Catuity is a loyalty and gift card processor. We provide technology-based solutions to retailers that are designed to increase the profit they receive from their customers at the Point of Sale (“POS”). Today, the Company sells a hosted, ASP-based system 1 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 stored valued programs, primarily through a closed loop gift card solution. In late 2004 and 2005, the Company invested in the development of its new software platform, the Catuity Advanced Loyalty System (“CALS”). The system can enable robust and highly customizable programs which work on a retailer’s POS 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 the deployment of our technology solution.
In 2004, Catuity underwent a significant change in its business strategy following the decision of a large U.S. chain retailer to stop issuing smart cards to its customers that held their Visa co-branded credit card. This resulted in 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
1 An Application Service Provider is a third-party entity that manages and distributes software-based services and solutions to customers across a wide area network from a central data center.
older smart loyalty software. This significantly reduced the near-term use of smart cards in the United States and resulted in Catuity adopting a change in its business strategy. Revenue from these two customers ended in the third quarter of 2004. The Company has no expectation that either Visa USA or the large U.S. retailer will be a significant customer going forward.
To meet the changing conditions of its market, the Company adopted the following strategies that were implemented in 2005:
• Continue to invest in upgrades and new releases of the CALS system to meet the needs of the U.S. and Canadian markets;
• Focus sales efforts on tier two chain retailers where the capabilities of CALS have a demonstrable return on investment;
• Develop a sales channel through merchant service providers, acquirers and processors who serve the more than two million smaller, individual merchants which are too small to be serviced directly through Catuity’s sales model;
• Strengthen the Company’s technology team to support client deployments and services around a hosted solution, rather than the traditional installed software business where the Company had found its initial success in the U.S.;
• Selectively explore projects and opportunities in which the Company leverages its technology and operational understanding of loyalty and gift card programs with partners who offer other strengths.
In North America and Australia, the Company is primarily targeting direct sales to retailers who tend to favor a hosted solution and, for competitive reasons, have a need to offer loyalty and gift card solutions to compete against the larger, tier one branded chains, while differentiating themselves from their smaller, local rivals.
In 2005 Catuity acquired Loyalty Magic Pty., Ltd., an Australian provider of loyalty processing and customer relationship management services to retailers in Australia. Loyalty Magic’s business model represents an excellent fit with the business Catuity was in the process of developing in the United States during 2005. Loyalty Magic provides loyalty processing and services to retailers on an ASP basis. It has effectively penetrated the Australian pharmacy retail market. Two of Loyalty Magic’s customers represented approximately 28% of Catuity’s total revenue in 2005.
Industry
Catuity competes in the loyalty market within the retail industry at the intersection of three significant and positive trends in retailing: upgrades of POS systems; rising gift card usage; and the growing budgets of retailers to enhance sales by driving loyalty among new and prospective customers.
POS Spending by Retailers: The Catuity Advanced Loyalty System works by installing a proprietary application at the point of sale inside a retailer or merchant’s stores. As might be expected, retailers are cautious about changes which affect their ability to accept payment. As such, Catuity gives priority to sales prospects, which have already decided to upgrade their POS systems, be it in hardware, software or both. Catuity may benefit when a POS upgrade is already anticipated because it has the potential to shorten the sales and deployment cycles. Numerous surveys and industry experts have reported that chain retailers are continuing to aggressively upgrade their point of sale systems, a trend first triggered by Y2K compliance concerns. In the Annual Survey of Retail Information Technology Trends, Chain Store Age ( www.chainstoreage.com ) magazine found that an average of 25% of the IT budgets were allocated for POS hardware and software in 2005. Equally significant, Catuity’s target market of tier two chain stores, those with sales of $100 million to $1 billion a year spent the largest portion of their technology budgets on POS needs; with most saying it was a top priority. Generally speaking, the lifecycle of POS upgrades continues to shorten. Except in extraordinary circumstances, hardware is replaced in a 5-7 year cycle at a typical chain store retailer, while software applications are replaced more quickly based on advancements and new functionality. In a separate study released in 2005, independent chain retailer research firm IHL Services ( www.ihlservices.com ) reported that retailers spent $6.5 billion on POS hardware, software and services last year for PC-based checkout systems. Catuity targets these types of retailers through its direct sales effort.
Gift Card Usage Trends: In the past decade, stored value cards have become one of the most sought after products at retailers. Gift cards are viewed as a key customer acquisition tool since they are typically purchased by a friend or relative and given to a potential shopper in lieu of cash. In fact, Deloitte & Touche ( www.deloitte.com ) found in their annual study that gift cards were now the No. 1 gift with a majority of shoppers choosing receiving a gift card as their preferred gift. At the same time, Deloitte reported that consumers now favor gift cards over cash by a two-to-one measure. For retailers, gift cards have become vital to their success during
the active Christmas holiday season and throughout the year. In its annual year-end survey of consumers, the National Retail Federation ( www.nrf.org ) found that consumers would spend at least $17 billion in value during the 2005 holiday season. Gift cards are not just a seasonal business. They are a year-round part of the strategy of retailers and a key profit center.
Retailers Emphasize Loyalty in Growth Strategy: Since Catuity entered the North American market in 2000, loyalty has evolved from an emerging strategy to an established practice and budgeted expenditure for retailers. Estimates of the size of the loyalty market vary widely and are often interchanged with estimates of the customer relationship management (“CRM”) market. These estimates can include everything from direct marketing services, branding and call center support to technology spending. Catuity defines our services to enable loyalty as the application, creation and management of the individual profile created when a customer joins a membership or reward program; and the transactional support necessary to make a loyalty program work seamlessly at the point of sale. Today, this does not include full-service database management, direct mail support, web-related services and full service analytics. These are capabilities that the Company expects to add through new development and acquisition. We would note that our acquisition of Loyalty Magic Pty. Ltd. increased our in-house ability to manage databases on behalf of clients. Additionally, Loyalty Magic includes some key functional capabilities, including, but not limited to, interfaces with kiosks and e-commerce platforms. Additionally, the company’s internal development plans for 2006 includes expansion of our capabilities.
For the services that we offer today, merchants (those with one to 25 locations) spend an average of $850 to $1,100 annually per store on basic loyalty programs. These fees are often charged in the form of a flat monthly subscription and transactional service for a turnkey program. While Catuity targets this market through resellers and referral, such as merchant services providers, we believe there is a potential market of at least 1.2 million small merchants — about one in four of the total market — in North America who do not yet have a loyalty or gift card solution. Using the lowest estimates for each, we believe that the small merchant market will spend at least $750 million on loyalty and gift card solutions annually. As Catuity expands our sales focus beyond our core market, the size of our opportunity will increase.
By the same measure, chain store retailers, which Catuity targets through direct sales, spend an average of $3,700 to $6,900 per store annually for the services which we sell to support loyalty and gift card solutions. The retailers in three market segments that we have targeted represent at least 55,000 locations in North America.
BUSINESS SEGMENTS
Catuity conducts all of its business in a single business segment – providing loyalty and gift card technology along with related services to retailers and their processor partners. During Catuity’s last two fiscal years, its revenue by type of product or service has been as shown below:
| 2005 | 2005 | 2004 | 2004 | |||||||||||||
| Revenue Type | Amount | % | Amount | % | ||||||||||||
Processing & Services |
$ | 839,645 | 86 | % | $ | 467,533 | 62 | % | ||||||||
License |
141,277 | 14 | % | 43,200 | 6 | % | ||||||||||
Project Related |
— | 0 | % | 248,379 | 32 | % | ||||||||||
Total Revenue |
$ | 980,922 | 100 | % | $ | 759,112 | 100 | % | ||||||||
In 2004 and 2005, 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 one of its clients, a large U.S. retailer, was discontinuing its use of smart cards. As a result, Visa USA determined that it would discontinue the development of its Smart Visa Rewards Platform and phase out the platform’s operations during 2004. Catuity’s loyalty software was a key component of the platform and this Visa-issuing retailer represented the vast majority of the Company’s revenue. The Company then embarked on an extensive effort to replace its existing technology with the new Catuity Advanced Loyalty System, or CALS. That system was designed to be architecturally flexible to meet the changing needs of clients and prospects. 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 and into 2005. During the Company’s refocusing efforts, the Company made limited progress in pursuing, managing and closing new sales.
During 2005, the Company established the operational team and the secure facility needed to enable it to host loyalty and gift card programs for customers. In addition, the Company successfully completed two capital raises, the acquisition of Loyalty Magic Pty. Ltd. and the post acquisition integration needed for efficient operations between Catuity’s and Loyalty Magic’s staffs.
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 spend more on targeted products and categories);
• Improving gross margin (giving customers reasons to buy higher margin products);
• Increasing customer purchase frequency (driving customers back to the store more often); and
• Increasing customer response rates
Our loyalty technology, CALS, provides the capabilities retailers need to achieve these goals via:
• Launching and managing membership-based programs;
• Managing points-based programs;
• Delivering discounts based on shopping behavior; and
• Offering customizable gift card programs which can be enhanced with loyalty functionality.
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 perform 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:
• In-House Solution: Retailers, especially the largest, often seek competitive advantage by custom development of proprietary in-house solutions. This is generally done in conjunction with loyalty consultancies, database service firms and IT service firms. This is not a primary market for Catuity due to the typically lengthy and complex sales cycle and the strict financial requirements placed on the provider, which tend to exclude smaller companies. While Catuity does not actively target tier one retailers or custom installation projects, we will provide this option at the request of our core customers.
• Hosted Solution: Retailers, especially the tier two chain retailers targeted by Catuity, favor a turnkey hosted solution which enables them to minimize capital investment; avoid the need for large, specialized IT; and reduce the risks associated with complex integration, deployment and upgrades. This market typically prefers a hosted solution which allows them to customize their programs — not their technology — to be aligned with the retailers’ merchandising and branding strategy. Many players, including payments processors, gift card solutions providers and marketing services firms are generally focused by vertical market.
• Program-Based Solution: Retailers actively participate in promotional programs which are generally designed to drive a single type of customer behavior, such as new account acquisition or customer retention, or target the sale of specific products. These programs are generally attractive because they have a defined cost; require little to no technology adoption and require no complex back-end technology to manage beyond a specific promotion. Catuity does not compete in this market.
Our ability to be successful depends on many factors, including:
• Our ability to establish a clear business case that is aligned with the strategy of our client and which has a clearly defined return on investment.
• Our ability to successfully market the features of our product and to continually make it easier for our clients to use.
• Our ability to continually expand our reputation and credibility in our markets and to differentiate Catuity from the many competitive alternatives.
• Our ability to leverage marquee client relationships to establish a more visible presence in North America and Australia.
• Our ability to execute on schedule and on budget and to consistently exceed our customers’ ongoing service requirements.
While Catuity focused on a new market in 2005, we believe that our reputation for innovation and delivery on behalf of our customers provides 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 2005 were primarily focused on completing subsequent releases of its new generation loyalty platform — CALS. The Company has enhanced existing functionality while constantly striving to make the system easier to use by retailers who generally lacked large or sophisticated technology departments. In 2006, the Company plans to enhance the management reporting capabilities of the system; continue to expand the number of POS systems to which we integrate and add new functionality that helps us deliver a technologically superior product in our markets. 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. 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. To date, discussions with potential buyers, re-sellers and other partners have not produced a viable transaction.
Through the acquisition of Loyalty Magic, Catuity acquired the LMX loyalty platform. For the most part, that technology platform is used by clients in Australia, New Zealand and the United Kingdom. The Company does not currently plan to market the software directly in North America. Additionally, most of the enhancements to the LMX system are client directed and funded and are not considered R&D investments. When assessing projects for possible R&D investment, Catuity makes efforts to ensure that new functionality can be used with both platforms.
Catuity believes that focus and consistent application of some basic design principles will ensure that we deliver a product that is strategically advantaged in our markets. To that end, the Company’s management balances every proposed development project against four design principles. These principles are:
• Every development project must give our customer control of their programs. This is important because retailers of all sizes want to be able to quickly and easily implement, measure and modify their marketing and loyalty programs. Because we are delivered in an ASP model, a key element of our R&D strategy is to always make it simpler and more intuitive for our customers to use the technology.
• Every development must offer superior data security. The security of customer information remains a major concern among retailers and payments industry players. Catuity addresses the security of our own system through the training of our people; clearly drafted policies and procedures; ongoing review and discussions with our customers about their best practices; and compliance with industry standards. Catuity is in the process of certifying its U.S. operations as being compliant with industry standards around customer data security.
• Every development must not impact the time of the total transaction. Because our programs work at the point of sale, it is critical that our technology never slow down the checkout process. Retailers equate delays at the checkout with lost business. Our technology, which requires a proprietary application to be installed at the POS, is designed to operate under the ISO 8583 message format, simultaneously with the approval of the payment transaction. Before any version of our applications are released, they are tested and improved to streamline the total transaction time so that Catuity never hurts the checkout time of one of its customers.
• Every development must minimize or eliminate integration and other IT-related risks for our customers. Like most buyers of technology driven solutions, retailers assess the total cost of deploying and managing a solution. Our investment in our Application Program Interface (“API”) development and integration with market-standard protocols is designed to reduce the upfront cost of doing business with Catuity. These upfront costs can act as a deterrent to a buying decision. We believe that a critical success factor in transaction-driven companies is to make it easy for customers to start doing business with us.
Development projects that do not meet these four standards are generally only considered if they are funded by a client.
INTELLECTUAL PROPERTY
Catuity respects the intellectual property rights of others and we expect others to respect our rights. Patents protect the rights of innovators and allow them to be rewarded for their innovation. Without protection for the reward from innovation, far less research and development would be undertaken.
We file patent applications to protect our innovations and to protect the business from legal action by others. Patents also provide recognition for our innovations, demonstrate our capabilities, and reflect the expertise of our employees. We see patents as part of our marketing strategy as they help convince others that we are indeed specialists in our field.
Catuity believes its patents are of significant value and as part of its agreements with licensees, Catuity grants rights to use the innovations described in its patents.
Catuity has been issued three patents related to the efficient storage and management of multiple applications in offline consumer devices and the systems to manage the applications, customer devices and terminals. This patent “family” has a priority date of December 4, 1998 and includes:
| Country | Patent Number | |||
United States |
6,449,684 | |||
United States |
6,532,518 | |||
Australia |
755,388 | |||
Patent applications are pending in the European Union, Japan and Brazil.
Catuity has also been issued patents in seven countries, with a priority date of February 22, 1999, which relate to the use of the Catuity System over the Internet and with traditional point of sale devices. It covers our system for managing and updating data on customer devices that are supported and controlled by a host system integrated to any number of offline and online terminals. The patent covers the operation of interactive programs and transactions that use methods ranging from POS terminals to the Internet. This patent “family” includes:
| Country | Patent Number | |||
Australia |
746,867 | |||
New Zealand |
513,678 | |||
Belgium |
1,163,633 | |||
Finland |
1,163,633 | |||
France |
1,163,633 | |||
Germany |
60020818.4 | |||
Great Britain |
1,163,633 | |||
This patent is also pending in Canada and Japan.
SALES BACKLOG AND PIPELINE
As of December 31, 2005, the Company had signed agreements with customers in the U.S. and Australia that it expects will result in revenue of approximately $1,900,000 in calendar 2006. As of this filing, the Company has a defined prospect base of approximately 800 companies. Our business objective remains to identify the organizations that will be making a buying decision during this year. At present, we have opportunities identified that are in various stages of our sales process and include prospects that are in the proposal or advanced review stage. Our agreements are typically for a minimum of three years. Our agreements include fees for the initial deployment of a loyalty and/or gift card program, recurring fees per account and/or per transaction, and, through a third party partner, residual revenue for provisioning of credit and debit card processing. We charge fees for on request services such as providing gift and loyalty cards, point of purchase merchandizing materials, training, and other services. In the Australian market, our offering is more focused and the average revenue of a typical customer is half of that of the U.S. Additionally, we have 4-6 existing clients in our Australian subsidiary with which we are pursuing expansion of the range of loyalty related services that they purchase to support their programs. Finally, in the re-seller market in the U.S., we are focused on revenue-sharing arrangements that provide Catuity with 35-50% of the gross monthly revenue generated from accounts sold by our resellers. To date, we have agreements with three re-sellers. Our target is to selectively add 7-10 by 2008. These re-sellers are strategically designed to give Catuity access to non-core markets. We have approximately 25-30 potential re-sellers targeted to meet our objectives. A re-seller agreement ranges from 3-5 years in length and is generally exclusive.
REVENUE AND ASSETS BY GEOGRAPHIC LOCATION
During the year ended December 31, 2005, 92% of our revenue was derived from operations in Australia and 8% from operations in the United States. During the year ended December 31, 2004 100% of our revenues was derived in the United States.
The Company’s assets are located at its headquarters in Livonia, MI along with its offices in Charlottesville, VA, Denver, CO, Melbourne, Australia and in Sydney, Australia.
EMPLOYEES AND FACILITIES
As of February 1, 2006, we had 36 full time employees, 13 of which are located in the U.S. and 23 of which are located in Australia. We expect the number of full time employees in the U.S. to increase in 2006. None of our employees is covered by a collective bargaining agreement. We consider our relations with our employees to be very good. Our corporate headquarters is located in Livonia, Michigan. Also see
