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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-KSB FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (Mark One)
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the transition period from to Commission file number 1-9330  INTELLIGENT SYSTEMS CORPORATION(Exact name of Registrant as specified in its charter)
 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 þ     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-KSB or any amendment to this Form 10-KSB. þ State registrants revenue for its most recent fiscal year. $22,332,000 As of February 28, 2005, 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 February 28,
2005 was $8,843,918 (computed using the closing price of the Common Stock on February 28, 2005 as
reported by the American Stock Exchange). DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrants Proxy Statement for the Annual
Meeting of Shareholders 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, related stockholder matters and
small business issuer repurchases of equity securities
    
    
    96. Managements discussion and analysis or plan of operations
    
    
    97. Financial statements
    
    
    168. Changes in and disagreements with accountants in accounting and financial disclosure
    
    
    168A. Controls and procedures
    
    
    16Part III9. Directors and executive officers of the registrant
    
    
    1610. Executive compensation
    
    
    1711. Security ownership of certain beneficial owners and management and related stockholder matters
    
    
    1712. Certain relationships and related transactions
    
    
    1713. Exhibits and reports on Form 8-K
    
    
    1714. Principal accountant fees and services
    
    
    19Signatures
    
    
    19EX-10.1 LEASE AGREEMENTEX-10.9 FIRST MODIFICATION TO LOAN DOCUMENTSEX-10.10 CONSENT ORDEREX-21.1 LIST OF SUBSIDIARIESEX-23.1 CONSENT OF TAUBER & BALSER, P.C.EX-23.2 CONSENT OF BDO SEIDMAN, LLP.EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEO & CFO




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PART I Forward-Looking Statements In addition to historical information, thisForm 10-KSBmay 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 6 of thisForm 10-KSB. 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




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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 Products and Services 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, 2004, we own 100
percent of our ChemFree and QS Technologies subsidiaries, 79 percent of VISaer and 87 percent of
CoreCard Software. Operations in the Information Technology Products and Services 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.
Depending on the contract terms and customer implementation and testing schedule, which are
typically outside of our control, the timing of revenue recognition is not generally within our
control or determinable by us with any degree of certainty in advance. 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 average three to four years. Our individual operations in both segments are relatively small in size and are subject to
considerable fluctuation in revenue and profitability which in turn affects our consolidated
revenue and margins. For instance, sales of ChemFree products, which were slightly higher in 2004
than in 2003, represented 28 percent of consolidated revenue in 2004, but had represented 47
percent of consolidated revenue in 2003. In 2004, VISaers revenue represented almost 52 percent of
consolidated revenue, compared to 24 percent in 2003. QS Technologies revenue accounted for 12
percent and 29 percent of consolidated revenue in 2004 and 2003, respectively. CoreCard
contributed an immaterial amount to consolidated revenues in 2003, but their contribution grew to
eight percent 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 15 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
6. of this Form 10-KSB. 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
Andover, Massachusetts, VISaer also has operations in England to support product development and
sales activities in Europe and a small technical and project management team in Australia. 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 installed its initial customers of its first Version 3 release, a fully Web-native version
of its complete MRO solution, in 2003. In 2004, VISaer focused on developing the next release of
its Version 3 software to establish strong reference accounts and did not allocate significant
resources to new sales and marketing programs. In addition to contracts to deliver professional
services and maintenance support in 2005, VISaer has additional signed contracts to purchase
software licenses for its Version 3 software and has $2.6 million in short-term deferred revenue,
net of related costs, at December 31, 2004 that is expected to be recognized in 2005. VISaer has
also identified a pipeline of additional prospects for license sales and professional services. 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 the second half of 2004 and continuing in recent months, there appears to be momentum building to move forward on delayed proposals to purchase MRO
software which we believe will Intelligent Systems Corporation




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provide an opportunity to build our pipeline of new business opportunities. 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, and small to mid-size domestic regional airlines. VISaer markets and sells its software in both domestic and international markets. International
customers represented 27 percent of VISaer revenue in 2004 but had represented a majority of VISaer
sales of products and services in each of the prior two years. The percentage decline in 2004
relates to unusually high domestic sales in 2004 due to completion of a multi-year contract more
than to a decline in the dollar value of international sales. The markets for VISaer products
include both airline-owned maintenance and engineering shops as well as third party MRO
organizations. 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.
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 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, although any technical or quality problems
that arise could delay the products implementation and negatively impact customer acceptance and
references. QS Technologies, Inc.- QS Technologies operates mainly from its Greenville, South Carolina
location, providing both health and human services and vital records software, along with
maintenance and support services to its installed customer base as well as to new customers. QS
Technologies products allow public health and government 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. Our vital records software is typically sold to a government
department that is implementing the software state-wide, compared with the market for health and
human services software which includes smaller, local city and county jurisdictions as well. 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 our products and the timing of contract awards is impacted by general
economic conditions as well as customer-specific factors such as preferred technology platform,
defined product specifications, 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 health and human services product
line, marketed under the Insight name, and added a vital records (birth and death) software
product and web-based capabilities. In 2003, QS Technologies benefited from 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, in 2003, QS Technologies had a record year for revenue
from new license sales and from annual maintenance contracts due to an expanded installed customer
base. As anticipated, in 2004, QS Technologies did not match the same level of new license revenue
as it did in 2003, although service revenue continues to provide a growing, recurring contribution
because new and existing customers typically sign annual maintenance and support contracts. The
level of new Requests For Proposal (RFP) activity in 2004 and into 2005 is creating a reasonable
pipeline of new business opportunities although RFPs contracts awards and timelines are always
subject to changes in state and federal budgets and funding. 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 product development (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 retail customer and recognized its first significant revenue 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 Intelligent Systems Corporation




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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. 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. 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 some of its competitors
and potential customers may 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. Moreover, some potential customers may be reluctant to acquire
software from a company with limited customer installations and choose instead a lower risk
strategy of acquiring different and perhaps older technology from more established companies.
Certain of CoreCards competitors, including processors, 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 its 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 is focusing its
development, marketing and sales activities on establishing a growing base of referenceable,
satisfied customers. CoreCard has certain non-compete restrictions related to the spin-off from
PaySys International, the last of which expires in April 2006. However, CoreCard believes that the
available worldwide market is substantial, even with this remaining restriction. CoreCard licenses its software products typically for a one-time license fee or, depending on
specific customer requirements and preferences, on a per transaction fee. 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. but may work with a small number of
resellers and third parties in international markets to identify, sell and support targeted
opportunities. CoreCard completed the initial functionality in its core software modules,
CoreISSUE, CoreFRAUD and CoreCOLLECT in 2003, developed further enhancements in 2004, and in
2005 expects to complete and deliver CoreACQUIRE and other product enhancements to its existing
products. Any delays or problems in completing, testing and delivering CoreCards new products
could adversely affect customer acceptance and references. 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, 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. ChemFree sells its products directly to high volume customers as well as through
several distribution channels, including international distributors in Europe, Canada, Latin
America 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 represented six percent and 13
percent of our consolidated revenue in 2004 and 2003, respectively, and 22 percent and 28 percent
of our Industrial Products Segment revenue in 2004 and 2003, respectively. 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 Intelligent Systems Corporation




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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. Customer and warranty service, typically covering a one-year period, generally consists of shipping
a replacement part to the customer or returning a defective product to either ChemFree or 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 it is possible to acquire subassemblies from multiple sources, ChemFree frequently
contracts with a single source for certain components in order to benefit from lower prices and
consistent quality, especially with respect to molded plastic parts which are produced using
ChemFree owned molds. 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, and a network of professional services.
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,
corporate ventures, and shared offices such as executive suites. 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. Our two largest current investments follow:  
    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 25.5 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. Research and Development We spent $7.6 million and $8.3 million in the years ended December 31, 2004 and 2003, respectively,
on company sponsored research and development. In 2004, the Information Technology segment spent
$757,000 less on software development than in 2003. In each of the last two years, 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. Total R&D expenses in 2004 were
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; and at VISaer, costs were lower due to reduced need for third party contractors
than were required during the early product development stages, and reassignment of some software
developers to customer support and professional services activities. VISaer released its first Version 3 software in 2003, delivered additional version releases and
modules in 2004, and expects to complete a release in early 2005 that will be used as the Go-Live
version for most existing and prospective customers. In 2005, CoreCard Software expects to
complete additional software modules, principally CoreACQUIRE, and to develop further enhancements
to its initial suite of products. Intelligent Systems Corporation




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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, Insight and others. Personnel As of February 28, 2005, we had 162 full-time equivalent employees in our company, including 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, 2005, we have leases covering approximately 61,000 square feet in Norcross, GA,
6,100 square feet in Greenville, SC, and 12,000 square feet in Andover, MA, to house our product
development, manufacturing, sales, service and administration operations, as well as a small
development office in Romania. Approximately 10 percent of the space we lease in Norcross is
subleased to businesses in our technology business incubator. We believe our facilities are
adequate for the foreseeable future. 
 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 filed a suit in the United States District Court for the Northern District of Georgia in
an action styled ChemFree Corporation vs. James C. McClure. During the quarter ended September 30,
2004, an agreement was reached to settle both litigation matters. ChemFree secured a full
assignment of interests in all of ChemFrees patents and patent applications worldwide from the
former consultant in return for periodic payments over a five year period. The payment schedule
provides for four monthly payments of $25,000, beginning August 2, 2004, and 48 monthly payments of
$8,333 beginning in August 2, 2005 for an aggregate consideration of $500,000 ($451,000 discounted
at 6.5%). In accordance with Statement of Financial Accounting Standards No. 142, Accounting for
Intangible Assets, we believe that the present value of the payment stream ($451,000) is fully
recoverable at this time. Based on our current estimations, we believe the average useful life of
these patents to be 10 years, which does not exceed legal lives. In 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, 2004. Intelligent Systems Corporation




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PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER REPURCHASES OF EQUITY SECURITIES 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. Year Ended December 31,
    
    2004
    
    
    2003High
    
    
    Low
    
    
    High
    
    
    Low1st Quarter
    
    $
    2.80
    
    
    $
    1.62
    
    
    $
    1.70
    
    
    $
    1.252nd Quarter
    
    
    2.53
    
    
    
    1.78
    
    
    
    2.04
    
    
    
    1.403rd Quarter
    
    
    2.09
    
    
    
    1.60
    
    
    
    2.20
    
    
    
    1.594th Quarter
    
    
    2.52
    
    
    
    1.91
    
    
    
    2.01
    
    
    
    1.55
 We had 370 shareholders of record as of February 28, 2005. 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 regular 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 5 to the Consolidated Financial Statements. 
 ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN 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,
customization, 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. 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, Intelligent Systems Corporation




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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 and delays. 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 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 2
to the Consolidated Financial Statements, we discuss aggregate charges totaling $639,000 in 2004 to
write-off the carrying value of our investment in Ardext Technologies and $1.2 million in 2003 to
reflect reductions in the carrying value of our investments in RF Solutions, Silverpop and
MediZeus. Charges were recorded in the fiscal quarter corresponding to 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 CoreCard Software subsidiary (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. Additionally, we may
acquire an intangible asset through other means, such as occurred in August 2004, when our ChemFree
subsidiary acquired intellectual property assets in settlement of long-standing legal matters, as
explained in more detail in Note 8 to the Consolidated Financial Statements. We recorded the
addition of $458,000 in intangible assets in 2004 related to the ChemFree intellectual property
assets which are being amortized over a ten year period. We did not acquire any companies in 2004
and no write-downs with respect to goodwill or other intangibles occurred in 2004 or 2003. The determination of the value of 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. Sometimes 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, 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. Intelligent Systems Corporation




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Overview Our consolidated subsidiaries operate in two industry segments: Information Technology Products and
Services and Industrial Products. Included in the Information Technology Products and Services
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 financial transactions involving credit accounts).
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, customization, 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 four 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 minor 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 the
consolidated revenue that we can recognize in a given quarterly or
annual period.
    Acquisitions may affect our revenue and expense levels. For
instance, in 2002, we acquired a controlling interest in CoreCard
Software. Consequently, we consolidated the results of operations
of CoreCard from the date 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, are not consistently profitable on a quarterly or annual
basis, 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. 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, although our funding in 2004 was lower than for 2003. We do not expect the same
level of cash investment in the future in these two entities and presently believe that customer
payments on existing and pending software contracts will be sufficient to fund VISaers operations on an annual basis 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. Intelligent Systems Corporation




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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. 2004 Compared to 2003 Revenue- Total revenue for the year ended December 31, 2004 was $22.3 million, an increase of 67
percent compared to the same period in 2003. Revenue from product sales increased 34 percent
year-to-year from $8.5 million to $11.4 million, whereas service revenue more than doubled, from
$4.9 million in 2003 to $10.9 million in 2004. Both product and service revenue were impacted
positively as a result of our Visaer subsidiarys recognition of revenue related to a multi-year
contract that had been deferred from prior years. This single contract with a major customer
contributed $7.5 million in total revenue and $4.9 million in gross margin in the year ended
December 31, 2004. It is unlikely that VISaer or any of the companys software subsidiaries will
have another contract of the same size in the foreseeable future. Product revenueincludes sales of industrial products by our Industrial Products segment as well as
software licenses by our Information Technology segment subsidiaries:  
    Sales of industrial products by our ChemFree subsidiary were slightly higher in 2004 than
in 2003, and the mix of revenue by source and product changed from year-to-year as well.
ChemFrees sales of parts washers, fluid and filters to the international market increased 29
percent overall compared to the prior year reflecting increased volume of units sold in the
European and Latin American markets; revenue from leased equipment in the domestic market
increased 25 percent compared to the 2003 level, mainly due to a new multi-location corporate
customer; and the volume of fluid and filters sold to the installed base of domestic customers
increased approximately four percent in 2004 as compared to 2003. Offset against these
increases was a decline in the number of machines sold through ChemFrees distribution network
in the domestic U.S. market. ChemFree expects one of its expiring leases to be renewed in
2005 but if it does not, the level of revenue from this source could decline.
    License revenue generated by our Information Technology segment increased by $2.8 million
(126 percent) in 2004 mainly due to the VISaer major customer contract described above which
contributed $2.7 million in license revenue. Additionally, our CoreCard Software subsidiary
generated its first significant license revenue in 2004, but this was offset by a year-to-year
decline in license revenue of approximately the same amount at our QS Technologies subsidiary
mainly due to a record high level of license sales in 2003 which, as expected, was not matched
in 2004. Service revenuegenerated by our Information Technology subsidiaries increased by $6.1 million (125
percent) in 2004 as compared to 2003. Of this amount, approximately $4.8 million was for
professional services, maintenance and reimbursable travel related to the VISaer major customer
contract and the balance of the increase is due to more maintenance, support and professional
services revenue from a larger installed base of customers at each of our software subsidiaries. Cost of Sales- Total cost of sales was $8.9 million in 2004, a 32 percent increase compared to
2003, on a 67 percent increase in revenue year-to-year. Cost of productsales in 2004 was $3.7
million, or 32 percent of total product revenue, compared to $3.3 million or 39 percent of total
product revenue in 2003. The difference between years is due to the significantly greater amount
of software license revenue generated in 2004, which has a lower cost of sales than do our
industrial products. Software license revenue represented 45 percent and 27 percent of total
product revenue in 2004 and 2003, respectively, whereas industrial products revenue represented 55
percent and 73 percent of total product revenue in 2004 and 2003, respectively. Cost of sales for
industrial products remained unchanged in 2004 and 2003 at 52 percent of industrial product
revenue. Cost of servicesales (which relates to the Information Technology subsidiaries only) represented
47 percent of service revenue or $5.2 million in 2004 compared to 69 percent of service revenue, or
$3.4 million, in 2003. The decrease in cost of sales as a percentage of service revenue in 2004 is
mainly due to lower costs as a percentage of sales associated with the professional services
revenue recognized by VISaer, as well as more efficient utilization of professional services
employees at VISaer. Partially offsetting this cost reduction was a 21 percent increase in cost of
service sales at the QS Technologies subsidiary due to higher personnel expenses to support a larger installed base of customers under annual maintenance contracts and to deliver more
professional services projects for new and existing customers. Intelligent Systems Corporation




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Operating Expenses- Consolidated operating expenses were nine percent lower in 2004 than in 2003,
decreasing from $15.0 million in 2003 to $13.7 million in 2004. Both general and administrative
expense and marketing expense declined by nine percent year-to-year, while research and development
expenses declined by eight percent year-to-year. The reduction in marketing expenses is mainly due
to fewer direct sales employees and their associated travel costs. The decrease in general and
administrative expense reflects lower costs at each of our subsidiaries mainly due to a reduction
in total number of U.S. based employees performing administrative functions, lower facility costs
at VISaer, and reduced depreciation expense. Offset against these declines is an increase of
$64,000 at the corporate group mainly for higher rent and audit fees. Research and development
expense was $686,000 less in 2004 than in 2003 mainly due to a combination of factors, including
reduction in the use of third party contractors at VISaer, the allocation of more developers
expense to cost of professional services at QS Technologies, and greater use of lower cost
employees at CoreCard Romania for certain testing and quality assurance functions. Interest Expense-We did not incur a net interest expense for 2004 despite a higher average bank
line of credit balance in 2004 as compared to 2003, because our interest expense of $11,000 was
offset by interest income of the same amount at a subsidiary. Investment Income- We recognized $2.5 million in net investment income in 2004 compared to net
investment income of $3.0 million in 2003. Included in the investment income in 2004 is a gain of
$2.7 million on distributions related to our holdings in ISC Guernsey, aggregate investment gains
totaling $513,000 related to transactions involving our holdings in Cirronet, Riverside Software
and RF Solutions, and a write-down of $639,000 on our holdings in Ardext Technologies. Refer to
Note 2 to the Consolidated Financial Statements for more details on each of these transactions. By
comparison, net investment income in 2003 is comprised mainly of a gain on the PaySys escrow stock
offset by write-downs on several minority owned investments, as explained in Note 2 to the
Consolidated Financial Statements. Equity Earnings (Losses) of Affiliate Companies-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 and year-to-year.
In 2004, we recorded $76,000 in equity losses of five affiliate companies (Horizon Software
International, Riverside Software, CoreXpand, Alliance Technology Ventures and Cirronet) for those
periods in 2004 in which we accounted for each by the equity method. By comparison, in 2003, we
recorded $184,000 in equity earnings of six affiliate companies (including Horizon Software
International, CoreXpand, Riverside Software, MediZeus, Alliance Technology Ventures and Cirronet)
for those periods in which we accounted for each by the equity method. Other Income, net- In 2004, other income includes $382,000 in recognition of the remaining balance
of deferred gain related to a VISaer product line sale in a prior period, $8,000 in currency
exchange gains, and other miscellaneous expense items. In 2003, the amount includes $137,000 in
recognition of deferred gain related to the VISaer product line sale, $124,000 in foreign currency
exchange gains, and other miscellaneous income. Taxes- The income tax liability of $3,000 recorded in 2004 reflects state tax liability at our QS
Technologies subsidiary. We did not accrue for any other income tax liability in 2004 and we
believe our deferred tax assets should be fully reserved given their character and our historical
losses. 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. Liquidity and Capital Resources Our cash balance at December 31, 2004 was $670,000, which is $463,000 lower than at the prior
year-end. During the year ended December 31, 2004, our principal sources of cash were $2.7 million
from distributions related to the ISC Guernsey sale of assets, $1.1 million from the sale of our
Cirronet stock, a net increase of $2.3 million in current deferred revenue related to payments by
customers for software and annual maintenance contracts for which the related revenue will be
recognized within twelve months and $113,000 from a lower level of inventory of industrial
products. During the year, our principal use of cash was $4.0 million for operations, which was
$1.4 million less than in 2003. We used $433,000 cash in 2004 to reduce accrued payroll, the
majority of which was for employee bonuses earned in 2003 but paid in 2004. Further, accounts
receivable increased by $1.4 million compared to December 31, 2003 reflecting the timing of
ChemFree invoices for quarterly lease payments that were dated December 31, 2004 compared to a
January 1 dating for the comparable invoices for the prior period and an annual maintenance billing
at the QS Technologies subsidiary that was delayed from the third to the fourth quarter of 2004 due
to a contract amendment. Intelligent Systems Corporation




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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 2004, we used $3.9 million to support these two subsidiaries, which was $2.8
million less than the $6.7 million we used in 2003. We do not expect 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 on an annual basis
and a growing portion of CoreCards expenses in 2005. 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 expect 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 QS Technologies subsidiary generated
sufficient cash in 2004 to offset a majority of the corporate office expenses and is expected to do
so again in 2005. There are no restrictions on the transfer of cash balances between the parent
and subsidiary companies. At December 31, 2004, we have several potential near-term sources of cash to support any negative
cash flow from consolidated operations, including periodic draws against our bank line of credit
and additional cash distributions of between $1.8 million and $2.1 million related to the ISC
Guernsey sale, as explained in more detail in Note 2 to the Consolidated Financial Statements.
Sales of investments, subsidiaries or assets have generated cash on an irregular basis in the past
but the amount and timing of sales of such transactions cannot be predicted with reasonable
certainty at this time and presently we do not have any firm pending transactions. Our budgeted
cash requirements for operations in 2005 are lower than for 2004 based on new and pending software
licenses and professional services contracts at our Information Technology subsidiaries. We expect
to use our bank line of credit as needed in 2005 to accommodate short-term timing differences in
consolidated cash flows, as we did in 2004. 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, 2005), we
may not be able to find a replacement line of credit on acceptable terms, if at all. Certain of
our software customer contracts tie cash payments to delivery dates of various software
deliverables. Delays in meeting project milestones or software delivery commitments could cause
customers to postpone payments and increase our need for cash during 2005. 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, if we do not control costs or if we encounter unforeseen
technical or quality problems, then we could require more cash than planned and we would need to
increase our use of our bank line of credit, scale back operations at the subsidiary or seek new
financing, which could affect performance under the contracts, at least in the short term. Beyond 2005, 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,
subsidiaries 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. 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. Intelligent Systems Corporation




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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 or poor quality control which may delay product releases, increase our costs, result in
non-acceptance of our software by customers or delay revenue recognition.
    Competitive pressures (including pricing, changes in customer requirements and preferences, and competitor product
offerings) which may cause prospective customers to choose an alternative product solution, resulting in lower revenue
and profits (or increased losses).
    The inability of our CoreCard or VISaer subsidiaries to establish a base of referenceable customers for their new product
offerings, resulting in lower revenue and profits (or increased losses), increased cash needs and possibly leading to
restructuring or cutting back of the subsidiarys operations.
    Failure of our products specifications and features to achieve market acceptance.
    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
which could cause them to misinterpret or fail to 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 to renew
expiring lease contracts for domestic customers could cause lower than anticipated sales and profits and impact projected
cash flow.
    An insufficient number of potential CoreCard customers decide to purchase and run an in-house software system and instead
choose to outsource their account transaction processing which could result in lower revenue and greater cash
requirements.
    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
any borrowing requirements under our bank line of credit.
    The recurrence of some incidence such as the SARS epidemic in 2003 or the terrorist attacks of 2001 that has a negative
impact on the aviation industry, resulting in delays in contract awards and customer implementations similar to the
unforeseen negative affect on cash and profits experienced by VISaer during the SARS epidemic and the aftermath of the
2001 attacks.
    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 8 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 December 2004, the FASB eliminated the application of the Accounting Principles Board (APB)
No. 25, Accounting for Stock Issued to Employees which permitted companies to use the alternative
intrinsic value method of accounting for stock based compensation. The change is effective for
small business issuers for the first interim or annual reporting period that begins after December
15, 2005. SFAS No. 123, Accounting for Stock Based Compensation requires companies to recognize
the cost of employee services received in exchange for awards of equity instruments based on the
grant-date fair value of those awards, with limited exceptions. We have not yet determined whether
the adoption of this statement after December 15, 2005 will have a material impact on our results
of operations or financial condition. In the discussion of Stock Based Compensation in Note 1 to
the Consolidated Financial Statements, we disclose the effect of the use of the fair-value
provisions of SFAS No. 123 on historical results of operations. In March 2004, the Emerging Issues Task Force reached a consensus on Issue No. 03-16, Accounting
for Investments in Limited Liability Companies. The consensus requires an investment in a Limited
Liability Company (LLC) that maintains a specific ownership account for each investor be viewed
as similar to an investment in a limited partnership for the purposes of determining whether a
noncontrolling investment in an LLC should be accounted for using the cost method or equity method
of accounting. The consensus was effective in the Intelligent Systems Corporation




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quarter beginning after June 15, 2004. The implementation of this consensus did not have a material
impact on our financial position or results of operations. 
 ITEM 7. 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 7
hereof. See Index to Financial Statements and Supplemental Schedules on page F-1 hereof. Report of Independent Registered Public Accounting Firm
Report of Previous Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2004 and 2003
Consolidated Statements of Operations for the two years ended December 31, 2004
Consolidated Statements of Changes in Stockholders Equity and Comprehensive Income (Loss)
  for the two years ended December 31, 2004
Consolidated Statements of Cash Flow for the two years ended December 31, 2004
Notes to Consolidated Financial Statements Financial Statements 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 related instruction 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 
 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On November 22, 2004, we dismissed BDO Seidman, LLP as our independent public accountants. No
report of BDO Seidman, LLP on our consolidated financial statements as of and for the fiscal years
ended December 31, 2003 and December 31, 2002 contained an adverse opinion or a disclaimer of
opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles.
During the period of BDOs appointment on July 3, 2002 through November 22, 2004, there were no
disagreements with BDO Seidman, 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 BDO Seidman, LLP, would have caused it to make reference to the subject matter of
the disagreement in connection with its reports for such periods. Effective November 22, 2004,
our Audit Committee appointed Tauber & Balser, P.C. as our new independent accountants. 
 ITEM 8A. 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 9. 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
2005 Annual Meeting of Shareholders for information about the individual nominated as director and about the executive officers of the company. This information is
incorporated into this Item 9 by reference. Intelligent Systems Corporation




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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 under the caption Section 16(a) Beneficial Ownership Reporting Compliance in this Proxy
Statement. This information is incorporated into this Item 9 by reference. The company adopted a Code of Ethics that applies to all directors, officers, and employees. The
Code of Ethics is posted on our website at www.intelsys.com. The company will disclose on its
website, within the time required by the rules of the SEC, any waivers of, or amendments to, the
Code of Ethics for the benefit of an executive officer. 
 ITEM 10. 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 9 for information about management
compensation. This information is incorporated into this Item 10 by reference. 
 ITEM 11. 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 9 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 11 by reference. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The lease on our headquarters and primary facility at 4355 Shackleford Road, Norcross, Georgia
expired May 31, 2004. The former landlord was unwilling to renew this lease and had instead
expressed a desire to sell the facility. On June 1, 2004, ISC Properties, LLC, an entity
controlled by J. Leland Strange, a director and President and Chief Executive Officer, purchased
the facility from the former landlord and leased approximately 45 percent of the facility to the
company in order to allow us to stay in the present facility and to avoid the disruption and
expense of a move. After careful consideration, the companys Board of Directors concluded that
the lease transaction was fair to the company and in the best interests of the company and its
shareholders, and approved the lease transaction between the company and ISC Properties, LLC
effective June 1, 2004. Mr. Strange recused himself from deliberations concerning, and voting to
approve, the lease transaction. In connection with this approval, the Board of Directors waived
the conflict of interest provisions of our Code of Ethics as they apply to Mr. Strange in
connection with the lease transaction. In 2004, we paid ISC Properties, LLC $229,000 in rent. We
also evaluated the arrangement to determine if ISC Properties, LLC should be considered a Variable
Interest Entity (VIE) within the guidance of Financial Accounting Standards Board FIN No. 46.
After carefully considering the characteristics of the relationship between the company and ISC
Properties, LLC, it was determined that ISC Properties, LLC did not meet the criteria of a VIE and,
as a result, ISC Properties, LLC is not consolidated with the company. In 2003, Mr. Strange participated as a common shareholder in the pro rata distribution of the
escrow fund related to the sale 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 $149,000 in the aggregate in two
payments in March and June 2003, which represented his pro rata share of the escrow funds released. 
 ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K (a) 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.) Intelligent Systems Corporation




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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 June 1, 2004, between the Registrant and ISC Properties, LLC.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 incorporated by reference to Exhibit 10.2(a) to the Registrants Form 10-K
for the year ended December 31, 2003. 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. (Incorporated by reference to Exhibit 10.3 to the Registrants Form 10-K for the
year ended December 31, 2003.)10.4
    Security Agreement by and among Intelligent Systems Corporation and Fidelity Bank dated as of
October 1, 2003. (Incorporated by reference to Exhibit 10.4 to the Registrants Form 10-K for
the year ended December 31, 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. (Incorporated by reference to
Exhibit 10.5 to the Registrants Form 10-K for the year ended December 31, 2003.)10.6
    Negative Pledge Agreement by and among Intelligent Systems Corporation and Fidelity Bank
dated October 1, 2003. (Incorporated by reference to Exhibit 10.6 to the Registrants Form
10-K for the year ended December 31, 2003.)10.7
    Commercial Promissory Note and Rider thereto of Intelligent Systems Corporation in favor of
Fidelity Bank dated October 1, 2004. (Incorporated by reference to Exhibit 10.7 to the
Registrants Form 10-K for the year ended December 31, 2003.)10.8
    Form of Guarantee of majority owned subsidiaries of Intelligent Systems Corporation in favor
of Fidelity Bank dated October 1, 2003. (Incorporated by reference to Exhibit 10.3 to the
Registrants Form 10-K for the year ended December 31, 2003.)10.9
    First Modification to Loan Documents by and among Intelligent Systems Corporation and
Fidelity Bank dated September 1, 2004.10.10
    Consent Order entered in United States District Court for the Northern District of Georgia,
Atlanta Division dated September 10, 2004.21.1
    List of subsidiaries of Registrant.23.1
    Consent of Tauber & Balser, P.C.23.2
    Consent of BDO Seidman, LLP. Intelligent Systems Corporation




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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 1, 2004 disclosing that we issued a press release on
November 1, 2004 announcing our financial results for the quarter ended September 30, 2004. We filed a report on Form 8-K on November 24, 2004 disclosing that we had changed our Registered
Public Accounting firm. 
 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 9 for information about the fees paid to
and services performed by our independent accountants. This information is incorporated into this
Item 14 by reference. 
 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 CORPORATIONRegistrantDate: March 30, 2005
    
    By:
    
    /s/ J. Leland StrangeJ. Leland StrangeChairman of the Board, Presidentand 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
    
    DateChairman of the Board, President,
    
    March 30, 2005/s/ J. Leland Strange
    
    Chief Executive Officer and DirectorJ. Leland Strange
    
    (Principal Executive Officer)/s/ Bonnie L. Herron
    
    Chief Financial Officer
    
    March 30, 2005Bonnie L. Herron
    
    (Principal Accounting and Financial Officer)/s/ James V. Napier
    
    Director
    
    March 30, 2005James V. Napier/s/ John B. Peatman
    
    Director
    
    March 30, 2005John B. Peatman/s/ Parker H. Petit
    
    Director
    
    March 30, 2005Parker H. Petit
 Intelligent Systems Corporation




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INTELLIGENT SYSTEMS CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULE The following consolidated financial statements and schedules of the Registrant and its
subsidiaries are submitted herewith in response to Item 7: Financial Statements:Report
of Independent Registered Public Accounting Firm
    
    
    F-2Report
of Previous Independent Registered Public Accounting Firm
    
    
    F-3Consolidated
Balance Sheets  December 31, 2004 and 2003
    
    
    F-4Consolidated Statements
of Operations  Two Years Ended December 31, 2004
    
    
    F-5Consolidated Statements of Changes in Stockholders Equity and Comprehensive Income (Loss) -
Two Years Ended December 31, 2004
    
    
    F-6Consolidated Statements of Cash
Flow  Two Years Ended December 31, 2004
    
    
    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




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of
Intelligent Systems Corporation: We have audited the accompanying consolidated balance sheet of Intelligent Systems Corporation and
subsidiaries (the Company) as of December 31, 2004, and the related consolidated statement of
operations, changes in stockholders equity and comprehensive income, and cash flow for the year
then ended. Our audit also included the financial statement schedule for the year ended December
31, 2004 listed in the accompanying index. These financial statements and financial statement
schedule are the responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (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 audit provides 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, 2004, and the results of their operations and their cash flow for the year then ended
in conformity with accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule for the year ended December 31, 2004, when
considered in relation to the basic consolidated financial statements taken as a whole, presents
fairly in all material respects the information set forth therein. /s/ Tauber & Balser, P.C. Atlanta, Georgia
March 3, 2005 Intelligent Systems Corporation




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REPORT OF PREVIOUS INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Intelligent Systems Corporation: We have audited the accompanying consolidated balance sheet of Intelligent Systems Corporation and
subsidiaries (the Company) as of December 31, 2003 and the related consolidated statements of
operations, changes in stockholders equity and comprehensive income (loss) and cash flow for the
year then ended. We have also audited the financial statement schedule for the year ended December
31, 2003 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 audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). 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 audit provides 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 the results of their operations and their cash flows for the year then ended
in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the 2003 schedule presents fairly, in all material respects, the information
set forth therein. /s/BDO Seidman, LLP Atlanta, Georgia
March 4, 2004 Intelligent Systems Corporation




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Intelligent Systems Corporation 
 CONSOLIDATED BALANCE SHEETS  (in thousands, except share amounts)
 As of December 31,
    
    2004
    
    
    2003ASSETSCurrent assets:Cash
    
    $
    670
    
    
    $
    1,133Accounts receivable, net
    
    
    2,931
    
    
    
    1,543Notes and interest receivable
    
    
    
    
    
    
    142Inventories
    
    
    653
    
    
    
    766Other current assets
    
    
    217
    
    
    
    614Total current assets
    
    
    4,471
    
    
    
    4,198Long-term investments
    
    
    4,879
    
    
    
    6,275Property and equipment, at cost less accumulated depreciation
    
    
    781
    
    
    
    746Goodwill, net
    
    
    2,049
    
    
    
    2,039Other intangibles, net
    
    
    699
    
    
    
    476Other assets, net
    
    
    25
    
    
    
    8Total assets
    
    $
    12,904
    
    
    $
    13,742LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Short-term borrowings
    
    $
    267
    
    
    $
    250Accounts payable
    
    
    867
    
    
    
    932Deferred revenue
    
    
    4,895
    
    
    
    2,586Deferred gain
    
    
    
    
    
    
    291Accrued expenses and other current liabilities
    
    
    1,480
    
    
    
    2,037Total current liabilities
    
    
    7,509
    
    
    
    6,096Deferred revenue, net of current portion
    
    
    
    
    
    
    5,060Other long-term liabilities
    
    
    310
    
    
    
    Total long term liabilities
    
    
    310
    
    
    
    5,060Commitments
and contingencies (note 8)Minority interest
    
    
    1,516
    
    
    
    1,516Stockholders equity:Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971
issued and outstanding at December 31, 2004 and 2003
    
    
    45
    
    
    
    45Paid-in capital
    
    
    18,410
    
    
    
    18,410Accumulated other comprehensive loss
    
    
    (124
    )
    
    
    (60
    )Accumulated deficit
    
    
    (14,762
    )
    
    
    (17,325
    )Total stockholders equity
    
    
    3,569
    
    
    
    1,070Total liabilities and stockholders equity
    
    $
    12,904
    
    
    $
    13,742
 The accompanying notes are an integral part of these consolidated balance sheets. Intelligent Systems Corporation




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Intelligent Systems Corporation 
 CONSOLIDATED STATEMENTS OF OPERATIONS  (in thousands, except share and per share amounts)
 Year Ended December 31,
    
    2004
    
    
    2003RevenueProducts
    
    $
    11,386
    
    
    $
    8,466Services
    
    
    10,946
    
    
    
    4,868Total revenue
    
    
    22,332
    
    
    
    13,334Cost of salesProducts
    
    
    3,699
    
    
    
    3,324Services
    
    
    5,177
    
    
    
    3,380Total cost of sales
    
    
    8,876
    
    
    
    6,704ExpensesMarketing
    
    
    2,558
    
    
    
    2,811General & administrative
    
    
    3,542
    
    
    
    3,895Research & development
    
    
    7,630
    
    
    
    8,316Loss from operations
    
    
    (274
    )
    
    
    (8,392
    )Other incomeInterest income, net
    
    
    
    
    
    
    2Investment income (expense)
    
    
    2,524
    
    
    
    3,040Equity in income (losses) of affiliate companies
    
    
    (76
    )
    
    
    184Other income, net
    
    
    392
    
    
    
    328Income (loss) before income tax provision (benefit)
    
    
    2,566
    
    
    
    (4,838
    )Income tax provision (benefit)
    
    
    3
    
    
    
    (40
    )Net income (loss)
    
    $
    2,563
    
    
    $
    (4,798
    )Basic net income (loss) per share
    
    $
    0.57
    
    
    $
    (1.07
    )Diluted net income (loss) per share
    
    $
    0.56
    
    
    $
    (1.07
    )Basic weighted average shares outstanding
    
    
    4,478,971
    
    
    
    4,483,458Diluted weighted average shares outstanding
    
    
    4,607,641
    
    
    
    4,483,458
 The accompanying notes are an integral part of these consolidated financial statements. Intelligent Systems Corporation




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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,STOCKHOLDERS EQUITY
    
    2004
    
    
    2003Common stock, number of shares,beginning of year
    
    
    4,478,971
    
    
    
    4,491,779Purchase and retirement of stock
    
    
    
    
    
    
    (12,808
    )End of year
    
    
    4,478,971
    
    
    
    4,478,971Common stock, amount,beginning and end of year
    
    $
    45
    
    
    $
    45Paid-in capital,beginning of year
    
    
    18,410
    
    
    
    18,432Purchase and retirement of stock
    
    
    
    
    
    
    (22
    )End of year
    
    
    18,410
    
    
    
    18,410Accumulated other comprehensive loss,beginning of year
    
    
    (60
    )
    
    
    (56
    )Foreign currency translation adjustment during year
    
    
    (67
    )
    
    
    (68
    )Net unrealized gain on marketable securities
    
    
    3
    
    
    
    64End of year
    
    
    (124
    )
    
    
    (60
    )Accumulated deficit,beginning of year
    
    
    (17,325
    )
    
    
    (12,527
    )Net income (loss)
    
    
    2,563
    
    
    
    (4,798
    )End of year
    
    
    (14,762
    )
    
    
    (17,325
    )Total stockholders equity
    
    $
    3,569
    
    
    $
    1,070COMPREHENSIVE INCOME (LOSS)Net income (loss)
    
    $
    2,563
    
    
    $
    (4,798
    )Other comprehensive income:Foreign currency translation adjustments
    
    
    (67
    )
    
    
    (68
    )Net unrealized gain on marketable securities
    
    
    3
    
    
    
    64Comprehensive income (loss)
    
    $
    2,499
    
    
    $
    (4,802
    )
 The accompanying notes are an integral part of these consolidated financial statements. Intelligent Systems Corporation




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Intelligent Systems Corporation 
 CONSOLIDATED STATEMENTS OF CASH FLOW  (in thousands)
 Year Ended December 31,2004
    
    
    2003OPERATIONS:Net income (loss)
    
    $
    2,563
    
    
    $
    (4,798
    )Adjustments to reconcile net income (loss) to net cash used for operating activities,
net of effects of acquisitions and dispositions:Depreciation and amortization
    
    
    598
    
    
    
    759Deferred gain recognized
    
    
    (382
    )
    
    
    (137
    )Investment (income) loss, net
    
    
    (2,524
    )
    
    
    (3,033
    )Equity in (income) loss of affiliate companies
    
    
    76
    
    
    
    (184
    )Changes in operating assets and liabilities, net of effects of acquisitionAccounts receivable
    
    
    (1,388
    )
    
    
    1,482Inventories
    
    
    113
    
    
    
    (95
    )Other current assets
    
    
    397
    
    
    
    (381
    )Deferred revenue
    
    
    (2,750
    )
    
    
    1,049Accounts payable
    
    
    (65
    )
    
    
    (369
    )Other assets
    
    
    (6
    )
    
    
    20Other liabilities
    
    
    310
    
    
    
    (27
    )Accrued expenses and other current liabilities
    
    
    (924
    )
    
    
    266Cash used for operating activities
    
    
    (3,982
    )
    
    
    (5,448
    )INVESTING ACTIVITIES:Proceeds related to sales of investments
    
    
    3,754
    
    
    
    4,540Acquisition of company, net of cash acquired
    
    
    (25
    )
    
    
    Distributions from long-term investments
    
    
    268
    
    
    
    40Acquisitions of long-term investments
    
    
    (47
    )
    
    
    (200
    )Repayments under notes receivable
    
    
    15
    
    
    
    116Advances under notes receivable
    
    
    
    
    
    
    (284
    )Purchases of property and equipment
    
    
    (399
    )
    
    
    (434
    )Cash provided by investing activities
    
    
    3,566
    
    
    
    3,778FINANCING ACTIVITIES:Borrowings under short-term borrowing arrangements
    
    
    2,201
    
    
    
    250Repayments under short-term borrowing arrangements
    
    
    (2,184
    )
    
    
    Exercise of stock options
    
    
    3
    
    
    
    Purchase and retirement of stock
    
    
    
    
    
    
    (22
    )Cash provided by financing activities
    
    
    20
    
    
    
    228Effects of exchange rate changes on cash
    
    
    (67
    )
    
    
    (69
    )Net decrease in cash
    
    
    (463
    )
    
    
    (1,511
    )Cash at beginning of year
    
    
    1,133
    
    
    
    2,644Cash at end of year
    
    $
    670
    
    
    $
    1,133SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the year for interest
    
    $
    21
    
    
    $
    Cash paid (received) during the year for income taxes
    
    
    3
    
    
    
    (40
    )
 The accompanying notes are an integral part of these consolidated financial statements. Intelligent Systems Corporation




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##### Table of Contents



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 15. 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, accrued expenses and deferred income taxes. 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. 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. They are stated at the amount management expects to
collect. 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 uncollectible. We include any accounts receivable 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 the information available to us, we believe our allowance for doubtful
accounts as of December 31, 2004 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. The value of inventories at
December 31, 2004 and 2003 is as follows: (in thousands)
    
    2004
    
    
    2003Raw materials
    
    $
    503
    
    
    $
    525Finished goods
    
    
    150
    
    
    
    241
 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, 2004 and 2003 is as follows: (in thousands)
    
    2004
    
    
    2003Operating equipment
    
    $
    3,254
    
    
    $
    3,041Furniture and fixtures
    
    
    217
    
    
    
    217Leasehold improvements
    
    
    239
    
    
    
    456
 Intelligent Systems Corporation




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##### Table of Contents



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: Useful life inClassification
    
    yearsOperating equipment
    
    
    3 - 5Furniture & fixtures
    
    
    5 - 7Leasehold improvements
    
    
    1 - 5
 Accumulated depreciation was $2.9 million and $3.0 million at December 31, 2004 and 2003,
respectively. Depreciation expense was $363,000 and $467,000 in 2004 and 2003, respectively.
These expenses are included in general and administrative expenses, except with respect to our
Industrial Products Segment, where the depreciation expense 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, 2004 and 2003 is as follows: (in thousands)
    
    2004
    
    
    2003Cost of equipment
    
    $
    924
    
    
    $
    820Carrying value of equipment
    
    
    284
    
    
    
    283Accumulated depreciation
    
    
    640
    
    
    
    537
 The minimum future lease revenue under non-cancelable contracts through March 31, 2005 is $206,000
at December 31, 2004. There is no contingent rental income under the leases. These assets are
included in Property and Equipment at December 31, 2004 and 2003. 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 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. At December 31, 2004 and 2003, the aggregate value of investments accounted for by
the equity method was $4 million and $5.2 million respectively. At December 31, 2004 and 2003, the
aggregate value of investments accounted for by the cost method was $689,000 and $1.1 million,
respectively. 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, 2004 and 2003, the aggregate fair market value of our
available-for-sale securities consisted of equity securities totaling $176,000 and $0,
respectively. These amounts include net unrealized holding gains of $3,000 and $0 as of December
31, 2004 and 2003, 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.
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 for the largest component of our intangible assets 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, 2004 and 2003, no impairment was identified. The carrying value of intangibles at December 31, 2004 is $2.7 million, of which $2.0 million
represents goodwill whereas the carrying value of intangibles at December 31, 2003 was $2.5
million, of which $2.0 million represented goodwill. Intangibles other than goodwill at December
31, 2004 increased by $223,000, compared to the prior year end, representing the net effect of the
addition of $458,000 related to the ChemFree patents (including $451,000 resulting from assignment
of patents to ChemFree in settlement of litigation as explained in Note 8), less $235,000 in
consolidated annual amortization expense. At December 31, 2004, intangibles other than goodwill are
primarily related to acquired software and the ChemFree patents, as more fully explained in Note 8.
At December 31, 2003, intangibles other than goodwill primarily relate to acquired software. In fiscal years 2004 and 2003, we recorded amortization expense related to intangible assets of
approximately $235,000 and $312,000, respectively. Accumulated amortization of intangibles totaled
$950,000 and $715,000 at December 31, 2004 and 2003, respectively. We had no goodwill amortization
expense in periods presented herein. Annual amortization expense for the following five years is
expected to be approximately $174,000, $174,000, $46,000, $46,000 and $46,000 for the years ending
December 31, 2005 through 2009, respectively. Accrued Expenses and Other Current Liabilities- Accrued expenses and other liabilities at December
31, 2004 and 2003 consist of the following: (in thousands)
    
    2004
    
    
    2003Accrued payroll
    
    $
    928
    
    
    $
    1,361Other accrued expenses
    
    
    552
    
    
    
    676
 Intelligent Systems Corporation




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##### Table of Contents



Deferred Revenue Current deferred revenue consists of advance payments by software customers for
annual maintenance and support services, advance payments from customers for software licenses
expected to be delivered in 2005, and payments by ChemFree lease customers that are billed
quarterly for leased equipment and supplies. We do not anticipate any loss under these contracts.
Deferred revenue is classified as long-term until such time that it becomes likely that the
services or products will be provided within 12 months of the balance sheet date. Fair Value of Financial Instruments- The carrying value of cash, accounts receivable, accounts
payable and certain other financial instruments (such as notes receivable, certain investments,
short-term borrowings, accrued expenses, and other current liabilities) 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 concentrated 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. 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 do not provide for estimated sales returns allowances and rebates because ChemFrees
well-established policy rarely authorizes such transactions. 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. 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. Intelligent Systems Corporation




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##### Table of Contents



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. 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. Thereafter, 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 two years ended December 31, 2004, 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, 2004 and 2003. Stock Based Compensation At December 31, 2004 we had three stock based compensation plans which
are more fully described in Note 13. As a small business issuer, 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. Beginning with the first reporting period that begins after December
31, 2005, we will no longer be allowed to use the intrinsic value recognition method and instead
will recognize the cost of employee services received in exchange for equity securities based on
the grant-date fair value of the awards. 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 amounts)
    
    2004
    
    
    2003Net income (loss), reported
    
    $
    2,563
    
    
    $
    (4,798
    )Add: 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
    
    
    (37
    )
    
    
    (48
    )Proforma net income (loss)
    
    $
    2,526
    
    
    $
    (4,846
    )Proforma net income (loss)
per common share basic
    
    $
    0.56
    
    
    $
    (1.08
    )Proforma net income (loss)
per common share diluted
    
    $
    0.55
    
    
    $
    (1.08
    )
 The fair value of each option granted in each of the last two 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,
    
    2004
    
    
    2003Risk free rate
    
    
    4
    %
    
    
    4
    %Expected life of option in years
    
    
    6.9
    
    
    
    6.7Expected dividend yield rate
    
    
    0
    %
    
    
    0
    %Expected volatility
    
    
    40
    %
    
    
    49
    %
 Under these assumptions, the weighted average fair value of options granted in 2004 and 2003 was
$0.93 and $0.83 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 attributable to
differences between the financial statement carrying amounts of the existing assets and liabilities
and their respective tax bases. Intelligent Systems Corporation




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##### Table of Contents



Comprehensive Income (Loss)- Comprehensive income (loss) represents net income (loss) adjusted for
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, 2004 and 2003. Reclassifications It is our policy to reclassify prior year amounts to conform with current year
financial statements presentation when necessary. New Accounting Pronouncements In December 2004, the FASB eliminated the application of the
Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees which
permitted companies to use the alternative intrinsic value method of accounting for stock based
compensation. The change is effective for small business issuers for the first interim or annual
reporting period that begins after December 15, 2005. SFAS No. 123, Accounting for Stock Based
Compensation requires companies to recognize the cost of employee services received in exchange
for awards of equity instruments based on the grant-date fair value of those awards, with limited
exceptions. We have not yet determined whether the adoption of this statement after December 15,
2005 will have a material impact on our results of operations or financial condition. In the
discussion of Stock-based Compensation earlier in this Note 1, we disclose the effect of the use of
the fair-value provisions of SFAS No. 123 on historical results of operations. In March 2004, the Emerging Issues Task Force reached a consensus on Issue No. 03-16, Accounting
for Investments in Limited Liability Companies. The consensus requires an investment in a Limited
Liability Company (LLC) that maintains a specific ownership account for each investor be viewed
as similar to an investment in a limited partnership for the purposes of determining whether a
noncontrolling investment in an LLC should be accounted for using the cost method or equity method
of accounting. The consensus was effective in the quarter beginning after June 15, 2004. The
implementation of this consensus did not have a material impact on our financial position or
results of operations. NOTE 2 SALES AND WRITE-DOWNS OF ASSETS Ardext Technologies, Inc.-In the quarter ended June 30, 2004, we wrote down the carrying value
of our investment in Ardext Technologies, Inc. We recorded a charge of $465,000 against long-term
investments and $162,000 against notes and interest receivable. In the quarter ended September 30,
2004, we reserved an additional $12,000 for a total investment write-off of $639,000. We believe
it is unlikely we will recover our investment and accordingly have reserved against the full
carrying value. Cirronet, Inc. On May 10, 2004, we sold our interest in Cirronet, Inc. in a private transaction
for an aggregate price of $1.1 million, paid in cash at the closing. We recognized a gain of
$256,000 on the transaction in the quarter ended June 30, 2004, on a carrying value of $817,000 and
an original cost basis of $525,000. ISC Guernsey, Ltd. We own a 19 percent interest in ISC Guernsey, Ltd., an entity whose principal
asset was an investment in a U.K. based company. During the second quarter of 2004, we were
informed that ISC Guernsey sold its investment in the U.K. company for cash and that it expected to
distribute a significant portion of the proceeds to its shareholders in the future, after
determining its ongoing business needs. In the year ended December 31, 2004, we received two cash
distributions aggregating $2.7 million and recognized $2.7 million which is reflected in investment
income. Based on information we received from ISC Guernsey at December 31, 2004, other
distributions to us are likely to follow in 2005 and are expected to aggregate between $1.8 million
and $2.1 million. However, we are not in a position to exert influence over the timing or extent
of such distributions. Based on our current projections, we do not expect to have any tax
withholdings or to incur a tax liability related to these cash distributions. 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. PaySys International, Inc.  On April 27, 2001, we sold our 32 percent ownership interest in
PaySys, an affiliate company, to First Data Corporation (FDC) and received cash proceeds of $17.8
million. An escrow fund was set aside for potential liabilities arising after the closing of the
sale. On March 21, 2003, a settlement was reached with FDC and we received $4.5 million cash in
the first half of 2003, which represented our 32 percent share of the net amount released from the escrow fund. The escrow payment was recorded as
investment income in the year ended December 31, 2003. 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 Anadigics, Inc., a publicly traded Intelligent Systems Corporation




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company, effective April 2003. We received $106,000 cash in partial repayment of a note receivable from RF Solutions and reserved
$92,000 against the $198,000 carrying value of the note. Under the terms of the sale, the note
holders and preferred shareholders of RF Solutions were eligible to receive an additional payment
in common stock of Anadigics, Inc. based on achievement of post-sale performance targets. Since
the amount of any future payment was not determinable at the time of the sale, in 2003 we fully
reserved our note balance and investment in RF Solutions. In the third quarter of 2004, we
received 47,025 shares of stock of Anadigics as additional payment and recorded investment income
of $173,000 in the same quarter. At December 31, 2004, we carry the shares of Anadigics stock at
its fair market value of $176,000 in accordance with SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Riverside Software, LLC Effective October 1, 2004, we sold our minority interest in Riverside
Software, LLC, a technology company which we accounted for under the equity method, to privately
held Paymetric, Inc. We received shares of common stock in Paymetric in exchange for our Riverside
Software interest. We recorded an investment gain of $83,000 on a carrying value of $15,000. At
December 31, 2004, the carrying value of our Paymetric stock is $98,000. 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 3 INVESTMENTS The following summarizes our ownership interest in our largest (ownership and investment value),
non-significant companies included in our long-term investments. At December 31, 2004, our ownership interest in each of the named companies was as follows: NKD
Enterprises, LLC (25.5%) and Horizon Software, LLC (17%). We accounted for each of the named
companies by the equity method of accounting in 2004. Cost BasisCarrying
    
    
    Before(in thousands)
    
    Value
    
    
    DistributionsNKD Enterprises
    
    $
    830
    
    
    $
    1,286Horizon Software
    
    
    2,711
    
    
    
    2,500
 At December 31, 2003, our ownership interest in each of the named companies was as follows: NKD
Enterprises, LLC (25.5%), Horizon Software, LLC (17%) and Cirronet, Inc. (22%). We accounted 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
 The following table presents summarized combined financial information for our 50 percent or less
owned investments named above for the respective time periods: As of and for the year ended December 31,(in thousands)
    
    2004
    
    
    2003Revenues
    
    $
    15,521
    
    
    $
    25,377Operating income
    
    
    351
    
    
    
    1,814Net income
    
    
    404
    
    
    
    1,539Current assets
    
    
    3,740
    
    
    
    8,174Non-current assets
    
    
    5,149
    
    
    
    5,595Current liabilities
    
    
    3,505
    
    
    
    4,863Non-current liabilities
    
    
    685
    
    
    
    445Stockholders equity
    
    
    4,699
    
    
    
    8,460
 Marketable Securities The carrying and estimated fair values of available-for-sale securities at
December 31, 2004 and 2003 are summarized as follows: (in thousands)
    
    2004
    
    
    2003Cost
    
    $
    173
    
    
    
    Gross unrealized gain
    
    
    3
    
    
    
    Estimated fair values
    
    $
    176
    
    
    
    
 Anadigics, Inc. [NASDAQ:ANAD] comprises the balance of $176,000 at December 31, 2004. We had no
available-for-sale securities at December 31, 2003. NOTE 4 ACCOUNTS AND NOTES RECEIVABLE At December 31, 2004 and 2003, our allowance for doubtful accounts amounted to $103,000 and
$124,000, respectively. Provisions for doubtful accounts were $67,000 and $63,000 for the years
ended December 31, 2004 and 2003, respectively. The following table indicates the percentage of consolidated revenue and year-end accounts
receivable represented by each Intelligent Systems Corporation




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customer for any period in which such customer represented more than
10 percent of consolidated revenue or year-end accounts receivable. Revenue
    
    
    
    A/R2004
    
    
    2003
    
    
    
    2004
    
    
    2003VISaerCustomer A
    
    
    
    
    
    
    11
    %
    
    
    
    
    
    
    
    Customer B
    
    
    34
    %
    
    
    
    
    
    
    
    
    
    
    
    QS TechnologiesCustomer C
    
    
    
    
    
    
    
    
    
    
    
    23
    %
    
    
    ChemFreeCustomer D
    
    
    
    
    
    
    13
    %
    
    
    
    
    
    
    
    11
    %Customer E
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    %
 NOTE 5 SHORT-TERM BORROWINGS Terms and borrowings under our credit facility are summarized as follows: Year ended December 31,(in thousands)
    
    2004
    
    
    2003Maximum outstanding (month-end)
    
    $
    763
    
    
    $
    250Outstanding at year end
    
    
    267
    
    
    
    250Interest rate at year end
    
    
    6.75
    %
    
    
    5.5
    %Average interest rate
    
    
    5.9
    %
    
    
    5.5
    %
 We established a working capital credit facility with a bank in October 2003 and renewed the line
in September 2004. The $1.5 million revolving line of credit bears interest at the prime rate
(5.25% at December 31, 2004) 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, 2005.
We may borrow an aggregate of 80 percent of qualified accounts receivable of our consolidated
subsidiaries plus 50 percent of inventory, up to a maximum of $1.5 million, less any amount tied to
a letter of credit. At December 31, 2004, our borrowing base calculation resulted in availability
of $1.4 million of which we had drawn down $267,000 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 6 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, remained contingently
liable for these obligations. VISaer recorded these liabilities as deferred gain. 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 $382,000 and
$137,000 of the deferred gain in the years ended December 31, 2004 and 2003, respectively, which is
recorded in the component of other income/expense in the consolidated statements of operations. As
of December 31, 2003, the balance of $291,000 in deferred gain consisted of accounts payable and
accrued expenses. In December 2004, the company determined that given the passage of time (over
four years) and the absence of any creditor or buyer claims, it was reasonable to assume that the
balance of the liabilities assumed by the buyer had been extinguished or settled. NOTE 7 INCOME TAXES The income tax provision (benefit) consists of the following: Year ended December 31,(in thousands)
    
    2004
    
    
    2003Current
    
    $
    3
    
    
    $
    (40
    )
 Following is a reconciliation of estimated income taxes at the blended statutory rate to estimated
tax expense as reported: Year ended December 31,
    
    2004
    
    
    2003Statutory rate, blended
    
    
    37
    %
    
    
    37
    %Change in valuation allowance
    
    
    (37
    %)
    
    
    (37
    %)Other
    
    
    0
    %
    
    
    (1
    %)Effective rate
    
    
    0
    %
    
    
    (1
    %)
 At December 31, 2004, our subsidiaries had net operating loss carryforwards totaling $8.5 million.
The net operating loss carryforwards, if unused as offsets to future taxable income, will expire
during the following years: Intelligent Systems Corporation




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(in thousands)2006-2009
    
    $
    1,1322017
    
    
    1,0382019
    
    
    2,9012021
    
    
    4952022
    
    
    6572023
    
    
    1,8302024
    
    
    454Total
    
    $
    8,507
 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 $14.2 million and $15.6 million at December 31, 2004 and 2003,
respectively. Since our ability to realize the deferred tax asset is uncertain, the amount is
offset in both 2004 and 2003 by a valuation allowance of an equal amount. The deferred tax asset at
December 31, 2004 and 2003 relates primarily to net operating loss and tax credit carryforwards,
loss limitations on investments and differences due to R&D costs, unearned revenue and various
reserves. 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 8 COMMITMENTS AND CONTINGENCIES Leases- We have noncancellable operating leases expiring at various dates through June 2009.
Future minimum lease payments are as follows: Year ended December 31,(in thousands)2005
    
    $
    5872006
    
    
    5282007
    
    
    4722008
    
    
    3932009
    
    
    164Total minimum lease payments
    
    $
    2,144
 Rental expense for leased facilities and equipment related to operations amounted to $640,000 and
$759,000 for the years ended December 31, 2004 and 2003, respectively. Companies in Intelligent
Systems Incubator sublease space from the company. For the years ended December 31, 2004 and 2003,
the company received $155,000 and $255,000, 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 challenged the ownership of various intellectual
property assets of ChemFree. ChemFree and the other parties to the litigation strongly denied the
allegations and filed suit against the consultant. The case against ChemFree was filed in the
Superior Court of Gwinnett County, Georgia and ChemFree filed suit in Federal Court seeking a
judgment against the consultant. During the quarter ended September 30, 2004, an agreement was
reached to settle both litigation matters. ChemFree secured a full assignment of interests in all
of ChemFrees patents and patent applications worldwide (41 in the aggregate) from the former
consultant in return for periodic payments over a five year period. The payment schedule provides
for four monthly payments of $25,000, beginning August 2, 2004, and 48 monthly payments of $8,333
beginning in August 2, 2005 for an aggregate consideration of $500,000 ($451,000 discounted at
6.5%). In accordance with Statement of Financial Accounting Standards No. 142, Accounting for
Intangible Assets, we believe that the present value of the future payment stream is fully
recoverable at this time. Based on our current estimations, we believe the average useful life of
these patents to be 10 years, which does not exceed legal lives. In the year ended December 31,
2004, amortization expense related to this asset was $15,000. The unamortized value of the
ChemFree patents of $443,000 (which includes other miscellaneous amounts in addition to the amount
discussed above) is included in the category other intangibles, net on the balance sheet at
December 31, 2004. 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 due to CoreCard discontinuing operations, ISC
has guaranteed to make available at its expense up to four employees to provide technical
assistance to the customer during a transition period of up to one year. The guarantee is limited
to the amount paid by the customer to CoreCard under the Software License Agreement at the time of
termination. The guarantee phases out upon the achievement of certain operational milestones by
CoreCard or after five years, whichever occurs sooner. As of December 31, 2004, it does not
appear probable that the guarantee will be paid; thus no amounts have been accrued with respect to
this guarantee. Upon acceptance of the software by the customer, CoreCard Intelligent Systems Corporation




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recognized $1.3 million in license revenue in respect of this license agreement in 2004. NOTE 9 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, 2004 and 2003, we have
accrued $100,000 and $150,000, respectively, for future payments under the plan. In January 2004,
we made a lump sum payment of $50,000 to a director upon his retirement from the board. NOTE 10 DEFINED CONTRIBUTION PLANS We maintain two 401(k) defined contribution plans covering substantially all U.S. employees. Our
matching contributions under the plans, which are optional and are based on the level of individual
participants contributions, amounted to $125,000, and $145,000 in 2004 and 2003, respectively. NOTE 11 RELATED PARTY TRANSACTION The lease on our headquarters and primary facility at 4355 Shackleford Road, Norcross, Georgia
expired May 31, 2004. The former landlord was unwilling to renew this lease and had instead
expressed a desire to sell the facility. On June 1, 2004, ISC Properties, LLC, an entity
controlled by our Chairman and Chief Executive Officer, J. Leland Strange, purchased the facility
from the former landlord and leased approximately 45 percent of the facility to the company in
order to allow us to stay in the present facility and to avoid the disruption and expense of a
move. After careful consideration, the companys Board of Directors concluded that the lease
transaction was fair to the company and in the best interests of the company and its shareholders,
and approved the lease transaction between the company and ISC Properties, LLC effective June 1,
2004. Mr. Strange recused himself from deliberations concerning, and voting to approve, the lease
transaction. In connection with this approval, the Board of Directors waived the conflict of
interest provisions of our Code of Ethics as they apply to Mr. Strange in connection with the lease
transaction. In 2004, we paid $229,000 in rent to ISC Properties, LLC. We also evaluated the
arrangement to determine if ISC Properties, LLC should be considered a Variable Interest Entity
(VIE) within the guidance of Financial Accounting Standards Board FIN No. 46. After carefully
considering the characteristics of the relationship between the company and ISC Properties, LLC, it
was determined that ISC Properties, LLC did not meet the criteria of a VIE and, as a result, ISC
Properties, LLC is not consolidated with the company. 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 year ended December 31, 2003, we
repurchased and retired 12,808 shares of our common stock at prevailing market prices. No
repurchases were made in 2004. 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. No options were granted under the 2003 Plan in 2004. During 2003, 100,000 options
were granted to officers under the 2003 Plan. 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, 2004, a total of 957,000
options under all three Plans have been granted, 724,320 have been exercised and 142,014 options
are fully vested and exercisable at a weighted average price per share of $3.19. All options expire
ten years from their respective dates of grant. At December 31, 2004, the weighted average
remaining contractual life of the outstanding options is 7 years. Intelligent Systems Corporation




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##### Table of Contents



Stock option transactions during the two years ended December 31, 2004 were as follows: 2004
    
    
    2003Options outstanding
at Jan. 1
    
    
    220,680
    
    
    
    104,680Options granted
    
    
    12,000
    
    
    
    116,000Options exercised
    
    
    
    
    
    
    Options canceled
    
    
    6,000
    
    
    
    Options outstanding at Dec. 31
    
    
    226,680
    
    
    
    220,680Options available for
grant at Dec. 31
    
    
    470,000
    
    
    
    482,000Options exercisable at Dec. 31
    
    
    142,014
    
    
    
    96,680Option price ranges per share:Granted
    
    $
    1.92
    
    
    $
    1.51-$1.75Exercised
    
    
    
    
    
    
    Canceled
    
    $
    1.75-$3.15
    
    
    
    Outstanding
    
    $
    1.51-$4.26
    
    
    $
    1.51-$4.26Weighted average option price per share:Granted
    
    $
    1.92
    
    
    $
    1.54Exercised
    
    
    
    
    
    
    Canceled
    
    $
    2.22
    
    
    
    Outstanding at Dec. 31
    
    $
    2.59
    
    
    $
    2.49Exercisable at Dec. 31
    
    $
    3.19
    
    
    $
    3.86
 NOTE 14 FOREIGN REVENUES AND OPERATIONS Foreign revenues are based on the location of the customer. Revenues from customers by geographic
areas for the two years ended December 31, 2004 are as follows: Year ended December 31,(in thousands)
    
    2004
    
    
    2003Foreign Countries:United Kingdom
    
    $
    2,484
    
    
    $
    2,727Chile
    
    
    1,043
    
    
    
    362Australia
    
    
    547
    
    
    
    374New Zealand
    
    
    155
    
    
    
    71Other
    
    
    170
    
    
    
    256Subtotal
    
    
    4,399
    
    
    
    3,790United States
    
    
    17,933
    
    
    
    9,544Total
    
    $
    22,332
    
    
    $
    13,334
 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, 2004 and
2003, income before provision for income taxes derived from foreign subsidiaries approximated
$103,000 and $0, respectively. Substantially all long-lived assets are in the United States. At December 31, 2004 and 2003, foreign subsidiaries had assets of $267,000 and $443,000,
respectively, and total liabilities of $743,000 and $698,000, 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 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 two years ended December 31, 2004. Intelligent Systems Corporation




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##### Table of Contents



Year ended December 31,(in thousands)
    
    2004
    
    
    2003Information TechnologyRevenue
    
    $
    16,032
    
    
    $
    7,118Operating income (loss)
    
    
    217
    
    
    
    (7,928
    )Depreciation and amortization
    
    
    374
    
    
    
    591Capital expenditures
    
    
    136
    
    
    
    150Identifiable assets
    
    
    4,777
    
    
    
    4,740Goodwill
    
    
    2,049
    
    
    
    2,039Industrial ProductsRevenue
    
    $
    6,300
    
    
    $
    6,216Operating income
    
    
    313
    
    
    
    276Depreciation and amortization
    
    
    195
    
    
    
    130Capital expenditures
    
    
    259
    
    
    
    272Identifiable assets
    
    
    3,013
    
    
    
    2,024Goodwill
    
    
    
    
    
    
    Consolidated SegmentsRevenue
    
    $
    22,332
    
    
    $
    13,334Operating income (loss)
    
    
    530
    
    
    
    (7,652
    )Depreciation and amortization
    
    
    569
    
    
    
    721Capital expenditures
    
    
    395
    
    
    
    422Identifiable assets
    
    
    7,790
    
    
    
    6,764Goodwill
    
    
    2,049
    
    
    
    2,039
 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)
    
    2004
    
    
    2003Consolidated segments operating
income (loss)
    
    $
    530
    
    
    $
    (7,652
    )Corporate expenses
    
    
    (804
    )
    
    
    (740
    )Consolidated operating loss
    
    
    (274
    )
    
    
    (8,392
    )Interest income
    
    
    
    
    
    
    2Investment income (loss)
    
    
    2,524
    
    
    
    3,040Equity of affiliates
    
    
    (76
    )
    
    
    184Other income
    
    
    392
    
    
    
    328Income (loss) before taxes
    
    
    2,566
    
    
    
    (4,838
    )Income taxes
    
    
    3
    
    
    
    (40
    )Net income (loss)
    
    $
    2,563
    
    
    $
    (4,798
    )Depreciation and amortizationConsolidated segments
    
    $
    569
    
    
    $
    721Corporate
    
    
    29
    
    
    
    38Consolidated
    
    $
    598
    
    
    $
    759Capital ExpendituresConsolidated segments
    
    $
    395
    
    
    $
    422Corporate
    
    
    4
    
    
    
    12Consolidated
    
    $
    399
    
    
    $
    434
 Year ended December 31,(in thousands)
    
    2004
    
    
    2003AssetsConsolidated segments
identifiable assets
    
    $
    7,790
    
    
    $
    6,764Corporate
    
    
    5,114
    
    
    
    6,978Consolidated
    
    $
    12,904
    
    
    $
    13,742
 NOTE 16 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 exceptper share data)
    
    2004
    
    
    2003BasicNet earnings (loss)
    
    $
    2,563
    
    
    $
    (4,798
    )Weighted average shares
outstanding
    
    
    4,479
    
    
    
    4,483Net earnings (loss)
per share
    
    $
    0.57
    
    
    $
    (1.07
    )DilutedNet earnings (loss)
    
    $
    2,563
    
    
    $
    (4,798
    )Weighted average shares
outstanding
    
    
    4,479
    
    
    
    4,483Effect of dilutive potential
common shares:Stock options
    
    
    129
    
    
    
    Total
    
    
    4,608
    
    
    
    4,483Net earnings (loss) per share
    
    $
    0.56
    
    
    $
    (1.07
    )
 At December 31, 2004, there were no potentially dilutive stock options excluded from diluted
weighted average shares outstanding. Intelligent Systems Corporation




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##### Table of Contents



Schedule II Intelligent Systems Corporation VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31, 2003 and 2004  (in thousands)
 Balance at
    
    
    Charged to
    
    
    
    
    
    
    Balance atBeginning
    
    
    Costs
    
    
    
    
    
    
    End ofDescription
    
    of Period
    
    
    and Expenses
    
    
    Deductionsa
    
    
    PeriodAllowance for Doubtful AccountsYear Ended December 31, 2003
    
    $
    62
    
    
    $
    63
    
    
    $
    (1
    )
    
    $
    124Year Ended December 31, 2004
    
    
    124
    
    
    
    67
    
    
    
    (88
    )
    
    
    103
   a.
    
    Write-offs of accounts receivable against allowance accounts. Intelligent Systems Corporation