Integral Systems (ISYS) 10-Q 2005 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(mark one)

x Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2005

or

¨ Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from            to            

Commission file number 0-18603

INTEGRAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Maryland	52-1267968
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
5000 Philadelphia Way, Lanham, MD	20706
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code (301) 731-4233

(Former name, address and fiscal year, if changed since last report)

Indicate by checkmark 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 checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

Registrant had 10,375,653 shares of common stock outstanding as of April 28, 2005.

INTEGRAL SYSTEMS, INC.

TABLE OF CONTENTS

			Page No.
PART I.FINANCIAL INFORMATION:
	Item 1.	Financial Statements
		Consolidated Balance Sheets – March 31, 2005 (unaudited) and September 30, 2004	1
		Unaudited Consolidated Statements of Operations – Three and Six Months Ended March 31, 2005 and March 31, 2004	3
		Unaudited Consolidated Statement of Stockholders’ Equity - Six Months Ended March 31, 2005	4
		Unaudited Consolidated Statements of Cash Flows – Six Months Ended March 31, 2005 and March 31, 2004	5
		Notes to Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
	Item 4.	Controls and Procedures	30
PART II.OTHER INFORMATION:
	Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	31
	Item 6.	Exhibits	32
	Signatures		33

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2005 and September 30, 2004

ASSETS

	March 31, 2005 (unaudited)		September 30, 2004
CURRENT ASSETS
Cash	$	25,170,698	$	18,198,832
Marketable Securities		30,106,000		29,060,396
Accounts Receivable, net		34,662,299		39,628,515
Notes Receivable		480,663		263,913
Prepaid Expenses		573,465		632,595
Inventory		1,095,414		1,312,161
Deferred Income Tax - Current Portion		941,866		855,700
Income Taxes Receivable		38,018		—
TOTAL CURRENT ASSETS		93,068,423		89,952,112
FIXED ASSETS
Electronic Equipment		4,190,980		4,884,764
Furniture & Fixtures		548,822		876,255
Leasehold Improvements		1,509,087		1,345,634
Software Purchases		752,938		846,413
SUBTOTAL - FIXED ASSETS		7,001,827		7,953,066
Less: Accum. Depreciation		3,378,590		4,395,933
TOTAL FIXED ASSETS		3,623,237		3,557,133
OTHER ASSETS
Notes Receivable - Non-Current		294,583		300,338
Intangible Assets, net		499,993		637,493
Goodwill		33,338,775		33,256,186
Software Development Costs		3,898,885		4,591,904
Deposits and Deferred Charges		160,927		171,275
TOTAL OTHER ASSETS		38,193,163		38,957,196
TOTAL ASSETS	$	134,884,823	$	132,466,441

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2005 and September 30, 2004

LIABILITIES & STOCKHOLDERS’ EQUITY

	March 31, 2005 (unaudited)		September 30, 2004
CURRENT LIABILITIES
Accounts Payable	$	4,052,089	$	5,491,629
Accrued Expenses		5,835,971		13,893,662
Capital Leases Payable		36,636		35,119
Billings in Excess of Revenue		7,868,816		5,581,124
Income Taxes Payable		0		672,148
TOTAL CURRENT LIABILITIES		17,793,512		25,673,682
LONG TERM LIABILITIES
Capital Leases Payable		6,413		25,119
Deferred Income Taxes		1,428,340		1,428,344
TOTAL LONG TERM LIABILITIES		1,434,753		1,453,463
STOCKHOLDERS’ EQUITY
Common Stock, $.01 par value, 40,000,000 shares authorized, and 10,368,893 and 9,944,494 shares issued and outstanding at March 31, 2005 and September 30, 2004, respectively		103,689		99,445
Additional Paid-in Capital		89,097,887		81,201,927
Retained Earnings		26,344,551		24,010,558
Accumulated Other Comprehensive Income		110,431		27,366
TOTAL STOCKHOLDERS’ EQUITY		115,656,558		105,339,296
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	134,884,823	$	132,466,441

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended March 31,						Six Months Ended March 31,
	2005			2004			2005			2004
Revenue	$	23,346,768		$	22,508,021		$	45,266,302		$	42,562,322
Cost of Revenue
Direct Labor		5,593,558			5,000,074			10,155,415			9,271,044
Overhead Costs		4,328,298			3,676,326			8,289,388			7,191,199
Travel and Other Direct Costs		656,087			672,061			1,169,716			1,220,776
Direct Equipment & Subcontracts		5,437,326			5,215,790			11,185,220			10,310,818
Total Cost of Revenue		16,015,269			14,564,251			30,799,739			27,993,837
Gross Margin		7,331,499			7,943,770			14,466,563			14,568,485
Selling, General & Administrative		3,112,946			3,228,720			6,884,952			6,085,163
Research & Development		470,228			915,251			1,252,998			1,706,492
Product Amortization		645,407			761,381			1,290,816			1,522,762
Intangible Asset Amortization		68,750			322,264			137,500			644,529
Income From Operations		3,034,168			2,716,154			4,900,297			4,609,539
Other Income (Expense)
Interest Income		258,160			140,323			471,227			309,409
Interest Expense		(1,588	)		(1,739	)		(3,073	)		(4,145	)
Gain (Loss) on Sale of Marketable Securities		(3,764	)		0			49,997			21,439
Miscellaneous, net		(112,794	)		(65,735	)		(420,057	)		(283,963	)
Total Other Income		140,014			72,849			98,094			42,740
Income Before Income Tax		3,174,182			2,789,003			4,998,391			4,652,279
Provision for Income Taxes		1,124,712			1,008,768			1,763,534			1,698,233
Net Income	$	2,049,470		$	1,780,235		$	3,234,857		$	2,954,046
Weighted Avg. Number of Common Shares:
Basic		10,258,510			9,955,794			10,151,819			9,843,386
Diluted		10,405,110			10,076,410			10,289,642			9,977,816
Earnings per Share (Basic)	$	0.20		$	0.18		$	0.32		$	0.30
Earnings per Share (Diluted)	$	0.20		$	0.18		$	0.31		$	0.30

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED MARCH 31, 2005

(Unaudited)

	Number of Shares		Common Stock At Par Value			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance September 30, 2004	9,944,494		$	99,445		$	81,201,927		$	24,010,558		$	27,366		$	105,339,296
Net Income	—			—			—			3,234,857			—			3,234,857
Unrealized Loss on Marketable Securities (net of deferred tax of $9,129)	—			—			—			—			(14,281	)		(14,281	)
Unrealized Gain on Foreign Currency Exchange Contracts	—			—			—			—			20,843			20,843
Effect of Currency Translation	—			—			—			—			76,503			76,503
Total Comprehensive Income	—			—			—			—			—			3,317,922
Repurchased Shares	(8,100	)		(81	)		(62,663	)		(82,726	)		—			(145,470	)
Shares Issued for FY04 RT Logic Earnout	230,349			2,303			4,184,059			—			—			4,186,362
Stock Options Exercised	202,150			2,022			3,774,564			—			—			3,776,586
Declared Dividends	—			—			—			(818,138	)		—			(818,138	)
Balance March 31, 2005	10,368,893		$	103,689		$	89,097,887		$	26,344,551		$	110,431		$	115,656,558

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INTEGRAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended March 31, 2005 and 2004

(Unaudited)

	For the Six Months Ended March 31,
	2005			2004
Cash flows from operating activities:
Net income	$	3,234,857		$	2,954,046
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,194,942			3,001,933
Reserve for doubtful accounts		(10,000	)		65,325
Gain on sale of marketable securities		(49,997	)		(21,439	)
Gain on warrants		—			(95,000	)
Loss on disposal of fixed assets		35,874			33,604
Changes in operating assets and liabilities, net:
Accounts receivable and other receivables		4,969,706			(2,041,232	)
Prepaid expenses and deposits		82,606			(87,343	)
Inventories		(128,121	)		(700,132	)
Accounts payable		(1,464,586	)		363,315
Accrued expenses		(3,888,532	)		(3,646,736	)
Billings in excess of revenue		2,287,692			(294,135	)
Income taxes payable		(656,581	)		(462,691	)
Total adjustments		3,373,003			(3,884,531	)
Net cash provided by (used in) operating activities		6,607,860			(930,485	)
Cash flows from investing activities:
Purchases of marketable securities		(1,195,000	)		(115,691	)
Sale of marketable securities		175,983			169,837
Issuance of notes receivable		(54,906	)		—
Proceeds from payments on notes receivable		110,515			61,353
Acquisition of fixed assets		(947,080	)		(517,092	)
Software development costs		(597,798	)		(1,094,223	)
Net cash (used in) investing activities		(2,508,286	)		(1,495,816	)
Cash flows from financing activities:
Proceeds from issuance of common stock		3,776,586			410,998
Stock repurchases		(145,470	)		(81,385	)
Dividend Payments		(818,138	)		—
Capital lease obligation payments		(17,189	)		(15,793	)
Net cash provided by financing activities		2,795,789			313,820
Effect of currency translations		76,503			44,537
Net increase in cash		6,895,363			(2,112,481	)
Cash – beginning of year		18,198,832			22,526,718
Cash - end of period	$	25,170,698		$	20,458,774

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The interim financial statements include the accounts of Integral Systems, Inc. (the “Company”) and its wholly owned subsidiaries, SAT Corporation (“SAT”), Newpoint Technologies, Inc. (“Newpoint”), Real Time Logic, Inc. (“RT Logic”), and Integral Systems Europe (“ISI Europe”). All significant intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, the financial statements reflect all adjustments consisting only of normal recurring accruals necessary for a fair presentation of results for such periods. The financial statements, which are condensed and do not include all disclosures included in the annual financial statements, should be read in conjunction with the consolidated financial statements of the Company for the fiscal year ended September 30, 2004. The results of operations for any interim period are not necessarily indicative of results for the full year.

2. Accounts Receivable

Accounts receivable at March 31, 2005 and September 30, 2004 consisted of the following:

	March 31, 2005			Sept. 30, 2004
Billed	$	12,991,225		$	15,117,607
Unbilled		21,677,006			24,467,186
Other		134,068			193,722
Reserve		(140,000	)		(150,000	)
Total	$	34,662,299		$	39,628,515

The Company’s accounts receivable consist of amounts due on prime contracts and subcontracts with the U.S. Government and contracts with various commercial and international organizations. Unbilled accounts receivable consist principally of amounts that are billed in the month following the incurrence of cost, amounts related to indirect cost variances on cost reimbursable type contracts or amounts related to milestones that are delivered under fixed price contracts. Substantially all unbilled receivables are expected to be billed and collected within one year.

The reserve for doubtful accounts is determined based upon management’s best estimate of potentially uncollectible accounts receivable.

In June 2004, the Company filed a claim in the amount of approximately $1.8 million against the National Oceanic Atmospheric Administration (NOAA) of the U.S. Department of Commerce. The claim arose under a contract with NOAA to provide the Data Collection System Automated Processing System II (DAPS-II System). Additional costs were incurred in the performance of this contract during the first and second quarter of fiscal year 2005. Additional revenue was recognized in the first quarter only. As of March 31, 2005, unbilled accounts receivable included approximately $1.3 million associated with the claim.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

3. Line of Credit

The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5% to 2.4% based on the ratio of funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable, inventory, equipment and insurance proceeds and has certain financial covenants, including minimum net worth and liquidity ratios. The Company had no balance outstanding at March 31, 2005 under the line of credit. The line of credit expires on February 28, 2007.

The Company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $43,000 at March 31, 2005. The outstanding balance is payable over a 14-month period and bears interest at a rate of 8.8% per annum.

4. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) 123 (Revised 2004),Shared-Based Payment. Revised SFAS 123 addresses the requirements of an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which an employee is required to provide services in exchange for the award. The Company will be required to adopt this Statement during the first quarter of fiscal year 2006 and is currently evaluating the impact that this pronouncement will have on its future operations and financial reporting.

5. Stock-Based Compensation

The Company recognizes expense for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost is recognized for the excess of the estimated fair value of the stock at the grant date over the exercise price, if any.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

5. Stock-Based Compensation (continued)

The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation for the three and six months ended March 31, 2005 and 2004 is as follows:

	Three Months Ended March 31,				Six Months Ended March 31,
	2005		2004		2005		2004
Net income, as reported	$	2,049,470	$	1,780,235	$	3,234,857	$	2,954,046
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards		441,432		386,140		889,200		833,484
Add: Stock-based employee compensation included in net income		—		—		—		—
Pro forma net income	$	1,608,038	$	1,394,095	$	2,345,657	$	2,120,562
Earnings per share:
As reported            -    basic	$	0.20	$	0.18	$	0.32	$	0.30
-    diluted	$	0.20	$	0.18	$	0.31	$	0.30
Pro forma              -    basic	$	0.16	$	0.14	$	0.23	$	0.22
-    diluted	$	0.15	$	0.14	$	0.23	$	0.21

These pro forma amounts are not necessarily indicative of future effects of applying the fair value-based method due to, among other things, the vesting period of the stock options and the fair value of additional stock options issued in future years.

6. Business Segment Information

Effective October 1, 2004, the Company reorganized its operations into four reportable segments. The primary purpose of the reorganization was to place the Company’s commercially oriented operations under common marketing and management leadership and to more efficiently sell and promote its products to common customers. The four segments are:

• Ground Systems - Government

• Ground Systems - Commercial

• Space Communications Systems

• Corporate

The Ground Systems – Government segment provides ground systems products and services to the U.S.Government. It is currently the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force and NOAA.

The Ground Systems – Commercial segment provides ground systems products and services to commercial enterprises and international governments and organizations. It consists of the Company’s core command and control business for commercial applications and three of the Company’s wholly owned subsidiaries as follows:

• SAT and Newpoint, acquired by the Company in August 2000 and January 2002, respectively, offer complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring and control and satellite data processing.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

6. Business Segment Information (continued)

• ISI Europe, the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business.

The Space Communications Systems segment, consisting exclusively of the Company’s wholly owned subsidiary, RT Logic, designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range operations.

The Corporate segment is the Company’s “all other” segment. It includes the Company’s Product Division, which is responsible for the Company’s core command and control product line (EPOCH IPS); business areas in the development stage (currently the Company’s Skylight product); and businesses being disbanded (the Company’s Antenna Division and the Company’s Integration and Test (I&T) Division). The Product Division licenses the Company’s EPOCH IPS product line to other operating segments and to third party customers. It is also the segment responsible for EPOCH IPS maintenance and support revenue and expenses.

The Company evaluates the performance of each segment based on operating income. There are no inter-segment allocations of overhead.

On November 17, 2004, the Company disposed of the intellectual property rights, inventory and certain other assets of the Antenna Division to LJT & Associates, Inc. of Montgomery, Alabama (“LJT”), effective as of November 1, 2004. As consideration, LJT agreed to pay the Company $215,000 and executed a promissory note requiring payment of that sum in eight equal installments of $26,875 due on each July 1 and January 1 beginning on July 1, 2005. As additional consideration, LJT agreed to make future contingent payments to the Company for the period beginning November 1, 2004 through December 31, 2006. The contingent payments are calculated every December 31 beginning December 31, 2005 based on pretax income as defined in the acquisition agreement. Under the acquisition agreement, the Company will continue to fulfill its obligations under existing customer contracts but will engage LJT as a subcontractor to perform the actual work. The Company did not record a material gain or a loss as a result of this transaction.

In addition, the Company loaned LJT $100,000 to assist with initial expenses arising from use of the acquired assets in operations. LJT executed a promissory note requiring payment of that sum in installments to coincide with milestone payments on a certain contract. The Company disbursed the loan to LJT by issuing a cash disbursement in the amount of $54,906, which represents the loan balance after deducting the net assumed obligations with an aggregate total of $45,094.

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Summarized financial information by business segment is as follows:

	Three Months Ended March 31, 2005			Three Months Ended March 31, 2004			Six Months Ended March 31, 2005			Six Months Ended March 31, 2004
Revenue
Ground Systems–Government	$	10,766,485		$	10,414,632		$	20,501,660		$	20,373,528
Ground Systems–Government intersegment		—			—			—			—
Ground Systems–Commercial		4,187,794			4,851,286			8,443,218			8,618,546
Ground Systems–Commercial intersegment		66,446			7,931			153,399			7,931
Space Communication Systems		6,960,681			5,794,957			13,847,771			10,540,483
Space Communication Systems intersegment		1,018,679			261,898			1,514,682			830,787
Corporate		1,431,808			1,447,146			2,473,653			3,029,765
Corporate intersegment		936,072			1,288,146			1,806,572			2,502,346
Elimination of intersegment sales		(2,021,197	)		(1,557,975	)		(3,474,653	)		(3,341,064	)
Total Revenue	$	23,346,768		$	22,508,021		$	45,266,302		$	42,562,322
Operating Income
Ground Systems–Government	$	1,059,366		$	1,057,833		$	1,783,321		$	2,097,790
Ground Systems–Government intersegment		—			—			—			—
Ground Systems–Commercial		(147,034	)		49,264			(26,852	)		86,769
Ground Systems–Commercial intersegment		(3,874	)		(487	)		(16,130	)		(487	)
Space Communication Systems		2,560,116			2,161,132			4,343,059			3,784,654
Space Communication Systems intersegment		7,293			—			7,293			—
Corporate		(438,279	)		(552,075	)		(1,199,230	)		(1,359,674	)
Corporate intersegment		(3,660	)		62			(10,029	)		(3,513	)
Elimination of intersegment Operating Income		240			425			18,865			4,000
Total Operating Income	$	3,034,168		$	2,716,154		$	4,900,297		$	4,609,539
Total Assets
Ground Systems–Government	$	17,239,592		$	18,039,057		$	17,239,592		$	18,039,057
Ground Systems–Commercial		13,741,601			14,170,812			13,741,601			14,170,812
Space Communication Systems		50,909,472			45,863,714			50,909,472			45,863,714
Corporate		69,326,507			58,974,743			69,326,507			58,974,743
Elimination of intersegment accounts receivable		(16,332,349	)		(14,853,097	)		(16,332,349	)		(14,853,097	)
Total Assets	$	134,884,823		$	122,195,229		$	134,884,823		$	122,195,229

7. Subsequent Event

On April 28, 2005, RT Logic Tract TT2, LLC, a newly-formed and wholly-owned subsidiary of Real Time Logic, Inc. (“RT Logic”), entered into a Purchase Agreement with Northgate Properties, LLC to purchase 10.373 acres of real property in Colorado Springs, Colorado for a purchase price of approximately $2.3 million, which will be paid in full at closing. The closing of the transaction is expected to occur before the end of the fiscal year, subject to due diligence review and customary closing conditions. RT Logic intends to construct its new headquarters on this property.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Integral Systems, Inc. (the “Company”) builds satellite ground systems and equipment for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 190 different satellite missions for communications, science, meteorology, and earth resource applications. The Company has an established domestic and international customer base that includes government and commercial satellite operators, spacecraft and payload manufacturers, and aerospace systems integrators.

The Company has developed innovative software products that reduce the cost and minimize the development risk associated with traditional custom-built systems. The Company believes that it was the first to offer a comprehensive commercial off-the-shelf (“COTS”) software product line for command and control. As a systems integrator, the Company leverages these products to provide turnkey satellite control facilities that can operate multiple satellites from any manufacturer. These systems offer significant cost savings for customers that have traditionally purchased a separate custom control center for each of their satellites.

Effective October 1, 2004, the Company reorganized its operations into four reportable segments. The primary purpose of the reorganization was to place the Company’s commercially oriented operations under common marketing and management leadership and to more efficiently sell and promote its products to common customers. The four segments are:

Ground Systems – Government

This segment provides ground systems products and services to the U.S. Government. It is the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force and the National Oceanic Atmospheric Administration (NOAA).

Ground Systems – Commercial

This segment provides ground systems products and services to commercial enterprises and international governments and organizations. It consists of the Company’s core command and control business for commercial applications and three of the Company’s wholly owned subsidiaries as follows:

SAT Corporation (“SAT”) and Newpoint Technologies, Inc. (“Newpoint”), acquired by the Company in August 2000 and January 2002, respectively, offer complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring, and control and satellite data processing.

Integral Systems Europe (“ISI Europe”), the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business.

Space Communications Systems

This segment, consisting exclusively of the Company’s wholly owned subsidiary, RT Logic designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range operations.

- 11 -

Corporate

This segment is the Company’s “all other” segment. It includes the Company’s Product Division, which is responsible for the Company’s core command and control product line (EPOCH IPS); business areas in the development stage (currently the Company’s Skylight product); and businesses being disbanded (the Company’s Antenna Division and the Company’s Integration and Test (I&T) Division). The Product Division licenses the Company’s EPOCH IPS product line to other operating segments and to third party customers. It is also the segment responsible for EPOCH IPS maintenance and support revenue and expenses.

All intra-segment and inter-segment revenues and expenses have been eliminated in consolidation as appropriate. Operating results for periods prior to October 1, 2004 have been reclassified for comparative purposes. In order to provide year to year reporting continuity, the Company has elected to provide additional disclosures for SAT and Newpoint through the end of fiscal year 2005.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) 123 (Revised 2004), “Shared-Based Payment”. Revised SFAS 123 addresses the requirements of an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which an employee is required to provide services in exchange for the award. The Company will be required to adopt this Statement during the first quarter of fiscal year 2006 and is currently evaluating the impact that this pronouncement will have on its future operations and financial reporting

- 12 -

COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004

Results of Operations

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the three months ended March 31, 2005 and 2004:

	Three Months Ended March 31,
	2005		% of Revenue	2004		% of Revenue
	(in thousands)			(in thousands)
Revenue	$	23,347	100.0	$	22,508	100.0
Cost of Revenue		16,015	68.6		14,564	64.7
Gross Margin		7,332	31.4		7,944	35.3
Operating Expenses
Selling, General & Admin. (SG&A)		3,113	13.3		3,229	14.3
Research and Development		470	2.0		915	4.1
Product Amortization		646	2.8		762	3.4
Amortization-Intangible Assets		69	0.3		322	1.4
Income from Operations		3,034	13.0		2,716	12.1
Other Income (Expense) (net)		140	.6		73	0.3
Income Before Income Taxes		3,174	13.6		2,789	12.4
Income Taxes		1,125	4.8		1,009	4.5
Net Income	$	2,049	8.8	$	1,780	7.9

Revenue

The Company earns revenue, both as a prime contractor and a subcontractor, from sales of its products and services through contracts that are funded by the U.S. Government as well as commercial and international organizations.

For the three months ended March 31, 2005 and 2004, the Company’s revenues were generated from the following sources:

	Three Months Ended March 31,
Revenue Type	2005		2004
U.S. Government Revenue (all segments)
NOAA	10	%	16	%
U.S. Air Force	53		53
Other U.S. Government Users	11		6
Subtotal	74		75
Commercial Revenue (all segments)	26		25
Total	100	%	100	%

- 13 -

On a consolidated basis, revenue increased 3.7%, or $800,000, to $23.3 million for the three months ended March 31, 2005, from $22.5 million for the three months ended March 31, 2004. Revenue for the three-month periods ended March 31, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	10,767		$	10,415		$	352
Ground Systems – Commercial
Command & Control		2,928			3,340			(412	)
Newpoint		883			772			111
SAT		604			1,269			(665	)
Intra-Segment Elimination		(161	)		(522	)		361
Ground Systems – Commercial		4,254			4,859			(605	)
Space Communications Systems		7,979			6,057			1,922
Corporate
Product Group		922			1,391			(469	)
Antenna		1,107			428			679
I&T		—			582			(582	)
Other		339			334			5
Corporate		2,368			2,735			(367	)
Elimination		(2,021	)		(1,558	)		(463	)
Total Revenue	$	23,347		$	22,508		$	839

Revenue increases in the Company’s Ground Systems - Government segment between the three months ended March 31, 2005 and 2004 primarily relate to increased sales of $1.4 million from the Company’s contracts with the U.S. Air Force partially offset by revenue decreases from NOAA.

Revenue decreases of approximately $410,000 for the Company’s Command & Control unit of its Ground Systems – Commercial segment resulted from lower revenues in the three months ended March 31, 2005 from ISI Europe compared to revenues recorded during the three months ended March 31, 2004. ISI Europe earned almost 40% of its entire fiscal year 2004 revenues in the second quarter last fiscal year. Revenues are expected to be more evenly distributed on a quarterly basis for ISI Europe in fiscal year 2005 than the revenues recorded in fiscal year 2004.

SAT’s revenue decrease relates to order delays and decreased order shipments during the three months ended March 31, 2005 compared to the three months ended March 31, 2004. SAT also recorded approximately $120,000 of current period charges primarily related to a software shipment which has not been accepted by the customer.

Newpoint revenue increased approximately $110,000 for the three month ended March 31, 2005 compared to the three months ended March 31, 2004 due to increased product shipments.

- 14 -

Revenue increases for the Company’s Space Communications Systems segment resulted from increased backlog and increased product shipments for the three months ended March 31, 2005 compared to the three months ended March 31, 2004.

In the Company’s Corporate segment, the Product Group recorded decreased license revenues for the three months ended March 31, 2005 compared to the three months ended March 31, 2004.

Antenna Division revenues increased approximately $680,000 for the three months ended March 31, 2005 compared to the three months ended March 31, 2004 primarily because of the Company’s on-going contract with the Malaysian military for the delivery of two antenna systems.

The Company disbanded its I&T Division during the fourth quarter of fiscal year 2004 and accordingly, no revenues were recorded for this division during the second quarter of fiscal year 2005.

Cost of Revenue/Gross Margin

The Company computes gross margin by subtracting cost of revenue from revenue. Included in cost of revenue are direct labor expenses, overhead charges associated with the Company’s direct labor base and other costs that can be directly related to specific contract cost objectives, such as travel, consultants, equipment, subcontracts and other direct costs.

Gross margins on contract revenues vary depending on the type of product or service provided. Generally, license revenues related to the sale of the Company’s COTS products have the greatest gross margins because of the minimal associated marginal costs to produce. By contrast, gross margins for equipment and subcontract pass-throughs seldom exceed 15%. Engineering service gross margins typically range between 20% and 40%. These definitions and ratios generally apply across all segments, although margins on equipment costs for the Space Communications Systems segment are generally greater than the equipment margins in the other segments because that segment’s business is more hardware intensive.

- 15 -

During the three months ended March 31, 2005, cost of revenue increased by 10.0%, or $1.4 million, compared to the same period during the prior year, increasing from $14.6 million during the three months ended March 31, 2004 to $16.0 million during the three months ended March 31, 2005. Gross margin decreased from $7.9 million to $7.3 million, a decrease of $600,000, or 7.7%, during the periods being compared. Cost of revenue and gross margin for the three months ended March 31, 2005 and 2004 for each of the Company’s segments are shown in the following table:

	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	8,429		$	8,247		$	182
Ground Systems – Commercial
Command & Control		2,220			2,649			(429	)
Newpoint		464			377			87
SAT		600			879			(279	)
Intra-Segment Elimination		(157	)		(525	)		368
Ground Systems – Commercial		3,127			3,380			(253	)
Space Communications Systems		4,521			2,474			2,047
Corporate
Product Group		437			467			(30	)
Antenna		1,177			710			467
I&T		—			509			(509	)
Other		328			321			7
Corporate		1,942			2,007			(65	)
Elimination		(2,004	)		(1,544	)		(460	)
Total Cost of Revenue	$	16,015		$	14,564		$	1,451
Gross Margin
Ground Systems – Government	$	2,338		$	2,168		$	170
Ground Systems – Commercial
Command & Control		708			691			17
Newpoint		419			395			24
SAT		4			390			(386	)
Intra-Segment Elimination		(4	)		3			(7	)
Ground Systems – Commercial		1,127			1,479			(352	)
Space Communications Systems		3,458			3,583			(125	)
Corporate
Product Group		485			924			(439	)
Antenna		(70	)		(282	)		212
I&T		—			73			(73	)
Other		11			13			(2	)
Corporate		426			728			(302	)
Elimination		(17	)		(14	)		(3	)
Total Gross Margin	$	7,332		$	7,944		$	(612	)

- 16 -

The increased gross margin in the Company’s Ground Systems – Government segment (approximately $170,000) relates to $350,000 of increased revenue recorded during the periods being compared. As a result, gross margin as a percentage of revenue for the Ground Systems - Government segment increased from 20.8% for the three months ended March 31, 2004 to 21.7% for the three months ended March 31, 2005.

The slightly higher gross margin (approximately $20,000) for the Command & Control unit of the Company’s Ground Systems - Commercial segment is primarily attributable to decreased direct equipment costs incurred during the periods being compared. Newpoint’s increased gross margin (also approximately $20,000) results from increased revenue earned in the current period. The approximate $390,000 gross margin decrease at SAT is a result of $670,000 lower revenue.

The Space Communications System segment experienced a decrease in gross margin despite increased revenue. The segment’s gross margin percentage declined from 59.2% for the three months ended March 31, 2004 to 43.3% for the three months ended March 31, 2005 due to a considerably greater mix of third party equipment costs in the segment’s cost of revenue in the current quarter than in the three months ended March 31, 2004. Similar to the Company’s other business segments, the Space Communications Systems segment typically earns less gross margin on third party equipment purchases than on other cost elements. Further, the segment had an unusually high percentage of production type revenue in the three months ended March 31, 2004. Generally, production type contracts generate higher gross margins due to increased efficiencies for this segment as compared to non-production oriented jobs.

In the Corporate segment, the Product Group experienced a lower gross margin of approximately $440,000 on a period-to-period basis because of decreased license revenue. Although the Antenna Division was able to reduce its gross margin deficit by approximately $210,000, the Antenna Division nonetheless recorded a $70,000 gross margin deficit during the current three-month period. The I&T Division posted no gross margins as it had no revenue for the current quarter.

- 17 -

Operating Expenses

Operating expenses for the three months ended March 31, 2005 and 2004 for each of the Company’s segments are shown in the following table:

	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Ground Systems – Government	$	1,279		$	1,110		$	169
Ground Systems – Commercial
Command & Control		441			399			42
Newpoint		336			381			(45	)
SAT		505			651			(146	)
Intra-Segment Elimination		(4	)		—			(4	)
Ground Systems – Commercial		1,278			1,431			(153	)
Space Communications Systems		890			1,421			(531	)
Corporate
Product Group		834			1,027			(193	)
Antenna		21			85			(64	)
I&T		—			256			(256	)
Other		13			(87	)		100
Corporate		868			1,281			(413	)
Elimination		(17	)		(15	)		(2	)
Total Operating Expenses	$	4,298		$	5,228		$	(930	)

Operating expenses in the Company’s Ground Systems – Government segment increased by approximately $170,000 for the three months ended March 31, 2005 compared to the three months ended March 31, 2004 due to increased bid and proposal expenses related to the Company’s recently announced RAIDRS contract with the U.S. Air Force.

Operating expenses in the Command & Control unit of the Company’s Ground Systems – Commercial segment increased by more than $40,000 for the three months ended March 31, 2005 compared to the three months ended March 31, 2004 due to allocated bid and proposal expenses. Operating expenses at SAT were down almost $150,000 principally due to reductions in product amortization expenses. At Newpoint operating expenses decreased by approximately $45,000 during the periods being compared.

The Space Communications Systems segment’s current period operating expenses were down approximately $530,000 compared to the second quarter of the last fiscal year. Amortization expense decreased approximately $255,000 resulting from certain intangible assets being fully amortized at June 30, 2004. Although SG&A expenses increased by approximately $60,000 on a period to period basis, R&D spending was lower by approximately $340,000 accounting for most of the remaining decline in operating expenses.

- 18 -

Operating expenses in the Corporate segment decreased by approximately $410,000 principally due to the closure of the I&T Division, the sale of operating assets of the Antenna Division in November 2004 and reduced product related selling expenses.

Income from Operations

Income from operations for the three months ended March 31, 2005 and 2004 for each of the Company’s segments is shown in the following table:

Segment	Three Months Ended March 31,						Increase/ (Decrease)
	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Ground Systems – Government	$	1,059		$	1,058		$	1
Ground Systems – Commercial
Command & Control		267			292			(25	)
Newpoint		83			14			69
SAT		(501	)		(261	)		(240	)
Intra-Segment Elimination		—			3			(3	)
Ground Systems – Commercial		(151	)		48			(199	)
Space Communications Systems		2,568			2,162			406
Corporate
Product Group		(349	)		(103	)		(246	)
Antenna		(91	)		(367	)		276
I&T		—			(183	)		183
Other		(2	)		100			(102	)
Corporate		(442	)		(553	)		111
Elimination		—			1			(1	)
Total Income from Operations	$	3,034		$	2,716		$	318

Income from operations during the periods compared was flat in the Company’s Ground Systems – Government segment as a result of increased gross margins offset by increased operating expenses.

Income from operations during the periods compared decreased by approximately $200,000 in the Company’s Ground Systems – Commercial segment as a result of reduced revenue and gross margins at SAT as described above.

The Space Communications Systems segment recorded increased income from operations principally due to decreased operating expenses.

In the Corporate segment, the Product Group posted an operating loss of almost $350,000 primarily because of amortization expense that exceeded $560,000 for the quarter coupled with lower license revenue. Although the Product Group recorded losses for the quarter, a large portion of the revenue generated in its ground systems business (both Government and Commercial) is a result of its EPOCH IPS product line, which the Company believes distinctly and favorably distinguishes it from its competitors.

- 19 -

Operating losses in the Antenna Division have been reduced due to the sale of the unit’s assets, while operating losses at the I&T Division have been eliminated due to the shutdown of that unit.

Other Income/Expense/Impairment of Marketable Securities

The changes in other income and expense between the quarters being compared, although considered immaterial, mostly result from increased interest income related to favorable interest rate changes.

Income Before Income Taxes/Net Income

Income before income taxes increased approximately $390,000 over amounts posted during the second quarter of last fiscal year principally due to increased operating income of approximately $320,000 as described above combined with increased interest income.

The Company’s effective tax rate decreased from 36.2% for the three months ended March 31, 2004 to 35.4% for the three months ended March 31, 2005 principally due to a higher percentage of tax exempt income compared to total income before income taxes in the current period.

As a result of the above, net income increased to approximately $2.050 million during the three months ended March 31, 2005 from $1.780 million during the three months ended March 31, 2004.

COMPARISON OF THE SIX MONTHS ENDED MARCH 31, 2005 AND 2004

Results of Operations

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the six months ended March 31, 2005 and 2004:

	Six Months Ended March 31,
	2005		% of Revenue		2004		% of Revenue
	(in thousands)			��	(in thousands)
Revenue	$	45,266	100.0		$	42,562	100.0
Cost of Revenue		30,799	68.0			27,994	65.8
Gross Margin		14,467	32.0			14,568	34.2
Operating Expenses
Selling, General & Admin. (SG&A)		6,885	15.2			6,085	14.3
Research and Development		1,253	2.8			1,706	4.0
Product Amortization		1,291	2.9			1,523	3.6
Amortization-Intangible Assets		138	0.3			645	1.5
Income from Operations		4,900	10.8			4,609	10.8
Other Income (Expense) (net)		98	0.2			43	0.1
Income Before Income Taxes		4,998	11.0			4,652	10.9
Income Taxes		1,763	3.9			1,698	4.0
Net Income	$	3,235	7.1		$	2,954	6.9

- 20 -

Revenue

The Company earns revenue, both as a prime contractor and a subcontractor, from sales of its products and services through contracts that are funded by the U.S. Government as well as commercial and international organizations.

For the six months ended March 31, 2005 and 2004, the Company’s revenues were generated from the following sources:

	Six Months Ended March 31,
Revenue Type	2005		2004
U.S. Government Revenue (all segments)
NOAA	11	%	16	%
U.S. Air Force	51		53
Other U.S. Government Users	12		6
Subtotal	74		75
Commercial Revenue (all segments)	26		25
Total	100	%	100	%

On a consolidated basis, revenue increased 6.4%, or $2.7 million, to $45.3 million for the six months ended March 31, 2005, from $42.6 million for the six months ended March 31, 2004. Revenue for the six-month periods ended March 31, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	20,502		$	20,374		$	128
Ground Systems – Commercial
Command & Control		5,689			5,574			115
Newpoint		1,576			1,382			194
SAT		1,560			2,458			(898	)
Intra-Segment Elimination		(228	)		(788	)		560
Ground Systems – Commercial		8,597			8,626			(29	)
Space Communications Systems		15,362			11,371			3,991
Corporate
Product Group		1,875			2,280			(405	)
Antenna		1,778			1,144			634
I&T		—			1,365			(1,365	)
Other		627			743			(116	)
Corporate		4,280			5,532			(1,252	)
Elimination		(3,475	)		(3,341	)		(134	)
Total Revenue	$	45,266		$	42,562		$	2,704

- 21 -

Revenue increases in the Company’s Ground Systems - Government segment between the six months ended March 31, 2005 and 2004 primarily relate to increased sales from the Company’s contracts with the U.S. Air Force partially offset by revenue decreases from NOAA.

Revenue increases in the Company’s Ground Systems – Commercial segment (other than SAT) resulted from increased backlog and increased product shipments to customers. SAT’s revenue decrease relates to decreased order shipments and order delays experienced during the six months ended March 31, 2005 compared to the six months ended March 31, 2004.

Revenue increases in the Company’s Space Communications Systems segment resulted from increased backlog and increased product shipments to customers.

In the Company’s Corporate segment, the Product Group recorded decreased license revenues between the periods being compared.

Antenna Division revenues increased approximately $630,000 between the periods being compared primarily because of the Company’s on-going contract with the Malaysian military for the delivery of two antenna systems.

The Company disbanded its I&T Division during the fourth quarter of fiscal year 2004 and accordingly, no revenues were recorded for this division during the first half of fiscal year 2005.

Cost of Revenue/Gross Margin

The Company computes gross margin by subtracting cost of revenue from revenue. Included in cost of revenue are direct labor expenses, overhead charges associated with the Company’s direct labor base and other costs that can be directly related to specific contract cost objectives, such as travel, consultants, equipment, subcontracts and other direct costs.

Gross margins on contract revenues vary depending on the type of product or service provided. Generally, license revenues related to the sale of the Company’s COTS products have the greatest gross margins because of the minimal associated marginal costs to produce. By contrast, gross margins for equipment and subcontract pass-throughs seldom exceed 15%. Engineering service gross margins typically range between 20% and 40%. These definitions and ratios generally apply across all segments, although margins on equipment costs for the Space Communications Systems segment are generally greater than the equipment margins in the other segments because that segment’s business is more hardware intensive.

- 22 -

During the six months ended March 31, 2005, cost of revenue increased by 10.0%, or $2.8 million, compared to the same period during the prior year, increasing from $28.0 million during the six months ended March 31, 2004 to $30.8 million during the six months ended March 31, 2005. Gross margin decreased from $14.6 million to $14.5 million, a decrease of $100,000, or .7%, during the periods being compared. Cost of revenue and gross margin for the three months ended March 31, 2005 and 2004 for each of the Company’s segments are shown in the following table:

	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	15,870		$	16,246		$	(376	)
Ground Systems – Commercial
Command & Control		4,393			4,621			(228	)
Newpoint		781			609			172
SAT		1,063			1,513			(450	)
Intra-Segment Elimination		(187	)		(791	)		604
Ground Systems – Commercial		6,050			5,952			98
Space Communications Systems		8,787			4,825			3,962
Corporate
Product Group		896			969			(73	)
Antenna		2,022			1,452			570
I&T		—			1,147			(1,147	)
Other		609			718			(109	)
Corporate		3,527			4,286			(759	)
Elimination		(3,435	)		(3,315	)		(120	)
Total Cost of Revenue	$	30,799		$	27,994		$	2,805
Gross Margin
Ground Systems – Government	$	4,632		$	4,128		$	504
Ground Systems – Commercial
Command & Control		1,296			953			343
Newpoint		795			773			22
SAT		497			945			(448	)
Intra-Segment Elimination		(41	)		3			(44	)
Ground Systems – Commercial		2,547			2,674			(127	)
Space Communications Systems		6,575			6,546			29
Corporate
Product Group		979			1,311			(332	)
Antenna		(244	)		(308	)		64
I&T		—			218			(218	)
Other		18			25			(7	)
Corporate		753			1,246			(493	)
Elimination		(40	)		(26	)		(14	)
Total Gross Margin	$	14,467		$	14,568		$	(101	)

- 23 -

The higher gross margin for the Company’s Ground Systems - Government segment is primarily attributable to lower equipment and subcontract costs incurred during the current six-month period. As a result, gross margin as a percentage of revenue for the Ground Systems - Government segment increased from 20.3% for the six months ended March 31, 2004 to 22.6% for the six months ended March 31, 2005.

The gross margin for the Company’s Ground Systems – Commercial segment primarily relates to increased revenue from the segment’s Command & Control Division coupled with lower current period equipment costs. Newpoint’s gross margin was flat between the periods being compared despite slightly higher revenues. Newpoint had a higher dollar and percentage content of equipment and subcontract costs in its current six-month cost mix compared to the first half of the last fiscal year, resulting in a lower gross margin percentage (50.4% vs. 55.9%). At SAT, gross margin declined by approximately $450,000 due to a $900,000 decrease in revenues.

Gross margin in the Space Communications System segment was flat during the periods being compared despite increased revenue of almost $4.0 million. The segment’s gross margin percentage declined from 57.6% for the six months ended March 31, 2004 to 42.8% for the six months ended March 31, 2005 due to a considerably greater mix of third party equipment costs in the segment’s cost of revenue in the six months ended March 31 2005 than in the six months ended March 31, 2004. Similar to the Company’s other business segments, the Space Communications Systems segment typically earns less gross margin on third party equipment purchases than on other cost elements. Further, the segment had an unusually high percentage of production type revenue in the six months ended March 31, 2004. Generally, production type contracts generate higher gross margins due to increased efficiencies for this segment as compared to non-production oriented jobs.

In the Corporate segment, the Product Group experienced a lower gross margin of approximately $330,000 on a period-to-period basis because of decreased license revenue. Although the Antenna Division was able to reduce its gross margin deficit by approximately $60,000, the Division nonetheless recorded a $240,000 gross margin deficit during the current six-month period. The I&T Division posted no gross margins as it had no revenue for the current half year period.

- 24 -

Operating Expenses

Operating expenses for the six months ended March 31, 2005 and 2004 for each of the Company’s segments are shown in the following table:

	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Ground Systems – Government	$	2,849		$	2,030		$	819
Ground Systems – Commercial
Command & Control		925			665			260
Newpoint		708			755			(47	)
SAT		988			1,169			(181	)
Intra-Segment Elimination		(31	)		—			(31	)
Ground Systems – Commercial		2,590			2,589			1
Space Communications Systems		2,224			2,761			(537	)
Corporate
Product Group		1,755			1,992			(237	)
Antenna		82			155			(73	)
I&T		—			484			(484	)
Other		125			(21	)		146
Corporate		1,962			2,610			(648	)
Elimination		(58	)		(31	)		(27	)
Total Operating Expenses	$	9,567		$	9,959		$	(392	)

Operating expenses in the Company’s Ground Systems – Government segment increased by approximately $820,000 for the six months ended March 31, 2005 compared to the six months ended March 31, 2004 due to increased bid and proposal expenses related to the Company’s recently announced RAIDRS contract with the U.S. Air Force.

Operating expenses in the Command & Control unit of the Company’s Ground Systems – Commercial segment increased by approximately $260,000 for the six months ended March 31, 2005 compared to the three months ended March 31, 2004 principally due to allocated bid and proposal expenses. Operating expenses at SAT were down approximately $180,000 principally due to reductions in product amortization expenses. At Newpoint operating expenses decreased by approximately $50,000 during the periods being compared.

The Space Communications Systems segment’s operating expenses for the six months ended March 31, 2005 were down approximately $540,000 compared to the six months ended March 31, 2004. Amortization expense decreased approximately $510,000 resulting from certain intangible assets being fully amortized at June 30, 2004. Although SG&A expenses increased by approximately $260,000 on a period to period basis, R&D spending was lower by approximately $290,000 accounting for most of the remaining decline in operating expenses.

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Operating expenses in the Corporate segment decreased by approximately $650,000 principally due to the closure of the I&T Division, the sale of operating assets of the Antenna Division in November 2004 and reduced product related selling expenses.

Income from Operations

Income from operations for the six months ended March 31, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Ground Systems – Government	$	1,783		$	2,098		$	(315	)
Ground Systems – Commercial
Command & Control		371			288			83
Newpoint		87			18			69
SAT		(491	)		(224	)		(267	)
Intra-Segment Elimination		(10	)		3			(13	)
Ground Systems – Commercial		(43	)		85			(128	)
Space Communications Systems		4,351			3,785			566
Corporate
Product Group		(776	)		(681	)		(95	)
Antenna		(326	)		(463	)		137
I&T		—			(266	)		266
Other		(107	)		46			(153	)
Corporate		(1,209	)		(1,364	)		155
Elimination		18			5			13
Total Income from Operations	$	4,900		$	4,609		$	291

Income from operations during the periods decreased approximately $320,000 in the Company’s Ground Systems – Government segment as a result of increased operating expenses partially offset by increased gross margin.

Income from operations during the periods compared decreased by approximately $130,000 in the Company’s Ground Systems – Commercial segment as a result of reduced revenue and gross margins at SAT as described above.

The Space Communications Systems segment recorded increased income from operations principally due to decreased operating expenses.

In the Corporate segment, the Product Group posted an operating loss of almost $780,000 primarily because of amortization expense that approached $1.2 million for the six months ended March 31, 2005 coupled with lower license revenue. Although the Product Group recorded losses for the first half of the fiscal year, a large portion of the revenue generated in its ground systems business (both Government and Commercial) is a result of its EPOCH IPS product line, which the Company believes distinctly and favorably distinguishes it from its competitors.

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Operating losses in the Antenna Division have been reduced due to the sale of the unit’s assets, while operating losses at the I&T Division have been eliminated due to the shutdown of that unit.

Other Income/Expense/Impairment of Marketable Securities

The changes in other income and expense between the periods being compared, although considered immaterial, mostly result from increased interest income related to more favorable interest rate changes.

Income Before Income Taxes/Net Income

Income before income taxes increased approximately $350,000 for the six months ended March 31, 2005 compared to the six months ended March 31, 2004 principally due to increased operating income of approximately $290,000 as described above combined with increased interest income.

The Company’s effective tax rate decreased from 36.5% for the six months ended March 31, 2004 to 35.3% for the six months ended March 31, 2005 principally due to a higher percentage of tax exempt income compared to total income before income taxes in the current period.

As a result of the above, net income increased to approximately $3.2 million during the six months ended March 31, 2005 from $3.0 million during the six months ended March 31, 2004.

OUTLOOK

This outlook section contains forward-looking statements, all of which are based on current expectations. There is no assurance that the Company’s projections will in fact be achieved and these projections do not reflect any acquisitions or divestitures that may occur in the future. Reference should be made to the various important factors listed under the heading “Forward-Looking Statements” that could cause actual future results to differ materially.

At this time, the Company has a backlog of work to be performed and it may receive additional contract awards based on proposals in the pipeline, although the estimated backlog under the Company’s government contracts is not necessarily indicative of revenues that will actually be realized under the contracts. Management believes that operating results for future periods will improve based on the following assumptions:

• Demand for satellite technology and related products and services will continue to expand; and

• Sales of its software products and engineering services will continue to increase.

As disclosed in its Form 10-K for the fiscal year ended September 30, 2004, the Company was anticipating that operating results for fiscal year 2005 would be comparable to results recorded for fiscal year 2004. After analyzing its results for the six months ended March 31, 2005, the Company believes that it is on target to meet these goals for fiscal year 2005 in its entirety.

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LIQUIDITY AND CAPITAL RESOURCES

Since the Company’s inception in 1982, it has been profitable on an annual basis and has generally financed its working capital needs through internally generated funds, supplemented by borrowings under the Company’s general line of credit facility with a commercial bank and the proceeds from the Company’s initial public offering in 1988. In June 1999, the Company supplemented its working capital position by raising approximately $19.7 million (net) through the private placement of approximately 1.2 million shares of its common stock. In February 2000, the Company raised an additional $40.9 million (net) for use in connection with potential acquisitions and other general corporate purposes through the private placement of 1.4 million additional shares of its common stock. With respect to the capital raised in the private placements, at March 31, 2005, $10.1 million was invested in variable rate State of Maryland debt securities and $20.0 million was invested in Banc of America Preferred Funding Corporation “Dividends Received Eligible Auction Market” preferred stock (“DREAMS”).

For the six months ended March 31, 2005, operating activities provided the Company approximately $6.6 million of cash. The Company used approximately $2.5 million in investing activities and financing activities provided approximately $2.8 million. Included in the $2.5 million of investing activities is approximately $600,000 in newly capitalized software development costs and $950,000 used for the purchase of fixed assets.

The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5% to 2.4% based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable, inventory, equipment, and insurance proceeds and has certain financial covenants, including minimum net worth and liquidity ratios. The Company had no balance outstanding at March 31, 2005 under the line of credit. The line of credit expires on February 28, 2007.

The Company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $43,000 at March 31, 2005. The outstanding balance is payable over a 14-month period and bears interest at a rate of 8.8% per annum.

The Company’s Board of Directors declared a cash dividend of $.04 per share to all stockholders of record as of close of business on March 3, 2005. The dividend was paid on March 30, 2005 in the amount of $413,708. In addition, the Company’s Board of Directors declared a cash dividend of $.04 per share to all stockholders of record as of close of business on June 2, 2005. The dividend will be paid on or about June 29, 2005.

The Company currently anticipates that its current cash balances, amounts available under its lines of credit and net cash provided by operating activities will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months. The Company plans to continue to invest in the on-going development and improvement of its current software products, EPOCH IPS, as well as the development of new products through the use of its current cash balances and cash provided by operating activities. The Company believes that its investment in product development for EPOCH IPS and OASYS will be less in fiscal year 2005 than it was in fiscal year 2004.

The Company believes that inflation did not have a material impact on the Company’s revenues or income from operations during the six months ended March 31, 2005 or in past fiscal years.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no “off-balance sheet arrangements” as such term is defined in Item 303(a)(4)(ii) of Regulation S-K.

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FORWARD LOOKING STATEMENTS

Certain of the statements contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section, in other parts of this quarterly report on Form 10-Q, and in this section, including those under the headings “Outlook” and “Liquidity and Capital Resources,” are forward looking. In addition, from time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. Forward-looking statements can be identified by the use of forward-looking terminology such as “may”, “will”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, or other similar words, including statements as to the intent, belief, or current expectations of the Company and its directors, officers, and management with respect to the Company’s future operations, performance, or positions or which contain other forward-looking information. These forward-looking statements are predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. The Company’s actual results may differ significantly from the results discussed in the forward-looking statements. While the Company believes that these statements are and will be accurate, a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s statements. The Company’s business is dependent upon general economic conditions and upon various conditions specific to its industry, and future trends cannot be predicted with certainty. Particular risks and uncertainties that may affect the Company’s business, other than those described elsewhere herein or in our other filings with the Securities and Exchange Commission (the “SEC” or the “Commission”), include the following:

• A significant portion of the Company’s revenue is derived from contracts or subcontracts funded by the U.S. Government, which are subject to termination without cause, government regulations and audits, competitive bidding, and the budget and funding process of the U.S. Government.

• The presence of competitors with greater financial resources and their strategic response to the Company’s new services.

• The potential obsolescence of the Company’s services due to the introduction of new technologies.

• The response of customers to the Company’s marketing strategies and services.

• The Company’s commercial contracts are subject to strict performance and other requirements.

• The intense competition in the satellite ground system industry could harm the Company’s financial performance.

• With respect to the Company’s acquisition strategy, if the Company is able to identify and acquire one or more businesses, the integration of the acquired business or businesses may be costly and may result in a decrease in the value of the Company’s common stock.

• The Company may not adequately assess the risks inherent in a particular acquisition candidate or correctly assess the candidate’s potential contribution to the Company’s financial performance.

• The Company may need to divert more management resources to integration of an acquired business than it planned, which may adversely affect its ability to pursue other more profitable activities.

• The difficulties of integrating an acquired business may be increased by the necessity of coordinating geographically separated organizations, integrating personnel with disparate backgrounds and combining different corporate cultures.

• The Company may not eliminate as many redundant costs as it anticipated in selecting acquisition candidates.

• Changes in activity levels in the Company’s core markets.

• The Company may not be able to effectively manage any continued growth.

• The business is subject to risks associated with international transactions.

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• The Company depends upon intellectual property rights and risks having its rights infringed.

• The estimated backlog is not necessarily indicative of revenues that will actually be realized under the contracts.

• The Company’s quarterly operating results may vary significantly from quarter to quarter.

• The market price of the Company’s common stock may be volatile.

While sometimes presented with numerical specificity, these forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which although considered reasonable by the Company, may not be realized. Because of the number and range of the assumptions underlying the Company’s forward-looking statements, many of which are subject to significant uncertainties and contingencies beyond the reasonable control of the Company, some of the assumptions inevitably will not materialize and unanticipated events and circumstances may occur subsequent to the date of this document. These forward-looking statements are based on current information and expectation, and the Company assumes no obligation to update. Therefore, the actual experience of the Company and the results achieved during the period covered by any particular forward-looking statement should not be regarded as a representation by the Company or any other person that these estimates will be realized, and actual results may vary materially. There can be no assurance that any of these expectations will be realized or that any of the forward-looking statements contained herein will prove to be accurate.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

While the Company currently does not have significant European operations, our customer base is expanding outside the U.S. and therefore certain contracts now and in the future will likely be denominated in currencies other than the U.S. dollar. As a result, the Company’s financial results could be affected by factors such as foreign currency exchange rates for contracts denominated in currencies other than the U.S. dollar. To mitigate the effect of changes in foreign currency exchange rates, the Company may hedge this risk by entering into forward foreign currency contracts. As of March 31, 2005, virtually all of the Company’s contracts are denominated in U.S. dollars. Three contracts were denominated in Euros that were hedged. These contracts are not material to the Company’s financial statements. As the Company enters into new foreign currency based contracts in the future, the Company may employ similar hedging contracts.

ITEM 4. CONTROLS AND PROCEDURES

a. Disclosure Controls and Procedures

As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company’s management carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as of the end of the fiscal quarter covered by this quarterly report. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s chief executive officer and chief financial officer. Based upon that evaluation, the Company’s chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and other procedures of the Company that are designed to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures.

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b. Changes in internal controls

As required by Rule 13a-15 under the Exchange Act, the Company’s management carried out an evaluation of any changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. This evaluation was carried out under the supervision and with the participation of the Company’s management, including the chief executive officer and chief financial officer. Based upon that evaluation, the Company concluded that there was no change in the Company’s internal control over financial reporting during this period that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, the Company’s chief executive officer and chief financial officer, and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

PART II. OTHER INFORMATION

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(c) On October 1, 2002, the Company acquired all of the issued and outstanding stock of RT Logic pursuant to an Agreement and Plan of Reorganization dated October 1, 2002 (the “Reorganization Agreement”) for an initial purchase price payable to the shareholders of RT Logic that included 683,870 shares of the Company’s common stock, par value $.01 per share. Pursuant to the terms of the Reorganization Agreement, in November 2002, the former shareholders of RT Logic received additional aggregate consideration that included 25,806 shares of the Company’s common stock. Pursuant to the Reorganization Agreement, in January 2004, the former shareholders of RT Logic received contingent purchase price with respect to the year ended September 30, 2003, that included 209,926 shares of the Company’s common stock. Pursuant to the Reorganization Agreement, in February 2005, the former shareholders of RT Logic received contingent purchase price with respect to the year ended September 30, 2004, that included 230,349 shares of the Company’s common stock and $4,186,369 in cash The Company relied on Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and Rule 506 under Regulation D of the Securities Act for the exemption from registration of the sale of such shares.

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The following is a table summarizing the Company’s purchases of its own equity securities during the three months ended March 31, 2005.

Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1)
January 1 to January 31, 2005	6,200	$	17.89	359,471	573,287
February 1 to February 28, 2005	1,900	$	18.18	361,371	571,387
March 1 to March 31, 2005	—		—	361,371	571.387

(1) On September 23, 2002, the Company announced a plan to repurchase up to 932,758 shares of its common stock. The stock repurchase program will be transacted over an indefinite period of time and purchases will be made as management and the Board of Directors deem prudent.

ITEM 6. EXHIBITS

Exhibits

10.1*†	Award/Contract No. FA8819-04-R-0018 from SMC/SYK Space & Missile Systems Center, effective February 25, 2005.
11.1	Computation of Per Share Earnings.
31.1	Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended.
31.2	Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended.
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Confidential treatment requested for certain portions of this Exhibit pursuant to Rule 24b-2 under the Securities Exchange Act, of 1934, as amended, which portions are omitted and filed separately with the Securities and Exchange Commission.

† The Attachments to this Award/Contract have been omitted in reliance upon the rules of the Securities and Exchange Commission. A copy will be delivered to the Securities and Exchange Commission upon request.

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SIGNATURES

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

	INTEGRAL SYSTEMS, INC.
	(Registrant)
Date: May 10, 2005	By:	/s/ THOMAS L. GOUGH
		Thomas L. Gough
		President & Chief Operating Officer
Date: May 10, 2005	By:	/s/ ELAINE M. PARFITT
		Elaine M. Parfitt
		Executive Vice President &
		Chief Financial Officer

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