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 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, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting 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 ☑

Securities registered pursuant to Section 12(b) of the Exchange Act:

As of JuneApril 30, 2020, 8,924,9882021, 8,882,350 shares of Common Stock of the issuer were outstanding.

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

(in thousands, except share amounts)

*At March 31, 2021, approximately $649,000 was authorized for future repurchases of our common stock. In April 2021, the Board authorized an additional $10 million for our share repurchase program.

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

Intelligent Systems Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Concentration of Revenue

The following table indicates the percentage of consolidated revenue represented by each customer that represented more than 10 percent of consolidated revenue in the three and six month periods ended June 30, 2020March 31, 2021 and 2019.2020. Most of our customers have multi-year contracts with recurring revenue as well as professional services fees that vary by period depending on their business needs.

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”, and “intend”“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, 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 65%71% and 50%66% of our consolidated revenues in the first six monthsquarters 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. Our contracts with this customer are filed as Exhibits 10.1, 10.2, 10.3 and 10.4 to this Form 10-Q. 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 converted one of their customers to our processing platform. We expect revenue for the remainder of 2021 and future years from servicing this customer and adding 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 recently declaredCOVID-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 first and second quarter results was limited and, for the second quarter, was mitigated primarily by new program offerings by a large customer related to government stimulus efforts. These programs are limited in duration and may not continue beyond the initial statutory term of one year. 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 530575 employees located in India and Romania. 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. We did not make anymade share repurchases of $2.7 million for the three months ended 2021, and no share repurchases in 2020 or 2019.the three month period ended March 31, 2020. We have $0.6 million of authorized share repurchases remaining at March 31, 2021. In April 2021, the Board authorized an additional $10 million for our share repurchase program.

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 six month periodsthree-month period ended June 30, 2020March 31, 2021 was $8,053,000 and $15,946,000, respectively,$8,912,000 which represents increasesa 13% percent increase over the first quarter of 7 percent and 10 percent compared to the respective periods in 2019.2020.

Cost of Revenue – Total cost of revenue was 4650 percent and 4544 percent of total revenue in the three and six monththree-month periods ended June 30,March 31, 2021 and 2020, respectively, compared to 39 percent and 38 percent of total revenue in the corresponding periods of 2019.respectively. The increase in cost of revenue as a percentage of revenue is primarily driven by decreased product sales with low associated costs.investments made in our processing infrastructure including hardware and software purchases and additional space in our data centers. 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. However,Investments in our infrastructure in 2020 and 2021 are in anticipation of adding customers in future periods. As such, we are continuing towill not experience economies of scale in our processing environment and did experience a decrease year over year for our cost of financial transaction processing servicesunless we add additional customers, as a percentage of transaction processing services revenue.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 monththree-month period ended June 30, 2020,March 31, 2021, total operating expenses from consolidated operations were lowergreater than in the corresponding period in 20192020 primarily due to lowerincreased research and development expenses, partially offset by decreased general and administrative expenses. In the six month period ended June 30, 2020, total operating expenses from consolidated operations were lower than in the corresponding period in 2019 primarily due to lower research and development expense. Research and development expenses were 7129% percent higher and 11 percent lower in three and six month periods in 2020, respectively,2021 as compared to the same periods in 2019. In the three month period ended June 30, 2020, research and development expenses were higher mainly due to increased payroll and related expense forto hiring of additional offshore technical personnel. InAdditionally, we hired onshore technical personnel to work on the six month period ended June 30, 2020, research and development expenses were lower mainly due to lower recognition-based bonus accruals, partially offset by payroll and related expense for additional offshore technical personnel.of an updated platform. General and administrative expenses were 36 percent lower in the three month period ended June 30,2021 than in 2020, primarily due to higherlower legal and advisory expenses related to 2019 contract negotiations and strategic initiatives ofcosts resulting from the Board that did not recursecurities litigation discussed in the comparable 2020 period. General and administrative expenses were 4 percent higher in the six month period ended June 30, 2020.Part II, Item 1 below. Marketing expenses decreased 39 percent and 29 percent for the three and six month periods in 2020, respectively, as compared to the same periods in 2019remained relatively unchanged year over year as we continued to place less focus on marketing initiatives for CoreCard. 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 six monthsquarter ended June 30, 2020,March 31, 2021, we recorded $95,000 and $1,145,000$133,000 of investment losses respectively, compared to investment losses of $21,000$1,050,000 for the three monthsquarter ended June 30, 2019 andMarch 31, 2020. The 2020 investment income of $4,000 for the six months ended June 30, 2019. The investment losses for the six months ended June 30, 2020 primarily relate to impairment charges on investments resulting from the economic downturn caused by the recent pandemic and losses on equity method investments. Equity method losses for the three months ended March 31, 2021 were $133,000. We did not record any impairments in 2021.

Other Income, (Loss)net – In the three and six monthsquarter ended June 30, 2020,March 31, 2021, we recorded $75,000 in other income of $117,000 and $253,000, respectively, compared to income of $146,000 and $249,000$136,000 for the comparable 2019 periods.quarter ended March 31, 2020. The decrease for the three month period is primarilyresults from lower interest income due to lower interest rates in the 2020 period.partially offset by higher cash and notes receivable balances.

Income Taxes– Our effective tax ratesrate for the three and six monthsquarter ended June 30, 2020 were 19.3 percent and 22.5 percentMarch 31, 2021, was 26.1% compared to an effective tax ratesrate of 22.7 percent and 23.4 percent28.5% for the respective periodsquarter ended March 31, 2020. The lower effective tax rate is due to a valuation allowance on investment losses recorded in 2019.the first quarter of 2020 that did not recur in the first quarter of 2021.

Liquidity and Capital Resources

Our cash balance at June 30, 2020,March 31, 2021 was $32,316,000$31,001,000 compared to $26,415,000$37,956,000 at December 31, 2019.2020. During the six monthsquarter ended June 30, 2020,March 31, 2021, cash provided byused for operations was $9,714,000$2,326,000 compared to cash provided by operations of $5,954,000$5,693,000 for the six monthsquarter ended June 30, 2019.March 31, 2020. The increasedecrease is primarily due to higherlower deferred revenue and lowerbalances, a decrease in cash held for program management funding, higher accounts receivable balances, and a non-cash impairment charge,losses in 2020 that did not recur in 2021, partially offset by lower net income and lower accrued payroll.higher depreciation. In addition, we advanced $550,000 and $1,000,000 on a Promissory NoteNotes for the three months ended March 31, 2021 and 2020, respectively, which is described in more detail in Note 3 to the Consolidated Financial Statements.

We used $2,767,000$1,496,000 of cash to acquire computer equipment primarily for the technical resources added in our India office and to upgradecontinued investments in our existing processing environment in the U.S.

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 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. Additionally, in November 2018, our Board of Directors authorized a share repurchase program of $5 million. We made share repurchases of $2.7 million in the first quarter of 2021, and we made no share repurchases in the first quarter of 2020.  At March 31, 2021, approximately $649,000 was authorized for future repurchases of our common stock. In April 2021, the Board authorized an additional $10 million for our share repurchase program.

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 six monththree-month period ended June 30, 2020,March 31, 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:

Item 3.4. 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 1. Legal Proceedings

On or about July 9, 2019, a securities class action complaint was filed in the United States District Court for the Eastern District of New York (Case No. 1:19-cv-03949) by Michael Skrzeczkoski, individually and on behalf of all others similarly situated, against the company, and certain current and former directors and officers. The complaint alleges, among other things, that certain of our press releases and SEC filings were misleading as a result of the failure to disclose alleged related party transactions affecting revenue recognition and the absence of disclosure regarding certain allegations against former director Parker H. Petit in connection with his former position with MiMedx, Inc. The complaint seeks to recover attorney’s fees and costs and unspecified damages on behalf of purchasers who acquired our stock during the period from January 23, 2019, through May 29, 2019, and purportedly suffered financial harm as a result of the alleged misleading statements. On September 26, 2019, the Court appointed Edgardo Canez as lead plaintiff (“Lead Plaintiff”) on behalf of the putative class. On November 18, 2019, Lead Plaintiff, individually and on behalf of a putative class of persons or entities who purchased or otherwise acquired publicly traded company securities from May 23, 2014 through May 29, 2019, filed an amended class action complaint against the company, and certain current and former directors and officers (the “Amended Complaint”). The Amended Complaint alleges similar allegations in violation of Sections 10(b) and 20(a) of the Securities Exchange Act as the previously filed complaint. The Amended Complaint seeks to recover attorney’s fees and costs and unspecified damages. On January 2, 2020, Defendants submitted a motion to dismiss, and on March 3, 2020, briefing on the motion to dismiss was completed. TheOn April 6, 2021, the Court entered an order granting the motion to dismiss is currently pending. We dispute these claims and intend to defend the matter vigorously.dismiss. 

On or about February 14, 2020, two purported shareholders, derivatively and on behalf of the Company, filed substantially similar shareholder derivative actions in the Eastern District of New York against certain current and former directors and officers (the “Individual Defendants”), and the Company as a nominal defendant (together with the Individual Defendants, the “Defendants”). The complaints assert a claim against Messrs. Strange, Moise, Petit, Fuzzell and Chandler for a violation of Section 14(a) of the Securities Exchange Act by issuing purportedly misleading statements in the Company’s 2017 and 2018 Proxies.  The complaints also assert claims against the Individual Defendants for breaches of fiduciary duty, waste of corporate assets, and unjust enrichment arising out of, among other things, purportedly undisclosed related party transactions, other relationships, and certain allegations against former director Parker H. Petit in connection with his former position with MiMedx, Inc. and other companies. The relief sought in the complaints includes changes to the Company’s corporate governance procedures, unspecified damages, equitable relief, restitution, and attorney’s fees and costs.  On April 20, 2020, the two derivative actions were consolidated and captioned, In re Intelligent Systems Corporation StockholderDerivative Litigation, Lead Case No. 1:20-cv-00832, in the Eastern District of New York.York (the “Derivative Matter”).  On June 19, 2020, Defendants filed their motion to dismiss. Plaintiffs’ opposition todismiss, and briefing was subsequently completed.  After a conference held on August 24, 2020, the parties agreed that Defendants’ motion to dismiss is currently duewould be temporarily withdrawn without prejudice to refile after the conclusion of any discovery permitted by August 18,further Court order. On September 8, 2020, Plaintiffs moved for leave to conduct limited discovery (“Plaintiffs’ Motion for Discovery”). On December 23, 2020, the Court entered a stipulation among the parties whereby Plaintiffs’ Motion for Discovery shall be withdrawn, the Company will engage in limited discovery, and Defendants’ reply brief in further supportthe parties agree that the Derivative Matter shall be stayed pending resolution of the motion to dismiss in the related above-mentioned securities litigation matter, among other things. The matter is due by September 28, 2020.currently stayed.    

For information regarding our accounting for legal contingencies, see Note 89 of the Notes to Consolidated Financial Statements in this Form 10-Q.

Item 4. Controls2. Unregistered Sales of Equity Securities and ProceduresUse of Proceeds

EvaluationRepurchases of Disclosure Control Over Financial ReportingSecurities

AsThe following table sets forth information regarding our purchases of shares of our common stock during the endthree months ended March 31, 2021:

¹ This price includes per share commissions paid.

² Our stock repurchase program, which was initially announced in November 2018, allows for the repurchase of up to a total of $5 million of our common stock, of which $4.35 million has been utilized. In April 2021, the period covered byBoard authorized an additional $10 million for our share repurchase program. Under this report, the company carried out an evaluation,publicly announced program, we are authorized to repurchase shares through open market purchases, privately-negotiated transactions or otherwise in accordance with applicable federal securities laws, including through Rule 10b5-1 trading plans and under the supervision and with the participationRule 10b-18 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 OfficerThe repurchase program does not have an expiration date and Chief Financial Officer concluded that the company’s disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There were no significant changes in the company’s internal control over financial reportingmay be suspended 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.discontinued at any time.

Part II. OTHER INFORMATION

Item 6.6. Exhibits

The following exhibits are filed or furnished with this report:

SignaturesSIGNATURES

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 IndexEXHIBIT INDEX