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:
|
|
Six
Months Ended
June
30,
2005
|
|
Expected
Life (Years)
|
|
|
5
|
|
Interest
Rate
|
|
|
4.00
|
%
|
Annual
Rate of Dividends
|
|
|
0
|
%
|
Volatility
|
|
|
67
|
%
|
The
weighted average fair value of options at date of grant using the fair value
based method during 2005 is estimated at $5.01.
(4)
Acquisitions
In
2005,
the Company completed acquisitions of three companies with products and services
complementary to our existing offerings. We acquired Continued Learning (“CL”),
a Florida-based provider of online training services on April 28, 2005. On
June
20, 2005, we acquired Addiction Management Systems, Inc (“AMS”), which
solidified our position as one of the nation’s largest suppliers of automated
computerized methadone dispensing systems. In September 2005, we completed
the
acquisition of CMHC Systems (“CMHC”), a leading competitor in the behavioral
healthcare software market. During the six-month period ended June 30, 2006,
the
Company evaluated the assets and liabilities acquired from CMHC and increased
deferred revenue by $304,001 and accrued expenses by $161,159 resulting in
an
increase to goodwill of $465,160.
With
respect to the CL acquisition, the purchase agreement provided for a potential
additional purchase price payment of up to $250,000 if certain revenue targets
were met within one year. At December 31, 2005, the Company recognized the
full
$250,000 of this additional payment, which was included in accrued expenses.
This amount has been paid as of June 30, 2006.
The
following unaudited proforma condensed consolidated statements of operations
assumes the CL, AMS and CMHC acquisitions occurred on January 1, 2005. In
the
opinion of management, all adjustments necessary to present fairly such
unaudited proforma statements have been made. These proforma amounts may
not be
indicative of what would have occurred had the acquisitions been completed
on
January 1, 2005 or results which may occur in the future.
|
|
Six
Months
Ended
June
30, 2005
|
|
Three
Months
Ended
June
30,
2005
|
|
|
|
(in
thousands except share and per share amounts)
|
|
(in
thousands except share and per share amounts)
|
|
Revenue
|
|
$
|
29,118
|
|
$
|
14,317
|
|
Net
Income
|
|
|
1,106
|
|
|
521
|
|
Net
Income Per Share
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.18
|
|
$
|
.08
|
|
Diluted
|
|
$
|
0.17
|
|
$
|
.08
|
|
Weighted
Average Number of Shares of Common Stock Outstanding
|
|
|
6,300,703
|
|
|
6,317,342
|
|
Weighted
Average Number of Shares of Common Stock and Common Stock Equivalents
Outstanding
|
|
|
6,516,346
|
|
|
6,530,183
|
|
(5)
Income
Taxes
The
provision for income taxes for the six months ended June 30, 2006, consists
of a
current tax provision of $520,000 and a deferred tax provision of approximately
$533,000. The provision for income taxes for the six months ended June 30,
2005,
consists of a current tax provision of $139,000 and a deferred tax provision
of
approximately $291,000. The provision for income taxes for the three months
ended June 30, 2006, consists of a current tax provision of $287,000 and
a
deferred tax provision of approximately $354,000. The provision for income
taxes
for the three months ended June 30, 2005, consists of a current tax provision
of
$60,000 and a deferred tax provision of approximately $154,000.
(6)
Stockholders’
Equity
During
the six months ended June 30, 2006, options to purchase 54,144 shares were
exercised and the Company received gross proceeds of $466,330. Pursuant to
option grants, employees have the right to pay for the exercise price of
the
options by delivering “mature” shares of common stock owned by them. Included in
the proceeds received upon the exercise of options, was 639 shares of the
Company’s common stock. The value of the shares received was $8,200, which was
based upon the market value of the common stock on the date of exercise in
accordance with the cashless exercise provisions of the Company’s stock option
plans.
On
April
1, 2006, 10,500 options were granted to outside members of our Board of
Directors, as stipulated in the 2001 Long - Term Incentive Plan. These options
were granted at a price of $13.86 per share for each option, which was equal
to
the fair market value at the date of grant, in accordance with the terms
if the
2001 Long-Term Incentive Plan. The options granted vested
immediately.
In
June
2006, the Company issued 3,489 shares of its Common stock in connection with
an
investor relations agreement whereby the Company would pay consulting fees
in
addition to the stock. These shares, which were valued at $12.90, the fair
market value at the date of grant, represented the cost of the services based
upon the contractual agreement.
(7)
Operating
Segments
The
Company currently classifies its operations in four business segments: (1)
Software and Related Systems and Services - NY, (2) Software and Related
Systems
and Services - Ohio, (3) Data Center Services and (4) Application Service
Provider Services (“ASP”). Software and Related Systems and Services - Ohio is a
new segment resulting from its acquisition in September 2005. NTST-Ohio offers
a
full suite of behavioral healthcare information management software for mental
health, substance abuse and addiction services agencies, developmental
disability centers, and behavioral health-related managed care organizations.
Software and Related Systems and Services for both the NY and Ohio segments
refer to 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
out patient environments, as well as clinical documentation and medical record
generation and management. Within these segments are large turnkey and small
turnkey components. The large turnkey components consist mostly of the Avatar
suite of products. When the Company is engaged in a fixed price arrangement,
these installations will usually extend over a six-month to a multi-year
time
period. The duration of the implementation is dependent on the size and
complexity of the customer organization and the specifics of the implementation.
The small turnkey components are usually completed within a six-month period.
Small turnkey contracts performed in the New York segment are mostly related
to
the Avatar methadone related products. The small turnkey contracts in the
Ohio
segment are for system installations for behavioral healthcare information
management software for mental health, substance abuse and addiction services
agencies, developmental disability centers and behavioral health-related
managed
care organizations.
Data
Center Services involve Company personnel performing data entry and data
processing services for customers. ASP services involve the Company offering
several of it software products on a virtual private network or internet
delivery approach, thereby allowing its customers to utilize the Company’s
products and pay on a monthly service basis.
Intersegment
sales and sales outside the United States are not material. Information
concerning the Company’s business segments is as follows:
|
|
Netsmart
-NY Software and Related Systems and Services
|
|
Data
Center
|
|
Application
Service Provider
|
|
Netsmart
- Ohio Software Related Systems and Services
|
|
Total
|
|
Six
Months Ended June 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large
Turnkey
|
|
$
|
8,659,041
|
|
|
|
|
|
|
|
|
|
|
$
|
8,659,041
|
|
Small
Turnkey
|
|
|
820,365
|
|
|
|
|
|
|
|
|
3,440,826
|
|
|
4,261,191
|
|
Maintenance
|
|
|
5,322,759
|
|
|
|
|
|
|
|
|
7,333,548
|
|
|
12,656,307
|
|
Other
|
|
|
—
|
|
|
882,413
|
|
|
1,684,010
|
|
|
|
|
|
2,566,423
|
|
Total
|
|
$
|
14,802,165
|
|
$
|
882,413
|
|
$
|
1,684,010
|
|
$
|
10,774,374
|
|
$
|
28,142,962
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before Income Taxes
|
|
$
|
691,885
|
|
$
|
185,291
|
|
$
|
(14,186
|
)
|
$
|
1,434,252
|
|
$
|
2,297,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Identifiable Assets at June 30, 2006
|
|
$
|
27,025,500
|
|
$
|
1,799,904
|
|
$
|
4,278,481
|
|
$
|
31,937,004
|
|
$
|
65,040,889
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six
Months Ended June 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large
Turnkey
|
|
$
|
8,291,364
|
|
|
|
|
|
|
|
$
|
—
|
|
$
|
8,291,364
|
|
Small
Turnkey
|
|
|
372,297
|
|
|
|
|
|
|
|
|
—
|
|
|
372,297
|
|
Maintenance
|
|
|
4,445,033
|
|
|
|
|
|
|
|
|
—
|
|
|
4,445,033
|
|
Other
|
|
|
|
|
|
946,258
|
|
|
1,133,046
|
|
|
—
|
|
|
2,079,304
|
|
Total
|
|
$
|
13,108,694
|
|
$
|
946,258
|
|
$
|
1,133,046
|
|
$
|
—
|
|
$
|
15,187,998
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before Income Taxes
|
|
$
|
927,239
|
|
$
|
266,987
|
|
$
|
48,395
|
|
$
|
—
|
|
$
|
1,242,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
Identifiable Assets at June 30, 2005
|
|
$
|
31,735,429
|
|
$
|
2,373,467
|
|
$
|
4,245,409
|
|
$
|
—
|
|
$
|
38,354,305
|
|
|
|
Netsmart
-NY Software and Related Systems and Services
|
|
Data
Center
|
|
Application
Service Provider
|
|
Netsmart
- Ohio Software Related Systems and Services
|
|
Total
|
|
Three
Months Ended June 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large
Turnkey
|
|
$
|
4,291,380
|
|
|
|
|
|
|
|
|
|
|
$
|
4,291,380
|
|
Small
Turnkey
|
|
|
460,842
|
|
|
|
|
|
|
|
|
1,857,427
|
|
|
2,318,269
|
|
Maintenance
|
|
|
2,639,351
|
|
|
|
|
|
|
|
|
3,702,886
|
|
|
6,342,237
|
|
Other
|
|
|
—
|
|
|
458,104
|
|
|
876,995
|
|
|
|
|
|
1,335,099
|
|
Total
|
|
$
|
7,391,573
|
|
$
|
458,104
|
|
$
|
876,995
|
|
$
|
5,560,313
|
|
$
|
14,286,985
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before Income Taxes
|
|
$
|
496,209
|
|
$
|
102,548
|
|
$
|
30,646
|
|
$
|
746,170
|
|
$
|
1,375,573
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large
Turnkey
|
|
$
|
4,316,903
|
|
|
|
|
|
|
|
$
|
—
|
|
$
|
4,316,903
|
|
Small
Turnkey
|
|
|
106,002
|
|
|
|
|
|
|
|
|
—
|
|
|
106,002
|
|
Maintenance
|
|
|
2,290,914
|
|
|
|
|
|
|
|
|
—
|
|
|
2,290,914
|
|
Other
|
|
|
—
|
|
|
467,853
|
|
|
577,625
|
|
|
—
|
|
|
1,045,478
|
|
Total
|
|
$
|
6,713,819
|
|
$
|
467,853
|
|
$
|
577,625
|
|
$
|
—
|
|
$
|
7,759,297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before Income Taxes
|
|
$
|
927,239
|
|
$
|
266,987
|
|
$
|
48,395
|
|
$
|
—
|
|
$
|
1,242,621
|
|
(7)
New
Accounting Pronouncements
In
March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets” (“SFAS 156”), which amends SFAS 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities,” with respect
to the accounting for separately recognized servicing assets and servicing
liabilities. SFAS 156 permits the choice of the amortization method or the
fair
value measurement method, with changes in fair value recorded in income,
for the
subsequent measurement for each class of separately recognized servicing
assets
and servicing liabilities. The statement is effective for years beginning
after
September 15, 2006, with earlier adoption permitted. The Company does not
expect
SFAS 156 to have a material impact on the Company's financial position or
results of operations.
In
July
2006, the Financial Accounting Standards Board (FASB) released FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the
accounting and reporting for uncertainties in income tax law. FIN 48 prescribes
a comprehensive model for the financial statement recognition, measurement,
presentation and disclosure of uncertain tax positions taken or expected
to be
taken in income tax returns. FIN 48 shall be effective for fiscal years
beginning after December 15, 2006. Earlier adoption is permitted as of the
beginning of an enterprise’s fiscal year, provided the enterprise has not yet
issued financial statements, including financial statements for any interim
period for that fiscal year. The cumulative effects, if any, of applying
FIN 48
will be recorded as an adjustment to retained earnings as of the beginning
of
the period of adoption. The Company has commenced the process of evaluating
the
expected effect of FIN 48 on its Consolidated Financial Statements and is
currently unable to determine such effects.
(8)
Subsequent
Event
On
August
1 2006, the Company acquired certain assets, including computer software,
customer lists and computer equipment of QS Technologies, Inc. (“QS”) for an
initial payment of $1,900,000 in cash and a $1,435,000 promissory note, together
with the assumption of approximately $1,800,000 in net liabilities, consisting
principally of deferred revenue. The transaction also provides for potential
additional payments to the seller of up to $1,450,000 in 2008, contingent
upon
the attainment of performance milestones by the QS business through 2007.
QS
Technologies delivers enterprise-wide public health solutions and vital records
software to 70 public health agencies, including nine states. The Company
also
assumed the facility lease of QS in Greenville, South Carolina. This lease
has a
total square footage of 5,761, is non cancelable and expires on February
23,
2011. The annual rent is $80,106 and is subject to escalation
clauses.
Item
2. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
Overview
Our
operations are grouped into four segments:
l |
Software
and Related Systems and Services - New
York
|
l |
Software
and Related Systems and Services - Ohio
|
l |
Data
Center Services (service bureau services)
|
l
|
Application
Service Provider Services (ASP)
|
Software
and Related Systems and Services is the design, installation, implementation
and
maintenance of computer information systems that provide comprehensive
healthcare information technology solutions, including billing, patient tracking
and scheduling for inpatient and outpatient environments, as well as clinical
documentation and medical record generation and management. We perform these
services in both the New York and Ohio segments. Within these segments, we
recognize revenue based on the nature of the products and services sold,
for
example, a turnkey system, a consulting contract or a maintenance contract.
Turnkey revenue includes turnkey systems labor revenue, third party hardware
and
software revenue, license revenue and sales from our small turnkey division.
We
further classify our revenue into large turnkey and small turnkey components.
The large turnkey components consist mostly of our Avatar suite of products.
When we are engaged in fixed price arrangements for large turnkey systems,
the
installations will usually extend over a six-month to a multi-year time period.
The duration of the implementation depends on the size and complexity of
the
customer organization and the specifics of the implementation. Installations
of
small turnkey components are usually completed within a six-month period.
Small
turnkey contracts performed in the New York segment are mostly related to
our
Avatar methadone related products. The small turnkey contracts in the Ohio
segment are for system installations for behavioral healthcare information
management software for mental health, substance abuse, and addiction services
agencies, developmental disability centers and behavioral health-related
managed
care organizations. The Software and Related Systems and Services - Ohio
segment
is a new segment established as a result of the acquisition of Netsmart -
Ohio,
formerly CMHC Systems, Inc. This acquisition occurred in October 2005 and
consequently operations from this acquisition are included in the results
of
operations for the six months ended June 30, 2006 but are not included in
the
comparable period for 2005. Data Center Services involves our personnel
performing data entry and data processing services for customers. Application
Service Provider Services involves the offering of our Avatar suite of products,
our CareNet products, our InfoScribeR products and our Netsmart University,
formerly ContinuedLearning, products on a virtual private network or through
an
internet delivery approach, thereby allowing our customers to deploy products
and pay on a monthly service basis, thus eliminating capital intensive system
requirements for such services.
In
addition to our acquisition of CMHC, we made two other acquisitions in fiscal
2005. On April 28, 2005, we acquired substantially all of the assets, including
computer software, customer lists and computer equipment, of ContinuedLearning
LLC, a company that offered a comprehensive family of web-based training
products and services, including its Learning Management System. On June
20,
2005, we acquired the assets of Addiction Management Systems, Inc (“AMS”). The
results of operations from these acquisitions are also included in the results
of operations for the six months ended June 30, 2006 but not the comparable
period for 2005.
Our
results of operations are subject to various risks and uncertainties, including
those described in Item 1A, “Risk Factors” in both this Form 10-Q and in our
Form 10-K for the fiscal year ended December 31, 2005, and the market risks
described in Item 7A, Quantitative and Qualitative Disclosures about Market
Risks in our Form 10-K for the fiscal year ended December 31,
2005.
Six
Months Ended June 30, 2006 and 2005
Results
of Operations
Our
total
revenue for the six months ended June 30, 2006 (“the “June 2006 period”) was
$28,143,000, an increase of $12,955,000, or 85%, from our revenue for the
six
months ended June 30, 2005 (the “June 2005 period”) which was $15,188,000.
Revenue from the Netsmart - Ohio acquisition accounted for $10,774,000 or
83% of
the increase in revenue from the June 2006 period to the June 2005 period.
Revenue from the AMS acquisition accounted for $987,000 or 8% of the increase
in
revenue from the June 2006 period to the June 2005 period.
Revenue
from contracts with state and local government agencies represented 37% of
revenue in the June 2006 period and 48% of revenue in the June 2005 period.
This
decrease was the result of the inclusion of the Netsmart - Ohio revenue,
approximately 20% of which is generated from contracts with state and local
government agencies.
Fixed
price software development contracts, which include labor, licenses and third
party resale components, accounted for 16% and 33% of consolidated revenue
for
the June 2006 period and the June 2005 period, respectively. This decrease
is
the result of a decrease in Software and Related Systems and Services revenue
generated from fixed price contracts and an increase in Software and Related
Systems and Services revenue generated on an as incurred basis. Our recurring
revenue components, which include our maintenance contract services, our
Data
Center and our ASP services, accounted for 54% of our consolidated revenue
for
the June 2006 period as compared to 43% of consolidated revenue for the June
2005 period. This increase was primarily the result of an increase in
maintenance revenue resulting from the inclusion of the operations of Netsmart
-
Ohio, as well as an increase in both maintenance and ASP revenue, exclusive
of
the Netsmart - Ohio acquisition, which was partially offset by a decrease
in
Data Center revenue.
Revenue
from large turnkey 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. Since the billing schedules under the
contracts differ from the recognition of revenue, at the end of any quarter,
these contracts generally result in either costs and estimated profits in
excess
of billing or billing in excess of costs and estimated profits. Revenue from
our
small turnkey fixed price contracts is accounted for under the completed
contract method.
Software
and Related Systems and Services - New York
Our
Software and Related Systems and Services - New York revenue for the June
2006
period was $14,802,000, an increase of $1,693,000, or 13%, from our revenue
for
the June 2005 period, which was $13,109,000. Software and Related Systems
and
Services - New York 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 in the markets
in
which we operated prior to our acquisition of our Ohio operations in September
2005.
Within
this segment are large turnkey and small turnkey components. The large turnkey
components consist mostly of our Avatar suite of products. When we are engaged
in fixed price arrangements for large turnkey systems, the installations
will
usually extend over a six-month to a multi-year time period; these installations
are accounted for under the percentage of completion method. The duration
of the
implementation depends on the size and complexity of the customer organization
and the specifics of the implementation. Installations of small turnkey
components are usually completed within a six-month period; these installations
are accounted for under the completed contract method. Small turnkey contracts
performed in the New York segment are mostly related to our Avatar methadone
related products.
The
largest component of Software and Related Systems and Services - New York
revenue was maintenance revenue, which increased $878,000, or 20%, to $5,323,000
in the June 2006 period from $4,445,000 in the June 2005 period. Revenue
from
the AMS acquisition accounted for approximately 88% of this increase. As
turnkey
systems are completed, they are transitioned to the maintenance division,
thereby increasing our installed base of recurring revenue. Turnkey systems
labor revenue increased $175,000, or 3%, to $5,184,000 in the June 2006 period
from $5,009,000 in the June 2005 period. Turnkey systems labor revenue refers
to
labor associated with turnkey installations and includes categories such
as
training, installation, project management and development. An increase of
$260,000 in turnkey systems labor revenue was primarily due to an increase
in
billable time spent on contracts. This increase was partially offset by $84,000
due to a 2% decrease in our average daily billing rate. Revenue from third
party
hardware and software increased 12% to $2,561,000 in the June 2006 period,
from
$2,294,000 in the June 2005 period. Sales of third party hardware and software,
such as pharmacy and database software, are made in connection with the sales
of
turnkey systems. These sales are typically made at lower gross margins than
our
software and related systems and services revenue. During the June 2006 period,
the increase in revenue from third party hardware and software was the result
of
an increase in database software sales and pharmacy related sales to various
customers. License revenue decreased 8% to $914,000 in the June 2006 period
from
$989,000 in the June 2005 period. License revenue is generated as part of
a sale
of a human services information system pursuant to a contract or purchase
order
that includes delivery of the system and maintenance. The decrease in revenue
is
substantially the result of a decrease in customer user count upgrade sales,
as
well as a decrease in large system license sales. Revenue from the sales
of our
small turnkey contracts increased 120% to $820,000 in the June 2006 period
from
$372,000 in the June 2005 period. Small turnkey contract sales relate to
turnkey
contracts that are less than $50,000 and are usually completed within one
to six
months. The increase in our small turnkey revenue for the June 2006 period
is
substantially due to the inclusion of sales of AMS products.
Gross
profit increased 5% to $6,842,000 in the June 2006 period from $6,497,000
in the
June 2005 period. Our gross profit percentage decreased to 46% in the June
2006
period from 50% in the June 2005 period. Our gross profit percentage decreased
as a result of the decrease in license revenue as well as an increase in
our
third party hardware and software revenue, which are typically made at lower
gross margins than our other revenue components. This decrease was partially
offset by improved efficiency from our maintenance division.
Software
and Related Systems and Services - Ohio
The
Software and Related Systems and Services-Ohio segment is a new segment
established as a result of the acquisition of Netsmart - Ohio, formerly CMHC
Systems, Inc. The Ohio operations commenced October 1, 2005. Netsmart - Ohio
offers a full suite of behavioral healthcare information management software
for
mental health, substance abuse, and addiction services agencies, developmental
disability centers, and behavioral health-related managed care organizations.
The small turnkey contracts in the Ohio segment are for system installations
for
behavioral healthcare information management software for mental health,
substance abuse, and addiction services agencies, developmental disability
centers and behavioral health-related managed care organizations. The small
turnkey contracts are usually completed within a six-month period.
Revenue
for the June 2006 period consisted of the following components: Maintenance
revenue of $7,334,000, third party hardware and software revenue of $898,000,
turnkey systems labor revenue of $1,384,000 and license revenue of
$1,159,000.
Gross
profit for the June 2006 period was $5,853,000 and our gross profit percentage
was 54%.
Data
Center Services (Service Bureau)
Data
center clients typically generate approximately the same amount of revenue
each
year. We bill on a transaction basis or on a fixed fee arrangement.
Historically, each year we increase the transaction or fixed fee by an amount
that approximates the New York urban consumer price index increase. The data
center revenue decreased to $882,000 in the June 2006 period from $946,000
in
the June 2005 period, representing a decrease of $64,000, or 7%. This decrease
was the result of one customer discontinuing the use of our
services.
Gross
profit decreased 4% to $479,000 in the June 2006 period from $497,000 in
the
June 2005 period. Our gross margin percentage increased to 54% in the June
2006
period from 53% in the June 2005 period. This increase in gross margin
percentage was the result of a reduction in the following costs: communication
costs decreased $25,000, and support overhead and facility costs decreased
$29,000. These decreases in costs, which increased our gross margin percentage,
were partially offset by a $10,000 increase in salary and fringe cost as
well as
the decrease in revenue mentioned above.
Application
Service Provider Services (“ASP”)
ASP
Services involves the offering of our Avatar suite of products, our CareNet
products, our Netsmart University products and our InfoScribeR products on
a
virtual private network or through an internet delivery approach, thereby
allowing our customers to rapidly deploy products and pay on a monthly service
basis, thus eliminating capital intensive system requirements for such services.
ASP
revenue increased to $1,684,000 in the June 2006 period from $1,133,000 in
the
June 2005 period, representing an increase of $551,000 or 49%. This increase
is
primarily the result of the inclusion of our Netsmart University revenue,
as
well as increases in our CareNet, Avatar ASP services and InfoScriber customer
base.
Gross
profit for the June 2006 period was $716,000 and for the June 2005 period
was
$469,000, representing an increase of $247,000, or 53%. The gross margin
percentage was 43% for the June 2006 period and 41% for the June 2005 period.
Although revenue increased, the gross profit and gross margin percentage
did not
increase proportionally due to the increased costs associated with the Netsmart
University operations, which amounted to $218,000 in the June 2006 period.
These
costs represent the required baseline costs to support the Netsmart University
operation. We expect that as revenue from Netsmart University increases,
gross
profit and margins for this segment will increase accordingly.
Operating
Expenses
Selling,
general and administrative expenses were $8,693,000 in the June 2006 period,
reflecting an increase of $4,334,000, or 99%, from $4,359,000 in the June
2005
period. Approximately $2,926,000 or 67% of this increase was related to the
selling, general and administrative costs associated with Netsmart - Ohio.
These
costs consist of : (1) general and administrative costs totaling $1,332,000,
of
which the major cost components are as follows - accounting, human resources
and
administrative salaries and fringe costs $253,000, rent and real estate taxes
related to the Ohio facility $293,000, reserve for bad debts $77,000, customer
list and contract backlog amortization $387,000 and equipment costs and
maintenance $103,000 and (2) sales and marketing costs totaling $1,594,000,
of
which the major cost components are as follows - salaries and fringe $947,000,
commissions $201,000, trade shows $144,000 and travel and lodging $120,000.
The
remaining 33% of the increases in selling, general and administrative costs
beyond the Netsmart - Ohio costs were in: sales and marketing salaries and
fringe costs, which increased by $396,000; commissions, which increased
$175,000; sales and marketing costs associated with travel and lodging which
increased by $72,000 advertising and promotion costs, which increased by
$98,000; general administrative salaries and fringe costs, which increased
$265,000; amortization of customer lists and contract backlog related to
various
acquisitions exclusive of NTST - Ohio which increased by $71,000; general
insurance costs which increased by $60,000; accounting costs which increased
by
$126,000; and provision for bonuses which increased by $113,000. These cost
increases were partially offset by a decrease in bad debt expense of $152,000.
We
incurred research, development and maintenance expenses of $2,971,000 in
the
June 2006 period, an increase of $1,002,000, or 51%, from $1,969,000 in the
June
2005 period. Approximately $1,077,000 of research, development and maintenance
expenses related to the Netsmart - Ohio operations. The Netsmart -New York
research, development and maintenance expenses decreased by approximately
$75,000 as a result of redirecting resources towards revenue generating
efforts.
Interest
expense was $107,000 in the June 2006 period, an increase of $70,000, or
189%,
from the $37,000 in June 2005 period. On October 7, 2005, we borrowed $2,500,000
pursuant to a term loan advanced under a new revolving credit and term loan
agreement. The increase in interest expense was the result of the increased
borrowings under this term loan.
Interest
income was $178,000 in the June 2006 period, an increase of $32,000, or 22%,
from $146,000 in the June 2005 period. This increase is the result an increase
in interest rates. Interest income is generated from short-term investments
made
with a substantial portion of the proceeds received from our term loan, as
well
as cash generated from operations.
We
have a
net operating loss tax carry forward of approximately $1.5 million at June
30,
2006. In the June 2006 period, we recorded a current income tax expense of
$520,000, which related to various state and local taxes, as well as a provision
for the Federal alternative minimum tax. The income tax provision also consists
of a deferred tax provision of $533,000. In the June 2005 period, we recorded
a
current income tax expense of $139,000, which related to various state and
local
taxes, as well as a provision for the Federal alternative minimum tax. The
income tax provision also consists of a deferred tax provision of
$291,000.
As
a
result of the foregoing factors, in the June 2006 period, we had net income
of
$1,244,000, or $.19 per share basic and $.18 per share diluted. For the June
2005 period, we had net income of $813,000, or $.15 per share, basic and
diluted.
Three
Months Ended June 30, 2006 and 2005
Results
of Operations
Our
total
revenue for the three months ended June 30, 2006 (“the “June 2006 quarter”) was
$14,287,000, an increase of $6,528,000, or 84%, from our revenue for the
three
months ended June 30, 2005 (the “June 2005 quarter”) which was $7,759,000.
Revenue from the Netsmart - Ohio acquisition accounted for $5,560,000 or
85% of
the increase in revenue from the June 2006 quarter to the June 2005 quarter.
Revenue from the AMS acquisition accounted for $480,000 or 7% of the increase
in
revenue from the June 2006 quarter the June 2005 quarter.
Revenue
from contracts with state and local government agencies represented 35% of
revenue in the June 2006 quarter and 45% of revenue in the June 2005 quarter.
This decrease was the result of the inclusion of the Netsmart - Ohio revenue,
approximately 20% of which is generated from contracts with state and local
government agencies.
Fixed
price software development contracts, which include labor, licenses and third
party resale components, accounted for 14% and 29% of consolidated revenue
for
the June 2006 quarter and the June 2005 quarter, respectively. This decrease
is
the result of a decrease in Software and Related Systems and Services revenue
generated from fixed price contracts and an increase in Software and Related
Systems and Services revenue generated on an as incurred basis. Our recurring
revenue components, which include our maintenance contract services, our
Data
Center and our ASP services, accounted for 54% of our consolidated revenue
for
the June 2006 quarter as compared to 43% of consolidated revenue for the
June
2005 quarter. This increase was primarily the result of an increase in
maintenance revenue resulting from the inclusion of the operations of Netsmart
-
Ohio, as well as an increase in both maintenance and ASP revenue, exclusive
of
the Netsmart - Ohio acquisition, which was partially offset by a decrease
in
Data Center revenue.
Revenue
from large turnkey 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. Since the billing schedules under the
contracts differ from the recognition of revenue, at the end of any quarter,
these contracts generally result in either costs and estimated profits in
excess
of billing or billing in excess of costs and estimated profits. Revenue from
our
small turnkey fixed price contracts is accounted for under the completed
contract method.
Software
and Related Systems and Services - New York
Our
Software and Related Systems and Services - New York revenue for the June
2006
quarter was $7,392,000, an increase of $678,000, or 10%, from our revenue
for
the June 2005 quarter, which was $6,714,000. Software and Related Systems
and
Services - New York 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 in the markets
in
which we operated prior to our acquisition of our Ohio operations in September
2005.
Within
this segment are large turnkey and small turnkey components. The large turnkey
components consist mostly of our Avatar suite of products. When we are engaged
in fixed price arrangements for large turnkey systems, the installations
will
usually extend over a six-month to a multi-year time period; these installations
are accounted for under the percentage of completion method. The duration
of the
implementation depends on the size and complexity of the customer organization
and the specifics of the implementation. Installations of small turnkey
components are usually completed within a six-month period; these installations
are accounted for under the completed contract method. Small turnkey contracts
performed in the New York segment are mostly related to our Avatar methadone
related products.
The
largest component of Software and Related Systems and Services - New York
revenue was maintenance revenue, which increased $348,000, or 15%, to $2,639,000
in the June 2006 quarter from $2,291,000 in the June 2005 quarter. Revenue
from
the AMS acquisition accounted for approximately $390,000 in increased
maintenance revenue. We experienced a decrease of approximately $42,000 in
other
areas of our maintenance revenue which were primarily associated with the
transition of customers acquired in previous acquisitions made in 2001 and
2004.
As turnkey systems are completed, customers are transitioned to the maintenance
division, thereby increasing our installed base of recurring revenue. Turnkey
systems labor revenue decreased $5,000 to $2,636,000 in the June 2006 quarter
from $2,641,000 in the June 2005 quarter. Turnkey systems labor revenue refers
to labor associated with turnkey installations and includes categories such
as
training, installation, project management and development. There was a decrease
in turnkey systems labor revenue of $80,000 due to a 4% decrease in our average
daily billing rate. The decrease was primarily offset by an increase of $75,000
in turnkey systems labor revenue primarily due to an increase in billable
time
spent on contracts. Revenue from third party hardware and software increased
1%
to $1,200,000 in the June 2006 quarter, from $1,189,000 in the June 2005
quarter. Sales of third party hardware and software, such as pharmacy and
database software, are made in connection with the sales of turnkey systems.
These sales are typically made at lower gross margins than our software and
related systems and services revenue. During the June 2006 quarter, the increase
in revenue from third party hardware and software was the result of an increase
in pharmacy related sales to various customers. License revenue decreased
6% to
$456,000 in the June 2006 quarter from $487,000 in the June 2005 quarter.
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 decrease in revenue is substantially the result
of a
decrease in customer user count upgrade sales, as well as a decrease in large
system license sales. Revenue from the sales of our small turnkey contracts
increased 335% to $461,000 in the June 2006 quarter from $106,000 in the
June
2005 quarter. Small turnkey contract sales relate to turnkey contracts that
are
less than $50,000 and are usually completed within one to six months. The
increase in our small turnkey revenue for the June 2006 quarter is substantially
due to the inclusion of sales of AMS products.
Gross
profit remained relatively constant at $3,433,000 in the June 2006 quarter
as
compared to $3,423,000 in the June 2005 quarter. Our gross profit percentage
decreased to 47% in the June 2006 quarter from 51% in the June 2005 quarter.
Our
gross profit percentage decreased as a result of the decrease in license
revenue, the 4% decrease in our average daily billing rate, as well as an
increase in our third party hardware and software revenue, which are typically
made at lower gross margins than our other revenue components.
Software
and Related Systems and Services - Ohio
The
Software and Related Systems and Services-Ohio segment is a new segment
established as a result of the acquisition of Netsmart - Ohio, formerly CMHC
Systems, Inc. The Ohio operations commenced October 1, 2005. Netsmart - Ohio
offers a full suite of behavioral healthcare information management software
for
mental health, substance abuse, and addiction services agencies, developmental
disability centers, and behavioral health-related managed care organizations.
The small turnkey contracts in the Ohio segment are for system installations
for
behavioral healthcare information management software for mental health,
substance abuse, and addiction services agencies, developmental disability
centers and behavioral health-related managed care organizations. The small
turnkey contracts are usually completed within a six-month period.
Revenue
for the June 2006 quarter consisted of the following components: Maintenance
revenue of $3,703,000, third party hardware and software revenue of $566,000,
turnkey systems labor revenue of $679,000 and license revenue of
$612,000.
Gross
profit for the June 2006 quarter was $2,936,000 and our gross profit percentage
was 53%.
Data
Center Services (Service Bureau)
Data
center clients typically generate approximately the same amount of revenue
each
year. We bill on a transaction basis or on a fixed fee arrangement.
Historically, each year we increase the transaction or fixed fee by an amount
that approximates the New York urban consumer price index increase. The data
center revenue decreased to $458,000 in the June 2006 quarter from $468,000
in
the June 2005 quarter, representing a decrease of $10,000, or 2%. This decrease
was the result of one customer discontinuing the use of our services which
was
partially offset by increased revenue activity from our existing customer
base.
Gross
profit increased 2% to $253,000 in the June 2006 quarter from $249,000 in
the
June 2005 quarter. Our gross margin percentage increased to 55% in the June
2006
quarter from 53% in the June 2005 quarter. This increase in gross margin
percentage was the result of a reduction in the following costs: communication
costs decreased $9,000, and support overhead and facility costs decreased
$10,000. These decreases in costs, which increased our gross margin percentage,
were partially offset by a $5,000 increase in salary and fringe costs, as
well
as the decrease in revenue mentioned above.
Application
Service Provider Services (“ASP”)
ASP
Services involves the offering of our Avatar suite of products, our CareNet
products, our Netsmart University products and our InfoScribeR products on
a
virtual private network or through an internet delivery approach, thereby
allowing our customers to rapidly deploy products and pay on a monthly service
basis, thus eliminating capital intensive system requirements for such services.
ASP
revenue increased to $877,000 in the June 2006 quarter from $578,000 in the
June
2005 quarter, representing an increase of $299,000 or 52%. This increase
is the
result of the inclusion of our Netsmart University revenue, as well as increases
in our CareNet, Avatar ASP services and InfoScriber customer base.
Gross
profit for the June 2006 quarter was $403,000 and for the June 2005 quarter
was
$190,000, representing an increase of $213,000, or 112%. The gross margin
percentage was 46% for the June 2006 quarter and 33% for the June 2005 quarter.
The increase in gross margin and gross margin percentage is the result of
the
increase in revenue partially offset by an increase in costs of approximately
$89,000. This increase in costs is almost entirely attributable to Netsmart
University. Netsmart University revenue accounted for 44% of the increase
in ASP
revenue.
Operating
Expenses
Selling,
general and administrative expenses were $4,270,000 in the June 2006 quarter,
reflecting an increase of $1,900,000, or 80%, from $2,370,000 in the June
2005
quarter. Approximately $1,317,000 or 69% of this increase was related to
the
selling, general and administrative costs associated with Netsmart - Ohio.
These
costs consist of : (1) general and administrative costs totaling $519,000,
of
which the major cost components are as follows - accounting, human resources
and
administrative salaries and fringe costs $81,000, rent and real estate taxes
related to the Ohio facility $122,000, reserve for bad debts $52,000, customer
list and contract backlog amortization $192,000 and equipment costs and
maintenance $48,000 and (2) sales and marketing costs totaling $798,000,
of
which the major cost components are as follows - salaries and fringe costs
$419,000, commissions $125,000, trade shows $132,000 and travel and lodging
$53,000. The remaining increases beyond the Netsmart - Ohio costs were in:
sales
and marketing salaries and fringe costs, which increased by $131,000;
commissions, which increased $55,000; sales and marketing costs associated
with
travel and lodging which increased by $25,000 advertising and promotion costs,
which increased by $103,000; general administrative salaries and fringe costs,
which increased $90,000; accounting costs which increased by $110,000; and
provision for bonuses which increased by $73,000. These cost increases were
partially offset by a decrease in bad debt expense of $161,000.
We
incurred research, development and maintenance expenses of $1,415,000 in
the
June 2006 quarter, an increase of $516,000, or 57%, from $899,000 in the
June
2005 quarter. Approximately $475,000 of research, development and maintenance
expenses related to the Netsmart - Ohio operations. The Netsmart -New York
research, development and maintenance expenses increased by approximately
$41,000 as a result of efforts towards routine product maintenance.
Interest
expense was $51,000 in the June 2006 quarter, an increase of $33,000, or
183%,
from the $18,000 in June 2005 quarter. On October 7, 2005, we borrowed
$2,500,000 pursuant to a term loan advanced under a new revolving credit
and
term loan agreement. The increase in interest expense was the result of the
increased borrowings under this term loan.
Interest
income remained relatively constant at $87,000 for the June 2006 quarter
and
$88,000 for the June 2005 quarter. Interest income is generated from short-term
investments made with a substantial portion of the proceeds received from
our
term loan, as well as cash generated from operations.
We
have a
net operating loss tax carry forward of approximately $1.5 million at June
30,
2006. In the June 2006 quarter, we recorded a current income tax expense
of
$287,000, which related to various state and local taxes, as well as a provision
for the Federal alternative minimum tax. The income tax provision also consists
of a deferred tax provision of $354,000. In the June 2005 quarter, we recorded
a
current income tax expense of $60,000, which related to various state and
local
taxes, as well as a provision for the Federal alternative minimum tax. The
income tax provision also consists of a deferred tax provision of
$154,000.
As
a
result of the foregoing factors, in the June 2006 quarter, we had net income
of
$735,000, or $.11 per share, basic and diluted. For the June 2005 quarter,
we
had net income of $449,000, or $.08 per share, basic and diluted.
Liquidity
and Capital Resources
We
had
working capital of approximately $6.5 million at June 30, 2006 as compared
to
working capital of approximately $4.1 million at December 31, 2005. This
increase of approximately $2.4 million in working capital was the result
of the
following: our net income, after adding back depreciation and amortization
and
other non-cash charges, which totaled $3,431,000, $215,000 for a goodwill
adjustment relating to deferred revenue and accrued liabilities; and net
proceeds from the exercise of stock options of $458,000. These increases
were
partially offset by $578,000 for the acquisition of equipment, $764,000 for
a
decrease in the current portions of the deferred tax asset and liability,
and
$149,000 of additional costs related to the private placement effort. The
remaining decrease in working capital of $178,000 was due to changes in other
current assets and liabilities.
In
October 2005, we entered into a revolving credit and term loan agreement
with
the Bank of America, which was amended as of December 31, 2005 (as so amended,
the “Credit Agreement”). This financing provides us with a five-year term loan
of $2.5 million. The term loan bears interest at LIBOR plus 2.25%. We have
entered into an interest rate swap agreement with the Bank for the amount
outstanding under the term loan whereby we converted our variable rate on
the
term loan to a fixed rate of 7.1% in order to reduce the interest rate risk
associated with these borrowings. On October 7, 2005, we borrowed the full
amount of the $2,500,000 term loan. The revolving credit facility provides
for
borrowings of up to $2,500,000. Any amounts borrowed under this arrangement
will
bear interest at a rate per annum to be elected by us, equal to either (1)
the
LIBOR Rate plus 2.5% or (2) the Bank's prime rate. We have not borrowed any
amounts under the revolving credit facility and there is no amount outstanding
as of June 30, 2006. The amount outstanding under the Term Loan Agreement
at
June 30, 2006 is $2,167,000.
The
terms
of the Credit Agreement require compliance with certain covenants, including
maintaining a minimum tangible net worth of $2,250,000 until June 30, 2006
with
provisions for increases in future periods, minimum cash reserves of $5,000,000,
maintenance of certain financial ratios, limitations on capital expenditures
and
indebtedness and prohibition of the payment of cash dividends. As of June
30,
2006, the Company was in compliance with the financial covenants of the Credit
Agreement.
A
part of
our growth strategy is to acquire other businesses that are related to our
current business. Such acquisitions may be made with cash, our securities,
or a
combination of cash and securities. If we fail to make any acquisitions our
future growth will be limited to only internal growth. We are continually
seeking acquisitions that will add complementary products to our offerings
and
that will provide value for the markets we serve. As of the date of this
Form
10-Q quarterly report, we did not have any formal or informal agreements
or
understandings with respect to any material acquisition, except for those
relating to the QS Technologies, Inc. acquisition made on August 1,
2006.
On
August
1 2006, we acquired certain assets, including computer software, customer
lists
and computer equipment of QS Technologies, Inc. (“QS”) for an initial payment of
$1,900,000 in cash and a $1,435,000 promissory note, together with the
assumption of approximately $1,800,000 in net liabilities, consisting
principally of deferred revenue. The transaction also provides for potential
additional payments to the seller of up to $1,450,000 in 2008, contingent
upon
the attainment of performance milestones by the QS business through 2007.
QS
Technologies delivers enterprise-wide public health solutions and vital records
software to 70 public health agencies, including nine states. We also assumed
the facility lease of QS in Greenville, South Carolina. This lease has a
total
square footage of 5,761, is non cancelable and expires on February 23, 2011.
The
annual rent is $80,106 and is subject to escalation clauses.
Based
on
our outstanding contracts and our continuing business, we believe that our
cash
flow from operations and our cash on hand will be sufficient to enable us
to
fund our operations for at least the next twelve months. It is possible that
we
may need additional funding if we go pursue 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 expectations.
Based
on
our market capitalization on June 30, 2006, the last day of our second fiscal
quarter, we will become an “accelerated filer” for our fiscal year ending
December 31, 2006. Our status as an accelerated filer will require us to
comply
with Section 404 of the Sarbanes-Oxley Act of 2002, which requires management
certification with respect to internal controls over financial reporting.
In
anticipation of the change to accelerated filer status, we have substantially
completed the steps necessary to enable management to evaluate such internal
controls. Consequently, we do not expect to make material expenditures in
connection with our Section 404 compliance.
Off-Balance
Sheet Arrangements
We
are
not a party to any off-balance sheet arrangements.
Contractual
Obligations
The
following table summarizes, as of June 30, 2006, our obligations and commitments
to make future payments under debt, capital leases, operating leases and
other
long-term liabilities:
Contractual
Obligations
|
|
Payments
Due by Period
|
|
|
|
|
|
|
|
|
|
Total
|
|
Less
than 1 year
|
|
1
- 3 years
|
|
4
- 5 years
|
|
Over
5 years
|
|
Long
Term Debt1
|
|
$
|
2,166,664
|
|
$
|
500,000
|
|
$
|
1,000,000
|
|
$
|
666,664
|
|
$
|
—
|
|
Capital
Lease Obligations2
|
|
|
31,056
|
|
|
31,056
|
|
|
|
|
|
|
|
|
|
|
Operating
Leases3
|
|
|
8,846,477
|
|
|
1,309,510
|
|
|
2,225,290
|
|
|
2,082,139
|
|
|
3,229,538
|
|
Other
Long-Term Liabilities3
|
|
|
1,606,332
|
|
|
802,434
|
|
|
787,960
|
|
|
15,938
|
|
|
|
|
Total
Contractual and Other Long-Term Obligations
|
|
$
|
12,650,529
|
|
$
|
2,643,000
|
|
$
|
4,013,250
|
|
$
|
2,764,741
|
|
$
|
3,229,538
|
|
1
See Note
7 to Netsmart’s Consolidated Financial Statements for the years ended December
31, 2005, 2004 and 2003, which describes the Company’s financing
agreements.
2
See Note
10 to Netsmart’s Consolidated Financial Statements for the years ended December
31, 2005, 2004 and 2003, which describes the Company’s Capital Lease
Obligation.
3
See Note
12 to Netsmart’s Consolidated Financial Statements for the years ended December
31, 2005, 2004 and 2003 which describes the Company’s Operating Lease and other
Contractual Obligations.
Critical
Accounting Policies and Estimates
Our
Consolidated Financial Statements are prepared in accordance with accounting
principles generally accepted in the United States of America. These accounting
principles require us to make certain estimates, judgments and assumptions.
We
believe that the estimates, judgments and assumptions upon which we rely
are
reasonable based upon information available to us at the time that these
estimates, judgments and assumptions are made. These estimates, judgments
and
assumptions can affect the reported amounts of assets and liabilities as
of the
date of the financial statements, as well as the reported amounts of revenues
and expenses during the periods presented. Among other things, estimates
are
used in accounting for allowances for bad debts, deferred income taxes, expected
realizable values of assets (primarily capitalized software development costs
and customer lists) and revenue recognition. To the extent there are material
differences between these estimates, judgments or assumptions and actual
results, our financial statements will be affected. Following is a discussion
of
the significant accounting policies and the significant estimates that we
believe are the most critical to aid in fully understanding and evaluating
our
reported financial results: