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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 September 30, 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 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes o No þ As of October 31, 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  Part I. FINANCIAL INFORMATIONItem 1. Financial StatementsIntelligent Systems Corporation CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts)Intelligent Systems Corporation CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited; in thousands, except share and per share amounts)Intelligent Systems Corporation CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (unaudited, in thousands)Intelligent Systems Corporation NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSItem 2. Managements Discussion and Analysis or Plan of OperationsItem 3. Controls and ProceduresPart II. OTHER INFORMATIONItem 1. Legal MattersItem 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  
 Part I. FINANCIAL INFORMATION 
 Item 1. Financial Statements 
 Intelligent Systems Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share amounts) September 30,
    
    December 31,2004
    
    2003ASSETS
    
    (unaudited)Current assets:Cash
    
    $
    1,215
    
    
    $
    1,133Accounts receivable, net
    
    
    2,127
    
    
    
    1,543Notes and interest receivable
    
    
    
    
    
    
    142Inventories
    
    
    722
    
    
    
    766Other current assets
    
    
    249
    
    
    
    614Total current assets
    
    
    4,313
    
    
    
    4,198Long-term investments
    
    
    4,985
    
    
    
    6,275Property and equipment, at cost less accumulated depreciation
    
    
    685
    
    
    
    746Goodwill, net
    
    
    1,955
    
    
    
    2,039Other intangibles, net
    
    
    821
    
    
    
    476Other assets, net
    
    
    20
    
    
    
    8Total assets
    
    $
    12,779
    
    
    $
    13,742LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    125
    
    
    $
    250Accounts payable
    
    
    1,086
    
    
    
    932Deferred revenue
    
    
    4,676
    
    
    
    2,586Deferred gain
    
    
    257
    
    
    
    291Accrued expenses and other current liabilities
    
    
    1,737
    
    
    
    2,037Total current liabilities
    
    
    7,881
    
    
    
    6,096Deferred revenue, net of current portion
    
    
    
    
    
    
    5,060Other long-term liabilities
    
    
    351
    
    
    
    Minority interest
    
    
    1,516
    
    
    
    1,516Commitments and contingencies (note 14)Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 shares
issued and outstanding at September 30, 2004 and December 31, 2003
    
    
    45
    
    
    
    45Paid-in capital
    
    
    18,410
    
    
    
    18,410Accumulated other comprehensive loss
    
    
    (91
    )
    
    
    (60
    )Accumulated deficit
    
    
    (15,333
    )
    
    
    (17,325
    )Total stockholders equity
    
    
    3,031
    
    
    
    1,070Total liabilities and stockholders equity
    
    $
    12,779
    
    
    $
    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
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003RevenuesProducts
    
    $
    4,291
    
    
    $
    1,727
    
    
    $
    9,303
    
    
    $
    5,231Services
    
    
    6,125
    
    
    
    1,021
    
    
    
    9,068
    
    
    
    3,508Total revenue
    
    
    10,416
    
    
    
    2,748
    
    
    
    18,371
    
    
    
    8,739Cost of revenueProducts
    
    
    1,054
    
    
    
    855
    
    
    
    2,843
    
    
    
    2,520Services
    
    
    2,775
    
    
    
    755
    
    
    
    4,292
    
    
    
    2,597Total cost of revenue
    
    
    3,829
    
    
    
    1,610
    
    
    
    7,135
    
    
    
    5,117ExpensesMarketing
    
    
    634
    
    
    
    714
    
    
    
    1,981
    
    
    
    2,166General & administrative
    
    
    996
    
    
    
    883
    
    
    
    2,805
    
    
    
    2,917Research & development
    
    
    1,684
    
    
    
    2,076
    
    
    
    5,885
    
    
    
    6,256Income (loss) from operations
    
    
    3,273
    
    
    
    (2,535
    )
    
    
    565
    
    
    
    (7,717
    )Other incomeInterest income (expense), net
    
    
    2
    
    
    
    9
    
    
    
    (6
    )
    
    
    4Investment income (expense), net
    
    
    1,728
    
    
    
    (24
    )
    
    
    1,357
    
    
    
    3,645Equity in earnings of affiliate companies
    
    
    46
    
    
    
    80
    
    
    
    59
    
    
    
    47Other income (expense), net
    
    
    (33
    )
    
    
    74
    
    
    
    17
    
    
    
    288Income (loss) before income tax benefit
    
    
    5,016
    
    
    
    (2,396
    )
    
    
    1,992
    
    
    
    (3,733
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (104
    )Net income (loss)
    
    $
    5,016
    
    
    $
    (2,396
    )
    
    $
    1,992
    
    
    $
    (3,629
    )Basic income (loss) per share
    
    $
    1.12
    
    
    $
    (0.53
    )
    
    $
    0.44
    
    
    $
    (0.81
    )Diluted income (loss) per share
    
    $
    1.09
    
    
    $
    (0.53
    )
    
    $
    0.43
    
    
    $
    (0.81
    )Basic weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,484,954Diluted weighted average shares outstanding
    
    
    4,584,210
    
    
    
    4,478,971
    
    
    
    4,585,742
    
    
    
    4,484,954
 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) Nine Months Ended September 30,2004
    
    2003OPERATIONS:Net income (loss)
    
    $
    1,992
    
    
    $
    (3,629
    )Adjustments to reconcile net income (loss) to net cash used for operating
activities, net of effects of acquisitions and dispositions:Depreciation and amortization
    
    
    432
    
    
    
    558Deferred gain recognized
    
    
    (34
    )
    
    
    (99
    )Investment (income) loss, net
    
    
    (1,357
    )
    
    
    (3,636
    )Equity in income of affiliate companies
    
    
    (59
    )
    
    
    (47
    )Changes in operating assets and liabilities, net of effects of acquisitionAccounts receivable
    
    
    (584
    )
    
    
    848Inventories
    
    
    44
    
    
    
    (80
    )Other current assets
    
    
    (87
    )
    
    
    (6
    )Accounts payable
    
    
    154
    
    
    
    (238
    )Accrued expenses and other liabilities
    
    
    (2,938
    )
    
    
    2,034Cash used for operating activities
    
    
    (2,437
    )
    
    
    (4,295
    )INVESTING ACTIVITIES:Proceeds related to sales of investments
    
    
    2,645
    
    
    
    4,540Distributions from (acquisition of) long-term investments, net
    
    
    180
    
    
    
    (160
    )Repayments under notes receivable
    
    
    15
    
    
    
    79Advances under notes receivable
    
    
    
    
    
    
    (224
    )Purchases of property and equipment
    
    
    (178
    )
    
    
    (215
    )Cash provided by investing activities
    
    
    2,662
    
    
    
    4,020FINANCING ACTIVITIES:Repayments under short-term borrowing arrangements
    
    
    (125
    )
    
    
    Purchase and retirement of common stock
    
    
    
    
    
    
    (22
    )Cash used for financing activities
    
    
    (125
    )
    
    
    (22
    )Effects of exchange rate changes on cash
    
    
    (18
    )
    
    
    (27
    )Net increase (decrease) in cash
    
    
    82
    
    
    
    (324
    )Cash at beginning of period
    
    
    1,133
    
    
    
    2,644Cash at end of period
    
    $
    1,215
    
    
    $
    2,320SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    2
    
    
    $
    
 The accompanying notes are an integral part of these condensed consolidated financial statements. Page 4




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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 and nine month periods ended September
30, 2004 and 2003. The interim results for the three and nine months
ended September 30, 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.
    
    Sale of Investment in Cirronet, Inc. On May 10, 2004, we sold
1,340,990 shares of common stock of Cirronet, Inc., representing all of
the Cirronet stock held by us, in a private transaction for an aggregate
price of $1,073,000, paid in cash at the closing. We recognized a gain of
$256,000 on the transaction in the quarter ended June 30, 2004, on a
carrying value of $817,000 and an original cost basis of $525,000. This
gain is included in year-to-date investment income (loss) on the
Consolidated Statement of Operations.  4.
    
    Write-down of Ardext Technologies, Inc. In the quarter ended June 30,
2004, we wrote down the carrying value of our investment in Ardext
Technologies, Inc. We recorded a charge of $465,000 against
long-term investments and $162,000 against notes and interest receivable.
In the quarter ended September 30, 2004, we reserved an additional $12,000
for a total investment write-off of $639,000. Although Ardext has a
promising technology and is making progress in semiconductor customer
trials of its initial software products, the companys timetable to and
ability to fund operations to breakeven is difficult to predict.
Accordingly, we believe it is unlikely we will recover our investment and
accordingly have reserved against the full carrying value.  5.
    
    Sale of Principal Asset of ISC Guernsey, Ltd. We own a 19 percent
interest in ISC Guernsey, Ltd., an entity whose principal asset was an
investment in a U.K. based company. During the second quarter of 2004, we
were informed that ISC Guernsey sold its investment in the U.K. company
for cash and that it expected to distribute a significant portion of the
proceeds to its shareholders in the future, after determining its ongoing
business needs. In August 2004, we received an initial cash distribution
of $1,567,000 which is reflected in investment income in the three and
nine-month periods ended September 30, 2004. Based on information we have
received from ISC Guernsey, other distributions to us are likely to follow
later in 2004 or early in 2005 and are expected to aggregate between $2.0
and $3.0 million. However, we are not in a position to exert influence
over the timing or extent of such distributions. At September 30, 2004,
the carrying value of our minority owned investment in ISC Guernsey is
$31,000. Based on our current projections, we do not expect to have any
tax withholdings or to incur a tax liability related to these cash
distributions.  6.
    
    Deferred Gain on Sale of RF Solutions, Inc. On September 28, 2004, we
received 47,025 shares of common stock of Anadigics, Inc., a publicly
traded company [NASDAQ:ANAD] as additional consideration related to the
sale in March 2003 of our interest in RF Solutions, Inc. to Anadigics. At
the time of the original sale, we wrote down the carrying value of our
interest in RF Solutions to zero due to the uncertainty of any additional
consideration receivable. Upon receipt of the shares of Anadigics stock,
we recorded investment income of $174,000 in the third quarter of 2004 and
are carrying the stock at its fair market value of $161,000 at September
30, 2004 in accordance with Statement of Financial Accounting Standards
No. 115 , Accounting for Certain Investments in Debt and Equity
Securities.  7.
    
    Settlement of Legal Matters As explained in Part II, Item 1 Legal
Matters of this report, during the quarter ended September 30, 2004, an
agreement was reached in certain litigation matters relating to ownership
of ChemFree patents. ChemFree secured a full assignment of interests in
all of ChemFrees patents and patent applications worldwide (41 in the
aggregate) from a former consultant of the company in return for periodic
payments over a five year period. The payment schedule provides for four
monthly payments of $25,000, beginning August 1, 2004, and 48 monthly
payments of $8,500 beginning in August 1, 2005 for an aggregate
consideration of $508,000 ($451,000 discounted at 6.5%). In accordance
with Statement of Financial Accounting Standards No. 142, Accounting for
Intangible Assets, we believe that the present value of the payment
stream ($451,000) is fully recoverable at this time. Based on our current
estimations, we believe the average useful life of these patents to be 10
years, which does not exceed legal lives. In the Page 5




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quarter ended September 30, 2004, amortization
expense related to this asset
was $3,670. The unamortized value of the ChemFree patents is included in
the category other intangibles, net  on the balance sheet at September 30,
2004.  8.
    
    Related Party TransactionAs previously disclosed in a Form 8-K filed
on May 11, 2004, the lease on our headquarters and primary facility at
4355 Shackleford Road, Norcross, Georgia expired May 31, 2004. The
current landlord was unwilling to renew this lease and had instead
expressed a desire to sell the facility. On June 1, 2004, ISC Properties,
LLC, an entity controlled by our Chairman and Chief Executive Officer, J.
Leland Strange, purchased the facility from the current landlord and
leased approximately 45 percent of the facility to the company in order to
allow us to stay in the present facility and to avoid the disruption and
expense of a move. After careful consideration, the companys Board of
Directors concluded that the lease transaction was fair to the company and
in the best interests of the company and its shareholders, and approved
the lease transaction between the company and ISC Properties, LLC
effective June 1, 2004. Mr. Strange recused himself from deliberations
concerning, and voting to approve, the lease transaction. In connection
with this approval, the Board of Directors waived the conflict of interest
provisions of our Code of Ethics as they apply to Mr. Strange in
connection with the lease transaction. We also evaluated the arrangement
to determine if ISC Properties, LLC should be considered a Variable
Interest Entity (VIE) within the guidance of Financial Accounting
Standards Board FIN No. 46. After carefully considering the
characteristics of the relationship between the company and ISC
Properties, LLC, it was determined that ISC Properties, LLC did not meet
the criteria of a VIE and, as a result, ISC Properties, LLC is not
consolidated with the company.  9.
    
    Comprehensive Loss In accordance with Financial Accounting Standards
Board Statement No. 130, Reporting Comprehensive Income, comprehensive
loss is the total of net loss and all other non-owner changes in equity in
a period. A summary follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Consolidated Statements of
Comprehensive Loss(unaudited, in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    5,016
    
    
    $
    (2,396
    )
    
    $
    1,992
    
    
    $
    (3,629
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    2
    
    
    
    (7
    )
    
    
    (18
    )
    
    
    (27
    )Unrealized gain (loss) on available-for-sale
securities
    
    
    (13
    )
    
    
    26
    
    
    
    (13
    )
    
    
    64Comprehensive income (loss)
    
    $
    5,005
    
    
    $
    (2,377
    )
    
    $
    1,961
    
    
    $
    (3,592
    )
  10.
    
    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, in thousands)
    
    2004
    
    2003
    
    2004
    
    2003ChemFree Customer A
    
    
    
    
    
    
    19
    %
    
    
    
    
    
    
    13
    %ChemFree Customer B
    
    
    
    
    
    
    14
    %
    
    
    
    
    
    
    11
    %ChemFree Customer C
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10
    %Visaer Customer D
    
    
    72
    %
    
    
    
    
    
    
    41
    %
    
    
    Visaer Customer E
    
    
    
    
    
    
    16
    %
    
    
    
    
    
    
    14
    %
  11.
    
    Stock-Based Compensation At September 30, 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. Page 6




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Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(unaudited, in thousands, except per share data)
    
    2004
    
    2003
    
    2004
    
    2003Net income (loss), reported
    
    $
    5,016
    
    
    $
    (2,396
    )
    
    $
    1,992
    
    
    $
    (3,629
    )Add: stock-based employee compensation included
in reported net 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
    
    
    (10
    )
    
    
    (9
    )
    
    
    (30
    )
    
    
    (21
    )Pro forma net income (loss)
    
    $
    5,006
    
    
    $
    (2,405
    )
    
    $
    1,962
    
    
    $
    (3,650
    )Pro forma net income (loss) per common share
basic
    
    $
    1.12
    
    
    $
    (0.53
    )
    
    $
    0.44
    
    
    $
    (0.81
    )Pro forma net income (loss) per common share
diluted
    
    $
    1.09
    
    
    $
    (0.53
    )
    
    $
    0.43
    
    
    $
    (0.81
    )
  12.
    
    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 was effective in the
quarter beginning after June 15, 2004. The implementation of this
consensus did not have a material impact on our financial position or
results of operations.  13.
    
    Commitments and Contingencies In May 2004, our QS Technologies
subsidiary was awarded a $1.1 million, multi-year software contract with a
state agency that required a performance bond for 10 percent of the
contract value. No revenue has yet been recognized on this contract. To
secure the performance bond, we agreed to guarantee the $115,000 value of
the bond in the event that QS Technologies defaults on the contract.
Initially, we secured the guarantee with a bank Certificate of Deposit in
the amount of $115,000. In July 2004, we substituted a standby letter of
credit that is tied to our $1.5 million bank line of credit for the CD and
converted the CD into unrestricted cash. Based on the successful
performance record of QS Technologies over a twenty-year period, we do not
presently believe the guarantee will be paid; thus no amount has been
accrued with respect to this guarantee.  14.
    
    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. Page 7




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The table following contains segment information for the three and nine
months ended September 30, 2004 and 2003. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(unaudited, in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Information TechnologyRevenue
    
    $
    9,072
    
    
    $
    1,217
    
    
    $
    13,662
    
    
    $
    3,986Operating income (loss)
    
    
    3,615
    
    
    
    (2,422
    )
    
    
    1,099
    
    
    
    (7,468
    )Industrial ProductsRevenue
    
    
    1,344
    
    
    
    1,531
    
    
    
    4,709
    
    
    
    4,753Operating income (loss)
    
    
    (129
    )
    
    
    36
    
    
    
    95
    
    
    
    337Consolidated SegmentsRevenue
    
    $
    10,416
    
    
    $
    2,748
    
    
    $
    18,371
    
    
    $
    8,739Operating income (loss)
    
    
    3,486
    
    
    
    (2,386
    )
    
    
    1,194
    
    
    
    (7,131
    )
 A reconciliation of consolidated segment data above to consolidated income
(loss) follows: Consolidated segments operating income
(loss)
    
    $
    3,486
    
    
    $
    (2,386
    )
    
    $
    1,194
    
    
    $
    (7,131
    )Corporate expenses
    
    
    (213
    )
    
    
    (149
    )
    
    
    (629
    )
    
    
    (586
    )Consolidated operating income (loss)
    
    
    3,273
    
    
    
    (2,535
    )
    
    
    565
    
    
    
    (7,717
    )Interest income (expense)
    
    
    2
    
    
    
    9
    
    
    
    (6
    )
    
    
    4Investment income (loss)
    
    
    1,728
    
    
    
    (24
    )
    
    
    1,357
    
    
    
    3,645Equity of affiliates
    
    
    46
    
    
    
    80
    
    
    
    59
    
    
    
    47Other income (loss)
    
    
    (33
    )
    
    
    74
    
    
    
    17
    
    
    
    288Income (loss) before taxes
    
    
    5,016
    
    
    
    (2,396
    )
    
    
    1,992
    
    
    
    (3,733
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (104
    )Net income (loss)
    
    $
    5,016
    
    
    $
    (2,396
    )
    
    $
    1,992
    
    
    $
    (3,629
    )Depreciation and AmortizationInformation Technology
    
    $
    61
    
    
    $
    152
    
    
    $
    279
    
    
    $
    458Industrial Products
    
    
    49
    
    
    
    30
    
    
    
    132
    
    
    
    80Consolidated segments
    
    
    110
    
    
    
    182
    
    
    
    411
    
    
    
    538Corporate
    
    
    8
    
    
    
    5
    
    
    
    21
    
    
    
    20Consolidated
depreciation and amortization
    
    $
    118
    
    
    $
    187
    
    
    $
    432
    
    
    $
    558Capital ExpendituresInformation Technology
    
    $
    15
    
    
    $
    62
    
    
    $
    16
    
    
    $
    133Industrial Products
    
    
    55
    
    
    
    34
    
    
    
    160
    
    
    
    79Consolidated segments
    
    
    70
    
    
    
    96
    
    
    
    176
    
    
    
    212Corporate
    
    
    3
    
    
    
    
    
    
    
    2
    
    
    
    3Consolidated capital expenditures
    
    $
    73
    
    
    $
    96
    
    
    $
    178
    
    
    $
    215
 September 30,
2004(unaudited)
    
    December 31, 2003Identifiable AssetsInformation Technology
    
    $
    6,524
    
    
    $
    4,740Industrial Products
    
    
    2,524
    
    
    
    2,024Consolidated segments
    
    
    9,048
    
    
    
    6,764Corporate
    
    
    3,731
    
    
    
    6,978Consolidated assets
    
    $
    12,779
    
    
    $
    13,742
 Page 8




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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 including 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 ISCs 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:  
    
    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. The third quarter 2004 results include $7.4 million of revenue and
approximately $4.9 million in profit contribution related to our VISaer
subsidiarys completion of a significant multi-year software contract.
Although the contract had been completed in the quarter ended June 30, 2004,
recognition of revenue was deferred until the third quarter of 2004 due to the
delivery in July 2004 of a then optional specified upgrade right in the
contract. Recognition of this revenue had a significant positive impact on the
companys result of operations for the third quarter ended September 30, 2004.
It is unlikely that VISaer or any of the companys subsidiaries will have
another contract of the same size in the foreseeable future. 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, may 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 and accepted by customers. Depending upon the size and number of
software licenses recognized in a Page 9




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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. 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 other 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. For instance, as explained in Notes 3 and 4 to the financial
statements, in the quarter ended June 30, 2004, we recognized a gain of
$256,000 on the unsolicited sale of our holdings in Cirronet, Inc. and also
wrote down the value of our holdings in Ardext Technologies, Inc. by $627,000
yielding a net investment loss of $371,000 for the quarter. Neither of these
events was predictable by us as to amount or timing with any degree of
confidence in advance. Similarly, as explained in Note 5 to the financial
statements, our 19 percent interest in ISC Guernsey Ltd., which is carried at
$31,000 as of September 30, 2004, resulted in a cash distribution of $1.57
million received in the third quarter ended September 30, 2004 and additional
cash distributions aggregating between $2.0 million and $3.0 million are
expected. However, in accordance with GAAP, cost basis investments are not
written up for expected cash distributions because we do not exert any control
over ISC Guernsey. As such we record the positive financial impact of these
cash distributions when ISC Guernsey actually makes cash distributions from the
proceeds of its asset sale to us. Based on our current projections, we do not
expect to have any tax withholdings or to incur a tax liability related to
these cash distributions. The net income of $5.0 million earned by the company in the third quarter of
2004 resulted in positive stockholders equity of $3.0 million as of September
30, 2004 compared to negative stockholders equity of $2.0 million at June 30,
2004. This negative equity position related to operating losses and deferral
of the VISaer software contract in the first half of 2004 was a very short-term
situation that was rectified in July 2004 with the recognition of the VISaer
contract. 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 expect
to reduce the personnel and overhead expenses to align their cost structure
with their business resources and prospects. Results of Operations The following discussion should be read in conjunction with the Consolidated
Financial Statements and the Notes to Consolidated Financial Statements
presented in this quarterly report. Revenue Total revenue in the three and nine month periods ended September 30,
2004 was $10,416,000 and $18,371,000, a 279 percent and 110 percent increase,
respectively, compared to the same periods in 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, was
$4,291,000 and $9,303,000 in the three and nine month periods of 2004,
representing increases of 148 percent and 78 percent, respectively, compared to
the same periods in 2003. The increase in product revenue in both periods is
due mainly to the recognition of $2,656,000 in software license revenue related
to the VISaer contract with UPS. Additionally, the nine-month period ended
September 30, 2004 includes $1,377,000 in software license revenue at the
CoreCard subsidiary due to completion of its first major customer installation
in the first quarter of 2004. Revenue from ChemFree industrial products
represented 31 percent and 50 percent of total product revenue in the three and
nine month periods of 2004 compared to approximately 90 percent of product
revenue in the three and nine month periods ended September 30, 2003. The
change in percent of product revenue attributable to ChemFree products is due
to the fact that the total revenue from ChemFree sales was slightly lower in
the third quarter and approximately flat in the year-to-date periods in 2004
compared to the same periods last year. The decline in ChemFree revenue in the
third quarter of 2004 reflects mainly lower unit volume sales in the domestic
market of SmartWasher machines offset in part by increased revenue from leased
machines and international sales. Page 10




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We do not expect that revenue and profit contribution from software licenses in
the last quarter of 2004 or in the foreseeable future will approach that of the
third quarter of 2004 since the multi-year VISaer software contract recognized
in the third quarter was significantly larger than the average software sale at
any of the software subsidiaries. At the end of September 30, 2004, we have
$4.7 million in net deferred revenue included on our balance sheet as a
liability in the category of current deferred revenue that is expected to be
recognized over the next 12 months. However, the specific timing of revenue
recognition for software licenses is difficult to predict with certainty due to
a number of factors such as acceptance criteria or scheduling delays due to
customer changes in funding or program priorities. Service revenue increased by 500 percent and 158 percent in the three and nine
month periods ended September 30, 2004, respectively, compared to the same
periods in 2003. The principal factor contributing to the increase in 2004 was
a higher level of professional services and reimbursable expenses at the VISaer
subsidiary related to the UPS contract. In addition, consolidated service
revenue increased during the three and nine-month periods of 2004 as compared
to the same periods in 2003 due to a more billable professional services and
annual maintenance fees due to a larger installed base of software customers at
all of the software subsidiaries. Cost of Revenue In the three and nine month periods ended September 30, 2004,
total cost of revenue was 37 percent and 39 percent, respectively, of
consolidated revenue compared to 59 percent in each of the comparative periods
in 2003.  
    
    Cost of product revenue was 25 percent of product revenue in the
three month period ended September 30, 2004 compared to 50 percent in
the corresponding three month period in 2003. Cost of product revenue
was 31 percent of product revenue in the nine month period ended
September 30, 2004 compared to 48 percent in the same period last year.
The principal reason for the difference in the three and nine-month
periods is due to the fact that software license revenue, which
represented a significantly higher proportion of product revenue in
2004, has a much lower cost of sales than ChemFree industrial products,
which represented almost 90 percent of product revenue in the three and
nine-month periods of 2003 and which have an average cost of sales of
approximately 52 percent.  
    
    Cost of service revenue (which relates to the software subsidiaries
only) was 45 percent in the three month period ended September 30, 2004
compared to 74 percent in the corresponding period in 2003. For the
nine month period ended September 30, 2004, cost of service revenue was
47 percent of service revenue compared to 74 percent of service revenue
in the same period of 2003. The period-to-period decrease as a
percentage of service revenue reflects mainly lower average cost
allocable to the VISaer service revenue related to the UPS contract and
more efficient utilization of professional services employees at the
VISaer subsidiary, partially offset by a slight increase in year-to-date
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 and nine month periods ended September 30,
2004, total consolidated operating expenses decreased by ten percent and six
percent, respectively, compared to the corresponding periods in 2003.
Marketing expense declined by 11 percent and nine percent in the three and
nine-month periods of 2004 compared to 2003 principally due to lower sales
personnel costs at VISaer. General and administrative costs were 13 percent
higher in the third quarter of 2004 but four percent lower year-to-date in 2004
compared to the corresponding periods in 2003. Of the $113,000 increase in
the third quarter, approximately $54,000 relates to higher legal fees at
ChemFree and the balance is due to higher facility rent and insurance expenses.
Year-to-date, the decline of $113,000 includes lower amortization and
personnel expenses at VISaer and QS Technologies offset in part by increased
legal fees at ChemFree and higher rent expenses. Research and development
expenses were 19 percent and six percent lower in the three and nine month
periods ended September 30, 2004 compared to the same periods last year. Most
of the decline is due to lower personnel costs reflecting fewer employees at
VISaer and CoreCard and more use of lower cost testing personnel at the
CoreCards offshore subsidiary. Investment Income In the three and nine month periods ended September 30,
2004, we recorded net investment income $1,728,000 and $1,357,000,
respectively. In the three and nine month periods, investment income includes
$1,567,000 related to the ISC Guernsey distribution and $174,000 related to the
deferred gain on the RF Solutions sale, as described in more detail in Notes 5
and 6, respectively, to the financial statements. In the year-to-date period
of 2004, the net investment income also includes an investment gain of $256,000
on the sale of our Cirronet stock offset by a write-down of our investment and
notes receivable totaling $639,000 related to Ardext Technologies, Inc., as
more fully explained in Notes 3 and 4 to the financial statements. In the
corresponding periods of 2003, we recorded an investment loss of $24,000 and a
net investment gain of $3,645,000, respectively. Included in the year-to-date
investment income in 2003 is income related to the settlement of an escrow fund
in the first and second quarters of 2003 arising from the sale of our ownership
interest in PaySys International, Inc., offset in part by a write-down in the
first quarter of 2003 to reduce the carrying value of our Page 11




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investment in RF Solutions, Inc., as more fully explained in Note 3 to the consolidated
financial statements in our Form 10-K for 2003. 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 $46,000 and $59,000 in net
equity in income of affiliate companies in the three and nine month periods
ended September 30, 2004, respectively, compared to $80,000 and $47,000 in net
equity in income of affiliate companies in the corresponding periods in 2003.
These results include our pro rata share of the net earnings and losses
reported by five affiliate companies (Alliance Technology Ventures, CoreXpand,
Riverside Software, Cirronet and Horizon Software) in 2004 and four affiliate
companies (CoreXpand, Riverside Software, MediZeus, and Horizon Software) in
2003. Other Income (Expense),
Net We recorded $33,000 in other expense and $17,000
in other income in the three and nine month periods ended September 30, 2004,
respectively, compared to other income of $74,000 and $288,000 in the
corresponding periods in 2003. In the third quarter of 2004, the amount
reflects foreign currency exchange losses. Year-to-date 2004 figures also
include recognition of $34,000 in deferred gain related to a VISaer product
line sale in July 2000 and $17,000 in other miscellaneous income, the majority
of which relates to foreign currency exchange gains. In 2003, the year-to-date
amounts include $99,000 deferred gain related to the VISaer product line sale
in July 2000, $118,000 in foreign currency exchange gain and approximately
$71,000 in non-recurring miscellaneous income. Income Taxes We did not accrue for any income tax liability in year-to-date
2004 because we currently estimate the company will not incur income tax
liability in 2004 and we believe the deferred tax assets should be fully
reserved given their character and our historical losses. The income tax benefit
of $104,000 recorded in 2003 reflects a refund of alternative minimum taxes
paid by the VISaer subsidiary in a prior year. Liquidity and Capital Resources Our cash balance at September 30, 2004 was $1,215,000 compared to $1,133,000 at
December 31, 2003. The companys principal uses of cash during the nine months
ended September 30, 2004 were for corporate expenses of $629,000, an increase
of $584,000 in accounts receivable mainly at the QS Technologies and ChemFree
subsidiaries, $125,000 to reduce the balance of the line of credit, and
$2,500,000 to support operations at the VISaer and CoreCard subsidiaries.
Sources of cash included $1,572,000 related to the distribution from ISC
Guernsey, $1,073,000 from the sale of our investment in Cirronet, Inc., a net
increase of $2,090,000 in current deferred revenue related to payments by
customers for software licenses and annual software maintenance contracts for
which the related revenue will be recognized within 12 months, offset by a
reduction of $206,000 in accrued payroll mainly for bonuses earned in 2003 and
paid in 2004 and other minor items. We have several near-term sources of cash to support any negative cash flow
from consolidated operations, including the remaining cash distributions
expected related to the ISC Guernsey transaction as explained in Note 5 to the
financial statements and periodic draws against our bank line of credit, if
needed. As of September 30, 2004, the outstanding balance on our line of
credit was $125,000 (which has been subsequently paid down to zero) and the
current availability under the line of credit is $1,385,000. Our bank line of
credit was renewed in September 2004 on terms and conditions substantially the
same as for the expiring line. We believe the anticipated cash distributions
from the ISC Guernsey transaction and cash flow from consolidated operations
will provide for our cash requirements for at least the next twelve months. In
addition, if our subsidiaries business operations or cash flows do not develop
as anticipated, we would expect to reduce personnel and overhead expenses to
align their cost structure with their business resources and prospects. 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 nine months Page 12




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ended September 30, 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 We entered into a new five-year facility lease on our principal facility in
Norcross, GA in June 2004 and our VISaer subsidiary entered into a new three
year lease on its facility in Andover, MA in July 2004, both of which are
included in the table below for our operating lease obligations. Additionally,
in the quarter ended September 30, 2004, our ChemFree subsidiary reached a
settlement with respect to two long-standing legal matters related to patent
issues. The agreement provides for assignment of disputed patent rights to
ChemFree in exchange for payments spread over a five year period aggregating
$508,000 ad explained in more detail in Part II, Item 1 of this report.
Payments totaling $50,000 were made in the quarter ended September 30, 2004,
payments totaling $50,000 are due in the fourth quarter of 2004 and the
remaining payments are due in equal monthly increments of $8,500 beginning
August 2005. We have no other long-term contractual obligations. Payment Due By PeriodContractual Obligations
    
    
    
    
    
    Less than
    
    1-3
    
    3-5
    
    More than(in thousands)
    
    Total
    
    1 year
    
    years
    
    years
    
    5 yearsOperating Lease Obligations
    
    $
    2,300
    
    
    $
    157
    
    
    $
    1,586
    
    
    $
    557
    
    
    
    ChemFree Patent Payments
    
    
    458
    
    
    
    50
    
    
    
    238
    
    
    
    170
    
    
    
    Total
    
    $
    2,758
    
    
    $
    207
    
    
    $
    1,824
    
    
    $
    727
    
    
    
    
 Off-Balance Sheet Arrangements We do not currently have any off balance sheet arrangements that are reasonably
likely to have a current or future material effect on our financial condition,
liquidity, capital expenditures or resources or results of operations. Factors That May Affect Future Operations Our 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:  
    
    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. Page 13




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##### Table of Contents




    
    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 low
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.  
    
    A significant increase in the costs associated with audits, reviews
and activities to comply with the provisions of the Sarbanes-Oxley Act
of 2002, particularly with respect to Section 404.  
    
    Other general economic and political conditions, particularly those
that 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. 
 Part II. OTHER INFORMATION 
 Item 1. Legal Matters During the quarter ended September 30, 2004, a court order was entered in the
United States District Court for the Northern District of Georgia approving an
agreement reached by the companys ChemFree subsidiary with a former consultant
related to certain patent ownership matters that was the subject of a lawsuit
pending in the Federal courts for a number of years. The agreement between the
parties provided for assignment to ChemFree of all interests that the
consultant may have had in all of ChemFrees patents and patent applications
worldwide in return for periodic payments aggregating $508,000 over five years
and dismissal of a related lawsuit initiated by the consultant. Accordingly,
on October 5, 2004, a mutual dismissal of the related lawsuit was entered in
the Superior Court of Gwinnett County for the State of Georgia. The accounting
treatment of this agreement relating to patent ownership is explained in note 7
to the financial statements. 
 Item 6. Exhibits and Reports on Form 8-K We filed the following reports on Form 8-K during the quarter ended September 30, 2004:  
    
    Form 8-K filed on August 10, 2004 furnishing a press release on
August 9, 2004 announcing our financial results for the three month
period ended June 30, 2004. 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.) Page 14




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##### Table of Contents



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 CORPORATION
RegistrantDate: November 15, 2004
    
    
    
    By: /s/ J. Leland StrangeJ. Leland Strange
Chief Executive Officer, PresidentDate: November 15, 2004
    
    
    
    By: /s/ Bonnie L. HerronBonnie L. Herron
Chief Financial Officer
 Page 15