SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Exact name of Registrant as specified in its charter)

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 x No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ x ]

As of March 31, 1999, 5,104,467 shares of Common Stock were outstanding. The aggregate market value of the Common Stock held by non-affiliates of the registrant was $8,763,000 (computed using the closing price of the Common Stock on March 31, 1999 as reported by the American Stock Exchange).

DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on June 11, 1999 are incorporated by reference in Part III hereof.

Item 1. Business 3

2. Properties 8

3. Legal proceedings 8

4. Submission of matters to a vote of security holders 8

5. Market for the registrant’s common equity and related stockholder matters 8

6. Selected financial data 9

7. Management’s discussion and analysis of financial condition and results of operations 9

7A. Quantitative and qualitative disclosures about market risk 13

8. Financial statements and supplementary data 13

9. Changes in and disagreements with accountants on accounting and financial disclosure 13

10. Directors and executive officers of the registrant 13

11. Executive compensation 13

12. Security ownership of certain beneficial owners and management 14

13. Certain relationships and related transactions 14

14. Exhibits, financial statement schedules and reports on Form 8-K 14

Signatures 16

Historical Overview. Intelligent Systems Corporation, a Georgia corporation, has operated either in corporate or partnership form since 1973 and its securities have been publicly traded since 1981. In this report, sometimes we use the terms "company", "we", "ours" and similar words to refer to Intelligent Systems Corporation. We operated as a master limited partnership from 1986 to 1991, when we merged into the present corporation. Our executive offices are located at 4355 Shackleford Road, Norcross, Georgia 30093 and our telephone number is (770) 381-2900. Our website address is www.intelsys.com.

Our companies operate in two industry segments (which are defined by the product or service provided rather than the market served): technology related products and services, and health care services. For the past three years, our majority-owned and controlled operating subsidiaries in the technology sector have included InterQuad Services (training/education for software products), ChemFree Corporation (bio-remediating parts washers for automotive and industrial applications), Intelligent Enclosures (mini-environment systems for ultraclean manufacturing) and HumanSoft LLC (health and human services software for public health agencies). In the health care services segment, our operations involve the PsyCare America subsidiary (psychiatric treatment programs for the Christian community). Our operating subsidiaries are relatively small in size and subject to greater fluctuation in revenue and profitability than larger, more established businesses would be.

Recent Developments. In 1998, several changes occurred that affect our ongoing consolidated operations. In April 1998, we sold the assets and business operations of our Intelligent Enclosures subsidiary to Daw Technologies. Later in the year, our HumanSoft subsidiary discontinued operations related to two of its three main product lines and subsequently filed a petition for relief under Chapter 11 of the federal bankruptcy laws. While HumanSoft is reorganizing under Chapter 11, its QS Technologies’ subsidiary continues to operate independently, providing its customers with the same products and services as it did prior to the HumanSoft actions. Please refer to Note 17 to the Consolidated Financial Statements for a more detailed description of HumanSoft’s present status. Finally, in early 1999, we sold our interest in our InterQuad Services subsidiary in a transaction described in more detail in Note 18 to the Consolidated Financial Statements. As a result of these transactions here, our ongoing consolidated operations will consist primarily of ChemFree Corporation, the QS Technologies operation of HumanSoft, and PsyCare America. Therefore, in reviewing the following business description, readers should remember that some of the businesses in which we were historically involved are no longer part of our current consolidated companies. We will also discuss some of our more significant and other minority-owned companies in the section titled "Affiliated Partner Companies" beginning on page 7 of this report.

Our main focus is to create and manage growing companies through flexible partnership arrangements. We actively explore opportunities, principally in the technology area, to develop partnerships with promising domestic companies or to start new businesses. Depending upon the needs of the partner company, we may be the sole, majority or minority owner of the business and will undertake a variety of roles which often include day-to-day management of operations, board of director participation, financing, market planning, strategic contract negotiations, personnel and administrative functions, etc. We do not consolidate the results of operations of companies in which we own less than a majority interest or in which we are not considered the controlling shareholder. We account for investments in which we own 20 to 50 percent by the equity method. In general, under the equity method, we include our pro rata share of the income or loss generated by each of these businesses as investment income (loss) on a quarterly basis. These equity losses and income decrease or increase, respectively, our cost basis of the investment. However, if there is no commitment for ISC to provide additional funding to the company, to the extent losses exceed our cost, we do not record a value below zero. Thus, because of this accounting treatment, some of our investments such as PaySys are shown as zero on our balance sheet but their real value is substantially higher, we believe. We may be actively engaged in managing strategic and operational issues with these companies and devote significant resources to the development of the business. From time to time, we may increase or decrease our ownership in the company, the business may become a stand-alone public company or it may be sold to another entity.

We operate the Shared Resource Technology Center, a small business incubator, at our corporate facility. The Center permits us to reduce overhead expense by subleasing excess capacity to small businesses that benefit from flexible, shared resources. At the same time, we have the opportunity for day-to-day contact with emerging companies that may become partnership companies, either as majority-owned subsidiaries or minority-owned affiliates. Additionally, the incubator increases the number of business and investment opportunities that we are presented with. Recently, we launched an internet incubator program at our facility to support our plan to become more active in companies tied to internet-related applications, tools or services.

We regularly discuss with interested parties possible investments, acquisitions, sales, or business combinations involving our operations, related businesses or new business opportunities. However, these discussions may not result in any completed transactions.

For ease of comprehension, the business discussion which follows contains information on prOducts, markets, competitors, research and development and manufacturing for our ongoing operating subsidiaries, organized by industry sector and by company. For further information concerning our historical domestic and foreign operations, see Notes 13 and 15 in the accompanying Notes to the Consolidated Financial Statements.

ChemFree Corporation – ChemFree Corporation (ChemFree) designs, manufactures and markets a line of parts washers under the SmartWasher^tm trademark that use an advanced bio-remediation system to clean automotive and machine parts without using hazardous, solvent-based chemicals. SmartWashers consist of a molded plastic tub and sink, recirculating pump, heater, control panel, filter with microorganisms, and aqueous based degreasing solutions. Unlike traditional solvent based systems, there are no regulated, hazardous products used or produced in the process and the SmartWasher system is completely self-cleaning. ChemFree sells replacement fluid and filters to its customers on a regular basis after the parts washer sale.

ChemFree’s markets include the automotive, transportation, industrial and military markets. The automotive market includes companies with fleets of vehicles to maintain; automobile manufacturers with extensive service networks such as Chrysler, GM and BMW; and individual and chains of auto repair shops and auto parts suppliers. Numerous public transport systems use the SmartWasher in maintenance facilities. The industrial market includes customers with machinery that requires routine maintenance, such as in the textile industry. Military applications include vehicle service depots in all branches of the military. ChemFree sells internationally in Europe, the Pacific Rim, Canada and Mexico.

ChemFree sells its products direct to high volume customers as well as through several distribution channels: distributors to the automotive aftermarket (e.g. NAPA); environment/pollution control equipment distributors; automobile manufacturers dealer equipment and service organizations (e.g. GM, Chrysler and BMW); and industrial product distributors. Distributors serving specific countries address international markets. ChemFree also sells in competitive bid situations, such as military procurements, and under a GSA schedule to government agencies. Marketing activities include trade show participation, public and press relations, advertisements in trade publications, and evaluation programs. The ChemFree business is not seasonal and would not be impacted significantly by the loss of one customer.

ChemFree competes with larger, established companies using solvent-based systems that require special handling and hauling of regulated material, other small companies using non-hazardous systems, and hazardous waste hauling firms. Although smaller than the established solvent-based firms, ChemFree believes it is competitive based on product features, positive environmental impact, improved health and safety features, elimination of regulatory compliance, and price. Warranty service, typically covering a one-year period, is provided by ChemFree personnel or through its distributors and dealers.

In 1998, ChemFree expanded its product line to include brake washers, more SmartWasher models with different sizes and features, and new formulations of degreasing fluid for specific applications. ChemFree subcontracts the manufacturing of major sub-assemblies built to its specifications to various vendors and performs final assembly and testing at its own facility. There are multiple sources available for subassemblies.

HumanSoft LLC – Historically, the HumanSoft subsidiary has specialized in the design, manufacture and sale of software programs which permit public health agencies to capture, analyze and manage client information. Within the past 18 months, HumanSoft acquired two former competitors, QS, Inc. and JK, Inc., with the goal of achieving the dominant position in a fragmented market. A key part of the strategy was to migrate the software offerings of the various companies to one platform that could be sold and supported on a profitable basis. Unfortunately, despite a substantial commitment of time and expense, a variety of circumstances prevented this software migration without a very significant development investment, which could not be justified on an economic basis. As a result, HumanSoft determined that it did not have the financial resources to continue to support two of its three product lines and was forced to take the actions that ultimately resulted in filing a petition for relief under Chapter 11 of the bankruptcy code. Refer to Note 17 to the Consolidated Financial Statements.

Despite the uncertainty surrounding the outcome of HumanSoft’s plan to reorganize under Chapter 11, the QS Technologies subsidiary of HumanSoft continues to operate from its Greenville, South Carolina based location, providing software products, maintenance and support services principally to its installed customer base. The market includes local, state and federal public health agencies nationwide as well as other government agencies, hospitals and clinics. The market is fragmented and not particularly large. QS Technologies competes against a number of other software companies, many of which are small vendors like itself and some of which are larger with access to greater resources. Typically, QS Technologies provides its customers with service and support under annual contracts. It is engaged in limited new product development and sales activities to expand its customer base and generate future revenue.

InterQuad Services – Historically, our UK based subsidiary, InterQuad Services, provided technical training and skills development programs for popular microcomputer software and network products. Some of the most popular offerings were courses for networking products from Novell Inc. and Microsoft Corporation.

InterQuad Services competed with a number of similar-sized training/education companies on the basis of quality of training staff, comprehensive and up-to-date course offerings, price and accessibility of training facilities. The market was extremely price competitive and had been undergoing a consolidation in the past few years. These market characteristics and high fixed costs for training staff and facilities contributed to InterQuad Services inability to sustain profitable operations and to its declining financial condition. Therefore, in early 1999, we sold our majority interest in InterQuad Services in exchange for a minority (19%) ownership in ISC Group. ISC Groups’ principal asset is a 49% interest in a business named InterQuad Group that provides technical training, consulting, hardware and software products to business customers. At the time of the sale, InterQuad Group received an infusion of capital from a new investor group. Following the sale of InterQuad Services, we will record our minority ownership by the cost method. Refer to Note 18 to the Consolidated Financial Statements for more details.

Intelligent Enclosures – As noted earlier, we sold the assets and business operations of our Intelligent Enclosures subsidiary in April 1998 and have not included the results of its operations since the sale date. Historically, Intelligent Enclosures (iE) designed, manufactured and marketed mini-environments used in ultra-clean manufacturing applications such as semiconductor fabrication. iE competed against traditional clean-room companies and other enclosure manufacturers that provided a variety of custom and standard products. However, the increasing preference of customers to buy enclosures as part of a full system implementation coupled with the generally unfavorable outlook for the semiconductor facility market made the sale of iE to a larger industry participant attractive.

PsyCare provides specialty treatment programs for individuals with psychiatric and psychological disorders, including depression and substance abuse. The programs are conducted under PsyCare’s Rapha® trademark and are directed toward individuals who prefer a treatment approach that integrates their physical and psychological needs with their Christian beliefs. PsyCare’s programs are principally in-patient hospital programs. PsyCare presently has 7 program sites in 7 states. The number of programs has declined significantly in the past two years for reasons noted below.

Hospitals in mid to large size metropolitan areas contract with PsyCare to conduct a Rapha treatment program in the hospital. PsyCare provides medical and program directors as well as therapists and maintains control over all aspects of the treatment, while the hospital provides the physical facility, administrative services, billing and nursing staff. The market for PsyCare’s treatment programs includes adults and adolescents suffering from illnesses such as depression, addiction and behavioral disorders. The program’s integrated approach appeals particularly to individuals affiliated with churches and other organizations with a Christian basis.

In the health care services business, the number of patients tends to decline during the summer months and prior to holidays. In addition, there are a number of fundamental changes taking place in the industry. In the past few years, the average length of stay for in-hospital treatment has declined dramatically. At the same time, managed care payors are reimbursing treatment providers and hospitals at much lower rates. Furthermore, managed care is also placing increased emphasis on drug-based treatment programs, with little or no hospital stay, rather than hospital-based behavioral modification programs such as those offered by PsyCare. The impact of these trends means that PsyCare must treat many more patients for shorter periods of stay while keeping strict control over expenses. The total number of inpatient programs declined in 1998 and 1997 compared to 1996 because of intense pressure by service providers to restrict hospital stay for mental health treatment, which made the Rapha programs less attractive to hospitals. Given these trends, PsyCare has reduced overhead and other costs and explored alternative business models. Although it was successful in maintaining profitability in 1998, it is uncertain whether its strategy will be effective long-term. In 1996, we derived approximately 37 percent of consolidated revenue from programs associated with one chain of psychiatric hospitals. This percentage declined to 13.5 percent in 1997 and 10.6 percent in 1998 as the number of programs declined. In some cases, replacement programs were opened at alternative hospitals.

PsyCare’s competitors include individual and group practices, private hospital-affiliated treatment programs, and other independent treatment programs with a religious component. With the advent of managed care and the restrictions on in-hospital treatment, PsyCare also competes with outpatient programs and drug-based therapies. PsyCare contracts with hospital facilities to provide the Rapha program in their hospital. This strategy reduces PsyCare’s fixed costs but makes it dependent upon decisions made by the hospital over which PsyCare has little control. Among PsyCare’s strengths are the consistent content and quality of its programs and the strong network of Christian organizations that support the program’s focus. However, unless there are significant positive changes in the healthcare environment, or a new business model proves feasible, PsyCare is unlikely to see its business prospects improve beyond current breakeven status.

The ChemFree subsidiary has several patents (both issued and pending) covering certain aspects of its products and processes. It may be possible for competitors to duplicate certain aspects of these products and processes even though we regard such aspects as proprietary. We have registered with the US Patent and Trademark Office and various foreign jurisdictions numerous trademarks and service marks for our products. We believe that an active trademark and copyright protection program is important in developing and maintaining brand recognition and protecting its intellectual property. Our companies presently market their products under trademarks and service marks such as Rapha, SmartWasher, OzzyJuice and others.

As of February 28, 1999, we had 75 full-time equivalent employees. Our employees are not represented by a labor union, we have not had any work stoppages or strikes and we believe our employee relations are good.

An important part of our business is to evaluate products and companies that we believe are involved in promising technologies or markets with good growth potential. From time to time, we have acquired or invested in such products, product rights or companies and expect to continue to do so as a regular part of our strategy. We hold investment positions in various growth stage companies, most of which are in technology-related fields and privately held. Because of the accounting treatment of non-consolidated companies, our balance sheet carrying cost of investments may not reflect their underlying value. For instance, we do not mark up the value of privately-owned businesses even when they raise money at higher valuations. Also, under equity method accounting, the carrying value of an investment in which we own 20 to 50 percent of the company may be reduced to zero because we record our pro rata share of the losses of the developing business against our cost basis. Consequently, the underlying value of the business and our investment in it may be substantially higher than our carrying value. Some examples of our involvement as of December 31, 1998 are as follows:

• A significant equity position in PaySys International, Inc. (PaySys), a leading software company involved in payment processing software systems. We own a 42 percent common stock interest in PaySys (which is approximately 29 percent on a fully-diluted basis). Revenue at PaySys grew 40 percent last year, reaching $46 million in 1998. PaySys has spent significant amounts on new product development during the same time period to maintain its technological leadership. During the past two years, PaySys has raised equity capital from several large venture capital firms at valuations higher than our original investment basis. On both occasions, we sold a small portion of our holdings as part of the investment transactions, recognizing significant gains. Our investment in PaySys is recorded at zero on our balance sheet. Refer to Note 3 to the Consolidated Financial Statements.
• A 34 percent equity position in Visibility, Inc., a privately held company involved in engineer-to-order software for large customers selling and managing complex products. Visibility’s revenue has grown in each of the past three years, reaching $30.2 million in 1998. The company added a new product line in 1998 allowing it to address a sizable new market.
• An approximately 30 percent equity position in Risk Laboratories, a privately held company involved in risk management software for corporate risk departments. In its first full year of product sales, Risk secured license and service contracts with a number of large corporate clients and is in the process of rounding out its management team to address the market opportunity aggressively. Our investment in Risk is recorded at zero on our balance sheet.
• A minority equity position in BT Squared Technologies, a privately held company involved in sales and order configuration software. BT Squared just completed a successful year of product sales and raised a new round of venture capital.
• A minority equity position in InfoWave Technologies, a privately held company involved in web-based resource and revenue management solutions for the professional services market. InfoWave has just raised a round of venture capital.
• A small investment in Media Metrix, a leader in providing statistically valid tools and methodology to measure Internet use and user demographics, an important component underlying the growth in Internet advertising and electronic business. Media Metrix recently filed a registration statement for an initial public offering.
• We recently completed the sale of the last of our holdings in Information Advantage, Inc., (formerly IQ Software Corporation), a software company in which we had been involved since prior to its initial public offering in 1992.
• We held a 23.5 percent equity position in Paragon Interface, a privately held company involved in data mapping and translation software, until we sold our interest in April 1998, doubling our investment in less than two years.

At February 28, 1999, to house our manufacturing, sales, service and administration operations, we have leases covering approximately 144,000 square feet in two facilities in Atlanta, GA and 6,100 square feet in Greenville, SC. We believe our leased facilities are adequate for our existing and foreseeable business operations. A portion of the Atlanta corporate facility is subleased to businesses in the small business incubator.

As noted earlier, our HumanSoft subsidiary has filed for relief under Chapter 11 of the federal bankruptcy code. While we believe we have taken adequate reserves for this situation, there can be no assurance that unanticipated claims or expenses related to this proceeding will not arise.

We are party to a small number of other legal matters arising in the ordinary course of business. It is management’s opinion that none of these matters will have a material adverse impact on our consolidated financial position or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

We did not submit any matter to a vote of our shareholders during the fiscal quarter ended December 31, 1998.

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed and traded on the American Stock Exchange ("AMEX") under the symbol "INS". The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock as reported by AMEX.

We had 512 shareholders of record as of February 26, 1999. We did not declare or pay any cash dividends in the two-year period ended December 31, 1998 nor do we intend to pay dividends in the foreseeable future.

Effective July 1, 1997, we acquired QS, Inc. and on January 1, 1998, we acquired JK, Inc. In both cases, we have included their results of operations in our consolidated results since the acquisition date. Effective April 1, 1998, we sold our Intelligent Enclosures’ business and have not included its results since the sale date. In August 1998, our HumanSoft subsidiary discontinued certain product lines and, in November, filed a petition for relief under Chapter 11 of the federal bankruptcy code. A significant amount of the variance in operating results in the past two years can be attributed to these transactions and events.

Note 18 to the Consolidated Financial Statements explains that on February 1, 1999, we completed the sale of our InterQuad Services company. Consequently, in future periods, our principal consolidated businesses will be ChemFree Corporation, the QS Technologies subsidiary of HumanSoft, and PsyCare America, along with the corporate holding company. As a result, our performance in past periods is not likely to be indicative of operating results to be expected in future periods.

Net sales are derived from two major areas: technology-related products and services and health care services. Historically, our principal consolidated subsidiaries in the technology segment were InterQuad Services (software training programs), ChemFree Corporation (bio-remediating parts washers), Intelligent Enclosures (mini-environment systems) and HumanSoft LLC, which includes the QS Technologies and JK operations (health and human services software). Our consolidated subsidiary in the health care segment is PsyCare America (specialty psychiatric treatment programs).

The net loss in 1998 was lower than in 1997 principally because we recorded investment income of $5.8 million, which offset to a large extent the operating losses of our consolidated businesses.

Sales – Net sales in 1998 were $18,253,000, a decline of 14 percent compared to 1997. The decrease is related to the sale of the Intelligent Enclosures business in early 1998 and the continued decline in revenue derived from the PsyCare operations, offset in part by an increased volume of products and services at ChemFree and InterQuad. In the last quarter of 1998, HumanSoft’s contribution to our revenue was substantially lower than in prior periods as a result of discontinuing two product lines and the Chapter 11 bankruptcy filing. Only the QS Technologies subsidiary of HumanSoft continues to generate license and maintenance revenue from software products.

Net sales in 1997 were $21,160,000 compared to $23,678,000 in 1996. Although each of the technology sector companies experienced revenue increases ranging from 11 percent to almost 100 percent, the 11 percent decline overall is attributed to a decrease of more than 45 percent in revenue derived from the PsyCare operations. PsyCare had fewer inpatient programs in 1997 than in 1996 and the contract reimbursement rates were lower in 1997 than in 1996. In the technology sector, the companies sold a greater volume of products and services in 1997 than in 1996. We also benefited from the acquisition of QS on July 1, 1997.

Health care services represent 23 percent, 29 percent and 55 percent of revenue in 1998, 1997 and 1996, respectively. The sharp decline in the contribution of the health care services is due to fewer inpatient programs and lower reimbursement rates at the PsyCare subsidiary. Revenue derived from international sales was 39 percent in 1998, compared to 33 percent in 1997 and 25 percent in 1996. The increase in each of the past two years was due to higher sales volume at the InterQuad subsidiary coupled with a decrease in PsyCare’s revenues, which are all domestic.

Cost of Sales – Cost of sales in 1998 was 68 percent of revenue compared to 62 percent in 1997. Although ChemFree, InterQuad and PsyCare reduced their respective cost of sales as a percentage of revenue in 1998 as compared to 1997, HumanSoft’s cost of sales increased dramatically. For much of 1998, HumanSoft’s expenses increased significantly for technical personnel to develop, install and support software for which the company was unable to record sufficient new revenue.

Cost of sales in 1997 was 62 percent of revenue compared to 54 percent of revenue in 1996. Cost of sales differs for each of our subsidiaries, ranging in 1997 from 50 to 72 percent of revenue. The overall increase in cost of sales as a percentage of revenue relates mainly to higher cost of services at the InterQuad subsidiary due to increased use of high paid contractors to conduct training classes for part of the year as a result of a shortage of qualified employees. In addition, PsyCare experienced lower average rates on contract reimbursement for inpatient programs.

Operating Expenses – In 1998, marketing expenses declined in absolute terms but increased as a percentage of revenue compared to 1997. This change represents the net effect of increased expenditures in the technology sector to support more customers and higher revenue levels offset by a decline in marketing spending at PsyCare due to a decline in in-patient hospital programs. Furthermore, in contrast to the prior period, in 1998 we include the operating expenses related to two acquired companies, JK and QS, for the full year. General and administrative expenses were $7.3 million in 1998 compared to $7.6 million in the prior year. PsyCare reduced expenses significantly through lower staffing levels and expense control, as did our corporate group. At the same time, however, general and administrative expenses at HumanSoft increased significantly. The increase includes a third-quarter charge of $955,000 to discontinue two product lines, a $191,000 restructuring charge in the first quarter following the JK acquisition, and increased amortization expense related to the acquisitions. The $955,000 charge includes a goodwill write-off of $558,000. Research and development expense for 1998 includes a one-time expense of $944,000 to allocate a portion of the JK purchase price to in-process research and development as well as increased new product development spending in the first 8 months of this year. By comparison, in 1997, R&D expense includes a one-time charge of $953,000 to allocate a portion of the QS purchase price to in-process research and development.

In 1997, marketing and general and administrative expenses declined by approximately 17 percent and 4 percent, respectively, compared to 1996 on an 11 percent decline in revenue. PsyCare reduced its marketing expenses significantly in line with lower revenue levels, while activities to generate and support higher sales volume increased expenses at certain technology subsidiaries. General and administrative expenses declined in absolute values year-to-year but increased slightly as a percentage of revenue in 1997 compared to 1996. The acquisition of QS increased overhead expenses in the second half of the year. Research and development expense was $$1.5 million in 1997 compared to $286,000 in 1996. The difference is due principally to a non-recurring charge of $953,000 booked in the third quarter of 1997 related to the allocation of a portion of the QS purchase price to in-process research and development. New product development at the HumanSoft operation contributed to the remaining increase.

Interest Income – In 1998, we recorded net interest expense of $289,000 compared to net interest income of $350,000 in the prior year. In 1998, we had interest expense on notes payable principally to the sellers of QS and JK as well as interest on a higher level of bank debt in 1998 than in 1997. We also earned less interest on interest-bearing notes receivable because some of the notes were repaid early in 1998. Net interest income in 1997 of $350,000 was 30 percent lower than in 1996. Higher interest expense in 1997 as well as a reduction in interest-bearing notes receivable contributed to the lower income level.

Investment Income – In 1998, we recorded a net gain of $5.8 million on investments compared to a net loss of $2.6 million in 1997. The main components of 1998 investment income include a gain of $1.0 million on the sale of IQ Software common stock, a gain of $2.5 million on the sale of PaySys stock, a gain of $457,000 on the sale of Paragon Interface stock, a gain of $1.2 million on the sale of the IE business, and $593,000 in net gains in the equity of investments accounted for by the equity method. Refer to Note 3 for details on the transactions mentioned in this section.

In 1997, we recorded a net loss of $2.6 million on investments compared to net investment income of $5.8 million in 1996. In 1997, the principal components of this category include a gain of $1.9 million on the sale of PaySys stock (see Note 3), a gain of $469,000 on the sale of an investment in Astra Communications, a gain of $217,000 on the sale of OrCAD stock (see Note 3), a $3.0 million write-off of a note receivable from DayStar Digital, Inc. and $2.3 million in net losses in the equity of investments accounted for by the equity method.

In 1996, we recorded gains of $6.6 million on aggregate sales of 315,000 shares of common stock of IQ Software Corporation. We also recorded a gain, net of taxes, of $337,000 on the sale of 104,484 shares of OrCAD, Inc. common stock in OrCAD’s initial public offering (see Note 3). In the fourth quarter of 1996, we incurred a charge of $1.0 million to reduce the carrying value of its minority equity investment in DayStar.

Other Income – Other income/expense in each of the last three years consists mainly of various minor, non-recurring sources of income and expense.

Taxes – We recognized a tax benefit in 1998 due to a net operating loss carryback at the JK, Inc. subsidiary. Taxes payable in 1997 relate to the operations of the QS, Inc. subsidiary acquired in 1997.

Common Shares – We repurchased common shares in 1996 and 1997 under a stock repurchase program. The repurchases resulted in 5,104,467 shares outstanding at December 31, 1998 and 1997 and 5,126,767 shares outstanding at December 31, 1996.

Year 2000 Readiness – We are in the process of analyzing potential problems arising from the inability of certain computer programs to correctly interpret dates designated as "00" as the year 2000 rather than the year 1900. We have reviewed our internal computer-based systems, have inquired of our key vendors and suppliers as to their Year 2000 readiness and anticipated problems, if any, and have received favorable responses. We intend to upgrade any non-compliant internal systems by September 1999 using our employees and readily available software. Our QS Technologies subsidiary licenses software to its customers and has either migrated its customers to software versions that we believe are Year 2000 compliant or has previously informed customers that certain older software versions would no longer be supported. We anticipate the cost to address internal compliance updates to be less than $100,000.

Presently, we do not anticipate a material impact on our operations or financial position. However, we have investments in a number of companies over which we do not exercise control. To the extent that any company in which we have a significant investment experiences a material negative impact on its business, the long-term value of our investment could be reduced. There can be no assurance that QS Technologies’ software products that are designed to be Year 2000 compliant contain all necessary date code changes or that we will not be exposed to potential claims resulting from system problems associated with the century change. In addition, Year 2000 non-compliance in our internal IT systems or by our business partners may have an adverse impact on our business, financial condition or results of operations. Because we have not yet identified any business function that is materially at risk of Year 2000 related disruption, we have not yet developed a contingency plan specific to Year 2000 events. We are prepared for the possibility, however, that we may identify risks in certain business functions, and we plan to develop contingency plans for these business functions when and if we identify them as being at risk.

Recent Accounting Pronouncements – In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income". The Statement requires companies to report comprehensive income and its components in its financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity in a period. We adopted the disclosure requirements of this statement in March 1998.

In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Statement requires a management approach to be used when reporting business segments. Reportable segments are based on products and services, geography, legal structure or management structure. We adopted the disclosure requirements of this statement in March 1998. Refer to Note 15.

In October 1997, the AICPA issued Statement of Position 97-2, "Software Revenue Recognition". SOP 97-2 clarifies and changes some software recognition practices and supersedes the existing guidance of SOP 91-1. We adopted SOP 97-2 effective January 1, 1998. Adopting SOP 97-2 did not have a material impact on our financial position or results of operations.

Liquidity and Capital Resources

In 1998, we derived most of our cash from the sale of common stock of IQ Software (now Information Advantage) for $1.2 million, the sale of our interest in Paragon Software and payment of a Paragon note for a total of $989,000, the sale of shares of common stock of PaySys for $2.5 million, advances of $750,000 under a bank loan at the InterQuad subsidiary, and a net cash return of $589,000 on another minority investment. Details on these sales are found in Note 3. We used approximately $5.3 million cash in 1998 to fund operating losses at certain subsidiaries (the majority of which relates to the HumanSoft operation), $200,000 for the initial payment related to the acquisition of JK, $700,000 to repay a domestic bank line, and $500,000 for a principal payment on a note related to the acquisition of QS. Accounts receivable are lower at December 31, 1998 than at December 31, 1997 mainly because of improved collection activity, lower revenue levels at the PsyCare subsidiary and reserves taken at the HumanSoft subsidiary related to the decision to discontinue certain product lines.

In 1997, our main sources of cash were $2.0 million from the sale of PaySys shares (see Note 3), $1.7 million from the sale of investments in OrCAD and Astra Communications, advances totaling approximately $700,000 under bank lines of credit, advances under short-term notes totaling $778,000, the maturity of certificates of deposit totaling $1.1 million and approximately $1.0 million generated from operations. We used approximately $870,000 to fund the acquisition of QS (see Note 2), $4.6 million to acquire a 34 percent equity position in Visibility, Inc. (a privately held software company), $1.7 million to increase our long-term investments in several small, privately-held technology companies, $1.2 million in net advances under loans to companies in which we hold long-term investments and $1.2 million to acquire property and equipment mainly for new facilities at the InterQuad subsidiary. Notes payable and long-term debt at December 31, 1997 are comprised of $700,000 in bank debt, $1.5 million in notes payable to the sellers of QS, and $778,000 in notes related to two acquisitions of long-term investments.

Early in 1999, we sold our remaining 95,449 shares of Information Advantage stock, generating $902,000 cash. We expect to need less cash to support subsidiary operating losses in 1999 than in 1998. Although our cash position will limit new investments in the near future, presently we believe we have adequate access to capital through bank borrowings or sale of assets to support current operations and plans. As explained in Note 1 to the Consolidated Financial Statements, a substantial deterioration in the financial condition of companies in which we have significant long-term investments could have an adverse effect on the company.

ITEM 7A. Quantitative and Qualitative disclosures about market risk

Not applicable.

The response to this item is submitted as a separate section of this report. See page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

No independent public accountant of the company has resigned, indicated any intent to resign or been dismissed as the independent public accountant of the company during the two years ended December 31, 1998 or at any time afterward.

Please refer to the subsection entitled "Proposal 1 - The Election of Directors - Nominees" and "Proposal 1 - The Election of Directors - Executive Officers" in our Proxy Statement for the Annual Meeting of Shareholders to be held on June 11, 1999 for information about those individuals nominated as directors and about the executive officers of the company. This information is incorporated into this Item 10 by reference. Information regarding compliance by directors and executive officers of the company and owners of more than 10 percent of our common stock with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, is contained under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement mentioned above. This information is incorporated into this Item 10 by reference.

ITEM 11. EXECUTIVE COMPENSATION

Please refer to the subsection entitled "Proposal 1 - The Election of Directors - Executive Compensation" in the Proxy Statement referred to in Item 10 for information about management compensation. This information is incorporated into this Item 11 by reference, except that we specifically do not incorporate into this Item 11 the information in the subsections entitled "Proposal 1 - The Election of Directors - Executive Compensation - Board Compensation Committee Report on Executive Compensation" and "Performance Graph."

Please refer to the subsection entitled "Voting - Principal Shareholders, Directors and Certain Executive Officers" in the Proxy Statement referred to in Item 10 for information about the ownership of our $0.01 par value common stock by certain persons. This information is incorporated into this Item 12 by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.

1. Financial Statements

The following consolidated financial statements and related reports of independent public accountants are included in this report and are incorporated by reference in Part II, Item 8 hereof. See the Index to Financial Statements and Supplemental Schedules on page F-1 hereof.

Report of Independent Public Accountants

Consolidated Balance Sheets at December 31, 1998 and 1997

Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996

Consolidated Statements of Changes in Stockholders’ Equity for the

years ended December 31, 1998, 1997 and 1996

Consolidated Statements of Cash Flow for the years ended December 31, 1998, 1997 and 1996

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

We are including the financial statement schedules listed below in this report. We omitted all other schedules required by certain applicable accounting regulations of the Securities and Exchange Commission because the omitted schedules are not required under the related instructions or do not apply or because we have included the information required in the consolidated financial statements or notes thereto. See the Index to Financial Statements and Supplemental Schedules on page F-1 hereof.

Schedule II - Valuation and Qualifying Accounts and Reserves

Report of Independent Auditors for InterQuad Services Limited

Report of Independent Auditors for PaySys International, Inc.

Consolidated Balance Sheets of PaySys at December 31, 1998 and 1997

Consolidated Statements of Operations of PaySys for the three years ended December 31, 1998

Consolidated Statements of Changes in Stockholders’ Equity of PaySys for the three years ended December 31, 1998

Consolidated Statements of Cash Flow of PaySys for the three years ended December 31, 1998

Notes to Consolidated Financial Statements of PaySys

Report of Independent Auditors for Visibility, Inc.

Consolidated Balance Sheets of Visibility at December 31, 1998 and 1997

Consolidated Statements of Operations of Visibility for the three years ended December 31, 1998

Consolidated Statements of Changes in Stockholders’ Equity of Visibility for the three years ended December 31, 1998

Consolidated Statements of Cash Flow of Visibility for the three years ended December 31, 1998

Notes to Consolidated Financial Statements of Visibility

3. Exhibits

We are filing the following exhibits with this report or incorporating them by reference to earlier filings. Shareholders may request a copy of any exhibit by contacting Bonnie L. Herron, Secretary, Intelligent Systems Corporation, 4355 Shackleford Road, Norcross, Georgia 30093; telephone (770) 381-2900. There is a charge of $.50 per page to cover expenses of copying and mailing.

1. Securities Purchase Agreement between Intelligent Systems Corporation and Advent Global GECC III Limited Partnership dated July 1, 1998.
      
   3(i) Articles of Amendment of Articles of Incorporation dated November 25, 1997. (Incorporated by reference to Exhibit 3.1 to the Registrant’s Report on Form 8-K dated November 25, 1997.)
      
   3(ii) Bylaws of the Registrant dated June 6, 1997. (Incorporated by reference to Exhibit 3(ii) of the Registrant’s Form 10-K/A for the year ended December 31, 1997.)
     
2. See Exhibits 3(i) and 3(ii) for instruments defining rights of holders of Common Stock and Preferred Stock of Registrant.
3. 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.)
4. Form of Rights Certificate. (Incorporated by reference to Exhibit 4.2 of the Registrant’s Report on Form 8-K dated November 25, 1997.)
5. Lease Agreement dated March 11, 1985, between a subsidiary of the Registrant and A.R. Weeks. (Incorporated by reference to Exhibit 10.1 to Intelligent Systems Corporation Annual Report on Form 10-K for the fiscal year ended March 31, 1986.)
6. Second Amendment to Lease Agreement dated June 19, 1997 between a subsidiary of the Registrant and A.R. Weeks. (Incorporated by reference to Exhibit 10.2 of the Registrant’s Form 10-K for the year ended December 31, 1997.)

10.3 Management Compensation Plans and Arrangements:

(a) Intelligent Systems Corporation 1991 Stock Incentive Plan, amended June 6, 1997.

(b) Intelligent Systems Corporation Change in Control Plan for Officers.

(c) Intelligent Systems Corporation Outside Director’s Retirement Plan.

Item 10.3 (a) is incorporated by reference to Exhibit 4.1 of the Registrant’s Form S-8 dated July 25, 1997.

Items 10.3 (b) and (c) are incorporated by reference to Exhibit 10.4 to Registrant’s Form 10-K for the year ended December 31, 1993.

7. Form of Promissory Note of Registrant in favor of sellers of QS, Inc. dated as of July 1, 1997. (Incorporated by reference to Exhibit 10.5 of the Registrant’s Form 10-K for the year ended December 31, 1997.)

23.2 Consent of Morley and Scott.

3. Consent of Ernst and Young LLP.

We did not file any reports on Form 8-K during the quarter ended December 31, 1998.

4. See Item 14(a)(2) above.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.

INTELLIGENT SYSTEMS CORPORATION

Registrant

Date: April 21, 1999 By: /s/ J. Leland Strange

J. Leland Strange

Chairman of the Board, President

and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

The following consolidated financial statements and schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 8:

Financial Statements:

Report of Independent Public Accountants F-2

Consolidated Balance Sheets - December 31, 1998 and 1997 F-3

Notes to Consolidated Financial Statements F-7

The following supplemental schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 14(a)(2):

Schedule II - Valuation and Qualifying Accounts and Reserves S-1

Report of Independent Auditors for InterQuad Services Limited S-2

Report of Independent Auditors for PaySys International, Inc. S-3

Consolidated Balance Sheets of PaySys at December 31, 1998 and 1997 S-4

Consolidated Statements of Operations of PaySys for the three years ended December 31, 1998 S-5

Consolidated Statements of Cash Flow of PaySys for the three years ended December 31, 1998 S-7

Notes to Consolidated Financial Statements of PaySys S-8

Report of Independent Auditors for Visibility, Inc. S-31

Consolidated Balance Sheets of Visibility at December 31, 1998 and 1997 S-32

Consolidated Statements of Operations of Visibility for the three years ended December 31, 1998 S-33

Consolidated Statements of Cash Flow of Visibility for the three years ended December 31, 1998 S-35

Notes to Consolidated Financial Statements of Visibility S-36

Schedule II – Valuation and Qualifying Accounts S-50

ORGANIZATION AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES

Organization – Intelligent Systems Corporation, a Georgia corporation was formed in November 1991 to acquire through merger the business, net assets and operations of Intelligent Systems Master, L.P. In this document, terms such as the company, we and us refer to Intelligent Systems Corporation.

Nature of Operations – Our business is to create, manage and invest in businesses which we believe have promising growth potential. Consolidated companies (in which we have majority ownership and control) are principally engaged in two industries: technology related products and services and health care services (as defined more specifically in Note 15). Our affiliate companies (in which we have a minority ownership or non-controlling interest) are mainly involved in the technology industry.

Use of Estimates – In preparing the financial statements in conformity with generally accepted accounting principles, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. These estimates and assumptions also affect amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Consolidation – The financial statements include the accounts of Intelligent Systems Corporation and its majority owned and controlled U.S. and non-U.S. subsidiary companies after elimination of material accounts and transactions between our subsidiaries.

Investments – For entities in which we have 20 to 50 percent ownership interest or where majority ownership is temporary, we account for these investments by the equity method. We account for investments of less than 20 percent in non-marketable equity securities at the lower of cost or market. When calculating gain or loss on the sale of an investment, we use the average cost basis of the securities. Marketable securities are accounted for in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115). At December 31, 1998, the aggregate fair value of our available-for-sale securities, which consist primarily of 95,449 shares of common stock of Information Advantage, Inc. (successor by merger to IQ Software Corporation (IQ)) totaled $725,000. At December 31, 1997, the aggregate fair value of our available-for-sale securities, which consist primarily of 157,801 shares of IQ common stock, totaled $1,288,000. These amounts include unrealized holding gains of $633,000 and $836,000 as of December 31, 1998 and 1997, respectively. These amounts are reflected as a separate component of stockholders’ equity.

We classify short-term investments as trading securities under SFAS No. 115. The impact on the December 31, 1998 and 1997 financial statements of applying SFAS No. 115 to the trading securities was immaterial. Our investment in Visibility represents approximately $5.6 million of our long-term investments at December 31, 1998 (see Note 4). If the financial condition of Visibility deteriorates, it could have an adverse effect on our financial condition.

Translation of Foreign Currencies – We consider that local currencies are the functional currencies for foreign operations. We translate assets and liabilities to U.S. dollars at year-end exchange rates. We translate income and expense items at average rates of exchange prevailing during the year. Translation adjustments are accumulated as a separate component of stockholders’ equity. Earnings include gains and losses that result from foreign currency transactions.

Inventories – We state the value of inventories at the lower of cost or market. Cost includes labor, materials and production overhead. Market is defined as net realizable value.

Property and Equipment – Property and equipment are carried at cost. For financial reporting purposes, we depreciate these assets using the 150 percent declining balance method over the estimated lives of the assets, as follows:

Accumulated depreciation and amortization was $2,241,000 and $2,632,000 at December 31, 1998 and 1997, respectively.

Intangibles – Intangibles are carried at cost net of related amortization. When we acquire a business, we generally amortize the excess of the cost of the acquisition over underlying net assets of the business acquired over three to five year periods using the straight-line method. Accumulated amortization of intangibles totaled $2.7 million and $1.8 million at December 31, 1998 and 1997, respectively. Our policy is to write off the asset and accumulated amortization for fully amortized intangibles. Periodically we review the values assigned to intangible assets to determine whether they have been permanently impaired. To measure whether goodwill is recoverable, we use an estimate of the undiscounted cash flows of the applicable entity over the remaining life of the goodwill. In 1998, we wrote off $558,000 of goodwill associated with discontinuing certain product lines of the HumanSoft subsidiary (see Note 17). This write-off is reflected in general and administrative expense in the accompanying statements of operations. In 1998, 1997 and 1996, we recorded intangible amortization expense of approximately $957,000, $604,000 and $332,000, respectively. In 1998, we expensed $944,000 of purchased research and development related to the acquisition of JK, Inc. (see Note 2). In 1997, we expensed $953,000 of purchased research and development related to the acquisition of QS, Inc. (see Note 2). These expenses are included in research and development expense on the accompanying statements of operations.

Accrued Expenses and Other Current Liabilities – Accrued expenses and other liabilities at December 31, 1998 and 1997 consist of the following:

Warranty Costs – We accrue the estimated costs associated with product warranties as an expense in the period the related sales are recognized.

Revenue Recognition –Sales of software licenses, technology-related products and services and health care services make up our revenue. We recognize revenue when products are shipped or, in the case of service providers, when the services are rendered. Revenue recognition practices for software are in accordance with Statement of Position 97-2, "Software Revenue Recognition". Generally, we recognize software license revenue upon delivery of the software and related documentation when there are no significant remaining obligations. We accrue the costs of insignificant remaining obligations at the time that we recognize software license revenue. Service fees received from the sale of software maintenance and support contracts provide customers access to technical support and minor upgrades to licensed revenues. These fees are recognized as services are provided over the life of such contracts. We provide for estimated sales returns in the period in which the sales are recorded.

Financial Instruments – The carrying value of cash, accounts receivable, accounts payable and other financial instruments included in the accompanying balance sheets approximates their fair value principally due to the short-term maturity of these instruments.

Cost of Sales – Cost of sales includes direct material, direct labor and production overhead for product companies and direct cost of services rendered for service companies.

Recent Accounting Pronouncements – In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income". The Statement requires companies to report comprehensive income and its components in its financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity in a period. We adopted the disclosure requirements of this statement in March 1998.

In June 1997, the Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information". The Statement requires a management approach to be used when repo