CoreCard Corp (CCRD) 2011 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Intelligent Systems Corporation earnings release and investors conference call.

All lines have been placed on mute to prevent any background noise. After Mr. Strange's remarks there will be a question-and-answer session. (Operator Instructions)

I will now turn the conference over to Mr. Leland Strange, President and CEO. Please go ahead, sir.

Thank you. Good morning and welcome to the ISC investor conference call. I have with me Bonnie Herron, the CFO, also here.

I actually expect this call to last less than 30 minutes, but it will give us the time to add some flavor to our press release. During the call we will briefly review the results of our fourth quarter and our fiscal 2011 and also update you on the progress, the strategy, and the outlook for our ChemFree and CoreCard operating companies.

I am going to assume that you have a copy of the earnings release from this morning and I don't plan to repeat all the information in the press release. At the end of the call we will have some time for questions and answers.

Our Form 10-K for 2011 will be filed later today with the SEC and it will be available on our website at www.intelsys.com or at SEC.gov. I invite you to read particularly the business section and the MD&A of the Form 10-K for a more complete understanding of our business, markets, and risk.

I guess before I start into remarks I need to dispense with the legalese and remind you that this discussion today many, and probably will, contain forward-looking statements that relate to ISC. All statements, trends analysis, and other information contained in this discussion, as well as statements that include the word such as anticipate, believe, plan, estimate, expect, likely, and intend, and other similar expressions do constitute forward-looking statements.

Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties. Actual results may, and probably will, differ materially from those contemplated by such forward-looking statements.

All forward-looking statements are based upon information available to us as of today. This will allow me to give you my best judgment of things as I see them and that judgment might sometimes prove to be wrong. I am not making firm predictions about future events, but simply conveying my expectations based on what I know and believe at this time.

So with that out of the way, let's talk about the fourth quarter and fiscal year 2011.

In that period we achieved period-to-period revenue growth in both products and services revenue. For the full year 2011 we reported a profit of $657,000 compared to a loss in 2010. For the fourth quarter of 2011 we had a loss from continuing operations of $326,000, almost the same as the $315,000 loss from continuing operations in the fourth quarter of 2010.

The main contributing factors to the results in 2011 were continued strong profitability at ChemFree, revenue growth and reduced losses at CoreCard despite continued heavy investment in software development and processing service business initiative, and a $450,000 one-time income related to payment of our former law firm representing the defendants in ChemFree's patent suit following sanctions against the law firm for frivolous defenses. ChemFree was paid $450,000 to reimburse for related legal expenses and I will go into the ChemFree patent matter in more detail a little later in this call that will explain some of that.

And on the balance sheet side, at December 31 we had cash of $3.1 million, we had no bank debt, and we had shareholders' equity of about $7 million.

So looking at the two main subsidiaries, starting with ChemFree overview. The profitability in 2011 continues the trends of the last two years. On an earlier call I said that in 2011 we expected that we were not likely to grow at the same rate as we had in 2010, but it would be a consistent, profitable business. I also said that some price inflation and materials, mainly plastics cost, as well as freight cost, would occur and that we might be able to offset some of this by price increases.

Well, 2011 did, in fact, unfold in line with our expectations. ChemFree continued with a strong contribution to profits, although slightly lower than the prior year due to higher legal expenses and an IT system upgrade. It had continued growth in revenue in the international markets and worldwide fluid and filters, what we call consumable supplies, that have lower revenue in the domestic US market for machine sales.

The rebound in machine sales that we saw last year as (inaudible) recovery slowly took hold has stalled somewhat in the US recently. We did have some price increases in raw materials, but were able to counter that to a large extent by increasing the sales price of certain products. Also, we had high-margin fluid filters that we sold to the installed base and to new customers and that, of course, was up year to year.

If we look at where we are headed for 2012, we expect consistent profitability and positive cash flow at ChemFree with perhaps just a modest top line revenue growth. We do have several new product models slated for introduction in midyear and these could have a modest impact on revenue in the latter part of 2012.

We do have several initiatives to revive machine sales in the US, but it's too early to know how successful they will be. We tried several things in 2011 and they didn't turn out to have much positive impact, but we have got some new things we will be trying in 2012. Overall, we expect a continuation of ChemFree to be a solid, profitable business.

As some of you know, in previous years we spent an awful lot of money on legal costs and that finally played out over the last couple of years. Last week the final ruling by the US Court of Appeals was issued on the patent matter that we have been involved in for, I think since starting in year 2004.

As a reminder, the lower court judge hearing our case issued his findings upholding an earlier ruling that found in ChemFree's favor on two of the matters but on the third matter ruled that certain claims in four of ChemFree's patents were invalid under the theory of obviousness. A US Supreme Court case in 2007, which was three years after we filed our action and 10 years after the patents were granted, substantially changed the standards for determining obviousness which we believe was an important factor in the invalidity ruling. In fact, this case was cited as part of that.

ChemFree, however, then appealed the ruling to the US Federal appeals court in July of last year. Earlier this year oral hearings were held in Washington and on March 12 the appeals court issued its final ruling. The ruling affirmed the ruling of the lower court which means that the invalidity of these four patents was upheld.

In other words, we lost. We lost based on the changing standards that Supreme Court added in 2007. Since we didn't prevail in the case, we expect to pay approximately $75,000 in certain what is called taxable court costs. This is not legal fees, but things like filing and copying cost.

And since the ruling came down before we filed our 10-K, we have accrued for this liability and we have expensed it in the 2011 financial statements and results of operations, so that negative $75,000 has already been included in our results.

While clearly it's a disappointing outcome in the fact that we spend a lot of money and a lot of time and resources on this trying to protect our patents, we don't expect the ruling to have any material or any immediate impact on the business. We do compete in the marketplace on factors other than patents, and on top of that, the patents all expire in 2014.

So despite all of those things, we are very happy with where we are with ChemFree. It's a very profitable business. We see it continuing on basically the same path, stable for 2012.

Now moving to CoreCard, which is anything but just a stable continuation of the same patent business. In 2011 CoreCard software license revenue and professional services revenue were higher than in 2010. The increase is due to a higher contract value for new license implementations that went live in 2011, as well as more professional services contracts completed.

The maintenance revenue from our licenses is pretty predictable. It recurs an increase in the quarter and annual periods in 2011 compared to the prior year as a result of simply having a larger base of customers. As with most of our installed base, we generate additional revenue from post-implementation services and support for a number of years.

Moving to strategy and focus, it has taken us at least a year longer than planned to develop our prepaid card processing business. You will recall that I have said several times that I wanted us to be in the processing business so we would be eating the same cooking that we serve to others who license our prepaid processing software. That will make us better as a licensee, it will make us stronger as a company, and it will enable us to offer more services to our licensees, as well as build somewhat of a processing business, although I never expect that to be a huge part of what we do.

I am happy to report that, as of now, we are finally processing prepaid card programs. We have a close working relationship with a national bank that is the issuer for a number of prepaid card programs, primarily today in the university area. They are transitioning all of their processing over to CoreCard.

We are also cooperating on new perspective programs for which the bank will be issuer and CoreCard will handle the processing operation. So we will be doing prepaid cards for universities as well as for payroll cards and some other things that this particular national bank is currently involved in.

This is a long-term initiative, it will not contribute significant revenue, and it will actually increase expenses in 2012 as we have put in place the necessary processes and infrastructure. We, of course, will continue to license our software for customers who wish to run it in-house, but our processing services will be another option, particularly for small card programs who prefer to outsource the processing of their prepaid card programs.

We actually believe that this will give us an advantage in selling card programs because many people think that they would like to move at some point from a processor to do it themselves. It's a fact that they don't understand how hard that would be and how complicating it will be, but nevertheless it's a belief in the market. And I think the fact that we will be the only processor who will also make available our platform for in-house makes us a distinctive -- puts us in a distinctive position.

CoreCard's product development and marketing strategy has always been to provide robust transaction process engines with versions or product features and functionality that can address a number of different markets and card types. This has been an expensive multiyear strategy, and as I said before, we can be open to criticism for not focusing on just one market rather than trying to address multiple markets at the same time. However, we now have product variation and customers for several different types of card programs.

We have got footprints in the private label card business -- this is revolving accounts receivable -- we have accounts receivable and short-term loans, we got prepaid cards, and we have fleet cards. And we have very good customers in each of these categories.

We are going to continue to focus on improving delivery of services and the best way to increase productivity and scalability of our business. In other words, we are going to emphasize on growing and training our development and testing teams in the India operations. We will be adding more employees.

We continue to invest and test automation. All of this is to complement our core US teams. We are clearly trying to establish a very strong infrastructure in the payment space.

Regulatory and banking environment will continue to provide challenges for both our customers and for us. We believe that CoreCard has shown the ability and is positioned to adjust to new changes and business requirements as they impact the financial services market. We expect to continue to cautiously invest in resources to build a solid, long-term business and, therefore, I do not expect to be profitable at CoreCard in 2012.

I think I will leave it there and ask for questions and answers. Hopefully that has given you a flavor of the last year's report and where we are headed with our strategy. And if you have got any questions, we will be happy to provide answers. If I can't I will turn it over to Bonnie and let her do it.

(Operator Instructions) Al Shans.

Yes, Leland, good morning. While I understand that CoreCard is not going to generate any cash flow or profits for this year, in your opinion do you really believe, sincerely believe, that we are creating long-term value for shareholders that in the future could be monetized?

Well, Al, I would say if I didn't believe it I would stop doing it. I really believe that we are creating something very powerful with what we are doing. I wish it had not taken so long, but if you look at the history of the payment space it usually takes longer than anyone expects. The good part about that we don't see it changing very quickly, so you have a longer time horizon in which to execute your plan. So, yes, I certainly do.

Okay. And kind of a follow-up to that, do you think we run the risk of getting outflanked by somebody else? Maybe a bigger player, another player comes in and kind of economically invalidates what you have worked to produce.

No, because there will be a lot of players who are doing the same thing. It's a huge market. Effectively, we compete against TSYS and First Data in terms of the huge guys and there are some smaller guys, so there is a place for a lot of people in this market. We are not going to be the one company that owns the market.

But just to give you an example, in the fleet processing business we have licenses with three of I am going to say top 10. Actually they are probably higher than that; they may all be in the top five. These are processors who actually -- who are much bigger than us and who are -- some of which are public companies and are large companies who have licensed software from us. They continue to build their number of cards or accounts that work on the software they have licensed from us.

So there are a lot of choices out there, but you would ask yourself why did these processors come to CoreCard to get a license versus either do it themselves or go to one of the large processors. And I don't think it was just cost. I think it had to do with the feature, functionality, and flexibility that we offer.

Okay. Then finally, kind of another way of asking the first question, do you expect to see a return of capital -- return of the capital and return on the capital we are spending in CoreCard?

Correct.

Okay, thank you. Good luck to you.

Thank you. Just another comment on that. We are actually a processor for or we provide processing software for processors, which is kind of interesting in that many of these processors are really very large and you wonder why they don't do it themselves. It tells you you have something.

Okay, great. Okay, thanks again.

(Operator Instructions) There are no further questions.

Okay. Well, thanks, everybody, for taking the time to be on the call. I told you it would not be a long call. I just wanted to give you a little flavor.

If you have any other questions later you think of that you feel that it would be appropriate for us to answer and we feel we could appropriately answer, please feel free to call either myself or Bonnie. Again, thank you for your interest in the Company and we will have another call in about six months. Thanks.

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.