Exhibit 99.1
APPENDIX 4E
PRELIMINARY FINAL REPORT
FULL YEAR ENDED DECEMBER 31, 2006
CATUITY INC.
ARBN 089 327 882
APPENDIX 4E
PRELIMINARY FINAL REPORT
FULL YEAR ENDED DECEMBER 31, 2006
CONTENTS
RESULTS FOR ANNOUNCEMENT TO THE MARKET 2
SUPPLEMENTARY APPENDIX 4E INFORMATION 2
FINANCIAL STATEMENTS, FOOTNOTES AND COMMENTARY ON RESULTS 3
Lodged with the ASX under Listing Rule 4.3A
1
APPENDIX 4E
PRELIMINARY FINAL REPORT
FULL YEAR ENDED DECEMBER 31, 2006
RESULTS FOR ANNOUNCEMENT TO THE MARKET
IN USD
$000
--------
Revenues from ordinary activities Up 99% To $ 1,949
(Consolidated Statement of Operations)
Loss from ordinary activities after tax Up 47% To $(4,380)
attributable to members
(Consolidated Statement of Operations)
Net Loss for the period attributable to members Up 47% To $(4,380)
(Consolidated Statement of Operations)
DIVIDENDS
The Company has not paid dividends in the past and does not anticipate paying
any dividends during 2006.
EXPLANATION OF REVENUE
Revenue includes processing and service revenue, licence revenue and project
related revenue as shown in the Consolidated Statement of Operations.
EXPLANATION OF NET PROFIT/(LOSS)
Refer to Commentary on Results
SUPPLEMENTARY APPENDIX 4E INFORMATION
2006 2005
USD $'000 USD $'000
--------- ---------
RETAINED EARNINGS
Accumulated losses at the beginning of the
financial period (37,246) (34,265)
Net profit/ (loss) for the year (4,380) (2,981)
Dividends paid during the year (389) --
Accumulated losses at the end of the financial
period (42,015) (37,246)
2006 2005
USD USD
------- ------
NTA BACKING
Net tangible asset backing per common share $ 1.13 $ 2.93
EPS
Earnings/ (loss) per security (basic and
diluted) $(2.02) $(2.48)
2
APPENDIX 4E
PRELIMINARY FINAL REPORT
FULL YEAR ENDED DECEMBER 31, 2006
CONTROL ENTITIES ACQUIRED OR DISPOSED
On 1 September 2005 the Company completed the acquisition of 100% of the stock
of Loyalty Magic Pty. Ltd. At that time, Loyalty Magic became a wholly owned
subsidiary of Catuity Inc. The purchase price for the acquisition was
A$3,600,000 plus 335,000 shares of Catuity common shares. The operating results,
assets, and liabilities of the combined companies have been consolidated from 1
September 2005.
Refer to the Commentary on Results for additional information regarding Loyalty
Magic.
ASSOCIATES AND JOINT VENTURES
The Company did not participate in any material joint ventures or associations
with other organisations.
ACCOUNTING STANDARDS
The Company's accounts are prepared in conformance with US GAAP.
AUDIT OF ACCOUNTS
This Appendix 4E report is based on accounts which are in the process of being
audited by the Company's independent auditors.
3
CATUITY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(all figures in USD)
DECEMBER 31
---------------------------
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,993,910 $ 958,746
Short term investments 0 2,245,839
Accounts receivable-trade, less allowance of
$235,000 in 2006, and $122,000 in 2005 390,116 543,200
Restricted cash 85,523 81,443
Work in process 0 39,760
Prepaid expenses and other 541,612 159,797
------------ ------------
TOTAL CURRENT ASSETS 3,011,161 4,028,785
------------ ------------
LONG TERM ASSETS:
Property and equipment, net 294,424 273,941
Notes Receivable LT 35,548 0
Deferred Financing Costs 338,395 0
Goodwill 3,142,420 3,004,667
Other intangible assets, net 1,532,898 1,811,752
------------ ------------
TOTAL LONG TERM ASSETS 5,343,685 5,090,360
------------ ------------
TOTAL ASSETS $ 8,354,846 $ 9,119,145
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 337,887 $ 175,643
Deferred revenue 80,957 114,721
Accrued compensation 345,473 98,160
Taxes, other than income 86,829 98,330
Other accrued expenses 263,459 150,412
Trust liability 85,523 81,443
------------ ------------
TOTAL CURRENT LIABILITIES 1,200,128 718,709
------------ ------------
LONG TERM LIABILITIES:
Leasing Liability 0 4,861
Accrued compensation 39,036 56,009
------------ ------------
TOTAL LONG TERM LIABILITIES 0 60,870
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock -- $.001 par value; Authorized -
6,666,667 shares: 2,257,770 shares issued
and 2,242,343 shares outstanding, 2,111,807
issued and outstanding in 2006 2,242 2,112
Preferred stock -- $0.001 par value;
Authorized - 666,667 shares 630,000 0
Warrants 606,269 0
Additional paid-in capital 47,698,826 45,797,503
Shareholder loans 0 (16,738)
Deferred equity compensation 0 (131,566)
Foreign currency translation adjustment 193,636 (65,589)
Accumulated deficit (42,015,292) (37,246,156)
TOTAL SHAREHOLDERS' EQUITY 7,115,681 8,339,566
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 8,354,846 $ 9,119,145
============ ============
See accompanying notes to condensed consolidated financial statements
4
CATUITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(all figures in USD)
YEAR ENDED DECEMBER 31
-------------------------
2006 2005
----------- -----------
REVENUES:
Processing $ 1,409,698 $ 510,826
Service 354,815 404,611
License 184,287 65,485
----------- -----------
TOTAL REVENUES 1,948,800 980,922
----------- -----------
COST OF REVENUE AND OTHER OPERATING EXPENSES:
Cost of processing revenue 1,770,500 533,163
Cost of service revenue 298,632 233,056
Cost of license revenue 0 21,384
Cost of revenue - amortization of intangibles 176,407 49,886
Cost of revenue - stock-based compensation 79,351 19,770
Research and development 465,321 728,108
Research and development - stock-based compensation 51,275 23,571
Sales and marketing 992,806 592,498
Sales and marketing - amortization of intangibles 137,368 54,813
Sales and marketing - stock-based compensation 7,229 35,305
General and administrative 2,254,959 1,685,152
General and administrative - amortization of intangibles 53,713 16,848
General and administrative - stock based compensation 417,973 77,050
----------- -----------
TOTAL COSTS AND EXPENSES 6,705,534 4,070,604
----------- -----------
OPERATING LOSS (4,756,734) (3,089,682)
Other income 270,469
INTEREST INCOME 106,097 108,652
----------- -----------
NET LOSS $(4,380,168) $(2,981,030)
NET LOSS PER SHARE -- BASIC & DILUTED $ (2.02) $ (2.48)
WEIGHTED AVERAGE SHARES OUTSTANDING--BASIC & DILUTED 2,161,852 1,203,584
See accompanying notes to condensed consolidated financial statements
5
CATUITY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(all figures in USD)
YEAR ENDED DECEMBER 31
-------------------------
2006 2005
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(4,380,168) $(2,981,030)
Adjustments used to reconcile net loss to net cash used
in operating activities:
Stock based compensation 555,828 155,694
Depreciation and amortization 501,429 217,751
In Process Research and Development 0 205,900
Changes in assets and liabilities:
Accounts receivable 153,084 (54,770)
Accounts payable 162,244 (167,330)
Deferred revenue (33,764) (78,618)
Accrued expenses and other liabilities 331,211 (344,740)
Other assets (290,428) 245,453
----------- -----------
Net cash used in operating activities (3,000,564) (2,801,690)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (154,424) (52,691)
Sale of Assets 0 --
Short Term Investments 2,245,839 (2,245,839)
Acquisition net of cash acquired 0 (2,810,280)
----------- -----------
Net cash used in investing activities 2,091,415 (5,108,810)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issue of common stock, net of expenses (99) 6,460,184
Repayment of fractional shares related to reverse
stock split (31) (1,104)
Deferred financing costs (338,395)
Proceeds from capital raise 2,250,000
Net cash provided by financing activities 1,911,475 6,459,080
Foreign exchange effect on cash 32,838 (150,517)
Net increase/(decrease) in cash and cash equivalents 1,035,164 (1,601,937)
Cash and cash equivalents, beginning of period 958,746 2,560,683
Cash and cash equivalents, end of period $ 1,993,910 $ 958,746
Non cash investing & financing activities:
Shares Issued in Acquisition $ 0 $ 2,512,000
See accompanying notes to condensed consolidated financial statements
6
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
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 rateably 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.
Service revenue also includes project related revenue which consists of
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.
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.
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.
7
SHORT TERM INVESTMENTS
In 2006 the Company invested in short-term bank commercial paper with an
original maturity greater than three months. At December 31, 2006 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 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, and are 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 2006.
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.
8
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.
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 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.
9
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consists of:
DECEMBER 31
-----------------------
2006 2005
---------- ----------
Computer equipment $1,035,295 $ 858,821
Leasehold improvements 70,736 65,431
Office furniture and equipment 108,682 98,536
Capital Leases 73,054 67,575
---------- ----------
Gross property and equipment $1,287,767 $1,090,363
Less accumulated depreciation (993,343) (816,422)
---------- ----------
Net property and equipment $ 294,424 $ 273,941
---------- ----------
NOTE 4. COMMITMENTS AND CONTINGENCIES
On December 6, 2006 the Company entered into an employment contract with Debra
Hoopes, the Company's new CFO and Sr. Vice President, which took effect January
2, 2007 and ends December 31, 2009. Under the terms of the agreement if Ms.
Hoopes is terminated without cause she is entitled to 12 months' salary
($185,000), and if so terminated after a "Change in Control" she is entitled to
the greater of 12 months' salary or the balance for the term of the agreement.
If she is terminated with cause or resigns without good cause compensation is
paid up to the termination date.
In September, 2005 the Company entered into employment agreements with Chris
Leach, then CEO of Loyalty Magic, John H. Lowry, then 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. Mr. Leach resigned
as CEO of Loyalty Magic on January 30, 2007 and his employment terminates on
February 28, 2007. Mr. Lowry resigned as CFO of Catuity on January 2, 2007 and
will continue as an employee until his contract expires. 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 12 months' salary
($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 $21,875.
NOTE 5. SHAREHOLDERS' EQUITY
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.
PREFERRED STOCK
The Company's Certificate of Incorporation authorizes 666,667 shares of
preferred stock, with a par value of $0.001 per share, 700 preferred shares were
issued by the board in November 2006 and these are the only outstanding
preferred shares at the time of this filing. 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.
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. The adoption of SFAS No. 123(R) had a
significant impact on the Company's results of
10
operations. The Company's consolidated statement of operations for the twelve
months ended December 31, 2006 and December 31, 2005 includes $158,275 and
$31,492 of stock-based compensation expense respectively. Stock-based
compensation expense for the twelve months ended December 31, 2006 and December
31, 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 December 31,
2006. We expect to expense $122,000 of that total in the remaining three months
of 2006.
Additionally, for awards granted prior to January 1, 2006 and that were not
fully vested, the Company recognizes compensation expense for the outstanding
portions of the awards using the modified prospective method of adoption for pro
forma disclosures under SFAS No. 123 and 148. 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 12 month period ended December 31, 2006.
EMPLOYEE AND DIRECTOR STOCK-BASED COMPENSATION PLANS
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 December 31, 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.
For the 12 month period ended December 31, 2006, the effects of applying the
provisions of SFAS 123(R) on the Company's operating results were as follows:
TWELVE MONTHS ENDED DECEMBER 31, 2006
---------------------------------------
As if under SFAS 123(R)
APB 25 adjustments As Reported
----------- ----------- -----------
Net income (loss) ($2,992,282) ($471,303) ($3,463,585)
Cash flow from operating activities ($2,920,398) 471,303 (2,449,095)
Loss per share: basic and diluted ($1.40) ($0.22) ($1.62)
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.
11
The following table sets forth the summary of option activity under the
Company's stock option program for the 12 month period ended December 31, 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 DECEMBER 31, 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 12 month period ended December 31, 2006
and 2005 were as follows:
TWELVE
MONTHS ENDED
DECEMBER 31,
-------------
2006 2005
----- -----
Weighted Average Fair Value $1.85 $4.58
A summary of the changes in the Company's nonvested shares during the twelve
months ended December 31, 2006 is presented below:
WEIGHTED
AVERAGE
GRANT DATE
SHARES FAIR 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 DECEMBER 31, 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 December 31, 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
Number Weighted Average Number Remaining
Range of Outstanding at Remaining Contractual Weighted Average Outstanding Contractual Weighted Average
Exercise Price Dec. 31, 2006 Life (Years) Exercise Price at Dec. 31, 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 December 31, 2006 was -$4,439,000 and -$3,662,000, respectively. The
intrinsic value is calculated as the difference between the market value as of
December 31, 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
12
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.
A summary of the unvested restricted stock as of December 31, 2007, 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 DECEMBER 31, 2006 160,627 $ 9.23
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.
CAPITAL RAISE IN 2006
The Company's 2006 Financing consists of our issuance to two new investors,
Gottbetter Capital Master, Ltd. and BridgePointe Master Fund Ltd. ("Investors")
of an aggregate of (a) US$1.8 million face amount of 10% Senior Convertible
Notes, (b) 700 shares of Series A Convertible Preferred Stock (stated amount
US$1,000 per share, or US$700,000 in the aggregate), and (c) Warrants to acquire
357,143 shares of Common Stock (at an initial exercise price of US$3.58 per
share). We issued the foregoing at a discount of 10% off face or stated value,
for total cash in the amount of US$2.25 million. As approved by our stockholders
February 5, 2007, the Senior Notes and Preferred Shares will be convertible into
an aggregate of 769,230 shares of Common Stock, at a conversion price of US$3.25
per share. This approval also covers shares that may additionally be issuable
pursuant to certain "anti-dilution" rights included in the Senior Notes,
Preferred Shares and Warrants, as well as any shares that may be issued on
conversion of accrued and unpaid interest or dividends (as noted below).
On November 22, 2006, we concluded a definitive securities purchase agreement
with the Investors. Pursuant to the securities purchase agreement, we issued the
Preferred Shares, the Senior Notes and the Warrants, as follows:
Senior Preferred
Investor Notes Warrants Shares
- -------- ---------- -------- ---------
Gottbetter Capital Master, Ltd. $1,111,112 220,459 432.10
BridgePointe Master Fund Ltd. $ 688,888 136,684 267.90
This sale was made pursuant to claim of exemption from registration under
applicable U.S. and other securities laws. We received $2,250,000 in proceeds
from the 2006 Financing on November 22, 2006, and we have been using these cash
proceeds for working capital and capital expenditures. We may also use them for
other purposes including asset and/or business acquisitions, as and when needed.
We presently have no firm plans, proposals or arrangements to use proceeds for
any specific acquisition.
The 2006 Financing raised cash needed to sustain our continued operations for
the short term. In the absence of the 2006 Financing or another financing at
this same time in similar amount, our short-term liquidity and our ability to
continue operations would have been severely impaired. Our Board approved the
2006 Financing after management conducted extensive fund-raising efforts finding
it to be the best-available financing alternative to raise needed funds.
As approved by our stockholders on February 5, 2007, the 2006 Financing will
result in substantial dilution of current stockholders resulting from the
issuance of securities convertible into or exercisable for a total of 1,126,373
shares of Common Stock. This is approximately 50.3% of our currently outstanding
shares, and will constitute approximately 33.5% of our total of then-outstanding
shares of Common Stock.
13
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 2005 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.
The purchase price (In US Dollars) has been 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.
A portion of the purchase price represents 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.
14
The following table details the amortization of the intangibles:
2011 to
Annual Totals Value Method 2005 2006 -* 2007 2008 2009 2010 2029
- ------------- ---------- -------- -------- -------- -------- -------- -------- -------- --------
Trademarks $ 592,681 SL $ 6,296 $ 20,072 $ 19,756 $ 19,756 $ 19,756 $ 19,756 $487,289
Software 674,363 CF based 49,887 176,407 163,764 137,580 92,604 54,121 --
Customer Contracts 298,175 CF based 30,991 85,823 69,888 52,140 35,028 24,305 --
Customer Relationships 291,163 CF based 23,823 51,545 45,072 39,768 34,464 29,160 67,331
Non-compete agreements 165,557 SL 10,552 33,641 33,099 33,099 33,099 22,066 --
Totals $2,021,939 $121,549 $367,488 $331,579 $282,343 $214,951 $149,408 $554,620
(* - Adjusted for exchange rate fluctuation)
The amortization of Goodwill and Other Intangible Assets associated with the
transaction are currently not deductible for tax purposes.
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
------------------------
2006 2005
---------- -----------
Domestic (4,445,285) ($3,350,057)
Foreign 65,117 369,027
---------- -----------
Loss before income taxes (4,380,168) ($2,981,030)
========== ===========
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
-------------------------
2006 2005
----------- -----------
Income taxes at statutory tax rate $(1,489,257) $(1,013,550)
Variable stock compensation 188,982 --
Research & development credit 270,469
Utilization of operating loss carry forward (19,535) (110,708)
Valuation allowance 1,511,397 1,139,019
Other (462,056) (14,761)
Provision for income taxes $ -- $ --
15
The statutory tax rate was 34% in the United States and 30% in Australia for the
years ended December 31, 2005 and 2005. 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
---------------------------
2006 2005
------------ ------------
Deferred tax assets:
Net operating loss carry-forwards $ 13,653,669 $ 12,059,673
Other 195,787 108,188
------------ ------------
Total deferred tax assets 13,849,456 12,167,861
Deferred tax liabilities:
Intangibles (521,220) (616,080)
------------ ------------
Total deferred tax liabilities (521,220) (616,080)
Valuation allowance (13,328,236) (11,551,781)
------------ ------------
Total net deferred tax assets $ -- $ --
============ ============
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, 2006, the Company had net operating loss carry-forwards of
$24,503,000 expiring in various amounts in 2020 and 2021 in the United States
and $16,320,000 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, 2006 and 2005. The Company's contributions were $100,846 and $58,339 for the
years ended December 31, 2006 and 2005 respectively.
There is a 401-K plan available for employees in the U.S. In 2006 the Company
has accrued $41,986 for 2006 matching contributions to the 401-K plan.
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 $85,523 and $81,443 at December 31, 2006 and 2005,
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.
16
NOTE 10. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA
As of December 31, 2006, 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.
2006 2005
----------------------- ---------------------
LONG-LIVED NET LONG-LIVED NET
ASSETS REVENUES ASSETS REVENUES
---------- ---------- ---------- --------
U.S. $145,513 $ 235,563 $ 84,906 $ 77,618
Australia 148,911 1,713,237 189,035 903,304
-------- ---------- -------- --------
Total $294,424 $1,948,800 $273,941 $980,922
======== ========== ======== ========
Revenue from two of Loyalty Magic's customers each exceeded 10% of Catuity's
revenue and, in total, represented approximately 44% of revenue in 2006. In
2005, revenue from two of Loyalty Magic's customers each exceeded 10% of
Catuity's revenue and, in total, represented approximately 28% 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.
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 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 has $1,993,910 in cash as of December 31, 2006. At the annual
shareholders meeting in May 2006, shareholders approved the issuance of 400,000
shares of common stock at a minimum price of $6.25 per share. The Company did
not issue the authorized shares due to the decline in share price levels below
the required minimum price. As a result, pursuant to Australian Stock Exchange
(ASX) Listing Rules, shareholder approval to issue the shares expired on August
12, 2006 and the 400,000 shares were not issued.
On February 9, 2007 the Company filed a prospectus to allow the selling
stockholders of the 2006 Financing to offer for resale up to
17
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 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.
CATUITY INC.
COMMENTARY ON RESULTS
REVIEW OF OPERATIONS
Catuity's 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.
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 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.
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.
2006 Significant Activities
Sales Prospects
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 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.
18
Infrastructure
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, 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,
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.
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.
As announced on August 30th, 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, 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 anticipate that we will require additional working capital before
the end of the second quarter of 2007 to fund our business.
19
FISCAL YEAR ENDED 2006 COMPARED TO 2005 (all figures in USD and rounded to
nearest $1,000)
On 1 September 2005, Catuity completed its acquisition of Loyalty Magic Pty.
Ltd. As a result, Catuity's 2005 financial statements reflect twelve months of
Catuity's operations and four months of Loyalty Magic's operations.
Total revenues in 2006 were $1,949,000, an increase of $968,000 or 99%, over
2005. The increase relates to revenue from Loyalty Magic following its
acquisition on 1 September 2005 ($1,713,000 of 2006 revenue). Total revenues
were derived from $1,410,000 of processing and $355,000 of services revenues, a
change of $899,000 and -$50,000 respectively over 2005, and $184,000 of license
fees, an increase of $119,000 over 2005. As described above, on 1 September 2005
the Company completed its acquisition of Loyalty Magic, an Application Service
Provider (ASP) of loyalty and Customer Relationship Marketing (CRM) software and
services on a hosted basis, located in Melbourne Australia. The addition of
Loyalty Magic in 2005, resulted in the significant changes in the types of, and
ways in which, the Company generates revenue.
The total cost of processing and service revenues 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. The costs for processing revenue
increased 225% from $544,000 in 2005 to $1,771,000 in 2006 and the cost of
service revenue increased 19% from $250,000 in 2005 to $299,000 in 2006.
Cost of license revenue primarily consisted 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 to customers. Cost of license revenue decreased from $21,000 for the
year ended December 31, 2005 to zero for the year ended December 31, 2006.
Research and Development expenses consist primarily of salaries, employee
benefits and overhead cost, incurred primarily by our technical staff for the
portion of their time spent furthering the development of our various software
products. Research and development expenses decreased $236,000, or 31%, to
$517,000 for the year ended December 31, 2006 from $752,000 for the year ended
December 31, 2005. The decrease occurred because, beginning in 2004, the Company
made a significant investment to complete a new generation of the Company's
software that would support the Company's new business model. While the effort
carried over into 2006, less time was spent in 2006 than in 2005. The reduction
in cost between the two years was primarily due to reductions in overhead costs
($24,000) and lower salary and related costs ($92,000) in the Company's Sydney
office.
Sales and marketing expenses consist primarily of salaries, employee benefits,
travel, marketing, public relations and related overhead costs in sales and
marketing. Sales and marketing expenses increased $455,000, or 67%, to
$1,137,000 for the year ended December 31, 2006 from $683,000 for the year ended
December 31, 2005. The increase was primarily related to higher salary and
related costs ($289,000), increase in amortization of intangibles ($83,000),
increase in the allocation of CEO costs ($55,000), and an increase in consulting
expenses ($18,000).
General and Administrative (G&A) expenses consist primarily of salaries,
employee benefits, related overhead costs and professional service fees. G&A
expenses increased $959,000, or 67%, to $2,727,000 for the year ended December
31, 2006 from $1,767,000 for the year ended December 31, 2005. The increase is
primarily attributable to a significant increase in stock-based compensation
expense ($380,000) and salaries and related expenses ($406,000).
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