -------- -------- -------- -------- -------- -------- -------- --------
Trademarks $ 566,700 30 SL $ 6,296 $ 18,888 $ 18,888 $ 18,888 $ 18,888 $ 18,888 $465,964
Software 644,800 5 CF based 49,887 166,236 163,764 137,580 92,604 34,729 --
Customer Contracts 285,100 5 CF based 30,991 80,580 69,888 52,140 35,028 16,473 --
Customer Relationships 278,400 10 CF based 23,823 48,168 43,092 38,028 32,952 27,888 64,449
Non-compete agreements 158,300 5 SL 10,552 31,656 31,656 31,656 31,656 21,124 --
---------- -------- -------- -------- -------- -------- -------- --------
Totals $1,933,300 $121,549 $345,528 $327,288 $278,292 $211,128 $119,102 $530,413
========== ======== ======== ======== ======== ======== ======== ========
(* - SL = Straight line CF based = Cash flow based)
Pro forma information for the Company and Loyalty Magic as if the acquisition
had been completed on January 1, 2005 is as follows:
Three Month Period Nine Month Period Ended
Ended Sept. 30, 2005 Sept. 30, 2005
-------------------- -----------------------
(unaudited) (unaudited)
Revenue $ 456,573 $ 1,616,682
Net Loss $(1,536,911) $(2,920,841)
Loss per share $ (0.72) $ (1.38)
7. MANAGEMENT PLANS
Catuity's primary business is providing a hosted loyalty and gift card
processing solution for chain retailers and their partners. Our focus is
primarily on retail organizations with 50 to 250 stores, a group commonly
referred to as tier two retailers, and on smaller, tier three retailers through
resellers. We offer member-based loyalty programs at the point-of-sale and gift
card programs. These programs are designed to help retailers improve customer
retention, add new customers and increase each customer's average spend amount.
Our operational priorities as a Company are in three areas.
Loyalty and Gift Card Processing: We believe the U.S. reseller market is
adopting the type of technology that Catuity offers. There is an apparent demand
for a turnkey solution for small to mid-sized chains and small merchants through
re-sellers, including merchant services companies, Independent Sales
Organizations, marketing companies and operators of coalition loyalty programs
in local markets. This is a good fit for Catuity because we believe that we have
an efficient product with an operational service capability that provides
turnkey outsourcing to resellers. This gives us the ability to leverage
Catuity's fixed costs faster than by selling exclusively to chain retailers.
Packaged Loyalty and Gift Card Products: Catuity also sells packaged products to
broaden our offering to retailers. We believe there is demand in the chain world
for packaged products, such as bundled loyalty, gift card and
F-27
payments processing services. Packaged products are generally co-branded with
the retailer, offered with a fixed set of benefits to the consumer, and at a
pre-determined cost per unit to the retailer. It is important to note that
introducing product packages does not require significant new development of our
technology.
Mergers and Acquisitions: Acquiring a profitable operating business remains
important to our strategy. Catuity continues to seek the acquisition of
complementary businesses such as traditional loyalty services and/or database
marketing firms to expand our range of products and services. Catuity's
technology generates a robust stream of information and our prospective clients
often rely on others to manage and maximize this type of data.
The Company had $639,707 in cash as of September 30, 2006.
On November 22, 2006, Catuity completed a $2,250,000 raise of new capital in the
form of notes convertible into shares of common stock, warrants and the issuance
preferred stock convertible into common stock. The capital is being used to fund
company operations, including the expansion of our sales and marketing function
in the U.S. We believe that the capital we have raised will enable us to support
our sales strategy into 2007. The company plans to raise additional capital in
2007.
The Company believes that in addition to funds currently on hand, together with
existing revenue opportunities and capital resources, funds from additional
financing activities (such as an acquisition or another capital raise) will be
needed in order to finance anticipated liquidity needs through 2007.
F-28
INDEPENDENT AUDITOR'S REPORT
The Directors
Loyalty Magic Pty Ltd
5th Floor, 140 Bourke Street
MELBOURNE VIC 3000
We have audited the accompanying balance sheet of Loyalty Magic Pty Ltd as of
30th June, 2005 and 30 June, 2004, and the related statements of profit and loss
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the auditing standards generally
accepted in the United States of America. 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 financial position of Loyalty Magic Pty Ltd at 30th
June, 2005 and 2004, and the results of its operations and its cash flows for
the years then ended in conformity with accounting principles generally accepted
in the United States of America, except for the following matter which is
referred to at Note 1 to the Financial Statements -
CONFORMITY WITH UNITED STATES OF AMERICA (US) GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES (GAAP)-
In order to comply with the provisions of US GAAP, capitalised Web Development
Costs, $70,017 (2004 - $54,391) and Development Costs of New Platform, $209,173
(2004 - $Nil), (refer to Notes 1 and 7), should be written off as expenses in
the year in which they are incurred. This adjustment would reduce the company's
net profit for the year by $224,799 (2004 - $54,391) and reduce net assets at
30th June, 2005 by $279,190 (2004 - $54,391).
MCINNES GRAHAM & GIBBS
/s/ Jeffrey E Graham
----------------------------------------
Jeffrey E Graham
Partner
16th December 2005
F-29
LOYALTY MAGIC PTY LIMITED
A.C.N. 075 350 239
DECLARATION BY DIRECTORS
The directors have determined that the company is not a reporting entity, but
that this special purpose financial report should be prepared in accordance with
the accounting policies described in Note 1 to the financial statements.
The directors of the company declare that the financial statements and notes as
set out in the attached accounts:
(a) comply with Accounting Standards as described in Note 1 to the financial
statements and the Corporations Regulations 2001; and
(b) give a true and fair view of the company's financial position as at 30 June
2005 and of its performance for the year ended on that date in accordance with
the accounting policies described in Note 1 to the financial statements.
In the directors' opinion:
(a) the financial statements and notes, as set out in the attached accounts are
in accordance with the Corporations Act 2001; and
(b) there are reasonable grounds to believe that the company will be able to pay
its debts as and when they become due and payable.
Made in accordance with a resolution of the directors.
DIRECTOR _______________________
DIRECTOR _______________________
Date this ______ day of _____________ 2005
F-30
LOYALTY MAGIC PTY LIMITED
BALANCE SHEET
AS AT 30TH JUNE 2005
2005 2004
NOTE $ $
---- ---------- ----------
CURRENT ASSETS
Cash 2 43,446 659,991
Receivables 3 855,159 450,248
Investments 4 4 4
Other 5 7,611 30,795
--------- ---------
TOTAL CURRENT ASSETS 906,220 1,141,038
--------- ---------
NON-CURRENT ASSETS
Property, plant and equipment 6 220,886 157,816
Intangibles 7 280,963 54,391
--------- ---------
TOTAL NON-CURRENT ASSETS 501,849 212,207
--------- ---------
TOTAL ASSETS 1,408,069 1,353,245
========= =========
CURRENT LIABILITIES
Accounts Payable 8 168,638 149,461
Borrowings 9 34,672 34,242
Provisions 10 137,684 243,301
Other 11 117,909 133,470
--------- ---------
TOTAL CURRENT LIABILITIES 458,903 560,474
========= =========
NON-CURRENT LIABILITIES
Borrowings 9 67,817 --
Provisions 10 10,617 --
--------- ---------
TOTAL NON-CURRENT LIABILITIES 78,434 --
--------- ---------
TOTAL LIABILITIES 537,337 560,474
========= =========
NET ASSETS (LIABILITIES) 870,732 792,771
========= =========
EQUITY
Issued capital 12 2,699,429 2,699,029
Accumulated losses (1,828,697) (1,906,258)
---------- ----------
TOTAL EQUITY 870,732 792,771
========== ==========
F-31
LOYALTY MAGIC PTY LIMITED
PROFIT & LOSS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
NOTE $ $
---- ---------- ----------
NET PROFIT(LOSS) BEFORE INCOME TAX (163,999) 236,693
Income Tax Expense 241,560 57,728
---------- ----------
NET PROFIT(LOSS) AFTER INCOME TAX 77,561 294,421
Retained Profits (Accumulated Losses) at
the beginning of the Financial Year (1,906,258) (2,200,679)
---------- ----------
TOTAL AVAILABLE FOR APPROPRIATION (1,828,697) (1,906,258)
---------- ----------
RETAINED PROFITS (ACCUMULATED LOSSES)
AT END OF FINANCIAL YEAR (1,828,697) (1,906,258)
========== ==========
LOYALTY MAGIC PTY LIMITED
PROFIT AND LOSS ACCOUNT
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
$ $
--------- ---------
SALES
ASP Sales 2,131,431 1,899,456
Subscription Services 113,031 11,475
License Income 252,137 617,259
Support Services 259,173 180,319
International Sales 90,000 73,600
--------- ---------
2,845,772 2,782,109
LESS: DIRECT COSTS
Purchases 117,292 149,061
Contract Data Entry 217,387 243,106
Terminal Costs 25,500 40,616
--------- ---------
360,179 432,783
--------- ---------
GROSS PROFIT FROM TRADING 2,485,593 2,349,326
EXPENDITURE 2,667,750 2,131,849
--------- ---------
(182,157) 217,477
OTHER INCOME
Interest Received 9,908 14,266
Government Subsidies 8,250 4,950
--------- ---------
18,158 19,216
--------- ---------
NET (PROFIT)LOSS 163,999 (236,693)
========= =========
F-32
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
1 STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES
This financial report is a special purpose financial report prepared for the use
by the members and directors of the company. Although the directors have
determined that the company is not a reporting entity, the report has been
prepared in accordance with Accounting Standards, Urgent Issues Group Consensus
Views, other authoritative pronouncements of the Australian Accounting Standards
Board and the Corporations Act 2001.
The report is also prepared on an accruals basis and is based on historic cost
and does not take into account changing money values or, except where
specifically stated, current valuations of non-current assets. The following
material accounting policies, which are consistent with the previous period
unless otherwise stated, have been adopted in the preparation of this report:-
(a) INCOME TAX
The company adopts the liability method of tax effect accounting whereby the
income tax expense is based on the operating profit adjusted for any permanent
differences.
Future income tax benefits are not brought to account unless realisation of the
asset is assured beyond any reasonable doubt. Future income tax benefits in
relation to tax losses are not brought to account unless there is virtual
certainty of realisation of the benefit.
(b) PROPERTY, PLANT AND EQUIPMENT
Each class of property, plant and equipment is accounted for at cost less
accumulated depreciation, and is depreciated on a diminishing value basis over
the expected useful lives to the company.
(c) INTANGIBLES
Web Site development costs are capitalised until completion of the relevant
platform, then amortised on a straight line basis over the period during which
the site is expected to benefit the company.
(d) EMPLOYEE ENTITLEMENTS
Provision is made for employee entitlements arising from services rendered by
employees to balance date.
(e) GOODS AND SERVICES TAX
Revenues, expenses and assets are recognised net of the amount of goods and
services tax (GST), except where the amount of GST incurred is not recoverable
from the Australian Tax Office (ATO). In these circumstances the GST is
recognised as part of the cost of acquisition of the asset or as part of the
cost of the expense.
The net amount of GST recoverable, or payable to, the ATO is included as a
current asset or liability in the balance sheet.
F-33
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
1 STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(f) REVENUE RECOGNITION
MAIN AREAS OF INCOME
(i) Application Service Provision Income
Fixed Charge Management fees - Invoiced monthly and brought to account monthly
Variable Fees - Invoiced monthly based on volume of transactions processed
(ii) Licensed Income
Customisation of Software - Taken up as unearned income and brought to account
as revenue, on completion of agreed milestones.
Support Fees - Invoiced in advance, taken up as unearned income and transferred
to revenue depending on the contract terms.
Upgrade rights - Invoiced annually in advance, taken up as unearned income and
transferred to revenue monthly on a straight line basis.
(g) LEASES
Leases of fixed assets, where substantially all the risks and benefits
incidental to the ownership of the asset, but not legal ownership, are
transferred to the company are classified as finance leases.
Finance leases are capitalised recording an asset and a liability equal to the
present value of the minimum lease payments, including any guaranteed residual
value.
Leased assets are depreciated on a straight line basis over their estimated
useful lives where it is likely that the economic entity will obtain ownership
of the asset or over the term of the lease.
Lease payments are allocated between the reduction of the lease liability and
the lease interest expense for the period.
CONFORMITY WITH UNITED STATES OF AMERICA (US) GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (GAAP)
In order to comply with the provisions of US GAAP, capitalised Web Development
Costs, $70,017 (2004 - $54,391) and Development Costs of New Platform, $209,173
(2004 - $Nil) (refer to Note 7), should be written off as expenses in the year
in which they are incurred. This adjustment would reduce the company's net
profit for the year by $224,799 (2004 - $54,391) and reduce net assets at 30th
June, 2005 by $279,190 (2004 - $54,391).
F-34
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
$ $
--------- ---------
2 CASH
Petty Cash 200 200
Cash at Bank 43,246 659,791
-------- ---------
43,446 659,991
======== =========
3 RECEIVABLES
CURRENT
Trade Debtors 633,599 407,520
Less: Provision for Doubtful Debts (80,000) (30,000)
-------- ---------
553,599 377,520
-------- ---------
Sundry Debtors 286,560 57,728
Rental Bond 15,000 15,000
-------- ---------
855,159 450,248
======== =========
4 INVESTMENTS
CURRENT
Shares in Associated Companies 4 4
======== =========
5 OTHER ASSETS
CURRENT
Prepayments 7,611 30,795
======== =========
F-35
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
$ $
--------- ---------
6 PROPERTY, PLANT & EQUIPMENT
Office Furniture & Equipment at
Cost 366,722 416,163
Less: Accumulated Depreciation (220,393) (258,347)
--------- ---------
146,329 157,816
--------- ---------
Leased Assets at Cost 92,556 --
Less: Accumulated Amortisation (17,999) --
--------- ---------
74,557 --
-------- --------
TOTAL PROPERTY, PLANT & EQUIPMENT 220,886 157,816
========= =========
7 INTANGIBLES
Development of New Platform -
at cost 209,173 --
Patents & Trademarks 1,773 --
Web Development - at cost 84,020 54,391
Less: Accumulated Amortisation (14,003) --
--------- ---------
70,017 54,391
--------- ---------
280,963 54,391
========= =========
8 ACCOUNTS PAYABLE
CURRENT
Sundry Creditors 44,903 27,198
Trade Creditors 123,735 122,263
--------- ---------
168,638 149,461
======== ========
9 BORROWINGS
CURRENT
GST Payable 34,672 34,242
========= =========
NON-CURRENT
Lease Liability 67,817 --
========= =========
F-36
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
$ $
--------- ---------
10 PROVISIONS
CURRENT
Provision for Annual Leave 104,635 81,654
Provision for Bonuses 33,049 161,647
NON CURRENT
Provision for Long Service Leave 10,617 --
--------- ---------
Aggregate employee entitlement
liability 148,301 243,301
========= =========
11 OTHER LIABILITIES
CURRENT
Income in Advance 117,909 133,470
========= =========
12 ISSUED CAPITAL
PAID UP CAPITAL:
Issued Capital 2,699,429 2,699,029
========= =========
13 EXPENDITURE
Salaries 1,460,293 1,156,712
General and Administrative 1,207,457 975,137
--------- ---------
Total Expenditure 2,667,750 2,131,849
========= =========
14 INCOME TAX EXPENSE
No income tax is payable on the net profit for the year as the company has
accumulated losses available as an income tax deduction from prior years.
Future income tax benefits not brought to account, the benefits of which
will only be realised if the relevant conditions for deductibility occur:
- timing differences 34,576 24,496
- tax losses 66,643 243,053
--------- ---------
Total 101,219 267,549
========= =========
Further, the company is entitled to receive a grant of $241,560 (2004 - $57,728)
from the Australian Taxation Office in respect of research and development
expenditure for the year ended 30 June 2005.
F-37
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
NOTE $ $
---- -------- --------
15 STATEMENT OF CASH FLOWS
RECONCILIATION OF OPERATING PROFIT TO NET CASH
INFLOW FROM OPERATING ACTIVITIES
Operating profit/(loss) after income tax 77,561 294,421
Depreciation expense 51,875 41,044
CHANGE IN OPERATING ASSETS AND LIABILITIES
(Increase)/Decrease in trade and other receivables (221,079) 109,438
(Increase)/Decrease in prepayments 23,184 (21,985)
Increase/(Decrease) in trade and other creditors 19,607 42,224
Increase/(Decrease) in borrowings -- (44,948)
Increase/(Decrease) in provisions (95,000) (75,871)
Increase/(Decrease) in unearned income (15,561) 2,887
Increase/(Decrease) in provision for income tax (183,832) 326,402
-------- --------
Net cash flow from operating activities (343,245) 673,612
======== ========
During the financial year the company acquired property, plant and equipment
with a cost of $92,556, by means of finance leases, these acquisitions are not
reflected in the Statement of Cash Flows.
16 CAPITAL AND LEASING COMMITMENTS
Finance Lease Commitments Payable
- not later than 1 year 33,588 --
- later than 1 year but not later than 5 yrs 35,241 --
- later than 5 years -- --
-------- --------
Minimum lease payments 68,829
Less future finance charges (1,011)
-------- --------
Total Lease Liability 9 67,818 --
======== ========
Operating Leases Commitments Payable
- no later than 1 year 66,938 63,548
- later than 1 year but not later than 5 years 76,428 143,365
- later than 5 years -- --
-------- --------
Total Lease Liability 143,365 206,914
======== ========
F-38
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
$ $
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Receipts from customers 2,617,382 2,899,384
Payments to suppliers and employees (3,024,948) (2,621,208)
Interest Received 9,907 14,266
Interest Paid (3,314) (2,960)
Income Tax Refund 57,728 384,130
---------- ----------
NET CASH INFLOW FROM OPERATING ACTIVITIES 15 (343,245) 673,612
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for property, plant and equipment (21,700) (61,833)
Proceeds from sale of property, plant and equipment -- --
Payments for Web Development (226,572) (54,391)
---------- ----------
NET CASH OUTFLOW FROM INVESTING ACTIVITIES (248,272) (116,224)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issue of Ordinary Shares 400 538
Repayment of lease liabilities (25,428) --
---------- ----------
Net cash inflow/(outflow) from financing activities (25,028) 538
Net increase/(decrease) in cash held (616,545) 557,926
Cash at the beginning of the financial year 2 659,991 102,065
---------- ----------
CASH AT THE END OF THE FINANCIAL YEAR 2 43,446 43,446
========== ==========
F-39
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005
The following unaudited pro forma Statement of Operations has been derived from
historical financial statements of Catuity, Inc, ("Catuity") and Loyalty Magic
Pty. Ltd. ("Loyalty Magic"), adjusted to give pro forma effect to the
acquisition of Loyalty Magic by Catuity (the "Transaction") as if the companies
had been combined for the full year ended December 31, 2005. Catuity completed
its acquisition of Loyalty Magic on September 1, 2005, has previously filed a
Current Report on Form 8-K concerning such transaction on September 7, 2005, and
filed an amended Current Report on Form 8-K/A on November 14, 2005.
The unaudited pro forma Statement of Operations for the year ended December 31,
2005 is presented for informational purposes only and does not purport to
represent what our results would actually have been had the Transaction occurred
at the beginning of 2005 or to project our results of operations for any future
period or date.
The pro forma adjustments are based upon available information and various
assumptions that we believe are reasonable. The pro forma adjustments are
described in the accompanying notes. The acquisition of Loyalty Magic has been
accounted for using the purchase method of accounting.
- --------------------------------------------------------------------------------------------------------------
CATUITY AND LOYALTY MAGIC LOYALTY MAGIC CATUITY PRO-FORMA COMBINED
PRO FORMA IN USD IN USD ADJUSTMENT (1) IN USD
-------------------------------------------------------------
STATEMENT OF OPERATIONS JAN.1 -- AUG.
YEAR ENDED DECEMBER 31, 2005 31, 2005 2005 2005
-------------------------------------------------------------
Revenue:
Processing 112,076 510,826 622,902
Service revenue 1,263,995 404,611 1,668,606
License revenue 20,199 65,485 85,684
------------------------------------------------------------
Total Revenue 1,396,270 980,922 2,377,192
------------------------------------------------------------
Cost of Revenue and Other Operating Expenses:
Cost of Processing Revenue 400,094 533,163 933,257
Cost of Service revenue 457,221 233,056 690,277
Cost of License revenue 0 21,384 21,384
Cost of Revenue Amortization of Intangibles 0 49,886 144,429 194,315
Cost of Revenue Stock Based Comp 0 19,770 19,770
Research and Development 218,751 728,108 946,859
Research and Development Stock Based Comp 0 23,571 23,571
Sales and Marketing 134,827 592,498 727,325
Sales and Marketing Stock Based Comp 0 35,305 35,305
Sales and Marketing Amortization of Intangibles 0 54,813 158,694 213,507
General & Administration 612,066 1,685,152 2,297,218
General & Administration Stock Based Comp 0 77,050 77,050
General & Administration Amortization of
Intangibles 0 16,848 48,777 65,625
------------------------------------------------------------
Total Costs and Expenses 1,822,959 4,070,604 351,900 6,245,463
Operating income/(loss) (426,689) (3,089,682) (351,900) (3,868,271)
Interest Income 4,910 108,652 0 113,562
Income tax (expense)/benefit 52,091 0 0 52,091
------------------------------------------------------------
Net Income/(Loss) (369,688) (2,981,030) (351,900) (3,702,618)
------------------------------------------------------------
Net loss per share-basic & diluted N/A ($2.48) ($1.79)
Weighted average shares outstanding-basic &
diluted NA 1,203,584 2,069,039
- -------------------------------------------------------------------------------------------------------------
</Table>
1) Pro-forma adjustments represent amortization of intangibles in
conjunction with the acquisition of Loyalty Magic.
F-40