INTEGRAL SYSTEMS INC /MD/ - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(mark one)

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

For the quarterly period ended June 30, 2004

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

For the transition period from to

Commission file number 0-18603

INTEGRAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)


Maryland		52-1267968
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5000 Philadelphia Way, Lanham, MD		20706
(Address of principal executive offices)		(Zip Code)

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

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

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

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

Registrant had 9,945,194 shares of common stock outstanding as of July 23, 2004.

INTEGRAL SYSTEMS, INC.

TABLE OF CONTENTS


		Page No.
PART I. FINANCIAL INFORMATION:

Item 1.	Financial Statements

	Consolidated Balance Sheets – June 30, 2004 (unaudited) and September 30, 2003	1

	Unaudited Consolidated Statements of Operations – Three and Nine Months Ended June 30, 2004 and June 30, 2003	3

	Unaudited Consolidated Statement of Stockholders’ Equity - Nine Months Ended June 30, 2004	4

	Unaudited Consolidated Statements of Cash Flow – Nine Months Ended June 30, 2004 and June 30, 2003	5

	Notes to Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25

Item 4.	Controls and Procedures	26

PART II. OTHER INFORMATION:

Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	27

Item 4.	Submission of Matters to a Vote of Security Holders	27

Item 6.	Exhibits and Reports on Form 8-K	27

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2004 and September 30, 2003


	June 30, 2004 (unaudited)		September 30, 2003
ASSETS
CURRENT ASSETS
Cash	$	22,029,763	$	22,526,718
Marketable Securities		28,525,660		28,188,935
Accounts Receivable, net		32,737,655		32,226,317
Notes Receivable		262,301		257,583
Prepaid Expenses		617,567		361,743
Inventory		1,562,131		973,702
Deferred Income Tax		876,585		876,585

TOTAL CURRENT ASSETS		86,611,662		85,411,583
FIXED ASSETS
Electronic Equipment		4,726,729		4,814,843
Furniture & Fixtures		810,635		776,323
Leasehold Improvements		977,944		971,965
Software Purchases		833,960		724,537

SUBTOTAL - FIXED ASSETS		7,349,268		7,287,668
Less: Accum. Depreciation		3,907,159		3,362,553

TOTAL FIXED ASSETS		3,442,109		3,925,115
OTHER ASSETS
Investment		201,000		0
Notes Receivable		333,594		430,917
Intangible Assets, net		706,243		1,419,522
Goodwill		25,744,261		25,715,264
Software Development Costs, net		4,981,295		5,754,971
Deposits, Deferred Charges, and Other		97,747		135,827

TOTAL OTHER ASSETS		32,064,140		33,456,501
TOTAL ASSETS	$	122,117,911	$	122,793,199

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

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2004 and September 30, 2003


	June 30, 2004 (unaudited)		September 30, 2003
LIABILITIES & STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts Payable	$	5,406,174	$	4,544,677
Accrued Expenses		5,235,603		12,507,716
Capital Leases Payable		34,384		32,270
Billings in Excess of Cost		5,562,455		7,009,629
Income Taxes Payable		231,256		601,978

TOTAL CURRENT LIABILITIES		16,469,872		24,696,270

LONG TERM LIABILITIES
Capital Leases Payable		34,179		60,238
Deferred Income Taxes		2,422,268		2,408,105

TOTAL LONG TERM LIABILITIES		2,456,447		2,468,343
STOCKHOLDERS’ EQUITY
Common Stock, $.01 par value, 40,000,000 shares authorized, and 9,946,102 and 9,723,802 shares issued and outstanding at June 30, 2004 and September 30, 2003, respectively		99,461		97,238
Additional Paid-in Capital		81,174,595		77,019,957
Retained Earnings		21,907,374		18,588,185
Accumulated other comprehensive income		10,162		(76,794	)

TOTAL STOCKHOLDERS’ EQUITY		103,191,592		95,628,586

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY	$	122,117,911	$	122,793,199

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

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended June 30,						Nine Months Ended June 30,
	2004			2003			2004			2003
Revenue	$	22,632,229		$	19,341,829		$	65,194,551		$	58,868,206
Cost of Revenue
Direct Labor		5,057,792			4,500,290			14,328,836			13,200,936
Overhead Costs		3,462,270			2,966,377			10,653,469			9,336,688
Travel and Other Direct Costs		580,638			583,681			1,801,414			1,754,722
Direct Equipment & Subcontracts		6,329,565			4,944,717			16,640,383			15,739,074

Total Cost of Revenue		15,430,265			12,995,065			43,424,102			40,031,420

Gross Margin		7,201,964			6,346,764			21,770,449			18,836,786
Selling, General & Administrative		3,273,869			3,068,584			9,359,032			8,739,236
Research & Development		960,666			759,701			2,667,158			1,868,203
Product Amortization		761,381			747,231			2,284,143			2,241,693
Intangible Asset Amortization		68,750			322,265			713,279			966,795

Income From Operations		2,137,298			1,448,983			6,746,837			5,020,859
Other Income (Expense)
Interest Income		139,611			155,619			449,020			460,243
Interest Expense		(1,585	)		(2,229	)		(5,730	)		(7,211	)
Gain on sale of marketable securities		0			27,900			21,439			36,227
Impairment of marketable securities		0			(1,364,180	)		0			(1,364,180	)
Miscellaneous, net		(108,434	)		(35,735	)		(392,397	)		(273,282	)

Total Other Income		29,592			(1,218,625	)		72,332			(1,148,203	)
Income Before Income Tax		2,166,890			230,358			6,819,169			3,872,656
Provision for Income Taxes		782,472			58,464			2,480,705			1,366,200

Net Income	$	1,384,418		$	171,894		$	4,338,464		$	2,506,456

Weighted Avg. Number of Common Shares:
Basic		9,950,330			9,717,815			9,879,034			9,709,750
Diluted		10,099,956			9,781,366			10,053,256			9,764,355
Earnings per Share (Basic)	$	0.14		$	0.02		$	0.44		$	0.26
Earnings per Share (Diluted)	$	0.14		$	0.02		$	0.43		$	0.26

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

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INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED JUNE 30, 2004

(Unaudited)


	Number of Shares		Common Stock At Par Value			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance September 30, 2003	9,723,802		$	97,238		$	77,019,957		$	18,588,185		$	(76,794	)	$	95,628,586
Net income	—			—			—			4,338,464			—			4,338,464
Unrealized Gain on Marketable Securities (net of deferred tax of $14,163)	—			—			—			—			22,153			22,153
Unrealized Loss on Foreign Currency Exchange Contracts	—			—			—			—			(29,029	)		(29,029	)
Effect of Currency Translation	—			—			—			—			93,832			93,832

Total Comprehensive Income										4,338,464			86,956			4,425,420
Repurchased Shares	(14,242	)		(142	)		(107,891	)		(129,803	)		—			(237,836	)
Shares issued to acquire RT Logic	209,926			2,099			3,817,924			—			—			3,820,023
Stock Options Exercised	26,616			266			444,605			—			—			444,871
Declared Dividends	—			—			—			(889,472	)		—			(889,472	)

Balance June 30, 2004	9,946,102		$	99,461		$	81,174,595		$	21,907,374		$	10,162		$	103,191,592

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

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INTEGRAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended June 30, 2004 and 2003

(Unaudited)


	For the Nine Months Ended June 30,
	2004			2003
Cash flows from operating activities:
Net income	$	4,338,464		$	2,506,456
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,269,085			4,365,955
Change in reserve for doubtful accounts		65,325			0
Gain on sale of marketable securities		(21,439	)		(36,227	)
Impairment of marketable securities					1,364,180
Loss on disposal of fixed assets		42,661			22,396
Changes in operating assets and liabilities, net:
Accounts receivable and other receivables		(576,663	)		(2,113,520	)
Prepaid expenses and deposits		(217,744	)		876,918
Inventories		(625,263	)		(346,199	)
Accounts payable		(27,975	)		(2,271,924	)
Accrued expenses		(3,473,282	)		(5,233	)
Billings in excess of revenue		(1,447,174	)		448,855
Income taxes payable, net		(370,722	)		3,157,124

Total adjustments		(2,383,191	)		5,462,325

Net cash provided by operating activities		1,955,273			7,968,781

Cash flows from investing activities:
Purchases of marketable securities		(649,807	)		0
Sale of marketable securities		169,837			16,191,027
Issuance of Notes Receivable		0			5,212,696
Proceeds from payments on notes receivable		92,605			0
Acquisition of fixed assets		(831,318	)		(1,011,682	)
Software development costs		(1,510,467	)		(1,719,797	)
Acquisition of RT Logic, net of cash received		0			(13,413,276	)

Net cash (used in) provided by investing activities		(2,729,150	)		5,258,968

Cash flows from financing activities:
Proceeds from issuance of common stock		444,871			273,803
Stock repurchases		(237,836	)		(6,251,644	)
Note Payable		0			(802,190	)
Capital lease obligation payments		(23,945	)		(22,003	)

Net cash provided by (used in) financing activities		183,090			(6,802,034	)

Effect of currency translations		93,832			0
Net (decrease) increase in cash		(590,787	)		6,425,715
Cash – beginning of year		22,526,718			16,064,363

Cash - end of period	$	22,029,763		$	22,490,078

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

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	Basis of Presentation

The interim financial statements include the accounts of Integral Systems, Inc. (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, 2003. The results of operations for any interim period are not necessarily indicative of results for the full year.

2.	Accounts Receivable

Accounts receivable at June 30, 2004 and September 30, 2003 consist of the following:


	June 30, 2004			Sept. 30, 2003
Billed	$	8,678,968		$	12,816,226
Unbilled		23,922,518			19,081,023
Other		285,362			412,936
Reserve		(149,193	)		(83,868	)

Total	$	32,737,655		$	32,226,317

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

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

In June 2004, Integral Systems filed a claim in the amount of approximately $1.8 million against the National Oceanic Atmospheric Administration (NOAA) of the U.S. Department of Commerce. The claim arose under a contract from NOAA to provide the Data Collection System Automated Processing System II (DAPS-II System). The Company recognized approximately $870,000 of unbilled revenue in accordance with SOP 81-1.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

3.	Line of Credit

The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5 to 2.4% based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable and contains certain customary covenants, including minimum net worth and liquidity ratios. The line expires February 28, 2006. The Company had no balance outstanding at June 30, 2004 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 $68,500 at June 30, 2004. The outstanding balance is payable over a 23-month period and bears interest at a rate of 8.8% per annum.

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.	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.

The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the three and nine months ended June 30, 2004 is as follows:


	Three Months Ended June 30,					Nine Months Ended June 30,
	2004		2003			2004		2003
Net income, as reported	$	1,384,418	$	171,894		$	4,338,464	$	2,506,456
Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards		398,486		459,812			1,231,970		1,301,245
Add: Stock-based employee compensation included in net income		—		—			—		—
Pro forma net income (loss)	$	985,932	$	(287,918	)	$	3,106,494	$	1,205,211
Earnings per share:
As reported - basic	$	0.14	$	0.02		$	0.44	$	0.26
- diluted	$	0.14	$	0.02		$	0.43	$	0.26
Pro forma - basic	$	0.10	$	(0.03	)	$	0.31	$	0.12
- diluted	$	0.10	$	(0.03	)	$	0.31	$	0.12

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

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

6.	Foreign Currency Exchange Contracts

The Company periodically uses foreign currency exchange contracts to hedge risk associated with its European long-term contracts. Under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” all derivative instruments must be recorded on the balance sheet as an asset or liability with any gain or loss recorded as a component of accumulated other comprehensive income until recognized in earnings. The fair value of the exchange contracts is based upon quoted market prices. If a derivative does not qualify for hedge accounting the gain or loss is recorded through earnings. For the nine month period ended June 30, 2004, the Company recorded as accumulated other comprehensive income an unrealized loss of $29,029. The Company also recorded a realized gain of $14,440 during the same period.

7.	Business Segment Information

The Company 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.

The Company provides equipment monitoring and control software to satellite operators and the telecommunications industry through its wholly owned subsidiary Newpoint.

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 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.

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INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

7.	Business Segment Information (continued)

Summarized financial information by business segment is as follows:


	Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Nine Months Ended June 30, 2004			Nine Months Ended June 30, 2003
Revenue
Satellite ground systems	$	16,026,807		$	13,054,487		$	45,004,162		$	41,769,384
Satellite ground systems – intercompany		527,985			209,302			1,254,644			845,532
Satellite & terrestrial CSM		975,661			652,948			3,216,739			2,242,485
Satellite & terrestrial CSM - intercompany		16,804			15,000			233,296			15,753
Equip. monitoring & control		581,545			344,064			1,384,952			1,718,061
Equip. monitoring & control – intercompany		63,839			36,586			643,092			36,586
Space communication systems		5,048,216			5,290,330			15,588,698			13,138,276
Space communication systems – intercompany		1,174,342			525,337			2,005,129			1,932,082
Elimination of intercompany Sales		(1,782,970	)		(786,225	)		(4,136,161	)		(2,829,953	)

Total Revenue	$	22,632,229		$	19,341,829		$	65,194,551		$	58,868,206

Operating Income
Satellite ground systems	$	631,325		$	368,894		$	1,657,860		$	2,590,395
Satellite ground systems – intercompany		1,799			(1,569	)		(1,630	)		1,243
Satellite & terrestrial CSM		(325,942	)		(480,899	)		(550,234	)		(1,316,675	)
Satellite & terrestrial CSM - intercompany		(1,182	)		14,690			(875	)		14,690
Equip. monitoring & control		(2,504	)		(294,975	)		20,139			(642,469	)
Equip. monitoring & control – intercompany		12,184			N/A			8,564			N/A
Space communication systems		1,834,419			1,855,963			5,619,072			4,389,608
Space communication systems– intercompany		(547	)		N/A			(547	)		(10	)
Elimination of intercompany Operating Income		(12,254	)		(13,121	)		(5,512	)		(15,923	)

Total Operating Income	$	2,137,298		$	1,448,983		$	6,746,837		$	5,020,859

Total Assets
Satellite ground systems							$	85,181,538		$	76,434,848
Satellite & terrestrial CSM								3,579,416			3,962,446
Equip. monitoring & control								3,548,013			4,093,966
Space communication systems								44,195,343			35,309,345
Elimination of intercompany accounts receivable								(14,386,399	)		(9,622,172	)

Total Assets							$	122,117,911		$	110,178,433

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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.

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COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003

Results of Operations

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the three months ended June 30, 2004 and June 30, 2003:


	Three Months Ended June 30,
	2004		% of Revenue	2003			% of Revenue
	(in thousands)			(in thousands)
Revenue	$	22,632	100.0	$	19,342		100.0
Cost of Revenue		15,430	68.2		12,995		67.2

Gross Margin		7,202	31.8		6,347		32.8
Operating Expenses
Selling, General & Admin. (SG&A)		3,274	14.5		3,068		15.9
Research and Development		961	4.2		760		3.9
Product Amortization		761	3.4		747		3.8
Amortization-Intangible Assets		69	0.3		323		1.7

Income from Operations		2,137	9.4		1,449		7.5
Impairment of Marketable Securities		0	0.0		(1,364	)	(7.0	)
Other Income (Expense) (net)		30	0.2		145		0.7

Income Before Income Taxes		2,167	9.6		230		1.2
Income Taxes		783	3.5		58		0.3

Net Income	$	1,384	6.1	$	172		0.9

Revenue

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

For the three months ended June 30, 2004 and 2003, the Company’s revenues were generated from the following sources:


	Three Months Ended June 30,
Revenue Type	2004		2003
Government Revenue
NOAA	15	%	20	%
Air Force	56		51
Other U.S. Government Users	6		7

Subtotal	77		78
Commercial Revenue	23		22

Total	100	%	100	%

- 11 -

On a consolidated basis, revenue increased 17.0%, or $3.3 million, to $22.6 million for the three months ended June 30, 2004, from $19.3 million for the three months ended June 30, 2003. Revenue for the three-month periods ended June 30, 2004 and 2003 for each of the Company’s segments is shown in the following table:


Segment	Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Revenue
Satellite Ground Systems (Integral)	$	16,555		$	13,264		$	3,291
Satellite & Terrestrial CSM (SAT)		992			668			324
Equip. Monitoring & Control (Newpoint)		645			381			264
Space Communication Systems (RT Logic)		6,223			5,815			408
Elimination		(1,783	)		(786	)		(997	)

Total Revenue	$	22,632		$	19,342		$	3,290

Revenue increases in the Company’s Satellite Ground Systems segment primarily pertain to increased sales volume as a result of the Company’s awards with the U.S. Air Force (specifically the CCS-C and SCNC contracts). The Company also recorded approximately $220,000 of revenue during the three months ended June 30, 2004 from this segment’s Antenna division established in May 2003. There were no such revenues recorded during the corresponding three-month period last fiscal year.

Revenue increases for SAT, Newpoint and RT Logic resulted from increased order bookings and increased product shipments to customers.

Cost of Revenue/Gross Margin

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

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

- 12 -

During the three months ended June 30, 2004, cost of revenue increased by 18.7%, or $2.4 million, compared to the same period during the prior year, increasing from $13.0 million during the three months ended June 30, 2003 to $15.4 million during the three months ended June 30, 2004. Gross margin increased from $6.3 million to $7.2 million, an increase of $900,000, or 13.5%, during the periods being compared. Cost of revenue and gross margin for the three months ended June 30, 2004 and 2003 for each of the Company’s segments are shown in the following table:


Segment	Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Satellite Ground Systems (Integral)	$	13,201		$	10,426		$	2,775
Satellite & Terrestrial CSM (SAT)		541			367			174
Equip. Monitoring & Control (Newpoint)		264			310			(46	)
Space Communication Systems (RT Logic)		3,179			2,645			534
Elimination		(1,755	)		(753	)		(1,002	)

Total Cost of Revenue	$	15,430		$	12,995		$	2,435

Gross Margin
Satellite Ground Systems (Integral)	$	3,354		$	2,838		$	516
Satellite & Terrestrial CSM (SAT)		451			301			150
Equip. Monitoring & Control (Newpoint)		381			71			310
Space Communication Systems (RT Logic)		3,044			3,170			(126	)
Elimination		(28	)		(33	)		5

Total Gross Margin	$	7,202		$	6,347		$	855

The higher gross margin for the Company’s Satellite Ground Systems segment is primarily attributable to revenue growth on the Company’s Air Force contracts described above. Gross margin for the segment would have been greater were it not for certain cost overruns in the segment’s Antenna Division established May 2003. Several fixed price contracts in this division were under-priced and under-bid, especially with respect to direct material and equipment costs. Further, the direct labor costs required to complete these contracts were underestimated in prior quarters. Consequently, this division recorded approximately $690,000 of cost of revenue against revenue of only $220,000 during the current quarter. As a result, the Company has recently made additional management changes in this business area and is exploring strategic options for this operation for the future.

As a result of the above, gross margin as a percentage of revenue for the Satellite Ground Systems segment decreased from 21.4% to 20.3%.

The increases in gross margin at SAT and Newpoint relate to a combination of increased revenue coupled with the effect of cost-cutting measures implemented at the end of fiscal year 2003.

RT Logic experienced a decrease in gross margin dollars and its gross margin percentage (which declined from 54.5% in the three months ended June 30, 2003 to 48.9% during the quarter ended June 30, 2004). The decline in both absolute dollars and gross margin percentage is due to a heavier mix of time and materials and cost plus revenue earned in the current quarter compared to the revenue earned in the prior year’s third quarter, which included a much greater proportion of more profitable fixed price contracts.

- 13 -

Operating Expenses

Operating Expenses for the three months ended June 30, 2004 and 2003 for each of the Company’s segments are shown in the following table:


Segment	Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Satellite Ground Systems (Integral)
SG&A	$	2,019		$	1,831		$	188
R&D		92			43			49
Amortization		610			597			13

Total Satellite Ground Systems (Integral)		2,721			2,471			250

Satellite & Terrestrial CSM (SAT)
SG&A		376			295			81
R&D		251			321			(70	)
Amortization		151			151			0

Total Satellite & Terrestrial CSM (SAT)		778			767			11

Equip. Monitoring & Control (Newpoint)
SG&A		298			334			(36	)
R&D		42			0			42
Amortization		31			31			0

Total Equip. Monitoring & Control (Newpoint)		371			365			6

Space Communication Systems (RT Logic)
SG&A		596			629			(33	)
R&D		577			394			183
Amortization		37			291			(254	)

Total Space Communication Systems (RT Logic)		1,210			1,314			(104	)

Elimination		(15	)		(19	)		4

Total Operating Expenses	$	5,065		$	4,898		$	167

In the Company’s Satellite Ground Systems segment, SG&A expenses increased by approximately $190,000 during the periods being compared. The increase principally pertains to increased management, marketing and proposal costs relating to new Air Force opportunities and the Company’s new SKYLIGHT product. R&D expenses for the three months ended June 30, 2004 primarily relate to SKYLIGHT and U.S. Air Force efforts. Product amortization increased nominally during the three months ended June 30, 2004 as compared to the three months ended June 30, 2003 due to higher capitalized development costs related to the Company’s EPOCH product line.

At SAT, current period SG&A expenses are approximately $80,000 higher relative to last fiscal year’s third quarter SG&A expenses. This increase primarily relates to the recovery of a bad debt recorded in the third quarter of last fiscal year that did not recur during the current three-month period. R&D spending decreased approximately $70,000 between the periods being compared due to reductions in staff implemented late last fiscal year.

- 14 -

Newpoint’s current period SG&A expenses are approximately $35,000 lower relative to last fiscal year’s third quarter SG&A expenses while R&D spending increased approximately $40,000 (from zero last fiscal year) due to new product undertakings at this segment.

RT Logic’s current period SG&A expenses were down 5% compared to last fiscal year’s third quarter SG&A expenses while R&D spending increased approximately $185,000 due to new product undertakings at this segment. R&D spending at RT Logic is consistent with the current year’s plan. Amortization expense decreased approximately $255,000 resulting from certain intangible assets being fully amortized at June 30, 2004.

The current and prior period amortization expenses for both Newpoint and RT Logic relate to the amortization of intangible assets that were acquired at the time of each company’s acquisition by the Company.

Income from Operations

Income from Operations for the three months ended June 30, 2004 and 2003 for each of the Company’s segments is shown in the following table:


Segment	Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Satellite Ground Systems (Integral)	$	633		$	367		$	266
Satellite & Terrestrial CSM (SAT)		(327	)		(466	)		139
Equip. Monitoring & Control (Newpoint)		10			(294	)		304
Space Communication Systems (RT Logic)		1,834			1,856			(22	)
Elimination		(13	)		(14	)		1

Total Income from Operations	$	2,137		$	1,449		$	688

Income from operations during the periods compared increased by almost $270,000 in the Company’s Satellite Ground Systems segment as a result of increased gross margins described above partially offset by increased operating expenses. Quarterly operating income for the segment for the current period would have been greater by approximately $550,000 were it not for operating losses posted by the segment’s Antenna Division.

Although SAT’s operating results improved on a quarter-to-quarter comparison, the Company had in fact expected considerably better results. Reduced profit percentages on three contracts coupled with certain one time legal and office relocation expenses contributed to the current period operating loss.

Newpoint posted a modest operating profit for the current quarter compared to operating losses for the quarter ended June 30, 2003, resulting from increased revenue and the effects of prior period cost cutting measures.

RT Logic recorded decreased income from operations principally due to gross margin declines and R&D spending increases described above partially offset by reduced current period amortization expenses.

Other Income/Expense/Impairment of Marketable Securities

During the three months ended June 30, 2003, the Company recorded a charge of approximately $1.36 million related to the permanent impairment of certain marketable equity securities. No such impairment occurred during the current three-month period.

The changes in other income and expense between the quarters being compared are considered immaterial.

- 15 -

Income Before Income Taxes/Net Income

Income before income taxes increased to $2.2 million from $230,000 between the two periods being compared principally due to the increases in income from operations and the lack of impairment charges related to marketable equity securities in the current period.

As a result of the above, net income increased to approximately $1.4 million during the three months ended June 30, 2004 from $170,000 during the three months ended June 30, 2003.

- 16 -

COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 2004 AND 2003

Results of Operations

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the nine months ended June 30, 2004 and June 30, 2003:


	Nine Months Ended June 30,
	2004		% of Revenue	2003			% of Revenue
	(in thousands)			(in thousands)
Revenue	$	65,195	100.0	$	58,868		100.0
Cost of Revenue		43,424	66.6		40,031		68.0

Gross Margin		21,771	33.4		18,837		32.0
Operating Expenses
Selling, General & Admin. (SG&A)		9,359	14.4		8,739		14.9
Research and Development		2,668	4.1		1,868		3.2
Product Amortization		2,284	3.5		2,242		3.8
Amortization-Intangible Assets		713	1.1		967		1.6

Income from Operations		6,747	10.3		5,021		8.5
Impairment of Marketable Securities		0	0.0		(1,364	)	(2.3	)
Other Income (Expense) (net)		72	0.2		216		0.4

Income Before Income Taxes		6,819	10.5		3,873		6.6
Income Taxes		2,481	3.8		1,367		2.3

Net Income	$	4,338	6.7	$	2,506		4.3

Revenue

For the nine months ended June 30, 2004 and 2003, the Company’s revenues were generated from the following sources:


	Nine Months Ended June 30,
Revenue Type	2004		2003
Government Revenue
NOAA	16		20
Air Force	54		49
Other U.S. Government Users	6		7

Subtotal	76		76
Commercial Revenue	24		24

Total	100	%	100	%

- 17 -

On a consolidated basis, revenue increased 10.7%, or $6.3 million, to $65.2 million for the nine months ended June 30, 2004, from $58.9 million for the nine months ended June 30, 2003. Revenue for the nine-month periods ending June 30, 2004 and 2003 for each of the Company’s segments is shown in the following table:


Segment	Nine Months Ended June 30, 2004			Nine Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Revenue
Satellite Ground Systems (Integral)	$	46,259		$	42,615		$	3,644
Satellite & Terrestrial CSM (SAT)		3,450			2,258			1,192
Equip. Monitoring & Control (Newpoint)		2,028			1,755			273
Space Communication Systems (RT Logic)		17,594			15,070			2,524
Elimination		(4,136	)		(2,830	)		(1,306	)

Total Revenue	$	65,195		$	58,868		$	6,327

Revenue increases in the Company’s Satellite Ground Systems segment primarily pertain to increased sales volume as a result of the Company’s awards with the U.S. Air Force (specifically the CCS-C and SCNC contracts.) The Company also recorded approximately $1.4 million of revenue during the nine months ended June 30, 2004 from this segment’s Antenna division established May 2003. There were no such revenues recorded during the corresponding nine-month period last fiscal year.

Revenue increases for SAT, Newpoint and RT Logic resulted from increased order bookings and increased product shipments to customers.

Cost of Revenue/Gross Margin

During the nine months ended June 30, 2004, cost of revenue increased by 8.5%, or $3.4 million, compared to the same period during the prior year, increasing from $40.0 million during the nine months ended June 30, 2003 to $43.4 million during the nine months ended June 30, 2004. Gross margin increased from $18.8 million to $21.8 million, an increase of $3.0 million, or 15.6%, during the periods being compared. Cost of revenue and gross margin for the nine months ended June 30, 2004 and 2003 for each of the Company’s segments are shown in the following table:


Segment	Nine Months Ended June 30, 2004			Nine Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Cost of Revenue
Satellite Ground Systems (Integral)	$	36,580		$	33,090		$	3,490
Satellite & Terrestrial CSM (SAT)		2,053			1,249			804
Equip. Monitoring & Control (Newpoint)		873			1,381			(508	)
Space Communication Systems (RT Logic)		8,004			7,079			925
Elimination		(4,086	)		(2,768	)		(1,318	)

Total Cost of Revenue	$	43,424		$	40,031		$	3,393

Gross Margin
Satellite Ground Systems (Integral)	$	9,679		$	9,525		$	154
Satellite & Terrestrial CSM (SAT)		1,397			1,009			388
Equip. Monitoring & Control (Newpoint)		1,155			374			781
Space Communication Systems (RT Logic)		9,590			7,991			1,599
Elimination		(50	)		(62	)		12

Total Gross Margin	$	21,771		$	18,837		$	2,934

- 18 -

The higher gross margin for the Company’s Satellite Ground Systems segment is primarily attributable to revenue growth on the Company’s Air Force contracts described above. Gross margin for the segment would have been even greater were it not for overruns in the segment’s newly established Antenna Division. Several fixed price contracts in this division were originally under-priced and under-bid, especially with respect to direct material and equipment costs. Consequently, this division recorded approximately $2.1 million of cost of revenue against revenue of only $1.4 million during the current nine-month period. As a result of the above, gross margin as a percentage of revenue for the Satellite Ground Systems segment decreased from 22.4% to 20.9%.

The increases in gross margin at SAT and Newpoint relate to a combination of increased revenue coupled with the effect of cost-cutting measures implemented at the end of fiscal year 2003.

The increase in gross margin at RT Logic pertains to increased revenue levels and a higher content of production oriented contracts. Production oriented contracts typically generate higher gross margins for this segment than non-production oriented jobs due to increased efficiencies. On several large contracts, product deliveries were completed at lower cost than anticipated resulting in higher gross margins for the period.

Significant research and development investments at RT Logic over the past several years have driven increased productivity through deployment of a common product architecture. In addition, by leveraging an efficient and consistent hardware and software architecture across multiple business areas, RT Logic has realized increased economies of scale in the application of this new architecture.

- 19 -

Operating Expenses

Operating Expenses for the nine months ended June 30, 2004 and 2003 for each of the Company’s segments are depicted in the following table:


Segment	Nine Months Ended June 30, 2004			Nine Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Operating Expenses
Satellite Ground Systems (Integral)
SG&A	$	5,979		$	5,032		$	947
R&D		212			111			101
Amortization		1,832			1,790			42

Total Satellite Ground Systems (Integral)		8,023			6,933			1,090

Satellite & Terrestrial CSM (SAT)
SG&A		846			922			(76	)
R&D		650			937			(287	)
Amortization		452			452			0

Total Satellite & Terrestrial CSM (SAT)		1,948			2,311			(363	)

Equip. Monitoring & Control (Newpoint)
SG&A		858			922			(64	)
R&D		174			0			174
Amortization		94			94			0

Total Equip. Monitoring & Control (Newpoint)		1,126			1,016			110

Space Communication Systems (RT Logic)
SG&A		1,721			1,909			(188	)
R&D		1,631			819			812
Amortization		619			873			(254	)

Total Space Communication Systems (RT Logic)		3,971			3,601			370

Elimination		(44	)		(45	)		1

Total Operating Expenses	$	15,024		$	13,816		$	1,208

In the Company’s Satellite Ground Systems segment, SG&A expenses increased during the two periods being compared by approximately $950,000. The increase principally pertains to increased management, marketing and proposal costs relating to new Air Force opportunities and the Company’s new SKYLIGHT product. As a percentage of revenue, SG&A for this segment represented 12.9% of revenue in the current period compared to 11.8% of revenue during the nine months ended June 30, 2003. R&D expenses for the nine months ended June 30, 2004 primarily relate to SKYLIGHT and U.S. Air Force efforts. Product amortization has increased by approximately $40,000 due to higher capitalized development costs related to the Company’s EPOCH product line.

At SAT, period-to-period SG&A costs are down approximately $75,000 due to cost reductions implemented at the end of last fiscal year while R&D expenses have decreased almost $290,000 resulting from the application of the engineering staff to direct contracts as opposed to R&D activities. Product amortization was approximately $450,000 for both periods being compared.

Newpoint’s current period SG&A expenses are more than $60,000 lower relative to last fiscal year’s nine-month SG&A expenses due to cost reductions implemented at the end of last fiscal year, while R&D spending increased approximately $175,000 (from zero last fiscal year) due to new product undertakings at this segment.

- 20 -

RT Logic’s current period SG&A expenses are approximately $190,000 lower than last fiscal year’s nine-month SG&A totals while R&D spending increased approximately $810,000 due to new product undertakings at this segment. R&D spending at RT Logic is consistent with the current year’s plan. Amortization expense decreased approximately $255,000 resulting from certain intangible assets being fully amortized at June 30, 2004.

The current period amortization expenses for both Newpoint and RT Logic relate to the amortization of intangible assets that were acquired at the time of each company’s acquisition by the Company.

Income from Operations

Income from Operations for the nine months ended June 30, 2004 and 2003 for each of the Company’s segments is shown in the following table:


Segment	Nine Months Ended June 30, 2004			Nine Months Ended June 30, 2003			Increase/ (Decrease)
	(in thousands)			(in thousands)			(in thousands)
Income from Operations
Satellite Ground Systems (Integral)	$	1,656		$	2,592		$	(936	)
Satellite & Terrestrial CSM (SAT)		(551	)		(1,302	)		751
Equip. Monitoring & Control (Newpoint)		29			(642	)		671
Space Communication Systems (RT Logic)		5,619			4,390			1,229
Elimination		(6	)		(17	)		11

Income from Operations	$	6,747		$	5,021		$	1,726

Income from operations during the periods compared decreased by approximately $940,000 in the Company’s Satellite Ground Systems segment principally as a result of increased operating expenses described above. Nine-month operating income for the segment would have been greater by approximately $1.0 million were it not for operating losses posted by the segment’s Antenna Division.

SAT’s operating loss was considerably reduced for the two periods being compared as this segment posted higher revenues and reduced current period operating expenses.

Newpoint posted a modest operating profit (i.e. approximately $30,000) for the current nine month period compared to operating losses of approximately $640,000 for the nine months ended June 30, 2003, resulting from increased revenues coupled with higher gross margins that were the result of prior period cost cutting measures.

RT Logic increased income from operations by approximately 28% over the first nine months of last fiscal year as a result of higher gross margins as described above, somewhat offset by increased R&D spending. Since its acquisition by the Company in October of 2002, RT Logic has cumulatively contributed in excess of $13.0 million of operating income over seven fiscal quarters.

Other Income/Expense/Impairment of Marketable Securities

During the nine months ended June 30, 2003, the Company recorded a charge of approximately $1.36 million related to the permanent impairment of certain marketable equity securities. No such impairment occurred during the current nine-month period.

The changes in other income and expense between the periods being compared are considered immaterial.

- 21 -

Income Before Income Taxes/Net Income

Income before income taxes increased by approximately $2.9 million to $6.8 million from $3.9 million between the two periods being compared principally due to the increases in income from operations and the avoidance of impairment charges related to marketable equity securities.

As a result of the above, net income increased to approximately $4.3 million during the nine months ended June 30, 2004 from approximately $2.5 million during the nine months ended June 30, 2003.

- 22 -

OUTLOOK

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

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

As disclosed in its Form 10-K for the fiscal year ending September 30, 2003, the Company was anticipating growth in revenue, operating income, net income, and fully diluted earnings per common share for fiscal year 2004 in its entirety of approximately 10%, 20%, 35%, and 35%, respectively over fiscal year 2003 levels. Although operating income, net income and fully diluted earnings per common share were all somewhat less than the Company’s internal plan for the nine months ended June 30, 2004, the Company believes that it is still generally on target to meet these previously announced goals for fiscal year 2004 in its entirety.

LIQUIDITY AND CAPITAL RESOURCES

Since the Company’s inception in 1982, it has been profitable on an annual basis and has generally financed its working capital needs through internally generated funds, supplemented by borrowings under the Company’s general line of credit facility with a commercial bank and the proceeds from the Company’s initial public offering in 1988. In June 1999, the Company supplemented its working capital position by raising approximately $19.7 million (net) through the private placement of approximately 1.2 million shares of its common stock. In February 2000, the Company raised an additional $40.9 million (net) for use in connection with potential acquisitions and other general corporate purposes through the private placement of 1.4 million additional shares of its common stock. With respect to the capital raised in the private placements, at June 30, 2004, $18.4 million was invested in variable rate State of Maryland debt securities, $10.0 million was invested in Banc of America Preferred Funding Corporation “Dividends Received Eligible Auction Market” preferred stock (“DREAMS”), and $40,000 was invested in common stock of independent third-party companies.

For the nine months ended June 30, 2004, operating activities provided the Company approximately $2.0 million of cash and we used approximately $2.7 million in investing activities. Included in the $2.7 million of investing activities is approximately $1.5 million in newly capitalized software development costs and $830,000 used for the purchase of fixed assets.

- 23 -

The Company’s Board of Directors declared a cash dividend of $.03 per share to all stockholders of record as of close of business on June 2, 2004. The dividend was paid on June 29, 2004 in the amount of $298,810. In addition, the Company’s Board of Directors declared a cash dividend of $.03 per share to all stockholders of record as of close of business on September 1, 2004. The dividend will be paid on or about September 28, 2004.

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 the investment in product development for EPOCH and OASYS will be less in fiscal year 2004 than it was in fiscal year 2003.

The Company believes that inflation did not have a material impact on the Company’s revenues or income from operations during the nine months ended June 30, 2004 or in past fiscal years.

OFF-BALANCE SHEET ARRANGEMENTS

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

FORWARD LOOKING STATEMENTS

Certain of the statements contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section, in other parts of this 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 effect the Company’s business, other than those described elsewhere herein or in our other filings with the Securities and Exchange Commission (the “SEC” or the “Commission”), include the following:

•

A substantial 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.

- 24 -

•

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

•

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

•

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

•

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

•

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

•

Risks related to the Company’s acquisition strategy.

•

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

•

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

•

The business is subject to risks associated with international transactions.

•

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

•

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

•

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

•

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

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

While the Company currently does not have significant European operations, our customer base is expanding outside the U.S. and therefore certain contracts now and in the future will likely be denominated in currencies other than the U.S. dollar. As a result, the Company’s financial results could be affected by factors such as foreign currency exchange rates for contracts denominated in currencies other than the U.S. dollar. To mitigate the effect of changes in foreign currency exchange rates, the Company may hedge this risk by entering into forward foreign currency contracts. As of June 30, 2004, virtually all of our contracts are denominated in U.S. dollars. Three contracts were denominated in Euros that were hedged. As we enter into new foreign currency based contracts in the future, we may employ similar hedging contracts. The change in fair value of our hedge at June 30, 2004 reflected an unrealized loss of $29,029

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ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

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

Changes in internal controls

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

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PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

(c)	Issuer Purchases of Equity Securities


Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1)
April 1 to April 30, 2004	—		—	341,171	591,587
May 1 to May 31, 2004	6,500	$	16.56	347,671	585,087
June 1 to June 30, 2004	3,092	$	15.79	350,763	581,995

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

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

The Annual Meeting of Stockholders of the Company was held on April 14, 2004. The following matter was voted on by stockholders, and received the votes indicated:

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


Director	For	Withheld
Steven R. Chamberlain	7,519,794	1,286,047
Thomas L. Gough	7,501,725	1,304,116
Bonnie K. Wachtel	8,441,314	364,527
Dominic Laiti	8,437,314	368,527
R. Doss McComas	8,437,414	368,427

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

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).

11.1		Computation of Per Share Earnings.

31.1		Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended.

31.2		Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended.

32.1		Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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Reports on Form 8-K

The Company filed a report on Form 8-K (dated August 9, 2004) with the Commission on August 10, 2004, reporting its earnings for the quarter and nine months ended June 30, 2004.

The Company filed a report on Form 8-K (dated May 10, 2004) with the Commission on May 11, 2004, reporting its earnings for the quarter and six months ended March 31, 2004.

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SIGNATURES

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



	INTEGRAL SYSTEMS, INC.
	(Registrant)

Date: August 12, 2004	By:	/s/ THOMAS L. GOUGH
		Thomas L. Gough
		President & Chief Operating Officer

Date: August 12, 2004	By:	/s/ ELAINE M. PARFITT
		Elaine M. Parfitt
		Executive Vice President &
		Chief Financial Officer

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