##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




---

FORM 10-Q

|                                        |  |                                                                                                
|--------------------------------------- |  | -----------------------------------------------------------------------------------------------
|[X]                                     |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
    15(d) OF
    THE SECURITIES EXCHANGE ACT OF 1934
|For the quarter ended June 30,
    2004
|OR                                     
|[  ]                                    |  | THE SECURITIES EXCHANGE ACT OF 1934                                                            

Commission File No. 0-30821

TELECOMMUNICATION SYSTEMS, INC.

(Exact name of registrant as specified in its
charter)


|                                                                           |  |                                               
|-------------------------------------------------------------------------- |  | ----------------------------------------------
|MARYLAND(State or Other Jurisdiction of
    Incorporation or Organization) |  | 52-1526369(I.R.S. Employer Identification No.)
|                                                                          
|275 West Street, Annapolis, MD(Address of principal executive
    offices) |  | 21401(Zip Code)                               

(410) 263-7616

(Registrants telephone number, including
area code)


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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act):
Yes [     ]     No [ X ]

Indicate the number of shares outstanding of each
of the issuers classes of common stock, as of the latest
practicable date.

|                                                    |  |                    |            | 
|--------------------------------------------------- |  | ------------------ | ---------- | 
|                                                    |  | Shares outstanding
|                                                    |  | as of June 30,    
|Title of Each Class                                 |  | 2004              
|                                                    |  |                   
|Class A Common Stock, par value
    $0.01 per share |  |                    | 24,575,405 | 
|Class B Common Stock, par value
    $0.01 per share |  |                    | 8,845,001  | 
|                                                    |  |                    |            | 
|Total Common Stock Outstanding                      |  |                    | 33,420,406 | 
|                                                    |  |                    |            | 



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TABLE OF CONTENTS



|                              |                                                                                               |                                                |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------- |  |  |  |  |  | 
|                              |                                                                                               | Consolidated Statement of Stockholders Equity
|                              |                                                                                               | Consolidated Statements of Cash Flows         
|                              |                                                                                               | Notes to Consolidated Financial Statements    
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                              | Item 4. Controls and Procedures                                                              
|PART II. -- OTHER INFORMATION
|                              | Item 1. Legal Proceedings                                                                    
|                              | Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities     
|                              | Item 3. Defaults Upon Senior Securities                                                      
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                              | Item 5. Other Information                                                                    
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|                              | SIGNATURES                                                                                   
|EX-3.(i).1                   
|EX-3.(i).2                   
|EX-31.1                      
|EX-31.2                      
|EX-32.1                      
|EX-32.2                      



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##### Table of Contents



INDEX

TELECOMMUNICATION SYSTEMS, INC.

|                              |  |            |  |                                                                                                      |    |      |    | 
|----------------------------- |  | ---------- |  | ---------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                              |  |            |  |                                                                                                      |    | Page
|                              |  |            |  |                                                                                                      |    |     
|PART I. FINANCIAL INFORMATION |  |            |  |                                                                                                     
|                              |  | Item 1.    |  | Financial Statements (Unaudited)                                                                     |    |      |    | 
|                              |  |            |  | Consolidated Statements of Operations for the
    three- and six-months ended June 30, 2004 and 2003 |    |      | 3  | 
|                              |  |            |  | Consolidated Balance Sheets as of June 30,
    2004 and December 31, 2003                            |    |      | 4  | 
|                              |  |            |  | Consolidated Statement of Stockholders
    Equity for the six-months ended June 30, 2004            |    |      | 5  | 
|                              |  |            |  | Consolidated Statements of Cash Flows for the
    six-months ended June 30, 2004 and 2003            |    |      | 6  | 
|                              |  |            |  | Notes to Consolidated Financial Statements                                                           |    |      | 7  | 
|                              |  | Item 2.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations            |    |      | 15 | 
|                              |  | Item 3.    |  | Qualitative and Quantitative Disclosures about
    Market Risk                                       |    |      | 30 | 
|                              |  | Item 4.    |  | Controls and Procedures                                                                              |    |      | 30 | 
|PART II. OTHER INFORMATION    |  |            |  |                                                                                                     
|                              |  | Item 1.    |  | Legal Proceedings                                                                                    |    |      | 31 | 
|                              |  | Item 2.    |  | Changes in Securities, Use of Proceeds and Issuer
    Purchases of Equity Securities                 |    |      | 31 | 
|                              |  | Item 3.    |  | Defaults Upon Senior Securities                                                                      |    |      | 31 | 
|                              |  | Item 4.    |  | Submission of Matters to a Vote of Security
    Holders                                              |    |      | 31 | 
|                              |  | Item 5.    |  | Other Information                                                                                    |    |      | 31 | 
|                              |  | Item 6.    |  | Exhibits and Reports on Form 8-K                                                                     |    |      | 32 | 
|                              |  | SIGNATURES |  |                                                                                                      | 33 |     





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##### Table of Contents



TeleCommunication Systems, Inc.

Consolidated Statements of
Operations

(amounts in thousands, except per share
data)


(unaudited)


|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |        |       |        | 
|------------------------------------------------- | ----------------------------------------------------------- | ----------------------------- | ---------------------------------- | -------------- | ----- | ------ | ------- | ----- | ----- | ------ | ------ | ------ | ----- | ------ | ------- | ------ | ----- | ------ | 
|                                                  |                                                             |                               |                                    |               
|                                                  |                                                             | Three months                  |                                    | Six months    
|                                                  |                                                             | ended June 30,                |                                    | ended June 30,
|                                                  |                                                             |                               |                                    |               
|                                                  |                                                             | 2004                          |                                    | 2003           |       | 2004   |         | 2003 
|                                                  |                                                             |                               |                                    |                |       |        |         |      
|Revenue:                                          |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|                                                  | Service bureau and subscriber                               |                               | $                                  | 20,103         |       |        | $       | 8,310 |       |        | $      | 40,839 |       |        | $       | 15,865 |      
|                                                  | Software systems:                                           |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |        |      
|                                                  |                                                             | Software licenses             |                                    |                | 5,808 |        |         |       | 788   |        |        |        | 7,504 |        |         |        | 3,255 |       
|                                                  |                                                             | Software systems and services |                                    |                | 3,257 |        |         |       | 1,492 |        |        |        | 6,098 |        |         |        | 2,633 |       
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|                                                  | Software systems total                                      |                               |                                    | 9,065          |       |        |         | 2,280 |       |        |        | 13,602 |       |        |         | 5,888  |      
|                                                  | Network solutions                                           |                               |                                    | 11,279         |       |        |         | 9,490 |       |        |        | 18,763 |       |        |         | 17,619 |      
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|                                                  |                                                             |                               | Total revenue                      |                |       | 40,447 |         |       |       | 20,080 |        |        |       | 73,204 |         |        |       | 39,372 | 
|Operating costs and expenses:                     |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|                                                  | Direct cost of service bureau and subscriber
    revenue    |                               |                                    | 12,718         |       |        |         | 3,961 |       |        |        | 25,985 |       |        |         | 7,967  |      
|                                                  | Direct cost of software systems revenue                     |                               |                                    | 3,203          |       |        |         | 1,352 |       |        |        | 5,607  |       |        |         | 3,037  |      
|                                                  | Direct cost of network solutions revenue                    |                               |                                    | 7,046          |       |        |         | 6,492 |       |        |        | 11,245 |       |        |         | 11,852 |      
|                                                  | Research and development expense                            |                               |                                    | 4,555          |       |        |         | 4,664 |       |        |        | 9,601  |       |        |         | 8,579  |      
|                                                  | Sales and marketing expense                                 |                               |                                    | 3,323          |       |        |         | 2,213 |       |        |        | 6,513  |       |        |         | 4,606  |      
|                                                  | General and administrative expense                          |                               |                                    | 4,766          |       |        |         | 2,707 |       |        |        | 9,253  |       |        |         | 5,610  |      
|                                                  | Non-cash stock compensation expense                         |                               |                                    | 346            |       |        |         | 389   |       |        |        | 703    |       |        |         | 762    |      
|                                                  | Depreciation and amortization of property and
    equipment |                               |                                    | 1,912          |       |        |         | 1,690 |       |        |        | 3,644  |       |        |         | 3,235  |      
|                                                  | Amortization of acquired intangible assets                  |                               |                                    | 532            |       |        |         | 139   |       |        |        | 1,064  |       |        |         | 277    |      
|                                                  | Amortization of software development costs                  |                               |                                    | 239            |       |        |         | 7,774 |       |        |        | 326    |       |        |         | 8,804  |      
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|                                                  |                                                             |                               | Total operating costs and expenses |                |       | 38,640 |         |       |       | 31,381 |        |        |       | 73,941 |         |        |       | 54,729 | 
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|Income/(loss) from operations                     |                                                             |                               | 1,807                              |                |       |        | (11,301 | )     |       |        | (737   | )      |       |        | (15,357 | )     
|Interest expense                                  |                                                             |                               | (857                               | )              |       |        | (216    | )     |       |        | (1,664 | )      |       |        | (492    | )     
|Other (expense)/income, net                       |                                                             |                               | (87                                | )              |       |        | 125     |       |       |        | (182   | )      |       |        | 409     |       
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|Net income/(loss)                                 |                                                             | $                             | 863                                |                |       | $      | (11,392 | )     |       | $      | (2,583 | )      |       | $      | (15,440 | )     
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|Earnings/(loss) per share  basic                 |                                                             | $                             | 0.03                               |                |       | $      | (0.38   | )     |       | $      | (0.08  | )      |       | $      | (0.52   | )     
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|Earnings/(loss) per share  diluted               |                                                             | $                             | 0.02                               |                |       | $      | (0.38   | )     |       | $      | (0.08  | )      |       | $      | (0.52   | )     
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|Weighted average shares outstanding 
    basic   |                                                             |                               | 32,566                             |                |       |        | 29,610  |       |       |        | 32,225 |        |       |        | 29,589  |       
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       
|Weighted average shares outstanding 
    diluted |                                                             |                               | 36,591                             |                |       |        | 29,610  |       |       |        | 32,225 |        |       |        | 29,589  |       
|                                                  |                                                             |                               |                                    |                |       |        |         |       |       |        |        |        |       |        |         |       

See accompanying Notes to Consolidated Financial
Statements

3



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##### Table of Contents



TeleCommunication Systems, Inc.

Consolidated Balance Sheets

(amounts in thousands, except share
data)


|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |          |     |        | 
|----------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------------ | --- | ------- | ------ | -------- | --- | ------ | 
|                                                                                                                        |                                                                              | June 30,                                                                                                            |                                            | December 31,
|                                                                                                                        |                                                                              | 2004                                                                                                                |                                            | 2003        
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |             
|                                                                                                                        |                                                                              | (unaudited)                                                                                                         |                                            |             
|Assets                                                                                                                  |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|Current assets:                                                                                                         |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        | Cash and cash equivalents                                                    |                                                                                                                     | $                                          | 15,763       |     |         | $      | 18,785   |    
|                                                                                                                        | Accounts receivable, net of allowance of $1,679
    in 2004 and $393 in 2003 |                                                                                                                     |                                            | 27,431       |     |         |        | 20,208   |    
|                                                                                                                        | Unbilled receivables                                                         |                                                                                                                     |                                            | 13,559       |     |         |        | 8,862    |    
|                                                                                                                        | Inventory                                                                    |                                                                                                                     |                                            | 2,836        |     |         |        | 451      |    
|                                                                                                                        | Other current assets                                                         |                                                                                                                     |                                            | 3,085        |     |         |        | 1,915    |    
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        |                                                                              |                                                                                                                     | Total current assets                       |              |     | 62,674  |        |          |     | 50,221 | 
|Property and equipment, net of accumulated
    depreciation and amortization of $24,569 in 2004 and $20,925 in
    2003 |                                                                              |                                                                                                                     | 15,080                                     |              |     |         | 11,449 |         
|Software development costs, net of accumulated
    amortization of $1,080 in 2004 and $754 in 2003                      |                                                                              |                                                                                                                     | 480                                        |              |     |         | 518    |         
|Acquired intangible assets, net of accumulated
    amortization of $1,064 in 2004                                       |                                                                              |                                                                                                                     | 5,755                                      |              |     |         |       |         
|Goodwill                                                                                                                |                                                                              |                                                                                                                     | 13,802                                     |              |     |         |       |         
|Other assets                                                                                                            |                                                                              |                                                                                                                     | 3,987                                      |              |     |         | 3,092  |         
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        |                                                                              |                                                                                                                     | Total assets                               |              | $   | 101,778 |        |          | $   | 65,280 | 
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|Liabilities and stockholders
    equity                                                                                |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|Current liabilities:                                                                                                    |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        | Accounts payable and accrued expenses                                        |                                                                                                                     | $                                          | 17,579       |     |         | $      | 8,817    |    
|                                                                                                                        | Accrued payroll and related liabilities                                      |                                                                                                                     |                                            | 3,936        |     |         |        | 3,331    |    
|                                                                                                                        | Deferred revenue                                                             |                                                                                                                     |                                            | 4,458        |     |         |        | 1,683    |    
|                                                                                                                        | Current portion of notes payable                                             |                                                                                                                     |                                            | 10,313       |     |         |        | 5,698    |    
|                                                                                                                        | Current portion of capital lease obligations                                 |                                                                                                                     |                                            | 1,474        |     |         |        | 2,154    |    
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        |                                                                              |                                                                                                                     | Total current liabilities                  |              |     | 37,760  |        |          |     | 21,683 | 
|Capital lease obligations and notes payable, less
    current portion                                                   |                                                                              |                                                                                                                     | 5,553                                      |              |     |         | 6,746  |         
|Convertible subordinated debentures, net of
    discount of $6,027 in 2004                                              |                                                                              |                                                                                                                     | 8,973                                      |              |     |         |       |         
|Stockholders equity:                                                                                                   |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        | Class A Common Stock; $0.01 par value:                                       |                                                                                                                     |                                            |              |     |         |        |          |    
|                                                                                                                        |                                                                              | Authorized shares  225,000,000; issued
    and outstanding shares of 24,575,405 in 2004 and 22,062,974 in
    2003 |                                            |              | 246 |         |        |          | 221 |       
|                                                                                                                        | Class B Common Stock; $0.01 par value:                                       |                                                                                                                     |                                            |              |     |         |        |          |    
|                                                                                                                        |                                                                              | Authorized shares  75,000,000; issued
    and outstanding shares of 8,845,001 in 2004 and 9,363,688 in 2003        |                                            |              | 88  |         |        |          | 94  |       
|                                                                                                                        | Deferred compensation                                                        |                                                                                                                     |                                            | (1,077       | )   |         |        | (1,399   | )  
|                                                                                                                        | Additional paid-in capital                                                   |                                                                                                                     |                                            | 184,149      |     |         |        | 169,256  |    
|                                                                                                                        | Accumulated other comprehensive loss:                                        |                                                                                                                     |                                            |              |     |         |        |          |    
|                                                                                                                        |                                                                              | Cumulative foreign currency translation adjustment                                                                  |                                            |              | (10 | )       |        |          |    |       
|                                                                                                                        | Accumulated deficit                                                          |                                                                                                                     |                                            | (133,904     | )   |         |        | (131,321 | )  
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        |                                                                              |                                                                                                                     | Total stockholders equity                 |              |     | 49,492  |        |          |     | 36,851 | 
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         
|                                                                                                                        |                                                                              |                                                                                                                     | Total liabilities and stockholders equity |              | $   | 101,778 |        |          | $   | 65,280 | 
|                                                                                                                        |                                                                              |                                                                                                                     |                                            |              |     |         |        |         

See accompanying Notes to Consolidated Financial
Statements

4



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##### Table of Contents



TeleCommunication Systems, Inc.






Consolidated Statement of Stockholders
Equity


(amounts in thousands, except share
data)


(unaudited)


|                                                                                                                                                        |  |         |     |         |  |              |    |            |  |               |        |             |  |       |         |  |  |   |     |   |  |   |          |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | --- | ------- |  | ------------ | -- | ---------- |  | ------------- | ------ | ----------- |  | ----- | ------- |  |  | - | --- | - |  | - | -------- | - |  | - | ------ | -
|                                                                                                                                                        |  |         |     |         |  |              |    |            |  | Accumulated   |        |             |  |      
|                                                                                                                                                        |  | Class A |     | Class B |  |              |    | Additional |  | Other         |        |             |  |      
|                                                                                                                                                        |  | Common  |     | Common  |  | Deferred     |    | Paid-in    |  | Comprehensive |        | Accumulated |  |      
|                                                                                                                                                        |  | Stock   |     | Stock   |  | Compensation |    | Capital    |  | Loss          |        | Deficit     |  | Total
|                                                                                                                                                        |  |         |     |         |  |              |    |            |  |               |        |             |  |      
|Balance at January 1, 2004                                                                                                                              |  | $       | 221 |         |  | $            | 94 |            |  | $             | (1,399 | )           |  | $     | 169,256 |  |  | $ |    |   |  | $ | (131,321 | ) |  | $ | 36,851 |  
|Options exercised for the purchase of 432,981
    shares of Class A Common Stock                                                                        |  |         | 4   |         |  |              |   |            |  |               |       |             |  |       | 901     |  |  |   |    |   |  |   |         |   |  |   | 905    |  
|Issuance of 37,860 shares of Class A Common
    Stock under Employee Stock Purchase Plan                                                                |  |         |    |         |  |              |   |            |  |               |       |             |  |       | 179     |  |  |   |    |   |  |   |         |   |  |   | 179    |  
|Issuance of 1,568,308 shares of Class A
    Common Stock in connection with the Enterprise acquisition and
    related financing, net of issuance costs |  |         | 16  |         |  |              |   |            |  |               |       |             |  |       | 8,366   |  |  |   |    |   |  |   |         |   |  |   | 8,382  |  
|Fair value of beneficial conversion feature of
    convertible subordinated debentures                                                                  |  |         |    |         |  |              |   |            |  |               |       |             |  |       | 3,662   |  |  |   |    |   |  |   |         |   |  |   | 3,662  |  
|Issuance of warrants to purchase 341,072 shares
    of Class A Common Stock                                                                             |  |         |    |         |  |              |   |            |  |               |       |             |  |       | 1,395   |  |  |   |    |   |  |   |         |   |  |   | 1,395  |  
|Conversion of 518,687 shares of Class B
    Common Stock to Class A Common Stock                                                                        |  |         | 5   |         |  |              | (5 | )          |  |               |       |             |  |       |        |  |  |   |    |   |  |   |         |   |  |   |       |  
|Stock compensation expense for issuance of
    Class A Common Stock options at below fair market value                                                  |  |         |    |         |  |              |   |            |  |               |       |             |  |       | 381     |  |  |   |    |   |  |   |         |   |  |   | 381    |  
|Amortization of deferred compensation expense                                                                                                           |  |         |    |         |  |              |   |            |  |               | 322    |             |  |       |        |  |  |   |    |   |  |   |         |   |  |   | 322    |  
|Stock compensation expense for options issued to
    non- employees for service                                                                         |  |         |    |         |  |              |   |            |  |               |       |             |  |       | 8       |  |  |   |    |   |  |   |         |   |  |   | 8      |  
|Foreign currency translation adjustment                                                                                                                 |  |         |    |         |  |              |   |            |  |               |       |             |  |       |        |  |  |   | (10 | ) |  |   |         |   |  |   | (10    | )
|Net loss for the six months ended June 30,
    2004                                                                                                     |  |         |    |         |  |              |   |            |  |               |       |             |  |       |        |  |  |   |    |   |  |   | (2,583   | ) |  |   | (2,583 | )
|                                                                                                                                                        |  |         |     |         |  |              |    |            |  |               |        |             |  |       |         |  |  |   |     |   |  |   |          |   |  |   |        |  
|Balance at June 30, 2004                                                                                                                                |  | $       | 246 |         |  | $            | 88 |            |  | $             | (1,077 | )           |  | $     | 184,149 |  |  | $ | (10 | ) |  | $ | (133,904 | ) |  | $ | 49,492 |  
|                                                                                                                                                        |  |         |     |         |  |              |    |            |  |               |        |             |  |       |         |  |  |   |     |   |  |   |          |   |  |   |        |  

See accompanying Notes to Consolidated Financial
Statements

5



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##### Table of Contents



TeleCommunication Systems, Inc.






Consolidated Statements of Cash
Flows


(amounts in thousands)


(unaudited)


|                                                                                                       |                                                                          |                                         |         |       |        |   |         |       |        |  
|------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------ | --------------------------------------- | ------- | ----- | ------ | - | ------- | ----- | ------ | -
|                                                                                                       |                                                                          |                                        
|                                                                                                       |                                                                          | Six months ended                       
|                                                                                                       |                                                                          | June 30,                               
|                                                                                                       |                                                                          |                                        
|                                                                                                       |                                                                          | 2004                                    |         | 2003 
|                                                                                                       |                                                                          |                                         |         |      
|Operating activities:                                                                                  |                                                                          |                                         |         |       |        |   |         |      
|Net loss                                                                                               |                                                                          | $                                       | (2,583  | )     |        | $ | (15,440 | )    
|Adjustments to reconcile net loss to net cash
    used in operating activities:                        |                                                                          |                                         |         |       |        |   |         |      
|                                                                                                       | Depreciation and amortization of property and
    equipment              |                                         |         | 3,644 |        |   |         | 3,371 |       
|                                                                                                       | Amortization of acquired intangible assets                               |                                         |         | 1,064 |        |   |         | 277   |       
|                                                                                                       | Non-cash employee compensation expense                                   |                                         |         | 703   |        |   |         | 762   |       
|                                                                                                       | Amortization of software development costs                               |                                         |         | 326   |        |   |         | 8,804 |       
|                                                                                                       | Amortization of debt discount                                            |                                         |         | 669   |        |   |         |      |       
|                                                                                                       | Amortization of deferred financing fees included
    in interest expense |                                         |         | 224   |        |   |         | 56    |       
|                                                                                                       | Other non-cash expenses                                                  |                                         |         | 359   |        |   |         | (50   | )     
|                                                                                                       | State of Maryland loan forgiveness                                       |                                         |         | (100  | )      |   |         | (100  | )     
|                                                                                                       | Changes in operating assets and liabilities:                             |                                         |         |       |        |   |         |       |       
|                                                                                                       |                                                                          | Accounts receivable, net                |         |       | (161   | ) |         |       | 5,486  |  
|                                                                                                       |                                                                          | Unbilled receivables                    |         |       | (4,697 | ) |         |       | (2,164 | )
|                                                                                                       |                                                                          | Inventory                               |         |       | (1,778 | ) |         |       |       |  
|                                                                                                       |                                                                          | Other current assets                    |         |       | (442   | ) |         |       | (84    | )
|                                                                                                       |                                                                          | Accounts payable and accrued expenses   |         |       | (168   | ) |         |       | (8,730 | )
|                                                                                                       |                                                                          | Accrued payroll and related liabilities |         |       | (434   | ) |         |       | 171    |  
|                                                                                                       |                                                                          | Deferred revenue                        |         |       | 442    |   |         |       | (326   | )
|                                                                                                       |                                                                          |                                         |         |       |        |   |         |      
|Net cash used in operating activities                                                                  |                                                                          |                                         | (2,932  | )     |        |   | (7,967  | )    
|Investing activities:                                                                                  |                                                                          |                                         |         |       |        |   |         |      
|Acquisition of Enterprise assets, net of cash
    acquired                                             |                                                                          |                                         | (17,800 | )     |        |   |        |      
|Purchases of property and equipment                                                                    |                                                                          |                                         | (4,859  | )     |        |   | (2,391  | )    
|Change in other assets                                                                                 |                                                                          |                                         | 477     |       |        |   | 62      |      
|Capitalized software development costs                                                                 |                                                                          |                                         |        |       |        |   | (1,865  | )    
|                                                                                                       |                                                                          |                                         |         |       |        |   |         |      
|Net cash used in investing activities                                                                  |                                                                          |                                         | (22,182 | )     |        |   | (4,194  | )    
|Financing activities:                                                                                  |                                                                          |                                         |         |       |        |   |         |      
|Payments on long-term debt and capital lease
    obligations                                           |                                                                          |                                         | (3,928  | )     |        |   | (2,447  | )    
|Proceeds from issuance of Class A Common
    Stock and Convertible subordinated debentures             |                                                                          |                                         | 21,000  |       |        |   |        |      
|Financing fees related to issuance of
    Class A Common Stock and Convertible subordinated debentures |                                                                          |                                         | (1,100  | )     |        |   |        |      
|Proceeds from issuance of long-term debt                                                               |                                                                          |                                         | 5,000   |       |        |   | 2,624   |      
|Proceeds from exercise of employee stock options
    and sale of stock                                 |                                                                          |                                         | 1,085   |       |        |   | 112     |      
|                                                                                                       |                                                                          |                                         |         |       |        |   |         |      
|Net cash provided by financing activities                                                              |                                                                          |                                         | 22,057  |       |        |   | 289     |      
|                                                                                                       |                                                                          |                                         |         |       |        |   |         |      
|Net decrease in cash                                                                                   |                                                                          |                                         | (3,057  | )     |        |   | (11,872 | )    
|Effect of exchange rates on cash and cash
    equivalents                                              |                                                                          |                                         | 35      |       |        |   |        |      
|Cash and cash equivalents at the beginning of the
    period                                           |                                                                          |                                         | 18,785  |       |        |   | 27,402  |      
|                                                                                                       |                                                                          |                                         |         |       |        |   |         |      
|Cash and cash equivalents at the end of the
    period                                                 |                                                                          | $                                       | 15,763  |       |        | $ | 15,530  |      
|                                                                                                       |                                                                          |                                         |         |       |        |   |         |      

See accompanying Notes to Consolidated Financial
Statements

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TeleCommunication Systems, Inc.






Notes to Consolidated Financial
Statements


June 30, 2004


(amounts in thousands, except per share
amounts)


(unaudited)




|   |                                                                         
|-- | ------------------------------------------------------------------------
|1. | Basis of Presentation and Summary of
    Significant Accounting Policies

The accompanying unaudited consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three- and
six-month periods ended June 30, 2004 are not necessarily
indicative of the results that may be expected for the year
ending December 31, 2004. These unaudited consolidated
financial statements should be read in conjunction with our
audited financial statements and related notes included in our
2003 Annual Report on Form 10-K, as amended.

Effective January 1, 2004, we acquired 100%
of the Enterprise Mobility Solutions division of Aether Systems,
Inc. (the Enterprise segment) in accordance with a
Purchase Agreement dated as of December 18, 2003 (the
Enterprise Acquisition). The operations for this
newly acquired segment have been included in the consolidated
financial statements as of January 1, 2004. All
intercompany balances and transactions have been eliminated.

Use of Estimates.The preparation of financial
statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions
that affect the reported amounts and related disclosures. Actual
results could differ from those estimates.

Allowances for Doubtful Accounts Receivable.We use estimates to determine the
amount of the allowance for doubtful accounts necessary to
reduce accounts receivable to their expected net realizable
value. We estimate the amount of the required allowance by
reviewing the status of significant past-due receivables and by
establishing general provisions for estimated losses by
analyzing current and historical bad debt trends. Actual
collection experience has not varied significantly from our
estimates, due primarily to credit and collection policies and
the financial strength of our customers. Receivables that are
ultimately deemed uncollectible are charged-off as a reduction
of receivables and the allowance for doubtful accounts.

Inventory.We
maintain inventory of component parts and finished product for
certain SwiftLink® units. Additionally, we maintain
inventory in conjunction with the Enterprise segment. The
Enterprise inventory consists of finished goods such as handheld
computers, pagers, wireless modems, and accessories. Inventory
is stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.

Goodwill.Goodwill
represents the excess of cost over the fair value of assets of
businesses acquired. Goodwill acquired in a purchase business
combination is not amortized, but instead tested at least
annually for impairment in accordance with the provisions of
Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets. See below for a
description of our accounting policies regarding testing
long-lived assets for impairment.

Acquired Intangible Assets.In conjunction with the Enterprise
Acquisition, we acquired customer contracts, a customer list,
developed technology, and trademarks that will be amortized over
their respective estimated useful lives of 3 
5 years, with a weighted-average useful life of
4.1 years, based on the ratio of the estimated cash flows
generated in each period to the estimated total cash flows to be
contributed from each asset.

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)

Impairment of Long-Lived Assets.Long-lived assets, including
intangible assets, are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of
an asset or group of assets may not be fully recoverable. If an
impairment indicator is present, we evaluate recoverability by a
comparison of the carrying amount of the assets to future
undiscounted net cash flows that we expect to generate from
these assets. If the assets are impaired, we recognize an
impairment charge equal to the amount by which the carrying
amount exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of carrying values or fair
values, less estimated costs of disposal.

Other Comprehensive Income/loss.Comprehensive income, as defined,
includes changes in the equity of a business during a period
from transactions and other events and circumstances from
non-owner sources. Other comprehensive income/loss refers to
revenue, expenses, gains and losses that under generally
accepted accounting principles are included in comprehensive
income, but excluded from net income. For operations outside the
U.S. that prepare financial statements in currencies other than
the U.S. dollar, results of operations and cash flows are
translated at average exchange rates during the period, and
assets and liabilities are translated at end-of-period exchange
rates. Translation adjustments for our international
subsidiaries are included as a separate component of accumulated
other comprehensive loss in stockholders equity.

Stock-Based Compensation.We have two stock-based employee
compensation plans, which are described more fully in Note 7. We
record compensation expense for all stock-based compensation
plans using the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees(APB No. 25) and related
interpretations. Under APB No. 25, compensation expense is
recorded over the vesting period to the extent that the fair
value of the underlying stock on the date of grant exceeds the
exercise or acquisition price of the stock or stock-based award.

Reclassifications.Certain prior period amounts have been
reclassified to conform to the current year presentation.



|   |                                      
|-- | -------------------------------------
|2. | Acquisition and Related
    Financing

Effective January 1, 2004, we acquired the
Enterprise segment in accordance with a Purchase Agreement dated
as of December 18, 2003.

The Enterprise segment provides wireless data
solutions, uniting messaging, synchronization and web
technologies. These solutions include package and vehicle
tracking, productivity tools, and the ability to capture digital
signatures for proof of delivery to a growing installed base of
logistics customers. The Enterprise segment is a leading
reseller of BlackberryTM devices and provides
real-time financial market data to wireless device users under
annual subscriber contracts in the U.S. and Europe. As a result
of the acquisition of the Enterprise segment, the Company
believes that it will be able to expand its product offerings to
both new and existing customers, expand its international sales,
and provide broader technology and expertise to its customers,
opening new markets to the Company.

The aggregate purchase price was approximately
$22,406, consisting of cash payments of $18,150, a note payable
in the amount of $1,000, bearing interest at the prime interest
rate, and 204,020 shares of our Class A Common Stock,
valued at $1,056, based on the average closing price for the
five days immediately preceding the closing of the acquisition.
In addition, management expects to incur approximately $2,200 of
costs directly related to the acquisition. The total purchase
price has been allocated based on independent third-party
valuation procedures performed on the acquired assets and
assumed liabilities, with the excess of the purchase price

8



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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)

over the assets acquired and liabilities assumed
being allocated to goodwill. The valuation has resulted in the
recognition of $13,802 of goodwill. This goodwill has been
allocated to the Enterprise segment, and we expect it to be
deductible for tax purposes.

The following table summarizes the estimated fair
values of the assets acquired and liabilities assumed at the
date of the acquisition:

|                                        |                   |   |        |        | 
|--------------------------------------- | ----------------- | - | ------ | ------ | 
|Assets:                                 |                   |   |        |       
|Cash                                    |                   | $ | 1,882  |       
|Accounts receivable, net                |                   |   | 7,047  |       
|Inventory                               |                   |   | 606    |       
|Other current assets                    |                   |   | 718    |       
|Property and equipment                  |                   |   | 750    |       
|Acquired software development costs     |                   |   | 287    |       
|Acquired intangible assets              |                   |   | 6,819  |       
|Goodwill                                |                   |   | 13,802 |       
|Other assets                            |                   |   | 30     |       
|                                        |                   |   |        |       
|                                        | Total assets      |   |        | 31,941 | 
|Liabilities:                            |                   |   |        |       
|Accounts payable and accrued expenses   |                   |   | 6,188  |       
|Accrued payroll and related liabilities |                   |   | 1,032  |       
|Deferred revenue                        |                   |   | 2,315  |       
|                                        |                   |   |        |       
|                                        | Total liabilities |   |        | 9,535  | 
|                                        |                   |   |        |       
|Net assets acquired                     |                   | $ | 22,406 |       
|                                        |                   |   |        |       

The following unaudited consolidated pro forma
results of operations of the Company for the three-and six-
month periods ended June 30, 2003, gives effect to the
January 1, 2004 acquisition as though it had occurred on
January 1, 2003:

|                       |                   |               |         |               |   |   |         |       |  
|---------------------- | ----------------- | ------------- | ------- | ------------- | - | - | ------- | ----- | -
|                       |                   | Three months  |         | Six months   
|                       |                   | Ended         |         | Ended        
|                       |                   | June 30, 2003 |         | June 30, 2003
|                       |                   |               |         |              
|Revenue                |                   | $             | 33,373  |               |   | $ | 67,047  |      
|Loss from operations   |                   |               | (11,607 | )             |   |   | (16,856 | )    
|Net loss               |                   |               | (12,195 | )             |   |   | (17,915 | )    
|                       |                   |               |         |               |   |   |         |      
|Loss per common share: |                   |               |         |               |   |   |         |      
|                       | Basic and diluted |               | $       | (0.39         | ) |   | $       | (0.58 | )
|                       |                   |               |         |               |   |   |         |      

The pro forma results include the estimated
amortization of intangibles, estimated depreciation of the fair
value of the property, plant and equipment acquired, and the
recognition of interest expense related to financing the
acquisition. The pro forma results are not necessarily
indicative of the results that would have occurred if the
acquisition had actually been completed on January 1, 2003
and do not reflect the reduction in recurring costs during the
latter part of 2003, nor are they necessarily indicative of
future consolidated results.

9



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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)



|   |                                                     
|-- | ----------------------------------------------------
|3. | Supplemental Disclosure of Cash Flow
    Information

Property and equipment acquired under capital
leases totaled $176 and $179 during the three months ended
June 30, 2004 and 2003, respectively, and $1,664 and $179
during the six months ended June 30, 2004 and 2003,
respectively.

Interest paid totaled $298 and $204 during the
three months ended June 30, 2004 and 2003, respectively,
and $561 and $436 during the six months ended June 30, 2004 and
2003, respectively.



|   |                    
|-- | -------------------
|4. | Segment Information

Beginning with our acquisition of the Enterprise
segment in January 2004, we manage our business across three
market segments: (i) our Wireless Carrier segment, which
consists principally of our products and services marketed
directly to wireless carriers consisting of monthly recurring
E9-1-1 and hosted software application offerings as well as
software license and service fees, (ii) our Government
segment, which includes the design, development and deployment
of information processing and communication systems and related
services to government agencies, and (iii) our Enterprise
segment, which comprises the operations we acquired from Aether
Systems, Inc., which offers subscriber-based services as well as
software licenses and services to Enterprise customers.

Management evaluates performance based on gross
profit. Gross profit is defined as revenue less direct cost of
revenue, excluding the amortization of software development
costs, which under accounting principles generally accepted in
the United States, is considered in determining gross profit
from software license revenues. We have restated prior period
segment information for comparative purposes.

|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |       |        | 
|----------------------------- | ----------------------------- | -------------------------------- | ----- | ------------------------------ | ------ | ---------- | ------ | ----- | ------ | ------- | ------ | ---------- | ------ | ---------- | ------ | ----- | ------ | - | ------ | ----- | ------ | - | ------ | - | ------ | - | ------ | ----- | ------ | - | ------ | ----- | ------ | 
|                              |                               |                                  |       |                               
|                              |                               | Three months ended June 30, 2004 |       | Six months ended June 30, 2004
|                              |                               |                                  |       |                               
|                              |                               | Wireless                         |       |                                |        | Wireless   |        |      
|                              |                               | Carrier                          |       | Government                     |        | Enterprise |        | Total |        | Carrier |        | Government |        | Enterprise |        | Total
|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |      
|Revenue:                      |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|Service bureau and subscriber |                               | $                                | 9,577 |                                |        | $          |       |       |        | $       | 10,526 |            |        | $          | 20,103 |       |        | $ | 18,695 |       |        | $ |       |   |        | $ | 22,144 |       |        | $ | 40,839 |      
|Software systems:             |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|                              | Software licenses             |                                  |       | 5,779                          |        |            |        |      |        |         |        | 29         |        |            |        | 5,808 |        |   |        | 7,443 |        |   |        |  |        |   |        | 61    |        |   |        | 7,504 |       
|                              | Software systems and services |                                  |       | 2,465                          |        |            |        |      |        |         |        | 792        |        |            |        | 3,257 |        |   |        | 4,324 |        |   |        |  |        |   |        | 1,774 |        |   |        | 6,098 |       
|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|Software systems total        |                               |                                  | 8,244 |                                |        |            |       |       |        |         | 821    |            |        |            | 9,065  |       |        |   | 11,767 |       |        |   |        |   |        |   | 1,835  |       |        |   | 13,602 |      
|Network solutions             |                               |                                  |      |                                |        |            | 11,279 |       |        |         |       |            |        |            | 11,279 |       |        |   |       |       |        |   | 18,763 |   |        |   |       |       |        |   | 18,763 |      
|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|                              |                               | Total revenue                    |       | $                              | 17,821 |            |        | $     | 11,279 |         |        | $          | 11,347 |            |        | $     | 40,447 |   |        | $     | 30,462 |   |        | $ | 18,763 |   |        | $     | 23,979 |   |        | $     | 73,204 | 
|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|Segment gross profit:         |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|Service bureau and subscriber |                               | $                                | 4,755 |                                |        | $          |       |       |        | $       | 2,630  |            |        | $          | 7,385  |       |        | $ | 9,545  |       |        | $ |       |   |        | $ | 5,309  |       |        | $ | 14,854 |      
|Software systems              |                               |                                  | 5,580 |                                |        |            |       |       |        |         | 282    |            |        |            | 5,862  |       |        |   | 7,552  |       |        |   |       |   |        |   | 443    |       |        |   | 7,995  |      
|Network solutions             |                               |                                  |      |                                |        |            | 4,233  |       |        |         |       |            |        |            | 4,233  |       |        |   |       |       |        |   | 7,518  |   |        |   |       |       |        |   | 7,518  |      
|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      
|                              |                               | Total segment gross profit       |       | $                              | 10,335 |            |        | $     | 4,233  |         |        | $          | 2,912  |            |        | $     | 17,480 |   |        | $     | 17,097 |   |        | $ | 7,518  |   |        | $     | 5,752  |   |        | $     | 30,367 | 
|                              |                               |                                  |       |                                |        |            |        |       |        |         |        |            |        |            |        |       |        |   |        |       |        |   |        |   |        |   |        |       |        |   |        |      

10



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)

|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |       |        | 
|----------------------------- | ----------------------------- | -------------------------------- | ----- | ------------------------------ | ------ | ---------- | ----- | ----- | ----- | ------- | - | ---------- | - | ---------- | ----- | ----- | ------ | - | ------ | ----- | ------ | - | ------ | - | ------ | - | - | - | - | - | ------ | ----- | ------ | 
|                              |                               |                                  |       |                               
|                              |                               | Three months ended June 30, 2003 |       | Six months ended June 30, 2003
|                              |                               |                                  |       |                               
|                              |                               | Wireless                         |       |                                |        | Wireless   |       |      
|                              |                               | Carrier                          |       | Government                     |        | Enterprise |       | Total |       | Carrier |   | Government |   | Enterprise |       | Total
|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |      
|Revenue:                      |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|Service bureau and subscriber |                               | $                                | 8,310 |                                |        | $          |      |       |       | $       |  |            |   | $          | 8,310 |       |        | $ | 15,865 |       |        | $ |       |   |        | $ |  |   |   | $ | 15,865 |      
|Software systems:             |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|                              | Software licenses             |                                  |       | 788                            |        |            |       |      |       |         |   |           |   |            |       | 788   |        |   |        | 3,255 |        |   |        |  |        |   |   |  |   |   |        | 3,255 |       
|                              | Software systems and services |                                  |       | 1,492                          |        |            |       |      |       |         |   |           |   |            |       | 1,492 |        |   |        | 2,633 |        |   |        |  |        |   |   |  |   |   |        | 2,633 |       
|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|Software systems total        |                               |                                  | 2,280 |                                |        |            |      |       |       |         |  |            |   |            | 2,280 |       |        |   | 5,888  |       |        |   |       |   |        |   |  |   |   |   | 5,888  |      
|Network solutions             |                               |                                  |      |                                |        |            | 9,490 |       |       |         |  |            |   |            | 9,490 |       |        |   |       |       |        |   | 17,619 |   |        |   |  |   |   |   | 17,619 |      
|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|                              |                               | Total revenue                    |       | $                              | 10,590 |            |       | $     | 9,490 |         |   | $          |  |            |       | $     | 20,080 |   |        | $     | 21,753 |   |        | $ | 17,619 |   |   | $ |  |   |        | $     | 39,372 | 
|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|Segment gross profit:         |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|Service bureau and subscriber |                               | $                                | 4,349 |                                |        | $          |      |       |       | $       |  |            |   | $          | 4,349 |       |        | $ | 7,898  |       |        | $ |       |   |        | $ |  |   |   | $ | 7,898  |      
|Software systems              |                               |                                  | 928   |                                |        |            |      |       |       |         |  |            |   |            | 928   |       |        |   | 2,851  |       |        |   |       |   |        |   |  |   |   |   | 2,851  |      
|Network solutions             |                               |                                  |      |                                |        |            | 2,998 |       |       |         |  |            |   |            | 2,998 |       |        |   |       |       |        |   | 5,767  |   |        |   |  |   |   |   | 5,767  |      
|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      
|                              |                               | Total segment gross profit       |       | $                              | 5,277  |            |       | $     | 2,998 |         |   | $          |  |            |       | $     | 8,275  |   |        | $     | 10,749 |   |        | $ | 5,767  |   |   | $ |  |   |        | $     | 16,516 | 
|                              |                               |                                  |       |                                |        |            |       |       |       |         |   |            |   |            |       |       |        |   |        |       |        |   |        |   |        |   |   |   |   |   |        |      

A reconciliation of segment gross profit to net
income/(loss) for the respective periods is as follows:

|                           |                                                             |                    |        |                  |   |      |         |        |   |   |        |        |   |   |         |        |  
|-------------------------- | ----------------------------------------------------------- | ------------------ | ------ | ---------------- | - | ---- | ------- | ------ | - | - | ------ | ------ | - | - | ------- | ------ | -
|                           |                                                             |                    |        |                 
|                           |                                                             | Three months ended |        | Six months ended
|                           |                                                             | June 30,           |        | June 30,        
|                           |                                                             |                    |        |                 
|                           |                                                             | 2004               |        | 2003             |   | 2004 |         | 2003  
|                           |                                                             |                    |        |                  |   |      |         |       
|Total segment gross profit |                                                             | $                  | 17,480 |                  |   | $    | 8,275   |        |   | $ | 30,367 |        |   | $ | 16,516  |       
|                           | Research and development expense                            |                    |        | (4,555           | ) |      |         | (4,664 | ) |   |        | (9,601 | ) |   |         | (8,579 | )
|                           | Sales and marketing expense                                 |                    |        | (3,323           | ) |      |         | (2,213 | ) |   |        | (6,513 | ) |   |         | (4,606 | )
|                           | General and administrative expense                          |                    |        | (4,766           | ) |      |         | (2,707 | ) |   |        | (9,253 | ) |   |         | (5,610 | )
|                           | Non-cash stock compensation expense                         |                    |        | (346             | ) |      |         | (389   | ) |   |        | (703   | ) |   |         | (762   | )
|                           | Depreciation and amortization of property and
    equipment |                    |        | (1,912           | ) |      |         | (1,690 | ) |   |        | (3,644 | ) |   |         | (3,235 | )
|                           | Amortization of acquired intangible assets                  |                    |        | (532             | ) |      |         | (139   | ) |   |        | (1,064 | ) |   |         | (277   | )
|                           | Amortization of software development costs                  |                    |        | (239             | ) |      |         | (7,774 | ) |   |        | (326   | ) |   |         | (8,804 | )
|                           | Interest expense                                            |                    |        | (857             | ) |      |         | (216   | ) |   |        | (1,664 | ) |   |         | (492   | )
|                           | Other (expense)/income                                      |                    |        | (87              | ) |      |         | 125    |   |   |        | (182   | ) |   |         | 409    |  
|                           |                                                             |                    |        |                  |   |      |         |        |   |   |        |        |   |   |         |       
|Net income/(loss)          |                                                             | $                  | 863    |                  |   | $    | (11,392 | )      |   | $ | (2,583 | )      |   | $ | (15,440 | )     
|                           |                                                             |                    |        |                  |   |      |         |        |   |   |        |        |   |   |         |       

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)



|   |                                                                          
|-- | -------------------------------------------------------------------------
|5. | Acquired Intangible Assets and Capitalized
    Software Development Costs

Our acquired intangible assets and capitalized
software development costs consisted of the following:

|                                                              |                    |               |       |                   |       |       |       |          |       |              |     |       |       |  |       |   |       |  |     |   |     |  |     |   |     | 
|------------------------------------------------------------- | ------------------ | ------------- | ----- | ----------------- | ----- | ----- | ----- | -------- | ----- | ------------ | --- | ----- | ----- |  | ----- | - | ----- |  | --- | - | --- |  | --- | - | --- | 
|                                                              |                    |               |       |                  
|                                                              |                    | June 30, 2004 |       | December 31, 2003
|                                                              |                    |               |       |                  
|                                                              |                    | Gross         |       |                   |       | Gross |       |         
|                                                              |                    | Carrying      |       | Accumulated       |       |       |       | Carrying |       | Accumulated  |     |      
|                                                              |                    | Amount        |       | Amortization      |       | Net   |       | Amount   |       | Amortization |     | Net  
|                                                              |                    |               |       |                   |       |       |       |          |       |              |     |      
|Acquired intangible assets:                                   |                    |               |       |                   |       |       |       |          |       |              |     |       |       |  |       |   |       |  |     |   |     |  |     |  
|                                                              | Customer Contracts |               | $     | 4,208             |       |       | $     | 690      |       |              | $   | 3,518 |       |  | $     |  |       |  | $   |  |     |  | $   |  |    
|                                                              | Customer List      |               |       | 1,942             |       |       |       | 319      |       |              |     | 1,623 |       |  |       |  |       |  |     |  |     |  |     |  |    
|                                                              | Trademarks         |               |       | 669               |       |       |       | 55       |       |              |     | 614   |       |  |       |  |       |  |     |  |     |  |     |  |    
|Software development costs, including acquired
    technology |                    |               | 1,559 |                   |       |       | 1,080 |          |       |              | 480 |       |       |  | 1,272 |   |       |  | 754 |   |     |  | 518 |  
|                                                              |                    |               |       |                   |       |       |       |          |       |              |     |       |       |  |       |   |       |  |     |   |     |  |     |  
|                                                              |                    | Total         |       | $                 | 8,378 |       |       | $        | 2,144 |              |     | $     | 6,235 |  |       | $ | 1,272 |  |     | $ | 754 |  |     | $ | 518 | 
|                                                              |                    |               |       |                   |       |       |       |          |       |              |     |       |       |  |       |   |       |  |     |   |     |  |     |  
|Estimated future amortization expense:                        |                    |               |       |                   |       |       |       |          |       |              |     |       |       |  |       |  
|Six months ending December 31,
    2004                       |                    | $             | 1,242 |                   |       |       |       |          |       |              |     |       |       |  |       |  
|Year ending December 31, 2005                                 |                    | $             | 2,460 |                   |       |       |       |          |       |              |     |       |       |  |       |  
|Year ending December 31, 2006                                 |                    | $             | 1,807 |                   |       |       |       |          |       |              |     |       |       |  |       |  
|Year ending December 31, 2007                                 |                    | $             | 566   |                   |       |       |       |          |       |              |     |       |       |  |       |  
|Year ending December 31, 2008                                 |                    | $             | 160   |                   |       |       |       |          |       |              |     |       |       |  |       |  

We routinely update our estimates of both the
recoverability of the software products that have been
capitalized and the fair value of the acquired intangible assets
recognized as a result of the acquisition of the Enterprise
segment. Management uses these estimates as the basis for
evaluating the carrying values of the respective assets.



|   |                                                      
|-- | -----------------------------------------------------
|6. | Concentrations of Credit Risk and Major
    Customers

Financial instruments that potentially subject us
to significant concentrations of credit risk consist primarily
of accounts receivable and unbilled receivables. Accounts
receivable are generally due within thirty days and no
collateral is required. We maintain allowances for potential
credit losses and historically such losses have been
insignificant and within our expectations.

The following table summarizes revenue
concentrations from our significant customers:

|                 |  |                  |  |                    |               |                    |  |               |     |               |  |  |               |  |  |  |     | 
|---------------- |  | ---------------- |  | ------------------ | ------------- | ------------------ |  | ------------- | --- | ------------- |  |  | ------------- |  |  |  | --- | 
|                 |  |                  |  |                    |               |                   
|                 |  |                  |  | % of Total Revenue |               | % of Total Revenue
|                 |  |                  |  |                    |               |                   
|                 |  |                  |  | For the three      |               | For the three      |  | For the six   |     | For the six  
|                 |  |                  |  | months ended       |               | months ended       |  | months ended  |     | months ended 
|Customer         |  | Segment          |  | June 30, 2004      |               | June 30, 2003      |  | June 30, 2004 |     | June 30, 2003
|                 |  |                  |  |                    |               |                    |  |               |     |              
|Federal Agencies |  | Government       |  |                    | 22%           |                    |  |               | 26% |               |  |  | 22%           |  |  |  | 27% | 
|Customer A       |  | Wireless Carrier |  |                    | 10%           |                    |  |               | 13% |               |  |  | 10%           |  |  |  | 14% | 
|Customer B       |  | Wireless Carrier |  |                    | Less than 10% |                    |  |               | 10% |               |  |  | Less than 10% |  |  |  | 10% | 

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)

|                 |  |                  |  |                     |               |             |  |  |               | 
|---------------- |  | ---------------- |  | ------------------- | ------------- | ----------- |  |  | ------------- | 
|                 |  |                  |  |                    
|                 |  |                  |  | As of June 30, 2004
|                 |  |                  |  |                    
|                 |  |                  |  | Accounts            |               | Unbilled   
|Customer         |  | Segment          |  | Receivable          |               | Receivables
|                 |  |                  |  |                     |               |            
|Federal Agencies |  | Government       |  |                     | 10%           |             |  |  | 53%           | 
|Customer A       |  | Wireless Carrier |  |                     | 23%           |             |  |  | Less than 10% | 
|Customer B       |  | Wireless Carrier |  |                     | Less than 10% |             |  |  | 11%           | 



|   |                         
|-- | ------------------------
|7. | Stock-Based Compensation

We have two stock-based employee compensation
plans: our Third Amended and Restated 1997 Stock Incentive Plan
(the Stock Incentive Plan) and our Employee Stock
Purchase Plan. We record compensation expense for all
stock-based compensation plans using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees(APB
No. 25) and related Interpretations. Under APB 25,
compensation expense is recorded over the vesting period to the
extent that the fair value of the underlying stock on the date
of grant exceeds the exercise or acquisition price of the stock
or stock-based award. The following table illustrates the effect
on net loss and loss per common share if we had applied the fair
value recognition provisions of Financial Accounting Standards
Board Statement No. 123, Accounting for Stock-Based
Compensation,to stock-based employee compensation.

|                                                                                                                    |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |       |  
|------------------------------------------------------------------------------------------------------------------- | ----------------------------- | ------------------ | ------ | ---------------- | - | ---- | ------- | ----- | - | - | ------ | ----- | - | - | ------- | ----- | -
|                                                                                                                    |                               |                    |        |                 
|                                                                                                                    |                               | Three months ended |        | Six months ended
|                                                                                                                    |                               | June 30,           |        | June 30,        
|                                                                                                                    |                               |                    |        |                 
|                                                                                                                    |                               | 2004               |        | 2003             |   | 2004 |         | 2003 
|                                                                                                                    |                               |                    |        |                  |   |      |         |      
|Net income/(loss), as reported                                                                                      |                               | $                  | 863    |                  |   | $    | (11,392 | )     |   | $ | (2,583 | )     |   | $ | (15,440 | )    
|Add: Stock-based employee compensation expense
    included in reported net loss                                    |                               |                    | 346    |                  |   |      | 389     |       |   |   | 703    |       |   |   | 762     |      
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards |                               |                    | (2,436 | )                |   |      | (1,348  | )     |   |   | (4,218 | )     |   |   | (2,686  | )    
|                                                                                                                    |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |      
|Pro forma net loss                                                                                                  |                               | $                  | (1,227 | )                |   | $    | (12,351 | )     |   | $ | (6,098 | )     |   | $ | (17,364 | )    
|                                                                                                                    |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |      
|Earnings/(loss) per common share:                                                                                   |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |      
|                                                                                                                    | Basic  as reported           |                    | $      | 0.03             |   |      | $       | (0.38 | ) |   | $      | (0.08 | ) |   | $       | (0.52 | )
|                                                                                                                    |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |      
|                                                                                                                    | Diluted  as reported         |                    | $      | 0.02             |   |      | $       | (0.38 | ) |   | $      | (0.08 | ) |   | $       | (0.52 | )
|                                                                                                                    |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |      
|                                                                                                                    | Basic and diluted  pro forma |                    | $      | (0.04            | ) |      | $       | (0.42 | ) |   | $      | (0.19 | ) |   | $       | (0.59 | )
|                                                                                                                    |                               |                    |        |                  |   |      |         |       |   |   |        |       |   |   |         |      

In calculating the fair value of our stock
options using Black-Scholes, we assumed that the expected life
was five years for options granted to employees and three years
for options granted to non-employees, that the risk free
interest rate was 3%, and that there was no dividend yield. We
also assumed that the expected volatility of our stock was 119%.

Prior to our initial public offering in 2000, we
granted incentive stock options to employees and directors to
purchase 885,983 shares of Class A Common Stock. The
options were granted at an exercise price less than the
estimated market value of Class A Common Stock at the date
of grant. Net income/(loss), as reported, includes $188 and $222
of non-cash stock compensation expense related to these grants
for the three-months ended June 30, 2004 and 2003,
respectively, and $381 and $595 of expense for the six-months
then ended. We expect to record future stock compensation
expense of $398 as a result of these option grants that will be
recognized over the remaining vesting period of two years.

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)

In the second quarter of 2003, we issued
restricted stock to directors and certain key executives. The
restrictions expire at the end of one year for directors and in
annual increments over three years for executives and are based
on continued employment. Net income/(loss), as reported,
includes $158 and $167 of non-cash stock compensation expense
related to these grants for the three-months ended June 30,
2004 and 2003, respectively, and $322 and $167 of expense for
the six-months then ended. We expect to record future stock
compensation expense of $1,077 as a result of these restricted
stock grants that will be recognized over the remaining vesting
period for executives.



|   |               
|-- | --------------
|8. | Long-Term Debt

To fund the acquisition of the Enterprise assets,
on January 13, 2004 the Company raised $21,000 in cash from
third-parties through the issuance of (i) convertible
subordinated debentures with a face value of $15,000, bearing
interest at a stated rate of 3% per annum and due in lump sum on
January 13, 2009 in cash or shares of the Company
Class A Common Stock at the option of the Company
(ii) warrants to purchase 341,072 shares of Class A
Common Stock at an exercise price of $6.50 per share and
expiring in January 2007, and (iii) 1,364,288 shares of
Class A Common Stock. We determined that the value of the
Class A Common Stock issued was $7,640 based on the quoted
closing price of the Companys Class A Common Stock on
the issue date of $5.60. The difference between the proceeds
from the issuance of these shares and their fair value was
recognized as a debt discount. The value of the warrants was
estimated to be $1,395, determined using the Black-Scholes
option-pricing model and was recorded as a debt discount and
additional paid-in capital. The convertible subordinated
debentures provide for a contractual conversion price of $5.38
per share, and were estimated to have an issuance date
beneficial conversion value of $3,662, which was recorded as a
debt discount and additional paid-in capital. The resulting
carrying value of the debt at issuance was $8,303, net of $6,697
of original issue discount that will be amortized over its
five-year term using the effective interest method, which will
yield an effective interest rate of 12.6%. As of June 30,
2004, the subordinated convertible debentures had a carrying
value of $8,973.

Additionally, during the three and six months
ended June 30, 2004, we borrowed approximately $2,500 and
$5,106, respectively, primarily to fund equipment purchases.
Approximately $2,606 of the debt, which was borrowed under the
terms of a note payable, bears interest at 7.75%, is payable
monthly through October 2005, and is secured by the accounts
receivable owed to us by certain customers. The remaining
$2,500, which was borrowed against our line of credit, bears
interest at prime plus 1.0% (minimum prime rate of 4.25%,
interest rate of 5.25% as of June 30, 2004), and is payable
upon the collection of the receivables collateralizing the loan.

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion and analysis of the
financial condition and results of operations should be read in
conjunction with the consolidated financial statements, related
notes, and other detailed information included elsewhere in this
Quarterly Report on Form 10-Q. This report contains certain
forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as
amended. Forward-looking statements are statements other than
historical information or statements of current condition. Some
forward-looking statements may be identified by the use of such
terms as believes, anticipates,
intends, or expects. For example, the
statements (a) regarding our belief as to the sufficiency
of our capital resources to meet our anticipated working capital
and capital expenditures for at least the next twelve months,
(b) regarding our belief that general and administrative
expenses will remain higher than 2003 levels and (c) that
we expect to realize approximately $34.2 million of backlog
during this year and $51.9 million in the next
12 months are forward-looking statements. These
forward-looking statements relate to our plans, objectives and
expectations for future operations. In light of the risks and
uncertainties inherent in all such projected operational
matters, the inclusion of forward- looking statements in this
report should not be regarded as a representation by us or any
other person that our objectives or plans will be achieved or
that any of our operating expectations will be realized. Our
actual financial results realized could differ materially from
the statements made herein, depending in particular upon the
risks and uncertainties described in our filings with the
Securities and Exchange Commission. These include without
limitation risks and uncertainties relating to our financial
results and our ability to (i) reach and maintain
profitability as early as anticipated or at all,
(ii) continue to rely on our customers and other third
parties to provide additional products and services that create
a demand for our products and services, (iii) conduct our
business in foreign countries, (iv) adapt and integrate new
technologies into our products, (v) develop software and
deliver products and services without any errors or defects,
(vi) protect our intellectual property rights,
(vii) implement our business strategy (viii) realize
backlog, and (vix) achieve continued revenue growth in the
foreseeable future for our E9-1-1 business. These factors should
not be considered exhaustive; we undertake no obligation to
release publicly the results of any future revisions we may make
to forward-looking statements to reflect events or circumstances
after the date hereof or to reflect the occurrence of
unanticipated events. We caution you not to put undue reliance
on these forward-looking statements.

Critical Accounting Policies and
Estimates

The information in this Item 2.
Managements Discussion and Analysis of Financial Condition
and Results of Operations discusses our unaudited
consolidated financial statements, which have been prepared in
accordance with U.S. generally accepted accounting principles
for interim financial information. The preparation of these
financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. On an on-going basis, management evaluates its estimates
and judgments, including those related to intangible assets and
contingencies and litigation. Management bases its estimates and
judgments on historical experience and on various other factors
that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the
carrying value of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.

We identified our most critical accounting
policies to be those related to revenue recognition for our
software contracts with multiple elements, contracts accounted
for using the percentage of completion method, the relevant
accounting related to valuation allowances, capitalized software
development costs, and other acquired intangible assets. We
describe these accounting policies in relevant sections of this
discussion and analysis. This discussion and analysis should be
read in

15



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##### Table of Contents



conjunction with our consolidated financial
statements and related notes included in our 2003 Annual Report
on Form 10-K, as amended.


Overview

On January 13, 2004, we consummated the
purchase of the Enterprise Mobility Solutions division of Aether
Systems, Inc. This unit brings to us a substantial base of 1,200
enterprise customers, more than 60,000 wireless data
subscribers, applications for logistics, financial services and
the mobile office, and 112 employees.

Prior to the January 2004 acquisition of the
Enterprise Mobility Solutions division of Aether Systems, Inc.,
we managed our business in three operating segments: Network
Software, Service Bureau and Network Solutions. Subsequent to
the acquisition, we realigned our segments to better manage the
business we operate. Our operating segments include (i) our
Wireless Carrier segment, which consists principally of the
previous Network Software and Service Bureau segments, and which
principally includes our products and services marketed directly
to wireless carriers consisting of monthly recurring E9-1-1 and
hosted software application offerings as well as software
license and service fees (ii) our Government segment, which
consists principally of the previous Network Solutions segment,
and which includes the design, development, and deployment of
information processing and communication systems and related
services, and (iii) our Enterprise segment, which comprises
the operations we acquired from Aether Systems, Inc. and which
offers subscriber-based services as well as software licenses
and services for Enterprise customers. The information in this
section is presented based on the operating segments through
which we manage our business.

This Item 2. Managements
Discussion and Analysis of Financial Condition and Results of
Operations provides information that our management
believes to be necessary to achieve a clear understanding of our
financial statements and results of operations.

Our management monitors and analyzes a number of
key performance indicators in order to manage our business and
evaluate our financial and operating performance. Those
indicators include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue.We derive
    revenue from products and services including service bureau and
    subscriber-based services, software license fees and related
    service fees relating to our developed software products, and
    network solutions revenue related to our communication systems
    delivered to governmental agencies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Cost of revenue.The
    major items impacting our cost of revenue are compensation and
    benefits as well as third-party hardware and software, airtime
    costs of subscriber-based revenue and overhead expenses.
    Hardware and third-party software costs are primarily associated
    with the delivery of product within our Government segment while
    also, to a lesser extent, may be attributed to the delivery of
    software licenses and services in both our Wireless Carrier and
    Enterprise segments. These costs tend to fluctuate as a result
    of the relative volume, mix of projects, level of service
    support required and the complexity of customized products and
    services delivered in a period. Airtime costs relate to the
    volume of monthly subscriber-based revenue experiences in our
    Enterprise segment.
|
| |  | Operating expenses.Operating expenses are substantially
    driven by compensation and benefits, travel costs, professional
    fees, facility costs, specific marketing and sales-related
    expenses as well as certain non-cash expenses such as non-cash
    stock compensation expenses, depreciation and amortization of
    property and equipment, of software development costs, and of
    acquired intangible assets. Operating expenses are incurred in
    connection with the development and marketing of new software
    applications as well as general corporate overhead expenses.                                                                                                                                                                                                                                                              

16



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Liquidity and cash flows.The primary driver of our cash flows
    is our results of operations. Important sources of our liquidity
    have been cash raised at the time of our initial public offering
    in 2000, our January 2004 private investment in public equity
    financing (as described below under Liquidity and Capital
    Resources), and borrowing and lease financings secured for
    the purchase of equipment.
|
| |  | Balance sheet.We
    view cash, working capital, accounts receivable balances and
    days revenues outstanding as important indicators of our
    financial health.                                                                                                                                                                                                                                                                   

Swiftlink®, XYPOINT® and Wireless
Internet GatewayTM are trademarks or service marks of
TeleCommunication Systems, Inc. or our subsidiaries. This
Quarterly Report on Form 10-Q also contains trademarks,
trade names and services marks of other companies that are the
property of their respective owners.

Results of Operations

Revenue and Cost of Revenue

The following discussion addresses the relative
revenue and direct cost for each segment of our business:

Wireless Carrier Segment:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively, a
period-over-period comparison of the key components of the
revenue and cost of revenue of our Wireless Carrier segment:

|                                             |                               |                            |      |                          |  |   |      |               |  |      |     |      |  |   |     |     |   |   |      |     |  |   |      |     |  |   |     |     |  |  |     |     |  
|-------------------------------------------- | ----------------------------- | -------------------------- | ---- | ------------------------ |  | - | ---- | ------------- |  | ---- | --- | ---- |  | - | --- | --- | - | - | ---- | --- |  | - | ---- | --- |  | - | --- | --- |  |  | --- | --- | -
|                                             |                               |                            |      |                         
|                                             |                               | Three Months Ended June 30 |      | Six Months Ended June 30
|                                             |                               |                            |      |                         
|                                             |                               |                            |      |                          |  |   |      |              
|                                             |                               |                            |      | 2004 vs. 2003            |  |   |      | 2004 vs. 2003
|                                             |                               |                            |      |                          |  |   |      |              
|($ in millions)                              |                               | 2004                       |      | 2003                     |  | $ |      | %             |  | 2004 |     | 2003 |  | $ |     | %  
|                                             |                               |                            |      |                          |  |   |      |               |  |      |     |      |  |   |     |    
|Service bureau and subscriber revenue        |                               | $                          | 9.6  |                          |  | $ | 8.3  |               |  | $    | 1.3 |      |  |   | 15  | %   |   | $ | 18.7 |     |  | $ | 15.9 |     |  | $ | 2.8 |     |  |  | 18  | %  
|Software systems revenue:                    |                               |                            |      |                          |  |   |      |               |  |      |     |      |  |   |     |     |   |   |      |     |  |   |      |     |  |   |     |     |  |  |     |    
|                                             | Software licenses             |                            |      | 5.8                      |  |   |      | 0.8           |  |      |     | 5.0  |  |   |     | N/M |   |   |      | 7.4 |  |   |      | 3.3 |  |   |     | 4.2 |  |  |     | N/M |  
|                                             | Software systems and services |                            |      | 2.5                      |  |   |      | 1.5           |  |      |     | 1.0  |  |   |     | 65  | % |   |      | 4.3 |  |   |      | 2.6 |  |   |     | 1.7 |  |  |     | 64  | %
|                                             |                               |                            |      |                          |  |   |      |               |  |      |     |      |  |   |     |     |   |   |      |     |  |   |      |     |  |   |     |     |  |  |     |    
|Software systems total                       |                               |                            | 8.2  |                          |  |   | 2.3  |               |  |      | 6.0 |      |  |   | N/M |     |   |   | 11.8 |     |  |   | 5.9  |     |  |   | 5.9 |     |  |  | 100 | %  
|Segment revenue                              |                               |                            | 17.8 |                          |  |   | 10.6 |               |  |      | 7.2 |      |  |   | 68  | %   |   |   | 30.5 |     |  |   | 21.8 |     |  |   | 8.7 |     |  |  | 40  | %  
|Direct cost of service bureau and subscriber |                               |                            | 4.8  |                          |  |   | 4.0  |               |  |      | 0.9 |      |  |   | 22  | %   |   |   | 9.2  |     |  |   | 8.0  |     |  |   | 1.2 |     |  |  | 15  | %  
|Direct cost of software systems              |                               |                            | 2.7  |                          |  |   | 1.4  |               |  |      | 1.3 |      |  |   | 97  | %   |   |   | 4.2  |     |  |   | 3.0  |     |  |   | 1.2 |     |  |  | 39  | %  
|                                             |                               |                            |      |                          |  |   |      |               |  |      |     |      |  |   |     |     |   |   |      |     |  |   |      |     |  |   |     |     |  |  |     |    
|Segment gross profit*                        |                               | $                          | 10.3 |                          |  | $ | 5.3  |               |  | $    | 5.1 |      |  |   | 96  | %   |   | $ | 17.1 |     |  | $ | 10.7 |     |  | $ | 6.3 |     |  |  | 59  | %  
|                                             |                               |                            |      |                          |  |   |      |               |  |      |     |      |  |   |     |     |   |   |      |     |  |   |      |     |  |   |     |     |  |  |     |    
|Percent of revenue                           |                               |                            | 58   | %                        |  |   | 50   | %             |  |      |     |      |  |   |     |     |   |   | 56   | %   |  |   | 49   | %   |  |   |     |     |  |  |     |    



---



|  |                                                                                                      
|- | -----------------------------------------------------------------------------------------------------
|* | See discussion of segment reporting in Note 4
    to the accompanying unaudited financial statements.

Service bureau revenue and cost of
revenue:

We market our service bureau and software
offerings to wireless carriers. Our service bureau offerings
include our E9-1-1, hosted Position Determining Entity
(PDE) and Text Message Distribution Center
(MDC) applications. Revenue from our service bureau
offerings primarily consists of monthly recurring service fees
and is recognized in the month earned. E9-1-1 and PDE service
fees are primarily dependent on the number of subscribers the
carrier covers, Public Service Answering Points (PSAPs) served
or carrier cell sites. As the carriers number of
subscribers, PSAPs, or cell sites increases, the monthly
recurring service fees increase. MDC revenue is priced

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based on message volume. In both the three-month
period as well as the six-month period of 2004, our revenue
reflected an increase in the number of wireless carriers served
as well as the volume served from the customer client base that
existed in the respective periods of 2003.


The direct cost of our service bureau revenue
consists primarily of compensation, benefits, travel expenses,
and consulting fees incurred when providing our services, as
well as the equipment maintenance and circuit costs of our
network operations centers circuits utilized for connectivity to
carrier customers and local governments PSAPs. In both the
three-month period as well as the six-month period of 2004, we
increased headcount as well as circuit costs required to support
this business, resulting in an increase in costs.

Software systems revenue and cost of
revenue:

We market our software systems products and
services by responding to requests for proposals, through our
direct sales force and through channel partners. We generate
software systems revenue from licensing of our software
products, and providing related maintenance and deployment
services. We also sell custom software applications. The Short
Message Service Center (SMSC), TCS Xypoint® Location
Platform products, Wireless Messaging Gateway (WMG), as well as
alerting and message notification applications are the principal
generators of software license fees.

We sell our software products directly to
wireless carriers. Initial licensing fees are a function of the
number of subscribers or other measure of usage of our software
in the network where our software is deployed. As a
carriers subscriber base or usage increases, the carrier
must purchase additional capacity under its license agreement
and we receive additional revenue. Generally, we recognize
license fee revenue when each of the following has occurred:
(1) evidence of an arrangement is in place; (2) we
have delivered software; (3) the fee is fixed or
determinable; and (4) collection of the fee is probable.
Software projects that require significant customization are
accounted for under the percentage-of-completion method. We
typically measure progress to completion using costs incurred
compared to estimated total costs. We recognize estimated losses
under long-term contracts in their entirety upon discovery.

If we did not accurately estimate total costs to
complete a contract or do not manage our contracts within the
planned budget, then future margins may be negatively affected
or losses on existing contracts may need to be recognized.
Software license fees billed and not recognized as revenue are
included in deferred revenue.

We have also historically sold some of our
network software products through channel relationships. This
sales process typically includes participation of our engineers
along with original equipment manufacturers in presenting our
products to prospective customers. In the three-months ended
June 30, 2004, software license revenue increased to
$5.8 million from $0.8 million in the comparable period
last year and in the six-month period ended June 30, 2004
software license revenue increased to $7.4 million from
$3.3 million primarily due to a large order for an upgrade of
license fees as required based on usage increases. Software
license revenue was positively impacted in the three-month and
the six-month periods due to revenue that was recognized in 2004
related to a large contract to deliver our location platforms
for a new customer in Europe, the revenue from which was higher
than a similar project in the prior year comparable periods.

Our software systems and services revenue arises
from annual maintenance fees for our packaged and custom
software products and fees from custom development and
implementation of software products. Maintenance fees on
packaged software are collected in advance and recognized
ratably over the maintenance period. Unrecognized maintenance
fees are included in deferred revenue. Custom software
development, implementation and maintenance services may be
provided under time and materials or fixed-fee contracts. We
also occasionally sell computer equipment as part of our
packaged software sales.

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In the three-month period ended June 30,
2004, 64% of software service revenues related to maintenance
fees, while 32% related to custom development and implementation
fees associated with the delivery of related software
applications and the remaining 4% related to third-party
hardware and software delivered as part of our packaged software
sales. In the comparable period in 2003, 55% of service revenue
is related to maintenance fees, while 45% of service revenue was
associated with custom development and implementation fees
associated with the delivery of related software applications.
In the six-month period of 2004, 64% of software service
revenues related to maintenance fees, while 33% related to
custom development and implementation fees associated with the
delivery of related software applications and the remaining 3%
related to third-party hardware and software delivered as part
of our packaged software sales. In the comparable period in
2003, 62% of service revenue is related to maintenance fees,
while 38% of service revenue was associated with custom
development and implementation fees associated with the delivery
of related software applications.

The direct cost of our software systems revenue
consists primarily of compensation, benefits, purchased
equipment, third-party software, travel expenses and consulting
fees incurred when providing our services. In the three-month
periods ended June 30, 2004 and 2003, 15% and 9%,
respectively of total direct costs related to the cost of
purchased equipment and third-party software delivered as part
of our packaged software sales. In the six-month period of 2004
and in 2003, 13% and 9%, respectively, of the total direct costs
related to the cost of purchased equipment and third-party
software delivered as part of our packaged software sales.

Gross profit for the Wireless Carrier segment
increased to 58% of revenue from 50% of revenue for the
three-month periods ended June 30, 2004 and 2003,
respectively, and increased to 56% of revenue from 49% of
revenue for the six-month periods ended June 30, 2004 and
2003, respectively. The increase for both the three- and
six-month periods is primarily attributable to increased sales
of high margin software license capacity in 2004.

Government Segment:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of the key components of our
Government segment revenue and cost of revenue:

|                                 |  |                            |      |                          |  |   |     |          |  |      |     |      |  |   |    |   |  |   |      |   |  |   |      |   |  |   |      |   |  |  |    |   
|-------------------------------- |  | -------------------------- | ---- | ------------------------ |  | - | --- | -------- |  | ---- | --- | ---- |  | - | -- | - |  | - | ---- | - |  | - | ---- | - |  | - | ---- | - |  |  | -- | --
|                                 |  |                            |      |                         
|                                 |  | Three Months Ended June 30 |      | Six Months Ended June 30
|                                 |  |                            |      |                         
|                                 |  |                            |      |                          |  |   |     |         
|                                 |  |                            |      | 2004 vs.                 |  |   |     | 2004 vs.
|                                 |  |                            |      | 2003                     |  |   |     | 2003    
|                                 |  |                            |      |                          |  |   |     |         
|($ in millions)                  |  | 2004                       |      | 2003                     |  | $ |     | %        |  | 2004 |     | 2003 |  | $ |    | %
|                                 |  |                            |      |                          |  |   |     |          |  |      |     |      |  |   |    |  
|Network solutions revenue        |  | $                          | 11.3 |                          |  | $ | 9.5 |          |  | $    | 1.8 |      |  |   | 19 | % |  | $ | 18.8 |   |  | $ | 17.6 |   |  | $ | 1.1  |   |  |  | 7  | % 
|Direct cost of network solutions |  |                            | 7.1  |                          |  |   | 6.5 |          |  |      | 0.6 |      |  |   | 9  | % |  |   | 11.2 |   |  |   | 11.9 |   |  |   | (0.6 | ) |  |  | (5 | %)
|                                 |  |                            |      |                          |  |   |     |          |  |      |     |      |  |   |    |   |  |   |      |   |  |   |      |   |  |   |      |   |  |  |    |   
|Segment gross profit*            |  | $                          | 4.2  |                          |  | $ | 3.0 |          |  | $    | 1.2 |      |  |   | 41 | % |  | $ | 7.5  |   |  | $ | 5.8  |   |  | $ | 1.8  |   |  |  | 30 | % 
|                                 |  |                            |      |                          |  |   |     |          |  |      |     |      |  |   |    |   |  |   |      |   |  |   |      |   |  |   |      |   |  |  |    |   
|Percent of revenues              |  |                            | 38   | %                        |  |   | 32  | %        |  |      |     |      |  |   |    |   |  |   | 40   | % |  |   | 33   | % |  |   |      |   |  |  |    |   



---



|  |                                                                                                      
|- | -----------------------------------------------------------------------------------------------------
|* | See discussion of segment reporting in Note 4
    to the accompanying unaudited financial statements.

We generate Government segment revenue from the
design, development, assembly and deployment of information
processing and communication systems, primarily for government
enterprises. Representative examples of recent network solutions
projects include delivery of our SwiftLink® product, a
lightweight, secure, deployable communications system, to the
U.S. Departments of State, Justice, and Defense, and information
services systems to local government agencies. SwiftLink®
provides secure voice, video and data communications, supports a
worldwide network during trips abroad and throughout the United
States and provides full network functionality and Internet
Protocol telephony capability using landlines and
satellite-based technologies. Our Government segment also
operates teleport facilities in Baltimore, MD and Manassas, VA,
which

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support the integration of satellite
communications and terrestrial wireless broadband with U.S.
broadband networks. Through our teleport facilities we offer
data connectivity via satellite to and from North and South
America, as well as Africa and Europe. We generally provide
network solutions under long-term contracts. We recognize
revenue under long-term contracts as billable costs are incurred
and for fixed-price contracts using the percentage-of-completion
method, measured by either total labor hours or total costs
incurred compared to total estimated labor hours or costs. We
recognize estimated losses on contracts in their entirety upon
discovery. If we did not accurately estimate total labor hours
or costs to complete a contract or do not manage our contracts
within the planned budget, then future margins may be negatively
affected or losses on existing contracts may need to be
recognized. Under our contracts with the U.S. government,
contract costs, including the allocated indirect expenses, are
subject to audit and adjustment by the Defense Contract Audit
Agency. We record revenue under these contracts at estimated net
realizable amounts.


In the three-and six- month periods ended
June 30, 2004, approximately 65% and 57%, respectively, of
network solutions revenue resulted from the sale of
SwiftLink® and related deployable communications systems.
In 2004, we also designed, tested and delivered products to
government customers related to other satellite-based
communication systems and information processing systems for
local government agencies as well as for the country of Bahrain.
In the three-and six- month periods ended June 30, 2003,
approximately 55% and 48%, respectively, of our revenue for this
segment resulted from the sale of SwiftLink® and related
deployable communication systems, while the remaining amount
related to the design, development and operation of other
communication systems, as well as the design, testing and
delivery of products for several government agencies.

The direct cost of our network solutions revenue
consists of compensation, benefits, travel, satellite
space segment and airtime. In the three-and
six-month periods ended June 30, 2004, approximately 68%
and 60%, respectively, of costs were related to purchased
equipment components, which we purchase as needed for customer
contracts or release from inventory, and the costs of
third-party contractors that we engage. Such costs represented
59% and 57% of direct cost of network solutions revenue in the
three-month and six-month periods ended June 30, 2003,
respectively.

Gross profit for the Government segment increased
to 38% of revenue from 32% of revenue for the three-month
periods ended June 30, 2004 and 2003, respectively, and
increased to 40% of revenue from 33% of revenue for the
six-month periods ended June 30, 2004 and 2003,
respectively. The increase for both the three- and six-month
periods is primarily attributable to an increased proportion of
sales of our SwiftLink® products and related deployable
communications systems, which yield higher margins than various
other types of projects.

20



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##### Table of Contents



Enterprise Segment:

The following table sets forth, for the three and
six-month periods ended June 30, 2004, the key components
of subscriber and software systems revenue and related cost of
revenue for the Enterprise segment:

|                                             |                               |                    |      |                  |  |   |      |     | 
|-------------------------------------------- | ----------------------------- | ------------------ | ---- | ---------------- |  | - | ---- | --- | 
|                                             |                               | Three months ended |      | Six months ended
|($ in millions)                              |                               | June 30, 2004      |      | June 30, 2004   
|                                             |                               |                    |      |                 
|Service bureau and subscriber revenue        |                               | $                  | 10.5 |                  |  | $ | 22.1 |    
|Software systems revenue:                    |                               |                    |      |                  |  |   |      |    
|                                             | Software systems licenses     |                    |      |                 |  |   |      | 0.1 | 
|                                             | Software systems and services |                    |      | 0.8              |  |   |      | 1.8 | 
|                                             |                               |                    |      |                  |  |   |      |    
|Software systems total                       |                               |                    | 0.8  |                  |  |   | 1.8  |    
|                                             |                               |                    |      |                  |  |   |      |    
|Total revenue                                |                               |                    | 11.3 |                  |  |   | 24.0 |    
|                                             |                               |                    |      |                  |  |   |      |    
|Direct cost of service bureau and subscriber |                               |                    | 7.9  |                  |  |   | 16.8 |    
|Direct cost of software systems              |                               |                    | 0.5  |                  |  |   | 1.4  |    
|                                             |                               |                    |      |                  |  |   |      |    
|Segment gross profit*                        |                               | $                  | 2.9  |                  |  | $ | 5.8  |    
|                                             |                               |                    |      |                  |  |   |      |    
|Percent of revenue                           |                               |                    | 26   | %                |  |   | 24   | %  



---



|  |                                                                                                      
|- | -----------------------------------------------------------------------------------------------------
|* | See discussion of segment reporting in Note 4
    to the accompanying unaudited financial statements.

No period-over-period comparison between 2003 and
2004 is presented for our Enterprise segment because the
Enterprise Mobility Solutions division of Aether Systems, Inc,
which makes up the Enterprise segment, was acquired in January
2004.

Subscriber revenue and cost of
revenue:

Our Enterprise segment sells mobile office,
mobile finance, and mobile asset services and products to
Enterprise customers. Subscriber-based revenue is generated from
all three segments. The table below summarizes subscriber-based
revenue categorized by type of subscriber:

|                           |  |                    |    |                  |  |  |    |  
|-------------------------- |  | ------------------ | -- | ---------------- |  |  | -- | -
|                           |  | Three months ended |    | Six months ended
|Subscriber Type            |  | June 30, 2004      |    | June 30, 2004   
|                           |  |                    |    |                 
|Mobile office subscribers  |  |                    | 62 | %                |  |  | 62 | %
|Mobile finance subscribers |  |                    | 25 | %                |  |  | 24 | %
|Mobile asset subscribers   |  |                    | 13 | %                |  |  | 14 | %

Subscriber-based revenue is billed to customers
on a monthly basis and is generally cancelable with 30-days
notice. Most corporate customers have retained their service for
three years or more.

The direct cost of our subscriber revenue
consists primarily of compensation, benefits, travel expenses,
airtime charges and consulting fees incurred when providing our
services, as well as the equipment maintenance and circuit costs
of our network operations centers circuits utilized for
connectivity to customer devices.

Major Customers

For the three and six months ended June 30,
2004, customers that accounted for 10% or more of total revenue
were Verizon Wireless and various U.S. Government agencies. The
loss of either of these customers would have a material adverse
impact on our business. For the six months ended June 30,
2003 customers that accounted for 10% or more of total revenue
were Verizon Wireless, United States Cellular Corporation, and
various U.S. Government agencies. Verizon Wireless and United
States Cellular Corporation are primarily customers of our
Wireless

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Carrier segment, and the various U.S. government
agencies are primarily a customer of our Government segment.


Revenue Backlog

As of June 30, 2004, we had unfilled orders,
or backlog, of approximately $83 million, of which
$63 million related to our Wireless Carrier segment,
$12 million related to our Government segment and
$8 million related to our Enterprise segment. We expect to
realize approximately $34 million of this backlog in the
balance of this year and $52 million of this backlog in the
next twelve months. The remaining backlog primarily represents
the balance of multi-year contracts for our service bureau
business. Total company backlog at June 30, 2003 was
$81 million, of which $72 million related to our
Wireless Carrier segment, $9 million related to our
Government segment.

Management utilizes backlog to evaluate financial
position as an indicator of committed future revenues. Our
backlog at any given time may be affected by a number of
factors, including contracts being renewed or new contracts
being signed before existing contracts are completed. Some of
our backlog could be canceled for causes such as late delivery,
poor performance, and other factors. Accordingly, a comparison
of backlog from period to period is not necessarily meaningful
and may not be indicative of eventual actual revenue.

Operating Expenses

Research and development expense:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of our research and development
expense:

|                                 |  |                            |     |                          |  |   |     |          |  |      |      |      |  |   |    |    |  |   |     |   |  |   |     |   |  |   |     |  |  |  |    |  
|-------------------------------- |  | -------------------------- | --- | ------------------------ |  | - | --- | -------- |  | ---- | ---- | ---- |  | - | -- | -- |  | - | --- | - |  | - | --- | - |  | - | --- |  |  |  | -- | -
|                                 |  |                            |     |                         
|                                 |  | Three Months Ended June 30 |     | Six Months Ended June 30
|                                 |  |                            |     |                         
|                                 |  |                            |     |                          |  |   |     |         
|                                 |  |                            |     | 2004 vs.                 |  |   |     | 2004 vs.
|                                 |  |                            |     | 2003                     |  |   |     | 2003    
|                                 |  |                            |     |                          |  |   |     |         
|($ in millions)                  |  | 2004                       |     | 2003                     |  | $ |     | %        |  | 2004 |      | 2003 |  | $ |    | % 
|                                 |  |                            |     |                          |  |   |     |          |  |      |      |      |  |   |    |   
|Research and development expense |  | $                          | 4.6 |                          |  | $ | 4.7 |          |  | $    | (0.1 | )    |  |   | (2 | )% |  | $ | 9.6 |   |  | $ | 8.6 |   |  | $ | 1.0 |  |  |  | 12 | %
|Percent of revenue               |  |                            | 11  | %                        |  |   | 23  | %        |  |      |      |      |  |   |    |    |  |   | 13  | % |  |   | 22  | % |  |   |     |  |  |  |    |  

We incur research and development costs to
enhance existing packaged software products as well as to create
new software products, including software hosted in our service
bureau network operations center. These costs primarily include
compensation and benefits, as well as costs associated with
using third-party laboratory and testing resources. We expense
research and development costs as they are incurred unless
technological feasibility has been reached and marketability is
certain. For new products, technological feasibility is
established when an operative version of the computer software
product is completed in the same software language as the
product to be ultimately marketed, performs all the major
functions planned for the product, and has successfully
completed initial customer testing. Technological feasibility
for enhancements to an existing product is established when a
detail program design is completed.

In 2004, we incurred research and development
expenses related to Wireless Carrier and Enterprise software
applications, which are being marketed to new and existing
customers on a global basis, with emphasis on expanded
functionality of our location platform software and E9-1-1
application. In 2003, the research and development expenditures
were primarily incurred in the development of our Wireless
Carrier software and E9-1-1 application. Research and
development expenditures remained relatively constant between
2004 and 2003 while these expenses as a percentage of revenue
decreased in 2004. The decrease as a percentage of revenue is
primarily the result of increased revenues in 2004 due to the
Enterprise acquisition and the significant increase of software
license revenue in 2004. Management continually assesses our
spending on research and development to ensure resources are
focused on products that are expected to achieve the highest
level of success.

22



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##### Table of Contents



Sales and marketing expense:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of our sales and marketing
expenses:

|                            |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |    |   |  |   |     |   |  |   |     |   |  |   |     |  |  |  |    |  
|--------------------------- |  | -------------------------- | --- | ------------------------ |  | - | --- | -------- |  | ---- | --- | ---- |  | - | -- | - |  | - | --- | - |  | - | --- | - |  | - | --- |  |  |  | -- | -
|                            |  |                            |     |                         
|                            |  | Three Months Ended June 30 |     | Six Months Ended June 30
|                            |  |                            |     |                         
|                            |  |                            |     |                          |  |   |     |         
|                            |  |                            |     | 2004 vs.                 |  |   |     | 2004 vs.
|                            |  |                            |     | 2003                     |  |   |     | 2003    
|                            |  |                            |     |                          |  |   |     |         
|($ in millions)             |  | 2004                       |     | 2003                     |  | $ |     | %        |  | 2004 |     | 2003 |  | $ |    | %
|                            |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |    |  
|Sales and marketing expense |  | $                          | 3.3 |                          |  | $ | 2.2 |          |  | $    | 1.1 |      |  |   | 50 | % |  | $ | 6.5 |   |  | $ | 4.6 |   |  | $ | 1.9 |  |  |  | 41 | %
|Percent of total revenue    |  |                            | 8   | %                        |  |   | 11  | %        |  |      |     |      |  |   |    |   |  |   | 9   | % |  |   | 12  | % |  |   |     |  |  |  |    |  

Our sales and marketing expenses include
compensation and benefits, trade show expenses, travel costs,
advertising and public relations costs as well as a
proportionate share of facility-related costs which are expensed
as incurred. Our marketing efforts also include speaking
engagements and attending and sponsoring industry conferences.
We sell our software products and services through our direct
sales force and through indirect channels. We have also
historically leveraged our relationship with original equipment
manufacturers to market our software products to wireless
carrier customers. We sell our network solutions primarily
through direct sales professionals. Costs incurred for sales and
marketing increased in 2004 from 2003 due to increased costs
associated with addressing the Enterprise market. We expect our
sales and marketing expense to increase in 2004 as a result of
our acquisition of the Enterprise segment. Such costs may
fluctuate quarter-to-quarter depending on spending on tradeshows
and variable compensation based on levels of revenue.

General and administrative expense:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of our general and
administrative expense:

|                                   |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |    |   |  |   |     |   |  |   |     |   |  |   |     |  |  |  |    |  
|---------------------------------- |  | -------------------------- | --- | ------------------------ |  | - | --- | -------- |  | ---- | --- | ---- |  | - | -- | - |  | - | --- | - |  | - | --- | - |  | - | --- |  |  |  | -- | -
|                                   |  |                            |     |                         
|                                   |  | Three Months Ended June 30 |     | Six Months Ended June 30
|                                   |  |                            |     |                         
|                                   |  |                            |     |                          |  |   |     |         
|                                   |  |                            |     | 2004 vs.                 |  |   |     | 2004 vs.
|                                   |  |                            |     | 2003                     |  |   |     | 2003    
|                                   |  |                            |     |                          |  |   |     |         
|($ in millions)                    |  | 2004                       |     | 2003                     |  | $ |     | %        |  | 2004 |     | 2003 |  | $ |    | %
|                                   |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |    |  
|General and administrative expense |  | $                          | 4.8 |                          |  | $ | 2.7 |          |  | $    | 2.1 |      |  |   | 76 | % |  | $ | 9.3 |   |  | $ | 5.6 |   |  | $ | 3.6 |  |  |  | 65 | %
|Percent of total revenue           |  |                            | 12  | %                        |  |   | 14  | %        |  |      |     |      |  |   |    |   |  |   | 13  | % |  |   | 14  | % |  |   |     |  |  |  |    |  

General and administrative expense consists
primarily of compensation costs and other costs associated with
management, finance, human resources and internal information
systems. These costs include compensation and benefits, travel,
and a proportionate share of rent, utilities and other
facilities costs which are expensed as incurred. In 2004 such
costs increased over 2003 largely due to costs incurred to
support the Enterprise segment. We expect general and
administrative expense to remain at a higher level than in 2003
for the remainder of 2004, as a result of our acquisition of the
Enterprise segment.

Non-cash stock compensation expense:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of our non-cash stock
compensation expense:

|                                    |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |     |    |  |   |     |  |  |   |     |  |  |   |     |  |  |  |    |   
|----------------------------------- |  | -------------------------- | --- | ------------------------ |  | - | --- | -------- |  | ---- | --- | ---- |  | - | --- | -- |  | - | --- |  |  | - | --- |  |  | - | --- |  |  |  | -- | --
|                                    |  |                            |     |                         
|                                    |  | Three Months Ended June 30 |     | Six Months Ended June 30
|                                    |  |                            |     |                         
|                                    |  |                            |     |                          |  |   |     |         
|                                    |  |                            |     | 2004 vs.                 |  |   |     | 2004 vs.
|                                    |  |                            |     | 2003                     |  |   |     | 2003    
|                                    |  |                            |     |                          |  |   |     |         
|($ in millions)                     |  | 2004                       |     | 2003                     |  | $ |     | %        |  | 2004 |     | 2003 |  | $ |     | % 
|                                    |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |     |   
|Non-cash stock compensation expense |  | $                          | 0.3 |                          |  | $ | 0.4 |          |  | $    | 0.0 |      |  |   | (11 | %) |  | $ | 0.7 |  |  | $ | 0.8 |  |  | $ | 0.1 |  |  |  | (8 | %)

Prior to our initial public offering in 2000, we
granted incentive stock options to employees and directors to
purchase 885,983 shares of Class A Common Stock. The
options were granted at an

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exercise price less than the estimated market
value of Class A Common Stock at the date of grant. Net
income/(loss), as reported, includes $188 and $222 of non-cash
stock compensation expense related to these grants for the three
month periods ended June 30, 2004 and 2003, respectively,
and $381 and $595 of expense for the six month periods then
ended. We expect to record future stock compensation expense of
$398 as a result of these option grants that will be recognized
over the remaining vesting period of two years.


In the second quarter of 2003, we issued
restricted stock to directors and certain key executives. The
restrictions expire at the end of one year for directors and in
annual increments over three years for executives and are based
on continued employment. Net income/(loss), as reported,
includes $158 and $167 of non-cash stock compensation expense
related to these grants for the three month periods ended
June 30, 2004 and 2003, respectively, and $322 and $167 of
expense for the six month periods then ended. We expect to
record future stock compensation expense of $1,077 as a result
of these restricted stock grants that will be recognized over
the remaining vesting period for executives.

Depreciation and amortization of property and
equipment:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of our depreciation and
amortization of property and equipment:

|                                                            |  |                            |      |                          |  |   |      |          |  |      |      |      |  |   |    |   |  |   |      |  |  |   |      |  |  |   |      |  |  |  |    |  
|----------------------------------------------------------- |  | -------------------------- | ---- | ------------------------ |  | - | ---- | -------- |  | ---- | ---- | ---- |  | - | -- | - |  | - | ---- |  |  | - | ---- |  |  | - | ---- |  |  |  | -- | -
|                                                            |  |                            |      |                         
|                                                            |  | Three Months Ended June 30 |      | Six Months Ended June 30
|                                                            |  |                            |      |                         
|                                                            |  |                            |      |                          |  |   |      |         
|                                                            |  |                            |      | 2004 vs.                 |  |   |      | 2004 vs.
|                                                            |  |                            |      | 2003                     |  |   |      | 2003    
|                                                            |  |                            |      |                          |  |   |      |         
|($ in millions)                                             |  | 2004                       |      | 2003                     |  | $ |      | %        |  | 2004 |      | 2003 |  | $ |    | %
|                                                            |  |                            |      |                          |  |   |      |          |  |      |      |      |  |   |    |  
|Depreciation and amortization of property and
    equipment |  | $                          | 1.9  |                          |  | $ | 1.7  |          |  | $    | 0.2  |      |  |   | 13 | % |  | $ | 3.6  |  |  | $ | 3.2  |  |  | $ | 0.4  |  |  |  | 13 | %
|Gross cost of property and equipment at period-end          |  | $                          | 39.6 |                          |  | $ | 28.4 |          |  | $    | 11.3 |      |  |   | 40 | % |  | $ | 39.6 |  |  | $ | 28.4 |  |  | $ | 11.3 |  |  |  | 40 | %

Depreciation and amortization expense (other than
amortization of software development costs and acquired
intangible assets, discussed below) represents the period costs
associated with our investment in computers, telephony
equipment, software, furniture and fixtures, and leasehold
improvements. We compute depreciation and amortization using the
straight-line method over the estimated useful lives of the
assets. In 2004, depreciation and amortization expense was
slightly higher than 2003 reflecting the level of capital
expenditures made primarily to support our network operations
centers and our development efforts.

Amortization of software development
costs:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively, a
period-over-period comparison of our amortization of software
development costs:

|                                            |  |                            |     |                          |  |   |     |          |  |      |      |      |  |   |     |    |  |   |     |   |  |   |     |  |  |   |      |   |  |  |     |   
|------------------------------------------- |  | -------------------------- | --- | ------------------------ |  | - | --- | -------- |  | ---- | ---- | ---- |  | - | --- | -- |  | - | --- | - |  | - | --- |  |  | - | ---- | - |  |  | --- | --
|                                            |  |                            |     |                         
|                                            |  | Three Months Ended June 30 |     | Six Months Ended June 30
|                                            |  |                            |     |                         
|                                            |  |                            |     |                          |  |   |     |         
|                                            |  |                            |     | 2004 vs.                 |  |   |     | 2004 vs.
|                                            |  |                            |     | 2003                     |  |   |     | 2003    
|                                            |  |                            |     |                          |  |   |     |         
|($ in millions)                             |  | 2004                       |     | 2003                     |  | $ |     | %        |  | 2004 |      | 2003 |  | $ |     | % 
|                                            |  |                            |     |                          |  |   |     |          |  |      |      |      |  |   |     |   
|Amortization of software development costs  |  | $                          | 0.2 |                          |  | $ | 7.8 |          |  | $    | (7.6 | )    |  |   | (97 | %) |  | $ | 0.3 |   |  | $ | 8.8 |  |  | $ | (8.5 | ) |  |  | (96 | %)
|Percent of network software license revenue |  |                            | 4   | %                        |  |   | N/M |          |  |      |      |      |  |   |     |    |  |   | 4   | % |  |   | N/M |  |  |   |      |   |  |  |     |   

We capitalize software development costs after we
establish technological feasibility, and amortize those costs
over the estimated useful lives of the software beginning on the
date when the software is first installed and used. We calculate
amortization of software development costs on a
product-by-product basis using the straight-line method over the
remaining estimated economic life of the product, which is never
greater than three years. We also compute amortization of
software development costs using the ratio that current revenue
for the product bears to the total

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current and anticipated future revenues for that
product. If this revenue curve method results in amortization
greater than the amount computed using the straight-line method,
we record amortization at that greater amount. Amortization as a
percentage of software license fees is generally a higher
percentage in the early stages of a products life cycle.
Our policies to determine when to capitalize software
development costs and how much to amortize in a given period
require us to make subjective estimates and judgments. If our
software products do not achieve the level of market acceptance
that we expect and our future revenue estimates for these
products change, the amount of amortization that we record may
increase compared to prior periods. In 2004 these expenses were
lower than in 2003 primarily due to the lower remaining balance
of capitalized software development costs. Additionally, in
connection with the acquisition of the Enterprise segment, we
recorded $0.3 million of developed technology, which is
being amortized over its estimated useful life of 3 years.


Amortization of acquired intangible assets:The acquired intangible assets
associated with our acquisition of the Enterprise segment are
being amortized over their useful lives of between 3 and
5 years. The expense recognized in 2004 relates to the
intangible assets acquired in the acquisition. The expense in
2003 related to the amortization of the Xypoint trade name that
was amortized based on its estimated useful life of three years
using the straight-line method and was fully amortized by
December 31, 2003.

Interest expense:

The following table sets forth, for the three-
and six-months ended June 30, 2004 and 2003, respectively,
a period-over-period comparison of our components of interest
expense:

|                                                                     |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |     |   |  |   |     |  |  |   |     |  |  |   |      |   |  |  |     |  
|-------------------------------------------------------------------- |  | -------------------------- | --- | ------------------------ |  | - | --- | -------- |  | ---- | --- | ---- |  | - | --- | - |  | - | --- |  |  | - | --- |  |  | - | ---- | - |  |  | --- | -
|                                                                     |  |                            |     |                         
|                                                                     |  | Three Months Ended June 30 |     | Six Months Ended June 30
|                                                                     |  |                            |     |                         
|                                                                     |  |                            |     |                          |  |   |     |         
|                                                                     |  |                            |     | 2004 vs.                 |  |   |     | 2004 vs.
|                                                                     |  |                            |     | 2003                     |  |   |     | 2003    
|                                                                     |  |                            |     |                          |  |   |     |         
|($ in millions)                                                      |  | 2004                       |     | 2003                     |  | $ |     | %        |  | 2004 |     | 2003 |  | $ |     | %
|                                                                     |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |     |  
|Interest expense incurred on notes payable                           |  | $                          | 0.2 |                          |  | $ | 0.1 |          |  | $    | 0.1 |      |  |   | 100 | % |  | $ | 0.5 |  |  | $ | 0.2 |  |  | $ | 0.3  |   |  |  | 150 | %
|Interest expense incurred on capital lease
    obligations           |  |                            | 0.1 |                          |  |   | 0.1 |          |  |      |    |      |  |   |    |   |  |   | 0.1 |  |  |   | 0.3 |  |  |   | (0.1 | ) |  |  | 100 | %
|Interest expense incurred on convertible
    subordinated debentures |  |                            | 0.1 |                          |  |   |    |          |  |      | 0.1 |      |  |   | N/M |   |  |   | 0.2 |  |  |   |    |  |  |   | 0.2  |   |  |  | N/M |  
|Amortization of deferred commitment fees                             |  |                            | 0.1 |                          |  |   |    |          |  |      | 0.1 |      |  |   | 100 | % |  |   | 0.2 |  |  |   | 0.1 |  |  |   | 0.1  |   |  |  | 100 | %
|Amortization of debt discount                                        |  |                            | 0.4 |                          |  |   |    |          |  |      | 0.4 |      |  |   | N/M |   |  |   | 0.7 |  |  |   |    |  |  |   | 0.7  |   |  |  | N/M |  
|                                                                     |  |                            |     |                          |  |   |     |          |  |      |     |      |  |   |     |   |  |   |     |  |  |   |     |  |  |   |      |   |  |  |     |  
|Total interest expense                                               |  | $                          | 0.9 |                          |  | $ | 0.2 |          |  | $    | 0.7 |      |  |   | N/M |   |  | $ | 1.7 |  |  | $ | 0.5 |  |  | $ | 1.2  |   |  |  | N/M |  

Interest expense is incurred under notes payable,
a line of credit, and capital lease obligations. Interest, under
the terms of our notes payable, is primarily at stated interest
rates of 7.75% while the portions related to the line of credit
and an equipment loan are at variable rates equal to 5.25% and
5.5%, respectively, as of July 30, 2004. We made a draw of
$2.5 million on our line of credit in June 2004. Because
the balance of notes payable has increased versus the prior
period, the related interest expense has also increased. Our
capital lease obligations include interest at various amounts
depending on the lease arrangement and are generally at slightly
higher rates than those incurred under notes payable. The
balance of our total capital lease obligations has decreased
since 2003. Therefore, the related interest expense was also
lower. Interest expense incurred on the convertible subordinated
debentures issued in connection with our recent acquisition of
the Enterprise segment accrues at the rate of 3% of the face
value of the note but may be payable in cash or stock. Debt
discount relates to the amount of discount computed as part of
that private placement. Such discount is recorded as a reduction
of debt and is being amortized over the life of the convertible
subordinated debenture of 5 years. The deferred commitment
fees relate to the up-front payment of fees that were incurred
to secure our notes payable and our revolving line of credit
facility and are being amortized over the term of the note or,
in the case of the line of credit, the life of the facility,
which expires in April 2006.

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Other (expense)/income, net:

Other (expense)/income consists primarily of
foreign currency translation/transaction gain or loss. We record
the effects of foreign currency translation on our receivables
that are stated in currencies other than our functional
currency. Investment income earned on cash equivalents, income
related to a loan-to-grant program provided by the State of
Maryland, and miscellaneous other gains or losses are also
recorded as a component of other (expense)/income. The other
components of other (expense)/income typically remain comparable
between periods, and changes in other (expense)/income are
primarily attributable to changes in the foreign currency
translation/transaction gain or loss recorded for the period.

Income taxes:

Because we have generated significant net
operating losses since 1999, no provision for federal or state
income taxes has been made for the three or six month periods
ended June 30, 2004 or any portion of 2003. We have
recorded a full valuation allowance for deferred tax assets as a
result of our inability to determine the realizability of our
net operating loss carry-forwards.

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##### Table of Contents



Liquidity and Capital Resources

The following table sets forth, for the
six-months ended June 30, 2004 and 2003, respectively, a
period-over-period comparison of key components of our liquidity
and capital resources:

|                                                                                                                |                      |                                         |      |       |      |               |      |      |      |   |      |      |      |   |     |     |    | 
|--------------------------------------------------------------------------------------------------------------- | -------------------- | --------------------------------------- | ---- | ----- | ---- | ------------- | ---- | ---- | ---- | - | ---- | ---- | ---- | - | --- | --- | -- | 
|                                                                                                                |                      |                                         |      |       |      |              
|                                                                                                                |                      |                                         |      |       |      | 2004 vs. 2003
|                                                                                                                |                      |                                         |      |       |      |              
|($ in millions)                                                                                                 |                      | 2004                                    |      | 2003  |      | $             |      | %   
|                                                                                                                |                      |                                         |      |       |      |               |      |     
|Net cash provided by (used in):                                                                                 |                      |                                         |      |       |      |               |      |      |      |   |      |      |      |   |     |    
|                                                                                                                | Operating activities |                                         | $    | (2.9  | )    |               | $    | (8.0 | )    |   | $    | 5.0  |      |   |     | (63 | %)
|                                                                                                                | Investing activities |                                         |      | (22.2 | )    |               |      | (4.2 | )    |   |      | 18.0 |      |   |     | N/M |   
|                                                                                                                | Financing activities |                                         |      | 22.1  |      |               |      | 0.3  |      |   |      | 21.8 |      |   |     | N/M |   
|Adjusted operating income/(loss), excluding
    non-cash charges (see reconciliation below)                     |                      |                                         | 4.5  |       |      |               | (1.4 | )    |      |   | 5.8  |      |      |   | N/M |    
|Purchases of property and equipment                                                                             |                      |                                         | (4.9 | )     |      |               | (2.4 | )    |      |   | (2.5 | )    |      |   | N/M |    
|Capitalized software development costs                                                                          |                      |                                         |     |       |      |               | (1.9 | )    |      |   | 1.9  |      |      |   | 100 | %  
|Payments under long-term debt and lease
    obligations                                                         |                      |                                         | (3.9 | )     |      |               | (2.4 | )    |      |   | (1.5 | )    |      |   | (61 | %) 
|Proceeds from issuance of Class A Common
    Stock and Convertible subordinated debentures                      |                      |                                         | 21.0 |       |      |               |     |      |      |   | 21.0 |      |      |   | N/M |    
|Proceeds from long-term debt                                                                                    |                      |                                         | 5.0  |       |      |               | 2.6  |      |      |   | 2.4  |      |      |   | 91  | %  
|Proceeds from exercise of employee stock options                                                                |                      |                                         | 1.1  |       |      |               | 0.1  |      |      |   | 1.0  |      |      |   | N/M |    
|Financing fees paid related to debenture and
    stock issued to fund the acquisition of the Enterprise segment |                      |                                         | (1.1 | )     |      |               |     |      |      |   | (1.1 | )    |      |   | N/M |    
|Effect of change in foreign currency exchange
    rates on cash                                                 |                      |                                         |     |       |      |               |     |      |      |   |     |      |      |   | N/M |    
|                                                                                                                |                      |                                         |      |       |      |               |      |      |      |   |      |      |      |   |     |    
|Cash and cash equivalents                                                                                       |                      |                                         | 15.8 |       |      |               | 15.5 |      |      |   | 0.2  |      |      |   | 2   | %  
|Changes in:                                                                                                     |                      |                                         |      |       |      |               |      |      |      |   |      |      |      |   |     |    
|                                                                                                                |                      | Accounts receivable, net                |      |       | (0.2 | )             |      |      | 5.5  |   |      |      | (5.7 | ) |     |     |    | 
|                                                                                                                |                      | Unbilled receivables                    |      |       | (4.7 | )             |      |      | (2.2 | ) |      |      | (2.5 | ) |     |     |    | 
|                                                                                                                |                      | Inventory                               |      |       | (1.8 | )             |      |      |     |   |      |      | (1.8 | ) |     |     |    | 
|                                                                                                                |                      | Other current assets                    |      |       | (0.4 | )             |      |      | (0.1 | ) |      |      | (0.4 | ) |     |     |    | 
|                                                                                                                |                      | Accounts payable and accrued expenses   |      |       | (0.2 | )             |      |      | (8.7 | ) |      |      | 8.6  |   |     |     |    | 
|                                                                                                                |                      | Accrued payroll and related liabilities |      |       | (0.4 | )             |      |      | 0.2  |   |      |      | (0.6 | ) |     |     |    | 
|                                                                                                                |                      | Deferred revenue                        |      |       | 0.4  |               |      |      | (0.3 | ) |      |      | 0.8  |   |     |     |    | 
|Days revenues outstanding in accounts receivable
    including unbilled receivables                             |                      |                                         | 91   |       |      |               | 117  |      |      |   |      |      |      |   |     |    

We have funded our operations and capital
expenditures primarily using revenue from our operations as well
as the net proceeds from our initial public offering in August
2000, which generated cash of approximately $83.2 million,
leasing activities, issuance of long-term debt, and the private
placement of our securities in connection with our recent
acquisition (as described below).

We currently believe that we have sufficient
capital resources to meet our anticipated working capital and
capital expenditures needs for the next twelve months. We may
consider raising capital in the public markets as a means to
meet our debt obligations or repay the amount of debt secured
under the terms of the convertible subordinated debentures.
While unanticipated events and opportunities may make it
necessary for us to return to the capital markets, establish new
credit facilities or raise capital in private transactions in
order to meet our capital requirements, we can offer no
assurances that we will be able to access these potential
sources of funds on terms acceptable to us or at all.

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Operating cash flows improved in 2004 primarily
as a result of improvements in gross profit from higher revenue.
Management believes that an important measure of cash flow from
operating results is a measure of adjusted operating
income/(loss), excluding non-cash charges. Management considers
adjusted operating income/(loss), excluding non-cash charges in
addition to, but not as a substitute for, earnings measured in
accordance with generally accepted accounting principles,
because it is indicative of the availability of discretionary
funds and the capacity to service debt. Adjusted operating
income/(loss), excluding non-cash charges is a non-GAAP
financial measure, which indicates the amount of cash generated
from/(used in) the operations of the business, before the impact
of changes in working capital. The following table sets forth
the calculation of adjusted operating income/(loss), excluding
non-cash charges from our Consolidated Statements of Operations
for the three-and six-months ended June 30, 2004 and 2003,
respectively:

|                                                                 |                                                                                |               |     |                  |  |      |       |      |  |   |      |     |  |   |       |     | 
|---------------------------------------------------------------- | ------------------------------------------------------------------------------ | ------------- | --- | ---------------- |  | ---- | ----- | ---- |  | - | ---- | --- |  | - | ----- | --- | 
|                                                                 |                                                                                |               |     |                 
|                                                                 |                                                                                | Three Months  |     | Six Months Ended
|                                                                 |                                                                                | Ended June 30 |     | June 30         
|                                                                 |                                                                                |               |     |                 
|($ in millions)                                                  |                                                                                | 2004          |     | 2003             |  | 2004 |       | 2003
|                                                                 |                                                                                |               |     |                  |  |      |       |     
|Net income/(loss)                                                |                                                                                | $             | 0.9 |                  |  | $    | (11.4 | )    |  | $ | (2.6 | )   |  | $ | (15.4 | )  
|Non-cash charges included in net loss:                           |                                                                                |               |     |                  |  |      |       |      |  |   |      |     |  |   |       |    
|                                                                 | Depreciation and amortization of property and
    equipment                    |               |     | 1.9              |  |      |       | 1.7  |  |   |      | 3.6 |  |   |       | 3.2 | 
|                                                                 | Non-cash stock compensation expense                                            |               |     | 0.3              |  |      |       | 0.4  |  |   |      | 0.7 |  |   |       | 0.8 | 
|                                                                 | Amortization of acquired intangible assets                                     |               |     | 0.5              |  |      |       | 0.1  |  |   |      | 1.1 |  |   |       | 0.3 | 
|                                                                 | Amortization of software development costs                                     |               |     | 0.2              |  |      |       | 7.8  |  |   |      | 0.3 |  |   |       | 8.8 | 
|                                                                 | Amortization of deferred debt discount, financing
    fees and commitment fees |               |     | 0.6              |  |      |       |     |  |   |      | 1.1 |  |   |       | 0.1 | 
|                                                                 |                                                                                |               |     |                  |  |      |       |      |  |   |      |     |  |   |       |    
|Adjusted operating income/(loss), excluding
    non-cash charges |                                                                                | $             | 4.5 |                  |  | $    | (1.4  | )    |  | $ | 4.3  |     |  | $ | (2.3  | )  
|                                                                 |                                                                                |               |     |                  |  |      |       |      |  |   |      |     |  |   |       |    

The favorable change in adjusted operating
income/(loss) for the three months and six months ended
June 30, 2004 was $5.9 and $6.6 million, respectively,
lowering the need for external financing.

Net cash used in investing activities increased
in 2004 from 2003 primarily related to the acquisition of the
Enterprise segment that was consummated in January 2004. In
2004, the total cash used for the purchase of property and
equipment and development of our software products was $4.9
million while they were $4.3 million in 2003. The increase
in 2004 is primarily related to an increase in the purchase of
property and equipment required for our network operations
center including the cost of leasehold improvements related to
the move into new office space, our software development
efforts, and our corporate administrative support. This increase
is offset by a reduction in capitalized software development
costs due to completion of certain software development projects
that were under development in prior years.

Net cash provided by financing activities
increased in 2004 from previous year levels as we secured
$21.0 million in financing to fund our acquisition of the
Enterprise segment. This amount was somewhat offset by financing
fees of $1.1 million paid to secure such funding.
Additionally, we received $2.5 million under the terms of a note
payable and $2.5 million borrowed against our bank line of
credit, principally to fund capital expenditure needs while
meeting our commitment to repay lease and long-term debt
obligations.

Under our bank credit agreement, we can borrow an
amount equal to up to 80% of receivables less than 90 days
old. The line of credit is secured by accounts receivable and
bears interest at the prime rate plus 1.25% for equipment loans
and at the prime rate plus 1.0% for all other loans, with a
minimum prime rate of 4.25% (borrowing rates of 5.5% and 5.25%,
respectively, at June 30, 2004). As part of this agreement,
we have borrowed $2.5 million as an equipment loan, secured
by purchased equipment, for a term of three years. The equipment
loan

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was drawn in full. We have also borrowed
$2.5 million against the line of credit as of June 30,
2004. As of July 15, 2004, there were no other borrowings
outstanding under the bank agreement. The line of credit will
expire in April 2006.


Effective January 1, 2004, we acquired the
Enterprise Mobility Solutions division of Aether Systems, Inc.
Consideration for the acquisition was valued at approximately
$20 million, consisting of $18.1 million in cash,
$1 million in the form of a note payable and 204,020 newly
issued shares of Class A Common Stock. Concurrent with the
acquisition, we closed on $21.0 million of financing with
two accredited institutional investors, which included a
subordinated convertible debenture with stated principal of
$15 million, bearing interest at a stated rate of 3% per
annum and due in lump sum on January 13, 2009 in cash or
shares of our Class A Common Stock at the option of the
Company, approximately 1.4 million newly issued shares of
our Class A Common Stock and warrants to purchase 341,072
shares of our Class A Common Stock at an exercise price of
$6.50 per share, expiring in January 2007. The majority of the
proceeds from this financing transaction were used to fund the
purchase of the acquired assets.

Off-Balance Sheet Arrangements

We are not a party to any off-balance sheet
financing arrangements.

Commitments

As of June 30, 2004, our most significant
commitments consisted of long-term debt, including convertible
subordinated debentures, obligations under capital leases and
non-cancelable operating leases. We lease certain furniture and
computer equipment under capital leases. We lease office space
and equipment under non-cancelable operating leases. As of
June 30, 2004 our commitments consisted of the following:

|                                   |  |        |      |       |  |       |     |           |  |       |      |  |  |   |     |  |  |   |      | 
|---------------------------------- |  | ------ | ---- | ----- |  | ----- | --- | --------- |  | ----- | ---- |  |  | - | --- |  |  | - | ---- | 
|                                   |  | Within |      |       |  |       |     |           |  |      
|                                   |  | 12     |      | 1-3   |  | 3-5   |     | More than |  |      
|($ in millions)                    |  | Months |      | years |  | years |     | 5 years   |  | Total
|                                   |  |        |      |       |  |       |     |           |  |      
|Notes payable                      |  | $      | 10.3 |       |  | $     | 4.4 |           |  | $     |     |  |  | $ |    |  |  | $ | 14.7 | 
|Convertible subordinated debenture |  |        |     |       |  |       |    |           |  |       | 15.0 |  |  |   |    |  |  |   | 15.0 | 
|Capital lease obligations          |  |        | 1.5  |       |  |       | 1.1 |           |  |       |     |  |  |   |    |  |  |   | 2.6  | 
|Operating leases                   |  |        | 3.3  |       |  |       | 3.4 |           |  |       | 3.1  |  |  |   | 1.7 |  |  |   | 11.5 | 
|                                   |  |        |      |       |  |       |     |           |  |       |      |  |  |   |     |  |  |   |      | 
|                                   |  | $      | 15.1 |       |  | $     | 8.9 |           |  | $     | 18.1 |  |  | $ | 1.7 |  |  | $ | 43.8 | 
|                                   |  |        |      |       |  |       |     |           |  |       |      |  |  |   |     |  |  |   |      | 

Related Party Transactions

The leases for substantially all of our
Annapolis, Maryland office facilities, including our principal
executive office, will expire in early 2005. We have begun
planning for facilities needs thereafter, including entering an
agreement with Annapolis Partners LLC to explore the opportunity
of relocating our Annapolis offices to a planned new real estate
development. Our President and Chief Executive Officer owns a
controlling voting and economic interest in Annapolis Partners
LLC and he also serves as a member. The financial and many other
terms of the lease have not yet been established. The lease is
subject to several contingencies and rights of termination. For
example, the lease can be terminated at the sole discretion of
our Board of Directors if the terms and conditions of the
development are unacceptable to us, including without limitation
the circumstances that market conditions make the lease not
favorable to us or the overall cost is not in the best interest
of us or our shareholders, or any legal or regulatory
restrictions apply. Our Board of Directors will evaluate this
opportunity along with alternatives that are or may become
available in the relevant time periods and there is no assurance
that we will enter into a definitive lease at this new
development site.

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|        |                                                               
|------- | --------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosures
    About Market Risk

Interest Rate Risk

As of June 30, 2004, we had
$6.9 million available and unused under the line of credit.
As of July 15, 2004, $2.0 million was outstanding
under the terms of an equipment loan that was secured by
purchased equipment, bearing interest at 5.5% and payable
monthly through December 2006. As of the same date,
$2.5 million was drawn against the line of credit and
secured by accounts receivable, bearing interest at 5.25% and
payable upon the collection of the receivables collateralizing
the loan. A hypothetical 100 basis point adverse movement
(increase) in the prime rate would have increased our
interest expense for the three- and six-month periods ended
June 30, 2004 by approximately $11,000 and $22,000,
respectively, resulting in no significant impact on our
consolidated financial position, results of operations or cash
flows.

At June 30, 2004, we had cash and cash
equivalents of $15.8 million. Cash and cash equivalents
consisted of demand deposits and money market accounts that are
interest rate sensitive. However, these investments have short
maturities mitigating their sensitivity to interest rates. A
hypothetical 100 basis point adverse movement (decrease) in
interest rates would have decreased our interest income for the
three- and six-month periods ended June 30, 2004 by
approximately $45,000 and $86,000, respectively, resulting in no
significant impact on our consolidated financial position,
results of operations or cash flows.

There have not been any material changes to our
interest rate risk as described in Item 7A of our 2003
Annual Report on Form 10-K.

Foreign Currency Risk

As of June 30, 2004, we had approximately
$1.3 million in accounts receivable and $1.5 million
in unbilled receivables that are exposed to foreign currency
exchange risk. We record transaction gains or losses as a
component of other (expense)/ income in our Consolidated
Statements of Operations. There have not been any material
changes to our foreign currency risk as described in
Item 7A of our 2003 Annual Report on Form 10-K.






|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

As of the end of the period ending June 30,
2004, the Company carried out an evaluation, under the
supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design
and operation of the Companys disclosure controls and
procedures pursuant to Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended. Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and
procedures are effective in timely alerting them to material
information relating to the Company required to be included in
the Companys periodic SEC filings. There have been no
significant changes in the Companys internal controls or
in other factors which could significantly affect internal
controls subsequent to the date the Company carried out its
evaluation.

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PART II.  OTHER INFORMATION




Item 1.     Legal
Proceedings

In November 2001, a shareholder class action
lawsuit was filed against us, certain of our current officers
and a director, and several investment banks that were the
underwriters of our initial public offering (the
Underwriters): Highstein v. Telecommunication
Systems, Inc., et al., United States District Court for the
Southern District of New York, Civil Action No.01-CV-9500. The
plaintiffs seek an unspecified amount of damages. The lawsuit
purports to be a class action suit filed on behalf of purchasers
of our common stock during the period August 8, 2000
through December 6, 2000. The plaintiffs allege that the
Underwriters agreed to allocate common stock offered for sale in
our initial public offering to certain purchasers in exchange
for excessive and undisclosed commissions and agreements by
those purchasers to make additional purchases of common stock in
the aftermarket at pre-determined prices. The plaintiffs allege
that all of the defendants violated Sections 11,12 and 15
of the Securities Act of 1933, as amended, and that the
underwriters violated Section 10(b) of the Securities
Exchange Act of 1934, as amended, and Rule 10b-5
promulgated thereunder. The claims against us of violation of
Rule 10b-5 have been dismissed with the plaintiffs having
the right to re-plead. We intend to vigorously defend the
lawsuit. We believe that more than 300 other companies have been
named in nearly identical lawsuits that have been filed by some
of the same law firms that represent the plaintiffs in the
lawsuit against us.

We are not currently subject to any other
material legal proceedings. However, we may from time to time
become a party to various legal proceedings arising in the
ordinary course of our business.




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

None.




Item 3.     Defaults
Upon Senior Securities

None.




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

None.




Item 5.     Other
Information

(a) None

(b) None.

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Item 6.     Exhibits
and Reports on Form 8-K

(a) Exhibits.

|        |        |             |  |                                                                                                                                
|------- | ------ | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |            
|Numbers |        | Description
|        |        |            
|        | 3(i).1 |             |  | Amended and Restated Articles of Incorporation                                                                                 
|        | 3(i).2 |             |  | Second Amended and Restated By-Laws                                                                                            
|        | 31.1   |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 302 of
    the Sarbanes-Oxley Act of 2002.
|        | 31.2   |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 302 of
    the Sarbanes-Oxley Act of 2002.
|        | 32.1   |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.
|        | 32.2   |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K.

On April 28, 2004, we filed a Form 8-K
attaching a press release announcing the Registrants
financial information for the fiscal quarter ended
March 31, 2004. This Current Report on Form 8-K was
furnished, not filed, to the Commission in accordance with
General Instruction B.6. of the General Instructions to
Form 8-K.

On June 30, 2004, we filed a Form 8-K
attaching a press release announcing information concerning its
revenue and earnings expectations for the periods ending
June 30, 2004. This Current Report on Form 8-K was
furnished, not filed, to the Commission in accordance with
General Instruction B.6. of the General Instructions to
Form 8-K.

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SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, as amended, the
Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized on the
3rd day of August 2004.



| |                                
| | -------------------------------
| | TELECOMMUNICATION SYSTEMS, INC.



| |     |                    
| | --- | -------------------
| | By: | /s/ MAURICE B. TOSÉ

| | 
| | 
| | 



| |                                                
| | -----------------------------------------------
| | Maurice B. Tosé                                
| | Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities
Exchange Act of 1934, as amended, this Report has been signed
below by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.

|                                                                  |  |                                                                                        
|----------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------
|/s/ MAURICE B. TOSÉMaurice B. Tosé
    August 3, 2004             |  | Chairman, President and Chief Executive
    Officer
    (Principal Executive Officer)  
|                                                                 
|/s/ THOMAS M. BRANDT, JR.Thomas M. Brandt, Jr.
    August 3, 2004 |  | Senior Vice President and Chief Financial
    Officer
    (Principal Financial Officer)

33