CoreCard Corp - Quarter Report: 2009 June (Form 10-Q)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

Cash

Accounts receivable, net

Notes and interest receivable, current portion

Inventories

Other current assets

 

Total current assets

 

Long-term investments

Notes and interest receivable, net of current portion

Property and equipment, at cost less accumulated depreciation

Other intangibles, net

 

Total assets

 

Current liabilities:

Short-term borrowings

Accounts payable

Deferred revenue

Accrued payroll

Accrued expenses and other current liabilities

 

Total current liabilities

Long-term liabilities, net of current portion

 

Commitments and contingencies (Note 9)

Intelligent Systems Corporation stockholders’ equity:

Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 shares issued and outstanding at June 30, 2009 and December 31, 2008

Additional paid-in capital

Accumulated other comprehensive loss

Accumulated deficit

 

Total Intelligent Systems Corporation stockholders’ equity

Noncontrolling interest ¹

 

Total stockholders’ equity

 

Total liabilities and stockholders’ equity

 

Revenue

Products

Services

 

Total revenue

 

Cost of revenue

Products

Services

 

Total cost of revenue

 

Expenses

Marketing

General & administrative

Research & development

 

Loss from operations

 

Other income (expense)

Interest income (expense), net

Equity in income of affiliate company

Other income

 

Loss from continuing operations before income taxes

Income taxes

 

Loss from continuing operations

Loss from discontinued operations

Gain on sale of discontinued operations

 

Net income (loss)

 

Loss per share from continuing operations:

Basic

Diluted

Income per share from discontinued operations:

Basic

Diluted

Income (loss) per share:

Basic

Diluted

Basic weighted average common shares outstanding

Diluted weighted average common shares outstanding

 

Net income (loss)

Adjustments to reconcile net income (loss) to net cash used for operating activities:

Depreciation and amortization

Stock-based compensation expense

Gain on sale of VISaer business

Non-cash interest income, net

Equity in income of affiliate company

Changes in operating assets and liabilities

Accounts receivable

Accrued interest

Inventories

Other current assets

Accounts payable

Deferred revenue

Accrued payroll

Accrued expenses and other current liabilities

Other liabilities

 

Net cash used for operating activities

 

 

Proceeds from sale of discontinued operations

Investment in subsidiary

Proceeds from notes and interest receivable

Purchases of property and equipment

 

Net cash provided by investing activities

 

 

Borrowings under line of credit

Repayments made under line of credit

Borrowings under notes payable

Payments on notes payable

 

Net cash provided by (used for) financing activities

 

 

Effects of exchange rate changes on cash

 

Net increase (decrease) in cash

Cash at beginning of period

 

Cash at end of period

 

 

Cash paid during the period for interest

Cash paid during the period for income taxes

Throughout this report, the terms “we”, “us”, “ours”, “ISC” and “company” refer to Intelligent Systems Corporation, including its wholly-owned and majority-owned subsidiaries.

The unaudited Consolidated Financial Statements presented in this Form 10-Q have been prepared in accordance with accounting principles generally accepted in the United States applicable to interim financial statements. Accordingly, they do not include all of the information and notes required for complete financial statements. In the opinion of ISC management, these Consolidated Financial Statements contain all adjustments (which comprise only normal and recurring accruals) necessary to present fairly the financial position and results of operations as of and for the three and six month periods ended June 30, 2009 and 2008. The interim results for the three and six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with our Consolidated Financial Statements and notes thereto for the fiscal year ended December 31, 2008, as filed in our Annual Report on Form 10-K.

Reclassification – Certain prior period amounts have been reclassified to conform to the current period presentation. On January 1, 2009, we adopted Statement of Financial Accounting Standards No. 160 (SFAS No. 160), “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51,” the provisions of which, among others, require that minority interests be renamed “noncontrolling interests” and be presented as a component of equity for all periods presented. Accordingly, $1,516,000 of minority interest which had been recorded in the liability section of the balance sheet at December 31, 2008 has been reclassified to stockholders’ equity for all periods presented.

We also reclassified shipping and handling amounts billed to customers from cost of sales to revenue totaling $369,000 and $640,000 for the three and six months ended June 30, 2008, respectively, to conform to our current period presentation. We classify shipping and handling amounts billed to customers in revenue and the cost of the shipping and handling to customers as a component of cost of revenue.

Discontinued Operations – As explained in more detail in Note 2 to the Consolidated Financial Statements included in our Form 10-K for the year ended December 31, 2008, effective April 16, 2008, the company and two subsidiaries, VISaer, Inc. and VISaer (U.K.) Limited (collectively, “VISaer”) completed the sale of substantially all the assets related to VISaer’s business pursuant to the terms of an asset purchase agreement (the “Asset Purchase Agreement”) between IBS Technics, Inc. (“IBS Technics”) and VISaer. IBS Technics is a subsidiary of IBS Software Services, Inc., a software services company that had previously provided certain software development services to VISaer as an independent third party contractor. The VISaer business is presented as discontinued operations for all periods presented.

The following condensed financial information is provided for the VISaer discontinued operations for the periods shown.

Net sales

Operating loss

Net loss from discontinued operations

Comprehensive Loss – In accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” comprehensive loss is the total of net loss and all other non-owner changes in equity in a period. A summary follows:

Net income (loss)

Other comprehensive income (loss):

Foreign currency translation adjustment

 

Comprehensive income (loss)

 

Stock-based Compensation – At June 30, 2009, we have two stock-based compensation plans in effect. In December 2004, the FASB issued FASB Statement No. 123R (SFAS No. 123R), “Share-Based Payment” which replaced APB No. 25 and SFAS No. 123. We adopted SFAS No.123R effective January 1, 2006 using the modified prospective application method of adoption which requires us to record compensation cost related to unvested stock awards by recognizing the unamortized grant date fair value in accordance with provisions of SFAS 123R on a straight line basis over the service periods of each award. We have estimated forfeiture rates based on our historical experience. Stock option compensation expense is recognized as a component of general and administrative expenses in the accompanying Consolidated Financial Statements. As a result of adopting SFAS No. 123R, we recorded $3,000 and $6,000 of stock-based compensation expense in the three months ended June 30, 2009 and 2008, respectively and $6,000 and $9,000 for the six month periods ended June 30, 2009 and 2008, respectively.

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

As of June 30, 2009, there is $13,000 of unrecognized compensation cost related to stock options. During the quarter ended June 30, 2009, an aggregate of 12,000 options were granted to the three independent members of our board of directors pursuant to the non-employee director stock option plan (Director Plan). Pursuant to the terms of the Director Plan, the options were granted at fair market value on the date of the Annual Shareholders meeting. No options were exercised or forfeited during the three and six month periods ended June 30, 2009. The following table summarizes options as of June 30, 2009:

Outstanding at June 30, 2009

Vested and exercisable at June 30, 2009

Concentration of Revenue – The following table indicates the percentage of consolidated revenue represented by each customer for any period in which such customer represented more than 10% of consolidated revenue.

ChemFree Customer A

ChemFree Customer B

ChemFree Customer C

ChemFree Customer D

Short-term Borrowings – In June 2009, we renewed our working capital line of credit with our bank. The revolving line of credit bears interest at the higher of the prime rate plus one and one half percent and 6.75% (6.75% at June 30, 2009), is secured by all assets of the company and our principal subsidiaries, is guaranteed by our subsidiaries, and expires June 30, 2010. We may borrow an aggregate of 80 percent of qualified accounts receivable of our consolidated subsidiaries plus 50 percent of inventory, up to a maximum of $1,250,000. At June 30, 2009, our borrowing base calculation resulted in availability of $1,250,000, of which we had drawn down $437,000 at June 30, 2009. The terms of the loan contain typical covenants not to sell or transfer material assets, to create liens against assets, to merge with another entity, to change corporate structure or the nature of our business, to declare or pay dividends, or to redeem shares of common stock. The loan agreement also contains covenants not to change the chief executive and chief financial officers of the company or to make loans to or invest in new minority-owned companies, without first obtaining the consent of our bank in each case. Furthermore, the terms of the loan renewal include a covenant requiring the company to maintain a minimum tangible net worth (as defined in the loan agreement) of various calculated amounts at the end of each calendar quarter beginning September 30, 2009.

Commitments and Contingencies –

Lease – On June 1, 2009, we entered into an amendment to our lease for the facility at 4355 Shackelford Road, Norcross, Georgia that houses our corporate offices and the operations of our two subsidiary companies. The amendment extended the term of the lease for three years through May 31, 2012. All other terms and conditions of the original lease remain unchanged. The lease is with a related party as explained in Note 12 to the Consolidated Financial Statements contained in our 2008 Form 10-K.

Future minimum lease payments are as follows:

2009

2010

2011

2012

 

Total minimum lease payments

 

Income Taxes – Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board Interpretation No. 48, (FIN No. 48) “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”. FIN No. 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. We have recognized tax benefits from all tax positions we have taken, and there has been no adjustment to any carry forwards (net operating loss or research and development credits) as a result of the implementation of FIN No. 48. The adoption of FIN No. 48 did not have a material effect on our consolidated financial position or results of operations. As of June 30, 2009, we do not have any unrecognized tax benefits and we do not anticipate any significant changes in the balance of unrecognized tax benefits during the next twelve months.

Industry Segments – Segment information is presented consistently with the basis described in the 2008 Form 10-K. The following table contains segment information for continuing operations for the three and six months ended June 30, 2009 and 2008.

Revenue

Operating loss

Revenue

Operating income (loss)

 

Revenue

Operating income (loss)

Corporate expenses

 

Consolidated operating loss from continuing operations

 

 

Information Technology

Industrial Products

 

Consolidated segments

Corporate

 

Consolidated depreciation and amortization

 

 

Information Technology

Industrial Products

 

Consolidated segments

Corporate

 

Consolidated capital expenditures

 

Information Technology

Industrial Products

 

Consolidated segments

Corporate

 

Consolidated assets

 

New Accounting Pronouncements – In December 2007, the FASB issued Statement No. 160 (SFAS No. 160) “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51.” SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and the deconsolidation of a subsidiary. It clarifies that the noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. It also changes the way the consolidated income statement is presented, requiring disclosure on the face of the income statement of the amount of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS No. 160 also establishes appropriate accounting for changes in a parent’s ownership interest that do not result in deconsolidation and when a subsidiary is deconsolidated. SFAS No. 160 requires expanded disclosure to identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Accordingly, we adopted SFAS No. 160 on January 1, 2009. The adoption of SFAS No. 160 resulted in the renaming of a minority interest totaling $1,516,000 which had previously been recorded in the liability section of the balance sheet to a noncontrolling interest presented as a component of stockholders’ equity for all periods presented.

Subsequent Event – On July 17, 2009, we completed a rights offering of common stock to our shareholders. Under the terms of the rights offering, we distributed at no charge to the holders of our common stock non-transferable rights to purchase shares of our common stock. We distributed one right for each share of common stock owned by such holder on the record date of June 17, 2009. Each right entitled the holder to purchase one share of our common stock at a subscription price of $.70 per share. Stockholders on the record date were also entitled to subscribe, subject to allotment among all subscribing stockholders, for additional shares not subscribed for by other stockholders. A registration statement relating to the rights offering filed with the Securities and Exchange Commission was declared effective on June 18, 2009. The rights offering commenced on June 18, 2009 and terminated on July 17, 2009. The company sold 4,479,014 new shares of common stock and received gross proceeds of $3,135,310 from the rights offering, which was oversubscribed. Giving effect to the rights offering, we have 8,957,942 shares of common stock outstanding as of July 30, 2009. We expect that expenses related to the transaction will be between $110,000 and $120,000. Subsequent to the completion of the rights offering, we paid down our working capital line of credit in full and expect to use remaining proceeds from the rights offering primarily to support plans for our CoreCard subsidiary as well as other general working capital purposes.

A change in revenue level at one of our subsidiaries may impact consolidated revenue or be offset by an opposing change at another subsidiary.

Customers may decide to postpone or cancel a planned implementation of our software for any number of reasons, which may be unrelated to our software features or contract performance, but which may affect the amount, timing and characterization of our deferred and/or recognized revenue.

Our subsidiaries are relatively small in revenue size and, in the Information Technology sector, revenue in a given period may consist of a relatively small number of new contracts. Consequently, even small delays in a delivery under a new software contract (which may be out of our control) could have a significant and unpredictable impact on consolidated revenue that we can recognize in a given quarterly or annual period.

Revenue from products, which includes sales and leases of equipment and supplies in our Industrial Products segment as well as software license fees related to the Information Technology segment, was $2.6 million in the three month period ended June 30, 2009, a 32 percent decline compared to the three month period ended June 30, 2008. Product revenue declined by 37 percent in the year-to-date period of 2009 compared to the first six months of 2008. The decline in product revenue in the second quarter and year-to-date periods in 2009 compared to the prior year periods is primarily associated with a decline in domestic sales of ChemFree parts washer equipment (our Industrial Products segment) due to the fact that in the first half of 2008, a new customer was in the middle of a national program to sell ChemFree products to its installed customer base, resulting in a high initial volume of sales. With the initial rollout complete, as anticipated the number of new machines sold to this customer in the three and six month period ended June 30, 2009 was lower than during the rollout period last year. There was also a period-to-period decline in international equipment sales reflecting the general economic slowdown in certain European markets. Total sales of ChemFree’s fluid and filter consumables in the domestic and international markets increased in the three and six month period ended June 30, 2009 compared to the same periods in 2008, reflecting an increasing base of users of its SmartWasher^® part washers. However, sales of fluid to the European market were lower in the year-to-date 2009 period compared to the six month period of 2008 reflecting the temporary impact of a transition to a new fluid blending facility in the UK to serve the European market. Software license revenue associated with the Information Technology segment increased in both the three and six month periods ended June 30, 2009 compared to the respective periods in 2008 but was not a significant contributor to product revenue in either period. The company recognizes software license revenue generally upon completion of each contract and acceptance by customers.

Service revenue associated with the Information Technology segment was $540,000 and $843,000 in the three and six months ended June 30, 2009, representing increases of 76 percent and 109 percent compared to the respective periods in 2008. The change is attributed to increased professional services projects that were completed for CoreCard customers as well as an increase in the installed base of customers that pay for maintenance and technical support.

Due to general economic conditions and uncertainty about the impact of a slow economy on the automotive repair and supplies industry, ChemFree expects a relatively flat volume of machine sales for the foreseeable future and is carefully managing its costs and inventory levels accordingly. We expect that sales of replenishment fluid and filter to the installed base of customers and lease revenue will be relatively unaffected by fluctuations in general economic conditions. Turmoil in the global financial markets could impact CoreCard’s revenue and prospects in the foreseeable future if customers or prospects postpone software purchases or implementations. We are carefully monitoring the evolving dynamics in the marketplace and proactively lowered expenses going into 2009. We expect to fully support existing customers and contracts and to continue to add new prospects and customers. We expect to use the funds received from the successful completion of our stockholder rights offering as described in more detail in Note 13 to the Consolidated Financial Statements to support CoreCard’s growth plans, as well as other general corporate purposes.

Cost of product revenue was 52 percent and 53 percent of product revenue in the three and six months ended June 30, 2009, respectively compared to costs of 60 percent and 58 percent of product revenue in the respective periods in 2008. Higher margin fluid and filters represented a larger percentage of product revenue in 2009 than in the comparable periods in 2008, resulting in the improved gross margin.

Cost of service revenue (which relates to our CoreCard business only) was significantly lower as a percent of service revenue in the three and six month periods ended June 30, 2009 as compared to the respective periods last year. The mix of service revenue in a given period, as well as the number of customers and new products being supported, impacts the gross margin on service revenue. The improvement in gross margin in 2009 is due in part to a higher volume of professional service revenue which has a relatively lower cost to deliver than does our customer support and maintenance revenue (both of which are included in the category of service revenue). CoreCard is providing a high level of support to its initial customers to ensure it builds a solid base of reference customers and puts in place an infrastructure for future growth. Cost of providing routine maintenance and support services as a percentage of service revenue is expected to decrease as CoreCard’s installed base of customers increases, whereas the cost of professional services is expected to have a relatively stable gross margin percentage from period to period.

Turmoil in the global financial markets could have a serious negative impact on CoreCard due to potential customers (most of whom are financial institutions or services firms) delaying purchase or implementation decisions.

Reluctance by financial institutions to act as sponsor banks for prospective customers (such as issuers and processors of credit and prepaid cards) could increase CoreCard’s losses and cash requirements.

It is unclear to what extent the continuing weakness in the domestic US and European economies will impact the automotive parts and repair industry and reduce demand for ChemFree’s SmartWasher^® products.

Delays in software development projects could cause our customers to delay implementations or delay payments, which would increase our costs and reduce our revenue.

Our CoreCard subsidiary could fail to deliver software products which meet the business and technology requirements of its target markets within a reasonable time frame and at a price point that supports a profitable, sustainable business model.

One of ChemFree’s customers represented 34 percent of our consolidated revenue in the first half of 2009 and any unplanned changes in the volume of orders or timeliness of payments from such customer could have a negative impact on revenue, profits, inventory levels and cash, at least in the near-term.

Failure by ChemFree to protect its intellectual property assets could increase competition in the marketplace and result in greater price pressure and lower margins, thus potentially impacting sales, profits and projected cash flows.

Software errors or poor quality control may delay product releases, increase our costs, result in non-acceptance of our software by customers or delay revenue recognition.

Compliance with the internal control over financial reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002 will increase audit-related expenses and divert management and staff resources.

Competitive pressures (including pricing, changes in customer requirements and preferences, and competitor product offerings) may cause prospective customers to choose an alternative product solution, resulting in lower revenue and profits (or increased losses).

CoreCard could fail to expand its base of customers, resulting in lower revenue and profits (or increased losses), increased cash needs and possibly leading to restructuring or cutting back of the subsidiary’s operations.

In certain limited situations, ChemFree lease customers are permitted to terminate the lease covering a SmartWasher^® machine, requiring the unamortized balance of the original machine cost to be written off which could reduce profits in that reporting period and result in lower revenue in future periods.

CoreCard could fail to retain key software developers and managers who have accumulated years of know-how in our target markets and company products, or fail to attract and train a sufficient number of new software developers and testers to support our product development plans and customer requirements at projected cost levels.

Delays in anticipated customer payments for any reason would increase our cash requirements and possibly our losses.

Declines in performance, financial condition or valuation of minority-owned companies could cause us to write-down the carrying value of our investment or postpone an anticipated liquidity event, which could negatively impact our earnings and cash flow.

Failure to regain compliance with the continued listing standards of NYSE Alternext U.S. could result in delisting of our common stock, with a potentially negative impact on market price and liquidity of our common stock.

Other general economic and political conditions could cause customers to delay or cancel software purchases.

Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991, as amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the Registrant’s Report on Form 8-K dated November 25, 1997.)

 

Bylaws of the Registrant dated December 7, 2007. (Incorporated by reference to Exhibit 3.2 of the Registrant’s Form 8-K dated December 7, 2007.)

 

First Amendment to the Lease agreement between the Registrant and ISC Properties, LLC dated June 1, 2009.

 

Eighth Modification to Loan Documents by and among Intelligent Systems and Fidelity Bank dated June 26, 2009.

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Certification of Chief Executive Officer and Chief Financial Officer furnished as required by Section 906 of the Sarbanes-Oxley Act of 2002.

 

Date: August 11, 2009

 

 

 

Date: August 11, 2009

 

 

 

Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991, as amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the Registrant’s Report on Form 8-K dated November 25, 1997.)

 

Bylaws of the Registrant dated December 7, 2007. (Incorporated by reference to Exhibit 3.2 of the Registrant’s Form 8-K dated December 7, 2007.)

 

First Amendment to the Lease agreement between the Registrant and ISC Properties, LLC dated June 1, 2009.

 

Eighth Modification to Loan Documents by and among Intelligent Systems and Fidelity Bank dated June 26, 2009

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Certification of Chief Executive Officer and Chief Financial Officer furnished as required by Section 906 of the Sarbanes-Oxley Act of 2002.