UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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)
146 Nassau Avenue, Islip, NY 11751
(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 February 11, 2003
------------------- ------------------------------------------
Common Stock, par value 3,956,633
$.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, 2002, 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 $7,702,000.
DOCUMENTS INCORPORATED BY REFERENCE
None
PART I
Item 1. Business
Introduction
We develop market and support application software products to providers of
services in the health and human services market, including mental health
clinics, substance abuse clinics, psychiatric hospitals, public health agencies,
managed care organizations and correctional facilities. Our software products
perform 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. The maintenance contracts provide us with
a recurring revenue stream.
We are a supplier of practice management systems to the behavioral health
market, with 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 $250,000 to
$1 million. Governmental agencies such as mental health, mental retardation,
child welfare, addiction, correction and public health facilities accounted for
approximately 52% of revenue in 2002, with the remainder from private hospitals,
smaller clinics, group and sole practitioners.
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 direct our marketing effort for these products towards
providers of services in the health and human services market. Our branded suite
of products has integrated point-of-services technologies which also include
smart cards and 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 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, which is generally known as
HIPAA. 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 that will begin to take effect in the
latter part of 2003.
We believe that this legislation will have the effect of requiring 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 all human
service providers.
Increased Demand. As a result of the recent acts 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
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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.
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, and probably will, 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, including the risks described
under "Risk Factors," and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" 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.
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, CSMC Corporation in June 1995 and to Netsmart Technologies, Inc. in
February 1996. Our executive offices are located at 146 Nassau Avenue, Islip,
New York 11751, telephone (631) 968-2000. Reference to us and to Netsmart
include our subsidiary, Creative Socio-Medics, 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.
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 government entities and include
entitlement programs. During 2002, we generated 52% of our revenue from
contracts that are directly or indirectly with government agencies, as compared
with 40% in 2001 and 51% in 2000. Government agencies generally have the right
to cancel 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
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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
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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, 2003, although each
of Messrs. Conway and Grisanti has the right on ninety, days notice to extend
his agreement for successive additional one year periods. In addition, Mr.
Koop's employment agreement is scheduled to expire on December 31, 2003,
following which he is expected to continue to work with us for a five-year
period pursuant to a consulting agreement between us dated January 1, 2001. 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
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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, and we rely on
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non-disclosure agreements with our employees. In addition, 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 also 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.
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, or pay down certain indebtedness.
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Our revolving credit and 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.
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. As of the date of this
prospectus, we do not have any agreement or understanding, either formal or
informal, as to any acquisition.
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.
We do not anticipate, and our loan agreement prohibits, the payment of dividends
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on our common stock, therefore, investors cannot rely on dividends to increase
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the value of their investment in Netsmart.
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We have never paid a cash dividend and we do not anticipate paying 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
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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.
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 the sum of
* his compensation for a twelve-month period plus
* an amount equal to his monthly compensation multiplied by
* the greater of 30 and
* 1.5 times the number of years the employee has been employed by
Netsmart, but not more than 36.
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
additional 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 and warrants which may adversely affect
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the market 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
664,702 shares were outstanding at December 31, 2002. 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.
In addition, we may issue stock upon the exercise of warrants to purchase an
aggregate of 768,544 shares of our common stock pursuant to various agreements,
of which warrants to purchase 708,544 shares were outstanding at December 31,
2002. The exercise of these warrants and the sale of the underlying shares of
common stock may have an adverse effect upon the price of our stock.
5
Software and Related Systems and Services
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 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. Since our products are designed to operate on hardware
platforms that either support the Microsoft Windows operating system platform
(Win_2000, NT, XP), or Unix operating system (IBM -AIX, Sun
Microsystems-Solaris, Hewlett Packard-HPUX). We also offer these products. 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 $1,753,000, or 7.9% of revenue, for 2002,
$747,000, or 4.1% of revenue, for 2001 and $2,603,000, or 12.9% of revenue, for
2000. A customer's purchase order may also include third party hardware or
software. Revenue from hardware and third party software accounted for
approximately $3,822,000, or 17.3% of revenue, for 2002, $2,390,000, or 13.2% of
revenue, for 2001 and $4,158,000, or 20.6% of revenue, for 2000. Revenue from
turnkey systems labor accounted for approximately $7,418,000, or 33.5% of
revenue, for 2002, $6,568,000, or 36.3% of revenue, for 2001 and $6,502,000, or
32.2% of revenue in 2000.
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 $6,247,000, or 28.2% of revenue, for 2002,
$5,192,000, or 28.7% of revenue, for 2001 and $3,521,000, or 17.5% of revenue,
for 2000. Our small systems revenue was approximately $929,000, or 4.2% of
revenue, for 2002, $1,180,000, or 6.5% of revenue, for 2001 and $1,124,000, or
5.6% of revenue, for 2000.
We currently offer five 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
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.
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* Avatar - Clinician Workstation: This workstation provides a clinician
with documentation and medical record management including assessment,
care planning, progress notes 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: Pursuant to a joint marketing agreement
with Mallinckrodt Pharmaceutical Specialties, a division of
Mallinckrodt Inc., we offer a solution for dispensing, admissions
and medical records, counselor 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.
Markets and Marketing
The market for behavioral/public health 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, 2002, 2001 and 2000, approximately 52%, 40%
and 51%, respectively, of revenue was generated from contracts with 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.
In addition to these major behavioral/public healthcare providers, there are a
larger number of sole practitioners, group practices and smaller clinics which
may also require behavioral/public healthcare facilities. We intend to market
our Internet-based systems to these potential customers.
We believe that the demand for information technology solutions is increasing as
a result of new 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
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.
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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 customer accounted for 10% or more of our revenue in 2002, 2001 and 2000.
We had a backlog of orders, including ongoing maintenance and data center
contracts for our behavioral health information systems of $25.3 million at
December 31, 2002 and $16.5 million at December 31, 2001. We expect to fill
approximately $21.3 million of the 2002 backlog during 2003.
The major components of backlog is revenue of approximately $15 million from
existing turnkey contracts. Maintenance of approximately $7 million that is
comprised of both amounts expected to be filled under unexpired maintenance
contracts and also amounts that are subject to automatic renewal, and unexpired
Data Center contracts of approximately $2 million calculated using historical
experience to determine future useage.
Data Center
Since our inception the Data Center has provided 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.
All of our products and services are offered not only in a turnkey mode of
operation but also in an Application Service Provider (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 Islip, New York and anticipate opening an
additional facility in Ohio in 2003.
Revenue from our Data Center was approximately $1,957,000 or 8.9% of revenue for
2002, $2,042,000 or 11.3% of revenue for 2001 and $2,263,000 or 11.2% of revenue
for 2000.
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. During 2001, this same major hospital accounted for $351,000, or 17.2%
of total Data Center revenue. During 2000, two customers each accounted for more
than 10% of the total Data Center revenue. Both were hospitals in New York City,
one of which accounted for $447,000 or 19.7% of total Data Center revenue and
the other which accounted for $269,000, or 11.9% 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, 2002 was $2,076,000. We anticipate that
all of this backlog will be earned in 2003. The Data Center backlog at December
31, 2001 was $1,974,000.
Product Development
We incurred product development costs relating to our health and human services
information systems of approximately $1,318,000 in 2002, $1,335,000 in 2001 and
$1,360,000 in 2000, all of which was company-sponsored. In 2001, we incurred
capitalized software development costs of approximately $167,000 associated with
our acquisition of software products from Advanced Institutional Management
Software, Inc. In 2000, we incurred capitalized software development costs of
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approximately $219,000 in connection with the development of our web portal
services and application service provider solutions for healthcare providers.
During 2000, we also incurred capitalized software development costs of $334,000
associated with our acquisition of the Connex suite of managed care and employee
assistance program information systems. Included in these costs is $100,000 of
valued assigned to the 15,528 shares of our common stock which we issued to
acquire the Connex suite.
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.
Healthcare information technology is an $18 billion industry served by numerous
vendors. The 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
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.
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:
Anasazi Software, Inc.
Askesis Development Group, Inc.
Civerex Systems, Inc.
CMHC Systems
Geneva Software
InfoMC, Inc.
IMPEL Strategic Solutions
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Multi-Health Systems, Inc.
Qualifacts System inc.
Raintree Systems Inc.
SecureHEALTH Inc.
Sequest Technologies Inc.
The Echo Group
UNI/CARE Systems, Inc.
XAKTsoft, Inc.
As our business has expanded to the sale of larger integrated healthcare
delivery systems, we have begun to compete with companies such as Siemens, HBOC,
IDX, Meditech, Quadramed, and Misys. In the public health arena, We have
competed against QS Technologies, MANTECH, and QS Inc.
Competitive Position:
Creative Socio-Medics has been in business since 1968. As a core part of its
strategic business model, Creative bids on competitive procurements numerous
times during the calendar year and has a very high win ratio, which is evidence
of its leadership. This is especially evident in the statewide mental
health/mental retardation field with Creative's dominance in that marketplace
having for which it has 26 statewide systems.
We have an established customer base of more than 500 clients nationwide,
including substantial private and government providers of healthcare services.
These 500 contracts 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
10
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 materially 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.
Employees
As of December 31, 2002, we had 145 employees, including 4 executive, 11 sales
and marketing, 121 technical and 9 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
-------- ------- ----- ------------- ----------
146 Nassau Avenue Executive 18,000 $327,000, plus 4% 12/31/03
Islip, New York offices square feet annual increases
1335 Dublin Road Offices 3,500 $56,000 11/30/03
Columbus, Ohio square feet
5120 Shoreham Place Offices 2,800 $72,000 07/31/05
San Diego, California square feet
We believe that our space is adequate for our immediate needs and that, if
additional space is required, it would be readily available on commercially
reasonable rates.
Item 3. Legal Proceedings
In October 2000, the Company's subsidiary, Creative Socio-Medics, commenced an
action against the City of Richmond, in the Supreme Court of the State of New
York, County of Suffolk, which action was subsequently removed to the United
States District Court for the Eastern District of New York, for failure to pay
more than $1 million pursuant to a contract between the Company and Richmond.
11
Richmond advised the court that it intended to move to dismiss the complaint for
lack of personal jurisdiction in New York and improper venue. In November 2000,
Richmond filed a complaint in the Circuit Court for the City of Richmond,
Richmond, Virginia, alleging, among other things, that the contract with
Creative Socio-Medics was procured through fraudulent misrepresentations
concerning the nature of the work to be performed and the price for the services
and that Creative Socio-Medics failed to perform its obligations under the
agreement, seeking damages of $373,000 and a finding that it owes no additional
amounts to Creative Socio-Medics. The parties entered into a stipulation staying
the Richmond action until a determination of Richmond's jurisdictional
challenges to the New York action. On August 21, 2002, the United States
District Court for the Eastern District of New York denied Richmond's motion to
dismiss the Company's complaint for lack of personal jurisdiction in New York on
the basis of improper venue. The Company believes it has valid claims against
Richmond and intends to vigorously pursue those claims. We also believe that the
allegations contained in Richmond's complaint are without merit and we intend to
vigorously defend against those claims.
The Company is involved in other litigation through the normal course of
business. The Company believes that the resolution of these matters will not
have a material adverse effect on the Company's consolidated financial position
and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
On January 9, 2003, we held a special meeting of stockholders.
The following proposals were approved as follows:
Votes For Votes Against Abstain Broker
Non-Votes
Amendment to the 2001 Long
Term Incentive Plan 1,605,099 106,583 9,189 1,810,906
Approval of the selection of
Marcum & Kliegman LLP as
independent auditors for 2002 3,481,645 3,666 7,621 38,845
12
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 sales prices of our Common Stock
for each quarterly period during 2002 and 2001.
Quarter Ended High Low
------------- ---- ---
March 31, 2002 3.45 2.40
June 30, 2002 2.89 2.08
September 30, 2002 4.60 1.70
December 31, 2002 7.03 4.10
March 31, 2001 2.84 2.08
June 30, 2001 2.27 2.06
September 30, 2001 2.11 1.68
December 31, 2001 3.06 1.69
As of December 31, 2002, there were approximately 2,310 beneficial owners of our
common stock. The closing price of our common stock was $4.68 per share on
February 10, 2003. These quotations reflect inter-dealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions.
We have not paid any cash dividends to the holders of our common stock since our
organization and do not anticipate that we will pay any dividends in the
foreseeable future. We currently intend to retain any future earnings for use in
the operation and development of our business and for potential acquisitions. In
addition, the terms of our revolving credit and term loan agreement prohibits us
from paying cash dividends.
Sales of Unregistered Securities
On April 10, 2002, the Company issued to Newbridge Securities Corporation,
Series E Common Stock Purchase Warrants to purchase 200,000 shares in connection
with a financial advisory agreement whereby the Company will pay consulting fees
in addition to the issuance of the warrants. These warrants, which expire 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. Either party may terminate the agreement. The warrants have 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 $2.70 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 issuance of the foregoing securities was issued in reliance upon the
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended, as a transaction not involving a public placement.
13
Equity Compensation Plan Information
------------------------------------
The following table sets forth information relating to our compensation plans as
of December 31, 2002.
Number of securities
--------------------
remaining available for
-----------------------
future issuance under
---------------------
Number of securities to Weighted-average equity compensation
----------------------- ---------------- -------------------
be issued upon exercise exercise price of plans (excluding
----------------------- ----------------- ----------------
of 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 1,038,246 $6.172 15,000
Equity compensation
plans not approved by
security holders 395,000 $5.446 --
--------- ----- -------
Total 1,433,246 $5.97 15,000
The terms of the options and warrants to purchase 395,000 shares not approved by
shareholders to be issued are as follows:
|*| warrants to purchase 100,000 shares of common stock at an exercise
price of $5.45 per share were issued in 1999 in connection with a
financial advisory agreement, whereby we paid consulting fees in
addition to the issuance of the warrants. These warrants were valued at
$.58 per warrant, which represented the cost of services based upon the
contractual agreement. The exercise price of the warrants represented a
15% premium over the market value of the stock at the time of issuance.
These warrants will expire in October 2004.
|*| warrants to purchase 20,000 shares of common stock at an exercise price
of $4.20 per share were issued in 1999 for financial services rendered.
These warrants were valued at $2.20 per warrant based upon the
Black-Scholes calculation, which included an interest rate of 5.51%,
and a volatility rate of .3. The exercise price of the warrants was the
market value of the stock at the time of issuance. These warrants will
expire in October 2004.
|*| options to purchase 75,000 shares at a price of $6.50 per shares were
issued as an inducement to a new employee. These options will expire in
March 2005.
|*| warrants to purchase 200,000 shares at prices ranging from $2.70 to
$8.00 per share were issued in 2002 in connection with a financial
advisory agreement, whereby we paid consulting fees in addition to the
issuance of the warrants. See "Sales of Unregistered Securities."
In addition to the options available for grant in equity compensation plans that
were approved by the stockholders, in January 2003, at a special meeting of
stockholders, the stockholders approved an increase of 370,000 in the number of
shares of common stock issuable pursuant to our 2001 Long-Term Incentive Plan,
of which options to purchase 217,500 shares were granted on January 27, 2003.
14
Item 6. Selected Financial Data
The selected consolidated financial data set forth below for the five years in
the period ended December 31, 2002 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,
----------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(in thousands except per share data)
Selected Statements
of Operations Data:
Revenue $22,126 $ 18,119 $ 20,171 $ 21,252 $ 13,165
Income from Continuing
Operations before interest
and other financing costs 1,095 399 2,141 1,895 759
Income (Loss) from Discontinued
Operations -- -- 70 180 (217)
Net Income 1,195(1) 315 2,386(2) 1,825 196
Per Share Data - Diluted:
Continuing Operations .29 .08 .61 .47 .12
Discontinued Operations -- -- .02 .05 (.08)
Net Income (loss) .29 .08 .63 .52 .04
Weighted average number
of shares outstanding 4,153 3,872 3,771 3,516 2,865
Selected Balance
Sheet Data:
Working Capital 9,656 7,903 5,858 2,012 10
Total Assets 22,275 18,007 15,301 13,972 10,289
Long Term Debt
Including Current Portion 1,750 2,250 -- -- --
Total Liabilities 10,968 8,060 5,997 8,617 7,005
Accumulated Deficit (9,376) (10,571) (10,886) (13,272) (15,097)
Stockholders' Equity 11,306 9,948 9,303 5,355 3,284
----------
(1) Includes benefit of net operating loss in the amount of $400,000.
(2) Includes benefit of net operating loss in the amount of $494,000.
All per share information has been retroactively adjusted for the one-for-
three reverse stock split which became effective September 1998.
15
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Our operations are grouped into two segments:
|*| Software and Related Systems and Services
|*| Data Center (service bureau services)
Results of Operations
Fixed price software development contracts and licenses accounted for 44% and
38% of consolidated revenue for the years ended December 31, 2002 and 2001,
respectively. 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 cost 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. As a result, during the third and fourth quarters, when many of
our employees are on vacation and holidays, our revenue was affected. Our time
spent on projects during the second half of the year generally ranges from 1% to
3% less than time spent on projects during the first half of the year.
Years Ended December 31, 2002 and 2001
Our total revenue for 2002 was $22,126,000, an increase of $4,007,000, or 22%,
from our revenue for 2001, which was $18,119,000.
Revenue from contracts from government agencies represented 52% of revenue in
2002 and 40% of revenue in 2001. This reflects an increase in new government
contracts.
Software and Related Systems and Services
Our Software and Related Systems and Services revenue for 2002 was $20,169,000,
an increase of $4,092,000, or 25%, from our revenue for 2001, which was
$16,077,000. 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 $7,418,000 in 2002, from $6,568,000 in 2001, reflecting a 13%
increase. 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 systmens labor revenue was
substantially the result of an increase in spending for the information systems
in the human services marketplace and our ability to provide the staff necessary
to generate additional revenue. Labor rate price changes from 2002 to 2001
resulted in a 1% increase in the average daily billing rate and accounted for
approximately $76,000, or 9%, of the total turnkey systems labor increase.
Revenue from third party hardware and software increased to $3,822,000 in 2002,
from $2,390,000 in 2001, which represents an increase of 60%. 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 $1,753,000 in 2002, from $747,000
in 2001, reflecting an increase of 135%. 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. The increase in
16
license revenue was the result of an increase in spending for information
systems in the human services marketplace. Maintenance revenue increased to
$6,247,000 in 2002, from $5,192,000 in 2001, reflecting an increase of 20%. 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 $929,000 in 2002, from $1,180,000 in 2001,
reflecting a decrease of 21%. Small turnkey division sales relate to turnkey
contracts that are less than $50,000 and are usually completed within one month.
We are experiencing a decline in small turnkey systems as a result of a
redirection of our sales efforts to larger turnkey sales.
Gross profit increased to $6,636,000 in 2002 from $5,095,000 in 2001, reflecting
an increase of 30.2%. Our gross margin percentage increased to 32.9% in 2002
from 31.7% in 2001. Although license and maintenance revenue, which are highly
margined revenue components, increased in 2002, our gross margin percentage did
not increase proportionately. This is because the mix of our revenue components
for 2002 included a larger amount of third party hardware and software revenue
than 2001. Our third party hardware and software revenue yields margins
significantly less than our margins from human services revenue.
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 decreased to $1,957,000 in 2002 from $2,042,000 in 2001,
representing a decrease of $85,000, or 4%. In 2001, we provided additional
services to a client for fees in the amount of $120,000. These services were not
provided for in 2002.
Gross profit decreased to $946,000 in 2002 from $1,023,000 in 2001. Our gross
margin percentage decreased from 50.1% in 2001 to 48.3% in 2002. This decrease
was the result of the reduction in revenue with no corresponding decrease in
costs.
Operating expenses
Selling, general and administrative expenses were $5,168,000 in 2002, reflecting
an increase of $784,000 or 18% from the $4,384,000 in 2001. This increase was
substantially in the area of provisions for bonuses, which increased by
$190,000, investor relations, which increased by $97,000, consulting fees, which
increased by $77,000, general insurance, which increased by $71,000, G&A
salaries which increased by $46,000, non recurring costs related to the national
users conference of $110,000 and settlement of a lawsuit for $69,000.
We incurred product development expenses of $1,318,000 in 2002, a decrease of 1%
from the $1,335,000 in 2001. During 2002, we continued to invest in improved
functionality and technology in our products, but at a lesser extent than in
2001.
Interest and other expenses was $262,000 in 2002, an increase of $75,000, or
40%, from the $187,000 in 2001. This increase was substantially the result of
interest associated with the $2,500,000 term loan, which we received in June
2001 and an other than temporary decline in the value of a security.
Interest and other income consisted of interest income of $46,000 in 2002 which
was generated from short term investments and interest income of $42,000 which
was generated from short term investments, and other income of $30,000, which
relates to a gain realized on stock investment in 2001.
17
We have a net operating loss tax carry forward of approximately $9 million. 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.
In 2001 we recorded an income tax benefit of $31,000. This benefit was based
upon an overaccrual of state and federal taxes in 2000 as well as the
recognition of an additional $6,000 benefit of our operating loss carry forward.
As a result of the foregoing factors, in 2002, we had a net income of
$1,195,000, or $.32 per share (basic) and $.29 per share (diluted). For 2001, we
had net income of $315,000, or $.09 per share (basic) and $.08 per share
(diluted).
Years Ended December 31, 2001 and 2000
Our total revenue for 2001 was $18,119,000, a decrease of $2,052,000, or 10%,
from our revenue for 2000, which was $20,171,000.
Revenue from contracts from government agencies represented 40% of revenue in
2001 and 51% of revenue in 2000. This decrease reflects a reduction in new
government contracts.
Software and Related Systems and Services
Our Software and Related Systems and Services revenue for 2001 was $16,077,000,
a decrease of $1,831,000, or 10%, from our revenue for 2000, which was
$17,908,000. The largest component of revenue was turnkey systems labor revenue,
which increased to $6,568,000 in 2001, from $6,502,000 in 2000, reflecting a 1%
increase. Turnkey systems labor revenue refers to labor associated with turnkey
installations and includes such categories as training, installation, project
management and development. Although there was a general decline in the sales of
turnkey systems due to an industry wide slowdown in information technology
purchasing activity, we were able to generate additional labor revenue for
customization and enhancements services for our existing client base as well as
increase our average daily billing rate by 7%. Revenue from third party hardware
and software decreased to $2,390,000 in 2001, from $4,158,000 in 2000, which
represents a decrease of 43%. Sales of third party hardware and software are
made in connection with the sales of turnkey systems and were affected by the
decline in the sales of turnkey systems. These sales are typically made at lower
gross margins than our behavioral health systems and services revenue. License
revenue decreased to $747,000 in 2001, from $2,603,000 in 2000, reflecting a
decrease of 71%. License revenue is generated as part of a sale of a human
services health information system pursuant to a contract or purchase order that
includes delivery of the system and maintenance and is affected by the decline
in revenue from turnkey systems. Maintenance revenue increased to $5,192,000 in
2001, from $3,521,000 in 2000, reflecting an increase of 48%. As turnkey systems
are completed, they are transitioned to the maintenance division. Included in
2001 is $935,000 of maintenance revenue related to contracts for Advanced
Institutional Management Systems ("AIMS") software. We acquired the rights to
the AIMS software, including its installed customer base, in May 2001. Revenue
from the sales of our small turnkey division increased to $1,180,000 in 2001,
from $1,124,000 in 2000, reflecting an increase of 5%.%. Small turnkey division
sales relate to turnkey contracts that are less than $50,000, in the methadone
dispensing market and are usually completed within one month.
Gross profit decreased to $5,095,000 in 2001 from $6,977,000 in 2000, reflecting
a decrease of 27%. Our gross margin percentage decreased to 32% in 2001 from 39%
in 2000. This decrease was the result of a decrease in our license revenue
mentioned above. In addition, the gross margin associated with the AIMS
maintenance revenue is lower than the gross margin experienced with our other
maintenance revenue.
18
Data Center
The data center (service bureau) revenue decreased to $2,042,000 in 2001, from
$2,263,000 in 2000, reflecting a decrease of 10%, or $221,000. In 2000, we
provided additional services to one client for fees in the amount of $226,000 as
compared to $120,000 in 2001. This represented $106,000 of the decrease. The
remaining $115,000 reduction was the result of a smaller client base.
Gross profit decreased to $1,023,000 in 2001 from $1,238,000 in 2000. Our gross
margin percentage decreased from 54.7% in 2000 to 50.1% in 2001. This decrease
was the result of the reduction in revenue with no corresponding decrease in
costs.
Operating expenses
Selling, general and administrative expenses were $4,384,000 in 2001, reflecting
a decrease of $331,000, or 7%, from the $4,715,000 in 2000. This decrease was
substantially due to a reduction in employee bonus provisions, which decreased
by $454,000 and costs which decreased by $181,000 related to issuance and
extensions of warrants that were issued for financial consulting services.
These decreases were partially offset by an increase in sales and marketing
costs of $172,000 and an increase in legal fees of $157,000.
We incurred product development expenses of $1,335,000 in 2001, a decrease of 2%
from the $1,360,000 in 2000. During 2001, we continued to invest in improved
functionality and technology in our products, but at a lesser extent than in
2000.
Interest expense was $187,000 in 2001, an increase of $26,000, or 16%, from the
$161,000 in 2000. This increase was substantially the result of interest
associated with the $2,500,000 term loan arrangement, which we entered into in
June 2001.
Interest and other income consisted of interest income of $42,000, which was
generated from short-term investments and other income of $30,000 which relates
to a gain realized on stock investment.
We have a net operating loss tax carry forward of approximately $11 million. In
2001 we recorded an income tax benefit of $31,000. This benefit was based upon
an overaccrual of state and federal taxes in 2000. In 2000, we provided for
income taxes in the amount of $157,000. The 2000 provision was based upon
federal alternative minimum tax calculations as well as for certain state taxes.
In addition, we recognized a partial tax benefit in the amount of $494,000
principally related to our net operating loss carry forwards. We recognized an
additional $6,000 benefit of our operating loss carry forwards in 2001.
As a result of the foregoing factors, in 2001, we had a net income of $315,000,
or $.09 per share (basic) and $.08 per share (diluted). For 2000, we had net
income of $2,386,000, or $.71 per share (basic) and $.63 per share (diluted).
Liquidity and Capital Resources
We had working capital of $9.7 million at December 31, 2002 as compared to
working capital of $7.9 million at December 31, 2001. The increase in working
capital was substantially the result of our net income after adding back
depreciation and amortization and partially offset by the acquisition of
equipment.
In June 2001, we entered into a revolving credit and term loan agreement with
Fleet Bank ("Fleet"). This financing provides us with a five-year term loan of
$2.5 million, as well as a two-year $1.5 million revolving line of credit. The
term loan bears interest at LIBOR plus 2.5%. We have entered into an interest
rate swap agreement with Fleet whereby we converted our variable interest rate
on the term loan to a fixed rate of 7.95%. The revolving line of credit bears
interest, at the Company's option, to be equal to either (i) LIBOR plus 2.0% or
(ii) the prime rate and incur an annual facility fee of 0.5%. Under our
revolving line of credit, we can borrow up to 75% of eligible receivables up to
a maximum of $1.5 million.
19
The maximum available to us at December 31, 2002 under the borrowing base
formula was $1.5 million. The proceeds of the term loan are designated for
acquisitions as well as for product enhancements specific to California
requirements. The revolving line of credit is available for general working
capital needs. We did not use the revolving line of credit from inception
through December 31, 2002. We have made principal payments on the $2.5 million
term loan and the amount outstanding at December 31, 2002 is $1.75 million.
The terms of our revolving credit and 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, 2002, we were in compliance
with the financial covenants of this agreement.
During 2001, we acquired the intellectual property, customer contracts and
certain other assets of AIMS. The acquisition was accounted for under the
purchase method of accounting. The principal assets acquired were the AIMS'
customer base and the rights to AIMS' Correctional and Public Health Systems
software. The purchase price consisted of $500,000 in cash and 180,000 shares of
our stock, valued at $376,200, which was the market price on the date of
acquisition. In addition, pursuant to the terms of the acquisition agreement, on
or before April 27,2004, we may be required to issue up to 100,000 additional
shares of common stock based upon revenue derived from new contracts for the
AIMS systems. The value of such shares, if issued, will be charged to
operations. We also assumed certain contract obligations. We allocated $194, 986
of assumed contract obligations to the purchase price. The total cost of the
acquisition, which included legal and accounting fees associated with the
acquisition, was $1,161,100, of which $167,000 was allocated to software
development and $994,100 was allocated to customer lists.
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. If we fail to make any acquisitions our
future growth may be limited to only internal growth. As of the date of this
Form 10-K annual report, we did not have any 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.
20
The following table summarizes, as of December 31, 2002, 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) 1,750,012 500,000 1,000,000 250,012 --
Capital Lease Obligations(2) 12,609 10,808 1,801 -- --
Operating Leases(3) 593,000 473,000 120,000 -- --
--------- ------- --------- ------- -------
Total Contractual Cash
Obligations 2,355,621 983,808 1,121,801 250,012 --
========= ======= ========= ======= =======
----------
(1) See Note 7 to Netsmart's Consolidated Financial Statements for the years
ended December 31, 2002, 2001 and 2000, which describes the Company's financing
agreement.
(2) See Note 10 to Netsmart's Consolidated Financial Statements for the
years ended December 31, 2002, 2001 and 2000, which describes the Company's
Capital Lease Obligation.
(3) See Note 12 to Netsmart's Consolidated Financial Statements for the years
ended December 31, 2002, 2001 and 2000, which describes the Company's Operating
Lease Obligations.
Based on our outstanding contracts and our continuing business, we believe that
our cash flow from operations, the availability under our financing agreement
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.
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. 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
Impairment of Capitalized Software Development Costs
Impairment of Customer Lists
21
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 on the estimated percentage-of-completion method.
Using 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 is recognized in the period in which the service is
provided. The above sources of revenue are recognized when, persuasive evidence
of an arrangement exists, delivery has occurred, the fee is fixed and
determinable an collectibility is probable.
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 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.
Impairment of Capitalized Software Development Costs - Capitalization of
computer software development costs begins upon the establishment of
technological feasibility. Technological feasibility for our computer software
products are generally based upon achievement of a detail program design free of
high risk development issues. 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 and
development. 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 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 5 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 Statement of Financial Accounting
Standards ("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.
22
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, and probably will, 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, 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 plus 2.5% rate increases above 7.95%, it
may have a positive effect on our net income.
23
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, 2002 and 2001. All
quarterly information was obtained from unaudited financial statements not
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
necessary indicative of the results for any future period.
In thousands, except per share data amounts
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
2002 (a)
Total revenue $ 4,830 $ 5,447 $ 6,044 $ 5,805
Gross profit 1,685 1,843 1,880 2,174
Net income 103 142 202 748
Per share amounts:
Net earnings - Basic: $ .03 $ .04 $ .05 $ .19
======= ====== ======= =======
Net earnings - Diluted: $ .03 $ .04 $ .05 $ .18
======= ====== ======= =======
2001
Total revenue $ 4,575 $ 4,665 $ 4,575 $ 4,304
Gross profit 1,482 1,577 1,486 1,573
Net income 65 70 50 130
Per share amounts:
Net earnings - Basic: $ 0.02 $ 0.02 $ 0.01 $ 0.04
======= ====== ======= =======
Net earnings - Diluted: $ 0.02 $ 0.02 $ 0.01 $ 0.03
======= ====== ======= =======
(a) Includes the benefit of a net operating loss in the amount of $400 in the
fourth quarter of 2002.
Earnings per share for each quarter are computed using the weighted-average
number of shares outstanding during that quarter, while earnings per share for
the full year are computed using the weighted-average number of shares
outstanding during the year. Thus, the sum of the earnings per share for the
four quarters' earnings per share may not equal the full-year earnings per
share.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data begin on page F-1 of this Form
10-K.
24
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure
On May 7, 2002, the audit committee of the board of directors recommended, and
the board of directors approved, the dismissal of Eisner LLP (formerly Richard
A. Eisner & Company, LLP), as our independent public accountants and the
selection of Marcum & Kliegman LLP to serve as our independent public accountant
for the year ending December 31, 2002. The selection of Marcum & Kliegman LLP
was approved by our stockholders.
At no time since its engagement has Marcum & Kliegman LLP had any direct or
indirect financial interest in or any connection with the Registrant or any of
its subsidiaries other than as independent accountants.
The Company's financial statements for the years ended December 31, 2001 and
2000 were audited by Eisner LLP, whose report on such financial statements did
not include any qualification, disclaimer, modification or explanatory
paragraph. There were no disagreements with Eisner LLP during the years ended
December 31, 2001 or 2000 or during the period subsequent to December 31, 2001
on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure.
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 55 Chief executive officer and director
Gerald O. Koop 64 President and director
Anthony F. Grisanti 53 Chief financial officer, treasurer and
secretary
John F. Phillips 65 Vice president and director
Joseph G. Sicinski(1 & 2) 70 Director
Edward D. Bright 66 Chairman of the board and director
Francis J. Calcagno(1 & 2) 53 Director
John S.T. Gallagher(1 & 2) 72 Director
------------
(1) Member of the compensation committee.
(2) Member of the audit committee.
Mr. James L. Conway has been our chief executive office since April
1998, a director since January 1996 and 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 and treasurer of ITT
Credit Corporation.
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.
25
Mr. John F. Phillips has been one of our directors and president of
Creative Socio-Medics since June 1994, when Creative Socio-Medics was acquired,
and our vice president since June 1994.
Mr. Joseph G. Sicinski has been one of our directors since June 1998.
He is president and a director of the Trans Global Services, Inc., a technical
staffing company, a position he held with Trans Global and its predecessor since
September 1992. From April 1998 until December 2001, he was also chief executive
officer of Trans Global.
Mr. Edward D. Bright has been our chairman of the board and a director
since April 1998. From April 1998 until 1999, Mr. Bright was chairman,
secretary, treasurer and a director of Consolidated Technology Group Ltd., a
public company now known as The Sagemark Companies, Ltd. In 2000, Mr. Bright was
reelected chairman of the board and a director of Sagemark. From January 1996
until April 1998, Mr. Bright was an executive officer of or advisor to Creative
Socio-Medics Corp., our wholly-owned subsidiary.
Mr. Francis J. Calcagno has been one of our directors since September
2001. He is a senior managing director of Dominick & Dominick LLC, 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. 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.
Directors are elected for a term of one year.
None of our officers and directors are related.
Our board of directors has two committees - the audit committee and the
compensation committee.
The audit committee consists of three independent directors, Messrs.
Francis J. Calcagno, who is chairman of the committee, John S.T. Gallagher and
Joseph G. Sicinski. The responsibilities of the audit committee is to oversee
our financial reporting process, report the results of its activities to the
board, approve the selection of the independent auditors, review our periodic
filings with the independent auditors prior to filing, and review and respond to
any matters raised by the independent auditors in their management letter. The
board of directors has determined that at least one member of the audit
committee, Mr. Calcagno, is an audit committee financial expert. Mr. Calcagno is
an independent director as defined in the rule of the Securities and Exchange
Commission pursuant to the Securities Exchange Act of 1934.
The compensation committee, which is composed of Messrs. Calcagno,
Gallagher 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.
Excluding actions by unanimous written consent, during 2002, the board
of directors held two meetings, the compensation committee held one meeting, and
the audit committee held four meetings. The audit committee met with our
independent accountants and chief financial officer prior to filing of this Form
10-K annual report to review the 2002 audited financial statements with the
independent auditors. During 2002, all of our directors attended at least 80% of
the meetings of the board and any committee of which they are members.
26
We pay a monthly fee of $1,250 to Mr. Calcagno, $750 to Mr. Sicinski
and $2,000 to Mr. Gallagher and we pay the chairman of the board a monthly fee
of $1,500.
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.
Compliance with Section 16(a) of the Securities Exchange Act
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
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, we believe that all Reporting Persons complied on a
timely basis with all filing requirements applicable to them with respect to
transactions during fiscal 2002, except that John Phillips filed 38 days late
for a filing due December 10, 2002 and 36 days late for a filing due December
12, 2002.
Item 11. Executive Compensation.
Set forth below is information with respect to compensation paid or
accrued by us for 2002, 2001 and 2000 to our chief executive officer and to each
of our other officers whose salary and bonus for 2002 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 2002 $193,151 $120,000 20,000
2001 182,239 61,261 --
2000 177,120 102,515 21,000
Gerald O. Koop, president 2002 170,807 170,408 20,000
2001 160,959 97,874 --
2000 156,480 139,269 21,000
John F. Phillips, vice president 2002 170,807 60,000 15,000
2001 160,959 41,041 --
2000 156,480 83,973 18,750
Anthony F. Grisanti, chief financial 2002 148,463 106,000 16,000
officer 2001 139,679 65,821 --
2000 135,840 104,656 18,750
The bonuses for Mr. Koop includes accrued commissions of $165,408 for 2002,
$82,874 for 2001 and $94,568 for 2000. These commissions will be paid in
installments through 2003.
27
In January 2001, we entered into employment agreements with Messrs. James L.
Conway, John F. Phillips, Gerald O. Koop and Anthony F. Grisanti for a term of
three years for Messrs. Conway and Grisanti and two years for Messrs. Koop and
Phillips. We believe that these officers are vital to our business. Each of the
officers has the right to extend the term for an additional year. Following
termination of the employment term, or earlier at the discretion of the officer,
each of the officers has the right to continue as a part-time consultant for a
term of five years for annual compensation of $75,000. Pursuant to these
employment agreements, these officers received the following salaries in 2002:
Mr. Conway - $178,751, Mr. Koop - $156,407, Mr. Phillips - $156,407, and Mr.
Grisanti - $134,063. The agreements provide for annual increases associated with
cost of living indexes. The agreements provide that the executives are eligible
to participate in a bonus pool to be determined annually by the board, based on
the executive's performance. The agreements also provide each of these officers
with an automobile allowance, which is included under "Salary", and insurance
benefits. In the event of the officer's dismissal or resignation or a material
change in his duties or in the event of a termination of employment by the
executive or by us as a result of a change of control, the officer may receive
severance payments of between 30 and 36 months' compensation. In January 2001,
we entered into a consulting agreement with Mr. Bright - see Item 13, Certain
Relationships and Related Transactions.
Compensation Committee Interlocks and Insider Participation
During fiscal 2002, our compensation committee consisted of Messrs. Clacagno,
Gallagher and Sincinski. None of them were our officers or employees during
fiscal 2002 nor did any of them have any relationship with us that is required
to be disclosed under this heading.
Option Exercises and Outstanding Options
The following table sets forth information concerning the grants of options made
during the year.
Options / SAR Grants in Last Fiscal Year
----------------------------------------
Potential Realized Value at
---------------------------
Assumed Annual Rates of Stock
-----------------------------
Price Appreciation for Option
-----------------------------
Individual Grants Term (4)
----------------- --------
Number of % of Total
--------- ----------
Securities Options / SARS
---------- --------------
Underlying Granted to
---------- ----------
Options / SARS Employees in Exercise or Base
-------------- ------------ ----------------
Name Granted # (1) Fiscal Year (2) Price ($/Sh) (3) Expiration Date 5%($) 10%($)
---- ------------- --------------- ---------------- --------------- ----- ------
James L. Conway, CEO 20,000 11.2% $2.50 3/11/08 $17,005 $38,578
Gerald O. Koop, President 20,000 11.2% $2.50 3/11/08 $17,005 $38,578
John F. Phillips, Vice President 15,000 8.4% $2.50 3/11/08 $12,754 $28,934
Anthony F. Grisanti, CFO 16,000 9.0% $2.50 3/11/08 $13,604 $30,862
----------
(1) Includes options granted during fiscal 2002.
(2) Based on a total of 178,500 shares subject to options granted to employees
under Netsmart's option plans in 2002.
(3) Under all stock option plans, the option purchase price is equal to the
fair market value at the date of the grant. Options were granted to executives
on March 11, 2002.
(4) In accordance with U.S. Securities and Exchange Commission rules, these
columns show gain 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 executives from these options will be
zero.
28
The following table sets forth information concerning the exercise of
options during the year ended December 31, 2002 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
(All options were fully exercisable at year end)
Number of
Securities Value of
Underlying Unexercised In-
Shares Unexercised the-Money
Acquired Value Options at Fiscal Options at Fiscal
Name Upon Exercise Realized Year End Year End
---- ------------- -------- -------- --------
James L. Conway 21,000 $62,769 68,250 $ 43,380
Gerald O. Koop 21,000 $62,769 100,000 321,900
John F. Phillips 30,000 $140,100 83,750 269,591
Anthony F. Grisanti 5,052 $18,339 34,750 88,310
The determination of "in the money" options at December 31, 2002, is
based on the closing price of the common stock on the Nasdaq SmallCap Market on
December 31, 2002, which was $4.67 per share.
The options held by Mr. Conway include warrants, exercisable at $12.00
per share, held by Mr. Conway (34,000 shares) and Mr. Conway's wife (14,250
shares). Mr. Conway disclaims beneficial interest in securities held by his
wife. These warrants are scheduled to expire on April 30, 2003, unless they are
extended by the Company.
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".
29
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Set forth below is information as of January 1, 2003, as to each person
owning of record or 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 Common
------------------
Name and Address Shares Stock
---------------- ------ -----
John F. Phillips 221,427 5.5%
146 Nassau Avenue
Islip, New York 11751
Edward D. Bright 198,172 4.9%
Gerald O. Koop 179,665 4.4%
James L. Conway 178,717 4.4%
Anthony F. Grisanti 134,815 3.4%
Joseph G. Sicinski 25,000 *
Francis J. Calcagno 5,000 *
John S.T. Gallagher 20,000 *
All directors and officers as a group (seven 962,796 22.0%
individuals)
-------------
* 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.
The number of shares owned by our directors and officers shown in the
table includes shares of common stock which are issuable upon exercise of
options and warrants that are exercisable at December 31, 2002 or will become
exercisable within 60 days after that date. Set forth below is the number of
shares issuable upon exercise of those options and warrants for each of our
directors and the officers named in the Summary Compensation Table.
Name Number
---- ------
John F. Phillips 83,750
Edward D. Bright 96,250
Gerald O. Koop 100,000
James L. Conway 68,250
Anthony F. Grisanti 34,750
All officers and directors as a group 413,000
The options and warrants held by Mr. Conway include warrants,
exercisable at $12.00 per share, to purchase 34,000 held by Mr. Conway and
14,250 shares held by Mr. Conway's wife, as to which he disclaims beneficial
ownership. These warrants are scheduled to expire on April 30, 2003.
30
Item 13. Certain Relationships and Related Transactions.
In August 2001, we entered into an non exclusive investment banking
agreement Dominick & Dominick, Inc., of which Mr. Francis J. Calcagno, one of
our directors, is a senior managing director. Mr. Calcagno was not a director at
the time we entered into this agreement with Dominick & Dominick. Dominick &
Dominick holds warrants to purchase 100,000 shares of common stock at an
exercise price of $5.45 per share. These warrants were issued pursuant to a
nonexclusive investment banking agreement dated September 8, 1999. During 2002,
this non exclusive investment banking agreement was terminated.
We entered into a consulting agreement with Mr. Bright dated January 1,
2001, pursuant to which Mr. Bright is to devote 50% of his time to our business
for a period of two years, with Mr. Bright having the right to extend the term
for an additional year. 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 between 30 and 36 months
compensation. We paid Mr. Bright total compensation of $87,000 for 2002, in
addition to a bonus of $5,000.
Item 14. Controls and Procedures
Within the 90-day period prior to the filing of this annual report, an
evaluation was performed under the supervision and with the participation of the
Company's management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures to Exchange Act Rule 13a-14. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of these disclosure controls and procedures were
effective. There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
31
Part IV
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K.
32
1. Financial Statements
Report of Marcum & Kliegman LLP
Report of Eisner LLP
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Income for the Years Ended December
31, 2002, 2001 and 2000 Consolidated Statements of
Stockholders' Equity for the Years Ended December 31, 2002,
2001 and 2000
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
None
3. Reports on Form 8-K
None
4. Exhibits
3.1(1) Restated Certificate of Incorporation, as amended
3.2(1) By-Laws
10.1(2) Employment Agreement dated January 1, 2001, between
the Registrant and James L. Conway.
10.2(2) Employment Agreement dated January 1, 2001, between
the Registrant and John F. Phillips.
10.3(2) Employment Agreement dated January 1, 2001, between
the Registrant and Gerald O. Koop.
10.4(2) Employment Agreement dated January 1, 2001,
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.
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
21.1 Subsidiaries of the Registrant.
23.1 Independent Auditors' Consent
25.1 Powers of attorney (See Signature Page)
----------
(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 herewith.
(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 November 14,
2002, relating to its 2002 Special Meeting of Stockholders held on January 9,
2003 and incorporated herein by reference.
(6) Filed as an exhibit to the Registrant's 8-K dated May 10, 2001.
33
NETSMART TECHNOLOGIES, INC.
AND SUBSIDIARIES
F-1
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
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------------
Independent Auditors' Report - Marcum & Kliegman LLP...............F-3
Independent Auditors' Report - Eisner, LLP.........................F-4
Consolidated Balance Sheets........................................F-5......F-6
Consolidated Statements of Income..................................F-7......F-8
Consolidated Statements of Stockholders' Equity....................F-9
Consolidated Statements of Cash Flows..............................F-10.....F-12
Notes to Consolidated Financial Statements ........................F-13.....F-30
. . . . . . . . . . .
F-2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders of
Netsmart Technologies, Inc.
We have audited the accompanying consolidated balance sheet of
Netsmart Technologies, Inc. and subsidiaries as of December 31, 2002 and the
related consolidated statements of income, stockholders' equity and cash flows
for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. 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 audit provides 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
Netsmart Technologies, Inc. and its subsidiaries as of December 31, 2002, and
the consolidated results of their operations and their consolidated cash flows
for the year then ended, in conformity with accounting principles generally
accepted in the United States of America.
/s/*
---------------------
Marcum & Kliegman LLP
Woodbury, New York
February 3, 2003
F-3
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders of
Netsmart Technologies, Inc.
We have audited the accompanying consolidated balance sheet of
Netsmart Technologies, Inc. and subsidiaries as of December 31, 2001 and the
related consolidated statements of income, stockholders' equity and cash flows
for each of the years in the two year period ended December 31, 2001. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. 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 enumerated above present
fairly, in all material respects, the consolidated financial position of
Netsmart Technologies, Inc. and its subsidiaries as of December 31, 2001, and
the consolidated results of their operations and their consolidated cash flows
for each of the years in the two year period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States of
America.
/s/*
--------------
Eisner LLP
(formerly Richard A. Eisner & Company LLP)
New York, New York
February 15, 2002
F-4
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
December 31,
2002 2001
---- ----
Assets:
Current Assets:
Cash and Cash Equivalents $ 7,251,740 $ 3,837,226
Accounts Receivable - Net 7,058,855 5,876,970
Costs and Estimated Profits in Excess
of Interim Billings 3,857,522 3,783,356
Deferred taxes 900,000 500,000
Other Current Assets 196,577 128,232
----------- ----------
Total Current Assets 19,264,694 14,125,784
----------- ----------
Property and Equipment - Net 364,306 366,356
----------- ----------
Other Assets:
Software Development Costs - Net 382,387 686,301
Customer Lists - Net 2,141,855 2,618,145
Other Assets 121,419 210,787
----------- ----------
Total Other Assets 2,645,661 3,515,233
----------- ----------
Total Assets $22,274,661 $18,007,373
========== ==========
See Notes to Consolidated Financial Statements.
F-5
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
December 31,
2002 2001
---- ----
Liabilities and Stockholders' Equity:
Current Liabilities:
Current Portion - Long Term Debt $ 500,000 $ 500,000
Current Portion Capital Lease Obligations 9,886 28,905
Accounts Payable 1,166,145 688,682
Accrued Expenses 922,417 359,908
Interim Billings in Excess of Costs and Estimated
Profits 5,914,970 3,959,230
Deferred Revenue 1,095,412 685,569
------------ -----------
Total Current Liabilities 9,608,830 6,222,294
------------ -----------
Capital Lease Obligations - Less current portion 1,864 12,519
Long Term Debt - Less current portion 1,250,012 1,750,004
Interest Rate Swap at Fair Value 107,713 74,875
------------ -----------
Total Non Current Liabilities 1,359,589 1,837,398
------------ -----------
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 4,046,430 shares
at December 31, 2002, 3,719,247 shares at
December 31, 2001 40,464 37,192
Additional Paid in Capital 21,411,777 20,856,166
Unearned Compensation (14,400) --
Accumulated Comprehensive loss - Interest Rate Swap (107,713) (74,875)
Accumulated Deficit (9,375,774) (10,570,992)
---------- ----------
11,954,354 10,247,491
Less: cost of shares of Common Stock held
in treasury - 89,797 at December 31, 2002 and
28,038 shares at December 31, 2001 648,112 299,810
---------- ----------
Total Stockholders' Equity 11,306,242 9,947,681
---------- ----------
Total Liabilities and Stockholders' Equity $22,274,661 $ 18,007,373
========== ==========
See Notes to Consolidated Financial Statements.
F-6
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Year ended December 31,
2002 2001 2000
---- ---- ----
Revenues:
Software and Related
Systems and Services:
General $13,921,449 $10,885,337 $14,387,256
Maintenance Contract
Services 6,247,336 5,191,986 3,520,717
---------- ---------- ----------
Total Software and Related
Systems and Services 20,168,785 16,077,323 17,907,973
Data Center Services 1,957,392 2,042,098 2,262,676
---------- ---------- ----------
Total Revenues 22,126,177 18,119,421 20,170,649
---------- ---------- ----------
Cost of Revenues:
Software and Related
Systems and Services:
General 10,184,637 7,367,949 8,645,275
Maintenance Contract
Services 3,348,217 3,614,336 2,285,663
---------- ---------- ----------
Total Software and Related
Systems and Services 13,532,854 10,982,285 10,930,938
Data Center Services 1,011,602 1,018,950 1,024,523
---------- ---------- ----------
Total Cost of Revenues 14,544,456 12,001,235 11,955,461
---------- ---------- ----------
Gross Profit 7,581,721 6,118,186 8,215,188
---------- ---------- ----------
Selling, General and
Administrative Expenses 5,168,184 4,384,291 4,714,829
Research and Development 1,318,124 1,334,577 1,359,781
---------- ---------- ----------
Total 6,486,308 5,718,868 6,074,610
---------- ---------- ----------
Income from Continuing Operations
before Interest Expense 1,095,413 399,318 2,140,578
Interest and Other Income 46,115 71,742 --
Interest and Other Expense 262,310 186,638 161,386
---------- ---------- ----------
Income from Continuing Operations
before Income Tax (Benefit) 879,218 284,422 1,979,192
Income Tax (Benefit) (316,000) (31,000) (336,827)
---------- --------- ----------
Income from Continuing Operations 1,195,218 315,422 2,316,019
---------- --------- ----------
See Notes to Consolidated Financial Statements.
F-7
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
--------------------------------------------------------------------------------
Year ended December 31,
2002 2001 2000
---- ---- ----
Discontinued Operations:
Gain on Sale of Discontinued Operations -- -- 70,000
--------- ---------- ---------
Net Income $1,195,218 $ 315,422 $2,386,019
========= ========== =========
Earnings Per Share of Common Stock:
Basic:
Income from Continuing Operations $ .32 $ .09 .69
Income from Discontinued Operations -- -- .02
--------- ---------- ---------
Net Income $ .32 $ .09 $ .71
========= ========== =========
Weighted Average Number of Shares of
Common Stock Outstanding 3,748,537 3,618,260 3,367,005
========= ========= =========
Diluted:
Income from Continuing Operations $ .29 $ .08 $ .61
Income from Discontinued Operations -- -- .02
--------- --------- ---------
Net Income $ .29 $ .08 $ .63
========= ========= =========
Weighted Average Number of Shares of
Common Stock and Common Stock
Equivalents Outstanding 4,153,484 3,871,876 3,770,992
========= ========= =========
See Notes to Consolidated Financial Statements.
F-8
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
------------------------------------------------------------------------------------------------------------------------------------
Additional Accumulated
---------- -----------
Paid-in Comprehensive
------- -------------
Capital Loss Total
------- ---- -----
Common Stock Common Unearned Accumulated Interest Rate Comprehensive Treasury Shares Stockholders'
------------ ------ -------- ----------- ------------- ------------- --------------- ------------
Shares Amount Stock Compensation Deficit Swap Income Shares Amount Equity
------ ------ ----- ------------ ------- ---- ------ ------ ------ ------
Balance -
January 1, 2000 2,988,738 $29,887 $18,657,579 $ -- $(13,272,433) $ -- $ -- 5,333 $ (60,000) $ 5,355,033
Common Stock
Issued -
Exercise of
Options 328,321 3,283 378,258 -- -- -- -- 22,705 (239,810) 141,731
Common Stock
Issued -
Exercise of
Warrants 192,105 1,921 1,137,709 -- -- -- -- -- -- 1,139,630
Common Stock
Issued -
Acquisition 15,528 155 99,845 -- -- -- -- -- -- 100,000
Issuance and
Extension of
Warrants -- -- 181,000 -- -- -- -- -- -- 181,000
Net Income -- -- -- -- 2,386,019 -- 2,386,019 2,386,019
--------- ------ ---------- ------ ---------- ------- --------- ------ ------- ----------
$2,386,019
=========
Balance -
December 31, 2000 3,524,692 35,246 20,454,391 -- (10,886,414) -- $ -- 28,038 (299,810) 9,303,413
Common Stock
Issued -
Exercise of
Options 14,555 146 21,688 -- -- -- -- -- -- 21,834
Common Stock
Issued -
Acquisition 180,000 1,800 374,400 -- -- -- -- -- -- 376,200
Issuance and
Extension of
Warrants -- -- 5,687 -- -- -- -- -- -- 5,687
Change in Fair
Value of
Interest Rate
Swap -- -- -- -- -- (74,875) (74,875) -- -- (74,875)
Net Income -- -- -- -- 315,422 -- 315,422 -- -- 315,422
--------- ------ ---------- ------ ---------- ------- --------- ------ ------- ----------
$ 240,547
=========
Balance -
December 31, 2001 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
See Notes to Consolidated Financial Statements.
F-9
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
Year ended December 31,
2002 2001 2000
---- ---- ----
Operating Activities:
Income from Continuing Operations $ 1,195,218 $ 315,422 $ 2,316,019
--------- ---------- ---------
Adjustments to Reconcile Income
from Continuing Operations to Net Cash
Provided by Operating Activities:
Depreciation and Amortization 1,036,721 1,010,821 717,776
Costs Related to Issuance
of warrants and options for services 39,273 5,687 181,000
Provision for Doubtful Accounts 370,000 340,000 330,000
Changes in Assets and Liabilities:
[Increase] Decrease in:
Accounts Receivable (1,551,885) (1,528,372) 771,136
Costs and Estimated Profits in
Excess of Interim Billings (74,166) 284,899 184,817
Deferred Taxes (400,000) (6,000) (494,000)
Other Current Assets (68,345) 16,710 22,574
Other Assets 89,368 (124,574) 76,259
Increase [Decrease] in:
Accounts Payable 477,463 (118,616) (1,754,789)
Accrued Expenses 562,509 (794,739) (88,901)
Interim Billings in Excess of
Costs and Estimated Profits 1,955,740 413,547 (400,150)
Deferred Revenue 409,843 77,125 519,898
--------- --------- ---------
Total Adjustments 2,846,521 (423,512) 65,620
--------- --------- ---------
Net Cash Provided (Used In)
by Operating Activities 4,041,739 (108,090) 2,381,639
--------- --------- ---------
Investing Activities:
Acquisition of Property and
Equipment (254,467) (120,765) (223,491)
Net Cost of AIMS Acquisition -- (589,914) --
Software Development Costs -- -- (536,100)
Cash Provided by Discontinued Operations -- -- 220,000
--------- --------- ---------
Net Cash Used In Investing Activities (254,467) (710,679) (539,591)
--------- --------- ---------
See Notes to Consolidated Financial Statements.
F-10
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
Year ended December 31,
----------------------
2002 2001 2000
---- ---- ----
Financing Activities:
Payment of Short-Term Notes -- -- (882,404)
Proceeds from Term Loan -- 2,500,000
Payment of Capitalized Lease Obligations (29,674) (34,790) (27,047)
Net Proceeds from Warrant Exercise -- -- 1,139,630
Net Proceeds from Stock Option Exercise 156,908 21,834 141,731
Payments of Term Loan (499,992) (249,996) --
--------- --------- ---------
Net Cash (Used in) Provided by
Financing Activities (372,758) 2,237,048 371,910
--------- --------- ---------
Net Increase in Cash
and Cash Equivalents 3,414,514 1,418,279 2,213,958
Cash and Cash Equivalents -
Beginning of Year 3,837,226 2,418,947 204,989
---------- --------- ---------
Cash and Cash Equivalents -
End of Year $7,251,740 $3,837,226 $2,418,947
========== ========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the years for:
Interest $ 167,542 $ 135,566 $ 172,556
Income Taxes $ 41,517 $ 87,859 $ 157,173
Supplemental Disclosures of Non-Cash Investing and Financing Activities:
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.
Year ended December 31, 2001:
The Company issued 180,000 shares of common stock related to the AIMS
acquisition. These shares were valued at $376,200 which was the market value at
the date of grant. The Company also recorded a liability of $194,986 for
contract obligations assumed.
The fair value of the interest rate swap calculated at December 31, 2001 was
$74,875.
F-11
Year ended December 31, 2000:
The Company issued 15,528 shares of common stock to acquire the Connex suite of
managed care and employee assistance program information systems software. These
shares were valued at $100,000 which was the market value on date of issuance.
During 2000, stock options to purchase 328,321 shares of common stock were
exercised and proceeds of $381,541 includes $239,810, representing the market
value of 22,705 shares of the Company's common stock which was received for the
exercise price of certain of these options.
During 2000, the Company entered into a capitalized lease obligation to purchase
equipment in the amount of $13,249.
See Notes to Consolidated Financial Statements
F-12
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #1
--------------------------------------------------------------------------------
[1] The Company
Netsmart Technologies, Inc. and subsidiaries (the "Company") licenses and
installs its proprietary software products, operates an established service
bureau 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.
During 2001, the Company acquired the intellectual property, customer contracts
and certain other assets of Advanced Institutional Management Systems ("AIMS").
The acquisition was accounted for under the purchase method of accounting. The
principal assets acquired were the AIMS customer base and the rights to AIMS
Correctional and Public Health Systems software. The purchase price consisted of
180,000 shares of the Company's common stock, valued at $376,200 and $500,000
cash. In addition, the Company may issue up to 100,000 additional shares of
common stock, based on revenue derived through April 2004 from new contracts for
the AIMS systems. The value of such shares, if issued, will be charged to
operations. The Company also assumed certain contract obligations. The Company
has allocated $194,986 of assumed contract obligations to the purchase price.
The cost of the acquisition was $1,161,100, of which $167,000 was allocated to
software development and $994,100 to customer lists. The Company is amortizing
the purchased software over a three-year life and the customer lists over a
seven-year life.
[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 AIMS acquisition is included from May 2001. All intercompany transactions
are eliminated in consolidation. Netsmart owned an 80% interest in a joint
venture, PsyMedX. No minority interest related to the joint venture has been
recorded, since the joint venture partner was in breach of the joint venture
agreement and in 2001 ceased to exist.
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. 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 $2,064,000 and $2,035,000 at December 31, 2002
and 2001 respectively.
Concentration of Credit Risk - The Company extends credit to customers which
results in accounts receivable 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 government entities and include
entitlement programs. During the years ended December 31, 2002, 2001 and 2000,
approximately 52%, 40% and 51% respectively, of the Company's revenue were
generated from contracts directly or indirectly with government agencies.
During the years ended December 31, 2002, 2001 and 2000, no one customer
accounted for more than 10% of revenue.
F-13
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
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, 2002
and 2001, cash and cash equivalent balances of $7.1 million and $3.6 million
respectively, were held at a financial institution in excess of federally
insured limits.
Revenue Recognition - The Company recognizes 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 is
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 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 - Property and equipment is stated at
cost less accumulated depreciation. 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 3-5 Years
Furniture and Fixtures 5 Years
Leasehold Improvements 2-5 Years
Capitalized Software Development 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 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 and
development. 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
F-14
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #3
--------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
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 5 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.
During 2000, the Company acquired the Connex suite of managed care and employee
assistance program information systems. The acquisition price consisted of
approximately $47,000 in cash and 15,528 shares of Netsmart's common stock
valued at $100,000. The purchase price was allocated to computer software in the
amount of $147,000. During 2000, the Company made additional enhancements to the
purchased software in the amount of $270,000. As of December 31, 2002, the
Company has invested approximately $417,000 on this effort of which $170,000 was
unamortized.
Information related to capitalized software costs applicable to continuing
operations is as follows:
Year ended December 31, 2002 2001 2000
----------------------- ---- ---- ----
Beginning of Year $ 686,301 $ 822,645 $ 310,722
Capitalized -- 167,000 636,100
Amortization (303,914) (303,344) (124,177)
--------- -------- --------
Net $ 382,387 $ 686,301 $ 822,645
========= ======== ========
Customer Lists - Customer lists represent a listing of customers obtained
through the acquisitions of CSM, Johnson and AIMS 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
and 7 years for the AIMS list.
Customer lists at December 31, 2002 and 2001 are as follows:
December 31,
------------
2002 2001
---- ----
Customer Lists $5,100,323 $5,100,323
Less: Accumulated Amortization 2,958,468 2,482,178
----------- -----------
Net $2,141,855 $2,618,145
========== ==========
Amortization expense amounted to $476,290, $440,787 and $334,276, respectively,
for the years ended December 31, 2002, 2001 and 2000.
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 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. The
F-15
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #4
--------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
provisions of these interpretations that are applicable to the Company were
implemented on a prospective basis as of January 1, 2002, which had no material
effect on the Company's consolidated financial position or results of
operations.
Stock Options and Similar Equity Instruments - At December 31, 2002, 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 ("SFAS
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 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:
Year ended
December 31,
2002 2001 2000
---- ---- ----
Net Income as Reported $1,195,218 $ 315,422 $2,386,019
Deduct: Total stock-based employee compensation
expense determined under fair value-based method
for all awards, net of related tax effect 123,952 473,749 94,022
--------- --------- ---------
Pro Forma Net Income (Loss) $1,071,266 $ (158,327) $2,291,997
========= ========= =========
Basic Net Income Per Share as Reported $ .32 $ .09 $ .71
========= ========= =========
Basic Pro Forma Net Income (Loss) Per Share $ .29 $ (.04) $ .68
========= ========= =========
Diluted Net Income Per Share as Reported $ .29 $ .08 $ .63
========= ========= =========
Diluted Pro Forma Net Income (Loss) Per Share $ .26 $ (.04) $ .61
========= ========= =========
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:
2002 2001 2000
---- ---- ----
Expected Life (Years) 5 5 5
Interest Rate 4.00% 4.00% 5.50%
Annual Rate of Dividends 0% 0% 0%
Volatility 63% 60% 57%
F-16
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
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 2002, 2001 and 2000 is estimated at $1.42, $1.45 and $1.50
respectively
Earnings Per Share - Basic earnings per share of common stock is computed by
dividing income from continuing operations and 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 dilutive 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 729,702, 723,385 and 974,275 during the years ended December 31,
2002, 2001 and 2000, respectively.
The following table sets forth the computation of basic and diluted earnings per
share:
Year ended December 31,
----------------------
2002 2001 2000
---- ---- ----
Numerator:
Income from continuing operations $1,195,218 $ 315,422 $2,316,019
Discontinued operations:
Gain on sale of discontinued operations -- -- 70,000
--------- --------- ---------
Net income available to common stockholders $1,195,218 $ 315,422 $2,386,019
========= ========= =========
Denominator:
Weighted average shares 3,748,537 3,618,260 3,367,005
--------- --------- ---------
Effect of dilutive securities:
Employee stock options 395,668 253,616 403,987
Stock warrants 9,279 -- --
--------- --------- --------
Dilutive potential common shares 404,947 253,616 403,987
--------- --------- --------
Denominator for diluted earnings per
share-adjusted weighted average shares
after assumed conversions 4,153,484 3,871,876 3,770,992
========= ========= =========
Advertising - Advertising costs are expensed as incurred. Advertising expense
amounted to $139,110, $290,146 and $226,024 for the years ended December 31,
2002, 2001 and 2000, respectively.
Reclassification - Certain prior years' amounts have been reclassified to
conform to the current year's presentation.
F-17
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #6
--------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
Financial Instruments - Effective June 2001 the Company adopted SFAS No. 133,
"Accounting for Derivative instruments and Hedging Activities" as amended. SFAS
No. 133 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.
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 Pronouncements - In June 2001, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 141, "Business Combinations," and SFAS No. 142,
"Goodwill and Other Intangible Assets". The provisions of these interpretations
that are applicable to the Company were implemented on a prospective basis as of
January 1, 2002, which had no material effect on the Company's consolidated
financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections".
SFAS No. 145 requires that gains and losses from extinguishment of debt be
classified as extraordinary items only if they meet the criteria in Accounting
Principles Board Opinion No. 30 ("Opinion No. 30"). Applying the provisions of
Opinion No. 30 will distinguish transactions that are part of an entity's
recurring operations from those that are unusual and infrequent that meets the
criteria for classification as an extraordinary item. The Company is required to
adopt SFAS No. 145 no later than the first quarter of fiscal 2003, although
early adoption is allowed. The adoption of this standard is not expected to have
a material effect on the Company's consolidated financial position and results
of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value when the liability is incurred. SFAS No.
146 is effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. The adoption of this
standard is not expected to have a material effect on the Company's consolidated
financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, ("FIN 45") "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 requires a company, at the time it
issues a guarantee, to recognize an initial liability for the fair value of
obligations assumed under the guarantee and elaborates on existing disclosure
requirements related to guarantees and warranties. The initial recognition
requirements of FIN 45 are
F-18
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #7
--------------------------------------------------------------------------------
[2] Summary of Significant Accounting Policies - [Continued]
effective for guarantees issued or modified after December 31, 2002 and adoption
of the disclosure requirements are effective for the Company as of December 31,
2002. The Company does not expect that the adoption of the recognition
requirements of FIN 45 will have a material effect on its consolidated financial
position or results of operations.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional financial support from other parties. FIN 46 is effective for all new
variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after June 15, 2003. The Company does not expect the adoption of FIN
46 will have a material effect on its consolidated financial position or results
of operations.
[3] Accounts Receivable
Accounts receivable is shown net of allowance for doubtful accounts of $530,640
and $357,994 at December 31, 2002 and 2001 respectively. The changes in the
allowance for doubtful accounts are summarized as follows:
Year Ended December 31,
----------------------
2002 2001 2000
---- ---- ----
Beginning Balance $ 357,994 $ 370,222 $ 305,226
Provision for Doubtful Accounts 370,000 340,000 330,000
Charge-offs (197,354) (352,228) (265,004)
------- ------- -------
Ending Balance $ 530,640 $ 357,994 $ 370,222
======= ======= =======
[4] Costs, estimated profits, and billings on uncompleted contracts are
summarized as follows:
December 31,
-----------
2002 2001
---- ----
Costs Incurred on Uncompleted Contracts $ 18,599,730 $ 16,065,533
Estimated Profits 10,501,200 8,803,818
---------- ----------
Total 29,100,930 24,869,351
Billings to Date 31,158,378 25,045,225
---------- ----------
Net $ (2,057,448) $ (175,874)
========== ==========
Included in the accompanying consolidated balance sheet under the following
captions:
Costs and estimated profits in
excess of interim billings $ 3,857,522 $ 3,783,356
Interim billings in excess of
costs and estimated profits (5,914,970) (3,959,230)
--------- ----------
Net $ (2,057,448) $ (175,874)
========= ==========
F-19
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #8
--------------------------------------------------------------------------------
[5] Discontinued Operations
During 1998 the Company discontinued its CarteSmart division which included its
interest in a joint venture. On June 30, 1998, the Company sold this division,
with an option to purchase the Company's interest in the joint venture if the
other party to the venture did not elect to acquire the Company's interest, to
Granite Technologies, Inc. ("Granite"), a corporation formed by the former
management of the division. Granite issued to the Company its $500,000
promissory note and an equity interest in Granite equal to 20% at the time of
transaction. Granite also agreed to pay certain royalties to the Company. The
note was subject to cancellation if the other party to the joint venture elected
to purchase the Company's interest. As the Company had virtually no influence
over the financing and operating policies of Granite, the interest in Granite
was accounted for using the cost method. During 2000, the Company's 20% interest
in Granite was diluted to 13% as a result of additional equity issued by Granite
to third parties.
During 2001, Granite was purchased by The Finx Group, Inc. ("Finx") and the
Company received 496,124 restricted shares of Finx for its 13% interest in
Granite. The Finx shares are traded on the OTC Bulletin Board. During 2001, the
Company advanced Granite $39,490 for working capital purposes. In December 2001,
Finx repaid the advance with 79,661 shares of its common stock. At December 31,
2001, the Company valued its aggregate holding in Finx, consisting of 575,785
shares at $69,490. At December 31, 2002, the Company reassessed its value in the
Finx stock and reduced it by $57,974 to $11,516. The adjustment was charged as
an other-than-temporary decline to interest and other expenses. The Finx shares
are included in other assets.
In October 1998, the other party to the joint venture exercised its right to
purchase the Company's interest in the joint venture for a $500,000 note. The
Company has been paid in full from installment payments on this note over a
period ranging from November 1998 through December 2000. The Company recognized
gain on the sale of discontinued operations as it continually revalued this note
throughout the payment period.
[6] Property and Equipment
Property and equipment consist of the following:
December 31,
-----------
2002 2001
---- ----
Equipment, Furniture and Fixtures $1,417,042 $1,191,975
Leasehold Improvements 305,862 294,152
--------- ---------
Totals - At Cost 1,722,904 1,486,127
Less: Accumulated Depreciation
and Amortization 1,358,598 1,119,771
--------- ---------
Net $ 364,306 $ 366,356
========= =========
Depreciation and amortization expense amounted to $256,517, $266,690, and
$259,323, respectively for the years ended December 31, 2002, 2001 and 2000.
[7] Bank Financing
Bank Financing - In June 2001, the Company entered into a financing agreement
with a bank. This improved credit facility and medium term financing replaces
the Company's asset based borrowing facility. The new financing provides the
Company with a five-year term loan of $2.5 million and a two year $1.5 million
revolving line of credit. The term loan is paid in equal monthly installments
during the term of the loan plus interest. Proceeds from the term loan are
available for acquisitions and to upgrade certain software systems to meet
requirements in California. Funds drawn down from the revolving line of credit
are to be used for working capital purposes. The term loan bears
F-20
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #9
--------------------------------------------------------------------------------
[7] Bank Financing - [Continued]
interest at LIBOR plus 2.5%. The revolving line of credit will bear interest,
at the Company's option, to be equal to either (i) LIBOR plus 2.0% or (ii) the
Prime Rate, and incur an annual facility fee of 0.5%. On July 12, 2001, 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 interest rate on the previous
facility was prime plus 2%. As of December 31, 2002, the Company owes
approximately $1,750,000 on the term loan, of which $500,000 is classified as a
current liability and the balance is classified as a long term liability. The
Company has not utilized any borrowing availability on the $1.5 million
revolving line of credit. The borrowing is collateralized by a first priority
security interest and lien on all the assets of the Company.
[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 year ended December 31, 2002, the Company utilized approximately $1.6
million of net operating loss carryforwards. At December 31, 2002 the Company
has remaining net operating loss carryforwards of approximately $9,045,000
expiring by 2021. Pursuant to Section 382 of the Internal Revenue Code regarding
substantial changes in Company ownership, utilization of approximately
$6,500,000 of this net operating loss carryforward is limited to approximately
$1,360,000 per year, plus any prior years' amounts not utilized. In addition,
the tax benefit of approximately $1,800,000 of net operating losses generated in
2000 on exercise of non-qualified compensatory stock options and warrants will
be credited to paid-in-capital as utilized.
The Company's provision for taxes for the year ended December 31, 2002 includes
certain state and local taxes.
The expiration dates of net operating loss carryforwards are as follows:
December 31, Amount
----------- ------
2015 $ 1,305,000
2016 2,413,000
2017 2,664,000
2018 716,000
2019 133,000
2020 1,810,000
2021 4,000
---------
$ 9,045,000
=========
F-21
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #10
--------------------------------------------------------------------------------
[8] Income Taxes - [Continued]
Provision for income taxes consists of the following:
Year ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Current:
Federal $ -- $ (43,280) $ 43,280
State 84,000 18,280 113,893
--------- -------- ---------
84,000 (25,000) 157,173
--------- -------- ---------
Deferred:
Federal (400,000) -- (442,000)
State -- (6,000) (52,000)
--------- -------- ---------
(400,000) (6,000) (494,000)
--------- -------- ---------
Total $ (316,000) $ (31,000) (336,827)
========= ======== =========
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,
-----------------------
2002 2001 2000
---- ---- ----
Income taxes at the federal statutory rate 34% 34 34%
State and local income taxes net of Federal taxes 5% 5 5%
Nondeductible expenses 6% 9 5%
Federal Minimum Tax -- -- 2%
Stock Option Deduction -- -- (46)%
Decrease in valuation allowance (82)% (14)% (25)%
Overaccrual from prior year (45)% --
Other 1% -- 8%
----- ----- -----
(36)% (11)% (17)%
====== ===== =====
Significant components of the Company's deferred tax assets are comprised of the
following:
December 31,
------------
2002 2001
---- ----
Net operating loss carryforward $ 3,704,000 $ 4,178,000
Allowance for doubtful accounts 211,000 136,000
Accrued vacation and bonuses 202,000 122,000
Alternative minimum tax credit carryforward 43,000 43,000
Benefit of stock based compensation awards 502,000 502,000
Other 262,000 --
---------- ----------
Total deferred tax assets 4,924,000 4,981,000
Valuation allowance (4,024,000) (4,481,000)
---------- ----------
Net deferred tax assets $ 900,000 $ 500,000
========== ===========
The valuation allowance decreased by $457,000 at December 31, 2002 The Company
believes that it is more likely than not, to use at least a portion of its net
operating loss carryforward.
F-22
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #11
--------------------------------------------------------------------------------
[8] Income Taxes - [Continued]
The change in the valuation allowance for deferred tax assets are summarized as
follows:
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Beginning Balance $ 4,481,000 $ 4,520,000 $ 5,425,000
Change in Allowance (457,000) (39,000) (905,000)
--------- ---------- ----------
Ending Balance $ 4,024,000 $ 4,481,000 $ 4,520,000
========= ========== ==========
[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, 2002.
Common Stock Issuances - During 2000, Series B Common Stock Purchase Warrants to
purchase an aggregate of 192,105 shares of Common Stock at $6 per share were
exercised. The Company received $1.1 million from the exercise of the warrants.
Treasury Stock - 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. During 2000, stock options to purchase 328,321 shares were
exercised, and the Company received gross proceeds of $381,541. Pursuant to the
option grants, employees have the right to pay for the exercise price of the
option by delivering shares of common stock owned by them. During 2000, the
Company received 22,705 shares, having a value of $239,810, as the exercise
price of the options.
Stock Options - See Note 13 for information relating to the Company's 1998, 1999
and 2001 Long-Term Incentive Plans.
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 options have
been issued as of December 31, 2002 under this plan.
[10] Capital Lease Obligations
Future minimum payments under capital lease obligations as of December 31, 2002
are as follows:
Year ending
-----------
December 31,
-----------
2003 10,808
2004 1,801
------
Total Minimum Payments 12,609
Less Amount Representing Interest at
12.6% Per annum 859
------
Balance $ 11,750
======
F-23
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #12
--------------------------------------------------------------------------------
[10] Capital Lease Obligations - [Continued]
Capital lease obligations are collateralized by equipment which has a cost of
$40,000 at December 31, 2002 and 2001 and accumulated amortization of $28,000
and $20,000 at December 31, 2002 and 2001 respectively. Amortization of $8,000
in each of 2002, 2001 and 2000, respectively, has been included in depreciation
expense.
[11] Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, and
accounts payable approximate the fair value of these instruments because of
their short maturities.
Long-term debt, including current maturities, has a carrying value of
approximately $1,750,000 and an estimated fair value of $1,800,000. 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 non
cancellable operating leases expiring December 31, 2003. In addition the Company
leases three sales and service offices under non cancelable operating leases
expiring at various times through July 2005.
Minimum annual rentals under noncancellable operating leases having terms of
more than one year are as follows:
Year ending
-----------
December 31,
-----------
2003 $ 473,000
2004 77,000
2005 43,000
-------
Total $ 593,000
----- =======
Rent expense amounted to $455,000, $482,000 and $464,000 respectively, for the
years ended December 31, 2002, 2001 and 2000.
Employment Agreements
---------------------
In January 2001, the Company entered into employment agreements with its four
executive officers for terms of two or three years with the right of the
employee to extend the agreement for an additional year. The aggregate base
compensation for these officers for 2003 is $657,000, subject to annual
increases equal to the greater of 5% or the increase in the cost of living
index. Each of the officers also has the right, at any time on 90 days notice,
to terminate his full time employment and continue as a consultant at an annual
salary of $75,000 for five years following the expiration or termination of his
employment. The agreements also provide the officers with an automobile
allowance. In the event of a change of control, the executive may receive
severance payments of between 30 and 36 months' compensation.
The Company also has a consulting agreement with a Director, which provides for
annual fees of $75,000 through December 31, 2003. The agreement also provides
the Director with an automobile allowance. In the event of a change of control,
the Director may receive severance payments of between 30 and 36 months
compensation.
F-24
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #13
--------------------------------------------------------------------------------
[12] Commitments and Contingencies - [Continued]
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 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, 2002 and 2001 the fair value of the swap of $107,713 and $74,875,
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 $32,838 and $74,875 during the years ended December 31, 2002 and
2001, respectively, has been recorded as part of comprehensive income.
[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"). The 2001 Plan was approved by the stockholders on March 7, 2002
and provides 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.
The 1999 Plan was approved by the stockholders in December 2000 and provides for
the issuance of 300,000 shares of common stock. The Company may issue 790,000,
300,000 and 550,000 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, 2002 there were 11,500, 2,000 and 1,500 shares
available for further issuance under the 1998 Plan, the 1999 Plan and 2001 Plan,
respectively, exclusive of any options available for grant as a result of the
increase in the 2001 Plan.
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 5,000 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, however, they were exercised during 2002.
The Company recognized a charge to income under the Black-Scholes formula in the
amount of $5,673.
During 2000, pursuant to an employment contract with a newly hired executive,
the Company issued a non-qualified stock option to purchase 75,000 shares of
stock at an exercise price of $6.50 per share.
F-25
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #14
--------------------------------------------------------------------------------
[13] Stock-Based Compensation - [Continued]
A summary of the activity under the Plans is as follows:
2002 2001 2000
------------------- ------------------ -------------------
Weighted Weighted Weighted
-------- -------- --------
Average Average Average
------- ------- -------
Exercise Exercise Exercise
-------- -------- --------
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding - Beginning of
Year 793,385 $1.917 809,718 $1.908 783,041 $1.176
Granted During the Year 198,500 2.505 3,500 1.900 375,000 2.748
Canceled During the Year -- -- (5,278) 1.810 (20,002) 1.250
Exercised During the Year (327,183) 1.544 (14,555) 1.500 (328,321) 1.167
------- ----- ------- ----- ------- -----
Outstanding - End of Year 664,702 $2.276 793,385 $1.917 809,718 $1.908
======= ===== ======= ===== ======= =====
Exercisable - End of Year 575,451 $2.242 789,885 $1.917 434,718 $1.183
======= ===== ======= ===== ======= =====
The following table summarizes stock option information as of December 31, 2002:
Options Outstanding
-------------------
Weighted
--------
Average Remaining Options
----------------- -------
Exercise Prices Number Outstanding Contractual Life Exercisable
--------------- ------------------ ---------------- -----------
$6.50 75,000 2.25 Years 75,000
$2.50 165,503 4.25 Years 82,752
$2.38 8,000 4.5 Years 4,000
$2.40 5,000 4.5 Years 2,500
$1.90 3,500 3.83 Years 3,500
$1.81 160,699 3 Years 160,699
$1.50 72,500 .42 Years 72,500
$1.00 174,500 .83 Years 174,500
------- --------- -------
Totals 664,702 2.41 Years 575,451
======= ========== =======
Warrants Issued as Compensation - In December 1999, the Company's $6 and $12
Series B Common Stock Purchase Warrants totaling 287,500 and 448,544,
respectively, were extended to February 29, 2000. These warrants had a previous
expiration date of December 31, 1999. The Company recognized a financing cost of
$81,000 with respect to this extension in 1999. In February 2000, these warrants
were further extended to April 30, 2000 and the Company recognized additional
financing costs of $125,000 in 2000. At the end of April 2000, 192,105 of the $6
warrants were exercised and 95,395 expired. During the course of 2001 the
448,544 $12 warrants were extended to January 31, 2002. In January 2002, the
448,544 $12 warrants were further extended to July 31, 2002. In July 2002, the
$12 warrants were 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 current market value of the
Company's stock at the date of the warrant extension.
F-26
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #15
--------------------------------------------------------------------------------
[13] Stock-Based Compensation - [Continued]
During 2002, the Company issued warrants to purchase 200,000 shares in
connection with a financial advisory agreement whereby the Company will pay
consulting fees in addition to the issuance of warrants. These warrants, which
expire 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. Either party may terminate the agreement. The warrants have 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 $2.70 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 will be charged to operations in the quarter ending March 31, 2003.
In October 2001, the Company issued warrants to purchase 40,000 shares in
connection with a public and investor relations agreement whereby the Company
will pay a monthly fee in addition to the issuance of the warrants. The warrants
have an exercise price of $2.50 for the first 5,000 shares; $3.00 for the next
5,000 shares; $3.50 for 15,000 shares and $4.00 for the final 15,000 shares.
These warrants were valued at an average price of $.14 per warrant based upon
the Black-Scholes calculation, which had an interest rate of 5.5% and a
volatility rate of .6. These warrants expired on October 28, 2002.
A summary of warrant activity is as follows:
2002 2001 2000
----------------- ----------------- ----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding - Beginning
of Year 608,544 $10.11 568,544 $10.57 790,044 $ 9.35
Granted During the Year 648,544 $ 9.89 488,544 $11.30 514,544 $11.13
Expired During the Year (488,544) $11.30 (448,544) $12.00 (543,939) $10.95
Exercised During the Year -- -- -- -- (192,105) $ 6.00
------- ----- ------- ----- ------- -----
Outstanding - End of Year 768,544 $ 9.17 608,544 $10.11 568,544 $10.57
======= ===== ======= ===== ======= =====
Exercisable - End of Year 708,544 $ 9.31 578,544 $10.44 568,544 $10.57
======= ===== ======= ===== ======= =====
F-27
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #16
--------------------------------------------------------------------------------
[13] Stock-Based Compensation - [Continued]
The following table summarizes warrant information as of December 31, 2002:
Weighted
--------
Average Remaining
-----------------
Exercise Prices Shares Contractual Life
--------------- ------ ----------------
$12.00 448,544 .08 Years
$ 8.00 30,000 2.08 Years
$ 7.00 30,000 2.00 Years
$ 6.00 30,000 1.33 Years
$ 5.45 100,000 1.75 Years
$ 5.00 30,000 1.17 Years
$ 4.20 20,000 1.75 Years
$ 4.00 30,000 .42 Years
$ 2.69 50,000 .25 Years
------- ----------
Total 768,544 .61 Years
======= ==========
The Company applies Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees", and related interpretations, for
stock options issued to employees in accounting for its stock options plans.
There was no compensation cost recognized for stock based employee compensation
awards for 2002, 2001and 2000.
F-28
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #17
[14] Operating Segments
The Company currently classifies its operations into two business segments: (1)
Software and Related Systems and Services and (2) Data Center 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
involve Company personnel performing data entry and data processing services for
customers. 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,
-----------------------
2002 2001 2000
---- ---- ----
Revenues:
--------
Software and Related Systems and Services $20,168,785 $16,077,323 $17,907,973
Data Center Services 1,957,392 2,042,098 2,262,676
---------- ---------- ----------
Total Revenues $22,126,177 $18,119,421 $20,170,649
-------------- ========== ========== ==========
Gross Profit:
------------
Software and Related Systems and Services $ 6,635,931 $ 5,095,038 $ 6,977,035
Data Center Services 945,790 1,023,148 1,238,153
---------- ---------- ----------
Total Gross Profit $ 7,581,721 $ 6,118,186 $ 8,215,188
------------------ ========== ========== ==========
Income (loss) From Continuing Operations before
-----------------------------------------------
Income Taxes:
------------
Software and Related Systems and Services $ 481,242 $ (242,072) $ 1,208,445
Data Center Services 397,976 526,494 770,747
---------- ---------- ----------
Total Income From Continuing
----------------------------
Operations before Income Taxes $ 879,218 $ 284,422 $ 1,979,192
------------------------------ ========== ========== ==========
Depreciation and Amortization:
-----------------------------
Software and Related Systems and Services $ 866,115 $ 847,369 $ 579,900
Data Center Services 170,606 163,452 137,876
---------- ---------- ----------
Total Depreciation and Amortization $ 1,036,721 $ 1,010,821 $ 717,776
----------------------------------- ========== ========== ==========
Capital Expenditures:
--------------------
Software and Related Systems and Services $ 248,201 $ 116,951 $ 850,893
Data Center Services 6,266 3,814 21,947
---------- ---------- ----------
Total Capital Expenditures $ 254,467 $ 120,765 $ 872,840
-------------------------- ========== ========== ==========
Identifiable Assets:
-------------------
Software and Related Systems and Services $20,411,376 $16,104,973 $12,659,935
Data Center Services 1,863,285 1,902,400 2,146,778
---------- ---------- ----------
Total Identifiable Assets $22,274,661 $18,007,373 $14,806,713
------------------------- ========== ========== ==========
F-29
NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Sheet #18
--------------------------------------------------------------------------------
[15] Legal Proceedings
In October 2000, the Company's subsidiary, CSM, commenced an action against the
City of Richmond, in the Supreme Court of the State of New York, County of
Suffolk, which action was subsequently removed to the United States District
Court for the Eastern District of New York, for failure to pay more than $1
million pursuant to a contract between the Company and Richmond. Richmond
advised the court that it intended to move to dismiss the complaint for lack of
personal jurisdiction in New York and improper venue. In November 2000, Richmond
filed a complaint in the Circuit Court for the City of Richmond, Richmond,
Virginia, alleging, among other things, that the contract with CSM was procured
through fraudulent misrepresentations concerning the nature of the work to be
performed and the price for the services and that CSM failed to perform its
obligations under the agreement, seeking damages of $373,000 and a finding that
it owes no additional amounts to CSM. The parties entered into a stipulation
staying the Richmond action until a determination of Richmond's jurisdictional
challenges to the New York action. On August 21, 2002, the United States
District Court for the Eastern District of New York denied Richmond's motion to
dismiss the Company's complaint for lack of personal jurisdiction in New York on
the basis of improper venue. The Company believes it has valid claims against
Richmond and intends to vigorously pursue those claims. The Company also
believes that the allegations contained in Richmond's complaint are without
merit and intends to vigorously defend against those claims. The outcome of this
case is not expected to have a material effect on the Company's consolidated
financial position or results of operations.
The Company is involved in other litigation through the normal course of
business. The Company believes that the resolution of these matters will not
have a material adverse effect on the Company's consolidated financial position
and results of operations.
[16] Subsequent Event
On January 27, 2003, the Company granted 217,500 options under the 2001 Plan,
following stockholder approval of the amendment to the 2001 Plan to increase the
number of shares of common stock subject to the plan to employees at a price of
$4.93, which was the fair market value at the date. The options vest 50% after
six months and 100% after one year.
F-30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amended report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NETSMART TECHNOLOGIES, INC.
Dated: August 21, 2003 By:/s/James L. Conway
--------------------------------
James L. Conway, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amended report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/James L. Conway Chief Executive Officer August 21, 2003
---------------------- and Director (Principal
James L. Conway Executive Officer)
/s/Anthony F. Grisanti Chief Financial Officer August 21, 2003
---------------------- (Principal Financial and
Anthony F. Grisanti Accounting Officer)
* Director August 21, 2003
----------------------
Edward D. Bright
* Director August 21, 2003
----------------------
John F. Phillips
* President and Director August 21, 2003
----------------------
Gerald O. Koop
* Director August 21, 2003
----------------------
Joseph G. Sicinski
* Director August 21, 2003
----------------------
Francis J. Calcagno
* Director August 21, 2003
----------------------
John S.T. Gallagher
* by James L. Conway, Attorney-in-Fact