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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-K FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (Mark One)x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2003 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from_________ to ____________ Commission file number 1-9330 INTELLIGENT SYSTEMS CORPORATION 
  Georgia
    
    58-1964787(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)4355 Shackleford Road, Norcross, Georgia
    
    30093(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (770) 381-2900 Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredCommon Stock, $.01 par value
    
    American Stock Exchange
 Securities registered pursuant to Section 12(g) of the Act:None Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes
o No x As of March 12, 2004, 4,478,971 shares of Common Stock were outstanding. The
aggregate market value of the Common Stock held by non-affiliates of the
registrant on June 30, 2003 was $4,484,511 (computed using the closing price of
the Common Stock on June 30, 2003 as reported by the American Stock Exchange). DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrants Proxy
Statement for the Annual Meeting of Shareholders to be held on May 27, 2004,
are incorporated by reference in Part III hereof.




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TABLE OF CONTENTS  
 PAGEPart IItem
    
    1.
    
    Business
    
    
    32.
    
    Properties
    
    
    83.
    
    Legal proceedings
    
    
    84.
    
    Submission of matters to a vote of security holders
    
    
    8Part II5.
    
    Market for the registrant's common equity and related stockholder matters
    
    
    96.
    
    Selected financial data
    
    
    97.
    
    Management's discussion and analysis of financial condition and results of operations
    
    
    107A.
    

    Quantitative and qualitative disclosures about market risk
    
    
    188.
    
    Financial statements and supplementary data
    
    
    189.
    
    Changes in and disagreements with accountants on accounting and financial disclosure
    
    
    189A.
    
    Controls and procedures
    
    
    18Part III10.
    
    Directors and executive officers of the registrant
    
    
    1811.
    
    Executive compensation
    
    
    1912.
    
    Security ownership of certain beneficial owners and management and related stockholder matters
    
    
    1913.
    
    Certain relationships and related transactions
    
    
    1914.
    
    Principal accountant fees and services
    
    
    19Part IV15.
    
    Exhibits, financial statement schedules and reports on Form 8-K
    
    
    19Signatures
    
    
    
    
    
    
    21EX-10.2 2003 STOCK INCENTIVE PLANEX-10.3 LOAN AGREEMENTEX-10.4 SECURITY AGREEMENTEX-10.5 FORM OF SECURITY AGREEMENTEX-10.6 NEGATIVE PLEDGE AGREEMENTEX-10.7 COMMERCIAL PROMISSORY NOTEEX-10.8 FORM OF GUARANTEEEX-21.1 LIST OF SUBSIDIARIES OF REGISTRANTEX-23.1 CONSENT OF BDO SEIDMAN, LLPEX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEO/CFO




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PART I Forward-Looking Statements  In addition to historical information, thisForm 10-Kmay contain
forward-looking statements relating to Intelligent Systems
Corporation (ISC). All statements, trend analysis and other
information contained in the following discussion 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, likely 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. A number
of the factors that we believe could impact our future operations
are discussed in Managements Discussion and Analysis in section
Item 7. of thisForm 10-K. ISC undertakes no obligation to update
or revise its forward-looking statements to reflect changed
assumptions, the occurrence of unanticipated events or changes in
future operating results. 
 ITEM 1. BUSINESS Overview Intelligent Systems Corporation, a Georgia corporation, has operated since 1973
and its securities have been publicly traded since 1981. In this report,
sometimes we use the terms company, we, ours and similar words to refer
to Intelligent Systems Corporation. Our executive offices are located at 4355
Shackleford Road, Norcross, Georgia 30093 and our telephone number is (770)
381-2900. Our Internet address is www.intelsys.com. We publish our SEC-filed
reports on our website as soon as reasonably practicable after we file them
with or furnish them to the SEC, and shareholders may access and download these
reports free of charge. Since the early 1980s, we have conducted our operations principally through
majority owned subsidiaries or minority owned affiliates to which we devote
extensive management resources. Frequent acquisitions of or investment in
early stage companies in the technology industry have long been components of
our overall strategy. From time to time, we may sell one of our companies or
we may increase our investment in a less-than-wholly owned company. As a
result, our ownership position in a given company may change from time to time,
our results of operations vary considerably from quarter-to-quarter and
year-to-year and our past performance is not necessarily indicative of future
results. Our strategy has been to help entrepreneurs build valuable companies by
providing operational and strategic management, practical business advice,
early stage equity capital, a network of business contacts and, in some cases,
an incubator program. Depending upon the needs of each company, we will
undertake a variety of roles which often include day-to-day management of
operations, board of director participation, financing, market planning,
strategic contract negotiations, personnel and administrative roles, and
similar functions. Our subsidiary and affiliate companies are in the
information technology industry (principally software for business
applications) although one of our subsidiary companies is in the industrial
products industry. Presently, our focus is on managing our subsidiary
companies and current minority investments and we do not anticipate significant
new investments or acquisitions in the foreseeable future. Financial Reporting We consolidate the results of operations of companies in which we own a
majority interest or over which we exert control. We generally account for
investments by the equity method for minority owned companies (i) in which we
own 20 to 50 percent and over which we do not exert control or (ii) entities
that are organized as partnerships or limited liability companies. In general,
under the equity method, we report our pro rata share of the income or loss
generated by each of these businesses as equity income/losses of affiliates on
a quarterly basis. These equity losses and income decrease or increase,
respectively, the cost basis of our investment. Privately owned corporations
in which we own less than 20 percent of the equity are carried at the lower of
cost or market. We do not mark up the value of privately-owned businesses even
when they raise money at higher valuations. We are often actively engaged in
managing strategic and operational issues with our non-consolidated companies
and devote significant resources to the development of their businesses. Intelligent Systems Corporation - 3 -




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Industry Segment Overview Our consolidated companies operate in two industry segments: Information
Technology Products and Services and Industrial Products. The Information
Technology segment includes our VISaer, Inc., QS Technologies, Inc. and
CoreCard Software, Inc. subsidiaries and the Industrial Products segment
includes ChemFree Corporation. As of December 31, 2003, we own 100 percent of
the ChemFree and QS Technologies subsidiaries, 65 percent of VISaer and 87
percent of CoreCard Software. Operations in the Information Technology segment are involved in the design,
development and marketing of application software products that are used by
business customers and government agencies to manage aspects of their
operations. Our software products are typically sold in competitive bids with
relatively long sales and implementation cycles. We receive software license
fees that vary depending upon the number of licensed users and the number of
software modules licensed with total contract revenue typically ranging from
$100,000 to over $1 million. We also derive service revenue from
implementation, customization, training and support services. The Industrial Products segment includes the design, assembly and sale of
equipment and associated supplies that are used by commercial, industrial,
military and government agencies to maintain and service machinery or vehicles
used in their operations. Our assembled products are shipped to resellers or
direct to customer sites and do not require set-up or on-site support from us.
Unit pricing varies by model but typical end-user prices are less than $2,000
per unit. Customers purchase replacement supplies from us after the sale. In
some cases, we provide equipment to multi-site corporate users under leases
which typically have averaged 3 to 4 years. Our individual operations in both segments are relatively small in size and are
subject to greater fluctuation in revenue and profitability than larger, more
established businesses. Sales of ChemFree products have represented between 47
and 50 percent of consolidated revenue in each of the last three years. QS
Technologies and VISaer have made up the balance of consolidated revenue, with
each contributing approximately one half of the remaining consolidated revenue.
In 2003, QS Technologies revenue exceeded VISaers whereas in the prior two
years, VISaers revenue was slightly greater than was QS Technologies.
CoreCard began to generate revenue in 2003 and contributed an immaterial amount
to consolidated revenues in 2003, although their contribution is expected to
increase in 2004. The business in our segments is not seasonal on a
consolidated basis although there is generally some slowdown in ChemFrees
European business in late summer. The business discussion which follows
contains information on products, markets, competitors, research and
development and manufacturing for our operating subsidiaries, organized by
industry segment and by company. For further detailed financial information
concerning our segments, see Note 16 in the accompanying Notes to Consolidated
Financial Statements. For further information about trends and risks likely to
impact our business, please refer to Managements Discussion and Analysis in
Item 7. of this Form 10-K. Industry Segment: Information Technology Products and Services VISaer, Inc.- VISaer develops, sells and supports software for the world-wide
aircraft maintenance and engineering industry. VISaer offers a fully
integrated, real time software solution that helps aviation customers
efficiently and cost-effectively manage the technical, commercial and
operational aspects of their maintenance, repair and overhaul (MRO)
operations while also meeting regulatory requirements, such as those of the
Federal Aviation Administration. Headquartered in Wilmington, Massachusetts,
VISaer also has operations in England to support product development and sales
activities in Europe. VISaer is the successor company of Visibility, Inc., a
software company whose operations were sold in July 2000 to allow VISaer to
concentrate on the MRO software market. VISaers product offering includes the
following major components: technical records planning and management, MRO
operations, materials management, production scheduling, commercial operations
and financial management. VISaer announced the first release of Version 3.1, a
fully Web-native version of its complete MRO solution, in late 2002 and the
first installation of this release was accomplished in 2003. VISaer has signed
contracts to purchase software licenses for its Version 3 software with four
customers and has $1.4 million in short-term deferred revenue and $5.1 million
in long-term deferred revenue at December 31, 2003 that will be recognized when
various releases of the Version 3 software are delivered to customers in 2004
and thereafter. In addition, VISaer has a sales and marketing program that has
identified additional prospects for MRO license sales, professional services
and maintenance contracts. However, due to resource constraints, in 2004
VISaer expects to focus on completing and delivering its Version 3 software to
establish strong reference accounts and generate cash flow and revenue before
allocating significant resources to new sales and marketing programs. During 2002 and much of 2003, the general slow-down in the economy, the
terrorist attacks of September 11, 2001, hostilities involving Iraq and the
outbreak of Sudden Acute Respiratory Syndrome had a significant negative impact
on the commercial aviation market, initially in the domestic market and then in
international markets. Some airlines delayed or canceled planned information
technology projects and others experienced a decline in financial strength
during the industry downturn. In recent months, there appears to be
momentum building, especially in international markets, to move forward on
delayed proposals to purchase MRO software which we believe will provide an Intelligent Systems Corporation - 4 -




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opportunity to build a pipeline of additional business. Regulatory
requirements dictate that airlines manage their MRO processes carefully and
there is increased pressure to improve and automate MRO record-keeping.
VISaers software products provide a comprehensive, cost-effective way to do
so. We believe significant sales opportunities exist in the Asian Pacific,
Latin American and Chinese markets, MRO service outsourcing companies, low-cost
airlines, defense related aviation, and small to mid-size domestic regional
airlines. VISaer markets and sells its software in both domestic and international
markets. International customers have represented a majority of VISaer sales
of products and services in each of the last two years and are expected to do
so in 2004 as well. The markets for VISaer products include both airline-owned
maintenance and engineering shops as well as third party MRO organizations.
Most of VISaers sales are direct to the customer with VISaer providing a
turnkey solution that covers project management, software, system
implementation, training, consulting and support. Prior to 2003, as VISaer was
building its internal capacity, VISaer sold its products through certain
re-sellers on a non-exclusive basis in certain markets. In most cases, sales
are made in response to competitive bids and requests for proposals and have
sales cycles of six to eighteen months with implementation periods of an
additional six to eighteen months. VISaer provides full suite implementation
services and post-sales support and maintenance activities under annual
contracts, as well as customization and professional services on an as needed
basis. VISaer has a number of competitors, some of whom offer MRO software as
part of an Enterprise Resource Planning package and who have significantly more
financial resources, larger customer bases and greater market coverage than
VISaer. Other competitors are small players focused on MRO solutions with
resources similar to VISaer. VISaer competes on the basis that its software
provides extensive product functionality using Web-native technology; provides
low cost-of-ownership; includes integrated modules offering a complete software
and service solution; and runs on industry standard technology platforms.
VISaer believes that its new Version 3 Web-native software is a strong
competitive offering. QS Technologies, Inc.- QS Technologies operates from its Greenville, South
Carolina location, providing health and human services software, maintenance
and support services to its installed customer base as well as to new
customers. QS Technologies products allow public health agencies to capture,
analyze and manage client information such as immunization, maternal health,
and birth and death records. The market includes local, state and federal
public health agencies nationwide as well as other government agencies,
hospitals and clinics. QS Technologies competes against a number of other
software companies, many of which are small vendors like itself and some of
which are larger with access to greater resources. QS Technologies competes on
the basis of product functionality and value, reputation for customer service,
and knowledge of market requirements acquired through more than twenty years in
the market. Sales are typically made in response to competitive bids and may
take six to twelve months before contracts are awarded. Demand for products
and the timing of contract awards is impacted by general economic conditions as
well as customer-specific factors such as state and local budgets and program
priorities, over which QS Technologies has little control. Typically, QS
Technologies provides its customers with post-sales service and support under
annual contracts that often renew for multiple years after the initial software
license fee is earned. QS Technologies has expanded its product line to
include vital records software and web-based capabilities. In 2003, QS
Technologies benefited from expanded sales and marketing activities in 2002 and
an industry-wide increase in the number of new projects contracted for after
several years of slowdown due to state and local budget constraints.
Consequently, QS Technologies had a record year for revenue from new license
sales and from annual maintenance contracts due to an expanded installed
customer base. Based on our current outlook and the generally months-long
process between submission of a proposal, contract award and delivery of the
software, it is unlikely that QS Technologies will experience the same level of
new license revenue in 2004 as it did in 2003, although the level of service
revenue should continue to provide a significant recurring contribution because
new and existing customers typically sign annual maintenance and support
contracts. CoreCard Software, Inc.- CoreCard Software was spun off from our former
affiliate company, PaySys International, in April 2001. CoreCard designs,
develops and markets software to accounts receivable businesses, banks, credit
unions and retailers to manage their credit card, merchant and loan accounts.
After more than seven years of extensive product development activity
(including prior to the spin-off), in 2003 CoreCard completed the first major
installation of its CoreISSUE and CoreCOLLECT application modules, based on
its proprietary CoreENGINE architecture, at a major catalog retailer customer
and will recognize revenue related to this contract in early 2004. CoreCard
products allow financial institutions and commercial customers to optimize
their account management systems, improve customer retention, lower operating
costs and create greater market differentiation. CoreCards feature-rich,
browser-based financial software allows customers to automate, streamline and
optimize business processes associated with the set-up, administration and
management of credit card, merchant and loan accounts, to process transactions
and to generate reports and statements for these accounts. Because CoreCards
products are designed to run on PC-based servers, rather than mini or mainframe
computers, customers benefit from a lower overall cost-of-ownership, faster
implementations and increased flexibility to respond to market conditions.
CoreCards product functionality includes embedded multilingual, multi-currency
support, web-based interface, real-time processing, complex rules-based
authorizations, unlimited account hierarchies, and flexible, customer-defined
pricing and payment terms. Intelligent Systems Corporation - 5 -




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CoreCards initial target markets include accounts receivable businesses, small
and mid-size banks, and retail and private-label issuers, in the United States
and in certain emerging international markets, most likely focusing on the
Pacific Rim. CoreCard competes with third-party card processors, larger and
more established software suppliers, and a number of software solution
providers that offer more limited functional modules. CoreCard has relatively
limited sales and marketing experience compared to many of its competitors and
it is unclear whether potential customers will choose to outsource their
account transaction processing rather than acquire software to manage their
transactions in-house, which could impact negatively the total addressable
market for CoreCard, if such a trend gains momentum. Moreover, it is uncertain
whether potential customers will be reluctant to acquire software from a
relatively small emerging company with limited customer installations and
choose instead a lower risk strategy of acquiring older technology from more
established companies. Certain of CoreCards competitors have significantly
more financial, marketing and development resources than does CoreCard and have
large, established customer bases often tied to long-term contracts. CoreCard
believes it can compete successfully in selected markets based on providing
customers with a next-generation technology platform, lower overall
cost-of-ownership, faster implementation cycles, greater system flexibility and
more customer-driven marketing options. Like most emerging software companies,
CoreCards challenge is to establish a growing base of referenceable, satisfied
customers and to overcome customer reluctance to implement a business-critical
system based on a new software product with limited installations. CoreCard
has certain non-compete restrictions related to the spin-off from PaySys
International, which limit for varying time periods through 2006 the customers
and markets that CoreCard can solicit and serve. However, CoreCard believes
that the available worldwide market is substantial, even with these
time-limited restrictions. CoreCard licenses its software products for either a one-time license fee or a
per transaction fee, depending on specific customer requirements and
preferences. It provides maintenance and support services under annual
contracts, as well as professional services on an as needed basis for
customization, implementation and training activities. Generally, CoreCard
expects to sell its products directly to its initial customers in the domestic
U.S. and is developing relationships with a small number of resellers and
third parties in international markets to identify, sell and support targeted
opportunities. CoreCard completed its initial software modules, CoreISSUE,
CoreFRAUD and CoreCOLLECTIONS in 2003 and expects to complete CoreACQUIRE in
2004 as customer demand and CoreCard resources allow. Industrial Products Segment ChemFree Corporation- Our only subsidiary in the Industrial Products segment
is ChemFree Corporation, one of our early incubator companies. ChemFree
designs, manufactures and markets a line of parts washers under the
SmartWasher® trademark. SmartWashers® use an advanced bio-remediation system
that cleans automotive and machine parts without using hazardous, solvent-based
chemicals. Typically, the SmartWasher® system consists of a molded plastic tub
and sink, recirculating pump, heater, control panel, filter with
microorganisms, and water-based degreasing solutions. Unlike traditional
solvent-based systems, there are no regulated, hazardous products used or
produced in the process and the SmartWasher® system is completely
self-cleaning. ChemFree sells replacement fluid and filters to its customers
on a regular basis after the initial parts washer sale. ChemFrees markets include the automotive, transportation, industrial and
military markets. The automotive market includes companies and governmental
agencies with fleets of vehicles to maintain, individual and chain automobile
service centers and auto parts suppliers, such as NAPA. The industrial market
includes customers with machinery that requires routine maintenance, such as
power plants and tool and equipment rental companies. Military applications
include vehicle, aircraft and weapons maintenance in all branches of the
military. ChemFree sells its products directly to high volume customers as well
as through several distribution channels, including international distributors
in Europe and the Pacific Rim. ChemFree also sells under a General Services
Administration schedule to government agencies. Because ChemFree sells in part
through large national distributors such as NAPA and Barnes Group in the United
States and exclusive distributors in certain international markets, its results
could be impacted negatively if one or more of such distributors stops carrying
ChemFree products. One of ChemFrees domestic distributors, NAPA, represented
13 percent and 14 percent of our consolidated revenue in 2003 and 2002,
respectively and 28 percent of our Industrial Products Segment revenue in both
2003 and 2002. Part of ChemFrees revenue is derived from multi- year lease
contracts under which ChemFree provides SmartWashers® and supplies to
nationwide chains of auto repair shops, such as Firestone and Pep Boys. ChemFree competes with larger, established companies that offer solvent-based
systems, other small companies using non-hazardous systems, and hazardous waste
hauling firms. Although smaller than the established solvent-based firms,
ChemFree believes it is
competitive based on product features, positive environmental impact, desirable
health and safety features, elimination of regulatory compliance, and price.
ChemFree believes that new regulations from governmental agencies such as the
Environmental Protection Agency that prohibit or restrict the use of
solvent-based products, with which ChemFrees products compete, will expand
overall market demand significantly if such regulations are enforced
effectively by state, local and federal governments. Intelligent Systems Corporation - 6 -




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Customer and warranty service, typically covering a one-year period, is
provided either by ChemFree personnel or through its distributors and dealers.
ChemFree subcontracts the manufacturing of major sub-assemblies built to its
specifications to various manufacturers and performs final assembly and testing
at its own facility. While there are multiple sources available for
subassemblies, ChemFree frequently contracts with a single source for certain
components in order to benefit from lower prices and consistent quality. Incubator Program For more than ten years, we have operated the Intelligent Systems Incubator at
our corporate facility in a suburb of Atlanta, Georgia. In exchange for a
monthly facility fee, incubator companies have access to resources such as
office space, conference facilities, telecommunication and network
infrastructure, business advice and planning, a network of professional
services, and, in some cases, financial capital from Intelligent Systems.
Depending upon the experience and needs of the founding entrepreneur, incubator
companies will choose to use some or all of the available resources. Income
from incubator companies reduces our total facility and personnel costs. Because we have a large facility, we have been able to offer the benefits of
the incubator program to companies in which we have no ownership interest. In
attracting companies to our incubator program, we compete with other sources of
business assistance, facilities and financial capital that may be available to
the entrepreneur. These sources include other incubator programs as well as
angel and venture capital investors, corporate partner relationships and
merger/sale opportunities. Minority-Owned Partner Companies Part of our business strategy has been to seek to own a minority interest in
companies that we believe are involved in promising technologies or markets
with good growth potential. From time to time, we have acquired an investment
in such companies and expect to continue to do so as a regular part of our
strategy. Typically, these companies are privately held, early stage companies
in technology-related fields. We are often actively involved in helping the
companies develop and implement their business plans. Some examples of our
involvement are as follows:  
    
    A 17 percent interest in Horizon Software International, Inc., a
leading provider of software and systems to manage the food service
operations of primary and secondary education, college, medical and
military facilities.  
    
    A 25 percent interest in NKD Enterprises, LLC (dba CoreXpand), a
software services company with an e-commerce application for
promotional and incentive product distributors and corporate
customers. CoreXpand is part of our incubator program.  
    
    A 22 percent interest in Cirronet, Inc., a privately held and former
Intelligent Systems incubator company involved in wireless
telecommunications products for industrial, medical and commercial
markets as well as residential and small business wireless Internet
markets. Research and Development We spent $8.3 million, $9.8 million and $3.4 million in the years ended
December 31, 2003, 2002 and 2001, respectively, on company sponsored research
and development. In 2003, the Information Technology segment spent $1.5
million less on software development than in 2002 when R&D spending had
increased by $6.4 million compared to 2001. In 2002, the significant increase
in spending was due to an intensive effort related to development of the VISaer
Version 3.0 product line and the initial software offering by CoreCard. In
2003, we spent less at both VISaer and CoreCard than in 2002 because fewer
personnel and third party resources were required than in the initial product
development phases. In both 2003 and 2002, of the consolidated research and
development expense, approximately 50 percent relates to VISaer product
development and 33 percent relates to CoreCard with the balance spent mainly
for development projects at QS Technologies and, to a small extent, at
ChemFree. We estimate that total R&D expenses in 2004 will be lower than in
2003 mainly due to a reduced number of U.S. based personnel at CoreCard
compared to 2003 coupled with a greater use of lower cost off-shore personnel
for testing and certain development tasks; reduced need for third party
developers than were required during the early
product development stages; at VISaer, increased use of customers personnel
for certain testing activities which contribute to lower overall costs; and the
ongoing benefit of a reduction in personnel in the third quarter of 2003 and
reassignment of some software developers to customer support and professional
services activities. VISaer released its first Version 3 software in 2003 and expects to complete
additional version releases and modules at various times in 2004. In 2004,
CoreCard Software plans to continue to complete additional software modules,
principally CoreACQUIRE, and to develop further enhancements to its initial
suite of products. Intelligent Systems Corporation - 7 -




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Patents, Trademarks and Trade Secrets Our ChemFree subsidiary has 11 U.S. patents issued and 15 patents in foreign
jurisdictions issued and pending covering various aspects of the design and
construction of the SmartWasher® system and the process of bioremediation used
in the SmartWasher® system. ChemFree considers these patents an important
component of their overall business strategy. (See Item 3 below). CoreCard has
filed several patent applications covering aspects of its core software engine.
It may be possible for competitors to duplicate certain aspects of these
products and processes even though we regard such aspects as proprietary. We
have registered with the U.S. Patent and Trademark Office and various foreign
jurisdictions numerous trademarks and service marks for our products. We
believe that an active trade secret, trade name, trademark, and copyright
protection program is important in developing and maintaining brand recognition
and protecting our subsidiaries intellectual property. Our companies
presently market their products under trademarks and service marks such as
SmartWasher®, OzzyJuice, VISaer, CoreENGINE, CoreISSUE, CoreCOLLECT and
others. Personnel As of February 28, 2004, we had 168 full-time equivalent employees in our
company as well as in our majority-owned companies. Our employees are not
represented by a labor union, we have not had any work stoppages or strikes and
we believe our employee relations are good. Financial Information About Geographic Areas Refer to Note 14 to the Consolidated Financial Statements for financial
information in response to this item. We do not believe there are any specific
risks attendant to our foreign operations that are significantly different than
the general business risks discussed elsewhere in this annual report. 
 ITEM 2. PROPERTIES At February 28, 2004, we have leases covering approximately 137,500 square feet
in Norcross, GA, 6,100 square feet in Greenville, SC, and 21,400 square feet in
Wilmington, MA, to house our product development, manufacturing, sales, service
and administration operations, as well as small sales and/or development
offices in England, Ireland, and Romania. A portion of the Norcross corporate
facility is subleased to businesses in our technology business incubator. Our
current lease on the Norcross facility expires May 31, 2004 and we are
presently evaluating options to move or stay in the same facility, which in
either case is likely to result in a substantial increase in facility lease
costs because our expiring lease was at below current market rates. We
anticipate successfully negotiating a lease to stay in the current facility
but, if not, we expect that adequate facilities will be available at prevailing
market rates. 
 ITEM 3. LEGAL PROCEEDINGS In 1999, a former consultant of the ChemFree subsidiary brought suit against
ChemFree and other third parties in an action styled James C. McClure vs. Zymo
International, Inc., G. Robert Whiteman and ChemFree Corporation et al.
challenging the ownership of certain of ChemFrees patents. ChemFree and other
parties to the suit deny the allegations and are vigorously defending the suit,
which is pending in the Superior Court of Gwinnett County, Georgia. ChemFree
has filed a counter suit in the United States District Court for the Northern
District of Georgia in an action styled ChemFree Corporation vs. James C.
McClure. The case in Federal Court was scheduled to go to trial early in 2004
but was postponed due to changes in the courts calendar and no new date has
been set. The case in the Superior Court of Gwinnett County is on hold pending
resolution of the Federal case. While we believe ChemFree has sufficient
evidence to prevail in both cases, there can be no assurance that the cases
will be resolved in ChemFrees favor. At this time it is unclear what, if any,
impact a finding in either case which is adverse to ChemFree would have on its
business or financial condition. In addition, from time to time we are or may
become a party to a number of other legal matters arising in the ordinary
course of business. It is
managements opinion that none of these other matters will have a material
adverse impact on our consolidated financial position or results of operations. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We did not submit any matter to a vote of our shareholders during the fiscal
quarter ended December 31, 2003. Intelligent Systems Corporation - 8 -




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PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS Our common stock is listed and traded on The American Stock Exchange (AMEX)
under the symbol INS. The following table sets forth, for the periods
indicated, the range of high and low sales prices for our common stock as
reported by AMEX. 2003
    
    2002Year Ended December 31,

    
    High
    
    Low
    
    High
    
    Low1st Quarter
    
    $
    1.70
    
    
    $
    1.25
    
    
    $
    3.28
    
    
    $
    2.952nd Quarter
    
    
    2.04
    
    
    
    1.40
    
    
    
    3.25
    
    
    
    2.853rd Quarter
    
    
    2.20
    
    
    
    1.59
    
    
    
    3.00
    
    
    
    1.604th Quarter
    
    
    2.01
    
    
    
    1.55
    
    
    
    1.92
    
    
    
    1.45
 We had 385 shareholders of record as of February 28, 2004. This number does not
include beneficial owners of our common stock whose shares are held in the
names of various dealers, clearing agencies, banks, brokers and other
fiduciaries. The company has in the past paid cash dividends from time to time
on an irregular basis but has not in the past paid regular dividends and does
not expect to pay any dividends in the foreseeable future. Under our revolving
line of credit facility, we are precluded from paying dividends without
obtaining consent from the bank. See Note 6 to the Consolidated Financial
Statements. 
 ITEM 6. SELECTED FINANCIAL DATA Twelve Months Ended December 31, (in thousands except share and per share amounts)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Net Sales
    
    $
    13,334
    
    
    $
    10,741
    
    
    $
    8,718
    
    
    $
    7,027
    
    
    $
    8,479Net Income (Loss)
    
    
    (4,798
    )a
    
    
    (12,257
    )b
    
    
    9,113
    c
    
    
    8,215
    d
    
    
    249
    eNet Income (Loss) Per Share (Basic)
    
    
    (1.07
    )
    
    
    (2.73
    )
    
    
    1.78
    
    
    
    1.47
    
    
    
    0.05Net Income (Loss) Per Share (Diluted)
    
    
    (1.07
    )
    
    
    (2.73
    )
    
    
    1.77
    
    
    
    1.46
    
    
    
    0.05Total Assets
    
    
    13,742
    
    
    
    17,860
    
    
    
    26,089
    
    
    
    18,057
    
    
    
    13,658Working Capital
    
    
    (1,898
    )
    
    
    1,490
    
    
    
    10,206
    
    
    
    3,294
    
    
    
    (48
    )Long-term Debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    363Stockholders Equity
    
    
    1,070
    
    
    
    5,894
    
    
    
    17,858
    
    
    
    14,674
    
    
    
    10,209Cash Dividends Paid Per Common Share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.52
    
    
    
    Shares Outstanding at Year End
    
    
    4,478,971
    
    
    
    4,491,779
    
    
    
    4,495,530
    
    
    
    5,623,784
    
    
    
    5,114,467Basic Weighted Average Shares Outstanding
    
    
    4,483,458
    
    
    
    4,495,058
    
    
    
    5,108,413
    
    
    
    5,606,715
    
    
    
    5,106,134Diluted Weighted Average Shares Outstanding
    
    
    4,483,458
    
    
    
    4,495,058
    
    
    
    5,145,691
    
    
    
    5,632,484
    
    
    
    5,336,776
  a.
    
    Includes net investment gains of $3.0 million, $184,000 in net
income in equity of affiliates and $328,000 other income.b.
    
    Includes net investment losses of $934,000, $235,000 in net losses
in equity of affiliates and $900,000 other income.c.
    
    Includes investment gains of $19.9 million, $2.2 million in net
losses in equity of affiliates and charges totaling $6.4 million
related to the write-off of in-process R&D in connection with the
acquisition of VISaer and subsequent goodwill impairment charge.d.
    
    Includes investment gains of $9.7 million and $771,000 in net losses
in equity of affiliates.e.
    
    Includes investment gains of $2.2 million and $948,000 in net losses
in equity of affiliates. Please refer to Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations and Notes to Consolidated Financial
Statements for a discussion of material acquisitions or dispositions that may
affect the comparability of this financial information. Intelligent Systems Corporation - 9 -




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of
operations are based upon our Consolidated Financial Statements which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amount of assets,
liabilities, revenues and expenses. We consider certain accounting policies
related to revenue recognition, valuation of acquired intangibles and
impairment of long-lived assets, and valuation of investments to be critical
policies due to the estimation processes involved in each. For a detailed
description on the application of these and other accounting policies, see Note
1 to the Consolidated Financial Statements beginning on page F-8. Revenue Recognition Product revenue consists of fees from software licenses
and sales or leases of industrial products. Service revenue consists of fees
for implementation, consulting, training, reimbursable expenses, maintenance
and support for software products. We recognize revenue for industrial products when products are shipped, at
which time title transfers to the customer. There are no remaining future
obligations and delivery occurs upon shipment. We provide for estimated sales
returns allowances and rebates in the period in which the sales are recorded.
As an alternative to selling the product, on occasion we may lease our
equipment. For leased equipment, we recognize revenue monthly at the
contracted monthly rate during the term of the lease. We recognize software fees in accordance with Statement of Position (SOP) No.
97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Software
Revenue Recognition, With Respect to Certain Transactions. Under SOP 97-2, we
recognize software license fees when the following criteria are met: (1) a
signed contract is obtained; (2) delivery of the product has occurred; (3) the
license fee is fixed or determinable; and (4) collectibility is probable.
Additionally, license fee revenue is not recognized until there are no material
uncertainties regarding customer acceptance, cancellation provisions, if any,
have expired and there are no significant vendor obligations remaining. SOP
No. 98-9 requires recognition of revenue using the residual method when (1)
there is vendor-specific objective evidence of the fair values of all
undelivered elements in a multiple-element arrangement that is not accounted
for using long-term contract accounting; (2) vendor-specific objective evidence
of fair value does not exist for one or more of the delivered elements in the
arrangement; and (3) all revenue recognition criteria in SOP No. 97-2 other
than the requirement for vendor-specific objective evidence of the fair value
of each delivered element of the arrangement are satisfied. Under the residual
method, the fair value of the undelivered elements is deferred and the
remaining portion of the license fee is recognized as revenue. For those
contracts that contain significant production, modification and/or
customization, software license fees are recognized utilizing Accounting
Research Bulletin (ARB) No. 45, Long-term Construction Type Contracts,
using the relevant guidance in SOP No. 81-1, Accounting for Performance of
Construction Type and Certain Production Type Contracts. For percentage of completion contracts, we measure the progress toward
completion and recognize the software license fees based upon input measures
(i.e. in the same proportion that the amount of labor hours incurred to date
bears to the total estimated labor hours required for the contract). If
reliable estimates cannot be determined, we follow the completed contract
method. Under the completed contract method, all revenue is deferred until the
customer has accepted the software and any refund rights have expired. A number of internal and external factors could affect our estimates related to
software contracts, including labor rates, utilization of resources, changes in
specifications or testing requirements, and unforeseen technical problems. If
we do not accurately estimate the resources required or the scope of work to be
performed, or we do not manage the contract properly, in future periods we may
need to restate revenues, to defer revenue longer than originally anticipated
or to incur additional cost which would impact our margins and reported
results. Valuation of Investments- We hold minority interests in non-publicly traded
companies whose values are difficult to determine and are based on managements
estimate of realizability of the carrying value of the investment. Future
adverse changes in market conditions, poor operating results, lack of progress
of the underlying investee company or its inability to raise capital to support
the business plan could result in investment losses or an inability to recover
the current carrying value of the investment. Many of the companies in which
we hold non-control, minority positions are backed by venture capital, and the
value of our investment may be impacted by the amount, terms and valuation of
the investees financial transactions with third party venture funds or the
terms of the sale of the investee company to a third party. Our policy with
respect to minority interests is to record an impairment charge when we believe
an investment has experienced a decline in value that is other than temporary.
For instance, this could occur if the investee company is sold for less than
our pro rata carrying value or if a new round of funding is at a lower
valuation than our investment was made or if the financing terms for the new Intelligent Systems Corporation - 10 -




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investors (such as preferences on liquidation) otherwise reduce the estimated
value of our investment. We do not write-up the carrying value of our
investments based on favorable changes or financial transactions. At least
quarterly, we review our investments to determine any impairment in their
carrying value and we write-down any impaired asset at quarter-end to our best
estimate of its current realizable value. Such charges could have a material
adverse impact on our financial condition or results of operations and are
generally not predictable or quantifiable in advance. For instance, in Note 3
to the Consolidated Financial Statements, we discuss aggregate charges totaling
$1.2 million which we recorded in 2003 to reflect a reduction in the carrying
value of our investments in RF Solutions, Silverpop and MediZeus. Charges were
recorded in the first, second and fourth quarters of 2003, respectively, based
on the timing of the events giving rise to managements change in estimated
valuation. Valuation of Intangibles- From time to time in the past, we have acquired
companies and we may do so in the future. Occasionally, as in the case with
our VISaer and CoreCard Software subsidiaries (as described in detail in Note 2
to the Consolidated Financial Statements), we may increase our ownership or
control of an entity from a minority to a majority position, which generally is
treated as an acquisition for accounting purposes. Purchase accounting for an
acquisition requires use of accounting estimates and judgments to allocate the
purchase price to the fair market value of the assets and liabilities
purchased. Our business acquisitions may result in the allocation of a portion
of the purchase price to goodwill and other intangible assets. The
determination of the value of such intangible assets requires management to
make estimates and assumptions that affect the amount of future period
amortization expenses and possible impairment expense that we will incur.
Typically, we use the services of a third party appraiser to provide a
valuation of material intangible assets. However, often the acquired company
is a small entity with limited operating history on which to base future
projections and thus valuing the assets requires the use of estimates which are
very subjective. Furthermore, the period over which we amortize certain
intangibles may change based on future conditions and consequently we may need
to adjust the intangible value and/or amortization period, which could require
us to increase the amount of amortization expense we record each period or to
take a non-cash charge to reduce the value of the intangible. On at least an
annual basis, generally with the assistance of a third party appraiser, we
review the values assigned to long-lived assets using an estimate of the
undiscounted cash flows of the entity over the remaining life of the asset.
Any resulting impairment could require a write-down that would have a material
adverse impact on our financial condition or results of operations. We did not
acquire any companies in 2003 and no write-downs with respect to goodwill or
other intangibles occurred in 2003 or 2002. By comparison, in 2001, we
recorded charges totaling $6.4 million related to the carrying value of VISaer
intangibles at the time of its acquisition and subsequent to the September 11,
2001 terrorist attacks. Overview Our consolidated subsidiaries operate in two industry segments: Information
Technology Products and Services and Industrial Products. Included in the
Information Technology sector are QS Technologies, Inc. (software for public
health and human services), VISaer, Inc. (software for maintenance, repair and
overhaul operations in the commercial aviation industry) and CoreCard Software,
Inc. (software for managing credit and debit cards). The Industrial Products
segment includes ChemFree Corporation (bio-remediating parts washers). We derive our product revenue from sales of software licenses in our
Information Technology sector and sales and leases of equipment and supplies in
our Industrial Products sector. Our service revenue consists of fees for
implementation, consulting, training, maintenance and support for software
products in our Information Technology sector. Our consolidated revenue is the
aggregate of the revenue generated at our four subsidiary companies. Our
revenue fluctuates from period to period and our results are not necessarily
indicative of the results to be expected in future periods. Period-to-period
comparisons may not be meaningful and it is difficult to predict the level of
consolidated revenue on a quarterly or annual basis for a number of reasons,
including the following:  
    
    A change in revenue level at one of our subsidiaries may impact
consolidated revenue or be offset by an opposing change at another
subsidiary.  
    
    Economic and marketplace trends may impact our subsidiaries
differently or not at all and two of our software subsidiaries have
very limited experience in their marketplaces which makes it difficult
to identify and evaluate trends that may impact their business.  
    
    Two of our software subsidiaries, CoreCard Software and VISaer, have
been involved in major new product development initiatives for the
past three years and have limited experience delivering and installing
their new products at customer sites, making it difficult to predict
with certainty when they will recognize revenue on individual software
contracts.  
    
    Our subsidiaries are relatively small in revenue size and, in the
Information Technology sector, license revenue at a subsidiary in a
given period may consist of a relatively small number of contracts.
Consequently, even small delays in a subsidiarys delivery under
a software contract (which may be out of their control) could have a
significant and unpredictable impact on consolidated revenue that we can
recognize in a given quarterly or annual period. Intelligent Systems Corporation - 11 -




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
    
    Acquisitions may affect our revenue and expense
levels. For instance, in 2002, we acquired a
controlling interest in CoreCard Software and in mid
2001, we acquired a controlling interest in VISaer.
Consequently, we consolidated the results of
operations of those companies from the dates of
acquisition but not for prior periods. Frequently we recognize consolidated operating losses on a quarterly and annual
basis and are likely to do so in the future from time to time. Our operating
expenses consist of the aggregate of our four subsidiaries expenses and the
corporate office expenses. Our ChemFree and QS Technologies subsidiaries
usually generate an operating profit on an annual basis but our early stage
subsidiaries, VISaer and CoreCard, presently do not, mainly due to significant
research and development expense that is invested to complete their new product
offerings and the deferral of revenue recognition until such products are
delivered to customers in future periods. Depending upon the size and number
of software licenses recognized in a particular period and the level of
expenses incurred to support development and sales activities, our subsidiaries
may report operating profits on an irregular basis as they build their customer
base. A significant portion of our subsidiaries expense is related to
personnel which is relatively fixed in the short-term and we continually
evaluate and strive to balance our financial resources with the resources
required to complete products under development and support our subsidiaries
customers. For these and other reasons, our operating profits or losses may
vary from quarter to quarter and at the present time are generally not
predictable with any degree of certainty. We also frequently generate income or losses from non-operating sources and we
may do so from time to time in the future. Occasionally we derive income from
sales of holdings in affiliate and other minority-owned companies or we record
a charge if we believe the value of a non-consolidated company is impaired. We
also recognize on a quarterly basis our pro rata share of the income or losses
of affiliate companies accounted for by the equity method. The timing and
amount of gain or loss recognized as a result of a sale or the amount of equity
in the income or losses of affiliates generally are not under our control and
are not necessarily indicative of future results, either on a quarterly or
annual basis. In recent years, most of our cash has been generated on an irregular basis from
sales of our investments in early stage technology companies. We have used a
significant amount of the cash received from these sales to support the
operations of our CoreCard Software and VISaer subsidiaries. We do not expect
and cannot support the same level of cash investment in the future in these two
entities and presently believe that customer payments on existing and pending
software contracts will be sufficient to fund VISaers operations and a growing
portion of CoreCards expenses. If the business or cash flow of either
subsidiary does not develop as anticipated, we would need to scale back or
restructure their operations. Results of Operations The following discussion should be read in conjunction with the Consolidated
Financial Statements and the Notes to Consolidated Financial Statements
presented in this annual report. 2003 Compared to 2002 Revenue- Total revenue for the year ended December 31, 2003 was $13.3 million,
an increase of 24 percent ($2.6 million) compared to the same period in 2002.
Revenue from product sales increased 34 percent year-to-year from $6.3 million
to $8.5 million whereas revenue from services billed by the Information
Technology segment increased 10 percent year-to-year from $4.4 million to $4.9
million. The increase in product revenue is due to several factors: software
license fees generated by our Information Technologies segment subsidiary, QS
Technologies, accounted for 57 percent of the total year-to-year increase and
the Industrial Products segment accounted for the remaining 43 percent of the
year-to-year increase due to increased revenue from ChemFree products in both
domestic and international markets. In 2003, QS Technologies benefited from pent-up demand for its products by
local and state governments after several years of reduced spending by such
entities on software products. Almost 80 percent of QS Technologies product
revenue was generated in the fourth quarter of 2003 upon delivery of its most
recent product release to new customers. Based on the current pipeline and
foreseeable demand, we may not achieve the same level of new license revenue in
2004 because we expect that state and local government budget constraints may
reduce overall spending, including for software products. Our Industrial Products segment achieved a 37 percent increase in international
sales and a 14.5 percent increase in domestic sales in 2003 compared to 2002.
The year-to-year increase was due to approximately 15 percent higher unit
shipments of SmartWasher® parts washers and fluid, a 14 percent increase in
revenue from units leased to customers under multi-site corporate lease
contracts, and an increase of approximately four percent in the average selling
price of parts washers and fluid due to price increases on certain products. Intelligent Systems Corporation - 12 -




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Some of the factors contributing to the year-to-year increase include expanded
geographic coverage by domestic distributors, more installations at new and
existing multi-site corporate facilities and a larger installed base of
customers who purchase replenishment supplies of fluids and filters. We expect
demand for ChemFree products to continue to grow, although it is unlikely we
would sustain the same level of high growth in the international markets in
2004 as in 2003. Our CoreCard Software subsidiary began generating limited revenue in 2003 while
license revenue booked by our VISaer subsidiary was approximately 27 percent
lower than in 2002, mainly due to deferring revenue on new licenses sold until
delivery of the final Web-based version of their licensed software in 2004. At
December 31, 2003, we have recorded $2.6 million of unearned short-term
deferred revenue and $5.1 million of long-term deferred revenue, of which 79
percent of the total is related to VISaer license fees and 15 percent of the
total is related to annual maintenance, support and lease contracts at three
subsidiaries which will be recognized ratably over twelve months in 2004. With respect to our revenue from services, the increase from year-to-year from
$4.4 million to $4.9 million reflects mainly a 20 percent or $252,000 increase
in maintenance and support revenue generated by our QS Technologies subsidiary
due to a larger installed base of customers paying annual maintenance fees as
well as approximately $165,000 more revenue from training and other services
provided (excluding billable travel) due to the record number of new customer
licenses sold during 2003. The level of service revenue generated by our
VISaer subsidiary was relatively constant year-to-year. Cost of Sales- Cost of product sales in 2003 was 39 percent of product
revenue, or $3.3 million compared to 48 percent of product revenue, or $3.0
million in 2002. The difference between years is due to the significantly
greater contribution of license revenue generated in 2003 by the QS
Technologies subsidiary which has a lower cost of sales than do our Industrial
Products, which experienced a relatively consistent cost as a percentage of
revenue in both 2003 and 2002 (52 percent and 55 percent in 2003 and 2002,
respectively). Cost of service sales in 2003 represented 69 percent of service revenue or $3.4
million compared to 64 percent of service revenue, or $2.9 million in 2002.
The increase is due to higher personnel costs. QS Technologies allocated more
resources to customer support functions in 2003 than in 2002 to support a high
volume of new customers in 2003 and VISaer utilized more expensive third party
contractors for certain specialized development services in the first half of
2003 and utilized more of its personnel in the customer support and
professional services departments in 2003 as compared to 2002. Operating Expenses- Consolidated operating expenses were 13 percent lower in
2003 than in 2002, decreasing from $17.3 million to $15.0 million. Both
general and administrative and research and development expenses declined 15
percent in 2003 compared to 2002 while marketing expenses were five percent
lower than the prior year. General and administrative expenses decreased from
$4.6 million in 2002 to $3.9 million in 2003 mainly due to lower administrative
and management personnel costs at CoreCard than had been incurred in early 2002
prior to the consolidation of CoreCard operations, saving approximately
$667,000 in 2003. Other factors contributing to the reduced expenses in 2003
were lower personnel costs at VISaer offset in part by an increase of $147,000
in legal fees at ChemFree and higher personnel costs at QS Technologies.
Research and development expense declined by 15 percent in 2003 compared to
2002 from $9.8 million to $8.3 million principally due to a net reduction in
the number of personnel employed in our domestic Information Technologies
subsidiaries and a reduction in contract programming expense that had been
incurred by VISaer in 2002 related to the initial conversion and development of
its Web-based software product. Interest Income- We recognized net interest income of $2,000 in 2003 compared
to $129,000 in 2002. In 2002, we earned interest on a higher level of notes
receivable balances because we had a $1.5 million note receivable outstanding
for five months in 2002 and a $3.0 million note receivable outstanding for four
months in 2002. Both notes were repaid or converted to equity in 2002. Investment Income-We earned net investment income of $3.0 million in 2003
compared to a net investment loss of $934,000 in 2002. In 2003, net investment
income includes a gain of $4.5 million related to the PaySys escrow settlement
(refer to Note 3 for details), offset in part by charges of $600,000, $76,000
and $501,000 to reduce the carrying value of our investments in RF Solutions
Inc, Silverpop, Inc. and MediZeus, Inc., respectively. In addition, we
recorded charges of $92,000 and $131,000 against the carrying values of notes
receivable of RF Solutions, Inc. and Medizeus, Inc., respectively. By
comparison, in 2002, we recorded investment gains of $1.1 million on the sale
of our holdings in Atherogenics stock and $474,000 on the sale of our remaining
interest in Risk Laboratories. Offset against
these gains were charges totaling $1.1 million to reduce the carrying value of
our investments in NuTec Sciences, Inc., Lumenor, Inc., and Novient, Inc.,
three privately-held software companies, and a charge of $1.3 million to
recognize the accumulated loss on our holdings in publicly traded Daw
Technologies, Inc. and Ixalt, Inc. Refer to Note 3 for more details regarding
these transactions. The timing and amounts of asset sales or writedowns, if
any, vary on an annual and quarterly basis and are generally not predictable by
us in advance. Intelligent Systems Corporation - 13 -




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Equity Earnings (Losses) of Affiliate Companies-On a quarterly basis, we
recognize our pro rata share of the earnings or losses of affiliate companies
that we record on the equity method. The amount recorded is not generally
predictable or indicative of future results because it is the aggregate
earnings (losses) of a number of relatively small companies operating in
various industries and thus aggregate earnings (losses) are subject to
considerable fluctuation from quarter-to-quarter. In 2003, we recorded
$184,000 in equity earnings of five affiliate companies (including Horizon
Software International, CoreXpand, Riverside Software, MediZeus, and Cirronet,
for those periods in which we accounted for each by the equity method) compared
to equity losses in 2002 of $235,000 in three affiliate companies (CoreXpand,
MediZeus and Horizon Software for those periods in which we accounted for each
by the equity method). Other Income, Net-We recognized $328,000 in other income in 2003 compared to
other income of $900,000 in 2002. In 2003, the amount includes $137,000 in
recognition of deferred gain related to a VISaer product line sale in a prior
period, $124,000 in foreign currency exchange gains, and other miscellaneous
income. By comparison, in 2002 other income consists mainly of $813,000 of
deferred gain related to the VISaer product line sale and other miscellaneous
income. Income Taxes-In 2003, we recorded an income tax credit of $40,000
representing the net of a $104,000 refund of alternative minimum taxes paid by
the VISaer subsidiary in a prior year and income tax of $64,000 related to our
QS Technologies state tax liability. We did not accrue for any other income
tax liability in 2003 and we believe that the deferred tax assets should be
fully reserved given their character and our recent losses. By comparison, in
2002, we recorded an income tax benefit of $343,000 reflective of a refund of
alternate minimum taxes paid in 2001. 2002 Compared to 2001 Revenue- Total revenue for the year ended December 31, 2002 was $10.7 million
versus $8.7 million in the same period in 2001, an increase of 23 percent.
Revenue from product sales increased 18 percent year-to-year whereas revenue
from services billed by the Information Technology segment increased 29 percent
year-to-year. The increase in product revenue is mainly due to a greater
number of units sold by the ChemFree subsidiary due to an increase in domestic
demand for its products. The increase in service revenue year-to-year reflects
mainly the fact that we included the results of VISaer for the full 12 months
in 2002 but only for six months in 2001. Approximately two-thirds of our
service revenue in 2002 was generated by VISaer for professional services with
the balance coming mainly from software maintenance contracts at the QS
Technologies subsidiary. At December 31, 2002, long-term deferred revenue was
$4.8 million, related to VISaers software license contract with a major U.S.
air freight company, which it expects to realize beginning in 2004. Cost of Sales- In 2002, total cost of sales was 55 percent of revenue compared
to 47 percent of revenue in 2001. Cost of productsales as a percentage of
product revenue was 48 percent in 2002 compared to 49 percent in 2001,
reflecting mainly a reduction in the unit cost of producing ChemFree products
because fixed production overhead was spread across a higher volume of goods
produced. Cost of servicesales almost doubled in 2002 as compared to 2001 and
represented 64 percent of services revenue in 2002 as compared to 42 percent in
2001. Approximately $1.0 million of the year-to-year increase in costs of
service sales is attributed to including VISaer costs for the full 12 months in
2002 as compared to only six months in 2001. Typically, costs associated with
VISaer service revenue involve higher labor costs than do costs associated with
QS Technologies services. Operating Expenses- In 2002, marketing expenses increased by $870,000 (42
percent) compared to 2001. Of the increase, approximately $330,000 is due to
the inclusion of VISaer expenses for 12 months in 2002, $283,000 is due to
increased expenditures at the ChemFree subsidiary to support a direct sales
initiative in selected markets, and the balance of $257,000 reflects mainly the
inclusion of CoreCard expenses in 2002. General and administrative expenses
were 53 percent lower in 2002 than in 2001, mainly reflecting the fact that
2001 expenses included non-cash charges totaling $6.0 million related to the
write-down of goodwill associated with the VISaer acquisition in 2001.
This decrease was offset by an increase of approximately $950,000 year-to-year mainly because we included the expenses of
VISaer for the full 12 months in 2002 as compared to only six months in 2001.
An increase in legal expenses in 2002 at ChemFree of approximately $140,000
related to intellectual property protection was offset by a reduction in G&A
personnel expenses at the QS Technologies subsidiary. Research and development
expense increased by $6.4 million (191
percent) in 2002 as compared to 2001. Approximately one-half of the increase
is attributable to each of VISaer and CoreCard due to the inclusion for the
full year of their respective expenses to support significant new product
development initiatives. Intelligent Systems Corporation - 14 -




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Interest Income- In 2002, we earned $129,000 in interest income compared to
$1.0 million in 2001. The reduced interest income is because we earned
significant interest on a high-interest loan to PaySys in 2001 before PaySys
was sold and the loan repaid. In 2002, we also had lower average cash balances
and notes receivable balances than in 2001 and we earned interest at a lower
rate than in 2001. Investment Income/Loss- In 2002, we had a net investment loss of $934,000
compared to net investment income of $19.9 million in 2001, of which $17.8
million was derived from the sale of our PaySys affiliate in 2001. In 2002, we
recorded investment gains of $1.1 million on the sale of our holdings in
Atherogenics stock and $474,000 on the sale of our remaining interest in Risk
Laboratories. Offset against these gains were charges totaling $1.1 million to
reduce the carrying value of our investments in NuTec Sciences, Lumenor, and
Novient, three privately-held software companies, and a charge of $1.3 million
to recognize the accumulated loss on our holdings in publicly traded Daw
Technologies, Inc. and Ixalt, Inc. Refer to Note 3 for more details regarding
these write-downs. The timing and amounts of asset sales or write-downs, if
any, vary on an annual and quarterly basis and are generally not predictable by
us in advance. Equity Losses of Affiliates- On a quarterly basis, we recognize our pro rata
share of the earnings or losses of affiliate companies that we record on the
equity method. In some cases, these companies are early stage companies that
incur losses during their development and early revenue period. In 2002, we
recorded equity losses of $235,000 related to four affiliate companies compared
to equity losses in 2001 of $2.2 million related to seven affiliate companies.
The main difference between years is that we consolidated VISaer and CoreCard
for the full year in 2002 but in 2001, we consolidated VISaer only for the last
half of the year and we accounted for CoreCard under the equity method for the
entire year. Other Income- In 2002, other income consists mainly of $813,000 of deferred
gain related to a VISaer product line sale in July 2000, compared to the
recognition of $961,000 of deferred gain related to the product line sale in
2001. Refer to Note 7 for detail on the deferred gain. Income Taxes- In 2002, we recorded an income tax benefit of $343,000
reflective of a refund of alternate minimum taxes paid in 2001. In 2001, we
incurred a net income tax expense of $173,000, representing a tax liability of
$343,000 for alternative minimum tax on the PaySys transaction and a tax
benefit of $211,000 recorded at the VISaer subsidiary. The difference between
our effective and statutory income tax rate is caused by our valuation
allowance on our deferred tax assets. Liquidity and Capital Resources Our cash balance at December 31, 2003 was $1.1 million, which is $1.5 million
lower than at the prior year-end. During the year ended December 31, 2003, our
principal source of cash was $4.6 million from settlement of the PaySys escrow
account as described in more detail in Note 3 to the Consolidated Financial
Statements. During the year, our principal use of cash was $5.5 million for
operations, which was $3.6 million less than in 2002. We used approximately
$328,000 cash, net of repayments and distributions, related to new and
follow-on investments or loans to investee companies in 2003 but plan to
concentrate our activities and resources in 2004 on our existing companies. In recent years, most of our cash has been generated on an irregular basis from
sales of our investments in non-consolidated technology companies and we have
used a significant amount of the cash received from these sales to support the
operations of our CoreCard Software and VISaer subsidiaries. In 2003, we used
$6.7 million to support these two subsidiaries which was $286,000 less than we
used in 2002. We do not expect and cannot support the same level of cash
investment in the future in these two subsidiaries. Based on recent trends and
current projections, we presently believe that scheduled customer payments on
existing and pending software contracts will be sufficient to fund
substantially all of VISaers operations and a growing portion of CoreCards
expenses in 2004. If the business or cash flow of either subsidiary does not
develop as anticipated either due to delays in customer payments, software
development or new contract acquisitions, we would need to scale back or
restructure the respective operations to a level that could be supported by
their internal cash flow with minimal cash, if any, provided by us, or to seek
alternative sources of funding for the subsidiaries. Most of our consolidated
expenses are related to personnel, none of whom are represented by a union or
have employment contracts. Thus, while there are no current plans to do so,
any action to reduce negative cash flow from operations would generally entail
a reduction in numbers of employees and the payment of accrued and severance
compensation which could increase cash requirements in a given quarter but
reduce cash needs in future quarters. Our established operating companies, QS
Technologies and ChemFree, generated
sufficient cash in 2003 to offset a majority of the corporate office expenses
and are expected to do so again in 2004. There are no restrictions on the
transfer of cash balances between the parent and subsidiary companies. Accounts receivable at December 31, 2003 were $1.5 million, 49 percent lower
than at December 31, 2002, when they were $3.0 million. At December 31, 2002,
our receivables were higher than normal for several reasons. First, at
December 31, 2002, $816,000 of the Intelligent Systems Corporation - 15 -




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accounts receivable was related to billings
to two VISaer customers upon the achievement of contract milestones and such
amounts were collected in early 2003. At year-end December 2003, there were no
such scheduled milestone billings included. Second, $150,000 of the
year-to-year difference in accounts receivable is attributable to timing
differences on billings of annual maintenance contracts for two VISaer
customers. Third, in the Industrial Products segment, increased emphasis on
collections and stricter credit policies resulted in reduced collection cycles
and improved cash flow in 2003 by approximately $360,000. In the aggregate,
current and non-current deferred revenue increased by $1.0 million in 2003
compared to 2002, representing cash payments in 2003 by customers for software
licenses and annual software maintenance contracts by our Information
Technology subsidiaries as well as leased Industrial Products equipment for
which the related revenue will be recognized in future periods. In 2003, we
used approximately $95,000 cash to increase inventory levels of ChemFree
products to support a growing volume of sales and leases of equipment to
domestic and international customers. Accounts payables declined by $369,000
at December 31, 2003 compared to December 31, 2002 for several reasons. Of the
decline, $83,000 is related to a planned reduction in the use of third-party
software contractors in 2003 and the balance is mostly related to improved cash
collections in the Industrial Products segment which allowed payment of
payables generally within current terms. We have several potential near-term sources of cash to support negative cash
flow from consolidated operations, including periodic draws against our bank
line of credit, sale(s) of investments or other assets or third party strategic
investment in a subsidiary. The amount and timing of sales of investments or
assets cannot be predicted with reasonable certainty at this time and presently
we do not have any firm pending transactions. Our budgeted cash requirements
for 2004 are substantially lower than for 2003 based on new and pending
software license and professional services contracts at our Information
Technology subsidiaries, recently negotiated periodic payments by two key
customers at VISaer, and lower product development costs at VISaer and
CoreCard. We expect to use our bank line of credit as needed in 2004 to
accommodate short-term timing differences in consolidated cash flows. We
presently project that we will have sufficient accounts receivable and
inventory balances throughout the year to provide the required borrowing base
for such draws under our bank line of credit; however, if we fail to do so, we
could experience a short-term cash shortfall unless the bank provided an
exception. Furthermore, if the bank elects not to renew our line of credit at
the end of the current term (September 1, 2004), we may not be able to find a
replacement line of credit on acceptable terms, if at all. Certain VISaer
customer contracts tie cash payments to delivery dates of various software
deliverables and in other cases, customers have agreed on periodic payments at
scheduled time periods to enable the company to dedicate resources to complete
contract deliverables. VISaer is working closely with key customers to meet
its project milestones but delays could cause customers to postpone payments
and increase VISaers need for cash during 2004. Also our ability to recognize
deferred revenue reflected on the balance sheet will depend on VISaer
delivering and the customer accepting the final software deliverables in 2004
and thereafter. Presently, we do not believe there is a material risk to
successfully performing under these contracts but if customer payments are
delayed for any reason or we do not control costs or we encounter unforeseen
technical problems, then VISaer could experience a cash shortfall to fund its
operations and would need to scale back its operations or seek new financing,
which could affect its performance under the contracts, at least in the short
term. In addition, unanticipated delays in contract awards and implementations
at CoreCard would have a negative impact on results of operations and increase
our cash requirements. Beyond 2004, we expect that liquidity will continue to improve and consolidated
operations will generate sufficient cash to fund their requirements with use of
our credit facility to accommodate short-term needs. Other long-term sources of
liquidity include potential sales of investments or other assets although the
timing and amount of any such transactions are uncertain and, to the extent
they involve non-consolidated companies, generally not within our control. We do not currently have any off balance sheet arrangements that are reasonably
likely to have a current or future material effect on our financial condition,
liquidity or results of operations. Long-Term Contractual Obligations Our only material long-term contractual obligations consist of operating leases
as indicated below: Payment Due By PeriodContractual Obligations
    
    
    
    
    
    Less than
    
    1-3
    
    3-5
    
    More than(in thousands)
    
    Total
    
    1 year
    
    years
    
    years
    
    5 yearsOperating Lease Obligations
    
    $
    404
    
    
    $
    345
    
    
    $
    59
    
    
    
    
    
    
    
    Total
    
    $
    404
    
    
    $
    345
    
    
    $
    59
    
    
    
    
    
    
    
    
 Intelligent Systems Corporation - 16 -




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Factors That May Affect Future Operations Future operations in both the Information Technology and Industrial Products
segments are subject to risks and uncertainties that may negatively impact our
future results of operations or projected cash requirements. It is difficult
to predict future quarterly and annual results with any certainty mainly
because several of our subsidiaries are early stage companies with limited
revenue and experience in their respective markets, all are relatively small in
size and, particularly in the Information Technology sector, revenue tends to
be associated with fewer and larger sales than in the Industrial Products
segment. Thus any trend or delay that affects even one of our subsidiaries
could have a negative impact on the companys consolidated results of
operations or cash requirements on a quarterly or annual basis. In addition,
the carrying value of our investments is impacted by a number of factors which
are generally beyond our control since we are typically a non-control
shareholder in a private company with limited liquidity. Among the numerous
factors that may affect our consolidated results of operations or financial
condition are the following:  
    
    Delays in software development projects which could cause our customers to delay implementations, delay payments or cancel
contracts, which would increase our costs and reduce our revenue.  
    
    Undetected software errors which may delay product releases, increase our costs, result in non-acceptance of our software
by customers or delay revenue recognition.  
    
    Competitive pressures (including pricing, changes in customer requirements and preferences, and competitor product
offerings) which may cause prospective customers to choose an alternative product solution, resulting in lower revenue and
profits (or increased losses).  
    
    The inability of our CoreCard or VISaer subsidiaries to establish a base of referenceable customers for their new product
offerings, resulting in lower revenue and profits (or increased losses), increased cash needs and possibly leading to
restructuring or cutting back of the subsidiarys operations.  
    
    Failure of our products specifications and features to achieve market acceptance.  
    
    Delays in anticipated customer payments for any reason which would increase our cash requirements and possibly our losses.  
    
    Declines in performance, financial condition or valuation of minority-owned companies which could cause us to write-down
the carrying value of our investment or postpone an anticipated liquidity event, which could negatively impact our earnings
and cash.  
    
    A reversal of the improving trend in the commercial aviation industry worldwide which could impact VISaers short-term
customer purchases, thus increasing its losses and need for cash.  
    
    The relatively limited sales and marketing experience of our VISaer and CoreCard subsidiaries in their respective markets
could cause them to misinterpret or fail to interpret or adjust to a trend in the market or to underestimate the sales
cycle time frame.  
    
    In the Industrial Products market, failure by ChemFree to achieve anticipated growth in the European market or in the
domestic national accounts and non-automotive markets for their products could cause lower than anticipated sales and
profits.  
    
    An insufficient number of potential CoreCard customers decide to purchase and run an in-house software system and instead
choose to outsource their account transaction processing which could result in lower revenue, increased costs and greater
cash requirements.  
    
    Budget reductions by state and local governments for information technology products that delay award of contracts or
implementations for our QS Technologies subsidiary.  
    
    An insufficient level of qualifying accounts receivable and inventories to support a borrowing base sufficient to meet our
anticipated borrowing requirements under our bank line of credit.  
    
    The recurrence of some incidence such as the SARS epidemic in 2003 that has a negative impact on the aviation industry,
resulting in delays in contract awards and customer implementations similar to the unforeseen negative impact on cash and
profits experienced by VISaer during the SARS epidemic.  
    
    Other general economic and political conditions, particularly those which may cause international business and domestic
government customers to delay or cancel software purchase decisions. We have certain lease commitments, legal matters and contingent liabilities
described in detail in Note 9 to the Consolidated Financial Statements. We are
not aware presently of any facts or circumstances related to these that are
likely to have a material negative impact on our results of operations or
financial condition. Recent Accounting Pronouncements In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities. FIN No. 46 clarifies the application of Accounting
Research Bulletin No. 51, Consolidated Financial Statements, to certain
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN No. 46 is applicable immediately for variable
interest entities created after January 31, 2003. For variable interest
entities created on or prior to January 31, 2003, the provisions of FIN No. 46
must be applied for the first Intelligent Systems Corporation - 17 -




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interim or annual period beginning after December
15, 2003. We have identified no variable interest entities and do not expect
FIN No. 46 to have an effect on our consolidated financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) because that financial instrument embodies an
obligation of the issuer. Many of such instruments were previously classified
as equity by issuers. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003, except for
mandatory redeemable financial instruments of nonpublic entities. The
statement is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance
of the date of the statement and still existing at the beginning of the interim
period of adoption. Restatement is not permitted. On November 7, 2003, the
FASB deferred the classification and measurement provisions of SFAS No. 150 as
they apply to certain mandatory redeemable non-controlling interests. This
deferral is expected to remain in effect while these provisions are further
evaluated by the FASB. The adoption of this statement did not have a
significant impact on our financial position, results of operations or cash
flows. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not have any material market risk because we have no long-term borrowings
or sales transactions involving financial instruments. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The response to this item is submitted as a separate section of this report.
See the Consolidated Financial Statements and Note 17 to the Consolidated
Financial Statements. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE On May 10, 2002, we dismissed Arthur Andersen LLP as our independent public
accountants. No report of Arthur Andersen LLP on the financial statements for
either of the two past years contained an adverse opinion or a disclaimer of
opinion, or was qualified or modified as to uncertainty, audit scope, or
accounting principles. There were no disagreements with Arthur Andersen LLP on
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreement, if not resolved
to the satisfaction of Arthur Andersen LLP, would have caused it to make
reference to the subject matter of the disagreement in connection with its
report during the companys two most recent fiscal years or any subsequent
interim period preceding the dismissal of Arthur Andersen LLP. Effective July
3, 2002, our Board of Directors, upon the recommendation of the Audit
Committee, appointed BDO Seidman, LLP as our new independent accountants. 
 ITEM 9A. CONTROLS AND PROCEDURES As of the end of the period covered by this report, the company carried out an
evaluation, under the supervision and with the participation of the companys
management, including the Companys Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the companys
disclosure controls and procedures pursuant to Rule 13a-15(b) under the
Exchange Act. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the companys disclosure controls and
the procedures are effective. There were no significant changes in the
companys internal controls over financial reporting or in other factors
identified in connection with this evaluation that occurred during the period
covered by this report that has materially affected, or is reasonably likely to
materially affect, the companys internal control over financial reporting. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Please
refer to the subsection entitled Proposal 1 - The Election of One
Director - Nominee and Proposal 1 - The Election of One
Director - Executive
Officers in our Proxy Statement for the Annual Meeting of Shareholders to be
held on May 27, 2004 for information about the individual nominated as director
and about the executive officers of the company. This information is
incorporated into this Item 10 by reference. Information regarding compliance
by directors and executive officers of the company and owners of more than 10
percent of our common stock with the reporting requirements of Section 16(a) of
the Securities Exchange Act of 1934, as amended, is contained Intelligent Systems Corporation - 18 -




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under the caption
Section 16(a) Beneficial Ownership Reporting Compliance in this Proxy
Statement. This information is incorporated into this Item 10 by reference. 
 ITEM 11. EXECUTIVE COMPENSATION Please refer to the subsection entitled Proposal 1 - The Election of One
Director - Executive Compensation in the Proxy Statement referred to in Item
10 for information about management compensation. This information is
incorporated into this Item 11 by reference. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Please refer to the subsections entitled Voting - Principal Shareholders,
Directors and Certain Executive Officers and Voting - Securities Authorized
for Issuance Under Equity Compensation Plan in the Proxy Statement referred to
in Item 10 for information about the ownership of our $0.01 par value common
stock by certain persons and securities authorized for issuance under our
equity compensation plans. This information is incorporated into this Item 12
by reference. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS J. Leland Strange, a director, and President and Chief Executive Officer of the
company, participated as a common shareholder in the pro rata distribution of
the escrow fund related to the sale in April 2001 of PaySys International, Inc.
as described more fully in Note 3 to the Consolidated Financial Statements.
Mr. Strange, who had owned his shares in PaySys since 1983 prior to the
companys investment in PaySys in 1994, received $149,106 in the aggregate in
two payments in March and June 2003, which represented his pro rata share of
the escrow funds released. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Please refer to the subsections entitled Audit Committee Report and
Independent Public Accountants in the Proxy Statement referred to in Item 10
for information about the fees paid to and services performed by our
independent accountants. This information is incorporated into this Item 14 by
reference. 
 PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K  (a)
    
    Documents filed as part of this report. 1. Financial Statements The following consolidated financial statements and related reports of
independent public accountants are included in this report and are incorporated
by reference in Part II, Item 8 hereof. See the Index to Financial Statements
and Supplemental Schedules on page F-1 hereof.  Report of Independent Certified Public AccountantsReport of Previous Independent Public AccountantsConsolidated Balance Sheets at December 31, 2003 and 2002Consolidated Statements of Operations for the three years ended December
31, 2003Consolidated Statements of Changes in Stockholders
Equity and Comprehensive Income (Loss) for the three years ended
December 31, 2003Consolidated Statements of Cash Flow for the three years ended December
31, 2003Notes to Consolidated Financial Statements 2. Financial Statement Schedule We are including the financial statement schedule listed below in this
report. We omitted all other schedules required by certain applicable
accounting regulations of the Securities and Exchange Commission because the
omitted schedules are not required under the Intelligent Systems Corporation - 19 -




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related instructions or do not
apply or because we have included the information required in the Consolidated
Financial Statements or notes thereto. See the Index to Financial Statements
and Supplemental Schedules on page F-1 hereof. Schedule II
- Valuation and Qualifying Accounts and Reserves 3. Exhibits We are filing the following exhibits with this report or incorporating
them by reference to earlier filings. Shareholders may request a copy of any
exhibit by contacting Bonnie L. Herron, Secretary, Intelligent Systems
Corporation, 4355 Shackleford Road, Norcross, Georgia 30093; telephone (770)
381-2900. There is a charge of $.50 per page to cover expenses of copying and
mailing.  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.)10.1
    
    Lease Agreement dated November 26, 2002, between the Registrant and Duke
Realty Limited Partnership (incorporated by reference to Exhibit 10.1 to
the Registrants Form 10-K for the year ended December 31, 2002).10.2
    
    Management Compensation Plans and Arrangements:  (a)
    
    Intelligent Systems Corporation 2003 Stock Incentive Plan(b)
    
    Intelligent Systems Corporation 1991 Stock Incentive Plan,
amended June 6, 1997(c)
    
    Intelligent Systems Corporation Change in Control Plan for
Officers(d)
    
    Intelligent Systems Corporation Outside Directors Retirement
Plan(e)
    
    Non-Employee Directors Stock Option Plan Exhibit 10.2(a) is filed herewith.Exhibit 10.2 (b) is incorporated by reference to Exhibit 4.1 of the
Registrants Form S-8 dated July 25, 1997.Exhibits 10.2 (c) and (d) are incorporated by reference to Exhibit 10.4 to
the Registrants Form 10-K for the year ended December 31, 1993.Exhibit 10.2 (e) is incorporated by reference to
Exhibit 10.3 to the Registrants Form 10-K for the year ended December 31, 2000.  10.3
    
    Loan Agreement by and among Intelligent Systems Corporation and Fidelity
Bank dated October 1, 2003.10.4
    
    Security Agreement by and among Intelligent Systems Corporation and
Fidelity Bank dated as of October 1, 2003.10.5
    
    Form of Security Agreement by and among majority owned subsidiary
companies of Intelligent Systems Corporation and Fidelity Bank as of
October 1, 2003.10.6
    
    Negative Pledge Agreement by and among Intelligent Systems Corporation
and Fidelity Bank dated October 1, 2003.10.7
    
    Commercial Promissory Note and Rider thereto of Intelligent Systems
Corporation in favor of Fidelity Bank dated October 1, 2003.10.8
    
    Form of Guarantee of majority owned subsidiaries of Intelligent Systems
Corporation in favor of Fidelity Bank dated October 1, 2003. Intelligent Systems Corporation - 20 -




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21.1
    
    List of subsidiaries of Registrant.23.1
    
    Consent of BDO Seidman, LLP.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 Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. We filed a report on Form 8-K on November 7, 2003 disclosing that we issued a
press release on November 7, 2003 announcing our financial results for the
quarter ended September 30, 2003. (c) See Item 15(a)(3) above. (d) See Item 15(a)(2) above. 
 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report to be signed on
its behalf by the undersigned, thereunto duly authorized. INTELLIGENT SYSTEMS CORPORATION
RegistrantDate: March 30, 2004
    By:
    /s/ J. Leland StrangeJ.
Leland StrangeChairman of the Board, President
and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated: Signature
    
    Capacity
    
    Date/s/ J. Leland Strange

J. Leland Strange
    
    Chairman of the Board, President,
Chief Executive Officer and Director
(Principal Executive Officer)
    
    March 30, 2004/s/ Bonnie L. Herron

Bonnie L. Herron
    
    Chief Financial Officer
(Principal Accounting and Financial Officer)
    
    March 30, 2004/s/ James V. Napier

James V. Napier
    
    Director
    
    March 30, 2004/s/ John B. Peatman

John B. Peatman
    
    Director
    
    March 30, 2004/s/ Parker H. Petit

Parker H. Petit
    
    Director
    
    March 30, 2004
 Intelligent Systems Corporation - 21 -




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INTELLIGENT SYSTEMS CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES The following consolidated financial statements and schedules of the Registrant
and its subsidiaries are submitted herewith in response to Item 8: Financial Statements:Report of Independent Certified Public Accountants
    
    
    F-2Report of Previous Independent Public Accountants
    
    
    F-3Consolidated
Balance Sheets - December 31, 2003 and 2002
    
    
    F-4Consolidated Statements of Operations -Three Years Ended December 31, 2003
    
    
    F-5Consolidated
Statements of Changes in Stockholders Equity and Comprehensive
(Loss) Income -Three Years Ended December 31, 2003
    
    
    F-6Consolidated
Statements of Cash Flow -Three Years Ended December 31, 2003
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Financial Statement Schedule:The following supplemental schedule of the Registrant and its
subsidiaries is submitted herewith in response to Item 15(a)(2):Schedule II
-  Valuation and Qualifying Accounts and Reserves
    
    
    S-1
 INTELLIGENT SYSTEMS CORPORATION F-1




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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Intelligent Systems Corporation: We have audited the accompanying consolidated balance sheets of Intelligent
Systems Corporation and subsidiaries (the Company) as of December 31, 2003
and 2002 and the related consolidated statements of operations, shareholders
equity and comprehensive (loss) income and cash flows for the two years then
ended. We have also audited the financial statement schedule for the years
ended December 31, 2003 and 2002 listed in the accompanying index. These
financial statements and schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits. The Companys consolidated
financial statements and financial statement schedule as of December 31, 2001,
and for the one year period ended December 31, 2001, were audited by other
auditors who have ceased operations. Those auditors expressed an unqualified
opinion on those consolidated financial statements and schedule in their report
dated March 1, 2002. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements and schedule are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements and schedule. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement and schedule
presentation. We believe that our audits provide a reasonable basis for our
opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Intelligent Systems
Corporation and subsidiaries as of December 31, 2003 and 2002 and the results
of their operations and their cash flows for the two years then ended in
conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, the 2003 and 2002 schedule presents fairly, in all
material respects, the information set forth therein. /s/BDO Seidman, LLP Atlanta, Georgia
March 4, 2004 INTELLIGENT SYSTEMS CORPORATION F-2




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##### Table of Contents



THE FOLLOWING REPORT IS A COPY OF A PREVIOUSLY ISSUED REPORT BY
ARTHUR ANDERSEN LLP AND IT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN
LLP. ARTHUR ANDERSEN LLP HAS NOT CONSENTED TO ITS INCORPORATION BY
REFERENCE INTO INTELLIGENT SYSTEMS CORPORATIONS PREVIOUSLY FILED
REGISTRATION STATEMENTS FILE NOS: 33-99432, 333-32157 AND 333-58134.
THEREFORE, AN INVESTORS ABILITY TO RECOVER ANY POTENTIAL DAMAGE MAY
BE LIMITED. 
 REPORT OF PREVIOUS INDEPENDENT PUBLIC ACCOUNTANTS TO INTELLIGENT SYSTEMS CORPORATION: We have audited the accompanying consolidated balance sheets of
Intelligent Systems Corporation (a Georgia corporation) and its
subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of operations, changes in stockholders
equity and comprehensive income, and cash flows for each of the three
years in the period ended December 31, 2001. These financial
statements and the schedule referred to below are the responsibility
of the Companys management. Our responsibility is to express an
opinion on these financial statements and schedule based on our
audits. The summarized financial data for PaySys International, Inc.
contained in Note 4 are based on the financial statements of PaySys
International, Inc., which were audited by other auditors. Their
report has been furnished to us and our opinion, insofar as it
relates to the data in Note 4, is based solely on the report of the
other auditors. We did not audit the December 31, 2000 financial
statements of VISaer, Inc., an investment which is reflected in the
accompanying financial statements using the equity method of
accounting. The investment in VISaer, Inc. represents 16 percent of
total assets in 2000, and the equity in 2000 net loss represents 9
percent of consolidated net income for 2000. The statements of
PaySys International, Inc. and VISaer, Inc. were audited by other
auditors whose reports have been furnished to us and our opinion,
insofar as it relates to the amounts included for PaySys
International, Inc. and VISaer, Inc., is based solely on the reports
of the other auditors. We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require
that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
and the reports of other auditors provide a reasonable basis for our
opinion. In our opinion, based on our audits and the reports of the other
auditors, the financial statements referred to above present fairly,
in all material respects, the financial position of Intelligent
Systems Corporation and its subsidiaries as of December 31, 2001 and
2000, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the
United States. Our audits were made for the purpose of forming an opinion on the
basic financial statements taken as a whole. The supplemental
Schedule II in Item 14(a)(2) is presented for purposes of complying
with the Securities and Exchange Commissions rules and is not part
of the basic financial statements. This schedule has been subjected
to the auditing procedures applied in the audit of the basic
financial statements and, in our opinion, is fairly stated in all
material respects in relation to the financial data required to be
set forth therein in relation to the basic financial statements taken
as a whole. ARTHUR ANDERSEN LLP Atlanta, Georgia
March 1, 2002 INTELLIGENT SYSTEMS CORPORATION F-3




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Intelligent Systems Corporation
CONSOLIDATED BALANCE SHEETS(in thousands, except share amounts) As of December 31,
    
    2003
    
    2002ASSETSCurrent assets:Cash
    
    $
    1,133
    
    
    $
    2,644Accounts receivable, net
    
    
    1,543
    
    
    
    3,025Notes and interest receivable
    
    
    142
    
    
    
    205Inventories
    
    
    766
    
    
    
    671Other current assets
    
    
    614
    
    
    
    213Total current assets
    
    
    4,198
    
    
    
    6,758Long-term investments
    
    
    6,275
    
    
    
    7,145Property and equipment, at cost less accumulated depreciation
    
    
    746
    
    
    
    761Goodwill, net
    
    
    2,039
    
    
    
    2,380Other intangibles, net
    
    
    476
    
    
    
    788Other assets, net
    
    
    8
    
    
    
    28Total assets
    
    $
    13,742
    
    
    $
    17,860LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    250
    
    
    $
    Accounts payable
    
    
    932
    
    
    
    1,301Deferred revenue
    
    
    2,586
    
    
    
    1,784Deferred gain
    
    
    291
    
    
    
    428Accrued expenses and other current liabilities
    
    
    2,037
    
    
    
    1,755Total current liabilities
    
    
    6,096
    
    
    
    5,268Deferred revenue, net of current portion
    
    
    5,060
    
    
    
    4,813Other long-term liabilities
    
    
    
    
    
    
    27Total long term liabilities
    
    
    5,060
    
    
    
    4,840Commitments and contingencies (note 9)Minority interest
    
    
    1,516
    
    
    
    1,516Redeemable preferred stock of subsidiary
    
    
    
    
    
    
    342Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 and
4,491,779 issued and outstanding at December 31, 2003 and 2002, respectively
    
    
    45
    
    
    
    45Paid-in capital
    
    
    18,410
    
    
    
    18,432Accumulated other comprehensive loss
    
    
    (60
    )
    
    
    (56
    )Accumulated deficit
    
    
    (17,325
    )
    
    
    (12,527
    )Total stockholders equity
    
    
    1,070
    
    
    
    5,894Total liabilities and stockholders equity
    
    $
    13,742
    
    
    $
    17,860
 The accompanying notes are an integral part of these consolidated financial
statements. INTELLIGENT SYSTEMS CORPORATION F-4




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Intelligent Systems Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except share and per share amounts) Year Ended December 31,
    
    2003
    
    2002
    
    2001RevenueProducts
    
    $
    8,466
    
    
    $
    6,296
    
    
    $
    5,321Services
    
    
    4,868
    
    
    
    4,445
    
    
    
    3,397Total revenue
    
    
    13,334
    
    
    
    10,741
    
    
    
    8,718Cost of salesProducts
    
    
    3,324
    
    
    
    3,019
    
    
    
    2,633Services
    
    
    3,380
    
    
    
    2,862
    
    
    
    1,439Total cost of sales
    
    
    6,704
    
    
    
    5,881
    
    
    
    4,072ExpensesMarketing
    
    
    2,811
    
    
    
    2,960
    
    
    
    2,090General & administrative
    
    
    3,895
    
    
    
    4,562
    
    
    
    9,605Research & development
    
    
    8,316
    
    
    
    9,798
    
    
    
    3,371Loss from operations
    
    
    (8,392
    )
    
    
    (12,460
    )
    
    
    (10,420
    )Other incomeInterest income, net
    
    
    2
    
    
    
    129
    
    
    
    1,017Investment income (expense)
    
    
    3,040
    
    
    
    (934
    )
    
    
    19,902Equity in income (losses) of affiliate companies
    
    
    184
    
    
    
    (235
    )
    
    
    (2,173
    )Other income, net
    
    
    328
    
    
    
    900
    
    
    
    960Income (loss) before income tax provision (benefit)
    
    
    (4,838
    )
    
    
    (12,600
    )
    
    
    9,286Income tax provision (benefit)
    
    
    (40
    )
    
    
    (343
    )
    
    
    173Net income (loss)
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Basic net income (loss) per share
    
    $
    (1.07
    )
    
    $
    (2.73
    )
    
    $
    1.78Diluted net income (loss) per share
    
    $
    (1.07
    )
    
    $
    (2.73
    )
    
    $
    1.77Basic weighted average shares outstanding
    
    
    4,483,458
    
    
    
    4,495,058
    
    
    
    5,108,413Diluted weighted average shares outstanding
    
    
    4,483,458
    
    
    
    4,495,058
    
    
    
    5,145,691
 The accompanying notes are an integral part of these consolidated financial
statements. INTELLIGENT SYSTEMS CORPORATION F-5




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Intelligent Systems Corporation
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)(in thousands, except share amounts) Year Ended December 31,2003
    
    2002
    
    2001STOCKHOLDERS EQUITYCommon stock, number of shares,beginning of year
    
    
    4,491,779
    
    
    
    4,495,530
    
    
    
    5,623,784Exercise of options during year
    
    
    
    
    
    
    
    
    
    
    3,334Purchase and retirement of stock
    
    
    (12,808
    )
    
    
    (3,751
    )
    
    
    (1,131,588
    )End of year
    
    
    4,478,971
    
    
    
    4,491,779
    
    
    
    4,495,530Common stock, amount,beginning of year
    
    $
    45
    
    
    $
    45
    
    
    $
    56Purchase and retirement of stock
    
    
    
    
    
    
    
    
    
    
    (11
    )End of year
    
    
    45
    
    
    
    45
    
    
    
    45Paid-in capital,beginning of year
    
    
    18,432
    
    
    
    18,438
    
    
    
    24,216Proceeds from options exercised
    
    
    
    
    
    
    
    
    
    
    14Purchase and retirement of stock
    
    
    (22
    )
    
    
    (6
    )
    
    
    (5,792
    )End of year
    

    
    18,410
    
    
    
    18,432
    
    
    
    18,438Accumulated other comprehensive income (loss),beginning of year
    
    
    (56
    )
    
    
    (355
    )
    
    
    (215
    )Foreign currency translation adjustment during year
    
    
    (68
    )
    
    
    4
    
    
    
    4Net unrealized gain (loss) on marketable securities
    
    
    64
    
    
    
    295
    
    
    
    (144
    )End of year
    
    
    (60
    )
    
    
    (56
    )
    
    
    (355
    )Accumulated deficit,beginning of year
    
    
    (12,527
    )
    
    
    (270
    )
    
    
    (9,383
    )Net income (loss)
    
    
    (4,798
    )
    
    
    (12,257
    )
    
    
    9,113End of year
    
    
    (17,325
    )
    
    
    (12,527
    )
    
    
    (270
    )Total stockholders equity
    
    $
    1,070
    
    
    $
    5,894
    
    
    $
    17,858COMPREHENSIVE INCOME (LOSS)Net income (loss)
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Other comprehensive income:Foreign currency translation adjustments
    
    
    (68
    )
    
    
    4
    
    
    
    4Net unrealized gain (loss) on marketable securities
    
    
    64
    
    
    
    295
    
    
    
    (144
    )Comprehensive income (loss)
    
    $
    (4,802
    )
    
    $
    (11,958
    )
    
    $
    8,973
 The accompanying notes are an integral part of these consolidated financial
statements. INTELLIGENT SYSTEMS CORPORATION F-6




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Intelligent Systems Corporation
CONSOLIDATED STATEMENTS OF CASH FLOW(in thousands) Year Ended December 31,2003
    
    2002
    
    2001OPERATIONS:Net income (loss)
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Adjustments to reconcile net income (loss) to net cash
used for operating activities, net of
effects of acquisitions and dispositions:Depreciation and amortization
    
    
    759
    
    
    
    1,031
    
    
    
    6,595Deferred gain recognized
    
    
    (137
    )
    
    
    (813
    )
    
    
    (961
    )Investment (income) loss, net
    
    
    (3,033
    )
    
    
    934
    
    
    
    (19,902
    )Equity in (income) loss of affiliate companies
    
    
    (184
    )
    
    
    235
    
    
    
    2,173Changes in operating assets and liabilities, net of effects of acquisitionAccounts receivable
    
    
    1,482
    
    
    
    (728
    )
    
    
    (33
    )Inventories
    
    
    (95
    )
    
    
    (124
    )
    
    
    (72
    )Other current assets
    
    
    (381
    )
    
    
    (24
    )
    
    
    126Accounts payable
    
    
    (369
    )
    
    
    287
    
    
    
    (166
    )Accrued expenses and other current liabilities
    
    
    1,308
    
    
    
    2,378
    
    
    
    1,110Cash used for operating activities
    
    
    (5,448
    )
    
    
    (9,081
    )
    
    
    (2,017
    )INVESTING ACTIVITIES:Proceeds from sales of investments
    
    
    4,540
    
    
    
    2,659
    
    
    
    20,540Acquisition of company, net of cash acquired
    
    
    
    
    
    
    39
    
    
    
    81Acquisitions of long-term investments
    
    
    (160
    )
    
    
    (2,880
    )
    
    
    (2,806
    )Repayments under notes receivable
    
    
    116
    
    
    
    4,902
    
    
    
    5,105Advances under notes receivable
    
    
    (284
    )
    
    
    (4,684
    )
    
    
    (2,087
    )Purchases of property and equipment, net
    
    
    (434
    )
    
    
    (335
    )
    
    
    (95
    )Cash provided by (used for) investing activities
    
    
    3,778
    
    
    
    (299
    )
    
    
    20,738FINANCING ACTIVITIES:Borrowings under short-term borrowing arrangements
    
    
    250
    
    
    
    
    
    
    
    889Repayments under short-term borrowings arrangements
    
    
    
    
    
    
    
    
    
    
    (2,393
    )Purchase and retirement of stock
    
    
    (22
    )
    
    
    (6
    )
    
    
    (5,803
    )Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    14Cash used for financing activities
    
    
    228
    
    
    
    (6
    )
    
    
    (7,293
    )Effects of exchange rate changes on cash
    
    
    (69
    )
    
    
    4
    
    
    
    4Net increase (decrease) in cash
    
    
    (1,511
    )
    
    
    (9,382
    )
    
    
    11,432Cash at beginning of year
    
    
    2,644
    
    
    
    12,026
    
    
    
    594Cash at end of year
    
    $
    1,133
    
    
    $
    2,644
    
    
    $
    12,026SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the year for interest
    
    $
    
    
    
    $
    
    
    
    $
    52Cash paid (received) during the year for income taxes
    
    
    (40
    )
    
    
    (362
    )
    
    
    577
 The accompanying notes are an integral part of these consolidated financial
statements. INTELLIGENT SYSTEMS CORPORATION F-7




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NOTE 1 ORGANIZATION AND SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES Organization- Intelligent Systems Corporation, a Georgia corporation, was
formed in November 1991 to acquire through merger the business, net assets and
operations of Intelligent Systems Master, L.P. In this document, terms such as
the company, we, us, and ISC refer to Intelligent Systems Corporation. Nature of Operations- We create, operate and invest in businesses, principally
in the information technology sector. Consolidated companies (in which we have
majority ownership and control) are engaged in two industries: Information
Technology products and services and Industrial Products. Operations in
Information Technology products and services, which consist of our VISaer, QS
Technologies and CoreCard Software subsidiaries, include development and sales
of software licenses and related professional services and software maintenance
contracts. Operations in the Industrial Product segment include the manufacture
and sale of bio-remediating parts washer systems by our ChemFree subsidiary.
Our operations are explained in further detail in Note 16. Our affiliate
companies (in which we have a minority ownership) are mainly involved in the
information technology industry. Use of Estimates- In preparing the financial statements in conformity with
accounting principles generally accepted in the United States, management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. Some areas where we use estimates and make
assumptions are to determine our allowance for doubtful accounts, valuation
allowances on our investments, depreciation and amortization expense, and
accrued expenses. These estimates and assumptions also affect amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates. Consolidation- The financial statements include the accounts of Intelligent
Systems Corporation and its majority owned and controlled U.S. and non-U.S.
subsidiary companies after elimination of material accounts and transactions
between our subsidiaries. Translation of Foreign Currencies- We consider that local currencies are the
functional currencies for foreign operations. We translate assets and
liabilities to U.S. dollars at period-end exchange rates. We translate income
and expense items at average rates of exchange prevailing during the period.
Translation adjustments are accumulated as a separate component of
stockholders equity. Gains and losses that result from foreign currency
transactions are recorded in the consolidated statement of operations. Cash- We consider all highly liquid instruments with maturities of less than
90 days to be cash. Accounts
Receivable and Allowance for Doubtful Accounts -Accounts receivable
are customer obligations due under normal trade terms. We sell our products to
distributors and end users involved in a variety of industries including
automotive, aircraft operators and maintenance providers, and government
entities. We perform continuing credit evaluations of our customers financial
condition and we generally do not require collateral. Senior management reviews accounts receivable on a monthly basis to determine
if any receivables will potentially be uncollectable. We include any accounts
receivable balances that are determined to be uncollectable, along with a
general reserve, in our overall allowance for doubtful accounts. After all
attempts to collect a receivable have failed, the receivable is written off
against the allowance. Based on the information available to us, we believe
our allowance for doubtful accounts as of December 31, 2003 is adequate.
However, actual write-offs might exceed the recorded allowance. Inventories- We state the value of inventories at the lower of cost or market
determined on a first-in first-out basis. Market is defined as net realizable
value. Property and Equipment- Property and equipment are carried at cost less
accumulated depreciation. The cost of each major class of property and
equipment at December 31, 2003 and 2002 is as follows: (in thousands)
    
    2003
    
    2002Operating equipment
    
    $
    3,041
    
    
    $
    2,616Furniture and fixtures
    
    
    217
    
    
    
    216Leasehold improvements
    
    
    456
    
    
    
    448
 For financial reporting purposes, we use a combination of the straight-line
method and the 150 percent declining balance method over the estimated lives of
the assets, as follows: Classification
    
    Useful life in yearsOperating equipment
    
    3  5Furniture & fixtures
    
    5  7Leasehold improvements
    
    1  3
 Accumulated depreciation was $3.0 million and $2.5 million at December 31, 2003
and 2002, respectively. Depreciation expense was $467,000, $721,000 and
$307,000 in 2003, 2002 and 2001, respectively. These expenses are included in
general and administrative expenses, except with respect to our Industrial
Products Segment, where the depreciation expense INTELLIGENT SYSTEMS CORPORATION F-8




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##### Table of Contents



relates primarily to products leased to customers and is included in cost of
sales. Leased Equipment- In the Industrial Products segment, certain equipment is
leased to customers. The cost, carrying value and accumulated depreciation
associated with the leased equipment at December 31, 2003 and 2002 is as
follows: (in thousands)
    
    2003
    
    2002Cost of equipment
    
    $
    820
    
    
    $
    657Carrying value of equipment
    
    
    283
    
    
    
    176Accumulated depreciation
    
    
    537
    
    
    
    481
 The minimum future lease revenue under non-cancelable contracts through October
2004 is $833,000 at December 31, 2003. There is no contingent rental income
under the leases. These assets are included in Property and Equipment at
December 31, 2003 and 2002. Investments- We account for investments by the equity method for (i) entities
in which we have a 20 to 50 percent ownership interest and over which we do not
exert control or (ii) entities that are organized as partnerships or limited
liability companies. We account for investments in corporations of less than 20
percent in non-marketable equity securities of corporations at the lower of
cost or market. When calculating gain or loss on the sale of an investment, we
use the average cost basis of the securities. Marketable securities are
accounted for in accordance with Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. At December 31, 2003 and 2002, the aggregate fair market value of
our available-for-sale securities consisted of equity securities totaling $0
and $36,000, respectively. These amounts include net unrealized holding losses
of $0 and $64,000 as of December 31, 2003 and 2002, respectively. These amounts
are reflected as a separate component of stockholders equity. Other Intangibles and Goodwill- Other intangibles are carried at cost net of
related amortization. Effective July 1, 2001, we account for acquisitions in
accordance with SFAS No. 141, Accounting for Business Combinations and SFAS
No. 142, Accounting for Intangible Assets. In accordance with SFAS No. 142,
we periodically, but at least annually, assess goodwill for indicators of
impairment. Our annual assessment date has been at the end of the third
quarter. When circumstances indicate that an intangible other than goodwill
may be impaired, we utilize the guidance provided by SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. For the years ended
December 31, 2003 and 2002, no impairment was identified. Prior to the adoption of SFAS No. 142, we periodically assessed the impairment
of enterprise level intangibles pursuant to the provisions of APB No. 17,
Intangible Assets and SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of. At September
30, 2001, we determined the long-lived assets associated with our VISaer
subsidiary were impaired under SFAS No. 121 (see Note 2). Accordingly, we
expensed $6.0 million related to goodwill in general and administrative expense
which is reflected in the statements of operations for the year ended December
30, 2001. Also in the year ended December 31, 2001, we expensed $425,000 of
purchased research and development related to the acquisition of VISaer (see
Note 2). The carrying value of intangibles at December 31, 2003 is $2.5 million, of
which $2.0 million represents goodwill. The carrying value of intangibles at
December 31, 2002 was $3.2 million, of which $2.4 million represented goodwill.
Intangibles other than goodwill primarily relate to acquired software.
Goodwill declined in 2003 as compared to December 31, 2002 due to a permanent
waiver of redemption rights by the holders of preferred stock of our VISaer
subsidiary that was effective March 28, 2003. We reclassed $342,000 accrued in
prior periods related to the redemption provision shown as redeemable
preferred stock of subsidiary at December 31, 2002 against goodwill. In fiscal years 2003, 2002 and 2001, we recorded amortization expense related
to intangible assets of approximately $312,000, $310,000 and $92,000,
respectively. Accumulated amortization of intangibles totaled $715,000 and
$403,000 at December 31, 2003 and 2002, respectively. We had no goodwill
amortization expense in periods presented herein. Annual amortization expense
for the following five years is expected to be approximately $220,000,
$129,000, $128,000, $0 and $0 for the years ending December 31, 2004 through
2008, respectively. Accrued Expenses and Other Current Liabilities- Accrued expenses and other
liabilities at December 31, 2003 and 2002 consist of the following: (in thousands)
    
    2003
    
    2002Income taxes payable
    
    $
    
    
    
    $
    7Accrued payroll
    
    
    1,361
    
    
    
    869Other accrued expenses
    
    
    676
    
    
    
    879
 Deferred Revenue Current deferred revenue consists of advance payments by
software customers for annual maintenance and support services as well as
advance payments from VISaer customers for software licenses expected to be
delivered in 2004. Deferred revenue, net of current portion, consists of
advance payments from one VISaer customer and is being accounted for on a
completed-contract basis. As of December 31, 2003, we had an outstanding
balance of deferred long-term revenue of $5.1 million. We do not anticipate
any loss under this contract. INTELLIGENT SYSTEMS CORPORATION F-9




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Fair Value of Financial Instruments- The carrying value of cash, accounts
receivable, accounts payable and certain other financial instruments (such as
notes receivable and certain investments) included in the accompanying
consolidated balance sheets approximates their fair value principally due to
the short-term maturity of these instruments. Financial instruments that potentially subject us to concentrations of
market/credit risk consist principally of cash and cash equivalents and trade
accounts receivable. We invest cash in high credit-quality financial
institutions. A concentration of credit risk may exist with respect to trade
receivables, as a substantial portion of our customers are affiliated in the
following industries (by subsidiary): ChemFree:
    
    Distributors in the automotive parts industryQS Technologies:
    
    State and local governmentsVISaer:
    
    Aviation
 We perform ongoing credit evaluations of customers worldwide and generally do
not require collateral from our customers. Management reviews our accounts
receivable on a regular basis to determine if any such amounts may be
potentially uncollectible. We include any balances that are determined to be
uncollectible, along with a general reserve, in our overall allowance for
doubtful accounts. After all attempts to collect a receivable have failed,
the receivable is written off against the allowance. Based on managements
best estimate, we believe our allowance for doubtful accounts is adequate.
Historically, we have not experienced significant losses related to
receivables from individual customers or groups of customers in any particular
industry or geographic area. Revenue Recognition- Product revenue consists of fees from software licenses
and sales or leases of industrial products. Service revenue consists of fees
for implementation, consulting, training, reimbursable expenses, maintenance
and support for software products. We recognize revenue for industrial products when products are shipped, at
which time title transfers to the customer. There are no remaining future
obligations and delivery occurs upon shipment. We provide for estimated sales
returns allowances and rebates in the period in which the sales are recorded.
As an alternative to selling the product, on occasion we may lease our
equipment. For leased equipment, we recognize revenue monthly at the
contracted monthly rate during the term of the lease. We recognize software fees in accordance with Statement of Position (SOP) No.
97-2, Software Revenue Recognition, as amended by SOP No. 98-9, Software
Revenue Recognition, With Respect to Certain Transactions. Under SOP 97-2, we
recognize software license fees when the following criteria are met: (1) a
signed contract is obtained; (2) delivery of the product has occurred; (3) the
license fee is fixed or determinable; and (4) collectibility is probable.
Additionally, license fee revenue is not recognized until there are no material
uncertainties regarding customer acceptance, cancellation provisions, if any,
have expired and there are no significant vendor obligations remaining. SOP
No. 98-9 requires recognition of revenue using the residual method when (1)
there is vendor-specific objective evidence of the fair values of all
undelivered elements in a multiple-element arrangement that is not accounted
for using long-term contract accounting; (2) vendor-specific objective evidence
of fair value does not exist for one or more of the delivered elements in the
arrangement; and (3) all revenue recognition criteria in SOP No. 97-2 other
than the requirement for vendor-specific objective evidence of the fair value
of each delivered element of the arrangement are satisfied. Under the residual
method, the fair value of the undelivered elements is deferred and the
remaining portion of the license fee is recognized as revenue. For those
contracts that contain significant production, modification and/or
customization, software license fees are recognized utilizing Accounting
Research Bulletin (ARB) No. 45, Long-term Construction Type Contracts,
using the relevant guidance in SOP No. 81-1, Accounting for Performance of
Construction Type and Certain Production Type Contracts. For percentage of completion contracts, we measure the progress toward
completion and recognize the software license fees based upon input measures
(i.e. in the same proportion that the amount of labor hours incurred to date
bears to the total estimated labor hours required for the contract). If
reliable estimates cannot be determined, we follow the completed contract
method. Under the completed contract method, all revenue is deferred until the
customer has accepted the software and any refund rights have expired. Service revenue related to implementation, consulting, training and other
professional services is recognized when the services are performed. Service
revenue related to software maintenance and support contracts is recognized on
a straight-line basis over the life of the contract (typically one year).
Substantially all of our software customers purchase software maintenance and
support contracts and renew such contracts annually. Reimbursable Expenses- Prior to January 1, 2002, we recorded reimbursement by
our customers for out-of-pocket expenses as a decrease to cost of services.
Our results of operations for the year ended December 31, 2002 have been
reclassified in accordance with the Emerging Issues Task Force (EITF) release
01-14, Income Statement Characterization of Reimbursement Received for Out of
Pocket Expenses Incurred. The effect of this reclassification was to increase
both services revenues and cost of services by $75,000 for the year ended INTELLIGENT SYSTEMS CORPORATION F-10




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December 31, 2002. The effects of the aforementioned adjustment was immaterial
for the year ended December 31, 2001. Cost of Sales- Cost of sales for product revenue includes direct material,
direct labor, production overhead and third party license fees. Cost of sales
for service revenue includes direct cost of services rendered, including
reimbursed expenses. Software Development Expense- We have evaluated the establishment of
technological feasibility of our products in accordance with SFAS No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise
Marketed.We sell products in markets that are subject to rapid technological
change, new product development and changing customer needs; accordingly, we
have concluded that technological feasibility has generally not been
established until the development stage of the product is nearly complete. We
define technological feasibility as the completion of a working model. The
time period during which cost could be capitalized, from the point of reaching
technological feasibility until the time of general product release, is very
short and, consequently, the amounts that could be capitalized are not material
to our financial position or results of operations. Therefore, we have charged
all such costs to research and development in the period incurred. In circumstances in which we acquire software, the annual amortization is the
greater of (1) the ratio of current revenues to the expected revenues from the
related product sales or (2) the straight-line method over the remaining useful
life of the product. See Note 2 for situations in which we acquired software. In accordance with SOP No. 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, we have expensed all cost incurred in
the preliminary project stage for software developed for internal use. We
capitalize all direct costs of materials and services consumed in developing or
obtaining internal use software. All costs incurred for upgrades, maintenance
and enhancements that do not result in additional functionality are expensed.
During the three years ended December 31, 2003, we did not capitalize any
internal use software costs. Warranty Costs- We accrue the estimated costs associated with product
warranties as an expense in the period the related sales are recognized. The
warranty accrual is included in accrued expenses and other current liabilities
at December 31, 2003 and 2002. Stock Based Compensation  -At December 31, 2003 we had three stock-based
compensation plans which are more fully described in Note 13. We account for
the plans under the intrinsic value recognition and measurement principles of
Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to
Employees, and related interpretations. The intrinsic value recognition is
measured by the difference between the exercise price and the market value of
the underlying securities. Based on the additional disclosure requirements of
SFAS No. 148, Accounting for Stock-Based Compensation  -  Transition and
Disclosure  -  an Amendment to SFAS No. 123, the following table illustrates the
effect of net income and earnings (loss) per share if we had applied the fair
value recognition provisions of SFAS No. 123, Accounting for Stock Based
Compensation. Year ended December 31,(in thousands except per share data)
    
    2003
    
    2002
    
    2001Net income (loss), reported
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Add: stock-based employee
compensation included in
reported net income (loss),
net of related tax effect
    
    
    
    
    
    
    
    
    
    
    Deduct: stock-based
compensation expense
determined under fair value
based method for all awards,
net of related tax effect
    
    
    (48
    )
    
    
    (14
    )
    
    
    (27
    )Proforma net income (loss)
    
    $
    (4,846
    )
    
    $
    (12,271
    )
    
    $
    9,086Proforma net income (loss) per
common share basic
    
    $
    (1.08
    )
    
    $
    (2.73
    )
    
    $
    1.78Proforma net income (loss) per
common share diluted
    
    $
    (1.08
    )
    
    $
    (2.73
    )
    
    $
    1.77
 The fair value of each option granted in each of the last three years has been
estimated as of the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions: Year ended December 31,
    
    2003
    
    2002
    
    2001Risk free rate
    
    
    4
    %
    
    
    4
    %
    
    
    4
    %Expected life of option
in years
    
    
    6.7
    
    
    7.3
    
    
    7.9Expected dividend yield rate
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected volatility
    
    
    49
    %
    
    
    47
    %
    
    
    51
    %
 Under these assumptions, the weighted average fair value of options granted in
2003, 2002 and 2001 was $0.83, $1.72 and $1.71 per share, respectively. The
fair value of the grants would be amortized over the vesting period for the
options. Income Taxes In accordance with SFAS No. 109, Accounting for Income Taxes,
we utilize the asset and liability method of accounting for income taxes.
Under the asset and liability method of SFAS No. 109, deferred tax assets and
liabilities are established to recognize the future tax consequences INTELLIGENT SYSTEMS CORPORATION F-11




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attributable to differences between the financial statement carrying amounts of
the existing assets and liabilities and their respective tax bases. Comprehensive Loss- Comprehensive loss represents net loss plus the results of
certain stockholders equity changes not reflected in the consolidated
statements of operations. These items are accumulated over time as accumulated
other comprehensive loss on the consolidated balance sheet and are primarily
the result of cumulative translation adjustments at December 31, 2003 and
unrealized losses on marketable securities at December 31, 2002. Reclassifications It is our policy to reclassify prior year amounts to
conform with current year financial statements presentation when necessary. New Accounting Pronouncements In January 2003, the FASB issued FIN No. 46,
Consolidation of Variable Interest Entities. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN No. 46 is applicable
immediately for variable interest entities created after January 31, 2003.
For variable interest entities created on or prior to January 31, 2003, the
provisions of FIN No. 46 must be applied for the first interim or annual
period beginning after December 15, 2003. We believe that the adoption of
this standard will have no material impact on our financial position and
results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) because that financial instrument embodies an
obligation of the issuer. Many of such instruments were previously classified
as equity by issuers. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003, except for
mandatory redeemable financial instruments of nonpublic entities. The
statement is to be implemented by reporting the cumulative effect of a change
in accounting principle for financial instruments created before the issuance
of the date of the statement and still existing at the beginning of the interim
period of adoption. Restatement is not permitted. On November 7, 2003, the
FASB deferred the classification and measurement provisions of SFAS No. 150 as
they apply to certain mandatory redeemable non-controlling interests. This
deferral is expected to remain in effect while these provisions are further
evaluated by the FASB. The adoption of this statement did not have a
significant impact on our financial position, results of operations or cash
flows. NOTE 2 ACQUISITIONS CoreCard Software, Inc.- We acquired 360,639 shares of common stock of
CoreCard, representing a 30.7% interest in CoreCard Software, Inc. (formerly
Delos Payment Systems, Inc.) (CoreCard) as a result of the spin-off of
CoreCard to the shareholders of PaySys prior to its sale in April 2001.
CoreCard develops software to handle account management and processing of card
systems (such as credit and debit cards) for financial and commercial
institutions. In 2001, we loaned $1.5 million to CoreCard. As a result of a
default on the loan during 2002, we acquired the right to and elected a
majority of the CoreCard board of directors and obtained the right to and
converted our loans into what resulted in a controlling interest. Therefore,
we began to consolidate the CoreCard operations during 2002. We recorded intangible assets upon consolidation in the first quarter of 2002
in accordance with SFAS No. 141. Of the intangibles acquired, $642,000 was
allocated to our pro rata share of CoreCards acquired software which is being
amortized at a rate of $128,400 annually over a five-year period, and $287,000
was recorded as goodwill. Of the goodwill amount, none is deductible for tax
purposes. The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of the CoreCard acquisition. At January 1, 2002 (in thousands)Current assets
    
    $
    138Property, plant, and equipment
    
    
    472Intangible assets
    
    
    642Goodwill
    
    
    287Total assets acquired
    
    
    1,539Current liabilities
    
    
    124Long-term debt
    
    
    1,415Total liabilities assumed
    
    $
    1,539
 During 2002, we converted $3.2 million of principal and interest outstanding
under the loans to CoreCard into 3,734 shares of Series B Convertible Preferred
Stock of CoreCard, at the same INTELLIGENT SYSTEMS CORPORATION F-12




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time as two other minority investors converted their loans to Series B
Preferred Stock of CoreCard. As a result, our ownership interest increased to
65% of the outstanding shares of CoreCard on an as-if converted basis. We
provided additional funds in the amount of $2.6 million to CoreCard under a
secured loan to fund working capital in the second half of 2002. The loan is
eliminated in consolidation. Effective January 2003, we converted $2.5 million
of CoreCards indebtedness to us into 10,137 additional shares of Series B
Convertible Preferred Stock, increasing our ownership to 87% of the outstanding
shares of CoreCard. VISaer, Inc.- As of June 30, 2001, we owned 40% of VISaer, Inc. (VISaer) and
accounted for our investment under the equity method of accounting. At that
date, we had a carrying value for VISaer of $2.9 million in long-term
investments and $1.7 million in principal and interest outstanding under
affiliate notes receivable from VISaer. VISaer, a software company that
designs and sells software that automates the maintenance, repair and overhaul
(MRO) operations of airlines, is the successor company of Visibility, Inc.,
an enterprise resource planning (ERP) company whose operations were spun off
in June 2000. Effective July 1, 2001, in an unplanned restructuring
transaction involving all preferred shareholders of VISaer, we converted
$956,000 of our VISaer note receivable into a new series of preferred stock of
VISaer. In addition, VISaer repaid the balance of $725,000 owed to us shortly
after the restructuring was completed. The debt to equity conversion in July 2001 resulted in our taking control of
VISaer. Our ownership of VISaer increased from 40% to 65%, and we accounted
for the transaction as a step acquisition. For financial reporting periods
after July 1, 2001, we account for VISaer under the consolidation method. The
accounting treatment for the step acquisition and related purchase accounting
of VISaer had the result of immediately creating $8.8 million in intangible
assets for financial reporting purposes. In accordance with SFAS No. 141,
based on third party valuations, we identified and valued the following
intangible assets: existing software technology ($2.0 million), in-process
research and development ($1.7 million) and a favorable lease contract
($200,000). At the time of the acquisition we recorded 25% of such amounts to
reflect the amount associated with our acquisition of an additional 25% step
of VISaer. The recorded amount for existing software technology ($500,000) is
being amortized over its estimated useful life of three years and the recorded
amount for the favorable lease contract ($50,000) is being amortized over the
remaining term of the lease (through July 2004). We immediately expensed
$425,000 (representing 4.8% of the $8.8 million of total intangibles) related
to purchased research and development projects that had not reached
technological feasibility and that did not have an alternative future use. This
amount is included in research and development expense in the accompanying
financial statements for the year ended December 31, 2001. The remaining excess
intangible value in the amount of $7.8 million was booked as goodwill at July
1, 2001. Post-acquisition Write-down of Goodwill- At September 30, 2001, as a result of
the terrorist attacks on September 11, 2001 which directly impacted the
aerospace industry into which VISaer sells its software products, we evaluated
the extent to which the VISaer reporting unit might be impaired. An analysis
by a third party based on an undiscounted cash flow model determined that under
SFAS No. 121, the long-lived assets associated with VISaer were impaired.
Based upon this appraisal, we assessed the total fair value of VISaer at
September 30, 2001 to be $3.7 million. Based on our 65% ownership, the value of
our ownership was $2.4 million. We expensed $6.0 million related to goodwill.
The non-cash charge is included in general and administrative expense in the
consolidated financial statements for the year ended December 31, 2001. We
loaned additional funds to VISaer for working capital needs in the amounts of
$4.4 million and $3.8 million during 2002 and 2003, respectively. These loans
eliminate in consolidation. NOTE 3 SALES AND WRITE-DOWNS OF ASSETS Atherogenics, Inc.- At various times in 2002, we sold all of our interest in
Atherogenics, Inc. [NASDAQ:AGIX], a company in which we were a seed-stage
investor. The average price per share for the 306,859 shares sold in 2002 was
$7.22. We received a total of $2.1 million cash from the sales and recorded a
gain of $1.1 million in the year ended December 31, 2002. Daw Technologies, Inc.- In the second quarter of 2002, we wrote off $1.2
million related to our holdings in Daw Technologies, Inc. (Daw). We had
acquired the Daw common stock in a prior sale of a subsidiary to Daw and had
accumulated $1.2 million of unrealized loss as of June 30, 2002 as a result of
a decline in the market price of Daw stock. We determined that the value of
our Daw stock was permanently impaired due to Daws delisting from NASDAQ and
poor financial condition. Consequently we took a charge of $1.2 million to
write off the unrealized loss and to reserve against the remaining carrying
value of the investment. We sold our interest in the fourth quarter of 2002 for
a minimal amount. HeadHunter.net- In the third quarter ended September 30, 2001, we sold 90,228
shares of common stock (representing all of our interest) of HeadHunter.net. We
originally acquired the shares in exchange for our holdings in privately held
MiracleWorker.com in August 2000. We received $821,000 cash and recognized a
gain of $471,000 on an original cost basis of $350,000. INTELLIGENT SYSTEMS CORPORATION F-13




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Lumenor, Inc.  -In 2002, we took a write-down of $500,000 against the original
$500,000 cost of our minority investment in Lumenor, Inc. based on the failure
of the business to raise new financing. MediZeus, Inc.  -In the fourth quarter of 2003, we took a write-down of
$501,000 against the carrying cost of $501,000 and our original investment cost
of $843,000 in MediZeus, Inc. based on a decision by the board of directors and
investors of the early stage, artificial intelligence software company to wind
down operations. At the same time, we wrote off $131,000 relating to a note
receivable from MediZeus. Novient, Inc.- In 2002, we sold our remaining interest in Novient, Inc., a
privately held software company, for $10,000 cash in a merger transaction
between Novient and a foreign corporation, recognizing a loss of $187,000 on
the sale. Previously, in 1999, we had sold part of our holdings in Novient in a
private transaction, recognizing a gain of $233,000 and netting $286,000 in
cash. NuTec Sciences, Inc.  -In 2002, we recorded an investment loss of $444,000 on
the sale of our minority interest in NuTec Sciences, Inc., in a transaction in
which we received cash of $56,000 on an original cost basis of $500,000. PaySys International, Inc.  -  On April 27, 2001, we sold our 32% ownership
interest in PaySys, an affiliate company, to First Data Corporation (FDC).
In exchange for the sale of all of our shares of PaySys common stock, we
received cash proceeds of $17.8 million and recorded a pretax gain of $17.8
million. In addition, PaySys repaid $4.3 million in principal and interest
related to short-term bridge loans. Furthermore, an escrow fund totaling $20.0
million was set aside for potential liabilities that may arise after the
closing of the sale. On March 21, 2003, a settlement was reached with FDC
related to the escrow fund. We received $4,464,000 cash in the first half of
2003, which represented our pro rata share of the amount released from the
escrow fund, after payment of legal and administrative expenses related to the
escrow. Since these escrow funds were contingent and not considered in the
previously reported gain on the sale of PaySys in April 2001, these escrow
payments are recorded as investment income in the year ended December 31, 2003. Immediately prior to the sale to FDC in April 2001, PaySys spun off two
subsidiaries to its shareholders. Accordingly, at that time we owned
approximately 31 percent of Delos Payment Systems, Inc. (now CoreCard Software)
and 31 percent of dbbAPPS, Inc. We did not record a gain on the distribution to
us of an interest in these two companies. Rather, due to uncertainty regarding
the two early stage companies, we booked a valuation reserve equal to the net
asset value and goodwill associated with our pro rata share of the value of our
interest in CoreCard and dbbAPPS. In the fourth quarter of 2001, in accordance
with Accounting Principles Board (APB) No. 18, The Equity Method of
Accounting for Investments in Common Stock, we classified a secured loan in
the amount of $1.5 million to CoreCard as additional investment. At the same
time, we recaptured $1.42 million in losses related to our pro rata share of
cumulative unrecorded losses. This loss is recorded in equity loss in
affiliates in the consolidated statements of operations for the year ended
December 31, 2001. As explained in Note 2, we acquired a controlling interest
in CoreCard effective January 2002 and consolidate its results of operations
since that date. The carrying value of dbbAPPS at December 31, 2003 and 2002 is
zero. RF Solutions, Inc.  -In the first quarter of 2003, we reserved $600,000 against
the $600,000 carrying value of our minority investment in RF Solutions, Inc.,
an early stage company that sold its principal assets to a publicly traded
company effective early in April 2003. We received $106,000 cash in partial
repayment of our note in 2003. We took a net reserve of $92,000 against the
$198,000 carrying value of a note receivable from RF Solutions. Under the
terms of the RF Solutions sale, the note holders and preferred shareholders of
RF Solutions, including other minority investors like ISC, received a cash
payment to repay part of the principal and interest outstanding on the notes
and may receive an additional payment on the note balance and preferred stock
investment, payable in common stock of Anadigics, Inc., the acquiror company
[NASDAQ: ANAD], based on achievement of certain performance targets in the
twelve month period following the acquisition. Since the amount of any future
payment, if any, was not determinable, in 2003, we fully reserved our remaining
note balance and investment in RF Solutions. Risk Laboratories, LLC- On March 21, 2000, we sold part of our interest in
Risk Laboratories, LLC in a private transaction. We sold 2,310,000 units for
$8.8 million in cash and a gain of $8.6 million. On January 18, 2001, we sold
214,273 units of Risk to the same buyer for a total of $900,000 cash and
recorded a gain of $893,000 based on a cost basis of $7,000. At the same time,
we acquired 107,137 common units from Risk for a total acquisition price of
$450,000. Concurrent with the purchase of these units, we recaptured $450,000
in losses related to our pro rata share of cumulative unrecorded losses. This
loss is recorded in equity loss in affiliates in the accompanying consolidated
statement of operations for 2001. On May 3, 2001, we sold an additional
257,127 common units of Risk to the same buyer. We received $1.0 million cash
and recorded a second quarter gain of $1.0 million on a cost basis of zero. On
March 14, 2002, we sold our remaining interest in Risk for a total of $474,000
cash, recording a gain of $474,000 on a cost basis of zero. INTELLIGENT SYSTEMS CORPORATION F-14




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Silverpop, Inc.  -During the quarter ended June 30, 2003, we reserved $76,000
against our original investment of $100,000 in Silverpop, Inc., an early stage
technology company, to reflect the valuation at which Silverpop raised
additional capital, which we believe indicates a non-temporary impairment of
our original carrying value. NOTE 4 INVESTMENTS The following summarizes our ownership interest in certain non-significant
companies included in our long-term investments. At December 31, 2003, our ownership interest in each of the named companies was
as follows: NKD Enterprises, LLC (25%), Horizon Software, LLC (17%) and
Cirronet, Inc. (22%). We account for each of the named companies by the equity
method of accounting in 2003. Cost BasisCarrying
    
    Before(in thousands)
    
    Value
    
    DistributionsNKD Enterprises
    
    $
    828
    
    
    $
    1,286Horizon Software
    
    
    2,850
    
    
    
    2,500Cirronet
    
    
    803
    
    
    
    525
 At December 31, 2002, our ownership interest in each of the named companies was
as follows: NKD Enterprises (25%), MediZeus (27%), Horizon Software (17%),
Cirronet (18%) and RF Solutions (3%). The material ownership interests are
classified below according to applicable accounting methods at December 31,
2002. Cost BasisCarrying
    
    Before(in thousands)
    
    Value
    
    DistributionsEquity MethodNKD Enterprises
    
    $
    862
    
    
    $
    1,286Horizon Software
    
    
    2,613
    
    
    
    2,500MediZeus
    
    
    615
    
    
    
    843Cost MethodCirronet
    
    $
    740
    
    
    $
    525RF Solutions
    
    
    600
    
    
    
    600
 The following table presents summarized combined financial information for our
50% or less owned investments named above for the respective time periods: As of and for the year ended
December 31, (in thousands)
    
    2003
    
    2002Revenues
    
    $
    25,377
    
    
    $
    23,446Operating Income
    
    
    1,814
    
    
    
    (6,619
    )Net Income
    
    
    1,539
    
    
    
    (7,227
    )Current Assets
    
    
    8,174
    
    
    
    8,166Non-current Assets
    
    
    5,595
    
    
    
    7,410Current Liabilities
    
    
    4,863
    
    
    
    6,813Non-current Liabilities
    
    
    445
    
    
    
    1,405Stockholders Equity
    
    
    8,460
    
    
    
    7,358
 Marketable
Securities -The carrying and estimated fair values of
available-for-sale securities at December 31, 2003 and 2002 are summarized as
follows: (in thousands)
    
    2003
    
    2002Cost
    
    
    
    
    
    $
    100Gross unrealized losses
    
    
    
    
    
    
    (64
    )Estimated fair values
    
    
    
    
    
    $
    36
 Matria Healthcare [NASDAQ:MATR] represents $36,000 at December 31, 2002. We
had no available-for-sale securities at December 31, 2003. NOTE 5 ACCOUNTS AND NOTES RECEIVABLE At December 31, 2003 and 2002, our allowance for doubtful accounts and sales
returns amounted to $124,000 and $63,000, respectively. Provisions for
doubtful accounts and sales returns were $63,000, $49,000 and $8,500 for the
years ended December 31, 2003, 2002 and 2001, respectively. At December 31, 2002, notes receivable included $163,000 from RF Solutions,
Inc., an early stage company in which we own a minority interest accounted for
on the cost basis. The convertible bridge loan bore interest at the rate of 8%
per annum and principal and accrued interest were due on March 1, 2003. In
2003, RF Solutions sold its principal assets to a third party. As a result, we
received $106,000 in partial payment of our note receivable, which was $198,000
at the time, and wrote off $92,000 in 2003 to reduce the balance of the note to
zero. Refer to Note 3 for additional details. INTELLIGENT SYSTEMS CORPORATION F-15




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The following table indicates the percentage of consolidated revenue and
year-end accounts receivable represented by each customer for any period in
which such customer represented more than 10% of consolidated revenue or
year-end accounts receivable. Revenue
    
    
    
    
    
    A/R2003
    
    2002
    
    2001
    
    2003
    
    2002VISaer-Customer A
    
    
    11
    %
    
    
    12
    %
    
    
    
    
    
    
    
    
    
    
    15
    %VISaer-Customer B
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21
    %VISaer-Customer C
    
    
    
    
    
    
    
    
    
    
    23
    %
    
    
    
    
    
    
    ChemFree-Customer D
    
    
    13

    %
    
    
    14
    %
    
    
    
    
    
    
    11
    %
    
    
    ChemFree-Customer E
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    %
    
    
    ChemFree-Customer F
    
    
    
    
    
    
    
    
    
    
    10
    %
    
    
    
    
    
    
    
 NOTE 6 BORROWINGS AND LONG-TERM DEBT Terms and borrowings under our credit facility are summarized as follows:  Year ended
December 31,(in
thousands)
    
    2003
    
    2002Maximum outstanding (month-end)
    
    $
    250
    
    
    
    Outstanding at year end
    
    
    250
    
    
    
    Average interest rate at year end
    
    
    5.5
    %
    
    
    Average interest rate
    
    
    5.5
    %
    
    
    N/A
 We established a new working capital credit facility with a bank in October
2003. The $1.5 million revolving line of credit bears interest at the prime
rate (4% at December 31, 2003) plus one and one half percent, is secured by all
assets of the company and our principal subsidiaries, is guaranteed by our
subsidiaries, and expires September 1, 2004. We may borrow an aggregate of
70-80% of qualified accounts receivable of our consolidated subsidiaries
(depending upon the type of account) plus 50% of inventory, up to a maximum of
$1.5 million. At December 31, 2003, our borrowing base calculation resulted in
availability of $1.1 million of which we drew down $250,000 at year end. The
terms of the loan contain typical covenants not to sell or transfer material
assets, to create liens against assets, to merge with another entity, to change
corporate structure or the nature of our business, to declare or pay dividends,
or to redeem shares of common stock as well as covenants not to change the
chief executive and chief financial officers of the company or to make loans to
or invest in new minority-owned companies, without first obtaining the consent
of the financial institution in each case. NOTE 7 DEFERRED GAIN In connection with the sale of one of our VISaer subsidiarys product lines in
July 2000, the buyer assumed the liabilities of the purchased line of business.
VISaer did not obtain releases from creditors for a portion of these
liabilities and contracts and, accordingly, remains contingently liable for
these obligations. VISaer recorded these liabilities as deferred gain. As of
December 31, 2003, the balance of $291,000 in deferred gain consisted of
accounts payable and accrued expenses. In accordance with SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities, a replacement of FASB Statement 125, VISaer recognizes the
deferred gain when the liability is paid and the company is relieved of its
obligation. We recognized $137,000, $813,000 and $961,000 of the deferred gain
in the years ended December 31, 2003, 2002 and 2001, respectively, which is
recorded in the component of other income/expense in the consolidated
statements of operations. NOTE 8 INCOME TAXES
The income tax provision (benefit) consists of the following: Year ended December 31,(in thousands)
    
    2003
    
    2002
    
    2001Current
    
    $
    (40
    )
    
    $
    (343
    )
    
    $
    173
 Following is a reconciliation of estimated income taxes at the blended
statutory rate to estimated tax expense as reported: Year ended December 31,
    
    2003
    
    2002
    
    2001Statutory rate, blended
    
    
    34
    %
    
    
    34
    %
    
    
    34
    %Change in valuation
allowance
    
    
    (34
    %)
    
    
    (34
    %)
    
    
    (32
    %)Other
    
    
    (1
    %)
    
    
    (3
    %)
    
    
    Effective rate
    
    
    (1
    %)
    
    
    (3
    %)
    
    
    2
    %
 At December 31, 2003, our subsidiaries had net operating loss carryforwards
totaling $8,653,000. The net operating loss carryforwards, if unused as offsets
to future taxable income, will expire by 2023. Approximately $1.1 million of
the net operating loss carryforward is subject to limitation by the Federal
Income Tax code section 382. We account for income taxes using SFAS No. 109, Accounting for Income Taxes.
We have a deferred tax asset of approximately $15.6 million and $13.6 million
at December 31, 2003 and 2002, respectively. Since our ability to realize the
deferred tax asset is uncertain, the amount is offset in both 2003 INTELLIGENT SYSTEMS CORPORATION F-16




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##### Table of Contents



and 2002 by a valuation allowance of an equal amount. The deferred tax asset at
December 31, 2003 and 2002 relates primarily to net operating loss and
tax credit carryforwards and loss limitations on investments. No deferred taxes have been
provided on temporary differences related to investments in foreign subsidiaries
because these investments are considered to be permanent. We do not believe it is
practicable to determine the amount of these unrecognized deferred taxes at this time. NOTE 9 COMMITMENTS AND CONTINGENCIES Leases- We have noncancellable operating leases expiring at various dates
through July 2005. Future minimum lease payments are as follows:  Year ended December 31,(in thousands)2004
    
    $
    3452005
    
    
    59Total minimum lease payments
    
    $
    404
 Rental expense for leased facilities and equipment related to operations
amounted to $759,000, $1.2 million and $1.0 million for the years ended
December 31, 2003, 2002 and 2001, respectively. Companies in Intelligent
Systems Incubator sublease space from the company. For the years ended
December 31, 2003, 2002 and 2001, the company received $255,000, $444,000 and
$484,000, respectively, in sublease rental income which reduced the companys
rental expense during these years. Legal Matters- In 1999, a suit was brought against our ChemFree subsidiary and
two other parties by a former consultant of ChemFree. The suit challenges the
ownership of various intellectual property assets of ChemFree. ChemFree and
the other parties to the litigation strongly deny the allegations, have filed
cross claims and intend to vigorously defend the suit. The case is pending in
the Superior Court of Gwinnett County, Georgia. ChemFree has filed suit in
Federal Court seeking a judgment against the consultant. The case was
scheduled to go to trial early in 2004 but was postponed due to a change in
the Courts calendar. A new trial date has not been set. While the company
believes ChemFree has sufficient evidence to refute the claims made, there can
be no assurance that the case will be resolved in favor of ChemFree. In
addition, from time to time we are party to a small number of legal matters
arising in the ordinary course of business. It is managements opinion that
none of these matters will have a material adverse impact on our consolidated
financial position or results of operations. ISC Guarantee 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 for certain reasons, ISC has guaranteed that CoreCard will 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 milestones or after five years, whichever occurs
sooner. As of December 31, 2003, it does not appear probable that the
guarantee will be paid; thus no amounts have been accrued with respect to this
guarantee. No revenue in respect of this license agreement has been recognized
in 2003. Investment Company Act- The Investment Company Act of 1940 broadly defines an
investment company generally as any issuer that is primarily engaged in, or
proposes to engage in, the business of investing, reinvesting, owning, holding
or trading in securities and owns or proposes to acquire investment securities
having a value exceeding 40% of the issuers total assets. We do not intend to
be and do not consider that we are an investment company and have relied on
Rule 3a-1 of the 1940 Act which provides that a company is not deemed to be an
investment company if not more than 45 percent of the value of its assets and
no more that 45 percent of its net income in the last four quarters is derived
from securities of companies it does not control. In the quarter ended March
31, 2001, we may technically have triggered the definition related to net
income because of gains generated from the sale of non-control securities in
the past four quarters. However, at that time and to the extent necessary to
do so, we elected to rely on safe harbor from the definition of an investment
company for transient investment companies contained in Rule 3a-2 under the
Investment Company Act. Rule 3a-2 provides a conditional one year exclusion
from the investment company definition for an issuer that, among other things,
has a bona fide intent not to be an investment company as soon as reasonably
practicable. No issuer may rely on Rule 3a-2 more frequently than once in any
three-year period. We were in compliance with the requirements of Rule 3a-1 of
the 1940 Act within the one-year exemption period and have been in compliance
since that time. NOTE 10 POST-RETIREMENT BENEFITS Effective January 1, 1992, we adopted the Outside Directors Retirement Plan
which provides that each nonemployee director, upon resignation from the Board
after reaching the age of 65, will receive a lump sum cash payment equal to
$5,000 for each full year of service as a director of the company (and its
predecessors and successors) up to $50,000. At December 31, 2003 and 2002, we
have accrued $150,000 for future payments under the plan. In January 2004, we
made a lump sum INTELLIGENT SYSTEMS CORPORATION F-17




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##### Table of Contents



payment of $50,000 to a director upon his retirement from the board. NOTE 11 REDEEMABLE PREFERRED STOCK OF SUBSIDIARY At December 31, 2002, this amount related to our VISaer subsidiarys obligation
to a minority shareholder of VISaer pursuant to the redemption provision of the
preferred stock of VISaer. On March 28, 2003, the holders of preferred stock
of VISaer consented to a permanent waiver of their redemption rights.
Accordingly, in 2003 we reclassed $342,000 accrued in prior periods against
goodwill. There was no income statement impact of this non-cash transaction. NOTE 12 STOCKHOLDERS EQUITY We have authorized 20,000,000 shares of Common Stock, $0.01 par value per
share, and 2,000,000 shares of Series A Preferred Stock, $0.10 par value per
share. No shares of Preferred Stock have been issued; however, we adopted a
Rights Agreement on November 25, 1997, which provides that, under certain
circumstances, shareholders may redeem the Rights to purchase shares of
Preferred Stock. The Rights have certain anti-takeover effects. The Board of
Directors has authorized stock repurchases from time to time. At various times
during the years ended December 31, 2003 and 2002, we repurchased and retired
12,808 and 3,751 shares, respectively, of our common stock at prevailing market
prices. On July 17, 2001, we repurchased and retired one million shares of our
common stock at $5.25 per share pursuant to a self-tender offer. We
repurchased and retired an additional 132,000 shares at fair market value
during the year ended December 31, 2001. NOTE 13 STOCK OPTION PLAN We instituted the 2003 Incentive Stock Plan (the 2003 Plan) in March 2003.
The 2003 Plan authorizes the issuance of up to 450,000 options to purchase
shares of common stock to officers and key employees. During 2003, 100,000
options were granted to officers. We instituted the 1991 Incentive Stock Plan
(the 1991 Plan) in December 1991 and amended it in 1997 to increase the
number of shares authorized under the Plan to 925,000. The Plan expired in
December 2001, with 148,000 shares ungranted. In August 2000, we instituted a
Non-Employee Directors Stock Option Plan (the Directors Plan) that
authorizes the issuance of up to 200,000 shares of common stock to non-employee
directors. Upon adoption of the Directors Plan, each non-employee director
was granted an option to acquire 5,000 shares. At each annual meeting, each
director receives a grant of 4,000 shares. Stock options under all three plans
are granted at fair market value on the date of grant. As of December 31, 2003,
a total of 945,000 options under all three Plans have been granted, 724,320
have been exercised and 96,680 options are fully vested and exercisable at a
weighted average price per share of $3.86. All options expire ten years from
their respective dates of grant. At December 31, 2003, the weighted average
remaining contractual life of the outstanding options is 6.7 years. Stock
option transactions during the three years ended December 31, 2003 were as
follows: 2003
    
    2002
    
    2001Options outstanding
at Jan. 1
    
    
    104,680
    
    
    
    88,680
    
    
    
    76,014Options granted
    
    
    116,000
    
    
    
    16,000
    
    
    
    16,000Options exercised
    
    
    
    
    
    
    
    
    
    
    3,334Options canceled
    
    
    
    
    
    
    
    
    
    
    Options outstanding
at Dec. 31
    
    
    220,680
    
    
    
    104,680
    
    
    
    88,680Options available for
grant at Dec. 31
    
    
    482,000
    
    
    
    148,000
    
    
    
    164,000Options exercisable at Dec. 31
    
    
    96,680
    
    
    
    68,349
    
    
    
    38,014Option price ranges
per share:Granted
    
    $
    1.51-1.75
    
    
    $
    3.15
    
    
    $
    4.26Exercised
    
    
    
    
    
    
    
    
    
    $
    4.25Canceled
    
    
    
    
    
    
    
    
    
    
    Weighted average
option price per
share:Granted
    
    $
    1.54
    
    
    $
    3.15
    
    
    $
    4.26Exercised
    
    
    
    
    
    
    
    
    
    $
    4.25Canceled
    
    
    
    
    
    
    
    
    
    
    Outstanding at
Dec. 31
    
    $
    2.49
    
    
    $
    3.80
    
    
    $
    3.91Exercisable at Dec. 31
    
    $
    3.86
    
    
    $
    4.59
    
    
    $
    3.53
 INTELLIGENT SYSTEMS CORPORATION F-18




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NOTE 14 FOREIGN REVENUES AND OPERATIONS Foreign revenues are based on the location of the customer. Revenues from
customers by geographic areas for three years ended December 31, 2003 are as
follows:  Year ended December 31,(in thousands)
    
    2003
    
    2002
    
    2001Foreign Countries:United Kingdom
    
    $
    2,727
    
    
    $
    2,846
    
    
    $
    2,429Australia
    
    
    374
    
    
    
    55
    
    
    
    Chile
    
    
    362
    
    
    
    214
    
    
    
    China
    
    
    110
    
    
    
    294
    
    
    
    244Other
    
    
    217
    
    
    
    165
    
    
    
    253Subtotal
    
    
    3,790
    
    
    
    3,574
    
    
    
    2,926United States
    
    
    9,544
    
    
    
    7,167
    
    
    
    5,792Total
    
    $
    13,334
    
    
    $
    10,741
    
    
    $
    8,718
 With the acquisition of VISaer on July 1, 2001, we acquired foreign
subsidiaries in the United Kingdom and Ireland. In 2003, we established a
subsidiary of CoreCard Software in Romania for certain software development and
testing activities. For the years ended December 31, 2003, 2002 and 2001,
income before provision for income taxes derived from foreign subsidiaries
approximated $0, $20,000 and $63,000, respectively. Substantially all
long-lived assets are in the United States. At December 31, 2003 and 2002, foreign subsidiaries had assets of $443,000 and
$356,000, respectively, and total liabilities of $698,000 and $464,000,
respectively. There are no currency exchange restrictions related to our foreign subsidiaries
that would affect our financial position or results of operations. Refer to Note 1 for a discussion regarding how we account for translation of
non-U.S. currency amounts. NOTE 15 EARNINGS (LOSS) PER SHARE Basic and diluted earnings (loss) per share are computed in accordance with
SFAS No. 128 Earnings per Share. Basic net earnings (loss) per share are
computed by dividing net earnings (loss) (numerator) by the weighted average
number of common shares outstanding (denominator) during the period and exclude
the dilutive effect of stock options. Diluted net earnings per share gives
effect to all dilutive potential common shares outstanding during a period. In
computing diluted net earnings per share, the average stock price for the
period is used in determining the number of shares assumed to be reacquired
under the treasury stock method for the hypothetical exercise of stock options. The following tables represent required disclosure of the reconciliation of the
earnings (loss) and the shares used in the basic and diluted net earnings
(loss) per share computation:  Year ended December 31,(in thousands except per share data)
    
    2003
    
    2002
    
    2001BasicNet earnings (loss)
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Weighted average shares
outstanding
    
    
    4,483
    
    
    
    4,495
    
    
    
    5,108Net earnings (loss)
per share
    
    $
    (1.07
    )
    
    $
    (2.73
    )
    
    $
    1.78DilutedNet earnings (loss)
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Weighted average shares
outstanding
    
    
    4,483
    
    
    
    4,495
    
    
    
    5,108Effect of dilutive potential
common shares:Stock options
    
    
    
    
    
    
    
    
    
    
    38Total
    
    
    4,483
    
    
    
    4,495
    
    
    
    5,146Net earnings (loss) per share
    
    $
    (1.07
    )
    
    $
    (2.73
    )
    
    $
    1.77
 At December 31, 2003 and 2002, there were no potentially dilutive stock options
excluded from diluted weighted average shares outstanding. NOTE 16 INDUSTRY SEGMENTS Our consolidated subsidiaries are involved in two industry segments:
Information Technology products and services and Industrial Products.
Operations in Information Technology products and services, which include our
VISaer, QS Technologies and CoreCard Software subsidiaries, involve development
and sales of software licenses and related professional services and software
maintenance contracts. Operations in the Industrial Product segment include the
manufacture and sale of bio-remediating parts washers by our ChemFree
subsidiary. Total revenue by industry segment includes sales to unaffiliated
customers. Sales between our industry segments are not material. Operating
profit (loss) is total revenue less operating expenses. None of the corporate
overhead expense is allocated to the individual industry segments. Identifiable
assets by industry segment are those assets that are used in our subsidiaries
in each industry segment. Corporate assets are principally cash, notes
receivable and investments. The table following contains segment information
for the three years ended December 31, 2003. INTELLIGENT SYSTEMS CORPORATION F-19




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##### Table of Contents



Year ended December 31,(in thousands)
    
    2003
    
    2002
    
    2001Information TechnologyRevenue
    
    $
    7,118
    
    
    $
    5,456
    
    
    $
    4,353Operating income (loss)
    
    
    (7,928
    )
    
    
    (11,096
    )
    
    
    (4,754
    )Depreciation and
amortization
    
    
    591
    
    
    
    858
    
    
    
    2,527Capital expenditures
    
    
    150
    
    
    
    116
    
    
    
    189Identifiable assets
    
    
    4,740
    
    
    
    6,334
    
    
    
    4,792Goodwill
    
    
    2,039
    
    
    
    2,380
    
    
    
    1,813Industrial ProductsRevenue
    
    
    6,216
    
    
    
    5,285
    
    
    
    4,365Operating income (loss)
    
    
    276
    
    
    
    (340
    )
    
    
    (227
    )Depreciation and
amortization
    
    
    130
    
    
    
    136
    
    
    
    157Capital expenditures
    
    
    272
    
    
    
    219
    
    
    
    83Identifiable assets
    
    
    2,024
    
    
    
    1,944
    
    
    
    1,730Goodwill
    
    
    
    
    
    
    
    
    
    
    Consolidated SegmentsRevenue
    
    $
    13,334
    
    
    $
    10,741
    
    
    $
    8,718Operating income (loss)
    
    
    (7,652
    )
    
    
    (11,436
    )
    
    
    (4,981
    )Depreciation and
amortization
    
    
    721
    
    
    
    994
    
    
    
    2,684Capital expenditures
    
    
    422
    
    
    
    335
    
    
    
    272Identifiable assets
    
    
    6,764
    
    
    
    8,278
    
    
    
    6,522Goodwill
    
    
    2,039
    
    
    
    2,380
    
    
    
    1,813
 A reconciliation of consolidated segment data above to consolidated income
(loss), depreciation and amortization, capital expenditures and assets follows:  Year ended December 31,(in thousands)
    
    2003
    
    2002
    
    2001Consolidated segments
operating loss
    
    $
    (7,652
    )
    
    $
    (11,436
    )
    
    $
    (4,981
    )Corporate expenses
    
    
    (740
    )
    
    
    (1,024
    )
    
    
    (5,439
    )Consolidated operating
loss
    
    
    (8,392
    )
    
    
    (12,460
    )
    
    
    (10,420
    )Interest income
    
    
    2
    
    
    
    129
    
    
    
    1,017Investment income (loss)
    
    
    3,040
    
    
    
    (934
    )
    
    
    19,902Equity of affiliates
    
    
    184
    
    
    
    (235
    )
    
    
    (2,173
    )Other income
    
    
    328
    
    
    
    900
    
    
    
    960Income (loss) before taxes
    
    
    (4,838
    )
    
    
    (12,600
    )
    
    
    9,286Income taxes
    
    
    (40
    )
    
    
    (343
    )
    
    
    173Net income (loss)
    
    $
    (4,798
    )
    
    $
    (12,257
    )
    
    $
    9,113Depreciation and
amortizationConsolidated segments
    
    $
    721
    
    
    $
    994
    
    
    $
    2,684Corporate
    
    
    38
    
    
    
    37
    
    
    
    3,911Consolidated
    
    $
    759
    
    
    $
    1,031
    
    
    $
    6,595Capital ExpendituresConsolidated segments
    
    $
    422
    
    
    $
    335
    
    
    $
    272Corporate
    
    
    12
    
    
    
    12
    
    
    
    25Consolidated
    
    $
    434
    
    
    $
    347
    
    
    $
    297AssetsConsolidated segments
identifiable assets
    
    $
    6,764
    
    
    $
    8,278
    
    
    $
    6,522Corporate
    
    
    6,978
    
    
    
    9,582
    
    
    
    19,567Consolidated
    
    $
    13,742
    
    
    $
    17,860
    
    
    $
    26,089
 NOTE 17 QUARTERLY FINANCIAL DATA (unaudited) The table following contains a summary of selected quarterly data for the
years ended December 31, 2003 and 2002. For Quarters Ended(in thousands except per share data)
    
    Mar. 31
    
    June 30
    
    Sept. 30
    
    Dec. 312003Net sales
    
    $
    3,170
    
    
    $
    2,821
    
    
    $
    2,748
    
    
    $
    4,595Operating loss
    
    
    (2,574
    )
    
    
    (2,609
    )
    
    
    (2,535
    )
    
    
    (675
    )Net (income) loss
    
    
    949
    a
    
    
    (2,183
    )
    
    
    (2,396
    )
    
    
    (1,168
    )bBasic (income) loss
per share
    
    
    0.21
    
    
    
    (0.49
    )
    
    
    (0.53
    )
    
    
    (0.26
    )Diluted (income) loss
per share
    
    
    0.21
    
    
    
    (0.49
    )
    
    
    (0.53
    )
    
    
    (0.26
    )2002Net sales
    
    $
    2,168
    
    
    $
    2,213
    
    
    $
    2,973
    
    
    $
    3,387Operating loss
    
    
    (3,617
    )
    
    
    (3,512
    )
    
    
    (2,885
    )
    
    
    (2,446
    )Net loss
    
    
    (2,122
    )c
    
    
    (4,708
    )d
    
    
    (2,697
    )e
    
    
    (2,730
    )Basic loss
per share
    
    
    (0.47
    )
    
    
    (1.05
    )
    
    
    (0.60
    )
    
    
    (0.61
    )Diluted loss
per share
    
    
    (0.47
    )
    
    
    (1.05
    )
    
    
    (0.60
    )
    
    
    (0.61
    )
  a.
    
    Includes net investment gain of $3.5 million.b.
    
    Includes net investment losses of $604,000.c.
    
    Includes investment gains of $797,000 and $751,000 deferred gain.d.
    
    Includes $1.3 million write-down of investment.e.
    
    Includes net investment losses of $360,000. INTELLIGENT SYSTEMS CORPORATION F-20




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##### Table of Contents



Schedule II INTELLIGENT SYSTEMS CORPORATION
Valuation and Qualifying Accounts and Reserves
For the Years Ended December 31, 2001, 2002 and 2003 Balance at Beginning
    
    Charged to Costs
    
    
    
    
    
    Balance atDescription
    
    of Period
    
    and Expenses
    
    Deductionsa
    
    End of PeriodAllowance for
Doubtful AccountsbYear Ended December 31, 2001
    
    $
    45,904
    
    
    $
    8,591
    
    
    $
    (9,511
    )
    
    $
    44,984Year Ended December 31, 2002
    
    
    44,984
    
    
    
    48,717
    
    
    
    (31,195
    )
    
    
    62,506Year Ended December 31, 2003
    
    
    62,506
    
    
    
    62,779
    
    
    
    (1,192
    )
    
    
    124,093
  a.
    
    Write-offs of accounts receivable against allowance accounts.b.
    
    This includes the combination of the Allowance for Sales Returns with the
Allowance for Doubtful Accounts. INTELLIGENT SYSTEMS CORPORATION S-1