UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-QSB

 

(Mark One)
x		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2006.
o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
		For the transition period from                     to

 

 

Commission file number 0-12551

 

 

ASPYRA, INC.
(formerly known as CREATIVE COMPUTER APPLICATIONS, INC.)

(Exact name of small business issuer as specified in its charter)

 

 

 

 

26115-A Mureau Road, Calabasas, California 91302

(Address of principal executive offices)

 

 

(818) 880-6700

(Issuer’s telephone number, including area code)

 

 

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

Yes     x   No    o

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes     o   No    x

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:  10,783,150 common shares as of November 10, 2006.

Transitional Small Business Disclosure Format (check one):

Yes     o   No    x

 

ASPYRA, INC.

FORM 10-QSB

I N D E X

PART I - Financial Information:
Item 1.		Financial Statements (unaudited)
		Condensed Consolidated Balance Sheets, at September 30, 2006 and December 31, 2005
		Condensed Consolidated Statements of Operations for the three months ended September 30, 2006 and September 30, 2005
		Condensed Consolidated Statements of Operations for the nine months ended September 30, 2006 and September 30, 2005
		Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and September 30, 2005
		Notes to Condensed Consolidated Financial Statements
Item 2.		Management’s Discussion and Analysis or Plan of Operation
Item 3.		Controls and Procedures
PART II - Other Information:
Item 6.		Exhibits
Signatures
Exhibit Index

 

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ASPYRA, INC.

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		September 30,			December 31,
		2006			2005
		(Unaudited)
ASSETS
CURRENT ASSETS:
Cash		$	1,964,545		$	1,329,753
Restricted cash (Note 6)		1,000,000			—
Receivables, net		2,391,021			1,547,699
Inventory		204,268			207,345
Prepaid expenses and other assets		434,532			589,510
TOTAL CURRENT ASSETS		5,994,366			3,674,307
PROPERTY AND EQUIPMENT, net		1,130,031			511,919
INVENTORY OF COMPONENT PARTS		112,733			158,302
CAPITALIZED SOFTWARE COSTS, net of accumulated amortization of $1,001,179 and $1,211,445		2,383,258			1,885,887
INTANGIBLES, net		4,245,359			4,697,240
GOODWILL		7,698,434			7,698,434
		$	21,564,181		$	18,626,089
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Notes payable (Note 6)		$	1,474,078		$	995,403
Accounts payable		819,903			1,218,698
Accrued liabilities:
Vacation pay		348,902			384,887
Accrued payroll		215,371			355,277
Accrued settlement		—			154,300
Accrued interest and penalty		281,596			—
Other		430,288			338,098
Deferred service contract income		2,060,468			1,611,644
Deferred revenue on system sales		1,930,958			1,165,521
Capital lease — current portion		127,297			—
TOTAL CURRENT LIABILITIES		7,688,861			6,223,828
CAPITAL LEASE		438,589			—
NOTES PAYABLE		19,055			220,871
TOTAL LIABILITIES		8,146,505			6,444,699
SHAREHOLDERS’ EQUITY:
Common shares, no par value; 20,000,000 shares authorized; 10,783,150 and 8,489,400 shares issued and outstanding		21,044,071			16,974,222
Additional paid-in-capital		276,871			—
Accumulated deficit		(7,878,103		)	(4,790,142		)
Accumulated other comprehensive loss		(25,163		)	(2,690		)
TOTAL SHAREHOLDERS’ EQUITY		13,417,676			12,181,390
		$	21,564,181		$	18,626,089

 

See Notes to Condensed Consolidated Financial Statements.

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ASPYRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Three Months Ended September 30,
		2006			2005
		(Unaudited)
NET SYSTEM SALES AND SERVICE REVENUE:
System sales		$	1,508,056		$	545,886
Service revenue		1,773,985			1,181,786
		3,282,041			1,727,672
COSTS OF PRODUCTS AND SERVICES SOLD:
System sales		964,343			393,686
Service revenue		779,871			414,985
		1,744,214			808,671
Gross profit		1,537,827			919,001
OPERATING EXPENSES
Selling, general and administrative		1,664,784			883,704
Research and development		499,084			314,456
Total operating expenses		2,163,868			1,198,160
Operating loss		(626,041		)	(279,159		)
INTEREST AND OTHER INCOME		43,938			3,873
INTEREST EXPENSE		(125,921		)	(3,989		)
Loss before provision for income taxes		(708,024		)	(279,275		)
PROVISION FOR INCOME TAXES		2,039			793,877
NET LOSS		$	(710,063	)	$	(1,073,152	)
LOSS PER SHARE (Note 5):
Basic		$	(.07	)	$	(.31	)
Diluted		(.07		)	(.31		)
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic		10,772,914			3,465,900
Diluted		10,772,914			3,465,900

 

See Notes to Condensed Consolidated Financial Statements.

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ASPYRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

		Nine Months Ended September 30,
		2006			2005
		(Unaudited)
NET SYSTEM SALES AND SERVICE REVENUE:
System sales		$	3,881,308		$	1,429,593
Service revenue		5,320,629			3,679,374
		9,201,937			5,108,967
COSTS OF PRODUCTS AND SERVICES SOLD:
System sales		2,874,810			1,218,254
Service revenue		2,176,019			1,239,678
		5,050,829			2,457,932
Gross profit		4,151,108			2,651,035
OPERATING EXPENSES
Selling, general and administrative		5,548,953			2,483,681
Research and development		1,460,776			873,396
Total operating expenses		7,009,729			3,357,077
Operating loss		(2,858,621		)	(706,042		)
INTEREST AND OTHER INCOME		64,862			13,015
INTEREST EXPENSE		(292,163		)	(11,750		)
Loss before provision for income taxes		(3,085,922		)	(704,777		)
PROVISION FOR INCOME TAXES		2,039			793,877
NET LOSS		$	(3,087,961	)	$	(1,498,654	)
LOSS PER SHARE (Note 5):
Basic		$	(.32	)	$	(.44	)
Diluted		(.32		)	(.44		)
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic		9,625,505			3,401,011
Diluted		9,625,505			3,401,011

 

See Notes to Condensed Consolidated Financial Statements.

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ASPYRA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash

 

		Nine Months Ended September 30,
		2006			2005
		(Unaudited)
OPERATING ACTIVITIES
Net loss		$	(3,087,961	)	$	(1,498,654	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		724,085			122,864
Provision for doubtful accounts		18,371			30,880
Amortization of capitalized software costs		218,574			259,950
Deferred tax provision		—			793,877
Stock based compensation		276,871			—
Increase (decrease) from changes in:
Receivables		(861,693		)	853,411
Inventories		48,646			(59,348		)
Prepaid expenses and other assets		154,978			(76,758		)
Accounts payable		(398,795		)	53,657
Accrued liabilities		43,596			(152,018		)
Deferred service contract income		448,824			(149,691		)
Deferred revenue on system sales		765,437			64,817
Net cash provided by (used in) operating activities		(1,649,067		)	242,987
INVESTING ACTIVITIES
Additions to property and equipment		(253,831		)	(256,925		)
Additions to deferred merger costs		—			(340,077		)
Additions to capitalized software costs		(715,946		)	(511,421		)
Net cash used in investing activities		(969,777		)	(1,108,423		)
FINANCING ACTIVITIES
Borrowings on line of credit		500,000			—
Payments on notes payable		(223,141		)	(100,000		)
Payments on capital leases		(70,599		)	—
Increase in restricted cash		(1,000,000		)
Net proceeds from sales of stock in private placement		4,033,883			—
Buyback of fractional shares related to merger		(234		)	—
Exercise of stock options		36,200			171,400
Net cash provided by financing activities		3,276,109			71,400
Foreign currency translation adjustment		(22,473		)	—
NET INCREASE (DECREASE) IN CASH		634,792			(794,036		)
CASH, beginning of period		1,329,753			1,655,063
CASH, end of period		$	1,964,545		$	861,027

 

See notes to Condensed Consolidated Financial Statements.

 

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ASPYRA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1-Presentation of Financial Statements

In the opinion of management of Aspyra, Inc. (the “Company” or “ASPYRA”), the accompanying unaudited condensed consolidated financial statements reflect all adjustments (which include only normal recurring accruals) necessary to present fairly the Company’s financial position as of September 30, 2006, the results of its operations for the three and nine-month periods ended September 30, 2006 and 2005, and cash flows for the nine months ended September 30, 2006 and 2005.  These results have been determined on the basis of accounting principles generally accepted in the United States and practices applied consistently with those used in preparation of the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2005.

The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results expected for any other period or for the entire year.

Note 2-Liquidity

As of September 30, 2006, the Company’s working capital amounted to a deficit of $1,694,495 compared to a deficit of $2,549,521, as of December 31, 2005.  The deficit working capital position on a consolidated basis is the result of ASPYRA merging with Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM, Inc.), which had a substantial negative working capital position at the time of the merger and the increase in deferred revenues, which in the aggregate amounted to approximately $3,991,000 at September 30, 2006 because of increased orders and delays in implementation of these orders.  On May 17, 2006, the Company sold in a private placement transaction 2,250,000 shares of its common stock and warrants to purchase up to 1,350,000 shares of its common stock pursuant to the terms of the Common Stock and Warrant Purchase Agreement, dated May 4, 2006.  The private placement generated $4,500,000, less costs, and improved the Company’s working capital position.

The Company’s primary source of working capital has been generated from private placements, which were completed in November 2005 and May 2006, and from borrowings.  The private placement that was completed in November 2005 generated $3,000,000, less costs.  The Company’s results of operations for the nine months ended September 30, 2006 produced negative operating cash flow of $1,649,067.  An unanticipated decline in sales, delays in implementations where payments are tied to delivery and/or performance of services or cancellations of contracts could have a negative effect on cash flow from operations and could in turn create short-term liquidity problems.  If sales are not as expected, the Company will consider certain cost cutting measures.  We believe that our current cash and cash equivalents, and cash flow from operations, will be sufficient to meet our current anticipated cash needs, including for working capital purposes, capital expenditures and various contractual obligations, for at least the next 12 months.  We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue.  The sale of convertible debt securities or additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in incurring debt service obligations and could result in operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additional financing will be available on acceptable terms, if at all. Although there are no present understandings, commitments or agreements with respect to the acquisition of any other businesses, applications or technologies, we may, from time to time, evaluate acquisitions of other businesses, applications or technologies.

Note 3-Inventories

Inventories consist primarily of computer hardware held for resale and are stated at the lower of cost or market (net realizable value).  Cost is determined using the first-in, first-out method. Supplies are charged to expense as incurred.

The Company also maintains an inventory pool of component parts to service systems previously sold, which is classified as non-current in the accompanying balance sheets.  Such inventory is carried at the lower of cost or market and is charged to cost of sales based on usage.  Allowances are made for quantities on hand in excess of

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estimated future usage.  At September 30, 2006 and December 31, 2005 the inventory allowance was $161,781 and $116,781, respectively.

Note 4-Goodwill and Intangible Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, goodwill is tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired.  In accordance with SFAS No. 144, Accounting for Impairment of Long-Lived Assets, management reviews definite life intangible assets to determine if events or circumstances have occurred which may cause the carrying values of intangible assets to be impaired. The purpose of these reviews is to identify any facts and circumstances, either internal or external, which may indicate that the carrying values of the assets may not be recoverable.  At September 30, 2006, the net carrying value of goodwill and intangible assets were $7,698,434 and $4,245,359, respectively.

Note 5-Earnings per Share

The Company accounts for its earnings per share in accordance with SFAS No.128, which requires presentation of basic and diluted earnings per share.  Basic earnings per share is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the reporting period.  Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts, such as stock options, to issue common stock were exercised or converted into common stock.

Earnings per share have been computed as follows:

 

		Nine Months Ended September 30, 2006			Nine Months Ended September 30, 2005			Three Months Ended September 30, 2006			Three Months Ended September 30, 2005
NET LOSS		$	(3,087,961	)	$	(1,498,654	)	$	(710,063	)	$	(1,073,152	)
Basic weighted average number of common shares outstanding		9,625,505			3,401,011			10,772,914			3,465,900
Dilutive effect of stock options		—			—			—			—
Diluted weighted average number of common shares outstanding		9,625,505			3,401,011			10,772,914			3,465,900
Basic loss per share		$	(.32	)	$	(.44	)	$	(.07	)	$	(.31	)
Diluted loss per share		$	(.32	)	$	(.44	)	$	(.07	)	$	(.31	)

 

For the three and nine months ended September 30, 2006, options to purchase 636,898 shares of common stock at per share prices ranging from $.72 to $2.75 were not included in the computation of diluted loss per share because inclusion would have been anti-dilutive. For the three and nine months ended September 30, 2005, options to purchase 210,000 shares of common stock at per share prices ranging from $.72 to $1.76 were not included in the computation of diluted loss per share because inclusion would have been anti-dilutive.

Note 6-Debt Obligations

The Company’s line of credit with its bank provides for $1,000,000 on a revolving basis through May 19, 2007.  The line of credit is secured by a $1,000,000 time deposit account.  On September 30, 2006, the total amount due to the bank was $1,000,000.  The Company acquired a note in conjunction with the merger with Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM, Inc.), with an interest rate of 7% with payments in the amount of $25,000 due monthly.  As of September 30, 2006, the total amount due on this note was $319,055.  The Company also acquired unsecured notes in conjunction with the merger with interest rates ranging from 7% to 8%.  These notes are due upon demand and the balance outstanding at September 30, 2006 was $174,078.

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Note 7-Stock-Based Compensation

As of September 30, 2006, the Company has two stock-based compensation plans, the 2005 Equity Incentive Plan and the 1997 Stock Option Plan, under which we may issue shares of our common stock to employees, officers, directors and consultants. Upon effectiveness of the 2005 Equity Incentive Plan on November 22, 2005, the 1997 Stock Option Plan was terminated for purposes of new grants.  Both of these plans have been approved by our shareholders.

Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” No stock-based employee compensation cost was recognized in our Statement of Operations for the three and nine months ended September 30, 2005 as all options granted under our plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment”, using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the three and nine months ended September 30, 2006 includes; (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R).  As SFAS No. 123(R) requires that stock-based compensation expense be based on awards that are ultimately expected to vest, stock-based compensation for the three and nine months ended September 30, 2006 has been reduced by estimated forfeitures based on historical trends of option forfeitures.  The Company has recorded $69,456 and $276,871 of stock-based compensation expense during the three and nine months ended September 30, 2006 as a result of the adoption of SFAS No. 123(R).  The Company did not record any excess tax benefits as a result of adopting SFAS No. 123(R) in the three and nine months ended September 30, 2006 because the Company is currently providing a valuation on future tax benefits realized until it can sustain a level of profitability that demonstrates its ability to utilize the assets.  Results for prior periods have not been restated.

A summary of option activities under the stock option plans during the nine months ended September 30, 2006 is presented as follows:

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for the 286,250 options that were in-the-money at September 30, 2006.  As of September 30, 2006, there was $388,214 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under our stock awards plans. That cost is expected to be recognized over a weighted-average period of two years.  The share-based compensation will be amortized based on the accelerated method over the vesting period.  During the three and nine-months ended

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September 30, 2006, the Company granted 120,000 and 170,000 options at a weighted average fair value price of $1.75 and $1.97 per share.

 A summary of the status of the Company’s non-vested stock options during the nine months ended September 30, 2006 is presented below:

 

The following table illustrates the proforma effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS No. 123(R) to all periods presented.

 

The Company issues all of its options at fair market value at the time of grant.  The fair value of each option was estimated on the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions: risk free interest rates ranging from 3.4% to 4.9%, expected life of options ranging from 3 to 5 years; volatility ranging from 70% to 106% and no assumed dividends.  The weighted-average grant-date fair value of options granted during 2005 was estimated to be $1.80.  There were 170,000 options granted in the nine months ended September 30, 2006 at a weighted average fair value of $1.97 per share.  For the nine months ended

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September 30, 2006, the Company used a forfeiture rate of 0% and 12% for non-qualified stock options and incentive stock options, respectively.

SFAS No. 123(R) requires us to make certain assumptions and judgments regarding the grant date fair value. These judgments include expected volatility, risk free interest rate, expected option life, dividend yield, vesting percentage and forfeitures. These estimations and judgments are determined by us using many different variables that in many cases are outside of our control. The changes in these variables or trends, including stock price volatility and risk free interest rate may significantly impact the grant date fair value resulting in a significant impact to our financial results.

Note 8-Commitments and Contingencies

In accordance with the bylaws of the Company, officers and directors are indemnified for certain events or occurrences arising as a result of the officer or director’s serving in such capacity.  The term of the indemnification period is for the lifetime of the officer or director.  The maximum potential amount of future payments the Company could be required to make under the indemnification provisions of its bylaws is unlimited.  However, the Company has a director and officer liability insurance policy that reduces its exposure and enables it to recover a portion of any future amounts paid.  As a result of its insurance policy coverage, the Company believes the estimated exposure for the indemnification provisions of its bylaws is minimal and, therefore, the Company has not recorded any related liabilities.

The Company enters into indemnification provisions under agreements with various parties in the normal course of business, typically with customers and landlords.  Under these provisions, the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or, in some cases, as a result of the indemnified party’s activities under the agreement.  These indemnification provisions often include indemnifications relating to representations made by the Company with regard to intellectual property rights.  These indemnification provisions generally survive termination of the underlying agreement.  The maximum potential amount of future payments the Company could be required to make under these indemnification provisions cannot be estimated.  The Company maintains general liability, errors and omissions, and professional liability insurance in order to mitigate such risks.  The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements.  As a result, the Company believes the estimated exposure under these agreements is minimal.  Accordingly, the Company has not recorded any related liabilities.

Note 9-Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, deferred tax liabilities and assets are determined based on the differences between the financial statements and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.  Income tax expense represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

Note 10-Acquisition of StorCOMM, Inc.

On November 22, 2005, the Company acquired StorCOMM, Inc. pursuant to an Agreement and Plan of Reorganization dated August 16, 2005 (the “Merger Agreement”). Simultaneously with the closing of the merger, ASPYRA sold in a private placement 1,500,000 shares of its common stock and warrants to purchase up to 300,000 shares of its common stock for $3,000,000, less costs, pursuant to the terms of the Common Stock and Warrant Purchase Agreement dated August 18, 2005. The private placement closed and became effective on November 22, 2005.

Pursuant to the Merger Agreement, the Company issued 3,498,000 shares of common stock in exchange for the business and assets of StorCOMM. Based upon the average closing price of the common stock for August 11, 2005

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through August 19, 2005, the value of the common stock was $7,765,560. In addition, the Company paid approximately $1,157,000 in transaction costs and had advanced StorCOMM $595,387.

The acquisition of StorCOMM is accounted for as a purchase business combination in accordance with SFAS No. 141, “Business Combinations.” The total purchase price related to the acquisition of StorCOMM was $9,517,590.

StorCOMM operates as a wholly owned subsidiary of ASPYRA and the Company’s financial statements include the results of StorCOMM from the closing date of the acquisition (November 22, 2005).

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The allocation of the purchase price was based on an independent third-party valuation of certain intangible assets. The excess purchase price over the estimated fair value of the assets acquired and liabilities assumed is recorded as goodwill.

At November 22, 2005

 

The purchased technology is comprised of internally created software, which was valued by the independent third-party who assigned an expected useful life of six years.

The other intangible assets are primarily comprised of customer relationships valued by the independent third-party. The expected useful life assigned is fifteen years.

The excess of the purchase price over the estimated fair value of the assets acquired and the liabilities assumed was recorded as goodwill, which is expected to be deductible for income tax purposes.

Since there is no step up in basis of the acquired intangible assets for tax purposes, amortization of purchased technology and other intangible assets is not deductible for tax purposes. A $1,634,734 deferred tax liability is calculated at the blended tax rate of 40% applied to the $1,976,836 purchased technology and $2,110,000 other intangible assets. At December 31, 2005, in accordance with SFAS No. 141, $1,634,734 of the deferred tax liability is expected to be realized over the term as the deferred tax asset, therefore $1,634,734 of the deferred tax liability was offset against the deferred tax asset of ASPYRA as part of the consolidated income tax provision. As a result of the transaction, ASPYRA’S deferred tax asset valuation was reduced. In accordance with SFAS No. 109, the change in valuation allowance was offset against goodwill.

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The following summarized unaudited pro forma consolidated results of operations are presented as if the acquisition of StorCOMM occurred on January 1, 2005. The unaudited pro forma results are not necessarily indicative of future earnings or earnings that would have been reported had the acquisition been completed and presented.

 

 

In January 2006, StorCOMM, Inc. changed its name to Aspyra Diagnostic Solutions, Inc.

Note 11-Private Placement

On May 17, 2006, ASPYRA sold in a private placement 2,250,000 shares of its common stock and warrants to purchase up to 1,350,000 shares of its common stock pursuant to the terms of the Common Stock and Warrant Purchase Agreement, dated May 4, 2006 (the “Purchase Agreement”), by and among ASPYRA and each of the Purchasers named therein. The shares of common stock and warrants were sold in units, with each unit consisting of a single share of ASPYRA common stock and three-fifths of a warrant to purchase one share of ASPYRA common stock. The price per unit was $2.00 for an aggregate purchase price of $4,500,000, less costs.  The exercise price of the warrants is $3.00 per share.  These shares were issued and sold pursuant to the exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”) that is available for offers and sales to accredited investors pursuant to Rule 506 of Regulation D under the Securities Act and Section 4(2) of the Securities Act.  Simultaneously with the execution of the Purchase Agreement, ASPYRA and each of the Purchasers entered into a Registration Rights Agreement, dated May 4, 2006, pursuant to which each of the Purchasers shall be entitled to certain registration rights.

During the three and nine months ended September 30, 2006 the Company accrued approximately $93,000 and $192,000 which is attributable to a penalty related to the private placement transactions that were completed in November 2005 and May 2006, whereby the investors were entitled to receive an amount of 1% per month of the private placement of $3,000,000 and $4,500,000 if the Company’s registration statement had not been declared effective within 120 days of the closing dates of the respective private placements.

Note 12-Supplemental Cash Flow

During the nine months ended September 30, 2006, the Company entered into capital leases for the purchase of equipment totaling $636,485 of which $70,599 was paid during the period.

 

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Note 13-New Accounting Pronouncements

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140.” SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes a contractual obligation to service a financial asset in certain circumstances. All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include the amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing income or net servicing loss, or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the period in which they occur. If the amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each reporting date. SFAS No. 156 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of SFAS No. 156 on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than not (i.e. a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Upon adoption, the cumulative effect of applying the recognition and measurement provisions of FIN 48, if any, shall be reflected as an adjustment to the opening balance of retained earnings.

FIN 48 requires that subsequent to initial adoption a change in judgment that results in subsequent recognition, derecognition or change in a measurement of a tax position taken in a prior annual period (including any related interest and penalties) be recognized as a discrete item in the period in which the change occurs. Currently, we record such changes in judgment, including audit settlements, as a component of our income tax provision. Thus, our reported quarterly income tax rate may become more volatile upon adoption of FIN 48. This change will not impact the manner in which we record income tax expense on an annual basis.

FIN 48 also requires expanded disclosures including identification of tax positions for which it is reasonably possible that total amounts of unrecognized tax benefits will significantly change in the next twelve months, a description of tax years that remain subject to examination by major tax jurisdiction, a tabular reconciliation of the total amount of unrecognized tax benefits at the beginning and end of each annual reporting period, the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate and the total amounts of interest and penalties recognized in the statements of operations and financial position. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of this standard on our consolidated financial statements.

On September 15, 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect SFAS No. 157 will have a significant impact on the Company’s consolidated financial statements.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 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.  The SEC staff believes that registrants should quantify errors using both the balance sheet and income statement approach when quantifying a misstatement. SAB 108 is effective for the Company’s fiscal year ending December 31, 2006.  The Company is currently evaluating the impact of SAB 108 on the Company’s consolidated financial statements.

Item 2.            Management’s Discussion and Analysis or Plan of Operation

The SEC encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. This Quarterly Report on Form 10-QSB contains

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such “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

Words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “will” and words and terms of similar substance used in connection with any discussion of future events, operating or financial performance, financing sources, product development, capital requirements, market growth and the like, identify forward-looking statements. Forward-looking statements are merely predictions and therefore inherently subject to uncertainties and other factors which could cause the actual results to differ materially from the forward-looking statement.  These forward-looking statements include, among others:

·      projections of revenues and other financial items;

·      statements of strategies and objectives for future operations;

·      statements concerning proposed applications or services;

·      statements regarding future economic conditions, performance or business prospects;

·      statements regarding competitors or competitive actions; and

·      statements of assumptions underlying any of the foregoing.

All forward-looking statements are present expectations of future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. The risks related to ASPYRA’s business discussed under “Risk Factors” of this Quarterly Report on Form 10-QSB, among others, could cause actual results to differ materially from those described in the forward-looking statements.  Such risks include, among others: the competitive environment; unexpected technical and marketing difficulties inherent in major product development efforts; the potential need for changes in our long-term strategy in response to future developments; future advances in clinical information technology and procedures, as well as potential changes in government regulations and healthcare policies, both of which could adversely affect the economics of the products offered by ASPYRA; and rapid technological change in the microelectronics and software industries.

The Company makes no representation as to whether any projected or estimated information or results contained in any forward-looking statements will be obtained or achieved. Shareholders are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-QSB. The Company is under no obligation, and it expressly disclaims any obligation, to update or alter any forward-looking statements after the date of this Quarterly Report on Form 10-QSB, whether as a result of new information, future events or otherwise.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion relates to the newly merged business of ASPYRA, which includes the operations of its wholly owned subsidiaries Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM, Inc.) and Aspyra Technologies, Ltd. (formerly StorCOMM Technologies, Ltd.).  The merger, which resulted in the acquisition of StorCOMM, was consummated on November 22, 2005 and this third fiscal quarter and nine-month period of 2006 is the third full quarterly report since the merger was consummated.

ASPYRA operates in one business segment and generates revenues primarily from the sale of its Clinical Information Systems (“CIS”) and Diagnostic Information Systems (“DIS”), which includes the license of proprietary application software, and may include the sale of servers and other hardware components to be integrated with its application software. In connection with its sales of its products, the Company provides implementation services for the installation, integration, and training of end users’ personnel. The Company also generates sales of ancillary software and hardware, including its data acquisition products, to its customers and to third parties. We recognize these revenues under system sales in our financial statements.  The Company also generates recurring revenues from the provision of comprehensive post implementation services to its customers, pursuant to extended service agreements. We recognize these revenues under service revenues in our financial statements.  This is an important aspect of its business as the Company’s products are “mission critical” systems that are used by healthcare providers in most cases 24 hours per day and 7 days per week. The ability to provide comprehensive services is crucial to obtaining new customers and maintaining existing customers.

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Because of the nature of its business, ASPYRA makes significant investments in research and development for new products and enhancements to existing products. Historically, ASPYRA has funded its research and development programs through cash flow primarily generated from operations.  Management anticipates that future expenditures in research and development will either continue at current levels or may increase for the foreseeable future, and will be funded primarily out of the Company’s cash flow.

ASPYRA’s results of operations for the third fiscal quarter and nine-month period ended September 30, 2006 were marked by an increase in sales and an increase in operating loss over the comparable periods of 2005 that are more fully discussed in the following section “Results of Operations.”  The Company’s increase in revenues was due to the addition of the revenues from ASPYRA’s wholly owned subsidiaries, Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM, Inc.) and Aspyra Technologies, Ltd. (formerly StorCOMM Technologies, Ltd.).  The Company concluded sales late in the quarter, which due to timing issues, were not fully implemented and recognized in the quarter resulting in deferred revenue on system sales of approximately $1.9 million at September 30, 2006.  Generally, sales cycles for CIS and DIS products are lengthy and on average exceed six months from inception to closure.  Because of the complexity of the sales process, a number of factors that are beyond the control of the Company can delay the closing of transactions.

The operating losses incurred by the Company during the current quarter and nine-month period ended September 30, 2006 were attributable to various factors.  The Company continued to experience delays related to closing sales, which delayed implementation of systems and recognition of revenue on many of its DIS and CIS sales.  In the third quarter ended September 30, 2006, the Company completed the sale of its Laboratory Information Systems (“LIS”) and Anatomic Pathology (“AP”) applications to a large community-based hospital in Chicago, which will be implemented in the fourth quarter of 2006 and several other CIS and DIS transactions.  Only a fraction of the sales completed in the quarter ended September 30, 2006, were actually recognized as revenue in that quarter.  The backlog of deferred revenue associated with such sales increased to $1,930,958 as of September 30, 2006, which will be recognized in future periods.  Additionally, the Company is still completing the integration and restructuring of the merged business and incurred certain costs associated with such activities which were only partially offset by reductions in redundant personnel and other expenses during the quarter ended September 30, 2006.  The Company expects to achieve synergies and cost reductions in its business as it completes further integration and restructuring by year-end.  Furthermore, the Company has been primarily reliant on distributors and channel partners for the sales of its diagnostic systems and has been subject to inconsistencies in the performance of such third parties and the timely consummation of orders.  Aspyra is in the process of transitioning to a direct sales model for some of the diagnostic system products to supplement the distribution and channel network so that it is less reliant on third parties in the sale of its diagnostic systems.  Aspyra also has completed new versions of its laboratory and radiology information systems products, as well as its new AccessRAD Radiology Information System (“RIS”) / Picture Archive Communication Systems (“PACS”) which it has begun marketing and anticipates increased sales related to such new product releases in the future.

Overall as compared to the second and first fiscal quarters of 2006, the Company’s operating losses in the third fiscal quarter ended September 30, 2006 declined by approximately $320,000 and $660,000, respectively.  Management believes that the operating losses will continue to decline as the integration plan is concluded and the Company reaches it sales objectives with its new improved products.

Results of Operations

The following table sets forth certain line items in our condensed consolidated statement of operations as a percentage of total revenues for the periods indicated:

		Three Months Ended September 30, 2006		Three Months Ended September 30, 2005		Nine Months Ended September 30, 2006		Nine Months Ended September 30, 2005
Revenues:
System sales		45.9	%	31.6	%	42.2	%	28.0	%
Service revenues		54.1		68.4		57.8		72.0
Total revenues		100.0		100.0		100.0		100.0
Cost of products and services sold:
System sales		29.4		22.8		31.2		23.8
Service revenues		23.7		24.0		23.7		24.3
Total cost of products and services		53.1		46.8		54.9		48.1
Gross profit		46.9		53.2		45.1		51.9
Operating expenses:
Selling, general and administrative		50.7		51.2		60.3		48.6
Research and development		15.2		18.2		15.9		17.1
Total operating expenses		65.9		69.4		76.2		65.7
Operating loss		(19.0	)	(16.2	)	(31.1	)	(13.8	)
Loss before provision for income taxes		(21.6	)	(16.2	)	(33.5	)	(13.8	)
Provision for income taxes		—		45.9		—		15.5
Net loss		(21.6	)	(62.1	)	(33.5	)	(29.3	)

 

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Revenues

Sales for the fiscal quarter ended September 30, 2006 increased to $3,282,041, as compared to $1,727,672 for the comparable quarter ended September 30, 2005, an overall increase of approximately $1,554,369 or 89.97%. For the nine-month period ended September 30, 2006 sales increased to $9,201,937, as compared to $5,108,967 for the same period in fiscal 2005, an overall increase of $4,092,970 or 80.1%.   When analyzed by revenue category for the quarter and nine-month period, sales of CIS and DIS products increased by $962,170, or 176.26%, and $2,451,715 or 171.5% respectively.  For the quarter and nine-month period, service revenues increased by $592,199 or 50.11% and $1,641,255 or 44.6% respectively. The increase in sales of CIS and DIS products was primarily attributable to the addition of the revenues from ASPYRA’s wholly owned subsidiaries, described above under “Overview”.  The increase in service revenues is attributable to the consolidation of service revenues from the subsidiaries and a greater number of client accounts under contract.  Service revenues are expected to continue to increase as and when the Company’s installed base of CIS and DIS installations increases.

The Company continues to invest heavily in sales and marketing activities focused on increasing its transaction pipeline and transitioning to more of a direct sales model so that it is less reliant on third parties in the sale of its CIS and DIS products while new improved product versions are being introduced.  While this transition is being completed management is cautiously optimistic about the near-term outlook for its sales of CIS and DIS products.  The Company has invested additional funds into marketing activities to further build its sales pipeline as well as to launch the newly merged company into new market opportunities.  The Company’s future operating results will continue to be subject to quarterly variations based upon a wide variety of factors, including the volume mix and timing of orders received during any quarter, and the temporary delays in the closing of new CIS and DIS sales.  In addition, the Company’s revenues associated with CIS and DIS sales may be delayed due to client related issues such as client staff availability for training, information technology infrastructure readiness, and the performance of third party contractors, all of which are issues outside of the control of ASPYRA.

Costs of products and services sold

Cost of sales for the quarter ended September 30, 2006 increased by $935,543 or 115.7% to $1,744,214, as compared to $808,671 for the same quarter of fiscal 2005.  Cost of sales for the nine-month period increased by $2,592,897 or 105.5% to $5,050,829 as compared to $2,457,932 for the same period of fiscal 2005.  For the quarter and nine-month period, the increases in cost of sales were primarily attributable to an increase in labor costs of $309,511 or 69.0%, and $978,058 or 71.8% respectively, increases in material costs of $330,178 or 633.2%, and $868,628 or 416.6% respectively; and increases in other costs of $295,854 or 96.2% and $746,211 or 84.2% respectively, as compared to the same periods in fiscal 2005.  The increase in material costs was attributable to the increase in sales of CIS and DIS products discussed above.  The increase in labor costs was attributable to the addition of personnel of Aspyra Diagnostic Solutions, Inc. The increase to other costs was also a result of the addition of the operations of the subsidiaries.  For the current quarter and nine-month period, cost of sales as a percentage of sales was 53% and 55% respectively, as compared to 47% and 48% respectively for the comparable periods of 2005.  The overall percentage increase in cost of sales, as a percentage of sales, was attributable to the volume and mix of sales during the periods discussed and the cost of sales related thereto.  The Company could potentially experience quarterly variations in gross margin as a result of the factors discussed above.

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Selling, general and administrative expenses

Selling, general and administrative expenses increased by $781,080 or 88.4% for the current fiscal quarter ended September 30, 2006 as compared to the same quarter in fiscal 2005.  For the nine-month period, selling, general and administrative expenses increased by $3,065,272 or 123.4% as compared to the same period in fiscal 2005. For the quarter the increases in selling, general and administrative expenses were primarily attributable to the addition of expenses from the consolidation of the subsidiaries of approximately $678,000 as well as additional expenses incurred during the quarter ended September 30, 2006, as follows:  corporate governance expenses of approximately $40,000, depreciation expense of approximately $22,000, and compensation expense of approximately $52,000 associated with the adoption of SFAS No. 123(R).  Also included in the current quarter, are additional expense consolidated from our subsidiaries was approximately $150,000 attributable to amortization of intangible assets.

For the nine-month period the increases in selling, general and administrative expenses were primarily attributable to the addition of expenses from the consolidation of the subsidiaries of approximately $2,212,000 as well as additional expenses incurred during the period as follows:  legal and accounting fees of approximately $146,000, corporate governance expenses of $120,000, tradeshow expenses of approximately $62,000, additional personnel, including commissions paid, in sales, regulatory affairs, and accounting of approximately $139,000, depreciation expense of $66,000, increase in utilities of approximately $42,000, compensation expense of approximately $213,000 associated with the adoption of SFAS No. 123(R),  and expenses related to the Company’s user symposium of approximately $72,000.  Also included in the current nine-month period as additional expense consolidated from our subsidiaries was approximately $452,000 attributable to amortization of intangible assets

The Company’s plans include increased further investment in its marketing and sales programs during the balance of its 2006 fiscal year.

Research and development expenses

Research and development expenses increased by $184,628, or 58.7% for the current fiscal quarter ended September 30, 2006 as compared to the same period in fiscal 2005.  For the nine-month period research and development expense increased $587,380 or 67.3%, as compared to the same period in fiscal 2005.  The increase is attributable to the addition of expenses from the consolidation of the subsidiaries, which amounted to approximately $169,000 during the current quarter and $471,000 for the nine-month period.  In addition there were other personnel additions, which amounted to $12,000 and $81,000 for the current quarter and nine-month period.  For the comparable third quarters of 2006 and 2005, the Company capitalized software costs of $216,360 and $171,000, respectively, which are generally amortized over the estimated useful life, not to exceed five years.  For the comparable nine-month periods of 2006 and 2005, the Company capitalized software costs of $715,946 and $511,421 respectively.  Such costs were attributable to the development of AccessRAD the new RIS/PACS platform that integrates the Company’s radiology information system CyberRAD with its AccessNET PACS system, and enhancements and new modules for the Company’s CIS and DIS products.  The Company plans to continue significant product development activities at current expense levels throughout the 2006 fiscal year.

Interest Expense

Interest expense for the current quarter ended September 30, 2006 increased by $121,932 or 3,057% as compared to the same quarter of fiscal 2005.  Interest expense for the current nine-month period increased $280,413 or 2,386% over the comparable nine-month period of fiscal 2005. Of this amount approximately $93,000 and $192,000 for the quarter and nine-month period, respectively, was attributable to a penalty related to the private placement transactions that were completed in November 2005 and May 2006 whereby the investors were entitled to receive an amount of 1% per month if the Company’s registration had not been declared effective within 120 days of the closing dates of the respective private placements.  The Company’s registration statement was declared effective on September 22, 2006 therefore, the Company is no longer in penalty on these private placement transactions.  The balance of the increase is a result of the increased borrowings during the current quarter and nine-month periods as compared to the third quarter and nine-month period of fiscal 2005.

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Net income (loss)

As a result of the factors discussed above, the Company incurred a net loss of $710,063 or basic and diluted loss per share of $.07 in the third fiscal quarter of 2006 as compared to net loss of $1,073,152 or basic and diluted loss per share of $.31 for the third fiscal quarter of 2005.  For the nine-month period ended September 30, 2006, the Company incurred a net loss of $3,087,961 or basic and diluted loss per share of $.32 as compared to net loss of $1,498,654 or basic and diluted loss per share of $.44 for the same period of 2005.

Liquidity and Capital Resources

Historically, the Company’s primary need for capital has been to invest in software development, and in computers and related equipment for its internal use.  The Company invested $715,946 and $511,421 respectively during the nine months ended September 30, 2006 and 2005 in software development.  These expenditures related to investment in the Company’s new RIS/PACS integrated system AccessRAD, enhancements to AccessNET, and the new browser version of the Company’s LIS product, CyberLAB, and other product enhancements.  The Company anticipates expending additional sums during the remainder of fiscal 2006 on product enhancements to all its products and the further development of AccessRAD, and the new browser version of the Company’s LIS product, CyberLAB.  During the nine months ended September 30, 2006 and 2005, the Company invested an aggregate of $890,316, of which $636,485 was under capital leases, and $256,925, respectively, in fixed assets primarily consisting of computers, network infrastructure, telephone and data communications systems, and software.

As of September 30, 2006, the Company’s working capital amounted to a deficit of $1,694,495 compared to a deficit of $2,549,521, as of December 31, 2005.  The deficit working capital position on a consolidated basis is the result of ASPYRA merging with Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM, Inc.), which had a substantial negative working capital position at the time of the merger and the increase in deferred revenues, which in the aggregate amounted to approximately $3,991,000 at September 30, 2006.  On May 17, 2006, the Company sold in a private placement transaction 2,250,000 shares of its common stock and warrants to purchase up to 1,350,000 shares of its common stock pursuant to the terms of the Common Stock and Warrant Purchase Agreement, dated May 4, 2006.  The private placement generated $4,500,000, less costs of approximately $470,000, and improved  the Company’s working capital position.

Cash used in operating activities was $1,649,067 for the nine-month period ended September 30, 2006 compared to cash provided by operations of $242,987 for the comparable period of fiscal 2005.  The decrease in cash flow from operating activities was primarily attributable to the net loss incurred and the net change in accrued receivables and payables compared to the same period of fiscal 2005.

Net cash used in investing activities totaled $969,777 for the nine-month period ended September 30, 2006, compared to $1,108,423 used in investing activities during the comparable period of 2005.  The decrease in cash used in investing activities was due to the reduction in capitalized acquisition costs partially offset by additional investment in capitalized software.

Cash flows from financing activities amounted to $3,276,109 during the nine-month period ended September 30, 2006 compared to $71,400 provided during the comparable period of fiscal 2005.  The increase was primarily attributable to proceeds from the private placement completed in May 2006, discussed above and from borrowings on its revolving line of credit with the bank offset by payments on notes payable and an increase in restricted cash.

The Company’s primary source of working capital has been generated from the private placement, which was completed in May 2006, and from borrowings.  The Company’s results of operations for the current period ended September 30, 2006 produced negative operating cash flow of approximately $1,649,067.  An unanticipated decline in sales, delays in implementations where payments are tied to delivery and/or performance of services or cancellations of contracts could have a negative effect on cash flow from operations and could in turn create short-term liquidity problems.  If sales are not as expected, the Company will consider certain cost cutting measures.  We believe that our current cash and cash equivalents, and cash flow from operations, will be sufficient to meet our current anticipated cash needs, including for working capital purposes, capital expenditures and various contractual obligations, for at least the next 12 months.  We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue.  The sale of convertible debt securities or additional equity securities could result in additional dilution to our shareholders.

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The incurrence of indebtedness would result in incurring debt service obligations and could result in operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additional financing will be available on acceptable terms, if at all. Although there are no present understandings, commitments or agreements with respect to the acquisition of any other businesses, applications or technologies, we may, from time to time, evaluate acquisitions of other businesses, applications or technologies.

Seasonality, Inflation and Industry Trends

The Company’s sales are generally higher in the winter and spring.  Inflation has not had a material effect on the Company’s business since the Company has been able to adjust the prices of its products and services in response to inflationary pressures.  Management believes that most phases of the healthcare segment of the computer industry will continue to be highly competitive, and that potential healthcare reforms including those promulgated by Health Insurance Portability and Accountability Act may have a long-term positive impact on its business.  The key issues driving demand for ASPYRA’s products are industry concerns about patient care and safety issues, development of a national standard for the electronic health record that will affect all clinical data, a paradigm shift from analog to digital imaging technologies, and regulatory compliance.  The Company has continued to invest heavily in new application modules to assist its customers in addressing these issues.  Management believes that new application modules and features that concentrate on such issues will be key selling points and will provide a competitive advantage.  In addition, management believes that the healthcare information technology industry will be marked with more significant technological advances, which will improve the quality of service and reduce costs.  The Company anticipates it will be able to meet these challenges.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of ASPYRA’s financial condition and results of operations are based upon the condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.  On an on-going basis, management evaluates estimates, including those related to the valuation of inventory and the allowance for uncollectible accounts receivable. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Inventory

The Company’s inventory is comprised of a current inventory account that consists of items that are held for resale and a long-term inventory account that consists of items that are held for repairs and replacement of hardware components that are serviced by the Company under long-term Extended Service Agreements with its clients.  Current inventory is valued at the lower of cost to purchase or the current estimated market value of the inventory items.  Inventory is evaluated on a continual basis and adjustments to recorded costs are made based on management’s estimate of future sales value, or in the case of the long-term component inventory, on management’s estimation of the usage of specific inventory items and net realizable value.  Management reviews inventory quantities on hand and makes determination of the excess or obsolete items in the inventory, which, are specifically reserved.  In addition, adjustments are made for the difference between the cost of the inventory and the estimated market value and charged to operations in the period in which the facts that give rise to the adjustments become known.  At September 30, 2006, the inventory reserve was approximately $161,800.

Accounts Receivable

Accounts receivable balances are evaluated on a continual basis and allowances are provided for potentially uncollectible accounts based on management’s estimate of the collectability of customer accounts. If the financial condition of a customer were to deteriorate, resulting in an impairment of their ability to make payments, an additional allowance may be required. Allowance adjustments are charged to operations in the period in which the facts that give

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rise to the adjustments become known.  The accounts receivable balance at September 30, 2006 was $2,391,021, net of an allowance for doubtful accounts of approximately $82,840.

Revenue Recognition

Revenues are derived primarily from the sale of CIS and DIS products and the provision of services.  The components of the system sales revenues are the licensing of computer software, installation, and the sale of computer hardware and sublicensed software. The components of service revenues are software support and hardware maintenance, training, and implementation services.  The Company recognizes revenue in accordance with the provisions of Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-4, SOP 98-9 and clarified by Staff Accounting Bulletin (SAB) 104 “Revenue Recognition in Financial Statements.”  SOP No 97-2, as amended, generally requires revenue earned on software arrangements involving multiple-elements to be allocated to each element based on the relative fair values of those elements.  The Company allocates revenue to each element in a multiple-element arrangement based on the element’s respective fair value, with the fair value determined by the price charged when that element is sold and specifically defined in a quotation or contract.  The Company determines the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance charged to customers, professional services portion of the arrangement, other than installation services, based on hourly rates which the Company charges for these services when sold apart from a software license, and the hardware and sublicense of software based on the prices for these elements when they are sold separately from the software.  At September 30, 2006 deferred revenue was $1,930,958.

Post Implementation software and hardware maintenance services are marketed under monthly, quarterly and annual arrangements and are recognized as revenue ratably over the contracted maintenance term as services are provided.  Deferred revenue related to CIS and DIS sales are comprised of deferrals for license fees, hardware, and other services for which the implementation has not yet been completed and revenues have not been recognized.  At September 30, 2006 deferred service contract income was $2,060,468.

Software Development Costs

Costs incurred internally in creating computer software products are expensed until technological feasibility has been established upon completion of a program design. Thereafter, applicable software development costs are capitalized and subsequently reported at the lower of amortized cost or net realizable value.  Capitalized costs are amortized based on current and expected future revenue for each product with minimum annual amortization equal to the straight-line amortization over the estimated economic life of the product, not to exceed five years.  For the nine-month periods ended September 30, 2006 and 2005, the Company capitalized $715,946 and $511,421, respectively.  At September 30, 2006, the balance of capitalized software costs was $2,383,258, net of accumulated amortization of $1,001,179.

Intangible Assets

Intangible assets, with definite and indefinite lives, consist of acquired technology, customer relationships, channel partners, and goodwill.  They are recorded at cost and are amortized, except goodwill, on a straight-line basis based on the period of time the asset is expected to contribute directly or indirectly to future cash flows, which range from four to 15 years.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, goodwill is tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired.  In accordance with SFAS No. 144, Accounting for Impairment of Long-Lived Assets, management reviews definite life intangible assets to determine if events or circumstances have occurred which may cause the carrying values of intangible assets to be impaired. The purpose of these reviews is to identify any facts or circumstances, either internal or external, which may indicate that the carrying value of the assets may not be recoverable.

Stock-based Compensation

We have two stock-based compensation plans, the 2005 Equity Incentive Plan and the 1997 Stock Option Plan, under which we may issue shares of our common stock to employees, officers, directors and consultants. Upon effectiveness of the 2005 Equity Incentive Plan on November 22. 2005, the 1997 Stock Option Plan was terminated for purposes of new grants.  Both of these plans have been approved by our shareholders.

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Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation. No stock-based employee compensation cost was recognized in our Statement of Operations for the three and nine months ended September 30, 2005 as all options granted under our plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the three and nine months ended September 30, 2006 includes; (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated.

SFAS No 123(R) requires us to make certain assumptions and judgments regarding the grant date fair value. These judgments include expected volatility, risk free interest rate, expected option life, dividend yield and vesting percentage. These estimations and judgments are determined by us using many different variables that in many cases are outside of our control. The changes in these variables or trends, including stock price volatility and risk free interest rate may significantly impact the grant date fair value resulting in a significant impact to our financial results.

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes,” which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, deferred tax liabilities and assets are determined based on the differences between the financial statements and the tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.  Income tax expense represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

Risk Factors

In evaluating the Company, various risk factors and other information should be carefully considered.  The risks and uncertainties described below are not the only ones that impact the Company.  Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also have an adverse impact on us.  Among other things, this discussion contains forward-looking statements that are based on certain assumptions about future risks and uncertainties.  We believe that our assumptions are reasonable.  Nonetheless, it is likely that at least some of these assumptions will not come true.

We have incurred losses recently that may adversely impact liquidity.

We have experienced operating losses and cash outflows.  For the nine months ended September 30, 2006, our net loss was $3,087,961.  At September 30, 2006, our cash and cash equivalents, including restricted cash, totaled $2,964,545 and our working capital deficit was $1,694,495.  We cannot be certain that Aspyra will become profitable and sustain profitability.  If Aspyra does not become profitable and sustain profitability, the market price of our common stock will decline.  The Company’s primary source of working capital has been generated from the private placements and borrowings.  The Company’s results of operations for the nine months ended September 30, 2006 produced negative operating cash flow of approximately $1,649,067.  Any decline in sales, delays in implementations where payments are tied to delivery and/or performance of services or cancellations of contracts could have a negative effect on cash flow from operations and could in turn increase our liquidity problem.  If sales are not as expected, the Company will consider certain cost cutting measures.  We may require additional cash resources to sustain our business.  The sale of convertible debt securities or additional equity securities could result in additional dilution to our shareholders.  The incurrence of additional indebtedness would result in incurring debt service obligations and could result in operating and financial covenants that would restrict our operations.  There can be no assurance that any additional financing will be available on acceptable terms, if at all.

 

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If ASPYRA and Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) fail to effectively integrate their operations, the combined company may not realize the potential benefits of the merger.

The integration of ASPYRA and Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) has been a time consuming and expensive process and may disrupt the combined company’s operations if it is not completed in a timely and efficient manner. The integration is still in process.  If this integration effort is not successful, the combined company’s results of operations could be harmed, employee morale could decline, key employees could leave, customers could cancel existing orders or choose not to place new ones and the combined company could have difficulty complying with regulatory requirements. In addition, the combined company may not achieve anticipated synergies or other benefits of the merger. ASPYRA and Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) must operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices. The combined company may encounter the following difficulties, costs and delays involved in integrating their operations:

·      failure to successfully manage relationships with customers and other important relationships;

·      failure of customers to accept new services or to continue using the products and services of the combined company;

·      difficulties in successfully integrating the management teams and employees of ASPYRA and Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM);

·      challenges encountered in managing larger, more geographically dispersed operations;

·      the loss of key employees;

·      diversion of the attention of management from other ongoing business concerns;

·      potential incompatibilities of technologies and systems;

·      potential difficulties integrating and harmonizing financial reporting systems; and

·      potential incompatibility of business cultures.

If the combined company’s operations do not meet the expectations of customers of ASPYRA or Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) then these customers may cease doing business with the combined company altogether, which would harm the results of operations and financial condition of ASPYRA.

If the anticipated benefits of the merger are not realized or do not meet the expectations of financial or industry analysts, the market price of ASPYRA common stock may decline. The market price of ASPYRA common stock may decline as a result of the merger if:

·      the integration of ASPYRA and Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) is unsuccessful;

·      the combined company does not achieve the expected benefits of the merger as quickly as anticipated or the costs of or operational difficulties arising from the merger are greater than anticipated;

·      the combined company’s financial results after the merger are not consistent with the expectations of financial or industry analysts;

·      the anticipated operating and product synergies of the merger are not realized; or

·      the combined company experiences the loss of significant customers or employees as a result of the merger.

We face intense competition from both established entities and new entries in the market that may adversely affect our revenues and profitability.

Our markets are competitive. There are many companies with active research and development programs both in and outside of the healthcare information technology industry.  Many of these companies have considerable experience in

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areas of competing interest to us.  Additionally, we cannot determine if other firms are conducting potentially competitive research, which could result in the development and introduction of products that are either comparable or superior to the products we sell.  Further, new product introductions, product enhancements and the use of other technologies by our competitors could lead to a loss of market acceptance and cause a decline in sales or gross margins.

If we are unable to anticipate or react to competition or if existing or new competitors gain market share, our sales may decline or be impaired and we may experience a decline in the prices we can charge for our products, which could adversely affect our operating results. Our competitive position depends on several factors, including:

·      our ability to adapt effectively to the continued development, acquisition or licensing of technology or product rights by our competitors;

·      our ability to enhance our products or develop new products;

·      our ability to adapt to changing technological demands; and

·      our strategic decisions regarding the best allocation of our limited resources.

Several of our current and potential competitors have greater financial, technical, sales, marketing and other resources than we do and consequentially may have an ability to influence customers to purchase their products that compete with ours. Our future and existing competitors could introduce products with superior features, scalability and functionality at lower prices than our products, and could also bundle existing or new products with other more established products in order to compete with us. Our competitors could also gain market share by acquiring or forming strategic alliances with our other competitors. If we do not adapt our business in the face of this competition, our business and operating results may be harmed.

Any failure to successfully introduce future products into the market could adversely affect our business.

The commercial success of future products depends upon their acceptance by the medical community.  Our future product plans include capital-intensive clinical information systems.  We believe that these products can significantly reduce labor costs, improve patient care and offer other distinctive benefits to the medical community.  However, there is often market resistance to products that require significant capital expenditures or which eliminate jobs through automation. We can make no assurance that the market will accept our future products and systems, or those sales of our future products and systems will grow at the rates expected by our management.

If we fail to meet changing demands of technology, we may not continue to be able to compete successfully with competitors.

The market for our products is characterized by rapid technological advances, changes in customer requirements and frequent new product introductions and enhancements.  Our future success depends upon our ability to introduce new products that keep pace with technological developments, enhance current product lines and respond to evolving client requirements.  ASPYRA has incurred, and we will need to continue to incur, significant research and development expenditures in future periods as we strive to remain competitive.  Our failure to meet these demands could result in a loss of our market share and competitiveness and could harm our revenues and results of operations.

Our success depends on our ability to attract, retain and motivate management and other skilled employees.

Our future success and growth depend on the continued services of our key management and employees, including Steven M. Besbeck, Bruce M. Miller, James R. Helms, and Samuel G. Elliott.  The loss of the services of any of these individuals or any other key employee could materially affect our business. Our future success also depends on our ability to identify, attract and retain additional qualified personnel. Competition for employees in our industry is intense and we may not be successful in attracting or retaining them.  There are a limited number of people with knowledge of, and experience in, our industry.  We do not have employment agreements with most of our key employees.  However, we generally enter into agreements with our employees regarding patents, confidentiality and related matters.  We do not maintain life insurance polices on our employees.  Our loss of key personnel, especially without advance notice, or our inability to hire or retain qualified personnel, could have a material adverse effect on sales and our ability to maintain our

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technological edge.  We cannot guarantee that we will continue to retain our key management and skilled personnel, or that we will be able to attract, assimilate and retain other highly qualified personnel in the future.

If we do not protect our proprietary information and prevent third parties from making unauthorized use of our products and technology, our financial results could be harmed.

We rely on a combination of confidentiality agreements and procedures and copyright, patent, trademark and trade secret laws to protect our proprietary information. However, all of these measures afford only limited protection and may be challenged, invalidated, or circumvented by third parties. Third parties may copy aspects of our products or otherwise obtain and use our proprietary information without authorization. Third parties may also develop similar or superior technology independently, including by designing around our patents. Furthermore, the laws of some foreign countries do not offer the same level of protection of our proprietary rights as the laws of the United States, and we may be subject to unauthorized use of our products in those countries. Any legal action that we may bring to protect proprietary information could be expensive and may distract management from day-to-day operations. Unauthorized copying or use of our products or proprietary information could result in reduced sales of our products.

Third parties claiming that we infringe their proprietary rights could cause us to incur significant legal expenses and prevent us from selling our products.

From time to time, we have received claims that we have infringed the intellectual property rights of others and may receive additional claims in the future.  Any such claim, with or without merit, could:

·      be time consuming to defend;

·      result in costly litigation;

·      divert management’s time and attention from our business;

·      require us to stop selling, to delay shipping or to redesign our products; or

·      require us to pay monetary amounts as damages to our customers.

In addition, we license and use software from third parties in our business. These third party software licenses may not continue to be available to us on acceptable terms. Also, these third parties may from time to time receive claims that they have infringed the intellectual property rights of others, including patent and copyright infringement claims, which may affect our ability to continue licensing their software. Our inability to use any of this third party software could result in disruptions in our business, which could materially and adversely affect our operating results.

ASPYRA operates in a consolidating industry which creates barriers to market penetration.

The healthcare information technology industry in recent years has been characterized by consolidation by both healthcare providers who are our customers and by those companies that we compete against. Large hospital chains and groups of affiliated hospitals prefer to negotiate comprehensive contracts for all of their system needs with larger vendors who offer broader product lines and services. The conveniences offered by these large vendors are administrative and financial incentives that we cannot offer our customers.

Our products may be subject to government regulation in the future that could impair our operations.

Our products could be subject to stringent government regulation in the United States and other countries in the future. Furthermore, we expect that the integration of our product and service offering will require us to comply with regulatory requirements and that we will devote significant time and resources to this effort.  These regulatory processes can be lengthy, expensive and uncertain. Additionally, securing necessary clearances or approvals may require the submission of extensive data and other supporting information.

Failure to comply with applicable requirements could result in fines, recall, total or partial suspension of distribution, withdrawal of existing product or our inability to integrate our service and product offerings. If any of these things occur, it could have a material adverse impact on our business.

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Changes in government regulation of the healthcare industry could adversely affect our business.

Federal and state legislative proposals are periodically introduced or proposed that would affect major changes in the healthcare system, nationally, at the state level or both. Future legislation, regulation or payment policies of Medicare, Medicaid, private health insurance plans, health maintenance organizations and other third-party payers could adversely affect the demand for our current or future products and our ability to sell our products on a profitable basis. Moreover, healthcare legislation is an area of extensive and dynamic change, and we cannot predict future legislative changes in the healthcare field or their impact on our industry or our business.

We are subject to the Health Insurance Portability and Accountability Act (HIPAA) and the cost of complying with HIPAA may negatively impact our net income.

Our business is substantially impacted by the requirements of HIPAA and our products must maintain the confidentiality of a patient’s medical records and information. These requirements also apply to most of our customers.  We believe our products meet the standards of HIPAA and may require our customers to upgrade their systems, but our customers’ preoccupation with HIPAA may adversely impact sales of our products, and the costs of compliance with HIPAA could have an impact on our product margins and selling, general and administrative expenses incurred by us and could negatively impact our net income.

Defective products or product failure may subject us to liability and could substantially increase our costs.

Our products are used to gather information for professionals to make medical decisions, diagnosis, and treatment.  Accordingly, the manufacture and sale of our products entails an inherent risk of product liability arising from an inaccurate, or allegedly inaccurate, test or procedure result.  In the past, ASPYRA has discovered errors and failures in certain of our product offerings after their introduction and have experienced delayed or lost revenues during the period required to correct these errors.  Errors and failures in products released by us could result in negative publicity, product returns, loss of or delay in market acceptance of our products, loss of competitive position or claims by customers or others.  Alleviating any of these problems could require significant expenditures of our capital and resources and could cause interruptions, delays or cessation of our sales, which could cause us to lose existing or potential customers and would adversely affect our operating results.  We may be subject to product liability claims as a result of any failure or errors in our products.  If a customer is successful in proving its damages, it could prove expensive and time-consuming to defend against these claims, and we could be liable for the damages suffered by our customers and other related expenses, which could adversely affect our operating results.  We currently maintain product liability insurance coverage for up to $2 million per incident and up to an aggregate of $4 million per year.  Although management believes this liability coverage is sufficient protection against future claims, there can be no assurance of the sufficiency of these policies.  We have not received any indication that our insurance carrier will not renew our product liability insurance at or near current premiums; however, we cannot guarantee that this will continue to be the case.

System or network failures could reduce our sales, increase costs or result in a loss of customers.

We rely on our management information systems to operate our business and to track our operating results. Our management information systems will require modification and refinement as we grow and our business needs change. If we experience a significant system failure or if we are unable to modify our management information systems to respond to changes in our business needs, then our ability to properly run our business could be adversely affected and could lead to a reduction in our sales, increase costs and a loss of customers.

Our evaluation of internal controls and remediation of potential problems will be costly and time consuming and could expose weakness in our financial reporting.

While we believe that we currently have adequate internal control procedures in place, we are still exposed to potential risks from recent legislation requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002. We are evaluating our internal controls system in order to allow management to report on our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 beginning in our fiscal year 2007.  The implementation process of Section 404 of the Sarbanes-Oxley Act of 2002 will be expensive, time-consuming and will require significant attention of the Company’s management. The Company cannot assure that it will not discover material weaknesses in its internal controls. The Company also cannot assure that it will complete the process of its evaluation and the auditors' attestation on time. If the Company discovers a material weakness, corrective action may be time-consuming, costly and further divert the attention of management. The disclosure of a material weakness, even if quickly remedied, could reduce the market's confidence in the Company’s financial statements, cause the delisting of its Common Stock from American Stock Exchange and harm its stock price, especially if a restatement of financial statements for past periods were to be necessary.

 

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Factors outside of our control may adversely affect our operations and operating results.

Our operations and operating results may be adversely affected by many different factors which are outside of our control, including:

·      deterioration in economic conditions in any of the healthcare information technology industry, which could reduce customer demand and ability to pay for our products and services;

·      political and military instability, which could slow spending within our target markets, delay sales cycles and otherwise adversely affect our ability to generate revenues and operate effectively;

·      budgetary constraints of customers, which are influenced by corporate earnings and spending objectives;

·      earthquakes, floods or other natural disasters affecting our headquarters located in Calabasas, California, an area known for seismic activity, or our other locations worldwide;

·      acts of war or terrorism; and

·      inadvertent errors.

Any of these factors could result in a loss of revenues and/or higher expenses, which could adversely affect our financial results.

Our international operations involve special risks that could increase our expenses, adversely affect our operating results and require increased time and attention of our management.

We expect to generate approximately 10% of our revenues from customers located outside of the United States in the fiscal year ending December 31, 2006.  We expect to expand our international operations and such expansion is contingent upon the successful growth of our international revenues. Our international operations are subject to risks in addition to those faced by our domestic operations, including:

·      potential loss of proprietary information due to piracy, misappropriation or laws that may be less protective of our intellectual property rights;

·      imposition of foreign laws and other governmental controls, including trade and employment restrictions;

·      enactment of additional regulations or restrictions on imports and exports;

·      fluctuations in currency exchange rates and economic instability such as higher interest rates and inflation, which could make our products more expensive in those countries;

·      limitations on future growth or inability to maintain current levels of revenues from international sales if we do not invest sufficiently in our international operations;

·      longer payment cycles for sales in foreign countries and difficulties in collecting accounts receivable;

·      difficulties in staffing, managing and operating our international operations;

·      difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations; and

·      political unrest, war or terrorism, particularly in areas in which we have facilities.

A portion of the Company’s transactions outside of the United States are denominated in foreign currencies. Our functional currency is the U.S. dollar.  Accordingly, our future operating results will continue to be subject to fluctuations in foreign currency rates. Hedging foreign currency transaction exposures is complex and subject to uncertainty. We may be negatively affected by fluctuations in foreign currency rates in the future, especially if international sales continue to grow as a percentage of our total sales.

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Changes to financial accounting standards and new exchange rules could make it more expensive to issue stock options to employees, which would increase compensation costs and may cause us to change our business practices.

We prepare our financial statements to conform with generally accepted accounting principles, (“GAAP”), in the United States. These accounting principles are subject to interpretation by the Public Company Accounting Oversight Board, the SEC and various other bodies. A change in those policies could have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced.

For example, we have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term shareholder value and, through the use of vesting, encourage employees to remain with our Company. The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards 123R that will require us to record a charge to earnings for employee stock option grants. In addition, regulations implemented by the American Stock Exchange generally require shareholder approval for all stock option plans, which could make it more difficult or expensive for us to grant stock options to employees. We may, as a result of these changes, incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business, operating results and financial condition.

Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) currently relies on third party distribution arrangements to distribute its products.  The loss of any of these relationships, or a material change in any of them, could materially harm our business.

For the three and nine months ended September 30, 2006 and September 30, 2005, Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) received approximately 90% and 80% of its revenues, respectively, through third party distribution arrangements. We expect that we will continue to generate a significant portion of our revenues through a limited number of distribution arrangements for the foreseeable future. A significant portion of the Company’s outstanding accounts receivable is with such third party distributors, which will result in a concentration of our credit risk. If any of these third party distributors decides not to market or distribute our products or decides to terminate or not renew its agreement with us, we may be unable to replace the affected agreements with acceptable alternatives, which could materially harm our business, operating results and financial condition.

We depend on channel partners and distributors for a significant portion of our revenues.

In each of fiscal 2005 and 2004, Aspyra Diagnostic Solutions, Inc. (formerly StorCOMM) generated approximately 90%, respectively, of its revenues from medical imaging related products. We expect to continue to derive a substantial portion of our revenues from this single product category. If this product category is not successful in the future or we are unable to develop new applications that are as successful, our future revenues could be limited and our business may suffer.

Risks Related to Our Common Stock

Future sales of our common stock could adversely affect our stock price.

Future sales of substantial amounts of shares of our common stock in the public market, or the perception that these sales could occur, may cause the market price of our common stock to decline.  In addition, we may be required to issue additional shares upon exercise of previously granted options or warrants such as the warrants to purchase up to 300,000 shares of Aspyra common stock that Aspyra issued in a private placement pursuant to the Common Stock and Warrant Purchase Agreement dated August 18, 2005 by and among Aspyra and each of the purchasers named therein, the Aspyra options and warrants to be issued in exchange for StorCOMM’s options and warrants pursuant to the merger, and the warrants to purchase up to 1,350,000 shares of Aspyra common stock that Aspyra issued in a private placement pursuant to the Common Stock and Warrant Purchase Agreement dated May 4, 2006 by and among Aspyra and each of the purchasers named therein.  Increased sales of our common stock in the market after exercise of stock options or warrants could exert significant downward pressure on our stock price.  These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price we deem appropriate.

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Our stock price may be volatile in the future, and you could lose the value of your investment.

The market prices of the common stock for ASPYRA have experienced significant fluctuations and our stock price may continue to fluctuate significantly, and you could lose the value of your investment. The market price of our common stock may be affected by a number of factors, including:

·      announcements of quarterly operating results and revenue and earnings forecasts by us, our competitors or our customers;

·      failure to achieve financial forecasts, either because expected sales do not occur or because they occur at lower prices or on terms that are less favorable to us;

·      rumors, announcements or press articles regarding changes in our management, organization, operations or prior financial statements;

·      changes in revenue and earnings estimates by securities analysts;

·      announcements of planned acquisitions by us or by our competitors;

·      announcements of new or planned products by us, our competitors or our customers;

·      gain or loss of a significant customer;

·      inquiries by the SEC, American Stock Exchange, law enforcement or other regulatory bodies; and

·      acts of terrorism, the threat of war and economic slowdowns in general.

The stock market has experienced extreme price volatility, which has adversely affected and may continue to adversely affect the market price of our common stock for reasons unrelated to our business or operating results.

Fluctuations in our quarterly financial results have affected the stock prices of ASPYRA in the past and could affect our stock price in the future.

The quarterly financial results of ASPYRA have fluctuated in the past, and the quarterly financial results of the combined company are likely to vary significantly in the future. A number of factors associated with the operations of our business may cause our quarterly financial results to fluctuate, including our ability to:

·      effectively align sales resources to meet customer needs and address market opportunities;

·      effectively respond to competitive pressures; and

·      effectively manage our operating expense levels.

A number of factors associated with our industry and the markets for our products, many of which are outside our control, may cause our quarterly financial results to fluctuate, including:

·      reduced demand for any of our products;

·      timing and amount of orders by customers and seasonality in the buying patterns of customers;

·      cancellation, deferral or limitation of orders by customers;

·      fluctuations in foreign currency exchange rates; and

·      weakness or uncertainty in general economic or industry conditions.

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Quarterly changes in our financial results could cause the trading price of our common stock to fluctuate significantly after the merger.  If our quarterly financial results or our predictions of future financial results fail to meet the expectations of securities analysts and investors, our stock price could be negatively affected. Any volatility in our quarterly financial results may make it more difficult for us to raise capital in the future or pursue acquisitions that involve issuances of our stock or securities convertible into or exercisable for our stock. You should not rely on the results of prior periods as predictors of our future performance.

New Accounting Pronouncements

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140.” SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes a contractual obligation to service a financial asset in certain circumstances. All separately recognized servicing assets and servicing liabilities are required to be initially measured at fair value. Subsequent measurement methods include the amortization method, whereby servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing income or net servicing loss, or the fair value method, whereby servicing assets or servicing liabilities are measured at fair value at each reporting date and changes in fair value are reported in earnings in the period in which they occur. If the amortization method is used, an entity must assess servicing assets or servicing liabilities for impairment or increased obligation based on the fair value at each reporting date. SFAS No. 156 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of SFAS No. 156 on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48) an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized in the financial statements when it is more likely than not (i.e. a likelihood of more than fifty percent) that the position would be sustained upon examination by tax authorities. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Upon adoption, the cumulative effect of applying the recognition and measurement provisions of FIN 48, if any, shall be reflected as an adjustment to the opening balance of retained earnings.

FIN 48 requires that subsequent to initial adoption a change in judgment that results in subsequent recognition, derecognition or change in a measurement of a tax position taken in a prior annual period (including any related interest and penalties) be recognized as a discrete item in the period in which the change occurs. Currently, we record such changes in judgment, including audit settlements, as a component of our income tax provision. Thus, our reported quarterly income tax rate may become more volatile upon adoption of FIN 48. This change will not impact the manner in which we record income tax expense on an annual basis.

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FIN 48 also requires expanded disclosures including identification of tax positions for which it is reasonably possible that total amounts of unrecognized tax benefits will significantly change in the next twelve months, a description of tax years that remain subject to examination by major tax jurisdiction, a tabular reconciliation of the total amount of unrecognized tax benefits at the beginning and end of each annual reporting period, the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate and the total amounts of interest and penalties recognized in the statements of operations and financial position. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of this standard on our consolidated financial statements.

Item 3.            Controls and Procedures

Attached as exhibits to this Quarterly Report on Form 10-QSB are certifications of ASPYRA’s Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section includes information concerning the controls and controls evaluation referred to in the certifications.  This section should be read in conjunction with the certifications for a more complete understanding of the topics presented.

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of the end of the period covered by this Form 10-QSB.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2006, our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 6.            Exhibits

Exhibit 3.1      Restated Articles of Incorporation, as Amended (previously filed as an exhibit to the Company’s Registration Statement on Form S-18 dated September 22, 1983, SEC File No. 2-85265 and incorporated herein by reference).

Exhibit 3.2      Amendment to the Restated Articles of Incorporation (incorporated by reference to Annex E to the joint proxy statement/prospectus that is part of the Company’s Registration Statement on Form S-4, originally filed on October 3, 2005, SEC file No. 333-128795).

Exhibit 3.3      By-Laws, as amended (previously filed as an exhibit to the Company’s Registration Statement on Form S-18 dated September 22, 1983, SEC File No. 2-85265 and incorporated herein by reference).

Exhibit 11       Statement re: computation of per share earnings.

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Exhibit 31.1    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

Exhibit 31.2            Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

Exhibit 32.1            Certification of Chief Executive Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934.

Exhibit 32.2            Certification of Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934.

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ASPYRA, INC.
(Registrant)
Date: November 14, 2006		/S/ Steven M. Besbeck
		Steven M. Besbeck, President and
		Chief Executive Officer (Principal Executive Officer)
Date: November 14, 2006		/S/ Anahita Villafane
		Anahita Villafane,
		Chief Financial Officer (Principal Financial and
		Accounting Officer)

 

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EXHIBIT INDEX

3.1                                 Restated Articles of Incorporation, as Amended (previously filed as an exhibit to the Company’s Registration Statement on Form S-18 dated September 22, 1983, SEC File No. 2-85265).

3.2                                 Amendment to the Restated Articles of Incorporation (incorporated by reference to Annex E to the joint proxy statement/prospectus that is part of the Company’s Registration Statement on Form S-4, originally filed on October 3, 2005, SEC file No. 333-128795).

3.3.1                        By-Laws, as amended (previously filed as an exhibit to the Company’s Registration Statement on Form S-18 dated September 22, 1983, SEC File No. 2-85265).

11                                    Statement re: computation of per share earnings.

31.1                           Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

31.2                           Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

32.1                           Certification of Chief Executive Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934.

32.2                           Certification of Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934.

 

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