Integral Systems (ISYS) 10-Q 2005 Q4 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 June 30, 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 10,424,163 shares of common stock outstanding as of July 29, 2005.

INTEGRAL SYSTEMS, INC.

TABLE OF CONTENTS

			Page No.
PART I. FINANCIAL INFORMATION:
	Item 1.	Financial Statements
		Consolidated Balance Sheets – June 30, 2005 (unaudited) and September 30, 2004	1
		Unaudited Consolidated Statements of Operations – Three and Nine Months Ended June 30, 2005 and June 30, 2004	3
		Unaudited Consolidated Statement of Stockholders’ Equity – Nine Months Ended June 30, 2005	4
		Unaudited Consolidated Statements of Cash Flows – Nine Months Ended June 30, 2005 and June 30, 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 1.	Legal Proceedings	31
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31
	Item 3.	Defaults Upon Senior Securities	31
	Item 4.	Submission of Matters to a Vote of Security Holders	31
	Item 5.	Other Information	32
	Item 6.	Exhibits	32
	Signatures		33

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2005 and September 30, 2004

	June 30, 2005		September 30, 2004
	(unaudited)
ASSETS
CURRENT ASSETS
Cash	$	28,969,421	$	18,198,832
Marketable Securities		27,951,000		29,060,396
Accounts Receivable, net		37,093,709		39,628,515
Notes Receivable		451,573		263,913
Prepaid Expenses		498,235		632,595
Inventory		2,097,549		1,312,161
Deferred Income Tax - Current Portion		941,866		855,700
Income Taxes Receivable		787,073		0
TOTAL CURRENT ASSETS		98,790,426		89,952,112
FIXED ASSETS
Electronic Equipment		4,389,167		4,884,764
Furniture & Fixtures		559,516		876,255
Leasehold Improvements		1,510,824		1,345,634
Software Purchases		795,715		846,413
SUBTOTAL - FIXED ASSETS		7,255,222		7,953,066
Less: Accumulated Depreciation		3,795,321		4,395,933
TOTAL FIXED ASSETS		3,459,901		3,557,133
OTHER ASSETS
Notes Receivable - Non-Current		294,583		300,338
Intangible Assets, net		431,243		637,493
Goodwill		33,338,768		33,256,186
Software Development Costs		3,247,130		4,591,904
Deposits and Deferred Charges		205,144		171,275
TOTAL OTHER ASSETS		37,516,868		38,957,196
TOTAL ASSETS	$	139,767,195	$	132,466,441

- 1 -

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2005 and September 30, 2004

	June 30, 2005			September 30, 2004
	(unaudited)
LIABILITIES & STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts Payable	$	6,445,710		$	5,491,629
Accrued Expenses		6,470,171			13,893,662
Capital Leases Payable		34,179			35,119
Billings in Excess of Revenue		7,748,940			5,581,124
Income Taxes Payable		0			672,148
TOTAL CURRENT LIABILITIES		20,699,000			25,673,682
LONG TERM LIABILITIES
Capital Leases Payable		0			25,119
Deferred Income Taxes		1,428,340			1,428,344
TOTAL LONG TERM LIABILITIES		1,428,340			1,453,463
STOCKHOLDERS’ EQUITY
Common Stock, $.01 par value, 40,000,000 shares authorized, and 10,406,613 and 9,944,494 shares issued and outstanding at June 30, 2005 and September 30, 2004, respectively		104,066			99,445
Additional Paid-in Capital		89,749,659			81,201,927
Retained Earnings		27,791,521			24,010,558
Accumulated Other Comprehensive Income		(5,391	)		27,366
TOTAL STOCKHOLDERS’ EQUITY		117,639,855			105,339,296
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	139,767,195		$	132,466,441

- 2 -

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended June 30,						Nine Months Ended June 30,
	2005			2004			2005			2004
Revenue	$	25,378,591		$	22,632,229		$	70,644,893		$	65,194,551
Cost of Revenue
Direct Labor		5,918,188			5,057,792			16,073,603			14,328,836
Overhead Costs		4,726,979			3,462,270			13,016,367			10,653,469
Travel and Other Direct Costs		568,555			580,638			1,738,271			1,801,414
Direct Equipment & Subcontracts		6,819,565			6,329,565			18,004,785			16,640,383
Total Cost of Revenue		18,033,287			15,430,265			48,833,026			43,424,102
Gross Margin		7,345,304			7,201,964			21,811,867			21,770,449
Selling, General & Administrative		3,383,394			3,273,869			10,268,346			9,359,032
Research & Development		618,852			960,666			1,871,850			2,667,158
Product Amortization		645,409			761,381			1,936,225			2,284,143
Intangible Asset Amortization		68,750			68,750			206,250			713,279
Income From Operations		2,628,899			2,137,298			7,529,196			6,746,837
Other Income (Expense)
Interest Income		347,644			139,611			818,871			449,020
Interest Expense		(1,138	)		(1,585	)		(4,211	)		(5,730	)
Gain on Sale of Marketable Securities		0			0			49,997			21,439
Miscellaneous, net		(105,180	)		(108,434	)		(525,237	)		(392,397	)
Total Other Income		241,326			29,592			339,420			72,332
Income Before Income Tax		2,870,225			2,166,890			7,868,616			6,819,169
Provision for Income Taxes		1,006,575			782,472			2,770,109			2,480,705
Net Income	$	1,863,650		$	1,384,418		$	5,098,507		$	4,338,464
Weighted Avg. Number of Common Shares:
Basic		10,392,973			9,950,330			10,232,203			9,879,034
Diluted		10,629,952			10,099,956			10,424,185			10,053,256
Earnings per Share (Basic)	$	0.18		$	0.14		$	0.50		$	0.44
Earnings per Share (Diluted)	$	0.18		$	0.14		$	0.49		$	0.43

- 3 -

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED JUNE 30, 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	—			—			—			5,098,507			—			5,098,507
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	—			—			—			—			(39,319	)		(39,319	)
Total Comprehensive Income	—			—			—			—			—			5,065,750
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	239,870			2,399			4,426,336			—			—			4,428,735
Declared Dividends	—			—			—			(1,234,818	)		—			(1,234,818	)
Balance June 30, 2005	10,406,613		$	104,066		$	89,749,659		$	27,791,521		$	(5,391	)	$	117,639,855

- 4 -

INTEGRAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended June 30, 2005 and 2004

(Unaudited)

	For the Nine Months Ended June 30,
	2005			2004
Cash flows from operating activities:
Net income	$	5,098,507		$	4,338,464
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,328,093			4,269,085
Reserve for doubtful accounts		(20,000	)		65,325
Gain on sale of marketable securities		(49,997	)		(21,439	)
Loss on disposal of fixed assets		40,395			42,661
Changes in operating assets and liabilities, net:
Accounts receivable and other receivables		2,548,296			(576,663	)
Prepaid expenses and deposits		113,619			(217,744	)
Inventories		(1,130,256	)		(625,263	)
Accounts payable		929,035			(27,975	)
Accrued expenses		(3,254,325	)		(3,473,282	)
Billings in excess of revenue		2,167,816			(1,447,174	)
Income taxes payable		(1,405,636	)		(370,722	)
Total adjustments		3,267,040			(2,383,191	)
Net cash provided by operating activities		8,365,547			1,955,273
Cash flows from investing activities:
Purchases of marketable securities		—			(649,807	)
Sale of marketable securities		1,135,983			169,837
Issuance of notes receivable		(54,906	)		—
Proceeds from payments on notes receivable		139,605			92,605
Acquisition of fixed assets		(1,207,258	)		(831,318	)
Software development costs		(591,451	)		(1,510,467	)
Net cash (used in) investing activities		(578,027	)		(2,729,150	)
Cash flows from financing activities:
Proceeds from issuance of common stock		4,428,735			444,871
Stock repurchases		(145,470	)		(237,836	)
Dividend payments		(1,234,818	)		—
Capital lease obligation payments		(26,059	)		(23,945	)
Net cash provided by financing activities		3,022,388			183,090
Effect of currency translations		(39,319	)		93,832
Net increase in cash		10,809,908			(590,787	)
Cash – beginning of year		18,198,832			22,526,718
Cash - end of period	$	28,969,421		$	22,029,763

- 5 -

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 June 30, 2005 and September 30, 2004 consisted of the following:

	June 30, 2005			Sept. 30, 2004
Billed	$	14,453,844		$	15,117,607
Unbilled		22,657,058			24,467,186
Other		112,807			193,722
Reserve		(130,000	)		(150,000	)
Total	$	37,093,709		$	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). During the three months ended June 30, 2005, the Company filed a second but unrelated claim under the same contract for an additional $320,000. As of June 30, 2005, unbilled accounts receivable included approximately $1.3 million associated with the claims.

- 6 -

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 June 30, 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 $34,200 at June 30, 2005. The outstanding balance is payable over a 11-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.

- 7 -

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 nine months ended June 30, 2005 and 2004 is as follows:

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

5. Stock-Based Compensation (continued)

	Three Months Ended June 30,				Nine Months Ended June 30,
	2005		2004		2005		2004
Net income, as reported	$	1,863,650	$	1,384,418	$	5,098,507	$	4,338,464
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards		386,914		398,486		1,275,654		1,231,970
Add: Stock-based employee compensation included in net income		—		—		—		—
Pro forma net income	$	1,476,736	$	985,932	$	3,822,853	$	3,106,494
Earnings per share:
As reported - basic	$	0.18	$	0.14	$	0.50	$	0.44
- diluted	$	0.18	$	0.14	$	0.49	$	0.43
Pro forma    - basic	$	0.14	$	0.10	$	0.37	$	0.31
- diluted	$	0.14	$	0.10	$	0.37	$	0.31

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.

- 8 -

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 and businesses being disbanded (the Company’s Antenna Division, the Company’s Skylight product, 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.

On April 28, 2005, RT Logic Tract TT2, LLC, a newly-formed and wholly-owned subsidiary of 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.

- 9 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

6. Business Segment Information (continued)

Summarized financial information by business segment is as follows:

	Three Months Ended June 30, 2005			Three Months Ended June 30, 2004			Nine Months Ended June 30, 2005			Nine Months Ended June 30, 2004
Revenue
Ground Systems–Government	$	12,596,099		$	12,037,703		$	33,097,759		$	32,411,231
Ground Systems–Government intersegment		—			250,252			—			250,252
Ground Systems–Commercial		4,862,193			4,253,005			13,305,411			12,871,551
Ground Systems–Commercial intersegment		128,116			7,180			281,515			15,111
Space Communication Systems		7,228,607			5,048,215			21,076,378			15,588,698
Space Communication Systems intersegment		901,184			1,174,342			2,415,866			2,005,129
Corporate		691,692			1,293,306			3,165,345			4,323,071
Corporate intersegment		847,417			958,694			2,653,989			3,461,040
Elimination of intersegment sales		(1,876,717	)		(2,390,468	)		(5,351,370	)		(5,731,532	)
Total Revenue	$	25,378,591		$	22,632,229		$	70,644,893		$	65,194,551
Operating Income
Ground Systems–Government	$	980,313		$	1,360,069		$	2,763,634		$	3,457,859
Ground Systems–Government intersegment		—			—			—			—
Ground Systems–Commercial		419,527			(202,022	)		392,675			(115,253	)
Ground Systems–Commercial intersegment		(6,134	)		26			(22,264	)		(461	)
Space Communication Systems		2,349,173			1,834,419			6,692,232			5,619,073
Space Communication Systems intersegment		(6,100	)		(547	)		1,193			(547	)
Corporate		(1,120,114	)		(855,168	)		(2,319,345	)		(2,214,842	)
Corporate intersegment		(422	)		2,206			(10,450	)		(1,307	)
Elimination of intersegment Operating Income		12,656			(1,685	)		31,521			2,315
Total Operating Income	$	2,628,899		$	2,137,298		$	7,529,196		$	6,746,837
Total Assets
Ground Systems–Government	$	18,725,638		$	21,168,555		$	18,725,638		$	21,168,555
Ground Systems–Commercial		13,468,004			12,170,512			13,468,004			12,170,512
Space Communication Systems		49,435,938			44,442,590			49,435,938			44,442,590
Corporate		71,025,955			58,450,937			71,025,955			58,450,937
Elimination of intersegment accounts receivable		(12,888,340	)		(14,114,683	)		(12,888,340	)		(14,114,683	)
Total Assets	$	139,767,195		$	122,117,911		$	139,767,195		$	122,117,911

- 10 -

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, Real Time Logic, Inc. (“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 and businesses being disbanded (the Company’s Antenna Division, the Company’s Skylight product 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 JUNE 30, 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 June 30, 2005 and 2004:

	Three Months Ended June 30,
	2005		% of Revenue	2004		% of Revenue
	(in thousands)			(in thousands)
Revenue	$	25,379	100.0	$	22,632	100.0
Cost of Revenue		18,034	71.1		15,430	68.2
Gross Margin		7,345	28.9		7,202	31.8
Operating Expenses
Selling, General & Admin. (SG&A)		3,383	13.3		3,274	14.5
Research and Development		619	2.4		961	4.2
Product Amortization		645	2.5		761	3.4
Amortization-Intangible Assets		69	0.3		69	0.3
Income from Operations		2,629	10.4		2,137	9.4
Other Income (Expense) (net)		241	0.9		30	0.2
Income Before Income Taxes		2,870	11.3		2,167	9.6
Income Taxes		1,006	4.0		783	3.5
Net Income	$	1,864	7.3	$	1,384	6.1

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 June 30, 2005 and 2004, the Company’s revenues were generated from the following sources:

	Three Months Ended June 30,
Revenue Type	2005		2004
U.S. Government Revenue (all segments)
NOAA	6	%	15	%
U.S. Air Force	58		56
Other U.S. Government Users	12		6
Subtotal	76		77
Commercial Revenue (all segments)	24		23
Total	100	%	100	%

- 13 -

On a consolidated basis, revenue increased 12.1%, or $2.8 million, to $25.4 million for the three months ended June 30, 2005, from $22.6 million for the three months ended June 30, 2004. Revenue for the three-month periods ended June 30, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Three Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	12,596		$	12,288		$	308
Ground Systems – Commercial
Command & Control		3,157			2,701			456
Newpoint		914			646			268
SAT		1,173			992			181
Intra-Segment Elimination		(254	)		(79	)		(175	)
Ground Systems – Commercial		4,990			4,260			730
Space Communications Systems		8,130			6,223			1,907
Corporate
Product Group		851			1,134			(283	)
Antenna		322			218			104
I&T		—			627			(627	)
Other		366			273			93
Corporate		1,539			2,252			(713	)
Elimination		(1,876	)		(2,391	)		515
Total Revenue	$	25,379		$	22,632		$	2,747

Revenue increases in the Company’s Ground Systems - Government segment between the three months ended June 30, 2005 and 2004 primarily relate to increased sales of $1.9 million from the Company’s contracts with the U.S. Air Force largely offset by revenue decreases from NOAA.

Revenue increases of approximately $460,000 for the Company’s Command & Control unit of its Ground Systems – Commercial segment resulted from increased order bookings and increased system shipments to customers for the three months ended June 30, 2005 compared to the three months ended June 30, 2004.

SAT’s revenue increase of approximately $180,000 relates to increased order shipments during the three months ended June 30, 2005 compared to the three months ended June 30, 2004. Newpoint revenue increased approximately $270,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 due to increased order bookings and increased product shipments.

Revenue increases for the Company’s Space Communications Systems segment resulted from increased backlog and increased product shipments for the three months ended June 30, 2005 compared to the three months ended June 30, 2004.

In the Company’s Corporate segment, revenues for the Product Group decreased approximately $280,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 principally due to decreased license revenue.

- 14 -

Antenna Division revenues increased approximately $100,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 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 third 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.

During the three months ended June 30, 2005, cost of revenue increased by 16.9%, or $2.6 million, compared to the same period during the prior year, increasing from $15.4 million during the three months ended June 30, 2004 to $18.0 million during the three months ended June 30, 2005. Gross margin increased from $7.2 million to $7.3 million, an increase of $100,000, or 2.0%, during the periods being compared. Cost of revenue and gross margin for the three months ended June 30, 2005 and 2004 for each of the Company’s segments are shown in the following table:

- 15 -

	Three Months Ended June 30,							Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)				(in thousands)
Cost of Revenue
Ground Systems – Government	$	10,254		$	9,762			$	492
Ground Systems – Commercial
Command & Control		2,455			2,250				205
Newpoint		477			264				213
SAT		691			541				150
Intra-Segment Elimination		(249	)		(67	)			(182	)
Ground Systems – Commercial		3,374			2,988				386
Space Communications Systems		4,388			3,179				1,209
Corporate
Product Group		836			479				357
Antenna		703			691				12
I&T		—			475		��		(475	)
Other		351			230				121
Corporate		1,890			1,875				15
Elimination		(1,872	)		(2,374	)			502
Total Cost of Revenue	$	18,034		$	15,430			$	2,604
Gross Margin
Ground Systems – Government	$	2,342		$	2,526			$	(184	)
Ground Systems – Commercial
Command & Control		702			451				251
Newpoint		437			382				55
SAT		482			451				31
Intra-Segment Elimination		(5	)		(12	)			7
Ground Systems – Commercial		1,616			1,272				344
Space Communications Systems		3,742			3,044				698
Corporate
Product Group		15			655				(640	)
Antenna		(381	)		(473	)			92
I&T		—			152				(152	)
Other		15			43				(28	)
Corporate		(351	)		377				(728	)
Elimination		(4	)		(17	)			13
Total Gross Margin	$	7,345		$	7,202			$	143

- 16 -

The decreased gross margin in the Company’s Ground Systems – Government segment (approximately $180,000) primarily relates to a lower percentage of fixed price revenue compared to cost reimbursable revenue in the segment’s revenue mix for the three months ended June 30, 2005 compared to the three months ended June 30, 2004. The Company generally earns higher margins on its fixed price contracts than its cost reimbursable type contracts because of the greater risk associated with fixed price efforts. Many of the Company’s new awards with the U.S. Air Force have been cost reimbursable type contract vehicles.

The higher gross margin (approximately $340,000) for the Company’s Ground Systems - Commercial segment is primarily attributable to increased revenue of $730,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 2004. All units in this segment posted increased gross margins and increased revenue for the current quarter.

The Space Communications System segment experienced an increase in gross margin of approximately $700,000 on increased revenue of $1.9 million for the three months ended June 30, 2005 compared to the three months ended June 30, 2004. The segment’s gross margin percentage declined from 48.9% for the three months ended June 30, 2004 to 46.0% for the three months ended June 30, 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 June 30, 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.

In the Corporate segment, the Product Group experienced a decrease in gross margin of approximately $640,000 on a period-to-period basis because of decreased license revenue. Further, effective with the beginning of the current quarter, the Company determined that its EPOCH IPS product line was substantially complete and therefore costs associated with the product were no longer eligible for capitalization. The costs of software bug fixes and support were higher in the current quarter than similar costs incurred during the three months ended June 30, 2004, thereby further contributing to the lower gross margin.

Although the Antenna Division was able to reduce its gross margin deficit by approximately $90,000, the Antenna Division nonetheless recorded a $380,000 gross margin deficit during the three months ended June 30, 2005. Contract overruns for the Division have continued on three of the unit’s four remaining contracts. The Company believes that all four of these contracts will be completed by calendar year end (with the exception of warranty obligations).

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 June 30, 2005 and 2004 for each of the Company’s segments are shown in the following table:

	Three Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Ground Systems – Government	$	1,361		$	1,165		$	196
Ground Systems – Commercial
Command & Control		342			325			17
Newpoint		411			371			40
SAT		472			778			(306	)
Intra-Segment Elimination		(22	)		(1	)		(21	)
Ground Systems – Commercial		1,203			1,473			(270	)
Space Communications Systems		1,399			1,210			189
Corporate
Product Group		799			936			(137	)
Antenna		18			75			(57	)
I&T		—			179			(179	)
Other		(47	)		41			(88	)
Corporate		770			1,231			(461	)
Elimination		(17	)		(15	)		(2	)
Total Operating Expenses	$	4,716		$	5,064		$	(348	)

Operating expenses in the Company’s Ground Systems – Government segment increased by approximately $200,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 due to increased bid and proposal costs coupled with increased costs incurred related to compliance with Sarbanes-Oxley regulations.

Operating expenses in the Company’s Ground Systems - Commercial segment decreased by approximately $270,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 due to decreased operating expenses at SAT. Operating expenses at SAT were down more than $300,000 principally due to reductions in research and development costs and product amortization expenses.

The Space Communications Systems segment’s operating expenses for the three months ended June 30, 2005 increased by approximately $190,000 compared to the three months ended June 30, 2004. Although R&D expense decreased approximately $80,000, SG&A expenses increased some $270,000, accounting for the overall increase.

Operating expenses in the Corporate segment for the three months ended June 30, 2005 decreased by approximately $460,000 compared to the three months ended June 30, 2004 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.

- 18 -

Income from Operations

Income from operations for the three months ended June 30, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Three Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Ground Systems – Government	$	981		$	1,361		$	(380	)
Ground Systems – Commercial
Command & Control		360			126			234
Newpoint		26			11			15
SAT		10			(327	)		337
Intra-Segment Elimination		17			(11	)		28
Ground Systems – Commercial		413			(201	)		614
Space Communications Systems		2,343			1,834			509
Corporate
Product Group		(784	)		(281	)		(503	)
Antenna		(399	)		(548	)		149
I&T		—			(27	)		27
Other		62			2			60
Corporate		(1,121	)		(854	)		(267	)
Elimination		13			(2	)		15
Total Income from Operations	$	2,629		$	2,138		$	491

Income from operations during the periods compared decreased by approximately $380,000 in the Company’s Ground Systems – Government segment as a result of decreased gross margins (related to a lower percentage of fixed price contracts) coupled with increased operating expenses.

Income from operations during the periods compared increased by approximately $610,000 in the Company’s Ground Systems – Commercial segment as a result of increased revenue and gross margins at all business units coupled with decreased operating expenses at SAT as described above.

The Space Communications Systems segment recorded increased income from operations of approximately $510,000 principally due to increased gross margins partially offset by increased operating expenses.

In the Corporate segment, the Product Group posted an operating loss in excess of $500,000 primarily because of decreased gross margin (resulting in part from lower license revenue) partially offset by lower operating expenses. Although the Product Group recorded losses for the quarter, a large portion of the revenue generated in the Company’s ground systems business (both Government and Commercial) is a result of its EPOCH IPS product line, which the Company believes favorably distinguishes it from its competitors.

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.

- 19 -

Other Income/Expense

Other income and expense increased by approximately $210,000 between the quarters being compared, mostly as a result from increased interest income related to favorable interest rate changes.

Income Before Income Taxes/Net Income

Income before income taxes increased by approximately $700,000 over amounts posted during the third quarter of last fiscal year principally due to increased operating income of approximately $490,000 as described above combined with increased interest income.

The Company’s effective tax rate decreased from 36.1% for the three months ended June 30, 2004 to 35.1% for the three months ended June 30, 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 $1.86 million during the three months ended June 30, 2005 from $1.38 million during the three months ended June 30, 2004.

COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 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 nine months ended June 30, 2005 and 2004:

	Nine Months Ended June 30,
	2005		% of Revenue	2004		% of Revenue
	(in thousands)			(in thousands)
Revenue	$	70,645	100.0	$	65,195	100.0
Cost of Revenue		48,833	69.1		43,424	66.6
Gross Margin		21,812	30.9		21,771	33.4
Operating Expenses
Selling, General & Admin. (SG&A)		10,269	14.5		9,359	14.4
Research and Development		1,872	2.6		2,668	4.1
Product Amortization		1,936	2.7		2,284	3.5
Amortization-Intangible Assets		206	0.4		713	1.1
Income from Operations		7,529	10.7		6,747	10.3
Other Income (Expense) (net)		340	0.4		72	0.2
Income Before Income Taxes		7,869	11.1		6,819	10.5
Income Taxes		2,770	3.9		2,481	3.8
Net Income	$	5,099	7.2	$	4,338	6.7

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.

- 20 -

For the nine months ended June 30, 2005 and 2004, the Company’s revenues were generated from the following sources:

	Nine Months Ended June 30,
Revenue Type	2005		2004
U.S. Government Revenue (all segments)
NOAA	9	%	16	%
U.S. Air Force	54		54
Other U.S. Government Users	12		6
Subtotal	75		76
Commercial Revenue (all segments)	25		24
Total	100	%	100	%

On a consolidated basis, revenue increased 8.4%, or $5.4 million, to $70.6 million for the nine months ended June 30, 2005, from $65.2 million for the nine months ended June 30, 2004. Revenue for the nine-month periods ended June 30, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Nine Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	33,098		$	32,662		$	436
Ground Systems – Commercial
Command & Control		8,846			8,275			571
Newpoint		2,490			2,028			462
SAT		2,733			3,450			(717	)
Intra-Segment Elimination		(482	)		(867	)		385
Ground Systems – Commercial		13,587			12,886			701
Space Communications Systems		23,492			17,594			5,898
Corporate
Product Group		2,726			3,414			(688	)
Antenna		2,100			1,362			738
I&T		—			1,992			(1,992	)
Other		993			1,016			(23	)
Corporate		5,819			7,784			(1,965	)
Elimination		(5,351	)		(5,732	)		381
Total Revenue	$	70,645		$	65,194		$	5,451

Revenue increases in the Company’s Ground Systems—Government segment between the nine months ended June 30, 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.

- 21 -

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 nine months ended June 30, 2005 compared to the nine months ended June 30, 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 $740,000 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 nine months ended June 30, 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.

During the nine months ended June 30, 2005, cost of revenue increased by 12.5%, or $5.4 million, compared to the same period during the prior year, increasing from $43.4 million during the nine months ended June 30, 2004 to $48.8 million during the nine months ended June 30, 2005. Gross margin remained relatively unchanged at $21.8 million during the periods being compared. Cost of revenue and gross margin for the nine months ended June 30, 2005 and 2004 for each of the Company’s segments are shown in the following table:

- 22 -

	Nine Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	26,124		$	26,008		$	116
Ground Systems – Commercial
Command & Control		6,848			6,871			(23	)
Newpoint		1,258			873			385
SAT		1,754			2,054			(300	)
Intra-Segment Elimination		(436	)		(858	)		422
Ground Systems – Commercial		9,424			8,940			484
Space Communications Systems		13,175			8,004			5,171
Corporate
Product Group		1,732			1,448			284
Antenna		2,725			2,143			582
I&T		—			1,622			(1,622	)
Other		960			948			12
Corporate		5,417			6,161			(744	)
Elimination		(5,307	)		(5,689	)		382
Total Cost of Revenue	$	48,833		$	43,424		$	5,409
Gross Margin
Ground Systems – Government	$	6,974		$	6,654		$	320
Ground Systems – Commercial
Command & Control		1,998			1,404			594
Newpoint		1,232			1,155			77
SAT		979			1,396			(417	)
Intra-Segment Elimination		(46	)		(9	)		(37	)
Ground Systems – Commercial		4,163			3,946			217
Space Communications Systems		10,317			9,590			727
Corporate
Product Group		994			1,966			(972	)
Antenna		(625	)		(781	)		156
I&T		—			370			(370	)
Other		33			68			(35	)
Corporate		402			1,623			(1,221	)
Elimination		(44	)		(43	)		(1	)
Total Gross Margin	$	21,812		$	21,770		$	42

- 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 nine-month period. As a result, gross margin as a percentage of revenue for the Ground Systems - Government segment increased from 20.4% for the nine months ended June 30, 2004 to 21.1% for the nine months ended June 30, 2005.

The gross margin for the Company’s Ground Systems – Commercial segment primarily relates to increased revenue from the segment’s Command & Control Division and from Newpoint. At SAT, gross margin declined by approximately $420,000 due to a $720,000 decrease in revenues.

Gross margin in the Space Communications System increased by approximately $730,000 during the periods being compared on increased revenue of approximately $5.9 million. The segment’s gross margin percentage declined from 54.5% for the nine months ended June 30, 2004 to 43.9% for the nine months ended June 30, 2005 due to a considerably greater mix of third party equipment costs in the segment’s cost of revenue in the nine months ended June 30, 2005 than in the nine months ended June 30, 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 nine months ended June 30, 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 decrease in gross margin of approximately $970,000 on a period-to-period basis because of decreased license revenue. Further, effective with the beginning of the current quarter, the Company determined that its EPOCH IPS product line was substantially complete and therefore costs associated with the product were no longer eligible for capitalization. The costs of software bug fixes and support were higher in the current nine month period than similar costs incurred during the nine months ended June 30, 2004, thereby further contributing to the lower gross margin.

Although the Antenna Division was able to reduce its gross margin deficit by approximately $160,000, the Antenna Division nonetheless recorded a $630,000 gross margin deficit during the nine months ended June 30, 2005. Contract overruns for the Division have continued on three of the unit’s four remaining contracts. The Company believes that all four of these contracts will be completed by December 31, 2005 (with the exception of warranty obligations).

The I&T Division posted no gross margins as it had no revenue for the current nine month period.

- 24 -

Operating Expenses

Operating expenses for the nine months ended June 30, 2005 and 2004 for each of the Company’s segments are shown in the following table:

	Nine Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Ground Systems – Government	$	4,210		$	3,195		$	1,015
Ground Systems – Commercial
Command & Control		1,267			990			277
Newpoint		1,119			1,126			(7	)
SAT		1,460			1,947			(487	)
Intra-Segment Elimination		(53	)		(1	)		(52	)
Ground Systems – Commercial		3,793			4,062			(269	)
Space Communications Systems		3,623			3,971			(348	)
Corporate
Product Group		2,554			2,928			(374	)
Antenna		100			230			(130	)
I&T		—			663			(663	)
Other		78			20			58
Corporate		2,732			3,841			(1,109	)
Elimination		(75	)		(46	)		(29	)
Total Operating Expenses	$	14,283		$	15,023		$	(740	)

Operating expenses in the Company’s Ground Systems – Government segment increased by approximately $1.02 million for the nine months ended June 30, 2005 compared to the nine months ended June 30, 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 $280,000 for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004 principally due to allocated bid and proposal expenses. Operating expenses at SAT were down approximately $490,000 principally due to reductions in product amortization expenses and lower research and development costs. At Newpoint operating expenses were essentially flat during the periods being compared.

The Space Communications Systems segment’s operating expenses for the nine months ended June 30, 2005 decreased approximately $350,000 compared to the nine months ended June 30, 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 $530,000 on a period to period basis, R&D spending was lower by approximately $370,000 accounting for most of the remaining decline in operating expenses.

- 25 -

Operating expenses in the Corporate segment decreased by approximately $1.1 million 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 nine months ended June 30, 2005 and 2004 for each of the Company’s segments is shown in the following table:

	Nine Months Ended June 30,						Increase/ (Decrease)
Segment	2005			2004
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Ground Systems – Government	$	2,764		$	3,459		$	(695	)
Ground Systems – Commercial
Command & Control		731			414			317
Newpoint		113			29			84
SAT		(481	)		(551	)		70
Intra-Segment Elimination		7			(8	)		15
Ground Systems – Commercial		370			(116	)		486
Space Communications Systems		6,694			5,619			1,075
Corporate
Product Group		(1,560	)		(962	)		(598	)
Antenna		(725	)		(1,011	)		286
I&T		—			(293	)		293
Other		(45	)		48			(93	)
Corporate		(2,330	)		(2,218	)		(112	)
Elimination		31			3			28
Total Income from Operations	$	7,529		$	6,747		$	782

Income from operations during the periods compared decreased approximately $700,000 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 increased by approximately $490,000 in the Company’s Ground Systems – Commercial segment as a result of increased revenue and gross margins exclusive of SAT. SAT recorded lower revenue and gross margins during the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004, but the decrease was somewhat offset by a decrease in operating expenses of approximately $70,000.

The Space Communications Systems segment recorded increased income from operations of approximately $1.08 million principally due to increased revenue and gross margins coupled with decreased operating expenses.

In the Corporate segment, the Product Group posted an operating loss of almost $1.56 million primarily because of amortization expense that approached $1.8 million for the nine months ended June 30, 2005

- 26 -

coupled with lower license revenue. Although the Product Group recorded losses for the first nine months of the fiscal year, a large portion of the revenue generated in the Company’s 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.

Operating losses in the Antenna Division have been reduced due to the sale of that unit’s assets, although overruns on three of the Antenna Division’s four remaining contracts have resulted in an operating loss of approximately $730,000 for the nine months ended June 30, 2005. Operating losses at the I&T Division have been eliminated due to the shutdown of that unit.

Other Income/Expense

Other income and expense increased approximately $270,000 between the nine-month periods being compared, mostly as a result from increased interest income related to favorable interest rate changes.

Income Before Income Taxes/Net Income

Income before income taxes increased approximately $1.05 million for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004 principally due to increased operating income of approximately $780,000 as described above combined with increased interest income.

The Company’s effective tax rate decreased from 36.4% for the nine months ended June 30, 2004 to 35.2% for the nine months ended June 30, 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, net income increased to approximately $5.1 million during the nine months ended June 30, 2005 from $4.3 million during the nine months ended June 30, 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 nine months ended June 30, 2005, the Company believes that it is on target to meet or even exceed these goals for fiscal year 2005 in its entirety.

- 27 -

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 June 30, 2005, $14.5 million was invested in variable rate State of Maryland debt securities and $13.5 million was invested in Banc of America Securities LLC Auction Rate Securities.

For the nine months ended June 30, 2005, operating activities provided the Company approximately $8.4 million of cash. The Company used approximately $600,000 (net) in investing activities; financing activities provided approximately $3.0 million. Included in the $600,000 of investing activities is approximately $600,000 in newly capitalized software development costs and $1.2 million used for the purchase of fixed assets which was offset by the proceeds provided by the sale of $1.2 million (net) in marketable securities.

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 June 30, 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 $34,200 at June 30, 2005. The outstanding balance is payable over an 11-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 June 2, 2005. The dividend was paid on June 29, 2005 in the amount of $416,680. 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 September 1, 2005. The dividend will be paid on or about September 28, 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 believes that inflation did not have a material impact on the Company’s revenues or income from operations during the nine months ended June 30, 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.

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,

- 28 -

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.

• 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.

- 29 -

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 June 30, 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.

- 30 -

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 1. LEGAL PROCEEDINGS

None.

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

The Annual Meeting of Stockholders of the Company was held on April 13, 2005. The following matters were voted on by stockholders, and received the votes indicated:

1. The stockholders elected the following individuals to the Board of Directors:

Director	For	Withheld
Steven R. Chamberlain	6,540,052	1,541,555
Thomas L. Gough	6,554,489	1,527,118
Bonnie K. Wachtel	8,035,918	45,689
Dominic Laiti	8,036,768	44,839
R. Doss McComas	7,632,245	449,362

- 31 -

2. The stockholders approved the Amended and Restated ISI 2002 Stock Option Plan:

For	Against	Abstain	Broker Non-Votes
5,486,780	709,759	1,885,068	—

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibits

10.1	Lease Agreement dated April 20, 2005 by and between Real Time Logic, Inc. and the John J. Gogian Jr. Revocable Trust of 1983.
10.2	Purchase Agreement dated April 28, 2005 by and between RT Logic Tract TT2, LLC and Northgate Properties, LLC.
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.

- 32 -

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: August 9, 2005	By:	/s/ THOMAS L. GOUGH
		Thomas L. Gough
		President & Chief Operating Officer
Date: August 9, 2005	By:	/s/ ELAINE M. PARFITT
		Elaine M. Parfitt
		Executive Vice President &
		Chief Financial Officer

- 33 -