AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 18, 2007
REGISTRATION NO. 333-140533
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Amendment No. 3
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CATUITY INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 7371 38-3518829
(STATE OR OTHER JURISDICTION (PRIMARY STANDARD (I.R.S. EMPLOYER
OF INCORPORATION INDUSTRIAL CLASSIFICATION IDENTIFICATION
OR ORGANIZATION) CODE NUMBER) NUMBER)
300 PRESTON AVENUE SUITE 302
CHARLOTTESVILLE, VA 22902
(434) 979-0724
(ADDRESS AND TELEPHONE NUMBER OF
PRINCIPAL EXECUTIVE OFFICES AND PRINCIPAL PLACE OF BUSINESS)
DEBRA R. HOOPES
CHIEF FINANCIAL OFFICER
300 PRESTON AVENUE SUITE 302
CHARLOTTESVILLE, VA 22902
(434) 979-0724
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: From time
to time after the effective date of this registration statement as determined by
market conditions.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
CALCULATION OF REGISTRATION FEE
================================================================================
PROPOSED
MAXIMUM PROPOSED
OFFERING MAXIMUM
TITLE OF AMOUNT PRICE AGGREGATE AMOUNT OF
EACH CLASS OF SECURITIES TO BE PER OFFERING REGISTRATION
TO BE REGISTERED REGISTERED UNIT(1) PRICE (1) FEE
- --------------------------------------------------------------------------------
Common Stock, $.001 par
value per share,
underlying
convertible preferred
stock 173,941 shares $3.25 $ 565,308 $ 74.90
- --------------------------------------------------------------------------------
Common Stock underlying
convertible
debentures 447,277 shares $3.25 $1,453,650 $192.60
- --------------------------------------------------------------------------------
Total 621,218 shares $2,018,959 $267.50
================================================================================
- ----------
(1) Calculated solely for the purposes of determining the registration fee
pursuant to Rule 457(g) promulgated under the Securities Act of 1933, as
amended.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
THE INFORMATION CONTAINED IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
THE SELLING SECURITY HOLDERS MAY NOT SELL THESE SECURITIES UNTIL THE
REGISTRATION STATEMENT CATUITY INC. FILES WITH THE SECURITIES AND EXCHANGE
COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE
SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE
WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED MAY 18, 2007
PROSPECTUS
(CATUITY LOGO)
REACH - REWARD - RETAIN(R)
621,218 SHARES OF COMMON STOCK
We have prepared this prospectus to allow the Selling Security Holders to
offer for resale up to 621,218 shares of our common stock to be issued by us to
the Selling Security Holders pursuant to conversion of convertible notes and
shares of convertible preferred stock that we sold to the Selling Security
Holders in a private placement completed on November 22, 2006 and approved by
our stockholders on February 5, 2007.
The shares of common stock offered by this prospectus could be sold in
several ways, including in the open market or otherwise at prevailing market
prices at the time of sale, in privately negotiated transactions at prices
agreed upon by the parties or through any other means described under the
heading "Plan of Distribution" beginning on page 45. The Selling Security
Holders may elect to sell all, a portion of, or none of the shares of common
stock offered hereby. Our company is not selling any shares of common stock in
this offering and therefore we will not receive any proceeds from any sale of
securities offered by this prospectus. We are registering the shares of common
stock offered under this prospectus to satisfy registration rights that we
granted to the Selling Security Holders in connection with the purchase of the
common stock by the Selling Security Holders. We have agreed to pay for all
expenses in connection with the registration of the securities offered by this
prospectus.
Our common stock is quoted on the NASDAQ Capital Market under the symbol
"CTTY" and is traded on the Australian Stock Exchange under the symbols "CAT"
and "CATN". On May 15, 2007, the last sales price of our common stock as
reported on the NASDAQ Capital Market was $1.44 per share.
No underwriter or any other person has been engaged to facilitate the sale
of the securities in this offering.
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK THAT IS
DESCRIBED IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 7 OF THIS PROSPECTUS.
WE URGE YOU TO CAREFULLY READ THE "RISK FACTORS" SECTION BEFORE YOU MAKE YOUR
INVESTMENT DECISION.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THE COMMON STOCK OFFERED HEREBY OR
PASSED UPON THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS MAY 18, 2007.
2
TABLE OF CONTENTS
Page
----
PART I
FORWARD LOOKING INFORMATION ............................................. 4
PROSPECTUS SUMMARY ...................................................... 5
ABOUT THE OFFERING AND THIS PROSPECTUS .................................. 5
RISK FACTORS ............................................................ 7
USE OF PROCEEDS ......................................................... 16
DESCRIPTION OF BUSINESS ................................................. 16
DESCRIPTION OF PROPERTY ................................................. 21
LEGAL PROCEEDINGS ....................................................... 22
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS ............ 22
DIRECTOR AND EXECUTIVE COMPENSATION ..................................... 24
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT .......... 27
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .......................... 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION ............... 28
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ................ 34
DESCRIPTION OF SECURITIES ............................................... 35
SELLING SECURITY HOLDERS ................................................ 44
PLAN OF DISTRIBUTION .................................................... 45
EXPERTS ................................................................. 46
LEGAL MATTERS ........................................................... 46
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES .......................................................... 47
WHERE YOU CAN FIND MORE INFORMATION ..................................... 47
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE ........................................................... 48
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS .................................. 48
INDEMNIFICATION OF DIRECTORS AND OFFICERS ............................ 48
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION .......................... 48
RECENT SALES OF UNREGISTERED SECURITIES .............................. 48
EXHIBITS ............................................................. 49
UNDERTAKINGS ......................................................... 49
INDEX TO FINANCIAL STATEMENTS ........................................... F-1
3
PART I - INFORMATON REQUIRED TO BE IN PROSPECTUS
FORWARD LOOKING INFORMATION
This document includes "forward-looking" statements within the meaning of
the Private Securities Litigation Act of 1995. This Act provides a "safe harbor"
for forward-looking statements to encourage companies to provide prospective
information so long as they identify these statements as forward-looking and
provide meaningful cautionary statements identifying important factors that
could cause actual results to differ from the expected results. All statements
other than statements of historical fact made in this document are forward
looking. In some cases, they can be identified by terminology such as "may,"
"will," "should," "expect," "plan," "anticipate," "believe," "estimate,"
"predict," "potential," or "continue," the negative of such terms or other
comparable terminology. These statements are only predictions. Actual events or
results may differ materially. In evaluating these statements, you should
consider various factors that may cause actual results to differ materially from
any forward-looking statements.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee our future results, levels of
activity, performance or achievement. Moreover, neither we nor any other person
assumes liability for the accuracy and completeness of the forward-looking
statements. Actual results may differ materially from those projected as a
result of certain risks and uncertainties, including but not limited to: changes
in currency exchange rates from period to period, inflation rates in the United
States and Australia, recession, and other external economic factors over which
the Company has no control; the timing and speed with which our major customers
and prospects execute their plans for the use of our loyalty software and
services; continued development of the Company's software products; competitive
product and pricing pressures; use of internally developed software
applications; patent and other litigation risks; the risk of key staff leaving
the Company; the risk that major customers of the Company's products and
services reduce their requirements or terminate their arrangements with the
Company; as well as other risks and uncertainties, including but not limited to
those detailed from time to time in the Company's Securities and Exchange
Commission filings. These forward-looking statements are made only as of the
date hereof, and the Company undertakes no obligation to update or revise the
forward-looking statements, whether as a result of new information, future
events or otherwise.
4
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
It does not contain all of the information that you should consider before
investing in our common stock. You should read the entire prospectus carefully,
including the section entitled "Risk Factors" and our consolidated financial
statements and the related notes. In this prospectus, we refer to Catuity Inc.
and our wholly owned subsidiary, Loyalty Magic Pty Ltd as "our company," "we,"
"us" and "our."
Catuity provides technology-based solutions to retailers that are designed
to increase the profit they receive from their customers at the Point of Sale
(POS). Today, the Company sells a hosted, ASP-based system that enables the
processing of member-based loyalty programs and which can deliver customized
discounts, promotions, rewards and points-based programs which are designed to
help retailers find, keep and profit from their best customers. The Company also
enables gift card solutions. In late 2004, the Company introduced the first
version of its new platform, the Catuity Advanced Loyalty System (CALS). The
system enables robust and highly customizable programs which work on a
retailer's payments terminals, Electronic Cash Register and on their internal
store networks. Catuity also offers IT services to retailers to support their
POS systems maintenance and custom development needs for both the deployment of
our technology solution and those of third parties which also touch the point of
sale.
Our executive offices are located at 300 Preston Avenue, Suite 302,
Charlottesville, VA 22902, and our telephone number is (434) 979-0724. We
maintain a site on the World Wide Web at the address http://www.catuity.com. The
information on our web site is not a part of this prospectus or incorporated by
reference herein.
WE URGE YOU TO REFER TO THE SECTION ENTITLED "RISK FACTORS" FOR AN
EXPLANATION OF THE RISKS OF INVESTING IN OUR COMMON STOCK.
ABOUT THE OFFERING AND THIS PROSPECTUS
This prospectus covers the resale of up to 621,218 shares of Common Stock
by the Selling Security Holders identified in this prospectus under the section
of this document titled "Selling Security Holders."
On November 22, 2006, we entered into a Securities Purchase Agreement with
the Selling Security Holders, pursuant to which we sold or issued to the Selling
Security Holders $1,800,000 in aggregate principal amount of our 10% Senior
Convertible Notes (we refer to the 10% Senior Convertible Notes as the Senior
Notes, Convertible Notes or Convertible Debentures), 700 shares of Series A
Convertible Preferred Stock ($700,000 aggregate stated value) (we refer to the
Series A Convertible Preferred Stock as the Preferred Stock or Preferred
Shares), and warrants (the "Warrants") to purchase 357,143 shares of our Common
Stock (the "Private Placement"). The Convertible Notes and Preferred Shares were
issued at 90% of face or stated value, for aggregate gross proceeds to us
(before deduction of advisory and other transaction-related fees and expenses)
of $2,250,000. The Warrants were issued as an additional inducement to the
Selling Security Holders.
The Private Placement was made in a transaction that was exempt from the
registration requirements of the Securities Act of 1933, as amended (the
"Securities Act") pursuant to Regulation D promulgated thereunder. Pursuant to a
Registration Rights Agreement entered into pursuant to the Securities Purchase
Agreement, we agreed to file a registration statement under the Securities Act
registering the resale of the common shares that are issuable on conversion of
the Convertible Notes and Preferred Shares that were issued in the Private
Placement.
The Convertible Notes bear interest at 10% per annum and mature 36 months
from the date of issuance. We began making interest-only payments on the
Convertible Notes on December 1, 2006 and will begin making monthly payments of
principal and interest on the Convertible Notes on December 1, 2007. The
indebtedness represented by the Convertible Notes is secured by a blanket lien
on substantially all of our and our subsidiaries' assets. The indebtedness due
under the Convertible Notes can be accelerated upon a change of control or
following an event of default, which includes customary events such as
nonpayment of interest and breach of restrictive covenants. We may prepay or
redeem the Convertible Notes at any time upon repayment of 120% of the
outstanding principal plus accrued but unpaid interest.
The Preferred Shares provide for cumulating, monthly preferred dividends at
the rate of 10% of stated value. The Preferred Shares have no voting rights, and
are not subject to mandatory redemption.
The Warrants are exercisable for a period of five (5) years with an initial
exercise price equal to $3.58 per common share. Under the Registration Rights
Agreement, the exercise price of the Warrants is reduced by 10% of the then
effective exercise price for each 30-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 Convertible 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 such a registration
statement will be declared effective 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. The Warrants contain a
cashless exercise feature and full-ratchet and other standard anti-dilution
protection.
5
The Convertible Notes and Preferred Shares are convertible, at the election
of the holder, into shares of our Common Stock at $3.25 per share (subject to
downward adjustment as a result of full-ratchet and other standard anti-dilution
protection). In the short-term we have the intention, and a reasonable basis to
believe that we will have the ability, to make all payments on the Convertible
Notes and Preferred Shares. However, as noted in the section entitled "Risk
Factors" included in this prospectus, additional financing will be required by
mid-year in order to meet liquidity needs. Our liquidity needs include required
debt service and dividend payments.
We paid the placement agent for the financing (Broadband Capital
Management, LLC) a fee of 7% of the gross cash proceeds we received in the
financing, together with reimbursement of its actual expenses. We paid the lead
investor's due diligence and legal fees and expenses and all of our own legal
and professional fees and expenses. The total legal and due diligence costs we
incurred as a result of the financing was approximately $120,000.
The foregoing discussion is qualified in its entirety by reference to the
documents and agreements executed in connection with the Private Placement, all
of which are attached to our Form 8-K filed November 22, 2006 and incorporated
herein by this reference.
The Selling Security Holders will acquire the shares offered by this
prospectus from us by conversion of the Convertible Notes and Preferred Shares
they now hold. We will not receive any proceeds from the resale of shares by any
Selling Security Holder. We have agreed to bear all expenses of registration of
the Common Stock offered by this prospectus.
This prospectus is part of a registration statement that we have filed with
the Securities and Exchange Commission (the "SEC") utilizing a "shelf"
registration process. Under the shelf registration process, the Selling Security
Holders may, from time to time, sell the Common Stock described in this
prospectus. We may prepare a prospectus supplement at any time to add, update or
change the information contained in this prospectus. This prospectus does not
contain all the information you can find in the registration statement or the
exhibits filed with or incorporated by reference into the registration
statement. You should read this prospectus and any prospectus supplement
together with the registration statement, the exhibits filed with or
incorporated by reference into the registration statement and the additional
information described under the section of this document titled "Where You can
Find More Information."
6
RISK FACTORS
The Company's business, financial condition and operating results could be
adversely affected by any of the following factors. These risks and
uncertainties, however, are not the only ones that the Company faces. Additional
risks and uncertainties not currently known to the Company, or that the Company
currently thinks are immaterial, may also impair its business operations.
FACTORS AFFECTING OUR OPERATING RESULTS, OUR BUSINESS AND OUR SHARE PRICE
RISKS RELATED TO OUR BUSINESS
WE ANTICIPATE THAT OUR BUSINESS WILL NOT GENERATE SUFFICIENT CASH FLOW TO
SUSTAIN THE CURRENT LEVEL OF OPERATIONAL ACTIVITY AND ADDITIONAL CASH RESOURCES
WILL BE NEEDED.
The consolidated financial statements contained in this prospectus 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.
WE HAVE A HISTORY OF LOSSES.
As of March 31, 2007 we had an accumulated deficit of $43,389,302. To date,
we have not achieved profitability. While management believes our strategies
will be successful, there can be no assurance that our business strategies will
be successful or that significant revenues or profitability will be achieved. If
we do achieve profitability, we cannot be certain that we can sustain or
increase profitability on an ongoing basis. Our auditor's opinion on our
consolidated financial statements contained in this prospectus cautions the
reader that there is substantial doubt about our ability to continue operating
as a going concern. Accordingly, customer perceptions concerning our financial
condition may adversely affect their decisions to do business with us.
In 2004, Catuity underwent a significant change in its business strategy
following the decision of a large U.S. chain retailer to stop issuing smart
cards to its customers that held their Visa co-branded credit card. This
resulted in Catuity adopting a change in its business strategy during the 3rd
quarter of 2004. As of September 30, 2004, the accumulated deficit stood at
$33,528,279 and since that
7
time has increased by $9,861,023 as of March 31, 2007. We currently anticipate
that we 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.
WE MAY BE ADVERSELY AFFECTED IF WE FAIL TO RETAIN KEY PERSONNEL AND ATTRACT
NEW QUALIFIED PERSONNEL.
Our operations will depend on our ability to attract new key personnel and
retain existing key personnel. We have from time to time in the past
experienced, and we expect to experience in the future, difficulty in hiring and
retaining highly skilled employees with appropriate qualifications. If we are
unable to hire or retain key employees, our business, results of operations and
financial condition will be harmed.
WE WILL BE ADVERSELY AFFECTED IF OUR CALS PRODUCT DOES NOT ACHIEVE MARKET
ACCEPTANCE.
We will be adversely affected if our software, the Catuity Advanced Loyalty
Systems ("CALS") introduced in late 2004, does not achieve market acceptance.
There can be no assurance that the product will perform all the desired
functions, or offer sufficient price/performance benefits or meet the technical
or other requirements of customers. Despite product testing and client adoption
and usage in 2006, there can be no assurance that all performance errors or
deficiencies have been discovered and remedied, that additional errors or
deficiencies will not occur, or if they occur, that we will be able to correct
such errors and deficiencies.
FAILURE TO OBTAIN CERTIFICATIONS IN A TIMELY MANNER.
To deploy our technology on behalf of a client, Catuity must install a
specialized application in the point of sale device used by its client. Because
of the diverse range of payment terminals, readers, electronic cash registers
and proprietary checkout systems used by merchants and retailers, Catuity must
certify its application to meet the standards of the independent manufacturers
of each model and series of terminals. Equally important, in some cases,
Catuity's POS application must be certified by the payments processor who
manages payment transactions for merchants and retailers. Catuity has been
successful in previous efforts with market leaders in terminal manufacturing
including Verifone, Hypercom and Schlumberger. However, we can make no assurance
that the Company will be able to obtain future certifications in a timely
manner. If we fail to obtain the necessary certifications, it could have a
material adverse impact us, including the loss of existing business, extended
delays in closing new business and/or the impairment of future revenues.
SALES ACTIVITIES WITH PROSPECTIVE CUSTOMERS MAY NOT GENERATE REVENUE FOR
THE COMPANY.
The success of our operations will be highly dependent on our ability to
generate revenue from current and future prospective customers. While management
believes that the Company will be successful in generating revenue from
prospective customers there can be no assurance of the level of revenue that
will be generated.
PLANNED ACQUISITIONS MAY NOT OCCUR OR MAY NOT GENERATE ANTICIPATED RESULTS.
A critical aspect of the Company's future is dependent upon acquiring new
businesses that are both profitable and cash flow positive. We believe that we
can acquire the types of new businesses that will enable the Company to grow,
profit and become more valuable. There is no assurance that we will be
successful in our efforts to close these acquisitions, and even if we do, the
anticipated results from the acquisitions may not meet our expectations.
RISKS RELATED TO OUR INDUSTRY
COMPETITION IN THE APPLICATION SOFTWARE INDUSTRY COULD HARM OUR BUSINESS.
The application software industry is highly competitive, rapidly developing
and subject to constant innovation and change. Numerous other companies operate
incentive marketing programs using both electronic and paper based systems, both
for retail stores and the Internet. Many of these companies have significantly
longer operating histories, greater name recognition, larger customer bases and
greater financial, technical and marketing resources than we do.
8
Our competitors may respond more quickly than we can to changing
technologies and customer requirements. For example, these competitors may:
- conduct more extensive marketing campaigns to capture market share;
- provide more attractive incentive and pricing packages to customers;
- negotiate more favorable contracts with existing and potential
employees and strategic partners;
- establish cooperative relationships among themselves or with third
parties, including large Internet participants, to increase the
ability of their products and services to address the needs of
prospective customers;
- bundle their products with other software or hardware, including
operating systems and browsers, in a manner that may discourage users
from purchasing products offered by us;
- establish cooperative relationships with our current or potential
competitors, thereby limiting our ability to sell our products through
particular reseller channels; and
- more quickly develop new products and services or enhance existing
products and services.
Our ability, and the ability of our resellers, to compete effectively in
the market for application software for incentive and loyalty marketing programs
will depend upon a variety of factors, including our ability to provide high
quality products and services at prices generally competitive with, or lower
than, those charged by our competitors. There can be no assurance that we will
be able to compete successfully. Moreover, there can be no assurance that
certain of our competitors will not be better situated to negotiate contracts
with retailers and resellers that are more favorable than contracts we
negotiate. In addition, there can be no assurance that the competition from
existing or new competitors or a decrease in the rates charged for products and
services by our competitors will not materially and adversely affect us.
NEW TECHNOLOGIES COULD RENDER OUR PRODUCT OBSOLETE.
The application software business is characterized by rapid technological
change, new product introduction and evolving industry standards. Advances in
applications software or the development of entirely new technologies to replace
existing applications software could render our product obsolete and
unmarketable. Our success will depend, in significant part, on our ability to
make timely and cost- effective enhancements and additions to our technology and
to introduce new products and services that meet customer demands. There can be
no assurance that we will be successful in developing new products, services and
enhancements. Delay in the introduction of new products, enhancements or
services, the inability to develop such new products, enhancements or services
or their failure to achieve market acceptance could have a material adverse
effect on us.
WE MAY FACE RISKS RELATED TO THE STORAGE OR PROVISION OF INACCURATE OR
CONFIDENTIAL INFORMATION.
It is possible that information provided through the use of our product or
information that is copied and stored by customers that have deployed our
product may contain errors. In such event, third parties could make claims
against us for losses incurred in reliance on such information. Although we
carry general liability insurance, our insurance may not cover potential claims
of this type or may not be adequate to indemnify us for all liability that may
be imposed. Any imposition of liability or legal defense expenses that is not
covered by insurance or that is in excess of insurance coverage could have a
material adverse effect on our business, financial condition and results of
operations.
In addition, from time to time, persons may unlawfully obtain information
concerning a customer's or retailer's program by unlawfully utilizing access
numbers, passwords and personal identification numbers. No assurance can be
given that future losses due to claims by third parties for unauthorized use
will not be material. We maintain no reserves for such risks.
There can be no assurance that our risk management practices will be
sufficient to protect us from unauthorized thefts of information that could have
a material adverse effect on us.
9
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS FOR USE OR MISUSE OF OUR
PRODUCT.
Retailers rely on our product in connection with providing promotions that
have a direct financial impact on their businesses and their customers. Use or
misuse of our product, whether due to accident, employee fraud, or otherwise,
may result in unintended or undesirable consequences that could result in
financial or other damages to our customers and to our customers' customers. A
product liability claim brought against us, even if not successful, would likely
be time consuming and costly and could have a material adverse effect on us.
WE MAY FACE RISKS RELATED TO THE USE OF ELECTRONIC PAYMENT CARDS.
Portions of our software may be integrated with or co-reside with a range
of third party payment and other software. For example, a payment card number
may be used as an identifier with our product. Alternatively, a portion of the
software comprising our product may be added to existing or new POS devices, so
that such software co-resides with payment programs. On the Internet and in
other environments, a portion of our software may be integrated with a third
party supplied e-commerce program. There can be no assurances that such
integration or co-residence will not adversely affect the payment system,
potentially giving rise to a claim that may have a material adverse effect on
our business, financial condition and results of operations. In addition, if our
customers experience problems with a payment system, it may be difficult to
determine if those problems originate from our product or other products with
which ours co-reside. Such difficulty may delay resolution of any such problem
and prove costly to us.
WE MAY BE AFFECTED BY POTENTIAL PRIVACY REGULATION.
The Federal Trade Commission is considering the adoption of regulations
regarding the collection and use of personal information obtained from
individuals when accessing Internet sites. These regulations could restrict our
ability to provide demographic data to retailers. At the international level,
the European Union has adopted a directive that will impose restrictions on the
collection and use of personal data. These developments could have an adverse
effect on our business, results of operations and financial condition.
WE MAY FACE INCREASED GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES.
Catuity will host or manage confidential customer information on behalf of
our clients. Certain high profile cases of customer information being
compromised have heightened concerns among our prospects, investors and state
and federal legislators about the need to ensure that the information of
individuals be protected. Since Sept. 11, 2001, regulation of public and
non-public information has increased significantly. Even though Catuity's
customers generally seek written permission from loyalty program participants to
collect and use information on their shopping behavior, the Company cannot
ensure that its customers will comply with appropriate regulations or industry
best practices. The gift card industry also continues to face regulatory,
legislative and judicial scrutiny. Attorney Generals have initiated lawsuits
against high profile gift card providers targeting their disclosure and
management practices. Proposed state and federal legislation, such as the Fair
Gift Card Act, is specifically directed at "escheatment", "breakage" and
liability management practices of card issuers. Broadly, this concerns the level
of required disclosure to consumers about fees and charges associated with their
accounts. To manage these risks, Catuity takes appropriate and customary steps
in our client agreements and through our operational procedures. Catuity has no
control over the pricing, disclosure and management strategies of its clients
and cannot ensure that our clients will comply with appropriate regulations or
industry best practices. To the extent that Catuity's customers face regulatory,
legislative or judicial action, the Company could be made a party to those
actions. These could materially and adversely affect us.
Catuity is in the business of managing vital business information on behalf
of our clients. This includes, but is not limited to, customer data, purchase
behavior, and payment transaction information. A myriad of laws, regulations and
industry standards apply to the management of this information across all the
jurisdictions in which we do business. A failure to comply with these laws,
regulations and standards - even if it were unintentional - could result in
financial penalties, additional cost to come into compliance, and loss of
reputation that could harm our business and impair our ability to meet our
strategic objectives. We make ongoing efforts to remain up to date on current
and pending changes in these laws, regulations and standards and to ensure that
our business practices meet or exceed applicable requirements. Further, while we
are not responsible for our clients' compliance, we make efforts to encourage
best practices by our clients and to actively support industry groups which
monitor, lobby for, and advocate regulation of our industry.
10
WE MAY FACE INTELLECTUAL PROPERTY CHALLENGES.
Our success and ability to compete are substantially dependent on our
proprietary technology and trademarks, which we attempt to protect through a
combination of patent, copyrights, trade secret and trademark laws as well as
confidentiality procedures and contractual provisions. However, any steps we
take to protect our intellectual property may be inadequate, time consuming and
expensive, and there can be no assurance that the steps taken by us will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as do the laws of the
United States. In addition, we may infringe upon the intellectual property
rights of third parties, including third party rights in patents that have not
yet been issued. Third-party infringement claims involving Internet technologies
and software products may increase. Any claims regarding the rights of third
parties, with or without merit, could be time consuming to defend, result in
costly litigation, divert management's attention and resources, cause product
shipment delays or require us to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
favorable to us, if at all. We have agreed, and may agree in the future, to
indemnify certain of our customers against claims that our products infringe the
intellectual property rights of others. We could incur substantial costs in
defending our sellers and our customers against infringement claims. A
successful claim of product infringement against us and our failure or inability
to license the infringed or similar technology could have a material adverse
effect on our business, financial condition and results of operations.
We have applied in the past for patents in relation to the method of
operation of incentive marketing programs using electronic means. We cannot
assure you that our patent applications will be approved. Moreover, even if
approved, they may not provide us with any competitive advantages or may be
challenged by third parties. In recent times a number of patents have been
granted in this area. Although we are not aware of any issued patent that our
product would infringe, legal standards relating to the validity, enforceability
and scope of intellectual property rights in Internet-related industries and use
of electronic data for granting of benefits and rewards are uncertain and still
evolving, and the future viability or value of any of our intellectual property
rights is uncertain.
CORPORATE AND MARKET RISKS
OUR TRADING VOLUME MAY BE LOW AND OUR SHARE PRICE MAY BE VOLATILE.
We are currently listed on two exchanges, the ASX in Australia, and the
NASDAQ Capital Market in the United States. There can be no assurance that an
adequate volume of trading in our shares will be achieved and maintained, on
NASDAQ or the ASX, in order to provide liquidity for our stockholders. Trading
volume in Catuity shares on NASDAQ and the ASX has been mixed with low volume
days and some very active periods. Through May 15, 2007, the combined average
daily trading volume in 2007 was 57,764 shares. In 2006 the combined average
daily trading volume was 92,380 shares while the average was 266,864 shares per
day in 2005.
The market price of our common stock may fluctuate significantly in
response to the following factors, some of which are beyond our control:
- variations in actual or anticipated quarterly or annual operating
results;
- changes in financial estimates by securities analysts;
- changes in market valuations of loyalty software & service companies;
- announcements by us of significant contracts, reseller arrangements,
strategic partnerships, joint ventures or capital commitments;
- additions or departures of key personnel;
- sales of common stock or termination of stock transfer restrictions;
and
- fluctuations in stock market price and volume, which are particularly
common among securities of small technology companies.
The market prices and volumes of the common stock of many publicly held
technology based companies have in the past been, and can in the future be
expected to be, especially volatile, which could cause the market price of our
common stock to fall for reasons not necessarily related to our business,
results of operations or financial condition. The market price of our stock also
might decline in reaction to events that affect other companies in our industry
even if these events do not directly affect us. Accordingly, you may not be able
to resell your shares of common stock at or above the price you paid. In the
past, following a period of volatility in the market
11
price of a company's securities, securities class action litigation often has
been instituted against such a company. Any such litigation could result in
substantial costs and a diversion of management's attention and our resources.
WE MAY BE SUBJECT TO ARBITRAGE RISKS.
Investors may seek to profit by exploiting the difference, if any, in the
price of our stock on the ASX and NASDAQ. Such arbitraging activities could
cause our stock price in the market with the higher value to decrease to the
price set by the market with the lower value.
COMPLYING WITH NASDAQ'S CONTINUED LISTING REQUIREMENTS.
We have experienced difficulty in the past maintaining all of NASDAQ's
continued listing requirements, due to the small size of our Company. The
requirements for continued listing on the NASDAQ Capital Market are as follows:
(1) either (a) stockholders' equity of $2,500,000, (b) net income in the
most recently completed fiscal year or in two of the last three years of
$500,000, or (c) market capitalization of $35,000,000;
(2) a public float of 500,000 shares;
(3) a market value of public float of $1,000,000;
(4) a minimum bid price of $1.00 per share;
(5) at least two market makers;
(6) at least 300 round lot stockholders; and
(7) compliance with NASDAQ corporate governance rules.
CERTAIN DELAWARE ANTI-TAKEOVER PROVISIONS MAY PRODUCE RESULTS DISFAVORED BY
OUR SHAREHOLDERS.
Provisions of Delaware law could make it more difficult for a third party
to acquire control of us without the consent of our board of directors, even if
our stockholders favored such a change. We are subject to Section 203 of the
Delaware General Corporation Law, which, subject to certain exceptions,
prohibits a publicly held Delaware corporation from engaging in any "business
combination" with any "interested stockholder" for a period of three years
following the date that such stockholder became an interested stockholder,
unless:
- prior to such date, the board of directors approved either the
business combination or the transaction that resulted in the
stockholder becoming an interested stockholder;
- upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned
at least 85% of our voting stock outstanding at the time the
transaction commenced; and
- on or subsequent to such date, the business combination is approved by
the board of directors and authorized at an annual or special meeting
of stockholders, and not by written consent, by the affirmative vote
of at least 66% of the outstanding voting stock that is not owned by
the interested stockholder.
Section 203 defines "business combination" to include:
- any merger or consolidation involving the corporation and the
interested stockholder;
- any sale, transfer, pledge or other disposition of 10% or more of our
assets involving the interested stockholder;
- subject to certain exceptions, any transaction that results in the
issuance or transfer by us of any of our stock to the interested
stockholder;
12
- any transaction involving us that has the effect of increasing the
proportionate share of the stock of any class or series beneficially
owned by the interested stockholder; and
- - the receipt by the "interested stockholder" of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by us or
through the corporation.
In general, Section 203 defines an interested stockholder as an entity or
person beneficially owning 15% or more of our outstanding voting stock and any
entity or person affiliated with or controlling or controlled by such entity or
person.
CHANGES IN, OR INTERPRETATIONS OF, ACCOUNTING RULES AND REGULATIONS, SUCH
AS EXPENSING OF STOCK OPTIONS, COULD RESULT IN UNFAVORABLE ACCOUNTING CHARGES.
We prepare our consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America. These
principles are subject to interpretation by the SEC and various bodies formed to
interpret and create appropriate accounting policies. A change in these policies
can have a significant effect on our reported results and may even retroactively
affect previously reported transactions. In particular, the FASB recently
enacted SFAS No. 123(R) (revised 2004), "Share-Based Payment" ("SFAS 123(R)")
which we adopted effective January 1, 2006. As a result, because SFAS 123(R)
requires the expensing of share based payments, it will have an adverse effect
on our reported financial results.
THE APPLICATION OF THE PENNY STOCK RULES COULD ADVERSELY AFFECT TRADING IN
OUR COMMON STOCK.
Our shares have frequently traded at prices below $5.00 per share. While
trading below $5.00 per share, our common stock is considered to be a
"low-priced" security under the "penny stock" rules promulgated under the
Securities Exchange Act of 1934. The "penny stock" rules impose additional sales
practice requirements on broker-dealers who sell securities to persons other
than established customers and accredited investors (generally those with assets
in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
with their spouse). In accordance with these rules, broker-dealers participating
in transactions in low-priced securities must first deliver a risk disclosure
document which describes the risks associated with such stocks, the
broker-dealer's duties in selling the stock, the customer's rights and remedies
and certain market and other information. Furthermore, the broker-dealer must
make a suitability determination approving the customer for low-priced stock
transactions based on the customer's financial situation, investment experience
and objectives. Broker-dealers must also disclose these restrictions in writing
to the customer, obtain specific written consent from the customer, and provide
monthly account statements to the customer. The effect of these restrictions
will probably decrease the willingness of broker-dealers to make a market in our
common stock, decrease liquidity of our common stock and increase transaction
costs for sales and purchases of our common stock as compared to other
securities.
Stockholders should be aware that, according to Securities and Exchange
Commission Release No. 34-29093, the market for penny stocks has suffered in
recent years from patterns of fraud and abuse. Such patterns include (i) control
of the market for the security by one or a few broker-dealers that are often
related to the promoter or issuer; (ii) manipulation of prices through
prearranged matching of purchases and sales and false and misleading press
releases; (iii) boiler room practices involving high-pressure sales tactics and
unrealistic price projections by inexperienced sales persons; (iv) excessive and
undisclosed bid-ask differential and markups by selling broker-dealers; and (v)
the wholesale dumping of the same securities by promoters and broker-dealers
after prices have been manipulated to a desired level, along with the resulting
inevitable collapse of those prices and with consequent investor losses. Our
management is aware of the abuses that have occurred historically in the penny
stock market. Although we do not expect to be in a position to dictate the
behavior of the market or of broker-dealers who participate in the market,
management will strive within the confines of practical limitations to prevent
the described patterns from being established with respect to our securities.
NASD SALES PRACTICE REQUIREMENTS MAY ALSO LIMIT A STOCKHOLDER'S ABILITY TO
BUY AND SELL OUR STOCK.
In addition to the "penny stock" rules described above, the NASD has
adopted rules that require that in recommending an investment to a customer, a
broker-dealer must have reasonable grounds for believing that the investment is
suitable for that customer. Prior to recommending speculative low priced
securities - which will be the case if and when our stock is trading below $5.00
per share (which it frequently has) - to their non-institutional customers,
broker-dealers must make reasonable efforts to obtain information about the
customer's financial status, tax status, investment objectives and other
information. The NASD requirements make it more difficult for broker-dealers to
recommend that their customers buy our common stock, which may limit your
ability to buy and sell our stock and have an adverse effect on the market for
our shares.
13
WE DO NOT ANTICIPATE PAYING ANY CASH DIVIDENDS IN THE FORESEEABLE FUTURE,
WHICH MAY REDUCE YOUR RETURN ON AN INVESTMENT IN OUR COMMON STOCK.
Other than the dividends owed to holders of the Preferred Shares, we
plan to use all of our earnings, to the extent we have earnings, to fund our
operations. We do not plan to pay any cash dividends in the foreseeable future.
We cannot guarantee that we will, at any time, generate sufficient surplus cash
that would be available for distribution as a dividend to the holders of our
common stock. Therefore, any return on your investment would derive from an
increase in the price of our stock, which may or may not occur.
SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY
DEPRESS OUR STOCK PRICE.
Upon effectiveness of our pending registration statement, and based on the
number of shares outstanding as of December 31, 2006, we will potentially have
2,863,560 registered shares outstanding. Upon conversion of the outstanding
Series A Preferred Stock and Senior Convertible Notes, the shares that are
pending registration will be freely tradable without restriction or further
registration under the federal securities laws, subject in some cases to volume
and other limitations.
If our stockholders sell substantial amounts of common stock in the public
market, or the market perceives that such sales may occur, the market price of
our common stock could fall. The sale of a large number of shares could impair
our ability to raise needed capital by depressing the price at which we could
sell our common stock.
WE MAY RAISE ADDITIONAL CAPITAL THROUGH A SECURITIES OFFERING THAT COULD
DILUTE YOUR OWNERSHIP INTEREST AND VOTING RIGHTS.
The power of the board of directors to issue shares of common stock,
preferred stock or warrants or options to purchase shares of our stock is
generally not subject to stockholder approval.
We anticipate that we will run out of cash before the end of the second
quarter of 2007 unless we are able to raise additional financing before the end
of the quarter to fund our business. If we raise additional funds through the
issuance of equity, equity-related or convertible debt securities, these
securities may have rights, preferences or privileges senior to those of the
holders of our common stock. The issuance of additional common stock or
securities convertible into common stock by our board of directors will also
have the effect of diluting the proportionate equity interest and voting power
of holders of our common stock.
OUR INCORPORATION DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER THAT
STOCKHOLDERS CONSIDER FAVORABLE AND COULD ALSO LIMIT THE MARKET PRICE OF YOUR
STOCK, WHICH MAY INHIBIT AN ATTEMPT BY OUR STOCKHOLDERS TO CHANGE OUR DIRECTION
OR MANAGEMENT.
Our amended and restated certificate of incorporation and bylaws contain
provisions that could delay or prevent a change in control of our company. Some
of these provisions:
- authorize our board of directors to determine the rights, preferences,
privileges and restrictions granted to, or imposed upon, the preferred
stock and to fix the number of shares constituting any series and the
designation of such series without further action by our stockholders;
- establish advance notice requirements for submitting nominations for
election to the board of directors and for proposing matters that can
be acted upon by stockholders at a meeting; and
In addition, we are governed by the provisions of Section 203 of Delaware
General Corporate Law. These provisions may prohibit large stockholders, in
particular those owning 15% or more of our outstanding voting stock, from
merging or combining with us, which may prevent or frustrate any attempt by our
stockholders to change our management or the direction in which we are heading.
These and other provisions in our amended and restated certificate of
incorporation and bylaws and under Delaware law could reduce the price that
investors might be willing to pay for shares of our common stock in the future
and result in the market price being lower than it would be without these
provisions.
New rules, including those contained in and issued under the Sarbanes-Oxley
Act of 2002, may make it difficult for us to retain or attract qualified
officers and directors, which could adversely affect the management of our
business and our ability to obtain or retain listing of our common stock.
We may be unable to attract and retain qualified officers, directors and
members of board committees required to provide for our effective management as
a result of the recent and currently proposed changes in the rules and
regulations which govern publicly-held
14
companies, including, but not limited to, certifications from executive officers
and requirements for financial experts on the board of directors. The perceived
increased personal risk associated with these recent changes may deter qualified
individuals from accepting these roles. The enactment of the Sarbanes-Oxley Act
of 2002 has resulted in the issuance of a series of new rules and regulations
and the strengthening of existing rules and regulations by the SEC. Further,
certain of these recent and proposed changes heighten the requirements for board
or committee membership, particularly with respect to an individual's
independence from the corporation and level of experience in finance and
accounting matters. We may have difficulty attracting and retaining directors
with the requisite qualifications. If we are unable to attract and retain
qualified officers and directors, the management of our business could be
adversely affected.
OUR INTERNAL CONTROLS OVER FINANCIAL REPORTING MAY NOT BE EFFECTIVE, AND
OUR INDEPENDENT AUDITORS MAY NOT BE ABLE TO CERTIFY AS TO THEIR EFFECTIVENESS,
WHICH COULD HAVE A SIGNIFICANT AND ADVERSE EFFECT ON OUR BUSINESS.
We are subject to various regulatory requirements, including the
Sarbanes-Oxley Act of 2002. We, like all other public companies, must incur
additional expenses and, to a lesser extent, diversion of our management's time
in our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002
regarding internal controls over financial reporting. We have not evaluated our
internal controls over financial reporting in order to allow management to
report on, and our independent auditors to attest to, our internal controls over
financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of
2002 and the rules and regulations of the SEC, which we collectively refer to as
Section 404. We have never performed the system and process evaluation and
testing required in an effort to comply with the management assessment and
auditor certification requirements of Section 404, which currently applies to us
in 2007 related to the management assessment requirements and applies to us in
2008 related to the auditor certification. Our lack of familiarity with Section
404 may unduly divert management's time and resources in executing the business
plan. If, in the future, management identifies one or more material weaknesses,
or our external auditors are unable to attest that our management's report is
fairly stated or to express an opinion on the effectiveness of our internal
controls, this could result in a loss of investor confidence in our financial
reports, have an adverse effect on our stock price and/or subject us to
sanctions or investigation by regulatory authorities.
THE MARKET PRICE FOR OUR COMMON SHARES IS PARTICULARLY VOLATILE GIVEN OUR
STATUS AS A RELATIVELY UNKNOWN COMPANY WITH A SMALL AND THINLY-TRADED PUBLIC
FLOAT AND LIMITED OPERATING HISTORY. THE PRICE AT WHICH YOU PURCHASE OUR COMMON
SHARES MAY NOT BE INDICATIVE OF THE PRICE THAT WILL PREVAIL IN THE TRADING
MARKET. YOU MAY BE UNABLE TO SELL YOUR COMMON SHARES AT OR ABOVE YOUR PURCHASE
PRICE, WHICH MAY RESULT IN SUBSTANTIAL LOSSES TO YOU.
The market for our common shares is characterized by significant price
volatility when compared to seasoned issuers, and we expect that our share price
will continue to be more volatile than a seasoned issuer for the indefinite
future. The volatility in our share price is attributable to a number of
factors. First, as noted above, our common shares are sporadically or thinly
traded. As a consequence of this lack of liquidity, the trading of relatively
small quantities of shares by our stockholders may disproportionately influence
the price of those shares in either direction. The price for our shares could,
for example, decline precipitously in the event that a large number of our
common shares are sold on the market without commensurate demand, as compared to
a seasoned issuer which could better absorb those sales without adverse impact
on its share price. Secondly, we are a speculative or "risky" investment due to
our limited operating history and lack of profits to date, lack of capital to
execute our business plan, and uncertainty of future market acceptance for our
business strategy. As a consequence of this enhanced risk, more risk-adverse
investors may, under the fear of losing all or most of their investment in the
event of negative news or lack of progress, be more inclined to sell their
shares on the market more quickly and at greater discounts than would be the
case with the stock of a seasoned issuer. The following factors may add to the
volatility in the price of our common shares: actual or anticipated variations
in our quarterly or annual operating results, market acceptance of our business
strategy, government regulations, announcement of significant acquisitions,
strategic partnerships or joint ventures, our capital commitments, and additions
or departures of our key personnel. Many of these factors are beyond our control
and may decrease the market price of our common shares, regardless of our
operating performance. We cannot make any predictions or projections as to what
the prevailing market price for our common shares will be at any time, including
as to whether our common shares will sustain their current market prices, or as
to what effect, if any, that the sale of shares or the availability of common
shares for sale at any time will have on the prevailing market price.
15
USE OF PROCEEDS
This prospectus relates to shares of our Common Stock that may be offered
and sold from time to time by the Selling Security Holders. We will receive no
proceeds from the sale of shares of Common Stock in this offering.
DESCRIPTION OF BUSINESS
OUR COMPANY
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 (POS) and gift card programs. 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.
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.
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.
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. The addition of these businesses would expand our product offering to
clients and prospects.
INDUSTRY
Catuity competes in the loyalty market within the retail industry at the
intersection of three significant and positive trends in retailing: upgrades of
POS systems; rising gift card usage; and the growing budgets of retailers to
enhance sales by driving loyalty among new and prospective customers.
POS Spending by Retailers: The Catuity Advanced Loyalty System works by
installing a proprietary application at the point of sale inside a retailer or
merchant's stores. As might be expected, retailers are cautious about changes
which affect their ability to accept payment. As such, Catuity gives priority to
sales prospects, which have already decided to upgrade their POS systems, be it
in hardware, software or both. Catuity may benefit when a POS upgrade is already
anticipated because it has the potential to shorten the sales and deployment
cycles. Numerous surveys and industry experts have reported that chain retailers
are continuing to aggressively upgrade their point of sale systems, a trend
first triggered by Y2K compliance concerns. In the Annual Survey of Retail
Information Technology Trends, Chain Store Age (www.chainstoreage.com) magazine
found that an average of 25% of the IT budgets was allocated for POS hardware
and software in 2005. Equally significant, Catuity's target market of tier two
chain stores, those with sales of $100 million to $1 billion a year spent the
largest portion of their technology budgets on POS needs; with most saying it
was a top priority. Generally speaking, the lifecycle of POS upgrades continues
to shorten. Except in extraordinary circumstances, hardware is replaced in a 5-7
year cycle at a typical chain store retailer, while software applications are
replaced more quickly based on advancements and new functionality. In a separate
study released in 2005, independent chain retailer research firm IHL Services
(www.ihlservices.com) reported that retailers spent $6.5 billion on POS
hardware, software and services last year for PC-based checkout systems. Catuity
targets these types of retailers through its direct sales effort.
Gift Card Usage Trends: In the past decade, stored value cards have become
one of the most sought after products at retailers. Gift cards are viewed as a
key customer acquisition tool since they are typically purchased by a friend or
relative and given to a potential shopper in lieu of cash. In fact, Deloitte &
Touche (www.deloitte.com) found in their annual study that gift cards were now
the No. 1
16
gift with a majority of shoppers choosing receiving a gift card as their
preferred gift. At the same time, Deloitte reported that consumers now favor
gift cards over cash by a two-to-one measure. For retailers, gift cards have
become vital to their success during the active Christmas holiday season and
throughout the year. In its annual year-end survey of consumers, the National
Retail Federation (www.nrf.org) found that consumers would spend at least $17
billion in value during the 2005 holiday season. Gift cards are not just a
seasonal business. They are a year-round part of the strategy of retailers and a
key profit center.
Retailers Emphasize Loyalty in Growth Strategy: Since Catuity entered the
North American market in 2000, loyalty has evolved from an emerging strategy to
an established practice and budgeted expenditure for retailers. Estimates of the
size of the loyalty market vary widely and are often interchanged with estimates
of the customer relationship management ("CRM") market. These estimates can
include everything from direct marketing services, branding and call center
support to technology spending. Catuity defines our services to enable loyalty
as the application, creation and management of the individual profile created
when a customer joins a membership or reward program; and the transactional
support necessary to make a loyalty program work seamlessly at the point of
sale. Today, this does not include full-service database management, direct mail
support, web-related services and full service analytics. These are capabilities
that the Company expects to add through new development and acquisition. We
would note that our acquisition of Loyalty Magic Pty. Ltd. increased our
in-house ability to manage databases on behalf of clients. Additionally, Loyalty
Magic includes some key functional capabilities, including, but not limited to,
interfaces with kiosks and e-commerce platforms.
For the services that we offer today, merchants (those with one to 25
locations) spend an average of $850 to $1,100 annually per store on basic
loyalty programs. These fees are often charged in the form of a flat monthly
subscription and transactional service for a turnkey program. While Catuity
targets this market through resellers and referral, such as merchant services
providers, we believe there is a potential market of at least 1.2 million small
merchants -- about one in four of the total market -- in North America who do
not yet have a loyalty or gift card solution. Using the lowest estimates for
each, we believe that the small merchant market will spend at least $750 million
on loyalty and gift card solutions annually. As Catuity expands our sales focus
beyond our core market, the size of our opportunity will increase.
By the same measure, chain store retailers, which Catuity targets through
direct sales, spend an average of $3,700 to $6,900 per store annually for the
services which we sell to support loyalty and gift card solutions. The retailers
in three market segments that we have targeted represent at least 55,000
locations in North America.
BUSINESS SEGMENTS
Catuity conducts all of its business in a single business segment --
providing loyalty and gift card technology along with related services to
retailers and their partners.
PRODUCTS AND SERVICES
During Catuity's last two fiscal years, its revenue by type of product or
service has been as shown below:
2006 2006 2005 2005
REVENUE TYPE AMOUNT % AMOUNT %
- ------------- ---------- ---- -------- ----
Processing $1,409,698 72% $510,826 52%
Service 354,815 18% 404,611 41%
License 184,287 10% 65,485 7%
---------- --- -------- ---
Total Revenue $1,948,800 100% $980,922 100%
In 2004 and 2005, Catuity underwent a major shift in business focus which
directly impacted our full year results. In 2004, the Company learned that one
of its clients, a large U.S. retailer, was discontinuing its use of smart cards.
As a result, Visa USA determined that it would discontinue the development of
its Smart Visa Rewards Platform and phase out the platform's operations during
2004. Catuity's loyalty software was a key component of the platform and this
Visa-issuing retailer represented the vast majority of the Company's revenue.
The Company then embarked on an extensive effort to replace its existing
technology with the new Catuity Advanced Loyalty System, or CALS. That system
was designed to be architecturally flexible to meet the changing needs of
clients and prospects.
Late in the third quarter of 2004, the Board of Directors named a new CEO,
who embarked on an internal restructuring of the efforts and focus of the sales
team and a reduction in the size of the technology team. These changes were
implemented during the fourth quarter of 2004 and into 2005. During the
Company's refocusing efforts, the Company made limited progress in pursuing,
managing and closing new sales.
17
During 2005, the Company established the operational team and the secure
facility needed to enable it to host loyalty and gift card programs for
customers. In addition, the Company successfully completed two capital raises,
the acquisition of Loyalty Magic Pty. Ltd. and the post acquisition integration
needed for efficient operations between Catuity's and Loyalty Magic's staffs.
In 2006, the Company was successful in deploying its new technology for
customers; in establishing marketing partnerships; in establishing a defined
sales pipeline; completing a series of application programmer's interfaces
(APIs) to streamline the process of integration to our system; in completing the
major development objectives for CALS, and in securing a set of clients which
are useful references for securing new customers.
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 inbound,
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.
Most retailers are interested in achieving one or more of the following
from their loyalty and reward programs:
- Increasing the wallet-share of existing customers (tapping into the
money that customers are spending at similar retailers)
- Increasing basket lift (giving customers reasons to spend more on
targeted products and categories);
- Improving gross margin (giving customers reasons to buy higher margin
products);
- Increasing customer purchase frequency (driving customers back to the
store more often); and
- Increasing customer response rates.
Our loyalty technology, CALS, provides the capabilities retailers need to
achieve these goals via:
- Launching and managing membership-based programs;
- Managing points-based programs;
- Delivering discounts or rebates based on shopping behavior; and
- Offering customizable gift card programs which can be enhanced with
loyalty functionality.
Catuity provides easy store-level deployment of its technology. We have
proactively invested in a series of integrations to major point of sale
platforms and have introduced secure APIs that we believe significantly reduce
the time and expense of integration to our platform by retailers and other third
parties.
COMPETITION
Catuity is focused on enabling loyalty and gift card programs in the U.S.
and Canada where demand is high and customers consider loyalty to be an
established part of their growth strategies. In North America, as in other
predominantly English-speaking markets globally, budgets for loyalty are
established -- not emerging -- but are not considered mature. Catuity's
prospects do not lack options in how they choose to spend their budgets to
acquire, retain and upsell their customer relationships. We have found that they
make one of three financial and strategic choices in executing their loyalty
strategy. These are:
- - IN-HOUSE SOLUTION: Retailers, especially the largest, often seek
competitive advantage by custom development of proprietary in-house
solutions. This is generally done in conjunction with loyalty
consultancies, database service firms and IT service firms. This is not a
primary market for Catuity due to the typically lengthy and complex sales
cycle and the strict financial requirements placed on the provider, which
tend to exclude smaller companies. While Catuity does not actively target
tier one retailers or custom installation projects, we will provide this
option at the request of our core customers.
- - HOSTED SOLUTION: Retailers, especially the tier two chain retailers
targeted by Catuity, favor a turnkey hosted solution which enables them to
minimize capital investment; avoid the need for large, specialized IT; and
reduce the risks associated with complex integration, deployment and
upgrades. This market typically prefers a hosted solution which allows them
to customize their programs -- not their technology -- to be aligned with
the retailers' merchandising and branding strategy. Many players, including
payments processors, gift card solutions providers and marketing services
firms are generally focused by vertical market.
- - PROGRAM-BASED SOLUTION: Retailers actively participate in promotional
programs which are generally designed to drive a single type of customer
behavior, such as new account acquisition or customer retention, or target
the sale of specific products. These programs are generally attractive
because they have a defined cost; require little to no technology adoption
and require no complex back-end technology to manage beyond a specific
promotion. Catuity does not compete in this market.
18
Our ability to be successful depends on many factors, including:
- - Our ability to establish a clear business case that is aligned with the
strategy of our client and which has a clearly defined return on
investment.
- - Our ability to successfully market the features of our product and to
continually make it easier for our clients to use.
- - Our ability to continually expand our reputation and credibility in our
markets and to differentiate Catuity from the many competitive
alternatives.
- - Our ability to leverage marquee client relationships to establish a more
visible presence in North America and Australia.
- - Our ability to execute on schedule and on budget and to consistently exceed
our customers' ongoing service requirements.
Catuity provides our customers and key prospects with a range of flexible
options. CALS is a robust and flexible platform which enables our customers to
create, manage and measure the success of their proprietary loyalty programs.
DEPENDENCE ON ONE OR A FEW MAJOR CUSTOMERS
Revenue from two of Loyalty Magic's customers each exceeded 10% of Catuity's
revenue (AMCAL at 24% and API at 20%) 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 (AMCAL at 15% and API at 13%) and, in
total, represented approximately 28% of revenue.
RESEARCH AND DEVELOPMENT
Catuity's product development efforts in 2006 were primarily focused on
completing a fully market ready processing platform, CALS. The Company has
enhanced existing functionality while constantly striving to make the system
easier to use by retailers who generally lacked large or sophisticated
technology departments. In 2006, the Company enhanced the management reporting
capabilities of the system; continued to expand the number of POS systems to
which we integrate and added new functionality that helped us deliver a
technologically advantaged product in our markets. During the first quarter of
2007, our research and development expense was $81,803. For the year ended
December 31, 2006 our research and development expense was $495,906 and for the
year ended December 31, 2005 it was $751,679.
Through the acquisition of Loyalty Magic, Catuity acquired the LMX loyalty
platform. For the most part, that technology platform is used by clients in
Australia, New Zealand and the United Kingdom. The Company does not currently
plan to market the software directly in North America. Additionally, most of the
enhancements to the LMX system are client directed and funded and are not
considered R&D investments. When assessing projects for possible R&D investment,
Catuity makes efforts to ensure that new functionality can be used with both
platforms.
Catuity believes that focus and consistent application of some basic design
principles will ensure that we deliver a product that is strategically
advantaged in our markets. To that end, the Company's management balances every
proposed development project against four design principles. These principles
are:
- - EVERY DEVELOPMENT PROJECT SHOULD GIVE OUR CUSTOMER CONTROL OF THEIR
PROGRAMS. This is important because retailers of all sizes want to be able
to quickly and easily implement, measure and modify their marketing and
loyalty programs. Because we are delivered in an ASP model, a key element
of our R&D strategy is to always make it simpler and more intuitive for our
customers to use the technology.
- - EVERY DEVELOPMENT SHOULD OFFER SUPERIOR DATA SECURITY. The security of
customer information remains a major concern among retailers and payments
industry players. Catuity addresses the security of our own system through
the training of our people; clearly drafted policies and procedures;
ongoing review and discussions with our customers about their best
practices; and compliance with industry standards. Catuity is in the
process of certifying its U.S. operations as being compliant with industry
standards around customer data security.
- - EVERY DEVELOPMENT SHOULD NOT IMPACT THE TIME OF THE TOTAL TRANSACTION.
Because our programs work at the point of sale, it is critical that our
technology never slow down the checkout process. Retailers equate delays at
the checkout with lost business. Our technology, which requires a
proprietary application to be installed at the POS, is designed to operate
under the ISO 8583 message format, simultaneously with the approval of the
payment transaction. Before any version of
19
our applications are released, they are tested and improved to streamline
the total transaction time so that Catuity never hurts the checkout time of
one of its customers.
- - EVERY DEVELOPMENT SHOULD MINIMIZE OR ELIMINATE INTEGRATION AND OTHER
IT-RELATED RISKS FOR OUR CUSTOMERS. Like most buyers of technology driven
solutions, retailers assess the total cost of deploying and managing a
solution. Our investment in our Application Program Interface ("API")
development and integration with market-standard protocols is designed to
reduce the upfront cost of doing business with Catuity. These upfront costs
can act as a deterrent to a buying decision. We believe that a critical
success factor in transaction-driven companies is to make it easy for
customers to start doing business with us.
Development projects that do not meet these four standards are generally
only considered if they are funded by a client.
INTELLECTUAL PROPERTY
Catuity respects the intellectual property rights of others and we expect
others to respect our rights. Patents protect the rights of innovators and allow
them to be rewarded for their innovation. Without protection for the reward from
innovation, far less research and development would be undertaken.
We file patent and trademark applications to protect our innovations and to
protect the business from legal action by others. Patents also provide
recognition for our innovations, demonstrate our capabilities, and reflect the
expertise of our employees. We see patents as part of our marketing strategy as
they help convince others that we are indeed specialists in our field.
Catuity believes its patents are of significant value and as part of its
agreements with licensees, Catuity grants rights to use the innovations
described in its patents.
Catuity has been issued three patents related to the efficient storage and
management of multiple applications in offline consumer devices and the systems
to manage the applications, customer devices and terminals. This patent "family"
has a priority date of December 4, 1998 and includes:
COUNTRY PATENT NUMBER
- ------- -------------
United States 6,449,684
United States 6,532,518
Australia 755,388
Patent applications are pending in the European Union, Japan and Brazil.
Catuity has also been issued patents in seven countries, with a priority
date of February 22, 1999, which relate to the use of the Catuity System over
the Internet and with traditional point of sale devices. It covers our system
for managing and updating data on customer devices that are supported and
controlled by a host system integrated to any number of offline and online
terminals. The patent covers the operation of interactive programs and
transactions that use methods ranging from POS terminals to the Internet. This
patent "family" includes:
COUNTRY PATENT NUMBER
- ------- -------------
Australia 746,867
New Zealand 513,678
Belgium 1,163,633
Finland 1,163,633
France 1,163,633
Germany 60020818.4
Great Britain 1,163,633
This patent is also pending in Canada and Japan.
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.
The Company has registered "Catuity" as a service mark (registration number
2621889) and as a trademark (registration number 2615770) with the US Patent and
Trademark Office (USPTO). Currently the service mark "Lift Card" (serial number
78770277) is pending at the USPTO.
20
SALES BACKLOG AND PIPELINE
As of December 31, 2006, the Company had 2,000 potential deployable
locations signed in the U.S. market, through our direct sales efforts to chain
retailers, franchise and merchant groups. A potentially deployable store
includes signed clients, franchise groups where we have won the right to market
to independent franchises, ongoing pilots and merchant groups in which we have
referral agreements. As always, we caution investors that deployment schedules
are uncertain in our business and that Catuity has limited control over when a
client executes a store-level deployment. As of this filing, the Company has a
defined and growing prospect base of companies which we are targeting for the
purchase of loyalty programs, gift card programs or credit and debit card
processing, or a bundle 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 resellers. These resellers are strategically
designed to give Catuity access to non-core markets. As of December 31, 2006
reseller agreement ranges from 3-5 years in length and is generally exclusive.
These resellers have generally been independent sales organizations (ISO), agent
groups, who have a defined geographic territory. 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
with various Australian banking systems to reach over 50% of the Australian
retail market. These banks provide credit and debit card processing services and
a growing list of value-added services through their EFTPOS facilities that
create revenue-generating opportunities for merchants. Loyalty Magic's diverse
range of loyalty programs is now available on these platforms. Management
believes we will increase our market penetration in 2007.
REVENUE AND ASSETS BY GEOGRAPHIC LOCATION
The Company's assets are located at its headquarters in Charlottesville, VA
along with its offices in Denver, CO, Melbourne, Australia and in Sydney,
Australia.
Revenue by Geographic Location: 2006 2005*
- ------------------------------- ---- -----
Catuity Inc. (US operations) 12% 8%
Loyalty Magic (Australia operations) 88% 92%
* - Loyalty Magic, the source of all our Australian revenue, was acquired in
September 2005 and therefore was included in our reported results for only
four months during 2005.
EMPLOYEES AND FACILITIES
As of December 31, 2006 we had 35 full time employees, 14 of which are
located in the U.S. and 21 of which are located in Australia. None of our
employees is covered by a collective bargaining agreement. We consider our
relations with our employees to be very good. Our corporate headquarters is
located in Charlottesville, Virginia.
DESCRIPTION OF PROPERTY
During 2006, our corporate headquarters was located in leased facilities in
Livonia, Michigan (a suburb of metropolitan Detroit). The property consisted of
approximately 1,500 square feet of office space with a lease expiring in
February, 2008. In January 2007, we relocated our corporate headquarters to
leased facilities in Charlottesville, VA consisting of approximately 1,000
square feet of office space. Our Client Management department is also located in
our Charlottesville office. The facilities are leased through September 2007.
Our Sales department is located in leased facilities in Denver, CO
consisting of approximately 800 square feet of office space. The facilities were
leased for a two year period ending in December, 2007.
21
Our primary office in Australia is Loyalty Magic's premises that are
located in leased facilities in Melbourne Victoria consisting of approximately
3,460 square feet of office space. The facilities are leased for a term of 5
years beginning August 1, 2002 with a further term of five years at the
Company's option.
We also have a Research and Development center located in leased facilities
in Sydney, Australia, consisting of approximately 330 square feet. Our lease
agreement expired on December 28, 2005 and has continued on a month-to-month
basis.
LEGAL PROCEEDINGS
Catuity was not during 2007 and is not as of the date of this prospectus a
party to any legal proceedings.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The following table sets forth our Directors, Executive Officers, Promoters
and Control persons and their ages as of March 31, 2007.
NAME AGE POSITION(S)
- -------------------------- --- ---------------------------------------------
Alexander S. Dawson 63 Chairman (1), (2), (3)
Alfred H.(John) Racine III 42 Director, President and Chief Executive Officer
Geoffrey C. Wild 67 Director (1), (3)
Donald C. Campion 58 Director (1), (2)
Clifford W. Chapman Jr. 38 Director (2), (3)
Debra R. Hoopes 46 Sr. Vice President, Chief Financial Officer, Treasurer and Secretary
Graham McStay 40 Managing Director of Loyalty Magic Pty. Ltd. (Australia)
(1) Audit Committee
(2) Compensation Committee
(3) Governance and Nominating Committee
Alexander S. Dawson is our non-executive Chairman of the Board of
Directors. He served as the Chairman of CAT, our wholly owned subsidiary, from
November 1992 to December 1999. From April 1987 to January 1991, he was Chief
Executive Officer of Arnotts Ltd., Australia's largest biscuit and snack food
manufacturing company. From January 1988 to December 1990 he was a member of the
Business Council of Australia. He served as Chairman of United Distillers
(Australasia) Limited from August 1994 to March 1996. Mr. Dawson is a Fellow of
The Institute of Chartered Accountants in Australia, has a Bachelor of Commerce
degree from the University of New South Wales and a Master of Business
Administration from Columbia University.
Alfred H. (John) Racine III is our President and Chief Executive Officer
and is a member of the Board of Directors. Prior to joining Catuity Mr. Racine
founded Altamont Partners in Charlottesville, Virginia in 1997. Altamont
Partners has advised many of the leading payment organizations in North America
and Europe regarding strategic and merger related issues. Prior to his tenure
with Altamont Partners, Mr. Racine was a principal at SNL Financial, also in
Charlottesville, Virginia, the highly regarded merger and financial analytics
provider for the financial services industry. From 1995-1997 Mr. Racine played a
key role in SNL's emergence as a market leader in the face of larger,
established competitors. Prior to that he spent five years in a variety of
operational and strategic roles in the financial services division at Thomson
Financial. Before spending the last 14 years working in the financial services
and payments industries Mr. Racine worked in the media industry at leading
companies including Ingersoll Publishing Co. and Capital Cities-ABC. He attended
Southern Illinois University at Carbondale.
Clifford W. Chapman, Jr. is one of our independent directors and the
Chairman of our Compensation Committee. Cliff Chapman is currently the head of
investment banking for Broadband Capital Management, a boutique investment and
merchant bank. In addition to working with Andersen Consulting and Booz Allen &
Hamilton, Mr. Chapman has also played key leadership roles in two high profile
successes. Most recently he was the CEO and investor in the turnaround of
mindSHIFT Technologies, a managed services provider focused on IT outsourcing
for small and medium enterprises. From June 2002 through October 2003 he
restructured the sales process, cut costs and acquired three companies to take
mindSHIFT to profitability. Prior to MindSHIFT, Mr. Chapman was the VP of
Business Integration for AppNet, a full-service Internet professional service
and managed hosting company. Prior to AppNet, Mr. Chapman co-founded NMP, a
full-service consulting business and managed hosting company. He has also worked
with numerous start-up businesses. Mr. Chapman holds an MBA from Columbia
Business School and a BS in Computer Engineering from Lehigh University.
22
Geoffrey C. Wild is one of our independent directors and is Chairman of the
Governance and Nominating Committee. He had a distinguished career in
advertising and marketing for 30 years and was awarded Australia's highest
honor, the Order of Australia (AM). In 1972, he founded Clemenger Advertising
Agency in Sydney and merged with US-based BBDO Group where he oversaw a
Pan-Asian expansion strategy through acquisition and start-up. He was Chairman
of the Advertising Federation of Australia, chairman of the Advertising Industry
Council and is a recognized authority on branding, advertising, marketing and
loyalty. Mr. Wild currently serves as the non-Executive Chairman of WPP Holdings
(Australia) Pty Ltd, the Group which owns Ogilvy & Mather, J Walter Thompson,
Young & Rubicam, Hill & Knowlton and Burson Marsteller. He was a director of TAB
Limited and currently serves on the boards of ComOps Limited, and the Arab Bank
Australia Limited. He is also a long serving Board member of the PGA
(Professional Golf Association) and IBIS World, the business and economic
forecasting group. He was awarded the Order of Australia (AM) for his
contribution to tourism, business and the Olympics. He is a Fellow of the
Advertising Institute (by examination) FAIA, and a Fellow of the Australian
Institute of Company Directors FICD.
Donald C. Campion is one of our independent directors and is Chairman of
our Audit Committee. Mr. Campion is a member of the Board of Directors for
Haynes International and also serves as the Chairman of its Audit Committee and
as a member of its Compensation Committee. He is also a member of the Board of
Directors of McLeodUSA, Inc., a privately held telecommunications company, where
he serves as the Chairman of its Audit Committee. Mr. Campion served as the
Chief Financial Officer for VeriFone Inc., North America's largest point of sale
terminal manufacturer. He was also the Chief Financial Officer of several other
corporations, including Special Devices, Inc., Cambridge Industries, Inc.,
Oxford Automotive, Inc., and Delco Electronics Corporation. Previously, Mr.
Campion held a variety of Senior Management roles with General Motors and its
affiliates. He holds an MBA and a BS in Applied Mathematics from the University
of Michigan.
Debra R. Hoopes began service as our Sr. Vice President, Chief Financial
Officer, Secretary and Treasurer on January 2, 2007. Ms. Hoopes was most
recently the interim Chief Financial Officer of Catcher Holdings, Inc., through
her relationship with Tatum Partners and prior to that was the Chief Financial
Officer of Intersections Inc., a Chantilly, Virginia-based company that provides
credit reporting and identity theft products for the consumer market. Ms. Hoopes
has eight years of experience as Chief Financial Officer or a senior financial
officer in private equity backed and public companies including Compel Holdings;
CityNet Telecommunications; and Winstar Telecommunications. Prior to that, Ms.
Hoopes managed a line of businesses for Cable & Wireless and was with MCI
Communications. Ms. Hoopes holds a B.S. in Accounting from Virginia Tech and an
MBA in Finance from George Washington University and is a CPA.
Graham McStay was appointed as Managing Director of our Australian
subsidiary, Loyal Magic, on January 30, 2007. Previously, he spent two years as
the head of operations at Loyalty Magic. In that capacity, he oversaw all client
management and the company's technology team. He has more than 10 years of
extensive operational management experience in leading Australian companies.
While at Retail Decisions, the fuel card division, Mr. McStay was the national
customer service and sales manager who oversaw the merger of two business units.
He held a similar position at the Centre for Adult Education, UCMS and at Ansett
Australia.
Each of our directors other than Mr. Racine is "independent" under the
independence standards applicable to Catuity pursuant to applicable securities
regulations. Each director holds office until the next annual meeting of
shareholders or until his successor has been duly elected or qualified or until
his earlier death, resignation or removal. Executive Officers are appointed by,
and serve at the discretion of, our board of directors. In the case of Mr.
Racine however, he will serve as President and Chief Executive Officer until the
expiration of his current agreement on September 30, 2007. Mr. Racine's
agreement may be extended for one year by mutual agreement between himself and
Catuity.
Our board of directors has an audit committee. The audit committee, among
other things, makes recommendations to the board of directors concerning the
engagement of independent auditors and monitors the results of our operating and
internal controls as reported by management and the independent auditors. The
audit committee contains at least one Financial Expert as that term is defined
in SEC rules.
Effective February 26, 2001, the board of directors established a
compensation committee. In 2003, the board of directors resolved that only
independent directors could serve on the compensation committee. The
compensation committee is responsible for establishing the compensation levels
for our executive officers. In recommending and determining compensation, the
committee takes into consideration the compensation practices of companies in
the markets that the Company competes for executive talent. Incentives in the
form of stock options are generally offered.
On March 22, 2005, the Board approved the establishment of a Nomination and
Governance Committee, which became effective on July 1, 2005. The Nomination and
Governance functions, which include selecting qualified individuals for approval
by
23
shareholders to serve as members of the Board and developing a set of corporate
governance principles applicable to the Company, was previously carried out by
the independent members of the Board as part of their Board responsibilities.
There are no family relationships among any of our directors. No
arrangement or understanding exists between any director and any other person
pursuant to which any director was selected to serve as a director. To the best
of our knowledge, (i) there are no material proceedings to which our director is
a party, or has a material interest, adverse to us; and (ii) there have been no
events under any bankruptcy act, no criminal proceedings and no judgments or
injunctions that are material to the evaluation of the ability or integrity of
any of the directors during the past five years.
DIRECTOR AND EXECUTIVE COMPENSATION
The following tables provide certain summary information concerning
compensation and stock options for our Principal Executive Officer, the named
executive officers that earned more than $100,000 (salary and bonus), and our
directors for all services rendered in all capacities to Catuity during the year
ended December 31, 2006.
SUMMARY COMPENSATION TABLE
SALARY (1) STOCK (2) OPTION (3) ALL OTHER
\NAME AND PRINCIPAL POSITION YEAR ($) AWARDS ($) AWARDS ($) COMPENSATION ($) TOTAL ($)
- ---------------------------------------------- ---- ------- ---------- ---------- ---------------- ---------
Alfred H. (John) Racine, III President and CEO 2006 253,365 57,415 174,398 7,600 491,778
John H. Lowry, III Vice President --
CFO, Secretary and Treasurer 2006 170,000 52,152 15,045 113,668 350,865
Chris Leach CEO of Loyalty Magic 2006 134,150 0 15,575 0 149,725
(1) The amount expensed per SFAS 123(R) in 2006 for stock awarded in 2006.
(2) The amount expensed per SFAS 123(R) in 2006 for options awarded in 2005 and
2006.
(3) For Mr. Lowry, includes $108,568 of salary and benefits to be paid in 2007
in connection with his employment agreement. Mr. Lowry resigned on
January 2, 2007.
OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2006
OPTION AWARDS STOCK AWARDS
----------------------------------------------------------------- -----------------------
MARKET
NUMBER OF NUMBER OF NUMBER VALUE
SECURITIES SECURITIES OF SHARES OF SHARES
UNDERLYING UNDERLYING OR UNITS OR UNITS
UNEXERCISED UNEXERCISED OPTION OF STOCK OF STOCK
OPTIONS (#) OPTIONS (#) OPTION EXERCISE EXPIRATION THAT HAVE THAT HAVE
NAME EXERCISABLE UNEXERCISABLE PRICE ($) DATE NOT VESTED NOT VESTED
- ---- ----------- ------------- --------------------- ----------- ---------- ----------
77,914 @ $4.20(2) and
Alfred H. (John)Racine, III 102,914 25,000 50,000 @ $6.86(3) 9-23-09 and 100,000(1) 444,000
9-23-15
8,333 @ $7.50 and
John H. Lowry, III 13,333 5,000 10,000(5) @ $10.52 6-20-10 and 20,000(4) 88,800
9-20-15
5,000 @ $16.99 and
Chris Leach 15,000 0 10,000 @ $18.35 (6) 9-1-10 -- --
- ----------
(1) 33,334 restricted shares will vest when the 30 day average closing price of
our common stock on the NASDAQ exceeds $15.00; 33,333 restricted shares
will vest when the 30 day average closing price of our common stock on the
NASDAQ exceeds $20.625; and 33,333 restricted shares will vest when the 20
day average closing price of our common stock on the NASDAQ exceeds $26.25.
(2) Vesting occurred between Nov. 2004 and Sep. 2005.
(3) Option exercise price is $6.86 and vesting as follows: twenty-five percent
(25%) on September 23, 2005 (actually vested on May 11, 2006 when
shareholders approved it); twenty-five percent (25%) on September 23, 2006;
and the remaining fifty percent (50%) on September 23, 2007.
24
(4) 6,667 restricted shares will vest when the 30-day average closing price of
our common stock exceeds $15; 6,667 restricted shares will vest when the
30-day average closing price of our common stock exceeds $20.625; and 6,666
restricted shares will vest when the 30-day average closing price of our
common stock exceeds $26.25.
(5) 10,000 options at $10.52 with 5,000 vested Sept. 28, 2006 and 5,000 vesting
on Sept. 28, 2007. 8,333 options at $7.50 and vested on Dec. 29, 2005.
(6) Options to purchase 15,000 shares common stock vesting: 5,000 vested on
September 1, 2005 with an exercise price equal to 25% above the 30-day
average closing price on NASDAQ preceding the grant ($16.99 USD); 5,000
vested on January 1, 2006 with an exercise price equal to 35% above the
30-day average closing price on NASDAQ preceding the date of the grant
($18.35 USD); and 5,000 vested on January 1, 2007 with the exercise price
equal to 35% above the 30-day average closing price on NASDAQ preceding the
date of the grant ($18.35 USD.)
DIRECTOR COMPENSATION
FEES
EARNED OR
PAID IN STOCK (1) OPTION (2)
NAME CASH ($) AWARDS ($) AWARDS ($) TOTAL ($)
- ---- --------- ---------- ---------- ---------
Alexander S. Dawson 30,250 30,254 6,426 66,930
Alfred H.(John) Racine III -- -- -- --
Geoffrey C. Wild 20,000 19,996 5,355 45,531
Donald C. Campion 20,750 20,753 5,355 46,858
Clifford W. Chapman Jr 18,250 18,251 5,355 41,856
- ----------
(1) Restricted stock awards vest on the first calendar day after the Company
has achieved profitability and positive cash flow for two consecutive
fiscal quarters. Total restricted shares outstanding at December 31, 2006
for Dawson: 8,745; Campion: 5,651; Chapman: 5,310; and Wild: 5,446.
(2) The options outstanding at December 31, 2006 for Dawson: 8,000; Campion:
5,000; Chapman: 5,667; and Wild: 5,000.
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL
AGREEMENTS
Alfred H. (John) Racine, III. We have an employment agreement with our
President and Chief Executive Officer, Alfred H. (John) Racine, III. Pursuant to
the agreement, Mr. Racine's salary is currently $262,500 per year. We have
granted Mr. Racine stock options and restricted shares pursuant to his
employment agreement, as depicted in the Summary Compensation Table above (note:
approved by shareholders on May 11, 2006; considered the grant date for
reporting purposes). The options have a term of ten (10) years from September
23, 2005 (September 23, 2015), and vest on the following schedule: (i)
twenty-five percent (25%) on September 23, 2005; (ii) twenty-five percent (25%)
on September 23, 2006; and (iii) the remaining fifty percent (50%) on September
23, 2007. The restricted shares vest on the following schedule: (i) 33,334
restricted shares will vest when the 30 day average closing price of our common
stock on the NASDAQ exceeds $15.00; (ii) 33,333 restricted shares will vest when
the 30 day average closing price of our common stock on the NASDAQ exceeds
$20.625; and (iii) 33,333 restricted shares will vest when the 20 day average
closing price of our common stock on the NASDAQ exceeds $26.25. The restricted
shares will vest immediately upon a change of control where Mr. Racine loses his
position as long as the consideration paid to Catuity stockholders in such
transaction is greater than $10.00 per share. Any unvested restricted shares are
forfeited if Mr. Racine voluntarily resigns or if his employment is terminated
for cause.
Debra R. Hoopes. Effective January 2, 2007, John H. Lowry, III resigned as
Chief Financial Officer, and was replaced by Debra R. Hoopes, who serves as our
Senior Vice President and Chief Financial Officer. We have an employment
agreement with Ms. Hoopes. Ms. Hoopes' employment agreement is for an initial
term commencing on January 2, 2007 and ending on December 31, 2009. The
employment agreement is automatically renewable for successive one year terms
thereafter unless either party timely terminates the agreement. Pursuant to the
employment agreement, Ms. Hoopes is paid an annual base salary of $185,000,
which will be reviewed annually by the Company's Chief Executive Officer and
Board of Directors. In addition to her base salary and in accordance with the
terms of her employment agreement, Ms. Hoopes is entitled to certain
incentive-based compensation payable in shares of the Company's common stock if
the Company satisfies certain performance criteria.
In addition, Ms. Hoopes received options to purchase 25,000 shares of the
Company's common stock (the "Options") at an exercise price equal to the volume
weighted average of the trading price of the Company's common stock on the
NASDAQ Capital Market ("NASDAQ") during the thirty calendar days preceding (and
ending on) December 6, 2006 (the "Initial Market Price"). Twenty-five percent of
the Options will vest on each of January 2, 2007 and December 31, 2007 and the
remaining fifty percent will vest on December 31, 2008. Ms. Hoopes will receive
50,000 shares of restricted stock (the "Restricted Stock"). One-third of the
shares of Restricted Stock will vest when the thirty calendar day volume
weighted average trading price of the Company's common stock on NASDAQ (the
"30-day VWAP") exceeds two times the Initial Market Price, one-third of the
shares of Restricted Stock will vest
25
when the 30-day VWAP exceeds three times the Initial Market Price and the
remaining one-third of the shares of Restricted Stock will vest when the 30-day
VWAP exceeds four times the Initial Market Price.
Graham McStay. Effective February 28, 2007, Chris Leach resigned as CEO of
Loyalty Magic and was replaced by Graham McStay. We have an employment agreement
with Mr. McStay. Mr. McStay's employment agreement is for an initial term
commencing on March 15, 2007 and ending on March 14, 2010. The employment
agreement is automatically renewable for successive one year terms thereafter
unless either party timely terminates the agreement. Pursuant to the employment
agreement, Mr. McStay is paid an annual salary of $180,000 AUD, which will be
reviewed annually by the Company's Chief Executive Officer and Board of
Directors. In addition to his base salary, Mr. McStay is entitled to certain
incentive-based compensation payable in shares of the Company's common stock if
Loyalty Magic achieves certain performance criteria.
In addition, Mr. McStay received options to purchase 10,000 shares of the
Company's common stock (the "McStay Options") at an exercise price equal to the
volume weighted average of the trading price of the Company's common stock on
NASDAQ during the thirty calendar days preceding (and ending on) March 15, 2007.
Twenty five percent of the McStay Options will vest on each of March 15, 2007,
2008, 2009 and 2010. Mr. McStay will also receive 15,000 shares of restricted
stock (the "McStay Restricted Stock"). One-half of the shares of McStay
Restricted Stock will vest if Loyalty Magic achieves 100% of EBIT goals for 2007
(subject to audit) and one-half of the shares of McStay Restricted Stock will
vest if Loyalty Magic achieves 100% of EBIT goals for 2008 (subject to audit).
John H. Lowry, III. Mr. Lowry served as Chief Financial Officer until
January 2, 2007. From January 2, 2007 through the end of the term of his
employment agreement (July 1, 2007), he will remain employed by the Company for
a limited role in order to assist with the transition of duties to Ms. Hoopes.
Under the terms of Mr. Lowry's employment agreement, Mr. Lowry's base salary is
currently $170,000. In addition, he was granted options to purchase shares of
our common stock and was awarded shares of restricted stock, as depicted in the
Summary Compensation Table above. One half of the options expired on September
28, 2006 and the remaining half will expire on September 28, 2007. One third of
the restricted shares will vest when the Company's 30 day average closing price
on NASDAQ exceeds $15.00, $20.625, and $26.25 respectively. Any unvested option
shares or restricted shares are forfeited if Mr. Lowry voluntarily resigns or if
his employment is terminated for cause.
Chris Leach. Mr. Leach served as CEO of Loyalty Magic until his resignation
on January 30, 2007. Chris remained an employee until February 28, 2007 to
assist with the CEO transition. On September 1, 2005 Catuity entered into a
services agreement with MIA Pty. Ltd. ("MIA") and Chris Leach requiring Mr.
Leach to provide executive management services to Catuity. Mr. Leach is an
officer and director of MIA and is authorized to approve and execute contracts
on its behalf. Mr. Leach, under contract with MIA, served as the Chief Executive
Officer of Loyalty Magic Pty. Ltd. prior to its acquisition by Catuity on
September 1, 2005. The contracted services with Catuity commenced on September
1, 2005 and continue until December 31, 2007. The services consist of general
executive management including the management of all Australian sales and
research and development efforts along with Catuity's existing and future
Australian operations.
Under the terms of the agreement, Mr. Leach's base salary was $195,000 AUD
(approximately $146,000 USD) plus a lump sum payment to MIA that is equal to the
cost of customary benefits to be paid in twelve (12) equal monthly installments.
In addition, Mr. Leach was awarded options to purchase 15,000 shares of our
common stock. The options vest on the following schedule: (1) 5,000 vested on
September 1, 2005 with an exercise price equal to 25% above the 30-day average
closing price on NASDAQ preceding the grant ($16.99 USD); (2) 5,000 vested on
January 1, 2006 with an exercise price equal to 35% above the 30-day average
closing price on NASDAQ preceding the date of the grant ($18.35 USD); and (3)
5,000 vested on January 1, 2007 with the exercise price equal to 35% above the
30-day average closing price on NASDAQ preceding the date of the grant ($18.35
USD.) Mr. Leach was also provided with an opportunity to earn 20,000 restricted
stock shares as follows: (1) 5,000 shares to be granted on January 30, 2006 if
Mr. Leach meets 100% of the revenue and EBITDA goals for the second half of
2005, which did not occur; (2) 7,000 shares to be granted on January 30, 2007
for meeting 100% of the revenue and EBITDA goals for 2006, which did not occur;
and (3) 8,000 shares to be granted on January 30, 2008 for meeting 100% of the
revenue and EBITDA goals for 2007.
26
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table provides certain information regarding beneficial
ownership of our common stock as of March 31, 2007 by: (i) each person who is
known by us to beneficially own more than five percent of our common stock; (ii)
our Principal Executive Officer and the four most highly compensated executive
officers that earned more than US$100,000 (salary and bonus) for all services
rendered in all capacities to Catuity during the year ended December 31, 2006;
(iii) each of our Directors; and (iv) all of our Directors and executive
officers as a group.
AMOUNT AND NATURE OF COMMON STOCK PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED (1) OWNED (2)
- ------------------------------------ --------------------------------- ---------
Alfred H. Racine III 101,998 Direct
11 Altamont Circle, #51 102,914 Vested Options
Charlottesville, VA 22902 204,912 8.5%
Geoffrey C. Wild 10,219 Direct
Level 5, 132 Arthur Street 5,000 Vested Options
North Sydney, NSW 2060 15,219 *
Alexander S. Dawson 33,183 Direct
38 McLeay Street 8,000 Vested Options
Potts Point, NSW 2011 Australia 41,183 1.8%
John H. Lowry III (3) 20,422 Direct
21972 Heatheridge 13,333 Vested Options
Northville, MI 48167 33,755 1.4%
Donald C. Campion 9,986 Direct
3747 Loch Bend Dr. 5,000 Vested Options
Commerce, MI 48382 14,986 *
Clifford W. Chapman Jr. 20,708 Direct
10 Warren Ave. 5,667 Vested Options
Spring Lake, NJ 07762 26,375 1.1%
Chris P. Leach (4) 28,409 Direct
23 Grover Ave. -- Vested Options 1.2%
Cromer, NSW 2099 28,409
All directors and executive officers 224,925 Direct
as a group (7 persons) 139,914 Vested Options 14.8%
364,839
- ----------
(1) Beneficial ownership is determined in accordance with the SEC rules and
generally includes voting or investment power with respect to securities.
Shares of common stock subject to options, warrants or other rights to
purchase common shares which are currently exercisable or are exercisable
within 60 days after March 31, 2007 are deemed vested and outstanding for
purposes of computing the percentage ownership of any person. Except as
indicated by footnotes and subject to community property laws, where
applicable, the persons named above have sole voting and investment power
with respect to all shares of Common Stock shown as beneficially owned by
them. Share data does not include any shares the beneficial ownership of
which has been disclaimed pursuant to SEC Rules. Restricted stock held by
the beneficial owner is included in the direct holdings in the above table.
(2) Percentage of beneficial ownership is calculated on the basis of the amount
of outstanding securities plus those securities of the named person deemed
to be outstanding under Rule 13d-3 (promulgated under the Exchange Act) by
virtue of such securities being subject to rights to acquire beneficial
ownership within 60 days after March 31, 2007. An asterisk indicates
beneficial ownership of less than 1% of the common stock outstanding.
(3) Mr. Lowry served as Chief Financial Officer during 2006, stepping down from
that position on January 2, 2007.
(4) Mr. Leach served as CEO of Loyalty Magic (a wholly-owned subsidiary of
Catuity) during 2006, stepping down from that position on January 30, 2007.
Mr. Leach's direct holdings are reported as of February 28, 2007, his last
day of employment.
27
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
In connection with the acquisition of Loyalty Magic Pty. Ltd., which closed
on September 1, 2005 Chris Leach, as a stockholder of Loyalty Magic Pty. Ltd.,
received 38,409 shares of our common stock and $152,217 AUD (approximately
$114,163 USD).
In connection with the 2006 Private Placement, the Company paid the
placement agent for the financing (Broadband Capital Management, LLC) a fee of
$157,500, representing 7% of the gross cash proceeds received by Company,
together with reimbursement of its actual expenses. One of the Company's
independent directors is employed as the head of investment banking by Broadband
Capital Management LLC.
Our Board of Directors presently consists, and at all times during 2006
consisted, of Chairman Alexander S. Dawson, and directors Alfred H. (John)
Racine III, Geoffrey C. Wild, Donald C. Champion and Clifford W. Chapman, Jr.
The Board has determined that all of our directors, with the exception of Mr.
Racine (who is our President and Chief Executive Officer.), are independent as
defined in the Nasdaq listing standards and the regulations of the Securities
and Exchange Commission. Our Compensation Committee, our Governance and
Nominating Committee and our Audit Committee are composed entirely of
independent directors.
The Audit Committee of our Board of Directors is responsible for reviewing
and approving all "related party transactions" (as defined in the applicable
Nasdaq listing standards). Before approving such a transaction, the Audit
Committee would take into account all relevant factors that it deems
appropriate, including whether the related party transaction is on terms no less
favorable to us than terms generally available from an unaffiliated third party
under the same or similar circumstances, and the extent of the related person's
interest in the transaction. The Audit Committee's responsibility for related
party transactions is set forth in the Committee's written charter. The
Committee's policy regarding related party transactions is not in writing, but
is the result of the oral consensus of the members of the Committee.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following is a summary of the consolidated operating results of Catuity
and contains forward looking statements based upon current expectations that
involve risks and uncertainties. The Company's actual results and the timing of
certain events could differ materially from those anticipated in these forward
looking statements. Refer to the section entitled Forward Looking Statements at
the beginning of this prospectus for a full discussion of the risks and
uncertainties associated with forward looking statements.
CATUITY'S BUSINESS
Catuity provides loyalty and gift card processing services to retailers which
are designed to increase the profit they earn from their customers at the Point
of Sale (POS). The Company sells a hosted, Application Service Provider (ASP)
based system that enables the processing of member-based loyalty programs that
can deliver customized discounts, promotions, rewards and points-based programs
designed to help retailers find, keep and profit from their best customers. The
Company also enables gift card solutions. The system enables robust and highly
customizable programs which work on a retailer's payment terminals and
Electronic Cash Registers (ECR) via their internal store networks. Catuity has
proactively integrated to leading POS systems because we believe that this
strategy will reduce the perceived IT risks for its retailer clients. This is
consistent with our four design principles discussed above in the Research and
Development section of this prospectus.
OVERVIEW OF SIGNIFICANT ACTIVITIES
Catuity completed several important steps in executing our strategy. As
previously stated in this prospectus, in 2007, the Company was successful in
shifting its U.S. Sales efforts to franchise-driven retailers in popular,
high-growth categories; in launching an interactive and direct marketing
campaign; in expanding its relationships with specialized resellers; and
expanding its relationships with point-of-sale software vendors. In 2006, the
Company was successful in deploying its new technology for customers; in
establishing marketing partnerships; in establishing a defined sales pipeline;
completing a series of APIs to streamline the process of integration to our
system; and in completing the major development objectives for CALS.
28
On November 22, 2006, we concluded a definitive securities purchase
agreement with Gottbetter Capital Master, Ltd. and BridgePointe Master Fund Ltd.
Pursuant to the securities purchase agreement, we issued the Preferred Shares,
the Senior Notes and the Warrants, as follows:
Gross
Cash
Preferred Proceeds
Investor Senior Notes Warrants Shares to Catuity
- ------------------------------- ------------ -------- --------- ----------
Gottbetter Capital Master, Ltd. $1,111,112 220,459 432.10 $1,388,890
BridgePointe Master Fund Ltd. 688,888 136,684 267.90 861,110
Totals $1,800,000 357,143 700.00 $2,250,000
Applicable securities listing rules of the Australian Stock Exchange and
NASDAQ Capital Market require that we obtain approval from our stockholders for
any conversion rights for the Senior Notes and Preferred Shares, and exercise
rights for the Warrants, which would result in more than 335,000 shares of
Common Stock being issuable on conversion or exercise of the foregoing
securities. Accordingly, such exercise or conversion rights are specifically
subject to obtaining stockholder approval. We agreed with the Investors that we
would convene the Special Meeting to seek this approval, and recommend to our
stockholders that such approval be given. In addition, the transaction documents
limit each Investor's beneficial ownership of Catuity to no more than 4.99% at
any given time, subject to the Investor's waiver of such restrictive covenant
upon giving advance notice to us.
On February 5, 2007 our 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 of an
aggregate of (a) US$1.8 million face amount of the Senior Notes, (b) 700 shares
of the Preferred Shares (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, the Senior Notes and Preferred
Shares will be convertible into an aggregate of 769,232 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.
Our progress in 2006 was based upon significant investment made in 2005 to
build infrastructure and add key team members to grow our business. On July 18,
2005, the Company's stockholders approved the acquisition of Loyalty Magic Pty.
Ltd. and the issuance of 700,000 shares of common stock to raise capital for the
cash portion of the acquisition purchase price as well as for working capital
purposes. On September 1, 2005 the Company completed the acquisition and raised
$5.25 million USD (A$7.0 million). Additionally, we completed a second, smaller
capital raise on September 19, 2005 for $2.025 million (270,000 shares of common
stock) on the same terms as the September 1, 2005 capital raise. As a result,
Catuity increased its cash balance to $4.39 million and its stockholders' equity
to $9.2 million following the acquisition of Loyalty Magic and capital raises.
Loyalty Magic's business is an excellent fit with the loyalty processing
business that Catuity is establishing in North America.
Catuity also made significant progress in executing its transition to a
loyalty processor in 2005 and 2006. As previously disclosed, in early 2004,
management determined it was necessary to substantially revise its corporate
strategy away from the struggling smart card market and began work on a new
strategy to position the company as a provider of member-based loyalty and gift
card solutions to tier two and tier three retailers in the U.S., Canada and
Australia. Today, the Company is focused on delivering loyalty and gift card
programs to retailers (and their partners) at the point of sale. The company is
focused on the needs of retailers who have a preference for purchasing a hosted
solution over an in-house solution. The Company has targeted its sales at
retailers who are looking for programs which improve customer retention,
increase customer spending in targeted categories along with increasing average
per visit sales and improve the frequency of their visit. One of the Company's
strengths lies in helping retailers execute merchandising strategies, especially
those which want to switch consumers from buying branded product to
higher-margin private label products. To date, the Company has qualified
prospects which meet its criteria and are focused on making sales proposals to
those who are expected to make a buying decision in 2007.
As previously noted, 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.
29
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 September 1, 2005 ($1,713,000 of 2006 revenue). As described
above, on September 1, 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.
Change
from 2005
Revenue 2006 2005 to 2006
- ------- ---------- -------- ---------
Processing $1,410,000 $511,000 $899,000
Service 355,000 405,000 (50,000)
License fees 184,000 65,000 119,000
Total $1,949,000 $981,000 $968,000
The 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. In 2006 the cost of processing
revenue exceeded processing revenue due to the expense of building up
infrastructure to support the commercialization of the CALS product that was
introduced that year. As the deployments from the sales pipeline increase in the
future we expect processing revenue to exceed the costs associated with it.
Change
from 2005
Cost of Revenue 2006 2005 to 2006
- --------------- ---------- -------- ----------
Processing $1,771,000 $533,000 $1,238,000
Service 299,000 233,000 66,000
License fees -- 21,000 (21,000)
Amortization of intellectual property 176,000 50,000 126,000
Stock-based Compensation 55,000 20,000 35,000
Total $2,301,000 $857,000 $1,444,000
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.
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 $256,000, or 34%, to
$496,000 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 reduced head count with 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 $448,000, or 66%, to
$1,131,000 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 ($293,000), increase in amortization of intangibles ($83,000),
increase in the allocation of CEO costs ($55,000), and an increase in consulting
expenses ($18,000).
30
General and Administrative (G&A) expenses consist primarily of salaries,
employee benefits, related overhead costs and professional service fees. G&A
expenses increased $820,000, or 46%, to $2,599,000 for the year ended December
31, 2006 from $1,779,000 for the year ended December 31, 2005. The increase is
primarily attributable to stock-based compensation expense ($332,000) and
salaries and related expenses ($406,000), including severance of $149,000 in
connection with the relocation of our corporate office to Virginia.
Other Income for the year ended December 31, 2006 represents tax
concessions provided by the Australian Taxation Office for research and
development activities for Loyalty Magic and Chip Application Technologies.
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 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%).
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have funded our operations with proceeds from the issuance
of common stock and cash collections from customers. As of March 31, 2007, the
Company had approximately $783,000 in cash and cash equivalents, a decrease of
$1,211,000 from the cash balance on 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.
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.
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.
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
31
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.
CRITICAL ACCOUNTING POLICIES AND ASSUMPTIONS
The accompanying consolidated financial statements were prepared in
conformity with accounting principles generally accepted in the United States.
When more than one accounting principle or the method of its application is
generally accepted, we select the principle or method that is appropriate in our
specific circumstances (see Note 2 of Notes to Consolidated Financial
Statements). Application of these accounting principles requires us to make
estimates about the future resolution of existing circumstances. As a result,
actual results could differ from these estimates. In preparing these financial
statements, we have made our best estimates and judgments of the amounts and
disclosures included in the consolidated financial statements, giving due regard
to materiality.
REVENUE RECOGNITION
The three distinct revenue streams that result from the Company's business
activities are processing, service 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.
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
32
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.
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 6
for a description of the expense recorded for the year ended 2006 under SFAS
123(R). Prior to 2006, the Company accounted for stock-based awards issued to
employees under the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock issued to Employees ("APB
25") and adopted the disclosure-only alternative of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No.
123").
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 adoption of FIN 48 did
not have a material impact on the Company's 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 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.
33
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Catuity ("CTTY") was listed on the NASDAQ Capital Market beginning December
1, 2000. Chip Application Technologies (then named Card Technologies Australia)
was listed on the Australian Stock Exchange ("ASX") under the trading symbol
"CAT" from July 11, 1997 to November 22, 1999. On November 23, 1999, upon
Catuity's acquisition of Chip Application Technologies, we replaced Chip
Application Technologies as the listed entity on the ASX under the same trading
symbol. We continue to be traded on the ASX. Also, 256,520 shares of common
stock were issued on September 1, 2005 to existing Australian shareholders and
accredited Australian institutional buyers pursuant to an exemption from
registration under Regulation S of the Securities Act of 1933, as amended.
Our high and low sales prices on the ASX and NASDAQ for each quarter within
the last two fiscal years and the first quarter of 2007 are shown below, both in
Australian dollars and in U.S. dollars.
SYMBOL - CAT SYMBOL - CATN SYMBOL - CTTY
------------------------------- ------------------------------- -------------------------------------
HIGH LOW HIGH LOW HIGH LOW
PERIOD (AUSTRALIAN $) (AUSTRALIAN $) (AUSTRALIAN $) (AUSTRALIAN $) (UNITED STATES $) (UNITED STATES $)
- ------ -------------- -------------- -------------- -------------- ----------------- -----------------
2005
First Quarter $ 7.00 $ 3.90 N/A N/A $ 8.30 $3.47
Second Quarter $18.50 $ 4.50 N/A N/A $22.58 $3.75
Third Quarter $23.00 $10.50 $13.50 $10.50 $20.39 $8.53
Fourth Quarter $14.20 $ 9.25 $11.00 $ 7.50 $12.10 $5.97
2006
First Quarter $11.00 $ 8.00 $10.00 $ 5.75 $ 9.17 $5.68
Second Quarter $10.00 $ 5.00 $ 8.00 $ 3.00 $ 8.03 $4.49
Third Quarter $ 7.00 $ 3.50 $ 5.00 $ 3.00 $ 4.97 $3.06
Fourth Quarter $ 7.50 $ 4.00 $ 5.20 $ 3.00 $ 6.19 $3.14
2007
First Quarter $ 5.60 $ 2.80 $ 5.20 $ 3.00 $ 4.59 $2.12
As of March 31, 2007 there were approximately 2,000 shareholders of record
of our common stock as reported to us by Computershare Investor Services, our
transfer agent.
DIVIDEND POLICY
The Company has never paid any cash dividends on its common stock, and
currently does not intend to pay any cash dividends on common stock. The Company
has paid dividends on its shares of convertible preferred stock starting
December 1, 2006.
Any decision to declare and pay dividends in the future will be made at the
discretion of the Board of Directors and will depend on, among other things, the
results of operations, capital requirements, financial condition, contractual
restrictions and other factors that the Board of Directors may deem relevant. In
addition, the terms of the Preferred Stock restricts the Company's ability to
pay dividends on its common stock. The holders of the Preferred Stock are
entitled to receive cumulative preferential cash dividends at the rate equal to
10% of the stated value of the Preferred Stock payable monthly in arrears, on
the first day of each month. The Company may not pay any dividends on its common
stock before all dividends are paid on the Preferred Stock.
34
EQUITY COMPENSATION PLAN INFORMATION
The following table reflects information about the securities authorized
for issue under our equity compensation plans as of December 31, 2006.
NUMBER OF
SECURITIES
REMAINING
AVAILABLE
NUMBER FOR FUTURE
OF ISSUANCE
SECURITIES UNDER
TO BE WEIGHTED- EQUITY
ISSUED AVERAGE COMPENSATION
UPON EXERCISE PLANS
EXERCISE OF PRICE OF (EXCLUDING
OUTSTANDING OUTSTANDING SECURITIES
OPTIONS OPTIONS REFLECTED IN
PLAN CATEGORY: (A) (B) COLUMN (A) (C)
- -------------- ----------- ----------- --------------
Equity compensation plans approved
by security holders:
The 2000 Employee Stock Option Plan 232,181 $18.81 67,221
The 2000 Non-employee Director
Stock Option Plan 23,667 $14.66 34,250
2005 Employee Restricted Stock Plan N/A N/A 119,000
2005 Non-employee Director
Restricted Stock Plan N/A N/A 24,848
Equity compensation plans not
approved by security holders: -0- -0- -0-
DESCRIPTION OF SECURITIES
COMMON STOCK
The securities being offered by the Selling Security Holders are shares of
our common stock. As of March 31, 2007 there were 2,317,486 shares issued and
outstanding of our common stock.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. The holders of common stock are
entitled to receive any dividends that may be declared from time to time by the
board of directors out of funds legally available for that purpose. In the event
of our liquidation, dissolution or winding up, the holders of common stock are
entitled to share in all assets remaining after payment of liabilities. The
common stock has no preemptive or conversion rights or other subscription
rights. All outstanding shares of common stock are fully paid and
non-assessable. Please review our certificate of incorporation, as amended, and
bylaws, copies of which have been filed with the SEC, as well as the applicable
statutes of the State of Delaware for a more complete description of the rights
and liabilities of holders of our shares.
The holders of common stock do not have a cumulative voting right, which
means that the holders of more than fifty percent of the shares of common stock
voting for election of directors may elect all the directors if they choose to
do so. In this event, the holders of the remaining shares aggregating less than
fifty percent will not be able to elect directors. Except as otherwise required
by Delaware law, and subject to the rights of the holders of preferred stock
then outstanding, all stockholder action is taken by the vote of a majority of
the issued and outstanding shares of common stock present at a meeting of
stockholders at which a quorum consisting of a majority of the issued and
outstanding shares of common stock is present in person or proxy.
SENIOR CONVERTIBLE 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 our and our subsidiaries' 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
35
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 Senior Notes 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 Holders 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.
PREFERRED STOCK
The Company's Board of Directors is authorized to issue up to 666,667
shares of preferred stock, par value $.001 per share, in one or more series and
to fix, by resolution, conditional, full, limited or no voting powers, and the
designations, preferences, the number of shares, dividend rates, conversion or
exchange rights, redemption provisions or other special rights of the shares
constituting any class or series as the Board of Directors may deem advisable
without any further vote or action by the stockholders. Any shares of preferred
stock issued by Catuity could have priority over Catuity common stock with
respect to dividends or liquidation rights and could have voting and other
rights of stockholders.
SERIES A CONVERTIBLE PREFERRED STOCK
The Company's Board of Directors has designated 700 shares of preferred
stock as "Series A Convertible Preferred Stock" with a stated value of $1,000
per share. There are presently 700 shares of Series A Convertible Preferred
Stock outstanding. The holders of Series A Convertible Preferred Stock will have
no voting rights other than as may be required by law.
When and if declared by the Board of Directors, 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 2006, the Board of Directors declared and the
Company paid $7,582 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. Under the
Registration Rights Agreement, the exercise price of the Warrants is reduced by
10% of the then effective exercise price for each 30-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
Convertible 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
such a registration statement will be declared effective before the 30% maximum
reduction is reached, we anticipate that the exercise price of the Warrants will
be reduced by 30% of $2.51. 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
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.
36
Upon a change of control of Catuity that is within Catuity'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 replacement of the warrants with terms
(including, without limitation, exercise rights and anti-dilution rights)
equivalent to those contained in the warrants.
PARTICULARS OF THE TRANSACTION
To assist in understanding the terms and dynamics of the transaction
between Catuity and the Selling Security Holders, presented below are tables and
notes that detail various payment amounts, calculations of the values of the
underlying securities, and other related information.
VALUE OF SECURITIES UNDERLYING THE CONVERTIBLE DEBENTURES AND PREFERRED STOCK
--------------------------------------------------------------------------------
Market Price Per Share
------------------------------------------------
Average Closing
Price from Oct.
18 - Nov. 21,
Number of 2006
Shares (Negotiation & Average Price
Underlying Due Diligence On Date of Closing
Securities to Multiplied by Phase of Transaction Price on
be Registered Market Price Transaction) Nov. 22, 2006 March 31, 2007
------------- ------------- --------------- ------------- --------------
$ 3.97 $ 5.53 $ 2.20
Common Stock underlying
Preferred Shares 173,941 $ 690,546 $ 961,894 $ 382,670
Common Stock underlying
Convertible Debentures 447,277 $1,775,689 $2,473,441 $ 984,009
------- ---------- ---------- ----------
Total 621,218 $2,466,235 $3,435,336 $1,336,680
======= ========== ========== ==========
Average Daily Trading Volumes 78,264 1,330,400 25,800
The closing price on November 21, 2006 (day before the transaction was
announced) was $4.73 per share with a trading volume of 91,600 shares. The
closing price on the date of the transaction was $6.18 per share with a trading
volume of 1,330,400. At $6.18 per share the total value of the transaction is
$4,753,854.
PAYMENTS TO THE SELLING SECURITY HOLDERS
-----------------------------------------------------------------------------
Other
Interest Potential
Payments Dividend Payments to Total Payments
Transaction on Payments on Selling Made or to be
Costs Paid By Convertible Preferred Security Made to Selling
Issuer Debentures Stock Holders Security Holders
SELLING SECURITY HOLDERS: (1) (2) (3) (4) (1)+(2)+(3)+(4)=(5)
------------- ----------- ----------- ----------- -------------------
Gottbetter Capital Master, Ltd. $61,500 $220,371 $129,630 $-- $411,501
BridgePointe Master Fund, Ltd. -- 136,629 80,370 -- 216,999
------- -------- -------- --- --------
TOTAL $61,500 $357,000 $210,000 $-- $628,500
======= ======== ======== === ========
(1) In connection with the sale of the Convertible Debentures and Preferred
Stock, the Company paid legal fees of $40,000 and due diligence fees of $21,500
incurred by the lead investor.
(2) The Convertible Debentures incur interest at the rate of 10% of the
outstanding principal amount per annum, payable monthly in arrears in cash. The
amounts disclosed for this item assume the Company makes all regularly scheduled
payments of principal and further assumes no conversion of principal or accrued
and unpaid interest during the three year term.
37
(3) The Convertible Preferred Stock designates a dividend rate of 10% of
the stated value of $700,000 per annum, payable monthly in arrears in cash,
when, as and if declared by the Board of Directors. For illustration purposes,
the amounts disclosed for this item represent the total cash dividends that
would be payable over a three year period (the term of the Convertible
Debentures) and assumes no conversion during such three year period.
(4) Under certain circumstances, the Company may be required to make
additional payments to the Selling Security Holders as described below:
(a) From and after the occurrence of an Event of Default (as defined
in the Convertible Debentures) interest on the Convertible Debentures
would increase from 10% to 15% per annum, until such time as the Event
of Default is cured;
(b) Upon an Event of Default, the holders of the Convertible
Debentures may require the Company to redeem all or any portion of the
Convertible Debentures in cash at a price equal to the greater of: (i)
125% (120% in certain circumstances) multiplied by the principal
amount being redeemed plus accrued but unpaid interest on such
principal amount and (ii) the product of (x) the principal amount
being redeemed (including accrued but unpaid interest on such
principal amount) divided by the then current conversion price with
respect to the principal amount being redeemed and (y) the closing
sale price of the Company's common stock on the date immediately
preceding such Event of Default;
(c) Upon a Change in Control (as defined in the Convertible
Debentures) involving the acquisition of voting control or direction
over 50% or more of the Company's outstanding common stock, the
holders of the Convertible Debentures have the right to cause the
Company to repurchase the Convertible Debentures 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% multiplied by the principal amount
being converted plus accrued but unpaid interest on such principal
amount. In the event of a Change in Control at a per share price which
is equal to or greater than 200% of the then current conversion price,
then 130% in (A) above will be reduced to 120%;
(d) In the event that the Company fails to timely issue shares of
common stock pursuant to the terms of conversion of the Convertible
Debentures, and the holder of such Convertible Debentures purchases
(in an open market transaction or otherwise) shares of the Company's
common stock to deliver in satisfaction of a sale or sales by the
holder of the Company's common stock that the holder anticipated
receiving from the Company, then the Company may be required to pay
cash to the holder in an amount equal to the holder's total purchase
price (including brokerage commissions and other out-of-pocket
expenses) for the shares of the Company's common stock so purchased;
(e) The Company has the right to redeem in cash any or all of the
outstanding Convertible Debentures at any time prior to maturity, upon
three (3) business days prior written notice, at the greater of (x)
one hundred twenty percent (120%) multiplied by the principal amount
to be redeemed or (y) the product of (i) the remaining principal
balance of the Convertible Debentures divided by the conversion price
in effect on the day before such redemption notice is sent and (ii)
the closing sale price of the Company's 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;
(f) In the event the Company does not pay any scheduled amounts under
the Convertible Debentures when due, other than interest, the Company
will be required to pay a late charge equal to interest at the rate of
15% per annum on the past due amount;
(g) Under certain conditions, the Company may become obligated to pay
costs of collection, enforcement and other costs incurred by the
holders of the Convertible Debentures;
(h) Upon a Change in Control (as defined in the Warrants Agreements)
of the Company that is within the Company's control, the holders of
the Warrants have the right to cause the Company to pay in cash the
Black-Scholes value of the Warrants subject to a volatility cap of
sixty (60) and a risk-free interest rate corresponding to the U.S.
treasury rate for a period equal to the remaining term of the
Warrants. To the extent not redeemed upon a Change in Control, each
Warrant holder has the right to cause the ultimate parent company of
the acquiring or surviving company in the Change in 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;
38
(i) 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 the
Company's common stock underlying the warrants are free trading, (ii)
the average daily dollar trading volume of the Company's 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;
(j) The Warrants contain a cashless exercise feature that allows the
holders of the Warrants to receive shares of the Company's common
stock in the event that shares of the Company's common stock
underlying the Warrants are not available for sale pursuant to a
registration statement;
(k) In the event that the Company fails to timely issue shares of
common stock pursuant to terms of exercise for the Warrants, the
Company shall pay in cash to the holder of the Warrants on each day
following the third business day that the shares of the Company's
common stock is not timely affected an amount equal to 1.5% multiplied
by the product of (x) the sum of the number of shares not timely
issued to the holder and (y) the closing sale price of the Company's
common stock on the trading day immediately preceding the last
possible date the Company could have timely issued the related shares;
(l) In the event that the Company fails to timely issue shares of
common stock pursuant to the terms of exercise of the Warrants, and
the holder of such Warrants purchases (in an open market transaction
or otherwise) shares of the Company's common stock to deliver in
satisfaction of a sale or sales by the holder of the Company's common
stock that the holder anticipated receiving from the Company, then the
Company may be required to pay cash to the holder in an amount equal
to the holder's total purchase price (including brokerage commissions
and other out-of-pocket expenses) for the shares of the Company's
common stock so purchased;
PAYMENTS TO THE SELLING SECURITY HOLDERS DURING
INITIAL TWELVE MONTH PERIOD
-----------------------------------------------------------------------------
Other
Interest Potential
Payments Dividend Payments to Total Payments
Transaction on Payments on Selling Made or to be
Costs Paid By Convertible Preferred Security Made to Selling
Issuer Debentures Stock Holders Security Holders
SELLING SECURITY HOLDERS: (1) (2) (3) (4) (1)+(2)+(3)+(4)=(5)
- ------------------------- ------------- ----------- ----------- ----------- -------------------
Gottbetter Capital Master, Ltd. $ 61,500 $113,889 $ 44,290 $-- $219,679
BridgePointe Master Fund, Ltd. -- 70,611 27,460 -- 98,071
-------- -------- -------- --- --------
TOTAL $ 61,500 $184,500 $ 71,750 $-- $317,750
======== ======== ======== === ========
(1) In connection with the sale of the Convertible Debentures and Preferred
Stock, the Company paid legal fees of $40,000 and due diligence fees of $21,500
incurred by the lead investor.
(2) The Convertible Debentures incur interest at the rate of 10% of the
outstanding principal amount per annum, payable monthly in arrears in cash. The
amounts disclosed for this item assume the Company makes all regularly scheduled
payments of principal and further assumes no conversion of principal or accrued
but unpaid interest during the initial twelve month period following issuance.
(3) The Preferred Stock designates a dividend rate of 10% of the stated
value of $700,000 per annum, payable monthly in arrears in cash, when, as and if
declared by the Board of Directors. The amounts disclosed for this item
represent the total cash dividends that would be payable during the initial
twelve month period following issuance and further assume no conversion during
such twelve month period.
(4) Under certain circumstances, the Company may be required to make
additional payments to the Selling Security Holders as described below:
(a) From and after the occurrence of an Event of Default (as defined
in the Convertible Debentures) interest on the Convertible Debentures
would increase from 10% to 15% per annum, until such time as the Event
of Default is cured;
(b) Upon an Event of Default, the holders of the Convertible
Debentures may require the Company to redeem all or any portion of the
Convertible Debentures in cash at a price equal to the greater of: (i)
125% (120% in certain circumstances) multiplied by the principal
amount being redeemed plus accrued but unpaid interest on such
principal amount and (ii) the
39
product of (x) the principal amount being redeemed (including accrued
but unpaid interest on such principal amount) divided by the then
current conversion price with respect to the principal amount being
redeemed and (y) the closing sale price of the Company's common stock
on the date immediately preceding such Event of Default;
(c) Upon a Change in Control (as defined in the Convertible
Debentures) involving the acquisition of voting control or direction
over 50% or more of the Company's outstanding common stock, the
holders of the Convertible Debentures have the right to cause the
Company to repurchase the Convertible Debentures 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% multiplied by the principal amount
being converted plus accrued but unpaid interest on such principal
amount. In the event of a Change in Control at a per share price which
is equal to or greater than 200% of the then current conversion price,
then 130% in (A) above will be reduced to 120%;
(d) In the event that the Company fails to timely issue shares of
common stock pursuant to the terms of conversion of the Convertible
Debentures, and the holder of such Convertible Debentures purchases
(in an open market transaction or otherwise) shares of the Company's
common stock to deliver in satisfaction of a sale or sales by the
holder of the Company's common stock that the holder anticipated
receiving from the Company, then the Company may be required to pay
cash to the holder in an amount equal to the holder's total purchase
price (including brokerage commissions and other out-of-pocket
expenses) for the shares of the Company's common stock so purchased;
(e) The Company has the right to redeem in cash any or all of the
outstanding Convertible Debentures at any time prior to maturity, upon
three (3) business days prior written notice, at the greater of (x)
one hundred twenty percent (120%) multiplied by the principal amount
to be redeemed or (y) the product of (i) the remaining principal
balance of the Convertible Debentures divided by the conversion price
in effect on the day before such redemption notice is sent and (ii)
the closing sale price of the Company's 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;
(f) In the event the Company does not pay any scheduled amounts under
the Convertible Debentures when due, other than interest, the Company
will be required to pay a late charge equal to interest at the rate of
15% per annum on the past due amount;
(g) Under certain conditions, the Company may become obligated to pay
costs of collection, enforcement and other costs incurred by the
holders of the Convertible Debentures;
(h) Upon a Change in Control (as defined in the Warrants Agreements)
of the Company that is within the Company's control, the holders of
the Warrants have the right to cause the Company to pay in cash the
Black-Scholes value of the Warrants subject to a volatility cap of
sixty (60) and a risk-free interest rate corresponding to the U.S.
treasury rate for a period equal to the remaining term of the
Warrants. To the extent not redeemed upon a Change in Control, each
Warrant holder has the right to cause the ultimate parent company of
the acquiring or surviving company in the Change in 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;
(i) 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 the
Company's common stock underlying the warrants are free trading, (ii)
the average daily dollar trading volume of the Company's 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;
(j) The Warrants contain a cashless exercise feature that allows the
holders of the Warrants to receive shares of the Company's common
stock in the event that shares of the Company's common stock
underlying the Warrants are not available for sale pursuant to a
registration statement.
40
TOTAL PROFIT POTENTIALLY REALIZABLE BY THE SELLING SECURITY HOLDERS FROM
CONVERTIBLE DEBENTURES AND PREFERRED STOCK
---------------------------------------------------------------------------------------------------------------
Market Conversion
Price per Price per Total
Share of Share of Shares of
Common Common Common Combined
Stock Stock Total Stock Conversion Combined Market
Underlying Underlying Shares of Combined Market Underlying Combined Market Price of Common Discount of
the the Common Price of Total the Price of Common Stock Common Stock
Convertible Convertible Stock Shares of Convertible Stock Underlying the Underlying the
Debentures Debentures Underlying Common Stock Debentures Underlying the Convertible Convertible
and and the Underlying the and Convertible Debentures Debentures
Preferred Preferred Convertible Convertible Preferred Debentures and and Preferred and Preferred
Stock Stock Debentures Debentures Stock Preferred Stock Stock Stock
(1) (2) (3) (1) X (3) = (4) (5) (1) X (5) = (6) (2) X (5) = (7) (6) - (7) = (8)
----------- ----------- ----------- --------------- ----------- --------------- --------------- ---------------
SELLING SECURITY
HOLDERS:
Gottbetter Capital
Master, Ltd. $5.53 $3.25 341,881 $1,890,602 474,835 $2,625,838 $1,543,214 $1,082,624
BridgePointe Master
Fund, Ltd. $5.53 $3.25 211,966 1,172,172 294,397 1,628,015 956,790 671,225
------- ---------- ------- ---------- ---------- ----------
TOTAL 553,847 $3,062,774 769,232 $4,253,853 $2,500,004 $1,753,849
======= ========== ======= ========== ========== ==========
(1) The market price per share was determined using the average of the high
($6.36) and low ($4.70) trading prices of the Company's common stock (as
reported by Nasdaq) on the date of issuance (November 22, 2006) of the
Convertible Debentures and Preferred Stock. The closing price of the
Company's common stock on November 22, 2006 was $6.18.
(2) The conversion price of the Convertible Debentures and Preferred Stock is
fixed at $3.25 per share, subject to certain anti-dilutive provisions as
follows:
(a) if after November 22, 2006 the Company issues options to purchase its
common stock (excluding options issued pursuant to the terms of the
Company's Employee Stock Option Plan or Director Stock Option Plan) at an
exercise price (the "new issuance price") less than the then current
conversion price of the Convertible Debentures and Preferred Stock, the
conversion price of the Convertible Debentures and Convertible Preferred
Stock shall be reduced to the new issuance price;
(b) if after November 22, 2006 the Company issues or sells any securities
convertible into the Company's common stock at a conversion price (the "new
conversion price") less than the then current conversion price of the
Convertible Debentures and Preferred Stock, the conversion price of the
Convertible Debentures and Preferred Stock shall be reduced to the new
conversion price;
(c) if after November 22, 2006 the Company changes the exercise price of
any options that were outstanding as of November 22, 2006, the then current
conversion price of the Convertible Debentures and Preferred Stock shall be
adjusted to the conversion price which would have been in effect at such
time had such options provided for such changed exercise price at the time
initially granted; provided, however, that for purposes of this section no
adjustment shall be made if such adjustment would result in an increase in
the conversion price of the Convertible Debentures and Preferred Stock;
(d) if after November 22, 2006 the Company subdivides (by stock split,
stock dividend, recapitalization or otherwise) one or more classes of its
common stock into a greater number of common shares, the then current
conversion price of the Convertible Debentures and Preferred Stock will be
proportionately reduced;
(e) if after November 22, 2006 the Company combines (by combination,
reverse stock split or otherwise) one or more classes of its common stock
into a smaller number of common shares, the then current conversion price
of the Convertible Debentures and Preferred Stock will be proportionately
increased;
(f) upon a Change in Control (as defined in the Certificate of
Designations, Preferences and Rights of the Series A Convertible Preferred
Stock), the then current conversion price of the Preferred Stock shall be
reduced by 20%.
41
(3) The total principal amount of the Convertible Debentures is $1,800,000.
Based upon the initial exercise price of $3.25 per share, the total common
stock that would be issued upon full conversion would be 553,847.
(5) The total stated value of the Preferred Stock is $700,000. Based upon the
initial exercise price of $3.25 per share, the total common stock that
would be issued upon full conversion would be 215,385.
TOTAL PROFIT POTENTIALLY REALIZABLE BY THE SELLING SECURITY HOLDERS FROM THE WARRANTS
-----------------------------------------------------------------------------------------------
Combined Market Combined
Market Price Conversion Price of Total Conversion Combined Market
per Share of Price per Share Total Shares of Shares of Price of Common Discount of
Common Stock of Common Stock Common Stock Common Stock Stock Common Stock
Underlying the Underlying the Underlying the Underlying the Underlying the Underlying the
Warrants to Warrants to Warrants to Warrants to Warrants to Warrants to
Purchase Common Purchase Common Purchase Common Purchase Common Purchase Purchase
Stock Stock Stock Stock Common Stock Common Stock
(1) (2) (3) (1) X (3) = (4) (2) X (3) = (5) (4) - (5) = (6)
--------------- --------------- --------------- --------------- --------------- ---------------
SELLING SECURITY HOLDERS:
Gottbetter Capital Master, Ltd. $5.53 $3.58 220,459 $1,219,138 $ 789,243 $429,895
BridgePointe Master Fund, Ltd. $5.53 $3.58 136,684 755,863 489,329 266,534
------- ---------- ---------- --------
TOTAL 357,143 $1,975,001 $1,278,572 $696,429
======= ========== ========== ========
(1) The market price per share was determined using the average of the high and
low trading prices of the Company's common stock (as reported by Nasdaq) on
the date of issuance (November 22, 2006) of the Warrants. The closing price
of the Company's common stock on November 22, 2006 was $6.18.
(2) The conversion price of the Warrants was initially set at $3.58 per share,
subject to certain anti-dilutive provisions as follows:
(a) if after November 22, 2006 the Company issues options to purchase its
common stock (excluding options issued pursuant to the terms of the
Company's Employee Stock Option Plan or Director Stock Option Plan) at an
exercise price (the "new issuance price") less than the then current
exercise price of the Warrants, the exercise price of the Warrants shall be
reduced to the new issuance price;
(b) if after November 22, 2006 the Company issues or sells any securities
convertible into the Company's common stock at a conversion price (the "new
conversion price") less than the then current exercise price of the
Warrants, the exercise price of the Warrants shall be reduced to the new
conversion price;
(c) if after November 22, 2006 the Company changes the exercise price of
any options that were outstanding as of November 22, 2006, the then current
exercise price of the Warrants shall be adjusted to the exercise price
which would have been in effect at such time had such options provided for
such changed exercise price at the time initially granted; provided,
however, that for purposes of this section no adjustment shall be made if
such adjustment would result in an increase in the exercise price of the
Warrants;
(d) if after November 22, 2006 the Company subdivides (by stock split,
stock dividend, recapitalization or otherwise) one or more classes of its
common stock into a greater number of common shares, the then current
exercise price of the Warrants will be proportionately reduced;
(e) if after November 22, 2006 the Company combines (by combination,
reverse stock split or otherwise) one or more classes of its common stock
into a smaller number of common shares, the then current exercise price of
the Warrants will be proportionately increased.
Pursuant to the terms of a registration rights agreement entered into by
the Company and the Selling Security Holders as of November 21, 2006, the
Company is required to file a registration statement covering the sale of the
Company's common stock underlying the Convertible Debentures and Preferred
Stock. Under the terms of the registration rights agreement, in the event that
the registration statement is not declared effective within ninety (90) days
(subject to an additional thirty (30) day grace period), then the exercise price
of the Warrants shall be reduced by ten percent (10%, or $0.36 based on the
initial exercise price of the Warrants) and be reduced by an additional ten
percent (10%) for each subsequent thirty (30) day period thereafter up to a
maximum aggregated reduction of thirty percent (30%, or $1.07 per share based on
the initial exercise price of the Warrants). 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
to $2.51 during the second quarter of 2007. At an exercise price of $2.51 ($3.58
less 30%), the combined market discount to Gottbetter Capital Master, Ltd. and
BridgePoint Master Fund, Ltd. would be $665,786 and $412,786, respectively.
42
TOTAL PROFIT POTENTIALLY REALIZABLE
BY THE SELLING SECURITY HOLDERS FROM THE CONVERTIBLE DEBENTURES, PREFERRED STOCK AND WARRANTS
---------------------------------------------------------------------------------------------------
Combined Market
Discount of
Gross Proceeds Gross Proceeds Common Stock
Received by Received by Underlying the
Issuer from Issuer from Total Payments Convertible
Issuance of Issuance of Total Gross Made or to be Total Net Debentures,
Convertible Preferred Proceeds to Made to Selling Proceeds to Preferred Stock
Debentures Stock Issuer Security Holders Issuer and Warrants
(1) (2) (1) + (2) = (3) (4) (3) - (4) = (5) (6)
-------------- -------------- --------------- ---------------- --------------- ---------------
SELLING SECURITY HOLDERS:
Gottbetter Capital Master, Ltd. 1,000,000 388,890 1,388,890 $411,501 $ 977,389 $1,512,519
BridgePointe Master Fund, Ltd. 620,000 241,110 861,110 216,999 644,111 937,759
--------- ------- --------- -------- ---------- ----------
TOTAL 1,620,000 630,000 2,250,000 $628,500 $1,621,500 $2,450,278
========= ======= ========= ======== ========== ==========
(1) The Convertible Debentures were sold at 90% of the face value of the
principal amount of $1,800,000.
(2) The Preferred Stock was sold at 90% of the stated value of $700,000.
(4) The total payments to be made to the Selling Security Holders includes
transaction costs of $61,500, interest payments on the Convertible
Debentures during their 3-year term of $357,000, and dividend payments on
the Preferred Stock over a 3-year period of $210,000. The amounts disclosed
under this item exclude scheduled principal payments on the Convertible
Debentures.
(5) The amounts disclosed pursuant to this item do not include the effects of
transaction related costs incurred by the Company of approximately
$338,000.
(6) Consists of the combined market discounts specified in the previous table
identified as "Total Profit Potentially Realizable by the Selling Security
Holders from Convertible Debentures and Preferred Stock" and the previous
table identified as "Total Profit Potentially Realizable by the Selling
Security Holders from the Warrants".
POTENTIAL RETURN ON THE CONVERTIBLE DEBENTURES TO THE SELLING SECURITY HOLDERS
-----------------------------------------------------------------------------------
Combined Market
Total Payments Discount of Net Proceeds to
Made or to be Common Stock Issuer From
Made to Selling Underlying the Issuance of the
Security Convertible Convertible
Holders Debentures Subtotal Debentures %
(1) (2) (1) + (2) = (3) (4) (3) / (4) = (5)
--------------- --------------- --------------- --------------- ---------------
SELLING SECURITY HOLDERS:
Gottbetter Capital Master, Ltd. 411,501 779,489 1,190,989 $1,000,000 119.1%
BridgePointe Master Fund, Ltd. 216,999 483,282 700,282 620,000 112.9%
------- --------- --------- ---------- -----
TOTAL 628,500 1,262,771 1,891,271 $1,620,000 116.7%
======= ========= ========= ========== =====
(4) The amounts disclosed pursuant to this item do not include transaction
related costs incurred by the Company of approximately $338,000.
43
SUPPLEMENTAL INFORMATION REGARDING OUTSTANDING COMMON STOCK
------------------------------------------------------------------------------------------
# of Shares
# of Shares Registered for
Registered for Resale by Selling # of Shares # of Shares
Resale by Security Holders Sold in Registered for
Selling (including Registered Resale on
# of Shares Security affiliates) in Prior Resale behalf of the
Outstanding Holders Registration Transactions by Selling
Prior to (including Statements still the Selling Security
Issuance of affiliates) in Held by the Selling Security Holders
Convertible Prior Security Holders Holders (including
Debentures and Registration (including (including affiliates) in
Preferred Stock Statements affiliates) affiliates) this Offering
SELLING SECURITY HOLDERS: (1) (2) (3) (4) (5)
- ------------------------- --------------- -------------- -------------------- --------------- --------------
Persons other than the
Selling Security Holders,
affiliates of the Company
and affiliates of the
Selling Security Holders 1,770,184 N/A N/A N/A N/A
Gottbetter Capital Master, Ltd. -- -- -- -- 447,277
BridgePointe Master Fund, Ltd. -- -- -- -- 173,941
--------- --- --- --- -------
TOTAL 1,770,184 -- -- -- 621,218
========= === === === =======
(1) As of November 22, 2006, there were 2,237,318 common shares
outstanding (including non-vested restricted shares), including
215,667 (9.6% of total outstanding) common shares held by directors and
officers of the Company and 251,467 (11.2% of total outstanding) held by
A&B Venture Fund. The number of shares disclosed for this item does not
include any shares underlying the Convertible Debentures, Preferred Stock
or Warrants issued on November 22, 2006 to the Selling Stockholders, nor
does it include any outstanding options issued by the Company under the
terms of its Employee Stock Option Plan or Director Stock Option Plan. As
of March 31, 2007, there were 2,317,486 common shares outstanding(including
non-vested restricted shares), including 246,761 (10.6%) common shares held
by directors and officers of the Company and 2,070,725 common shares held
by non-affiliates of the Company. The number of the common shares being
registered pursuant to this filling therefore represents 30% of our public
float as of March 31, 2007.
SELLING SECURITY HOLDERS
The Selling Security Holders listed in the table below may use this
prospectus for the resale of shares of Common Stock being registered hereunder,
although no Selling Security Holder is obligated to sell any such shares. None
of the shares of Common Stock offered by this prospectus are outstanding as of
the date hereof, and all such shares of Common Stock are issuable upon the
conversion of certain outstanding convertible securities. The Selling Security
Holders who hold the Convertible Notes and Preferred Shares are not required to
convert, as applicable, such securities. The table below sets forth information
as of March 31, 2007 to reflect the sale of shares being offered by the
Selling Security Holders. No Selling Security Holders has, or within the past
three years has had, any position, office or other material relationship with us
or any of our predecessors or affiliates.
We are not able to estimate the number of shares that will be held by the
Selling Security Holders after the completion of this offering because the
Selling Security Holders may offer all or some of the shares and because there
are currently no agreements, arrangements or understandings with respect to the
sale of any shares offered hereby, except as otherwise noted below. The
following table assumes that all of the shares being registered hereby will be
sold.
44
NUMBER SHARES OF
SHARES OF OF SHARES COMMON STOCK
COMMON STOCK OF COMMON BENEFICIALLY
BENEFICIALLY OWNED STOCK TO OWNED AFTER
PRIOR TO OFFERING BE SOLD THE OFFERING
--------------------- IN THE -----------------
SELLING SECURITY HOLDERS: NUMBER PERCENT OFFERING NUMBER PERCENT
- ------------------------- --------- ------- --------- ------- -------
Gottbetter Capital Master, Ltd. 695,294(1) 23.08 383,468 311,826 9.59
BridgePointe Master Fund Ltd. 431,081(2) 15.68 237,750 193,331 6.17
--------- ----- ------- ------- -----
TOTAL 1,126,375 32.71 621,218 505,157 14.67
(1) Comprised of 341,881 shares issuable upon conversion of the Senior Notes;
132,954 shares issuable upon conversion of the Preferred Shares; and
220,459 shares issuable upon exercise of the Warrants.
(2) Comprised of 211,966 shares issuable upon conversion of the Senior Notes;
82,431 shares issuable upon conversion of the Preferred Shares; and 136,684
shares issuable upon exercise of the Warrants.
The name of the person who has voting or investment control over the
securities owned by Gottbetter Capital Master, Ltd., is Adam Gottbetter.
Gottbetter Capital Master, Ltd. is managed by Gottbetter Capital Management, LP.
Mr. Adam Gottbetter also has voting and investment control over that entity and
ultimately Gottbetter Capital Master, Ltd.
The names of the persons who have voting or investment control over the
securities owned by BridgePointe Master Fund Ltd. are Michael Kendrick and Eric
Swartz.
Our written agreements with the Selling Security Holders provide that they
and their respective affiliates cannot convert their note or their convertible
preferred shares, or exercise any warrants, if such action would cause a Selling
Security Holders and its affiliates to own in excess of 4.99% of our outstanding
common stock.
PLAN OF DISTRIBUTION
Each Selling Security Holders of our Common Stock and any of their
pledgees, assignees and successors-in-interest may, from time to time, sell any
or all of their shares of Common Stock on our principal markets or any other
stock exchange, market or trading facility on which the shares are traded or in
private transactions. These sales may be at fixed or negotiated prices. A
Selling Security Holders may use any one or more of the following methods when
selling shares:
- ordinary brokerage transactions and transactions in which the
broker-dealer solicits buyers;
- block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
- purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
- an exchange distribution in accordance with the rules of the
applicable exchange;
- privately negotiated transactions;
- settlement of short sales entered into after the date of this
prospectus;
- broker-dealers may agree with the Selling Security Holders to sell a
specified number of such shares at a stipulated price per share;
- a combination of any such methods of sale;
- through the writing or settlement of options or other hedging
transactions, whether through an options exchange or otherwise; or
- any other method permitted pursuant to applicable law.
The Selling Security Holders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this prospectus.
Broker-dealers engaged by the Selling Security Holders may arrange for
other brokers-dealers to participate in sales. Broker-dealers may receive
commissions or discounts from the Selling Security Holders (or, if any
broker-dealer acts as agent for the Buyer of shares, from the Buyer) in amounts
to be negotiated. Each Selling Security Holder does not expect these commissions
and discounts relating to its sales of shares to exceed what are customary in
the types of transactions involved.
45
In connection with the sale of our common stock or interests therein, the
Selling Security Holders may enter into hedging transactions with broker-dealers
or other financial institutions, which may in turn engage in short sales of the
common stock in the course of hedging the positions they assume. The Selling
Security Holders may also sell shares of our common stock short and deliver
these securities to close out their short positions, or loan or pledge the
common stock to broker-dealers that in turn may sell these securities. The
Selling Security Holders may also enter into option or other transactions with
broker-dealers or other financial institutions or the creation of one or more
derivative securities which require the delivery to such broker-dealer or other
financial institution of shares offered by this prospectus, which shares such
broker-dealer or other financial institution may resell pursuant to this
prospectus (as supplemented or amended to reflect such transaction).
The Selling Security Holders and any broker-dealers or agents that are
involved in selling the shares may be deemed to be "underwriters" within the
meaning of the Securities Act in connection with such sales and may have civil
liability under Sections 11 and 12 of the Securities Act for any omissions or
misstatements in this prospectus and the registration statement of which it is a
part. In such event, any commissions received by such broker-dealers or agents
and any profit on the resale of the shares purchased by them may be deemed to be
underwriting commissions or discounts under the Securities Act. Each Selling
Security Holder has informed us that it does not have any agreement or
understanding, directly or indirectly, with any person to distribute the Common
Stock.
We are required to pay certain fees and expenses we incur incident to the
registration of the shares. We have agreed to indemnify the Selling Security
Holders against certain losses, claims, damages and liabilities, including
liabilities under the Securities Act.
Because Selling Security Holders may be deemed to be "underwriters" within
the meaning of the Securities Act, they will be subject to the prospectus
delivery requirements of the Securities Act. In addition, any securities covered
by this prospectus which qualify for sale pursuant to Rule 144 under the
Securities Act may be sold under Rule 144 rather than under this prospectus.
Each Selling Security Holder has advised us that they have not entered into any
agreements, understandings or arrangements with any underwriter or broker-dealer
regarding the sale of the resale shares. There is no underwriter or coordinating
broker acting in connection with the proposed sale of the resale shares by the
Selling Security Holders.
We agreed to keep this prospectus effective until the earlier of (i) the
date on which the shares may be resold by the Selling Security Holders without
registration and without regard to any volume limitations by reason of Rule
144(e) under the Securities Act or any other rule of similar effect or (ii) all
of the shares have been sold pursuant to the prospectus or Rule 144 under the
Securities Act or any other rule of similar effect. The resale shares will be
sold only through registered or licensed brokers or dealers if required under
applicable state securities laws. In addition, in certain states, the resale
shares may not be sold unless they have been registered or qualified for sale in
the applicable state or an exemption from the registration or qualification
requirement is available and is complied with.
Under applicable rules and regulations under the 1934 Act, any person
engaged in the distribution of the resale shares may not simultaneously engage
in market making activities with respect to our common stock for a period of two
business days prior to the commencement of the distribution. In addition, the
Selling Security Holders will be subject to applicable provisions of the 1934
Act and the rules and regulations thereunder, including Regulation M, which may
limit the timing of purchases and sales of shares of our common stock by the
Selling Security Holders or any other person. We will make copies of this
prospectus available to the Selling Security Holders and have informed them of
the need to deliver a copy of this prospectus to each Buyer at or prior to the
time of the sale.
EXPERTS
The Company's full-year financial statements included in this prospectus
have been audited by BDO Seidman, LLP, an independent registered public
accounting firm to the extent and for the periods set forth in its report (the
report on the financial statements as of and for the year ending December 31,
2006 contains an explanatory paragraph regarding the Company's ability to
continue as a going concern) appearing elsewhere herein and are included in
reliance upon such report given upon the authority of this firm as experts in
auditing and accounting.
The full-year pre-acquisition financial statements of Loyalty Magic
included in this prospectus have been audited by the independent firm of
McInnes, Graham & Gibbs, to the extent and for the periods set forth in its
report appearing elsewhere herein and are included in reliance upon such report
given upon the authority of this firm as experts in auditing and accounting.
LEGAL MATTERS
The validity of the issuance of the common shares to be sold by the Selling
Security Holders under this prospectus and warrants was passed upon for our
company by Jaffe, Raitt, Heuer & Weiss, Professional Corporation.
46
DISCLOSURE OF COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
We have adopted provisions in our certificate of incorporation that limit
the liability of our directors for monetary damages for breach of their
fiduciary duty as directors, except for liability that cannot be eliminated
under the Delaware General Corporation Law. Delaware law provides that directors
of a company will not be personally liable for monetary damages for breach of
their fiduciary duty as directors, except for liabilities:
- - for any breach of their duty of loyalty to us or our stockholders;
- - for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- - for unlawful payment of dividend or unlawful stock repurchase or
redemption, as provided under Section 174 of the Delaware General
Corporation Law; or
- - for any transaction from which the director derived an improper personal
benefit.
In addition, our bylaws provide for the indemnification of officers,
directors and third parties acting on our behalf, to the fullest extent
permitted by Delaware General Corporation Law, if our board of directors
authorizes the proceeding for which such person is seeking indemnification
(other than proceedings that are brought to enforce the indemnification
provisions pursuant to the bylaws). We maintain directors' and officers'
liability insurance.
These indemnification provisions may be sufficiently broad to permit
indemnification of the registrant's executive officers and directors for
liabilities (including reimbursement of expenses incurred) arising under the
Securities Act of 1933.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to our directors, officers and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act of 1933 and is, therefore, unenforceable. No
pending material litigation or proceeding involving our directors, executive
officers, employees or other agents as to which indemnification is being sought
exists, and we are not aware of any pending or threatened material litigation
that may result in claims for indemnification by any of our directors or
executive officers.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the SEC. You may read and copy any reports, statements or other
information the Company files at the SEC's public reference room at 450 Fifth
Street, N.W., Washington, D.C., 20549. Please call the SEC at 1-800-SEC-0330 for
further information on the operation of the public reference room. Our SEC
filings are also available to the public from commercial document retrieval
services and through the web site maintained by the SEC at www.sec.gov.
This prospectus is part of a registration statement on Form SB-2 that we
have filed with the SEC utilizing a "shelf" registration process. Under the
shelf registration process, the Selling Security Holders may, from time to time,
sell the Common Stock described in this prospectus. We may prepare a prospectus
supplement at any time to add, update or change information contained in this
prospectus.
As allowed by SEC rules, this prospectus does not contain all the
information you can find in the registration statement or the exhibits filed
with or incorporated by reference into the registration statement. Whenever a
reference is made in this prospectus to an agreement or other document of the
Company, be aware that such reference is not necessarily complete and that you
should refer to the exhibits that are filed with or incorporated by reference
into the registration statement for a copy of the agreement or other document.
You may review a copy of the registration statement at the SEC's public
reference room in Washington, D.C., as well as through the web site maintained
by the SEC at www.sec.gov.
You should read this prospectus and any prospectus supplement together with
the registration statement and the exhibits filed with or incorporated by
reference into the registration statement. The information contained in this
prospectus speaks only as of its date unless the information specifically
indicates that another date applies.
We have not authorized any person to give any information or to make any
representations that differ from, or add to, the information discussed in this
prospectus. Therefore, if anyone gives you different or additional information,
you should not rely on it.
47
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with our accountants on
accounting and financial disclosure during the last two fiscal years.
PART II - INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to officers,
directors and other corporate agents in terms sufficiently broad to permit such
indemnification under certain circumstances and subject to certain limitations.
The registrant's certificate of incorporation includes a provision that
eliminates the personal liability of its directors for monetary damages for
breach of their fiduciary duty as directors.
In addition, the registrant's bylaws provide for the indemnification of
officers, directors and third parties acting on our behalf, to the fullest
extent permitted by Delaware General Corporation Law, if our board of directors
authorizes the proceeding for which such person is seeking indemnification
(other than proceedings that are brought to enforce the indemnification
provisions pursuant to the bylaws). The registrant maintains director and
officer liability insurance.
These indemnification provisions may be sufficiently broad to permit
indemnification of the registrant's executive officers and directors for
liabilities (including reimbursement of expenses incurred) arising under the
Securities Act of 1933.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the estimated expenses to be incurred in
connection with the issuance and distribution of the securities being
registered.
Registration Fee $ 267.50
Legal Fees and Expenses $ 10,000
Accounting Fees and Expenses $ 22,500
Miscellaneous $ 10,000
Total $42,767.50
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
2006
On November 22, 2006, Catuity entered into a Securities Purchase Agreement,
pursuant to which Catuity sold or issued $1,800,000 in aggregate principal
amount of its 10% Senior Convertible Notes (the "Senior Notes"), 700 shares of
Series A Convertible Preferred Stock ($700,000 aggregate stated value)(the
"Preferred Shares"), and warrants to purchase 357,143 shares of its common stock
(the "Warrants") (the "2006 Private Placement"). These Senior Notes and
Preferred Shares were issued at a discount to face or stated value, for
aggregate gross proceeds to Catuity (before deduction of advisory and other
transaction-related fees and expenses) of $2,250,000.
The Private Placement was made to two accredited investors in a transaction
that was exempt from the registration requirements of the Securities Act of
1933, as amended (the "Securities Act") pursuant to Regulation D promulgated
thereunder. Pursuant to a Registration Rights Agreement entered into pursuant to
the Securities Purchase Agreement, Catuity agreed to file a registration
statement under the Securities Act registering the resale of the common shares
that are issuable on conversion of the Senior Notes and Preferred Shares that
were issued in the Private Placement.
Catuity paid the placement agent for the financing (Broadband Capital
Management, LLC) a fee of 7% of the gross cash proceeds received by Catuity in
the financing, together with reimbursement of its actual expenses. Catuity paid
the lead investor's due diligence and legal fees and expenses and shall bear all
of its own legal and professional fees and expenses, including but not limited
to those associated with the filing of its Registration Statement as
contemplated by this transaction. The total legal and due diligence costs
Catuity incurred as a result of the financing were approximately $120,000.
48
2005
On September 19, 2005, Catuity issued 270,000 shares of its common stock in
a private placement to five accredited institutional investors. These shares
were issued pursuant to an exemption from registration under Regulation D of the
Securities Act. The shares were issued under the same pricing, terms and
conditions as the shares issued on September 1, 2005 as part of the Company's
acquisition of Loyalty Magic Pty. Ltd and its associated capital raise. The
shares were issued at $7.50 per share and raised $2,025,000. The Company paid
fees of $160,620 in order to raise the $2,025,000.
On September 1, 2005, the Company issued 335,000 shares of its common stock
to the shareholders of Loyalty Magic as part of the consideration for the
Company acquiring Loyalty Magic. These shares were issued pursuant to an
exemption from registration under Regulation D of the Securities Act of the
United States.
Also on September 1, 2005, the Company issued 700,000 shares of its common
stock to existing Australian shareholders who opted to subscribe for shares,
accredited Australian institutional buyers, and certain U.S. accredited
institutional investors who purchased shares that were not subscribed for by
Australian buyers. 256,520 shares of common stock were issued to existing
Australian shareholders and accredited Australian institutional buyers pursuant
to an exemption from registration under Regulation S of the Securities Act of
the United States. 443,480 shares of common stock were issued to accredited U.S.
institutional investors and members of Catuity's Board of Directors pursuant to
an exemption from registration under Regulation D of the Securities Act of the
United States. The shares were sold for A$10.00 per share in Australia and $7.50
per share (A$10.00 per share at a .7500 foreign currency exchange rate). The
sale of shares to Australian shareholders and institutional buyers resulted in
A$2,565,200 ($1,923,900). The sale of shares to U.S. accredited institutional
investors and Directors resulted in A$4,434,800 ($3,326.100) to the Company. The
Company paid a total of A$488,300 ($366,200) in brokerage commissions and
placement fees in order to raise the A$7,000,000 ($5,250,000). All U.S. dollar
amounts shown above were determined using a foreign currency exchange rate
between the Australian and U.S. dollar of .7500.
ITEM 27. EXHIBITS
(a) Exhibits.
The exhibits filed with this registration statement or incorporated herein
by reference are set forth on the Exhibit Index set forth elsewhere herein.
ITEM 28. UNDERTAKINGS
(a) The undersigned registrant hereby undertakes:
1. To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post-effective
amendment thereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in the registration statement.
Notwithstanding the foregoing, any increase or decrease in volume of securities
offered (if the total dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of prospectus
filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in the
effective registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
2. That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
3. To remove from registration by means of a post-effective amendment any
of the securities being registered which remains unsold at the termination of
the offering.
49
4. That, for the purpose of determining liability of the registrant under
the Securities Act of 1933 to any purchaser in the initial distribution of the
securities, the undersigned registrant undertakes that in a primary offering of
securities of the undersigned registrant pursuant to this registration
statement, regardless of the underwriting method used to sell the securities to
the purchaser, if the securities are offered or sold to such purchaser by means
of any of the following communications, the undersigned registrant will be a
seller to the purchaser and will be considered to offer or sell such securities
to such purchaser:
(i) Any preliminary prospectus or prospectus of the undersigned registrant
relating to the offering required to be filed pursuant to Rule 424;
(ii) Any free writing prospectus relating to the offering prepared by or on
behalf of the undersigned registrant or used or referred to by the undersigned
registrant;
(iii) The portion of any other free writing prospectus relating to the
offering containing material information about the undersigned registrant or its
securities provided by or on behalf of the undersigned registrant; and
(iv) Any other communication that is an offer in the offering made by the
undersigned registrant to the purchaser.
(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the SEC such indemnification is against
public policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred by a
director, officer or controlling person of the registrant in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act of 1933 and will be governed by the final
adjudication of such issue.
50
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of
Charlottesville, Commonwealth of Virginia, on May 18, 2007.
CATUITY INC.
By: /s/ Alfred H. (John) Racine, III
------------------------------------
Alfred H. (John) Racine, III
Chief Executive Office
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers and
directors of Catuity Inc. hereby constitutes and appoints each of Alfred H.
(John) Racine, III and Debra R. Hoopes, his attorney-in-fact and agent, with
full power of substitution and resubstitution for him in any and all capacities,
to sign any or all amendments or post-effective amendments to this registration
statement, and to file the same, with exhibits thereto and other documents in
connection therewith or in connection with the registration of the shares of
Common Stock under the Securities Act of 1933, with the Securities and Exchange
Commission, granting unto each such attorney-in-fact and agent full power and
authority to do and perform each and every act and thing requisite and necessary
in connection with such matters as fully to all intents and purposes as he might
or could do in person, hereby ratifying and confirming all that such
attorney-in-fact and agent or his substitute may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date indicated.
NAME TITLE DATE
---- ----- ----
/s/ Alexander S. Dawson Chairman May 18, 2007
- -------------------------------------
Alexander S. Dawson
/s/ Alfred H.(John) Racine III President, Chief May 18, 2007
- ------------------------------------- Executive Officer and Director
Alfred H.(John) Racine III (Principal Executive Officer)
/s/ Geoffrey C. Wild Director May 18, 2007
- -------------------------------------
Geoffrey C. Wild
/s/ Donald C. Campion Director May 18, 2007
- -------------------------------------
Donald C. Campion
/s/ Clifford W. Chapman Jr. Director May 18, 2007
- -------------------------------------
Clifford W. Chapman Jr.
/s/ Debra R. Hoopes Sr. Vice President, Chief May 18, 2007
- ------------------------------------- Financial Officer and Secretary
Debra R. Hoopes (Principal Accounting Officer)
51
EXHIBIT LIST
The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the SEC. Catuity shall furnish copies of
exhibits for a reasonable fee (covering the expense of furnishing copies) upon
request.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1 Registrant's Certificate of Incorporation, which appears as Exhibit
3.3 to Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.
3.2 Registrant's Certificate of Amendment to the Certificate of
Incorporation, which appears as Exhibit 3.4 to Registrant's Form
10-12G filed March 21, 2000, which is incorporated herein by
reference.
3.3 Registrant's Certificate of Designations for Series A Convertible
Preferred Stock, which appears as Exhibit 3.1 to Registrant's Form 8-K
filed November 22, 2006, which is incorporated herein by reference.
3.4 Registrant's By-Laws, which appears as Exhibit 3.5 to Registrant's
Form 10-12G filed March 21, 2000, which is incorporated herein by
reference.
3.5 Certificate of Registration of Card Technologies Australia Limited,
which appears as Exhibit 3.1 to Registrant's Form 10-12G filed March
21, 2000, which is incorporated herein by reference.
3.6 Certificate of Registration on change of name from Card Technologies
Australia Limited to Chip Application Technologies Limited, which
appears as Exhibit 3.2 to Registrant's Form 10-12G filed March 21,
2000, which is incorporated herein by reference.
3.7 Bylaws of Catuity, Inc. (formerly Novatec Inc.) as amended June 25,
2001, which appears as Exhibit 3(ii) to Registrant's Form 10-Q for the
quarter ended June 30, 2001, which is incorporated herein by
reference.
3.8 Bylaws of Catuity Inc. (formerly Novatec Inc.) as amended effective
September 1, 2004, which appears as Exhibit 3(g) to Registrant's Form
10-Q for the quarter ended June 30, 2004, which is incorporated herein
by reference.
3.9 Certificate of Amendment of Amended Certificate of Incorporation of
Catuity Inc. which appears as Exhibit 3(h) to Registrant's Form 10-K
for the year ended December 31, 2004, which is incorporated herein by
reference.
5 Opinion of Jaffe, Raitt, Heuer & Weiss, Professional Corporation, as
to legality of the securities being offered.
10.1 Registrant's 2000 Director Stock Option Plan, which appears as Exhibit
4.2 to Registrant's Form S-8 filed December 20, 2000, which is
incorporated herein by reference.*
10.2 Employment agreement of John H. Lowry III, which appears as Exhibit
10.10 to Registrant's Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.*
10.3 Amendment to John H. Lowry III Employment Agreement with Catuity Inc.,
which appears as Exhibit 10(d-1) to Registrant's Form 10-Q for the
quarter ended June 30, 2004, which is incorporated herein by
reference. *
10.4 Form of Indemnification Agreement, which appears as Exhibit 10.24 to
Registrant's Form 10-12G filed March 21, 2000, which is incorporated
herein by reference.
10.5 Form of Stock option Plan and Form of Stock Option Agreement under
Plan, which appears as Exhibit 10.25 to Registrant's Form 10-12G filed
March 21, 2000, which is incorporated herein by reference.*
10.6 Catuity, Inc. 2000 Director Stock Option Plan as approved by the
Shareholders of Catuity, Inc. on May 23, 2001, which appears as
Exhibit 10.2(bb) to Registrant's Form 10-Q for the quarter ended June
30, 2001, which is incorporated herein by reference.*
10.7 Amendment to Stock Option Plan, as approved by the Shareholders of
Catuity, Inc. on May 24, 2001, which appears as Exhibit 10(s) to
Registrant's Form 10-K for the year ended December 31, 2001, which is
incorporated herein by reference. *
10.8 Consulting agreement between Visa U.S.A and Catuity, Inc., signed
November 17, 2000, which appears as Exhibit 10(t) to Registrant's form
10-K for the year ended December 31, 2001, which is incorporated
herein by reference.
10.9 Catuity, Inc. 2002 Executive Stock Purchase Plan, which appears as
Exhibit 4.1 to Registrant's Form S-8 filed December 6, 2002, which is
incorporated here in by reference.*
10.10 Catuity, Inc. 2003 Executive Director Stock Purchase Plan which
appears as exhibit 10(v) to Registrant's Form 10-K for the year ended
December 31, 2003, which is incorporated herein by reference
10.11 Employment Agreement of Alfred H. Racine, with Catuity Inc. dated
September 23, 2004, which appears as exhibit 10(w) to Registrant's
Form 8-K filed September 28, 2004, which is incorporated herein by
reference *
52
10.12 Nonqualified Stock Option Agreement with Alfred H. Racine approved by
the Shareholders of Catuity Inc. on July 18, 2005, which appears as
Appendix A to Registrant's proxy dated June 6, 2005, which is
incorporated herein by reference.*
10.13 Catuity Inc. 2005 Employee Restricted Stock Plan approved by the
Shareholders of Catuity Inc. on July 18, 2005, which appears as
Appendix B to Registrant's proxy dated June 6, 2005, which is
incorporated herein by reference.*
10.14 Catuity Inc. 2005 Nonemployee Director Restricted Stock Plan approved
by the Shareholders of Catuity Inc. on July 18, 2005, which appears as
Appendix C to Registrant's proxy dated June 6, 2005, which is
incorporated herein by reference.*
10.15 Amendment dated September 21, 2005 to Alfred H. Racine employment
agreement with Catuity Inc. dated September 23, 2004, which appears as
exhibit 10(a) to Registrant's Form 10-Q for the quarter ended
September 30, 2005, which is incorporated herein by reference.*
10.16 Amendment dated September 21, 2005 to John H. Lowry employment
agreement with Catuity Inc. dated April 18, 2000, which appears as
exhibit 10(b) to Registrant's Form 10-Q for the quarter ended
September 30, 2005, which is incorporated herein by reference.*
10.17 Agreement between Catuity Inc. and MIA Pty. Ltd. and Chris Leach,
individually for Management services dated August 31, 2005, which
appears as exhibit 10(c) to Registrant's Form 10-Q for the quarter
ended September 30, 2005, which is incorporated herein by reference.*
10.18 Amendment dated December 21, 2005, to Alfred H. Racine III Employment
Agreement With Catuity Inc. Dated September 23, 2004 As Amended
Effective September 7, 2005.*
10.19 Employment Agreement of Debra Hoopes with Catuity Inc. dated December
6, 2006, which appears as exhibit 10.1 to Registrant's Form 8-K filed
December 12, 2006, which is incorporated herein by reference *
10.20 Amendment dated January 24, 2007 to Employment Agreement of Debra
Hoopes with Catuity Inc. dated December 6, 2006*
10.21 Securities Purchase Agreement for the Senior Notes, Preferred Shares
and Warrants, dated November 22, 2006, by and among Catuity, Inc. and
the investors thereto which appears as Exhibit 10.1 to Registrant's
Form 8-K filed for November 22, 2006, which is incorporated herein by
reference.
10.22 Senior Notes issued pursuant to Securities Purchase Agreement which
appears as Exhibit 10.2 to Registrant's Form 8-K filed for November
22, 2006, which is incorporated herein by reference.
10.23 Warrants issued pursuant to Securities Purchase Agreement which
appears as Exhibit 10.3 to Registrant's Form 8-K filed for November
22, 2006, which is incorporated herein by reference.
10.24 Registration Rights Agreement executed pursuant to the Securities
Purchase Agreement which appears as Exhibit 10.4 to Registrant's Form
8-K filed for November 22, 2006, which is incorporated herein by
reference.
10.25 Security Agreement executed pursuant to the Securities Purchase
Agreement which appears as Exhibit 10.5 to Registrant's Form 8-K filed
for November 22, 2006, which is incorporated herein by reference.
10.26 Guaranty executed by Catuity subsidiaries pursuant to the Securities
Purchase Agreement which appears as Exhibit 10.6 to Registrant's Form
8-K filed for November 22, 2006, which is incorporated herein by
reference.
10.27 Employment Agreement of Graham McStay with Catuity Inc. dated March
15, 2007, which appears as Exhibit 10.1 to Registrant's Form 8-K filed
March 19, 2007, which is incorporated herein by reference. *
16.1 Letter from Ernst & Young LLP to the Securities and Exchange
Commission regarding change in certifying accountant, which appears as
exhibit 16.1 to Registrant's Form 8-K dated September 24, 2004.
21 Subsidiaries of Registrant, which appears as Exhibit 21 to
Registrant's Form 10-KSB dated March 30, 2006
23.1 Consent of Independent Registered Public Accounting Firm -- BDO
Seidman, LLP
23.2 Consent of Independent Chartered Accounting Firm - McInnes, Graham &
Gibbs
23.3 Consent of Counsel - Jaffe, Raitt, Heuer & Weiss, Professional
Corporation (included in Exhibit 5)
24 Powers of Attorney Contained on Signature Page
- ----------
* Indicates that exhibit is a management contract or compensatory plan or
arrangement.
53
INDEX TO
FINANCIAL STATEMENTS
F- PAGE
-------
CATUITY INC
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ............. F-2
CONSOLIDATED BALANCE SHEETS - DECEMBER 31, 2006 AND 2005 ............ F-3
CONSOLIDATED STATEMENTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 2006
AND 2005 ......................................................... F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS - YEARS ENDED DECEMBER 31, 2006
AND 2005 ......................................................... F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - YEARS ENDED
DECEMBER 31, 2006 AND 2005 ....................................... F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - DECEMBER 31, 2006 ........ F-7
CONSOLIDATED BALANCE SHEETS - MARCH 31, 2007 AND DECEMBER 31, 2006 .. F-22
CONSOLIDATED STATEMENTS OF OPERATIONS - THREE MONTHS ENDED
MARCH 31, 2007 AND 2006 .......................................... F-23
CONSOLIDATED STATEMENTS OF CASH FLOWS - THREE MONTHS ENDED
MARCH 31, 2007 AND 2006 .......................................... F-24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - MARCH 31, 2007 ......... F-25
LOYALTY MAGIC
2005 AND 2004 INDEPENDENT AUDITOR'S REPORT .......................... F-33
BALANCE SHEETS - JUNE 30, 2005 AND 2004 ............................. F-35
PROFIT AND LOSS - YEARS ENDED JUNE 30, 2005 AND 2004 ............... F-36
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS ............... F-37
STATEMENTS OF CASH FLOWS - YEARS ENDED JUNE 30, 2005 AND 2004 ....... F-40
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS - YEAR ENDED DECEMBER
31, 2005 ......................................................... F-41
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Catuity, Inc.
Charlottesville, Virginia
We have audited the accompanying consolidated balance sheets of Catuity, Inc.
and subsidiaries (the Company) as of December 31, 2006 and 2005 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Catuity, Inc. and
subsidiaries at December 31, 2006 and 2005, and the results of its operations
and its cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 13 to
the consolidated financial statements, the Company has suffered recurring losses
from operations and has a substantial accumulated deficit that raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 13. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
As discussed in Notes 2 and 6 to the consolidated financial statements, the
Company changed its method of accounting for share-based compensation on January
1, 2006 by adopting Statement of Financial Accounting Standards No. 123(R),
"Share-Based Payment."
BDO SEIDMAN, LLP
Troy, Michigan
March 30, 2007
F-2
CATUITY INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
---------------------------
2006 2005
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,993,910 $ 958,746
Short term investments -- 2,245,839
Accounts receivable-trade, less allowance of $250,000 in 2006,
and $122,000 in 2005 390,116 543,200
Restricted cash 85,523 81,443
Non-income taxes receivable 290,711 --
Prepaid expenses and other 250,899 199,557
------------ ------------
TOTAL CURRENT ASSETS 3,011,159 4,028,785
------------ ------------
LONG TERM ASSETS:
Property and equipment, net 294,424 273,941
Notes receivable 35,548 --
Deferred financing costs, net 236,876 --
Goodwill 3,142,420 3,004,667
Other intangible assets, net 1,532,898 1,811,752
------------ ------------
TOTAL LONG TERM ASSETS 5,242,166 5,090,360
------------ ------------
TOTAL ASSETS $ 8,253,325 $ 9,119,145
============ ============
LIABILITIES AND STOCKHOLDERS' 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
Senior convertible notes, net of discount of $1,794,710 in 2006 5,290 --
Trust liability 85,523 81,443
------------ ------------
TOTAL CURRENT LIABILITIES 1,205,418 718,709
------------ ------------
LONG TERM LIABILITIES:
Leasing liability -- 4,861
Accrued compensation 39,036 56,009
------------ ------------
TOTAL LONG TERM LIABILITIES 39,036 60,870
------------ ------------
TOTAL LIABILITIES 1,244,454 779,579
------------ ------------
Commitments and Contingencies (note 4) -- --
STOCKHOLDERS' EQUITY:
Common stock -- $.001 par value; Authorized -- 6,666,667
shares: 2,242,343 shares issued and 2,076,691 shares
outstanding in 2006, 2,111,807 issued and 2,069,039
outstanding in 2005 2,242 2,112
Preferred stock -- $0.001 par value; Authorized -- 666,667
shares; 700 shares Series A issued and outstanding in 2006 450,187 --
Additional paid-in capital 48,299,469 45,797,503
Stockholder loans -- (16,738)
Deferred equity compensation -- (131,566)
Accumulated other comprehensive income 193,636 (65,589)
Accumulated deficit (41,936,663) (37,246,156)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 7,008,871 8,339,566
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 8,253,325 $ 9,119,145
============ ============
See accompanying notes to consolidated financial statements
F-3
CATUITY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
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 -- 21,384
Cost of revenue -- amortization of intangibles 176,407 49,886
Cost of revenue -- stock-based compensation 54,527 19,770
Research and development 465,321 728,108
Research and development -- stock-based compensation 30,585 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 742 35,305
General and administrative 2,136,279 1,685,152
General and administrative -- amortization of intangibles 53,713 16,850
General and administrative -- stock based compensation 409,338 77,048
----------- -----------
TOTAL COSTS AND EXPENSES 6,526,218 4,070,604
----------- -----------
OPERATING LOSS (4,577,418) (3,089,682)
Other income 270,469 --
Interest income, net of interest expense of $31,886 in 2006 74,211 108,652
----------- -----------
NET LOSS $(4,232,738) $(2,981,030)
Preferred stock dividends (457,769) --
----------- -----------
Net loss attributable to common stockholders $(4,690,507) $(2,981,030)
=========== ===========
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS PER SHARE --
BASIC & DILUTED $ (2.26) $ (2.48)
----------- -----------
WEIGHTED AVERAGE SHARES OUTSTANDING--BASIC & DILUTED 2,072,789 1,203,584
----------- -----------
See accompanying notes to consolidated financial statements
F-4
CATUITY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------
2006 2005
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(4,232,738) $(2,981,030)
Adjustments used to reconcile net loss to net cash
used in operating activities:
Stock based compensation 495,192 155,694
Depreciation and amortization 508,197 217,751
In process research and development -- 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 336,392 (344,740)
Other assets (381,687) 245,453
----------- -----------
Net cash used in operating activities (2,993,080) (2,801,690)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (154,424) (52,691)
Short Term Investments 2,245,839 (2,245,839)
Acquisition net of cash acquired -- (2,810,280)
----------- -----------
Net cash provided by (used in) investing activities 2,091,415 (5,108,810)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issue of common stock, net of expenses -- 6,460,184
Proceeds from issuance of convertible notes,
preferred stock and warrants, net of expenses 1,911,605 --
Repayment of fractional shares related to
reverse stock split (31) (1,104)
Cash Dividends paid on preferred stock (7,582) --
----------- -----------
Net cash provided by financing activities 1,903,992 6,459,080
----------- -----------
Foreign exchange effect on cash 32,837 (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 $-- $ 2,512,000
=========== ===========
See accompanying notes to consolidated financial statements
F-5
CATUITY, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ADDITIONAL
(AT PAR) PAID
------------------ PREFERRED IN CAPITAL SHAREHOLDER
SHARES AMOUNT STOCK AMOUNT LOANS
--------- ------ --------- ----------- -----------
BALANCES AT DECEMBER 31, 2004 778,184 $ 778 $ -- $36,603,127 $(79,533)
Exercise of options 1,282 1 6,300
Restricted stock granted 42,768 43 242,200
Capital raise & acquisition shares 1,305,000 1,305 8,964,758
Stock option expense 45,017
Deferred stock compensation
Repayment of fractional shares related to stock split (1,104)
Adjust shareholder loan to fair value (62,795) 62,795
Buyback of shares (15,427) (15)
Net loss
Foreign currency translation
Comprehensive loss
--------- ------ -------- ----------- --------
BALANCES AT DECEMBER 31, 2005 2,111,807 2,112 -- 45,797,503 (16,738)
Stock-based compensation 495,192
Restricted stock granted, net of forfeitures 130,536 130
Issuance of preferred stock, senior convertible notes and warrants 450,187 2,250,000
Costs attributable to issuance of preferred stock (94,752)
Repayment of fractional shares related to stock split (31)
Adjust shareholder loan to fair value (16,738) 16,738
Preferred stock dividends
Adoption of FAS 123R effective 1/1/2006 (131,705)
Net loss
Foreign currency translation
Comprehensive loss
--------- ------ -------- ----------- --------
BALANCES AT DECEMBER 31, 2006 2,242,343 $2,242 $450,187 $48,299,469 $ --
========= ====== ======== =========== ========
ACCUMULATED
DEFERRED OTHER TOTAL
EQUITY COMPREHENSIVE ACCUMULATED STOCKHOLDERS'
COMPENSATION INCOME DEFICIT EQUITY
------------ ------------- ------------ -------------
BALANCES AT DECEMBER 31, 2004 $ -- $ 96,656 $(34,265,126) $2,355,902
Exercise of options 6,301
Restricted stock granted (242,243) --
Capital raise & acquisition shares 8,966,063
Stock option expense 45,017
Deferred stock compensation 110,677 110,677
Repayment of fractional shares related to stock split (1,104)
Adjust shareholder loan to fair value --
Buyback of shares (15)
Net loss (2,981,030) (2,981,030)
Foreign currency translation (162,245) (162,245)
----------
Comprehensive loss (3,143,275)
--------- --------- ------------ ----------
BALANCES AT DECEMBER 31, 2005 (131,566) (65,589) (37,246,156) 8,339,566
Stock-based compensation 495,192
Restricted stock granted, net of forfeitures 130
Issuance of preferred stock, senior convertible notes and warrants (450,187) 2,250,000
Costs attributable to issuance of preferred stock (94,752)
Repayment of fractional shares related to stock split (31)
Adjust shareholder loan to fair value --
Preferred stock dividends (7,582) (7,582)
Adoption of FAS 123R effective 1/1/2006 131,566 139 --
Net loss (4,232,738) (4,232,738)
Foreign currency translation 259,086 259,086
----------
Comprehensive loss (3,973,652)
--------- --------- ------------ ----------
BALANCES AT DECEMBER 31, 2006 $ -- $ 193,636 $(41,936,663) $7,008,871
========= ========= ============ ==========
See accompanying notes to consolidated financial statements
F-6
CATUITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER, 31 2006
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 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. Catuity has operations in the US and in Australia
including its subsidiary Loyalty Magic, based in Melbourne, which was acquired
in September 2005.
NOTE 2. SUMMARY OF ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the consolidation of the
accounts of the Company and its wholly owned subsidiaries. All significant
inter-company transactions and balances have been eliminated.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results may
differ from those estimates.
REVENUE RECOGNITION
The three distinct revenue streams that result from the Company's business
activities are processing, service 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.
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 of, 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
F-7
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.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
CASH AND CASH EQUIVALENTS
The Company considers all cash and highly liquid investments purchased with
an original maturity of three months or less to be cash equivalents.
SHORT TERM INVESTMENTS
The Company periodically invests in short-term commercial paper with an
original maturity greater than three months. At December 31, 2005 there was no
difference between cost and fair value.
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 five years).
FOREIGN CURRENCY TRANSLATION
All balance sheet accounts for the Company's Australian subsidiaries are
translated at the exchange rates in effect at the balance sheet date. Revenues
and expenses for the Company's 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 in "Accumulated other
comprehensive income" as a component of stockholders' equity in the consolidated
balance sheets. 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
F-8
Goodwill represents the excess of the purchase price in a business
combination over the fair value of net tangible and intangible assets acquired.
Goodwill amounts are not amortized, and are tested for impairment at the
reporting unit level at least annually under Statement of Financial Accounting
Standards (SFAS) No. 142. 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. Under SFAS No. 144, 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.
After review of our goodwill and intangible assets we did not recognize any
impairment charges in 2006. The change in goodwill in 2006 was due to foreign
currency translation adjustments.
BUSINESS COMBINATIONS
The acquisition, discussed in Note 8, has been accounted for as a purchase
in accordance with SFAS No. 141, Business Combinations.
RESEARCH AND DEVELOPMENT
All research and development costs are expensed as incurred. The Company
did not incur any costs eligible for capitalization under SFAS No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of certain financial instruments such as cash and cash
equivalents, accounts receivable-trade, and accounts payable approximate their
fair values.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS No.
109"), which requires the use of the liability method in accounting for income
taxes. Under SFAS No. 109, deferred tax assets and liabilities are measured
based on differences between the financial reporting and tax bases of assets and
liabilities using enacted tax rates and laws that are expected to be in effect
when the differences are expected to reverse. The Company records a valuation
allowance to reduce deferred tax assets to the amount that it expects is more
likely than not to be realized.
STOCK-BASED COMPENSATION
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 are an alternative to financial statement recognition. As a result
SFAS 123(R), the expensing of stock options has an adverse effect on our
financial results. The level of impact on the Company's financial statements
depends, in part, on grants awarded. See Note 6 for a description of the expense
recorded for 2006 under SFAS 123(R).
Prior to 2006, the Company accounted for stock-based awards issued to
employees under the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB
25") and met the disclosure required for Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123").
NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted net loss per share is
computed using the weighted-average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist primarily of stock options, restricted stock awards and shares
that can be converted to common stock under our outstanding convertible senior
notes and preferred stock.
Due to our net loss for all periods presented, 1,190,730 and 248,236
potentially dilutive common equivalent shares were excluded from the diluted
loss per share calculation in 2006 and 2005, respectively, because their
inclusion would have been anti-dilutive.
F-9
OTHER INCOME
Other income for the year ended December 31, 2006 represents tax
concessions provided by the Australian Taxation Office for research and
development activities for Loyalty Magic and Chip Application Technologies.
RECENT ACCOUNTING PRONOUNCEMENTS
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. The Company is currently assessing the
impact of FIN 48 on its consolidated financial position and results of
operations.
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 approaches to quantitatively evaluate 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.
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 February, 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.
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
---------- ----------
For the years ending December 31, 2006 and 2005, depreciation expense was
$133,941 and $96,202, respectively.
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
F-10
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. As of
December 31, 2006, the Company recorded a liability of $109,000 related to the
estimated remaining obligations under Mr. Lowry's employment agreement. 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.
F-11
The following table presents our third party contractual obligations and
commitments as of January 1, 2007 over the next 5 years.
Contractual Obligations: Total 2007 2008 2009 2010 2011
- ------------------------ -------- -------- ------ ---- ---- ----
Operating Leases $ 95,314 $ 93,040 $2,274 -- -- --
Capital Leases 9,622 9,622 -- -- -- --
-------- -------- ------ --- --- ---
Total $104,936 $102,662 $2,274 -- -- --
======== ======== ====== === === ===
Rent expense for the years ending December 31, 2006 and 2005, was $143,268
and $67,575, respectively. There were no material changes in our lease
obligations in 2006.
NOTE 5. 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 553,847 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 has 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 is considered a
deemed dividend at the date of issuance and was recorded as a reduction of 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
F-12
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.
2005 PRIVATE PLACEMENTS
On September 19, 2005, the Company issued 270,000 shares of its common
stock in a private placement to five accredited institutional investors. These
shares were issued pursuant to an exemption from registration under Regulation D
of the Securities Act. The shares were issued under the same pricing, terms and
conditions as the shares issued on September 1, 2005 as part of the Company's
acquisition of Loyalty Magic Pty. Ltd and its associated capital raise. The
shares were issued at $7.50 per share and raised $2,025,000.
On September 1, 2005, the Company issued 335,000 shares of its common stock
to the stockholders of Loyalty Magic as part of the consideration for the
Company acquiring Loyalty Magic. These shares were issued pursuant to an
exemption from registration under Regulation D of the Securities Act.
Also on September 1, 2005, the Company issued 700,000 shares of its common
stock to existing Australian stockholders who opted to subscribe for shares,
accredited Australian institutional buyers, and certain U.S. accredited
institutional investors who purchased shares that were not subscribed for by
Australian buyers. 256,520 shares of common stock were issued to existing
Australian stockholders and accredited Australian institutional buyers pursuant
to an exemption from registration under Regulation S of the Securities Act.
443,480 shares of common stock were issued to accredited U.S. institutional
investors and members of the Company's Board of Directors pursuant to an
exemption from registration under Regulation D of the Securities Act. The shares
were sold for A$10.00 per share in Australia and $7.50 per share (A$10.00 per
share at a .7500 foreign currency exchange rate) in the United States. The sale
of shares to Australian stockholders and institutional buyers resulted in
A$2,565,200 ($1,923,900). The sale of shares to U.S. accredited institutional
investors and Directors resulted in A$4,434,800 ($3,326,100) to the Company.
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 December 31, 2006 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 2006, the Board of Directors declared and the
Company paid $7,582 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 December 31, 2006, 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 then-current exercise price in
F-13
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.
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.
NOTE 6. 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 operations.
The Company's consolidated statements of operations for the twelve months ended
December 31, 2006 and December 31, 2005 includes $495,192 and $155,694 of
stock-based compensation expense, respectively. Unrecognized stock-based
compensation expense expected to be recognized over an estimated
weighted-average amortization period of 2.36 years was $688,903 at December 31,
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.
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
-------------- -----
Risk Free Interest Rate 4.55--4.98% 3.00%
Expected Dividend Yield -- --
Expected Lives (years) 2.5 -- 5 1.00
Weighted Avg. Expected Volatility 95.31%
Expected Volatility 90.4 -- 107.6% 96.8%
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 does not affect 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:
DATE OF
SHARES STOCKHOLDER
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
F-14
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 a total of 322,711 options and 183,152 restricted
shares had been awarded, of which 255,848 options and 165,652 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.
For the year ended December 31, 2006, the effects of applying the
provisions of SFAS 123(R) on the Company's operating results were as follows:
YEAR ENDED DECEMBER 31, 2006
---------------------------------------
SFAS
As if under 123(R)
APB 25 adjustments As Reported
----------- ----------- -----------
Net loss attributable to common stockholders $(4,381,872) $(308,635) $(4,690,507)
Net loss attributable to common stockholders
per share: basic and diluted $ (2.11) $ (0.15) $ (2.26)
Had compensation costs for stock-based awards issued to employees been
determined consistent with SFAS No. 123, the Company's net loss and net loss per
share for the year ending December 31, 2005 would have been reported as follows:
2005
-----------
Net Loss as Reported $(2,981,030)
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards (305,098)
-----------
Pro forma net loss $(3,286,128)
===========
Loss per share:
basic & diluted -- as reported $ (2.48)
-----------
basic & diluted -- pro forma $ (2.73)
-----------
STOCK OPTIONS
The maximum contractual term for awards under the ESOP and DSOP is ten
years from the date of grant. The maximum contractual vesting period for awards
granted under the ESOP is five years from the date of grant. The DSOP does not
have a maximum vesting period specified. Awards granted under the ESOP may be
service, market, or performance based. Market based options include shares that
vest once the Company's share price reaches a certain target level defined in
the award. Performance based awards include those where vesting is tied to the
achievement of certain personal or Company targets or goals, such as achieving a
targeted number of customer location deployments or achieving a targeted sales
goal as measured by revenue over the term of new customer agreements.
The following table sets forth the summary of option activity under the
Company's stock option program:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
------- --------
OUTSTANDING OPTIONS AT DECEMBER 31, 2004 53,630 $91.02
Granted 182,802 7.00
Forfeited (29,482) 49.02
Exercised (1,282) 4.80
------- ------
OUTSTANDING OPTIONS AT DECEMBER 31, 2005 205,668 23.16
Granted 87,500 10.08
Forfeited (37,320) 11.17
------- ------
OUTSTANDING OPTIONS AT DECEMBER 31, 2006 255,848 $18.62
======= ======
F-15
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 $4.05 and $4.58, respectively.
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 4.05
Vested (34,159) 3.81
Forfeited (27,610) 4.77
------- -----
NONVESTED OPTIONS AT DECEMBER 31, 2006 89,095 $4.55
======= =====
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. The total
intrinsic value of options exercised in 2005 was $6,264.
Information regarding the stock options outstanding at December 31, 2006 is
summarized below:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -------------------------------------
Weighted Weighted
Number Average Weighted Number Average Weighted
Outstanding Remaining Average Outstanding Remaining Average
Range of at Dec. 31, Contractual Exercise at Dec. 31, Contractual Exercise
Exercise Price 2006 Life (Years) Price 2006 Life (Years) Price
- --------------- ----------- ------------ -------- ----------- ------------ --------
$3.11 -- 4.27 99,414 5.01 $ 3.97 89,414 4.40 $ 4.07
5.31 -- 7.50 38,433 2.64 6.34 20,838 2.85 6.81
10.52 -- 33.60 87,333 6.44 10.24 25,833 6.24 14.91
39.60 -- 178.38 30,668 2.29 106.93 30,668 2.29 106.93
------- ---- ------- ------- ---- -------
255,848 3.53 $ 18.62 166,753 3.12 $ 25.01
======= ==== ======= ======= ==== =======
The aggregate intrinsic value of options outstanding and options
exercisable as of December 31, 2006 was $46,000 and $33,000, 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 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.
F-16
A summary of the unvested restricted stock as of December 31, 2006, and
changes years ending December 31, 2006 and 2005 is as follows:
WEIGHTED
AVERAGE
GRANT
DATE
SHARES FAIR VALUE
-------- ----------
UNVESTED RESTRICTED STOCK AT DECEMBER 31, 2004 -- $ --
Granted 42,768 10.71
-------- ------
UNVESTED RESTRICTED STOCK AT DECEMBER 31, 2005 42,768 10.71
Granted 140,384 5.69
Vested (7,500) 11.62
Forfeited (10,000) 11.62
-------- ------
UNVESTED RESTRICTED STOCK AT DECEMBER 31, 2006 165,652 $ 6.50
======== ======
For all awards issued to employees, the Company records an expense based on
the grant date fair value and amortizes it over the service period.
NOTE 7. SENIOR CONVERTIBLE NOTES
As of December 31, 2006, 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 our and our subsidiaries' 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.
NOTE 8. 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 Stockholders 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.
F-17
The Company, as part of its turnaround strategy, determined that the
acquisition of Loyalty Magic and its combination 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
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
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 Stockholders $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.
F-18
The following table details the amortization of the intangibles as adjusted
for changes in the exchange rate during 2006:
December 31, 2006 December 31, 2005
-------------------------------------- --------------------------------------
Accumulated Net Book Accumulated Net Book
Category Cost Amortization Value Cost Amortization Value
- -------- ---------- ------------ ---------- ---------- ------------ ----------
Trademarks $ 592,681 $ (26,368) $ 566,313 $ 566,700 $ (6,296) $ 560,404
Software 674,363 (226,294) 448,069 644,800 (49,887) 594,913
Customer Contracts 298,171 (116,814) 181,357 285,100 (30,991) 254,109
Customer Relationships 291,163 (75,368) 215,795 278,400 (23,823) 254,577
Non-compete agreements 165,557 (44,193) 121,364 158,300 (10,552) 147,748
---------- --------- ---------- ---------- --------- ----------
Totals $2,021,935 $(489,037) $1,532,898 $1,933,300 $(121,549) $1,811,751
========== ========= ========== ========== ========= ==========
Amortization expense for the years ended December 31, 2006 and 2005 was
$367,488 and $121,549, respectively. The estimated amortization expense for
intangible assets for each of the years ending December 31 is as follows: 2007 -
$331,579, 2008 - $282,343, 2009 - $214,951, 2010 - $149,408, 2011 - $48,916;
thereafter - $505,701. The amortization of intangible assets associated with the
acquisition is 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, 2005 is as follows:
YTD 12/31/2005
--------------
(unaudited)
Revenue $ 2,377,192
Net loss (3,702,618)
Net loss per share -
basic and diluted $ (1.79)
NOTE 9. INCOME TAXES
The components of profit/(loss) before income taxes and extraordinary
items consisted of the following:
YEAR ENDED DECEMBER 31
-------------------------
2006 2005
----------- -----------
Domestic $(4,297,855) $(3,350,057)
Foreign 65,117 369,027
----------- -----------
Loss before income
taxes $(4,232,738) $(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 $(1,439,131) $(1,013,550)
Utilization of operating loss carry forward (19,453) (110,708)
Valuation allowance 1,462,233 1,139,019
Other (3,649) (14,761)
----------- -----------
Provision for income taxes $ -- $ --
=========== ===========
F-19
The statutory tax rate was 34% in the United States and 30% in Australia
for the years ended December 31, 2006 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 $ 13,564,462 $ 12,059,673
Other 364,152 108,188
------------ ------------
Total deferred tax assets 13,928,614 12,167,861
Deferred tax liabilities:
Intangibles (521,220) (616,080)
Beneficial conversion feature attributable
to convertible notes (393,380) --
------------ ------------
Total deferred tax liabilities (914,600) (616,080)
Valuation allowance (13,014,014) (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 10. 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 11. 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.
F-20
NOTE 12. 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 (AMCAL at 24% and API at 20%) 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 (AMCAL at 15% and API
at 13%) and, in total, represented approximately 28% of revenue.
NOTE 13. MANAGEMENT'S 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 years ended December 31, 2006 and 2005, the Company incurred net
losses of $4,232,738 and $2,981,030, respectively. As of December 31, 2006, the
Company had an accumulated deficit of $41,936,663 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.
Management currently estimates that additional debt and/or equity financing
will be required during the second quarter of 2007 in order to meet expected
liquidity requirements for the balance of 2007. 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.
Although management believes that its efforts in obtaining additional
financing and completing one or more strategic acquisitions will be successful,
there can be no assurance that its efforts will ultimately be successful. 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.
NOTE 14. RELATED PARTY TRANSACTIONS
In connection with the 2006 Private Placement discussed in Note 5, the Company
paid the placement agent for the financing (Broadband Capital Management, LLC) a
fee of $157,500, representing 7% of the gross cash proceeds received by Company,
together with reimbursement of its actual expenses. One of the Company's
independent directors is employed as the head of investment banking by Broadband
Capital Management LLC.
F-21
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
F-22
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
F-23
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
F-24
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 adoption of FIN 48 did
not have a material impact on the Company's 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)
=========== ===========
F-25
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.
F-26
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.
F-27
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.
F-28
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.
F-29
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.
F-30
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.
F-31
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.
F-32
INDEPENDENT AUDITOR'S REPORT
The Directors
Loyalty Magic Pty Ltd
5th Floor, 140 Bourke Street
MELBOURNE VIC 3000
We have audited the accompanying balance sheet of Loyalty Magic Pty Ltd as of
30th June, 2005 and 30 June, 2004, and the related statements of profit and loss
and cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Loyalty Magic Pty Ltd at 30th
June, 2005 and 2004, and the results of its operations and its cash flows for
the years then ended in conformity with accounting principles generally accepted
in the United States of America, except for the following matter which is
referred to at Note 1 to the Financial Statements -
CONFORMITY WITH UNITED STATES OF AMERICA (US) GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES (GAAP)-
In order to comply with the provisions of US GAAP, capitalised Web Development
Costs, $70,017 (2004 - $54,391) and Development Costs of New Platform, $209,173
(2004 - $Nil), (refer to Notes 1 and 7), should be written off as expenses in
the year in which they are incurred. This adjustment would reduce the company's
net profit for the year by $224,799 (2004 - $54,391) and reduce net assets at
30th June, 2005 by $279,190 (2004 - $54,391).
MCINNES GRAHAM & GIBBS
/s/ Jeffrey E Graham
----------------------------------------
Jeffrey E Graham
Partner
16th December 2005
F-33
LOYALTY MAGIC PTY LIMITED
A.C.N. 075 350 239
DECLARATION BY DIRECTORS
The directors have determined that the company is not a reporting entity, but
that this special purpose financial report should be prepared in accordance with
the accounting policies described in Note 1 to the financial statements.
The directors of the company declare that the financial statements and notes as
set out in the attached accounts:
(a) comply with Accounting Standards as described in Note 1 to the financial
statements and the Corporations Regulations 2001; and
(b) give a true and fair view of the company's financial position as at 30 June
2005 and of its performance for the year ended on that date in accordance with
the accounting policies described in Note 1 to the financial statements.
In the directors' opinion:
(a) the financial statements and notes, as set out in the attached accounts are
in accordance with the Corporations Act 2001; and
(b) there are reasonable grounds to believe that the company will be able to pay
its debts as and when they become due and payable.
Made in accordance with a resolution of the directors.
DIRECTOR _______________________________
DIRECTOR _______________________________
Date this ____ day of _____________ 2005
F-34
LOYALTY MAGIC PTY LIMITED
BALANCE SHEET
AS AT 30TH JUNE 2005
2005 2004
NOTE $ $
---- ---------- ----------
CURRENT ASSETS
Cash 2 43,446 659,991
Receivables 3 855,159 450,248
Investments 4 4 4
Other 5 7,611 30,795
---------- ----------
TOTAL CURRENT ASSETS 906,220 1,141,038
---------- ----------
NON-CURRENT ASSETS
Property, plant and equipment 6 220,886 157,816
Intangibles 7 280,963 54,391
---------- ----------
TOTAL NON-CURRENT ASSETS 501,849 212,207
---------- ----------
TOTAL ASSETS 1,408,069 1,353,245
========== ==========
CURRENT LIABILITIES
Accounts Payable 8 168,638 149,461
Borrowings 9 34,672 34,242
Provisions 10 137,684 243,301
Other 11 117,909 133,470
---------- ----------
TOTAL CURRENT LIABILITIES 458,903 560,474
========== ==========
NON-CURRENT LIABILITIES
Borrowings 9 67,817 --
Provisions 10 10,617 --
---------- ----------
TOTAL NON-CURRENT LIABILITIES 78,434 --
---------- ----------
TOTAL LIABILITIES 537,337 560,474
========== ==========
NET ASSETS (LIABILITIES) 870,732 792,771
========== ==========
EQUITY
Issued capital 12 2,699,429 2,699,029
Accumulated losses (1,828,697) (1,906,258)
---------- ----------
TOTAL EQUITY 870,732 792,771
========== ==========
F-35
LOYALTY MAGIC PTY LIMITED
PROFIT & LOSS
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
NOTE $ $
---- ---------- ----------
NET PROFIT(LOSS) BEFORE INCOME TAX (163,999) 236,693
Income Tax Expense 241,560 57,728
---------- ----------
NET PROFIT(LOSS) AFTER INCOME TAX 77,561 294,421
Retained Profits (Accumulated Losses) at
the beginning of the Financial Year (1,906,258) (2,200,679)
---------- ----------
TOTAL AVAILABLE FOR APPROPRIATION (1,828,697) (1,906,258)
---------- ----------
RETAINED PROFITS (ACCUMULATED LOSSES)
AT END OF FINANCIAL YEAR (1,828,697) (1,906,258)
========== ==========
LOYALTY MAGIC PTY LIMITED
PROFIT AND LOSS ACCOUNT
FOR THE YEAR ENDED 30TH JUNE 2005
2005 2004
$ $
---------- ----------
SALES
ASP Sales 2,131,431 1,899,456
Subscription Services 113,031 11,475
License Income 252,137 617,259
Support Services 259,173 180,319
International Sales 90,000 73,600
--------- ---------
2,845,772 2,782,109
LESS: DIRECT COSTS
Purchases 117,292 149,061
Contract Data Entry 217,387 243,106
Terminal Costs 25,500 40,616
--------- ---------
360,179 432,783
--------- ---------
GROSS PROFIT FROM TRADING 2,485,593 2,349,326
EXPENDITURE 2,667,750 2,131,849
--------- ---------
(182,157) 217,477
OTHER INCOME
Interest Received 9,908 14,266
Government Subsidies 8,250 4,950
--------- ---------
18,158 19,216
--------- ---------
NET (PROFIT)LOSS 163,999 (236,693)
========= =========
F-36
LOYALTY MAGIC PTY LIMITED
NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
FOR THE YEAR ENDED 30TH JUNE 2005
1 STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES
This financial report is a special purpose financial report prepared for the use
by the members and directors of the company. Although the directors have
determined that the company is not a reporting entity, the report has been
prepared in accordance with Accounting Standards, Urgent Issues Group Consensus
Views, other authoritative pronouncements of the Australian Accounting Standards
Board and the Corporations Act 2001.
The report is also prepared on an accruals basis and is based on historic cost
and does not take into account changing money values or, except where
specifically stated, current valuations of non-current assets. The following
material accounting policies, which are consistent with the previous period
unless otherwise stated, have been adopted in the preparation of this report:-
(a) INCOME TAX
The company adopts the liability method of tax effect accounting whereby the
income tax expense is based on the operating profit adjusted for any permanent
differences.
Future income tax benefits are not brought to account unless realisation of the
asset is assured beyond any reasonable doubt. Future income tax benefits in
relation to tax losses are not brought to account unless there is virtual
certainty of realisation of the benefit.
(b) PROPERTY, PLANT AND EQUIPMENT
Each class of property, plant and equipment is accounted for at cost less
accumulated depreciation, and is depreciated on a diminishing value basis over
the expected useful lives to the company.
(c) INTANGIBLES
Web Site development costs are capitalised until completion of the relevant
platform, then amortised on a straight line basis over the period during which
the site is expected to benefit the company.
(d) EMPLOYEE ENTITLEMENTS
Provision is made for employee entitlements arising from services rendered by
employees to balance date.
(e) GOODS AND SERVICES TAX
Revenues, expenses and assets are recognised net of the amount of goods and
services tax (GST), except where the amount of GST incurred is not recoverable
from the Australian Tax Office (ATO). In these circumstances the GST is
recognised as part of the cost of acquisition of the asset or as part of the
cost of the expense.
The net amount of GST recoverable, or payable to, the ATO is included as a
current asset or liability in the balance sheet.
1 STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(f) REVENUE RECOGNITION
MAIN AREAS OF INCOME
(i) Application Service Provision Income
Fixed Charge Management fees - Invoiced monthly and brought to account monthly
Variable Fees - Invoiced monthly based on volume of transactions processed
(ii) Licensed Income
F-37
Customisation of Software - Taken up as unearned income and brought to account
as revenue, on completion of agreed milestones.
Support Fees - Invoiced in advance, taken up as unearned income and transferred
to revenue depending on the contract terms.
Upgrade rights - Invoiced annually in advance, taken up as unearned income and
transferred to revenue monthly on a straight line basis.
(g) LEASES
Leases of fixed assets, where substantially all the risks and benefits
incidental to the ownership of the asset, but not legal ownership, are
transferred to the company are classified as finance leases.
Finance leases are capitalised recording an asset and a liability equal to the
present value of the minimum lease payments, including any guaranteed residual
value.
Leased assets are depreciated on a straight line basis over their estimated
useful lives where it is likely that the economic entity will obtain ownership
of the asset or over the term of the lease.
Lease payments are allocated between the reduction of the lease liability and
the lease interest expense for the period.
CONFORMITY WITH UNITED STATES OF AMERICA (US) GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (GAAP)
In order to comply with the provisions of US GAAP, capitalised Web Development
Costs, $70,017 (2004 - $54,391) and Development Costs of New Platform, $209,173
(2004 - $Nil) (refer to Note 7), should be written off as expenses in the year
in which they are incurred. This adjustment would reduce the company's net
profit for the year by $224,799 (2004 - $54,391) and reduce net assets at 30th
June, 2005 by $279,190 (2004 - $54,391).
2005 2004
$ $
---------- ----------
2 CASH
Petty Cash 200 200
Cash at Bank 43,246 659,791
---------- ----------
43,446 659,991
========== ==========
3 RECEIVABLES
CURRENT
Trade Debtors 633,599 407,520
Less: Provision for Doubtful Debts (80,000) (30,000)
---------- ----------
553,599 377,520
---------- ----------
Sundry Debtors 286,560 57,728
Rental Bond 15,000 15,000
---------- ----------
855,159 450,248
========== ==========
4 INVESTMENTS
CURRENT
Shares in Associated Companies 4 4
========== ==========
5 OTHER ASSETS
CURRENT
Prepayments 7,611 30,795
========== ==========
6 PROPERTY, PLANT & EQUIPMENT
Office Furniture & Equipment at Cost 366,722 416,163
Less: Accumulated Depreciation (220,393) (258,347)
---------- ----------
146,329 157,816
---------- ----------
Leased Assets at Cost 92,556 --
Less: Accumulated Amortisation (17,999) --
---------- ----------
74,557 --
---------- ----------
TOTAL PROPERTY, PLANT & EQUIPMENT 220,886 157,816
========== ==========
7 INTANGIBLES
Development of New Platform - at cost 209,173 --
F-38
Patents & Trademarks 1,773 --
Web Development - at cost 84,020 54,391
Less: Accumulated Amortisation (14,003) --
---------- ----------
70,017 54,391
---------- ----------
280,963 54,391
========== ==========
8 ACCOUNTS PAYABLE
CURRENT
Sundry Creditors 44,903 27,198
Trade Creditors 123,735 122,263
---------- ----------
168,638 149,461
========== ==========
9 BORROWINGS
CURRENT
GST Payable 34,672 34,242
========== ==========
NON-CURRENT
Lease Liability 67,817 --
========== ==========
10 PROVISIONS
CURRENT
Provision for Annual Leave 104,635 81,654
Provision for Bonuses 33,049 161,647
NON CURRENT
Provision for Long Service Leave 10,617 --
---------- ----------
Aggregate employee entitlement liability 148,301 243,301
========== ==========
11 OTHER LIABILITIES
CURRENT
Income in Advance 117,909 133,470
========== ==========
12 ISSUED CAPITAL
PAID UP CAPITAL:
Issued Capital 2699,429 2699,029
========== ==========
13 EXPENDITURE
Salaries 1460,293 1,156,712
General and Administrative 1,207,457 975,137
---------- ----------
Total Expenditure 2,667,750 2,131,849
========== ==========
14 INCOME TAX EXPENSE
No income tax is payable on the net profit for the year as the company has
accumulated losses available as an income tax deduction from prior years.
Future income tax benefits not brought to account, the benefits of which will
only be realised if the relevant conditions for deductibility occur:
- - timing differences 34,576 24,496
- - tax losses 66,643 243,053
---------- ----------
Total 101,219 267,549
========== ==========
Further, the company is entitled to receive a grant of $241,560 (2004 - $57,728)
from the Australian Taxation Office in respect of research and development
expenditure for the year ended 30 June 2005.
F-39
2005 2004
NOTE $ $
---- ---------- ----------
15 STATEMENT OF CASH FLOWS
RECONCILIATION OF OPERATING PROFIT TO NET CASH
INFLOW FROM OPERATING ACTIVITIES
Operating profit/(loss) after income tax 77,561 294,421
Depreciation expense 51,875 41,044
CHANGE IN OPERATING ASSETS AND LIABILITIES
(Increase)/Decrease in trade and other
receivables (221,079) 109,438
(Increase)/Decrease in prepayments 23,184 (21,985)
Increase/(Decrease) in trade and other creditors 19,607 42,224
Increase/(Decrease) in borrowings -- (44,948)
Increase/(Decrease) in provisions (95,000) (75,871)
Increase/(Decrease) in unearned income (15,561) 2,887
Increase/(Decrease) in provision for income tax (183,832) 326,402
---------- ----------
Net cash flow from operating activities (343,245) 673,612
========== ==========
During the financial year the company acquired property, plant and equipment
with a cost of $92,556, by means of finance leases, these acquisitions are not
reflected in the Statement of Cash Flows.
16 CAPITAL AND LEASING COMMITMENTS
Finance Lease Commitments Payable
- not later than 1 year 33,588 --
- later than 1 year but not later than 5 yrs 35,241 --
- later than 5 years -- --
---------- ----------
Minimum lease payments 68,829
Less future finance charges (1,011)
---------- ----------
Total Lease Liability 9 67,818 --
========== ==========
Operating Leases Commitments Payable
- no later than 1 year 66,938 63,548
- later than 1 year but not later than 5 years 76,428 143,365
- later than 5 years -- --
---------- ----------
Total Lease Liability 143,365 206,914
========== ==========
2005 2004
$ $
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Receipts from customers 2,617,382 2,899,384
Payments to suppliers and employees (3,024,948) (2,621,208)
Interest Received 9,907 14,266
Interest Paid (3,314) (2,960)
Income Tax Refund 57,728 384,130
---------- ----------
NET CASH INFLOW FROM OPERATING ACTIVITIES 15 (343,245) 673,612
CASH FLOWS FROM INVESTING ACTIVITIES
Payments for property, plant and equipment (21,700) (61,833)
Proceeds from sale of property, plant and
equipment -- --
Payments for Web Development (226,572) (54,391)
---------- ----------
NET CASH OUTFLOW FROM INVESTING ACTIVITIES (248,272) (116,224)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issue of Ordinary Shares 400 538
Repayment of lease liabilities (25,428) --
---------- ----------
Net cash inflow/(outflow) from financing
activities (25,028) 538
Net increase/(decrease) in cash held (616,545) 557,926
Cash at the beginning of the financial year 2 659,991 102,065
---------- ----------
CASH AT THE END OF THE FINANCIAL YEAR 2 43,446 43,446
========== ==========
F-40
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2005
The following unaudited pro forma Statement of Operations has been derived from
historical financial statements of Catuity, Inc, ("Catuity") and Loyalty Magic
Pty. Ltd. ("Loyalty Magic"), adjusted to give pro forma effect to the
acquisition of Loyalty Magic by Catuity (the "Transaction") as if the companies
had been combined for the full year ended December 31, 2005. Catuity completed
its acquisition of Loyalty Magic on September 1, 2005, has previously filed a
Current Report on Form 8-K concerning such transaction on September 7, 2005, and
filed an amended Current Report on Form 8-K/A on November 14, 2005.
The unaudited pro forma Statement of Operations for the year ended December 31,
2005 is presented for informational purposes only and does not purport to
represent what our results would actually have been had the Transaction occurred
at the beginning of 2005 or to project our results of operations for any future
period or date.
The pro forma adjustments are based upon available information and various
assumptions that we believe are reasonable. The pro forma adjustments are
described in the accompanying notes. The acquisition of Loyalty Magic has been
accounted for using the purchase method of accounting.
CATUITY AND LOYALTY MAGIC LOYALTY MAGIC
PRO FORMA IN USD CATUITY COMBINED
STATEMENT OF OPERATIONS JAN.1 -- AUG. IN USD PRO-FORMA IN USD
YEAR ENDED DECEMBER 31, 2005 31, 2005 2005 ADJUSTMENT (1) 2005
---------------------------- ------------- ---------- -------------- ----------
Revenue:
Processing 112,076 510,826 622,902
Service revenue 1,263,995 404,611 1,668,606
License revenue 20,199 65,485 85,684
--------- ---------- ----------
Total Revenue 1,396,270 980,922 2,377,192
--------- ---------- ----------
Cost of Revenue and Other Operating Expenses:
Cost of Processing Revenue 400,094 533,163 933,257
Cost of Service revenue 457,221 233,056 690,277
Cost of License revenue 0 21,384 21,384
Cost of Revenue Amortization of Intangibles 0 49,886 144,429 194,315
Cost of Revenue Stock Based Comp 0 19,770 19,770
Research and Development 218,751 728,108 946,859
Research and Development Stock Based Comp 0 23,571 23,571
Sales and Marketing 134,827 592,498 727,325
Sales and Marketing Stock Based Comp 0 35,305 35,305
Sales and Marketing Amortization of Intangibles 0 54,813 158,694 213,507
General & Administration 612,066 1,685,152 2,297,218
General & Administration Stock Based Comp 0 77,050 77,050
General & Administration Amortization of
Intangibles 0 16,848 48,777 65,625
--------- ---------- -------- ----------
Total Costs and Expenses 1,822,959 4,070,604 351,900 6,245,463
Operating income/(loss) (426,689) (3,089,682) (351,900) (3,868,271)
Interest Income 4,910 108,652 0 113,562
Income tax (expense)/benefit 52,091 0 0 52,091
--------- ---------- -------- ----------
Net Income/(Loss) (369,688) (2,981,030) (351,900) (3,702,618)
--------- ---------- -------- ----------
Net loss per share-basic & diluted N/A ($2.48) ($1.79)
Weighted average shares outstanding-basic &
diluted NA 1,203,584 2,069,039
--------- ---------- -------- ----------
- ----------
1) Pro-forma adjustments represent amortization of intangibles in conjunction
with the acquisition of Loyalty Magic.
F-41