##### 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
   o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
  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 September 30, 2007 and December 31, 2006
    
    
    3Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006
    
    
    4Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis or Plan of Operation
    
    
    10Item 3.
    
    Controls and Procedures
    
    
    16Part II
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    
    16Item 6.
    
    Exhibits
    
    
    16Signatures
    
    
    
    
    17Exhibit 31.1Exhibit 31.2Exhibit 32.1
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Item 1. Financial Statements
 
 Intelligent Systems Corporation
CONSOLIDATED BALANCE SHEETS  (in thousands, except share amounts)
 September 30,
    
    
    December 31,2007
    
    
    2006ASSETS
    
    (unaudited)Current assets:Cash
    
    $
    2,563
    
    
    $
    2,136Accounts receivable, net
    
    
    2,742
    
    
    
    2,006Notes and interest receivable, current portion
    
    
    531
    
    
    
    3,445Inventories
    
    
    1,098
    
    
    
    904Other current assets
    
    
    780
    
    
    
    1,072Total current assets
    
    
    7,714
    
    
    
    9,563Long-term investments
    
    
    1,222
    
    
    
    1,174Notes and interest receivable, net of current portion
    
    
    476
    
    
    
    841Property and equipment, at cost less accumulated depreciation
    
    
    1,691
    
    
    
    1,009Goodwill, net
    
    
    2,047
    
    
    
    2,047Other intangibles, net
    
    
    325
    
    
    
    359Other assets, net
    
    
    17
    
    
    
    17Total assets
    
    $
    13,492
    
    
    $
    15,010LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Note payable
    
    $
    156
    
    
    $
    Accounts payable
    
    
    2,275
    
    
    
    1,558Deferred revenue
    
    
    2,618
    
    
    
    3,094Accrued payroll
    
    
    965
    
    
    
    974Accrued expenses and other current liabilities
    
    
    1,369
    
    
    
    1,088Total current liabilities
    
    
    7,383
    
    
    
    6,714Long-term liabilities
    
    
    213
    
    
    
    356Commitments and contingencies (Note 9)Minority interest
    
    
    1,516
    
    
    
    1,516Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 shares
issued and outstanding at September 30, 2007 and December 31, 2006
    
    
    45
    
    
    
    45Additional paid-in capital
    
    
    18,433
    
    
    
    18,425Accumulated other comprehensive loss
    
    
    (142
    )
    
    
    (127
    )Accumulated deficit
    
    
    (13,956
    )
    
    
    (11,919
    )Total stockholders equity
    
    
    4,380
    
    
    
    6,424Total liabilities and stockholders equity
    
    $
    13,492
    
    
    $
    15,010
 The accompanying notes are an integral part of these consolidated financial statements.
  Page 3




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Intelligent Systems Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS  (unaudited; in thousands, except share and per share amounts)
 Three Months Ended Sept. 30,
    
    
    Nine Months Ended Sept. 30,2007
    
    
    2006
    
    
    2007
    
    
    2006RevenueProducts
    
    $
    4,667
    
    
    $
    2,464
    
    
    $
    10,325
    
    
    $
    6,656Services
    
    
    1,127
    
    
    
    996
    
    
    
    3,375
    
    
    
    5,233Total revenue
    
    
    5,794
    
    
    
    3,460
    
    
    
    13,700
    
    
    
    11,889Cost of revenueProducts
    
    
    2,676
    
    
    
    1,170
    
    
    
    5,241
    
    
    
    3,397Services
    
    
    641
    
    
    
    435
    
    
    
    1,995
    
    
    
    2,401Total cost of revenue
    
    
    3,317
    
    
    
    1,605
    
    
    
    7,236
    
    
    
    5,798ExpensesMarketing
    
    
    1,057
    
    
    
    545
    
    
    
    2,083
    
    
    
    1,577General & administrative
    
    
    1,113
    
    
    
    868
    
    
    
    3,011
    
    
    
    2,833Research & development
    
    
    1,275
    
    
    
    1,390
    
    
    
    3,704
    
    
    
    4,279Loss from operations
    
    
    (968
    )
    
    
    (948
    )
    
    
    (2,333
    )
    
    
    (2,598
    )Other income (expense)Interest income (expense), net
    
    
    33
    
    
    
    (7
    )
    
    
    130
    
    
    
    (68
    )Investment income, net
    
    
    
    
    
    
    2,638
    
    
    
    81
    
    
    
    2,645Equity in income of affiliate companies
    
    
    6
    
    
    
    188
    
    
    
    48
    
    
    
    351Other income (expense), net
    
    
    (31
    )
    
    
    (45
    )
    
    
    (38
    )
    
    
    (8
    )Income (loss) from continuing operations before income taxes
    
    
    (960
    )
    
    
    1,826
    
    
    
    (2,112
    )
    
    
    322Income taxes
    
    
    22
    
    
    
    
    
    
    
    22
    
    
    
    Income (loss) from continuing operations
    
    
    (982
    )
    
    
    1,826
    
    
    
    (2,134
    )
    
    
    322Income from discontinued operations, no tax effect
    
    
    
    
    
    
    317
    
    
    
    
    
    
    
    600Gain on sale of discontinued operations, no tax effect
    
    
    
    
    
    
    4,873
    
    
    
    97
    
    
    
    4,873Net income (loss)
    
    $
    (982
    )
    
    $
    7,016
    
    
    $
    (2,037
    )
    
    $
    5,795Income (loss) per share from continuing operations:
    Basic
    $
    (0.22
    )
    
    $
    0.41
    
    
    $
    (0.47
    )
    
    $
    0.07Diluted
    $
    (0.22
    )
    
    $
    0.40
    
    
    $
    (0.47
    )
    
    $
    0.07Income per share from discontinued operations:
    Basic
    $
    
    
    
    $
    1.16
    
    
    $
    0.02
    
    
    $
    1.22Diluted
    $
    
    
    
    $
    1.12
    
    
    $
    0.02
    
    
    $
    1.18Income (loss) per share:
    Basic
    $
    (0.22
    )
    
    $
    1.57
    
    
    $
    (0.45
    )
    
    $
    1.29Diluted
    $
    (0.22
    )
    
    $
    1.52
    
    
    $
    (0.45
    )
    
    $
    1.25Basic weighted average common shares outstanding
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971Diluted weighted average common shares outstanding

    
    
    4,478,971
    

    
    
    4,615,619
    

    
    
    4,478,971
    

    
    
    4,620,552
 The accompanying notes are an integral part of these consolidated financial statements.
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Intelligent Systems Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS  (unaudited, in thousands)
 Nine Months Ended Sept. 30,CASH PROVIDED BY (USED FOR):
    
    2007
    
    
    2006OPERATING ACTIVITIES:Net income (loss)
    
    $
    (2,037
    )
    
    $
    5,795Adjustments to reconcile net income (loss) to net cash used for operating activities:Depreciation and amortization
    
    
    346
    
    
    
    396Stock-based compensation expense
    
    
    8
    
    
    
    9Gain on sale of QS business
    
    
    (97
    )
    
    
    (4,873
    )Investment income
    
    
    (81
    )
    
    
    (2,645
    )Equity in earnings of affiliate companies
    
    
    (48
    )
    
    
    (351
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (736
    )
    
    
    (586
    )Accrued interest receivable
    
    
    93
    
    
    
    (23
    )Inventories
    
    
    (194
    )
    
    
    (68
    )Other current assets
    
    
    303
    
    
    
    (133
    )Accounts payable
    
    
    718
    
    
    
    445Accrued payroll
    
    
    (8
    )
    
    
    (145
    )Deferred revenue
    
    
    (476
    )
    
    
    (268
    )Accrued expenses and other current liabilities
    
    
    321
    
    
    
    146Other liabilities
    
    
    (38
    )
    
    
    246Cash used for operating activities
    
    
    (1,926
    )
    
    
    (2,055
    )INVESTING ACTIVITIES:Proceeds related to sales of investments or marketable securities
    
    
    39
    
    
    
    3,033Proceeds from sale of QS Business
    
    
    
    
    
    
    1,900Proceeds from notes and interest receivable
    
    
    3,278
    
    
    
    35Distributions from long-term investments
    
    
    
    
    
    
    385Payments on notes payable
    
    
    (105
    )
    
    
    (66
    )Purchases of property and equipment
    
    
    (989
    )
    
    
    (498
    )Cash provided by investing activities
    
    
    2,223
    
    
    
    4,797FINANCING ACTIVITIES:Borrowings under short-term borrowing arrangements
    
    
    156
    
    
    
    2,220Repayment under short-term borrowing arrangements
    
    
    
    
    
    
    (2,320
    )Proceeds from exercise of stock options in subsidiary
    
    
    
    
    
    
    3Cash provided by (used for) financing activities
    
    
    156
    
    
    
    (97
    )Effects of exchange rate changes on cash
    
    
    (26
    )
    
    
    (29
    )Net increase in cash
    
    
    427
    
    
    
    2,616Cash at beginning of period
    
    
    2,136
    
    
    
    378Cash at end of period
    
    $
    2,563
    
    
    $
    2,994SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for income taxes
    
    $
    8
    
    
    $
    Cash paid during the period for interest
    
    $
    3
    
    
    $
    74
 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 nine month periods ended September 30, 2007
and 2006. The interim results for the three and nine months ended September 30, 2007 are not
necessarily indicative of the results to be expected for the full year. While we believe that
the disclosures presented herein are adequate to make the information not misleading, these
statements should be read in conjunction with our Consolidated Financial Statements and notes
thereto for the fiscal year ended December 31, 2006, as filed in our Annual Report on Form
10-KSB.3.
    
    Discontinued Operations As explained in more detail in Note 2 to the Consolidated
Financial Statements included in our 2006 Form 10-KSB, effective July 31, 2006, we completed
the sale of the business and certain assets of our QS Technologies, Inc. (QS) subsidiary to
Netsmart Public Health, Inc. and its parent company, Netsmart Technologies, Inc., referred to
collectively as Netsmart. In accordance with Financial Accounting Standards Board Statement
No.144, Accounting for the Impairment or Disposal of Long-Lived Assets, the QS business is
presented as discontinued operations for the three and nine months ended September 30, 2007
and 2006.The following condensed financial information is provided for the QS Discontinued Operations for
the periods shown.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(in thousands)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Net sales
    
    $
    
    
    
    $
    524
    
    
    $
    
    
    
    $
    1,934Operating income
    
    
    
    
    
    
    317
    
    
    
    
    
    
    
    602Net income before tax
    
    
    
    
    
    
    317
    
    
    
    
    
    
    
    600Income tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income from discontinued operations
    
    $
    
    
    
    $
    317
    
    
    $
    
    
    
    $
    600
 Terms of the sale of the QS Discontinued Operations included certain contingency payments based
on post-transaction performance criteria. As of September 30, 2007, the company estimates
additional payments in 2008 of $1.0 million to $1.4 million, subject to a final reconciliation
by NetSmart.4.
    
    Contract Settlement In February 2007, our CoreCard subsidiary reached a mutual agreement
with one of its customers to terminate a Software License Agreement between them. The
Settlement Agreement assigns no fault to either party and reflects a change in priorities and
available funding at the customer. The customer paid $380,000 on the effective date of the
Settlement Agreement, including a $100,000 termination fee, resulting in aggregate
non-refundable payments to CoreCard of $1.1 million under the Software License Agreement
(including amounts paid in 2006 and included in deferred revenue as of December 31, 2006). In
the quarter ended March 31, 2007, the company recognized license revenue of $1.1 million
related to this contract. In the quarter ended June 30, 2007, CoreCard proposed a
termination to a foreign customer contract due to a change in the customers technical
management team and software requirements which CoreCard deemed not to be in its best
interest. The customer agreed to the termination, with no refund of payments. Accordingly, in
the quarter ended June 30, 2007, CoreCard recognized $131,000 in revenue for services rendered
and paid for prior to the termination.
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5.
    
    Comprehensive Income (Loss) In accordance with Financial Accounting Standards Board Statement
No. 130, Reporting Comprehensive Income, comprehensive income (loss) is the total of net
income (loss) and all other non-owner changes in equity in a period. A summary follows:
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited, in thousands)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Net income (loss)
    
    $
    (982
    )
    
    $
    7,016
    
    
    $
    (2,037
    )
    
    $
    5,795Other comprehensive loss:Foreign currency translation adjustment
    
    
    (12
    )
    
    
    (16
    )
    
    
    (142
    )
    
    
    (29
    )Comprehensive income (loss)
    
    $
    (994
    )
    
    $
    7,000
    
    
    $
    (2,179
    )
    
    $
    5,766
 6.
    
    Stock-based Compensation At September 30, 2007, we have two stock-based
compensation plans in effect. In December 2004, the FASB issued FASB Statement No. 123R,
Share-Based Payment (SFAS 123R) which replaced APB No. 25 and SFAS 123. We adopted SFAS
123R effective January 1, 2006 using the modified prospective application method of adoption
which requires us to record compensation cost related to unvested stock awards as of December
31, 2005 by recognizing the unamortized grant date fair value in accordance with provisions of
SFAS 123R on a straight line basis over the service periods of each award. We have estimated
forfeiture rates based on our historical experience. Stock option compensation expense is
recognized as a component of general and administrative expenses in the accompanying
Consolidated Financial Statements.The estimated fair value of the options granted during prior years was calculated using the
Black Scholes option pricing model with assumptions as previously disclosed in our Form 10-KSB.As a result of the adoption of SFAS 123(R), we recorded $4,000 and $3,000 of stock-based
compensation expense for the three months ended September 30, 2007 and 2006, respectively, and
$8,000 and $9,000 of stock-based compensation expense for the nine months ended September 30,
2007 and 2006, respectively, related to our stock option plans. Had we continued to account for
these options under APB 25, we would have recorded no such expense in any period.As of September 30, 2007, there is $17,000 of unrecognized compensation cost related to stock
options. In the quarter ended June 30, 2007, an aggregate of 12,000 options were granted to
independent directors at fair market value on the date of the annual shareholders meeting, as
provided in the Directors Stock Option Plan. No options were exercised or forfeited during the
three or nine month periods ended September 30, 2007. The following table summarizes options as
of September 30, 2007:
 Wgt Avg
    
    
    Wgt Avg
    
    
    AggregateExercise
    
    
    Remaining
    
    
    Intrinsic# of Shares
    
    
    Price
    
    
    Life in Years
    
    
    ValueOutstanding at Sept. 30, 2007
    
    
    215,666
    
    
    $
    2.47
    
    
    
    5.3
    
    
    $
    245,882Vested and exercisable at
Sept. 30, 2007
    
    
    203,666
    
    
    $
    2.39
    
    
    
    5.2
    
    
    $
    245,882
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7.
    
    Concentration of Revenue The following table indicates the percentage of consolidated revenue
represented by each customer for any period in which such customer represented more than 10% of
consolidated revenue.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006ChemFree Customer A
    
    
    53
    %
    
    
    
    
    
    
    30
    %
    
    
    ChemFree Customer B
    
    
    
    
    
    
    12
    %
    
    
    
    
    
    
    11
    %ChemFree Customer C
    
    
    
    
    
    
    14
    %
    
    
    
    
    
    
    VISaer Customer D
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15
    %
 8.
    
    Notes Receivable As explained in Note 2 to the Consolidated Financial Statements included
in our 2006 Form 10-KSB, in connection with the sale of our QS Technologies business, we
received a promissory note from the buyer in the amount of $1,435,000. The principal amount of
the note was subject to adjustment based on revenue and earnings of the QS business for the
period from August 1, 2006 through January 31, 2007. In the quarter ended March 31, 2007, the
buyer informed the company that it was not proposing any adjustment to the note. Accordingly,
in the three months ended March 31, 2007, the company reversed the balance of its transaction
related contingency accrual and recognized additional gain of $97,000 on the sale of the QS
discontinued operations. Such amount is recorded in Gain on Sale of Discontinued Operations
in the results for the nine months ended September 30, 2007.On August 31, 2006, as explained in Note 3 to the Consolidated Financial Statements included in
our 2006 Form 10-KSB, we received a promissory note from the buyer of our Horizon Software
investment in the principal amount of $2,850,000. On January 4, 2007, the note and accrued
interest were paid in full.9.
    
    Commitments and Contingencies Please refer to Note 9 to our Consolidated Financial
Statements included in our 2006 Form 10-KSB for a description of our commitments and
contingencies. There has been no material change since December 31, 2006 in the commitments
described in such note.Legal Matters  As explained in Note 9 to our Consolidated Financial Statements included in our
2006 Form 10-KSB, our ChemFree subsidiary was involved in two legal matters, one of which has
been completed as explained in the description of the Zymo matter below. In December 2004,
ChemFree filed a patent infringement action against J. Walter Co. Ltd. and J. Walter, Inc.
(collectively the Defendant) 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 court issued a ruling in July
2007 with respect to the parties Markman submissions, a preliminary procedure for defining
certain patent-related terms, which ruling generally confirmed ChemFrees definitions. The
parties are in the discovery phase of the case and no trial date has been set. In a separate
matter, an arbitrator issued a ruling in February 2007 in an arbitration proceeding involving
ChemFree versus Zymo International, Inc. (Zymo). The arbitrator found in ChemFrees favor on
all substantive issues. Among other items, the arbitrator ruled that ChemFree was not in breach
of the co-ownership agreement and that Zymo must pay an aggregate of $156,000 to ChemFree for
its share of legal expenses and damages for lack of cooperation in patent matters covered by the
co-ownership agreement. The arbitrator also ruled that, if Zymo participates in a certain J.
Walter patent infringement action after June 30, 2007, it must pay an additional $27,500 to
ChemFree. Since the ruling, Zymo paid to ChemFree $156,000, less $5,000 in expenses allocable
to ChemFree for amounts previously paid by Zymo for co-owned patent matters. Zymo also received
court approval to withdraw from the J. Walter infringement action described above.ISC Guarantees  In conjunction with a Software License Agreement entered into on June 12, 2003
between our majority owned subsidiary, CoreCard Software, Inc. and a CoreCard customer, ISC
entered into a letter of guarantee with the CoreCard customer. Under the guarantee, in the
event that the Software License is terminated due to CoreCard discontinuing operations, ISC has
guaranteed to make available at its expense up to four employees to provide technical assistance
to the customer during a transition period of up to one year. The guarantee phases out upon the
achievement of certain operational milestones by CoreCard or after five years, whichever occurs
sooner. As of September 30, 2007, it does not appear probable that the guarantee will be paid;
thus no amounts have been accrued with respect to this guarantee.
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10.
    
    Industry Segments Segment information is presented consistently with the basis described
in the 2006 Form 10-KSB. The table following contains segment information for continuing
operations for the three and nine month periods ended September 30, 2007 and 2006.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited, in thousands)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006Information TechnologyRevenue
    
    $
    1,154
    
    
    $
    1,218
    
    
    $
    4,706
    
    
    $
    5,794Operating Loss
    
    
    (1,082
    )
    
    
    (865
    )
    
    
    (1,971
    )
    
    
    (1,938
    )Industrial ProductsRevenue
    
    
    4,640
    
    
    
    2,242
    
    
    
    8,995
    
    
    
    6,095Operating income
    
    
    312
    
    
    
    161
    
    
    
    491
    
    
    
    145Consolidated SegmentsRevenue
    
    
    5,794
    
    
    
    3,460
    
    
    
    13,700
    
    
    
    11,889Operating loss
    
    
    (770
    )
    
    
    (704
    )
    
    
    (1,480
    )
    
    
    (1,793
    )Corporate expenses
    
    
    (198
    )
    
    
    (244
    )
    
    
    (853
    )
    
    
    (805
    )Consolidated operating loss fromcontinuing operations
    
    $
    (968
    )
    
    $
    (948
    )
    
    $
    (2,333
    )
    
    $
    (2,598
    )Depreciation and AmortizationInformation Technology
    
    $
    78
    
    
    $
    65
    
    
    $
    190
    
    
    $
    199Industrial Products
    
    
    30
    
    
    
    64
    
    
    
    140
    
    
    
    189Consolidated segments
    
    
    108
    
    
    
    129
    
    
    
    330
    
    
    
    388Corporate
    
    
    5
    
    
    
    6
    
    
    
    16
    
    
    
    16Consolidated depreciation and amortization
    
    $
    113
    
    
    $
    135
    
    
    $
    346
    
    
    $
    404Capital ExpendituresInformation Technology
    
    $
    62
    
    
    $
    47
    
    
    $
    543
    
    
    $
    81Industrial Products
    
    
    254
    
    
    
    47
    
    
    
    436
    
    
    
    385Consolidated segments
    
    
    316
    
    
    
    94
    
    
    
    979
    
    
    
    466Corporate
    
    
    4
    
    
    
    13
    
    
    
    10
    
    
    
    32Consolidated capital expenditures
    
    $
    320
    
    
    $
    107
    
    
    $
    989
    
    
    $
    498
 (in thousands)
    
    September 30, 2007
    
    
    December 31, 2006Identifiable AssetsInformation Technology
    
    $
    4,318
    
    
    $
    3,624Industrial Products
    
    
    5,638
    
    
    
    3,849Consolidated segments
    
    
    9,956
    
    
    
    7,473Corporate
    
    
    3,536
    
    
    
    7,537Consolidated assets
    
    $
    13,492
    
    
    $
    15,010
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11.
    
    New Accounting Pronouncements On July 13, 2006, the FASB issued FASB Interpretation No. 48
(FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48 prescribes a comprehensive
model for how a company should recognize, measure, present and disclose in its financial
statements uncertain tax positions that the company has taken or expects to take on a tax
return. FIN 48 is applicable to all uncertain positions for taxes accounted for under FASB
Statement 109, Accounting for Income Taxes and requires that a company record any change in
net assets that results from the application of the interpretation as an adjustment to
retained earnings. The interpretation is effective for fiscal years that start after December
15, 2006 and, accordingly we adopted FIN 48 effective January 1, 2007. See discussion in Note
12 below.In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements (SFAS 157)
to increase consistency and comparability in fair value measurements. SFAS 157 defines fair
value, establishes a framework for measuring fair value, and expands disclosures about fair
value measurements of certain assets, liabilities and items in stockholders equity that are
measured at fair value. SFAS 159 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, although early adoption is encouraged. We have not yet
determined the impact that the adoption of the standard will have on our financial statements.On February 15, 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities: Including an amendment of FASB Statement No. 115 (SFAS 159).
SFAS 159, which builds on other Statements related to fair value such as SFAS 157 above, permits
entities to elect to measure many financial instruments and certain other items at fair value
with changes in value reported in earnings. It is designed to mitigate earnings volatility that
arises when assets and liabilities are measured differently. SFAS 159 is effective for
financial statements issued for fiscal years beginning after November 15, 2007. We have not yet
determined the impact that the adoption of the standard will have on our financial statements.12.
    
    Adoption of FIN 48 Effective January 1, 2007, we adopted the provisions of Financial
Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes
  an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a recognition
threshold that a tax position is required to meet before being recognized in the financial
statements and provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition issues. We have
recognized tax benefits from all tax positions we have taken, and there has been no adjustment
to any carry forwards (net operating loss or research and development credits) as a result of
the implementation of FIN 48. The adoption of FIN 48 did not have a material effect on our
consolidated financial position or results of operations. As of September 30, 2007, we do not
have any material unrecognized tax benefits and we do not anticipate any significant changes
in the balance of unrecognized tax benefits during the next twelve months.Our policy is to recognize accrued interest related to uncertain tax positions in interest
expense and related penalties, if applicable, in general and administrative expense. No interest
expense or penalties were recognized during the three and nine months ended September 30, 2007.We file a consolidated U.S. federal income tax return for all subsidiaries in which our
ownership exceeds 80%, as well as individual subsidiary returns in various states and foreign
jurisdictions. Our VISaer subsidiary files a separate U.S. federal income tax return. With few
exceptions we are no longer subject to U.S. federal, state and local or foreign income tax
examinations by taxing authorities for years before 2003.
 
 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 Operations. 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, 2006 as filed with the Securities
and Exchange Commission.
 Overview
   
    
    A change in revenue level at one of our subsidiaries may impact consolidated revenue or
be offset by an opposing change at another subsidiary.
    
    Economic and marketplace trends may impact our subsidiaries differently or not at all
depending upon their particular marketplaces.
    
    Our software subsidiaries, CoreCard Software and VISaer, have been involved in major new
product development initiatives for the past six years and have limited experience
delivering and installing their new products at customer sites, making it difficult to
predict with certainty when they will complete the requirements to recognize license 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 is recognized in a given quarterly or
annual period.
   Results of Operations
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Revenue ®
 
    
    Revenue from products, which includes sales of equipment in our Industrial Products segment
as well as software license fees related to the Information Technology segment, was $4.7
million in the three month period ended September 30, 2007, an 89% increase compared to $2.5
million in the three months ended September 30, 2006. In the nine month period ended
September 30, 2007, product revenue increased 55% to $10.3 million, compared to $6.7 million
in the year-to-date period in 2006. Product revenue associated with the Industrial Products
segment grew by 107% and 48% in the three and nine month periods ended September 30, 2007,
compared to the respective periods in 2006. The period-to-period growth in product revenue in
2007 is attributed mainly to a higher volume of ChemFree SmartWasher® products sold to
domestic corporate customers in the second and third quarter of 2007, as well as an increase
in international sales in the first quarter of this year. The higher volume of Smartwasher®
sales in the second and third quarters of 2007 is due to the successful rollout of a national
sales program by a new end-user customer. It is not likely that the customer will maintain
the same level of machine purchases once the initial rollout is complete, although recurring
revenue from consumable supplies for the machines is expected to increase over time. Product
revenue associated with the Information Technology segment increased by $770,000 in the nine
months ended September 30, 2007 compared to the same period last year, reflecting primarily a
single software license contract recognized by our CoreCard Software subsidiary in the first
quarter of 2007.
    
    Service revenue increased by 13% in the three month period ended September 30, 2007 but
declined by 36% in the first nine months of 2007 compared to the same periods last year. The
increase in third quarter revenue is attributed to greater professional services revenue at
the VISaer subsidiary, while the decline in year-to-date service revenue is attributed mainly
to the fact that in 2006, VISaer recognized $1.8 million in service revenue upon completion of
a single multi-year contract. There was no such comparable contract in the first nine months
of 2007.
 Cost of Revenue
 
    
    Cost of product revenue was 57% of product revenue in the third quarter of 2007 compared
to 47% of product revenue in the same period in 2006. The principal reason for the
increase in product cost as a percent of product revenue is mainly due to a change in
product mix between periods. In 2007, ChemFree sold a higher volume of parts washer
machines during the rollout of a new program with a large domestic corporate customer and
also experienced an increase in the cost of certain plastic components. ChemFree expects
that margins will improve in future periods with an increase in sales of higher margin
consumable supplies to an expanded base of installed machines. Cost of product sales was
51% of product revenue in the nine month periods ended September 30, 2007 and 2006.
Although the overall cost of product sales percentages were the same in both periods, there
was a year-to-date 2007 decline in ChemFree product margins (for the reasons explained
above) that was offset by a higher margin contribution from software license revenue at our
CoreCard Software subsidiary in the same period.
    
    Cost of service revenue (which relates to the software subsidiaries only) was 57% and
44% of service revenue in the three months ended September 30, 2007 and 2006, respectively.
Cost of service revenue was 59% and 46% of service revenue in the nine-month periods ended
September 30, 2007 and 2006, respectively. The decline in gross margin percentage between
periods reflects primarily the fact that the number of hours and the average standard cost
allocated to CoreCards customer support and professional services activities were higher
in 2007 than in the same periods in 2006.
 Operating Expenses
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Interest Income (Expense), Net
 Investment Income, Net
 Equity Earnings of Affiliate Companies
 Other Income (Expense), Net
 Income Taxes
 Discontinued Operations
 Net Income from Discontinued Operations
 Gain on Sale of Discontinued Operations
 Liquidity and Capital Resources
 ®
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Off-Balance Sheet Arrangements
  Critical Accounting Policies and Estimates
   Page 14




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Factors That May Affect Future Operations
   
    
    Delays in software development projects which could cause our customers to delay
implementations, delay payments or cancel contracts, which would increase our costs and reduce
our revenue.
    
    Failure of our CoreCard subsidiary to improve its ability to deliver software products
which meet the business and technology requirements of specific target markets within a
reasonable time frame and at a price point that supports a profitable, sustainable business
model.
    
    In the Industrial Products market, failure by ChemFree to protect its intellectual property
assets, which could increase competition in the marketplace and result in greater price
pressure and lower margins, thus impacting sales, profits and projected cash flow.
    
    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.
    
    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.
    
    Water shortages in Georgia, ChemFrees operations base, which could impact availability or
price of water that is used in the manufacture of one of its products, OzzyJuice fluid,
resulting in reduced revenue and gross margins.
    
    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.
    
    An insufficient number of potential CoreCard customers decide to purchase and run an
in-house software system and instead choose to outsource their account transaction processing
which could result in lower revenue and greater cash requirements or an unsuccessful business
model
    
    Failure of our products specifications and features to achieve market acceptance.
    
    The inability of our software subsidiaries to retain key software developers and managers
who have accumulated years of know-how in our target markets and company products, or failure
to attract and train a sufficient number of new software developers and testers to support our
product development plans and customer requirements at projected cost levels.
    
    Further increases in the price of oil, which could increase ChemFrees product costs and
which could affect VISaers results if potential aviation customers delay or cancel purchases
of software or services in the face of declining industry trends or poor financial condition.
    
    Delays in anticipated customer payments for any reason which would increase our cash
requirements and possibly our losses.
    
    Declines in performance, financial condition or valuation of minority-owned companies which
could cause us to write-down the carrying value of our investment or postpone an anticipated
liquidity event, which could negatively impact our earnings and cash.
    
    Negative trends affecting the commercial aviation industry worldwide which could impact
VISaers prospective customer purchases, thus increasing its losses and need for cash.
    
    Other general economic and political conditions that cause customers to delay or cancel
software purchases.
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Item 3. Controls and Procedures
  
 Part II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 6. Exhibits
  3(i)
    
    Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991,
as amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrants
Annual Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the
Registrants Report on Form 8-K dated November 25, 1997.)3(ii)
    
    Bylaws of the Registrant dated June 6, 1997. (Incorporated by reference to Exhibit 3(ii)
of the Registrants Form 10-K/A for the year ended December 31, 1997.)4.1
    
    Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock
Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the
Registrants Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)4.2
    
    Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrants
Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial Officer furnished as required by
Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
  INTELLIGENT SYSTEMS CORPORATION
RegistrantDate: November 14, 2007
    
    By:
    
    /s/ J. Leland StrangeJ. Leland Strange
Chief Executive Officer, PresidentDate: November 14, 2007
    
    By:
    
    /s/ Bonnie L. HerronBonnie L. Herron
Chief Financial Officer
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EXHIBIT INDEX
 3(i)
    
    Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991,
as amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrants
Annual Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the
Registrants Report on Form 8-K dated November 25, 1997.)3(ii)
    
    Bylaws of the Registrant dated June 6, 1997. (Incorporated by reference to Exhibit 3(ii)
of the Registrants Form 10-K/A for the year ended December 31, 1997.)4.1
    
    Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock
Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the
Registrants Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)4.2
    
    Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrants
Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial Officer furnished as required by
Section 906 of the Sarbanes-Oxley Act of 2002.
  Page 18