INTEGRAL SYSTEMS INC /MD/, 10KSB, 1999-12-17

INTEGRAL SYSTEMS INC /MD/
10KSB, 1999-12-17
COMPUTER INTEGRATED SYSTEMS DESIGN

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-KSB

(Mark One)
X ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE
-------- SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 1999
------------------
or
TRANSITION REPORT UNDER 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.
- -----------------------------------------------------------------------------
(Name of small business issuer in its charter)

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

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

Issuer's telephone number (301) 731-4233
--------------

Securities registered under Section 12(b) of the Exchange Act:

Title of each class Name of each exchange on which registered
----------------------------- -----------------------------------------

----------------------------- -----------------------------------------

Securities registered under Section 12(g) of the Exchange Act:

Common
- --------------------------------------------------------------------------------
(Title of class)

- --------------------------------------------------------------------------------
(Title of class)

Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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
---- ----

Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB [ ]

As of November 30, 1999, the aggregate market value of the Common Stock of the
Registrant (based upon the average bid and ask prices of the Common Stock as
reported by the market makers) held by non-affiliates of the Registrant was
$250,430,992.

As of November 30, 1999, 7,232,909 shares of the Common Stock of the Registrant
were outstanding.

For the year ended September 30, 1999, the Registrant's revenues were
$39,579,371.

TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): Yes[ ] No [X]
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PART 1

Item 1. Business
--------

Company Overview

Integral Systems, Inc. (the "Company") builds satellite ground systems for
command and control, integration and test, data processing, and simulation.
Since its inception in 1982, the Company has provided ground systems for over
100 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.

For over 17 years, the Company has provided flexible, reliable and
affordable ground system solutions. This has allowed the Company to stay ahead
of the competition and perform well in an industry that has traditionally been
dominated by much larger aerospace firms. The Company believes that it has a
unique combination of competitive advantages, including the following:

. Experience. More experience with different types of satellites and
operational scenarios than any competitor.

. Technology. Internationally recognized and proven COTS products that
were first to market and that continue to lead the competition in
functionality.

. Capabilities. Turnkey systems for customers who need a comprehensive
range of products and services.

. Delivery schedule and price. Ability to deliver systems faster and at a
lower cost than the competition.

Through its wholly owned subsidiary Integral Marketing, Inc. ("IMI"), the
Company acts as a manufacturers' representative, selling electronic test
instrumentation and equipment to customers primarily in Maryland, Virginia and
the District of Columbia. For a discussion of the Company's business segments,
see Note 12 to the Consolidated Financial Statements.

Integral Systems, Inc. is a Maryland corporation incorporated in 1982.

Industry Background

The space industry can be broken down into several industry sectors: (i)
infrastructure, (ii) communications, (iii) emerging applications, and (iv)
support services. Each of these sectors is funded by both government and
commercial investments. Space infrastructure encompasses the development,
manufacture and procurement of hardware and related systems for both space
assets (i.e., satellites and payloads) and ground assets (i.e., satellite ground
systems). The Company's business is focused in the ground system component of
the infrastructure sector. The communications sector of the space industry
includes revenue generated by satellite systems for commercial
telecommunications services and government and military communications.
Satellite technology has become critical to supporting many aspects of
telecommunications infrastructure, including long-distance telephony, personal
communications systems, and private networks. The emerging applications market
includes space technologies utilized for new applications such as global
positioning systems and remote sensing. Support services

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for the space industry include technical support, engineering, finance and
consulting, which facilitate growth in space-related markets.

According to a recent study by the International Space Business Council,
space industry revenues were $98 billion in 1998 and will grow at a rate of
approximately 9% per year. Industry growth is supported by a study recently
cited in Space News predicting that nearly 1,700 satellites will be launched
over the next 10 years. The 1998 space infrastructure revenues were
approximately $55 billion, comprising over half of the total space market. The
ground sector, which includes ground equipment, installations, and operations,
accounted for approximately $23 billion of total space infrastructure revenues.
The ground sector is almost as large as all other sectors of the space
infrastructure market combined.

The Company estimates that the current worldwide command and control market
represents approximately $4 billion. However, the Company also believes that the
increasing acceptance of COTS products will lead to substantial price reductions
and a subsequent decrease in market volume. The Company believes that its COTS
software products leave it well positioned to capitalize on this market trend,
resulting in an increase in both its revenues and market share.

The space industry exhibits certain general characteristics. First, the
space industry is by nature global. There is a trend towards privatization and
deregulation in the communications and space industries which has engendered
numerous opportunities for private concerns to become players in these
traditionally government dominated markets. Opportunities in the space industry
have also been generated by the rapid growth in the information technology
industry.

Second, there is an increasing demand for satellite-based applications.
Improvements in space and communications technologies have resulted in modern
communications satellites with power, capacity, switching capabilities and
longevity significantly greater than those of their predecessors. These
improvements in performance, together with satellites' inherent geographic
coverage and technical advantages, have made satellite-based communications
increasingly competitive with other communications technologies, broadening the
market for satellite support services.

Third, government and business organizations are increasingly demanding
that satellite ground systems be designed for interoperability with computer
hardware and software products and that such products be usable with existing
legacy systems. In addition, concerns over excessive development costs and the
rapid pace of technological change have led both government and business
organizations to demand flexible systems created by adapting COTS software and
hardware, rather than systems that have been built to customized specifications.
This emphasis on system flexibility using readily available commercial products
creates extensive opportunities for flexible COTS products and for systems
integration.

The Company Solution

The Company offers satellite ground systems that provide low-cost,
efficient and flexible operations. The principal characteristics of the
Company's approach are as follows:

Open Systems and Ease of Integration. The Company's family of products
addresses the dynamic environment of satellite operation through a commitment to
open systems architecture. The Company's products are implemented as open
systems with full adherence to industry hardware and software standards. The
Company's software can be rehosted to virtually any UNIX platform. A Windows NT
version is currently slated for release in 2000. The open architecture of the
Company's products allows interoperability with existing systems. Although the
Company's software components are typically sold as bundled products, they may
be purchased and operated separately or integrated with existing command and
control software.

Advanced Architecture. Unlike the traditional host-based approach, the
Company's ground systems are fully distributed, consisting of a set of
workstations all communicating via a local area network (''LAN'') backbone. Any
software function can be performed on any workstation, eliminating the host
computer bottleneck and allowing the

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processing and network loading to be fine-tuned by reallocation of logical
processes to physical hardware. This approach also provides more reliable
operations by eliminating single points of failure.

Depth of Functionality. The Company's command and control software supports
all aspects of satellite operation through a bundle of four inter-operable
software products: (i) a real-time package; (ii) an off-line package; (iii) an
orbit analysis package; and (iv) a database package. The Company's real-time
package performs daily and routine satellite operations, including commanding,
telemetry processing and fault detection and correction. The off-line package
supports sustaining engineering functions, including trending and statistical
analysis of data archived by the real-time system. The orbit analysis package
performs orbit determination and prediction functions to monitor and control the
position of the satellite in space. The database package tailors the performance
of the other three packages, which are general in scope, to the specific
requirements of each satellite mission. That is, the database defines the
telemetry and command characteristics and the desired orbital elements and
tolerances.

Flexibility/Adaptability. A critical element to achieving initial operator
acceptance of a new system and facilitating rapid implementation is the ability
of the Company's software to serve the needs of particular satellite systems.
All of the Company's software is database driven, allowing it to support
satellite design changes or different series of satellites, without modifying
the underlying software. Similarly, the software also supports a wide range of
COTS hardware, including antenna, radio frequency (RF) and baseband equipment,
allowing the total system to be delivered in the most efficient configuration
for each mission. Finally, the software is platform independent and can run on
any UNIX computer, with a Windows NT capability slated for release in early
2000. This platform independence makes it possible for the Company and its
customers to take full advantage of rapidly declining computer costs.

Superior Price/Performance. The Company seeks to achieve superior
price/performance by providing comprehensive solutions within the budgetary
needs of its customers. The Company believes that its COTS software products
provide advanced yet cost-effective solutions for satellite operators. These
COTS software products eliminate the need for expensive development services,
thereby substantially reducing the overall cost of a ground system. The
Company's database driven software allows satellites to be added over time,
which permits the initial system acquisition costs to be amortized over years of
operations. The Company believes its software products exceed industry
expectations in functionality, technical sophistication and ease of use.

Company Strategy

The Company is currently a leading provider of satellite command and
control systems, providing systems for a wide variety of satellites. The Company
intends to extend its leadership and to expand its market share in world command
and control solutions for users of all satellite types. Primary elements of the
Company's strategy include:

Technological Leadership. The Company intends to continue to commit
substantial resources to further develop the next generation of its EPOCH and
OASYS off-the-shelf products. For example, the products are currently being re-
engineered to operate under the Windows NT operating system to take advantage of
the tremendous third-party product base available on NT platforms, and to
eliminate the risk of UNIX becoming obsolete. The Company anticipates that it
will have migrated most of its software solutions to the Windows NT platform in
2000. In addition, because the satellite infrastructure industry is increasingly
requiring standards compliance, the Company intends to adhere to existing and
future industry standards and participate in the further development of such
standards.

Strategic Alliances and Partnerships. In addition to its own development
and marketing organization, the Company has and will continue to establish
partnerships with select third parties, primarily satellite and hardware
manufacturers, to assist the Company in successfully integrating its software
products, implementing total solution command and control systems and developing
customer relationships.

Integration with Complementary Products. The Company believes that its
ability to offer command and control software products that can integrate
seamlessly with all satellite types and ground system components is a key
competitive advantage. The Company also intends to integrate its software
products with complementary

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products, including visualization tools, scheduling engines and decision support
aids in order to maintain its competitive advantage and provide maximum
flexibility for its customers.

Sales, Support, Service and Marketing Organizations. The Company currently
sells and supports its command and control software through direct sales to
satellite operators and systems integrators in North America, Europe and Asia.
The Company plans to invest significantly in expanding its sales, support and
service capabilities in these geographic regions while simultaneously gaining
entry into emerging markets in South America and Africa. The Company also
intends to augment its direct marketing efforts with U.S. Government
organizations to capitalize on the growing acceptance of COTS solutions in the
government sphere.

In addition to expanding its market share in its core business, the Company
intends to draw on its capabilities and reputation in the command and control
area to develop opportunities in related areas. The key aspects of this growth
strategy are as follows:

New Suite of Off-the-Shelf Applications. The Company intends to continue to
broaden its COTS line beyond command and control to include other applications
currently utilizing customized solutions. These applications, which include
payload data processing, payload integration and test ("I&T") and ground
equipment monitoring and control, have overlapping functionality with the
Company's command and control applications and provide significant market growth
opportunities. To date, the Company is building or has delivered 12 payload data
processing systems, six satellite payload I&T systems and several monitoring and
control systems.

Professional Services Capabilities. The Company believes that providing
comprehensive services and a high level of customer support is critical to its
ability to maintain its leading position in command and control systems and to
expand into new markets. Therefore, the Company intends to expand its
professional services organization in areas such as hardware testing, pre- and
post-sale software support, quality assurance, project installation management
and training. For example, the Company is implementing an ISO 9000 compliance
program and anticipates certification by late 2000.

Products

Most of the Company's sales involve a combination of COTS software and
hardware products together with development services for mission-specific
requirements and system integration as summarized below.

Command and Control Software.

EPOCH 2000, the Company's COTS software solution for satellite command and
control, is designed to operate a variety of satellites with a minimum of
personnel. EPOCH 2000's success has placed the Company at the forefront of
replacing antiquated satellite control centers with smaller systems that can fly
multiple satellites produced by any manufacturer. EPOCH 2000's open
architecture, in combination with a graphical user interface and automated
monitoring and control features, allows operators to monitor and control both
their satellites and ground systems.

EPOCH features a modern, distributed architecture consisting of a series of
user workstations interconnected via an Ethernet LAN. This approach provides
better performance than traditional mini-computer based ground systems at a
lower cost. EPOCH provides end-to-end satellite command and control
capabilities, including telemetry processing and display, commanding and command
verification (''CV''), ground station automation, alarm/event processing and
data archive and retrieval. These functions are driven by the EPOCH database,
allowing the system to support multiple satellites solely through database
updates, without modifying the run-time software. This results in lower
maintenance and operations costs throughout the lifecycle.

The typical EPOCH installation consists of a front-end processor which
provides the interface to the front-end hardware (e.g., bit syncs, command
encoders) and a series of user analysis workstations, all interconnected via the
LAN. The front-end processor executes a real-time version of UNIX and services
all the time-critical requirements. The analyst stations provide the mechanism
for users to control and monitor the satellite and the ground equipment.

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With this approach, the processing burden is distributed across the network. The
system can be expanded indefinitely (up to the capacity of the network) by
adding new workstation nodes. Even the network capacity limitations can be
overcome by dividing the system into subnets inter-connected by bridges and
routers. Thus, additional users can be accommodated during peak loads with no
degradation in system response times.

Functionally, the software addresses all of the requirements for real-time
satellite control, including:

Telemetry Processing. The EPOCH software provides end-to-end telemetry
processing support, including frame decommutation, engineering unit (''EU'')
conversion and limits checking.

Commanding. EPOCH provides full support for satellite commanding and CV.
The commanding software is mnemonic-based; the user can transmit a command to
the satellite by typing in the mnemonic from a pull-down list arranged
alphabetically or by spacecraft subsystem.

Automation. Routine satellite and ground system control procedures can be
fully automated via the EPOCH Satellite Test and Operations Language (''STOL'').
STOL allows frequently used command and configuration sequences to be stored in
ASCII procedure files for automatic execution.

Alarms/Events. EPOCH provides a centralized alarm/events processor for
detecting and optionally correcting the following conditions: command or
telemetry verification failure, telemetry out-of-limits condition, front-end
processor failure or network communication problems.

Data Archive and Retrieval. A built-in archive capability provides a
permanent record of all significant ground system activity for long-term
trending and analysis.

OASYS, the Company's mission-planning software, provides full spectrum
support for spacecraft orbit determination and control, including measurement
set reductions, orbit determination, ephemeris propagation, maneuver planning
and orbit events/reports. OASYS allows the user to manage a single spacecraft or
a fleet in any Earth orbit, including low Earth, geosynchronous and Molniya-type
orbits.

ABE, the Company's offline analysis package, provides trending and
statistical analysis of the information recorded in the real-time EPOCH
archives. ABE supports automatic data extraction of key data, along with
summary-level statistics (i.e., daily and seasonal minimums and maximums),
advanced statistical processing techniques (i.e., covariance, convolution
and regression) and graphical data visualization.

All of these applications are tailored to specific customer requirements
through a fourth package, the database. The database application is based on a
commercial package for Relational Data Base Management System (''RDBMS''), with
a top-level user interface and functional extensions developed by the Company.
The database provides ''fill-in-the-blank'' menu edit forms allowing the
operator to specify every relevant operational characteristic and threshold for
the satellite, its orbit and the associated ground equipment.

LEO-T, the Low Earth Orbiting Terminal, is a product developed by the
Company as an extension of its existing command and control products. The LEO-T
software provides fully automated, un-manned, remote operations of satellite
ground stations, also known as telemetry, tracking, and control (''TT&C'')
sites, for low Earth orbit ("LEO") satellites. The chief difference between LEO-
T and the other COTS software products is that LEO-T involves the monitoring and
control of the ground equipment, rather than satellites themselves. The software
controls antenna positioning and tracking, RF and baseband setup, communications
path switching and management of redundant equipment. The software also provides
a mechanism for transferring data between the tracking sites and the central
satellite control facility.

Development Services and Systems Integration.

The Company provides services to support mission-specific requirements for
both government and commercial customers. Most of the Company's ground system
contracts have a service component. Depending on the application, the services
may include tailoring of COTS software products, integration of third-party
hardware and

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software and/or custom software development. The Company also provides post-
delivery warranty and maintenance service for most of its systems. The Company
believes that its expertise and experience in satellite systems and operations,
computer software and hardware, engineering/mathematical analysis and end-user
applications allow it to provide ground systems that exceed traditional
expectations on system performance, cost and implementation schedule. The
Company's experience, together with its innovative COTS software products and
software tools, reduce the risks and lead time associated with ground systems
development.

Applications.

The Company believes that it has strengthened its position in the
marketplace by developing a business base in certain critical application areas
that offer continued growth potential. The Company provides products and
services in different combinations in order to deliver systems for the following
applications:

Command and Control. The Company's EPOCH 2000 product line provides the
complete spectrum of capabilities for operating satellites from any
manufacturer. The Company sells the EPOCH 2000 software as a stand-alone
product or bundled as a turnkey system with third-party hardware (e.g. antenna,
RF, baseband and computer equipment).

Integration and Test. The Company provides I&T systems for the spacecraft
bus and payload. The I&T systems are based on the EPOCH 2000 product line and
software tools developed by the Company for data visualization and analysis for
payload I&T.

Station Automation. The Company has extended the EPOCH 2000 product line to
include the LEO-T software, which provides fully automated un-manned operations
of remote tracking stations for LEO satellites.

Data Processing. The Company offers software tools and custom development
services for satellite payload data acquisition and processing. The Company's
principal work in this area has been for meteorological satellites.

Simulation. The Company builds satellite simulators which are used for
ground systems checkout, training, spacecraft anomaly resolution and flight
software validation.

Customers

In general, there are three major applications for satellites:
communications, remote sensing, and science. The Company has customers in each
of these areas. The Company believes that the combination of its proven COTS
software products and its strength as a systems integrator has positioned it to
serve as an end-to-end provider of total solutions for all of these
applications.

Communications.

The Company provides satellite command and control products for a variety
of communications satellites. One of the principal advantages that the Company's
products offer in the commercial sector is the ability to operate fleets of
satellites from multiple vendors. This capability allows operators to reduce
costs by consolidating their control centers and using a single software package
to operate their satellites.

The Company's products are currently flying communications satellites from
most of the major satellite manufacturers, including Hughes Space and
Communications Company, Lockheed Martin Corporation, Loral Space &
Communications Ltd., Matra, and Alcatel. The Company's customers include GE
Americom, Loral Skynet, Shin Satellite Public Company Ltd., Binariang Satellite
Systems Sdn. Bhd. and China Telecommunications Broadcast Satellite Corporation.
All of these operators have purchased the Company's products to operate their
fleets of geosynchronous Earth orbit (''GEO'') communications satellites.

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Remote Sensing and Meteorology.

The Company builds command and control systems as well as payload and image
data processing systems for meteorological satellites. Since its inception, the
Company has provided ground systems for the U.S. National Oceanic and
Atmospheric Administration ("NOAA"), including both their Geostationary
Operational Environmental Satellite Program ("GOES") and the Television Infrared
Observational Satellite ("TIROS") programs. The Company's systems support
mission operations, instrument data processing, simulation and flight software
validation. The Company also built the complete command and control system for
the U.S. Air Force Defense Meteorological Satellite Program (''DMSP''), whose
operations were recently transitioned to civilian control under NOAA's aegis.
Since 1982, the Company has also been under contract to provide the DMSP program
with satellite simulators used for training, ground system checkout and flight
software analysis.

High-performance ground systems are required to support Earth resource
satellites that provide military and civilian customers with accurate image
data. The Company has provided such command and control subsystems to Space
Imaging/EOSAT and other operators.

The Company's DOMSAT receive station (''DRS'') is a PC-based product that
receives real-time environmental information via satellite from ground-based
data collection platforms and provides integrated capability for data management
and analysis. The Company has sold over 70 DRS systems in the U.S. for a
variety of government and commercial applications. Customers include the U.S.
Geological Survey, the U.S. Army Corps of Engineers, the State of Louisiana and
the City of Colorado Springs, Colorado.

Scientific Research.

The Company has supported a variety of diverse and complex science
missions. The Company has supported more than a dozen missions for the National
Aeronautics and Space Administration (''NASA''), including the Small Explorer
(''SMEX'') missions, International Solar-Terrestrial Physics (''ISTP'')
missions, X-ray Timing Explorer (''XTE'') and Tropical Rainfall Measuring
Mission (''TRMM''). Projects range from the development of distributed command
and control systems to validation of complex embedded flight software.

The Company was selected by the Johns Hopkins University Applied Physics
Laboratory to support the first NASA Discovery Mission, the Near Earth Asteroid
Rendezvous Program (''NEAR''). NEAR is the first in a series of low-cost,
small-planet exploratory missions designed to gather data about asteroids in the
solar system. The Company's EPOCH 2000 product forms the core of the mission's
command and control ground system and also supports the spacecraft I&T. The
Applied Physics Laboratory is also using the Company's products for other
science missions.

The National Space Program Office (''NSPO'') for the Republic of China
selected the Company to provide the complete command and control system for
their ROCSAT-1 satellite. As a subcontractor to AlliedSignal, the Company
provided the control center software, baseband hardware and system engineering
and integration support. The Company also supports small satellite missions in
America such as Orbital Sciences Corporation's SeaStar and Microlab programs.

Marketing

The Company relies upon senior corporate management, project managers and
senior technical staff to carry out its marketing program, including the
development and execution of marketing plans, proposal presentations and the
performance of related tasks. These individuals collect information concerning
requirements of current and potential customers in the course of contract
performance and formal and informal briefings, from published literature and
through participation in professional and industry organizations. Senior
management evaluates this information, identifies potential business
opportunities and coordinates proposal efforts. The primary source of business
in the Company's existing markets is by referral from existing customers.
Additionally, the Company advertises extensively in Space News Magazine and
other industry publications.

The Company seeks business believed to be of long-term benefit based on
considerations such as technical sophistication, favorable market positioning
and potential product spin-offs. One of the Company's primary

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marketing strategies is to anticipate and understand the changing needs of its
customers and then to be prepared to meet those needs as they arise in new
programs or in new program functions. This approach to marketing is mirrored in
the Company's products that are highly adaptable to growth and change in the
requirements of each user.

Contract Revenue

The Company earns revenues from sales of its products and services through
contracts that are funded by the U.S. Government as well as commercial and
international organizations. The Company may be either a prime contractor
directly to the end-user of its products and services or it may act as a
subcontractor under a contract with another company.

The percentages of revenues received by the Company from prime contracts
and subcontracts for fiscal years 1999 and 1998 are as follows:

<TABLE>
<CAPTION>
Fiscal Year
-----------------------------
Contract Source 1999 1998
----------------- ----- -----
<S> <C> <C>
Prime Contract 64% 68%
Subcontract 36% 32%
</TABLE>

For a given contract, the revenue mix may include the Company's COTS
software products, pass-through of third-party hardware and software, and
services provided by the Company or its subcontractors. The Company, through its
wholly owned subsidiary IMI, earns commission revenue by representing a number
of electronic product manufacturers in Maryland, Virginia and the District of
Columbia, principally in space-related markets .

The Company generates revenue under three types of contracts: cost plus,
fixed price, and time and material ("T&M") contracts. Under a cost plus
contract, the Company is reimbursed for allowable costs within the contractual
terms and conditions and is paid a negotiated fee. The fee may be fixed or based
on performance incentives. Revenue recognition under a cost plus contract is
based upon actual costs incurred and a pro rata amount of the negotiated fee.
Under a fixed price contract, the Company is paid a stipulated price for
services or products and bears the risk of increased or unexpected costs.
Revenue under a fixed price contract is recognized using the percentage of
completion method of accounting based on costs incurred in relation to total
estimated costs. Under a T&M contract, the Company receives fixed hourly rates
intended to cover salary costs attributable to work performed on the contract
and related overhead expenses, reimbursement for other direct costs and a
profit. Revenue is recognized under a T&M contract at the contractual rates as
labor hours and direct expenses are incurred. A significant amount of the
Company's revenue is earned under cost plus contracts. To date, the vast
majority of contracts for the purchase of the Company's COTS software products
have been fixed priced in nature, either firm fixed price contracts or T&M fixed
labor rate contracts.

The following table summarizes the percentage of revenues attributable to
each contract type for the period indicated:

<TABLE>
<CAPTION>
Fiscal Year
-----------------------------
Contract Type 1999 1998
----------------- ----- -----
<S> <C> <C>
Cost Plus 34% 41%
Fixed Price 63% 56%
Time and Materials 3% 3%
</TABLE>

Based on recent trends, the Company believes that the relative percentage
of cost plus contracts will decline in future fiscal periods.

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U.S. Government Contracts

Company revenues from U.S. Government contracts are derived from a
combination of contracts with the U.S. Government and subcontracts with other
companies that have prime contracts with the U.S. Government. For both fiscal
years 1999 and 1998, approximately 65% of the Company's revenues were derived
from contracts or subcontracts funded by the U.S. Government.

NOAA, one agency, represented 47% and 43% of revenues, respectively, for
fiscal years 1999 and 1998. The Company expects that at least 29% of its
revenue for fiscal year 2000 will be derived from NOAA contracts. The loss of
any one of these NOAA contracts could significantly affect the Company's
performance. Similarly, the expiration, or termination for convenience, of any
major contract could significantly affect the Company's performance if not
renewed or replaced by contracts of similar value. It is estimated that the
single largest NOAA contract will represent approximately 13% of the Company's
fiscal year 2000 revenue. This contract is to develop the ground system used to
operate the next generation of geosynchronous weather satellites at NOAA.

U.S. Government contracts are awarded by formal advertising or procurement
by negotiation. Negotiated procurements may, but do not necessarily, involve the
solicitation of competitive proposals. If competitive proposals are solicited,
the U.S. Government selects the proposal most advantageous to it and then
conducts negotiations with the selected bidder.

Many of the U.S. Government programs in which the Company participates as a
contractor or subcontractor extend for several years but are funded only on an
annual basis. Accordingly, the Company's contracts and subcontracts are subject
to termination, reduction or modification in the event of changes in the
government's requirements or budgetary constraints. Additionally, when the
Company participates in a project as a subcontractor, it is subject to the risk
that the prime contractor may fail or be unable to perform the prime contract.

All of the Company's U.S. Government contracts and subcontracts are also
subject to termination for ''convenience.'' Should a contract be so terminated,
the Company would be reimbursed for allowable costs to the date of termination
and would be paid a proportionate amount of the stipulated profits or fees
attributable to the work actually performed.

The Company's books and records are subject to audit by the Defense
Contract Audit Agency (DCAA). Such audits can result in adjustments to contract
costs and fees. Although the Company thus far has not been required to make any
material audit adjustments, the possibility that such adjustments will be
required always exists. Management is of the opinion that any such audit
adjustments would not have a material adverse effect on the financial position
or results of operations of the Company.

The Company's contracts and subcontracts with federal government agencies
are subject to competition and awarded on the basis of technical merit,
personnel qualifications, experience and price. The Company's business,
financial condition and results of operations could be materially affected by
changes in procurement policies, a reduction in funds available for the services
provided by it and other risks generally associated with federal government
contracts. New government contract awards also are subject to protest by
competitors at the time of award that can result in the re-opening of the
competition or evaluation process, or the award of a contract to a competitor.
The Company considers such bid protests to be a customary element in the process
of procuring government contracts.

In addition to the right to terminate, U.S. Government contracts are
conditioned upon the continuing availability of congressional appropriations.
Congress usually appropriates funds on a fiscal year basis even though contract
performance may take several years. Consequently, at the outset of a major
program, the contract is usually incrementally funded, and additional funds are
normally committed to the contract by the procuring agency as appropriations are
made by Congress for future fiscal years. In addition, contractors often
experience revenue uncertainties during the first quarter of the government's
fiscal year (beginning October 1) until differences between budget requests and
appropriations are resolved. To date, Congress has funded all years of the
multi-year major program contracts for which the Company has served as prime
contractor or a subcontractor, although there can be no assurance that this will
be the case in the future.

9
<PAGE>

Non-U.S. Government Contracts

In addition to having contracts with the U.S. Government, the Company also
has contracts with commercial and international organizations. For both fiscal
years 1999 and 1998 approximately 35% of the Company's revenues were derived
from non-U.S. Government contracts. These contracts are typically with
commercial satellite operators, satellite manufacturers, aerospace systems
integrators and foreign governments.

Most of the Company's non-U.S. Government contracts are awarded
competitively and are performed on a fixed price basis. Typically, these
contracts are for turnkey systems that are delivered by the Company in six to
eighteen months. Payment is most often based on delivery milestones established
in the Company's contract. In addition, the contracts may include a system
warranty period that lasts one to two years. The Company also offers extended
support for the system on a fixed price or T&M basis.

For certain of the Company's non-U.S. Government contracts, the Company
often has terms in its contracts under which the customer can enforce
performance of the Company or seek damages in case the Company does not perform
as agreed to in the contract. Contracts may require the Company to post a
performance bond, establish an irrevocable letter of credit, or agree to pay
liquidated damages in the event of late delivery.

Backlog

The Company's estimated backlog is as follows:

<TABLE>
<CAPTION>
Sept. 30, 1999 Sept. 30, 1998
---------------- ----------------

<S> <C> <C>
Outstanding Commitments (1).................. $ 29,292,235 $17,389,358
General Commitments (2)...................... 14,633,439 25,212,281
------------ -----------
Total................................... $43,9725,674 $42,601,639
============ ===========
</TABLE>
- --------------
(1) Represents orders that are firm and funded.
(2) Represents orders that are firm but not yet funded and contracts awarded
but not yet signed.

Under outstanding commitments, the Company agrees to provide specific
services, frequently over an extended period of time, with continued performance
of those services contingent upon the customer's year-to-year decision to fund
the contract.

General commitments consist of contract options and sole source business
that management believes likely to be exercised or awarded in connection with
existing contracts. Contract options are the Company's contractual agreement to
perform specifically defined services only in the event the customer thereafter
requests the Company to do so. Sole source business refers to contract work
which the Company reasonably expects to be awarded based on its unique expertise
in a specific area or because it has previously done all such work in that area
for the customer or prime contractor who will award the contract. The Company
estimates that 67% of backlog as of September 30, 1999 will be completed during
fiscal year 2000. Estimated backlog includes contract options through September
30, 2002, including general commitments.

Many of the Company's contracts are multi-year contracts and contracts with
option years, and portions of these contracts are carried forward from one year
to the next as part of the Company's contract backlog. The Company's total
contract backlog represents management's estimate of the aggregate unearned
revenues expected to be earned by the Company over the life of all of its
contracts, including option periods. Because many factors affect the scheduling
of projects, there can be no assurance as to when revenues will be realized on
projects included in the Company's backlog. In addition, although contract
backlog represents only business which is considered to be firm, there can be no
assurance that cancellations or scope adjustments will not occur. The majority
of backlog represents contracts under the terms of which cancellation by the
customer would entitle the Company to all or a portion of its costs incurred and
potential fees to the date of cancellation.

10
<PAGE>

However, the Company also believes that backlog is not necessarily
indicative of future revenues. The Company's backlog typically is subject to
large variations from quarter to quarter as existing contracts are renewed or
new contracts are awarded. Additionally, all U.S. Government contracts included
in backlog may be terminated at the convenience of the government.

Competition

The Company experiences significant competition in all of the areas in
which it does business. The Company believes it is one of four companies in the
United States that derive the major portion of their revenue from the
development of satellite ground systems. The Company competes with numerous
companies having similar capabilities, some of which are larger and have
considerably greater financial resources, including Lockheed Martin Corporation,
Loral Space & Communications Ltd., Orbital Sciences Corporation, AlliedSignal,
Computer Sciences Corporation, Alcatel Espace, and Matra Marconi Space. Many of
these competitors are significantly larger and have greater financial resources
than the Company, and some of these competitors are divisions or subsidiaries of
large, diversified companies that have access to the financial resources of
their parent companies. In addition, several smaller companies have specialized
capabilities in similar areas. In general, the markets in which the Company
competes are not dominated by a single company; instead, a large number of
companies offer services that overlap and are competitive with those offered by
the Company. There can be no assurance that the Company will be able to compete
successfully.

Because its command and control business is specialized and the Company is
a leader in COTS software products, the market for this business is somewhat
less competitive. In the command and control software market, the Company
competes against other companies in the space industry. The Company's products
also face competition from certain government off-the-shelf (GOTS) products for
satellite command and control. In its other business areas, ground equipment and
systems integration, the Company competes against systems integrators and
product manufacturers.

The Company believes that the principal competitive factors in the
businesses in which it operates are technical understanding, management
capability, past contract performance, personnel qualifications, and price.

The Company principally obtains contracts and subcontracts through
competitive procurements offered by the U.S. Government or commercial
enterprises. Because of its size, the Company often joins with a larger company
in pursuing major procurements. It is not unusual for the Company to compete
with a company for a contract while simultaneously joining with the same company
in pursuit of another contract.

It is not possible to predict how the Company's competitive position may be
affected by changing economic or competitive conditions, customer requirements
or technological developments.

Proprietary Rights

The Company regards its products as proprietary trade secrets and
confidential information. The Company relies on a combination of common law
copyright and trade secret laws, third party nondisclosure agreements and other
industry standard methods for protecting ownership of its proprietary software.
There can be no assurance, however, that in spite of these precautions, an
unauthorized third party will not obtain and use information that the Company
considers proprietary. To date, the Company has not registered any of its
copyrights or trademarks. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to the same extent as the laws of the
United States. There can be no assurance that the mechanisms used by the Company
to protect its software will be adequate or that the Company's competitors will
not independently develop software products that are substantially equivalent or
superior to the Company's products. None of the Company's software is patented.
The Company believes that it has all necessary rights to market its products,
although there can be no assurance third parties will not assert infringement
claims in the future.

The Company believes that, due to the nature of its products, the skill of
personnel, knowledge and experience of management, and familiarity with the
operation of the Company's products are more important in maintaining a

11
<PAGE>

leadership position in the industry than the protection of intellectual property
rights.

Employees

The Company believes that its employees and their knowledge and
capabilities are a major asset. The Company has been successful in attracting
and retaining employees skilled in its core business competencies. The Company
intends to continue to employ highly skilled personnel, as well as personnel
knowledgeable concerning the needs and operations of its major customers.

As of November 24, 1999, the Company employed approximately 209 employees
of whom 204 are full-time employees and 175 of whom are considered professionals
in engineering related disciplines. Of the engineering professionals, 91% have
undergraduate degrees in a scientific discipline and 43% of those have advanced
degrees in a scientific discipline. Approximately 81% of the engineering staff
have at least seven years experience.

The Company believes that its relations with its employees are good. None
of the Company's employees are covered by collective bargaining agreements.

There is significant competition for employees with the computer,
engineering and information technology skills required to perform the services
the Company offers. The Company's success will depend in part upon the Company's
ability to attract, retain, train and motivate highly skilled employees.

Research and Development

The Company is continually engaged in research and development activities
both to improve its existing software products as well as probe additional
product areas for the future growth and development of the Company. Currently,
the Company is focusing its research and development efforts primarily on
developing and improving the user interface systems for its COTS software
products. In fiscal years 1999 and 1998, total capitalized software development
expenditures were $1,180,643 and $693,309 respectively.

Environment

No material effects on the Company's expenditures, earnings, or competitive
position are anticipated as a result of compliance with federal, state, and
local provisions which have been enacted or adopted regulating the discharge of
material into the environment, or otherwise related to the protection of the
environment.

Financing

During fiscal year 1999, the Company had access to a general line of credit
facility through which it could borrow up to $3.0 million. Borrowings under the
line of credit bear interest at the Eurodollar Rate plus 1.9% per annum. The
line of credit was secured by the Company's billed and unbilled accounts
receivable. The line also had certain financial covenants, including minimum
net worth and liquidity ratios. The line expired July 31, 1999. At September
30, 1999 and 1998, the Company had no amounts outstanding under the line of
credit.

Since August 1, 1999 through December, 1999, the Company operated without a
line of credit, relying on its newly raised private placement equity and
retained cash to fund operations. The Company is negotiating a new credit
facility to supplement operating cash flow and to fund small acquisitions on
terms generally more favorable than the terms of its prior credit facility.

The Company also has access to a $2.0 million equipment lease line of
credit under which it had $1,315,000 outstanding as of September 30, 1999. The
outstanding balance is payable over a 36 month period and bears interest at a
rate of 8.8% per annum.

12
<PAGE>

See Footnote Numbers 5 and 7 of the notes to the Financial Statements for
further information regarding these matters.

Financial Information in Industry Segments

During the year ended September 30, 1999, the Company's operations included
two reportable segments: satellite ground systems and electronic test
instrumentation and equipment marketing.

The Company provides satellite ground systems - computer systems for
satellite command and control, data processing, simulation, and flight software
validation. Customers for these systems include U.S. Government organizations
such as NASA, NOAA, and the U.S. Air Force, as well as commercial satellite
operators, both domestic and foreign.

Through its wholly-owned subsidiary, IMI, the Company acts as a
manufacturer's representative, selling electronic test instrumentation and
equipment to customers primarily in Maryland, Virginia and the District of
Columbia. (The Company's other wholly-owned subsidiary, InterSys, Inc. provides
consulting services for satellite design and procurement, but is presently
inactive.)

See Footnote Number 12 of the notes to the Financial Statements for
financial information regarding these segments.

Item 2. Properties
----------

The Company's headquarters occupies approximately 46,700 square feet at
5000 Philadelphia Way, Lanham, Maryland 20706. The lease expires May 31, 2009,
and the annual lease cost for this lease is approximately $471,670, excluding
operating expenses of approximately $81,725. During fiscal year 1997, the
Company contracted for an additional 17,638 square feet of space at 4200 Forbes
Blvd. Lanham, Maryland 20706. This second lease expired April 15, 1999 and had
an annual lease cost, excluding operating expenses, of approximately $148,000.
During April, 1999 the Company contracted for 24,224 square feet at 5200
Philadelphia Way, Lanham, Maryland 20706. The lease expires May 31, 2009 and has
an annual lease cost of $244,662, excluding operating expenses of approximately
$47,237.

The Company believes that it has adequate insurance coverage to protect its
properties and assets.

Item 3. Legal Proceedings
----------------

The Company is from time to time involved in litigation incidental to the
conduct of its business. The Company is not currently a party to any lawsuit or
proceeding which, in the opinion of management, would be likely to have a
material adverse effect on the Company's business, financial condition or
results of operations.

13
<PAGE>

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder's Matters
-----------------------------------------------------------------------

The following table sets forth the high and low prices of the Common Stock
as reported by The NASDAQ National Market, where the Common Stock trades under
the Symbol ''ISYS.'' The prices reported have been adjusted to give retroactive
effect to changes resulting from stock dividends and stock splits.

1999 Fiscal Year High Low
- ---------------- -------- --------
<S> <C> <C>
First Quarter 29.88 13.00
Second Quarter 20.38 11.50
Third Quarter 24.94 17.56
Fourth Quarter 29.00 20.88
</TABLE>

1998 Fiscal Year High Low
- ---------------- -------- --------
<S> <C> <C>
First Quarter 7.06 4.88
Second Quarter 16.00 6.59
Third Quarter 17.00 11.69
Fourth Quarter 18.50 10.63
</TABLE>

As of September 30, 1999, there were approximately 1,977 holders of record
of the Company's Common Stock.

Historically, the Company has not paid any cash dividends, nor does the
Company anticipate declaring or paying cash dividends in the foreseeable future.
Instead, the Company intends to invest earnings in the operations, development
and growth of its business. The payment of future dividends on the Common Stock
and the rate of such dividends, if any, will be determined in light of any
applicable contractual restrictions limiting the Company's ability to pay
dividends, the Company's earnings, financial condition, capital requirements and
other factors deemed relevant by the Board of Directors. See ''Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources.''

Item 6. Management's Discussion And Analysis Of Financial Condition And Results
-----------------------------------------------------------------------
Of Operations
-------------

COMPARISON OF FISCAL YEAR 1999
------------------------------
TO FISCAL YEAR 1998
-------------------

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 100
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.

14
<PAGE>

Results of Operations

The components of the Company's income statement as a percentage of revenue
are depicted in the following table for the fiscal years ended September 30,
1999 and September 30, 1998:

<TABLE>
<CAPTION>
Fiscal Year Fiscal Year
1999 1998
Fiscal Year % of Fiscal Year % of
1999 Revenue 1998 Revenue
----------------------- ------------------ --------------------- -------------------
(in thousands) (in thousands)

<S> <C> <C> <C> <C>
Revenue $39,579 100.0 $28,036 100.0
Cost of revenue 28,260 71.4 20,677 73.8
------- ----- ------- -----

Gross margin 11,319 28.6 7,359 26.2
SG&A 4,644 11.7 3,047 10.9
Offering Expenses 0 0 378 1.3
Prod. amortization 660 1.7 660 2.3
------- ----- ------- -----

Income from operations 6,015 15.2 3,274 11.7
Other income (exp.) net 39 .1 -167 -.6
------- ----- ------- -----

Income before taxes 6,054 15.3 3,107 11.1
Income taxes 2,338 5.9 1,198 4.3
------- ----- ------- -----

Net income 3,716 9.4 1,909 6.8
======= ===== ======= =====
</TABLE>

Revenue

The Company earns revenue from sales of its products and services through
contracts that are funded by the U.S. Government, both as a prime contractor or
a subcontractor, as well as commercial and international organizations. The
Company, through its wholly-owned subsidiary IMI, earns commission revenue by
representing a number of electronic product manufacturers in Maryland, Virginia
and the District of Columbia, principally in space related markets.

Internally, the Company classifies revenues in two separate categories on
the basis of the contracts' procurement and development requirements: (i)
contracts which require compliance with Government procurement and development
standards ("Government Services") are classified as government revenue, and (ii)
contracts conducted according to commercial practices ("Commercial Products and
Services") are classified as commercial revenue, regardless of whether the end
customer is a commercial or government entity. Sales of the Company's COTS
products are classified as Commercial Products and Services revenue. IMI sales
of third-party hardware and software are also classified as Commercial Products
and Services revenue.

For the fiscal years ended September 30, 1999 and 1998, the Company's
revenues were generated from the following sources:

15
<PAGE>

<TABLE>
<CAPTION>
Fiscal Year Fiscal Year
Revenue Type 1999 1998
-------------- ----------- ----------
<S> <C> <C>
Commercial Products & Services
Commercial Users 35% 35%
U.S. Government Users 4 8
---- ----
Subtotal 39 43
---- ----

Government Services
NOAA 47 43
NASA 10 5
Other U.S. Government Users 4 9
---- ----
Subtotal 61 57
---- ----
Total 100% 100%
==== ====
</TABLE>

Based on the Company's revenue categorization system, the Company
classified 39% and 43% of its revenue as Commercial Products and Services
revenue with the remaining 61% and 57% classified as Government Services revenue
for fiscal years ended September 30, 1999 and 1998, respectively. By way of
comparison, if the revenues were classified strictly according to end-user
(independent of the Company's internal revenue categorization system), the U.S.
Government would account for 65% of the total revenues for both fiscal years
1999 and 1998.

On a consolidated basis, revenue increased 41.2%, or $11.6 million, to
$39.6 million for fiscal year 1999, from $28.0 million for fiscal year 1998. The
increase was principally due to increases in both the Company's Government
Services revenues and the Company's Commercial Products and Services revenues.
During fiscal year 1999, the Company continued to make progress in selling its
EPOCH based ground systems to commercial clients while also making in-roads
selling EPOCH based systems to governmental clients, especially NOAA, as U.S.
Government customers increased their purchases of the Company's EPOCH product
line and related services for both command and control applications and for
Integration and Test ("I&T") services.

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 35%, while gross margins for IMI
vary considerably depending on sales volume achieved.

During fiscal year 1999, cost of revenue increased to $28.3 million from
$20.7 million in fiscal year 1998 due primarily to increases in direct labor and
related overhead costs necessary to staff the Company's new contracts and
revenue growth. Cost of equipment and subcontracts also increased $2.5 million
between fiscal year 1999 and fiscal year 1998. Cost of revenue expressed as a
percentage of revenues declined to 71.4% for fiscal year 1999 from 73.8% for
fiscal year 1998.

The Company's gross margin increased 53.8%, or $4.0 million, to $11.3
million for fiscal year 1999 from $7.4 million for fiscal year 1998. The
increase was principally due to margin increases in virtually all of the
Company's revenue components (i.e. licenses, engineering services, and pass-
throughs) that occurred as a result of several factors, including an increase in
revenue from high margin license sales, which nearly doubled between fiscal year
1998 and fiscal year 1999. As a result of the foregoing factors, gross margin as
a percentage of revenue was 28.6% during fiscal year 1999 compared to 26.2% for
fiscal year 1998.

16
<PAGE>

Operating Expenses/Income from Operations

Selling, General & Administrative expenses (SG&A) increased to
approximately $4.6 million in fiscal year 1999 from $3.0 million in fiscal year
1998. The change was primarily due to increases in the Company's selling and
marketing infrastructure costs combined with increased bid and proposal
expenses. As a percentage of revenue, SG&A accounted for 11.7% of revenue in
fiscal year 1999 compared to 10.9% in the preceding fiscal year. Product
amortization was $660,000 for both fiscal years 1999 and 1998.

During fiscal year 1998, the Company charged approximately $380,000 to
operating expense in connection with its decision to indefinitely postpone a
secondary public offering that was registered with the Securities and Exchange
Commission (SEC) in July 1998 on Form S-1 and withdrawn in September 1998.
However, in June 1999, the Company successfully raised $19.7 million (net) in
the private placement of approximately 1.2 million shares of its common stock.

Income from operations increased 83.7% to $6.0 million for fiscal year 1999
from $3.2 million for fiscal year 1998 primarily due to increases in gross
margin dollars described above. As a percentage of revenue, income from
operations increased to 15.2% for fiscal year 1999 from 11.7% for the prior
fiscal year. This increase was principally the result of improved gross margin
rates combined with a lower percentage of product amortization as a function of
revenue. Further, fiscal year 1998 offering expenses ($380,000) did not recur
in fiscal year 1999.

The Company's effective tax rate was 38.6% for both fiscal years 1999 and
1998.

Outlook

The Company's strong fiscal year results represent a continued trend from
prior fiscal years of increased sales and profitability on those sales. At this
time, the Company has a significant backlog of work to be performed, as well as
potential contract awards it believes are probable based on proposals in the
pipeline. Management believes that operating results for future periods will
continue to improve based on the following assumptions:

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

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

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.

For fiscal year 1999, the Company generated approximately $4.4 million of
cash from operating activities, and used approximately $20.1 million for
investing activities, $18.1 million of which was used to purchase short term
marketable securities. Further, the Company invested approximately $1.2 million
for newly capitalized software development costs. During fiscal year 1999, the
Company also purchased approximately $790,000 of fixed assets (principally new
computers and equipment) and procured an additional $610,000 of electronic
equipment under its capital lease.

During fiscal year 1999 through July 31, 1999, the Company had access to a
general line of credit facility through which it could borrow up to $3.0
million. Borrowings under the line of credit bore interest at the Eurodollar
Rate plus 1.9% per annum. Any accrued interest was payable monthly. The line
of credit was secured by the Company's billed and unbilled accounts receivable.
The line also had certain financial covenants, including minimum net worth and
liquidity ratios. At September 30, 1999 and 1998, the Company had no amounts
outstanding under the line of credit.

17
<PAGE>

During the period August 1, 1999 through December, 1999, the Company
operated without a line of credit relying on its newly raised private placement
equity and retained cash to fund operations. The Company is negotiating a new
credit facility to supplement operating cash flow and to fund small acquisitions
on terms generally more favorable than the terms of its prior credit facility.

The Company also has access to a $2.0 million equipment lease line of
credit under which it had $1,300,000 outstanding as of September 30, 1999. The
outstanding balance is payable over a 36 month period and bears interest at a
rate of 8.8% per annum.

The Company currently anticipates that its current cash balances, amounts
available under its lease line of credit and a new line 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 in fiscal years 1999 and 1998 to date.

Year 2000 Compliance

Many currently installed computer systems, software products, and
microprocessor-dependent equipment are coded to accept only two digit entries in
the date code field. To distinguish 21st century dates from 20th century dates,
these date code fields must be able to accept four digit entries.

The Company may realize exposure and risk if the systems it relies upon to
conduct day-to-day operations are not year 2000 compliant. The potential areas
of exposure include electronic data exchange systems operated by third parties
with whom the Company transacts business, products purchased from third parties
and computers, software, telephone systems and other equipment used internally.
To minimize the potential adverse effects of the year 2000 problem, the Company
established an internal project team comprised of all functional disciplines.
This project team has begun a three-phase process of:

. identifying the Company's internal information and non-information technology
systems that are not year 2000 compliant;

. determining their significance in the effective operation of the Company; and

. developing plans to resolve the issues where necessary.

The Company has been communicating with its suppliers and others with whom
it does business to coordinate year 2000 readiness. The responses received by
the Company to date indicate that steps are currently being taken to address
this concern. However, if those third parties are not able to make all systems
year 2000 compliant, there could be a material adverse impact on the Company.

After initial review of the Company's computer systems, software products
and microprocessor dependent equipment, management has determined the Company to
be year 2000 compliant and, as such, does not anticipate any material adverse
operational issues to arise. Based on current estimates, management expects that
the Company's future costs in connection with its year 2000 compliance project
will not exceed $20,000; however, future anticipated costs are difficult to
estimate with any certainty and may differ materially from those currently
projected based on the results of phase one of the Company's year 2000
compliance project. The anticipated costs associated with the Company's year
2000 compliance program do not include time and costs that may be incurred as a
result of any potential failure of third parties to become year 2000 compliant
or costs to implement the Company's future contingency plans. The Company has
not yet developed a contingency plan in the event that any non-compliant
critical systems are not remedied by January 1, 2000, nor has it formulated a
timetable to create a contingency plan. Upon completion of our review, if
systems material to the Company's operations have not been made year 2000
compliant in a timely manner, the year 2000 issue could have a material adverse
effect on the Company's business, financial condition and results of operations.

18
<PAGE>

Forward Looking Statements

Certain of the statements contained in the Business section, in other parts
of this 10-KSB, 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. 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
including the following:

. A significant portion of the Company's revenue is derived from
contracts or subcontracts funded by 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.

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

While sometimes presented with numerical specificity, these forward-looking
statements are based upon a variety of assumptions relating to the business of
the Company, which although considered reasonable by the Company, may not be
realized. Because of the number and range of the assumptions underlying the
Company's forward-looking statements, many of which are subject to significant
uncertainties and contingencies beyond the reasonable control of the Company,
some of the assumptions inevitably will not materialize and unanticipated events
and circumstances may occur subsequent to the date of this document. These
forward-looking statements are based on current information and expectation, and
the Company assumes no obligation to update. 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.

19
<PAGE>

Item 7. Financial Statements and Supplementary Data
-------------------------------------------

INTEGRAL SYSTEMS, INC.
AND SUBSIDIARIES

--------------

CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998
AND
INDEPENDENT AUDITORS' REPORT

<PAGE>

TABLE OF CONTENTS

<TABLE>
<CAPTION>
DESCRIPTION PAGES

<S> <C>
Independent Auditors' Report F-1

Consolidated Balance Sheet as of September 30, 1999 F-2

Consolidated Statements of Operations for the Years Ended
September 30, 1999 and 1998 F-3

Consolidated Statements of Stockholders' Equity for the Years Ended
September 30, 1999 and 1998 F-4

Consolidated Statements of Cash Flows for the Years Ended
September 30, 1999 and 1998 F-5

Notes to Consolidated Financial Statements F-6-16
</TABLE>

<PAGE>

Rubino & McGeehin, Chartered
Certified Public Accountants
6905 Rockledge Drive, Suite 700
Bethesda, MD 20817-1818

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
Integral Systems, Inc.

We have audited the accompanying consolidated balance sheet of Integral
Systems, Inc. and its subsidiaries as of September 30, 1999, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended September 30, 1999 and 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Integral
Systems, Inc. and its subsidiaries as of September 30, 1999, and their
consolidated results of operations and consolidated cash flows for the years
ended September 30, 1999 and 1998, in conformity with generally accepted
accounting principles.

November 20, 1999
Bethesda, Maryland

F-1
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 1999

---------------------

ASSETS
<TABLE>
<S> <C>
Current assets
Cash and cash equivalents $ 7,027,446
Marketable securities 18,136,000
Accounts receivable, net 12,990,182
Employee receivables and other receivables 62,638
Prepaid expenses 78,123
-----------

Total current assets 38,294,389

Property and equipment, at cost, net of accumulated
depreciation and amortization 1,825,441
Software development costs, net of accumulated amortization 2,006,194
Deposits 13,666
-----------

Total assets $42,139,690
===========
</TABLE>

LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
<S> <C>
Current liabilities
Accounts payable - trade $ 2,838,639
Accrued expenses 2,555,850
Capital leases payable - current portion 601,327
Billings in excess of revenue for contracts in progress 1,666,484
Income taxes payable 173,637
Deferred income taxes 146,890
-----------

Total current liabilities 7,982,827

Capital leases payable - long term portion 714,106
-----------

Total liabilities 8,696,933
-----------

Commitments and contingencies

Common stock, $.01 par value, 40,000,000 shares authorized,
7,163,908 shares issued and outstanding 71,639
Additional paid-in capital 21,993,620
Retained earnings 11,377,498
-----------

Total stockholders' equity 33,442,757
-----------

Total liabilities and stockholders' equity $42,139,690
===========
</TABLE>

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

F-2
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended September 30, 1999 and 1998

---------------------

<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Revenue $39,579,371 $28,035,506
----------- -----------

Cost of revenue
Direct labor 9,807,008 6,679,422
Direct equipment and subcontracts 10,452,268 7,985,289
Travel and other direct costs 1,155,842 951,895
Overhead costs 6,844,902 5,059,996
----------- -----------

Total cost of revenue 28,260,020 20,676,602
----------- -----------

Gross margin 11,319,351 7,358,904

Selling, general and administrative 4,644,666 3,047,042
Product amortization 660,000 660,000
Offering expenses - 378,110
----------- -----------

Income from operations 6,014,685 3,273,752

Other income (expense)
Interest income 383,812 60,447
Interest expense (120,244) (86,556)
Miscellaneous, net (224,306) (140,816)
----------- -----------

Income before income taxes 6,053,947 3,106,827

Provision for income taxes 2,338,100 1,197,801
----------- -----------

Net income $ 3,715,847 $ 1,909,026
=========== ===========

Weighted average number of common shares:
Basic 6,319,090 5,793,433

Diluted 6,772,601 6,232,933

Earnings per share:
Basic $.59 $.33
=========== ===========

Diluted $.55 $.31
=========== ===========
</TABLE>

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

F-3
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1999 and 1998

---------------------

Number of Common Stock Additional Retained
Shares at Par Value Paid-in Capital Earnings Total
--------- ------------ --------------- --------- ------

<S> <C> <C> <C> <C> <C>
Balance, September 30, 1997 5,724,904 $57,249 $ 812,159 $ 5,752,625 $ 6,622,033

Stock options exercised 115,080 1,150 361,201 - 362,351
Tax benefit of stock options
exercised - - 225,622 - 225,622

Net income - - - 1,909,026 1,909,026
--------- ------- ----------- ----------- -----------

Balance, September 30, 1998 5,839,984 58,399 1,398,982 7,661,651 9,119,032

Private placement offering 1,183,268 11,833 19,650,219 - 19,662,052
Stock options exercised 140,656 1,407 455,740 - 457,147
Tax benefit of stock options
exercised - - 488,679 - 488,679

Net income - - - 3,715,847 3,715,847
--------- ------- ----------- ----------- -----------

Balance, September 30, 1999 7,163,908 $71,639 $21,993,620 $11,377,498 $33,442,757
========= ======= =========== =========== ===========
</TABLE>

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

F-4
<PAGE>

Cash flows from operating activities:
Net income $ 3,715,847 $ 1,909,026
------------ -----------
Reconciling adjustments:
Depreciation and amortization 1,386,979 1,188,994
Change in deferred income taxes 329,581 (138,367)
Tax benefit of stock options exercised 488,679 225,622
(Increase) decrease in:
Accounts receivable (2,077,809) (1,843,966)
Prepaid expenses and deposits (27,647) 52,229
Employee and other receivables (59,953) (1,486)
(Decrease) increase in:
Accounts payable - trade (245,325) 196,545
Accrued expenses 292,164 760,367
Billings in excess of revenue for contracts in progress 1,147,764 (284,461)
Income taxes payable (574,140) 572,767
------------ -----------

Total adjustments 660,293 728,244
------------ -----------

Net cash provided by operating activities 4,376,140 2,637,270
------------ -----------

Cash flows from investing activities:
Acquisition of marketable securities (18,136,000) -
Acquisition of property and equipment (792,499) (108,648)
Software development costs (1,180,643) (693,309)
------------ -----------

Net cash used in investing activities (20,109,142) (801,957)
------------ -----------

Cash flows from financing activities:
Net proceeds from private placement 19,662,052 -
Proceeds from exercise of stock options 457,147 362,351
Payments on capital lease obligations (413,895) (149,134)
Proceeds from sale/lease back - 500,000
Payments on line of credit - (500,000)
------------ -----------

Net cash provided by financing activities 19,705,304 213,217
------------ -----------

Net increase in cash and cash equivalents 3,972,302 2,048,530

Cash and cash equivalents, beginning of year 3,055,144 1,006,614
------------ -----------

Cash and cash equivalents, end of year $ 7,027,446 $ 3,055,144
============ ===========
</TABLE>

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

F-5
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998
________________

1. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of
Integral Systems, Inc. (the Company) and its wholly owned subsidiaries,
Integral Marketing, Inc. (IMI) and InterSys, Inc. (InterSys). All
significant intercompany transactions have been eliminated in
consolidation.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures.
Accordingly, actual results could differ from those estimates.

Marketable Securities

Marketable securities, comprised of variable rate State of Maryland debt
securities at September 30, 1999, are considered available-for-sale and are
carried at estimated current value based on quoted market prices. Current
value at September 30, 1999, approximates cost.

Contract Revenue

Revenue under cost-plus-fixed-fee contracts is recorded on the basis of
direct costs plus indirect costs incurred and an allocable portion of the
fixed fee. Revenue from fixed-price contracts is recognized on the
percentage-of-completion method, measured by the cost-to-cost method for
each contract. Revenue from time and materials contracts is recognized
based on fixed hourly rates for direct labor expended. The fixed rate
includes direct labor, indirect expenses and profits. Material or other
specified direct costs are recorded at actual cost.

Contract costs include all direct material and labor costs and those
indirect costs related to contract performance. General and administrative
costs are charged to expense as incurred. Provisions for estimated losses
on contracts in progress are made in the period in which such losses are
determined. Changes in job performance, job conditions, and estimated
profitability, including final contract settlements, may result in
revisions to costs and income and are recognized in the period in which the
revisions are determined. The Company's contracts vary in length from one
to four years.

The fees under certain government contracts may be increased or decreased
in accordance with cost or performance incentive provisions which measure
actual performance against established targets or other criteria. Such
incentive fee awards or penalties are included in revenue at the time the
amounts can be reasonably determined.

Unbilled accounts receivable represents revenue recognized in excess of
amounts billed. The liability, billings in excess of revenue for contracts
in progress, represents billings in excess of revenue recognized.

F-6
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998
_____________

1. Summary of Significant Accounting Policies (continued)

Depreciation and Amortization

Property and equipment are stated at cost. The Company provides for
depreciation and amortization by charges, using the straight-line method,
to operating expenses at rates based on estimated useful lives as follows:

<TABLE>
<CAPTION>
Classification Estimated Useful Lives
<S> <C> <C>

Electronic equipment 3 Years
Furniture and fixtures 5 Years
Leasehold improvements Life of lease
Software 3 Years
</TABLE>

Maintenance and repair costs are charged to expense as incurred.
Replacements and betterments are capitalized. At the time properties are
retired or otherwise disposed of, the property and related accumulated
depreciation or amortization accounts are relieved of the applicable
amounts and any gain or loss is credited or charged to income.

Software Development Costs

The Company has capitalized costs related to the development of certain
software products. In accordance with Statement of Financial Accounting
Standards No. 86, capitalization of costs begins when technological
feasibility has been established and ends when the product is available for
general release to customers. Amortization is computed on an individual
product basis and has been recognized for those products available for
market based on the products' estimated economic lives of three to five
years. Due to inherent technological changes in software development,
however, the period over which such capitalized costs is being amortized
may have to be modified.

Earnings Per Share

Basic earnings per share is computed using the weighted average number of
shares outstanding during the period. The only reconciling item between
the shares used for basic and diluted earnings per share related to
outstanding stock options. No reconciling items existed between the net
income used for basic and diluted earnings per share. The earnings per
share computations have been adjusted retroactively where appropriate for
the stock splits discussed in Note 11.

Cash Concentrations and Cash Equivalents

The Company considers all highly-liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents. Cash accounts are
maintained primarily with one federally insured financial institution.
Balances usually exceed insured limits, but management does not consider
this to be a significant concentration of credit risk.

F-7
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATMENTS
Years Ended September 30, 1999 and 1998
____________

1. Summary of Significant Accounting Policies (continued)

Segment Information

In 1999, the Company adopted Statement of Financial Accounting Standard
(SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related
Information". SFAS No. 131 supercedes SFAS No. 14, "Financial Reporting
for Segments of a Business Enterprise". Under the new standard, the
Company is required to use the "management" approach to reporting its
segments. The management approach designates the internal organization,
used by management for making operating decisions and assessing
performance, as the source of the Company's segments. The adoption of SFAS
No. 131 had no impact on the Company's consolidated financial position,
results of operations or cash flows.

2. Accounts Receivable and Revenue

Accounts receivable at September 30, 1999, consist of the following:

<TABLE>
<CAPTION>
Billed
<S> <C>
Government services
Prime contracts $ 1,766,729
Subcontracts 2,960,656
Commercial products and services 3,031,186
------------

Total billed 7,758,571
------------

Unbilled

Government services
Prime contracts 1,153,135
Subcontracts 2,311,688
Commercial products and services 1,766,788
------------

Total unbilled 5,231,611
------------

Total accounts receivable, net $ 12,990,182
============
</TABLE>

Unbilled accounts receivable include amounts arising primarily from the use
of the percentage-of-completion or other methods of recognizing revenue
that differ from contractual billing terms. Substantially all unbilled
receivables are expected to be billed and collected in one year.

The Company earns revenue, both as a prime contractor and a subcontractor,
from sales of its products and services through contracts funded by the
U.S. government, as well as commercial and international organizations.
The Company's subsidiary, IMI, earns commission revenue by representing
electronic product manufacturers.

F-8
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998
_____________

2. Accounts Receivable and Revenue (continued)

The Company classifies contract revenues in two separate categories on the
basis of the contract's procurement and development requirements: (i)
contracts which require compliance with government procurement and
development standards are classified as government revenue (government
services) and (ii) contracts conducted according to commercial practices
are classified as commercial revenue (commercial products and services),
regardless of whether the end customer is a commercial or government
entity. Sales of the Company's commercial-off-the-shelf software products
are classified as commercial products and services revenue. IMI sales of
third party hardware and software are also classified as commercial
products and services revenue.

During the years ended September 30, 1999 and 1998, approximately 61% and
57%, respectively, of the Company's revenue was from government services,
primarily the National Oceanic and Atmospheric Administration (NOAA) and
the National Aeronautics and Space Administration (NASA). The remaining
revenue is from commercial products and services as defined above.

By the way of comparison, if revenues were reclassified according to end
customer, the Company's revenue from U.S. government customers, both as a
prime contractor and a subcontractor, for each of the years ended September
30, 1999 and 1998, was 65%. Revenue from non-U.S. government customers for
each of the years ended September 30, 1999 and 1998, was 35%.

3. Property and Equipment

Property and equipment as of September 30, 1999, are as follows:

<TABLE>
<S> <C>
Electronic equipment $ 655,272
Furniture and fixtures 380,904
Leasehold improvements 132,110
Software 67,861
Equipment under capital lease 1,911,463
-------------

Total property and equipment 3,147,610
Less: accumulated depreciation and amortization (1,322,169)
-------------

Property and equipment, net $ 1,825,441
=============
</TABLE>

4. Software Development

Software development costs as of September 30, 1999, consist of the
following:

<TABLE>
<S> <C>
Costs incurred $ 5,155,635
Less: accumulated amortization (3,149,441)
-------------

Software development costs, net $ 2,006,194
=============
</TABLE>

Amortization expense for each of the years ended September 30, 1999 and 1998,
was $660,000.

F-9
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998

----------

5. Line of Credit

The Company had a line of credit agreement with a bank for $3,000,000 which
expired July 31, 1999. Borrowings under the line were due on demand with
interest at the Eurodollar Rate, plus 1.9% per annum. The line of credit
was secured by the Company's billed and unbilled accounts receivable and
had certain financial covenants, including minimum net worth and liquidity
ratios. At September 30, 1999, the Company had no outstanding balance
under the line of credit. The Company is currently negotiating a revised
line of credit.

6. Accrued Expenses

Accrued expenses at September 30, 1999, consist of the following:

<TABLE>
<S> <C>
Accrued payroll and withholdings $1,515,350
Accrued vacation 670,255
Accrued profit sharing 370,245
----------

Total accrued expenses $2,555,850
==========
</TABLE>

7. Commitments and Contingencies

Capital Leases

During the year ended September 30, 1998, the Company secured a $2,000,000
equipment lease line of credit and entered into a sale-leaseback
arrangement. Under the arrangement, the Company sold certain electronic
equipment and leased it back for a period of three years. The leaseback
has been accounted for as a capital lease. There was no significant
difference between the book value and fair value of the equipment sold, and
accordingly, no gain or loss from the sale was recorded.

The Company also incurred additional capital lease obligations when it
entered into new leases for equipment. Capital lease additions were
$609,996 and $1,298,966, for the years ended September 30, 1999 and 1998,
respectively. Future payments under the capital lease obligations at
September 30, 1999, are as follows:

<TABLE>
<S> <C>
Years ending September 30, 2000 $ 679,197
2001 492,374
2002 143,023
2003 38,877
2004 38,877
Thereafter 78,033
----------

Total payments 1,470,381
Less amount representing interest at 8.8% per annum (154,948)
----------

Present value of future lease payments $1,315,433
==========
</TABLE>

F-10
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998

----------

7. Commitments and Contingencies (continued)

Operating Leases

The Company leases its office space. The current lease expires in 2009.
Future minimum lease payments under the office lease are as follows:

<TABLE>
<S> <C>
Years ending September 30, 2000 $ 680,000
2001 700,000
2002 720,000
2003 740,000
2004 770,000
Thereafter 3,890,000
----------

Total payments $7,500,000
==========
</TABLE>

Lease payments do not include operating expenses or utilities, which are
adjusted annually. Rent expense was $577,621 and $468,280, for the years
ended September 30, 1999 and 1998, respectively.

Government Contracts

A significant portion of the Company's revenues represent payments made by
the U.S. government and by contractors that have prime contracts with the
U.S. government. These revenues are subject to adjustment upon audit by
the Defense Contract Audit Agency (DCAA). Audits by the DCAA have been
completed on the Company's contracts and subcontracts through the year
ended September 30, 1998. Management is of the opinion that any
disallowances of costs for subsequent fiscal years by the government
auditors, other than amounts already provided, will not materially affect
the Company's financial statements.

8. Income Taxes

For the years ended September 30, 1999 and 1998, the provision for income
taxes consists of the following:

<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Current tax expense
Federal $1,652,585 $1,096,247
State 355,934 239,921
---------- ----------
2,008,519 1,336,168
Deferred tax expense (benefit) 329,581 (138,367)
---------- ----------

Total provision $2,338,100 $1,197,801
========== ==========
</TABLE>

F-11
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998

----------

8. Income Taxes (continued)

At September 30, 1999, the tax effect of significant temporary differences
representing deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
Asset (Liability)

<S> <C>
Depreciation and amortization $(412,190)
Vacation accrual 261,400
Revenue reserve 3,900
---------

Net deferred tax liability $(146,890)
=========
</TABLE>

The effective income tax rates differ from the statutory U.S. income tax
rate due principally to the following:

<TABLE>
<CAPTION>
1999 1998
---------- ----------

<S> <C> <C>
Federal statutory rate 34.0% 34.0%
State tax, net of federal
Income tax benefit 4.6 4.6
---- ----

Effective rate 38.6% 38.6%
==== ====
</TABLE>

9. Profit Sharing and Employee Benefits Plans

The Company has a profit sharing and 401(k) plan for the benefit of
substantially all employees. Profit sharing contributions consist of
discretionary amounts determined each year by the Board of Directors of the
Company based upon net profits for the year and total compensation paid.
The 401(k) feature allows employees to make elective deferrals not to
exceed 10% of compensation. The Company also has a money purchase plan
which obligates the Company to contribute 5% of eligible salaries under the
plan. For the years ended September 30, 1999 and 1998, contributions to
the plans totalled $1,173,001 and $797,470, respectively.

10. Stock Option Plan

Effective May 25, 1988, as amended on January 1, 1994, the Company
established a stock option plan to create additional incentives for the
Company's employees, consultants and directors to promote the financial
success of the Company. The Board of Directors has sole authority to
select full-time employees, directors or consultants to receive awards of
options for the purchase of stock under this plan. At September 30, 1999,
the maximum number of shares of common stock which may be issued pursuant
to the stock option plan is 1,800,000. The price of each option is set at
the stock's bid price on the date of the Board of Directors meeting at
which the option is granted. Options expire no later than ten years from
the date of grant (five years for greater-than-10% owners) or when
employment ceases, whichever comes first, and vest from one to five years.

F-12
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998

----------

10. Stock Option Plan (continued)

The stock option plan is accounted for under Accounting Principles Board
(APB) Opinion No. 25. Accordingly, no compensation has been recognized for
the plan. Had compensation cost for the plans been determined based on the
estimated fair value of the options at the grant dates consistent with the
method of Statement of Financial Accounting Standards (SFAS) No. 123, the
Company's net income and earnings per share for the years ended
September 30, 1999 and 1998, would have been:

<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Net income:
As reported $3,715,847 $1,909,026
Pro forma $2,890,707 $1,511,608

Earnings per share:
As reported - basic $ .59 $ .33
- dilutive $ .55 $ .31
Pro forma - basic $ .46 $ .26
- dilutive $ .43 $ .24
</TABLE>

The fair value of the options granted is estimated on the date of the grant
using the Black-Scholes options pricing model assuming the following: no
dividend yield, risk-free interest rate of 6%, expected volatility of 40%,
and an expected term of the options of four years. Stock option balances and
activity discussed herein have been adjusted for the stock splits discussed
in Note 11.

At September 30, 1999, options to purchase stock under this plan were
outstanding to employees as follows:

<TABLE>
<CAPTION>
Number of Exercise Price
Shares Per Share
<S> <C>
79,872 $ 2.00 - 2.99
347,100 $ 3.00 - 3.99
92,100 $ 4.00 - 4.99
8,200 $ 5.00 - 5.99
1,221 $ 6.00 - 6.99
2,000 $ 9.00 - 9.99
7,000 $ 12.00 - 12.99
8,000 $ 13.00 - 13.99
10,500 $ 14.00 - 14.99
12,785 $ 15.00 - 15.99
258,750 $ 18.00 - 18.99
4,700 $ 19.00 - 19.99
7,500 $ 22.00 - 22.99
5,000 $ 23.00 - 23.99
1,500 $.24.00 - 24.99
3,000 $.26.00 - 26.99
1,000 $ 28.00 - 28.99
-------

850,228
=======
</TABLE>

F-13
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998

----------

10. Stock Option Plan (continued)

Of the options outstanding at September 30, 1999, 418,562 options are
exercisable immediately, and 431,666 options are exercisable over the next
five years. Transactions involving the plan for the years ended
September 30, 1999 and 1998, were as follows:

<TABLE>
<CAPTION>
Weighted Average
Shares Exercise Prices

<S> <C> <C>
Options outstanding, September 30, 1997 737,240 $ 3.40
Granted 98,308 $ 9.17
Exercised (115,080) $ 5.09
Cancelled (7,974) $ 3.26
--------

Options outstanding, September 30, 1998 712,494 $ 4.23
Granted 296,840 $19.01
Exercised (140,656) $ 3.25
Cancelled (18,450) $13.46
--------

Options outstanding, September 30, 1999 850,228 $ 9.36
========
</TABLE>

The weighted average fair values of options granted during the years ended
September 30, 1999 and 1998, were $7.50 and $3.72, respectively.

11. Stock Splits and Authorized Shares

On May 29, 1998, the Company's board of directors declared a two-for-one
stock split in the form of a 100% stock dividend for stockholders of record
as of June 9, 1998. All references to number of shares, per share amounts,
stock option data, and market prices of common stock have been restated to
give retroactive recognition to the stock split.

In June 1999, the Company issued stock under a private placement. The
Company received approximately $20 million from this offering. The costs
associated with this private placement are included as a direct reduction
to paid-in capital.

12. Business Segment Information

During the years ended September 30, 1999 and 1998, the Company's
operations included two reportable segments: Satellite ground systems and
electronic test instrumentation and equipment marketing. The Company
provides satellite ground systems - computer systems for satellite command
and control, data processing, simulation, and flight software validation.
Customers for these systems include U.S. government organizations such as
National Aeronautics and Space Administration (NASA), the National Oceanic
and Atmospheric Administration (NOAA), and the U.S. Air Force, as well as
commercial satellite operators, both domestic and foreign.

F-14
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998
_____________

12. Business Segment Information (continued)

Through its wholly-owned subsidiary, IMI, the Company acts as a
manufacturer's representative, selling electronic test instrumentation and
equipment to customers primarily in Maryland, Virginia and the District of
Columbia. (The Company's other wholly-owned subsidiary, InterSys, provides
consulting services for satellite design and procurement, but is presently
inactive.)

The accounting policies of the segments are the same as those described in
Note 1. The Company evaluates the performance of each segment based on
profit or loss before income taxes. Summarized financial information by
business segment is as follows:

<TABLE>
<CAPTION>
1999 1998
---- ----
Revenue
<S> <C> <C>
Satellite ground systems $ 38,359,256 $ 26,621,259
Equipment marketing $ 1,220,115 $ 1,414,247

Income before taxes
Satellite ground systems $ 5,701,407 $ 2,623,586
Equipment marketing $ 352,540 $ 483,241

Assets
Satellite ground systems $ 40,873,456 $ 15,559,810
Equipment marketing $ 1,266,234 $ 1,140,511

Capital expenditures
Satellite ground systems $ 783,515 $ 106,855
Equipment marketing $ 8,984 $ 1,793

Depreciation and amortization
Satellite ground systems $ 720,206 $ 522,929
Equipment marketing $ 6,773 $ 6,065

Amortization of intangible assets
Satellite ground systems $ 660,000 $ 660,000
Equipment marketing $ - $ -
</TABLE>

There were no significant intercompany sales. Satellite ground systems
capital expenditures for the years ended September 30, 1999 and 1998,
excludes the addition of equipment under capital leases totalling $609,996
and $1,298,966, respectively.

Major customer information and revenue by customer category is discussed in
Note 2. Revenue from foreign sources, primarily with corporations located
in France, totalled $2,383,646 for the year ended September 30, 1999.
Revenue from foreign sources, primarily with corporations located in
Thailand, totalled $1,868,694 for the year ended September 30, 1998. The
Company has no significant long-lived assets located in foreign countries.

F-15
<PAGE>

INTEGRAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1999 and 1998
______________

13. Supplemental Cash Flow Information

For the years ended September 30, 1999 and 1998, income taxes paid, were
$2,115,189 and $537,733, respectively, and interest expense incurred and
paid was $120,244 and $86,556, respectively.

F-16
<PAGE>

Item 8. Disagreements on Accounting and Financial Disclosure
----------------------------------------------------

Not Applicable.

F-17
<PAGE>

PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons;
-------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act.
-------------------------------------------------

Name Position with the Company
---- -------------------------

Steven R. Chamberlain Chairman of the Board,
Chief Executive Officer and Director
Thomas L. Gough President, Chief Operating Officer, and Director
Steven A. Carchedi Executive Vice President, Business Development
Robert P. Sadler Vice President, Quality Control, Secretary,
Treasurer, and Director
Steven K. Kowal Vice President, Commercial Products
Donald F. Mack, Jr. Vice President, Integration & Test Programs
William I. Tittley Vice President, Asia Pacific Operations
Elaine M. Parfitt Vice President and Chief Financial Officer
Patrick R. Woods Vice President, Government Programs
Peter J. Gaffney Vice President, Commercial Division
Carroll G. Dudley Vice President, NASA Projects
Bonnie K. Wachtel Outside Director
Dominic A. Laiti Outside Director
R. Doss McComas Outside Director

Directors serve until the next annual meeting of stockholders or until
successors have been duly elected and qualified. Officers of the Company serve
at the discretion of the Board of Directors.

Steven R. Chamberlain, 44, a Company founder, has been Chairman of the Board
since June 1992, President since May 1988, and a Director since 1982. He served
as Vice President from 1982 until he became President. From 1978 to 1982, OAO
Corporation ("OAO") employed Mr. Chamberlain where he progressed from Systems
Analyst to Manager of the Offutt Air Force Base field support office. Mr.
Chamberlain holds a B.S. degree in Physics from Memphis State University and has
done graduate work in Physics and Mathematics at Memphis State and the
University of Maryland.

Thomas L. Gough, 51, became a member of the Company's staff in January 1984. In
March 1996, he was elected to the Board of Directors of the Company. He has
served as President and Chief Operating Officer of the Company since June 1992.
For three years before being named President, he served as Vice President and
Chief Financial Officer. Prior to joining the Company, he was employed by
Business and Technological Systems, Inc., serving initially as a Project Leader
and later as the Software Systems Division Manager. From 1972 to 1977, he was
employed by Computer Sciences Corporation, where he progressed from Programmer
Analyst to Section Manager. Mr. Gough earned a B.S. degree from the University
of Maryland where he majored in Information Systems Management in the School of
Business and Public Administration.

Steven A. Carchedi, 48, joined the Company in 1991, and has been Vice President
of Commercial Programs since 1994. Before joining the Company as a full-time
employee in 1991, Mr. Carchedi worked with the Company for two years as an
independent business development consultant. Previously, he worked for
Computational Engineering, Inc., where he held positions as a Mathematician,
Program Manager, Corporate Director, and Vice President of Business Development.
Mr. Carchedi holds a B.S. degree in Mathematics from Wake Forest University and
a M.A. degree in Mathematics from the University of Maryland.

Robert P. Sadler, 49, a Company founder, has been a Director, Secretary, and
Treasurer since 1982. In May 1988, he was appointed Vice President of
Administration; in June 1992, he was appointed Vice President, Quality Control.
Since 1994 he has been the head of the EPOCH Database group. From 1976 to 1982,
OAO employed Mr. Sadler, where he progressed from Computer Analyst to Project
Manager. Mr. Sadler obtained a B.S. in Mathematics and a B.S. in Computer
Sciences from Pennsylvania State University, and a M.S. in Management of
Information Systems Technology from George Washington University.

F-18
<PAGE>

Steven K. Kowal, 46, a Company founder, has been with the Company since 1982.
In May 1998, he was appointed Vice President, Commercial Products while in May
1988, he was appointed Vice President of Engineering Manufacturing. Mr. Kowal
is the Chairman of the Board of IMI. From 1979 to 1982, OAO employed Mr. Kowal,
where he was a Manager of Hardware Development on several of OAO's major
systems. Mr. Kowal holds a B.S. degree in Electrical Engineering from the
University of Delaware.

Donald F. Mack, Jr., 46, joined the Company in 1986 and has been Vice President,
Integration and Test and Data Systems Division since May 1998. In July 1989, he
was appointed Vice President of Engineering. He is currently developing new
business areas for the Company in the areas of satellite and payload I&T and
satellite image data processing. From 1979 to 1986, General Electric
Corporation's Space Systems Division employed Mr. Mack, where he progressed from
Design Engineer to Senior Project Supervisor for systems development. Mr. Mack
holds a B.S. degree in Electrical Engineering from Northeastern University and a
M.S. degree in Electrical Engineering from Johns Hopkins University.

William I. Tittley, 56, joined the Company in 1992, performing as Project
Manager on the first EPOCH 2000 sale to the Chinese Government. In March 1995,
Mr. Tittley was appointed Vice President, Asia Pacific Operations, to oversee
the Company's operations and business development in that region. Formerly, Mr.
Tittley was with OAO (from 1977 through 1992), where he performed duties as
Director of Space Systems Programs in charge of the technical and financial
direction of aerospace programs. Mr. Tittley holds a B.S. equivalent in
Aerospace Vehicle Design from the Academy of Aeronautics (State University of
New York), and has pursued graduate studies in Astronomy at the University of
Maryland and Engineering at the California Coast University.

Elaine M. Parfitt, 36, joined the Company in 1983. She served as Staff
Accountant/Personnel Administrator until January 1995, when she was promoted to
Controller/Director of Accounting. In March 1997, Ms. Parfitt was appointed
Vice President and Chief Financial Officer. She holds a B.S. degree in
Accounting from the University of Maryland.

Patrick R. Woods, 44, joined the Company in 1995, and has been Vice President,
Government Programs since May 1998. From 1996 to April 1998, Mr. Woods served
as Vice President, NOAA Programs. From 1994 to 1995, he worked for Space
Systems/Loral (SS/L), and from 1985 to 1994, he worked for the Lockheed Martin
Corporation (formerly Loral Aerospace). Mr. Woods served as the Director of
Mission Operations for both SS/L and the AeroSys Division of Loral Aerospace.
While at Loral Aerospace, Mr. Woods received the NASA Public Service Group
Achievement Award from NASA Administrator Admiral Richard Truly for his
management of the Hubble Space Telescope control center development and launch
support. Mr. Woods holds a B.S. in Public Administration and a M.P.A. in Public
Management from Indiana University.

Peter J Gaffney, 40, joined the Company in 1986. In May 1999, Mr. Gaffney was
appointed Vice President, Commercial Division. From 1986 to 1992, he worked on
simulators for the Company's DMSP and Tiros programs. In 1992, he became a
project manager for EPOCH 2000 ground systems programs which included the
Command and Range Generator project for GE Americom, the Loral Skynet Telstar 3,
4, and 5 ground systems, and the Echostar 1, 2, 3, and 4 ground systems. Prior
to joining Integral Systems, Mr. Gaffney was a design engineer for the General
Electic Co., where he worked on the DSCS, Milstar, Landsat, and Spot satellite
programs. Mr. Gaffney graduated from the University of MD in 1981 with a BS in
Electrical Engineering.

Carroll G. Dudley, 58, joined the Company in 1999. In June 1999, he was
appointed Vice President, NASA Projects. Formerly, Mr. Dudley was with NASA
Goddard Space Flight Center from 1966 through 1998, where he performed duties as
Deputy Director of Mission Operations and Deputy Director of Applied Engineering
and Technology. During his tenure at the Goddard Space Flight Center, Mr.
Dudley progressed from a telemetry systems engineer working with the Apollo
ground tracking network, to manager of the Hubble Space Telescope control center
development, and to Division Chief of the Mission Operations Division. Mr.
Dudley holds a BS degree in Electrical Engineering from Virginia Polytechnic
Institute and State University and a MS degree in Engineering Administration
from the George Washington University.

Bonnie K. Wachtel, 44, has served as an outside director since May 1988. Since
1984, she has been Vice President, General Counsel, and a Director of Wachtel &
Co., Inc., an investment-banking firm in Washington, DC.

F-19
<PAGE>

Ms. Wachtel serves as a Director of several corporations, including VSE
Corporation and Information Analysis, Inc. She holds a B.A. and M.B.A. from the
University of Chicago and a J.D. from the University of Virginia, and is a
Certified Financial Analyst.

Dominic A. Laiti, 68, was elected as an outside director of the Company in July
1995. Mr. Laiti is presently employed as an independent consultant and was
President and Director of Globalink, Inc. from, January 1990 to December 1994.
He has over 26 years of experience in starting, building, and managing high-
technology private and public companies with annual revenues from 2 million to
over 120 million dollars. Mr. Laiti was President of Hadron, Inc. from 1979 to
1989; Vice President of Xonics, Inc. from 1972 to 1979; and Vice President of
KMS Industries from 1968 to 1972. He is a former Director of United Press
International, Saturn Chemicals Company, Hadron, Inc., Telecommunications
Industries, Inc., MAXXAM Technology, Inc., and Jupiter Technology, Inc.

R. Doss McComas, 45, joined the Board as an outside director in July 1995. He
is President of Integrated Wireless Systems, Inc. a manufacturer and integrator
of cellular and wireless local loop systems. Previously, he held positions with
COMSAT RSI, including Chairman of its Equity Investments, Plexsys International,
as well as Vice President of various areas, including General Counsel,
Acquisitions, Strategic Planning and International Marketing. He holds a B.A.
degree from Virginia Polytechnic Institute; an M.B.A. from Mt. Saint Mary's; and
a J.D. from Gonzaga University.

Section 16(A) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's officers and directors, and persons who
own more than 10% of the Company's Common Stock, to file reports of ownership
and changes in ownership of the Company's Common Stock with the Securities and
Exchange Commission and Nasdaq. Based on a review of the copies of such reports,
the Company believes that during the fiscal year ending September 30, 1999 its
executive officers, directors and greater than ten percent stockholders filed on
a timely basis all reports due under Section 16(a) of the Exchange Act, with the
following exceptions: Carroll Dudley, an executive officer of the Company,
inadvertently filed late a Form 3; Steven Carchedi, an executive officer of the
Company, inadvertently filed late a Form 4 for January 1999, reporting two
transactions; Dominic Laiti, an outside director of the Company, inadvertently
filed late a Form 4 for August 1999 reporting one transaction.

F-20
<PAGE>

Item 10. Executive Compensation
----------------------

a. Summary Compensation Table
--------------------------

The following table sets forth compensation received by the Company's CEO and
four highest paid executive officers that earned over $100,000 during the fiscal
year ended September 30, 1999:

Annual Compensation Long-Term Compensation
------------------- -----------------------------
Awards Payouts
------ -------
Name and Principal Shares All Other
Position Year Salary Bonus Underlying Options Compensation (1)
- -------------------- ---- ------ ----- ------------------ ---------------
<S> <C> <C> <C> <C> <C>
Chief Executive Officer
Steven. R. Chamberlain 1999 $187,862 $65,000 20,000 $19,066
1998 $140,120 $30,000 0 $13,847
1997 $117,088 $13,000 0 $11,639

Chief Operating Officer/Pres.
Thomas L. Gough 1999 $167,545 $35,000 0 $16,885
1998 $125,251 $20,000 0 $12,357
1997 $106,242 $11,000 0 $10,508

Executive Vice Pres.,
Business Devel.
Steven A. Carchedi 1999 $162,476 $35,000 12,000 $16,092
1998 $122,432 $20,000 0 $11,092
1997 $103,701 $11,000 0 $10,136

Vice Pres. Commercial Prods.
Steven K. Kowal 1999 $157,386 $12,000 8,000 $15,695
1998 $119,672 $12,000 0 $11,711
1997 $102,257 $10,000 0 $10,001

Vice Pres. Government Progs.
Patrick R. Woods 1999 $156,119 $30,000 12,000 $16,799
1998 $117,284 $15,000 0 $12,382
1997 $104,857 $ 8,000 0 $ 9,674
</TABLE>

(1) All Other Compensation represents employer pension contributions. It does
not include the value of insurance premiums paid by or on behalf of the Company
with respect to term life insurance for the benefit of each identified
individual in the amounts of $594, $584, and $435 for fiscal years 1999, 1998
and 1997 respectively.

F-21
<PAGE>

OPTION/SAR GRANTS IN LAST FISCAL YEAR

- ------------------------------------------------------------------------------------------------------------------------
Individual Grants
- ------------------------------------------------------------------------------------------------------------------------
Percent of Total
Number of Options/SARs
Options/ Granted to
SARs Employees in Exercise/Base Expiration
Name Granted Fiscal Year Price($) Date
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CEO
Steven R. Chamberlain 20,000 7% $18.88 2004

EXECUTIVE VP BUSINESS DEVELOPMENT
Steven A. Carchedi 12,000 4% $18.88 2004

VP COMMERCIAL PRODUCTS
Steven K. Kowal 8,000 3% $18.88 2004

VP GOVERNMENT PROGRAMS
Patrick R. Woods 12,000 4% $18.88 2004
</TABLE>

b. Compensation Pursuant to Plans
------------------------------

The Company's Board of Directors awards annual bonuses to officers and
employees on a discretionary basis. Currently, no formal plan exists for
determining bonus amounts.

Effective October 1, 1987, the Company established a 401K pension and profit
sharing plan ("the Plan") under Section 401 of the Internal Revenue Code ("the
Code"). Under the Plan the Company contributes annually an amount equal to 5%
of an eligible employee's salary, and may make additional contributions of up to
7.0% of an eligible employee's salary. The employee may contribute up to an
additional 10% as salary deferral. In fiscal years 1998 and 1997, the Company
contributed a total of 11% of eligible employees' salaries to the plans.

c. Stock Option Plan
-----------------

Effective May 25, 1988, the Company established a stock option plan, as
amended and restated in 1994 and 1998 (the ''Stock Option Plan''), to create
additional incentives for the Company's employees, consultants and directors to
promote the financial success of the Company. The Stock Option Committee has the
authority to select full-time employees, directors or consultants to receive
awards of options for the purchase of stock of the Company under this plan. The
maximum number of shares of Common Stock which may be issued pursuant to the
Stock Option Plan was increased from 300,000 to 1,200,000 during fiscal year
1994. At the Annual Meeting of stockholders of the Company held on July 22, 1998
(the ''1998 Annual Meeting''), the stockholders approved an amendment and
restatement of the Stock Option Plan which, among other changes, increased the
number of shares subject to options under the Stock Option Plan from 1,200,000
to 1,800,000 shares. Options to purchase a total of 296,840 shares of Common
Stock were issued and options to purchase 140,656 shares of Common Stock were
exercised during fiscal year 1999. The Company has reserved for issuance an
aggregate of 1,353,580 shares of Common Stock, of which options to purchase
850,228 shares are outstanding. Pursuant to the Stock Option Plan, options may
be incentive stock options within the meaning of Section 422 of the Code or
nonstatutory stock options, although incentive stock options may be granted only
to employees.

F-22
<PAGE>

Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values

Two of the executives named below exercised stock options during the fiscal year
ended September 30,1999.

Steven A. Carchedi exercised a total of 63,000 options, consisting of 21,000
Non-Statutory Stock Options and 42,000 Incentive Stock Options. Thomas L. Gough
exercised 6,000 Incentive Stock Options.

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e)
- ----------------------------------------------------------------------------------------------------------------------------------
Number of
Securities Underlying Value of Unexercised
Unexercised Options/ SARS In-the-Money Options/ SARS
at FY-end (#) at FY end ($)1

Shares Acquired on Exercisable Exercisible
Name Exercise (#) Value Realized Unexercisable Unexercisable

- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Chief Executive Officer -- -- 104,400 $2,644,632
Steven R. Chamberlain (exercisable) (exercisable)
50,600 $ 960,358
(unexercisable) (unexercisable)
- ----------------------------------------------------------------------------------------------------------------------------------
Chief Operating Officer/Pres. 6,000 $ 58,980 22,000 $ 546,260
Thomas L. Gough (exercisable) (exercisable)
24,000 $ 595,920
(unexercisable) (unexercisable)
- ----------------------------------------------------------------------------------------------------------------------------------
Executive Vice President of 63,000 $959,508 51,750 $1,305,068
Business Development (exercisable) (exercisable)
Steven A. Carchedi 29,250 $550,643
(unexercisable) (unexercisable)

- ----------------------------------------------------------------------------------------------------------------------------------
Vice President Commercial Products 18,000 $ 453,060
Steven K. Kowal (exercisable) (exercisable)
14,000 $ 230,020
(unexercisable) (unexercisable)
- ----------------------------------------------------------------------------------------------------------------------------------
Vice President Government Programs 0 $ 0
Patrick R. Woods (exercisable) (exercisable)
12,000 $ 118,500
(unexercisable) (unexercisable)
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Value for "In the Money" options represents the difference between the
exercise prices of outstanding options and the fair market value of the
Company's common stock of $28.75 per share at September 30, 1999.

d. Compensation of Directors
-------------------------

Presently, outside directors who are not employees of the Company receive
$5,000 per year for their services. Bonnie K. Wachtel, Dominic A. Laiti and R.
Doss McComas are outside directors who are not employees of the Company.

e. Termination of Employment and Change of Control Termination
-----------------------------------------------------------

The Company has no compensatory plan or arrangement with respect to any
individual named in the Summary Compensation Table (Item 10(a)) which results or
will result from the resignation, retirement or any other termination of such
individual's employment with the Company or its subsidiaries or from a change in
control of the Company or a change in the individual's responsibilities
following a change in control.

F-23
<PAGE>

Item 11. Security Ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------

a. Security Ownership of Certain Beneficial Owners (as of 9/30/99)
---------------------------------------------------------------

The following table sets forth certain information regarding the beneficial
ownership of the Company's common stock, par value $.01 (the "Common Stock"), as
of September 30, 1999, by each person (other than directors and executive
officers of the Company) known by the Company to beneficially own 5% or more of
the outstanding shares of Common Stock.

<TABLE>
<CAPTION>
Name and Address of Beneficial Owner Amount and Nature of Percent of
- ------------------------------------ -------------------- ----------
Beneficial Owner Class
----------------- -----
<S> <C> <C>
Chartwell Capital Investors II LP 555,556 7.8%
One Independent Drive
Suite 3120
Jacksonville, FL 32202
</TABLE>

b. Security Ownership of Management (as of 9/30/99)
------------------------------------------------

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of September 30, 1999, by (i) each
director and officer of the Company and (ii) all directors and executive
officers as a group. Except as indicated in the table, the address of the
below-named directors and executive officers is that of the Company's principal
executive offices.

Steven R. Chamberlain 422,905 (1) 5.8%
Thomas L. Gough 174,600 (2) 2.4%
Robert P. Sadler 235,190 (3) 3.3%
Elaine M. Parfitt 13,400 (4) *
Donald F. Mack, Jr 50,100 (5) *
Steven K. Kowal 217,376 (6) 3.0%
Steven A. Carchedi 117,750 (7) 1.6%
William I. Tittley 3,750 (8) *
Patrick Woods -- *
Peter J. Gaffney 27,000 (9) *
Bonnie K. Wachtel 44,400 (10) *
1101 Fourteenth Street, N.W.
Suite 800
Washington, D.C. 20036
Dominic A. Laiti 24,000 (11) *
12525 Knoll Brook Drive
Clifton, Va. 22024
R. Doss McComas 21,000 (12) *
409 Biggs Drive
Front Royal, Va. 22630
Carroll G. Dudley 600 *
All Directors and Executive Officers as a
group (14 persons). 1,352,071 18.1%
</TABLE>

* Less than one percent of the Common Stock outstanding.
(1) Includes outstanding options to purchase 104,400 shares of Common Stock
which are exercisable within 60 days.
(2) Includes outstanding options to purchase 22,000 shares of Common Stock which
are exercisable within 60 days.

F-24
<PAGE>

(3) Includes 218,760 shares, which Mr. Sadler holds with his wife, and 3,900 as
trustee for his children. Also includes outstanding options to purchase
2,250 shares of Common Stock which are exercisable within 60 days.
(4) Includes outstanding options to purchase 3,000 shares of Common Stock which
are exercisable within 60 days.
(5) Includes outstanding options to purchase 10,500 shares of Common Stock
which are exercisable within 60 days.
(6) Includes outstanding options to purchase 18,000 shares of Common Stock
which are exercisable within 60 days.
(7) Includes outstanding options to purchase 51,750 shares of Common Stock
which are exercisable within 60 days.
(8) Includes outstanding options to purchase 3,750 shares of Common Stock which
are exercisable within 60 days.
(9) Includes outstanding options to purchase 24,000 shares of Common Stock
which are exercisable within 60 days.
(10) Includes outstanding options to purchase 18,000 shares of Common Stock
which are exercisable within 60 days.
(11) Includes outstanding options to purchase 24,000 shares of Common Stock
which are exercisable within 60 days.
(12) Includes outstanding options to purchase 21,000 shares of Common Stock
which are exercisable within 60 days.

Item 12. Certain Relationships and Related Transactions
----------------------------------------------

In June 1999, the Company sold an aggregate of 1,183,268 shares of its Common
Stock, par value $.01 per share, to accredited investors, which represented that
they were accredited investors. The aggregate offering price for such sale was
$21,298,824. No underwriters were involved in the sale. The Company relied on
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"),
and Rule 506 under Regulation D of the Securities Act for the exemption from
registration of the sale of such shares. Pursuant to the foregoing offering,
Chartwell Capital Investors II LP ("Chartwell"), an accredited investor,
purchased 555,556 shares of the Company's Common Stock, after which purchase
Chartwell was a beneficial owner of greater than 5% of the Company's Common
Stock.

Item 13. Exhibits, Lists, and Reports on Form 8K
---------------------------------------

(a) Exhibits

3.1 Articles of Restatement of the Company (Incorporated by reference
to the Registration Statement on Form S-3 (File No. 333-82499) filed
with the Commission on July 8, 1999.

3.2 By-Laws of the Company (Incorporated by reference to the Company's
Annual Report on Form 10-KSB filed by the Company with the Commission
on December 29, 1998).

4.1 Specimen Common Stock Certificate (Incorporated by reference to the
Registration Statement on Form S-1 (File No. 333-58453) filed by the
Company with the Commission on July 2, 1998).

10.1 1988 Stock Plan (Incorporated by reference to the Registration
Statement on Form S-8 (File No. 333- 61559) filed by the Company with
the Commission on August 14, 1998).

10.2 Contract effective May 17, 1996 between Integral Systems Inc. and the
U.S. National Oceanic and Atmospheric Administration (Incorporated by
reference to the Company's Annual Report on Form 10-KSBA filed by the
Company with the Commission on July 10, 1997). (Portions of this
exhibit have been omitted pursuant to an order for confidential
treatment granted by the Commission).

10.3 Lease dated June 1, 1999, between Integral Systems Inc. and ASP
Washington, L.L.C. (Incorporated by reference to the Company's June 30,
1999 10-QSB filed by the Company on August 11,1999).

10.4 Master Equipment Lease Agreement dated December 3, 1997 between
NationsBanc Leasing Corporation and Integral Systems Inc. (Incorporated
by reference to the Registration Statement on Form S-1 (File No. 333-
58453) filed by the Company with the Commission on July 2, 1998).

10.5 Loan Agreement dated November 14, 1997 between NationsBank N.A. and
Integral Systems, Inc. Promissory Note dated November 14, 1997 by
Integral Systems Inc. in favor of NationsBank N.A. (Incorporated by
reference to the Registration Statement on Form S-1 (File No. 333-
58453) filed by the Company with the Commission on July 2, 1998).

10.6 Subcontract (J8-759124-C3JP) between Hughes Space and Communications
Company and Integral

F-25
<PAGE>

Systems, Inc. dated March 3, 1999 (Incorporated by reference to the
Company's June 30, 1999 10-QSB filed by the Company on August 11,
1999). (Portions of this exhibit have been omitted pursuant to a
request for confidential treatment filed with the commission).

11.1 Computation of Per Share Earnings

21.1 List of Subsidiaries of the Registrant

23.1 Consent of Rubino & McGeehin, Chartered

27.1 Financial Data Schedule

(b) Reports on Form 8-K

The Company did not file any reports on Form 8-K for the fiscal year ended
September 30, 1999

F-26
<PAGE>

In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

Signature Titles Date

/s/ Chairman of the Board, Director, 12/13/99
- ----------------------- --------
Steven R. Chamberlain Chief Executive Officer

/s/ President, Chief Operating Officer, 12/13/99
- ----------------------- --------
Thomas L. Gough Director

/s/ Vice President of Quality Control, 12/13/99
- ----------------------- --------
Robert P. Sadler Secretary & Treasurer; Director

/s/ Director 12/13/99
- ----------------------- --------
Bonnie K. Wachtel

/s/ Director 12/13/99
- ----------------------- --------
Dominic A. Laiti

/s/ Director 12/13/99
- ----------------------- --------
R. Doss McComas

<PAGE>

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

INTEGRAL SYSTEMS, INC.

DATE: 12/13/99 BY: /s/
-------- ---------------------------------
Steven R. Chamberlain
Chairman of the Board and
Chief Executive Officer

DATE: 12/13/99 BY: /s/
-------- ---------------------------------
Thomas L. Gough
President, Chief Operating Officer
Director

DATE: 12/13/99 BY: /s/
-------- ---------------------------------
Elaine M. Parfitt
Chief Financial Officer, Principal
Accounting Officer

<PAGE>

Exhibit 11.1

INTEGRAL SYSTEMS INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE

<TABLE>
<CAPTION>
Three Months Ended Twelve Months Ended
September 30, September 30,
Basic: 1999 1998 1999 1998
----------------- ----------------- ----------------- ---------------
<S> <C> <C> <C> <C>
Weighted average number of
common shares 7,152,991 5,834,184 6,319,090 5,793,433

Net income $1,356,145 $ 312,968 $3,715,847 $1,909,026
Earnings per share $ 0.19 $ 0.05 $ .59 $ .33

Diluted:
Weighted average number of
common shares 7,681,158 6,330,166 6,772,601 6,232,933
Net income $1,356,145 $ 312,968 $3,715,847 $1,909,026
Earnings per share $ 0.18 $ 0.05 $ .55 $ .31
</TABLE>

<PAGE>

Exhibit 21.1

Integral Marketing, Inc., incorporated under the laws of Maryland.

InterSys, Inc., incorporated under the laws of Delaware.

<PAGE>

Exhibit 23.1

CONSENT OF INDEPENDENT AUDITORS

We hereby consent to the use in the Annual Report of Integral Systems Inc. on
Form 10-KSB of our report dated November 20, 1999, on our audits of the
consolidated financial statements of Integral Systems, Inc. and its subsidiaries
as of September 30, 1999 and for the years ended September 30, 1999 and 1998.

/s/ Rubino & McGeehin, Chartered
---------------------------------
Rubino & McGeehin, Chartered
Certified Public Accountants

Bethesda, Maryland
December 17, 1999

<PAGE>

<ARTICLE> 5
<MULTIPLIER> 1,000
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> SEP-30-1999
<CASH> 25,163,446
<SECURITIES> 78,123<F1>
<RECEIVABLES> 13,052,820
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 38,294,389
<PP&E> 5,167,470<F2>
<DEPRECIATION> 1,322,169
<TOTAL-ASSETS> 42,139,690
<CURRENT-LIABILITIES> 8,696,933<F3>
<BONDS> 0
0
0
<COMMON> 71,639
<OTHER-SE> 33,371,118
<TOTAL-LIABILITY-AND-EQUITY> 42,139,690
<SALES> 39,579,371
<TOTAL-REVENUES> 39,579,371
<CGS> 28,260,020
<TOTAL-COSTS> 11,319,351
<OTHER-EXPENSES> 5,145,160
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 120,244
<INCOME-PRETAX> 6,053,947
<INCOME-TAX> 2,338,100
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,715,847
<EPS-BASIC> 0.59
<EPS-DILUTED> 0.55
<FN>
<F1>Does not represent securities. Includes Prepaid expenses @ $78,123
<F2>Includes PP&E @ $3,147,610 + S/W dev. Costs @ $2,006,194 + Misc. deposits
@ $13,666
<F3>Includes Capital Leases Payable/Long-Term @ $714,106
</FN>

</TABLE>