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Edited Transcript of INS earnings conference call or presentation 15-Mar-18 3:00pm GMT

Q4 2017 Intelligent Systems Corp Earnings Call

NORCROSS Mar 16, 2018 (Thomson StreetEvents) -- Edited Transcript of Intelligent Systems Corp earnings conference call or presentation Thursday, March 15, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James Leland Strange

Intelligent Systems Corporation - Chairman, CEO and President

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Conference Call Participants

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* Sam Rebotsky

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Presentation

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Operator [1]

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Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the earnings release and investor conference call. (Operator Instructions) Leland Strange, CEO of Intelligent Systems, you may begin your conference.

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [2]

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Good morning. Welcome to the Intelligent Systems Investor Conference Call. In line with our past investor calls, I expect my prepared outline portion of this call to last about 20 minutes, and I plan to do 2 things; first, briefly comment on the 2017 year-end balance sheet and results; and second, update you on the progress and outlook for our CoreCard business, which is our primary business. Keep in mind that CoreCard and its affiliated companies is really our only operating entity.

I'll adhere to the be brief and be gone adage, as you will have time at the end to ask any questions on material that I don't cover to your satisfaction. The purpose in having the call is to add flavor to the factual information that you have and what we file and to summarize where we are this year thus far. I'm going to assume by being on the call that you have a copy of the earnings release from this morning. I'm not going to repeat all of the information in the press release. Our CFO, Karen Reynolds, is with me on the call, if you have any questions specific to the numbers in the Q&A.

We will file our Form 10-K for the past year later today. It will be available on our website, at intelsys.com, and also at sec.gov shortly thereafter. Obviously, there's a lot of detail in that, and you should read it for a more complete understanding of our business and its risks and opportunities.

Even with what I call my proclivity for brevity, I still need to do the legal preface and point out that this call will contain forward-looking statements -- that's an SEC-recognized term -- about Intelligent Systems and its operations. Much of my commentary will fall within the definition of forward-looking statements, for example, where I use words such as anticipate or I believe or plan or expect or likely or intend or any other similar expressions. I'm going to provide my best judgment and description of things as I see them as of this minute, and it might prove to be wrong. In fact, I can almost guarantee that our situation will evolve, so I cannot or will not be entirely accurate.

Let's start with the financial results. When we review financials, I'll remind you again that CoreCard is ISC's core business and the primary focus of our management time and resource allocation. So first, about liquidity.

Our cash decreased from about $17 million at the end of '16 to $14 million at the end of 2017. A big reason was that in December, we purchased approximately $1.7 million of additional processing equipment to be able to handle a potential new customer. This year, we made substantial additional purchases in anticipation of a contract currently in negotiations with this potential customer. It was only a slight risk as the potential customer agreed to take ownership and reimburse us for the equipment if things don't work out. However, we believe this relationship will have a positive outcome, and the equipment had to be purchased in order to meet some aggressive testing timelines.

Also during 2017, we invested slightly less than another $1 million in capital equipment for CoreCard's processing and technical operations. We used approximately $700,000 in cash for operations and customer expenses. The $700,000 of cash used for operations is less than the approximately $1.3 million used in the prior year.

So operationally, revenue from services, which includes licensed software, software maintenance, processing services and professional services, grew 9% overall in the fourth quarter of 2017 and 14% for the full fiscal year compared to the same periods in 2016. We benefited from both an increase in our processing services customer base and a number of transactions processed as well as an increase in our maintenance and software support.

License revenue actually decreased year-over-year. If you remember, in 2016, we had the initial implementation of a global license customer. We cautioned then we did not anticipate having the same growth for license revenue in 2017, although the customer did implement a second site and has plans to do a third site this year. This is an international licensee that utilizes a significant quantity of CoreCard resources on an ongoing basis. In fact, we have a permanent team devoted to the customer and work with them and their processing clients throughout the world.

Let me stray here from a strictly financial analysis for a little more explanation about licensing versus processing. It's a question I received from several new shareholders in the past couple of months.

CoreCard is unique in that it will license to an entity the same software it uses in its own processing environment. But our history has now educated us to the extent that we actively discourage licensing in most situations. What we have found is that the licensee quickly wants one-off software code to meet their custom needs and needs a lot more ongoing services from CoreCard than they originally anticipated when they made the decision to license rather than be processed. So they really save very little considering the total cost of ownership while having to support their own infrastructure. It simply shifts where the licensee sends or spends their money. They do not get the cost benefits that come from sharing a data center with all of its intended infrastructure costs such as annual PCI audits or shared management of the CoreCard environment. And we obviously cannot give priority to every now and then type of demands from a licensing customer as we need to focus on our processing customers, which is an everyday recurring task.

In the future, we will be charging more for licensee professional help than for processing customers professional help unless they guarantee certain minimums that will support management and the team since it requires almost standby resources. So yes, we will license in special situations but we don't plan on using our resources to build up that side of the business. We'd rather focus on processing, where we can scale and not require as many personnel resources dedicated to one customer's custom software.

Now back to the financial discussion. As in the past, we will continue to caution about the timing of revenue recognition particularly on new contracts. It's often unpredictable and often not under our control. Importantly, our annual revenue is still not large enough to account for some of the quarterly swings in revenue we'll likely to experience. We expect to continue to see volatility in revenue in the income line, but as our processing services grow, we will slowly begin to level out from the volatility, but don't expect that this year.

As you also can see from the press release, our R&D expenditures increased 59% in 2017 over 2016. We started an expansion in our India operations during 2017, adding 40 additional staff, and we opened our second office in India near Mumbai in the fourth quarter. You'll most likely continue to see us increase expenditures in R&D in the near term as we continue to enhance our product offerings. With the increase in R&D expenses, CoreCard operations, which includes our India and Romania subsidiaries, experienced a small loss from operations for 2017.

From that, let's go to investments. From time to time, when the appropriate opportunity becomes available, we do invest in companies, primarily in FinTech or related industries that complement our CoreCard operation. During 2017, we sold the majority of our equity position in one such investment. It is a company which also has a substantial processing contract with CoreCard, and we we're happy to be one of their first investors. This resulted in an approximate $1.5 million gain. We had various other investment activity during 2017, which you can read about further in the footnotes to our financial statements.

Shareholders often ask, "Do you have any other gems hidden in the investment category?" Well, my flippant response is, "I hope so." But the truth is that is likely to be erratic, and as you have seen in the past, we sometimes end up with the kind that what we prefer to forget that entail write-offs. But yes, we hope we have some possibilities will eventually generate some good returns, but don't expect one to materialize in 2018.

Primarily because of the investment income recognized in 2017, Intelligent Systems is reporting a $473,000 profit for the year. Although you're always pleased to end the year net positive, regardless of how you got there, we remain focused on the operations side of the business.

So then, looking at strategic initiatives. I've often mentioned that we're exploring and open to strategic initiatives that will benefit the company. We still remain open and we're still considering various alternatives, as I have stated in the past. We want to do what is best for the shareholder, of which I'm a large one. That can take the form of a sale of the company, a merger or we can acquire another company for cash or stock complementary to CoreCard that will speed up our growth.

How does that play out day to day? We have conversation with private equity groups and others who have capital and are serious about this space. But we don't go looking for them; they come to us. Some we engage in a little more conversation, and some we dismiss. They typically end up saying they're looking for opportunities that are under-managed that they can throw management at to make their returns. After minimum due diligence, if you can call it that, they report back unimpressed -- they report back very impressed with our customer base and with our platform, but they don't see how either more resources or additional management would be beneficial. So frankly, we're not a good fit for a financial buyer or a partner. We're a good fit for someone already in the business. And we do talk to others in our business that might make sense in thinking about business combinations. And we've talked to some banks that want to expand their programs and processing visions, either to buy them, they buy us or we merge. And we have conversations with current and prospective customers who may want to lock up CoreCard for their particular business.

The point I'm making is twofold: one, we will be opportunistic; and two, nothing is serious with any current conversation, so there's nothing you can bank on here. But we run the company day-to-day as if we're going to be here and independent for a long time and grow to be a substantial player in the payment issuing and processing business. That means we may turn down quick chunks of revenue that does not move us towards being a good long-term recurring revenue business.

So there are 3 keys to our ability to scale: there are resources, and by this, we primarily talk about people; there's a strong customer base; and then there's the power of our platform. Let me comment on each of those. From resources, we now have around 350 experienced and very talented technical payment professionals at our subsidiaries in the U.S., Romania and India. And again, from an operational perspective, we consider them to be one company under the CoreCard name.

We are enjoying and experiencing strong demand for these very talented and experienced technical resources on both the licensing and processing sides of our business and are increasing capacity to support our growth. But it takes a year or more for them to be productive.

In India, we have expanded our employee count by about 25% since the end of 2016, and we're going to continue to add more resources. We have approximately 315 employees primarily housed in our building, plus we opened a second location near Mumbai. In the U.S., our management team remains constant with greater than 12 years average with the company. The management team is highly integrated with offshore, and we are adding a few resources in the U.S. Romania remains a small developer tester group. Average tenure is 10 years. We may add some specific skill sets to the Romanian team.

So that's the resource side. Then the customer base. We have a customer base that encompasses a wide range of spectrums. We have very large customers who have hundreds or even thousands of internal IT resources. And then we have some small startups. We have recently added a second license for a global licensed customer -- that's a prepaid card processor, with complex and dynamic program requirements. They also use what I will call fleet-light CoreCard software, and they process from their European headquarters. We have also successfully completed conversion from our competitors. And one of our licensees, with a great deal of assistance from CoreCard, has completed a conversion of 1 million-plus accounts for an Australian bank. So our software is used around the world by our customer base.

Then the third point was the platform. We're very good with revolving credit processing. That's private label, which sometimes called closed loop; and association network, think Visa and MasterCard. We can do really complex things, and it's being recognized in the FinTech world even though we do no marketing and have no sales force. We're very fast to market, we're very flexible, and we do some things other large processors cannot do well. Plus, we do prepaid in all of its variations, including payroll and gift. We do fleet cards with a really robust architecture. We do installment loans, rewards. Virtually anything that has an account with a currency attached, we can handle. So we believe we are good now, but our goal is to be able to say, "We are a world-class processor," by next year.

That leads me to the outlook summary. I mentioned earlier some of the relationships that are active. Due to the time lag it may take for startup or to reach large quantities of accounts, coupled with the additional R&D expenses we may choose to incur to prepare for future growth, it's difficult to project 2018 numbers. But I fully expect to have a good year. We believe we will at a minimum continue to grow our revenue similar to or better than last year.

Some recent relationship discussions and short-term contract work may result in significant revenue and profit growth in this year and in our future years, but we do not, as of today, have this work contracted beyond the short-term. So we will be conservative and just predict what we feel we know.

It will be very difficult to add any more business relationships this year, 2018. We're working with some very well-known companies, and have severe resource constraints in taking care of everyone, and we don't want to take business that we cannot deliver successfully.

So in summary, if you want to know how we'll do this year, the answer is very well but I don't know how that will translate to actual revenue and profit recognition. We have signed and unsigned relationships that will definitely provide good revenue. If, and I underlined that, some contracted business has the account expansion they believe that will happen and we execute contracts with each of the groups we're currently providing services for, we will have a really good year in 2018 and a great year in 2019. I should add, it's possible we will not be able to come to terms with one of the relationships. And if not, we will still generate good revenue as we help them transition elsewhere. A basic ethical premise of our business, and you've heard me say this before, is that we treat all customers fairly and expect to be paid the same thing for the same services, adjusted for volume and circumstances. Sometimes, that gets in the way of a deal, but in the long run it makes us a stronger and credible company.

So I hope all this helps you, our shareholders and prospective shareholders, understand management's view of our current business.

And with that, I will open things up for questions, and we'll try to provide answers if anybody has any.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Sam Rebotsky.

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Sam Rebotsky, [2]

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Maybe there are other people online to ask questions and I'll jump off and then come back. It seems like you made a lot of good accomplishments during the current year, increasing the number of employees and the potential business. And one thing that you may not -- you probably don't realize, the 10-K has been filed and that makes it easier for me to be more aware of what's going on.

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [3]

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Good.

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Sam Rebotsky, [4]

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So as far as the $1.7 million processing equipment, was that paid for? Or does that have anything to do with the notes receivable of $1.250 million? Or what's the story about the $1.7 million additional processing equipment?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [5]

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No, the $1.7 million was paid for with cash. We have now invoiced for the $1.7 million, plus a substantial additional amount that is -- has been bought this year. We may or may not get that paid for by the end of this quarter, so it may show up as a receivable in the quarter. But it's a -- it's with a A111, AAA whatever ready company, so we don't have any problems believing that we'll get paid for that unless we decide to keep it on our balance sheet, which is unlikely, highly unlikely, and move this from a licensing to a processing situation.

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Sam Rebotsky, [6]

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So this is the notes receivable of $1.250 million at year-end?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [7]

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No, that is the -- the notes receivable has to do with a -- I'm going to call it an investment. It's actually a -- sometimes, we do our investments in ways that we feel are protect us the best. So we have effectively loaned someone some money, and it will be a convertible or with warrants. I don't really want to get into detail. But it will be -- consider it equity. Although we earn interest on it quarterly, and we expect to get it paid back and still have equity at the company.

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Sam Rebotsky, [8]

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Okay. So your revenue increased about $1.1 million for the current year, and you're talking about a similar percentage increase. And is it -- and you don't expect for 2018 any of the customers to really go into full force, where this revenue can increase more significantly? And what do you have to do to get more expansive growth in the revenue and product sales?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [9]

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No. I think what I've tried to say is the revenue could increase greater than what we did last year. But I'm saying I'm going to be conservative and say I don't have that contracted. And in the processing business, we can only process what our customers bring in, meaning, if their accounts grow rapidly, then we're going to get more revenue. But they're not really our accounts. That's their accounts and it's their business. So their business has to grow for ours to grow. And I think I said that some of the -- either the customers or potential customers expect their account base to grow significantly. If that happens, our revenue will grow quicker. But it's not something that we control. And I can't add new customers. So we're at this point at the mercy of the growth of the folks that we have now contracted or that we're potentially contracting.

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Sam Rebotsky, [10]

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Okay. If a significant customer would add to significant revenue, would that be something you'd put out a press release on or is it that significant or material?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [11]

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I don't know that I can answer that because it could be just quarter-to-quarter growth that would show up in the quarterlies. So no, I don't think there will be in a situation where we would probably be putting out a press release. We're not talking about doubling our revenues now. We're just talking about maybe growing in excess of the 14% we grew last year.

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Sam Rebotsky, [12]

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Okay. Now the R&D that you're spending, like $4,367,000 versus $2,740,000. Do you expect that is going to increase? Is that -- do you get reimbursed for this R&D or do you -- how does that work?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [13]

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We don't get reimbursed for R&D. R&D is money that we spend on our product to make it better.

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Sam Rebotsky, [14]

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Okay. But you spent $4,367,000 with revenue of $9 million. That's pretty -- is that included in -- no, that's really pretty heavy expenses. Now to the extent that you charge off this R&D, what timeframe do you have to expect to receive rewards for the money you are spending on?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [15]

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I expect to see rewards every quarter. This is not R&D that we can book and capitalize over the long term. This is very short-term kind of things that will -- that go into our base product, so it's not charged to any particular customer.

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Sam Rebotsky, [16]

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Okay, okay. And okay, let's see, as far as the investment that's carried $1.35 million, this is the new $1 million that you invested in early 2017?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [17]

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Yes.

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Sam Rebotsky, [18]

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Okay. All right. So I guess the bottom line is -- I mean, you're spending a lot of money on R&D. You have that capital to do that. And I guess, the timeframe for being rewarded for that at this point is a little longer even though you're breaking even or you're losing a little money.

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [19]

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Yes, Sam, but I think you have to understand there that we talk about we -- operationally, we used about $700,000 last year. That included all of that $4 million or $5 million R&D. So the overall cash is not negative. No, it's not something that's going to be negative despite the R&D. And if you want to be a world-class processor, you're going to spend money on R&D.

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Sam Rebotsky, [20]

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Okay, okay. Well, look, it's a good result, and hopefully, you can get more customers so that you could make some decent amount of money more so sooner than later. Leland, good luck going forward.

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [21]

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Thank you.

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Operator [22]

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(Operator Instructions)

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO and President [23]

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Okay. If there are no more questions, I will tell you that our next conference call will generally be at the end of the second quarter, unless there are significant new developments to report before then. And we thank you for your interest in the company. We look forward to continued good results. Thank you, everyone.

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Operator [24]

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Thank you. This concludes today's conference call. You may now disconnect.