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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File No.: 0-22073
DAOU SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0284454
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5120 SHOREHAM PLACE, SAN DIEGO, CALIFORNIA 92122
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (858) 452-2221
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE PER SHARE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES /X/ NO / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 21, 2000 was $79,705,656.
As of March 21, 2000, the number of issued and outstanding shares of
the Registrant's Common Stock was 17,712,368.
PART I
ITEM 1: BUSINESS.
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All forward-looking statements are
inherently uncertain as they are based on current expectations and assumptions
concerning future events or future performance of the Company. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
are only predictions and speak only as of the date hereof. Forward-looking
statements usually contain the words "estimate," "anticipate," "believe,"
"expect," or similar expressions, and are subject to numerous known and unknown
risks and uncertainties. In evaluating such statements, prospective investors
should carefully review various risks and uncertainties identified in this
report, including the matters set forth under the captions "Risk Factors" and in
the Company's other SEC filings. These risks and uncertainties could cause the
Company's actual results to differ materially from those indicated in the
forward-looking statements. The Company undertakes no obligation to update or
publicly announce revisions to any forward-looking statements to reflect future
events or developments.
GENERAL
DAOU Systems, Inc. ("DAOU" or the "Company") provides integrated
information technology (IT) solutions and services and Internet professional
services to the U.S. healthcare industries. The Company's capabilities range
from strategic planning (using IT to support key business goals), to the design
and integration of IT components (voice, video and data networks, application
implementation, Internet infrastructure, data warehouses), to the management and
delivery of operational services (IT department, desktop management, ASP
services, network management), and beginning in the year 2000, to Internet
solutions and professional services supporting organizations executing an
eBusiness strategy. DAOU aggregates professional expertise to create service
solutions for clients utilizing commercially available third-party IT products.
DAOU is principally focused on providing IT services and solutions to
healthcare organizations, such as integrated delivery networks (IDN's),
hospitals, academic medical centers, government organizations, managed care and
insurance companies, and medical groups. DAOU's strengths lie in its offering of
a comprehensive set of IT and eCommerce servives and solutions as well as
extensive knowledge and experience in the healthcare industry. As a member of
the prestigious Healthcare Research and Development Institute (HRDI), and
through its 15 member CIO Advisory Board, DAOU has the opportunity to fine-tune
its strategic plans with influential healthcare executives. DAOU is a "trusted
advisor" to leading organizations in the provider arena (integrated delivery
networks, hospitals, physician groups, ancillaries) as well as the payor/insurer
segment of the market (Health Maintenance Organizations, Health insurers, Blues
plans, Independent Practice Associations, Preferred Provider Organizations,
Physician/Hospital Organizations) and the administrative/vendor segment (Third
party administrators, Medical Services Organizations, service vendors, software
vendors, hardware vendors). DAOU's philosophy is built on attention to the
customer's objectives and the pursuit of excellence in every area in which its
professional staff works. DAOU sells no proprietary hardware, and other than its
Enosis Integration Engine product, develops no major software applications.
The Company was incorporated in California on July 16, 1987 under the
name DAOU Systems, Inc., and reincorporated in Delaware on November 15, 1996.
Unless the context otherwise requires, as used in this report the "Company" and
"DAOU" refer to the Company, its predecessor entity and its wholly-owned
subsidiaries, DAOU-Sentient, Inc., a Delaware corporation ("DAOU-Sentient"),
DAOU-Synexus, Inc., a Delaware corporation ("DAOU-Synexus"), DAOU-TMI, Inc., a
Delaware corporation ("DAOU-TMI"), DAOU-RHI, Inc., a Delaware corporation
("DAOU-RHI") and Enosus, Inc., a Delaware corporation ("Enosus"). The Company's
principal executive offices are located at 5120 Shoreham Place, San Diego,
California 92122; its telephone and facsimile numbers are (858) 452-2221 and
(858) 452-1338; its e-mail address is [email protected]; and its URL is
http://www.daou.com.
1
IT CONSULTING AND MANAGED CARE IMPLEMENTATION
DAOU's IT consulting and managed care implementation group (IT
Consulting) (formerly Technology Management Inc., and currently operated through
DAOU-TMI) helps healthcare management meet their business and IT objectives and
anticipate and plan their future IT needs. The group's senior consultants offer
clients the benefit of overall project management vision as well as application
and technical skills appropriate for specific assignments. The IT Consulting
group works with its clients in a goal-directed, strategic partnership to
achieve results in a timely and cost-effective manner.
Among its specific capabilities, DAOU's management consulting group
develops business plans and solves problems for healthcare IT managers, installs
and integrates applications, engineers, installs and integrates infrastructure,
and manages IT systems.
In the area of general management consulting, the IT Consulting
group provides counsel on business process improvement, business strategy and
critical management problem solving, planning, and procurement of managed
care systems, hospital systems and physician practice management systems.
More than two-thirds of DAOU's consulting revenue derives from the
implementation of managed care systems such as Erisco's Facets-Registered
Trademark-, McKessonHBOC's Amisys-Registered Trademark-, AMISYS-Registered
Trademark-, QCSI's QMACS-Registered Trademark-, and HSD's DIAMOND-Registered
Trademark-systems.
The engagement period for these services typically averages six
months, but varies depending on the size and complexity of the project.
Implementation projects can last one to two years.
DAOU's contracts for these services run month-to-month, and so there
is no firm backlog. However, as of March 2000, DAOU had contracted business
of approximately $3,000,000 that it expects to fulfill by the end of the year.
COMMUNICATIONS INFRASTRUCTURE
DAOU's communications infrastructure group focuses on IT infrastructure
solutions for healthcare enterprises, including IDN's, hospitals and large
academic medical centers. The group's services include the design and
implementation of sophisticated computer networks, desktop support, and voice,
video and data solutions. The group supports healthcare organizations in all
stages of infrastructure design and implementations, from the requisition and
purchase of hardware to the installation and support of turn-key networks.
NETWORK DESIGN. Before installing a computer network, the Company first
conducts a detailed network assessment and design to determine the network's
connectivity and product requirements. DAOU's network design capabilities are
maximized by supplier independence, allowing broad flexibility with hardware and
software specifications. The communications infrastructure group team can
customize a system platform ready to utilize the very best technologies and
services available. Appropriate hardware, software, and internal/external
cabling provide the backbone for efficient systems. Network design consists of
network analysis and planning. Analysis services include initial assessment,
inventory and evaluation of the customer's existing network, as well as site
visits, interviews, data collection and preparation of schematic diagrams of the
customer's network. Planning services include review of data, establishment of
the organization's needs and collaborative development of a complete network
design and migration strategy. The final design deliverable includes a network
schematic diagram specifying and pricing all labor, hardware, software and
cabling necessary to implement the network.
NETWORK IMPLEMENTATION. DAOU's certified network implementation
staff analyzes and installs computer networks, from basic local area networks
to sophisticated wide area networks ("WAN"), using today's newest
technologies from companies including Cisco, 3Com, Fore, and Novell. Services
include the purchase, testing, delivery and installation of enterprise-wide
computer network systems. The group's leading-edge technology solutions, such
as the implementation of voice over Internet Protocol IP network, are
targeted to meet the particular demands of the healthcare industry. Networks
installed by the Company provide a variety of features and services,
including switch/bridge/router configuration, PC-to-host emulation, legacy
network integration, gateway installation, universal workstation design and
installation, remote-site connectivity solutions, dial-up remote access
solutions, document management, imaging installations, video conferencing,
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telecommunications and telemedicine installations. For each implementation
project, the Company assigns a project management team typically consisting of a
project manager, a senior engineer and other technical personnel, as well as
subcontractors and third-party vendors if required. The project team creates an
installation schedule, ensures compliance with established milestones, provides
on-site coordination of the activities of DAOU's personnel, subcontractors and
third-party vendors, tests network performance (including stress and data
traffic diagnostics) and provides regular progress reports to the project
manager.
The Company's in-house laboratories allow the group to test the
network's configuration, connectivity, compatibility and analyze the load and
data throughput capacity of the network prior to delivery of the network to the
customer site. This testing process simulates the customer's actual computing
environment in accordance with the customer's software specifications, and
reduces downtime risk, helping to ensure that the network installation will
occur with minimal disruption to the customer's ongoing business operations.
After testing is completed, DAOU installs the computer network according to the
customer's specifications.
The engagement period for design and implementation services generally
ranges from three to nine months, although certain projects have required a year
or more for completion, and varies depending on the size and complexity of the
implementation project. The group's services are generally performed on a time
and expense basis and billed semi-monthly or monthly. Certain projects,
generally those with significant hardware content, are performed on a fixed-fee
basis, with revenue recognized as services are performed, and billing based on
certain delivery milestones.
DESKTOP COMPUTING SERVICES. DAOU's desktop computing services group
helps healthcare providers, primarily IDN's, to optimize, understand and manage
the cost of desktop computing. The group's services enable customers to
appropriately balance their end-user service levels with costs. The group's
consultants also assist healthcare organizations in the preparation of and
transition to co-source or outsource strategies for help desk, call center and
IT department/facilities functions.
DAOU's desktop computing consultants provide support for integration of
desktop and network solutions, asset management services from procurement
through disposal, cost of desktop computing analysis, break/fix problem
resolutions, help desk analysis, virus repair processes, on-going software
management audit, quality controls and end-user satisfaction measurement. The
group's asset management services include asset inventory and management, PC
configuration and rollout, development of hardware/software standards and
technology refresh.
The engagement period for these services generally averages six months,
but varies depending on the size and complexity of the project. The group's
services are normally provided to customers on a time and expense basis, with
billing occurring semi-monthly or monthly. Certain projects are bid on a price
per node basis and billed monthly.
VOICE, VIDEO AND DATA SOLUTIONS. DAOU's voice, video and data solutions
group provides leading-edge voice, video and data solutions to IDN's, hospitals,
academic medical centers, educational institutions, architects and government
organizations. The group's voice solutions include baseline assessment and
detailed designs of current telecommunications hardware, software, carrier and
support services. The group's consultants examine cable infrastructure, PBX
systems, call centers, key systems, voice processing systems and local and long
distance service. The group prepares an enterprise-wide plan to determine
cost-effective wireless systems, integrated call centers and interactive
voice-response programs. For voice applications, DAOU helps customers interface
their local and long-range pagers, wireless phones, high-tech call centers, PBX
and integrated messaging systems.
DAOU's video solutions include the planning, design, implementation and
management of total visual information systems. The group's consultants can
assist in the design and implementation of clinical video solutions including
telemedicine, telesurgery, teleradiology, compressed digital video and
home-based triage. The group's business and educational video solutions include
videoconferencing, video production, collaborative and interactive electronic
meetings, distance learning, CME programs, teaching networks and electronic
grand rounds.
The engagement period for voice and video consulting services generally
ranges from three to six months, but varies depending on the size and complexity
of the project. The group's services are primarily provided to customers on a
time and expense basis, with billing occurring semi-monthly or monthly. Certain
architectural and educational projects are bid on a fixed-fee basis and billed
monthly.
3
APPLICATION IMPLEMENTATION
DAOU's application implementation group supplies temporary,
vendor-certified consultants to hospitals and other healthcare organizations.
The application implementation group's primary focus is assisting customers
with the installation of third-party software applications such as
McKessonHBOC STAR-Registered Trademark-, SMS INVISION-Registered Trademark-
and most other commonly used healthcare software applications.
The application implementation group provides expertise in the
following areas: application implementation, project management, interim IT
management, application programming, system programming, decision support and
interface support. The group also supports the following service lines:
- CORE Healthcare Information Systems ("HIS");
- clinical systems;
- financial systems;
- decision support systems; and
- interface support.
The engagement period for these services generally averages six months,
but varies depending on the size and complexity of the project. The group's
services are provided to customers on a time and expense basis, with billing
occurring on a semi-monthly or monthly basis.
INTEGRATION SERVICES
DAOU's integration services group (formerly Sentient Systems, Inc., and
currently operated through DAOU-Sentient) provides custom integration, data
warehousing and programming solutions that allow healthcare organizations to
share and access data housed across multiple platforms and environments. By
developing interfaces, implementing existing interfaces, Web-enabling a system,
or migrating data to more compatible systems, the integration services group
provides healthcare organizations with low-cost methods of sharing data between
legacy systems, on-line transaction processing systems, and off-the-shelf
applications, regardless of technology platform or location. The engagement
period for these services generally ranges from nine to twelve months, but
varies depending on the size and complexity of the project.
The group's consultants are experienced in healthcare information
systems (financial, clinical and management) for hospitals, HMOs, insurers,
clinics and physician offices. This group offers expertise in three specific
healthcare application areas:
- - Government healthcare systems, including the Department of Defense, Health
Affairs, the Department of Veterans Affairs and the Department of Indian
Health Services;
- - Clinical/financial application systems for laboratory, pharmacy,
radiology, nursing, medical records, DRG, materials management, patient
accounting, medical billing, HIS and physician practice management for
hospitals, clinical and physician's offices; and
- - Managed care support including conversion and development projects for
health plans, insurance companies and managed care organizations migrating
to new enterprise applications.
During 1999, this group achieved a number of significant
accomplishments. In the government area, the group achieved a breakthrough into
the Department of Defense Health Affairs (DoD) arena, providing
application/system integration, application development services and the Enosis
Integration Engine. DAOU-Sentient provided DoD Health Affairs a site license for
approximately $1.5 million to integrate DoD's health systems with
commercial-off-the-shelf packages. In the clinical area, the group established
relationships with major clinical information system vendors. The group also
expanded DAOU's healthcare focus by providing services to a new healthcare
segment, Contract Research Organizations (CROs). For the managed healthcare
area, the group completed several successful conversion projects for clients
migrating to new enterprise applications.
4
OUTSOURCING
DAOU's outsourcing group provides support and management services that
are designed to maintain the effective performance of a customer's computer
network system, as well as I/S function outsourcing services, such as desktop
outsourcing, that are designed to manage a customer's information services
functions. As healthcare IT systems become more complex, provider organizations
are experiencing difficulties in hiring, training and retaining information
technology professionals who can maintain the performance and functionality of
their advanced systems. Accordingly, healthcare provider organizations have
begun to outsource certain functions of their information systems departments.
The Company generally provides these services in multi-year engagements on a
fixed-price basis.
TECHNICAL SUPPORT. The Company provides a 24-hour technical support
hotline available seven days a week, as well as other network support resources
such as on-site seminars, on-line support and continuous network monitoring in
order to monitor remotely the performance of computer network systems on an
ongoing basis and detect and report network problems. DAOU also informs its
customers of new technological advances and network solutions that may help
increase the utility and functionality of their computer network systems. The
initial engagement period for the Company's existing support services typically
is for one year, subject to annual renewal.
TECHNICAL MANAGEMENT SERVICES. The Company provides a range of
technical management services to manage and support its customer's computer
network systems. The Company uses its technical expertise and staffing
experience to package, price and deliver combinations of technical management
services at collective rates that are frequently lower than if provided in-house
by the customer. The engagement period for these services typically ranges from
one to five years. The Company offers the following technical management
services, including combinations of these services, selected by the customer to
meet its specific needs:
- - DAOU EMPLOYEES ON-SITE. DAOU works with the customer to assess the
appropriate staffing needs to maintain and support its computer network
system. The Company places its employees on-site on a full-time basis to
provide network support services and ongoing training of the customer's
internal staff.
- - CONTINUOUS NETWORK PLANNING. DAOU's design personnel evaluate the
customer's computer network system and provide recommendations for new
network capabilities and capacity on an ongoing basis consistent with the
evolving needs and strategy of the customer. In addition, DAOU evaluates
hardware and software options, interprets research and development
results, updates existing network designs and researches specific products
and technologies of interest to customers. The Company provides these
services subject to predetermined schedules.
- - "BURST MODE" IMPLEMENTATION. DAOU provides additional technical personnel
during periods of peak network requirements to accommodate and assist in
network upgrade implementation or to accommodate the anticipated or
unanticipated need for additional technical staff.
- - TECHNICAL SUPPORT. Depending on the specific needs of each customer,
the Company also provides network support services as part of its
combination of enterprise network management services.
IT FUNCTION OUTSOURCING. The Company provides IT function outsourcing
services for healthcare provider organizations that elect to outsource all or a
portion of their information systems functions. IT function outsourcing services
involve long-term engagements where the Company may staff portions of its
customers' information systems department and is responsible for the management
and support of those functions. DAOU provides its IT function outsourcing
services in accordance with pre-determined, detailed schedules and plans
established with the customer. The Company typically provides help desk and
these services in multi-year engagements on a fixed-price fee per node basis.
5
INTERNET AND ELECTRONIC COMMERCE
DAOU recently formed Enosus, Inc., a Delaware corporation and
wholly-owned subsidiary ("Enosus"), to provide Internet and electronic commerce
("eCommerce") services. Enosus expects to market these services to healthcare
companies and other small to medium businesses seeking to outsource some or all
of their Internet and eCommerce requirements. Enosus initially will target
healthcare businesses nationwide though the national DAOU sales force.
Additionally, Enosus will develop its own sales team that will focus on
providing services to eHealth companies and supporting venture capital firm's
efforts to accelerate the IT capabilities of their start-ups. The Enosus sales
team will focus on venture capital firms in Seattle, San Francisco, San Jose,
Los Angeles, Irvine, San Diego, Austin, Boston, New York, Philadelphia,
Washington, D.C., Raleigh and Atlanta.
Enosus offers three categories of services:
- - innovation services to assist customers in finding innovative
solutions to their eBusiness needs;
- - engineering services that will utilize project managers,
programmers, database administrators, network designers,
Internet-call centers and telecommunications specialists to
implement the solutions devised by innovation services; and
- - operations services to assist customers in maintaining these
solutions over the long term by providing hosting, system
monitoring, security, technical support and maintenance services.
In addition, Enosus intends to utilize the Company's existing service
offerings to provide data, voice and video services to its customers. Enosus
initially will be forced to outsource certain services, but intends to recruit
the necessary employees to implement its end-to-end services strategy.
Enosus has applied for trademark protection on the name "Enosus" as
well as the phrase "Because the Internet Waits for No One."
DAOU ADVISORY BOARD
In 1994, the Company established its Advisory Board (the "Advisory
Board"), a non-governing body currently comprised of 15 chief information
officers ("CIOs") of various healthcare provider organizations. The Advisory
Board meets annually and the members confer separately with the Company
periodically to provide advice on issues and trends in the healthcare industry
and emerging technologies, as well as to provide strategic direction and
feedback regarding the Company's current and future services. Members of the
Advisory Board are reimbursed for travel, lodging and meal expenses incurred in
connection with attendance at the Advisory Board's sessions. Ward Keever, the
CIO of the University of Pennsylvania, serves as the Chairman of the Advisory
Board.
RECRUITING AND TRAINING OF TECHNICAL EMPLOYEES
The Company dedicates significant time and resources to recruit, train
and retain qualified technical personnel, including consultants, engineers and
technicians providing IT Consulting, managed care implementation, application
implementation, integration, communications infrastructure, outsourcing and
Internet services. The Company maintains an internal recruiting team to attract
technical personnel.
The Company's technical staff undergoes extensive training and
maintains certifications from leading IT technology vendors such as Cisco
Systems, Erisco, Everdream, Fore, HSD, Novell, Lotus, Microsoft, Network
Engines, Oracle, Premier, Sybase System, STC, Sunquest, 3Com, McKessonHBOC,
SMS, and other leading application vendors. In addition, the Company is a
member of leading technological forums and organizations, including HRDI, the
ATM Forum, the CHIM Telecommunications Committee, the HL7 Committee and the
BICSI Organization.
The Company believes that its future success will depend in large part
on its ability to hire, train and
6
retain qualified technical personnel who together have expertise in a wide array
of sophisticated IT solutions and a broad understanding of the healthcare
provider organizations that the Company serves. Competition for qualified
technical personnel is intense and is expected to increase. Consequently, there
can be no assurance that the Company will be successful in attracting and
retaining such personnel. Any inability of the Company to hire, train and retain
a sufficient number of qualified technical personnel could impair the Company's
ability to adequately manage and complete its existing projects or to obtain new
projects, which, in turn, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "--Risk Factors--
THE COMPANY MAY NOT MANAGE SUCCESSFULLY ITS BUSINESS OPERATIONS IF IT FAILS TO
HIRE, TRAIN AND RETAIN QUALIFIED COMPUTER NETWORK ENGINEERS, SOFTWARE
APPLICATION CONSULTANTS AND KEY MANAGEMENT EMPLOYEES."
Each technical employee is required to enter into a confidentiality and
proprietary information agreement with the Company designed to protect the
Company's trade secrets and other confidential information during and subsequent
to employment with the Company. Any significant loss of employees to a
competitor could have a material adverse effect on the Company's business,
financial condition and results of operations
SALES AND MARKETING
The Company's communications infrastructure, application
implementation, outsourcing and eHealth sales are generated primarily from
corporate-managed regional sales organizations located in the west, central,
northeast and southeast regions of the United States. A vice president manages
each regional organization and oversees the development of new customers and the
management of existing customers by local business development directors.
While the corporate-managed sales team generally sells to providers
(IDNs, hospitals, academic medical centers and large clinics), each of the
Company's business units maintain smaller, dedicated business development teams
dedicated to pursuing opportunities within specific healthcare IT technology
market segments. DAOU's IT Consulting subsidiary sales team markets its services
primarily to payor organizations (managed care and insurance companies) and has
also created and resourced a HIPAA practice comprised of multidisciplinary
talent from all of DAOU's business divisions. DAOU's set of security-focused
products and services, enhanced through a recent resale agreement with respect
to Celotek Corporation's CellCase encryption devices, positions the Company to
help customers respond to HIPAA's requirements and to support secure
eBusiness-based initiatives in the healthcare arena. The Company's integration
subsidiary sales team markets its services to clinical and governmental
organizations. Enosus, the Company's eCommerce and Internet solutions provider
subsidiary, maintains a dedicated sales team to market its Internet professional
services and solutions to organizations executing an eBusiness strategy and
"dot.com" companies.
The Company seeks to establish long-term relationships with its
customers by providing high levels of service and by becoming an integral part
of their IT operations. The Company focuses its sales and marketing efforts on
the CIOs and other technology decision-makers of IDNs, hospitals, managed care
and insurance companies and other healthcare provider organizations. The Company
relies upon its reputation in the marketplace, the personal contacts and
networking of its professionals and the various programs of its marketing
department to develop new business opportunities. The Company also receives
sales leads directly from consultants, value added resellers ("VARs"), and
product and service vendors.
The principal objectives of the Company's marketing department are to
increase the Company's market presence, provide strategic direction and generate
sales leads. Based primarily on valuable feedback from customers, HRDI, the
Advisory Board, and other trusted advisors, DAOU's marketing program is centered
around the corporate positioning of DAOU as the single source for healthcare
information technology solutions principally focused on improving the cost,
quality and access of healthcare clients. As a supplement to the direct selling
efforts of the Company, the marketing department has developed various programs
that include advertising campaigns, tradeshow participation, direct mail
campaigns, public relations programs, marketing research and communications and
the development of sales presentation materials. Public speaking engagements and
the publication of technical articles and reports directed to the healthcare
information technology industry enhance the Company's marketing efforts. The
Company's marketing group is also responsible for the continued development of
the Company's presence on the Internet as a new marketing channel.
The Company has entered into marketing agreements with LAN Vision
Systems, IDX Systems Corporation and Health Systems Technologies, each of which
market the Company's services to their respective customer bases. The Company
also has entered into a marketing alliance with STC Corporation ("STC"),
7
whereby, as one of STCs preferred information system integration vendors, the
Company offers computer network design, implementation and support services to
STC's customers. The Company intends to pursue additional marketing agreements,
joint ventures and alliances as part of its marketing plan. In addition, Enosus
recently entered into a strategic relationship with Viador Inc., a leader in the
Enterprise Information Portal (EIP) market, to provide healthcare and
non-healthcare customers with secure, web-based access to enterprise-wide
information.
COMPETITION
The healthcare IT services industry is comprised of a large number of
participants and is subject to rapid change and intense competition. The
Company's competitors include:
- consulting companies;
- information technology vendors;
- VARs;
- system integrators;
- local and regional network services firms; and
- telecommunications providers and network equipment vendors.
Many of the Company's competitors have significantly greater financial,
technical and marketing resources and greater name recognition than does the
Company. The Company's competitors include consulting firms such as First
Consulting Group, Inc., and Superior Consultant Holdings Corporation; healthcare
information technology companies such as McKesson HBOC and Shared Medical
Systems Corporation; hardware firms such as Cisco Systems, Inc., FORE Systems
Inc., 3Com Corporation and Integrated Systems Solution Corporation, a division
of International Business Machines Corporation; and
networking/telecommunications firms such as GTE Corporation, AT&T Corporation
and Sprint Corporation. Each DAOU business segment competes against a different
group of companies. For example, the integration services group competes against
the information technology companies and consulting firms, but has little
competition with hardware or networking telecommunication firms. Enosus competes
against consulting firms and pure Internet services firms such as IXL, Sapient,
Appnet, etc. In addition to these major companies, the Company also competes
with smaller regional IT systems firms, which have a niche in selected
geographical areas of the country. In addition, the Company has faced, and
expects to continue to face, additional competition from new entrants into its
markets. Other healthcare information technology companies not presently
offering or emphasizing network systems services and large network services
companies not currently focusing on healthcare may enter the Company's markets.
Increased competition could result in price reductions, fewer customer projects,
under-utilization of employees, reduced operating margins and loss of market
share, any of which could materially and adversely affect the Company's
business, financial condition and results of operations. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors. The failure of the Company to compete successfully would
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, most of the Company's customers have
internal IT support and service capabilities and could choose to satisfy their
needs through internal resources rather than through outside service providers.
As a result, the decision by the Company's customers or potential customers to
perform IT services internally could have a material adverse effect on the
Company's business, financial condition and results of operations. See "--Risk
Factors-- INTENSE COMPETITION IN ITS INDUSTRY FROM COMPETITORS WITH GREATER
FINANCIAL, TECHNICAL AND MARKETING RESOURCES COULD PREVENT THE COMPANY FROM
INCREASING REVENUES AND ACHIEVING OR SUSTAINING PROFITABILITY."
The Company believes that the principal competitive factors in the
markets in which it competes include reputation, healthcare industry expertise,
network performance and reliability, timely delivery of services, quality of
service, responsiveness to customers, product knowledge and technological
expertise, marketing, customer relationships and price. The Company believes
that it is competitive with respect to the above mentioned factors.
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CUSTOMERS
The Company has provided services to over 1,300 U.S. healthcare
organizations, including 50% of the top IDNs. The Company provides services to
IDNs, hospitals, academic medical centers, managed care and insurance companies,
government organizations and medical groups. Enosus is pursuing selective B2B
opportunities outside of the healthcare industry with companies executing
eBusiness strategies and "dot.com" companies.
The Company has derived, and believes that it will continue to derive,
a significant portion of its revenues from a relatively limited number of large
customer contracts. For the year ended December 31, 1999, the Company's five
largest customers accounted for approximately 26% of total revenues, with Saint
Mary's Health Network ("SMHN") accounting for approximately 10% of total
revenues. For the years ended December 31, 1998 and 1997, the Company's five
largest customers accounted for approximately 19% and 22% of total revenues,
respectively, with no single customer accounting for 10% or more of total
revenues. See "--Risk Factors--THE COMPANY DEPENDS ON A SMALL NUMBER OF LARGE
CUSTOMERS TO PROVIDE A SIGNIFICANT PORTION OF ITS REVENUES."
In 1999, the Company's top five revenue generating customers were from
the following business segments:
1. outsourcing - full IT department;
2. application implementation;
3. outsourcing - co-source IT department;
4. outsourcing - co-source IT department; and
5. IT Consulting - managed care implementation
The Company has transferred existing Internet related business from the
Integration group to Enosus.
EMPLOYEES
As of December 31, 1999, the Company employed 704 technology and
support professionals. Of these employees, 49 were involved in IT Consulting and
managed care implementations, 75 in communications infrastructure, 201 in
application implementation, 108 in integration services, 198 in outsourcing and
73 in sales and marketing, finance, human resources, recruiting and
administrative. To support its growth, the Company employs full-time recruiters
dedicated to the hiring of its technical and support professionals. In 1999, the
Company initiated a referral bonus program throughout the organization to
encourage employees to refer or recommend qualified professionals for employment
with the Company. Referring employees are rewarded with a bonus for each
candidate hired by the Company. The Company's employees are not represented by a
labor union and the Company's management believes that its relationship with its
employees is good.
RISK FACTORS
An investment in DAOU's Common Stock involves a high degree of risk. In
addition to the other information in this report, the following risk factors
should be considered carefully in evaluating the Company and its business. This
report contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended. Prospective investors are cautioned that
such statements are only predictions and that actual event or results may differ
materially. Forward-looking statements usually contain the word "estimate,"
"anticipate," "believe", "expect" or similar expressions. All forward-looking
statements are inherently uncertain as they are based on various expectations
and assumptions concerning future events and are subject to numerous known and
unknown risks and uncertainties. The forward-looking statements included herein
are based on current expectations and entail various risks and uncertainties as
those sets forth below and in the Company's other SEC filings. These risks and
uncertainties could cause the Company's actual results to differ materially from
those projected in the forward-looking statements.
9
THE COMPANY MAY NOT MANAGE SUCCESSFULLY ITS BUSINESS OPERATIONS IF IT FAILS TO
HIRE, TRAIN AND RETAIN QUALIFIED COMPUTER NETWORK ENGINEERS, SOFTWARE
APPLICATION CONSULTANTS AND KEY MANAGEMENT EMPLOYEES.
DAOU's business strategy depends in large part on the services of its
key management and technical personnel such as computer network engineers and
software application consultants. These personnel are in short supply, and the
competition for their services is intense. This shortage is especially acute for
senior network engineers and software application consultants who have
experience in and understand the hospitals, integrated healthcare delivery
networks and other healthcare provider organizations that the Company serves,
and for the programmers, database administrators, network engineers and system
analysts with internet and electronic commerce experience that the Company
intends to recruit for Enosus. DAOU's business also requires that its employees
learn and implement the latest technical applications and innovations for its
customers. In addition, the Company has experienced significant turnover among
its technical personnel due in part to the significant time and travel demands
and increased competition for their services. Furthermore, DAOU will be
transferring certain technical personnel to Enosus, many of whom will need to be
replaced. Any inability to hire, train and retain a sufficient number of
qualified computer network engineers, programmers, database administrators
(DBA's), eBusiness specialists, network engineers, and system analysts with
internet and electronic commerce experience, could impair its ability to
adequately manage and complete its existing projects or to obtain new customers
and projects. DAOU's failure to retain key personnel or to attract additional
qualified employees could materially and adversely affect its ability to deliver
services to its customers in a timely and effective manner, if at all.
In addition, during this calendar year, the Company has experienced
turnover in its senior management. In March 1999, the Company appointed Larry
Grandia to serve as its President, replacing Daniel Daou; and, in June 1999,
the Company appointed Mr. Grandia as its Chief Executive Officer, replacing
Georges Daou. In addition, in September 1999, the Company appointed Donald
Myll as its Chief Financial Officer, replacing Fred McGee. In early 1999, the
Company also transitioned its Vice President of Human Resources to other
duties. This transition of management personnel may adversely affect its
operating performance, given the diversion of management's attention from
operational to recruitment activities and the time required for new senior
personnel to assimilate and manage effectively its business operations.
THE COMPANY DEPENDS ON A SMALL NUMBER OF LARGE CUSTOMERS TO PROVIDE A
SIGNIFICANT PORTION OF ITS REVENUES.
The Company receives a significant portion of its revenues from a
relatively limited number of large customer contracts, and expects this pattern
to continue in the future. As a percentage of total revenues, its five largest
customers accounted for approximately 26% for the year ended December 31, 1999,
19% for the year ended December 31, 1998, 22% for the year ended December 31,
1997; and 27% for the year ended December 31, 1996.
The loss of any large customer could materially and adversely affect
its revenues and financial condition. In particular, three of its large
information technology customers represented approximately 19% of total revenues
during the year ended December 31, 1999. If the Company loses one of these
outsourcing customers, then the Company will face significant challenges in
finding other engagements on which to staff these employees. Delays in
reassigning and the resulting under-utilization of these employees would impact
negatively its operating results and financial condition.
INTENSE COMPETITION IN ITS INDUSTRY FROM COMPETITORS WITH GREATER FINANCIAL,
TECHNICAL AND MARKETING RESOURCES COULD PREVENT THE COMPANY FROM INCREASING
REVENUES AND ACHIEVING OR SUSTAINING PROFITABILITY.
The industry for healthcare information technology services has a large
number of participants and is subject to rapid change and intense competition.
In addition, many of its competitors have significantly greater financial,
technical and marketing resources and greater name recognition than the Company.
The Company currently competes against:
- consulting firms such as First Consulting Group, Inc. and
Superior Consulting Holdings Corporation and the consulting
divisions of the major accounting firms;
- healthcare information technology companies such as McKesson
HBOC and Shared Medical Systems Corporation;
- system integrators such as Science Applications International
Corporation, Electronic Data Systems Corporation and Perot
Systems Corporation;
10
- telecommunications providers and network equipment vendors; and
- eCommerce consulting firms such as IXC, Scient, Viant and
Razorfish.
The Company also competes with smaller regional network services firms
in selected geographical areas of the country. In addition, the Company has
faced, and expects to continue to face, additional competition from new entrants
into its markets, such as other healthcare information technology companies not
presently offering or emphasizing network systems services and large network
services companies not currently focusing on healthcare. Increased competition
could result in price reductions, fewer customer projects, under-utilization of
employees, reduced operating margins and loss of market share, any of which
could materially and adversely affect its business, financial condition and
results of operations. The Company cannot assure you that it will compete
successfully against current and future competitors.
The Internet and eCommerce services industry is new, rapidly evolving
and intensely competitive, and DAOU expects this competition to intensify in the
future. Barriers to entry are minimal, and competitors may develop and offer
similar services in the future. Although the Company believes that there may be
opportunities for several providers of services similar to those offered by
Enosus, a single provider may dominate the market. The Company's business,
financial condition and operating results could be severely harmed if Enosus
does not compete successfully against current or future competitors. In addition
to the competition for small business customers, Enosus faces competition in
entering into strategic alliances with outside service providers. Most of
Enosus' current and potential competitors have longer operating histories,
larger customer bases and greater brand recognition in business and Internet
markets and significantly greater financial, marketing, technical and other
resources. Enosus' competitors may be able to devote significantly greater
resources to marketing and promotional campaigns, may adopt more aggressive
pricing polices or may try to attract users by offering products or services for
free or below their cost, and may devote substantially more resources to develop
new services.
MANY FACTORS HAVE CAUSED AND WILL CONTINUE TO CAUSE ITS FINANCIAL RESULTS TO
FLUCTUATE.
The Company has experienced significant quarterly fluctuations in its
operating results mainly due to: shift in demand for the Company's services;
difficulties in successfully integrating its acquired companies; the
commencement and completion of large fixed fee contracts; and the closure and
wind down of operating units. Variations in its revenues and operating results
may continue from time to time, due to various factors, including:
- the failure to achieve a successful sales program and to secure
and deliver new customer contracts at the budgeted rate;
- industry spending patterns and market conditions that may affect
adversely the buying decisions of the Company's current and
prospective customers, such as the uncertain level of spending
on information technology before and after the year 2000
conversion, the continued consolidation among healthcare
provider entities and the projected reduction in reimbursements
available to healthcare providers;
- the relatively longer sales cycle in obtaining new customers and
larger contracts;
- the timing and extent of employee training or the loss of key
employees;
- competition;
- government regulations;
- the reduction in size, delay in commencement, interruption or
termination of one or more significant projects;
- the loss or termination of preferred partnership relationships
with software vendors or hospital groups;
11
- the failure to estimate accurately the resources required to
complete new or ongoing projects, including increased labor
costs due to delays in project delivery schedules;
- the commencement or completion during a quarter of one or more
significant projects;
- variations in the product or professional service content of the
Company's projects;
- the development and introduction of new services;
- the continued effect of acquisitions, including additional
administrative staffing and other increased infrastructure
requirements to integrate the newly acquired companies; and
- the effect of negative publicity relating to the Company's
litigation and operations.
Although the Company's revenues fluctuate from quarter to quarter, the
substantial majority of its operating expenses, particularly personnel and
related costs, depreciation and rent, are relatively fixed. The Company expect
these costs to increase in the future as it intends to grow its business and
correspondingly expand its resources, such as additional programmers, database
administrators, network engineers and system analysts and other employees and
new offices, systems and other infrastructure. Accordingly, a variation in the
timing of the commencement or completion of customer projects or contracts,
particularly at or near the end of any quarter, may cause significant variations
in operating results from quarter to quarter and could result in losses for a
particular quarter. In addition, an unanticipated delay or termination of a
major project or contract, or a series of smaller projects or contracts, could
require it to maintain or terminate under-utilized employees, which could result
in higher than expected expenses during a quarter.
THE COMPANY MAY BE REQUIRED TO REDEEM THE SERIES A PREFERRED STOCK, WHICH WOULD
REDUCE SIGNIFICANTLY THE COMPANY'S LIQUIDITY AND WORKING CAPITAL AND COULD FORCE
THE COMPANY TO SCALE BACK ITS OPERATIONS.
The holders of the Series A Preferred Stock have the right to cause
the Company to redeem their stock for an aggregate amount equal to $12.3
million, plus accrued dividends, upon the occurrence of certain events that
are outside the Company's control. This amount constitutes more than 77% of
the Company's available cash and more than 37% of the Company's current
working capital. If the Company is forced to redeem the Series A Preferred
Stock, then the Company may be forced to raise additional capital in order to
continue its current level of operations, which could have a material adverse
effect on the Company's business, financial condition and results of
operations. The Company may not be able to raise additional capital on terms
favorable to the Company, if at all.
THE COMPANY MAY EXPERIENCE DISRUPTIONS IN ITS BUSINESS OPERATIONS AND INCREASED
EXPENSES IF IT DOES NOT MANAGE EFFECTIVELY ITS RECENT GROWTH AND ACQUISITIONS.
DAOU's revenue growth and acquisitions during the last few years have
placed significant demands on its management, operational, technical, financial
and other systems and resources. This growth has:
- increased its working capital funding requirements;
- caused it to expand its efforts to recruit qualified personnel;
- forced it to expand its operational capacity; and
- resulted in new and increased responsibilities for management
personnel.
During 1997 and 1998, the Company acquired 11 companies through
pooling-of-interests mergers. The Company continues to face significant
challenges and risks relating to these acquisitions, including the
standardization of diverse management information and accounting systems and the
training and retention of employees who work at various Company and customer
sites throughout the United States. To more effectively manage its various
business divisions, the Company is implementing new enterprise resource planning
software that is designed to coordinate accounting, utilization management,
purchasing and other management functions. The Company expects to complete its
transition to the new software by the second quarter of 2000. However,
12
this software may not adequately integrate the operations of its business
divisions, and the Company may experience disruptions in its operations during
the transition to the new software.
The Company must continue to improve its operational, financial and
internal systems to accommodate the anticipated increase in the number of
projects and customers and the increased size of its operations, workforce and
facilities. In addition, the Company continues to analyze and determine which
processes and functions require standardization across the Company, such as
common billing, collection and contract procedures, and which functions are
better managed independently by the operating divisions. The Company cannot
assure you that it will address successfully the demands caused by its recent
growth and acquisitions.
THROUGH ENOSUS, THE COMPANY WILL ENTER INTO AN ENTIRELY NEW BUSINESS SEGMENT AND
WILL ENCOUNTER NUMEROUS RISKS ASSOCIATED WITH THIS NEW INDUSTRY; THE COMPANY'S
PRIOR OPERATING HISTORY MAY NOT BE A MEANINGFUL GUIDE TO EVALUATING THE FUTURE
PERFORMANCE OF ENOSUS.
Prior to the formation of Enosus, the Company primarily provided
information technology services to the healthcare industry. In January 2000,
Enosus began to offer Internet and eCommerce services to its traditional
healthcare customers and to other non-healthcare related entities. However, the
Company may not implement successfully Enosus' business model. This risk is
heightened because the Company is operating in the new and rapidly evolving
Internet and eCommerce services market. The Company's historical results of
operations do not reflect its new service offerings, and could be materially and
adversely affected if the Company fails to implement successfully the Enosus
business plan.
ENOSUS INITIALLY WILL DEPEND ON AGREEMENTS WITH OUTSIDE SERVICE PROVIDERS TO
PERFORM CERTAIN INTERNET AND ECOMMERCE SERVICES THAT IT INTENDS TO OFFER TO ITS
CUSTOMERS.
Although Enosus intends to offer end-to-end Internet and eCommerce
services to its customers, the Company does not believe that Enosus initially
will have all of the necessary employees in place to perform each of these
services. Accordingly, Enosus will need to enter into agreements with outside
service providers to fulfill certain Internet and eCommerce services until it
can recruit these necessary employees. If these outside service providers fail
to provide Enosus' customers with quality service, then Enosus may lose the
affected customers. In addition, if Enosus loses one or more of these service
providers, even for a short period of time, then Enosus may not provide its
customers certain Internet and eCommerce services that it is contractually
obligated to provide.
THE SUCCESS OF ENOSUS WILL DEPEND ON THE INCREASED ACCEPTANCE AND USE OF THE
INTERNET AS A MEDIUM OF COMMERCE.
The ability of Enosus to grow its revenues will depend on the
increasing use of the Internet as a medium of commerce. If the Internet fails to
grow at anticipated rates, then Enosus' business will be materially and
adversely affected. Rapid growth in the use of the Internet is a recent
phenomenon, and, as a result, acceptance and use of the Internet may not develop
at projected rates. If the Internet is not broadly adopted as quickly as Enosus
anticipates, then its ability to increase revenues will be materially and
adversely affected. A number of factors could prevent the acceptance and growth
of electronic commerce, including:
- electronic commerce is at an early stage and buyers may be
unwilling to shift their traditional means of obtaining business
services;
- increased government regulations or taxation may adversely
affect the viability of electronic commerce;
- insufficient availability of telecommunications services or
changes in telecommunication services may result in slower
response times; and
- adverse publicity and consumer concern about the reliability,
cost, ease of access, quality of service, capacity, performance
and security of electronic commerce transactions could
discourage its acceptance and growth.
13
THE COMPANY'S CUSTOMERS CAN TERMINATE, WITHOUT PENALTY, SOME OF THEIR
FIXED-PRICE AND OUTSOURCING CONTRACTS.
Although the Company enters into multi-year contracts with many of its
customers, certain of its fixed-price and outsourcing customers can reduce or
cancel their use of its services before the end of the contract term. In
addition, the Company has provided and expects to continue providing services to
customers without long-term contracts. When a customer defers, modifies or
cancels a project, the Company must rapidly redeploy its technical and other
personnel to other projects to minimize the under-utilization of employees and
the resulting adverse impact on its operating results. Furthermore, its
operating expenses are relatively fixed and cannot be reduced on short notice to
compensate for unanticipated variations in the number or size of projects in
progress. As a result, any termination, significant reduction or modification of
its business relationships with any significant customers or with a number of
smaller customers could materially and adversely affect its operating results.
FUTURE SALES OF THE COMPANY'S COMMON STOCK IN THE PUBLIC MARKET COULD ADVERSELY
AFFECT THE PRICE OF ITS COMMON STOCK AND ITS ABILITY TO RAISE ADDITIONAL EQUITY
CAPITAL.
The sale of substantial amounts of its common stock in the public
market, the prospect of these sales or the sale or issuance of convertible
securities or warrants could affect adversely the market price of the Company's
common stock. Of the 17,712,368 shares outstanding as of March 21, 2000,
12,989,536 shares of common stock are freely tradable without restriction in the
public market, unless the shares are held by "affiliates" of the Company as
defined in Rule 144 under the Securities Act of 1933, or are otherwise required
to comply with specific sale volume limitations and other restrictions under
Rule 144. The remaining 4,722,832 shares are "restricted securities" as defined
in Rule 144. In September 1999, the Company recently registered 2,750,000 shares
of common stock that will be freely tradable upon conversion of the 2,181,818
outstanding shares of series A convertible preferred stock. In addition, the
Company has registered on a form S-8 registration statement an aggregate of
4,000,000 shares of common stock under the DAOU Systems, Inc. 1996 Stock Option
Plan. As of March 21, 2000, an additional 550,000 shares of common stock were
subject to other outstanding stock options.
THE COMPANY MAY BE SUED IF ITS COMPUTER NETWORK SYSTEMS FAIL TO PROVIDE
ACCURATE, RELIABLE AND TIMELY INFORMATION TO HEALTHCARE PROVIDERS.
DAOU's computer network systems are designed to provide access to and
accurate delivery of a wide range of information within a healthcare provider
organization, including information used by clinicians in the diagnosis and
treatment of patients. If a computer network system that the Company installed
or maintains fails to provide accurate, reliable and timely information to a
patient's healthcare provider, and, as a result, that patient is injured, then
either the patient or the healthcare provider might bring a claim against the
Company based on its installation or management of the computer network system.
In addition, the Company may be sued if a patient is injured because of a
service that the Company have performed or failed to perform for the healthcare
provider organization. Although the Company maintains errors and/or omissions
insurance, this insurance coverage may not adequately cover any claims asserted
against the Company. In addition, appropriate insurance may not continue to be
available to the Company in the future at commercially reasonable rates.
THE COMPANY MUST CONTINUALLY OFFER SERVICES AND PRODUCTS THAT MEET ITS
CUSTOMERS' DEMANDS, AS NEW TECHNOLOGIES OR INDUSTRY STANDARDS COULD RENDER ITS
SERVICES OBSOLETE OR UNMARKETABLE.
The Company receives a significant portion of its revenues from
projects based on complex computer networks. The markets for computer network
products and services are continuing to develop and are characterized by rapid
change. The Company cannot make assurances that products, systems or
technologies developed by third parties will not render one or more of its
services noncompetitive or obsolete. DAOU's success will depend on its ability
to offer services and products that keep pace with continuing changes in
technology, evolving industry standards and the changing preferences of its
healthcare customers. The Company cannot assure that it will successfully
address these developments.
14
THE COMPANY MAY BE ADVERSELY AFFECTED BY UNEXPECTED YEAR 2000 COMPLIANCE ISSUES.
Although the Company has not experienced any significant disruptions in
its critical information technology and non-information technology systems,
there can be no assurance that no year 2000 related disruptions will arise in
the future. In addition, the Company may face claims and increased obligations
under its sales, service, and maintenance agreements with its customers if
vendors, manufacturers and service providers of Third-Party Products do not: (i)
remediate successfully Third-Party Products affected by the year 2000, or (ii)
adequately indemnify the Company or provide pass-through warranties to its
customers for products re-sold, installed and maintained by the Company. Any
such claims could affect materially and adversely the Company's business,
results of operations and financial condition.
The Company may also be exposed to potential liability as a result of
year 2000 compliance claims arising in connection with certain sales, service,
and maintenance agreements, that could result in increased claims from the
Company's customers, including defense and indemnity of third-party claims
against customers related to year 2000 readiness, as well as direct claims
against the Company by third parties. Any of these unexpected year 2000
compliance problems could impact materially and adversely the Company's
business, results of operations and financial condition.
FIXED-PRICE AND FIXED-TIME FRAME CONTRACTS MAY ADVERSELY AFFECT ITS
PROFITABILITY IF THE COMPANY DOES NOT ACCURATELY ESTIMATE THE RESOURCES AND TIME
REQUIRED TO COMPLETE THESE CONTRACTS.
The Company offers a portion of its computer network system and
consulting services on a fixed-price, fixed-time frame basis. Consequently, the
Company bears the risk of cost over-runs in connection with these projects.
DAOU's failure to estimate accurately the resources and time required for a
project or its failure to complete its contractual obligations within the
committed fixed-time frame could reduce its profit or cause a loss. In addition,
the amount of time that it takes to complete a project often depends on factors
outside of its control, including the customer's existing information technology
systems or the customer's lack of resources to devote to the project. The
Company might not achieve the profitability and staff utilization that it
expects under its fixed-price and fixed-time contracts, and may even incur
losses on these contracts in the future.
THE COMPANY'S LONG SALES AND PROJECT DELIVERY CYCLES EXPOSE IT TO POTENTIAL
LOSSES.
DAOU's sales process for network projects is often subject to delays
associated with the lengthy approval process that typically accompanies
significant capital expenditures by its customers. During this process, the
Company expends substantial time, effort and resources marketing its services,
preparing contract proposals and negotiating contracts. Any failure to obtain a
signed contract and receive payment for its services after expending significant
time, effort and resources could materially and adversely affect its revenues
and financial condition.
THE COMPANY'S OFFICERS AND DIRECTORS HAVE THE POWER TO INFLUENCE THE ELECTION OF
DIRECTORS AND THE PASSAGE OF STOCKHOLDER PROPOSALS BECAUSE THEY COLLECTIVELY
HOLD A SUBSTANTIAL NUMBER OF SHARES OF ITS COMMON STOCK.
As of March 21, 2000, the Company's executive officers, directors and
affiliated persons beneficially owned approximately 34% of the outstanding
shares of common stock. As a result, these stockholders can exercise significant
influence over all matters requiring stockholder approval, including the
election of directors and approval of significant corporate transactions. This
concentration of ownership also may delay or prevent a change in control of the
Company.
THE CONSOLIDATION AND CHANGING REGULATORY ENVIRONMENT OF THE HEALTHCARE INDUSTRY
MAY REDUCE THE SIZE OF ITS TARGET CUSTOMER MARKET AND RESULT IN THE TERMINATION
OF CUSTOMER CONTRACTS.
The Company receives substantially all of its revenues from customers
involved in the healthcare industry. Consequently, its business is vulnerable to
changing conditions affecting this industry. Many healthcare provider
organizations are combining through affiliation and consolidation to create
larger organizations with greater regional market power and are forming
affiliations for purchasing products and
15
services. This consolidation could reduce its target market and result in the
termination of customer contracts. In particular, some of its customers have
scaled back or terminated their relationship with the Company following their
acquisition, and this trend may continue in the future. Moreover, consolidated
enterprises or affiliated enterprises may try to use their greater bargaining
power to negotiate reductions in the amounts paid to the Company for its
services. Any reduction in the size of its target market or failure to maintain
adequate price levels could materially and adversely affect its revenues and
financial condition. In addition new regulations governing the standardization
and security for healthcare information under the recently enacted Health
Insurance Portability and Accountability Act (HIPAA) could significantly impact
the amount, timing and types of services requested by customers.
The healthcare industry also is subject to changing political, economic
and regulatory influences that may affect the procurement practices and
operations of participants in the healthcare industry. For example, recent
federal legislation may reduce the reimbursements available for hospitals.
Reduced reimbursements may negatively impact the spending patterns and demand
for its information technology services. The Company cannot predict with any
certainty what impact these developments could have on its business.
MANY FACTORS RELATED TO THE COMPANY'S BUSINESS OPERATIONS AND INDUSTRY COULD
IMPACT ITS FUTURE STOCK PRICE, CAUSING WIDE FLUCTUATIONS IN VALUE AND
SIGNIFICANT VOLATILITY.
Based upon the historical performance of its common stock, the Company
anticipates that the future price of its common stock may be subject to wide
fluctuations because of announcements of:
- quarterly fluctuations in its operating results;
- changes in earnings estimates by analysts;
- negative publicity relating to its litigation and operations;
- strategic relationships or acquisitions;
- new customer contracts or services by the Company or its
competitors;
- general conditions in the market for computer network services;
- healthcare industry and general market conditions; and
- changes in its pricing policies or those of its competitors.
In addition, in recent years, the stock market in general and the
shares of technology companies in particular have experienced extreme price
fluctuations. Fluctuations in the price of the Company's shares of common
stock may be disproportionate or unrelated to its operating performance and
may affect adversely the market price of its common stock.
PROVISIONS OF DELAWARE LAW AND THE COMPANY'S CERTIFICATE OF INCORPORATION AND
BYLAWS MAY DETER PREVENT OR DELAY TAKEOVER ATTEMPTS AND A CHANGE OF CONTROL OF
THE COMPANY.
A number of provisions of Delaware law and the Company's certificate of
incorporation and bylaws could delay, defer or prevent a change in control of
the Company and could limit the price that some investors might be willing to
pay in the future for shares of its common stock. These provisions:
- prohibit the Company from engaging in any business combination
with any interested stockholder for a period of three years from
the date the person became an interested stockholder unless
specific conditions are met;
- permit its board of directors to issue shares of preferred stock
without stockholder approval on the terms as its board may
determine;
- provide for a classified board of directors;
- eliminate the right of its stockholders to act by written
consent without a meeting;
- require advanced stockholder notice to nominate directors and
raise matters at the annual stockholders meeting;
- eliminate cumulative voting in the election of directors; and
16
- allow for the removal of directors only for cause and with a
two-thirds vote of its outstanding shares.
ITEM 2: DESCRIPTION OF PROPERTIES.
The Company leases the following office space for its principal administrative,
operating, support and training facilities:
APPROXIMATE
LOCATION SQUARE FOOTAGE EXPIRATION PRINCIPAL USE
- ----------------------- --------------------- ----------------------- ---------------------------------------
San Diego, CA 38,000 February 2005 Corporate office facility (1)
Kensington, MD 30,000 February 2001 Operating and support facilities
Alexandria, VA 21,000 May 2005 Operating and support facilities (1)
Indianapolis, IN 5,100 April 2000 Operating and support facilities
Mountainside, NJ 4,000 November 2003 Operating and support facilities (1)
Exton, PA 3,700 January 2003 Operating and support facilities
Naperville, IL 1,853 November 2000 Operating and support facilities
Norristown, PA 3,122 April 2001 Operating and support facilities (1)
(1) Portions of the property have been subleased.
In addition, the Company has leased executive offices in several
locations in the United States to provide regional sales and support
activities to its customers. The Company continually evaluates the adequacy
of its existing facilities and believes that its current and planned
facilities will be adequate for the next twelve months.
ITEM 3: LEGAL PROCEEDINGS.
Gary Colvin, an ex-employee of the Company, filed a lawsuit on February
25, 1997 against the Company and certain of its officers and directors in the
U.S. District Court of the Southern District of California (Colvin v. DAOU
Systems, et al.). The complaint alleged various causes of action, including
wrongful termination, civil rights violations, breach of contract, fraud and
violations of wage & hour laws. On February 9, 1998, the parties stipulated to
the dismissal of the ex-employee's remaining Federal claim under the Fair Labor
Standards Act. As a result, on March 4, 1998, the lawsuit was dismissed without
prejudice after the court declined to exercise supplemental jurisdiction over
the remaining state law claims. On March 31, 1998, the plaintiff re-filed in
state court (Colvin v. DAOU Systems, Inc., et., al.). On March 19, 1999, the
Company received a verdict in its favor on all causes of action. Mr. Colvin has
appealed this verdict, but the state appellate court has not yet set a briefing
schedule or a hearing date.
On September 18, 1997, seven present and/or former employees of the
Company filed a lawsuit in the Superior Court of the State of California for the
County of San Diego, titled Smyth, et al. v. DAOU Systems, Inc. (Case No.
714187), purporting to represent a class of all present and former DAOU
employees classified as exempt from overtime pay requirements within the
preceding three years. The plaintiffs claim that they and other exempt employees
were not actually exempt under Federal and California law from overtime pay and
are entitled to pay for unpaid overtime and penalties in an unstated amount. The
plaintiffs also claim that, in response to their filing complaints with the
Labor Board for the State of California, they were subjected to retaliatory
discrimination by the Company. In October 1997, the Company successfully removed
the lawsuit to the United States District Court for the Southern District of
California. The plaintiffs' application for class certification was denied by
the court, and one of the seven plaintiffs subsequently dismissed his claim and
withdrew from the lawsuit. Trial is currently scheduled to begin on May 2, 2000.
As of the date of this report, the potential amount of exposure to the Company
from this lawsuit, in the event of an unfavorable outcome, cannot be estimated.
The Company believes that the lawsuit is without merit and intends to defend the
lawsuit vigorously.
On August 24, 1998, August 31, 1998, September 14, 1998 and September
23, 1998, separate complaints were filed against the Company and certain of its
officers and directors in the United States District Court for the Southern
District of California. A group of shareholders has been appointed the lead
plaintiffs and they filed an amended consolidated complaint on February 24,
1999. The new complaint realleges the same theory of liability previously
asserted, namely the alleged improper use of the percentage-of-completion
17
accounting method for revenue recognition. These complaints were brought on
behalf of a purported class of investors in the Company's Common Stock and do
not allege specific damage amounts. In addition, on October 7, 1998 and October
15, 1998, separate complaints were filed in the Superior Court of San Diego,
California. These additional complaints mirror the allegations set forth in the
federal complaints and assert common law fraud and the violation of certain
California statutes. By stipulation of the parties, the state court litigation
has been stayed pending the resolution of a motion to dismiss that was filed on
February 22, 2000 in the federal litigation. The Company believes that the
allegations set forth in all of the foregoing complaints are without merit and
intends to defend against these allegations vigorously. No assurance as to the
outcome of this matter can be given, however, and an unfavorable resolution of
this matter could have a material adverse effect on the Company's business,
results of operations and financial condition.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5: MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's shares of Common Stock have traded on the Nasdaq National
Market System under the symbol DAOU since February 12, 1997. The prices set
forth below represent quotes between dealers and do not include commissions,
mark-ups or mark-downs, and may not necessarily represent actual transactions.
Common Stock
HIGH LOW
---- ---
1999
1st Quarter $ 9.063 $ 5.125
2nd Quarter 6.500 4.563
3rd Quarter 5.750 4.063
4th Quarter 5.500 2.750
1998
1st Quarter $ 31.000 $16.250
2nd Quarter 23.656 15.063
3rd Quarter 23.438 5.750
4th Quarter 7.000 3.438
On March 21, 2000, the closing bid and ask prices of the Company's
Common Stock were $4.438 and $4.875, respectively. As of March 21, 2000, there
were 111 holders of record of common stock.
DIVIDEND POLICY
DAOU has never declared nor paid cash dividends on its capital stock.
The Company currently intends to retain any earnings for future growth and,
therefore, does not intend to pay any cash dividends in the foreseeable future.
Holders of the Series A Redeemable Preferred Stock are entitled to
receive cumulative dividends at the rate of six percent per annum, payable in
the form of shares of Series A Preferred Stock.
18
RECENT SALES OF UNREGISTERED SECURITIES
SERIES A REDEEMABLE PREFERRED STOCK
On July 26, 1999, the Company issued an aggregate of 2,181,818 shares
of its Series A Preferred Stock to Galen Partners III, L.P., Galen Partners
International III, L.P., and Galen Employee Fund III, L.P., for aggregate
proceeds of $12,000,000. The Series A Preferred Stock is convertible at the
option of the holder into Common Stock at a conversion price of $5.50 per share
(subject to adjustment), and automatically converts at the adjusted conversion
price if the closing price of the Common Stock equals or exceeds $11.00 per
share (after adjustments for any stock split, dividend, combination or other
recapitalization) for 20 consecutive trading days after July 26, 2000. The
holders of the Series A Preferred Stock may cause the Company to redeem their
shares upon the occurrence of (i) the resignation of Larry Grandia as Chief
Executive Officer of the Company, (ii) the failure of the Company to hire a
replacement for Larry Grandia as Chief Executive Officer within 180 days of his
termination as Chief Executive Officer, or (iii) the failure of Georges Daou or
Daniel Daou to vote their shares of Common Stock in favor of a merger
transaction or a liquidation of the Company if the majority of the Company's
board of directors has approved such merger transaction or liquidation. The
holders of the Series A Preferred Stock are entitled to receive cumulative
dividends at an initial annual rate of 6%. This annual rate will increase by 1%
per year after July 26, 2001, up to a maximum annual rate of 12%. The dividends
on the Series A Preferred Stock, which accrue and are payable semi-annually, are
payable in additional shares of Series A Preferred Stock valued at $5.50 per
share.
The shares of Series A Preferred stock were sold in a private placement
to accredited investors pursuant to Regulation D under the Securities Act of
1933, as amended (the "Securities Act").
The Company registered 2,750,000 shares of Common Stock for resale upon
the conversion of the shares of Series A Preferred Stock. The related
Registration Statement on Form S-3 (file no. 33-87103) was declared effective by
the SEC on October 25, 1999.
OPTIONS ISSUED UNDER THE 1996 STOCK OPTION PLAN
Between January 1, 1999 and December 31, 1999, the Company granted
options to purchase 541,500 shares of its Common Stock to certain of its
officers and employees. These options are exercisable at prices ranging from
$4.38 to $4.88 per share. These options were granted under the Company's 1996
Stock Option Plan pursuant to Section 4(2) of the Securities Act. As of the date
of this report, none of these options have been exercised.
OPTIONS NOT ISSUED UNDER THE 1996 STOCK OPTION PLAN
Between January 1, 1999 and December 31, 1999, the Company granted
options to purchase 550,000 shares of its Common Stock to certain of its
officers. These options are exercisable at prices ranging from $4.28 to $5.00
per share. These nonqualified stock options were granted outside of the
Company's 1996 Stock Option Plan pursuant to Section 4(2) of the Securities Act.
As of the date of this report, none of these options have been exercised.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
On February 12, 1997, the Securities and Exchange Commission declared
effective the Company's Registration Statement on Form SB-2 File No. 333-18155
(the "Registration Statement") relating to the initial public offering (the
"Offering") of the Company's Common Stock. The managing underwriters for the
offering were Alex. Brown & Sons Incorporated, Cowen & Company and Hambrecht &
Quist LLC. The Registration Statement registered an aggregate of 2,000,000
shares of Common Stock offered by the Company. The Offering commenced on
February 13, 1997 and the 2,000,000 shares of Common Stock covered by the
Registration Statement were sold at $9.00 per share, resulting in aggregate
offering proceeds to the Company of $18,000,000.
The expenses incurred by the Company in connection with the Offering
were approximately $2,216,000, of which $1,260,000 constituted underwriting
discounts and commissions and $956,000 constituted other expenses including
registration and filing fees, printing, accounting and legal expenses. No direct
or
19
indirect payments were made to any directors, officers, owners of ten percent
or more of any class of the Company's equity securities or other affiliates of
the Company other than for reimbursement of expenses incurred on the road show.
Net offering proceeds to the Company after deducting these expenses were
approximately $15,784,000.
As of December 31, 1999, the Company has used all of the proceeds from
its initial public offering toward general corporate purposes, including working
capital, and toward the purchase and installation of equipment, the repayment of
indebtedness and the construction of plant, building and facilities.
USE OF PROCEEDS FROM SERIES A REDEEMABLE PREFERRED STOCK OFFERING
The net proceeds were used to retire the Company's line of credit that
expired in July 1999 and approximately $5,300,000 of the Company's long term
debt. The balance of the net proceeds will be used for general corporate and
working capital purposes.
20
ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA.
The following table presents selected consolidated financial data
of the Company. The information set forth below is not necessarily indicative of
the results of future operations and should be read in conjunction with the
other sections of "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in Item 7 of this report and the consolidated
financial statements and the related notes thereto included elsewhere herein.
(in thousands, except per share data):
YEARS ENDED DECEMBER 31,
1995 1996 1997 1998 1999
--------------- -------------- --------------- ---------------- -----------------
Revenues $ 36,448 $ 50,327 $ 68,656 $ 104,784 $ 103,400
Cost of revenues 22,583 33,110 45,154 78,021 75,927
---------------------------------------------------------------------------------
Gross profit 13,865 17,217 23,502 26,763 27,473
Operating expenses:
Sales and marketing 2,928 4,166 7,780 12,203 10,398
General and administrative 8,930 9,945 12,425 18,456 25,071
Merger and related expenses - - 718 2,825 -
---------------------------------------------------------------------------------
Total operating expenses 11,858 14,111 20,923 33,484 35,469
---------------------------------------------------------------------------------
Income (loss) from operations 2,007 3,106 2,579 (6,721) (7,996)
Interest income, net 193 369 873 163 779
---------------------------------------------------------------------------------
Income (loss) before income taxes 2,200 3,475 3,452 (6,558) (7,217)
Provision (benefit) for income taxes 889 149 947 (802) 1,761
---------------------------------------------------------------------------------
Net income (loss) 1,311 3,326 2,505 (5,756) (8,978)
Dividends on preferred stock - - - - (308)
---------------------------------------------------------------------------------
Net income (loss) available to
common stockholders $ 1,311 $ 3,326 $ 2,505 $ (5,756) $ (9,286)
=================================================================================
Net income (loss) per common share:
Basic $ 0.11 $ 0.26 $ 0.15 $ (0.33) $ (0.52)
=================================================================================
Diluted $ 0.10 $ 0.23 $ 0.15 $ (0.33) $ (0.52)
=================================================================================
Shares used in computing net
income (loss) per common
share:
Basic 12,260 12,580 16,231 17,657 17,697
=================================================================================
Diluted 12,548 14,385 17,246 17,657 17,697
=================================================================================
Cash equivalents and short-term
investments $ 7,493 $ 3,962 $ 18,288 $ 7,780 $ 15,548
Total assets 19,735 21,672 54,105 54,517 46,060
Long-term debt, less current portion 45 32 49 26 -
Redeemable convertible preferred stock 7,705 8,190 - - 11,382
Total stockholders' equity 3,498 6,304 41,837 34,775 24,974
21
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion of the Financial Condition and Results of
Operations contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended. Prospective investors are cautioned
that such statements are only predictions and that actual events or results may
differ materially. Forward-looking statements usually contain the word
"estimate," "anticipate," "believe", "expect" or similar expressions. All
forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and are subject to
numerous known and unknown risks and uncertainties. The forward-looking
statements included herein are based on current expectations and entail various
risks and uncertainties as those set forth previously and in the Company's other
SEC filings. In evaluating such statements, prospective investors should
specifically consider various factors identified in this report, including the
matters set forth previously under the caption "Risk Factors," which could cause
actual results to differ materially from those indicated by such forward-looking
statements.
OVERVIEW
DAOU provides integrated information technology (IT) solutions and
services to the U.S. healthcare and Internet professional services industries.
The Company's capabilities range from strategic planning (using IT to support
key business goals), to the design and integration of IT components (voice,
video and data networks, application implementation, Internet infrastructure,
data warehouses), to the management and delivery of operational services (IT
department, desktop management, ASP services, network management), and beginning
in the year 2000 to Internet solutions and professional services supporting
organizations executing an eBusiness strategy.
The Company's service offerings are segmented into the following
business units:
- IT CONSULTING AND MANAGED CARE IMPLEMENTATION (IT Consulting) -
develops business plans and solves problems for managed care
organizations, installs and integrates managed care
applications, and manages IT systems.
- COMMUNICATIONS INFRASTRUCTURE - focuses on the IT infrastructure
in healthcare enterprises, primarily IDNs, hospitals, academic
medical centers and medical groups, provides networking,
desktop, and voice, video and data solutions.
- APPLICATION IMPLEMENTATION - supplies hospitals and other
healthcare organizations with temporary, certified consultants
who are capable of installing and servicing approximately 90% of
the most common healthcare software applications.
- INTEGRATION SERVICES - focuses on integration of the customers
information systems with existing or new infrastructure that
allow healthcare organizations to share and access data housed
across multiple platforms and environments.
- OUTSOURCING - performs a full range of IT outsourcing services
including co-source or outsource of call centers, help desks,
desktop support, server management, network management, voice
management and complete IT department outsourcing.
- ENOSUS - provides Internet professional services and solutions
to organizations executing an eBusiness strategy.
The Company's service offerings represent aggregated end-to-end
healthcare IT solutions. Depending on the specific needs of its customers, the
Company's relationships may begin anywhere along the IT solution process,
growing within one of the groups or developing cohesively across the complete
end-to-end IT solution process from conceptualization to operation.
The Company's gross margin with respect to fixed-fee based service
contracts varies significantly depending on the percentage of such services
consisting of products (with respect to which the Company obtains a lower
margin) versus professional services. Payments received in advance of services
performed are recorded as deferred revenues. Certain contract payment terms may
result in customer billing occurring at a pace slower
22
than revenue recognition. The resulting revenues recognized in excess of amounts
billed and project costs are included in contract work in progress on the
Company's balance sheet.
In 1998 and 1997, the majority of the Company's contract services were
generally provided on a fixed-fee basis. Revenues on fixed-fee contracts are
recognized using the percentage-of-completion method with progress to completion
measured by labor costs incurred to date compared to total estimated labor
costs. The Company's gross margin with respect to these contracts for services
varies significantly depending on the percentage of such services consisting of
third-party products (with respect to which the Company obtains a lower margin)
versus professional services. In 1999, the Company began to focus on providing
its professional services on a "time and expense" basis, under which revenues
are recognized as the services are performed. Billings for these services occur
on a semi-monthly or monthly basis. The Company also provides support and
management service revenues, which are recognized ratably over the period that
these services are provided.
The communications infrastructure, application implementation, and
integration services groups' projects generally range from three to six months,
although certain projects have required more than a year to complete. The IT
Consulting group engagements typically average six months but may vary depending
on the size and complexity of the project. The outsourcing group generally
provides services in multi-year engagements on a fixed-price basis.
As a result of falling gross margins experienced with fixed-fee based
contracts, the Company closed its cabling subsidiary, DAOU On-Line, Inc.,
formerly associated with the communications infrastructure group. During 1999,
with the commencement of a five-year full IT department outsourcing contract,
revenues and gross profit for the outsourcing group improved from 1998. Also,
the Company often hires employees in anticipation of commencement of a project,
and if delays in contract signing occur, the Company's gross margin could vary
due to the associated loss of revenues to cover fixed labor costs.
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, certain statement of
operations data as a percentage of net revenues.
YEARS ENDED DECEMBER 31,
1999 1998 1997
---------------- -------------- ----------------
Revenues 100% 100% 100%
Cost of revenues 73 74 66
---------------- -------------- ----------------
Gross profit 27 26 34
Operating expenses 34 32 30
---------------- -------------- ----------------
Income (loss) from operations (7) (6) 4
Interest income (expense), net 1 0 1
---------------- -------------- ----------------
Income (loss) before income taxes (6) (6) 5
Provision (benefit) for income taxes 2 (1) 1
---------------- -------------- ----------------
Net income (loss) (8) (5) 4
================ ============== ================
YEARS ENDED DECEMBER 31, 1999 AND 1998
The Company's revenues were $103.4 million and $104.8 million for the
years ended December 31, 1999 and 1998, respectively, representing a decrease of
1%. This decrease in revenue resulted primarily from the closure of the
Company's cabling division and reduced demand for the infrastructure group's
services due to delays in the customer's decisions regarding investment in IT
infrastructure pending Y2k remediation efforts. This decrease in communications
infrastructure group revenue was partially offset by increased revenue in the
outsourcing group due to the SMHN outsourcing contract and increased demand for
application implementation services during the first and second quarters driven
by Y2k remediation demand. Services to DAOU's five largest customers accounted
for $26.4 million of revenues for the year ended December 31, 1999, representing
26% of total revenues. One of the top five customers, SMHN, accounted for $10.8
million in revenues for the year ended December 31, 1999, representing 10% of
total revenues.
Cost of revenues was $75.9 million and $78.0 million for the years
ended December 31, 1999 and 1998, respectively, representing a decrease of 3%.
This decrease is primarily the result of a decrease in revenues
23
from the communications infrastructure group resulting from the closure of the
Company's cabling division.
Gross margin was 27% and 26% for the years ended December 31, 1999 and
1998, respectively. This increase in gross margin during the year ended December
31, 1999 was primarily due to improved gross margins associated with the
increased use of time and expense contracts and the completion or expiration of
the fixed-fee contracts which historically had lower profit margins. The
improved margins were partially offset by lower labor utilization rates within
the communications infrastructure and integration services groups.
Sales and marketing expenses were $10.4 million and $12.2 million for
the years ended December 31, 1999 and 1998, respectively, representing a
decrease of 15%. This decrease was primarily due to a reduction in sales staff
and related expenditures as a result of consolidation and integration of the
sales and marketing functions of acquired companies to the corporate level.
Sales and marketing expenses were 10% and 12% of total revenues for the years
ended December 31, 1999 and 1998, respectively.
General and administrative expenses were $25.1 million and $18.5
million for the years ended December 31, 1999 and 1998, respectively,
representing an increase of 36%. The primary factors contributing to this
increase in costs were associated with additional administrative staffing and
infrastructure requirements at the beginning of 1999 to support growth and
integration of acquired companies, executive management severance, the closure
of DAOU-On Line, increased legal fees resulting from the stockholder litigation,
and increased bad debt expenses. As a percentage of total revenues, general and
administrative expenses were 24% and 18% of total revenues for the years ended
December 31, 1999 and 1998, respectively.
Other income (expense), net, was $779,000 and $163,000 for the years
ended December 31, 1999 and 1998, respectively. This other income is comprised
primarily of interest income on cash and cash equivalents, and investments.
Interest expense consists primarily of interest associated with the Company's
business lines of credit. The increase in net other income (expense), net was
primarily due to a $546,000 gain from the sale of investments, higher average
cash reserves available for investment and reduced interest expense after the
payoff of outstanding debt during the year ended December 31, 1999 as compared
to 1998.
The effective income tax rate for the year ended December 31, 1999 was
56%. Although the Company had a pre-tax loss, a provision for taxes was required
to reserve the Company's net deferred tax assets. The effective income tax
benefit rate for the year ended December 31, 1998 was (12)% due to the
non-deductibility of certain merger and related costs and adjustments made to
convert the former S corporation status of certain acquired businesses to the C
corporation status of the Company.
YEARS ENDED DECEMBER 31, 1998 AND 1997
The Company's revenues were $104.8 million and $68.7 million for the
years ended December 31, 1998 and 1997, respectively, representing an increase
of $36.1 million or 53%. Revenues increased primarily due to the increased
number of professional services consulting contracts, which accounted for $15.6
million, increases in professional services management contracts which accounted
for $7.3 million and an increase in large network implementation contracts of
$6.3 million. Services to DAOU's five largest customers accounted for $20.3
million of total revenues in 1998, representing 19% of total revenues.
Cost of revenues for the years ended December 31, 1998 and 1997 were
$78.0 million and $45.2 million, respectively, representing an increase of $32.8
million or 73%. Gross margin for the years ended December 31, 1998 and 1997, was
26% and 34%, respectively. This decrease in gross margin during 1998 was
primarily due to the following: i) an increase in the product content of the
Company's large network implementation contracts, ii) increased labor costs as a
result of delays in project delivery schedules due to both external and internal
customer delays and the associated loss of revenues to cover the fixed labor
costs, iii) an unforeseen requirement on one fixed price contract to use an
alternate labor union at a higher than projected cost and iv) increased labor
costs as a result of a shortfall in planned revenue which the Company believes
was caused by delays in contract signings due to the negative publicity and
shareholder lawsuits concerning questions about the Company's accounting
practices. The Company's margins also were affected by a decision to provide
additional services on certain fixed price contracts at no additional cost to
certain customers to increase the probability of closing large long-term
professional services management contracts.
24
Sales and marketing expenses were $12.2 million and $7.8 million for
the years ended December 31, 1998 and 1997, respectively, representing an
increase of 57%. This increase was primarily due to continued development of a
regional sales structure, an increase in sales personnel and related expenses
due to increased sales volume and activity. Sales and marketing expenses were
12% and 11% of total revenues for the years ended December 31, 1998 and 1997,
respectively. Although the Company believes that it can achieve a decrease in
these expenses as a percentage of revenue, the Company also expects that sales
and marketing expenses will continue to increase in dollar terms to support the
anticipated growth in the Company's business.
General and administrative expenses were $18.5 million (excluding
one-time direct merger costs of $2.8 million) and $12.4 million for the years
ended December 31, 1998 and 1997, respectively, representing an increase of 49%.
The primary factors contributing to this increase were costs associated with
additional administrative staffing and other increased infrastructure
requirements to support growth and integration of acquired companies, increased
recruiting costs, increases in the provision for uncollectible accounts and
increased legal and accounting fees associated with the negative publicity and
shareholder lawsuits surrounding the Company's accounting practices. General and
administrative expenses were 18% of total revenues for the years ended December
31, 1998 and 1997. The Company expects some increase in general and
administrative expenses in dollar terms to support the anticipated growth in the
Company's business and the continued integration of acquired companies.
Net interest income was $163,000 and $873,000 for the years ended
December 31, 1998 and 1997, respectively. Interest income consisted of interest
on cash and cash equivalents and short-term investments. Interest expense
consisted of interest associated with the Company's business lines of credit.
The decrease in net interest income was primarily due to overall lower average
cash reserves available for investment during 1998 as compared to 1997.
INCOME TAXES
In 1999, 1998 and 1997, the effective tax rates were 56%, (12)% and
27%, respectively. In 1999 the effective rate was different from the expected
federal statutory rate of 35% due to a provision for taxes to reserve the
Company's net deferred tax assets attributable to income tax benefits
received in prior years. In 1998 and 1997, the effective rates were different
from the expected federal statutory rate due to the fact that Integrex,
On-Line, Sentient, Synexus, TMI and RHI were S-corporations prior to the
merger with DAOU and as well as the conversion from the cash method to the
accrual method of accounting for tax purposes. Consequently, taxes on the
pre-acquisition income of Integrex, On-Line, Sentient, Synexus, TMI and RHI
were the direct responsibility of its stockholders. During 1998 and 1997, the
benefit of Integrex's, On-Line's, Sentient's, Synexus, TMI's and RHI's lower
tax rates were partially offset by additional taxes on the conversion of
S-corporation to C-corporation.
LIQUIDITY AND CAPITAL RESOURCES
On December 31, 1999, the Company had working capital of $32.2
million, an increase of $500,000 from $31.7 million on December 31, 1998.
For the year ended December 31, 1999, cash provided by operating
activities was $3.0 million, compared to cash used in operating activities of
$9.0 million for the year ended December 31, 1998. The increase in cash from
operations resulted primarily from decreases in trade accounts receivable and
contract work in progress, and was partially offset by the Company's net loss,
decreases in trade accounts payable and other accrued liabilities, and accrued
salaries and benefits, and by the current portion of long-term debt as compared
to 1998.
Net cash used in investing activities was $164,000 for the year ended
December 31, 1999, compared to net cash provided by investing activities of $7.5
million in the comparable prior period. This decrease was primarily due to the
maturing of investments of $7.3 million that were not reinvested in 1998.
Net cash provided by financing activities was $5.9 million for the year
ended December 31, 1999, compared to $328,000 in the comparable prior period.
This increase was primarily the result of the net proceeds from the issuance of
Series A Preferred Stock in 1999, which raised $11.1 million, partially offset
by the repayments of debt and lines of credit, of $5.2 million.
On June 29, 1999, the Company secured an $8.0 million revolving line of
credit that expires on June 29, 2001. The line of credit bears interest at prime
plus 1% per annum, is secured by substantially all of the
25
assets of the Company and contains customary covenants and restrictions. There
are no compensating balance requirements and borrowings under the line of credit
are limited to 80% of qualifying receivables. No amount remained outstanding
under this revolving line of credit as of December 31, 1999.
Although the Company has an accumulated deficit as of December 31,
1999, the Company believes that its available funds together with anticipated
cash from operating activities will be sufficient to meet its capital
requirements, including the start-up costs for Enosus, for the foreseeable
future. The Company may sell additional equity or debt securities or obtain
additional credit facilities. The sale of additional equity securities or
issuance of equity securities in future acquisitions would result in dilution to
the Company's stockholders and the incurrence of additional debt could result in
additional interest expense.
In July 1999 the Company issued 2,181,818 shares of Series A Preferred
Stock. The holders of the series A Preferred Stock have the right to cause the
Company to redeem their stock for an aggregate amount equal to $12 million, plus
accrued dividends, upon the occurrence of certain events that are outside the
Company's control. If the Company is forced to redeem the Series A Preferred
Stock, then the Company may be forced to sell additional equity or debt
securities, or draw down its credit facility. The Company may not be able to
raise additional capital on terms favorable to the Company, if at all. See "Risk
Factors -- THE COMPANY MAY BE REQUIRED TO REDEEM THE SERIES A PREFERRED STOCK,
WHICH WOULD REDUCE SIGNIFICANTLY THE COMPANY'S LIQUIDITY AND WORKING CAPITAL AND
COULD FORCE THE COMPANY TO SCALE BACK ITS OPERATIONS."
YEAR 2000
The Company has experienced no significant disruptions in its critical
information technology and non-information technology systems and believes these
systems responded successfully to the year 2000 date change. The Company is not
aware of any material problems resulting from year 2000 compliance issues,
either with its internal systems, or with the products and services of third
parties. The Company will continue to monitor its critical computer
applications, as well as those of its suppliers and vendors throughout the year
2000 to ensure that any latent year 2000 compliance matters that may arise are
addressed promptly.
THIRD-PARTY PRODUCTS AND SALES, SERVICE AND MAINTENANCE AGREEMENTS.
Third-Party Products that are re-sold, installed and/or maintained by the
Company in connection with its sales, service and maintenance agreements with
its customers may fail to operate properly or as expected because of year 2000
compliance issues. These Third-Party Product failures could disrupt customer
operations through a temporary inability to, among other things, diagnose and
treat patients, operate medical communications systems, access medical
information and databases, process transactions, send invoices or engage in
similar medical and business activities.
Although the Company has completed its plan for remediation of year
2000 compliance issues and has not experienced significant failures in its
operations, the Company may nonetheless face claims and increased obligations
under its sales, service and maintenance agreements with its customers if
vendors, manufacturers and service providers of Third-Party Products do not: (i)
remediate successfully Third-Party Product failures affected by the year 2000,
or (ii) adequately indemnify the Company or provide pass-through warranties to
its customers for products re-sold, installed and maintained by the Company.
These increased claims could affect materially and adversely the Company's
business, results of operations and financial condition.
The Company has entered into a number of sales, service and maintenance
agreements that contain differing terms and conditions with respect to the
products and/or services provided by the Company that are not year 2000
compliant. During the last quarter of 1999 and the first two months of 2000, the
Company has experienced no significant failures or costs associated with these
obligations. Nonetheless, the agreements referenced above could expose the
Company to increased claims from the Company's customers, including defense and
indemnity of third-party claims against customers related to year 2000
readiness, as well as direct claims against the Company by third parties.
Therefore, the Company could incur significant expenses, costs and damages under
these agreements that could impact materially and adversely the Company's
business, results of operations and financial condition.
COMPANY SOFTWARE PRODUCTS. The Company also distributes certain
software products through its subsidiary, DAOU-Sentient. The Company has
completed its assessment and testing of these products and
26
believes that they are year 2000 compliant. The Company is not aware of any
significant disruptions affecting these software products.
COSTS. As of December 31, 1999, the Company had incurred aggregate
costs of approximately $200,000 in connection with its year 2000 identification,
assessment, testing and remediation, of which $100,000 was incurred for
internal-use systems, and $100,000 was incurred for assessing the Company's
liability and the status of the year 2000 compliance of Third-Party Products.
RISKS. If certain internal-use systems and Third-Party Products are not
year 2000 compliant, then such non-compliance could negatively impact the
Company's business, results of operations and financial condition. The failure
of these products to be year 2000 compliant could result in increased costs from
many factors, including but not limited to the following: diversion of resources
and personnel; litigation; service delays; increased warranty and other claims;
availability of adequately trained personnel; damage to the Company's
reputation; and decreased revenues if current and prospective customers devote a
substantial portion of their information systems spending to evaluation and
remediation of year 2000 issues that could divert money away from expenditures
relating to the Company's services.
The Company currently cannot accurately assess or estimate the possible
impact of the foregoing risks and potential liabilities because: there is no
uniform definition of "compliance with year 2000"; the legal standards for year
2000 liability presently are uncertain; the Company's year 2000 obligations will
depend on, among other things, the varying contractual terms contained in its
sales, service and maintenance agreements with respect to the particular
customer and the nature of such customer's year 2000 compliance issue; and
indemnification or pass-through arrangements relating to the Company's sales,
service and maintenance agreements may not cover all of the Company's
liabilities and costs incurred in year 2000 related claims.
Consequently, the Company cannot provide assurances that the aggregate
cost of resolving and/or defending the foregoing issues and claims will not
affect materially and adversely its business, results of operations and
financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We invest our excess cash primarily in U.S. government securities and
marketable debt securities of financial institutions and corporations with
strong credit ratings. These instruments have maturities of three months or
less when acquired. We do not utilize derivative financial instruments,
derivitive commodity instruments or other market risk sensitive instruments,
positions or transactions in any material fashion. Accordingly, we believe
that, while the instruments we hold are subject to changes in the financial
standing of the issuer of such securities, we are not subject to any material
risks arising from changes in interest rates, foreign currency exchange
rates,commodity prices, equity prices or other market changes that affect
market risk sensitive instruments.
27
ITEM 8: FINANCIAL STATEMENTS.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DAOU SYSTEMS, INC.
Report of Ernst & Young LLP, Independent Auditors F-1
Report of Deloitte & Touche LLP, Independent Auditors F-2
Consolidated Balance Sheets at December 31, 1999 and 1998 F-3
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999, 1998 and 1997 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997 F-7
Notes to Consolidated Financial Statements F-9
28
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders,
DAOU Systems, Inc.
We have audited the consolidated balance sheets of DAOU Systems, Inc. as of
December 31, 1999 and 1998 and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1999. Our audit also included financial statement
Schedule II listed in Item 14(a). These consolidated financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits. We did not audit the statement of operations, stockholders' equity or
cash flows of Sentient Systems, Inc. for the year ended December 31, 1997, which
statements reflect net income constituting 28% of the related consolidated
financial statement totals for the year ended December 31, 1997. These
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to Sentient Systems, Inc., is based
solely on the report of other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of the other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of DAOU Systems, Inc. at
December 31, 1999 and 1998 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1999 in conformity
with accounting principles generally accepted in the United States. Also, in our
opinion the related financial statement schedule, when considered in relation to
the basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.
/s/ ERNST & YOUNG LLP
San Diego, California
February 18, 2000
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Sentient Systems, Inc.
Kensington, Maryland
We have audited the statements of operations, changes in stockholders' equity,
and cash flows of Sentient Systems, Inc. (the Company) for the year ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements present fairly, in all material
respects, the Company's results of operations and cash flows for the year ended
December 31, 1997, in conformity with accounting principles generally accepted
in the United States.
/s/ Deloitte & Touche LLP
McLean, Virginia
February 13, 1998
F-2
DAOU Systems, Inc.
Consolidated Balance Sheets
(IN THOUSANDS)
DECEMBER 31,
1999 1998
------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,480 $ 6,756
Investments, available-for-sale 68 1,024
Accounts receivable, net of allowance for doubtful accounts of
$1,868 and $956 in 1999 and 1998, respectively 21,912 24,582
Contract work in progress 2,816 12,272
Income tax receivable 378 234
Deferred income taxes - 3,362
Other current assets 670 1,072
------------------------------------
Total current assets 41,324 49,302
Due from officers/stockholders 98 171
Equipment, furniture and fixtures, net 4,319 4,735
Other assets 319 309
------------------------------------
$ 46,060 $54,517
====================================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities
Trade accounts payable $ 849 $ 3,514
Accrued salaries and benefits 4,248 3,907
Other accrued liabilities 3,220 4,402
Income taxes payable 450 -
Deferred revenue 179 361
Deferred compensation to officers - 559
Current portion of severance payable 210 210
Current portion of long-term debt and line of credit - 4,684
------------------------------------
Total current liabilities 9,156 17,637
Deferred rent 145 45
Long-term debt - 26
Severance payable 403 613
Deferred income taxes - 1,421
Commitments and contingencies (Notes 7 & 11)
Redeemable convertible preferred stock, $.001 par value. Authorized 3,520
shares; issued and outstanding 2,182 and 0 shares at December 31, 1999 and
1998, respectively, with a liquidation preference of
$12,308 and $0 at December 31, 1999 and 1998 respectively,
including accrued dividends. 11,382 -
Stockholders' equity:
Common stock, $.001 par value. Authorized 50,000 shares; issued
and outstanding 17,712 and 17,689 at December 31, 1999 and 1998,
respectively 18 18
Additional paid-in capital 37,395 38,419
Deferred compensation (192) (980)
Accumulated other comprehensive income (43) 236
Retained deficit (12,204) (2,918)
------------------------------------
Total stockholders' equity 24,974 34,775
------------------------------------
$ 46,060 $54,517
====================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
DAOU Systems, Inc.
Consolidated Statements of Operations
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
YEARS ENDED DECEMBER 31,
1999 1998 1997
-------------------------------------------------
Revenues $103,400 $104,784 $ 68,656
Cost of revenues 75,927 78,021 45,154
-------------------------------------------------
Gross profit 27,473 26,763 23,502
Operating expenses:
Sales and marketing 10,398 12,203 7,780
General and administrative 25,071 18,456 12,425
Merger and related expenses - 2,825 718
-------------------------------------------------
35,469 33,484 20,923
-------------------------------------------------
Income (loss) from operations (7,996) (6,721) 2,579
Interest income, net 779 163 873
-------------------------------------------------
Income (loss) before income taxes (7,217) (6,558) 3,452
Provision (benefit) for income taxes 1,761 (802) 947
-------------------------------------------------
Net income (loss) (8,978) (5,756) 2,505
Accrued dividends on preferred stock (308) - -
-------------------------------------------------
Net income (loss) available to common stockholders $ (9,286) $ (5,756) $ 2,505
=================================================
Net income (loss) per common share:
Basic $ (0.52) $ (0.33) $ 0.15
=================================================
Diluted $ (0.52) $ (0.33) $ 0.15
=================================================
Shares used in computing net income (loss)
per common share:
Basic 17,697 17,657 16,231
=================================================
Diluted 17,697 17,657 17,246
=================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
DAOU Systems, Inc.
Consolidated Statements of Stockholders' Equity
(IN THOUSANDS)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
----------------------------- PAID-IN DEFERRED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION INCOME
---------------------------------------------------------------------------
Balance at December 31, 1996 12,796 $ 13 $ 1,584 $ (1,166) $ 101
Issuance of common stock upon initial public
offering, net 2,000 2 15,782 - -
Conversion of redeemable preferred stock upon
initial public offering 1,603 2 7,616 - -
Issuance of common stock upon secondary public
offering, net 500 - 9,320 - -
Issuance of common stock upon exercise of
stock options 142 - 639 - -
Tax benefit from exercise of noncompensatory
stock options - - 1,103 - -
Amortization of deferred compensation - - - 259 -
Shares issued in connection with formation of
S corporation 584 1 (1) - -
Repurchase of founders' stock (680) (1) (3) - -
Distribution to Integrex stockholders (NOTE 3) - - - - -
Distribution to On-Line stockholders (NOTE 3) - - - - -
Distribution to Sentient stockholders (NOTE 3) - - - - -
Distribution to TMI stockholders (NOTE 3) - - - - -
Comprehensive income:
Unrealized gain on short-term investments - - - - 45
Net income - - - - -
Comprehensive income
---------------------------------------------------------------------------
Balance at December 31, 1997 16,945 $17 $36,040 $ (907) $146
Shares issued in connection with formation of
S corporations 506 1 506 - -
Deferred compensation - - 385 (385) -
Tax benefit from exercise of noncompensatory
stock options - - 630 - -
Amortization of deferred compensation - - - 312 -
Distribution to Sentient stockholders (NOTE 3) - - - - -
Distribution to TMI stockholders (NOTE 3) - - - - -
Distribution to RHI stockholders (NOTE 3) - - - - -
Issuance of common stock upon exercise of
stock options 236 - 844 - -
Issuance of common stock upon exercise of
warrants 2 - 14 - -
Comprehensive loss:
Unrealized gain on short-term investments - - - - 90
Net loss - - - - -
Comprehensive loss
---------------------------------------------------------------------------
Balance at December 31, 1998 17,689 $18 $38,419 $ (980) $236
---------------------------------------------------------------------------
ACCRETION OF
REDEEMABLE RETAINED TOTAL
PREFERRED EARNINGS STOCKHOLDERS'
STOCK (DEFICIT) EQUITY
----------------------------------------------------
Balance at December 31, 1996 $ (572) $ 6,344 $ 6,304
Issuance of common stock upon initial public
offering, net - - 15,784
Conversion of redeemable preferred stock upon
initial public offering 572 - 8,190
Issuance of common stock upon secondary public
offering, net - - 9,320
Issuance of common stock upon exercise of
stock options - - 639
Tax benefit from exercise of noncompensatory
stock options - - 1,103
Amortization of deferred compensation - - 259
Shares issued in connection with formation of
S corporation - - -
Repurchase of founders' stock - (1,116) (1,120)
Distribution to Integrex stockholders (NOTE 3) - (94) (94)
Distribution to On-Line stockholders (NOTE 3) - (63) (63)
Distribution to Sentient stockholders (NOTE 3) - (391) (391)
Distribution to TMI stockholders (NOTE 3) - (644) (644)
Comprehensive income:
Unrealized gain on short-term investments - - 45
Net income - 2,505 2,505
------------------
Comprehensive income 2,550
----------------------------------------------------
Balance at December 31, 1997 $ - $ 6,541 $ 41,837
Shares issued in connection with formation of
S corporations - - 507
Deferred compensation - - -
Tax benefit from exercise of noncompensatory
stock options - - 630
Amortization of deferred compensation - - 312
Distribution to Sentient stockholders (NOTE 3) - (252) (252)
Distribution to TMI stockholders (NOTE 3) - (2,945) (2,945)
Distribution to RHI stockholders (NOTE 3) - (506) (506)
Issuance of common stock upon exercise of
stock options - - 844
Issuance of common stock upon exercise of
warrants - - 14
Comprehensive loss:
Unrealized gain on short-term investments - - 90
Net loss - (5,756) (5,756)
------------------
Comprehensive loss (5,666)
----------------------------------------------------
Balance at December 31, 1998 $ - $ (2,918) $ 34,775
----------------------------------------------------
See accompanying notes to consolidated financial statements.
F-5
DAOU Systems, Inc.
Consolidated Statements of Stockholders' Equity
(IN THOUSANDS)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
----------------------------- PAID-IN DEFERRED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION INCOME
---------------------------------------------------------------------------
Balance at December 31, 1998 17,689 $18 $38,419 $ (980) $ 236
Issuance of common stock upon exercise of
stock options 23 - 95 - -
Amortization of deferred compensation - - - 299 -
Reversal of deferred compensation for
separated employees - - (489) 489 -
Accrued dividends on preferred stock - - - - -
Reversal of tax benefit from exercise of
noncompensatory stock options - - (630) - -
Comprehensive loss:
Net realized gain on investments - - - - (279)
Net loss - - - - -
Comprehensive loss
---------------------------------------------------------------------------
Balance at December 31, 1999 17,712 $18 $37,395 $ (192) $ (43)
===========================================================================
ACCRETION OF
REDEEMABLE RETAINED TOTAL
PREFERRED EARNINGS STOCKHOLDERS'
STOCK (DEFICIT) EQUITY
------------------------------------------------
Balance at December 31, 1998 $ - $ (2,918) $ 34,775
Issuance of common stock upon exercise of
stock options - - 95
Amortization of deferred compensation - - 299
Reversal of deferred compensation for
separated employees - - -
Accrued dividends on preferred stock - (308) (308)
Reversal of tax benefit from exercise of
noncompensatory stock options - - (630)
Comprehensive loss:
Net realized gain on investments - - (279)
Net loss - (8,978) (8,978)
------------------
Comprehensive loss (9,257)
-----------------------------------------------
Balance at December 31, 1999 $ - $ (12,204) $ 24,974
===============================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
DAOU Systems, Inc.
Consolidated Statements of Cash Flows
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
1999 1998 1997
----------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $(8,978) $(5,756) $ 2,505
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 2,077 1,715 1,324
Provision for uncollectible accounts 1,643 644 70
Deferred income taxes 1,311 (1,378) 266
Gain on sale of investment (546) - -
Loss on retirement of fixed assets 88 - -
Changes in operating assets and liabilities:
Accounts receivable 1,027 (9,482) (5,370)
Contract work in progress 9,456 1,019 (9,169)
Other current assets and income taxes receivable 258 458 (1,087)
Accounts payable and accrued liabilities and
income taxes payable (3,397) 2,773 2,358
Accrued salaries and benefits 341 1,232 419
Deferred revenue (182) (8) (741)
Severance payable (210) (210) 1,033
Deferred rent 100 (10) (37)
----------------------------------------------------
Net cash provided by (used in) operating activities 2,988 (9,003) (8,429)
INVESTING ACTIVITIES
Purchase of equipment, furniture and fixtures (1,450) (2,279) (3,163)
Decrease (increase) in other assets (10) 156 (186)
Purchases of investments - (8) (9,462)
Proceeds from sale and maturities of investments 1,223 9,381 39
Payments from (advances to) officers/stockholders 73 200 (143)
----------------------------------------------------
Net cash provided by (used in) investing activities (164) 7,450 (12,915)
FINANCING ACTIVITIES
Proceeds from long-term debt, line of credit and
deferred compensation to officers 657 5,795 1,246
Repayments of long-term debt, line of credit and
deferred compensation to officers (5,926) (3,129) (60)
Distributions to stockholders of acquired companies - (3,703) (706)
Proceeds from issuance of common stock 95 1,365 26,842
Proceeds from issuance of redeemable convertible
preferred stock 11,074 - -
Repurchase of founders' stock - - (1,120)
----------------------------------------------------
Net cash provided by financing activities 5,900 328 26,202
----------------------------------------------------
Increase (decrease) in cash and cash equivalents 8,724 (1,225) 4,858
Cash and cash equivalents at beginning of year 6,756 7,981 3,123
----------------------------------------------------
Cash and cash equivalents at end of year $15,480 $ 6,756 $ 7,981
====================================================
Cash paid during the year for:
Income taxes $ 213 $ 144 $ 115
====================================================
Interest $ 262 $ 290 $ 113
====================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-7
DAOU Systems, Inc.
Consolidated Statements of Cash Flows
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
1999 1998 1997
----------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Accrued preferred stock dividends to redeemable
preferred stockholders $ 308 $ - $ -
====================================================
Accrued dividends payable to TMI, Inc. stockholders $ - $ - $ 487
====================================================
Deferred tax benefit from exercise of
noncompensatory options $ (630) $ 630 $ -
====================================================
Conversion of redeemable preferred stock and
accreted dividends to common stock $ - $ - $7,618
====================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-8
DAOU Systems, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BASIS OF PRESENTATION
DAOU Systems, Inc. ("DAOU" or the "Company") a Delaware company, was
incorporated in July 1987. DAOU provides integrated information technology
("IT") solutions and services to the U.S. healthcare industry. DAOU's
capabilities range from IT strategic consulting to system design and
implementation to long-term tactical system support. The Company's segments
included, IT consulting and managed care implementation services (IT
Consulting), communications infrastructure group, application implementation,
integration services, outsourcing and Internet services through Enosus. The IT
Consulting group is focused on helping managed care organizations meet their
business and IT objectives.The Company's communications infrastructure group
focuses on the information superstructure in healthcare enterprises, including
networking, Intranet and Internet, desktop, voice, video and data solutions. The
Company's application implementation group supplies staffing resources to
hospitals and other healthcare organizations. Integration services provide
custom integration solutions that allow organizations to share and access data
housed across multiple platforms and environments. The outsourcing group
performs a full range of IT outsourcing services, including co-source or
outsourcing of call centers, help desks, desktop support, server, network, voice
management, and complete IT outsourcing. The consolidated financial statements
reflect the combined financial position and operating results for the Company.
All significant intercompany accounts have been eliminated.
REVENUE RECOGNITION
Contract revenue for the development and implementation of network solutions
under fixed-fee contracts is recognized using the percentage-of-completion
method with progress to completion measured by labor costs incurred to date
compared to total estimated labor costs. Provisions for estimated losses on
contracts, if any, are made during the period when the loss becomes probable and
can be reasonably estimated. Revenues recognized in excess of amounts billed and
project costs are classified as contract work in progress. Revenue from
technical support and network management services is recognized as the services
are performed. Payments received in advance of services performed are recorded
as deferred revenue and amortized as the services are performed.
CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMER
Substantially all of the Company's accounts receivable are from hospitals and
other healthcare providers. Generally, the Company obtains a significant deposit
from its customers upon signing a contract and collateral is not required. The
Company provides for losses from uncollectible accounts and such losses have
historically not exceeded management's expectations. Services to DAOU's five
largest customers accounted for approximately $26.4 million of revenues for the
year ended December 31, 1999, representing approximately 26% of total revenues.
One of the top five customers accounted $10.8 million of revenues for the year
ended December 31, 1999, representing approximately 10% of total revenues.
CASH, CASH EQUIVALENTS AND INVESTMENTS
Cash and cash equivalents consist of cash and highly liquid investments with
maturities of three months or less when purchased. The Company has established
guidelines relative to diversification and maturities that are periodically
reviewed and modified to take advantage of trends in yields and interest rates.
The Company historically has not experienced any material losses on its cash
equivalents or short-term investments.
The Company classifies its investments as "Available-for-Sale" and records such
assets at the estimated fair value on the balance sheet with unrealized gains
and losses excluded from earnings and reported as a separate component of
comprehensive income until realized. The basis for computing realized gains or
losses is by specific identification.
F-9
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures are carried at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the assets,
ranging from three to seven years. Leasehold improvements are amortized over the
lesser of the estimated useful lives of the assets or the remaining lease term.
The Company does not sell or license the rights to use future software;
accordingly, software development costs, consisting of internally developed
software and web site development costs, are accounted for using Statement of
Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." In accordance with SOP-98-1, internal and
external costs incurred to develop internal use computer software during the
application development stage are capitalized. Application development stage
costs generally include software configuration, coding, installation to
hardware, and testing. Capitalized internal-use software development costs are
included in property and equipment and are amortized on a straight-line basis
over the estimated useful lives of the related software applications of up to
three years.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, which will be
effective January 1, 2001. SFAS No. 133 establishes accounting and reporting
standards requiring that every derivative instrument, including certain
derivative instruments imbedded in other contracts, be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement also requires that changes in the derivative's fair value be
recognized in earnings unless specific hedge accounting criteria are met. The
Company believes the adoption of SFAS No. 133 will not have a material effect
on the financial statements.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
about the future that affect the amounts reported in the financial statements
and disclosures made in the accompanying notes of the financial statements. The
actual results could differ from those estimates.
NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed in accordance with FASB Statement No.
128, EARNINGS PER SHARE. Basic net income (loss) per share is computed using the
weighted average number of common shares outstanding during each period. Diluted
net income (loss) per share includes the dilutive effect of common shares
potentially issuable upon the exercise of stock options and warrants. In 1999,
diluted loss per share is unchanged from basic loss per share because the
effects of the assumed conversion of stock options and warrants would be
antidilutive.
The following table sets forth the computation of the shares used in the basic
and diluted net income (loss) per share and calculation thereof (in thousands,
except per share information):
DECEMBER 31,
1999 1998 1997
-------------- ------------------ ---------------
Numerator:
Net income (loss) available to common shareholders $ (9,286) $ (5,756) $ 2,505
Denominator:
Shares used in basic net income (loss) per share -
weighted average common shares
outstanding 17,697 17,657 16,231
Effect of conversion of preferred stock from
date of issuance - - 189
Net effect of dilutive common share equivalents
based on treasury stock method - - 826
--------------- ------------------ ---------------
Denominator for diluted net income (loss) per
share - adjusted weighted average common
shares outstanding $ 17,697 $ 17,657 $ 17,246
=============== ================== ===============
Basic net income (loss) per share $ (.52) $ (.33) $ .15
=============== =================== ==============
Diluted net income (loss) per share $ (.52) $ (.33) $ .15
=============== =================== ==============
F-10
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations
in accounting for its employee and director stock options because the
alternative fair value accounting provided for under SFAS No. 123, ACCOUNTING
FOR STOCK-BASED COMPENSATION ("SFAS 123"), requires the use of option valuation
models that were not developed for use in valuing employee and director stock
options. Under SFAS 123, compensation cost is determined using the fair value of
stock-based compensation determined as of the grant date, and is recognized over
the periods in which the related services are rendered. If companies elect to
continue using the current implicit value accounting method specified in APB 25
to account for stock-based compensation, they must disclose in the notes to the
financial statements the pro forma effect of using the fair value method for its
stock-based compensation.
2. FOURTH QUARTER ADJUSTMENTS
During the fourth quarter of 1999 the Company recorded reserves and related
charges totaling $4 million directly related to its previously closed down
On-Line business and also based on a critical review of its receivables.
During 1999, in addition to the closedown of On-Line, the Company reduced
headcount, experienced turnover in key positions and significantly
restructured its organization. The significance of these changes adversely
affected the Company's ability to address timely the completion and
settlement for some of its larger implementation and consulting contracts.
The Company is actively pursuing final settlements for work performed;
however, reserves were provided to ensure that the carrying value of the
Company's assets does not exceed net realizable value.
The Company's 1999 net loss results in the Company being in a cumulative loss
position over the last three fiscal years. In accordance with generally accepted
accounting principles, the realization of the Company's net deferred tax assets
is not assured beyond a reasonable doubt. Accordingly, during the fourth quarter
a revaluation allowance of $3,501,000 was also recorded to fully reserve
cumulative deferred tax assets recorded through September 30, 1999.
3. ACQUISITIONS
During June 1998, the Company acquired through its wholly-owned subsidiaries
DAOU-TMI, Inc. and DAOU-RHI, Inc. (i) Technology Management, Inc. ("TMI"), a
privately-held company that provides information technology consulting services
primarily to the healthcare industry, (ii) International Health Care Systems,
Inc. ("IHCS"), a privately-held company with a common shareholder with TMI that
provides information technology consulting services primarily to the healthcare
industry on behalf of TMI, (iii) Resources in Healthcare Innovations, Inc.
("RHI"), a privately-held information technology services firm that provides
contract management services for healthcare information systems to hospitals and
managed care organizations, and (iv) Healthcare Transition Resources, Inc.
("HTR"), (v) Ultitech Resources Group, Inc. ("URG"), (vi) Innovative Systems
Solutions, Inc. ("ISS") and (vii) Grand Isle Consulting, Inc. ("GIC"), each a
privately held company with common shareholders of RHI that implements software
applications from third parties and provides support services to healthcare
enterprises. Shareholders of TMI, IHCS, RHI, HTR, URG, ISS and GIC received
1,078,963, 224,668, 1,839,381, 275,662, 282,551, 308,583 and 223,645 shares,
respectively, of the Company's common stock in exchange for all of the
outstanding stock of each of these companies. The above acquisitions have been
accounted for using the pooling-of-interests method of accounting, and
accordingly, the historical financial statements of periods prior to the
consummation of the combinations have been restated as though the companies had
been combined for all periods presented.
During March 1998, the Company acquired through its wholly-owned subsidiaries
DAOU-Synexus, Inc. and DAOU- Sentient, Inc.: Synexus Incorporated ("Synexus"), a
privately-held company specializing in the planning, design and implementation
of enterprise networks in healthcare environments; and Sentient Systems, Inc.
("Sentient"), a privately-held company which provides integration and support
services primarily to healthcare organizations. Shareholders of Synexus and
Sentient received 161,235 and 1,397,550 shares, respectively, of the Company's
common stock in exchange for all of the outstanding stock of each of these
companies. The acquisitions have been accounted for using the
pooling-of-interests method of accounting, and accordingly, the historical
financial statements of periods prior to the consummation of the combinations
have been restated as though the companies had been combined for all periods
presented.
F-11
3. ACQUISITIONS (CONTINUED)
On September 25, 1997, the Company acquired through its wholly-owned subsidiary
DAOU On-Line, Inc. all of the issued and outstanding shares of On-Line
Networking, Inc. ("On-Line") in exchange for 150,000 shares of the Company's
common stock. On-Line is a provider of communication infrastructure services
primarily within the healthcare information technology market.
On July 9, 1997, the Company acquired through its wholly owned subsidiary
DAOU-Integrex, Inc. all of the issued and outstanding shares of Integrex Systems
Corporation ("Integrex") in exchange for 700,000 shares of the Company's common
stock. Integrex provides advanced network design, integration and consulting
support services primarily to healthcare organizations and also to educational
and governmental institutions, all of which are primarily located in the state
of Virginia. Integrex specializes in voice and video networks and also designs
integrated cable plants capable of supporting voice, video and high-speed data
transmission.
Both the Integrex and On-Line acquisitions were accounted for using the
pooling-of-interests method of accounting and, accordingly, the historical
financial statements for all periods prior to the consummation of the
combinations have been restated as though the companies had been combined for
all periods presented.
4. INVESTMENTS, AVAILABLE-FOR-SALE
Short-term investments, available-for-sale, consist of the following
(in thousands):
GROSS GROSS
AMORTIZED COST UNREALIZED GAINS UNREALIZED LOSSES ESTIMATED FAIR VALUE
------------------ -------------------- ------------------- -----------------------
DECEMBER 31, 1999
Government debt securities $ 111 $ - $ (43) $ 68
================== ==================== =================== =======================
------------------ -------------------- ------------------- -----------------------
DECEMBER 31, 1998
Mutual Funds $ 788 $ 286 $ (50) $ 1,024
================== ==================== =================== =======================
------------------ -------------------- ------------------- -----------------------
DECEMBER 31, 1997
Equity securities $ 707 $ 154 $ (2) $ 859
Government and corporate debt
securities 9,454 - (6) 9,448
------------------ -------------------- ------------------- -----------------------
Mutual Funds $10,161 $ 154 $ (8) $10,307
================== ==================== =================== =======================
The government debt securities mature in 2008.
F-12
5. SELECTED BALANCE SHEET DETAILS
Contract work in progress consist of the following (in thousands):
DECEMBER 31,
1999 1998
--------------- -------------
Unbilled accounts receivable $ 2,474 $10,296
Other 342 1,976
--------------- -------------
$ 2,816 $12,272
=============== =============
Equipment, furniture and fixtures consist of the following (in thousands):
DECEMBER 31,
1999 1998
--------------- -------------
Equipment and furniture $ 9,575 $ 8,836
Leasehold improvements 664 244
--------------- -------------
10,239 9,080
Less accumulated depreciation and amortization (5,920) (4,345)
=============== =============
$ 4,319 $ 4,735
=============== =============
Other accrued liabilities consist of the following (in thousands):
DECEMBER 31,
1999 1998
--------------- -------------
Accrued contract costs $ 740 $2,936
Other accrued liabilities 2,480 1,466
=============== =============
$3,220 $4,402
=============== =============
6. LINES OF CREDIT
On June 29, 1999, the Company secured a replacement $8.0 million revolving line
of credit, which expires June 29, 2001. The line of credit bears interest at
prime plus 1% per annum and is secured by substantially all of the assets of the
Company and contains customary covenants and restrictions. There are no
compensating balance requirements and borrowings under the line of credit are
limited to 80% of qualifying receivables. No amounts were outstanding under this
revolving line of credit as of December 31, 1999.
At December 31, 1998, the Company had a $700,000 line of credit, which expired
on May 1, 1999, under which $30,000, was available for future borrowing. Under
the terms of the agreement, advances were subject to interest at the bank's
prime rate plus 0.25% (8.00% at December 31, 1998) per annum. There were no
compensating balance requirements and borrowings under the line of credit were
limited to 65% of qualifying receivables.
During June 1998, the Company secured two borrowing facilities, a $2.0 million
revolving line of credit, under which none was available for future borrowings
at December 31, 1998, and an additional $8,000,000 line of credit, under which
$6.0 million was available for future borrowings at December 31, 1998. Advances
under both lines were subject to interest at the bank's prime rate plus 0.25%
(8.0% at December 31, 1998) per annum. These lines of credit expired on July 31,
1999, and were secured by substantially all of the assets of the Company and
contained customary covenants and restrictions.
The Company had $0 and $4.7 million outstanding at December 31, 1999 and 1998,
respectively under these various lines of credit. Interest expense for the above
lines of credit for the years ended December 31, 1999, 1998 and 1997 was
approximately $253,000, $216,000 and $43,000, respectively.
F-13
7. COMMITMENTS
LEASE COMMITMENTS
The Company leases its facilities and certain equipment under operating lease
agreements. The facility leases provide for abatement of rent during certain
periods and escalating rent payments during the lease term. Rent expense for
1999, 1998 and 1997 totaled approximately $2,213,000, $1,665,000 and $1,187,000
respectively.
Annual future minimum lease payments under noncancelable operating leases with
initial terms of one year or more at December 31, 1999, consist of the following
(in thousands):
2000 $ 2,230
2001 1,622
2002 1,451
2003 1,317
2004 1,259
Thereafter 343
--------------
$ 8,222
==============
SEVERANCE PAYABLE
In connection with the retirement of one of the RHI original founders, RHI
entered into a severance agreement whereby RHI will repay the retiring founder a
total of $1,050,000 in severance payments, payable in sixty consecutive monthly
installments of $17,500 beginning on December 20, 1997. At December 31, 1999,
the Company had an outstanding payable of $612,500. The aggregate minimum future
payments under the severance agreements as of December 31, 1999 are $210,000,
$210,000 and $192,500 for the years ending December 31, 2000, 2001 and 2002,
respectively.
RELATED PARTY TRANSACTIONS
The Company had an agreement with a former officer that guaranteed a cash
bonus for the amount of any difference between (i) the net value at November
11, 1999 of the options granted to the officer during 1996 and (ii)
$1,550,000. The Company paid the officer $827,000 in November of 1999.
In 1999 the Company provided implementation services to a company in which
the Chairman of the Board is an investor. Revenues, costs, and gross profit
related to these contracts totaled approximately $1,567,000, $1,377,000 and
$190,000, respectively. The Company has $840,000 in accounts receivable
outstanding at December 31, 1999 related to the implementation services
provided.
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
REDEEMABLE CONVERTIBLE PREFERRED STOCK
During 1995, 1,603,430 shares of redeemable preferred stock were issued at $4.99
per share for proceeds of $7,618,000, net of issuance costs. Holders of the
redeemable preferred stock were entitled to receive cumulative dividends at the
rate of $0.03 per share per annum, when and if declared by the Board of
Directors and prior to any dividends on the common stock. Each share of
redeemable convertible preferred stock has full voting rights and powers equal
to one share of common stock. The redeemable preferred stock had a liquidation
preference of $4.99 per share plus any declared but unpaid dividends and was
convertible at the option of the holder into one share of common stock, subject
to certain antidilution adjustments. The shares of preferred stock were
automatically converted into shares of common stock in connection with the
initial public offering of the Company's common stock, which closed in February
1997. The increase in the redemption value of the redeemable preferred stock was
$87,000 in 1995 and $485,000 in 1996.
On July 26, 1999, 2,181,818 shares of Series A Preferred Stock were issued at
$5.50 per share to a related party. Holders of the Series A Preferred Stock are
entitled to receive cumulative dividends at the rate of six percent per annum,
payable in the form of shares of Series A Preferred Stock. Such dividend rate
shall increase an additional one-percent per annum for each successive year
after the second anniversary of the purchase date. The Series A Preferred Stock
has a liquidation preference of $5.50 per share plus any accrued (whether or not
declared) but unpaid dividends and is convertible, at the option of the holder,
into 2,181,818 shares of common stock, subject to certain antidilution
adjustments. The Company
F-14
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(CONTINUED)
may be required to redeem the Series A Preferred Stock for cash upon
occurrence of certain events outside of the control of the Company. The
Series A Preferred Stock is also redeemable at the option of the Company four
years after the date of issuance. In addition, the Series A Preferred Stock
is subject to mandatory conversion in the event the Company's common stock
price reaches certain predetermined price targets. The offering resulted in
net proceeds of approximately $11.1 million after expenses incurred by the
Company in connection with the offering of approximately $926,000 (which
include commissions and other expenses including registration and filing
fees, printing, accounting and legal expenses). No direct or indirect
payments were made to any directors, officers, owners of ten percent or more
of any class of the Company's equity securities or other affiliates of the
Company other than for reimbursement of expenses incurred on the road show.
The net proceeds were used to retire the line of credit that expired in July
1999 and long term debt of approximately $5.3 million. The balance of the net
proceeds will be used for general corporate and working capital purposes.
The Company registered 2,750,000 shares of Common Stock for issuance upon
conversion of 2,181,818 shares of Series A Preferred Stock on the Registration
Statement on Form S-3 (File No. 33-87103), as declared effective by the
Commission on October 25, 1999.
STOCK OPTION PLANS
During 1996, the Company adopted the 1996 Stock Option Plan (the "Plan"), under
which 947,025 shares of the Company's common stock were initially reserved for
issuance upon exercise of options granted by the Company. During November 1996,
the Board of Directors adopted and the shareholders approved an amendment to the
Plan, which increased the number of shares reserved for issuance under the plan
to 1,367,925. In May 1998, the Board of Directors adopted and the shareholders
approved an amendment to the Plan, which increased the number of shares reserved
for issuance under the Plan to 4,000,000 shares. The Plan provides for the grant
of both incentive and nonstatutory stock options to officers, directors,
employees and consultants of the Company. Options granted by the Company
generally vest over a three to five-year period and are exercisable for a period
of ten years from the date of the grant.
The Company recorded $1,243,000 of deferred compensation for options granted
during the year ended December 31, 1996, representing the difference between the
option exercise price and the deemed fair value for financial statement
presentation purposes. From January through May 1998, the Company recorded
$385,000 of deferred compensation related to options granted with exercise
prices below the fair market value on the date of the increase in the number of
shares reserved for issuance under the Plan was approved by the shareholders.
The Company is amortizing the deferred compensation ratably over the vesting
period of the options.
F-15
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(CONTINUED)
The following summary of the Company's stock option activity and related
information includes 140,300 non-qualified stock options at an exercise price
of $4.28 per share and 550,000 non-qualified stock options at an exercise
price ranging from $4.31 to $5.50 per share granted outside the plan in 1996
and 1999 respectively:
1999 1998 1997
---------------------------- ------------------------------- ---------------------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
------------ --------------- -------------- ---------------- ----------- ---------------
Outstanding - beginning of
year 3,226,794 $10.44 1,540,399 $7.49 941,413 $ 5.05
Granted 1,091,500 4.94 2,699,045 13.22 971,943 9.61
Exercised (22,240) 4.28 (235,637) 6.16 (144,487) 4.44
Forfeited (929,868) 13.21 (777,013) 16.29 (228,470) 5.86
------------ --------------- -------------- ---------------- ----------- ---------------
Outstanding - end of year 3,366,186 $ 7.94 3,226,794 $10.44 1,540,399 $ 7.49
============ =============== ============== ================ =========== ===============
Exercisable at end of year 985,534 $ 8.58 266,526 $13.35 230,705 $ 6.57
============ =============== ============== ================ =========== ===============
Weighted-average fair value
of options granted during
the year $ 3.30 $ 6.79 $ 4.30
=============== ================ ===============
The following table summarizes information about stock options outstanding at
December 31, 1999:
OUTSTANDING EXERCISABLE
---------------------------------------------------------- ------------------------------------
WEIGHTED-AVERAGE
RANGE OF EXERCISE REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE
PRICES NUMBER OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISABLE EXERCISE PRICE
- ----------------------- ------------------- -------------------- ----------------- ------------------- ---------------
$2.75 - $5.50 2,344,194 8.8 $ 4.96 636,095 $ 4.84
$5.50 - $8.25 213,595 7.1 $ 6.01 75,407 $ 6.01
$8.25 - $11.00 83,827 7.1 $10.23 46,215 $10.21
$11.00 - $13.75 334,000 8.3 $13.62 72,067 $13.61
$13.75 - $16.50 84,000 6.4 $16.09 17,400 $16.06
$16.50 - $19.25 41,200 5.4 $16.95 22,200 $16.94
$19.25 - $22.00 78,870 7.0 $21.75 18,150 $21.75
$22.00 - $24.75 40,000 6.4 $24.25 20,800 $24.25
$24.75 - $27.50 146,500 5.1 $25.00 77,200 $25.00
=================== ==================== ================= =================== ===============
3,366,186 8.3 $ 7.94 985,534 $ 8.58
=================== ==================== ================= =================== ===============
At December 31, 1999, options for 781,450 common shares were available for
future grant.
Adjusted pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
statement. The fair value for these options was estimated at the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions for 1999, 1998 and 1997: risk-free interest rate of 6% for all
years; dividend yield of 0% for all years; volatility factors of the expected
market price of the Company's common stock of 75% for all years; and a
weighted-average expected life of the options of five years for all years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. For purposes of
adjusted pro forma disclosures, the estimated fair value of the options is
amortized to expense over the vesting period of the options. The
F-16
8. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(CONTINUED)
Company's adjusted pro forma information is as follows (in thousands, except for
per share information):
YEARS ENDED DECEMBER 31,
1999 1998 1997
------------------- ---------------- -----------------
Adjusted pro forma net income (loss) $(19,294) $(16,380) $(1,129)
=================== ================ =================
Adjusted pro forma net income (loss) per share:
Basic $ (1.09) $ (0.93) $(0.07)
=================== ================ =================
Diluted $ (1.09) $ (0.93) $(0.07)
=================== ================ =================
WARRANTS
In connection with the issuance of the redeemable preferred stock in 1995, the
Company issued two warrants to purchase an aggregate of 133,285 shares of common
stock at an exercise price of $4.99 per share. The warrants are exercisable
immediately and expire on October 26, 2000. As of December 31, 1999, warrants to
purchase an aggregate of 130,393 shares of common stock remain outstanding.
COMMON STOCK RESERVED
Shares reserved for future issuance:
Redeemable convertible preferred stock 2,750,000
Stock options 3,597,636
Warrants 130,393
=========
Total 6,478,029
=========
9. INCOME TAXES
The provision for income taxes consists of the following (in thousands):
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1999 1998 1997
- ----------------------------------------- -------------------- ------------------ ------------------
Current:
Federal $ - $ - $ 581
State 450 576 97
-------------------- ------------------ ------------------
450 576 678
Deferred:
Federal 1,119 (1,205) 238
State 192 (173) 31
-------------------- ------------------ ------------------
1,311 (1,378) 269
==================== ================== ==================
$1,761 $ (802) $ 947
==================== ================== ==================
Deferred income taxes are provided for temporary differences in recognizing
certain income and expense items for financial and tax reporting purposes.
F-17
9. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities are
shown below (in thousands):
1999 1998
- ---------------------------------------------------------------- ------------------ ---------------
Deferred tax liabilities:
Accounting method change for tax purposes $ 1,322 $ 2,005
Depreciation and amortization 229 126
------------------ ---------------
1,551 2,131
Deferred tax assets:
Reserves and allowances 945 1,792
Net operating losses 3,594 2,280
Other - -
------------------ ---------------
4,539 4,072
Net deferred tax asset before valuation allowance (2,988) (1,941)
------------------ ---------------
Valuation allowance for deferred tax assets 2,988 -
------------------ ---------------
Net deferred tax asset $ - $(1,941)
================== ===============
At December 31, 1999, the Company has federal and state net operating loss
carryforwards of approximately $9,141,000 and $6,873,000, respectively. The
federal and state loss carryforwards will begin to expire in 2018 and 2002,
respectively, unless previously utilized.
Under sections 382 and 383 of the Internal Revenue Code, the annual use of the
Company's net operating loss carryforwards may be limited in the event of a
cumulative change in ownership of more that 50%. However, the Company does not
believe such a limitation will have a material impact on the ultimate
utilization of these carryforwards.
The reconciliation of income tax computed at the federal statutory rate to the
total provision for income taxes is as follows:
YEARS ENDED DECEMBER 31,
------------ ------------------- -------------
1999 1998 1997
------------ ------------------- ----------------
Tax at federal statutory rate (35.0)% (35.0)% 35.0 %
S corporation income not subject to corporate income taxes - (18.1) (33.7)
Nondeductible expenses - 10.6 9.4
Adjustment on conversion of S corporation to C corporation - 27.6 15.4
State taxes, net of federal benefit 9.3 1.9 2.1
Valuation allowance 81.9 - -
Other - 1.0 (0.8)
------------ ------------------- ---------------
56.2 % (12.0)% 27.4 %
============ =================== ==============
10. BENEFIT PLANS
Effective November 1, 1999, the Company initiated a new DAOU Systems, Inc.
401(k) Salary Savings Plan (New Plan) which covers employees who meet certain
age and service requirements. Employees may contribute a portion of their
earnings each plan year subject to certain Internal Revenue Service limitations.
This new Plan replaces the former DAOU Systems, Inc. 401(k) Salary Savings Plan.
The Company has various other defined contribution plans under which employees
also participated. Contributions under these plans are made at the sole
discretion of the Company and were $428,000, $471,000 and $397,000 for
1999,1998, and 1997, respectively.
F-18
11. CONTINGENCIES
Gary Colvin, an ex-employee of the Company, filed a lawsuit on February 25, 1997
against the Company and certain of its officers and directors in the U.S.
District Court of the Southern District of California (Colvin v. DAOU Systems,
et al.). The complaint alleged various causes of action, including wrongful
termination, civil rights violations, breach of contract, fraud and violations
of wage & hour laws. On February 9, 1998, the parties stipulated to the
dismissal of the ex-employee's remaining Federal claim under the Fair Labor
Standards Act. As a result, on March 4, 1998, the lawsuit was dismissed without
prejudice after the court declined to exercise supplemental jurisdiction over
the remaining state law claims. On March 31, 1998, the plaintiff re-filed in
state court (Colvin v. DAOU Systems, Inc., et., al.). On March 19, 1999, the
Company received a verdict in its favor on all causes of action. Mr. Colvin has
appealed this verdict, but the state appellate court has not yet set a briefing
schedule or a hearing date.
On September 18, 1997, seven present and/or former employees of the Company
filed a lawsuit in the Superior Court of the State of California for the County
of San Diego, titled Smyth, et al. v. DAOU Systems, Inc. (Case No. 714187),
purporting to represent a class of all present and former DAOU employees
classified as exempt from overtime pay requirements within the preceding three
years. The plaintiffs claim that they and other exempt employees were not
actually exempt under Federal and California law from overtime pay and are
entitled to pay for unpaid overtime and penalties in an unstated amount. The
plaintiffs also claim that, in response to their filing complaints with the
Labor Board for the State of California, they were subjected to retaliatory
discrimination by the Company. In October 1997, the Company successfully removed
the lawsuit to the United States District Court for the Southern District of
California. The plaintiffs' application for class certification was denied by
the court, and one of the seven plaintiffs subsequently dismissed his claim and
withdrew from the lawsuit. Trial is currently scheduled to begin on May 2, 2000.
As of the date of this report, the potential amount of exposure to the Company
from this lawsuit, in the event of an unfavorable outcome, cannot be estimated.
The Company believes that the lawsuit is without merit and intends to defend the
lawsuit vigorously.
On August 24, 1998, August 31, 1998, September 14, 1998 and September 23, 1998,
separate complaints were filed against the Company and certain of its officers
and directors in the United States District Court for the Southern District of
California. A group of shareholders has been appointed the lead plaintiffs and
they filed an amended consolidated complaint on February 24, 1999. The new
complaint realleges the same theory of liability previously asserted, namely the
alleged improper use of the percentage-of-completion accounting method for
revenue recognition. These complaints were brought on behalf of a purported
class of investors in the Company's Common Stock and do not allege specific
damage amounts. In addition, on October 7, 1998 and October 15, 1998, separate
complaints were filed in the Superior Court of San Diego, California. These
additional complaints mirror the allegations set forth in the federal complaints
and assert common law fraud and the violation of certain California statutes. By
stipulation of the parties, the state court litigation has been stayed pending
the resolution of a motion to dismiss that was filed on February 22, 2000 in the
federal litigation. The Company believes that the allegations set forth in all
of the foregoing complaints are without merit and intends to defend against
these allegations vigorously. No assurance as to the outcome of this matter can
be given, however, and an unfavorable resolution of this matter could have a
material adverse effect on the Company's business, results of operations and
financial condition.
F-19
12. DISCLOSURE OF SEGMENT INFORMATION
For the years ended December 31, 1999, 1998 and 1997, the Company has the
following five reportable segments: information technology consulting,
communications infrastructure, applications implementation, integration
services, and outsourcing. Beginning in early 2000, the Company formed Enosus, a
new segment that will offer internet and eCommerce services. The applications
implementation group provides IT consulting resources to hospitals and other
healthcare organizations. The communications infrastructure group installs,
implements and maintains IT infrastructure for healthcare organizations. The
management consulting group focuses on providing senior consultants to assist
healthcare management to plan and meet their business and IT objectives. The
integration services group concentrates on integration of existing healthcare
systems (financial, clinical and management) to reduce overall costs and improve
the quality of care.
The accounting policies used to develop segment information correspond to those
described in the summary of significant accounting policies. The Company manages
segment reporting at a gross margin level. Selling, general and administrative
expenses, and fixed assets are managed at the corporate level separately from
the segments and therefore are not separately allocated to the segments. The
Company's segments are managed on an integrated basis in order to serve clients
by assembling multi-disciplinary teams, which provide comprehensive services
across its principal services.
IT CONSULTING
AND
MANAGED CARE COMMUNICATIONS APPLICATION INTEGRATION
IMPLEMENTATION INFRASTRUCTURE IMPLEMENTATION SERVICES OUTSOURCING TOTAL
--------------- ---------------- --------------- ------------- ------------- -------------
YEAR ENDED DECEMBER 31, 1999
Total revenues $11,353 $23,493 $30,938 $14,166 $23,450 $103,400
Cost of services 6,713 24,854 17,135 8,831 18,394 75,927
--------------- ---------------- --------------- ------------- ------------- -------------
Gross profit $4,640 $(1,361) $13,803 $5,335 $5,056 27,473
=============== ================ =============== ============= =============
Gross profit percent 40.9% -5.8% 44.6% 37.7% 21.6% 26.6%
Sales and marketing 10,398
General and administrative 25,071
Merger and related expenses -
-------------
Loss from operations $(7,996)
-------------
YEAR ENDED DECEMBER 31, 1998
Total revenues $11,161 $44,248 $20,612 $12,897 $15,866 $104,784
Cost of services 6,880 39,415 11,500 7,328 12,898 78,021
--------------- ---------------- --------------- ------------- ------------- -------------
Gross profit $4,281 $4,833 $9,112 $5,569 $2,968 26,763
=============== ================ =============== ============= =============
Gross profit percent 38.4% 10.9% 44.2% 43.2% 18.7% 25.5%
Sales and marketing 12,203
General and administrative 18,456
Merger and related expenses 2,825
-------------
Loss from operations $ (6,721)
-------------
YEAR ENDED DECEMBER 31, 1997
Total revenues $ 6,371 $34,102 $ 9,545 $ 9,462 $9,176 $68,656
Cost of services 3,909 24,468 6,072 4,890 5,815 45,154
--------------- ---------------- --------------- ------------- ------------- -------------
Gross profit $ 2,462 $9,634 $ 3,473 $ 4,572 $3,361 23,502
=============== ================ =============== ============= =============
Gross profit percent 38.6% 28.3% 36.4% 48.3% 36.6% 34.2%
Sales and marketing 7,780
General and administrative 12,425
Merger and related expenses 718
-------------
Income from operations $ 2,579
=============
F-20
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------- ------------- -------------------------------- ----------------- ---------------
COL. A COL. B COL. C COL. D COL. E
- ------------------------------------- ------------- -------------------------------- ----------------- ---------------
Additions
-------------- ----------------- ----------------- ---------------
Balance at Charged to Charged to Other
Beginning Costs Accounts-- Balance at
Description of Period and Expenses Describe Write-offs End of Period
- ------------------------------------- ------------- -------------- ----------------- ----------------- ---------------
Year Ended December 31, 1999:
Allowance for doubtful accounts $956 $1,643 $ - $ 731 $1,868
Year Ended December 31, 1998:
Allowance for doubtful accounts $312 $ 644 $ - $ - $956
Year Ended December 31, 1997:
Allowance for doubtful accounts $310 $ 70 $ - $68 $312
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10: DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information required by this item is included under the captions
entitled "Elections of Directors" and "Information Concerning Directors and
Executive Officers" in the Company's Proxy Statement and is incorporated herein
by reference.
ITEM 11: EXECUTIVE COMPENSATION.
The information required by this item is included under the caption
entitled "Executive Compensation" in the Company's Proxy Statement and is
incorporated herein by reference.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under the caption
entitled "Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement and is incorporated herein by reference.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is included under the caption entitled
"Certain Relationships and Related Transactions " in the Company's Proxy
Statement and is incorporated herein by reference.
29
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following are filed as part of this Report.
(1) Current reports on Form 8-K. No Current reports on Form 8-K were
filed with the Commission during the fourth quarter of the year
ended December 31, 1999.
(b) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1(1) Agreement and Plan of Merger, dated as of January 9, 1997, by
and between the Registrant and DAOU Systems, Inc., a
California corporation.
2.2(2) Agreement and Plan of Merger, dated as of July 8, 1997, by
and among the Registrant, DAOU-Integrex, Inc., a Delaware
corporation and wholly-owned subsidiary of the Registrant,
Integrex Systems Corporation, a Delaware corporation, and the
stockholders of Integrex Systems Corporation.
2.3(+)(3) Agreement and Plan of Merger, dated as of September 25, 1997,
by and among the Registrant, DAOU On-Line, a Delaware
corporation and wholly-owned subsidiary of the Registrant,
On-Line Networking, Inc., a New Jersey corporation, and the
stockholders of On-Line Networking, Inc.
2.4(+)(4) Agreement and Plan of Merger, dated as of March 27, 1998, by
and among the Registrant, DAOU-Synexus, Inc., a Delaware
corporation and wholly-owned subsidiary of the Registrant,
Synexus Incorporated, a Pennsylvania corporation, and the
stockholders of Synexus Incorporated.
2.5(+)(4) Agreement and Plan of Merger, dated as of March 30, 1998, by
and among the Registrant, DAOU-Sentient, Inc., a Delaware
corporation and wholly-owned subsidiary of the Registrant,
Sentient Systems, Inc., a Maryland corporation, and the
stockholders of Sentient Systems, Inc.
2.6(+)(5) Agreement and Plan of Merger, dated as of June 16, 1998, by
and among the Registrant, DAOU-TMI, Inc., a Delaware
corporation and wholly-owned subsidiary of the Registrant,
Technology Management, Inc., an Indiana corporation, and the
stockholders of Technology Management, Inc.
2.7(+)(5) Agreement and Plan of Merger, dated as of June 16, 1998, by
and among the Registrant, DAOU-TMI, Inc., a Delaware
corporation and wholly-owned subsidiary of the Registrant,
International Health Care Systems, Inc., a Florida
corporation, and the stockholders of International Health
Care Systems, Inc.
2.8(+)(6) Agreement and Plan of Merger, dated as of June 26, 1998, by
and among the Registrant, DAOU-RHI, Inc., a Delaware
corporation and wholly-owned subsidiary of the Registrant,
Resources in Healthcare Innovations, Inc., an Indiana
corporation, Healthcare Transition Resources, Inc., an
Indiana corporation, Ultitech Resources Group, Inc., an
Indiana corporation, Innovative Systems Solutions, Inc., an
Indiana corporation, Grand Isle Consulting, Inc., an Indiana
corporation and the shareholders of Resources in Healthcare
Innovations, Inc., Healthcare Transition Resources, Inc.,
Ultitech Resources Group, Inc., Innovative Systems Solutions,
Inc., Grand Isle Consulting, Inc.
3.1(1) Amended and Restated Certificate of Incorporation of the
Registrant.
3.2(1) Bylaws of the Registrant.
4.1 Reference is made to Exhibits 3.1 and 3.2.
4.2(1) Specimen stock certificate.
4.3(1) Investors' Rights Agreement, dated as of October 26, 1995,
between the Registrant and the parties named therein.
4.4(1) Series A Preferred Stock Purchase Warrant No. 1, dated
October 26, 1995, issued to Needham & Company, Inc.
30
4.5(1) Series A Preferred Stock Purchase Warrant No. 2, dated
October 26, 1995, issued to Needham Capital S.B.I.C., L.P.
4.6(10) Certificate of Designations of the Registrant, as filed with
the Secretary of State of the State of Delaware on July 23,
1999.
4.7(10) Registration Rights Agreement, dated as of July 26, 1999, by
and between the Registrant, Galen Partners III, L.P., a
Delaware limited partnership ("GALEN III"), Galen Partners
International III, L.P., a Delaware limited partnership
("GALEN INTERNATIONAL"), and Galen Employee Fund III, L.P., a
Delaware limited partnership ("GALEN EMPLOYEE FUND").
10.1(1) Form of Indemnification Agreement.
10.2(#)(1) DAOU Systems, Inc. 1996 Stock Option Plan, as amended.
10.3(#)(1) Form of Incentive Stock Option Agreement under the 1996 Stock
Option Plan.
10.4(#)(1) Form of Nonstatutory Stock Option Agreement under the 1996
Stock Option Plan.
10.5(#)(1) Employment Agreement, dated as of November 11, 1996, by and
between the Registrant and Robert C. McNeill.
10.6(1) Sublease Agreement, dated as of March 1, 1996, by and between
the Registrant and Adobe Systems Incorporated.
10.7(+)(1) Information Management Agreement, dated as of April 1, 1996,
by and between the Registrant and Candler Health System.
10.8(+)(1) Principal Agreement, dated as of June 18, 1996, by and
between the Registrant and Catholic Medical Center of
Brooklyn & Queens, Inc.
10.9(+)(1) Principal Agreement, dated as of June 29, 1995, by and
between the Registrant and Mercy Health Services.
10.10(+)(1) Master Agreement, dated as of June 4, 1996, by and between
the Registrant and Atlantic Health System.
10.11(1) Form of Master Services Agreement.
10.12(*)(7) Information Management Agreement, dated as of January 1,
1999, by and between the Registrant and Saint Mary's Health
Network.
10.13(8) Consulting Agreement, dated as of March 15, 1999, by and
between the Registrant and Larry D. Grandia.
10.14(9) Employment Agreement, dated as of June 15, 1999, by and
between the Registrant and Larry D. Grandia.
10.15(9) Loan and Security Agreement, dated as of June 29, 1999, by
and among the Registrant, DAOU-Sentient, Inc., DAOU-RHI,
Inc., DAOU-TMI, Inc., DAOU-Synexus, Inc. and HCFP Funding,
Inc.
10.16(9) Revolving Credit Note, dated as of June 29, 1999, issued to
HCFP Funding, Inc. by the Registrant, DAOU-Sentient, Inc.,
DAOU-RHI, Inc., DAOU-TMI, Inc. and DAOU-Synexus, Inc.
10.17(10) Voting Agreement, dated as of July 26, 1999, by and among the
Registrant, Daniel J. Daou, Georges J. Daou, Galen III, Galen
International and Galen Employee Fund.
10.18(10) Series A Preferred Stock Purchase Agreement, dated as of July
26, 1999, by and among the Registrant, Galen III, Galen
International and Galen Employee Fund.
10.19(11) Letter Agreement to Separation and Release Agreement and
Consulting Agreement, dated as of July 26, 1999, by and
between the Registrant and Daniel J. Daou.
10.20(11) Separation and Release Agreement, dated as of July 2, 1999,
by and between the Registrant and Frederick C. McGee.
10.21(11) Employment Agreement, dated as of September 8, 1999, by and
between the Registrant and Donald R. Myll.
10.22 Separation Agreement and General Release, dated as of October
4, 1999, by and between the Registrant and Robert McNeill.
31
21 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, independent auditors.
23.2 Consent of Deloitte & Touche LLP, independent auditors.
24 Power of Attorney (included on the signature page to this
report).
27 Financial Data Schedule.
(+) Confidential treatment has been granted with respect to certain
portions of this exhibit.
(*) Confidential treatment has been requested with respect to certain
portions of this exhibit.
(#) Identifies a management contract or compensatory plan or arrangement
of the Registrant.
(1) Incorporated by reference to the similarly described exhibit included
with the Registrant's Registration Statement on Form SB-2, File No.
333-18155, declared effective by the Commission on February 12, 1997.
(2) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on July 18, 1997.
(3) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on October 29, 1997.
(4) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on April 14, 1998.
(5) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on July 10, 1998.
(6) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on August 7, 1998.
(7) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on January 15, 1999.
(8) Incorporated by reference to the similarly described exhibit included
with the Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999, filed with the Commission on May 17, 1999.
(9) Incorporated by reference to the similarly described exhibit included
with the Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1999, filed with the Commission on August 16, 1999.
(10) Incorporated by reference to the similarly described exhibit included
with the Registrant's Current Report on Form 8-K, filed with the
Commission on July 29, 1999.
(11) Incorporated by reference to the similarly described exhibit included
with the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1999, filed with the Commission on November 15,
1999.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 28, 2000
. DAOU SYSTEMS, INC.
By: /s/ Larry D. Grandia
-----------------------
Larry D. Grandia
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Larry D. Grandia and Donald R. Myll,
jointly and severally, as his or her attorney-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this report and to file the same, with exhibits thereto and other documents
in connection therewith, with the Commission, hereby ratifying and confirming
all that each of said attorneys-in-fact, or his substitute or substitutes, may
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ----------------------------- ------------------------------------------------- -------------------
/s/ Georges J. Daou Chairman of the Board March 28, 2000
- -----------------------------
Georges J. Daou
/s/ Larry D. Grandia President and Chief Executive Officer
- ----------------------------- (Principal Executive Officer) March 28, 2000
Larry D. Grandia
/s/ Donald R. Myll Executive Vice President, March 28, 2000
- ----------------------------- Chief Financial Officer and Secretary
Donald R. Myll (Principal Financial and Accounting Officer)
/s/ Richard B. Jaffe Director March 28, 2000
- -----------------------------
Richard B. Jaffe
/s/ David W. Jahns Director March 28, 2000
- -----------------------------
David W. Jahns
/s/ Kevin M. Fickenscher, M.D. Director March 28, 2000
- -----------------------------
Kevin M. Fickenscher, M.D.
/s/ John H. Moragne Director March 28, 2000
- -----------------------------
John H. Moragne
33