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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-QSB (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO 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)
 Registrants telephone number, including area code: (770) 381-2900 Indicate by a 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 þ No o As of April 30, 2004, 4,478,971 shares of Common Stock were outstanding. Transitional Small Business Disclosure Format (check one): Yes o No þ




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TABLE OF CONTENTS  Item 1. Financial StatementsItem 2. Managements Discussion and Analysis or Plan of OperationsItem 3. Controls and ProceduresPart II. OTHER INFORMATIONItem 6. Exhibits and Reports on Form 8-KSIGNATURESEX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEO/CFO    Table of Contents  
 Item 1. Financial Statements Intelligent Systems Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share amounts) March 31,
    
    December 31,2004
    
    2003(unaudited)ASSETSCurrent assets:Cash
    
    $
    770
    
    
    $
    1,133Accounts receivable, net
    
    
    2,122
    
    
    
    1,543Notes and interest receivable
    
    
    140
    
    
    
    142Inventories
    
    
    564
    
    
    
    766Other current assets
    
    
    524
    
    
    
    614Total current assets
    
    
    4,120
    
    
    
    4,198Long-term investments
    
    
    6,209
    
    
    
    6,275Property and equipment, at cost less accumulated depreciation
    
    
    742
    
    
    
    746Goodwill
    
    
    2,038
    
    
    
    2,039Intangibles, net
    
    
    398
    
    
    
    476Other assets
    
    
    8
    
    
    
    8Total assets
    
    $
    13,515
    
    
    $
    13,742LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    250
    
    
    $
    250Accounts payable
    
    
    1,221
    
    
    
    932Deferred revenue
    
    
    3,266
    
    
    
    2,586Deferred gain
    
    
    258
    
    
    
    291Accrued expenses and other current liabilities
    
    
    1,763
    
    
    
    2,037Total current liabilities
    
    
    6,758
    
    
    
    6,096Deferred revenue, net of current portion
    
    
    5,015
    
    
    
    5,060Minority interest
    
    
    1,516
    
    
    
    1,516Commitments and contingenciesStockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 shares
issued and outstanding at March 31, 2004 and December 31, 2003
    
    
    45
    
    
    
    45Paid-in capital
    
    
    18,410
    
    
    
    18,410Accumulated other comprehensive loss
    
    
    (84
    )
    
    
    (60
    )Accumulated deficit
    
    
    (18,145
    )
    
    
    (17,325
    )Total stockholders equity
    
    
    226
    
    
    
    1,070Total liabilities and stockholders equity
    
    $
    13,515
    
    
    $
    13,742
 The accompanying notes are an integral part of these condensed consolidated financial statements. Page 2




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Intelligent Systems Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited; in thousands, except share and per share amounts) Three Months Ended March 31,2004
    
    2003RevenueProducts
    
    $
    3,227
    
    
    $
    1,704Services
    
    
    1,385
    
    
    
    1,466Total revenue
    
    
    4,612
    
    
    
    3,170Cost of revenueProducts
    
    
    985
    
    
    
    759Services
    
    
    810
    
    
    
    1,050Total cost of revenue
    
    
    1,795
    
    
    
    1,809ExpensesMarketing
    
    
    660
    
    
    
    771General & administrative
    
    
    894
    
    
    
    1,083Research & development
    
    
    2,100
    
    
    
    2,081Loss from operations
    
    
    (837
    )
    
    
    (2,574
    )Other incomeInterest expense, net
    
    
    (3
    )
    
    
    (5
    )Investment income, net
    
    
    
    
    
    
    3,464Equity in losses of affiliate companies
    
    
    (38
    )
    
    
    (67
    )Other income, net
    
    
    59
    
    
    
    27Income (loss) before income tax provision (benefit)
    
    
    (819
    )
    
    
    845Income tax provision (benefit)
    
    
    1
    
    
    
    (104
    )Net income (loss)
    
    $
    (820
    )
    
    $
    949Basic and diluted net income (loss) per share
    
    $
    (0.18
    )
    
    $
    0.21Basic and diluted weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,490,467
 The accompanying notes are an integral part of these condensed consolidated financial statements. Page 3




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Intelligent Systems Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW(unaudited, in thousands) Three Months Ended March 31,2004
    
    2003CASH PROVIDED BY (USED FOR):OPERATIONS:Net income (loss)
    
    $
    (820
    )
    
    $
    949Adjustments to reconcile net income (loss) to net cash used for operating
activities, net of
effects of acquisitions and dispositions:Depreciation and amortization
    
    
    172
    
    
    
    177Deferred gain recognized
    
    
    (33
    )
    
    
    (35
    )Investment income
    
    
    
    
    
    
    (3,458
    )Equity in losses of affiliate companies
    
    
    38
    
    
    
    67Changes in operating assets and liabilities, net of effects of acquisitionAccounts receivable
    
    
    (579
    )
    
    
    686Inventories
    
    
    202
    
    
    
    (9
    )Other current assets
    
    
    90
    
    
    
    52Accounts payable
    
    
    289
    
    
    
    (217
    )Accrued expenses and other liabilities
    
    
    357
    
    
    
    136Cash used for operating activities
    
    
    (284
    )
    
    
    (1,652
    )INVESTING ACTIVITIES:Proceeds from sales of investments
    
    
    
    
    
    
    4,183Disposition of long-term investments
    
    
    28
    
    
    
    Repayments under notes receivable
    
    
    15
    
    
    
    Advances under notes receivable
    
    
    (13
    )
    
    
    Purchases of property and equipment
    
    
    (85
    )
    
    
    (59
    )Cash (used for) provided by investing activities
    
    
    (55
    )
    
    
    4,124FINANCING ACTIVITIES:Purchase and retirement of common stock
    
    
    
    
    
    
    (4
    )Cash used for financing activities
    
    
    
    
    
    
    (4
    )Effects of exchange rate changes on cash
    
    
    (24
    )
    
    
    (4
    )Net increase (decrease) in cash
    
    
    (363
    )
    
    
    2,464Cash at beginning of period
    
    
    1,133
    
    
    
    2,644Cash at end of period
    
    $
    770
    
    
    $
    5,108SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    3
    
    
    $
    Cash paid (received) during the period for income taxes
    
    
    1
    
    
    
    (104
    )
 The accompanying notes are an integral part of these condensed consolidated
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Intelligent Systems Corporation
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  1.
    
    Throughout this report, the terms we, us, ours, ISC and company
refer to Intelligent Systems Corporation, including its subsidiaries.2.
    
    The unaudited condensed consolidated financial statements presented in
this Form 10-QSB 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 month periods ended March 31, 2004 and
2003. The interim results for the three months ended March 31, 2004 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, 2003, as filed in our annual report on Form 10-K.3.
    
    Comprehensive Income (Loss) In accordance with Financial Accounting
Standards Board Statement No. 130, Reporting Comprehensive Income,
comprehensive income is the total of net income (loss) and all other
non-owner changes in equity in a period. A summary follows: Consolidated Statements of Comprehensive Income (Loss)
    
    Three Months Ended March 31,(unaudited, in thousands)
    
    2004
    
    2003Net
income (loss)
    
    $
    (820
    )
    
    $
    949Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (24
    )
    
    
    (4
    )Unrealized gain on available-for-sale securities
    
    
    
    
    
    
    5Comprehensive income (loss)
    
    $
    (844
    )
    
    $
    950
  4.
    
    Stock-Based Compensation At March 31, 2004, we had two stock-based
compensation plans. We account for the plans under the intrinsic value
recognition and measurement principles of Accounting Principles Board
(APB) No. 25, Accounting for Stock Issued to Employees, and related
interpretations. The intrinsic value recognition is measured by the
difference between the exercise price and the market value of the
underlying securities. Based on the additional disclosure requirements of
Statement of Financial Accounting Standards (SFAS) No. 148, Accounting
for Stock-Based Compensation  Transition and Disclosure  an Amendment to
SFAS No. 123, the following table illustrates the effect of net income
and earnings (loss) per share if we had applied the fair value recognition
provisions of SFAS No. 123, Accounting for Stock Based Compensation. Three Months Ended March 31,(in thousands, except per share data)
    
    2004
    
    2003Net income (loss), reported
    
    $
    (820
    )
    
    $
    949Add: stock-based employee compensation included
in reported net income (loss), net of related tax effect
    
    
    
    
    
    
    Deduct: stock-based compensation expense determined under fair
value based method for all awards, net of related tax effect
    
    
    (9
    )
    
    
    (3
    )Pro forma net income (loss)
    
    $
    (829
    )
    
    $
    946Pro forma net income (loss) per common share basic and diluted
    
    $
    (0.19
    )
    
    $
    0.21
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5.
    
    Industry Segments Our consolidated subsidiaries are involved in two
industry segments: Information Technology products and services, and
Industrial Products. Operations in Information Technology products and
services include development and sales of software licenses and related
professional services and software maintenance contracts provided through
three subsidiaries: QS Technologies, Inc., VISaer, Inc., and CoreCard
Software, Inc. Operations in the Industrial Products segment include the
manufacture and sale of bio-remediating parts washing systems by our
ChemFree Corporation subsidiary. Total revenue by industry segment
includes sales to unaffiliated customers. Sales between our industry
segments are not material. Operating profit (loss) is total revenue less
operating expenses. None of the corporate overhead expense is allocated to
the individual industry segments. Identifiable assets by industry segment
are those assets that are used in our subsidiaries in each industry
segment. Corporate assets are principally cash, notes receivable and
investments. The table following contains segment information for the
quarters ended March 31, 2004 and 2003. Quarter ended March 31,(unaudited, in thousands)
    
    2004
    
    2003Information TechnologyRevenue
    
    $
    2,954
    
    
    $
    1,577Operating loss
    
    
    (678
    )
    
    
    (2,542
    )Industrial ProductsRevenue
    
    
    1,658
    
    
    
    1,593Operating income
    
    
    84
    
    
    
    205Consolidated SegmentsRevenue
    
    $
    4,612
    
    
    $
    3,170Operating loss
    
    
    (594
    )
    
    
    (2,337
    )A reconciliation of consolidated segment data above to consolidated income (loss) follows:Consolidated segments operating loss
    
    $
    (594
    )
    
    $
    (2,337
    )Corporate expenses
    
    
    (243
    )
    
    
    (237
    )Consolidated operating loss
    
    
    (837
    )
    
    
    (2,574
    )Interest expense
    
    
    (3
    )
    
    
    (5
    )Investment income
    
    
    
    
    
    
    3,464Equity of affiliates
    
    
    (38
    )
    
    
    (67
    )Other income
    
    
    59
    
    
    
    27Income (loss) before taxes
    
    
    (819
    )
    
    
    845Income tax provision (benefit)
    
    
    1
    
    
    
    (104
    )Net income (loss)
    
    $
    (820
    )
    
    $
    949Depreciation and AmortizationInformation Technology
    
    $
    123
    
    
    $
    148Industrial Products
    
    
    42
    
    
    
    22Consolidated segments
    
    
    165
    
    
    
    170Corporate
    
    
    7
    
    
    
    7Consolidated depreciation and amortization
    
    $
    172
    
    
    $
    177Capital ExpendituresInformation Technology
    
    $
    16
    
    
    $
    40Industrial Products
    
    
    69
    
    
    
    16Consolidated segments
    
    
    85
    
    
    
    56Corporate
    
    
    
    
    
    
    3Consolidated capital expenditures
    
    $
    85
    
    
    $
    59
 March 31, 2004
    
    December 31, 2003(unaudited)
    
    (audited)Identifiable AssetsInformation Technology
    
    $
    4,525
    
    
    $
    4,740Industrial Products
    
    
    2,051
    
    
    
    2,024Consolidated segments
    
    
    6,576
    
    
    
    6,764Corporate
    
    
    6,939
    
    
    
    6,978Consolidated assets
    
    $
    13,515
    
    
    $
    13,742
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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 EndedMarch 31(unaudited, in thousands)
    
    2004
    
    2003ChemFree Customer A
    
    
    
    
    
    
    12
    %CoreCard Customer B
    
    
    29
    %
    
    
    VISaer Customer C
    
    
    
    
    
    
    21
    %
  7.
    
    New Accounting Pronouncements In March 2004, the Emerging Issues Tax
Force reached a consensus on Issue No. 03-16, Accounting for Investments
in Limited Liability Companies. The consensus requires an investment in a
Limited Liability Company (LLC) that maintains a specific ownership
account for each investor be viewed as similar to an investment in a
limited partnership for the purposes of determining whether a
noncontrolling investment in an LLC should be accounted for using the cost
method or equity method of accounting. The consensus will be effective in
the quarter beginning after June 15, 2004. We will evaluate the effects of
this Issue for implementation on July 1, 2004.8.
    
    Subsequent Event On April 14, 2004, we entered into a letter agreement
to sell all of the shares of common stock that we held in Cirronet, Inc.,
a technology company in which we were a minority investor. The
unsolicited offer from a third party involved the purchase of all
1,340,990 shares of common stock held by us at a price per share of $0.80
cash for an aggregate price of $1,073,000, payable in cash at the closing.
The transaction closed on May 10, 2004. The company will recognize a
pretax investment gain of approximately $250,000 on the transaction in the
quarter ended June 30, 2004. The equity method carrying value and cost
basis of the investment at March 31, 2004 were $831,000 and $525,000,
respectively. 
 Item 2. Managements Discussion and Analysis or Plan of Operations In addition to historical information, this Form 10-QSB may contain
forward-looking statements relating to ISC. All statements, trend analysis 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, and that actual results may differ materially from those
contemplated by such forward-looking statements included those factors
described below under Factors That May Affect Future Performance. ISC
undertakes no obligation to update or revise forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated events or changes
in future operating results. For purposes of this discussion and analysis, we are assuming and relying upon
the readers familiarity with the information contained in Item 7, Managements
Discussion and Analysis, in the Form 10-K for the year ended December 31, 2003
as filed with the Securities and Exchange Commission. Overview Our consolidated subsidiaries operate in two industry segments: Information
Technology Products and Services and Industrial Products. Included in the
Information Technology sector are QS Technologies, Inc. (software for public
health and human services), VISaer, Inc. (software for maintenance, repair and
overhaul operations in the commercial aviation industry) and CoreCard Software,
Inc. (software for managing credit and debit cards). The Industrial Products
segment includes ChemFree Corporation (bio-remediating parts washers). We derive our product revenue from sales of software licenses in our
Information Technology sector and sales and leases of equipment and supplies in
our Industrial Products sector. Our service revenue consists of fees for
implementation, consulting, training, maintenance and support for software
products in our Information Technology sector. Our consolidated revenue is the
aggregate of the revenue generated at our four subsidiary companies. Our
revenue fluctuates from period to period and our results are not necessarily
indicative of the results to be expected in future periods. Period-to-period
comparisons may not be meaningful and it is difficult to predict the level of
consolidated revenue on a quarterly or annual basis for a number of reasons,
including the following: Page 7




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
    
    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 two of our software subsidiaries have very
limited experience in their marketplaces which makes it difficult to
identify and evaluate trends that may impact their business.
    
    Two of our software subsidiaries, CoreCard Software and VISaer, have
been involved in major new product development initiatives for the past
three years and have limited experience delivering and installing their
new products at customer sites, making it difficult to predict with
certainty when they will recognize revenue on individual software
contracts.
    
    Our subsidiaries are relatively small in revenue size and, in the
Information Technology sector, license revenue at a subsidiary in a
given period may consist of a relatively small number of contracts.
Consequently, even small delays in a subsidiarys delivery under a
software contract (which may be out of its control) could have a
significant and unpredictable impact on consolidated revenue that we can
recognize in a given quarterly or annual period. Frequently we recognize consolidated operating losses on a quarterly and annual
basis and are likely to do so in the future from time to time. Our operating
expenses consist of the aggregate of our four subsidiaries expenses and the
corporate office expenses. Our ChemFree and QS Technologies subsidiaries
usually generate an operating profit on an annual basis but our early stage
subsidiaries, VISaer and CoreCard, presently do not, mainly due to significant
research and development expense that is invested to complete their new product
offerings and the deferral of revenue recognition until such products are
delivered to customers. Depending upon the size and number of software
licenses recognized in a particular period and the level of expenses incurred
to support development and sales activities, our subsidiaries may report
operating profits on an irregular basis as they build their customer base. A
significant portion of our subsidiaries expense is related to personnel which
is relatively fixed in the short-term and we continually evaluate and strive to
balance our financial resources with the resources required to complete
products under development and support our subsidiaries customers. For these
and other reasons, our operating profits or losses may vary from quarter to
quarter and at the present time are generally not predictable with any degree
of certainty. We also frequently generate income or losses from non-operating sources and we
may do so from time to time in the future. Occasionally we derive income from
sales of holdings in affiliate and other minority-owned companies or we record
a charge if we believe the value of a non-consolidated company is impaired. We
also recognize on a quarterly basis our pro rata share of the income or losses
of affiliate companies accounted for by the equity method. The timing and
amount of gain or loss recognized as a result of a sale or the amount of equity
in the income or losses of affiliates generally are not under our control and
are not necessarily indicative of future results, either on a quarterly or
annual basis. In recent years, most of our cash has been generated on an irregular basis from
sales of our investments in early stage technology companies. We have used a
significant amount of the cash received from these sales to support the
operations of our CoreCard Software and VISaer subsidiaries. We do not expect
the same level of cash investment in the future in these two entities and
presently believe that customer payments on existing and pending software
contracts will be sufficient to fund most of the expenses of VISaers
operations and a growing portion of CoreCards expenses. If the business or
cash flow of either subsidiary does not develop as anticipated, we would need
to scale back or restructure their operations. 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 revenues in the three month period ended March 31, 2004 were
$4,612,000, a 45 percent increase compared to the first quarter of 2003.
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, increased by 89 percent from $1,704,000 in the three months
ended March 31, 2003 to $3,227,000 in the three months ended March 31, 2004.
The increase in product revenue is due mainly to the recognition of $1,377,000
in software license revenue at the CoreCard subsidiary due to completion of its
first major customer installation in early 2004. Although it is unlikely that
the company will experience similar period-to-period revenue growth in other
fiscal quarters in 2004, the specific timing of revenue recognition for
software licenses at CoreCard and our other software company
subsidiaries
is difficult to predict with certainty due to a number of
factors. Product revenue related to software products represented 49 percent
of total product revenue in the three months ended March 31, 2004 compared to
six percent in the corresponding period in 2003. Service revenue declined by
six percent, or $81,000 period-to-period, mainly due to a 19 percent decline in
the contribution by the VISaer subsidiary as a result of finishing a
significant professional services contract during 2003, partially offset by a
20 percent increase in service revenue at the QS Technologies subsidiary due to
a larger Page 8




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installed base of customers that pay annual maintenance fees and some initial
services revenue contribution from the CoreCard Software subsidiary in the
first quarter of 2004. Cost of Revenue- In the three month period ended March 31, 2004, total cost of
revenue was 39 percent of consolidated revenue compared to 57 percent in the
three month period in 2003. Cost of product revenue was 31 percent of product
revenue in the three month period ended March 31, 2004 compared to 45 percent
in the corresponding three month period in 2003. The principal reason for the
difference is due to the fact that software license revenue, which has a low
cost of sales compared to the ChemFree industrial products, represented 49
percent of product revenue in the three month period ended March 31, 2004
compared to six percent of product revenue in the corresponding period in 2003.
The cost of sales for the Industrial Products segment was 57% of sales in the
first quarter of 2004, compared to 47% of sales in the first quarter of 2003.
Typically, cost of sales for the Industrial Products segment averages 52% to
56% based on the product mix for the period. In the first quarter of
2004 our product mix resulted in less favorable margins than in the
corresponding quarter in 2003 and we incurred, in the first quarter
of 2004, an expense of
$56,000 to reduce the carrying value of demonstration inventory. Cost of service revenue (which relates to the software
subsidiaries only) was 58 percent in the three month period of 2004 compared to
72 percent in the corresponding period in 2003. The $240,000 decrease in total
dollars spent for service revenue costs in the first quarter of 2004 compared
to the first quarter of 2003 reflects the net effect of a reduction of $298,000
in costs at the VISaer subsidiary principally related to third party
contractors offset by an increase of $58,000 mainly in personnel costs at the
QS Technologies subsidiary due to a larger installed base of customers
requiring support and maintenance services. Operating Expenses- In the three month period ended March 31, 2004, total
consolidated operating expenses decreased by 7 percent compared to the
corresponding period in 2003. Consolidated marketing expenses were 14 percent
lower in the first quarter of 2004, mainly due to reduced expenses at VISaer as
the subsidiary focused its resources on its existing contracts and pipeline of
business. Consolidated general and administrative expenses declined by 17
percent in the three month period ended March 31, 2004, compared to the
corresponding period in 2003. This reduction reflects mainly the elimination
of certain administrative and personnel expenses at the VISaer subsidiary,
although all of the subsidiaries contributed in some measure to the general and
administrative expense reduction. Consolidated research and development
expenses were approximately the same in absolute dollar amounts in the first
quarter of 2004 and 2003, but represented 46 percent and 66 percent of total
revenue in the three months ended March 31, 2004 and 2003, respectively, as a
result of achieving higher revenue in 2004. Research and development expense
at VISaer declined slightly year-to-year and was offset by a slight increase in
such expenses at the CoreCard subsidiary. If our forecasts develop as planned
we expect that R&D expense for the remainder of the year will be at
approximately the same level as for the first quarter of 2004. Interest Expense- In the three months ended March 31, 2004, we recorded $3,000
in interest expense compared to interest expense of $5,000 in the corresponding
period in 2003. Investment Income- We had no investment gains or losses in the three months
ended March 31, 2004. In the corresponding period of 2003, we recorded a net
investment gain of $3,464,000 comprising $4,183,000 related to the PaySys
escrow settlement, offset in part by write-downs of $600,000 to reduce the
carrying value of our investments in RF Solutions, Inc. and a charge of
$119,000 to reduce the carrying value of a note receivable from RF Solutions,
Inc. Equity Earnings (Losses) of Affiliate Companies-On a quarterly basis, we
recognize our pro rata share of the earnings or losses of affiliate companies
that we record on the equity method. We recorded $38,000 and $67,000 in net
equity in losses of affiliate companies in the three months ended March 31,
2004 and 2003, respectively. These results include our pro rata share of the
net earnings and losses reported by four affiliate companies (CoreXpand,
Riverside Software, Cirronet and Horizon Software) in 2004 and three affiliate
companies (CoreXpand, MediZeus, and Horizon Software) in 2003. Other Income, Net- Other income is $59,000 and $27,000 in the three months
ended March 31, 2004 and 2003, respectively. Such amounts include recognition
of deferred gain of $34,000 in each period related to a VISaer product line
sale in July 2000 and $25,000 in other miscellaneous income in the first
quarter of 2004, the majority of which relates to foreign currency exchange
gains. Income Taxes- In the three months ended March 31, 2003, we recorded an income
tax benefit of $104,000 that reflects a refund of alternative minimum taxes
paid by the VISaer subsidiary in a prior year. Page 9




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Liquidity and Capital Resources Our cash balance at March 31, 2004 was $770,000 compared to $1,133,000 at
December 31, 2003. The $363,000 decrease in the cash balance was principally
to fund operations. The companys principal uses of cash during the three
months ended March 31, 2003 were for corporate office expenses of $243,000 and
an increase of $579,000 in accounts receivable reflecting more revenue booked
by ChemFree and VISaer in March 2004 as compared to December of 2003. Sources
of cash included a net increase of $662,000 in current liabilities, of which
$680,000 relates to payments by customers for software licenses and annual
software maintenance contracts (mainly at our VISaer subsidiary) for which the
related revenue will be recognized later in 2004, and a $289,000 increase in
accounts payables, offset by a reduction of $266,000 in accrued payroll for
bonuses earned in 2003 and paid in 2004 and other minor items. We have several potential near-term sources of cash to support negative cash
flow from consolidated operations, including the sale of an investment and
periodic draws against our bank line of credit. As explained in Note 8 to
the Consolidated Financial Statements contained herein, we entered into an
agreement to sell our shares of common stock in Cirronet, Inc. to a third party
in response to an unsolicited offer for an aggregate sales price of $1,073,000
in cash. The transaction closed on May 10, 2004. We paid down the outstanding
balance on our bank line with part of the sale proceeds and intend to use the
remaining proceeds to fund short-term operating needs, if any, of our
subsidiaries. We believe there is sufficient availability under our line of
credit if needed to support any short-term timing differences in consolidated
cash flows which may occur from time to time and to provide for our cash
requirements for at least the next twelve months. Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amount of assets,
liabilities, revenues and expenses. We consider certain accounting policies
related to revenue recognition, valuation of acquired intangibles and
impairment of long-lived assets, 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, 2003. Reference is also made to the discussion of the application of these
critical accounting policies and estimates contained in Managements Discussion
and Analysis in our annual report on Form 10-K for 2003. During the quarter
ended March 31, 2004, there were no significant or material changes in the
application of critical accounting policies that would require an update to the
information provided in the Form 10-K for 2003. Long-Term Contractual Obligations Our only material long-term contractual obligations consist of operating leases
as indicated below: Payment Due By PeriodContractual Obligations
    
    
    
    
    
    Less than
    
    1-3
    
    3-5
    
    More than(in thousands)
    
    Total
    
    1 year
    
    years
    
    years
    
    5 yearsOperating Lease Obligations
    
    $
    404
    
    
    $
    345
    
    
    $
    59
    
    
    
    
    
    
    
    Total
    
    $
    404
    
    
    $
    345
    
    
    $
    59
    
    
    
    
    
    
    
    
 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 any certainty
mainly because several of our subsidiaries are early stage companies with
limited revenue and experience in their respective markets, all are relatively
small in size and, particularly for our software subsidiaries, revenue tends to
be associated with fewer and larger sales than for our industrial products
subsidiary. Thus any trend or delay that affects even one of our subsidiaries
could have a negative impact on the companys consolidated results of
operations or cash requirements on a quarterly or annual basis. In addition,
the carrying value of our investments is impacted by a number of factors which
are generally beyond our control since we are typically a non-control
shareholder in a private company with limited liquidity. Among the numerous
factors that may affect our consolidated results of operations or financial
condition are the following: Page 10




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
    
    Delays in software development projects which could cause our
customers to delay implementations, delay payments or cancel contracts,
which would increase our costs and reduce our revenue.
    
    Undetected software errors which 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) which
may cause prospective customers to choose an alternative product
solution, resulting in lower revenue and profits (or increased losses).
    
    The inability of our CoreCard or VISaer subsidiaries to establish a
base of referenceable customers for their new product offerings,
resulting in lower revenue and profits (or increased losses), increased
cash needs and possibly leading to restructuring or cutting back of the
subsidiarys operations.
    
    Failure of our products specifications and features to achieve
market acceptance.
    
    Delays in anticipated customer payments for any reason which would
increase our cash requirements and possibly our losses.
    
    Declines in performance, financial condition or valuation of
minority-owned companies which 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.
    
    A reversal of the improving trend in the commercial aviation industry
worldwide which could impact VISaers short-term customer purchases,
thus increasing its losses and need for cash.
    
    The relatively limited sales and marketing experience of our VISaer
and CoreCard subsidiaries in their respective markets could cause them
to misinterpret or fail to interpret or adjust to a trend in the market
or to underestimate the sales cycle time frame.
    
    In the Industrial Products market, failure by ChemFree to achieve
anticipated growth in the European market or in the domestic national
accounts and non-automotive markets for their products could cause lower
than anticipated sales and profits.
    
    An insufficient number of potential CoreCard customers decide to
purchase and run an in-house software system and instead choose to
outsource their account transaction processing which could result in
lower revenue, increased costs and greater cash requirements.
    
    Budget reductions by state and local governments for information
technology products that delay award of contracts or implementations for
our QS Technologies subsidiary.
    
    The recurrence of some incidence such as the SARS epidemic in 2003
that has a negative impact on the aviation industry, resulting in delays
in contract awards and customer implementations similar to the
unforeseen negative impact on cash and profits experienced by VISaer
during the SARS epidemic.
    
    Other general economic and political conditions, particularly those
which may cause international business and domestic government customers
to delay or cancel software purchase decisions. 
 Item 3. 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
the procedures are effective. There were no changes in the companys internal
controls over financial reporting or in other factors identified in connection
with this evaluation that occurred during the period covered by this report
that has materially affected, or is reasonably likely to materially affect, the
companys internal control over financial reporting. Page 11




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Part II. OTHER INFORMATION 
 Item 6. Exhibits and Reports on Form 8-K We filed a Form 8-K on March 18, 2004 disclosing that we issued a press release
on March 18, 2004 announcing our financial results for the three and twelve
month periods ended December 31, 2003. The following exhibits are filed or furnished with this report: 3(i)
    
    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(ii)
    
    Bylaws of the Registrant dated June 6, 1997. (Incorporated by reference
to Exhibit 3(ii) of the Registrants Form 10-K/A for the year ended
December 31, 1997.)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.
 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, hereunto duly authorized. INTELLIGENT SYSTEMS CORPORATIONRegistrantDate: May 14, 2004
    
    By:
    
    /S/ J. Leland StrangeJ. Leland StrangeChief Executive Officer, PresidentDate: May 14, 2004
    
    By:
    
    /S/ Bonnie L. HerronBonnie L. HerronChief Financial Officer
 Page 12