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Integral Systems 10-Q 2005
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-Q

 


 

(Mark one)

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

 

For the quarterly period ended June 30, 2005

 

or

 

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

 

For the transition period from              to             

 

Commission file number 0-18603

 


 

INTEGRAL SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 


 

Maryland   52-1267968

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

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

 

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

 

 

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

 


 

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

 

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

 

Registrant had 10,424,163 shares of common stock outstanding as of July 29, 2005.

 



Table of Contents

INTEGRAL SYSTEMS, INC.

 

TABLE OF CONTENTS

 

             Page No.

PART I. FINANCIAL INFORMATION:

    
    Item 1.   Financial Statements     
        Consolidated Balance Sheets – June 30, 2005 (unaudited) and September 30, 2004    1
        Unaudited Consolidated Statements of Operations – Three and Nine Months Ended June 30, 2005 and June 30, 2004    3
        Unaudited Consolidated Statement of Stockholders’ Equity – Nine Months Ended June 30, 2005    4
        Unaudited Consolidated Statements of Cash Flows – Nine Months Ended June 30, 2005 and June 30, 2004    5
        Notes to Consolidated Financial Statements    6
    Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    11
    Item 3.   Quantitative and Qualitative Disclosures About Market Risk    30
    Item 4.   Controls and Procedures    30

PART II. OTHER INFORMATION:

    
    Item 1.   Legal Proceedings    31
    Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    31
    Item 3.   Defaults Upon Senior Securities    31
    Item 4.   Submission of Matters to a Vote of Security Holders    31
    Item 5.   Other Information    32
    Item 6.   Exhibits    32
    Signatures    33


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2005 and September 30, 2004

 

    

June 30,

2005


  

September 30,

2004


     (unaudited)     

ASSETS

             

CURRENT ASSETS

             

Cash

   $ 28,969,421    $ 18,198,832

Marketable Securities

     27,951,000      29,060,396

Accounts Receivable, net

     37,093,709      39,628,515

Notes Receivable

     451,573      263,913

Prepaid Expenses

     498,235      632,595

Inventory

     2,097,549      1,312,161

Deferred Income Tax - Current Portion

     941,866      855,700

Income Taxes Receivable

     787,073      0
    

  

TOTAL CURRENT ASSETS

     98,790,426      89,952,112
    

  

FIXED ASSETS

             

Electronic Equipment

     4,389,167      4,884,764

Furniture & Fixtures

     559,516      876,255

Leasehold Improvements

     1,510,824      1,345,634

Software Purchases

     795,715      846,413
    

  

SUBTOTAL - FIXED ASSETS

     7,255,222      7,953,066

Less: Accumulated Depreciation

     3,795,321      4,395,933
    

  

TOTAL FIXED ASSETS

     3,459,901      3,557,133

OTHER ASSETS

             

Notes Receivable - Non-Current

     294,583      300,338

Intangible Assets, net

     431,243      637,493

Goodwill

     33,338,768      33,256,186

Software Development Costs

     3,247,130      4,591,904

Deposits and Deferred Charges

     205,144      171,275
    

  

TOTAL OTHER ASSETS

     37,516,868      38,957,196

TOTAL ASSETS

   $ 139,767,195    $ 132,466,441
    

  

 

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Table of Contents

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

June 30, 2005 and September 30, 2004

 

    

June 30,

2005


    September 30,
2004


     (unaudited)      

LIABILITIES & STOCKHOLDERS’ EQUITY

              

CURRENT LIABILITIES

              

Accounts Payable

   $ 6,445,710     $ 5,491,629

Accrued Expenses

     6,470,171       13,893,662

Capital Leases Payable

     34,179       35,119

Billings in Excess of Revenue

     7,748,940       5,581,124

Income Taxes Payable

     0       672,148
    


 

TOTAL CURRENT LIABILITIES

     20,699,000       25,673,682
    


 

LONG TERM LIABILITIES

              

Capital Leases Payable

     0       25,119

Deferred Income Taxes

     1,428,340       1,428,344
    


 

TOTAL LONG TERM LIABILITIES

     1,428,340       1,453,463

STOCKHOLDERS’ EQUITY

              

Common Stock, $.01 par value, 40,000,000 shares authorized, and 10,406,613 and 9,944,494 shares issued and outstanding at June 30, 2005 and September 30, 2004, respectively

     104,066       99,445

Additional Paid-in Capital

     89,749,659       81,201,927

Retained Earnings

     27,791,521       24,010,558

Accumulated Other Comprehensive Income

     (5,391 )     27,366
    


 

TOTAL STOCKHOLDERS’ EQUITY

     117,639,855       105,339,296
    


 

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY

   $ 139,767,195     $ 132,466,441
    


 

 

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Table of Contents

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

    

Three Months Ended

June 30,


   

Nine Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Revenue

   $ 25,378,591     $ 22,632,229     $ 70,644,893     $ 65,194,551  

Cost of Revenue

                                

Direct Labor

     5,918,188       5,057,792       16,073,603       14,328,836  

Overhead Costs

     4,726,979       3,462,270       13,016,367       10,653,469  

Travel and Other Direct Costs

     568,555       580,638       1,738,271       1,801,414  

Direct Equipment & Subcontracts

     6,819,565       6,329,565       18,004,785       16,640,383  
    


 


 


 


Total Cost of Revenue

     18,033,287       15,430,265       48,833,026       43,424,102  
    


 


 


 


Gross Margin

     7,345,304       7,201,964       21,811,867       21,770,449  

Selling, General & Administrative

     3,383,394       3,273,869       10,268,346       9,359,032  

Research & Development

     618,852       960,666       1,871,850       2,667,158  

Product Amortization

     645,409       761,381       1,936,225       2,284,143  

Intangible Asset Amortization

     68,750       68,750       206,250       713,279  
    


 


 


 


Income From Operations

     2,628,899       2,137,298       7,529,196       6,746,837  

Other Income (Expense)

                                

Interest Income

     347,644       139,611       818,871       449,020  

Interest Expense

     (1,138 )     (1,585 )     (4,211 )     (5,730 )

Gain on Sale of Marketable Securities

     0       0       49,997       21,439  

Miscellaneous, net

     (105,180 )     (108,434 )     (525,237 )     (392,397 )
    


 


 


 


Total Other Income

     241,326       29,592       339,420       72,332  

Income Before Income Tax

     2,870,225       2,166,890       7,868,616       6,819,169  

Provision for Income Taxes

     1,006,575       782,472       2,770,109       2,480,705  
    


 


 


 


Net Income

   $ 1,863,650     $ 1,384,418     $ 5,098,507     $ 4,338,464  
    


 


 


 


Weighted Avg. Number of Common Shares:

                                

Basic

     10,392,973       9,950,330       10,232,203       9,879,034  

Diluted

     10,629,952       10,099,956       10,424,185       10,053,256  

Earnings per Share (Basic)

   $ 0.18     $ 0.14     $ 0.50     $ 0.44  

Earnings per Share (Diluted)

   $ 0.18     $ 0.14     $ 0.49     $ 0.43  

 

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Table of Contents

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED JUNE 30, 2005

(Unaudited)

 

    

Number

of

Shares


   

Common
Stock

At Par
Value


    Additional
Paid-in
Capital


    Retained
Earnings


    Accumulated
Other
Comprehensive
Income


    Total

 

Balance September 30, 2004

   9,944,494     $ 99,445     $ 81,201,927     $ 24,010,558     $ 27,366     $ 105,339,296  

Net Income

   —         —         —         5,098,507       —         5,098,507  

Unrealized Loss on Marketable Securities (net of deferred tax of $9,129)

   —         —         —         —         (14,281 )     (14,281 )

Unrealized Gain on Foreign Currency Exchange Contracts

   —         —         —         —         20,843       20,843  

Effect of Currency Translation

   —         —         —         —         (39,319 )     (39,319 )
                                          


Total Comprehensive Income

   —         —         —         —         —         5,065,750  

Repurchased Shares

   (8,100 )     (81 )     (62,663 )     (82,726 )     —         (145,470 )

Shares Issued for FY04 RT Logic Earnout

   230,349       2,303       4,184,059       —         —         4,186,362  

Stock Options Exercised

   239,870       2,399       4,426,336       —         —         4,428,735  

Declared Dividends

   —         —         —         (1,234,818 )     —         (1,234,818 )
    

 


 


 


 


 


Balance June 30, 2005

   10,406,613     $ 104,066     $ 89,749,659     $ 27,791,521     $ (5,391 )   $ 117,639,855  
    

 


 


 


 


 


 

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Table of Contents

INTEGRAL SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended June 30, 2005 and 2004

(Unaudited)

 

    

For the Nine Months Ended

June 30,


 
     2005

    2004

 

Cash flows from operating activities:

                

Net income

   $ 5,098,507     $ 4,338,464  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation and amortization

     3,328,093       4,269,085  

Reserve for doubtful accounts

     (20,000 )     65,325  

Gain on sale of marketable securities

     (49,997 )     (21,439 )

Loss on disposal of fixed assets

     40,395       42,661  

Changes in operating assets and liabilities, net:

                

Accounts receivable and other receivables

     2,548,296       (576,663 )

Prepaid expenses and deposits

     113,619       (217,744 )

Inventories

     (1,130,256 )     (625,263 )

Accounts payable

     929,035       (27,975 )

Accrued expenses

     (3,254,325 )     (3,473,282 )

Billings in excess of revenue

     2,167,816       (1,447,174 )

Income taxes payable

     (1,405,636 )     (370,722 )
    


 


Total adjustments

     3,267,040       (2,383,191 )
    


 


Net cash provided by operating activities

     8,365,547       1,955,273  
    


 


Cash flows from investing activities:

                

Purchases of marketable securities

     —         (649,807 )

Sale of marketable securities

     1,135,983       169,837  

Issuance of notes receivable

     (54,906 )     —    

Proceeds from payments on notes receivable

     139,605       92,605  

Acquisition of fixed assets

     (1,207,258 )     (831,318 )

Software development costs

     (591,451 )     (1,510,467 )
    


 


Net cash (used in) investing activities

     (578,027 )     (2,729,150 )
    


 


Cash flows from financing activities:

                

Proceeds from issuance of common stock

     4,428,735       444,871  

Stock repurchases

     (145,470 )     (237,836 )

Dividend payments

     (1,234,818 )     —    

Capital lease obligation payments

     (26,059 )     (23,945 )
    


 


Net cash provided by financing activities

     3,022,388       183,090  
    


 


Effect of currency translations

     (39,319 )     93,832  

Net increase in cash

     10,809,908       (590,787 )

Cash – beginning of year

     18,198,832       22,526,718  
    


 


Cash - end of period

   $ 28,969,421     $ 22,029,763  
    


 


 

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Table of Contents

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Basis of Presentation

 

The interim financial statements include the accounts of Integral Systems, Inc. (the “Company”) and its wholly owned subsidiaries, SAT Corporation (“SAT”), Newpoint Technologies, Inc. (“Newpoint”), Real Time Logic, Inc. (“RT Logic”), and Integral Systems Europe (“ISI Europe”). All significant intercompany accounts and transactions have been eliminated in consolidation.

 

In the opinion of management, the financial statements reflect all adjustments consisting only of normal recurring accruals necessary for a fair presentation of results for such periods. The financial statements, which are condensed and do not include all disclosures included in the annual financial statements, should be read in conjunction with the consolidated financial statements of the Company for the fiscal year ended September 30, 2004. The results of operations for any interim period are not necessarily indicative of results for the full year.

 

2. Accounts Receivable

 

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

 

     June 30, 2005

    Sept. 30, 2004

 

Billed

   $ 14,453,844     $ 15,117,607  

Unbilled

     22,657,058       24,467,186  

Other

     112,807       193,722  

Reserve

     (130,000 )     (150,000 )
    


 


Total

   $ 37,093,709     $ 39,628,515  
    


 


 

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

 

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

 

In June 2004, the Company filed a claim in the amount of approximately $1.8 million against the National Oceanic Atmospheric Administration (NOAA) of the U.S. Department of Commerce. The claim arose under a contract with NOAA to provide the Data Collection System Automated Processing System II (DAPS-II System). During the three months ended June 30, 2005, the Company filed a second but unrelated claim under the same contract for an additional $320,000. As of June 30, 2005, unbilled accounts receivable included approximately $1.3 million associated with the claims.

 

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Table of Contents

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

3. Line of Credit

 

The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5% to 2.4% based on the ratio of funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable, inventory, equipment and insurance proceeds and has certain financial covenants, including minimum net worth and liquidity ratios. The Company had no balance outstanding at June 30, 2005 under the line of credit. The line of credit expires on February 28, 2007.

 

The Company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $34,200 at June 30, 2005. The outstanding balance is payable over a 11-month period and bears interest at a rate of 8.8% per annum.

 

4. Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) 123 (Revised 2004), Shared-Based Payment. Revised SFAS 123 addresses the requirements of an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which an employee is required to provide services in exchange for the award. The Company will be required to adopt this Statement during the first quarter of fiscal year 2006 and is currently evaluating the impact that this pronouncement will have on its future operations and financial reporting.

 

5. Stock-Based Compensation

 

The Company recognizes expense for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, compensation cost is recognized for the excess of the estimated fair value of the stock at the grant date over the exercise price, if any.

 

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Table of Contents

The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the three and nine months ended June 30, 2005 and 2004 is as follows:

 

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

5. Stock-Based Compensation (continued)

 

    

Three Months Ended

June 30,


  

Nine Months Ended

June 30,


     2005

   2004

   2005

   2004

Net income, as reported

   $ 1,863,650    $ 1,384,418    $ 5,098,507    $ 4,338,464

Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards

     386,914      398,486      1,275,654      1,231,970

Add: Stock-based employee compensation included in net income

     —        —        —        —  

Pro forma net income

   $ 1,476,736    $ 985,932    $ 3,822,853    $ 3,106,494

Earnings per share:

                           

As reported - basic

   $ 0.18    $ 0.14    $ 0.50    $ 0.44

 - diluted

   $ 0.18    $ 0.14    $ 0.49    $ 0.43

Pro forma    - basic

   $ 0.14    $ 0.10    $ 0.37    $ 0.31

 - diluted

   $ 0.14    $ 0.10    $ 0.37    $ 0.31

 

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

 

6. Business Segment Information

 

Effective October 1, 2004, the Company reorganized its operations into four reportable segments. The primary purpose of the reorganization was to place the Company’s commercially oriented operations under common marketing and management leadership and to more efficiently sell and promote its products to common customers. The four segments are:

 

    Ground Systems - Government

 

    Ground Systems - Commercial

 

    Space Communications Systems

 

    Corporate

 

The Ground Systems – Government segment provides ground systems products and services to the U.S. Government. It is currently the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force and NOAA.

 

The Ground Systems – Commercial segment provides ground systems products and services to commercial enterprises and international governments and organizations. It consists of the Company’s core command and control business for commercial applications and three of the Company’s wholly owned subsidiaries as follows:

 

    SAT and Newpoint, acquired by the Company in August 2000 and January 2002, respectively, offer complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring and control and satellite data processing.

 

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Table of Contents

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

6. Business Segment Information (continued)

 

    ISI Europe, the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business.

 

The Space Communications Systems segment, consisting exclusively of the Company’s wholly owned subsidiary, RT Logic, designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range operations.

 

The Corporate segment is the Company’s “all other” segment. It includes the Company’s Product Division, which is responsible for the Company’s core command and control product line (EPOCH IPS); business areas in the development stage and businesses being disbanded (the Company’s Antenna Division, the Company’s Skylight product, and the Company’s Integration and Test (I&T) Division). The Product Division licenses the Company’s EPOCH IPS product line to other operating segments and to third party customers. It is also the segment responsible for EPOCH IPS maintenance and support revenue and expenses.

 

The Company evaluates the performance of each segment based on operating income. There are no inter-segment allocations of overhead.

 

On November 17, 2004, the Company disposed of the intellectual property rights, inventory and certain other assets of the Antenna Division to LJT & Associates, Inc. of Montgomery, Alabama (“LJT”), effective as of November 1, 2004. As consideration, LJT agreed to pay the Company $215,000 and executed a promissory note requiring payment of that sum in eight equal installments of $26,875 due on each July 1 and January 1 beginning on July 1, 2005. As additional consideration, LJT agreed to make future contingent payments to the Company for the period beginning November 1, 2004 through December 31, 2006. The contingent payments are calculated every December 31 beginning December 31, 2005 based on pretax income as defined in the acquisition agreement. Under the acquisition agreement, the Company will continue to fulfill its obligations under existing customer contracts but will engage LJT as a subcontractor to perform the actual work. The Company did not record a material gain or a loss as a result of this transaction.

 

In addition, the Company loaned LJT $100,000 to assist with initial expenses arising from use of the acquired assets in operations. LJT executed a promissory note requiring payment of that sum in installments to coincide with milestone payments on a certain contract. The Company disbursed the loan to LJT by issuing a cash disbursement in the amount of $54,906, which represents the loan balance after deducting the net assumed obligations with an aggregate total of $45,094.

 

On April 28, 2005, RT Logic Tract TT2, LLC, a newly-formed and wholly-owned subsidiary of RT Logic, entered into a Purchase Agreement with Northgate Properties, LLC to purchase 10.373 acres of real property in Colorado Springs, Colorado for a purchase price of approximately $2.3 million, which will be paid in full at closing. The closing of the transaction is expected to occur before the end of the fiscal year, subject to due diligence review and customary closing conditions. RT Logic intends to construct its new headquarters on this property.

 

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Table of Contents

INTEGRAL SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

6. Business Segment Information (continued)

 

Summarized financial information by business segment is as follows:

 

    

Three Months
Ended

June 30, 2005


   

Three Months
Ended

June 30, 2004


   

Nine Months
Ended

June 30, 2005


   

Nine Months
Ended

June 30, 2004


 

Revenue

                                

Ground Systems–Government

   $ 12,596,099     $ 12,037,703     $ 33,097,759     $ 32,411,231  

Ground Systems–Government intersegment

     —         250,252       —         250,252  

Ground Systems–Commercial

     4,862,193       4,253,005       13,305,411       12,871,551  

Ground Systems–Commercial intersegment

     128,116       7,180       281,515       15,111  

Space Communication Systems

     7,228,607       5,048,215       21,076,378       15,588,698  

Space Communication Systems intersegment

     901,184       1,174,342       2,415,866       2,005,129  

Corporate

     691,692       1,293,306       3,165,345       4,323,071  

Corporate intersegment

     847,417       958,694       2,653,989       3,461,040  

Elimination of intersegment sales

     (1,876,717 )     (2,390,468 )     (5,351,370 )     (5,731,532 )
    


 


 


 


Total Revenue

   $ 25,378,591     $ 22,632,229     $ 70,644,893     $ 65,194,551  
    


 


 


 


Operating Income

                                

Ground Systems–Government

   $ 980,313     $ 1,360,069     $ 2,763,634     $ 3,457,859  

Ground Systems–Government intersegment

     —         —         —         —    

Ground Systems–Commercial

     419,527       (202,022 )     392,675       (115,253 )

Ground Systems–Commercial intersegment

     (6,134 )     26       (22,264 )     (461 )

Space Communication Systems

     2,349,173       1,834,419       6,692,232       5,619,073  

Space Communication Systems intersegment

     (6,100 )     (547 )     1,193       (547 )

Corporate

     (1,120,114 )     (855,168 )     (2,319,345 )     (2,214,842 )

Corporate intersegment

     (422 )     2,206       (10,450 )     (1,307 )

Elimination of intersegment Operating Income

     12,656       (1,685 )     31,521       2,315  
    


 


 


 


Total Operating Income

   $ 2,628,899     $ 2,137,298     $ 7,529,196     $ 6,746,837  
    


 


 


 


Total Assets

                                

Ground Systems–Government

   $ 18,725,638     $ 21,168,555     $ 18,725,638     $ 21,168,555  

Ground Systems–Commercial

     13,468,004       12,170,512       13,468,004       12,170,512  

Space Communication Systems

     49,435,938       44,442,590       49,435,938       44,442,590  

Corporate

     71,025,955       58,450,937       71,025,955       58,450,937  

Elimination of intersegment accounts receivable

     (12,888,340 )     (14,114,683 )     (12,888,340 )     (14,114,683 )
    


 


 


 


Total Assets

   $ 139,767,195     $ 122,117,911     $ 139,767,195     $ 122,117,911  
    


 


 


 


 

 

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Table of Contents

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

 

Overview

 

Integral Systems, Inc. (the “Company”) builds satellite ground systems and equipment for command and control, integration and test, data processing, and simulation. Since its inception in 1982, the Company has provided ground systems for over 190 different satellite missions for communications, science, meteorology, and earth resource applications. The Company has an established domestic and international customer base that includes government and commercial satellite operators, spacecraft and payload manufacturers, and aerospace systems integrators.

 

The Company has developed innovative software products that reduce the cost and minimize the development risk associated with traditional custom-built systems. The Company believes that it was the first to offer a comprehensive commercial off-the-shelf (“COTS”) software product line for command and control. As a systems integrator, the Company leverages these products to provide turnkey satellite control facilities that can operate multiple satellites from any manufacturer. These systems offer significant cost savings for customers that have traditionally purchased a separate custom control center for each of their satellites.

 

Effective October 1, 2004, the Company reorganized its operations into four reportable segments. The primary purpose of the reorganization was to place the Company’s commercially oriented operations under common marketing and management leadership and to more efficiently sell and promote its products to common customers. The four segments are:

 

Ground Systems – Government

 

This segment provides ground systems products and services to the U.S. Government. It is the Company’s largest segment in terms of revenue and consists of the Company’s core command and control business for government applications. Its primary customers are the U.S. Air Force and the National Oceanic Atmospheric Administration (NOAA).

 

Ground Systems – Commercial

 

This segment provides ground systems products and services to commercial enterprises and international governments and organizations. It consists of the Company’s core command and control business for commercial applications and three of the Company’s wholly owned subsidiaries as follows:

 

SAT Corporation (“SAT”) and Newpoint Technologies, Inc. (“Newpoint”), acquired by the Company in August 2000 and January 2002, respectively, offer complementary ground system components and systems. This includes turnkey systems, hardware and software for satellite and terrestrial communications signal monitoring, network and ground equipment monitoring, and control and satellite data processing.

 

Integral Systems Europe (“ISI Europe”), the Company’s wholly owned subsidiary formed in March 2001, with headquarters in Toulouse, France, serves as the focal point for the support of all of the Company’s European business.

 

Space Communications Systems

 

This segment, consisting exclusively of the Company’s wholly owned subsidiary, Real Time Logic, Inc. (“RT Logic”), designs and builds satellite communications equipment and systems, principally for military applications. This equipment is used in satellite tracking stations, control centers, spacecraft factories and range operations.

 

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Table of Contents

Corporate

 

This segment is the Company’s “all other” segment. It includes the Company’s Product Division, which is responsible for the Company’s core command and control product line (EPOCH IPS); business areas in the development stage and businesses being disbanded (the Company’s Antenna Division, the Company’s Skylight product and the Company’s Integration and Test (I&T) Division). The Product Division licenses the Company’s EPOCH IPS product line to other operating segments and to third party customers. It is also the segment responsible for EPOCH IPS maintenance and support revenue and expenses.

 

All intra-segment and inter-segment revenues and expenses have been eliminated in consolidation as appropriate. Operating results for periods prior to October 1, 2004 have been reclassified for comparative purposes. In order to provide year to year reporting continuity, the Company has elected to provide additional disclosures for SAT and Newpoint through the end of fiscal year 2005.

 

Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) 123 (Revised 2004), “Shared-Based Payment”. Revised SFAS 123 addresses the requirements of an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which an employee is required to provide services in exchange for the award. The Company will be required to adopt this Statement during the first quarter of fiscal year 2006 and is currently evaluating the impact that this pronouncement will have on its future operations and financial reporting

 

 

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Table of Contents

COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2005 AND 2004

 

Results of Operations

 

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the three months ended June 30, 2005 and 2004:

 

     Three Months Ended June 30,

     2005

   % of
Revenue


   2004

   % of
Revenue


     (in thousands)         (in thousands)     

Revenue

   $ 25,379    100.0    $ 22,632    100.0

Cost of Revenue

     18,034    71.1      15,430    68.2
    

  
  

  

Gross Margin

     7,345    28.9      7,202    31.8

Operating Expenses

                       

Selling, General & Admin. (SG&A)

     3,383    13.3      3,274    14.5

Research and Development

     619    2.4      961    4.2

Product Amortization

     645    2.5      761    3.4

Amortization-Intangible Assets

     69    0.3      69    0.3
    

  
  

  

Income from Operations

     2,629    10.4      2,137    9.4

Other Income (Expense) (net)

     241    0.9      30    0.2
    

  
  

  

Income Before Income Taxes

     2,870    11.3      2,167    9.6

Income Taxes

     1,006    4.0      783    3.5
    

  
  

  

Net Income

   $ 1,864    7.3    $ 1,384    6.1
    

  
  

  

 

Revenue

 

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

 

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

 

    

Three Months Ended

June 30,


 

Revenue Type


   2005

    2004

 

U.S. Government Revenue (all segments)

            

NOAA

   6 %   15 %

U.S. Air Force

   58     56  

Other U.S. Government Users

   12     6  
    

 

Subtotal

   76     77  

Commercial Revenue (all segments)

   24     23  
    

 

Total

   100 %   100 %
    

 

 

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Table of Contents

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

 

    

Three Months Ended

June 30,


   

Increase/
(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Revenue

                        

Ground Systems – Government

   $ 12,596     $ 12,288     $ 308  

Ground Systems – Commercial

                        

Command & Control

     3,157       2,701       456  

Newpoint

     914       646       268  

SAT

     1,173       992       181  

Intra-Segment Elimination

     (254 )     (79 )     (175 )
    


 


 


Ground Systems – Commercial

     4,990       4,260       730  
    


 


 


Space Communications Systems

     8,130       6,223       1,907  

Corporate

                        

Product Group

     851       1,134       (283 )

Antenna

     322       218       104  

I&T

     —         627       (627 )

Other

     366       273       93  
    


 


 


Corporate

     1,539       2,252       (713 )
    


 


 


Elimination

     (1,876 )     (2,391 )     515  
    


 


 


Total Revenue

   $ 25,379     $ 22,632     $ 2,747  
    


 


 


 

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

 

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

 

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

 

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

 

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

 

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Antenna Division revenues increased approximately $100,000 for the three months ended June 30, 2005 compared to the three months ended June 30, 2004 primarily because of the Company’s on-going contract with the Malaysian military for the delivery of two antenna systems.

 

The Company disbanded its I&T Division during the fourth quarter of fiscal year 2004 and accordingly, no revenues were recorded for this division during the third quarter of fiscal year 2005.

 

Cost of Revenue/Gross Margin

 

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

 

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

 

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

 

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Table of Contents
    

Three Months Ended

June 30,


   

Increase/

(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Cost of Revenue

                        

Ground Systems – Government

   $ 10,254     $ 9,762     $ 492  

Ground Systems – Commercial

                        

Command & Control

     2,455       2,250       205  

Newpoint

     477       264       213  

SAT

     691       541       150  

Intra-Segment Elimination

     (249 )     (67 )     (182 )
    


 


 


Ground Systems – Commercial

     3,374       2,988       386  
    


 


 


Space Communications Systems

     4,388       3,179       1,209  

Corporate

                        

Product Group

     836       479       357  

Antenna

     703       691       12  

I&T

     —         475       (475 )

Other

     351       230       121  
    


 


 


Corporate

     1,890       1,875       15  
    


 


 


Elimination

     (1,872 )     (2,374 )     502  
    


 


 


Total Cost of Revenue

   $ 18,034     $ 15,430     $ 2,604  
    


 


 


Gross Margin

                        

Ground Systems – Government

   $ 2,342     $ 2,526     $ (184 )

Ground Systems – Commercial

                        

Command & Control

     702       451       251  

Newpoint

     437       382       55  

SAT

     482       451       31  

Intra-Segment Elimination

     (5 )     (12 )     7  
    


 


 


Ground Systems – Commercial

     1,616       1,272       344  
    


 


 


Space Communications Systems

     3,742       3,044       698  

Corporate

                        

Product Group

     15       655       (640 )

Antenna

     (381 )     (473 )     92  

I&T

     —         152       (152 )

Other

     15       43       (28 )
    


 


 


Corporate

     (351 )     377       (728 )
    


 


 


Elimination

     (4 )     (17 )     13  
    


 


 


Total Gross Margin

   $ 7,345     $ 7,202     $ 143  
    


 


 


 

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Table of Contents

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

 

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

 

The Space Communications System segment experienced an increase in gross margin of approximately $700,000 on increased revenue of $1.9 million for the three months ended June 30, 2005 compared to the three months ended June 30, 2004. The segment’s gross margin percentage declined from 48.9% for the three months ended June 30, 2004 to 46.0% for the three months ended June 30, 2005 due to a considerably greater mix of third party equipment costs in the segment’s cost of revenue in the current quarter than in the three months ended June 30, 2004. Similar to the Company’s other business segments, the Space Communications Systems segment typically earns less gross margin on third party equipment purchases than on other cost elements.

 

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

 

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

 

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

 

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Table of Contents

Operating Expenses

 

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

 

    

Three Months Ended

June 30,


   

Increase/
(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Operating Expenses

                        

Ground Systems – Government

   $ 1,361     $ 1,165     $ 196  

Ground Systems – Commercial

                        

Command & Control

     342       325       17  

Newpoint

     411       371       40  

SAT

     472       778       (306 )

Intra-Segment Elimination

     (22 )     (1 )     (21 )
    


 


 


Ground Systems – Commercial

     1,203       1,473       (270 )
    


 


 


Space Communications Systems

     1,399       1,210       189  

Corporate

                        

Product Group

     799       936       (137 )

Antenna

     18       75       (57 )

I&T

     —         179       (179 )

Other

     (47 )     41       (88 )
    


 


 


Corporate

     770       1,231       (461 )
    


 


 


Elimination

     (17 )     (15 )     (2 )
    


 


 


Total Operating Expenses

   $ 4,716     $ 5,064     $ (348 )
    


 


 


 

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

 

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

 

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

 

Operating expenses in the Corporate segment for the three months ended June 30, 2005 decreased by approximately $460,000 compared to the three months ended June 30, 2004 principally due to the closure of the I&T Division, the sale of operating assets of the Antenna Division in November 2004 and reduced product related selling expenses.

 

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Table of Contents

Income from Operations

 

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

 

    

Three Months Ended

June 30,


   

Increase/

(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Income from Operations

                        

Ground Systems – Government

   $ 981     $ 1,361     $ (380 )

Ground Systems – Commercial

                        

Command & Control

     360       126       234  

Newpoint

     26       11       15  

SAT

     10       (327 )     337  

Intra-Segment Elimination

     17       (11 )     28  
    


 


 


Ground Systems – Commercial

     413       (201 )     614  
    


 


 


Space Communications Systems

     2,343       1,834       509  

Corporate

                        

Product Group

     (784 )     (281 )     (503 )

Antenna

     (399 )     (548 )     149  

I&T

     —         (27 )     27  

Other

     62       2       60  
    


 


 


Corporate

     (1,121 )     (854 )     (267 )
    


 


 


Elimination

     13       (2 )     15  
    


 


 


Total Income from Operations

   $ 2,629     $ 2,138     $ 491  
    


 


 


 

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

 

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

 

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

 

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

 

Operating losses in the Antenna Division have been reduced due to the sale of the unit’s assets, while operating losses at the I&T Division have been eliminated due to the shutdown of that unit.

 

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Table of Contents

Other Income/Expense

 

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

 

Income Before Income Taxes/Net Income

 

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

 

The Company’s effective tax rate decreased from 36.1% for the three months ended June 30, 2004 to 35.1% for the three months ended June 30, 2005 principally due to a higher percentage of tax exempt income compared to total income before income taxes in the current period.

 

As a result of the above, net income increased to approximately $1.86 million during the three months ended June 30, 2005 from $1.38 million during the three months ended June 30, 2004.

 

COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 2005 AND 2004

 

Results of Operations

 

The components of the Company’s income statement as a percentage of revenue are depicted in the following table for the nine months ended June 30, 2005 and 2004:

 

     Nine Months Ended June 30,

     2005

   % of
Revenue


   2004

   % of
Revenue


     (in thousands)         (in thousands)     

Revenue

   $ 70,645    100.0    $ 65,195    100.0

Cost of Revenue

     48,833    69.1      43,424    66.6
    

  
  

  

Gross Margin

     21,812    30.9      21,771    33.4

Operating Expenses

                       

Selling, General & Admin. (SG&A)

     10,269    14.5      9,359    14.4

Research and Development

     1,872    2.6      2,668    4.1

Product Amortization

     1,936    2.7      2,284    3.5

Amortization-Intangible Assets

     206    0.4      713    1.1
    

  
  

  

Income from Operations

     7,529    10.7      6,747    10.3

Other Income (Expense) (net)

     340    0.4      72    0.2
    

  
  

  

Income Before Income Taxes

     7,869    11.1      6,819    10.5

Income Taxes

     2,770    3.9      2,481    3.8
    

  
  

  

Net Income

   $ 5,099    7.2    $ 4,338    6.7
    

  
  

  

 

Revenue

 

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

 

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Table of Contents

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

 

     Nine Months Ended
June 30,


 

Revenue Type


   2005

    2004

 

U.S. Government Revenue (all segments)

            

NOAA

   9 %   16 %

U.S. Air Force

   54     54  

Other U.S. Government Users

   12     6  
    

 

Subtotal

   75     76  

Commercial Revenue (all segments)

   25     24  
    

 

Total

   100 %   100 %
    

 

 

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

 

    

Nine Months Ended

June 30,


   

Increase/

(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Revenue

                        

Ground Systems – Government

   $ 33,098     $ 32,662     $ 436  

Ground Systems – Commercial

                        

Command & Control

     8,846       8,275       571  

Newpoint

     2,490       2,028       462  

SAT

     2,733       3,450       (717 )

Intra-Segment Elimination

     (482 )     (867 )     385  
    


 


 


Ground Systems – Commercial

     13,587       12,886       701  
    


 


 


Space Communications Systems

     23,492       17,594       5,898  

Corporate

                        

Product Group

     2,726       3,414       (688 )

Antenna

     2,100       1,362       738  

I&T

     —         1,992       (1,992 )

Other

     993       1,016       (23 )
    


 


 


Corporate

     5,819       7,784       (1,965 )
    


 


 


Elimination

     (5,351 )     (5,732 )     381  
    


 


 


Total Revenue

   $ 70,645     $ 65,194     $ 5,451  
    


 


 


 

Revenue increases in the Company’s Ground Systems—Government segment between the nine months ended June 30, 2005 and 2004 primarily relate to increased sales from the Company’s contracts with the U.S. Air Force partially offset by revenue decreases from NOAA.

 

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Table of Contents

Revenue increases in the Company’s Ground Systems – Commercial segment (other than SAT) resulted from increased backlog and increased product shipments to customers. SAT’s revenue decrease relates to decreased order shipments and order delays experienced during the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004.

 

Revenue increases in the Company’s Space Communications Systems segment resulted from increased backlog and increased product shipments to customers.

 

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

 

Antenna Division revenues increased approximately $740,000 between the periods being compared primarily because of the Company’s on-going contract with the Malaysian military for the delivery of two antenna systems.

 

The Company disbanded its I&T Division during the fourth quarter of fiscal year 2004 and accordingly, no revenues were recorded for this division during the nine months ended June 30, 2005.

 

Cost of Revenue/Gross Margin

 

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

 

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

 

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

 

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Table of Contents
    

Nine Months Ended

June 30,


   

Increase/

(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Cost of Revenue

                        

Ground Systems – Government

   $ 26,124     $ 26,008     $ 116  

Ground Systems – Commercial

                        

Command & Control

     6,848       6,871       (23 )

Newpoint

     1,258       873       385  

SAT

     1,754       2,054       (300 )

Intra-Segment Elimination

     (436 )     (858 )     422  
    


 


 


Ground Systems – Commercial

     9,424       8,940       484  
    


 


 


Space Communications Systems

     13,175       8,004       5,171  

Corporate

                        

Product Group

     1,732       1,448       284  

Antenna

     2,725       2,143       582  

I&T

     —         1,622       (1,622 )

Other

     960       948       12  
    


 


 


Corporate

     5,417       6,161       (744 )
    


 


 


Elimination

     (5,307 )     (5,689 )     382  
    


 


 


Total Cost of Revenue

   $ 48,833     $ 43,424     $ 5,409  
    


 


 


Gross Margin

                        

Ground Systems – Government

   $ 6,974     $ 6,654     $ 320  

Ground Systems – Commercial

                        

Command & Control

     1,998       1,404       594  

Newpoint

     1,232       1,155       77  

SAT

     979       1,396       (417 )

Intra-Segment Elimination

     (46 )     (9 )     (37 )
    


 


 


Ground Systems – Commercial

     4,163       3,946       217  
    


 


 


Space Communications Systems

     10,317       9,590       727  

Corporate

                        

Product Group

     994       1,966       (972 )

Antenna

     (625 )     (781 )     156  

I&T

     —         370       (370 )

Other

     33       68       (35 )
    


 


 


Corporate

     402       1,623       (1,221 )
    


 


 


Elimination

     (44 )     (43 )     (1 )
    


 


 


Total Gross Margin

   $ 21,812     $ 21,770     $ 42  
    


 


 


 

 

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Table of Contents

The higher gross margin for the Company’s Ground Systems - Government segment is primarily attributable to lower equipment and subcontract costs incurred during the current nine-month period. As a result, gross margin as a percentage of revenue for the Ground Systems - Government segment increased from 20.4% for the nine months ended June 30, 2004 to 21.1% for the nine months ended June 30, 2005.

 

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

 

Gross margin in the Space Communications System increased by approximately $730,000 during the periods being compared on increased revenue of approximately $5.9 million. The segment’s gross margin percentage declined from 54.5% for the nine months ended June 30, 2004 to 43.9% for the nine months ended June 30, 2005 due to a considerably greater mix of third party equipment costs in the segment’s cost of revenue in the nine months ended June 30, 2005 than in the nine months ended June 30, 2004. Similar to the Company’s other business segments, the Space Communications Systems segment typically earns less gross margin on third party equipment purchases than on other cost elements. Further, the segment had an unusually high percentage of production type revenue in the nine months ended June 30, 2004. Generally, production type contracts generate higher gross margins due to increased efficiencies for this segment as compared to non-production oriented jobs.

 

In the Corporate segment, the Product Group experienced a decrease in gross margin of approximately $970,000 on a period-to-period basis because of decreased license revenue. Further, effective with the beginning of the current quarter, the Company determined that its EPOCH IPS product line was substantially complete and therefore costs associated with the product were no longer eligible for capitalization. The costs of software bug fixes and support were higher in the current nine month period than similar costs incurred during the nine months ended June 30, 2004, thereby further contributing to the lower gross margin.

 

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

 

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

 

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Operating Expenses

 

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

 

    

Nine Months Ended

June 30,


   

Increase/

(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Operating Expenses

                        

Ground Systems – Government

   $ 4,210     $ 3,195     $ 1,015  

Ground Systems – Commercial

                        

Command & Control

     1,267       990       277  

Newpoint

     1,119       1,126       (7 )

SAT

     1,460       1,947       (487 )

Intra-Segment Elimination

     (53 )     (1 )     (52 )
    


 


 


Ground Systems – Commercial

     3,793       4,062       (269 )
    


 


 


Space Communications Systems

     3,623       3,971       (348 )

Corporate

                        

Product Group

     2,554       2,928       (374 )

Antenna

     100       230       (130 )

I&T

     —         663       (663 )

Other

     78       20       58  
    


 


 


Corporate

     2,732       3,841       (1,109 )
    


 


 


Elimination

     (75 )     (46 )     (29 )
    


 


 


Total Operating Expenses

   $ 14,283     $ 15,023     $ (740 )
    


 


 


 

Operating expenses in the Company’s Ground Systems – Government segment increased by approximately $1.02 million for the nine months ended June 30, 2005 compared to the nine months ended June 30, 2004 due to increased bid and proposal expenses related to the Company’s recently announced RAIDRS contract with the U.S. Air Force.

 

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

 

The Space Communications Systems segment’s operating expenses for the nine months ended June 30, 2005 decreased approximately $350,000 compared to the nine months ended June 30, 2004. Amortization expense decreased approximately $510,000 resulting from certain intangible assets being fully amortized at June 30, 2004. Although SG&A expenses increased by approximately $530,000 on a period to period basis, R&D spending was lower by approximately $370,000 accounting for most of the remaining decline in operating expenses.

 

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Operating expenses in the Corporate segment decreased by approximately $1.1 million principally due to the closure of the I&T Division, the sale of operating assets of the Antenna Division in November 2004 and reduced product related selling expenses.

 

Income from Operations

 

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

 

    

Nine Months Ended

June 30,


   

Increase/

(Decrease)


 

Segment


   2005

    2004

   
     (in thousands)     (in thousands)     (in thousands)  

Income from Operations

                        

Ground Systems – Government

   $ 2,764     $ 3,459     $ (695 )

Ground Systems – Commercial

                        

Command & Control

     731       414       317  

Newpoint

     113       29       84  

SAT

     (481 )     (551 )     70  

Intra-Segment Elimination

     7       (8 )     15  
    


 


 


Ground Systems – Commercial

     370       (116 )     486  
    


 


 


Space Communications Systems

     6,694       5,619       1,075  

Corporate

                        

Product Group

     (1,560 )     (962 )     (598 )

Antenna

     (725 )     (1,011 )     286  

I&T

     —         (293 )     293  

Other

     (45 )     48       (93 )
    


 


 


Corporate

     (2,330 )     (2,218 )     (112 )
    


 


 


Elimination

     31       3       28  
    


 


 


Total Income from Operations

   $ 7,529     $ 6,747     $ 782  
    


 


 


 

Income from operations during the periods compared decreased approximately $700,000 in the Company’s Ground Systems – Government segment as a result of increased operating expenses, partially offset by increased gross margin.

 

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

 

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

 

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

 

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coupled with lower license revenue. Although the Product Group recorded losses for the first nine months of the fiscal year, a large portion of the revenue generated in the Company’s ground systems business (both Government and Commercial) is a result of its EPOCH IPS product line, which the Company believes distinctly and favorably distinguishes it from its competitors.

 

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

 

Other Income/Expense

 

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

 

Income Before Income Taxes/Net Income

 

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

 

The Company’s effective tax rate decreased from 36.4% for the nine months ended June 30, 2004 to 35.2% for the nine months ended June 30, 2005 principally due to a higher percentage of tax exempt income compared to total income before income taxes in the current period.

 

As a result, net income increased to approximately $5.1 million during the nine months ended June 30, 2005 from $4.3 million during the nine months ended June 30, 2004.

 

OUTLOOK

 

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

 

At this time, the Company has a backlog of work to be performed and it may receive additional contract awards based on proposals in the pipeline, although the estimated backlog under the Company’s government contracts is not necessarily indicative of revenues that will actually be realized under the contracts. Management believes that operating results for future periods will improve based on the following assumptions:

 

 

    Demand for satellite technology and related products and services will continue to expand; and

 

    Sales of its software products and engineering services will continue to increase.

 

As disclosed in its Form 10-K for the fiscal year ended September 30, 2004, the Company was anticipating that operating results for fiscal year 2005 would be comparable to results recorded for fiscal year 2004. After analyzing its results for the nine months ended June 30, 2005, the Company believes that it is on target to meet or even exceed these goals for fiscal year 2005 in its entirety.

 

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Table of Contents

LIQUIDITY AND CAPITAL RESOURCES

 

Since the Company’s inception in 1982, it has been profitable on an annual basis and has generally financed its working capital needs through internally generated funds, supplemented by borrowings under the Company’s general line of credit facility with a commercial bank and the proceeds from the Company’s initial public offering in 1988. In June 1999, the Company supplemented its working capital position by raising approximately $19.7 million (net) through the private placement of approximately 1.2 million shares of its common stock. In February 2000, the Company raised an additional $40.9 million (net) for use in connection with potential acquisitions and other general corporate purposes through the private placement of 1.4 million additional shares of its common stock. With respect to the capital raised in the private placements, at June 30, 2005, $14.5 million was invested in variable rate State of Maryland debt securities and $13.5 million was invested in Banc of America Securities LLC Auction Rate Securities.

 

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

 

The Company has a line of credit agreement with a local bank for $10.0 million for general corporate purposes. Borrowings under the line are due on demand with interest at the London Inter-Bank Offering Rate (LIBOR), plus a spread of 1.5% to 2.4% based on the ratio of funded debt to earnings before interest, taxes and depreciation (EBITDA). The line of credit is secured by the Company’s billed and unbilled accounts receivable, inventory, equipment, and insurance proceeds and has certain financial covenants, including minimum net worth and liquidity ratios. The Company had no balance outstanding at June 30, 2005 under the line of credit. The line of credit expires on February 28, 2007.

 

The Company also has access to a $2.0 million equipment lease line of credit that had a balance of approximately $34,200 at June 30, 2005. The outstanding balance is payable over an 11-month period and bears interest at a rate of 8.8% per annum.

 

The Company’s Board of Directors declared a cash dividend of $.04 per share to all stockholders of record as of close of business on June 2, 2005. The dividend was paid on June 29, 2005 in the amount of $416,680. In addition, the Company’s Board of Directors declared a cash dividend of $.04 per share to all stockholders of record as of close of business on September 1, 2005. The dividend will be paid on or about September 28, 2005.

 

The Company currently anticipates that its current cash balances, amounts available under its lines of credit and net cash provided by operating activities will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months.

 

The Company believes that inflation did not have a material impact on the Company’s revenues or income from operations during the nine months ended June 30, 2005 or in past fiscal years.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

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

 

FORWARD LOOKING STATEMENTS

 

Certain of the statements contained in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section, in other parts of this quarterly report on Form 10-Q, and in this section,

 

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Table of Contents

including those under the headings “Outlook” and “Liquidity and Capital Resources,” are forward looking. In addition, from time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters. Forward-looking statements can be identified by the use of forward-looking terminology such as “may”, “will”, “believe”, “expect”, “anticipate”, “estimate”, “continue”, or other similar words, including statements as to the intent, belief, or current expectations of the Company and its directors, officers, and management with respect to the Company’s future operations, performance, or positions or which contain other forward-looking information. These forward-looking statements are predictions. No assurances can be given that the future results indicated, whether expressed or implied, will be achieved. The Company’s actual results may differ significantly from the results discussed in the forward-looking statements. While the Company believes that these statements are and will be accurate, a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s statements. The Company’s business is dependent upon general economic conditions and upon various conditions specific to its industry, and future trends cannot be predicted with certainty. Particular risks and uncertainties that may affect the Company’s business, other than those described elsewhere herein or in our other filings with the Securities and Exchange Commission (the “SEC” or the “Commission”), include the following:

 

    A significant portion of the Company’s revenue is derived from contracts or subcontracts funded by the U.S. Government, which are subject to termination without cause, government regulations and audits, competitive bidding, and the budget and funding process of the U.S. Government.

 

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

 

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

 

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

 

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

 

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

 

    With respect to the Company’s acquisition strategy, if the Company is able to identify and acquire one or more businesses, the integration of the acquired business or businesses may be costly and may result in a decrease in the value of the Company’s common stock.

 

    The Company may not adequately assess the risks inherent in a particular acquisition candidate or correctly assess the candidate’s potential contribution to the Company’s financial performance.

 

    The Company may need to divert more management resources to integration of an acquired business than it planned, which may adversely affect its ability to pursue other more profitable activities.

 

    The difficulties of integrating an acquired business may be increased by the necessity of coordinating geographically separated organizations, integrating personnel with disparate backgrounds and combining different corporate cultures.

 

    The Company may not eliminate as many redundant costs as it anticipated in selecting acquisition candidates.

 

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

 

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

 

    The business is subject to risks associated with international transactions.

 

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

 

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

 

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

 

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

 

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Table of Contents

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

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

While the Company currently does not have significant European operations, our customer base is expanding outside the U.S. and therefore certain contracts now and in the future will likely be denominated in currencies other than the U.S. dollar. As a result, the Company’s financial results could be affected by factors such as foreign currency exchange rates for contracts denominated in currencies other than the U.S. dollar. To mitigate the effect of changes in foreign currency exchange rates, the Company may hedge this risk by entering into forward foreign currency contracts. As of June 30, 2005, virtually all of the Company’s contracts are denominated in U.S. dollars. Three contracts were denominated in Euros that were hedged. These contracts are not material to the Company’s financial statements. As the Company enters into new foreign currency based contracts in the future, the Company may employ similar hedging contracts.

 

ITEM 4. CONTROLS AND PROCEDURES

 

  a. Disclosure Controls and Procedures

 

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

 

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Table of Contents
  b. Changes in internal controls

 

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

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None.

 

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

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

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

 

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

 

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

 

Director


   For

   Withheld

Steven R. Chamberlain

   6,540,052    1,541,555

Thomas L. Gough

   6,554,489    1,527,118

Bonnie K. Wachtel

   8,035,918    45,689

Dominic Laiti

   8,036,768    44,839

R. Doss McComas

   7,632,245    449,362

 

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

 

        For        


 

    Against    


 

    Abstain    


 

Broker Non-Votes


5,486,780

  709,759   1,885,068   —  

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

Exhibits

 

10.1    Lease Agreement dated April 20, 2005 by and between Real Time Logic, Inc. and the John J. Gogian Jr. Revocable Trust of 1983.
10.2    Purchase Agreement dated April 28, 2005 by and between RT Logic Tract TT2, LLC and Northgate Properties, LLC.
11.1    Computation of Per Share Earnings.
31.1    Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended.
31.2    Certification Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934, as amended.
32.1    Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

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Table of Contents

SIGNATURES

 

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

 

    INTEGRAL SYSTEMS, INC.
                    (Registrant)

Date: August 9, 2005

  By:  

/s/ THOMAS L. GOUGH


        Thomas L. Gough
        President & Chief Operating Officer

Date: August 9, 2005

  By:  

/s/ ELAINE M. PARFITT


        Elaine M. Parfitt
        Executive Vice President &
        Chief Financial Officer

 

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