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Edited Transcript of INS earnings conference call or presentation 1-Nov-19 3:00pm GMT

Q3 2019 Intelligent Systems Corp Earnings Call

NORCROSS Nov 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Intelligent Systems Corp earnings conference call or presentation Friday, November 1, 2019 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 & President

* Matthew A. White

Intelligent Systems Corporation - VP, CFO & Corporate Secretary

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Conference Call Participants

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* Ishfaque Ahmed Faruk

Sidoti & Company, LLC - Analyst

* Sam Rebotsky

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the earnings release and investors conference call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to the speaker today, Matt White, Chief Financial Officer. Please go ahead, sir.

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Matthew A. White, Intelligent Systems Corporation - VP, CFO & Corporate Secretary [2]

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Thank you. Good morning, everyone. As Leland noted in our press release this morning, revenue and profitability results met our expectations, as our platform continues to be validated by leading corporations. Revenue for the third quarter of 2019 was $9.522 million compared to revenue for the third quarter of 2018 of $5.415 million, an increase of 76%. The components of our revenue for the third quarter consisted of license revenue at $$2.225 million, professional services revenue of $4.579 million, processing and maintenance revenue of $2.235 million and third-party revenue of $483,000.

I'd now like to talk to the important components of our revenue. As we've mentioned in previous statements, our license revenue will vary from quarter-to-quarter. The third quarter increase in license revenue was driven by the retail launch of a new product related to our largest customer. As a reminder, we received license revenue primarily when our customers achieve new active account tiers. Once the customer achieves a new tier level, they receive a perpetual license up to that number of accounts. Inactive accounts do not count towards the license tier. In addition, we charge annual maintenance to our licensed customers, which is reflected in our processing and maintenance revenue line. Maintenance revenue increases when customers reach new license tiers. And the contract with our largest license customer includes a maximum tier level, which, because of the significant number of accounts, allows them to utilize the software for any number of active accounts once the maximum tier level is achieved. We would expect it to be several years, if ever, before they hit the maximum tier level. This large customer currently uses the software for a single institution, additional license fees apply if multiple institutions are added.

Looking further into the revenue detail provided, professional services revenue continues to comprise a significant portion of our overall revenue for the third quarter in the 9-month period 2019. However, as we previously stated, we expect that to decrease as a percentage of total revenue over time as our customers utilize the new features we've developed to add active accounts to their system, which is ultimately reflected in our license revenue and processing and maintenance revenue lines.

Additionally, we continuously create new functionality for our customers. And as such, we charge annual maintenance fees for our professional services, which is also reflected in our processing and maintenance line. As a reminder, we do not perform any professional services for third-parties that are not licensed or processing customers. And lastly, for revenue, our third-party revenue generally has a very low margin and constitutes services we provide on behalf of our customers, which we charge at or slightly above cost. We recognize this revenue growth for accounting purposes.

And now I'll turn to some other highlights on our income statement. We reported significantly higher income from operations of $4.200 million for Q3 2019 compared to $1.736 million for Q3 2018. This resulted in operating margin of 44% for Q3 2019 compared to 32% for Q3 2018, and 35% for Q3 2019. The year-over-year improvement was driven by our license revenue contributing significantly more to total revenue.

We achieved a sequential increase in margin for the third quarter of 2019 compared to both the first and second quarters of 2019. This improvement, again, was driven by higher license revenue, partially offset by higher general and administrative expenses related to legal and hiring costs, and also higher research and development expenses related to accrued employee bonuses. Our year-to-date 2019 tax rate was 24.7% compared to 4.6% in the comparable 2018 period due to the utilization of net operating loss carryforward since 2018. And finally, earnings per diluted share for the quarter was $0.34 compared to $0.21 for Q3 2018.

And with that, I'll turn it to Leland.

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

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Okay. Thanks, Matt. Matt talked about the actual financial numbers, but I'll be adding commentary, and everything I say, and anything Matt just said that was not in actual financial reporting patch should be considered a process as what is commonly known as a forward-looking statement. We're saying what we think and believe as we sit here today, and you should process all of it as just that. It's what we think and believe and not a promise or prediction. I wish we didn't have to format every conversation this way, but given our litigious society and our recent experience with the legal system, it's a required warning and caveat.

I guess staying on the subject of litigation or legal matters, there's actually nothing material to report. I will note regarding the claims from the short that a lead plaintiff has been affirmed by the federal judge and a hearing has been scheduled later in November. The independent INS Directors have also asked a firm to provide them an independent report on the claims and that is in process. Earlier, I thought these issues would be resolved this year, but now counsel has advised it will probably linger on into the next year.

As I stated on an earlier call, we believe there's no substance to any of the claims. I'll be glad if I could report this litigation is behind us, but it is not today, and it does have cost to both dollars and management time. We do not expect to pay anything out to the claimants. Counsel has advised against being more specific about cost, but they're not large. I'll even guess them to be under $500,000 as for unreimbursed by insurance to the company. On the other hand, our insurance costs have gone up, both as a result of these actions and the higher revenues and valuation of the company.

Now on what really counts, results from operations. The quarter pretty much played out as we expected. The license revenue was always going to be difficult to project and it came in towards the middle of the road, although I surmise some expected and much larger number.

I earlier said there could be what I characterize as pops in license revenue. Was this a pop in my vernacular? No. I'll reiterate it was middle of the road from our perspective and resulted from one of the most successful launches of a new credit card product ever. Our clients and partners in this particular endeavor are very happy with the result, although there were and still are plenty of bumps in the road. Talking a little more about that. Every day, we have more cards on our system than we had the day before. That means we can expect to see new problems continually popped up that need to be resolved. This is not new for us and is exactly what has happened for the last many years. We certainly do not think we're ready to immediately process 10 million or 20 million accounts with the system exactly as it is today, but we're confident that we see a path to get there. And every day, we move further down that path.

There will not be an a-ha moment when it is "done". It's a continuous, evolving process that's best undertaken with close cooperation between our exceptional CoreCard team and the expertise and experience of our clients and partners. We are laser-focused today on building a solid infrastructure to enable CoreCard to eventually take on the very largest clients that the giants in the industry currently serve. That includes parallel development to initially have (inaudible).

One of our advantages is our ability to add new functionality rapidly, and that word, rapidly, needs to be taken contextually within how it's understood in the industry. Coding the functionality is just the beginning of the process as different functionality places different stresses on the operating infrastructure components such as database hits or CPU utilization. It also often requires substantial rewriting of reports. I bring this up just to emphasize what I've stated before, this is a very, very complex software undertaking, which is why there have been very few new entrants in the open loop credit card space the past 20 years.

I should add here, however, that I do expect new competition. Many of the prepaid card processors are spending large sums to get into the credit game. They will definitely eventually get there, but their early customers can expect some really, really rugged periods as they find it is a magnitude, perhaps times 10, more difficult than prepaid. What you don't know, you don't know.

If I had any surprise for the quarter, it'd be the amount of professional services we delivered. It was higher than I expected, and I would not expect a number this high the next few quarters, although the numbers will still be very solid and very good. It's too early to have any better visibility or good handle on 2020 as most of our current clients are now focusing on getting through this holiday shopping season.

We are hiring new employees at rapid clip, both internationally and in Atlanta. I probably would not have expected the current growth projection for new employees in Atlanta, but it's currently needed to provide the needed expertise for our current and projected business needs. We expect at least 30 new hires for the second half of 2019, but we will also experience normal attrition in our India offices. This growth in resources should speak to our belief as to the stability of our professional services.

Our base underlying business, both processing and licensed customer revenue sources, continues to grow. I just want to make the point that we continue to grow our current base of business from existing customers. We're not just relying on new opportunities to provide growth. There are new opportunities that will also add to our revenues next year, although I am uncomfortable trying to project how quickly they will come online.

I know investors always want us to talk pipeline. It's not easy in our present situation to explicitly frame opportunities that way. We think strategically for longer term contribution as to what new business we bring on. And we do it day by day, depending on what we see. To help you understand that, we have inbound request for discussions about providing a processing services every single week. Now we don't see large opportunities weekly, they may just come in every month or so. And when we decide to pursue one of these, it may be 3 to 9 months before they contribute meaningfully to revenue. These have to be vetted against what current customers want to do to expand their business, and in most situations, we'll choose to develop more resources to current customers.

The reason investors want us to talk about pipeline is that they could be used as a proxy for future results. We don't give what is generally called guidance but we do try to give a general sense of what we believe will happen for the next few quarters. Our current belief is that fourth quarter would not be as strong, but still good as the third quarter for professional services revenues and that license revenue is likely to be similar to the third quarter. Certainly, the fourth quarter this year will be better than the fourth quarter of the 2018 year. For 2020, we see continued growth, but not at the pace we had for the full year 2019 over 2018. But we do expect to grow and see the 2020 year as the one to catch our breath while hardening our infrastructure to line up for higher growth in the future years.

So that pretty well sums up both the third quarter and how we see the future. I think I will spend most of the rest of our time talking about questions. And operator, you can take questions, and we also have some that were faxed in that I will deal with.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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

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Okay. While she's compiling the Q&A, I'm taking a list of questions that some of you have faxed in. And I'm going to take the -- what I consider the funniest one first. So please, as I read this and answer this, everyone in this room has got a smile on their face as I do. So here's what it says. I'll skip the first part, it says something about, I don't want you to retire but you could do whatever you want. You don't need this job. In 2009 -- hey, everybody understand. So this investor went all the way back to 2009 to read what I said, that's somewhat scary. But he said, in 2009 you mentioned that you're too old to be talking about 10 years. Now we're in 2019, how long would you be happy to be the CEO of Intelligent Systems? And I actually like to remember somebody asking me a question a long time ago, saying, what do you see out in 10 years? And I'm sure I said, I'm not even going to look out there because that will be somebody else doing it. And lo and behold, I'm still doing it. So I'm not going to answer how long. I guess as long as it's fun and as long as we're making progress, but I thought that was a real interesting situation that someone went all the way back to there.

Operator, do you have any questions? Otherwise, I'll take some others that I have here that were emailed in.

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Operator [3]

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Your first question comes from the line of Ishfaque Faruk from Sidoti & Company.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [4]

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Leland and Matt, just a few questions for me. And congrats on the really strong results across the board. Your license revenue really surprised to the upside, and it's just not me, I think, I asked, a lot of people feel that your license revenue was higher than many anticipated. And Leland, you briefly touched on that you expect Q4 license revenues to be similar to Q3, but going forward, when you look out into 2020 and 2021, do you feel as good about license revenues being at these, if you want to call it, new normals from prior quarters?

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

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Well, I've always said it's going to be lumpy. And going out further, I don't expect every quarter to be similar to this quarter, or what I said for the fourth quarter. I don't know whether the first quarter will have much license revenue or not. I'm not saying it won't, I just don't know. And remember, license revenue depends on how well other people do, not what we do. And they don't know either how well they'll do. So it's just really hard to project that. We will continue to have, I will suspect, significant license revenue in 2020. I just don't know how it'll break out quarter by quarter.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [6]

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Okay. And as a follow-up to that and -- can you give us a sense for what percentage or what chunk of the license revenue in Q3 was from this major new customer? And if you had any new ones?

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

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Yes, no, I really can't. That would be disclosing more than we're allowed to disclose from a customer perspective. Sorry, I can't do that. Listen, listen, let me add, I'll make it say that most of it came from there. How about that.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [8]

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Yes, that's exactly -- that works for me. Okay. Yes, in terms of professional services, Matt told me previously that professional services was expected to sort of taper off in Q3, but it was much higher than I expected. Matt or Leland, can you give me a sense of what happened during Q3 and do you expect that to sort of roll into Q4?

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

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Well, I think it's a good example of how it's so hard to predict. But here we are already in Q4 and I can't tell you whether they'll will be the same or more. I could tell you I expect them to be less.

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Matthew A. White, Intelligent Systems Corporation - VP, CFO & Corporate Secretary [10]

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They were actually less for Q3 if you look at it compared to Q2. So -- but it was a pretty minimal decline.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [11]

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Yes. It was pretty much...

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [12]

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Yes, it's really hard, for 2 reasons. One is, we don't know exactly what the current demand would be. And second, there is the issue of GAAP accounting. You finish a project and then you can put $300,000 in that quarter or you don't finish that project and it goes into the next quarter. Well, that's the 2 reasons it really is very difficult. I think what should be important to advisers release is the sense of how solid it is, or is it going to vaporize. And I think, what we're telling you, we expect and we believe that it's going to stay pretty solid. Now our bet, that's probably middle of the line, I guess, for the next year, meaning it could go up or it could go down. We won't be surprised to see it deviate from the line some. In fact, I would -- I don't want to project any closer than that, but it's going to -- it's solid, it's recurring in every sense of the word, repeating in every sense of the word is a better way to say it.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [13]

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Okay. And since we're talking about recurring, so when I look at your recurring revenues, it's around low 20%, 23% or so, I believe. But when I look at like large, established processing companies, let's say for example, FIS, their recurring revenue base is around like 82% or so. When you look out in the long term, what's your take that -- what's the recurring revenue can grow up to in the future for INS?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [14]

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I would say when I get as big as FIS, then I will be 82% also. We're really small for those percentages to be used as any kind of indicator at this point in time. We're just too small and the revenue components are different from FIS. So I could come up with those kind of numbers and play games with it, but I just resisted doing that because it really is not relevant.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [15]

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Yes. Got it. Okay. And Leland and Matt, we talked about this before and can you give me a sense for your new -- you mentioned in your prepared remarks that you're seeing more interest from processing clients than licensing customers. Can you tell me, in Q3, or we're already in Q4, what has been the recent conversations with clients on the processing and the licensing side? And how many, that would be great too.

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [16]

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I really can't answer that with that kind of specificity. I really can't. We constantly have conversations and I'm not going to make numbers or talk about numbers, sorry about that, can't do that.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [17]

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Okay. Can you give me some sort of color in terms of other than most of your customers being processing clients?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [18]

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Well, not really. I mean you have to look at -- you're talking about the size of the clients or are you talking about the size of revenue? We're going to get -- I mean there are so many ways to look at that. I don't think I can say anything meaningful. Sorry, I just don't think I can answer that.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [19]

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Okay. And in terms of other large, major financial institutions, do you have like any inbound on -- in terms of like similar big sized clients?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [20]

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Again, I'm not going to comment on that. And let me just say, I appreciate your question, but let's give some other people a chance to ask some questions, too. And if you like to call us afterwards, we can answer whatever we can. But I appreciate your questions, they're good questions. They're just sort of things you know that we can't answer. But thanks.

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Operator [21]

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Your next question comes from the line of [Calvin Secotch] from [Ten NX Capital].

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Unidentified Analyst, [22]

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Leland, yes, I hope that you can extend the call because some of us couldn't even get our questions across. I really like the example whereby you demonstrated the Base Pro Shops example. So I'm just thinking about this, right, given the level of flexibility of the software and having a real possibility of being adopted by a larger customer, can you share maybe some general feedback on existing customers or stories that highlight the power of your platform or how has CoreCard been able to help them in their businesses?

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

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I think you may have e-mailed that question. It's just not an easy question to answer. It's -- in order to get a licensed customer, it takes months of talking about the platform and looking at a bunch of things. So there's not any elevator pitch or elevator answer that I can give you, just like they don't accept an elevator pitch. It's the whole -- I've said this, I think, over and over, it's the whole bundle that makes it work. It's not a single 1, 2, 3, here's the top 3, and here's why people choose it. It -- this is very complex and it's a whole bundle of things that cause people to choose it. So again, I can't give you highlights, I can't give you a headline that makes that work.

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Operator [24]

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Your next question comes from the line of Sam Rebotsky from SER Asset Management.

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Sam Rebotsky, [25]

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As far as the licensing revenue, do we need more people to take on more clients? And the licensing revenue that we have, is there -- will that produce processing? Is it producing processing yet, and sort of, will it make the processing significantly greater amount?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [26]

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Yes, okay, thanks. Licensing does not produce processing. I mean licensing is strictly some other -- our customer doing their own processing. So it doesn't produce any processing license for us. It does produce maintenance and some more. So there is recurring revenue from the licensing. As to your question about do we need new people to take on new clients? The answer is yes. I think most companies that grow have to have -- add new employees in order to grow. We have to add new employees to grow and we are adding new employees. It of course did take some time for training to make that happen and -- but we're doing that. So yes, we are adding new employees in order to be able to grow.

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Sam Rebotsky, [27]

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And then, our investment, the $3.300 million investment that we have 40%, could you talk a little bit more about that, where they're going? How -- are they growing? I think that it's an Indian company, I think, you had mentioned. Any color on that and how they're doing? And are you pleased with their growth at this point?

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [28]

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It's not an Indian company. It's a domestic company. And it's a different kind of company. So it's hard to -- again, hard to answer that. We'll probably talk more about that next year as they kind of get more visibility, but it's a company that does conferencing and has expertise in identity that applies to the card world. And it's not something that has to do with our processing, but it's -- we think it's a nice company and we hope to get a good return from the investment. But it is not as closely aligned to what we do as we thought it might be when we made the first connection, I will just say that upfront. But we think it's a good situation. It's not something we spent any time with whatsoever, but we expect to get a decent return from it, not some 10x like we got with a couple others, but we hope to make money on it.

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Operator [29]

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There are no further questions at this time. Leland, I turn the call back over to you.

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James Leland Strange, Intelligent Systems Corporation - Chairman, CEO & President [30]

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All right. Well, we thank everyone for joining the call today. As usual, I end it by saying that if you have other questions that we will be able to answer, knowing that we can't -- we can never answer everything you want us to answer, but please give us a call, we are available. So we look forward to connecting again on our next call. Thanks everybody for joining us.

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Operator [31]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.