CoreCard Corp (CCRD) 2019 Q2 法說會逐字稿

Good day, and thank you for standing by. My name is Lee, and I'll be your conference operator today. At this time, I would like to welcome everyone to the earnings release and investor conference call. (Operator Instructions)

Leland Strange, you may begin your conference.

Good morning, everyone. Welcome to the Intelligent Systems Second Quarter Investor Earnings Conference Call. We filed our 10-Q this morning with second quarter results and also posted a press release with summary results and comments. We also filed an 8-K this morning reporting the resignation of Pete Petit as a company Director. I hope you either have or will, during this call, review those filings. Please note the typical forward-looking statements in the filings apply to this call.

The call today will consist of about 15 to 20 minutes of company commentary, and we'll leave up to about 15 minutes for questions. In addition to taking questions directly from callers, if you'd like to comment or ask a question by e-mail, which we're monitoring real-time, you can e-mail the question to fax@intelsys.com, that's fax, F-A-X.

We have the Q and the 8-K on the website now and will be posting an edited version of this call immediately following the call ending, the Q&A to be added to the transcript later. Our website address is intelsys.com, that's I-N-T-E-L-S-Y-S, intelsys.com.

Again, send questions as we talk to fax@intelsys.com. I don't plan to necessarily identify the sender of the question, but we'll consider any questions that come in to be answered during this call. We'll cover on the call second quarter results, competitive landscape, high-level view of third quarter and remainder of the year, comment on Directors and a legal update.

I will turn the next few minutes over to Matt White, the Intelligent Systems' and CoreCard's CFO for second quarter results comments.

Thanks, Leland. Before I start, I'd like to remind everyone that during the call, we will be making certain forward-looking statements to help you understand Intelligent Systems and its business environment. These statements involve a number of risk factors, uncertainties and other factors that could cause actual results to differ materially from our expectations. Factors and risks that may affect future operations are included in the filings with the SEC, including our 2018 Form 10-K and subsequent filings. So consider those in making your investment decisions.

And now onto the second quarter results. Revenue for the second quarter of 2019 was $7.512 million compared to revenue for the second quarter of 2018 of $4.573 million, an increase of 64%. The components of our revenue for the second quarter consisted of license revenue of $700,000, professional services revenue of $4.663 million, processing and maintenance revenue of $1.724 million and third-party revenue of $425,000.

As we've mentioned in previous statements, our license revenue will vary from quarter-to-quarter, but we do anticipate a significant increase in license revenue in the second half of 2019. We receive license revenue primarily when our customers achieve new active account tiers. Once the customer achieves each tier level, they receive a perpetual license up to that number of active accounts. Inactive accounts do not count towards a licensed year.

We charge annual millions to our licensed customers, which is reflected in our processing and maintenance revenue line. Maintenance revenue increases when new license tiers are achieved. For our largest licensed customer, the customer receives an unlimited perpetual license at a maximum tier level, a very large number of accounts that allows them to utilize the software for any number of active accounts. They currently use the software for a single institution. Additional license fees apply if multiple institutions are added.

We would expect it to be several years, if ever, more than 5 years to hit the maximum tier level. As you can see from the revenue detail provided, professional services revenue comprises a significant portion of our overall revenue for the second quarter and first half of 2019. However, 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 charge annual maintenance fees for professional services that result in new functionality to our customer, which is also reflected in our processing and maintenance line.

We do not generally perform any professional services for third parties that are not licensed or processing customers. So while a significant portion of our growth in Q2 2019 -- in the first half of 2019 is in license and professional services revenue, we expect that to translate into future processing and maintenance revenue.

And finally for revenue, our third-party revenue generally has a very low margin and represents services we provide on behalf of our customers that we charge at or slightly above cost. We recognize this revenue growth for accounting purposes.

And now, for the rest of the highlights on our income statement. We recorded income from operations of $2.601 million for Q2 2019 compared to $1.058 million for Q2 2018. This resulted in an operating margin of 35% for Q2 2019 compared to 29% for Q2 2018 and 37% for Q1 2019.

We experienced some margin erosion in Q2 2019 compared to Q1 2019 due to higher G&A expenses related to some strategic Board initiatives, higher research and development expenses related to accrued employee bonuses and revenue mix, and I mean a little bit lower license revenue for Q2 2019 compared to Q1 2019.

Our year-to-date tax -- year-to-date 2019 tax rate was 23.4% compared to 3.5% in the comparable 2018 period due to the utilization of net operating loss carryforwards in 2018. Earnings per diluted share for the quarter was $0.23 compared to $0.12 for Q2 2018.

And now I'll turn it back to Leland.

Thanks, Matt. Let me remind you, as a pure play in the issuer segment of the payment landscape, our revenue generally comes from 5 sources. First, there's license fees. Very little current cost, so high margin. It usually equates to the number of active accounts for which CoreCard's software's being used but not always. Sometimes the accounts have not met the minimums in the contract. And other times, they may have reached a maximum tier. We have none to date that have reached the maximum tier and don't expect anyone to reach that in the foreseeable future. Second, maintenance and support for licensees. Recurring revenues that increase with certain professional service work as we add features to the software and as we get additional license fees. Third, professional services. Not technically recurring, but certainly repeating. And fourth, processing services, recurring and generally per account per month. Fifth, managed services. Sometimes, we monitor or assist in the running of our software for our licensees. They are both permanent and temporary situations prevalent with managed services. I guess I should say there's a sixth that is, what do we call it, revenue -- third-party revenue that is pretty much dismissed as real revenue since it's passed on immediately to other parties.

While we want to be as transparent as possible regarding each of these revenue streams, we're most mindful that we're constantly negotiating fees and rates with new customers. Our competitors would like to dissect exactly how we price. We believe it not to be in our shareholders' best interest to be more precise.

Let me also explain a comment I made to an analyst last week, who was trying to develop a model similar to those he has for Global Payments, Fiserv and FIS. I said, we are an analyst model nightmare. Why? First, we're still a small cap company, not yet reaching revenues that have scalable histories. We're being modeled against, not mid-caps, which would be the next capitalization category up, but against some of the largest companies in the payments universe.

The approximate capitalization of now the big 3 are Global Payments combined with TSYS at $45 billion, Fiserv combined with First Data at $40 billion, and FIS with TSYS at $42 billion. If my math is correct, their market caps average over 100x those of Intelligent Systems. And none are into pure issuing as we are.

Look at their press releases, they're pushing and competing heavily in the POS category. For those of you not into the business, I'm not being disrespectful as POS is an acronym for point-of-sale.

Lastly, acquiring segment of the payments system, which we do not desire to participate in at this time and probably never. And except for TSYS combining with Global Payments, none have a system they license. For TSYS, it's not a product focus, and it's not the system they use for processing in the U.S. We're different, and for better or worse, depending on your investment philosophy, we're in a category by ourselves, albeit with similarities to the issuing segments of the bigger processors. That's the reason I want to emphasize our revenue sources.

I mentioned earlier that the average capitalization of the big 3 is approximately $40 billion, 100x our size. The average revenues protected from the big 3 in 2019 are approximately $12 billion. That's over 300x our revenues this year.

I'll say a little more about the big 3 in a minute, but now I'm going to switch gears to legal. The company is going to vigorously defend from the legal actions forced in on the company by the 2 short and distort reports. It already has in the second quarter and will continue in future quarters, caused shareholder's money and impact our earnings as we deal with these frivolous claims.

We were in the process of renewing our D&O insurance, and of course that renewal policy went up a good bid. Today, approximately 30 law firms have jumped on the bandwagon soliciting clients in an effort to participate in a class action with the hope of getting some settlement money. I personally do not expect to ever pay one dime from the company to the lawyers to settle. That's my personal observation.

I'll note there was a high level of short interest in our stock as the last FINRA report. It was at 20-plus-percent of our float. That will have to be covered at some point. For current investors, you may want to check with your brokers to see if they're lending out your shares.

Interactive brokers is charging this morning approximately 56% APR to lend shares. So it could be highly profitable to lend, but also detrimental to your stock price. I assure you the large shareholders are not allowing the broker to lend for short sales.

I said several calls ago that we'd be working through proper board governance that reflects the current company's business and capitalization. We're continuing to discuss how that might play out, but we will certainly be adding independent Board members and maybe sooner than anticipated due to the announced resignation of Pete Petit from the Board. I want to thank Pete for his 18 years of service and his continued belief during those years as we invested in R&D to realize the potential of the CoreCard technology.

In concluding my remarks, I will just reiterate that I continue to believe, and major corporations have validated, the future of CoreCard. I mentioned earlier the revenues of the big 3 in the payment space as being 300x current CoreCard revenue.

While all of that revenue is not from the issuing segment, I believe it goes to the size of the markets we're serving. They are huge and everyone is not going to want to have their credit system of record with the big 3. We are a great alternative with our innovative products and speed to market. We're very pleased with where we are now and where we're headed.

In a previous call, I referenced Warren Buffet when he says the same thing as we emphasize that accounting treatments don't always translate to the actual progress of the business quarter-to-quarter. Our quarters are going to be lumpy, although since I first started saying that 2 years ago, it does not and has not, to date, appeared true. But it is and will be at some point as we get big bumps from license revenue or/and as we transition from one big customer to another.

I'll close with another belief of mine that has been shared recently by Buffet, which is, don't obsess on the details as you look quarter-to-quarter. The big picture is that it is a big market, and we're going to conservatively keep moving forward.

I'll stop and take questions. Remember, you can send them to fax@intelsys.com, if you wish. Operator, open the line for questions, please.

(Operator Instructions) Your first question is from [Jonathan Ang].

I'm so excited to talk to you, I am an investor from Malaysia. And I come from the opposite part of the world. It's 11 o'clock at night here. But your story of CoreCard was so inspiring that I just had to call in to congratulate you as a strong leader. I mean you can easily be my grandfather and yet you're going strong. I understand that...

Well, thank you very much.

I understand that you're currently working with a very big licensing client. And it seems that the project is about to materialize anytime soon, and we expect -- you're going to expect millions of transactions coming in. I understand that for a company that are growing especially for INS, there may be speed bumps along the way as you secure your business. Could you add some color if we might experience any speed bumps or any potential risks or operational gaps in the business? For example, will the data centers be able to transact as such in millions of transactions? And will there be any material backlash if INS back end can't handle this transactions smoothly?

Sure. Be glad to comment on that. First I can tell you there have been many, many hundreds of hours testing to make sure that we can handle a very big client load or that our software can handle it. It's always a combination of partners that make the complete product. For example, if you are issuing a credit card, you're going to have somebody apply. That application is usually not on our system, that's on a third-party system. The company that's issuing the card is going to have to have rules and connections to other people to get the data they need to decide whether they will approve the credit cardholder. And after that happens, when you're -- assuming it is approved, you still have issues where you might have reward vendors, you may have third-party records for the software. So there's -- I'm going to say there's probably 10 different parties involved in the issuance of software. Now we'd like to say that we're the most important, of course, some of those others might say the same thing. But we're the system of record. We keep up with all the finances, which are the most important and the most complex thing.

It's possible that there could be problems in a new system that have nothing to do with us. For example, we may be sending responses to someone and the other party times out, meaning they can't take it as fast as we can send it. Now we have tested, tested, tested. We're able to do really large numbers of transaction per second, larger than any of the partners that we're working with, with a couple of large clients, actually, can accept and handle at this point of time. So, I guess, first, I don't really expect any big problems. I would expect some little bumps, but I don't expect any big problems. And I think one has to be cautious even though everybody goes back and looks at CoreCard since we're the system of record, the problem really could be other places as opposed to CoreCard. We don't anticipate we're going to have a problem.

I just have one follow-up question, thank you for being so generous with your time. So when you say you guys can handle a larger transactions per second, are we talking about in the neighborhood of 10,000 per second, 20,000 per second. Could you give us some color on that?

Let's say we're talking about between -- I don't want to be specific, between 250,000 per second. Now that's based on the particular set of hardware and software that's currently stood up. You could add more hardware and probably go much higher. We think it's scalable to much higher, but there's no reason for that. We think the 250,000, 200,000 per second is sufficient for anything we see in the next year or 2.

Your next question is from (inaudible) Beth.

I have a question to follow-up on this -- the progress on the processing 25 million accounts. You have mentioned in the last call that the architecture and hardware was one of the bottleneck. Can you update us the status now? And have you overcomes the challenges?

We're not even trying to deal with that right now. We've got our focus on getting a big licensed customer up and a couple of other things. I gave you where we -- I thought we would head and we're going to head there, but that's not really a big target that we have to have right now. So let's not even -- that's not even something we're looking at or working on right now.

Okay. And with the -- I thought that the quarter 1 or the quarter 2 2019, the G&A was $1.1 million. But the last quarter was $594,000. Can you share with us why is there a big jump?

This is Matt. As I mentioned in my remarks, that's due to some additional legal costs and some Board initiatives that are causing that increase.

Is this cost -- also includes more -- hiring more people?

No. It's more third-party cost due to legal and some other things the Board decided to do.

Okay. And the last question that I want to ask is the -- INS has been very busy with this very large customer and this has taken up most of your resources. Is this going -- how long will this take on? And with -- how long are you going to start working with other customers who's putting on hold?

Okay. First let me say, it's not taking on most of our resources. It's not taking on half of our resources. I'd be hard pressed to say exactly how many, but the resources assigned to that project are shifting to working a whole lot of hours. We have other -- obviously, other revenue, as you can see from the report. And we have a lot of people dedicated to that other revenue. Now in some cases, that the revenue may not be as profitable even as this depending on what it's doing. So it's not taking on even half of our resources. Not close, I would say at this point.

Your next question is from [Calvin Sitch].

This is Calvin here. So on 13th April CoreCard shared that it expended at international processing services. So apart from reading the press release, how should investors interpret it? Because I'm just figuring like out why would it warrant a press release? And how does it enhance our ability to actually win more businesses from other clients?

Kevin (sic) [Calvin], there are a lot of reason for doing press releases, and many of them are customer related or potential customer related. So I certainly don't want to get into more details in that.

Your next question is from [Audrey Chen].

Just a question. How does our company and share quality of workforce were expanding fast to meet professional services or handle multi-clients? In terms of the company culture, can you share what is so unique that allow many employees to stay on for many years? And do you see any key employee leave?

Gosh. I would like to be -- I'd like to say it's because of great management they stay a long time, but I'm smiling as I say that. No, it is a company culture that we both try to select and it's a little bit of self-selection to try to find folks that want to be dedicated to the mission that we have. And to see this thing ultra successful. We try to treat employees well. We respect the employees, we understand that they're the important part of what makes all this work. But other than that, I don't know what to tell you, but yes we do have a lot more long-term employees, particularly internationally than practically any other -- well, than any other company that I know of and nobody else is even close. Do we see any key employees leave? We certainly don't know of any at this point. We think we're rewarding them well and don't see any problems with that.

Just another question. How are we positioning ourselves to reduce if there's any key employee who leaves us? And then are we also expecting to hire more people in the coming few quarters?

Well, we're always hiring people. So there's always job openings. And we had new employees start today. We'll have new employees starting every week, not in masses. In India, you end up making an offer and it's usually 60 days before they can come. Sometimes they don't show because they end up getting a better offer in between time, but we're always -- we've clearly got plenty of job openings, and we are continuing to hire employees and will continue to do that for a long time as far as I can tell.

Okay. Just one last question. Do you face -- do your employee face like other companies poaching them?

I'm sorry, I didn't understand. What...

Do your employees face like other companies poaching them like...

Oh, yes, constantly. When you're as successful as we are and when you have employees that are very experienced in the payment space, you've got recruiters calling them all the time. They consistently, pretty much let us know. And yes, they're constantly trying to poach them. Occasionally, they get some. So it's not like we never lose any. We hope the ones we lose are only those with 2 or 3 years of experience, not those with 5 to 10 or 15 years of experience. And that has been our experience. Those that stay over 5 years, we're usually able to keep. But yes, there have been -- all of these big companies I've named, they're trying to poach our employees.

Your next question is from [Matthew Schroder].

Congratulations on an excellent quarter. Just one question, in reviewing the 10-Q, there was some -- a little bit of discussion about an investment in which the company now has a 40% equity interest and extended another $1 million loan. Could you give us a little bit more color on what your vision or strategy is for that investment?

Yes. It's connected in a slight way with CoreCard in that it's in the fintech space, it's in the identity space. And we made the first investment in it several years ago. And I actually just really believed in the people and the company. I think there could be some continued connection with CoreCard, but even if it's not, we're -- we believe, it's a good company that might give us a nice exit at some point. So it's -- that's a little bit of the VC or the investment side, but it's staged with the fintech side. And we probably wouldn't have done it as a brand new investment, but since it's one that we've had for a little while, we decided to go ahead and let's stand it up in a way that it can be very successful. They do a lot of consulting in the identity space. They run conferences in identity space. And you need identity for everything. Even Alexa, with Amazon, Alexa needs to know who's talking to it. And so we'll probably give more color to that sometime next year as it makes more -- as it becomes -- as it has more traction. But that's the highlight of it.

Excellent. And then one more small question. I know everyone is focused on big licensing customer that's coming up. In the 10-Q, I think for the first time, you've broken out European revenue versus U.S. revenue and to, perhaps, my surprise, it was about 16% of revenue and it's growing quite nicely. Could you just give us an idea of your view on that and outlook?

Yes. I'll let Matt talk about that.

Yes, that's something we usually break out in our 10-K, we started including in the 10-Q, I believe starting in Q1. But that's been a customer of ours -- we've been operating in the European Union for several years. So it's not a new space for us. So we expect that to continue to grow.

We have license revenue -- we have license customers that are international. I would expect we'll end with some others, but that's probably, primarily from one major license customer where that's increased.

Your next question is from Sam Rebotsky.

Good quarter. You had indicated you previously were unable to take on additional large customers. Do you have an idea when you would expect to be able to take on a large -- another large customer?

Well, we're talking to several possibilities at this point. And you take on folks a little at a time. You may have a potential very large customer, but the first year, they may be fairly small. So it's not quite on/off, it's more of a volume transition. I -- but if I had to answer it more like a on/off, I'm going to say, toward the end of the year, but that doesn't mean you're getting a lot of revenues toward the end of the year, it mean you're just starting again with a large customer.

Okay. And as far as the number of employees, I -- is it my recollection, it was like 400. Is that the number of employees you can presently have? Have you increased your -- the number of employees in this quarter?

It's closer to 500 now.

500. 500. That's good. That's very good.

It may actually be a little over, but it's in that range.

Okay. Very good. And -- okay. Look, Leland, I guess with the speculation of your -- of the major customer you have that's -- that feeds the stock unfortunately. And I guess at some point you'll talk more precisely when you're allowed to talk about customers. And good luck with the lawsuit, you've done nothing wrong. Unfortunately, the stock has risen and decreased and risen and decreased. And it's all these speculators, basically, who didn't know you a couple of years ago and just discovered Intelligent Systems. Keep up the good work.

Okay. Thank you, Stan. Let me -- while operator lines up any other questions, let me answer a couple that came in by e-mail.

One said that you've generated approximately $15 million in free cash flow since last year, plus cash as the largest component of working capital. Can you please talk about how you intend to use that cash?

Only thing I can say about that is we've made no specific plans. We are always looking at potential acquisitions. We haven't done anything that fits a criteria that's priced the way we would like it right now. But we could use part of that cash to invest partially in the company rather than take it on completely. We're not planning on doing dividends with it at this point. I'm not going to say we never would, but that's not the current plan. We're going to keep holding the cash as we find a good strategic use for it.

The other part of the question, hold on a minute, was as you transition to processes from licensing, do you think you can remain profitable on a quarterly basis?

Well yes, I don't expect this to -- even though I talk about lumpy, I'm not talking about lumpy in the sense of "Oh, we're going to lose money." No, we should remain very profitable on a quarterly basis and the license bumps should also be up as opposed to the -- anything either way. So I hope that clarifies anything I might have said already. When I'm talking about bumps I'm not -- or when I'm talking about transition, I'm not really talking about any serious downside. I'm really talking about well we've been having some really nice revenues that may not get repeated in the next quarter or the next one.

Another question that came in on e-mail was expand on the comments on lending.

I've -- I'm tending to make sure that people understand that's the secret sauce. That's the hard thing that people do, and that's the big thing that we do that a lot of other people can't do in the same way we can. So lending, whether it be credit cards, whether it be other types of lending, we have customers that are doing point-of-sale lending for other very big companies around the world. So we do all kinds of lending. We also to the simple stuff, the prepaid, gift, rewards. But lending is the bread and butter and the reason people would generally come to us. And I say that slowly because people also come to us for just prepaid and other kinds of things also. All right. Are there any other questions, operator?

Yes, sir. Your next question is a follow-up question from [Jonathan Ang].

I'm starting to realize CoreCard is able to do some complex transactions, which differentiates your software even further. So pertaining to the licensing revenue model, I mean in a typical scenario, which you've given in Q2 2018, you mentioned that -- you mentioned about $1 million -- sorry, you mentioned about $1 million for 1 million customers as a hypothetical example. So for clients requiring a greater complexity, what are the contributions in how you price your licenses? And how do you feel about pricing it at about $1 per license? Is that cheap in the industry? So I just want to understand more about the industry.

Well, you used the right word. I said $1 hypothetically in order to try to explain how tiers work. I didn't say that we priced credit at $1. And I said earlier, I am not going to talk about how we price it, it might be $5 for small licensee with small numbers. It could be $10 for a small licensee with small numbers. It could be $0.60 for a licensee that had 50 million accounts. So there's a wide range of pricing based on the complexity and also the number of accounts. And I'm not going to get into any details as exactly what it would be for which because that's not in our best interest in discussing with current or future customers.

Your next question is from [Calvin Sau].

Congratulations on the -- on a great quarter. My question is more pertaining to the destruction in the fintech space right now. And when we look at China, we have the likes of Alipay, WeChat Pay and even Facebook is coming up with Libra. Basically the gateway and processors together and they were able to charge lower processing fees. And some of the fintech are really doing that too. So in the long term, given our pricing structure, how do you feel about our pricing structure in comparison with the market or any potential destruction coming up?

I talked about earlier about the size of the market, given the big 3. We're talking about billions of dollars that are out there in revenue. We're not going to be looking for the low end of the revenue chain, we're going to be dealing -- we'll let somebody else have it. That's fine. Can we do it? sure we could do it. Can we price and make money? Probably. But we're going to go for the more complex things, not the ones where -- Alipay. But I will say we have customers that may be dealing with Alipay now and -- in some of the things they do. And Alipay is paying for it. So I'm not worried about that destruction of pricing at all.

Your next question...

How many more? We're getting close to the end of our time.

Yes, sir. Your question is a follow-up question from (inaudible) Beth.

My question is you were talking about processing complex stuff. Can you share with us more about the key features of -- on this processing cost? And also the real advantage of having a real time processing? How does this helps in this payment industry?

That's really probably way too much to talk about in a Q&A. I mean real time environment is simply what everybody wants. You can't do it with the legacy systems. You can do pseudo real time, which is what they're doing, but people want real time. That's the only way you can do certain things. I think the other part of the question about complex credit, go back and read a -- one of our scripts from either the last or 2 -- either the last call or the one before that where I explained an example with Bass Pro Shop for a very complex credit. There are all kinds of complex credits. So it would not be, I think, helpful to try to dissect that anymore on a Q&A. But thank you for the question. Operator, do you have any other questions that are not follow-up? Any new questioners? Because I -- we need to cut it off here shortly.

There are no further questions at this time. You may continue.

Okay. Thanks everyone for joining us. It looks like a rough day in the market. So we'll conclude and let you go back and tend to your assets. Thanks everyone.

This concludes today's conference call. Thank everyone for participating. You may now disconnect.