Integral Systems 10Q 2007 Q4 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(mark one)

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

For the quarterly period ended June 30, 2007 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-2of the Exchange Act). Yes ¨ No x

The Registrant had 11,209,377 shares of its $.01 par value common stock outstanding as of July 31, 2007.

INTEGRAL SYSTEMS, INC.

TABLE OF CONTENTS


		Page No.
PART I. FINANCIAL INFORMATION:

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets – June 30, 2007 (unaudited) and September 30, 2006	1

	Unaudited Condensed Consolidated Statements of Operations – Three and Nine Months Ended June 30, 2007 and June 30, 2006	3

	Unaudited Condensed Consolidated Statement of Stockholders’ Equity - Nine Months Ended June 30, 2007	4

	Unaudited Condensed Consolidated Statements of Cash Flows – Nine Months Ended June 30, 2007 and June 30, 2006	5

	Notes to Condensed 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	33

Item 4.	Controls and Procedures	33

PART II.OTHER INFORMATION:

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	35

Item 4.	Submission of Matters to a Vote of Security Holders	36

Item 6.	Exhibits	36

Signatures		37

Item 1. Financial Statements

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

June 30, 2007 and September 30, 2006

ASSETS


	June 30, 2007			September 30, 2006
	(unaudited)		��
CURRENT ASSETS
Cash and cash equivalents	$	27,750,023		$	24,658,698
Marketable securities, net		39,100,402			38,155,781
Accounts receivable, net of allowance for doubtful accounts		20,716,546			12,513,929
Unbilled receivables		19,420,251			16,939,616
Employee and other receivables		170,223			299,497
Inventories		4,426,199			3,849,475
Prepaid expenses		684,851			984,906
Notes receivable		124,788			230,864
Income tax receivable		1,667,256			308,930
Deferred income taxes		934,492			923,545

TOTAL CURRENT ASSETS		114,995,031			98,865,241

PROPERTY AND EQUIPMENT, NET		15,479,384			14,989,514

OTHER ASSETS
Notes receivable, net of current portion		53,750			107,500
Deferred income taxes, net of current portion		150,134			227,711
Goodwill		51,303,651			51,303,651
Intangible assets, net		61,400			220,868
Software development costs, net of accumulated amortization		403,543			1,021,693
Deposits and deferred charges		124,647			114,760

TOTAL OTHER ASSETS		52,097,125			52,996,183

TOTAL ASSETS	$	182,571,540		$	166,850,938

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

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

June 30, 2007 and September 30, 2006

LIABILITIES & STOCKHOLDERS’ EQUITY


	June 30, 2007		September 30, 2006
	(unaudited)
CURRENT LIABILITIES
Accounts payable	$	10,443,912	$	6,996,997
Accrued expenses		8,111,581		8,952,646
Billings in excess of revenue		11,355,681		8,199,148

TOTAL CURRENT LIABILITIES		29,911,174		24,148,791

STOCKHOLDERS’ EQUITY
Common Stock, $.01 par value,
40,000,000 shares authorized, and
11,207,877 and 11,037,406 shares issued and outstanding at June 30, 2007 and September 30, 2006, respectively		112,079		110,374
Additional paid-in capital		110,769,537		105,890,333
Retained earnings		41,515,480		36,537,576
Accumulated other comprehensive income		263,270		163,864

TOTAL STOCKHOLDERS’ EQUITY		152,660,366		142,702,147

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	182,571,540	$	166,850,938

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

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended June 30,						Nine Months Ended June 30,
	2007			2006			2007			2006
Revenue	$	35,871,536		$	27,415,992		$	92,306,551		$	88,825,652

Cost of Revenue
Direct labor		7,291,566			6,338,185			20,206,766			18,415,060
Overhead costs		5,300,744			5,035,946			15,721,275			14,975,996
Travel and other direct costs		409,841			476,633			1,455,336			1,630,122
Direct equipment & subcontracts		11,420,427			6,350,081			24,680,085			24,530,958

Total Cost of Revenue		24,422,578			18,200,845			62,063,462			59,552,136

Gross Margin		11,448,958			9,215,147			30,243,089			29,273,516

Selling, general & administrative (Includes stock based compensation costs of $102,294 and $130,042 for the three months ended June 30, 2007 and 2006, respectively, and $482,250 and $256,758 for the nine months ended June 30, 2007 and 2006)		5,254,590			4,286,954			16,512,339			11,706,574
Research & development		663,921			563,236			1,636,365			2,149,569
Product amortization		206,050			400,000			618,150			1,200,000
Intangible asset amortization		40,156			104,262			159,469			483,028

Income From Operations		5,284,241			3,860,695			11,316,766			13,734,345

Other Income (Expense)
Interest income		565,370			530,321			1,646,506			1,315,759
Interest expense		(1,151	)		(5,780	)		(3,716	)		(7,779	)
Miscellaneous, net		(104,404	)		(45,123	)		(746,223	)		(333,687	)

Total Other Income (Expense)		459,815			479,418			896,567			974,293

Income Before Income Tax		5,744,056			4,340,113			12,213,333			14,708,638

Provision for Income Taxes		1,925,965			1,589,532			4,194,465			5,343,947

Net Income	$	3,818,091		$	2,750,581		$	8,018,868		$	9,364,691

Weighted Avg. Number of Common Shares:
Basic		11,167,556			11,026,439			11,110,724			10,857,121
Diluted		11,202,735			11,221,116			11,148,864			10,993,572

Earnings per Share (Basic)	$	0.34		$	0.25		$	0.72		$	0.86
Earnings per Share (Diluted)	$	0.34		$	0.25		$	0.72		$	0.85

Cash Dividends per Share	$	0.07		$	0.05		$	0.21		$	0.15

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

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED JUNE 30, 2007

(Unaudited)


	Number of Shares		Common Stock At Par Value			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income		Total
Balance September 30, 2006	11,037,406		$	110,374		$	105,890,333		$	36,537,576		$	163,864	$	142,702,147

Net income	—			—			—			8,018,868			—		8,018,868
Effect of currency translation	—			—			—			—			99,406		99,406

Total Comprehensive Income	—			—			—			—			—		8,118,274

Repurchased shares	(47,585	)		(476	)		(427,425	)		(690,130	)				(1,118,031	)
Stock options exercised	218,056			2,181			4,420,546			—			—		4,422,727
Declared dividends	—			—			—			(2,350,834	)		—		(2,350,834	)
Stock option compensation cost	—			—			482,250			—			—		482,250
Tax benefit of stock options exercised	—			—			403,833			—			—		403,833

Balance June 30, 2007	11,207,877		$	112,079		$	110,769,537		$	41,515,480		$	263,270	$	152,660,366

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

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INTEGRAL SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended June 30, 2007 and 2006

(Unaudited)


	For the Nine Months Ended June 30,
	2007			2006
Cash flows from operating activities:

Net income	$	8,018,868		$	9,364,691

Adjustments to reconcile net income to net cash provided by operating activities, net of acquisition
Depreciation and amortization		2,230,833			3,075,553
Reserve for doubtful accounts		(10,000	)		4,375
Stock option compensation costs		482,250			256,758
Tax benefits of stock option exercises		(403,833	)		—
Loss on disposal of fixed assets		8,027			—
Provision for deferred income taxes		151,652			—
Changes in operating assets and liabilities:
Accounts receivable and other receivables		(10,543,978	)		7,262,119
Prepaid expenses and deposits		290,168			(48,501	)
Inventories		(529,183	)		(271,863	)
Accounts payable		3,462,983			(2,304,430	)
Accrued expenses		(841,065	)		(3,604,159	)
Billings in excess of revenue		3,156,533			2,873,557
Income taxes payable, net		(1,039,515	)		315,108

Total adjustments		(3,585,128	)		7,558,517

Net cash provided by operating activities, net of effects of acquisition		4,433,740			16,923,208

Cash flows from investing activities:
Purchase of marketable securities		(1,044,621	)		(20,000,000	)
Sale of marketable securities		100,000			14,596,000
Proceeds from collections on notes receivable		159,826			271,574
Acquisition of fixed assets		(1,162,535	)		(1,050,000	)
Building under construction		(861,756	)		(5,821,427	)
Proceeds from sale of fixed assets		9,570			—
Acquisition of Lumistar, net of cash received		—			(4,922,752	)

Net cash used in investing activities		(2,799,516	)		(16,926,605	)

Cash flows from financing activities:
Proceeds from issuance of common stock		4,422,727			6,787,530
Tax benefits of stock option exercises		403,833			—
Stock repurchases		(1,118,031	)		(892,333	)
Lumistar stock repurchase		—			(6,412,783	)
Dividend payments		(2,350,834	)		(1,642,088	)
Notes Payable proceeds		—			5,669,640
Capital lease obligation payments		—			(25,119	)

Net cash provided by financing activities		1,357,695			3,484,847

Net increase in cash and cash equivalents		2,991,919			3,481,450
Effect of currency translations		99,406			89,132
Cash and cash equivalents – beginning of year		24,658,698			24,775,460

Cash and cash equivalents - end of period	$	27,750,023		$	28,346,042

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

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INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED 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, 2006. The results of operations for any interim period are not necessarily indicative of results for the full year.

2.	Accounts Receivable

Accounts receivable consist of the following:


	June 30, 2007			September 30, 2006
Billed	$	20,891,546		$	12,698,929
Allowance		(175,000	)		(185,000	)
Unbilled		19,420,251			16,939,616
Other		170,223			299,497

Total	$	40,307,020		$	29,753,042

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.

3.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 June 30, 2007 and September 30, 2006 consist of the following:


	June 30, 2007		September 30, 2006
Finished Goods	$	2,838,728	$	2,551,275
Work in process		—		—
Raw Materials		1,587,471		1,298,200

Total	$	4,426,199	$	3,849,475

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INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

4.	Line of Credit

The Company has a line of credit agreement with a local bank (the “Credit Agreement”) for $10.0 million for working capital, the issuance of letters of credit, to finance the performance of contracts, and for general corporate purposes. Borrowings under the line are due on demand with interest at a fluctuating LIBOR (London Inter-Bank Offering Rate)-based rate. The Credit Agreement requires the Company to comply with specified financial covenants, including the maintenance of a certain maximum funded debt to EBITDA ratio and a certain minimum fixed charge coverage ratio. The Credit Agreement also contains various covenants, including affirmative covenants that require, among other things, certain financial reporting by the Company, and negative covenants that, among other things, may limit the Company’s ability to incur additional indebtedness, incur liens, reorganize, consolidate or merge with any other corporation, make acquisitions or stock repurchases, and undertake certain additional actions. The Credit Agreement also contains certain provisions concerning events of default. Upon the occurrence of any such event of default, the lender is permitted, among other things, to accelerate the maturity of any loans under the Credit Agreement. The Credit Agreement is secured by certain assets of the Company, including the Company’s accounts, payments due or to become due under the Company’s government contracts, deposit accounts, chattel paper, inventory, equipment, and general intangibles. The maturity date for the Credit Agreement is February 28, 2010. The Company did not use and had no balance outstanding at June 30, 2007 and September 30, 2006.

5.	Stock Option Plan and 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. The Company adopted the modified prospective application in implementing SFAS 123R. Under this transition method compensation costs recognized include 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 represents 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 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

5.	Stock Option Plan and Stock-Based Compensation (continued)

As a result of adopting SFAS 123R the Company included approximately $482,000 and $257,000 of share-based compensation expense as general and administrative expenses in the Consolidated Statements of Operations for the nine month periods ended June 30, 2007 and 2006, respectively.

Cash received from the exercise of options under all Company Stock Option Plans for the nine months ending June 30, 2007 and 2006 was $4,422,727 and $6,787,530, respectively. The Company currently plans to satisfy future stock option exercises under these plans with registered shares available to be issued. The aggregate intrinsic value of stock options exercised during the nine month periods ending June 30, 2007 and 2006 was $1,062,723 and $3,103,822, respectively.

Effective May 1, 2002, the Company established the 2002 Stock Option Plan, which was amended and restated on May 1, 2005 and December 6, 2006, 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) 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. The maximum number of shares of common stock which may be issued pursuant to the 1988 Stock Option Plan is 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) and vest from one to five years. Pursuant to the approval by stockholders at the April 17, 2002 Annual Meeting of the Stockholders, no further options have been granted since April 30, 2002 under the 1988 Stock Option Plan.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

5.	Stock Option Plan and Stock-Based Compensation (continued)

The following table summarizes the Company’s activity for all of its stock option awards during the nine months ended June 30, 2007:


	*Shares*		*Weighted* *Average* *Exercise Prices*		*Weighted* *Average* *Remaining* *Life*	Aggregate Intrinsic Value *($ in millions)*
Options outstanding September 30, 2006	753,378		$	21.64	2.89	$	7.25
Granted	15,000		$	23.95
Exercised	(218,056	)	$	20.28
Cancelled	(55,975	)	$	25.37

Options outstanding June 30, 2007	494,347		$	21.88	2.66	$	1.67

Exercisable at June 30, 2007	411,033		$	20.91	2.25	$	1.65

The following table summarizes non-vested stock options as of June 30, 2007, as well as activity for the nine months then ended:


*Non-vested Shares*	*Shares*		*Weighted Average Grant* *Date Fair Value*
Non-vested at September 30, 2006	181,194		$	8.61
Granted	15,000		$	6.48
Vested	(77,880	)	$	7.79
Cancelled	(35,000	)	$	8.23

Non-vested at June 30, 2007	83,314		$	9.02

The following table summarizes additional information about stock options outstanding at June 30, 2007:


	*Options Outstanding*				*Options Exercisable*
*Exercise PricePer Share***	*Number of* *Shares*	*Weighted* *Average* *Remaining* *Life*	*Weighted* *Average* *Exercise* *Price*		*Number* *Exercisable*	*Weighted* *Average* *Exercise* *Price*
$ 15.00 – 19.99	239,748	2.15 Years	$	18.58	237,354	$	18.59
$20.00 – 28.00	254,599	3.14 Years	$	24.99	173,679	$	24.08

	494,347	2.66 Years	$	21.88	411,033	$	20.91

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INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

5.	Stock Option Plan and Stock-Based Compensation (continued)

The weighted average grant date fair value of options which were granted during the nine months ended June 30, 2007 and 2006 was $6.48 and $8.47, 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 nine month period.


	2007	2006
Expected volatility	35.18%	33.59%
Risk free interest rate	4.53%	4.80%
Dividend yield	1.11%	.68%
Expected lives	3.00 years	3.86 years

As of June 30, 2007, there was $657,283 of unrecognized compensation expense related to remaining non-vested stock options that will be recognized over a weighted-average period of 3.2 years. The total fair value of options which vested during the nine month period ending June 30, 2007 and 2006 was $606,433 and $131,912, respectively.

6.	Commitments and Contingencies

Litigation, Claims, and Assessments

The Company is subject to various legal proceedings and threatened legal proceedings from time to time. We are not currently a party to any legal proceedings, the adverse outcome of which, individually or in the aggregate, management believes would have a material adverse effect on the Company’s business, results of operations, financial condition or cash flows.

As previously disclosed, on March 1, 2007, the Company learned that the Securities and Exchange Commission (the “SEC”) had issued a formal order of investigation regarding the Company. The Company and certain of its officers have received subpoenas in connection with the investigation. The Board of Directors of the Company established a Special Committee (SEC/NASDAQ Inquiry) of independent directors of the Company to supervise the Company’s responses to the SEC’s investigation and to investigate related matters. The Special Committee (SEC/NASDAQ Inquiry) consists of the following members of the Company’s Board of Directors: John M. Albertine, Paul Casner, William F. Leimkuhler; and R. Doss McComas. The Special Committee (SEC/NASDAQ Inquiry) has retained the law firm of Foley Hoag LLP to serve as its independent counsel.

The investigation by the SEC and a related inquiry by NASDAQ include questions as to whether Gary A. Prince was acting as a de facto executive officer of the Company prior to the promotion to the position of Executive Vice President and Managing Director of Operations of the Company in August 2006. The investigation and inquiry also include questions as to whether Mr. Prince was practicing as an accountant before the SEC while an employee of the Company. Mr. Prince agreed with the SEC in 1997 to a permanent injunction barring him from practicing as an accountant before the SEC, as part of a settlement with the SEC related to Mr. Prince’s guilty plea to charges brought against him for conduct principally occurring in 1988 through 1990 while he was employed by Financial News Network, Inc. and United Press International.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

6.	Commitments and Contingencies (continued)

Litigation, Claims, and Assessments (continued)

Effective March 30, 2007, the Company terminated the employment of Mr. Prince. Mr. Prince’s employment termination was at the direction of the Special Committee (SEC/NASDAQ Inquiry), as a result of the investigation of the Special Committee (SEC/NASDAQ Inquiry) concerning the matters under investigation by the SEC and the related inquiries by NASDAQ. The Company had placed Mr. Prince on paid administrative leave effective November 1, 2006, pending developments in the inquiries by the SEC and NASDAQ and the ongoing investigation by the Special Committee (SEC/NASDAQ Inquiry). On April 24, 2007 Mr. Prince sent a letter to the Company demanding a severance payment of $224,960 and a bonus payment of $60,000 for fiscal year 2006 services. On May 17, 2007, Mr. Prince filed a lawsuit against the Company demanding payment of $854,879 for unpaid wages and treble damages related thereto. The Company disputes claims made in the letter and the lawsuit by Mr. Prince, and believes that it has valid defenses to refute the claims.

The Company is cooperating fully with the SEC and NASDAQ in connection with the investigation and the inquiry.

On December 14, 2006, the Company received notice that LJT & Associates Inc. (“LJT”) filed an action against the Company on December 8, 2006 in the circuit court for Howard County, Maryland, alleging breach by the Company of the asset purchase agreement dated November 1, 2004 between LJT and the Company, pursuant to which the Company sold assets of its antenna division to LJT. The complaint with respect to this action also alleges, among other things, tortious interference with contract, misappropriation of trade secrets in violation of the Maryland Uniform Trade Secrets Act, conspiracy to misappropriate trade secrets, respondeat superior, and breach of good faith and fair dealing. According to the complaint, LJT seeks injunctive relief against the Company, damages in an amount of not less than $500,000 with respect to each of certain claims against the Company, and other unspecified monetary damages, among other relief.

The Company believes that it has valid defenses to the claims made by LJT in this action and intends to defend the action vigorously.

The Company believes that the final outcome of the matter described above will not have a significant adverse effect on its financial position or results of operations. However, if litigation as described above proceeds, and even if the Company’s defense is successful, the litigation could require significant management time and will be costly. Should the Company not prevail in this litigation matter, its operating results, financial position and cash flows could be adversely impacted.

Additional information regarding this matter is included at note 10 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K filed with the SEC on December 14, 2006

- 11 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

7.	Recent Accounting Pronouncements

FASB Statement No. 159 -” The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“FAS 159”). In February 2007, the FASB issued FAS 159, which becomes effective for the Company on October 1, 2008. This standard permits companies to choose to measure many financial instruments and certain other items at fair value and report unrealized gains and losses in earnings. Such accounting is optional and is generally to be applied instrument by instrument. The Company does not anticipate that election, if any, of this fair-value option will have a material effect on its results of operations or consolidated financial position.

FIN 48—”Accounting for Uncertainty in Income Taxes.”In July 2006, FASB Interpretation No. 48—”Accounting for Uncertainty in Income Taxes,” or FIN 48, was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109—”Accounting for Income Taxes.” FIN 48 is effective for fiscal years beginning after December 15, 2006. We expect to implement FIN 48 beginning on October 1, 2007. The Company is in the process of determining the effect, if any, the adoption of FIN 48 will have on its financial statements.

SFAS 157—”Fair Value Measurements.” In October 2006, FASB issued Statement of Financial Accounting Standards No. 157—”Fair Value Measurements,” or SFAS 157. This standard establishes a framework for measuring fair value and expands disclosures about fair value measurement of a company’s assets and liabilities. This standard also requires that the fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and, generally, must be applied prospectively. We expect to adopt this standard beginning in October 2008. Currently, we are evaluating the impact that this new standard will have on our financial position and results of operations.

8.	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 U.S. Government. It is currently the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force, NASA 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.

- 12 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

8.	Business Segment Information (continued)

•

ISI Europe, the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business. ISI Europe also pursues ground systems business in Europe and Africa for command and control, signal monitoring, and network management using products from the Company and all of the Company’s subsidiaries.

The Space Communications Systems segment includes the Company’s wholly-owned subsidiary, 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 wholly-owned, indirect subsidiary Lumistar (acquired October 3, 2005), which provides system level and board level telemetry products.

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.

- 13 -

INTEGRAL SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

8.	Business Segment Information (continued)

Summarized financial information by business segment is as follows:


	Three Months Ended June 30, 2007			Three Months Ended June 30, 2006			Nine Months Ended June 30, 2007			Nine Months Ended June 30, 2006
Revenue
Ground Systems–Government	$	20,247,790		$	13,573,734		$	49,118,517		$	43,820,562
Ground Systems–Commercial		5,478,065			4,392,733			16,293,802			13,819,362
Ground Systems–Commercial intersegment		204,543			409,477			490,273			858,950
Space Communication Systems		9,696,189			9,035,800			25,581,820			29,350,419
Space Communication Systems intersegment		1,780,809			1,740,034			5,002,970			4,566,007
Corporate		449,492			468,451			1,312,412			1,890,036
Corporate intersegment		1,543,335			803,101			3,239,574			3,415,570
Elimination of intersegment sales		(3,528,687	)		(3,007,338	)		(8,732,817	)		(8,895,254	)

Total Revenue	$	35,871,536		$	27,415,992		$	92,306,551		$	88,825,652

Operating Income
Ground Systems–Government	$	1,543,448		$	1,057,066		$	4,125,342		$	3,598,359
Ground Systems–Commercial		1,103,259			777,252			3,117,725			2,144,563
Ground Systems–Commercial intersegment		(314	)		110			(314	)		110
Space Communication Systems		2,519,014			2,545,905			6,602,834			8,465,501
Space Communication Systems intersegment		(1,849	)		—			559			—
Corporate		118,520			(519,528	)		(2,529,135	)		(474,078	)
Corporate intersegment		6,177			(1,154	)		6,457			(2,067	)
Elimination of intersegment Operating Income		(4,014	)		1,044			(6,702	)		1,957

Total Operating Income	$	5,284,241		$	3,860,695		$	11,316,766		$	13,734,345

Interest Income		565,370			530,321			1,646,506			1,315,759
Interest Expense		(1,151	)		(5,780	)		(3,716	)		(7,779	)
Other Expense		(112,463	)		(47,823	)		(757,541	)		(379,882	)
Intersegment Eliminations		8,059			2,700			11,318			46,195

Total Income Before Income Taxes	$	5,744,056		$	4,340,113		$	12,213,333		$	14,708,638

Asset information for the Company’s segments at June 30, 2007 and September 30, 2006 is shown in the following table:


	June 30, 2007			September 30, 2006
Total Assets
Ground Systems–Government	$	23,094,140		$	15,392,530
Ground Systems–Commercial		11,179,871			10,594,928
Space Communication Systems		80,717,372			82,416,028
Corporate		94,472,933			90,044,882
Elimination of intersegment accounts receivable		(26,892,776	)		(31,597,430	)

Total Assets	$	182,571,540		$	166,850,938

- 14 -

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

Overview

The Company builds satellite ground systems and equipment for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 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 and hardware 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 U.S. Government. It is currently the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force, U.S. Navy, NASA 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. ISI Europe also pursues ground systems business in Europe and Africa for command and control, signal monitoring, and network management using products from the Company and all of the Company’s subsidiaries.

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 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

FASB Statement No. 159- “ The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“FAS 159”). In February 2007, the FASB issued FAS 159, which becomes effective for the Company on October 1, 2008. This standard permits companies to choose to measure many financial instruments and certain other items at fair value and report unrealized gains and losses in earnings. Such accounting is optional and is generally to be applied instrument by instrument. The Company does not anticipate that election, if any, of this fair-value option will have a material effect on its results of operations or consolidated financial position.

- 16 -

COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2007 AND 2006

Results of Operations

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the three months ended June 30, 2007 and 2006:


	Three Months Ended June 30,
	2007		% of Revenue	2006		% of Revenue
	(in thousands)		(in thousands)
Revenue	$	35,872	100.0	$	27,416	100.0
Cost of Revenue		24,423	68.1		18,201	66.4

Gross Margin		11,449	31.9		9,215	33.6

Operating Expenses
Selling, General & Admin. (SG&A)		5,255	14.6		4,287	15.7
Research and Development		664	1.9		563	2.1
Product Amortization		206	0.6		400	1.3
Amortization-Intangible Assets		40	0.1		104	.4

Income from Operations		5,284	14.7		3,861	14.1
Other Income (Expense) (net)		460	1.3		479	1.7

Income Before Income Taxes		5,744	16.0		4,340	15.8
Income Taxes		1,926	5.4		1,589	5.8

Net Income	$	3,818	10.6	$	2,751	10.0

Revenue

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

For the three months ended June 30, 2007 and 2006, the Company’s revenues were generated from the following sources:


	Three Months Ended June 30,
Revenue Type	2007		2006
U.S. Government Revenue (all segments)
U.S. Air Force	55	%	55	%
National Programs	9		1
U.S. Navy	8		9
NOAA	3		8
NASA	3		5
Other U.S. Government Users	3		4

Subtotal	81		82

Commercial Revenue (all segments)	19		18

Total	100	%	100	%

- 17 -

On a consolidated basis, revenue increased 30.8%, or $8.5 million, to $35.9 million for the three months ended June 30, 2007, from $27.4 million for the three months ended June 30, 2006. Revenue for the three-month periods ended June 30, 2007 and 2006 for each of the Company’s segments is shown in the following table:


	Three Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Revenue
Ground Systems – Government	$	20,248		$	13,574		$	6,674

Ground Systems – Commercial
Command & Control		2,864			3,306			(442	)
Newpoint		981			781			200
SAT		1,955			909			1,046
Intra-Segment Elimination		(117	)		(194	)		77

Ground Systems – Commercial		5,683			4,802			881

Space Communications Systems		11,477			10,775			702

Corporate
Product Group		1,814			998			816
Antenna		25			68			(43	)
Other		154			206			(52	)

Corporate		1,993			1,272			721

Elimination		(3,529	)		(3,007	)		(522	)

Total Revenue	$	35,872		$	27,416		$	8,456

Revenue increases of approximately $6.7 million in the Company’s Ground Systems - Government segment between the three months ended June 30, 2007 and 2006 primarily relate to increased sales volume of approximately $6.2 million from the U.S. Air Force coupled with approximately $1.5 million in revenue increases from National Programs due to a recent contract award which was partially offset by approximately $950,000 in revenue decreases in NOAA programs.

Revenue increases of approximately $880,000 for the Company’s Ground Systems - Commercial segment resulted primarily from increased backlog and increased product shipments to customers from SAT and Newpoint which were partially offset by revenue decreases in the Command & Control unit.

Revenue increases of approximately $700,000 for the Company’s Space Communications Systems segment between the three months ended June 30, 2007 and 2006 resulted primarily from approximately $1.2 million in increased backlog and increased product shipments to customers from RT Logic which were partially offset by revenue decreases at Lumistar, resulting from decreased shipments to customers.

In the Company’s Corporate segment, revenues for the Product Group increased approximately $820,000 for the three months ended June 30, 2007 compared to the three months ended June 30, 2006 principally due to increased license sales.

Antenna Division revenues declined approximately $40,000 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 as the Division’s residual contracts are completed.

- 18 -

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, firmware and software products.

During the three months ended June 30, 2007, cost of revenue increased by 34.2%, or $6.2 million, compared to the same period during the prior year, increasing from $18.2 million during the three months ended June 30, 2006 to $24.4 million during the three months ended June 30, 2007. Gross margin increased by $2.2 million, or 24.2%, increasing from $9.2 million during the three months ended June 30, 2006 to $11.4 million during the three months ended June 30, 2007.

- 19 -

Cost of revenue and gross margin for the three months ended June 30, 2007 and 2006 for each of the Company’s segments are shown in the following table:


	Three Months Ended June 30,						Increase/ (Decrease)
Segment	2007			2006
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	16,886		$	10,797		$	6,089

Ground Systems – Commercial
Command & Control		2,035			2,299			(264	)
Newpoint		432			363			69
SAT		949			397			552
Intra-Segment Elimination		(112	)		(151	)		39

Ground Systems – Commercial		3,304			2,908			396

Space Communications Systems		6,838			6,399			439

Corporate
Product Group		777			780			(3	)
Antenna		(7	)		119			(126	)
Other		140			193			(53	)

Corporate		910			1,092			(182	)

Elimination		(3,515	)		(2,995	)		(520	)

Total Cost of Revenue	$	24,423		$	18,201		$	6,222

Gross Margin
Ground Systems – Government	$	3,362		$	2,777		$	585

Ground Systems – Commercial
Command & Control		829			1,007			(178	)
Newpoint		549			418			131
SAT		1,006			512			494
Intra-Segment Elimination		(5	)		(43	)		38

Ground Systems – Commercial		2,379			1,894			485

Space Communications Systems		4,639			4,376			263

Corporate
Product Group		1,037			218			819
Antenna		32			(51	)		83
Other		14			13			1

Corporate		1,083			180			903

Elimination		(14	)		(12	)		(2	)

Total Gross Margin	$	11,449		$	9,215		$	2,234

- 20 -

The higher gross margin in the Company’s Ground Systems – Government segment of approximately $590,000 is primarily attributable to increased revenues between the periods being compared partially offset by higher equipment and subcontract costs. As a result, gross margin as a percentage of revenue for the Ground Systems - Government segment decreased from 20.5% for the three months ended June 30, 2006 to 16.7% for the three months ended June 30, 2007. As discussed above, gross margins for purchased equipment and subcontract pass-throughs are generally lower than margins on licenses and engineering services.

The higher gross margin for the Company’s Ground Systems – Commercial segment primarily relates to increased revenue from SAT and Newpoint, partially offset by decreased gross margin in the Command and Control unit, resulting from decreased revenue.

The Space Communications Systems segment experienced an increase in gross margin of approximately $260,000 on increased revenue at RT Logic, partially offset by revenue decreases at Lumistar, Inc. As a percentage of sales, the segment’s gross margin remained relatively flat at 40.4% for the three months ended June 30, 2007 compared to 40.6% for the three months ended June 30, 2006.

In the Corporate segment, the Product Group experienced a higher gross margin of approximately $820,000 on a period-to-period basis because of increased license revenue. Antenna Division gross margin deficits from the three months ended June 30, 2006 were eliminated during the three month period ended June 30, 2007.

Operating Expenses

Operating expenses for the three months ended June 30, 2007 and 2006 for each of the Company’s segments are shown in the following table:


	Three Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Operating Expenses

Ground Systems – Government	$	1,819		$	1,720		$	99

Ground Systems – Commercial
Command & Control		427			439			(12	)
Newpoint		383			346			37
SAT		466			371			95
Intra-Segment Elimination		—			(39	)		39

Ground Systems – Commercial		1,276			1,117			159

Space Communications Systems		2,122			1,830			292

Corporate Product Group		420			680			(260	)
Antenna		(1	)		18			(19	)
Other		539			3			536

Corporate		958			701			257

Elimination		(10	)		(13	)		3

Total Operating Expenses	$	6,165		$	5,355		$	810

Operating expenses in the Company’s Ground Systems - Government segment increased by approximately $100,000 for the three months ended June 30, 2007 compared to the three months ended June 30, 2006 due partly to an increased allocation of corporate expenses.

- 21 -

Operating expenses in the Company’s Ground Systems - Commercial segment increased by approximately $160,000 for the three months ended June 30, 2007 compared to the three months ended June 30, 2006, due principally to increased selling expenses at SAT and Newpoint. Operating expenses in the Command and Control unit decreased an immaterial amount during the periods being compared.

Operating expenses in the Space Communications Systems segment increased approximately $290,000 during the current period compared to the third quarter of the last fiscal year. Selling expenses, including bid and proposal expenses and general & administrative expenses each increased approximately $120,000 while R&D expenses increased approximately $110,000. These increases were offset by a decrease in intangible asset amortization of approximately $60,000.

Operating expenses in the Corporate segment increased approximately $260,000 principally due to legal costs of approximately $380,000 associated with the previously disclosed SEC investigation and NASDAQ inquiry, as discussed below in “Part II. Other Information - Item 1. Legal Proceedings.” Additionally, other corporate expenses including stock-based compensation cost, due diligence expenses associated with the exploration of strategic alternatives to maximize stockholder value, and state tax allocation increased approximately $150,000 during the three months ended June 30, 2007 compared to the three months ended June 30, 2006. These increases were offset by $190,000 in decreased product amortization costs and approximately $80,000 in decreased allocation of corporate expenses and selling expenses during the periods being compared.

Income from Operations

Income from operations for the three months ended June 30, 2007 and 2006 for each of the Company’s segments is shown in the following table:


	Three Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Income from Operations

Ground Systems – Government	$	1,543		$	1,057		$	486

Ground Systems – Commercial
Command & Control		402			568			(166	)
Newpoint		166			72			94
SAT		540			141			399
Intra-Segment Elimination		(5	)		(4	)		(1	)

Ground Systems – Commercial		1,103			777			326

Space Communications Systems		2,517			2,546			(29	)

Corporate Product Group		617			(462	)		1,079
Antenna		33			(68	)		101
Other		(525	)		10			(535	)

Corporate		125			(520	)		645

Elimination		(4	)		1			(5	)

Total Income from Operations	$	5,284		$	3,861		$	1,423

Income from operations during the periods compared increased by approximately $490,000 in the Company’s Ground Systems - Government segment as a result of increased gross margins partially offset by increased operating expenses.

- 22 -

Income from operations during the periods compared increased by approximately $330,000 in the Company’s Ground Systems - Commercial segment as a result of approximately $400,000 in improved results at SAT. Newpoint also contributed approximately $90,000 in increased income due primarily to increased sales which was offset by $170,000 in decreased operating income in the Command and Control unit as discussed above.

The Space Communications Systems segment recorded decreased income from operations of approximately $30,000 principally due to gross margin increases resulting from increased product sales at RT Logic which were more than offset by increased operating expenses.

The Corporate segment had operating income of approximately $130,000 for the three months ended June 30, 2007 compared to an operating loss of approximately $520,000 for the three months ended June 30, 2006. The Product Division recorded operating income of approximately $620,000 for the three months ended June 30, 2007 compared to an operating loss of $460,000 for the three months ended June 30, 2006. The operating income is primarily due to increased license revenue coupled with decreased product amortization expense. Offsetting the Product Division’s operating income is an operating loss of approximately $530,000 during the periods being compared related to $380,000 associated with the previously disclosed SEC investigation and NASDAQ inquiry and $150,000 in corporate expenses described above. The Antenna Division posted operating income of approximately $30,000 due to increased gross margins on the residual contracts.

Other Income (Expense)

Other income decreased approximately $20,000 between the quarters being compared, primarily due to an increase in interest income resulting from favorable interest rates changes which was more than offset by the higher unallowable expenses.

Income Before Income Taxes/Net Income

Income before income taxes increased approximately 32.3% during the three months ended June 30, 2007 compared to the amounts posted during the third quarter of fiscal year 2006, primarily as a result of increased revenue partially offset by increased operating expenses.

The Company’s effective tax rate decreased from 36.6% for the three months ended June 30, 2006 to 33.5% for the three months ended June 30, 2007 due to a decrease in the effective state tax rate.

As a result of the above, net income increased 38.8% to approximately $3.8 million during the three months ended June 30, 2007 from $2.8 million during the three months ended June 30, 2006.

- 23 -

COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 2007 AND 2006

Results of Operations

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the nine months ended June 30, 2007 and 2006:


	Nine Months Ended June 30,
	2007		% of Revenue	2006		% of Revenue
	(in thousands)		(in thousands)
Revenue	$	92,307	100.0	$	88,826	100.0
Cost of Revenue		62,064	67.2		59,552	67.0

Gross Margin		30,243	32.8		29,274	33.0

Operating Expenses
Selling, General & Admin. (SG&A)		16,512	17.9		11,707	13.2
Research and Development		1,636	1.7		2,150	2.4
Product Amortization		618	0.7		1,200	1.4
Amortization-Intangible Assets		160	0.2		483	0.5

Income from Operations		11,317	12.3		13,734	15.5
Other Income (Expense) (net)		896	0.9		975	1.1

Income Before Income Taxes		12,213	13.2		14,709	16.6

Income Taxes		4,194	4.5		5,344	6.1

Net Income	$	8,019	8.7	$	9,365	10.5

Revenue

For the nine months ended June 30, 2007 and 2006, the Company’s revenues were generated from the following sources:


	Nine Months Ended June 30,
Revenue Type	2007		2006
U.S. Government Revenue (all segments)
U.S. Air Force	57	%	59	%
Navy	6		4
National Programs	6		3
NOAA	4		5
NASA	4		4
Other U.S. Government Users	3		4

Subtotal	80		79

Commercial Revenue (all segments)	20		21

Total	100	%	100	%

- 24 -

On a consolidated basis, revenue increased 3.9%, or $3.5 million, to $92.3 million for the nine months ended June 30, 2007, from $88.8 million for the nine months ended June 30, 2006. Revenue for the nine-month periods ended June 30, 2007 and 2006 for each of the Company’s segments is shown in the following table:


	Nine Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Revenue

Ground Systems – Government	$	49,119		$	43,821		$	5,298

Ground Systems – Commercial
Command & Control		9,424			9,528			(104	)
Newpoint		2,888			2,531			357
SAT		5,117			3,049			2,068
Intra-Segment Elimination		(645	)		(430	)		(215	)

Ground Systems – Commercial		16,784			14,678			2,106

Space Communications Systems		30,585			33,916			(3,331	)

Corporate
Product Group		3,932			3,721			211
Antenna		102			812			(710	)
Other		518			773			(255	)

Corporate		4,552			5,306			(754	)

Elimination		(8,733	)		(8,895	)		162

Total Revenue	$	92,307		$	88,826		$	3,481

Revenue increases of approximately $5.3 million in the Company’s Ground Systems - Government segment between the nine months ended June 30, 2007 and 2006 primarily relate to increased sales volume of approximately $4.5 million from the U.S. Air Force coupled with approximately $2.2 million in revenue increases from National Programs due to a recent contract award which was partially offset by approximately $1.4 million in revenue decreases in NOAA programs.

Revenue increases of approximately $2.1 million for the Company’s Ground Systems - Commercial segment resulted primarily from increased backlog and increased product shipments to customers from SAT and Newpoint which were partially offset by revenue decreases in the Command & Control unit.

Revenue decreases for the Company’s Space Communications Systems segment was due to decreased bookings in the third and fourth quarters of fiscal year 2006 which resulted in decreased product shipments to customers during the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006.

In the Company’s Corporate segment, revenues for the Product Group increased approximately $210,000 for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006 principally due to increased support and license revenue.

Antenna Division revenues declined approximately $710,000 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 as the Division’s residual contracts are completed.

- 25 -

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 composed of internally developed hardware, firmware and software products.

During the nine months ended June 30, 2007, cost of revenue increased by 4.2%, or $2.5 million, compared to the same period during the prior year, increasing from $59.6 million during the nine months ended June 30, 2006 to $62.1 million during the nine months ended June 30, 2007. Gross margin increased by $970,000, or 3.3%, during the periods compared, increasing from $29.3 million for the nine months ended June 30, 2006 to $30.2 million for the nine months ended June 30, 2007. Cost of revenue and gross margin for the nine months ended June 30, 2007 and 2006 for each of the Company’s segments are shown in the following table:

- 26 -


	Nine Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Ground Systems – Government	$	39,706		$	35,514		$	4,192

Ground Systems – Commercial
Command & Control		6,582			7,044			(462	)
Newpoint		1,352			1,170			182
SAT		2,768			1,441			1,327
Intra-Segment Elimination		(638	)		(273	)		(365	)

Ground Systems – Commercial		10,064			9,382			682

Space Communications Systems		18,001			19,803			(1,802	)

Corporate
Product Group		2,464			2,264			200
Antenna		41			707			(666	)
Other		477			745			(268	)

Corporate		2,982			3,716			(734	)

Elimination		(8,689	)		(8,863	)		174

Total Cost of Revenue	$	62,064		$	59,552		$	2,512

Gross Margin

Ground Systems – Government	$	9,413		$	8,307		$	1,106

Ground Systems – Commercial
Command & Control		2,842			2,484			358
Newpoint		1,536			1,361			175
SAT		2,349			1,608			741
Intra-Segment Elimination		(7	)		(157	)		150

Ground Systems – Commercial		6,720			5,296			1,424

Space Communications Systems		12,584			14,113			(1,529	)

Corporate
Product Group		1,468			1,457			11
Antenna		61			105			(44	)
Other		41			28			13

Corporate		1,570			1,590			(20	)

Elimination		(44	)		(32	)		(12	)

Total Gross Margin	$	30,243		$	29,274		$	969

The higher gross margin in the Company’s Ground Systems – Government segment of approximately $1.1 million is primarily attributable to the increase in revenue during the periods being compared. Gross margin as a percentage of revenue for the Ground Systems - Government segment remained relatively flat at 19.1% for the nine months ended June 30, 2007 compared to 18.9% for the nine months ended June 30, 2006.

- 27 -

The Space Communications System segment experienced a decrease in gross margin of approximately $1.5 million on decreased revenue of $3.3 million. As a percentage of revenue, gross margin declined slightly to 41.1% for the nine months ended June 30, 2007 from 41.6% for the nine months ended June 30, 2006.

In the Corporate segment, the Product Group experienced a slightly higher gross margin on a period-to-period basis because of increased support and license revenue, while gross margin in the Antenna Division decreased slightly on reduced sales for the nine months ended June 30, 2007 when compared to the nine months ended June 30, 2006.

Operating Expenses

Operating expenses for the nine months ended June 30, 2007 and 2006 for each of the Company’s segments are shown in the following table:


	Nine Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Operating Expenses

Ground Systems – Government	$	5,288		$	4,709		$	579

Ground Systems – Commercial
Command & Control		1,302			1,185			117
Newpoint		1,061			1,052			9
SAT		1,241			1,024			217
Intra-Segment Elimination		(2	)		(109	)		107

Ground Systems – Commercial		3,602			3,152			450

Space Communications Systems		5,981			5,647			334

Corporate
Product Group		1,406			2,032			(626	)
Antenna		55			53			2
Other		2,631			(19	)		2,650

Corporate		4,092			2,066			2,026

Elimination		(37	)		(34	)		(3	)

Total Operating Expenses	$	18,926		$	15,540		$	3,386

Operating expenses in the Company’s Ground Systems - Government segment increased by approximately $580,000 for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006 due in part to increased bid and proposal expenses related to a significant new business opportunity with the U.S. Air Force and an increased allocation of corporate expenses.

Operating expenses in the Company’s Ground Systems - Commercial segment increased by approximately $450,000 for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006. At SAT, increased operating expenses were primarily related to higher selling expenses and higher R&D spending. In the Command and Control unit, the increase was primarily due to approximately $80,000 in SG&A increases at ISI-Europe. At Newpoint, increased selling expenses were essentially offset by the elimination of intangible asset amortization.

- 28 -

Operating expenses in the Space Communications Systems segment increased approximately $330,000 during the current period compared to the nine months ended June 30, 2006. Increased selling expenses, including bid and proposal expenses of $650,000, coupled with $500,000 in increased general and administrative expenses were partially offset by lower R&D spending of approximately $560,000 and the elimination of $260,000 in intangible asset amortization.

Operating expenses in the Corporate segment increased approximately $2.0 million principally due to legal costs of approximately $2.1 million associated with the previously disclosed SEC investigation and NASDAQ inquiry, as discussed below in “Part II. Other Information - Item 1. Legal Proceedings.” Additionally, other corporate expenses including stock-based compensation cost, due diligence expenses associated with the exploration of strategic alternatives to maximize stockholder value, and state tax allocation increased approximately $470,000 during the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006. These increases were offset by $580,000 in decreased product amortization costs during the periods being compared.

Income from Operations

Income from operations for the nine months ended June 30, 2007 and 2006 for each of the Company’s segments is shown in the following table:


	Nine Months Ended June 30,						Increase/ (Decrease)
	2007			2006			Increase/ (Decrease)
Segment	(in thousands)			(in thousands)			(in thousands)
Income from Operations

Ground Systems – Government	$	4,125		$	3,598		$	527

Ground Systems – Commercial
Command & Control		1,540			1,299			241
Newpoint		475			309			166
SAT		1,108			584			524
Intra-Segment Elimination		(5	)		(48	)		43

Ground Systems – Commercial		3,118			2,144			974

Space Communications Systems		6,603			8,466			(1,863	)

Corporate
Product Group		62			(575	)		637
Antenna		6			52			(46	)
Other		(2,590	)		47			(2,637	)

Corporate		(2,522	)		(476	)		(2,046	)

Elimination		(7	)		2			(9	)

Total Income from Operations	$	11,317		$	13,734		$	(2,417	)

Income from operations during the periods compared increased by approximately $530,000 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 $970,000 in the Company’s Ground Systems - Commercial segment as a result of increased gross margins partially offset by increased operating expenses in all of the segment’s units. SAT’s improved operating results were responsible for more than half of the segment’s operating income increase.

- 29 -

The Space Communications Systems segment recorded decreased income from operations of approximately $1.9 million principally due to gross margin decreases resulting from decreased sales coupled with increased selling general and administrative expenses.

The Corporate segment had an operating loss of approximately $2.5 million for the nine months ended June 30, 2007 compared to an operating loss of approximately $480,000 for the nine months ended June 30, 2006. The loss is primarily a result of approximately $2.1 million in legal costs associated with the previously disclosed SEC investigation and NASDAQ inquiry coupled with $470,000 in corporate operating expenses described above. Offsetting the loss is $60,000 in operating income for the Product Division for the nine months ended June 30, 2007 compared to a $580,000 operating loss for the nine months ended June 30, 2006. The operating income is primarily due to increased support and license revenue coupled with decreased product amortization expense. The Antenna Division was essentially breakeven for the nine months ended June 30, 2007.

Other Income (Expense)

Other income decreased approximately $80,000 between the quarters being compared, primarily due to an increase in interest income resulting from favorable interest rates changes which was more than offset by the higher unallowable expenses.

Income Before Income Taxes/Net Income

Income before income taxes decreased approximately 17.0% for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006, primarily as a result of decreased operating income coupled with increased other expenses.

The Company’s effective tax rate decreased from 36.3% for the nine months ended June 30, 2006 to 34.3% for the nine months ended June 30, 2007 principally due to a higher percentage of tax exempt income compared to total income before income taxes coupled with a lower effective state tax rate in the current period.

As a result of the above, net income decreased 14.4% to approximately $8.0 million during the nine months ended June 30, 2007 from $9.4 million during the nine months ended June 30, 2006.

OUTLOOK

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

At this time, the Company has a backlog of work to be performed and it may receive additional contract awards based on proposals in the pipeline, although the estimated backlog under the Company’s government contracts is not necessarily indicative of revenues that will actually be realized under the contracts.

As disclosed in its Form 10-K for the fiscal year ended September 30, 2006, the Company was anticipating that results for revenue, operating income, net income and fully diluted earnings per common share in fiscal year 2007 would exceed results for fiscal year 2006 by approximately 13%, 6%, 10% and 9%, respectively, exclusive of expenses related to the previously disclosed SEC investigation and NASDAQ inquiry, and related supervision and investigation by the Special Committee (SEC/NASDAQ Inquiry) of the Board of Directors as discussed below in “Part II. Other Information - Item 1. Legal Proceedings.”

As disclosed in its Form 10-Q for the three months ended March 31, 2007, the Company anticipated that revenue for fiscal year 2007 would be $131 million, up approximately 13% over revenue posted in fiscal year 2006, but that net income would decrease to $1.07 per share and operating income, net income, and fully diluted earnings per common share would decrease 3%, 3% and 4%, respectively, as compared to fiscal year 2006, exclusive of legal fees associated with the SEC investigation and related inquiry by NASDAQ.

- 30 -

The Company now anticipates that revenue for fiscal year 2007 will be $130 million, up approximately 13% over revenue posted in fiscal year 2006, which is consistent with the Company’s previously issued guidance. In addition, due to improvements in its gross profit margins, primarily in its Ground Systems – Commercial segment operations, and improvements in its net interest income, the Company now expects net income to be $1.12 per fully diluted share for fiscal year 2007 and believes operating income, net income, and fully diluted earnings per share for fiscal year 2007 will be in line with fiscal year 2006. This guidance excludes the legal fees associated with the SEC investigation and related inquiry by NASDAQ and also excludes a potential benefit of up to $1 million that may be available to the Company in connection with the Company’s review of a research and development tax credit for the years 2001 through 2006. The availability of any such tax credit will be subject to review by the Internal Revenue Service.

Although the Company cannot provide any assurances as to the fiscal year 2007 forecasted results described above, the Company currently believes these results are achievable because the Company’s existing backlog in its Ground Systems - Government segment indicates growth in revenue and operating income.

LIQUIDITY AND CAPITAL RESOURCES

Since the Company’s inception in 1982, it has been profitable on an annual basis and has generally financed its working capital needs through internally generated funds, supplemented by borrowings under the Company’s general line of credit facility with a commercial bank and the proceeds from the Company’s initial public offering in 1988. In June 1999, the Company supplemented its working capital position by raising approximately $19.7 million (net) through the private placement of approximately 1.2 million shares of its common stock. In February 2000, the Company raised an additional $40.9 million (net) for use in connection with potential acquisitions and other general corporate purposes through the private placement of 1.4 million additional shares of its common stock. With respect to the capital raised in the private placements, at June 30, 2007, $20.0 million was invested in a Bank of America Preferred Funding Corporation “Dividends Received Eligible Auction Market” (“DREAMS”) preferred stock, $12.9 million was invested in Banc of America Securities, LLC, Auction Rate Securities, and $5.1 million was invested in variable rate State of Maryland debt securities.

For the nine months ended June 30, 2007, operating activities provided the Company approximately $4.4 million of cash. The Company used approximately $2.8 million in investing activities and financing activities provided approximately $1.4 million. Included in the Company’s investing activity is approximately $1.2 million for the purchase of fixed assets (principally new computers and equipment). Included in the financing activities is approximately $4.4 million in proceeds from the issuance of the Company’s common stock as a result of stock option exercises which was partially offset by $2.4 million in dividend payments and approximately $1.1 million for the repurchase of the Company’s common stock.

- 31 -

The Company’s Board of Directors declared a cash dividend of $.07 per share to all stockholders of record as of close of business on May 31, 2007. The dividend was paid on June 27, 2007 in the amount of $788,040. In addition, on August 6, 2007 the Company’s Board of Directors declared a quarterly cash dividend of $.07 per share to all stockholders of record as of close of business on August 29, 2007. The dividend will be paid on or about September 26, 2007. The Company’s general line of credit facility prohibits the declaration or payment of dividends by the Company until all of its obligations under the facility are paid in full or performed. As of June 30, 2007 all of the Company’s obligations under the facility have been met.

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 June 30, 2007 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 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 risk factors described in “Item 1A. Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006, as supplemented by the risk factors set forth in this Form 10-Q. When considering the forward-looking statements in this Form 10-Q, the reader should keep in mind the risk factors and other cautionary statements set forth herein and in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2006.

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.

- 32 -

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 June 30, 2007, 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 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.

- 33 -

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

As previously disclosed, on March 1, 2007, Integral Systems, Inc. (the “Company”) learned that the Securities and Exchange Commission (the “SEC”) had issued a formal order of investigation regarding the Company. The Company and certain of its officers have received subpoenas in connection with the investigation. The Board of Directors of the Company established a Special Committee (SEC/NASDAQ Inquiry) of independent directors of the Company to supervise the Company’s responses to the SEC’s investigation and to investigate related matters. The Special Committee (SEC/NASDAQ Inquiry) consists of the following members of the Company’s Board of Directors: John M. Albertine, Paul Casner, William F. Leimkuhler; and R. Doss McComas. The Special Committee (SEC/NASDAQ Inquiry) has retained the law firm of Foley Hoag LLP to serve as its independent counsel.

The investigation by the SEC and a related inquiry by NASDAQ include questions as to whether Gary A. Prince was acting as a de facto executive officer of the Company prior to his promotion to the position of Executive Vice President and Managing Director of Operations of the Company in August 2006. The investigation and inquiry also include questions as to whether Mr. Prince was practicing as an accountant before the SEC while an employee of the Company. Mr. Prince agreed with the SEC in 1997 to a permanent injunction barring him from practicing as an accountant before the SEC, as part of a settlement with the SEC related to Mr. Prince’s guilty plea to charges brought against him for conduct principally occurring in 1988 through 1990 while he was employed by Financial News Network, Inc. and United Press International.

Effective March 30, 2007, the Company terminated the employment of Mr. Prince. Mr. Prince’s employment termination was at the direction of the Special Committee (SEC/NASDAQ Inquiry), as a result of investigation of the Special Committee (SEC/NASDAQ Inquiry) concerning the matters under investigation by the SEC and the related inquiries by NASDAQ. The Company had placed Mr. Prince on paid administrative leave effective November 1, 2006, pending developments in the inquiries by the SEC and NASDAQ and the ongoing investigation by the Special Committee (SEC/NASDAQ Inquiry). On April 24, 2007 Mr. Prince sent a letter to the Company demanding a severance payment of $224,960 and a bonus payment of $60,000 for fiscal year 2006 services. On May 17, 2007, Mr. Prince filed a lawsuit against the Company demanding payment of $854,879 for unpaid wages and treble damages related thereto. The Company disputes claims made in the letter and the lawsuit by Mr. Prince, and believes that it has valid defenses to refute the claims.

The Company is cooperating fully with the SEC and NASDAQ in connection with the investigation and the inquiry.

The Company believes that it has valid defenses to the claims made by LJT in this action and intends to defend the action vigorously.

- 34 -

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors previously disclosed in Item 1A in our Annual Report on Form 10-K for the fiscal year ended September 30, 2006, which was filed with the SEC on December 14, 2006, except as follows:

The Company currently is subject to an investigation by the SEC and related inquiry by NASDAQ, which are requiring significant legal resources and management attention and could have a material adverse effect on the Company.

As previously disclosed, the SEC had issued a formal order of investigation regarding the Company and NASDAQ has inquired about the same. The investigation by the SEC and a related inquiry by NASDAQ include questions as to whether Gary A. Prince was acting as a de facto executive officer of the Company prior to his promotion to the position of Executive Vice President and Managing Director of Operations of the Company in August 2006. The investigation and inquiry also include questions as to whether Mr. Prince was practicing as an accountant before the SEC while an employee of the Company. See above at “Part II. Other Information - Item 1. Legal Proceedings.” The Board of Directors of the Company has established a Special Committee (SEC/NASDAQ Inquiry) of independent directors of the Company to supervise the Company’s responses to such investigation and inquiry and to investigate related matters. The Special Committee (SEC/NASDAQ Inquiry) has retained the law firm of Foley Hoag LLP to serve as its independent counsel. The Company is cooperating fully with the SEC and NASDAQ. We are unable to determine at this time either the timing of these inquiries and investigations, the impact, if any, which these inquiries and investigations could have on the Company, or the outcome of these inquiries and investigations.

The Company has recently eliminated certain measures that it previously had in place that could have impeded the takeover of the Company.

Until recently, the Company had in place various measures, any one or more of which may have impeded or made more difficult a takeover of the Company without the approval of our board of directors or discouraged acquisition bids with respect to the Company. These measures which have been eliminated, included provisions in our charter or bylaws that:

•

provided for a classified, or “staggered,” board of directors;

•

required the affirmative vote of at least two-thirds of all of the votes entitled to be cast by the stockholders generally in the election of directors to remove a director, and then only for cause;

•

provided for fixing the number of directors only by a vote of directors;

•

provided for filling vacancies on the board only by the vote of the remaining directors; and

•

established certain requirements and procedures for calling special meetings of stockholders, including a provision that provided that the secretary of the Company could only call a special meeting of the stockholders upon the request of the stockholders on the written request of the stockholders entitled to cast at least a majority of the votes entitled to be cast at the meeting.

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

The Annual Meeting of Stockholders of the Company was held on April 18, 2007. The following matter was voted on by stockholders, and received the votes indicated:

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


Director	For	Withheld
John M. Albertine	9,557,422	781,243
Alan W. Baldwin	9,537,422	801,243
Paul G. Casner, Jr.	9,557,772	780,893
Peter J. Gaffney	9,444,378	894,287
Thomas L. Gough	9,430,079	908,586
William F. Harley III	9,755,517	583,148
William F. Leimkuhler	9,500,925	837,740
R. Doss McComas	9,001,106	1,337,559

The terms of each of the elected directors will expire at the next Annual Meeting of Stockholders in 2008 or when their successors are elected and qualified.

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 and as supplemented by Articles Supplementary of the Company dated February 12, 2006. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q filed by the Company on May 10, 2007).

	3.2	Amended and Restated By-Laws of the Company, as amended (Incorporated by reference to the Company’s Current Report on Form 8-K filed by the Company on February 13, 2007).

	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: August 8, 2007	By:	/S/ ALAN W. BALDWIN
		Alan W. Baldwin
		Chief Executive Officer

Date: August 8, 2007	By:	/S/ WILLIAM R. LEWIS
		William R. Lewis
		Chief Financial Officer

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

Integral Systems (ISYS) Inactive 10-Q2007 Q4 Quarterly report

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