##### 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 September 30, 2008
 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
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ
 o þ




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##### 



Intelligent Systems Corporation
 Index
Form 10-Q
 PagePart I Financial InformationItem 1 Financial StatementsConsolidated Balance Sheets at September 30, 2008 and December 31, 2007
    
    
    3Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007
    
    
    4Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007
    
    
    5Notes to Consolidated Financial Statements
    
    
    7Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 4 Controls and Procedures
    
    
    16Part II Other InformationItem 1 Legal Proceedings
    
    
    16Item 6 Exhibits
    
    
    16Signatures
    
    
    17Ex. 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)
 September 30,
    
    
    December 31,2008
    
    
    2007(unaudited)ASSETSCurrent assets:Cash
    
    $
    674
    
    
    $
    554Accounts receivable, net
    
    
    2,370
    
    
    
    2,139Notes and interest receivable, current portion
    
    
    481
    
    
    
    540Inventories
    
    
    1,248
    
    
    
    1,424Other current assets
    
    
    711
    
    
    
    2,217Total current assets
    
    
    5,484
    
    
    
    6,874Long-term investments
    
    
    1,246
    
    
    
    1,127Notes and interest receivable, net of current portion
    
    
    1,298
    
    
    
    350Property and equipment, at cost less accumulated depreciation
    
    
    1,660
    
    
    
    1,894Goodwill
    
    
    369
    
    
    
    2,047Other intangibles, net
    
    
    279
    
    
    
    313Other assets
    
    
    
    
    
    
    17Total assets
    
    $
    10,336
    
    
    $
    12,622LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Line of credit
    
    $
    343
    
    
    $
    593Note payable, current portion
    
    
    97
    
    
    
    Accounts payable
    
    
    975
    
    
    
    1,482Deferred revenue
    
    
    2,336
    
    
    
    2,527Accrued payroll
    
    
    757
    
    
    
    1,162Accrued expenses and other current liabilities
    
    
    1,001
    
    
    
    1,235Total current liabilities
    
    
    5,509
    
    
    
    6,999Long-term liabilities
    
    
    272
    
    
    
    95Commitments and contingencies (Note 8)Minority interest
    
    
    1,516
    
    
    
    1,516Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 shares
issued and outstanding at September 30, 2008 and December 31, 2007
    
    
    45
    
    
    
    45Additional paid-in capital
    
    
    18,452
    
    
    
    18,437Accumulated other comprehensive loss
    
    
    (194
    )
    
    
    (127
    )Accumulated deficit
    
    
    (15,264
    )
    
    
    (14,343
    )Total stockholders equity
    
    
    3,039
    
    
    
    4,012Total liabilities and stockholders equity
    
    $
    10,336
    
    
    $
    12,622
 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
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007RevenueProducts
    
    $
    2,884
    
    
    $
    4,657
    
    
    $
    10,275
    
    
    $
    10,315Services
    
    
    305
    
    
    
    149
    
    
    
    709
    
    
    
    798Total revenue
    
    
    3,189
    
    
    
    4,806
    
    
    
    10,984
    
    
    
    11,113Cost of revenueProducts
    
    
    1,573
    
    
    
    2,673
    
    
    
    5,582
    
    
    
    5,239Services
    
    
    185
    
    
    
    170
    
    
    
    606
    
    
    
    650Total cost of revenue
    
    
    1,758
    
    
    
    2,843
    
    
    
    6,188
    
    
    
    5,889ExpensesMarketing
    
    
    620
    
    
    
    978
    
    
    
    2,158
    
    
    
    1,843General & administrative
    
    
    907
    
    
    
    1,019
    
    
    
    3,429
    
    
    
    2,690Research & development
    
    
    902
    
    
    
    847
    
    
    
    2,615
    
    
    
    2,459Loss from operations
    
    
    (998
    )
    
    
    (881
    )
    
    
    (3,406
    )
    
    
    (1,768
    )Other income (expense)Interest income (expense), net
    
    
    5
    
    
    
    39
    
    
    
    (4
    )
    
    
    152Investment income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81Equity in income of affiliate companies
    
    
    21
    
    
    
    6
    
    
    
    74
    
    
    
    48Other expense
    
    
    (1
    )
    
    
    (28
    )
    
    
    (1
    )
    
    
    (34
    )Loss from continuing operations before income taxes
    
    
    (973
    )
    
    
    (864
    )
    
    
    (3,337
    )
    
    
    (1,521
    )Income taxes
    
    
    12
    
    
    
    4
    
    
    
    29
    
    
    
    4Loss from continuing operations
    
    
    (985
    )
    
    
    (868
    )
    
    
    (3,366
    )
    
    
    (1,525
    )Income (loss) from discontinued operations
    
    
    7
    
    
    
    (114
    )
    
    
    (439
    )
    
    
    (609
    )Gain on sale of discontinued operations, no tax effect
    
    
    
    
    
    
    
    
    
    
    2,884
    
    
    
    97Net loss
    
    $
    (978
    )
    
    $
    (982
    )
    
    $
    (921
    )
    
    $
    (2,037
    )Loss per share from continuing operations:Basic
    
    $
    (0.22
    )
    
    $
    (0.19
    )
    
    $
    (0.75
    )
    
    $
    (0.34
    )Diluted
    
    $
    (0.22
    )
    
    $
    (0.19
    )
    
    $
    (0.75
    )
    
    $
    (0.34
    )Income (loss) per share from discontinued operations:Basic
    
    $
    
    
    
    $
    (0.03
    )
    
    $
    0.55
    
    
    $
    (0.11
    )Diluted
    
    $
    
    
    
    $
    (0.03
    )
    
    $
    0.54
    
    
    $
    (0.11
    )Loss per share:Basic
    
    $
    (0.22
    )
    
    $
    (0.22
    )
    
    $
    (0.20
    )
    
    $
    (0.45
    )Diluted
    
    $
    (0.22
    )
    
    $
    (0.22
    )
    
    $
    (0.20
    )
    
    $
    (0.45
    )Basic weighted average common shares outstanding
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971Diluted weighted average common shares outstanding
    
    
    4,545,837
    
    
    
    4,478,971
    
    
    
    4,545,764
    
    
    
    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)
 Nine Months EndedSeptember 30,CASH PROVIDED BY (USED FOR):
    
    2008
    
    
    2007OPERATIONS:Net loss
    
    $
    (921
    )
    
    $
    (2,037
    )Adjustments to reconcile net loss to net cash used for operating activities:Depreciation and amortization
    
    
    384
    
    
    
    346Stock-based compensation expense
    
    
    15
    
    
    
    8Gain on sale of discontinued operations
    
    
    (2,884
    )
    
    
    (97
    )Non-cash interest expense (income), net
    
    
    (33
    )
    
    
    Investment income
    
    
    
    
    
    
    (81
    )Equity in income of affiliate companies
    
    
    (74
    )
    
    
    (48
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    (231
    )
    
    
    (736
    )Accrued interest receivable
    
    
    5
    
    
    
    93Inventories
    
    
    175
    
    
    
    (194
    )Other current assets
    
    
    811
    
    
    
    303Accounts payable
    
    
    (35
    )
    
    
    718Accrued payroll
    
    
    (146
    )
    
    
    (8
    )Deferred revenue
    
    
    393
    
    
    
    (476
    )Accrued expenses and other current liabilities
    
    
    (290
    )
    
    
    321Other liabilities
    
    
    (35
    )
    
    
    (38
    )Cash used for operating activities
    
    
    (2,866
    )
    
    
    (1,926
    )INVESTING ACTIVITIES:Proceeds from sale of discontinued operations
    
    
    3,025
    
    
    
    Investment in subsidiary
    
    
    (125
    )
    
    
    Proceeds from sale of investment or marketable securities
    
    
    
    
    
    
    39Proceeds from notes and interest receivable
    
    
    407
    
    
    
    3,278Payments on notes payable
    
    
    (168
    )
    
    
    (105
    )Purchases of property and equipment
    
    
    (133
    )
    
    
    (989
    )Cash provided by investing activities
    
    
    3,006
    
    
    
    2,223FINANCING ACTIVITIES:Borrowings under line of credit
    
    
    1,743
    
    
    
    Repayments made under line of credit
    
    
    (1,820
    )
    
    
    Borrowings under other short-term arrangements
    
    
    124
    
    
    
    156Cash provided by financing activities
    
    
    47
    
    
    
    156Effects of exchange rate changes on cash
    
    
    (67
    )
    
    
    (26
    )Net increase in cash
    
    
    120
    
    
    
    427Cash at beginning of period
    
    
    554
    
    
    
    2,136Cash at end of period
    
    $
    674
    
    
    $
    2,563
 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)
 Nine Months EndedSeptember 30,2008
    
    
    2007SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    12
    
    
    $
    3Cash paid during the period for income taxes
    
    $
    12
    
    
    $
    8
 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:
 Line of Credit and Notes Payable:
 Sale of VISaer Business (Discontinued Operations):
  (unaudited, in $000s)Proceeds from sale:Cash
    
    $
    3,025Note receivable, net of discount
    
    
    1,261Liabilities assumed by (assets transferred to) buyer:Other current assets
    
    
    (695
    )Property, plant and equipment, net
    
    
    (15
    )Intangible assets
    
    
    (1,803
    )Other assets
    
    
    (17
    )Accrued payroll
    
    
    258Accounts payable
    
    
    472Deferred revenue
    
    
    584Other liability
    
    
    (126
    )Accrued transaction related expenses
    
    
    (60
    )Gain on sale of VISaer business
    
    $
    2,884
 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 nine month periods ended September 30, 2008
and 2007. The interim results for the three and nine months ended September 30, 2008 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, 2007, as filed in our Annual Report on Form 10-KSB.3.
    
    Discontinued Operations- Effective April 16, 2008, the company and two subsidiaries, VISaer,
Inc. and VISaer (U.K.) Limited (collectively, VISaer) completed the sale of substantially
all the assets related to VISaers business pursuant to the terms of an asset purchase
agreement (the Asset Purchase Agreement) between IBS Technics, Inc. (IBS Technics) and
VISaer. IBS Technics is a subsidiary of IBS Software Services, Inc., a software services
company that had previously provided certain software development services to VISaer as an
independent third party contractor.The purchase price consisted of $3,025,000 paid in cash at closing plus future earn-out and
contingent payments to be paid over four years based on certain performance metrics of the
VISaer business following the sale, with guaranteed minimum payments aggregating $1.5 million in
cash (discounted to a net present value of $1,261,000), payable in three equal installments in
2010, 2011 and 2012. In addition, IBS Technics assumed approximately $258,000 in liabilities of
VISaer related to employee vacation benefits and $437,000 payable to IBS Technics for prior
services. IBS hired the VISaer employees as of the effective date of the transaction. IBS
Technics acquired assets, net of liabilities, of $48,000 related to customer contracts and
assumed the ongoing liabilities and obligations associated with such contracts. We retained the
remainder of the liabilities of the VISaer business along with cash and accounts receivable
aggregating approximately $465,000 as of the closing date. Based on the carrying value of the
assets and liabilities transferred to IBS Technics and the estimated costs and expenses incurred
in connection with the sale, the company reported a gain on the sale transaction of $2,884,000
in the quarter ended June 30, 2008.The transaction also provides for contingent payments which may be earned based on the
attainment by the acquired VISaer business of certain levels of revenue in each of the calendar
years 2008 through 2011. As the amount, if any, of such payments is not quantifiable at this
time, no amount has been recorded for such contingency payments.The following condensed financial information is provided for the VISaer discontinued operations
for the periods shown.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited, in thousands)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Net sales
    
    $
    
    
    
    $
    988
    
    
    $
    761
    
    
    $
    2,587Operating loss
    
    
    (17
    )
    
    
    (87
    )
    
    
    (471
    )
    
    
    (566
    )Income (loss) from discontinued operations
    
    
    7
    
    
    
    (114
    )
    
    
    (439
    )
    
    
    (609
    )
 
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4.
    
    Comprehensive Income (Loss)- In accordance with Financial Accounting Standards Board Statement
No. 130, Reporting Comprehensive Income, 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 of
    
    Three Months Ended
    
    
    Nine Months EndedComprehensive Loss
    
    September 30,
    
    
    September 30,(unaudited, in thousands)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Net loss
    
    $
    (978
    )
    
    $
    (982
    )
    
    $
    (921
    )
    
    $
    (2,037
    )Other comprehensive income (loss)
Foreign currency translation adjustment
    
    
    
    
    
    
    (12
    )
    
    
    (67
    )
    
    
    (142
    )Comprehensive loss
    
    $
    (978
    )
    
    $
    (994
    )
    
    $
    (988
    )
    
    $
    (2,179
    )
 5.
    
    Stock-based Compensation- At September 30, 2008, we have two stock-based compensation plans
in effect. In December 2004, the FASB issued FASB Statement No. 123R, Share-Based Payment
(SFAS No. 123R) which replaced APB No. 25 and SFAS No. 123. We adopted SFAS No.123R effective
January 1, 2006 using the modified prospective application method of adoption which requires
us to record compensation cost related to unvested stock awards by recognizing the unamortized
grant date fair value in accordance with provisions of SFAS 123R on a straight line basis over
the service periods of each award. We have estimated forfeiture rates based on our historical
experience. Stock option compensation expense is recognized as a component of general and
administrative expenses in the accompanying Consolidated Financial Statements. As a result of
adopting SFAS No. 123R, we recorded $6,000 and $4,000 of stock based compensation expense for
the three months ended September 30, 2008 and 2007, respectively, and $15,000 and $8,000 of
stock-based compensation expense for the nine months ended September 30, 2008 and 2007,
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-KSB.As of September 30, 2008, there is $18,000 of unrecognized compensation cost related to stock
options. During the quarter ended June 30, 2008, a total of 12,000 options were granted to the
three independent members of the board of directors pursuant to the Non-employee Director Stock
Option Plan (Director Plan). Pursuant to the terms of the Director Plan, the options were
granted at fair market value on the date of the Annual Shareholders meeting. No options were
exercised or forfeited during the three and nine months ended September 30, 2008. The following
table summarizes options as of September 30, 2008:
 Wgt Avg
    
    
    AggregateWgt Avg
    
    
    Remaining Life
    
    
    Intrinsic# of Shares
    
    
    Exercise Price
    
    
    in Years
    
    
    ValueOutstanding at September 30, 2008
    
    
    221,000
    
    
    $
    2.46
    
    
    
    4.7
    
    
    $
    65,582Vested and exercisable at
September 30, 2008
    
    
    203,000
    
    
    $
    2.37
    
    
    
    4.2
    
    
    $
    65,582
 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 third
quarter of 2008 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
September 30, 2008. The amount of aggregate intrinsic value will change based on the fair
market value of the companys stock.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
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007ChemFree Customer A
    
    
    43
    %
    
    
    64
    %
    
    
    45
    %
    
    
    36
    %ChemFree Customer B
    
    
    12
    %
    
    
    
    
    
    
    14
    %
    
    
    12
    %ChemFree Customer C
    
    
    12
    %
    
    
    
    
    
    
    10
    %
    
    
    ChemFree Customer D
    
    
    
    
    
    
    
    
    
    
    10
    %
    
    
    10
    %
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7.
    
    Industry Segments - Segment information is presented consistently with the basis described in
the 2007 Form 10-KSB. The following table contains segment information for continuing
operations for the three and nine months ended September 30, 2008 and 2007.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited, in thousands)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Information TechnologyRevenue
    
    $
    320
    
    
    $
    166
    
    
    $
    751
    
    
    $
    2,119Operating loss
    
    
    (914
    )
    
    
    (995
    )
    
    
    (2,936
    )
    
    
    (1,406
    )Industrial ProductsRevenue
    
    
    2,869
    
    
    
    4,640
    
    
    
    10,233
    
    
    
    8,994Operating income
    
    
    98
    
    
    
    312
    
    
    
    270
    
    
    
    491Consolidated SegmentsRevenue
    
    
    3,189
    
    
    
    4,806
    
    
    
    10,984
    
    
    
    11,113Operating loss
    
    
    (816
    )
    
    
    (683
    )
    
    
    (2,666
    )
    
    
    (915
    )Corporate expenses
    
    
    (182
    )
    
    
    (198
    )
    
    
    (740
    )
    
    
    (853
    )Consolidated operating loss from
continuing operations
    
    $
    (998
    )
    
    $
    (881
    )
    
    $
    (3,406
    )
    
    $
    (1,768
    )Depreciation and AmortizationInformation Technology
    
    $
    14
    
    
    $
    48
    
    
    $
    73
    
    
    $
    122Industrial Products
    
    
    103
    
    
    
    30
    
    
    
    291
    
    
    
    140Consolidated segments
    
    
    117
    
    
    
    78
    
    
    
    364
    
    
    
    262Corporate
    
    
    7
    
    
    
    5
    
    
    
    20
    
    
    
    16Consolidated depreciation and amortization
    
    $
    124
    
    
    $
    83
    
    
    $
    384
    
    
    $
    278Capital ExpendituresInformation Technology
    
    $
    (32
    )
    
    $
    62
    
    
    $
    (68
    )
    
    $
    541Industrial Products
    
    
    9
    
    
    
    255
    
    
    
    194
    
    
    
    436Consolidated segments
    
    
    (23
    )
    
    
    317
    
    
    
    126
    
    
    
    977Corporate
    
    
    1
    
    
    
    4
    
    
    
    10
    
    
    
    10Consolidated capital expenditures
    
    $
    (22
    )
    
    $
    321
    
    
    $
    136
    
    
    $
    987
 (in thousands)
    
    September 30, 2008
    
    
    December 31, 2007Identifiable AssetsInformation Technology
    
    $
    3,388
    
    
    $
    4,171Industrial Products
    
    
    5,015
    
    
    
    4,932Consolidated segments
    
    
    8,403
    
    
    
    9,103Corporate
    
    
    1,933
    
    
    
    3,519Consolidated assets
    
    $
    10,336
    
    
    $
    12,622
 8.
    
    Commitments and Contingencies- Please refer to Note 9 to our Consolidated Financial
Statements included in our 2007 Form 10-KSB for a description of our commitments and
contingencies. As a result of the sale of the VISaer business as described in Note 3, the
VISaer property lease was assumed by the buyer. Accordingly, our future minimum lease
payments for 2008, 2009 and 2010 will be lower than previously reported by $108,000, $145,000
and $85,000, respectively.Legal Matters- In December 2004, ChemFree filed a patent infringement action against J. Walter
Co. Ltd. and J. Walter, Inc. in the United States Court for the Northern District of Georgia.
The complaint alleges that certain of the defendants products infringe various U.S. patents
held by ChemFree and seeks a ruling to compel the defendant to cease its infringing activities.
The defendant has asserted various defenses. The parties have completed the discovery phase of
the case and no trial date has been set. While the resolution and timing of any legal action is
not predictable, ChemFree believes it has sufficient grounds to prevail in these actions,
although there can be no assurance that the disputes will be resolved in its favor. During the
second and third quarter of 2008, several pre-trial rulings were made by the judge
assigned to the case with respect to various motions submitted by ChemFree and J. Walter Co.
Ltd. and J. Walter, Inc. One of the rulings awarded ChemFree legal expenses related to a
certain matter in an amount to be determined. Since the amount of the award has not been
determined at this time, no amount for awarded legal expenses has been accrued in the
accompanying Consolidated Financial Statements included in this filing.
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VISaer Stock Purchase Transaction - On April 3, 2008, the company acquired additional shares of
common stock of VISaer, Inc. from a minority shareholder. The purchase price for the stock was
$125,000 paid in cash plus an additional amount to be paid in the future, contingent upon the
net amount of cash realized by Intelligent Systems (calculated in accordance with a formula
agreed between the parties) resulting from the VISaer sale transaction. Presently, the company
estimates that the additional amount that would be payable to the minority shareholder in 2010,
2011 and 2012 (based on the guaranteed minimum payments of the VISaer buyer as explained in Note
3) aggregates approximately $126,000 ($150,000 undiscounted); accordingly, the company has
accrued $126,000 as a long-term liability in the Consolidated Financial Statements. The total
purchase price for the additional VISaer stock, consisting of the initial payment of $125,000
and the accrued liability for future payments of $126,000, was recorded as additional goodwill
of VISaer at the time of the transaction and included in the calculation of the gain on sale for
the VISaer transaction.9.
    
    Income Taxes- Effective January 1, 2007, we adopted the provisions of Financial Accounting
Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an
Interpretation of FASB Statement No. 109 (FIN No. 48). FIN No. 48 prescribes a recognition
threshold that a tax position is required to meet before being recognized in the financial
statements and provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition issues. We have
recognized tax benefits from all tax positions we have taken, and there has been no adjustment
to any carry forwards (net operating loss or research and development credits) as a result of
the implementation of FIN No. 48. The adoption of FIN No. 48 did not have a material effect on
our consolidated financial position or results of operations. As of September 30, 2008, we do
not have any unrecognized tax benefits and we do not anticipate any significant changes in the
balance of unrecognized tax benefits during the next twelve months.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. No such
interest expense or penalties were recognized during the three or nine months ended September
30, 2008 and 2007.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. Through April 15, 2008, our VISaer subsidiary filed a separate U.S.
federal income tax return. For periods after April 15, 2008, we will include VISaer in our
consolidated 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 2005.10.
    
    New Accounting Pronouncements- In September 2006, the FASB issued FASB Statement No. 157,
Fair Value Measurements (FASB No.157) to increase consistency and comparability in fair
value measurements. FASB No. 157 defines fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value measurements of certain assets,
liabilities and items in stockholders equity that are measured at fair value. FASB No. 157
is effective for financial statements issued for fiscal years beginning after November 15,
2007. Accordingly, we adopted FASB No. 157 effective January 1, 2008. The adoption of the
standard did not have a material impact on our Consolidated Financial Statements.On February 15, 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities: Including an amendment of FASB Statement No. 115 (FASB
No.159). FASB No. 159, which builds on other statements related to fair value such as FASB No.
157 above, permits entities to elect to measure many financial instruments and certain other
items at fair value with changes in value reported in earnings. It is designed to mitigate
earnings volatility that arises when assets and liabilities are measured differently. FASB No.
159 is effective for financial statements issued for fiscal years beginning after November 15,
2007. Accordingly, we adopted FASB 159 effective January 1, 2008. The adoption of the standard
did not 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 Performance, 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 or Plan
of Operation, in the Form 10-KSB for the year ended December 31, 2007 as filed with the Securities
and Exchange Commission.
 Overview
   
    
    A change in revenue level at one of our subsidiaries may impact consolidated revenue or
be offset by an opposing change at another subsidiary.
    
    Economic and marketplace trends may impact our subsidiaries differently or not at all and
our software subsidiary has limited experience in its marketplace which may affect its
ability to identify and evaluate trends that may impact its business.
    
    CoreCard Software has been involved in major new product development initiatives for a
number of years and has limited experience delivering and installing products at customer
sites, making it difficult to predict with certainty when it may recognize revenue on
individual software contracts.
    
    Our subsidiaries are relatively small in revenue size and, in the Information Technology
sector, revenue in a given period may consist of a relatively small number of contracts.
Consequently, even small delays in a delivery under a software contract (which may be out of
our control) could have a significant and unpredictable impact on consolidated revenue that
we can recognize in a given quarterly or annual period.
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Results of Operations
  Revenue
 
    
    Revenue from products, which includes sales of equipment in our Industrial Products segment
as well as software license fees related to the Information Technology segment, was $2.9
million in the three month period ended September 30, 2008, a 38 percent decline compared to
$4.7 million in the three months ended September 30, 2007. For the nine month period ended
September 30, 2008, revenue from products was $10.3 million, essentially flat compared to the
same period in 2007. The decline in product revenue in the third quarter of 2008 compared to
the prior year is primarily associated with a change in domestic sales of ChemFree products
(our Industrial Products segment) due to the fact that in the third quarter of last year, a
new customer began a national program to sell ChemFree products to its installed customer
base, resulting in a high initial volume of sales. With the initial rollout complete, the
number of new machines sold to this customer in the third quarter of 2008 was lower than
during the peak period last year. ChemFree experienced an increase of 14 percent in revenue
in the nine month period ended September 30, 2008 as compared to the nine month period in
2007, reflecting a 12 percent increase in domestic sales and a 26 percent increase in
international sales. Sales of ChemFrees fluid and filter consumables increased significantly
in both the three and nine month periods of 2008 compared to 2007, reflecting the increasing
base of users of its SmartWasher part washers. Due to general economic conditions and
uncertainty about the impact of a slowing economy on the automotive repair and supplies
industry, the company is planning for relatively flat or perhaps slightly lower volume of
machine sales than in the third quarter of 2008 and is carefully managing its costs and
inventory levels accordingly. ChemFrees installed base of lease customers as well as the need
for customers to purchase replacement consumable supplies provide an ongoing base of business
that we believe will be relatively unaffected by fluctuations in general economic conditions.
Software license revenue associated with the Information Technology segment was minimal in the
three and nine month periods ended September 30, 2008 compared to approximately $1.3 million
in license revenue in the nine months ended September 30, 2007 (which reflected primarily a
single software license contract recognized by our CoreCard Software subsidiary in the first
quarter of 2007). The company recognizes software license revenue only upon completion of
each contract and acceptance by customers. At September 30, 2008, CoreCard Software had
approximately $1.6 million in deferred revenue associated with in-process customer contracts
that it expects to recognize upon contract completion within the next three to six months,
depending to a large extend on customer go-live schedules.
    
    Service revenue associated with the Information Technology segment was nine percent higher
and seven percent lower, respectively, in the three and nine month periods ended September 30,
2008 compared to the same periods last year. The change is attributed mainly to changes in
the amount and timing of professional services projects that are requested and delivered to
CoreCard customers. Revenue from professional services can vary considerably from period to
period based mainly on the timing of customer projects.
    
    Turmoil in the global financial markets could impact CoreCards revenue and prospects in
the foreseeable future if customers or prospects postpone software purchases or
implementations. We are carefully monitoring the evolving dynamics in the marketplace and
have proactively taken steps to lower expenses through reduction in payroll and discretionary
marketing spending. We expect to support existing customers and contracts and to continue to
add new prospects and customers as opportunities arise in these uncertain times.
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Cost of Revenue
 
    
    Cost of product revenue was 55 percent and 54 percent of product revenue in the three
and nine month periods, respectively, in 2008 compared to 57 percent and 51 percent of
product revenue in the respective periods in 2007. The principal reason for the slight
decline in product cost as a percent of product revenue in the third quarter of 2008 is due
mainly to a favorable mix of higher margin consumable supplies to machine sales. In the
nine month period of 2008, cost of product revenue as a percent of product revenue was
slightly higher than in the same period last year because in the nine month period in 2007,
product revenue included $1.1 million in software licenses which have a low cost of
revenue. Excluding the software revenue, cost of product revenue in the nine month period
ended September 30, 2007 would have been 58 percent of product revenue compared to 54
percent in the same period in 2008 due to a favorable mix of higher margin consumable
supplies to machine sale in the current year.
 
    
    Cost of service revenue (which relates to our software business only) was 60 percent and
86 percent of service revenue in the three and nine month periods ended September 30, 2008
compared to 114 percent and 82 percent of service revenue in the respective periods in
2007. Services include maintenance and customer support activities as well as professional
services for software projects. 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. CoreCard is providing a high level of support to its initial customers to
ensure it builds a solid base of reference customers and puts in place an infrastructure
for future growth. Cost of providing routine maintenance and support services as a
percentage of service revenue is expected to decrease as CoreCards installed base of
customers increases whereas the cost of professional services as a percent of revenue is
expected to have a relatively stable gross margin percentage from period to period.
 Operating Expenses
 Interest Income (Expense)
 Investment Income (Loss)
 Equity Earnings of Affiliate Companies
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Income Taxes
 Discontinued Operations
 Net Loss from Discontinued Operations
 Gain on Sale of Discontinued Operations
 Liquidity and Capital Resources
    Off-Balance Sheet Arrangements
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Critical Accounting Policies and Estimates
  Factors That May Affect Future Operations
   
    
    Turmoil in the global financial markets could have a serious negative impact on CoreCard
due to potential customers (most of whom are financial institutions) delaying purchase or
implementation decisions.
    
    Delays in CoreCards software development projects could cause customers to delay
implementations, delay payments or cancel contracts, which would increase our costs and reduce
our revenue.
    
    Our CoreCard subsidiary could fail to deliver software products which meet the business and
technology requirements of its target markets within a reasonable time frame and at a price
point that supports a profitable, sustainable business model.
    
    One of ChemFrees customers represented approximately 45 percent of consolidated revenue in
the first nine months of 2008; any unforeseen 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.
    
    Failure by our ChemFree subsidiary to protect its intellectual property assets could
increase competition in the marketplace and result in greater price pressure and lower
margins, thus potentially impacting sales, profits and projected cash flows.
    
    Software errors or poor quality control may delay product releases, increase our costs,
result in non-acceptance of our software by customers or delay revenue recognition.
    
    Compliance with the internal controls over financial reporting requirements of Section 404
of the Sarbanes-Oxley Act of 2002 could increase operating expenses and divert management and
staff resources.
    
    Competitive pressures (including pricing, changes in customer requirements and preferences,
and competitor product offerings) may cause prospective customers to choose an alternative
product solution, resulting in lower revenue and profits (or increased losses).
    
    CoreCard could fail to establish a base of reference customers for its product offerings,
resulting in lower revenue and profits (or increased losses) and increased cash needs.
    
    In certain limited 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.
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
    
    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 Alternext US (formerly The
American Stock Exchange) could result in delisting of our common stock, with a potentially
negative impact on market price and liquidity of our common stock.
    
    Other general economic and political conditions could cause customers to delay or cancel
software purchases.
  
 Item 4. Controls and Procedures
  
 Part II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 6. Exhibits
  3.1
    
    
    Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991, as
amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrants
Annual Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the
Registrants Report on Form 8-K dated November 25, 1997.)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).4.1
    
    
    Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock
Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the
Registrants Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)4.2
    
    
    Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrants
Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)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.
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SIGNATURES
  INTELLIGENT SYSTEMS CORPORATION
RegistrantDate: November 14, 2008
    
    By:
    
    /s/ J. Leland Strange

J. Leland StrangeChief Executive Officer, PresidentDate: November 14, 2008
    
    By:
    
    /s/ Bonnie L. Herron

Bonnie L. HerronChief Financial Officer
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EXHIBIT INDEX
 ExhibitNo.
    
    Descriptions3.1
    
    
    Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991, as
amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrants Annual
Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the Registrants
Report on Form 8-K dated November 25, 1997.)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).4.1
    
    
    Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock Transfer &
Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the Registrants Report
on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)4.2
    
    
    Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrants Report on
Form 8-K dated November 25, 1997 and filed on December 16, 1997.)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 18