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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For Quarter Ended September 30, 2003
Commission File Number 0-21177

NETSMART TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

Delaware 13-3680154
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

146 Nassau Avenue, Islip, NY 11751
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (631) 968-2000

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes X No__
---

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

Yes __ No X
---



Number of shares of common stock outstanding as of October 24, 2003: 4,813,615
=========


1



Netsmart Technologies, Inc. and Subsidiary

Index

Part I: - Financial Information:

Item 1. Financial Statements: Page
----


Condensed Consolidated Balance Sheets - September 30, 2003 (Unaudited)
and December 31, 2002 1-2

Condensed Consolidated Statements of Income - (Unaudited)
Nine Months Ended September 30, 2003 and 2002 and Three

Months Ended September 30, 2003 and 2002 3

Condensed Consolidated Statements of Cash Flows - (Unaudited)
Nine Months Ended September 30, 2003 and 2002 4-5

Condensed Consolidated Statement of Stockholders' Equity - (Unaudited)
Nine Months Ended September 30, 2003 6-7

Notes to Condensed Consolidated Financial Statements 8-13

Item 2. Management's Discussion and Analysis of

Financial Condition and Results of Operations 14-21

Item 3. Quantitative and Qualitative Disclosures About Market Risk 21

Item 4. Controls and Procedures 22

Part II Other Information

Item 6. Exhibits and Reports on Form 8-K 22



2



NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
September 30, December 31,
------------ -----------
2003 2002
---- ----
Unaudited
---------


Assets:
Current Assets:

Cash and Cash Equivalents $11,752,518 $ 7,251,740
Accounts Receivable - Net 6,241,107 7,058,855
Costs and Estimated Profits in Excess
of Interim Billings 2,539,125 3,857,522
Deferred taxes 918,000 459,000
Other Current Assets 509,896 337,719
---------- ----------

Total Current Assets 21,960,646 18,964,836
---------- ----------

Property and Equipment - Net 697,028 364,306
---------- ----------

Other Assets:
Software Development Costs - Net 1,025,300 382,387
Customer Lists - Net 2,851,049 2,141,855
Deferred taxes less current portion 882,000 441,000
Other Assets 215,984 121,419
---------- ----------

Total Other Assets 4,974,333 3,086,661
---------- ----------

Total Assets $27,632,007 $22,415,803
========== ==========

See Notes to Condensed Consolidated Financial Statements.


3



NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------

September 30, December 31,
------------ -----------
2003 2002
---- ----
Unaudited
---------



Liabilities and Stockholders' Equity:
Current Liabilities:

Current Portion - Long Term Debt $ 666,667 $ 500,000
Current Portion Capital Lease Obligations 62,840 9,886
Accounts Payable 849,042 1,166,145
Accrued Expenses 1,480,459 1,063,559
Interim Billings in Excess of Costs and Estimated
Profits 6,577,025 5,914,970
Deferred Revenue 733,295 1,095,412
---------- ----------

Total Current Liabilities 10,369,328 9,749,972
---------- ----------

Capital Lease Obligations - Less current portion 101,314 1,864
Long Term Debt - Less current portion 1,166,684 1,250,012
Interest Rate Swap at Fair Value 75,082 107,713
---------- ----------

Total Non Current Liabilities 1,343,080 1,359,589
---------- ----------

Commitments and Contingencies

Stockholders' Equity:
Preferred Stock - $.01 Par Value, 3,000,000
Shares Authorized; None issued and outstanding -- --

Common Stock - $.01 Par Value; Authorized
15,000,000 Shares; Issued 5,001,505 shares at
September 30, 2003 and 4,046,430 at December 31, 2002 50,015 40,464

Additional Paid in Capital 24,390,549 21,411,777
Unearned Compensation -- (14,400)
Accumulated Comprehensive loss - Interest Rate Swap (75,082) (107,713)
Accumulated Deficit (7,037,103) (9,375,774)
---------- ----------
17,328,379 11,954,354
Less: cost of shares of Common Stock held
in treasury - 205,220 shares at September 30, 2003
and 89,797 at December 31, 2002 1,408,780 648,112
---------- ----------

Total Stockholders' Equity 15,919,599 11,306,242
---------- ----------

Total Liabilities and Stockholders' Equity $ 27,632,007 $ 22,415,803
========== ==========


See Notes to Condensed Consolidated Financial Statements.

4






NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME - (Unaudited)
- --------------------------------------------------------------------------------
Nine Months ended Three months ended
September 30, September 30,
-------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----

Revenues:

Software and Related
Systems and Services:
General $ 13,060,682 $ 10,361,414 $ 4,799,001 $ 4,061,727
Maintenance Contract
Services 5,283,395 4,521,469 1,796,190 1,499,181
---------- ---------- ----------- ----------
Total Software and Related
Systems and Services 18,344,077 14,882,883 6,595,191 5,560,908

Data Center Services 1,471,785 1,438,254 512,482 482,859
---------- ---------- ----------- ----------

Total Revenues 19,815,862 16,321,137 7,107,673 6,043,767
---------- ---------- ----------- ----------

Cost of Revenues:
Software and Related
Systems and Services:
General 8,165,333 7,457,227 2,833,193 3,006,903
Maintenance Contract
Services 2,600,031 2,660,630 860,130 889,418
---------- ---------- ---------- ----------
Total Software and Related
Systems and Services 10,765,364 10,117,857 3,693,323 3,896,321

Data Center Services 793,741 794,327 262,065 267,382
---------- ---------- ---------- ----------

Total Cost of Revenues 11,559,105 10,912,184 3,955,388 4,163,703
---------- ---------- ---------- ----------

Gross Profit 8,256,757 5,408,953 3,152,285 1,880,064
---------- ---------- ---------- ----------

Selling, General and
Administrative Expenses 5,100,127 3,799,164 1,820,403 1,314,642
Research and Development 1,509,377 992,557 566,350 308,097
---------- ---------- ---------- ----------

Total 6,609,504 4,791,721 2,386,753 1,622,739
---------- ---------- ---------- ----------

Income from Operations before Interest 1,647,253 617,232 765,532 257,325

Interest Income 52,409 32,847 21,781 12,394

Interest and Other Expense 150,991 158,823 49,154 50,162
---------- ---------- ---------- ----------

Income before Income Tax Expense (Benefit) 1,548,671 491,256 738,159 219,557

Income Tax Expense (Benefit) (790,000) 44,000 (808,000) 18,000
---------- ---------- ---------- ----------

Net Income $ 2,338,671 $ 447,256 $ 1,546,159 $ 201,557
========== =========== ========== ==========

Earnings Per Share of Common Stock:
Basic:
Net Income $ .56 $ .12 $ .34 $ .05
========== =========== ========== ==========

Weighted Average Number of Shares of
Common Stock Outstanding 4,159,740 3,696,159 4,512,891 3,696,709
========== =========== ========== ==========

Diluted:
Net Income $ .52 $ .11 $ .33 $ .05
========== =========== =========== ==========

Weighted Average Number of Shares of
Common Stock and Common Stock
Equivalents Outstanding 4,468,963 4,062,130 4,706,257 4,070,466
========== =========== =========== ==========

See Notes to Consolidated Financial Statements.


5




NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (Unaudited)
- --------------------------------------------------------------------------------
Nine Months ended
September 30,

2003 2002
---- ----


Operating Activities:
Net Income $ 2,338,671 $ 447,256
---------- ----------

Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation and Amortization 870,298 772,280
Bad Debt Expense 125,000 183,413
Amortization of Warrants Issued for Services
and Costs Related to Warrant Extension 20,736 32,073
Deferred Taxes (900,000) --

Changes in Assets and Liabilities:
[Increase] Decrease in:
Accounts Receivable 692,748 (295,915)
Costs and Estimated Profits in
Excess of Interim Billings 1,318,397 (232,568)
Other Current Assets (313,319) 103,023
Other Assets 33,768 20,368

Increase [Decrease] in
Accounts Payable (317,103) 53,739
Accrued Expenses 551,234 459,630
Interim Billings in Excess of
Costs and Estimated Profits 600,795 82,304
Deferred Revenue (362,117) 194,862
---------- ----------

Total Adjustments 2,320,437 1,373,209
---------- ----------

Net Cash Provided by
Operating Activities 4,659,108 1,820,465
---------- ----------

Investing Activities:
Acquisition of Property and Equipment (356,221) (162,210)
Net Cost of CareNet Acquisition (1,047,845) --
---------- ----------

Net Cash Used In Investing Activities (1,404,066) (162,210)
---------- ----------

See Notes to Condensed Consolidated Financial Statements.



6



NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
- --------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (Unaudited)
- --------------------------------------------------------------------------------
Nine Months ended
September 30,
-----------------
2003 2002
---- ----


Financing Activities:
Payments on Capitalized Lease Obligations $ (30,922) $ (27,390)
Net Proceeds from Stock Options and Warrants Exercised 2,134,766 9,550
Payments on Term Loans (416,661) (374,994)
Dividend Paid (441,447) --
----------- -----------

Net Cash Provided By (Used in) Financing Activities 1,245,736 (392,834)
----------- -----------

Net Increase in Cash
and Cash Equivalents 4,500,778 1,265,421

Cash and Cash Equivalents -
Beginning of Period 7,251,740 3,837,226
----------- -----------

Cash and Cash Equivalents -
End of Period $ 11,752,518 $ 5,102,647
=========== ===========

Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 153,780 $ 161,638
Income Taxes $ 99,587 $ 23,992

Non Cash Investing and Financing Activities:
The fair value of the interest rate swap decreased by $32,631 for the nine
months ended September 30, 2003. The fair value of the interest rate swap
increased by $38,255 for the nine months ended September 30, 2002.

The Company acquired equipment in the amount of $183,326 in connection with a
capital lease during the nine months ended September 30, 2003.

During the nine months ended September 30, 2003, the Company received 115,423
shares of its common stock as consideration for the exercise of certain stock
options. The value of the shares received was $760,668, which was the market
value of the common stock on the date of exercise.

During the nine months ended September 30, 2003, the Company issued 100,000
shares of common stock in connection with its acquisition of CareNet
acquisition. See Note 13. These shares were valued at $528,000, which was based
upon the average stock price three days before and after the acquisition was
agreed to and announced. The Company also issued a $500,000 three-year
promissory note and assumed contract obligations and vacation liabilities
totaling $68,068.

See Notes to Condensed Consolidated Financial Statements.



7



NETSMART TECHNOLOGIES, INC. AND SUBSIDIARY
- ------------------------------------------------------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------

Additional Accumulated
---------- -----------
Paid-in Comprehensive
------- -------------
Capital Loss Total
------- ---- -----
Common Stock Common Unearned Accumulated Interest Rate Comprehensive Treasury Shares Stockholders'
------------ ------ -------- ----------- ------------- ------------- --------------- ------------
Shares Amount Stock Compensation Deficit Swap Income Shares Amount Equity
------ ------ ----- ------------ ------- ---- ------ ------ ------ ------



Balance -
January 1, 2003 4,046,430 $40,464 $21,411,777 $(14,400) $(9,375,774) $(107,713) 89,797 $ (648,112) $11,306,242

Common Stock
Issued -
Exercise of
Options 565,075 5,651 1,403,953 1,409,604

Common Stock
Issued -
Exercise of
Warrants 290,000 2,900 1,482,930 1,485,830

Common Stock
Issued -
Acquisition 100,000 1,000 527,000 528,000

Cost Related
to Warrant
Extension 6,336 6,336

Change in
Fair Value
of Interest
Rate Swap 32,631 $ 32,631 32,631

Treasury Shares
from Cashless
Exercise of
Stock Options 115,423 (760,668) (760,668)

Amortization of
Warrants Issued
for Services 14,400 14,400

Dividends (441,447) (441,447)

Net Income 2,338,671 2,338,671 2,338,671
---------

--------- ------ ---------- ------ --------- ------ $2,371,302 ------- --------- ---------
=========
Balance -
September 30,
2003 5,001,505 $50,015 $24,390,549 $ -- $(7,037,103) $ (75,082) 205,220 $(1,408,780) $15,919,599
========= ====== ========== ====== ========== ====== ======= ========= ==========


See Notes to Consolidated Financial Statements.


8




NETSMART TECHNOLOGIES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------

(1) Financial Statements
--------------------

In the opinion of the Company, the accompanying unaudited financial statements
contain all adjustments (consisting of only normal recurring accruals) necessary
to present fairly the financial position of the Company as of September 30, 2003
and the results of its operations for the nine and three months ended September
30, 2003 and 2002 and the changes in cash flows for the nine months ended
September 30, 2003 and 2002. The results of operations for the nine and three
months ended September 30, 2003 are not necessarily indicative of the results to
be expected for the full year.

(2) Accounting Policies
-------------------

The accounting policies followed by the Company are set forth in Notes 1 and 2
to the Company's consolidated financial statements as filed in its Form 10-K/A
for the year ended December 31, 2002.

(3) Earnings Per Share
------------------

The following table sets forth the components used in the computation of basic
and diluted earnings per share:

Nine Months Ended September 30, Three Months Ended September 30
------------------------------- -------------------------------
2003 2002 2003 2002
---- ---- ---- ----



Numerator:
Net income $ 2,338,671 $ 447,256 $ 1,546,159 $ 201,557
=========== =========== =========== ===========

Denominator:
Weighted average shares 4,159,740 3,696,159 4,512,891 3,696,709
----------- ----------- ----------- -----------
Effect of dilutive securities:
Employee stock options 307,086 364,176 193,366 371,140
Stock warrants 2,137 1,795 -- 2,617
----------- ----------- ----------- -----------
Dilutive potential common shares 309,223 365,971 193,366 373,757
----------- ----------- ----------- -----------

Denominator for diluted earnings per
share-adjusted weighted average shares
after assumed conversions 4,468,963 4,062,130 4,706,257 4,070,466
=========== =========== ========== ==========


(4) Stock Options and Similar Equity Instruments
--------------------------------------------

At September 30, 2003, the Company had three stock-based employee compensation
plans. As permitted under SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure", which amended SFAS No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation", the Company has elected to
continue to follow the intrinsic value method in accounting for its stock-based
employee compensation arrangements, as defined by Accounting Principles Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees", and related
interpretations including Financial Accounting Standards Board Interpretation
No. 44, "Accounting for Certain Transactions Involving Stock Compensation", an
interpretation of APB No. 25. No stock-based employee compensation cost is
reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the



9



date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS 123 to stock-based employee compensation:

Nine Months Ended September 30, Three Months Ended September 30,
------------------------------- --------------------------------
2003 2002 2003 2002
---- ---- ---- ----



Net Income as Reported $ 2,338,671 $ 447,256 $ 1,546,159 $ 201,557

Deduct: Total stock-based employee compensation
expense determined under fair value-based method
for all awards, net of related tax effect 573,649 140,179 275,025 62,086
---------- --------- ---------- ---------

Pro Forma Net Income $ 1,765,022 $ 307,077 $ 1,271,134 $ 139,471
========== ========= ========== =========

Basic Net Income Per Share as Reported $ . 56 $ .12 $ .34 $ .05
========== ========= ========== =========

Basic Pro Forma Net Income Per Share $ .42 $ .08 $ .28 $ .04
========== ========= ========== =========

Diluted Net Income Per Share as Reported $ .52 $ .11 $ .33 $ .05
========== ========= ========== =========

Diluted Pro Forma Net Income Per Share $ .39 $ .08 $ .27 $ .03
========== ========= ========== =========

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:

Nine Months Ended
-----------------
September 30, September 30,
------------ ------------
2003 2002
---- ----
Expected Life (Years) 5.04 5
Interest Rate 4% 4%
Annual Rate of Dividends --% --%
Volatility 66% 63%

The weighted average fair value of options at date of grant using the fair value
based method during 2003 and 2002 is estimated at $2.38 and $1.41 respectively.

(5) Income Taxes
------------

The provision for income taxes for the period ended September 30, 2003, consists
of a current provision of $110,000. The current income tax provision was reduced
by $780,000 as a result of the use of available net operating losses. The
deferred tax asset and valuation allowance were reduced by the same amount.
During the September 2003 period, the Company recognized an additional $900,000
benefit from a reduction in its deferred tax asset valuation allowance
associated with its net operating loss carry forwards.

(6) Stockholders' Equity
--------------------

On January 27, 2003, following stockholder approval of the amendment to its 2001
Plan to increase the number of shares of common stock available for issuance
pursuant to the 2001 Plan, the Company granted to employees options to purchase


10


217,500 shares under the 2001 Plan at a price per share of $4.93, which was the
fair market value at the date of grant. On May 22, 2003, the Company granted to
employees additional options to purchase 152,500 shares under the 2001 Plan at a
price per share of $4.37, which was the fair market value at the date of grant.
On August 12, 2003, the Company granted to employees additional options to
purchase 8,250 shares and 2,750 under the 1999 Plan and the 1998 Plan,
respectively, at a price per share of $6.61, which was the fair market value at
the date of grant. The majority of the options granted to date under the above
Plans vest 50% after six months and 100% after one year.

On February 27, 2003, the Board of Directors authorized management to purchase
up to $100,000 of the Company's common stock at any time the market price of the
common stock is less than $3.50 per share. Purchases of stock will be made from
time to time, depending on market conditions, in open market or in privately
negotiated transactions, at prices deemed appropriate by management. There is no
set time limit on the purchases. The Company expects to fund any stock
repurchases from its operating cash flow. As of September 30, 2003, the Company
had not made any stock repurchases.

During the nine months ended September 30, 2003, warrants to purchase 290,000
shares were exercised and the Company received gross proceeds of $1,543,500.
During the nine month ended September 30, 2003, options to purchase 565,075
shares were exercised and the Company received gross proceeds of $1,409,604.
Included in the gross proceeds received from the exercise of options was the
delivery of 115,423 shares of the Company's common stock, which were valued at
$760,668, which was based upon the market price of the common stock on the date
of the exercise in accordance with the cashless exercise provisions of the
Company's stock option plans.

Included in the above options exercised were 320,000 options owned by certain of
the Company's Officers and members of the Board of Directors. These options were
exercised by delivery of 88,295 shares of the Company's common stock valued at
$561,295, which was based upon the market price of the common stock on the date
of exercise in accordance with the cashless exercise provisions of the Company's
stock option plans.

In January 2003, the expiration date of the company's Series B warrants to
purchase 448,535 shares of common stock at $12.00 per share were extended from
January 31, 2003 to April 30, 2003. In April 2003, the Company agreed to extend
the expiration date of these same warrants from April 30, 2003 to July 31, 2003.
The Company re-measured the fair value of the warrants at the dates of
extension. No financing costs were recorded associated with the warrant
extensions made in January 2003, as there was no material change in their fair
value. The Company charged $1,125 to operations related to the warrant extension
made in April 2003. In July 2003, the Company agreed to extend the expiration
date of these same warrants from July 31, 2003 to October 31, 2003. The Company
re-measured the fair value of the warrants at the date of extension and charged
$5,211 of financing costs to operations in July 2003.

(7) Operating Segments
------------------

The Company currently classifies its operations into two business segments:
(1) Software and Related Systems and Services and (2) Data Center Services.
Software and Related Systems and Services is the design, installation,
implementation and maintenance of computer information systems that provide
comprehensive healthcare information technology solutions including billing,
patient tracking and scheduling for inpatient and outpatient environments,
as well as clinical documentation and medical record generation and
management. Data Center

11



Services involve Company personnel performing data entry and data processing
services for customers. Intersegment sales and sales outside the United States
are not material. Information concerning the Company's business segments are as
follows:

Software and
------------
Related Systems Data Center
--------------- -----------
Nine Months Ended September 30, and Services Services Consolidated
- ------------------------------ ------------ -------- ------------
2003
- ----


Revenue $ 18,344,077 $ 1,471,785 $ 19,815,862
Income before income taxes 1,220,333 328,338 1,548,671
Total identifiable assets at September 30, 2003 25,324,692 2,307,315 27,632,007

Nine Months Ended September 30,
- ------------------------------
2002
- ----
Revenue $ 14,882,883 $ 1,438,254 $ 16,321,137
Income before income taxes 254,815 236,441 491,256
Total identifiable assets at September 30, 2002 17,233,292 1,651,111 18,884,403

Three Months Ended September 30,
- -------------------------------
2003
- ----
Revenue $ 6,595,191 $ 512,482 $ 7,107,673
Income before income taxes 595,906 142,253 738,159

Three Months Ended September 30,
- -------------------------------
2002
- ----
Revenue $ 5,560,908 $ 482,859 $ 6,043,767
Income before income taxes 130,714 88,843 219,557


(8) New Accounting Pronouncements
-----------------------------

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". SFAS No. 145 requires that gains and losses from extinguishment
of debt be classified as extraordinary items only if they meet the criteria in
Accounting Principles Board Opinion No. 30 ("Opinion No. 30"). Applying the
provisions of Opinion No. 30 will distinguish transactions that are part of
an entity's recurring operations from those that are unusual and infrequent
that meet the criteria for classification as an extraordinary item. The
Company adopted SFAS No. 145 during the first quarter of fiscal 2003. The
adoption of this standard did not have a material effect on the Company's
consolidated financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 addresses accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)". SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value when the liability is incurred. SFAS No.
146 is effective for exit or disposal activities that are initiated after
December 31, 2002. The adoption of this standard did not have a material effect
on the Company's consolidated financial position or results of operations.

In November 2002, the FASB issued Interpretation No. 45, ("FIN 45") "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect


12


Guarantees of Indebtedness of Others." FIN 45 requires a company, at the time it
issues a guarantee, to recognize an initial liability for the fair value of
obligations assumed under the guarantee and elaborates on existing disclosure
requirements related to guarantees and warranties. The initial recognition
requirements of FIN 45 are effective for guarantees issued or modified after
December 31, 2002. The Company's adoption of the recognition requirements of FIN
45 did not have a material effect on its consolidated financial position or
results of operations.

In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51."
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional financial support from other parties. FIN 46 is effective for all new
variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after December 15, 2003. The Company does not expect the adoption of
FIN 46 to have a material effect on its consolidated financial position or
results of operations.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This Statement amends and
clarifies SFAS No. 133 "Accounting for Derivative Instruments and Hedging
Activities." This statement clarifies the accounting guidance on (1) derivative
instruments (including certain derivative instruments embedded in other
contracts) and (2) hedging activities that fall within the scope of the SFAS
133. SFAS 149 also amends certain other existing pronouncements, which will
result in more consistent reporting of contracts that are derivatives in their
entirety or that contain embedded derivatives that warrant separate accounting.
SFAS 149 is effective (1) for contracts entered into or modified after September
30, 2003, with certain exceptions, and (2) for hedging relationships designated
after September 30, 2003. The guidance is to be applied prospectively. The
Company does not expect the adoption of SFAS No. 149 to have a material impact
on its consolidated financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
addresses certain financial instruments that, under previous guidance, could be
accounted for as equity, but now must be classified as liabilities in statements
of financial position. These financial instruments include: 1) mandatorily
redeemable financial instruments, 2) obligations to repurchase the issuer's
equity shares by transferring assets, and 3) obligations to issue a variable
number of shares. SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. The Company
is evaluating the impact that the adoption of SFAS No. 150 will have on its
consolidated financial position and results of operations.

(9) Reclassifications
-----------------

Certain accounts in the prior year financial statements have been reclassified
for comparative purposes to conform to the presentation in the current year
financial statements. These reclassifications have no effect on previously
reported income.

(10) Acquisitions
------------

On June 25, 2003, the Company acquired substantially all of the assets of the
CareNet segment ("CareNet") of Shuttle Data Systems Corporation, d/b/a Adia
Information Management Corp. ("Adia"), pursuant to an asset purchase agreement
dated June 25, 2003, among the Company, Adia and Steven Heintz, Jr., the
president and majority shareholder of Adia. The principal assets acquired were
the intellectual property and customer contracts of CareNet. The total purchase

13


price, including acquisition costs, was $2,003,913 which consisted of 100,000
shares of common stock of the Company valued at $528,000, $838,740 in cash and a
three-year promissory note in the principal amount of $500,000 payable in 36
equal monthly installments of principal plus interest at the average prime rate
plus 1% as defined in the note agreement. Adia has received certain piggyback
registration rights with respect to these 100,000 shares. The cash portion of
the purchase price was paid out of existing working capital. The Company also
assumed certain contractual obligations and liabilities totaling $68,068 and
incurred $69,105 in legal and accounting costs which are included in the
purchase price.

In addition, in connection with the acquisition, the Company entered into a
non-compete and non-solicitation agreement with Steven Heintz, Jr. and Jennifer
Lindbert for which they were paid a fee of an aggregate $140,000, which fee was
paid in cash out of existing working capital and is included in "other assets"
on the balance sheet.

The cost of the acquisition was allocated to purchased software in the amount of
$883,075, customer lists in the amount of $1,097,138, covenant not to compete in
the amount of $140,000 and computer hardware in the amount of $23,700. The
Company is amortizing the purchased software over an eight-year life and the
customer lists over a nine-year life. The covenant not to compete is currently
being amortized over a three-year life.

The Company accounted for this acquisition pursuant to the purchase method of
accounting. For accounting purposes the Company recorded the assets and related
liabilities of CareNet effective as of June 30, 2003. The Company incorporated
the operations of CareNet into its operations commencing July 1, 2003.

The following unaudited proforma condensed consolidated statements of operations
assumes the CareNet acquisition occurred on January 1, 2002. In the opinion of
management, all adjustments necessary to present fairly such unaudited proforma
statements have been made.

Nine months ended September 30,
(in 000's except Per Share Data)

2003 2002
---- ----
Revenue $20,171 $16,776
Net Income $ 2,349 $ 428
Net Income Per Share - Basic $ .55 $ .11
Diluted $ .51 $ .10



(11) Dividends
---------

In July 2003, the Company's Board of Directors approved a cash dividend of $0.10
per share of common stock which was paid in September 2003 to all stockholders
of record on August 20, 2003. The amount charged to surplus in August 2003,
based upon the shares outstanding on August 20, 2003, the record date for the
dividend, was $441,447.

(12) Legal Proceedings
-----------------

In October 2002, the Company commenced an action against the City of Richmond,
in the United States District Court for the Eastern District of New York, for
failure to pay more than $1 million pursuant to a contract between the Company
and Richmond. On July 29, 2003, this action was settled and the Company received
an amount of $205,000. This settlement had no material adverse effect on the
results of operations of the Company.

14



(13) Commitments and Contingencies
-----------------------------

The Company plans to relocate its Islip, New York headquarters facility to a
larger facility in Great River, New York. The Company is party to a lease
agreement that was signed by the Company on September 25, 2003. The lease is for
a ten year and ten month period and calls for fixed rent payments of $5.8
million over the ten year and ten month period. The actual commencement date of
the lease is dependent upon the ability of the landlord to deliver possession of
the property to the Company. Included in the terms and conditions of the lease
is the requirement of the Company to provide to the Landlord a letter of credit
in the amount of $292,980, which represents approximately six months rent. The
letter of credit was provided to the landlord on October 31, 2003. The letter of
credit is required for the first 22 months of the lease and will be reduced as
follows:

$244,150 for months 23 through 34 of the lease.
$195,320 for months 35 through 46 of the lease.
$146,490 for months 47 through 58 of the lease.
$97,660 for months 59 to the expiration of the lease.

The letter of credit will expire in September 2004, at which time the Company is
required to renew the letter of credit per the above terms.

(14) Major Customers
---------------

During the nine months ended September 30, 2003 and 2002, no one customer
accounted for more than 10% of revenue. During the three months ended September
30, 2003, one customer accounted for approximately $890,000 or 13% of revenue.
The account receivable from this customer at September 30, 2003 was $89,000 or
1% of the total accounts receivable. No one customer accounted for more than 10%
of revenue for the three months ended September 30, 2002.

(15) Subsequent Event
----------------

On October 23, 2003, the Company reduced the exercise price of its Series B
Common Stock Purchase Warrants from $12.00 per share to $10.00 per share. These
warrants will not be extended beyond their maturity date of October 31, 2003. As
of October 29, 2003, 8,500 warrants have been exercised and the Company has
received gross proceeds in the amount of $85,000.


15



Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

Overview

Our operations are grouped into two segments:

|*| Software and Related Systems and Services
|*| Data Center [service bureau services]

Results of Operations

Fixed price software development contracts and licenses accounted for 44% of
consolidated revenue for both of the nine-month periods ended September 30, 2003
and 2002. We recognize revenue for fixed price contracts using the percentage of
completion method. Since the billing schedules under the contracts differ from
the recognition of revenue, at the end of any period these contracts generally
result in either costs and estimated profits in excess of billing or billing in
excess of costs and estimated profits. Revenue from fixed price software
development contracts is determined using the percentage of completion method
which is based upon the time spent by our technical personnel on a project. As a
result, during the third and fourth quarters, when many of our employees are on
vacation and holidays, our revenue could be affected. Our time spent on projects
during the second half of the year generally ranges from 1% to 3% less than time
spent on projects during the first half of the year.

Nine months ended September 30, 2003 and 2002

Our total revenue for the nine months ended September 30, 2003 (the "September
2003 period") was $19,816,000, an increase of $3,495,000, or 21%, from our
revenue for the nine months ended September 30, 2002 (the "September 2002
period"), which was $16,321,000. Revenue from contracts from government agencies
represented 59% of revenue in the September 2003 period and 53% of revenue in
the September 2002 period. This reflects an increase in new government
contracts, primarily relating to contracts with two new county agencies.

Software and Related Systems and Services
- -----------------------------------------

Our Software and Related Systems and Services revenue for the September 2003
period was $18,344,000, an increase of $3,461,000, or 23%, from our revenue for
the September 2002 period, which was $14,883,000. Software and related systems
and services revenue is comprised of turnkey systems labor revenue, revenue from
sales of third party hardware and software, license revenue, maintenance revenue
and revenue from small turnkey systems.

The largest component of revenue was turnkey systems labor revenue, which
increased to $7,131,000 in the September 2003 period, from $5,357,000 in the
September 2002 period, reflecting a 33% increase. Turnkey systems labor revenue
refers to labor associated with turnkey installations and includes categories
such as training, installation, project management and development. This
increase was substantially the result of an increase in spending for information
systems in the human services marketplace and our ability to provide the staff
necessary to generate additional revenue. Labor rate price changes from
September 2003 period to the September 2002 period resulted in a 13% increase in
the average daily billing rate and accounted for approximately $441,000, or 25%,
of the total turnkey systems labor increase. The acquisition of the operations
of CareNet accounted for $191,000 or 11% of the total turnkey systems labor
increase. Revenue from third party hardware and software increased to $3,470,000
in the September 2003 period, from $2,964,000 in the September 2002 period,
which represents an increase of 17%. Sales of third party hardware and software
are made in connection with the sales of turnkey systems. These sales are
typically made at lower gross margins than our human services revenue. License
revenue increased to $1,877,000 in the September 2003 period, from $1,388,000 in
the September 2002 period, reflecting an increase of 35%. License revenue is
generated as part of a sale of a human services information system pursuant to a
contract or purchase order that includes delivery of the system and maintenance.
This increase in license revenue was the result of an increase in spending for

16


information systems in the human services marketplace. Maintenance revenue
increased to $5,283,000 in the September 2003 period, from $4,521,000 in the
September 2002 period, reflecting an increase of 17%. As turnkey systems are
completed, they are transitioned to the maintenance division, thereby increasing
our installed base. Revenue from the sales of our small turnkey division
decreased to $583,000 in the September 2003 period, from $653,000 in the
September 2002 period, reflecting a decrease of 11%. This decrease is the result
a redirection of our sales efforts to larger turnkey sales. Small turnkey
division sales relate to turnkey contracts that are less than $50,000 and are
usually completed within one month.

Gross profit increased to $7,578,000 in the September 2003 period from
$4,765,000 in the September 2002 period, reflecting an increase of 59%. Our
gross margin percentage increased to 41% in the September 2003 period from 32%
in the September 2002 period. Our gross margins have increased primarily as a
result of increased maintenance and license revenue and, to a lesser extent, an
increase in our labor revenue. Our infrastructure costs with respect to our
maintenance division are substantially in place and as new maintenance revenue
occurs, our gross profit margins are improved accordingly.

Data Center
- -----------

Data center clients typically generate approximately the same amount of revenue
each year. We bill on a transaction basis or on a fixed fee arrangement.
Historically, each year, we increase the transaction or fixed fees by an amount
that approximates the New York urban consumer price index increase. The data
center revenue increased to $1,472,000 in the September 2003 period, from
$1,438,000 in the September 2002 period, representing an increase of $34,000, or
2%. This increase was due to an increase in the client base.

Gross profit increased to $678,000 in the September 2003 period from $644,000 in
the September 2002 period, reflecting an increase of 5%. Our gross margin
percentage increased to 46% in the September 2003 period from 45% in the
September 2002 period. This increase was the result of the increase in revenue
with no additional increase in costs.

Operating Expenses

Selling, general and administrative expenses were $5,100,000 in the September
2003 period, reflecting an increase of $1,301,000, or 34%, from the $3,799,000
in the September 2002 period. This increase was in the area of sales and
marketing salaries and commissions, which increased by $381,000; advertising and
promotion, which increased by $145,000; an increase in general and
administrative salaries, which increased by $237,000; and provisions for
bonuses, which increased by $465,000.

We incurred product development expenses of $1,509,000 in the September 2003
period, an increase of 52% from the $993,000 in September 2002 period. The
increase in product development expense is the result of continuing investment
in product enhancement and extensions. These extensions include the development
of new software modules including Minimum Data Set (MDS) reporting, which is
designed to address Federal reporting requirements, and a Computerized Physician
Order Entry (CPOE) module, as well as continued investment in core products
including a new version of our addictions management software products. These
amounts have been appropriately accounted for in accordance with SFAS No. 86,
"Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise
Marketed."

Interest and other expense was $151,000 in the September 2003 period, a decrease
of $8,000, or 5%, from the $159,000 in the September 2002 period. This decrease
is the result of reduced borrowing during the September 2003 period.

17



Interest income was $52,000 in the September 2003 period, an increase of
$20,000, or 60%, from 33,000 in the September 2002 period. Interest income is
generated from short-term investments made with a substantial portion of the
proceeds received from the term loan, as well as cash generated from operations.

We have a net operating loss tax carry forward of approximately $6.95 million.
In the September 2003 period, we recorded a current income tax expense of
$110,000, which related to various state and local taxes, as well as a provision
for the Federal alternative minimum tax. The current income tax provision was
reduced by $780,000 as a result of the use of available net operating losses.
The deferred tax asset and the valuation allowance were reduced by the same
amount. We also re-evaluated the deferred tax asset valuation allowance and
further reduced the allowance by $900,000, which was recorded as a tax benefit.
In the September 2002 period we provided for taxes in the amount of $44,000.
This provision was based upon certain state taxes.

As a result of the foregoing factors, in the September 2003 period, we had net
income of $2,339,000, or $.56 per share (basic) and $.52 per share (diluted).
For the September 2002 period, we had net income of $447,000, or $.12 per share
(basic) and $.11 per share (diluted).

Three Months Ended September 30, 2003 and 2002

Results of Operations

Fixed price software development contracts and licenses accounted for 39% of
consolidated revenue for the three months ended September 30, 2002 (the
"September 2003 quarter") and 48% of consolidated revenue for the three months
ended June 30, 2002 (the "September 2002 quarter"). We recognize revenue for
fixed price contracts on the percentage of completion method. Since the billing
schedules under the contracts differ from the recognition of revenue, at the end
of any period these contracts generally result in either costs and estimated
profits in excess of billing or billing in excess of cost and estimated profits.
Revenue from fixed price software development contracts is determined using the
percentage of completion method which is based upon the time spent by our
technical personnel on a project. As a result, during the third and fourth
quarters, when many of our employees are on vacation and holidays, our revenue
could be affected. Our time spent on projects during the second half of the year
generally ranges from 1% to 3% less than time spent on projects during the first
half of the year.

Our total revenue for the September 2003 quarter was $7,108,000, an increase of
$1,064,000, or 18%, from our revenue for the September 2002 quarter, which was
$6,044,000. Revenue from contracts from government agencies represented 54% of
revenue in the September 2003 quarter and 53% of revenue in the September 2002
quarter. This reflects an increase in new government contracts, primarily
relating to contracts with two new county agencies. Revenue from one client,
Hennepin County, accounted for 12.5% of total consolidated revenue for the
September 2003 quarter. No one client accounted for more than 10% of total
consolidated revenue for the September 2002 quarter.

Software and Related Systems and Services
- -----------------------------------------

Our Software and Related Systems and Services revenue for the September 2003
quarter was $6,595,000, an increase of $1,034,000, or 19%, from our revenue for
the September 2002 quarter, which was $5,561,000. Software and related systems
and services revenue is comprised of turnkey systems labor revenue, revenue from
sales of third party hardware and software, license revenue, maintenance revenue
and revenue from small turnkey systems.

The largest component of revenue was turnkey systems labor revenue, which
increased to $2,631,000 in the September 2003 quarter or 46%, from $1,808,000 in
the September 2002 quarter. Turnkey systems labor revenue refers to labor
associated with turnkey installations and includes categories such as training,
installation, project management and development. This increase was
substantially the result of an increase in spending for information systems in

18


the human services marketplace and our ability to provide the staff necessary to
generate additional revenue. Labor rate price changes from September 2003
quarter to the September 2002 quarter resulted in an 11% increase in the average
daily billing rate and accounted for approximately $114,000, or 14%, of the
total turnkey systems labor increase. The acquisition of the operations CareNet
accounted for $191,000 or 23% of the total turnkey systems labor increase.
Revenue from third party hardware and software decreased to $1,324,000 in the
September 2003 quarter, from $1,586,000 in the September 2002 quarter, which
represents a decrease of 17%. This decrease was primarily the result of a large
sale of computer hardware of approximately $686,000 made to a client in the
September 2002 period. Sales of third party hardware and software are made in
connection with the sales of turnkey systems. These sales are typically made at
lower gross margins than our human services revenue. License revenue increased
to $632,000 in the September 2003 quarter, from $476,000 in the September 2002
quarter, reflecting an increase of 33%. License revenue is generated as part of
a sale of a human services information system pursuant to a contract or purchase
order that includes delivery of the system and maintenance. This increase in
license revenue was the result of an increase in spending for information
systems in the human services marketplace. Maintenance revenue increased to
$1,796,000 in the September 2003 quarter, or 20%, from $1,499,000 in the
September 2002 quarter. As turnkey systems are completed, they are transitioned
to the maintenance division, thereby increasing our installed base. Revenue from
the sales of our small turnkey division increased to $212,000 in the September
2003 quarter, from $192,000 in the September 2002 quarter, reflecting an
increase of 10%. This increase is the result of sales of our new Avatar
Addictions Management product introduced during the September 2003 quarter.
Small turnkey division sales relate to turnkey contracts that are less than
$50,000 and are usually completed within one month.

Gross profit increased to $2,902,000 in the September 2003 quarter from
$1,665,000 in the September 2002 quarter, reflecting an increase of 74%. Our
gross margin percentage increased to 44% in the September 2003 quarter from 30%
in the September 2002 quarter. Our gross margins have increased as a result of
increased maintenance and license revenue and to a lesser extent, an increase in
our labor revenue. Our infrastructure costs with respect to our maintenance
division are substantially in place and as new maintenance revenue occurs, our
gross profit margins are improved accordingly.

Data Center
- -----------

Data center clients typically generate approximately the same amount of revenue
each year. We bill on a transaction basis or on a fixed fee arrangement.
Historically, each year, we increase the transaction or fixed fees by an amount
that approximates the New York urban consumer price index increase. The data
center revenue increased to $512,000 in the September 2003 quarter, from
$483,000 in the September 2002 quarter, representing an increase of $30,000, or
6%. The increase in revenue was primarily due to an increase in the client base.

Gross profit increased to $250,000 in the September 2003 quarter from $215,000
in September 2002 quarter, reflecting an increase of 16%. Our gross margin
percentage increased to 49% in the September 2003 quarter from 45% in the
September 2002 quarter. This increase was the result of an increase in revenue
with no corresponding increase in costs.

Operating Expenses

Selling, general and administrative expenses were $1,820,000 in the September
2003 quarter, reflecting an increase of $506,000, or 38%, from the $1,315,000 in
the September 2002 quarter. This increase was in the area of sales and marketing
salaries and commissions, which increased by $132,000; advertising and
promotion, which increased by $62,000; an increase in general and administrative
salaries, which increased by $75,000; an increase in the provisions for bonuses,
which increased by $166,000 and the addition of the amortization of the CareNet
acquisition which was $70,000 in the September 2003 quarter and was not present
in the September 2002 quarter.

19


We incurred product development expenses of $566,000 in the September 2003
quarter, an increase of 84% from the $308,000 in September 2002 quarter. The
increase in product development expense is the result of continuing investment
in product enhancement and extensions. These extensions include the development
of new software modules including Minimum Data Set (MDS) reporting, which is
designed to address Federal reporting requirements and a Computerized Physician
Order Entry (CPOE) module as well as continued investment in core products
including a new version of our addictions management software products. These
amounts have been appropriately accounted for in accordance with SFAS No. 86,
"Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise
Marketed."

Interest and other expense was $49,000 in the September 2003 quarter, a decrease
of $1,000, or 2%, from the $50,000 in the September 2002 quarter. This decrease
is the result of reduced borrowing during the September 2003 period and was
partially offset by interest associated with a new capitalized lease
arrangement.

Interest income was $22,000 in the September 2003 quarter, an increase of
$9,000, or 76%, from $12,000 in the September 2002 quarter. Interest income is
generated from short-term investments made with a substantial portion of the
proceeds received from the term loan, as well as cash generated from operations.

We have a net operating loss tax carry forward of approximately $6.95 million.
In the September 2003 quarter, we recorded a current income tax credit of
$8,000, which related to various state and local net operating loss tax benefits
as well as a provision for the Federal alternative minimum tax. The current
income tax credit was further reduced by $412,000 as a result of the use of
available net operating losses. The deferred tax asset and the valuation
allowance were reduced by the same amount. We also re-evaluated the deferred tax
asset valuation allowance and further reduced the allowance by $800,000, which
was recorded as a tax benefit. In the September 2002 quarter, we provided for
taxes in the amount of $18,000. This provision was based upon certain state
taxes.

As a result of the foregoing factors, in the September 2003 quarter, we had net
income of $1,546,000, or $.34 per share (basic) and $.33 per share (diluted).
For the September 2002 quarter, we had net income of $202,000, or $.05 per share
basic and diluted.

Liquidity and Capital Resources

We had working capital of approximately $11.5 million at September 30, 2003 as
compared to working capital of approximately $9.2 million at December 31, 2002.
This increase of $2.3 million in working capital was the result of the
following: our net income, after adding back depreciation and amortization and
adjusting for the current portion of the deferred tax asset, increased working
capital by $2.8 million. The increase in working capital also included $2.2
million in net proceeds from the exercise of our stock options and warrants.
These increases were partially offset by the costs related to the CareNet
acquisition, which utilized approximately $979,000 of our cash. Our working
capital was further reduced by the CareNet acquisition because of the current
portion of the long-term debt assumed, which we recorded in the amount of
$166,000, and the assumption of certain other contract obligations totaling
$68,000. We also reduced our working capital by $441,000 as a result of the
payment of a dividend and by an additional $357,000 forthe acquisition of
equipment. The remaining reduction in working capital of $689,000 was due to
changes in other current assets and liabilities.

In June 2001, we entered into a revolving credit and term loan agreement with
Fleet Bank ("Fleet"). This financing provides us with a five-year term loan of
$2.5 million, as well as a two year $1.5 million revolving line of credit. The
$1.5 million line of credit expired in June 2003. We did not utilize this line
of credit during its duration. We are currently exploring our options with
Fleet, relating to the possible increase in its term loan to be used for
acquisitions, as well as an additional term loan to assist in financing costs
associated with the relocation of our corporate headquarters. The current term
loan bears interest at LIBOR plus 2.5%. We have entered into an interest rate
swap agreement with Fleet for the amount outstanding under the term loan whereby

20


we converted our variable rate on the term loan to a fixed rate of 7.95% in
order to reduce the interest rate risk associated with these borrowings. The
proceeds of the term loan are designated for acquisitions as well as for product
enhancements specific to California requirements. We have made principal
payments on the $2.5 million term loan and the amount outstanding at September
30, 2003 is $1.4 million.

The terms of our term loan agreement require compliance with certain covenants,
including maintaining a minimum net equity of $9 million, minimum cash reserves
of $500,000, maintenance of certain financial ratios, limitations on capital
expenditures and indebtedness and prohibition of the payment of cash dividends.
We received Fleet's consent to the payment of the dividend declared in August
2003 and paid in September 2003. As of September 30, 2003, we were in compliance
with the financial covenants of this agreement.

On February 27, 2003, our Board of Directors authorized the purchase of up to
$100,000 of our common stock at any time the market price is less than $3.50 per
share. Purchases of stock will be made from time to time, depending on market
conditions, in open market or in privately negotiated transactions, at prices
deemed appropriate by management. There is no set time limit on the purchases.
We expect to fund any stock repurchases from our operating cash flow. As of
September 30, 2003, we have not made any stock repurchases.

On June 25, 2003, we acquired substantially all of the assets of the CareNet
segment of Shuttle Data Systems Corporation, d/b/a Adia Information Management
Corp., pursuant to an asset purchase agreement dated June 25, 2003, among the
Netsmart, Adia and Steven Heintz, Jr., the president and majority shareholder of
Adia. The principal assets acquired were the intellectual property and customer
contracts of CareNet. The total purchase price, including acquisition costs, was
$2,003,913 which consisted of 100,000 shares of common stock valued at $528,000,
$838,740 in cash, and a three-year promissory note in the principal amount of
$500,000 payable in 36 equal monthly installments of principal plus interest at
the prime rate plus 1%. The cash portion of the purchase price was paid for out
of existing working capital. We also assumed certain contractual obligations and
liabilities totaling $68,068 and incurred $69,105 in legal and accounting costs
which are included in the purchase price.

In addition, in connection with the acquisition, we entered into a non-compete
and non-solicitation agreement with Steven Heintz, Jr. and Jennifer Lindbert for
which they were paid a fee of an aggregate $140,000, which fee was paid in cash
out of existing working capital and is included in "other assets" on the balance
sheet.

The cost of the acquisition was allocated to purchased software in the amount of
$883,075, customer lists in the amount of $1,097,138, the covenant not to
compete in the amount of $140,000 and computer hardware in the amount of
$23,700. We are amortizing the purchased software over an eight-year life and
the customer lists over a nine-year life. The covenant not to compete is
currently being amortized over a three-year life.

We accounted for this acquisition pursuant to the purchase method of accounting.
For accounting purposes we recorded the assets and related liabilities of
CareNet effective as of June 30, 2003. We incorporated the operations of CareNet
into our operations commencing July 1, 2003.

A part of our growth strategy is to acquire other businesses that are related to
our current business. Such acquisitions may be made with cash, our securities or
a combination of cash and securities. If we fail to make any acquisitions our
future growth will be limited to only internal growth. As of the date of this
Form 10-Q quarterly report, we did not have any formal or informal agreements or
understandings with respect to any material acquisitions, and we cannot give any
assurance that we will be able to complete any material acquisitions.

Based on our outstanding contracts and our continuing business, we believe that
our cash flow from operations, and our cash on hand will be sufficient to enable
us to fund our operations for at least the next twelve months. It is possible
that we may need additional funding if we go forward with certain acquisitions
or if our business does not develop as we anticipate or if our expenses,
including our software development costs relating to our expansion of our

21


product line and our marketing costs for seeking to expand the market for our
products and services to include smaller clinics and facilities and sole group
practitioners, exceed our expectation.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. These accounting
principles require us to make certain estimates, judgments and assumptions. We
believe that the estimates, judgments and assumptions upon which we rely are
reasonable based upon information available to us at the time that these
estimates, judgments and assumptions are made. These estimates, judgments and
assumptions can affect the reported amounts of assets and liabilities as of the
date of the financial statements, as well as the reported amounts of revenues
and expenses during the periods presented. Among other things, estimates are
used in accounting for allowances for bad debts, deferred income taxes, expected
realizable values of assets (primarily capitalized software development costs
and customer lists) and revenue recognition. To the extent there are material
differences between these estimates, judgments or assumptions and actual
results, our financial statements will be affected. The significant accounting
policies that we believe are the most critical to aid in fully understanding and
evaluating our reported financial results include the following:

Revenue Recognition
Impairment of Capitalized Software Development Costs
Impairment of Customer Lists

Revenue Recognition: Revenue associated with fixed price turnkey sales consists
of the following components: licensing of software, labor associated with the
installation and implementation of the software; and maintenance services
rendered in connection with such licensing activities. Revenue from fixed price
software development contracts and revenue under license agreements, which
require significant modification of the software package to the customer's
specifications, are recognized on the estimated percentage-of-completion method.
Using the units-of-work-performed method to measure progress towards completion,
revisions in cost estimates and recognition of losses on these contracts are
reflected in the accounting period in which the facts become known. The
complexity of the estimation process and issues related to the assumptions,
risks and uncertainties inherent with the application of the percentage of
completion method of accounting affect the amounts of revenue and related
expenses reported in our Consolidated Financial Statements. A number of internal
and external factors can affect our estimates, including labor rates,
utilization and efficiency variances and specification and testing requirement
changes. Maintenance contract revenue is recognized on a straight-line basis
over the life of the respective contract. We also derive revenue from the sale
of third party hardware and software which is recognized based upon the terms of
each contract. Consulting revenue is recognized when the services are rendered.
Data Center revenue is recognized in the period in which the service is
provided. The above sources of revenue are recognized when, persuasive evidence
of an arrangement exists, delivery has occurred, the fee is fixed and
determinable and collectibility is probable.

Contract terms provide for billing schedules that differ from revenue
recognition and give rise to costs and estimated profits in excess of billings,
and billings in excess of costs and estimated profits.

Deferred revenue represents revenue billed and collected but not yet earned.

The cost of maintenance revenue, which consists solely of staff payroll and
applicable overhead, is expensed as incurred.

Capitalized Software Development Costs - Capitalization of computer software
development costs begins upon the establishment of technological feasibility.
Technological feasibility for our computer software products is generally based
upon achievement of a detail program design free of high risk development
issues. The establishment of technological feasibility and the ongoing

22



assessment of recoverability of capitalized computer software development costs
requires considerable judgment by management with respect to certain external
factors, including, but not limited to, technological feasibility, anticipated
future gross revenue, estimated economic life and changes in software and
hardware technology. Prior to reaching technological feasibility these costs are
expensed as incurred and included in research and development. Amortization of
capitalized computer software development costs commences when the related
products become available for general release to customers. Amortization is
provided on a product by product basis. The annual amortization is the greater
of the amount computed using (a) the ratio that current gross revenue for a
product bear to the total of current and anticipated future gross revenue for
that product or (b) the straight-line method over the remaining estimated
economic life of the product. The estimated life of these products range from 3
to 8 years.

We periodically perform reviews of the recoverability of such capitalized
software costs. At the time a determination is made that capitalized amounts are
not recoverable based on the estimated cash flows to be generated from the
applicable software, any remaining capitalized amounts are written off.

Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", we evaluate
our long-lived assets for financial impairment, and continue to evaluate them as
events or changes in circumstances indicate that the carrying amount of such
assets may not be fully recoverable. We evaluate the recoverability of
long-lived assets by measuring the carrying amount of the assets against the
estimated undiscounted future cash flows associated with them. At the time such
evaluations indicate that the future undiscounted cash flows of certain
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are adjusted to their fair values.

Impairment of Customer Lists - Pursuant to SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", we evaluate our long-lived assets
for financial impairment, and continue to evaluate them as events or changes in
circumstances indicate that the carrying amount of such assets may not be fully
recoverable. We evaluate the recoverability of long-lived assets by measuring
the carrying amount of the assets against the estimated undiscounted future cash
flows associated with them. At the time such evaluations indicate that the
future undiscounted cash flows of certain long-lived assets are not sufficient
to recover the carrying amount of such assets, the assets are adjusted to their
fair values.

The following table summarizes, as of September 30, 2003, our obligations and
commitments to make future payments under debt, capital leases and operating
leases:

Contractual Obligations Payments Due by Period
----------------------- ----------------------

Total Less than 1 - 3 years 4 - 5 years Over 5 years
1 year


Long Term Debt 1,833,351 666,667 1,166,684 -- --

Capital Lease Obligations 164,154 62,840 101,314 -- --

Operating Leases 286,360 227,054 59,306 -- --

Total Contractual Cash
Obligations 2,283,865 956,561 1,327,304 -- --


We plan to relocate our Islip, New York headquarters facility to a larger
facility located in Great River, New York. We are a party to a lease agreement
that was signed by us on September 25, 2003. The lease is for a ten year and ten
month period and calls for fixed rent payments of $5.8 million over the ten year
and ten month period. The rental payments are excluded from the contractual


23


obligations chart because the commencement date of the rental payments is
dependent upon the ability of the landlord to deliver possession of the property
to us as per the specifications contained in the lease.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to changes in interest rates. Most of our
debt is at fixed rates of interest after completing an interest rate swap
agreement, which effectively converted our variable rate debt into a fixed rate
debt of 7.95%. Therefore, if the LIBOR rate plus 2.5% increases above 7.95%, it
may have a positive effect on our net income.

Most of our invested cash and cash equivalents, which are invested in money
market accounts and commercial paper, are at variable rates of interest. If
market interest rates decrease by 10 percent from levels at September 30, 2003,
the effect on our net income would be a decrease of approximately $7,200 per
year.

Item 4. Controls and Procedures

Evaluation and Disclosure Controls and Procedures

Based on their evaluation as of a date within 90 days of the filing of this
Form 10-Q, our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, conducted an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures, as required by
Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer have concluded that our disclosure controls and
procedures were effective to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported with the time periods specified by the SEC's
rules and forms.

Changes in Internal Controls

There were no significant changes in our internal controls over financial
reporting that occurred during the quarter ended September 30, 2003 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.

Limitations on the Effectiveness of Controls

We believe that a control system, no matter how well designed and operated,
cannot provide absolute assurance that the objectives of the control system are
met, and no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company have been
detected.

Part II OTHER INFORMATION

Item 1. Legal Proceedings

In October 2002, the Company commenced an action against the City of
Richmond, in the United States District Court for the Eastern District of New
York, for failure to pay more than $1 million pursuant to a contract between the
Company and Richmond. On July 29, 2003, this action was settled and the Company
received $205,000.


24



Item 2. Changes in Securities

On June 25, 2003, the Company issued 100,000 shares of common stock in
connection with its acquisition of substantially all of the assets of the
CareNet segment of Shuttle Data Systems Corporation, d/b/a Adia Information
Management Corp., pursuant to an asset purchase agreement dated June 25, 2003,
among the Company, Adia and Steven Heintz, Jr., the president and majority
shareholder of Adia. The issuance of the foregoing securities was issued in
reliance upon the exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended, as a transaction not involving a public
placement based on the fact that it was an issuance of securities to one person
and the shares were legended to prevent their transfer.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit No. Description
----------- -----------

31.1 Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act.
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 8 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

(b) Reports on Form 8-K

Report on Form 8-K dated June 25, 2003, as amended by Form 8-K/A filed
September 2, 2003 - Items 2 and 7 containing the audited financial
statements of the CareNet segment of Shuttle Data Systems for the year
ended December 31, 2002 and the three month periods ended March 31,
2003 and 2002 and the pro forma financial statements of Netsmart and
CareNet for the year ended December 31, 2002 and for the three months
ended March 31, 2003.

Report on Form 8-K filed July 8, 2003 - Items 4 and 7.


25


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

NETSMART TECHNOLOGIES, INC.




/s/* Chief Executive Officer October 29, 2003
- ------------------------ (Principal Executive Officer)
James L. Conway



/s/* Chief Financial Officer October 29, 2003
- ------------------------ (Principal Financial and
Anthony F. Grisanti Accounting Officer)


26


Index of Exhibits
-----------------

Exhibit No. Description
- ----------- -----------

31.1 Certification of Chief Executive Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 8 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.