UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-QSB

            (Mark One)

     For the quarterly period ended September 30, 2004

OR

     For the transition period from    to    

Commission file number 1-9330

INTELLIGENT SYSTEMS CORPORATION

Registrant’s telephone number, including area code: (770) 381-2900

Indicate by a 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 an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No þ

As of October 31, 2004, 4,478,971 shares of Common Stock were outstanding.

Transitional Small Business Disclosure Format (check one): Yes o No þ

Table of Contents

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Intelligent Systems Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Intelligent Systems Corporation
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in thousands, except share and per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Intelligent Systems Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited, in thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Intelligent Systems Corporation
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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quarter ended September 30, 2004, amortization expense related to this asset was $3,670. The unamortized value of the ChemFree patents is included in the category “other intangibles, net ” on the balance sheet at September 30, 2004.

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The table following contains segment information for the three and nine months ended September 30, 2004 and 2003.

A reconciliation of consolidated segment data above to consolidated income (loss) follows:

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Item 2. Management’s Discussion and Analysis or Plan of Operations

In addition to historical information, this Form 10-QSB may contain forward-looking statements relating to ISC. All statements, trend analysis and other information relative to markets for our products and trends in revenue, gross margins and anticipated expense levels, as well as other statements including words such as “anticipate”, “believe”, “plan”, “estimate”, “expect”, and “intend”, and other similar expressions, constitute forward-looking statements. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements including those factors described below under “Factors That May Affect Future Performance”. 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 7, Management’s Discussion and Analysis, in ISC’s Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission.

Overview

Our consolidated subsidiaries operate in two industry segments: Information Technology Products and Services and Industrial Products. Included in the Information Technology sector are QS Technologies, Inc. (software for public health and human services), VISaer, Inc. (software for maintenance, repair and overhaul operations in the commercial aviation industry) and CoreCard Software, Inc. (software for managing credit and debit cards). The Industrial Products segment includes ChemFree Corporation (bio-remediating parts washers).

We derive our product revenue from sales of software licenses in our Information Technology sector and sales and leases of equipment and supplies in our Industrial Products sector. Our service revenue consists of fees for implementation, consulting, training, maintenance and support for software products in our Information Technology sector. Our consolidated revenue is the aggregate of the revenue generated at our four subsidiary companies. Our revenue fluctuates from period to period and our results are not necessarily indicative of the results to be expected in future periods. Period-to-period comparisons may not be meaningful and it is difficult to predict the level of consolidated revenue on a quarterly or annual basis for a number of reasons, including the following:

The third quarter 2004 results include $7.4 million of revenue and approximately $4.9 million in profit contribution related to our VISaer subsidiary’s completion of a significant multi-year software contract. Although the contract had been completed in the quarter ended June 30, 2004, recognition of revenue was deferred until the third quarter of 2004 due to the delivery in July 2004 of a then optional specified upgrade right in the contract. Recognition of this revenue had a significant positive impact on the company’s result of operations for the third quarter ended September 30, 2004. It is unlikely that VISaer or any of the company’s subsidiaries will have another contract of the same size in the foreseeable future.

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, may not, mainly due to significant research and development expense that is invested to complete their new product offerings and the deferral of revenue recognition until such products are delivered to and accepted by customers. Depending upon the size and number of software licenses recognized in a

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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. 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 other 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. For instance, as explained in Notes 3 and 4 to the financial statements, in the quarter ended June 30, 2004, we recognized a gain of $256,000 on the unsolicited sale of our holdings in Cirronet, Inc. and also wrote down the value of our holdings in Ardext Technologies, Inc. by $627,000 yielding a net investment loss of $371,000 for the quarter. Neither of these events was predictable by us as to amount or timing with any degree of confidence in advance. Similarly, as explained in Note 5 to the financial statements, our 19 percent interest in ISC Guernsey Ltd., which is carried at $31,000 as of September 30, 2004, resulted in a cash distribution of $1.57 million received in the third quarter ended September 30, 2004 and additional cash distributions aggregating between $2.0 million and $3.0 million are expected. However, in accordance with GAAP, cost basis investments are not written up for expected cash distributions because we do not exert any control over ISC Guernsey. As such we record the positive financial impact of these cash distributions when ISC Guernsey actually makes cash distributions from the proceeds of its asset sale to us. 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.

The net income of $5.0 million earned by the company in the third quarter of 2004 resulted in positive stockholders’ equity of $3.0 million as of September 30, 2004 compared to negative stockholders’ equity of $2.0 million at June 30, 2004. This negative equity position related to operating losses and deferral of the VISaer software contract in the first half of 2004 was a very short-term situation that was rectified in July 2004 with the recognition of the VISaer contract.

In recent years, most of our cash has been generated on an irregular basis from sales of our investments in early stage technology companies. We have used a significant amount of the cash received from these sales to support the operations of our CoreCard Software and VISaer subsidiaries. We do not expect 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 most of the expenses of VISaer’s operations and a growing portion of CoreCard’s expenses. If the business or cash flow of either subsidiary does not develop as anticipated, we would expect to reduce the personnel and overhead expenses to align their cost structure with their business resources and prospects.

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 in the three and nine month periods ended September 30, 2004 was $10,416,000 and $18,371,000, a 279 percent and 110 percent increase, respectively, compared to the same periods in 2003. Revenue from products, which includes sales of equipment in our Industrial Products segment as well as software license fees related to the Information Technology segment, was $4,291,000 and $9,303,000 in the three and nine month periods of 2004, representing increases of 148 percent and 78 percent, respectively, compared to the same periods in 2003. The increase in product revenue in both periods is due mainly to the recognition of $2,656,000 in software license revenue related to the VISaer contract with UPS. Additionally, the nine-month period ended September 30, 2004 includes $1,377,000 in software license revenue at the CoreCard subsidiary due to completion of its first major customer installation in the first quarter of 2004. Revenue from ChemFree industrial products represented 31 percent and 50 percent of total product revenue in the three and nine month periods of 2004 compared to approximately 90 percent of product revenue in the three and nine month periods ended September 30, 2003. The change in percent of product revenue attributable to ChemFree products is due to the fact that the total revenue from ChemFree sales was slightly lower in the third quarter and approximately flat in the year-to-date periods in 2004 compared to the same periods last year. The decline in ChemFree revenue in the third quarter of 2004 reflects mainly lower unit volume sales in the domestic market of SmartWasher machines offset in part by increased revenue from leased machines and international sales.

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We do not expect that revenue and profit contribution from software licenses in the last quarter of 2004 or in the foreseeable future will approach that of the third quarter of 2004 since the multi-year VISaer software contract recognized in the third quarter was significantly larger than the average software sale at any of the software subsidiaries. At the end of September 30, 2004, we have $4.7 million in net deferred revenue included on our balance sheet as a liability in the category of current deferred revenue that is expected to be recognized over the next 12 months. However, the specific timing of revenue recognition for software licenses is difficult to predict with certainty due to a number of factors such as acceptance criteria or scheduling delays due to customer changes in funding or program priorities.

Service revenue increased by 500 percent and 158 percent in the three and nine month periods ended September 30, 2004, respectively, compared to the same periods in 2003. The principal factor contributing to the increase in 2004 was a higher level of professional services and reimbursable expenses at the VISaer subsidiary related to the UPS contract. In addition, consolidated service revenue increased during the three and nine-month periods of 2004 as compared to the same periods in 2003 due to a more billable professional services and annual maintenance fees due to a larger installed base of software customers at all of the software subsidiaries.

Cost of Revenue — In the three and nine month periods ended September 30, 2004, total cost of revenue was 37 percent and 39 percent, respectively, of consolidated revenue compared to 59 percent in each of the comparative periods in 2003.

Operating Expenses — In the three and nine month periods ended September 30, 2004, total consolidated operating expenses decreased by ten percent and six percent, respectively, compared to the corresponding periods in 2003. Marketing expense declined by 11 percent and nine percent in the three and nine-month periods of 2004 compared to 2003 principally due to lower sales personnel costs at VISaer. General and administrative costs were 13 percent higher in the third quarter of 2004 but four percent lower year-to-date in 2004 compared to the corresponding periods in 2003. Of the $113,000 increase in the third quarter, approximately $54,000 relates to higher legal fees at ChemFree and the balance is due to higher facility rent and insurance expenses. Year-to-date, the decline of $113,000 includes lower amortization and personnel expenses at VISaer and QS Technologies offset in part by increased legal fees at ChemFree and higher rent expenses. Research and development expenses were 19 percent and six percent lower in the three and nine month periods ended September 30, 2004 compared to the same periods last year. Most of the decline is due to lower personnel costs reflecting fewer employees at VISaer and CoreCard and more use of lower cost testing personnel at the CoreCard’s offshore subsidiary.

Investment Income — In the three and nine month periods ended September 30, 2004, we recorded net investment income $1,728,000 and $1,357,000, respectively. In the three and nine month periods, investment income includes $1,567,000 related to the ISC Guernsey distribution and $174,000 related to the deferred gain on the RF Solutions sale, as described in more detail in Notes 5 and 6, respectively, to the financial statements. In the year-to-date period of 2004, the net investment income also includes an investment gain of $256,000 on the sale of our Cirronet stock offset by a write-down of our investment and notes receivable totaling $639,000 related to Ardext Technologies, Inc., as more fully explained in Notes 3 and 4 to the financial statements. In the corresponding periods of 2003, we recorded an investment loss of $24,000 and a net investment gain of $3,645,000, respectively. Included in the year-to-date investment income in 2003 is income related to the settlement of an escrow fund in the first and second quarters of 2003 arising from the sale of our ownership interest in PaySys International, Inc., offset in part by a write-down in the first quarter of 2003 to reduce the carrying value of our

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investment in RF Solutions, Inc., as more fully explained in Note 3 to the consolidated financial statements in our Form 10-K for 2003.

Equity Earnings (Losses) of Affiliate Companies — On a quarterly basis, we recognize our pro rata share of the earnings or losses of affiliate companies that we record on the equity method. We recorded $46,000 and $59,000 in net equity in income of affiliate companies in the three and nine month periods ended September 30, 2004, respectively, compared to $80,000 and $47,000 in net equity in income of affiliate companies in the corresponding periods in 2003. These results include our pro rata share of the net earnings and losses reported by five affiliate companies (Alliance Technology Ventures, CoreXpand, Riverside Software, Cirronet and Horizon Software) in 2004 and four affiliate companies (CoreXpand, Riverside Software, MediZeus, and Horizon Software) in 2003.

Other Income (Expense), Net — We recorded $33,000 in other expense and $17,000 in other income in the three and nine month periods ended September 30, 2004, respectively, compared to other income of $74,000 and $288,000 in the corresponding periods in 2003. In the third quarter of 2004, the amount reflects foreign currency exchange losses. Year-to-date 2004 figures also include recognition of $34,000 in deferred gain related to a VISaer product line sale in July 2000 and $17,000 in other miscellaneous income, the majority of which relates to foreign currency exchange gains. In 2003, the year-to-date amounts include $99,000 deferred gain related to the VISaer product line sale in July 2000, $118,000 in foreign currency exchange gain and approximately $71,000 in non-recurring miscellaneous income.

Income Taxes — We did not accrue for any income tax liability in year-to-date 2004 because we currently estimate the company will not incur income tax liability in 2004 and we believe the deferred tax assets should be fully reserved given their character and our historical losses. The income tax benefit of $104,000 recorded in 2003 reflects a refund of alternative minimum taxes paid by the VISaer subsidiary in a prior year.

Liquidity and Capital Resources

Our cash balance at September 30, 2004 was $1,215,000 compared to $1,133,000 at December 31, 2003. The company’s principal uses of cash during the nine months ended September 30, 2004 were for corporate expenses of $629,000, an increase of $584,000 in accounts receivable mainly at the QS Technologies and ChemFree subsidiaries, $125,000 to reduce the balance of the line of credit, and $2,500,000 to support operations at the VISaer and CoreCard subsidiaries. Sources of cash included $1,572,000 related to the distribution from ISC Guernsey, $1,073,000 from the sale of our investment in Cirronet, Inc., a net increase of $2,090,000 in current deferred revenue related to payments by customers for software licenses and annual software maintenance contracts for which the related revenue will be recognized within 12 months, offset by a reduction of $206,000 in accrued payroll mainly for bonuses earned in 2003 and paid in 2004 and other minor items.

We have several near-term sources of cash to support any negative cash flow from consolidated operations, including the remaining cash distributions expected related to the ISC Guernsey transaction as explained in Note 5 to the financial statements and periodic draws against our bank line of credit, if needed. As of September 30, 2004, the outstanding balance on our line of credit was $125,000 (which has been subsequently paid down to zero) and the current availability under the line of credit is $1,385,000. Our bank line of credit was renewed in September 2004 on terms and conditions substantially the same as for the expiring line. We believe the anticipated cash distributions from the ISC Guernsey transaction and cash flow from consolidated operations will provide for our cash requirements for at least the next twelve months. In addition, if our subsidiaries’ business operations or cash flows do not develop as anticipated, we would expect to reduce personnel and overhead expenses to align their cost structure with their business resources and prospects.

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. 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-K for the fiscal year ended December 31, 2003. Reference is also made to the discussion of the application of these critical accounting policies and estimates contained in Management’s Discussion and Analysis in our annual report on Form 10-K for 2003. During the nine months

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ended September 30, 2004, 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-K for 2003.

Long-Term Contractual Obligations

We entered into a new five-year facility lease on our principal facility in Norcross, GA in June 2004 and our VISaer subsidiary entered into a new three year lease on its facility in Andover, MA in July 2004, both of which are included in the table below for our operating lease obligations. Additionally, in the quarter ended September 30, 2004, our ChemFree subsidiary reached a settlement with respect to two long-standing legal matters related to patent issues. The agreement provides for assignment of disputed patent rights to ChemFree in exchange for payments spread over a five year period aggregating $508,000 ad explained in more detail in Part II, Item 1 of this report. Payments totaling $50,000 were made in the quarter ended September 30, 2004, payments totaling $50,000 are due in the fourth quarter of 2004 and the remaining payments are due in equal monthly increments of $8,500 beginning August 2005. We have no other long-term contractual obligations.

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, capital expenditures or resources or results of operations.

Factors That May Affect Future Operations

Our operations 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 for our software subsidiaries, revenue tends to be associated with fewer and larger sales than for our industrial products subsidiary. Thus any trend or delay that affects even one of our subsidiaries could have a negative impact on the company’s consolidated results of operations or cash requirements on a quarterly or annual basis. In addition, the carrying value of our investments is impacted by a number of factors which are generally beyond our control since we are typically a non-control shareholder in a private company with limited liquidity. Among the numerous factors that may affect our consolidated results of operations or financial condition are the following:

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Item 3. 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 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 II. OTHER INFORMATION

Item 1. Legal Matters

During the quarter ended September 30, 2004, a court order was entered in the United States District Court for the Northern District of Georgia approving an agreement reached by the company’s ChemFree subsidiary with a former consultant related to certain patent ownership matters that was the subject of a lawsuit pending in the Federal courts for a number of years. The agreement between the parties provided for assignment to ChemFree of all interests that the consultant may have had in all of ChemFree’s patents and patent applications worldwide in return for periodic payments aggregating $508,000 over five years and dismissal of a related lawsuit initiated by the consultant. Accordingly, on October 5, 2004, a mutual dismissal of the related lawsuit was entered in the Superior Court of Gwinnett County for the State of Georgia. The accounting treatment of this agreement relating to patent ownership is explained in note 7 to the financial statements.

Item 6. Exhibits and Reports on Form 8-K

We filed the following reports on Form 8-K during the quarter ended September 30, 2004:

The following exhibits are filed or furnished with this report:

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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.

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