##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
  þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 OR
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 1-9330
 INTELLIGENT SYSTEMS CORPORATION
  Georgia
    
    58-1964787(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)4355 Shackleford Road, Norcross, Georgia
    
    30093(Address of principal executive offices)
    
    (Zip Code)
 (770) 381-2900
 þ o
 o þ
  o þ




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##### 



Intelligent Systems Corporation
Index
Form 10-QSB
 PAGEPart I
    
    Financial InformationItem 1.
    
    Financial StatementsConsolidated Balance Sheets at June 30, 2006 and December 31, 2005
    
    
    3Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005
    
    
    4Consolidated Statements of Cash Flow for the six months ended June 30, 2006 and 2005
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Management Discussion and Analysis or Plan of Operation
    
    
    10Item 3.
    
    Controls and Procedures
    
    
    16Part II
    
    Other InformationItem 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    16Item 6.
    
    Exhibits
    
    
    16Signatures
    
    
    17EX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF CFOEX-32.1 SECTION 302 CERTIFICATION OF CEO/CFO
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Item 1. Financial Statements
 Intelligent Systems Corporation
 
 CONSOLIDATED BALANCE SHEETS  (in thousands, except share amounts)
 June 30,
    
    December 31,2006
    
    2005(unaudited)ASSETSCurrent assets:Cash
    
    $
    447
    
    
    $
    378Accounts receivable, net
    
    
    3,590
    
    
    
    1,827Inventories
    
    
    1,039
    
    
    
    770Other current assets
    
    
    498
    
    
    
    355Total current assets
    
    
    5,574
    
    
    
    3,330Long-term investments
    
    
    4,173
    
    
    
    4,571Property and equipment, at cost less accumulated depreciation
    
    
    1,150
    
    
    
    940Goodwill, net
    
    
    2,047
    
    
    
    2,047Other intangibles, net
    
    
    445
    
    
    
    532Other assets, net
    
    
    28
    
    
    
    17Total assets
    
    $
    13,417
    
    
    $
    11,437LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    2,012
    
    
    $
    100Accounts payable
    
    
    1,801
    
    
    
    847Deferred revenue
    
    
    4,531
    
    
    
    4,779Accrued payroll
    
    
    1,036
    
    
    
    1,092Accrued expenses and other current liabilities
    
    
    1,263
    
    
    
    849Total current liabilities
    
    
    10,643
    
    
    
    7,667Other long-term liabilities
    
    
    486
    
    
    
    248Commitments and contingencies (Note 8)Minority interest
    
    
    1,516
    
    
    
    1,516Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized,
4,478,971 shares issued and outstanding at June 30, 2006 and
December 31, 2005
    
    
    45
    
    
    
    45Paid-in capital
    
    
    18,410
    
    
    
    18,410Accumulated other comprehensive loss
    
    
    (74
    )
    
    
    (61
    )Accumulated deficit
    
    
    (17,609
    )
    
    
    (16,388
    )Total stockholders equity
    
    
    772
    
    
    
    2,006Total liabilities and stockholders equity
    
    $
    13,417
    
    
    $
    11,437
 The accompanying notes are an integral part of these consolidated financial statements.
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Intelligent Systems Corporation
 
 CONSOLIDATED STATEMENTS OF OPERATIONS  (unaudited; in thousands, except share and per share amounts)
 Three Months Ended June 30
    
    
    Six Months Ended June 302006
    
    
    2005
    
    
    2006
    
    
    2005RevenueProducts
    
    $
    2,427
    
    
    $
    2,820
    
    
    $
    4,466
    
    
    $
    4,883Services
    
    
    1,802
    
    
    
    1,842
    
    
    
    5,374
    
    
    
    3,358Total revenue
    
    
    4,229
    
    
    
    4,662
    
    
    
    9,840
    
    
    
    8,241Cost of salesProducts
    
    
    1,226
    
    
    
    869
    
    
    
    2,227
    
    
    
    1,732Services
    
    
    751
    
    
    
    980
    
    
    
    2,404
    
    
    
    1,849Total cost of sales
    
    
    1,977
    
    
    
    1,849
    
    
    
    4,631
    
    
    
    3,581ExpensesMarketing
    
    
    595
    
    
    
    601
    
    
    
    1,186
    
    
    
    1,142General & administrative
    
    
    949
    
    
    
    800
    
    
    
    2,143
    
    
    
    1,759Research & development
    
    
    1,545
    
    
    
    1,675
    
    
    
    3,245
    
    
    
    3,302Loss from operations
    
    
    (837
    )
    
    
    (263
    )
    
    
    (1,365
    )
    
    
    (1,543
    )Other incomeInterest income (expense), net
    
    
    (33
    )
    
    
    12
    
    
    
    (61
    )
    
    
    18Investment income, net
    
    
    2
    
    
    
    914
    
    
    
    7
    
    
    
    1,956Equity in earnings of affiliate companies
    
    
    91
    
    
    
    19
    
    
    
    163
    
    
    
    36Other income, net
    
    
    1
    
    
    
    13
    
    
    
    35
    
    
    
    21Income (loss) before income taxes
    
    
    (776
    )
    
    
    695
    
    
    
    (1,221
    )
    
    
    488Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Net income (loss)
    
    $
    (776
    )
    
    $
    695
    
    
    $
    (1,221
    )
    
    $
    476Basic net income (loss) per share
    
    $
    (0.17
    )
    
    $
    0.16
    
    
    $
    (0.27
    )
    
    $
    0.11Diluted net income (loss) per share
    
    $
    (0.17
    )
    
    $
    0.15
    
    
    $
    (0.27
    )
    
    $
    0.10Basic weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971Diluted weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,628,183
    
    
    
    4,478,971
    
    
    
    4,638,043
 The accompanying notes are an integral part of these consolidated financial statements.
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Intelligent Systems Corporation
 
 CONSOLIDATED STATEMENTS OF CASH FLOW  (unaudited, in thousands)
 Six Months Ended June 30,CASH PROVIDED BY (USED FOR):
    
    2006
    
    
    2005OPERATIONS:Net income (loss)
    
    $
    (1,221
    )
    
    $
    476Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:Depreciation and amortization
    
    
    260
    
    
    
    257Stock based compensation expense
    
    
    6
    
    
    
    Investment income, net
    
    
    (7
    )
    
    
    (1,956
    )Equity in earnings of affiliate companies
    
    
    (163
    )
    
    
    (36
    )Changes in operating assets and liabilitiesAccounts receivable
    
    
    (1,763
    )
    
    
    (661
    )Inventories
    
    
    (269
    )
    
    
    (88
    )Other current assets
    
    
    (143
    )
    
    
    (269
    )Other non-current assets
    
    
    
    
    
    
    8Accounts payable
    
    
    953
    
    
    
    (32
    )Accrued payroll
    
    
    (56
    )
    
    
    284Deferred revenue
    
    
    (248
    )
    
    
    898Accrued expenses and other current liabilities
    
    
    398
    
    
    
    (37
    )Other liabilities
    
    
    239
    
    
    
    Cash used for operating activities
    
    
    (2,014
    )
    
    
    (1,156
    )INVESTING ACTIVITIES:Proceeds related to sales of investments
    
    
    183
    
    
    
    2,117Purchases of intangible assets
    
    
    
    
    
    
    (6
    )Distributions from long-term investments
    
    
    385
    
    
    
    9Purchases of property and equipment
    
    
    (384
    )
    
    
    (268
    )Cash provided by investing activities
    
    
    184
    
    
    
    1,852FINANCING ACTIVITIES:Borrowings under short-term borrowing arrangements
    
    
    1,912
    
    
    
    705Repayments under short-term borrowing arrangements
    
    
    
    
    
    
    (672
    )Cash provided by financing activities
    
    
    1,912
    
    
    
    33Effects of exchange rate changes on cash
    
    
    (13
    )
    
    
    32Net increase in cash
    
    
    69
    
    
    
    761Cash at beginning of period
    
    
    378
    
    
    
    670Cash at end of period
    
    $
    447
    
    
    $
    1,431SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    41
    
    
    $
    7Cash paid during the period for income taxes
    
    
    
    
    
    
    
 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 and six month periods ended June 30, 2006 and
2005. The interim results for the three and six months ended June 30, 2006 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, 2005, as filed in our annual report on Form 10-KSB.3.
    
    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:
 Three Months Ended
    
    
    Six Months EndedConsolidated Statements of Comprehensive Income (loss)
    
    June 30,
    
    
    June 30,(unaudited, in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    (776
    )
    
    $
    695
    
    
    $
    (1,221
    )
    
    $
    476Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (15
    )
    
    
    17
    
    
    
    (13
    )
    
    
    32Unrealized loss on available-for-sale securities
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    (85
    )Comprehensive income (loss)
    
    $
    (791
    )
    
    $
    736
    
    
    $
    (1,234
    )
    
    $
    423
 4.
    
    Stock-Based Compensation  At June 30, 2006, we had two stock-based compensation plans under
which stock options have been granted. Stock options for employees generally vest over a
three or four year term and stock options for directors vest over a two year term; options
have a maturity of ten years from issuance date; and option exercise prices are equal to the
closing price on the American Stock Exchange of the common stock on the grant date. Prior to
2006, we accounted for stock-based compensation in accordance with the Accounting Principles
Board (APB) No. 25, Accounting for Stock Issued to Employees, which permitted companies
to use the alternative intrinsic value method of accounting for stock based compensation and
we adopted the disclosure provisions of SFAS No. 123, Accounting for Stock Issued to
Employees. In December 2005, the FASB issued FASB Statement No. 123R, Share Based Payment,
which replaced APB No. 25 and SFAS No. 123. The change was effective for our company for the
reporting period beginning January 1, 2006. SFAS No. 123R requires companies to recognize in
financial statements the cost of employee services received in exchange for awards of equity
instruments based on the grant-date fair value of those awards. We have adopted SFAS 123R
using the modified prospective application method of adoption which requires the company 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. The company has estimated
forfeiture rates based on its historical experience. Stock based compensation for the three
and six month periods ended June 30, 2006 has been recognized as a component of general and
administrative expenses in the accompanying Consolidated Financial Statements.No options were granted, exercised or forfeited in the first six months of 2006. In the second
quarter of 2005, 12,000 options were granted at fair market value on the date of grant pursuant
to the Non-employee Directors Stock Option Plan. 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.As a result of adopting SFAS 123R, the impact to the Consolidated Financial Statements was to
increase the net loss for the three and six months ended June 30, 2006 by $3,000 and $6,000,
respectively, than if the company had continued to account for stock-based compensation under
APB 25. The impact on both basic and diluted loss per share for the three and six months ended
June 30, 2006 was $0 and $0 per share, respectively. Pro forma net loss as if the fair value
based method had been applied to all awards is as follows:
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Three Months
    
    
    Six MonthsEnded June 30,
    
    
    Ended June 30,(in thousands, except per share data)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss), reported
    
    $
    (776
    )
    
    $
    695
    
    
    $
    (1,221
    )
    
    $
    476Add: stock-based compensation
programs recorded as expense, net of
related tax
    
    
    3
    
    
    
    
    
    
    
    6
    
    
    
    Deduct: total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
    
    
    (3
    )
    
    
    (10
    )
    
    
    (6
    )
    
    
    (18
    )Pro forma net income (loss)
    
    $
    (776
    )
    
    $
    685
    
    
    $
    (1,221
    )
    
    $
    458Income (loss) per common share:Basic, as reported
    
    $
    (0.17
    )
    
    $
    0.16
    
    
    $
    (0.27
    )
    
    $
    0.11Basic, pro forma
    
    $
    (0.17
    )
    
    $
    0.15
    
    
    $
    (0.27
    )
    
    $
    0.10Diluted, as reported
    
    $
    (0.17
    )
    
    $
    0.15
    
    
    $
    (0.27
    )
    
    $
    0.10Diluted, pro forma
    
    $
    (0.17
    )
    
    $
    0.15
    
    
    $
    (0.27
    )
    
    $
    0.10
  Wgt Avg
    
    Wgt Avg
    
    AggregateExercise
    
    Remaining
    
    Intrinsic# of Shares
    
    Price
    
    Life in Years
    
    ValueOutstanding at June 30, 2006
    
    
    238,680
    
    
    $
    2.56
    
    
    
    5.7
    
    
    $
    55,440Vested and exercisable at June 30, 2006
    
    
    232,680
    
    
    
    2.57
    
    
    
    5.4
    
    
    
    55,440
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5.
    
    Industry Segments Segment information is presented consistently with the basis described in
the 2005 Form 10-KSB. The table following contains segment information for the three and six
month periods ended June 30, 2006 and 2005.
 Three Months Ended June 30,
    
    
    
    Six Months Ended June 30,(unaudited, in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Information TechnologyRevenue
    
    $
    2,101
    
    
    $
    3,219
    
    
    $
    5,987
    
    
    $
    5,095Operating loss
    
    
    (641
    )
    
    
    (192
    )
    
    
    (674
    )
    
    
    (1,501
    )Industrial ProductsRevenue
    
    
    2,128
    
    
    
    1,443
    
    
    
    3,853
    
    
    
    3,146Operating income (loss)
    
    
    78
    
    
    
    153
    
    
    
    (16
    )
    
    
    442Consolidated SegmentsRevenue
    
    $
    4,229
    
    
    $
    4,662
    
    
    $
    9,840
    
    
    $
    8,241Operating loss
    
    
    (563
    )
    
    
    (39
    )
    
    
    (689
    )
    
    
    (1,059
    )A reconciliation of consolidated
segment data above to consolidated
income (loss) follows:Consolidated segments
operating loss
    
    $
    (563
    )
    
    $
    (39
    )
    
    $
    (689
    )
    
    $
    (1,059
    )Corporate expenses
    
    
    (274
    )
    
    
    (224
    )
    
    
    (676
    )
    
    
    (484
    )Consolidated operating loss
    
    
    (837
    )
    
    
    (263
    )
    
    
    (1,365
    )
    
    
    (1,543
    )Interest income (expense), net
    
    
    (33
    )
    
    
    12
    
    
    
    (61
    )
    
    
    18Investment income
    
    
    2
    
    
    
    914
    
    
    
    7
    
    
    
    1,956Equity in income of affiliates
    
    
    91
    
    
    
    19
    
    
    
    163
    
    
    
    36Other income, net
    
    
    1
    
    
    
    13
    
    
    
    35
    
    
    
    21Income (loss) before income taxes
    
    
    (776
    )
    
    
    695
    
    
    
    (1,221
    )
    
    
    488Income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12Net income (loss)
    
    $
    (776
    )
    
    $
    695
    
    
    $
    (1,221
    )
    
    $
    476Depreciation and AmortizationInformation Technology
    
    $
    69
    
    
    $
    69
    
    
    $
    139
    
    
    $
    133Industrial Products
    
    
    65
    
    
    
    62
    
    
    
    125
    
    
    
    117Consolidated segments
    
    
    134
    
    
    
    131
    
    
    
    264
    
    
    
    250Corporate
    
    
    (7
    )
    
    
    1
    
    
    
    (3
    )
    
    
    7Consolidated depreciation and
amortization
    
    $
    127
    
    
    $
    132
    
    
    $
    261
    
    
    $
    257Capital ExpendituresInformation Technology
    
    $
    14
    
    
    $
    44
    
    
    $
    22
    
    
    $
    57Industrial Products
    
    
    140
    
    
    
    173
    
    
    
    338
    
    
    
    181Consolidated segments
    
    
    154
    
    
    
    217
    
    
    
    360
    
    
    
    238Corporate
    
    
    6
    
    
    
    30
    
    
    
    24
    
    
    
    30Consolidated capital expenditures
    
    $
    160
    
    
    $
    247
    
    
    $
    384
    
    
    $
    268June 30,  2006
    
    
    
    
    
    December 31, 2005(unaudited)Identifiable AssetsInformation Technology
    
    
    
    
    
    $
    4,893
    
    
    
    
    
    
    $
    3,746Industrial Products
    
    
    
    
    
    
    3,967
    
    
    
    
    
    
    
    2,913Consolidated segments
    
    
    
    
    
    
    8,860
    
    
    
    
    
    
    
    6,659Corporate
    
    
    
    
    
    
    4,557
    
    
    
    
    
    
    
    4,778Consolidated assets
    
    
    
    
    
    $
    13,417
    
    
    
    
    
    
    $
    11,437
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6.
    
    Concentration of Revenue The following table indicates the percentage of consolidated
revenue represented by each customer for any period in which such customer represented more
than 10% of consolidated revenue.
 Three Months Ended June 30,
    
    Six Months Ended June 30,(unaudited)
    
    2006
    
    2005
    
    2006
    
    2005VISaer Customer A
    
    
    
    
    
    
    
    
    
    
    18
    %
    
    
    VISaer Customer B
    
    
    
    
    
    
    14
    %
    
    
    
    
    
    
    VISaer Customer C
    
    
    11
    %
    
    
    
    
    
    
    
    
    
    
    10
    %
 7.
    
    Contract Settlement In March 2006, our VISaer subsidiary reached a mutual agreement with
one of its customers to terminate a Software License Agreement between them. The Settlement
and Release Agreement assigns no fault to either party and provides for a refund to the
customer of $512,000 of certain prepaid maintenance and other expenses, with such refund to be
paid interest-free in monthly installments of $14,222 over a three year period. Accordingly,
since VISaer had completed all of the requirements for revenue recognition, in the quarter
ended March 31, 2006, VISaer recognized $1,779,000 in services revenue and $827,174 in cost of
sales related to this contract, and recorded the refund amount as a liability of which
$135,000 was recorded in other current liabilities and $311,000 in long-term liabilities at
March 31, 2006, ($446,000 in total, which is equal to $512,000 discounted at 9.25%). At June
30, 2006, the amount related to this settlement that is included in current and long-term
liabilities is $135,077 and $277,924, respectively. The liability, which is an obligation of
VISaer, is not secured by any assets or guaranteed by the parent company.8.
    
    Commitments and Contingencies Please refer to Note 8 to our Consolidated Financial
Statements included in our 2005 Form 10-KSB for a description of our commitments and
contingencies. There has been no material change since December 31, 2005 in the commitments
described in such note, except that the Contract Settlement referenced in Note 7 above
involves a commitment by our VISaer subsidiary to make monthly payments of $14,222 each
beginning April 1, 2006 until the $512,000 refund due its customer is paid in full.Legal Matters  In December 2004, ChemFree filed a patent infringement action against J. Walter
Co. Ltd. and J. Walter, Inc. in the United States Court for the Northern District of Georgia.
The complaint alleges that certain of the defendants products infringe various U.S. patents
held by ChemFree and seeks a ruling to compel defendant to cease its infringing activities. The
defendant has asserted various defenses and a counterclaim. The case is pending and no trial
date has been set. In 2005, ChemFree participated in an arbitration proceeding versus ZYMO
International, Inc. (Zymo), a patent co-owner, that resulted in the issuance of a favorable
arbitration ruling for ChemFree. In December 2005, ChemFree initiated a proceeding under the
Federal Arbitration Act in the United States District Court for the Northern District of Georgia
to obtain judicial confirmation of the arbitration ruling and to arbitrate a number of other
disputes between ChemFree and Zymo that fall within the arbitration provisions of the
co-ownership agreement between the parties. In July 2006, the judge issued a ruling confirming
ChemFrees request to compel arbitration and the matter will now move through the arbitration
process. While the resolution and timing of any legal action is not predictable, ChemFree
believes it has sufficient grounds to prevail in these actions although there can be no
assurance that the disputes will be resolved in its favor.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 is limited to the
amount paid by the customer to CoreCard under the Software License Agreement at the time of
termination. The guarantee phases out upon the achievement of certain operational milestones by
CoreCard or after five years, whichever occurs sooner. As of
June 30, 2006, it does not
appear probable that the guarantee will be paid; thus no amounts have been accrued with respect
to this guarantee.In connection with and to facilitate a software license contract between Ardext Technologies,
Inc., a privately held company in which ISC holds a minority ownership, and a customer of
Ardexts, ISC entered into agreements with Ardext and the customer to receive and hold milestone
payments by the customer and to return such payments either to the customer or to Ardext
depending on the outcome of Ardexts performance under the contract. At June
30, 2006, ISC has recorded payments totaling $150,000 received from the customer as Other
Current Liabilities on the balance sheet and ISC expects to return such amount to the customer
in August 2006 based on a recent
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decision by the customer to terminate the Ardext Technologies
project. ISC has no other obligations under the agreements.9.
    
    Significant Equity Investee The following condensed financial information is provided for
Horizon Software, LLC, an investee company in which we own a 17% equity interest and which, at
June 30, 2006, constituted more than 20% of our consolidated assets.
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,(unaudited, in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    5,272
    
    
    $
    4,956
    
    
    $
    9,609
    
    
    $
    8,554Gross profit
    
    
    3,826
    
    
    
    3,781
    
    
    
    7,084
    
    
    
    6,544Net income from continuing operations
    
    
    556
    
    
    
    924
    
    
    
    912
    
    
    
    1,047Net income
    
    
    556
    
    
    
    924
    
    
    
    912
    
    
    
    1,047ISC share of net income
    
    
    95
    
    
    
    158
    
    
    
    156
    
    
    
    179
 10.
    
    New Accounting Pronouncements In December 2005, the FASB issued FASB Statement No. 123R,
Share Based Payment, which replaces APB No. 25 and SFAS No. 123. The change is effective
for small business issuers for the first interim or annual reporting period that begins after
December 15, 2005. SFAS No. 123R requires companies to recognize in financial statements the
cost of employee services received in exchange for awards of equity instruments based on the
grant-date fair value of those awards. We adopted SFAS No. 123R effective January 1, 2006.
There was no material impact on our results of operations or financial condition. Refer to
Note 4.In December 2004, the FASB issued FASB Statement No. 151, Inventory Costs  An amendment of ARB
No. 43. SFAS No. 151 clarifies that certain abnormal amounts of production related expenses
should be expensed as incurred and not included in overhead. Further, it requires that
allocation of fixed production overheads to conversion costs should be based on normal capacity
of production facilities. FASB No. 151 is effective for fiscal years beginning after June 15,
2005. We adopted SFAS No. 151 effective January 1, 2006. The adoption of this standard did not
have a material impact on our financial position and results of operations.11.
    
    Subsequent Event Effective July 31, 2006, the company completed the sale of the business
and certain assets of its QS Technologies, Inc. (QS) subsidiary to Netsmart Public Health,
Inc. and its parent company, Netsmart Technologies, Inc. [NASDAQ SC:NTST]. The company sold
assets associated with the QS business consisting principally of intangibles, furniture and
equipment, prepaid expenses and work-in-process for a combination of $1.9 million in cash, a
promissory note of Netsmart in the amount of $1.435 million and the assumption by Netsmart
Public Health of approximately $1.8 million in net liabilities of QS. The company retained
accounts receivable and cash of QS aggregating approximately $ 2.0 million. The promissory
note of Netsmart Technologies, Inc. bears interest at the rate of 8.25 percent and is payable
in thirty-six monthly payments of $45,133 beginning September 1, 2006. The principal amount
of the note is subject to adjustment based on revenue and earnings of the QS business for the
period from August 1, 2006 through December 31, 2006. The transaction also provides for
contingent payments to the company of up to $1.45 million in 2008 based on the attainment by
the QS business of certain levels of revenue and bookings in 2007. The company will report a
gain on the sale in the third quarter ending September 30, 2006. Further details of the
transaction are included in the companys Form 8-K dated August 1, 2006 filed with the
Securities and Exchange Commission.   On
August 11, 2006, the renewal date for the company's
$2 million bank line of credit was changed from
September 1, 2006 to December 1, 2006 under essentially the
same terms and conditions.
 
 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.
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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, 2005 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
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 five 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
  Cost
of Sales
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Operating
Expenses
 Interest
Income (Expense)
 Investment
Income 
 Equity
Earnings (Losses) of Affiliate Companies
 Other
Income, Net
 Income
Taxes
 Liquidity and Capital Resources
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Critical Accounting Policies and Estimates
  Factors That May Affect Future Operations
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
    
    Delays in software development projects which could cause our customers to delay implementations, delay payments or
cancel contracts, which would increase our costs and reduce our revenue.
    
    Undetected software errors 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 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.
    
    Continued 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.
    
    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 or to prevail in
legal matters described in Item 3 of our Form 10-KSB for the year ended December 31, 2005, which could increase
competition in the market place and result in greater price pressure and lower margins, thus impacting sales, profits
and projected cash flow.
    
    An insufficient number of potential CoreCard customers decides 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, particularly those which may cause international business and domestic
government customers to delay or cancel software purchases.
  
 Item 3. Controls and Procedures
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Part II. OTHER INFORMATION
 
 Item 4. Submission of Matters to a Vote of Security Holders
  
 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.
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SIGNATURES
  INTELLIGENT SYSTEMS CORPORATION
RegistrantDate: August 11, 2006
    
    By:
    
    /s/J. Leland Strange

J. Leland StrangeChief Executive Officer, PresidentDate: August 11, 2006
    
    By:
    
    /s/Bonnie L. Herron

Bonnie L. HerronChief Financial Officer
 Page 17