##### 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 September 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




---



##### 



Intelligent Systems Corporation
Index
Form 10-QSB
 PAGEPart I
    
    Financial InformationItem 1.
    
    Financial StatementsConsolidated Balance Sheets at September 30, 2006 and December 31, 2005
    
    3Consolidated Statements of Operations for the three and nine months ended Sept. 30, 2006 and 2005
    
    4Consolidated Statements of Cash Flow for the nine months ended Sept. 30, 2006 and 2005
    
    5Notes to Consolidated Financial Statements
    
    7Item 2.
    
    Managements Discussion and Analysis or Plan of Operation
    
    12Item 3.
    
    Controls and Procedures
    
    17Part II
    
    Other InformationItem 1.
    
    Legal Proceedings
    
    18Item 6.
    
    Exhibits
    
    18Signatures
    
    18EX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICAITON OF CFOEX-32.1 SECTION 906 CERTIFICATION OF CEO AND CFO
  Page 2




---



##### Table of Contents



Item 1. Financial Statements
 Intelligent Systems Corporation
 
 CONSOLIDATED BALANCE SHEETS
 (in thousands, except share amounts)
 September 30,
    
    December 31,2006
    
    2005(unaudited)ASSETSCurrent assets:Cash
    
    $
    2,994
    
    
    $
    378Accounts receivable, net
    
    
    2,413
    
    
    
    1,827Notes and interest receivable, current portion
    
    
    3,316
    
    
    
    Inventories
    
    
    838
    
    
    
    770Other current assets
    
    
    625
    
    
    
    355Total current assets
    
    
    10,186
    
    
    
    3,330Long-term investments
    
    
    1,299
    
    
    
    4,571Notes receivable, net of current portion
    
    
    957
    
    
    
    Property and equipment, at cost less accumulated depreciation
    
    
    1,136
    
    
    
    940Goodwill, net
    
    
    2,047
    
    
    
    2,047Other intangibles, net
    
    
    402
    
    
    
    532Other assets, net
    
    
    28
    
    
    
    17Total assets
    
    $
    16,055
    
    
    $
    11,437LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    
    
    
    $
    100Accounts payable
    
    
    1,244
    
    
    
    847Deferred revenue
    
    
    2,780
    
    
    
    4,779Accrued payroll
    
    
    827
    
    
    
    1,092Accrued expenses and other current liabilities
    
    
    1,476
    
    
    
    849Total current liabilities
    
    
    6,327
    
    
    
    7,667Other long-term liabilities
    
    
    428
    
    
    
    248Commitments and contingencies (Note 10)Minority interest
    
    
    1,516
    
    
    
    1,516Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized,
4,478,971 shares issued and outstanding at September 30, 2006 and
December 31, 2005
    
    
    45
    
    
    
    45Paid-in capital
    
    
    18,422
    
    
    
    18,410Accumulated other comprehensive loss
    
    
    (90
    )
    
    
    (61
    )Accumulated deficit
    
    
    (10,593
    )
    
    
    (16,388
    )Total stockholders equity
    
    
    7,784
    
    
    
    2,006Total liabilities and stockholders equity
    
    $
    16,055
    
    
    $
    11,437
 The accompanying notes are an integral part of these consolidated financial statements.
 Page 3




---



##### Table of Contents



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. 30,2006
    
    
    2005
    
    
    2006
    
    
    2005RevenueProducts
    
    $
    2,464
    
    
    $
    1,541
    
    
    $
    6,656
    
    
    $
    5,856Services
    
    
    996
    
    
    
    1,093
    
    
    
    5,233
    
    
    
    3,276Total revenue
    
    
    3,460
    
    
    
    2,634
    
    
    
    11,889
    
    
    
    9,132Cost of salesProducts
    
    
    1,170
    
    
    
    733
    
    
    
    3,397
    
    
    
    2,465Services
    
    
    435
    
    
    
    603
    
    
    
    2,401
    
    
    
    1,953Total cost of sales
    
    
    1,605
    
    
    
    1,336
    
    
    
    5,798
    
    
    
    4,418ExpensesMarketing
    
    
    545
    
    
    
    397
    
    
    
    1,577
    
    
    
    1,375General & administrative
    
    
    868
    
    
    
    827
    
    
    
    2,833
    
    
    
    2,360Research & development
    
    
    1,390
    
    
    
    1,562
    
    
    
    4,279
    
    
    
    4,539Loss from operations
    
    
    (948
    )
    
    
    (1,488
    )
    
    
    (2,598
    )
    
    
    (3,560
    )Other incomeInterest income (expense), net
    
    
    (7
    )
    
    
    1
    
    
    
    (68
    )
    
    
    20Investment income (loss), net
    
    
    2,638
    
    
    
    (48
    )
    
    
    2,645
    
    
    
    1,908Equity in earnings of affiliate companies
    
    
    188
    
    
    
    358
    
    
    
    351
    
    
    
    393Other income (loss), net
    
    
    (45
    )
    
    
    (21
    )
    
    
    (8
    )
    
    
    (1
    )Income (loss) from continuing operations before income taxes
    
    
    1,826
    
    
    
    (1,198
    )
    
    
    322
    
    
    
    (1,240
    )Income taxes
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    4Income (loss) from continuing operations
    
    
    1,826
    
    
    
    (1,199
    )
    
    
    322
    
    
    
    (1,244
    )Income from discontinued operations, no tax effect
    
    
    317
    
    
    
    41
    
    
    
    600
    
    
    
    562Gain on sale of discontinued operations, no tax effect
    
    
    4,873
    
    
    
    
    
    
    
    4,873
    
    
    
    Net income (loss)
    
    $
    7,016
    
    
    $
    (1,158
    )
    
    $
    5,795
    
    
    $
    (682
    )Income (loss) per share from continuing operations:Basic
    
    $
    0.41
    
    
    $
    (0.27
    )
    
    $
    0.07
    
    
    $
    (0.28
    )Diluted
    
    $
    0.40
    
    
    $
    (0.27
    )
    
    $
    0.07
    
    
    $
    (0.28
    )Income per share from discontinued operations:Basic
    
    $
    1.16
    
    
    $
    0.01
    
    
    $
    1.22
    
    
    $
    0.13Diluted
    
    $
    1.12
    
    
    $
    0.01
    
    
    $
    1.18
    
    
    $
    0.13Income (loss) per share:Basic
    
    $
    1.57
    
    
    $
    (0.26
    )
    
    $
    1.29
    
    
    $
    (0.15
    )Diluted
    
    $
    1.52
    
    
    $
    (0.26
    )
    
    $
    1.25
    
    
    $
    (0.15
    )Basic weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971
    
    
    
    4,478,971Diluted weighted average shares outstanding
    
    
    4,615,619
    
    
    
    4,478,971
    
    
    
    4,620,552
    
    
    
    4,478,971
 The accompanying notes are an integral part of these consolidated financial statements.
 Page 4




---



##### Table of Contents



Intelligent Systems Corporation
 
 CONSOLIDATED STATEMENTS OF CASH FLOW
 (unaudited, in thousands)
 Nine Months Ended Sept. 30,CASH PROVIDED BY (USED FOR):
    
    2006
    
    
    2005OPERATIONS:Net income (loss)
    
    $
    5,795
    
    
    $
    (682
    )Adjustments to reconcile net income (loss) to net cash used for operating activities:Depreciation and amortization
    
    
    396
    
    
    
    382Stock based compensation expense
    
    
    9
    
    
    
    Gain on sale of QS business
    
    
    (4,873
    )
    
    
    Investment income, net
    
    
    (2,645
    )
    
    
    (1,908
    )Equity in earnings of affiliate companies
    
    
    (351
    )
    
    
    (393
    )Changes in operating assets and liabilities, net of effect of sale of QS businessAccounts receivable
    
    
    (586
    )
    
    
    798Accrued interest receivable
    
    
    (23
    )
    
    
    Inventories
    
    
    (68
    )
    
    
    (149
    )Other current assets
    
    
    (133
    )
    
    
    (143
    )Other non-current assets
    
    
    
    
    
    
    8Accounts payable
    
    
    445
    
    
    
    17Accrued payroll
    
    
    (145
    )
    
    
    71Deferred revenue
    
    
    (268
    )
    
    
    1,134Accrued expenses and other current liabilities
    
    
    146
    
    
    
    153Other liabilities
    
    
    246
    
    
    
    Cash used for operating activities
    
    
    (2,055
    )
    
    
    (712
    )INVESTING ACTIVITIES:Proceeds related to sales of investments
    
    
    3,033
    
    
    
    2,243Purchases of intangible assets
    
    
    
    
    
    
    (6
    )Proceeds from sale of QS business
    
    
    1,900
    
    
    
    Proceeds from notes receivable
    
    
    35
    
    
    
    Payments on notes payable
    
    
    (66
    )
    
    
    Distributions from long-term investments
    
    
    385
    
    
    
    28Purchases of property and equipment
    
    
    (490
    )
    
    
    (329
    )Cash provided by investing activities
    
    
    4,797
    
    
    
    1,936FINANCING ACTIVITIES:Borrowings under short-term borrowing arrangements
    
    
    2,220
    
    
    
    836Repayments under short-term borrowing arrangements
    
    
    (2,320
    )
    
    
    (1,103
    )Proceeds from exercise of stock options in subsidiary
    
    
    3
    
    
    
    Cash used for financing activities
    
    
    (97
    )
    
    
    (267
    )Effects of exchange rate changes on cash
    
    
    (29
    )
    
    
    47Net increase in cash
    
    
    2,616
    
    
    
    1,004Cash at beginning of period
    
    
    378
    
    
    
    670Cash at end of period
    
    $
    2,994
    
    
    $
    1,674
 The accompanying notes are an integral part of these consolidated financial statements.
 Page 5




---



##### Table of Contents



Intelligent Systems Corporation
CONSOLIDATED STATEMENTS OF CASH FLOW (CONTINUED)  (unaudited, in thousands)
 Nine Months Ended Sept. 30,2006
    
    
    2005SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the period for interest
    
    $
    74
    
    
    $
    7
 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
     (unaudited, in $000s)Proceeds from sale:Cash
    
    $
    1,900Note receivable
    
    
    1,435Other receivables
    
    
    305Liabilities assumed by (assets transferred to) buyer:Other current assets
    
    
    (167
    )Property, plant and equipment, net
    
    
    (28
    )Accrued payroll
    
    
    120Accounts payable
    
    
    49Deferred revenue
    
    
    1,730Other current liabilities
    
    
    44Accrued transaction related expenses
    
    
    (515
    )Gain on sale of QS Technologies business
    
    $
    4,873
 The accompanying notes are an integral part of these consolidated financial statements.
 Page 6




---



##### Table of Contents



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, 2006
and 2005. The interim results for the three and nine months ended September 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 in
our annual report on Form 10-KSB for the fiscal year ended December 31, 2005, as filed with
the Securities and Exchange Commission (the SEC) on March 31, 2006.3.
    
    Discontinued Operations 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., referred to collectively as
Netsmart. The Company sold the operations and assets associated with the QS business for a
combination of $1,900,000 in cash, a promissory note of Netsmart in the amount of $1,435,000
and additional payments totaling $305,000 for unbilled receivables of QS. In addition,
Netsmart assumed liabilities of QS, net of assets acquired, of $1,748,000 in the aggregate.
The Company retained accounts receivable and cash of QS. The promissory note of Netsmart
bears interest at the rate of 8.25 percent and is payable in thirty-six monthly payments of
$45,133 beginning September 1, 2006. At September 30, 2006, the current portion of the
principal amount of the note is $443,000 and the non-current portion is $957,000. 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.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 in the consolidated statements of operations for the three and nine months ended
September 30, 2006 and all prior periods have been reclassified to conform to this presentation.
Based on the carrying basis of the assets and liabilities transferred to Netsmart at July 31,
2006 and estimated costs and expenses incurred in connection with the sale, the Company recorded
a net gain on the sale of QS of $4,873,000.The transaction also provides for contingent payments of up to $1,450,000 which may be earned by
the Company in 2008 based on the attainment by the QS business of certain levels of revenue and
bookings in 2007. As the amount, if any, of such payments is not quantifiable at this time, no
amount has been recorded for such contingency payments.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,(unaudited, in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    524
    
    
    $
    644
    
    
    $
    1,934
    
    
    $
    2,386Operating income
    
    
    317
    
    
    
    94
    
    
    
    602
    
    
    
    623Net income before tax
    
    
    317
    
    
    
    94
    
    
    
    600
    
    
    
    623Income tax
    
    
    
    
    
    
    53
    
    
    
    
    
    
    
    61Net income from discontinued operations
    
    $
    317
    
    
    $
    41
    
    
    $
    600
    
    
    $
    562
 4.
    
    Sale of Horizon Software Interest Effective August 31, 2006, the Company completed the sale
of its 17 percent ownership position in Horizon Software International, LLC (Horizon) to
Horizon Software Holdings, Inc., an entity comprised of the founder and officers of Horizon
(the Horizon Buyer) for a purchase price of $5,600,000. Simultaneously, the Company sold
its interest in an affiliate company of Horizon for $100,000. At the close of the
transaction, the Company received an aggregate of $2,850,000 in cash and a promissory note of
the Horizon Buyer in the principal amount of $2,850,000. The Company recorded a gain of
$2,638,000 on the sale of its Horizon interest.
 Page 7




---



##### Table of Contents



The following condensed financial information is provided for Horizon which had been accounted
for on the equity method prior to the sale of our interest in Horizon on August 31, 2006.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30, *
    
    
    September 30, *(unaudited, in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    5,393
    
    
    $
    6,782
    
    
    $
    15,002
    
    
    $
    15,336Gross profit
    
    
    4,038
    
    
    
    4,842
    
    
    
    11,122
    
    
    
    11,386Net income from continuing operations
    
    
    1,639
    
    
    
    1,802
    
    
    
    2,551
    
    
    
    2,849Net income
    
    
    1,639
    
    
    
    1,802
    
    
    
    2,551
    
    
    
    2,849ISC share of net income
    
    
    281
    
    
    
    309
    
    
    
    437
    
    
    
    488
 
 *
    
    Results for 2006 are for the two and eight month periods ended August 31, 2006, the
date of the Horizon sale. 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 EndedConsolidated Statements of Comprehensive Income (loss)
    
September 30,
    
    September 30,(unaudited, in thousands)
    
    2006
    
    2005
    
    2006
    
    2005Net income (loss)
    
    $
    7,016
    
    
    $
    (1,158
    )
    
    $
    5,795
    
    
    $
    (682
    )Other comprehensive income (loss):Foreign currency translation adjustment
    
    
    (16
    )
    
    
    15
    
    
    
    (29
    )
    
    
    47Unrealized loss on available-for-sale securities
    
    
    
    
    
    
    82
    
    
    
    
    
    
    
    (3
    )Comprehensive income (loss)
    
    $
    7,032
    
    
    $
    (1,061
    )
    
    $
    5,766
    
    
    $
    (638
    )
 6.
    
    Stock-Based Compensation  At September 30, 2006, we had two stock-based compensation plans
under which stock options to acquire shares of common stock in Intelligent Systems 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 before adopting the disclosure
provisions of SFAS No. 123, Accounting for Stock-Based Compensation. In December 2004, 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 nine month periods ended
September 30, 2006 has been recognized as a component of general and administrative expenses
in the accompanying Consolidated Financial Statements.No options related to the above referenced stock option plans were granted, exercised or
forfeited in the first nine 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, net income for the three and nine months ended September 30,
2006 was lower by $3,000 and $9,000, respectively, than if the Company had continued to account
for stock-based compensation under APB No. 25. The impact on both basic and diluted loss per
share for the three and nine months ended September 30,
 Page 8




---



##### Table of Contents



2006 was $0 per share in both periods.
Pro forma net income (loss) as if the fair value based method had been applied to all awards is
as follows:
 Three Months Ended
    
    
    Nine Months EndedSept. 30,
    
    
    Sept. 30,(in thousands, except per share data)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss), reported
    
    $
    7,016
    
    
    $
    (1,158
    )
    
    $
    5,795
    
    
    $
    (682
    )Add: stock-based compensation programs recorded as expense, net of related tax
    
    
    3
    
    
    
    
    
    
    
    9
    
    
    
    Deduct: total stock-based employee compensation expense determined under fair
value based method for all awards, net of related tax
    
    
    (3
    )
    
    
    (10
    )
    
    
    (9
    )
    
    
    (28
    )Pro forma net income (loss)
    
    $
    7,016
    
    
    $
    (1,168
    )
    
    $
    5,795
    
    
    $
    (710
    )Income (loss) per common share:Basic, as reported
    
    $
    1.57
    
    
    $
    (0.26
    )
    
    $
    1.29
    
    
    $
    (0.15
    )Basic, pro forma
    
    $
    1.57
    
    
    $
    (0.26
    )
    
    $
    1.29
    
    
    $
    (0.16
    )Diluted, as reported
    
    $
    1.52
    
    
    $
    (0.26
    )
    
    $
    1.25
    
    
    $
    (0.15
    )Diluted, pro forma
    
    $
    1.52
    
    
    $
    (0.26
    )
    
    $
    1.25
    
    
    $
    (0.16
    )
  Wgt Avg
    
    Wgt Avg
    
    AggregateExercise
    
    Remaining
    
    Intrinsic# of Shares
    
    Price
    
    Life in Years
    
    ValueOutstanding at Sept. 30, 2006
    
    
    238,680
    
    
    $
    2.56
    
    
    
    5.4
    
    
    $
    103,662Vested and exercisable at Sept. 30, 2006
    
    
    232,680
    
    
    $
    2.57
    
    
    
    5.2
    
    
    $
    101,871
  Page 9




---



##### Table of Contents



7.
    
    Industry Segments Segment information for continuing operations is presented consistently
with the basis described in the 2005 Form 10-KSB and reflects the reclassification of the QS
Technologies operations as discontinued operations, as explained in more detail in Note 3
above. The table following contains segment information for the three and nine month periods
ended September 30, 2006 and 2005.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited, in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Information TechnologyRevenue
    
    $
    1,218
    
    
    $
    1,218
    
    
    $
    5,794
    
    
    $
    4,570Operating loss
    
    
    (865
    )
    
    
    (1,314
    )
    
    
    (1,938
    )
    
    
    (3,344
    )Industrial ProductsRevenue
    
    
    2,242
    
    
    
    1,416
    
    
    
    6,095
    
    
    
    4,562Operating income
    
    
    161
    
    
    
    31
    
    
    
    145
    
    
    
    472Consolidated SegmentsRevenue
    
    
    3,460
    
    
    
    2,634
    
    
    
    11,889
    
    
    
    9,132Operating loss
    
    
    (704
    )
    
    
    (1,284
    )
    
    
    (1,793
    )
    
    
    (2,872
    )Corporate expenses
    
    
    (244
    )
    
    
    (204
    )
    
    
    (805
    )
    
    
    (688
    )Consolidated operating loss from continuing operations
    
    $
    (948
    )
    
    $
    (1,488
    )
    
    $
    (2,598
    )
    
    $
    (3,560
    )Depreciation and AmortizationInformation Technology
    
    $
    65
    
    
    $
    56
    
    
    $
    199
    
    
    $
    173Industrial Products
    
    
    64
    
    
    
    43
    
    
    
    189
    
    
    
    176Consolidated segments
    
    
    129
    
    
    
    99
    
    
    
    388
    
    
    
    349Corporate
    
    
    6
    
    
    
    2
    
    
    
    16
    
    
    
    9Consolidated depreciation and amortization
    
    $
    135
    
    
    $
    101
    
    
    $
    404
    
    
    $
    358Capital ExpendituresInformation Technology
    
    $
    47
    
    
    $
    41
    
    
    $
    81
    
    
    $
    96Industrial Products
    
    
    47
    
    
    
    14
    
    
    
    385
    
    
    
    194Consolidated segments
    
    
    94
    
    
    
    55
    
    
    
    466
    
    
    
    290Corporate
    
    
    13
    
    
    
    3
    
    
    
    32
    
    
    
    33Consolidated capital expenditures
    
    $
    107
    
    
    $
    58
    
    
    $
    498
    
    
    $
    323
 September 30, 2006
    
    
    December 31, 2005(unaudited)Identifiable AssetsInformation Technology
    
    $
    3,192
    
    
    $
    3,746Industrial Products
    
    
    3,860
    
    
    
    2,913Consolidated segments
    
    
    7,052
    
    
    
    6,659Corporate
    
    
    9,003
    
    
    
    4,778Consolidated assets
    
    $
    16,055
    
    
    $
    11,437
 Page 10




---



##### Table of Contents



8.
    
    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 Sept. 30,
    
    Nine Months Ended Sept. 30,(unaudited)
    
    2006
    
    2005
    
    2006
    
    2005VISaer Customer A
    
    
    
    
    
    
    
    
    
    
    15
    %
    
    
    VISaer Customer B
    
    
    
    
    
    
    14
    %
    
    
    
    
    
    
    13
    %ChemFree Customer C
    
    
    12
    %
    
    
    13
    %
    
    
    11
    %
    
    
    ChemFree Customer D
    
    
    14
    %
    
    
    
    
    
    
    
    
    
    
    
 9.
    
    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
September 30, 2006, the amount related to this settlement that is included in current and
long-term liabilities is $135,000 and $245,000, respectively. The liability, which is an
obligation of VISaer, is not secured by any assets or guaranteed by the parent company.
 10.
    
    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 (i) the Contract Settlement referenced in Note 9 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 and (ii) as
a result of the sale of the QS operations and the assumption by the buyer of the QS facility
lease, the amount of the Companys noncancelable operating leases shown in the above
referenced Note 8 in the 2005 Form 10-KSB will be reduced by approximately $80,000-$88,000
annually through February 2011.On August 11, 2006, the maturity date for the Companys $2 million bank line of credit was
extended from September 1, 2006 to December 1, 2006 on the same terms and conditions.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. In the third quarter of 2006, an arbitrator was
assigned and the initial submissions of the parties to the arbitrator are due in November 2006.
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 September 30, 2006, it does not appear probable that the
guarantee will be paid; thus no amounts have been accrued with respect to this guarantee.
 Page 11




---



##### Table of Contents



In connection with and to facilitate a contract between Ardext Technologies, Inc., a privately
held company in which ISC held a minority ownership, and an Ardext customer, ISC entered into
agreements with Ardext and the customer to hold milestone payments by the customer totaling
$150,000. During the quarter ended September 30, 2006, the customer requested a refund of the
payments and ISC returned the $150,000 to the customer. ISC has no further obligations under
the agreements.11.
    
    New Accounting Pronouncements In December 2004, 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. For a full
discussion of the affect of the Companys adoption of SFAS No. 123R, see Note 6.In December 2004, the FASB issued FASB Statement No. 151, Inventory Costs  an amendment of ARB
No. 43, Chapter 4. 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.In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements to increase
consistency and comparability in fair value measurements. SFAS No. 157 defines fair value,
establishes a framework for measuring fair value, and expands disclosures about fair value
measurements of certain assets, liabilities and items in stockholders equity that are measured
at fair value. FASB No. 157 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, although early adoption is encouraged. The Company has not
yet determined when it will adopt the standard or the impact that the adoption of the standard
will have on its financial statements.
 
 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 analyses 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 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.
 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 SEC on
March 31, 2006.
 Overview
   Page 12




---



##### Table of Contents




    
    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.
     Page 13




---



##### Table of Contents



Results of Operations
  Continuing Operations:
 Revenue ®
  Cost of Sales
 Operating Expenses
 Page 14




---



##### Table of Contents



Interest Income (Expense)
 Investment Income (Expense) -
 Equity Earnings (Losses) of Affiliate Companies -
 Income Taxes
 Net Income (Loss) from Continuing Operations 
 Discontinued Operations:
 Net Income from Discontinued Operations 
 Gain on Sale of Discontinued Operations
 Liquidity and Capital Resources
   Page 15




---



##### Table of Contents



Critical Accounting Policies and Estimates
  Factors That May Affect Future Operations
   
    
    Delays in software development projects which could cause our customers to delay implementations, delay payments or
cancel contracts, which would increase our costs and reduce our revenue.
 Page 16




---



##### Table of Contents




    
    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.
 
    
    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.
 
    
    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 Note 10 to the consolidated financial statements, 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 decide to purchase and run an in-house software system and
instead choose to outsource their account transaction processing which could result in lower revenue and greater cash
requirements.
 
    
    Other general economic and political conditions, particularly those which may cause international business and domestic
government customers to delay or cancel software purchases.
  
 Item 3. Controls and Procedures
  Page 17




---



##### Table of Contents



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 and filed on December 16,1997.)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 and filed on May 21, 1998.)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
  INTELLIGENT SYSTEMS CORPORATION
RegistrantDate:  November 14, 2006
    By:
    /s/ J. Leland StrangeJ. Leland StrangeChief Executive Officer, PresidentDate:  November 14, 2006
    By:
    /s/ Bonnie L. HerronBonnie L. HerronChief Financial Officer Page 18