Integral Systems 10Q 2006 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, 2006 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 check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Registrant had 10,994,975 shares of common stock outstanding as of April 28, 2006.

INTEGRAL SYSTEMS, INC.

TABLE OF CONTENTS


			Page No.
PART I. FINANCIAL INFORMATION:

	Item 1.	Financial Statements

		Consolidated Balance Sheets – March 31, 2006 (unaudited) and September 30, 2005	1

		Unaudited Consolidated Statements of Operations – Three and Six Months Ended March 31, 2006 and March 31, 2005	3

		Unaudited Consolidated Statement of Stockholders’ Equity - Six Months Ended March 31, 2006	4

		Unaudited Consolidated Statements of Cash Flows – Six Months Ended March 31, 2006 and March 31, 2005	5

		Notes to Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34

	Item 4.	Controls and Procedures	34

PART II. OTHER INFORMATION:

	Item 1.	Legal Proceedings	36

	Item 2.	Unregistered Sale of Equity Securities and Use of Proceeds	36

	Item 6.	Exhibits	37

	Signatures		38

Item 1. Financial Statements

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2006 and September 30, 2005

ASSETS


	March 31, 2006		September 30, 2005
	(unaudited)
CURRENT ASSETS
Cash	$	24,524,339	$	24,775,460
Marketable securities		38,120,000		32,716,000
Accounts receivable, net of allowance for doubtful accounts		14,144,113		19,162,918
Unbilled receivables		20,237,410		17,915,939
Employee and other receivables		511,540		87,655
Notes receivable		302,017		378,055
Prepaid expenses		636,843		585,740
Inventories		3,415,093		2,223,373
Deferred income tax		951,230		878,066

TOTAL CURRENT ASSETS		102,842,585		98,723,206

PROPERTY AND EQUIPMENT
Land		2,327,329		2,327,329
Electronic equipment		4,699,852		4,642,158
Furniture & fixtures		611,893		659,612
Leasehold improvements		1,734,680		1,706,393
Software purchases		707,371		808,520

		10,081,125		10,144,012
Less: accumulated depreciation		4,092,618		4,240,409

NET FIXED ASSETS		5,988,507		5,903,603

OTHER ASSETS
Notes receivable		107,500		267,708
Intangible assets, net		384,787		362,493
Goodwill		49,924,779		41,011,844
Software development costs, net		1,801,693		2,601,693
Deposits, deferred charges, and other		2,978,539		325,736

TOTAL OTHER ASSETS		55,197,298		44,569,474

TOTAL ASSETS	$	164,028,390	$	149,196,283

The accompanying notes are an integral part of these consolidated financial statements.

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

March 31, 2006 and September 30, 2005

LIABILITIES & STOCKHOLDERS’ EQUITY


	March 31, 2006		September 30, 2005
	(unaudited)
CURRENT LIABILITIES
Accounts payable	$	6,595,341	$	6,360,140
Accrued expenses		7,199,091		14,722,834
Capital leases payable		6,413		25,119
Billings in excess of revenue		9,798,383		7,088,015
Income taxes payable		286,359		188,285
Notes payable		2,745,490		—

TOTAL CURRENT LIABILITIES		26,631,077		28,384,393

LONG TERM LIABILITIES
Deferred income taxes		273,052		125,644

TOTAL LONG TERM LIABILITIES		273,052		125,644

STOCKHOLDERS’ EQUITY
Common Stock, $.01 par value, 40,000,000 shares authorized, and 10,962,777 and 10,447,623 shares issued and outstanding at March 31, 2006 and September 30, 2005, respectively		109,628		104,476
Additional paid-in capital		103,370,445		91,963,338
Retained earnings		33,605,146		28,575,843
Accumulated other comprehensive income		39,042		42,589

TOTAL STOCKHOLDERS’ EQUITY		137,124,261		120,686,246

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	164,028,390	$	149,196,283

The accompanying notes are an integral part of these consolidated financial statements.

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended March 31,						Six Months Ended March 31,
	2006			2005			2006			2005
Revenue	$	32,152,070		$	23,346,768		$	61,409,660		$	45,266,302

Cost of Revenue
Direct labor		6,486,523			5,593,558			12,076,875			10,155,415
Overhead costs		5,197,432			4,328,298			9,940,050			8,289,388
Travel and other direct costs		614,906			656,087			1,153,489			1,169,716
Direct equipment & subcontracts		9,199,682			5,437,326			18,180,877			11,185,220

Total Cost of Revenue		21,498,543			16,015,269			41,351,291			30,799,739

Gross Margin		10,653,527			7,331,499			20,058,369			14,466,563

Selling, general & administrative		3,893,073			3,112,946			7,292,904			6,884,952
Research & development		843,032			470,228			1,586,333			1,252,998
Stock based compensation cost		126,716			—			126,716			—
Product amortization		400,000			645,407			800,000			1,290,816
Intangible asset amortization		162,528			68,750			378,766			137,500

Income From Operations		5,228,178			3,034,168			9,873,650			4,900,297

Other Income (Expense)
Interest income		407,389			258,160			785,438			471,227
Interest expense		(824	)		(1,588	)		(1,999	)		(3,073	)
Gain (Loss) on sale of marketable securities		0			(3,764	)		0			49,997
Miscellaneous, net		(120,863	)		(112,794	)		(288,564	)		(420,057	)

Total Other Income (Expense)		285,702			140,014			494,875			98,094

Income Before Income Tax		5,513,880			3,174,182			10,368,525			4,998,391

Provision for Income Taxes		1,970,224			1,124,712			3,754,415			1,763,534

Net Income	$	3,543,656		$	2,049,470		$	6,614,110		$	3,234,857

Weighted Avg. Number of Common Shares:
Basic		10,874,278			10,258,510			10,772,462			10,151,819
Diluted		11,033,685			10,405,110			10,897,380			10,289,642
Earnings per Share (Basic)	$	0.33		$	0.20		$	0.61		$	0.32
Earnings per Share (Diluted)	$	0.32		$	0.20		$	0.61		$	0.31

Cash Dividends per Share	$	0.05		$	0.04		$	0.10		$	0.08

The accompanying notes are an integral part of these consolidated financial statements.

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED MARCH 31, 2006

(Unaudited)


	Number of Shares		Common Stock At Par Value			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance September 30, 2005	10,447,623		$	104,476		$	91,963,338		$	28,575,843		$	42,589		$	120,686,246

Net income	—			—			—			6,614,110			—			6,614,110
Effect of currency translation	—			—			—			—			(3,547	)		(3,547	)

Total Comprehensive Income	—			—			—			—			—			6,610,563

Repurchased shares	(45,900	)		(459	)		(388,183	)		(503,691	)					(892,333	)
Shares issued to acquire net assets of Lumistar LLC	224,931			2,249			4,732,099			—			—			4,734,348
Shares issued for FY05 RT Logic earnout	171,396			1,714			3,803,791			—			—			3,805,505
Stock options exercised	164,727			1,648			3,132,684			—			—			3,134,332
Declared dividends	—			—			—			(1,081,116	)		—			(1,081,116	)
Stock option compensation cost	—			—			126,716									126,716

Balance March 31, 2006	10,962,777		$	109,628		$	103,370,445		$	33,605,146		$	39,042		$	137,124,261

The accompanying notes are an integral part of these consolidated financial statements.

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INTEGRAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended March 31, 2006 and 2005

(Unaudited)


	For the Six Months Ended March 31,
	2006			2005
Cash flows from operating activities:

Net income	$	6,614,110		$	3,234,857

Adjustments to reconcile net income to net cash provided by operating activities, net of acquisition
Depreciation and amortization		2,146,113			2,194,942
Reserve for doubtful accounts		4,375			(10,000	)
Stock option compensation costs		126,716			—
Gain on sale of marketable securities		—			(49,997	)
Loss on disposal of fixed assets		—			35,874
Changes in operating assets and liabilities, net:
Accounts receivable and other receivables		3,696,701			4,969,706
Prepaid expenses, deposits, and deferred charges		(2,693,906	)		82,606
Inventories		(456,383	)		(128,121	)
Accounts payable		(1,455,122	)		(1,464,586	)
Accrued expenses		(4,071,158	)		(3,888,532	)
Billings in excess of revenue		2,710,368			2,287,692
Income taxes payable, net		172,318			(656,581	)

Total adjustments		180,022			3,373,003

Net cash provided by operating activities, net of effects of acquisition		6,794,132			6,607,860

Cash flows from investing activities:
Purchase of marketable securities		(20,000,000	)		(1,195,000	)
Sale of marketable securities		14,596,000			175,983
Issuance of Notes Receivable		—			(54,906	)
Proceeds from collections on notes receivable		236,246			110,515
Acquisition of fixed assets		(838,868	)		(947,080	)
Acquisition of Lumistar, LLC, including cash, 224,931 shares of common stock valued at $4,734,348, and $79,647 of acquisition costs		(4,922,752	)		—
Software development costs		—			(597,798	)

Net cash used in investing activities		(10,929,374	)		(2,508,286	)

Cash flows from financing activities:
Proceeds from issuance of common stock		3,134,332			3,776,586
Stock repurchases		(892,333	)		(145,470	)
Dividend payments		(1,081,115	)		(818,138	)
Notes Payable proceeds		2,745,490			—
Capital lease obligation payments		(18,706	)		(17,189	)

Net cash provided by financing activities		3,887,668			2,795,789

Effect of currency translations		(3,547	)		76,503
Net (decrease) increase in cash		(247,574	)		6,895,363
Cash – beginning of year		24,775,460			18,198,832

Cash - end of period	$	24,524,339		$	25,170,698

The accompanying notes are an integral part of these consolidated financial statements.

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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”), Lumistar, Inc. (“Lumistar”), 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, 2005. The results of operations for any interim period are not necessarily indicative of results for the full year.

2.	Acquisition of Net Assets of Lumistar, LLC.

On October 3, 2005, Lumistar, Inc. (the “Acquisition Subsidiary”), a newly-formed subsidiary of Real Time Logic, Inc. (“RT Logic”), a subsidiary of Integral Systems, Inc. (the “Company”), acquired substantially all of the assets of Lumistar, LLC (the “Seller”) relating to the Seller’s business of providing system level and board level telemetry acquisition products (the “Business”) pursuant to an Asset Purchase Agreement dated as of October 3, 2005 by and among the Company, RT Logic, the Acquisition Subsidiary, the Seller and certain members of the Seller. The primary reason for acquiring Lumistar was to expand the Company’s existing products to Lumistar’s client base. The initial purchase price was approximately $10 million, including cash paid of approximately $5 million and 224,931 shares of the Company’s common stock at an estimated value of approximately $5 million. During November 2005, the Company recorded a $423,000 reduction in goodwill resulting from a $266,000 adjustment in the value of the 224,931 shares of common stock issued to the Seller as well as a $157,000 purchase price adjustment that was paid to the Company from funds escrowed after closing. For purposes of the financial statements, the value of the 224,931 shares of common stock was determined based on the average market price of the Company’s common shares over the 2-day period before and after the terms of the acquisition were agreed to and announced. The number of common shares issued to the Seller at the closing was determined based on the average closing price per share of the Company’s common stock over the 30-day period ending on September 30, 2005. For purposes of the financial statements, the adjusted purchase price was $9,577,453, including cash paid of $4,843,105 and the Company’s common stock at a value of $4,734,348. The acquisition was accounted for using the purchase method of accounting under the guidance in FASB Statement 141, Business Combinations. Accordingly, operating results have been consolidated since October 3, 2005 and the initial purchase price has been allocated to assets acquired and liabilities assumed as follows:


Current assets	$	2,162,964
Property and equipment		213,383
Goodwill		8,833,289
Intangibles		401,059
Other assets		10,000

Total assets acquired		11,620,695
Current liabilities		2,043,242

Net assets acquired	$	9,577,453

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

2.	Acquisition of Net Assets of Lumistar, LLC (continued)

The identified intangible assets will be amortized on a straight-line basis over an estimated useful life of approximately four years for the technology ($159,500) and up to nine months for the customer related intangibles ($241,559). Goodwill, which represents the excess of the purchase price over the fair value of tangible and identified intangible assets acquired, is not being amortized but will be reviewed annually for impairment, or more frequently if impairment indicators arise, in accordance with Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). In part, goodwill reflects the competitive advantages the Company expects to realize from introducing its existing products into Lumistar’s client base.

The Seller may also be entitled to contingent consideration payments on the Business’s pre-tax earnings for a period of up to four years after the closing. Any contingent earn-out payments may be payable fifty percent in cash and fifty percent in stock and will be recorded as additional goodwill.

3.	Accounts Receivable

Accounts receivable at March 31, 2006 and September 30, 2005 consist of the following:


	March 31, 2006			Sept. 30, 2005
Billed	$	14,288,488		$	19,302,918
Allowance		(144,375	)		(140,000	)
Unbilled		20,237,410			17,915,939
Other		511,540			87,655

Total	$	34,893,063		$	37,166,512

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 and May 2005, Integral Systems filed claims in the amount of approximately $1.8 million and $319,000, respectively, against National Oceanic and Atmospheric Administration (“NOAA”). The claims arose under a contract from NOAA to provide the Data Collection System Automated Processing System II (DAPS-II System). Integral Systems had submitted appeals to the General Services Board of Contract Appeals (“GSBCA”) related to these claims. In August 2005, the Company filed another claim against NOAA in the amount of $135,000. This claim arose under a contract from NOAA to perform software and hardware upgrades on NOAA’s Polar Acquisition and Control Subsystem. On March 1, 2006, a settlement agreement was executed with NOAA which added approximately $1.4 million to the DAPS II contract in settlement of the Company’s outstanding claims. The Company received payment for these claims in April 2006.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

4.	Inventories

Inventories are priced at the lower of cost or market using the first in, first-out (FIFO) method of accounting. Obsolete inventory is written off and its value is removed from inventory at the time its obsolescence is determined. Inventories at March 31, 2006 and September 30, 2005 consist of the following:


	March 31, 2006		September 30, 2005
Finished Goods	$	2,471,590	$	2,004,158
Work in process		—		—
Raw Materials		943,503		219,215

Total	$	3,415,093	$	2,223,373

5.	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 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, 2006 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 $6,400 at March 31, 2006. The outstanding balance is payable over a 2-month period and bears interest at a rate of 8.8% per annum.

On February 10, 2006, RT Logic Tract TT2, LLC (“Borrower”), a wholly-owned subsidiary of RT Logic, entered into a Construction Loan Agreement (the “Loan Agreement”) for an aggregate amount of $9 million for the purpose of financing the construction of a new 60,000 square foot office building (the “Building”) in Colorado Springs, Colorado that will serve as the corporate headquarters for RT Logic. The Loan Agreement is further evidenced by a Promissory Note from Borrower dated February 10, 2006 in the principal sum of $9 million (the “Note”), which provides for interest at a variable rate equal to the prime rate reported in theWall Street Journalfrom time to time during the term of the Note. The Loan Agreement became effective on February 24, 2006.

The entire principal balance and any accrued and unpaid interest on the Note is due and payable on February 10, 2007. Borrower may prepay the Note in whole or in part at any time without penalty.

Borrower’s obligations under the Note and the Loan Agreement are secured by the real property upon which the building will be constructed and all equipment, inventory, general intangibles and fixtures purchased for or used in the construction of the Building. In addition, RT Logic has guaranteed payment of the amounts due under the Note and the Loan Agreement.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

5.	Line of Credit (continued)

The Loan Agreement includes certain customary events of default, including failure to pay any amounts due under the Note, the insolvency or bankruptcy of Borrower, Borrower’s failure to perform its obligations under the Loan Agreement, the Note or any of the other loan documents, a material adverse change in Borrower’s financial condition, or certain delays in construction that would prevent the Building from being completed on or before February 10, 2007. If an event of default occurs, the lender may declare the entire unpaid principal amount and any accrued and unpaid interest due and payable, and may enforce its rights as a secured creditor, including foreclosing upon its security interest and mortgage and taking possession of the property securing the obligations under the Note and the Loan Agreement.

At March 31, 2006 the interest rate was 7.5% and the balance outstanding under the Note and the Loan Agreement was $2,745,490.

6.	Capitalization of Interest Cost

As discussed in Note 5, RT Logic Tract TT2, LLC entered into a Construction Loan Agreement in the amount of $9.0 million for the construction of a new 60,000 square foot facility that will become the headquarters for RT Logic. Upon completion, the new Building asset will be placed into service and depreciated over its useful life. In accordance with FASB Statement No. 34, “Capitalization of Interest Cost”, the Company capitalized interest of approximately $11,200 at March 31, 2006 recognized on the borrowings.

7.	Stock-Based Compensation

Effective October 1, 2005, the Company adopted the provisions of Statement of Financial Accounting Standard No. 123R, Share-Based Payment (“SFAS 123R”). SFAS 123R requires compensation costs related to share-based payments, including stock options, to be recognized in the Consolidated Statement of Operations based on their fair values. The expense is recognized over the requisite service period of the award. The Company previously recognized 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 (“APB 25”). Accordingly, compensation expense was recognized for the excess, if any, of the stock price on the grant date over the option exercise price. No compensation expense was recorded under APB 25 for awards granted under the Company’s employee stock option plan as all options issued had exercise prices at least equal to the fair value of the stock on the grant date. The pro forma effects upon net income and earnings per share for stock options for the respective periods in 2005 are disclosed below per FASB Statement No. 123, “Accounting for Stock-Based Compensation.” The Company adopted the modified prospective application in implementing SFAS 123R. Under this transition method compensation costs recognized in fiscal year 2006 includes the cost for all share based awards granted prior to October 1, 2005 which had not yet vested as of that date. The expense is based on the grant-date fair value of these awards as calculated for pro forma disclosures under FASB Statement No. 123 and uses the Black-Scholes valuation model. The expense for share-based awards granted on or after October 1, 2005 represent the grant-date fair value of the options calculated in accordance with the provisions of SFAS 123R and use the Black-Scholes valuation model. In using the modified prospective application, prior interim period financial statements were not adjusted to show the effect of compensation costs and the related tax effects as though they had been accounted for using FASB Statement No. 123.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

7.	Stock-Based Compensation (continued)

As a result of adopting SFAS 123R the Company included approximately $124,500 and $127,000 of share-based compensation expense in the Consolidated Statements of Operations for the three and six month periods ended March 31, 2006. The Company did not record any tax benefits associated with its share-based compensation expense in the six month period ended March 31, 2006. The following table shows the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation in the periods prior to the adoption of SFAS No. 123R, and the actual effects on net income and earnings per share for the periods subsequent to the adoption of SFAS No. 123R:


	Three Months Ended March 31						Six Months Ended March 31
	2006			2005			2006			2005
Net income, as reported	$	3,543,656		$	2,049,470		$	6,614,110		$	3,234,857
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of tax effects of $45,013 and $227,404 for the three months ended and $0 and $458,072 for the six months ended		(79,227	)		(441,432	)		(2,477	)		(889,200	)
Add: Stock-based employee compensation included in net income, net of tax effects of $45,013 and $0 for the three months ended and $0 and $0 for the six months ended		79,227			—			2,477			—
Pro forma net income	$	3,543,656		$	1,608,038		$	6,614,110		$	2,345,657

Earnings per share:
As reported - basic	$	0.33		$	0.20		$	0.61		$	0.32
- diluted	$	0.32		$	0.20		$	0.61		$	0.31
Pro forma - basic	$	0.33		$	0.16		$	0.61		$	0.23
- diluted	$	0.32		$	0.15		$	0.61		$	0.23

Cash received from the exercise of options under all Company Stock Option Plans for the six months ending March 31, 2006 and 2005 was $3,134,332 and $3,776,586 respectively. The Company currently plans to satisfy future stock option exercises under these plans with registered shares available to be issued.

On August 19, 2005, the Board of Directors approved resolutions to accelerate the vesting of all outstanding unvested options previously awarded to employees and officers of the Company effective August 31, 2005. However, holders of incentive stock options had the option to decline the acceleration of their options to prevent changing the status of the incentive stock options to a non-qualified stock option for federal income tax purposes. Holders of options to purchase 4,772 shares elected to decline the accelerated vesting. Options to purchase 453,268 shares of stock with exercise prices ranging from $16.13 to $22.96 were accelerated.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

7.	Stock-Based Compensation (continued)

The primary purpose of the accelerated vesting was to eliminate future compensation expense the Company would otherwise recognize in its statement of operations with respect to these options upon the adoption of SFAS No. 123R. The acceleration of the vesting of these options resulted in the Company recording a non-cash stock compensation expense of approximately $1.2 million during the Company’s fourth quarter of fiscal year 2005 using the intrinsic value method. However, the related future compensation expense to be recorded upon adoption of SFAS 123R that was eliminated as a result of the acceleration of the vesting of these options is approximately $4.1 million.

Effective May 1, 2002, the Company established the 2002 Stock Option Plan, which was amended and restated effective May 1, 2005, to create additional incentives for the Company’s employees, consultants and directors to promote the financial success of the Company. The Stock Option Committee of the Board of Directors has sole authority to select full-time employees, directors or consultants to receive awards of options for the purchase of stock under this plan. The maximum number of shares of common stock that may be issued pursuant to the Amended and Restated 2002 Stock Option Plan is 1,150,000. The exercise price of each option is set at the stock’s closing price on the date the option is granted by the Stock Option Committee of the Board of Directors. Options expire no later than ten years from the date of grant (five years for greater-than-10% owners) or three months after employment ceases, whichever occurs first, and vest from one to five years.

Prior to adoption of the 2002 Stock Option Plan, the Company established the 1988 Stock Option Plan which was effective May 25, 1988 and amended on January 1, 1994 and May 8, 1998. This plan was created to provide additional incentives for the Company’s employees, consultants and directors to promote the financial success of the Company. The Stock Option Committee of the Board of Directors has sole authority to select full-time employees, directors or consultants to receive awards of options for the purchase of stock under this plan. At September 30, 2005, the maximum number of shares of common stock which may be issued pursuant to the 1988 Stock Option Plan was 1,800,000. The exercise price of each option was set at the stock’s closing price on the date the option was granted by the Stock Option Committee of the Board of Directors. Options expire no later than ten years from the date of grant (five years for greater-than 10% owners) or three months after employment ceases, whichever comes first, and vest from one to five years. Pursuant to the approval by stockholders at the April 17, 2002 Annual Meeting of the Shareholders, no further options were granted after April 30, 2002 under the 1988 Stock Option Plan.

The following table summarizes the Company’s activity for all of its stock option awards during the six months ended March 31, 2006:


	*Shares*		Weighted Average Exercise Prices
Options outstanding September 30, 2005	1,038,490		$	19.43

Granted	15,625		$	21.86
Exercised	(165,227	)	$	18.97
Cancelled	(5,550	)	$	19.36

Options outstanding March 31, 2006	883,338		$	19.55

- 11 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

7.	Stock-Based Compensation (continued)

The following table summarizes additional information about stock options outstanding at March 31, 2006:


		*Options Outstanding*				*Options Exercisable*
Exercise Price Per Share		Number of Shares	Weighted- Average Remaining Life	Weighted- Average Exercise Price		Number Exercisable	Weighted- Average Exercise Price
$	15.00 – 19.99	526,237	2.98 Years	$	18.37	521,465	$	18.37
$	20.00 – 27.00	357,101	1.79 Years	$	21.29	357,101	$	21.29

		883,338	2.50 Years	$	19.55	878,566	$	19.56

The weighted-average grant date fair value of options which were granted during the six months ended March 31, 2006 and 2005 was $7.79 and $9.14, respectively. The fair value of the options granted was estimated on the date of the grant using the Black-Scholes options pricing model. The following table shows the assumptions used for the grants that occurred in each six month period.


	2006		2005
Expected volatility	35.22	%	47.89	%
Risk free interest rate	4.56	%	3.75	%
Dividend yield	.84	%	.65	%
Expected lives	4.25 years		5.00 years

As of March 31, 2006, there was $27,368 of unrecognized compensation expense related to remaining non-vested stock options that will be recognized over a weighted average period of 2.76 years. The total fair value of options which vested during the six month period ending March 31, 2006 and 2005 was $121,763 and $189,315, respectively.

8.	Recent Accounting Pronouncements

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.” The EITF reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss and how that criteria should be applied to investments accounted for under SFAS No. 115, “Accounting in Certain Investments in Debt and Equity Securities.” EITF 03-01 also included accounting considerations subsequent to the recognition of other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. Additionally, EITF 03-01 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the Financial Accounting Standards Board (FASB) delayed the accounting provisions of EITF 03-01; however, the disclosure requirements remain effective for annual reports for fiscal years ending after June 15, 2004. The Company will evaluate the impact of EITF 03-01 once final guidance is issued.

- 12 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

8.	Recent Accounting Pronouncements (continued)

In November 2004, the FASB published Statement of Financial Accounting Standards No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. Statement 151 amends the guidance in Chapter 4, “Inventory Pricing” of ARB No. 43 and clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Statement 151 requires that those items be recognized as current-period charges. Statement 151 also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. Statement 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Statement 151 was effective for the Company’s 2006 fiscal year and upon adoption did not have a material impact on the Company’s financial statements.

9.	Business Segment Information

The Company is organized into four reportable segments as follows:

•

Ground Systems - Government

•

Ground Systems - Commercial

•

Space Communications Systems

•

Corporate

The Ground Systems – Government segment provides ground systems products and services to the Federal 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.

•

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 includes the Company’s wholly owned subsidiary, RT Logic (RT), which 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 segment also includes the Company’s recently acquired (October 3, 2005) wholly owned and indirect subsidiary, Lumistar, Inc. (Lumistar). Lumistar provides system level and board level telemetry products.

- 13 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

9.	Business Segment Information (continued)

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 (none currently exist); and businesses being disbanded (the Company’s Antenna 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.

Summarized financial information by business segment is as follows:


	Three Months Ended March 31, 2006			Three Months Ended March 31, 2005			Six Months Ended March 31, 2006			Six Months Ended March 31, 2005
Revenue
Ground Systems–Government	$	16,385,760		$	10,766,485		$	30,246,828		$	20,501,660
Ground Systems–Government intersegment		—			—			—			—
Ground Systems–Commercial		4,736,204			4,187,794			9,426,629			8,443,218
Ground Systems–Commercial intersegment		360,089			66,446			449,473			153,399
Space Communication Systems		10,407,112			6,960,681			20,314,619			13,847,771
Space Communication Systems intersegment		1,615,765			1,018,679			2,825,973			1,514,682
Corporate		622,995			1,431,808			1,421,585			2,473,653
Corporate intersegment		1,316,244			936,072			2,612,469			1,806,572
Elimination of intersegment sales		(3,292,099	)		(2,021,197	)		(5,887,916	)		(3,474,653	)

Total Revenue	$	32,152,070		$	23,346,768		$	61,409,660		$	45,266,302

Operating Income
Ground Systems–Government	$	1,231,840		$	1,059,366		$	2,541,293		$	1,783,321
Ground Systems–Government intersegment		—			—			—			—
Ground Systems–Commercial		809,164			(147,034	)		1,367,311			(26,852	)
Ground Systems–Commercial intersegment		—			(3,874	)		—			(16,130	)
Space Communication Systems		3,199,188			2,560,116			5,919,596			4,343,059
Space Communication Systems intersegment		—			7,293			—			7,293
Corporate		(12,014	)		(438,279	)		45,450			(1,199,230	)
Corporate intersegment		1,047			(3,660	)		(913	)		(10,029	)
Elimination of intersegment Operating Income		(1,047	)		240			913			18,865

Total Operating Income	$	5,228,178		$	3,034,168		$	9,873,650		$	4,900,297

Total Assets
Ground Systems–Government	$	18,377,671		$	17,239,592		$	18,377,671		$	17,239,592
Ground Systems–Commercial		10,881,317			13,741,601			10,881,317			13,741,601
Space Communication Systems		85,380,277			50,909,472			85,380,277			50,909,472
Corporate		79,004,230			69,326,507			79,004,230			69,326,507
Elimination of intersegment accounts receivable		(29,615,105	)		(16,332,349	)		(29,615,105	)		(16,332,349	)

Total Assets	$	164,028,390		$	134,884,823		$	164,028,390		$	134,884,823

- 14 -

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

Overview

The Company builds satellite ground systems for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 205 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.

The Company is organized into four reportable segments as follows:

Ground Systems – Government

This segment provides ground systems products and services to the Federal 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 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 includes the Company’s wholly owned subsidiary, Real Time Logic, Inc. (“RT Logic”), which 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 segment also includes the Company’s recently acquired (October 3, 2005) wholly owned subsidiary, Lumistar, Inc. (“Lumistar”), which acquired substantially all of the assets of Lumistar LLC on October 3, 2005. Lumistar provides system level and board level telemetry products.

- 15 -

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 (none currently exist); and businesses being disbanded (the Company’s Antenna 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 significant intra-segment and inter-segment revenues and expenses have been eliminated in consolidation as appropriate.

Recent Accounting Pronouncements

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.” The EITF reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss and how that criteria should be applied to investments accounted for under SF AS No. 115,“Accounting in Certain Investments in Debt and Equity Securities.”EITF 03-01 also included accounting considerations subsequent to the recognition of other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. Additionally, EITF 03-01 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the Financial Accounting Standards Board (FASB) delayed the accounting provisions of EITF 03-01; however, the disclosure requirements remain effective for annual reports for fiscal years ending after June 15, 2004. The Company will evaluate the impact of EITF 03-01 once final guidance is issued.

- 16 -

COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005

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, 2006 and 2005:


	Three Months Ended March 31,
	2006		% of Revenue	2005		% of Revenue
	(in thousands)			(in thousands)
Revenue	$	32,152	100.0	$	23,347	100.0
Cost of Revenue		21,499	66.9		16,015	68.6

Gross Margin		10,653	33.1		7,332	31.4

Operating Expenses
Selling, General & Admin. (SG&A)		3,893	12.1		3,113	13.3
Research and Development		843	2.6		470	2.0
Stock Based Compensation Cost		127	0.4		—	—
Product Amortization		400	1.3		646	2.8
Amortization-Intangible Assets		162	0.5		69	0.3

Income from Operations		5,228	16.2		3,034	13.0
Other Income (Expense) (net)		286	0.9		140	0.6

Income Before Income Taxes		5,514	17.1		3,174	13.6
Income Taxes		1,970	6.1		1,125	4.8

Net Income	$	3,544	11.0	$	2,049	8.8

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, 2006 and 2005, the Company’s revenues were generated from the following sources:


	Three Months Ended March 31,
Revenue Type	2006		2005
U.S. Government Revenue (all segments)
U.S. Air Force	62	%	53	%
NOAA	4		10
Other U.S. Government Users	14		11

Subtotal	80		74

Commercial Revenue (all segments)	20		26

Total	100	%	100	%

- 17 -

On a consolidated basis, revenue increased 37.7%, or $8.8 million, to $32.2 million for the three months ended March 31, 2006, from $23.3 million for the three months ended March 31, 2005. Revenue for the three-month periods ended March 31, 2006 and 2005 for each of the Company’s segments is shown in the following table:


Segment	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	16,386		$	10,767		$	5,619

Ground Systems – Commercial
Command & Control		3,349			2,928			421
Newpoint		826			883			(57	)
SAT		1,044			604			440
Intra-Segment Elimination		(123	)		(161	)		38

Ground Systems – Commercial		5,096			4,254			842

Space Communications Systems		12,023			7,979			4,044

Corporate
Product Group		1,451			922			529
Antenna		267			1,107			(840	)
Other		221			339			(118	)

Corporate		1,939			2,368			(429	)

Elimination		(3,292	)		(2,021	)		(1,271	)

Total Revenue	$	32,152		$	23,347		$	8,805

Revenue increases in the Company’s Ground Systems - Government segment between the three months ended March 31, 2006 and 2005 primarily relate to increased revenues from the U.S. Air Force. The Company’s RAIDRS contract with the U.S. Air Force, which was awarded in February 2005, was responsible for virtually the entire revenue increase.

Revenue increases for the Company’s Ground Systems - Commercial segment resulted from increased backlog and increased product shipments to customers. All operating units in the segment posted higher revenues during the three months ended March 31, 2006 compared to the three months ended March 31, 2005, although Newpoint’s quarter to quarter revenues were down insignificantly. SAT also benefited from approximately $230,000 of intercompany RAIDRS revenue during the current three-month period.

Revenue increases for the Company’s Space Communications Systems segment resulted from increased backlog and increased product shipments to customers. Further, current period revenues from Lumistar of approximately $1.9 million were incremental to the segment’s revenue totals for the three months ended March 31, 2006, as the Company did not acquire Lumistar until October 2005.

In the Company’s Corporate segment, the Product Group recorded increased license revenues of approximately $480,000 between the periods being compared, accounting for most of the period to period revenue increase.

- 18 -

Antenna Division revenues declined approximately $840,000 between the periods being compared because the Company has not been pursuing new business for this operation since the summer of 2004. The principal operating assets of the division were sold in November 2004 to LJT & Associates, Inc. Revenues for the Antenna Division are expected to continue to decline throughout the fiscal year as the Division’s residual contracts are completed.

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 rates 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 composed of internally developed hardware products.

During the three months ended March 31, 2006, cost of revenue increased by 34.2%, or $5.5 million, compared to the same period during the prior year, increasing from $16.0 million during the three months ended March 31, 2005 to $21.5 million during the three months ended March 31, 2006. Gross margin increased from $7.3 million to $10.9 million, an increase of $3.6 million or 48.9%, during the periods being compared. Cost of revenue and gross margin for the three months ended March 31, 2006 and 2005 for each of the Company’s segments are shown in the following table:

- 19 -


Segment	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	13,586		$	8,429		$	5,157

Ground Systems – Commercial
Command & Control		2,445			2,220			225
Newpoint		370			464			(94	)
SAT		440			600			(160	)
Intra-Segment Elimination		(75	)		(157	)		82

Ground Systems – Commercial		3,180			3,127			53

Space Communications Systems		6,821			4,521			2,300

Corporate
Product Group		741			437			304
Antenna		241			1,177			(936	)
Other		210			328			(118	)

Corporate		1,192			1,942			(750	)

Elimination		(3,280	)		(2,004	)		(1,276	)

Total Cost of Revenue	$	21,499		$	16,015		$	5,484

Gross Margin
Ground Systems – Government	$	2,800		$	2,338		$	462

Ground Systems – Commercial
Command & Control		904			708			196
Newpoint		456			419			37
SAT		604			4			600
Intra-Segment Elimination		(48	)		(4	)		(44	)

Ground Systems – Commercial		1,916			1,127			789

Space Communications Systems		5,202			3,458			1,744

Corporate
Product Group		710			485			225
Antenna		26			(70	)		96
Other		11			11			—

Corporate		747			426			321

Elimination		(12	)		(17	)		5

Total Gross Margin	$	10,653		$	7,332		$	3,321

- 20 -

The higher gross margin for the Company’s Ground Systems - Government segment during the three months ended March 31, 2006 compared to the three months ended March 31, 2005 is primarily attributable to increased revenues and the elimination of certain losses on NOAA contracts. However, gross margin as a percentage of revenue for the Ground Systems - Government segment decreased from 21.7% for the three months ended March 31, 2005 to 17.1% for the three months ended March 31, 2006 principally as a result of a greater mix of low margin equipment and subcontracts costs in the segment’s cost of revenue mix during the period ended March 31, 2006. The RAIDRS contract in particular, is an equipment and subcontract intensive program, so this trend in relatively low gross margin rates for the Ground Systems - Government segment is likely to continue in future periods.

The higher gross margin for the Company’s Ground Systems - Commercial segment during the three months ended March 31, 2006 compared to the three months ended March 31, 2005 primarily relates to increased revenue and the elimination of contract losses from SAT. Despite slightly lower revenues, Newpoint was able to modestly increase gross margin for the current quarter while the segment’s Command & Control unit experienced an approximate $200,000, or 27.7%, increase in gross margins on increased revenues of approximately $420,000 on a period-to-period basis.

The Space Communications System segment experienced an increase in gross margin of approximately $1.7 million on increased revenue of $4.0 million. Approximately $960,000 of the $1.7 million quarter to quarter increase is attributable to Lumistar.

In the Corporate segment, the Product Group experienced a higher gross margin of approximately $230,000 on a period-to-period basis because of increased license revenue. Antenna Division gross margin deficits from the three months ended March 31, 2005 were eliminated during the three-month period ended March 31, 2006.

Operating Expenses

Operating expenses for the three months ended March 31, 2006 and 2005 for each of the Company’s segments are shown in the following table:


Segment	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Ground Systems – Government	$	1,568		$	1,279		$	289

Ground Systems – Commercial
Command & Control		421			441			(20	)
Newpoint		382			336			46
SAT		352			505			(153	)
Intra-Segment Elimination		(48	)		(4	)		(44	)

Ground Systems – Commercial		1,107			1,278			(171	)

Space Communications Systems		2,003			890			1,113

Corporate
Product Group		689			834			(145	)
Antenna		17			21			(4	)
Other		52			13			39

Corporate		758			868			(110	)

Elimination		(11	)		(17	)		6

Total Operating Expenses	$	5,425		$	4,298		$	1,127

- 21 -

Operating expenses in the Company’s Ground Systems - Government segment increased by approximately $290,000 for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 principally due to increased legal and accounting expenses incurred to become and remain compliant with provisions of the Sarbanes-Oxley Act and related Securities and Exchange Commission (“SEC”) regulations.

Operating expenses in the Company’s Ground Systems - Commercial segment decreased by approximately $170,000 for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 due partly to a decreased allocation of corporate expenses in the segment’s Command & Control Division. More significantly, operating expenses at SAT were down approximately $150,000 during the periods being compared primarily related to lower R&D expenditures incurred during the current three-month period compared to the same three-month period during the last fiscal year and because of the elimination of product amortization expenses during the current period.

Operating expenses in the Space Communications Systems segment increased approximately $1.1 million during the current period compared to the second quarter of the last fiscal year. Approximately $180,000 of the increase is attributable to operating expenses from Lumistar, for which the Company recorded no operating expenses during the three months ended March 31, 2005. Increased R&D spending coupled with increased General & Administrative expenses at RT Logic accounted for most of the remaining increase in operating expenses from this segment.

Operating expenses in the Corporate segment decreased by approximately $110,000 principally due to the decreased selling expenses and product amortization costs in the Product Division.

Income from Operations

Income from operations for the three months ended March 31, 2006 and 2005 for each of the Company’s segments is shown in the following table:


Segment	Three Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Ground Systems – Government	$	1,232		$	1,059		$	173

Ground Systems – Commercial
Command & Control		483			267			216
Newpoint		74			83			(9	)
SAT		252			(501	)		753
Intra-Segment Elimination		—			—			—

Ground Systems – Commercial		809			(151	)		960

Space Communications Systems		3,199			2,568			631

Corporate
Product Group		21			(349	)		370
Antenna		9			(91	)		100
Other		(41	)		(2	)		(39	)

Corporate		(11	)		(442	)		431

Elimination		(1	)		—			(1	)

Total Income from Operations	$	5,228		$	3,034		$	2,194

- 22 -

Income from operations during the periods compared increased by approximately $170,000 in the Company’s Ground Systems - Government segment as a result of increased gross margins partially offset by increased operating expenses.

Income from operations during the periods compared increased by approximately $960,000 in the Company’s Ground Systems - Commercial segment as a result of increased gross margins coupled with decreased operating expenses. SAT’s improved operating income results were responsible for more than $750,000 of the segment’s operating income increase.

The Space Communications Systems segment recorded increased income from operations of approximately $630,000 principally due to gross margin increases resulting from increased sales partially offset by increased operating expenses. Included in current period income from operations was approximately $780,000 contributed from Lumistar.

In the Corporate segment, the Product Group had operating income of approximately $20,000 for the three months ended March 31, 2006 compared to an operating loss of approximately $350,000 for the three months ended March 31, 2005. The increase is primarily due to lower amortization expense coupled with increased license revenue. Operating losses in the Antenna Division were eliminated in the current three-month period.

In summary, all operating segments posted operating income during the current three month period (excluding the Corporate segment which essentially broke even) and all segments (including the Corporate segment) achieved operating income improvement during the three months ended March 31, 2006 compared to the three months ended March 31, 2005.

Other Income (Expense)

Other income increased between the quarters being compared, primarily because of increased interest income.

Income Before Income Taxes/Net Income

Income before income taxes increased approximately 73.7% during the three months ended March 31, 2006 compared to the amounts posted during the second quarter of last fiscal year, primarily as a result of improved operating income as discussed above.

The Company’s effective tax rate increased from 35.4% for the three months ended March 31, 2005 to 35.7% for the three months ended March 31, 2006 principally due to a lower 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 $3.5 million during the three months ended March 31, 2006 from $2.0 million during the three months ended March 31, 2005.

Quarterly revenue, operating income, net income and earnings per share were all historic highs for the Company exceeding prior records (all posted during the first quarter of this fiscal year) by 10%, 13%, 15%, and 14% respectively.

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COMPARISON OF THE SIX MONTHS ENDED MARCH 31, 2006 AND 2005

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, 2006 and 2005:


	Six Months Ended March 31,
	2006		% of Revenue	2005		% of Revenue
	(in thousands)			(in thousands)
Revenue	$	61,410	100.0	$	45,266	100.0
Cost of Revenue		41,351	67.3		30,799	68.0

Gross Margin		20,059	32.7		14,467	32.0

Operating Expenses
Selling, General & Admin. (SG&A)		7,293	11.9		6,885	15.2
Research and Development		1,586	2.6		1,253	2.8
Stock Based Compensation Cost		127	0.2		—	—
Product Amortization		800	1.3		1,291	2.9
Amortization-Intangible Assets		379	0.6		138	0.3

Income from Operations		9,874	16.1		4,900	10.8
Other Income (Expense) (net)		495	0.8		98	0.2

Income Before Income Taxes		10,369	16.9		4,998	11.0
Income Taxes		3,755	6.1		1,763	3.9

Net Income	$	6,614	10.8	$	3,235	7.1

Revenue

For the six months ended March 31, 2006 and 2005, the Company’s revenues were generated from the following sources:


	Six Months Ended March 31,
Revenue Type	2006		2005
U.S. Government Revenue (all segments)
U.S. Air Force	60	%	51	%
NOAA	4		11
Other U.S. Government Users	14		12

Subtotal	78		74

Commercial Revenue (all segments)	22		26

Total	100	%	100	%

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On a consolidated basis, revenue increased 35.7%, or $16.1 million, to $61.4 million for the six months ended March 31, 2006, from $45.3 million for the six months ended March 31, 2005. Revenue for the six-month periods ended March 31, 2006 and 2005 for each of the Company’s segments is shown in the following table:


Segment	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	30,247		$	20,502		$	9,745

Ground Systems – Commercial
Command & Control		6,222			5,689			533
Newpoint		1,750			1,576			174
SAT		2,140			1,560			580
Intra-Segment Elimination		(236	)		(228	)		(8	)

Ground Systems – Commercial		9,876			8,597			1,279

Space Communications Systems		23,141			15,362			7,779

Corporate
Product Group		2,723			1,875			848
Antenna		744			1,778			(1,034	)
Other		567			627			(60	)

Corporate		4,034			4,280			(246	)

Elimination		(5,888	)		(3,475	)		(2,413	)

Total Revenue	$	61,410		$	45,266		$	16,144

Revenue increases in the Company’s Ground Systems - Government segment between the six months ended March 31, 2006 and 2005 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 resulted from increased backlog and increased product shipments to customers. SAT also benefited from approximately $300,000 of inter-company RAIDRS revenue during the current six-month period.

Revenue increases in the Company’s Space Communications Systems segment resulted from increased backlog and increased product shipments to customers. Further, current period revenues from Lumistar of approximately $4.4 million were incremental to the segment’s revenue totals for the six months ended March 31, 2006, as the Company did not acquire Lumistar until October 2005.

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

Antenna Division revenues declined approximately $1.0 million between the periods being compared because the Company has not been pursuing new business for this operation since the summer of 2004. The principal operating assets of the division were sold in November 2004 to LJT & Associates, Inc.

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Cost of Revenue/Gross Margin

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 six months ended March 31, 2006, cost of revenue increased by 34.3%, or $10.6 million, compared to the same period during the prior year, increasing from $30.8 million during the six months ended March 31, 2005 to $41.3 million during the six months ended March 31, 2006. Gross margin increased by $5.8 million, or 40.4%, during the periods compared, increasing from $14.5 million for the six months ended March 31, 2005 to $20.3 million for the six month ended March 31, 2006. Cost of revenue and gross margin for the six months ended March 31, 2006 and 2005 for each of the Company’s segments are shown in the following table:

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Segment	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	24,717		$	15,870		$	8,847

Ground Systems – Commercial
Command & Control		4,745			4,393			352
Newpoint		807			781			26
SAT		1,044			1,063			(19	)
Intra-Segment Elimination		(122	)		(187	)		65

Ground Systems – Commercial		6,474			6,050			424

Space Communications Systems		13,404			8,787			4,617

Corporate
Product Group		1,484			896			588
Antenna		588			2,022			(1,434	)
Other		552			609			(57	)

Corporate		2,624			3,527			(903	)

Elimination		(5,868	)		(3,435	)		(2,433	)

Total Cost of Revenue	$	41,351		$	30,799		$	10,552

Gross Margin
Ground Systems – Government	$	5,530		$	4,632		$	898

Ground Systems – Commercial
Command & Control		1,477			1,296			181
Newpoint		943			795			148
SAT		1,096			497			599
Intra-Segment Elimination		(114	)		(41	)		(73	)

Ground Systems – Commercial		3,402			2,547			855

Space Communications Systems		9,737			6,575			3,162

Corporate
Product Group		1,239			979			260
Antenna		156			(244	)		400
Other		15			18			(3	)

Corporate		1,410			753			657

Elimination		(20	)		(40	)		20

Total Gross Margin	$	20,059		$	14,467		$	5,592

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a greater mix of low margin equipment and subcontracts costs in the segment’s cost of revenue mix during the period ended March 31, 2006. The RAIDRS contract in particular, is an equipment and subcontract intensive program, so this trend in relatively low gross margin rates for the Ground Systems Government segment is likely to continue in future periods.

The higher gross margin for the Company’s Ground Systems - Commercial segment during the six months ended March 31, 2006 compared to the six months ended March 31, 2005 primarily relates to increased revenue and the elimination of contract losses from SAT.

The Space Communications System segment experienced an increase in gross margin of approximately $3.2 million on increased revenue of $7.8 million. Approximately $1.8 million of the $3.2 million period-to-period increase is attributable to Lumistar.

In the Corporate segment, the Product Group experienced a higher gross margin of approximately $260,000 on a period-to-period basis because of increased license revenue. Antenna Division gross margin deficits from the six months ended March 31, 2005 were eliminated during the six-month period ended March 31, 2006.

Operating Expenses

Operating expenses for the six months ended March 31, 2006 and 2005 for each of the Company’s segments are shown in the following table:


Segment	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Ground Systems – Government	$	2,989		$	2,849		$	140

Ground Systems – Commercial
Command & Control		746			925			(179	)
Newpoint		706			708			(2	)
SAT		653			988			(335	)
Intra-Segment Elimination		(70	)		(31	)		(39	)

Ground Systems – Commercial		2,035			2,590			(555	)

Space Communications Systems		3,817			2,224			1,593

Corporate
Product Group		1,352			1,755			(403	)
Antenna		35			82			(47	)
Other		(22	)		125			(147	)

Corporate		1,365			1,962			(597	)

Elimination		(21	)		(58	)		37

Total Operating Expenses	$	10,185		$	9,567		$	618

Operating expenses in the Company’s Ground Systems - Government segment increased by approximately $140,000 for the six months ended March 31, 2006 compared to the six months ended March 31, 2005 principally due to increased legal and accounting expenses incurred to remain compliant with provisions of the Sarbanes-Oxley Act and related SEC regulations.

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Operating expenses in the Company’s Ground Systems - Commercial segment decreased by approximately $560,000 for the six months ended March 31, 2006 compared to the six months ended March 31, 2005 due partly to a decreased allocation of corporate expenses in the segment’s Command & Control Division. More significantly, operating expenses at SAT were down approximately $340,000 during the periods being compared primarily related to lower R&D expenditures incurred during the current six-month period compared to the same six-month period last fiscal year and because of the elimination of product amortization expenses during the current period.

Operating expenses in the Space Communications Systems segment increased approximately $1.6 million during the current period compared to the first half of the last fiscal year. Approximately $440,000 of the increase is attributable to operating expenses from Lumistar, for which the Company recorded no operating expenses during the six months ended March 31, 2005. Increased R&D spending coupled with increased General & Administrative expenses at RT Logic accounted for most of the remaining increase in operating expenses from this segment.

Operating expenses in the Corporate segment decreased by approximately $600,000 principally due to the decreased selling expenses and product amortization costs in the Product Division.

Income from Operations

Income from operations for the six months ended March 31, 2006 and 2005 for each of the Company’s segments is shown in the following table:


Segment	Six Months Ended March 31,						Increase/ (Decrease)
Segment	2006			2005			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Ground Systems – Government	$	2,541		$	1,783		$	758

Ground Systems – Commercial
Command & Control		731			371			360
Newpoint		237			87			150
SAT		443			(491	)		934
Intra-Segment Elimination		(44	)		(10	)		(34	)

Ground Systems – Commercial		1,367			(43	)		1,410

Space Communications Systems		5,920			4,351			1,569

Corporate
Product Group		(113	)		(776	)		663
Antenna		121			(326	)		447
Other		37			(107	)		144

Corporate		45			(1,209	)		1,254

Elimination		1			18			(17	)

Total Income from Operations	$	9,874		$	4,900		$	4,974

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Income from operations during the periods compared increased by approximately $760,000 in the Company’s Ground Systems - Government segment as a result of increased gross margins partially offset by increased operating expenses.

Income from operations during the periods compared increased by approximately $1.4 million in the Company’s Ground Systems - Commercial segment as a result of increased gross margins coupled with decreased operating expenses. SAT’s improved operating income results were responsible for more than $930,000 of the segment’s operating income increase.

The Space Communications Systems segment recorded increased income from operations of approximately $1.6 million principally due to gross margin increases resulting from increased sales partially offset by increased operating expenses. Included in current period income from operations was approximately $1.3 million contributed from Lumistar.

In the Corporate segment, the Product Group pared its operating loss by approximately $660,000 for the six months ended March 31, 2006. The improvement is primarily due to lower amortization expense coupled with increased license revenue. Although the Product Group recorded an operating loss 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 the Company from its competitors.

Operating losses in the Antenna Division were eliminated in the current six-month period.

In summary, all operating segments posted operating income during the current six-month period and all segments achieved operating income improvement during the six months ended March 31, 2006 compared to the six months ended March 31, 2005.

Other Income (Expense)

Other income increased between the periods being compared, primarily because of increased interest income.

Income Before Income Taxes/Net Income

Income before income taxes more than doubled for the six months ended March 31, 2006 compared to the six months ended March 31, 2005 principally due to increased operating income of approximately $5.0 million as described above combined with increased interest income.

The Company’s effective tax rate increased from 35.3% for the six months ended March 31, 2005 to 36.2% for the six months ended March 31, 2006 principally due to a lower 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 $6.6 million during the six months ended March 31, 2006 from $3.2 million during the six months ended March 31, 2005.

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

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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, 2005, the Company was anticipating that operating results for fiscal year 2006 in its entirety will exceed results for fiscal year 2005 for revenue, operating income, net income and fully diluted earnings per common share by approximately 15%, 45%, 55% and 53% respectively. In terms of dollars, the Company was therefore anticipating targets for revenue, operating income, net income and fully diluted earnings per common share of $112.5 million, $14.3 million, $9.8 million and $.92 per share respectively.

Although the Company cannot provide any assurances as to the fiscal year 2006 forecasted results described above, the Company currently believes these results are more than achievable because:

•

The Company’s existing backlog in its Ground Systems - Government segment indicates growth in revenue and operating income.

•

The Company does not anticipate a significant fiscal year 2006 charge for non-recurring compensation related to stock options.

•

The Company does not anticipate fiscal year 2006 losses associated with its Antenna Division.

•

The Company believes that its acquisition of substantially all of the assets of Lumistar LLC will be immediately accretive to operating results.

During the first half of fiscal year 2006, the Company has already exceeded its results posted for fiscal year 2005 in its entirety for operating income, net income and earnings per share by 1%, 5% and 2% respectively. As a result of these record results, the Company is now increasing its targets for revenue, operating income, net income and earnings per share to $115.0 million, $17.0 million, $11.5 million and $1.04 per share respectively.

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, 2006, $5.1 million was invested in variable rate State of Maryland debt securities, $13.0 was invested in Banc of America Securities LLC Auction Rate Securities, and $20.0 million was invested in Bank of America Preferred Funding Corporation “Dividends Received Eligible Auction Market” preferred stock (“DREAMS”).

For the six months ended March 31, 2006, operating activities provided the Company approximately $6.8 million of cash. The Company used approximately $10.9 million in investing activities and financing activities provided approximately $3.9 million. Included in the $10.9 million of investing activities is approximately $4.9 million for the acquisition of substantially all of the assets of Lumistar, LLC and $840,000 used for the purchase of fixed assets. The Company also repurchased approximately $890,000 of its Common Stock during the period.

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The company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $6,400 at March 31, 2006. The outstanding balance is payable over a 2-month period and bears interest at a rate of 8.8% per annum.

On February 10, 2006, RT Logic Tract TT2, LLC (“Borrower”), a wholly-owned subsidiary of RT Logic, entered into a Construction Loan Agreement (the “Loan Agreement”) for an aggregate amount of $9 million for the purpose of financing the construction of a new 60,000 square foot office building in Colorado Springs, Colorado that will serve as the corporate headquarters for RT Logic. The Loan Agreement is further evidenced by a Promissory Note from Borrower dated February 10, 2006 in the principal sum of $9 million (the “Note”), which provides for interest at a variable rate equal to the prime rate reported in theWall Street Journal from time to time during the term of the Note. RT Logic has guaranteed payment of the amounts due under the Note and the Loan Agreement. The loan had a balance of $2,745,490 as of March 31, 2006. The principal balance and any accrued and unpaid interest is due on February 10, 2007. Borrower may prepay the loan in whole or in part at any time without penalty.

The Company’s Board of Directors declared a cash dividend of $.05 per share to all stockholders of record as of close of business on March 2, 2006. The dividend was paid on March 29, 2006 in the amount of $546,060. In addition, the Company’s Board of Directors has declared a cash dividend of $.05 per share to all stockholders of record as of close of business on June 1, 2006. The dividend will be paid on or about June 28, 2006.

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 other 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 three months ended March 31, 2006 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 this Management’s Discussion and Analysis of Financial Condition and Results of Operations section, including those under the headings “Outlook” and “Liquidity and Capital Resources,” and in other parts of this 10-Q, 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

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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, 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, integration of the companies and assets the Company has acquired or, if the Company is able to identify and acquire one or more businesses, may acquire, may be costly and may result in a decrease in the value of the Company’s common stock.

•

The Company may not have adequately assessed the risks inherent in the companies or assets it has acquired or correctly assessed the potential contribution of those companies or assets to its financial performance, and in the future 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 or assets than it planned, which may adversely affect its ability to pursue other more profitable activities.

•

The difficulties of integrating an acquired business or assets 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 the companies or assets it has acquired or may acquire.

•

The companies or assets the Company has acquired or may acquire may have liabilities or adverse operating issues that the Company failed to discover through its diligence prior to the acquisition.

•

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 risk 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.

- 33 -

•

The Company has measures in place that could impede the takeover of the Company or make it difficult for its stockholders to remove its board of directors or management.

These forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which 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, its 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, 2006, virtually all of the Company’s contracts were denominated in U.S. dollars, and the Company did not have any outstanding hedge agreements. 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

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 subject to 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.

Changes in Internal Controls Over Financial Reporting

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

- 34 -

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.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Securities and Exchange Commission (the “Commission”) and NASDAQ have informally inquired with the Company about the circumstances related to Bonnie K. Wachtel’s refusal to stand for re-election as a director of the Company. The Company is cooperating fully with the Commission and NASDAQ.

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. Pursuant to the Reorganization Agreement, in January 2006, the former shareholders of RT Logic received contingent purchase price with respect to the year ended September 30, 2005, that included 171,396 shares of the Company’s common stock and $3,805,512 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.

The following is a table summarizing the Company’s purchases of its own equity securities during the three months ended March 31, 2006.


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, 2006	20,800	$	19.57	400,671	532,087
February 1 to February 28, 2006	6,600	$	19.93	407,271	525,487
March 1 to March 31, 2006	—		—	407,271	525,487
Total	27,400	$	19.66	407,271	525,487

(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.

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ITEM 6. EXHIBITS


Exhibits
3.1		Articles of Restatement of the Company dated May 7, 1999, as supplemented by Articles Supplementary of the Company dated March 13, 2006 (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on March 13, 2006).

3.2		Amended and Restated By-Laws of the Company, as amended by Amendment No. 1 to the Amended and Restated By-Laws of the Company (Incorporated by reference to the Company’s Current Report on Form 8-K filed by the Company on March 22, 2006).

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.

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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 9, 2006	By:	/s/ THOMAS L. GOUGH
		Thomas L. Gough
		President

Date: May 9, 2006	By:	/s/ ELAINE M. BROWN
		Elaine M. Brown
		Executive Vice President &
		Chief Financial Officer

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Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

Integral Systems (ISYS) Inactive 10-Q2006 Q3 Quarterly report

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