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TMCNet:  INTELLIGENT SYSTEMS CORP - 10-K/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[December 14, 2012]

INTELLIGENT SYSTEMS CORP - 10-K/A - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) 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 intangibles, and valuation of investments to be critical policies due to the estimation processes involved in each. For a detailed description on the application of these and other accounting policies, see Note 1 to the Consolidated Financial Statements.


Revenue Recognition - Product revenue consists of fees from software licenses and sales or leases of industrial products. Service revenue related to our software products consists of fees for consulting, training, customization, reimbursable expenses, maintenance, customer support and processing services.

We recognize revenue for industrial products when products are shipped, at which time title transfers to the customer and there are no remaining future obligations. We do not provide for estimated sales returns allowances because ChemFree's well-established policy rarely authorizes such transactions. As an alternative to selling our parts washers, we may lease our equipment. For leased equipment, we recognize revenue monthly at the contracted monthly rate during the term of the lease. We also recognize royalty income based on the quantity of ChemFree's proprietary fluid that is blended for the European market pursuant to an arrangement with ChemFree's master distributor. We classify shipping and handling amounts billed to customers in net revenue and the costs of the shipping and handling to customers as a component of cost of revenue.

Our software arrangements generally fall into one of the following four categories: · an initial contract with the customer to license certain software modules, to provide services to get the customer live on the software (such as training and customization) and to provide post contract support ("PCS") for a specified period of time thereafter (typically three months), · purchase of additional licenses for new modules or for tier upgrades for a higher volume of licensed accounts after the initial contract, · other optional standalone contracts, usually performed after the customer is live on the software, for services such as new interfaces or custom features requested by the customer, additional training and problem resolution not covered in annual maintenance contracts, and · contracts for certain software products and processing services that involve an initial fee plus recurring monthly fees for software usage, maintenance and support, for which the total fees are recognized ratably over the estimated term of the contract.

We review each contract to determine if multiple elements exist. Currently, only arrangements under the initial contract described above contain multiple elements. Our revenue recognition policies for each of the situations described above is discussed below.

Presently, our initial software contracts do not meet the criteria for separate accounting because the software may require significant modification or customization that is essential to its functionality. At present, we use the completed contract method to account for our contracts as we do not have an adequate historical basis on which to prepare reliable estimates of percentage-of-completion for these contracts. Moreover, there are inherent hazards with new software implementations, principally related to changes in customer requirements, that make estimates unreliable.

Accordingly, software revenue related to the license and the specified service elements (except for PCS) in the initial contract are recognized at the completion of the contract, when (i) there are no material uncertainties regarding customer acceptance, (ii) cancellation provisions, if any, have expired and (iii) there are no significant obligations remaining. We account for the PCS element contained in the initial contract based on vendor-specific objective evidence of fair value, which are annual PCS renewal fees, and PCS is recognized ratably on a straight-line basis over the period specified in the contract. Upon renewal of the PCS contract by the customer, we recognize revenues ratably on a straight-line basis over the period specified in the PCS contract. Substantially all of our software customers purchase software maintenance and support contracts and renew such contracts annually.

Intelligent Systems Corporation -9- -------------------------------------------------------------------------------- Services provided under standalone contracts that are optional to the customer and are outside of the scope of the initial contract are single element services contracts. These standalone services contracts are not essential to the functionality of the software contained in the initial contracts and generally do not include acceptance clauses or refund rights as are typical in the initial software contracts, as described above. Revenues from these services contracts, which are generally performed within a relatively short period of time, are recognized when the services are complete.

For contracts for licensed software and for processing services which include an initial fee plus recurring monthly fees for software usage, maintenance and support, we recognize the total fees ratably on a straight line basis over the estimated life of the contract.

A number of internal and external factors could affect our estimates related to software contracts, including labor rates, utilization of resources, changes in specifications or testing requirements, unforeseen technical problems and delays caused by customer issues such as lack of resources or change in project priorities. If we do not accurately estimate the resources required or the scope of work to be performed or we do not manage the contract properly, in future periods we may need to defer revenue longer than originally anticipated or to incur additional cost which would result in a loss on the contract or impact our financial results.

Valuation of Investments - We hold minority interests in non-publicly traded companies whose values are difficult to determine and are based on management's estimate of realizability of the value of the investment. Future adverse changes in market conditions, poor operating results, lack of progress of the underlying investee company or its inability to raise capital to support its business plan could result in investment losses or an inability to recover the current carrying value of the investment. Since some of the companies in which we hold minority positions are backed by venture capitalists, the value of our investment may be impacted by the amount, terms and valuation of the investee's financial transactions with third party venture funds or the terms of the sale of the investee company to a third party. Our policy with respect to minority interests is to record an impairment charge when we believe an investment has experienced a decline in value that is other than temporary. For instance, this could occur if the investee company is sold for less than our pro rata carrying value or if a new round of funding is at a lower valuation than our investment was made or if the financing terms for the new investors (such as preferences on liquidation) otherwise reduce the estimated value of our investment. We do not write-up the carrying value of our investments based on favorable changes or financial transactions. At least quarterly, we review our investments to determine any impairment in their carrying value and we write-down any impaired asset at quarter-end to our best estimate of its current realizable value. Any such charges could have a material adverse impact on our financial condition or results of operations and are generally not predictable in advance.

Valuation of Intangibles - The determination of the value of intangible assets, especially with respect to goodwill, requires management to make estimates and assumptions that affect the amount of future period amortization expenses and possible impairment expense that we will incur. Sometimes we use the services of a third party appraiser to provide a valuation of material intangible assets.

However, the nature of some assets requires management to make estimates which are very subjective. Furthermore, the period over which we amortize certain intangibles may change based on future conditions and consequently we may need to adjust the intangible value and/or amortization period, which could require us to increase the amount of amortization expense we record each period or to take a non-cash charge to reduce the value of the intangible. We review the values assigned to long-lived assets, generally using an estimate of the undiscounted cash flows of the entity over the remaining life of the asset, when conditions exist or events occur that cause us to believe that long-lived assets are impaired. Any resulting impairment, which is the excess of the carrying value over the fair value of the long lived assets, could require a write-down that would have a material adverse impact on our financial condition or results of operations. At December 31, 2011, the carrying value of intangibles of $133,000 relates solely to the ChemFree patents.

Accrued Expenses - Management regularly makes estimates with respect to expenses that should be accrued in the current reporting period, based on its best judgment of expenses that may be incurred in the future. Our ChemFree subsidiary accrues for estimated costs associated with its product warranties as an expense in the period the related sales are recognized. Such estimates are based on a number of factors, mainly on historical data of costs for warranty parts and services. Warranty accrual rates are reviewed and adjusted periodically. For new products introduced into the market, there is no historical data on which to base accrual rates and management estimates the warranty rates based on its best judgment, taking into consideration warranty costs for similar products where possible. In hindsight, actual warranty expenses may be more or less than estimated and could result in an adjustment to the warranty accrual in future periods. Management also regularly assesses any liability related to legal activity and uses its best judgment to determine the likelihood and potential cost for any such liability and what amount, if any, should be accrued. The litigation process is inherently uncertain and it is possible that the resolution of a legal matter might be different than management's belief and judgment, which could have a material adverse effect upon the financial condition and/or results of operations of the company.

Intelligent Systems Corporation -10- -------------------------------------------------------------------------------- Executive Summary We derive our product revenue from sales and leases of equipment and supplies in our Industrial Products sector and from sales of software licenses in our Information Technology Products and Services sector. Our service revenue consists of fees for consulting, customization, training, processing services, maintenance and support for software products in our Information Technology Products and Services sector. 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.

· Software license revenue in a given period may consist of a relatively small number of contracts and contract values can vary considerably depending on the software product and scope of the license sold. Consequently, even minor delays in delivery under a software contract (which may be out of our control) could have a significant and unpredictable impact on the consolidated revenue that we recognize in a given quarterly or annual period.

· 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 or contract performance, but which may affect the amount, timing and characterization of our deferred and/or recognized revenue.

We have frequently recognized consolidated operating losses on a quarterly and annual basis and are likely to do so in the future from time to time. Our ChemFree subsidiary generates an operating profit and positive cash flow on a quarterly and annual basis and is focusing on maintaining profitable operations at current revenue levels. Our CoreCard subsidiary is not consistently profitable, mainly due to significant research and development expense that is invested in its product offerings and the deferral of initial contract revenue recognition until licensed software and associated services are delivered to and implemented by its customers. Depending upon the size and number of software licenses recognized in a particular period and the level of expenses incurred to support existing customers and development and sales activities, CoreCard may report operating profits on an irregular basis as it builds a larger customer base. A significant portion of CoreCard's expense is related to personnel, including a workforce of approximately 200 employees located in India. In addition, CoreCard is now offering processing services as an alternative for customers who prefer to outsource this function instead of licensing our software and running the application in-house. There are a number of uncertainties related to a new line of business. We are likely to incur losses in the near future for the processing business because contract revenue is spread out over the life of each contract while we are currently investing in the infrastructure, resources and processes to support a growing processing business. For these and other reasons, our operating results may vary from quarter to quarter and at the present time are generally not predictable with a reasonable degree of certainty on a quarterly basis.

From time to time, we derive income from sales of holdings in affiliate and other minority-owned companies or we may 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 the gain or loss recognized as a result of a sale or the amount of equity in the income or losses of affiliates generally are not under our control and are not necessarily indicative of future results, either on a quarterly or annual basis.

In recent years, most of our cash has been generated by our ChemFree operations and, on an irregular basis, from sales of our investments or subsidiaries, and from a shareholder rights offering in mid-2009. We have used a significant amount of the cash received from these transactions and operations to support the domestic and international operations associated with our CoreCard subsidiary and the corporate office.

For additional comments on issues that may impact us, please read the section entitled Factors That May Affect Future Operations on page 15.

Intelligent Systems Corporation -11- -------------------------------------------------------------------------------- Results of Operations The following discussion should be read in conjunction with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements presented in this Annual Report. As explained in Note 3 to the Consolidated Financial Statements, we sold our former VISaer business in April 2008 and have accounted for the VISaer business as Discontinued Operations in the Consolidated Financial Statements since the sale. Accordingly, management's discussion of the results of operations does not include the VISaer operations in the discussion of continuing operations for either period presented.

Overview of 2011 Compared to 2010 In 2011, results were essentially in line with our expectations. ChemFree achieved revenue growth of 4 percent compared to 2010, and careful management of costs and inventory levels as well as non-recurring income of $450,000 (less $75,000 of taxable costs) related to resolution of legal matters resulted in a solidly profitable year for ChemFree. We anticipate that ChemFree will continue to be consistently profitable in the foreseeable future as it focuses on maintaining current revenue levels pending a more robust recovery in the markets it serves. CoreCard licenses its software to customers in the financial services industry which has been experiencing a changing regulatory environment and some global instability. We believe this has had and may continue to have some impact on CoreCard's revenue and prospects for new customers (such as issuers, processors and program managers of credit and prepaid cards) in the foreseeable future as companies postpone software purchases and implementations or encounter reluctance by financial institutions to act as sponsor banks for prospective customers. We are carefully monitoring the evolving dynamics in our markets as we add new resources, products, infrastructure and marketing activities to support existing customers and to continue to add new customers. It has taken more time and resources than expected to build the relationships and infrastructure to support CoreCard's processing services initiative. We believe CoreCard is now positioned to expand its prepaid card processing business in 2012, although we expect to incur losses in the processing business in the near term as revenue from processing customers is spread over multi-year contracts and we will need to continue to invest in this effort.

Revenue - Total consolidated revenue for the year ended December 31, 2011 was $16.3 million, an increase of 6 percent compared to $15.4 million for the prior year. Revenue in 2011 from product sales was $13.8 million, an increase of 4 percent compared to 2010 while revenue from services rose by 17 percent in 2011 to $2.5 million.

Product revenue includes sales and leases of SmartWasher® machines and consumable supplies by our ChemFree subsidiary in the Industrial Products segment as well as software licenses by our CoreCard Software subsidiary in the Information Technology Products and Services segment.

· In 2011, total product revenue was $13.8 million compared to $13.3 million in 2010. In both 2011 and 2010, over 85 percent of total product revenue is derived from sales of products in the Industrial Products segment and the balance is license revenue generated by the Information Technology and Services segment. ChemFree's revenue from international sales as well as domestic U.S.

consumable supplies and lease revenue grew year-over-year, reflecting a larger installed base of Smartwasher® units. However, a significant decrease in the number of new Smartwasher® units sold in the domestic U.S. market in 2011 resulted in an overall decline in ChemFree revenue of 3 percent compared to 2010.

· Product revenue from ChemFree's international sales increased by 10 percent in 2011 compared to 2010. The increase in the number of machines and consumables sold reflects stronger demand in our European markets as well as Australia in which our distributor network combines a regular service component with machines that their customers lease from them. This is similar to a successful sales model employed by ChemFree's largest domestic customer.

· Compared to 2010, license revenue generated by the Information Technology Products and Services segment almost doubled in 2011, representing approximately 13 percent of total product revenue in 2011. Revenue recognized in a given period reflects both the number of new software implementations completed as well as the contract value of completed contracts. Our contract values range from $150,000 to over $1 million depending on the scope and type of software licensed. In 2011, the value of the contracts completed was higher than in 2010, resulting in the increase in revenue from year-to-year. 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. With mission-critical, complex software systems such as those sold by CoreCard, customer requirements, available resources and testing cycles may increase the scope and length of time to complete the project beyond the original schedule.

Intelligent Systems Corporation -12--------------------------------------------------------------------------------- Service revenue generated by our Information Technology Products and Services segment increased by 17 percent to $2.5 million in 2011 as compared to 2010.

This year-to-year increase reflects more professional services projects that were completed for customers in 2011 and more maintenance revenue associated with a growing installed base of customers that pay for maintenance and technical support. We expect that maintenance 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.

Cost of Revenue - Total cost of revenue was $8.3 million (51 percent of total revenue) in 2011 compared to $8.1 million (52 percent of total revenue) in 2010.

· Cost of product revenue in 2011 was $6.7 million (48 percent of total product revenue) as compared to $7.0 million (52 percent of total product revenue) in 2010. The change between periods primarily reflects favorable changes in product mix in 2011 as compared to 2010. In the Industrial Products sector, a larger percentage of revenue was derived from consumable supplies which have a lower cost of sales than do parts washers, which made up a significantly larger component of product revenue in 2010. Also, compared to 2010, a larger percentage of total product revenue in 2011 was derived from sales of software licenses which have a relatively lower cost of sales than do parts washer equipment. Also, in 2011, ChemFree increased the selling price of certain of its products, offsetting in part increases in the cost of certain component parts and raw materials. For competitive and other reasons, it may not be able increase prices on a regular basis in the future.

· Cost of service revenue (which relates to the Information Technology Products and Services segment only) was $1.6 million (62 percent of service revenue) in 2011 as compared to $1.1 million (52 percent of service revenue) in 2010. The mix of service revenue in a given period, as well as the number of customers and new products being supported, impacts the cost and gross margin on service revenue. Cost of service revenue includes three components: costs to provide annual maintenance and support services to our installed base of licensed customers, costs to provide professional services and costs to provide our card processing services. The cost and gross margins on professional services revenue are tied to specific projects and vary depending on the specific project requirements and complexity as well as the mix of U.S. and offshore employees working on the project. Our initial costs to provide card processing services are high relative to the revenue earned because we are putting in place the systems and processes necessary to support this new service initiative. We had no such costs in 2010 because we were not yet offering card processing services. CoreCard is providing a high level of support to its customers for both maintenance and professional services activities to ensure it builds a solid base of customers and puts in place an infrastructure for future growth.

Operating Expenses - Total consolidated operating expenses were 9 percent higher in 2011 than in 2010. Consolidated marketing expenses were 2 percent ($49,000) lower in 2011 compared to 2010 primarily due to lower sales commissions paid on lower parts washer machine sales. Consolidated general and administrative expenses were higher by 8 percent ($231,000) in 2011 compared to 2010 due mainly to higher legal expenses related to the legal matters described in Notes 4 and 9 to the Consolidated Financial Statements and consulting expenses related to an accounting system upgrade. Consolidated research and development expenses were 20 percent ($429,000) higher in 2011 as compared to 2010, due mainly to an increase in the number of employees and compensation rates at the company's India based software development and testing operations.

Interest Income, net - We had net interest income of $31,000 in 2011 and $80,000 in 2010, respectively. The decrease between periods reflects primarily the fact that our note receivable related to the sale of our former VISaer subsidiary was lower in 2011 than in 2010 due to a write down of the carrying balance of the note receivable in the quarter ended December 31, 2010, as explained in more detail in Note 3 to the Consolidated Financial Statements.

Equity Earnings (Losses) of Affiliate Company - We recognize our pro rata share of the earnings and losses of an affiliate company that we record on the equity method. In 2011 we recorded $2,000 in net equity income of the affiliate company compared to $41,000 in net equity losses of the affiliate in 2010. The change between periods reflects improved profitability of the affiliate company.

Other Income - As explained in more detail in Note 4 and Note 9 to the Consolidated Financial Statements, the results for 2011 include income of $450,000 earned by our ChemFree subsidiary upon the settlement of a legal matter as well as an accrued expense of $75,000 related to taxable costs to be paid by ChemFree based on the final ruling of the Court of Appeals on the patent matter.

Intelligent Systems Corporation -13- -------------------------------------------------------------------------------- Income Taxes - We recorded $93,000 and $130,000, in the years ended December 31, 2011 and 2010, respectively, for state income tax expense, including amounts accrued for uncertain tax positions.

Discontinued Operations Loss on Sale of Discontinued Operations - As explained in more detail in Note 3 to the Consolidated Financial Statements, in 2010 we wrote down the carrying value of a note receivable from the buyer of the assets of our VISaer business and reduced a related note payable. The net effect was $345,000 which was recorded as a loss on sale of discontinued operations in the fourth quarter of 2010.

Liquidity and Capital Resources Our cash balance at December 31, 2011 was $3.2 million compared to a cash balance of $3.0 million at December 31, 2010. During the 12 months ended December 31, 2011, significant sources of cash include a $600,000 payment from the purchaser of our former VISaer subsidiary (as explained in more detail in Note 3 to the Consolidated Financial Statements) as well as receipt of a $450,000 payment related to settlement of a legal matter (as explained in more detail in Note 4 to the Consolidated Financial Statements). We generated $397,000 net cash from operations. Working capital changes included: · an increase in accounts receivable of $277,000 due mainly to higher balances at our international distribution partners · a net decrease in current deferred revenue of $717,000 reflecting the recognition of revenue in 2011 upon completion of new software contracts on which milestone billings had been deferred in prior periods until contract completion · an increase in accounts payable of $141,000 due mainly to differences in the amount and timing of non-inventory vendor invoices at year end · a decrease in accrued payroll of $90,000 due mainly to bonuses earned by the ChemFree management team in 2010 that were paid in the first quarter of 2011 In 2011, we used $464,000 cash to acquire capital equipment mainly to upgrade CoreCard's data centers and the India office for its new processing services, software testing automation initiatives and additional off-shore employees as well as vehicle, production and software purchases at ChemFree. We do not expect any significant changes to this spending level in the foreseeable future and presently do not foresee any difficulties funding such purchases. We also used $222,000 cash to purchase marketable securities classified as available-for-sale but do not expect to make any significant additional purchases in the foreseeable future.

We currently project that we will have sufficient liquidity from cash on hand, continued cash positive operations at ChemFree, projected customer payments at CoreCard and periodic working capital borrowings or sale of marketable securities, if needed, to support our operations and capital equipment purchases in the foreseeable future. We renewed our line of credit in June 2011 with a maximum principal availability of $1.25 million based on qualified receivables and inventory levels which we will use as necessary to support short-term cash needs. In 2011, we did not have any borrowings under the bank line of credit. We presently project that we will have sufficient accounts receivable, inventory balances and tangible net worth for the foreseeable future to support the borrowing base and loan covenants for any required draws under our bank line of credit. The line of credit expires June 30, 2012, subject to the bank renewing the line for an additional period. If the bank does not renew our line of credit and if we have unforeseen cash requirements, we may experience a short-term cash shortfall. Delays in meeting project milestones or software delivery commitments at CoreCard could cause customers to postpone payments and increase our need for cash. Presently, we do not believe there is a material risk that we will not perform successfully on any 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 presently planned.

Long-term, 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 there are no current plans to do so. Furthermore, the timing and amount of any such transactions are uncertain and, to the extent they involve non-consolidated companies, generally not within our control.

Intelligent Systems Corporation -14- -------------------------------------------------------------------------------- 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 adverse effect on our financial condition, liquidity or results of operations.

Factors That May Affect Future Operations Future operations in both the Information Technology Products and Services 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 certainty. 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: · Further weakness in the global financial markets could have a negative impact on CoreCard due to potential customers (most of whom perform some type of financial services) delaying purchase or software 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 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 approximately 27 percent of our consolidated revenue in 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.

· 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. In 2011, the company raised prices on certain of its SmartWasher® products to offset cost increases but may not be able to do so in the future due to competitive pressure.

· 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.

Intelligent Systems Corporation -15--------------------------------------------------------------------------------- · 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.

· 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.

We have certain lease commitments, legal matters and contingent liabilities described in detail in Note 9 to the Consolidated Financial Statements.

Recent Accounting Pronouncements Recent Accounting Pronouncements - In May 2011, the Financial Accounting Standards Board ("FASB") issued an accounting pronouncement related to fair value measurement (FASB ASC Topic 820), which amends current guidance to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards. The amendments generally represent clarification of FASB ASC Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We will adopt this pronouncement for our fiscal year beginning January 1, 2012. We do not expect this pronouncement to have a material effect on our consolidated financial statements.

In June 2011, the FASB issued an accounting pronouncement that provides new guidance on the presentation of comprehensive income (FASB ASC Topic 220) in financial statements. Entities are required to present total comprehensive income either in a single, continuous statement of comprehensive income or in two separate, but consecutive, statements. Under the single-statement approach, entities must include the components of net income, a total for net income, the components of other comprehensive income and a total for comprehensive income.

Under the two-statement approach, entities must report an income statement and, immediately following, a statement of other comprehensive income. The provisions for this pronouncement are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. We will adopt this pronouncement for our fiscal year beginning January 1, 2012. We do not expect this pronouncement to have a material effect on our consolidated financial statements.

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.

Intelligent Systems Corporation -16- --------------------------------------------------------------------------------

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