##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
 (Mark One)
 þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2007
 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
 days. Yes þ No o
 Act). Yes o No þ
  o þ




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##### 



Intelligent Systems Corporation
 Index
Form 10-QSB
 PagePart I
    
    Financial InformationItem1.
    
    Financial StatementsConsolidated Balance Sheets at March 31, 2007 and December 31, 2006
    
    
    3Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006
    
    
    4Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Management's Discussion and Analysis or Plan of Operation
    
    
    10Item 3.
    
    Controls and Procedures
    
    
    14Part II
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    14Item 6.
    
    Exhibits
    
    
    14Signatures
    
    
    
    
    15Exhibit 31.1 - Section 302 Certification of Chief Executive OfficerExhibit 31.2 - Section 302 Certification of Chief Financial OfficerExhibit 32.1 - Section 906 Certification of Chief Executive Officer and Chief Financial Officer
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Item 1. Financial Statements
 
 Intelligent Systems Corporation
CONSOLIDATED BALANCE SHEETS  (in thousands, except share amounts)
 March 31,
    
    
    December 31,2007
    
    
    2006ASSETS
    
    (unaudited)Current assets:Cash
    
    $
    3,576
    
    
    $
    2,136Accounts receivable, net
    
    
    2,238
    
    
    
    2,006Notes and interest receivable, current portion
    
    
    538
    
    
    
    3,445Inventories
    
    
    934
    
    
    
    904Other current assets
    
    
    963
    
    
    
    1,072Total current assets
    
    
    8,249
    
    
    
    9,563Long-term investments
    
    
    1,175
    
    
    
    1,174Notes and interest receivable, net of current portion
    
    
    722
    
    
    
    841Property and equipment, at cost less accumulated depreciation
    
    
    1,161
    
    
    
    1,009Goodwill, net
    
    
    2,047
    
    
    
    2,047Other intangibles, net
    
    
    347
    
    
    
    359Other assets, net
    
    
    17
    
    
    
    17Total assets
    
    $
    13,718
    
    
    $
    15,010LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,156
    
    
    $
    1,558Deferred revenue
    
    
    2,259
    
    
    
    3,094Accrued payroll
    
    
    953
    
    
    
    974Accrued expenses and other current liabilities
    
    
    1,233
    
    
    
    1,088Total current liabilities
    
    
    5,601
    
    
    
    6,714Long-term liabilities
    
    
    293
    
    
    
    356Commitments and contingencies (Note 10)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 March 31, 2007 and December 31, 2006
    
    
    45
    
    
    
    45Additional paid-in capital
    
    
    18,425
    
    
    
    18,425Accumulated other comprehensive loss
    
    
    (110
    )
    
    
    (127
    )Accumulated deficit
    
    
    (12,052
    )
    
    
    (11,919
    )Total stockholders equity
    
    
    6,308
    
    
    
    6,424Total liabilities and stockholders equity
    
    $
    13,718
    
    
    $
    15,010
 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 March 31,2007
    
    
    2006RevenueProducts
    
    $
    3,086
    
    
    $
    1,852Services
    
    
    963
    
    
    
    3,024Total revenue
    
    
    4,049
    
    
    
    4,876Cost of revenueProducts
    
    
    1,070
    
    
    
    1,001Services
    
    
    572
    
    
    
    1,433Total cost of revenue
    
    
    1,642
    
    
    
    2,434ExpensesMarketing
    
    
    437
    
    
    
    521General & administrative
    
    
    980
    
    
    
    1,102Research & development
    
    
    1,264
    
    
    
    1,521Loss from operations
    
    
    (274
    )
    
    
    (702
    )Other income (expense)Interest income (expense), net
    
    
    63
    
    
    
    (28
    )Investment income (loss), net
    
    
    (11
    )
    
    
    5Equity in income of affiliate companies
    
    
    1
    
    
    
    72Other income (loss), net
    
    
    (9
    )
    
    
    34Loss from continuing operations
    
    
    (230
    )
    
    
    (619
    )Income from discontinued operations, no tax effect
    
    
    
    
    
    
    174Gain on sale of discontinued operations, no tax effect
    
    
    97
    
    
    
    Net loss
    
    $
    (133
    )
    
    $
    (445
    )Loss per share from continuing operations:Basic and diluted
    
    $
    (0.05
    )
    
    $
    (0.14
    )Income per share from discontinued operations:Basic and diluted
    
    
    0.02
    
    
    
    0.04Net loss per share:Basic and diluted
    
    $
    (0.03
    )
    
    $
    (0.10
    )Basic weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,478,971Diluted weighted average shares outstanding
    
    
    4,582,666
    
    
    
    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)
 Three Months Ended March 31,CASH PROVIDED BY (USED FOR):
    
    2007
    
    
    2006OPERATIONS:Net loss
    
    $
    (133
    )
    
    $
    (445
    )Adjustments to reconcile net loss to net cash used for operating activities:Depreciation and amortization
    
    
    127
    
    
    
    134Stock-based compensation expense
    
    
    
    
    
    
    3Gain on sale of QS business
    
    
    (97
    )
    
    
    Investment income (loss)
    
    
    11
    
    
    
    (5
    )Equity in earnings of affiliate companies
    
    
    (1
    )
    
    
    (72
    )Changes in operating assets and liabilities
Accounts receivable
    
    
    (235
    )
    
    
    (722
    )Accrued interest receivable
    
    
    67
    
    
    
    Inventories
    
    
    (79
    )
    
    
    (292
    )Other current assets
    
    
    127
    
    
    
    (19
    )Accounts payable
    
    
    (360
    )
    
    
    453Accrued payroll
    
    
    (21
    )
    
    
    (3
    )Deferred revenue
    
    
    (834
    )
    
    
    (145
    )Accrued expenses and other current liabilities
    
    
    248
    
    
    
    118Other liabilities
    
    
    (29
    )
    
    
    (40
    )Cash used for operating activities
    
    
    (1,209
    )
    
    
    (1,035
    )INVESTING ACTIVITIES:Proceeds related to sales of investments or marketable securities
    
    
    39
    
    
    
    5Proceeds from notes and interest receivable
    
    
    2,907
    
    
    
    Payments on notes payable
    
    
    (35
    )
    
    
    Purchases of property and equipment
    
    
    (267
    )
    
    
    (223
    )Cash provided by (used for) investing activities
    
    
    2,644
    
    
    
    (218
    )FINANCING ACTIVITIES:Borrowings under short-term borrowing arrangements
    
    
    
    
    
    
    1,081Cash provided by financing activities
    
    
    
    
    
    
    1,081Effects of exchange rate changes on cash
    
    
    5
    
    
    
    3Net increase (decrease) in cash
    
    
    1,440
    
    
    
    (169
    )Cash at beginning of period
    
    
    2,136
    
    
    
    378Cash at end of period
    
    $
    3,576
    
    
    $
    209SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    12
    
    
    $
    19
 The accompanying notes are an integral part of these consolidated financial
statements.
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Intelligent Systems Corporation
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1.
    
    Throughout this report, the terms we, us, ours, ISC and company refer to
Intelligent Systems Corporation, including its majority-owned subsidiaries.
 2.
    
    The unaudited 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, 2007 and 2006.
The interim results for the three months ended March 31, 2007 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, 2006, as filed in our Annual Report on Form 10-KSB.
 3.
    
    Discontinued Operations As explained in more detail in Note 2 to the Consolidated
Financial Statements included in our 2006 Form 10-KSB, effective July 31, 2006, we completed
the sale of the business and certain assets of our QS Technologies, Inc. (QS) subsidiary to
Netsmart Public Health, Inc. and its parent company, Netsmart Technologies, Inc., referred to
collectively as Netsmart. In accordance with Financial Accounting Standards Board Statement
No.144, Accounting for the Impairment or Disposal of Long-Lived Assets, the QS business is
presented as discontinued operations for the three months ended March 31, 2007 and 2006.The following condensed financial information is provided for the QS Discontinued Operations for
the periods shown.
 Three Months Ended March 31,(in thousands)
    
    2007
    
    
    2006Net sales
    
    
    
    
    
    $
    734Operating income
    
    
    
    
    
    
    174Net income before tax
    
    
    
    
    
    
    174Income tax
    
    
    
    
    
    
    Net income from discontinued operations
    
    $
    
    
    
    $
    174
 4.
    
    Contract Settlement In February 2007, our CoreCard subsidiary reached a mutual agreement
with one of its customers to terminate a Software License Agreement between them. The
Settlement Agreement assigns no fault to either party and reflects a change in priorities and
available funding at the customer. The customer paid $380,000 on the effective date of the
Settlement Agreement, including a $100,000 termination fee, resulting in aggregate
non-refundable payments to Corecard of $1.1 million under the Software License Agreement
(including amounts paid in 2006 and included in deferred revenue as of December 31, 2006). In
the quarter ended March 31, 2007, the company recognized license revenue of $1.1 million
related to this contract.
 5.
    
    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 Comprehensive Loss
    
    Three Months Ended March 31,(unaudited, in thousands)
    
    2007
    
    
    2006Net loss
    
    $
    (133
    )
    
    $
    (445
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    5
    
    
    
    3Comprehensive loss
    
    $
    (128
    )
    
    $
    (442
    )
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6.
    
    Stock based Compensation  At March 31, 2007, 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 123. We adopted SFAS 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 as of December 31,
2005 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.The estimated fair value of the options granted during prior years was calculated using the
Black Scholes option pricing model with assumptions as previously disclosed in our Form 10-KSB.As a result of the adoption of SFAS 123(R), we recorded $0 and $3,000 of stock-based
compensation expense for the three months ended March 31, 2007 and 2006, respectively, related
to our stock option plans. Had we continued to account for these options under APB 25, we would
have recorded no such expense.As of March 31, 2007, there is no unrecognized compensation cost related to stock options. No
options were granted, exercised or forfeited during the quarter ended March 31, 2007. The
following table summarizes options as of March 31, 2007:
 Wgt Avg
    
    
    Wgt Avg
    
    
    AggregateExercise
    
    
    Remaining
    
    
    Intrinsic# of Shares
    
    
    Price
    
    
    Life in Years
    
    
    ValueOutstanding at March 31, 2007
    
    
    203,666
    
    
    $
    2.39
    
    
    
    5.5
    
    
    $
    388,000Vested and exercisable at
March 31, 2007
    
    
    197,666
    
    
    $
    2.40
    
    
    
    5.3
    
    
    $
    375,000
 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 first
quarter of 2007 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
March 31, 2007. The amount of aggregate intrinsic value will change based on the fair market
value of the companys stock.7.
    
    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 March 31,(unaudited)
    
    2007
    
    
    2006VISaer Customer A
    
    
    
    
    
    
    31
    %CoreCard Customer B
    
    
    28
    %
    
    
    ChemFree Customer C
    
    
    10
    %
    
    
    
 8.
    
    Notes Receivable As explained in Note 2 to the Consolidated Financial Statements included
in our 2006 Form 10-KSB, in connection with the sale of our QS Technologies business, we
received a promissory note from the buyer in the amount of $1,435,000. The principal amount of
the note was subject to adjustment based on revenue and earnings of the QS business for the
period from August 1, 2006 through January 31, 2007. In the quarter ended March 31, 2007, the
buyer informed the company that it was not proposing any adjustment to the note. Accordingly,
in the three months ended March 31, 2007, the company reversed the balance of its transaction
related contingency accrual and recognized additional gain of $97,000 on the sale of the QS
discontinued operations.On August 31, 2006, as explained in Note 3 to the Consolidated Financial Statements included in
our 2006 Form 10-KSB, we received a promissory note from the buyer of our Horizon Software
investment in the principal amount of $2,850,000. On January 4, 2007, the note and accrued
interest were paid in full.
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9.
    
    Industry Segments Segment information is presented consistently with the basis described
in the 2006 Form 10-KSB. The table following contains segment information for continuing
operations for the quarters ended March 31, 2007 and 2006.
 Three Months Ended March 31,(unaudited, in thousands)
    
    2007
    
    
    2006Information TechnologyRevenue
    
    $
    2,104
    
    
    $
    3,152Operating loss
    
    
    (48
    )
    
    
    (263
    )Industrial ProductsRevenue
    
    
    1,945
    
    
    
    1,724Operating income (loss)
    
    
    159
    
    
    
    (94
    )Consolidated SegmentsRevenue
    
    
    4,049
    
    
    
    4,876Operating income (loss)
    
    
    111
    
    
    
    (357
    )Corporate expenses
    
    
    (385
    )
    
    
    (345
    )Consolidated operating loss from continuing operations
    
    $
    (274
    )
    
    $
    (702
    )Depreciation and amortizationInformation Technology
    
    $
    63
    
    
    $
    68Industrial Products
    
    
    59
    
    
    
    60Consolidated segments
    
    
    122
    
    
    
    128Corporate
    
    
    5
    
    
    
    4Consolidated depreciation and amortization
    
    $
    127
    
    
    $
    132Capital ExpendituresInformation Technology
    
    $
    227
    
    
    $
    5Industrial Products
    
    
    35
    
    
    
    198Consolidated segments
    
    
    262
    
    
    
    203Corporate
    
    
    5
    
    
    
    18Consolidated capital expenditures
    
    $
    267
    
    
    $
    221
 March 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006Identifiable AssetsInformation Technology
    
    $
    3,968
    
    
    $
    3,624Industrial Products
    
    
    3,844
    
    
    
    3,849Consolidated segments
    
    
    7,812
    
    
    
    7,473Corporate
    
    
    5,906
    
    
    
    7,537Consolidated assets
    
    $
    13,718
    
    
    $
    15,010
 10.
    
    Commitments and Contingencies Please refer to Note 9 to our Consolidated Financial
Statements included in our 2006 Form 10-KSB for a description of our commitments and
contingencies. There has been no material change since December 31, 2006 in the commitments
described in such note.Legal Matters  As explained in Note 9 to our Consolidated Financial Statements included in our
2006 Form 10-KSB, on February 6, 2007, an arbitrator issued a ruling in an arbitration
proceeding involving our ChemFree subsidiary versus Zymo International, Inc. (Zymo). The
arbitrator found in ChemFrees favor on all substantive issues. Among other items, the
arbitrator ruled that ChemFree was not in breach of the co-ownership agreement and that Zymo
must pay an aggregate of $156,000 to ChemFree for its share of legal expenses and damages for
lack of cooperation in patent matters cover by the co-ownership agreement. The arbitrator also
ruled that, if Zymo participates in a certain J. Walter patent infringement action after June
30, 2007, it must pay an additional $27,500 to ChemFree. Since the ruling, Zymo paid to
ChemFree $156,000, less $5,000 in expenses allocable to ChemFree for amounts previously paid by
Zymo for
co-owned patent matters. Zymo has also initiated a filing with the court to remove itself from
the J. Walter infringement action.
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ISC Guarantees  In conjunction with a Software License Agreement entered into on June 12, 2003
between our majority owned subsidiary, CoreCard Software, Inc. and a CoreCard customer, ISC
entered into a letter of guarantee with the CoreCard customer. Under the guarantee, in the
event that the Software License is terminated due to CoreCard discontinuing operations, ISC has
guaranteed to make available at its expense up to four employees to provide technical assistance
to the customer during a transition period of up to one year. The guarantee phases out upon the
achievement of certain operational milestones by CoreCard or after five years, whichever occurs
sooner. As of March 31, 2007, it does not appear probable that the guarantee will be paid;
thus no amounts have been accrued with respect to this guarantee.
 11.
    
    New Accounting Pronouncements On July 13, 2006, the FASB issued FASB Interpretation No. 48
(FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48 prescribes a comprehensive
model for how a company should recognize, measure, present and disclose in its financial
statements uncertain tax positions that the company has taken or expects to take on a tax
return. FIN 48 is applicable to all uncertain positions for taxes accounted for under FASB
Statement 109, Accounting for Income Taxes and requires that a company record any change in
net assets that results from the application of the interpretation as an adjustment to
retained earnings. The interpretation is effective for fiscal years that start after December
15, 2006 and, accordingly we adopted FIN 48 effective January 1, 2007. See discussion in Note
12 below.In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements 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, although early adoption is encouraged. We have not yet
determined the impact that the adoption of the standard will have on our 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. Statement
No. 159, which builds on other Statements related to fair value such as Statement 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. We
have not yet determined the impact that the adoption of the standard will have on our financial
statements.
 12.
    
    Adoption of FIN 48 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 48). FIN 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 48. The adoption of FIN 48 did not have a material effect on our
consolidated financial position or results of operations. As of March 31, 2007, 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 interest
expense or penalties were recognized during the three months ended March 31, 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. Our VISaer subsidiary files 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 2003.
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Item 2. Managements Discussion and Analysis or Plan of Operation
 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 6. Managements Discussion and Analysis or Plan
of Operation, in the Form 10-KSB for the year ended December 31, 2006 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 subsidiaries have limited experience in their marketplaces which makes it
difficult to identify and evaluate trends that may impact their business.
 
    
    Our software subsidiaries, CoreCard Software and VISaer, have been involved in major new
product development initiatives for the past six 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.
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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 $3.1
million in the three month period ended March 31, 2007, a 67 percent increase compared to $1.9
million in the three months ended March 31, 2006. Product revenue associated with the
Industrial Products segment grew by 13 percent compared to the prior year period and
represented 63 percent of product revenue in the quarter ended March 31, 2007. The increase is
attributed mainly to a higher volume of ChemFree products sold in international markets.
Product revenue associated with the Information Technology segment increased by $1.0 million
in the three months ended March 31, 2007 compared to the same period last year, reflecting a
single software license contract recognized by our CoreCard Software subsidiary.
 
    
    Service revenue decreased by 68 percent, or $2.1 million, in the first quarter of 2007
compared to the same period last year. The change is attributed mainly to a single multi-year
contract at the VISaer subsidiary that was completed and recognized in the first quarter of
2006, contributing $1.8 million in service revenue.
 Cost of Revenue 
 
    
    Cost of product revenue was 35 percent of product revenue in the first quarter of 2007
compared to 54 percent of product revenue in the same period in 2006. The principal reason
for the difference in product cost as a percent of product revenue is due to the fact that
a higher percentage of product revenue in the first quarter of 2007 is software license
revenue which has a very low cost of revenue compared to the cost of revenue associated
with industrial products, which averaged 55 percent and 57 percent in the three months
ended March 31, 2007 and 2006, respectively.
 
    
    Cost of service revenue (which relates to the software subsidiaries only) was 59 percent
and 47 percent of service revenue in the three months ended March 31, 2007 and 2006,
respectively. The change between periods reflects primarily the fact that VISaers single
multi-year contract that contributed $1.8 million in service revenue in 2006 had a
proportionately lower cost of sales than is typical of professional services contracts and
maintenance revenue. In addition, in the first quarter of 2007, the number of hours and
the average standard cost associated with CoreCards customer support activities were
higher than in the same period in 2006.
 Operating Expenses
 Interest Income (Expense)
 Investment Income
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Equity Earnings of Affiliate Companies 
 Other Income (Expense), Net
 Income Taxes
 Discontinued Operations
 Net income from Discontinued Operations 
 Gain on Sale of Discontinued Operations
 Liquidity and Capital Resources
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Off-Balance Sheet Arrangements
  Critical Accounting Policies and Estimates
  Factors That May Affect Future Operations
   
    
    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 or poor quality control 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.
 
    
    The inability of our software subsidiaries to retain key software developers and managers who have accumulated years of
know-how in our target markets and company products, or failure 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.
 
    
    Further increases in the price of oil, which could increase ChemFrees product costs and which could affect VISaers
results if potential aviation customers delay or cancel purchases of software or services in the face of declining
industry trends or poor financial condition.
 
    
    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.
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##### Table of Contents




    
    Increased operating expenses and diversion of resources related to compliance with the internal control over financial
reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
 
    
    Negative trends affecting the commercial aviation industry worldwide which could impact VISaers short-term customer
purchases, thus increasing its losses and need for cash.
 
    
    In the Industrial Products market, failure by ChemFree to protect its intellectual property assets, which could
increase competition in the marketplace and result in greater price pressure and lower margins, thus impacting sales,
profits and projected cash flow.
 
    
    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 and greater cash
requirements.
 
    
    Other general economic and political conditions that cause customers to delay or cancel software purchases.
  
 Item 3. Controls and Procedures
  
 Part II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 6. Exhibits
  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.
  Page 14




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##### Table of Contents



SIGNATURES
  INTELLIGENT SYSTEMS CORPORATION
RegistrantDate:  May 15, 2007
    By:
    /s/ J. Leland StrangeJ. Leland StrangeChief Executive Officer, PresidentDate:  May 15, 2007
    By:
    /s/ Bonnie L. HerronBonnie L. HerronChief Financial Officer  Page 15




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EXHIBIT INDEX
 ExhibitNo.
    
    Description3(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.
  Page 16