40-F

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 40-F

Registration statement pursuant to Section 12 of the Securities Exchange Act of 1934

or

Annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2006             Commission File Number 000-30224

CRYPTOLOGIC INC.
(Exact name of registrant as specified in its charter)

Ontario, Canada
(Province or Other Jurisdiction of Incorporation or Organization) 7999
(Primary Standard Industrial Classification Code) Not Applicable
(I.R.S. Employer Identification No.)

55 St. Clair Avenue West

3^rd Floor

Toronto, Ontario

M4V 2Y7

(416) 545-1455

(Address and telephone number of registrant’s principal executive offices)

CT Corporation
111 8^th Avenue
New York, NY 10011
(212) 894-8940 
(Name, address (including zip code) and telephone number (including area code) of agent for service in the United States)

Securities to be registered pursuant to Section 12(b) of the Act:

Title of Each Class:	Name of Each Exchange On Which Registered:
Common Shares	NASDAQ Global Select Market Toronto Stock Exchange London Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

For annual reports, indicate by check mark the information filed with this form:

[ X ] Annual Information Form [ X ] Audited Annual Financial Statements

Indicate the number of outstanding shares of each of the registrant’s classes of capital or common stock as of the close of the period covered by the annual report:

	Class	Outstanding at
		December 31, 2006
Common shares, no par value			13,641,234

Indicate by check mark whether the Registrant by filing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934 (the “Exchange Act”). If “Yes” is marked, indicate the filing number assigned to the Registrant in connection with such Rule.[ ]Yes[ ]No

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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[ ]No

DISCLOSURE CONTROLS AND PROCEDURES

The Registrant carried out an evaluation, as of the end of the period covered by the report, under the supervision and with the participation of the Registrant’s management, including the Registrant’s Chief Executive Officer and Treasurer, of the effectiveness of the Registrant’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934 (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Registrant’s disclosure controls and procedures as of December 31, 2006 were effective to ensure that information required to be disclosed by the Registrant in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to the Registrant’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely disclosure regarding required disclosure.

MANAGEMENT’S REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING

The management of the Registrant is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of the Registrant’s financial reporting for external purposes in accordance with accounting principles generally accepted in Canada and in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions and dispositions of the assets of the Registrant; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements in accordance with generally accepted accounting principles; providing reasonable assurance that receipts and expenditures are made in accordance with authorizations of management and directors of the Registrant; and providing reasonable assurance that unauthorized acquisition, use or disposition of company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, management concluded that the Registrant’s internal control over financial reporting was effective as of December 31, 2006.

During the fiscal year ended December 31, 2006, there were no changes in the Registrant’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting (as defined in Rules 13(a)-15(f) and 15d-14(f) under the Securities Exchange Act of 1934).

This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.

AUDIT COMMITTEE FINANCIAL EXPERT

Stephen Freedhoff serves as a member of the Audit Committee of the Registrant’s Board of Directors. The Board of Directors has reviewed the definition of “audit committee financial expert” under item 8(a) of General Instruction B to Form 40-F and determined that Stephen Freedhoff satisfies the criteria for an audit committee financial expert under the Exchange Act. The SEC has indicated that the designation of Stephen Freedhoff as an Audit Committee

financial expert does not make Stephen Freedhoff an “expert” for any purpose, impose any duties, obligations or liability on Stephen Freedhoff that are greater than those imposed on members of the audit committee and board of directors who do not carry this designation or affect the duties, obligations or liability of any other member of the audit committee.

CODE OF ETHICS

Our Board of Directors has developed and adopted a Code of Conduct and Business Ethics applicable to our Chief Executive Officer, our Company’s principal executive officer, and the Chief Financial Officer, our Company’s principal financial and accounting officer, with the goal of promoting the highest moral, legal and ethical standards and conduct within our Company. Copies of this Code of Conduct and Business Ethics are available without charge upon request by contacting CryptoLogic’s investor relations department by mail at our head office, 55 St. Clair Avenue West, 3^rd Floor, Toronto, Ontario, Canada, M4V 2Y7, by telephone: 416-545-1455, by email at investor.relations@cryptologic.com, and also posted on the Company’s web site at www.cryptologic.com.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

KPMG LLP has been the auditor of the Company since 1998.

Fees payable to KPMG LLP for the years ended December 31, 2006 and 2005 were as follows:

(In thousands of US dollars)	2006		2005
Audit fees	$	505	$	294
Audit-related fees	$	109	$	77
Tax fees	$	372	$	187
Other fees	$	34	$	14
Total	$	1,020	$	572

Audit Fees

These audit fees were for professional services rendered for the audits of the Company’s consolidated financial statements and subsidiary companies, the review of interim financial statements, the review of accounting disclosure requirements regarding other business activities and review of documents filed with US, Canadian and UK securities regulatory authorities.

Audit-Related Fees

These audit-related fees were for advisory services related to Sarbanes-Oxley (Section 404).

Tax Fees

These tax fees were for tax compliance, tax advice and tax planning. These services included the preparation and review of corporate tax returns, assistance with tax audits and transfer pricing matters, expatriate advisory services as well as advisory services relating to federal, provincial and international tax compliance for customs and duties, and regarding common forms of domestic and international taxation (i.e. income tax, VAT, GST and excise taxes).

Other Fees

Other fees were for services other than audit fees, audit-related fees and tax fees as described above. These services included probity checks of employees and licensees and call centre advisory.

Pre-Approval Policies and Procedures

The Company’s audit committee has direct communications channels with internal personnel responsible for financial statement preparation and with external auditors, and has concluded that the provision of services other than audit services is compatible with maintaining the auditors’ independence. The audit committee monitors audit functions and the preparation of financial statements, and meets with external auditors independent of management. The audit committee has adopted a policy regarding its pre-approval of all audit and permissible non-audit services provided by the independent auditors. The policy gives guidance to the Company’s management as to the specific types of services that have been pre-approved. The Company’s senior management periodically provides the audit committee with a summary of services provided by the independent auditors in accordance with the pre-approval policy. For the year ended December 31, 2006, none of the audit, tax and other fees described above were an exception to the audit committee’s pre-approval policy.

OFF-BALANCE SHEET ARRANGEMENTS

The Registrant is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Registrant’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.

TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The disclosure provided in the table that summarizes our outstanding cash commitments as of December 31, 2006 on page 38 of Exhibit 99.2 (2006 Management’s Discussion and Analysis) is incorporated by reference herein.

CORPORATE GOVERNANCE DIFFERENCES

The common shares of the Company are listed on the NASDAQ National Market (“NASDAQ”). Section 4350(a)(1) of the NASDAQ company guide permits NASDAQ to consider the laws, customs and practices of foreign issuers in relaxing certain NASDAQ listing criteria, and to grant exemptions from NASDAQ listing criteria based on these considerations. A description of the significant ways in which the Company’s governance practices differ from those followed by US domestic companies pursuant to NASDAQ standards is as follows:

Shareholder Meeting Quorum Requirement: The NASDAQ minimum quorum requirement for a shareholder meeting is 33 1/3% of the outstanding shares of common voting stock. In addition, a company listed on NASDAQ is required to state its quorum requirement in its bylaws. The Company’s quorum requirement is set forth in its articles, which provide that shareholders of one-quarter of the Company’s issued shares entitled to be voted at a meeting present in person or by proxy shall be a quorum for a general meeting of shareholders.

Proxy Delivery Requirement: The NASDAQ requires the solicitation of proxies and delivery of proxy statements for all shareholder meetings, and requires that these proxies be solicited pursuant to a proxy statement that conforms to the proxy rules of the U.S. Securities and Exchange Commission. The Company is a foreign private issuer as defined in Rule 3b-4 under the U.S. Securities Exchange Act of 1934, as amended, (the “Exchange Act”) and the equity securities of the Company are accordingly exempt from the proxy rules set forth in Sections 14(a), 14(b), 14(c) and 14(f) of the Exchange Act. The Company solicits proxies in accordance with applicable rules and regulations of Canada.

UNDERTAKINGS

The Registrant undertakes to make available, in person or by telephone, representatives to respond to inquiries made by the Commission staff, and to furnish promptly, when requested to do so by the Commission staff, information relating to the securities registered pursuant to Form 40-F; the securities in relation to which the obligation to file an annual report on Form 40-F arises; or to transactions in said securities.

SIGNATURES

Pursuant to the requirements of the Exchange Act, the Registrant certifies that it meets all of the requirements for filing on Form 40-F and has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.

CRYPTOLOGIC INC.

/s/ Lewis N. Rose                                                                           

Lewis N. Rose

President and Chief Executive Officer

Date: March 28, 2007

EXHIBIT INDEX

The following documents are being filed with the Commission as exhibits to this annual report on Form 40-F.

Exhibit	Description
1.	Annual Information Form
2.	Management’s Discussion and Analysis
3.	Annual Financial Statements
4.	Consent of KPMG LLP
5.	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13(a)-14(a) or 15(d)-14 of the Securities Exchange Act of 1934.
6.	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350.

EX-1

EXHIBIT 1

CryptoLogic Inc.

RENEWAL ANNUAL INFORMATION FORM

For the year ended December 31, 2006

Dated March 28, 2007

TABLE OF CONTENTS

ITEM 1: INTRODUCTION	1
ITEM 2: CORPORATE STRUCTURE	1
Name, Address and Incorporation	1
Intercorporate Relationships	2
ITEM 3: GENERAL DEVELOPMENT OF THE BUSINESS	3
Three-Year History	4
ITEM 4: DESCRIBE THE BUSINESS	10
Summary	11
Principal Markets	11
Distribution Methods	13
Revenue	14
Production and Services	14
Specialized Skill and Knowledge	15
Competitive Conditions	15
New Products and Services	16
Intellectual Property	18
Cycles	19
Economic Dependence	19
Changes to Contracts	19
Employees	19
Foreign Operations	19
Risk Factors	20
ITEM 5: DIVIDENDS	28
ITEM 6: DESCRIPTION OF CAPITAL STRUCTURE	28
ITEM 7: MARKET FOR SECURITIES	28
ITEM 8: DIRECTORS AND OFFICERS	29
ITEM 9: AUDIT COMMITTEE AND RELATIONSHIP WITH AUDITOR	33
ITEM 10: LEGAL PROCEEDINGS	34
ITEM 11: TRANSFER AGENTS AND REGISTRARS	35
ITEM 12: NAME OF EXPERTS	35
ITEM 13: ADDITIONAL INFORMATION	35
SCHEDULE A – AUDIT COMMITTEE TERMS OF REFERENCE	36

Item 1:    INTRODUCTION

All dollar amounts in this Annual Information Form are in United States dollars, except where indicated otherwise. Effective January 1, 1998, CryptoLogic Inc.’s (“CryptoLogic” or “the Company”) reporting currency is in United States dollars. Some figures and percentages may not total exactly due to rounding.

Certain general information contained in this Annual Information Form concerning the industry in which the Company operates has been obtained from publicly available information from third party sources. The Company has not verified the accuracy or completeness of any information contained in such publicly available information. In addition, the Company has not determined if there has been any omission by any such third party to disclose any facts, information or events which may have occurred prior to or subsequent to the date as of which any such information contained in such publicly available information has been furnished or which may affect the significance or accuracy of any information contained in any such information and summarized herein.

Certain statements contained in this Annual Information Form constitute forward-looking statements within the meaning of applicable securities laws. Forward-looking statements may include estimates, plans, expectations, opinions, forecasts, projections, guidance or other statements that are not statements of fact including, without limitation, statements regarding the growth of the online gaming industry and future governmental, legislative and legal developments. When used in this document, the words “may,” “would,” “could,” “should,” “will,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “expect” and similar expressions, as they relate to the Company or our management, are intended to identify forward-looking statements. Such statements reflect the Company’s current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause the Company’s actual results, performance or achievements that may be expressed or implied by such forward-looking statements to vary from those described herein. Should one or more of these risks or uncertainties materialize, or should assumptions underlying forward-looking statements prove incorrect, actual results may vary materially from those described herein as intended, planned, anticipated, believed, estimated or expected. The Company does not intend, and does not assume any obligation, to update these forward-looking statements.

Item 2:    CORPORATE STRUCTURE

Name, Address and Incorporation

CryptoLogic Inc. was formed by articles of amalgamation (the “Amalgamation”) under the Business Corporations Act (Ontario) effective March 7, 1996 pursuant to an amalgamation agreement dated January 19, 1996 between Inter.tain.net Inc., a private corporation, and Biroco Kirkland Mines Limited. Immediately prior to the Amalgamation, Biroco Kirkland Mines Limited did not carry on active operations.

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The Company’s registered office is located at 220 Bay Street, 7^th Floor, Toronto, Ontario, Canada, M5J 2W4. The Company’s head office is located at 55 St. Clair Avenue West, 3^rd Floor, Toronto, Ontario, Canada, M4V 2Y7.

On June 28, 1996, the Company changed its name from “Inter.tain.net Inc.” to its current name, “CryptoLogic Inc.”

Intercorporate Relationships

The organizational structure of the Company and our operating subsidiaries (collectively, the “Subsidiaries”) as of December 31, 2006 is set forth below. CryptoLogic is the software group located in Canada, which provides software development, upgrades and technical support for WagerLogic Limited (“WagerLogic”). Located in Cyprus and the United Kingdom (“UK”), the WagerLogic group of companies provides software hosting and licensing for our Internet gaming software, e-cash systems and support, customer support, marketing support and other services to third-party gaming operators or licensees around the world. Our WagerLogic subsidiary is responsible for the overall licensing of our total gaming software solution and services including the provision of 24/7 customer support to our licensees’ global player base. Our ECash Direct subsidiary provides e-cash systems and support that enables licensees’ players to deposit and withdraw funds through a wide range of payment options for use with the licensee. Our AdsDotCom subsidiary offers marketing services to licensees. For the remainder of this document, the consolidated operations of the Company and our Subsidiaries will be referred to collectively as “we”, “our”, the “Company” or “CryptoLogic,” unless otherwise specifically noted.

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Note: In all cases in the above chart, the parent company owns directly or indirectly, all of the issued and outstanding shares of the applicable subsidiary.

Item 3:    GENERAL DEVELOPMENT OF THE BUSINESS

Founded in 1995, CryptoLogic is a pioneer and a global leading software developer and services provider to the Internet gaming market, outside of the United States, around the world through offices in Cyprus and the UK. Today, we are one of the industry’s longest-established publicly traded online gaming software companies, with our software development operations in Toronto, Canada. Our wholly-owned subsidiary, WagerLogic Limited (“WagerLogic”), provides software hosting and licensing, e-cash systems and support, customer support and marketing support services for our Internet gaming software to third-party gaming operators.

CryptoLogic’s software offers a complete online gaming solution to licensees which is comprised of:

1. A broad, turn-key Internet-based game suite featuring:

• more than 260 download and non-download casino table and slot games

• player-to-player poker

• multi-languages (English, Spanish, Greek, Japanese, Chinese, French, German, Italian)

• multi-currencies (US dollars, British pounds and Euros)

• multi-platforms (download, non-download (Java and Flash), wireless)

• multi-player bingo;

2. E-cash systems and support for player deposits and withdrawals;

3. Business intelligence and data analysis tools to assist licensees in their marketing efforts;

4. Licensee support through WagerLogic’s 24/7 multi-language customer support; and

5. Marketing support services, to assist licensees to develop and execute strategies for marketing their online gaming businesses.

WagerLogic licenses our software products and services to a select international client base (“licensees” or “customers”), while retaining ownership and control of the software. As at December 31, 2006, we had 10 licensees located around the world, including well-known UK and global land-based gaming organizations.

Our licensees operate under government authority where their Internet business subsidiaries are domiciled, in the Netherlands Antilles. During the year, one of our customers was a licensed operator in Alderney, a British Crown Dependency in the Channel Islands, and that customer relationship has since been terminated. We added three new licensees in 2006: DTD Poker; Betsafe.com; and Oceania Caribe Licensing NV (PlayboyGaming). Since December 31, 2006, we have added two new licensees, a private company in Malta operating Parbet.com, and Holland Casino, which is expected to launch in June 2007.

Substantially all of our revenue is of a recurring nature. WagerLogic’s licensees pay an ongoing fee over the contract term for the licensing of our software and services, calculated as a percentage of each licensee’s level of activity. In 2006, 10.5% (2005: 7.3%) of our revenue came from other sources, including software customization, certain marketing support services, advertising services and interest income.

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Historically, revenue has been seasonal with slower sales in the summer months (our second and third quarters), when players tend to spend less time indoors and at their computers. Typically, our first and fourth quarters (during the winter and fall seasons) are our strongest revenue periods.

Three-Year History

The global online gaming industry including the United States grew from $5.7 billion in 2003 to $10.7 billion in revenue in 2005 (source: Global Betting and Gaming Consultants, February 2007 (“GBGC”)). However, on September 29, 2006, the United States Congress approved the Unlawful Internet Gambling Enforcement Act (UIGEA), which prohibits financial transaction processing in the US online gaming market. Accordingly, we worked with WagerLogic’s licensees to ensure that they stopped taking wagers from US-based players immediately. The Act was made law on October 13, 2006. Earlier US legislation, including US federal and state statutes, has been, and could continue to be, construed to prohibit or restrict gaming through the use of the Internet. Also, some US credit card processors had already been blocking online gaming transactions, dating back to 2001.

At the time the UIGEA was passed, the entire US market was estimated to represent approximately 50% of the global online gaming market (GBGC). Approximately 70% of our licensees’ revenue was derived from international sources; the significant international representation among CryptoLogic’s licensees’ player base was a direct result of the Company’s strategy since 2002 to focus on licensees that primarily target international markets, most notably the UK and Continental Europe. In 2001, only 30% of licensees’ revenue came from players outside the US. After the UIGEA enactment, 100% of licensees’ revenue came from outside the United States.

We anticipate that the industry-wide impact of UIGEA will have a significant short-term impact on our financial results and may increase competition in our core European markets. However, as our licensees have significant exposure to the international market compared to those of our significant competitors, we believe that we remain in a strong competitive position. As evidence of this strength, the Company has signed four new licensees (Betsafe, DTD Poker, a private company in Malta that operates Parbet.com, and Holland Casino) and renewed an agreement for three years with one of its largest customers, the UK betting company William Hill, subsequent to the passage of the UIGEA.

It is not yet clear what the full effect of the UIGEA will be on the growth and size of the overall Internet gaming industry. However, CryptoLogic will not support licensees who participate in the US market until the legislative environment there permits.

International markets such as the UK and Continental Europe have become a core focus for CryptoLogic over the past three years. Our international strategy focuses on investing in and capitalizing on our relationships with leading, international brand name licensees in international markets that are embracing Internet gaming and represent attractive growth potential.

In the UK, we are investing in initiatives to position the Company for the pending implementation of the regulatory framework under the new Gambling Act 2005, and to offer this jurisdiction as an option for our customers, provided it is practicable to do so. In enabling the regulation of Internet gaming for the first time in the UK, this Act opens the door to a large, credible and stable industry in a regulated and licensed environment, which is expected to become fully operational by September 2007.

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Elsewhere in Europe the legislative environment continues to evolve, with some countries showing signs of following the UK’s lead while others are moving to protect state gambling monopolies. The EU Commission has commenced infringement proceedings against nine Member States that are taking a protectionist approach— a development that the Company believes is favourable to the industry in Europe. CryptoLogic has long advocated a regulatory approach to foster a transparent, credible and growing online gaming industry. We have sought and achieved certification of our software in strictly regulated jurisdictions. It is through this process that we maintain our reputation as the pioneer in online gaming and a trusted provider for licensees and their customers.

While online gaming continues to promise vast potential, it is expected to account for only 5.5% of global gambling revenue by 2012 (source: GBGC). The market is already dominated by several major operators. Competition is intensifying for players and market position. The industry is undergoing consolidation as operators increase market share through acquisition. We continue to operate in a challenging business environment faced with regulatory uncertainty including ongoing efforts aimed at banning or restricting online gaming.

As the industry becomes increasingly competitive and sophisticated, we must offer a strong value proposition to our customers to help them respond to players, who are demanding more choice and entertainment value. Accordingly, CryptoLogic continues to emphasize product innovation in our core Internet casino and Internet poker software, which are proven, major growth markets in online gaming. We continue to offer an expanding array of new and innovative products and services that enhance the game experience and create opportunities for licensees to improve their marketing and help them attract, retain and re-activate players, and to ensure CryptoLogic remains an industry leader. In order to accomplish this, considerable time and financial resources have been invested in strategic areas of our product development and system capabilities over the past three years. Above and beyond our significant normal course expenditures, in the third quarter of 2004 CryptoLogic implemented a $12.5 million investment program. The program, continued in 2005, significantly upgraded our casino and poker game offering, system infrastructure and scalability and back-office systems and customer support. In 2006, the Company invested further to maintain its strategic flexibility in technology, specifically enhancements to graphics and functionality aimed at the online players themselves; back office upgrades, including strengthened e-cash systems and support, data analytics, reporting and fraud detection; and software adaptability to changing jurisdictional requirements. Most significantly the Company in 2006 invested in software enhancements and process to allow faster and more efficient implementation of new casino and poker games by licensees, including alternate languages and currencies; this investment phase is expected to be substantially completed in 2007, and is expected to give the Company a material competitive edge.

The following summarizes key milestones the Company has achieved over the past three years that have been important to maintaining our stature as a leading publicly traded software company in the online gaming industry:

International growth – CryptoLogic has achieved increasing geographic diversification. Licensees’ revenue from international sources was 70% of total revenue at the time the UIGEA passed, a steady increase from over 65% in 2005, over 60% in 2004, and only 30% in 2001, after which the Company initiated its strategy to focus on global markets. As a result of the UIGEA, 100% of licensees’ revenue now comes from outside the US. We work with some of the best international names in online and land-based gaming, as well as major entertainment brands, including William Hill, PlayboyGaming, Littlewoods Gaming, InterCasino and ukbetting. We have developed a strong presence in the UK. In April 2005, the UK enacted law to regulate online gaming for the first time in that jurisdiction. The British government is currently drafting the underlying rules and codes to establish its new regulatory framework. However, there is no assurance that the UK regulatory regime will provide a commercially-viable market and may create restrictions

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that can have a material adverse effect on our customers, our business, revenues, operating results and financial condition. The true impact of the new UK Gambling Act will not be known until these rules and regulations are made public.

1. Our licensees’ geographic mix represents a well-diversified business that mitigates regulatory uncertainty in any one jurisdiction, while taking advantage of opportunities around the world.

In order to focus on quality of licensees that yield the greatest “return on effort”, WagerLogic decided to rationalize and reduce the number of licensees from a high of 21 in 2003 to 10 in 2006. Over this same period, CryptoLogic’s revenue and earnings have increased 135% and 163% respectively (2003 revenue: $44.2 million, 2003 earnings: $9.4 million). CryptoLogic solidified its customer base in 2006 through a number of agreements:

• Signed three new licensees: PlayboyGaming (casino and poker), Betsafe (poker) and DTD Poker (poker). DTD Poker launched in December 2006, while PlayboyGaming poker and Betsafe launched in January 2007;

• Renewed for five years the financial terms with our largest customer, Overseas Internet Gaming Entertainment NV, which operates the award-winning InterCasino and Interpoker sites;

• Renewed our exclusive relationship with major customer, William Hill, under financial terms that are materially the same as those in our former agreement, with rate incentives for William Hill to increase gaming activity. The term is for three years, which can be shortened if after working together the companies decide that the relationship is significantly hampered by the terms of the UK Gambling Act, to be implemented in September 2007;

• Renewed an agreement with ukbetting to be the exclusive poker software provider through to 2009 and a non-exclusive casino software provider until 2008; and

• Announced Holland Casino as a new customer. A milestone exclusive three-year agreement was announced in February 2007 to provide both poker and casino software for Holland Casino, the Netherlands Government-owned casino operator. The new site, run by Holland Casino on behalf of the Dutch government, is expected to launch in June 2007, and will be available to residents of Netherlands only.

Betfair exited the Cryptologic poker network at the end of October 2006, having announced in 2005 its intention to bring its poker software in-house. Betfair had been added as a new licensee in 2004 as a poker-only customer operating a sports betting exchange outside the US. Betfair’s decision was in line with its long term strategy to own and operate all of its core products. The Ritz Club also left our network in the fourth quarter. We expect that revenue and player growth from continuing licensees in both poker and casino and revenue from new sites launched or launching subsequent to the exit of Betfair and the Ritz Club Online, including PlayboyGaming, Betsafe, DTD Poker, Parbet and Holland Casino will help offset the effect of the departure of these two licensees, as well as the industry-wide impact of the UIGEA enactment.

The addition of relatively few customers over the past three years is a reflection of the Company’s “return on effort strategy”. During this time, CryptoLogic has sought licensees that meet these strict criteria:

• An established brand that works well on the Internet;

• An audience with a propensity to gamble; and

• Sufficient resources and commitment to be successful marketing the business.

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In the online casino market, this has not changed. It is difficult to get a sufficient return by adding smaller, less-established casino customers. However after we implemented significant poker technology enhancements in 2006, we now have the infrastructure and capacity in place to pursue more aggressively less-established European Internet poker brands that offer exciting growth potential, like Betsafe and DTD Poker. We intend to pursue additional similar opportunities.

In 2006, we also established our first Asian presence by hiring a Managing Director for Asia-Pacific, based in Singapore. The population of Asia is approximately 10 times that of North America and gambling has been part of the Asian culture for thousands of years. In January 2007 the Company demonstrated success in executing its strategy to grow in Asia when we signed a memorandum of understanding with Brilliance Technology Co. (“Brilliance”) and 568 Network Inc. (“Game568”) to create a joint venture to penetrate the high growth, high potential Chinese market. While CryptoLogic believes that Asia will be the next major Internet gaming market, there are regional legislative issues and limited payment forms to support the industry today Accordingly, CryptoLogic foresees modest revenue in 2007 and significant revenue from Asia only beginning sometime beyond 2007.

2. Market-oriented solutions – Although CryptoLogic was instrumental in pioneering the Internet gaming software industry, there has been increasing competition over the past three years. In order to remain an industry leader, we have invested and continue to invest significantly in product research and development and service enhancements, including our major investment program highlighted earlier. The Company has launched a major initiative to upgrade its software development capability (refer to page 5 above).

In the last few years, we have continued to expand and enhance our core casino and poker software. Since 2004, we have introduced 94 popular new slot and casino table games. Some highlights include unique, first-to-market offerings such as:

• The Internet’s first and only multi-currency jackpot video slot games featuring popular Marvel action characters such as The Incredible Hulk, Daredevil and X-Men, and more recently Thor, Elektra, and Ghost Rider, which brands have been exclusively licensed for CryptoLogic-developed games;

• The world’s first and only play-for-real slot versions of highly popular online casual games, such as Cubis^TM, an award-winning, three-dimensional puzzle game, and Bejeweled, a gem-matching game—both among the most popular games played on AOL, MSN and other major portals;

• Our own patented progressive jackpot slot, Millionaires Club™, which offers the largest online jackpot in history, currently exceeding five million dollars—or pounds or euros, depending on the currency wagered;

• Our Texas Hold’em Bonus Poker is the first-ever online version of the widely popular land-based casino game - combining the huge popularity of poker with the excitement of a casino card game; and

• The Internet’s first “Fruit Machines”, a tradition in UK pubs.

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Over the past three years, we have also continued to expand the game offering and functionality of our poker software including:

• A major upgrade to our poker platform that significantly increases the capacity for simultaneous online playing, allowing for near-perfect network uptime, and enables “live” seamless updates of new features and games,;

• An appealing poker software redesign that includes enhancements to the main lobby, game tables and tournament lobby, making it easier than ever for players to navigate, select their game and stake level, and access key statistics on games, tournaments and their play;

• Introduced Hold’Em Blackjack^TM, a brand new game developed by CryptoLogic that combines the simplicity of blackjack with the intensity of poker. Hold’Em Blackjack^TM breathes new life into the traditional game of 21 by giving players the betting and bluffing excitement of Texas Hold’Em Poker along with the straightforward play of casino blackjack;

• Introduced Thunder Tournaments^TM for high-speed tournament action, broader access to land-based tournaments, and a tournament leader board to give licensees opportunities to create exciting new events;

• Launched My Poker Points, a loyalty rewards system; and

• Launched a Spanish poker site for William Hill, adding to the Greek site we created for them in 2005. Such localized sites are critical advantages in an increasingly competitive European market.

To help our licensees understand, respond to and market to their players in a personalized fashion, we also enhanced our back-office, decision-management and contact centre tools. We have continued to expand our payment solutions including new e-check/debit methods (e.g. Click2Pay, EverywhereMoney, PaySafe™), added a new European processor and expanded fraud controls (e.g., third-party address/credit card verifications, negative databases, poker fraud tool).

3. Regulatory leadership – We are one of the few online gaming providers in the world to have our software certified in highly regulated jurisdictions comparable to land-based casino standards. In order to achieve government approval, we were subject to extensive probity to ensure the integrity of our Company and key personnel, and our software was reviewed and certified by government-accredited independent testing organizations that audited our software to ensure fair and responsible gaming. Listed on the TSX, NASDAQ Global Select Market, and Main Board of the London Stock Exchange, CryptoLogic is one of the first publicly traded online gaming software companies in the world. Our public company transparency, regulatory approval and experience provide us with a competitive advantage as more jurisdictions such as the UK move to implement high regulatory standards for online gaming.

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Trends

While the global online gaming market continues to promise vast growth potential, competition is intensifying for players and market position, growth in online poker is moderating from previous exponential rates, and the global legislative environment for online gaming continues to evolve. Despite these challenges, CryptoLogic remains optimistic about the future of online gaming and believes that its disciplined strategy will continue to help the Company remain a leader within it.

In order to remain competitive, CryptoLogic has had to devote increasing financial and human resources to meet the technological and regulatory challenges associated with remaining an industry leader. As product diversification and player sophistication increases, our need to hire greater numbers of software and industry specialists has increased. This has contributed to higher operating costs to accommodate the growth of our business and in order to maintain our competitive advantage in our priority game areas. In particular, we have increased investments in Internet casino and poker to broaden our product offering in response to growing competition and player demands. We have already experienced positive returns from these investments. See page 5 above,

Given the trend to regulate online gaming in certain European markets, the costs associated with carrying on business may increase as regulatory initiatives may require greater resources to meet changing compliance standards. Changes in regulatory requirements, including regulatory fees and taxation, could impact on the costs of doing business.

In 2007, financial results of the Company will be negatively affected by the industry-wide impact of UIGEA as it will reduce revenue in the short term, and while we are exercising even tighter control over discretionary expenses, we are not planning a cost reduction sufficient to offset the lost revenue. Management estimates that the UIGEA enactment, which had an industry-wide impact, resulted in approximately $8 million in lost revenue in the fourth quarter and $6 million in lost earnings related to those revenues. Management estimates that the enactment of the UIGEA would have reduced revenue by $31 million and earnings by $24 million if the act had been in force for all of 2006. Management estimates that the UIGEA will result in lower revenue and earnings in 2007. By the latter part of 2008, we should start to trend toward quarterly revenue run rates similar to those realized prior to the UIGEA enactment, and continue to strive for net margins (net earnings as a percentage of revenue) in excess of 20%.

The Company is being very vigilant to ensure revenues and expenses remain at an acceptable ratio and is not planning significant changes to its cost structure at this time. The Company will use current resources to execute current projects and take advantage of significant revenue-enhancing opportunities in Europe, Asia and other major international markets. CryptoLogic remains optimistic about the future of online gaming and the Company’s position as one of the leaders within it. The Company is in excellent financial position to build on the global strategy that has led to record results in both 2005 and 2006. In particular, the Company will:

• Continue its game innovation strategy. The Company is fully committed to several innovative casino and poker projects, both underway and planned, and is confident they will contribute to building licensees’ revenue as similar projects have done before;

• Aggressively pursue new poker opportunities, like Betsafe and DTD Poker, that will enhance the liquidity of our licensees’ poker network—already one of the world’s largest that excludes US-based players. The Company will also continue to pursue “blue chip” casino opportunities in accordance with its return on effort strategy;

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• Control and optimize expenditures by a thorough, ongoing review of discretionary costs, operating expenses and capital expenditures;

• Aggressively pursue strategic, accretive acquisition opportunities to accelerate the advancement of the Company’s strategies. Acquisition opportunities have multiplied since passage of the UIGEA, and the Company will continue to evaluate new and existing prospect; and

• Expand in Asia. CryptoLogic will continue to build its European leadership position and over time will expand its Asian presence to become a significant participant in this large, emerging market.

To advance its global strategy, CryptoLogic announced in September 2006 a proposal, subject to regulatory and shareholder approvals, to establish its headquarters in the Republic of Ireland and listing on the Main Market of the London Stock Exchange, while maintaining its NASDAQ and Toronto Stock Exchange listings. The headquarters functions of the Chief Executive Officer, the Chief Financial Officer, the Vice President of Human Resources, and the head of Investor Relations will be transitioned to Ireland. We believe that locating the Company’s executive headquarters in Europe will provide several strategic benefits, including:

• Bringing the Company closer to the world’s major markets that embrace Internet gaming, and therefore, closer to its key customers, investment community and prospects;

• Operating in a gaming-friendly environment that enables the Company to provide a wider range of marketing support and brand management services to licensees;

• Broadening the Company’s strategic acquisition opportunities; and

• Focusing on increasing the trading of the Company’s shares on the London Stock Exchange, the major market for trading Internet gaming stocks.

The Company expects to hold a shareholders’ meeting in connection with this matter in May 2007. If approved by shareholders, the new executive office is expected to increase costs and capital expenditures for the year. While for the most part, management personnel will remain unchanged, Lewis Rose, CryptoLogic’s President and CEO, has chosen not to relocate to Ireland due to family commitments, and the Company has hired an executive search firm which has been actively seeking the most suitable replacement. CryptoLogic believes that the strategic benefits of the new location will yield a significant return on investment by better positioning the Company for the future.

Not all changes in the industry are foreseeable, but the growth of the industry, heightened competition and anticipated legislation will likely accelerate the need to offer comprehensive player solutions at an increasing rate.

Significant Acquisitions

On January 15, 2007, CryptoLogic completed the purchase of the poker brand and related assets of Parbet.com, a popular Scandinavian online poker room. CryptoLogic licensed the Parbet assets, poker software, payment processing services, multi-lingual customer support and services to a private Maltese online gaming company that will operate Parbet.com. The purchase included all rights to the Parbet brand name, associated domain names such as Parbet.com, customer lists, databases and players’ cash on deposit.

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Under the agreement, WagerLogic paid $11.9 million for the brand and assets, and may potentially pay additional amounts up to a maximum amount of $5.3 million, contingent on improved performance of the assets over a six-month earn-out period.

The purchase extended the Company’s brand ownership and management strategy, which it has used very successfully with the award-winning InterCasino and InterPoker brands and related brands, such as ExtremePoker. Under this strategy, WagerLogic owns or controls key brands that it licenses to third party operators, along with its full suite of online gaming software, network services, and marketing support services, in order to generate higher revenue to WagerLogic.

Item 4:    DESCRIBE THE BUSINESS

Summary

CryptoLogic is one of the first publicly listed online gaming software developers and suppliers, and a leader in the global Internet gaming industry. We trade on the Toronto Stock Exchange (symbol: CRY), NASDAQ Global Select Market (symbol: CRYP) and the London Stock Exchange’s Main Market (symbol: CRP). Our head office is located in Toronto, Canada and provides software development, upgrades and technical support for WagerLogic, a wholly-owned subsidiary of CryptoLogic, as well as all usual administrative functions. Located in Cyprus and the UK, the WagerLogic group of companies provides licensing and hosting for our Internet gaming software, e-cash systems and support, customer support, marketing support and other services to third-party gaming operators or licensees around the world. Our e-cash ssystems and support system enables licensees’ players to deposit and withdraw funds through a wide range of payment options for use with the licensee. Our 24/7 customer call centre support helps our licensees’ players with technical questions or assistance with the gaming software and e-cash accounts.

As at December 31, 2006, we had 10 licensees located around the world including a number of well-known UK brand name and land-based gaming organizations. Our licensees have government authority to operate their online gaming operations in the Netherlands Antilles.

Principal Markets

CryptoLogic, through WagerLogic, provides a complete, turn-key online gaming solution predominantly focused on the Internet casino and poker markets of the global online gaming industry. We work with a select group of international brand name licensees and target prospective licensees with a focus in the key geographic markets for online gaming including the UK and Continental Europe, which we view as the regions that offer the best near-term growth opportunities. As a result of the UIGEA, the Company will not support licensees who take wagers from US-based players. In the longer term, we see Asia as the next major market. The population is ten times that of North America and gaming has been part of the culture for thousands of years. However, significant regulatory and commercial challenges remain in the market, which the Company does not believe will be resolved immediately. In 2006 CryptoLogic established its first Asian presence in Singapore and the Company is developing its strategy for the region from that base. As well the Company announced it had entered a memorandum of understanding to create a joint venture for China (see page 8).

Our total online gaming solution is comprised of:

1. A broad, turn-key Internet-based gaming software suite featuring:

• more than 200 downloadable casino table and slot games and over 60 non-download games

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• player-to-player poker

• multi-player bingo

• multiple languages (English, Spanish, Japanese, Chinese, French, German, Italian, Greek)

• multiple currencies (US dollars, British pounds and Euros)

• multiple platforms (download, non-download (Flash and Java ), wireless)

• play-for-fun and play-for-cash mode

2. Proprietary e-cash systems and support;

3. 24/7 multi-language customer support;

4. Back-office support tools to assist licensees with their marketing efforts; and

5. Marketing support services

Our Internet-based gaming and electronic commerce software products are used by licensees to create virtual casinos, poker rooms or bingo halls. Currently, no customer licenses our bingo software. The downloadable software package transfers the “front end” information (i.e., playing cards, roulette wheel, dice numbers) between users and remote servers. The software package utilizes each user’s computer to generate the graphics of the virtual casino, poker room or bingo hall, while the licensees’ gaming servers perform the “dealer” function, generating the random numbers of playing cards, roulette numbers and dice numbers, as applicable. Many of our most popular casino games are also available on either the Flash and Java platforms, which provide an entertaining gaming experience without having to wait for software to download.

Among other things, our software contains proprietary encryption features, which allow secure transmission of data, and permits our licensees to offer multi-player games, a panoramic virtual casino floor populated by real players, progressive jackpots, Internet browsing features and inter-player chatting.

As part of our commitment to safe and responsible gaming, our gaming solution provides personal options and security features including deposit and bet limits, temporary and permanent account locks, personal identification verification, and online tracking of a player’s gaming activity and financial transactions. We are also able to restrict registration and game play from residents of prohibited jurisdictions.

Our gaming solution is complemented by e-cash systems and support. We provide Internet-based electronic commerce support and technology to our licensees and their respective customers and maintain, through subsidiaries, electronic commerce accounts for both merchants of our electronic commerce software and their end-users. For the majority of our licensees, we report and remit to our licensees the net transaction revenues less licensing and support fees payable to the Company (as specified in the applicable licensing agreements). Some licensees have responsibility for their own e-cash systems and support to enable an integrated account of all their online offerings, which have our licensees remit licensing fees to us.

Utilizing our e-cash software, players can use a wide range of payment options, including credit and debit card and various electronic wallets. Web cashier accounts can be opened in United States dollars, British pound and Euros.

To assist our licensees in retaining players and re-activating lapsed accounts, we have invested significantly in our customer relationship management solution. We have introduced and improved our back-office offering with sophisticated business

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intelligence, data warehousing and marketing tools to assist licensees in understanding, servicing and building one-on-one relationships with their players.

We also provide 24/7 customer support in the languages and currencies supported by our software for enhanced convenience to our licensees’ global player base, which is available to help players with technical questions or assist with the gaming software and e-cash accounts.

Increasingly, we view our marketing support services as a key differentiator in our product and service offering, as they form a key part of the Company’s brand ownership and management strategy. During 2006, OIGE NV, operator of the InterCasino, InterPoker and ExtremePoker brands, was the only licensee to use our marketing support services. In 2007, the Company will provide these services to Oceania Caribe Licensing N.V., operator of PlayboyGaming, as well. Our ability to offer these services was a key differentiator in winning the business of the Playboy brand.

It is our objective to continue to introduce innovative software products, support tools and services that appeal to broad segments of gaming audiences worldwide.

Distribution Methods

We currently market our technology and services through a select sales and marketing strategy whereby we identify key potential customers that meet our licensee profile, and then contact such prospects directly. We also attend industry trade shows around the world to generate new prospects, and respond to referrals from existing customers and other industry participants. Consistent with our “return on effort” philosophy, in recent years, CryptoLogic has sought licensees that meet these strict criteria:

• An established brand that works well on the Internet;

• An audience with a propensity to gamble; and

• Sufficient resources and commitment to be successful in marketing the business.

In the online casino market, this has not changed. It is difficult to get a sufficient return by adding smaller, less-established casino customers. However after we implemented significant poker technology enhancements in 2006, we now have the infrastructure and capacity in place to more aggressively pursue less-established European Internet poker brands that offer exciting growth potential, like Betsafe and DTD Poker. We intend to pursue additional similar opportunities.

As a result of the UIGEA, the Company will not support licensees who take wagers from US-based players. We are leveraging our strong UK licensee base to continue to focus our sales and marketing efforts in our key markets of the UK and Continental Europe, and to explore longer term prospects in other markets such as Asia. Our strategy in these markets includes the use of or introduction of multi-language and multi-currency software versions, by marketing current languages and currencies and introducing new ones with existing and new customers, as well as exploring foreign payment options that increase the ability of our customers to attract a broader, international player base.

While Asia offers large market potential, this region represents a longer term opportunity because of higher barriers to entry due to fragmented legislation and no single popular payment form. In 2006, we established our first Asian presence by hiring a Managing

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Director for Asia-Pacific, based in Singapore, who is responsible for our strategy development and implementation in the region and is identifying local partners that can help us establish meaningful contacts with governments and major, brand name gaming organizations. We will continue to pursue opportunities in this market that we believe will generate an appropriate return.

In January 2007 we demonstrated success in executing on this strategy, when we signed a memorandum of understanding with Brilliance and Game568 to penetrate the high growth, high potential Chinese market.

The three companies plan to jointly establish a new company in China to adapt our online casino and poker games to the Chinese market and develop new poker and casual, skill-based games that are more familiar to those players. Brilliance will establish an operator division to deliver the games in two modes: “play-for-fun” subscriptions for users in internet cafés and on mobile devices, and “play-for-money” through retail locations licensed by China Welfare Lottery, the nation’s gaming licensing authority. Brilliance will enter into an exclusive licensing agreement with respect to the new company’s online gaming software and service offering, and will apply for all required gaming licenses.

It is intended that Cryptologic’s investment will initially be a minority interest in the new company, with an option to increase its investment to a controlling position.

Revenue

Substantially all of our revenue is of an recurring nature in that WagerLogic’s licensees pay an ongoing fee over the contract term for the licensing and support of our software, calculated as a percentage of each licensee’s level of activity. Additional revenues are derived from other sources including fees for the provision of certain marketing support services, software customization and advertising services. Historically, we experience seasonality with slower sales in the second and third quarters, as the use of the Internet is not as strong in the summer months when players tend to spend less time indoors and at their computers. Typically, our first and fourth quarters (during the winter and fall seasons) are our strongest revenue periods.

In 2006, revenue was $104.0 million (2005: $86.3 million), with 89.5% (2005: 92.7%) of this amount represented by ongoing software licensing fees. Other revenue sources accounted for 10.5% of revenue (2005: 7.3%).

Fee revenue from our casino business is calculated as a percentage of a licensee’s level of activity in its online casino site. By contrast, fees from Internet poker are based on a percentage of the licensee’s “rake” per hand in regular or ring games (the rake is typically 5% of the pot, up to a maximum amount per hand), or fixed fees for entry into poker tournaments. $59.2 million or 56.9% of our total revenue was derived from our casino business in 2006 (2005: $53.0 million or 61.4%). Internet poker fees grew to $33.9 million or 32.6% of total revenue in 2006 (2005: $27.0 million or 31.3%).

Production and Services

Through its wholly-owned subsidiary, WagerLogic, the Company’s gaming software, e-cash systems and support and 24/7 customer support, are licensed, typically as a complete solution, to an international customer base. WagerLogic licensees pay an initial one-time customization fee to brand the software to the look and feel of that particular customer and then an ongoing fee for the licensing and support of the software, calculated as described earlier. WagerLogic retains ownership and control of the software being licensed.

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Fees for our marketing support services are reflected in both higher licensing fee rates as well as separate charges for specific work performed.

The Company’s research and development (R&D) activities are predominantly performed in Canada by approximately 23% of the Company’s workforce at 2006 year end. Certain game variations, themes and components may be outsourced to third-party development organizations. In 2004, we began to organize our Company into dedicated teams to specialize in strategic focus areas: i) casino and poker game development and enhancements; ii) system infrastructure and scalability; and iii) enhancement of our customer support and back-office systems. Of the Company’s total staff in 2006, 13% were in casino software development; 10% in poker software development; 8% in product support and compliance; 59% in licensee support operations; and 10% in administrative & finance. This representation is not expected to change materially. System infrastructure servers, which include gaming servers, e-cash servers, database servers and download servers, are required to ensure effective operations of licensees’ online gaming sites. The Company owns and maintains the infrastructure servers, which are located in various jurisdictions around the world in secure facilities. The game servers are owned by a third party and contracted to the Company for its use.

Specialized Skill and Knowledge

As at December 31, 2006, our Company, including our subsidiaries, employed 400 people, with 256employees located in Canada and 144located internationally. 90% of our staff are dedicated to development, licensee support operations and product support.

Our ability to attract and retain highly skilled technical and management personnel and a multi-lingual customer support staff is one of the key factors in our success.

As the demand for gaming options and the quality of products has increased, additional staffing requirements have been necessary to remain competitive. In 2006, our employees increased to 400 from 358 in 2005. We anticipate moderate future growth in the number of employees, particularly as we focus on tight control over costs in the wake of the UIGEA.

Competitive Conditions

Although online gaming is a fast-growing industry, it is becoming increasingly competitive and sophisticated. GBGC, a UK consulting firm focused on the land-based and online interactive gaming industries, estimates that the global market for online gaming, which is comprised of casino games, sports betting, poker, bingo, and lotteries, reached $7.2 billion in annual revenue in 2006 (excluding the United States), up from $2.7 billion in 2003. While it is difficult to confirm the exact number of Internet gaming sites since most companies are private, current estimates are around 2,300 online gaming properties down from more than 2,800 (source: GBGC) several years ago – which points to industry consolidation. As Internet gaming has developed and increased in sophistication, so have the players who can choose from a proliferation of sites. Competition for players’ attention and share of wallet is intensifying, and players are demanding more value, more games and the ultimate entertainment experience.

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CryptoLogic’s primary focus areas are Internet casino and poker, which are proven, cash generative business sectors on the Internet. Online casino first developed 11 years ago. Therefore, Internet casino is a more mature marketplace, although it remains a major pillar at 33.5% of the global online gaming market in 2006 (excluding the United States) (source: GBGC). While online casino growth outside the US is predicted to remain healthy at over 21% per year in the next two years (source: GBGC), we expect it will be insufficient to compensate for the loss of the US market throughout the year. Industry experts forecast casino to reach $4.2 billion by 2012, excluding the United States (source: GBGC).

While Internet poker first took off a few years ago, it has grown almost eighteen-fold to an estimated $1.6 billion in 2006 (excluding the United States) (source: GBGC). This sector is already dominated by major operators offering liquidity (that is, a site which is well populated to ensure a player will always find a game, at the appropriate stake level and in the appropriate currency, around the clock), and a variety of games and tournaments. While online poker growth outside the US is predicted to remain strong at over 17% per year in the next two years (source: GBGC), we expect it will be insufficient to compensate for the loss of the US market in 2007. Industry experts forecast poker to reach $3.5 billion by 2012, excluding the United States (source: GBGC).

Licensees of our software compete with existing and more established recreational services and products, in addition to other forms of entertainment. Our success will depend, in part, upon our ability to enhance our products and services, expand our system infrastructure and resiliency, keep pace with technological developments, respond to evolving customer requirements and achieve continued market acceptance.

We compete with a number of public and private companies, which provide electronic commerce and/or Internet gaming software. Given the stage of development of the industry and the number of private organizations operating in the industry, information about the nature of our competitors, their operations and their resources is difficult to compile. In addition to current known competitors, traditional land-based gaming operators and other entities, many of which have significant financial resources and name brand recognition, may provide Internet gaming services in the future, and thus become competitors of CryptoLogic. Increased competition from current and future competitors and increased expenditures has and could continue to result in the reduction of margins, or could result in the loss of market share.

The global nature of the Internet makes most Internet markets, including the online gaming industry, relatively accessible to a wide number of entities and individuals. We believe the principal competitive factors in our industry that create certain barriers to entry include reputation, technology, financial stability and resources, proven track record of successful operations, critical mass (particularly relating to online poker), regulatory compliance, independent oversight and transparency of business practices. While these barriers will limit those able to enter or compete effectively in the market, it is likely that new competitors will be established in the future, in addition to known current competitors.

New Products and Services

In 2006, we continued to introduce new poker software enhancements and features. We launched a redesigned poker interface. The appealing new design includes enhancements to the main lobby, game tables and tournament lobby, making it easier than ever for players to navigate, select their game and stake level, and access key statistics on the game and their play. We also introduced high-speed Thunder Tournaments™, our own unique poker game, Hold’em Blackjack™, and a tournament leader board that provides licensees with new opportunities to create exciting events and gives their players new chances to win. Finally, we provided poker players the ability to launch blackjack or any of our casino games from the poker room. Today, we offer one of the most

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extensive poker offerings on the Internet, ranging from play for fun, 0.15/0.25 to 150/300 games for a wider range of stakes, levels and speed of play, all in the three major currencies (US dollars, British pounds and Euros).

We continued to expand the capacity and resiliency of our poker system through a major upgrade that significantly increases capacity, allows for near-perfect network uptime, enables “live” seamless updates of new features and games, and gives licensees seamless mobility to locate their shared online poker room in markets that offer the best growth opportunities. Today, twelve major licensees use our solution (with Holland Casino expected to come on line in June 2007) and are benefiting from increased player traffic and revenue growth derived from the central poker room they share, which currently attracts more than 6,000 concurrent online players at peak, down from a peak of over 9,000 players earlier in 2006, primarily because of the industry-wide impact of the UIGEA and the exit of Betfair and the Ritz Club Online from the poker room in the fourth quarter.

As a result, our Internet poker fees rose 25.6% reaching $33.9 million (2005: $27.0 million) and exceeded the industry growth rate of 21.0% (source: GBGC). These fees accounted for 32.6% of revenue (2005: 31.3%).

In 2006, we continued to expand our game suite in our core casino business with a succession of new themes and variations. New games help re-energize players and drive increased revenue for our licensees and CryptoLogic. During 2006, we released more than 49 casino games between two major releases, including:

• More of our multi-currency jackpot video slot games featuring popular Marvel action characters, including Thor, Silver Surfer, Elektra, and Ghost Rider, which brands have been exclusively licensed for CryptoLogic-developed games;

• The first and only play-for-real slot version of Cubis^TM, the highly popular, award-winning, three-dimensional puzzle game that is among the most popular games played on AOL, MSN and other major portals. CryptoLogic has the exclusive license to Cubis^TM in online gaming for five years;

• Texas Hold’em Bonus Poker^TM—the first-ever online version of the popular land-based casino game, combining the popularity of poker with the excitement of a casino card game; and

• Frightmare Jackpot Slots—classic horror-themed jackpot and bonus slots featuring armies of the undead, warlocks and witches

Together, these new game releases represented over 20% of licensee revenue in December 2006. As a result of new game introductions, our online casino revenue rose 11.7% to $59.2 million in 2006 (2005: $53.0 million), despite the fact that this market is more developed. Internet casino remains our core business, representing 56.9% of our total revenue in 2006 (2005: 61.4%).

During 2006, we also introduced support in our e-cash software for Click2Pay, a payment method that is extremely popular in the German market. We have also enhanced our back-office offering with improved business intelligence and data mining solutions to help our licensees retain and re-activate lapsed players. Finally, we introduced the “Interactive Intelligence” technology platform for our 24/7 contact centre, which automatically routes player requests, whether by telephone, fax, emails or chat, to the best representative. The new support system improves player retention through faster, more personal service by connecting players with customer service representatives who have the right skill set in the right language.

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Intellectual Property

As a leading software developer in the Internet gaming industry, our business is based on licensing our gaming software and related proprietary e-commerce technology and support services through WagerLogic. Licensing contracts generally extend three years in term, are exclusive and have renewal provisions, which provide us with a recurring revenue stream. We rely on a combination of laws and contractual provisions to establish and protect our rights in our software and proprietary technology. We believe that our competitive position is in part dependent upon our ability to protect our proprietary information and technology. We generally enter into non-disclosure and invention agreements with employees, licensees, consultants and customers, and historically have provided restricted access to our software products’ source codes. Our source codes are proprietary to us and we attempt to protect the source code versions of our products as trade secrets and unpublished copyrighted works. Despite our precautions and measures implemented to protect against such attempts, unauthorized parties may have or could in the future copy or otherwise reverse engineer portions of our product or otherwise obtain and use information that we regard as proprietary.

We have patents and trademarks in certain jurisdictions and are in the process of applying for further trademark registrations and patents, which may provide protection in relevant jurisdictions. However, there can be no assurance that this will be sufficient to fully protect our proprietary technology. In addition, certain provisions of our license agreements, including provisions protecting against unauthorized use, transfer and disclosure, may be found to be unenforceable in certain jurisdictions.

We believe that patent, trademark, copyright and other legal protections are less significant to our success than other factors such as the knowledge, ability and experience of our personnel, new product and service developments, frequent product enhancements, customer service and ongoing product support.

We also have a proprietary interest in our name. The names “CryptoLogic” and “WagerLogic” have become well known in the Internet gaming industry. Accordingly, our competitive position could be affected if our name was misappropriated and our reputation compromised.

There can be no assurance that the steps we have taken to protect our proprietary rights will be adequate to deter misappropriation of our technology or independent development by others of technologies that are substantially equivalent or superior to our technology. Any misappropriation of our name, technology or development of competitive technologies could have a material adverse effect on our business, revenues, operating results and financial condition.

We also have licensing agreements with third parties for intellectual property that we use in the provision of our gaming software and services, which are subject to renewal. Management is not aware of any instances where the Company has breached others’ intellectual property; however due to the complex and sophisticated nature of the business, there can be no assurance that there has been no unintentional breach of some parties’ intellectual property rights.

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Cycles

Historically, we have experienced slower revenues in the second and third quarters, as the use of the Internet is not as strong in the summer months, when players tend to spend less time indoors and at their computers. Typically, our first and fourth quarters (during the winter and fall seasons) are our strongest revenue periods.

Economic Dependence

In 2006, our top 7 licensees accounted for 84% of total revenue. In addition our licensees operate from one licensing jurisdiction. The loss of one or more of these key licensees or their license in their respective jurisdictions or a material change in the terms of the license agreements could have a material adverse effect on our business, revenues, operating results and financial condition. One customer contract comes up for renewal in 2007.

Changes to Contracts

The Company’s online gaming software solution and services are licensed to third-party gaming operators around the world. Licensing contracts generally extend 3 years, are exclusive, and have renewal provisions, which provide us with a long term ongoing revenue stream. Contracts are subject to renewal, renegotiation and may be contingent on certain performance requirements. There can be no assurance that license agreements will be renewed or that there will not be a material change in the terms of the contract, which could adversely affect our business, revenues, operating results and financial condition. One customer contract comes up for renewal in 2007.

Employees

As at December 31, 2006, our Company, including our subsidiaries, employed 400 people, with 256 employees located in Canada and 144 located internationally.

Foreign Operations

The vast majority of our revenues is derived from licensing and support fees in countries outside North America. The Company and our licensees are subject to local laws and regulations in those jurisdictions in which they operate. While some jurisdictions have introduced regulations designed to restrict Internet gaming, others have demonstrated acceptance of such activities. Currently, approximately 85 jurisdictions worldwide regulate or are in the process of legalizing some form of Internet gaming (source: River City Group).

As companies and consumers involved in Internet gaming, including the players of our licensees, are located around the globe, there is uncertainty regarding exactly which government has jurisdiction or authority to regulate or legislate with respect to various aspects of the industry. The uncertainty surrounding the regulation of Internet gaming in the various jurisdictions in which we operate could have a material adverse effect on our business, revenues, operating results and financial condition.

There are certain difficulties and risks inherent in doing business internationally, including the burden of complying with multiple and conflicting regulatory requirements, foreign exchange controls, potential restrictions or tariffs on gaming activities that may be

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imposed, potentially adverse tax consequences and tax risks, and changes in the political and economic stability, regulatory and taxation structures, and the interpretation thereof, of jurisdictions in which the Company and its licensees operate, and in which our licensees’ customers are located, all of which could have a material adverse effect on our business, revenues, operating results and financial condition.

Our ability to expand our business in certain countries will require modification of our products, particularly domestic language availability, currency support and potentially the development of new games that have greater regional appeal. There can be no assurance that we will be able to sustain or increase revenue derived from international operations or that we will be able to penetrate linguistic, cultural or other barriers to new foreign markets.

Risk Factors

CryptoLogic operates in a rapidly changing environment that involves numerous risks and uncertainties, many of which are beyond our control and which could have a material adverse effect on our business, revenues, operating results and financial condition. The following discussion highlights some of these risks and uncertainties. In addition, readers should carefully review the risk factors described in the Company’s 2006 Management’s Discussion and Analysis filed with various Securities Commissions.

Industry Risks

Government Regulation

The Company and our licensees are subject to applicable laws in the jurisdictions in which they operate. At the present time, our licensees hold government licenses to operate Internet gaming sites in the Netherlands Antilles. Some jurisdictions have introduced regulations attempting to restrict or prohibit Internet gaming, while other jurisdictions have taken the position that Internet gaming is legal and have adopted or are in the process of considering legislation to regulate Internet gaming.

While the UK and other European countries such as Malta and Gibraltar are adopting a regulated online gaming approach, opposing views are developing in Europe. Some European countries, including Italy, Germany and France where there are state-owned monopolies, are taking action aimed at banning foreign online gaming operators. Such actions by these European Union (EU) member states are in contrast with a favourably-viewed ruling from the European Court of Justice and have prompted the European Commission (EC) to look at creating new legislation that could harmonize online gaming within the EU, in line with the EC’s goal to encourage a free and open cross-border market.

As companies and consumers involved in Internet gaming are located around the globe, including our licensees and their players, there is uncertainty regarding which government has authority to regulate or legislate the industry. Legislation designed to prohibit Internet gaming was enacted on October 13, 2006 in the United States (UIGEA), and may be adopted in other jurisdictions.

Future decisions may have a material impact on our operations and financial results. There is a risk that governmental authorities may view us or our licensees as having violated the local law of their end users, despite CryptoLogic’s requirement that each licensee is

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licensed to operate an Internet gaming business by the governmental authority of the country in which the gaming servers associated with the licensees’ gaming operations are located. Therefore, there is a risk that civil and criminal proceedings, including class actions brought by or on behalf of public entities or private individuals, could be initiated against us, our licensees, Internet service providers, credit card processors, advertisers and others involved in the Internet gaming industry and could involve substantial litigation expense, penalties, fines, injunctions or other remedies or restrictions being imposed upon us or our licensees or others while diverting the attention of key executives. Such proceedings could have a material adverse effect on our business, revenues, operating results and financial condition.

There can be no assurance that prohibiting legislation will not be proposed and passed in potentially relevant jurisdictions to legislate or regulate various aspects of the Internet or the Internet gaming industry. The burden of compliance with any such legislation may have a material adverse effect on our business, financial condition and results of operations.

There have recently been a number of legal developments associated with the manner in which the business of gaming, and in particular, Internet gaming, is treated in the UK and Continental Europe. Some of these developments can be considered as positive and some as negative. In this regard a brief summary of the regulatory situation in the UK and Europe follows:

United Kingdom

In April 2005, the UK enacted law to regulate online gaming for the first time in that jurisdiction. The British government is currently finalizing the underlying rules and codes and tax structure to establish its new regulatory framework. However, while the regulation of on-line gaming by the United Kingdom is generally considered as being positive, there is no assurance that the UK regulatory regime will provide a commercially-viable market and may create restrictions that can have a material adverse effect on our customers, our business, revenues, operating results and financial condition.

Europe

France and Germany

France and Germany in particular appear to moving towards imposing greater restrictions on internet gaming operators, both by virtue of proposed changes to legislation and through heightened enforcement measures. It is possible that adverse legal developments in these countries could have a material adverse impact on the Company and/or it licensees.

Italy and Spain

With respect to Italy and Spain, recent willingness to regulate certain forms of internet gaming could be perceived as indicative of a liberalization of the internet gaming industry as a whole in those countries. However, at present, the form of regulation put forward by these jurisdictions has failed to create attractive market conditions for our licensees. As such, notwithstanding the fact that these markets may appear to be liberalizing, in practice, they have not liberalized in a manner, or to a degree, that is helpful to the Company or its licensees. The Company and its licensees remain at risk that Italy and Spain may take aggressive action against parties whose operations at are not licensed pursuant to the regulatory regimes established by these countries.

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Holland

It is expected that the agreement with the state-sponsored casino operator, Holland Casino, to supply casino and poker room software for the Dutch market will be very positive for the Company. However, various of the licensees of the Company presently operate in the Dutch market. In the event that the Dutch government seeks to take steps to protect the on-line business of Holland Casino by discouraging other operators from operating the Dutch marketplace, either through changes in legislation or enforcement measures, it is possible that the Company’s licensees could be adversely impacted.

Scandinavia

Governments in most Scandinavian countries have attempted to discourage their citizens from gambling with on-line operators by taxing their citizens’ winnings. Generally speaking, winnings realized through a state sponsored operator are not taxable, but winnings from other sources are. Until such time as the tax authorities in the various countries make an official pronouncement on the manner in which these tax laws will be applied, it is unclear as to what impact these tax policies will have on the business of the Company’s licensees. However, it is expected that individuals gaming with operators based within the EU will not have their winnings taxed in this manner.

Payment Processing

With the enactment of the UIGEA, financial institutions in the United States ceased to accept online gaming transactions This event has had a negative impact on the Internet gaming industry as a whole, on our licensees, and on the Company, as evidenced by lower revenues in the fourth quarter of 2006. There can be no assurance that other financial institutions or credit card issuers outside the United States will not enact additional restrictions. Any such developments would have a material adverse effect on our business, revenues, operating results and financial condition. The loss of a major payment option could have a material adverse affect on our business.

There can be no assurance that our systems and measures in place will or can guarantee protection against fraudulent activities and unauthorized access from minors, which could have a material adverse effect on our reputation, business, revenue, operating results and financial conditions. We attempt to mitigate these concerns with systematic controls and a dedicated fraud team. There is an audit trail for every transaction contrary to land-based gaming activities that are primarily cash processors. As well, we establish relationships with financial institutions that are subject to stringent banking regulations in their respective jurisdictions.

E-commerce Law

In addition to regulations pertaining specifically to online gaming, we may become subject to any number of laws and regulations that may be adopted with respect to the Internet and electronic commerce. New laws and regulations that address issues such as user privacy, pricing, online content regulation, taxation, advertising, intellectual property, information security, and the characteristics and quality of online products and services may be enacted. As well, current laws, which predate or are incompatible with the Internet and electronic commerce, may be applied and enforced in a manner that restricts the electronic commerce market. The application of such pre-existing laws regulating communications or commerce in the context of the Internet and electronic commerce is uncertain. Moreover, it may take years to determine the extent to which existing laws relating to issues such as intellectual property ownership and infringement, libel and personal privacy are applicable to the Internet.

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The adoption of new laws or regulations relating to the Internet, or particular applications or interpretations of existing laws, could decrease the growth in the use of the Internet, decrease the demand for our products and services, increase our cost of doing business or could otherwise have a material adverse affect on our business, revenues, operating results and financial condition.

Business Risks

Internet Viability and System Infrastructure and ReliabilityThe growth of Internet usage has caused frequent interruptions and delays in processing and transmitting data over the Internet. There can be no assurance that the Internet infrastructure or the Company’s own network systems will continue to be able to support the demands placed on it by the continued growth of the Internet, the overall online gaming industry or that of our customers.

The Internet’s viability could be affected if the necessary infrastructure is not sufficient, or if other technologies and technological devices eclipse the Internet as a viable channel.

End-users of our software depend on Internet service providers, online service providers and our system infrastructure for access to the Internet gaming sites operated by our licensees. Many of these services have experienced service outages in the past and could experience service outages, delays and other difficulties due to system failures, stability or interruption. Our licensees may lose customers as a result of delays or interruption in service, including delays or interruptions relating to high volumes of traffic or technological problems. As a result, we may not be able to meet a level of service that we have contracted for, and we may be in breach of our contractual commitments, which could materially adversely affect our business, revenues, operating results and financial condition.

Market Demand

The Internet gaming industry continues to evolve rapidly and is characterized by an increasing number of market entrants. The demand and acceptance for new products and services are subject to a level of uncertainty and growing competition, and if our production services do not continue to receive market acceptance, our business, revenues, operating results and financial condition could be materially adversely affected.

Security

Our Internet gaming software and electronic commerce services are reliant on technologies and network systems to securely handle transactions and user information over the Internet, which may be vulnerable to system intrusions, unauthorized access or manipulation. As users become increasingly sophisticated and devise new ways to commit fraud, our security and network systems may be tested and subject to attack. We have experienced such system attacks in the past and implemented measures to protect against these intrusions. However, there is no assurance that all such intrusions or attacks will or can be prevented in the future, and any

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system intrusion/attack may cause a delay, interruption or financial loss, which could have a material adverse effect on our business, revenue, operating results and financial condition.

Reliance on Other Parties

Our electronic commerce product relies on Internet Service Providers (ISPs) to allow our licensees’ customers and servers to communicate with each other. If ISPs experience service interruptions, it may prevent communication over the Internet and impair our ability to carry on business. In addition, our ability to process e-commerce transactions depends on bank processing and credit card systems. In order to prepare for system problems, we are strengthening and enhancing our current facilities and the capability of our system infrastructure and support. Nevertheless, any system failure as a result of reliance on third parties, including network, software or hardware failure, which causes a delay or interruption in our e-commerce services could have a material adverse effect on our business, revenues, operating results and financial condition.

Competition

Licensees of our software compete with existing and established recreational services and products, in addition to other forms of entertainment. Our success will depend, in part, upon our ability to enhance our products and services to keep pace with technological developments, respond to evolving customer requirements and achieve continued market acceptance.

We compete with a number of public and private companies, which provide electronic commerce and/or Internet gaming software. In addition to known current competitors, traditional land-based casino operators and other entities, many of which have significant financial resources, an entrenched position in the market and name-brand recognition, may provide Internet gaming services in the future, and thus become our competitors. As well, such companies may be able to require that their own software, rather than the software of others, including our gaming software or our e-cash systems and support be used in connection with their payment mechanisms.

The barriers to entry into most Internet markets are relatively low, making them accessible to a wide number of entities and individuals. We believe the principal competitive factors in our industry that create certain barriers to entry include reputation, technology, financial stability and resources, proven track record of successful operations, critical mass (particularly relating to online poker), regulatory compliance, independent oversight and transparency of business practices. While these barriers will limit those able to enter or compete effectively in the market, it is likely that new competitors will be established in the future, in addition to our known current competitors.

Increased competition from current and future competitors has and may in the future result in price reductions and reduced margins, or may result in the loss of market share, any of which could materially adversely affect our business, revenues, operating results and financial condition.

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Dependence on Licensees

In fiscal 2006, our top 7 licensees accounted for 84% (2005: 90%) of our total revenue. In addition, all our key licensees operate from one licensing jurisdiction. The loss of one or more of these key licensees, or the loss of their license in their respective jurisdictions, could have a material adverse effect on our business, revenues, operating results and financial condition.

Chargebacks

We are subject to exposure in regard to chargebacks, which may also result in possible penalties and shut off of the payment option. Chargebacks are any deposit transaction credited to a user’s account that is later reversed or repudiated. While the Company has fraud control measures to minimize exposure and provision for chargebacks, this factor could have a material adverse effect on our business, revenues, operating results and financial conditions.  

Foreign Operations

As companies and consumers involved in Internet gaming, including the players of our licensees, are located around the globe, there is uncertainty regarding exactly which government has jurisdiction or authority to regulate or legislate with respect to various aspects of the industry. The uncertainty surrounding the regulation of Internet gaming in the various jurisdictions in which we operate could have a material adverse effect on our business, revenues, operating results and financial condition.

There are certain difficulties and risks inherent in doing business internationally, including the burden of complying with multiple and conflicting regulatory requirements, foreign exchange controls, potential restrictions or tariffs on gaming activities that may be imposed, potentially adverse tax consequences and tax risks, and changes in the political and economic stability, regulatory and taxation structures, and the interpretation thereof, of jurisdictions in which we, our subsidiaries and our licensees operate, and in which our licensees’ customers are located, all of which could have a material adverse effect on our business, revenues, operating results and financial condition.  

There can be no assurance that we will be able to sustain or increase revenue derived from international operations or that we will be able to penetrate linguistic, cultural or other barriers to new foreign markets.

Foreign Exchange

Our financial results are reported in US currency, which is subject to fluctuations in respect of the currencies of the countries in which we operate, including British pound sterling, Euros, and Canadian dollars. Accordingly, fluctuations in the exchange rate of world currencies could have a positive or negative effect on our reported results. We may utilize a hedging program from time to time and/or take advantage of the natural hedge in having operations in multiple currencies to mitigate a portion of our currency risks, but there can be no assurance that we will not experience currency losses in the future, which could have a material adverse effect on our business, revenues, operating results and financial condition.

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Legal Proceedings

We, and certain of our subsidiaries, may be involved in litigation arising in the ordinary course and conduct of business. The outcome of such matters cannot be predicted with certainty, and could have a material adverse effect on our business, revenues, operating results and financial condition.

Moreover, from time to time, third parties have asserted and may continue to assert patent, trademark, copyright and other intellectual property rights to technologies or business methods that we consider important. There can be no assurance that the assertion of such claims will not result in litigation or that we would prevail in any such litigation or be able to obtain a license for the use of any infringed intellectual property from a third party or, if such a license is required, that it would be available on terms acceptable to us.

Intellectual Property

We rely on a combination of laws and contractual provisions to establish and protect our rights in our software and proprietary technology. We believe that our competitive position is dependent in part upon our ability to protect our proprietary technology. We generally enter into non-disclosure and invention agreements with employees, licensees, consultants and customers, and historically have restricted access to our software products’ source codes. We regard our source codes as proprietary information, and attempt to protect the source code versions of our products as trade secrets and unpublished copyrighted works. Despite our precautions and measures implemented to protect against such attempts, unauthorized parties may have or could in the future copy or otherwise reverse engineer portions of our products or otherwise obtain and use information that we regard as proprietary.

Our Company has patent and trademarks in certain jurisdictions and is in the process of applying for further trademark registrations and patents, which may provide such protection in relevant jurisdictions. However, there can be no assurance that this will be sufficient to fully protect our proprietary technology. In addition, certain provisions of our license agreements, including provisions protecting against unauthorized use, transfer and disclosure, may be found to be unenforceable in certain jurisdictions.

We believe that patent, trademark, copyright and other legal protections are less significant to our success than other factors such as the knowledge, ability and experience of our personnel, new product and service developments, frequent product enhancements, customer service and ongoing product support.  

We also have a proprietary interest in our name. The names “CryptoLogic” and “WagerLogic” have become known in the Internet gaming industry. Accordingly, our competitive position could be affected if our name was misappropriated and our reputation in any way compromised.

There can be no assurance that the steps we have taken to protect our proprietary rights will be adequate to deter misappropriation of our technology or independent development by others of technologies that are substantially equivalent or superior to our technology.

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Any misappropriation of our name, technology or development of competitive technologies could have a material adverse effect on our business, revenues, operating results and financial condition.

Due to the complex, sophisticated and global nature of the business, there can be no assurance that there has been no breach of third parties’ intellectual property rights by the Company, and any adverse judgement in this regard could have a material adverse effect on our business, revenues, operating results and financial condition.

Hiring and Retaining Employees

Our future success is dependent on certain key management and technical personnel. The loss of these individuals or the inability to attract and retain highly qualified employees and advisors could have a material adverse effect on our business, revenues, operating results and financial condition.

Managing Rate of Growth

We have a history of growth. The expansion of our business and the increasing complexity of our product offerings, coupled with the rapid evolution of our markets, and increasing competition that will put pressure on margins have placed, and are expected to continue to place, a significant strain on our management and operational resources and to increase demands on our internal systems, procedures and controls. Our future operating results will depend on management’s ability to develop and manage growth, enhance our products and services to respond to market demand, deal with competition and evolving customer requirements, manage our system infrastructure and requirements to meet the growing demands of our business, hire and retain significant numbers of qualified employees, accurately forecast revenues and control expenses. A decline in the growth rate of our revenues without a corresponding and timely slowdown in our expenses, or our inability to manage or build future growth efficiently, could have a material adverse effect on our business, revenues, operating results and financial condition.

Future Acquisitions and Investments

As part of our business strategy, we may make acquisitions of, or significant investments in, businesses or technology that offer complementary products, services, and technologies. Any acquisition or investment will be accompanied by risks, including the difficulty of assimilating the operations and personnel of the acquired businesses; the potential diversion of the attention of management from our business; the inability of management to maximize the financial and strategic position of our Company or returns from the investment or acquired businesses; changing technology approach and requirements, the maintenance of uniform standards, controls, procedures and policies; and the impairment of relationships with employees and clients as a result of and integration of the investment, acquisition or new personnel.

Stock Volatility

The market price of our common shares has experienced significant fluctuation and may continue to fluctuate significantly. The market price of our common shares may be adversely affected by various factors, such as proposed Internet gaming legislation or

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enforcement of existing laws, the loss of a customer, the announcement of new products or enhancements, innovation and technological changes, quarterly variations in revenue and results of operations, changes in earnings estimates by financial analysts, speculation in the press or analyst community and general market conditions or market conditions specific to particular industries, including the Internet and gaming.

In addition, the stock market has from time to time experienced extreme price and volume fluctuations. These company-specific or broad market fluctuations may adversely affect the market price for our common shares. Anti-online gaming legislation could also impact our ability to remain listed.

Although our common shares are listed and traded on the Toronto Stock Exchange, the NASDAQ National Market and the London Stock Exchange’s Main Market, this should not imply that there will always be a liquid market in our common shares.

Item 5:    DIVIDENDS

On September 10, 2003, CryptoLogic’s Board of Directors adopted a quarterly dividend policy, the first in our history. The Board declared our inaugural quarterly dividend of $0.03 per common share (annual rate of $0.12), paid on November 24, 2003. On November 4, 2004, CryptoLogic’s Board approved an increase in our quarterly dividend from $0.03 to $0.05 per common share (annual rate of $0.20), commencing with the quarterly dividend paid on December 15, 2004. On the dividend’s third anniversary, a subsequent increase to $0.07 per common share per quarter (annual rate of $0.28) was announced on November 1, 2005, commencing with the quarterly dividend paid December 15, 2005. On May 9, 2006, the Company announced a further increase to $0.12 per share (annual rate of $0.48). On February 14, 2007, a dividend of $0.12 per share was announced, the same rate as the prior four quarters. Each future quarterly dividend will be subject to Board approval based on the Company’s financial results.

Item 6:    DESCRIPTION OF CAPITAL STRUCTURE

Our authorized capital consists of an unlimited number of common shares. As of December 31, 2006, there were 13,641,234 common shares issued and outstanding. The common shares entitle holders to one vote per share at all shareholder meetings. Common shareholders are also entitled to receive any dividends declared by the Board of Directors.

Item 7:    MARKET FOR SECURITIES

Our common shares have been listed for trading on the Toronto Stock Exchange since September 30, 1998 under the symbol “CRY”, on the NASDAQ Global Select Market (formerly NASDAQ National Market) since March 20, 2000 under the symbol “CRYP”, and on the Main Market of the London Stock Exchange since September 15, 2003 under the symbol “CRP.” The following table provides the monthly trading information of the Company’s shares on the Toronto Stock Exchange for the year ended December 31, 2006*:

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* Trading information is in Canadian dollars, except the number of trades and volume traded.

Item 8:    DIRECTORS AND OFFICERS

The names of the directors and senior officers of our Company at March 28, 2007, their municipalities of residence, their respective positions with our Company and the date upon which they were first elected as a director or officer of CryptoLogic are set out in the table below:

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Name and Municipality of Residence	Principal Occupation	Date of First Election as Director(5)/Officer	Common Shares Held as at March 28, 2007(6)	Options Held as at March 28, 2007(6	LTIP Units Held as at March 28, 2007
Robert H. Stikeman(2)(4) Toronto, Ontario	•     Chairman of the Board and Director of the Company •     Partner, Stikeman, Graham, Keeley & Spiegel LLP (a law firm)	March 7,1996	5,000	92,000	Nil
Randall Abramson(1)(3)(4) Toronto, Ontario	•     Director of the Company •     President, Trapeze Capital Corp. and co-founder and Chief Executive Officer of its affiliate, Trapeze Asset Management Inc.	May 1, 2003	0	9,999	Nil
Stephen H. Freedhoff, CA, CFP(1)(2)(3) Toronto, Ontario	•     Director of the Company •     Self-employed consultant	May 1, 2003	0	13,333	Nil
Lewis N. Rose, CA(7) Toronto, Ontario	•     Director of the Company •     President and CEO of the Company	July 15, 2002	10,000	Nil	8,000
Nigel Simon(1)(3) London, England	•     Director of the Company •     Self-employed consultant	September 2, 2005	1,600	55,000	Nil
Stephen B. Taylor, CA Toronto, Ontario	•     CFO of the Company	August 8, 2005	3,700	77,500	25,000
Michael Starzynski Toronto, Ontario	•     CTO of the Company	March 17, 2003	5,000	28,750	37,500
Andrew Goetsch Toronto, Ontario	•     VP, Poker Software Development	December 20, 2004	500	56,500	22,500
Justin Thouin Toronto, Ontario	•     VP, Casino Software Development	August 1, 2006	0	30,250	14,500
Marilyn Shabot Toronto, Ontario	•     VP, Human Resources	January 14, 2003	0	5,000	4,500

Notes:

1. Member of Audit Committee

2. Member of Corporate Governance & Compliance Committee

3. Member of Compensation Committee

4. Member of Nominating Committee

5. Each director is elected annually to hold office until the next annual meeting of shareholders.

6. Common shares beneficially owned, directly or indirectly, or exercised control or direction over by director or officer

7. Lewis Rose was appointed Interim President and CEO of the Company on July 15, 2002 and appointed President and CEO on March 7, 2003

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As of March 28, 2007, the directors and officers of the Company, as a group, beneficially owned, directly or indirectly, or exercised control or direction over 0.19% of the issued and outstanding common shares of the Company.

Further details for each of the directors and officers set out in the above table and their respective positions held for the last five years are noted below.

Robert H. Stikeman was named Chairman of the Board in May 2003, has been a Director since May 2002 and also serves as the Company’s Secretary. He has been a partner for the past 20 years in Stikeman, Graham, Keeley & Spiegel LLP, a law firm he was instrumental in establishing. His firm acts as outside counsel to the Company. Mr. Stikeman plays a key role in guiding CryptoLogic’s legal and compliance strategies, and has since 1996. He is also Chairman of two Board committees: the Nominating Committee and the Compliance and Corporate Governance Committee.

Randall Abramson is co-founder and President of Trapeze Capital Corp. and co-founder and Chief Executive Officer of its affiliate, Trapeze Asset Management Inc., both Toronto-based portfolio management firms for high net worth individuals and institutions. Prior to founding Trapeze Capital and Trapeze Asset, Mr. Abramson was a portfolio manager and analyst at wealth management firm, Connor Clark & Company from 1996 to 1998, and prior thereto, was a portfolio manager and analyst at institutional money manager, Hodgson Roberton Laing Limited (now Yield Management Group) from 1991 to 1996.

Stephen H. Freedhoff, CA, CFP has been a self-employed consultant since July 1999. Previously, he was a partner of a Canadian national accounting firm for 30 years. Mr. Freedhoff is also Chairman of the Company’s Audit Committee.

Lewis N. Rose, CA was appointed Interim President and Chief Executive Officer on July 15, 2002, and was appointed President and Chief Executive Officer on March 7, 2003. Mr. Rose was also appointed to the Board on May 1, 2003. He has two decades of experience in the consumer products, entertainment and financial services sectors in leadership roles at some of North America’s best-known companies.From 2000 to 2002, he was CEO of E-TV Interactive Technologies Inc., a private interactive technology company. From 1998 to 2000, he was President and a Director of Alliance Atlantis Communications Inc., one of the largest publicly traded television and film entertainment companies in Canada, and President and a Director of its predecessor, Atlantis Communications Inc., from 1997 to 1998. Mr. Rose was previously Chief Financial Officer and a Director of Maple Leaf Foods Inc., the largest publicly traded food-processing company in Canada, and President of Maple Leaf’s Grocery Products Division. Before that, Mr. Rose was Assistant Vice President in the Mergers and Acquisition Group of Wood Gundy Inc. (now CIBC World Markets). Mr. Rose obtained his Chartered Accountant designation with Coopers & Lybrand (now PricewaterhouseCoopers).

Nigel Simon has been a self-employed consultant since January 2005. Previously, he held senior management and marketing roles for 20 years with Gallaher Group PLC, an approximately $4 billion FTSE 50 and NYSE-listed international tobacco company based in the UK, with sales in 69 countries and manufacturing locations in the UK, Austria, Kazakhstan, Poland, Romania, Russia, Ukraine and Sweden. Most recently, Mr. Simon led a multi-billion-dollar business in Continental Europe for Gallaher. He served for 7 years as a Main Board Director of Gallaher, held positions as Chairman of Germany’s largest vending retailer, and as a Board member for Germany’s largest convenience store wholesaler. He also serves as a trustee for a major UK charity and as a mentor for the Prince’s trust charity – a charity founded by the Prince of Wales to help less-privileged young adults get their start in business. Mr. Simon is Chairman of CryptoLogic’s Compensation Committee.

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Stephen B. Taylor, CA was appointed Chief Financial Officer on August 8, 2005 and brings more than two decades of experience in financial and business management, public markets, and mergers and acquisitions. Mr. Taylor is a Chartered Accountant. From 2001 to 2005, he was President of BCL Advisors Inc., an investment banking company affiliated with Seale & Associates of Arlington, VA, which he founded. From 2002 to 2004, Mr. Taylor also served as Executive Vice President and Chief Operating Officer of Buffett, Taylor & Associates, a benefits consulting and wellness practice, functioning as Executive in Residence. Previous posts included senior financial and corporate roles at Derlan Industries, a TSX-listed aerospace company; President and Chief Operating Officer of Spellcaster Telecommunications, an early-stage private software company; and Vice President of Mergers and Acquisitions with Ernst & Young’s corporate finance practice. Mr. Taylor spent the first 11 years of his career Coopers & Lybrand (now PricewaterhouseCoopers) auditing multinational clients in the manufacturing, mining and financial services sectors.

Michael Starzynskiwas appointed Chief Technology Officer on March 17, 2003, and has more than 20 years of global information technology experience in both the telecommunications and financial services sectors at some of North America’s largest companies as well as leading entrepreneurial organizations. From 2000 to 2003, he was Chief Technology Officer of Financial Models Company, a leading provider of investment management systems and services. From 1998 to 2000, he was Chief Technology Officer of SRG Software Inc., a software and consulting services company. Previously he was Chief Technology Architect at CGI Canada, and had been thirteen years with Bell Canada, Canada’s leading telecommunication service provider prior to that.

Andrew Goetsch joined CryptoLogic as Vice President, Poker Software Development on December 20, 2004. Mr. Goetsch’s extensive strategic planning and poker experience is helping CryptoLogic continue the development of its software product plans in the online poker market. He is an experienced poker player who has had several final table appearances, and more than 200 “in the money” finishes in tournaments held both online and around the world, including the main event in the 2004 World Series of Poker.

As a senior executive with over 20 years experience in strategic planning, technology, finance and mergers and acquisitions, Mr. Goetsch has increased sales and profits for consumer goods and manufacturing companies. He obtained his Certified Public Accountant designation with Coopers & Lybrand (now PricewaterhouseCoopers).

Justin Thouin is the Vice President of Casino Software Development at CryptoLogic Inc., and has been with the company since July 21, 2003. Mr. Thouin leads the strategic direction of CryptoLogic’s Internet casino suite to ensure that the Company continues to lead the market in innovation. He is responsible for player research to drive game development and for developing strategic partnerships with such top brands as Marvel and Bejeweled. Prior to his tenure at CryptoLogic, Justin worked at Maple Leaf Foods, Canada’s largest food company, in a variety of roles including consumer marketing, sales, and finance. Justin has a Commerce (Honours) degree from Queen’s University in Kingston Ontario, a leading Canadian business school.

Marilyn Shabot was appointed Vice President, Human Resources on January 14, 2003, having joined CryptoLogic in March 2002 as Director, Human Resources. Ms. Shabot has more than 15 years in human resources with extensive experience in recruiting at all levels, department set-up, policy development, group benefit design, training assessment and implementation, and employee relations. From 2000 to 2002, she was Manager of Human Resources with Documentum Canada (The Bulldog Group Inc.), a leading provider of content management solutions. From 1997 to 2000, Ms. Shabot was Manager of Human Resources with Simcoe Parts Service Inc., an affiliate of Honda Canada Manufacturing.

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Conflicts of Interest

Robert Stikeman is Chairman of CryptoLogic’s Board of Directors and reports to the Board, not to management. Mr. Stikeman is a partner in a law firm that provides advice to the Company. While the Company does not believe that there is any material conflict of interest, as in any situation, there is potential for conflict when outside counsel is also a member of the Board. The Company does not believe Mr. Stikeman’s relationship with the Company should reasonably be perceived to materially interfere with his ability to act in the best interests of the Company; however, under Toronto Stock Exchange Guidelines, he is considered a “related director”, as he has a business relationship with the Board as a paid advisor.

Item 9:    AUDIT COMMITTEE AND RELATIONSHIP WITH AUDITOR

Multilateral Instrument 52-110 of the Canadian Securities Administrators (“MI 52-110”) requires the Company to disclose in its Annual Information Form certain information concerning the constitution of its Audit Committee and its relationship with its independent auditor, as set forth in the following:

The Audit Committee’s Charter (Terms of Reference)

The Audit Committee has a charter which is provided in Schedule “A” hereto.

Composition of the Audit Committee

The members of the Audit Committee are Stephen Freedhoff, Randall Abramson and Nigel Simon. All members are “independent” within the meaning of MI 52-110. All members are considered to be “financially literate”. A member is considered financially literate if he has the ability to read and understand a set of financial statements that present a breadth of complexity of accounting issues that are generally comparable to the breadth and complexity of the issues that can be reasonably expected to be raised by the Company’s financial statements. A member of the committee is independent if the member has no direct or indirect material relationship with the Company which could in view of the Board of Directors reasonably interfere with the exercise of the member’s independent judgment.

Relevant Education and Experience

Stephen Freedhoff, CA, CFP was a partner of a Canadian national accounting firm for 30 years and has extensive experience with public company financial reporting. He is Chairman of the Audit Committee.

Randall Abramson is a Chartered Financial Analyst and has been a portfolio manager for 13 years. He is is co-founder and President of Trapeze Capital Corp. and co-founder and Chief Executive Officer of its affiliate, Trapeze Asset Management Inc., both portfolio management firms, and as such has extensive knowledge of public company financial reporting.

Nigel Simon has held senior management roles for 20 years with an approximately $4 billion FTSE 50 and NYSE-listed international company and studied corporate finance at the London Business School in England, and is familiar with financial reporting and accounting issues.

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Reliance on Certain Exemptions

At no time since the commencement of the Company’s recently completed financial year did the Company rely on exemptions in MI 52-110 (2.4), (3.2), (3.3(2)), (3.4), (3.5), (3.6), (3.8) or Part 8.

Audit Committee Oversight

The Audit Committee has not made any recommendations to the Board of Directors to nominate or compensate any external auditor that was not accepted by the Board of Directors.

Pre-Approval Policies and Procedures

The Audit Committee Charter sections 3(2)(f) and (g) require the Audit Committee to review all non-audit engagements of the auditor, and these reviews are individually considered on a case by case basis.

External Auditor Service Fees

The Audit Committee has reviewed the nature and amount of the non-audit services provided by KPMG LLP, to the Corporation to ensure auditor independence. Fees payable to KPMG LLP for audit and non-audit services in the last two fiscal years are outlined in the following table:

Years ended December 31, (In thousands of US dollars)	2006		2005
Audit Fees(1)	$	505	$	294
Audit-Related Fees(2	$	109	$	77
Tax Fees(3)	$	372	$	187
All Other Fees(4)	$	34	$	14
Total:	$	1,020	$	572

Notes:

1. Audit fees were for professional services rendered for the audits of the Company’s consolidated financial statements and subsidiary companies, the review of interim financial statements, the review of accounting disclosure requirements regarding other business activities and review of documents filed with US, Canadian and UK securities regulatory authorities.

2. Audit-related fees were for advisory services related to Sarbanes-Oxley (Section 404).

3. Tax fees were for tax compliance, tax advice and tax planning. These services included the preparation and review of corporate tax returns, assistance with tax audits and transfer pricing matters, expatriate advisory services as well as advisory services relating to federal, provincial and international tax compliance for customs and duties, and regarding common forms of domestic and international taxation (i.e. income tax, VAT, GST and excise taxes).

4. Other fees were for services other than audit fees, audit-related fees and tax fees as described above. These services included probity checks of employees and licensees and call centre advisory.

Item 10:    LEGAL PROCEEDINGS

As at March 28, 2007 (being the latest practicable date prior to the publication of this document) the Company and its subsidiaries are not involved nor have they been involved in any legal or arbitration proceedings (including any such proceedings which are pending or threatened, of which the Company or its subsidiaries are aware) which may have or had in the past 12 months a significant effect on our financial position.

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Given the nature of the business environment in which we operate and the relative strength of our financial position, other third parties have threatened to issue legal proceedings against the Company based on alleged infringement of patents, trademark, copyright and/or other intellectual property rights. None of these threats has as yet resulted in legal proceedings, although there can be no assurance that the assertion of such claims will not result in litigation or that the Company would prevail. An adverse determination in litigation proceedings could subject the Company to significant liabilities to third parties. Although patent and intellectual property disputes are often settled through licensing or similar arrangements, the costs associated with such arrangements may be substantial and could include ongoing royalties. Furthermore, the necessary licences may not be available to the Company on satisfactory terms, if at all.

The Company closely monitors the progress of all threatened litigation and, where the Directors consider it appropriate, makes the appropriate provisions and reserves in its financial statements for litigation contingencies that are likely to result in material exposure and the amount is quantifiable.

Item 11:    TRANSFER AGENTS AND REGISTRARS

The Company’s transfer agents are Equity Transfer & Trust Company Inc. (Toronto, Canada) and Continental Stock Transfer & Trust Company (New York, USA).

Item 12:   NAME OF EXPERTS

KPMG LLP, Chartered Accountants, has audited the consolidated financial statements of the Company for the years ended December 31, 2006 and 2005. KPMG LLP is independent in accordance with the rules of professional conduct of the Institute of Chartered Accountants of Ontario

Item 13:   ADDITIONAL INFORMATION

Additional information regarding the Company, including directors’ and officers’ remuneration, principal holders of the Company’s securities, securities authorized for issuance under equity compensation plans and interests of insiders in material transactions, if applicable, will be contained in the Company’s information circular. Additional financial information is provided in the Company’s comparative consolidated financial statements and notes thereto and Management’s Discussion and Analysis for the fiscal year ended December 31, 2006, which have been filed with the Ontario Securities Commission, the US Securities and Exchange Commission and the London Stock Exchange and will be provided in the Company’s 2006 Annual Report.

Copies of the above documents and additional copies of this Annual Information Form may be obtained upon request by contacting the Company’s Investor Relations Department at the head office located at 55 St. Clair Avenue West, 3^rd Floor, Toronto, Ontario, Canada, M4V 2Y7, telephone: 416-545-1455, fax: 416-545-1454, e-mail: investor.relations@cryptologic.com and have been filed and are available on SEDAR (www.sedar.com).

Marvel and all related character names and the distinctive likeness thereof: TM and © 2007 Marvel Characters, Inc. All rights reserved. www.marvel.com

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SCHEDULE A – AUDIT COMMITTEE TERMS OF REFERENCE

1 PURPOSE

The overall purpose of the Audit Committee (the “Committee”) of the Company is to monitor the Company’s system of internal financial controls and procedures, to evaluate and report on the integrity of the financial statements of the Company, to enhance the independence of the Company’s external auditors and to oversee the financial reporting process of the Company.

2. COMPOSITION, PROCEDURES AND ORGANIZATION

2.1 The Committee shall consist of at least three members of the board of directors of the Company (the “Board”), each of whom shall be, in the determination of the Board, “unrelated” as that term is defined by the Toronto Stock Exchange Corporate Governance Guidelines, as amended from time to time, and Multilateral Instrument 52-110 where applicable, and the majority of whom shall be resident Canadians.

2.2 At least one member of the Committee shall be, in the determination of the Board, based on industry standards, “financially literate”, and at least one member of the Committee must have, in the determination of the Board, “accounting or related financial expertise”.

2.3 For the purposes of these terms of reference, a person is “financially literate” who, in the determination of the Board, based on industry standards, has the ability to understand financial statements of a breadth and level appropriate for complexity appropriate for the Company, and to evaluate the appropriateness and quality of financial reports to unit holders, with reference to balancing management’s objectives, investor pressures for earnings and revenues, balance with generally accepted accounting principles and auditing standards, and underlying business performance.

2.4 For the purposes of these terms of reference, a person who has “accounting or related financial expertise” has, through education and experience as a public accountant or auditor or a principal financial officer, comptroller or principal accounting officer of an issuer, or from a position involving the performance of similar functions: (i) an understanding of Canadian generally accepted accounting principles, auditing standards, and financial statements; (ii) experience in the preparation or auditing of financial statements of generally comparable issuers, and (b) the application of Canadian generally accepted accounting principles and standards in connection with the accounting for estimates, accruals and reserves; (iii) experience with internal accounting controls and procedures and the verification of same; and (iv) an understanding of audit committee functions.

2.5 The Board, at its organizational meeting held in conjunction with each annual meeting of shareholders, shall appoint the members of the Committee for the ensuing year. The Board may at any time remove or replace any member of the Committee and may fill any vacancy in the Committee. Any member of the Committee ceasing to be a director shall cease to be a member of the Committee.

2.6 Unless the Board shall have appointed a chair of the Committee, the members of the Committee shall elect a chair from amongst their number. The chair shall be an “unrelated” director and shall not have a second, or casting, vote.

2.7 The Committee shall have access to such officers and employees of the Company and to the Company’s external auditors and its legal counsel, and to such information respecting the Company as it considers to be necessary or advisable in order to perform its duties.

2.8 Notice of every meeting shall be given to the external auditors, who shall, at the expense of the Company, be entitled to attend and to be heard thereat.

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2.9 Meetings of the Committee shall be conducted as follows:

(a) the Committee shall meet on a regular basis, at such times and at such locations as the chair of the Committee shall determine;

(b) the external auditors or any member of the Committee may call a meeting of the Committee;

(c) any director of the Company may request the chair of the Committee to call a meeting of the Committee and may attend such meeting to inform the Committee of a specific matter of concern to such director, and may participate in such meeting to the extent permitted by the chair of the Committee;

(d) the external auditors and management employees shall, when required by the Committee, attend any meeting of the Committee; and

(e) the Committee may require any attendee at a meeting who is not an “unrelated” director to excuse himself from any meeting.

2.10 The external auditors may communicate directly with the chair of the Committee and may meet separately with the Committee. The Committee, through its chair, may contact directly any employee in the Company as it deems necessary, and any employee may bring before the Committee through the chair any matter involving questionable, illegal or improper practices or transactions, with open access to the Committee through appropriate channels that ensure the employee’s confidentiality and job security, as appropriate.

2.11 Compensation to members of the Committee shall be limited to director’s fees, either in the form of cash or equity, and members shall not accept consulting, advisory or other compensatory fees from the Company (other than as members of the Board and Board committee members).

2.12 The Committee as a whole or any individual member of the Committee is authorized, at the Company’s expense, to retain independent counsel and other advisors as it determines necessary to carry out its duties.

3. DUTIES

3.1 The overall duties of the Committee shall be to:

(a) assist the Board in the discharge of its duties relating to the Company’s accounting policies and practices, reporting practices and internal controls;

(b) establish and maintain a direct line of communication with the Company’s external auditors and assess their performance;

(c) oversee the co-ordination of the activities of the external auditors;

(d) ensure that the management of the Company has designed, implemented and is maintaining an effective system of internal controls;

(e) monitor the credibility and objectivity of the Company’s financial reports and satisfy itself that adequate procedures are in place for the review of Company information extracted from the financial statements;

(f) report regularly to the Board on the fulfillment of the Committee’s duties;

(g) establish procedures for the receipt and retention of complaints received by the Company regarding accounting, audit, and control matters;

(h) assist the Board in the discharge of its duties relating to risk assessment and risk management; and

(i) review and approve the hiring policies regarding employees or former employees of the external auditor.

3.2 The duties of the Committee as they relate to the external auditors shall be to:

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(a) review management’s recommendations for the appointment of external auditors, and in particular their qualifications and independence, and to recommend to the Board a firm of external auditors to be engaged to provide audit services;

(b) review, where there is to be a change of external auditors, all issues related to the change, including the information to be included in the notice of change of auditor called for under National Policy 31 or any successor legislation, and the planned steps for an orderly transition;

(c) review all reportable events, including disagreements, unresolved issues and consultations, as defined in National Policy 31 or any successor legislation, on a routine basis, whether or not there is to be a change of external auditor;

(d) review the engagement letters of the external auditors, both for audit and non-audit services and recommend to the Board their compensation;

(e) review the performance, including the fee, scope and timing of the audit and other related services and any non-audit services provided by the external auditors;

(f) review the nature of and fees for any non-audit services performed for the Company by the external auditors and with outside legal advice confirm that the nature and extent of such services does not contravene the requirements of applicable legislation that require the firm’s independence be maintained in carrying out the audit function; and

(g) pre-approve all non-audit services to be provided to the Company or its affiliates by the external auditor.

3.3 The duties of the Committee as they relate to audits and financial reporting shall be to:

(a) review the audit plan with the external auditor and management;

(b) review with the external auditor and management any proposed changes in accounting policies, the presentation of the impact of significant risks and uncertainties, and key estimates and judgments of management that may in any such case be material to financial reporting;

(c) review the contents of the audit report;

(d) question the external auditor and management regarding significant financial reporting issues discussed during the fiscal period and the method of resolution;

(e) review the scope and quality of the audit work performed;

(f) review the adequacy of the Company’s financial and auditing personnel;

(g) review the co-operation received by the external auditor from the Company’s personnel during the audit, any problems encountered by the external auditors and any restrictions on the external auditor’s work and resolve disagreements between management and the external auditor regarding financial reporting;

(h) review the internal resources used;

(i) review the evaluation of internal controls by the internal auditor (or persons performing the internal audit function) and the external auditors, together with management’s response to the recommendations, including subsequent follow-up of any identified weaknesses;

(j) review the appointments of the chief financial officer, internal auditor (or persons performing the internal audit function) and any key financial executives involved in the financial reporting process;

(k) review and recommend to the Board, the Company’s annual audited financial statements and those of its subsidiaries in conjunction with the report of the external auditors thereon, and obtain an explanation from management of all significant variances between comparative reporting periods before release to the public;

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(1) review and recommend to the Board, the Company’s interim unaudited financial statements, MD&A and press release, and obtain an explanation from management of all significant variances between comparative reporting periods before release to the public;

(m) establish a procedure for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters and employees’ confidential anonymous submission of concerns regarding accounting and auditing matters;

(n) review the terms of reference for an internal auditor or internal audit function;

(o) recommend to the Board each year the external auditor to be nominated , and their compensation

3.4 The duties of the Committee as they relate to accounting and disclosure policies and practices shall be to:

(a) review changes to accounting principles of the Canadian Institute of Chartered Accountants and their US and UK counterparts which would have a significant impact on the Company’s financial reporting as reported to the Committee by management and the external auditors;

(b) review the appropriateness of the accounting policies used in the preparation of the Company’s financial statements and consider recommendations for any material change to such policies;

(c) review the status of material contingent liabilities or accruals as reported to the Committee by management;

(d) review the status of income tax returns and potentially significant tax problems as reported to the Committee by management;

(e) review any errors or omissions in the current or prior year’s financial statements and establish guidelines for re-statement;

(f) review and approve before their release all public disclosure documents containing audited or unaudited financial information, including all press releases, prospectuses, annual reports to shareholders, annual information forms and management’s discussion and analysis;

(g) oversee and review all financial information and earnings guidance provided to analysts and rating agencies; and,

(h) ensure adequate procedures are in place for management review of public disclosure of financial information as required by statute

3.5 The other duties of the Committee shall include:

(a) reviewing any inquires, investigations or audits of a financial nature by governmental, regulatory or taxing authorities;

(b) formulating clear hiring policies for employees or former employees of the Company’s external auditors;

(c) reviewing annual operating and capital budgets;

(d) reviewing the funding and administration of the Company’s compensation and pension plans;

(e) reviewing and reporting to the Board on difficulties and problems with regulatory agencies which are likely to have a significant financial impact;

(f) inquiring of management and the external auditors as to any activities that may be or may appear to be illegal or unethical; and

(g) any other questions or matters referred to it by the Board.

EX-2

EXHIBIT 2

Management’s Discussion and Analysis

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s President and Chief Executive Officer and the Chief Financial Officer and effected by the Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

It includes those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the Company, provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures are made only in accordance with authorization of management and the Board of Directors, and that prevention or timely detection of the unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the annual or interim financial statements of the Company, is assured.

Management assessed the design effectiveness of internal control over financial reporting as at December 31, 2006. Based on this assessment, management concludes that, as of December 31, 2006, internal control over financial reporting is effective. Also, management determined that there were no material weaknesses in the Company’s internal control over financial reporting as at December 31, 2006.

For the year ended December 31, 2006, no change occurred in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Lewis Rose

President and Chief Executive Officer

Stephen Taylor

Chief Financial Officer

Toronto, Canada, March 16, 2007

INTRODUCTION

The following report contains management’s discussion and analysis (“MD&A”) of CryptoLogic’s consolidated results of operations and financial condition for the year ended December 31, 2006 in comparison with the year ended December 31, 2005,

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

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and should be read in conjunction with the audited consolidated financial statements and accompanying notes. This MD&A is dated March 16, 2007.

CryptoLogic and our subsidiaries are referred to collectively as “CryptoLogic”, “the Company”, “we”, “us”, and “our” throughout this MD&A, unless otherwise specified.

All currency amounts are in US dollars, unless otherwise indicated. Some figures and percentages may not total exactly due to rounding.

The Company and its subsidiaries maintain a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to Multilateral Instrument 52-109 is recorded, processed, summarized and reported within the time periods specified in the Canadian Securities Administrators’ rules and forms. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the disclosure controls and procedures as of December 31, 2006 and concluded that the current disclosure controls and procedures are effective at the reasonable assurance level.

Statements in this document, which are not historical, are forward-looking statements made pursuant to the safe harbour provisions of the Private Securities Litigation Reform Act of 1995. It should be noted that the forward-looking statements in this document are based on management’s best estimates of the current operating environment. These statements are related to, but not limited to, our operations, anticipated financial performance, business prospects and strategies. Forward-looking information typically contains statements with words such as “may”, “would”, “could”, “should”, “will”, “intend”, “seek”, “propose”, “anticipate”, “believe”, “expect”, “plan” or similar expressions suggesting future outcomes. Such forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from future results expressed, projected or implied by such forward-looking statements. Such factors include, but are not limited to, risks associated with the Company’s financial conditions, legal risks associated with Internet gaming and risks of government legislation and regulation, market acceptance and technological changes, dependence on licensees and key licensees, international operations and increased competition. A description of these factors can be found in the section contained herein titled “Risks and Uncertainties.” CryptoLogic does not intend, and does not assume any obligations, to update these forward-looking statements.

BUSINESS OVERVIEW

Founded in 1995, CryptoLogic is a pioneer and a global leading software developer and services provider to the Internet gaming market, outside of the United States, around the world through offices in Cyprus and the UK. Today, we are one of the industry’s longest-established publicly traded online gaming software companies, with our software development operations in Toronto, Canada. Our wholly-owned subsidiary, WagerLogic Limited (“WagerLogic”), provides software hosting and

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licensing, e-cash systems and support, customer support and marketing support services for our Internet gaming software to third-party gaming operators.

CryptoLogic’s software offers a complete online gaming solution to licensees which is comprised of:

1. A broad, turn-key Internet-based game suite featuring:

• more than 260 download and non-download casino table and slot games

• player-to-player poker

• multi-languages (English, Spanish, Greek, Japanese, Chinese, French, German, Italian)

• multi-currencies (US dollars, British pound sterling and Euros)

• multi-platforms (download, non-download (Java and Flash), wireless)

• multi-player bingo;

2. E-cash systems and support for player deposits and withdrawals;

3. Business intelligence and data mining tools to assist licensees in their marketing efforts;

4. Licensee support through WagerLogic’s 24/7 multi-language customer support; and

5. Marketing support services, to assist licensees to develop and execute strategies for marketing their online gaming businesses.

WagerLogic licenses our software products and services to a select international client base(“licensees” or “customers”), while retaining ownership and control of the software. As at December 31, 2006, we had 10 licensees located around the world, including well-known UK and global land-based gaming organizations.

Our licensees operate under government authority where their Internet business subsidiaries are domiciled, in the Netherlands Antilles. During the year, one of our customers was a licensed operator in Alderney, a British Crown Dependency in the Channel Islands, and that customer relationship has since been terminated. We added three new licensees in 2006: DTD Poker; Betsafe.com; and Oceania Caribe Licensing NV (PlayboyGaming). Since December 31, 2006, we have added two new licensees, a private company in Malta operating Parbet.com, and Holland Casino, which is expected to launch in June 2007.

Substantially all of our revenue is of a recurring nature. WagerLogic’s licensees pay an ongoing fee over the contract term for the licensing of our software and services, calculated as a percentage of each licensee’s level of activity. In 2006, 10.5% (2005: 7.3%) of our revenue came from other sources, including software customization, certain marketing support services, advertising services and interest income.

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For the year ended December 31, 2006

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Historically, revenue has been seasonal with slower sales in the summer months (our second and third quarters), when players tend to spend less time indoors and at their computers. Typically, our first and fourth quarters (during the winter and fall seasons) are our strongest revenue periods.

BUSINESS CONDITIONS

Since CryptoLogic was established 11 years ago, there has been significant growth in both our company and the industry. In total, the Internet gaming market including the United States grew from $5.7 billion to approximately $10.7 billion in wagers in the years between 2003 and 2005 (source: Global Betting and Gaming Consultants, February 2007, or “GBGC”). However, on October 13, 2006 the United States, estimated to represent approximately 50% of the global online gaming market, passed the Unlawful Internet Gaming Enforcement Act (UIGEA) which effectively banned online gaming by making it illegal to process the related financial transactions. The Internet casino and Internet poker markets outside the US, the core areas of our business, are expected to continue to grow rapidly. By the end of 2006, after the US ban, the non-US online casino market was estimated to be worth $2.4 billion, and this market is expected to grow by almost 100% to approximately $4.2 billion by 2012. The online poker market outside the US was estimated to be worth $1.6 billion at the end of 2006 and is expected to more than double to $3.5 billion by 2012 (source: GBGC).

While online gaming outside the United States continues to promise vast potential, it is expected to account for only 5.5% of the global gaming revenue by 2012 (source: GBGC). The market is already dominated by major operators. Competition is intensifying for players and market position. The industry is also experiencing consolidation as operators increase market share through acquisition.

In order to grow and remain a market leader, software providers must be able to offer a strong value proposition to their customers to help them respond to players that are increasingly sophisticated and demanding more choice. We must offer an expanding array of new and innovative products and services that enhance the game experience and create opportunities to market to players in order to help customers attract, retain and re-activate players.

STRATEGY UPDATE

CryptoLogic’s growth strategy is designed to capitalize on the growth in key product and geographical markets of the global online gaming industry, and to produce cash earnings despite continuing regulatory uncertainty and an increasingly competitive and sophisticated business environment.

In 2007, CryptoLogic expects financial results to be negatively impacted by reduced revenues arising from the enactment of the UIGEA. Although we shall be vigilant in cutting costs and maintaining cost awareness, we are not planning significant changes to our cost structure as we will use current resources to execute current projects and take advantage of significant revenue-enhancing opportunities we foresee in Europe

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and Asia, our two primary geographical markets, as well as other major international markets.

CryptoLogic remains optimistic about the future of online gaming and the Company’s position as one of the leaders within it. We are in an excellent financial position to build on a global strategy that has led to record results in both 2005 and 2006. In 2007, we are focusing on:

1. Game innovation. Continuing our strategy to enhance and expand our offering with innovative games that increase the entertainment value for players and encourage repeat business, thereby growing sustainable revenue for our customers and CryptoLogic. 

The strategy has been successful to date. We achieved solid double-digit growth in our Internet casino business – up 11.7% in 2006 versus a year ago – and in a gaming sector that is more developed. Our Internet poker fees outpaced the industry – up 25.6% in 2006, which exceeded the average industry growth rate of 21.0% (source: GBGC).

In 2006, we introduced 49 new Internet casino games (25 downloadable and 24 non-downloadable) which are important customer acquisition tools. We also:

•  developed the world’s first and only play-for-real, slot version of the highly popular puzzle game, Cubis^TM;

• added to our popular roster of multi-currency Marvel video slot games, with new versions based on Thor^TM, Silver Surfer^TM, Elektra^TM, GhostRider^TM and others; and

• designed and patented the first-ever online version of Texas Hold’em Bonus Poker, the popular land-based casino game that combines the huge popularity of poker with the excitement of a casino card game.

Meanwhile, the jackpot for our own patented progressive jackpot slot, Millionaires Club™, grew to over five million dollars —a world record for online gaming. All of these innovative concepts are exclusively available to WagerLogic’s licensees.

We also introduced a number of poker enhancements in 2006:

• a major upgrade to our poker platform that significantly increases the capacity for simultaneous online playing, allowing for near-perfect network uptime, enables “live” seamless updates of new features and games, and giving licensees seamless mobility to locate their shared online poker room in markets that offer the best growth opportunities;  

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• an appealing poker software redesign that includes enhancements to the main lobby, game tables and tournament lobby, making it easier than ever for players to navigate, select their game and stake level, and access key statistics on games, tournaments and their play;

• introduced Hold’Em Blackjack^TM, a brand new game developed by CryptoLogic that combines the simplicity of blackjack with the intensity of poker. Hold’Em Blackjack^TM breathes new life into the traditional game of 21 by giving players the betting and bluffing excitement of Texas Hold’Em Poker along with the straightforward play of casino blackjack;

• introduced Thunder Tournaments^TM for high-speed tournament action, broader access to land-based tournaments, and a tournament leader board to give licensees opportunities to create exciting new events;

• launched My Poker Points, a loyalty rewards system; and

• launched a Spanish poker site for William Hill, adding to the Greek site we created for them in 2005. Such localized sites are critical advantages in an increasingly competitive European market.

We also enhanced our back-office and decision-support tools to help our licensees better understand, respond to and target market their players.

2. New customer opportunities. The Company will continue to pursue “blue chip” casino opportunities that meet these rigorous standards:

• an established brand that has presence on the Internet that is compatible with gaming;

• an audience favorable to a casino offering on the Internet; and,

• sufficient resources and commitment to be successful marketing the business. 

We will also aggressively pursue new poker opportunities that will enhance the liquidity of the licensees’ poker network—already one of the world’s largest that excludes US players. Our 2006 upgraded poker platform provides infrastructure and capacity to accept licensees that offer exciting growth potential to contribute to overall poker network liquidity.

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For the year ended December 31, 2006

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In 2006 and early 2007, we added four new branded licensees:

• PlayboyGaming, one of the world’s most recognizable entertainment and lifestyle brands, in both casino and poker. The Playboy brand epitomizes our philosophy of working with blue-chip brands;

• Betsafe, a popular poker site among Scandinavian players. Scandinavia is one of the hottest poker markets in the world;

• DTD Poker, the online home of DUSKTILLDAWN, a new land-based UK poker club scheduled to open in April 2007. Once open, DUSKTILLDAWN will be the largest live poker venue in Europe and the first fully-licensed dedicated poker facility in the UK; and

• Holland Casino, which was engaged as a new licensee in February 2007 in a milestone exclusive three-year agreement, CryptoLogic’s first with a government. CryptoLogic will provide both poker and casino software for Holland Casino, the Dutch government-owned casino operator. The new sites, to be run by Holland Casino under license from the Dutch government, are expected to launch in June 2007, and will be available to residents of the Netherlands only.

In addition, the Company acquired Parbet.com (see Strategic Acquisitions below).

3. Controlling expenditures. Control and optimize expenditures by a thorough, ongoing review of discretionary costs, operating expenses and capital expenditures.

4. Strategic acquisitions. Aggressively pursue strategic, accretive acquisition opportunities including brands that can be licensed to operators to accelerate the advancement of the Company’s strategies. Acquisition opportunities have multiplied since passage of the UIGEA, and the Company will continue to evaluate new and existing prospects.

In January 2007, CryptoLogic achieved its first success under this strategy by completing the purchase of the poker brand and related assets of Parbet.com, a popular Scandinavian online poker room. CryptoLogic companies licensed these Parbet assets, together with poker software, payment processing services and multi-lingual customer support and services, to a private Maltese online gaming Company that will operate Parbet.com. The purchased assets include all rights to the Parbet brand name, associated domain names such as Parbet.com, customer lists, databases and active player accounts.

This purchase extended the Company’s brand ownership and licensing strategy, which it has used very successfully with the award-winning

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InterCasino and InterPoker brands and related brands, such as ExtremePoker, which are licensed by Oceania Internet Gaming Entertainment NV. Under this strategy, WagerLogic owns or controls key brands that it licenses to third party operators, along with its full suite of online gaming software, network services, and marketing support services, in order to generate higher revenue.

5. Expanding in Asia. CryptoLogic intends to expand its Asian presence to become a significant participant in this large, emerging market.

In January 2007 we demonstrated success in executing on this strategy, when we signed a memorandum of understanding with Brilliance Technology Co. (“Brilliance”) and 568 Network Inc. (“Game568”) aimed at entering the high growth, high potential Chinese market.

The three companies plan to establish a new jointly held company in China to adapt our online casino and poker games to the Chinese market, and develop new poker and casual, skill-based games that are more familiar to those markets. Brilliance intends to establish an operator division to deliver the games in two modes: “play-for-fun” subscriptions for users in internet cafés and on mobile devices, and “play-for-money” through retail locations licensed by China Welfare Lottery, the nation’s gaming licensing authority. Brilliance will enter into an exclusive licensing agreement with respect to the new company’s online gaming software and service offering, and will apply for all required gaming licenses.

Cryptologic’s investment will initially be a minority interest in the new company, with an option to increase its investment to a controlling position. Cryptologic will have the right to appoint all members of the board of the new company.

Given our business focus on Europe today and Asia tomorrow, we have proposed to establish our executive headquarters in the Republic of Ireland. We believe that the location offers many benefits:

• brings the Company closer to the world’s major markets that embrace Internet gaming, and therefore, closer to its key customers and customer prospects;

• a gaming-friendly environment that enables the Company to provide a wider range of marketing support and brand management services to licensees and to recruit personnel;

• extends the Company’s strategic acquisition opportunities by operating in the heart of the geographic centers where business opportunities are more likely to arise; and

• is intended to increase trading of the Company’s shares on the London Stock Exchange.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-8-

We are proposing that the headquarter functions of the Chief Executive Officer, the Chief Financial Officer, the Vice President of Human Resources and the head of Investor Relations be transitioned to Ireland. The transition to Ireland will be effected by way of a court and shareholder-approved Plan of Arrangement, expected to be presented to shareholders in the second quarter of 2007.

In executing our strategy, we remain committed to the highest standards of transparency and regulatory compliance, as one of the world’s few providers with government-approved gaming software. We continue to follow disciplined regulatory practices comparable to stringent land-based gaming standards, which subject our company, key personnel, systems and software product to ongoing independent government review.

Strategic Performance Measures

In 2006, CryptoLogic continued to deliver profitable growth, positive operating cash flow and improved return on equity. The following table sets out key financial performance indicators as measures of our progress:

(In thousands of US dollars, except per share data)	2006	2005	2004
Income Statement
Revenue	$104,022	$86,307	$63,714
Re-organization charges re move of HQ to Ireland	$3,700	-	-
EBITDA after reorganization charges(1)	$27,176	$22,303	$17,337
Earnings	$24,812	$20,530	$13,668
Fully Diluted EPS	$1.81	$1.46	$1.01
Financial Position
Cash Flow From Operating Activities	$40,654	$34,721	$18,919
Net Cash(2)	$128,440	$99,134	$85,964
Working Capital (3)	$93,787	$73,569	$62,818
Dividend Per Share/Quarter(4)	$0.12	$0.07	$0.05
Value Measure
Return on Equity	25%	25%	22%

⁽¹⁾ Management believes EBITDA (earnings before interest, taxes, depreciation and amortization) is a useful supplemental measure of performance. However, because EBITDA is not a recognized measure under generally accepted accounting principles (GAAP) and does not have a standardized meaning, it may not be comparable across different companies.

 

CryptoLogic reconciles EBITDA to earnings as follows:

(In thousands of US dollars)	2006	2005	2004
Earnings	$24,812	$20,530	$13,668
Income taxes	$4,679	1,506	2,873
Interest	($7,092)	(3,627)	(1,293)
Amortization	$4,777	3,894	2,089
EBITDA	$27,176	$22,303	$17,337

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-9-

 

⁽²⁾ Net cash includes cash and cash equivalents, short term investments and security deposits.

⁽³⁾ Working capital (current assets minus current liabilities)

⁽⁴⁾ CryptoLogic’s inaugural quarterly dividend of $0.03 per common share (annual rate of $0.12) was first declared on September 10, 2003, and paid November 24, 2003. On November 4, 2004, CryptoLogic’s Board approved an increase in our quarterly dividend from $0.03 to $0.05 per common share (annual rate of $0.20), commencing with the quarterly dividend paid December 15, 2004. A subsequent increase to $0.07 per common share (annual rate of $0.28) was announced on November 1, 2005, commencing with the quarterly dividend paid December 15, 2005. On May 9, 2006, we announced the Board’s decision to increase the dividend to $0.12 per share (annual rate of $0.48), commencing with the quarterly dividend paid on June 15, 2006. On February 14, 2007, a dividend of $0.12 per share was announced, the same rate as the prior four quarters. Each future quarterly dividend will be subject to Board approval based on the Company’s financial results.

ABILITY TO DELIVER RESULTS

CryptoLogic’s competitive advantages have been key to our growth and financial performance, and we believe, will continue to be integral to our future.

Brand name licensees

CryptoLogic works with some well-known international brand name gaming and media customers, such as William Hill, PlayboyGaming, Littlewoods, InterCasino and now Holland Casino. In a market where player trust is critical, we believe the quality of our licensees enhances our opportunities to acquire additional licensees of like stature. Our decade of experience has proven that operators with a trusted brand and an established user base to cross-market new offerings grow sustainable online businesses. In competition with hundreds of gaming sites on the Internet, our licensees must also be committed to market in order to effectively vie for player attention.

CryptoLogic’s disciplined customer strategy continues to produce strong results. We have intentionally reduced our licensee base in recent years to focus on a core group of substantial name brand online and land-based operators. While the number of our licensees has declined to 10 at the end of 2006 from a high of 21 in 2003, CryptoLogic’s revenue and earnings have increased 135% and 163% respectively during that same period.

In 2005, Betfair, one of our poker software licensees, brought its poker software in-house, in line with its long term strategy to own and operate all of its core products. CryptoLogic was compensated by Betfair throughout 2006 for offering them the flexibility to choose their exit date, which was October 31, 2006. Betfair has significant internal technical expertise to bring its offering in-house, which we view as unique to Betfair and not characteristic of online gaming companies. Our other customers, which are primarily gaming and/or casino organizations, continue to benefit from the greater liquidity, outsourced technical expertise and expanding product offering and knowledge developed by CryptoLogic.

We expect that revenue and player growth from continuing licensees in both poker and casino and revenue from new sites launched or launching subsequent to Betfair’s

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-10-

exit, including PlayboyGaming, Betsafe, DTD Poker, Parbet and Holland Casino, will offset the effect of the departure of Betfair and the Ritz in 2006.

CryptoLogic’s record of growing revenue and earnings validates our commitment to work with a targeted group of major licensees to generate the highest returns.

Comprehensive and innovative product portfolio

In an industry characterized by a proliferation of gaming sites, we design our product suite to enable our licensees to satisfy a broad player range of preferences in order to attract more players, generate longer play time and extend the player life value and revenue potential. We conduct extensive player research and competitive benchmarking to drive our software development as well as seek and enter into strategic exclusive partnerships with premier consumer brands such as Marvel, Bejeweled and Cubis^TM to enhance the trust and entertainment value of our game offering.

CryptoLogic delivers a comprehensive product portfolio across the casino and poker markets. We continually expand our online game mix with the latest innovations and entertainment concepts to appeal to increasingly sophisticated players wanting more choice and a more engaging experience.

Internet casino – Our largest revenue and profit contributor is online casino fees – a core market that accounts for approximately 34% of global online gaming revenue excluding the United States (source: GBGC). We achieved 11.7% growth in 2006 casino revenue over 2005, net of a 35.9% decrease in Q4 2006 from 2005. We continually invest in market research and product research and development to ensure a succession of new game concepts, themes and variations to create marketing opportunities for our licensees. This helps to re-energize players, keeps them coming back and drives incremental revenue, and we expect this revenue growth to continue.

CryptoLogic is at the forefront of bringing the latest product innovations and concepts to Internet gaming. We have introduced a number of unique games to the Internet – the first ever and only British pub-style fruit machines; the first to offer play-for-real slot versions of Bejeweled and Cubis, two extremely popular online casual games; the first and only online slots featuring Marvel Super Heroes; the first Internet version of Texas Hold’Em Bonus Poker; and our own patented progressive jackpot slot, Millionaires Club™, which offers world-record online jackpots. Our expertise in offering the depth and complexity of the modern-style casino games demanded by online gamers should contribute to our continued growth and market leadership in this lucrative game area.

Internet poker – Online poker service fees have grown quickly to become our second largest profit contributor since first offering this product four years ago. It is another core market representing approximately 23% of worldwide Internet gaming revenue excluding the United States (source: GBGC). Internet poker is a fast-growing sector dominated by sizeable poker rooms, where attracting and retaining a critical mass of players is key to success. The continuous presence of many players in a virtual room

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-11-

(liquidity) allows players to find a game at the stake they want, when they want, around the clock. By providing a platform for the players of all our poker licensees – among the largest gaming and entertainment brands online and on-land – in a central poker room, we offer a well-populated poker network that currently attracts at peak times more than 6,000 poker players simultaneously from around the globe, which is down from 9,000 at the end of 2005 due to the UIGEA and exit of Betfair.

In Internet poker, we also continually expand our variety of games and tournament capabilities, and invest in system scalability to provide the capacity for increasing traffic and volumes at our licensees’ poker sites. Our expansive poker network and wide range of games, stakes and tournament offerings have translated into a 25.6% growth in our poker fees in 2006 compared to a year ago. We expect Internet poker to continue to be a strong contributor to our results in 2007.

Customer service and support

Licensee competition for players is intense and the cost of player acquisition has risen significantly. To assist our licensees in retaining players and re-activating lapsed accounts, we have invested significantly in our customer relationship management solution. We have introduced and improved our back-office offering with sophisticated business intelligence, data warehousing and marketing tools to assist licensees in understanding, servicing and building one-on-one relationships with their players.

Marketing Support

To help our customers develop and execute their marketing strategies, we offer our licensees marketing support services, through AdsDotCom, a subsidiary of WagerLogic. Increasingly we view these services as a key differentiator in our offering. They have been instrumental in our winning certain new business and form a key part of the Company’s brand ownership and management strategy.

Regulatory leadership and public company record

Trust is vital for our business, our customers, and our industry. This is why CryptoLogic has committed to strong corporate governance and compliance – and demonstrated a long-standing history of public company disclosure and regulatory leadership.

“Tier One” Regulation – CryptoLogic has long advocated regulation of Internet gaming for the protection of players and the integrity of the industry. We are one of the few software providers worldwide who have earned government-certification in a, “tier-one” jurisdiction. We are subject to stringent requirements similar to those found in land-based gaming, including intensive government probity review of directors, senior management and key personnel, as well as rigorous independent third-party testing and ongoing gaming software review. This adherence to high standards of government approval is an important competitive advantage. Our regulatory compliance enables us to offer licensees a choice of regulated markets for their online businesses. It also enhances our credibility and marketability as more jurisdictions view regulation as the best solution for safe and responsible online gaming.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-12-

Given our regulatory expertise, we are positioned for the pending implementation of The Gambling Act 2005 in the United Kingdom, and to offer this jurisdiction as an option for our customers, provided the British government establishes a commercially-attractive marketplace. In enabling the regulation of Internet gaming for the first time in the UK, the Act opens the door to a large, credible and stable industry in a regulated and licensed environment. The new regulatory regime is expected to become fully operational by September 2007. In the meantime, we are planning to invest in initiatives to position our company for a regulated UK market, and doing our part to provide input to the process of developing the final legislative codes.

Public company disclosure and compliance – CryptoLogic’s status as a public company traded on three senior exchanges – the Toronto Stock Exchange, NASDAQ Global Select Market and the Main Market of the London Stock Exchange – subjects us to the highest standards of corporate governance and disclosure. CryptoLogic has demonstrated a steady record of earnings and cash flow performance and disclosure. We are one of the Internet gaming industry’s first publicly listed companies since 1996. Our corporate governance practices and quality and certification of our products and business are competitive advantages for CryptoLogic.

Financial strength and performance

CryptoLogic has a proven record for revenue growth, positive operating profit, healthy cash flow and no debt since our first full year of operation. The strength of our balance sheet gives customers the assurance that we have the resources to invest in our product solutions today and in the future. We have the financial strength to pay a quarterly cash dividend and repurchase shares through normal course purchases, as appropriate. Our solid financial position also means we can consider potential opportunities to accelerate our growth plans through strategic, accretive acquisitions.

OVERVIEW OF RESULTS

Year 2006

CryptoLogic achieved another year of record revenue and earnings in 2006, notwithstanding the challenging fourth quarter. Revenue of $104.0 million (2005: $86.3 million) was up 20.5% year-over-year, driven by increasing fees from both our online casino and poker software.

Owing to new products and enhancements and the growing liquidity of our licensees’ central poker room, poker fees rose 25.6%, reaching $33.9 million (2005: $27.0 million). In Internet casino, our revenue rose 11.7% to $59.2 million (2005: $53.0 million), representing double-digit growth in this more developed market.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-13-

We attributed our continued growth in casino to the addition of more than 25 new games to our gaming suite, particularly the appeal of our Marvel-branded games, online slot versions of casual games such as Bejeweled and Cubis^TM, and our mega-jackpot, progressive slot game, Millionaires Club®. In addition, our customer relationship solution and tools are helping licensees to attract and retain players.

Other revenue, which includes software customization, advertising services, and certain marketing support fees and interest income accounted for 10.5% of CryptoLogic’s total revenue (2005: 7.3%). In 2006, other revenue also included non-recurring revenue from our exit agreement with Betfair.

EBITDA⁽¹⁾ increased 21.8% to $27.2 million in 2006 (2005: $22.3 million). EBITDA⁽¹⁾ margin as a percentage of revenue remained solid at 26.1% (2005: 25.8%), which includes non-recurring expense incurred during 2006 related to the proposed establishment of an executive headquarters in Ireland (see Reorganization Charges). As a result of higher revenue in 2006, we saw a 20.9% rise in earnings to $24.8 million, or $1.81 per diluted share (2005: $20.5 million or $1.46 per diluted share).

Once again, CryptoLogic finished the year with positive operating cash flow and a strong balance sheet. Cash, cash equivalents, short term investments, and security deposits, totaled $128.4 million (2005: $99.1 million). Working capital grew to $93.8 million (2005: $73.6 million), after the payment of quarterly dividends totaling $5.8 million (2005: $3.0 million).

CryptoLogic’s 2006 performance reflected the continued disciplined execution of our business strategies. While we expect that the industry-wide impact of UIGEA will reduce our revenue and earnings in 2007, we enter the new year with the financial strength to continue to execute our strategies, focused on the rapidly-growing Internet casino and Internet poker markets outside the US, particularly the UK, continental Europe and Asia.

The following table presents selected financial data for each of the three most recent financials years of the Company on a consolidated basis:

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-14-

For the years ended December 31,	2006	% of Revenue	2005	% of Revenue	2004	% of Revenue
(In thousands of US dollars, except per share data)
Revenue	$104,022	100.0%	$86,307	100.0%	$63,714	100.0%
Expenses
Operating expense	64,685	62.2%	52,658	61.0%	39,975	62.7%
Re-organization charge (2)	3,700	3.6%	-	-	-	-
General and administrative	7,907	7.6%	7,642	8.9%	6,028	9.5%
Software development expense	-		3,287	3.8%	--	--
Finance	554	0.5%	417	0.5%	374	0.6%
Amortization	4,777	4.6%	3,894	4.5%	2,089	3.3%
	81,623	78.5%	67,898	78.7%	48,466	76.1%
Earnings before undernoted	22,399	21.5%	18,409	21.3%	15,248	23.9%
Interest income	7,092	6.8%	3,627	4.2%	1,293	2.1%
Earnings before income taxes	29,491	28.3%	22,036	25.5%	16,541	26.0%
Income taxes
Current	4,957	4.7%	935	1.0%	1,033	1.6%
Future	(278)	(0.3)-	571	0.7%	1,840	2.9%
	4,679	4.4%	1,506	1.7%	2,873	4.5%
Earnings	24,812	23.9%	$20,530	23.8%	$13,668	21.5%
EBITDA(1)	27,176	26.1%	$22,303	25.8%	$17,337	27.2%
Total assets	184,520		$154,398		$124,222
Dividend per share/quarter(3)	$0.12		$0.07		$0.05

 

⁽¹⁾ Refer to EBITDA note on page 9

⁽²⁾ Refer to Reorganization note on page 22

⁽³⁾ Refer to Dividend note on page 29

Fourth quarter 2006

Q4 2006 results were below those of Q4 2005, as the industry adjusted to the U.S. ban on online gaming in October 2006.

Total Revenue: Total revenue for the quarter was $19.0 million, 24.2% lower than Q4 2005.

EBITDA⁽¹⁾ was $1.5 million in the quarter, 69.5% below Q4 2005. The Company’s EBITDA⁽¹⁾ margin in the quarter was 8.0%, compared to 19.8% in Q4 2005. The decrease was due to reduced revenue and $1.1 million in costs incurred in Q4 2006 related to establishing new headquarters in Ireland. Excluding this charge, EBITDA⁽¹⁾ would have been $2.6 million and the EBITDA⁽¹⁾ margin would have been 13.7%.

Earnings and Earnings per Diluted Share: Earnings were $1.7 million, 70.6% lower than Q4 2005. Diluted earnings per share were $0.12, 72.1% below Q4 2005. Excluding the charge for the new Irish headquarters, Q4 earnings would have been $2.7 million and diluted EPS, $0.19.

The following table sets out selected unaudited financial information of CryptoLogic on a consolidated basis for the last eight quarters. For more information, readers should refer to CryptoLogic’s 2006 and 2005 quarterly financial reports.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-15-

Fiscal 2006 Quarters	First	Second	Third	Fourth	Annual
(In thousands of US dollars, except per share data)
Revenue	$26,997	$30,351	$27,690	$18,984	$104,022
Interest income	1,443	1,758	1,960	1,931	7,092
Earnings	7,662	8,194	7,244	1,712	24,812
Basic earnings per share	0.57	0.60	0.53	0.13	1.83
Diluted earnings per share	0.56	0.59	0.53	0.12	1.81
Basic weighted average number of shares (000’s)	13,415	13,586	13,601	13,630	13,558
Diluted weighted average number of shares (000’s)	13,687	13,851	13,789	13,736	13,731

Fiscal 2005 Quarters	First	Second	Third	Fourth	Annual
(In thousands of US dollars, except per share data)
Revenue	$20,274	$19,923	$21,049	$25,061	$86,307
Interest income	637	874	967	1,149	3,627
Earnings	4,839	4,739	5,127	5,825	20,530
Basic earnings per share	$0.36	$0.34	$0.37	$0.44	$1.51
Diluted earnings per share	$0.34	$0.33	$0.36	$0.43	$1.46
Basic weighted average number of shares (000’s)	13,573	13,736	13,681	13,363	13,588
Diluted weighted average number of shares (000’s)	14,184	14,361	14,063	13,665	14,067

RESULTS OF OPERATIONS - YEAR 2006

Revenue

CryptoLogic achieved record revenue for the year ended December 31, 2006. Revenue of $104.0 million rose 20.5% (2005: $86.3 million), which exceeded our long term goal of growing year-over-year revenue by a minimum of 20%. In 2006, revenue growth was led by increasing fees from both Internet poker and Internet casino.

Licensing fees and services from our casino licensees are calculated as a percentage of a licensee’s level of activity in its online casino site. Fees from online poker are based on a percentage of the licensee’s “rake” per hand in regular or ring games (the rake is typically 5% of the pot, up to a maximum amount per hand) or fixed fees for entry into poker tournaments.

Internet casino

In the more established yet expanding Internet casino market, fee revenue increased 11.7% to $59.2 million (2005: $53.0 million). We attributed our continued expansion

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-16-

in this area to the ongoing popularity of innovative, exclusive games such as Bejeweled and our mega-jackpot slot game, Millionaires Club® and the addition of more than 25 new casino games in the last year including:

• the world’s first and only play-for-real, slot version of the highly popular puzzle game, Cubis^TM;

• our popular roster of multi-currency Marvel video slot games, with new versions based on Thor, Silver Surfer, Elektra, GhostRider and others; and

• the first-ever online version of Texas Hold’em Bonus Poker, the popular land-based casino game that combines the huge popularity of poker with the excitement of a casino card game.

Internet casino licensing and support fees constitutes our core revenue base, representing 56.9% of our total revenue in 2006 (2005: 61.4%). While casino fees continued to grow in absolute dollar terms, casino declined as a percentage of revenue due to the more rapid growth of our fees from the poker sector.

We experienced strong growth in casino in 2006 despite a challenging fourth quarter for our licensees following the passage of the UIGEA. In 2007, we intend to continue delivering a succession of new product innovations that are key growth drivers in our casino business and in the Internet casino market. While online casino fee revenue growth outside the US is predicted to remain healthy at over 21% per year in the next two years (source: GBGC), we expect that it will be insufficient to compensate for the loss of the US market throughout 2007.

Internet poker

Owing to new product enhancements and the liquidity of our licensees’ central poker network, the number of simultaneous poker players attracted at peak times is more than 6,000 from around the globe, which is down from 9,000 at the end of 2005 due to the UIGEA and exit of Betfair. Our Internet poker fees rose 25.6% reaching $33.9 million (2005: $27.0 million) and exceeded the industry growth rate of 21.0% (source: GBGC).

We attribute our growth in this market to:

• organic growth of our existing customers comprised of prominent online and land-based operators that continue to leverage their brand strength and financial resources to cross-market poker to their established player base; and

• new poker software enhancements and features including an appealing poker software redesign; the introduction of Hold’Em Blackjack^TM, which combines elements of blackjack and poker; tournament innovation such as Thunder Tournaments^TMfor high-speed play, a new tournament leader board and the ability to qualify for a broad selection of land-based events; and the launch of My Poker Points,

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-17-

a loyalty rewards system. Poker has grown to be a significant revenue contributor. It accounted for 32.6% of our 2006 revenue (2005: 31.3%).

We experienced strong growth in poker fees in 2006 despite the FIFA World Cup competing for players’ attention, the exit of Betfair from the poker network at the end of October, and the loss of the US market to our licensees in October.

In 2007, we intend to continue delivering a succession of new product innovations and aggressively pursue new poker licensees, which are key growth drivers in the Internet poker market. While online poker fee growth outside the US is predicted to remain strong at over 17% per year in the next two years (source: GBGC), we expect that it will be insufficient to compensate for the loss of the US market in 2007. Accordingly, we expect lower online poker revenue in 2007.

Other revenue

Other revenue increased to $10.9 million (2005: $6.3 million), which included fees for software customization and advertising and marketing services. This accounted for 10.5% of total revenue (2005: 7.3%). The increase over 2005 is primarily attributable to non-recurring revenue from our exit agreement with Betfair, higher revenue from our marketing support services, and increased revenue associated with our gaming information portal.

Product Diversification

(% of total revenue)

Internet casino and poker accounted for 90% of total revenue in 2006.

International diversification

CryptoLogic’s global strategy has resulted in a geographically-diversified business to mitigate the risks of ongoing legislative uncertainty in various countries, increase exposure to gaming-friendly jurisdictions like the UK, and benefit from near-term growth opportunities in overseas markets.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-18-

When the UIGEA passed in October 2006, licensees’ revenue from outside the US was approximately 70% of total revenue, as it was at the end of 2005, and up dramatically from only 30% at the end of 2001, when the Company began its international diversification strategy. Outside the US, our presence is concentrated in the UK and Continental Europe, which represented 35% and 32%, respectively, of licensees’ total revenue in 2006 (2005: 32% and 29%, respectively). In Q4 2006, the UK and Continental Europe represented 44% and 41%, respectively, of licensees’ total revenue.

Our strength in these markets is attributable to a licensee roster that includes some of the most respected names in European gaming. The United Kingdom’s 2005 enactment of a new law to regulate online gaming for the first time in that country should continue to foster favourable growth for the Internet gaming industry, for our customers and for CryptoLogic. In the short-term, we expect licensees to maintain a fairly consistent geographic mix to that of Q4 2006, while longer-term we expect that Asia will begin to represent a more significant portion of their revenues.

Recurring Revenue

CryptoLogic’s strong recurring revenue stream reflects the strength of a revenue model based on building long-standing relationships with premium customers. In 2006, 89.5% (2005: 92.7%) of CryptoLogic’s fee revenue was generated from software licensing and services contracts that generate recurring revenue and generally extend three years in term.

Betfair exited the poker network in October 2006 as per our 2005 agreement with them, and we were unable to renew under mutually agreeable terms with The Ritz Club Online during the year.

We successfully renewed two customer contracts within 2006, including one with our largest licensee, OIGE NV, which operates the InterCasino, InterPoker and ExtremePoker brands, another with William Hill, one of our largest customers. ukbetting was renewed in December 2005. Only one customer contract is due for renewal within 2007, which should enhance the stability of our revenue stream.

In 2007, we expect to grow our revenue related to licensees’ European gaming activities, both through the organic growth of licensees that were active on our platforms in 2006 and through revenue from our new licensees that have launched or will launch in 2007, together with modest revenue from Asia.

Expenses

In 2006, the Company incurred expenses in five categories: operating, general and administrative, reorganization charges, finance and amortization. In 2005, we also incurred certain expense associated with expensing previously capitalized software, for which there was no similar expense in 2006.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-19-

Total expenses were $81.6 million (2005: $67.9 million), largely in step with our 20.5% increase in revenue. Increases occurred across all expenditure categories, with operating expense accounting for 62.2% of total revenues (2005: 61.0%).

Expenses in the first half of 2006 were relatively consistent as a percentage of revenue, but rose in Q3 and Q4 as a result of costs associated with the anticipated establishment of the Company’s executive headquarters in Ireland, and also as a result of the UIGEA significantly reducing revenue in Q4.

As one of our strategies, we are keeping even closer control over all discretionary expenditures as we adjust to the new market environment, though we do not expect to make significant changes to the cost structure. We expect our costs in total to remain relatively consistent with Q4 2006 levels through 2007, with the following qualifications:

• most of the additional costs associated with the establishment of the head office in Ireland, estimated to be approximately $4.8 million, will be incurred in the first half of 2007, for a cumulative total of $8.5 million; and

• we expect annual operating expense to increase by approximately $2.5 to $3.0 million related mainly to the incremental costs of operating the new Irish executive headquarters, though only a portion of this amount will be incurred in 2007, reflecting that portion of the year during which the Ireland office will be operational.

Operating Expense

The Company’s operating expense comprises development and support expense, which includes all personnel and equity compensation costs for employee stock options and long term incentive program; licensee support; e-cash systems and support costs; customer service expense; and expense related to regulatory compliance.

Development costs are expensed as incurred unless costs meet the criteria for deferral and amortization under generally accepted accounting principles.

Total operating expense was $64.7 million, or 62.2% of revenue (2005: $52.7 million or 61.0%). We continued to invest in our core product and services to help customers grow market share and player loyalty. While operating expense stayed relatively level on a percentage of revenue basis, they increased in absolute and relative terms over 2005 due to:

• higher software development expense, reflecting our growing game and back-office portfolio;

• higher e-cash transaction processing fees resulting from increased transaction volumes at our customers’ growing businesses; and

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-20-

• higher performance-related compensation expense accruals due to CryptoLogic’s better-than-expected financial performance in 2006.

At December 31, 2006, CryptoLogic had 400 employees dedicated to implementing our strategy in a competitive and increasingly sophisticated market, up from 358 a year earlier.

At year-end, we had 92 employees in casino and poker development, representing 23% of the total. Given the importance and distinctiveness of the core aspects of our business, we have specialized teams in each strategic development area. In 2006, 13% of our staff were in casino software development; 10% in poker software development; 8% in product support and compliance; 59% in licensee support operations; and 10% in administrative and finance. This representation is not expected to change materially.

2006 Employee Breakdown

 

90% of employees were in areas devoted to delivery of products and services to licensees, such as development, licensee support operations and product support

General and Administrative Expense

General and Administrative (G&A) expense includes overhead and administrative expense, travel expense and professional fees relating to our business development, infrastructure and public company listings.

In 2006, G&A expense of $7.9 million represented 7.6% of revenue (2005: $7.6 million, or 8.9%), down from the previous year as a percentage of revenue due to strong revenue generation in 2006 and the relocation of the Company’s Toronto office in 2005, which increased costs in that period.

Increased G&A expense, in absolute terms, reflected higher consulting fees in connection with our Sarbanes-Oxley compliance initiatives, and higher professional

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fees due to regulatory and strategic activities, including the exploration of acquisition opportunities, and work on new customer contracts.

G&A expense should remain relatively stable as a percentage of revenue in the near future, and should increase modestly in absolute terms in tandem with our growth.

Reorganization Charges

Reorganization Charges are associated with CryptoLogic’s anticipated establishment of its executive headquarters in the Republic of Ireland. In 2006, such costs totaled $3.7 million, or 3.6% of revenue (2005: nil) and primarily comprise professional fees and expenses related to employee relocation and severance.

In 2007, we expect a further $4.8 million in reorganization costs, most of which is expected to be incurred in the first half of the year. Due to their nature, these costs are not expected to recur.

Software Development Expense

In the fourth quarter of 2005, we incurred $3.3 million of expense related to previously capitalized software development and severance. There was no comparable expense in 2006.

Amortization

Amortization expense is based on the estimated useful lives of the assets and includes the amortization of our investments in computer equipment, leasehold improvements, software licenses, and capitalized software development costs to support our business activities.

Amortization expense was $4.8 million, or 4.6% of revenue (2005: $3.9 million, or 4.5%). The increase reflected (a) the higher investment in computer equipment, leasehold improvements, software licenses, and capitalized software development expenses, where required by GAAP, and (b) change in the estimated useful lives of computer equipment and office furniture and equipment. These expenses are expected to grow in absolute dollars and increase as a percentage of revenue, due to the growth of our company and as amortization for capital expenditures related to our investment program continues.

EBITDA⁽¹⁾

Earnings before interest, taxes, depreciation and amortization (EBITDA⁽¹⁾) increased 21.8% to a record $27.2 million (2005: $22.3 million). EBITDA⁽¹⁾ margin, or EBITDA⁽¹⁾ as a percentage of revenue, grew slightly to 26.1% (2005: 25.8%), despite the loss of the US market by our licensees in Q4 2006.

In 2007, CryptoLogic expects EBITDA⁽¹⁾ and EBITDA⁽¹⁾ margin to be negatively affected, as the industry-wide impact of the UIGEA will reduce revenue in the short term, and while we are exercising even tighter control over discretionary expenses,

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we are not planning a cost reduction sufficient to offset the lost revenue. Longer term, we expect to be able to return to and exceed 2006 revenue, EBITDA⁽¹⁾ and EBITDA⁽¹⁾ margin levels.

EBITDA⁽¹⁾

(US$ millions)

EBITDA⁽¹⁾ grew by 22% to a record $27.2 million in 2006.

⁽¹⁾ Refer to EBITDA on page 9.

Interest Income

Interest income, comprising interest earned on the Company’s cash and short term investment balances, grew to $7.1 million in 2006 (2005: $3.6 million) as a result of growing cash and cash equivalents balances and higher interest yield. We expect our interest income to continue to move in accordance with changes in our cash and investment balances, and the interest yield.

Provision for Income Taxes

Income taxes were $4.7 million (2005: $1.5 million), net of a small future income tax recovery. The increase in 2006 primarily resulted from higher taxable income driven by higher revenues in 2006, and the use of tax loss carryforwards in 2005. The fluctuation in future income taxes results from differences between tax and accounting recognition with respect to certain of the Company’s expenses.

We are subject to tax in many jurisdictions. Subject to significant changes in the tax rates of those jurisdiction or significant changes in our corporate structure, we generally expect a blended tax rate of approximately 15%.

Earnings

Reflecting our strong revenue growth, and despite the loss of the US market to licensees in Q4 2006, CryptoLogic’s earnings rose 20.9% to $24.8 million or $1.81

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per diluted share (2005: $20.5 million or $1.46 per diluted share).

In 2007, our earnings will be negatively affected by the industry-wide impact of the UIGEA as it will reduce revenue in the short term, and while we are exercising even tighter control over discretionary expenses, we are not planning a cost reduction sufficient to offset the lost revenue. Management estimates that the enactment of the UIGEA would have reduced revenue by $31 million and earnings by $24 million if the act had been in force for all of 2006. Management estimates that the UIGEA will result in lower revenue and earnings in 2007. By the latter part of 2008, we should start to trend toward quarterly revenue run rates similar to those realized prior to the UIGEA enactment, and continue to strive for net margins (net earnings as a percentage of revenue) in excess of 20%.

Return on Equity

CryptoLogic’s return on shareholders’ equity was unchanged from 2005 reflecting primarily the negative impact of the Q4 2006 UIGEA announcement, as follows:

	2006	2005	2004
Return on equity	25%	25%	22%

CryptoLogic has a well-established track record for solid investor returns.

RESULTS OF OPERATIONS - FOURTH QUARTER 2006

Revenue

CryptoLogic’s results may vary on a quarterly basis due to the seasonal nature of the online gaming industry. Historically, sales are slower in the second and third quarters, as Internet usage moderates in the summer months when players tend to be outdoors. Typically, our first and fourth quarters (during the winter and fall seasons) are our strongest revenue periods. We expect seasonality in our business to continue to be a contributing factor in both casino and poker.

While we believe that seasonal factors continued to affect our results and the industry, we experienced other offsetting factors in the quarter. Revenue decreased 24.2% in Q4 2006 to $19.0 million (Q4 2005: $25.1 million):

• the major factor was the loss of our licensees’ US-based players as a result of the UIGEA having been passed in October 2006, which was heightened as it occurred in the fourth quarter which is historically the strongest quarter of the year. To a much lesser extent, revenue was impacted by the exit of Betfair and the Ritz from the network during the quarter;

• the revenue loss was partially offset by the release of 18 innovative new casino games in Q4 2006. Revenue from new games introduced in Q4 was

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$1.9 million, or 10.2% of total revenue. Strong performances from casino games released in earlier periods also increased revenue in Q4.

Internet Casino

Q4 2006 Internet casino fees decreased 35.9% to $10.0 million (Q4 2005: $15.5 million) and accounted for 52.4% of total Q4 2006 revenue (Q4 2005: 61.9%). This decrease followed the UIGEA enactment in early October 2006.

Internet Poker

Q4 2006 Internet poker fees decreased 15.8% to $6.7 million (Q4 2005: $7.9 million) and represented 35.4% of Q4 2006 revenue (Q4 2005: 31.6%). This decrease followed the UIGEA enactment in early October 2006.

Other Revenue

Other revenue in Q4 2006 was $2.3 million, or 12.2% of total revenue (Q4 2005: $1.6 million, or 6.5% of revenue). The increase in Q4 2006 over Q4 2005 is primarily attributable to non-recurring revenue from our exit agreement with Betfair.

We expect the expiry of our exit agreement with Betfair in January 2007 and the UIGEA to reduce other sources of revenue, although revenue from the Parbet.com, PlayboyGaming and DTD Poker properties that began in Q1 2007 will partially offset these factors.

In Q4 2006, our online bingo licensee stopped offering this product. Bingo accounted for an immaterial amount of revenue in 2006.

Expenses

Operating Expense

Operating expense was $14.2 million in Q4 2006, or 75.0% of revenue (Q4 2005: $14.7 million, or 58.7% of revenue).

Operating expense decreased slightly in absolute terms over Q4 2005 due to:

• lower software development costs; and

• lower e-cash system and support fees resulting from decreased volumes at our customers’ businesses; partially offset by

• higher compensation costs related to increased product development and customer support staffing.

Notwithstanding that operating expense in dollar terms decreased slightly as compared to 2005, operating expense, which is largely fixed, increased as a percentage of revenue in 2006.

General and Administrative Expense

General and Administrative (G&A) expense was $2.0 million for the quarter, or 10.3% of revenue (Q4 2005: $2.0 million, or 7.9% of revenue). Notwithstanding that

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G&A expense in dollar terms was unchanged compared to 2005, G&A expense increased as a percentage of revenue in 2006.

Software Development Expense

In the fourth quarter of 2005, the Company incurred $3.3 million of expense related to previously capitalized software development and severance. There was no comparable expense in 2006. The severance expense in 2005 related to termination of software development staff.

Reorganization Charges

Reorganization Charges associated with CryptoLogic’s plan to establish its executive headquarters in the Republic of Ireland were $1.1 million in Q4 2006. Such costs are primarily comprised of professional fees and expenses related to employee relocation and severance. There were no similar costs in the comparable periods of 2005. The reorganization is subject to shareholder and regulatory approvals.

EBITDA

EBITDA decreased by 69.5% to $1.5 million (Q4 2005: $5.0 million) in the quarter. EBITDA⁽¹⁾ margin decreased to 8.0% of revenue in Q4 2006 (Q4 2005: 19.8%), mainly due to lower revenue in the quarter attributable to the loss of US player revenue (approximately $8 million in lower revenue), which gave rise to approximately $6 million in lower EBITDA, partially offset by lower expense in the quarter driven primarily by lower software development expense as compared to the prior year.

EBITDA is reconciled to earnings as follows:

	For the three months Ended December 31,
(In thousands of US dollars)	2006	2005
Earnings	$1,712	$5,825
Income taxes	361	(855)
Interest income	(1,931)	(1,149)
Amortization	1,375	1,153
EBITDA	$1,517	$4,974
EBITDA before re-organization expense	$2,601	$4,974

Amortization

Amortization expense was $1.4 million during the quarter ended December 31, 2006 (Q4 2005: $1.2 million). The increase is due mainly to (a) the higher investment in computer equipment, leasehold improvements, software licenses, and capitalized software development expenses, where required by GAAP, and (b) change in estimated service lives for computer equipment and office furniture and equipment.

Interest Income

Interest income, comprising interest earned on the Company’s cash and short term investment balances, was $1.9 million in Q4 2006 (Q4 2005: $1.1 million). The increases were a result of higher cash and short term investment positions and better interest yield.

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For the year ended December 31, 2006

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Provision for Income Taxes

Income taxes in Q4 2006 were $0.4 million (Q4 2005: ($0.9) million), including amounts for future income tax of ($1.1) million in the quarter (Q4 2005: $0.3 million). The fluctuation in future income taxes resulted from differences between tax and accounting recognition with respect to certain of the Company’s expenses.

Earnings

Earnings in the quarter were down 70.6% to $1.7 million, or $0.12 per diluted share (Q4 2005: $5.8 million, or $0.43 per diluted share), after deducting an after-tax $1.0 million non-recurring charge, or $0.07 per share, related to reorganization costs for the proposed establishment of CryptoLogic’s new executive headquarters in Ireland.

LIQUIDITY AND CAPITAL RESOURCES

CryptoLogic remained highly liquid and debt-free in 2006. Given our significant cash resources of $128.4 million and undrawn credit facilities of $3.0 million at year-end, we have the financial flexibility to continue investing in the enhancement of our solutions and the growth of our business, pay dividends, repurchase our own shares through issuer bids and consider strategic, accretive acquisition opportunities that may arise.

Net Cash Position

As of December 31, 2006, our net cash position grew to $128.4 million or $9.35 per diluted share (2005: $99.1 million or $7.05 per diluted share), which comprised cash and cash equivalents, short term investments, and included security deposits of $1.5 million (2005: $1.5 million). The Company will have expended a minimum of $11.9 million of this cash in 2007 for the previously-announced acquisition of Parbet.com, with a contingent further payment of $5.3 million to be made in 2007.

There was a shift in asset mix towards short term investments and away from cash and cash equivalents during the year for more effective cash and yield management. As a result, short term investments rose by $46.8 million, and cash and cash equivalents balance declined by $17.5 million to $76.9 million (2005: $3.2 million and $94.4 million, respectively).

We continued to pledge $1.5 million in security deposits at year end (2005: $1.5 million). We maintain security on deposits as collateral granted to banks and payment processors that process deposit transactions on our behalf.

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For the year ended December 31, 2006

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Net Cash Position

(US$ millions)

 

CryptoLogic remained highly liquid with net cash of $128.4 million at 2006 year end.

Operating Activities

CryptoLogic deploys its positive cash flow to fund investment initiatives that will drive long term growth. Operating cash flow increased significantly to $40.7 million (2005: $34.7 million) due largely to higher earnings in 2006. As well, accounts payable and accrued liabilities were $10.3 million higher at 2006 year end as compared to last year, primarily due to:

• higher jackpot provisions, which reflect the growing jackpot prizes for our progressive slot games; and

• higher provisions for performance-related compensation costs due to better-than-expected financial performance and strong share price performance, which affects calculation of our long-term incentive plan liabilities

Financing Activities

In 2006, $2.7 million was used (2005: $7.2 million used) for financing activities as follows:

• $3.1 million (2005: $5.0 million) was raised from the exercise of stock options during the year. No common shares were repurchased in 2006 (2005: $9.2 million); and

• $5.8 million (2005: $3.0 million) was paid in quarterly cash dividends in 2006. This higher amount was attributed to an increase in our quarterly cash dividend from $0.07 per share to $0.12 per share (an annual rate of $0.48) commencing with the dividend paid on June 15, 2006.

While each future quarterly dividend is subject to Board approval based on our financial results for that particular period and the Board’s view from time to time on

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For the year ended December 31, 2006

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the optimal uses of cash, we expect to continue paying dividends on a regular basis. With the industry-wide impact of the UIGEA enactment, revenues and earnings will be negatively impacted. However, as noted above, by the latter part of 2008, we should start to trend toward quarterly revenue run rates similar to those realized prior to the UIGEA enactment, and continue to strive for net margins (net earnings as a percentage of revenue) in excess of 20%.

Investing Activities

Investing activities used cash of $55.4 million in 2006 (2005: $23.7 million provided). This was largely due to a shift of $46.8 million of cash and cash equivalents into short term investments (2005: shift of short term investments into cash and cash equivalents, in the amount of $32.6 million), for more efficient cash and interest yield management in response to volatility in interest rates.

Additionally, funds used for capital expenditures amounted to $8.6 million (2005: $8.9 million), which related to purchases in the normal course of business for hardware, leasehold improvements, software licenses, and capitalized software development expenses as discussed earlier. In 2007 capital expenditures will be increased materially over 2006 levels mainly due to higher capitalized software development expenditures related to improving the ability of the Company to modify its gaming software programs going forward.

Working Capital

CryptoLogic’s financial position remained highly liquid in 2006. Working capital increased by 27.5% to $93.8 million or $6.82 per diluted share as at December 31, 2006 (2005: $73.6 million or $5.23 per diluted share). The year-over-year increase was primarily due to higher earnings.

In the foreseeable future, we expect our cash needs to be funded through existing cash resources and operating cash flow. Our liquidity gives us the financial flexibility to continue to invest in our business and take advantage of opportunities in our markets, consider potential strategic acquisitions, pay shareholders dividends, and repurchase common shares under our Normal Course Issuer Bid.

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Working Capital

(US$ millions)

Working capital grew 27.5% to $93.8 millionin 2006.

User funds held on deposit

User funds held on deposit decreased 19.6% to $20.9 million at December 31, 2006 (2005: $26.0 million). The decrease reflects the reduction of players’ deposits subsequent to the UIGEA passage. Cash related to user funds on deposit is segregated and shown separately as an asset and liability on the balance sheet, and does not form part of the Company’s total cash position.

Capitalization

Since inception, CryptoLogic has had no debt, including at year-end 2006, and also has unutilized credit facilities. As of December 31, 2006, we had 13,641,234 common shares and 1,006,584 stock options outstanding.

CryptoLogic entered 2006 with a Normal Course Issuer Bid, which authorized the buy back of up to 1.34 million common shares. In Q4 2005, the Company bought back 239,200 shares at an average price of $16.62 under this 2005/2006 bid. On September 27, 2006, the Board of Directors approved the renewal of our Normal Course Issuer Bid, which authorizes the Company to purchase up to 1.35 million common shares from September 29, 2006 to September 28, 2007, under which we have yet to buyback any shares. Our buyback programs allow us to repurchase our shares on occasions when we believe that our share price provides an opportunity to reduce our outstanding share capital at an attractive price

Cash commitments and contractual obligations

The following table summarizes our outstanding cash commitments as of December 31, 2006:

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For the year ended December 31, 2006

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(In thousands of US dollars)	Total	Less than 1 year	2-3 years	4-5 years	After 5 years
Facility leases	$15,061	$2,319	$3,581	$3,282	$5,879
Guarantees	$4,916	$150	$2,378	$2,388	--
Total outstanding cash commitments	$19,977	$2,469	$5,959	$5,670	$5,879

Total cash commitments at the end of fiscal 2006 totaled $20.0 million (2005: $14.1 million). The Company has entered into lease agreements for premises expiring at various periods up to July 2015.

RESEARCH AND DEVELOPMENT

CryptoLogic makes significant investments in research and development to remain competitive with technology advancements and product evolution in the global online gaming market. 23% of our workforce was comprised of research and development personnel at 2006 year end (2005: 23%).

CRITICAL ACCOUNTING POLICIES

CryptoLogic’s accounting policies are specified in the notes to our financial statements, in particular note 1. The accounting estimates discussed below are considered particularly important as they require judgments by management. Management has instituted policies that are intended to ensure these judgments are well controlled and consistently applied from period to period.

Each time progressive jackpot casino games are played by an end user a specified amount is added to the “Jackpot”. The “Jackpot” is won by a player on a random basis and is not predictive. Each “Jackpot” also has a minimum amount of prize money. As the “Jackpot” progresses the Company regularly collects funds from participating licensees and assumes the liability of future “Jackpot” wins. Management provides for the “Jackpot” based on frequency of each game played, history of wins and minimum prize requirements.

The Company may receive from time to time claims and enter into litigation arising out of the ordinary course and conduct of business including intellectual property matters. Management assesses such claims, and if considered likely to result in material exposure and where the amount of the claim is quantifiable, provisions for loss are made based on management’s assessment of the likely outcome. Management does not make provisions for claims that are considered unlikely to result in a significant loss, claims for which the outcome is not determinable or claims where the amount of the loss cannot be reasonably estimated. Any settlements or awards under such claims are provided for when reasonably determinable. Adjustments will be made to the accrual for such amounts as new information is obtained or the claim settled.

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The Company has a stock option plan where the amount of compensation expensed is determined using an option pricing model. In addition, the Company provides a long term incentive program where the amount of the compensation expensed is determined based on estimated performance criteria and the Company’s stock price. Calculations for these plans with the necessary assumptions inherently mean judgments are required by management.

RELATED PARTY TRANSACTIONS

In 2006, $0.6 million (2005: $0.6 million) was paid in legal fees to Stikeman, Graham, Keeley and Spiegel LLP, a law firm that provides legal services to the Company of which the Chairman of the Board of Directors is a partner.

In 2005, the Company purchased software from another company in which an officer of the Company has a personal interest. Payments to this executive in 2006, relating to this transaction, amounted to $0.04 million (2005: $0.15 million).

RISKS AND UNCERTAINTIES

CryptoLogic operates in a rapidly changing environment that involves numerous risks and uncertainties, many of which are beyond our control and which could have a material adverse effect on our business, revenues, operating results and financial condition. The following discussion highlights some of these risks and uncertainties.

Industry Risks

Government Regulation

The Company and our licensees are subject to applicable laws in the jurisdictions in which they operate. At the present time, our licensees hold government licenses to operate Internet gaming sites in the Netherlands Antilles. Some jurisdictions have introduced regulations attempting to restrict or prohibit Internet gaming, while other jurisdictions have taken the position that Internet gaming is legal and have adopted or are in the process of considering legislation to regulate Internet gaming.

While the UK and other European countries such as Malta and Gibraltar are adopting a regulated online gaming approach, opposing views are developing in Europe. Some European countries, including Italy, Germany and France where there are state-owned monopolies, are taking action aimed at banning foreign online gaming operators. Such actions by these European Union (EU) member states are in contrast with favourably-viewed rulings from the European Court of Justice which prompted the European Commission (EC) to look at creating new legislation that could harmonize online gaming within the EU, in line with the EC’s goal to encourage a free and open cross-border market. There is no indication that any such legislation will be introduced in the near term.

As companies and consumers involved in Internet gaming are located around the globe, including our licensees and their players, there is uncertainty regarding which

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government has authority to regulate or legislate the industry. Legislation designed to prohibit Internet gaming was enacted on October 13, 2006 in the United States (UIGEA), and may be adopted in other jurisdictions.

Future decisions may have a material impact on our operations and financial results. There is a risk that governmental authorities may view us or our licensees as having violated local law. Therefore, there is a risk that civil and criminal proceedings, including class actions brought by or on behalf of public entities or private individuals, could be initiated against us, our licensees, Internet service providers, credit card processors, advertisers and others involved in the Internet gaming industry and could involve substantial litigation expense, penalties, fines, injunctions or other remedies or restrictions being imposed upon us or our licensees or others while diverting the attention of key executives. Such proceedings could have a material adverse effect on our business, revenues, operating results and financial condition.

There can be no assurance that prohibiting legislation will not be proposed and passed in potentially relevant jurisdictions to legislate or regulate various aspects of the Internet or the Internet gaming industry. The burden of compliance with any such legislation may have a material adverse effect on our business, financial condition and results of operations.

There have recently been a number of legal developments associated with the manner in which the business of gaming, and in particular, Internet gaming, is treated in the UK and Continental Europe. Some of these developments can be considered as positive and some as negative. In this regard a brief summary of the regulatory situation in the UK and Continental Europe follows:

United Kingdom

In April 2005, the UK enacted law to regulate online gaming for the first time in that jurisdiction. The British government is currently drafting the underlying rules and codes to establish its new regulatory framework. However, while the regulation of online gaming by the UK is generally considered as being positive, there is no assurance that the UK regulatory regime will provide a commercially-viable market and may create restrictions that can have a material adverse effect on our customers, our business, revenues, operating results and financial condition.

The true impact of the new UK Gambling Act will not be known until these rules and regulations are made public.

Continental Europe

France and Germany

France and Germany in particular appear to moving towards imposing greater restrictions on internet gaming operators, both by virtue of proposed changes to legislation and through heightened enforcement measures. It is possible that adverse legal developments in these countries could have a material adverse impact on the Company and/or its licensees.

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Italy and Spain

With respect to Italy and Spain, recent willingness to regulate certain forms of internet gaming could be perceived as indicative of a liberalization of the internet gaming industry as a whole in those countries. However, at present, the form of regulation put forward by these jurisdictions has failed to create attractive market conditions for our licensees. As such, notwithstanding the fact that these markets may appear to be liberalizing, in practice, they have not liberalized in a manner, or to a degree, that is helpful to the Company or its licensees. The Company and its licensees remain at risk that Italy and Spain may take aggressive action against parties whose operations at are not licensed pursuant to the regulatory regimes established by these countries.

Holland

It is expected that the agreement with the state-sponsored casino operator, Holland Casino, to supply casino and poker room software for the Dutch market will be very positive for the Company. However, various of the licensees of the Company presently operate in the Dutch market. In the event that the Dutch government seeks to take steps to protect the online business of Holland Casino by discouraging other operators from operating the Dutch marketplace, either through changes in legislation or enforcement measures, it is possible that the Company’s licensees could be adversely impacted.

Scandinavia

Governments in most Scandinavian countries have attempted to discourage their citizens from gambling with online operators by taxing their citizens’ winnings. Generally speaking, winnings realized through a state sponsored operator are not taxable, but winnings from other sources are. Until such time as the tax authorities in the various countries make an official pronouncement on the manner in which these tax laws will be applied, it is unclear as to what impact these tax policies will have on the business of the Company’s licensees. However, it is expected that individuals gaming with operators based within the EU will not have their winnings taxed in this manner.

Payment Processing

With the enactment of the UIGEA, financial institutions in the United States ceased to accept online gaming transactions This event has had a negative impact on the Internet gaming industry as a whole, on our licensees, and on the Company, as evidenced by lower revenues in the fourth quarter of 2006. There can be no assurance that other financial institutions or credit card issuers outside the United States will not enact additional restrictions. Any such developments would have a material adverse effect on our business, revenues, operating results and financial condition. The loss of a major payment option could have a material adverse affect on our business.

There can be no assurance that our systems and measures in place will or can guarantee protection against fraudulent activities and unauthorized access from

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For the year ended December 31, 2006

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minors, which could have a material adverse effect on our reputation, business, revenue, operating results and financial conditions. We attempt to mitigate these concerns with systematic controls and a dedicated fraud team. There is an audit trail for every transaction. As well, we establish relationships with financial institutions that are subject to stringent banking regulations in their respective jurisdictions.

E-commerce Law

In addition to regulations pertaining specifically to online gaming, we may become subject to any number of laws and regulations that may be adopted with respect to the Internet and electronic commerce. New laws and regulations that address issues such as user privacy, pricing, online content regulation, taxation, advertising, intellectual property, information security, and the characteristics and quality of online products and services may be enacted. As well, current laws, which predate or are incompatible with the Internet and electronic commerce, may be applied and enforced in a manner that restricts the electronic commerce market. The application of such pre-existing laws regulating communications or commerce in the context of the Internet and electronic commerce is uncertain. Moreover, it may take years to determine the extent to which existing laws relating to issues such as intellectual property ownership and infringement, libel and personal privacy are applicable to the Internet.

The adoption of new laws or regulations relating to the Internet, or particular applications or interpretations of existing laws, could decrease the growth in the use of the Internet, decrease the demand for our products and services, increase our cost of doing business or could otherwise have a material adverse affect on our business, revenues, operating results and financial condition.

Business Risks

Internet Viability and System Infrastructure and Reliability

The growth of Internet usage has caused frequent interruptions and delays in processing and transmitting data over the Internet. There can be no assurance that the Internet infrastructure or the Company’s own network systems will continue to be able to support the demands placed on it by the continued growth of the Internet, the overall online gaming industry or that of our customers.

The Internet’s viability could be affected if the necessary infrastructure is not sufficient, or if other technologies and technological devices eclipse the Internet as a viable channel,

End-users of our software depend on Internet service providers, online service providers and our system infrastructure for access to the Internet gaming sites operated by our licensees. Many of these services have experienced service outages in the past and could experience service outages, delays and other difficulties due to system failures, stability or interruption. Our licensees may lose customers as a result of delays or interruption in service, including delays or interruptions relating to high

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volumes of traffic or technological problems. As a result, we may not be able to meet a level of service that we have contracted for, and we may be in breach of our contractual commitments, which could materially adversely affect our business, revenues, operating results and financial condition.

Market Demand

The Internet gaming industry continues to evolve rapidly and is characterized by an increasing number of market entrants. The demand and acceptance for new products and services are subject to a level of uncertainty and growing competition, and if our production.services do not continue to receive market acceptance, our business, revenues, operating results and financial condition could be materially adversely affected.

Security

Our Internet gaming software and electronic commerce services are reliant on technologies and network systems to securely handle transactions and user information over the Internet, which may be vulnerable to system intrusions, unauthorized access or manipulation. As users become increasingly sophisticated and devise new ways to commit fraud, our security and network systems may be tested and subject to attack. We have experienced such system attacks in the past and implemented measures to protect against these intrusions. However, there is no assurance that all such intrusions or attacks will or can be prevented in the future, and any system intrusion/attack may cause a delay, interruption or financial loss, which could have a material adverse effect on our business, revenue, operating results and financial condition.

Reliance on Other Parties

Our electronic commerce product relies on Internet Service Providers (ISPs) to allow our licensees’ customers and servers to communicate with each other. If ISPs experience service interruptions, it may prevent communication over the Internet and impair our ability to carry on business. In addition, our ability to process e-commerce transactions depends on bank processing and credit card systems. In order to prepare for system problems, we are strengthening and enhancing our current facilities and the redundancy of our system infrastructure and support. Nevertheless, any system failure as a result of reliance on third parties, including network, software or hardware failure, which causes a delay or interruption in our e-commerce services could have a material adverse effect on our business, revenues, operating results and financial condition.

Competition

Licensees of our software compete with existing and established recreational services and products, in addition to other forms of entertainment. Our success will depend, in part, upon our ability to enhance our products and services to keep pace with technological developments, respond to evolving customer requirements and achieve continued market acceptance.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

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We compete with a number of public and private companies, which provide electronic commerce and/or Internet gaming software. In addition to known current competitors, traditional land-based casino operators and other entities, many of which have significant financial resources, an entrenched position in the market and name-brand recognition, may provide Internet gaming services in the future, and thus become our competitors. As well, such companies may be able to require that their own software, rather than the software of others, including our gaming software or our e-cash software and support be used in connection with their payment mechanisms.

The barriers to entry into most Internet markets are relatively low, making them accessible to a wide number of entities and individuals. We believe the principal competitive factors in our industry that create certain barriers to entry include reputation, technology, financial stability and resources, proven track record of successful operations, critical mass (particularly relating to online poker), regulatory compliance, independent oversight and transparency of business practices. While these barriers will limit those able to enter or compete effectively in the market, it is likely that new competitors will be established in the future, in addition to our known current competitors.

Increased competition from current and future competitors has and may in the future result in price reductions and reduced margins, or may result in the loss of market share, any of which could materially adversely affect our business, revenues, operating results and financial condition.

Dependence on Licensees

In fiscal 2006, our top 7 licensees accounted for 84% (2005: 90%) of our total revenue. In addition, all of our key licensees operate from one licensing jurisdiction. The loss of one or more of these key licensees, or the loss of their license in their respective jurisdictions, could have a material adverse effect on our business, revenues, operating results and financial condition.

Chargebacks

We are subject to exposure in regard to chargebacks, which may also result in possible penalties and shut off of the payment option. Chargebacks are any deposit transaction credited to a user’s account that is later reversed or repudiated. While the Company has fraud control measures to minimize exposure and provision for chargebacks, this factor could have a material adverse effect on our business, revenues, operating results and financial conditions.

Foreign Operations

As companies and consumers involved in Internet gaming, including the players of our licensees, are located around the globe, there is uncertainty regarding exactly which government has jurisdiction or authority to regulate or legislate with respect to various aspects of the industry. The uncertainty surrounding the regulation of Internet gaming in the various jurisdictions in which we operate could have a material adverse effect on our business, revenues, operating results and financial condition.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-37-

There are certain difficulties and risks inherent in doing business internationally, including the burden of complying with multiple and conflicting regulatory requirements, foreign exchange controls, potential restrictions or tariffs on gaming activities that may be imposed, potentially adverse tax consequences and tax risks, and changes in the political and economic stability, regulatory and taxation structures, and the interpretation thereof, of jurisdictions in which we, our subsidiaries and our licensees operate, and in which our licensees’ customers are located, all of which could have a material adverse effect on our business, revenues, operating results and financial condition.

There can be no assurance that we will be able to sustain or increase revenue derived from international operations or that we will be able to penetrate linguistic, cultural or other barriers to new foreign markets.

Foreign Exchange

Our financial results are reported in US currency, which is subject to fluctuations in respect of the currencies of the countries in which we operate, including British pounds, Euros, and Canadian dollars. Accordingly, fluctuations in the exchange rate of world currencies could have a positive or negative effect on our reported results. We may utilize a hedging program from time to time and/or take advantage of the natural hedge in having operations in multiple currencies to mitigate a portion of our currency risks, but there can be no assurance that we will not experience currency losses in the future, which could have a material adverse effect on our business, revenues, operating results and financial condition.

Legal Proceedings

We, and certain of our subsidiaries, may be involved in litigation arising in the ordinary course and conduct of business. The outcome of such matters cannot be predicted with certainty, and could have a material adverse effect on our business, revenues, operating results and financial condition.

Moreover, from time to time, third parties have asserted and may continue to assert patent, trademark, copyright and other intellectual property rights to technologies or business methods that we consider important. There can be no assurance that the assertion of such claims will not result in litigation or that we would prevail in any such litigation or be able to obtain a license for the use of any infringed intellectual property from a third party or, if such a license is required, that it would be available on terms acceptable to us.

Intellectual Property

We rely on a combination of laws and contractual provisions to establish and protect our rights in our software and proprietary technology. We believe that our competitive position is dependent in part upon our ability to protect our proprietary technology. We generally enter into non-disclosure and invention agreements with employees, licensees, consultants and customers, and historically have restricted access to our software products’ source codes. We regard our source codes as

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-38-

proprietary information, and attempt to protect the source code versions of our products as trade secrets and unpublished copyrighted works. Despite our precautions and measures implemented to protect against such attempts, unauthorized parties may have or could in the future copy or otherwise reverse engineer portions of our products or otherwise obtain and use information that we regard as proprietary.

Our Company has patent and trademarks in certain jurisdictions and is in the process of applying for further trademark registrations and patents, which may provide such protection in relevant jurisdictions. However, there can be no assurance that this will be sufficient to fully protect our proprietary technology. In addition, certain provisions of our license agreements, including provisions protecting against unauthorized use, transfer and disclosure, may be found to be unenforceable in certain jurisdictions.

We believe that patent, trademark, copyright and other legal protections are less significant to our success than other factors such as the knowledge, ability and experience of our personnel, new product and service developments, frequent product enhancements, customer service and ongoing product support.

We also have a proprietary interest in our name. The names “CryptoLogic” and “WagerLogic” have become known in the Internet gaming industry. Accordingly, our competitive position could be affected if our name was misappropriated and our reputation in any way compromised.

There can be no assurance that the steps we have taken to protect our proprietary rights will be adequate to deter misappropriation of our technology or independent development by others of technologies that are substantially equivalent or superior to our technology. Any misappropriation of our name, technology or development of competitive technologies could have a material adverse effect on our business, revenues, operating results and financial condition.

Due to the complex, sophisticated and global nature of the business, there can be no assurance that there has been no breach of third parties’ intellectual property rights by the Company, and any adverse judgement in this regard could have a material adverse effect on our business, revenues, operating results and financial condition.

Hiring and Retaining Employees

Our future success is dependent on certain key management and technical personnel. The loss of these individuals or the inability to attract and retain highly qualified employees and advisors could have a material adverse effect on our business, revenues, operating results and financial condition.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

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Managing Rate of Growth

We have a history of growth. The expansion of our business and the increasing complexity of our product offerings, coupled with the rapid evolution of our markets, and increasing competition that will put pressure on margins have placed, and are expected to continue to place, a significant strain on our management and operational resources and to increase demands on our internal systems, procedures and controls. Our future operating results will depend on management’s ability to develop and manage growth, enhance our products and services to respond to market demand, deal with competition and evolving customer requirements, manage our system infrastructure and requirements to meet the growing demands of our business, hire and retain significant numbers of qualified employees, accurately forecast revenues and control expenses. A decline in the growth rate of our revenues without a corresponding and timely slowdown in our expenses, or our inability to manage or build future growth efficiently, could have a material adverse effect on our business, revenues, operating results and financial condition.

Future Acquisitions and Investments

As part of our business strategy, we may make acquisitions of, or significant investments in, businesses or technology that offer complementary products, services, and technologies. Any acquisition or investment will be accompanied by risks, including the difficulty of assimilating the operations and personnel of the acquired businesses; the potential diversion of the attention of management from our business; the inability of management to maximize the financial and strategic position of our Company or returns from the investment or acquired businesses; changing technology approach and requirements, the maintenance of uniform standards, controls, procedures and policies; and the impairment of relationships with employees and clients as a result of and integration of the investment, acquisition or new personnel.

Stock Volatility

The market price of our common shares has experienced significant fluctuation and may continue to fluctuate significantly. The market price of our common shares may be adversely affected by various factors, such as proposed Internet gaming legislation or enforcement of existing laws, the loss of a customer, the announcement of new products or enhancements, innovation and technological changes, quarterly variations in revenue and results of operations, changes in earnings estimates by financial analysts, speculation in the press or analyst community and general market conditions or market conditions specific to particular industries, including the Internet and gaming.

In addition, the stock market has from time to time experienced extreme price and volume fluctuations. These company-specific or broad market fluctuations may adversely affect the market price for our common shares. Anti-online gaming legislation could also impact our ability to remain listed.

Although our common shares are listed and traded on the Toronto Stock Exchange, the NASDAQ Global Select Market and the London Stock Exchange’s Main Market, this should not imply that there will always be a liquid market in our common shares.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-40-

OUTLOOK

While the global online gaming market continues to promise vast growth potential, competition is intensifying for players and market position, and growth in online poker is moderating from previous exponential rates. Additionally, in October 2006 the United States Government approved the UIGEA, which prohibits financial transaction processing in the US online gaming market. As a result, WagerLogic’s licensees will not take wagers from US-based players. Despite these challenges, CryptoLogic remains optimistic about the future of online gaming and the Company’s position as a leader within it.

UIGEA and future strategy

CryptoLogic believes that the UIGEA will have a significant short-term negative impact on the industry and on future financial results. Additionally, the UIGEA may increase competition throughout Europe, which could negatively impact the Company’s business.

Since 2002, CryptoLogic had been preparing for this eventuality by shifting its business to Europe, and our record revenue and earnings in 2006 arise from our success in these markets and others that embrace Internet gaming. Our thriving European customers, strong balance sheet, and new business in Asia enable us to face the future with confidence.

The Company is in excellent financial position to build on the global strategy that has led to record results in both 2005 and 2006. In particular, the Company will:

• continue its game innovation strategy. The Company has several innovative casino and poker projects, both underway and planned, which are designed to enhance licensees’ revenue;

• aggressively pursue new poker licensees, like Betsafe and DTDPoker, to enhance the liquidity of licensees’ poker network. The Company will also continue to pursue “blue chip” casino licensees in accordance with its return on effort strategy. In February 2007, the Company announced an exclusive three-year contract to provide both poker and casino software for Holland Casino, the Dutch government-owned casino operator. This new site to be run by Holland Casino is expected to launch in June 2007 and will be available to residents of the Netherlands only;

• aggressively pursue strategic, accretive acquisition opportunities to accelerate the advancement of the Company’s strategies. Acquisition opportunities have multiplied since passage of the new US law, and the Company will continue to evaluate new, exciting existing prospects, like Parbet;

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-41-

• control and optimize expenditures by a thorough, ongoing review of discretionary costs, operating expenses and capital expenditures; and

• expand in Asia. CryptoLogic will continue to build its European leadership position and intends over time, to expand its Asian presence to become a strong competitor in this large, emerging market. We took our first major step down this path in January 2007 when we signed a Memorandum of Understanding with two Chinese companies that will help us develop and license games for China and the Chinese diaspora.

We intend to lead this strategy from a new executive headquarters in the Republic of Ireland, subject to regulatory and shareholder approvals.

We expect to incur approximately $4.5 million in non-recurring expenses and $1.0 million in capital expenditure associated with the anticipated establishment of a new head office in Ireland in 2007, plus incremental annual operating expense of approximately $2.5 to $3.0 million beginning in 2007. We believe that we will generate a strong return on this investment in the long run, as we expect the new office to:

• bring the Company closer to the world’s major markets (UK, Europe and Scandinavia) that embrace Internet gaming, and therefore, closer to its key customers, investment community and prospects;

• establish the Company in a gaming-friendly environment that enables the Company to provide a wider range of marketing support and brand management services to licensees;

• broaden the Company’s strategic acquisition opportunities; and

• increase liquidity in the Company’s shares trading in the UK.

Internet casino

In Internet casino, players have grown more sophisticated through a broad choice of gaming platforms, such that the market is demanding increasingly entertaining and innovative games. Accordingly, we will continue to deliver an array of new and engaging games to help our licensees refresh their offerings to players, and foster player loyalty.

For example, in Q4 2006 our licensees launched games from our Bonus Pack 10, including the Frightmare Jackpot Slots series, andthe latest slots based on Marvel Super Heroes, including Elektra, Ghost Rider and Iron Man. The game pack also included the first-ever slot version of Cubis^TM, the enormously popular casual game. William Hill also introduced 24 of our new non-download games in the quarter. In total in 2006, we released over 50 new casino games.

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-42-

We plan to release two new downloadable casino game packs in 2007 and continue to upgrade our non-download game offering, both of which we expect will continue to be solid business drivers for our casino licensees, and CryptoLogic. We will continue to focus on partnerships with leading entertainment and casual game brands, like Marvel, Bejeweled and Cubis^TM. We will also enhance our localized offerings for key European markets.

Internet poker

Internet poker has grown at exponential rates in the past few years, but has recently showed signs of moderating—a natural development in young, high-growth markets. At the same time, competition in online poker has grown more intense and the importance of enhancing online poker room liquidity has increased.

As the UIGEA has effectively made online poker illegal in the U.S—previously the world’s largest online poker market—the industry’s focus has shifted to building liquidity in Europe, where CryptoLogic’s licensees’ central poker room is particularly strong. Just before the UIGEA, approximately 85% of licensees’ poker revenues came from outside the US, the vast majority of that from continental Europe and the UK.

Subsequently, Betfair exited the shared poker network which was the conclusion of a process they started in 2005 to bring their poker technology in-house. At the same time, CryptoLogic has added five new licensees which have been attracted by and which will build on the network’s strength in Europe:

• PlayboyGaming, one of the world’s most recognizable entertainment and lifestyle brands, in both casino and poker. The Playboy brand epitomizes our philosophy of working with blue-chip brands;

• Betsafe, a rapidly-growing Scandinavian-focused poker business;

• DTD Poker, the online home of the new UK-based poker club, DUSKTILLDAWN, which when its doors open in Nottingham in April 2007 will be the largest live poker venue in Europe and the first fully-licensed dedicated poker facility in the UK;

• a private Maltese company that operates Parbet.com, a popular Scandinavian online poker room, and its brand name and poker assets, which WagerLogic purchased as part of CryptoLogic’s brand ownership and licensing strategy; and

• Holland Casino, which was engaged as a new licensee in February 2007 in a milestone exclusive three-year agreement, CryptoLogic’s first with a government. CryptoLogic will provide both poker and casino software for Holland Casino, the Dutch government-owned casino operator. The new sites, to be run by Holland Casino under license from the Dutch government,

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

-43-

are expected to launch in June 2007, and will be available to residents of the Netherlands only.

We have used our brand management and licensing strategy very successfully with the award-winning InterCasino and InterPoker brands and related brands, such as ExtremePoker. Under the strategy, WagerLogic owns or controls key brands that it licenses to third party operators, along with its full suite of online gaming software, network services, and marketing support services, in order to generate higher revenue.

Exciting new games and features have also been successful in enhancing liquidity in the poker network. In Q4 2006 alone, we launched a new Spanish poker site for William Hill; totally redesigned our poker software to update game tables and lobbies for greater simplicity, selection and statistics; and introduced a tournament leader board to help licensees create exciting events that give their players new chances to win.

With a significant increase in 2006 in capacity for simultaneous online playing and an ability to add new games seamlessly, we will continue to build liquidity through new poker licensees and new poker innovations, including the wide choice of languages, currencies, games, stake levels and tournaments around the clock.

Long-term Financial Goals

CryptoLogic expects 2007 to be a year of transition and growth in both Europe and Asia. The Company has signed its largest customers to long-term agreements, launched five new customer sites since December, and expects to launch three more in the second quarter of 2007 (PlayboyGaming’s Internet casino and Holland Casino’s poker and casino sites). Later this year, CryptoLogic expects to benefit from modest revenue from its new venture in China.

Beyond 2007, industry analysts continue to expect strong growth from the European market, which has been CryptoLogic’s core focus for the last five years. In addition, rapid online growth in Asia is expected in the years to come. Accordingly, the Company has the following long-term financial objectives in future years for its continuing business in Europe and Asia:

• Grow revenue and earnings at 20% year-over-year for Europe and Asia combined;

• Achieve net margin and return on equity of 20%;

• Achieve double digit resrve growth in casino and poker; and

• Achieve net margin and return on equity of 20%;

• Exceed industry growth rates in key casino and poker markets.

Marvel and all related character names and the distinctive likeness thereof: TM and © 2007 Marvel Characters, Inc. All rights reserved. www.marvel.com

CryptoLogic Management’s Discussion & Analysis of Operating Results & Financial Condition

For the year ended December 31, 2006

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EX-3

EXHIBIT 3

MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING

The accompanying consolidated financial statements of CryptoLogic Inc. are the responsibility of Management and have been approved by the Board of Directors.

The consolidated financial statements have been prepared by Management in accordance with Canadian generally accepted accounting principles. These statements include some amounts that are based on best estimates and judgment. Management has determined such amounts on a reasonable basis in order to ensure that the financial statements are presented fairly, in all material respects.

CryptoLogic’s policy is to maintain systems of internal accounting and administrative controls of high quality, consistent with reasonable cost. Such systems are designed to provide reasonable assurance that the financial information is relevant, accurate and reliable and that the Company’s assets are appropriately accounted for and adequately safeguarded.

The Board of Directors is responsible for ensuring that Management fulfills its responsibilities for financial reporting and is ultimately responsible for approving the financial statements. The Board carries out this responsibility principally through its Audit Committee.

The Audit Committee is appointed by the Board and is comprised of a majority of outside Directors. The committee meets periodically with Management and the external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues to satisfy itself that each party is properly discharging its responsibilities. The Audit Committee reviews the Company’s annual consolidated financial statements, the external auditors’ report and other information in the Annual Report. The committee reports its findings to the Board for consideration by the Board when it approves the financial statements for issuance to the shareholders.

On behalf of the shareholders, the financial statements have been audited by KPMG LLP, the external auditors, in accordance with Canadian generally accepted auditing standards. KPMG LLP has full and free access to the Audit Committee.

/s/ LEWIS ROSE		/s/ STEPHEN TAYLOR
Lewis Rose	Stephen Taylor
President and CEO		Chief Financial Officer

February 13, 2007

Consolidated Financial Statements

(In U.S. dollars)

CRYPTOLOGIC INC.

Years ended December 31, 2006 and 2005

AUDITORS’ REPORT TO THE SHAREHOLDERS

We have audited the consolidated balance sheets of CryptoLogic Inc. as at December 31, 2006 and 2005 and the consolidated statements of earnings, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2006 and 2005 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Chartered Accountants

/s/ KPMG

Toronto, Canada

February 13, 2007

CRYPTOLOGIC INC.

Consolidated Balance Sheets

(In thousands of U.S. dollars)

December 31, 2006 and 2005

	2006		2005
Assets
Current assets:
Cash and cash equivalents	$	76,940	$	94,420
Security deposits (note 2)		1,500		1,500
Short-term investments		50,000		3,214
Accounts receivable and other		8,251		8,629
Prepaid expenses		7,027		4,615
		143,718		112,378
User funds on deposit (note 3)		20,872		25,953
Capital assets (note 4)		18,106		14,214
Intangible assets (note 5)		48		77
Goodwill		1,776		1,776
	$	184,520	$	154,398
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable and accrued liabilities	$	47,766	$	37,495
Income taxes payable		2,165		1,314
		49,931		38,809
User funds held on deposit (note 3)		20,872		25,953
Future income taxes (note 12)		2,133		2,411
		72,936		67,173
Shareholders’ equity:
Share capital (note 7)		29,096		25,171
Stock options (note 8)		3,631		2,163
Retained earnings		78,857		59,891
		111,584		87,225
Commitments and contingencies (note 9)
Subsequent event (note 16)
	$	184,520	$	154,398

See accompanying notes to consolidated financial statements.

On behalf of the Board:

/s/ ROBERT H. STIKEMAN Director, Chairman

/s/ LEWIS N. ROSE Director

1

CRYPTOLOGIC INC.

Consolidated Statements of Earnings

(In thousands of U.S. dollars, except per share disclosure)

Years ended December 31, 2006 and 2005

	2006			2005
Revenue	$	104,022		$	86,307
Expenses:
Operating		64,685			52,658
General and administrative		7,907			7,642
Reorganization (note 11)		3,700			—
Software development (note 4)		—			3,287
Finance		554			417
Amortization		4,777			3,894
		81,623			67,898
Earnings before the undernoted		22,399			18,409
Interest income		7,092			3,627
Earnings before income taxes		29,491			22,036
Income taxes (recovery) (note 12):
Current		4,957			935
Future		(278	)		571
		4,679			1,506
Earnings	$	24,812		$	20,530
Earnings per common share (note 10):
Basic	$	1.83		$	1.51
Diluted		1.81			1.46

See accompanying notes to consolidated financial statements.

2

CRYPTOLOGIC INC.

Consolidated Statements of Retained Earnings

(In thousands of U.S. dollars)

Years ended December 31, 2006 and 2005

	2006			2005
Retained earnings, beginning of year	$	59,891		$	50,593
Earnings		24,812			20,530
Dividends paid		(5,846	)		(2,984	)
Excess of purchase price of treasury
shares over stated value (note 7)		—			(8,248	)
Retained earnings, end of year	$	78,857		$	59,891

See accompanying notes to consolidated financial statements.

3

CRYPTOLOGIC INC.

Consolidated Statements of Cash Flows

(In thousands of U.S. dollars)

Years ended December 31, 2006 and 2005

	2006			2005
Cash flows from (used in) operating activities:
Earnings	$	24,812		$	20,530
Adjustments to reconcile earnings to cash
provided by (used in) operating activities:
Amortization		4,777			3,894
Future income taxes		(278	)		571
Stock options		2,255			1,807
		31,566			26,802
Change in operating assets and liabilities:
Security deposits		—			5,500
Accounts receivable and other		378			(2,142	)
Prepaid expenses		(2,412	)		(2,861	)
Accounts payable and accrued liabilities		10,271			7,439
Income taxes payable		851			(17	)
		40,654			34,721
Cash flows from (used in) financing activities:
Issue of capital stock		3,138			4,986
Repurchase of common shares		—			(9,201	)
Dividends paid		(5,846	)		(2,984	)
		(2,708	)		(7,199	)
Cash flows from (used in) investing activities:
Purchase of intangible assets		—			(2	)
Additions to capital assets		(8,640	)		(8,850	)
Short-term investments		(46,786	)		32,568
		(55,426	)		23,716
Increase (decrease) in cash and cash equivalents		(17,480	)		51,238
Cash and cash equivalents, beginning of year		94,420			43,182
Cash and cash equivalents, end of year	$	76,940		$	94,420
Supplemental cash flow information:
Income taxes paid	$	4,208		$	951
Interest received		6,626			3,830
Non-cash portion of options and warrants exercised		787			962

See accompanying notes to consolidated financial statements.

4

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

CryptoLogic Inc. (the “Company”) is a software development company with leading proprietary commerce-enabling technology, permitting secure, reliable, high-speed and private financial transactions over the Internet. Substantially all of the Company’s revenue is earned in U.S. dollars, British pounds and Euros in the form of licensing fees and support services from licensees located outside of North America. Revenue from the top seven licensees constituted 84% (2005 - 90%) of revenue. The licensees’ internet businesses are licensed by the government of the Netherlands Antilles. The Company measures and reports its results in U.S. dollars.

1. Significant accounting policies:

The consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles (“GAAP”). Note 18 describes and reconciles the significant measurement differences between Canadian and U.S. GAAP affecting the accompanying consolidated financial statements. A summary of significant accounting policies is set out below:

(a) Basis of presentation:

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

(b) Revenue recognition:

The Company enters into non-exclusive gaming software hosting, licensing and services arrangements related to the design and operation of casino sites on the internet on behalf of licensed casinos.

Revenue from software hosting and support services to licensees is recognized, as the services are performed, on a daily basis, at the time of the gaming transactions, pursuant to the agreements with the licensees in which the Company participates in a pro rata share of the daily gaming profits. In addition, the Company receives a standard monthly fee for the provision of hosting and related services.

5

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

1. Significant accounting policies (continued):

Revenue from the customization of the software graphics, sound and texts to the specifications of the licensees is recognized on a straight-line basis over the term of the software and support agreements.

Interest income is recognized on an accrual basis.

(c) Cash and cash equivalents:

Cash and cash equivalents include highly liquid investments with original maturity dates of 90 days or less, and are stated at cost, which approximates market value.

(d) Short-term investments:

Short-term investments include highly liquid investments (primarily certificates of deposit and commercial paper) with original maturity dates between 3 and 12 months, and are stated at the lower of cost or market value. At the balance sheet date, cost approximates market value.

(e) Capital assets:

Capital assets are stated at cost less accumulated amortization. Amortization, based on the estimated useful lives of the assets, is provided using the following methods and annual rates:

Asset	Basis	2006		2005
Computer equipment	Diminishing balance		40%		30%
Office furniture and equipment	Diminishing balance		25%		20%
Computer software and licenses	Straight line		3 - 5 years		3 - 5 years
Capitalized software development	Straight line		5 years		5 years
Leasehold improvements	Straight line		Term of lease		Term of lease

6

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

1. Significant accounting policies (continued):

(f) Software development:

Costs related to the development of software are expensed as incurred unless such costs meet the criteria for deferral and amortization under Canadian generally accepted accounting principles. Under The Canadian Institute of Chartered Accountants’ (“CICA”) Handbook Section 3450, Research and Development Costs, the Company capitalizes certain computer software development costs incurred subsequent to establishing technological feasibility; and amortizes the capitalized software development costs using the straight-line method over the estimated useful life of the software once the software is available for general release.

(g) Provision for jackpots:

Each time certain casino games are played, a preset amount is added to a cumulative jackpot for that specific game. The jackpot is won on a random basis by a player on a licensee website. The Company is liable for funding the jackpot wins and accrues the jackpot amount for all games on a monthly basis. The jackpot provision is reduced when payment is made to a winning player. The accrual for the jackpot at the balance sheet date is included in accounts payable and accrued liabilities.

(h) Income taxes:

The Company uses the asset and liability method of accounting for income taxes. Future income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss carry forwards. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in tax rates is recognized in income in the year that includes the enactment or substantive enactment date.

7

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

1. Significant accounting policies (continued):

(i) Stock-based compensation:

(i) Stock options:

The Company has a stock option plan for directors, officers and other key employees. Effective January 1, 2003, the Company adopted the amended recommendations of CICA with respect to accounting for stock-based compensation and other stock-based payments. The Company applies the fair value method to all grants of stock options. Based on the transitional provisions, all stock options granted on or after January 1, 2003 are accounted for as capital transaction at the time of the grant and are reflected as stock options in shareholders’ equity. The fair value of options granted is estimated at the date of grant using the Black-Scholes option pricing model incorporating assumptions regarding risk-free interest rates, dividend yield, volatility factor of the expected market price of the Company’s stock and a weighted average expected life of options. The estimated fair value of the options is recorded over the options’ vesting period. Any consideration paid on the exercise of stock options is credited to share capital.

(ii) Long-term incentive plan:

Effective January 1, 2005, the Company introduced a long-term incentive plan for its officers and directors. The plan provides for the granting of performance share units to reward participants for the growth in the Company’s earnings per share, calculated on a fully diluted basis, and share price, with vesting over a three-year performance period. These awards are settled in cash upon vesting and therefore are recorded as a liability and included in accounts payable and accrued liabilities on the consolidated balance sheet.

Changes in this liability, which arise from fluctuations in the Company’s stock price and estimated future diluted earnings per share, are recorded in operating costs over the vesting period.

8

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

1. Significant accounting policies (continued):

(j) Foreign currency translation:

Monetary items denominated in currencies other than U.S. dollars are translated into U.S. dollars at exchange rates in effect at the balance sheet dates, and non-monetary items are translated at rates of exchange in effect when the assets were acquired or obligations incurred. Revenue and expenses are translated at rates in effect at the time of the transactions. Foreign exchange gains and losses are included in the consolidated statements of earnings.

(k) Intangible assets:

Intangible assets consist of customer lists and domain names and are amortized over their useful lives, generally three to five years.

(l) Goodwill:

Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the assets acquired, less liabilities assumed, based on their fair values.

Goodwill is not amortized and is tested for impairment annually, or more frequently, if events or changes in circumstances indicate that the asset might be impaired. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit is compared with its fair value. When the fair value exceeds its carrying amount, goodwill is considered not to be impaired and the second step of the impairment test is unnecessary. The second step is carried out when the carrying amount of the reporting unit exceeds its fair value, in which case, the implied fair value of the goodwill is compared with its carrying amount to measure the amount of the impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the value of goodwill is determined in a business combination described in the preceding paragraph, using the fair value of the reporting unit as if it was the purchase price. When the carrying amount of goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess and is presented as a separate line item in the statements of earnings.

For the years ended December 31, 2006 and 2005, the Company assessed impairment of goodwill and has determined that there was no impairment in value.

9

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

1.  Significant accounting policies (continued):

(m) Earnings per common share:

The Company uses the treasury stock method in computing diluted earnings per common share. The treasury stock method is a method of recognizing the use of proceeds that could be obtained upon the exercise of options and warrants in computing diluted earnings per common share. It assumes that any proceeds would be used to purchase its common shares at the average market price during the year being reported on.

(n) Variable interest entities:

In June 2003, the CICA issued Accounting Guideline 15, Variable Interest Entities (“AcG-15”), which became applicable to the Company on January 1, 2005. Variable interest entities (“VIEs”) include entities in which the equity investors do not have a controlling financial interest or the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support by other parties.

Management assessed the Company’s operations and relationships in light of AcG-15 and concluded that there are no VIEs in respect of which the Company is the primary beneficiary. Accordingly, no VIEs are consolidated in the consolidated financial statements.

(o) Use of estimates:

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the year. Actual amounts could differ from those estimates.

(p) Recent accounting pronouncements - financial instruments:

In January 2005, the CICA issued Handbook Section 3855, Financial Instruments - Recognition and Measurement, Handbook Section 1530, Comprehensive Income, and Handbook Section 3865, Hedges. The new standards will be effective for the Company for interim and annual periods commencing January 1, 2007.

10

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

1. Significant accounting policies (continued):

The new standards will require presentation of a separate consolidated statement of comprehensive income and the classification of financial instruments as “held for trading”, “held-to-maturity” or “available-for-sale”. Comprehensive income is the change in net equity of an enterprise during a period from transactions and other events and circumstances from non-owner sources.

Upon adoption of these standards, the Company will classify its short-term investments as held for trading instruments. Management does not expect that the adoption of these standards will have a material impact on the Company’s consolidated financial statements.

2. Security deposits:

Security deposits are amounts held by the Company’s bank as collateral provided to foreign banks and payment processors that process deposit and credit card transactions.

3. User funds on deposit:

User funds on deposit represent amounts deposited by end users of licensees for playing online games. These funds are treated as deposits of the end users until such games are played.

4. Capital assets:

2006	Cost		Accumulated amortization		Net book value
Computer equipment	$	10,781	$	5,116	$	5,665
Office furniture and equipment		2,137		738		1,399
Computer software and licenses		8,956		5,493		3,463
Capitalized software development		4,602				4,602
Leasehold improvements		4,134		1,157		2,977
	$	30,610	$	12,504	$	18,106

11

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

4. Capital assets (continued):

2005	Cost		Accumulated amortization		Net book value
Computer equipment	$	9,108	$	3,948	$	5,160
Office furniture and equipment		1,878		396		1,482
Computer software and licenses		6,699		3,664		3,035
Capitalized software development		1,489				1,489
Leasehold improvements		3,918		870		3,048
	$	23,092	$	8,878	$	14,214

Amortization expense of capital assets during the year was $4,748 (2005 - $3,863).

During 2005, the Company determined that certain software being developed no longer met the criteria for capitalization. As a result of this decision, the Company expensed $2,744 of software development costs incurred in 2005. Together with severances of $543, the Company took a total charge against earnings of $3,287 in 2005.

The change in the estimated useful lives of computer equipment and office furniture and equipment resulted in additional amortization expense of $681 in 2006.

5. Intangible assets:

Intangible assets consist of customer lists and domain names. At December 31, 2006 and 2005, customer lists with a cost of $315 have been fully amortized. At December 31, 2006, domain names have a cost of $157 (2005 - $157) and a net book value of $48 (2005 - $77).

6. Credit facilities:

The Company has an operating credit facility with a Canadian chartered bank in the amount of $3,000. No amount has been utilized under this line in 2006 and 2005.

12

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

7. Share capital:

(a) Authorized:

Unlimited common shares

Issued and outstanding:

	Common shares						Series F Warrants						Contributed		Total
	Number			Amount			Number			Amount			surplus		amount
Balance, December 31, 2004		13,311,498		$	20,108			30,000		$	272		$	—	$	20,380
Repurchase and
cancellation of shares		(509,700	)		(953	)		—			—			—		(953	)
Exercise of stock options		498,102			5,318			—			—			—		5,318
Exercise of Series F
purchase warrants		22,500			630			(22,500	)		(204	)		—		426
Expiry of Series F
purchase warrants		—			—			(7,500	)		(68	)		68		—
Balance, December 31, 2005		13,322,400			25,103			—			—			68		25,171
Exercise of stock options		318,834			3,925			—			—			—		3,925
Balance, December 31, 2006		13,641,234		$	29,028			—		$	—		$	68	$	29,096

13

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

7. Share capital (continued):

(b) Normal course issuer bid:

During 2006 and 2005 under normal course issuer bids, the Board of Directors approved the repurchase and cancellation of up to the following number of shares representing 10% of the outstanding common shares at that time:

		Repurchased and cancelled shares
Normal course issuer bid	Authorized shares	2006	2005	Total under plan
September 23, 2004 to
September 22, 2005	1,250,000	—	270,500	270,500
September 28, 2005 to
September 27, 2006	1,340,000	—	239,200	239,200
September 29, 2006, to
September 28, 2007	1,350,000	—	—	—

Under the September 23, 2004 to September 22, 2005 bid, the Company repurchased and cancelled 270,500 common shares during 2005 for a total cost of $5,225, of which $4,722, representing the excess of purchase price over stated value, was charged to retained earnings.

Under the September 28, 2005 to September 27, 2006 bid, the Company repurchased and cancelled 239,200 common shares during 2005 for a total cost of $3,976, of which $3,526, representing the excess of purchase price over stated value, was charged to retained earnings.

In September 2006, the Board of Directors approved the renewal of the above share purchase plan, under a normal course issuer bid, to repurchase and cancel up to 1,350,000 of the Company’s outstanding common shares for the period commencing September 29, 2006 and ending September 28, 2007. As at December 31, 2006, the Company had not repurchased any shares from the renewed normal course issuer bid.

14

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

8. Stock-based compensation:

(a) Stock option plan:

Under the stock option plan, the Company may grant options to directors, officers and other key employees to purchase common shares. Under the plan, a maximum of 3,000,000 common shares may be issued. The exercise price of the options may not be less than the market value of the underlying common shares on the date of grant. The Company does not grant stock options with an exercise price below the market value at the date of grant. There are 781,350 (2005 - 351,695) common shares available to be issued under the stock option plan as at December 31, 2006. Options typically vest over a period of three or four years and the term of the options may not exceed five years.

Details of stock option transactions are as follows:

	2006					2005
	Number of options			Weighted average exercise price of		Number of options			Weighted average exercise price of
				(Cdn. $)					(Cdn. $)
Options outstanding,
beginning of year		1,105,073		$	17.59		1,427,661		$	13.75
Granted		387,300			24.89		337,250			25.93
Exercised		(318,834	)		11.28		(498,102	)		11.42
Forfeited		(166,955	)		23.90		(161,736	)		20.43
Options outstanding,
end of year		1,006,584			21.35		1,105,073			17.59
Options exercisable,
end of year		295,105		$	19.83		340,841		$	15.79

15

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

8. Stock-based compensation (continued):

	2006			2006
	Options outstanding			Options exercisable
Range of exercise price	Number outstanding	Weighted average remaining life (years	Weighted average exercise price	Number exercisable	Weighted average exercise price
(Cdn. $)			(Cdn. $)
$5.00-$10.00	115,750	1.08	$  7.59	33,875	$  8.12
$10.01-$15.00	13,375	1.71	13.03	6,750	13.63
$15.01-$20.00	168,209	2.10	17.37	98,459	17.95
$20.01-$25.00	495,625	3.96	23.46	132,083	22.99
$25.01-$30.00	198,125	3.96	27.15	20,688	27.60
$30.01-$35.00	10,500	3.41	31.10	2,000	30.85
$35.01-$40.00	5,000	3.30	36.86	1,250	36.86
	1,006,584	3.28	21.35	295,105	19.83

	2006			2006
	Options outstanding			Options exercisable
Range of exercise price	Number outstanding	Weighted average remaining life (years	Weighted average exercise price	Number exercisable	Weighted average exercise price
(Cdn. $)			(Cdn. $)
$5.00-$10.00	115,750	1.08	$  7.59	33,875	$  8.12
$5.00-$10.00	341,750	1.89	$  7.84	153,813	$  8.16
$10.01-$15.00	29,000	2.66	12.45	10,250	12.89
$15.01-$20.00	302,210	3.17	17.55	97,041	17.87
$20.01-$25.00	285,125	4.35	23.01	46,249	22.82
$25.01-$30.00	92,650	4.03	27.24	5,150	25.75
$30.01-$35.00	34,000	2.51	33.28	15,000	33.97
$35.01-$40.00	9,338	2.91	36.80	3,338	36.06
$40.01-$45.00	11,000	0.95	44.23	10,000	44.34
	1,105,073	3.10	17.59	340,841	15.79

16

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

8. Stock-based compensation (continued):

The Company expenses the cost of all stock option grants issued on or after January 1, 2003, determined using the fair value method. The estimated fair value of the options is recorded over the periods that the options vest. The fair value of options granted were estimated using the Black-Scholes option pricing model with the following weighted average assumptions:

	2006	2005
Dividend yield	2.00%	0.75%
Risk-free interest rate	4.25%	3.25%
Expected volatility	55.00%	50.00%
Expected life of options in years	5	5

The weighted average fair value of options granted during 2006 was $9.98 (2005 - $9.49).

Included in operating costs is the cost of stock options in the amount of $2,255 (2005 - $1,807).

For the year ended December 31, 2002, no compensation cost was recorded on the grant of stock options during that year. In accordance with the transitional provisions related to the CICA Handbook, additional pro forma disclosure is provided as if the fair value method of accounting had been used to account for these stock options. The fair value of options granted in 2002 was determined using the Black-Scholes option pricing model, using the following weighted average assumptions:

Dividend yield	0.00%
Risk-free interest rate	2.00%
Expected volatility	100.00%
Expected life of options in years	5

17

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

8. Stock-based compensation (continued):

Had compensation expense been determined based on the fair value of the employee stock option awards at the grant dates in accordance with the new accounting recommendations, the Company’s earnings and earnings per share for the year would have been changed to the following pro forma amounts:

	2006				2005
	As reported		Pro forma		As reported		Pro forma
Earnings	$	24,812	$	24,437	$	20,530	$	19,988
Earnings per common share:
Basic	$	1.83	$	1.80	$	1.51	$	1.47
Diluted		1.81		1.78		1.46		1.42

For stock options issued in 2002, the compensation cost for the year ended December 31, 2006 would have been $375 (2005 - $542).

(b) Long-term incentive plan:

During the year, the Company expensed $2,028 (2005 - $430) in costs related to units awarded under its long-term incentive plan, of which $346 is included in reorganization expense as a result of accelerated vesting for certain employees with termination agreements.

18

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

9. Commitments and contingencies:

(a) The Company has operating lease agreements for premises expiring at various periods up to July 2015. The future minimum annual rental payments on the operating leases are as follows:

2007	$2,319
2008	1,993
2009	1,588
2010	1,641
2011	1,641
Thereafter	5,879

(b) The Company has guaranteed minimum payments for certain intellectual property rights up to 2010:

2007	$   150
2008	804
2009	1,574
2010	2,388

(c) The Company and its subsidiaries are involved in certain claims and litigation arising out of the ordinary course and conduct of business including intellectual property matters. Management assesses such claims, and if considered likely to result in material exposure and where the amount of the claim is quantifiable, provisions for loss are made based on management’s assessment of the likely outcome. Management does not provide for claims that are considered unlikely to result in a significant loss, claims for which the outcome is not determinable or claims where the amount of the loss cannot be reasonably estimated. Any settlements or awards under such claims are provided for when reasonably determinable.

19

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

10. Earnings per common share:

Basic and diluted earnings per common share were calculated using the weighted average number of common shares and the weighted average number of common shares on a diluted basis.

	2006	2005
	(000's)
Weighted average number of common
shares outstanding	13,558	13,588
Weighted average number of common
shares outstanding - diluted	13,731	14,067

Basic and diluted earnings per common share are as follows:

	2006		2005
Earnings	$	24,812	$	20,530
Earnings per common share:
Basic	$	1.83	$	1.51
Diluted		1.81		1.46

Options to purchase 193,625 common shares (2005 - 54,338) were excluded from the computation of diluted earnings per share as the exercise price exceeded the average market price of common shares for the reporting year.

20

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

11. Reorganization:

On September 25, 2006, the Company announced a plan to move the corporate head office to Ireland in 2007 to be located in a gaming friendly environment. Total expected cost to be incurred is $8,500 largely related to professional fees, search fees, relocation and employee severance.

Accrual, December 31, 2005	$	—
Professional fees		1,257
Employee severance		1,942
Employee relocation and recruitment		501
		3,700
Payments		(1,466	)
Included in accounts payable and
accrued liabilities at December 31, 2006	$	2,234

12. Income taxes:

The income tax provision differs from the amount which would be obtained by applying the Canadian statutory income tax rate to the earnings before income taxes. The following explains the major differences:

	2006			2005
Earnings before income taxes	$	29,491		$	22,036
Income taxes based on a statutory rate of 36.12%
(2005 - 36.12%)	$	10,652		$	7,960
Increase (decrease) in income taxes resulting from:
Lower effective income tax rates in foreign jurisdictions		(7,227	)		(4,213	)
Tax cost of non-deductible items		1,286			1,084
Recognition of tax benefit of non-capital loss carryback		—			(1,041	)
Recognition of tax benefit on non-capital loss carryforward		—			(1,942	)
Other		(32	)		(342	)
Actual income tax expense	$	4,679		$	1,506

21

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

12. Income taxes (continued):

The tax effects of temporary differences that give rise to significant portions of the future income tax assets and future income tax liabilities at December 31, 2006 and 2005 are as follows:

	2006			2005
Future income tax assets:
Long-term incentive plan	$	319		$	—
Capital assets		—			42
Provisions for known matters		702			657
		1,021			699
Future income tax liabilities:
Capital items		(695	)		(301	)
Unrealized foreign exchange gains		(2,395	)		(2,626	)
		(3,090	)		(2,927	)
Less valuation allowance		64			183
Net future income tax liabilities	$	(2,133	)	$	(2,411	)

13. Related party transactions:

In the normal course of operations, the Company currently engages the services of a law firm in which a member of the Board of Directors is a partner. Fees paid to this firm were $653 (2005 - $589).

In 2005, the Company purchased, in the normal course of operations, software from another company in which a member of the Company’s executive has a personal interest. Payments to this individual in 2006 relating to this transaction amounted to $43 (2005 - $145).

14. Foreign exchange:

In 2006, the Company recognized a total foreign exchange gain of $574 (2005 - foreign exchange loss of $1,761).

22

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

15. Financial instruments:

(a) Fair values:

The carrying values of financial instruments, which consist of cash and cash equivalents, security deposits, short-term investments, accounts receivable and other, user funds on deposit, accounts payable and accrued liabilities and user funds held on deposit, approximate their fair values due to the short-term nature of these financial instruments.

(b) Interest rate:

The weighted average effective interest rate on short-term investments as at December 31, 2006 is 5.30% (2005 - 4.20%).

16. Subsequent event:

On January 15, 2007, the Company signed an agreement to purchase the poker brand and related assets of Parbet.com, a Norwegian company. Under this agreement, the Company paid cash of $11,867 for the brand and assets of Parbet.com, and may potentially pay additional amounts up to a maximum of $5,274, contingent on improved performance of the assets over a six-month earn- out period.

17. Product revenue:

The Company develops and hosts software that allows licensees to provide online casino and poker games and considers this activity to be one reportable segment. Revenue from licensing software for online casino and poker games in 2006 was $59,211 (2005 - $52,998) and $33,934 (2005 - $27,013), respectively.

23

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

18.  Differences between Canadian and United States generally accepted accounting principles:

On January 1, 2006, the Company adopted, on a modified prospective basis, FASB Statement No. 123 (revised 2004), Share-Based Payment (“FAS 123(R)”) for new awards granted on or after this date under the Company’s stock option and long-term incentive plans and for the unvested portion of existing awards on January 1, 2006.

(a) Stock options:

Under Canadian GAAP, the Company does not estimate forfeitures in determining the expense to be recognized over the service period and forfeitures are accounted for as they occur. FAS 123(R) requires an entity to estimate the number of options for which the requisite service is expected to be rendered.

On January 1, 2006, the Company estimated the number of outstanding options for which the requisite service is not expected to be rendered. Amounts recorded as compensation cost in earlier years for options outstanding at January 1, 2006 for which requisite service is not expected to be rendered have been eliminated and recognized in earnings as the cumulative effect of a change in accounting principle on January 1, 2006.

The cumulative effects of adopting FAS 123(R) on January 1, 2006 and the 2006 U.S. GAAP stock-based compensation adjustment were $601 and $223, respectively. These amounts were quantified using a weighted average forfeiture rate assumption of 27%.

(b) Long-term incentive plan:

Under Canadian GAAP, the Company uses an intrinsic value-based method to record compensation expense for liability classified awards. The prospective adoption of FAS 123(R) requires the use of a fair value-based method, rather than an intrinsic value-based method, to measure and record compensation expense for these awards. The Company has determined there is no material difference between the intrinsic value and the fair value of the units awarded under its long-term incentive plan.

24

CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)

Years ended December 31, 2006 and 2005

18. Differences between Canadian and United States generally accepted accounting principles (continued):

The significant measurement differences between Canadian and U.S. GAAP affecting the consolidated financial statements, as noted above, are as follows:

	2006		2005
Earnings based on Canadian GAAP	$	24,812	$	20,530
Adjustment for stock-based compensation (a)		824		—
Earnings based on U.S. GAAP	$	25,636	$	20,530
Earnings per common share based on U.S. GAAP:
Basic	$	1.89	$	1.51
Diluted		1.87		1.46

(c) Guidance for quantifying financial statement misstatements:

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). SEC staff issued SAB 108 to address what they identified as diversity in practice whereby entities were using either an income statement approach or a balance sheet approach, but not both, when evaluating whether an error is material to an entity’s financial statements. SAB 108 requires that in quantifying and analyzing misstatements, both the income statement approach and the balance sheet approach should be used to evaluate the materiality of financial statement misstatements. SAB 108 is effective for the Company for the year ended December 31, 2006. The Company assessed misstatements using both the income statement and balance sheet approaches and concluded that misstatements are not material to the consolidated financial statements under either approach.

25

EX-4

EXHIBIT 4

CONSENT OF KPMG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in this Annual Report (Form 40-F) of Cryptologic Inc. of our auditors’ report dated February 13, 2007 with respect to the financial statements of Cryptologic Inc. included in the Annual Report (Form 40-F) for the year ended December 31, 2006.

/s/ KPMG LLP

Chartered Accountants

Toronto, Canada

March 28, 2007

EX-5

EXHIBIT 5

CERTIFICATIONS

I, Lewis N. Rose, certify that:

1. I have reviewed this annual report on Form 40-F of Cryptologic Inc.;

2.            Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.            Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the issuer as of, and for, the periods presented in this report;

4.             The issuer’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)           Evaluated the effectiveness of the issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)           Disclosed in this report any change in the issuer’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the issuer’s internal control over financial reporting.

5.             The issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the issuer’s auditors and the audit committee of the issuer’s board of directors (or persons performing the equivalent functions):

(a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the issuer’s ability to record, process, summarize and report financial information; and

(b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal control over financial reporting.

Date: March 28, 2007

/s/ LEWIS N. ROSE

Lewis N. Rose

President and Chief Executive Officer

CERTIFICATIONS

I, Stephen Taylor, certify that:

1. I have reviewed this annual report on Form 40-F of Cryptologic Inc.;

2.            Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.            Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the issuer as of, and for, the periods presented in this report;

4.             The issuer’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)           Evaluated the effectiveness of the issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)           Disclosed in this report any change in the issuer’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the issuer’s internal control over financial reporting.

5.             The issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the issuer’s auditors and the audit committee of the issuer’s board of directors (or persons performing the equivalent functions):

(a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the issuer’s ability to record, process, summarize and report financial information; and

(b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal control over financial reporting.

Date: March 28, 2007

/s/ STEPHEN B. TAYLOR

Stephen B. Taylor

Chief Financial Officer

EX-7

EXHIBIT 6

CERTIFICATION PURSUANT TO

18 U.S.C. §1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Cryptologic Inc. (the “Company”) on Form 40-F for the year ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Lewis N. Rose, the President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 28, 2007

/s/ LEWIS N. ROSE

Lewis N. Rose

President and Chief Executive Officer

CERTIFICATION PURSUANT TO

18 U.S.C. §1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Cryptologic Inc. (the “Company”) on Form 40-F for the year ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen Taylor, the Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 28, 2007

/s/ STEPHEN B. TAYLOR

Stephen B. Taylor

Chief Financial Officer