Current assets:

Cash

Accounts receivable, net

Notes and interest receivable, current portion

Inventories, net

Other current assets

 

Total current assets

 

Investments

Notes and interest receivable, net of current portion

Property and equipment, at cost less accumulated depreciation

Patents, net

 

Total assets

 

 

Current liabilities:

Accounts payable

Deferred revenue, current portion

Accrued payroll

Accrued expenses

Other current liabilities

 

Total current liabilities

 

Deferred revenue, net of current portion

 

Other long-term liabilities

 

Commitments and contingencies (Note 6)

Intelligent Systems Corporation stockholders’ equity:

Common stock, $0.01 par value, 20,000,000 shares authorized, 8,958,028 issued and outstanding at March 31, 2011 and December 31, 2010

Additional paid-in capital

Accumulated other comprehensive loss

Accumulated deficit

 

Total Intelligent Systems Corporation stockholders’ equity

Non-controlling interest

 

Total stockholders’ equity

 

Total liabilities and stockholders’ equity

 

Revenue

Products

Services

 

Total revenue

 

Cost of revenue

Products

Services

 

Total cost of revenue

 

Expenses

Marketing

General & administrative

Research & development

 

Operating income (loss)

 

Other income (expense)

Interest income, net

Equity in income (loss) of affiliate company

Other income

 

Income (loss) before income taxes

Income taxes

 

Net income (loss)

 

Income (loss) per share:

Basic

Diluted

 

Basic weighted average common shares outstanding

Diluted weighted average common shares outstanding

 

 

Net income (loss)

Adjustments to reconcile net income (loss) to net cash used for operating activities:

Depreciation and amortization

Stock-based compensation expense

Non-cash interest income, net

Equity in (income) loss of affiliate company

Changes in operating assets and liabilities

Accounts receivable

Inventories

Other current assets

Accounts payable

Deferred revenue

Accrued payroll

Accrued expenses

 

Net cash used for operating activities

 

 

Proceeds from notes and interest receivable

Purchases of property and equipment

 

Net cash provided by (used for) investing activities

 

 

Payments on notes payable

 

Net cash used for financing activities

 

 

Effects of exchange rate changes on cash

 

Net decrease in cash

Cash at beginning of period

 

Cash at end of period

 

 

Cash paid during the period for interest

Cash paid during the period for income taxes

Throughout this report, the terms “we”, “us”, “ours”, “ISC” and “company” refer to Intelligent Systems Corporation, including its wholly-owned and majority-owned subsidiaries. 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 month periods ended March 31, 2011 and 2010. The interim results for the three months ended March 31, 2011 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, 2010, as filed in our Annual Report on Form 10-K.

Comprehensive Income (Loss) — Comprehensive income (loss) is the total of net income (loss) and all other non-owner changes in equity in a period. A summary follows:

Net income (loss)

Other comprehensive loss

Foreign currency translation adjustment

 

Comprehensive income (loss)

 

Stock-based Compensation — At March 31, 2011, we have one stock-based compensation plan in effect. We record compensation cost related to unvested stock awards by recognizing the unamortized grant date fair value on a straight line basis over the vesting periods of each award. We have estimated forfeiture rates based on our historical experience. Stock option compensation expense for the periods ended March 31, 2011 and 2010 has been recognized as a component of general and administrative expenses in the accompanying Consolidated Financial Statements. We recorded $8,000 and $3,000 of stock-based compensation expense in the quarters ended March 31, 2011 and 2010, respectively.

The estimated fair value of options granted is calculated using the Black-Scholes option pricing model with assumptions as previously disclosed in our 2010 Form 10-K.

As of March 31, 2011, there is $62,000 of unrecognized compensation cost related to stock options. During the three months ended March 31, 2011, a total of 80,000 options were granted at fair market value, with one third of the options vesting on each anniversary date in 2012, 2013 and 2014. The following table summarizes options as of March 31, 2011:

Outstanding at March 31, 2011

Vested and exercisable at March 31, 2011

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 first quarter of 2011 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 March 31, 2011. The amount of aggregate intrinsic value will change based on the fair market value of the company’s stock.

Fair Value of Financial Instruments — The carrying value of cash, accounts receivable, accounts payable and certain other financial instruments (such as 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. The carrying value of non-interest bearing note receivable beyond one year has been discounted at a rate of 4% which approximates rates offered in the market for notes receivable with similar terms and conditions. The fair value of equity method and cost method investments has not been determined as it was impracticable to do so due to the fact that the investee companies are relatively small, early stage private companies for which there is no comparable valuation data available without unreasonable time and expense.

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, trade accounts and note receivable. Our available cash is held in accounts managed by third-party financial institutions. Cash may exceed the Federal Deposit Insurance Corporation, or FDIC, insurance limits. While we monitor cash balances on a regular basis and adjust the balances as appropriate, these balances could be impacted if the underlying financial institutions fail. To date, we have experienced no loss or lack of access to our cash; however, we can provide no assurances that access to our cash will not be impacted by adverse conditions in the financial markets.

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.

ChemFree Customer A

ChemFree Customer B

ChemFree Customer C

ChemFree Customer D

Commitments and Contingencies — Please refer to Note 7 to our Consolidated Financial Statements included in our 2010 Form 10-K for a description of our commitments and contingencies in addition to those disclosed here.

Legal Matters — ChemFree Patent Matter — In December 2004, our ChemFree subsidiary filed a patent infringement action against J. Walter Co. Ltd. and J. Walter, Inc. (“J. Walter”) in the United States Court for the Northern District of Georgia. The complaint alleged that certain of the defendants’ products infringed four U.S. patents held by ChemFree and sought a ruling to compel the defendants to cease their infringing activities. The trial took place during the week of July 13, 2009. On June 18, 2010, the judge issued his preliminary Findings of Fact and Conclusions of Law which found (i) that certain of J. Walter’s products did infringe on ChemFree’s four patents-in-suit; (ii) in ChemFree’s favor on the issue of the patents’ named co-inventors and (iii) in J. Walter’s favor on the issue of invalidity of the four patents-in-suit for “obviousness”. In his ruling on invalidity of four of ChemFree’s patents due to obviousness, the judge relied heavily on a 2007 U.S. Supreme Court ruling (issued more than three years after ChemFree’s lawsuit was filed) which modified the manner for determining obviousness of a patent by replacing the long-standing rigid application of the “teaching, suggestion or motivation test” for determining obviousness with an “expansive and flexible approach”. On July 6, 2010, ChemFree filed a Motion for Reconsideration of the judge’s findings and conclusions followed on July 23, 2010 by the filing of a Second Motion for Additional Findings and Conclusions. In an unusual turn of events, in October 2010, the judge hearing the case was arrested by the Federal Bureau of Investigation on criminal charges, subsequently resigned and ChemFree’s case was reassigned to a new judge. A hearing with the new judge was held on February 11, 2011 and the parties have submitted various additional filings for the judge’s consideration. We cannot be certain when the case will finally be disposed of or what the ultimate resolution will be.

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 we are not currently involved in any legal proceedings that will have a material adverse impact on our consolidated financial position or results of operations.

Industry Segments — Segment information is presented consistently with the basis described in the 2010 Form 10-K. The following table contains segment information for the three months ended March 31, 2011 and 2010.

Revenue

Operating loss

Revenue

Operating income

 

Revenue

Operating income (loss)

Corporate expenses

 

Consolidated operating income (loss)

 

 

Information Technology

Industrial Products

 

Consolidated segments

Corporate

 

Consolidated depreciation and amortization

 

 

Information Technology

Industrial Products

 

Consolidated segments

Corporate

 

Consolidated capital expenditures

 

Information Technology

Industrial Products

 

Consolidated segments

Corporate

 

Consolidated assets

 

Income Taxes — 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) in the past two years. As of March 31, 2011 and December 31, 2010, the company has recorded a liability of $90,000, in connection with unrecognized tax benefits related to uncertain tax positions. The liability includes $15,000 of interest and penalties. As of March 31, 2011, management expects some incremental, but not significant, changes in the balance of unrecognized tax benefits over 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. During the three months ended March 31, 2011 and 2010, no interest or penalties were recognized.

We file a consolidated U.S. federal income tax return for all subsidiaries in which our ownership equals or exceeds 80%, as well as individual subsidiary returns in various states and foreign jurisdictions. Our VISaer subsidiary filed a separate U.S. federal income tax return prior to April 1, 2008. 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 2006.

Recent Accounting Pronouncements —We have considered all recently issued accounting pronouncements and do not believe the adoption of such pronouncements will have a material impact on our Consolidated Financial Statements.

Subsequent Event — We evaluated subsequent events through the date when these financial statements were issued. We are not aware of any significant events that occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on our Consolidated Financial Statements.

A change in revenue level at one of our subsidiaries may be offset by an opposing change at another subsidiary.

Customers may decide to postpone or cancel a planned implementation of our software for any number of reasons, which may be unrelated to our software features or contract performance, but which may affect the amount, timing and characterization of our deferred and/or recognized revenue.

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 an unpredictable impact on consolidated revenue that is recognized in a given quarterly or annual period.

Revenue from products, which includes sales and leases of equipment and supplies in our Industrial Products segment as well as software license fees related to the Information Technology segment, was $3.0 million in the three month period ended March 31, 2011, compared to $3.3 million in the three months ended March 31, 2010. The slight decline in product revenue in the first quarter of 2011 compared to the prior year is the net effect of an increase in international revenue and total consumable supplies offset by a decline in domestic sales of ChemFree’s SmartWasher^® parts washer machines. Software license revenue associated with the Information Technology segment declined in the three month period ended March 31, 2011 compared to the three month period ended March 31, 2010 due to a change in a customer’s go-live date which postponed license revenue recognition until the second quarter of 2011. By comparison, in the first quarter of 2010, CoreCard recognized revenue on the successful installation of its first international customer. As we have frequently cautioned, a number of factors, some of which may be outside of our control, can cause delays in delivery of our software and implementation by the customer, thus delaying license revenue recognition.

Service revenue associated with the Information Technology segment was $512,000 in the first quarter of 2011, a 46 percent increase compared to $350,000 in the first quarter of 2010. The change is attributed mainly to an increase in the installed base of CoreCard customers that pay for maintenance and technical support as well as more professional services projects that were completed for customers in 2011. We expect that professional services revenue will continue to grow as CoreCard’s customer base increases; however, it is not possible to predict with any accuracy the number and value of professional services contracts that CoreCard’s customers will require in a given period. Customers typically require our professional services to modify or enhance their CoreCard software implementation based on their specific business strategy and operational requirements, which vary from customer to customer and period to period.

an increase in accounts receivable of $98,000

an increase of $80,000 in inventory due mainly to receipt of a shipment of backlogged parts at the end of the quarter

a net increase in deferred revenue of $156,000 reflecting milestone billings to CoreCard customers in advance of revenue recognition

an increase in accounts payable reflecting the timing of receipt of inventory parts at quarter end

Further weakness in the global financial markets could have a negative impact on CoreCard due to potential customers (most of whom are financial institutions or services firms) delaying purchase or implementation decisions.

Stricter regulations and reluctance by financial institutions to act as sponsor banks for prospective customers (such as issuers and processors of credit and prepaid cards) could increase CoreCard’s losses and cash requirements.

Delays in software development projects could cause our customers to delay implementations or delay payments, 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.

As an alternative to licensing its software, CoreCard is now offering outsourced processing services running on the CoreCard software system. There are numerous risks associated with entering any new line of business and if CoreCard fails to manage the risks associated with its processing operations, it could have a negative impact on our business.

One of ChemFree’s customers represented 31 percent of our consolidated revenue in the first quarter of 2011 and any unplanned changes in the volume of orders or timeliness of payments from such customer could potentially have a negative impact on inventory levels and cash, at least in the near-term.

It is unclear whether the activity in the ChemFree legal action described in Note 2 to the Consolidated Financial Statements will have any impact on our ChemFree subsidiary in the foreseeable future but if the finding of invalidity of certain of ChemFree’s patents is sustained in the judge’s final ruling, it could result in increased competition in the marketplace and greater price pressure and lower margins, thus potentially impacting revenue, profits and projected cash flows. In addition, it is possible that a negative ruling could affect management’s estimate of future cash flows related to the patents. This could result in a write down of some or all of the unamortized carrying value of the patents, which was $166,000 as of March 31, 2011.

Delays in production or shortages of certain sole-sourced parts for our ChemFree products could impact revenue and orders.

Anticipated increases in prices of raw materials and sub-assemblies could reduce ChemFree’s gross profit if it is not able to offset such increased costs with higher selling prices for its products or other reductions in production costs.

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.

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).

Increasing and changing government regulations in the United States and foreign countries related to such issues as data privacy, financial and credit transactions could require changes to our products and services which could increase our costs and could affect our existing customer relationships or prevent us from getting new customers.

CoreCard could fail to expand its base of customers as quickly as anticipated, resulting in lower revenue and profits (or increased losses) and increased cash needs.

In certain 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.

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 Amex could result in delisting of our common stock, with a potentially negative impact on the market price and liquidity of our common stock.

Our future capital needs are uncertain and depend on a number of factors; additional capital may not be available on acceptable terms, if at all.

Other general economic and political conditions could cause customers to delay or cancel software purchases.

Amended and Restated Articles of Incorporation of the Registrant dated May 4, 2011, filed herewith.

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.)

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Certification of Chief Executive Officer and Chief Financial Officer furnished as required by Section 906 of the Sarbanes-Oxley Act of 2002.

Amended and Restated Articles of Incorporation of the Registrant dated May 4, 2011, filed herewith.

 

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.)

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

Certification of Chief Executive Officer and Chief Financial Officer furnished as required by Section 906 of the Sarbanes-Oxley Act of 2002.