The Board of Directors has also adopted, and we have posted in the Investor Relations section of our website, written Charters for each of the Board’s standing committees. We will provide without charge, upon a stockholder’s request to our address set forth in the preceding section, a copy of the codes of ethics or the Charter of any standing committee of the Board.
Business Segments
For a detailed description of the assets and profits of each of our business segments see note 14 to our Consolidated Financial Statements.
Software and Related Systems and Services - New York
We develop, market and support computer software and provide implementation and business services that enable health and human services organizations to access, manage and share information related to their financial, clinical and management processes.
Customer organizations typically purchase our software 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 reseller agreements with these partners. Our products are designed to operate on most hardware platforms and on most operating systems, including UNIX, Microsoft Windows and Linux. Because our products operate on a variety of platforms, we are not dependent on any single hardware vendor or operating system. Since our Avatar suite of software products utilizes the Cache database and development software provided by Intersystems Corporation, we resell Cache software. Since Avatar is designed to operate solely with Cache products, we are dependent on Cache products for our operations.
Our professional services offerings include project management, implementation, training, consulting and software development services, which are provided either on a time-and-material or fixed-price contract basis. Our software development services may require the adaptation of healthcare 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 $5,000,000 for multi-unit care organizations such as those run by state agencies. Revenue from license fees was approximately $2,126,000, or 3.6% of consolidated revenue, for 2006, $2,210,000, or 5.8% of consolidated revenue, for 2005 and $2,066,000, or 7.1% of consolidated revenue, for 2004. A customer’s purchase order may also include third party hardware or software. Revenue from hardware and third party software accounted for approximately $5,433,000, or 9.2% of consolidated revenue, for 2006, $5,544,000, or 14.6% of consolidated revenue, for 2005 and $4,336,000, or 15.0% of consolidated revenue, for 2004. Revenue from turnkey systems labor accounted for approximately $10,492,000, or 18.5% of consolidated revenue, for 2006, $9,845,000, or 25.9% of consolidated revenue, for 2005 and $9,602,000, or 33.1% of consolidated revenue in 2004.
Our small systems revenue was approximately $1,889,000, or 3.2% of consolidated revenue, for 2006, $1,042,000, or 2.7% of consolidated revenue, for 2005 and $928,000, or 3.2% of consolidated revenue, for 2004.
Maintenance services have generated increasing revenue and have become a more significant portion of our business, since most purchasers of healthcare 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 desk support and maintain and upgrade their software. Maintenance contracts may require us to make modifications to meet any new federal and state reporting requirements that 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 $10,933,000, or 18.5% of consolidated revenue, for 2006, $9,784,000, or 25.8% of consolidated revenue, for 2005 and $8,290,000, or 28.6% of consolidated revenue, for 2004.
Software and Related Systems and Services - Ohio
As with Netsmart New York, the Netsmart Ohio operation develops computer software and provides implementation and business services that are designed to enable health and human services organizations to access, manage and share information related to their financial, clinical and management processes.
The Ohio segment consists mainly of the operations of the former CMHC Systems, Inc., now named Netsmart Ohio. The results of operations from this acquisition are included from October 1, 2005 through December 31, 2006. The focus of the Ohio segment consists primarily of contracts for turnkey system installations of behavioral healthcare information management software for mental health, substance abuse, and addiction services agencies, and some developmental disability centers and behavioral health-related managed care organizations. These turnkey installations are usually completed within a six-month period.
The core product of the Ohio segment is the CMHC/MIS, a comprehensive billing and clinical software product designed for the UNIX operating system. As with the Avatar software, customer organizations typically purchase the CMHC/MIS in the form of a perpetual license to use the system, as well as purchasing professional services, support, and maintenance. In addition, Netsmart Ohio resells third party hardware, typically in the form of servers used to run the application. Professional services for installation and implementation of the software are provided either on a time-and-material or fixed-price contract basis.
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 $500,000 for multi-unit care organizations. Revenue from license fees was approximately $1,814,000, or 3.1% of revenue, for 2006. A customer’s purchase order may also include third party hardware or software. Revenue from hardware and third party software accounted for approximately $1,742,000, or 3.0% of revenue, for 2006. Revenue from turnkey systems labor accounted for approximately $2,574,000, or 4.4% of revenue, for 2006.
Software and Related Systems and Services - Public Health
The Public Health segment consists mainly of the operations of the former QS Technologies, Inc., now named Netsmart Public Health. The results of operations from this acquisition are included from August 1, 2006 through December 31, 2006.
This segment develops computer software and provides implementation and business services designed to enable public health departments to manage programs such as immunizations, adult health, family planning, STD, AIDS, epidemiology, tuberculosis, lab records, and case management. In addition, the segment develops software designed to support the management of vital records data.
The focus of the Public Health segment includes contracts for turnkey system installations of public health information management software for state and county public health departments. These turnkey installations are usually completed within a six month period. The Public Health segment also provides contracts for vital records solutions with state, county and city vital records departments.
The core products of the Public Health segment include Insight, a comprehensive public health system designed for the Windows operating system; PCMS, an enterprise public health system designed for the AS/400 operating system; and QSTVRS, a vital records management system designed for the Windows operating system. Customer organizations typically purchase Insight, PCMS and QSTVRS in the form of a perpetual license to use the system, together with professional services, support and maintenance. Professional services for installation and implementation of the software are provided either on a time-and-materials or fixed-price contract basis.
Our typical license for a public health information system ranges from $50,000 to $500,000 for a county health department and $500,000 to $1,000,000 for state wide system. Our typical license for a vital records system ranges from $100,000 to $500,000 for a city or county vital records department and $500,000 to $2,000,000 for a complete state vital records system. The acquisition of this segment occurred on July 31, 2006 and as a result, revenue from this segment is included from August 2006 through December 2006. Revenue from license fees was approximately $858,000, or 1.5% of revenue, for 2006. Revenue from turnkey systems labor accounted for approximately $260,000, or .4% of revenue, for 2006.
Data Center Services
Our Data Center provides software that performs clinical and billing services for mental health, alcohol and substance abuse outpatient facilities. Services include statistical reporting, data entry, electronic billing and submission.
Revenue from our Data Center was approximately $1,736,000, or 2.9% of our consolidated revenue, for 2006, $1,795,000, or 4.7% of our consolidated revenue, for 2005 and $2,058,000, or 7.1% of our consolidated revenue, for 2004.
In 2006, three customers each accounted for 10% or more of total Data Center revenue. One customer was a New York State agency, which accounted for $208,000, or 12% of total Data Center revenue. The other two clients were hospitals in New York City, which accounted for $186,000 and $185,000, or 11% and 11% respectively, of total Data Center revenue. None of the above mentioned clients accounted for more than 10% of our consolidated revenue.
In 2005, three customers each accounted for 10% or more of total Data Center revenue. One customer was a New York State agency, which accounted for $211,000, or 12% of total Data Center revenue. The other two clients were hospitals in New York City, which accounted for $209,000 and $192,000, or 11.6% and 10.7%, respectively, of total Data Center revenue. None of the above mentioned clients accounted for more than 10% of our consolidated revenue.
In 2004, two customers each accounted for 10% or more of the total Data Center revenue. One customer was a New York State agency, which accounted for $207,000, or 10% of total Data Center revenue. The other client was a hospital in New York City, which accounted for $216,000, or 10.5% of total Data Center revenue. None of the above mentioned clients accounted for more than 10% of our consolidated revenue.
Application Service Provider
Our ASP services make our Avatar software suite, CareNet, Netsmart University and InfoScriber products available either via a secure connection to the Internet or via a virtual private network (“VPN”). With the ASP option, Netsmart operates and maintains the software on behalf of customers on computers in a secure data center facility in Columbus, Ohio. This enables customers to rapidly deploy products and pay on a monthly service basis, thus eliminating capital intensive system requirements. Our CareNet product is a subscription-based Internet solution for managed care organizations that want to exchange data with their providers without having to maintain their own information technology infrastructure. CareNet furnishes a private, secure Web-based portal site where providers and their partner agencies can log in via the Internet to access client information and complete paperwork and necessary reporting on-line.
The InfoScriber product is a secure, Web-based e-prescribing system that enables practitioners in public or private practices to write and transmit electronic prescriptions to pharmacies of choice. We believe it is the only e-prescribing system solely focused on the behavioral healthcare market with its unique medications, treatment settings and reporting requirements.
Revenue from ASP services was approximately $3,556,000 for 2006 and $2,538,000 for 2005, or 6% and 7% respectively, of our consolidated revenue..
During 2006, one customer accounted for $797,000, or 22%, of total ASP revenue and during 2005, this same customer accounted for $661,000, or 26%, of total ASP revenue. This customer did not account for more than 10% of our total consolidated revenue in either 2006 or 2005.
Our ASP backlog at December 31, 2006 was $3,784,000. We anticipate that all of this backlog will be earned in 2007. Our ASP backlog at December 31, 2005 was $3,011,000.
Markets
Our target market for information systems and related services consists of both private and publicly-operated providers offering hospital or community-based outpatient behavioral/public healthcare services, substance abuse, MR/DD and social services. These healthcare providers require comprehensive information systems to administer their programs. We believe that there are at least 15,000 healthcare providers that fall in our target markets 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, 2006, 2005 and 2004, approximately 40%, 44% and 49%, respectively, of our consolidated revenue was generated from contracts with state and local government agencies. Contracts with government agencies generally include provisions which permit the contracting agency to cancel the contract for its convenience, although we have not experienced a termination for convenience in the last five years.
We believe that the demand for information technology solutions will continue to increase as the result of additional federal data standards and requirements for information exchange, 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, health and human services delivery networks need comprehensive financial, clinical and management 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 increasing demand for behavioral healthcare information technology. These data management needs include analysis of patient assessments, maintenance of patient records, administration of patient treatment plans and the overall coordination of in-office and remote case management.
In addition to our focus on the behavioral healthcare market segment, we also serve a growing number of public healthcare organizations. Our products are designed with functionality to assist this market segment with important considerations like maximizing the ability for clinicians to provide care to individual patients in high volume patient settings; near real-time analysis of data from different systems for disease outbreak investigations and resolution; and interoperability with other internal health department databases, including environmental health. Our acquisition of QS Technologies in August 2006 has increased our focus on the public health market. Since many of the consumers of services of our clients are some of the poorest Americans, they receive their primary care from public health clinics. We believe this is driving the trend towards integration and data sharing between these agencies.
We are also actively engaged in a number of key industry associations and organizations to help us pro-actively address trends and future needs of our customers. In addition, there are active Netsmart user group organizations at the state, regional and national levels. These user groups provide us with a customer/user perspective on emerging requirements and ongoing feedback that helps us determine future product direction and requirements.
Additionally, the health and human services market in which we operate is always subject to changes in state and federal regulations, as well as new demands required by consumers. Some factors which we believe are affecting market demand for software such as ours include:
Electronic Health Record (EHR). There is much discussion at the national level about the implementation of a standardized electronic health record. Proponents state that such a record for patients could enable a virtual healthcare team and a coordinated system of care with consistent, streamlined information exchange and transfer of clinical and billing data. Exchanging health information through secure means — including appropriate authorizations from patients/consumers — could link information from health-related entities with consumers’ personal health information. This connection would be intended to make important data available at the right times and places to support optimal treatment across a variety of healthcare levels. We believe that, despite varying views on the best path for adoption of an EHR, it will eventually become reality.
Integrated Services . This concept, sometimes referred to as “no wrong door,” is an approach whereby consumers seeking assistance from social services agencies receive complete and comprehensive services, regardless of their point of entry into the system. As a result, many social service agencies are seeking to implement a technology infrastructure that supports integrated services.
HIPAA. As a supplier of practice management, we believe that the Health Insurance Portability and Accountability Act, generally known as HIPAA, essentially mandates that the U.S. Department of Health and Human Services enact standards regarding the standardization, privacy and security of health care information. This legislation requires more providers of services in the under-automated health and human services industry to install automated systems, creating an increased demand for automated software solutions. We believe that our products, in conjunction with products offered by other companies with which we have a marketing arrangement, enable us to offer comprehensive enterprise-wide HIPAA-compliant and HIPAA-related business services for most human service providers.
General Unrest . With the creation of the Department of Homeland Security (DHS) and an increased focus on anti-terrorism preparedness and response, the demand for services in the mental health and public health arena has increased. Anxiety and fear have motivated a growing number of people to seek mental health services. This increased demand puts more pressure on providers to improve the efficiency of their care through the use of practice management and clinical systems. We believe that the potential threat of bio-terrorism will also put similar pressure on public health agencies to improve their delivery capabilities in much the same way. We also believe that this focus on preparedness will lead to more cross-department integration requirements, which play well to our strengths.
We are positioning our existing products and developing additional products in order to address these factors.
No single customer accounted for more than 10% of consolidated revenue for the years ended December 31, 2006 and 2005.
Sales and Marketing
We have a sales force of 42 people who sell and market our products. In addition, since the acquisition of CMHC Systems, we have aligned our go-to-market strategy with the key vertical markets we serve: State Systems, Integrated Delivery Networks (such as hospitals with multiple facilities and behavioral healthcare offerings), Community and Public Healthcare, and Methadone Providers. We also expanded our direct sales force and aligned them with the vertical markets above to enable our sales force to develop in-depth knowledge of the unique needs of each segment. In addition, we established an account management team which is designed to maintain and grow relationships with our current customers, and to identify opportunities to sell additional software and services from our present product offerings to that current customer base. We also added a dedicated business development organization to cultivate large strategic opportunities and build relationships with the large systems integrators that service these organizations. This approach is expected to enable us to leverage our resources and to further extend our reach within the markets we serve.
Backlog
We had a backlog of orders, including ongoing maintenance and data center contracts for our behavioral health information systems, of $58.8 million at December 31, 2006 and $44.1 million at December 31, 2005. We expect to fill approximately $51.2 million of the 2006 backlog during 2007.
Our backlog consists of revenue of approximately $22.0 million from existing turnkey contracts; maintenance revenue of approximately $30.3 million that is comprised both of amounts expected to be filled under unexpired maintenance contracts and amounts that are subject to automatic renewal; unexpired Data Center contracts of approximately $1.6 million, calculated using historical experience to determine future usage; unexpired ASP backlog of approximately $3.8 million; and facility management contracts of approximately $1.1 million, which are also calculated using historical experience to determine twelve months of future usage.
Product Development
We incurred product development and maintenance costs relating to our health and human services information systems of approximately $6,553,000 in 2006, $4,547,000 in 2005 and $3,498,000 in 2004, all of which was company-sponsored and expensed as research, development and maintenance. In 2006, we acquired software with a fair value of approximately $2,306,000 associated with our acquisition of QS Technologies, Inc. In 2005, we acquired software with a fair value of approximately $3,300,000, $2,051,000 and $692,000 associated with our acquisitions of CMHC Systems, Inc., AMS and Continued Learning, respectively. In 2005, we also capitalized software development costs of $42,000 relating to one of our Avatar products. The costs related to this Avatar product are being amortized over a three year period and in 2006 we charged $14,000 to operations. In 2004, we acquired software with a fair value of approximately $150,000 associated with our acquisition of TxM software which was related to our partnership arrangement with the MSJ Communications Corporation, a wholly-owned subsidiary of the Betty Ford Center. In 2004, we capitalized software development costs of $185,500 relating to our RAD Plus 2004 products. The costs related to the RAD Plus 2004 product are being amortized over a three year period and in 2006, we charged $78,400 to operations.
To assure that our customers are informed about our latest product plans and deliverables, we have developed product roadmaps for our major products. The roadmaps provide details about anticipated future product releases (both “version” and “maintenance”) along with estimated dates and timeframes. The product roadmaps are intended to enable our customers to effectively plan and budget for future use of our products and related services.
Competition and Competitive Position
The multi-billion dollar healthcare software industry is highly competitive, and is served by numerous vendors. Although we believe that we can provide healthcare facilities and managed care organizations with software to enable them to perform their services more effectively than our competitors, other software companies provide comparable systems and also have the staff and resources to develop competitive systems. We believe that we compete effectively with such vendors based on product functionality, product reliability and price.
Some dominant health care information technology vendors have achieved annual sales of more than $1 billion by focusing on solutions for large medical/surgical healthcare providers. As such, their target market has been large hospital systems and health maintenance organizations, and they 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 is better designed to meet the needs of this market. However, the behavioral health information systems business is serviced by a number of companies, some of which are better capitalized with larger infrastructures than Netsmart, and we may not be able to continue to compete effectively with such companies. As our business expands and includes sales to larger, integrated healthcare delivery networks, we begin to compete with companies such as Siemens, HBOC, IDX, Meditech, Quadramed, and Misys.
Additionally, we face significant competition in the clearinghouse, medical systems and ASP markets. General ASP utilities offer customers the use of computer facilities and operations staff to process either generalized medical software or software selected by the customer from other software vendors. Many organizations start with billing as their primary reason for automation-related spending. Large billing and clearinghouse computer service companies provide a broad spectrum of billing services for a diverse marketplace. In addition, some professional service firms provide staff to operate a customer’s in-house system when the customer believes that such an approach will provide the needed expertise at a cost-effective price.
Our ASP offering is focused on a specific subset of the large health and human services marketplace. Because behavioral healthcare requires the ideal organization of software, systems and staff to enable a customer to maximize service at a reasonable cost, we believe our specialized experience and investment in related software provides us with a competitive advantage. In addition, our ASP service is based on use of our proprietary suite of Avatar products. This enables our customers to use any or all components of a broad array of clinical and financial systems for as long as these functions are needed. In addition, our experience has shown that once a customer has contracted with us for software and services, they generally remain our customer and seldom move away from us to a competitive offering. In fact, some of our customers have been working with us for 30 years.
We compete with the following behavioral healthcare vendors, among others:
Anasazi Software, Inc.
Askesis Development Group, Inc.
Civerex Systems, Inc.
InfoMC, Inc.
IMPEL Strategic Solutions
Multi-Health Systems, Inc.
Qualifacts System Inc.
Raintree Systems Inc.
SecureHEALTH Inc.
Sequest Technologies Inc.
The Echo Group
UNI/CARE Systems, Inc.
XAKTsoft, Inc.
As a core part of our business model and growth strategy, we bid on numerous competitive procurements during the calendar year, and have a high win ratio, especially in the statewide mental health/mental retardation field, where we provide 33 statewide systems.
We have an established base of more than 1,200 providers nationwide, including substantial private and government providers of healthcare services. These providers represent approximately 50,000 clinicians, and include 33 state agencies and installations in all 50 states and several foreign countries.
Government Regulations and Contracts
The federal government and state governments have adopted numerous regulations affecting the healthcare industry, including those relating to payments to healthcare providers for various services. The adoption of new regulations can have a significant effect upon the revenue stream and operations of healthcare providers and insurance companies. Our solutions are designed to help our customers meet a variety of regulations and payment requirements, mitigating some of the problems resulting from government regulations. With constantly-changing regulations and efforts to reduce the cost of healthcare, 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 healthcare in the United States can have a material effect on companies that provide services to the healthcare industry, including those such as us that provide software.
Although we believe that the likely direction which may result from the current study of the healthcare industry would be an increased trend toward 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. Our business may be adversely affected to the extent that the healthcare industry evolves with greater government-sponsored programs and fewer privately-run organizations. Furthermore, to the extent that each state changes its own regulations in the healthcare field, it may be necessary for us to modify our behavioral health information systems to meet 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 local economic and budgetary problems, and government procurement regulations, which may include the need for approval by more than one agency before a contract is signed. In addition, government agencies generally include provisions in their contracts which permit the contracting agency to cancel the contract at its convenience. We have not experienced a termination for convenience in the last five years.
The Sarbanes-Oxley Act of 2002 and rules promulgated there under by the SEC and the Nasdaq Stock Market have imposed substantial new or enhanced regulations and disclosure requirements in the areas of corporate governance (including director independence, director selection and audit, corporate governance and compensation committee responsibilities), equity compensation plans, auditor independence, pre-approval of auditor fees and services and disclosure and internal control procedures. We are committed to industry best practices in these areas and believe we are in compliance with the relevant rules and regulations.
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 to our system. The disclosure of the codes used in any proprietary product, whether or not in violation of a non-disclosure agreement, could have a material adverse effect upon us, even if we are successful in obtaining injunctive relief. We must continue to invest in product development, employee training, and customer support.
Employees
As of December 31, 2006, we had 337 employees, including 6 executives, 42 sales and marketing, 247 technical and 42 clerical and administrative employees.
Executive Officers
Information concerning our executive officers is included in Item 10, Directors and Executive Officers of the Registrant.
Item 1A. Risk Factors.
In the event that we are unable to successfully complete the currently proposed merger, our stock price is likely to decline.
On November 18, 2006, we entered into the Merger Agreement. In the event that our stockholders approve the merger pursuant to the terms of the Merger Agreement, Netsmart will cease to be a public company. There is no guaranty that the stockholders will approve the Merger Agreement. Following the execution of the Merger Agreement, our stock price began trading at approximately $16.25, $0.25 less than the price proposed to be paid upon consummation of the merger. In the event that our stockholders fail to approve the Merger Agreement, our stock price is likely to decline.
In addition, Netsmart will still be responsible for the cost incurred by it in connection with the merger, which are currently estimated to be approximately $2.2 million. The costs will adversely effect Netsmart’s results of operations which may result in a decline in the market price of our common stock.
There are certain material weaknesses in Netsmart’s internal control over financial reporting that could affect the accuracy and/or timing of future regulatory filings.
As of December 31, 2006, Netsmart’s management concluded that there were certain material weakness relating to its calculation of earnings per share, its calculation of its income tax accrual and the ability to ensure that its disclosures in its regulatory filings under the Securities Exchange Act of 1934, as amended (“Exchange Act”) are prepared in accordance with accounting principles generally accepted in the United States. Until remediated, these weaknesses could affect the accuracy and/or timing of future filings with the SEC and other regulatory authorities. See also Item 9A. Controls and Procedures - Evaluation of Disclosure Controls and Procedures and — Management’s Report on Internal Control Over Financial Reporting.
Because we are particularly dependent upon government contracts, any decrease in funding for entitlement programs could result in decreased revenue.
We market our health information systems principally to behavioral health facilities, many of which are operated by state and local government entities and include entitlement programs. During 2006, 2005 and 2004, we generated 40%, 44% and 49%, respectively, of our revenue from contracts that are directly or indirectly with government agencies. Government agencies generally have the right to cancel certain contracts at their convenience. Our ability to generate business from government agencies is affected by funding for entitlement programs, and our revenue would decline if state agencies reduce this funding.
Changes in government regulation of the health care industry may adversely affect our revenue, operating expenses and profitability.
Our business is based on providing systems for behavioral and public health organizations in both the public and private sectors. The federal and state governments have adopted numerous regulations relating to the health care industry, including regulations relating to payments to health care providers for various services, and our systems are designed to provide information based on these requirements. The adoption of new regulations can have a significant effect upon the operations of health care providers, particularly those operated by state agencies. Furthermore, changes in regulations in the health care field may force us to modify our health information systems to meet any new record-keeping or other requirements and may impose added costs on our business. If that happens, we may not be able to generate revenues sufficient to cover the costs of developing the modifications. In addition, any failure of our systems to comply with new or amended regulations could result in reductions in our revenue and profitability.
If we are not able to take advantage of technological advances, we may not be able to remain competitive and our revenue may decline.
Our customers require software which enables them to store, retrieve and process very large quantities of data and provides 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 or develop new technology would have a significant adverse effect upon our business.
We may have difficulty competing with larger companies that offer similar services, which may result in decreased revenue.
Our customers in the human services market include entitlement programs, managed care organizations and specialty care facilities which have a need for access to information over a distributed data network. Each of the software industry, in general, and the health information software business in particular, is 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 systems and services.
If we are unable to protect our intellectual property, our competitors may gain access to our technology, which could harm our ability to successfully compete in our market.
We have no patent protection for our proprietary software. We rely on copyright protection for our software and non-disclosure and secrecy agreements with employees and third parties to whom we disclose information. This protection does not prevent our competitors from independently developing products similar or superior to our products and technologies. To further develop our services or products, we may need to acquire licenses for intellectual property. These licenses may not be available on commercially reasonable terms, if at all. Our failure to protect our proprietary technology or to obtain appropriate licenses could have a material adverse effect on our business, operating results or financial condition. Since our business is dependent upon our proprietary products, the unauthorized use or disclosure of this information could harm our business.
We cannot guarantee that in the future, third parties will not claim that we infringed 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 our financial condition.
Government programs may suggest or mandate initiatives that could impact our ability to sell our products, resulting in decreased revenue.
A major initiative being pushed by President Bush and the Department of Health and Human Services is the National Electronic Health Record. The federal government is promoting this platform and technology which is based on supplying “freeware” to any agency who desires; however, support is not supplied. This initiative competes with the private for profit Health Information Systems vendor community and could adversely affect our ability to sell our products, resulting in decreased revenue.
The covenants in our loan agreements restrict our financial and operational flexibility, including our ability to complete additional acquisitions, invest in new business opportunities, pay down certain indebtedness or declare dividends.
Our term loan agreements contain 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 our 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 agreements were accelerated, the lender could proceed against those consolidated assets. Any event of default, therefore, could have a material adverse effect on our business. The loan agreements also require 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 continue to 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.
As a result of the costs related to the proposed merger transaction, we were in violation of one of the financial covenants in our loan agreement. Consequently, we were forced to obtain a waiver from the lenders of that covenant in order to prevent an event of default under our loan agreement. There is no assurance that the lender will provide such a waiver in future fiscal periods.
We have only paid one cash dividend after getting our lender’s consent and we do not anticipate paying any further cash dividends on our common stock in the foreseeable future. We presently intend to retain future earnings, if any, in order to provide funds for use in the operation and expansion of our business. Consequently, investors cannot rely on the payment of dividends to increase the value of their investment in us. In addition, our loan agreements prohibit us from paying cash dividends without the prior consent of the lender.
Our growth may be limited if we cannot make acquisitions.
A part of our business strategy is to acquire other businesses that are related to our current business. These acquisitions may be made with cash or 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 hereof, we do not have any agreement or understanding, either formal or informal, as to any acquisition.
We may be unable to effectively integrate any future acquisitions, which may disrupt or have a negative impact on our business.
A part of our business strategy is to make acquisitions of businesses related to our current business. We may have difficulty integrating the personnel and operations of such business with our own. In addition, the key personnel of any acquired business may not be willing to work for us, and its officers may exercise their rights to terminate their employment with us. We cannot predict the effect 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.
Because we are dependent on our management, the loss of key executive officers could disrupt our business and our financial performance could suffer.
Our business is largely dependent upon our senior executive officers, Messrs. James L. Conway, our chief executive officer and Anthony F. Grisanti, our chief financial officer. Although we have employment agreements with these officers, the employment agreements do not guarantee that those officers will continue as our employees, and each of those officers has the right to terminate his employment on 90 days notice. Our agreements with Messrs. Conway and Grisanti are scheduled to expire on December 31, 2007. In connection with the proposed merger transaction, we entered into new employment agreements with Messrs. Conway and Grisanti; however, these agreements will not take effect unless the merger transaction is consummated. Our business may be adversely affected if any key management personnel or other key employees left our employ.
Any issuance of preferred stock may adversely effect the voting power and equity interest of our common stock.
Our certificate of incorporation gives our board of directors the right to create new series of preferred stock. As a result, the board of directors may, without stockholder approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights which could adversely affect the voting power and equity interest of the holders of our common stock. The preferred stock, which could be issued with the right to more than one vote per share, could be utilized as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention to issue any shares of preferred stock or to create any series of preferred stock, we may issue such shares in the future. If we issue preferred stock in a manner which dilutes the voting rights of the holders of our common stock, our listing on The Nasdaq Capital Market may be impaired.
Item 1B. Unresolved SEC Staff Comments.
None.
Item 2. Property.
We lease office space at the following locations:
|
Location
|
Purpose
|
Space
|
Annual
Rental
|
Expiration
|
|
3500
Sunrise Highway
Great
River, New York
|
Executive
offices
Software
and Related Systems and Services - NY
Data
Center Services
|
32,600
square feet
|
$552,000,
plus 3% annual increases
|
10/22/14**
|
|
570
Metro Place North
Dublin,
Ohio
|
Software
& Related Systems and Services - OH
|
32,000
square feet
|
$377,172
|
09/30/2010
|
|
5120
Shoreham Place
San
Diego, California
|
Software
and Related Systems and Services - NY
|
2,800
square feet
|
$75,000
|
08/31/08
|
|
117
North 1 st
Street
Ann
Arbor, Michigan
|
ASP
Services
|
2,200
square feet
|
$49,000
|
01/31/07
|
|
146
Second Street North
St.
Petersburg, Florida
|
ASP
Services
|
2,000
square feet
|
$29,000
|
03/31/08
|
|
37
Villa Road
Greenville,
South Carolina
|
Public
Health
Software
and Related Systems and Services
|
5,761
square feet
|
$81,000
|
02/23/11
|
|
69-730
Highway 11
Rancho
Mirage, CA
|
Software
and Related Systems and Services - NY
|
1,400
square feet
|
*
|
*
|
We believe that our space is adequate for our immediate needs and that, if additional space is required, whether due to the scheduled expiration of a lease or otherwise, it would be readily available at commercially reasonable rates.
Note: In 2007, the Company negotiated an additional 8,553 square feet at its Great River facility at an annual rental of $149,678 with a lease expiration of 10/22/14. The Company expects to occupy that space in early 2007.
*
Month to month rental
**
This lease provides for an early termination option by the Company in December 2009.
Item 3.
Legal Proceedings.
On November 21, 2006, a class action complaint entitled Levy Investments, LTD. v. Netsmart Technologies, Inc ., et al., Civil Action No. 2566-N, was filed against Netsmart, its directors, Buyer and Merger Sub in the Delaware Court of Chancery, New Castle County. On November 21, 2006, a class action complaint entitled Superior Partners v. James L. Conway, et al ., Civil Action No. 2563-N, was filed against Netsmart, its directors, Kevin Scalia, Alan B. Tillinghast, Buyer and Merger Sub in the Delaware Court of Chancery, New Castle County. On November 21, 2006, a class action complaint entitled Joe B. Ingram v. Netsmart Technologies, Inc ., et al., Index No. 06-32611, was filed against Netsmart and its directors in the Supreme Court of New York, Suffolk County. On November 22, 2006, a class action complaint entitled Mark Anthony v. Netsmart Technologies, Inc., et al ., Index No. 06-32720, was filed against Netsmart, its directors, Alan B. Tillinghast, Kevin Scalia, Insight and Bessemer in the Supreme Court of New York, Suffolk County. On December 1, 2006, a class action complaint entitled Jon Landon v. Francis J. Calcagno et al ., Civil Action No. 2586-N, was filed against Netsmart, its directors, Buyer, Merger Sub and NT Investor Holdings, Inc. (“Parent”) in the Delaware Court of Chancery, New Castle County. On December 12, 2006, a class action complaint entitled Leviticus Partners, L.P. v. James L. Conway, et al ., Civil Action No. 2597-N,was filed against Netsmart, its directors, Buyer, Merger Sub, Insight and Bessemer in the Delaware Court of Chancery, New Castle County. The complaints allege, among other things, that each of the directors of Netsmart individually breached the fiduciary duties owing to the Netsmart stockholders by voting to approve the Merger Agreement, thereby enabling management to benefit to the detriment of the stockholders. Each of the complaints seeks, among other relief, the court’s designation of class action status, an injunction preventing the consummation of the merger and, in the event of consummation of the merger, rescission and damages. In Mark Anthony v. Netsmart Technologies, Inc., et al ., on December 6, 2006, the plaintiff moved for approval of voluntary discontinuance of the action. The motion was granted by order signed on January 4, 2007. On December 11, 2006, the Delaware Court of Chancery entered an order on consent consolidating the three actions filed in that court as of that date. On December 14, 2006, the plaintiff in Leviticus Partners, L.P. v. James L. Conway, et al . filed a motion for consolidation and for reconsideration of the order entered December 11, 2006, in the Delaware Court of Chancery. On December 18, 2006, the plaintiff in Leviticus Partners, L.P. v. James L. Conway, et. al. filed a notice of withdrawal of its motion for consolidation and reconsideration of the December 11, 2006 order and represented to the court its intent to file suit in Suffolk County, New York. By letter to the court dated December 19, 2006, the defendants requested the court to decline to enter the proposed order granting the notice of dismissal. On December 20, 2006, Vice Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery denied the plaintiff’s request to enter an order dismissing the action. On January 5, 2007, the plaintiffs in the consolidated Delaware action filed a Consolidated Amended Complaint, inter alia , adding certain nondisclosure claims based on Netsmart’s preliminary proxy statement. On January 10, 2007, the plaintiff in Joe B. Ingram v. Netsmart et al . filed a First Amended Class Action Complaint adding certain nondisclosure claims based on Netsmart’s preliminary proxy statement and naming as additional defendants Insight, Bessemer, Kevin Scalia and Alan B. Tillinghast. On January 12, 2007, the defendants in Joe B. Ingram v Netsmart et al . moved to dismiss the action in favor of the substantially identical actions pending in Delaware. By order dated February 6, 2007, the court granted the defendants motion and dismissed the Suffolk County action. On January 16, 2007, the Delaware Court of Chancery entered, on consent, an Amended Order of Consolidation consolidating Leviticus Partners, L.P. v James L. Conway, et al . with the three previously consolidated Delaware actions. On January 25, 2007, plaintiffs in the consolidated Delaware action filed (1) a motion for expedited discovery; and (2) a notice of intent to file a motion for a preliminary injunction. On January 26, 2007, Vice Chancellor Leo E. Strine, Jr. conducted a telephonic conference in the consolidated Delaware action. During this telephonic conference, Vice Chancellor Strine ordered that discovery was to be expedited and ordered defendants to produce, by no later than February 2, 2007, documents in response to plaintiffs’ request for production of documents, and that depositions of the witnesses be completed by no later than February 11, 2007. Vice Chancellor Strine also held a hearing for Plaintiff’s Motion for a Preliminary Injunction on February 27, 2007. On March 14, 2007, the Court of Chancery issued a decision permitting a stockholder vote on the merger to be held after Netsmart makes supplemental disclosures consisting of certain financial projections and the text of the Court’s decision. The board of directors unanimously believes that the actions are without merit, and intends for Netsmart and the directors to defend vigorously against them.
From time to time we are also involved in ordinary and routine litigation matters in the normal course of business. We believe that the resolution of these matters will not have a material adverse effect on our consolidated financial position and results of operations.
Item 4.
Submission of Matters to a Vote of Security Holders.
On December 7, 2006 we held our 2006 annual meeting of stockholders.
The following individuals were elected as directors:
|
Name
|
Votes
For
|
Withheld
|
|
James
L. Conway
|
5,519,325
|
414,004
|
|
Kevin
Scalia
|
5,314,412
|
618,917
|
|
Alan
Tillinghast
|
5,519,325
|
414,004
|
|
Joseph
G. Sicinski
|
5,294,192
|
639,137
|
|
Francis
Calcagno
|
5,287,492
|
645,837
|
|
John
S.T. Gallagher
|
5,296,692
|
636,637
|
|
Yacov
Shamash
|
5,250,287
|
683,042
|
The following proposals were approved as follows:
|
Votes
For
|
|
Votes
Against
|
|
Abstain
|
|
Broker
Non Votes
|
|||||||
|
Proposal
to increase the number
|
|||||||||||||
|
of
shares available under the Company’s
|
|||||||||||||
|
2001
Long-Term Incentive Plan
|
3,220,677
|
1,075,526
|
208,593
|
1,428,533
|
|||||||||
|
Approval
of amendments to the 2001
|
|||||||||||||
|
Long
Term Incentive Plan
|
3,313,965
|
981,138
|
209,693
|
1,428,533
|
|||||||||
|
Approval
of the selection of
|
|||||||||||||
|
Marcum
& Kliegman LLP as the
|
|||||||||||||
|
Company’s
independent certified
|
|||||||||||||
|
Accountants
for 2006
|
5,891,821
|
5,194
|
36,314
|
Part II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
(a) Our common stock is traded on The Nasdaq Capital 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 2006 and 2005.
|
Quarter
Ended
|
High
|
|
Low
|
||||
|
March
31, 2006
|
$
|
13.86
|
$
|
10.48
|
|||
|
June
30, 2006
|
14.60
|
12.03
|
|||||
|
September
30, 2006
|
15.05
|
11.75
|
|||||
|
December
31, 2006
|
16.32
|
12.36
|
|||||
|
March
31, 2005
|
$
|
10.27
|
8.28
|
||||
|
June
30, 2005
|
9.74
|
8.50
|
|||||
|
September
30, 2005
|
12.50
|
8.94
|
|||||
|
December
31, 2005
|
15.00
|
12.17
|
As of March 15, 2007, there were approximately 860 beneficial owners of our common stock. The closing price of our common stock was $16.35 per share on March 15, 2007. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
We do not anticipate that we will pay any dividends in the foreseeable future. We currently intend to retain future earnings for use in operation and development of our business and for potential acquisitions. In addition, the terms of our term loan agreement require our lender’s consent with respect to the payment of cash dividends.
The information required by
