CoreCard Corp — Interim / Quarterly Report 2008

Nov 14, 2008

10-Q 1 c77143e10vq.htm FORM 10-Q Filed by Bowne Pure Compliance PAGEBREAK

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-9330

INTELLIGENT SYSTEMS CORPORATION

(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

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 whether the registrant is a large accelerated file, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of October 31, 2008, 4,478,971 shares of Common Stock of the Issuer were outstanding.

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Intelligent Systems Corporation

Index Form 10-Q

Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets at September 30, 2008 and December 31, 2007	3
Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007	4
Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007	5
Notes to Consolidated Financial Statements	7
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 4 Controls and Procedures	16
Part II Other Information
Item 1 Legal Proceedings	16
Item 6 Exhibits	16
Signatures	17
Ex. 31.1 Section 302 Certification of Chief Executive Officer
Ex. 31.2 Section 302 Certification of Chief Financial Officer
Ex. 32.1 Section 906 Certification of Chief Executive Officer and Chief Financial Officer

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Part I FINANCIAL INFORMATION

Item 1. Financial Statements

Intelligent Systems Corporation

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

	September 30, — 2008	2007
	(unaudited)
ASSETS
Current assets:
Cash	$ 674	$	554
Accounts receivable, net	2,370		2,139
Notes and interest receivable, current portion	481		540
Inventories	1,248		1,424
Other current assets	711		2,217
Total current assets	5,484		6,874
Long-term investments	1,246		1,127
Notes and interest receivable, net of current portion	1,298		350
Property and equipment, at cost less accumulated depreciation	1,660		1,894
Goodwill	369		2,047
Other intangibles, net	279		313
Other assets	—		17
Total assets	$ 10,336	$	12,622
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Line of credit	$ 343	$	593
Note payable, current portion	97		—
Accounts payable	975		1,482
Deferred revenue	2,336		2,527
Accrued payroll	757		1,162
Accrued expenses and other current liabilities	1,001		1,235
Total current liabilities	5,509		6,999
Long-term liabilities	272		95
Commitments and contingencies (Note 8)
Minority interest	1,516		1,516
Stockholders’ equity:
Common stock, $0.01 par value, 20,000,000 shares authorized, 4,478,971 shares
issued and outstanding at September 30, 2008 and December 31, 2007	45		45
Additional paid-in capital	18,452		18,437
Accumulated other comprehensive loss	(194	)	(127	)
Accumulated deficit	(15,264	)	(14,343	)
Total stockholders’ equity	3,039		4,012
Total liabilities and stockholders’ equity	$ 10,336	$	12,622

The accompanying notes are an integral part of these Consolidated Financial Statements.

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Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; in thousands, except share and per share amounts)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2008		2007		2008		2007
Revenue
Products	$ 2,884		$ 4,657		$ 10,275		$ 10,315
Services	305		149		709		798
Total revenue	3,189		4,806		10,984		11,113
Cost of revenue
Products	1,573		2,673		5,582		5,239
Services	185		170		606		650
Total cost of revenue	1,758		2,843		6,188		5,889
Expenses
Marketing	620		978		2,158		1,843
General & administrative	907		1,019		3,429		2,690
Research & development	902		847		2,615		2,459
Loss from operations	(998	)	(881	)	(3,406	)	(1,768	)
Other income (expense)
Interest income (expense), net	5		39		(4	)	152
Investment income	—		—		—		81
Equity in income of affiliate companies	21		6		74		48
Other expense	(1	)	(28	)	(1	)	(34	)
Loss from continuing operations before income taxes	(973	)	(864	)	(3,337	)	(1,521	)
Income taxes	12		4		29		4
Loss from continuing operations	(985	)	(868	)	(3,366	)	(1,525	)
Income (loss) from discontinued operations	7		(114	)	(439	)	(609	)
Gain on sale of discontinued operations, no tax effect	—		—		2,884		97
Net loss	$ (978	)	$ (982	)	$ (921	)	$ (2,037	)
Loss per share from continuing operations:
Basic	$ (0.22	)	$ (0.19	)	$ (0.75	)	$ (0.34	)
Diluted	$ (0.22	)	$ (0.19	)	$ (0.75	)	$ (0.34	)
Income (loss) per share from discontinued operations:
Basic	$ —		$ (0.03	)	$ 0.55		$ (0.11	)
Diluted	$ —		$ (0.03	)	$ 0.54		$ (0.11	)
Loss per share:
Basic	$ (0.22	)	$ (0.22	)	$ (0.20	)	$ (0.45	)
Diluted	$ (0.22	)	$ (0.22	)	$ (0.20	)	$ (0.45	)
Basic weighted average common shares outstanding	4,478,971		4,478,971		4,478,971		4,478,971
Diluted weighted average common shares outstanding	4,545,837		4,478,971		4,545,764		4,478,971

The accompanying notes are an integral part of these Consolidated Financial Statements.

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Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

CASH PROVIDED BY (USED FOR):	Nine Months Ended September 30, — 2008		2007
OPERATIONS:
Net loss	$ (921	)	$ (2,037	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization	384		346
Stock-based compensation expense	15		8
Gain on sale of discontinued operations	(2,884	)	(97	)
Non-cash interest expense (income), net	(33	)	—
Investment income	—		(81	)
Equity in income of affiliate companies	(74	)	(48	)
Changes in operating assets and liabilities
Accounts receivable	(231	)	(736	)
Accrued interest receivable	5		93
Inventories	175		(194	)
Other current assets	811		303
Accounts payable	(35	)	718
Accrued payroll	(146	)	(8	)
Deferred revenue	393		(476	)
Accrued expenses and other current liabilities	(290	)	321
Other liabilities	(35	)	(38	)
Cash used for operating activities	(2,866	)	(1,926	)
INVESTING ACTIVITIES:
Proceeds from sale of discontinued operations	3,025		—
Investment in subsidiary	(125	)	—
Proceeds from sale of investment or marketable securities	—		39
Proceeds from notes and interest receivable	407		3,278
Payments on notes payable	(168	)	(105	)
Purchases of property and equipment	(133	)	(989	)
Cash provided by investing activities	3,006		2,223
FINANCING ACTIVITIES:
Borrowings under line of credit	1,743		—
Repayments made under line of credit	(1,820	)	—
Borrowings under other short-term arrangements	124		156
Cash provided by financing activities	47		156
Effects of exchange rate changes on cash	(67	)	(26	)
Net increase in cash	120		427
Cash at beginning of period	554		2,136
Cash at end of period	$ 674		$ 2,563

The accompanying notes are an integral part of these Consolidated Financial Statements.

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Intelligent Systems Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

	Nine Months Ended
	September 30,
	2008	2007
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest	$ 12	$ 3
Cash paid during the period for income taxes	$ 12	$ 8

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:

Line of Credit and Notes Payable: As explained in more detail in Note 6 to our Consolidated Financial Statements included in our Form 10-KSB for the year ended December 31, 2007, our ChemFree subsidiary borrowed $176,000 under a short-term line of credit, which amount is included in the line item Line of Credit on the Consolidated Balance Sheet as of December 31, 2007. ChemFree borrowed an additional $124,000 in the first quarter of 2008 and then converted the aggregate amount into a 3 year term loan effective February 24, 2008. As of September 30, 2008, the outstanding balance under the term loan is included in the categories Note Payable, Current Portion and Long-Term Liabilities on the Consolidated Balance Sheet.

Sale of VISaer Business (Discontinued Operations):

Below is a reconciliation of the cash and non-cash activities associated with the sale of the VISaer business, as disclosed in Note 3 to the Consolidated Financial Statements.

	(unaudited, in $000s)
Proceeds from sale:
Cash	$ 3,025
Note receivable, net of discount	1,261
Liabilities assumed by (assets transferred to) buyer:
Other current assets	(695	)
Property, plant and equipment, net	(15	)
Intangible assets	(1,803	)
Other assets	(17	)
Accrued payroll	258
Accounts payable	472
Deferred revenue	584
Other liability	(126	)
Accrued transaction related expenses	(60	)
Gain on sale of VISaer business	$ 2,884

The accompanying notes are an integral part of these Consolidated Financial Statements.

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Intelligent Systems Corporation

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

| 1. | Throughout this report, the terms “we”, “us”, “ours”, “ISC” and “company” refer to
Intelligent Systems Corporation, including its wholly-owned and majority-owned subsidiaries. |
| --- | --- |
| 2. | The unaudited Consolidated Financial Statements presented in this Form 10-Q have been
prepared in accordance with accounting principles generally accepted in the United States
applicable to interim financial statements. Accordingly, they do not include all of the
information and notes required for complete financial statements. In the opinion of ISC
management, these Consolidated Financial Statements contain all adjustments (which comprise
only normal and recurring accruals) necessary to present fairly the financial position and
results of operations as of and for the three and nine month periods ended September 30, 2008
and 2007. The interim results for the three and nine months ended September 30, 2008 are not
necessarily indicative of the results to be expected for the full year. These statements
should be read in conjunction with our Consolidated Financial Statements and notes thereto for
the fiscal year ended December 31, 2007, as filed in our Annual Report on Form 10-KSB. |
| 3. | Discontinued Operations - Effective April 16, 2008, the company and two subsidiaries, VISaer,
Inc. and VISaer (U.K.) Limited (collectively, “VISaer”) completed the sale of substantially
all the assets related to VISaer’s business pursuant to the terms of an asset purchase
agreement (the “Asset Purchase Agreement”) between IBS Technics, Inc. (“IBS Technics”) and
VISaer. IBS Technics is a subsidiary of IBS Software Services, Inc., a software services
company that had previously provided certain software development services to VISaer as an
independent third party contractor. |
| | The purchase price consisted of $3,025,000 paid in cash at closing plus future earn-out and
contingent payments to be paid over four years based on certain performance metrics of the
VISaer business following the sale, with guaranteed minimum payments aggregating $1.5 million in
cash (discounted to a net present value of $1,261,000), payable in three equal installments in
2010, 2011 and 2012. In addition, IBS Technics assumed approximately $258,000 in liabilities of
VISaer related to employee vacation benefits and $437,000 payable to IBS Technics for prior
services. IBS hired the VISaer employees as of the effective date of the transaction. IBS
Technics acquired assets, net of liabilities, of $48,000 related to customer contracts and
assumed the ongoing liabilities and obligations associated with such contracts. We retained the
remainder of the liabilities of the VISaer business along with cash and accounts receivable
aggregating approximately $465,000 as of the closing date. Based on the carrying value of the
assets and liabilities transferred to IBS Technics and the estimated costs and expenses incurred
in connection with the sale, the company reported a gain on the sale transaction of $2,884,000
in the quarter ended June 30, 2008. |
| | The transaction also provides for contingent payments which may be earned based on the
attainment by the acquired VISaer business of certain levels of revenue in each of the calendar
years 2008 through 2011. As the amount, if any, of such payments is not quantifiable at this
time, no amount has been recorded for such contingency payments. |
| | The following condensed financial information is provided for the VISaer discontinued operations
for the periods shown. |

	Three Months Ended
	September 30,			September 30,
(unaudited, in thousands)	2008	2007		2008		2007
Net sales	$ —	$	988	$	761	$	2,587
Operating loss	(17	)	(87	)	(471	)	(566	)
Income (loss) from discontinued operations	7		(114	)	(439	)	(609	)

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1. Comprehensive Income (Loss) - In accordance with Financial Accounting Standards Board Statement No. 130, “Reporting Comprehensive Income”, comprehensive income (loss) is the total of net income (loss) and all other non-owner changes in equity in a period. A summary follows:

Consolidated Statements of	Three Months Ended				Nine Months Ended
Comprehensive Loss	September 30,				September 30,
(unaudited, in thousands)	2008		2007		2008		2007
Net loss	$ (978	)	$ (982	)	$ (921	)	$ (2,037	)
Other comprehensive income (loss)
Foreign currency translation adjustment	—		(12	)	(67	)	(142	)
Comprehensive loss	$ (978	)	$ (994	)	$ (988	)	$ (2,179	)

| 5. |
| --- |
| The estimated fair value of options granted is calculated using the Black Scholes option pricing
model with assumptions as previously disclosed in our Form 10-KSB. |
| As of September 30, 2008, there is $18,000 of unrecognized compensation cost related to stock
options. During the quarter ended June 30, 2008, a total of 12,000 options were granted to the
three independent members of the board of directors pursuant to the Non-employee Director Stock
Option Plan (“Director Plan”). Pursuant to the terms of the Director Plan, the options were
granted at fair market value on the date of the Annual Shareholders meeting. No options were
exercised or forfeited during the three and nine months ended September 30, 2008. The following
table summarizes options as of September 30, 2008: |

		Wgt Avg	Wgt Avg — Remaining Life	Aggregate — Intrinsic
# of Shares		Exercise Price	in Years	Value
Outstanding at September 30, 2008	221,000	$ 2.46	4.7	$ 65,582
Vested and exercisable at
September 30, 2008	203,000	$ 2.37	4.2	$ 65,582

| | The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value
(the difference between the company’s closing stock price on the last trading day of the third
quarter of 2008 and the exercise price, multiplied by the number of in-the-money options) that
would have been received by the option holders had all option holders exercised their options on
September 30, 2008. The amount of aggregate intrinsic value will change based on the fair
market value of the company’s stock. |
| --- | --- |
| 6. | Concentration of Revenue - The following table indicates the percentage of consolidated
revenue represented by each customer for any period in which such customer represented more
than 10% of consolidated revenue. |

	Three Months Ended — September 30,		Nine Months Ended — September 30,
(unaudited)	2008	2007	2008	2007
ChemFree Customer A	43 %	64 %	45 %	36 %
ChemFree Customer B	12 %	—	14 %	12 %
ChemFree Customer C	12 %	—	10 %	—
ChemFree Customer D	—	—	10 %	10 %

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1. Industry Segments - Segment information is presented consistently with the basis described in the 2007 Form 10-KSB. The following table contains segment information for continuing operations for the three and nine months ended September 30, 2008 and 2007.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(unaudited, in thousands)	2008		2007		2008		2007
Information Technology
Revenue	$ 320		$ 166		$ 751		$ 2,119
Operating loss	(914	)	(995	)	(2,936	)	(1,406	)
Industrial Products
Revenue	2,869		4,640		10,233		8,994
Operating income	98		312		270		491
Consolidated Segments
Revenue	3,189		4,806		10,984		11,113
Operating loss	(816	)	(683	)	(2,666	)	(915	)
Corporate expenses	(182	)	(198	)	(740	)	(853	)
Consolidated operating loss from
continuing operations	$ (998	)	$ (881	)	$ (3,406	)	$ (1,768	)
Depreciation and Amortization
Information Technology	$ 14		$ 48		$ 73		$ 122
Industrial Products	103		30		291		140
Consolidated segments	117		78		364		262
Corporate	7		5		20		16
Consolidated depreciation and amortization	$ 124		$ 83		$ 384		$ 278
Capital Expenditures
Information Technology	$ (32	)	$ 62		$ (68	)	$ 541
Industrial Products	9		255		194		436
Consolidated segments	(23	)	317		126		977
Corporate	1		4		10		10
Consolidated capital expenditures	$ (22	)	$ 321		$ 136		$ 987

(in thousands)	September 30, 2008	December 31, 2007
Identifiable Assets
Information Technology	$ 3,388	$ 4,171
Industrial Products	5,015	4,932
Consolidated segments	8,403	9,103
Corporate	1,933	3,519
Consolidated assets	$ 10,336	$ 12,622

| 8. |
| --- |
| Legal Matters - In December 2004, ChemFree filed a patent infringement action against J. Walter
Co. Ltd. and J. Walter, Inc. in the United States Court for the Northern District of Georgia.
The complaint alleges that certain of the defendant’s products infringe various U.S. patents
held by ChemFree and seeks a ruling to compel the defendant to cease its infringing activities.
The defendant has asserted various defenses. The parties have completed the discovery phase of
the case and no trial date has been set. While the resolution and timing of any legal action is
not predictable, ChemFree believes it has sufficient grounds to prevail in these actions,
although there can be no assurance that the disputes will be resolved in its favor. During the
second and third quarter of 2008, several pre-trial rulings were made by the judge
assigned to the case with respect to various motions submitted by ChemFree and J. Walter Co.
Ltd. and J. Walter, Inc. One of the rulings awarded ChemFree legal expenses related to a
certain matter in an amount to be determined. Since the amount of the award has not been
determined at this time, no amount for awarded legal expenses has been accrued in the
accompanying Consolidated Financial Statements included in this filing. |

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| | VISaer Stock Purchase Transaction - On April 3, 2008, the company acquired additional shares of
common stock of VISaer, Inc. from a minority shareholder. The purchase price for the stock was
$125,000 paid in cash plus an additional amount to be paid in the future, contingent upon the
net amount of cash realized by Intelligent Systems (calculated in accordance with a formula
agreed between the parties) resulting from the VISaer sale transaction. Presently, the company
estimates that the additional amount that would be payable to the minority shareholder in 2010,
2011 and 2012 (based on the guaranteed minimum payments of the VISaer buyer as explained in Note
3) aggregates approximately $126,000 ($150,000 undiscounted); accordingly, the company has
accrued $126,000 as a long-term liability in the Consolidated Financial Statements. The total
purchase price for the additional VISaer stock, consisting of the initial payment of $125,000
and the accrued liability for future payments of $126,000, was recorded as additional goodwill
of VISaer at the time of the transaction and included in the calculation of the gain on sale for
the VISaer transaction. |
| --- | --- |
| 9. | Income Taxes - Effective January 1, 2007, we adopted the provisions of Financial Accounting
Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an
Interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 prescribes a recognition
threshold that a tax position is required to meet before being recognized in the financial
statements and provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition issues. We have
recognized tax benefits from all tax positions we have taken, and there has been no adjustment
to any carry forwards (net operating loss or research and development credits) as a result of
the implementation of FIN No. 48. The adoption of FIN No. 48 did not have a material effect on
our consolidated financial position or results of operations. As of September 30, 2008, we do
not have any unrecognized tax benefits and we do not anticipate any significant changes in the
balance of unrecognized tax benefits during the next twelve months. |
| | Our policy is to recognize accrued interest related to uncertain tax positions in interest
expense and related penalties, if applicable, in general and administrative expense. No such
interest expense or penalties were recognized during the three or nine months ended September
30, 2008 and 2007. |
| | We file a consolidated U.S. federal income tax return for all subsidiaries in which our
ownership exceeds 80 percent, as well as individual subsidiary returns in various states and
foreign jurisdictions. Through April 15, 2008, our VISaer subsidiary filed a separate U.S.
federal income tax return. For periods after April 15, 2008, we will include VISaer in our
consolidated U.S. federal income tax return. With few exceptions we are no longer subject to
U.S. federal, state and local or foreign income tax examinations by taxing authorities for years
before 2005. |
| 10. | New Accounting Pronouncements - In September 2006, the FASB issued FASB Statement No. 157,
“Fair Value Measurements” (“FASB No.157”) to increase consistency and comparability in fair
value measurements. FASB No. 157 defines fair value, establishes a framework for measuring
fair value, and expands disclosures about fair value measurements of certain assets,
liabilities and items in stockholders’ equity that are measured at fair value. FASB No. 157
is effective for financial statements issued for fiscal years beginning after November 15,
2007. Accordingly, we adopted FASB No. 157 effective January 1, 2008. The adoption of the
standard did not have a material impact on our Consolidated Financial Statements. |
| | On February 15, 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities: Including an amendment of FASB Statement No. 115” (“FASB
No.159”). FASB No. 159, which builds on other statements related to fair value such as FASB No.
157 above, permits entities to elect to measure many financial instruments and certain other
items at fair value with changes in value reported in earnings. It is designed to mitigate
earnings volatility that arises when assets and liabilities are measured differently. FASB No.
159 is effective for financial statements issued for fiscal years beginning after November 15,
2007. Accordingly, we adopted FASB 159 effective January 1, 2008. The adoption of the standard
did not have a material impact on our Consolidated Financial Statements. |

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In addition to historical information, this Form 10-Q may contain forward-looking statements relating to ISC. All statements, trend analyses and other information relative to markets for our products and trends in revenue, gross margins and anticipated expense levels, as well as other statements including words such as “anticipate”, “believe”, “plan”, “estimate”, “expect”, and “intend”, and other similar expressions, constitute forward-looking statements. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties including those factors described below under “Factors That May Affect Future Performance”, and that actual results may differ materially from those contemplated by such forward-looking statements. ISC undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in future operating results.

For purposes of this discussion and analysis, we are assuming and relying upon the reader’s familiarity with the information contained in Item 6 Management’s Discussion and Analysis or Plan of Operation, in the Form 10-KSB for the year ended December 31, 2007 as filed with the Securities and Exchange Commission.

Overview

Our consolidated subsidiaries operate in two industry segments: Information Technology Products and Services (“Information Technology”) and Industrial Products. The Industrial Products segment includes ChemFree Corporation (bio-remediating parts washers). The Information Technology sector has consisted of VISaer, Inc. (software for maintenance, repair and overhaul operations in the commercial aviation industry) and CoreCard Software, Inc. (software for managing accounts receivables, credit and debit cards). As discussed in Note 3 to the Consolidated Financial Statements, we sold our VISaer business as of April 16, 2008. Accordingly, the Consolidated Financial Statements reported in this Form 10-Q and the discussion below do not include the results of our VISaer subsidiary as part of continuing operations.

We derive our product revenue from sales of software licenses in our Information Technology sector and sales and leases of equipment and supplies in our Industrial Products sector. Our service revenue consists of fees for implementation, consulting, training, maintenance and support for software products in our Information Technology sector. Our consolidated revenue is the aggregate of the revenue generated at our 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
our software subsidiary has limited experience in its marketplace which may affect its
ability to identify and evaluate trends that may impact its business. |
| • | CoreCard Software has been involved in major new product development initiatives for a
number of years and has limited experience delivering and installing products at customer
sites, making it difficult to predict with certainty when it may recognize revenue on
individual software contracts. |
| • | Our subsidiaries are relatively small in revenue size and, in the Information Technology
sector, revenue in a given period may consist of a relatively small number of contracts.
Consequently, even small delays in a delivery under a software contract (which may be out of
our control) could have a significant and unpredictable impact on consolidated revenue that
we can recognize in a given quarterly or annual period. |

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 subsidiaries’ expenses and the corporate office expenses. Our ChemFree subsidiary generates an operating profit on a regular basis but our early stage subsidiary, CoreCard, is not consistently profitable, mainly due to significant research and development expense that is invested to complete new product offerings and the deferral of revenue recognition until such products are delivered to and accepted by 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, CoreCard may report operating profits on an irregular basis as it builds its customer base. A significant portion of our subsidiaries’ expense is related to personnel. 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.

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We also frequently generate income or incur losses from non-operating sources and we may do so from time to time in the future. We may derive income from sales of holdings in subsidiary, affiliate and other minority-owned companies, as exemplified in the VISaer sale, discussed in more detail in Note 3 to the Consolidated Financial Statements. Occasionally, 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.

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 quarterly report.

Revenue - Total revenue from continuing operations in the three month period ended September 30, 2008 was $3.2 million, a 34 percent decrease compared to the third quarter of 2007. For the nine month period ended September 30, 2008, total revenue from continuing operations was $11.0 million, a one percent decline compared to $11.1 million in the nine month period in 2007.

| • | Revenue from products, which includes sales of equipment in our Industrial Products segment
as well as software license fees related to the Information Technology segment, was $2.9
million in the three month period ended September 30, 2008, a 38 percent decline compared to
$4.7 million in the three months ended September 30, 2007. For the nine month period ended
September 30, 2008, revenue from products was $10.3 million, essentially flat compared to the
same period in 2007. The decline in product revenue in the third quarter of 2008 compared to
the prior year is primarily associated with a change in domestic sales of ChemFree products
(our Industrial Products segment) due to the fact that in the third quarter of last year, a
new customer began a national program to sell ChemFree products to its installed customer
base, resulting in a high initial volume of sales. With the initial rollout complete, the
number of new machines sold to this customer in the third quarter of 2008 was lower than
during the peak period last year. ChemFree experienced an increase of 14 percent in revenue
in the nine month period ended September 30, 2008 as compared to the nine month period in
2007, reflecting a 12 percent increase in domestic sales and a 26 percent increase in
international sales. Sales of ChemFree’s fluid and filter consumables increased significantly
in both the three and nine month periods of 2008 compared to 2007, reflecting the increasing
base of users of its SmartWasher part washers. Due to general economic conditions and
uncertainty about the impact of a slowing economy on the automotive repair and supplies
industry, the company is planning for relatively flat or perhaps slightly lower volume of
machine sales than in the third quarter of 2008 and is carefully managing its costs and
inventory levels accordingly. ChemFree’s installed base of lease customers as well as the need
for customers to purchase replacement consumable supplies provide an ongoing base of business
that we believe will be relatively unaffected by fluctuations in general economic conditions.
Software license revenue associated with the Information Technology segment was minimal in the
three and nine month periods ended September 30, 2008 compared to approximately $1.3 million
in license revenue in the nine months ended September 30, 2007 (which reflected primarily a
single software license contract recognized by our CoreCard Software subsidiary in the first
quarter of 2007). The company recognizes software license revenue only upon completion of
each contract and acceptance by customers. At September 30, 2008, CoreCard Software had
approximately $1.6 million in deferred revenue associated with in-process customer contracts
that it expects to recognize upon contract completion within the next three to six months,
depending to a large extend on customer go-live schedules. |
| --- | --- |
| • | Service revenue associated with the Information Technology segment was nine percent higher
and seven percent lower, respectively, in the three and nine month periods ended September 30,
2008 compared to the same periods last year. The change is attributed mainly to changes in
the amount and timing of professional services projects that are requested and delivered to
CoreCard customers. Revenue from professional services can vary considerably from period to
period based mainly on the timing of customer projects. |
| • | Turmoil in the global financial markets could impact CoreCard’s revenue and prospects in
the foreseeable future if customers or prospects postpone software purchases or
implementations. We are carefully monitoring the evolving dynamics in the marketplace and
have proactively taken steps to lower expenses through reduction in payroll and discretionary
marketing spending. We expect to support existing customers and contracts and to continue to
add new prospects and customers as opportunities arise in these uncertain times. |

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Cost of Revenue - Total cost of revenue was 55 percent and 56 percent of total revenue in the three and nine month periods ended September 30, 2008, respectively, compared to costs of 59 percent and 53 percent of total revenue in the comparable periods in 2007. The change is related principally to changes in the product mix from period to period.

• Cost of product revenue was 55 percent and 54 percent of product revenue in the three and nine month periods, respectively, in 2008 compared to 57 percent and 51 percent of product revenue in the respective periods in 2007. The principal reason for the slight decline in product cost as a percent of product revenue in the third quarter of 2008 is due mainly to a favorable mix of higher margin consumable supplies to machine sales. In the nine month period of 2008, cost of product revenue as a percent of product revenue was slightly higher than in the same period last year because in the nine month period in 2007, product revenue included $1.1 million in software licenses which have a low cost of revenue. Excluding the software revenue, cost of product revenue in the nine month period ended September 30, 2007 would have been 58 percent of product revenue compared to 54 percent in the same period in 2008 due to a favorable mix of higher margin consumable supplies to machine sale in the current year.

• Cost of service revenue (which relates to our software business only) was 60 percent and 86 percent of service revenue in the three and nine month periods ended September 30, 2008 compared to 114 percent and 82 percent of service revenue in the respective periods in 2007. Services include maintenance and customer support activities as well as professional services for software projects. The mix of service revenue in a given period, as well as the number of customers and new products being supported, impacts the gross margin on service revenue. CoreCard is providing a high level of support to its initial customers to ensure it builds a solid base of reference customers and puts in place an infrastructure for future growth. Cost of providing routine maintenance and support services as a percentage of service revenue is expected to decrease as CoreCard’s installed base of customers increases whereas the cost of professional services as a percent of revenue is expected to have a relatively stable gross margin percentage from period to period.

Operating Expenses - In the three month period ended September 30, 2008, total consolidated operating expenses were 15 percent lower than in the corresponding period in 2007. In the nine month period ended September 30, 2008, total consolidated operating expenses were 17 percent higher than in the same period in 2007. Consolidated marketing expenses declined 37 percent in the three month period in 2008 but increased by 17 percent year-to-date 2008 compared to the same periods in 2007. The changes between periods reflect principally fluctuations in sales commission expense associated with certain of ChemFree’s domestic sales, as well as an increase in CoreCard’s marketing personnel expense. Consolidated general and administrative expenses were 11 percent lower in the third quarter of 2008 but 27 percent higher in the nine month period of 2008 as compared to the respective three and nine month periods in 2007. The changes reflect primarily period-to-period fluctuations in legal expenses related to the ChemFree patent matter described in Note 8 to the Consolidated Financial Statements with significantly higher expenses year-to-date in 2008 but lower expenses in the third quarter of 2008 compared to the same period last year. In addition, there were increases in 2008 in depreciation and consulting expenses associated with implementation of a new accounting system and higher payroll and bonus expense at the ChemFree subsidiary. Consolidated research and development expenses were higher by six percent in both the three and nine month periods ended September 30, 2008 as compared to the corresponding periods in 2007. The increase is due principally to a combination of fluctuations in US employee payroll and consultant expenses at CoreCard and an increase in average wages for our Romania and India based employees in part due to relatively stronger local currencies compared to the US dollar in 2008.

Interest Income (Expense) - We recorded net interest income of $5,000 and net interest expense of $4,000 in the three and nine month periods ended September 30, 2008 compared net interest income of $39,000 and $152,000 in the respective periods in 2007. The difference between periods is due to greater interest expense in 2008 related to higher bank borrowings mainly during the first quarter of 2008 prior to the sale of the VISaer business.

Investment Income (Loss) - We did not have any investment income or loss in the three and nine month periods ended September 30, 2008. We recorded investment income of $81,000 in the nine month periods ended September 30, 2007 reflecting cash distributions related to previously owned investments in Horizon Software and Aderis Pharmaceuticals offset in part by a loss on the sale of a marketable security.

Equity Earnings of Affiliate Companies - On a quarterly basis, we recognize our pro rata share of the earnings or losses of affiliate companies that we record on the equity method. We recorded $21,000 and $74,000 in net equity income of one affiliate company in the three and nine month periods ended September 30, 2008 compared to net equity income of $6,000 and $48,000 in the respective three and nine month periods of 2007. The change between periods reflects increased profitability of the affiliate company.

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Income Taxes - We recorded $12,000 and $29,000 in the three and nine month periods ended September 30, 2008 for income tax liability related to several miscellaneous state tax liabilities. We believe our net deferred tax assets should be fully reserved at September 30, 2008 given their character and our historical losses.

Discontinued Operations

Net Loss from Discontinued Operations - The amounts recorded in 2008 and 2007 reflect the operations of our VISaer subsidiary which has been classified as a discontinued operation as a result of the sale of the VISaer business as explained in Note 3 to the Consolidated Financial Statements.

Gain on Sale of Discontinued Operations - In the second quarter of 2008, we recorded a gain of $2,884,000 reflecting the sale of the VISaer business. In the nine month period in 2007, we recorded an additional gain of $97,000 on the 2006 sale of our QS business as a result of the buyer confirming that no post-closing adjustments would be asserted.

Liquidity and Capital Resources

Our cash balance at September 30, 2008 was $674,000 compared to a cash balance of $554,000 at December 31, 2007. During the nine months ended September 30, 2008, our principal sources of cash were cash proceeds of $3,025,000 from the sale of the VISaer business, $1,225,000 representing payment in full of the earnout payments due from the buyer of our QS business in 2006 which had been earned in 2007 and recorded in the category “other current assets” as of December 31, 2007, and bank borrowings aggregating $1,867,000, including $1,743,000 under our line of credit and $124,000 under a term loan for ChemFree’s new accounting software system. In the nine months ended September 30, 2008, we used proceeds from the VISaer sale to pay down $1,820,000 on our line of credit and used approximately $2,660,000 in the aggregate to support CoreCard Software and our international R&D operations. We also paid $125,000 to purchase additional common stock in VISaer as explained in Note 8 to the Consolidated Financial Statements. Other changes in working capital included a decline of $176,000 in ChemFree inventory, a decrease of $507,000 in accounts payable, reflecting primarily payables assumed by the VISaer buyer, and a net increase of $231,000 in accounts receivable related mainly to ChemFree.

We currently project that we will have sufficient liquidity from cash on hand, monthly payments on notes receivable, projected customer payments and working capital borrowings to support our operations in the foreseeable future. Due to uncertainty regarding general economic and financial market conditions and the extent to which customer buying decisions in the near-term will be impacted (both for ChemFree and CoreCard), the company implemented some cost reduction measures early in the fourth quarter of 2008 including reductions in payroll expense and discretionary spending and will make further reductions if conditions deteriorate. We are also considering the possibility of raising additional funding in order to accelerate and support our CoreCard subsidiary’s marketing initiatives, product development and rollout, although it is too early to tell in what form or whether such funding would be available, if at all, on terms acceptable to the company. We expect to renew our $2.0 million line of credit on December 1, 2008 and will use it as necessary to support any short-term cash needs. We presently project that we will have sufficient accounts receivable and inventory balances for the foreseeable future to support the borrowing base for any required draws under our bank line of credit; however, if we fail to do so, we could experience a short-term cash shortfall. Furthermore, although we have no indication that the line of credit will not be renewed, if the bank does not renew our line of credit, we may experience a short-term cash shortfall. Several significant milestone payments on CoreCard contracts are expected in the fourth quarter of 2008. Delays in meeting project milestones or software delivery commitments could cause customers to postpone payments and increase our need for cash. 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. As a result, we may need to increase the use of our bank line of credit, scale back operations or seek alternative financing.

Beyond the next twelve months, we currently 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.

Off-Balance Sheet Arrangements

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.

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Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is 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. Management discusses its estimates and judgments with the Audit Committee of the Board of Directors. For a detailed description on the application of these and other accounting policies, see Note 1 to the Consolidated Financial Statements contained in our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2007. Reference is also made to the discussion of the application of these critical accounting policies and estimates contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-KSB for 2007. During the nine month period ended September 30, 2008, there were no significant or material changes in the application of critical accounting policies that would require an update to the information provided in the Form 10-KSB for 2007.

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 CoreCard is an early stage company with limited revenue and experience in its markets, is relatively small in size, and revenue tends to be associated with fewer and larger sales than in the Industrial Products segment. Thus any trend or delay that affects our subsidiary could have a negative impact on the company’s consolidated results of operations or cash requirements on a quarterly or annual basis. In addition, the carrying value of our investments is impacted by a number of factors which are generally beyond our control since we are typically a non-control shareholder in a private company with limited liquidity.

Among the numerous factors that may affect our consolidated results of operations or financial condition are the following:

| • | Turmoil in the global financial markets could have a serious negative impact on CoreCard
due to potential customers (most of whom are financial institutions) delaying purchase or
implementation decisions. |
| --- | --- |
| • | Delays in CoreCard’s software development projects could cause customers to delay
implementations, delay payments or cancel contracts, which would increase our costs and reduce
our revenue. |
| • | Our CoreCard subsidiary could fail to deliver software products which meet the business and
technology requirements of its target markets within a reasonable time frame and at a price
point that supports a profitable, sustainable business model. |
| • | One of ChemFree’s customers represented approximately 45 percent of consolidated revenue in
the first nine months of 2008; any unforeseen changes in the volume of orders or timeliness of
payments from such customer could have a negative impact on inventory levels and cash, at
least in the near-term. |
| • | Failure by our ChemFree subsidiary to protect its intellectual property assets could
increase competition in the marketplace and result in greater price pressure and lower
margins, thus potentially impacting sales, profits and projected cash flows. |
| • | Software errors or poor quality control may delay product releases, increase our costs,
result in non-acceptance of our software by customers or delay revenue recognition. |
| • | Compliance with the internal controls over financial reporting requirements of Section 404
of the Sarbanes-Oxley Act of 2002 could increase operating expenses and divert management and
staff resources. |
| • | Competitive pressures (including pricing, changes in customer requirements and preferences,
and competitor product offerings) may cause prospective customers to choose an alternative
product solution, resulting in lower revenue and profits (or increased losses). |
| • | CoreCard could fail to establish a base of reference customers for its product offerings,
resulting in lower revenue and profits (or increased losses) and increased cash needs. |
| • | In certain limited situations, ChemFree’s lease customers are permitted to terminate the
lease covering a SmartWasher ® machine, requiring the unamortized balance of the original
machine cost to be written off which could reduce profits in that reporting period and result
in lower revenue in future periods. |
| • | CoreCard could fail to retain key software developers and managers who have accumulated
years of know-how in our target markets and company products, or fail to attract and train a
sufficient number of new software developers and testers to support our product development
plans and customer requirements at projected cost levels. |

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| • | Delays in anticipated customer payments for any reason would increase our cash requirements
and possibly our losses. |
| --- | --- |
| • | Declines in performance, financial condition or valuation of minority-owned companies 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. |
| • | Failure to meet the continued listing standards of NYSE Alternext US (formerly The
American Stock Exchange) could result in delisting of our common stock, with a potentially
negative impact on market price and liquidity of our common stock. |
| • | Other general economic and political conditions could cause customers to delay or cancel
software purchases. |

We have certain lease commitments, legal matters and contingent liabilities described in detail in Note 9 to the Consolidated Financial Statements included in our 2007 Form 10-KSB. Except as explained in Note 8 in this Form 10-Q, 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.

Item 4. 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 procedures are effective. There were no significant changes in the company’s internal control over financial reporting or in other factors identified in connection with this evaluation that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

Other than as described in Note 8 to the Consolidated Financial Statements, we are not currently subject to any material legal proceedings. However, from time to time, we may become a party to certain legal proceedings in the ordinary course of business. As of September 30, 2008, we do not believe any ongoing legal proceedings will have a material adverse effect on our consolidated financial position or results of operations.

Item 6. Exhibits

The following exhibits are filed or furnished with this report:

| 3.1 | Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991, as
amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrant’s
Annual Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the
Registrant’s Report on Form 8-K dated November 25, 1997.) |
| --- | --- |
| 3.2 | Bylaws of the Registrant dated December 7, 2007. (Incorporated by reference to Exhibit 3.2 of
the Registrant’s Form 8-K dated December 7, 2007). |
| 4.1 | Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock
Transfer & Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the
Registrant’s Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.) |
| 4.2 | Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrant’s
Report on Form 8-K dated November 25, 1997 and filed on December 16, 1997.) |
| 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. |
| 31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. |
| 32.1 | Certification of Chief Executive Officer and Chief Financial Officer furnished as required by
Section 906 of the Sarbanes-Oxley Act of 2002. |

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.

Date: November 14, 2008	INTELLIGENT SYSTEMS CORPORATION Registrant — By :	/s/ J. Leland Strange J. Leland Strange
		Chief Executive Officer, President
Date: November 14, 2008	By :	/s/ Bonnie L. Herron Bonnie L. Herron
		Chief Financial Officer

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EXHIBIT INDEX

Exhibit
No.	Descriptions
3.1	Amended and Restated Articles of Incorporation of the Registrant dated November 14, 1991, as
amended November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Annual
Report on Form 10-K for the year ended December 31, 1991 and to Exhibit 3.1 to the Registrant’s
Report on Form 8-K dated November 25, 1997.)
3.2	Bylaws of the Registrant dated December 7, 2007. (Incorporated by reference to Exhibit 3.2 of the
Registrant’s Form 8-K dated December 7, 2007).
4.1	Rights Agreement dated as of November 25, 1997 between the Registrant and American Stock Transfer &
Trust Company as Rights Agent. (Incorporated by reference to Exhibit 4.1 of the Registrant’s Report
on Form 8-K dated November 25, 1997 and filed on December 16, 1997.)
4.2	Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrant’s Report on
Form 8-K dated November 25, 1997 and filed on December 16, 1997.)
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer and Chief Financial Officer furnished as required by
Section 906 of the Sarbanes-Oxley Act of 2002.

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