##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2010
 OR
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 1-9330
 INTELLIGENT SYSTEMS CORPORATION
  Georgia
    
    58-1964787(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)4355 Shackleford Road, Norcross, Georgia
    
    30093(Address of principal executive offices)
    
    (Zip Code)
 (770) 381-2900
 Yes þ No o
 Yes
o No o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ(Do not check if a smaller 
reporting company)
 Yes o No þ




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##### 



Intelligent Systems Corporation
 Index
Form 10-Q
 PagePart I Financial InformationItem 1 Financial StatementsConsolidated Balance Sheets at June 30, 2010 and December 31, 2009
    
    
    3Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009
    
    
    4Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 4 Controls and Procedures
    
    
    14Part II Other InformationItem 1 Legal Proceedings
    
    
    14Item 5 Exhibits
    
    
    15Signatures
    
    
    15Ex. 10.1 Ninth Modification to Loan DocumentsEx. 31.1 Section 302 Certification of Chief Executive OfficerEx. 31.2 Section 302 Certification of Chief Financial OfficerEx. 32.1 Section 906 Certification of Chief Executive Officer and Chief Financial Officer
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Part I FINANCIAL INFORMATION
 
 Item 1.
    
    Financial Statements
 Intelligent Systems Corporation
 
 CONSOLIDATED BALANCE SHEETS  (in thousands, except share amounts)
 June 30,
    
    
    December 31,2010
    
    
    2009(unaudited)ASSETSCurrent assets:Cash
    
    $
    2,400
    
    
    $
    2,795Accounts receivable, net
    
    
    2,380
    
    
    
    1,680Notes and interest receivable, current portion
    
    
    983
    
    
    
    492Inventories, net
    
    
    773
    
    
    
    964Other current assets
    
    
    180
    
    
    
    399Total current assets
    
    
    6,716
    
    
    
    6,330Long-term investments
    
    
    1,196
    
    
    
    1,219Notes and interest receivable, net of current portion
    
    
    554
    
    
    
    1,006Property and equipment, at cost less accumulated depreciation
    
    
    1,271
    
    
    
    1,256Patents, net
    
    
    200
    
    
    
    223Total assets
    
    $
    9,937
    
    
    $
    10,034LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    624
    
    
    $
    576Deferred revenue
    
    
    720
    
    
    
    1,355Accrued payroll
    
    
    433
    
    
    
    423Accrued expenses
    
    
    682
    
    
    
    565Other current liabilities
    
    
    351
    
    
    
    406Total current liabilities
    
    
    2,810
    
    
    
    3,325Long-term liabilities
    
    
    110
    
    
    
    100Commitments and contingencies (Note 8)Intelligent Systems Corporation stockholders equity:Common stock, $0.01 par value, 20,000,000 shares
authorized, 8,958,028 shares
issued and outstanding at June 30, 2010 and December 31, 2009
    
    
    90
    
    
    
    90Additional paid-in capital
    
    
    21,415
    
    
    
    21,410Accumulated other comprehensive loss
    
    
    (8
    )
    
    
    (28
    )Accumulated deficit
    
    
    (15,996
    )
    
    
    (16,379
    )Total Intelligent Systems Corporation stockholders equity
    
    
    5,501
    
    
    
    5,093Non-controlling interest
    
    
    1,516
    
    
    
    1,516Total stockholders equity
    
    
    7,017
    
    
    
    6,609Total liabilities and stockholders equity
    
    $
    9,937
    
    
    $
    10,034
 The accompanying notes are an integral part of these Consolidated Financial Statements.
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Intelligent Systems Corporation
 
 CONSOLIDATED STATEMENTS OF OPERATIONS  (unaudited; in thousands, except share and per share amounts)
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009RevenueProducts
    
    $
    3,764
    
    
    $
    2,583
    
    
    $
    7,111
    
    
    $
    5,068Services
    
    
    844
    
    
    
    540
    
    
    
    1,194
    
    
    
    843Total revenue
    
    
    4,608
    
    
    
    3,123
    
    
    
    8,305
    
    
    
    5,911Cost of revenueProducts
    
    
    2,159
    
    
    
    1,351
    
    
    
    3,868
    
    
    
    2,668Services
    
    
    387
    
    
    
    247
    
    
    
    560
    
    
    
    542Total cost of revenue
    
    
    2,546
    
    
    
    1,598
    
    
    
    4,428
    
    
    
    3,210ExpensesMarketing
    
    
    553
    
    
    
    456
    
    
    
    1,119
    
    
    
    900General & administrative
    
    
    672
    
    
    
    766
    
    
    
    1,397
    
    
    
    1,690Research & development
    
    
    492
    
    
    
    506
    
    
    
    929
    
    
    
    1,010Income (loss) from operations
    
    
    345
    
    
    
    (203
    )
    
    
    432
    
    
    
    (899
    )Other income (expense)Interest income, net
    
    
    17
    
    
    
    16
    
    
    
    44
    
    
    
    31Equity in income (loss) of affiliate company
    
    
    (10
    )
    
    
    12
    
    
    
    (22
    )
    
    
    19Other income
    
    
    7
    
    
    
    
    
    
    
    13
    
    
    
    13Income (loss) before income taxes
    
    
    359
    
    
    
    (175
    )
    
    
    467
    
    
    
    (836
    )Income taxes
    
    
    61
    
    
    
    2
    
    
    
    84
    
    
    
    3Net income (loss)
    
    $
    298
    
    
    $
    (177
    )
    
    $
    383
    
    
    $
    (839
    )Income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    (0.04
    )
    
    $
    0.04
    
    
    $
    (0.19
    )Diluted
    
    $
    0.03
    
    
    $
    (0.04
    )
    
    $
    0.04
    
    
    $
    (0.19
    )Basic weighted average common shares
outstanding
    
    
    8,958,028
    
    
    
    4,478,971
    
    
    
    8,958,028
    
    
    
    4,478,971Diluted weighted average common shares
outstanding
    
    
    8,962,735
    
    
    
    4,478,971
    
    
    
    8,962,493
    
    
    
    4,478,971
 The accompanying notes are an integral part of these Consolidated Financial Statements.
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Intelligent Systems Corporation
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  (unaudited, in thousands)
 Six Months Ended June 30,CASH PROVIDED BY (USED FOR):
    
    2010
    
    
    2009OPERATIONS:Net income (loss)
    
    $
    383
    
    
    $
    (839
    )Adjustments to reconcile net income (loss) to net cash used for operating activities:Depreciation and amortization
    
    
    234
    
    
    
    270Stock-based compensation expense
    
    
    5
    
    
    
    6Non-cash interest income, net
    
    
    (36
    )
    
    
    (36
    )Equity in (income) loss of affiliate company
    
    
    22
    
    
    
    (19
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    (700
    )
    
    
    (294
    )Inventories
    
    
    192
    
    
    
    251Other current assets
    
    
    219
    
    
    
    (165
    )Accounts payable
    
    
    48
    
    
    
    (20
    )Deferred revenue
    
    
    (635
    )
    
    
    308Accrued payroll
    
    
    10
    
    
    
    (105
    )Accrued expenses and other current liabilities
    
    
    182
    
    
    
    96Net cash used for operating activities
    
    
    (76
    )
    
    
    (547
    )INVESTING ACTIVITIES:Proceeds from notes and interest receivable
    
    
    2
    
    
    
    263Purchases of property and equipment
    
    
    (226
    )
    
    
    (64
    )Net cash provided by (used for) investing activities
    
    
    (224
    )
    
    
    199FINANCING ACTIVITIES:Borrowings under line of credit
    
    
    
    
    
    
    335Repayments made under line of credit
    
    
    
    
    
    
    (223
    )Payments on notes payable
    
    
    (116
    )
    
    
    (49
    )Net cash provided by (used for) financing activities
    
    
    (116
    )
    
    
    63Effects of exchange rate changes on cash
    
    
    21
    
    
    
    6Net decrease in cash
    
    
    (394
    )
    
    
    (279
    )Cash at beginning of period
    
    
    2,795
    
    
    
    1,074Cash at end of period
    
    $
    2,400
    
    
    $
    795SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    3
    
    
    $
    22Cash paid during the period for income taxes
    
    $
    25
    
    
    $
    2
 The accompanying notes are an integral part of these Consolidated Financial Statements.
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Intelligent Systems Corporation
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (unaudited)
 1.

    
    Throughout this report, the terms we, us, ours, ISC and company refer to
Intelligent Systems Corporation, including its wholly-owned and majority-owned subsidiaries.
 2.

    
    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, 2010 and
2009. The interim results for the three and six months ended June 30, 2010 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, 2009, as filed in our Annual Report on Form 10-K.
 3.

    
    Comprehensive Income (Loss) Comprehensive income (loss) is the total of net income (loss)
and all other non-owner changes in equity in a period. A summary follows:
 Consolidated Statements ofComprehensive Loss
    
    Three Months Ended June 30,
    
    
    Six Months Ended June 30,(unaudited, in thousands)
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009Net income (loss)
    
    $
    298
    
    
    $
    (177
    )
    
    $
    383
    
    
    $
    (839
    )Other comprehensive income:Foreign currency
translation adjustment
    
    
    4
    
    
    
    19
    
    
    
    20
    
    
    
    6Comprehensive income (loss)
    
    $
    302
    
    
    $
    (158
    )
    
    $
    403
    
    
    $
    (833
    )
 4.

    
    Stock-based Compensation At June 30, 2010, we have two stock-based compensation
plans in effect. We record compensation cost related to unvested stock awards by recognizing
the unamortized grant date fair value 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. We recorded $2,000 and $3,000
of stock-based compensation expense in the three months ended June 30, 2010 and 2009,
respectively and $5,000 and $6,000 for the six month periods ended June 30, 2010 and 2009,
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, 2010, there is $12,000 of unrecognized compensation cost related to stock
options. During the quarter ended June 30, 2010, 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 during the three and six month periods ended June 30, 2010. During the quarter ended
June 30, 2010, 11,000 employee options expired unexercised. The following table summarizes
options as of June 30, 2010:
 Wgt AvgRemaining
    
    
    AggregateWgt Avg
    
    
    Contractual Life
    
    
    Intrinsic# of Shares
    
    
    Exercise Price
    
    
    in Years
    
    
    ValueOutstanding at June 30, 2010
    
    
    234,000
    
    
    $
    2.22
    
    
    
    3.7
    
    
    $
    7,440Vested and exercisable at June 30, 2010
    
    
    216,000
    
    
    $
    2.32
    
    
    
    3.2
    
    
    $
    3,360
 The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value
(the difference between the companys closing stock price on the last trading day of the second
quarter of 2010 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
June 30, 2010. The amount of aggregate intrinsic value will change based on the fair market
value of the companys stock.
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5.

    
    Fair Value of Financial Instruments The carrying value of cash, accounts receivable,
accounts payable and certain other financial instruments (such as short-term borrowings,
accrued expenses, and other current liabilities) included in the accompanying consolidated
balance sheets approximates their fair value principally due to the short-term maturity of
these instruments. The carrying value of non-interest bearing notes receivable beyond one
year have been discounted at a rate of 6% which approximates rates offered in the market for
notes receivable with similar terms and conditions. The fair value of equity method and cost
method investments has not been determined as it was impracticable to do so.
 Financial instruments that potentially subject us to concentrations of credit risk consist
principally of cash, trade accounts and notes receivable. Our available cash is held in
accounts managed by third-party financial institutions. Cash may exceed the Federal Deposit
Insurance Corporation, or FDIC, insurance limits. While we monitor cash balances on a regular
basis and adjust the balances as appropriate, these balances could be impacted if the underlying
financial institutions fail. To date, we have experienced no loss or lack of access to our cash;
however, we can provide no assurances that access to our cash will not be impacted by adverse
conditions in the financial markets.
 6.

    
    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.
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,(unaudited)
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009ChemFree Customer A
    
    
    28
    %
    
    
    33
    %
    
    
    31
    %
    
    
    34
    %ChemFree Customer B
    
    
    13
    %
    
    
    12
    %
    
    
    13
    %
    
    
    13
    %ChemFree Customer C
    
    
    
    
    
    
    11
    %
    
    
    
    
    
    
    12
    %CoreCard Customer D
    
    
    11
    %
    
    
    
    
    
    
    
    
    
    
    
 7.

    
    Short-term Borrowings On June 28, 2010, 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 6.5% (6.5% at June 30, 2010), is secured by all assets of the
company and our principal subsidiaries, is guaranteed by our subsidiaries, and expires June
30, 2011. 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, 2010, our borrowing base calculation resulted in availability of $1,250,000, of which
we had drawn down $0. 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 include a covenant requiring the company to maintain a
minimum tangible net worth as defined in the loan agreement at the end of each calendar
quarter during the loan term.
 8.
    
    Commitments and Contingencies Please refer to Note 7 in the Consolidated Financial
Statements included in our 2009 Form 10-K for a description of our commitments and
contingencies in addition to those disclosed here.
 Legal Matters  In December 2004, our ChemFree subsidiary filed a patent infringement
action against J. Walter Co. Ltd. and J. Walter, Inc. (J. Walter) in the United States Court
for the Northern District of Georgia. The complaint alleged that certain of the defendants
products infringed four U.S. patents held by ChemFree and sought a ruling to compel the
defendants to cease their infringing activities. The defendants asserted various defenses. The
trial took place during the week of July 13, 2009. On June 18, 2010, the judge issued his
Findings of Fact and Conclusions of Law which found (i) that certain of J. Walters products did
infringe on ChemFrees four patents-in-suit; (ii) in ChemFrees favor on the issue of the
patents named co-inventors and (iii) in J. Walters favor on the issue of invalidity of the
four patents-in-suit for obviousness. In his ruling on invalidity of four of ChemFrees
patents due to obviousness, the judge relied heavily on a 2007 U.S. Supreme Court ruling (issued
more than three years after ChemFrees lawsuit was filed) which modified the manner for
determining obviousness of a patent by replacing the long-standing rigid application of the
teaching, suggestion or motivation test for determining obviousness with an expansive and
flexible approach. On July 6, 2010, ChemFree filed a Motion for Reconsideration of the judges
findings and conclusions followed on July 23, 2010, by the filing of a Second Motion for
Additional Findings and Conclusions. Depending upon the outcome of these additional filings and
the judges final order in the case, ChemFree will have a number of options to consider which
could include but are not limited to an appeal. The timing of the final outcome of this matter
is not predictable with any degree of certainty.
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As previously disclosed, IBS Technics, the company that acquired certain assets and the
operations of our VISaer subsidiary in April 2008, has alleged a breach of certain
representations and warranties in the Asset Purchase Agreement (APA). On April 15, 2010, we
received a claim from IBS Technics seeking indemnification under the APA in the amount of
approximately $2.6 million. We replied to their notice, disputing their allegations. On June
17, 2010, we notified IBS Technics that they had failed to make a guaranteed earnout payment of
$500,000 due on June 15, 2010 in accordance with the terms of the APA. If we cannot agree on a
mutually acceptable resolution to these matters, it is possible that it will proceed to binding
arbitration as required under the APA. Given the status of the matter and our belief that we
have reasonable grounds to refute IBS Technics allegations and prevail in any litigation,
presently we have not taken a reserve against the amount receivable from IBS Technics. If the
matter is taken to arbitration or other legal proceedings, it is at least reasonably possible
that the amount of the receivable could be reduced.
 Except as noted above, other commitments and contingencies described in Note 7 to our
Consolidated Financial Statements included in our 2009 Form 10-K are unchanged.
 9.

    
    Industry Segments Segment information is presented consistently with the basis described in
our 2009 Form 10-K. The following table contains segment information for continuing
operations for the three and six months ended June 30, 2010 and 2009.
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,(unaudited, in thousands)
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009Information TechnologyRevenue
    
    $
    1,376
    
    
    $
    566
    
    
    $
    1,938
    
    
    $
    910Operating loss
    
    
    (41
    )
    
    
    (267
    )
    
    
    (318
    )
    
    
    (846
    )Industrial ProductsRevenue
    
    
    3,232
    
    
    
    2,557
    
    
    
    6,367
    
    
    
    5,001Operating income
    
    
    641
    
    
    
    332
    
    
    
    1,311
    
    
    
    587Consolidated SegmentsRevenue
    
    
    4,608
    
    
    
    3,123
    
    
    
    8,305
    
    
    
    5,911Operating income
    
    
    600
    
    
    
    65
    
    
    
    993
    
    
    
    (260
    )Corporate expenses
    
    
    (255
    )
    
    
    (268
    )
    
    
    (561
    )
    
    
    (639
    )Consolidated operating income ( loss)
    
    $
    345
    
    
    $
    (203
    )
    
    $
    (432
    )
    
    $
    (899
    )Depreciation and AmortizationInformation Technology
    
    $
    1
    
    
    $
    28
    
    
    $
    24
    
    
    $
    29Industrial Products
    
    
    100
    
    
    
    114
    
    
    
    202
    
    
    
    232Consolidated segments
    
    
    101
    
    
    
    142
    
    
    
    226
    
    
    
    261Corporate
    
    
    4
    
    
    
    4
    
    
    
    8
    
    
    
    9Consolidated
depreciation and amortization
    
    $
    105
    
    
    $
    146
    
    
    $
    234
    
    
    $
    270Capital ExpendituresInformation Technology
    
    $
    59
    
    
    $
    69
    
    
    $
    158
    
    
    $
    47Industrial Products
    
    
    36
    
    
    
    10
    
    
    
    67
    
    
    
    13Consolidated segments
    
    
    95
    
    
    
    79
    
    
    
    225
    
    
    
    60Corporate
    
    
    
    
    
    
    3
    
    
    
    1
    
    
    
    4Consolidated capital expenditures
    
    $
    95
    
    
    $
    82
    
    
    $
    226
    
    
    $
    64
 (unaudited, in thousands)
    
    June 30, 2010
    
    
    December 31, 2009Identifiable AssetsInformation Technology
    
    $
    2,874
    
    
    $
    2,693Industrial Products
    
    
    5,192
    
    
    
    3,824Consolidated segments
    
    
    8,066
    
    
    
    6,517Corporate
    
    
    1,871
    
    
    
    3,517Consolidated assets
    
    $
    9,937
    
    
    $
    10,034
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10.

    
    Income Taxes As of June 30, 2010, the company has recorded a liability of $65,000 in
connection with unrecognized tax benefits related to uncertain tax positions. The liability
includes $8,622 of interest and penalties. As of June 30, 2010, management expects some
incremental but not significant changes in the balance of unrecognized tax benefits over the
next twelve months.
 Our policy is to recognize accrued interest related to uncertain tax positions in interest
expense and related penalties, if applicable, in general and administrative expense. During the
three and six months ended June 30, 2010, we recognized $4,113 in interest expense and $4,509 in
penalties related to the uncertain tax positions. No interest or penalties were recognized in
2009.
 We file a consolidated U.S. federal income tax return for all subsidiaries in which our
ownership exceeds 80 percent, as well as individual subsidiary returns in various states and
foreign jurisdictions. For periods prior to April 15, 2008, our VISaer subsidiary filed a
separate U.S. federal income tax return. With few exceptions we are no longer subject to U.S.
federal, state and local or foreign income tax examinations by taxing authorities for years
before 2005.
 11.

    
    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. The
company sold 4,479,014 new shares of common stock and received gross proceeds of $3,135,310,
less expenses related to the transaction of $149,000, from the rights offering. Giving effect
to the rights offering, we have 8,958,028 shares of common stock outstanding as of June 30,
2010.
 12.

    
    Recent Accounting Pronouncements In October 2009, the Financial Accounting Standards Board
(FASB) issued accounting guidance which amends the criteria for allocating a contracts
consideration to individual services or products in multiple-deliverable arrangements. The
guidance establishes a selling price hierarchy for determining the selling price of a
deliverable, which includes: (1) vendor-specific objective evidence if available, (2)
third-party evidence if vendor-specific evidence is not available, and (3) estimated selling
price if neither vendor-specific nor third-party evidence is available. This guidance is
effective for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010 (January 1, 2011 for us), and we are currently evaluating
the potential impact, if any, on our Consolidated Financial Statements.
 We have considered all other recently issued accounting pronouncements and do not believe the
adoption of such pronouncements will have a material impact on our Consolidated Financial
Statements.
 13.

    
    Subsequent Events We evaluated subsequent events through August 13, 2010 when these
financial statements were issued. Except as otherwise disclosed in this report, we are not
aware of any significant events that occurred subsequent to the balance sheet date but prior
to the filing of this report that would have a material impact on our Consolidated Financial
Statements.
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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-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s
familiarity with the information contained in Item 6. Managements Discussion and Analysis of
Financial Condition and Results of Operations, in the Form 10-K for the year ended December 31,
2009 as filed with the Securities and Exchange Commission.
 Overview
   
    
    A change in revenue level at one of our subsidiaries may 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.
    
    In the Information Technology sector, revenue in a given period may consist of a
relatively small number of contracts. Consequently, even small delays in a delivery under a
software contract (which may be out of our control) could have an unpredictable impact on
consolidated revenue that is recognized in a given quarterly or annual period.
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Results of Operations
  Revenue
 
    
    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 $3.8 million in the three month period ended June 30, 2010, a 46
percent increase compared to the three month period ended June 30, 2009. Product revenue
increased by 40 percent to $7.1 million in the six month period ended June 30, 2010 compared
to the first six months of 2009. The period to period increases reflect stronger sales of
ChemFrees SmartWasher® parts washer in both the domestic and international markets due to
increased demand as the economy recovers as well as new sales programs. Fluid and filter
consumables in both domestic and international markets increased in the three and six month
periods ended June 30, 2010 compared to the same periods in 2009. The increase reflects in
part an increasing base of new and existing users of the SmartWasher® part washers and, in
part, increased availability in 2010 of fluid for the European market following a transition
to a new fluid processing facility that took place during the second quarter of 2009 (during
which time fluid supplies were limited). Software license revenue associated with the
Information Technology segment increased significantly in both the three and six month periods
ended June 30, 2010 compared to the respective periods in 2009 and represented over ten
percent of product sales in each period in 2010. We recognize software license revenue
generally upon completion of each contract and acceptance by customers. Second quarter and
year-to-date software revenue in 2010 was bolstered by the completion and recognition of a
software contract that contributed almost $500,000 in revenue.
 
    
    Service revenue associated with the Information Technology segment was $844,000 and
$1,194,000 in the three and six months ended June 30, 2010, representing increases of 56
percent and 42 percent compared to the respective periods in 2009. 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.
 Cost of Revenue
 
    
    Cost of product revenue was 57 percent and 54 percent of product revenue in the three
and six months ended June 30, 2010, respectively compared to costs of 52 percent and 53
percent of product revenue in the respective periods in 2009. In 2010, sales of ChemFrees
SmartWasher® machines, which have a higher cost of sales compared to higher margin fluid
and filters, increased and represented a larger percentage of product revenue in both the
quarter and year-to-date periods of 2010 than in the comparable periods in 2009. As a
result, while both sales and gross profit dollars increased in 2010, the gross margin
percentage declined slightly due to the change in ChemFree product mix. In addition, the
increase in license revenue at CoreCard in both the three and six month periods ended June
30, 2010 was accompanied by an increase in cost associated with bringing new software
implementations successfully to completion (which included CoreCards first international
customer and first major conversion customer).
    
    Cost of service revenue (which relates to our CoreCard business only) was 46 percent and
47 percent of service revenue in the three and six month periods ended June 30, 2010 as
compared to 46 percent and 64 percent of service revenue in 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 cost to
provide annual maintenance and support services as a percentage of service revenue has
declined as CoreCards installed base of customers with maintenance contracts has
increased, since certain costs are spread across a larger maintenance revenue base. The
cost and gross margins on professional services revenue are tied to specific projects and
will vary depending on the specific project requirements and complexity as well as the mix
of our U.S. and offshore employees working on the project. CoreCard is providing a high
level of support to its customers for both maintenance and professional services activities
to ensure it builds a solid base of reference customers and puts in place an infrastructure
for future growth.
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Operating Expenses
 Interest Income, net
 Equity in Income (Loss) of Affiliate Company
 Income Taxes
 Liquidity and Capital Resources
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Off-Balance Sheet Arrangements
  Critical Accounting Policies and Estimates
 Form 10-K
 Factors That May Affect Future Operations
   
    
    Weakness 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.
 
    
    Stricter regulations and 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.
 
    
    Delays in software development projects could cause our customers to delay implementations
or delay payments, which would increase our costs and reduce our revenue.
 
    
    It is unclear whether the recent activity in the legal action described in Note 8 to the
Consolidated Financial Statements will have any impact on our ChemFree subsidiary in the
foreseeable future but there is at least a reasonable possibility that a finding of invalidity
of certain of ChemFrees patents could increase competition in the marketplace and result in
greater price pressure and lower margins, thus potentially impacting sales, profits and
projected cash flows.
 
    
    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.
 
    
    As an alternative to licensing its software, CoreCard is now offering outsourced processing
services running on the CoreCard software system. There are numerous risks associated with
entering any new line of business and if CoreCard fails to manage the risks associated with
its processing operations, it could have a negative impact on our business.
 
    
    One of ChemFrees customers represented 31 percent of our consolidated revenue in the first
half of 2010 and any unplanned changes in the volume of orders or timeliness of payments from
such customer could have a negative impact on inventory levels and cash, at least in the
near-term.
 
    
    Delays in production or shortages of certain sole-sourced parts for our ChemFree products
could impact revenue and orders. The company has experienced some ongoing difficulty securing
acceptable quality of one plastic part that impacts one of its specialty product models and
expects it will take a number of months to improve the situation.
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
    
    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.
 
    
    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).
 
    
    Increasing government regulation in the United States and foreign countries related to such
issues as data privacy, financial and credit transactions could require changes to our
products and services and could affect our existing customer relationships or prevent us from
getting new customers.
 
    
    CoreCard could fail to expand its base of customers as quickly as anticipated, resulting in
lower revenue and profits (or increased losses) and increased cash needs.
 
    
    In certain situations, ChemFrees 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.
 
    
    Failure to meet the continued listing standards of NYSE Amex could result in delisting of
our common stock, with a potentially negative impact on the market price and liquidity of our
common stock.
 
    
    Other general economic and political conditions could cause customers to delay or cancel
software purchases.
 
 Item 4.
    
    Controls and Procedures
  
 Part II. OTHER INFORMATION
 
 Item 1.
    
    Legal Proceedings
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Item 5.
    
    Exhibits
  3.1
    
    
    Amended and Restated Articles of Incorporation of the Registrant dated March 18, 2010.
(Incorporated by reference to Exhibit 3.(1) to the Registrants Annual Report on Form 10-K for
the year ended December 31, 2009.)3.2
    
    
    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.)10.1
    
    
    Ninth Modification to Loan Documents by and among Intelligent Systems Corporation and
Fidelity Bank dated June 28, 2010.31.1
    
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    
    Certification of Chief Executive Officer and Chief Financial Officer furnished as required by
Section 906 of the Sarbanes-Oxley Act of 2002.
 
 SIGNATURES
  INTELLIGENT SYSTEMS CORPORATION
RegistrantDate:  August 13, 2010
    By:
    
    /s/J. Leland StrangeJ. Leland StrangeChief Executive Officer, PresidentDate:  August 13, 2010
    By:
    
    /s/Bonnie L. HerronBonnie L. HerronChief Financial Officer  Page 15




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EXHIBIT INDEX
 ExhibitNo.
    
    Descriptions3.1
    
    
    Amended and Restated Articles of Incorporation of the Registrant dated March 18, 2010.
(Incorporated by reference to Exhibit 3.(1) to the Registrants Annual Report on Form 10-K for the
year ended December 31, 2009.)3.2
    
    
    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.)10.1
    
    
    Ninth Modification to Loan Documents by and among Intelligent Systems Corporation and Fidelity Bank
dated June 28, 2010.31.1
    
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    Certification of Chief Executive Officer and Chief Financial Officer furnished as required by
Section 906 of the Sarbanes-Oxley Act of 2002.
  Page 16