Intelligent Systems Corporation

Index

Form 10-Q

10-Q

Part I Financial InformationFINANCIAL INFORMATION

Item 1. Financial Statements

Intelligent Systems Corporation

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

The accompanying notes are an integral part of these Consolidated Financial Statementsconsolidated financial statements.

Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except share and per share amounts)amounts)

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(unaudited, in thousands)

The accompanying notes are an integral part of these Consolidated Financial Statements.consolidated financial statements.

Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(unaudited, in thousands, except share amounts)

*At June 30, 2021, approximately $5,601,000 was authorized for future repurchases of our common stock.

The accompanying notes are an integral part of these consolidated financial statements.

Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYCASH FLOWS

(unaudited, in thousands)

The accompanying notes are an integral part of these Consolidated Financial Statements.consolidated financial statements.

Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

The accompanying notes are an integral part of these Consolidated Financial Statements.

Intelligent Systems Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

In February 2021, we entered into and advanced a $550,000 Promissory Note with a privately held technology company and program manager in the FinTech industry, discussed further below in Note 4. The note bears interest at the rate of 4.6 percent annually with the maturity date of October 2023.

In the second quarter of 2021, we invested $1,000,000 in a privately held company that provides supply chain and receivables financing. The carrying amount of $1,000,000 is accounted for at cost and is included in investments on the Consolidated Balance Sheet.

The lease on our headquarters and primary facility in Norcross, Georgia is held by ISC Properties, LLC, an entity controlled by our Chairman and Chief Executive Officer, J. Leland Strange. Mr. Strange holds a 100% ownership interest in ISC Properties, LLC. In March 2021, we signed a new lease for our headquarters facility for a 5 year term as disclosed on our Form 8-K dated April 1, 2021.

At SeptemberJune 30, 2020, 2021, we have three3 stock-based compensation plans in effect. In August 2020, shareholders approved the 2020 Non-Employee Directors’ Stock Incentive Plan (the “2020“2020 Plan”), which authorizes the issuance of 200,000 shares of common stock to non-employee directors. We record compensation cost related to unvested stock awards by recognizing the unamortized grant date fair value on a straight-line basis over the vesting periods of each award. We have estimated forfeiture rates based on our historical experience. Stock option compensation expense for the three and ninesix month periods ended SeptemberJune 30, 2020 2021 and 20192020 has been recognized as a component of general and administrative expenses in the accompanying Consolidated Financial Statements. We recorded $207,000$198,000 and $49,000$61,000 of stock-based compensation expense for the three months ended SeptemberJune 30, 2020 2021 and 2019,2020, respectively, and $330,000$255,000 and $129,000$123,000 for the ninesix months ended SeptemberJune 30, 2020 2021 and 2019,2020, respectively.

As of SeptemberJune 30, 2020, 2021, there is $235,000$74,000 of unrecognized compensation cost related to stock options. There were no0 and 67,500 options exercised during the three and ninesix months ended SeptemberJune 30, 2020.2021, respectively. During the quarter ended SeptemberJune 30, 2020, 2021, an aggregate of 4,3804,443 shares totaling $150,000 were granted to the three independent members of our board of directors pursuant to the 2020 Plan. Pursuant to the terms of the 2020 Plan, the shares were granted at fair market value on the date of the Annual Meeting of Shareholders and vested upon issuance. No options expired unexercised during the quarter. The following table summarizes options as of SeptemberJune 30, 2020:2021:

The estimated fair value of options granted is calculated using the Black-Scholes option pricing model with assumptions as previously disclosed in our 20192020 Form 10-K.10-K.

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’scompany’s closing stock price on the last trading day of the thirdsecond quarter of 20202021 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on SeptemberJune 30, 2020. 2021. The amount of aggregate intrinsic value will change based on the market value of the Company’scompany’s stock.

9.         INCOME TAXES

We recognize deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are recognized, net of a valuation allowance, for the estimated future tax effects of deductible temporary differences and tax credit carry-forwards. A valuation allowance against deferred tax assets is recorded when, and if, based upon available evidence, it is more likely than not that some or all deferred tax assets will not be realized.

There were no0 unrecognized tax benefits at SeptemberJune 30, 2020 2021 and December 31, 2019. 2020. Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. There were no0 accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized during the periods presented. We have determined we have no0 uncertain tax positions.

We file a consolidated U.S. federal income tax return for all subsidiaries in which our ownership equals or exceeds 80 percent,80%, as well as individual subsidiary returns in various states and foreign jurisdictions. With few exceptions we are no longer subject to U.S. federal, state and local or foreign income tax examinations by taxing authorities for returns filed more than three years ago.

Item 2. Management’sManagement’s Discussion and Analysis of Financial Condition and Results of Operations

In addition to historical information, this Form 10-Q may contain forward-looking statements relating to ISC. All statements, trend analyses and other information relative to markets for our products and trends in revenue, gross margins and anticipated expense levels, as well as other statements including words such as “anticipate”“anticipate”, “believe”“believe”, “plan”“plan”, “estimate”“estimate”, “expect”“expect”, “intend”and “intend”, and other similar expressions, constitute forward-looking statements. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties including those factors described below under “Factors“Factors That May Affect Future Operations”Operations”, and that actual results may differ materially from those contemplated by such forward-looking statements. ISC undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results.

For purposes of this discussion and analysis, we are assuming and relying upon the reader’sreader’s familiarity with the information contained in Item 7. Management’sManagement’s Discussion and Analysis of Financial Condition and Results of Operations, in the Form 10- K for the year ended December 31, 20192020 as filed with the Securities and Exchange Commission.

Overview

Our consolidated operations consist of our CoreCard Software subsidiary and its affiliate companies in Romania, India and India,the United Arab Emirates as well as the corporate office which provides significant administrative, human resources and executive management support to CoreCard.

We provide technology solutions and processing services to the financial services market, commonly referred to as the FinTech industry. We derive our product revenue from licensing our comprehensive suite of financial transaction management software to accounts receivable businesses, financial institutions, retailers and processors to manage their credit and debit cards, prepaid cards, private label cards, fleet cards, buy now pay later programs, loyalty programs, and accounts receivable and loan transactions. Our service revenue consists of fees for software maintenance and support for licensed software products, fees for processing services that we provide to companies that outsource their financial transaction processing functions to us, and professional services primarily for software customizations provided to both license and processing customers.

Our results vary in part depending on the size and number of software licenses recognized as well as the value and number of professional services contracts recognized in a particular period. As we continue to grow our Processing Services business, we continue to gain economies of scale on the investment we have made in the infrastructure, resources, processes and software features developed over the past number of years to support this growing side of our business. We are adding new processing customers at a faster pace than we are adding new license customers, resulting in steady growth in the processing revenue stream. However, we also receive license revenue and are also experiencing growth in our professional services revenue due to the addition of Goldman Sachs Group, Inc. as a large new customer in 2018.2018, referred to as “Customer A” in the Notes to Consolidated Financial Statements. In total, this customer represented 67%71% and 58%65% of our consolidated revenues in the first ninesix months of 20202021 and 2019,2020, respectively. We expect future professional services, maintenance, and license revenue from this customer in 20202021 and future years; however, the amount and timing will be dependent on various factors not in our control such as the number of accounts on file and the level of customization needed by the customer. License revenue from this customer, similar to other license arrangements, is tiered based on the number of active accounts on the system. Once the customer achieves each tier level, they receive a perpetual license up to that number of accounts; inactive accounts do not count toward the license tier. The customer receives an unlimited perpetual license at a maximum tier level that allows them to utilize the software for any number of active accounts. They currently use the software for a single institution and additional license fees apply if multiple institutions are added.added, which we expect to occur in the second half of 2021. Support and maintenance fees are charged based on the tier level achieved and increase at new tier levels.

WhileIn 2020, we experienced the loss of a large customer due to insolvency. In October 2020, we opened offices in Dubai and Chennai and hired some of the insolvent customer’s employees. In April 2021, we completed an agreement to purchase computer hardware and customer intangible assets and collected previously unrecognized accounts receivable resulting in revenue of $0.6 million for the quarter ended June 30, 2021. We have collected and settled all outstanding receivables from this customer, and we do not anticipate receiving additional revenue from them in the future. In the second quarter of 2021, we converted one of their customers to our processing platform. We expect revenue for the remainder of 2021 and future years from servicing this new customer and adding other new customers in the region.

We typically receive revenue based on the number of active accounts on file rather than transaction volume and therefore the COVID-19 pandemic and related to the coronavirus could adverselyeconomic slowdown has had a muted impact on our future results if the abilityresults. Most of our customers to continue to add new accounts is negatively impacted by the decrease in economic activity caused by the virus. As noted above, we receive license revenue when our customers achieve new active account tiers. The impact of slower growth or declines in active accounts would result in lower than expected license revenue which would then result in lower than expected maintenance revenue. Similarly, we typically receive processing revenue based on the number of active accounts our customers have on our system. If our customers fail to add new accounts or experience declines in active accounts due to inactivity, we could experience lower than expected growth in processing revenue or lower processing revenue. We could also experience delays or declines in professional services revenue and new customer sign-ups and implementations if customers or potential customers delay or cancel their plans due to the virus related economic slowdown. Thus far, we have experienced some slowdowns in customer account growth and some customers have stopped adding new accounts resulting in flat or declining active accounts. The impact on results to date was limited and, for the second and third quarter, was mitigated primarily by new program offerings by a large customer related to government stimulus efforts. These programs are limited in duration and will likely start to decline in the fourth quarter. We could therefore experience more significant negative impacts on full year results which we are not currently able to quantify.

Additionally, our operations could be impacted, and we could experience higher costs if, despite our mitigation and prevention efforts, the virus spread prevents affected employees from performing key duties. Our employees in India have been requiredworking remotely throughout the pandemic which has primarily impacted our ability to work remotely since mid-March.hire and train new employees. We have maintainedbeen able to maintain key functions;functions and business continuity while delivering growth in our professional services revenue; however, the continuancehiring and training constraints could impact future growth in our professional services revenue. Additionally, with the recent increase in severity of remote work will likely negatively impact productivitythe pandemic in India, we could experience operational disruptions or service delays which could impact operationsthe amount and revenues.timing of revenues for the remainder of the year.

The infrastructure of our multi customer environment is scalable for the future. A significant portion of our expense is related to personnel, including approximately 530610 employees located in India, Romania and Romania.Dubai. In October 2020, we added new locations in Dubai, United Arab Emirates and Chennai, India to expand our international capabilities. Our ability to hire and train employees on our processes and software impacts our ability to onboard new customers and deliver professional services for software customizations. In addition, we have certain corporate office expenses associated with being a public company that impact our operating results.

Our revenue fluctuates from period to period and our results are not necessarily indicative of the results to be expected in future periods. It is difficult to predict the level of consolidated revenue on a quarterly or annual basis for a number of reasons, including the following:

We continue to maintain a strong cash position. We intend to use cash balances to support the domestic and international operations associated with our CoreCard business and to expand our operations in the FinTech industry through financing the growth of CoreCard and, if appropriate opportunities become available, through acquisitions of businesses in this industry. In November 2018, our Board of Directors authorized a share repurchase program of $5 million.million, all of which has been utilized. In April 2021, the Board authorized an additional $10 million for our share repurchase program, of which $4.4 million has been utilized. We did not make anymade share repurchases of $7.8 million for the six months ended 2021, and no share repurchases in 2020 or 2019.the six month period ended June 30, 2020. We have $5.6 million of authorized share repurchases remaining at June 30, 2021.

Results of Operations

The following discussion should be read in conjunction with the unaudited Consolidated Financial Statements and the Notes to Consolidated Financial Statements presented in this quarterly report.

Revenue – Total revenue in the three and ninesix month periods ended SeptemberJune 30, 20202021 was $10,304,000$13,355,000 and $26,250,000,$22,267,000, respectively, which represents increases of 866 percent and 940 percent compared to the respective periods in 2019.2020.

Cost of Revenue – Total cost of revenue was 4142 percent and 4345 percent of total revenue in the three and ninesix month periods ended SeptemberJune 30, 2020,2021, respectively, compared to 3246 percent and 3545 percent of total revenue in the corresponding periods of 2019. The increase in cost of revenue as a percentage of revenue is primarily driven by decreased product sales with low associated costs.2020. Cost of revenue includes costs to provide annual maintenance and support services to our installed base of licensed customers, costs to provide professional services, and costs to provide our financial transaction processing services. The cost and gross margins on such revenues can vary considerably from period to period depending on the customer mix, customer requirements and project complexity as well as the mix of our U.S. and offshore employees working on the various aspects of services provided. In addition, we continue to devote the resources necessary to support our growing processing business, including direct costs for regulatory compliance, infrastructure, network certifications, and customer support. Investments in our infrastructure in 2020 and 2021 are in anticipation of adding customers in future periods. As such, we will not experience economies of scale unless we add additional customers, as anticipated. This may be subject to change in the future if new regulations or processing standards are implemented causing us to incur additional costs to comply.

Operating Expenses – In the three and six month periodperiods ended SeptemberJune 30, 2020,2021, total operating expenses from consolidated operations were higher than in the corresponding period in 20192020 primarily due to higher generalresearch and administrative expenses. In the nine month period ended September 30, 2020, total operating expenses from consolidated operations were slightly higher than in the corresponding period in 2019 primarily due todevelopment costs and higher  general and administrative expenses, partially offset by lower research and development and marketing expenses. Research and development expenses were 4188 percent higher and 4159 percent lowerhigher in three and ninesix month periods in 2020,2021, respectively, as compared to the same periods in 2019.2020. In the three and six month periodperiods ended SeptemberJune 30, 2020,2021, research and development expenses were higher mainly due to payroll and related expense for additional offshore technical personnel. Inpersonnel and hardship bonus payments related to the nine month period ended September 30, 2020, research andpandemic’s impact on our offshore employees. Additionally, we hired onshore technical personnel to work on the development expenses were lower mainly due to lower recognition-based bonus accruals, partially offset by higher payroll and related expense for additional offshore technical personnel.of an updated platform. General and administrative expenses were 3476 percent and 20 percent higher in the three and six month periodperiods ended SeptemberJune 30, 20202021, respectively, due to higherbonus accruals in the current period as well as a stock compensation and salaries expenses duegrant to the new 2020 Non-Employee Directors’ Stock Incentive Plan and an increase in headcount, respectively. Additionally, General and administrative expenses were 13 percent higherboard in the nine month period ended September 30, 2020 due to higher legal and advisory expenses related to ongoing securities litigation as discussed below partially offset by strategic initiativessecond quarter of the Board2021 that did not recurwas similarly granted in the comparable 2020 period.third quarter in 2020. Marketing expenses decreased 11increased 48 percent and 2432 percent for the three and ninesix month periods in 2020,2021, respectively, as compared to the same periods in 2019 as we continued to place less focus on marketing initiatives for CoreCard.2020. Our client base continues to increase with minimal marketing efforts as we continue to have prospects contact us via online searches; however, we will continue to re-evaluate our marketing expenditures as needed to competitively position the Processing Services business.  

Investment Income (Loss) – In the three and ninesix months ended SeptemberJune 30, 2020,2021, we recorded $92,000$134,000 and $1,237,000$267,000 of investment losses, respectively, compared to investment losses of $109,000$95,000 and $105,000$1,145,000 for the three and ninesix months ended SeptemberJune 30, 2019,2020, respectively. The 2020 investment losses for the nine months ended September 30, 2020 primarily relate to first quarter 2020 impairment charges on investments resulting from the economic downturn caused by the recent pandemic and losses on equity method investments. We did not record any impairments in 2021.

Other Income (Loss) – In the three and ninesix months ended SeptemberJune 30, 2020,2021, we recorded income of $59,000$81,000 and $312,000,$156,000, respectively, compared to income of $104,000$117,000 and $353,000$253,000 for the comparable 20192020 periods. The decrease for the three and nine month periods is primarily due toresults from lower interest rates and lower cash balances in the 20202021 period.

Income Taxes – Our effective tax rates for the three and ninesix months ended SeptemberJune 30, 20202021 were 18.926.3 percent and 20.926.2 percent compared to effective tax rates of 26.319.3 percent and 24.722.5 percent for the respective periods in 2019. In the three and nine month periods ended September 30, 2020, our effective tax rates were lower primarily due to research and development tax credits recognized in the third quarter.2020.

Liquidity and Capital Resources

Our cash balance at SeptemberJune 30, 20202021, was $34,391,000$26,210,000 compared to $26,415,000$37,956,000 at December 31, 2019.2020. During the ninesix months ended SeptemberJune 30, 2020,2021, cash provided by operations was $15,184,000$405,000 compared to cash provided by operations of $7,679,000$9,714,000 for the ninesix months ended SeptemberJune 30, 2019.2020. The increasedecrease is primarily due to higherlower deferred revenue and lowerbalances, higher accounts receivable balances and a non-cash impairment charge,decrease in cash held for program management funding, partially offset by lower accrued income taxes,higher net income and accrued payroll.higher depreciation. In addition, during the second quarter of 2021, we advancedinvested $1,000,000 onin a Promissory Noteprivately held supply chain financing company which is described in more detail in Note 34 to the Consolidated Financial Statements. We used $6,173,000$2,612,000 of cash to acquire computer equipment primarily for continued investments in our existing processing environment in the U.S and technical resources added in our India office and to upgrade our existing processing environment in the U.S.office.

We expect to have sufficient liquidity from cash on hand as well as projected customer payments to support our operations and capital equipment purchases in the foreseeable future. Currently we expect to use cash in excess of what is required for our current operations for share repurchases and opportunities we believe will expand our CoreCardFinTech business, as exemplified in transactions described in Notes 3 and FinTech business,4, although there can be no assurance that appropriate opportunities will arise. In November 2018, our Board of Directors authorized a share repurchase program of $5 million, all of which has been utilized. In April 2021, the Board authorized an additional $10 million for our share repurchase program, of which $4.4 million has been utilized. We made share repurchases of $7.8 million for the six months ended 2021, and no share repurchases in the six month period ended June 30, 2020. We have $5.6 million of authorized share repurchases remaining at June 30, 2021.

Off-Balance Sheet Arrangements

We do not currently have any off-balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial condition, liquidity or results of operations.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. We consider certain accounting policies related to revenue recognition and valuation of investments to be critical policies due to the estimation processes involved in each. Management discusses its estimates and judgments with the Audit Committee of the Board of Directors. For a detailed description on the application of these and other accounting policies, see Note 1 to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.2020. Reference is also made to the discussion of the application of these critical accounting policies and estimates contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for 2019.2020. During the ninesix month period ended SeptemberJune 30, 2020,2021, there were no significant or material changes in the application of critical accounting policies.

Factors That May Affect Future Operations

Future operations are subject to risks and uncertainties that may negatively impact our future results of operations or projected cash requirements. It is difficult to predict future quarterly and annual results with certainty.

Among the numerous factors that may affect our consolidated results of operations or financial condition are the following: