SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (mark one) [X] Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2003 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 (I.R.S. Employer incorporation or organization) Identification No.) 5000 Philadelphia Way, Lanham, MD 20706 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (301) 731-4233 - -------------------------------------------------------------------------------- (Former name, address and fiscal year, if changed since last report) Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Registrant had 9,713,762 shares of common stock outstanding as of April 25, 2003. INTEGRAL SYSTEMS, INC. TABLE OF CONTENTS Page No. -------- PART I. FINANCIAL INFORMATION: Item 1. Financial Statements Balance Sheets - March 31, 2003 (unaudited) and September 30, 2002.................1 Unaudited Statements of Operations - Three and Six Months Ended March 31, 2003 and March 31, 2002..................................................3 Unaudited Statement of Stockholders' Equity - Six Months Ended March 31, 2003...............................................................4 Unaudited Statements of Cash Flow - Six Months Ended March 31, 2003 and March 31, 2002..................................................5 Notes to Financial Statements......................................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................................12 Item 3. Quantitative and Qualitative Disclosures About Market Risk........................27 Item 4. Controls and Procedures...........................................................28 PART II. OTHER INFORMATION: Item 6. Exhibits and Reports on Form 8-K..................................................28 PART I. FINANCIAL INFORMATION Item 1. Financial Statements INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31, 2003 AND SEPTEMBER 30, 2002 ASSETS March 31, 2003 September 30, (unaudited) 2002 -------------- -------------- CURRENT ASSETS Cash $ 20,452,437 $ 16,064,363 Marketable Securities 31,118,588 46,885,581 Accounts Receivable 23,848,764 17,001,393 Notes Receivable 121,201 118,226 Prepaid Expenses 824,905 916,756 Inventory 304,188 0 Deferred Income Tax - Current Portion 1,221,175 887,832 Income Taxes Receivable 398,483 1,110,703 -------------- -------------- TOTAL CURRENT ASSETS 78,289,741 82,984,854 FIXED ASSETS Electronic Equipment 4,248,754 4,293,779 Furniture & Fixtures 748,919 665,840 Leasehold Improvements 929,715 355,642 Software Purchases 646,857 646,009 Equip. Under Capital Lease 0 579,496 -------------- -------------- SUBTOTAL - FIXED ASSETS 6,574,245 6,540,766 Less: Accum. Depreciation 2,544,696 3,072,859 -------------- -------------- TOTAL FIXED ASSETS 4,029,549 3,467,907 OTHER ASSETS Notes Receivable - Non-Current 227,147 288,500 Intangible Assets, net 2,064,052 437,500 Goodwill 17,686,294 2,610,180 Software Development Costs 6,184,947 6,490,640 Deposits and Deferred Charges 113,151 337,274 -------------- -------------- TOTAL OTHER ASSETS 26,275,591 10,164,094 TOTAL ASSETS $ 108,594,881 $ 96,616,855 ============== ============== - 1 - INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31, 2003 AND SEPTEMBER 30, 2002 LIABILITIES & STOCKHOLDERS' EQUITY March 31, 2003 September 30, (unaudited) 2002 -------------- -------------- CURRENT LIABILITIES Accounts Payable $ 4,073,508 $ 5,916,194 Accrued Expenses 4,453,958 3,249,323 Capital Leases Payable 30,934 29,653 Billings in Excess of Cost 5,094,792 2,625,602 -------------- -------------- TOTAL CURRENT LIABILITIES 13,653,192 11,820,772 -------------- -------------- LONG TERM LIABILITIES Capital Leases Payable 76,714 92,508 Deferred Income Taxes 2,480,902 2,447,395 -------------- -------------- TOTAL LONG TERM LIABILITIES 2,557,616 2,539,903 STOCKHOLDERS' EQUITY Common Stock, $.01 par value, 40,000,000 shares authorized, and 9,712,038 and 9,322,783 shares issued and outstanding at March 31, 2003 and September 30, 2002, respectively 97,120 93,228 Additional Paid-in Capital 76,761,961 65,070,787 Retained Earnings 15,856,384 17,599,042 Accumulated other comprehensive income (331,392) (506,877) -------------- -------------- TOTAL STOCKHOLDERS' EQUITY 92,384,073 82,256,180 -------------- -------------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 108,594,881 $ 96,616,855 ============== ============== - 2 - INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Six Months Ended March 31, March 31, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Revenue $ 19,956,596 $ 10,557,529 $ 39,526,377 $ 20,814,986 Cost of Revenue Direct Labor 4,514,164 3,171,993 8,700,646 5,752,355 Overhead Costs 3,199,103 2,279,745 6,370,311 4,234,965 Travel and Other Direct Costs 579,698 399,087 1,171,041 783,922 Direct Equipment & Subcontracts 4,789,988 1,655,825 10,794,357 3,879,092 ------------ ------------ ------------ ------------ Total Cost of Revenue 13,082,953 7,506,650 27,036,355 14,650,334 ------------ ------------ ------------ ------------ Gross Margin 6,873,643 3,050,879 12,490,022 6,164,652 Selling, General & Administrative 2,936,196 2,346,786 5,670,652 4,053,926 Research & Development 578,885 5,218 1,108,502 206,119 Product Amortization 747,231 547,276 1,494,462 1,094,526 Intangible Asset Amortization 322,265 0 644,530 0 ------------ ------------ ------------ ------------ Income From Operations 2,289,066 151,599 3,571,876 810,081 Other Income 77,318 556,126 70,422 766,236 ------------ ------------ ------------ ------------ Income Before Income Tax 2,366,384 707,725 3,642,298 1,576,317 Provision for Income Taxes 881,630 274,126 1,307,736 526,613 ------------ ------------ ------------ ------------ Net Income $ 1,484,754 $ 433,599 $ 2,334,562 $ 1,049,704 ============ ============ ============ ============ Weighted Avg. Number of Common Shares: Basic 9,710,205 9,120,763 9,705,717 9,096,980 Diluted 9,758,275 9,316,743 9,751,072 9,296,883 Earnings per Share (Basic) $ 0.15 $ 0.05 $ 0.24 $ 0.12 Earnings per Share (Diluted) $ 0.15 $ 0.05 $ 0.24 $ 0.11 - 3 - CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE SIX MONTHS ENDED MARCH 31, 2003 (Unaudited) COMMON ACCUMULATED NUMBER STOCK ADDITIONAL OTHER OF AT PAR PAID-IN RETAINED COMPREHENSIVE SHARES VALUE CAPITAL EARNINGS INCOME TOTAL ------------ ------------ ------------ ------------ ------------- ------------ Balance September 30, 2002 9,322,783 $ 93,228 $ 65,070,787 $ 17,599,042 $ (506,877) $ 82,256,180 Comprehensive Income Net Income - - - 2,334,562 - 2,334,562 Unrealized Gain on Marketable Securities (net of deferred tax of $112,495) - - - - 175,485 175,485 ------------ Total Comprehensive Income 2,510,047 Repurchased Shares (329,121) (3,292) (2,171,132) (4,077,220) - (6,251,644) Shares Issued to Acquire RT Logic 709,676 7,097 13,742,903 - - 13,750,000 Stock Options Exercised 8,700 87 119,403 - - 119,490 ------------ ------------ ------------ ------------ ------------- ------------ Balance March 31, 2003 9,712,038 $ 97,120 $ 76,761,961 $ 15,856,384 $ (331,392) $ 92,384,073 ============ ============ ============ ============ ============= ============ - 4 - INTEGRAL SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS SIX MONTHS ENDED MARCH 31, 2003 AND 2002 (Unaudited) For the Six Months Ended March 31, 2003 2002 ------------ ------------ Cash flows from operating activities: Net income $ 2,334,562 $ 1,049,704 ------------ ------------ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,904,086 1,707,252 Gain on sale of marketable securities (8,327) (386,599) Loss on disposal of fixed assets 22,396 0 Changes in operational assets and liabilities, net of effects from acquisition: Accounts receivable and other receivables (1,336,112) 2,198,421 Prepaid expenses and deposits 381,144 (463,071) Inventory 265,568 0 Income taxes receivable, net 3,472,284 1,215,293 Accounts payable (2,915,247) (4,668,019) Accrued expenses (221,496) (171,990) Billings in excess of cost 523,094 (742,974) ------------ ------------ Total adjustments 3,087,390 (1,311,687) ------------ ------------ Net cash provided by (used in) operating activities 5,421,952 (261,983) ------------ ------------ Cash flows from investing activities: Sale of marketable securities, net 16,063,000 7,035,045 Notes receivable, net 5,182,958 55,549 Acquisition of fixed assets (734,614) (656,446) Software development costs (1,188,769) (2,022,808) Acquisition of RT Logic, net of cash received (13,407,596) 0 Net advances to Newpoint Technologies 0 (448,332) Acquisition of Newpoint Technologies 0 (118,749) ------------ ------------ Net cash provided by (used in) investing activities 5,914,979 3,844,259 ------------ ------------ Cash flows from financing activities: Proceeds from issuance of common stock 119,490 349,852 Stock repurchases (6,251,644) (109,650) Note Payable (802,190) 0 Capital lease obligation payments (14,513) (92,305) ------------ ------------ Net cash provided by (used in) financing activities (6,948,857) 147,897 ------------ ------------ Net increase (decrease) in cash 4,388,074 3,730,173 Cash - beginning of year 16,064,363 2,379,503 ------------ ------------ Cash - end of period $ 20,452,437 $ 6,109,676 ============ ============ - 5 - INTEGRAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The interim financial statements include the accounts of Integral Systems, Inc. (ISI or the Company) and its wholly owned subsidiaries, SAT Corporation (SAT), Newpoint Technologies, Inc. (Newpoint), Real Time Logic, Inc. (RT Logic), and Integral Systems Europe (ISI Europe). All significant intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, the financial statements reflect all adjustments consisting only of normal recurring accruals necessary for a fair presentation of results for such periods. The financial statements, which are condensed and do not include all disclosures included in the annual financial statements, should be read in conjunction with the consolidated financial statements of the Company for the fiscal year ended September 30, 2002. The results of operations for any interim period are not necessarily indicative of results for the full year. Certain accounts in the prior period financial statements have been reclassified for comparative purposes to conform with the presentation in the current year financial statements. 2. Accounts Receivable Accounts receivable at March 31, 2003 and September 30, 2002 consist of the following: March 31, 2003 Sept. 30, 2002 -------------------- -------------------- Billed $ 6,599,641 $ 4,082,202 Unbilled 17,099,962 12,836,578 Other 149,161 82,613 -------------------- -------------------- Total $ 23,848,764 $ 17,001,393 ==================== ==================== The Company's accounts receivable consist of amounts due on prime contracts and subcontracts with the U.S. Government and contracts with various private 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. All unbilled receivables are expected to be billed and collected within one year. During the three months ended June 30, 2002, the Company fully reserved $315,000 against a receivable due to SAT from SSP/Litronic, Inc. (SSP Solutions), a publicly traded company located in Irvine, California. At the time, the Company determined that doubt existed regarding the collection of this receivable. The Company has since collected $20,000 against this receivable during the three months ended September 30, 2002 and $120,000 during the six months ended March 31, 2003. - 6 - INTEGRAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 3. Line of Credit The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5 to 2.4% based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company's billed and unbilled accounts receivable and has certain financial covenants, including minimum net worth and liquidity ratios. The line expires February 29, 2004. The Company had no balance outstanding at March 31, 2003 under the line of credit. The Company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $108,000 at March 31, 2003. 4. Inventory Inventory consists of service parts and materials and is stated at the lower of cost or market using the first-in, first-out (FIFO) method of accounting. 5. Acquisition of RT Logic On October 1, 2002, the Company acquired all of the issued and outstanding stock of RT Logic pursuant to an Agreement and Plan of Reorganization dated October 1, 2002 (the "Reorganization Agreement"). The primary reason for acquiring RT Logic was to expand the Company's existing products into RT Logic's government client base. The initial purchase price payable to the shareholders of RT Logic was $13.25 million in cash and 683,870 shares of the Company's common stock. Pursuant to the Reorganization Agreement, in November 2002 the former shareholders of RT Logic received additional consideration of $500,000 in cash and 25,806 shares of the Company's common stock. The Reorganization Agreement further provides that the former RT Logic shareholders will be entitled to receive contingent consideration, which is payable in the event that RT Logic's business meets certain earnings performance targets during a period of up to four years following the acquisition. One half of any contingent consideration will be payable in cash and the remainder will be payable in shares of the Company's common stock. Any shares of the Company's common stock issued in connection with the contingent consideration will be valued based on a 30-trading-day average leading up to the end of each applicable earn-out period. The contingent consideration is subject to claims by us under the indemnification provisions of the Reorganization Agreement. - 7 - INTEGRAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 5. Acquisition of RT Logic (continued) The acquisition was accounted for using the purchase method of accounting prescribed by SFAS No. 141, Business Combinations. Accordingly, a portion of the purchase price has been allocated to assets acquired and liabilities assumed and other identified intangible assets based on estimated fair values on the acquisition date. The purchase price allocation is based on preliminary estimates and is subject to change as final valuations are made. A summary of the purchase price allocation as of October 1, 2002 is as follows (in thousands): Current assets $ 9,821 Property, plant & equipment 615 Intangibles 2,271 Goodwill 15,061 Notes receivables 5,125 Long-term assets 79 Current liabilities (5,247) Total purchase price $ 27,725 The identified intangible assets relate to acquired technology ($650,000) and customer contracts ($1,621,000) and will be amortized on a straight-line basis over an estimated useful life of 5 years and 18 months, respectively. Goodwill is not being amortized but is being reviewed annually for impairment in accordance with SFAS No. 142 Goodwill and Other Intangible Assets. The notes receivable relate to loans made by RT Logic to its shareholders to exercise RT Logic stock options prior to the sale to Integral. The notes receivable were classified in Stockholders Equity on October 1, 2002. During the first quarter ended December 31, 2002, all notes receivable were settled and the cash was received by Integral. As a result of this transaction, Integral realized an income tax deduction (equal to the difference between the option exercise price and the fair value of the stock). The resulting income tax benefit of $2,760,000 is included in current assets in the table above. As RT Logic was acquired on October 1, 2002, the full results of its operations have been included in Integral's statements of operation for the three months and six months ended March 31, 2003 respectively. Unaudited pro forma information provided below has been prepared to reflect the acquisition of RT Logic by the Company as if it had occurred on October 1, 2001. The unaudited pro forma financial information is not necessarily indicative of the results of operations that may have actually occurred had the acquisition occurred on the dates specified, or of the future results of the combined companies. Three Months Ended Six Months Ended March 31, 2002 March 31, 2002 (unaudited) (unaudited) (in thousands, except (in thousands, except Net Income per Share) Net Income per Share) ---------------------- ---------------------- Revenues $ 13,875 $ 27,358 Net Income $ 268 $ 1,070 Net Income per Share (Basic) $ 0.03 $ 0.12 Net Income per Share (Diluted) $ 0.03 $ 0.11 - 8 - INTEGRAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 6. Stock-Based Compensation The Company recognizes expense for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost is recognized for the excess of the estimated fair value of the stock at the grant date over the exercise price, if any. In accordance with SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure (SFAS 148), the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation is as follows: THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, MARCH 31, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Net income, as reported $ 1,484,754 $ 433,599 $ 2,334,562 $ 1,049,704 Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards 430,211 254,810 841,433 495,949 Add: Stock-based employee compensation included in net income 0 0 0 0 Pro forma net income $ 1,054,543 $ 178,789 $ 1,493,129 $ 553,755 Earnings per share: As reported - basic $ 0.15 $ 0.05 $ 0.24 $ 0.12 - dilutive $ 0.15 $ 0.05 $ 0.24 $ 0.11 Pro forma - basic $ 0.11 $ 0.02 $ 0.15 $ 0.06 - dilutive $ 0.11 $ 0.02 $ 0.15 $ 0.06 These proforma amounts are not necessarily indicative of future effects of applying the fair value-based method due to, among other things, the vesting period of the stock options and the fair value of the additional stock options issued in future years. 7. Business Segment Information With the acquisition of RT Logic, the Company now operates in four business segments: . satellite ground systems; . satellite and terrestrial communications signal monitoring (CSM); . equipment monitoring and control; and . space communication systems. Integral Systems, Inc. and ISI Europe build satellite ground systems for command and control, integration and test, data processing, and simulation. Through its wholly owned subsidiary SAT, the Company offers turnkey systems and software for satellite and terrestrial communications signal monitoring. - 9 - INTEGRAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 7. Business Segment Information (continued) The Company provides equipment monitoring and control software to satellite operators and the telecommunications industry through its wholly owned subsidiary, Newpoint (acquired January 2002). Through its wholly owned subsidiary RT Logic (acquired October 2002), the Company manufactures telemetry processing components and systems for military applications, including tracking stations, control centers, and range operations. The accounting policies of the segments are the same as those described in Note 1. The Company evaluates the performance of each segment based on operating income. There are no inter-segment allocations of overhead and all corporate-level expenses are included in the Satellite Ground Systems segment. Summarized financial information by business segment is as follows: - 10 - INTEGRAL SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (Unaudited) 7. Business Segment Information (continued) Three Months Three Months Six Months Six Months Ended Ended Ended Ended March 31, 2003 March 31, 2002/1/ March 31, 2003 March 31, 2002/1/ Revenue Satellite ground systems $ 14,087,008 $ 8,906,995 $ 28,714,897 $ 18,098,490 Satellite ground systems - intercompany 257,053 155,723 636,230 207,983 Satellite & terrestrial CSM 1,103,723 1,043,130 1,589,537 2,109,092 Satellite & terrestrial CSM - intercompany N/A N/A 753 N/A Equip. monitoring & control 521,161 607,404 1,373,997 607,404 Space communication systems 4,244,704 N/A 7,847,946 N/A Space communication systems - intercompany 675,416 N/A 1,406,745 N/A Elimination of Interco. Sales (932,469) (155,723) (2,043,728) (207,983) -------------- -------------- -------------- -------------- Total Revenue $ 19,956,596 $ 10,557,529 $ 39,526,377 $ 20,814,986 ============== ============== ============== ============== Operating Income Satellite ground systems $ 1,338,277 $ 584,469 $ 2,221,501 $ 1,146,628 Satellite ground systems - intercompany 5,684 166 2,812 223 Satellite & terrestrial CSM (253,259) (293,622) (835,776) (197,299) Equip. monitoring & control (183,453) (139,248) (347,494) (139,248) Space communication systems 1,387,501 N/A 2,533,645 N/A Space communication systems - intercompany 259 N/A (10) N/A Elimination of intercompany (5,943) (166) (2,802) (223) -------------- -------------- -------------- -------------- Total Operating Income $ 2,289,066 $ 151,599 $ 3,571,876 $ 810,081 ============== ============== ============== ============== Income Before Income Taxes Satellite ground systems $ 1,471,220 $ 1,188,668 $ 2,407,677 $ 1,926,845 Satellite & terrestrial CSM (282,968) (314,167) (899,021) (183,752) Equip. monitoring & control (232,734) (166,776) (458,322) (166,776) Space communication systems 1,410,866 N/A 2,591,964 N/A -------------- -------------- -------------- -------------- Total Income Before Income Taxes $ 2,366,384 $ 707,725 $ 3,642,298 $ 1,576,317 ============== ============== ============== ============== Total Assets Satellite ground systems $ 75,477,595 $ 86,416,068 Satellite & terrestrial CSM 3,613,305 4,333,443 Equip. monitoring & control 4,358,534 4,166,063 Space communication systems 33,792,760 N/A Elimination of intercompany accounts receivable (8,647,313) (4,660,306) -------------- -------------- Total Assets $ 108,594,881 $ 90,255,268 ============== ============== /1/. Includes two (2) months ended March 31, 2002 for the equipment monitoring and control business segment. - 11 - ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Integral Systems, Inc. builds satellite ground systems for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 190 different satellite missions for communications, science, meteorology, and earth resource applications. The Company has an established domestic and international customer base that includes government and commercial satellite operators, spacecraft and payload manufacturers, and aerospace systems integrators. The Company has developed innovative software products that reduce the cost and minimize the development risk associated with traditional custom-built systems. The Company believes that it was the first to offer a comprehensive COTS (Commercial Off-the-Shelf) 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. Through its wholly owned subsidiary SAT, acquired in August 2000, the Company also offers turnkey systems and software for satellite and terrestrial communications signal monitoring. In March 2001 the Company formed a wholly owned subsidiary, ISI Europe, with headquarters in Toulouse, France. ISI Europe serves as the focal point for the support of all of Integral's European business. On January 30, 2002, the Company acquired Newpoint. Newpoint provides equipment monitoring and control software to satellite operators and the telecommunications industry. In October 2002, the Company acquired RT Logic. RT Logic manufactures telemetry processing components and systems for military applications, including tracking stations, control centers, and range operations. - 12 - COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002 RESULTS OF OPERATIONS The components of the Company's income statement as a percentage of revenue are depicted in the following table for the three months ended March 31, 2003 and March 31, 2002: THREE MONTHS ENDED MARCH 31, % OF % OF 2003 REVENUE 2002 REVENUE -------------- -------------- -------------- -------------- (IN THOUSANDS) (IN THOUSANDS) Revenue $ 19,957 100.0 $ 10,558 100.0 Cost of Revenue 13,083 65.6 7,507 71.1 -------------- -------------- -------------- -------------- Gross Margin 6,874 34.4 3,051 28.9 Operating Expenses Selling, General & Admin. (SG&A) 2,936 14.7 2,347 22.2 Research and Development 579 2.9 5 0.1 Product Amortization 747 3.7 547 5.2 Amortization-Intangible Assets 323 1.6 0 0.0 -------------- -------------- -------------- -------------- Income from Operations 2,289 11.5 152 1.4 Other Income (Expense) (net) 78 0.4 556 5.3 -------------- -------------- -------------- -------------- Income Before Income Taxes 2,367 11.9 708 6.7 Income Taxes 882 4.5 274 2.6 -------------- -------------- -------------- -------------- Net Income $ 1,485 7.4 $ 434 4.1 ============== ============== ============== ============== REVENUE The Company earns revenue, both as a prime contractor and a subcontractor, from sales of its products and services through contracts that are funded by the U.S. Government as well as commercial and international organizations. Internally, the Company classifies revenues in two separate categories on the basis of the contracts' procurement and development requirements: (i) contracts which require compliance with Government procurement and development standards are classified as government revenue, and (ii) contracts conducted according to commercial practices are classified as commercial revenue, regardless of whether the end customer is a commercial or government entity. Sales of the Company's COTS products are classified as commercial revenue. Revenues attributable to SAT, Newpoint, and ISI Europe are also classified as commercial revenue. - 13 - For the three months ended March 31, 2003 and 2002, the Company's revenues were generated from the following sources: THREE MONTHS ENDED MARCH 31, REVENUE TYPE 2003 2002 ------------ ------------ ------------ COMMERCIAL REVENUE Commercial Users 26% 49% U.S. Government Users 0 0 ------------ ------------ Subtotal 26 49 GOVERNMENT REVENUE NOAA 15 38 Air Force 49 7 Other U.S. Government Users 10 6 ------------ ------------ Subtotal 74 51 Total 100% 100% ============ ============ Based on the Company's revenue categorization system, the Company classified 26% of its revenue as commercial revenue with the remaining 74% classified as government revenue for the three months ended March 31, 2003. For the three months ended March 31, 2002 the Company classified 49% of its revenue as commercial revenue with the remaining 51% classified as government revenue. By way of comparison, if the revenues were classified strictly according to end user (independent of the Company's internal revenue categorization system), the U.S. Government would account for 74% and 51% of the total revenues for the three months ended March 31, 2003 and 2002, respectively. On a consolidated basis, revenue increased 89.0%, or $9.4 million, to $20.0 million for the three months ended March 31, 2003, from $10.6 million for the three months ended March 31, 2002. Revenue for the three-month periods ending March 31, 2003 and 2002 for each of the Company's segments is shown in the following table: THREE MONTHS ENDED THREE MONTHS ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - --------------------------------------------------- ------------------ ------------------- ---------------- REVENUE Satellite Ground Systems (Integral) $ 14,344 $ 9,064 $ 5,280 Satellite & Terrestrial CSM (SAT) 1,104 1,043 61 Equip. Monitoring & Control (Newpoint) 521 607 (86) Space Communication Systems (RT Logic) 4,920 0 4,920 Elimination (933) (156) (777) Total Revenue $ 19,956 $ 10,558 $ 9,398 /1/. Includes only two (2) months of revenue for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. Revenue increases in the Company's Satellite Ground Systems segment pertain to increased sales volume as a result of the Company's contract awards with the U.S. Air Force (specifically the CCS-C and SCNC programs) that were made in the Spring of 2002. Revenue levels for SAT and Newpoint were relatively comparable quarter to quarter. However, last year's second quarter included only two months of activity for Newpoint, which was acquired by the Company on January 31, 2002. RT Logic was acquired subsequent to March 31, 2002, so the Company reported no revenue for this segment for the three-month period then ended. - 14 - 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. During the three months ended March 31, 2003, cost of revenue increased by 74.3%, or $5.6 million, compared to the same period during the prior year, increasing from $7.5 million during the three months ended March 31, 2002 to $13.1 million during the three months ended March 31, 2003. Gross margin increased from $3.1 million to $6.9 million, an increase of $3.8 million, or 125.3%, during the periods being compared. Cost of revenue and gross margin for the three months ended March 31, 2003 and 2002 for each of the Company's segments are shown in the following table: THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, MARCH 31, INCREASE/ 2003 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - ---------------------------------------------------- --------------- --------------- --------------- COST OF REVENUE Satellite Ground Systems (Integral) $ 10,707 $ 6,316 $ 4,391 Satellite & Terrestrial CSM (SAT) 632 853 (221) Equip. Monitoring & Control (Newpoint) 367 473 (106) Space Communication Systems (RT Logic) 2,289 0 2,289 Elimination (912) (136) (776) Total Cost of Revenue $ 13,083 $ 7,506 $ 5,577 GROSS MARGIN Satellite Ground Systems (Integral) $ 3,637 $ 2,747 $ 890 Satellite & Terrestrial CSM (SAT) 472 190 282 Equip. Monitoring & Control (Newpoint) 155 134 21 Space Communication Systems (RT Logic) 2,631 0 2,631 Elimination (21) (20) (1) Total Gross Margin $ 6,874 $ 3,051 $ 3,823 /1/. Includes only two (2) months of activity for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. Cost of Revenue and Gross Margin increases during the periods compared for the Company's Satellite Ground Systems business essentially track the increases in revenue from this segment, although gross margin as a percentage of revenue for this segment declined from 30.3% to 25.4% as result of a higher content of equipment and subcontract pass-through business principally on the Company's Air Force contracts during the current quarter compared to the three months ended March 31, 2002. The increases in Gross Margin at SAT are related to last year's overruns on two fixed price contracts that did not recur during the current period. RT Logic was acquired subsequent to March 31, 2002, so the Company reported no costs of revenue or gross margin for this segment for the three-month period then ended. - 15 - OPERATING EXPENSES Operating Expenses for the three months ended March 31, 2003 and 2002 for each of the Company's segments are shown in the following table: THREE MONTHS THREE MONTHS ENDED ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - ---------------------------------------------------- --------------- ------------------ --------------- OPERATING EXPENSES Satellite Ground Systems (Integral) SG&A $ 1,658 $ 1,706 $ (48) R&D 38 5 33 Amortization 596 451 145 Total Satellite Ground Systems (Integral) 2,292 2,162 130 Satellite & Terrestrial CSM (SAT) SG&A 301 388 (87) R&D 274 0 274 Amortization 150 97 53 Total Satellite & Terrestrial CSM (SAT) 725 485 240 Equip. Monitoring & Control (Newpoint) SG&A 307 273 34 R&D 0 0 0 Amortization 32 0 32 Total Equip. Monitoring & Control (Newpoint) 339 273 66 Space Communication Systems (RT Logic) SG&A 685 0 685 R&D 267 0 267 Amortization 291 0 291 Total Space Communication Systems (RT Logic) 1,243 0 1,243 Elimination (15) (20) 5 Total Operating Expenses $ 4,584 $ 2,900 $ 1,684 /1/. Includes only two (2) months of activity for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. In the Company's Satellite Ground Systems business, SG&A expenses were comparable during the periods compared. However, as a percentage of revenue, SG&A for this segment only represented 11.6% of revenue in the current period compared to 18.8% of revenue during the three months ended March 31, 2002. SG&A expenses were essentially flat while revenue for the segment increased by almost $5.3 million. R&D expenses for this segment were immaterial for both three-month periods. Product amortization has increased by almost $150,000 during the three months ended March 31, 2003 as compared to the three months ended March 31, 2002 due to higher capitalized development costs related to the Company's EPOCH product line. At SAT, period-to-period SG&A costs are down slightly while R&D expenses have increased from zero to more than $270,000. The increase in current period R&D expenses was due to efforts related to new development on SAT's signal monitoring capabilities. Costs associated with such efforts had been capitalized last fiscal year. Product amortization increased by more than $50,000 during the periods compared due to higher capitalized development costs. - 16 - Newpoint's current period SG&A expenses were up slightly over last year's amounts during the comparable period. However, last year's amounts included only two months of activity because Newpoint was acquired by the Company on January 31, 2002. RT Logic was acquired subsequent to March 31, 2002, so the Company reported no operating expenses for this segment for the three-month period then ended. The current period amortization expenses for both Newpoint and RT Logic relate to the amortization of intangible assets that arose from purchase accounting entries made at the time of each company's acquisition by the Company. INCOME FROM OPERATIONS Income from Operations for the three months ended March 31, 2003 and 2002 for each of the Company's segments is shown in the following table: THREE MONTHS THREE MONTHS ENDED ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - ---------------------------------------------------- --------------- ------------------ --------------- INCOME FROM OPERATIONS Satellite Ground Systems (Integral) $ 1,344 $ 585 $ 759 Satellite & Terrestrial CSM (SAT) (254) (294) 40 Equip. Monitoring & Control (Newpoint) (183) (139) (44) Space Communication Systems (RT Logic) 1,388 0 1,388 Elimination (6) 0 (6) Total Income from Operations $ 2,289 $ 152 $ 2,137 /1/. Includes only two (2) months of activity for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. Income from operations during the periods compared increased by almost $760,000 in the Company's Satellite Ground Systems segment as a result of increased revenues principally due to the Air Force programs described above. Operating losses at SAT during the three months ended March 31, 2003 have resulted from increased R&D and amortization expenses and overall depressed conditions in the commercial satellite market. Newpoint's operating losses are related to overall depressed conditions in the commercial satellite market, and resultant low revenue levels. Although results for RT Logic were not included with the results for the Company for the three months ended March 31, 2002, the current quarter is the most profitable in RT Logic's history. For comparison purposes, RT logic recorded approximately $62,000 of operating income during the three months ended March 31, 2002. Overall, operating income increases at the Company's Satellite Ground Systems segment coupled with the operating income posted by RT Logic, allowed the Company to post a fifteen fold increase in operating income during the periods being compared. OTHER INCOME During the three months ended March 31, 2003, the Company recorded $139,000 of interest income compared to $240,000 of interest income recorded for the three months ended March 31, 2002. The decrease is due to the general decline in interest rates in response to cuts by the Federal Reserve Board and due to the Company's reduction in interest generating capital resulting from the repurchase of approximately $6.3 million of Company stock in September and October of 2002 and the payment of $13.75 million of cash used to purchase RT Logic. Further, the Company recorded approximately $390,000 of gains on the sale of marketable equity securities during the three months ended March 31, 2002, which gains did not recur in the current three-month period. - 17 - Income before income taxes increased by approximately $1.7 million to $2.4 million from $700,000 between the two periods being compared principally due to the increase in operating income, which was partially offset by declines in other income described above. The Company's effective tax rate slightly decreased from 38.7% for the three months ended March 31, 2002 to 37.3% for the three months ended March 31, 2003. As a result of the above, net income increased to approximately $1.5 million during the three months ended March 31, 2003 from approximately $435,000 during the three months ended March 31, 2002. - 18 - COMPARISON OF THE SIX MONTHS ENDED MARCH 31, 2003 AND 2002 RESULTS OF OPERATIONS The components of the Company's income statement as a percentage of revenue are depicted in the following table for the six months ended March 31, 2003 and March 31, 2002: SIX MONTHS ENDED MARCH 31, % OF % OF 2003 REVENUE 2002 REVENUE -------------- -------------- -------------- -------------- (IN THOUSANDS) (IN THOUSANDS) Revenue $ 39,526 100.0 $ 20,815 100.0 Cost of Revenue 27,036 68.4 14,650 70.4 -------------- -------------- -------------- -------------- Gross Margin 12,490 31.6 6,165 29.6 Operating Expenses Selling, General & Admin.(SG&A) 5,671 14.4 4,054 19.5 Research and Development 1,109 2.8 206 1.0 Product Amortization 1,494 3.8 1,094 5.2 Amortization-Intangible Assets 644 1.6 0.0 0.0 -------------- -------------- -------------- -------------- Income from Operations 3,572 9.0 811 3.9 Other Income (Expense)(net) 71 0.2 766 3.7 -------------- -------------- -------------- -------------- Income Before Income Taxes 3,643 9.2 1,577 7.6 Income Taxes 1,308 3.3 527 2.6 -------------- -------------- -------------- -------------- Net Income $ 2,335 5.9 $ 1,050 5.0 ============== ============== ============== ============== For the six months ended March 31, 2003 and 2002, the Company's revenues were generated from the following sources: SIX MONTHS ENDED MARCH 31, REVENUE TYPE 2003 2002 ------------ ------------ ------------ COMMERCIAL REVENUE Commercial Users 24% 48% U.S. Government Users 0 1 ------------ ------------ Subtotal 24 49 GOVERNMENT REVENUE NOAA 21 38 Air Force 47 7 Other U.S. Government Users 8 6 ------------ ------------ Subtotal 76 51 Total 100% 100% ============ ============ Based on the Company's revenue categorization system, the Company classified 24% of its revenue as commercial revenue with the remaining 76% classified as government revenue for the six months ended March 31, 2003. For the six months ended March 31, 2002 the Company classified 49% of its revenue as commercial revenue with the remaining 51% classified as government revenue. By way of comparison, if the revenues were classified strictly according to end user (independent of the Company's internal revenue categorization system), the U.S. Government would account for 76% and 52% of the total revenues for the six months ended March 31, 2003 and 2002, respectively. - 19 - On a consolidated basis, revenue increased 89.9%, or $18.7 million, to $39.5 million for the six months ended March 31, 2003, from $20.8 million for the six months ended March 31, 2002. Revenue for the six-month periods ending March 31, 2003 and 2002 for each of the Company's segments is shown in the following table: SIX MONTHS ENDED SIX MONTHS ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - ------------------------------------------- ---------------- ----------------- -------------- REVENUE Satellite Ground Systems (Integral) $ 29,351 $ 18,307 $ 11,044 Satellite & Terrestrial CSM (SAT) 1,590 2,109 (519) Equip. Monitoring & Control (Newpoint) 1,374 607 767 Space Communication Systems (RT Logic) 9,255 0 9,255 Elimination (2,044) (208) (1,836) Total Revenue $ 39,526 $ 20,815 $ 18,711 /1/. Includes only two (2) months of revenue for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. Revenue increases in the Company's Satellite Ground Systems segment pertain to increased sales volume as a result of the Company's contract awards with the U.S. Air Force (specifically the CCS-C and SCNC programs) that were made in the Spring of 2002. Revenue decreases at SAT relate to a decreased backlog of orders at September 30, 2002 and overall poor market conditions in the commercial satellite market. Since December 31, 2002, bookings for new orders at SAT have improved but not enough to bring year-to-date revenue in line with last year's amounts. Current period revenue for Newpoint is for a six-month duration while last year's revenue for Newpoint, which was acquired by the Company on January 31, 2002, only involved two months of activity. Newpoint revenue is essentially flat on a year-to-year basis if we were to prorate last year's results. RT Logic was acquired subsequent to March 31, 2002, so the Company reported no revenues for this segment for the six-month period then ended. - 20 - COST OF REVENUE/GROSS MARGIN During the six months ended March 31, 2003, cost of revenue increased by 84.5%, or $12.4 million, compared to the same period during the prior year, increasing from $14.7 million during the six months ended March 31, 2002 to $27.0 million during the six months ended March 31, 2003. Gross margin increased from $6.2 million to $12.5 million, an increase of $6.3 million, or 102.6%, during the periods being compared. Cost of revenue and gross margin for the six months ended March 31, 2003 and 2002 for each of the Company's segments are shown in the following table: SIX MONTHS ENDED SIX MONTHS ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - ------------------------------------------- ---------------- ----------------- -------------- COST OF REVENUE Satellite Ground Systems (Integral) $ 22,664 $ 12,966 $ 9,698 Satellite & Terrestrial CSM (SAT) 882 1,392 (510) Equip. Monitoring & Control (Newpoint) 1,071 473 598 Space Communication Systems (RT Logic) 4,434 0 4,434 Elimination (2,015) (181) (1,834) Total Cost of Revenue $ 27,036 $ 14,650 $ 12,386 GROSS MARGIN Satellite Ground Systems (Integral) $ 6,687 $ 5,341 $ 1,346 Satellite & Terrestrial CSM (SAT) 708 717 (9) Equip. Monitoring & Control (Newpoint) 303 134 169 Space Communication Systems (RT Logic) 4,821 0 4,821 Elimination (29) (27) (2) Total Gross Margin $ 12,490 $ 6,165 $ 6,325 /1/. Includes only two (2) months activity for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. Cost of Revenue and Gross Margin increases during the periods compared for the Company's Satellite Ground Systems business essentially track the increases in revenue from this segment, although gross margin as a percentage of revenue for this segment declined from 29.2% to 22.8% as result of a higher content of equipment and subcontract pass-through business principally on the Company's Air Force contracts during the current six-month period compared to the six months ended March 31, 2002. The decreases in Cost of Revenue at SAT during the periods compared are related to the revenue decline for this segment. Gross Margins at SAT improved during the period ended March 31, 2003 as compared to the period ended March 31, 2002 as overruns on two fixed price contracts that this segment experienced last year did not recur this year. Cost of Revenue and Gross Margin increases at Newpoint are proportionate to the revenue increases posted at this segment. RT Logic was acquired subsequent to March 31, 2002, so the Company reported no costs of revenue or gross margin for this segment for the six-month period then ended. - 21 - OPERATING EXPENSES Operating Expenses for the six months ended March 31, 2003 and 2002 for each of the Company's segments are depicted in the following table: SIX MONTHS SIX MONTHS ENDED ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - -------------------------------------------------- ---------------- ------------------ -------------- OPERATING EXPENSES Satellite Ground Systems (Integral) SG&A $ 3,201 $ 3,087 $ 114 R&D 68 206 (138) Amortization 1,193 901 292 Total Satellite Ground Systems 4,462 4,194 268 Satellite & Terrestrial CSM (SAT) SG&A 627 721 (94) R&D 616 0 616 Amortization 301 194 107 Total Satellite & Terrestrial CSM (SAT) 1,544 915 629 Equip. Monitoring & Control (Newpoint) SG&A 588 273 315 R&D 0 0 0 Amortization 63 0 63 Total Equip. Monitoring & Control (Newpoint) 651 273 378 Space Communication Systems (RT Logic) SG&A 1,280 0 1,280 R&D 425 0 425 Amortization 582 0 582 Total Space Communication Systems (RT Logic) 2,287 0 2,287 Elimination (26) (27) 1 Total Operating Expenses $ 8,918 $ 5,355 $ 3,563 /1/. Includes only two (2) months activity for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. In the Company's Satellite Ground Systems segment, SG&A expenses increased during the periods compared by approximately $110,000 principally because of marketing efforts related to the Company's new SKYLIGHT product. However, as a percentage of revenue, SG&A for this segment only represented 10.9% of revenue in the current period compared to 16.9% of revenue during the six months ended March 31, 2002. SG&A expenses increased insignificantly while revenue for the segment increased by almost $11.0 million. R&D expenses for the six months ended March 31, 2002 primarily related to Air Force projects that have ended, while current period R&D expenses relate to SKYLIGHT efforts. Product amortization has increased by almost $300,000 due to higher capitalized development costs related to the Company's EPOCH product line. At SAT, period-to-period SG&A costs are down more than $90,000 due to cost reductions implemented at the end of last fiscal year while R&D expenses have increased from zero to more than $610,000. The increase in current period R&D expenses was due to efforts related to new development on SAT's signal monitoring capabilities. Costs associated with such efforts had been capitalized last fiscal year. Product - 22 - amortization increased by more than $100,000 during the periods compared due to higher capitalized development costs. SG&A expenses at Newpoint are for six months in the current period, but only for two months in the prior year's period, because Newpoint was acquired by the Company on January 31, 2002. RT Logic was acquired subsequent to March 31, 2002, so the Company reported no operating expenses for this segment for the six-month period then ended. The current period amortization expenses for both Newpoint and RT Logic relate to the amortization of intangible assets that arose from purchase accounting entries made at the time of each company's acquisition by the Company. INCOME FROM OPERATIONS Income from Operations for the six months ended March 31, 2003 and 2002 for each of the Company's segments is shown in the following table: SIX MONTHS SIX MONTHS ENDED ENDED INCREASE/ MARCH 31, 2003 MARCH 31, 2002/1/ (DECREASE) SEGMENT (IN THOUSANDS) (IN THOUSANDS) (IN THOUSANDS) - -------------------------------------------------- ---------------- ------------------ -------------- INCOME FROM OPERATIONS Satellite Ground Systems (Integral) $ 2,224 $ 1,147 $ 1,077 Satellite & Terrestrial CSM (SAT) (836) (198) (638) Equip. Monitoring & Control (Newpoint) (347) (139) (208) Space Communication Systems (RT Logic) 2,534 0 2,534 Elimination (3) 0 (3) Income from Operations $ 3,572 $ 810 $ 2,762 /1/. Includes only two (2) months activity for the equipment monitoring and control business segment because Newpoint was acquired by the Company on January 31, 2002. Income from operations during the periods compared increased by approximately $1.1 million in the Company's Satellite Ground Systems segment as a result of increased revenues principally due to the Air Force programs described above. Operating losses at SAT during the six months ended March 31, 2003 have resulted from revenue declines due to depressed conditions in the commercial satellite market and increased R&D and amortization expenses period to period. Newpoint's losses are also related to overall depressed conditions in the commercial satellite market, but its losses were not as severe as SAT's since Newpoint's market is not as dependent on satellite operators. Although results for RT Logic were not included with the results for the Company for the six months ended March 31, 2002, the current six month period is the most profitable in RT Logic's history. For comparison purposes, RT logic recorded approximately $783,000 of operating income during the six months ended March 31, 2002. OTHER INCOME During the six months ended March 31, 2003, the Company recorded $300,000 of interest income compared to $470,000 of interest income recorded for the six months ended March 31, 2002. The decrease is due to the general decline in interest rates in response to cuts by the Federal Reserve Board and due to the Company's reduction in interest generating capital resulting from the repurchase of approximately $6.3 million of Company stock in September and October of 2002 and the payment of $13.75 million of cash used to purchase RT Logic. Further, the Company recorded approximately $390,000 of gains on the sale of marketable equity securities during the six months ended March 31, 2002, and only recorded approximately $10,000 of such gains during the current six month period. - 23 - Income before income taxes increased by approximately $2.1 million to $3.7 million from $1.6 million between the two periods being compared principally due to the increase in operating income, which was partially offset by declines in other income described above. The Company's effective tax rate increased from 33.4% for the six months ended March 31, 2002 to 35.9% for the six months ended March 31, 2003. The increase was primarily a result of a lower percentage of tax-free interest income compared to operating income recorded in the current six-month period compared to the prior year's first six-month period. As a result of the above, net income increased to approximately $2.3 million during the six months ended March 31, 2003 from approximately $1.1 million during the six months ended March 31, 2002. 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 which 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 contract. Management believes that operating results for future periods will improve based on the following assumptions: . Demand for satellite technology and related products and services will continue to expand; and . Sales of its software products and engineering services will continue to increase. Looking forward to fiscal year 2003 in its entirety, the Company has reported anticipated growth in revenue, net income, and fully diluted earnings per common share of approximately 50% over fiscal year 2002 levels. Anticipated growth in net income and earnings per share for fiscal year 2003 would have been much greater were it not for fiscal year 2002 gains on marketable securities of approximately $1.2 million which are not forecasted for fiscal year 2003. The Company has anticipated that operating income for fiscal year 2003 would be almost triple the amounts recorded in fiscal year 2002, increasing from $1.8 million in fiscal year 2002 to approximately $5.4 million in fiscal year 2003. Based on operating results through the half point of the fiscal year (i.e., through March 31, 2003), the Company believes that results for the full fiscal year ending September 30, 2003 will be no less than the results anticipated above. - 24 - LIQUIDITY AND CAPITAL RESOURCES Since the Company's inception in 1982, it has been profitable on an annual basis and has generally financed its working capital needs through internally generated funds, supplemented by borrowings under the Company's general line of credit facility with a commercial bank and the proceeds from the Company's initial public offering in 1988. In June 1999, the Company supplemented its working capital position by raising approximately $19.7 million (net) through the private placement of approximately 1.2 million shares of its common stock. In February 2000, the Company raised an additional $40.9 million (net) for use in connection with potential acquisitions and other general corporate purposes through the private placement of 1.4 million additional shares of its common stock. With respect to the capital raised in the private placements, at March 31, 2003, $19.4 million was invested in variable rate State of Maryland debt securities, $10 million was invested in Banc of America Preferred Funding Corporation "Dividends Received Eligible Auction Market" preferred stock ("DREAMS"), and $1.7 million was invested in common stock. For the six months ended March 31, 2003, the Company generated approximately $5.4 million of cash from operating activities and $5.9 million in investing activities. Included in the $5.9 million of investing activities is approximately $1.2 million used for newly capitalized software development costs and $700,000 for the purchase of fixed assets. The Company also repurchased $6.3 million of its common stock during the period. The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5 to 2.4% based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company's billed and unbilled accounts receivable and has certain financial covenants, including minimum net worth and liquidity ratios. The line expires February 29, 2004. The Company had no balance outstanding at March 31, 2003 under the line of credit. The Company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $108,000 at March 31, 2003. The Company currently anticipates that its current cash balances, amounts available under its lines of credit and net cash provided by operating activities will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months. The Company plans to continue to invest in the on-going development and improvement of its current software products, EPOCH and OASYS, as well as the development of new products through the use of its current cash balances and cash provided by operating activities. The Company believes that inflation did not have a material impact on the Company's revenues or income from operations during the six months ended March 31, 2003 or in past fiscal years. - 25 - FORWARD LOOKING STATEMENTS Certain of the statements contained in the Management's Discussion and Analysis of Financial Condition and Results of Operations section, in other parts of this 10-Q, and in this section, including those under the headings "Outlook" and "Liquidity and Capital Resources," are forward looking. In addition, from time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. Forward-looking statements can be identified by the use of forward-looking terminology such as "may", "will", "believe", "expect", "anticipate", "estimate", "continue", or other similar words, including statements as to the intent, belief, or current expectations of the Company and its directors, officers, and management with respect to the Company's future operations, performance, or positions or which contain other forward-looking information. These forward-looking statements are predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. While the Company believes that these statements are and will be accurate, a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's statements. The Company's business is dependent upon general economic conditions and upon various conditions specific to its industry, and future trends cannot be predicted with certainty. Particular risks and uncertainties that may affect the Company's business, other than those described elsewhere herein or in our other filings with the Securities and Exchange Commission (the "Commission" or the "SEC"), include the following: . A significant portion of the Company's revenue is derived from contracts or subcontracts funded by the U.S. Government, which are subject to termination without cause, government regulations and audits, competitive bidding, and the budget and funding process of the U.S. Government. . The presence of competitors with greater financial resources and their strategic response to the Company's services. . The potential obsolescence of the Company's services due to the introduction of new technologies. . The response of customers to the Company's marketing strategies and services. . The Company's commercial contracts are subject to strict performance and other requirements. . The Company's ability to manage effectively any continued growth. . The intense competition in the satellite ground system industry. . The Company's dependency on the satellite industry for most of its revenue. . Risks related to the Company's acquisition strategy. In particular, the Company may not be able to find any attractive candidates or it may find that the acquisition terms proposed by potential acquisition candidates are not favorable to the Company. In addition, the Company may compete with other companies for these acquisition candidates, which competition may make an acquisition more expensive for the Company. If the Company is unable to identify and acquire any suitable candidates, the Company may not be able to find alternative uses for the cash proceeds of its previous private placements that improve the Company's business, financial conditions, or results of operations to the extent that an acquisition could. In addition, the integration of the acquired business or businesses, including SAT, Newpoint and RT Logic, may be costly and may result in a decrease in the value of the Company's common stock for the following reasons, among others: . the Company may not adequately assess the risks inherent in a particular acquisition candidate or correctly assess the candidate's potential contribution to the Company's financial performance; - 26 - . the Company may need to divert more management resources to integration than it planned, which may adversely affect its ability to pursue other more profitable activities; . the difficulties of integration may be increased by the necessity of coordinating geographically separated organizations, integrating personnel with disparate backgrounds and combining different corporate cultures; . the Company may not eliminate as many redundant costs as it anticipated in selecting acquisition candidates; and . an acquisition candidate may have liabilities or adverse operating issues that the Company failed to discover through its due diligence prior to the acquisition. . The Company may be exposed to product liability or related claims with respect to its products. . The Company's products may become obsolete due to rapid technological change in the satellite industry. . The Company's business is subject to risks associated with international transactions. . The Company depends on attracting and retaining highly skilled professional staff, and the Company depends on the services of its key personnel. . The Company depends on its intellectual property rights and risks having those rights infringed. . The market price of the Company's common stock may be volatile. . The Company's quarterly results may vary significantly from quarter to quarter. . Changes in activity levels in the Company's core markets. While sometimes presented with numerical specificity, these forward-looking statements are based upon a variety of assumptions relating to the business of the Company, which although considered reasonable by the Company, may not be realized. Because of the number and range of the assumptions underlying the Company's forward-looking statements, many of which are subject to significant uncertainties and contingencies beyond the reasonable control of the Company, some of the assumptions inevitably will not materialize and unanticipated events and circumstances may occur subsequent to the date of this document. These forward-looking statements are based on current information and expectation, and the Company assumes no obligation to update. The actual experience of the Company and the results achieved during the period covered by any particular forward-looking statement may vary materially. Therefore, these forward-looking statements should not be regarded as a representation by the Company or any other person that these estimates will be realized. There can be no assurance that any of these expectations will be realized or that any of the forward-looking statements contained herein will prove to be accurate. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK During fiscal 2003, the Company had two contracts in denominated in Euros. While the Company currently does not have significant European operations, our customer base is expanding outside the U.S. and therefore certain contracts now and in the future will likely be denominated in currencies other than the U.S. dollar. As a result, the Company's financial results could be affected by factors such as foreign currency exchange rates for contracts denominated in currencies other than the U.S. dollar. To mitigate the effect of changes in foreign currency exchange rates, the Company may hedge this risk by entering into forward foreign currency contracts. As of March 31, 2003, virtually all of our contracts were denominated in U.S. dollars, and we only had one contract denominated in Euros that was hedged. The second contract denominated in Euros was hedged in the subsequent quarter. As we enter into new foreign currency based contracts in the future, we may employ similar hedging contracts. The fair value of our hedge at March 31, 2003 was de minimus. - 27 - ITEM 4. CONTROLS AND PROCEDURES a. Evaluation of disclosure controls and procedures As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the "Exchange Act"), within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"), the Company carried out an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures. 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 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 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. b. Changes in internal controls There were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's internal controls subsequent to the Evaluation Date, including any corrective actions with regard to significant deficiencies and material weaknesses. PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits 3.1 Articles of Restatement of the Company (Incorporated by reference to the Registration Statement on Form S-3 (File No. 333-82499) filed with the Commission on July 8, 1999). 3.2 Amended and Restated Bylaws of the Company (Incorporated by reference to the Company's Annual Report on Form 10-K for the Fiscal Year ended September 30, 2000 filed with the Commission on December 21, 2000). 10.1 Indemnification Agreements 11.1 Computation of Per Share Earnings. 99.1 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b. Reports on Form 8-K The Company filed a report on Form 8-K (dated May 13, 2003) with the Commission on May 13, 2003, reporting its earnings for the quarter and six months ended March 31, 2003. - 28 - SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTEGRAL SYSTEMS, INC. ---------------------- (Registrant) Date: May 14, 2003 By: /s/ -------------------------------- Thomas L. Gough President & Chief Operating Officer Date: May 14, 2003 By: /s/ -------------------------------- Elaine M. Parfitt Executive Vice President & Chief Financial Officer - 29 - CHIEF EXECUTIVE OFFICER CERTIFICATION I, Steven R. Chamberlain, Chairman and Chief Executive Officer of Integral Systems, Inc. (the "Registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the Registrant; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of the Registrant's board of directors: a) All significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Integral Systems, Inc. Date: May 14, 2003 /s/ ------------------------------------- Steven R. Chamberlain Chairman and Chief Executive Officer - 30 - CHIEF FINANCIAL OFFICER CERTIFICATION I, Elaine M. Parfitt, Chief Financial Officer of Integral Systems, Inc. (the "Registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the Registrant; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report; 4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of the Registrant's board of directors: a) All significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Integral Systems, Inc. Date: May 14, 2003 /s/ ----------------------------------- Elaine M. Parfitt Chief Financial Officer - 31 - EXHIBIT 10.1 INDEMNIFICATION AGREEMENT THIS INDEMNIFICATION AGREEMENT (this "Agreement"), effective as of December 4, 2002, is made and entered into by and between Integral Systems, Inc., a Maryland corporation (the "Company"), and ________________ [a/an director/officer/employee] of the Company ("Indemnitee"). RECITALS WHEREAS, It is essential to the Company to retain and attract as directors, officers and employees the most capable persons available; WHEREAS, Indemnitee is [a/an director/officer/employee] of the Company; WHEREAS, Both the Company and Indemnitee recognize the increased risk of litigation and other claims being asserted against directors of public companies; and WHEREAS, In recognition of Indemnitee's need for substantial protection against personal liability and in order to maintain Indemnitee's continued service to the Company in an effective manner and to provide Indemnitee with specific contractual assurance that such protection will be available to Indemnitee, the Company desires to provide in this Agreement for the indemnification of and the advancement of expenses to Indemnitee to the fullest extent (whether partial or complete) permitted by the Maryland General Corporation Law, in effect as of the date hereof (the "Maryland Law"), as set forth in this Agreement and, to the extent officers' and directors' liability insurance is maintained by the Company, to provide for the continued coverage of Indemnitee under the Company's officers' and directors' liability insurance policies. NOW, THEREFORE, in consideration of the mutual agreements herein set forth and of Indemnitee's continuing service to the Company, the parties hereto hereby agree as follows: 1. Indemnification of Indemnitee; Expenses; Insurance. (a) The Company shall indemnify Indemnitee to the fullest extent permitted by Maryland Law against judgments, penalties, fines, settlements and reasonable expenses actually incurred by Indemnitee in the event Indemnitee has been made, or is threatened to be made, a party to an action, suit, arbitration, alternative dispute resolution mechanism, administrative hearing or other proceeding, whether civil, criminal, administrative, investigative, or otherwise (including an action, suit, arbitration, alternative dispute resolution mechanism, administrative hearing, or other proceeding by or in the right of the Company) (each a "Proceeding"), by reason of Indemnitee's present or prior service as a director, officer or employee of the Company, as the case may be, or present or prior service at the request of the Company as a director, officer or employee or as a fiduciary of an employee benefit plan, or as an employee or agent of another corporation, partnership, joint venture, trust or other enterprise (such present or prior service, "Corporate Service"). Notwithstanding anything in this Agreement to the contrary, prior to a Change in Control (as defined below) Indemnitee shall not be entitled to indemnification pursuant to this Agreement in connection with any Proceeding initiated by Indemnitee against the Company or any director or officer of the Company unless the Company has joined in or consented to the initiation of such Proceeding. (b) The Company shall advance or reimburse all reasonable expenses actually incurred by or on behalf of Indemnitee to the maximum extent permitted by Maryland Law, in connection - 1 - with any Proceeding to which Indemnitee has been, or is threatened to be, made a party, by reason of Indemnitee's Corporate Service, after the receipt by the Company of a written statement or statements from such person requesting such payment from time to time, whether prior to or after final disposition of such Proceeding. Such statement or statements shall reasonably evidence the expenses actually incurred or to be incurred by Indemnitee in connection with such Proceeding and shall include or be preceded or accompanied by a written affirmation by Indemnitee of Indemnitee's good faith belief that the standard of conduct necessary for indemnification by the Company as authorized by law has been met and a written undertaking by or on behalf of such person to repay any costs or expenses paid for by the Company if it shall ultimately be determined that such standard of conduct has not been met. (c) To the extent the Company maintains an insurance policy or policies providing director, officer and/or employee liability insurance, Indemnitee shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage available for any director, officer or employee (as the case may be) of the Company. The Company shall not be liable under this Agreement to make any payment to Indemnitee to the extent Indemnitee has otherwise actually received payment (under any insurance policy, the Company's Articles of Incorporation, as amended (the "Charter") or the Company's Bylaws or otherwise) of the amounts otherwise indemnifiable. 2. Action by Company. The Company will use commercially reasonable efforts to take, or cause to be taken, all action necessary to fulfill any requirements to providing indemnification as contemplated by this Agreement, including, but not limited to, any actions required by Maryland Law. 3. Presumptions. For purposes of this Agreement, the termination of any Proceeding: (a) by judgement, order or settlement (whether with or without court approval) will not in and of itself create a presumption that Indemnitee did not meet the requisite standard of conduct provided by Maryland Law, and (b) by conviction, or upon a plea of nolo contendere or its equivalent, or an entry of an order of probation prior to judgment, will create a rebuttable presumption that Indemnitee did not meet the requisite standard of conduct provided by Maryland Law. 4. Non-Exclusivity, Etc. The rights of Indemnitee hereunder will be in addition to any other rights Indemnitee may have under the Company's Charter, the Company's Bylaws, Maryland Law or otherwise; provided, however, that to the extent that any change is made to Maryland Law (whether by legislative action or judicial decision), the Company's Charter and/or the Company's Bylaws which permits any greater right to indemnification than that provided under this Agreement as of the date hereof, Indemnitee will be deemed to have such greater right hereunder. The Company will not adopt any amendment to its Charter or Bylaws the effect of which would be to deny, diminish or encumber Indemnitee's right to indemnification under its Charter, its Bylaws, Maryland Law or otherwise as applied to any act or failure to act occurring in whole or in part prior to the date upon which the amendment was approved by the Company's Board of Directors and/or its stockholders, as the case may be. 5. Change in Control. (a) The Company agrees that if there is a Change in Control, then with respect to all matters thereafter arising concerning the rights of Indemnitee to indemnity payments and expense advances under this Agreement or any other agreement, the Company's Articles of Incorporation, or the Company's Bylaws in effect relating to any Proceeding to which Indemnitee has been, or is threatened to be, made a party, by reason of Indemnitee's Corporate Service, the Company shall seek legal advice only from a "Special Independent Counsel" selected by Indemnitee, having prior experience with indemnification claims under Maryland Law and approved by the Company (which approval shall not be unreasonably withheld or delayed), and who has not otherwise performed services for the Company or Indemnitee within the last five years (other than in connection with such matters). Such Special Independent Counsel, among - 2 - other things, shall render his, her or its written opinion to the Company and Indemnitee as to whether and to what extent Indemnitee would be permitted to be indemnified under applicable Maryland Law. The Company agrees to pay the reasonable fees of the Special Independent Counsel referred to above and shall fully indemnify such Special Independent Counsel against any and all expenses (including attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement. (b) For purposes of this Agreement, a "Change in Control" occurs if (i) any person becomes the direct or indirect beneficial owner of securities constituting 40% or more of the total voting power of the Company's outstanding voting securities without the consent of the Company's Board of Directors, (ii) within any two consecutive year period, individuals who at the beginning of such period constitute the Board of Directors of the Company and any new director(s) appointed or nominated for election to the Board of Directors by a majority of the directors then still in office who either were directors at the beginning of such period or whose appointment or nomination was previously so approved cease for any reason to constitute a majority of the Board of Directors, or (iii) the stockholders of the Company approve a merger, a consolidation, a plan of complete liquidation of the Company or the sale or disposition of all or substantially all the Company's assets (in one transaction or a series of transactions) without the consent of the Board of Directors. 6. Successors and Binding Agreement. The Company will use commercially reasonable efforts to cause any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization or otherwise) to all or substantially all of the business or assets of the Company to assume and agree to perform this Agreement in the same manner and to the same extent the Company would be required to perform if no such succession had taken place. This Agreement will be binding upon and inure to the benefit of the Company and any successor to the Company, including, without limitation, any person acquiring directly or indirectly all or substantially all of the business or assets of the Company whether by purchase, merger, consolidation, reorganization or otherwise (and such successor will thereafter be deemed the "Company" for purposes of this Agreement), but will not otherwise be assignable, transferable or delegable by the Company. This Agreement will inure to the benefit of and be enforceable by Indemnitee and Indemnitee's personal or legal representatives, executors, administrators, successors, heirs, distributees and legatees. 7. Counterparts. This Agreement may be executed in any number of counterparts and any party hereto may execute any such counterpart, each of which when executed and delivered shall be deemed to be an original and all of which counterparts taken together shall constitute but one and the same instrument. 8. Governing Law. This Agreement shall be governed by and construed, interpreted and enforced in accordance with the laws of the State of Maryland without giving effect to the principles of conflicts of laws. 9. Severability. The provisions of this Agreement shall be severable in the event that any of the provisions hereof (including any provision within a single section, paragraph or sentence) are held by a court of competent jurisdiction to be invalid, void or otherwise unenforceable in any respect, and the validity and enforceability of any such provision in every other respect and of the remaining provisions shall not be in any way impaired, and shall remain enforceable to the fullest extent permitted by Maryland Law. 10. No Third Party Beneficiaries. Except as expressly provided herein, no provision of this Agreement is intended, nor will be interpreted, to provide or create any third party beneficiary rights or any other rights of any kind in any client, customer, affiliate, shareholder, employee or partner of Indemnitee (as the case may be) or any other person or entity. 11. Headings; Section References. The headings and other captions in this Agreement are for convenience and reference only and shall not be used in interpreting, construing or enforcing any of the provisions of this Agreement. - 3 - 12. Miscellaneous. No provision of this Agreement may be waived, modified or discharged unless such waiver, modification or discharge is agreed to in a writing signed by Indemnitee and the Company. No waiver by either party hereto at any time of any breach by the other party hereto or compliance with any condition or provision of this Agreement to be performed by such other party will be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. ***** Signature Page Follows. - 4 - IN WITNESS WHEREOF, the parties to this Agreement have executed this Agreement as of the date first above written. INTEGRAL SYSTEMS, INC. By: ------------------------ Name: ------------------------ Title: ------------------------ INDEMNITEE ----------------------------- ----------------------------- Name: - 5 - Form of Indemnification Agreement Each of the persons listed below entered into an Indemnification Agreement with Integral Systems, Inc. substantially identical in all material respects to the Form of Indemnification Agreement to which this Schedule is attached, except as to the parties thereto, the dates of execution, and the other details set forth below. The material details in which each such Indemnification Agreement differ from the Form of Indemnification Agreement are set forth below. The Indemnification Agreements are not filed as separate documents in accordance with Item 601 (Instruction 2) of Regulation S-K. PERSON DATE POSITION OF PERSON ------ ---- ------------------ Steven Chamberlain Dec. 4, 2002 Chief Executive Officer Peter Gaffney Dec. 4, 2002 Executive Vice President, Products Thomas Gough Dec. 4, 2002 President Dominic Laiti Dec. 4, 2002 Director R. Doss McComas Dec. 4, 2002 Director Elaine Parfitt Dec. 4, 2002 Executive Vice President, C.F.O. Gary Prince Dec. 4, 2002 Director of Mergers and Acquisitions Bonnie Wachtel Dec. 4, 2002 Director Patrick Woods Dec. 4, 2002 Executive Vice President, Government Division - 6 - EXHIBIT 11.1 INTEGRAL SYSTEMS INC. AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE Three Months Ended Six Months Ended March 31, March 31, 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Numerator: Net Income $ 1,484,754 $ 433,599 $ 2,334,562 $ 1,049,704 Denominator: Denominator for basic earnings per share-weighted-average shares 9,710,205 9,120,763 9,705,717 9,096,980 Effect of dilutive securities: Employee stock options 48,070 195,980 45,355 199,903 Denominator for diluted earnings per share adjusted weighted-average shares and assumed conversions 9,758,275 9,316,743 9,751,072 9,296,883 Basic earnings per share $ 0.15 $ 0.05 $ 0.24 $ 0.12 Diluted earnings per share $ 0.15 $ 0.05 $ 0.24 $ 0.11 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Integral Systems, Inc. (the "Company") on Form 10-Q for the quarter ending March 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Steven R. Chamberlain the Chief Executive Officer of the Company, certify, pursuant to and for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. \s\ - --------------------------- Steven R. Chamberlain Chief Executive Officer Date: May 14, 2003 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Integral Systems, Inc. (the "Company") on Form 10-Q for the quarter ending March 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Elaine M. Parfitt, the Chief Financial Officer of the Company, certify, pursuant to and for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. \s\ - --------------------------- Elaine M. Parfitt Chief Financial Officer Date: May 14, 2003