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2005
 UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-KSB
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2005
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the transition period from  to
 Commission File Number 000-30045
 CATUITY INC.
  DELAWARE
(State or other jurisdiction of incorporation or organization)
    
    38-3518829
(I.R.S. Employer Identification Number)
 37650 Professional Center Drive, Suite 145A, Livonia, MI
(Address of principal executive offices)
    
    48154
(Zip code)
  
 
 þ o
 þ o
 o
 o þ
   DOCUMENTS INCORPORATED BY REFERENCE
  o þ




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##### 



CATUITY INC.
FORM 10-KSB
For the Year Ended December 31, 2005
TABLE OF CONTENTS
 PART I
    
    
    3Item 1. Description of Business
    
    
    3Item 2. Description of Property
    
    
    9Item 3. Legal Proceedings
    
    
    10Item 4. Submission of Matters to a Vote of Security Holders
    
    
    10PART II
    
    
    10Item 5. Market for Common Equity and Related Stockholder Matters
    
    
    10Item 6. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 7. Financial Statements
    
    
    20Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    35Item 8A. Controls and Procedures
    
    
    36PART III
    
    
    36Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act
    
    
    36Item 10. Executive Compensation
    
    
    38Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    38Item 12. Certain Relationships and Related Transactions
    
    
    38Item 13. Exhibits
    
    
    38Item 14. Principal Accountant Fees and Services
    
    
    40Amendment dated December 21, 2005, to Alfred H. Racine III Employment AgreementSubsidiaries of Registrant as of December 2005Consent of Independent Accountants BDO SEIDMAN, LLPCertification Pursuant to Section 302, by Alfred H. Racine III, the Registrant's Chief Executive OfficerCertification Pursuant to Section 302, by John H. Lowry, the Registrant's Chief Financial OfficerCertification Pursuant to Section 906, signed by Alfred H. Racine and John H. Lowry
  2




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As used in this Annual Report on form 10-KSB, Company, us, we, our and similar terms means
Catuity, Inc. a Delaware corporation.
  
 PART I
 The Companys annual report on Form 10-KSB , quarterly reports on Form 10-QSB , current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of
the Exchange Act are made available free of charge through the Companys website, located at
http://www.catuity.com, as soon as reasonably practicable after reports have been filed with the
Securities and Exchange Commission (SEC). The SEC also maintains an Internet site at
http://www.sec.gov where these reports and other information about the Company can be obtained.
 
 Item 1. Description of Business
 Our Business
 1
  
 1
    
    An Application Service Provider is a third-party entity that manages and distributes
software-based services and solutions to customers across a wide area network from a central data
center. 3




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
    
    Continue to invest in upgrades and new releases of the CALS system to meet the needs of the U.S. and Canadian markets;
    
    Focus sales efforts on tier two chain retailers where the capabilities of CALS have a demonstrable return on investment;
    
    Develop a sales channel through merchant service providers, acquirers and processors
who serve the more than two million smaller, individual merchants which are too small to be
serviced directly through Catuitys sales model;
    
    Strengthen the Companys technology team to support client deployments and services
around a hosted solution, rather than the traditional installed software business where the
Company had found its initial success in the U.S.;
    
    Selectively explore projects and opportunities in which the Company leverages its
technology and operational understanding of loyalty and gift card programs with partners who
offer other strengths.
   Industry
  POS Spending by Retailers www.chainstoreage.com www.ihlservices.com
 Gift Card Usage Trends www.deloitte.com
 4




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www.nrf.org
 Retailers Emphasize Loyalty in Growth Strategy
     2005
    
    2005
    
    2004
    
    2004Revenue Type
    
    Amount
    
    %
    
    Amount
    
    %Processing & Services
    
    $
    839,645
    
    
    
    86
    %
    
    $
    467,533
    
    
    
    62
    %License
    
    
    141,277
    
    
    
    14
    %
    
    
    43,200
    
    
    
    6
    %Project Related
    
    
    
    
    
    
    0
    %
    
    
    248,379
    
    
    
    32
    %Total Revenue
    
    $
    980,922
    
    
    
    100
    %
    
    $
    759,112
    
    
    
    100
    %
  5




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Products and Services
  
    
    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
  
    
    Launching and managing membership-based programs;
    
    Managing points-based programs;
    
    Delivering discounts based on shopping behavior; and
    
    Offering customizable gift card programs which can be enhanced with loyalty functionality.
  Competition
  
    
    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.
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
    
    Program-Based Solution: Retailers actively participate in promotional programs which are
generally designed to drive a single type of customer behavior, such as new account
acquisition or customer retention, or target the sale of specific products. These programs
are generally attractive because they have a defined cost; require little to no technology
adoption and require no complex back-end technology to manage beyond a specific promotion.
Catuity does not compete in this market.
  
    
    Our ability to 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.
  Research and Development
    
    
    Every development project must give our customer control of their programs.This is
important because retailers of all sizes want to be able to quickly and easily implement,
measure and modify their marketing and loyalty programs. Because we are delivered in an ASP
model, a key element of our R&D strategy is to always make it simpler and more intuitive for
our customers to use the technology.
    
    Every development must offer superior data security.The security of customer information
remains a major concern among retailers and payments industry players. Catuity addresses the
security of our own system through the training of our people; clearly drafted policies and
procedures; ongoing review and discussions with our customers about their best practices;
and compliance with industry standards. Catuity is in the process of certifying its U.S.
operations as being compliant with industry standards around customer data security.
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
    
    Every development must not impact the time of the total transaction.Because our programs
work at the point of sale, it is critical that our technology never slow down the checkout
process. Retailers equate delays at the checkout with lost business. Our technology, which
requires a proprietary application to be installed at the POS, is designed to operate under
the ISO 8583 message format, simultaneously with the approval of the payment transaction.
Before any version of our applications are released, they are tested and improved to
streamline the total transaction time so that Catuity never hurts the checkout time of one
of its customers.
    
    Every development must minimize or eliminate integration and other IT-related risks for
our customers.Like most buyers of technology driven solutions, retailers assess the total
cost of deploying and managing a solution. Our investment in our Application Program
Interface (API) development and integration with market-standard protocols is designed to
reduce the upfront cost of doing business with Catuity. These upfront costs can act as a
deterrent to a buying decision. We believe that a critical success factor in
transaction-driven companies is to make it easy for customers to start doing business with
us.
       Country
    
    Patent NumberUnited States
    
    
    6,449,684United States
    
    
    6,532,518Australia
    
    
    755,388
   Country
    
    Patent NumberAustralia
    
    
    746,867New Zealand
    
    
    513,678Belgium
    
    
    1,163,633Finland
    
    
    1,163,633France
    
    
    1,163,633Germany
    
    
    60020818.4Great Britain
    
    
    1,163,633
  8




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Item 2. Description of Property
      9




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Item 3. Legal Proceedings
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 PART II
 
 Item 5. Market for Common Equity and Related Stockholder Matters
   Symbol - CAT
    
    Symbol - CATN
    
    Symbol - CTTYHigh
    
    Low
    
    High
    
    Low
    
    High
    
    LowPeriod
    
    (Australian $)
    
    (Australian $)
    
    (Australian $)
    
    (Australian $)
    
    (United States $)
    
    (United States $)2005First Quarter
    
    $
    7.00
    
    
    $
    3.90
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    8.30
    
    
    $
    3.47Second Quarter
    
    $
    18.50
    
    
    $
    4.50
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    22.58
    
    
    $
    3.75Third Quarter
    
    $
    23.00
    
    
    $
    10.50
    
    
    $
    13.50
    
    
    $
    10.50
    
    
    $
    20.39
    
    
    $
    8.53Fourth Quarter
    
    $
    14.20
    
    
    $
    9.25
    
    
    $
    11.00
    
    
    $
    7.50
    
    
    $
    12.10
    
    
    $
    5.972004First Quarter
    
    $
    42.00
    
    
    $
    12.30
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    42.00
    
    
    $
    10.65Second Quarter
    
    $
    16.50
    
    
    $
    6.45
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    17.25
    
    
    $
    4.50Third Quarter
    
    $
    10.65
    
    
    $
    5.10
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    6.75
    
    
    $
    3.30Fourth Quarter
    
    $
    6.00
    
    
    $
    4.36
    
    
    
    N/A
    
    
    
    N/A
    
    
    $
    9.10
    
    
    $
    3.30
  Equity Compensation Plan Information
  Number of securities remainingNumber of securities
    
    
    
    
    
    available for future issuance underto be issued upon
    
    Weighted-average
    
    equity compensation plansexercise of
    
    exercise price of
    
    (excluding securities reflected inPlan Category:
    
    outstanding options
    
    outstanding options
    
    column (a)(a)
    
    (b)
    
    (c)Equity compensation plans
approved by security holders
    
    
    255,668
    (1)
    
    $
    21.45
    
    
    
    58,568Equity compensation plans
not approved by security holders
    
    
    -0-
    
    
    
    -0-
    
    
    
    -0-
 
 (1)
    
    50,000 of the options granted to Mr. Racine are conditional and pending approval by
Catuitys stockholders at the 2006 Annual Meeting. 10




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Item 6. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Catuitys Business
   Overview of Significant Activities
    11




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12




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13




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Revenue Recognition
   Software Revenue Recognition
 Revenue Recognition in Financial Statements Revenue Recognition
  Deferred Tax Assets
  Accounting for Equity Instruments
 st
   14




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Risks Related to Our Business
 We have a history of losses.
  We may be adversely affected if we fail to retain key personnel and attract new qualified
personnel.
  We will be adversely affected if our CALS product does not achieve market acceptance.
  Failure to Obtain Certifications in a Timely Manner.
  Sales Activities with Prospective Customers may not Generate Revenue for the Company.
  15




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Risks Related to Our Industry
 Competition in the application software industry could harm our business.
   
    
    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.
  New technologies could render our product obsolete.
  We may face risks related to the storage or provision of inaccurate or confidential information.
  
 We may be subject to product liability claims for use or misuse of our product.
  16




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We may face risks related to the use of electronic payment cards.
  We may be affected by potential privacy regulation.
  We may face increased governmental regulation and legal uncertainties.
  We may face intellectual property challenges.
   17




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Corporate and Market Risks
 Our trading volume may be low and our share price may be volatile.
   
    
    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.
  We may be subject to arbitrage risks.
  Complying with NASDAQs continued listing requirements.
         Certain Delaware anti-takeover provisions may produce results disfavored by our shareholders.
  18




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
    
    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.
  
    
    any merger or consolidation involving the corporation and the interested stockholder;
    
    any sale, transfer, pledge or other disposition of 10% or more of our assets involving the interested stockholder;
    
    subject to certain exceptions, any transaction that results in the issuance or transfer
by us of any of our stock to the interested stockholder;
    
    any transaction involving us that has the effect of increasing the proportionate share
of the stock of any class or series beneficially owned by the interested stockholder; and
    
    the receipt by the interested stockholder of the benefit of any loans, advances,
guarantees, pledges or other financial benefits provided by us or through the corporation.
  Changes in, or interpretations of, accounting rules and regulations, such as expensing of stock
options, could result in unfavorable accounting charges.
  19




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Item 7. Financial Statements
  Report of Independent Registered Public Accounting Firm
    
    
    21Consolidated Balance Sheets
    
    
    22Consolidated Statements of Operations
    
    
    23Consolidated Statements of Cash Flows
    
    
    24Consolidated Statements of Shareholders Equity
    
    
    25Notes to Consolidated Financial Statements
    
    
    26
 20




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Report of Independent Registered Public Accounting Firm
 
   ,
 
 21




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DECEMBER 312005
    
    
    2004ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    958,746
    
    
    $
    2,560,683Short term investments
    
    
    2,245,839
    
    
    
    Accounts receivable-trade, less allowance of
$122,000 in 2005, and $5,000 in 2004
    
    
    543,200
    
    
    
    36,211Restricted cash
    
    
    81,443
    
    
    
    116,012Work in process
    
    
    39,760
    
    
    
    Prepaid expenses and other
    
    
    159,797
    
    
    
    127,429Total Current Assets
    
    
    4,028,785
    
    
    
    2,840,335Long Term Assets:Property and equipment, net
    
    
    273,941
    
    
    
    162,780Goodwill
    
    
    3,004,667
    
    
    
    Other intangible assets, net
    
    
    1,811,752
    
    
    
    Total Long Term Assets
    
    
    5,090,360
    
    
    
    162,780Total Assets
    
    $
    9,119,145
    
    
    $
    3,003,115LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    175,643
    
    
    $
    150,584Deferred revenue
    
    
    114,721
    
    
    
    266Accrued compensation
    
    
    98,160
    
    
    
    278,250Taxes, other than income
    
    
    98,330
    
    
    
    9,669Other accrued expenses
    
    
    150,412
    
    
    
    77,539Trust liability
    
    
    81,443
    
    
    
    91,722Total Current Liabilities
    
    
    718,709
    
    
    
    608,030Long Term Liabilities:Leasing Liability
    
    
    4,861
    
    
    
    Accrued compensation
    
    
    56,009
    
    
    
    39,183Total Long Term Liabilities
    
    
    60,870
    
    
    
    39,183Shareholders Equity:Common stock  $.001 par value; Authorized 
6,666,667 shares: 2,111,807 shares issued and
2,069,039 shares outstanding,
778,184 issued and outstanding in 2004
    
    
    2,112
    
    
    
    778Preferred stock  $0.001 par value; Authorized 
666,667 shares
    
    
    
    
    
    
    Additional paid-in capital
    
    
    45,797,503
    
    
    
    36,603,127Shareholder loans
    
    
    (16,738
    )
    
    
    (79,533
    )Deferred equity compensation
    
    
    (131,566
    )
    
    
    Foreign currency translation adjustment
    
    
    (65,589
    )
    
    
    96,656Accumulated deficit
    
    
    (37,246,156
    )
    
    
    (34,265,126
    )Total Shareholders Equity
    
    
    8,339,566
    
    
    
    2,355,902Total Liabilities and Shareholders Equity
    
    $
    9,119,145
    
    
    $
    3,003,115
  22




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YEAR ENDED DECEMBER 312005
    
    
    2004Revenues:Processing and Service
    
    $
    839,645
    
    
    $
    467,533License
    
    
    141,277
    
    
    
    43,200Project Related
    
    
    
    
    
    
    248,379Total revenues
    
    
    980,922
    
    
    
    759,112Cost of revenue and other operating expenses:Cost of processing and service revenue
    
    
    766,219
    
    
    
    297,075Cost of license revenue
    
    
    21,384
    
    
    
    Cost of project related revenue
    
    
    
    
    
    
    103,151Research and development
    
    
    728,108
    
    
    
    1,282,753Sales and marketing
    
    
    592,498
    
    
    
    867,362General and administrative
    
    
    1,685,152
    
    
    
    1,912,999General and
administrative-stock based compensation
    
    
    155,694
    
    
    
    Amortization of intangibles
    
    
    121,549
    
    
    
    Total costs and expenses
    
    
    4,070,604
    
    
    
    4,463,340Operating loss
    
    
    (3,089,682
    )
    
    
    (3,704,228
    )Interest income
    
    
    108,652
    
    
    
    96,777Net loss
    
    $
    (2,981,030
    )
    
    $
    (3,607,451
    )Net loss per share  basic & diluted
    
    $
    (2.48
    )
    
    $
    (4.64
    )Weighted
average shares outstandingbasic & diluted
    
    
    1,203,584
    
    
    
    777,226
  23




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YEAR ENDED DECEMBER 312005
    
    
    2004Cash flows from operating activities:Net Loss
    
    $
    (2,981,030
    )
    
    $
    (3,607,451
    )Adjustments used to reconcile net loss to net
cash used in operating activities:Stock based compensation
    
    
    155,694
    
    
    
    Depreciation and amortization
    
    
    217,751
    
    
    
    127,926In Process Research and Development
    
    
    205,900
    
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    (54,770
    )
    
    
    365,898Accounts payable
    
    
    (167,330
    )
    
    
    274,249Deferred revenue
    
    
    (78,618
    )
    
    
    (110,295
    )Accrued expenses and other liabilities
    
    
    (344,740
    )
    
    
    (346,194
    )Other assets
    
    
    245,453
    
    
    
    134,683Net cash used in operating activities
    
    
    (2,801,690
    )
    
    
    (3,161,184
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (52,691
    )
    
    
    (71,492
    )Sale of Assets
    
    
    
    
    
    
    4,253Short Term Investments
    
    
    (2,245,839
    )
    
    
    Acquisition net of cash acquired
    
    
    (2,810,280
    )
    
    
    Net cash used in investing activities
    
    
    (5,108,810
    )
    
    
    (67,239
    )Cash flows from financing activities:Issue of common stock, net of expenses
    
    
    6,460,184
    
    
    
    14,057Repayment of fractional shares related to reverse stock split
    
    
    (1,104
    )
    
    
    (2,136
    )Net cash provided by financing activities
    
    
    6,459,080
    
    
    
    11,921Foreign exchange effect on cash
    
    
    (150,517
    )
    
    
    8,357Net increase/(decrease) in cash and cash equivalents
    
    
    (1,601,937
    )
    
    
    (3,208,145
    )Cash and cash equivalents, beginning of period
    
    
    2,560,683
    
    
    
    5,768,828Cash and cash equivalents, end of period
    
    $
    958,746
    
    
    $
    2,560,683Non cash investing & financing activities:Shares Issued in Acquisition
    
    $
    2,512,000
    
    
    $
    
  24




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Common Stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign
    
    
    
    
    
    
    Total(at par)
    
    
    Additional
    
    
    Deferred
    
    
    Shareholder
    
    
    Currency
    
    
    Accumulated
    
    
    ShareholdersShares
    
    
    Amount
    
    
    Paid In Capital
    
    
    Comp
    
    
    Loans
    
    
    Translation
    
    
    Deficit
    
    
    EquityBalances at December 31, 2003
    
    
    776,374
    
    
    $
    776
    
    
    $
    36,979,841
    
    
    
    
    
    
    $
    (468,166
    )
    
    $
    88,299
    
    
    $
    (30,657,675
    )
    
    $
    5,943,075Issuance of common stock
    
    
    1,810
    
    
    
    2
    
    
    
    14,055
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,057Repayment of fractional shares
related to stock split
    
    
    
    
    
    
    
    
    
    
    (2,136
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,136
    )Adjust shareholder loan to current
fair market value
    
    
    
    
    
    
    
    
    
    
    (388,633
    )
    
    
    
    
    
    
    388,633Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,607,451
    )
    
    
    (3,607,451
    )Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,357
    
    
    
    
    
    
    
    8,357Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,599,094
    )Balances at December 31, 2004
    
    
    778,184
    
    
    $
    778
    
    
    $
    36,603,127
    
    
    
    
    
    
    ($
    79,533
    )
    
    $
    96,656
    
    
    ($
    34,265,126
    )
    
    $
    2,355,902Issuance of common stockExercise of options
    
    
    1,282
    
    
    
    1
    
    
    
    6,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,301Restricted Stock Granted
    
    
    42,768
    
    
    
    43
    
    
    
    242,200
    
    
    
    (242,243
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Capital Raise & Acquisition Shares
    
    
    1,305,000
    
    
    
    1,305
    
    
    
    8,964,758
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,966,063Stock Option Expense
    
    
    
    
    
    
    
    
    
    
    45,017
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,017Deferred Stock Compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110,677
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    110,677Repayment of fractional shares
related to stock split
    
    
    
    
    
    
    
    
    
    
    (1,104
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,104
    )Adjust shareholder loan to current
fair market value
    
    
    
    
    
    
    
    
    
    
    (62,795
    )
    
    
    
    
    
    
    62,795
    
    
    
    
    
    
    
    
    
    
    
    Buyback of shares
    
    
    (15,427
    )
    
    
    (15
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ($
    2,981,030
    )
    
    
    (2,981,030
    )Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (162,245
    )
    
    
    
    
    
    
    (162,245
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,143,275
    )Balances at December 31, 2005
    
    
    2,111,807
    
    
    $
    2,112
    
    
    $
    45,797,503
    
    
    
    ($131,566
    )
    
    ($
    16,738
    )
    
    
    ($65,589
    )
    
    ($
    37,246,156
    )
    
    $
    8,339,566
  25




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##### Table of Contents



NOTE 1. DESCRIPTION OF BUSINESS
  NOTE 2. SUMMARY OF ACCOUNTING POLICIES
        Software Revenue Recognition
 Revenue Recognition in Financial Statements Revenue Recognition
  26




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27




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Business Combinations
  Accounting for the Costs of Computer
Software to Be Sold, Leased, or Otherwise Marketed.
       :
 YEAR ENDED DECEMBER 312005
    
    
    2004Net Loss as Reported
    
    $
    (2,981,030
    )
    
    $
    (3,607,451
    )Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards
    
    
    259,989
    
    
    
    47,224Pro forma net loss
    
    $
    (3,241,019
    )
    
    $
    (3,654,675
    )Loss per share:basic & diluted  as reported
    
    $
    (2.48
    )
    
    $
    (4.64
    )Pro forma basic & diluted
loss per share
    
    $
    (2.69
    )
    
    $
    (4.70
    )
 :
 DECEMBER 312005
    
    2004Risk Free Interest Rate
    
    
    3.00
    %
    
    
    2.00
    %Expected Dividend Yield
    
    
    
    
    
    
    Expected Lives (years)
    
    
    1.00
    
    
    
    1.13Expected Volatility
    
    
    0.968
    
    
    
    0.862
 28




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##### Table of Contents



NOTE 3. PROPERTY AND EQUIPMENT
  DECEMBER 312005
    
    
    2004Computer equipment
    
    $
    858,821
    
    
    $
    558,759Leasehold improvements
    
    
    65,431
    
    
    
    69,912Office furniture and equipment
    
    
    98,536
    
    
    
    99,622Capital Leases
    
    
    67,575
    
    
    
    $
    1,090,363
    
    
    $
    728,293Less accumulated depreciation
    
    
    (816,422
    )
    
    
    (565,513
    )$
    273,941
    
    
    $
    162,780
 NOTE 4. COMMITMENTS AND CONTINGENCIES
   NOTE 5. SHAREHOLDERS EQUITY
   29




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##### Table of Contents



NUMBER OF
    
    
    WEIGHTED AVERAGEOPTION
    
    
    EXERCISE PRICESHARES
    
    
    PER SHAREOutstanding at December 31, 2003
    
    
    79,732
    
    
    $
    86.85Granted
    
    
    7,179
    
    
    $
    5.21Cancelled/lapsed
    
    
    (33,281
    )
    
    
    53.58Exercised
    
    
    
    
    
    
    Outstanding at December 31, 2004
    
    
    53,630
    
    
    $
    91.02
 30




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##### Table of Contents



NUMBER OF
    
    
    WEIGHTED AVERAGEOPTION
    
    
    EXERCISE PRICESHARES
    
    
    PER SHAREGranted
    
    
    182,802
    
    
    $
    7.00Cancelled/lapsed
    
    
    (29,482
    )
    
    
    49.02Exercised
    
    
    (1,282
    )
    
    
    4.80Outstanding at December 31, 2005
    
    
    205,668
    
    
    $
    23.16
   Options Outstanding
    
    Options ExercisableWeightedAverageExercise Price
    
    Number of
    
    Weighted Avg.
    
    Contractual Life
    
    Number of
    
    Weighted AverageRange
    
    Shares
    
    Exercise Price
    
    (Years)
    
    Shares
    
    Exercise Price$4.05-$4.27
    
    
    78,914
    
    
    $
    4.20
    
    
    
    4.59
    
    
    
    78,914
    
    
    $
    4.20$5.31-$7.50
    
    
    38,586
    
    
    $
    6.64
    
    
    
    3.78
    
    
    
    15,222
    
    
    $
    7.46$10.52-$33.60
    
    
    56,499
    
    
    $
    14.68
    
    
    
    4.98
    
    
    
    16,166
    
    
    $
    15.61$39.60-$178.38
    
    
    31,669
    
    
    $
    106.76
    
    
    
    3.29
    
    
    
    31,669
    
    
    $
    106.76
           31




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##### Table of Contents



NOTE 6. ACQUISITION
 Business Combinations
    Condensed Balance SheetCurrent Assets
    
    $
    840,865Long Term Assets
    
    
    164,330Other Intangible Assets & In-process R&D
    
    
    2,139,200Goodwill Including Acquisition Cost
    
    
    3,004,667Total Assets
    
    
    6,149,062Liabilities
    
    
    (680,835
    )Purchase Price
    
    $
    5,468,227Transaction Cash & EquityCash Paid to Loyalty Magic Shareholders
    
    $
    2,700,000Shares of Catuity Stock @ $7.50*
    
    
    2,512,000Acquisition and Other Costs
    
    
    256,227Purchase 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.  32




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##### Table of Contents



2111 toAnnual Totals
    
    Value
    
    Method
    
    2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    2010
    
    2029Trademarks
    
    $
    566,700
    
    
    SL
    
    $
    6,296
    
    
    $
    18,888
    
    
    $
    18,888
    
    
    $
    18,888
    
    
    $
    18,888
    
    
    $
    18,888
    
    
    $
    465,964Software
    
    
    644,800
    
    
    CF based
    
    
    49,887
    
    
    
    166,236
    
    
    
    163,764
    
    
    
    137,580
    
    
    
    92,604
    
    
    
    34,729
    
    
    
    Customer Contracts
    
    
    285,100
    
    
    CF based
    
    
    30,991
    
    
    
    80,580
    
    
    
    69,888
    
    
    
    52,140
    
    
    
    35,028
    
    
    
    16,473
    
    
    
    Customer Relationships
    
    
    278,400
    
    
    CF based
    
    
    23,823
    
    
    
    48,168
    
    
    
    43,092
    
    
    
    38,028
    
    
    
    32,952
    
    
    
    27,888
    
    
    
    64,449Non-compete agreements
    
    
    158,300
    
    
    SL
    
    
    10,552
    
    
    
    31,656
    
    
    
    31,656
    
    
    
    31,656
    
    
    
    31,656
    
    
    
    21,124
    
    
    
    Totals
    
    $
    1,933,300
    
    
    
    
    
    
    $
    121,549
    
    
    $
    345,528
    
    
    $
    327,288
    
    
    $
    278,292
    
    
    $
    211,128
    
    
    $
    119,102
    
    
    $
    530,413
   YTD 12/31/2005
    
    YTD 12/31/2004(unaudited)
    
    (unaudited)Revenue
    
    $
    2,377,192
    
    
    $
    2,833,315Net Loss
    
    ($
    3,702,618
    )
    
    ($
    4,229,770
    )Earnings per share
    
    $
    (1.79
    )
    
    $
    (2.04
    )
 NOTE 7. INCOME TAXES
  YEAR ENDED DECEMBER 312005
    
    2004Domestic
    
    
    ($3,350,057
    )
    
    
    ($4,251,120
    )Foreign
    
    
    369,027
    
    
    
    643,669Loss before income taxes
    
    
    ($2,981,030
    )
    
    
    ($3,607,451
    )
  YEAR ENDED DECEMBER 312005
    
    
    2004Income taxes at statutory tax rate
    
    $
    (1,013,550
    )
    
    $
    (1,226,533
    )Variable stock compensation
    
    
    
    
    
    
    Utilization of operating
loss carryforward
    
    
    (110,708
    )
    
    
    (193,101
    )Valuation allowance
    
    
    1,139,019
    
    
    
    1,445,381Other
    
    
    (14,761
    )
    
    
    (25,747
    )Provision for income taxes
    
    $
    
    
    
    $
    
  33




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##### Table of Contents



DECEMBER 312005
    
    
    2004Deferred tax assets:Net operating loss carry-forwards
    
    $
    12,059,673
    
    
    $
    11,579,661Other
    
    
    108,188
    
    
    
    48,068Total deferred tax assets
    
    
    12,167,861
    
    
    
    11,627,729Deferred tax liabilities:Intangibles
    
    
    (616,080
    )
    
    
    Total deferred tax liabilities
    
    
    (616,080
    )
    
    
    Valuation allowance
    
    
    (11,551,781
    )
    
    
    (11,627,729
    )Total net deferred tax assets
    
    $
    
    
    
    $
    
  .
 NOTE 8. DEFINED CONTRIBUTION PLAN
   NOTE 9. RESTRICTED CASH
    NOTE 10. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA
  34




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##### Table of Contents



2005
    
    
    2004Long-Lived
    
    
    Net
    
    
    Long-Lived
    
    
    NetAssets
    
    
    Revenues
    
    
    Assets
    
    
    RevenuesU.S.
    
    $
    84,906
    
    
    $
    77,618
    
    
    $
    81,101
    
    
    $
    759,112Australia
    
    
    189,035
    
    
    
    903,304
    
    
    
    81,679
    
    
    
    Total
    
    $
    273,941
    
    
    $
    980,922
    
    
    $
    162,780
    
    
    $
    759,112
  NOTE 11. MANAGEMENTS PLANS (UNAUDITED
       
 Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
  35




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##### Table of Contents



Item 8A. Controls and Procedures
    
 PART III
 
 Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section
16(a) of the Exchange Act
  Name
    
    Age
    
    Position(s)Alexander S. Dawson
    
    
    62
    
    
    Chairman (1), (2), (3)Alfred H.(John)
Racine III
    
    
    41
    
    
    Director, President and Chief Executive OfficerGeoffrey C. Wild
    
    
    66
    
    
    Director (1), (3)Donald C. Campion
    
    
    57
    
    
    Director (1), (2)Clifford W. Chapman Jr.
    
    
    37
    
    
    Director (2), (3)John H. Lowry III
    
    
    58
    
    
    Vice President, Chief Financial Officer, Treasurer and SecretaryChris Leach
    
    
    56
    
    
    CEO of Loyalty Magic Pty. Ltd. (Australia)
 
      36




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37




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##### Table of Contents



Item 10. Executive Compensation
  
 Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
  
 Item 12. Certain Relationships and Related Transactions
  
 Item 13. Exhibits
  38




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##### Table of Contents



ExhibitNumber
    
    Description3(a)
    
    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(b)
    
    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(c)
    
    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(d)
    
    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(e)
    
    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(f)
    
    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(g)
    
    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(h)
    
    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.10(a)
    
    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(b)
    
    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(c)
    
    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(d)
    
    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(e)
    
    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(f)
    
    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(g)
    
    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(h)
    
    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(i)
    
    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(j)
    
    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(k)
    
    Employment Agreement of Alfred H. Racine , with Catuity Inc. dated September 23, 2004., which appears as exhibit 10(w) to Registrants
Form 8-K filed September 28, 2004, which is incorporated herein by reference. *10(l)
    
    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(m)
    
    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(n)
    
    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(o)
    
    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(p)
    
    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(q)
    
    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(r)
    
    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.*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 as of
March 31, 2006.23.1
    
    Consent of Independent Accountants-BDO SEIDMAN, LLP24
    
    Powers of Attorney Contained on
Page 40 of this Annual Report on Form 10-KSB31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by Alfred H. Racine, the Registrants Chief Executive Officer.31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by John H. Lowry, the Registrants Chief Financial Officer.32
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by
Alfred H. Racine and John H. Lowry99.1
    
    Audit Committee Charter, which appears as Exhibit 99.1 to Registrants Form 10-Q filed November 14, 2000, which is incorporated herein
by reference.99.2
    
    Catuity Inc. Audit Committee charter as amended October 22, 2001, which appears as exhibit 99.2 to Registrants Form 10-Q for the
quarter ended September 30, 2001, which is incorporated herein by reference99.3
    
    Catuity Inc. Audit Committee
charter as amended March 11, 2004, which appears as exhibit 99.3
to Registrants Form 10-K for the year ended December 31, 2004,
which is incorporated herein by reference.99.4
    
    Catuity Inc. Compensation Committee
charter as amended March 11, 2004, which appears as exhibit 99.4
to Registrants Form 10-K for the year ended December 31, 2004, which
is incorporated herein by reference.
 
 *
    
    Indicates that exhibit is a management contract or compensatory plan or arrangement. 39




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##### Table of Contents



Item 14. Principal Accountant Fees and Services
  
   Date: March 31, 2006
    
    
    
    CATUITY INC.By:
    
    /s/ John H. LowryJohn H. LowryVice President, CFO and Secretary
    Signature
    
    Title(s)
    
    Date/s/ Alexander S. Dawson
    
    Chairman and Director
    
    March 31, 2006Alexander S. Dawson/s/ Alfred H. Racine
    
    President, CEO and Director
    
    March 31, 2006Alfred H. Racine/s/ Clifford Chapman
    
    Director
    
    March 31, 2006Clifford Chapman/s/ Geoffrey C. Wild
    
    Director
    
    March 31, 2006Geoffrey C. Wild/s/ Donald C. Campion
    
    Director
    
    March 31, 2006Donald C. Campion/s/ John H. Lowry
    
    Vice President, CFO and Secretary
    
    March 31, 2006John H. Lowry
 40




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##### Table of Contents



EXHIBIT INDEX
 EX No.
    
    DESCRIPTION10(r)
    
    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.*21
    
    Subsidiaries of Registrant as of
March 31, 200623.1
    
    Consent of Independent Accountants-BDO SEIDMAN, LLP24
    
    Powers of Attorney Contained on
Page 40 of this Annual Report on Form 10-KSB31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by Alfred H. Racine, the Registrants Chief
Executive Officer.31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, by John H. Lowry, the Registrants Chief
Financial Officer.32
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
signed by Alfred H. Racine and John H. Lowry99.1
    
    Audit Committee Charter, which appears as Exhibit 99.1 to Registrants Form 10-Q filed November 14, 2000, which is
incorporated herein by reference.99.2
    
    Catuity Inc. Audit Committee charter as amended October 22, 2001,
which appears as exhibit 99.2 to Registrants Form 10-Q
for the quarter ended September 30, 2001, which is incorporated herein by reference99.3
    
    Catuity Inc. Audit Committee
charter as amended March 11, 2004, which appears as exhibit 99.3
to Registrants Form 10-K for the year ended December 31, 2004,
which is incorporated herein by reference.99.4
    
    Catuity Inc. Compensation Committee charter as amended March 11, 2004,
which appears as exhibit 99.4
to Registrants Form 10-K for the year ended December 31, 2004, which
is incorporated herein by reference.
 41