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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-QSB
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934.
For the quarterly period ended March 31, 2007.
[ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from _______ to _______
Commission File No: 000-30045
CATUITY INC.
(Exact Name of Small Business Issuer as specified in its charter)
Delaware 38-3518829
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
300 Preston Avenue, Suite 302
Charlottesville, VA 22902
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(434) 979-0724
Check whether the issuer (1) filed all reports required by Section 13 or 15(d)
of the Exchange Act during the past 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practical date:
Common stock outstanding - 2,344,986 shares as of May 1, 2007.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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1
CATUITY INC.
FORM 10-QSB
INDEX
Part I. FINANCIAL INFORMATION.............................................. 3
Item 1. Financial Statements............................................ 3
Consolidated Balance Sheets - March 31, 2007 and December 31,
2006.............................................................. 3
Consolidated Statements of Operations - Three months ended
March 31, 2007 and 2006........................................... 4
Consolidated Statements of Cash Flows - Three months ended
March 31, 2007 and 2006........................................... 5
Notes To Consolidated Financial Statements - March 31, 2007.......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 14
Item 3. Controls and Procedures......................................... 21
PART II. OTHER INFORMATION................................................. 23
Item 1. Legal Proceedings............................................... 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..... 23
Item 3. Defaults Upon Senior Securities................................. 23
Item 4. Submission of Matters to a Vote of Security Holders............. 23
Item 5. Other Information............................................... 23
Item 6. Exhibits........................................................ 23
SIGNATURES AND CERTIFICATIONS.............................................. 24
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CATUITY INC.
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2007 2006
------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 782,995 $ 1,993,910
Accounts receivable-trade, less allowance of
$283,000 in 2007 and $250,000 in 2006 369,419 390,116
Restricted cash 87,549 85,523
Non-income taxes receivable 69,221 290,711
Prepaid expenses and other 236,406 250,899
------------ ------------
TOTAL CURRENT ASSETS 1,545,590 3,011,159
------------ ------------
LONG TERM ASSETS:
Property and equipment, net 303,163 294,424
Notes receivable 23,947 35,548
Deferred financing costs, net 253,180 236,876
Goodwill 3,216,870 3,142,420
Other intangible assets, net 1,484,006 1,532,898
------------ ------------
TOTAL LONG TERM ASSETS 5,281,166 5,242,166
------------ ------------
TOTAL ASSETS $ 6,826,756 $ 8,253,325
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 262,750 $ 337,887
Deferred revenue 69,756 80,957
Accrued compensation 204,117 345,473
Taxes, other than income 50,132 86,829
Other accrued expenses 275,064 263,459
Senior convertible notes, net of discount of
$1,762,907 in 2007 and $1,794,710 in 2006 37,093 5,290
Trust liability 87,549 85,523
------------ ------------
TOTAL CURRENT LIABILITIES 986,461 1,205,418
------------ ------------
LONG TERM LIABILITIES:
Accrued compensation 43,638 39,036
------------ ------------
TOTAL LONG TERM LIABILITIES 43,638 39,036
------------ ------------
TOTAL LIABILITIES 1,030,099 1,244,454
------------ ------------
Commitments and Contingencies (Note 5) -- --
STOCKHOLDERS' EQUITY:
Common stock - $.001 par value; Authorized -
6,666,667 shares; 2,317,486 shares issued and
2,076,691 shares outstanding in 2007,
2,242,343 shares issued and 2,076,691
outstanding in 2006 2,317 2,242
Preferred stock - $0.001 par value; Authorized -
666,667 shares; 700 shares Series A issued and
outstanding in 2007 and 2006 450,187 450,187
Additional paid-in capital 48,407,196 48,299,469
Accumulated other comprehensive income 326,259 193,636
Accumulated deficit (43,389,302) (41,936,663)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 5,796,657 7,008,871
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,826,756 $ 8,253,325
============ ============
See accompanying notes to consolidated financial statements
3
CATUITY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------
2007 2006
----------- -----------
REVENUES:
Processing $ 335,919 $ 347,582
Service 68,442 114,585
License 14,809 18,280
----------- -----------
TOTAL REVENUES 419,170 480,447
COST OF REVENUE AND OTHER OPERATING EXPENSES:
Cost of processing revenue 507,474 381,146
Cost of service revenue 26,996 72,035
Cost of revenue - amortization of intangibles 47,445 41,559
Cost of revenue - stock based compensation 10,076 20,232
Research and development 76,083 127,070
Research and development - stock based compensation 5,720 8,910
Sales and marketing 249,074 225,395
Sales and marketing - amortization of intangibles 34,095 32,187
General and administrative 688,540 492,571
General and administrative - amortization of intangibles 15,254 12,636
General & administrative - stock based compensation 108,848 126,384
----------- -----------
TOTAL COSTS AND EXPENSES 1,769,605 1,540,125
----------- -----------
OPERATING LOSS (1,350,435) (1,059,678)
Interest income (expense), net (84,704) 32,334
----------- -----------
NET LOSS (1,435,139) (1,027,344)
Preferred stock dividends (17,500) --
----------- -----------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $(1,452,639) $(1,027,344)
=========== ===========
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS PER SHARE -
BASIC & DILUTED $ (0.64) $ (0.49)
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING-BASIC & DILUTED 2,281,400 2,111,807
=========== ===========
See accompanying notes to consolidated financial statements
4
CATUITY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------
2007 2006
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(1,435,139) $(1,027,344)
Adjustments used to reconcile net loss to net
cash used in operating activities:
Stock based compensation 124,644 139,106
Depreciation and amortization 189,596 103,611
Changes in assets and liabilities:
Accounts receivable 20,697 81,966
Accounts payable (75,137) (4,577)
Deferred revenue (11,201) 3,802
Accrued expenses and other liabilities (161,846) (16,168)
Other assets 187,462 43,033
----------- -----------
Net cash used in operating activities (1,160,924) (676,571)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (39,751) (10,311)
Short term investments -- 2,245,839
----------- -----------
Net cash provided by (used in) investing activities (39,751) 2,235,528
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid on preferred stock (17,500) --
Repayment of fractional shares related to reverse stock
split (8) (16)
----------- -----------
Net cash provided by (used in) financing activities (17,508) (16)
----------- -----------
Foreign exchange effect on cash 7,268 (12,127)
----------- -----------
Net increase/(decrease) in cash and cash equivalents (1,210,915) 1,546,814
Cash and cash equivalents, beginning of period 1,993,910 958,746
----------- -----------
Cash and cash equivalents, end of period $ 782,995 $ 2,505,560
=========== ===========
See accompanying notes to consolidated financial statements
5
CATUITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 2007
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(b) 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. The balance sheet as of December 31, 2006 has been derived
from the audited financial statements as of 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 month period ended March 31, 2007 are not necessarily indicative of the
results that may be expected for any subsequent quarter or for the year ended
December 31, 2007. 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, 2006.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2007, the Company adopted 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. The Company does not expect
the adoption of FIN 48 to have a material impact on its results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements"
("SFAS 157"). SFAS 157 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 February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities -- Including an amendment of FASB
Statement No. 115, ("SFAS 159"). SFAS 159 permits an entity, at specified
election dates, to choose to measure certain financial instruments and other
items at fair value. The objective of SFAS 159 is to provide entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently, without having to apply complex
hedge accounting provisions. SFAS 159 is effective for accounting periods
beginning after November 15, 2007. The Company is currently assessing any
potential impact of adopting this pronouncement.
3. COMPREHENSIVE INCOME/ (LOSS)
Comprehensive income / (loss) for the three months ended March 31, 2007 and 2006
are summarized below:
MARCH 31, MARCH 31,
2007 2006
----------- -----------
Net loss $(1,435,139) $(1,027,344)
Foreign currency translation 132,623 (12,127)
----------- -----------
Total comprehensive loss $(1,302,516) $(1,039,471)
=========== ===========
6
4. STOCK BASED COMPENSATION
Effective January 1, 2006, the Company adopted the provisions of SFAS 123(R),
Share-Based Payment, and adopted this standard using the modified prospective
method. Under the modified prospective method, compensation expense for
share-based awards granted prior to January 1, 2006 are recognized over the
remaining service period using the compensation cost calculated for pro forma
disclosure purposes under SFAS 123 and compensation expense for awards granted
after December 31, 2005 are based on the grant date fair value estimated in
accordance with the provisions of SFAS 123(R). Stock option valuations are
estimated by using the Black-Scholes option pricing model and restricted stock
awards are measured based on the market value of the Company's common stock on
the date of grant. The adoption of SFAS No. 123(R) had a significant impact on
the Company's results of operations. The Company's consolidated statements of
operations for the three months ended March 31, 2007 and 2006 includes $124,644
and $139,106 of stock-based compensation expense, respectively. Unrecognized
stock-based compensation expense expected to be recognized over an estimated
weighted-average amortization period of 4.49 years was $898,617 as of March 31,
2007.
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:
2007 2006
------------- --------------
Risk Free Interest Rate 4.46--4.87% 4.55--4.98%
Expected Dividend Yield -- --
Expected Lives (years) 5.5 -- 5.8 2.5 -- 5.0
Expected Volatility 89.9 -- 91.1% 90.4 -- 107.6%
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 did not affect the Company's net operating cash flows or its
net financing cash flows in the three month periods ended March 31, 2007 and
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:
DATE OF
SHARES STOCKHOLDER
PLAN NAME AUTHORIZED APPROVAL
- --------- ---------- -----------
The 2000 Employee Stock Option Plan (the "ESOP") 300,000 3/16/2000
The 2000 Non-employee Director Stock Option
Plan (the "DSOP") 58,667 5/21/2001
The 2005 Employee Restricted Stock Plan (the "ERSP") 267,000 7/18/2005
The 2005 Non-employee Director Restricted Stock Plan
(the "DRSP") 50,000 7/18/2005
As of March 31, 2007 a total of 357,711 options and 258,295 restricted shares
had been awarded, of which 270,848 options and 240,795 non-vested restricted
shares remained outstanding. 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.
7
The following table sets forth the summary of option activity under the
Company's stock option program for the three months ended March 31, 2007:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
------- --------
OUTSTANDING OPTIONS AT DECEMBER 31, 2006 255,848 $18.62
Granted 35,000 4.83
Forfeited (20,000) $15.62
-------
OUTSTANDING OPTIONS AT MARCH 31, 2007 270,848 $17.24
=======
The weighted average estimated grant date fair values of options granted under
the Company's stock option plans for the three months ended March 31, 2007 was
$2.28.
A summary of the changes in the Company's non-vested options during the three
months ended March 31, 2007 is presented below:
WEIGHTED
AVERAGE
GRANT
DATE
FAIR
SHARES VALUE
------- --------
NON-VESTED OPTIONS AT DECEMBER 31, 2006 89,095 $4.55
Granted 35,000 2.28
Vested (40,750) 4.37
Forfeited (1,500) 3.59
-------
NON-VESTED OPTIONS AT MARCH 31, 2007 81,845 $3.66
-------
The total grant date fair values of options that vested during the three months
ended March 31, 2007 was $178,214.
Information regarding the stock options outstanding and exercisable as of March
31, 2007 is summarized below:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ------------------------------------
Weighted Weighted
Number Average Weighted Number Average Weighted
Outstanding Remaining Average Outstanding Remaining Average
Range of at Mar. 31, Contractual Exercise at Mar. 31, Contractual Exercise
Exercise Price 2007 Life (Years) Price 2007 Life (Years) Price
- -------------- ----------- ------------ -------- ----------- ------------ --------
$2.88 -- 4.27 109,414 3.86 $ 3.87 93,914 3.32 $ 4.02
5.25 -- 7.50 109,933 7.20 6.41 48,588 6.75 6.72
10.52 -- 33.60 20,833 7.41 12.53 15,833 7.07 13.17
39.60 -- 178.38 30,668 1.87 106.93 30,668 1.87 106.93
------- -------
270,848 5.26 $ 17.24 189,003 4.28 $ 22.18
------- -------
The aggregate intrinsic value of options outstanding and options exercisable as
of March 31, 2007 was nil. The intrinsic value is calculated as the difference
between the market value of the Company's common stock as of March 31, 2007
($2.20 per share) and the exercise price of the options.
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 an employee 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 has achieved profitability and
positive cash flow for two consecutive fiscal quarters.
8
A summary of the changes in the non-vested restricted stock for the three months
ended March 31, 2007 is as follows:
WEIGHTED
AVERAGE
GRANT
DATE
FAIR
SHARES VALUE
------- --------
NON-VESTED RESTRICTED STOCK AT DECEMBER 31, 2006 165,652 $6.50
Granted 75,143 3.17
Vested -- --
Forfeited -- --
-------
NON-VESTED RESTRICTED STOCK AT MARCH 31, 2007 240,795 $5.46
-------
For all restricted share awards issued to employees, the Company records an
expense based on the grant date fair value and amortizes it over the service
period using the straight-line method.
5. COMMITMENTS AND CONTINGENCIES
In September 2005, the Company entered into an employment agreement with Alfred
H. Racine III, the CEO of Catuity Inc. The agreement expires on September 30,
2007. Under the terms of Mr. Racine's employment agreement, if Mr. Racine is
terminated after a change in control of the Company he will receive severance in
an amount equal to the greater of twelve months salary or the balance of his
contract, which as of March 31, 2007 would represent a payment of $262,500. Also
under the terms of Mr. Racine's employment agreement, if Mr. Racine is
terminated without cause for any reason, other than a change of control, he will
receive one month salary, which as of March 31, 2007 would represent a payment
of $21,875.
In December 2006, the Company entered into an employment agreement with Debra
Hoopes, the CFO of Catuity Inc. The agreement, as amended in January 2007,
expires on December 31, 2009. Under the terms of Ms. Hoopes' employment
agreement, if Ms. Hoopes is terminated without cause or Ms. Hoopes resigns for
good reason she will receive severance in an amount equal to twelve months
salary, which as of March 31, 2007 would represent a payment of $185,000. Also
under the terms of Ms. Hoopes' employment agreement, if Ms. Hoopes is terminated
without cause or Ms. Hoopes resigns for good reason following a change in
control of the Company in which the consideration to the Company's stockholders
is greater than $10 per share, she will receive severance in an amount equal to
the greater of twelve months salary or the balance of her contract, which as of
March 31, 2007 would represent a payment of approximately $508,750.
In March, 2007 the Company entered into an employment agreement with Graham
McStay, the CEO of Loyalty Magic. The agreement expires on March 14, 2010. Under
the terms of Mr. McStay's employment agreement, if Mr. McStay is terminated
without cause or Mr. McStay resigns for good reason he will receive severance in
an amount equal to twelve months salary, which as of March 31, 2007 would
represent a payment of approximately $145,000 (USD). Also under the terms of Mr.
McStay's employment agreement, if Mr. McStay is terminated without cause or Mr.
McStay resigns for good reason following a change in control of the Company in
which the consideration to the Company's stockholders is greater than $10 per
share, he will receive severance in an amount equal to the greater of twelve
months salary or the balance of his contract, which as of March 31, 2007 would
represent a payment of approximately $430,000 (USD).
In September, 2005 the Company entered into an employment agreements with John
H. Lowry, the former CFO of Catuity Inc. Mr. Lowry resigned his position on
January 2, 2007 and is scheduled to remain an employee of the Company until June
30, 2007. As of March 31, 2007, the total payments (including benefits)
remaining under Mr. Lowry's employment agreement totaled approximately $58,000
and are included in accrued compensation in the accompanying consolidated
balance sheet as of such date.
9
6. STOCKHOLDERS' EQUITY
2006 PRIVATE PLACEMENT
On November 22, 2006, the Company entered into a Securities Purchase Agreement,
pursuant to which the Company 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") (collectively, the "2006 Private Placement"). The Senior Notes
and Preferred Shares were issued at a discount to face or stated value, for
aggregate gross proceeds to the Company (before deduction of advisory and other
transaction-related fees and expenses) of $2,250,000.
The Private Placement was made to two accredited investors in a transaction that
was exempt from registration under Regulation D of the Securities Act of 1933,
as amended (the "Securities Act"). Pursuant to a Registration Rights Agreement
entered into pursuant to the Securities Purchase Agreement, the Company 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 2006 Private Placement. In February
2007, the Company filed a registration statement on Form SB-2 to register the
shares underlying the Senior Notes and Preferred Shares.
The Senior Notes were issued in the aggregate principal amount of $1,800,000 and
carry interest at the rate of 10% per annum, compounded monthly. The Company
issued and sold the Senior Notes and the Warrants at a discount off of face
amount, for an aggregate sales price of $1,620,000. The Senior Notes are
convertible into common stock of the Company at a conversion rate of $3.25 per
common share, or a maximum total of 553,846 common shares, subject to
anti-dilution provisions.
The Preferred Shares were issued in the aggregate stated value of $700,000 and
carry a dividend rate of 10% per annum. The Company issued and sold the
Preferred Shares at a discount off of face amount, for an aggregate sales price
of $630,000. The Preferred Shares are convertible into common stock of the
Company at the conversion rate of $3.25 per common share or a maximum total of
215,385 common shares, subject to anti-dilution provisions.
The Company accounted for the issuance of the Senior Notes, Preferred Shares and
Warrants in accordance with Emerging Issues Task Force Issue No. 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios" ("EITF 98-5") and EITF 00-27,
"Application of Issue No. 98-5 to Certain Convertible Instruments."
Additionally, the Company analyzed the guidance contained in EITF 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock" and Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS No. 133") in accounting for this transaction. Based on our
analysis of EITF 00-19 and SFAS 133, the embedded conversion option contained in
the Senior Notes was not required to be bifurcated and accounted for separately
and the Preferred Shares and Warrants were deemed to be equity instruments.
Accordingly, as required by EITF 98-5 and EITF 00-27, the Company allocated the
$2,250,000 of net proceeds received to each instrument based on their relative
fair values at the date of issuance (the commitment date as defined by EITF
00-27). This resulted in proceeds of $1,157,623 being allocated to the Senior
Notes, proceeds of $450,187 being allocated to the Preferred Shares and proceeds
of $642,190 being allocated to the Warrants. The next step in the analysis was
to review the conversion feature in the Senior Notes and Preferred Shares to
determine if it was beneficial to the investors at the issuance date. Because
the fair value of our common stock exceeded the conversion price in these
instruments, we calculated the beneficial conversion feature associated with the
Senior Notes ($1,157,623) and Preferred Shares ($450,187). The beneficial
conversion feature related to the Preferred Shares was considered a deemed
dividend at the date of issuance and was recorded as an increase to the
accumulated deficit. The beneficial conversion feature related to the Senior
Notes, combined with the discount from the face amount and the allocation of
proceeds to the Warrants resulted in a discount on the Senior Notes of
$1,800,000 which is being recognized as interest expense over their 3-year term
using the effective yield method.
10
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.
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.
As of March 31, 2007 there were 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, 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. During the three months ending March 31, 2007, the Board of
Directors declared and the Company paid $17,500 of dividends to holders of the
Series A Convertible Preferred Stock.
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
As of March 31, 2007, there were outstanding warrants to acquire up to 357,143
shares of common stock.
Each Warrant is exercisable at any time prior to November 21, 2011 at an initial
exercise price equal to $3.58 per share of common stock. The Warrants contain a
cashless exercise feature and standard anti-dilution protection, including
full-ratchet provisions that would require an adjustment to the exercise price
of the Warrants in the event that the Company issues common stock (or common
stock equivalents, including options and convertible securities) at a price per
share that is less than the the then-current exercise price in Warrants. The
Company has the right to redeem the warrants at $.01 per share on 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, and no single trading day is less than
$200,000, 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.
Pursuant to a Registration Rights Agreement executed in connection with the 2006
Private Placement, the Company agreed to file a registration statement under the
Securities Act of 1933 registering the resale of the common shares underlying
the Senior Notes and Preferred Shares. Under the Registration Rights Agreement,
the exercise price of the Warrants is reduced by 10% of the then effective
exercise price for each thirty day period following March 22, 2007, prior to the
beginning of which a registration statement registering for sale all of the
shares of common stock issuable upon conversion of the Senior Notes and
Preferred Shares has not been declared effective by the SEC, up to a maximum
aggregated reduction of 30%. Because we do not believe that we will be able to
register all of the shares before the 30% maximum reduction is reached, we
anticipate that the exercise price of the Warrants will be reduced by 30% to
$2.51 during the second quarter of 2007.
Upon a change of control of the Company that is within the Company's control,
the warrant holders have the right to cause the Company 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.
11
7. SENIOR CONVERTIBLE NOTES
As of March 31, 2007, there were Senior Convertible Notes ("The Senior Notes")
in the aggregate principal amount of $1,800,000 issued and outstanding. The
Senior Notes carry interest at the rate of 10% per annum compounded monthly. The
Senior Notes are convertible into common stock of the Company at a conversion
rate of $3.25 per common share, or a maximum total of 553,846 common shares,
subject to anti-dilution provisions. The Senior Notes are secured by a senior
security interest in all of the Company's assets. The Company issued and sold
the Senior Notes in connection with the 2006 Private Placement.
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 holders of
the Senior Notes have the right to cause Catuity to repurchase the Senior Notes
in cash for the greater of (A) 130% multiplied by the product of (x) the
principal amount being converted plus accrued but unpaid interest on such
principal amount and (y) the closing sales price of the Company's common stock
immediately following the public announcement of such change in control; or (B)
150% of the principal amount being converted plus accrued but unpaid interest on
such principal amount. 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.
The principal amount of the Senior Notes is repayable in monthly installments of
$75,000 beginning on December 1, 2007. The Senior Notes mature on November 21,
2009. Future principal payments by year are as follows: 2007 -- $75,000; 2008 --
$900,000; and 2009 -- $825,000.
8. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of March 31, 2007 and
December 31, 2006:
MARCH 31, 2007 DECEMBER 31, 2006
-------------- -----------------
Computer equipment $ 1,079,737 $1,035,295
Leasehold improvements 72,412 70,736
Office furniture and equipment 121,638 108,682
Capital Leases 74,785 73,054
----------- ----------
Gross property and equipment $ 1,348,572 $1,287,767
Less accumulated depreciation (1,045,409) (993,343)
----------- ----------
Net property and equipment $ 303,163 $ 294,424
----------- ----------
Depreciation expense for the three months ending March 31, 2007 and 2006
were $34,015 and $35,453, respectively.
12
9. INTANGIBLES
In connection with the acquisition of Loyalty Magic during 2005, a portion of
the purchase price paid was allocated to intangible assets. The following table
details the amortization of the intangibles:
MARCH 31, 2007 DECEMBER 31, 2006
-------------------------------------- --------------------------------------
Accumulated Net Book Accumulated Net Book
Category Cost Amortization Value Cost Amortization Value
- -------- ---------- ------------ ---------- ---------- ------------ ----------
Trademarks $ 606,723 $ (32,070) $ 574,653 $ 592,681 $ (26,368) $ 566,313
Software 690,338 (273,739) 416,599 674,363 (226,294) 448,069
Customer Contracts 305,235 (137,541) 167,694 298,171 (116,814) 181,357
Customer Relationships 298,062 (88,735) 209,327 291,163 (75,368) 215,795
Non-compete agreements 169,479 (53,746) 115,733 165,557 (44,193) 121,364
---------- --------- ---------- ---------- --------- ----------
Totals $2,069,837 $(585,831) $1,484,006 $2,021,935 $(489,037) $1,532,898
---------- --------- ---------- ---------- --------- ----------
Amortization expense associated with intangibles assets for the three months
ended March 31, 2007 and 2006 were $96,794 and $86,382, respectively.
10. MANAGEMENT PLANS
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the settlement
of liabilities in the normal course of business and continuation of the Company
as a going concern. Liquidation values may be substantially different from
carrying values as shown and these consolidated financial statements do not give
effect to adjustments, if any, that would be necessary to the carrying values
and classification of assets and liabilities should the Company be unable to
continue as a going concern.
For the three months ended March 31, 2007, the Company incurred a net loss of
$1,435,139. For the years ended December 31, 2006 and 2005, the Company incurred
net losses of $4,232,738 and $2,981,030, respectively. As of March 31, 2007, the
Company had an accumulated deficit of $43,389,302 and insufficient cash on hand
to meet its expected liquidity requirements for 2007. These factors raise
substantial doubt as to the Company's ability to continue as a going concern.
Management's strategy in 2007 consists of the following components: 1) to remain
focused on offering our core customer base -- retailers and their partners -- a
broad range of products, services and programs to help them reach, reward and
retain their customers; 2) to raise additional debt and/or equity financing to
allow the Company to continue in operation and satisfy its financial
obligations; and 3) to complete one or more strategic acquisitions.
The Company will run out of cash before the end of the second quarter of 2007
unless we are successful in raising additional funding before the end of the
quarter. Based on discussions with numerous potential funding sources in recent
weeks, management believes it will be very difficult for the Company to
successfully raise capital in the timeframe remaining before we run out of cash.
The Company was successful in raising capital during the years ended December
31, 2006 and 2005. However, there can be no assurance that the Company will
continue to be able to raise additional funds as necessary, nor can there be any
assurance that additional funds, if available, will be on terms satisfactory to
the Company or that they will not have a significant dilutive effect on existing
stockholders.
Management's focus in evaluating potential acquisition candidates is to identify
companies that are in a similar line of business that fit with our strategy,
have achieved and sustained profitability, and generate positive cash flow from
operations. Management currently estimates that the Company will not achieve
profitability by the end of 2008 unless it is successful in completing one or
more acquisitions. However, there can be no assurance that management will be
able to complete such an acquisition, nor can there be any assurance that an
acquisition, if completed, will not have a significant dilutive effect on
existing stockholders.
Management is uncertain that we can raise additional capital and as such can
provide no assurance. In the event that management is unable to raise additional
capital from external sources, or is unable to successfully complete an
acquisition of a profitable company, the Company may be forced to curtail or
cease operations.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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.
As used in this Quarterly Report on form 10-QSB, "Company," "us," "we," "our"
and similar terms means Catuity Inc., a Delaware corporation.
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 customers and
prospects execute their plans for the use of our loyalty software processing 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. For a discussion of these and certain other factors, please
refer to the discussion of "Risk Factors" contained in our Annual Report on Form
10-KSB for the year ended December 31, 2006.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our financial statements are based on the selection and application of
significant accounting policies, some of which require management to make
estimates and assumptions regarding matters that are inherently uncertain. We
believe that the following are the more critical judgment areas in the
application of our accounting policies that currently affect our financial
condition and results of operations.
Revenue Recognition
The three distinct revenue streams that result from the Company's business
activities are processing, service and license revenue.
- Processing revenue includes ASP management fees, installation and
training, processing of data, card sales and related hardware and
software sales.
- Service revenue includes customization work for particular client
applications, maintenance, customer support, consulting and other
client services.
- Licensing revenue includes non-ASP and ASP software licenses,
maintenance and upgrades.
Processing revenue (ASP) is generally recognized as revenue in the month that
the services are performed. Payments for processing revenue are generally not
refundable. Accordingly, we recognize revenue for monthly hosting fees in the
month the hosting service is provided. Under our hosting arrangements the
customer does not have the contractual right to take possession of the software
element and the customer does not have the right to run the software on its own
hardware or contract with another party to host the software.
14
Service revenue for recurring services provided to customers in support of their
loyalty and/or gift card programs is recognized in the month the service is
rendered. 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.
Processing and service revenue can also includes client projects such as
integration, customization and miscellaneous 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 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 collectability 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.
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.
Stock-Based Compensation
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 consolidated financial statements
will depend, in part, on future grant awards. See note 4 for a description of
the expense recorded for the each of the three month periods ended March 31,
2007 and 2006 under SFAS 123(R).
Going Concern
We anticipate that our business will not generate sufficient cash flow to
sustain the current level of operational activity and additional cash resources
will be required.
The accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the settlement
of liabilities in the normal course of business and continuation of the Company
as a going concern. Liquidation values may be substantially different from
carrying values as shown and these consolidated financial statements do not give
effect to adjustments, if any, that would be necessary to the carrying values
and classification of assets and liabilities should the Company be unable to
continue as a going concern.
For the three months ended March 31, 2007, the Company incurred a net loss of
$1,435,139. For the years ended December 31, 2006 and 2005, the Company incurred
net losses of $4,232,738 and $2,981,030, respectively. As of
15
March 31, 2007, the Company had an accumulated deficit of $43,389,302 and
insufficient cash on hand to meet its expected liquidity requirements for 2007.
These factors raise substantial doubt as to the Company's ability to continue as
a going concern.
Management's strategy in 2007 consists of the following components: 1) to remain
focused on offering our core customer base -- retailers and their partners -- a
broad range of products, services and programs to help them reach, reward and
retain their customers; 2) to raise additional debt and/or equity financing to
allow the Company to continue in operation and satisfy its financial
obligations; and 3) to complete one or more strategic acquisitions.
The Company will run out of cash before the end of the second quarter of 2007
unless we are successful in raising additional funding before the end of the
quarter. Based on discussions with numerous potential funding sources in recent
weeks, management believes it will be very difficult for the Company to
successfully raise capital in the timeframe remaining before we run out of cash.
The Company was successful in raising capital during the years ended December
31, 2006 and 2005. However, there can be no assurance that the Company will
continue to be able to raise additional funds as necessary, nor can there be any
assurance that additional funds, if available, will be on terms satisfactory to
the Company or that they will not have a significant dilutive effect on existing
stockholders.
Management's focus in evaluating potential acquisition candidates is to identify
companies that are in a similar line of business that fit with our strategy,
have achieved and sustained profitability, and generate positive cash flow from
operations. Management currently estimates that the Company will not achieve
profitability by the end of 2008 unless it is successful in completing one or
more acquisitions. However, there can be no assurance that management will be
able to complete such an acquisition, nor can there be any assurance that an
acquisition, if completed, will not have a significant dilutive effect on
existing stockholders.
Management is uncertain that we can raise additional capital and as such can
provide no assurance. In the event that management is unable to raise additional
capital from external sources, or is unable to successfully complete an
acquisition of a profitable company, the Company may be forced to curtail or
cease operations.
Recent Accounting Pronouncements
On January 1, 2007, the Company adopted 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. The Company does not expect
the adoption of FIN 48 to have a material impact on its 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.
16
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities -- including an amendment of FASB
Statement No. 115, or SFAS 159. SFAS 159 permits an entity, at specified
election dates, to choose to measure certain financial instruments and other
items at fair value. The objective of SFAS 159 is to provide entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently, without having to apply complex
hedge accounting provisions. SFAS 159 is effective for accounting periods
beginning after November 15, 2007. The Company is currently assessing the impact
of adopting SFAS 159 on its consolidated financial statements.
OVERVIEW OF 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 75 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 utilizing a hosted,
application service provider based system that enables the processing of
member-based loyalty programs that can deliver customized discounts, promotions,
rewards and points-based programs. Our system also enables robust and highly
customizable gift card programs that work on a retailer's payment terminals and
electronic cash registers via their internal store networks. These programs are
designed to help retailers improve customer retention, add new customers and
increase the average amount spent by customers.
Our operational priorities as a Company are in three areas.
1) Loyalty and Gift Card Processing: We believe the U.S. 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 and through
resellers, 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 and flexible processing platform with an operational capability
that provides a turnkey product.
2) 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 new product packages does not require significant new development of
our technology.
3) Acquisitions: Acquiring profitable and cash flow positive operating
businesses remains important to our strategy. Catuity continues to seek the
acquisition of complementary businesses such as traditional loyalty services,
database marketing, direct marketing and processing technology and services
firms. We believe the addition of these businesses would expand our product
offering to clients and prospects.
Our technology platform, CALS and our other intellectual property plays an
important role in our business. We continue to enhance the existing
functionality of CALS while striving to make the system easier to use by our
target retail clients who generally lack large or sophisticated technology
departments. In 2007, we have 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 helps us deliver a technologically advanced
product in our markets.
We believe our patents are of significant value and as part of our agreements
with licensees, Catuity grants rights to use the innovations described in our
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. Catuity has
also been issued patents in seven countries that 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.
17
2007 SIGNIFICANT ACTIVITIES
Catuity is focusing on delivering loyalty and gift card programs to retailers
and their partners through a hosted solution. Catuity has targeted retailers who
are seeking loyalty and gift card programs to improve customer retention,
increase customer spending in targeted categories along with increasing average
per visit sales and improve the frequency of their customer's visits. Catuity is
most focused on selling its products and services to retailers with 75-250
stores locations. Most are privately held, prefer a hosted solution because they
have limited IT staff and budget; and are undergoing significant growth and may
be expanding from a local or regional presence to a national strategy.
In the first quarter of 2007, our U.S. sales effort shifted primarily to
franchise-driven retailers in popular, high-growth categories. The Company is
marketing a processing bundle that most often includes loyalty, gift card and
credit and debit card processing. During the first quarter, we successfully
launched a new focus on direct marketing to our prospects by utilizing
interactive marketing as well as branding and direct response marketing
techniques to engage our customers. As a result, our rate of in-bound,
pre-qualified sales leads has increased significantly and our efforts have
shortened our sales cycle. In addition, the Company has continued to expand its
relationships with specialized resellers. These include independent sales
organizations who collectively are selling 4,000 new store locations per month.
Catuity's services are offered to these merchants and we have experienced
month-over-month increases in store-level contracts. These single-location
merchants represent a large market that we do not target directly. Additionally,
we have expanded our relationships with specialized resellers, namely
point-of-sale software vendors, who have a proprietary and trusted relationship
with their retail clients. We have established a growing referral and
revenue-sharing network with these companies.
As we entered 2007, the Company increased its focus on consummating acquisitions
or mergers with one or more profitable companies. Management's focus in
evaluating potential acquisition candidates is to identify companies that are in
the loyalty, stored value (gift card) and marketing services markets which
complement our existing products and services, have achieved and sustained
profitability, and generate positive cash flow from operations. During 2006, the
Company was not successful in finding companies that met management's criteria.
However, management believes that the 2007 market is a very different market.
The number of suitable targets which are open to an acquisition or merger
proposal has increased significantly. As of the date of this filing, the company
has several written merger proposals pending for U.S. based companies and is
actively engaged with more than a dozen companies about possible acquisitions of
companies ranging in size from USD $5 million to $67 million in annual revenues.
It is important to note that the Company cannot make any assurance about our
ability to consummate one or more transactions. The ability to execute a merger
is dependent on many factors which Catuity cannot control, including, but not
limited to, competitive forces, regulatory approvals, consent of shareholders,
negotiation of suitable terms and financing of a transaction.
As of the date of this filing, the Company has retained a new patent counsel to
manage the licensing and enforcement of our existing and pending patents in the
U.S., Canada, Japan, Australia and five European markets. The Company believes
that the business method patents, which concern the transfer of information
between a chip and numerous devices, has broad application in the payments,
loyalty, contact-less payment, healthcare and identity markets. Most notably,
the use of contact-less payment methods have grown significantly in the U.S.
market. In Canada, major banks and other payments processors have recently
announced plans to begin converting the payments infrastructure in the country
to EMV-compliant chip-based cards beginning in 2008. Management believes that
these developments have created additional licensing opportunities.
18
OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2007 COMPARED TO THE
THREE MONTHS ENDED MARCH 31, 2006
REVENUES
The following table sets forth revenues by category for the three months ended
March 31, 2007 and 2006, as well as the dollar and percentage changes:
2007 2006 $ CHANGE % CHANGE
-------- -------- -------- --------
Processing $335,919 $347,582 $(11,663) (3.4)%
Service 68,442 114,585 (46,143) (40.3)%
License 14,809 18,280 (3,471) (19.0)%
-------- -------- -------- -----
Total Revenues $419,170 $480,447 $(61,277) (12.8)%
-------- -------- -------- -----
The decrease in processing revenue relates primarily to the operations of
Loyalty Magic and reflects lower recurring revenues from its two largest
customers. Additionally, for the three months ended March 31, 2006, service
revenues included non-recurring customer projects of approximately $37,000.
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 customer programs. Service revenues are generally non-recurring in
nature and result from one-time projects for customers. License revenues consist
of software license and maintenance fees for customers who host our software on
their own equipment.
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 our staff that directly support customer programs. Cost
of processing revenue was approximately $507,000 and $381,000 for the three
months ended March 31, 2007 and 2006, respectively, an increase of $126,000
(33.1%). The increase in costs resulted primarily from higher payroll and
benefits costs for our U.S. and Australia customer support staffs.
COST OF SERVICE REVENUE
Cost of service revenue primarily consists of employee salary and related costs,
third party costs and overhead costs associated with our staff that supports
special projects and software customization for our customers. Cost of service
revenue was approximately $27,000 and $72,000 for the three months ended March
31, 2007 and 2006, respectively, a decrease of $45,000 (62.5%). The decrease in
costs relates to the non-recurring customer projects performed in 2006 mentioned
previously.
COST OF REVENUE - AMORTIZATION OF INTANGIBLES
The cost of revenue - amortization of intangibles represents the amortization of
the portion of the purchase price paid for Loyalty Magic allocated to
proprietary software that relates to processing. Capitalized software costs
included in intangible assets are amortized over the estimated useful life of 5
years based on expected annual cash flows. Amortization expense was
approximately $47,000 and $42,000 for three months ended March 31, 2007 and
2006, respectively, an increase of $5,000 (11.9%).
COST OF REVENUE - STOCK BASED COMPENSATION
Cost of revenue - stock based compensation represents the costs related to
share-based compensation awards under the Company's restricted stock and stock
option plans in accordance with SFAS 123(R) for our employees whose compensation
cost is charged to cost of revenue. Stock-based compensation expense was
approximately $10,000 and $20,000 for the three months ended March 31, 2007 and
2006, respectively, a decrease of $10,000 (50.0%).
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries, employee
benefits and overhead costs, incurred mainly by our technical staffs in
Australia for work on upgrades and future releases of the Company's proprietary
software. Research and development costs were approximately $76,000 and $127,000
for the three months ended
19
March 31, 2007 and 2006, respectively, a decrease of $51,000 (40.2%). The
decrease resulted primarily from costs incurred in 2006 to complete the
Company's new generation of software. Those activities were completed in 2006
and did not carry over into 2007.
RESEARCH AND DEVELOPMENT - STOCK BASED COMPENSATION
Research and development - stock based compensation represents the costs related
to share-based compensation awards under the Company's restricted stock and
stock option plans in accordance with SFAS 123(R) for our employees whose
compensation cost is charged to research and development. Stock-based
compensation expense was approximately $6,000 and $9,000 for the three months
ended March 31, 2007 and 2006, respectively, a decrease of $3,000 (33.3%)
consistent with our reduced R&D efforts.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, employee benefits,
travel, advertising, marketing, and related overhead costs of the Company's
sales and marketing functions. Sales and marketing expenses were approximately
$249,000 and $225,000 for the three months ended March 31, 2007 and 2006,
respectively, an increase of $24,000 (10.7%). The increase in costs resulted
primarily from higher payroll and benefits costs associated with our U.S. based
sales team and our increased sales efforts.
SALES AND MARKETING - AMORTIZATION OF INTANGIBLES
Sales and marketing - amortization of intangibles represents the amortization of
the portion of the purchase price paid for Loyalty Magic allocated to customer
contracts and customer relationships. Customer contracts and customer
relationships included in intangible assets are amortized over their estimated
useful lives of 5 and 10 years, respectively, based upon expected annual cash
flows. Amortization expense was approximately $34,000 and $32,000 for the three
months ended March 31, 2007 and 2006, respectively, an increase of $2,000
(6.3%).
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 were
approximately $689,000 and $493,000 for the three months ended March 31, 2007
and 2006, respectively, an increase of $196,000 (39.8%). The increase in costs
resulted primarily from our U.S. based operations and includes higher payroll,
benefits and employee training costs of $120,000, higher travel and
entertainment costs of $28,000 related primarily to the relocation of our
corporate offices to Virginia, higher legal and accounting fees of $26,000
related primarily to activities associated with the 2006 Private Placement, and
higher financial printing and registry costs of $8,000 related primarily to the
special meeting of shareholders held during February 2007.
GENERAL AND ADMINISTRATIVE - AMORTIZATION OF INTANGIBLES
General and administrative - amortization of intangibles represents the
amortization of the portion of the purchase price paid for Loyalty Magic
allocated to trademarks and non-compete agreements. Trademarks included in
intangible assets are amortized on a straight-line basis over their estimated
useful life of 30 years. Non-compete agreements included in intangible assets
are amortized on a straight-line basis over 5 years. Amortization expense was
approximately $15,000 and $13,000 for the three months ended March 31, 2007 and
2006, respectively, an increase of $2,000 (15.4%).
GENERAL AND ADMINISTRATIVE - STOCK BASED COMPENSATION
General and administrative - stock based compensation expense represents the
costs related to share-based compensation awards under the Company's restricted
stock and stock option plans in accordance with SFAS 123(R) for our employees
and directors whose compensation cost is charged to general and administrative
expense. Stock based compensation was approximately $109,000 for the three
months ended December 31, 2007 compared to $126,000 in 2006, a decrease of
$17,000 (13.5%).
20
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our operations with proceeds from the issuance of
shares of our common and preferred stock, issuance of our debt securities and
cash collections from customers. As of March 31, 2007, the Company had
approximately $783,000 in cash and cash equivalents, a decrease of $1,211,000
from December 31, 2006. The decrease is primarily attributable to the net loss
incurred during the three months ended March 31, 2007, an increase in working
capital requirements, and cash interest and dividend payments made on the Senior
Notes and Preferred Shares issued in connection with the 2006 Private Placement,
partially offset by an Australian R&D refund received during the first quarter.
Net cash used in operating activities was $1,161,000 for the three months ended
March 31, 2007 compared with $677,000 for the three months ended March 31, 2006.
The increase is primarily attributable to a $336,000 increase in the cash-based
net loss (total net loss less depreciation, amortization and stock-based
compensation) in 2007.
Cash used by investing activities was $40,000 for the three months ended March
31, 2007 compared with cash provided by investing activities of $2,235,000 for
the three months ended March 31, 2006. The cash provided by investing activities
in 2006 related to the maturity of a short-term investment of $2,246,000.
Purchases of property and equipment in 2007 were approximately $40,000 compared
to $10,000 in 2006.
Net cash used in financing activities during the three months ended March 31,
2007 resulted primarily from dividend payments on the Series A Preferred Stock
we issued in November 2006 in connection with the 2006 Private Placement.
We had $783,000 in cash and cash equivalents as of March 31, 2007. The Company
will run out of cash before the end of the second quarter of 2007 unless we are
successful in raising additional funding before the end of the quarter. Based
on discussions with numerous potential funding sources in recent weeks,
management believes it will be very difficult for the Company to successfully
raise capital in the timeframe remaining before we run out of cash. The Company
was successful in raising capital during the years ended December 31, 2006 and
2005. However, there can be no assurance that the Company will continue to be
able to raise additional funds as necessary, nor can there be any assurance
that additional funds, if available, will be on terms satisfactory to the
Company or that they will not have a significant dilutive effect on existing
stockholders.
Additional capital is required in order for us to sustain operations and meet
our estimated cash requirements for the next twelve months. Management is
uncertain that we can raise additional capital and as such can provide no
assurance. In the event that management is unable to raise additional capital
from external sources, or is unable to successfully complete an acquisition of
a profitable company, the Company may be forced to curtail or cease operations.
CONTRACTUAL OBLIGATIONS
The following table presents our contractual obligations and commitments as of
March 31, 2007 over the next 5 years:
TYPE OF OBLIGATION: TOTAL 2007 2008 2009 2010 2011
- ------------------- ------- ------- ------ ---- ---- ----
Operating Leases $72,054 $69,780 $2,274 -- -- --
Capital Leases 7,216 7,216 -- -- -- --
------- ------- ------ --- --- ---
Total $79,270 $76,996 $2,274 -- -- --
------- ------- ------ --- --- ---
ITEM 3. CONTROLS AND PROCEDURES
Management, including the Company's Chief Executive Officer and Chief Financial
Officer, evaluated the effectiveness of the design and operation of the
Company's disclosure controls and procedures, pursuant to Rule 13a-15 of the
Securities and Exchange Act of 1934 as of March 31, 2007. The Company's
disclosure controls and procedures are designed to ensure: (1) that information
required to be disclosed by the Company in its periodic SEC filings is recorded,
processed and reported within the time periods specified by the SEC and (2) that
information required to be disclosed is accumulated and communicated to the
Company's management, including its principal executive and financial officers,
to allow timely decisions regarding required disclosure. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective as of March
31, 2007. The disclosure controls and procedures are designed to provide
reasonable assurance that the information required to be disclosed in the
reports the Company files and submits under the Exchange Act is recorded,
processed, summarized and reported as required on a timely basis. The Chief
Executive Officer and Chief Financial Officer concluded that the disclosure
controls and procedures are effective at the reasonable assurance level.
During the first quarter of 2007, we relocated our corporate headquarters from
Livonia, Michigan to Charlottesville, Virginia. In connection with this
relocation, we replaced our entire internal accounting staff with new personnel
including the Chief Financial Officer. Except as discussed in this paragraph,
there has been no change in the Company's internal controls over financial
reporting during the first quarter of 2007 that materially affected, or is
reasonably likely to materially affect, the Company's internal controls over
financial reporting. There were no
21
significant deficiencies or material weaknesses identified in the evaluation
and, therefore, no corrective actions were taken.
22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 5, 2007, Catuity held a special meeting at which time the
stockholders approved our 2006 Financing pursuant to Marketplace Rule
4350(i)(1)(D) of the Marketplace Rules promulgated by the National Association
of Securities Dealers, Inc. and Australian Stock Exchange Limited Listing Rule
7.1. Our 2006 Financing consisted of the issuance to two new investors,
Gottbetter Capital Master, Ltd. And BridgePointe Master Fund Ltd. of an
aggregate of (a) $1,800,000 face amount of our 10% Senior Convertible Notes, (b)
700 shares of our Series A Convertible Preferred Stock (stated amount $1,000 per
share, or $700,000 in the aggregate), and (c) Warrants to acquire 357,143 shares
of our Common Stock at an initial exercise price of $3.58 per share. The
approval of our 2006 Financing was the only proposal put before the stockholders
at the special meeting.
The tabulation of the voting on the approval of our 2006 Financing is presented
below:
VOTES VOTES
PROPOSAL FOR AGAINST WITHHELD ABSTAIN NON-VOTE
-------- ------- ------- -------- ------- ---------
1. To approve the 2006 Financing 655,571 63,695 3,405 1,397,836
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a) Exhibit Description
------- -----------
31.1 Certification by Alfred H. Racine III, President and Chief
Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
31.2 Certification by Debra R. Hoopes, Senior Vice President and Chief
Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
32 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
23
SIGNATURES AND CERTIFICATIONS
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CATUITY INC.
(Registrant)
By: /s/ Alfred H. Racine III
------------------------------------
Alfred H. Racine III
President and Chief Executive
Officer
By: /s/ Debra R. Hoopes
------------------------------------
Debra R. Hoopes
Senior Vice President and Chief
Financial Officer
Date: May 11, 2007
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
31.1 Certification by Alfred H. Racine III, President and Chief
Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
31.2 Certification by Debra R. Hoopes, Senior Vice President and
Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certifications pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
24