**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**





x ANNUAL
      REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
      the
      fiscal year ended December 31, 2006





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.
                Employerincorporation
                or organization)
            Identification
                Number)





3500
      Sunrise Highway, Suite D-122, Great River, NY  11739


(Address
      of principal executive offices)  (Zip
      Code)





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





Securities
      registered pursuant to Section 12(b) of the Act:





Title
                of each class
            Name
                of each exchange on which registeredNone
            None





Securities
      registered pursuant to section 12(g) of the Act:





Common
      Stock, par value $.01 per share


(Title
      of
      class)





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.   oYes  xNo





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.   oYes  xNo





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. xYes oNo





Indicate
      by a check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S - K is not contained herein, and will not be contained, to the
      best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. o









Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
                accelerated filer o
            Accelerated
                filer x
            Non-accelerated
                filer o





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act) oYes
x No





As
      of
      June 30, 2006, the last day of the Registrant’s second fiscal quarter, the
      aggregate market value of the voting and non-voting common equity held by non
      affiliates was approximately $77,508,000.





As
      of
      March 1, 2007, the registrant had outstanding 6,570,434 shares of common
      stock.





DOCUMENTS
      INCORPORATED BY REFERENCE





None







**Part
      I**








**Forward-Looking
      Statements**





Statements
      in this Form 10-K annual report may be “forward-looking statements” within the
      meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking
      statements include, but are not limited to, statements that express our
      intentions, beliefs, expectations, strategies, predictions or any other
      statements relating to our future activities or other future events or
      conditions. These statements are based on current expectations, estimates and
      projections about our business based, in part, on assumptions made by
      management. These statements are not guarantees of future performance and
      involve risks, uncertainties and assumptions that are difficult to predict.
      Therefore, actual outcomes and results may differ materially from what is
      expressed or forecasted in the forward-looking statements due to numerous
      factors, including those risks discussed from time to time in this Form 10-K
      annual report for the year ended December 31, 2006, and in other documents
      which
      we file with the Securities and Exchange Commission. In addition, such
      statements could be affected by risks and uncertainties related to product
      demand, market and customer acceptance, competition, government regulations
      and
      requirements, pricing and development difficulties, as well as general industry
      and market conditions and growth rates, and general economic conditions. Any
      forward-looking statements speak only as of the date on which they are made,
      and
      we do not undertake any obligation to update any forward-looking statement
      to
      reflect events or circumstances after the date of this Form 10-K.




**Item
      1.**  **Business.**





In
      this
      report, the terms “Netsmart”, “we”, “us” or “our” mean Netsmart Technologies,
      Inc. and the subsidiaries in our consolidated financial statements.





**Introduction**





We
      develop market, and support application software for health and human services
      organizations. In many cases, our software serves as the foundation for the
      financial, clinical and management processes for our customers, which include
      mental health clinics, substance abuse clinics, psychiatric hospitals, public
      health agencies, and managed care entities. We also market and support
      enterprise-wide public health solutions and vital records software to public
      health agencies.





Our
      software facilitates key functions, such as patient management, billing,
      scheduling, and electronic medical records, for all modalities of care. We
      sell
      our software products, either on a licensed or a subscription basis. We also
      offer software support and upgrades under maintenance agreements with our
      customers, an arrangement which provides us with a recurring revenue stream.
      We
      currently have in place contracts with more than 1,250 customer organizations
      in
      all 50 states, U.S. territories and several other countries. These contracts
      represent more than 100,000 users and include more than 30 state agencies that
      operate and/or manage multiple facilities.





The
      ability for government agencies and non-profit organizations to integrate their
      services is becoming more critical as they face requirements to provide a wider
      range of services to more clients, but with less money. Our software, services,
      and industry knowledge are designed to help our customers gain operational
      efficiencies, while at the same time protecting the privacy of sensitive health
      data. As a result, we are seeing increased demand for our software from
      government agencies who are integrating services, and from major systems
      integrators interested in reselling our software as part of their role in
      supporting these agencies.





The
      cost
      of a new software system for our customers typically ranges from $10,000 to
      $100,000 for a single-facility healthcare organization to $250,000 to several
      million dollars for multi-unit care organizations, such as those run by state
      agencies. Government agencies, such as mental health, mental retardation, child
      welfare, addiction, correction and public health facilities, accounted for
      approximately 40% of revenue in 2006, with the remainder coming from private
      hospitals, smaller clinics, group and sole practitioners.





1


Netsmart
      also furnishes data center services to providers that do not wish to maintain
      the staff and infrastructure required to manage a direct-bill relationship
      with
      multiple payers for mental health, alcohol and substance abuse services. Data
      Center services include statistical reporting, data entry, electronic billing
      and submission. This business line provides a recurring revenue stream that
      contributes to the recurring revenue base described above.





We
      also
      offer an Application Service Provider (“ASP”) option, which makes our Avatar
      software suite, CareNet, InfoScriber and Netsmart University products available
      either via a secure connection to the Internet or via a virtual private network
      (“VPN”). The ASP model reduces the upfront capital investment required for
      customers to procure our software and enables customers to deploy our products
      more rapidly and to pay a monthly services-based fee rather than an upfront
      license fee. The ASP model also eliminates the need for customers to continually
      upgrade their hardware systems. In addition, it provides an opportunity for
      us
      to become more integrated with the customer’s day-to-day
      operations.





**Recent
      Acquisitions**





On
      August
      1, 2006, we acquired the business of QS Technologies, Inc. (“QS”) from
      Intelligent Systems Corporation. They deliver enterprise-wide public health
      solutions and vital records software to 70 public health agencies, including
      nine states. This acquisition expands our product offerings, and enhances our
      ability to offer our customers a wide range of products and services that are
      designed to meet their needs.





**Proposed
      Merger Transaction**





On
      November 18, 2006, we entered into an Agreement and Plan of Merger (the “Merger
      Agreement”) with NT Acquisition, Inc., a Delaware corporation (“Buyer”) and NT
      Merger Sub, Inc., a Delaware corporation (“Merger Sub”), and NT Acquisition,
      Inc., a Delaware corporation (“Buyer”). Under the terms of the Merger Agreement,
      Merger Sub will be merged with and into Netsmart, the separate corporate
      existence of Merger Sub will cease with Netsmart continuing as the surviving
      corporation. Merger Sub and Buyer are or will be controlled by funds which
      are
      affiliated with Insight Venture Partners (“Insight”) and Bessemer Venture
      Partners (“Bessemer” and, together with Insight, the “Sponsors”), private equity
      firms.





At
      the
      effective time of the merger, each outstanding share of common stock of
      Netsmart, other than any shares owned by Merger Sub, its affiliates, Netsmart
      or
      any shareholders who are entitled to and who properly exercise appraisal rights
      under Delaware law, will be cancelled and converted into the right to receive
      $16.50 in cash, without interest. Warrant holders and option holders will be
      entitled to receive the difference between the exercise price of such security
      and $16.50 per share in cash.





FFDOCS1\734055.01
 A
      special
      meeting of stockholders has been called for Thursday, April 5, 2007 for the
      purpose of considering the Merger Agreement.





**Organization
      of the Company**





We
      are a
      Delaware corporation formed in September 1992 under the name Medical Services
      Corp. Our name was changed to Carte Medical Corporation in October 1993 to
      CSMC
      Corporation in June 1995 and to Netsmart Technologies, Inc. in February 1996.





Our
      executive offices are located at 3500 Sunrise Highway, Suite D-122, Great River,
      New York 11739, telephone (631) 968-2000. Reference to us and to Netsmart
      includes our legal subsidiaries Netsmart New York, Inc., Netsmart Ohio and
      Netsmart Public Health, Inc. Our website is located at www.ntst.com .





2


Neither
      the information contained in our website nor the information contained in any
      Internet Web site is a part of this Form 10-K annual report.





**Available
      Information:**





The
      public may read and copy any materials filed by us with the SEC at the SEC’s
      public reference room at 450 Fifth Street, NW, Washington D.C., 20549. The
      public may obtain information about the operation of the SEC’s public reference
      rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website
      at http://www.sec.gov that
      contains reports, proxy and information statements and other information about
      issuers such as us that file electronically with the SEC.





In
      addition, we make available free of charge on our website at www.ntst.com our
      annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
      on
      Form 8-K and amendments to those reports filed or furnished pursuant to Section
      13(a) or 15(d) under the Exchange Act as soon as reasonably practical after
      we
      electronically file such material with, or furnish it to, the SEC.





Our
      Board
      of Directors has adopted a Code of Business Conduct applicable to the Company’s
      officers and employees, and has also adopted a Code of Ethics for its senior
      financial officers. These codes of ethics are posted on the Company’s website at
      www.ntst.com in the Investor Relations section. Any amendment of the codes
      of
      ethics or waiver thereof applicable to any director or executive officer of
      the
      Company, including the Chief Executive Officer or any senior financial officer,
      will be disclosed on the Company’s website within four business days of the date
      of such amendment or waiver. In the case of a waiver, the nature of the waiver,
      the name of the person to whom the waiver was granted and the date of the waiver
      will also be disclosed.





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.





3


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.





4


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.





5


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.





6


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.





7


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.





8


**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.





9


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.





10


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.





11


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.





12


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.





13


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.




14




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
            Expiration3500
                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
            09/30/20105120
                Shoreham Place
              San
                Diego, California
            Software
                and Related Systems and Services - NY
            2,800
                square feet
            $75,000
            08/31/08117
                North 1stStreet
              Ann
                Arbor, Michigan
            ASP
                Services
            2,200
                square feet
            $49,000
            01/31/07146
                Second Street North
              St.
                Petersburg, Florida
            ASP
                Services
            2,000
                square feet
            $29,000
            03/31/0837
                Villa Road
              Greenville,
                South Carolina
            Public
                Health
              Software
                and Related Systems and Services
            5,761
                square feet
            $81,000
            02/23/1169-730
                Highway 11
              Rancho
                Mirage, CA
            Software
                and Related Systems and Services - NY
            1,400
                square feet
            *
            *





15


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.





16


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
            WithheldJames
                L. Conway
            5,519,325
            414,004Kevin
                Scalia
            5,314,412
            618,917Alan
                Tillinghast
            5,519,325
            414,004Joseph
                G. Sicinski
            5,294,192
            639,137Francis
                Calcagno
            5,287,492
            645,837John
                S.T. Gallagher
            5,296,692
            636,637Yacov
                Shamash
            5,250,287
            683,042





The
      following proposals were approved as follows:





Votes
                For
            
            Votes
                Against
            
            Abstain
            
            Broker
                Non VotesProposal
                to increase the numberof
                shares available under the Company’s2001
                Long-Term Incentive Plan
            
            
            3,220,677
            
            
            1,075,526
            
            
            208,593
            
            
            1,428,533Approval
                of amendments to the 2001Long
                Term Incentive Plan
            
            
            3,313,965
            
            
            981,138
            
            
            209,693
            
            
            1,428,533Approval
                of the selection ofMarcum
                & Kliegman LLP as theCompany’s
                independent certifiedAccountants
                for 2006
            
            
            5,891,821
            
            
            5,194
            
            
            36,314




17


**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
            
            LowMarch
                31, 2006
            
            $
            13.86
            
            $
            10.48June
                30, 2006
            
            
            14.60
            
            
            12.03September
                30, 2006
            
            
            15.05
            
            
            11.75December
                31, 2006
            
            
            16.32
            
            
            12.36March
                31, 2005
            
            $
            10.27
            
            
            8.28June
                30, 2005
            
            
            9.74
            
            
            8.50September
                30, 2005
            
            
            12.50
            
            
            8.94December
                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 Item 201(d) of Regulation S-K is located under “Item 12.
      Security Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters”.





(b)
      During the year ended December 31, 2006, no purchases were made under the
      Company’s stock buyback plan.




18


**Item
                    6.**
                **Selected
                    Financial
                    Data.**





The
      selected consolidated financial data set forth below for the five years in
      the
      period ended December 31, 2006 has been derived from the company’s audited
      Consolidated Financial Statements. This information should be read in
      conjunction with the audited Consolidated Financial Statements and notes
      thereto.





Year
                Ended December 31,2006(1)(5)
            
            2005(1)
            
            2004
            
            2003
            
            2002(in
                thousands except per share data)Selected
                Statementsof
                Income Data:Revenue
            
            $
            59,050
            
            $
            37,978
            
            $
            29,005
            
            $
            27,175
            
            $
            22,126Income
                from Operationsbefore
                interest, other financingcosts
                and income tax
            
            $
            4,139
            
            
            2,556
            
            
            3,065
            
            
            2,368
            
            
            1,095Net
                Income
            
            $
            1,853
            
            
            1,590
            
            
            2,7532
            
            
            3,0283
            
            
            1,1954Dividends
                DeclaredPer
                Common Share
            
            
            --
            
            
            --
            
            
            --
            
            
            .10
            
            
            --Per
                Share Data - Diluted:Net
                Income
            
            $
            .27
            
            $
            .27
            
            $
            .50
            
            $
            .64
            
            $
            .29Weighted
                average numberof
                shares outstanding
            
            
            6,748
            
            
            5,935
            
            
            5,537
            
            
            4,752
            
            
            4,153Selected
                BalanceSheet
                Data:Working
                Capital
            
            $
            3,758
            
            $
            4,043
            
            $
            18,216
            
            $
            14,714
            
            $
            9,215Total
                Assets
            
            
            70,525
            
            
            64,622
            
            
            37,707
            
            
            34,633
            
            
            22,416Long
                Term DebtIncluding
                Current Portion
            
            
            3,209
            
            
            2,750
            
            
            1,000
            
            
            1,667
            
            
            1,750Capitalized
                Leases IncludingCurrent
                Portion
            
            
            10
            
            
            71
            
            
            86
            
            
            147
            
            
            12Stock
                dividend
            
            
            --
            
            
            --
            
            
            --
            
            
            441
            
            
            --Total
                Liabilities
            
            
            31,753
            
            
            28,336
            
            
            13,080
            
            
            13,633
            
            
            11,110(Accumulated
                Deficit)
            
            
            (151
            )
            
            (2,004
            )
            
            (3,594
            )
            
            (6,347
            )
            
            (9,376
            )Stockholders’
                Equity
            
            $
            38,771
            
            $
            36,286
            
            $
            24,627
            
            $
            21,000
            
            $
            11,306










1  In
      2006,
      the Company completed one acquisition. In 2005, the Company completed three
      acquisitions (see note 5 to the Consolidated Financial Statements).





2  The
      Company’s tax provision has been reduced as a result of a $1,014,000 reduction
      in its deferred tax asset valuation allowance.





3   The
      Company’s tax provision has been reduced as a result of available net operating
      loss carry forwards. In addition, a $900,000 tax benefit was recognized, as
      a
      result of a further reduction in its deferred tax asset valuation
      allowance.





4  The
      Company’s tax provision has been reduced as a result of available net operating
      loss carry forwards. In addition, a $400,000 tax benefit was recognized, as
      a
      result of a further reduction in its deferred tax asset valuation
      allowance .




5  The
      Company recognized $1,581,000 of costs associated with the proposed merger
      transaction in the fourth quarter of 2006. These costs were not deductible
      for
      tax purposes.


19





**Item
              7.**
            **Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations.**





**Overview**





Our
      operations are grouped into five segments:


§
            Software
                and Related Systems and Services - New
                York


§
            Software
                and Related Systems and Services -
                Ohio


§
            Software
                and Related Systems and Services - Public
                Health


§
            Data
                Center Services (service bureau
                services)


§
            Application
                Service Provider Services (“ASP”)





Software
      and Related Systems and Services is the design, installation, implementation
      and
      maintenance of computer information systems that provide comprehensive
      healthcare information technology solutions, including billing, patient tracking
      and scheduling for inpatient and outpatient environments, as well as clinical
      documentation and medical record generation and management. We perform these
      services in each of the New York, Public Health and Ohio segments. Within these
      segments, we recognize revenue based on the nature of the products and services
      sold, for example, a turnkey system, a consulting contract or a maintenance
      contract. Turnkey revenue includes turnkey systems labor revenue, third party
      hardware and software revenue, license revenue and sales from our small turnkey
      division. We further classify our revenue into large turnkey and small turnkey
      components. The large turnkey components consist mostly of our Avatar suite
      of
      products. When we are engaged in fixed price arrangements for large turnkey
      systems, the installations will usually extend over a six-month to a multi-year
      time period. The duration of the implementation depends on the size and
      complexity of the customer organization and the specifics of the implementation.
      Installations of small turnkey components are usually completed within a
      six-month period. Small turnkey contracts performed in the New York segment
      are
      mostly related to our Avatar methadone related products. The small turnkey
      contracts in the Ohio segment are for system installations for behavioral
      healthcare information management software for mental health, substance abuse,
      and addiction services agencies, developmental disability centers and behavioral
      health-related managed care organizations. The Software and Related Systems
      and
      Services - Ohio segment was established as a result of the acquisition of
      Netsmart Ohio, formerly CMHC Systems, Inc (“CMHC”). This acquisition occurred on
      September 28, 2005 and consequently operations from this acquisition are
      included in the results of operations for the year ended December 31, 2006,
      but
      are not included in the entire comparable period for 2005. The small turnkey
      contracts in the Public Health segment are for system installations for a
      comprehensive set of public health and vital records solutions for public health
      agencies of all sizes. The Software and Related Systems and Services - Public
      Health segment is a new segment established as a result of the acquisition
      of
      the business of QS Technologies, Inc. (“QS”) by Netsmart’s Public Health
      subsidiary. This acquisition occurred in August 2006 and consequently operations
      from this acquisition are included in the results of operations for the five
      months ended December 31, 2006 but are not included in the comparable period
      for
      2005. Data Center Services involves our personnel performing data entry and
      data
      processing services for customers. Application Service Provider Services
      involves the offering of our Avatar suite of products, our CareNet products,
      our
      InfoScribeR products and our Netsmart University products on a virtual private
      network or through an internet delivery approach, thereby allowing our customers
      to deploy products and pay on a monthly service basis, thus eliminating capital
      intensive system requirements for such services.





20


On
      April
      28, 2005, we acquired substantially all of the assets, including computer
      software, customer lists and computer equipment, of Continued Learning (“CL”), a
      company that offered a comprehensive family of web-based training products
      and
      services, including its Learning Management System. The total purchase price,
      including acquisition costs and recognition of an additional payment, was
      $739,238 which consisted of cash of $252,917, which was paid out of existing
      working capital including legal fees of $18,632, and broker fees of $10,000,
      20,000 shares of our common stock valued at $191,400, assumed liabilities of
      $44,921 and an accrual for a probable additional payment of $250,000. The
      purchase agreement provides for an additional payment of up to $250,000 if
      certain revenue targets are met in year one. Based upon the attainment of those
      revenue targets as of December 31, 2005, we recognized the full $250,000 of
      this
      additional payment at December 31, 2005, which amount was paid in 2006. We
      also
      entered into a two year employment agreement at an annual salary of $100,000
      per
      year with the principal of CL, whereby the principal can receive an additional
      $300,000 in cash, to be accounted for as compensation expense, if certain
      revenue targets are met within a two-year period. As of December 31, 2006,
      certain revenue targets have been met and additional compensation expense in
      the
      amount of $100,000 has been recognized and paid.





On
      June
      20, 2005, we acquired the assets of Addiction Management Systems, Inc (“AMS”).
      The total purchase price, including acquisition costs, was $3,610,682, which
      consisted of cash of $2,641,945 plus legal fees of $19,904 and assumed
      liabilities for services to be provided of $948,833.





On
      September 28, 2005, we acquired 100% of the equity interest in CMHC, a company
      that offers a full suite of behavioral healthcare information management
      software for mental health, substance abuse, and addiction services agencies,
      developmental disability centers, and behavioral health-related managed care
      organizations. The purchase price totaled approximately $19,565,956, as follows:
      $12,994,758 in cash, 435,735 shares of our common stock (valued at $4,915,091),
      acquisition costs of $864,083, plus additional cash consideration estimated
      at
      $792,024 as required by the “working capital adjustment”. We had accrued
      $792,024 as the “working capital adjustment” which was calculated in accordance
      with the merger agreement. This calculation was subject to adjustment; during
      2006 the working capital adjustment was finalized in the amount of $524,935,
      which amount was paid. The difference of $267,089 was reflected as a reduction
      in goodwill and accrued expenses. Additionally during 2006, we evaluated the
      assets and liabilities acquired from CMHC and increased deferred revenue by
      $151,218 and accrued expenses by $342,766, which was partially offset by an
      increase in deferred tax asset of $355,000, resulting in a net increase to
      goodwill of $138,984. In addition, we booked a deferred tax liability in the
      amount of $3,843,000 relating to the non-deductible nature of certain acquired
      intangible assets, which liability will be amortized in future
      periods.





On
      August
      1, 2006, we acquired certain assets, including computer software, customer
      lists
      and computer equipment of QS Technologies, Inc. (“QS”). The purchase price
      totaled approximately $5,466,000 as follows: an initial payment of $1,900,000
      in
      cash and a three year $1,435,000 promissory note paid monthly, at an annual
      rate
      of 8.25%, together with the assumption of approximately $2,095,000 in net
      liabilities, consisting principally of deferred revenue, and acquisition costs
      of approximately $36,000. The transaction also provides for potential additional
      payments to the seller of up to $1,450,000 in 2008, contingent upon the
      attainment of performance milestones by the QS business through 2007. The
      milestones relate to the attainment of maintenance revenue, vital records
      contract awards, and other software contract awards. Based on our analysis,
      the
      attainment of these milestones would result in a contingent purchase price
      adjustment. The QS business delivers enterprise-wide public health solutions
      and
      vital records software to 70 public health agencies, including nine
      states.





Our
      results of operations are subject to various risks and uncertainties, including
      those described in Item 1A, Risk Factors, above and the market risks described
      in Item 7A, Quantitative and Qualitative Disclosures about Market Risks,
      below.





**Years
      Ended December 31, 2006 and 2005**





**Results
      of Operations**





Our
      total
      revenue for 2006 was $59,050,000, an increase of $21,071,000, or 55%, from
      our
      revenue for 2005 which was $37,979,000. Revenue from the Netsmart - Ohio
      acquisition accounted for $15,675,000 or 74% of the increase in revenue from
      2006 to 2005. Revenue from the Netsmart - Public Health acquisition accounted
      for $1,991,000 or 9% of the increase from 2006 to 2005. Revenue from the AMS
      acquisition accounted for $783,000 or 4% of the increase in revenue from 2006
      to
      2005.





21


Revenue
      from contracts with state and local government agencies represented 40% of
      revenue in 2006 and 44% of revenue in 2005. This decrease was the result of
      the
      inclusion of the Netsmart - Ohio revenue, which has a lower percentage
      (approximately 20%) of revenue generated from contracts with state and local
      government agencies.





Fixed
      price software development contracts, which include labor, licenses and third
      party resale components, accounted for 15% and 24% of consolidated revenue
      for
      2006 and 2005, respectively. This decrease is the result of a decrease in
      Software and Related Systems and Services revenue generated from fixed price
      contracts, an increase in Software and Related Systems and Services revenue
      generated on an as incurred basis, as well as an increase in our recurring
      revenue components. Our recurring revenue components, which include our
      maintenance contract services, our Data Center and our ASP services, accounted
      for 54% of our consolidated revenue for 2006 as compared to 46% of consolidated
      revenue for 2005. This increase was primarily the result of an increase in
      maintenance revenue resulting from the inclusion of the operations of Netsmart
      -
      Ohio and Netsmart - Public Health, as well as an increase in both maintenance
      and ASP revenue, exclusive of the Netsmart - Ohio and Netsmart - Public Health
      acquisitions, which was partially offset by a decrease in Data Center
      revenue.





Revenue
      from large turnkey fixed price software development contracts is determined
      using the percentage of completion method, which is based upon the time spent
      by
      our technical personnel on a project. Since the billing schedules under the
      contracts differ from the recognition of revenue, at the end of any quarter,
      these contracts generally result in either costs and estimated profits in excess
      of billing or billing in excess of costs and estimated profits. Revenue from
      our
      small turnkey fixed price contracts is accounted for under the completed
      contract method.





**Software
      and Related Systems and Services - New York**





Our
      Software and Related Systems and Services - New York revenue for 2006 was
      $30,873,000, an increase of $2,448,000, or 9%, from our revenue for 2005, which
      was $28,425,000. Software and Related Systems and Services - New York revenue
      is
      comprised of turnkey systems labor revenue, revenue from sales of third party
      hardware and software license revenue, maintenance revenue and revenue from
      small turnkey systems in the markets in which we operated prior to our
      acquisition of our Ohio operations in September 2005.





Within
      this segment is large turnkey and small turnkey components. The large turnkey
      components consist mostly of our Avatar suite of products. When we are engaged
      in fixed price arrangements for large turnkey systems, the installations will
      usually extend over a six-month to a multi-year time period and are accounted
      for under the percentage of completion method. The duration of the
      implementation depends on the size and complexity of the customer organization
      and the specifics of the implementation. Installations of small turnkey
      components are usually completed within a six-month period and are accounted
      for
      under the completed contract method. Small turnkey contracts performed in the
      New York segment are mostly related to our Avatar methadone related
      products.





The
      largest component of Software and Related Systems and Services - New York
      revenue was maintenance revenue, which increased $1,149,000, or 12%, to
      $10,933,000 in 2006 from $9,784,000 in 2005. Revenue from the AMS acquisition
      accounted for approximately 67% of this increase. As turnkey systems are
      completed, they are transitioned to the maintenance division, thereby increasing
      our installed base of recurring revenue. Turnkey systems labor revenue increased
      $647,000, or 7%, to $10,492,000 in 2006 from $9,845,000 in 2005. Turnkey systems
      labor revenue refers to labor associated with turnkey installations and includes
      categories such as training, installation, project management and development.
      An increase of $1,091,000 in turnkey systems labor revenue was primarily due
      to
      an increase in billable time spent on contracts. This increase was partially
      offset by $444,000 due to a 7% decrease in our average daily billing rate.
      Revenue from third party hardware and software decreased 2% to $5,433,000 in
      2006 from $5,544,000 in 2005. Sales of third party hardware and software, such
      as pharmacy and database software, are made in connection with the sales of
      turnkey systems. These sales are typically made at lower gross margins than
      our
      software and related systems and services revenue. During 2006, the decrease
      in
      revenue from third party hardware and software was the result of a decrease
      in
      database software sales and pharmacy related sales to various customers. License
      revenue decreased 4% to $2,126,000 in 2006 from $2,210,000 in 2005. License
      revenue is generated as part of a sale of a human services information system
      pursuant to a contract or purchase order that includes delivery of the system
      and maintenance. The decrease in revenue is substantially the result of a
      decrease in customer user count upgrade sales, as well as a decrease in large
      system license sales. Revenue from the sales of our small turnkey contracts
      increased 81% to $1,889,000 in 2006 from $1,042,000 in 2005. Small turnkey
      contract sales relate to turnkey contracts that are less than $50,000 and are
      usually completed within one to six months. The increase in our small turnkey
      revenue for 2006 is substantially due to work being performed on two substantial
      Avatar methadone contracts.





22


Gross
      profit increased 6% to $14,656,000 in 2006 from $13,836,000 in 2005. Our gross
      profit percentage decreased to 48% in 2006 period from 49% in 2005. Our gross
      profit percentage decreased as a result of the decrease in license revenue,
      as
      well as an increase in our small turnkey revenue, which are typically performed
      at lower gross margins than our other revenue components. This decrease was
      partially offset by improved efficiency from our maintenance
      division.





**Software
      and Related Systems and Services - Ohio**





The
      Software and Related Systems and Services-Ohio segment is a new segment
      established as a result of the acquisition of Netsmart - Ohio, formerly CMHC
      Systems, Inc. The Ohio operations were acquired on September 28, 2005 and its
      results of operations are included from October 1, 2005. Netsmart - Ohio offers
      a full suite of behavioral healthcare information management software for mental
      health, substance abuse, and addiction services agencies, developmental
      disability centers, and behavioral health-related managed care organizations.
      The small turnkey contracts in the Ohio segment are for system installations
      for
      behavioral healthcare information management software for mental health,
      substance abuse, and addiction services agencies, developmental disability
      centers and behavioral health-related managed care organizations. The small
      turnkey contracts are usually completed within a six-month period.





Revenue
      for 2006 consisted of the following components: Maintenance revenue of
      $14,764,000, third party hardware and software revenue of $1,742,000, turnkey
      systems labor revenue of $2,574,000 and license revenue of
      $1,814,000.





Gross
      profit for 2006 was $11,556,000 and our gross profit percentage was 55%. The
      gross profit for the three months that Netsmart-Ohio operations were included
      in
      2005 was $2,704,000 and our gross profit percentage was 52%. The improvement
      in
      gross profit percentages from 52% in 2005 to 55% in 2006 was the results of
      reduced costs and operating efficiencies.





**Software
      and Related Systems and Services - Public Health**





The
      Software and Related Systems and Services-Public Health segment is a new segment
      established as a result of the acquisition of the business of QS by Netsmart
      -
      Public Health. The Public Health operations were acquired on August 1, 2006.
      Netsmart - Public Health delivers enterprise-wide public health solutions and
      vital records software to 70 public health agencies, including nine states.
      The
      small turnkey contracts in the Public Health segment are for system
      installations for Public Health information management software and vital
      records software for public health agencies. The small turnkey contracts are
      usually completed within a six-month period.





Revenue
      for 2006 consisted of the following components: Maintenance revenue of $865,000,
      third party reimbursable revenue of $8,000, turnkey systems labor revenue of
      $260,000 and license revenue of $858,000.





23


Gross
      profit for 2006 was $1,323,000 and our gross profit percentage was
      66%.





**Data
      Center Services (Service Bureau)**





Data
      center clients typically generate approximately the same amount of revenue
      each
      year. We bill on a transaction basis or on a fixed fee arrangement.
      Historically, each year we increase the transaction or fixed fee by an amount
      that approximates the New York urban consumer price index increase. The data
      center revenue decreased to $1,736,000 in 2006 from $1,795,000 in 2005,
      representing a decrease of $60,000, or 3%. This decrease was the result of
      one
      customer discontinuing the use of our services.





Gross
      profit increased 1% to $919,000 in 2006 from $908,000 in 2005. Our gross margin
      percentage increased to 53% in 2006 from 51% in 2005. This increase in gross
      margin percentage was the result of a reduction in the following costs:
      communication costs decreased $32,000, supplies decreased $12,000 and support
      overhead and facility costs decreased $56,000. These decreases in costs, which
      increased our gross margin percentage, were partially offset by a $30,000
      increase in salary and fringe cost, as well as the decrease in revenue described
      above.





**Application
      Service Provider Services (“ASP”)**





ASP
      Services involves the offering of our Avatar suite of products, our CareNet
      products, our Netsmart University products and our InfoScribeR products on
      a
      virtual private network or through an internet delivery approach, thereby
      allowing our customers to rapidly deploy products and pay on a monthly service
      basis, thus eliminating capital intensive system requirements for such services.





ASP
      revenue increased to $3,556,000 in 2006 from $2,538,000 in 2005, representing
      an
      increase of $1,018,000 or 40%. This increase is primarily the result of the
      inclusion of our Netsmart University revenue, as well as increases in our
      CareNet, Avatar ASP services and InfoScriber customer base.





Gross
      profit for 2006 was $1,325,000 and for 2005 it was $927,000, representing an
      increase of $398,000, or 43%. The gross margin percentage was 37% for 2006
      and
      2005. Although revenue increased, the gross profit and gross margin percentage
      did not increase proportionally due to the increased costs associated with
      the
      Netsmart University operations, which amounted to $457,000 in 2006. We believe
      that the costs currently in place represent the required costs to support the
      Netsmart University operation, as well as a provision for bonus of $100,000
      in
      accordance with the provisions of an employment contract with the principal
      of
      Netsmart University. We expect that as revenue from Netsmart University
      increases, gross profit and margins for this segment will increase
      accordingly.





**Operating
      Expenses**





Selling,
      general and administrative expenses were $19,087,000 in 2006, reflecting an
      increase of $7,815,000, or 69%, from $11,272,000 in 2005. Approximately
      $3,510,000 or 46% of this increase was related to the sales and marketing and
      general and administrative costs associated with Netsmart - Ohio. These costs
      consist of : (1) general and administrative costs totaling $1,577,000, of which
      the major cost components are as follows: accounting, human resources and
      administrative salaries and fringe costs - $336,000, rent and real estate taxes
      related to the Ohio facility - $304,000, reserve for bad debts - $201,000,
      customer list and contract backlog amortization - $458,000, and equipment costs
      and maintenance - $105,000 and (2) sales and marketing costs totaling
      $1,933,000, of which the major cost components are as follows - salaries and
      fringe benefits - $1,280,000, commissions - $246,000, trade shows - $146,000
      and
      travel and lodging - $160,000. These increases are based upon 2005 costs for
      Netsmart-Ohio being included only for the period of the acquisition date
      (10/1/05 through December 31, 2005 and for the full year in 2006. The remaining
      54% of the increase in selling, general and administrative costs in excess
      of
      the Netsmart - Ohio costs were as follows, sales and marketing salaries and
      fringe benefit costs, which increased $430,000; commissions, which increased
      $511,000; general administrative salaries and fringe benefits costs, which
      increased $306,000; general insurance costs which increased $130,000; accounting
      costs which increased $193,000; provision for bonuses which increased $211,000;
      and costs associated with the process of privatization $1,581,000.





24


We
      incurred research, development and maintenance expenses of $6,553,000 in 2006,
      an increase of $2,006,000, or 44%, from $4,547,000 in 2005. Approximately
      $1,257,000 of the increase in research, development and maintenance expenses
      related to the Netsmart - Ohio operations and $328,000 related to the Netsmart
      Public Health operations. The Netsmart -New York research, development and
      maintenance expenses increased by $421,000 in 2006 as compared to 2005. This
      increase was substantially related to investment in product enhancements and
      extensions. These extensions include the development of new software modules
      which address Federal reporting requirements, as well as continuing investment
      in core products. These amounts have been appropriately accounted for in
      accordance with SFAS No. 86, “Accounting for the Cost of Computer Software to be
      Sold, Leased, or Otherwise Marketed.”





Interest
      expense was $252,000 in 2006, an increase of $133,000, or 112%, from the
      $119,000 in 2005. On October 7, 2005, we borrowed $2,500,000 pursuant to a
      term
      loan advanced under a new revolving credit and term loan agreement. In August
      2006, in connection with the acquisition of Netsmart - Public Health, we issued
      a three year promissory note in the amount of $1,435,000. The increase in
      interest expense was partially the result of the increased borrowings both
      under
      the term loan and related to this note.





Interest
      income was $377,000 in 2006, an increase of $66,000, or 21%, from $311,000
      in
      2005. This increase is the result an increase in interest rates. Interest income
      is generated from short-term investments made with a substantial portion of
      the
      proceeds received from our term loan, as well as cash generated from
      operations.





We
      have a
      net operating loss tax carry forward of approximately $3,321,000 at December
      31,
      2006 Pursuant to Section 382 of the Internal Revenue Code regarding substantial
      changes in company ownership, utilization of this net operating loss
      carryforward is limited. In 2006, we recorded a current income tax expense
      of
      $2,289,000, which related to various state and local taxes, as well as a
      provision for the Federal alternative minimum tax. The income tax provision
      was
      increased by a deferred tax charge of $121,000. The increase in the effective
      tax rate of 56.5% for 2006 compared to 42% for 2005 is substantially
      attributable to the costs of the Proposed Merger Transaction in the amount
      of
      $1,581,000 not being deductible for income tax purposes. In 2005, we recorded
      a
      current income tax expense of $324,000, which related to various state and
      local
      taxes, as well as a provision for the Federal alternative minimum tax. The
      income tax provision was increased by a deferred tax provision of
      $835,000





As
      a
      result of the foregoing factors, in 2006 we had net income of $1,853,000, or
      $.28 per share (basic) and $.27 per share (diluted). For 2005, we had net income
      of $1,590,000, or $.28 per share (basic) and $.27 per share
      (diluted).





**Years
      Ended December 31, 2005 and 2004**





**Results
      of Operations**





Our
      total
      revenue for 2005 was $37,978,000, an increase of $8,973,000, or 31%, from our
      revenue for 2004 which was $29,005,000. Revenue from the Netsmart - Ohio
      acquisition accounted for $5,219,000 of the increase in revenue from 2005 to
      2004. This revenue was for the period October 1, 2005 through December 31,
      2005.





Revenue
      from contracts with state and local government agencies represented 44% of
      revenue in 2005 and 49% of revenue in 2004. This decrease was the result of
      the
      inclusion of the Netsmart - Ohio revenue, which has a lower percentage
      (approximately 20%) of revenue generated from contracts with state and local
      government agencies.





25


Fixed
      price software development contracts, which include labor, licenses and third
      party resale components, accounted for 24% and 34% of consolidated revenue
      for
      2005 and 2004, respectively. This decrease is the result of a decrease in
      Software and Related Systems and Services revenue generated from fixed price
      contracts and an increase in Software and Related Systems and Services revenue
      generated on an as incurred basis. Our recurring revenue components, which
      include our **** maintenance
      contract services, our Data Center and ASP services, accounted for 46% of our
      consolidated revenue for 2005 compared to 42% of consolidated revenue for 2004.
      This increase was the result of an increase in both maintenance and ASP revenue
      which was partially offset by a decrease in Data Center revenue. Revenue from
      large turnkey fixed price software development contracts is determined using
      the
      percentage of completion method, which is based upon the time spent by our
      technical personnel on a project. Since the billing schedules under the
      contracts differ from the recognition of revenue, at the end of any quarter,
      these contracts generally result in either costs and estimated profits in excess
      of billing or billing in excess of costs and estimated profits. Revenue from
      our
      small turnkey fixed price contracts is accounted for under the completed
      contract method.





**Software
      and Related Systems and Services - New York**





Our
      Software and Related Systems and Services - New York revenue for 2005 was
      $28,425,000, an increase of $3,204,000, or 13%, from our revenue for 2004,
      which
      was $25,221,000. Software and Related Systems and Services - New York revenue
      is
      comprised of turnkey systems labor revenue, revenue from sales of third party
      hardware and software license revenue, maintenance revenue and revenue from
      small turnkey systems in the markets in which we operated prior to our
      acquisition of our Ohio operations in September 2005.





Within
      this segment are large turnkey and small turnkey components. The large turnkey
      components consist mostly of our Avatar suite of products. When we are engaged
      in fixed price arrangements for large turnkey systems, the installations will
      usually extend over a six-month to a multi-year time period; these installations
      are accounted for under the percentage of completion method. The duration of
      the
      implementation depends on the size and complexity of the customer organization
      and the specifics of the implementation. Installations of small turnkey
      components are usually completed within a six-month period; these installations
      are accounted for under the completed contract method. Small turnkey contracts
      performed in the New York segment are mostly related to our Avatar methadone
      related products.





The
      largest component of Software and Related Systems and Services revenue was
      turnkey systems labor revenue, which increased $243,000, or 3%, to $9,845,000
      in
      2005 from $9,602,000 in 2004. Turnkey systems labor revenue refers to labor
      associated with turnkey installations and includes categories such as training,
      installation, project management and development. The increase in turnkey
      systems labor revenue was primarily due to a 4% increase in the average daily
      billing rate, which accounted for total labor revenue increase of $208,000
      in
      2005 as compared to 2004. Revenue from third party hardware and software
      increased 28% to $5,544,000 in 2005, from $4,335,000 in 2004. Sales of third
      party hardware and software, such as pharmacy and database software, are made
      in
      connection with the sales of turnkey systems. These sales are typically made
      at
      lower gross margins than our software and related systems and services revenue.
      During 2005, the increase in revenue from third party hardware and software
      was
      partially the result of an increase in database software sales and pharmacy
      sales to various customers. License revenue increased 7% to $2,210,000 in 2005,
      from $2,066,000 in 2004. 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. During 2005, approximately
      one-third of the increase in license revenue was the result of increased user
      license sales to existing customers. Maintenance revenue increased 18% to
      $9,784,000 in 2005 from $8,290,000 in 2004. Revenue from the AMS acquisition
      accounted for approximately one-half of this increase. 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 contracts
      increased 12% to $1,042,000 in 2005 from $928,000 in 2004. Small turnkey
      contract sales relate to turnkey contracts that are less than $50,000 and are
      usually completed within one to six months. On June 20, 2005, we acquired AMS.
      AMS typically has the type of contracts included in the small turnkey revenue;
      sales of AMS products and services totaled $216,000 in 2005.





Gross
      profit increased 17% to $13,836,000 in 2005 from $11,849,000 in 2004. Our gross
      margin percentage increased to 49% in 2005 from 47% in 2004. Our gross margin
      increased as a result of improved efficiency from our maintenance division,
      as
      well as an increase in our license revenue.





26


**Software
      and Related Systems and Services - Ohio**





The
      Software and Related Systems and Services-Ohio segment is a new segment
      established as a result of the acquisition of Netsmart - Ohio, formerly CMHC
      Systems, Inc. The Ohio operations were acquired on September 28, 2005 and are
      included commencing October 1, 2005. Netsmart - Ohio offers a full suite of
      behavioral healthcare information management software for mental health,
      substance abuse, and addiction services agencies, developmental disability
      centers, and behavioral health-related managed care organizations. The small
      turnkey contracts in the Ohio segment are for system installations for
      behavioral healthcare information management software for mental health,
      substance abuse, and addiction services agencies, developmental disability
      centers and behavioral health-related managed care organizations. The small
      turnkey contracts are usually completed within a six-month period.





Revenue
      for October 1 through December 31, 2005 was $5,219,000 and consisted of the
      following components; Maintenance revenue of $3,533,000, third party hardware
      and software revenue of $654,000, turnkey systems labor revenue of $802,000
      and
      license revenue of $230,000.





Gross
      profit for 2005 was $2,704,000 and our gross margin percentage was 52%.





**Data
      Center Services (Service Bureau)**





Data
      center clients typically generate approximately the same amount of revenue
      each
      year. We bill on a transaction basis or on a fixed fee arrangement.
      Historically, each year we increase the transaction or fixed fee by an amount
      that approximates the New York urban consumer price index increase. The data
      center revenue decreased to $1,795,000 in 2005 from $2,058,000 in 2004,
      representing a decrease of $263,000, or 13%. This decrease was the result of
      two
      customers discontinuing the use of our services.





Gross
      profit decreased 25% to $908,000 in 2005 from $1,209,000 in 2004. Our gross
      margin percentage decreased to 51% in 2005 from 59% in 2004. This decrease
      was
      the result of the decrease in revenue, as well as an increase in costs of
      approximately $38,000. The increase in costs was substantially the result of
      an
      increase in communications costs of $29,000, depreciation of $20,000 and
      salaries of $7,000, which was partially offset by a decrease in support overhead
      of approximately $18,000.





**Application
      Service Provider Services (“ASP”)**





ASP
      Services involves the offering of our Avatar suite of products, our CareNet
      products, our ContinuedLearning products and our InfoScribeR products on a
      virtual private network or through an internet delivery approach, thereby
      allowing our customers to rapidly deploy products and pay on a monthly service
      basis, thus eliminating capital intensive system requirements for such services.





ASP
      revenue increased to $2,538,000 in 2005 from $1,725,000 in 2004, representing
      an
      increase of $813,000 or 47%. This increase is the result of additional users,
      including one new customer of our Avatar suite of products, the inclusion of
      our
      Netsmart University revenue for the period April 28, 2005 through December
      31,
      2005, as well as increases in our CareNet and InfoScriber revenue.





On
      April
      28, 2005, we acquired substantially all of the assets, including computer
      software, customer lists and computer equipment, of ContinuedLearning LLC,
      a
      company that offers a comprehensive family of web-based training products and
      services, including its Learning Management System. ContinuedLearning revenue
      totaled $235,000 for 2005.





27


Gross
      profit for 2005 was $927,000 and for 2004 was $799,000. The gross margin
      percentage was 37% in 2005 and 46% in 2004. Although revenue increased, the
      gross profit and gross margin percentage did not increase proportionally due
      to
      the increased costs associated with the ContinuedLearning operations which
      amounted to $494,000 in 2005. These costs represent the required baseline costs
      to support the ContinuedLearning operation. We expect that as new revenue is
      added to this operation, gross profit and margins will increase
      accordingly.





**Operating
      Expenses**





Selling,
      general and administrative expenses were $11,272,000 in 2005, reflecting an
      increase of $3,978,000, or 55%, from $7,294,000 in 2004. Approximately
      $1,571,000 or 39% of this increase was related to the selling, general and
      administrative costs associated with Netsmart - Ohio. Theses costs included
      such
      categories as salary and fringe benefits of $720,000, consulting costs of
      $199,000 and rent of $170,000. Approximately $641,000 or 16% of this increase
      was related to an increase in bad debts, which included $340,000 related to
      one
      customer who filed for bankruptcy. The remaining increases were in: sales and
      marketing salaries and fringe benefits, which increased by $503,000; sales
      and
      marketing consulting costs, which increased by $282,000; other consulting which
      increased by $215,000, of which $86,000 related to Sarbanes Oxley compliance
      efforts and $79,000 related to strategic planning efforts; sales and marketing
      conference costs which increased by $151,000; general administrative salaries
      and fringe benefits, which increased by $187,000 and $558,000 which related
      to
      increased amortization related to the ContinuedLearning, Netsmart - Ohio and
      AMS
      acquisitions. The cost increases were partially offset by reductions in:
      depreciation, which decreased by $133,000; and provision for bonuses, which
      decreased by $142,000.





We
      incurred research, development and maintenance expenses of $4,547,000 in 2005,
      an increase of 30% from $3,498,000 in 2004. Approximately $853,000 or 81% of
      this increase was related to the Netsmart - Ohio operations after the
      acquisition. During the latter part of 2004, we invested in infrastructure
      that
      is designed to improve the way we support our customers and products. This
      increased infrastructure cost relates to product version control, which includes
      design, programming, testing, documentation and quality control of our products.
      These efforts accounted for the remaining increase in our research, development
      and maintenance expenses. We also continue to invest in product enhancement
      and
      extensions. These extensions include the development of new software modules
      which address Federal reporting requirements, as well as continuing investment
      in core products. These amounts have been appropriately accounted for in
      accordance with SFAS No. 86, “Accounting for the Cost of Computer Software to be
      Sold, Leased, or Otherwise Marketed.”





Interest
      and other expense was $119,000 in 2005, a decrease of $10,000, or 8%, from
      the
      $129,000 in 2004. This decrease is the result of the completion of the
      amortization of the financing costs associated with our then-current loan
      agreement, which was amortized over a three year period, as well as reduced
      borrowing under our then-current loan agreement during 2005. On October 7,
      2005,
      we borrowed $2,500,000 pursuant to a term loan advanced under a new revolving
      credit and term loan agreement. The decrease in interest expense was partially
      offset by an increase in interest expense relating to the increased borrowings
      under the new term loan.





Interest
      income was $311,000 in 2005, an increase of $185,000, or 147%, from $126,000
      in
      2004. This increase is the result of maintaining higher cash balances during
      2005, as well as an increase in interest rates. Interest income is generated
      from short-term investments made with a substantial portion of the proceeds
      received from our term loan, as well as cash generated from operations and
      the
      proceeds of the exercise of options and warrants.





We
      have a
      net operating loss tax carry forward of approximately $5,300,000 at December
      31,
      2005. In 2005, we recorded a current income tax expense of $324,000, which
      related to various state and local taxes, as well as a provision for the Federal
      alternative minimum tax. The income tax provision was increased by a deferred
      tax provision of $835,000. In 2004, we recorded a current income tax expense
      of
      $187,000, which related to various state and local taxes, as well as a provision
      for the Federal alternative minimum tax. The current provision was reduced
      by
      $952,000 as a result of the use of the available net operating loss carry
      forward. During 2004, the deferred tax valuation allowance of $1,731,000 was
      reversed, $717,000 of which was recorded as an addition to additional paid
      in
      capital and $1,014,000 as a deferred tax benefit. The deferred tax provision
      was
      $1,136,000 based on utilization of net operating loss carry forwards offset
      by a
      reduction in the deferred tax asset valuation allowance of
      $1,014,000.





28


As
      a
      result of the foregoing factors, in 2005 we had net income of $1,590,000, or
      $.28 per share (basic) and $.27 per share (diluted). For 2004, we had net income
      of $2,753,000, or $.52 per share (basic) and $.50 per share
      (diluted).





**Liquidity
      and Capital Resources**





We
      had
      working capital of approximately $3,758,000 at December 31, 2006 as compared
      to
      working capital of approximately $4,043,000 at December 31, 2005. This decrease
      of approximately $285,000 in working capital was the result of the following:
      $4,242,000 in cash used in, and the assumption of net current liabilities
      associated with, the Netsmart - Public Health acquisition; $1,144,000 for the
      acquisition of equipment; $2,075,000 related to current income taxes payable
      and
      $159,000 of additional costs related to the private placement effort completed
      in 2005. These decreases were substantially offset by: our net income, after
      adding back depreciation, amortization and other noncash charges, which totaled
      $6,191,000; $290,000 for a goodwill adjustment relating to deferred revenue
      and
      accrued liabilities; and net proceeds from the exercise of stock options and
      warrants in the amount of $562,000. The remaining increase in working capital
      of
      $292,000 was due to changes in other current assets and
      liabilities.





In
      October 2005, we entered into a revolving credit and term loan agreement with
      the Bank of America, which was amended as of December 31, 2005, and further
      amended as of September 29, 2006 (as so amended, the “Credit Agreement”). This
      financing provides us with a five-year term loan of $2,500,000. The term loan
      bears interest at LIBOR plus 2.25%. We have entered into an interest rate swap
      agreement with the Bank for the amount outstanding under the term loan whereby
      we converted our variable rate on the term loan to a fixed rate of 7.1% in
      order
      to reduce the interest rate risk associated with these borrowings. On October
      7,
      2005, we borrowed the full amount of the $2,500,000 term loan. The revolving
      credit facility provides for borrowings of up to $2,500,000. Any amounts
      borrowed under this arrangement will bear interest at a rate per annum to be
      elected by us, equal to either (1) the LIBOR Rate plus 2.5% or (2) the Bank's
      prime rate. We have not borrowed any amounts under the revolving credit facility
      and there is no amount outstanding as of December 31, 2006. The amount
      outstanding under the Credit Agreement at December 31, 2006 is
      $1,917,000.





The
      terms
      of the Credit Agreement require compliance with certain covenants, including
      maintaining a minimum tangible net worth of a negative $600,000 until December
      30, 2006 with provisions for increases in future periods, minimum cash reserves
      of $5,000,000, maintenance of certain financial ratios, limitations on capital
      expenditures and indebtedness and prohibition of the payment of cash dividends.
      As of December 31, 2006, we were not in compliance with one of the financial
      covenants of the Credit Agreement. As a result, the Bank agreed to waive any
      non-compliance by us for the no loss in any quarter provision. We incurred
      a net
      loss of approximately $500,000 as a result of expensing $1,581,000 of costs
      related to the proposed merger transaction. The nature of these costs did not
      allow us to recognize any tax benefit associated with these costs. As a result
      of the Bank agreeing to waive our non compliance, as of December 31, 2006,
      we
      were in compliance with the terms of the Credit Agreement.





A
      part of
      our growth strategy is to acquire other businesses that are related to our
      current business. Such acquisitions may be made with cash, our securities,
      or a
      combination of cash and securities. If we fail to make any acquisitions our
      future growth will be limited to only internal growth. We are continually
      seeking acquisitions that will add complementary products to our offerings
      and
      that will provide value for the markets we serve. As of the date of this Form
      10-K annualy report, we did not have any formal or informal agreements or
      understandings with respect to any material acquisition by us.





29


On
      August
      1, 2006, we acquired certain assets, including computer software, customer
      lists
      and computer equipment of QS Technologies, Inc. (“QS”). The purchase price
      totaled approximately $5,466,000 as follows: an initial payment of $1,900,000
      in
      cash and a three year $1,435,000 promissory note paid monthly, at an annual
      rate
      of 8.25% together with the assumption of approximately $2,095,000 in net
      liabilities, consisting principally of deferred revenue, and acquisition costs
      of approximately $36,000. The transaction also provides for potential additional
      payments to the seller of up to $1,450,000 in 2008, contingent upon the
      attainment of performance milestones by the QS business through 2007. The
      milestones would result from the attainment of maintenance revenue, vital
      records contract awards, and other software contract awards. Based on our
      analysis, the attainment of these milestones would result in a contingent
      purchase price adjustment. The QS business delivers enterprise-wide public
      health solutions and vital records software to 70 public health agencies,
      including nine states. We also assumed the facility lease of QS in Greenville,
      South Carolina. This lease has a total square footage of 5,761, is non
      cancelable and expires on February 23, 2011. The annual rent is $80,106 and
      is
      subject to escalation clauses. The amount outstanding under the promissory
      note
      at December 31, 2006 was $1,292,000.





Based
      on
      our market capitalization on June 30, 2006, the last day of our second fiscal
      quarter, we became an “accelerated filer” for our fiscal year ending December
      31, 2006. Our status as an accelerated filer required us to comply with Section
      404 of the Sarbanes-Oxley Act of 2002 for the year ended December 31, 2006,
      which requires management certification with respect to internal controls over
      financial reporting. In anticipation of the change to accelerated filer status,
      we have substantially completed the steps necessary to enable management to
      evaluate such internal controls. Consequently, we do not expect to make material
      expenditures in connection with our Section 404 compliance, other than the
      attestation by our independent registered accountants.





On
      November 18, 2006, we entered into the Merger Agreement with NT Acquisition,
      Inc. and NT Merger Sub, Inc. 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. Whether or not our stockholders approve the Merger Agreement,
      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.





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 pursue certain acquisitions or if our business
      does not develop as we anticipate, or if our expenses, including our software
      development costs relating to our expansion of our product line and our
      marketing costs for seeking to expand the market for our products and services
      to include smaller clinics and facilities and sole group practitioners, exceed
      our expectations.





**Off-Balance
      Sheet Arrangements**





We
      are
      not a party to any off-balance sheet arrangements.




30




**Contractual
      Obligations**





The
      following table summarizes, as of December 31, 2006, our obligations and
      commitments to make future payments under debt, capital leases, operating leases
      and other long-term liabilities:




**Contractual
                Obligations**
            
            **Payments
                Due by Period****Total**
            
            **Less
                than**
              **1
                year**
            
            **1
                - 3 years**
            
            **4
                - 5 years**
            
            **Over
                5 years**Long
                Term Debt1
            
            $
            1,916,662
            
            $
            500,000
            
            $
            1,000,000
            
            $
            416,662
            
            $
            --Contractual
                Interest Expense Payments
            
            $
            422,172
            
            $
            211,254
            
            $
            197,196
            
            $
            13,722
            
            $
            --Asset
                Purchase Agreement4
            
            
            1,292,468
            
            
            451,802
            
            
            840,666
            
            
            --
            
            
            --Capital
                Lease Obligations2
            
            
            9,521
            
            
            9,521
            
            
            --
            
            
            --
            
            
            --Operating
                Leases3
            
            
            8,557,397
            
            
            1,317,169
            
            
            2,597,412
            
            
            2,054,326
            
            
            2,588,450Other
                Long-Term Liabilities3
            
            
            1,558,598
            
            
            1,145,632
            
            
            391,716
            
            
            21,250
            
            
            --Total
                Contractual and Other Long-TermObligations
            
            $
            13,756,778
            
            $
            3,635,378
            
            $
            5,026,990
            
            $
            2,505,960
            
            $
            2,588,450





1 See Note
      7 to Netsmart’s Consolidated Financial Statements for the years ended December
      31, 2006, 2005 and 2004, which describes the Company’s financing
      agreements.


2 See Note
      10 to Netsmart’s Consolidated Financial Statements for the years ended December
      31, 2006, 2005 and 2004, which describes the Company’s Capital Lease
      Obligation.


3 See Note
      12 to Netsmart’s Consolidated Financial Statements for the years ended December
      31, 2006, 2005 and 2004 which describes the Company’s Operating Lease and other
      Contractual Obligations.


4 See
      Note
      5 to Netsmart’s Consolidated Financial Statements for the year ended December
      31, 2006.





**Critical
      Accounting Policies and Estimates**





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





Revenue
      Recognition


Capitalized
      Software Development Costs


Impairment
      of Customer Lists


Bad
      Debts


Fair
      Value of Acquired Deferred Post-Contract Customer Support


Valuation
      Allowance for Deferred Income Tax Assets


Purchase
      Price Allocation of Netsmart Ohio and QS Technologies acquisitions





31


Revenue
      Recognition - We
      recognize large turnkey revenue from long-term (six months or longer), fixed
      price contracts for financial statement purposes under the percentage of
      completion method when significant modification of the software package is
      required to meet the customer specifications. The percentage of completion
      method takes into account progress towards completion of a contract using time
      spent by technical personnel on a particular project as the measuring standard.
      Revisions in cost estimates and recognition of losses on these contracts are
      reflected in the accounting period in which the facts become known. Contract
      terms provide for billing schedules that differ from revenue recognition and
      give rise to costs and estimated profits in excess of billings, and billings
      in
      excess of costs and estimated profits.





We
      recognize small turnkey revenue from short-term (less than six months), fixed
      price contracts for financial statement purposes under the completed contract
      method. Payments received in advance by customers are deferred until earned
      and
      represented as deferred revenue in the accompanying balance sheet.





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. The complexity of the estimation process and issues
      related to the assumptions, risks and uncertainties inherent with the
      application of the percentage of completion method of accounting affect the
      amounts of revenue and related expenses reported in our Consolidated Financial
      Statements. A number of internal and external factors can affect our estimates,
      including labor rates, utilization and efficiency variances and specification
      and testing requirement changes. Maintenance contract revenue is recognized
      on a
      straight-line basis over the life of the respective contract. We also derive
      revenue from the sale of third party hardware and software which is recognized
      based upon the terms of each contract. Consulting revenue is recognized when
      the
      services are rendered. Data Center revenue and Application Service Provider
      revenue are recognized in the period in which the services are provided. The
      above sources of revenue are recognized when persuasive evidence of an
      arrangement exists, delivery has occurred, the fee is fixed and determinable
      and
      collectibility is probable.





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





Deferred
      revenue represents revenue maintenance and application services provider revenue
      billed 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 and ends upon its availability for
      general release to customers. Technological feasibility for our computer
      software products is generally based upon achievement of a detail program design
      free of high risk development issues. We capitalize only those costs directly
      attributable to the development of the software. The establishment of
      technological feasibility and the ongoing assessment of recoverability of
      capitalized computer software development costs require considerable judgment
      by
      management with respect to certain external factors, including, but not limited
      to, technological feasibility, anticipated future gross revenue, estimated
      economic life and changes in software and hardware technology. Prior to reaching
      technological feasibility these costs are expensed as incurred and included
      in
      research, development and maintenance. Activities undertaken after the products
      are available for general release to customers to correct errors or keep the
      product updated are expensed as incurred and included in research, development
      and maintenance. Amortization of capitalized computer software development
      costs
      commences when the related products become available for general release to
      customers. Amortization is provided on a product by product basis. The annual
      amortization is the greater of the amount computed using (a) the ratio that
      current gross revenue for a product bears to the total of current and
      anticipated future gross revenue for that product or (b) the straight-line
      method over the remaining estimated economic life of the product. The estimated
      life of these products ranges from 3 to 8 years.





32


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





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





Bad
      Debts - We
      maintain allowances for doubtful accounts for estimated bad debts. Our practice
      is to specifically identify clients and invoices where we believe collection
      may
      be at risk and provide for these on a current basis. If the financial condition
      of our customers were to deteriorate, resulting in an impairment of their
      ability to make payments, additional allowances might be required. In addition,
      since we evaluate each account and invoice on a case-by-case basis, the
      provision could vary from period to period.





Fair
      value of acquired deferred post-contract customer support
      (“PCS”) - We
      value PCS in accordance with View B of Emerging Issues Task Force (“EITF”)
      04-11. In order to remain competitive and maintain our existing customer base,
      we upgrade and maintain software for purposes of bug fixes and ongoing
      regulatory changes, as well as software corrections and enhancements. These
      services are not sold separately and are therefore fair valued as a single
      unit.
      Although these services are provided on a when-and-if-available basis, we have
      an obligation to our existing customer base to develop upgrades and enhancements
      in order to maintain our customer relationships, as well as increase future
      revenue. The fair value of this liability is estimated using the value of the
      services provided using an estimated fulfillment margin. We intend to fulfill
      100% of our obligations under these assumed PCS obligations
      assumed.





Valuation
      Allowance for Deferred Income Tax Assets - We
      measure deferred income taxes using enacted tax rates and laws that we expect
      will be in effect when the underlying assets or liabilities settle. We record
      a
      valuation allowance against our deferred income tax assets balance when it
      is
      more likely than not that the benefits of the net tax asset balance will not
      be
      realized, and record a corresponding charge to income tax expense. Our ability
      to reduce the valuation allowance for deferred income tax assets depends on
      our
      ability to generate taxable income in the future. Based on our projection of
      our
      future taxable income we have determined that a valuation allowance is no longer
      required.





Purchase
      Price Allocation of Acquisitions - Purchase
      price allocations are subject to change. Changes could include a reallocation
      of
      intangible assets which would likely have the effect of increasing or decreasing
      future amortization expense, since the intangible assets are initially assigned
      varied lives. Additionally, the lives assigned to the identifiable intangible
      assets represent management’s best estimates of the time periods in which it
      will continue to receive benefits from these assets. The useful lives may need
      to be adjusted in the future based upon changes to the expected useful lives
      of
      such assets.





33


**Item
                7A.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**





We
      are
      exposed to market risk related to changes in interest rates. Most of our debt
      is
      at fixed rates of interest after completing interest rate swap agreements,
      which
      effectively converted our variable rate debt into fixed rate debt at 7.95% and
      7.1% per annum. Therefore, if the LIBOR rate plus 2.5% increases above 7.95%
      or
      7.1% per annum, it may have a positive effect on our comprehensive
      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 December 31, 2006, the
      effect on our net income would be a decrease of approximately $34,000 per
      year.





34




**Netsmart
      Technologies, Inc.**


**Quarterly
      Summary**


Unaudited





The
      following table sets forth certain unaudited quarterly results of operations
      for
      each of the quarters in the years ended December 31, 2006 and 2005. All
      quarterly information was obtained from unaudited financial statements not
      otherwise contained in this report. We believe that all necessary adjustments
      have been made to present fairly the quarterly information when read in
      conjunction with the Consolidated Financial Statements and notes thereto
      included elsewhere in this report. The operating results for any quarter are
      not
      necessarily indicative of the results for any future period.





In
      thousands, except per share data amounts


1st
                Quarter
            
            2nd
                Quarter
            
            3rd
                Quarter
            
            4th
                Quarter**2006
                (a)**Total
                revenue
            
            $
            13,856
            
            $
            14,287
            
            $
            15,392
            
            $
            15,515Gross
                profit
            
            
            6,866
            
            
            7,025
            
            
            7,779
            
            
            8,109Net
                income (loss)
            
            
            510
            
            
            735
            
            
            1,025
            
            
            (417
            )Per
                share amounts:Net
                earnings (loss) - Basic:
            
            $
            .08
            
            $
            .11
            
            $
            .16
            
            $
            (.06
            )Net
                earnings (loss) - Diluted:
            
            $
            .08
            
            $
            .11
            
            $
            .15
            
            $
            (.06
            )





(a)
      During 2006, the Company made one acquisition. See note 5 to the consolidated
      Financial Statements. Includes $1,581,000 in costs in the fourth quarter
      associated with the proposed merger transaction which were non-deductible
      for income tax purposes.




**2005
                (b)**Total
                revenue
            
            $
            7,429
            
            $
            7,759
            
            $
            8,517
            
            $
            14,273Gross
                profit
            
            
            3,600
            
            
            3,862
            
            
            3,896
            
            
            7,018Net
                income
            
            
            363
            
            
            449
            
            
            379
            
            
            399Per
                share amounts:Net
                earnings - Basic:
            
            $
            .07
            
            $
            .08
            
            $
            .07
            
            $
            .06Net
                earnings - Diluted:
            
            $
            .07
            
            $
            .08
            
            $
            .07
            
            $
            .05





(b)
      During 2005, the Company made three acquisitions. See note 5 to the Consolidated
      Financial Statements.


35


**Item
              8.**
            **Financial
                Statements and Supplementary
                Data.**





The
      financial statements and supplementary data begin on page F-1 of this Form
      10-K.








**Item
              9.**
            **Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure.**





None




**Item
              9A.**
            **Controls
                and Procedures.**





**Evaluation
      of Disclosure Controls and Procedures**




Our
      management, with the participation of our Chief Executive Officer and Chief
      Financial Officer, conducted an evaluation of the effectiveness of the design
      and operation of our disclosure controls and procedures, as required by Exchange
      Act Rule 13a-15. Our disclosure controls and procedures are designed to ensure
      that information required to be disclosed by us in the reports that we file
      or
      submit to the Securities and Exchange Commission under the Exchange Act, is
      recorded, processed, summarized and reported within the time periods specified
      by the Commission’s rules and forms, and that information is accumulated and
      communicated to our management, including our Chief Executive Officer and our
      Chief Financial Officer, as appropriate to allow timely decisions regarding
      required disclosure. Based upon the evaluation that was conducted, the Chief
      Executive Officer and Chief Financial Officer have concluded that as of the
      end
      of the period covered by this report our disclosure controls and procedures
      were
      not effective due to the material weaknesses in internal control over financial
      reporting described below.





**Management’s
      Report on Internal Control Over Financial Reporting**





Management
      is responsible for establishing and maintaining adequate internal control over
      financial reporting. Under the supervision and with the participation of
      management, including the chief executive officer and chief financial officer,
      management assessed the effectiveness of internal control over financial
      reporting as of December 31, 2006 based on the framework in “Internal
      Control—Integrated Framework” issued by the Committee of Sponsoring
      Organizations of the Treadway Commission. Based on that assessment, management
      has concluded that the Company’s internal control over financial reporting was
      not effective at December 31, 2006 to provide reasonable assurance regarding
      the
      reliability of its financial reporting and the preparation of its financial
      statements for external purposes in accordance with United States generally
      accepted accounting principles. Management determined that these were certain
      material weaknesses relating to its calculation of earnings per share, the
      calculation of its income tax accrual and the ability to ensure that the
      disclosures in its regulatory filings under the 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. Due to its
      inherent limitations, even internal control over financial reporting that is
      functioning effectively may not prevent or detect misstatements. Also,
      projections of any evaluation of effectiveness to future periods are subject
      to
      the risk that controls may become inadequate because of changes in conditions,
      or that the degree of compliance with the policies or procedures may
      deteriorate.





Marcum
      & Kleigman LLP, an independent registered public accounting firm, has
      audited the Company’s financial statements included in this report on Form 10-K
      and issued its report on management’s assessment of the effectiveness of the
      Company’s internal control over financial reporting as of December 31, 2006,
      which is included herein.





36


**Changes
      in Internal Control Over Financial Reporting**




During
      2006, we continued integrating the New York and Ohio operations. We have chosen
      to use the most efficient processes and internal controls of the two operations
      in each location. During 2006, we completed the implementation of the same
      accounting system in Ohio as we use in New York. We are or will be in the
      process of implementing the billing, purchase order and cash receipts
      procedures.





Management
      intends to take steps to remediate the material weaknesses in the Company’s
      internal control over financial reporting commencing in the second fiscal
      quarter.





Also
      during 2006, in connection with the QS acquisition we have integrated the
      accounting for the QS operations into our New York accounting system and related
      controls.





**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.
      Our
      disclosure controls and procedures and internal controls over financial
      reporting are designed to provide a reasonable assurance of achieving their
      objectives and our Chief Executive Officer and Chief Financial Officer have
      concluded that such controls are effective at the “reasonable assurance”
level.





37


**Report
      of Independent Registered Public Accounting Firm on Internal Control Over
      Financial Reporting**




To
      the
      Audit Committee of


the
      Board
      of Directors and Stockholders


Netsmart
      Technologies, Inc.




We
      have
      audited management’s assessment, included in the accompanying “Management’s
      Report on Internal Control Over Financial Reporting”, that Netsmart
      Technologies, Inc. and Subsidiaries (the “Company”) did not maintain
      effective internal control over financial reporting as of December 31,
      2006, because of the effect of three material weaknesses in the Company’s
      internal control noted below, based on criteria established in Internal Control
      - Integrated Framework issued by the Committee of Sponsoring Organizations
      of
      the Treadway Commission (the “COSO” criteria). The Company’s management is
      responsible for maintaining effective internal control over financial reporting
      and for its assessment of the effectiveness of internal control over financial
      reporting. Our responsibility is to express an opinion on management’s
      assessment and an opinion on the effectiveness of the Company’s internal control
      over financial reporting based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether
      effective internal control over financial reporting was maintained in all
      material respects. Our audit included obtaining an understanding of internal
      control over financial reporting, evaluating management’s assessment, testing
      and evaluating the design and operating effectiveness of internal control,
      and
      performing such other procedures as we considered necessary in the
      circumstances. We believe that our audit provides a reasonable basis for our
      opinion.




A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company;
      (2) provide reasonable assurance that transactions are recorded as
      necessary to permit preparation of financial statements in accordance with
      generally accepted accounting principles, and that receipts and expenditures
      of
      the company are being made only in accordance with authorizations of management
      and directors of the company; and (3) provide reasonable assurance
      regarding prevention or timely detection of unauthorized acquisition, use,
      or
      disposition of the company’s assets that could have a material effect on the
      financial statements.




Because
      of its inherent limitations, internal control over financial reporting
      may not prevent or detect misstatements. Also, projections of any
      evaluation of effectiveness to future periods are subject to the risk that
      controls may become inadequate because of changes in conditions, or that
      the degree of compliance with the policies or procedures
      may deteriorate.





A
      material weakness is a control deficiency, or combination of control
      deficiencies, that results in more than a remote likelihood that a material
      misstatement of the annual or interim financial statements will not be prevented
      or detected. The following material weaknesses have been identified and included
      in management’s assessment:





1.
            The
                Company did not maintain effective controls over the calculation
                of
                earnings per share. There are no controls in place to prevent inadvertent
                errors that could result in a material
                misstatement.





2.
            The
                Company did not maintain effective controls over the calculation
                of the
                income tax provision or the related footnote disclosures. The Company
                relies primarily on a single individual and does not possess adequate
                resources to perform a comprehensive review. Such process is ineffective
                in preventing an inadvertent error that could result in a material
                misstatement.





38


3.
            The
                Company did not maintain effective controls over the preparation
                of
                disclosures required by generally accepted accounting principles.
                There
                are no controls in place to prevent inadvertent errors that could
                result
                in a material disclosure
                deficiency.





These
      material weaknesses were considered in determining the nature, timing, and
      extent of audit tests applied in our audit of the 2006 consolidated financial
      statements and this report does not affect our report dated March 7,
      2007,
      except
      for Note 16 as to which the date is March 14, 2007,on those consolidated
      financial statements.





In
      our
      opinion, management’s assessment that Netsmart Technologies, Inc. and
      Subsidiaries did not maintain effective internal control over financial
      reporting as of December 31, 2006, is fairly stated, in all material
      respects, based on the COSO criteria. Also, in our opinion, because of the
      effect of the material weaknesses described above on the achievement of the
      objectives of the control criteria, Netsmart Technologies, Inc. and
      Subsidiaries has not maintained effective internal control over financial
      reporting as of December 31, 2006, based on the COSO criteria.






/s/
                Marcum & Kliegman LLP




Marcum
      & Kliegman LLP


Melville,
      New York


March
      7,
      2007








**Item
              9B.**
            **Other
                Information.**





None





39


**Part
      III**





**Item
      10.**  **Directors
      and Executive Officers of the Registrant.**





Our
      directors and executive officers are as follows:





Name
            Age
            PositionJames
                L. Conway
            59
            Chief
                Executive Officer and DirectorAnthony
                F. Grisanti
            57
            Chief
                Financial Officer, Treasurer and SecretaryAlan
                Tillinghast
            43
            DirectorKevin
                Scalia
            46
            DirectorFrancis
                J. Calcagno1,
                2 & 3
            57
            DirectorJohn
                S.T. Gallagher1,
                2 & 3
            75
            DirectorYacov
                Shamash3
            57
            DirectorJoseph
                G. Sicinski1
                & 2
            74
            Director


____________


1
            Member
                of the compensation committee.


2
            Member
                of the audit committee.


3
            Member
                of the nominating and governance
                committee.








Director
      and Executive Officer Biographies





Mr.
      James
      L. Conway has been the Company’s chief executive officer since April 1998, a
      director since January 1996 and president from January 1996 until January 2001.
      From 1993 until April 1998, he was president of a Long Island based manufacturer
      of specialty vending equipment for postal, telecommunication and other
      industries. He was previously vice president, treasurer and director of ITT
      Credit Corporation. Mr. Conway was recently elected to the board of LISTnet
      which is an organization with the objective of promoting Long Island as one
      of
      the national centers of excellence for software and technology solutions. He
      also serves and is a member of the CEO Roundtable for Long Island.





Mr.
      Anthony F. Grisanti has been our Treasurer since June 1994, Secretary since
      February 1995 and Chief Financial Officer since January 1996.





Mr.
      Alan
      B. Tillinghast was elected as a director in December 2006. Mr. Tillinghast
      was
      appointed as Netsmart’s Chief Technology Officer and Executive Vice President
      for Operations in December 2006. Prior thereto, Mr. Tillinghast held senior
      executive positions with the Company’s wholly-owned subsidiary Netsmart New York
      since 1999. Previously Mr. Tillinghast held senior positions with Saint
      Vincent’s Catholic Medical Center where he was responsible for the
      implementation of a variety of systems for their Behavioral Healthcare Division.
      He also serves as a board member for Options for Community Living, a
      not-for-profit organization serving the health and human service needs of Long
      Island.





Mr.
      Kevin
      Scalia **** was
      elected as a director in December 2006. Mr. Scalia was appointed as Netsmart’s
      Executive Vice President, Corporate Development in December 2006 and prior
      to
      that date was serving as Executive Vice President, Corporate Development of
      the
      Company’s wholly-owned subsidiary, Netsmart New York since October 2005. From
      January 2004 to October 2005, he served as Vice-President of Operations of
      Netsmart New York. From 2002 to 2004 Kevin was director of business development
      for the company and its subsidiaries. Prior to joining Netsmart, Mr. Scalia
      served as President and COO of Galt Technologies, Melville, New York, a Long
      Island based professional services firm which provided enterprise applications
      to mid-size and fortune 500 companies, and served as chairman and CEO of a
      manufacturer of supercomputers, security equipment and medical imaging
      equipment. He is a Founding Member of the Long Island Software and Technology
      Network, and a member of the College of Engineering Advisory Board, State
      University of New York at Stony Brook.





40


Mr.
      Francis J. Calcagno has been one of the Company’s directors since September
      2001. He is a senior managing director of Dominick & Dominick LLC, 150
      E.52nd Street, New York, New York 10022, an investment banking firm, a
      position he has held since 1997. From 1993 until 1997, he was a managing
      director of Deloitte and Touche, LLP.





Mr.
      John
      S.T. Gallagher **** has
      been
      one of the Company’s directors since March 2002. He has been a consultant to the
      President of SUNY Stony Brook, Stony Brook, New York 11794-2200, since December
      2005. From 2001 until 2005, he was deputy county executive for health and human
      services in Nassau County, New York, 1 West Street, Mineola, New York
      11501. Prior thereto he was a senior executive officer of North Shore University
      Hospital and North Shore—Long Island Jewish Health System since 1982, having
      served as executive vice president of North Shore from 1982 until 1992,
      president from 1992 until 1997 and chief executive officer of the combined
      hospital system from 1997 until January 2002. In January 2002, he became
      co-chairman of the North Shore—Long Island Jewish Heath System Foundation.
      Mr. Gallagher is also a director of Perot Systems Corporation, a worldwide
      provider of information technology services.





Dr.
      Yacov
      Shamash has been one of the Company’s directors since January 2004. Dr. Shamash
      is Vice President for Economic Development and the Dean of the College of
      Engineering and Applied Sciences at Stony Brook University, Stony Brook, New
      York 11794-2200. Prior to joining SUNY Stony Brook in 1992, Dr. Shamash served
      as the Director of the School of Electrical Engineering and Computer Science
      at
      Washington State University. He has also held faculty positions at Florida
      Atlantic University, the University of Pennsylvania and Tel Aviv University.
      He
      received his undergraduate and graduate degrees from Imperial College of Science
      and Technology in London, England. Dr. Shamash has been a member of the Board
      of
      Directors of KeyTronic Corporation, a contract manufacturer, since 1989, of
      American Medical Alert Corporation, a healthcare service provider, since 2001
      and of Applied DNA Sciences, Inc., a company engaged in the business of
      researching, developing and selling security and anti-counterfeiting products
      that utilize plant DNA for verification purposes, since 2006 and is a member
      of
      the board of directors of LISTnet which is an organization with the objective
      of
      promoting Long Island as one of the national centers of excellence for software
      and technology solutions.





Mr.
      Joseph G. Sicinski has been one of the Company’s directors since June 1998. He
      was president and director of Trans Global Services, Inc., 8707 Katy Freeway,
      Suite 300, Houston, Texas 77024, a technical staffing company, from September
      1992 until April 1998. From April 1998 until September 2002 he was also
      chief executive officer of Trans Global. In September 2003 he retired from
      Trans
      Global and co-founded Novus Management Services, Inc, a company providing
      services related to the insurance industry where he is also a board member.
      In
      February 2004 he co-founded BDS Strategic Solutions, Inc., a company providing
      permanent and temporary staffing solution services and programs related to
      human
      resource issues. He is chairman of the board of directors of
      BDS.





Directors
      are elected for a term of one year.





None
      of
      our officers and directors are related.





Our
      certificate of incorporation includes certain provisions, permitted under
      Delaware law, which provide that a director shall not be personally liable
      to us
      or our stockholders for monetary damages for breach of fiduciary duty as a
      director except for liability (i) for any breach of the director’s duty of
      loyalty to us or our stockholders, (ii) for acts or omissions not in good faith
      or which involve intentional misconduct or a knowing violation of law, (iii)
      for
      any transaction from which the director derived an improper personal benefit,
      or
      (iv) for certain conduct prohibited by law. The Certificate of Incorporation
      also contains broad indemnification provisions. These provisions do not affect
      the liability of any director under federal or applicable state securities
      laws.





41


Board
      Committees





Our
      board
      of directors has three standing committees - the audit committee, the
      compensation committee and the nominating and governance committee. The board
      of
      directors also established a special committee to evaluate the advisability
      of
      entering into the Merger Agreement. All of the members of each committee are
      “independent” as defined under Nasdaq rules.





The
      responsibilities of the audit committee include overseeing our financial
      reporting process, reporting the results of its activities to the board,
      retaining and ensuring the independence of our independent registered public
      accountants, approving services to be provided by our independent registered
      public accountants, reviewing our periodic filings with the independent
      registered public accountants prior to filing, and reviewing and responding
      to
      any matters raised by the Independent Registered Public Accountants in their
      management letter and SAS 61 Communications. The audit committee consists of
      Mr.
      John S.T. Gallagher, who is chairman of the committee and Messrs. Francis
      Calcagno and Joseph G. Sicinski. The board of directors has determined that
      each
      of Messrs. Gallagher and Calcagno, qualifies as an “Audit Committee financial
      expert,” as defined by Securities and Exchange Commission rules, based in his
      education, experience and background. A copy of the Audit Committee charter
      can
      be found on our website at www.ntst.com .





The
      compensation committee serves as the stock option committee for our stock option
      plans and the employee stock purchase plan, and it reviews and approves any
      employment agreements with management and changes in compensation for our
      executive officers. The members of the compensation committee are Mr. Gallagher,
      who is chairman of the committee and Messrs. Calcagno and Sicinski. A copy
      of
      the Compensation Committee charter can be found on our website at www.ntst.com .





The
      nominating and governance committee is primarily responsible for reviewing
      our
      corporate governance principles and independence standards: overseeing the
      annual evaluation of our board and its committees; discharging the board’s
      responsibilities related to compensation of directors; identifying and
      evaluating individuals for board and committee membership and chairs; making
      recommendations to the board concerning the selection of director nominees
      and
      making recommendations as to the size and composition of the board and its
      committees. It will consider director nominee recommendations by stockholders
      provided that the names of such nominees, accompanied by relevant biographical
      information are properly submitted to our Secretary in accordance with the
      stockholder nomination procedures adopted by the Board of Directors, as
      described below. The members of the Nominating and Governance Committee are
      Dr.
      Shamash, who is the chairman of the committee and Messrs. Gallagher and
      Calcagno. A copy of the Nominating and Governance Committee charter can be
      found
      on our website at www.ntst.com .





The
      board
      of directors established the special committee to represent the interests of
      the
      unaffiliated stockholders in considering whether to pursue a proposal to sell
      Netsmart and the strategy of continuing Netsmart’s business without engaging in
      such a transaction. The special committee consists of Mr. Calcagno, who is
      chairman of the committee, and Messrs. Gallagher, Shamash and
      Sicinski.





Excluding
      actions by unanimous written consent, during 2006, the board of directors held
      twelve meetings, the compensation committee held six meetings, the nominating
      and governance committee held one meeting and the audit committee held five
      meetings. The special committee held twelve meetings and the independent
      directors held four meetings.





The
      audit
      committee met with our independent registered public accountants and chief
      financial officer prior to filing of this Form 10-K annual report to review
      the
      2006 audited financial statements with the independent registered public
      accountants. During 2006, all of our directors attended at least 75% of the
      aggregate of meetings of the board and the meetings of any committee of which
      they are members.





42


Section
      16(a) Beneficial Ownership Reporting Compliance





Section
      16(a) of the Securities Exchange Act of 1934 requires our executive officers,
      directors and persons who own more than ten percent of a registered class of
      our
      equity securities ("Reporting Persons") to file reports of ownership and changes
      in ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission
      and
      the Nasdaq Stock Exchange. These Reporting Persons are required by SEC
      regulation to furnish us with copies of all Forms 3, 4 and 5 they file with
      the
      SEC and Nasdaq. Based solely upon our review of the copies of the forms we
      have
      received, and upon representations received from such Reporting Persons, we
      believe that all Reporting Persons complied on a timely basis with all filing
      requirements applicable to them with respect to transactions during fiscal
      2005
      except that each of Messrs. Gallagher, Sicinski, Calcagno and Shamash failed
      to
      timely file the requisite Form 4 reporting the grant of certain options pursuant
      to the automatic grant provisions of our 2001 Long Term Incentive
      Plan.





Code
      of Ethics





We
      have
      adopted a Code of Ethics applicable to our principal executive officers,
      principal financial officer, principal accounting officer and controller and
      a
      Code of Business Conduct applicable to all of our employees, each which is
      posted on our website at www.ntst.com .
      Our
      Board of Directors has adopted a Code of Business Conduct applicable to the
      Company’s officers and employees, and has also adopted a Code of Ethics for its
      senior financial officers. These codes of ethics are posted on the Company’s
      website at www.ntst.com in the Investor Relations section. Any amendment of
      the
      codes of ethics or waiver thereof applicable to any director or executive
      officer of the Company, including the Chief Executive Officer or any senior
      financial officer, will be disclosed on the Company’s website within four
      business days of the date of such amendment or waiver. In the case of a waiver,
      the nature of the waiver, the name of the person to whom the waiver was granted
      and the date of the waiver will also be disclosed. A copy of the codes of ethics
      may also be obtained without charge by writing to Mr. Anthony F. Grisanti,
      Chief
      Financial Officer, Netsmart Technologies, Inc, 3500 Sunrise Highway, Great
      River, NY 11739.





**Item
              11.**
            **Executive
                Compensation.**





**Executive
      Compensation Program Objectives and Overview**





Netsmart’s
      current executive compensation programs are intended to achieve three
      fundamental objectives: (1) attract and retain qualified executives;
      (2) motivate performance to achieve specific strategic and operating
      objectives of Netsmart; and (3) align executives’ interests with the
      long-term interests of Netsmart’s stockholders. As described in more detail
      below, the material elements of our current executive compensation program
      for
      our principal executive officer, principal financial officer and the other
      most
      highly compensated executive officers, (“Named Officers”) include a base salary,
      an annual bonus opportunity, perquisites, retirement benefits, severance
      protection for certain actual or constructive terminations of the Named
      Officers’ employment, and other post-termination benefits payable upon
      retirement, death or disability.




43




We
      believe that each element of our executive compensation program helps us to
      achieve one or more of our compensation objectives. The table below lists each
      material element of our executive compensation program and the compensation
      objective or objectives that it is designed to achieve.




**Compensation
                Element**
            **Compensation
                Objectives Attempted to be Achieved**Base
                Salary
            Attract
                and retain qualified executivesBonus
                Compensation
            Motivate
                performance to achieve specific strategies and operating objectives
              Attract
                and retain qualified executivesPerquisites
                and Personal Benefits
            Attract
                and retain qualified executivesEquity-Based
                Compensation (stock options)
            Align
                Named Officers’ long-term interests with stockholders’ long-term interests
              Motivate
                performance to achieve specific strategies and operating objectives
              Attract
                and retain qualified executivesRetirement
                Benefits (e.g., 401(k), Executive Retirement, Non Competition and
                Consulting Plan
            Attract
                and retain qualified executivesSeverance
                and Other Benefits Upon Termination of Employment
            Attract
                and retain qualified executives
              Motivate
                performance to achieve specific strategies and operating
                objectives





As
      illustrated by the table above, base salaries, perquisites and personal
      benefits, retirement benefits and severance and other termination benefits
      are
      all primarily intended to attract and retain qualified executives. These are
      the
      elements of our current executive compensation program where the value of the
      benefit in any given year is not dependent on performance (although base salary
      amounts and benefits determined by reference to base salary will increase from
      year to year depending on performance, among other things). We believe that
      in
      order to attract and retain top-caliber executives, we need to provide
      executives with predictable benefit amounts that reward the executive’s
      continued service. Some of the elements, such as base salaries and perquisites
      and personal benefits, are generally paid out on a short-term or current basis.
      The other elements are generally paid out on a longer-term basis, such as upon
      retirement or other termination of employment. We believe that this mix of
      longer-term and short-term elements allows us to achieve our dual goals of
      attracting and retaining executives (with the longer-term benefits geared toward
      retention and the short-term awards focused on recruitment).





Our
      annual bonus opportunity is primarily intended to motivate our executives’
performance to achieve specific strategies and operating objectives, although
      we
      also believe it helps us attract and retain executives. Certain of our
      executives are also eligible for commissions based on sales. Our equity-based
      compensation is primarily intended to align our executives’ long-term interests
      with stockholders’ long-term interests, although we also believe they help
      motivate performance and help us attract and retain executives. These are the
      elements of our current executive compensation program that are designed to
      reward performance and the creation of stockholder value, and therefore the
      value of these benefits is dependent on performance. Each executive’s annual
      bonus opportunity is paid out on an annual short-term basis and is designed
      to
      reward performance for that period. Equity-based compensation is generally
      paid
      out or earned on a longer-term basis and is designed to reward performance
      over
      the term of the award.





The
      Compensation Committee’s general philosophy is that bonus and equity
      compensation should fluctuate with the Company’s success in achieving financial
      and other goals, and that Netsmart should continue to use long-term compensation
      such as stock options to align stockholder and executives’ interests. The
      Compensation Committee and Netsmart’s Chairman believe in reserving significant
      amounts for results-based incentive compensation and thus setting fixed-amount
      base salaries near the median of peer companies.




44




The
      Company retains GK Partners, an outside executive compensation consulting firm
      (which provides no other services to the Company) to provide general
      compensation expertise, explore alternative incentive programs and analyze
      comparative compensation information for the Compensation Committee. In carrying
      out its responsibilities in 2006, the Committee sought the consulting firm’s
      advice regarding compensation levels within the industry and the advisability
      of
      adopting alternative or additional performance incentives. In addition, the
      consulting firm provided valuable information to the Committee by benchmarking
      the Committee’s executive compensation program against those of a peer group of
      comparable software companies, which was suggested by the consulting firm and
      which included such companies as American Medical Alert, Applix, Inc.,
      Bitstream, Inc., CAS Medical Systems, Inc., Enzo Biochem, Inc., Exar
      Corporation, Hauppauge Digital, Inc., Hi Tech Pharmacal Co., Inc., Insightful
      Corp., LanVision Systems, Inc., Mediware Systems, Inc. and Quality Systems,
      Inc.
      This benchmarking was performed for comparative purposes. The Committee then
      determined the amount of the components of our executive compensation program
      using, among other factors, the information provided to it by the consulting
      firm. Because we generally determine the components of our executive
      compensation program, in part, by using such benchmarked information, we do
      not
      generally factor in amounts realized from prior compensation paid to our
      executives.





**Current
      Executive Compensation Program Elements**





Base
      Salaries





Like
      most
      companies, Netsmart’s policy is to pay our executives’ base salaries in cash.





In
      April
      2004, we entered into revised employment agreements with Messrs. James L. Conway
      and Anthony F. Grisanti. The terms and conditions of the revised contracts
      are
      identical in all material respects to the previous contracts except that (i)
      the
      term of each individual’s contract was extended by one year, so that Messrs.
      Conway and Grisanti’s contract will expire on December 31, 2006 and (ii) the
      revised contracts do not provide for a five-year consulting period following
      each individual’s respective term of employment during which such individual
      would have been entitled to compensation of $75,000 per year. Messrs. Conway
      and
      Grisanti’s contracts also provide for an option, which has been exercised, to
      extend their contracts for one additional year so that their contracts now
      expire on December 31, 2006.





In
      January 2006, one of our subsidiaries, Netsmart-NY entered into an employment
      agreement with Mr. Alan Tillinghast as an Executive Vice President with such
      contract expiring on December 31, 2008 (the “Tillinghast Agreement”). The
      Tillinghast Agreement provides for an option to extend his contract for
      continuing subsequent two year terms unless terminated by Netsmart-NY or Mr.
      Tillinghast on not less than sixty days written notice prior to the expiration
      of the contract. Mr. Tillinghast was appointed as an executive officer of
      Netsmart on December 2007. In February 2005, one of our subsidiaries,
      Netsmart-NY entered into an employment agreement with Mr. Kevin Scalia as an
      Executive Vice President with such contract expiring on February 14, 2008 (the
      “Scalia Agreement”). The Scalia Agreement provides for an option to extend his
      contract for continuing subsequent two year terms unless terminated by
      Netsmart-NY or Mr. Scalia on not less than sixty days written notice prior
      to
      the expiration of the contract. Mr. Scalia was appointed as an executive officer
      of Netsmart in December 2006.





The
      agreements provide for annual increases associated with cost of living indexes
      or 5%, whichever is greater. The agreements provide that the executives are
      eligible to participate in a bonus pool to be determined annually by the board,
      based on the executive’s performance. The agreements also provide each of these
      officers with an automobile allowance and insurance benefits. In approving
      our
      executives’ salary increases, our board took into account, among other things,
      the greater responsibility of our executives positions, peer group comparisons
      provided by the Committee’s outside consulting firm, and the executives’
individual experience and increased responsibilities. The base salary that
      was
      paid to each Named Officer in 2006 is the amount reported for such officer
      in
      Column (c) of the Summary Compensation Table.




45




In
      connection with the proposed merger transaction, we entered into new contracts
      with each of Mr. Conway (the “Conway Agreement”) and Mr. Grisanti (the “Grisanti
      Agreement”). These agreements were entered into in connection with the proposed
      merger transaction and are not a part of our compensation program. Consequently,
      the Conway Agreement and Grisanti Agreement were not approved by the
      Compensation Committee. The Conway Agreement provides that following the closing
      of the proposed merger, Mr. Conway will continue to act as the Chief Executive
      Officer of Netsmart for a term of two years commencing on the date of the
      closing of the merger, such term to be automatically renewed for successive
      one
      year terms thereafter unless the Conway Agreement is terminated pursuant to
      its
      terms. During the term of the Conway Agreement, Mr. Conway will continue to
      receive a base salary of $367,500, which is his current base salary, and will
      no
      longer have the right to automatic annual base salary increases, as provided
      in
      his current employment agreement.





Under
      the
      terms of the Grisanti Agreement, following the closing of the proposed merger
      transaction, Mr. Grisanti will continue to act as the Chief Financial Officer
      of
      Netsmart for a term of two years commencing on the date of the closing of the
      merger, such term to be automatically renewed for successive one year terms
      thereafter unless the Grisanti Agreement is terminated pursuant to its terms.
      During the term of the Grisanti Agreement, Mr. Grisanti will continue to receive
      a base salary of $204,750, which is his current base salary, and will no longer
      have the right to automatic annual base salary increases, as provided in his
      current employment agreement.





Annual
      Bonuses





Netsmart’s
      policy is to pay any discretionary annual bonuses to the Named Officers in
      cash.
      Each of the Named Officers have agreements whereby they are eligible to
      participate in a bonus pool to be determined annually by the Compensation
      Committee, based upon their performance. The Compensation Committee, in
      accordance with the compensation philosophy outlined above, approved cash
      bonuses for 2006 for the Named Officers as shown in column (d) of the Summary
      Compensation Table. The bonuses provided for our Named Officers were included
      in
      an executive bonus pool that was calculated at approximately 12% of income
      before taxes and provision for such bonuses. This pool provided bonuses for
      other executives in addition to the Named Executives. In considering the amount
      of the bonuses for the Named Officers for fiscal 2006, the Committee took into
      account the executive’s responsibilities, his performance, and other factors
      such as Company profitability, market share and industry position. For 2006,
      the
      Named Officers’ salaries and bonuses represented the following percentages of
      their respective total compensation: Mr. Conway—93%, Mr. Grisanti—89%,
      Mr. Tillinghast—68% and Mr. Scalia—68%. Additionally, Messrs. Tillinghast and
      Scalia participate in a commission pool and each receives .25% of our
      commissionable sales bookings for the year. Commissions earned by Messrs.
      Tillinghast and Scalia for 2006 were $109,080 and $100,022, respectively.
      According to the Company’s outside compensation consulting firm, the Company’s
      executive compensation is in line with average executive compensation among
      peer
      companies.





Pursuant
      to the Conway Agreement, for the 2006 fiscal year, Mr. Conway is entitled to
      receive a bonus in the amount of $140,000, which is the target bonus previously
      established by the Company at the beginning of the 2006 fiscal year. Thereafter,
      Mr. Conway is entitled to receive an annual bonus of at least $225,000 if
      Company performance targets are met as determined by the compensation committee
      of the Company’s board of directors. In addition, no later than the tenth day
      following the closing of the merger, Mr. Conway will receive a special one-time
      cash bonus in the amount of $1,000,000, provided that he executes an effective
      release in favor of Netsmart and Parent and certain of their respective
      affiliates releasing his existing rights to payments under his existing
      employment agreement and the Netsmart Executive Retirement, Non Competition
      and
      Consulting Plan, as amended (the “Retirement Plan”), including his right to
      receive a change-in-control payment of approximately $2,300,000 upon
      consummation of the merger.





Pursuant
      to the Grisanti Agreement, for the 2006 fiscal year, Mr. Grisanti is entitled
      to
      receive a bonus in the amount of $96,000, which is the target bonus previously
      established by the Company at the beginning of the 2006 fiscal year. Thereafter,
      Mr. Grisanti is entitled to receive an annual bonus of at least $96,000 if
      Company performance targets are met, as determined by the compensation committee
      of the Company’s board of directors.


46


In
      addition, no later than the tenth day after the closing of the merger, Mr.
      Grisanti will receive a special one-time cash bonus in the amount of $601,500,
      provided that he executes an effective release in favor of Netsmart and Parent
      and certain of their affiliates releasing his existing rights to payments under
      his existing employment agreement and the Retirement Plan, including his right
      to receive a change-in control payment of approximately $1,400,000 upon
      consummation of the merger.





Perquisites





In
      addition to base salaries and annual bonus opportunities, Netsmart provides
      the
      Named Officers with certain perquisites and personal benefits, including
      automobile-related expenses. We believe that perquisites and personal benefits
      are often a tax-advantaged way to provide the Named Officers with additional
      annual compensation that supplements their base salaries and bonus
      opportunities. When determining each Named Officer’s base salary, we take the
      value of each Named Officer’s perquisites and personal benefits into
      consideration.





The
      perquisites and personal benefits paid to each Named Officer in 2006 are
      reported in Column (i) of the Summary Compensation Table below, and are
      further described in footnotes (2), (3), (4) and (5) to the Summary
      Compensation Table.





Equity-Based
      Compensation





Netsmart’s
      policy is that the Named Officers’ long-term compensation should be directly
      linked to the value provided to stockholders of Netsmart common stock.
      Accordingly, the Compensation Committee grants equity awards under the 2001
      Long
      Term Incentive Plan designed to link an increase in stockholder value to
      compensation. During 2006, the Compensation Committee did not award any grants
      of Incentive Stock Options to any of the Named Officers. Nevertheless, the
      Compensation Committee believes that the use of these awards encourages
      executives to continue to use their best professional skills and to remain
      in
      Netsmart’s employ. Options granted by Netsmart under the 2001 Long Term
      Incentive Plan generally vest and become exercisable in installments of 50%
      after six months and 100% thereafter. The life of the options is generally
      five
      years. When considering the equity grants, the Compensation Committee considers
      each Named Officer’s responsibilities, his performance during the prior year,
      his expected future contribution to Netsmart’s performance, competitive data on
      grant values at comparable companies.





Pursuant
      to the Conway Agreement, within thirty days after the closing of the merger,
      upon approval by the Compensation Committee, Mr. Conway will be granted an
      option to purchase shares of the Parent’s common stock having a value equal to
      an aggregate 2.25% of the fully diluted shares (including all options, warrants
      and convertible securities on an exercised or as-converted basis) of the
      Parent’s common stock as of the closing date with an exercise price based on the
“Merger Consideration” (as such term is defined in the Merger Agreement), a
      portion of which shall be subject to time-based vesting and a portion of which
      shall be subject to performance-based vesting, which options shall be
      memorialized in a stock option agreement pursuant to a stock option plan to
      be
      established by Parent consistent with his employment agreement.





Pursuant
      to the Grisanti Agreement, within thirty days after the closing of the merger,
      upon approval by the compensation committee, Mr. Grisanti will be granted an
      option to purchase shares of Parent’s common stock having a value equal to 0.5%
      of the fully diluted shares (including all options, warrants and convertible
      securities on an exercised or as-converted basis) of Parent’s common stock as of
      the closing date with an exercise price based on the “Merger Consideration” (as
      such term is defined in the Merger Agreement), which shall be subject to
      time-based vesting, which option shall be memorialized in a stock option
      agreement pursuant to a stock option plan to be established by
      Parent.




47




Retirement
      Benefits and Deferred Compensation Opportunities





Effective
      April 1, 2004, we adopted an Executive Retirement, Non-Competition and
      Consulting Plan which was subsequently amended August 5, 2004 effective April
      1,
      2004, pursuant to which, following their retirement, selected officers will
      be
      entitled to receive a minimum payment of approximately $85,000 per year for
      a
      period of six years, provided, that such officers (i) provide a minimum amount
      of consulting days each month and (ii) agree to certain covenants not to
      compete. The annual payments are subject to 10% increases up to a maximum of
      $136,893 per year. Pursuant to the Executive Retirement, Non-Competition and
      Consulting Plan, the selected officers are also entitled to receive health
      benefits for life, provided that there are no breaches of the covenants not
      to
      compete. Each of Messrs. Conway and Grisanti are entitled to receive benefits
      under the plan.





Deferred
      compensation is a tax-advantaged means of providing the Named Officers with
      additional compensation that supplements their base salaries and bonus
      opportunities.





Severance
      and Other Benefits Upon Termination of Employment





Netsmart’s
      policy is to provide Named Officers with certain payments in the event of the
      termination of their employment prior to the end of their current employment
      term due to death, disability or other than “for cause” (as defined in their
      respective employment agreements). Netsmart selected such events because they
      are standard termination triggers in employment contracts. Netsmart determined
      that its failure to provide such standard termination provisions would adversely
      affect its ability to achieve its compensation objectives.





Please
      see the “Potential Payments Upon Termination or Change in Control” section below
      for a description of the potential payments that may be made to the Named
      Officers in connection with their termination of employment or a change in
      control.





Stock
      Ownership Guidelines





The
      Company does not have formal guidelines for the amount of officer and director
      Netsmart stock ownership.





Section
      162(m) Policy





Section 162(m) of
      the Internal Revenue Code limits the deductibility by Netsmart of cash
      compensation in excess of $1 million paid to the Chief Executive Officer and
      the
      four highest compensated executive officers during any taxable year, unless
      such
      compensation meets certain requirements. Base compensation and the subjective
      portion of the cash bonuses paid to executive officers for 2006 were within
      the
      $1 million Section 162(m) threshold and should, therefore, also be
      deductible by Netsmart. Stock options under Netsmart’s existing plans, as well
      as the formulaic portion of the cash bonus, are intended to comply with the
      rules under Section 162(m) for treatment as performance based
      compensation. Therefore, Netsmart should be allowed to deduct compensation
      related to options granted under each of these plans and the formula portion
      of
      the cash bonuses.




48




Compensation
      Committee’s Report on Executive Compensation (1)





Netsmart’s
      Compensation Committee has certain duties and powers as described in its
      charter. The Compensation Committee is currently composed of the three
      non-employee directors named at the end of this report each of whom is
      independent as defined by the NASD Rule 4200(a)(15). The Compensation Committee
      has reviewed and discussed with management the disclosures contained in the
      Compensation Discussion and Analysis section of this Item 11. Based upon this
      review and our discussions, the Netsmart Compensation Committee recommended
      to
      its Board of Directors that the Compensation Discussion and Analysis section
      be
      included in this Annual Report on Form 10-K.





**Compensation
      Committee of**


**the
      Board of Directors**


John
      S.
      T. Gallagher (Chair)


Joseph
      Sicinski


Francis
      Calcagno


(1)         
      SEC filings sometimes “incorporate information by reference.” This means the
      Company is referring you to information that has previously been filed with the
      SEC, and that this information should be considered as part of the filing you
      are reading. Unless the Company specifically states otherwise, this Compensation
      Committee Report shall not be deemed to be incorporated by reference and shall
      not constitute soliciting material or otherwise be considered filed under the
      Securities Act or the Securities Exchange Act.





Compensation
      Committee Interlocks and Insider Participation





The
      Compensation Committee members whose names appear above were committee members
      during all of 2006. No member of the Compensation Committee is or has been
      a
      former or current officer or employee of the Company or had any relationships
      requiring disclosure by the Company under the SEC’s rules requiring
      disclosure of certain relationships and related-party transactions. None of
      the
      Company’s executive officers served as a director or a member of a compensation
      committee (or other committee serving an equivalent function) of any other
      entity, the executive officers of which served as a director or member of the
      Compensation Committee during the fiscal year ended December 31,
      2006.




49




Summary
      Compensation Table




**Name and Principal Position**
            **Year**
            **Salary**
              **($)**
            **Bonus**
              **($)**
            **Option**
              **Awards**
              **($)(2)**
            **All**
              **Other**
              **Compensation**
              **($)**
            **Total**
              **($)****(a)**
            **(b)**
            **(c)**
            **(d)**
            **(e)**
            **(f)**
            **(g)****James
                L. Conway****(1)
                (3)**
              *Chief
                Executive Officer*
            2006
              2005
              2004
            367,500
              290,386
              197,073
            140,000
              75,000
              175,000
            --
              100,000
              215,900
            38,987
              23,004
              21,625
            546,487
              488,390
              609,598**Anthony
                F. Grisanti****(4)**
              *Chief
                Financial Officer, Treasurer, and Secretary*
            2006
              2005
              2004
            204,750
              178,415
              147,804
            96,000
              60,000
              125,000
            --
              180,000
              139,700
            35,554
              26,017
              19,731
            336,304
              444,432
              432,235**Alan
                Tillinghast,****(5)
                (6)**
              *Executive
                Vice President, Operations*
            2006
            178,759
            80,000
            --
            123,480
            382,239**Kevin
                Scalia****(5)
                (7)**
              *Executive
                Vice President, Corporate Development*
            2006
            166,295
            80,000
            
            114,422
            360,717







(1)
            Messrs.
                Conway, Tillinghast and Scalia serve on the Board of Directors but
                receive
                no compensation for their service as
                directors.


(2)
            The
                value of the option awards in each year was calculated using the
                Black
                Scholes value at the date of grant multiplied by the number of options
                granted to the Named Officer. The Black Scholes value for options
                granted
                was $4.00 and $5.08 per share for options granted in 2005 and 2004,
                respectively.


(3)
            All
                Other Compensation for 2006 consists of $14,400 for automobile allowance,
                $20,192 in vacation pay and $4,395 for life insurance premiums.


(4)
            All
                Other Compensation for 2006 consists of $14,400 for automobile allowance,
                $16,500 in vacation pay and $4,654 for life insurance premiums.


(5)
            Messrs.
                Tillinghast and Scalia were appointed as executive officers in December
                2006.


(6)
            All
                Other Compensation for 2006 consists of $109,080 in commissions and
                $14,400 for automobile allowance.


(7)
            All
                Other Compensation for 2006 consists of $100,022 in commissions and
                $14,400 for automobile allowance.





Compensation
      of Named Officers





The
      Summary Compensation Table should be read in connection with the tables and
      narrative descriptions that follow. The Outstanding Equity Awards at Fiscal
      Year
      End and Option Exercises and Stock Vested tables provide further information
      on
      the Named Officers’ potential realizable value and actual value realized with
      respect to their equity awards.





The
      discussion of the potential payments due upon a termination of employment or
      change in control is intended to further explain the potential future payments
      that are, or may become, payable to our Named Officers.


50


Netsmart
      has traditionally awarded annual stock incentives to employees (including the
      Named Officers) each year. However, Netsmart did not make any grants of
      plan-based awards in 2006.




Outstanding
                  Equity Awards At Fiscal Year EndOption
                  AwardsName
              
              Number
                  of Securities Underlying Unexercised Options Exercisable
              
              Number
                  of Securities Underlying Unexercised Options Unexercisable
              
              Option
                  Exercise Price
              
              Option
                  Expiration DateJames
                  L. Conway
              
              
              100,000
              
              
              -
              
              $
              9.85
              
              
              7/13/201042,500
              
              
              -
              
              $
              8.49
              
              
              5/13/2009142,500
              
              
              -Anthony
                  F. Grisanti
              
              
              10,000
              
              
              -
              
              $
              4.37
              
              
              5/21/200817,500
              
              
              -
              
              $
              4.93
              
              
              1/26/200845,000
              
              
              -
              
              $
              9.85
              
              
              7/13/201027,500
              
              
              -
              
              $
              8.49
              
              
              5/13/2009100,000
              
              
              -Alan
                  Tillinghast
              
              
              5,000
              
              
              -
              
              $
              4.37
              
              
              5/21/200827,500
              
              
              -
              
              $
              8.49
              
              
              5/13/200945,000
              
              
              -
              
              $
              9.85
              
              
              7/13/201077,500
              
              
              -Kevin
                  Scalia
              
              
              5,000
              
              
              -
              
              $
              6.61
              
              
              8/11/2013878
              
              
              -
              
              $
              4.93
              
              
              1/26/200845,000
              
              
              -
              
              $
              9.85
              
              
              7/13/201022,500
              
              
              -
              
              $
              8.49
              
              
              5/13/200973,378
              
              
              -




There
      were no stock awards.


51


The
      following table presents information regarding the exercise of stock options
      by
      Named Officers during 2006.





Option
      Exercises And Stock Vested




**Name**
            **Option
                Awards**
              **Number
                of Shares**
              **Acquired
                on**
              **Exercise**
              **(#)**
            **Value**
              **Realized
                on**
              **Exercise**
              **($)****(a)**
            **(b)**
            **(c)**James
                L. Conway
            None
            NoneAnthony
                F. Grisanti
            None
            NoneAlan
                Tillinghast
            None
            NoneKevin
                Scalia
            10,000
            $73,000








Potential
      Payments Upon Termination Or Change In Control





*Severance
      Provisions of Employment Agreements*





Messrs.
      Conway and Grisanti’s current employment agreements provide that in the event of
      their dismissal or resignation or a material change in their duties or in the
      event of a termination of employment by the executive or us as a result of
      a
      change in control, Messrs. Conway and Grisanti may receive severance payments
      of
      48 months compensation. Under the Conway and the Grisanti Agreement, Each of
      Messrs. Conway and Grisanti’s existing employment agreements also provides for
      severance benefits and welfare and perquisite continuation in the event that
      the
      executive officer is terminated for a reason other than death, disability or
      cause or resigns as a result of or following a change of control. The completion
      of the transactions contemplated by the Merger Agreement would constitute a
      change of control under each executive officer’s employment agreement. In such
      event, each of Messrs. Conway and Grisanti is entitled to receive severance
      payments calculated by determining the greatest after-tax benefit to the officer
      of payment of either (i) 48 months’ compensation or (ii) an amount equal to 2.99
      times his “base compensation amount,” as defined in Section 280G of the Internal
      Revenue Code. For the purposes of determining the amount of 48 months’
compensation, each of Messrs. Conway and Grisanti is entitled to receive an
      amount equal to the product of 48 multiplied by one-twelfth of the sum of his
      salary, average bonus for the prior three years, annual automobile allowance
      and
      annual vacation pay.





Pursuant
      to the Tillinghast Agreement, if Mr. Tillinghast’s employment is terminated as a
      result of death or disability, then the Company is required to pay to Mr.
      Tillinghast his salary at the annual rate in effect at the date of death or
      termination resulting from a disability, until the earlier of six months from
      the date of death of termination or the expiration of the term. If Mr.
      Tillinghast’s employment is terminated for causes other than death, disability
      or for cause (excluding any termination upon a change in control (as defined
      in
      the Tillinghast Agreement) or disposition of Netsmart-NY, as discussed below),
      then the Company shall pay to Mr. Tillinghast as severance payments his salary
      and expenses for the balance of the term of his contract as well as the bonus
      and commissions which he would otherwise be entitled to receive. The bonus
      and
      commission amount payable is defined as the greater of the prior year’s bonus
      and commissions or the average bonus and commissions paid to Mr. Tillinghast
      over the preceding three years. In addition, for a period of eighteen months
      after such termination, the Company shall provide Mr. Tillinghast, or his
      beneficiary, with the hospitalization, life insurance, medical and major medical
      benefits which would have been provided to him if he had continued his employ
      with the Company, except that the Company shall not be required to provide
      life
      insurance coverage for any beneficiary of Mr. Tillinghast. The Tillinghast
      Agreement provides for certain payments in the event of his termination upon
      either (i) a change in control (as defined in the employment agreement) or
      (ii)
      a disposition by Netsmart of the business of the Company’s Netsmart-NY
      subsidiary. In such event, if Mr. Tillinghast resigns due to either (i) a
      significant change in his duties or (ii) the Company changes his place of work
      to a location more than 50 miles from the current headquarters in Great River,
      NY, then he would be entitled to receive an amount (based on his rate of pay
      at
      the time of his termination) equal to his salary for 24 months, his bonus amount
      for the two preceding years, any unpaid commissions through the end of the
      term
      and all other benefits due to him pursuant to the terms of his agreement.





52


Pursuant
      to the Scalia Agreement, if Mr. Scalia’s employment is terminated as a result of
      death or disability, then the Company is required to pay to Mr. Scalia his
      salary at the annual rate in effect at the date of death or termination
      resulting from a disability, until the earlier of six months from the date
      of
      death of termination or the expiration of the term. If Mr. Scalia’s employment
      is terminated for causes other than death, disability or for cause (excluding
      any termination upon a change in control (as defined in the Scalia Agreement)
      or
      disposition of Netsmart-NY, as discussed below), then the Company shall pay
      to
      Mr. Scalia as severance payments his salary and expenses for the balance of
      the
      term of his contract as well as the bonus and commissions which he would
      otherwise be entitled to receive. The bonus and commission amount payable is
      defined as the greater of the prior year’s bonus and commissions or the average
      bonus and commissions paid to Mr. Scalia over the preceding three years. In
      addition, for a period of eighteen months after such termination, the Company
      shall provide Mr. Scalia, or his beneficiary, with the hospitalization, life
      insurance, medical and major medical benefits which would have been provided
      to
      him if he had continued his employ with the Company, except that the Company
      shall not be required to provide life insurance coverage for any beneficiary
      of
      Mr. Scalia. The Scalia Agreement provides for certain payments in the event
      of
      his termination upon either (i) a change in control (as defined in the
      employment agreement) or (ii) a disposition by Netsmart of the business of
      the
      Company’s Netsmart-NY subsidiary. In such event, if Mr. Scalia resigns due to
      either (i) a significant change in his duties or (ii) the Company changes his
      place of work to a location more than 50 miles from the current headquarters
      in
      Great River, NY, then he would be entitled to receive an amount (based on his
      rate of pay at the time of his termination) equal to his salary for 24 months,
      his bonus amount for the two preceding years, any unpaid commissions through
      the
      end of the term and all other benefits due to him pursuant to the terms of
      his
      agreement.





Pursuant
      to the Conway Agreement, if Mr. Conway’s employment is terminated for cause (as
      such term is defined in the Conway Agreement), he will receive his accrued
      but
      unpaid salary, and lifetime medical insurance at a cost to Netsmart not to
      exceed $600 per month. If Mr. Conway terminates his employment without good
      reason (as such term is defined in the Conway Agreement), Mr. Conway will
      receive accrued but unpaid salary, any accrued but unpaid bonus, retirement
      benefits (in a series of annual payments not to exceed $684,465 in the
      aggregate) and the lifetime medical insurance as described in the immediately
      preceding sentence. However, if Mr. Conway terminates his employment during
      2007
      or 2008 without good reason (as such term is defined in the Conway Agreement),
      he will forfeit his retirement benefits. If Mr. Conway’s employment is
      terminated without cause, he terminates his employment for good reason or the
      Company provides notice of non-renewal of the term of his employment agreement,
      he will receive an amount equal to one year of his then current annual salary,
      a
      bonus prorated for the number of days worked during the year of termination
      (assuming that any personal performance criteria applicable to the bonus are
      maximally obtained), the payment of any accrued but unpaid bonus earned during
      the year prior to the year in which the termination occurs, the lifetime medical
      insurance and retirement benefits described above, and accelerated vesting
      as of
      the termination date of that portion of his time-based vesting options that
      would have vested if he had remained employed for an additional year (with
      full
      accelerated vesting if such termination is within one year of a subsequent
      change in control of the Company), provided that if Mr. Conway’s employment is
      terminated for any reason other than for cause on or after the second
      anniversary of the Closing of the merger and his performance-based vesting
      options have fully vested, no less than three quarters of his time-based vesting
      options shall be deemed to be fully vested as of his termination date. In the
      event of Mr. Conway’s death during the employment term, his estate shall receive
      the bonus earned during the year of his death, calculated on a pro-rata basis
      for the number of days worked (assuming that any personal performance criteria
      applicable to the bonus are maximally obtained), any bonus earned but unpaid
      in
      the year prior to the year of his death, any earned but unpaid salary,
      retirement benefits (in a series of annual payments not to exceed $746,688
      in
      the aggregate) and accelerated vesting as of the termination date of that
      portion of his time-based vesting options that would have vested if he had
      remained employed for an additional year. If Mr. Conway’s employment is
      terminated due to his disability, he shall receive the same benefits as he
      would
      upon his death, with the addition of the lifetime medical insurance described
      above. Upon any employment termination (other than a termination for cause),
      a
      portion of the benefits for which the executive shall be eligible shall be
      subject to his (or his representative’s) effective execution of a release in
      favor of the Company and its related parties. If Mr. Conway’s employment is
      terminated by Netsmart without cause or he terminates his employment for good
      reason within two years after the closing date of the merger, he shall also
      be
      eligible to receive an additional payment to negate the after-tax effect of
      a
      portion of the excise tax he incurs (if any) as a result of the merger under
      the
      so-called “golden parachute” rules of Internal Revenue Code Section
      280G.





53


Pursuant
      to the Grisanti Agreement, if Mr. Grisanti’s employment is terminated for cause
      (as such term is defined in the Grisanti Agreement), he will receive his accrued
      but unpaid salary, and lifetime medical insurance at a cost to Netsmart not
      to
      exceed $600 per month. If Mr. Grisanti terminates his employment without good
      reason (as such term is defined in the Grisanti Agreement), Mr. Grisanti will
      receive accrued but unpaid salary, any accrued but unpaid bonus, retirement
      benefits (in a series of annual payments not to exceed $452,450 in the
      aggregate) and the lifetime medical insurance as described in the immediately
      preceding sentence. If Mr. Grisanti’s employment is terminated without cause, he
      terminates his employment for good reason, or the Company provides a notice
      of
      non-renewal of the term of his agreement he will receive an amount equal to
      six
      months of his then current annual salary, a bonus prorated for the number of
      days worked during the year of termination (assuming that any personal
      performance criteria applicable to the bonus are maximally obtained), the
      payment of any accrued but unpaid salary and bonus earned during the year prior
      to the year in which the termination occurs, the lifetime medical insurance
      and
      retirement benefits described above, and accelerated vesting as of the
      termination date of that portion of his sign-on option that would have vested
      if
      he had remained employed for an additional year. In the event of Mr. Grisanti’s
      death during the employment term, his estate shall receive the bonus earned
      during the year of his death, calculated on a pro-rata basis for the number
      of
      days worked (assuming that any personal performance criteria applicable to
      the
      bonus are maximally obtained), any bonus earned but unpaid in the year prior
      to
      the year of the executive’s death, any earned but unpaid salary, retirement
      benefits (in a series of annual payments not to exceed $452,450 in the aggregate
      and accelerated vesting as of the termination date of that portion of his
      sign-on option that would have vested if he had remained employed for an
      additional year). If Mr. Grisanti’s employment is terminated due to his
      disability, he shall receive the same benefits as he would upon his death,
      with
      the addition of the lifetime medical insurance described above. Upon any
      employment termination (other than a termination for cause), a portion of the
      benefits for which the executive shall be eligible shall be subject to his
      (or
      his representative’s) effective execution of a release in favor of the Company
      and its related parties. To the extent that Mr. Grisanti would be subject to
      the
      so-called “golden parachute” rules of Internal Revenue Code Section 280G, the
      payments to which he would be entitled upon a termination of employment would
      be
      reduced below the threshold at which the golden parachute excise tax is imposed
      to the extent such reduction would enable him to retain a greater portion of
      the
      payments from Netsmart after remittance of tax than he would have had he
      received the unreduced payments.





***Change
      in Control Severance Plan***





***Estimation
      of Benefits***





Set
      forth
      below is an estimation of the benefits payable to each of the Named Officers
      assuming that such officer’s employment were terminated under the circumstances
      described above in connection with a change in control of the Company and that
      the event triggering such payment occurred on 12/31/06.




54




**Severance
      Benefits—Change in Control**




**Name**
            **Estimated**
              **Total
                Value of**
              **Cash
                Payments**
              **(Base Salary**
              **and Annual****(1)**
              **Bonus Amounts)**James
                L. Conway
            $2,189,000Anthony
                F. Grisanti
            1,330,000




(1) Payments
      are calculated pursuant to Mr. Conway and Mr. Grisanti’s current employment
      agreements based upon forty eight months multiplied by the sum of current annual
      salary plus the average bonus over the past three years plus auto allowance
      and
      vacation pay divided by twelve months.





Directors’
      Compensation





Cash
      Compensation: Our
      directors play a critical role in guiding the Company’s strategic direction and
      overseeing the management of the Company. The increased demand for qualified
      and
      talented public company directors requires that we provide adequate incentives
      for our directors’ continued performance and participation. Our board of
      directors has three standing committees - the audit committee, the compensation
      committee and the nominating and governance committee. The board of directors
      also established a special committee to evaluate the advisability of entering
      into the Merger Agreement. For fiscal year 2006 each member of a committee
      of
      the Board (Audit, Compensation, and Nominating and Governance) received annual
      fees of $20,000 for their service. In addition, as set forth below, for his
      service as a chairperson of a committee (in addition to the fee for serving
      as a
      member of a committee) , the chairperson received the following additional
      fees:





Audit
                Committee Chair
            $
                6,250Compensation
                Committee Chair
            $
                6,250





In
      addition, Messrs. Calcagno, Gallagher, Shamash and Sicinski received meeting
      fees of $1,500 per meeting of the special committee. Mr. Calcagno also received
      an additional $60,000 for his additional responsibilities as chairman of the
      special committee.





We
      are
      also authorized to reimburse directors for expenses in connection with
      attendance at meetings.





Equity
      Compensation: Non-employee directors also received an automatic grant of stock options
      pursuant to the automatic grant provisions of the Company’s 2001 Long-Term
      Incentive Plan.





The
      2001
      Long-Term Incentive Plan, as amended, currently provides for the following
      automatic grants of options to each non-employee director:





Automatic
      grant to each non-employee director of a non-qualified option to purchase 10,000
      shares of common stock on April 1 st of each
      year; provided that each non-employee director serving as the chairman of the
      audit committee or compensation committee granted an option to purchase 12,500
      shares of common stock on April 1 st of each
      year, provided, that if one person serves as chairman of both committees he
      receives a grant of options to purchase a total of 12,500 shares.





55


All
      options granted under the Plan have a term of 5 years and are fully vested
      after
      six months. The exercise price of options granted under the Plan is determined
      by the Compensation Committee. It has been the practice if the Committee to
      use
      the closing price of the stock at the close of business on the date of
      grant.





**2006
      Director Compensation**





AllFees
                Earned
            
            Option
            
            OtherName
            
            or
                Paid in Cash
            
            Awards
                (1)
            
            Compensation
            
            TotalJames
                L. Conway(2)
            
            
            None
            
            
            --
            
            
            --
            
            
            --Gerald
                O. Koop(2)
            
            
            None
            
            
            --
            
            
            --
            
            
            --John
                F. Phillips (2)(3)
            
            
            None
            
            
            --
            
            
            122,500
            
            
            122,500John
                S.T. Gallagher
            
            
            63,000
            
            
            24,214
            
            
            --
            
            
            87,214Joseph
                Sicinski
            
            
            38,000
            
            
            18,904
            
            
            --
            
            
            56,904Frank
                Calcagno
            
            
            98,000
            
            
            18,904
            
            
            --
            
            
            116,904Yacov
                Shamash
            
            
            38,000
            
            
            18,904
            
            
            --
            
            
            56,904Kevin
                Scalia(2)
            
            
            None
            
            
            --
            
            
            --
            
            
            --Alan
                Tillinghast(2)
            
            
            None
            
            
            --
            
            
            --
            
            
            --





(1) The
      value of the option awards were calculated using the Black Scholes value at
      the
      date of grant multiplied by the amount of options granted in the respective
      years.





(2) Messrs.
      Conway, Koop, Phillips, Scalia and Tillinghast do not receive compensation
      for
      their service as directors.





(3) Included
      in all other compensation is $85,000 in payments under the Executive Retirement,
      Non-Competition and Consulting Plan and $37,500 under a separate consulting
      arrangement.








As
      of
      December 31, 2006, the following number of non-qualified stock options were
      outstanding and held by each Director.





**2006
      Director Stock Options**





Number
                of OptionsDirector
            OutstandingJames
                L. Conway
            142,500Gerald
                O. Koop
            65,000John
                F. Phillips
            NoneJohn
                S.T. Gallagher
            27,500Joseph
                Sicinski
            18,000Frank
                Calcagno
            28,000Yacov
                Shamash
            18,000Kevin
                Scalia
            73,378Alan
                Tillinghast
            77,500




56




**Item
      12.**  **Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters.**





Set
      forth
      below is information as of February 20, 2007, as to each person known by us,
      based on information provided to us by the persons named below and filings
      with
      the Securities and Exchange Commission, to own beneficially at least 5% of
      our
      common stock, each director, each officer listed in the Summary Compensation
      Table and all officers and directors as a group.





Name
                and Address
            
            Shares
            
            Percent
                of Outstanding Common StockJames
                L. Conway
            
            
            248,848
            
            
            3.7
            %Anthony
                F. Grisanti
            
            
            204,815
            
            
            3.1
            %Joseph
                G. Sicinski
            
            
            43,000
            
            
            *Francis
                J. Calcagno
            
            
            28,000
            
            
            *John
                S.T. Gallagher
            
            
            37,500
            
            
            *Yacov
                Shamash
            
            
            18,000
            
            
            *Alan
                Tillinghast
            
            
            117,837
            
            
            1.8
            %Kevin
                Scalia
            
            
            73,378
            
            
            1.1
            %All
                directors and officers as a group (eight individuals)
            
            
            771,378
            
            
            10.9
            %Eagle
                Asset Management
              880
                Carillon Parkway
              St.
                Petersburg, FL
            
            
            868,099
            
            
            13.2
            %Dawson
                Herman
              354
                Pequot Avenue
              Southport,
                CT
            
            
            715,203
            
            
            10.9
            %Daniel
                Zeff
              50
                California St.
              San
                Francisco, CA.
            
            
            330,870
            
            
            5.0
            %FMR
                Corp.
              82
                Devonshire St.
              Boston,
                MA
            
            
            423,978
            
            
            6.5
            %Mosaix
                Ventures L.P.
              1822
                North Mohawk
              Chicago,
                IL
            
            
            612,055
            
            
            9.2
            %


_____________


*  Less
      than
      1%.





Except
      as
      set forth in the following paragraphs, each person has the sole voting and
      sole
      investment power and direct beneficial ownership of the shares. Each person
      is
      deemed to beneficially own shares of common stock issuable upon exercise of
      options or warrants which are exercisable on or within 60 days after the date
      as
      of which the information is provided.




57





Except
      as
      otherwise noted above, the address of each person listed is c/o Netsmart
      Technologies, Inc., 3500 Sunrise Highway, Great River, NY 11739.





The
      number of shares owned by our directors and officers shown in the table above
      includes shares of common stock which are issuable upon exercise of options
      that
      are exercisable at February 20, 2007 or will become exercisable within 60 days
      after that date. Set forth below is the number of shares issuable upon exercise
      of those options for each of such directors and officers.





Name
            NumberYacov
                Shamash
            18,000James
                L. Conway
            142,500Anthony
                F. Grisanti
            100,000Joseph
                G. Sicinski
            18,000Francis
                J. Calcagno
            28,000John
                S.T. Gallagher
            27,500Alan
                Tillinghast
            77,500Kevin
                Scalia
            73,378All
                officers and directors as a group
            484,878








**Equity
      Compensation Plan Information**





The
      following table sets forth information relating to our compensation plans as
      of
      December 31, 2006.


Plan
                Category
            
            Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights
            
            Weighted-average
                exercise price of outstanding options, warrants and rights
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a))(a)
            
            (b)
            
            (c)Equity
                compensation plans approved by security holders
            
            
            898,505
            
            $
            8.790
            
            
            586,0452Equity
                compensation plans not approved by security holders
            
            
            24,9001
            
            $
            14.77
            
            
            --Total
            
            
            923,405
            
            $
            8.951
            
            
            586,045





1 Options
      to acquire 30,000 shares were granted to certain former employees of
      Netsmart-Ohio to induce them to remain in our employ. The options have a
      ten-year term, an exercise price of $14.77 per share and become exercisable
      over
      a period of three years.





2
      Options
      to purchase an aggregate shares are granted annually to the four non-employee
      directors pursuant to the automatic grant provisions of the 2001 Long-Term
      Incentive Plan.








**Item
              13.**
            **Certain
                Relationships and Related Transactions and Director
                Independence.**





Effective
      April 1, 2004, we adopted an Executive Retirement, Non-Competition and
      Consulting Plan which was subsequently amended August 5, 2004 effective April
      1,
      2004, pursuant to which, following their retirement, selected officers will
      be
      entitled to receive a minimum payment of approximately $85,000 per year for
      a
      period of six years, provided, that such officers (i) provide a minimum amount
      of consulting days each month and (ii) agree to certain covenants not to
      compete. The annual payments are subject to 10% increases up to a maximum of
      $136,893 per year. Pursuant to the Executive Retirement, Non-Competition and
      Consulting Plan, the selected officers are also entitled to receive health
      benefits for life, provided that there are no breaches of the covenants not
      to
      compete. Each of Messrs. Conway, and Grisanti are entitled to receive benefits
      under the plan.





58


Mr.
      Koop’s employment contract expired on December 31, 2005 and he retired as
      President as of that date. He is still employed by Netsmart but not as an
      executive officer. As of December 2006, Mr. Koop was no longer a member of
      the
      Board of Directors. Upon his retirement as an employee, pursuant to the terms
      of
      our Executive Retirement, Non-Competition and Consulting Plan, Mr. Koop will
      receive $85,000 per year for each of the six years following his retirement;
      provided, that he complies with the non-competition covenants of the
      plan.





Netsmart
      was a party to an employment agreement with John Phillips, a former Vice
      President. Mr. Phillip’s employment contract expired on December 31, 2003 and he
      retired effective April 1, 2004. Pursuant to the terms of Netsmart’s Executive
      Retirement, Non-Competition and Consulting Plan, Mr. Phillips will receive
      $85,000 per year for each of the next six years; provided that he complies
      with
      the non-competition covenants of the plan. As of December 2006, Mr. Phillips
      was
      no longer a member of the Board of Directors.





Each
      of
      Messrs. Calcagno, Gallagher, Sicinski and Shamash are independent in accordance
      with the categorical standars of independence included in NASD Rule 4200(a)(15),
      which includes a series of objective tests, such as that the director is not
      an
      employee of the companyand has not engaged in various types of business dealings
      with the company. All of the standing committees of the Board are composed
      of
      independent directors.





In
      connection with the proposed merger transaction, we entered into the Conway
      Agreement and the Grisanti Agreement. For a detailed description of the
      provisions of these agreements, see Item 11 “Executive Compensation-Current
      Executive Compensation Program Elements.”








**Item
              14.**
            **Principal
                Accounting Fees and
                Services.**





**Audit
      Fees**





We
      were
      billed by Marcum & Kliegman LLP the aggregate amount of approximately
      $401,200 in respect of fiscal 2006 Audit and Sarbanes-Oxley (“SOX”) Compliance
      and $337,000 in respect of fiscal 2005 for fees for professional services
      rendered for the audit of our annual financial statements and review of our
      financial statements included in our Forms 10-K and 10-Q.





**Audit-Related
      Fees**





We
      were
      billed by Marcum & Kliegman LLP in fiscal 2006 and 2005 in the amounts of
      $99,100 and $99,200, respectively for assurance and related services such as
      for
      our 401K audit, and acquisition services, that were reasonably related to the
      performance of the audit or review of our financial statements that are not
      reported under the preceding paragraph i ncluding
      services rendered in connection with acquisitions, reviews of registration
      statements and issuances of related consents, audits of employees benefit plans
      and advice regarding common stock purchase warrants and Sox 404 related
      efforts.





**Tax
      Fees**





We
      were
      billed by Marcum & Kliegman LLP the aggregate amount of $164,450 in respect
      of fiscal 2006 and $72,050 in respect of fiscal 2005 for fees for services
      consisting primarily of tax compliance, tax advice or tax planning in respect
      of
      the preparation of our federal and state tax returns.





59


**All
      Other Fees**





Marcum
      & Kliegman did not render any other services during fiscal 2006 and fiscal
      2005 that are not described in the preceding paragraphs.





**Auditor
      Independence**





Our
      Audit
      Committee has determined that the provision of services by Marcum & Kliegman
      LLP other than for audit related services is compatible with maintaining the
      independence of Marcum & Kliegman as our independent accountants.





**Pre-Approval
      Policies**





Our
      Audit
      Committee has pre-approved the provision by Marcum & Kliegman LLP of audit
      services and of non-prohibited audit related services for fees in an amount
      not
      to exceed an aggregate of $10,000 as well as $25,000 for acquisition due
      diligence services. Our Audit Committee has not otherwise adopted any blanket
      pre-approval policies.





Our
      Audit
      Committee approved all of the services provided by Marcum & Kliegman LLP and
      described in the preceding paragraphs.








**Part
      IV**





**Item
      15.**  **Exhibits,
      Financial Statements Schedules and Reports on Form 8-K.**





1.
            Financial
                Statements


Report
      of
      Marcum & Kliegman LLP


Consolidated
      Balance Sheets as of December 31, 2004 and 2003


Consolidated
      Statements of Income for the Years Ended December 31, 2004, 2003
      and


2002


Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31,
      2004,


2003
      and
      2002


Consolidated
      Statements of Cash Flows for the Years Ended December 31, 2004, 2003
      and


2002


Notes
      to
      Consolidated Financial Statements





2.
            Financial
                Statement Schedules


None





3.
            Exhibits


3.1
            Restated
                Certificate of Incorporation, as amended (Filed as an exhibit to
                the
                Registrant’s registration statement on Form S-1, File No. 333-2550, which
                was declared effective by the Commission on August 13, 1996, and
                incorporated herein by reference.)


3.2
            By-Laws
                (Filed as an exhibit to the Registrant’s registration statement on Form
                S-1, File No. 333-2550, which was declared effective by the Commission
                on
                August 13, 1996, and incorporated herein by
                reference.)


10.1
            Employment
                Agreement dated April 1, 2004, between the Registrant and James L.
                Conway
                (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.2
            Consulting
                Agreement dated April 1, 2004, between the Registrant and John F.
                Phillips
                (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.3
            Employment
                Agreement dated April 1, 2004, between the Registrant and Gerald
                O. Koop
                (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.4
            Employment
                Agreement dated April 1, 2004, between the Registrant and Anthony
                F.
                Grisanti (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.6
            1993
                Long-Term Incentive Plan (Filed as an exhibit to the Registrant’s
                registration statement on Form S-1, File No. 333-2550, which was
                declared
                effective by the Commission on August 13, 1996, and incorporated
                herein by
                reference.)


10.7
            1998
                Long-Term Incentive Plan (Filed as an appendix to the Registrant’s proxy
                statement dated September 30, 1999, relating to its 1999 Annual Meeting
                of
                Stockholders and incorporated herein by
                reference.)




60




10.8
            1999
                Long-Term Incentive Plan (Filed as an appendix to the Registrant’s proxy
                statement dated November 9, 2000, relating to its 2000 Annual Meeting
                of
                Stockholders and incorporated herein by
                reference.)


10.9
            2001
                Long-Term Incentive Plan - Amended (Filed as an exhibit to the
                Registrant’s 8-K dated June 16,
                2005.)


10.10
            1999
                Employee Stock Purchase Plan (Filed as an appendix to the Registrant’s
                proxy statement dated November 9, 2000, relating to its 2000 Annual
                Meeting of Stockholders and incorporated herein by
                reference.)


10.11
            Agreement
                dated June 1, 2001, between the Registrant and Fleet Bank (Filed
                as an
                exhibit to the Registrant’s 10-K/A dated August 21,
                2003.)


10.12
            AIMS
                Acquisition Agreement (Filed as an exhibit to the Registrant’s 8-K dated
                May 10, 2001.)


10.13
            Agreement
                dated June 25, 2003, among Registrant, Creative Socio-Medics Corp.,
                Shuttle Data Systems Corp., d/b/a/ ADIA Information Management Corp.
                and
                Steven Heintz, Jr. (Filed as an exhibit to the Registrant’s 8-K dated July
                8, 2003.)


10.14
            Lease
                agreement dated as of December 22, 2003, between Registrant and Spacely
                LLC. (Filed as an exhibit to the Registrant’s 10-K dated March 23,
                2004.)


10.15
            Amended
                Executive Retirement, Non Competition and Consulting Plan. (Filed
                as an
                exhibit to the Registrant’s 10-Q dated August 9,
                2004.)


10.16
            Merger
                Agreement dated September 20, 2005, between CMHC Systems, Inc., Hayes
                Acquisition Corp., a newly-formed wholly-owned subsidiary of the
                Registrant, and John Paton, solely in the capacity of Securities
                Holders
                Representative. (Filed as an exhibit to the Registrant’s Form 8-K dated
                September 19, 2005.)


10.17
            Revolving
                Credit and Term Loan Agreement with Netsmart Technologies, Inc. and
                the
                Bank of America, N.A. (Filed as an exhibit to the Registrant’s Form 8-K
                dated October 7, 2005.)


10.18
            Asset
                Purchase Agreement dated June 17, 2005 between Addiction Management
                Systems, Inc. and Creative Socio-Medics Corp. (Filed as an exhibit
                to the
                Registrant’s Form 8-K dated June 21,
                2005.)


10.20
            Amendment
                No. 1 to Employment Agreement dated June 16, 2005, between the Registrant
                and James L. Conway. (Filed as an exhibit to the Registrant’s Form 8-K
                dated June 16, 2005.)


10.21
            Amendment
                No. 1 to Employment Agreement dated June 16, 2005 between the Registrant
                and Anthony F. Grisanti. (Filed as an exhibit to the Registrant’s Form 8-K
                dated June 16, 2005.)


10.22
            Asset
                Purchase Agreement dated April 27, 2005 between ContinuedLearning
                LLC and
                Creative Socio-Medics Corp. (Filed as an exhibit to the Registrant’s Form
                8-K dated April 27, 2005.)


10.23
            Employment
                Agreement dated April 27, 2005 between Netsmart Technologies, Inc.
                and A.
                Sheree Graves. (Filed as an exhibit to the Registrant’s Form 8-K dated
                April 27, 2005.)


10.24
            Letter
                Agreement between Griffin Securities, Inc. and Netsmart Technologies,
                Inc.
                dated as of August 9, 2005. (Filed as an exhibit to the Registrant’s Form
                S-3, File No. 333-129265.)


10.25
            Letter
                Agreement between Griffin Securities, Inc. and Netsmart Technologies,
                Inc.
                dated as of October 11, 2005. (Filed as an exhibit to the Registrant’s
                Form S-3, File No. 333-129265.)


10.26
            First
                Amendment and Waiver to Loan Agreement dated as of December 31, 2005
                between the Registrant and Bank of America, N.A. (Filed as an exhibit
                to
                Registrant’s Form 8-K dated February 23,
                2006)


10.27
            Employment
                Agreement between the Registrant and Gerald Koop dated April 5, 2006(Filed
                as an exhibit to Registrant’s Form 8-K dated April 5,
                2006)


10.28
            Asset
                Purchase Agreement dated as of July 31, 2006 by and between QS
                Technologies, Inc. and Intelligent Systems Corporation, as Sellers
                and
                Netsmart Public Health, Inc., as Buyer and Netsmart Technologies,
                Inc.
                (Filed as an exhibit to Registrant’s Form 8-K dated August 1,
                2006)


10.29
            Second
                Amendment and Waiver to Loan Agreement dated as of July 31, 2006
                between
                the Registrant and Bank of America, N.A. (Filed as an exhibit to
                Registrant’s Form 8-K dated September 29,
                2006)


10.30
            Merger
                Agreement dated November 18, 2006 between Netsmart Technologies,
                Inc., a
                Delaware corporation with NT Acquisition, Inc., NT Merger Sub, Inc.,and
                NT
                Acquisition, Inc. (Filed as an exhibit to the Registrant’s Form 8-K dated
                November 18, 2006.)


10.31
            Amendment
                to employment agreement, between James L. Conway, dated as of November
                18,
                2006, with NT Investor Holdings, Inc., and the Registrant. (Filed
                as an
                exhibit to the Registrant’s Form 8-K/A dated November 30,
                2006).


10.32
            Amendment
                to employment agreement, between Anthony F. Grisanti, dated as of
                November
                18, 2006, with NT Investor Holdings, Inc., and the Registrant. (Filed
                as
                an exhibit to the Registrant’s Form 8-K/A dated November 30, 2006).


21.1
            Subsidiaries
                of the Registrant


23.1
            Consent
                of Marcum & Kliegman LLP


24
            Powers
                of Attorney (See Signature Page)


31.1
            Certification
                of Chief Executive Officer


31.2
            Certification
                of Chief Financial Officer


32
            Certification
                pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002




61







**NETSMART
      TECHNOLOGIES, INC.**


**AND
      SUBSIDIARIES**













F-1





**NETSMART
      TECHNOLOGIES, INC.**  **AND
      SUBSIDIARIES**





**INDEX**








Page
                to PageReport
                of Independent Registered Public Accounting Firm
            F-3Consolidated
                Balance Sheets
            F-4  
                F-5Consolidated
                Statements of Income
            F-6  
                F-7Consolidated
                Statements of Stockholders' Equity
            F-8Consolidated
                Statements of Cash Flows
            F-9  
                F-11Notes
                to Consolidated Financial Statements
            F-12  
                F-45







**.
       .  .  .  .  .  .  .  .  . 
..**




F-2


REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To
      the
      Audit Committee of the


Board
      of
      Directors and Stockholders of


Netsmart
      Technologies, Inc.








We
      have
      audited the accompanying consolidated balance sheets of Netsmart Technologies,
      Inc. and Subsidiaries (the "Company") as of December 31, 2006 and 2005, and
      the
      related consolidated statements of income, stockholders' equity and cash flows
      for each of the three years in the period ended December 31, 2006. These
      consolidated financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the
      consolidated financial statements are free of material misstatement. An audit
      includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the financial statements. An audit also includes assessing the
      accounting principles used and significant estimates made by management, as
      well
      as evaluating the overall financial statement presentation. We believe that
      our
      audits provide a reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of Netsmart
      Technologies, Inc. and Subsidiaries, as of December 31, 2006 and 2005, and
      the
      consolidated results of its operations and its cash flows for each of the three
      years in the period ended December 31, 2006 in conformity with generally
      accepted accounting principles (United States).





We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of the Company's internal
      control over financial reporting as of December 31, 2006, based on the criteria
      established in Internal Control-Integrated Framework issued by the Committee
      of
      Sponsoring Organizations of the Treadway Commission and our report dated, March
      7, 2007, expressed an unqualified opinion on management's assessment of the
      effectiveness of the Company's internal control over financial reporting and
      an
      adverse opinion on the effectiveness of the Company's internal control over
      financial reporting because of the existence of three material
      weaknesses.





/s/
      Marcum & Kliegman LLP





Marcum
      & Kliegman LLP


Melville,
      New York


March
      7,
      2007, except for the Note 16 as to which the date is March 14, 2007




F-3


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**





**December
                31,****2006**
            
            **2005****Assets:****Current
                Assets:**Cash
                and Cash Equivalents
            
            $
            10,163,291
            
            $
            11,445,525Accounts
                Receivable - Net
            
            
            16,370,032
            
            
            11,524,811Costs
                and Estimated Profits in Excessof
                Interim Billings
            
            
            2,936,575
            
            
            1,811,986Deferred
                taxes
            
            
            754,863
            
            
            1,594,863Other
                Current Assets
            
            
            1,607,490
            
            
            1,466,577**Total
                Current Assets**
            
            
            31,832,251
            
            
            27,843,762**Property
                and Equipment - Net**
            
            
            2,726,423
            
            
            2,665,429**Other
                Assets:**Goodwill
            
            
            18,445,646
            
            
            18,735,751Capitalized
                Software Costs - Net
            
            
            7,227,002
            
            
            6,534,551Customer
                Lists - Net
            
            
            9,898,827
            
            
            8,110,864Contract
                Backlog - Net
            
            
            --
            
            
            379,500Other
                Assets
            
            
            394,404
            
            
            351,997**Total
                Other Assets**
            
            
            35,965,879
            
            
            34,112,663**Total
                Assets**
            
            $
            70,524,553
            
            $
            64,621,854







See
      Notes
      to Consolidated Financial Statements.


F-4


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**





**CONSOLIDATED
      BALANCE SHEETS**





**December
                31,****2006**
            
            **2005****Liabilities
                and Stockholders’ Equity:**
            
            ****
            
            ******CurrentLiabilities:**Current
                Portion - Long Term Debt
            
            $
            951,802
            
            $
            833,369Current
                Portion Capital Lease Obligations
            
            
            9,521
            
            
            61,315Accounts
                Payable
            
            
            2,799,952
            
            
            2,013,968Accrued
                Expenses
            
            
            2,893,531
            
            
            2,916,021Interim
                Billings in Excess of Costs and EstimatedProfits
            
            
            4,995,402
            
            
            7,938,422Deferred
                Revenue
            
            
            16,424,427
            
            
            10,037,813**Total
                Current Liabilities**
            
            
            28,074,635
            
            
            23,800,908Long
                Term Debt - Less current portion
            
            
            2,257,328
            
            
            1,916,667Capital
                Lease Obligations - Less current portion
            
            
            --
            
            
            9,521Interest
                Rate Swaps at Fair Value
            
            
            --
            
            
            7,812Deferred
                Tax Liability
            
            
            883,091
            
            
            2,118,603Deferred
                Rent Payable
            
            
            538,185
            
            
            482,048**Total
                Non Current Liabilities**
            
            
            3,678,604
            
            
            4,534,651**Commitments
                and Contingencies****Stockholders’
                Equity:**Preferred
                Stock - $.01 Par Value, 3,000,000Shares
                Authorized; None issued and outstanding
            
            
            --
            
            
            --Common
                Stock - $.01 Par Value; Authorized15,000,000
                Shares; Issued and outstanding6,787,396
                and 6,555,183 shares at December 31, 2006,6,719,517
                and 6,487,943 shares at December 31, 2005
            
            
            67,874
            
            
            67,195Additional
                Paid-in Capital
            
            
            40,622,043
            
            
            39,997,558Accumulated
                Comprehensive Income (Loss) - InterestRate
                Swap
            
            
            6,780
            
            
            (7,812
            )Accumulated
                Deficit
            
            
            (150,669
            )
            
            (2,004,132
            )40,546,028
            
            
            38,052,809Less:
                cost of shares of Common Stock heldin
                treasury - 232,213 shares at December 31, 2006and
                231,574 shares at December 31, 2005
            
            
            1,774,714
            
            
            1,766,514**Total
                Stockholders’ Equity**
            
            
            38,771,314
            
            
            36,286,295Total
                Liabilities and Stockholders’ Equity
            
            $
            70,524,553
            
            $
            64,621,854





See
      Notes
      to Consolidated Financial Statements.




F-5




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF INCOME**





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004****Revenues:**Software
                and RelatedSystems
                and Services:Turnkey
                Systems
            
            $
            27,156,766
            
            $
            20,326,805
            
            $
            16,931,606Maintenance
                Contract Services
            
            
            26,601,208
            
            
            13,317,744
            
            
            8,289,525Application
                Service Provider Services
            
            
            3,555,769
            
            
            2,538,457
            
            
            1,725,473Data
                Center Services
            
            
            1,735,940
            
            
            1,795,448
            
            
            2,058,240**Total
                Revenues**
            
            
            59,049,683
            
            
            37,978,454
            
            
            29,004,844**Cost
                of Revenues:**Software
                and RelatedSystems
                and Services:Turnkey
                Systems
            
            
            16,895,754
            
            
            11,682,754
            
            
            9,203,071Maintenance
                Contract Services
            
            
            9,327,734
            
            
            5,421,575
            
            
            4,168,975Application
                Service Provider Services
            
            
            2,230,290
            
            
            1,611,026
            
            
            926,333Data
                Center Services
            
            
            817,203
            
            
            887,169
            
            
            849,353**Total
                Cost of Revenues**
            
            
            29,270,981
            
            
            19,602,524
            
            
            15,147,732**Gross
                Profit**
            
            
            29,778,702
            
            
            18,375,930
            
            
            13,857,112**Selling,
                General and****Administrative
                Expenses**
            
            
            19,087,284
            
            
            11,272,446
            
            
            7,293,865**Research,
                Development and Maintenance**
            
            
            6,552,541
            
            
            4,547,114
            
            
            3,498,448**Total**
            
            
            25,639,825
            
            
            15,819,560
            
            
            10,792,313**Operating
                Income**
            
            
            4,138,877
            
            
            2,556,370
            
            
            3,064,799**Interest
                and Other Income**
            
            
            376,998
            
            
            311,496
            
            
            126,379**Interest
                and Other Expense**
            
            
            (252,412
            )
            
            (119,090
            )
            
            (129,213
            )**Income
                before Income Tax**
            
            
            4,263,463
            
            
            2,748,776
            
            
            3,061,965**Income
                Tax**
            
            
            2,410,000
            
            
            1,159,000
            
            
            309,000**Net
                Income**
            
            $
            1,853,463
            
            $
            1,589,776
            
            $
            2,752,965







See
      Notes
      to Consolidated Financial Statements.


F-6


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF INCOME**





**Year
                ended December
                31,************2006**
            
            **2005**
            
            **2004******
            
            ****
            
            ****
            
            ******Earnings
                Per Share (“EPS”) of Common Stock****Basic
                EPS**
            
            $
            .28
            
            $
            .28
            
            $
            .52**Weighted
                Average Number of Shares of****Common
                Stock Outstanding**
            
            
            6,529,343
            
            
            5,684,191
            
            
            5,331,700**Diluted
                EPS**
            
            $
            .27
            
            $
            .27
            
            $
            .50**Weighted
                Average Number of Shares of****Common
                Stock and Common Stock****Equivalents
                Outstanding**
            
            
            6,747,983
            
            
            5,935,405
            
            
            5,536,731








See
      Notes
      to Consolidated Financial Statements.


F-7


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**





**CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY**





**Accumulated****Comprehensive****Additional**
            
            
            
            **Income
                (Loss)**
            
            
            
            
            
            
            
            **Total****Common
                Stock**
            
            **Paid-In**
            
            **Accumulated**
            
            **Interest
                Rate**
            
            **Comprehensive**
            
            **Treasury
                Shares**
            
            **Stockholders’****Shares**
            
            **Amount**
            
            **Capital**
            
            **Deficit**
            
            **Swap**
            
            **Income**
            
            **Shares**
            
            **Amount**
            
            **Equity****Balance
                - January 1, 2004**
            
            
            5,528,247
            
            $
            55,282
            
            $
            29,010,212
            
            $
            (6,346,873
            )
            $
            (59,068
            )
            $
            --
            
            
            223,758
            
            $
            (1,659,449
            )
            $
            21,000,104Common
                Stock Issued - Exercise of Options
            
            
            38,877
            
            
            389
            
            
            166,011
            
            
            --
            
            
            --
            
            
            --
            
            
            4,166
            
            
            (53,533
            )
            
            112,867Change
                in Deferred Tax Asset ValuationAllowance
            
            
            --
            
            
            --
            
            
            717,000
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            717,000Change
                in Fair Value of Interest Rate Swap
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            43,916
            
            
            43,916
            
            
            --
            
            
            --
            
            
            43,916Net
                Income
            
            
            --
            
            
            --
            
            
            --
            
            
            2,752,965
            
            
            --
            
            
            2,752,965
            
            
            --
            
            
            --
            
            
            2,752,965$
            2,796,881**Balance
                - December 31, 2004**
            
            
            5,567,124
            
            
            55,671
            
            
            29,893,223
            
            
            (3,593,908
            )
            
            (15,152
            )
            
            
            
            
            227,924
            
            
            (1,712,982
            )
            
            24,626,852Common
                Stock Issued - Exercise of Options
            
            
            206,658
            
            
            2,067
            
            
            852,173
            
            
            --
            
            
            --
            
            $
            --
            
            
            3,650
            
            
            (53,532
            )
            
            800,708Common
                Stock Issued - Private Placement
            
            
            490,000
            
            
            4,900
            
            
            4,488,204
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            4,493,104Cost
                Related to Private Placement
            
            
            --
            
            
            --
            
            
            (377,976
            )
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            (377,976
            )Common
                Stock Issued - Acquisitions
            
            
            455,735
            
            
            4,557
            
            
            5,101,934
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            5,106,491Change
                in Fair Value of Interest Rate Swaps
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            7,340
            
            
            7,340
            
            
            --
            
            
            --
            
            
            7,340Tax
                Benefit from Exercise of Options
            
            
            --
            
            
            --
            
            
            40,000
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            40,000Net
                Income
            
            
            --
            
            
            --
            
            
            --
            
            
            1,589,776
            
            
            --
            
            
            1,589,776
            
            
            --
            
            
            --
            
            
            1,589,776$
            1,597,116**Balance
                - December 31, 2005**
            
            
            6,719,517
            
            
            67,195
            
            
            39,997,558
            
            
            (2,004,132
            )
            
            (7,812
            )
            
            
            
            
            231,574
            
            
            (1,766,514
            )
            
            36,286,295Common
                Stock Issued - Exercise of OptionsAnd
                Warrants
            
            
            64,390
            
            
            644
            
            
            569,711
            
            
            --
            
            
            --
            
            
            --
            
            
            639
            
            
            (8,200
            )
            
            562,155Shares
                Issued for Services
            
            
            3,489
            
            
            35
            
            
            44,965
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            45,000Change
                in Fair Value of Interest Rate Swap
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            14,592
            
            
            14,592
            
            
            --
            
            
            --
            
            
            14,592Costs
                Related to 2005 Private Placement
            
            
            --
            
            
            --
            
            
            (158,349
            )
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            (158,349
            )Share-Based
                Compensation Expense
            
            
            --
            
            
            --
            
            
            120,158
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            120,158Tax
                Benefit from Exercise of Options
            
            
            --
            
            
            --
            
            
            48,000
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            48,000Net
                Income
            
            
            --
            
            
            --
            
            
            --
            
            
            1,853,463
            
            
            --
            
            
            1,853,463
            
            
            --
            
            
            --
            
            
            1,853,463$
            1,868,055**Balance
                - December 31, 2006**
            
            
            6,787,396
            
            $
            67,874
            
            $
            40,622,043
            
            $
            (150,669
            )
            $
            6,780
            
            
            
            
            
            232,213
            
            $
            (1,774,714
            )
            $
            38,771,314








See
      Notes
      to Consolidated Financial Statements.





F-8


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**







**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004****Operating
                Activities:**Net
                Income
            
            $
            1,853,463
            
            $
            1,589,776
            
            $
            2,752,965Adjustments
                to Reconcile Net Incometo
                Net Cash Provided by Operating Activities:Depreciation
                and Amortization
            
            
            4,317,317
            
            
            2,451,456
            
            
            1,624,393Share-Based
                Compensation
            
            
            165,158
            
            
            --
            
            
            --Provision
                for Doubtful Accounts
            
            
            770,727
            
            
            465,004
            
            
            (204,000
            )Excess
                tax Benefit from Exercise of Options
            
            
            48,000
            
            
            40,000
            
            
            --Deferred
                Income Taxes
            
            
            121,488
            
            
            805,431
            
            
            122,000Changes
                in Assets and Liabilities:[Increase]
                Decrease in:Accounts
                Receivable
            
            
            (5,615,948
            )
            
            953,963
            
            
            (3,506,210
            )Costs
                and Estimated Profits inExcess
                of Interim Billings
            
            
            (982,438
            )
            
            (840,448
            )
            
            1,180,150Other
                Current Assets
            
            
            13,055
            
            
            (686,023
            )
            
            (54,795
            )Other
                Assets
            
            
            (71,460
            )
            
            (258,856
            )
            
            28,431Increase
                [Decrease] in:Accounts
                Payable
            
            
            693,340
            
            
            (3,274,348
            )
            
            243,165Accrued
                Expenses
            
            
            563,300
            
            
            (681,174
            )
            
            (43,046
            )Deferred
                Rent Payable
            
            
            56,137
            
            
            26,621
            
            
            455,427Interim
                Billings in Excess ofCosts
                and Estimated Profits
            
            
            (2,943,020
            )
            
            440,649
            
            
            234,488Deferred
                Revenue
            
            
            4,353,341
            
            
            945,721
            
            
            (197,705
            )Total
                Adjustments
            
            
            1,392,997
            
            
            387,996
            
            
            (117,702
            )**Net
                Cash Provided by Operating Activities**
            
            
            3,246,460
            
            
            1,977,772
            
            
            2,635,263**Investing
                Activities:**Acquisition
                of Property andEquipment
            
            
            (1,144,482
            )
            
            (458,092
            )
            
            (1,328,050
            )Capitalized
                Software Development
            
            
            --
            
            
            (42,000
            )
            
            (185,000
            )Business
                Acquisitions - Net of $4,218,614of
                Acquired Cash in 2005
            
            
            (2,798,797
            )
            
            (12,554,994
            )
            
            (16,263
            )**Net
                Cash Used In Investing Activities**
            
            $
            (3,943,279
            )
            $
            (13,055,086
            )
            $
            (1,529,313
            )





See
      Notes
      to Consolidated Financial Statements.




F-9




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**







**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**







**Year
                endedDecember
                31,****2006**
            
            **2005**
            
            **2004****Financing
                Activities:**Payment
                of Capitalized Lease Obligations
            
            $
            (61,315
            )
            $
            (60,327
            )
            $
            (61,416
            )Proceeds
                from Term Loan
            
            
            --
            
            
            2,500,000
            
            
            --Repayment
                of Promissory NoteAssumed
                in Acquisition
            
            
            --
            
            
            (494,413
            )Cost
                Related to Private Placement
            
            
            (158,349
            )
            
            --
            
            
            --Net
                Proceeds from Stock Options andWarrants
                Exercised
            
            
            562,155
            
            
            800,708
            
            
            112,867Net
                Proceeds from Private Placement
            
            
            --
            
            
            4,115,128
            
            
            --Payments
                of Long-Term Debt
            
            
            (975,906
            )
            
            (749,992
            )
            
            (666,659
            )Excess
                tax benefit from Exercise of Option
            
            
            48,000
            
            
            --
            
            
            --**Net
                Cash (Used in) Provided by****Financing
                Activities**
            
            
            (585,415
            )
            
            6,111,104
            
            
            (615,208
            )**Net
                (Decrease) Increase in Cash****and
                Cash Equivalents**
            
            
            (1,282,234
            )
            
            (4,966,210
            )
            
            490,742**Cash
                and Cash Equivalents -****Beginning
                of Year**
            
            
            11,445,525
            
            
            16,411,735
            
            
            15,920,993**Cash
                and Cash Equivalents -****End
                of Year**
            
            $
            10,163,291
            
            $
            11,445,525
            
            $
            16,411,735**Supplemental
                Disclosure of Cash Flow Information:**Cash
                paid during the years for:Interest
            
            $
            246,171
            
            $
            107,810
            
            $
            132,635Income
                Taxes
            
            $
            2,465,338
            
            $
            338,254
            
            $
            237,879





**Supplemental
      Disclosures of Non-Cash Investing and Financing
      Activities:**





Year
      Ended December 31, 2006 :





The
      fair
      value of the interest rate swap increased by $14,592 for the year ended December
      31, 2006.





On
      August
      1, 2006, Netsmart Technologies, Inc. and Subsidiaries (the “Company”), acquired
      certain assets, including computer software, customer lists and computer
      equipment of QS Technologies, Inc. (“QS”). The purchase price totaled
      approximately $5,466,000 as follows: an initial payment of $1,900,000 in cash
      and a three year $1,435,000 promissory note paid monthly, at an annual rate
      of
      8.25% together with the assumption of approximately $2,095,000 in net
      liabilities, consisting principally of deferred revenue, and acquisition costs
      of approximately $36,000.





During
      2006, the Company received 639 shares of its common stock in consideration
      for
      the cashless exercise of certain stock options. The value of the shares received
      was $8,200, which was the market value of the common stock on the date of
      exercise.





During
      2006, the Company issued, 3,489 shares of its common stock in connection with
      an
      investor relations agreement.




F-10




During
        2006, the Company analyzed the value of the assets previously acquired from
        CMHC
        Systems, Inc. (“CMHC”), as more fully described below, and increased deferred
        revenue by $151,218 and accrued expenses by $342,766, offset by an increase
        in
        deferred tax assets of $517,000. It also settled its working capital payoff
        by
        paying $524,935 in settlement of $792,024, which was the original provision.
        As
        a result accrued expenses were reduced by $267,089. The above adjustments
        resulted in a net decrease to goodwill in the amount of $290,105.


Year
      Ended December 31, 2005





During
      2005, the Company acquired for $489,238 in cash and stock, the software,
      customer lists and other assets of ContinuedLearning LLC. The consideration
      consisted of $252,917 in cash plus 20,000 shares of common stock, valued at
      $191,400, based upon the average weighted stock price of $9.57 for the period
      commencing three days before and ending three days after the acquisition was
      agreed to and announced. The consideration also included the assumption of
      $44,921 for certain liabilities for services to be performed in the future.
      The
      agreement also included contingent consideration of $250,000 if certain revenue
      targets were met within one year of the closing of the acquisition, which closed
      on April 28, 2005. Based upon results through the end of fiscal 2005, the
      Company has provided for the full $250,000 of this contingent consideration
      and
      has adjusted the related balance sheet accounts accordingly. The $250,000
      additional provision is included in accrued expenses. These revenue targets
      were
      met during 2006 and the $250,000 has been paid.





During
      2005, the Company acquired for $3,610,682, the software, customer lists and
      other assets of Addiction Management Systems. The consideration consisted of
      $2,641,945 in cash plus legal fees of $19,904 and the assumption of $948,833
      for
      certain liabilities for services to be performed in the future.





During
      2005, the Company acquired 100% of the equity interest in CMHC. The purchase
      price totaled approximately $19,565,956 as follows: 435,735 shares of Netsmart’s
      common stock (valued at $4,915,091), $12,994,758 in cash plus additional cash
      consideration initially estimated at $792,024 required by the “working capital
      adjustment”, calculated and payable in accordance with the merger agreement, and
      acquisition costs of $864,083. The value of the 435,735 shares of common stock
      was based upon the average weighted stock price of $11.28 for the period
      commencing three days before and ending three days after the acquisition was
      agreed to and announced. The working capital adjustment was finalized in fiscal
      2006, resulting in a reduction in accrued expenses, as more fully described
      above.





During
      2005, the Company received 3,650 shares of its common stock as consideration
      for
      the exercise of certain stock options. The value of the shares received was
      $53,533, which was the market value of the common stock on the date of
      exercise.





Year
      Ended December 31, 2004 :





During
      2004, the Company received 4,166 shares of its common stock as consideration
      for
      the exercise of certain stock options. The value of the shares received was
      $53,533, which was the market value of the common stock on the date of
      exercise.





During
      2004, the Company acquired for $250,000 TxM software and customer lists. The
      consideration consisted of $16,263 in cash and the assumption of $233,707 for
      certain liabilities for services to be performed in the future.





The
      fair
      value of the interest rate swap decreased by $43,916 for the year ended December
      31, 2004. At December 31, 2004, it is valued at $15,152.





See
      Notes
      to Consolidated Financial Statements





F-11


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**







***[1]
      The Company***





The
      Company licenses, customizes and installs its proprietary software products,
      operates a service bureau (“Data Center Services”) and provides Application
      Service Provider (“ASP”) Services and enters into long term maintenance
      agreements with behavioral health and public health organizations, methadone
      clinics and other substance abuse facilities throughout the United States.
      The
      Company currently classifies it operations in five business segments: (1)
      Software and Related Systems and Services - New York (2) Software and Related
      Systems and Services - Ohio (3) Software and Related Systems and Services -
      Public Health (4) Data Center Services and (5) Application Service Provider
      Services (“ASP”). Software and Related Systems and Services for each of the NY,
      Public Health and Ohio segments refer to the design, installation,
      implementation and maintenance of computer information systems that provide
      comprehensive healthcare information technology solutions including billing,
      patient tracking and scheduling for inpatient and out patient environments,
      as
      well as clinical documentation and medical record generation and management.
      Within these segments are large turnkey and small turnkey components. The large
      turnkey components consist mostly of the Avatar suite of products. When the
      Company is engaged in a fixed price arrangement, these large turnkey
      installations will usually extend over a six-month to a multi-year time period;
      these installations are performed in the New York segment. The duration of
      the
      implementation is dependant on the size and complexity of the customer
      organization and the specifics of the implementation. The small turnkey
      components are usually completed within a six-month period. Small turnkey
      contracts performed in the New York segment are mostly related to the Avatar
      methadone related products. The small turnkey contracts in the Ohio and Public
      Health segments are for system installations for behavioral healthcare and
      public health information management software for mental health, substance
      abuse, and addiction services agencies, developmental disability centers and
      behavioral health-related managed care organizations. Revenue for these segments
      is recognized based on the nature of the product sold. See note 2.





The
      Data
      Center Services involve Company personnel performing data entry and data
      processing services for customers. ASP services involve the Company offering
      several of it software products on a virtual private network or internet
      delivery approach, thereby allowing its customers to utilize the Company’s
      products and pay on a monthly service basis.





***[2]
      Summary of Significant Accounting Policies***





***Principles
      of Consolidation -*** The
      Consolidated Financial Statements include Netsmart Technologies, Inc.
      (“Netsmart”), and its wholly-owned subsidiaries, Netsmart New York, Inc.,
      (“NTST-NY”) formerly Creative Socio-Medics Corp. (“CSM”), Netsmart Ohio, Inc.,
      (“NTST-Ohio”), formerly CMHC and Netsmart Public Health Inc., (“NTST-PH”) which
      acquired the assets of QS Technologies, Inc. (“QS”). In addition, the results of
      operations from the ContinuedLearning LLC (“CL”) acquisition are included from
      April 28, 2005, the results of operations from the Addictions Management
      Systems, Inc. (“AMS”) acquisition are included from June 20, 2005, the results
      of operations of the NTST- Ohio acquisition are included from October 1, 2005,
      and the results of operations from the NTST-PH acquisition are included from
      August 1, 2006 (see note 5). All intercompany transactions are eliminated in
      consolidation.





***Estimates
      -*** The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenue and expenses during
      the




F-12




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





reporting
      period. Critical estimates include management’s judgements associated with: the
      application of the percentage of completion method to the recognition of
      revenue, determination of an allowance for doubtful accounts receivable,
      deferred income tax valuation allowance, the application of purchase accounting
      to the Company’s acquisitions and the capitalization, impairment analysis,
      depreciation and amortization of certain long-term assets. Actual results could
      differ from those estimates.





***Cash
      and Cash Equivalents*** - The
      Company considers all highly liquid instruments purchased with a maturity of
      three months or less to be cash equivalents. Cash equivalents totaled
      approximately $6,786,000 and $8,218,000 at December 31, 2006 and 2005,
      respectively.





***Concentration
      of Credit Risk -*** The
      Company extends credit to customers which results in accounts receivable and
      costs and estimated profits in excess of interim billings arising from its
      normal business activities. The Company does not require collateral or other
      security to support financial instruments subject to credit risk. The Company
      routinely assesses the financial strength of its customers and based upon
      factors surrounding the credit risk of the customers, believes that its accounts
      receivable credit risk exposure is limited. If the financial condition of the
      Company’s customers were to deteriorate, resulting in an impairment of their
      ability to make payments, additional allowances might be required. In addition,
      since the Company evaluates each account and invoice on a case-by-case basis,
      the provision could vary from period to period.





The
      Company’s behavioral health information systems are marketed to specialized care
      facilities, many of which are operated by various state and local government
      entities and include entitlement programs. During the years ended December
      31,
      2006, 2005 and 2004, approximately 40%, 44% and 49% respectively, of the
      Company’s revenue were generated from contracts directly or indirectly with
      government agencies.





No
      one
      customer accounted for more than 10% of consolidated revenue for the years
      ended
      December 31, 2006, 2005 and 2004.





The
      Company places its cash and cash equivalents with high credit quality financial
      institutions. The amount on deposit in any one institution that exceeds
      federally insured limits is subject to credit risk. At December 31, 2006 and
      2005, cash and cash equivalent balances of $10.0 million and $11.3 million
      respectively, were held at a financial institution in excess of federally
      insured limits.





***Revenue
      Recognition -*** The
      Company presents its revenue in four different categories: Software and Related
      Systems and Services- Turnkey, Software and Related Systems and Services-
      Maintenance, ASP Services and Data Center Services, as follows:





Software
      and Related Systems and Services- Turnkey





The
      Company recognizes large turnkey revenue from long-term (six months or longer),
      fixed price contracts for financial statement purposes under the percentage
      of
      completion method when significant modification of the software package is
      required to meet the customer specifications. The percentage of completion
      method takes into account progress towards completion of a contract using time
      spent by technical personnel on a particular project as the measuring standard.
      Revisions in cost estimates and




F-13




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





recognition
      of losses on these contracts are reflected in the accounting period in which
      the
      facts become known. Contract terms provide for billing schedules that differ
      from revenue recognition and give rise to costs and estimated profits in excess
      of billings, and billings in excess of costs and estimated profits.





The
      Company recognizes small turnkey revenue from short-term (less than six months),
      fixed price contracts for financial statement purposes under the completed
      contract method. Payments received in advance by customers are deferred until
      earned and represented as deferred revenue in the accompanying balance
      sheet.





The
      Company also enters into multiple element arrangements contracts which do not
      require significant customization and modification, in which it includes a
      software license, one year’s maintenance and sometimes training. In accordance
      with Statement of Position 97-2 “Software Revenue Recognition”, as amended,
      revenue is allocated using the residual method. The Company sells both annual
      maintenance contracts and training separately, with long established pricing
      to
      its customers. Annual maintenance contracts are generally sold at a fee based
      upon a percentage of the underlying software license. The Company also sells
      training separately with established per diem rates for its trainers.
      Accordingly, the Company uses vendor specific objective evidence to ascertain
      the fair values of all undelivered elements in a multiple element arrangement.
      The residual amount is allocated to the software license. Each of these
      components is recognized when persuasive evidence of an arrangement exists,
      delivery has occurred, the fee is fixed and determinable and collectibility
      is
      probable.





The
      Company also derives revenue from the sale of third party hardware and software
      which is recognized based upon the terms of each contract. These sources of
      revenue, which do not require significant customization or modification, are
      recognized when persuasive evidence of an arrangement exists, delivery has
      occurred, the fee is fixed and determinable and collectibility is
      probable.





Software
      and Related Systems and Services- Maintenance


Maintenance
      contract revenue consists of services provided to customers for telephone help
      services, as well as maintaining and upgrading the software, including ongoing
      enhancements. The Company’s maintenance contracts may require it to make
      modifications to meet any new federal or state reporting requirements which
      become effective during the term of the maintenance contract. Maintenance
      contract revenue sold under separate contractual arrangements is recognized
      on a
      straight-line basis over the life of the respective contract.





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





ASP
      Services


ASP
      Services consist of the Company’s offering of its Avatar suite of products,
      including CareNet, Continued Learning (now Netsmart University) and InfoScriber
      products, on a virtual private network or internet delivery approach. This
      service allows the Company’s customers to rapidly deploy its products and pay on
      a monthly service basis instead of making a capital intensive investment in
      the
      purchase of the system at their own facility. ASP Services contract revenue,
      sold under separate contractual arrangements, is recognized on a straight-line
      basis over the life of the respective contract.





F-14


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





Data
      Center Services


Information
      processing revenue, which represents Data Center Services, is recognized in
      the
      period in which the service is provided. The Data Center provides software
      which
      performs clinical and billing services for outpatient facilities, including
      mental health, alcohol and substance abuse facilities. Data Center services
      include statistical reporting, data entry, electronic billing and submission.
      The Company bills its clients on a transaction basis or on a fixed monthly
      fee
      arrangement. Revenue is recognized as the services are performed.





***Property
      and Equipment and Depreciation and Amortization -*** Property
      and equipment is stated at cost less accumulated depreciation and amortization.
      Depreciation of property and equipment is computed using the straight-line
      method at rates adequate to allocate the cost of applicable assets over their
      expected useful lives. Amortization of leasehold improvements is computed using
      the shorter of the lease term or the expected useful life of these
      assets.





Estimated
      useful lives are as follows:





Equipment
            3-7
                YearsFurniture
                and Fixtures
            5-10
                YearsLeasehold
                Improvements
            Life
                of the Lease





***Capitalized
      Software Costs -*** Capitalization of computer software development costs begins upon the
      establishment of technological feasibility. Technological feasibility for the
      Company’s computer software products is generally based upon achievement of a
      detail program design free of high risk development issues. The Company
      capitalizes only those costs directly attributable to the development of the
      software. The establishment of technological feasibility and the ongoing
      assessment of recoverability of capitalized computer software development costs
      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, development and maintenance.
      Activities undertaken after the products are available for general release
      to
      customers to correct errors or keep the product updated are expensed as incurred
      and included in research, development and maintenance. Amortization of
      capitalized computer software development costs commences when the related
      products become available for general release to customers. Amortization is
      provided on a product by product basis and is included in the applicable cost
      of
      revenue. The annual amortization is the greater of the amount computed using
      (a)
      the ratio that current gross revenue for a product bears to the total of current
      and anticipated future gross revenue for that product or (b) the straight-line
      method over the remaining estimated economic life of the product. The estimated
      life of these products range from 3 to 8 years.





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





F-15


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





The
      amounts allocated to purchased software development costs related to the NTST-PH
      acquisition in 2006, NTST-Ohio, CL and AMS acquisitions in 2005 (see note 5),
      totaled $2,305,881, $3,300,000, $692,020 and $2,050,700,
      respectively.





Capitalized
      software development costs applicable to operations are as follows:





Year
                ended December 31,
            
            2006
            
            2005
            
            2004Beginning
                of Year
            
            $
            6,534,551
            
            $
            1,132,453
            
            $
            1,087,116Capitalized
            
            
            2,305,881
            
            
            6,084,720
            
            
            334,872Amortization
            
            
            (1,613,430
            )
            
            (682,622
            )
            
            (289,535
            )**Net**
            
            $
            7,227,002
            
            $
            6,534,551
            
            $
            1,132,453





***Customer
      Lists*** -
      Customer lists represent a listing of customers obtained through the
      acquisitions of CSM, Johnson Computing System, (“Johnson”), Advanced
      Institutional Management Systems (“AIMS”), CareNet, NTST-Ohio, CL, AMS and
      NTST-PH (see note 5), and other to which the Company can market its products.
      Customer lists are being amortized on a straight line method over an estimated
      useful life of 20 years for the NTST -Ohio list, 12 years for the NTST - NY
      and
      Johnson lists, 10 years for the NTST-PH list, 9 years for the CareNet list,
      8
      years for the AMS list, 7 years for the AIMS list, 3 years for the CL lists
      and
      6 years for the other list. The amount allocated to customer lists related
      to
      the NTST-PH, NTST-Ohio, AMS and CL acquisitions are $2,965,100, $5,300,000,
      $1,396,902 and $5,218, respectively.





Customer
      lists at December 31, 2006 and 2005 are as follows:


December
                31,2006
            
            2005Customer
                Lists
            
            $
            15,948,519
            
            $
            12,983,419Less:
                Accumulated Amortization
            
            
            (6,049,692
            )
            
            (4,872,555
            )Net
            
            $
            9,898,827
            
            $
            8,110,864





Amortization
      expense amounted to $1,177,137, $770,493 and $606,352, respectively, for the
      years ended December 31, 2006, 2005 and 2004 and is included in selling, general
      and administrative expenses.





Future
      amortization of customer lists are approximately $1,037,000, $929,000, $890,000,
      $864,000 and $858,000 for the years ending December 31, 2007, 2008, 2009, 2010
      and 2011 respectively, and $5,321,000 thereafter.





***Contract
      Backlog*** -
      Contract backlog represented profit to be earned on customer contracts and
      purchase orders that were not fully completed as of the acquisition date of
      NTST- Ohio, but are expected to be completed at some future point. As a result,
      there was still revenue and profits to be earned on these orders.




F-16


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





Contract
      backlog costs were amortized over a one-year period commencing October 1, 2005
      through September 30, 2006. Contract backlog costs at December 31, 2006 are
      as
      follows:





Contract
                backlog
            
            $
            502,000Less:
                Accumulated Amortization
            
            
            (502,000
            )Net
            
            $
            --





Amortization
      expense amounted to $379,500 for the year ended December 31, 2006.





Pursuant
      to Statement of Financial Accounting Standards (“SFAS”) No. 144, "Accounting for
      the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
      of", the Company evaluates its long-lived assets for financial impairment,
      and
      continues to evaluate them as events or changes in circumstances indicate that
      the carrying amount of such assets may not be fully recoverable.





The
      Company evaluates the recoverability of long-lived assets by measuring the
      carrying amount of the assets against the estimated undiscounted future cash
      flows associated with them. At the time such evaluations indicate that the
      future undiscounted cash flows of certain long-lived assets are not sufficient
      to recover the carrying value of such assets, the assets are adjusted to their
      fair values.





***Goodwill***





Goodwill
      in the amount of $18,445,646 resulted from the acquisition of NTST-Ohio (See
      note 5). Goodwill is not amortized but is tested for impairment at least on
      an
      annual basis or more frequently if events or changes in circumstances indicate
      that the asset might be impaired. We determined that there was no impairment
      of
      goodwill at December 31, 2006.





***Stock
      Options and Similar Equity Instruments*** - At
      December 31, 2006, the Company had three stock-based employee compensation
      plans
      as well as outstanding inducement options granted to certain employees of
      NTST-Ohio, which are described more fully in note 13. Effective January 1,
      2006,
      the Company adopted the fair value recognition provisions of Statement of
      Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based
      Payment,” (SFAS 123R), using the modified -prospective-transition method. As a
      result, the Company’s income before taxes for the year ended December 31, 2006
      is $120,158 lower than if it had continued to account for share -based
      compensation under Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting For Stock Issued to Employees”.





The
      Company has $197,276 of stock based compensation expense remaining to be
      recognized over the period January 2007 through October 2008.





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 elected to continue to
      follow the intrinsic value method in accounting for its stock-based employee
      compensation arrangements, as defined by APB Opinion No. 25, “Accounting for
      Stock Issued to Employees,” and related interpretations including Financial
      Accounting Standards Board




F-17




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**







***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





Interpretation
      No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” an
      interpretation of APB No. 25 for the periods up to and including December 31,
      2005. No stock-based employee compensation cost is reflected in net income
      for
      periods prior to December 31, 2005, as all options granted under those plans
      had
      an exercise price equal to the market value of the underlying common stock
      on
      the date of grant. The following table illustrates the effect on net income
      and
      earnings per share if the Company had applied the fair value recognition
      provisions of SFAS 123 to stock-based employee compensation for periods prior
      to
      December 31, 2005.


Year
                endedDecember
                31,2005
            
            2004Net
                Income as Reported
            
            $
            1,589,776
            
            $
            2,752,965Deduct:
                Total stock-based employee compensationexpense
                determined under the fair value-basedmethod
                for all awards, net of related tax effect
            
            
            1,724,201
            
            
            1,368,139Pro
                Forma Net (Loss) Income
            
            $
            (134,425
            )
            $
            1,384,826Basic
                Net Income Per Share as Reported
            
            $
            .28
            
            $
            .52Basic
                Pro Forma Net (Loss) Income Per Share
            
            $
            (.02
            )
            $
            .26Diluted
                Net Income Per Share as Reported
            
            $
            .27
            
            $
            .50Diluted
                Pro Forma Net (Loss) Income Per Share
            
            $
            (.02
            )
            $
            .25





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:





2005
            
            2004Expected
                Life (Years)
            
            
            5
            
            
            5Interest
                Rate
            
            
            4.00
            %
            
            4.00
            %Annual
                Rate of Dividends
            
            
            0
            %
            
            0
            %Volatility
            
            
            65
            %
            
            68
            %





The
      weighted average fair value of options at date of grant using the fair value
      based method during 2005 and 2004 is estimated at $5.39, and $3.95,
      respectively.


F-18


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





***Earnings
      Per Share -*** Basic
      earnings per share of common stock is computed by dividing net income by the
      weighted average number of shares of common stock outstanding during the period.
      Diluted earnings per share reflects the amount of earnings for the period
      available to each share of common stock outstanding during the reporting period,
      giving effect to all potentially dilutive shares of common stock from the
      potential exercise of stock options and warrants.





The
      computation of diluted earnings per share does not assume conversion, exercise
      or contingent issuance of securities that would have an antidilutive effect
      on
      earnings per share (i.e. improving earnings per share). The dilutive effect
      of
      outstanding options and warrants and their equivalents are reflected in diluted
      earnings per share by the application of the treasury stock method. Options
      and
      warrants will have a dilutive effect only when the average market price of
      the
      common stock during the period exceeds the exercise price of the options or
      warrants. The Company had potentially dilutive options and warrants outstanding
      of 39,900, 30,000 and 300,780 during the years ended December 31, 2006, 2005
      and
      2004, respectively, that were not included in the calculation of diluted
      earnings per share because they were anti dilutive.





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





Year
                ended December 31,2006
            
            2005
            
            2004Numerator:Net
                Income
            
            $
            1,853,463
            
            $
            1,589,776
            
            $
            2,752,965Denominator:Weighted
                average shares
            
            
            6,529,343
            
            
            5,684,191
            
            
            5,331,700Effect
                of dilutive securities:Employee
                stock options
            
            
            200,733
            
            
            244,416
            
            
            205,031Stock
                warrants
            
            
            17,907
            
            
            6,798
            
            
            --Dilutive
                potential common shares
            
            
            218,640
            
            
            251,214
            
            
            205,031Denominator
                for diluted earnings pershare-adjusted
                weighted average sharesafter
                assumed conversions
            
            
            6,747,983
            
            
            5,953,405
            
            
            5,536,731





***Advertising
      -*** Advertising
      costs are expensed as incurred. Advertising expense amounted to $634,986,
      $395,476 and $392,575 for the years ended December 31, 2006, 2005 and 2004,
      respectively.





***Financial
      Instruments -*** SFAS No.
      133, “Accounting for Derivative Instruments and Hedging Activities” as amended,
      requires the recognition of all derivative instruments as either assets or
      liabilities on the balance sheet measured at fair value. Generally, increases
      or
      decreases in the fair value of a derivative instrument will be recognized as
      gains or losses in earnings in the period of change. If the derivative
      instrument is designated and qualifies as a cash flow hedge, the change in
      fair
      value of the derivative instrument will be recorded as a separate component
      of
      stockholders’ equity.




F-19




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





The
      Company entered into interest rate swaps to hedge exposure related to changes
      in
      the LIBOR rate. Before entering into a derivative transaction for hedging
      purposes, it is determined that a high degree of initial effectiveness exists
      between the change in value of the hedged item and the change in the value
      of
      the determinative instrument from movement in interest rates. High effectiveness
      means that the change in the value of the derivative instrument will effectively
      offset the change in the fair value of the hedged item. The effectiveness of
      each hedged item is measured throughout the hedged period. Any hedge
      ineffectiveness as defined by SFAS No. 133 is recognized in the income
      statement.





***New
      Accounting Pronouncements***





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159
      provides companies with an option to report selected financial assets and
      liabilities at fair value.  The objective of SFAS 159 is to reduce
      both complexity in accounting for financial instruments and the volatility
      in
      earnings caused by measuring related assets and liabilities differently.
      Generally accepted accounting principles have required different measurement
      attributes for different assets and liabilities that can create artificial
      volatility in earnings.  The FASB has indicated it believes that
      SFAS 159 helps to mitigate this type of accounting-induced volatility by
      enabling companies to report related assets and liabilities at fair value,
      which
      would likely reduce the need for companies to comply with detailed rules for
      hedge accounting. SFAS 159 also establishes presentation and disclosure
      requirements designed to facilitate comparisons between companies that choose
      different measurement attributes for similar types of assets and liabilities.
      SFAS 159 does not eliminate disclosure requirements included in other
      accounting standards, including requirements for disclosures about fair value
      measurements included in SFAS 157 and SFAS No. 107, “Disclosures about Fair
      Value of Financial Instruments.” SFAS 159 is effective for the Company as of the
      beginning of fiscal year 2009. The Company has not yet determined the impact
      SFAS 159 may have on its consolidated financial position, results of operations,
      or cash flows.





In
      December 2006, the FASB approved FASB Staff Position (FSP) No. EITF
      00-19-2, “Accounting for Registration Payment Arrangements” (“FSP EITF
      00-19-2”), which specifies that the contingent obligation to make future
      payments or otherwise transfer consideration under a registration payment
      arrangement, whether issued as a separate agreement or included as a provision
      of a financial instrument or other agreement, should be separately recognized
      and measured in accordance with SFAS No. 5, “Accounting for
      Contingencies”. FSP EITF 00-19-2 also requires additional disclosure
      regarding the nature of any registration payment arrangements, alternative
      settlement methods, the maximum potential amount of consideration and the
      current carrying amount of the liability, if any. The guidance in
      FSP EITF 00-19-2 amends FASB Statements No. 133, “Accounting for
      Derivative Instruments and Hedging Activities”, and No. 150, “Accounting for
      Certain Financial Instruments with Characteristics of both Liabilities and
      Equity”, and FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure
      Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
      of
      Others”, to include scope exceptions for registration payment arrangements.
      FSP EITF 00-19-2 is effective immediately for registration payment
      arrangements and the financial instruments subject to those arrangements that
      are entered into or modified subsequent to the issuance date of this FSP, or
      for
      financial statements issued for fiscal years beginning after December 15, 2006,
      and interim periods within those fiscal years, for registration payment
      arrangements entered into prior to the issuance date of this FSP. The adoption
      of this pronouncement is not expected to have an impact on the Company’s
      consolidated financial position, results of operations or cash
      flows.




F-20


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[2]
      Summary of Significant Accounting Policies -
      [Continued]***





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
      157”). This statement defines fair value, establishes a framework for measuring
      fair value in accordance with accounting principles generally accepted in the
      United States (“GAAP”), and expands disclosures about fair value measurements.
      SFAS 157 does not require any new fair value measurements. However, for some
      entities, the application of SFAS 157 will change current practice. SFAS 157
      is
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years, with earlier
      application permitted. The Company does not expect SFAS 157 to have a material
      impact on the Company’s financial position or results of
      operations.





In
      September 2006, the staff of the Securities and Exchange Commission issued
      Staff
      Accounting Bulletin No. 108 (“SAB 108”) which provides interpretive guidance on
      how the effects of the carryover or reversal of prior year misstatements should
      be considered in quantifying a current year misstatement. SAB 108 becomes
      effective in fiscal 2007. Adoption of SAB 108 did not have a material impact
      on
      the Company’s consolidated financial position or results of
      operations.





In
      July
      2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty
      in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48
      clarifies the accounting and reporting for uncertainties in income tax law.
      FIN
      48 prescribes a comprehensive model for the financial statement recognition,
      measurement, presentation and disclosure of uncertain tax positions taken or
      expected to be taken in income tax returns. FIN 48 shall be effective for fiscal
      years beginning after December 15, 2006. The cumulative effects, if any, of
      applying FIN 48 will be recorded as an adjustment to retained earnings as of
      the
      beginning of the period of adoption. The Company has commenced the process
      of
      evaluating the expected effect of FIN 48 on its financial position and results
      of operations and is currently unable to determine such effects.





In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets” (“SFAS 156”), which amends SFAS 140, "Accounting for Transfers and
      Servicing of Financial Assets and Extinguishments of Liabilities,” with respect
      to the accounting for separately recognized servicing assets and servicing
      liabilities. SFAS 156 permits the choice of the amortization method or the
      fair
      value measurement method, with changes in fair value recorded in income for
      the
      subsequent measurement for each class of separately recognized servicing assets
      and servicing liabilities. The statement is effective for years beginning after
      September 15, 2006, with earlier adoption permitted. The Company does not expect
      SFAS 156 to have a material impact on the Company's financial position or
      results of operations.





In
      October 2005, the FASB issued FSP FAS 123(R)-2, “Practical Accommodation to the
      Application of Grant Date as Defined in FASB Statement No. 123(R)”, which
      provides clarification of the concept of mutual understanding between employer
      and employee with respect to the grant date of a share-based payment award.
      This
      FSP provides that a mutual understanding of the key terms and conditions of
      an
      award shall be presumed to exist on the date the award is approved by management
      if the recipient does not have the ability to negotiate the key terms and
      conditions of the award and those key terms and conditions will be communicated
      to the individual recipient within a relatively short time period after the
      date
      of approval. This guidance was applicable upon the initial adoption of SFAS
      123(R). The adoption of this pronouncement did not have an impact on the
      Company's consolidated financial position, results of operations, or cash
      flows.




F-21




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[3]
      Accounts Receivable***





Accounts
      receivable is shown net of allowance for doubtful accounts of $682,409 and
      $350,291 at December 31, 2006 and 2005, respectively. The changes in the
      allowance for doubtful accounts are summarized as follows:


Year
                Ended December 31,2006
            
            2005Beginning
                Balance
            
            $
            443,666
            
            $
            517,095Provision
                (credit) for Doubtful Accounts
            
            
            770,727
            
            
            465,004Charge-offs
            
            
            (531,984
            )
            
            (538,433
            )Ending
                Balance
            
            $
            682,409
            
            $
            443,666








***[4]
      Costs, estimated profits, and billings on uncompleted contracts are summarized
      as follows:***


December
                31,2006
            
            2005Costs
                Incurred on Uncompleted Contracts
            
            $
            10,032,972
            
            $
            5,389,787Estimated
                Profits
            
            
            3,599,608
            
            
            3,028,931Total
            
            
            13,632,580
            
            
            8,418,718Billings
                to Date
            
            
            15,691,407
            
            
            14,545,154**Net**
            
            $
            (2,058,827
            )
            $
            (6,126,436
            )




Included
      in the accompanying consolidated balance sheet under the following
      captions:





Costs
                and estimated profits in excess of interim billings
            
            $
            2,936,575
            
            $
            1,811,986Interim
                billings in excess of costs and estimated profits
            
            
            (4,995,402
            )
            
            (7,938,422
            )**Net**
            
            $
            (2,058,827
            )
            $
            (6,126,436
            )





F-22




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[5]
      Acquisitions***





On
      August
      1, 2006, the Company acquired certain assets, including computer software,
      customer lists and computer equipment of QS. The purchase price totaled
      approximately $5,466,000 as follows: an initial payment of $1,900,000 in cash
      and a three year $1,435,000 promissory note paid monthly, with an annual
      interest rate of 8.25% together with the assumption of approximately $2,095,000
      in net liabilities, consisting principally of deferred revenue, and acquisition
      costs of approximately $36,000. The transaction also provides for potential
      additional payments to the seller of up to $1,450,000 in 2008, contingent upon
      the attainment of performance milestones by the NTST-PH business through 2007.
      The milestones would result from the attainment of maintenance revenue, vital
      records contract awards, and other software contract awards. The attainment
      of
      these milestones would result in a contingent purchase price adjustment. The
      NTST-PH business delivers enterprise-wide public health solutions and vital
      records software to 70 public health agencies, including nine states. The
      Company also assumed the facility lease of NTST-PH in Greenville, South
      Carolina. This lease has a total square footage of 5,761, is non cancelable
      and
      expires on February 23, 2011. The annual rent is $77,772 and is subject to
      escalation clauses.





The
      cost
      of the NTST-PH acquisition was allocated as follows: $2,965,000 to customer
      lists, $2,306,000 to purchased software, $167,000 to other current assets and
      $28,000 to properly and equipment. The Company is amortizing the customer list
      over a 10 year life, the purchased software over a 6 year life and the property
      and equipment over a 2 year life.





In
      2005,
      the Company completed acquisitions of three companies with products and services
      complementary to its existing offerings. The Company acquired Continued Learning
      (“CL”), a Florida-based provider of online training services on April 28, 2005.
      On June 20, 2005, the Company acquired Addiction Management Systems, Inc
      (“AMS”). In September 2005, the Company completed the acquisition of CMHC
      Systems (“NTST- Ohio”), a leading competitor in the behavioral healthcare
      software market.





CL





On
      April
      28, 2005, the Company acquired substantially all of the assets, including
      computer software, customer lists and computer equipment, of CL, a company
      that
      offered a comprehensive family of web-based training products and services,
      including its Learning Management System. The total purchase price, including
      acquisition costs and a recognition of a probable additional payment, was
      $739,238 which consisted of cash of $252,917, which was paid out of existing
      working capital including legal fees of $18,632, and broker fees of $10,000,
      20,000 shares of the Company’s common stock valued at $191,400, assumed
      liabilities of $44,921 and an accrual for a probable additional payment of
      $250,000.




F-23




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[5]
      Acquisitions - [Continued]***





The
      purchase agreement provides for the potential additional payment of up to
      $250,000 if certain revenue targets are met in year one. Based upon the
      attainment of certain revenue targets as of December 31, 2005, the Company
      recognized the full $250,000 of this additional payment at December 31, 2005.
      This amount has been paid in 2006. The Company also entered into a two year
      employment agreement at an annual salary of $100,000 per year with the principal
      of CL, whereby the principal can receive up to an additional $300,000 in cash,
      to be accounted for as compensation expense, if certain revenue targets are
      met
      within a two-year period. As of December 31, 2006, certain revenue targets
      have
      been met and additional compensation expense in the amount of $100,000 has
      been
      recognized and paid.





The
      cost
      of the CL acquisition was allocated as follows: $692,020 to purchased software,
      $5,218 to customer lists, $17,000 to computer hardware, and $25,000 to a
      covenant not to compete. The Company is amortizing the purchased software over
      a
      6 year life, the customer lists and computer hardware over a 3 year life, and
      the covenant not to compete over a 2 year life. Amortization expense for the
      covenant not to compete was $8,333 for the year ended December 31,
      2005.





AMS





On
      June
      20, 2005, the Company acquired the assets of AMS. The total purchase price,
      including acquisition costs, was $3,610,682 which consisted of cash of
      $2,641,945, legal fees of $19,904 and assumed liabilities for services to be
      provided of $948,833.





The
      cost
      of the AMS acquisition was allocated as follows: $2,050,700 to purchased
      software, $1,396,902 to customer lists, $127,698 to accounts receivable, $32,048
      to inventory, and $3,334 to a security deposit. The Company is amortizing the
      purchased software and the customer lists over an 8 year life.





NTST-Ohio





On
      September 28, 2005, the Company acquired 100% of the equity interest of
      NTST-Ohio (formerly CMHC) a company that offers a full suite of behavioral
      healthcare information management software for mental health, substance abuse,
      and addiction services agencies, developmental disability centers, and
      behavioral health-related managed care organizations. The primary reason for
      this acquisition was to acquire a significant customer base (over 400 clients)
      which provided a large recurring revenue stream, and included a workforce with
      significant domain knowledge.





The
      Company believes that due to the factors above and the potential long range
      benefits of the combined company that the purchase price paid fairly represents
      the value of NTST-Ohio. The purchase price totaled approximately $19,565,956
      as
      follows: 435,735 shares of the Company’s common stock (valued at $4,915,091),
      $12,994,758 in cash plus additional cash consideration recorded in accrued
      expenses as of December 31, 2005, estimated at $792,024 as required by the
      “working capital adjustment”, calculated and payable in accordance with the
      merger agreement, and acquisition costs of $864,083. During 2006, the working
      capital adjustment was finalized and the estimated amount of $792,024 was
      settled for a payment of $524,935. The difference of $267,089 was reflected
      as a
      reduction in goodwill and accrued expenses. Additionally during 2006, the
      Company evaluated the assets and liabilities acquired from CMHC and increased
      deferred revenue by $151,218 and accrued





F-24


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[5]
      Acquisitions - [Continued]***





expenses
      by $342,766, which was partially offset by an increase in deferred tax asset
      of
$517,000,
      resulting in a net increase to goodwill of $290,105.





The
      Company also renegotiated and assumed the NTST-Ohio facility lease in Dublin,
      Ohio. This facility is leased from a Partnership whose general partner is the
      former majority stockholder of CMHC and currently a 5.3% stockholder of the
      Company. This lease has a total square footage of 34,230, is non cancelable
      and
      expires on September 30, 2010. The annual rent is $377,172 and is subject to
      annual real estate tax assessments.





John
      Paton, the former majority stockholder of CMHC Systems, entered into an
      employment agreement with the Company pursuant to which Mr. Paton is to receive,
      in addition to the amounts he received as a former security holder of CMHC,
      a
      base salary at the rate of $150,000 per annum for the fifteen month term of
      the
      agreement.





The
      following table summarizes the estimated fair value of the assets acquired
      and
      liabilities assumed at the date of the acquisition of NTST-Ohio.





**At
      September 30, 2005**


($
      in
      thousands)





Cash
            
            $
            4,218Other
                current assets
            
            
            2,880Property
                and equipment - net
            
            
            464Capitalized
                software cost
            
            
            3,300Customer
                lists
            
            
            5,300Goodwill
            
            
            18,736Contract
                backlog
            
            
            502Deferred
                tax asset - long term
            
            
            1,381Other
                assets
            
            
            26Total
                assets acquired
            
            
            36,807Deferred
                revenue
            
            
            8,134Other
                current liabilities
            
            
            5,898Deferred
                tax liability - long term
            
            
            3,171Long-term
                debt
            
            
            38Total
                liabilities assumed
            
            
            17,241Net
                assets acquired
            
            $
            19,566




Included
      in other current liabilities of $5,898,000 is a promissory note which NTST-Ohio
      issued in April 2005 in the amount of $500,000. This note accrued interest
      at a
      rate of 14% per annum and was due on October 31, 2005. This promissory note
      was
      paid in full in October 2005.





None
      of
      the goodwill or amortization of the contract backlog, capitalized software
      or
      customer list will be deductible on the Company’s tax return. For financial
      statement purposes the Company is amortizing


F-25


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[5]
      Acquisitions - [Continued]***





the
      contract backlog over one year, the capitalized software over 4 years and the
      customer list over 20 years. The goodwill is not amortized and will be reviewed
      each year to determine if any impairment adjustment will be
      required.





The
      following unaudited proforma condensed financial information of operations
      assumes the CL, AMS, NTST-Ohio and NTST-PH acquisitions occurred on January
      1,
      2005. Shares related to the private placement (see note 9) are included in
      the
      weighted average per share calculations. In the opinion of management, all
      adjustments necessary to present fairly such unaudited proforma statements
      have
      been made. These proforma amounts may not be indicative of what would have
      occurred had the acquisitions been completed on January 1, 2005 or results
      which
      may occur in the future.





Years
                EndedDecember
                31,2006
            
            2005Unaudited
            
            Unaudited(in
                thousands, except share and per share amounts)Revenue
            
            $
            60,554
            
            $
            60,053Net
                Income
            
            
            2,458
            
            
            1,654Net
                Income Per Share;Basic
            
            $
            .38
            
            $
            .26Diluted
            
            $
            .36
            
            $
            .25Weighted
                Average Numberof
                Shares of CommonStock
                Outstanding
            
            
            6,529,343
            
            
            6,387,381Weighted
                Average Numberof
                Shares of CommonStock
                and Common StockEquivalents
                Outstanding
            
            
            6,747,983
            
            
            6,638,595





The
      Company accounted for the CL, AMS, NTST-PH and NTST-Ohio acquisitions pursuant
      to the purchase method of accounting as required under SFAS No. 141 “Business
      Combinations”.





Purchase
      price allocations are subject to change. Changes could include a reallocation
      of
      intangible assets which would likely have the effect of increasing or decreasing
      future amortization expense, since the intangible assets are initially assigned
      varied lives. Additionally, the lives assigned to the identifiable intangible
      assets represent management’s best estimates of the time periods in which it
      will continue to receive benefits from these assets. The useful lives may need
      to be adjusted in the future based upon changes to the expected useful lives
      of
      such assets.


F-26


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**







***[6]
      Property and Equipment***





Property
      and equipment consist of the following:


December
                31,2006
            
            2005Equipment,
                Furniture and Fixtures
            
            $
            4,962,940
            
            $
            3,843,666Leasehold
                Improvements
            
            
            678,186
            
            
            632,989Totals
                - At Cost
            
            
            5,641,126
            
            
            4,476,655Less:
                Accumulated Depreciationand
                Amortization
            
            
            2,914,703
            
            
            1,811,226**Net**
            
            $
            2,726,423
            
            $
            2,665,429





Depreciation
      and amortization expense amounted to $1,111,417, $820,841, and $681,839,
      respectively for the years ended December 31, 2006, 2005 and 2004.


***[7]
        Long Term Debt***
 
 Long-term
        debt at December 31, 2006 consists of the following:
 
 Term
                  loan payable, bank - due in monthly installmentsof
                  $41,667 (a)
              
              $
              1,916,662Note
                  payable, Intelligent Systems - due in monthlyinstallments
                  of $45,133 which includes interest (b)
              
              
              1,292,468Total
                  Long-Term Debt
              
              
              3,209,130Less:
                  Current Portion
              
              
              951,802Long-Term
                  Debt, Less Current Portion
              
              $
              2,257,328
 
 (a)
        On
        October 7, 2005, the Company entered into a revolving credit and term loan
        agreement with Bank of America pursuant to which the bank has agreed to make
        loans to the Company consisting of (i) a $2,500,000 revolving credit loan
        and
        (ii) a $2,500,000 term loan (collectively, the “Loans”).
 
 The
        Loans
        are secured by a security interest in the Company’s personal property, including
        a pledge of the stock of the Company’s wholly-owned subsidiaries. The Loans are
        guaranteed by the Company’s significant wholly-owned subsidiaries, NTST-NY,
        NTST-PH and NTST-Ohio, whose assets represent substantially all of the assets
        of
        the Company.




F-27


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[7]
        Long Term Debt - [Continued]***


On
      October 7, 2005, the Company borrowed the full amount of the $2,500,000 term
      Loan. The Company has not borrowed any amounts under the revolving credit Loan.
      The term Loan bears interest at LIBOR plus 2.25%. The Company has entered into
      an interest rate swap agreement with the Bank for the amount outstanding under
      the term Loan whereby it converted the variable rate on the term Loan to a
      fixed
      rate of 7.1% in order to reduce the interest rate risk associated with these
      borrowings (Note 12). The revolving credit facility will bear interest at a
      rate
      per annum to be elected by the Company, equal to either (1) the LIBOR rate
      plus
      2% or (2) the Bank’s prime rate. The financing agreement contains certain
      covenants including limitations on the Company’s ability to incur liens,
      maintain a minimum tangible net worth of $2,250,000 and requires the maintenance
      of certain financial ratios. As of December 31, 2006, we were not in compliance
      with one of the financial covenants of the Financing Agreement. The Bank has
      waived our non-compliance so that at December 31, 2006, we were in compliance
      with the covenants of the term Loan.





(b)
      In
      connection with the acquisition of NTST-PH (see note 5), the Company issued
      a
      three year promissory note to Intelligent Systems, Inc. in the principal amount
      of $1,435,000 payable in 36 monthly installments of principal and interest
      calculated at 8.25%.


Maturities
        of long-term debt at December 31, 2006 are as follows:
 
 For
                  the Year EndingDecember
                  31,
              
              Amount2007
              
              $
              951,8022008
              
              
              990,5182009
              
              
              850,1482010
              
              
              416,662Total
              
              $
              3,209,130
  ***[8]
        Income Taxes***
 
 The
        Company utilizes an asset and liability approach to determine the extent
        of any
        deferred income taxes, as described in SFAS No. 109, “Accounting for Income
        Taxes.” This method gives consideration to the future tax consequences
        associated with differences between financial statement and tax bases of
        assets
        and liabilities.
 
 During
        the years ended December 31, 2006 and 2005, the Company utilized approximately
        $2.2 million and $2.9 million, respectively of net operating loss carryforwards.
        At December 31, 2006, the Company has remaining net operating loss carryforwards
        of approximately $3,321,000 expiring through 2025. Pursuant to Section 382
        of
        the Internal Revenue Code regarding substantial changes in Company ownership,
        utilization of this net operating loss carryforward is limited. Approximately
        $830,000 can be used in each of 2007, 2008, 2009 and 2010; unused amounts
        can be
        carried forward. In addition, the $717,000 tax benefit related to approximately
        $1,800,000 of net operating losses generated in 2000 on exercise of
        non-qualified compensatory stock options and warrants was credited to
        paid-in-capital in 2004.
 
 The
        Company’s provision for taxes for the year ended December 31, 2006 includes
        certain state and local taxes.


F-28





**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[8]
      Income Taxes - [Continued]***





The
      expiration dates of net operating loss carryforwards are as
      follows:





December
                31,
            
            TotalAmount2021
            
            $
            1,537,0002022
            
            
            9,0002023
            
            
            709,0002024
            
            
            9,0002025
            
            
            1,057,000$
            3,321,000




Provision
      for income taxes consists of the following:





Year
                ended December 31,2006
            
            2005
            
            2004Current:Federal
            
            $
            1,730,000
            
            $
            63,000
            
            $
            56,000State
            
            
            559,000
            
            
            261,000
            
            
            131,0002,289,000
            
            
            324,000
            
            
            187,000Deferred:Federal
            
            
            (113,000
            )
            
            642,000
            
            
            104,000State
            
            
            234,000
            
            
            193,000
            
            
            18,000121,000
            
            
            835,000
            
            
            122,000Total
            
            $
            2,410,000
            
            $
            1,159,000
            
            $
            309,000




F-29


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[8]
      Income Taxes - [Continued]***





The
      difference between income taxes at the statutory Federal income tax rate and
      income taxes reported in the income statement is as follows:




Year
                ended December 31,2006
            
            2005
            
            2004Income
                taxes at the federal statutory rate
            
            
            34
            %
            
            34
            %
            
            34
            %State
                and local income taxes net of Federal taxes
            
            
            7.7
            
            
            6
            
            
            3Nondeductible
                expenses(1)
            
            
            14.1
            
            
            1
            
            
            2Federal
                Alternative Minimum Tax
            
            
            --
            
            
            1
            
            
            2Other
            
            
            .7
            
            
            --
            
            
            --Decrease
                in valuation allowance
            
            
            --
            
            
            --
            
            
            (31
            )%56.5
            %
            
            42
            %
            
            10
            %


(1)Includes
      $1,581,000 of cost associated
      with the proposed merger transaction.




Significant
      components of the Company’s deferred taxes are comprised of the
      following:




December
                31,2006
            
            2005Deferred
                Tax Asset:Net
                operating loss carryforward
            
            $
            1,214,000
            
            $
            2,024,000Allowance
                for doubtful accounts
            
            
            228,000
            
            
            175,000Accrued
                vacation and bonuses
            
            
            233,000
            
            
            384,000Alternative
                minimum tax credit carryforward
            
            
            --
            
            
            241,000Net
                book value property plant and equipment
            
            
            47,000
            
            
            278,000Deferred
                Stock Option Compensation
            
            
            46,000
            
            
            --Other
            
            
            294,000
            
            
            (37,000
            )Total
                deferred tax assets
            
            
            2,062,000
            
            
            3,065,000Deferred
                Tax Liabilities:Net
                book value - intangible assets
            
            
            (2,190,000
            )
            
            (3,589,000
            )Net
                deferred tax liability assets
            
            $
            (128,000
            )
            $
            (524,000
            )




The
      deferred taxes are presented in the Consolidated Balance Sheet as
      follows:




December
                31,2006
            
            2005Current
                asset
            
            $
            755,000
            
            $
            1,595,000Long
                term liability
            
            
            (883,000
            )
            
            (2,119,000
            )Net
                deferred tax liability assets
            
            $
            (128,000
            )
            $
            (524,000
            )





F-30


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[8]
      Income Taxes - [Continued]***





During
      2004, the Company reduced the valuation allowance totaling $1,731,000 at January
      1, 2004 to zero based upon its belief that it is more likely than not that
      the
      entire net operating loss carry forward will be utilized.




***[9]
      Stockholders’ Equity***





The
      Company’s Board of Directors is authorized to issue preferred stock from time to
      time without stockholder action, in one or more distinct series. The Board
      of
      Directors is authorized to determine the rights and preferences of the preferred
      stock when issued. The Board of Directors has authorized the issuance of Series
      A, Series B and Series D preferred stock. No shares of any series of preferred
      stock were outstanding on December 31, 2006.





***Common
      Stock Issuances -*** In June
      2006, the Company issued 3,489 shares of its common stock in connection with
      an
      investor relations agreement in addition to consulting fees. These shares were
      valued at $12.90, the fair market value at the date of grant. On April 28,
      2005,
      the Company issued 20,000 shares of its common stock in connection with the
      acquisition of CL. On September 28, 2005, the Company issued 435,735 shares
      of
      its common stock in connection with the acquisition of NTST-Ohio.





In
      October 2003, the Company sold to investors, pursuant to a private placement
      agreement, an aggregate 490,000 shares of common stock and warrants to purchase
      122,504 shares of common stock. The Company received $4,493,104 in gross
      proceeds and paid commissions of $275,000 and $102,976 in other professional
      costs during 2005 and $158,350 in other professional costs in 2006 related
      to
      the private placement. The Company also issued a warrant to purchase 24,500
      shares to the placement agent. The private placement agreement required the
      Company to file a registration statement within 30 days of the closing of the
      private placement, and to use its reasonable best efforts to have such
      registration statement declared effective within 90 days of the closing to
      keep
      such registration statement effective for a two year period. Generally, the
      private placement agreement further provided for a penalty to be paid to the
      investors should the Company fail to meet its registration obligations. Such
      penalty was payable to the investors in cash at the rate of 2.5% of the gross
      proceeds per month, up to a maximum penalty of 20% of the gross proceeds. The
      Company has satisfied its registration obligations. The Company has accounted
      for the proceeds of the private placement as equity in accordance with View
      A of
      EITF 05-04, “The Effect of a Liquidated Damages Clause on a Freestanding
      Financial Instrument Subject to Issue No. 00-19”. Any potential penalties
      incurred pursuant to the registration rights agreement will be recorded in
      earnings when and if incurred as per SFAS 5, “Accounting for Contingencies”. As
      of December 31, 2006, the Company has not incurred any penalties relating to
      this private placement.





***Treasury
      Stock*** - During
      2006, options and warrants to purchase 64,390 shares were exercised and the
      Company received gross proceeds of $570,355. Pursuant to option grants,
      employees have the right to pay for the exercise price of the options by
      delivering “mature” shares of common stock owned by them. Included in the
      proceeds received upon the exercise of options were 639 shares of the Company’s
      common stock. The value of the shares received was $8,200, which was based
      upon
      the market value of the common stock on the date of exercise in accordance
      with
      the cashless exercise provisions of the Company’s stock option
      plans.





F-31


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[9]
      Stockholders’ Equity - [Continued]***





During
      2005, options to purchase 206,658 shares were exercised and the Company received
      gross proceeds of $854,240. Pursuant to option grants, employees have the right
      to pay for the exercise price of the options by delivering “mature” shares of
      common stock owned by them. Included in the 2005 exercise of options were 12,250
      options owned by a Company officer. These options were exercised by the delivery
      of 3,650 shares of the Company’s common stock, which were valued at $53,532,
      which was based upon the market price of the common stock on the dates of
      exercise in accordance with the cashless exercise provisions of the Company’s
      stock option plans.





During
      2004, options to purchase 38,877 shares were exercised and the Company received
      gross proceeds of $166,400. Pursuant to the option grants, employees have the
      right to pay for the exercise price of the options by delivering “mature” shares
      of common stock owned by them. Included in the 2004 exercise of options were
      12,250 options owned by a Company officer. These options were exercised by
      the
      delivery of 4,166 shares of the Company’s common stock, which were valued at
      $53,533, which was based upon the market price of the common stock on the dates
      of exercise in accordance with the cashless exercise provisions of the Company’s
      stock option plans.





***Stock
      Options and Warrants -*** See note
      13 for information relating to the Company’s 1998, 1999 and 2001 Long-Term
      Incentive Plans.





During
      2005, the Company announced the completion of a private placement of units
      consisting of an aggregate 490,000 shares of its common stock and warrants
      to
      purchase 147,003 shares of common stock, which include 24,500 warrants issued
      to
      the placement agent. The warrants have an exercise price of $11 per share.
      The
      Company received net proceeds of approximately $4.0 million.





During
      2005, the Company granted 30,000 inducement options to employees of NTST-Ohio
      to
      encourage the recipients to continue to remain in the employ of NTST-Ohio after
      the acquisition. The options were granted at a price of $14.77 which was equal
      to the fair market value at the date of grant. The options vest over a period
      of
      three years. The fair value of the options granted was $250,000.





On
      December 21, 2000, the stockholders of the Company approved the 1999 Employee
      Stock Purchase Plan. The plan reserves 150,000 shares of common stock. The
      plan
      provides eligible employees with the opportunity to purchase shares of common
      stock at a discounted price through regular payroll deductions. No shares have
      been issued as of December 31, 2006 under this plan.





F-32




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[10]
      Capital Lease Obligations***





Future
      minimum payments under capital lease obligations as of December 31, 2006 are
      as
      follows:





Year
                endingDecember
                  31,Total
                Minimum Payments due in 2007
            
            $
            9,695Less
                Amount Representing Interest at 11.63% Per annum
            
            
            174Balance
            
            $
            9,521




Capital
      lease obligations are collateralized by equipment which has a cost of $37,180
      at
      December 31, 2006 and $214,426 at December 31, 2005 and accumulated amortization
      of $34,082 and $162,119 at December 31, 2006 and 2005, respectively.
      Amortization of $33,580 in 2006 and $70,456 in 2005 and 61,109 in 2004,
      respectively, has been included in depreciation expense.




***[11]
      Fair Value of Financial Instruments***





The
      carrying amount of cash and cash equivalents, accounts receivable, accounts
      payable and the note payable to Intelligent Systems approximate the fair value
      of these instruments because of their short maturities or floating interest
      rates.





The
      bank
      debt (see note 7), including current maturities, has a carrying value of
      $1,916,662 and an estimated fair value of $1,910,000. Estimated fair value
      is
      based on the expected current rates offered to the Company for instruments
      of
      the same or similar maturities, after considering the effect of the interest
      rate swap.




***[12]
      Commitments and Contingencies***





***Leases***





The
      Company leases space for its executive offices and facilities under an operating
      lease expiring October 2014 which has an option to cancel in December 2009.
      The
      lease is for a ten year and ten month period. The lease provides for a fixed
      monthly rent of $45,700 and includes an annual escalation increase of 3%. There
      are no lease payments required during the first ten months of the lease and
      the
      Company has the option of canceling the lease after six years. However, upon
      cancellation, certain unamortized costs must be reimbursed to the landlord.
      Future maturities of this lease were considered for the entire ten year and
      ten
      month period. In addition, the Company leases six sales and service offices
      under non cancelable operating leases expiring at various times through December
      2010. The Company leases space for NTST-Ohio under a non-cancellable operating
      lease expiring September 2010. The lease provides for a fixed monthly rent
      of
      approximately $31,000. This facility is leased from a Partnership whose general
      partner is a 5.3% stockholder of the Company. The amount paid in connection
      with
      this facility was $377,000 for the year ended December 31, 2006.





F-33


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[12]
      Commitments and Contingencies - [Continued]***





Minimum
      annual rentals under noncancellable operating leases having terms of more than
      one year are as follows:





Year
                endingDecember
                31,2007
            
            
            1,317,0002008
            
            
            1,328,0002009
            
            
            1,270,0002010
            
            
            1,201,0002011
            
            
            853,000Thereafter
            
            
            2,588,000Total
            
            $
            8,557,000




Rent
      expense amounted to $1,277,900, $1,009,700 and $833,000 respectively, for the
      years ended December 31, 2006, 2005 and 2004.





***Employment
      Agreements***





In
      April
      2004, the Company entered into revised employment agreements with Messrs. James
      L. Conway and Anthony F. Grisanti. The terms and conditions of the revised
      contracts are identical in all material respects to the previous contracts
      except that (i) the term of each individual’s contract was extended by one year,
      so that Messrs. Conway and Grisanti’s contract were to expire on December 31,
      2006 and (ii) the revised contracts do not provide for a five-year consulting
      period following each individual’s respective term of employment during which
      such individual would have been entitled to compensation of $75,000 per year.
      Messrs. Conway and Grisanti’s contracts also provide for an option, which have
      been exercised, to extend their contracts for one additional year so that their
      contracts would expire on December 31, 2007.





During
      November 2006, in connection with the proposed merger transaction, we entered
      into new contracts with each of Mr. Conway (the “Conway Agreement”) and Mr.
      Grisanti (the “Grisanti Agreement”). These agreements were entered into in
      connection with the proposed merger transaction and are not a part of our
      compensation program. Consequently, the Conway Agreement and Grisanti Agreement
      were not approved by the Compensation Committee. The Conway Agreement provides
      that following the closing of the proposed merger, Mr. Conway will continue
      to
      act as the Chief Executive Officer of Netsmart for a term of two years
      commencing on the date of the closing of the merger, such term to be
      automatically renewed for successive one year terms thereafter unless the Conway
      Agreement is terminated pursuant to its terms. During the term of the Conway
      Agreement, Mr. Conway will continue to receive a base salary of $367,500, which
      is his current base salary, and will no longer have the right to automatic
      annual base salary increases, as provided in his current employment agreement.
      The Conway agreement also provides for a change of control payment in the amount
      of $1 million.





F-34


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[12]
      Commitments and Contingencies - [Continued]***





Under
      the
      terms of the Grisanti Agreement, following the closing of the proposed merger
      transaction, Mr. Grisanti will continue to act as the Chief Financial Officer
      of
      Netsmart for a term of two years commencing on the date of the closing of the
      merger, such term to be automatically renewed for successive one year terms
      thereafter unless the Grisanti Agreement is terminated pursuant to its terms.
      During the term of the Grisanti Agreement, Mr. Grisanti will continue to receive
      a base salary of $204,750, which is his current base salary, and will no longer
      have the right to automatic annual base salary increases, as provided in his
      current employment agreement. The Grisanti agreement also provides for a change of control
      payment in the amount of $601,500.





In
      February 2005, one of our subsidiaries, Netsmart New York, entered into an
      employment agreement with Mr. Kevin Scalia as an Executive Vice President of
      the
      Company with such contract expiring on February 14, 2008. Mr. Scalia’s contract
      provides for an option to extend his contract for continuing subsequent two
      year
      terms unless terminated by the Company or Mr. Scalia on not less than sixty
      days
      written notice prior to the expiration of the contract.





In
      January 2006, one of our subsidiaries, Netsmart New York, entered into an
      employment agreement with Mr. Alan Tillinghast as an Executive Vice President
      of
      the Company with such contract expiring on December 31, 2008. Mr. Tillinghast’s
      contract provides for an option to extend his contract for continuing subsequent
      two year terms unless terminated by the Company or Mr. Tillinghast on not less
      than sixty days written notice prior to the expiration of the
      contract.





The
      minimum aggregate base compensation for its four officers is $930,000 for 2006.
      The minimum aggregate base compensation for its four officers is $976,000 in
      2007 and $222,000 in 2008, subject to annual increases equal to the greater
      of
      5% or the increase in the cost of living index. The agreements also provide
      for
      the officers with an automobile allowance. In the event of a change of control,
      Messrs. Conway and Grisanti may receive severance payments equal to 48 months
      compensation.





The
      Company also has a consulting agreement with a former Director, which provides
      for annual fees of $75,000 through December 31, 2007. The agreement also
      provides the former Director with an automobile allowance. In the event of
      a
      change of control, the former Director may receive severance payments of 36
      months compensation.





Effective
      April 1, 2004, the Company adopted an Executive Retirement, Non-Competition
      and
      Consulting Plan which was subsequently amended August 5, 2004 retroactively
      effective to April 1, 2004, pursuant to which, following their retirement,
      selected officers will be entitled to receive a minimum payment of approximately
      $85,000 per year for a period of six years, provided, that such officers (i)
      provide a minimum amount of consulting days each month and (ii) agree to certain
      covenants not to compete. The annual payments are subject to 10% increases
      up to
      a maximum of $136,893 per year. Pursuant to the Executive Retirement,
      Non-Competition and Consulting Plan, the selected officers are also entitled
      to
      receive health benefits for life, provided that there are no breaches of the
      covenants not to compete. Each of Messrs. Conway and Grisanti are entitled
      to
      receive benefits under the plan.





The
      Company was a party to an employment agreement with John Phillips, a former
      Vice
      President and director of the Company. Mr. Phillip’s employment contract expired
      on December 31, 2003 and he retired




F-35




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[12]
      Commitments and Contingencies - [Continued]***





effective
      April 1, 2004. Pursuant to the terms of the Company’s Executive Retirement,
      Non-Competition and Consulting Plan, Mr. Phillips will receive $85,000 per
      year
      for each of the next six years commencing from the date of retirement; provided
      that he complies with the non-competition covenants of the plan.





Future
      minimum payments related to consulting and Executive Retirement, Non-Competition
      and Consulting agreements for the next five years are as follows:


Year
                EndingDecember
                31,
            
            Amount2007
            
            
            169,0002008
            
            
            85,0002009
            
            
            85,0002010
            
            
            21,000Total
            
            $
            360,000




***Interest
      Rate Swap***





In
      June
      2001, the Company entered into an interest rate swap with a bank, which expired
      on June 1, 2006. In October, 2005, the Company entered into another interest
      rate swap with a bank, which expires on October 6, 2010. The swap transactions
      were entered into to protect the Company from upward movement in interest rates
      relating to outstanding bank debt (see note 7) and calls for a fixed rate of
      7.95% for the 2001 transaction and 7.1% for the 2005 transaction. When the
      one-month LIBOR rate is below the fixed rate then the Company is obligated
      to
      pay the bank for the difference in rates. When the one-month LIBOR rate is
      above
      the fixed rate then the bank is obligated to pay the Company for the difference
      in rates. At December 31, 2006 and 2005 the fair value of the swaps of $(6,780)
      and $7,812, respectively, is recorded as a non current asset in 2006 and as
      a
      non-current liability in 2005. The swap transactions have been accounted for
      as
      a hedge, and accordingly, the change in the fair value of the swaps of
      $(14,952), $7,340 and $43,916 during the years ended December 31, 2006, 2005,
      and 2004, respectively, has been recorded as part of comprehensive
      income.





***Letter
      of Credit***





The
      Company relocated its Islip, New York headquarters to a larger facility in
      Great
      River, New York. Included in the terms and conditions of the Great River lease
      is the requirement that the Company provide to the landlord a letter of credit
      in the amount of $292,980, which represents approximately six months rent.
      This
      letter of credit was provided to the landlord on October 31, 2003. On June
      15,
      2006, the letter of credit was reduced to $244,150. The Company has currently
      applied to reduce the letter of credit to $195,320 and will apply for subsequent
      reduction as follows:





$146,490
      for months 47 through 58 of the lease.


$97,660
      for months 59 to the expiration of the lease.




***[13]
      Stock-Based Compensation***





***Long
      Term Incentive Plans -*** The
      Company has three long-term incentive plans, the 1998 Long-Term


F-36


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[13]
      Stock-Based Compensation - [Continued]***





Incentive
      Plan (the “1998 Plan”), as amended, the 1999 Long-Term Incentive Plan (the “1999
      Plan”) and the 2001 Long-Term Incentive Plan (the “2001 Plan”), as amended. The
      2001 Plan was approved by the stockholders on March 7, 2002 and originally
      provided for the issuance of 180,000 shares of common stock. In January 2003,
      the 2001 Plan was amended and approved by the stockholders to provide for an
      increase in the number of shares subject to the plan from 180,000 to 550,000.
      In
      May 2004, the 2001 Plan was further amended and approved by the stockholders
      to
      provide an increase in the number of shares subject to the plan from 550,000
      to
      950,000. In July 2005, the plan was amended and approved by the stockholders
      to
      provide an increase in the number of shares subject to the plan from 950,000
      to
      1,350,000. In December 2006, the plan was amended and approved by the
      stockholders to provide an increase in the number of shares subject to the
      plan
      from 1,350,000 to 1,950,000. The maximum shares issuable by the Company are
      790,000, 300,000 and 1,950,000 shares of Common Stock pursuant to the 1998
      Plan,
      the 1999 Plan and the 2001 Plan, respectively. The options, when granted vest
      ratably over one year except
      for the 400,000 options granted in July
      2005, which vested prior to December 31, 2005. These 400,000 options were
      granted at an exercise of $9.85 which was equal to the fair market value at
      the
      date of grant. Automatic options granted to the independent members of the
      Board
      of Directors vest fully after six months. At December 31, 2006 there were 0,
      0
      and 586,045 shares available for further issuance under the 1998 Plan, the
      1999
      Plan and 2001 Plan, respectively.





The
      1998
      Plan, the 1999 Plan and the 2001 Plan (collectively, the “Plans”) are
      administered by the Compensation Committee of the board of directors. Officers
      and other key employees, consultants and directors (other than non-employee
      directors) are eligible to receive options or other equity-based incentives
      under the Plans.





The
      2001
      Plan provides that each non-employee director automatically receives a
      nonqualified stock option to purchase 10,000 shares of common stock and the
      chairman of the audit committee and the compensation committee will receive
      a
      nonqualified stock option to purchase 12,500 shares of common stock on April
      1
      of each year. However, if there are not sufficient shares available under the
      applicable Plan, the non-employee director will receive a lesser number of
      shares. In April 2006, the Company granted 10,500 options to its non-employee
      directors under the automatic grant provisions of its 2001 Plan. These options
      were granted at a price of $13.86 which was equal to the fair market value
      of
      the options at the date of grant. These options were fully vested by December
      31, 2006. In December 2006, upon the approval of the increase in shares
      available under the 2001 Plan, the Company granted 15,000 options to its
      non-employee directors under the 2001 plan. These options were granted at a
      price if $16.21 which was equal to the fair market value of the options at
      the
      date of grant. These options will be fully vested by May 2007.




F-37


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[13]
      Stock-Based Compensation - [Continued]***





A
      summary
      of the activity under the Plans and the NTST-Ohio inducement options (see note
      9) are as follows:




2006
            
            2005
            
            2004Weighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            AverageExercise
            
            
            
            Exercise
            
            
            
            ExerciseShares
            
            Price
            
            Shares
            
            Price
            
            Shares
            
            PriceOutstanding
                - Beginning ofYear
            
            
            945,467
            
            $
            8.758
            
            
            724,333
            
            $
            6.476
            
            
            365,755
            
            $
            4.111Granted
                During the Year
            
            
            25,500
            
            
            15.242
            
            
            438,292
            
            
            10.181
            
            
            397,455
            
            
            8.438Canceled
                During the Year
            
            
            (6,142
            )
            
            13.935
            
            
            (10,500
            )
            
            1.81
            
            
            --
            
            
            --Exercised
                During the Year
            
            
            (41,420
            )
            
            7.67
            
            
            (206,658
            )
            
            4.134
            
            
            (38,877
            )
            
            4.280Outstanding
                - End of Year
            
            
            923,405
            
            $
            8.951
            
            
            945,467
            
            $
            8.758
            
            
            724,333
            
            $
            6.476Exercisable
                - End of Year
            
            
            895,688
            
            $
            8.751
            
            
            915,467
            
            $
            8.561
            
            
            525,606
            
            $
            5.734





The
      aggregate intrinsic values of the outstanding and exercisable shares at December
      31, 2006 were $6,730,679 and $6,707,935, respectively.





The
      weighted average fair value of options issued at date of grant using the fair
      value based method during 2006 is estimated at $3.17. The total intrinsic value
      of options exercised during 2006 was $207,809.





The
      following table summarizes stock option information as of December 31,
      2006:




Options
                OutstandingWeightedAverage
                Remaining
            
            OptionsExercise
                Prices
            
            Number
                Outstanding
            
            Contractual
                Life
            
            Exercisable$16.21
            
            
            15,000
            
            
            4.92
                Years
            
            
            2,500$14.77
            
            
            24,900
            
            
            3.83
                Years
            
            
            9,683$13.86
            
            
            10,500
            
            
            4.33
                Years
            
            
            10,500$13.29
            
            
            1,500
            
            
            2.25
                Years
            
            
            1,500$
                9.85
            
            
            396,458
            
            
            3.50
                Years
            
            
            396,458$
                9.57
            
            
            8,292
            
            
            3.25
                Years
            
            
            8,292$
                8.49
            
            
            276,460
            
            
            2.42
                Years
            
            
            276,460$
                8.20
            
            
            75,775
            
            
            2.50
                Years
            
            
            75,775$
                6.61
            
            
            8,000
            
            
            1.58
                Years
            
            
            8,000$
                4.93
            
            
            59,378
            
            
            1.08
                Years
            
            
            59,378$
                4.37
            
            
            7,500
            
            
            6.50
                Years
            
            
            7,500$
                4.37
            
            
            31,642
            
            
            1.50
                Years
            
            
            31,642$
                2.50
            
            
            3,000
            
            
            .25
                Years
            
            
            3,000$
                2.38
            
            
            5,000
            
            
            .50
                Years
            
            
            5,000Totals
            
            
            923,405
            
            
            2.89
                Years
            
            
            895,688


F-38


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[13]
      Stock-Based Compensation - [Continued]***





A
      summary
      of the option activity of nonvested options at December 31 2006, and changes
      during the year ended December 31, 2006 is presented below:


WeightedAverageGrant
                Date2006
            
            Fair
                ValueNonvested
                at January 1,
            
            
            23,234
            
            $
            14.770Vested
            
            
            (12,500
            )
            $
            14.744Issued
            
            
            15,000
            
            $
            16.21Forfeited
            
            
            1,983
            
            
            --Nonvested
                at December 31,
            
            
            27,717
            
            $
            15.075





The
      total
      fair value of shares vested during the year ended December 31, 2006 was
      $66,939.





The
      fair
      value of options at date of grant was estimated using the Black-Scholes fair
      value based method during 2006 with the following weighted average
      assumptions:





2006Expected
                Life (Years)
            
            
            1.95Risk
                Free Rate
            
            
            4.68
            %Expected
                Dividends
            
            
            --
            %Volatility
            
            
            30
            %




F-39





**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[13]
      Stock-Based Compensation - [Continued]***





Warrants





During
      2005, the Company announced the completion of a private placement of units
      consisting of an aggregate 490,000 shares of its common stock and warrants
      to
      purchase 147,003 shares of common stock, which include 24,500 warrants issued
      to
      the placement agent. The warrants have an exercise price of $11 per share and
      will expire in October 2010. The Company received net proceeds of approximately
      $4.0 million.





A
      summary
      of warrant activity is as follows:





2006
            
            2005
            
            2004Weighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            AverageExercise
            
            
            
            Exercise
            
            
            
            ExerciseShares
            
            Price
            
            Shares
            
            Price
            
            Shares
            
            PriceOutstanding
                - Beginningof
                Year
            
            
            147,003
            
            $
            11.00
            
            
            --
            
            
            --
            
            
            --
            
            
            --Granted
                During the Year
            
            
            --
            
            
            --
            
            
            147,003
            
            $
            11.00
            
            
            --
            
            
            --Expired
                During the Year
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --
            
            
            --Exercised
                During the Year
            
            
            (22,970
            )
            $
            11.00
            
            
            --
            
            
            --
            
            
            --
            
            
            --Outstanding
                - End of Year
            
            
            124,033
            
            $
            11.00
            
            
            147,003
            
            $
            11.00
            
            
            --
            
            
            --Exercisable
                - End of Year
            
            
            124,033
            
            $
            11.00
            
            
            147,003
            
            $
            11.00
            
            
            --
            
            
            --





F-40


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[14]
      Operating Segments***





The
      Company currently classifies its operations in five business segments: (1)
      Software and Related Systems and Services - New York, (2) Software and Related
      Systems and Services - Ohio, (3) Software and Related Systems and Services
      -
      Public Health, (4) Data Center Services and (5) Application Service Provider
      Services (“ASP”). Software and Related Systems and Services - Public Health is a
      new segment resulting from the Company’s acquisition of QS Technologies, Inc. in
      August 2006, consisting of the subsidiary NTST - PH which delivers enterprise
      wide public health solutions and vital records software to public health
      agencies. Software and Related Systems and Services - Ohio is a new segment
      resulting from the Company’s acquisition of CMHC in September 2005. NTST - Ohio
      offers a full suite of behavioral healthcare information management software
      for
      mental health, substance abuse and addiction services agencies, developmental
      disability centers, and behavioral health-related managed care organizations.
      Software and Related Systems and Services for each of the New York, Public
      Health and Ohio segments refers to the design, installation, implementation
      and
      maintenance of computer information systems that provide comprehensive
      healthcare information technology solutions including billing, patient tracking
      and scheduling for inpatient and out patient environments, as well as clinical
      documentation and medical record generation and management. Within these
      segments are large turnkey and small turnkey components. The large turnkey
      components consist mostly of the Avatar suite of products. When the Company
      is
      engaged in a fixed price arrangement, these installations will usually extend
      over a six-month to a multi-year time period. The duration of the implementation
      is dependent on the size and complexity of the customer organization and the
      specifics of the implementation. The small turnkey components are usually
      completed within a six-month period. Small turnkey contracts performed in the
      New York segment are mostly related to the Avatar methadone related products.
      The small turnkey contracts in the Ohio and Public Health segments are for
      system installations for behavioral healthcare and public health information
      management software for mental health, substance abuse and addiction services
      agencies, developmental disability centers and behavioral health-related managed
      care organizations.





Data
      Center Services involve Company personnel performing data entry and data
      processing services for customers. ASP services involve the Company offering
      several of it software products on a virtual private network or internet
      delivery approach, thereby allowing its customers to utilize the Company’s
      products and pay on a monthly service basis.





Intersegment
      sales and sales outside the United States are not material. Information
      concerning the Company’s business segments is as follows:





F-41




**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[14]
      Operating Segments - [Continued]***




Sotware
                  and Related Systems and Services - New York
              
              Data
                  Center Services
              
              Application
                  Service Provider Services
              
              Sofware
                  and Related Systems and Services - Ohio
              
              Software
                  and Related Systems and Services - Public Health
              
              TotalYear
                  Ended December 31, 2006RevenueLarge
                  Turnkey
              
              $
              18,051,217
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              18,051,217Small
                  Turnkey
              
              
              1,888,693
              
              
              -
              
              
              -
              
              
              6,090,613
              
              
              1,126,243
              
              
              9,105,549Maintenance
              
              
              10,933,446
              
              
              -
              
              
              -
              
              
              14,803,280
              
              
              864,482
              
              
              26,601,208Other
              
              
              -
              
              
              1,735,940
              
              
              3,555,769
              
              
              -
              
              
              -
              
              
              5,291,709Total
              
              $
              30,873,356
              
              $
              1,735,940
              
              $
              3,555,769
              
              $
              20,893,893
              
              $
              1,990,725
              
              $
              59,049,683Gross
                  ProfitTurnkey
              
              $
              8,446,320
              
              $
              -
              
              $
              -
              
              $
              844,313
              
              $
              970,379
              
              $
              10,261,012Maintenance
              
              
              6,209,358
              
              
              -
              
              
              -
              
              
              10,711,947
              
              
              352,169
              
              
              17,273,474Other
              
              
              -
              
              
              918,737
              
              
              1,325,479
              
              
              -
              
              
              -
              
              
              2,244,216Total
              
              $
              14,655,678
              
              $
              918,737
              
              $
              1,325,479
              
              $
              11,556,260
              
              $
              1,322,548
              
              $
              29,778,702Income
                  before Income Taxes
              
              $
              1,084,398
              
              $
              294,700
              
              $
              (328,304
              )
              $
              2,689,516
              
              $
              523,153
              
              $
              4,263,463Depreciation
                  and Amortization
              
              $
              1,633,347
              
              $
              108,897
              
              $
              542,950
              
              $
              1,740,589
              
              $
              291,534
              
              $
              4,317,317Capital
                  Expenditures
              
              $
              493,058
              
              $
              6,937
              
              $
              243,983
              
              $
              379,743
              
              $
              5,291,742
              
              $
              6,415,463Identifiable
                  Assets
              
              $
              27,045,397
              
              $
              1,629,132
              
              $
              4,136,343
              
              $
              31,315,172
              
              $
              6,398,509
              
              $
              70,524,553Goodwill
              
              
              -
              
              
              -
              
              
              -
              
              $
              18,445,646
              
              
              -
              
              $
              18,445,646Year
                  Ended December 31, 2005RevenueLarge
                  Turnkey
              
              
              17,599,035
              
              
              -
              
              
              -
              
              
              
              
              
              -
              
              
              17,599,035Small
                  Turnkey
              
              
              1,041,866
              
              
              -
              
              
              -
              
              
              1,685,904
              
              
              -
              
              
              2,727,770Maintenance
              
              
              9,784,488
              
              
              -
              
              
              -
              
              
              3,533,256
              
              
              -
              
              
              13,317,744Other
              
              
              -
              
              
              1,795,448
              
              
              2,538,457
              
              
              -
              
              
              -
              
              
              4,333,905Total
              
              
              28,425,389
              
              
              1,795,448
              
              
              2,538,457
              
              
              5,219,160
              
              
              -
              
              
              37,978,454Gross
                  ProfitTurnkey
              
              
              8,434,026
              
              
              -
              
              
              -
              
              
              210,025
              
              
              -
              
              
              8,644,051Maintenance
              
              
              5,402,433
              
              
              -
              
              
              -
              
              
              2,493,736
              
              
              -
              
              
              7,896,169Other
              
              
              -
              
              
              908,279
              
              
              927,431
              
              
              -
              
              
              -
              
              
              1,835,710Total
              
              
              13,836,459
              
              
              908,279
              
              
              927,431
              
              
              2,703,761
              
              
              -
              
              
              18,375,930Income
                  before Income Taxes
              
              
              2,151,923
              
              
              384,465
              
              
              (116,027
              )
              
              328,414
              
              
              -
              
              
              2,748,775Depreciation
                  and Amortization
              
              
              1,489,017
              
              
              110,479
              
              
              401,835
              
              
              450,125
              
              
              -
              
              
              2,451,456Capital
                  Expenditures
              
              
              3,755,207
              
              
              6,445
              
              
              863,605
              
              
              9,121,675
              
              
              -
              
              
              13,746,932Identifiable
                  Assets
              
              
              26,219,605
              
              
              1,909,546
              
              
              3,221,333
              
              
              33,271,370
              
              
              -
              
              
              64,621,854Goodwill
              
              
              -
              
              
              -
              
              
              -
              
              
              18,735,751
              
              
              -
              
              
              18,735,751Year
                  Ended December 31, 2004RevenueLarge
                  Turnkey
              
              
              16,003,646
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              16,003,646Small
                  Turnkey
              
              
              927,960
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              927,960Maintenance
              
              
              8,289,525
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              8,289,525Other
              
              
              -
              
              
              2,058,240
              
              
              1,725,473
              
              
              -
              
              
              -
              
              
              3,783,713Total
              
              
              25,221,131
              
              
              2,058,240
              
              
              1,725,473
              
              
              -
              
              
              -
              
              
              29,004,844Gross
                  ProfitTurnkey
              
              
              7,728,535
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              7,728,535Maintenance
              
              
              4,120,550
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              4,120,550Other
              
              
              -
              
              
              1,208,887
              
              
              799,140
              
              
              -
              
              
              -
              
              
              2,008,027Total
              
              
              11,849,085
              
              
              1,208,887
              
              
              799,140
              
              
              -
              
              
              -
              
              
              13,857,112Income
                  before Income Taxes
              
              
              2,095,722
              
              
              784,353
              
              
              181,890
              
              
              -
              
              
              -
              
              
              3,061,965Depreciation
                  and Amortization
              
              
              1,247,962
              
              
              113,676
              
              
              262,755
              
              
              -
              
              
              -
              
              
              1,624,393Capital
                  Expenditures
              
              
              950,094
              
              
              12,144
              
              
              93,501
              
              
              -
              
              
              -
              
              
              1,055,739Identifiable
                  Assets
              
              
              31,291,838
              
              
              2,775,036
              
              
              3,640,027
              
              
              -
              
              
              -
              
              
              37,706,901




F-42
 
 **NETSMART
        TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





***[15]
      Subsequent Events***





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.




***[16]
        Going Private Transaction and Related
        Litigation***




Going
        Private Transaction
 
 On
        November 18, 2006, we entered into an Agreement and Plan of Merger (the “Merger
        Agreement”) with NT Acquisition, Inc., a Delaware corporation (“Buyer”) and NT
        Merger Sub, Inc., a Delaware corporation (“Merger Sub”). Under the terms of the
        Merger Agreement, Merger Sub will be merged with and into Netsmart (the
“Merger”), the separate corporate existence of Merger Sub will cease with
        Netsmart continuing as the surviving corporation (the “Surviving Corporation”).
        Merger Sub and Buyer are or will be controlled by funds which are affiliated
        with Insight Venture Partners (“Insight”) and Bessemer Venture Partners
        (“Bessemer” and, together with Insight, the “Sponsors”), private equity firms.
 
 At
        the
        effective time of the merger, each outstanding share of common stock of
        Netsmart, other than any shares owned by Merger Sub, its affiliates, Netsmart
        or
        any shareholders who are entitled to and who properly exercise appraisal
        rights
        under Delaware law, will be cancelled and converted into the right to receive
        $16.50 in cash, without interest. Warrant holders and option holders will
        be
        entitled to receive the difference between the exercise price of such security
        and $16.50 per share in cash.
 
 A
        special
        meeting of stockholders has been called for Thursday, April 5, 2007 for the
        purpose of considering the Merger Agreement.
  Litigation


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 shareholders
        by
        voting to approve the Merger Agreement, thereby enabling management to benefit
        to the detriment of the shareholders. Each of the complaints seeks, among
        other
        relief, the court’s designation of class action status, an injunction




F-43


**NETSMART
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**







***[16]
        Going Private Transaction and Related Litigation -
        [Continued]***
 
 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 the Company is also involved in ordinary and routine litigation
        matters in the normal course of business. The Company believes that the
        resolution of these matters will not have a material adverse effect on its
        consolidated financial position and results of operations.




F-44


SIGNATURES





Pursuant
      to the requirements of Section 13 or 15(d) 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.Dated:
              March 16, 2007
            By:
            /s/
              James L. ConwayJames
              L. Conway, Chief Executive Officer


Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated. Each person whose signature appears
      below
      hereby authorizes James L. Conway and Anthony F. Grisanti (or any of them acting
      in the absence of the others), as his true and lawful attorney-in-fact and
      agent, with full power of substitution and resubstitution for him and in his
      name, place and stead, in any and all capacities to sign any and all amendments
      to this report, and to file same, with all exhibits thereto and other documents
      in connection therewith, with the Securities and Exchange
      Commission.




Signature
            
            Title
            Date/s/
                James L. Conway
            
            Chief
                Executive Officer
            March
                16, 2007James
                L. Conway
            
            and
                Director (Principal Executive Officer)/s/
                Anthony F. Grisanti
            
            Chief
                Financial Officer
            March
                16, 2007Anthony
                F. Grisanti
            
            (Principal
                Financial and Accounting Officer)/s/
                Kevin Scalia
            
            Executive
                Vice PresidentKevin
                Scalia
            
            and
                Director
            March
                16, 2007/s/
                Alan Tillinghast
            
            Executive
                Vice PresidentAlan
                Tillinghast
            
            and
                Director
            March
                16, 2007/s/
                Joseph G. Sicinski
            
            Director
            March
                16, 2007Joseph
                G. Sicinski/s/
                Francis J. Calcagno
            
            Director
            March
                16, 2007Francis
                J. Calcagno/s/
                John S.T. Gallagher
            
            Director
            March
                16, 2007John
                S.T. Gallagher/s/
                Yacov Shamash
            
            Director
            March
                16, 2007Dr.
                Yacov Shamash







EXHIBIT
      INDEX





Exhibits


3.1
            Restated
                Certificate of Incorporation, as amended (Filed as an exhibit to
                the
                Registrant’s registration statement on Form S-1, File No. 333-2550, which
                was declared effective by the Commission on August 13, 1996, and
                incorporated herein by reference.)


3.2
            By-Laws
                (Filed as an exhibit to the Registrant’s registration statement on Form
                S-1, File No. 333-2550, which was declared effective by the Commission
                on
                August 13, 1996, and incorporated herein by
                reference.)


10.1
            Employment
                Agreement dated April 1, 2004, between the Registrant and James L.
                Conway
                (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.2
            Consulting
                Agreement dated April 1, 2004, between the Registrant and John F.
                Phillips
                (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.3
            Employment
                Agreement dated April 1, 2004, between the Registrant and Gerald
                O. Koop
                (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.4
            Employment
                Agreement dated April 1, 2004, between the Registrant and Anthony
                F.
                Grisanti (Filed as an exhibit to the Registrant’s 10-Q dated May 5,
                2004.)


10.6
            1993
                Long-Term Incentive Plan (Filed as an exhibit to the Registrant’s
                registration statement on Form S-1, File No. 333-2550, which was
                declared
                effective by the Commission on August 13, 1996, and incorporated
                herein by
                reference.)


10.7
            1998
                Long-Term Incentive Plan (Filed as an appendix to the Registrant’s proxy
                statement dated September 30, 1999, relating to its 1999 Annual Meeting
                of
                Stockholders and incorporated herein by
                reference.)


10.8
            1999
                Long-Term Incentive Plan (Filed as an appendix to the Registrant’s proxy
                statement dated November 9, 2000, relating to its 2000 Annual Meeting
                of
                Stockholders and incorporated herein by
                reference.)


10.9
            2001
                Long-Term Incentive Plan - Amended (Filed as an exhibit to the
                Registrant’s 8-K dated June 16,
                2005.)


10.10
            1999
                Employee Stock Purchase Plan (Filed as an appendix to the Registrant’s
                proxy statement dated November 9, 2000, relating to its 2000 Annual
                Meeting of Stockholders and incorporated herein by
                reference.)


10.11
            Agreement
                dated June 1, 2001, between the Registrant and Fleet Bank (Filed
                as an
                exhibit to the Registrant’s 10-K/A dated August 21,
                2003.)


10.12
              AIMS
                  Acquisition Agreement (Filed as an exhibit to the Registrant’s 8-K dated
                  May 10, 2001.)


10.13
            Agreement
                dated June 25, 2003, among Registrant, Creative Socio-Medics Corp.,
                Shuttle Data Systems Corp., d/b/a/ ADIA Information Management Corp.
                and
                Steven Heintz, Jr. (Filed as an exhibit to the Registrant’s 8-K dated July
                8, 2003.)


10.14
            Lease
                agreement dated as of December 22, 2003, between Registrant and Spacely
                LLC. (Filed as an exhibit to the Registrant’s 10-K dated March 23,
                2004.)


10.15
            Amended
                Executive Retirement, Non Competition and Consulting Plan. (Filed
                as an
                exhibit to the Registrant’s 10-Q dated August 9,
                2004.)


10.16
            Merger
                Agreement dated September 20, 2005, between CMHC Systems, Inc., Hayes
                Acquisition Corp., a newly-formed wholly-owned subsidiary of the
                Registrant, and John Paton, solely in the capacity of Securities
                Holders
                Representative. (Filed as an exhibit to the Registrant’s Form 8-K dated
                September 19, 2005.)


10.17
            Revolving
                Credit and Term Loan Agreement with Netsmart Technologies, Inc. and
                the
                Bank of America, N.A. (Filed as an exhibit to the Registrant’s Form 8-K
                dated October 7, 2005.)


10.18
            Asset
                Purchase Agreement dated June 17, 2005 between Addiction Management
                Systems, Inc. and Creative Socio-Medics Corp. (Filed as an exhibit
                to the
                Registrant’s Form 8-K dated June 21,
                2005.)


10.20
            Amendment
                No. 1 to Employment Agreement dated June 16, 2005, between the Registrant
                and James L. Conway. (Filed as an exhibit to the Registrant’s Form 8-K
                dated June 16, 2005.)


10.21
            Amendment
                No. 1 to Employment Agreement dated June 16, 2005 between the Registrant
                and Anthony F. Grisanti. (Filed as an exhibit to the Registrant’s Form 8-K
                dated June 16, 2005.)


10.22
            Asset
                Purchase Agreement dated April 27, 2005 between ContinuedLearning
                LLC and
                Creative Socio-Medics Corp. (Filed as an exhibit to the Registrant’s Form
                8-K dated April 27, 2005.)


10.23
            Employment
                Agreement dated April 27, 2005 between Netsmart Technologies, Inc.
                and A.
                Sheree Graves. (Filed as an exhibit to the Registrant’s Form 8-K dated
                April 27, 2005.)


10.24
            Letter
                Agreement between Griffin Securities, Inc. and Netsmart Technologies,
                Inc.
                dated as of August 9, 2005. (Filed as an exhibit to the Registrant’s Form
                S-3, File No. 333-129265.)


10.25
            Letter
                Agreement between Griffin Securities, Inc. and Netsmart Technologies,
                Inc.
                dated as of October 11, 2005. (Filed as an exhibit to the Registrant’s
                Form S-3, File No. 333-129265.)


10.26
            First
                Amendment and Waiver to Loan Agreement dated as of December 31, 2005
                between the Registrant and Bank of America, N.A. (Filed as an exhibit
                to
                Registrant’s Form 8-K dated February 23,
                2006)


10.27
            Employment
                Agreement between the Registrant and Gerald Koop dated April 5, 2006(Filed
                as an exhibit to Registrant’s Form 8-K dated April 5,
                2006)









10.28
            Asset
                Purchase Agreement dated as of July 31, 2006 by and between QS
                Technologies, Inc. and Intelligent Systems Corporation, as Sellers
                and
                Netsmart Public Health, Inc., as Buyer and Netsmart Technologies,
                Inc.
                (Filed as an exhibit to Registrant’s Form 8-K dated August 1,
                2006)


10.29
            Second
                Amendment and Waiver to Loan Agreement dated as of July 31, 2006
                between
                the Registrant and Bank of America, N.A. (Filed as an exhibit to
                Registrant’s Form 8-K dated September 29,
                2006)


10.30
            Merger
                Agreement dated November 18, 2006 between Netsmart Technologies,
                Inc., a
                Delaware corporation with NT Acquisition, Inc., NT Merger Sub, Inc.,and
                NT
                Acquisition, Inc. (Filed as an exhibit to the Registrant’s Form 8-K dated
                November 18, 2006.)


10.31
            Amendment
                to employment agreement, between James L. Conway, dated as of November
                18,
                2006, with NT Investor Holdings, Inc., and the Registrant. (Filed
                as an
                exhibit to the Registrant’s Form 8-K/A dated November 30,
                2006).


10.32
            Amendment
                to employment agreement, between Anthony F. Grisanti, dated as of
                November
                18, 2006, with NT Investor Holdings, Inc., and the Registrant. (Filed
                as
                an exhibit to the Registrant’s Form 8-K/A dated November 30, 2006).


21.1
            Subsidiaries
                of the Registrant


23.1
            Consent
                of Marcum & Kliegman LLP


24
            Powers
                of Attorney (See Signature Page)


31.1
            Certification
                of Chief Executive Officer


31.2
            Certification
                of Chief Financial Officer


32
            Certification
                pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002