UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For Quarter Ended March 31, 2005
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, Great River, NY 11739
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (631) 968-2000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No__
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes __ No X
---
Number of shares of common stock outstanding as of May 2, 2005: 5,351,607
=========
Netsmart Technologies, Inc. and Subsidiary
Index
Part I: - Financial Information:
Item 1. Financial Statements: Page
----
Condensed Consolidated Balance Sheets - March 31, 2005 (Unaudited)
and December 31, 2004 1-2
Condensed Consolidated Statements of Income - (Unaudited)
Three Months Ended March 31, 2005 and 2004 3
Condensed Consolidated Statements of Cash Flows - (Unaudited)
Three Months Ended March 31, 2005 and 2004 4-5
Condensed Consolidated Statement of Stockholders' Equity-(Unaudited)
Three Months Ended March 31, 2005 6
Notes to Condensed Consolidated Financial Statements 7-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11-20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 21
Part II Other Information
Item 6. Exhibits and Reports on Form 8-K 22
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
March 31, December 31,
--------- ------------
2005 2004
---- ----
Unaudited
---------
Assets:
Current Assets:
Cash and Cash Equivalents $18,101,393 $16,411,735
Accounts Receivable - Net 9,308,207 11,714,691
Costs and Estimated Profits in Excess
of Interim Billings 673,431 636,985
Deferred taxes 1,076,000 1,111,000
Other Current Assets 614,436 596,253
---------- ----------
Total Current Assets 29,773,467 30,470,664
---------- ----------
Property and Equipment - Net 2,485,768 2,546,948
---------- ----------
Other Assets:
Software Development Costs - Net 1,066,989 1,132,453
Customer Lists - Net 2,026,444 2,179,237
Deferred taxes less current portion 1,182,000 1,284,000
Other Assets 86,009 93,599
---------- ----------
Total Other Assets 4,361,442 4,689,289
---------- ----------
Total Assets $36,620,677 $37,706,901
========== ==========
See Notes to Condensed Consolidated Financial Statements.
1
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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CONDENSED CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------------
March 31, December 31,
--------- ------------
2005 2004
---- ----
Unaudited
---------
Liabilities and Stockholders' Equity:
Current Liabilities:
Current Portion - Long Term Debt $ 666,667 $ 666,667
Current Portion Capital Lease Obligations 65,737 64,450
Accounts Payable 1,668,741 1,572,930
Accrued Expenses 1,222,448 1,545,127
Interim Billings in Excess of Costs and Estimated
Profits 6,107,017 7,497,773
Deferred Revenue 1,218,599 907,630
---------- ----------
Total Current Liabilities 10,949,209 12,254,577
---------- ----------
Long Term Debt - Less current portion 166,696 333,361
Capital Lease Obligations - Less current portion 4,607 21,532
Interest Rate Swap at Fair Value 8,420 15,152
Deferred Rent Payable 463,633 455,427
---------- ----------
Total Non Current Liabilities 643,356 825,472
---------- ----------
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
5,574,531 and 5,346,607 shares at
March 31, 2005 and 5,567,124 and 5,339,200
shares at December 31, 2004 55,745 55,671
Additional Paid in Capital 29,924,495 29,893,223
Accumulated Comprehensive loss - Interest Rate Swap (8,420) (15,152)
Accumulated Deficit (3,230,726) (3,593,908)
---------- ----------
26,741,094 26,339,834
Less: cost of shares of Common Stock held
in treasury - 227,924 shares at March 31, 2005
and December 31, 2004 1,712,982 1,712,982
---------- ----------
Total Stockholders' Equity 25,028,112 24,626,852
---------- ----------
Total Liabilities and Stockholders' Equity $ 36,620,677 $ 37,706,901
========== ==========
See Notes to Condensed Consolidated Financial Statements.
2
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME - (Unaudited)
-------------------------------------------------------------------------------
Three months ended
March 31,
------------------
2005 2004
---- ----
Revenues:
Software and Related
Systems and Services:
General $4,240,756 $4,062,955
Maintenance Contract
Services 2,154,119 1,917,226
--------- ---------
Total Software and Related
Systems and Services 6,394,875 5,980,181
Application Service Provider Services 555,421 354,814
Data Center Services 478,405 487,981
--------- ---------
Total Revenues 7,428,701 6,822,976
--------- ---------
Cost of Revenues:
Software and Related
Systems and Services:
General 2,260,327 2,234,567
Maintenance Contract
Services 1,060,759 985,474
--------- ---------
Total Software and Related
Systems and Services 3,321,086 3,220,041
Application Service Provider Services 276,848 226,510
Data Center Services 230,743 214,057
--------- ---------
Total Cost of Revenues 3,828,677 3,660,608
--------- ---------
Gross Profit 3,600,024 3,162,368
--------- ---------
Selling, General and
Administrative Expenses 1,988,112 1,830,886
Research, Development and Maintenance 1,070,382 778,608
--------- ---------
Total 3,058,494 2,609,494
--------- ---------
Operating Income 541,530 552,874
Interest and Other Income 57,289 31,640
Interest and Other Expense (19,637) (41,584)
--------- ---------
Income before Income Tax Expense 579,182 542,930
Income Tax Expense 216,000 218,000
--------- ---------
Net Income $ 363,182 $ 324,930
========= =========
Earnings Per Share ("EPS")of Common Stock:
Basic EPS $ .07 $ .06
========= =========
Weighted Average Number of Shares of
Common Stock Outstanding 5,342,489 5,317,574
========= =========
Diluted EPS $ .07 $ .06
========= =========
Weighted Average Number of Shares of
Common Stock and Common Stock
Equivalents Outstanding 5,560,537 5,571,569
========= =========
See Notes to Condensed Consolidated Financial Statements.
3
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (Unaudited)
-------------------------------------------------------------------------------
Three Months ended
March 31,
------------------
2005 2004
---- ----
Operating Activities:
Net Income $ 363,182 $ 324,930
---------- ----------
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation and Amortization 406,851 388,146
Provision for Doubtful Accounts 99,000 --
Deferred Income Taxes 137,000 187,000
Changes in Assets and Liabilities:
[Increase] Decrease in:
Accounts Receivable 2,307,484 (195,578)
Costs and Estimated Profits in
Excess of Interim Billings (36,446) 187,673
Other Current Assets (18,183) 18,907
Other Assets (4,077) 10,157
Increase [Decrease] in
Accounts Payable 95,811 (249,718)
Accrued Expenses (322,679) (202,553)
Interim Billings in Excess of
Costs and Estimated Profits (1,390,756) (1,291,792)
Deferred Revenue 310,969 236,569
Deferred Rent Payable 8,206 --
---------- ----------
Total Adjustments 1,593,180 (911,189)
---------- ----------
Net Cash Provided by (Used In)
Operating Activities 1,956,362 (586,259)
---------- ----------
Investing Activities:
Acquisition of Property and Equipment (115,747) (964,503)
Capitalized Software Development -- (44,000)
---------- ----------
Net Cash Used In Investing Activities (115,747) (1,008,503)
---------- ----------
See Notes to Condensed Consolidated Financial Statements.
4
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (Unaudited)
-------------------------------------------------------------------------------
Three Months ended
March 31,
------------------
2005 2004
---- ----
Financing Activities:
Payment of Capitalized Lease Obligations $ (15,638) $ (16,314)
Net Proceeds from Stock Options Exercised 31,346 105,677
Payments of Term Loan (166,665) (166,665)
---------- ----------
Net Cash Used in Financing Activities (150,957) (77,302)
---------- ----------
Net Increase (Decrease) in Cash
and Cash Equivalents 1,689,658 (1,672,064)
Cash and Cash Equivalents -
Beginning of Period 16,411,735 15,920,993
---------- ----------
Cash and Cash Equivalents -
End of Period $18,101,393 $14,248,929
========== ==========
Supplemental Disclosure of Cash
Flow Information:
Cash paid during the period for:
Interest $ 42,470 $ 42,351
Income Taxes $ 88,990 $ 139,598
Non Cash Investing and Financing Activities:
The fair value of the interest rate swap decreased by $6,732 for the three
months ended March 31, 2005. The fair value of the interest rate swap decreased
by $7,172 for the three months ended March 31, 2004.
During the three months ended March 31, 2004, the Company received 4,166 shares
of its common stock as consideration for the exercise of certain stock options.
The value of the share received was $53,533, which was the market value of the
common stock on the date of exercise.
See Notes to Condensed Consolidated Financial Statements.
5
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - (UNAUDITED)
-----------------------------------------------------------------------------------------------------------------------------------
Additional Accumulated
---------- -----------
Paid-in Comprehensive
------- -------------
Capital Loss Total
------- ---- -----
Common Stock Common Accumulated Interest Rate Comprehensive Treasury Shares Stockholders'
------------ ------ ----------- ------------- ------------- --------------- -------------
Shares Amount Stock Deficit Swap Income Shares Amount Equity
------ ----- ----- ------ ---- ------ ------ ------ ------
Balance-
January 1, 2005 5,567,124 $55,671 $29,893,223 $(3,593,908) $(15,152) $ -- 227,924 $(1,712,982) $24,626,852
Common Stock
Issued - Exercise
of Options 7,407 74 31,272 -- -- -- -- -- 31,346
Change in Fair
Value of Interest
Rate Swap -- -- -- -- 6,732 6,732 -- -- 6,732
Net Income -- -- -- 363,182 -- 363,182 -- -- 363,182
---------
$ 369,914
--------- ------ ---------- --------- ------ ========= ------- -------- ----------
Balance -
March 31, 2005 5,574,531 $55,745 $29,924,495 $ 3,230,726 $ (8,420) 227,924 $(1,712,982) $25,028,112
========= ====== ========== ========= ====== ======= ========= ==========
See Notes to Condensed Consolidated Financial Statements.
6
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
(1) Financial Statements
The accompanying condensed consolidated financial statements include the
accounts of Netsmart Technologies, Inc. and its subsidiary ("the Company"). All
intercompany balances and transactions have been eliminated in consolidation.
These unaudited, condensed consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. The results of operations for any interim period are not
necessarily indicative of the results of operations to be expected for the
fiscal year. For further information, refer to the consolidated financial
statements and accompanying footnotes included in the Company's annual report on
Form 10-K for the year ended December 31, 2004.
(2) Earnings Per Share
The following table sets forth the components used in the computation of basic
and diluted earnings per share:
Three Months Ended March 31,
----------------------------
2005 2004
---- ----
Numerator:
Net income $ 363,182 $ 324,930
========= =========
Denominator:
Weighted average shares 5,342,489 5,317,574
Effect of dilutive securities:
Employee stock options 218,048 253,995
--------- ---------
Denominator for diluted earnings
per share-adjusted weighted
average shares after assumed
conversions 5,560,537 5,571,569
========= =========
Options to purchase 1,500 shares of the company's common stock that were
outstanding as of March 31, 2005 were not included in the calculation of diluted
earnings per share for the three months ended March 31, 2005 since such
inclusion would have been antidilutive.
(3) Stock Options and Similar Equity Instruments
At March 31, 2005, the Company had three stock-based employee compensation
plans. As permitted under Statement of Financial Accounting Standards ("SFAS")
No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure",
which amended SFAS No. 123 ("SFAS 123"), "Accounting for Stock-Based
7
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 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 123 to stock-based
employee compensation:
Three Months Ended March 31,
----------------------------
2005 2004
---- ----
Net Income as Reported $ 363,182 $ 324,930
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method for
all awards, net of related tax effect 311,832 95,082
---------- ----------
Pro Forma Net Income $ 51,350 $ 229,848
========== ==========
Basic Net Income Per Share as Reported $ .07 $ .06
========== ==========
Basic Pro Forma Net Income Per Share $ .01 $ .04
========== ==========
Diluted Net Income Per Share as Reported $ .07 $ .06
========== ==========
Diluted Pro Forma Net Income Per Share $ .01 $ .04
========== ==========
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:
Three Months Ended
------------------
March 31,
2005 2004
---- ----
Expected Life (Years) 5 5
Interest Rate 4.00% 4.00%
Annual Rate of Dividends 0% 0%
Volatility 67% 68%
The weighted average fair value of options at date of grant using the fair value
based method during 2005 and 2004 is estimated at $5.01 and $2.83 respectively.
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.
8
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 January 1, 2006. 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 December 31, 2005. The Company will utilize the fair value method
for any future instruments issued or outstanding but not vested after the
implementation date.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107, "Share Based
Payments" ("SAB 107"). The interpretations in SAB 107 express views of the staff
regarding the interaction between SFAS 123R and certain SEC rules and
regulations and provide the staff's views regarding the valuation of share-based
payment arrangements for public companies. In particular, SAB 107 provides
guidance related to share-based payment transactions with non-employees, the
transition from non-public to public entity status, valuation methods (including
assumptions such as expected volatility and expected term), the accounting for
certain redeemable financial instruments issued under share-based payment
arrangements, the classification of compensation expense, non-GAAP financial
measures, first-time adoption of SFAS 123R in an interim period, capitalization
of compensation cost related to share-based payment arrangements, the accounting
for income tax effects of share-based payment arrangements upon adoption of SFAS
123R, the modification of employee share options prior to adoption of SFAS 123R,
and disclosures in Management's Discussion and Analysis subsequent to adoption
of SFAS 123R.
(4) Income Taxes
The provision for income taxes for the three months ended March 31, 2005,
consists of a current tax provision of $79,000 and a deferred tax provision of
approximately $137,000. The provision for income taxes for the period ended
March 31, 2004, consists of a current tax provision of $31,000 and a deferred
tax provision of $187,000. The deferred tax provision was $239,000 based upon
utilization of available net operating loss carry forwards offset by a reduction
in the deferred tax asset valuation allowance of $52,000.
(5) Stockholders' Equity
During the three months ended March 31, 2005, options to purchase 7,407 shares
were exercised and the Company received gross proceeds of $31,346.
(6) Operating Segments
The Company currently classifies its operations into three business segments:
(1) Software and Related Systems and Services, (2) Data Center Services and (3)
Application Service Provider ("ASP") Services. 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 Company personnel
performing data entry and data processing services for customers. ASP Services
involve the Company offerings of its Avatar suite of products, its CareNet
products and InfoScribeR products on a virtual private network or internet
delivery approach, thereby allowing its customers to rapidly deploy products and
pay on a monthly service basis, thus eliminating capital
9
intensive system requirements. Intersegment sales and sales outside the
United States are not material. Information concerning the Company's business
segments are as follows:
Software and Application
------------ -----------
Related Systems Data Center Service Provider
--------------- ----------- ----------------
and Services Services Services Consolidated
------------ -------- -------- ------------
Three Months Ended March 31, 2005
---------------------------------
Revenue $ 6,394,875 $ 478,405 $ 555,421 $ 7,428,701
Income before income taxes 370,613 138,512 70,057 579,182
Total identifiable assets at
March 31, 2005 30,247,345 2,343,246 4,030,086 36,620,677
Three Months Ended March 31, 2004
---------------------------------
Revenue $ 5,980,181 $ 487,981 $ 354,814 $ 6,822,976
Income before income taxes 394,733 163,427 (15,230) 542,930
Total identifiable assets at
March 30, 2003 27,194,311 2,271,929 3,234,038 32,700,278
(7) Reclassifications
Certain accounts in the prior year financial statements have been reclassified
for comparative purposes to conform to the presentation in the current year
financial statements. These reclassifications have no effect on previously
reported income.
(8) Subsequent Events
In April 2005, options to purchase 5,000 shares were exercised and the Company
received gross proceeds of $21,850.
In April 2005, the Company acquired substantially all of the assets, including
computer software, customer lists and computer equipment, of ContinuedLearning
LLC, a company that offered a comprehensive family of web-based training
products and services including its Learning Management System. The online
training is focused on offering regulatory, clinical, direct service, and
administrative training to clients such as provider organizations, behavioral
professional associations, employee assistance programs, and managed care
companies. The Asset Purchase Agreement provided for a purchase price of
$250,000 cash and 20,000 shares of the Company's common stock. It also provides
for a potential additional payment of $250,000 if certain revenue targets are
met. The Company also entered into an employment agreement with the principal of
ContinuedLearning LLC, whereby in addition to salaries and benefits commensurate
with Company managers on a similar level, the principal can receive an
additional $300,000 payment if certain revenue targets are met.
10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Our operations are grouped into three segments:
* Software and Related Systems and Services
* Data Center (service bureau) Services
* 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.
Three Months Ended March 31, 2005 and 2004
Results of Operations
Our total revenue for the three months ended March 30, 2005 (the "March 2005
period") was $7,429,000, an increase of $606,000, or 9%, from our revenue for
the three months ended March 30, 2004 (the "March 2004 period"), which was
$6,823,000.
Revenue from contracts with state and local government agencies represented 47%
of revenue in the March 2005 and March 2004 periods.
Fixed price software development contracts, third party hardware and software
components and licenses accounted for 37% and 34% of consolidated revenue for
the three months ended March 31, 2005 and 2004, respectively. This increase is
the result of an increase in labor revenue being generated from fixed price
contracts and a reduction in labor revenue being generated on an as incurred
basis. Our recurring revenue components, which include our maintenance contract
services, our Data Center and ASP services, accounted for 43% of our
consolidated revenue for the three months ended March 31, 2005 compared to 40%
of consolidated revenue for the three months ended March 31, 2004. This increase
was the result of increases in maintenance and ASP revenue. 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.
Software and Related Systems and Services
Our Software and Related Systems and Services revenue for the March 2005 period
was $6,395,000, an increase of $415,000, or 7%, from our revenue for the March
2004 period, which was $5,980,000. 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.
11
The largest component of segment revenue was turnkey systems labor revenue,
which increased 4% to $2,367,000 in the March 2005 period from $2,266,000 in the
March 2004 period. Turnkey systems labor revenue refers to labor associated with
turnkey installations and includes categories such as training, installation,
project management and development. The increase in turnkey systems labor
revenue was substantially the result of a 3% increase in the average daily
billing rate from the March 2005 period to the March 2004 period which accounted
for approximately $28,000, or 28%, of the total turnkey systems labor increase.
The balance of the increase was the result of increased staff working on turnkey
labor contracts. Revenue from third party hardware and software increased 26% to
$1,105,000 in the March 2005 period, from $880,000 in the March 2004 period.
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 other software and related
systems and services revenue. During the March 2005 period, we performed on two
state contracts that included increased third party revenue components as
compared to the March 2004 period resulting in an overall decrease in gross
margins. License revenue decreased 20% to $502,000 in the March 2005 period,
from $630,000 in the March 2004 period. 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 sold and
performed on fewer contracts containing license revenue in the March 2005 period
than in the March 2004 period. We are actively pursuing courses of action to
retain or increase our customer base. Some methods of achieving this are to
offer price incentives or payment plans on a customer by customer basis. The
result of offering price incentives with respect to our license revenue is a
contributing factor to the decrease in our license revenue. Maintenance revenue
increased 12% to $2,154,000 in the March 2005 period from $1,917,000 in the
March 2004 period. 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 7% to $266,000 in the March
2005 period from $287,000 in the March 2004 period. We sold and performed on
fewer small turnkey contracts in the March 2005 period than in the March 2004
period. Small turnkey division sales relate to turnkey contracts that are less
than $50,000 and are usually completed within one month.
Gross profit increased 11% to $3,074,000 in the March 2005 period from
$2,760,000 in the March 2004 period. Our gross margin percentage increased to
48% in the March 2005 period from 46% in the March 2004 period. Our gross margin
increased as a result of improved labor efficiency on our fixed price contracts.
This increase was partially offset by a decrease in our license revenue.
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 fee by an amount
that approximates the New York urban consumer price index increase. The data
center revenue decreased to $478,000 in the March 2005 period from $488,000 in
the March 2004 period, representing a decrease of $10,000, or 2%. This decrease
was the result of one customer discontinuing the use of our services.
Gross profit decreased 9% to $248,000 in the March 2005 period from $274,000 in
the March 2004 period. Our gross margin percentage decreased to 52% in the March
2005 period from 56% in the March 2004 period. This decrease was the result of
the decrease in revenue, as well as an increase in costs of approximately
$17,000. The increase in costs was substantially the result of an increase in
communications costs of $15,000.
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
12
delivery approach, thereby allowing our customers to rapidly deploy products and
pay on a monthly service basis, thus eliminating capital intensive system
requirements.
ASP revenue increased to $555,000 in the March 2005 period from $355,000 in the
March 2004 period, representing an increase of $200,000 or 56%. The components
of the ASP revenue are as follows:
March 2005 March 2004
Period Period
---------- ----------
Avatar $ 261,000 $ 114,000
CareNet 226,000 183,000
Infoscriber 68,000 58,000
-------- --------
Total $ 555,000 $ 355,000
-------- --------
Avatar ASP revenue increased in the March 2005 period by 129% as compared to the
March 2004 period. This increase was substantially the result of increased usage
from our existing customer base, as well as the addition of one new customer in
the March 2005 period.
CareNet revenue increased in the March 2005 period by 23% as compared to the
March 2004 period. Approximately 29% of the revenue increase is associated with
the original CareNet customer base acquired in June 2003 with the balance of the
increase resulting from sales to new customers.
Infoscriber revenue increased in the March 2005 period by 17% as compared to the
March 2004 period. This increase is the result of an increase in our client
base.
Gross profit for the March 2005 period was $279,000 and for the March 2004
period was $128,000. The gross margin percentage was 50% in the March 2005
period compared to 36% in the March 2004 period. The increase in gross profit
and gross margin is substantially the result of the increase in revenue,
partially offset by an increase in costs. ASP costs increased to $277,000 in the
March 2005 period from $227,000 in the March 2004 period, representing an
increase of $50,000 or 22%. The increases were: maintenance, which increased by
$18,000; depreciation, which increased by $15,000; salaries and fringe benefits,
which increased by $5,000 and office supplies, which increased by $10,000.
Operating Expenses
Selling, general and administrative expenses were $1,988,000 in the March 2005
period, reflecting an increase of $157,000, or 9%, from $1,831,000 in the March
2004 period. The increases were: sales and marketing salaries and fringe
benefits, which increased by $83,000; sales and marketing consulting costs,
which increased by $60,000; conferences, which increased by $24,000; consulting
which increased by $55,000 of which $44,000 related to Sarbanes Oxley compliance
efforts; and bad debt expense which increased by $99,000. The cost increases
were partially offset by reductions in: trade shows, which decreased by $47,000;
general insurance, which decreased by $21,000; investment banker fees, which
decreased by $37,000; depreciation, which decreased by $36,000 and provision for
bonuses, which decreased by $20,000.
We incurred research, development and maintenance expenses of $1,070,000 in the
March 2005 period, an increase of 37% from $779,000 in the March 2004 period.
During the latter part of 2004, we invested in infrastructure to improve the way
we support our customers and products. This increased infrastructure costs
relate to 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
13
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 $20,000 in the March 2005 period, a decrease of
$22,000, or 52%, from the $42,000 in the March 2004 period. 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 the March 2005 period under our loan agreement.
Interest income was $57,000 in the March 2005 period, an increase of $25,000, or
78%, from the $32,000 in the March 2004 period. 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 $3.4 million at
March 31, 2005. In the March 2005 period, we recorded a current income tax
expense of $79,000, which related to various state and local taxes, as well as a
provision for the Federal alternative minimum tax. The income tax provision was
increased by a deferred tax provision of $137,000. In the March 2004 period, we
recorded a current income tax expense of $31,000, which related to various state
and local taxes, as well as a provision for the Federal alternative minimum tax.
The income tax provision was increased by a deferred tax provision of $187,000.
The deferred tax provision was $239,000 based upon utilization of available net
operating loss carry forwards offset by a reduction in the deferred tax asset
valuation allowance of $52,000.
As a result of the foregoing factors, in the March 2005 period we had net income
of $363,000, or $.07 per share basic and diluted. For the March 2004 period, we
had net income of $325,000, or $.06 per share basic and diluted.
Liquidity and Capital Resources
We had working capital of approximately $18.8 million at March 31, 2005 as
compared to working capital of approximately $18.2 million at December 31, 2004.
This increase of approximately $608,000 in working capital was the result of the
following: our net income, after adding back depreciation and amortization,
increased working capital by $770,000. The increase in working capital also
included $31,000 in net proceeds from the exercise of stock options. These
increases were partially offset by $116,000 for the acquisition of equipment and
a decrease in the current portion of the deferred tax asset in the amount of
$35,000. The remaining decrease in working capital of $42,000 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. The amount
outstanding at March 31, 2005 is $625,000.
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 March 31, 2005, we were in compliance with the financial covenants of the
loan agreement.
14
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
purchases. We expect to fund any stock repurchases from our operating cash flow.
As of March 31, 2005, we have not made any stock repurchases.
We have a note payable to Shuttle Data Systems Corporation, d/b/a Adia
Information Management Corp from the acquisition of the Carenet Segment. This
three year promissory note is 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 March 31, 2005 is $208,000.
In the March 2004 period, we capitalized software development costs of $44,000
relating to our RAD Plus 2004 product. We did not capitalize any software
development costs in the March 2005 period.
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. We are continually
seeking acquisitions that will add complementary products to our offerings and
that will provide value for the markets we serve. Although we are in discussions
with several potential acquisitions and have a letter of intent with one
specific potential acquisition, there are no assurances 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.
Contractual Obligations
The following table summarizes, as of March 31, 2005, 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 years
1 year
Long Term Debt(1) $ 833,363 $ 666,667 $ 166,696 $ -- $ --
Capital Lease Obligations(2) 73,594 68,957 4,637 -- --
Operating Leases(3) 6,408,015 734,782 1,319,384 1,256,258 3,097,591
Total Contractual Cash
Obligations $7,314,972 $1,470,406 $1,490,717 $1,256,258 $3,097,591
15
(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
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.
16
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.
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.
ISSUES AND UNCERTAINTIES
This Quarterly Report on Form 10-Q contains statements that are forward-looking.
These statements are based on current expectations and assumptions that are
subject to risks and uncertainties. Actual results could differ materially
because of issues and uncertainties such as those listed below under "Risk
Factors" and elsewhere in this report, which, among others, should be considered
in evaluating our financial outlook.
Risk Factors
Because we are particularly dependent upon government contracts, any decrease in
funding for entitlement programs could result in decreased revenue.
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 the March 2005 period, we generated 47%
17
of our revenue from contracts that are directly or indirectly with government
agencies, as compared with 47% in the March 2004 period. 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.
Changes in government regulation of the health care industry may adversely
affect our revenue, operating expenses and profitability.
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
able to remain competitive and our revenue may decline.
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
offer similar services, which may result in decreased revenue.
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
could disrupt our business and our financial performance could suffer.
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,
18
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.
If we are unable to protect our intellectual property, our competitors may gain
access to our technology, which could harm our ability to successfully compete
in our market.
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
ability to sell our products.
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
flexibility, including our ability to complete additional acquisitions, invest
in new business opportunities, pay down certain indebtedness or declare
dividends.
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. 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.
19
Our growth may be limited if we cannot make acquisitions.
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
business.
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
law may deter or prevent a takeover attempt and may reduce the price investors
might be willing to pay for our common stock.
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
interest of our common stock.
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
price of our common stock.
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
716,926 shares were outstanding at March 31, 2005. 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.
20
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks related to changes in interest rates. 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 cash and cash equivalents, which are invested in money market
accounts and commercial paper, are at variable rates of interest. If short-term
market interest rates decrease by 10% from the levels at March 31, 2005, the
effect on our net income would be a decrease of approximately $27,000 per year.
Item 4. Controls and Procedures
Evaluation and Disclosure Controls and Procedures
Based on their evaluation as of the end of the period covered by this Form 10-Q,
our management, with the participation of our Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of the design
and operation of our disclosure controls and procedures, as required by Exchange
Act Rule 13a-15. Our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit to the Securities and Exchange Commission under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported within
the time periods specified by the Commission's rules and forms, and that
information is accumulated and communicated to our management, including our
Chief Executive Officer and our Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosure. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer have concluded that, due to
the remediation during the period covered by this report of the issues regarding
internal control over financial reporting described below, our disclosure
controls and procedures were effective as of the end of the period covered by
this report.
Changes in Internal Controls
During the quarter ended December 31, 2004, our independent registered public
accountants 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, as
follows:
o 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.
o 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.
These weaknesses were the result of the limited size of our organization and
existed prior to the requirement that we evaluate internal controls over
financial reporting.
o During the period ended March 31, 2005, in order to further remediate the
weaknesses described above, we implemented the following changes in our
internal controls: we completed the integration of the tax consultant who
was hired in November 2004; we hired an additional competent professional
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 improved segregation of duties and approval
process in the areas of purchase orders and accounts payable processing,
payroll processing and cash disbursements, accounts receivable transaction
processing and cash receipts; and we instituted technology controls with
respect to our financial data including a password policy, system status
reporting policy and a network resource security policy.
Except as described above, there were no changes in our internal controls over
financial reporting that occurred during our most recent fiscal quarter 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
controls 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 our controls and
procedures are effective at the "reasonable assurance" level.
21
Forward-Looking Statements
Statements in this Form 10-Q quarterly 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 our 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-Q.
Part II OTHER INFORMATION
Item 6. Exhibits.
Exhibit No. Description
----------- -----------
10.1 Asset Purchase Agreement dated April 27, 2005 between
ContinuedLearning LLC and Creative Socio-Medics Corp.
(incorporated by reference to Exhibit 10.1 to Form 8-K
dated April 27, 2005).
10.2 Employment Agreement dated April 27, 2005 between
Netsmart Technologies, Inc. and A. Sheree Graves
(incorporated by reference to Exhibit 10.2 to Form 8-K
dated April 27, 2005).
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 8 U.S.C. section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amended report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETSMART TECHNOLOGIES, INC.
/s/ James L. Conway Chief Executive Officer December 8, 2005
---------------------- (Principal Executive Officer)
James L. Conway
/s/ Anthony F. Grisanti Chief Financial Officer December 8, 2005
----------------------- (Principal Financial and
Anthony F. Grisanti Accounting Officer)
23
Index of Exhibits
-----------------
Exhibit No. Description
----------- -----------
10.1 Asset Purchase Agreement dated April 27, 2005 between
ContinuedLearning LLC and Creative Socio-Medics Corp.
(incorporated by reference to Exhibit 10.1 to Form 8-K
dated April 27, 2005).
10.2 Employment Agreement dated April 27, 2005 between
Netsmart Technologies, Inc. and A. Sheree Graves
(incorporated by reference to Exhibit 10.2 to Form 8-K
dated April 27, 2005).
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 8 U.S.C. section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 8 U.S.C. section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.