CoreCard Corp (CCRD) 2010 Q4 法說會逐字稿

Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Intelligent Systems Corporation annual earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to turn the call over to Leland Strange, President and CEO. Please go ahead, sir.

Good morning. Welcome, everyone, to the Intelligent Systems investor conference call. I expect our call to last about 30 minutes or so, and during that time, I think that will include enough time for questions as it usually does. We're going to briefly review the results of our fiscal year ended December 31, 2010, we'll also update you on the progress, strategy and outlook for both ChemFree and CoreCard Software, our main two operating companies. We'll also provide a high level outlook without any kind of estimates for 2011.

I assume that you all have a copy of the earnings release that was put out this morning and I will not repeat the information that's in the press release. As I said earlier, we will have time for some questions and answers at the end. Our Form 10-K will be filed today, and will be available on our website at Intelsys.com, and also at the SEC, SEC.gov. For any copies of our annual report on Form 10-K and proxy statement for our annual shareholders meeting will be mailed to shareholders by about the middle of April.

I guess, before I start I've got to go through some of the legalese and remind you that this discussion today will probably contain forward-looking statements relating to Intelligent Systems. Any of the statements or the other information in the discussion or in the Q&A, where I use words such as anticipate, believe, plan, estimate, expect, likely, intend, and who knows, I may even use the word hope, any other similar expressions constitute forward-looking statements. Prospective investors are cautioned that these forward-looking statements are not guarantees of future performance and they do involve risks and uncertainties. They're all based on the information that we have today. I do want to give you my best judgment of things as I see them, and that judgment might sometimes be wrong. But it is given for no purpose other than to let you know what I personally think, so that you can use that. But it's not a prediction, nor an absolute.

So now when I look at the last year's results, we notice that profit from continuing operations were $158,000 in 2010, compared to a loss of $1.2 million in 2009. The main reasons for that are that ChemFree had continued strong profitability, along with good revenue growth, and you'll recall as I've said earlier, one of the things that was dragging on ChemFree was legal expenses, and we had much lower legal expenses in 2010, so that contributed to their profits. Also, we had improved financial performance at CoreCard, with year-to-year increases in software licenses, professional services, and maintenance customers, albeit all of this is still fairly small.

We also show in the results discontinued operations charge. We took a nonrecurring charge in the fourth quarter of $345,000, which shows as a loss from discontinued operations, and that was related to a settlement of a legal action with the purchaser of our VISaer business in 2008. We reported before and have discussed with you that they had made claims of about $2.5 million against us, and we had counter-claims for non-payment of an earn-out amount due in 2010.

In January of 2011, we both agreed to compromise and settle all matters. They paid us $600,000 in February of 2011, and will pay us $250,000 in 2012, and another $250,000 in 2013. Although the total payment is less than what we had carried the note receivable, from them on the balance sheet, we felt this was the right decision, given the possibility of additional legal expense, risk, and also the aversion of a lengthy arbitration process. So we settled this in full, and took the approximately $345,000 off of what they had owed us, and I guess we both agreed to say nothing bad about each other.

So in the Q4 2010, we do have a loss reported, and that's due to the $345,000 write-down and also because we did not book any new license revenue at CoreCard. You recall that for CoreCard, we do have to deal with license revenue based on when we complete the job or at least that's the way we're handling the accounting at this point. So we had several large contracts in process at the end of the year. We did not book any of that as revenue. They are expected to go live in the first half of 2011, and we will book that revenue in 2011. Despite not booking revenue, all these customers have made significant payments during that six-to-nine month contract cycle, so we did receive cash.

Speaking of cash, on the balance sheet side, as of December 31, we had cash of $2.9 million. We had no bank debt and we had shareholders equity of $6.5 million. We have a $1.25 million bank line of credit. We didn't use any of it in 2010, and I don't really anticipate doing any borrowings under the line for the foreseeable future, given our cash position and near-term outlook. We also have on the balance sheet deferred revenue of over $1.6 million that will be recognized in 2011.

So going to the operating subsidiaries specifically, we'll talk about the ChemFree overview first. We did have record profitability in 2010, and that continued the trends that had begun in 2009. Increased revenue growth, good expense control, and in particular, lower legal expenses. Going into 2010, ChemFree had a solid level of sales at both domestic and international markets, and we had expected to see some uptick in sales, particularly in the international markets. The year unfolded pretty much in line with what our expectations were. At the end of the year, ChemFree had slightly exceeded its 2010 revenue and profit goals.

Revenue growth in 2010 in both the domestic US, and it was particularly strong in the international markets, with renewed demand for the SmartWasher machines as the economic recovery began to impact the industrial and automotive parts and repairs market. Likewise, our fluid and filters that we sell to installed base with new customers was up year-to-year as we would expect. Despite the revenue growth, total expenses at ChemFree were lower, mainly due to lower legal expenses.

You recall, we have had a good bit of legal expenses and we continue to deal with legal issues at ChemFree. Most of these issues for those of you who are not familiar, are issues where we have sued or filed action against other parties for infringing on our patents. These are not legal suits where people have sued us for things. We did have a trial on our patents, on our main patent suit in July of 2009 in front of a judge and in 2010, the judge issued preliminary findings and conclusions that said two things, that gave us two rulings that were in our favor. But the third ruling said that four of our US patents were invalid on the basis of obviousness.

In November, before the judge issued his final ruling, the judge, quote, retired, after being charged by the FBI with criminal charges, and actually since that time, he has been sentenced to 30 days in jail. This is a senior retired federal judge. He wasn't retired when he heard the suit, but he retired immediately after being charged with some felonies. We now have a new judge that's assigned. Remember, we did not get a final ruling, so it was not effective. There will be more filings and hearings in February. Actually, there were more filings and hearings in February, and there will still be some others going forward. We're going to have to wait for the new judge's ruling.

When it's final, if it's not in our favor, we'll have the option to appeal. Don't know whether we will or will not. It certainly does not have any immediate impact on ChemFree. We basically compete in the marketplace on things other than the patents. However, the patents -- lack of a patent may make it easier for other people to compete with us. I guess the good thing and the bad thing about all this is the patents -- well, most of them expire anyway in 2014, so we're not looking at any long win, even if we win on this thing.

All of the expenses for the -- all the legal matters have been recorded in prior periods. There will be some additional legal expense in the first quarter of 2011, but nothing like what we have experienced in the past few years. If we lose the case, we may need to write down some or all of the carrying value of the patents, that's about $150,000, but that's not a cash item. That's simply a write-down of an asset that's on the books. I do think that we have some other avenues where we may have some financial gain from this, even if we don't totally win it. However, I do not expect some big windfall. I don't think either way we'll be getting some big quantity of money out of it, but hopefully some.

Looking forward, as far as the business, everybody knows about price inflation in materials. We're certainly getting that in plastics as well as we're getting inflation in terms of freight costs. We may be able to offset this in terms of price increases. We'll have to see how that works out. I will say that it would be unrealistic to expect the business to grow at the same rate in 2011 as it did in 2010, but I do expect it to be a consistent profitable business. So you can look at ChemFree as a good cash cow, a good profitable business, with perhaps not super growth prospects but some prospects for growth. But even in the worst case, it should be a stable line of business, and a stable supplier of cash.

Moving on to the other major subsidiary, is CoreCard. Revenue from license and services were up in 2010 compared to 2009. During 2010, more license revenue was recognized on completed contracts. We did have one significant new contract which was a conversion customer, and we completed that in Q2. We also had our first international customer in Q1. So we feel like that we put down some good bricks in the building that we're building in CoreCard in early 2010.

As we expected, and told you earlier, we did not have the same year-over-year license growth in the second half of 2010. And that's because we're working on some larger contracts that did not go live during the year. Again, license revenue will continue to be bumpy, since we only record it at the point that a new contract goes live. In terms of controlling go-live, that's not our -- that's not under our control. It sometimes causes a lot of frustration on the folks' part here, particularly financial, when you're trying to plan a budget.

But if you'll think about what happens, while we end up working on a contract and everybody thinks they know what they want, as it gets closer to testing and the customer starts looking at what's there, they usually realize they have forgotten things, there are other things they would like to add, and the deals simply stretch out as customers tend to find they want to add more things or do something else or maybe they just even misread the direction they wanted to go. So we have customarily delivered what the customer asks for, on time, and within budget. But there are just normal extensions in the process.

Professional services during the year, they vary by quarter, and were significantly higher in 2010 than in 2009, due to more customer projects. Maintenance is pretty predictable, and that's recurring and increasing every year. We signed new license contracts in 2010 that expanded the number of customers using our software. One of the new licenses was in fleet cars, and you recall, we already have a fleet car, a large fleet car customer that has been live for several years and very happy utilizing our software. We now have another very large fleet customer.

Let me just make a point here, to say that when I mentioned the type of customer we have, some of you who have been around for a while recall, we don't always name customers, and we very seldom name them on our website. This is to our disadvantage, but it's to our customer's advantage, and we believe that long-term if we do the right thing for our customers, that will be the right thing for CoreCard. Many customers let their customers believe they wrote the software, and we have no reason to try to toot our horn. We're here to try to help our customers, and let them deal with our customers.

When I say we have a large fleet customer, it was a very large fleet customer, a public company. We also had a very well, VC-backed, high profile VCs who are backing a Company in Texas that are using our software for some of their high growth areas, the first time they've ever outsourced software development to anyone else. So we're pleased with several of the new situations.

If I look a little farther, look at our strategy or focus, I will say that it's taken us at least a year longer than planned to be in a position to become a prepaid card processor. That has been one of our goals for the last couple of years. We do process private label. Private label is -- I guess that's the same thing as closed loop. We are processing a few customers on that. However, our goal has been to get into prepaid, using the association cards. That's Visa, MasterCard, Discover, Star and Pulse. It's been fairly difficult, because banks and their regulators, they've become very wary about approving new prepaid card programs that use the Bank's identification number, which is called a BIN within the industry. We have had to find ways around that. There were ways to get in but they would have been short-term. They would have been a little hokey and I wanted to do it the right way.

So what we've done now, we have negotiated an agreement with a bank partner that will work with us to develop our prepaid card processor business. It's fairly early. I do not expect any significant revenue out of that this year. I do expect some revenue. I do expect us to be solidly in the business, processing before the end of this year which will set us up for in a good position for the following year. It's taken -- we'll continue to license our software for customers also who wish to run in-house, but our processing services will simply be another option, particularly for small card programs who prefer to outsource the processing of their prepaid card programs. Keep in mind, this is a long-term initiative, and as I said before, it will not contribute significant revenue. It may increase expenses in 2011, as we put in place the necessary processes and infrastructure.

CoreCard's product development and market strategy has been to provide robust transaction processing engine with versions and products features and functionality that can address a number of markets and card types. This has been an expensive, multi-year strategy, and I realize we could be criticized for not focusing on just one market rather than trying to address multiple markets at the same time. However, as a result of this strategy, we now have product variations and good customers for several different types of card programs. It's private label cards or closed loop, accounts receivable, short-term loans, this is revolving credit, prepaid cards, and fleet cards. And I can tell you that it's my belief that any one of these four different types of programs could be a complete business in itself with the right focus.

We're going to continue to work on each of them, not focusing on any one of them yet. You may not hear me say that forever, but at this point we're going to continue expanding on each of those. We'll continue to focus on improving delivery of services and the best way to increase productivity and to scale the business. In other words, we're going to put some emphasis on growing and trending our development and testing teams at the India operations. By the way, we added about 20% -- we had an increase of about 20% of employees in 2010, even though we did not have a substantial increase in revenues, and that's simply because we're training a good, strong bench of folks in India that we believe will complement our core US teams and give us, I think, a nice competitive advantage.

The team in India, with approximately 200 employees, I think is the envy of several other groups that we've actually been approached by some folks about just buying our India operation. Of course, they're not for sale. They're the key component for the expanding of CoreCard, but we developed that I think very well. The regulatory and banking environment's going to continue to provide challenges, both for our customers and for us. We believe that CoreCard has shown the ability, and the position to adjust to new changes and business requirements as they impact the financial services market. We expect to continue to cautiously invest the resources there to build a solid, long-term business.

I guess we go to Q&A from there. That's pretty much the summary of what we have done, what we're doing, what our plans are. I guess, let me mention this before we take the questions, because someone's going to ask anyway. They're going to mention the stock price movement, the last -- I guess the last month and likewise the volume has certainly increased. The only information that we have that could account for some of it, and that's only the last week or so, is the Bowser Report, which is a small newsletter that has put Intelligent Systems as their stock of the month for this month. I'm sure that had some impact on the stock.

As you guys know, we don't say much. We don't talk much. We're not trying to pump the stock. We don't really care what the price is at this point. We're simply focused on trying to build the Company, and ultimately the proof will be in the pudding, and the stock price should reflect the size of the building that we build here, brick by brick, with CoreCard. So with that, let me open things up to questions, if there are any.

(Operator Instructions) Sam Rebotsky.

Yes, good morning, Leland.

Good morning.

This seems an exciting time for Intelligent Systems with the two operating entities, one has a lot of growth ahead of it, the CoreCard, and the ChemFree, which is creating the profits. Do we see a way to grow the ChemFree more, or do something to have greater volume, whether it's with another company or somehow to grow the ChemFree, or just let it be a cash cow at this point?

Well, I'm not going to ever give in and say there's no way to grow the Company, and we certainly are constantly exploring all kinds of avenues to do that. At the same time, I'm going to be realistic and say it's a difficult market for us to grow. We compete with some pretty big guys out there, Safety-Kleen is in this business, but they do not have a biodegradable aqueous-based machine. But they're very formidable, because of a lot of things -- they've been around a long time, they can do a lot of things on pricing, so it's very difficult to go head-to-head with those guys.

So to answer your question, I'm not going to give shareholders the hope that we can grow it exponentially. Doesn't mean we're not going to keep trying and turning over every rock we can and looking to consultants and talk to anybody we can to figure out how to do it, but realistically, I don't think it's wise to plan on heavy growth. I think I want to absolutely make sure we stabilize what we have. It is a good, nice, wonderful cash flow business. So that's the best way I can answer that.

We don't sit around saying we're not going to grow. We sit around looking at ways to grow, and we're actually hiring some of our own sales force, and have done some experiments that seem to be fairly successful. But they're not going to result in a doubling in the size of the Company in three years. I hope they do result in growth, but it's still in a test mode right now, so you know me, I don't make promises I can't keep, so I can't promise anything else.

Okay, well, that sounds reasonable, and hopefully the legal situation gets resolved fairly soon, and hopefully it's in our best interest, et cetera, even though the patents will expire in 2014. We don't know when that gets resolved, I assume?

We have no idea. It's already run on three or four years longer than I thought it should. Let me just comment on the patents, too. It's not a huge issue. There's patents, and then there's business knowledge and trade secrets, and we have a darn good cleaning fluid that is not easy to replicate. Yes, people can claim theirs does just as well, and they can do things. But we've done this through trial and error over many years, so we have a very good, stable, solid operating platform that -- it's going to be hard for somebody to replicate. If they spend a lot of money on marketing and sales, they can sell an inferior product, and out-gun us. At the same time, we have a really good product that we think will compete in the marketplace with or without the patent.

That sounds good. Now, the CoreCard, which is going to be your growth engine, you have the deferred revenue of about $1.6 million.What does your pipeline look like, and what is the type of projects that you could be working on that would increase your revenue? You enumerated them, and I guess you're making a judgment to the extent, whether you will concentrate in any one particular one. But there's been a lot of growth with some of your competition, I guess Green Dot and NetSpend and various other companies, and do you want to put more money into any of these things that would speed your process up, or what is your timetable?

Green Dot and NetSpend are not really our competition. These are program managers. I know they appear to be, and we can look at multiples like that, but they simply have their own programs and their own distribution channel. In fact, Green Dot is a -- I would call it a distribution company. Their processing is done by [Tesis]. Remember, we're the processor. We're the back end, not the front exposure.

So we're approaching it differently. I would say that we're putting [our money] in prepaid right now, because that's where we're weakest, as a prepaid processor. So I'm trying to get a good, stable position, all of these, then we'll make the call as to either how to divide them up and run with them, or exactly what to do. I don't need money to do anything right now. Will that change in six months? Possibly. We just need to work on a strategy, a little further, and see if it works out the way I think it will, then we'll make some decisions that I guess realistically, I have to look at 2012 as the place where we top out of this, as far as hiring salespeople, marketing people, and start really growing whichever one or ones we decide to push.

Right now, I want to get in the processing business as a prepaid processor. See, the next step after that may be -- remember, my forward-looking statements here, before I say this, guys. My next step after that may be able to process association credit cards, the Visa, Discover, MasterCard. We can do it, but you have to have bank sponsorship. Once you are processing, let's say you're processing fleet cards, you're processing credit cards, you're processing prepaid cards, you're doing what Tesis and FirstData does. Maybe the direction goes that way, along with continued license sales.

So I'm just giving you the possibilities. I'm not going to tell you this is the strategy just yet. There are a lot of reasons for that, because we have people who listen to our conference call who are our competitors. We have each of the companies I mentioned, who hit our website fairly frequently to see what we're doing. So I'm just saying these are things that are possible that we might do.

Leland, it's very exciting. You're doing the right thing, and hopefully for all the shareholders you will succeed, and keep doing what you're doing. Good luck, Leland.

Thank you.

Bob Bowser.

Hello. This is Max Bowser.

Hello.

Yes, just a couple questions for you. On ChemFree, you mentioned your competition, which still has the -- doesn't have the clean cleanser that you have, but is there any other competition that is as effective as yours?

We're not aware of any. That's the best way I can say it. In terms of the aqueous-based SmartWashers, we think we're one of the largest, if not the largest in the US, and we're not aware of anybody that could come close in terms of being able to clean as well.

I see. This is a generic question. When you take over a company, that's been your business for 30 years, does the top management of that company you're taking over come along with it?

Well, typically we haven't taken over, we've built them. We may invest in them when they're very small, and for example, ChemFree, we had two guys that came in with an idea, and it wasn't even this idea. So we worked with those guys to develop it. So typically we're not in the take-over business. We're in the low-end, seed capital, start-up business. And yes, you work with your founder, but the founders typically expect someone else to run the company.

Right now we're more focused on these two companies, the two subsidiaries that we're running, more so than adding any new start-ups. That's not to say we wouldn't add one. And we're constantly talking to people. So if the right opportunity came in, yes, we would work with them and do it. But we're not in the take-over business.

I see. Is the same thing, the history of CoreCard about the same?

CoreCard is actually a spin-out of a company that we were involved in. We sold the predecessor to CoreCard for around $135 million to First Data, and we kept off part of it. So we just kept some of the same folks out at CoreCard, but management did not come with that. Management went with the company that we sold.

Physically, when you locate the company, I can see with ChemFree there's only two guys, they just moved into your offices, right?

Right. We have a large building where we actually lease space to other people. We have a good number of start-ups and small companies around here.

Yes, I know. Right. Okay. Well, listen, it was our pleasure to recommend you as our Company of the Month.

Well, thank you. Obviously, you put out some exposure, as I said earlier. We don't actually go look for that, but we also don't fight it if it comes.

All right. In a sense, we're in the same business. We isolate these small companies, penny stocks, and there's just an ocean of lousy penny stocks floating around.

Yes, there's not many public companies that have been around with the record that we've had over the past.

Right. Well, we've been around 35 years.

Right.

And every company that we recommend is profitable. So we don't promote storage stocks. We're, hey, these people have a wonderful solution to baldness, and as soon as that comes on, you'll be wealthy. We don't go for that sort of thing.

All right. Well, thank you, and just stay in touch.

Will do. Thanks a lot.

(Operator Instructions) [Al Shams].

Leland, I need to rush out for a meeting, not really so much a question as just a comment. Thanks for the good, hard work, keep it up, and let's see if we can really turn this into something.

Okay, Al. Thanks, thanks for your comments.

Okay.

At this time, there are no further questions.

Okay. Well, thank you for tuning in. Let me let you know our 2011 annual meeting is set for May 26th at 4 PM in the Company offices. As mentioned earlier, the annual report on Form 10-K and a proxy statement will be mailed in mid-April. Our next conference call, we generally only hold them about twice a year, unless there's something significant to talk about, so we'll let you know when we schedule the next call. Again, thanks, everybody, for their support and for their hanging in there on the stock. We'll talk to you later, thank you.

This concludes today's conference. You may now disconnect.