##### Table of Contents



2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
    FORM 10-K (MARK ONE)x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004o
    
    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 No)2711 E. JEFFERSON AVE. DETROIT MICHIGAN
(Address of principal executive offices)
    
    48207
(Zip code)
 (313-567-4348)
(REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE)    SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $.001 PER SHARE
    
    NASDAQ SMALL CAP MARKET
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
(ss. 229.405 of this chapter) is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act
Rule 12b-2). Yes o No
þ At June 30, 2004 the aggregate market value of voting and non-voting stock held by non-affiliates
of the Registrant totaled approximately $5,130,000 based on the last sale price as reported on the
Nasdaq Small Cap Market. As of March 15, 2005 there were 778,184 shares of the Registrants common
stock outstanding, par value $.001 per share. DOCUMENTS INCORPORATED BY REFERENCE The registrant incorporates the information required by Items 11, 12, 13, and 14 by reference to
its proxy statement to be furnished to shareholders for its Annual Meeting of Shareholders to be
held in May 2005.




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CATUITY INC.
FORM 10-K
For the Year Ended December 31, 2004
TABLE OF CONTENTS PART I
    
    
    3ITEM 1. BUSINESS
    
    
    3ITEM 2. PROPERTIES
    
    
    9ITEM 3. LEGAL PROCEEDINGS
    
    
    9ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
    
    
    9PART II
    
    
    9ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
    
    
    9ITEM 6. SELECTED FINANCIAL DATA
    
    
    10ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    10ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    
    22ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
    
    
    38ITEM 9A. CONTROLS AND PROCEDURES
    
    
    38PART III
    
    
    39ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    
    
    39ITEM 11. EXECUTIVE COMPENSATION
    
    
    40ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
    
    
    40ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    
    41ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    41PART IV
    
    
    41ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
    
    
    41Certificate of Amendment of Amended Certificate of IncorporationSubsidiaries of Registrant as of March 30, 2005Consent of Independent Accountants - BDO Seidman, LLPConsent of Independent Accountants - Ernst & Young, LLPCertification to Section 302 by Alfred H. Racine, CEOCertification to Section 302 by John H. Lewry, CFOCertification to Section 906 by Alfred H. Racine and John H. LewryCatuity Inc. Audit Committee charter as amended March 11, 2004Catuity Inc. Compensation Committee charter as amended March 11, 2004
 2




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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. 
 PART I The Companys annual report on Form 10-K, quarterly reports on Form 10-Q, 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. BUSINESS OUR BUSINESS 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 system1 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. In 2004, Catuity underwent a significant change in its business strategy following the decision of
Target Corporation to stop issuing smart cards to its customers that hold their Target-Visa
co-branded credit card. This resulted in the eventual shutdown of the Visa Smart Rewards Platform
that Visa USA had been developing for smart card usage in the United States and which utilized
Catuitys older smart loyalty software. This had a profound effect on the near-term use of smart
cards in the United States and resulted in Catuity adopting a change in its business strategy. In
2004, Visa represented 75% of Catuitys revenue while Target represented 11%.   1
    
    Application Service Provider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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That revenue ended in the third quarter of 2004. The Company has no expectation that either Visa
USA or Target Corp. will be a significant customer going forward. To meet the changing conditions of its market, the Companys Board of Directors adopted a strategy
which:  n
    Drove the release of the new CALS system to meet the changing technology requirements of
the U.S. and Canadian marketsn
    Refocused the sales efforts on tier two chain retailers, especially pharmacies, home
improvement stores and auto services, where the capabilities of CALS have a demonstrable
return on investmentn
    Developed a sales channel through merchant services, 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.n
    Shifted the Companys technology team from pure research and development to being
largely focused on 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.n
    Leverages the Companys experience with the aim of offering a managed gift card solution
in Australia by the second half of 2005 to meet the growing interest by retailers of all
sizes.n
    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. In the U.S. and Canada, the Company is targeting a large middle tier of retailers who favor a
hosted solution and who, for competitive reasons, have a need to offer loyalty and gift card
solutions to compete against the national branded chains, while differentiating them from their
smaller, local rivals. INDUSTRY SUMMARY 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. Therefore, 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
23rd Annual Survey of Retail Information Technology trends, Chain Store Age
(www.chainstoreage.com) magazine found that 25.2% of the IT budgets were allocated for POS hardware
and software in 2004. The survey, published in the November 2004 issue of the magazine, found that
the average retailers IT budget was $17.7 million last year. The survey suggests that with an
average expenditure of $4.46 million, that POS was the single greatest priority for retailers who
took part in the national survey. The survey was based on interviews with leading executives at
121 North American retailers whose combined sales were valued at nearly $250 billion. 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 91.9%
saying it was a top priority. That compares to 86.2% of all participants in the survey. Generally
speaking, ,the lifecycle of POS upgrades continues to shorten. Except in extraordinary
circumstances, hardware is replaced in a 5-7 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 March 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 SKUs (stock keeping units) at a retailer. 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 a late 2004 study that gift
cards were now the No. 1 gift with 64% 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 7,349
consumers, the National Retail Federation (www.nrf.org) found that consumers would spend an average
of $80.45 per card, representing $17.3 billion in value during the 2004 holiday season. That
accounts for 11.5% of total holiday spending in the U.S. Gift cards are not just a seasonal
business. They are a year-round part of the strategy of retailers and a key profit center. Tower
Group (www.towergroup.com), a 4




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research firm specializing in payments and other transaction driven industries, estimates that
consumers put $45 billion in value on stored value cards in 2003, the last year for which data was
available. Tower forecasts that the market size in the U.S. alone will reach $90 billion by 2007.
The Company currently delivers magnetic stripe gift cards, through an older version of our loyalty
software, to chain retailers through its direct sales effort and small retailers with one to 25
locations, through re-sellers, such as our clients KESM and EMS. 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 in North America
reaching up to $85 billion. These estimates can include everything from direct marketing, 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 pending acquisition of Loyalty Magic Pty Ltd will increase 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
more information on the announced merger, please see the Subsequent Events section on page 36. For the services that we offer today, merchants (those with one to 25 locations) spend an average
of $625-850 annually per store on basic loyalty programs. These fees are often charged in the form
of a flat monthly subscription service for a turnkey program. While Catuity targets this market
through resellers, 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 411 retailers in three market segments that we have targeted represent
at least 55,000 locations in North America. Again, using the minimum numbers, Catuity believes that
our target market has a minimum potential value of $2.035 billion annually. In total, our combined target markets for the products and services that we sell today are valued
at $2.785 billion. BUSINESS SEGMENTS Catuity conducts all of its business in a single business segment  providing loyalty technology
and related services to retailers and their processor partners. During Catuitys last three fiscal
years, its revenue by type of product or service has been as shown below: 2004
    
    
    2004
    
    
    2003
    
    
    2003
    
    
    2002
    
    
    2002Amount
    
    
    %
    
    
    Amount
    
    
    %
    
    
    Amount
    
    
    %Revenue TypeSoftware Development
    
    $
    248,379
    
    
    
    33
    %
    
    $
    2,323,441
    
    
    
    47
    %
    
    $
    1,666,890
    
    
    
    56
    %Services
    
    
    467,533
    
    
    
    62
    %
    
    
    902,222
    
    
    
    18
    %
    
    
    1,258,996
    
    
    
    42
    %License
    
    
    43,200
    
    
    
    5
    %
    
    
    1,756,725
    
    
    
    35
    %
    
    
    45,788
    
    
    
    2
    %Total Revenue
    
    $
    759,112
    
    
    
    100
    %
    
    $
    4,982,388
    
    
    
    100
    %
    
    $
    2,971,674
    
    
    
    100
    %
 In 2004, Catuity underwent a major shift in business focus which directly impacted our full year
results. In the first quarter of 2004, the Company learned that Target Corporation, 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 Visa-Target represented
the vast majority of the Companys 5




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revenue. The Company then embarked on an extensive effort to replace its existing technology with
the new Catuity Advanced Loyalty System, or CALS. That system was designed to be architecturally
flexible to meet the changing needs of clients and prospects. The first version of that technology
was announced in the third quarter of 2004 and consumed substantially all of the internal
technology resources of the Company. Late in the third quarter of 2004, the Board of Directors
named a new CEO, who embarked on an internal restructuring of the efforts and focus of the sales
team and a reduction in the size of the technology team. These changes were implemented during the
fourth quarter of 2004. During the Companys refocusing efforts in 2004, the Company made limited
progress in pursuing, managing and closing new sales. Complete financial information regarding the Companys business segment may be found in Item 8,
Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. OUR PRODUCTS AND SERVICES Most retailers are interested in achieving one or more of the following from their loyalty and reward programs:  
    increasing basket lift (giving customers reasons to buy a higher value of products)
    improving gross margin (giving customers reasons to buy higher margin products)
    increasing customer purchase frequency (driving customers back to the store more often)
    and/or 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 More Targeted Discounts
    Offering Unique Gift Card Programs (June 2005) Because CALS requires integration to a clients point of sale system, Catuity offers traditional IT
services to retailers. While our primary focus is on serving the needs of clients in relation to a
planned deployment of our system in their chain of stores, Catuity will actively seek contract work
to manage projects for retailers. Industry research firm IHL Services reports that maintenance and
development of existing retail systems represents more than half of the average chain retailers IT
budget for projects ranging from installation of new POS software systems to upgrades of hardware
and the addition of new technologies. In 2005, examples of leading types of projects, according to
researchers, include the installation of in-store kiosk systems which are linked to the POS; the
addition of RFID-reader systems and the addition of specialized check readers to comply with the
new U.S. check truncation laws. Catuity does not maintain a bench of consultants or technologists
to manage such projects. However, the Company has established relationships with companies and
teams of experienced technologists which it can contract with to provide these services. COMPETITION Catuity Inc. 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:  n
    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. 6




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n
    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.n
    Program-Based Solution: Retailers actively participate in promotional programs
which are generally designed to drive a single type of customer behavior, such as
new account acquisition or customer retention, or target the sale of specific
products. These programs are generally attractive because they have a defined cost;
require little to no technology adoption and require no complex back-end technology
to manage beyond a specific promotion. Catuity does not compete in this market. Our ability to be successful depends on many factors, including:  n
    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.n
    Our ability to successfully market the features of our product and to continually
make it easier for our clients to use.n
    Our ability to continually expand our reputation and credibility in our markets
and to differentiate Catuity from the many competitive alternatives.n
    Our ability to leverage marquee client relationships to establish a more visible
presence in the U.S. and Canada.n
    Our ability to execute on schedule and on budget and to consistently exceed our
customers ongoing service requirements. While Catuity is focused on a new market in 2005, we believe that our reputation for innovation and
delivery on behalf of Visa USA and Target Corporation, provide a foundation for our growth plans.
CALS is a robust and flexible platform which enables our customers to create, manage and measure
the success of their proprietary loyalty programs. RESEARCH AND DEVELOPMENT Catuitys product development efforts in 2004 were primarily focused on completing the first
release of its new generation loyalty platform  CALS. The Company has enhanced existing
functionality while constantly striving to make the system easier to use. In 2005, the Company will
enhance the management reporting capabilities of the system; complete the build out of its new gift
card module and establish a series of new, embedded analytical features which make it easier for
clients to track the success of their loyalty programs. In the North American market, CALS replaces
the Companys older smart loyalty platform which was used primarily for smart card-based loyalty.
While the Company continues to support existing customers who use the smart loyalty platform,
Catuity is not actively marketing the system because of its limitations in the U.S. market. The
smart loyalty platform is designed to meet the Europay-MasterCard-Visa (EMV) requirements in
Europe, Asia-Pacific, South America and other regions. The Company has previously announced that it
may sell the smart loyalty system and/or the associated patent portfolio. In 2004, Catuity devoted a substantial portion of its development teams time to the development of
CALS. The first release of the CALS software was completed in late 2004. Internal development costs
in 2004 were approximately (USD) $1,280,000. During 2004, and particularly after the completion of
release 1.0 of CALS, the Company significantly reduced the size of its development team based in
Sydney, Australia. The Company has retained the most experienced developers on its staff to
continue to enhance CALS and provide deployment and technical support to customers. 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 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. 7




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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 1 April 1998 and includes: Country
    
    Patent NumberUnited States
    
    
    6,449,684United States
    
    
    6,532,518Australia
    
    
    755,388
 Patent applications are pending in the European Union, Japan and Brazil. Catuity has also been issued two patents, with a priority date of 22 February 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 terminals ranging from POS
terminals to the Internet. This patent family includes: Country
    
    Patent NumberAustralia
    
    
    746,867New Zealand
    
    
    513,678
 In February 2005 we were notified that our patent application for use of the Catuity System over
the Internet and with traditional point of sale devices has been allowed by the European Patent
Office. This patent must be translated into German and French before it is nationalized in many
European countries. It is expected to be issued in numerous European countries in the first half of
2005. This patent is also pending in Canada and Japan. SALES BACKLOG AND PIPELINE As of December 31, 2004, the Company had signed agreements with customers that will result in
committed revenue of approximately $100,000 in 2005. At December 31, 2003, the Company had
approximately $600,000 of revenue related to signed agreements and projects in progress. As
previously disclosed, the Company is not currently forecasting revenue in 2005 from announced
contracts with Maritz, a leading loyalty solutions provider, Certegy, one of the largest credit
card and retailer payment service companies in North America, and EDS, a global IT service firm. At
the date of this filing, the Company has a defined prospect base of approximately 411 chain
retailers in its three designated markets. Our business objective remains to identify the 25-40
true prospects from that database which will make a buying decision in 2005. The Company has an
executed exclusive letter of intent with a new partner and is currently finalizing the deployment
plan and final contract terms. This partner provides customer acquisition and retention programs to
more than 50,000 small merchants through more than 400 local coalition partners. REVENUE AND ASSETS BY GEOGRAPHIC LOCATION During the three years ended December 31, 2004, 2003 and 2002, 100% of our revenues were derived in
the United States. The Companys assets are located at its headquarters in Detroit, Michigan and its product
development facility in Sydney, Australia. EMPLOYEES AND FACILITIES As of January 31, 2005, we had 10 full time employees, comprised of six in the U.S. and four in
Australia. We expect the number of full time employees in the U.S. to increase in 2005 in the
areas of sales & marketing and customer service. None of our employees is represented by a
collective bargaining agreement. We consider our relations with our employees to be very good. Our
corporate headquarters is located in Detroit, Michigan. Our research and product development
facility is in Sydney, Australia. We have no other foreign operations. Also see Item 2, Properties,
below. 8




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ITEM 2. PROPERTIES Our corporate headquarters is located in leased facilities in Detroit, Michigan consisting of
approximately 1,950 square feet of office space. The facilities are leased for a term of one year
beginning March 1, 2005 and the lease is renewable at the Companys option on a multi-year, annual,
or monthly basis. Our research and development center is located in leased facilities in Sydney, Australia,
consisting of approximately 330 square feet. Our lease agreement expires on December 28, 2005 and
is renewable for a further term of one year, at our option. 
 ITEM 3. LEGAL PROCEEDINGS Catuity was not a party to any legal proceedings during 2004 or as of the date of filing of this
Form 10-K. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On November 1, 2004, Catuity held a special meeting of shareholders at which time the shareholders
approved the granting of authority to the Board of Directors to effect a reverse stock split. Resolution: Approve the granting of authority to the Board of Directors to amend the Certificate
of Incorporation to effect a reverse stock split at one of the following three ratios: one-for-ten;
one-for-fifteen; or one-for-twenty at a date to be determined by the Board of Directors prior to
March 31, 2005. Votes FOR
    
    
    7,183,173Votes AGAINST
    
    
    124,244Abstentions
    
    
    26,711Broker-Non-Votes
    
    
    4,145,913Total
    
    
    11,480,041
 Following shareholder approval, the Board authorized a one for fifteen shares reverse stock split
that became effective on November 12, 2004. 
 PART II 
 ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Catuity (CTTY) was listed on the Nasdaq Small Cap Market beginning December 1, 2000. Chip
Application Technologies (then named Card Technologies Australia) was listed on the Australian
Stock Exchange (ASX) under the trading symbol CAT from July 11, 1997 to November 22, 1999. On
November 23, 1999, upon Catuitys acquisition of Chip Application Technologies, we replaced Chip
Application Technologies as the listed entity on the ASX under the same trading symbol. We continue
to be traded on the ASX. Our high and low sales prices on the ASX and NASDAQ for each quarter within the last two fiscal
years are shown below, both in Australian dollars and in U.S. dollars. A reverse stock split was
effected in November 2004, all prices below have been adjusted to show the retroactive effect of
the reverse stock split. High
    
    
    Low
    
    
    High
    
    
    LowPeriod
    
    (Australian $)
    
    
    (Australian $)
    
    
    (United States $)
    
    
    (United States $)2004First Quarter
    
    $
    42.00
    
    
    $
    12.30
    
    
    $
    42.00
    
    
    $
    10.65Second Quarter
    
    $
    16.50
    
    
    $
    6.45
    
    
    $
    17.25
    
    
    $
    4.50Third Quarter
    
    $
    10.65
    
    
    $
    5.10
    
    
    $
    6.75
    
    
    $
    3.30Fourth Quarter
    
    $
    6.00
    
    
    $
    4.36
    
    
    $
    9.10
    
    
    $
    3.302003First Quarter
    
    $
    60.00
    
    
    $
    45.75
    
    
    $
    36.00
    
    
    $
    26.25Second Quarter
    
    $
    53.25
    
    
    $
    32.25
    
    
    $
    34.50
    
    
    $
    21.00Third Quarter
    
    $
    88.50
    
    
    $
    32.25
    
    
    $
    52.50
    
    
    $
    20.10Fourth Quarter
    
    $
    42.00
    
    
    $
    30.45
    
    
    $
    29.55
    
    
    $
    23.25
 9




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##### Table of Contents



As of December 17, 2004 there were approximately 3,114 shareholders of record of our common
stock as reported to us by Computershare Investor Services, our transfer agent. To date, we have
not paid any dividends on our common stock. EQUITY COMPENSATION PLAN INFORMATION Number of securitiesremaining available forNumber of securities
    
    
    
    
    
    
    future issuance underto be issued upon
    
    
    Weighted-average
    
    
    equity compensation plansexercise of
    
    
    exercise price of
    
    
    (excluding securities reflectedPlan Category
    
    outstanding options
    
    
    outstanding options
    
    
    in column (a)(a)
    
    
    (b)
    
    
    (c)Equity compensation plans
approved by security holders
    
    
    53,630
    
    
    $
    91.02
    
    
    
    18,370Equity compensation plans
not approved by security holders(1)
    
    
    77,914
    
    
    $
    4.20
    
    
    
    0
   (1)
    
    The granting of these options is conditional upon approval by the Companys shareholders
at the 2005 annual meeting, to be held in late May 2005. 
 ITEM 6. SELECTED FINANCIAL DATA FOR YEARS ENDED DECEMBER 31(IN THOUSANDS EXCEPT PER SHARE DATA)2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000INCOME STATEMENT DATA:Net Revenues
    
    $
    759
    
    
    $
    4,982
    
    
    $
    2,972
    
    
    $
    1,616
    
    
    $
    751Operating Loss(1)
    
    
    (3,704
    )
    
    
    (678
    )
    
    
    (2,829
    )
    
    
    (4,119
    )
    
    
    (3,883
    )Net Loss
    
    
    (3,607
    )
    
    
    (595
    )
    
    
    (2,769
    )
    
    
    (3,875
    )
    
    
    (3,811
    )Net Loss per
sharebasic & diluted
    
    
    ($4.64
    )
    
    
    ($0.92
    )
    
    
    ($5.12
    )
    
    
    ($7.34
    )
    
    
    ($8.14
    )
 DECEMBER 312004
    
    
    2003(2)
    
    
    2002(3)
    
    
    2001
    
    
    2000(4)BALANCE SHEET DATA:Total Assets
    
    $
    3,003
    
    
    $
    6,773
    
    
    $
    4,592
    
    
    $
    5,870
    
    
    $
    9,500Total Shareholders Equity
    
    $
    2,356
    
    
    $
    5,943
    
    
    $
    1,998
    
    
    $
    3,857
    
    
    $
    8,194
   (1)
    
    Includes variable stock compensation of ($41,996) in 2003, ($53,363) in 2002,
($973,350) in 2001 and ($716,192) in 2000.(2)
    
    Includes private placements totaling 205,999 shares of common stock which raised
$4,085,430 in net cash proceeds.(3)
    
    Includes a private placement of 30,244 shares of common stock which raised $925,000 in
net cash proceeds.(4)
    
    Includes a private placement of 47,333 shares of common stock which raised $6,245,000 in
net cash proceeds. 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a summary of the consolidated operating results of Catuity Inc. 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 Form 10-K for a full discussion of the risks and uncertainties
associated with forward looking statements. 10




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Catuitys Business 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 system2 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. Overview of Significant Activities 2004 was a year of significant change for Catuity. As we have reported throughout 2004, in late
February, Target Corporation decided to discontinue its issuance of smart cards and phase out of
its participation in the Visa Smart Rewards platform. Catuitys loyalty software was one of the
principal drivers of the Smart Rewards program that had been, and was being, developed by Visa for
retailers. Targets decision resulted in Visa ceasing operation of the Smart Rewards program in
October 2004. In addition, Targets decision to discontinue issuing smart cards signaled to the
U.S. retail and credit card industries that the much anticipated growth in the use of smart cards
in the United States was going to be much longer in arriving than had been expected. As a result of this significant development, management determined it was necessary to
substantially revise its corporate strategy away from the smart card market and began work on a new
strategic plan in March 2004. Prior to the Target Corporation decision, the Company had focused its
efforts on licensing its smart card based loyalty software to large retailers in North America.
From its strategic planning efforts, the Company determined that its business focus should be on
providing a hosted or customized software solution for tier two chain retailers (and their
partners) and on providing services to retailers, merchant service providers, and POS equipment
manufacturers for their needs at the point of sale. As a result, the Companys market focus is on
tier two retailers with approximately 50 to 250 stores, and in particular, pharmacy chains, home
improvement, auto services and other chain retailers looking to improve customer retention, add new
customers, and increase each customers average spend amount. The Company also determined that it needed to become active in the mergers and acquisitions market
as a means to provide growth in as short a period of time as possible. As a result, in the middle
of 2004, the Company began an active effort to identify companies that would represent an
appropriate business fit with Catuitys business, provide positive cash-flow, and profits from
their operations. On March 17, 2005, the Company announced an agreement to purchase all of the
outstanding shares of Loyalty Magic Pty. Ltd., an Australian company located in Melbourne for A$5.5
million ($4.35 million USD based on the foreign exchange rate in effect on the day before the
announcement of the agreement). This represents a significant step in the Companys turnaround plan
toward profitability. Loyalty Magic was both cashflow positive and profitable in its fiscal year
ended June 30, 2004 and expects continued growth in 2005 and beyond. Of the A$5.5 million purchase
price, which excludes acquisition related costs, 35% will be issued in new Catuity shares with the
remainder to be paid in cash. Loyalty Magics management team and its largest shareholder, A&B
Venture Fund Company Pty Ltd., will hold the majority of the shares. Catuity will undertake a
capital raising, anticipated to be approximately A$6 million (or approximately $4.74 million USD),
in order to pay the cash portion of the transaction and to provide increased working capital. The
combined company will have a 40-person team serving existing customers in Australia, New Zealand,
and North America. The acquisition of Loyalty Magic and associated capital raise, which is subject
to shareholder approval, is expected to close following Catuitys Annual Shareholder Meeting in
late May 2005. In September 2004, the Board hired Alfred H. (John) Racine III, to become its President and CEO.
Mr. Racine had served as the consultant to Catuity in developing the Companys revised business
strategy. Mr. Racine was the founder and managing principal of Altamont Partners, which
specializes in the payments industry, and was retained in March 2004 to advise the Company on its
business strategy and merger & acquisition alternatives. During 2004, additional management changes
were made in order to align the experience and skills of key personnel in the Company with those
needed to succeed in its new market focus. In addition, in September the Board of Directors asked
Mr. Clifford Chapman to join the Board. Mr. Chapman is very experienced in turnaround company
situations and also brings substantial merger & acquisition experience to the board.   2
    
    Application Service Provider  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. 11




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In May of 2004, the minimum bid price for Catuity shares on Nasdaq had remained below $1.00 for 30
consecutive days, resulting in the Company being out of compliance with one of Nasdaqs continuous
listing requirements. In order to regain compliance, on November 1, 2004, the Company held a
special shareholders meeting in Sydney Australia for the purpose of seeking shareholder support for
a reverse stock split, also known as a share consolidation. The proposal overwhelmingly passed,
authorizing the Board to effect a reverse split. Immediately after the special shareholders
meeting, the Board of Directors unanimously authorized a 1 for 15 reverse split to be effective on
November 12, 2004, the earliest date that trading could begin in the post-reverse shares. As a
result of the reverse stock split, on December 2, 2004, the Company regained compliance with all of
Nasdaqs continued listing requirements. The balance sheet, earnings per share, and other
appropriate data in this annual report on Form 10-K have been restated to reflect the reverse stock
split. The Companys total shareholders equity at December 31, 2004, was below Nasdaqs minimum continued
listing requirement of $2.5M. While the Company will follow Nasdaqs required steps to regain
compliance, the issuance of new shares related to the pending acquisition of Loyalty Magic Pty.
Ltd. will bring the Company into compliance with Nasdaqs continuous listing requirements. Throughout 2004, Catuity developed its new Catuity Advanced Loyalty System or CALS. Most
significantly, the architecture of the platform is database and operating system agnostic thereby
reducing integration risks and hidden costs that can deter a client from making a buying decision.
The system is also agnostic at the point of sale. CALS will work with any customer identifier
selected by the client. It works with leading and emerging POS media, including magnetic stripe,
bar code, account number, biometric access device, RFID signal and even a smart card. Catuity
announced its initial release of CALS in the third quarter of 2004 and will continue to make
enhancements to the system to seek competitive advantage in the market. The system is maintained on
an internal hosting system in both Sydney, Australia and near the companys headquarters in
Detroit, Michigan. In the second quarter of 2005, the Company expects to establish its first
commercial host under an Application Service Provider (ASP) model which is commonly used in North
America. Catuitys 2004 revenue declined to $750,000 from $5 million in 2003 due to the cessation of new
development efforts and phasing out of the Visa Smart Rewards Platform. Expenses were reduced by
approximately $1.2 million, despite incurring one-time severance costs and significant research and
development cost on CALS. Most importantly, as the Company entered 2005, it had significantly
reduced its average monthly expenses. While the Company has undergone significant downsizing, it
also has undertaken efforts to retain its key people that have the expertise needed to sell to and
service its existing customers and its targeted customers. Management believes the Company is in a
position to significantly grow revenue without having to add significant cost. FISCAL YEAR ENDED 2004 COMPARED TO 2003 (all figures in USD and rounded to nearest $1,000) In 2004, total revenues were $759,000. These revenues were derived from $248,000 in software
development (a decrease of $2,075,000 or 89% over 2003), $468,000 in services related to
implementation, training and support activities (a decrease of $435,000 or 48% over 2003) and
$43,000 in customer license fees (a decrease of $1,714,000 over 2003). The significant decrease
in all three revenue streams was primarily due to the phase-out of the Smart Visa Rewards System
that utilized Catuitys loyalty software. Cost of software development revenue primarily consists of salaries, employee benefits, related
expenses and office overhead for the portion of time spent by our technical staff who work on
software development for customers. Cost of software development decreased $1,238,000 or 92%, to
$103,000 for the year ended December 31, 2004 from $1,342,000 for the year ended December 31, 2003.
The decrease in cost of software development corresponded with the decrease in software
development revenue and significant reductions in staffing that occurred in the 4th
quarter of 2004. Cost of service revenue primarily consists of salaries, employee benefits, related expenses and
office overhead for the customer implementation and support staff for the portion of their time
spent on service related activities. Cost of service revenue decreased $384,000, or 56%, to
$297,000 for the year ended December 31, 2004 from $681,000 for the year ended December 31, 2003
The decrease in cost of service corresponded with the decrease in service revenue and the
elimination of the use of outside contractors. 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 Catuitys software products. Research and development expenses increased $867,000,
or 208%, to $1,283,000 for the year ended December 31, 2004 from $416,000 for the year 12




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##### Table of Contents



ended December 31, 2003. The increase in R&D cost reflected the increase in staff hours spent on
the development of the Companys new loyalty software application, CALS. Sales and marketing expenses consist primarily of salaries, employee benefits, travel, marketing,
public relations and related overhead costs of the sales and marketing department. Sales and
marketing expenses decreased $424,000, or 33%, to $867,000 for the year ended December 31, 2004
from $1,291,000 for the year ended December 31, 2003. The decrease was primarily related to
reductions in staff size ($315,000), lower professional services costs ($73,000), and a decrease in
travel ($36,000). General and administrative expenses consist primarily of salaries, employee benefits, related
overhead costs and professional service fees. General and administrative expenses decreased
$60,000, or 3%, to $1,913,000 for the year ended December 31, 2004 from $1,973,000 for the year
ended December 31, 2003. General and administrative expenses in 2004 included an accrual related
to severance pay for the Companys former CEO and in 2003 included an accrual related to severance
pay for the Companys former Chairman,. The decrease in on-going general & administrative expenses
in 2004 primarily related to lower insurance premiums and other professional services. General and administrative  variable stock compensation expense/(credits) are due to the Companys
1995 non-recourse loans to the Companys former Chairman to acquire stock and are a non-cash
expense/(credit). In 2004, no expense/(credit) was recorded as the Companys stock price was below
the average loan share price and the cumulative stock compensation expense balance was zero. The
Companys variable stock compensation expense/(credits) are solely attributable to movements in the
Companys stock price from period to period. Other income increased in 2004 to $97,000 compared to $83,000 in 2003. Interest income earned in
Australia was positively impacted in 2004 by a 13% increase in the average exchange rate for the
Australian dollar compared to the U.S. dollar and a 11% increase in the average interest rate on
short-term deposits. FISCAL YEAR ENDED 2003 COMPARED TO 2002 (all figures in USD and rounded to nearest $1,000) In 2003, total revenues were $4,982,000. These revenues were derived from $2,323,000 in software
development (an increase of $656,000 or 39% over 2002), $1,757,000 in customer license fees (an
increase of $1,711,000 over 2002) and $902,000 in services relating to implementation, training and
support activities (a decrease of $357,000 or 28% over 2002). The increase in software development
revenue in 2003 was primarily due to the delivery of several major releases of the Smart Visa
Rewards program. License revenue increased significantly in 2003 as a result of the production
use of our software at Visa and Target. The decrease in service revenue in 2003 compared to 2002
was primarily due to a large service project in 2002, for which we utilized outside resources. Direct cost of software development revenue primarily consists of salaries, employee benefits,
related expenses and office overhead for the portion of time spent by our technical staff located
in Sydney, Australia, and our project managers and business analysts located in Arlington,
Virginia, who also work on software development activities. Direct cost of software development
increased $361,000 or 37%, to $1,342,000 for the year ended December 31, 2003 from $981,000 for the
year ended December 31, 2002. Expenses incurred in Australia increased in U.S. dollar terms in
2003 due to a 20% increase in the average exchange rate for the Australian dollar compared to the
U.S. dollar. 2003 expenses were also higher because more time was spent on customer related
development projects in 2003 compared to 2002. The increase in direct cost of software development
corresponded with the increase in software development revenue. Direct cost of service revenue primarily consists of salaries, employee benefits, related expenses
and office overhead for the customer implementation and support staff in Arlington, Virginia, for
the portion of their time spent on service related activities. Direct cost of service revenue
decreased $424,000, or 38%, to $681,000 for the year ended December 31, 2003 from $1,105,000 for
the year ended December 31, 2002. The decrease principally resulted from the Arlington service
staffs increased focus on development and sales & marketing activities versus service related
activities. The decrease in direct cost of service corresponded with the decrease in service
revenue. 2003 expenses also reflected a decrease due to the elimination of the use of outside
contractors, and lower costs associated with project related staff transfers from Australia. Research and Development expenses consist primarily of salaries, employee benefits and overhead
cost, incurred primarily by the technical staff in Sydney Australia, for the portion of their time
spent on research and development activities. Research and development expenses decreased
$123,000, or 23%, to $416,000 for the year ended December 31, 2003 from $539,000 for the year 13




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##### Table of Contents



ended December 31, 2002. The decrease principally resulted from increased efforts related to
billable customer development projects versus internal research and development activities. Sales and marketing expenses consist primarily of salaries, employee benefits, travel, marketing,
public relations and related overhead costs of the sales and marketing department. Sales and
marketing expenses decreased $467,000, or 27%, to $1,291,000 for the year ended December 31, 2003
from $1,758,000 for the year ended December 31, 2002. The decrease was primarily related to
reductions in staff size, lower professional services costs, and a decrease in travel. General and administrative expenses consist primarily of salaries, employee benefits, related
overhead costs and professional service fees. General and administrative expenses increased
$502,000, or 34%, to $1,972,000 for the year ended December 31, 2003 from $1,470,000 for the year
ended December 31, 2002. On-going general & administrative expenses were consistent between 2002
and 2003. The unfavorable expense variance in 2003 compared to 2002 was primarily the result of two
non-recurring credits in 2002 versus a non-recurring expense that occurred in 2003. In 2002 the
reversal of accrued legal fees related to a legal settlement at costs less than anticipated and a
reduction to the provision for doubtful accounts receivable resulted in non-recurring expense
credits of approximately $250,000. The 2002 credits, combined with a 2003 accrual for severance
pay for the Companys former Chairman, per contractual obligations, accounted for the expense
increase in 2003. General and administrative  variable stock compensation expense/(credits) are due to the Companys
1995 non-recourse loans to the Companys former Chairman to acquire stock and are of a non-cash
expense/(credit) in nature. In 2003, a credit of $42,000 was recorded compared to a credit of
$53,000 for the year ended December 31, 2002. The Companys variable stock compensation
expense/(credits) are solely attributable to movements in the Companys stock price from period to
period. Other income increased in 2003 to $83,000 compared to $60,000 in 2002. Interest income earned in
Australia was positively impacted in 2003 by a 20% increase in the average exchange rate for the
Australian dollar compared to the U.S. dollar. The Company maintained a higher cash balance in
Australia in 2003 compared to 2002. LIQUIDITY AND CAPITAL RESOURCES Historically, we have funded our operations with proceeds from the private placement of our common
stock and cash collections from customers. As of December 31, 2004, the Company had approximately
$2,561,000 in cash and cash equivalents, a decrease of $3,208,000 from December 31, 2003. Net cash
used in operating activities during 2004 was $3,161,000, compared with $2,138,000 during 2003. The
decline in total revenue was the primary factor contributing to the increase in net cash used in
operating activities. Net cash used in investing activities during 2004 totaled $67,000, which was a $222,000 decrease
from the cash used of $287,000 in 2003. The decrease was primarily due to reductions in capital
purchases in 2004 combined with higher than normal purchases in 2003. Capital purchases in 2003
included software licenses to facilitate automated testing of our system and updated computer
equipment for developers in Australia. Cash flows from investing activities was also positively
impacted in 2004 from the sale of excess computer equipment in Australia resulting from the
downsizing that occurred in the 4th quarter of 2004. Net cash provided by financing activities during 2004 totalled $12,000 and related to shares of
common stock purchased at fair market value under the Companys Executive Stock Purchase Plan, and
payments to shareholders for fractional shares related to the Companys reverse stock split. Net
cash provided by financing activities during 2003 was $4,172,000 and primarily related to cash
received from the private placement of approximately 200,000 shares of common stock to seven
accredited investors. The Company intends to raise equity capital in 2005, anticipated to be approximately A$6 million
(or approximately $4.74 million USD), in order to fund the cash portion of the Loyalty Magic Pty
Ltd. acquisition and to provide increased working capital. In the event that the acquisition does
not occur, Catuitys Board of Directors will initiate a shareholder rights offering with the
objective of raising $2,000,000 USD. The completion of the acquisition is dependent on factors
including, but not limited to, the approval of shareholders and the successful completion of a
capital raise. In either instance, the five individual members of the Board of Directors has
committed at least $325,000 USD toward the capital raise. The Company has also significantly reduced operating expenses and believes that the investment made
in the new CALS platform in 2004, in combination with the Boards new market strategy, will begin
to reflect favorably on the cash position of the Company. The Companys Board of Directors has
adopted a strategy which:  n
    Drove the release of the new CALS system to meet the changing technology requirements of
the U.S. and Canadian markets 14




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n
    Refocused the sales efforts on tier two chain retailers, especially pharmacies, home
improvement stores and auto services, where the capabilities of CALS have a demonstrable
return on investmentn
    Developed a sales channel through merchant services, 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.n
    Shifted the Companys technology team from pure research and development to being
largely focused on 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.n
    Leverages the Companys experience with the aim of offering a managed gift card solution
in Australia by the second half of 2005 to meet the growing interest by retailers of all
sizes.n
    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. The Company believes that the significant reductions made in the Companys operating expenses,
combined with its existing capital resources and revenue opportunities, are adequate to meet its
cash requirements for the next twelve months. As of December 31, 2004, the Company had net operating tax loss carry-forwards of $20,000,000
expiring in various amounts from 2020 through 2024 in the United States and $15,900,000 of net
operating tax loss carry-forwards 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 are subject to limits due
to continuity of ownership tests under Section 382 if the Internal Revenue Service Code. 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 We have three distinct revenue streams: software development revenue, service revenue, and license
revenue. Software development revenue includes integration, customization and development related to our
software application and the customers related hardware and software. Software development
revenue is generally billed on a fixed price basis. The Company recognizes revenue on fixed price
contracts on the proportional performance method in accordance with SAB 101, Revenue Recognition in
Financial Statements, and SAB 104, Revenue Recognition, based on actual hours incurred as a
proportion of estimated total hours of the respective project. Managements estimate of total
project hours is based on actual hours incurred to date combined with current hours estimated to
complete remaining project tasks. It is reasonable that the estimated number of total hours may
change, however this does not impact total project revenue recognized as the sales price is
typically fixed. The cumulative impact of any revisions in estimated total revenues and direct
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. Service revenue includes training, consulting, installation support, post-installation support and
maintenance fees. 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. Service revenue in 2004
consisted of post-installation customer support, which was based on a contracted number of monthly
support hours, and maintenance. 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 and acceptance of the software has occurred, no essential undelivered elements
remain on the Companys part that are essential to the functionality of the delivered software, the
fee is fixed and determinable, and collection has either occurred or is probable. Billings in
excess of revenue are recorded as deferred 15




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revenue until revenue recognition criteria are met. 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. All of the license revenue recognized in
2004 was related to a license agreement in which revenue was recognized monthly, based on a minimum
number of transactions. The Company generally does not provide for a right of return in its
license contracts. Deferred Tax Assets The Company records a full valuation allowance against net deferred tax assets. Based on
historical operating losses, it is difficult to determine the amount or timing of future earnings,
therefore, there is currently no tax benefit recorded by the Company due to the full valuation
allowance. Accounting for Equity Instruments The Company accounts for stock-based awards issued to employees under the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock issued to
Employees (APB 25) and has adopted the disclosure-only alternative of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). Based on
the Companys election to become a small-business issuer beginning in fiscal 2005, we will adopt
SFAS 123(R) beginning with the
1st
quarter of 2006, as required. SFAS 123(R) requires
the measurement of all employee share-based awards using a fair-value-based method. As a result,
because SFAS 123(R) requires the expensing of stock options, it will have an adverse effect on our
reported financial results. However, we have not yet assessed the level of impact to be able to
quantify the adverse effect. The shareholder loan outstanding, which relates to loans issued to a director in 1995 and 1996 to
purchase stock, is re-valued at each respective balance sheet date if the Companys period ending
fair market price per share is below the price per share at which the loan was made. The
offsetting entry is made to additional paid in capital. If the Companys ending fair market price
per share is above the price per share at which the loan was made, we record variable stock
compensation expense, based on the difference in price per share, on a cumulative basis. LEGAL PROCEEDINGS Catuity was not a party to any legal proceedings during 2004 or as of the date of filing of this
Form 10-K. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment (SFAS 123(R)) which requires the measurement of all employee
share-based payments to employees, including grants of employee stock options, using a
fair-value-based method and the recording of such expense in the consolidated statement of
operations. The accounting provisions of SFAS 123(R) are effective for reporting periods beginning
after December 15, 2005. We will adopt SFAS 123(R) effective as of the first quarter of 2006. The
pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to
financial statement recognition. As a result, because SFAS 123(R) requires the expensing of stock
options, it will have an adverse effect on our reported financial results. However, we have not
yet assessed the level of impact to be able to quantify the adverse effect. FACTORS AFFECTING OUR OPERATING RESULTS, OUR BUSINESS AND OUR SHARE PRICE In addition to the other information contained in this Form 10-K, you should carefully read and
consider the following risks and uncertainties described below. The risks and uncertainties
described below are not the only ones facing Catuity. Additional risks and uncertainties not
presently known to us also may impair our business. The occurrence of any of the following risks
could adversely affect our business, operating results or financial condition. 16




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Risks Related to Our Business We have a history of losses and anticipate future losses.
As of December 31, 2004, we had an accumulated deficit of $34,265,126. 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. 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 new generation of software, the Catuity Advanced Loyalty
Systems (CALS), does not achieve market acceptance. CALS had not been commercially deployed, and
there can be no assurance that the product will perform all the desired functions, or offer
sufficient price/performance benefits or meet the technical or other requirements of customers.
Despite testing of our product prior to its commercial release, there can be no assurance that all
performance errors or deficiencies have been discovered and remedied, that additional errors or
deficiencies will not occur, or if they occur, that we will be able to correct such errors and
deficiencies. Failure to Obtain Certifications in A Timely Manner
To deploy our technology on behalf of a client, Catuity must install a specialized application at
the point of sale for a 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 many cases, Catuitys POS application must be
certified by the payments processor who manages the transactional side of the business for
merchants and retailers. Catuity has been successful in previous efforts with market leaders
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. Risks Related to Our Industry Competition in the application software industry could harm our business.
The application software industry is highly competitive, rapidly developing and subject to constant
innovation and change. Numerous other companies operate incentive marketing programs using both
electronic and paper based systems, both for retail stores and the Internet. Many of these
companies have significantly longer operating histories, greater name recognition, larger customer
bases and greater financial, technical and marketing resources than we do. Our competitors may respond more quickly than we can to changing technologies and customer
requirements. For example, these competitors may:  
    conduct more extensive marketing campaigns to capture market share;
    provide more attractive incentive and pricing packages to customers;
    negotiate more favorable contracts with existing and potential employees and strategic partners;
    establish cooperative relationships among themselves or with third parties, including
large Internet participants, to increase the ability of their products and services to
address the needs of prospective customers;
    bundle their products with other software or hardware, including operating systems and
browsers, in a manner that may discourage users from purchasing products offered by us; 17




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
    establish cooperative relationships with our current or potential competitors, thereby
limiting our ability to sell our products through particular reseller channels; or
    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. We may be subject to product liability claims for use or misuse of our product.
Retailers rely, and will continue to 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, our product may be added to existing or new electronic payment
cards, either by the addition of software to a chip or by using the payment card number as an
identifier with our product. Alternatively, a portion of the software comprising our product may be
added to existing or new payment 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. 18




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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 enable or manage confidential customer information on behalf of our clients. Recent
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. At present, Attorney Generals in at least 26 states in the U.S. 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 both 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. 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. We expect that third-party infringement claims involving Internet technologies and software
products will 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 for patents in relation to the method of operation of incentive marketing programs
using electronic means. We cannot assure you that our patent applications will be approved.
Moreover, even if approved, they may not provide us with any competitive advantages or may be
challenged by third parties. In recent times a number of patents have been granted in this area.
Although we are not aware of any issued patent that our product would infringe, legal standards
relating to the validity, enforceability and scope of intellectual property rights in
Internet-related industries and use of electronic data for granting of benefits and rewards are
uncertain and still evolving, and the future viability or value of any of our intellectual property
rights is uncertain. Corporate and Market Risks Our trading volume may be low and our share price may be volatile.
We are currently listed on two exchanges, the ASX, in Australia, and the Nasdaq Small Cap Market,
in the United States. There can be no assurance that an adequate volume of trading in our shares
will be achieved and maintained, on Nasdaq or the ASX, in order to provide liquidity for our
investors. Trading in Catuity shares on Nasdaq and the ASX averaged 1,937 shares per day in 2004. The market price of our common stock may fluctuate significantly in response to the following
factors, some of which are beyond our control: 19




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
    variations in actual or anticipated quarterly or annual operating results;
    changes in financial estimates by securities analysts;
    changes in market valuations of loyalty software & service companies;
    announcements by us of significant contracts, reseller arrangements, strategic
partnerships, joint ventures or capital commitments;
    additions or departures of key personnel;
    sales of common stock or termination of stock transfer restrictions; and
    fluctuations in stock market price and volume, which are particularly common among
securities of small technology companies. The market prices and volumes of the common stock of many publicly held technology based companies
have in the past been, and can in the future be expected to be, especially volatile, which could
cause the market price of our common stock to fall for reasons not necessarily related to our
business, results of operations or financial condition. The market price of our stock also might
decline in reaction to events that affect other companies in our industry even if these events do
not directly affect us. Accordingly, you may not be able to resell your shares of common stock at
or above the price you paid. In the past, following a period of volatility in the market price of
a companys securities, securities class action litigation often has been instituted against such a
company. Any such litigation could result in substantial costs and a diversion of managements
attention and our resources. We may be subject to arbitrage risks.
Investors may seek to profit by exploiting the difference, if any, in the price of our stock on the
ASX and Nasdaq. Such arbitraging activities could cause our stock price in the market with the
higher value to decrease to the price set by the market with the lower value. Complying with Nasdaqs continued listing requirements
We have experienced, and continue to experience, difficulty maintaining all of Nasdaqs continued
listing requirements, due to the small size of our Company. The requirements for continued listing
on the Nasdaq SmallCap Market are as follows: (1) either (a) stockholders equity of $2,500,000, (b) net income in the most recently completed
fiscal year or in two of the last three years of $500,000, or (c) market capitalization of
$35,000,000; (2) a public float of 500,000 shares; (3) a market value of public float of $1,000,000; (4) a minimum bid price of $1.00 per share; (5) at least two market makers; (6) at least 300 round lot stockholders; 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; 20




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
    subject to certain exceptions, any transaction that results in the issuance or transfer
by us of any of our stock to the interested stockholder;
    any transaction involving us that has the effect of increasing the proportionate share
of the stock of any class or series beneficially owned by the interested stockholder; and
    the receipt by the interested stockholder of the benefit of any loans, advances,
guarantees, pledges or other financial benefits provided by us or through the corporation. In general, Section 203 defines an interested stockholder as an entity or person beneficially
owning 15% or more of our outstanding voting stock and any entity or person affiliated with or
controlling or controlled by such entity or person. Changes in, or interpretations of, accounting rules and regulations, such as expensing of stock
options, could result in unfavorable accounting charges.
We prepare our consolidated financial statements in conformity with accounting principles generally
accepted in the United States of America. These principles are subject to interpretation by the
SEC and various bodies formed to interpret and create appropriate accounting policies. A change in
these policies can have a significant effect on our reported results and may even retroactively
affect previously reported transactions. In particular, the FASB recently enacted SFAS No. 123
(revised 2004), Share-Based Payment (SFAS 123(R)) which we will adopt effective the first
quarter of 2006. As a result, because SFAS 123(R) requires the expensing of stock options, it will
have an adverse effect on our reported financial results. However, we have not yet assessed the
level of impact to be able to quantify the adverse effect. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We are exposed to foreign currency exchange rate risk inherent in our expenses, assets and
liabilities denominated in the Australian dollar. To date, we have not utilized any foreign
currency hedging or other derivative instruments to reduce exchange rate risk. We do not expect to
employ these or other strategies to hedge the risk in the foreseeable future. As of December 31, 2004, and 2003 the Companys net current assets (defined as current assets less
current liabilities) subject to foreign currency risk are $1,588,000 and $1,940,000. The potential
decrease in net assets from a hypothetical 10% adverse change in quoted foreign currency exchange
rates would be approximately $158,800 and $194,000. Net current assets subject to foreign currency
risk are larger as of December 31, 2003 compared to 2004 due to larger cash balances maintained in
Australia. We are also exposed to interest rate risk on deposits of cash, which are affected by changes in the
general level of interest rates in the United States and Australia. Since we generally invest in
very short-term interest bearing deposits, we do not believe we are subject to any material market
risk exposure. 21




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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS Report of Independent Registered Public Accounting Firm
    
    
    23Consolidated Balance Sheets
    
    
    25Consolidated Statements of Operations
    
    
    26Consolidated Statements of Cash Flows
    
    
    27Consolidated Statements of Shareholders Equity
    
    
    28Notes to Consolidated Financial Statements
    
    
    29
 22




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Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders
Catuity, Inc.
Detroit, Michigan We have audited the accompanying consolidated balance sheet of Catuity, Inc. and subsidiaries as of
December 31, 2004 and the related consolidated statements of operations, stockholders equity, and
cash flows for the year ended December 31, 2004. We have also audited the schedule listed in the
accompanying index. These financial statements and schedule are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial statements
and schedule based on our audit. We conducted our audit 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 and schedule 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 audit includes 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 and schedule, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the financial
statements and schedule. We believe that our audit 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, 2004,
and the results of its operations and its cash flows for the year ended December 31, 2004,in
conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the schedule presents fairly, in all material respects, the information set
forth therein. BDO SEIDMAN, LLP Troy, Michigan
March 17, 2005 23




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Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders
Catuity, Inc. We have audited the accompanying consolidated balance sheet of Catuity, Inc. and subsidiaries as of
December 31, 2003, and the related consolidated statements of operations, shareholders equity, and
cash flows for each of the two years in the period ended
December 31, 2003. Our audits also included the financial
statement schedule listed in the index at Item 15(a). These financial
statements and schedule are the responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements and schedule 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. We
were not engaged to perform an audit of the Companys 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 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, and 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 consolidated financial position of Catuity, Inc. and subsidiaries at December 31,
2003, and the consolidated results of their operations and their cash flows for each of the two
years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects
the information set forth therein. /s/ Ernst & Young LLP Detroit, Michigan
February 26, 2004 24




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CATUITY, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 312004
    
    
    2003AssetsCurrent Assets:Cash and cash equivalents
    
    $
    2,560,683
    
    
    $
    5,768,828Accounts receivable-trade, less allowance of
$5,000 in 2004, and $62,000 in 2003
    
    
    36,211
    
    
    
    402,109Restricted cash
    
    
    116,012
    
    
    
    119,009Work in process
    
    
    
    
    
    
    70,692Prepaid expenses and other
    
    
    127,429
    
    
    
    188,423Total current assets
    
    
    2,840,335
    
    
    
    6,549,061Property and equipment, net
    
    
    162,780
    
    
    
    223,466Total Assets
    
    $
    3,003,115
    
    
    $
    6,772,527Liabilities and Shareholders EquityCurrent Liabilities:Accounts payable
    
    $
    150,584
    
    
    $
    101,335Deferred revenue
    
    
    266
    
    
    
    110,561Accrued compensation
    
    
    317,433
    
    
    
    345,476Other accrued expenses
    
    
    87,208
    
    
    
    116,742Trust liability
    
    
    91,722
    
    
    
    95,586Total current liabilities
    
    
    647,213
    
    
    
    769,700Accrued compensation
    
    
    
    
    
    
    59,752Shareholders equity:Common stock  $.001 par value; Authorized 
6,666,667 shares: issued and outstanding
778,184 in 2004 and 776,374 in 2003
    
    
    778
    
    
    
    776Preferred stock  $0.001 par value; Authorized 
666,667 shares
    
    
    
    
    
    
    Additional paid-in capital
    
    
    36,603,127
    
    
    
    36,979,841Shareholder loans
    
    
    (79,533
    )
    
    
    (468,166
    )Foreign currency translation adjustment
    
    
    96,656
    
    
    
    88,299Accumulated deficit
    
    
    (34,265,126
    )
    
    
    (30,657,675
    )Total shareholders equity
    
    
    2,355,902
    
    
    
    5,943,075Total Liabilities and Shareholders Equity
    
    $
    3,003,115
    
    
    $
    6,772,527
 See accompanying notes to consolidated financial statements 25




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CATUITY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 312004
    
    
    2003
    
    
    2002Revenues:Software development revenue
    
    $
    248,379
    
    
    $
    2,323,441
    
    
    $
    1,666,890Service revenue
    
    
    467,533
    
    
    
    902,222
    
    
    
    1,258,996License revenue
    
    
    43,200
    
    
    
    1,756,725
    
    
    
    45,788Total revenue
    
    
    759,112
    
    
    
    4,982,388
    
    
    
    2,971,674Cost of revenue and other operating
expenses:Cost of software development
    
    
    103,151
    
    
    
    1,341,619
    
    
    
    981,329Cost of service revenue
    
    
    297,075
    
    
    
    681,445
    
    
    
    1,105,207Research and development
    
    
    1,282,753
    
    
    
    415,809
    
    
    
    539,282Sales and marketing
    
    
    867,362
    
    
    
    1,290,899
    
    
    
    1,758,245General and administrative
    
    
    1,912,999
    
    
    
    1,972,656
    
    
    
    1,470,324General and
administrative 
variable stock compensation
stock compensation
    
    
    
    
    
    
    (41,996
    )
    
    
    (53,363
    )Total costs and expenses
    
    
    4,463,340
    
    
    
    5,660,432
    
    
    
    5,801,024Operating loss
    
    
    (3,704,228
    )
    
    
    (678,044
    )
    
    
    (2,829,350
    )Interest income
    
    
    96,777
    
    
    
    82,714
    
    
    
    60,195Net loss
    
    $
    (3,607,451
    )
    
    $
    (595,330
    )
    
    $
    (2,769,155
    )Net loss per share  basic & diluted
    
    $
    (4.64
    )
    
    $
    (0.92
    )
    
    $
    (5.12
    )Weighted average shares
outstanding-basic & diluted
    
    
    777,226
    
    
    
    645,452
    
    
    
    540,613
 See accompanying notes to consolidated financial statements 26




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CATUITY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 312004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net Loss
    
    $
    (3,607,451
    )
    
    $
    (595,330
    )
    
    $
    (2,769,155
    )Adjustments used to reconcile net loss to net
cash used in operating activities:Stock based compensation
    
    
    
    
    
    
    (41,996
    )
    
    
    (53,363
    )Depreciation and amortization
    
    
    127,926
    
    
    
    264,050
    
    
    
    125,273Non cash services
    
    
    
    
    
    
    
    
    
    
    27,751Changes in assets and liabilities:Accounts receivable
    
    
    365,898
    
    
    
    (24,891
    )
    
    
    291,264Accounts payable
    
    
    274,249
    
    
    
    (201,379
    )
    
    
    31,279Deferred revenue
    
    
    (110,295
    )
    
    
    (1,701,365
    )
    
    
    977,412Accrued expenses and other liabilities
    
    
    (346,194
    )
    
    
    138,145
    
    
    
    (428,159
    )Other assets
    
    
    134,683
    
    
    
    25,046
    
    
    
    118,781Net cash used in operating activities
    
    
    (3,161,184
    )
    
    
    (2,137,720
    )
    
    
    (1,678,917
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (71,492
    )
    
    
    (287,099
    )
    
    
    (110,493
    )Sale of Assets
    
    
    4,253
    
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (67,239
    )
    
    
    (287,099
    )
    
    
    (110,493
    )Cash flows from financing activities:Issuance of common stock, net of expenses
    
    
    14,057
    
    
    
    4,130,121
    
    
    
    941,829Repayment of fractional shares related to
reverse stock split
    
    
    (2,136
    )
    
    
    
    
    
    
    Repayment of Shareholder Loan
    
    
    
    
    
    
    41,665
    
    
    
    Net cash provided by financing activities
    
    
    11,921
    
    
    
    4,171,786
    
    
    
    941,829Foreign exchange effect on cash
    
    
    8,357
    
    
    
    410,414
    
    
    
    (5,835
    )Net increase/(decrease) in cash and cash
equivalents
    
    
    (3,208,145
    )
    
    
    2,157,381
    
    
    
    (853,416
    )Cash and cash equivalents, beginning of period
    
    
    5,768,828
    
    
    
    3,611,447
    
    
    
    4,464,863Cash and cash equivalents, end of period
    
    $
    2,560,683
    
    
    $
    5,768,828
    
    
    $
    3,611,447Supplemental disclosure of cash flow information:Taxes paid
    
    $
    
    
    
    $
    
    
    
    $
    Interest paid
    
    $
    
    
    
    $
    
    
    
    $
    
 See accompanying notes to consolidated financial statements 27




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CATUITY, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY Common Stock
    
    
    
    
    
    
    
    
    
    
    Foreign
    
    
    
    
    
    
    Total(at par)
    
    
    Additional
    
    
    Shareholder
    
    
    Currency
    
    
    Accumulated
    
    
    Shareholders'Shares
    
    
    Amount
    
    
    Paid In Capital
    
    
    Loans
    
    
    Translation
    
    
    Deficit
    
    
    EquityBalances at January 1, 2002
    
    
    536,612
    
    
    $
    537
    
    
    $
    32,223,640
    
    
    $
    (757,733
    )
    
    $
    (316,280
    )
    
    $
    (27,293,190
    )
    
    $
    3,856,974Issuance of common stock
    
    
    31,085
    
    
    
    31
    
    
    
    959,308
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    959,339Exercise of options
    
    
    67
    
    
    
    0
    
    
    
    1,691
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,691Sale of option right
    
    
    
    
    
    
    
    
    
    
    8,550
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,550Stock based compensation
    
    
    
    
    
    
    
    
    
    
    (53,363
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (53,363
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,769,155
    )
    
    
    (2,769,155
    )Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,835
    )
    
    
    
    
    
    
    (5,835
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,774,990
    )Balances at December 31, 2002
    
    
    567,764
    
    
    $
    568
    
    
    $
    33,139,826
    
    
    $
    (757,733
    )
    
    $
    (322,115
    )
    
    $
    (30,062,345
    )
    
    $
    1,998,201Issuance of common stock
    
    
    208,543
    
    
    
    208
    
    
    
    4,127,614
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,127,822Exercise of options
    
    
    67
    
    
    
    0
    
    
    
    2,299
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,299Repayment of shareholder loan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,665
    
    
    
    
    
    
    
    
    
    
    
    41,665Adjust shareholder loan to fair
value
    
    
    
    
    
    
    
    
    
    
    (247,902
    )
    
    
    247,902
    
    
    
    
    
    
    
    
    
    
    
    0Stock based compensation
    
    
    
    
    
    
    
    
    
    
    (41,996
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (41,996
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (595,330
    )
    
    
    (595,330
    )Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    410,414
    
    
    
    
    
    
    
    410,414Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (184,916
    )Balances 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
    )
    
    $
    2,355,902
 See accompanying notes to consolidated financial statements 28




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NOTE 1. DESCRIPTION OF BUSINESS 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 system3 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. 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. REVENUE RECOGNITION The three distinct revenue streams that result from the Companys business activities are license
revenue, software development revenue, and service revenue. License Revenue: License revenue is recognized in accordance with Statement of Position (SOP)
97-2, Software Revenue Recognition, which provides for recognition of revenue when persuasive
evidence of an arrangement exists, delivery of the product has occurred, no significant
obligations remain on the Companys part with regard to implementation, the fee is fixed and
determinable, and collectibility is probable. SOP 97-2 generally requires revenue earned on
software arrangements involving multiple elements to be allocated to each element based on the
relative fair value of each element. Revenue recognized from multiple-element arrangements is
allocated to undelivered elements of the arrangement, such as maintenance, based on the relative
fair value of each element. The Companys determination of fair value of each element in
multi-element arrangements is based on vendor-specific objective evidence (VSOE). The Company
limits its assessment of VSOE for each element to either the price charged when the same element
is sold separately or the price established by management for an element not yet sold separately.
The Company has established VSOE for maintenance services. The Company does not generally
provide for a right of return in its license contracts. Software Development Revenue: Software development revenue includes integration, customization
and development fees of both the customers hardware and software and the Companys software.
Software development 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 software development
contracts. Service Revenue: Service revenue includes training, consulting, installation support,
post-installation support and maintenance fees. 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. Payments for service revenues are generally not refundable.   3
    
    Application Service Provider  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. 29




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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. 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. ACCOUNTS RECEIVABLE AND CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk
consist primarily of trade receivables. The credit risk associated with trade receivables is
limited due to the size and creditworthiness of the Companys customers. The Company generally
does not require collateral for its trade receivables. 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. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation and amortization expense is recorded
using the straight-line method over the estimated useful lives of the respective assets (which
range from three to ten years). The Company reviews long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. Impairment is estimated in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. FOREIGN CURRENCY TRANSLATION The accounts of the Companys Australian subsidiaries are translated in accordance with Statement
of Financial Accounting Standards No. 52, Foreign Currency Translation. All balance sheet
accounts for the Australian subsidiaries are translated at the exchange rates in effect at the
balance sheet date. Revenues and expenses for the Australian subsidiaries are translated at the
average exchange rate during the month in which the transaction occurs. All cumulative
translation gains and losses are included as a separate component of shareholders equity in the
consolidated balance sheet. Currency transaction gains and losses are included in the
consolidated statement of operations and are not material for all years presented. The Company accounts for foreign currency exchange gains or losses on inter-company transactions
in accordance with SFAS No. 52, Foreign Currency Translation. Transactions occurring between
the Companys U.S. office and the Australian office 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). 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. 30




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RESEARCH & DEVELOPMENT Research and Development costs are expensed as incurred. 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. STOCK-BASED COMPENSATION The Company accounts for stock-based awards issued to employees under the intrinsic value method
in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB 25) and has adopted the disclosure-only alternative of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). Had compensation costs for stock-based awards issued to employees been determined consistent with
SFAS No. 123, the Companys net loss and net loss per share would have been reported as follows: YEAR ENDED DECEMBER 312004
    
    
    2003
    
    
    2002Net Loss as Reported
    
    $
    (3,607,451
    )
    
    $
    (595,330
    )
    
    $
    (2,769,155
    )Deduct: Total stock-based
employee compensation
expense determined under
fair value based method for
all awards
    
    
    47,224
    
    
    
    318,404
    
    
    
    700,604Pro forma net loss
    
    $
    (3,654,675
    )
    
    $
    (913,734
    )
    
    $
    (3,469,759
    )Loss per share:basic &
diluted  as reported
    
    $
    (4.64
    )
    
    $
    (0.92
    )
    
    $
    (5.12
    )Pro forma basic & diluted
loss per share
    
    $
    (4.70
    )
    
    $
    (1.42
    )
    
    $
    (6.42
    )
 For disclosure purposes, the fair value of stock based compensation was computed using the
Black-Scholes option pricing model with the following weighted average assumptions used for 2004,
2003, and 2002 grants: DECEMBER 312004
    
    
    2003
    
    
    2002Risk Free Interest Rate
    
    
    2.00
    %
    
    
    2.00
    %
    
    
    3.00
    %Expected Dividend Yield
    
    
    
    
    
    
    
    
    
    
    Expected Lives (years)
    
    
    1.13
    
    
    
    0.62
    
    
    
    1.27Expected Volatility
    
    
    0.862
    
    
    
    0.717
    
    
    
    0.773
 For all fixed awards issued to employees, the Company records an expense based on the
intrinsic value at the date of grant and amortizes it over the vesting period. For variable
awards issued to employees, we record an expense based on the intrinsic value at each balance
sheet date until the contingency is resolved and number or price is known. For variable awards
issued to non-employees, the Company records an expense based on the fair value of the options at
each balance sheet date. RECENT ACCOUNTING PRONOUNCEMENTS In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment (SFAS 123(R)) which requires the measurement of all employee
share-based payments to employees, including grants of employee stock options, using a
fair-value-based method and the recording of such expense in the consolidated statement of
operations. The accounting provisions of SFAS 123(R) are effective for reporting periods
beginning after December 15, 2005. We will adopt SFAS 123(R) effective as of the first quarter
of 2006. The pro forma disclosures previously permitted under SFAS 123 no longer will be an
alternative to financial statement recognition. As a result, because
SFAS 123(R) requires the
expensing of stock options, it will have an adverse effect on our reported financial results.
However, we have not yet assessed the level of impact to be able to quantify the adverse effect. 31




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NOTE 3. PROPERTY AND EQUIPMENT Property and equipment consists of: DECEMBER 312004
    
    
    2003Computer equipment
    
    $
    558,759
    
    
    $
    605,055Leasehold improvements
    
    
    69,912
    
    
    
    67,169Office furniture and equipment
    
    
    99,622
    
    
    
    139,225$
    728,293
    
    
    $
    811,449Less accumulated depreciation
    
    
    (565,513
    )
    
    
    (587,983
    )$
    162,780
    
    
    $
    223,466
 NOTE 4. COMMITMENTS AND CONTINGENCIES During December 2004 the Companys R&D team, located in Sydney Australia, vacated its existing
office space and relocated to a new office building. Although there has been no formal claim
filed and no legal proceedings have been instituted, the Company believes it is possible for the
Company to have an outstanding monetary obligation if the lease agreement related to the vacated
space that expired in December 2003, is determined to have been extended for an additional 4 year
period. The Company believes that at the time the office space was vacated, there was only a
month-to-month rental agreement in effect. If, in the future a claim is filed, and a legal
determination is subsequently made that a long-term lease did in fact exist, then the Company
could be obligated to pay the landlord for some amount of rental losses, which can not be
estimated at this time. As of December 31, 2004, the Company had entered into employment agreements with 3 employees.
Under each of the three agreements, in the event employment is terminated (other than voluntarily
by the employee or by the Company for cause), the Company is committed to make a one-time
severance payment equal to 30% of annual salary or approximately $80,000 in total. NOTE 5. SHAREHOLDERS EQUITY REVERSE STOCK SPLIT On November 1, 2004, the Company held, a special shareholders meeting in Sydney Australia for the
purpose of seeking support of a majority of all shares outstanding for a reverse stock split,
also known as a share consolidation. The reverse stock split became necessary to bring the
Company into compliance with Nasdaqs on-going listing rule requiring that shares on Nasdaq trade
above $1.00. The proposal passed, authorizing the Board to effect a split. Immediately after
the special shareholders meeting, the Board of Directors unanimously authorized a 1 for 15
reverse split effective on November 12, 2004, the earliest date that trading could begin in the
post-reverse shares. The balance sheet, earnings per share, and other appropriate data have been
restated to reflect the reverse split. SHAREHOLDER LOANS In 1995 and 1996, the Company issued loans to a former Australian director for the purpose of
purchasing approximately 18,400 shares of the Companys stock. The Companys recourse for
repayment of the loans is limited to after-tax dividends and proceeds from the disposal of the
shares. In 1999, $75,000 AUD of the loan was repaid ($48,000 USD at the exchange rate in effect
on the date of the transaction) related to the sale of 1,667 shares. In the fourth quarter of
2003, approximately $60,750 AUD was repaid ($42,000 USD at the exchange rate in effect on the
date of the transaction) related to the sale of 1,350 shares. In each reporting period the
Company records a debit or a credit to expense for the loans based on the difference between the
loan share grant price and the Companys share price at the respective period ending balance
sheet dates, on a cumulative basis. For the years ended December 31, 2004, 2003 and 2002,
credits of $0, $41,996 and $53,363 respectively were recorded. The amount of the loan
outstanding is re-valued at each respective balance sheet date if the Companys period ending
fair market price per share is below the price per share at which the loan was made. The
offsetting entry is made to additional paid in capital. EMPLOYEE STOCK OPTION PLAN The Companys shareholders approved the establishment of an Employee Stock Option Plan (Plan)
at a March 2000 special meeting of shareholders. Under the Plan the Company grants stock options
at an exercise price that may be determined by the 32




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Board of Directors at the time of issuance, but is generally at the closing price of the stock on
the date of the grant or the average closing price of the stock for the 30 calendar days
preceding the grant date, whichever is higher. Option vesting schedules are determined by the
Board of Directors at the time of issuance, but are generally over one to three years from the
date of the grant. Employees must exercise the options within two to six months of terminating
their employment with the Company or the options lapse. The Plan authorizes a maximum of 63,333
shares to be issued. At December 31, 2004, there were 16,537 shares available for issuance under
the Plan. DIRECTOR STOCK OPTION PLAN On October 24, 2000 the members of the Board of Directors, who are employees of the Company,
approved the establishment of a Director Stock Option Plan (Plan) effective October 1, 2000 for
outside Directors. The Plan is designed to provide a portion of the outside Directors
compensation through stock options. Under the Plan, outside Directors receive 667 non-qualified
option shares on the date they join the Board or on the date the plan became effective, in the
case of existing outside Directors. In addition, each outside Director receives 333 non-qualified
option shares on the last business day in September of each succeeding year for as long as the
Director remains on the Board. The option issue price will be the closing price on the grant
date, or the closing price on the last trading day preceding the grant date in the event the
grant date falls on a weekend or holiday. The options vest on the date of grant and expire after
eight years, or six months after the Director ceases to be a member of the Board, whichever
occurs first. The Plan is limited so that no more than 8,667 option shares may be outstanding at
any one time. OPTIONS ISSUED TO THIRD PARTIES While the Company did not grant options to purchase shares of common stock to third parties
during 2004 or 2003, options were issued during the year ended December 31, 2002, primarily for
services provided to the Company. The Company valued these options using the Black-Scholes
option-pricing model. Expense, relating to these options, amounted to $8,550 and was charged to
operations in the year they were granted as they vested immediately. SUMMARY OF STOCK OPTIONS/WARRANTS The following is a summary of stock and warrant activity: WEIGHTEDAVERAGENUMBER OF
    
    
    EXERCISEOPTION
    
    
    PRICESHARES
    
    
    PER SHAREOutstanding at January 1, 2002
    
    
    76,829
    
    
    $
    103.50Granted
    
    
    20,407
    
    
    $
    40.65Cancelled/lapsed
    
    
    (15,563
    )
    
    
    79.05Exercised
    
    
    (67
    )
    
    
    25.35Outstanding at December 31, 2002
    
    
    81,606
    
    
    $
    95.25Granted
    
    
    19,310
    
    
    $
    33.90Cancelled/lapsed
    
    
    (21,117
    )
    
    
    108.30Exercised
    
    
    (67
    )
    
    
    34.50Outstanding at December 31, 2003
    
    
    79,732
    
    
    $
    86.85Granted
    
    
    7,179
    
    
    $
    5.21Cancelled/lapsed
    
    
    (33,281
    )
    
    
    53.58Exercised
    
    
    0
    
    
    
    0.00Outstanding at December 31, 2004
    
    
    53,630
    
    
    $
    91.02
 The weighted average fair value of options/warrants granted during the three years ended
December 31, 2004, 2003 and 2002 were $3.09, $12.90 and $17.10, respectively. The weighted
average fair value is calculated using the Black-Scholes valuation model. 33




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##### Table of Contents



The following is additional information relating to options outstanding as of December 31,
2004: OPTIONS OUTSTANDING
    
    
    OPTIONS EXERCISABLEWEIGHTEDWEIGHTED
    
    
    AVERAGE
    
    
    
    
    
    
    WEIGHTEDAVERAGE
    
    
    CONTRACTUAL
    
    
    
    
    
    
    AVERAGEEXERCISE PRICE
    
    NUMBER OF
    
    
    EXERCISE
    
    
    LIFE
    
    
    NUMBER OF
    
    
    EXERCISERANGE
    
    SHARES
    
    
    PRICE
    
    
    (YEARS)
    
    
    SHARES
    
    
    PRICE$4.35 - $33.60
    
    
    8,083
    
    
    $
    15.99
    
    
    
    4.05
    
    
    
    4,466
    
    
    $
    19.56$39.60-$66.70
    
    
    12,580
    
    
    $
    48.62
    
    
    
    3.45
    
    
    
    12,580
    
    
    $
    48.62$90.69-$129.75
    
    
    15,634
    
    
    $
    103.19
    
    
    
    3.91
    
    
    
    15,634
    
    
    $
    103.19$142.50-$185.59
    
    
    17,333
    
    
    $
    145.81
    
    
    
    3.98
    
    
    
    17,333
    
    
    $
    145.81
 The dilutive effect of stock options has not been included in the loss per share calculation, as
the effect would be anti-dilutive. COMMON STOCK On January 21, 2003 the members of the Board of Directors adopted the Catuity, Inc. 2003
Executive Director Stock Purchase Plan (Plan) which became effective upon approval by the
Companys shareholders at a March 2003 special meeting of shareholders. Under the Plan,
executive directors may elect to purchase shares of the Companys common stock at the closing
price of the stock on the last trading day of each month. The plan automatically terminates on
the date all shares approved under the Plan have been purchased unless terminated earlier by the
Board of Directors. The maximum number of shares that may be purchased under the plan is 6,667
shares. On November 20, 2002 the members of the Board of Directors approved the establishment of an
Executive Stock Purchase Plan (Plan) for executives of the Company. Under the plan, executive
employees could elect to purchase shares of the Companys common stock at the closing price of
the stock on the last trading day of each month beginning in December 2002. The maximum number
of shares that could be purchased under the plan was 1,667 shares. The Plan terminated in
November 2003 in accordance with the plan document. PREFERRED STOCK The Companys Certificate of Incorporation authorizes 666,667 shares of preferred stock, with a
par value of $0.001 per share, none of which is issued or outstanding. The Board of Directors has
the authority to issue the preferred stock in one or more series and to fix rights, preferences,
privileges and restrictions, including dividends, and the number of shares constituting any
series or the designation of such series, without any further vote or action by the shareholders. PRIVATE PLACEMENT In July 2003, the Company concluded a private placement in Australia of 200,000 shares of the
Companys common stock to seven accredited investors at a price of $30.00 AUD per share ($19.50
USD based on the foreign exchange rate in effect on the date of the transaction). The price
represented an 11% discount to the shares fair market value on the Australian Stock Exchange
(ASX) on the transaction date. The Company issued the shares in
two tranches  the first on July
25, 2003 for 41,667 shares (the maximum permitted under ASX listing rules prior to receiving
shareholder approval) and the second for 158,333 shares on September 22, 2003 following
shareholder approval at a special meeting of shareholders on September 19, 2003. The Company
paid a placement fee of 3% of the purchase price to the Placement Agent for both tranches. The
second tranche of shares included 13,067 shares sold to Mr. Duncan P.F. Mount, Chairman of the
Company. The proceeds from all of the placement shares were added to the Companys general
working funds to be used for general operating purposes. The shares were sold without
registration under US securities laws pursuant to an exemption from such registration. At a special meeting of the shareholders on March 26, 2003 the Companys shareholders approved
the sale of 6,000 common shares and 2,000 warrant shares to Boom Australia Pty. Ltd. (Boom),
the family trust of Mr. Duncan P.F. Mount, Chairman of the Company. The aggregate offering price
was $337,500 AUD ($189,900 USD), which is net of a 3% placement fee paid to the investor. These
shares were sold without registration under US securities laws pursuant to an exemption from
such registration. The 2,000 warrant shares expired in November 2004 and had an exercise price of $63
AUD ($33.75 USD). 34




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In November 2002, the Company received net proceeds of $925,000 from the private placement of
common stock to accredited professional investors in Australia at a price of $56.25 AUD per share
($31.65 USD based on the foreign exchange rate in effect on the date of the transaction). The
price equaled the fair market value of the shares on the Australian Stock Exchange (ASX) on the
transaction date. In addition, one warrant share at an exercise price of $63 AUD ($38.55 USD)
for every three (3) shares purchased were granted, and expire in November 2004. The exercise
price of the warrants represented approximately a 12% premium over the fair market price of the
Companys shares on the date of transaction. A placement fee of 3% of the purchase price was
paid to each investor. Net proceeds from the placement were $925,000. NOTE 6. INCOME TAXES The components of profit/(loss) before income taxes and extraordinary items consisted of the
following: YEAR ENDED DECEMBER 312004
    
    
    2003
    
    
    2002Domestic
    
    
    ($4,251,120
    )
    
    
    ($1,065,811
    )
    
    
    ($3,904,994
    )Foreign
    
    
    643,669
    
    
    
    470,481
    
    
    
    1,135,839Loss before income
taxes and
extraordinary item
    
    
    ($3,607,451
    )
    
    
    ($595,330
    )
    
    
    ($2,769,155
    )
 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 carryforwards
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 312004
    
    
    2003
    
    
    2002Income taxes at statutory tax rate
    
    $
    (1,226,533
    )
    
    $
    (202,412
    )
    
    $
    (941,513
    )Variable stock compensation
    
    
    0
    
    
    
    12,599
    
    
    
    16,009Utilization of operating
loss carryforward
    
    
    (193,101
    )
    
    
    (141,144
    )
    
    
    (340,752
    )Valuation allowance
    
    
    1,445,381
    
    
    
    362,440
    
    
    
    1,327,700Other
    
    
    (25,747
    )
    
    
    (31,482
    )
    
    
    (61,445
    )Provision for income taxes
    
    $
    
    
    
    $
    
    
    
    $
    
 The statutory tax rate was 34% for the years ended December 31, 2004, 2003 and 2002.
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 312004
    
    
    2003Deferred tax assets:Net operating loss carry-forwards
    
    $
    11,579,661
    
    
    $
    10,327,480Other
    
    
    48,068
    
    
    
    136,052Total deferred tax assets
    
    
    11,627,729
    
    
    
    10,463,532Valuation allowance
    
    
    (11,627,729
    )
    
    
    (10,463,532
    )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, 2004, the Company had operating loss carry-forwards of $20,000,000 expiring in
various amounts from 2020 through 2024 in the United States and $15,900,000 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 are subject to limits due to continuity of ownership tests under Section 382 of the
Internal Revenue Service Code. 35




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NOTE 7. DEFINED CONTRIBUTION PLANS On behalf of its Australian employees, the Company contributes a government mandated percentage
of each employees gross salary to a defined contribution plan. The prescribed charge percentage
was 9% for the three years ended December 31, 2004, 2003 and 2002. The Companys contributions
were $96,111, $132,321, and $115,001 for the three years ended December 31, 2004, 2003 and 2002
respectively. There is a 401-K plan available for employees in the U.S. The Company has not made matching
contributions to the 401-K plan to date. NOTE 8. 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 $91,722 and $95,586 at December 31,
2004 and 2003, respectively. On August 31, 2001, in accordance with an agreement between the Company and Westbus Pty Limited,
the Transcard system was discontinued. As of that date, no additional cards were issued and
consumers could no longer use their cards to purchase goods or services. The Company is serving
as the administrator to refund all requested prepaid balances remaining on consumers cards as of
the date the system was discontinued. In addition, the Company had restricted cash of $24,290, and $23,424 as of December 31, 2004 and
2003, respectively, related to an amount held as security for an operating lease. NOTE 9. SUBSEQUENT EVENTS On March 17, 2005, the Company announced an agreement to purchase all of the outstanding shares
of Loyalty Magic Pty. Ltd., an Australian company located in Melbourne for A$5.5 million ($4.35
million USD based on the foreign exchange rate in effect on the day before the signing of the
agreement). This represents a significant step in the Companys turnaround plan toward
profitability. Loyalty Magic was both cashflow positive and profitable in its fiscal year ended
June 30, 2004 and expects continued growth in 2005 and beyond. Of the A$5.5 million purchase
price, which excludes acquisition related costs, 35% will be issued in new Catuity shares with
the remainder to be paid in cash. Loyalty Magics management team and A&B Venture Fund Company
Pty Ltd. will hold the majority of the shares. Catuity will undertake a capital raising,
anticipated to be approximately A$6 million, in order to pay the cash portion of the transaction
and to provide increased working capital. The combined company will have a 40-person team serving
existing customers in Australia, New Zealand, and North America. The acquisition of Loyalty Magic
and associated capital raise, which is subject to shareholder approval, is expected to close
following Catuitys Annual Shareholder Meeting in late May 2005. NOTE 10. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA As of December 31, 2004, the Company conducts all of its business in a single segment, providing
loyalty technology and related services to retailers and their processor partners. For the year
ended December 31, 2004, one U.S. customer represented 75% of net revenue while two U.S.
customers each represented 11% of net revenue. Two U.S. customers represented 85% and 14% of net revenue for the year ended December 31, 2003.
The same two customers represented 80% and 16% of net revenue for the year ended December 31,
2002. 36




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The following table shows net revenues and long-lived assets by geographic area. 2004
    
    
    2003
    
    
    2002Long-Lived
    
    
    Net
    
    
    Long-Lived
    
    
    Net
    
    
    Long-Lived
    
    
    NetAssets
    
    
    Revenues
    
    
    Assets
    
    
    Revenues
    
    
    Assets
    
    
    RevenuesU.S.
    
    $
    81,101
    
    
    $
    759,112
    
    
    $
    88,789
    
    
    $
    4,982,388
    
    
    $
    98,402
    
    
    $
    2,971,674Australia
    
    
    81,679
    
    
    
    
    
    
    
    134,677
    
    
    
    
    
    
    
    102,015
    
    
    
    Total
    
    $
    162,780
    
    
    $
    759,112
    
    
    $
    223,466
    
    
    $
    4,982,388
    
    
    $
    200,417
    
    
    $
    2,971,674
 NOTE 11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Three Months EndedMarch 31
    
    
    June 30
    
    
    September 30
    
    
    December 312004
    
    
    2004
    
    
    2004
    
    
    2004Net revenues
    
    $
    478,536
    
    
    $
    135,279
    
    
    $
    104,303
    
    
    $
    40,994Total direct cost of revenue
    
    
    238,821
    
    
    
    75,292
    
    
    
    67,621
    
    
    
    18,492Gross Margin$
    239,715
    
    
    $
    59,987
    
    
    $
    36,682
    
    
    $
    22,502Total operating expenses
    
    
    874,270
    
    
    
    1,222,782
    
    
    
    1,183,755
    
    
    
    782,307Operating loss
    
    
    (634,555
    )
    
    
    (1,162,795
    )
    
    
    (1,147,073
    )
    
    
    (759,805
    )Total other income
    
    
    30,914
    
    
    
    23,291
    
    
    
    19,614
    
    
    
    22,958Net loss
    
    $
    (603,641
    )
    
    
    ($1,139,504
    )
    
    
    ($1,127,459
    )
    
    
    ($736,847
    )Net
loss per share  basic & diluted
    
    
    ($0.78
    )
    
    
    ($1.47
    )
    
    
    ($1.45
    )
    
    
    ($0.95
    )
 March 31
    
    
    June 30
    
    
    September 30
    
    
    December 312003
    
    
    2003
    
    
    2003
    
    
    2003Net revenues
    
    $
    1,475,167
    
    
    $
    1,666,009
    
    
    $
    1,117,493
    
    
    $
    723,719Total direct cost of revenue
    
    
    335,924
    
    
    
    601,958
    
    
    
    671,094
    
    
    
    414,088Gross Margin
    
    $
    1,139,243
    
    
    $
    1,064,051
    
    
    $
    446,399
    
    
    $
    309,631Total operating costs and
expenses (1)
    
    
    852,240
    
    
    
    1,089,418
    
    
    
    822,335
    
    
    
    873,375Operating income/(loss)
    
    
    287,003
    
    
    
    (25,367
    )
    
    
    (375,936
    )
    
    
    (563,744
    )Total other income
    
    
    17,687
    
    
    
    10,602
    
    
    
    15,371
    
    
    
    39,054Net income/(loss)
    
    $
    304,690
    
    
    
    ($14,765
    )
    
    
    ($360,565
    )
    
    
    ($524,690Net income/(loss) per
share  basic & diluted
    
    $
    0.54
    
    
    
    ($0.03
    )
    
    
    ($0.58
    )
    
    
    ($0.68
    )
  (1)
    Includes non-cash variable stock compensation expense/(credit) of ($39,702), ($918),
and ($1,376), in the three month periods ended June 30, September 30, and December 31, 2003
respectively. There was no non-cash variable stock compensation expense/(credit)
recognized in the quarter ended March 31, 2003 NOTE 12. MANAGEMENTS PLANS (UNAUDITED) In early 2004, management determined it was necessary to substantially revise its corporate
strategy away from the smart card market and began work on a new strategic plan. Prior to the
Target Corporation decision to discontinue issuing smart cards, the Company had focused its efforts
on licensing its smart card based loyalty software to large retailers in North America. From its
strategic planning efforts, the Company determined that its business focus should be on providing a
hosted or customized software solution for tier two chain retailers (and their partners) and on
providing services to retailers, merchant service providers, and POS equipment manufacturers for
their needs at the point of sale. As a result, the Companys market focus is on tier two retailers
with approximately 50 to 250 stores, and in particular, pharmacy chains, home improvement, auto
services and other chain retailers looking to improve customer retention, add new customers, and
increase each customers average spend amount. The Company also determined that it needed to become active in the mergers and acquisitions market
as a means to provide growth in as short a period of time as possible. As a result, in the middle
of 2004, the Company began an active effort to identify companies that 37




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would represent an appropriate business fit with Catuitys business, provide positive cash-flow,
and profits from their operations. (See Note 9 on page 36 for more information on current
acquisition activity.) 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On September 6, 2004, the Audit Committee of the Board of Directors of the Company authorized
management to prepare a Request For Proposal to seek bids for the annual audit of Catuity Inc.s
2004 financial statements and the reviews of its quarterly financial statements. Ernst & Young LLP,
the auditors engaged at the time, were also invited to bid on the audit. On September 21, 2004,
Ernst & Young LLP advised Catuity management that it was declining to bid on Catuitys work,
effectively declining to stand for re-election. The reports of Ernst & Young LLP on the Companys financial statements for the past two fiscal
years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or
modified as to uncertainty, audit scope, or accounting principles. In connection with the audits of the Companys financial statements for each of the two fiscal
years ended December 31, 2002 and 2003, and in the subsequent interim period, there were no
disagreements with Ernst & Young LLP on any matters of accounting principles or practices,
financial statement disclosure, or auditing scope and procedures which, if not resolved to the
satisfaction of Ernst & Young LLP would have caused Ernst & Young LLP to make reference to the
matter in their report. Further, Ernst & Young LLP did not advise the Company of any reportable
events pursuant to Item 304(a)(1)(v) of Regulation S-K in connection with the audits of the
Companys financial statements for each of the two fiscal years ended December 31, 2002 and 2003
respectively, or in the subsequent interim period. On November 1, 2004, the Audit Committee of the Board of Directors named BDO Seidman, LLP as its
independent accounting firm, replacing Ernst & Young LLP. BDO began its engagement with the review
of Catuitys financial statements for the third quarter of 2004. The change in accountants referenced herein was approved by the Companys independent Audit
Committee on November 1, 2004. During the two most recent fiscal years ended December 31, 2003 and 2002, and through November 1,
2004, the Company did not consult with BDO regarding either: (i) the application of accounting
principles to a specified transaction, either completed or proposed; or the type of audit opinion
that might be rendered on the Companys consolidated financial statements; or (ii) any matter that
was either the subject of a disagreement (as that term is defined in Item 304(a)(1)(iv) of
Regulation S-K and the related instructions to that Item) or a reportable event (as that term is
defined in Item 304(a)(1)(v) of Regulation S-K). There were no disagreements
with BDO Seidman, LLP. 
 ITEM 9A. CONTROLS AND PROCEDURES Management, including the Companys Chief Executive Officer and Chief Financial Officer, evaluated
the effectiveness of the design and operation of the Companys disclosure controls and procedures
as of December 31, 2004, the end of the period covered by this Annual Report on Form 10-K, pursuant
to Rule 13a-15 of the Securities and Exchange Act of 1934. The Companys disclosure controls and
procedures are designed to ensure that information required to be disclosed by the Company in its
periodic SEC filings is recorded, processed and reported within the time periods specified in the
SECs rules and forms. Based upon, and as of the date of that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures
are effective, in all material respects, to ensure that information required to be disclosed in the
reports the Company files and submits under the Exchange Act is recorded, processed, summarized and
reported as and when required. There have been no significant changes in the Companys internal controls or in other factors that
could significantly affect internal controls subsequent to the date the Company carried out its
evaluation. There were no significant deficiencies or material weaknesses identified in the
evaluation and, therefore, no corrective actions were taken. 38




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##### Table of Contents



PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT a) The following table sets forth our executive officers and directors, and their ages as of
February 28, 2005. Name
    
    Age
    
    Position(s)Duncan P.F. Mount
    
    
    57
    
    
    Chairman (1), (2)Alfred H.(John)
Racine III
    
    
    40
    
    
    Director, President and Chief Executive OfficerAlexander S. Dawson
    
    
    61
    
    
    Director(1),(2)Alan L. Gilman
    
    
    61
    
    
    Director(1),(2)Clifford W. Chapman Jr.
    
    
    36
    
    
    DirectorJohn H. Lowry III
    
    
    57
    
    
    Vice President, Chief Financial Officer,
Treasurer and Secretary
   (1)
    
    Member, Audit Committee(2)
    
    Member, Compensation Committee Duncan P.F. Mount is currently our non-employee Chairman. He has served as our Chairman
since May 2003 and as a non-employee Director of Catuity from December 1999 to May 2003, and as
a non-employee Director of CAT, our wholly owned subsidiary, from March 1999 to December 1999.
From October 1996 to September 1999, he was the Asian adviser to CEF.TAL Investment Management
Limited, a Hong Kong based joint venture between the Canadian Imperial Bank of Commerce, Cheung
Kong Holdings Limited and TAL Investment Counsel. He spent 17 years in Hong Kong as the Managing
Director of Gartmore Investment Management Limited, from May 1980 to October 1988, and as
managing director of CEF Investment Management Limited from May 1988 to October 1996, entities
which are fund management and investment companies. From October 1996 to December 1998, he was
Managing Director of CEF.TAL Australia Limited. He holds a Bachelor and Master of Arts degree in
Economics and Law (Hons) from Cambridge University. Alfred H. (John) Racine III is currently serving a one year term as our President and Chief
Executive Officer and as a member of the Board of Directors. He began his term with Catuity on
September 27, 2004. From 1997 to September 2004, Mr. Racine was the founding partner of Altamont
Partners, a Charlottesville, VA based strategy and merger advisory firm specializing in payments
companies. From 1995 to 1997, he was a principal at SNL Financial, a merger and financial
analytics provider for the financial service industry, which is also located in Charlottesville.
Prior to SNL, he spent five years in a variety of operational and strategic roles in the
financial service division of Thomson Financial. These roles ranged from senior editor of
American Banker to heading strategic, marketing and product development. Mr. Racine began his
career as a prize-winning journalist. He studied journalism and political science at Southern
Illinois University at Carbondale. Alexander S. Dawson is currently one of our non-employee 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. He has a Bachelor of Commerce degree from the University of New
South Wales, a Master of Business Administration from Columbia University and is a Fellow of the
Institute of Chartered Accountants in Australia. Alan L. Gilman is currently one of our non-employee Directors. He joined the Board of
Directors, following his retirement from Arthur Andersen LLP, on July 1, 2000 and serves as
chairman of the Audit and Compensation Committees of the Board. 39




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Previously Mr. Gilman spent over 20 years with Arthur Andersen LLP specializing in the
retail industry. From September 1992 to August 1999 he served as the managing partner of
Senn-Delaney, a unit of Arthur Andersen specializing in the retail industry. In addition to his
role with Senn-Delaney, he held worldwide leadership responsibility for Arthur Andersens retail
industry and consumer products activities. Prior to September 1992, he was an Audit Partner at
Arthur Andersen focusing primarily on retail distribution and advertising. Clifford Chapman joined our Board in September 2004 as one of our non-employee Directors.
From 2002 to 2004, he was CEO of mindSHIFT Technologies, a managed services provider focused on
IT outsourcing for small and medium enterprises. From 1998 to 2000, he was the V.P. of Business
Integration for AppNet, a full service internet professional service and managed company. In
1995, he co-founded NMP a full service consulting business and managed hosting company. He holds
an MBA from Columbia Business School and a Bachelor of Science in Computer Engineering from
Lehigh University. John H. Lowry III has served as our Vice President and Chief Financial Officer since May
2000 and since July 2000, has also served as Secretary and Treasurer. From August 1992 to January
2000, he was Vice President Finance for Kelly Services, a Michigan based publicly held staffing
services company, responsible for all financial activities for operations of over 500 staffing
offices in 190 cities with annual sales exceeding $800 million. From August 1982 to July 1992 he
was Corporate Controller and Senior Financial Officer for Crain Communications, a magazine
publishing company in Michigan. Prior to this he was a Senior Manager at Arthur Andersen. He
holds a Masters degree in Business Administration and a Bachelor of Engineering degree from the
University of Michigan. Each of our directors 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 and as a Director until the expiration of his current agreement on September 27, 2005.
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. Disclosure of Catuitys Financial Expert is incorporated by reference to
the section entitled Report of the Audit Committee of the Board of Directors of the
registrants 2005 Proxy Statement. 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. b) Compliance With Section 16(a) of the Exchange Act Incorporated by reference to the section entitled Compliance with SEC Reporting Requirements
of the registrants 2005 Proxy Statement. c) Code of Ethics Incorporated by reference to the section entitled Code of Ethics of the registrants 2005
Proxy Statement. 
 ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference to the section entitled Director Compensation and the section
entitled Summary Compensation Table of the registrants 2005 Proxy Statement. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference to the section entitled Ownership of Securities of the registrants
2005 Proxy Statement. 40




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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference to the section entitled Certain Relationships and Related
Transactions of the registrants 2005 Proxy Statement. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Incorporated by reference to the section entitled Principal Accountant Fees and Services of the
registrants 2005 Proxy Statement. 
 PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following documents are filed as part of the Annual Report on form 10-K:  1.
    All Financial Statements: The consolidated financial statements are filed as part of this
report under Item 8  Financial Statements and Supplementary Data.2.
    Financial Statement Schedules: SCHEDULE
II  VALUATION AND QUALIFYING ACCOUNTS CATUITY INC. Column A
    
    Column B
    
    
    Column C
    
    
    Column D
    
    
    Column EADDITIONSBALANCE AT
    
    
    CHARGED TO
    
    
    
    
    
    
    BALANCEBEGINNING
    
    
    COSTS AND
    
    
    DEDUCTIONS 
    
    
    AT ENDDESCRIPTION
    
    OF PERIOD
    
    
    EXPENSES
    
    
    DESCRIBE
    
    
    OF PERIODYear Ended December 31, 2004Valuation allowance for trade receivable
    
    $
    61,922
    
    
    
    
    
    
    
    ($56,922
    )(1)
    
    $
    5,000Valuation allowance for deferred tax assets
    
    
    10,463,532
    
    
    
    1,164,197
    
    
    
    
    
    
    
    11,627,729Year Ended December 31, 2003Valuation allowance for trade receivable
    
    $
    54,207
    
    
    $
    7,895
    
    
    
    
    
    
    $
    61,922Valuation allowance for deferred tax assets
    
    
    10,246,713
    
    
    
    216,819
    
    
    
    
    
    
    
    10,463,532Year Ended December 31, 2002Valuation allowance for trade receivable
    
    $
    113,550
    
    
    $
    
    
    
    
    ($59,523
    )(1)
    
    $
    54,027Valuation allowance for deferred tax assets
    
    
    9,040,684
    
    
    
    1,206,029
    
    
    
    
    
    
    
    10,246,713Year Ended December 31, 2001Valuation allowance for trade receivable
    
    $
    44,421
    
    
    $
    113,550
    
    
    
    ($44,421
    )(2)
    
    $
    113,550Valuation allowance for deferred tax assets
    
    
    7,327,037
    
    
    
    1,713,647
    
    
    
    
    
    
    
    9,040,684
   (1)
    
    reduction in valuation allowance estimate(2)
    
    Uncollectible accounts written off. All other schedules are omitted as the required information is inapplicable or the information
is presented in the Consolidated Financial statements and notes thereto in Item 8 above. 41




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3. Exhibits (a) 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. 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.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(d)
    
    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(d-1)
    
    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 Une 30, 2004, which is
incorporated herein by reference. *10(h)
    
    Lease for premises located at 68-72 Wentworth Avenue Surry
Hills, New South Wales, Australia, which appears as Exhibit
10.11 to Registrants Form 10-12G filed March 21, 2000, which
is incorporated herein by reference.10(i)
    
    Lease for premises located at 2711 East Jefferson Avenue,
Detroit, Michigan, which appears as Exhibit 10.12 to
Registrants Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.10(k)
10(l)
    
    Smart Loyalty Technical Work Group Agreement between Visa
U.S.A. and Chip Application Technologies limited, which
appears as Exhibit 10.14 to Registrants Form 10-12G filed
March 21, 2000, which is incorporated herein by reference.
Partner Program Loyalty Services Agreement between Visa
International Service Association and Chip Application,
Technologies Limited, which appears as Exhibit 10.15 to
Registrants Form 10-12G filed March 21, 2000, which is
incorporated herein by reference.10(n)
    
    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(o)
    
    Form of Stock option Plan and Form of Stock Option Agreement
 42




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##### Table of Contents



ExhibitNumber
    
    Descriptionunder Plan, which appears as Exhibit 10.25 to Registrants
Form 10-12G filed March 21, 2000, which is incorporated herein
by reference.*10(p)
    
    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(s)
    
    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(t)
    
    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(u)
    
    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(v)
    
    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 reference10(w)
    
    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 *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 30, 200523.1
    
    Consent of Independent Accountants
 BDO SEIDMAN, LLP23.2
    
    Consent of Independent Accountants
 Ernst & Young LLP24
    
    Powers of Attorney Contained on Page 44 of this Annual Report
on Form 10-K31.1
    
    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, 200499.4
    
    Catuity Inc. Compensation Committee charter as amended March
11, 2004.
   *
    
    Indicates that exhibit is a management contract or compensatory plan or arrangement. 43




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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. Date: March 30, 2005 CATUITY, INC.By:
    /s/John H. LowryJohn H. LowryVice President, CFO and Secretary POWER OF ATTORNEY Know All Persons By These Presents, that each person whose signature appears below
constitutes and appoints John H. Lowry his or her attorneys-in-fact, for such person in any and
all capacities, to sign any amendments to this report and to file the same, with exhibits
thereto, and other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that either of said attorney-in-fact, or
substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated. Signature
    
    Title(s)
    
    Date/s/Duncan P F. Mount

Duncan P. F. Mount
    
    Chairman and Director
    
    March 30, 2005/s/Alfred H. Racine

Alfred H. Racine
    
    President, CEO and Director
    
    March 30, 2005/s/Clifford Chapman

Clifford Chapman
    
    Director
    
    March 30, 2005/s/Alexander S. Dawson

Alexander S. Dawson
    
    Director
    
    March 30, 2005/s/Alan L. Gilman

Alan L. Gilman
    
    Director
    
    March 30, 2005/s/John H. Lowry

John H. Lowry
    
    Vice President, CFO and Secretary
    
    March 30, 2005
 44




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ExhibitNumber
    
    Description3(h)
    
    Certificate of Amendment of Amended Certificate of
Incorporation of Catuity Inc.21
    
    Subsidiaries of Registrant as of March 30, 200523.1
    
    Consent of Independent Accountants
 BDO SEIDMAN, LLP23.2
    
    Consent of Independent Accountants
 Ernst & Young, LLP24
    
    Powers of Attorney Contained on Page 44 of this Annual
Report
on Form 10-K31.1
    
    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. Lowry99.3
    
    Catuity Inc. Audit Committee charter as amended March 11,
200499.4
    
    Catuity Inc. Compensation Committee charter as amended
March 11, 2004.
 45