United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 (Mark(Mark One)

For the quarterly period ended March 31,September 30, 2018

OR

For the transition period from _________ to ____________

Commission file number 1-9330

INTELLIGENT SYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (770) 381-2900

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicated by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes ☑     No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”filer”, “accelerated filer,” “smaller reporting company,”company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use to the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

As of April 30,October 31, 2018, 8,777,9888,817,988 shares of Common Stock of the issuer were outstanding.

Intelligent Systems Corporation

Index

Form 10-Q

10-Q

Part I      Financial 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 statements.

Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF OPERATIONS

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

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

Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWSFLOWS

(unaudited, in thousands)

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

Intelligent Systems Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Item 2. Management’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”, “believe”, “plan”, “estimate”, “expect”, 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 That May Affect Future Operations”, and that actual results may differ materially from those contemplated by such forward-lookingstatements. 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’s familiarity with the information contained in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, in the Form 10-K for the year ended December 31, 2017 as filed with the Securities and Exchange Commission.

Overview 

Our consolidated operations consist of our CoreCard Software subsidiary and its affiliate companies in Romania and India, 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. 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. 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, loyalty programs, and accounts receivable and small loan transactions.

We have frequently recognized consolidated operating losses on a quarterly and annual basis. As we continue to grow our customer base and scale operations, we may, in the future, report operating profits on a quarterly and annual basis. Our results vary in part depending on the size and number of software licenses recognized as well the value and number of professional services contracts recognized in a particular period. As an example, for the quarterthree and nine months ended March 31,September 30, 2018, we reported consolidated operating income,revenue greater than the previous year due, in part, due to revenue associated with professional services provided to both a new license customer, with a potential long-term commitment, and to an existing global license customer for customizations of our base product offering as well as the recognition of a third license add-on tiers for multiple customers all of which positively impacted our consolidated results. We anticipate software license revenue from the same globalaforementioned new license customer. In addition, we recognized revenue, with no associated cost of revenue, on a one-time contractual minimum guarantee arrangement.customer in future quarters. As we continue to grow our Processing Services business, we continue to gain economies of scale on the investmentinvestments 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.stream with the third quarter of 2018 growing 16 percent and 22 percent, respectively, over the second quarter and first quarter of 2018. The infrastructure of our multi customer environment is scalable for the future. A significant portion of our expenses is related to personnel, including approximately 360385 employees located in India and Romania. In the fourth quarter of 2017, we opened a second office in India, located near Mumbai, India, to enable us to attract additional talent required for our software development and testing. 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. In the latter part of December 2017, and in the first quarter of 2018, we purchased additional hardware and software for our processing environmenta new customer in anticipation of a new contract, currently being negotiated with a potentialwhich was executed in October 2018. During the third quarter of 2018, the customer that may result in increased revenue over the next few years. While there is no assurance that the contemplated agreement will be finalized, management believes it will have a successful outcome and in the event the agreement is not finalized, the potential customer has agreed to take title to and reimbursereimbursed us for the equipment purchases.purchases as part of a Bill of Sale executed in the third quarter. This reimbursement, along with cash provided from operating activities, strengthened our cash position further. 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.

Results of Operations

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

Revenue – Total revenue in the three and nine month periodperiods ended March 31,September 30, 2018 was $4,058,000$5,415,000 and $14,046,000, respectively, which represents a 139increases of 193 percent increase overand 112 percent compared to the first quarter ofrespective periods in 2017.

Cost of Revenue – Total cost of revenue was 43 percent of total revenue in both the three and 53nine month periods ended September 30, 2018 compared to 44 percent and 46 percent of total revenue in the three month period ended March 31, 2018 and 2017, respectively.corresponding periods of 2017.

Operating Expenses – In the three and nine month periodperiods ended March 31,September 30, 2018, total operating expenses from consolidated operations were greater12 percent and eight percent less than in the corresponding periodperiods in 2017 primarily as the result of increaseddecreased research and development expenses. Research and development expenses for the three and nine months ended September 30, 2018, were 21 percent higher$327,000 (29 percent) and $494,000 (17 percent), respectively, less in 2018 as compared to 2017, mainlyprimarily due to payroll and related expense for additional offshore technical personnel, expandingre-allocating R&D resources from our hiring capabilitiesbase product offering development efforts to customizations reflected in cost of technical resources by opening a second office located near Mumbai, India and a recognition based bonus accrual.revenue. General and administrative expenses were lowerincreased $123,000 and $136,000 for the three and nine month periods ended September 30, 2018, respectively, compared to the corresponding periods in 2018 than in 2017,2017. The quarterly and year-to-date increase is mainly due to lower personnel-related expense athigher professional fees associated with the corporate officesreview of a new customer contract executed in 2018.October. Marketing expenses decreased 14 percent year over year as we continued to place less focus on marketing initiatives for CoreCardremain relatively consistent, from a total cost standpoint, with the comparable periods in 2018.the prior year. Our client base increased in 2017 and continues to increase in 2018 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.

Other Income (Loss) – In the quarterthree and nine months ended March 31,September 30, 2018, we recorded $72,000 in other income comprised primarily of $245,000 and $128,000, respectively, compared to other income of $1,868,000 and $1,842,000 for the comparable 2017 periods. In the quarter ended September 30, 2018, we recorded $171,000 of one-time interest income related to finance charges on the sale of equipment purchased for a new license customer as well as recognizing income earned on our cash balances and interest incomebalances. The year-to-date 2018 period is inclusive of the write-down of $250,000 on our Notes Receivablean investment, as described in more detail in Note 3.

Liquidity3 to the Consolidated Financial Statements. The quarter and Capital Resources

Our cash balance at March 31, 2018 was $10,183,000 compared to $14,024,000 at December 31, 2017. The principal useyear-to-date other income for 2017 is primarily comprised of cash during the period wasgain of $1,466,000 on the prepaymentsale of approximately $2,580,000 for processing equipment, software and related licenses. This prepayment wasour investment in addition to approximately $1,745,000 for comparable equipment purchaseda privately-held technology company in the latter partthird quarter 2017, and the gain of December 2017. The processing equipment is being installed to enhance our processing environment$372,000 from funds held in anticipation of a significant contract under negotiations. As the potential customer has agreed to take title and reimburse us for the equipment purchases, the prepayment is shown in “Other Current Assets” at March 31, 2018. In addition, we advanced $250,000escrow on a Promissory Note and we advanced $235,000 on a Convertible Loan Agreement,an investment sale from 2015, both of which are described in more detail in Note 3 to the Consolidated Financial Statements.

Income Taxes – We recorded $115,000 and $185,000 in the three and nine month periods ended September 30, 2018, respectively, for state income tax expense.

Liquidity and Capital Resources

Our cash balance at September 30, 2018 was $17,350,000 compared to $14,024,000 at December 31, 2017. During the threenine months ended March 31,September 30, 2018, we used $3,187,000provided $4,986,000 of cash from operations compared to a use of cash of $1,005,000 for operations.the comparable period in 2017. The most significant working capital change since December 31, 2017principal source of cash during the period was an increase in other current assetsdriven by operating activities including higher net income and the receipt, net of $2,673,000,equipment purchases, of which $2,580,000 relates to the aforementionedapproximately $1,745,000, plus associated finance carrying charges, for processing equipment, software and software purchasesrelated licenses purchased on behalf of a potential new customerlicense customer. Such contract was executed, subsequent to the third quarter of 2018, in the form of a Software License and an increase in accounts receivableSupport Agreement.

The principal uses of $1,716,000,cash during the period were advances of $250,000, $225,000 and $75,000 on three separate Promissory Notes, the funding of the final $250,000 on a Loan Agreement, and the advance of $235,000 on a Convertible Loan Agreement, all of which our three largest customers comprisingare described in more detail in Note 4 to the majority of the increase in accounts receivable remitted payment in April 2018 of approximately $1,566,000 in total.

Consolidated Financial Statements. We used $170,000$663,000 of cash to acquire computer equipment and related software primarily to enhance our existing processing environment in the U.S. as well for computer equipment for the technical resources added in our India office and to upgrade our existing processing environment in the U.S.during 2018.

We expect to have sufficient liquidity from cash on hand as well as projected customer payments to support our operations and capital equipment purchases infor the foreseeable future. Currently we expect to use cash in excess of what is required for our current operations for opportunities we believe will expand our CoreCard and FinTech business, although there can be no assurance that appropriate opportunities will arise. Additionally, we may use excess cash to repurchase shares under the program authorized by our Board of Directors on November 6, 2018, to repurchase up to $5,000,000 of common stock. 

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, valuation of investments and accrued costs and expenses 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, 2017. 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 2017. During the threenine month period ended March 31,September 30, 2018, there were no significant or material changes in the application of critical accounting policies, other than the adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606) and the related reclassifications as describe further in Notes 1 and 2 to the Consolidated Financial Statements, that would require an update to the information provided in the Form 10-K for 2017.

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:

Item 4. Controls and Procedures

As of the end of the period covered by this report, the company carried out an evaluation, under the supervision and with the participation of the company’s management, including the company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the company’s disclosure controls and procedures pursuant to Rule 13a-15(b) under the Exchange Act. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures are effective. There were no significant changes in the company’s internal control over financial reporting or in other factors identified in connection with this evaluation that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 6.6. Exhibits

The following exhibits are filed or furnished with this report:

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.

Exhibit Index

1517