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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission File Number 0-21177
NETSMART TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3680154
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3500 Sunrise Highway, Suite D-122, Great River, NY 11739
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (631) 968-2000
Securities registered pursuant to Section 12(b) of the Act: ____
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class Outstanding shares as of March 2, 2005
------------------- --------------------------------------
Common Stock, par value 5,346,607
$.01 per share
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes_X_ No__
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S - K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes [ ] No [X]
As of June 30, 2004, the last day of our second quarter, the aggregate market
value of the voting and non-voting common equity held by non affiliates was
approximately $43,997,000.
DOCUMENTS INCORPORATED BY REFERENCE
None
PART I
Item 1. Business
Introduction
We develop, market and support application software products designed for
providers of services in the health and human services market, including mental
health clinics, substance abuse clinics, psychiatric hospitals, public health
agencies and managed care organizations. Our software products perform various
functions such as patient management, billing, scheduling, and electronic
medical records solutions for all modalities of care. These products are
deployed utilizing current technologies. We sell our software products through
our wholly owned subsidiary, Creative Socio-Medics Corporation, either on a
license or a subscription basis to health care providers and we offer our
clients software support under maintenance agreements. These maintenance
agreements provide us with a recurring revenue stream. We currently have over
500 contracts in place, representing approximately 50,000 clinicians, including
24 state agencies and installations in 43 states.
The cost of a new system to customers is typically in the range of $10,000 to
$100,000 for a single facility healthcare organization to $250,000 to $1 million
for multi-unit care organizations such as those run by state agencies.
Governmental agencies such as mental health, mental retardation, child welfare,
addiction, correction and public health facilities accounted for approximately
49% of revenue in 2004, with the remainder from private hospitals, smaller
clinics, group and sole practitioners.
Our Data Center provides software which performs clinical and billing services
for outpatient facilities, including mental health, alcohol and substance abuse
facilities. Our services include statistical reporting, data entry, electronic
billing and submission.
Application Service Provider ("ASP") services involves us offering our Avatar
suite of products, our CareNet products and InfoScribeR products on a virtual
private network or through an internet delivery approach, thereby allowing our
customers to deploy products and pay on a monthly service basis, thus
eliminating capital intensive system requirements.
Business Strategy
Our systems provide comprehensive healthcare information technology solutions
including billing, patient tracking and scheduling for inpatient and outpatient
environments, as well as clinical documentation and medical record generation
and management. We target providers of services in the health and human services
market. Our branded suite of products has integrated point-of-services
technologies which also include personal digital assistants, which are commonly
referred to as PDAs.
The health and human services market is always subject to changes in state and
federal regulations as well as new demands required by the population. Some of
the factors which we believe are affecting the market demand include the
following.
HIPAA. As a supplier of practice management solutions to the behavioral health
and substance abuse industry, we believe that we can benefit as a result of the
Health Insurance Portability and Accountability Act, generally known as HIPPA.
HIPAA essentially mandates the Health and Human Services department of the U.S.
Government to enact standards regarding the standardization, privacy and
security of health care information.
1
This legislation requires more providers of services in the under-automated
health and human services industry to make the leap to install automated
systems. We believe that our product suite, in conjunction with products offered
by other companies with which we have a marketing arrangement, enables us to
offer comprehensive enterprise-wide solutions for most human service providers.
General Unrest. As a result of an increased awareness of terrorism, the demand
for services in the mental health and public health services has increased.
Anxiety and fear have gripped many people who are now seeking mental health
services. This increased demand puts more pressure on providers to improve the
efficiency of care through the use of practice management and clinical systems.
We believe that the potential threat of bio terrorism will also put similar
pressure on public health agencies to improve their delivery capabilities in
much the same way.
Organization of the Company
We are a Delaware corporation formed in September 1992 under the name Medical
Services Corp. Our name was changed to Carte Medical Corporation in October 1993
to CSMC Corporation in June 1995 and to Netsmart Technologies, Inc. in February
1996. Our executive offices are located at 3500 Sunrise Highway, Suite D-122,
Great River, New York 11739, telephone (631) 968-2000. Reference to us and to
Netsmart include our subsidiary, Creative Socio-Medics, which we acquired in
June 1994, unless the context indicates otherwise. Our website is located at
www.csmcorp.com. Neither the Information contained in our website nor the
information contained in any Internet website is a part of this Form 10-K annual
report.
Available Information:
The public may read and copy any materials filed by us with the SEC at the SEC's
public reference room at 450 Fifth Street, NW, Washington D.C. 20549. The public
may obtain information about the operation of the SEC's public reference rooms
by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at
http://www.sec.gov that contains reports, proxy and information statements and
other information about issuers such as us that file electronically with the
SEC.
In addition, we make available free of charge on our website at www.csmcorp.com
our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) under the Exchange Act as soon as reasonably practical
after we electronically file such material with, or furnish it to, the SEC.
Risk Factors
Because we are particularly dependent upon government contracts, any decrease in
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funding for entitlement programs could result in decreased revenue.
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We market our health information systems principally to behavioral health
facilities, many of which are operated by state and local government entities
and include entitlement programs. During 2004, we generated 49% of our revenue
from contracts that are directly or indirectly with government agencies, as
compared with 57% in 2003 and 52% in 2002. Government agencies generally have
the right to cancel certain contracts at their convenience. Our ability to
generate business from government agencies is affected by funding for
entitlement programs, and our revenue would decline if state agencies reduce
this funding.
2
Changes in government regulation of the health care industry may adversely
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affect our revenue, operating expenses and profitability.
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Our business is based on providing systems for behavioral and public health
organizations in both the public and private sectors. The federal and state
governments have adopted numerous regulations relating to the health care
industry, including regulations relating to the payments to health care
providers for various services, and our systems are designed to provide
information based on these requirements. The adoption of new regulations can
have a significant effect upon the operations of health care providers,
particularly those operated by state agencies. Furthermore, changes in
regulations in the health care field may force us to modify our health
information systems to meet any new record-keeping or other requirements and may
impose added costs on our business. If that happens, we may not be able to
generate revenues sufficient to cover the costs of developing the modifications.
In addition, any failure of our systems to comply with new or amended
regulations could result in reductions in our revenue and profitability.
If we are not able to take advantage of technological advances, we may not be
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able to remain competitive and our revenue may decline.
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Our customers require software which enables them to store, retrieve and process
very large quantities of data and to provide them with instantaneous
communications among the various data bases. Our business requires us to take
advantage of recent advances in software, computer and communications
technology. This technology has been developing at rapid rates in recent years,
and our future may be dependent upon our ability to use and develop or obtain
rights to products utilizing such technology. New technology may develop in a
manner which may make our software obsolete. Our inability to use new technology
would have a significant adverse effect upon our business.
Because of our size, we may have difficulty competing with larger companies that
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offer similar services, which may result in decreased revenue.
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Our customers in the human services market include entitlement programs, managed
care organizations and specialty care facilities which have a need for access to
information over a distributed data network. The software industry in general,
and the health information software business in particular, are highly
competitive. Other companies have the staff and resources to develop competitive
systems. We may not be able to compete successfully with such competitors. The
health information systems business is served by a number of major companies and
a larger number of smaller companies. We believe that price competition is a
significant factor in our ability to market our health information systems and
services, and our inability to offer competitive pricing may impair our ability
to market our system.
Because we are dependent on our management, the loss of key executive officers
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could disrupt our business and our financial performance could suffer.
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Our business is largely dependent upon our senior executive officers, Messrs.
James L. Conway, our chief executive officer, Gerald O. Koop, our president, and
Anthony F. Grisanti, our chief financial officer. Although we have employment
agreements with these officers, the employment agreements do not guarantee that
the officers will continue with us, and each of these officers has the right to
terminate his employment with us on 90 days notice. Our agreements with Messrs.
Conway and Grisanti are scheduled to expire on December 31, 2006. In addition,
Mr. Koop's employment agreement is scheduled to expire on December 31, 2005,
following which he is expected to continue to work with us for a six-year period
pursuant to our Executive Retirement, Non-Competition & Consulting Plan dated
April 1, 2004. Our business may be adversely affected if any of our key
management personnel or other key employees left our employ.
3
If we are unable to protect our intellectual property, our competitors may gain
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access to our technology, which could harm our ability to successfully compete
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in our market.
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We have no patent protection for our proprietary software. We rely on copyright
protection for our software and non-disclosure and secrecy agreements with our
employees and third parties to whom we disclose information. This protection
does not prevent our competitors from independently developing products similar
or superior to our products and technologies. To further develop our services or
products, we may need to acquire licenses for intellectual property. These
licenses may not be available on commercially reasonable terms, if at all. Our
failure to protect our proprietary technology or to obtain appropriate licenses
could have a material adverse effect on our business, operating results or
financial condition. Since our business is dependent upon our proprietary
products, the unauthorized use or disclosure of this information could harm our
business.
We cannot guarantee that in the future, third parties will not claim that we
infringed on their intellectual property. Asserting our rights or defending
against third party claims could involve substantial costs and diversion of
resources, which could materially and adversely affect us.
Government programs may suggest or mandate initiatives that could impact our
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ability to sell our products.
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A major initiative being pushed by President Bush and the Department of Health
and Human Services is the National Electronic Health Record. The federal
government is promoting this platform and technology which is based on supplying
"freeware" to any agency who desires; however, support is not supplied. This
initiative does compete with the private for profit Health Information Systems
vendor community.
The covenants in our loan agreement restrict our financial and operational
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flexibility, including our ability to complete additional acquisitions, invest
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in new business opportunities, pay down certain indebtedness or declare
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dividends.
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Our term loan agreement contains covenants that restrict, among other things,
our ability to borrow money, make particular types of investments, including
investments in our subsidiaries, make other restricted payments, swap or sell
assets, merge or consolidate, or make acquisitions. An event of default under
our loan agreement could allow the lender to declare all amounts outstanding to
be immediately due and payable. We have pledged substantially all of our
consolidated assets to secure the debt under our loan agreement. If the amounts
outstanding under the loan agreement were accelerated, the lender could proceed
against those consolidated assets. Any event of default, therefore, could have a
material adverse effect on our business. Our loan agreement also requires us to
maintain specified financial ratios. Our ability to meet these financial ratios
can be affected by events beyond our control, and we cannot assure you that we
will meet those ratios. We also may incur future debt obligations that might
subject us to restrictive covenants that could affect our financial and
operational flexibility or subject us to other events of default.
We have only paid one cash dividend after getting our lender's consent and we do
not anticipate paying any further cash dividends on our common stock in the
foreseeable future. We presently intend to retain future earnings, if any, in
order to provide funds for use in the operation and expansion of our business.
Consequently, investors cannot rely on the payment of dividends to increase the
value of their investment on Netsmart. In addition, we are a party to a loan
agreement which prohibits us from paying cash dividends without the prior
consent of our lender.
4
Our growth may be limited if we cannot make acquisitions.
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A part of our growth strategy is to acquire other businesses that are related to
our current business. Such acquisitions may be made with cash or our securities
or a combination of cash and securities. To the extent that we require cash, we
may have to borrow the funds or issue equity, which could dilute our earnings or
the book value per share of our common stock. Our stock price may adversely
affect our ability to make acquisitions for equity or to raise funds for
acquisitions through the issuance of equity securities. If we fail to make any
acquisitions, our future growth may be limited.
If we make any acquisitions, they may disrupt or have a negative impact on our
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business.
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If we make acquisitions, we could have difficulty integrating the acquired
company's personnel and operations with our own. In addition, the key personnel
of the acquired business may not be willing to work for us, and our officers may
exercise their rights to terminate their employment with us. We cannot predict
the affect expansion may have on our core business. Regardless of whether we are
successful in making an acquisition, the negotiations could disrupt our ongoing
business, distract our management and employees and increase our expenses.
The employment contracts with our executive officers and provisions of Delaware
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law may deter or prevent a takeover attempt and may reduce the price investors
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might be willing to pay for our common stock.
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The employment contracts between us and each of James Conway, Gerald Koop and
Anthony Grisanti provide that in the event there is a change in control of
Netsmart, the employee has the option to terminate his employment agreement.
Upon such termination, each of Messrs. Conway, Koop and Grisanti has the right
to receive a lump sum payment equal to his compensation for a forty-eight month
period.
In addition, Delaware law restricts business combinations with stockholders who
acquire 15% or more of a company's common stock without the consent of the
company's board of directors.
These provisions could deter or prevent a takeover attempt and may also reduce
the price that certain investors might be willing to pay in the future for
shares of our common stock.
Any issuance of preferred stock may adversely effect the voting power and equity
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interest of our common stock.
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Our certificate of incorporation gives our board of directors the right to
create new series of preferred stock. As a result, the board of directors may,
without stockholder approval, issue preferred stock with voting, dividend,
conversion, liquidation or other rights which could adversely affect the voting
power and equity interest of the holders of common stock. The preferred stock,
which could be issued with the right to more than one vote per share, could be
utilized as a method of discouraging, delaying or preventing a change of
control. The possible impact on takeover attempts could adversely affect the
price of our common stock. Although we have no present intention to issue any
shares of preferred stock or to create any series of preferred stock, we may
issue such shares in the future. If we issue preferred stock in a manner which
dilutes the voting rights of the holders of the common stock, our listing on The
Nasdaq SmallCap Market may be impaired.
Shares may be issued pursuant to options which may adversely affect the market
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price of our common stock.
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We may issue stock upon the exercise of options to purchase shares of our common
stock pursuant to our long term incentive plans, of which options to purchase
724,333 shares were outstanding at December 31, 2004. The exercise of these
options and the sale of the underlying shares of common stock may have an
adverse effect upon the price of our stock.
5
Business Segments
For a detailed description of the assets and profits of each of our business
segments see note 14 to our consolidated financial statements.
Software and Related Systems and Services
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We develop, market and support computer software which enables health and human
services healthcare organizations to provide a full range of services in a
network computing environment.
Users typically purchase one of several healthcare information and operating
systems, in the form of a perpetual license to use the system, as well as
purchasing professional services, support, and maintenance. In addition, we
resell third party hardware and software to our customers pursuant to value
added resale arrangements with them. Our products are designed to operate on
most hardware platforms. Due to the fact that our products operate on a variety
of platforms, we are not dependent on any single hardware vendor or operating
system. Since our products utilize the Cache database and development software
provided by Intersystems Corporation, we resell this software. Due to the fact
that our products are designed to operate solely with Cache products, we are
dependent on Cache products for our operations.
The professional services include project management, training, consulting and
software development services, which are provided either on a time and material
basis or pursuant to a fixed-price contract. The software development services
may require the adaptation of health care information technology systems to meet
the specific requirements of the customer.
Our typical license for a health information system ranges from $10,000 to
$100,000 for a single facility healthcare organization to $250,000 to $1,000,000
for multi-unit care organizations such as those run by state agencies. Revenue
from license fees were approximately $2,066,000, or 7.1% of revenue, for 2004,
$2,781,000, or 10.2% of revenue, for 2003 and $1,753,000, or 7.9% of revenue,
for 2002. A customer's purchase order may also include third party hardware or
software. Revenue from hardware and third party software accounted for
approximately $4,336,000, or 15.0% of revenue, for 2004, $4,444,000, or 16.4% of
revenue, for 2003 and $3,822,000, or 17.3% of revenue, for 2002. Revenue from
turnkey systems labor accounted for approximately $9,602,000, or 33.1% of
revenue, for 2004, $9,548,000, or 35.1% of revenue, for 2003 and $7,418,000, or
33.5% of revenue in 2002.
Maintenance services have generated increasing revenue and have become a more
significant portion of our business since most purchasers of health care
information system licenses also purchase maintenance service. Maintenance
revenue increases as existing customers purchase additional licenses and new
customers purchase their initial software licenses. By agreement with our
customers, we provide telephone help services and maintain and upgrade their
software. Maintenance contracts may require us to make modifications to meet any
new federal and state reporting requirements which become effective during the
term of the maintenance contract. We do not maintain the hardware and third
party software sold to our customers, but we provide a telephone help line
service for certain third party software which we license to our customers. Our
maintenance revenue was approximately $8,290,000, or 28.6% of revenue, for 2004,
$7,069,000, or 26% of revenue, for 2003 and $6,247,000, or 28.2% of revenue, for
2002. Our small systems revenue was approximately $928,000, or 3.2% of revenue,
for 2004, $768,000, or 2.8% of revenue, for 2003 and $929,000, or 4.2% of
revenue, for 2002.
We currently offer four product modules that provide a range of core application
requirements for behavioral healthcare providers. These products consist of a
suite of complete information technology applications developed by us, together
with software provided by others which enables us to offer enterprise-wide
6
solutions to the behavioral health industry. We offer the products in a variety
of delivery modes.
* Avatar - Practice Management: This system is a comprehensive
solution providing patient management functions, billing, tracking,
scheduling, and reporting for inpatient treatment facilities.
* Avatar - Clinician Workstation: This workstation provides a
clinician with documentation and medical record management including
assessment, care planning, progress notes, order entry and on-line
medical records. The clinician workstation is our electronic medical
record system for behavioral health, which integrates the clinical
tools necessary for an interdisciplinary approach to the delivery of
human services.
* Methadone Clinical System: This system offers a solution for
dispensing, admissions and medical records, counselling and
reception/security specifically for methadone clinics. We can
integrate Methadone Clinical System with our other behavioral health
products.
* Avatar - Managed Care: The managed care and employee assistance
program modules include such features as service request management,
contact tracking (patients, providers, others), import of
eligibility information by contract, provider search by location,
specialty, contract, hospital privileges, claims adjudication and
payment.
Data Center
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Our Data Center provides software which performs clinical and billing services
for outpatient facilities, including mental health, alcohol and substance abuse
facilities. Services include statistical reporting, data entry, electronic
billing and submission.
Revenue from our Data Center was approximately $2,058,000 or 7.1% of revenue for
2004, $1,973,000 or 7.3% of revenue for 2003 and $1,957,000 or 8.9% of revenue
for 2002.
During 2004, two customers each accounted for 10% or more of the total Data
Center revenue. One customer was a New York State agency, which accounted for
$207,000, or 10% of total Data Center revenue. The other client was a hospital
in New York City, which accounted for $216,000, or 10.5% of total Data Center
revenue. During 2003, one customer, a hospital in New York City, accounted for
$274,000 or 13% of the total Data Center revenue. During 2002, two customers
each accounted for more than 10% of the total Data Center revenue. One customer
was a New York State agency, which accounted for $199,000, or 10.2% of total
Data Center revenue. The other client was a hospital in New York City, which
accounted for $225,000, or 11.5% of total Data Center revenue. None of the above
mentioned clients accounted for more than 10% of our consolidated revenue.
Our Data Center backlog at December 31, 2004 was $2,132,000. We anticipate that
all of this backlog will be earned in 2005. The Data Center backlog at December
31, 2003 was $2,006,000.
Application Service Provider
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ASP services involves the offering of our Avatar suite of products, our CareNet
products and our InfoScriber products on a virtual private network or internet
delivery approach, thereby allowing our customers to rapidly deploy products and
7
pay on a monthly service basis, thus eliminating capital intensive system
requirements. Our CareNet product is a subscription-based Internet solution for
Managed Care Organizations that want tighter control over their providers
without having to maintain an information technology infrastructure. CareNet
establishes a private portal site where providers and partnering agencies can
login via the Internet to access client information and complete their virtual
paperwork and necessary reporting.
Our InfoScriber product is a secure, web-based system enabling practitioners in
organizations or private practices to write and transmit electronic
prescriptions to pharmacies of choice. This is the first year that we have
accounted for ASP Services as a segment. Prior to our acquisition of CareNet on
June 25, 2003, our ASP operations were immaterial.
All of our products and services are offered not only in a turnkey mode of
operation but also in an ASP mode in which the client uses our software products
with part or all of the software's operation taking place on the computer
facilities of our data centers. At present we have a data center service
facility in Great River, New York and an ASP facility in Columbus, Ohio.
Revenue from our ASP services was approximately for $1,725,000 for 2004 which
consisted of revenue from our CareNet operations of $839,000, revenue from our
InfoScriber operations of $243,000 and revenue from our Avatar ASP services
operations of $643,000.
During 2004, one customer accounted for $443,000 or 26% of the total ASP
revenue. This county did not account for more than 10% of our total consolidated
revenue.
Our ASP backlog at December 31, 2004 was $2,233,000. We anticipate that all of
this backlog will be earned in 2004.
Markets and Marketing; Customers
The market for information systems and related services consists of both private
and publicly operated providers offering hospital or community-based outpatient
behavioral/public healthcare services. These healthcare providers require a
healthcare information system to administer their programs. We believe that
there are at least 15,000 behavioral/public healthcare providers in the United
States, including public and private hospitals, private and community-based
residential facilities and federal, state and local governmental agencies.
Many long-term behavioral/public healthcare facilities are operated by
government entities and include those operated as part of entitlement programs.
During the years ended December 31, 2004, 2003 and 2002, approximately 49%, 57%
and 52%, respectively, of revenue was generated from contracts with state and
local government agencies. Contracts with government agencies generally include
provisions which permit the contracting agency to cancel the contract for its
convenience, although we have not experienced a termination for convenience in
the last five years.
We believe that the demand for information technology solutions will continue to
increase as a result of federal initiatives for data standards as well as
continuous pressure from managed care providers to reduce healthcare delivery
costs while expanding the availability of services.
In order to remain competitive, the health and human services health delivery
networks need detailed clinical and management information systems that enable
providers within the networks to maintain a broad scope of accurate medical and
financial information, manage costs and deliver quality care efficiently. In
addition, the need to upgrade existing systems to meet the increased demand for
8
data processing needs of managed care and regulatory oversight has also resulted
in an increased demand for behavioral/public healthcare information technology.
These data processing needs include analysis of patient assessments, maintenance
of patient records, administration of patient treatment plans and the overall
coordination of patient case management.
We coordinate our marketing effort with the state agencies and other major users
of our systems. Our state agency clients formed a User Group Association,
presently consisting of state organizations or agencies from 26 states. The
association's members work with us to assess and determine future requirements
in both patient managed care coordination and regulatory reporting.
No one customer accounted for more than 10% of consolidated revenue for the
years ended December 31, 2004. During the year ended December 31, 2003, one
customer accounted for approximately $2,861,000 or 11.4% of software and related
systems and services revenue and 10.5% of consolidated revenue. The account
receivable from this customer at December 31, 2003 was $589,000 or 7% of the
total accounts receivable.
Backlog
We had a backlog of orders, including ongoing maintenance and data center
contracts for our behavioral health information systems of $25.8 million at
December 31, 2004 and $24.0 million at December 31, 2003. We expect to fill
approximately $21.1 million of the 2004 backlog during 2005.
Our backlog consists of revenue of approximately $10.3 million from existing
turnkey contracts; maintenance of approximately $10.1 million that is comprised
of both amounts expected to be filled under unexpired maintenance contracts and
also amounts that are subject to automatic renewal; unexpired Data Center
contracts of approximately $2.1 million calculated using historical experience
to determine future useage and unexpired application service provider backlog of
approximately $2.2 million and facility management contracts of approximately
$1.1 million which are also calculated using historical experience to determine
twelve months of future usage.
Product Development
We incurred product development costs relating to our health and human services
information systems of approximately $3,498,000 in 2004, $2,255,000 in 2003 and
$1,318,000 in 2002, all of which was company-sponsored and expensed as research,
development and maintenance. In 2004, we capitalized software development costs
of $185,000 relating to our RAD Plus 2004 product. The RAD Plus 2004 product is
being amortized over a three year period and in 2004 we charged $19,600 to
operations. In 2004, we incurred capitalized software development costs of
approximately $150,000 associated with our acquisition of TxM software which was
related to our partnership arrangement with the MSJ Communications Corporation,
a wholly-owned subsidiary of the Betty Ford Center. In 2003, we capitalized
software development costs of $179,500 relating to our Avatar AM, Order Entry
and RAD Plus 2004 products. The Avatar AM and Order Entry products are being
amortized over a three year period and in 2004, we charged $43,100 to
operations. In 2003, we incurred capitalized software development costs of
approximately $883,000 associated with our acquisition of software products from
CareNet.
Competition
The healthcare software industry is highly competitive. Although we believe that
we can provide a health care facility or managed care organization with software
to enable it to perform its services more effectively, other software companies
provide comparable systems and also have the staff and resources to develop
competitive systems.
9
Healthcare information technology is a multi-billion dollar industry served by
numerous vendors. Some dominant health care information technology vendors have
achieved annual sales of more than $1 billion by focusing on solutions for large
medical/surgical health care providers, such as large hospital systems and
health maintenance organizations, and, have not focused on the behavioral/public
healthcare industry. We believe that most of the presently available healthcare
management software does not meet the specific needs of the behavioral/public
healthcare industry, and that the functionality of our information systems are
better designed to meet the needs of this market. However, the behavioral health
information systems business is serviced by a number of companies, some of which
are better capitalized with larger infrastructure than we, and we may not be
able to continue to compete effectively with such companies. As our business
expands and includes sales to larger integrated healthcare delivery networks, we
begin to compete with companies such as Siemens, HBOC, IDX, Meditech, Quadramed,
and Misys.
Additionally, we face significant competition in the Data Center medical systems
ASP market. General ASP utilities offer clients use of computer facilities and
operations staff to process either generalized medical software or software
selected by the client from other software vendors. Large billing and clearing
house computer service companies provide a broad area of billing for a diverse
marketplace. Many organizations start with billing as their primary reason for
automation spending. Several types of professional service firms offer
departmental staff to operate a client's already in-house system when the client
believes that such an approach will provide the needed expertise at a cost
effective price. Our ASP service is focused on providing a complete and cost
effective service to a specific set of sectors in the large health and human
services marketplace. Behavioral health requires the ideal organization of
software, systems and staff to enable a client to maximize service at a
reasonable cost. Most important is that the service is based on the exclusive
use of the Company's proprietary suite of Avatar products which enables a
potential client to initiate the use of any part of a broad array of needed
clinical and financial systems for as long as these functions are needed knowing
that these services are developed, operated, and updated by a professional IT
staff which is on call as needed. In addition, our experience is that, once a
client has contracted for services, it generally remains a client and is
unaffected by competitive offerings. Some of our clients have been working with
us for up to thirty years. We believe our specialized experience and investment
in related software provides us with a competitive advantage.
We compete in the Health and Human Services Systems market with the following
behavioral healthcare vendors among others:
Anasazi Software, Inc.
Askesis Development Group, Inc.
Civerex Systems, Inc.
CMHC Systems
Geneva Software
InfoMC, Inc.
IMPEL Strategic Solutions
Multi-Health Systems, Inc.
Qualifacts System inc.
Raintree Systems Inc.
SecureHEALTH Inc.
Sequest Technologies Inc.
The Echo Group
UNI/CARE Systems, Inc.
XAKTsoft, Inc.
10
Competitive Position:
As a core part of our strategic business model, we bid on numerous competitive
procurements during the calendar year and have a high win ratio, especially in
the statewide mental health/mental retardation field for which we have 26
statewide systems. This has contributed to our growth.
We have an established base of more than 500 providers nationwide, including
substantial private and government providers of healthcare services. These
providers represent approximately 50,000 clinicians, including 26 state agencies
and installations in 43 states.
Government Regulations and Contracts
The federal and state governments have adopted numerous regulations relating to
the health care industry, including regulations relating to the payments to
health care providers for various services. The adoption of new regulations can
have a significant effect upon the operations of health care providers and
insurance companies. Although our business is aimed at meeting certain of the
problems resulting from government regulations and from efforts to reduce the
cost of health care, we cannot predict the effect of future regulations by
governments and payment practices by government agencies or health insurers,
including reductions in the funding for or scope of entitlement programs. Any
change in the structure of health care in the United States can have a material
effect on companies, such as us, that provide services to the health care
industry, including those providing software. Although we believe that the
likely direction which may result from the current study of the health care
industry would be an increased trend to managed care programs, thereby
increasing the importance of automation, our business may not benefit from any
changes in the industry structure. Even if the industry does evolve toward more
healthcare being provided by managed care organizations, it is possible that
there will be substantial concentration in a few very large organizations, which
may seek to develop their own software or obtain software from other sources. To
the extent that the health care industry evolves with greater
government-sponsored programs and less privately run organizations, our business
may be adversely affected. Furthermore, to the extent that each state changes
its own regulations in the health care field, it may be necessary for us to
modify our behavioral health information systems to meet any new record-keeping
or other requirements imposed by changes in regulations, and we may not be able
to generate revenues sufficient to cover the costs of developing the
modifications.
A significant amount of our business has been with government agencies,
including specialized care facilities operated by, or under contract with,
government agencies. The decision on the part of a government agency to enter
into a contract is dependent upon a number of factors, including economic and
budgetary problems affecting the local area, and government procurement
regulations, which may include the need for approval by more than one agency
before a contract is signed. In addition, government agencies generally include
provisions in their contracts which permit the contracting agency to cancel the
contract at its convenience. We have not experienced a termination for
convenience in the last five years.
Intellectual Property Rights
We have no patent rights for our behavioral health information system software,
but we rely upon copyright protection for our software, as well as
non-disclosure and secrecy agreements with our employees and third parties to
whom we disclose information. We may not be able to protect our proprietary
rights to our system and third parties may claim rights in the system.
Disclosure of the codes used in any proprietary product, whether or not in
violation of a non-disclosure agreement, could have a material adverse affect
upon us, even if we are successful in obtaining injunctive relief. We must
continue to invest in product development, employee training, and client
support.
11
Employees
As of December 31, 2004, we had 168 employees, including 3 executive, 17 sales
and marketing, 136 technical and 12 clerical and administrative employees.
Executive Officers
Information concerning our executive officers is included in Item 11,
Directors and Executive Officers for the Registrant.
Item 2. Property
We lease office space at the following locations:
Location Purpose Space Annual Rental Expiration
-------- ------- ----- ------------- ----------
3500 Sunrise Highway Executive offices 32,600 square $521,000, plus 10/22/14
Great River, New York Software and Related feet 3% annual
Systems and Services increases
Data Center Services
1335 Dublin Road Software and Related 3,500 square $59,000 11/30/06
Columbus, Ohio Systems and Services feet
ASP Services
5120 Shoreham Place Software and Related 2,800 square $71,000 05/31/05
San Diego, California Systems and Services feet
Software and Related 1,400 square $30,000 10/31/06
69-730 Highway 11 Systems and Services feet
Ranch Mirage, California
117 North 1st Street ASP Services 2,200 square $49,000 1/31/07
Ann Arbor, Michigan feet
220 E. Huron Software and Related 625 square $989 per month Month to
Ann Arbor, Michigan Systems and Services feet month
We believe that our space is adequate for our immediate needs and that, if
additional space is required, it would be readily available at commercially
reasonable rates.
Item 3. Legal Proceedings
From time to time we are involved in ordinary and routine litigation matters in
the normal course of business. We believe that the resolution of these matters
will not have a material adverse effect on our consolidated financial position
and results of operations.
12
Item 4. Submission of Matters to a Vote of Security Holders
None
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
Our common stock is traded on The Nasdaq SmallCap Market under the symbol NTST.
Set forth below is the reported high and low bid prices of our Common Stock for
each quarterly period during 2004 and 2003.
Quarter Ended High Low
------------- ---- ---
March 31, 2004 $18.70 $11.49
June 30, 2004 13.85 7.11
September 30, 2004 10.00 6.07
December 31, 2004 9.25 7.30
March 31, 2003 $ 6.00 3.53
June 30, 2003 5.53 4.00
September 30, 2003 10.90 5.15
December 31, 2003 19.85 8.45
As of December 31, 2004, there were approximately 2,900 beneficial owners of our
common stock. The closing price of our common stock was $10.00 per share on
March 1, 2005. These quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
In July 2003, the Company's Board of Directors approved a one-time cash dividend
of $.10 per share of common stock which was paid in September 2003 to all
stockholders of record on August 20, 2003. The amount charged to surplus in
August 2003, based upon the shares outstanding on August 20, 2003, the record
date of the dividend, was $441,447. We do not anticipate that we will pay any
further dividends in the foreseeable future. We currently intend to retain
future earnings for use in operation and development of our business and for
potential acquisitions. In addition, the terms of our term loan agreement
requires our lender's consent with respect to the payment of cash dividends.
13
During the year ended December 31, 2004, no purchases were made under the
Company's stock buyback plan.
Equity Compensation Plan Information
------------------------------------
The following table sets forth information relating to our compensation plans
as of December 31, 2004.
Number of securities
--------------------
remaining available for
-----------------------
Number of securities future issuance under
--------------------- ---------------------
to be issued upon Weighted-average equity compensation
------------------ ------------------ -------------------
exercise of exercise price of plans (excluding
------------ ------------------- ----------------
outstanding options, outstanding options, securities reflected in
--------------------- ------------------- -----------------------
Plan Category warrants and rights warrants and rights column (a))
------------- ------------------- ------------------- ----------
(a) (b) (c)
Equity compensation plans
approved by security holders
724,333 $6.476 8,295
Equity compensation plans not
approved by security holders
-- -- --
------- ------ -----
Total 724,333 $6.476 8,295
======= ====== =====
14
Item 6. Selected Financial Data
The selected consolidated financial data set forth below for the five years in
the period ended December 31, 2004 has been derived from the company's audited
consolidated financial statements. This information should be read in
conjunction with the audited consolidated financial statements and notes
thereto.
Year Ended December 31,
-----------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(in thousands except per share data)
Selected Statements
of Operations Data:
Revenue $ 29,005 $ 27,175 $ 22,126 $ 18,119 $ 20,171
Income from Continuing
Operations before interest
and other financing costs 3,065 2,368 1,095 399 2,141
Income from Discontinued
Operations -- -- -- -- 70
Net Income 2,753(1) 3,028(2) 1,195(3) 315 2,386(4)
Dividends Declared
Per Common Share -- .10 -- -- --
Per Share Data - Diluted:
Continuing Operations .50 .64 .29 .08 .61
Discontinued Operations -- -- -- -- .02
Net Income $ .50 $ .64 $ .29 $ .08 $ .63
Weighted average number
of shares outstanding 5,537 4,752 4,153 3,872 3,771
Selected Balance
Sheet Data:
Working Capital $ 18,216 $ 14,714 $ 9,215 $ 7,903 $ 5,858
Total Assets 37,707 34,633 22,416 18,007 15,301
Long Term Debt
Including Current Portion 1,000 1,667 1,750 2,250 --
Capitalized Leases Including
Current Portion 86 147 12 41 76
Stock dividend -- 441 -- -- --
Total Liabilities 13,080 13,633 11,110 8,060 5,997
Accumulated Deficit (3,594) (6,347) (9,376) (10,571) (10,886)
Stockholders' Equity $ 24,627 $ 21,000 $ 11,306 $ 9,948 $ 9,303
----------
(1) The Company's tax provision has been reduced as a result of a $1,014,000
reduction in its deferred tax asset valuation allowance
(2) The Company's tax provision has been reduced as a result of available net
operating loss carry forwards. In addition, a $900,000 tax benefit was
recognized, as a result of a further reduction in its deferred tax asset
valuation allowance.
(3) The Company's tax provision has been reduced as a result of available net
operating loss carry forwards. In addition, a $400,000 tax benefit was
recognized, as a result of a further reduction in its deferred tax asset
valuation allowance..
(4) The Company's tax provision has been reduced as a result of available net
operating loss carry forwards. In addition, a $494,000 tax benefit was
recognized, as a result of a further reduction in its deferred tax asset
valuation allowance
15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Our operations are grouped into three segments:
|X| Software and Related Systems and Services
|X| Data Center (service bureau services)
|X| Application Service Provider Services (ASP)
Software and Related Systems and Services is the design, installation,
implementation and maintenance of computer information systems that provide
comprehensive healthcare information technology solutions, including billing,
patient tracking and scheduling for inpatient and outpatient environments, as
well as clinical documentation and medical record generation and management.
Data Center Services involves our personnel performing data entry and data
processing services for customers. Application Service Provider services
involves us offering our Avatar suite of products, our CareNet products and
InfoScriber products on a virtual private network or through an internet
delivery approach, thereby allowing our customers to deploy products and pay on
a monthly service basis, thus eliminating capital intensive system requirements.
Prior to the acquisition of CareNet, our ASP operations were immaterial and were
included in Software and Related Systems and Services.
Years Ended December 31, 2004 and 2003
Results of Operations
Fixed price software development contracts, third party hardware and software
components and licenses accounted for 34% and 44% of consolidated revenue for
the years ended December 31, 2004 and 2003, respectively. This decrease is the
result of more labor revenue being generated on an as incurred basis, as well as
a change in the overall mix of our revenue components. Our recurring revenue
components, which include our maintenance contract services and our Data Center
and ASP services, accounted for 42% of our consolidated revenue for the year
ended December 31, 2004 compared to 35% of consolidated revenue for the year
ended December 31, 2003. We recognize revenue for fixed price contracts on the
estimated percentage of completion basis. Since the billing schedules under the
contracts differ from the recognition of revenue, at the end of any period,
these contracts generally result in either costs and estimated profits in excess
of billing or billing in excess of costs and estimated profits. Revenue from
fixed price software development contracts is determined using the percentage of
completion method which is based upon the time spent by our technical personnel
on a project.
Our total revenue for 2004 was $29,005,000, an increase of $1,830,000, or 7%,
from our revenue for 2003, which was $27,175,000.
Revenue from contracts with state and local government agencies represented 49%
of revenue in 2004 and 57% of revenue in 2003. This decrease is the result of
the substantial completion towards the end of 2003 of one state contract and two
county contracts.
Software and Related Systems and Services
Our Software and Related Systems and Services revenue for 2004 was $25,221,000,
an increase of $611,000, or 2%, from our revenue for 2003, which was
$24,610,000. Software and related systems and services revenue is comprised of
turnkey systems labor revenue, revenue from sales of third party hardware and
16
software, license revenue, maintenance revenue and revenue from small turnkey
systems.
The largest component of revenue was turnkey systems labor revenue, which
increased to $9,602,000 in 2004 from $9,548,000 in 2003, reflecting a 1%
increase. Turnkey systems labor revenue refers to labor associated with turnkey
installations and includes categories such as training, installation, project
management and development. Revenue from third party hardware and software
decreased to $4,335,000 in 2004, from $4,444,000 in 2003, which represents a
decrease of 2%. Sales of third party hardware and software, such as pharmacy and
database software, are made in connection with the sales of turnkey systems.
These sales are typically made at lower gross margins than our human services
revenue. During 2004, we did not sell and perform on as many contracts
containing such third party items. License revenue decreased to $2,066,000 in
2004, from $2,781,000 in 2003, reflecting a decrease of 26%. License revenue is
generated as part of a sale of a human services information system pursuant to a
contract or purchase order that includes delivery of the system and maintenance.
We did not sell and perform on as many contracts containing license revenue in
2004 as we did in 2003. In addition, in order to encourage our existing
customers to upgrade from our old product to our new Avatar product, we
discounted the license fees to our existing clients. Maintenance revenue
increased to $8,290,000 in 2004 from $7,069,000 in 2003, reflecting an increase
of 17%. As turnkey systems are completed, they are transitioned to the
maintenance division, thereby increasing our installed base. Revenue from the
sales of our small turnkey division increased to $928,000 in 2004 from $768,000
in 2003, reflecting an increase of 21%. This increase is the result of the
introduction of our new Avatar Addictions Management product into the market
place during the latter part of 2003. Small turnkey division sales relate to
turnkey contracts that are less than $50,000 and are usually completed within
one month.
Gross profit decreased to $11,849,000 in 2004 from $11,953,000 in 2003,
reflecting a decrease of 1%. Our gross margin percentage was 47% in 2004
compared to 49% in 2003. Our gross margin decreased as a result of the decrease
in license revenue. This decrease was partially offset by improved labor
efficiency on our fixed price contracts.
Data Center Services (Service Bureau)
Data center clients typically generate approximately the same amount of revenue
each year. We bill on a transaction basis or on a fixed fee arrangement.
Historically, each year we increase the transaction or fixed fees by an amount
that approximates the New York urban consumer price index increase. The data
center revenue increased to $2,058,000 in 2004 from $1,973,000 in 2003,
representing an increase of $85,000, or 4%. This increase was due to an increase
in the client base as well as increases in pricing.
Gross profit increased to $1,209,000 in 2004 from $939,000 in 2003, reflecting
an increase of 29%. Our gross margin percentage increased to 59% in 2004 from
48% in the 2003. This increase was the result of the increase in revenue as well
as a reduction in costs of approximately $185,000. The major areas of cost
reductions were in the area of payroll and fringe benefits in the amount of
$21,000, support overhead in the amount of $65,000, facility costs in the amount
of $22,000, supplies in the amount of $22,000, depreciation in the amount of
$15,000, and other costs in the amount of $23,000.
Application Service Provider Services ("ASP")
ASP Services involves the offering of our Avatar suite of products, our CareNet
products and our InfoScriber products on a virtual private network or internet
delivery approach, thereby allowing our customers to rapidly deploy products and
pay on a monthly service basis, thus eliminating capital intensive system
requirements. This is the first year that we have accounted for ASP Services as
a segment. Prior to our acquisition of CareNet on June 25, 2003, our ASP
operations were immaterial.
17
Revenue for 2004 was $1,725,000, which consisted of revenue from our CareNet
operations of $839,000, revenue from our InfoScriber operations of $243,000 and
revenue from our Avatar ASP services operations of $643,000. Revenue for the
2003 was $591,000, which consisted of revenue from our CareNet operations of
$380,000 and revenue from our Avatar ASP services operations of $211,000.
Gross profit for 2004 was $799,000 and our gross margin percentage was 46%. The
gross profit for 2003 was $214,000 and our gross margin percentage was 36%.
Because the ASP operations were in their infancy during the 2003, any
comparisons between the periods would not be meaningful.
Operating Expenses
Selling, general and administrative expenses were $7,294,000 in 2004, reflecting
a decrease of $675,000, or 8%, from $7,969,000 in 2003. The decreases were in:
bad debt expense, which decreased by $1,250,000; provision for bonuses which
decreased by $172,000; and general and administrative salaries and related
fringe expense, which decreased by $101,000. These costs decreases were
partially offset by increases in: depreciation expense which increased by
$351,000; amortization of the CareNet acquisition costs, which increased by
$139,000; consulting costs which increased by $124,000; commissions, which
increased by $87,000; sales salaries and related fringe benefits expense, which
increased by $54,000; advertising and promotion, which increased by $47,000;
accounting costs, which increased by $40,000; and sales and marketing travel and
living costs, which increased by $41,000.
We incurred research, development and maintenance expenses of $3,498,000 in the
2004, an increase of 26% from $2,770,000 in 2003. During 2004, we invested in
infrastructure to improve the way we support our customers and products. These
changes related to redirecting personnel that were previously employed
performing actual customer program "bug" fixing procedures, which would be
included in costs of goods sold, to our research, development and maintenance
area. These personnel now perform product version control, which includes
design, programming, testing, documentation and quality control of our products.
These efforts accounted for a substantial increase in our research, development
and maintenance expenses. The increase in research, development and maintenance
expense is also the result of continuing investment in product enhancement and
extensions. These extensions include the development of new software modules
which addresses Federal reporting requirements, as well as continued investment
in core products. These amounts have been appropriately accounted for in
accordance with SFAS No. 86, "Accounting for the Cost of Computer Software to be
Sold, Leased, or Otherwise Marketed."
Interest and other expense was $129,000 in 2004, a decrease of $71,000, or 35%,
from $200,000 in 2003. This decrease is the result of the completion of the
amortization of the financing costs associated with our loan agreement, which
was amortized over a three year period, as well as reduced borrowing during 2004
under our loan with Bank of America. This decrease was partially offset by an
increase in borrowing related to the promissory note issued to Shuttle Data
Systems Corp. in connection with our acquisition of CareNet.
Interest income was $126,000 in 2004, an increase of $52,000, or 70%, from the
$74,000 in 2003. Interest income is generated from short-term investments made
with a substantial portion of the proceeds received from the term loan, as well
as cash generated from operations and the proceeds of the exercise of options
and warrants.
We have a net operating loss tax carry forward of approximately $4.0 million at
December 31, 2004. In the 2004 period, we recorded a current income tax expense
of $187,000, which related to various state and local taxes, as well as a
provision for the Federal alternative minimum tax. The current provision was
reduced by $952,000 as a result of a use of the available net operating loss
carry forward. The income tax provision was increased by a net deferred tax
provision of $122,000. The deferred tax asset valuation allowance of $1,731,000
18
was reversed of which $717,000 was recorded as an addition to additional paid in
capital and $1,014,000 as a deferred tax benefit, during 2004. The deferred tax
provision was $1,136,000 based on utilization of net operating loss carry
forwards offset by the reduction in the deferred tax asset valuation allowance
of $1,014,000. In 2003, we recorded a current income tax expense of $113,000,
which related to various state and local taxes, as well as a provision for the
Federal alternative minimum tax. The current income tax provision was reduced by
$942,000 as a result of the use of available net operating losses. The deferred
tax asset and the valuation allowance were reduced by the same amount. We also
re-evaluated the deferred tax asset valuation allowance and further reduced the
allowance by $900,000 to zero, which was recorded as a tax benefit.
As a result of the foregoing factors, in the 2004 period we had net income of
$2,753,000, or $.52 per share (basic) and $.50 per share (diluted). For 2003, we
had net income of $3,029,000, or $.69 per share (basic) and $.64 per share
(diluted).
Years Ended December 31, 2003 and 2002
Our total revenue for 2003 was $27,175,000, an increase of $5,049,000, or 23%,
from our revenue for 2002, which was $22,126,000.
Revenue from contracts from government agencies represented 57% of revenue in
2003 and 52% of revenue in 2002. This reflects an increase in new government
contracts, primarily relating to contracts with two new county agencies.
Software and Related Systems and Services
Our Software and Related Systems and Services revenue for 2003 was $24,610,000,
an increase of $4,441,000, or 22%, from our revenue for 2002, which was
$20,169,000. Software and related systems and services revenue is comprised of
turnkey systems labor revenue, revenue from sales of third party hardware and
software, license revenue, maintenance revenue and revenue from small turnkey
systems.
The largest component of revenue was turnkey systems labor revenue, which
increased to $9,548,000 in 2003, from $7,418,000 in 2002, reflecting a 29%
increase. Turnkey systems labor revenue refers to labor associated with turnkey
installations and includes categories such as training, installation, project
management and development. This increase was substantially the result of an
increase in spending for information systems in the human services marketplace
and our ability to provide the staff necessary to generate additional revenue.
Labor rate price changes from 2003 to 2002 resulted in an 11% increase in the
average daily billing rate and accounted for approximately $567,000, or 27%, of
the total turnkey systems labor increase. Revenue from third party hardware and
software increased to $4,444,000 in 2003, from $3,822,000 in 2002, which
represents an increase of 16%. Sales of third party hardware and software are
made in connection with the sales of turnkey systems. These sales are typically
made at lower gross margins than our human services revenue. License revenue
increased to $2,781,000 in 2003, from $1,753,000 in 2002, reflecting an increase
of 59%. License revenue is generated as part of a sale of a human services
information system pursuant to a contract or purchase order that includes
delivery of the system and maintenance. This increase in license revenue was the
result of an increase in spending for information systems in the human services
marketplace. Maintenance revenue increased to $7,069,000 in 2003, from
$6,247,000 in 2002, reflecting an increase of 13%. As turnkey systems are
completed, they are transitioned to the maintenance division, thereby increasing
our installed base. Revenue from the sales of our small turnkey division
decreased to $768,000 in 2003, from $929,000 in 2002, reflecting a decrease of
17%. This decrease is the result a redirection of our sales efforts to larger
turnkey sales. Small turnkey division sales relate to turnkey contracts that are
less than $50,000 and are usually completed within one month.
Gross profit increased to $11,953,000 in 2003 from $7,357,000 in 2002,
reflecting an increase of 62%. Our gross margin percentage increased to 49% in
19
2003 from 37% in 2002. Our gross margin percentage increased primarily as a
result of increased maintenance and license revenue and, to a lesser extent, an
increase in our labor revenue. Our infrastructure costs with respect to our
maintenance division are substantially in place and as new maintenance revenue
occurs, our gross profit margins are improved accordingly.
Data Center (Service Bureau Services)
Data center clients typically generate approximately the same amount of revenue
each year. We bill on a transaction basis or on a fixed fee arrangement.
Historically, each year, we increase the transaction or fixed fees by an amount
that approximates the New York urban consumer price index increase. The data
center revenue increased to $1,973,000 in 2003, from $1,957,000 in 2002,
representing an increase of $16,000, or 1%. This increase was due to an increase
in the client base.
Gross profit decreased to $939,000 in 2003 from $946,000 in 2002, reflecting a
decrease of less than 1%. Our gross margin percentage however, remained constant
at 48% for 2003 and 2002.
Application Service Provider Services
ASP Services involves the offering of our Avatar suite of products, our CareNet
products and our InfoScriber products on a virtual private network or internet
delivery approach, thereby allowing our customers to rapidly deploy products and
pay on a monthly service basis, thus eliminating capital intensive system
requirements. The year 2004 is the first year that we have accounted for ASP
Services as a segment. Prior to our acquisition of CareNet on June 25, 2003, our
ASP operations were immaterial. Certain items in the year 2003 has been
reclassified to conform to the 2004 presentation.
Revenue for 2003 was $591,000, which consisted of revenue from our CareNet
operations of $380,000 and revenue from our Avatar ASP services operations of
$211,000. There was no ASP revenue in 2002.
Gross profit for 2003 was $214,000 and our gross margin percentage was 36%.
Because the ASP operations were in their infancy during the 2003 period, any
comparisons between the periods would not be meaningful.
Operating Expenses
Selling, general and administrative expenses were $7,969,000 in 2003, reflecting
an increase of $2,431,000, or 44%, from $5,538,000 in 2002. This increase was in
the area of sales and marketing salaries, which increased by $342,000; sales
commissions, which increased by $210,000; advertising and promotion, which
increased by $181,000; an increase in general and administrative salaries, which
increased by $316,000; provisions for bonuses, which increased by $404,000
provision for bad debts, which increased by $676,000 and the addition of the
amortization of the CareNet acquisition which was $139,000 in 2003 and was not
present in 2002.
We incurred product development and maintenance expenses of $2,770,000 in 2003,
an increase of 66% from the $1,669,000 in 2002. The increase in product
development and maintenance expense was the result of continuing investment in
product enhancement and extensions. These extensions include the development of
new software modules including Minimum Data Set (MDS) reporting, which was
designed to address Federal reporting requirements, as well as continued
investment in core products. These amounts have been appropriately accounted for
in accordance with SFAS No. 86, "Accounting for the Cost of Computer Software to
be Sold, Leased, or Otherwise Marketed."
Interest and other expense was $200,000 in 2003, a decrease of $62,000, or 24%,
from the $262,000 in 2002. This decrease was the result of reduced borrowing
during 2003 with respect to our bank. The decrease in interest expense was
20
partially offset by in increase in borrowing related to the promissory note
issued to Shuttle Data Systems Corp. in connection with our acquisition of
CareNet and an increase in our capitalized lease arrangements.
Interest income was $74,000 in 2003, an increase of $28,000, or 61%, from 46,000
in 2002. Interest income is generated from short-term investments made with a
substantial portion of the proceeds received from the term loan, as well as cash
generated from operations and the proceeds the exercise of options and warrants.
We have a net operating loss tax carry forward of approximately $6.5 million. In
2003, we recorded a current income tax expense of $113,000, which related to
various state and local taxes, as well as a provision for the Federal
alternative minimum tax. The current income tax provision was reduced by
$942,000 as a result of the use of available net operating losses. The deferred
tax asset and the valuation allowance were reduced by the same amount. We also
re-evaluated the deferred tax asset valuation allowance and further reduced the
allowance by $900,000, which was recorded as a tax benefit. In 2002, we recorded
current income tax expense of $84,000, which related to various state and local
taxes. In addition, we recognized a partial deferred tax benefit in the amount
of $400,000 principally due to a reduction in the valuation allowance of
$400,000 related to our net operating loss carry forward.
As a result of the foregoing factors, in 2003, we had net income of $3,029,000,
or $.69 per share (basic) and $.64 per share (diluted). For 2002, we had net
income of $1,195,000, or $.32 per share (basic) and $.29 per share (diluted).
Liquidity and Capital Resources
We had working capital of approximately $18.2 million at December 31, 2004 as
compared to working capital of approximately $14.7 million at December 31, 2003.
This increase of approximately $3.5 million in working capital was the result of
the following: our net income, after adding back depreciation and amortization,
increased working capital by $4,377,000. The increase in working capital also
included $113,000 in net proceeds from the exercise of our stock options and an
increase in the current portion of the deferred tax asset in the amount of
$193,000. These increases were partially offset by an investment in capitalized
software of $185,000, by an additional $621,000 for the acquisition of equipment
and by $233,000 for the acquisition of certain software and customer lists. The
remaining decrease in working capital of $142,000 was due to changes in other
current assets and liabilities.
In June 2001, we entered into a term loan agreement with Fleet Bank, which was
subsequently acquired by the Bank of America ("B of A"). This financing provides
us with a five-year term loan of $2.5 million. The current term loan bears
interest at LIBOR plus 2.5%. We have entered into an interest rate swap
agreement with B of A for the amount outstanding under the term loan whereby we
converted our variable rate on the term loan to a fixed rate of 7.95% in order
to reduce the interest rate risk associated with these borrowings. We have made
principal payments on the $2.5 million term loan and the amount outstanding at
December 31, 2004 is $750,000.
The terms of our term loan agreement require compliance with certain covenants,
including maintaining a minimum net equity of $9 million, minimum cash reserves
of $500,000, maintenance of certain financial ratios, limitations on capital
expenditures and indebtedness and prohibition of the payment of cash dividends.
As of December 31, 2004, we were in compliance with the financial covenants of
this agreement.
On February 27, 2003, our Board of Directors authorized the purchase of up to
$100,000 of our common stock at any time that the market price is less than
$3.50 per share. Purchases of stock will be made from time to time, depending on
market conditions, in open market or in privately negotiated transactions, at
prices deemed appropriate by management. There is no set time limit on the
21
purchases. We expect to fund any stock repurchases from our operating cash flow.
As of December 31, 2004, we have not made any stock repurchases.
In June 2003, we acquired substantially all of the assets of the CareNet segment
of Shuttle Data Systems Corporation, d/b/a Adia Information Management Corp. The
total purchase price included, among other consideration, a three year
promissory note in the principal amount of $500,000 payable in 36 equal monthly
installments of principal plus interest at the prime rate plus 1%. We have made
the required principal and interest payments on the note and the principal
amount outstanding at December 31, 2004 is $250,000.
In 2004, we capitalized software development costs of $185,000 relating to our
RAD Plus 2004 product.
A part of our growth strategy is to acquire other businesses that are related to
our current business. Such acquisitions may be made with cash, our securities,
or a combination of cash and securities. If we fail to make any acquisitions our
future growth will be limited to only internal growth. As of the date of this
Form 10-K annual report, we did not have any formal or informal agreements or
understandings with respect to any material acquisitions, and we cannot give any
assurance that we will be able to complete any material acquisitions.
Based on our outstanding contracts and our continuing business, we believe that
our cash flow from operations and our cash on hand will be sufficient to enable
us to fund our operations for at least the next twelve months. It is possible
that we may need additional funding if we go forward with certain acquisitions
or if our business does not develop as we anticipate or if our expenses,
including our software development costs relating to our expansion of our
product line and our marketing costs for seeking to expand the market for our
products and services to include smaller clinics and facilities and sole group
practitioners, exceed our expectation.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements.
22
Contractual Obligations
The following table summarizes, as of December 31, 2004, our obligations and
commitments to make future payments under debt, capital leases and operating
leases:
Contractual Obligations Payments Due by
Period
Total Less than 1 - 3 years 4 - 5 years Over 5
1 year years
Long Term Debt(1) $1,000,028 $ 666,667 $ 333,361 $ -- $ --
Capital Lease Obligations(2) 90,834 68,957 21,877 -- --
Operating Leases(3) 6,597,155 745,379 1,340,772 1,253,124 3,257,880
Total Contractual Cash
Obligations $7,688,017 $1,481,003 $1,696,010 $1,253,124 $3,257,880
----------
(1) See Note 7 to Netsmart's Consolidated Financial Statements for the years
ended December 31, 2004, 2003 and 2002, which describes the Company's financing
agreement.
(2) See Note 10 to Netsmart's Consolidated Financial Statements for the
years ended December 31, 2004, 2003 and 2002, which describes the Company's
Capital Lease Obligation.
(3) See Note 12 to Netsmart's Consolidated Financial Statements for the years
ended December 31, 2004, 2003 and 2002, which describes the Company's Operating
Lease Obligations.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. These accounting
principles require us to make certain estimates, judgments and assumptions. We
believe that the estimates, judgments and assumptions upon which we rely are
reasonable based upon information available to us at the time that these
estimates, judgments and assumptions are made. These estimates, judgments and
assumptions can affect the reported amounts of assets and liabilities as of the
date of the financial statements, as well as the reported amounts of revenues
and expenses during the periods presented. Among other things, estimates are
used in accounting for allowances for bad debts, deferred income taxes, expected
realizable values of assets (primarily capitalized software development costs
and customer lists) and revenue recognition. To the extent there are material
differences between these estimates, judgments or assumptions and actual
results, our financial statements will be affected. The significant accounting
policies that we believe are the most critical to aid in fully understanding and
evaluating our reported financial results include the following:
Revenue Recognition
Capitalized Software Development Costs
Impairment of Customer Lists
Revenue Recognition - Revenue associated with fixed price turnkey sales consists
of the following components: licensing of software, labor associated with the
installation and implementation of the software; and maintenance services
rendered in connection with such licensing activities. Revenue from fixed price
23
software development contracts and revenue under license agreements, which
require significant modification of the software package to the customer's
specifications, are recognized utilizing the estimated percentage-of-completion
method which uses the units-of-work-performed method to measure progress towards
completion. Revisions in cost estimates and recognition of losses on these
contracts are reflected in the accounting period in which the facts become
known. The complexity of the estimation process and issues related to the
assumptions, risks and uncertainties inherent with the application of the
percentage of completion method of accounting affect the amounts of revenue and
related expenses reported in our Consolidated Financial Statements. A number of
internal and external factors can affect our estimates, including labor rates,
utilization and efficiency variances and specification and testing requirement
changes. Maintenance contract revenue is recognized on a straight-line basis
over the life of the respective contract. We also derive revenue from the sale
of third party hardware and software which is recognized based upon the terms of
each contract. Consulting revenue is recognized when the services are rendered.
Data Center revenue and Application Service Provider revenue are recognized in
the period in which the services are provided. The above sources of revenue are
recognized when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed and determinable and collectibility is probable.
Contract terms often provide for billing schedules that differ from revenue
recognition and give rise to costs and estimated profits in excess of billings,
and billings in excess of costs and estimated profits.
Deferred revenue represents revenue billed and collected but not yet earned.
The cost of maintenance revenue, which consists solely of staff payroll and
applicable overhead, is expensed as incurred.
Capitalized Software Development Costs - Capitalization of computer software
development costs begins upon the establishment of technological feasibility and
ends upon its availability for general release to customers. Technological
feasibility for our computer software products is generally based upon
achievement of a detail program design free of high risk development issues. We
capitalize only those costs directly attributable to the development of the
software. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized computer software development costs
require considerable judgment by management with respect to certain external
factors, including, but not limited to, technological feasibility, anticipated
future gross revenue, estimated economic life and changes in software and
hardware technology. Prior to reaching technological feasibility these costs are
expensed as incurred and included in research, development and maintenance.
Activities undertaken after the products are available for general release to
customers to correct errors or keep the product updated are expensed as incurred
and included in research, development and maintenance. Amortization of
capitalized computer software development costs commences when the related
products become available for general release to customers. Amortization is
provided on a product by product basis. The annual amortization is the greater
of the amount computed using (a) the ratio that current gross revenue for a
product bears to the total of current and anticipated future gross revenue for
that product or (b) the straight-line method over the remaining estimated
economic life of the product. The estimated life of these products range from 3
to 8 years.
We periodically perform reviews of the recoverability of such capitalized
software costs. At the time a determination is made that capitalized amounts are
not recoverable based on the estimated cash flows to be generated from the
applicable software, any remaining capitalized amounts are written off.
24
Impairment of Customer Lists - Pursuant to SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", we evaluate our long-lived assets
for financial impairment, and continue to evaluate them as events or changes in
circumstances indicate that the carrying amount of such assets may not be fully
recoverable. We evaluate the recoverability of long-lived assets by measuring
the carrying amount of the assets against the estimated undiscounted future cash
flows associated with them. At the time such evaluations indicate that the
future undiscounted cash flows of certain long-lived assets are not sufficient
to recover the carrying amount of such assets, the assets are adjusted to their
fair values.
Risk Factors - The results of the Company's operations are subject to certain
risks and uncertainties. See "Risk Factors", above.
Forward-Looking Statements
Statements in this Form 10-K annual report may be "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements include, but are not limited to, statements that
express our intentions, beliefs, expectations, strategies, predictions or any
other statements relating to our future activities or other future events or
conditions. These statements are based on current expectations, estimates and
projections about our business based, in part, on assumptions made by
management. These statements are not guarantees of future performance and
involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is
expressed or forecasted in the forward-looking statements due to numerous
factors, including those described above and those risks discussed from time to
time in this Form 10-K annual report for the year ended December 31, 2004,
including the risks described under "Risk Factors" and in other documents which
we file with the Securities and Exchange Commission. In addition, such
statements could be affected by risks and uncertainties related to product
demand, market and customer acceptance, competition, government regulations and
requirements, pricing and development difficulties, as well as general industry
and market conditions and growth rates, and general economic conditions. Any
forward-looking statements speak only as of the date on which they are made, and
we do not undertake any obligation to update any forward-looking statement to
reflect events or circumstances after the date of this Form 10-K.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk related to changes in interest rates. Most of our
debt is at fixed rates of interest after completing an interest rate swap
agreement, which effectively converted our variable rate debt into a fixed rate
debt of 7.95%. Therefore, if the LIBOR rate plus 2.5% increases above 7.95%, it
may have a positive effect on our comprehensive income.
Most of our invested cash and cash equivalents, which are invested in money
market accounts and commercial paper, are at variable rates of interest. If
market interest rates decrease by 10 percent from levels at December 31, 2004,
the effect on our net income would be a decrease of approximately $12,300 per
year.
Netsmart Technologies, Inc.
Quarterly Summary
Unaudited
The following table sets forth certain unaudited quarterly results of operations
for each of the quarters in the years ended December 31, 2004 and 2003. All
quarterly information was obtained from unaudited financial statements not
25
otherwise contained in this report. We believe that all necessary adjustments
have been made to present fairly the quarterly information when read in
conjunction with the consolidated financial statements and notes thereto
included elsewhere in this report. The operating results for any quarter are not
necessarily indicative of the results for any future period.
In thousands, except per share data amounts
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
2004 (a)(c)
Total revenue $6,823 $7,189 $7,421 $7,572
Gross profit 3,163 3,435 3,565 3,694
Net income 325 493 633 1,302
Per share amounts:
Net earnings - Basic: $ .06 $ .09 $ .12 $ .24
====== ====== ====== ======
Net earnings - Diluted: $ .06 $ .09 $ .11 $ .24
====== ====== ====== ======
(a) The Company utilized an effective income tax rate of approximately 28%
through the third quarter of 2004. In the fourth quarter of 2004, the Company
determined that the effective income tax rate should approximate 10%.
Accordingly, the change in estimate recorded in the fourth quarter was to reduce
the income tax provision by approximately $360,000 related to the first three
quarters of 2004.
(c) During the fourth quarter the Company changed its method of calculating
overhead for its research, development and maintenance costs, from using a
standard overhead rate factor to a specific costs method. As a result, $1,248 of
costs have been reclassified from research, development and maintenance costs
into costs of goods sold. The effect of this reclassification on gross profit
for each quarter during 2004 has been reflected above.
2003 (b) (d)
Total revenue $6,119 $6,589 $7,108 $7,359
Gross profit 2,576 2,868 3,388 4,275
Net income 271 521 1,546 691
Per share amounts:
Net earnings - Basic: $ .07 $ .13 $ .34 $ .13
====== ====== ====== ======
Net earnings - Diluted: $ .06 $ .12 $ .33 $ .13
====== ====== ====== ======
(b) Includes a $100 and $800 reduction in the deferred tax asset valuation
allowance for the second and third quarters of 2003 respectively.
(d) The effect of the $515 reclassification to research, development and
maintenance, from costs of goods sold on each quarter, has been reflected above.
The Company recorded a $701 increase in its allowance for bad debts in the
fourth quarter of 2003. Also during the fourth quarter of 2003, the Company
capitalized $144 of software development costs incurred in quarters one through
three of 2003, totaling $62, $62 and $20 respectively.
26
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data begin on page F-1 of this Form
10-K.
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Item 9A. Controls and Procedures
Evaluation and Disclosure Controls and Procedures
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rule 13d-15(e) and 15d-15(e)). Based upon
that evaluation and the material weaknesses described below, our Chief Executive
Officer and Chief Financial Officer concluded that as of the end of the period
covered by this Annual Report on Form 10-K our disclosure controls and
procedures were not adequate to enable us to record, process, summarize and
report information required to be included in the Company's periodic SEC filings
within the required time period.
Changes in Internal Controls
We are not an accelerated filer (as defined in the Securities Exchange Act) and
are not required to deliver management's report on control over financial
reporting until our fiscal year ended December 31, 2006 (or December 31, 2005 in
the event we become an accelerated filer). Nevertheless, in our efforts to
comply with Section 404 of the Sarbanes-Oxley Act of 2002, during the quarter
ended December 31, 2004, we identified certain matters that would constitute
material weaknesses (as such term is defined under the Public Company Accounting
Oversight Board Auditing Standard No. 2) in our internal controls over financial
reporting.
The first material weakness is the lack of the necessary corporate accounting
resources to ensure consistently complete and accurate reporting of financial
information with respect to the preparation of our tax accrual. In order to
correct this deficiency, in November 2004, we engaged an outside consultant to
prepare and review our tax accruals. This consultant prepared our tax provision
for the year ended December 31, 2004.
The other material weakness is the lack of the necessary corporate accounting
resources to realign and cross-train current finance and accounting personnel.
This has led to a dependence on our Chief Financial Officer, the loss of whom
could impair our ability to ensure consistently complete and accurate financial
reporting, particularly with respect to our revenue recognition on work in
process contracts. In order to correct this deficiency, we are seeking to hire
additional competent personnel to assist in the segregation of duties with
respect to financial reporting, Sarbanes Oxley 404 compliance and revenue
recognition on work in process contracts.
We believe that for the reasons described above we will be able to improve our
disclosure controls and procedures and remedy the material weaknesses identified
above. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, will be or have been detected.
27
Except as described above, there were no significant changes in our internal
controls over financial reporting that occurred during the year ended December
31, 2004 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls
We believe that a control system, no matter how well designed and operated,
cannot provide absolute assurance that the objectives of the control system are
met, and no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company have been
detected. Our disclosure controls and procedures are designed to provide a
reasonable assurance of achieving their objectives and our Chief Executive
Officer and Chief Financial Officer have concluded that such controls and
procedures are effective at the "reasonable assurance" level.
Item 9B. Other Information
None
28
Part III
Item 10. Directors and Executive Officers of the Registrant.
Our directors and executive officers are as follows:
Name Age Position
---- --- --------
James L. Conway 57 Chief executive officer and director
Gerald O. Koop 66 President and director
Anthony F. Grisanti 55 Chief financial officer, treasurer and
secretary
John F. Phillips 66 Director
Joseph G. Sicinski(1 & 2) 72 Director
Francis J. Calcagno(1, 2 & 3) 55 Director
John S.T. Gallagher(1, 2 & 3) 74 Director
Yacov Shamash(3) 55 Director
------------
(1) Member of the compensation committee.
(2) Member of the audit committee.
(3) Member of the nominating and governance committee.
Director Biographies
--------------------
Mr. James L. Conway has been our Chief Executive Officer since April 1998, a
director since January 1996 and was President from January 1996 until January
2001. From 1993 until April 1998, he was president of a Long Island based
manufacturer of specialty vending equipment for postal, telecommunication and
other industries. He was previously vice president, treasurer and director of
ITT Credit Corporation. Mr. Conway was recently elected to the board of LISTnet
which is an organization with the objective of promoting Long Island as one of
the national centers of execellence for software and technology solutions. He
also serves and is a member of the CEO Roundtable for Long Island.
Mr. Gerald O. Koop has been one of our directors since June 1998 and president
since January 2001. He has held management positions with Creative Socio-Medics
for more than the past five years, most recently as its Chief Executive Officer,
a position he has held since 1996.
Mr. John F. Phillips has been one of our directors of Creative Socio-Medics
since June 1994, when Creative Socio-Medics was acquired.
Mr. Anthony F. Grisanti has been our Treasurer since June 1994, Secretary since
February 1995 and Chief Financial Officer since January 1996.
Mr. Joseph G. Sicinski has been one of our directors since June 1998. He was
president and a director of the Trans Global Services, Inc., a technical
staffing company, a position he held with Trans Global and its predecessor from
September 1992 until September 2003. From April 1998 until December 2001, he was
also chief executive officer of Trans Global.
29
Mr. Francis J. Calcagno has been one of our directors since September 2001. He
is a senior managing director of Dominick & Dominick LLC, a company engaged in
investment banking, a position he has held since 1997. From 1993 until 1997, he
was a managing director of Deloitte and Touche, LLP.
Mr. John S.T. Gallagher has been one of our directors since March 2002. He is
deputy county executive for health and human services in Nassau County, New
York, a position he has held since February 2002. He has been a senior executive
officer of North Shore University Hospital and North Shore - Long Island Jewish
Health System since 1982, having served as executive vice president of North
Shore from 1982 until 1992, president from 1992 until 1997 and chief executive
officer of the combined hospital system from 1997 until January 2002. In January
2002, he became co-chairman of the North Shore - Long Island Jewish Heath System
Foundation. Mr. Gallagher is also a director of Perot Systems Corporation, a
worldwide provider of information technology services.
Dr. Yacov Shamash is Vice President for Economic Development and the Dean of the
College of Engineering and Applied Sciences at Stony Brook University. Prior to
joining SUNY Stony Brook in 1992, Dr. Shamash served as the Director of the
School of Electrical Engineering and Computer Science at Washington State
University. He has also held faculty positions at Florida Atlantic University,
the University of Pennsylvania and Tel Aviv University. He received his
undergraduate and graduate degrees from Imperial College of Science and
Technology in London, England. Dr. Shamash has been a member of the Board of
Directors of KeyTronic Corporation, a contract manufacturer, since 1989, of
American Medical Alert Corporation, a healthcare service provider, since 2001
and of Manchester Technologies, Inc., a hardware and software technology
provider, since December 2003. He is also on the Boards of Directors of a number
of start-up companies and serves on the Boards of not-for-profit organizations.
Dr. Shamash has authored over 110 technical publications and he is a Fellow of
the IEEE.
Directors are elected for a term of one year.
None of our officers and directors are related.
Our certificate of incorporation includes certain provisions, permitted under
Delaware law, which provide that a director shall not be personally liable to us
or our stockholders for monetary damages for breach of fiduciary duty as a
director except for liability (i) for any breach of the director's duty of
loyalty to us or our stockholders, (ii) for acts or omissions not in good faith
or which involve intentional misconduct or a knowing violation of law, (iii) for
any transaction from which the director derived an improper personal benefit, or
(iv) for certain conduct prohibited by law. The Certificate of Incorporation
also contains broad indemnification provisions. These provisions do not affect
the liability of any director under federal or applicable state securities laws.
Board Committees
----------------
Our board of directors has three committees - the audit committee, the
compensation committee and the nominating and governance committee.
The audit committee consists of three independent directors, Messrs. John S.T.
Gallagher, who is chairman of the committee, Francis Calcagno and Joseph G.
Sicinski. The responsibilities of the audit committee include overseeing our
financial reporting process, reporting the results of its activities to the
board, retaining and ensuring the independence of our auditors, approving
services to be provided by our auditors, reviewing our periodic filings with the
independent auditors prior to filing, and reviewing and responding to any
matters raised by the Independent Registered Public Accountants in their
management letter. The board of directors has determined that each of Messrs.
Gallagher, Sicinski and Calcagno, qualifies as an "Audit Committee financial
expert," as defined by Securities and Exchange Commission rules, based in his
education, experience and background. A copy of the Audit Committee charter can
be found on our website at www.csmcorp.com.
30
The compensation committee, which is composed of Mr. Gallagher, who is chairman
of the committee and Messrs. Calcagno and Sicinski, serves as the stock option
committee for our stock option plans and the employee stock purchase plan, and
it reviews and approves any employment agreements with management and changes in
compensation for our executive officers. A copy of the Compensation Committee
charter can be found on our website at www.csmcorp.com.
In February 2004, we formed our Nominating and Governance Committee. The
Nominating and Governance Committee is primarily responsible for reviewing our
corporate governance principles and independence standards: overseeing the
annual evaluation of our board and its committees; discharging the board's
responsibilities related to compensation of directors; identifying and
evaluation individuals for board and committee membership and chairs; making
recommendations to the board concerning the selection of director nominees and
making recommendations as to the size and composition of the board and its
committees. The members of the Nominating and Governance Committee are Dr.
Shamash, who is the chairman of the committee and Messrs. Gallagher and
Calcagno. A copy of the Nominating and Governance Committee charter can be found
on our website at www.csmcorp.com.
Excluding actions by unanimous written consent, during 2004, the board of
directors held eight meetings, the compensation committee held three meetings,
the independent directors held one meeting and the audit committee held five
meetings. The audit committee met with our independent registered public
accountants and chief financial officer prior to filing of this Form 10-K annual
report to review the 2004 audited financial statements with the independent
registered public accountants. During 2004, all of our directors attended at
least 85% of the meetings of the board and 100% of the meetings of any committee
of which they are members, except one director who attended 60% of the audit
committee meetings.
Directors' Fees
---------------
We pay an annual fee of $20,000 to Messrs. Calcagno, Sicinski, Shamash and
Gallagher and we pay an additional $12,500 per annum to Mr. Gallagher in respect
of his services as chairman of our Audit Committee and Compensation Committee.
Stockholder Nomination Procedures
---------------------------------
Any stockholder who wants to nominate a candidate for election to the Board must
deliver timely notice to our Secretary at our principal executive offices. In
order to be timely, the notice must be delivered
* in the case of an annual meeting, not less than 120 days prior to
the anniversary date of the immediately preceding annual meeting of
stockholders, although if we did not hold an annual meeting or the
annual meeting is called for a date that is not within 30 days of
the anniversary date of the prior year's annual meeting, the notice
must be received a reasonable time before we begin to print and mail
our proxy materials; and
* in the case of a special meeting of stockholders called for the
purpose of electing directors, the notice must be received a
reasonable time before we begin to print and mail our proxy
materials.
Section 16(a) Beneficial Ownership Reporting Compliance
-------------------------------------------------------
Section 16(a) of the Securities Exchange Act of 1934 requires our executive
officers, directors and persons who own more than ten percent of a registered
class of our equity securities ("Reporting Persons") to file reports of
ownership and changes in ownership on Forms 3, 4 and 5 with the Securities and
Exchange Commission and the Nasdaq Stock Exchange. These Reporting Persons are
31
required by SEC regulation to furnish us with copies of all Forms 3, 4 and 5
they file with the SEC and Nasdaq. Based solely upon our review of the copies of
the forms we have received, and upon representations received from such
Reporting Persons, we believe that all Reporting Persons complied on a timely
basis with all filing requirements applicable to them with respect to
transactions during fiscal 2004, except for Mr. Phillips who filed a Form 4 to
report sale transactions forty-eight days late.
Code of Ethics
--------------
We have adopted a Code of Ethics applicable to our principal executive officers,
principal financial officer, principal accounting officer and controller and a
Code of Business Conduct applicable to all of our employees, each which is
posted on our website at www.csmcorp.com. A copy of the Code of Ethics and Code
of Business Conduct may also be obtained without charge by writing to Mr.
Anthony F. Grisanti, Chief Financial Officer, Netsmart Technologies, Inc, 3500
Sunrise Highway, Great River, NY 11739.
Item 11. Executive Compensation.
Set forth below is information with respect to compensation paid or accrued by
us for the three years ended December 31, 2004, 2003 and 2002 to our chief
executive officer and to each of our other officers whose salary and bonus for
2004 exceeded $100,000.
SUMMARY COMPENSATION TABLE
--------------------------
Annual Long-Term
------ ---------
Compensation Compensation
------------ ------------
(Awards)
--------
Options, SARs
-------------
Name and Principal Position Year Salary Bonus (Number)
--------------------------- ---- ------ ----- --------
James L. Conway, CEO 2004 $218,698 $175,000 42,500
2003 207,814 188,000 49,500
2002 193,151 120,000 20,000
Gerald O. Koop, president 2004 194,665 174,078 40,000
2003 189,880 206,539 49,500
2002 170,807 170,408 20,000
Anthony F. Grisanti, chief 2004 167,535 125,000 27,500
financial officer 2003 162,343 144,000 27,500
2002 148,463 106,000 16,000
The bonuses for Mr. Koop includes accrued commissions of $111,578 for 2004,
$135,539 for 2003 and $165,408 for 2002. The 2004 commissions will be paid in
installments through 2005, the 2003 commissions were paid in installments
through 2004 and the 2002 commissions were paid in installments through 2003.
Employment Agreements
In April 2004, we entered into revised employment agreements with Messrs. James
L. Conway, Gerald O. Koop and Anthony F. Grisanti. The terms and conditions of
the revised contracts are identical in all material respects to the previous
contracts except that (i) the term of each individual's contract was extended by
one year, so that Messrs. Conway and Grisanti's contract will expire on December
31, 2006 and Mr. Koop's contract will expire on December 31, 2005 and (ii) the
revised contracts do not provide for a five-year consulting period following
each
32
individual's respective term of employment during which such individual would
have been entitled to compensation of $75,000 per year. Messrs. Conway and
Grisanti's contracts also provide for an option to extend their contracts for
one additional year so that upon the exercise of such option, their contracts
would expire on December 31, 2007. We believe that these officers are vital to
our business.
Pursuant to these employment agreements, these officers received the following
salaries in 2004: Mr. Conway - $211,473, Mr. Koop - $186,839, and Mr. Grisanti -
$162,204. The agreements provide for annual increases associated with cost of
living indexes or 5%, whichever is greater. The agreements provide that the
executives are eligible to participate in a bonus pool to be determined annually
by the board, based on the executive's performance. The agreements also provide
each of these officers with an automobile allowance, which is included under
"Salary", and insurance benefits. In the event of the officer's dismissal or
resignation or a material change in his duties or in the event of a termination
of employment by the executive or by us as a result of a change of control, the
officer may receive severance payments of 36 months' compensation. In January
2001, we entered into a consulting agreement with Mr. Bright, which was amended
in March 2004 and in April 2004 we entered into a consulting agreement with Mr.
Phillips - see Item 13, Certain Relationships and Related Transactions.
Effective April 1, 2004, we adopted an Executive Retirement, Non-Competition and
Consulting Plan which was subsequently amended August 5, 2004 effective April 1,
2004, pursuant to which, following their retirement, selected officers will be
entitled to receive a minimum payment of approximately $85,000 per year for a
period of six years, provided, that such officers (i) provide a minimum amount
of consulting days each month and (ii) agree to certain covenants not to
compete. The annual payments are subject to 10% increases up to a maximum of
$136,893 per year. Pursuant to the Executive Retirement, Non-Competition and
Consulting Plan, the selected officers are also entitled to receive health
benefits for life, provided that there are no breaches of the covenants not to
compete. Each of Messrs. Conway, Koop and Grisanti are entitled to receive
benefits under the plan.
Mr. Phillip's employment contract expired on December 31, 2003 and he retired
effective April 1, 2004. Pursuant to the terms of our Executive Retirement,
Non-Competition and Consulting Plan, Mr. Phillips will receive $85,000 per year
for each of the next six years; provided that he complies with the
non-competition covenants of the plan.
Compensation Committee Interlocks and Insider Participation
-----------------------------------------------------------
During fiscal 2004, our compensation committee consisted of Messrs. Calcagno,
Gallagher and Sicinski. None of them were our officers or employees during
fiscal 2004 or were previously an officer of ours nor did any of them have any
relationship with us that is required to be disclosed under this heading.
33
COMPENSATION COMMITTEE
REPORT ON EXECUTIVE COMPENSATION
The compensation of our executive officers is determined by the Compensation
Committee of our board of directors, subject to applicable employment
agreements. Each member of the Compensation Committee is a director who is not
employed by us or any of our affiliates. The following report with respect to
certain compensation paid or awarded to our executive officers during fiscal
2004 is furnished by the directors who comprised the Compensation Committee
during fiscal 2004.
General Policies
Our compensation programs are intended to enable us to attract, motivate, reward
and retain the management talent required to achieve our corporate objectives,
and thereby increase shareholder value. It is our policy to provide incentives
to our senior management to achieve both short-term and long-term objectives and
to reward exceptional performance and contributions to the development of our
businesses. To attain these objectives, our executive compensation program
includes a competitive base salary, cash incentive bonuses and stock-based
compensation. See "Executive Compensation -- Employment Agreements".
Stock options are granted to employees, including our executive officers, under
our option plans. The Committee believes that stock options provide an incentive
that focuses the executive's attention on managing Netsmart from the perspective
of an owner with an equity stake in the business. Options are awarded with an
exercise price equal to the market value of common stock on the date of grant.
Among our executive officers, the number of shares subject to options granted to
each individual generally depends upon the level of that officer's
responsibility. The largest grants are awarded to the most senior officers who,
in the view of the Compensation Committee, have the greatest potential impact on
our profitability and growth. Previous grants of stock options are reviewed but
are not considered the most important factor in determining the size of any
executive's stock option award in a particular year.
Relationship of Compensation to Performance and Compensation of Chief Executive
Officer
The Compensation Committee annually establishes, subject to the approval of our
board of directors and any applicable employment agreements, the salaries to be
paid to our executive officers during the coming year. The base salary of each
of Messrs. Conway, Koop and Grisanti is established by contract. In setting
salaries, the Compensation Committee takes into account several factors,
including the extent to which an individual may participate in the stock plans
maintained by us, and qualitative factors bearing on an individual's experience,
responsibilities, management and leadership abilities, and job performance.
For fiscal 2004, pursuant to the terms of his employment agreement with us, our
Chairman received a base salary and additional compensation (See "Executive
Compensation - Employment Agreements").
The Compensation Committee:
John S.T. Gallagher (Chairman)
Francis J. Calcagno
Joseph G. Sicinski
34
Option Exercises and Outstanding Options
The following table sets forth information concerning the grants of options made
during the year ended December 31, 2004.
Options Grants in Last Fiscal Year
Potential Realized Value
at Assumed Annual Rates
of Stock Price Appreciation
for Option Term (4)
% of Total
Number of Securities Options Granted
Underlying Options to Employees in Exercise or Base Expiration
Granted (1) 2004 (2) Price $/Sh (3) Date 5% ($) 10% ($)
Koop 40,000 10.1% $ 8.49 5/13/09 $115,496 $262,022
$ -- $ --
------- ----- ------- -------
40,000 10.1% $115,496 $262,022
------- ----- ------- -------
Phillips 15,000 3.8% $ 8.49 5/13/09 $ 43,311 $ 98,258
$ -- $ --
------- ----- ------- -------
15,000 3.8% $ 43,311 $ 98,258
------- ----- ------- -------
Yacov Shamash 5,625 1.4% $ 8.49 5/13/09 $ 16,242 $ 36,847
Yacov Shamash 375 0.1% $ 13.29 4/1/09 $ 1,695 $ 3,845
------- ----- ------- -------
6,000 1.5% $ 17,937 $ 40,692
------- ----- ------- -------
Anthony Grisanti 27,500 6.9% $ 8.49 5/13/09 $ 79,404 $180,140
$ -- $ --
------- ----- ------- -------
27,500 6.9% $ 79,404 $180,140
------- ----- ------- -------
James Conway 42,500 10.7% $ 8.49 5/13/09 $122,715 $278,398
$ -- $ --
------- ----- ------- -------
42,500 10.7% $122,715 $278,398
------- ----- ------- -------
Joseph Sicinski 5,625 1.4% $ 8.49 5/13/09 $ 16,242 $ 36,847
Joseph Sicinski 375 0.1% $ 13.29 4/1/09 $ 1,695 $ 3,845
------- ----- ------- -------
6,000 1.5% $ 17,937 $ 40,692
------- ----- ------- -------
Frank Calcagno 5,625 1.4% $ 8.49 5/13/09 $ 16,242 $ 36,847
Frank Calcagno 375 0.1% $ 13.29 4/1/09 $ 1,695 $ 3,845
------- ----- ------- -------
6,000 1.5% $ 17,937 $ 40,692
------- ----- ------- -------
Jack Gallagher 7,125 1.8% $ 8.49 5/13/09 $ 20,573 $ 46,673
Jack Gallagher 375 0.1% $ 13.29 4/1/09 $ 1,695 $ 3,845
------- ----- ------- -------
7,500 1.9% $ 22,268 $ 50,518
------- ----- ------- -------
(1) Includes options granted in 2004
(2) Based on a total of 397,455 shares subject to options granted to employees
under Netsmart's options plans in 2004.
(3) Under all stock option plans, the option purchase price is equal to the fair
market value at the date of grant. Options were granted to executives on
April 1, 2004 and May 13, 2004.
(4) In accordance with the U.S. Securities and Exchange Commission rules, these
columns show gains that could accrue for the respective options, assuming that
the market price of Netsmart common stock appreciates from the date of grant
over a period of 6 years at an annualized rate of 5% and 10%, respectively. If
the stock price does not increase above the exercise price at the time of
exercise, realized value to the named executive from these options would be
zero.
35
The following table sets forth information concerning the exercise of options
during the year ended December 31, 2004 and the year-end value of options held
by our officers named in the Summary Compensation Table. No stock appreciation
rights have been granted.
Aggregate Option Exercises in Last Fiscal Year and Fiscal
Year-End Option Value (Includes options that were fully exercisable
at year end or by 60 days after the date as of which the
information is provided)
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/At Fiscal Options/At Fiscal
Shares Acquired Value Year-End (#) Year-End ($)
--------------- ----- ------------ ------------
Upon Exercise Realized Exercisable/ Exercisable/
------------- -------- ------------ ------------
Name ($) Unexercisable Unexercisable
---- --- ------------- -------------
(a) (b) (c) (d) (e)
James L. Conway 0 $0 46,000/21,250 $117,510/10,413
Gerald O. Koop 12,250 $101,063 57,000/20,000 $173,370/9,800
Anthony F. Grisanti 0 $0 76,000/13,750 $361,831/6,737
The determination of "in the money" options at December 31, 2004, is based on
the closing price of the common stock on the Nasdaq SmallCap Market on December
31, 2004, which was $8.98 per share.
Information relating to securities issued under equity compensation plans is
disclosed in response to "Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters".
36
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Set forth below is information as of March 3, 2005, as to each person known by
us, based on information provided to us by the persons named below and filings
with the Securities and Exchange Commission, to own beneficially at least 5% of
our common stock, each director, each officer listed in the Summary Compensation
Table and all officers and directors as a group.
Percent of
----------
Outstanding
-----------
Name and Address Shares Common Stock
---------------- ------ ------------
John F. Phillips 109,825 2.0%
Gerald O. Koop 183,576 3.4%
James L. Conway 152,498 2.8%
Anthony F. Grisanti 159,815 2.9%
Joseph G. Sicinski 31,000 *
Francis J. Calcagno 16,000 *
John S.T. Gallagher 22,500 *
Yacov Shamash 6,000 *
All directors and officers as a group (eight 681,214 12.0%
individuals)
Eagle Asset Management 564,618 10.6%
880 Carillon Parkway
St. Petersburg, FL
Dawson Herman 562,250 10.5%
354 Pequot Avenue
Southport, CT
Daniel Zeff 330,870 6.2%
50 California St.
San Francisco, CA.
-------------
* Less than 1%.
Except as set forth in the following paragraphs, each person has the sole voting
and sole investment power and direct beneficial ownership of the shares. Each
person is deemed to beneficially own shares of common stock issuable upon
exercise of options or warrants which are exercisable on or within 60 days after
the date as of which the information is provided.
Except as otherwise noted above, the address of each person listed is c/o
Netsmart Technologies, Inc., 3500 Sunrise Highway, Great River, NY 11739.
37
The number of shares owned by our directors and officers shown in the table
above includes shares of common stock which are issuable upon exercise of
options that are exercisable at February 2, 2005 or will become exercisable
within 60 days after that date. Set forth below is the number of shares issuable
upon exercise of those options for each of such directors and the officers.
Name Number
---- ------
John F. Phillips 41,250
Yacov Shamash 6,000
Gerald O. Koop 64,750
James L. Conway 67,250
Anthony F. Grisanti 89,750
Joseph G. Sicinski 11,000
Francis J. Calcagno 16,000
John S.T. Gallagher 17,500
All officers and directors as a group 313,500
Item 13. Certain Relationships and Related Transactions.
We entered into a consulting agreement with Mr. Bright, a former director,
dated January 1, 2001, as amended in March 2004, pursuant to which Mr. Bright
is to devote 50% of his time to our business for a period of two years.
Following the completion of the term, or earlier at the discretion of
Mr. Bright, Mr. Bright continues as a consultant for an additional five years.
Mr. Bright receives compensation at the annual rate of $75,000 during the
consulting term, and we provide him with an automobile allowance and
insurance benefits. Mr. Bright is eligible, at the discretion of the board,
to participate in a bonus pool which may be established by the board. In the
event that Mr. Bright's consultant relationship is terminated as a result
of a change of control, we are to pay him as severance pay of 36 months
compensation. We paid Mr. Bright total compensation of $102,000 for 2004.
Effective April 1, 2004, we adopted an Executive Retirement, Non-Competition and
Consulting Plan which was subsequently amended August 5, 2004 effective April 1,
2004, pursuant to which, following their retirement, selected officers will be
entitled to receive a minimum payment of approximately $85,000 per year for a
period of six years, provided, that such officers (i) provide a minimum amount
of consulting days each month and (ii) agree to certain covenants not to
compete. The annual payments are subject to 10% increases up to a maximum of
$136,893 per year. Pursuant to the Executive Retirement, Non-Competition and
Consulting Plan, the selected officers are also entitled to receive health
benefits for life, provided that there are no breaches of the covenants not to
compete. Each of Messrs. Conway, Koop and Grisanti are entitled to receive
benefits under the plan.
Mr. Phillip's employment contract expired on December 31, 2003 and he retired
effective April 1, 2004. Pursuant to the terms of our Executive Retirement,
Non-Competition and Consulting Plan, Mr. Phillips will receive $85,000 per year
for each of the next six years; provided, that he complies with the
non-competition covenants of the plan. In addition, Mr. Phillips has a one year
consulting agreement with us. We paid Mr. Phillips total compensation of
$131,293 in 2004, of which $13,049 was for consulting services.
Item 14. Principal Accounting Fees and Services
Audit Fees
We were billed by Marcum & Kliegman LLP the aggregate amount of approximately
$151,000 in respect of fiscal 2004 and $142,500 in respect of fiscal 2003 for
38
fees for professional services rendered for the audit of our annual financial
statements and review of our financial statements included in our Forms 10-Q.
Audit-Related Fees
We were billed by Marcum & Kliegman LLP in fiscal 2004 and 2003 in the amounts
of $13,241 and $76,798, respectively for assurance and related services such as
fees for our 401K audit and acquisition services, that were reasonably related
to the performance of the audit or review of our financial statements that are
not reported under the preceding paragraph. Including, services rendered in
connection with acquisitions, reviews of registration statements and issuances
of related consents, audits of employees benefit plans and advice regarding
common stock purchase warrants and Sox 404 related efforts.
Tax Fees
We were billed by Marcum & Kliegman LLP the aggregate amount of $25,600 in
respect of fiscal 2004 and $25,819 in respect of fiscal 2003 for fees for
services consisting primarily of tax compliance, tax advice or tax planning in
respect of the preparation of our federal and state tax returns.
Our Audit Committee has determined that the provision of services by Marcum &
Kliegman LLP other than for audit related services is compatible with
maintaining the independence of Marcum & Kliegman as our independent
accountants.
Pre-Approval Policies
Our Audit Committee has pre-approved the provision by Marcum & Kliegman LLP of
audit services and of non-prohibited audit related services for fees in an
amount not to exceed an aggregate of $10,000 as well as $25,000 for acquisition
due diligence services. Our Audit Committee has not otherwise adopted any
blanket pre-approval policies.
Our Audit Committee approved all of the services provided by Marcum & Kliegman
LLP and described in the preceding paragraphs.
Part IV
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K.
39
1. Financial Statements
Report of Marcum & Kliegman LLP
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income for the Years Ended December
31, 2004, 2003 and 2002 Consolidated Statements of Stockholders'
Equity for the Years Ended December 31, 2004,
2003 and 2002
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
None
3. Exhibits
3.1(1) Restated Certificate of Incorporation, as amended
3.2(1) By-Laws
10.1(9) Employment Agreement dated April 1, 2004, between the
Registrant and James L. Conway
10.2(9) Consulting Agreement dated April 1, 2004, between the
Registrant and John F. Phillips
10.3(9) Employment Agreement dated April 1, 2004, between the
Registrant and Gerald O. Koop
10.4(9) Employment Agreement dated April 1, 2004, between the
Registrant and Anthony F. Grisanti
10.5(2) Consulting Agreement dated January 1, 2001, between the
Registrant and Edward D. Bright
10.6(1) 1993 Long-Term Incentive Plan
10.7(3) 1998 Long-Term Incentive Plan
10.8(4) 1999 Long-Term Incentive Plan
10.9(5) 2001 Long-Term Incentive Plan - Amended
10.10(4) 1999 Employee Stock Purchase Plan
10.11(2) Agreement dated June 1,2001, between the Registrant and
Fleet Bank
10.12(6) AIMS Acquisition Agreement
10.13(7) Agreement dated June 25, 2003, among Registrant,
Creative Socio-Medics Corp., Shuttle Data Systems Corp.,
d/b/a/ ADIA Information Management Corp. and Steven
Heintz, Jr.
10.14(8) Lease agreement dated as of December 22, 2003, between
Registrant and Spacely LLC.
10.14(10) Amended Executive Retirement, Non Competition and
Consulting Plan.
21.1 Subsidiary of the Registrant
23.1 Consent of Marcum & Kliegman LLP
24 Powers of Attorney (See Signature Page)
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32 Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
----------
(1) Filed as an exhibit to the Registrant's registration statement on
Form S-1, File No. 333-2550, which was declared effective by the Commission on
August 13, 1996, and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's 10-K/A dated August 21, 2003.
(3) Filed as an appendix to the Registrant's proxy statement dated
September 30, 1999, relating to its 1999 Annual Meeting of Stockholders and
incorporated herein by reference.
(4) Filed as an appendix to the Registrant's proxy statement dated
November 9, 2000, relating to its 2000 Annual Meeting of Stockholders and
incorporated herein by reference.
(5) Filed as an appendix to the Registrant's proxy statement dated
March 30, 2004, relating to its 2004 Annual Meeting of Stockholders and
incorporated herein by reference.
(6) Filed as an exhibit to the Registrant's 8-K dated May 10, 2001.
(7) Filed as an exhibit to the Registrant's 8-K dated July 8, 2003.
(8) Filed as an exhibit to the Registrant's 10-K dated March 23, 2004.
(9) Filed as an exhibit to the Registrant's 10-Q dated May 5, 2004.
(10) Filed as an exhibit to the Registrant's 10-Q dated August 9, 2004.
40
NETSMART TECHNOLOGIES, INC.
AND SUBSIDIARY
F-1
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
--------------------------------------------------------------------------------
INDEX
--------------------------------------------------------------------------------
Page to Page
------------
Report of Independent Registered Public Accounting Firm...........F-3
Consolidated Balance Sheets.................................... ..F-4......F-5
Consolidated Statements of Income.................................F-6......F-7
Consolidated Statements of Stockholders' Equity............... ........F-8
Consolidated Statements of Cash Flows.............................F-9......F-11
Notes to Consolidated Financial Statements .......................F-12.....F-30
. . . . . . . . . . .
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee of the
Board of Directors and Stockholders of
Netsmart Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Netsmart
Technologies, Inc. and subsidiary ("the Company") as of December 31, 2004 and
2003, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company as of
December 31, 2004 and 2003, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2004, in conformity with accounting principles generally accepted in the United
States of America.
/s/ Marcum & Kliegman LLP
------------------------
Marcum & Kliegman LLP
Melville, NY
February 4, 2005
F-3
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
December 31,
2004 2003
---- ----
Assets:
Current Assets:
Cash and Cash Equivalents $16,411,735 $15,920,993
Accounts Receivable - Net 11,714,691 8,004,481
Costs and Estimated Profits in Excess
of Interim Billings 636,985 1,817,135
Deferred taxes 1,111,000 918,000
Other Current Assets 596,253 541,458
---------- ---------
Total Current Assets 30,470,664 27,202,067
---------- ----------
Property and Equipment - Net 2,546,948 2,591,758
---------- ----------
Other Assets:
Capitalized Software Costs - Net 1,132,453 1,087,116
Customer Lists - Net 2,179,237 2,701,751
Deferred Taxes 1,284,000 882,000
Other Assets 93,599 168,697
---------- ----------
Total Other Assets 4,689,289 4,839,564
---------- ----------
Total Assets $37,706,901 $34,633,389
========== ==========
See Notes to Consolidated Financial Statements.
F-4
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
December 31,
2004 2003
---- ----
Liabilities and Stockholders' Equity:
Current Liabilities:
Current Portion - Long Term Debt $ 666,667 $ 666,667
Current Portion Capital Lease Obligations 64,450 61,416
Accounts Payable 1,572,930 1,329,765
Accrued Expenses 1,545,127 2,295,454
Interim Billings in Excess of Costs and Estimated
Profits 7,497,773 7,263,285
Deferred Revenue 907,630 871,628
---------- ----------
Total Current Liabilities 12,254,577 12,488,215
---------- ----------
Long Term Debt - Less current portion 333,361 1,000,020
Capital Lease Obligations - Less current portion 21,532 85,982
Interest Rate Swap at Fair Value 15,152 59,068
Deferred Rent Payable 455,427 --
---------- ----------
Total Non Current Liabilities 825,472 1,145,070
---------- ----------
Commitments and Contingencies
Stockholders' Equity:
Preferred Stock - $.01 Par Value, 3,000,000
Shares Authorized; None issued and outstanding -- --
Common Stock - $.01 Par Value; Authorized
15,000,000 Shares; Issued and outstanding
5,567,124 and 5,339,200 shares at December 31, 2004,
5,528,247 and 5,304,489 shares at December 31, 2003 55,671 55,282
Additional Paid-in Capital 29,893,223 29,010,212
Accumulated Comprehensive loss - Interest Rate Swap (15,152) (59,068)
Accumulated Deficit (3,593,908) (6,346,873)
---------- ----------
26,339,834 22,659,553
Less: cost of shares of Common Stock held
in treasury - 227,924 shares at December 31, 2004
and 223,758 shares at December 31, 2003 1,712,982 1,659,449
---------- ----------
Total Stockholders' Equity 24,626,852 21,000,104
---------- ----------
Total Liabilities and Stockholders' Equity $ 37,706,901 $ 34,633,389
========== ==========
See Notes to Consolidated Financial Statements.
F-5
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Year ended December 31,
2004 2003 2002
---- ---- ----
Revenues:
Software and Related
Systems and Services:
General $16,931,606 $17,541,356 $13,921,449
Maintenance Contract
Services 8,289,525 7,069,000 6,247,336
------------- ------------- -------------
Total Software and Related
Systems and Services 25,221,131 24,610,356 20,168,785
Application Service Provider Services 1,725,473 591,202 --
Data Center Services 2,058,240 1,973,492 1,957,392
------------- ------------- -------------
Total Revenues 29,004,844 27,175,050 22,126,177
------------ ------------ ------------
Cost of Revenues:
Software and Related
Systems and Services:
General 9,203,071 9,250,378 9,463,380
Maintenance Contract
Services 4,168,975 3,406,183 3,348,217
------------- ------------- -------------
Total Software and Related
Systems and Services 13,372,046 12,656,561 12,811,597
Application Service Provider Services 926,333 377,305 --
Data Center Services 849,353 1,034,382 1,011,602
-------------- ------------- -------------
Total Cost of Revenues 15,147,732 14,068,248 13,823,199
------------ ------------ ------------
Gross Profit 13,857,112 13,106,802 8,302,978
------------ ------------ -------------
Selling, General and
Administrative Expenses 7,293,865 7,968,892 5,538,184
Research, Development and Maintenance 3,498,448 2,769,811 1,669,381
------------- ------------- -------------
Total 10,792,313 10,738,703 7,207,565
------------ ------------ -------------
Operating Income 3,064,799 2,368,099 1,095,413
Interest and Other Income 126,379 73,800 46,115
Interest and Other Expense (129,213) (199,573) (262,310)
--------------- --------------- ---------------
Income before Income Tax (Benefit) 3,061,965 2,242,326 879,218
Income Tax (Benefit) 309,000 (786,575) (316,000)
-------------- --------------- ---------------
Net Income $ 2,752,965 $ 3,028,901 $ 1,195,218
============ ============ ============
See Notes to Consolidated Financial Statements.
F-6
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Year ended December 31,
2004 2003 2002
---- ---- ----
Earnings Per Share ("EPS") of Common Stock
Basic EPS $ .52 $ .69 $ .32
=========== =========== ===========
Weighted Average Number of Shares of
Common Stock Outstanding 5,331,700 4,418,364 3,748,537
=========== =========== ===========
Diluted EPS $ .50 $ .64 $ .29
=========== =========== ===========
Weighted Average Number of Shares of
Common Stock and Common Stock
Equivalents Outstanding 5,536,731 4,752,068 4,153,484
=========== =========== ===========
See Notes to Consolidated Financial Statements.
F-7
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
-----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------------------------------------------------------------------------------------------
Accumulated
-----------
Comprehensive
-------------
Additional Loss Total
---------- ---- -----
Common Stock Paid-in Unearned Accumulated Interest Rate Comprehensive Treasury Shares Stockholders'
------------ ------- -------- ----------- ------------- ------------- --------------- ------------
Shares Amount Capital Compensation Deficit Swap Income Shares Amount Equity
------ ------ ------- ------------ ------- ---- ------ ------ ------ ------
Balance -
January 1, 2002 3,719,247 $37,192 $20,856,166 $ -- $(10,570,992) $ (74,875) $ -- 28,038 $ (299,810) $ 9,947,681
Common Stock
Issued -
Exercise of
Options 327,183 3,272 501,938 -- -- -- -- 61,759 (348,302) 156,908
Issuance of
Warrants
and Options -- -- 53,673 (14,400) -- -- -- -- -- 39,273
Change in Fair
Value of Interest
Rate Swap -- -- -- -- -- (32,838) (32,838) -- -- (32,838)
Net Income -- -- -- -- 1,195,218 -- 1,195,218 -- -- 1,195,218
--------- ------ ---------- ------- ----------- ------- --------- ------ --------- ----------
$1,162,380
=========
Balance -
December 31, 2002 4,046,430 40,464 21,411,777 (14,400) (9,375,774) (107,713) 89,797 (648,112) 11,306,242
Common Stock
Issued -
Exercise of
Options 668,197 6,682 1,793,574 -- -- -- $ -- 133,961 (1,011,337) 788,919
Common Stock
Issued -
Exercise of
Warrants 713,620 7,136 5,712,972 -- -- -- -- -- -- 5,720,108
Common Stock
Issued -
Acquisition 100,000 1,000 527,000 -- -- -- -- -- -- 528,000
Cost Related
to Warrant
Extension -- -- 6,336 -- -- -- -- -- -- 6,336
Change in Fair
Value of
Interest Rate
Swap -- -- -- -- -- 48,645 48,645 -- -- 48,645
Amortization of
Warrants Issued
for Services -- -- -- 14,400 -- -- -- -- -- 14,400
Dividends -- -- (441,447) -- -- -- -- -- -- (441,447)
Net Income -- -- -- -- 3,028,901 -- 3,028,901 -- -- 3,028,901
--------- ------ ---------- ------- ----------- ------- --------- ------ --------- ----------
$3,077,546
=========
Balance -
December 31, 2003 5,528,247 55,282 29,010,212 -- (6,346,873) (59,068) 223,758 (1,659,449) 21,000,104
Common Stock
Issued -
Exercise of
Options 38,877 389 166,011 -- -- -- $ -- 4,166 (53,533) 112,867
Change in
Deferred Tax
Asset Valuation
Allowance -- -- 717,000 -- -- -- -- -- -- 717,000
Change in
Fair Value of
Interest Rate
Swap -- -- -- -- -- 43,916 43,916 -- -- 43,916
Net Income -- -- -- -- 2,752,965 -- 2,752,965 -- -- 2,752,965
--------- ------ ---------- ------- ----------- ------- --------- ------ --------- ----------
$2,796,881
=========
Balance -
December 31, 2004 5,567,124 $55,671 $29,893,223 $ -- $(3,593,908) $ (15,152) 227,924 $(1,712,982) $24,626,852
========= ====== ========== ====== ========== ======= ======= ========== ==========
See Notes to Consolidated Financial Statements.
F-8
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
-------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------
Year ended December 31,
2004 2003 2002
---- ---- ----
Operating Activities:
Net Income $ 2,752,965 $ 3,028,901 $ 1,195,218
------------ ------------ ------------
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation and Amortization 1,624,393 1,233,592 1,036,721
Costs Related to Issuance
of warrants and options -- 20,736 39,273
Provision for Doubtful Accounts (204,000) 1,046,094 370,000
Deferred Income Taxes 122,000 (900,000) (400,000)
Loss on Retirement of Property and Equipment -- 18,632 --
Changes in Assets and Liabilities:
[Increase] Decrease in:
Accounts Receivable (3,506,210) (1,991,720) (1,551,885)
Costs and Estimated Profits in
Excess of Interim Billings 1,180,150 2,040,387 (74,166)
Other Current Assets (54,795) (344,881) (68,345)
Other Assets 28,431 69,389 89,368
Increase [Decrease] in:
Accounts Payable 243,165 163,620 477,463
Accrued Expenses (43,046) 645,226 562,509
Deferred Rent Payable 455,427 -- --
Interim Billings in Excess of
Costs and Estimated Profits 234,488 1,287,055 1,955,740
Deferred Revenue (197,705) (223,784) 409,843
-------------- ---------------- --------------
Total Adjustments (117,702) 3,064,346 2,846,521
--------------- -------------- --------------
Net Cash Provided by Operating Activities 2,635,263 6,093,247 4,041,739
------------- -------------- --------------
Investing Activities:
Acquisition of Property and
Equipment (1,328,050) (1,633,226) (254,467)
Capitalized Software Development (185,000) (179,500) --
Other (16,263) -- --
CareNet Acquisition -- (1,047,845) --
------------- ------------- --------------
Net Cash Used In Investing Activities $ (1,529,313) $ (2,860,571) $ (254,467)
------------- -------------- ---------------
See Notes to Consolidated Financial Statements.
F-9
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
-------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------
Year ended December 31,
2004 2003 2002
---- ---- ----
Financing Activities:
Payment of Capitalized Lease Obligations $ (61,416) $ (47,678) $ (29,674)
Dividend Paid -- (441,447) --
Net Proceeds from Stock Options and
Warrants Exercised 112,867 6,509,027 156,908
Payments of Term Loan (666,659) (583,325) (499,992)
-------------- -------------- -------------
Net Cash (Used in) Provided by
Financing Activities (615,208) 5,436,577 (372,758)
-------------- ------------ -------------
Net Increase in Cash
and Cash Equivalents 490,742 8,669,253 3,414,514
Cash and Cash Equivalents -
Beginning of Year 15,920,993 7,251,740 3,837,226
------------ ------------ -----------
Cash and Cash Equivalents -
End of Year $ 16,411,735 $ 15,920,993 $ 7,251,740
============ =========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the years for:
Interest $ 132,635 $ 159,940 $ 167,542
Income Taxes $ 237,879 $ 93,639 $ 41,517
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
Year Ended December 31, 2004:
During 2004, the Company received 4,166 shares of its common stock as
consideration for the exercise of certain stock options. The value of the shares
received was $53,533, which was the market value of the common stock on the date
of exercise.
During 2004, the Company acquired for $250,000 TxM software and customer lists.
The consideration consisted of $16,263 in cash and the assumption of $233,707
for certain liabilities for services to be performed in the future.
The fair value of the interest rate swap decreased by $43,916 for the year ended
December 31, 2004. At December 31, 2004, it is valued at $15,152.
Year ended December 31, 2003:
During 2003, the Company acquired equipment in the amount of $183,326 in
connection with a capital lease.
During 2003, the Company received 133,961 shares of its common stock as
consideration for the exercise of certain stock options. The value of the shares
F-10
received was $1,011,337, which was the market value of the common stock on the
date of exercise.
During 2003, the Company accrued $721,003 of fixed assets related to its new
facility.
During 2003, the Company issued 100,000 shares of its common stock in connection
with the acquisition of CareNet. See Note 5. These shares were valued at
$528,000, which was based upon the average stock price three days before and
after the acquisition was agreed to and announced. The Company also issued a
$500,000 three-year promissory note and assumed contract obligations and
vacation liabilities totaling $68,068.
The fair value of the interest rate swap decreased by $48,645 for the year ended
December 31, 2003. At December 31, 2003, it is valued at $59,068.
Year ended December 31, 2002:
During 2002, stock options to purchase 327,183 shares of common stock were
exercised and proceeds of $505,210 includes $348,302, representing the market
value of the Company's common stock which was received for the exercise price of
certain of these options.
The fair value of the interest rate swap calculated at December 31, 2002 was
$107,713.
See Notes to Consolidated Financial Statements
F-11
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #1
-------------------------------------------------------------------------------
[1] The Company
Netsmart Technologies, Inc. and subsidiaries (the "Company") licenses,
customizes and installs its proprietary software products, operates a service
bureau and provides Application Service Provider ("ASP") Services and enters
into long term maintenance agreements with behavioral health and public health
organizations, methadone clinics and other substance abuse facilities throughout
the United States.
[2] Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include
Netsmart Technologies, Inc. ("Netsmart"), and its wholly-owned subsidiary,
Creative Socio-Medics Corp. ("CSM"). In addition, the results of operations from
the CareNet acquisition (see note 5) is included from July 2003. All
intercompany transactions are eliminated in consolidation.
Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the reporting period. Critical estimates include
management's judgements associated with: the application of the percentage of
completion method to the recognition of revenue, determination of an allowance
for doubtful accounts receivable, deferred income tax valuation allowance and
the capitalization, depreciation and amortization of certain long-term assets
(primarily software development costs and customer lists). Actual results could
differ from those estimates.
Cash and Cash Equivalents - The Company considers all highly liquid instruments
purchased with a maturity of three months or less to be cash equivalents. Cash
equivalents totaled approximately $1,053,000 and $1,042,000 at December 31, 2004
and 2003, respectively.
Concentration of Credit Risk - The Company extends credit to customers which
results in accounts receivable and costs and estimated profits in excess of
interim billings arising from its normal business activities. The Company does
not require collateral or other security to support financial instruments
subject to credit risk. The Company routinely assesses the financial strength of
its customers and based upon factors surrounding the credit risk of the
customers, believes that its accounts receivable credit risk exposure is
limited.
The Company's behavioral health information systems are marketed to specialized
care facilities, many of which are operated by various state and local
government entities and include entitlement programs. During the years ended
December 31, 2004, 2003 and 2002, approximately 49%, 57% and 52% respectively,
of the Company's revenue were generated from contracts directly or indirectly
with government agencies.
No one customer accounted for more than 10% of revenue for the years ended
December 31, 2004 and 2002. During the year ended December 31, 2003, one
customer accounted for approximately $2,861,000 or 10.5% of revenue. The account
receivable from this customer at December 31, 2003 was $589,000 or 7% of the
total accounts receivable.
F-12
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #2
[2] Summary of Significant Accounting Policies - [Continued]
The Company places its cash and cash equivalents with high credit quality
financial institutions. The amount on deposit in any one institution that
exceeds federally insured limits is subject to credit risk. At December 31, 2004
and 2003, cash and cash equivalent balances of $16.4 million and $15.8 million
respectively, were held at a financial institution in excess of federally
insured limits.
Revenue Recognition - The Company derives revenue principally from the licensing
of its software and maintenance services rendered in connection with such
licensing activities. Information processing revenue is recognized in the period
in which the service is provided. Maintenance contract revenue and ASP revenue
are recognized on a straight-line basis over the life of the respective
contract. The Company also derives revenue from the sale of third party hardware
and software which is recognized based upon the terms of each contract. The
above sources of revenue which do not require significant customization or
modification are recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed and determinable and collectibility is
probable. In addition, consulting revenue is recognized when the services are
rendered
Software development revenue from time-and-materials contracts, which require
customization and modification, are recognized as services are performed.
Revenue from fixed price software development contracts and revenue under
license agreements which require significant modification of the software
package to the customer's specifications, are recognized on the estimated
percentage-of-completion method. Progress towards completion on a contract is
measured using the units of work performed method. Revisions in cost estimates
and recognition of losses on these contracts are reflected in the accounting
period in which the facts become known. Contract terms provide for billing
schedules that differ from revenue recognition and give rise to costs and
estimated profits in excess of billings, and billings in excess of costs and
estimated profits.
Deferred revenue represents maintenance and ASP revenue billed and collected but
not yet earned.
The cost of maintenance revenue, which consists solely of staff payroll and
applicable overhead, is expensed as incurred.
Property and Equipment and Depreciation and Amortization - Property and
equipment is stated at cost less accumulated depreciation and amortization.
Depreciation of property and equipment is computed using the straight-line
method at rates adequate to allocate the cost of applicable assets over their
expected useful lives. Amortization of leasehold improvements is computed using
the shorter of the lease term or the expected useful life of these assets.
Estimated useful lives are as follows:
Equipment 3-7 Years
Furniture and Fixtures 5-10 Years
Leasehold Improvements Life of the Lease
Capitalized Software Costs - Capitalization of computer software development
costs begins upon the establishment of technological feasibility. Technological
feasibility for the Company's computer software products is generally based upon
achievement of a detail program design free of high risk development issues. The
Company capitalizes only those costs directly attributable to the development of
the software. The establishment of technological feasibility and the ongoing
assessment of recoverability of capitalized computer software development costs
requires considerable judgment by management with respect to certain external
factors, including, but not limited to, technological feasibility, anticipated
future gross revenue, estimated economic life and changes in software and
hardware technology. Prior to reaching technological feasibility these costs are
expensed as incurred and included in research development and maintenance.
Activities undertaken after the products are available for general release to
customers to correct errors or keep the product updated are expensed as incurred
and included in research, development and maintenance. Amortization of
capitalized computer software development costs commences when the related
products become available for general release to customers.
F-13
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #3
-------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
Amortization is provided on a product by product basis. The annual
amortization is the greater of the amount computed using (a) the ratio that
current gross revenue for a product bear to the total of current and anticipated
future gross revenue for that product or (b) the straight-line method over the
remaining estimated economic life of the product. The estimated life of these
products range from 3 to 8 years.
The Company periodically performs reviews of the recoverability of such
capitalized software costs. At the time a determination is made that capitalized
amounts are not recoverable based on the estimated cash flows to be generated
from the applicable software, any remaining capitalized amounts are written off.
The amount allocated to purchased software related to the CareNet acquisition
(see note 5), totaled $883,075.
Information related to capitalized software development costs applicable to
operations is as follows:
Year ended December 31, 2004 2003 2002
----------------------- ----------- ----------- ---------
Beginning of Year $1,087,116 $ 382,387 $ 686,301
Capitalized 334,872 1,062,575 --
Amortization (289,535) (357,846) (303,914)
----------- ------------ -----------
Net $1,132,453 $ 1,087,116 $ 382,387
=========== ============ ===========
Customer Lists - Customer lists represent a listing of customers obtained
through the acquisitions of CSM, Johnson Computing System, ("Johnson"), AIMS,
CareNet (see note 5), and other to which the Company can market its products.
Customer lists are being amortized on the straight-line method over an estimated
useful life of 12 years for the CSM and Johnson lists, 9 years for the CareNet
list, 7 years for the AIMS list and 6 years for other list. The amount allocated
to customer lists related to the CareNet acquisition totaled $1,097,138.
Customer lists at December 31, 2004 and 2003 are as follows:
December 31,
2004 2003
------ ----
Customer Lists $ 6,281,299 $ 6,197,461
Less: Accumulated Amortization (4,102,062) (3,495,710)
------------- -------------
Net $ 2,179,237 $ 2,701,751
============= =============
Amortization expense amounted to $606,352, $537,242 and $476,290, respectively,
for the years ended December 31, 2004, 2003 and 2002.
Future amortization of customer lists are approximately $612,000,
$611,000,$299,000, $193,000 and $154,000 for the years ending December 31, 2005,
2006, 2007, 2008 and 2009 respectively, and $310,000 thereafter.
Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of", the Company evaluates its long-lived assets for financial
impairment, and continues to evaluate them as events or changes in circumstances
indicate that the carrying amount of such assets may not be fully recoverable.
The Company evaluates the recoverability of long-lived assets by measuring the
carrying amount of
F-14
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #4
-------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
the assets against the estimated undiscounted future cash flows associated with
them. At the time such evaluations indicate that the future undiscounted cash
flows of certain long-lived assets are not sufficient to recover the carrying
value of such assets, the assets are adjusted to their fair values.
Stock Options and Similar Equity Instruments - At December 31, 2004, the Company
had three stock-based employee compensation plans, which are described more
fully in Note 13. As permitted under SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure", which amended SFAS No. 123,
"Accounting for Stock-Based Compensation", the Company has elected to continue
to follow the intrinsic value method in accounting for its stock-based employee
compensation arrangements as defined by Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees", and related
interpretations including Financial Accounting Standards Board ("FASB")
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation", an interpretation of APB No. 25. No stock-based employee
compensation cost is reflected in net income, as all options granted under those
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation:
Year ended
December 31,
2004 2003 2002
---- ---- ----
Net Income as Reported $2,752,965 $3,028,901 $1,195,218
Deduct: Total stock-based employee compensation
expense determined under the fair value-based method
for all awards, net of related tax effect 1,368,139 857,768 123,952
----------- ------------ ------------
Pro Forma Net Income $1,384,826 $2,171,133 $1,071,266
========== ========== ==========
Basic Net Income Per Share as Reported $ .52 $ .69 $ .32
========== ========== ==========
Basic Pro Forma Net Income Per Share $ .26 $ .49 $ .29
========== ========== ==========
Diluted Net Income Per Share as Reported $ .50 $ .64 $ .29
========== ========== ==========
Diluted Pro Forma Net Income Per Share $ .25 $ .46 $ .26
========== ========== ==========
The fair value of options at date of grant was estimated using the Black-Scholes
fair value based method with the following weighted average assumptions:
2004 2003 2002
---- ---- ----
Expected Life (Years) 5 5 5
Interest Rate 4.00% 4.00% 4.00%
Annual Rate of Dividends 0% 0% 0%
Volatility 68% 66% 63%
F-15
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #5
-------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
The weighted average fair value of options at date of grant using the fair value
based method during 2004, 2003 and 2002 is estimated at $3.95, $2.38 and $1.42,
respectively.
In December 2004, FASB issued SFAS No. 123 (Revised), "Share-Based Payments
(Revised 2004)". See new accounting pronouncements.
Earnings Per Share - Basic earnings per share of common stock is computed by
dividing net income by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per share reflects the amount of
earnings for the period available to each share of common stock outstanding
during the reporting period, giving effect to all potentially dilutive shares of
common stock from the potential exercise of stock options and warrants.
The computation of diluted earnings per share does not assume conversion,
exercise or contingent issuance of securities that would have an antidilutive
effect on earnings per share (i.e. improving earnings per share). The dilutive
effect of outstanding options and warrants and their equivalents are reflected
in diluted earnings per share by the application of the treasury stock method.
Options and warrants will have a dilutive effect only when the average market
price of the common stock during the period exceeds the exercise price of the
options or warrants. The Company had potentially dilutive options and warrants
outstanding of 300,780, -- and 713,544 during the years ended December 31, 2004,
2003 and 2002, respectively, that were not included in the calculation of
diluted earnings per share because they were anti dilutive.
The following table sets forth the computation of basic and diluted earnings per
share:
Year ended December 31,
2004 2003 2002
---- ---- ----
Numerator:
Net Income $2,752,965 $3,028,901 $1,195,218
========== ========== ==========
Denominator:
Weighted average shares 5,331,700 4,418,364 3,748,537
----------- ----------- -----------
Effect of dilutive securities:
Employee stock options 205,031 333,704 395,668
Stock warrants -- -- 9,279
----------- ------------ -----------
Dilutive potential common shares 205,031 333,704 404,947
----------- ------------ -----------
Denominator for diluted earnings per
share-adjusted weighted average shares
after assumed conversions 5,536,731 4,752,068 4,153,484
=========== ============ ===========
Advertising - Advertising costs are expensed as incurred. Advertising expense
amounted to $392,575, $328,199 and $139,110 for the years ended December 31,
2004, 2003 and 2002, respectively.
Reclassification - Certain prior years' amounts have been reclassified to
conform to the current year's presentation.
Financial Instruments - SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" as amended requires the recognition of all derivative
instruments as either assets or liabilities on the balance sheet measured at
fair value. Generally, increases or decreases in the fair value of derivative
instrument will be recognized as gains or losses in earnings in the period of
change. If the derivative instrument is designated and qualifies as a cash flow
hedge, the change in fair value of the derivative instrument will be recorded as
a separate component of stockholders' equity.
F-16
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #6
-------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
The Company entered into an interest rate swap to hedge exposure related to
changes in the LIBOR rate. Before entering into a derivative transaction for
hedging purposes, it is determined that a high degree of initial effectiveness
exists between the change in value of the hedged item and the change in the
value of the determinative instrument from movement in interest rates. High
effectiveness means that the change in the value of the derivative instrument
will effectively offset the change in the fair value of the hedged item. The
effectiveness of each hedged item is measured throughout the hedged period. Any
hedge ineffectiveness as defined by SFAS No. 133 is recognized in the income
statement.
New Accounting Pronuncements - In December 2004, the FASB issued SFAS No. 123R,
"Share-Based Payment." SFAS No. 123R eliminates the alternative to use APB No.
25's intrinsic value method of accounting that was provided in SFAS No 123 as
originally issued. SFAS No. 123R requires entities to recognize the cost of
employee services in exchange for awards of equity instruments based on the
grant-date fair value of those awards (with limited exceptions). That cost will
be recognized over the period during which the employee is required to provide
the service in exchange for the award. No compensation cost is recognized for
equity instruments for which employees do not render the requisite service. SFAS
No. 123R requires entities to initially measure the cost of employee services
received in exchange for an award of liability instruments based on its current
fair value; the fair value of the award will be remeasured at each reporting
date through the settlement date. Changes in fair value during the requisite
service period will be recognized as compensation cost over that period. The
grant date fair value of employee share options and similar instruments will be
estimated using option-pricing models adjusted for the unique characteristics of
those instruments. SFAS No. 123R is effective as of the beginning of the
Company's interim reporting period that begins on July 1, 2005. The transitional
provisions of SFAS No. 123R will not have a material effect on the Company's
consolidated financial position or results of operations as substantially all
outstanding equity instruments vest on or prior to June 30, 2005. The Company
will utilize the fair value method for any future instruments after the
implementation date.
In December 2004, the FASB issued FAS No. 153, "Exchanges of Nonmonetary Assets,
an amendment of APB Opinion No. 29." This Statement eliminates the exception
from fair value measurement for nonmonetary exchanges of similar productive
assets in paragraph 21(b) of APB Opinion No. 29 and replaces it with an
exception for exchanges that do not have commercial substance. This Statement
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. The provisions of this Statement are effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The Company
will apply the provisions of this Statement prospectively to nonmonetary asset
exchanges occurring on or after January 1, 2006.
In April 2004, the EITF issued Statement No. 03-06 "Participating Securities and
the Two-Class Method Under FASB Statement No. 128, Earnings Per Share" ("EITF
03-06"). EITF 03-06 addresses a number of questions regarding the computation of
earnings per share by companies that have issued securities other than common
stock that contractually entitle the holder to participate in dividends and
earnings of the company when, and if, it declares dividends on its common stock.
The issue also provides further guidance in applying the two-class method of
calculating earnings per share, clarifying what constitutes a participating
security and how to apply the two-class method of computing earnings per share
once it is determined that a security is participating, including how to
allocate undistributed earnings to such a security. EITF 03-06 is effective for
fiscal periods beginning after March 31, 2004. The adoption of this statement
did not have any effect on the Company's calculation of EPS.
In September 2004, the EITF issued statement EITF Issue No. 04-08, "The Effect
of Contingently Convertible on Debt on Diluted Earnings per Share" ("EITF
04-08"). Contingently convertible debt instruments are generally convertible
into common shares of an issuer after the common stock price has exceeded a
predetermined threshold for a specified period of time (the "market price
contingency"). EITF 04-08 requires that shares issuable upon conversion of
contingently convertible debt be included in diluted earnings per share
computations regardless of whether the market price contingency contained in the
debt instrument has been met. EITF 04-08 is effective for reporting periods
ending after
F-17
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #7
-------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
December 15, 2004 and requires restatement of prior periods to the extent
applicable. The adoption of this statement is not expected to have an effect on
the Company's calculation of EPS.
[3] Accounts Receivable
Accounts receivable is shown net of allowance for doubtful accounts of $423,720
and $1,126,236 at December 31, 2004 and 2003 respectively. The changes in the
allowance for doubtful accounts are summarized as follows:
Year Ended December 31,
2004 2003
---- ----
Beginning Balance $ 1,126,236 $ 530,640
Provision for Doubtful Accounts (204,000) 1,046,094
Charge-offs (498,516) (450,498)
------------ -----------
Ending Balance $ 423,720 $ 1,126,236
=========== ===========
[4] Costs, estimated profits, and billings on uncompleted contracts are
summarized as follows:
December 31,
2004 2003
---- ----
Costs Incurred on Uncompleted Contracts $10,663,115 $11,540,502
Estimated Profits 5,657,902 7,615,475
------------- ------------
Total 16,321,017 19,155,977
Billings to Date 23,181,805 24,602,127
------------- ------------
Net $(6,860,788) $(5,446,150)
============= ============
Included in the accompanying consolidated balance sheet under the following
captions:
Costs and estimated profits in excess
of interim billings $ 636,985 $ 1,817,135
Interim billings in excess of costs and
estimated profits (7,497,773) (7,263,285)
------------- ------------
Net $(6,860,788) $(5,446,150)
============= ============
[5] Acquisitions
On June 25, 2003, the Company acquired substantially all of the assets of the
CareNet segment ("CareNet") of Shuttle Data Systems Corporation, d/b/a Adia
Information Management Corp. ("Adia"), pursuant to an asset purchase agreement
dated June 25, 2003, among the Company, Adia and Steven Heintz, Jr., the
president and majority shareholder of Adia. The principal assets acquired were
the intellectual property and customer contracts of CareNet. The total purchase
price, including acquisition costs, was $2,003,913 which consisted of 100,000
shares of common stock of the Company valued at $528,000, $838,740 in cash and a
three-year promissory note in the principal amount of $500,000 payable in 36
equal monthly installments of principal plus interest at the average prime rate
plus 1% as defined in the note agreement. Adia has received certain piggyback
registration rights with respect to these 100,000 shares. The cash portion of
the purchase price was paid out of existing working capital. The Company also
assumed certain contractual obligations and liabilities totaling $68,068 and
incurred
F-18
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #8
-------------------------------------------------------------------------------
[5] Acquisitions - [Continued]
$69,105 in legal and accounting costs which are included in the purchase price.
The cost of the acquisition was allocated to purchased software in the amount of
$883,075, customer lists in the amount of $1,097,138, and computer hardware in
the amount of $23,700. The Company is amortizing the purchased software over an
eight-year life and the customer lists over a nine-year life.
In addition, in connection with the acquisition, the Company entered into a
three year non-compete and non-solicitation agreement with Steven Heintz, Jr.
and Jennifer Lindbert for which they were paid an aggregate fee of $140,000,
which fee was paid in cash out of existing working capital and is included in
"other assets" on the consolidated balance sheet. The covenant not to compete is
being amortized over the three year life. Amortization expense for the years
ended December 31, 2004 and 2003 was $46,667 and $23,333 respectively.
The Company accounted for this acquisition pursuant to the purchase method of
accounting. For accounting purposes the Company recorded the assets and related
liabilities of CareNet effective as of June 30, 2003. The Company incorporated
the operations of CareNet into its operations commencing July 1, 2003.
The following unaudited proforma operating results assumes the CareNet
acquisition occurred on January 1, 2002. In the opinion of management, all
adjustments necessary to present fairly such unaudited proforma information has
been made. The results presented are not necessarily indicative of the results
of operations had the acquisition actually occurred on January 1, 2002.
Year ended December 31,
(in 000's except Per Share Data)
2003 2002
---- ----
Revenue $27,530 $22,773
Net Income $ 3,040 $ 1,218
Net Income Per Share - Basic $ .69 $ .32
Diluted $ .64 $ .29
[6] Property and Equipment
Property and equipment consist of the following:
December 31,
2004 2003
---- ----
Equipment, Furniture and Fixtures $2,980,440 $2,337,632
Leasehold Improvements 556,893 562,672
------------ ------------
Totals - At Cost 3,537,333 2,900,304
Less: Accumulated Depreciation
and Amortization 990,385 308,546
------------ ------------
Net $2,546,948 $2,591,758
============ ============
Depreciation and amortization expense amounted to $681,839, $315,171, and
$256,517, respectively for the years ended December 31, 2004, 2003 and 2002.
F-19
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #9
-------------------------------------------------------------------------------
[7] Long Term Debt
Long-term debt at December 31, 2004 consists of the following:
Term loan payable, bank - due in monthly installments
of $41,666. $ 750,028
Note payable, ADIA - due in monthly installments of
$13,889. 250,000
------------
Total Long-Term Debt 1,000,028
Less: Current Portion 666,667
-----------
Long-Term Debt, Less Current Portion $ 333,361
============
The Company has a five-year term loan with a bank with an original principal
balance of $2.5 million which matures in June 2006. The term loan is paid in
equal monthly installments during the term of the loan plus interest. The term
loan bears interest at LIBOR plus 2.5%. In addition, the Company entered into an
interest rate swap agreement on the term loan at 7.95% for five years (Note 12).
The financing agreement contains certain covenants including limitations on the
Company's ability to incur liens, enter into change of control transactions,
maintain a minimum net worth at $9,000,000 and requires the maintenance of
certain financial ratios. The borrowing is collateralized by a first priority
security interest and lien on all the assets of the Company. As of December 31,
2004, the Company was in compliance with the financial covenants of this
agreement.
In connection with the acquisition of CareNet (see note 5), the Company issued a
three year promissory note to Adia in the principal amount of $500,000 payable
in 36 equal monthly installments of principal plus interest at the prime rate
plus 1% on the date of issuance adjusted on each note anniversary date (5.25% at
December 31, 2004).
Maturities of long-term debt at December 31, 2004 are as follows:
For the Year Ending
December 31, Amount
----------- ------
2005 $ 666,667
2006 333,361
-----------
Total $ 1,000,028
[8] Income Taxes
The Company utilizes an asset and liability approach to determine the extent of
any deferred income taxes, as described in SFAS No. 109, "Accounting for Income
Taxes." This method gives consideration to the future tax consequences
associated with differences between financial statement and tax bases of assets
and liabilities.
During the years ended December 31, 2004 and 2003, the Company utilized
approximately $2.4 million and $2.8 million, respectively of net operating loss
carryforwards. At December 31, 2004, the Company has remaining net operating
loss carryforwards of approximately $4,026,000 expiring through 2020. Pursuant
to Section 382 of the Internal Revenue Code regarding substantial changes in
Company ownership, utilization of this net operating loss carryforward is
limited. Approximately $3,199,000 can be used in 2005 and $827,000 can be used
in 2006; unused amounts can be carried forward. In addition, the $717,000 tax
benefit related to approximately $1,800,000 of net operating losses generated in
2000 on exercise of non-qualified compensatory stock options and warrants was
credited to paid-in-capital in 2004.
F-20
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #10
-------------------------------------------------------------------------------
[8] Income Taxes - [Continued]
The Company's provision for taxes for the year ended December 31, 2004 includes
certain state and local taxes.
The expiration dates of net operating loss carryforwards are as follows:
December 31, Amount
------------ ------
2017 2,216,000
2020 1,810,000
------------
$ 4,026,000
Provision for income taxes consists of the following:
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
Current:
Federal $ 56,000 $ 24,000 $ --
State 131,000 89,425 84,000
---------- ----------- ------------
187,000 113,425 84,000
---------- ----------- ------------
Deferred:
Federal 104,000 (900,000) (400,000)
State 18,000 -- --
----------- ------------ ------------
122,000 (900,000) (400,000)
----------- ------------ -------------
Total $ 309,000 $ (786,575) $ (316,000)
========== ============ =============
The difference between income taxes at the statutory Federal income tax rate and
income taxes reported in the income statement is as follows:
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
Income taxes at the federal statutory rate 34% 34% 34%
State and local income taxes net of Federal taxes 3 3 5
Nondeductible expenses 2 2 6
Federal Minimum Tax 2 --
Decrease in valuation allowance (31) (76) (82)
Other -- -- 1
----- ------ ------
10% (35)% (36)%
===== ====== ======
F-21
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #11
-------------------------------------------------------------------------------
[8] Income Taxes - [Continued]
Significant components of the Company's deferred tax assets are comprised of the
following:
December 31,
------------
2004 2003
---- ----
Net operating loss carryforward $ 1,605,000 $ 2,640,000
Allowance for doubtful accounts 169,000 457,000
Accrued vacation and bonuses 317,000 364,000
Alternative minimum tax credit carryforward 147,000 98,000
Other 157,000 (28,000)
------------- ------------
Total deferred tax assets 2,395,000 3,531,000
Valuation allowance -- (1,731,000)
------------- ------------
Net deferred tax assets $ 2,395,000 $ 1,800,000
============= ============
The valuation allowance decreased by $1,731,000 at December 31, 2004 of which
$717,000 was recorded as an addition to Additional Paid in Capital from stock
based net operating loss carry forwards. During 2004, the Company reduced the
valuation allowance to zero based upon its belief that it is more likely than
not that the entire net operating loss carry forward will be utilized.
The change in the valuation allowance for deferred tax assets are summarized as
follows:
Year Ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
Beginning Balance $ 1,731,000 $ 4,010,000 $ 4,467,000
Change in Allowance (1,731,000) (2,279,000) (457,000)
------------ ----------- ----------
Ending Balance $ -- $ 1,731,000 $ 4,010,000
============ =========== ==========
[9] Stockholders' Equity
The Company's Board of Directors is authorized to issue preferred stock from
time to time without stockholder action, in one or more distinct series. The
Board of Directors is authorized to determine the rights and preferences of the
preferred stock when issued. The Board of Directors has authorized the issuance
of Series A, Series B and Series D preferred stock. No shares of any series of
preferred stock were outstanding on December 31, 2004.
Common Stock Issuances - On June 25, 2003 the Company issued 100,000 shares of
its common stock in connection the acquisition of CareNet. See note 5 for
information relating to this acquisition.
Treasury Stock - During 2004, options to purchase 38,877 shares were exercised
and the Company received gross proceeds of $166,400. Pursuant to the option
grants, employees have the right to pay for the exercise price of the options by
delivering shares of common stock owned by them. Included in the 2004 exercise
of options were 12,250 options owned by a Company officer. These options were
exercised by the delivery of 4,166 shares of the Company's common stock, which
were valued at $53,533, which was based upon the market price of the common
stock on the date of exercise in accordance with the cashless exercise
provisions of the Company's stock option plans.
During 2003, stock options to purchase 668,197 shares were exercised and the
Company received gross proceeds of $1,800,256. Included in the gross proceeds
received from the exercise of the options was the
F-22
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #12
-------------------------------------------------------------------------------
[9] Stockholders' Equity - [Continued]
delivery of 133,961 shares of the Company's common stock, which were valued at
$1,011,337, which was based upon the market price of the common stock on the
date of the exercise in accordance with the cashless exercise provisions fo the
Company's stock option plans.
Included in the 2003 option exercises were 350,280 options owned by certain of
the Company's officers and members of the Board of Directors. Pursuant to the
option grants, employees have the right to pay for the exercise price of the
options by delivering shares of common stock owned by them. These options were
exercised by delivery of 97,718 shares of the Company's common stock valued at
$682,965, which was based upon the market price of the common stock on the date
of exercise in accordance with the cashless exercise provisions of the Company's
stock option plans.
During 2002, stock options to purchase 327,183 shares were exercised and the
Company received gross proceeds of $505,210. Pursuant to the option grants,
employees have the right to pay for the exercise price of the options by
delivering shares of common stock owned by them. During 2002, the Company
received 61,759 shares having a value of $348,302, as the exercise price of the
options which was based upon the market price of the common stock on the date of
exercise in accordance with the cashless exercise provisions of the Company's
stock option plans.
Stock Options and Warrants - See Note 13 for information relating to the
Company's 1998, 1999 and 2001 Long-Term Incentive Plans.
During 2003, warrants to purchase 713,620 shares were exercised and the Company
received net proceeds of $5,720,108.
On February 27, 2003, the Board of Directors authorized management to purchase
up to $100,000 of the Company's common stock at any time the market price of the
common stock is less than $3.50 per share. Purchases of stock will be made from
time to time, depending on market conditions, in the open market or in privately
negotiated transactions, at prices deemed appropriate by management. There is no
set time limit on the purchases. The Company expects to fund any stock
repurchases from its operating cash flow. As of December 31, 2004, the Company
had not made any stock repurchases.
On December 21, 2000, the stockholders of the Company approved the 1999 Employee
Stock Purchase Plan. The plan reserves 150,000 shares of common stock. The plan
provides eligible employees with the opportunity to purchase shares of common
stock at a discounted price through regular payroll deductions. No shares have
been issued as of December 31, 2004 under this plan.
Dividends - In July 2003, the Company's Board of Directors approved a cash
dividend of $.10 per share of common stock which was paid in September 2003 to
all stockholders of record on August 20, 2003. The amount charged to additional
paid-in capital in August 2003, based upon the shares outstanding on August 20,
2003, the record date of the dividend, was $441,447.
[10] Capital Lease Obligations
Future minimum payments under capital lease obligations as of December 31, 2004
are as follows:
Year ending
-----------
December 31,
------------
2005 68,957
2006 21,877
--------
Total Minimum Payments 90,834
Less Amount Representing Interest at 7.9% Per annum 4,852
---------
Balance $ 85,982
========
F-23
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #13
-------------------------------------------------------------------------------
[10] Capital Lease Obligations - [Continued]
Capital lease obligations are collateralized by equipment which has a cost of
$183,326 at December 31, 2004 and $223,326 at December 31, 2003 and accumulated
amortization of $91,663 and $66,554 at December 31, 2004 and 2003, respectively.
Amortization of $61,109 in 2004 and $38,554 in 2003 and 8,000 in 2002,
respectively, has been included in depreciation expense.
[11] Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, accounts
payable and the note payable to Adia approximate the fair value of these
instruments because of their short maturities or floating interest rates.
The Bank debt, including current maturities, has a carrying value of
approximately $750,028 and an estimated fair value of $757,000. Estimated fair
value is based on the expected current rates offered to the Company for
instruments of the same or similar maturities, after considering the effect of
the interest rate swap.
[12] Commitments and Contingencies
Leases
------
The Company leases space for its executive offices and facilities under a
cancellable operating lease expiring October 2014. In addition the Company
leases four sales and service offices under non cancelable operating leases
expiring at various times through January 2007.
In December 2003, the Company relocated its Islip, New York headquarters
facility to a larger facility in Great River, New York. The lease is for a ten
year and ten month period. The lease provides for a fixed monthly rent of
$45,700 and includes an annual escalation increase of 3%. There are no lease
payments required during the first ten months of the lease and the Company has
the option of canceling the lease after six years. However, upon cancellation,
certain unamortized costs must be reimbursed to the landlord. Future maturities
of this lease were considered for the entire ten year and ten month period.
Minimum annual rentals under noncancellable operating leases having terms of
more than one year are as follows:
Year ending
-----------
December 31,
------------
2005 $ 745,000
2006 724,000
2007 617,000
2008 629,000
2009 624,000
Thereafter 3,258,000
-----------
Total $ 6,597,000
Rent expense amounted to $833,000, $519,000 and $455,000 respectively, for the
years ended December 31, 2004, 2003 and 2002.
F-24
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #14
-------------------------------------------------------------------------------
[12] Commitments and Contingencies [Continued]
Employment Agreements
---------------------
In April 2004, the Company entered into revised employment agreements with
Messrs. James L. Conway, Chief Executive Officer, Gerald O. Koop, President and
Anthony F. Grisanti, Chief Financial Officer. Messrs. Conway and Grisanti's
contract will expire on December 31, 2006 and Mr. Koop's contract will expire on
December 31, 2005. Messrs. Conway and Grisanti's contracts also provide for an
option to extend their contracts for one additional year so that upon the
exercise of such option, their contracts would expire on December 31, 2007. The
minimum aggregate base compensation for its three officers is $543,000 for 2005
and $362,000 for each of 2006 and 2007, subject to annual increases equal to the
greater of 5% or the increase in the cost of living index. The agreements also
provide the officers with an automobile allowance. In the event of a change of
control, the executive may receive severance payments equal to 36 months
compensation.
The Company also has a consulting agreement with a former Director, which
provides for annual fees of $75,000 through December 31, 2007. The agreement
also provides the former Director with an automobile allowance. In the event of
a change of control, the former Director may receive severance payments of 36
months compensation.
Effective April 1, 2004, we adopted an Executive Retirement, Non-Competition and
Consulting Plan which was subsequently amended August 5, 2004 effective April 1,
2004, pursuant to which, following their retirement, selected officers will be
entitled to receive a minimum payment of approximately $85,000 per year for a
period of six years, provided, that such officers (i) provide a minimum amount
of consulting days each month and (ii) agree to certain covenants not to
compete. The annual payments are subject to 10% increases up to a maximum of
$136,893 per year. Pursuant to the Executive Retirement, Non-Competition and
Consulting Plan, the selected officers are also entitled to receive health
benefits for life, provided that there are no breaches of the covenants not to
compete. Each of Messrs. Conway, Koop and Grisanti are entitled to receive
benefits under the plan.
Mr. Phillip's employment contract expired on December 31, 2003 and he retired
effective April 1, 2004. Pursuant to the terms of our Executive Retirement,
Non-Competition and Consulting Plan, Mr. Phillips will receive $85,000 per year
for each of the next six years; provided that he complies with the
non-competition covenants of the plan.
Future minimum payments related to consulting and Executive Retirement,
Non-Competition and Consulting agreements for the next five years are as
follows:
Year Ending
December 31, Amount
------------ ------
2005 169,000
2006 160,000
2007 160,000
2008 85,000
2009 85,000
Thereafter 21,000
----------
Total $ 680,000
Interest Rate Swap
------------------
In June 2001 the Company entered into an interest rate swap with a bank, which
expires on June 1, 2006. The swap transaction was entered into to protect the
Company from upward movement in interest rates
F-25
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #15
[12] Commitments and Contingencies - [Continued]
relating to outstanding bank debt (See note 7) and calls for a fixed rate of
7.95%. When the one-month LIBOR rate is below the fixed rate then the Company is
obligated to pay the bank for the difference in rates. When the one-month LIBOR
rate is above the fixed rate then the bank is obligated to pay the Company for
the difference in rates. At December 31, 2004 and 2003 the fair value of the
swap of $15,152 and $59,068, respectively, is recorded as a non-current
liability. The swap transaction has been accounted for as a hedge, and
accordingly, the change in the fair value of the swap of $43,916, $48,645 and
$32,838 during the years ended December 31, 2004, 2003, and 2002, respectively,
has been recorded as part of comprehensive income.
Letter of Credit
The Company relocated its Islip, New York headquarters to a larger facility in
Great River, New York. Included in the terms and conditions of the Great River
lease is the requirement that the Company provide to the landlord a letter of
credit in the amount of $292,980, which represents approximately six months
rent. This letter of credit was provided to the landlord on October 31, 2003.
After the first 22 months of the lease the letter of credit will be reduced to
the amounts as follows:
$224,150 for months 23 through 34 of the lease.
$195,320 for months 35 through 46 of the lease.
$146,490 for months 47 through 58 of the lease.
$97,660 for months 59 to the expiration of the lease.
[13] Stock-Based Compensation
Long Term Incentive Plans - The Company has three long-term incentive plans, the
1998 Long-Term Incentive Plan (the "1998 Plan"), as amended, the 1999 Long-Term
Incentive Plan (the "1999 Plan") and the 2001 Long-Term Incentive Plan (the
"2001 Plan"), as amended. The 2001 Plan was approved by the stockholders on
March 7, 2002 and originally provided for the issuance of 180,000 shares of
common stock. In January 2003, the 2001 Plan was amended and approved by the
stockholders to provide for an increase in the number of shares subject to the
plan from 180,000 to 550,000. In May 2004, the 2001 Plan was further amended and
approved by the stockholders to provide an increase in the number of shares
subject to the plan from 550,000 to 950,000. The Company may issue 790,000,
300,000 and 950,000 shares of Common Stock pursuant to the 1998 Plan, the 1999
Plan and the 2001 Plan, respectively. The options, when granted vest ratably
over one year. At December 31, 2004 there were 0, 4,250 and 4,045 shares
available for further issuance under the 1998 Plan, the 1999 Plan and 2001 Plan,
respectively.
The 1998 Plan, the 1999 Plan and the 2001 Plan (collectively, the "Plans") are
administered by the Compensation Committee of the board of directors. Officers
and other key employees, consultants and directors (other than non-employee
directors) are eligible to receive options or other equity-based incentives
under the Plans.
The Plans provides that each non-employee director automatically receives a
nonqualified stock option to purchase 6,000 shares of common stock and the
chairman of the audit committee and the compensation committee will receive a
nonqualified stock option to purchase 7,500 shares of common stock on April 1 of
each year. However, if there are not sufficient shares available under the
applicable Plan, the non-employee director will receive a lesser number of
shares.
During 2002, pursuant to an arrangement with a consultant, the Company issued a
non-qualified stock option to purchase 10,000 shares of stock at an exercise
price of $2.75, which was the fair market value of the stock at the date of
grant. The options were valued at $.57 per option based upon the Black-Scholes
calculation, which had an interest rate of 4% and a volatility rate of .48.
These options had a term of one year, and were exercised during 2002. The
Company recognized a charge to income under the Black-Scholes formula in the
amount of $5,673.
F-26
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #16
[13] Stock-Based Compensation - [Continued]
A summary of the activity under the Plans is as follows:
2004 2003 2002
------------------------- -------------------------- -----------------------
Weighted Weighted Weighted
-------- -------- --------
Average Average Average
------- ------- -------
Exercise Exercise Exercise
-------- -------- --------
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding - Beginning of
Year 365,755 $4.111 664,702 $2.276 793,385 $1.917
Granted During the Year 397,455 8.438 381,000 4.754 198,500 2.505
Canceled During the Year -- -- (11,750) 1.724 -- --
Exercised During the Year (38,877) 4.280 (668,197) 2.694 (327,183) 1.544
-------- ------- ---------- ------- --------- -------
Outstanding - End of Year 724,333 $6.476 365,755 $4.111 664,702 $2.276
======== ======= ========== ======= ========= =======
Exercisable - End of Year 525,606 $5.734 226,253 $3.721 575,451 $2.242
======== ======= ========== ======= ========= =======
The following table summarizes stock option information as of December 31, 2004:
Options Outstanding
-------------------
Weighted
--------
Average Remaining Options
----------------- -------
Exercise Prices Number Outstanding Contractual Life Exercisable
--------------- ------------------ ---------------- -----------
$13.29 1,500 4.25 Years 750
$8.49 299,280 4.42 Years 149,640
$8.20 96,675 4.50 Years 48,338
$6.61 9,000 3.58 Years 9,000
$4.93 124,628 3.08 Years 124,628
$4.37 7,500 8.50 Years 7,500
$4.37 106,250 3.50 Years 106,250
$2.50 24,000 2.25 Years 24,000
$2.40 5,000 2.50 Years 5,000
$2.38 5,000 2.50 Years 5,000
$1.81 45,500 1.00 Years 45,500
----- -------- ---------- --------
Totals 724,333 3.78 Years 525,606
======== ========== ========
Warrants Issued as Compensation - In 2001, the term of the Company's $12 Series
B Common Stock Purchase Warrants for 448,544 shares, was extended to January 31,
2002. In January 2002, the term of the 448,544 $12 warrants was further extended
to July 31, 2002. In July 2002, the term of the warrants was further extended to
January 31, 2003. There was no financing costs associated with the warrant
extensions in 2001 and 2002 because of the variance between the $12 exercise
price and the market value of the Company's stock at the date of the warrant
extension. In January 2003, the term of the warrants was further extended to
April 30, 2003. In April 2003, the Company agreed to extend the term of these
warrants to July 31, 2003. The Company re-measured the fair value of the
warrants at the dates of extension. No financing costs were recorded associated
with the warrant extension made in January 2003, as there was no material change
in their fair value. The Company charged $1,125 to operations related to the
warrant extension made in April 2003. In July 2003, the Company agreed to extend
the term of these same warrants from July 31, 2003 to October 31, 2003. The
Company re-measured the fair value of the warrants at the date of extension and
charged $5,211 of financing costs to operations
F-27
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #17
-------------------------------------------------------------------------------
[13] Stock-Based Compensation - [Continued]
in July 2003. On October 23, 2003, the Company reduced the exercise price of the
warrants from $12.00 per share to $10.00 per share and through October 31, 2003,
423,620 warrants were exercised and the Company received gross proceeds of
$4,236,200 less $59,592 of costs. The remaining 24,924 warrants expired
unexercised.
During 2003, 120,000 warrants that were issued in 1999 were exercised and the
Company received gross proceeds of $629,000.
During 2002, the Company issued warrants to purchase 200,000 shares in
connection with a financial advisory agreement whereby the Company would pay
consulting fees in addition to the issuance of warrants. These warrants, expired
over various times ranging from one to two years, were valued at $.24 per
warrant, which represented the costs of the services based upon the contractual
agreement. The warrants had the following exercise price, vesting dates and
expiration date for the number of shares set forth below:
Shares Exercise Price Vesting Date Expiration Date
------ -------------- ------------ ---------------
50,000 $2.69 April 10, 2002 March 31, 2003
30,000 $4.00 June 1, 2002 May 31, 2003
30,000 $5.00 September 1, 2002 February 28, 2004
30,000 $6.00 November 1, 2002 April 30, 2004
30,000 $7.00 January 1, 2003 December 31, 2004
30,000 $8.00 February 28, 2003 January 31, 2005
The $48,000 value of the warrants is being charged to operations over the
vesting period. As a result, $33,600 was charged to operations in 2002 and
$14,400 was charged to operations in 2003. During 2003, 170,000 of these
warrants were exercised and the Company received gross proceeds of $914,500 and
30,000 warrants with an exercise price of $4.00 expired.
A summary of warrant activity is as follows:
2004 2003 2002
------------------------- -------------------------- -----------------------
Weighted Weighted Weighted
-------- -------- --------
Average Average Average
------- ------- -------
Exercise Exercise Exercise
-------- -------- --------
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding - Beginning
of Year -- -- 768,544 $9.17 608,544 $10.11
Granted During the Year -- -- -- -- 648,544 $ 9.89
Expired During the Year -- -- (54,924) $6.72 (488,544) $11.30
Exercised During the Year -- -- (713,620) $8.10 -- --
-------- ----- --------- ------ ---------- -------
Outstanding - End of Year -- -- -- $ -- 768,544 $ 9.17
======== ====== ========== ======= ========== =======
Exercisable - End of Year -- -- -- $ -- 708,544 $ 9.31
======== ====== ========== ======= ========== =======
F-28
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #18
[14] Operating Segments
The Company currently classifies its operations into three business segments:
(1) Software and Related Systems and Services, (2) Data Center Services, (3)
Application Service Provider Services ("ASP"). Software and Related Systems and
Services is the design, installation, implementation and maintenance of computer
information systems that provide comprehensive healthcare information technology
solutions including billing, patient tracking and scheduling for inpatient and
outpatient environments, as well as clinical documentation and medical record
generation and management. Data Center Services involve Company personnel
performing data entry and data processing services for customers. ASP services
involve the Company offering several of its software products on a virtual
private network or internet delivery approach, thereby allowing its customers to
utilize the Company's products and pay on a monthly service basis. ASP services
is a new segment established as a result of the CareNet acquisition in June
2003. Prior to the acquisition of CareNet, the Company's ASP operations were
immaterial and were included in Software and Related Systems and Services.
Intersegment sales and sales outside the United States are not material.
Information concerning the Company's business segments is as follows:
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
Revenues:
---------
Software and Related Systems and Services $25,221,131 $24,610,356 $20,168,785
Data Center Services 2,058,240 1,973,492 1,957,392
Application Service Provider Services 1,725,473 591,202 --
------------- -------------- -----------
Total Revenues $29,004,844 $27,175,050 $22,126,177
-------------- =========== =========== ===========
Gross Profit:
-------------
Software and Related Systems and Services $11,849,085 $11,953,795 $ 7,357,188
Data Center Services 1,208,887 939,110 945,790
Application Service Provider Services 799,140 213,897 --
------------- -------------- ------------
Total Gross Profit $13,857,112 $13,106,802 $ 8,302,978
------------------ =========== =========== ============
Income before Income Taxes:
---------------------------
Software and Related Systems and Services $ 2,095,722 $ 1,700,571 $ 486,371
Data Center Services 784,353 476,959 392,847
Application Services Provider Services 181,890 64,796 --
-------------- --------------- -------------
Total Income before Income Taxes $ 3,061,965 $ 2,242,326 $ 879,218
-------------------------------- ============ ============ ============
Depreciation and Amortization:
------------------------------
Software and Related Systems and Services $ 1,247,962 $ 1,012,367 $ 866,115
Data Center Services 113,676 103,285 170,606
Application Services Provider Services 262,755 117,940 --
-------------- -------------- -------------
Total Depreciation and Amortization $ 1,624,393 $ 1,233,592 $ 1,036,721
----------------------------------- ============ ============ ============
Capital Expenditures:
---------------------
Software and Related Systems and Services $ 950,094 $ 2,546,295 $ 248,201
Data Center Services 12,144 151,390 6,266
Application Services Provider Services 93,501 2,006,683 --
--------------- ------------- -------------
Total Capital Expenditures $ 1,055,739 4,704,368 $ 254,467
-------------------------- ============ ============= =============
Identifiable Assets:
--------------------
Software and Related Systems and Services $31,291,838 $29,530,139 $20,540,031
Data Center Services 2,775,036 2,607,681 1,875,772
Application Services Provider Services 3,640,027 2,495,569 --
------------- ------------- -------------
Total Identifiable Assets $37,706,901 $34,633,389 $22,415,803
------------------------- =========== =========== ============
F-29
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #19
-------------------------------------------------------------------------------
[15] Legal Proceedings
From time to time the Company is involved in ordinary and routine litigation
matter in the normal course of business. The Company believes that the
resolution of these matters will not have a material adverse effect on its
consolidated financial position and results of operations.
F-30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NETSMART TECHNOLOGIES, INC.
Dated: March 17, 2005 By: /s/ James L. Conway
------------------------------
James L. Conway, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated. Each person whose signature
appears below hereby authorizes James L. Conway and Anthony F. Grisanti (or any
of them acting in the absence of the others), as his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution
for him and in his name, place and stead, in any and all capacities to sign any
and all amendments to this report, and to file same, with all exhibits thereto
and other documents in connection therewith, with the Securities and Exchange
Commission.
Signature Title Date
--------- ----- ----
/s/ James L. Conway Chief Executive Officer March 17, 2005
----------------------- and Director (Principal
James L. Conway Executive Officer)
/s/ Anthony F. Grisanti Chief Financial Officer March 17, 2005
----------------------- (Principal Financial and
Anthony F. Grisanti Accounting Officer)
/s/ John F. Phillips Director March 17, 2005
-----------------------
John F. Phillips
President and Director March __, 2005
-----------------------
Gerald O. Koop
/s/ Joseph G. Sicinski Director March 17, 2005
-----------------------
Joseph G. Sicinski
Francis J. Calcagno Director March 17, 2005
-----------------------
Francis J. Calcagno
/s/ John S.T. Gallagher Director March 17, 2005
-----------------------
John S.T. Gallagher
__________________ Director March __, 2005
Dr. Yacov Shamash
EXHIBIT INDEX
-------------
3.1(1) Restated Certificate of Incorporation, as amended
3.2(1) By-Laws
10.1(9) Employment Agreement dated April 1, 2004, between the
Registrant and James L. Conway
10.2(9) Consulting Agreement dated April 1, 2004, between the
Registrant and John F. Phillips
10.3(9) Employment Agreement dated April 1, 2004, between the
Registrant and Gerald O. Koop
10.4(9) Employment Agreement dated April 1, 2004, between the
Registrant and Anthony F. Grisanti
10.5(2) Consulting Agreement dated January 1, 2001, between the
Registrant and Edward D. Bright
10.6(1) 1993 Long-Term Incentive Plan
10.7(3) 1998 Long-Term Incentive Plan
10.8(4) 1999 Long-Term Incentive Plan
10.9(5) 2001 Long-Term Incentive Plan - Amended
10.10(4) 1999 Employee Stock Purchase Plan
10.11(2) Agreement dated June 1, 2001, between the Registrant and
Fleet Bank
10.12(6) AIMS Acquisition Agreement
10.13(7) Agreement dated June 25, 2003, among Registrant, Creative
Socio-Medics Corp., Shuttle Data Systems Corp.,
d/b/a/ ADIA Information Management Corp. and Steven
Heintz, Jr.
10.14(8) Lease agreement dated as of December 22, 2003, between
Registrant and Spacely LLC.
10.14(10) Amended Executive Retirement, Non Competition and Consulting
Plan.
21.1 Subsidiary of the Registrant
23.1 Consent of Marcum & Kliegman LLP
24 Powers of Attorney (See Signature Page)
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32 Certification pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
----------
(1) Filed as an exhibit to the Registrant's registration statement on
Form S-1, File No. 333-2550, which was declared effective by the Commission on
August 13, 1996, and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's 10-K/A dated August 21, 2003.
(3) Filed as an appendix to the Registrant's proxy statement dated
September 30, 1999, relating to its 1999 Annual Meeting of Stockholders and
incorporated herein by reference.
(4) Filed as an appendix to the Registrant's proxy statement dated November 9,
2000, relating to its 2000 Annual Meeting of Stockholders and incorporated
herein by reference.
(5) Filed as an appendix to the Registrant's proxy statement dated
March 30, 2004, relating to its 2004 Annual Meeting of Stockholders and
incorporated herein by reference.
(6) Filed as an exhibit to the Registrant's 8-K dated May 10, 2001.
(7) Filed as an exhibit to the Registrant's 8-K dated July 8, 2003.
(8) Filed as an exhibit to the Registrant's 10-K dated March 23, 2004.
(9) Filed as an exhibit to the Registrant's 10-Q dated May 5, 2004.
(10) Filed as an exhibit to the Registrant's 10-Q dated August 9, 2004.