CoreCard Corp (CCRD) 2004 Q2 法說會逐字稿

Good morning. My name is Crystal and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Intelligent Systems second-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). Thank you. Mr. Strange, you may begin your conference.

Thank you, good morning and welcome to the Intelligent Systems conference call. We feel like we had a pretty good quarter last quarter, but you would never know it from the press release or from looking at the numbers, so we welcome the opportunity to maybe expand on that somewhat. The conference call is being recorded, it will be posted on our webcast by the end of the day today, and it will be archived for twelve months.

Before we start, I need to remind you that during the call I will likely make what will be called, or could be called, forward-looking statements. We are relying on the provisions of the Private Securities Litigation Reform Act in providing this information and the info is based on our current assumptions and the current information available to us. Obviously, that changes over time, so what we actually end up doing may be different from that. You should read our Form 10-QSB that we will file at the end of this week to better understand some of the risks and uncertainties that may affect us.

I am assuming you've seen the press release you we issued this morning, so I'm not going to repeat all of that. I will try to provide some additional explanations and other nonfinancial information, and at the end, answer any questions you may have.

I'd start by saying that I am somewhat more optimistic than earlier in the year, although I have to say still cautiously so. But I am optimistic based on somewhat better visibility of customer prospects as well as existing and potential contracts. I think historically I have been pretty conservative in expressing optimism and I want to stay fairly pragmatic, but I would say we feel pretty good that things are fairly solid, not necessarily good that things are going straight up, which they are not.

Our established companies, QS Technologies and ChemFree, both entered this year after a record year in sales and profits last year. They are both about on plan for year-to-date, and based on their current contract pipeline and forecast, they expect to finish 2004 with another solidly profitable year. In the first half of 2004, both VISaer and CoreCard Software made good progress on development of their latest Web-based software products and also on expanding their installed base of customers and new business prospects. As you read in the press release, much of this progress, particularly at VISaer, is not reflected in the financial report for the June quarter, but we expect to see a significant revenue and profit contribution from VISaer in the 3rd and 4th quarters of this year.

Compared to the second quarter of last year, we reduced our losses from operations by increasing our total revenues and improving our gross margin on products and services while keeping the expenses at the same level as last year. I'll go into more details on that progress and talk about each company a little later in the call. And also touch on some of the factors that have affected our subsidiary company's results in the second quarter and those that we believe could impact our operations and plans for the balance of the year. We'll also touch on a recently-completed financial transaction that is explained in the press release that will make a significant positive impact to both our financial reporting results as well as cash resources in the second half of 2004.

At this time, I'm going to ask Bonnie Herron, our CFO, to review the results of our second quarter and the year-to-date periods in more details. Then I will come back and talk about each of the companies. Bonnie?

Thanks, Leland, and hello to everyone. Our consolidated results for 2004 include the same four subsidiaries as in 2003. So the comparison between the three and six months periods of 2004 and '03 reflect the consolidated results of our three information technology subsidiaries, QS Technologies, VISaer, and CoreCard, and our one industrial product subsidiary, ChemFree.

Our consolidated revenue includes both product revenue and service revenue. Our total revenue for the second quarter was 3.3 million, which was a 19 percent increase compared to 2.8 million in the second quarter last year. Of this amount, our product revenue, which includes sales of ChemFree products as well as software license fees at VISaer, CoreCard, and QS, was essentially flat compared to the second quarter of last year. And our service revenue, which includes professional services and maintenance contracts at our software subsidiaries, increased by 53 percent compared to the same period last year. The main reason why our revenue grew by 522,000 in the second quarter of 2004 compared to last year is mainly due to the fact that our software subsidiaries have larger installed bases of customers paying annual maintenance fees, and we had a number of new contracts that involved more professional services than in 2003.

On a year-to-date basis, our product revenue was up by 43 percent compared to the first six months of last year. This growth occurred mainly because, in the first quarter of 2004, our CoreCard subsidiary recorded its first significant license revenue, adding 1.3 million to our revenue in the three and six months periods of 2004. Our gross margin improved by over 15 percentage points in both the three and six months periods of 2004 compared to last year, because a greater percentage of our revenue came from higher-margin software sales and services as well as sales of higher margin consumable products at the ChemFree subsidiary.

In our last conference call, I talked about the significant amount of deferred revenue that was reflected on our balance sheet at March 30th, 2004 that would be recognized in future periods. I also commented that a number of factors could impact the timing of the revenue recognition by quarter and many of these factors are outside of our control, making it difficult to predict with certainty in which quarter a particular contract will be recognized. And certainly, this quarter's results gave truth to that statement. As you can see from looking at the balance sheet that is provided in the press release, at the end of June we continued to have significant net deferred revenue -- over 8.9 million that we expect to recognize in the next 12 months. We were disappointed that are VISaer subsidiary had to continue to defer approximately 7.4 million in revenue and 4.9 million in profit contribution into the third quarter of 2004. VISaer had completed a major contract with UPS in the second quarter, but because of an optional specified upgrade right that the customer could choose, the GAAP accounting treatment requires that the revenue recognition on the entire contract be deferred until the optional upgrade is delivered. VISaer delivered the upgrade in early July, and therefore will recognize the entire contract revenue, which counts for almost 5 million of the deferred revenue on the balance sheet, in the third quarter of 2004.

In the second quarter and year-to-date periods in 2004, we reduced our operating loss by 28 and 48 percent respectively compared to last year, mainly because of the increase in higher margin sales related to software licenses, services and consumable products, while maintaining a strong focus on expense control. During the second quarter, we recorded a net loss on investments of 371,000. That reflects a gain of 256,000 on the private sale of our investment in Cirronet, a privately held technology company that was carried on our balance sheet at 831,000 due to equity method accounting, but our actual original cash investment was 525,000. We received just over a million in cash on the Cirronet sale in mid-May.

Offset against this gain, we wrote down the carrying value of our investment in another privately held startup company, Ardext, by 627,000. While Ardext has made good progress on its initial product and customer trials and it may ultimately be successful, we felt it prudent to record this reserve due to the uncertainty of the current realizable valuation of this investment. By comparison, in last year's year-to-date results, we had a major source of non-recurring investment income related to the settlement of the Paces (ph) escrow funds that we have talked about in past calls.

Turning to the balance sheet, I'd like to comment on another transaction that is disclosed in the press release that, again, we expect to have a significant positive impact on our financial results and condition beginning in the third quarter. In June, we were informed that a U.K. company, in which we are a minority investor, had sold its investment in another U.K.-based company for cash. We were also informed that we are likely to receive cash distributions related to our share of the proceeds of that investment of between 3.5 and $4.5 million over the next six months or so, with the exact amount and timing dependent on the current business needs of the U.K company as well as the currency exchange rate. We expect the first cash distribution of over $1 million to take place this month. As a result of this transaction and the recognition of the VISaer contract revenue in July, our balance sheet will look very different at the end of the third quarter than it does at June 30th. In fact, I'm sure you noticed that shareholders equity at June 30th was, in fact, negative. However, we know that was a very short-term condition resulting from the one-month deferral of the VISaer contract. And then, in fact, our shareholders equity is now solidly positive and we expect it will continue to be for the foreseeable future due to the VISaer contribution in the second half of the year and the cash distributions and income related to the U.K. transaction.

As mentioned earlier, a large component -- approximately 8.9 million -- of the total liabilities on our balance sheet is made up of current deferred revenue, which represents the value of the software services paid for by our customers to be delivered to them and recognized as revenue in future periods. Again, we believe that almost 5 million of the 8.9 on the June 30th balance sheet will be recognized in the third quarter. And the result of these two developments, our cash position, profitability, and shareholders equity will show considerable improvement compared to the June 30th balance sheet.

At this point, I will turn the call back over to Leland for some additional remarks.

Thank you, Bonnie. Let's take a little more time looking at each of the four subsidiaries. As Bonnie mentioned earlier, the ChemFree sub had a solid start to 2004 with revenue up in the quarter and year-to-date periods by 5 percent over a strong first-half in 2003. While we expect 2004 to be a decent year for ChemFree, it's probably unrealistic to expect to achieve the same level of double-digit growth in the last half of '04 as was experienced in 2003, especially in the international markets. So, I think I would summarize ChemFree as saying it is solid; there's lots of upside, lots of room to grow, but it will not be on any kind of big trajectory at this point. Nevertheless, it is very solid.

The QS Technologies sub is also coming off a very strong year in 2003, and its first half of '04 was close to plan with a little slippage in revenue from the first half to the second half, mainly due to customer schedules. Early in the second quarter, QS learned that it has been awarded a significant statewide contract for one of its newer products which we view as a good indication that its products are meeting the market requirements. Most of their contracts are with state and local governments and they generally take nine to 12 months to complete. And again, the timing of revenue recognition on software licenses is often very difficult to predict on a quarter-by-quarter basis due to a number of factors outside of QS's control. Fortunately, QS has a large installed base of customers that purchased annual maintenance and support contracts, and this does provide a consistent level of service revenue and positive cash flow on an annual basis. Again in summary, QS is doing well, doing fine. I'm not sure what the final reporting will be for the year just based on the rules for software recognition.

On a recent conference call, I said that I thought VISaer was on the verge of becoming a very good company delivering the best industry-specific software solution for the aircraft maintenance and engineering market worldwide. Beginning in late 2003, VISaer focused its resources on completing the first full Web-based version of its software for initial delivery to customer in 2004. The first major customer was Jet Blue Airlines, and they have been an outstanding development and financial partner in this process. And we expect to deliver a major release of the software to them in the near future. This'll represent a major milestone for VISaer and its new product line. It will still take several months -- before Jet Blue goes live with the software -- before we know how we stand fully as far as bugs, so it may very well run into '05 before we know exactly where we stand there.

As reported by Bonnie, VISaer completed a major amendment to its existing contract with UPS, its largest historical customer, in the second quarter. And that provided an acceptance of the software that had been delivered to them. It has also created a reasonable basis for VISaer to do additional professional services work for them in 2004 and beyond. VISaer also has contracted with several other airlines, such as Quantas (ph) and Land Chile (ph) and other third-party maintenance providers as well as other prospects in the process of final negotiations that we hope and expect will generate new license and professional service revenue as well. It is always a challenge for a small company to deal with large or international firms because it often takes longer than planned to negotiate and implement contracts, and that makes predicting and managing cash flow very difficult in the short-term. However, VISaer's experienced management team continues to tightly manage its expenses to identify the growing base of business with its current and new customers, and we at IC have been able to significantly reduce our cash investment in VISaer during the past two quarters as compared to the same periods last year.

I think in summary, I believe VISaer has more visibility now than in the past with respect to business opportunities, and also the quality and timeliness of its product development and software deliveries. But all of these will be important determinants of when and to what extent it can turn these opportunities into a bright future. So I would say, unlike the two subs I just mentioned, VISaer -- there are still some question marks as to how well we will do and when we will turn that corner completely.

CoreCard also faces some of the same challenges as VISaer. It does not yet have the same level of prospects and customers since VISaer has been around for a good number of years. As Bonnie also mentioned earlier, CoreCard recognized significant software license revenue in the first quarter of this year with the successful completion and payments on its contract with Fingerhut Direct. Fingerhut has been an excellent business partner and they would say that the installation is an unqualified success. So they will be a strong reference for our next customer prospects. We are continuing to do additional post-contract work for Fingerhut, some of which they pay us for, some of which we do gratis because it's the kind of thing that ought to be in the base product, and they are very good at especially doing specifications for us.

We have been in negotiations for several months with several other near-term prospects, and we are certain that one of them -- at least one -- will sign in the near future. And frankly, one is all we can handle at this point in time. So, we are going to hang tough on our contract negotiations and pick the one that we think will be best for the company.

We are incrementally stepping up our marketing efforts to identify several more target prospects, but expect to continue to be reasonably selective about the number and types of new customers that we take in the near future, so we can make our current customers in the early installation very successful. Also, our restriction with selling to Paces customers goes away next April, so most of our incremental marketing will be targeted to getting some visibility into that target base.

Because CoreCard sales tend to be high-dollar installations, it really only takes a couple to make a big difference and change the company dynamics in a big way. Of course, the inverse of that is also true. As Bonnie discussed earlier in the call, the U.K. investment sale transaction is likely to have a fairly significant positive impact on liquidity and operating results in the last half of the year. Although we did expect investment to be good and we did have certain expectations, I can say that there was a pleasant upside surprise that exceeded those expectations. And I think that just reinforces how difficult it is to predict our results on a quarter-to-quarter basis, or why we do not publicly try to place a future value on our minority-held investments in private companies.

In closing, let me advise you we will be filing our Form 10-Q SB at the end of the week and you should read that for any additional information and disclosures for a more complete understanding of the company.

At this time, we will open the lines for any specific questions if any of you have any questions.

(OPERATOR INSTRUCTIONS) Sir, at this time there are no questions.

All right, fine. Well, thank you for your attendance on the call, and we will keep doing what we have been doing and hope for some other pleasant surprises. Thank you.

This concludes today's Intelligent Systems second-quarter earnings conference. You may now disconnect.