##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q


|                                     |  |                                                                                              
|------------------------------------ |  | ---------------------------------------------------------------------------------------------
|                                     |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
    THE SECURITIES EXCHANGE ACT OF 1934  
|For the quarter ended March 31, 2006
|OR                                  
|                                     |  | TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
    THE SECURITIES EXCHANGE ACT OF 1934



TELECOMMUNICATION SYSTEMS, INC.




|                                                                           |  |                                               
|-------------------------------------------------------------------------- |  | ----------------------------------------------
|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




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|                                                    |  |                    |            | 
|--------------------------------------------------- |  | ------------------ | ---------- | 
|                                                    |  | Shares outstanding |           
|                                                    |  | as of March 31,    |           
|Title of Each Class                                 |  | 2006               |           
|                                                    |  |                    |           
|Class A Common Stock, par value
    $0.01 per share |  |                    | 31,579,253 | 
|Class B Common Stock, par value
    $0.01 per share |  |                    | 7,907,035  | 
|                                                    |  |                    |           
|Total Common Stock Outstanding                      |  |                    | 39,486,288 | 
|                                                    |  |                    |           









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##### 










INDEX


TELECOMMUNICATION SYSTEMS, INC.


|                              |  |            |  |                                                                                                  |    |      |    | 
|----------------------------- |  | ---------- |  | ------------------------------------------------------------------------------------------------ | -- | ---- | -- | 
|                              |  |            |  |                                                                                                  |    | Page |   
|                              |  |            |  |                                                                                                  |    |      |   
|PART I. FINANCIAL INFORMATION |  |            |  |                                                                                                 
|                              |  | Item 1.    |  | Financial Statements (Unaudited)                                                                 |    |      |    | 
|                              |  |            |  | Consolidated Statements of Operations for
    the three-months ended March 31, 2006 and 2005     |    |      | 1  | 
|                              |  |            |  | Consolidated Balance Sheets as of
    March 31, 2006 and December 31, 2005                       |    |      | 2  | 
|                              |  |            |  | Consolidated Statement of
    Stockholders Equity for the three-months ended
    March 31, 2006 |    |      | 3  | 
|                              |  |            |  | Consolidated Statements of Cash Flows for
    the three-months ended March 31, 2006 and 2005     |    |      | 4  | 
|                              |  |            |  | Notes to Consolidated Financial
    Statements                                                   |    |      | 5  | 
|                              |  | Item 2.    |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations        |    |      | 18 | 
|                              |  | Item 3.    |  | Quantitative and Qualitative Disclosures
    About Market Risk                                   |    |      | 35 | 
|                              |  | Item 4.    |  | Controls and Procedures                                                                          |    |      | 35 | 
|PART II. OTHER INFORMATION    |  |            |  |                                                                                                 
|                              |  | Item 1.    |  | Legal Proceedings                                                                                |    |      | 36 | 
|                              |  | Item 1A.   |  | Risk Factors                                                                                     |    |      | 36 | 
|                              |  | Item 2.    |  | Unregistered Sales of Equity Securities and
    Use of Proceeds                                  |    |      | 36 | 
|                              |  | Item 3.    |  | Defaults Upon Senior Securities                                                                  |    |      | 36 | 
|                              |  | Item 4.    |  | Submission of Matters to a Vote of Security
    Holders                                          |    |      | 36 | 
|                              |  | Item 5.    |  | Other Information                                                                                |    |      | 36 | 
|                              |  | Item 6.    |  | Exhibits                                                                                         |    |      | 36 | 
|                              |  | SIGNATURES |  |                                                                                                  | 37 |     
|EX-31.1                      
|EX-31.2                      
|EX-32.1                      
|EX-32.2                      





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##### Table of Contents



TeleCommunication Systems, Inc.





Consolidated Statements of Operations


(amounts in thousands, except per share data)


(unaudited)


|                                                   |                                                                                                                              |                    |                                          |        |        |        |        |        |        |        | 
|-------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------- | ------------------ | ---------------------------------------- | ------ | ------ | ------ | ------ | ------ | ------ | ------ | 
|                                                   |                                                                                                                              | Three Months Ended |                                         
|                                                   |                                                                                                                              | March 31,          |                                         
|                                                   |                                                                                                                              |                    |                                         
|                                                   |                                                                                                                              | 2006               |                                          |        | 2005   |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              | (unaudited)        |                                         
|Revenue                                            |                                                                                                                              |                    |                                          |        |        |        |        |       
|                                                   | Hosted, subscriber, and maintenance                                                                                          |                    | $                                        | 14,772 |        |        | $      | 11,826 |       
|                                                   | Services                                                                                                                     |                    |                                          | 7,172  |        |        |        | 5,021  |       
|                                                   | Systems                                                                                                                      |                    |                                          | 9,742  |        |        |        | 8,009  |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              | Total revenue      |                                          |        | 31,686 |        |        |        | 24,856 |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Direct costs of revenue                            |                                                                                                                              |                    |                                          |        |        |        |        |       
|                                                   | Direct cost of hosted, subscriber, and maintenance
    revenue1                                                              |                    |                                          | 8,046  |        |        |        | 5,590  |       
|                                                   | Direct cost of services
    revenue1                                                                                         |                    |                                          | 5,128  |        |        |        | 2,949  |       
|                                                   | Direct cost of systems revenue, including amortization of
    software development costs of $281 and $191,
    respectively1 |                    |                                          | 4,950  |        |        |        | 3,533  |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              |                    | Total direct cost of revenue             |        |        | 18,124 |        |        |        | 12,072 | 
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Hosted, subscriber, and maintenance gross profit   |                                                                                                                              |                    | 6,726                                    |        |        |        | 6,236  |       
|Services gross profit                              |                                                                                                                              |                    | 2,044                                    |        |        |        | 2,072  |       
|Systems gross profit                               |                                                                                                                              |                    | 4,792                                    |        |        |        | 4,476  |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              |                    | Total gross profit                       |        |        | 13,562 |        |        |        | 12,784 | 
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Operating costs and expenses                       |                                                                                                                              |                    |                                          |        |        |        |        |       
|                                                   | Research and development
    expense1                                                                                        |                    |                                          | 2,932  |        |        |        | 4,302  |       
|                                                   | Sales and marketing
    expense1                                                                                             |                    |                                          | 3,048  |        |        |        | 2,856  |       
|                                                   | General and administrative
    expense1                                                                                      |                    |                                          | 4,227  |        |        |        | 3,771  |       
|                                                   | Depreciation and amortization of property and equipment                                                                      |                    |                                          | 2,445  |        |        |        | 2,035  |       
|                                                   | Amortization of acquired intangible assets                                                                                   |                    |                                          | 37     |        |        |        | 37     |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              |                    | Total operating costs and expenses       |        |        | 12,689 |        |        |        | 13,001 | 
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Income/(loss) from operations                      |                                                                                                                              |                    | 873                                      |        |        |        | (217   | )     
|Interest expense                                   |                                                                                                                              |                    | (559                                     | )      |        |        | (317   | )     
|Other income/(expense), net                        |                                                                                                                              |                    | 28                                       |        |        |        | (41    | )     
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Income/(loss) from continuing operations           |                                                                                                                              |                    | 342                                      |        |        |        | (575   | )     
|Loss from discontinued
    operations1             |                                                                                                                              |                    | (2,054                                   | )      |        |        | (1,512 | )     
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Net loss                                           |                                                                                                                              | $                  | (1,712                                   | )      |        | $      | (2,087 | )     
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Income/(loss) per share-basic and diluted          |                                                                                                                              |                    |                                          |        |        |        |        |       
|Income/(loss) per share from continuing operations |                                                                                                                              | $                  | 0.01                                     |        |        | $      | (0.01  | )     
|Loss per share from discontinued operations        |                                                                                                                              |                    | (0.05                                    | )      |        |        | (0.04  | )     
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Net loss per share-basic and diluted               |                                                                                                                              | $                  | (0.04                                    | )      |        | $      | (0.05  | )     
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Weighted average shares outstanding-basic          |                                                                                                                              |                    | 39,085                                   |        |        |        | 38,496 |       
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|Weighted average shares outstanding- diluted:      |                                                                                                                              |                    |                                          |        |        |        |        |       
|                                                   |                                                                                                                              |                    | Income/(loss) from continuing operations |        |        | 39,546 |        |        |        | 38,496 | 
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              |                    | Loss from discontinued operations        |        |        | 39,546 |        |        |        | 38,496 | 
|                                                   |                                                                                                                              |                    |                                          |        |        |       
|                                                   |                                                                                                                              |                    | Net loss                                 |        |        | 39,546 |        |        |        | 38,496 | 
|                                                   |                                                                                                                              |                    |                                          |        |        |       






|  |                                                                                                            
|- | -----------------------------------------------------------------------------------------------------------
|1 | Includes non-cash stock compensation expense as detailed in
    Note 2 to Consolidated Financial Statements



1



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##### Table of Contents



TeleCommunication Systems, Inc.





Consolidated Balance Sheets


(amounts in thousands, except share data)


|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |     |        |        |          |     |        | 
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------------ | --- | ------ | ------ | -------- | --- | ------ | 
|                                     |                                                                                                                     | March 31,                                                                                                       |                                                                                                              |                                            | December 31, |    
|                                     |                                                                                                                     | 2006                                                                                                            |                                                                                                              |                                            | 2005         |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                     |                                                                                                                     | (unaudited)                                                                                                     |                                                                                                              |                                            |             
|Assets                              
|                                     | Current assets:                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |     |        |        |         
|                                     |                                                                                                                     | Cash and cash equivalents                                                                                       |                                                                                                              | $                                          | 10,330       |     |        | $      | 9,320    |    
|                                     |                                                                                                                     | Accounts receivable, net of allowance of $403 in 2006 and $233
    in 2005                                      |                                                                                                              |                                            | 22,124       |     |        |        | 20,886   |    
|                                     |                                                                                                                     | Unbilled receivables                                                                                            |                                                                                                              |                                            | 7,321        |     |        |        | 6,361    |    
|                                     |                                                                                                                     | Inventory                                                                                                       |                                                                                                              |                                            | 2,936        |     |        |        | 3,197    |    
|                                     |                                                                                                                     | Other current assets                                                                                            |                                                                                                              |                                            | 3,491        |     |        |        | 2,970    |    
|                                     |                                                                                                                     | Current assets of discontinued operations                                                                       |                                                                                                              |                                            | 22,978       |     |        |        | 22,891   |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              | Total current assets                       |              |     | 69,180 |        |          |     | 65,625 | 
|                                     | Property and equipment, net of accumulated depreciation and
    amortization of $36,579 in 2006 and $34,134 in 2005 |                                                                                                                 |                                                                                                              | 14,528                                     |              |     |        | 16,323 |         
|                                     | Software development costs, net of accumulated amortization of
    $2,271 in 2006 and $1,990 in 2005                |                                                                                                                 |                                                                                                              | 4,044                                      |              |     |        | 3,825  |         
|                                     | Acquired intangible assets, net of accumulated amortization of
    $251 in 2006 and $214 in 2005                    |                                                                                                                 |                                                                                                              | 967                                        |              |     |        | 1,004  |         
|                                     | Goodwill                                                                                                            |                                                                                                                 |                                                                                                              | 1,813                                      |              |     |        | 1,813  |         
|                                     | Other assets                                                                                                        |                                                                                                                 |                                                                                                              | 2,468                                      |              |     |        | 1,982  |         
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              | Total assets                               |              | $   | 93,000 |        |          | $   | 90,572 | 
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                    
|Liabilities and stockholders equity
|                                     | Current liabilities:                                                                                                |                                                                                                                 |                                                                                                              |                                            |              |     |        |        |         
|                                     |                                                                                                                     | Accounts payable and accrued expenses                                                                           |                                                                                                              | $                                          | 8,279        |     |        | $      | 10,175   |    
|                                     |                                                                                                                     | Accrued payroll and related liabilities                                                                         |                                                                                                              |                                            | 1,385        |     |        |        | 3,971    |    
|                                     |                                                                                                                     | Deferred revenue                                                                                                |                                                                                                              |                                            | 5,835        |     |        |        | 4,123    |    
|                                     |                                                                                                                     | Current portion of notes payable, including line of credit                                                      |                                                                                                              |                                            | 6,003        |     |        |        | 10,180   |    
|                                     |                                                                                                                     | Current portion of capital lease obligations                                                                    |                                                                                                              |                                            | 2,990        |     |        |        | 3,001    |    
|                                     |                                                                                                                     | Current liabilities of discontinued operations                                                                  |                                                                                                              |                                            | 7,608        |     |        |        | 6,719    |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              | Total current liabilities                  |              |     | 32,100 |        |          |     | 38,169 | 
|                                     | Notes payable, less current portion and net of debt discount of
    $3,359                                          |                                                                                                                 |                                                                                                              | 6,766                                      |              |     |        | 483    |         
|                                     | Capital lease obligations, less current portion                                                                     |                                                                                                                 |                                                                                                              | 2,279                                      |              |     |        | 2,858  |         
|                                     | Stockholders equity:                                                                                               |                                                                                                                 |                                                                                                              |                                            |              |     |        |        |         
|                                     |                                                                                                                     | Class A Common Stock; $0.01 par value:                                                                          |                                                                                                              |                                            |              |     |        |        |          |    
|                                     |                                                                                                                     | Authorized shares  225,000,000; issued and
    outstanding shares of 31,579,253 in 2006 and 31,381,575 in 2005 |                                                                                                              |                                            | 315          |     |        |        | 314      |    
|                                     |                                                                                                                     | Class B Common Stock; $0.01 par value:                                                                          |                                                                                                              |                                            |              |     |        |        |          |    
|                                     |                                                                                                                     |                                                                                                                 | Authorized shares  75,000,000; issued and outstanding
    shares of 7,907,035 in 2006 and 8,035,963 in 2005 |                                            |              | 79  |        |        |          | 80  |       
|                                     |                                                                                                                     | Additional paid-in capital                                                                                      |                                                                                                              |                                            | 214,536      |     |        |        | 210,044  |    
|                                     |                                                                                                                     | Accumulated other comprehensive loss:                                                                           |                                                                                                              |                                            |              |     |        |        |          |    
|                                     |                                                                                                                     |                                                                                                                 | Cumulative foreign currency translation adjustment                                                           |                                            |              | (27 | )      |        |          | (40 | )     
|                                     |                                                                                                                     | Accumulated deficit                                                                                             |                                                                                                              |                                            | (163,048     | )   |        |        | (161,336 | )  
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              | Total stockholders equity                 |              |     | 51,855 |        |          |     | 49,062 | 
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              | Total liabilities and stockholders equity |              | $   | 93,000 |        |          | $   | 90,572 | 
|                                     |                                                                                                                     |                                                                                                                 |                                                                                                              |                                            |              |    



2



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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  |   |    | Paid-In     |  |   | Comprehensive |  |  | Accumulated |     |   |      
|                                                                                         |  | Stock   |     |  | Stock   |   |    | Capital     |  |   | Loss          |  |  | Deficit     |     |   | Total |  
|                                                                                         |  |         |     |  |         |   |    |             |  |   |               |  |  |             |     |   |       |  
|Balance at January 1, 2006                                                               |  | $       | 314 |  |         | $ | 80 |             |  | $ | 210,044       |  |  | $           | (40 | ) |       | $ | (161,336 | ) |  | $ | 49,062 |  
|Options exercised for the purchase of 30,843 shares of
    Class A Common Stock          |  |         |    |  |         |   |   |             |  |   | 35            |  |  |             |    |   |       |   |         |   |  |   | 35     |  
|Issuance of 37,907 shares of Class A Common Stock
    under Employee Stock Purchase Plan |  |         |    |  |         |   |   |             |  |   | 67            |  |  |             |    |   |       |   |         |   |  |   | 67     |  
|Conversion of 128,928 shares of Class B Common Stock
    to Class A Common Stock         |  |         | 1   |  |         |   | (1 | )           |  |   |              |  |  |             |    |   |       |   |         |   |  |   |       |  
|Warrants to purchase 1,750,000 shares of Class A
    Common Stock                        |  |         |    |  |         |   |   |             |  |   | 2,861         |  |  |             |    |   |       |   |         |   |  |   | 2,861  |  
|Adjustment of terms for warrants to
    purchase 886,787 shares of Class A Common Stock  |  |         |    |  |         |   |   |             |  |   | 594           |  |  |             |    |   |       |   |         |   |  |   | 594    |  
|Stock compensation expense for continuing operations                                     |  |         |    |  |         |   |   |             |  |   | 811           |  |  |             |    |   |       |   |         |   |  |   | 811    |  
|Stock compensation expense of discontinued operations                                    |  |         |    |  |         |   |   |             |  |   | 114           |  |  |             |    |   |       |   |         |   |  |   | 114    |  
|Stock compensation for options issued to non-employees for
    service                   |  |         |    |  |         |   |   |             |  |   | 10            |  |  |             |    |   |       |   |         |   |  |   | 10     |  
|Foreign currency translation adjustment                                                  |  |         |    |  |         |   |   |             |  |   |              |  |  |             | 13  |   |       |   |         |   |  |   | 13     |  
|Net loss for the three months ended March 31, 2006                                       |  |         |    |  |         |   |   |             |  |   |              |  |  |             |    |   |       |   | (1,712   | ) |  |   | (1,712 | )
|                                                                                         |  |         |     |  |         |   |    |             |  |   |               |  |  |             |     |   |       |  
|Balance at March 31, 2006                                                                |  | $       | 315 |  |         | $ | 79 |             |  | $ | 214,536       |  |  | $           | (27 | ) |       | $ | (163,048 | ) |  | $ | 51,855 |  
|                                                                                         |  |         |     |  |         |   |    |             |  |   |               |  |  |             |     |   |       |  



3



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##### Table of Contents



TeleCommunication Systems, Inc.





Consolidated Statements of Cash Flows


(amounts in thousands)


(unaudited)


|                                                                                                                         |                                                                          |                                         |        |        |        |   |        |        |        |  
|------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------ | --------------------------------------- | ------ | ------ | ------ | - | ------ | ------ | ------ | -
|                                                                                                                         |                                                                          | Three Months Ended                      |       
|                                                                                                                         |                                                                          | March 31,                               |       
|                                                                                                                         |                                                                          |                                         |       
|                                                                                                                         |                                                                          | 2006                                    |        |        | 2005   |  
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Operating activities:                                                                                                    |                                                                          |                                         |        |        |        |   |        |       
|Net loss                                                                                                                 |                                                                          | $                                       | (1,712 | )      |        | $ | (2,087 | )     
|                                                                                                                         | Less: Loss from discontinued operations                                  |                                         |        | (2,054 | )      |   |        | (1,512 | )     
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|                                                                                                                         | Income/(loss) from continuing operations                                 |                                         |        | 342    |        |   |        | (575   | )     
|Adjustments to reconcile net loss from continuing operations to
    net cash (used in)/provided by operating activities: |                                                                          |                                         |        |        |        |   |        |       
|                                                                                                                         | Depreciation and amortization of property and equipment                  |                                         |        | 2,445  |        |   |        | 2,035  |       
|                                                                                                                         | Amortization of acquired intangible assets                               |                                         |        | 37     |        |   |        | 37     |       
|                                                                                                                         | Non-cash stock compensation expense                                      |                                         |        | 811    |        |   |        | 205    |       
|                                                                                                                         | Amortization of software development costs                               |                                         |        | 281    |        |   |        | 191    |       
|                                                                                                                         | Amortization of debt discount                                            |                                         |        | 96     |        |   |        |       |       
|                                                                                                                         | Amortization of deferred financing fees included in interest
    expense |                                         |        | 226    |        |   |        | 84     |       
|                                                                                                                         | Other non-cash income                                                    |                                         |        | (45    | )      |   |        | (62    | )     
|                                                                                                                         | Changes in operating assets and liabilities:                             |                                         |        |        |        |   |        |        |       
|                                                                                                                         |                                                                          | Accounts receivable, net                |        |        | (1,226 | ) |        |        | 3,694  |  
|                                                                                                                         |                                                                          | Unbilled receivables                    |        |        | (960   | ) |        |        | (4,540 | )
|                                                                                                                         |                                                                          | Inventory                               |        |        | 261    |   |        |        | (1,066 | )
|                                                                                                                         |                                                                          | Other current assets                    |        |        | (511   | ) |        |        | 579    |  
|                                                                                                                         |                                                                          | Other assets                            |        |        | 17     |   |        |        | (67    | )
|                                                                                                                         |                                                                          | Accounts payable and accrued expenses   |        |        | (1,928 | ) |        |        | (1,756 | )
|                                                                                                                         |                                                                          | Accrued payroll and related liabilities |        |        | (2,588 | ) |        |        | 301    |  
|                                                                                                                         |                                                                          | Deferred revenue                        |        |        | 1,702  |   |        |        | 1,417  |  
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Net cash (used in)/provided by operating activities of
    continuing operations                                         |                                                                          |                                         | (1,040 | )      |        |   | 477    |       
|Net cash (used in)/provided by operating activities of
    discontinued operations                                       |                                                                          |                                         | (862   | )      |        |   | 2,242  |       
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Total net cash (used in)/provided by operating activities                                                                |                                                                          |                                         | (1,902 | )      |        |   | 2,719  |       
|Investing activities:                                                                                                    |                                                                          |                                         |        |        |        |   |        |       
|Purchases of property and equipment                                                                                      |                                                                          |                                         | (484   | )      |        |   | (509   | )     
|Capitalized software development costs                                                                                   |                                                                          |                                         | (500   | )      |        |   |       |       
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Net cash used in investing activities of continuing operations                                                           |                                                                          |                                         | (984   | )      |        |   | (509   | )     
|Net cash used in investing activities of discontinued operations                                                         |                                                                          |                                         | (275   | )      |        |   | (484   | )     
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Total net cash used in investing activities                                                                              |                                                                          |                                         | (1,259 | )      |        |   | (993   | )     
|Financing activities:                                                                                                    |                                                                          |                                         |        |        |        |   |        |       
|Payments on long-term debt and capital lease obligations                                                                 |                                                                          |                                         | (1,285 | )      |        |   | (2,509 | )     
|Payments on short-term line of credit, net                                                                               |                                                                          |                                         | (5,004 | )      |        |   |       |       
|Proceeds from issuance of long-term debt                                                                                 |                                                                          |                                         | 11,000 |        |        |   |       |       
|Financing fees related to issuance of long-term debt and
    Class A Common Stock                                        |                                                                          |                                         | (672   | )      |        |   | (81    | )     
|Proceeds from exercise of employee stock options and sale of
    stock                                                   |                                                                          |                                         | 112    |        |        |   | 274    |       
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Total net cash provided by/(used in) financing activities                                                                |                                                                          |                                         | 4,151  |        |        |   | (2,316 | )     
|Effect of exchange rates on cash of discontinued operations                                                              |                                                                          |                                         | 20     |        |        |   | (7     | )     
|Net increase/(decrease) in cash from continuing operations                                                               |                                                                          |                                         | 2,127  |        |        |   | (2,348 | )     
|Net (decrease)/increase in cash from discontinued operations                                                             |                                                                          |                                         | (1,117 | )      |        |   | 1,751  |       
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Total net increase/(decrease) in cash                                                                                    |                                                                          |                                         | 1,010  |        |        |   | (597   | )     
|Cash and cash equivalents at the beginning of the period                                                                 |                                                                          |                                         | 9,320  |        |        |   | 18,251 |       
|                                                                                                                         |                                                                          |                                         |        |        |        |  
|Cash and cash equivalents at the end of the period                                                                       |                                                                          | $                                       | 10,330 |        |        | $ | 17,654 |       
|                                                                                                                         |                                                                          |                                         |        |        |        |  



4



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##### Table of Contents






TeleCommunication Systems, Inc.


Notes to Consolidated Financial Statements


March 31, 2006


(amounts in thousands, except per share amounts)


(unaudited)




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

Basis of Presentation. 10-Q S-X. 10-K.


Capital Resource Risks.




Reclassifications.


Use of Estimates.


5



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




Software Development Costs.






Stock-Based Compensation. Share Based Payment




Earnings per share.


|                                                                                                        |  |                    |        |  |      |  |        | 
|------------------------------------------------------------------------------------------------------- |  | ------------------ | ------ |  | ---- |  | ------ | 
|                                                                                                        |  | Three Months Ended |       
|                                                                                                        |  | March 31,          |       
|                                                                                                        |  |                    |       
|                                                                                                        |  | 2006               |        |  | 2005 | 
|                                                                                                        |  |                    |        |  |      | 
|Basic weighted average common shares outstanding                                                        |  |                    | 39,085 |  |      |  | 38,496 | 
|Dilutive common shares outstanding                                                                      |  |                    | 461    |  |      |  |       | 
|                                                                                                        |  |                    |        |  |      | 
|Diluted weighted average common shares outstanding used in the
    calculation of diluted income/(loss) |  |                    | 39,546 |  |      |  | 38,496 | 
|                                                                                                        |  |                    |        |  |      | 

Recent Accounting Pronouncements. Share Based Payment


6



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)


out-of


Accounting for Certain Hybrid Financial Instruments-an
amendment of FASB Statements No. 133 and 140.


Accounting for Servicing of Financial Assets-an amendment of
FASB Statement No. 140.




|   |                         
|-- | ------------------------
|2. | Stock-Based Compensation

Accounting for Stock Issued to Employees Accounting for Stock-Based
Compensation-Transition and Disclosure




7



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)








|                                                                                 |                                                                          |                 |     |     |      |   |     |   | 
|-------------------------------------------------------------------------------- | ------------------------------------------------------------------------ | --------------- | --- | --- | ---- | - | --- | - | 
|                                                                                 |                                                                          | Three Months    |    
|                                                                                 |                                                                          | Ended March 31, |    
|                                                                                 |                                                                          |                 |    
|                                                                                 |                                                                          | 2006            |     |     | 2005 |  
|                                                                                 |                                                                          |                 |     |     |      |  
|Continuing operations:                                                           |                                                                          |                 |     |     |      |   |     |  
|Stock options granted at fair value                                              |                                                                          | $               | 646 |     |      | $ |    |  
|Restricted stock                                                                 |                                                                          |                 | 155 |     |      |   | 145 |  
|Employee stock purchase plan                                                     |                                                                          |                 | 10  |     |      |   |    |  
|Options granted at less than fair value prior to our initial
    public offering |                                                                          |                 |    |     |      |   | 60  |  
|                                                                                 |                                                                          |                 |     |     |      |  
|Total stock compensation expense included in continuing
    operations           |                                                                          |                 | 811 |     |      |   | 205 |  
|Discontinued operations:                                                         |                                                                          |                 |     |     |      |   |     |  
|Stock options granted at fair value                                              |                                                                          |                 | 114 |     |      |   |    |  
|                                                                                 |                                                                          |                 |     |     |      |  
|                                                                                 | Total stock compensation expense included in discontinued
    operations |                 | $   | 114 |      |   | $   |  | 

8



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




|                                                       |                                                              |                              |     |     |      |   |       |       |  |   |      |     |  |      |   |       |  |   |   |   |  |   |   |   | 
|------------------------------------------------------ | ------------------------------------------------------------ | ---------------------------- | --- | --- | ---- | - | ----- | ----- |  | - | ---- | --- |  | ---- | - | ----- |  | - | - | - |  | - | - | - | 
|                                                       |                                                              | Three Months Ended March 31, |    
|                                                       |                                                              |                              |    
|                                                       |                                                              | 2006                         |     |     | 2005 |  
|                                                       |                                                              |                              |     |     |      |  
|                                                       |                                                              | Comm.                        |     |     |      |   | Comm. |       |  |  
|                                                       |                                                              | Apps                         |     |     | Gvmt |   |       | Total |  |   | Apps |     |  | Gvmt |   | Total | 
|                                                       |                                                              |                              |     |     |      |   |       |       |  |   |      |     |  |      |   |       | 
|Stock compensation included in direct cost of revenue: |                                                              |                              |     |     |      |   |       |       |  |   |      |     |  |      |   |       |  |   |   |   |  |   |   |  
|Direct cost of hosted, subscriber, and maintenance     |                                                              | $                            | 186 |     |      | $ | 3     |       |  | $ | 189  |     |  | $    | 9 |       |  | $ |  |   |  | $ | 9 |  
|Direct cost of services                                |                                                              |                              | 5   |     |      |   | 131   |       |  |   | 136  |     |  |      |  |       |  |   |  |   |  |   |  |  
|Direct cost of systems                                 |                                                              |                              | 25  |     |      |   | 14    |       |  |   | 39   |     |  |      |  |       |  |   |  |   |  |   |  |  
|                                                       |                                                              |                              |     |     |      |   |       |       |  |   |      |     |  |      |   |       |  |  
|                                                       | Total stock compensation included in direct costs of revenue |                              | $   | 216 |      |   | $     | 148   |  |   | $    | 364 |  |      | $ | 9     |  |   | $ |  |  |   | $ | 9 | 
|                                                       |                                                              |                              |     |     |      |   |       |       |  |   |      |     |  |      |   |       |  |  

|                                                   |                                                         |              |     |     |      |   |     |     | 
|-------------------------------------------------- | ------------------------------------------------------- | ------------ | --- | --- | ---- | - | --- | --- | 
|                                                   |                                                         | Three Months |    
|                                                   |                                                         | Ended        |    
|                                                   |                                                         | March 31,    |    
|                                                   |                                                         |              |    
|                                                   |                                                         | 2006         |     |     | 2005 |  
|                                                   |                                                         |              |     |     |      |  
|Stock compensation included in operating expenses: |                                                         |              |     |     |      |   |     |    
|Research and development expense                   |                                                         | $            | 95  |     |      | $ |    |    
|Sales and marketing expense                        |                                                         |              | 69  |     |      |   | 10  |    
|General and administrative expense                 |                                                         |              | 283 |     |      |   | 186 |    
|                                                   |                                                         |              |     |     |      |  
|                                                   | Total stock compensation included in operating expenses |              | $   | 447 |      |   | $   | 196 | 
|                                                   |                                                         |              |     |     |      |  



|                                                                                         |  |           |           |          |          |   |      | 
|---------------------------------------------------------------------------------------- |  | --------- | --------- | -------- | -------- | - | ---- | 
|                                                                                         |  |           |           | Weighted |         
|                                                                                         |  |           |           | Average  |         
|                                                                                         |  | Number of |           |          | Exercise |  
|(Share amounts in thousands)                                                             |  | Options   |           |          | Price    |  
|                                                                                         |  |           |           |          |          |  
|Outstanding, beginning of year                                                           |  |           | 9,793     |          |          | $ | 3.86 | 
|Granted                                                                                  |  |           | 2,082     |          |          | $ | 2.37 | 
|Exercised                                                                                |  |           | (31       | )        |          | $ | 1.15 | 
|Forfeited                                                                                |  |           | (155      | )        |          | $ | 3.61 | 
|                                                                                         |  |           |           |          |          |  
|Outstanding, end of year                                                                 |  |           | 11,689    |          |          | $ | 3.59 | 
|                                                                                         |  |           |           |          |          |  
|Exercisable, at end of year                                                              |  |           | 6,124     |          |          | $ | 4.55 | 
|                                                                                         |  |           |           |          |          |  
|Estimated weighted-average grant- date fair value of options
    granted during the year |  | $         | 2.37      |          |          |   |      | 
|                                                                                         |  |           |           |          |          |  
|Weighted-average remaining contractual life of options
    outstanding at end of year    |  |           | 7.6 years |          |          |   |      | 
|                                                                                         |  |           |           |          |          |  

9



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




|                |  |             |       |                  |                     |                  |                       |                     |  |  |             |                  |  |                     |       |  |  |   |       | 
|--------------- |  | ----------- | ----- | ---------------- | ------------------- | ---------------- | --------------------- | ------------------- |  |  | ----------- | ---------------- |  | ------------------- | ----- |  |  | - | ----- | 
|                |  |             |       |                  |                     | Weighted-Average |                       |                     |  |  |            
|                |  |             |       | Weighted-Average |                     |                  | Remaining Contractual |                     |  |  |             | Weighted-Average | 
|                |  | Options     |       |                  | Exercise Prices of  |                  |                       | Life of Options     |  |  | Options     |                  |  | Exercise Prices of  |      
|Exercise Prices |  | Outstanding |       |                  | Options Outstanding |                  |                       | Outstanding (Years) |  |  | Exercisable |                  |  | Options Exercisable |      
|                |  |             |       |                  |                     |                  |                       |                     |  |  |             |                  |  |                     |      
|$ 0.01 - $ 2.61 |  |             | 5,600 |                  |                     | $                | 2.28                  |                     |  |  | 8.63        |                  |  |                     | 1,031 |  |  | $ | 1.71  | 
|$ 2.61 - $ 5.21 |  |             | 3,531 |                  |                     | $                | 3.43                  |                     |  |  | 6.12        |                  |  |                     | 2,539 |  |  | $ | 3.36  | 
|$ 5.21 - $ 7.82 |  |             | 2,501 |                  |                     | $                | 6.76                  |                     |  |  | 7.28        |                  |  |                     | 2,497 |  |  | $ | 6.76  | 
|$ 7.82 - $10.42 |  |             | 26    |                  |                     | $                | 8.37                  |                     |  |  | 7.05        |                  |  |                     | 26    |  |  | $ | 8.37  | 
|$10.42 - $26.05 |  |             | 31    |                  |                     | $                | 14.06                 |                     |  |  | 4.32        |                  |  |                     | 31    |  |  | $ | 14.06 | 



Accounting for Stock-Based Compensation


|                                                                                                                    |                                               |                    |        |        |  
|------------------------------------------------------------------------------------------------------------------- | --------------------------------------------- | ------------------ | ------ | ------ | -
|                                                                                                                    |                                               | Three Months Ended |       
|                                                                                                                    |                                               | Mar. 31, 2005      |       
|                                                                                                                    |                                               |                    |       
|Net loss, as reported                                                                                               |                                               | $                  | (2,087 | )     
|Add: Stock-based employee compensation expense included in
    reported net loss                                    |                                               |                    | 205    |       
|Deduct: Total stock-based employee compensation expense
    determined under fair value based method for all awards |                                               |                    | (1,542 | )     
|                                                                                                                    |                                               |                    |       
|Pro forma net loss                                                                                                  |                                               | $                  | (3,424 | )     
|Loss per common share:                                                                                              |                                               |                    |        |       
|                                                                                                                    | Basic and diluted  as reported               |                    | $      | (0.05  | )
|                                                                                                                    |                                               |                    |       
|                                                                                                                    | Basic and diluted  pro forma                 |                    | $      | (0.09  | )
|                                                                                                                    |                                               |                    |       
|Weighted average shares outstanding:                                                                                |                                               |                    |        |       
|                                                                                                                    | Basic and diluted  as reported and pro forma |                    |        | 38,496 |  
|                                                                                                                    |                                               |                    |       



|                           |  |              |      |   |      |  |      |  
|-------------------------- |  | ------------ | ---- | - | ---- |  | ---- | -
|                           |  | Three Months |     
|                           |  | Ended        |     
|                           |  | March 31,    |     
|                           |  |              |     
|                           |  | 2006         |      |   | 2005 | 
|                           |  |              |      |   |      | 
|Expected life (in years)   |  |              | 5.5  |   |      |  | 5.5  |  
|Risk-free interest rate(%) |  |              | 4.75 | % |      |  | 3.35 | %
|Volatility(%)              |  |              | 94   | % |      |  | 113  | %
|Dividend yield(%)          |  |              | 0    | % |      |  | 0    | %

10



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




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







|   |                                          
|-- | -----------------------------------------
|4. | Enterprise Assets-Discontinued Operations

10-Q Accounting for the Impairment or Disposal of
Long-Lived Assets


®




|                                      |                                                             |                                        |        |        |              |   |        |        |        | 
|------------------------------------- | ----------------------------------------------------------- | -------------------------------------- | ------ | ------ | ------------ | - | ------ | ------ | ------ | 
|                                      |                                                             | March 31,                              |        |        | December 31, |  
|                                      |                                                             | 2006                                   |        |        | 2005         |  
|                                      |                                                             |                                        |        |        |              |  
|Assets:                               |                                                             |                                        |        |        |              |   |        |       
|                                      | Accounts receivable                                         |                                        | $      | 2,497  |              |   | $      | 3,263  |       
|                                      | Unbilled receivables                                        |                                        |        | 57     |              |   |        | 260    |       
|                                      | Inventory                                                   |                                        |        | 843    |              |   |        | 558    |       
|                                      | Other current assets                                        |                                        |        | 1,762  |              |   |        | 1,225  |       
|                                      | Property and equipment, net of accumulated depreciation     |                                        |        | 2,097  |              |   |        | 1,863  |       
|                                      | Software development costs, net of accumulated amortization |                                        |        | 533    |              |   |        | 533    |       
|                                      | Acquired intangible assets, net of accumulated amortization |                                        |        | 2,516  |              |   |        | 2,516  |       
|                                      | Goodwill                                                    |                                        |        | 12,633 |              |   |        | 12,633 |       
|                                      | Other assets                                                |                                        |        | 40     |              |   |        | 40     |       
|                                      |                                                             |                                        |        |        |              |  
|                                      |                                                             | Assets of discontinued operations      |        |        | 22,978       |   |        |        | 22,891 | 
|                                      |                                                             |                                        |        |        |              |  
|Liabilities:                          |                                                             |                                        |        |        |              |   |        |       
|                                      | Accounts payable and accrued expenses                       |                                        |        | 5,094  |              |   |        | 4,514  |       
|                                      | Accrued payroll and related liabilities                     |                                        |        | 840    |              |   |        | 844    |       
|                                      | Deferred revenue                                            |                                        |        | 1,674  |              |   |        | 1,361  |       
|                                      |                                                             |                                        |        |        |              |  
|                                      |                                                             | Liabilities of discontinued operations |        |        | 7,608        |   |        |        | 6,719  | 
|                                      |                                                             |                                        |        |        |              |  
|Net assets of discontinued operations |                                                             | $                                      | 15,370 |        |              | $ | 16,172 |       
|                                      |                                                             |                                        |        |        |              |  

11



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




|                                                          |                    |          |     |       |              |  |     |       |       |  |     |       |       | 
|--------------------------------------------------------- | ------------------ | -------- | --- | ----- | ------------ |  | --- | ----- | ----- |  | --- | ----- | ----- | 
|                                                          |                    | Gross    |     |       |              |  |    
|                                                          |                    | Carrying |     |       | Accumulated  |  |     |      
|                                                          |                    | Amount   |     |       | Amortization |  |     | Net   |      
|                                                          |                    |          |     |       |              |  |     |       |      
|Acquired intangible assets:                               |                    |          |     |       |              |  |     |       |       |  |     |      
|                                                          | Customer Contracts |          | $   | 4,519 |              |  | $   | 3,043 |       |  | $   | 1,476 |      
|                                                          | Customer Lists     |          |     | 2,165 |              |  |     | 1,458 |       |  |     | 707   |      
|                                                          | Trademarks         |          |     | 630   |              |  |     | 297   |       |  |     | 333   |      
|Software development costs, including acquired technology |                    |          | 844 |       |              |  | 311 |       |       |  | 533 |      
|                                                          |                    |          |     |       |              |  |     |       |      
|                                                          |                    | Total    |     | $     | 8,158        |  |     | $     | 5,109 |  |     | $     | 3,049 | 
|                                                          |                    |          |     |       |              |  |     |       |      





|                                                                                        |                    |                    |        |       |      |   |        |       | 
|--------------------------------------------------------------------------------------- | ------------------ | ------------------ | ------ | ----- | ---- | - | ------ | ----- | 
|                                                                                        |                    | Three Months Ended |       
|                                                                                        |                    | March 31,          |       
|                                                                                        |                    |                    |       
|                                                                                        |                    | 2006               |        |       | 2005 |  
|                                                                                        |                    |                    |        |       |      |  
|Hosted, subscriber and maintenance revenue                                              |                    | $                  | 3,924  |       |      | $ | 6,974  |      
|Systems revenue                                                                         |                    |                    | 665    |       |      |   | 1,249  |      
|                                                                                        |                    |                    |        |       |      |  
|                                                                                        | Total revenue      |                    |        | 4,589 |      |   |        | 8,223 | 
|                                                                                        |                    |                    |        |       |      |  
|Hosted, subscriber and maintenance gross profit                                         |                    |                    | 1,010  |       |      |   | 2,173  |      
|Systems gross loss                                                                      |                    |                    | (448   | )     |      |   | (162   | )    
|                                                                                        |                    |                    |        |       |      |  
|                                                                                        | Total gross profit |                    |        | 562   |      |   |        | 2,011 | 
|                                                                                        |                    |                    |        |       |      |  
|Research and development, sales, marketing, and general and
    administrative expenses |                    |                    | 2,616  |       |      |   | 2,571  |      
|Depreciation and amortization                                                           |                    |                    |       |       |      |   | 952    |      
|                                                                                        |                    |                    |        |       |      |  
|Loss from discontinued operations                                                       |                    | $                  | (2,054 | )     |      | $ | (1,512 | )    
|                                                                                        |                    |                    |        |       |      |  





|   |                       
|-- | ----------------------
|5. | Financing Arrangements



12



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##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)








|   |                    
|-- | -------------------
|6. | Segment Information



tm


®




13



---



##### Table of Contents



TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |   |       |       |       |   |        |        |        | 
|------------------------------------------------------- | ------------------ | ---------------------------- | ------ | ----- | ------ | - | ----- | ----- | ------ | - | ------ | ------ | ------ | ---- | ------ | ----- | ------ | - | ----- | ----- | ----- | - | ------ | ------ | ------ | 
|                                                        |                    | Three Months Ended March 31, |       
|                                                        |                    |                              |       
|                                                        |                    | 2006                         |        |       | 2005   |  
|                                                        |                    |                              |        |       |        |  
|                                                        |                    | Comm.                        |        |       |        |   | Comm. |       |        |  
|                                                        |                    | Apps                         |        |       | Gvmt   |   |       | Total |        |   | Apps   |        |        | Gvmt |        |       | Total  |  
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  
|Revenue                                                 |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |   |       |       |       |   |        |       
|Hosted, subscriber and maintenance                      |                    | $                            | 14,631 |       |        | $ | 141   |       |        | $ | 14,772 |        |        | $    | 11,740 |       |        | $ | 86    |       |       | $ | 11,826 |       
|Services                                                |                    |                              | 518    |       |        |   | 6,654 |       |        |   | 7,172  |        |        |      | 630    |       |        |   | 4,391 |       |       |   | 5,021  |       
|Systems                                                 |                    |                              | 3,466  |       |        |   | 6,276 |       |        |   | 9,742  |        |        |      | 4,732  |       |        |   | 3,277 |       |       |   | 8,009  |       
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  
|                                                        |                    | Total revenue                |        |       | 18,615 |   |       |       | 13,071 |   |        |        | 31,686 |      |        |       | 17,102 |   |       |       | 7,754 |   |        |        | 24,856 | 
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  
|Operating costs and expenses                            |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |   |       |       |       |   |        |       
|Direct cost of hosted, subscriber, and
    maintenance1 |                    |                              | 7,859  |       |        |   | 187   |       |        |   | 8,046  |        |        |      | 5,585  |       |        |   | 5     |       |       |   | 5,590  |       
|Direct cost of
    services1                            |                    |                              | 338    |       |        |   | 4,790 |       |        |   | 5,128  |        |        |      | 333    |       |        |   | 2,616 |       |       |   | 2,949  |       
|Direct cost of
    systems1                             |                    |                              | 889    |       |        |   | 4,061 |       |        |   | 4,950  |        |        |      | 1,135  |       |        |   | 2,398 |       |       |   | 3,533  |       
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  
|                                                        | Total direct costs |                              |        | 9,086 |        |   |       | 9,038 |        |   |        | 18,124 |        |      |        | 7,053 |        |   |       | 5,019 |       |   |        | 12,072 |       
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  
|Gross profit                                            |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |   |       |       |       |   |        |       
|Hosted, subscriber, and maintenance gross profit        |                    |                              | 6,772  |       |        |   | (46   | )     |        |   | 6,726  |        |        |      | 6,155  |       |        |   | 81    |       |       |   | 6,236  |       
|Services gross profit                                   |                    |                              | 180    |       |        |   | 1,864 |       |        |   | 2,044  |        |        |      | 297    |       |        |   | 1,775 |       |       |   | 2,072  |       
|Systems gross profit                                    |                    |                              | 2,577  |       |        |   | 2,215 |       |        |   | 4,792  |        |        |      | 3,597  |       |        |   | 879   |       |       |   | 4,476  |       
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  
|                                                        |                    | Total gross profit           |        | $     | 9,529  |   |       | $     | 4,033  |   |        | $      | 13,562 |      |        | $     | 10,049 |   |       | $     | 2,735 |   |        | $      | 12,784 | 
|                                                        |                    |                              |        |       |        |   |       |       |        |   |        |        |        |      |        |       |        |  

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)


|                                         |                                                         |                    |        |        |      |   |        |        |  
|---------------------------------------- | ------------------------------------------------------- | ------------------ | ------ | ------ | ---- | - | ------ | ------ | -
|                                         |                                                         | Three Months Ended |       
|                                         |                                                         | March 31,          |       
|                                         |                                                         |                    |       
|                                         |                                                         | 2006               |        |        | 2005 |  
|                                         |                                                         |                    |        |        |      |  
|Total segment gross profit               |                                                         | $                  | 13,562 |        |      | $ | 12,784 |       
|                                         | Research and development
    expense1                   |                    |        | (2,932 | )    |   |        | (4,302 | )
|                                         | Sales and marketing
    expense1                        |                    |        | (3,048 | )    |   |        | (2,856 | )
|                                         | General and administrative
    expense1                 |                    |        | (4,227 | )    |   |        | (3,771 | )
|                                         | Depreciation and amortization of property and equipment |                    |        | (2,445 | )    |   |        | (2,035 | )
|                                         | Amortization of acquired intangible assets              |                    |        | (37    | )    |   |        | (37    | )
|                                         | Interest expense                                        |                    |        | (559   | )    |   |        | (317   | )
|                                         | Other income/(expense), net                             |                    |        | 28     |      |   |        | (41    | )
|                                         |                                                         |                    |        |        |      |  
|Income/(loss) from continuing operations |                                                         |                    | 342    |        |      |   | (575   | )     
|Loss from discontinued
    operations1   |                                                         |                    | (2,054 | )      |      |   | (1,512 | )     
|                                         |                                                         |                    |        |        |      |  
|Net loss                                 |                                                         | $                  | (1,712 | )      |      | $ | (2,087 | )     
|                                         |                                                         |                    |        |        |      |  






|  |                                                                       
|- | ----------------------------------------------------------------------
|1 | includes non-cash stock compensation expense as detailed in
    Note 2



|   |          
|-- | ---------
|7. | Inventory



|                |                               |          |       |       |          |   |       |       | 
|--------------- | ----------------------------- | -------- | ----- | ----- | -------- | - | ----- | ----- | 
|                |                               | Mar. 31, |       |       | Dec. 31, |  
|                |                               | 2006     |       |       | 2005     |  
|                |                               |          |       |       |          |  
|Component parts |                               | $        | 1,725 |       |          | $ | 1,934 |      
|Finished goods  |                               |          | 1,211 |       |          |   | 1,263 |      
|                |                               |          |       |       |          |  
|                | Total inventory at period end |          | $     | 2,936 |          |   | $     | 3,197 | 
|                |                               |          |       |       |          |  

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




|   |                                                                          
|-- | -------------------------------------------------------------------------
|8. | Acquired Intangible Assets and Capitalized Software
    Development Costs



|                                                          |                      |                |       |     |                   |  |       |     |       |          |        |     |             |              |       |     |       |  |       |     |       |  |       |     |       | 
|--------------------------------------------------------- | -------------------- | -------------- | ----- | --- | ----------------- |  | ----- | --- | ----- | -------- | ------ | --- | ----------- | ------------ | ----- | --- | ----- |  | ----- | --- | ----- |  | ----- | --- | ----- | 
|                                                          |                      | March 31, 2006 |       |     | December 31, 2005 | 
|                                                          |                      |                |       |     |                   | 
|                                                          |                      | Gross          |       |     |                   |  | Gross |     |       |         
|                                                          |                      | Carrying       |       |     | Accumulated       |  |       |     |       | Carrying |        |     | Accumulated |              |       |    
|                                                          |                      | Amount         |       |     | Amortization      |  |       | Net |       |          | Amount |     |             | Amortization |       |     | Net   | 
|                                                          |                      |                |       |     |                   |  |       |     |       |          |        |     |             |              |       |     |       | 
|Acquired intangible assets:                               |                      |                |       |     |                   |  |       |     |       |          |        |     |             |              |       |     |       |  |       |     |       |  |       |    
|                                                          | Customer Lists       |                | $     | 606 |                   |  | $     | 203 |       |          | $      | 403 |             |              | $     | 606 |       |  | $     | 174 |       |  | $     | 432 |      
|                                                          | Trademarks & Patents |                |       | 612 |                   |  |       | 48  |       |          |        | 564 |             |              |       | 612 |       |  |       | 40  |       |  |       | 572 |      
|Software development costs, including acquired technology |                      |                | 6,315 |     |                   |  | 2,271 |     |       |          | 4,044  |     |             |              | 5,815 |     |       |  | 1,990 |     |       |  | 3,825 |    
|                                                          |                      |                |       |     |                   |  |       |     |       |          |        |     |             |              |       |     |       | 
|                                                          |                      | Total          |       | $   | 7,533             |  |       | $   | 2,522 |          |        | $   | 5,011       |              |       | $   | 7,033 |  |       | $   | 2,204 |  |       | $   | 4,829 | 
|                                                          |                      |                |       |     |                   |  |       |     |       |          |        |     |             |              |       |     |       | 
|Estimated future amortization expense:                    |                      |                |       |     |                   |  |       |     |       |          |        |     |             |              |       |    
|Nine-months ending December 31, 2006                      |                      | $              | 1,120 |     |                   |  |       |     |       |          |        |     |             |              |       |    
|Year ending December 31, 2007                             |                      | $              | 1,603 |     |                   |  |       |     |       |          |        |     |             |              |       |    
|Year ending December 31, 2008                             |                      | $              | 1,078 |     |                   |  |       |     |       |          |        |     |             |              |       |    
|Year ending December 31, 2009                             |                      | $              | 766   |     |                   |  |       |     |       |          |        |     |             |              |       |    
|Year ending December 31, 2010                             |                      | $              | 444   |     |                   |  |       |     |       |          |        |     |             |              |       |    





|   |                                                  
|-- | -------------------------------------------------
|9. | Concentrations of Credit Risk and Major Customers





|                                           |  |                         |  |                            |               |  |      |  |    |  
|------------------------------------------ |  | ----------------------- |  | -------------------------- | ------------- |  | ---- |  | -- | -
|                                           |  |                         |  | % of Total Revenue For the |              
|                                           |  |                         |  | Three Months Ended         |              
|                                           |  |                         |  | March 31,                  |              
|                                           |  |                         |  |                            |              
|Customer                                   |  | Segment                 |  | 2006                       |               |  | 2005 | 
|                                           |  |                         |  |                            |               |  |      | 
|Federal Agencies                           |  | Government              |  |                            | 31%           |  |      |  | 19 | %
|Verizon Wireless, including indirect sales |  | Commercial Applications |  |                            | 21%           |  |      |  | 14 | %
|Hutchison Whampoa                          |  | Commercial Applications |  |                            | Less than 10% |  |      |  | 15 | %

|                 |  |                         |  |                      |    |   |             |  |               | 
|---------------- |  | ----------------------- |  | -------------------- | -- | - | ----------- |  | ------------- | 
|                 |  |                         |  | As of March 31, 2006 |   
|                 |  |                         |  |                      |   
|                 |  |                         |  | Accounts             |    |   | Unbilled    | 
|Customer         |  | Segment                 |  | Receivable           |    |   | Receivables | 
|                 |  |                         |  |                      |    |   |             | 
|Federal Agencies |  | Government              |  |                      | 27 | % |             |  | 64%           | 
|Customer A       |  | Commercial Applications |  |                      | 20 | % |             |  | Less than 10% | 
|Customer B       |  | Commercial Applications |  |                      | 12 | % |             |  | Less than 10% | 

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TeleCommunication Systems, Inc.


Notes to Consolidated Financial
Statements  (Continued)




|    |               
|--- | --------------
|10. | Line of Credit









17



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

10-Q 10-Q). 10-Q 10-Q


Critical Accounting Policies and Estimates


percentage-of


18



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percentage-of 10-K 10-K.)


Overview




Managements
Discussion and Analysis of Financial Condition and Results of
Operations.




10-K 10-Q.


19



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Indicators of Our Financial and Operating Performance






| |   |                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue and gross profit. We derive revenue from products
    and services including recurring monthly service and subscriber
    fees, software licenses and related service fees for the design,
    development, and deployment of software and communication
    systems, and products and services derived from the delivery of
    information processing and communication systems to governmental
    agencies.





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Operating expenses. Our operating expenses are primarily
    compensation and benefits, professional fees, facility costs,
    marketing and sales-related expenses, and travel costs as well
    as certain non-cash expenses such as non-cash stock compensation
    expense, depreciation and amortization of property and
    equipment, and amortization of acquired intangible assets.                                                                                                 
|
| |  | Liquidity and cash flows. The primary driver of our cash
    flows is the results of our operations including discontinued
    operations. Important sources of our liquidity have been cash
    raised from our 2004 financings in connection with our 2004
    acquisitions and our 2006 debt financing, as described below
    under Liquidity and Capital Resources, and
    borrowings under our bank credit agreement and lease financings
    secured for the purchase of equipment.
|
| |  | Balance sheet. We view cash, working capital, and
    accounts receivable balances and days revenues outstanding as
    important indicators of our financial health                                                                                                                                                                                                                                                                                                                         

® ® 10-Q


Results of Operations


Recent Developments:


Share Based Payment,  10-Q




20



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|                                                                       |                                                                          |                 |     |     |               |   |     |   |  |   |      |     |  |  |    |    | 
|---------------------------------------------------------------------- | ------------------------------------------------------------------------ | --------------- | --- | --- | ------------- | - | --- | - |  | - | ---- | --- |  |  | -- | -- | 
|                                                                       |                                                                          | Three Months    |     |     |              
|                                                                       |                                                                          | Ended March 31, |     |     | 2006 vs. 2005 |  
|                                                                       |                                                                          |                 |     |     |               |  
|($ in millions)                                                        |                                                                          | 2006            |     |     | 2005          |   |     | $ |  |   | %    |    
|                                                                       |                                                                          |                 |     |     |               |   |     |   |  |   |      |    
|Continuing operations:                                                 |                                                                          |                 |     |     |               |   |     |   |  |   |      |     |  |  |    |   
|Stock options granted at fair value                                    |                                                                          | $               | 0.6 |     |               | $ |    |   |  | $ | 0.6  |     |  |  | NM |   
|Restricted stock                                                       |                                                                          |                 | 0.2 |     |               |   | 0.1 |   |  |   | 0.1  |     |  |  | NM |   
|Options granted prior to our initial public offering                   |                                                                          |                 |    |     |               |   | 0.1 |   |  |   | (0.1 | )   |  |  | NM |   
|                                                                       |                                                                          |                 |     |     |               |   |     |   |  |   |      |    
|Total stock compensation expense included in continuing
    operations |                                                                          |                 | 0.8 |     |               |   | 0.2 |   |  |   | 0.6  |     |  |  | NM |   
|Discontinued operations:                                               |                                                                          |                 |     |     |               |   |     |   |  |   |      |     |  |  |    |   
|Stock options granted at fair value                                    |                                                                          |                 | 0.1 |     |               |   |    |   |  |   | 0.1  |     |  |  | NM |   
|                                                                       |                                                                          |                 |     |     |               |   |     |   |  |   |      |    
|                                                                       | Total stock compensation expense included in discontinued
    operations |                 | $   | 0.1 |               |   | $   |  |  |   | $    | 0.1 |  |  |    | NM | 



|                                                      |                                                              |                              |     |     |      |   |       |       |  |   |      |     |      |   |       |   |  |   |   |   |  |   |   |   | 
|----------------------------------------------------- | ------------------------------------------------------------ | ---------------------------- | --- | --- | ---- | - | ----- | ----- |  | - | ---- | --- | ---- | - | ----- | - |  | - | - | - |  | - | - | - | 
|                                                      |                                                              | Three Months Ended March 31,
|                                                      |                                                              |                             
|                                                      |                                                              | 2006                         |     |     | 2005
|                                                      |                                                              |                              |     |     |     
|                                                      |                                                              | Comm.                        |     |     |      |   | Comm. |       | 
|                                                      |                                                              | Apps                         |     |     | Gvmt |   |       | Total |  |   | Apps |     | Gvmt |   | Total
|                                                      |                                                              |                              |     |     |      |   |       |       |  |   |      |     |      |   |      
|Stock compensation included in direct cost of revenue |                                                              |                              |     |     |      |   |       |       |  |   |      |     |      |   |       |   |  |   |   |   |  |   |   |  
|Direct cost of hosted, subscriber, and maintenance    |                                                              | $                            | 0.2 |     |      | $ |      |       |  | $ | 0.2  |     |      | $ |      |   |  | $ |  |   |  | $ |  |  
|Direct cost of services                               |                                                              |                              |    |     |      |   | 0.2   |       |  |   | 0.2  |     |      |   |      |   |  |   |  |   |  |   |  |  
|                                                      |                                                              |                              |     |     |      |   |       |       |  |   |      |     |      |   |       |   |  |  
|                                                      | Total stock compensation included in direct costs of revenue |                              | $   | 0.2 |      |   | $     | 0.2   |  |   | $    | 0.4 |      |   | $     |  |  |   | $ |  |  |   | $ |  | 
|                                                      |                                                              |                              |     |     |      |   |       |       |  |   |      |     |      |   |       |   |  |  

|                                                        |                                    |                 |     |     |      |   |     |     | 
|------------------------------------------------------- | ---------------------------------- | --------------- | --- | --- | ---- | - | --- | --- | 
|                                                        |                                    | Three Months    |    
|                                                        |                                    | Ended March 31, |    
|                                                        |                                    |                 |    
|                                                        |                                    | 2006            |     |     | 2005 |  
|                                                        |                                    |                 |     |     |      |  
|Stock compensation included in operating expenses       |                                    |                 |     |     |      |   |     |    
|                                                        | Research and development expense   |                 | $   | 0.1 |      |   | $   |    | 
|                                                        | Sales and marketing expense        |                 |     | 0.1 |      |   |     |    | 
|                                                        | General and administrative expense |                 |     | 0.2 |      |   |     | 0.2 | 
|                                                        |                                    |                 |     |     |      |  
|Total stock compensation included in operating expenses |                                    | $               | 0.4 |     |      | $ | 0.2 |    
|                                                        |                                    |                 |     |     |      |  





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Revenue and Cost of Revenue


Discontinued Operations  Enterprise assets




| |                                 
| | --------------------------------
| | Commercial Applications Segment:

|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |      |   |  |     |    |   
|--------------------------------------------------------------- | ------------------------------------------------- | --------------- | ---- | ---- | ------------- | - | ---- | ---- | - | - | ---- | ---- | - |  | --- | -- | --
|                                                                |                                                   | Three Months    |      |      |              
|                                                                |                                                   | Ended March 31, |      |      | 2006 vs. 2005 |  
|                                                                |                                                   |                 |      |      |               |  
|($ in millions)                                                 |                                                   | 2006            |      |      | 2005          |   |      | $    |   |   | %    |     
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|Hosted, subscriber, and maintenance revenue                     |                                                   | $               | 14.6 |      |               | $ | 11.8 |      |   | $ | 2.8  |      |   |  | 25  | % 
|Services revenue                                                |                                                   |                 | 0.5  |      |               |   | 0.6  |      |   |   | (0.1 | )    |   |  | (18 | %)
|Systems revenue                                                 |                                                   |                 | 3.5  |      |               |   | 4.7  |      |   |   | (1.2 | )    |   |  | (27 | %)
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|                                                                | Commercial Applications segment revenue           |                 |      | 18.6 |               |   |      | 17.1 |   |   |      | 1.5  |   |  |     | 9  | % 
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|Direct cost of hosted, subscriber, and maintenance
    revenue1 |                                                   |                 | 7.9  |      |               |   | 5.6  |      |   |   | 2.3  |      |   |  | 41  | % 
|Direct cost of services
    revenue1                            |                                                   |                 | 0.3  |      |               |   | 0.3  |      |   |   |     |      |   |  |    |   
|Direct cost of systems
    revenue1                             |                                                   |                 | 0.9  |      |               |   | 1.1  |      |   |   | (0.2 | )    |   |  | (22 | %)
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|                                                                | Commercial Applications segment cost of revenue   |                 |      | 9.1  |               |   |      | 7.0  |   |   |      | 2.1  |   |  |     | 29 | % 
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|Hosted, subscriber, and maintenance gross profit                |                                                   |                 | 6.7  |      |               |   | 6.2  |      |   |   | 0.5  |      |   |  | 10  | % 
|Services gross profit                                           |                                                   |                 | 0.2  |      |               |   | 0.3  |      |   |   | (0.1 | )    |   |  | (39 | %)
|Systems gross profit                                            |                                                   |                 | 2.6  |      |               |   | 3.6  |      |   |   | (1.0 | )    |   |  | (28 | %)
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|                                                                | Commercial Applications segment gross
    profit2 |                 | $    | 9.5  |               |   | $    | 10.1 |   |   | $    | (0.6 | ) |  |     | (5 | %)
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     
|                                                                | Segment gross profit as a percent of revenue      |                 |      | 51   | %             |   |      | 59   | % |   |      |      |   |  |     |    |   
|                                                                |                                                   |                 |      |      |               |   |      |      |   |   |      |     






| |                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1See discussion of the allocation of non-cash stock compensation
    expense in Note 2 to the accompanying unaudited
    consolidated financial statements and under Recent
    Developments above
|
| | 2See discussion of segment reporting in Note 6 to the
    accompanying unaudited consolidated financial statements (NM =
    Not meaningful)                                                        



| |                                                                                                            
| | -----------------------------------------------------------------------------------------------------------
| | Commercial Applications Hosted, Subscriber, and Maintenance
    Revenue, Cost of Revenue, and Gross Profit:



E9-1


tm


22



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| |                                                                                 
| | --------------------------------------------------------------------------------
| | Commercial Applications Services Revenue, Cost of Revenue,
    and Gross Profit:





| |                                                                   
| | ------------------------------------------------------------------
| | Commercial Systems Revenue, Cost of Revenue, and Gross
    Profit:





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percentage-of








24



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| |                    
| | -------------------
| | Government Segment:

|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |     |  |  |    |    |  
|--------------------------------------------------------------- | -------------------------------------------- | --------------- | --- | ---- | ------------- | - | --- | --- | - | - | ---- | --- |  |  | -- | -- | -
|                                                                |                                              | Three Months    |     |      |              
|                                                                |                                              | Ended March 31, |     |      | 2006 vs. 2005 |  
|                                                                |                                              |                 |     |      |               |  
|($ in millions)                                                 |                                              | 2006            |     |      | 2005          |   |     | $   |   |   | %    |    
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|Hosted, subscriber, and maintenance revenue                     |                                              | $               | 0.2 |      |               | $ | 0.1 |     |   | $ | 0.1  |     |  |  | 64 | % 
|Services revenue                                                |                                              |                 | 6.7 |      |               |   | 4.4 |     |   |   | 2.3  |     |  |  | 52 | % 
|Systems revenue                                                 |                                              |                 | 6.2 |      |               |   | 3.3 |     |   |   | 2.9  |     |  |  | 92 | % 
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|                                                                | Government segment revenue                   |                 |     | 13.1 |               |   |     | 7.8 |   |   |      | 5.3 |  |  |    | 69 | %
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|Direct cost of hosted, subscriber, and maintenance
    revenue1 |                                              |                 | 0.2 |      |               |   |    |     |   |   | 0.2  |     |  |  | NM |   
|Direct cost of services
    revenue1                            |                                              |                 | 4.8 |      |               |   | 2.6 |     |   |   | 2.2  |     |  |  | 83 | % 
|Direct cost of systems
    revenue1                             |                                              |                 | 4.1 |      |               |   | 2.4 |     |   |   | 1.7  |     |  |  | 69 | % 
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|                                                                | Government segment cost of revenue           |                 |     | 9.1  |               |   |     | 5.0 |   |   |      | 4.1 |  |  |    | 80 | %
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|Hosted, subscriber, and maintenance gross profit                |                                              |                 |    |      |               |   | 0.1 |     |   |   | (0.1 | )   |  |  | NM |   
|Services gross profit                                           |                                              |                 | 1.9 |      |               |   | 1.8 |     |   |   | 0.1  |     |  |  | 5  | % 
|Systems gross profit                                            |                                              |                 | 2.1 |      |               |   | 0.9 |     |   |   | 1.2  |     |  |  | NM |   
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|                                                                | Government segment gross
    profit2         |                 | $   | 4.0  |               |   | $   | 2.8 |   |   | $    | 1.2 |  |  |    | 48 | %
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    
|                                                                | Segment gross profit as a percent of revenue |                 |     | 31   | %             |   |     | 35  | % |   |      |     |  |  |    |    |  
|                                                                |                                              |                 |     |      |               |   |     |     |   |   |      |    






|  |                                                                                                                                                                                                    
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1 | See discussion of the allocation of non-cash stock
    compensation expense in Note 2 to the accompanying
    unaudited consolidated financial statements and under
    Recent Developments above
| 
|2 | See discussion of segment reporting in Note 6 to the
    accompanying unaudited consolidated financial statements                                                                                  

percentage-of




| |                                                                                               
| | ----------------------------------------------------------------------------------------------
| | Government Hosted, Subscriber, and Maintenance Revenue, Cost
    of Revenue, and Gross Profit:





| |                                                                    
| | -------------------------------------------------------------------
| | Government Services Revenue, Cost of Revenue, and Gross
    Profit:



25



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| |                                                                   
| | ------------------------------------------------------------------
| | Government Systems Revenue, Cost of Revenue, and Gross
    Profit:

® percentage-of






26



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##### Table of Contents



Major Customers




Revenue Backlog




|                                                       |  |           |       |  |      |   |      | 
|------------------------------------------------------ |  | --------- | ----- |  | ---- | - | ---- | 
|                                                       |  | March 31, |      
|                                                       |  |           |      
|($ in millions)                                        |  | 2006      |       |  | 2005 |  
|                                                       |  |           |       |  |      |  
|Commercial Applications segment                        |  | $         | 64.1  |  |      | $ | 57.1 | 
|Government segment                                     |  |           | 51.2  |  |      |   | 37.6 | 
|                                                       |  |           |       |  |      |  
|Total backlog                                          |  | $         | 115.3 |  |      | $ | 94.7 | 
|                                                       |  |           |       |  |      |  
|Expected to be realized during the current fiscal year |  | $         | 49.4  |  |      | $ | 41.7 | 
|                                                       |  |           |       |  |      |  
|Expected to be realized within 12 months               |  | $         | 61.4  |  |      | $ | 52.6 | 
|                                                       |  |           |       |  |      |  



Operating Expenses




| |                                  
| | ---------------------------------
| | Research and development expense:

|                                 |  |              |     |   |               |   |     |   |  |   |      |   |  |  |      |  
|-------------------------------- |  | ------------ | --- | - | ------------- | - | --- | - |  | - | ---- | - |  |  | ---- | -
|                                 |  | Three Months |     |   |               |   |    
|                                 |  | Ended        |     |   |              
|                                 |  | March 31,    |     |   | 2006 vs. 2005 |  
|                                 |  |              |     |   |               |  
|($ in millions)                  |  | 2006         |     |   | 2005          |   |     | $ |  |   | %    |  
|                                 |  |              |     |   |               |   |     |   |  |   |      |  
|Research and development expense |  | $            | 2.9 |   |               | $ | 4.3 |   |  | $ | (1.4 | ) |  |  | (32% | )
|Percent of total revenue         |  |              | 9   | % |               |   | 17  | % |  |   |      |   |  |  |      |  





27



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| |                             
| | ----------------------------
| | Sales and marketing expense:

|                            |  |              |     |   |               |   |     |   |  |   |     |  |  |  |    | 
|--------------------------- |  | ------------ | --- | - | ------------- | - | --- | - |  | - | --- |  |  |  | -- | 
|                            |  | Three Months |     |   |               |   |    
|                            |  | Ended        |     |   |              
|                            |  | March 31,    |     |   | 2006 vs. 2005 |  
|                            |  |              |     |   |               |  
|($ in millions)             |  | 2006         |     |   | 2005          |   |     | $ |  |   | %   | 
|                            |  |              |     |   |               |   |     |   |  |   |     | 
|Sales and marketing expense |  | $            | 3.0 |   |               | $ | 2.9 |   |  | $ | 0.1 |  |  |  | 7% | 
|Percent of total revenue    |  |              | 10  | % |               |   | 12  | % |  |   |     |  |  |  |    | 





| |                                    
| | -----------------------------------
| | General and administrative expense:

|                                   |  |              |     |   |               |   |     |   |  |   |     |  |  |  |     | 
|---------------------------------- |  | ------------ | --- | - | ------------- | - | --- | - |  | - | --- |  |  |  | --- | 
|                                   |  | Three Months |     |   |               |   |    
|                                   |  | Ended        |     |   |              
|                                   |  | March 31,    |     |   | 2006 vs. 2005 |  
|                                   |  |              |     |   |               |  
|($ in millions)                    |  | 2006         |     |   | 2005          |   |     | $ |  |   | %   | 
|                                   |  |              |     |   |               |   |     |   |  |   |     | 
|General and administrative expense |  | $            | 4.2 |   |               | $ | 3.8 |   |  | $ | 0.4 |  |  |  | 12% | 
|Percent of total revenue           |  |              | 13  | % |               |   | 15  | % |  |   |     |  |  |  |     | 

Recent Development


28



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| |                                                         
| | --------------------------------------------------------
| | Depreciation and amortization of property and equipment:

|                                                               |  |              |      |  |          |   |      |   |  |   |     |  |  |  |    |  
|-------------------------------------------------------------- |  | ------------ | ---- |  | -------- | - | ---- | - |  | - | --- |  |  |  | -- | -
|                                                               |  | Three Months |      |  |         
|                                                               |  | Ended        |      |  | 2006 vs. |  
|                                                               |  | March 31,    |      |  | 2005     |  
|                                                               |  |              |      |  |          |  
|($ in millions)                                                |  | 2006         |      |  | 2005     |   |      | $ |  |   | %   | 
|                                                               |  |              |      |  |          |   |      |   |  |   |     | 
|Depreciation and amortization of property and equipment        |  | $            | 2.4  |  |          | $ | 2.0  |   |  | $ | 0.4 |  |  |  | 20 | %
|Average gross cost of property and equipment during the period |  | $            | 50.8 |  |          | $ | 45.1 |   |  | $ | 5.7 |  |  |  | 13 | %





| |                                            
| | -------------------------------------------
| | Amortization of acquired intangible assets:

|                                           |  |              |     |  |               |   |     |   |  |   |   |  |  |  |   | 
|------------------------------------------ |  | ------------ | --- |  | ------------- | - | --- | - |  | - | - |  |  |  | - | 
|                                           |  | Three Months |     |  |               |   |    
|                                           |  | Ended        |     |  |              
|                                           |  | March 31     |     |  | 2006 vs. 2005 |  
|                                           |  |              |     |  |               |  
|($ in millions)                            |  | 2006         |     |  | 2005          |   |     | $ |  | % |  
|                                           |  |              |     |  |               |   |     |   |  |   |  
|Amortization of acquired intangible assets |  | $            | 0.1 |  |               | $ | 0.1 |   |  | $ |  |  |  |  |  | 





| |                  
| | -----------------
| | Interest expense:

|                                              |  |              |     |  |               |   |     |   |  |   |     |  |  |  |     |   
|--------------------------------------------- |  | ------------ | --- |  | ------------- | - | --- | - |  | - | --- |  |  |  | --- | --
|                                              |  | Three Months |     |  |               |   |    
|                                              |  | Ended        |     |  |              
|                                              |  | March 31     |     |  | 2006 vs. 2005 |  
|                                              |  |              |     |  |               |  
|($ in millions)                               |  | 2006         |     |  | 2005          |   |     | $ |  |   | %   | 
|                                              |  |              |     |  |               |   |     |   |  |   |     | 
|Interest expense on notes payable             |  | $            | 0.2 |  |               | $ | 0.1 |   |  | $ | 0.1 |  |  |  | 62  | % 
|Interest expense on capital lease obligations |  |              | 0.1 |  |               |   | 0.1 |   |  |   |    |  |  |  | (14 | %)
|Amortization of deferred commitment fees      |  |              | 0.2 |  |               |   | 0.1 |   |  |   | 0.1 |  |  |  | 95  | % 
|Amortization of debt discount                 |  |              | 0.1 |  |               |   |    |   |  |   | 0.1 |  |  |  | NM  |   
|                                              |  |              |     |  |               |   |     |   |  |   |     | 
|Total interest expense                        |  | $            | 0.6 |  |               | $ | 0.3 |   |  | $ | 0.3 |  |  |  | 76  | % 
|                                              |  |              |     |  |               |   |     |   |  |   |     | 



10-Q,


29



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| |                             
| | ----------------------------
| | Other income/(expense), net:





| |              
| | -------------
| | Income taxes:





| |                                            
| | -------------------------------------------
| | Discontinued Operations  Enterprise assets

®


30



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|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |      |   |  |     |     |   
|--------------------------------------------------------------------------------------- | --------------------------------- | ------------ | ---- | ---- | ------------- | - | ---- | ---- | - | - | ---- | ---- | - |  | --- | --- | --
|                                                                                        |                                   | Three Months |      |      |               |   |     
|                                                                                        |                                   | Ended        |      |      |              
|                                                                                        |                                   | March 31     |      |      | 2006 vs. 2005 |  
|                                                                                        |                                   |              |      |      |               |  
|($ in millions)                                                                         |                                   | 2006         |      |      | 2005          |   |      | $    |   |   | %    |     
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     
|Hosted, subscriber, and maintenance revenue                                             |                                   | $            | 3.9  |      |               | $ | 7.0  |      |   | $ | (3.1 | )    |   |  | (44 | %) 
|Systems revenue                                                                         |                                   |              | 0.7  |      |               |   | 1.2  |      |   |   | (0.5 | )    |   |  | (46 | %) 
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     
|                                                                                        | Total Enterprise revenue          |              |      | 4.6  |               |   |      | 8.2  |   |   |      | (3.6 | ) |  |     | (44 | %)
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     
|Hosted, subscriber, and maintenance gross profit                                        |                                   |              | 1.0  |      |               |   | 2.2  |      |   |   | (1.2 | )    |   |  | (52 | %) 
|Systems gross profit                                                                    |                                   |              | (0.4 | )    |               |   | (0.2 | )    |   |   | (0.2 | )    |   |  | NM  |    
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     
|                                                                                        | Total Enterprise gross profit     |              |      | 0.6  |               |   |      | 2.0  |   |   |      | (1.4 | ) |  |     | (69 | %)
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     
|Research and development, sales, marketing, and general and
    administrative expenses |                                   |              | 2.6  |      |               |   | 2.6  |      |   |   |     |      |   |  |    |    
|Depreciation and amortization                                                           |                                   |              |     |      |               |   | 0.9  |      |   |   | (0.9 | )    |   |  | NM  |    
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     
|                                                                                        | Loss from discontinued operations |              | $    | (2.1 | )             |   | $    | (1.5 | ) |   | $    | (0.6 | ) |  |     | (36 | %)
|                                                                                        |                                   |              |      |      |               |   |      |      |   |   |      |     

Recent
Developments






| |          
| | ---------
| | Net loss:

|                |  |              |      |   |               |   |      |   |  |   |     |  |  |  |    |  
|--------------- |  | ------------ | ---- | - | ------------- | - | ---- | - |  | - | --- |  |  |  | -- | -
|                |  | Three Months |      |   |               |   |     
|                |  | Ended        |      |   |              
|                |  | March 31,    |      |   | 2006 vs. 2005 |  
|                |  |              |      |   |               |  
|($ in millions) |  | 2006         |      |   | 2005          |   |      | $ |  |   | %   | 
|                |  |              |      |   |               |   |      |   |  |   |     | 
|Net loss        |  | $            | (1.7 | ) |               | $ | (2.1 | ) |  | $ | 0.4 |  |  |  | 18 | %



31



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Liquidity and Capital Resources


|                                                                                    |                                                    |              |      |      |               |   |      |      |   |   |      |      |   |  |    |    | 
|----------------------------------------------------------------------------------- | -------------------------------------------------- | ------------ | ---- | ---- | ------------- | - | ---- | ---- | - | - | ---- | ---- | - |  | -- | -- | 
|                                                                                    |                                                    | Three Months |      |      |               |   |     
|                                                                                    |                                                    | Ended        |      |      |              
|                                                                                    |                                                    | March 31,    |      |      | 2006 vs. 2005 |  
|                                                                                    |                                                    |              |      |      |               |  
|($ in millions)                                                                     |                                                    | 2006         |      |      | 2005          |   |      | $    |   |   | %    |     
|                                                                                    |                                                    |              |      |      |               |   |      |      |   |   |      |     
|Net cash and cash equivalents provided by/(used in):                                |                                                    |              |      |      |               |   |      |      |   |   |      |      |   |  |    |   
|Continuing operations                                                               |                                                    |              |      |      |               |   |      |      |   |   |      |      |   |  |    |   
|Income/(loss)                                                                       |                                                    | $            | 0.3  |      |               | $ | (0.6 | )    |   | $ | 0.9  |      |   |  | NM |   
|Non-cash charges                                                                    |                                                    |              | 3.9  |      |               |   | 2.5  |      |   |   | 1.4  |      |   |  | 55 | % 
|Net changes in working capital                                                      |                                                    |              | (5.2 | )    |               |   | (1.4 | )    |   |   | (3.8 | )    |   |  | NM |   
|                                                                                    |                                                    |              |      |      |               |   |      |      |   |   |      |     
|                                                                                    | Operating activities                               |              |      | (1.0 | )             |   |      | 0.5  |   |   |      | (1.5 | ) |  |    | NM | 
|Purchases of property and equipment                                                 |                                                    |              | (0.5 | )    |               |   | (0.5 | )    |   |   |     |      |   |  | (5 | %)
|Capitalized software development costs                                              |                                                    |              | (0.5 | )    |               |   |     |      |   |   | (0.5 | )    |   |  | NM |   
|Proceeds from new borrowings                                                        |                                                    |              | 11.0 |      |               |   |     |      |   |   | 11.0 |      |   |  | NM |   
|Other financing activities                                                          |                                                    |              | (6.9 | )    |               |   | (2.3 | )    |   |   | (4.6 | )    |   |  | NM |   
|                                                                                    |                                                    |              |      |      |               |   |      |      |   |   |      |     
|                                                                                    | Cash provided by/(used in) continuing operations   |              |      | 2.1  |               |   |      | (2.3 | ) |   |      | (4.4 | ) |  |    | NM | 
|Discontinued operations                                                             |                                                    |              |      |      |               |   |      |      |   |   |      |      |   |  |    |   
|Operating activities                                                                |                                                    |              | (0.9 | )    |               |   | 2.2  |      |   |   | (3.1 | )    |   |  | NM |   
|Investing activities                                                                |                                                    |              | (0.3 | )    |               |   | (0.5 | )    |   |   | 0.2  |      |   |  | 43 | % 
|                                                                                    |                                                    |              |      |      |               |   |      |      |   |   |      |     
|                                                                                    | Cash provided by/(used in) discontinued operations |              |      | (1.2 | )             |   |      | 1.7  |   |   |      | (2.9 | ) |  |    | NM | 
|Net increase/(decrease) in cash                                                     |                                                    | $            | 1.0  |      |               | $ | (0.6 | )    |   | $ | 1.6  |      |   |  | NM |   
|                                                                                    |                                                    |              |      |      |               |   |      |      |   |   |      |     
|Days revenues outstanding in accounts receivable including
    unbilled receivables |                                                    |              | 84   |      |               |   | 98   |      |   |   |      |      |   |  |    |   



10-Q,




32



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33



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##### Table of Contents









Off-Balance Sheet Arrangements




Contractual Commitments




|                          |                               |           |     |      |       |   |      |       |  |   |           |     |       |   |   |   |  |   |      |      | 
|------------------------- | ----------------------------- | --------- | --- | ---- | ----- | - | ---- | ----- |  | - | --------- | --- | ----- | - | - | - |  | - | ---- | ---- | 
|                          |                               | Within 12 |     |      | 1-3   |   |      | 3-5   |  |   | More than |     |      
|($ in millions)           |                               | Months    |     |      | Years |   |      | Years |  |   | 5 Years   |     | Total |  
|                          |                               |           |     |      |       |   |      |       |  |   |           |     |       |  
|Notes payable             |                               | $         | 3.0 |      |       | $ | 10.1 |       |  | $ |          |     |       | $ |  |   |  | $ | 13.1 |     
|Line of credit            |                               |           | 3.0 |      |       |   |     |       |  |   |          |     |       |   |  |   |  |   | 3.0  |     
|Capital lease obligations |                               |           | 3.2 |      |       |   | 2.3  |       |  |   |          |     |       |   |  |   |  |   | 5.5  |     
|Operating leases          |                               |           | 3.3 |      |       |   | 5.4  |       |  |   | 2.2       |     |       |   |  |   |  |   | 10.9 |     
|                          |                               |           |     |      |       |   |      |       |  |   |           |     |       |   |  
|                          | Total contractual commitments |           | $   | 12.5 |       |   | $    | 17.8  |  |   | $         | 2.2 |       |   | $ |  |  |   | $    | 32.5 | 
|                          |                               |           |     |      |       |   |      |       |  |   |           |     |       |   |  

Related Party Transactions




34



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##### Table of Contents








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

Interest Rate Risk


10-K.


Foreign Currency Risk




10-K.







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

Evaluation of Disclosure Controls and Procedures




Changes in Internal Control over Financial Reporting




35



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##### Table of Contents






PART II.  OTHER INFORMATION







|        |                  
|------- | -----------------
|Item 1. | Legal Proceedings

10-K.







|         |             
|-------- | ------------
|Item 1A. | Risk Factors

10-K.







|        |                                                                
|------- | ---------------------------------------------------------------
|Item 2. | Unregistered Sales of Equity Securities and Use of
    Proceeds








|        |                                
|------- | -------------------------------
|Item 3. | Defaults Upon Senior Securities








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








|        |                  
|------- | -----------------
|Item 5. | Other Information










|        |         
|------- | --------
|Item 6. | Exhibits

|        |      |             |  |                                                                                                                               
|------- | ---- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Numbers |      | Description
|        |      |            
|        | 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

36



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SIGNATURES






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



| |     |                    
| | --- | -------------------
| | By: | /s/ Maurice B. Tosé

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



|                                                                        |  |                                                                                    
|----------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------
|/s/ Maurice B.
    ToséMaurice
    B. Tosé
    May 10, 2006             |  | Chairman, President and Chief Executive Officer
    (Principal Executive Officer)  
|                                                                       
|/s/ Thomas M. Brandt,
    Jr.Thomas
    M. Brandt, Jr.
    May 10, 2006 |  | Senior Vice President and Chief Financial Officer
    (Principal Financial Officer)

37